What is Consistency Principle?
The Consistency Principle, in its simplest form, states that once your company, or more particularly, your bookkeeper, or accounting department, chooses a certain accounting principle or technique of recording and reporting information, that approach must be applied consistently going forward.
Why do we use the consistency principle?
The financial accounts should be similar from one period to the next, which is the main goal of the consistency principle. It is anticipated that the accounting rules employed last year will be followed this year because consistency is one of the sore accounting assumptions and there is no documentation to the contrary. No matter the industry, uniformity makes account preparation simple.
To provide clarity and prevent misunderstanding for accountants and readers of the financial statements, accounting policies and assumptions should be followed consistently from year to year. Both the accounting and auditing fields benefit from the consistency principle. It offers a strong foundation for accountants to quickly record company transactions. It helps auditors compare financial statements with those from the prior year.
The advantages of the consistency principle
Comparable financial information:
The financial reports will have a comparable structure if a consistent accounting system is used from one accounting period to the next. This enables comparing the success of the company across many fiscal years simpler for bankers, manager, creditors and other stakeholders.
Familiarisation:
Cost and time saving are possible with a consistent accounting approach. Managers and accountants will acquire accustomed to the accounting approach, and if you are consistent, you will just need to do the initial training for this method.
Auditors:
Auditors are independent persons with the training to verify that the accounting information given by a business. Following the consistency principle, auditors will request justification for any changes that can influence how financial statements of corporation are interpreted.
Examples of Consistency in Accounting Method
To get a look at the Consistency Principle, let’s look at two main methods of reporting account inventory and the cost of good sold.
First-in, First-out (FIFO)
This cost flow assumption states that the most recent expenses, which are frequently the highest, will remain in inventory and be recorded on the balance sheet while the oldest costs of inventory, which are frequently the lowest, will be first withdrawn. For instance, a business purchased an extra 50 units at RM15 each after having 30 units of Product A on hand in January at a cost of RM10 each. When 40 units are sold, the company will note 30 sales at RM10 and 10 sales at RM15, leaving the cost of invent
Last-in, First-out (LIFO)
According to this cost flow assumption, items most recent expenses are the first to leave inventory while their oldest costs remain there. For instance, a business purchased an extra 50 units at RM15 each after having 30 units of Product A on hand on January at a cost of RM 10 each. When 40 units are sold, they will record 40 sales at RM 15, leaving an inventory cost of 10 units of RM 15 and 30 units at RM 10. This approach frequently results in a smaller net income, which can help to reduce taxes.
The company may select one of these approached and may even switch between them once. However, a company cannot report using LIFO one year in order to pay fewer taxes, then switch to FIFO the next year in order to show a greater net income and be more appealing to investors, then return to LIFO the year after that. It is hard to conduct a competent audit and assess patterns in financial accounts if this is done.
When a company’s managers attempt to record greater revenue or profits than would be permitted by a precise interpretation of the accounting rules, the consistency principle is most commonly disregarded. When the underlying corporate operational actively levels remain constant, but earnings grow abruptly, this is a revealing sign of the situation.
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