The comparability principle is an important accounting concept that states that financial statements must be presented in manner that allows readers to compare them. This means that the statements should be presented using the same accounting methods and assumptions. For example, if a company uses the accrual basis of accounting, it should continue use of this method from one year to the next. This allows readers to compare the financial statements of organization from one year to the next and see how the company is performing.
The comparability principle also applies to the way in which companies present their financial statements. For example, all companies should use the same format for their income statements. This allows readers to easily compare the income statements of different companies.
The comparability principle is essential because it allow investors and other users of financial statements to compare organizations. This comparison can be useful in making investment decisions and in other decision-making.
There are a number of examples of the comparability principle in action.
- Using the same accounting methods: As mentioned above, one example of the comparability principle is using the same accounting method from one year to the next. This allows readers to easily compare the financial statements of a company from one year to the next. Consider Company A using the accrual basis of accounting in the first year. This means that regardless of when cash is received, Company A reports revenue when it is earned. Company A chooses to adopt the cash basis of accounting in year two. As a result, Company A only reports revenue after receiving payment. The financial statements for years 1 and 2 would not be comparable if Company A did not adhere to the comparability principle. Investors and other users of the financial statements would find it challenging to compare the two years and assess the company’s performance in this situation.
- Using the same format: Another example of the comparability principle is using the same format for financial statements. This allows readers to easily compare the statements of different companies. For example, all companies should use the same format for their income statements. This means that the income statement should always start with revenue and then list the expenses. This format makes it easy for readers to compare the income statements of different companies.
- Disclosing accounting policies: Publishing accounting policies is another instance of the comparability principle in action. This implies that businesses should be transparent about the accounting techniques and presumptions they employ when creating their financial statements. Readers can comprehend how a firm created its financial statements by understanding the accounting policies that have been disclosed. When comparing businesses, having this knowledge is crucial.
- Making adjustments for material items: Another example of the comparability principle is making adjustments for material items. This means that companies should make adjustments to their financial statements for items that are material in nature. For example, imagine that Company A uses the accrual basis of accounting and records revenue when it is earned. Company A has a contract to provide services to Company B. Company A complete the services in year 1 but does not bill Company B until year 2. Under the accrual basis of accounting, Company A would record the revenue in year 1. However, under the comparability principle, Company A would make an adjustment to its financial statements for the revenue that was earned in year 1 but not billed until year 2. This adjustment would make the financial statements of Company A more comparable to other companies.