Definition and explanation
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.
A company can change its accounting methods and policies only and only if there are one or more reasonable grounds to do so and the change reflects a more accurate picture of financial performance and position of the business in company’s financial statements.
LMN CO calculated depreciation on its fixed assets by using straight line method in YEAR 1, reducing balance method in YEAR 2 and again straight line method in YEAR 3. The Company appointed new auditors in YEAR 4 who noted that the consistency principle of accounting was not being followed and the arbitrary change did not contribute any positive change in financial statements of the company. Further, it resulted in incorrect calculation of depreciation which constituted the fixed assets being carried at incorrect amounts in the balance sheet of the company.
Change in accounting policies and methods
The consistency principle does not prohibit companies to change their accounting policies and methods. 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 so adopted more clearly reflects the business through financial statements. The change so applied must be supported by credible reasons and must also be disclosed in the notes to the financial statements along with the date of change, appropriate reasons for change and the date from which the change will take place.
In a board meeting, the PQR company decided to change its accounting methods of recording revenue from when the customers actually receive the goods to when the goods are dispatched to the customers, the reason for doing so was a truer representation of sales of the company as many customers were from varying cities which resulted in about 35% of sales being recorded with a delay of 2-5 days. The change would improve the sales representation of PQR during a particular financial year and present a truer picture of business of PQR. PQR also documented the change in notes to the financial statements along with date of change, reason of change and date from which the change would take place.
Importance/advantages of consistency principle
There are a number of reasons why the consistency principle of accounting is given much importance in the accounting profession. Following are some of the major reasons:
The auditors give due attention to the consistency principle while auditing financial statements of companies and demand reasons when it is not followed by the company’s management.
2. Ease for management:
When accounting methods for recording similar transactions and events are consistently applied, it provides management ease as they become familiar with the recording procedures and accounting terminologies used during recording.
3. Cost efficiency:
It helps in reducing overall costs of an organization as only initial cost of training is incurred at the time of adopting particular accounting methods and policies.
4. Comparable financial information:
When accounting methods are consistently applied from one financial period to another, it results in financial reports of similar structure of different accounting periods. This helps stakeholders in comparing the financial performance of company with relative ease.