When companies make an assessment, financial statements must be computed and prepared to adhere to the correct accounting rules. The matching principle is one such concept.
The matching concept must be used to generate documentation more effectively with correct analysis. This article will find the answer to what is matching concept, its advantages, limitations, and examples of the matching principle of accounting.
What is the Matching Principle of Accounting?
A fundamental, underlying accounting theory known as the “matching principle” asserts that expenditures should be reported simultaneously with the corresponding revenues. One of the ten accounting principles found in Generally Accepted Accounting Principles (GAAP) is the matching principle, which mandates that companies reconcile their income and expenses over a given period.
The matching principle is never applied in cash accounting because it was created to be used with accrual accounting.
If you want to understand the matching concept in accounting, then the following accounting terminologies are essential to know:
Accrual Method
Accrual accounting is one of two approaches used in accounting methods. The accrual method records income when work is finished rather than when money is received. In contrast, expenses are recorded when they happen rather than when they are paid.
Cash Method
Cash accounting is the simplest method of accounting, recognizing revenue when payments are received and expenses when payments are made.
Expenses
Any charge or fee the company is paying Is counted as an expense. Expense accounts are temporary accounts that are closed out to zero after each accounting period so that the following period begins with a balance of zero.
Revenue
Revenue is money received regularly through business operations. A revenue account is a brief account cancelled out after each accounting period, much like an expense account.
How Does the Matching Principle of Accounting Work?
The matching principle ensures consistency between an organization’s revenue statements and balance sheets.
Let’s learn how it works:
In the same period in which revenues are earned, expenses are recorded on the income statement. At the end of the accounting period, liabilities are recorded on the balance sheet.
Expenses with no direct connection to revenue should be reported on the income statement in the same period they are incurred.
Moreover, identifying the points at which expenses lead to revenue may be challenging if detected too soon or too late. Financial statements may be manipulated; as a result, investors have a hazy picture of the company’s overall financial situation.
For instance, early expenditure recognition decreases net income. Conversely, your net income will increase if you discover it too late.
What Is Revenue Recognition?
The matching principle of accounting could be seen as a combination of revenue recognition principles and accrual accounting approaches. The revenue recognition principle states that when revenue is received or realized, it must be recognized and documented on the income statement.
Businesses can report this sales revenue without waiting for the cash payment to arrive. For instance, when a vendor records revenue for a single job, they do so even if the client doesn’t pay the invoice until the next accounting period.
Examples Of Matching Principles of Accounting
Let’s take some matching concept examples to get a better understanding of matching principles of accounting:
Commission
The money given to a staff member as compensation for closing a deal is referred to as a commission. Here is an example to understand better about the commission.
EXAMPLE 1
Let’s imagine Bhaskar made 10% commissions in September and received his commission in October. Let’s assume the business would pay him ₹8000 in October as a commission if he sold products worth ₹80,000 in September. According to the matching principle, Rs. 8,000 in commissions must be included on the October statement with ₹80,000 in product sales.
Bonuses
An employee’s extra money over and above their base salary is an employee bonus. Employers frequently reward employees with a bonus if they perform above expectations at work.
EXAMPLE 2
In 2019, Bhaskar received a bonus of ₹40,000 bonus based on his work productivity. He didn’t receive the bonus until 2020. Using the matching principle, the ₹40,000 expense should be reflected on the income statement in the year Bhaskar earned it. In this situation, they would include it on the income statement in 2019.
Depreciation
Depreciation is the term used to describe how much an asset loses in value over time due to normal wear and tear. Here is an illustration of the Depreciation of the matching principle.
EXAMPLE 3
Let’s say, in 2021, Pranay spent ₹750,000 to purchase a new CNG car with an expected lifespan of 15 years. The car’s purchase price and the money it has brought in must be equal.
Let’s assume that Pranay utilized it to commute to work in this situation, saving him extra money that he would spend on petrol. In this case, he should apply the car’s purchase price to a depreciation expense of ₹50,000 per year, totalling 15 years.
Wages
Wages are the financial compensation you earn from your boss for the job you perform. Here is an illustration of the matching principle used for wages:
EXAMPLE 4
Let’s imagine Pranay is an employee of ABC company. The company’s pay period closes on June 20, and he doesn’t get his salary until July 5. This expense will be reflected in the June income statement for the salary he received from June 20 to June 30. This is because he kept working through the end of the salary period, in this example, the final few days of June.
Limitations of Matching Principle of Accounting
The matching principle might not be ideal when a company uses cash accounting as an alternative to accrual accounting. This idea has some limitations, including the following:
- It is more difficult when there is no direct correlation between income and expenses.
- When related revenue is distributed across time, as with advertising or marketing expenditures, it doesn’t work either.
Even yet, there are only a few circumstances in which it becomes more challenging to utilize. Overall, it is a good idea to recognize the matching principle for everyday accounting.
Conclusion
The fundamental of business is that you must spend to generate money. The matching principle allows businesses to acknowledge this concept while maintaining their accounting records.
To put it another way, while applying the matching principle, a company must include the expenditure in the income statement for the period during which the corresponding revenues have been generated. A balance sheet to complete that accounting period must also be prepared.
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