The consistency principle states that companies should use the same accounting treatment for similar events and transactions over time. In other words, companies shouldn’t use one accounting method today, use another tomorrow, and switch back the day after that. Similar transactions should be accounted for using the same accounting method over time. This creates consistency in the financial information given to creditors and investors.
The consistency principle does not state that businesses always have to use the same accounting method forever. Companies are allowed to switch accounting methods if the company can demonstrate why the new method is better than the old method. The company then must disclose the change in its financial statement notes along with the effect of the change, date when the change occurred, and the justification for the accounting method change.
As you can see, the consistency principle is intended to keep financial statements similar and comparable. If companies changed accounting methods for valuing inventory every single year, investors and creditors wouldn’t be able to compare the company’s financial performance or financial position year after year. They would have to recalculate everything to make the financial statements equivalent to each other.
Examples
– Bob’s Computers, a computer retailer, has historically used FIFO for valuing its inventory. In the last few years, Bob’s has become quite profitable and Bob’s accountant suggests that Bob switch to the LIFO inventory system to minimize taxable income. According to the consistency principle, Bob’s can change accounting methods for a justifiable reason. Whether minimizing taxes is a justifiable reason is debatable.
– Assume Bob’s Computers switched from FIFO to LIFO in year 2. In year 3, Bob’s income is extremely loan and Bob is trying to show a profit to get another bank loan. Bob asks his accountant to switch from LIFO back to FIFO. This is a violation of the consistency principle. Bob can make a justifiable change in accounting method like in the first example, but he cannot switch back and forth year after year.
– Ed’s Lakeshore Real Estate buys software licenses for its property listing programs every year. Ed usually has to buy at least 10 licenses that cost $15,000 a piece. Ed’s capitalizes these licenses and amortizes them in the years he doesn’t need a deduction and he expenses them in the years that he needs a tax deduction. This violates the consistency principle because Ed uses different accounting treatments for the same or similar transactions over time.
