The Consistency Principle in Accounting

Financial accounting rests on two pillars of recording and summarizing the accounting records. These accounting records from registering in a ledger to analyzing and interpretation must follow some rules. Without following rules the data presented and evaluated would be null and void. There are several accounting principles or concepts that a business can follow or must follow to comply with regulatory instructions. Perhaps, the simplest of the accounting principles is the consistency principle.

What is Consistency Principle in Accounting?

The principle of consistency means that:

 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. According to ACCA.

Basically, the convention of consistency refers to consistent use of accounting principles in a company or business entity. Typically, in the balance sheet of each entity, it contains several assets and liabilities. These items can be recorded in different ways. Valuation and recording methods for these items will directly affect the balance sheet and profit and loss statements. In fact, it will eventually affect all financial statements including cash flow and statement of equity. Some assets directly affecting profits such as inventory will require a uniform valuation treatment.

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. This is because such company applies both accounting estimate as well as its accounting policy consistently.

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In addition, the consistency principle of accounting calls for a consistent accounting method or policy for an entity. Without a consistent approach, the financial results would be meaningless and could be easily manipulated. For example, any cost accountant would adjust the asset depreciation to adjust the period profits showing unrealistic profitability.

Apart from recording, the other half of accounting practice summarizing is equally important too. If the business does not follow the consistency principle, it will not be able to summarize its financial performance consistently. Financial accounts’ summary i.e. the financial statements would represent meaningless data without a useful comparison. Comparing financial data from one accounting period to another or an industry-standard provides a realistic picture of the entity’s financial performance. Thus, without a consistent approach is accounting principles, the summary of accounts would provide meaningless information. Consistent use of one accounting practice also eliminates irregularities and restricts anomalies.

Benefits of the Consistency Principle

Accounting information or precisely financial statements are prepared for many users like management, auditors, government, public, and most importantly shareholders. All accounting principles combined play an important role in providing useful financial information to these stakeholders. The consistency principle of accounting also offers a valuable contribution to all stakeholders:

  1. This principle helps in preparing consistent and uniform accounting records
  2. It avoids accounting manipulation tricks used by accountants to present unrealistic and favorable financial statements
  3. This principle also offers great control over asset valuation methods such as treating inventory and depreciation of assets
  4. It helps in preparing useful financial information that can be compared within the entity over the accounting periods or in comparison with industry trends
  5. Shareholders can interpret financial information easily and feel the reliability of the information presented
  6. It improves audit performance by following consistent accounting principles
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Example

Let us understand how the consistency principle helps in maintaining accurate records with an example.

Suppose Green Horizon deals in electronics sales. It purchases different units monthly to maintain its inventory. For one accounting period its records for inventory purchases are as:

MonthUnits purchasedAmount in $
January10010,000
February10010,000
March10011,000
April15016,500
May15018,150
June15018,150

Green horizon acquired a total of 750 units for 06 months. Let us assume that Green horizon sold 500 units. The company can calculate its inventory in two ways with the LIFO or the FIFO methods.

FIFO Method:

200 × 100 = 20,000 + 250 × 110 = 27,500 + 50 × 121 = 6,050

Total cost of inventory= $ 53,550

LIFO Method:

300 × 121 = 36,300 + 200 × 110 = 22,000

Total cost of inventory= $ 58,300

If the company Green Horizon uses the FIFO method in one accounting period and the LIFO method in the next period, the financial statements will represent false results. In other words, financial accounting information will be inconsistent. As we can see the selection of inventory valuation methods offered different results, which affect the cost of goods sold and revenue directly. Although the consistency principle doesn’t compel businesses to choose from any accounting methods, it holds stress on a consistent approach.

In a complex and large business, the selection of accounting principles such as inventory costing methods can put huge effects on financial results. On the flip side, cost accountants can also use the lack of consistency to showcase favorable accounting results and increased profits. The practical implications of not following the consistency principle can be calamitous for the company. The company may face auditing and compliance irregularity penalties. The competition’s commissions such as SEC can also interpret such moves as artificial profit manipulation and result in penalties.

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Important Considerations with the Accounting Consistency Principle

  • The company may change its accounting principles and opt for efficient accounting practices over time. It can improve a company’s accounting standards reliability and relevance to updated compliance rules.
  • The company needs to disclose to all its stakeholders about its accounting principles adopted and any changes in accounting principles.
  • If the company does not follow the consistency principle the financial performance comparisons with previous company records or industry standards cannot be deemed useful

Conclusion

The consistency principle of accounting is not a standalone practice; it is used in conjunction with other accounting principles. This principle should not be considered a hindrance to accounting standard improvements. The prominent feature of the consistency principle demands to adapt and comply with a consistent accounting approach for a specific accounting period. However, when regulatory authorities update accounting standards, such as new regulations from GAAP or ISA the business must comply with these updates. After completion of one accounting period, the company may adopt to other accounting methods provided they inform all the stakeholders about the change. Modern economic conditions have become rapidly changing and fiercely competitive. Thus, the performance comparison within (Intra-business) and outside (Inter-business) have gained even more importance. Without a consistent accounting approach these comparisons cannot provide useful information.

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