What is the Consistency Principle?

//What is the Consistency Principle?
What is the Consistency Principle? 2017-10-02T02:47:00+00:00

Definition: The consistency principle is an accounting concept that requires the same method of accounting be used from one period to the next. The main purpose of this principle is to keep the financial statements comparable from year to year.

What Does Consistency Principle Mean?

External users need to be able to evaluate trends and compare financial data from year to year when they are making their business decisions. If companies change their major accounting methods and practices every year, none of their statements will be comparable because the company’s activities will be measured in different ways each year.

This isn’t to say that companies can’t ever change their accounting methods. They can. It just has to be infrequent and justifiable. A one-time change is fine. Companies just can’t flip-flop their accounting methods every year.

Let’s look at an example.

Example

Inventory valuation methods are a good example of an accounting method that companies usually change at some point in their history. Each method has a slightly different outcome depending on what management is trying to accomplish.

For instance, LIFO raises cost of goods sold expense because higher value inventory is sold off first. This decreases income and inventory levels. Companies in high tax brackets often use LIFO to decrease their taxable income.

FIFO, on the other hand, tends to increase income and inventory levels because lower value inventory is sold off first. The lower cost of goods sold recognized allows the company to show a higher net income than if it used LIFO.

Companies can change from using LIFO to FIFO or vise versa and still be in agreement with the consistency principle. A one-time change isn’t prohibited. Companies cannot, however, change to LIFO in one year in order to minimize taxes, change to FIFO the following year to appeal to lenders, and change back to LIFO the year after that to minimize taxes again.

This type of back and forth causes the financial statements to be incomparable and useless for trend analysis.