Accounting Concepts Definitions Part : 10 (The comparability concept)
Accounting Concepts Definitions Part : 10
The comparability concept
Accounting information is not all about just design, timeliness and organization. Rather this information needs a comprehensive quality which makes such data unique and that is comparability. If data can’t be compared then that can’t pass as good accounting data. Why? Because, accounting data is supposed to be the prime thing. This is a quality which makes the data capable to be similar and comparable with data from same industry, same nature or, from previous years.
What is it?
This concept states:
“The accounting data, which is true and well documented, should be kept in such a way that the data should be complied with the policies, the industry standard and the standards followed in the previous years. This is named ‘The comparability concept’.”
This quality makes possible a way to do analysis easily and comprehensively. This is required to make the investors capable to get the overview and comparison within the industry to shape up their investment decision. Such decision is necessary for the entity to be in order and running with the flow of current investment. Investment is the primary concern to keep the wheels running and that is not possible without the investors who will not come into the fray without the presence of data- comparable, timely, policy followed and true.
Now, everything being said the comparability concept needs a little explanation and that is as followed:
XYZ co. kept their depreciation for the year 2000 To 2013 in straight line format but in the current accounting period the entity changed the format of depreciation to double declining method.
See, there is just a sentence which provides a piece of information about a change in format. Though this change leads to only a figure change this year, the change should be incorporated with the previous years. The demand is greater than that. The notes to the financial statements of the company should declare the changes in a noticeable fashion and if possible show the changes in a comparative fashion. The change in depreciation policy should be applied to the previous years and the changes in amounts should be calculated. The changes will happen to the depreciation expense and will also happen to net income, asset value and accumulated depreciation both for current year and previous year.
As there is no binding that the company should keep the depreciation in a fixed format, there is no problem in that case. But, the best practice is to follow the industry standard and go by the same policy that the rest of the industry follows. This makes the whole complexion simple and easy, because, that lets the data to be comparable. Also there is a thing to keep in mind and that is the method which should be followed or, taken in place of an existing one needs review by a professional accountant.
Always following what the industry is doing is not wise, so, taking expert consultation is a necessary step forward as always. At this point it may seem that all the barging is about policy change and so, but, keep in mind that this is an example and so this covers only that area which makes this change feasible and comparable.
If the change is in place only for the current year and not applied to the previous years then the data will lose the comparability character and apparently will become untrue without proper base.
The concept of consistency means that accounting methods once adopted must be applied consistently in future. Also same methods and techniques must be used for similar situations.
It implies that a business must refrain from changing its accounting policy unless on reasonable grounds. If for any valid reasons the accounting policy is changed, a business must disclose the nature of change, the reasons for the change and its effects on the items of financial statements.
Consistency concept is important because of the need for comparability, that is, it enables investors and other users of financial statements to easily and correctly compare the financial statements of a company.
- Company A 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 company wants to change it to another depreciation method, say for example the straight line method, it must provide in its financial report, the reason(s) for the change, the nature of the change and the effects of the change on items such as accumulated depreciation.
- Company B is a retailer dealing in shoes. It used first-in-first-out method of inventory valuation in respect of shoes at Branch X and weighted average inventory valuation method in respect of similar shoes at Branch Y. Here, the auditors must investigate whether there are any valid reasons for the different treatment of similar inventory located at different locations. If not, they must direct the company to use any one of the valuation method uniformly for the whole class of inventory.
Written by Irfanullah Jan