Matching Principle & Concept

Matching principle therefore results in the presentation of a more balanced and consistent view of the financial performance of an organization than would result from the use of cash basis of accounting. The company should recognize the entire $2,000 cost as expense in the same reporting period as the sale, since the recognition of revenue and the cost of goods sold are tightly linked. A company acquires production equipment for $100,000 that has a projected useful life of 10 years. It should charge the cost of the equipment to depreciation expense at the rate of $10,000 per year for ten years, so that the expense is recognized over the entirety of its useful life. Certain financial elements of business also benefit from the use of the matching principle.

Thus, here it would be wrong to imply that a loss of two thousand rupees was incurred since the company invested four thousand rupees in the production of all commodities. The matching concept/principle is a concept of accounting according to which a business needs to record its expenses in the same period of time as the revenues that they are related with. The matching of the expenses and revenues is done in the income statement for a time period. In other words, when using the matching principle, a business needs to report the expense in the income statement for the period in which the revenues related to it have been earned. It also needs to be prepared on the balance sheet for the end of that accounting period. The matching concept in accounting is an accounting principle used for keeping a record of revenues and expenses.

As a result of paying the commission, the cash balance decreases, and the liability is eliminated. It shows the working of the principle with the accrual basis of accounting. The cash decreased, and the liability increased with the same amount. The matching principle is a part of the accrual accounting technique. Investors like a smooth and normalized income statement that connects revenues and expenses rather than one that is unconnected. In other words, in matching principle accounting, the revenue for the given time must be examined first, followed by the expenses incurred to generate that revenue.

This ensures expenses are matched with revenues generated, providing accurate financial reporting. A major development from the application of matching principle is the use of depreciation in the accounting for non-current assets. One of the ways to implement the matching concept in accounting is to do a journal entry. Moreover, journal entries help accurately document and reflect the matching of revenues and expenses, contributing to accurate financial statements.

The reduction of the inventories corresponding to revenues is called the cost of goods sold. It helps the income statement portray a more realistic picture of a company’s operations. Read on to learn how HighRadius’ Autonomous Accounting Software helps you get rid of manual matching processes that lead to reporting inaccuracies. PP&E, unlike current assets such as inventory, has a useful life assumption greater than one year. It may last for ten or more years, so businesses can distribute the expense over ten years instead of a single year. The matching concept can have numerous disadvantages, such as the usage of estimation cannot be allowed.

According to the matching principle of accounting, the incomes or revenues of a particular period must be matched with the expenses of that particular period. Consider there is a marketing team that creates messages that will attract potential customers into visiting the website of a business. This will plant a seed when the customer visits the website, even if the customer does not make any purchase then or for several years. Revenue cannot be directly correlated to spending in this case or any other similar cases. So, the expenses incurred for online search ads are recorded in the period of the expense rather than dispersed over a period of time.

We call these accounting concepts or accounting concepts and principles. The matching principle of accounting is a natural extension of the accounting period principle. It is impossible to know if a better location or a bigger space will bring in more revenue. It is not possible to know if the employees will be more productive in the new location.

What is the Matching Concept?

With the matching principle, you must match expenses with related revenues and report both at the end of an accounting period. The matching principle  requires that revenues and any related expenses be recognized together in the same reporting period. Thus, if there is a cause-and-effect relationship between revenue and certain expenses, then record them at the same time. In some cases, it will be necessary to conduct a systematic allocation of a cost across multiple reporting periods, such as when the purchase cost of a fixed asset is depreciated over several years. If there is no cause-and-effect relationship, then charge the cost to expense at once. The matching principle in accounting is a process that involves matching a company’s expenses with its corresponding revenues in the same accounting period.

As a result, implying that the company lost two thousand rupees is incorrect, given that the company invested four thousand rupees in the production of all items. Matching Principle requires that expenses incurred by an organization must be charged to the income statement in the accounting period in which the revenue, to which those expenses relate, is earned. According to the realization accounting concept, revenue is only recognized when it is realized. Now revenue is the cash inflow for a business arising from the sale of goods or services. And we assume this revenue as realized only when it legally arises to be received.

  • It is not possible to know if the employees will be more productive in the new location.
  • Let’s suppose a company produces a hundred books for the cost of four thousand.
  • The materiality of a transaction will depend on its nature, value and its significance to the external user.
  • The matching principle allows distributing an asset and matching it over the course of its useful life in order to balance the cost over a period.

As it can be seen, none of these factors is related directly to the business’s new location. Due to this lack of direct relation, businesses will generally spread the cost incurred in purchasing property for the business over several years or even decades. For example, when the users use financial statements and see the cost of goods sold increases, they will note that the sales revenue should be increasing consistently. The salary expenses are the cost of services the company renders from its staff. The services rendered in which months and salary expenses should be recorded on those months.

Matching Principle Example

The matching principle links expenses to the related revenues, while the revenue recognition principle requires revenue to be recognized when it’s earned. They ensure accurate financial reporting by recognizing revenue in the period it’s earned and linking expenses to the revenues they generate. These businesses report commission expenses on the December income statement. In this case, they report the commission in January because it is the payment month. The alternative is reporting the expense in December, when they incurred the expense.

Is the Matching Principle Used Under the Cash Basis of Accounting?

Based on the Matching Principle, the cost of goods sold amount $40,000 have to be recorded in December 2016, same as revenue of $70,000 recognized. The marching principle is recognized in the same ways as accrual or cash. A bonus plan pays a $60,000 incentive to an employee depending on measurable components of her performance over a year. The bonus expense should be recorded within the year the employee received it. Commissions, depreciation, bonus payments, wages, and the cost of items sold are all examples of the matching principle. For example, if a salesperson sells 200 copies of a book in January, the cost price of those 200 copies must be matched with the January income to determine the profit or loss.

Disadvantages of the matching principle

It takes more effort from the accountant to record accruals to transfer expenses across reporting periods. Because it is relatively sophisticated, small firms without accountants may find it challenging to use. Because revenue recognition and the cost of goods sold are so closely related, the corporation should recognize the entire $4,000 cost as an expense in the same reporting period as the sale. Because it requires that the complete effect of a transaction be recorded within the same reporting period, this is one of the most important ideas in accrual basis accounting. If an item isn’t directly related to revenue, it should be mentioned in the income statement in the prevailing accounting period in which it expires or is depleted.

Matching Principle: Explanation

This matches costs to sales and therefore gives a more accurate representation of the business, but results in a temporary discrepancy between profit/loss and the cash position of the business. If an expense is not directly tied to revenues, the expense should be reported on the income statement in the accounting period in which it expires or is used up. If the future the pros and cons of leasing vs buying office space benefit of a cost cannot be determined, it should be charged to expense immediately. The principle is at the core of the accrual basis of accounting and adjusting entries. The cause and effect relationship is the basis for the matching principle. If there’s no cause and effect relationship, then the accountant will charge the cost to the expense immediately.

When to Use the Matching Principle

Therefore, the tax expense for the year of $40,000 may also be derived by applying the tax rate of 40% to the profit before tax of $100,000. Let’s suppose a company produces a hundred books for the cost of four thousand. Later, it sells twenty copies for fifty rupees per unit, thereby getting revenue of two thousand rupees. The Matching principle dictates that although the total cost of production was four thousand, the profit would be twelve hundred rupees despite the revenue being 2000. In other words, in matching principle accounting, the revenue must be considered first for the given period, and then one must see the expenses incurred to produce that revenue.

Thus, revenue is recognized when cash is received, and supplier invoices are recognized when cash is paid. This means that the matching principle is ignored when you use the cash basis of accounting. Matching principle is especially important in the concept of accrual accounting.

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