Final answer:
The integral theory approach treats each interim period as part of the annual period with consistent accounting practices. Discrete theory views each interim period separately, recognizing revenues and expenses strictly connected to that period, which can cause periodic fluctuations in financial results.
Step-by-step explanation:
The integral theory approach to preparing interim financial reports involves a continuous view of financial activities, meaning that each interim period is treated as an integral part of the annual reporting period. With this approach, companies attempt to apply the same accounting principles and practices as if the interim period were a shorter segment of the annual accounting period. For example, a company would allocate annual expenses like depreciation evenly across all interim periods, regardless of seasonal fluctuations.
In contrast, the discrete theory approach views each interim period as an independent reporting period. Companies adopting this approach might only recognize expenses or revenues that are directly attributable to that specific interim period, which could lead to income fluctuations. For instance, a retailer that earns a significant portion of its revenue during the holiday season might report higher earnings in the last quarter compared to other quarters.
Understanding the difference between these theories is important for analysts and investors to interpret financial data correctly during interim periods. While integral theory smoothens out financial results, discrete theory can result in more volatility in reported earnings due to seasonal or periodic factors.