matching principle definition and meaning

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. The matching principle concept is extremely beneficial when it comes to reporting revenues and expenses. An expense needs to relate to the time period that it occurred and not during the actual payment of the invoices.

• However, matching the expenses to the earnings might sometimes be challenging.
• There are situations in which using the matching principle can be a disadvantage.
• This facilitates a comparison of performances and allows stakeholders to get timely information.
• The matching principle, also called the “revenue recognition principle,” ensures that expenses are recorded in the correct period by relating them to the revenues earned in the same period.

The accrual or matching principle states that we should simultaneously calculate the cost of producing a commodity as we calculate the income from sold commodities. 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. To illustrate the matching principle, let’s assume that a company’s sales are made entirely through sales representatives (reps) who earn a 10% commission. The commissions are paid on the 15th day of the month following the calendar month of the sales. For instance, if the company has $60,000 of sales in December, the company will pay commissions of $6,000 on January 15.

A marketing team crafts messages to entice potential customers to visit a business website. The customer may not make a purchase until weeks, months, or years later. It’s not always possible to directly correlate revenue to spending in these cases. Expenses for online search ads appear in the expense period instead of dispersing over time. On a larger scale, you may consider purchasing a new building for your business.

The matching principle works well in cases where revenues and expenses are clarified. But, there are times when the expenses will apply to more than one area of revenue, or it could even be vice versa. There is a need for the accounts department of a business to come up with estimates in cases where no clear correlation exists between revenues and expenses. A business will purchase office supplies for the employees that could be stationery items. While these notebooks, pens, staplers and staple pins are essential, they cannot be correlated with revenue. The matching principle, then, requires that expenses should be matched to the revenues of the appropriate accounting period and not the other way around.

Matching Concept in Accounting: Benefits and Challenges

It helps you compare how much you made in sales with how much you spent to make those sales during an accounting period. When you use the cash basis of accounting, the recordation of accounting transactions is triggered by the movement of cash. 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. Recognizing expenses at the wrong time may distort the financial statements greatly.

Our mission is to empower readers with the most factual and reliable financial information possible to help them make informed decisions for their individual needs. At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content. Similarly, if a fee is earned for providing a service, the first test is to ensure that the service in question has been duly provided. If we include any revenue in a particular period, we should be sure of two key facts. There are many drawbacks to the matching notion, one of which is that estimation cannot be used.

Matching Principle Example Calculation

Commissions are paid on the 15th of the month succeeding the month in which the sales were made. Commissions, office supplies, and rent are examples of period costs that aren’t directly related to the product. So therefore, these costs aren’t directly linked to the product or service.

The matching of the expenses and revenues is done in the income statement for a time period. Business runs with the well-known concept that in order to make money, it is essential to spend money. The matching concept is aligned with adjusting entries and the accrual basis of accounting. It provides businesses with a means of recognising this idea while keeping their accounting records.

What Is Revenue Recognition Principle?

Accrual accounting is based on the matching principle, which defines how and when businesses adjust the balance sheet. If there is no cause-and-effect relationship leading to future related revenue, then the expenses can be recorded immediately without adjusting entries. The matching principle is part of the Generally Accepted Accounting Principles (GAAP), based on the cause-and-effect relationship between spending and earning.

Solved Matching Concept Example

The difference of $10,000 between accounting profit and taxable profit is due to prepaid income which is taxable on cash basis. First, it minimizes the risk of misstating whether a business has generated a profit or loss in any given reporting period. This is particularly important when a firm generally operates near a breakeven level. It also results in more consistent reporting of profits across reporting periods, minimizing large fluctuations. This is especially important in relation to charging off the cost of fixed assets through depreciation, rather than charging the entire amount of these assets to expense as soon as they are purchased. 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.

What is meant by the matching principle in accounting?

If there is no cause-and-effect relationship, then charge the cost to expense at once. Therefore, if the company used “cash-based accounting”, it might have recognized the expense in February because it paid in cash in February. However, under “accruals accounting,” the firm must record the power charge in January rather than February because the item was incurred in January.

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A business may end up with an inaccurate financial position of its finances. The matching principle helps businesses avoid misstating profits for a period. According what do you need to prepare a partnership tax return to the matching principle, both the commission fees (expenses) and cosmetic sales (related revenue) must be recorded in the same accounting period.

However, losses even those not realized but with the remote possibility of occurring should be included in the financial statements. So all losses are recognized – those that have occurred or are even likely to occur. By contrast, if the company used the cash basis of accounting rather than accrual, they would record the revenue in November and the commission in December. When expenses are recognized too early or late, it can be difficult to see where they result in revenue. This can potentially distort financial statements and give investors an unclear view of the overall financial position. For example, if you recognize an expense too early it reduces net income.

A lot of external users depend on these financial statements for their information to make investing decisions. So no information/transactions etc of relevance to anyone of them will be omitted from these statements for the benefit of the company. Sometimes, expenditures are incurred either in advance or subsequent to the accounting period even though they relate to expenses for goods or services sold during the current accounting period.