What is the Consistency Principle?

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What is the consistency principle in accounting?

In the event of a change, be sure to fully document its effects and include the documentation in the notes that accompany the financial statements. single entry system – what is it Let’s assume that a U.S. corporation uses the FIFO cost flow assumption for valuing its inventory and determining its cost of goods sold. Due to the increasing cost of its materials, it concludes that LIFO will better indicate the company’s true profit.

Improvement in Accounting Practices

• Consistency also allows users to make meaningful comparisons between financial statements from different periods, helping them to better understand an entity’s financial performance and make informed decisions.
• To ensure consistent financial reporting, businesses should document their accounting policies and methods.
• When entities use consistent accounting methods and principles, users can more easily identify trends, changes, and anomalies in an entity’s financial position and performance.
• There are several accounting principles or concepts that a business can follow or must follow to comply with regulatory instructions.
• Each method has a slightly different outcome depending on what management is trying to accomplish.
• Entities must ensure that they apply accounting standards consistently and in a manner that accurately reflects the economic substance of transactions and events.
• If ABC Retailers makes this change without a valid reason or proper explanation, it goes against the Consistency Principle.

Although the consistency principle doesn’t compel businesses to choose from any accounting methods, it holds stress on a consistent approach. The consistency principle of accounting states that a company should use the same accounting policies and methods for recording similar events or transactions from one financial period to another. It is necessary that a company consistently apply its accounting methods and policies from one financial year to another. When a business uses the same accounting methods and principles consistently, stakeholders can clearly understand how the company’s financial results are derived. All accounting policies or accounting assumptions are to be followed consistently to compare financial statements easily.

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• In fact, companies are free to change their accounting policies and methods if there are one or more logical reasons to do so, and the change more clearly reflects the business through financial statements.
• Consistency concept is important because of the need for comparability, that is, it enables investors and other users of financial statements to easily and correctly compare the financial statements of a company.
• For example, a company can adopt different accounting methods or policies if they reflect a more accurate picture of its business, performance, and financial position through its financial statements.
• In addition, the consistency principle of accounting calls for a consistent accounting method or policy for an entity.
• The consistency principle states that once you decide on an accounting method or principle to use in your business, you need to stick with and follow this method or principle consistently throughout your accounting periods.
• If a company changed accounting treatment for its accounts receivable every single year, it would be difficult to compare the prior years’ accounts receivable balances with the current year.

For auditors, it assists in comparing financial statements with the previous year. Auditors are especially concerned that their clients follow the consistency principle, so that the results reported from period to period are comparable. This means that some audit activities will include discussions of consistency issues with the management team.

Ease for management:

In the year of the change from FIFO to LIFO (and in years when comparisons are presented), the company must disclose the break in consistency. But, the company subsequently wants to change its accounting policies from a straight line to a declining balance. Moreover, the consistency principle helps entities profit and loss statement to identify errors and omissions in financial statements, enabling them to correct any inaccuracies before the financial statements are released to users. In addition to promoting comparability and accuracy in financial reporting, the consistency principle also promotes transparency in accounting.

Changes can be made to improve work of accounting, but an appropriate note must be given which explains about change made. In these notes, businesses will need to clearly lay out what changes took place, the date the change was made, and the effect this change had on their financial reports. To get a look at the Consistency Principle, let’s take a look at two main methods of reporting account inventory and the cost of goods sold. The company can calculate its inventory in two ways with the LIFO or the FIFO methods. The use of the same methods, for the same items, either from period to period within a reporting entity or in a single period across entities.

If ABC Retailers makes this change without a valid reason or proper explanation, it goes against the Consistency Principle. For example, if the performance is based on Net Sales, management might not recognize revenues by using the same accounting policies. Accounting standards do not say that business should adhere to the principle of consistency in every case.

What is the consistency principle?

When you need to borrow money, look for investors for expansion, or take your company public, your financial statements and your third stimulus check can be seized here’s what to know accounting methods will be reviewed. An accurate view of your company’s numbers is critical for lenders and investors in determining whether your business is “worth the risk,” so to speak. For instance, if a business opts to use FIFO or LIFO method for its inventory management, it needs to use the same method consistently. Similarly, depreciation of assets follows different approaches from accountants like straight line or WDV method. Thus, a company using the same accounting principles from year to year is an application of consistency principle.