What Is an Accounting Period and Its Common Types?

An accounting period is the specific interval of time covered by a company’s financial statements. This timeframe allows a business to report its financial activities consistently, creating a reliable basis for comparing performance over time. This consistency provides valuable insights for stakeholders, such as investors, lenders, and internal management, who rely on these reports to make informed decisions.

Common Types of Accounting Periods

The most prevalent type of accounting period is the calendar year, which runs for 12 consecutive months from January 1 to December 31. Its widespread use stems from its simplicity and direct alignment with the individual tax year. For many businesses, adopting the calendar year is a straightforward approach, as it simplifies record-keeping by matching the business’s reporting cycle with the owner’s personal tax obligations.

A business may instead select a fiscal year, which is a 12-month period that ends on the last day of a month other than December. For example, a company could have a fiscal year that runs from July 1 to June 30. A variation is the 52-53-week year, where the accounting period is defined as 52 or 53 weeks and always ends on the same day of the week. This method is often used by retail and manufacturing companies to ensure that sales periods are comparable from one year to the next without being distorted by the number of weekends in a month.

In certain circumstances, a business will use a short period, which is an accounting period of less than 12 months. This occurs when a company first begins operations and adopts a year-end partway through the year. A short period is also necessary in a company’s final year if it ceases to exist before its established tax year. Another reason for a short period is when a business changes its accounting period, creating a transitional timeframe.

Selecting Your Business’s Accounting Period

A significant consideration is the natural business year. This approach involves selecting a year-end that coincides with the lowest point of business activity, which typically follows the busiest season. For instance, a retail company that generates most of its revenue during the holiday season might choose a January 31 year-end. This allows for post-holiday sales and inventory counts to be completed before closing the books.

The business’s legal structure also plays a role in determining its accounting period. Sole proprietorships are generally required to use a calendar year because the business is not legally separate from its owner. S corporations and partnerships are also typically required by the IRS to use a calendar year. These entities can adopt a fiscal year only if they demonstrate a valid business purpose, such as a natural business year. C corporations, however, have more flexibility and can choose either a calendar or a fiscal year upon formation.

Adopting an accounting period happens when the business files its first federal income tax return. This initial filing establishes the company’s tax year, and it must be used consistently in subsequent years. Aligning the accounting period with operational cycles or industry norms from the outset can simplify financial management.

Changing an Established Accounting Period

Once a business has established its accounting period, it cannot be changed arbitrarily. Altering a tax year, such as switching from a calendar year to a fiscal year, generally requires obtaining permission from the IRS. This process is initiated by filing Form 1128, Application to Adopt, Change, or Retain a Tax Year. The form must be filed by the due date of the tax return for the short period required to make the change.

To gain approval, the business must provide a substantial business purpose for making the change. The IRS wants to ensure the change is not being made primarily to defer or reduce tax liability. A valid business purpose could include aligning the company’s tax year with its natural business year or changing to the tax year of a new parent company after an acquisition. Some changes may qualify for automatic approval if specific conditions are met, but many businesses will need to await a formal ruling from the IRS.