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Sunday, 7 March 2010

Accounting Principles - Consistency of Presentation

The consistency concept-or consistency of presentation-in financial accounting, is one of four fundamental assumptions of IAS 1 (International Accounting Standard 1), along with going concern, accruals and fair presentation. Consistency holds that accounting methods used in one accounting period should be the same as methods used for events/transactions, which are materially similar, in other periods. Naturally, there are unique circumstances in which entities can change methods and not follow the consistency concept, although there must be good reason for this.

The requirement for consistency reinforces qualitative characteristics of financial statements, such as reliability and comparability. Its aim is to facilitate historical comparisons of financial accounts of an entity. The consistency concept arose because, in accounting, there several methods or techniques to determine valuations or costs. A classic example is depreciation, which can be determined using the straight-line or reducing balance method. Another good example is the application of the historical cost convention or the LIFO (Last in/ First out)/ FIFO (First in/ First out) methods for stock valuation.

For example, assume that ABC Company Ltd. purchases equipment for $100,000.00 in 20X7. It decides to use the straight-line method of depreciation for that equipment. Two years later, ABC Company Ltd decides that it is more appropriate to use the reducing balance method. Notwithstanding the bases for exemptions from consistency, IAS 1 does not permit ABC to change its method of depreciation for that particular asset. Since it chose the straight-line method for depreciation first, it must stick with it.

The International Financial Reporting Standards are not unreasonably rigid or fixed. Financial accounts can depart from the consistency assumption if:

a) The nature of business operations changes in a material way or a more suitable/fairer method of presentation information is identified.

b) An International Financial Reporting Standard requires a change in presentation

Consistency is an important assumption in the accounting standards because it facilitates comparability for information users. Financial statements for an entity can be properly compared over time because the accounts are treated the same way and the same methods are applied.

In addition, consistency facilitates reliability and fair presentation. It prevents entities from conveniently using methods to skew the financial position of the entity. After all, without consistency, entities would be able to select the methods that represent the best financial position for each period. That would be unethical, since it would be unfaithful presentation and would contradict the principle of prudence as well. It is, therefore, easy to glean the importance of consistency of presentation in financial accounting.

Consistency of presentation also affects the qualitative aspects of financial statements.

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