Consistency Concept

In: Business and Management

Submitted By charmine97
Words 380
Pages 2

• Usefulness: The consistency principle is important because of the need for comparability, that is, it enables investors and other users of financial statements to easily, similar and correctly compare the financial statements of a company.

• Limitation: The consistency principle is most frequently ignored when the managers of a business are trying to report more profits or revenues to avoid through a strict interpretation of the accounting standards. For instance when there is an underlying company operational activity levels do not change, but the profits suddenly increased. The calculation of cost is determined in large area by the accounting principles and the requirements of financial reporting.

Example: Bobby's Computers, a computer retailer, has historically used FIFO for valuing its inventory. In the last few years, Bobby's business has become quite profitable and Bobby's accountant suggests that Bobby switch to the LIFO inventory system to minimize the taxable income. According to the consistency principle, Bobby can change the accounting methods for a justifiable reason for example like minimizing taxes is an acceptable reason is debatable. Assume Bobby's Computers switched from FIFO to LIFO in year 2. In year 3, Bobby's income is extremely loan and he is trying to show a profit to get another bank loan. Bobby asks his accountant to switch from LIFO back to FIFO. This is a violation of the consistency principle. Bobby can make a justifiable change in accounting method like in the first example, but he cannot switch back and forth year after year.

Example: (2) Tommy’s IT Company, has been using declining balance depreciation method for its IT equipment. According to consistency concept it should continue to use declining balance depreciation method in respect of its IT equipment in the following periods. If the…...

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