Last editedDec 20222 min read
Financial statements are the backbone of a company’s accounting records. Before you take out a loan, find investors, or prepare your taxes, you’ll need to make sure that these statements are complete and accurate. The consistency principle is a term you might come across if your financial statements are ever audited, making it an important one to know. So, what is the consistency principle in accounting, and why is it important? Here’s what every business owner should know.
What is the consistency principle in accounting?
There are numerous accounting methods for businesses to choose from, provided they’re included in the generally accepted accounting principles (GAAP). The consistency principle states that once a business chooses one accounting method, this method should be used consistently going forward. For example, if you use the cash basis of accounting this should be applied to your cash flow statement, balance sheet, and income statement. It should also be used as you draw up your accounts payable and receivable reports, both now and in the future. You can’t use the accrual basis for your balance sheet and the cash basis for your cash flow statement. This would be inconsistent and violate the consistency principle.
The accounting principle of consistency simply ensures that all financial records use the same methodology for greater accuracy and clarity. It’s important to auditors who need comparable results from one accounting period to the next. If your financial statements violate the consistency principle, the auditor may refuse to give an opinion.
What is a consistency concept in accounting example?
We’ve given one consistency concept in accounting example above with the case of cash vs accrual methods. A second comparison would be between the First-In, First Out (FIFO) method and the Last-in, First-out (LIFO) methods of reporting inventory.
With FIFO, the oldest inventory costs are removed from the balance sheet first. More recent costs remain on the balance sheet. By contrast, with LIFO, the more recent costs of products come out of your inventory first, leaving the older costs on the balance sheet. To record the cost of goods sold, a business needs to choose either FIFO or LIFO. There are benefits to each method; typically reporting based on LIFO results in lower taxes due to a lower net income, while FIFO shows a higher net income. If a business reports using LIFO one year to reduce its tax bill, it can’t switch to FIFO the next to attract investors. This makes trend analysis impossible due to the inconsistency.
Accounting principle of consistency advantages
There are multiple advantages to following the consistency principle.
It makes auditing easier with a clear methodology between accounting periods and financial statements. Auditors might refuse to provide an opinion if this principle isn’t followed due to the inherent risk and volatility.
It helps your business track trends over time. You’ll need consistency between accounts to track trends accurately, or the data becomes meaningless.
It saves time for your accounting team. Whether you use accounting software like Xero or simply rely on manual spreadsheets, you’ll know which method to use when reporting data.
Accounting principle of consistency challenges
At the same time, there are some challenges to keep in mind when looking at the consistency principle. Sometimes this is easier said than done, particularly if you rely on different bookkeepers. If you employ one person to record your financial data and another to pull together reports, you’ll need to make sure they follow the same accounting methods. Automating your transactions and accounting processes can help ensure consistency across all accounts. For example, GoCardless integrates with multiple accounting partners to ensure that payments, invoices, and accounts match across all systems. This helps give a strong foundation to your bookkeeping team.
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GoCardless is a global payments solution that helps you automate payment collection, cutting down on the amount of financial admin your team needs to deal with. Find out how GoCardless can help you with one-off or recurring payments.