In accounting, the matching principle is used for recording revenue and expenses. The process records expenses alongside the earned revenues. The matching principle demonstrates how businesses incur expenses to earn revenue. The concept of the matching principle is one that dictates how companies report expenses at the same time as the revenue they are related to is reported. The matching principle is part of the accrual accounting process for adjusting entries and bookkeeping. It is part of the Generally Accepted Accounting Principles and is based on cause-and-effect relationships. The purpose is to help a company maintain consistency across its balance sheets and income statements.
Here is an example of the matching principle as it applies to accounting. Depreciation is the decrease in the value of an item or asset over time. This occurs due to wear and tear. Suppose a company purchased a new computer for $15,000 in 2020. The life expectancy of the computer is 10 years. While the computer is depreciating in value, it will also be bringing in revenue for the business. The accountant will charge the price of the computer as a depreciation expense of $1500 per year for the next 10 years. This way, the expense of the computer will match the revenue the company brings in during that time.
What is the Matching Principle?
The matching principle in accounting is a concept that requires expenses and related revenue to be reported at the same time. Both revenues and expenses are matched on income statements for a period, whether that is a month, a quarter, or a year. It is one of the core concepts in accrual basis accounting because it directs that the whole effect of a transaction is recorded in a single (the same) reporting period. This ensures that profits are not accelerated inappropriately and that they are not delayed. When revenue is reported, all the expenses that are associated with it are reported at the same time.
What is the Purpose of the Matching Principle?
The purpose of the matching principle is to ensure consistency across the balance sheets and income statements of a company. It is the foundation for accrual accounting and defines how and when a business adjusts its balance sheet. It demonstrates the cause-and-effect of expenses and revenue. However, if there is no revenue, then expenses are recorded without adjusting revenue entries.
What is the Importance of the Matching Principle in Accrual Accounting?
In accrual accounting, the matching principle helps prevent a business from misstating profits in a period. Expenses that are recognized at the wrong time can greatly distort the company’s financial statements. Businesses could end up with inaccurate financial information. Business decisions based on inaccurate information could be detrimental. Recognizing expenses too early can yield a lower net income; recognizing them too late can result in a higher net income than what is actual.
What are Examples of the Matching Principle?
The matching principle dictates that expenses must relate to the period they occur rather than in the period an invoice is paid. The key is adjusting journal entries at the right time. One example is wages. Let’s say the current pay period ends on April 23; the next employee’s payday is not until May 1. If your employees earned $3500 for the remaining portion of April, these payroll expenses must be accrued to April. This entry will be reversed in May so that May’s payroll expenses are not overstated.
Depreciation is another example of the matching principle. It refers to an asset losing value over its longevity. For instance, a manager purchases new equipment for the factory. The equipment is used in the production process, so it provides monetary benefits for the business. The matching principle is used to match the earned revenue with the equipment’s expense over the life of the asset. An accountant may need to show the depreciation expense over the next few years, or over the equipment’s useful life to balance out the books.
Sales commission is also an example of the matching principle. Sales personnel earn about 15% commission on average. But commissions are not paid until the following month. They will need to be accrued for the month the expense is tied to the sales revenue that was earned.
What are the Difficulties of the Matching Principle?
The matching principle works well when connecting revenues to expenses are done directly through a cause-and-effect relationship. But there are a few times when the connection is not as clear, and estimates are in order. When extra accounting efforts are needed to record accruals and expenses need to be shifted across reporting periods, it can be difficult. It is a complex process, and small businesses that do not have an accountant may find it difficult.
There are also some instances where there isn’t an obvious cause-and-effect relationship between revenue and expenses. This makes it hard to decide how much to charge for expenses in each period, as well as how the expense can be recognized over numerous reporting periods fairly. An example of when the marketing principle is a disadvantage is ongoing expenses for marketing on sales. Usually, marketing expenses are recorded when they were incurred.
When Should You Apply the Matching Principle?
The matching principle is often a labor-intensive task. Because of this, some company controllers do not employ it for non-tangible items. For example, it might not be sensible to create a journal entry to recognize a $150 supplier invoice over numerous months, even though it will affect several months. Small items are usually charged as expenses when they occur. That saves accountants time and has no impact on financial statements.
What are the Benefits of Matching Principles in Accounting?
The primary benefit of using the matching principle in accounting is consistency across financial statements. When revenue and expenses are not recorded accurately, both the income statement and balance sheet will be wrong. Another benefit of the matching principle is being able to recognize and record depreciation expenses over the life of an asset. This helps prevent recording the expense in just one accounting period, which can skew the final results.
What are the Limitations of Matching Principles in Accounting?
Because of some limitations of the matching principle, some businesses choose the cash accounting method rather than accrual. principles are not always the best choice for the cash method. The matching principle doesn’t work as effectively when revenue is spread out over time, such as in the example of advertising or marketing costs. Using the matching principle is also more challenging if there is not a direct cause-and-effect relationship between expenses and revenue.
What is the Relationship Between the Matching Principle and Depreciation?
The relationship between the matching principle and depreciation is that they balance out the books and financial records of the company. The accountant is spreading out a fixed asset’s cost over time. To balance the books, the period costs must match up. So the matching principle allows the cost of the asset to “match” up with the revenue during the same time period.
Long-term assets depreciate over time. The matching principle allows businesses to distribute the asset over time and match its useful life so that the cost is balanced over a period. For instance, if a company purchases specialized equipment for $35,000, it should last for ten or more years. The business can distribute the expense over a 10-year period instead of just one year.
Is the Matching Principle Applied in Cash Basis Accounting?
No, in cash basis accounting, revenue is recognized when cash is received. Also, supplier invoices are recognized when cash is paid. The matching principle is not applicable when cash basis accounting is in use since there is not a direct cause-and-effect relationship between revenue and expense.