Consistency principle definition

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  1. When doing your accounting, there are a number of different methods or principles that accountants can use.
  2. As discussed in Note X to the financial statements, the 20X2 financial statements have been restated to correct a misstatement.
  3. A second comparison would be between the First-In, First Out (FIFO) method and the Last-in, First-out (LIFO) methods of reporting inventory.
  4. The federal government began working with professional accounting groups to establish standards and practices for consistent and accurate financial reporting.

For example, if a business uses the straight-line method for Depreciation on its motor vehicles in 2015 but changes it to the declining balance method for next year, accounts of these two years will not be comparable. In this case, the entity should apply with IAS 8 whether it is a retrospective or prospective change. All of the change requires full disclosure in the financial statements and how the change is affected. Overall, the consistency principle is important in accounting because it promotes accuracy, comparability, transparency, and reliability in financial reporting.

A second comparison would be between the First-In, First Out (FIFO) method and the Last-in, First-out (LIFO) methods of reporting inventory. – Ed’s Lakeshore Real Estate buys software licenses for its property listing programs every year. Ed’s capitalizes these licenses and amortizes them in the years he doesn’t need a deduction and he expenses them in the years that he needs a tax deduction. This violates the because Ed uses different accounting treatments for the same or similar transactions over time.

As an example of a clearly immaterial item, you may have prepaid $100 of rent on a post office box that covers the next six months; under the matching principle, you should charge the rent to expense over six months. However, the amount of the expense is so small that no reader of the financial statements will be misled if you charge the entire $100 to expense in the current period, rather than spreading it over the usage period. In fact, if the financial statements are rounded to the nearest thousand or million dollars, this transaction would not alter the financial statements at all. 6 “Change in reporting entity” is a change that results in financial statements that, in effect, are those of a different reporting entity. This isn’t to say that companies can’t ever change their accounting methods. One of the key principles of these standards is the GAAP consistency principle.

Why do we use the Consistency Principle?

The concept of accounting consistency refers to the principle that companies should use the same accounting methods to record similar transactions over time. In other words, companies shouldn’t bounce between accounting rules and treatments to manipulate profits or other financial statement elements. Auditors are especially concerned that their clients are reporting the financial statements following the stale dated checks. This makes the results from period to period comparable for the users of those financial statements including investors and creditors.

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The lower cost of goods sold recognized allows the company to show a higher net income than if it used LIFO. For instance, LIFO raises cost of goods sold expense because higher value inventory is sold off first. Companies in high tax brackets often use LIFO to decrease their taxable income.

What Is the Consistency Principle

This means that both ratio analysis and trend analysis wouldn’t be available for investors and creditors to help gauge the company’s current performance. GAAP does allow companies to change accounting treatments when it is reasonable and justifiable. Companies are not allowed to change from one method to another in a current year then back to the previous method the following year. Accountants are encouraged to use a consistent accounting method from year to year in order to prevent manipulation of financial statements, and so that the business reports are accurate and depict comparable information.

For accountants, it provides a solid framework to record business transactions easily. For auditors, it assists in comparing financial statements with the previous year. With FIFO, the oldest inventory costs are removed from the balance sheet first. By contrast, with LIFO, the more recent costs of products come out of your inventory first, leaving the older costs on the balance sheet.

In short, GAAP is designed to ensure a consistent presentation of financial statements, making it easier for people to read and comprehend the information contained in the statements. This type of back and forth causes the financial statements to be incomparable and useless for trend analysis. Companies can change from using LIFO to FIFO or vise versa and still be in agreement with the consistency principle.

The CEO and CFO were basing revenues and asset values on opinions and guesses, it turned out. The materiality principle is especially important when deciding whether a transaction should be recorded as part of the closing process, since eliminating some transactions can significantly reduce the amount of time required to issue financial statements. It is useful to discuss with the company’s auditors what constitutes a material item, so that there will be no issues with these items when the financial statements are audited.

Accounting Consistency

Doing so makes it impossible to analyze trends in financial statements and provide a proper audit. The primary reason for the Consistency Principle is to make the financial statements comparable from period to period. As consistency is one of the fundamental accounting assumptions unless there is documentation supporting a change, it is assumed that the accounting policies used last year are followed in the current year.

This standard clarifies that the auditor’s evaluation of consistency should encompass previously issued financial statements for the relevant periods. It is highly discouraged that a company uses one accounting method in the current period, a different method in the next period and so on. The consistency principle requires that companies have a consistent set of policies and standards that are used while preparing the financial statements.