Consistency principle of accounting

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.

Companies can change their accounting methods or policies only on reasonable grounds. 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.

Example 1

WASA Company calculated depreciation on its fixed assets using the straight line method in Year 1, the reducing balance method in Year 2, and the straight line method again in Year 3. The company appointed new auditors in Year 4, who noted that the company did not follow the consistency principle and that the change did not contribute anything positive to its financial statements. Further, the arbitrary change caused an incorrect computation of depreciation on fixed assets and carried them on the balance sheet at incorrect amounts.

Change in accounting policies and methods

The consistency principle does not prohibit companies from changing 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 more clearly reflects the business through financial statements. Moreover, the change must also be disclosed in the notes to the financial statements, along with the date of the change suggested, appropriate reasons for the change, and the date from which the change would take place.

Example 2

PQR Company decided to change its accounting methods of recording revenue from when customers receive the goods to when goods are dispatched to them. The reason for doing so was a truer representation of sales as many customers were from varying cities, which resulted in about 35% of sales being recorded with a delay of 2 to 5 days. The change would improve the representation of the company’s sales during a given accounting period. The company also documented the change in notes to its financial statements, along with the date of change, reason for the change, and date from which the change would become effective.

Importance/advantages of consistency principle

The consistency principle is of significant importance in the accounting profession for a number of reasons. Some major reasons are listed below:

1. Audit:

While auditing the companies’ financial statements, auditors pay special attention to the consistency principle of accounting. If they find that a company does not follow this principle, they ask management for the reason.

2. Ease for management:

When the same accounting methods and policies are consistently applied to record transactions over a number of periods, management and accounting personnel become familiar with the relevant accounting terminology and recording procedures. It creates ease in recording business transactions and saves a lot of time.

3. Cost efficiency:

The consistency principle helps organizations reduce their overall costs because they need to incur the training cost only once when they decide to adopt a specific set of accounting methods and policies.

4. Comparable financial information:

The consistent application of a particular set of accounting methods and policies results in financial reports with a similar structure for multiple consecutive accounting periods. This helps stakeholders easily compare their company’s financial performance over multiple periods.