Matching Principle Definition + Concept Examples

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.

All forms of business organizations (proprietorship, partnership, company, AOP, etc) must follow this assumption. Follow Khatabook for the latest updates, news blogs, and articles related to micro, small and medium businesses (MSMEs), business tips, income tax, GST, salary, and accounting. If a business that does landscaping bookkeeping services examples has completed the work of building a swimming pool at a farmhouse, the business has earned the fee, irrespective of when the customer will release the payment for that job. The matching principle in accounting is one of the basic fundamental principles in Generally Accepted Accounting Principles (“GAAP”).

Matching Principle for Employee Bonuses

The matching principle is an accounting concept that dictates that companies report expenses at the same time as the revenues they are related to. Revenues and expenses are matched on the income statement for a period of time (e.g., a year, quarter, or month). Then, in a month, the company sold a total of 10 pencils for 10 rupees. It would simply be wrong to consider that a loss of 490 rupees occurred when the company made a profit of 9 rupees. This allows the company to have a more accurate status of its finances. 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.

  • A major development from the application of matching principle is the use of depreciation in the accounting for non-current assets.
  • As a result, investors pay close attention to the company’s cash balance and cash flow timing.
  • The next section discusses the various challenges accountants face in matching revenue with expenses.
  • Commissions, depreciation, bonus payments, wages, and the cost of items sold are all examples of the matching principle.

As a result, revenue is recorded when money is received, and supplier bills are recorded when money is paid. When you employ the cash basis of accounting, the principle is disregarded. 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. Because use of the matching principle can be labor-intensive, company controllers do not usually employ it for immaterial items.

What is meant by the matching principle in accounting?

Another example is that the salesman in your company could earn some commission due to their sales performance. For example, when we sell the goods to our customers, the revenue increases and decreases the inventories. The reduction of the inventories corresponding to revenues is called the cost of goods sold. PP&E, unlike current assets such as inventory, has a useful life assumption greater than one year.

The Matching Principle Accounting Definition

But by utilizing depreciation, the Capex amount is allocated evenly until the PP&E balance reaches zero by the end of Year 10. As shown in the screenshot below, the Capex outflow is shown as negative $100 million, which is an outflow of cash used to increase the PP&E balance. If we assume a useful life assumption of 10 years and straight-line depreciation with a residual value of zero, the annual depreciation comes out to $10 million. Upgrading to a paid membership gives you access to our extensive collection of plug-and-play Templates designed to power your performance—as well as CFI’s full course catalog and accredited Certification Programs. Access and download collection of free Templates to help power your productivity and performance.

Matching principle

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. So in simpler terms, the profit earned will be recorded when it is actually earned. Depreciation distributes the asset’s cost over its expected life span according to the matching principle. 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.

Matching Principle of Accounting FAQs

For example, if a business pays a 10% commission to sales representatives at the end of each month. If the company has $50,000 in sales in the month of December, the company will pay the commission of $5,000 next January. Assume the revenue per cash basis is recognized in January 2017, then the cost of goods sold $40,000 should also recognize in 2017 as well. If the Capex was expensed as incurred, the abrupt $100 million expense would distort the income statement in the current period — in addition to upcoming periods showing less Capex spending. The principle works well when it’s easy to connect revenues and expenses via a direct cause and effect relationship. There are times, however, when that connection is much less clear, and estimates must be taken.

Matching Principle Impact: Revenue and Expense Recognition

This concept states the obvious assumption that the accounting transaction recorded should be objective, i.e. free from any bias of the person recording it. So each transaction should be verifiable by supporting documents like vouchers, bills, letters, challans, certificates, invoices etc. Once the company decides on a certain accounting policy it should not be frequently changed.

First, that the revenue has been earned in the period in which it is included in the income statement. There is no way to precisely quantify the timing and impact of the new office on sales; the company will depreciate the total cost over the usable life of the additional office space (measured in years). The idea works well when it’s simple to connect revenues and expenses via a direct cause-and-effect relationship. However, there are situations when that link is less evident, and estimates must be made.

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