What is the key to an Effective Bookkeeping System?
Financial statements are essential to showing the state and stability of a business. For example, if a company looks to take out a loan, the financial statements and accounting measures need reviewing. In addition, reviewing the financial statements, which includes the chart of accounts, income statement, and general ledger within a business allows lenders and investors an accurate view of current numbers to determine if the company is credit-worthy or worth the risk.
Financial statements and transactions of a business may be audited at the request of a lender or investor. This is done to investigate internal controls and determine if the financial statements conform to generally accepted accounting principles. In order for these financial statements to be reviewed and compared, they must be consistent throughout each accounting period. One of the aspects auditors look for is known as the Consistency Principle.
Accounting Methods and the Consistency Principle
The Consistency Principle states that once an entity adopts an accounting principle or method, it must continue to follow it in future accounting periods. A change in accounting principle or method can only occur if the new version improves reported financial results. Auditors are particularly concerned that their clients follow the Consistency Principle. This is because, for the results from the auditor to be accurate, the reports must be consistent. Bookkeeping software, such as QuickBooks Online, provides an easy way to pull the financial information that any lender or auditor may require of you while keeping that consistency.
What if You Want to Change Your Accounting Method?
It is perfectly fine for a company to change accounting methods; however, they must be infrequent and justifiable. An example of this is companies switching from LIFO (last in, first out) to FIFO (first in, first out) and vice versa. LIFO raises the cost of goods sold because higher-value inventory is sold first. As a result, companies in higher tax brackets often utilize LIFO to decrease taxable income. On the other hand, FIFO tends to increase income and inventory levels because lower value inventory is sold first. As a result, the lower cost of goods sold allows companies to show higher net income rather than if they used LIFO. Companies can change from using LIFO to FIFO or vice versa and still agree with the Consistency Principle; however, companies cannot change to LIFO for one year to minimize taxes, then switch the following year.
A company using declining balance depreciation for its equipment is another example of a company updating its accounting methods while maintaining consistency with the Consistency Principle. To comply with the Consistency Principle, the company should continue to use declining balance depreciation; however, if the company wishes to change to the straight-line method, it must state the reasons for the change, the nature of the change, and the effects of the change in its financial report.
The Key to Effective Bookkeeping is…
The Consistency Principle is also important because it allows for comparable financial information to be provided. This is especially crucial to bankers, managers, creditors, and other stakeholders. The Consistency Principle also helps bookkeepers and accountants to become familiar with the method, which can be cost and time-efficient. In the end, consistency is key to an effective bookkeeping system.
