Your financial statements are key to showing the state and solvency of your business. When you need to borrow money, look for investors for expansion, or take your company public, your financial statements and accounting methods will be reviewed. An accurate view of your company’s numbers is critical for lenders and investors in determining whether your business is “worth the risk,” so to speak.

Many times, a lender or investor will want a client’s financial statements to be audited, showing the internal controls as well as whether generally accepted accounting principles (GAAP) have been used. One aspect auditors look for is the Consistency Principle in order to compare results from period to period. If you aren’t familiar with this principle and why it is important, in this article our CPAs break it down, explain the advantages of using it, give reasons for its importance, and provide some examples.

Defining the Consistency Principle

Simply put, the Consistency Principle means that once your organization, or, more specifically, your bookkeeper or accounting department, adopts an accounting principle or method of documenting and reporting information, that method has to be used consistently moving forward. This applies to the line items on your financial statements, including things like:

  • Cash flow statements
  • Balance sheets
  • Profit & loss statements
  • Accounts payable/accounts receivable reports

Relying on a consistent accounting method ensures that statements and information will be comparable, and it will be easier to see trends and extract accurate information.

Only when a principle or method has a new version that improves reported financial results should you change. In the event of a change, be sure to fully document its effects and include the documentation in the notes that accompany the financial statements.

The Importance of the Consistency Principle

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. Regardless of the industry, consistency creates ease in the preparation of accounts.

Accounting policies and assumptions should be followed continuously from year to year in order for accountants and users of the financial statements to have clarity and avoid confusion. The Consistency Principle is important from both the accounting and auditing perspectives. For accountants, it provides a solid framework to record business transactions easily. For auditors, it assists in comparing financial statements with the previous year.

Advantages of the Consistency Principle

As a business owner, following the Consistency Principle offers several specific advantages:

  • Ease of auditing by a third party. Consistency helps accountants record the accounting transactions and work with the accounts. It helps the auditors compare the financial statements and provides the basis for the reliability of financial statements. In fact, often auditors refuse to provide an analysis if the Consistent Principle hasn’t been followed.
  • Saves time. Instead of trying to learn and train in different ways, you and your accounting team know one, consistent way to report data.
  • Track patterns and trends. As a business owner, it is important to be able to track patterns and trends in your finances. When there is no set way of reporting and recording the information, you may miss these.

Challenges of the Consistency Principle

In theory, maintaining consistent accounting and bookkeeping methods shouldn’t be a problem. However, the disconnect is most likely to happen in two scenarios:

High Turnover or Relying on Different Bookkeepers

When you have several different people recording data, compiling reports, and performing other financial documentation, the Consistency Principle is seldom followed. You need a set method in place internally or to rely on an accounting firm who follows consistent policies and procedures in order to ensure GAAP is followed.

Intentionally Shifting Reporting to Show an Advantage

In some cases, organizations will change how they report information in order to take advantage of loopholes or manipulate how data looks.

Examples of Consistency in Accounting Methods

To get a look at the Consistency Principle, let’s take a look at two main methods of reporting account inventory and the cost of goods sold.

First-in, First-out (FIFO)

This is a cost flow assumption in which oldest costs of inventory (which are often the lowest) will be the first removed from a balance sheet account inventory, and the most recent costs (which are often the highest) will remain in inventory and reported on the balance sheet. For example, a company had 30 units of Product A on hand at $10 per unit in January, then bought an additional 50 units at $15 per unit. When they sell, 40 units, they will record 30 sales at $10 and 10 sales at $15, leaving a cost of inventory of 40 units at $15. This method often shows a higher net income.

Last-in, First-out (LIFO)

This is a cost flow assumption in which the most recent costs of products are the first to come out of inventory so the oldest costs stay in. For example, a company had 30 units of Product A on hand at $10 per unit in January, then bought an additional 50 units at $15 per unit. When they sell, 40 units, they will record 40 sales at $15, leaving a cost of inventory of 10 units at $15 and 30 at $10. This method often shows a lower net income which can be beneficial to minimize taxes.

A business can choose either of these methods, and can even make a one-time change between the two. However, a business can’t report based on LIFO one year to pay less in taxes, then the next year shift to FIFO to show a higher net income and be more attractive to investors, then go back to LIFO the following. Doing so makes it impossible to analyze trends in financial statements and provide a proper audit.

Schedule a Business Accounting Consultation

Our CPAs offer the services you need to ensure consistent accounting practices in your business. From bookkeeping that is highly accurate and can work with you on a monthly, quarterly, or annual basis to financial statement preparation, we’re here to support you however we can. If you do need a third party audit for your statement, we can provide those services too. With our range of comprehensive accounting services for businesses, you can get customized accounting for your organization. We serve Raleigh, Durham, Wake Forest, Wilson, Garner, Cary, and surrounding communities. Schedule a consultation today by calling us at  (919) 872-0866 or filling out the form below to get started.

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