Matching Concept in Accounting: Work, Examples, Use & Benefits

Application of matching principle results in the deferral of prepaid expenses in order to match them with the revenue earned in future periods. Similarly, accrued expenses are charged in the income statement in which they are incurred to match them with the current period’s revenue. Together with the time period assumption and the revenue recognition principle the matching principle forms a necessary part of the accrual living amends scholarship basis of accounting. The alternative method of accounting is the cash basis in which revenue is recorded when received and expenses are recorded when paid. The matching principle or matching concept is one of the fundamental concepts used in accrual basis accounting.

Step 5: Ensure the reporting is GAAP-compliant

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 frequency of mirroring the move of the revenue and expenses is really dependent on how much of those have been earned or the increase in expenses. However, the accrual basis of account treatment I am talking about right now recognizes sales and expenditures when they are incurred instead of when money is received or paid. The reported amounts on his balance sheet for assets such as equipment, vehicles, and buildings are routinely reduced by depreciation. Depreciation expense is used for assets whose life is not indefinite—equipment wears out, vehicles become too old and costly to maintain, buildings age, and some assets (like computers) become obsolete.

Revenue Reconciliation

In practice, the matching principle is evident in the treatment of depreciation. When a company purchases a long-term asset, such as machinery, the cost is allocated over the asset’s useful life through depreciation, matching the expense with the revenue generated by the asset. This allocation prevents significant fluctuations in financial results, offering a more stable view of a company’s performance over time. 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.

📆 Date: 15-16 Feb 2025🕛 Time: 8:30-11:30 AM EST📍 Venue: OnlineInstructor: Dheeraj Vaidya, CFA, FRM

By aligning expenses with the revenues they generate, the principle provides a comprehensive understanding of financial activities within a specific accounting period. This is particularly relevant for businesses with long-term projects or services, where revenues and expenses may not occur simultaneously. The matching principle states that all expenses incurred during a business’s fiscal year should value relevance of accounting information be matched with the corresponding revenue earned from the sale of products or services. This helps ensure accurate financial reporting by creating a correlation between expenses and income, which results in a more realistic view of the company’s financial performance.

Allocating Expenses to Revenues

• They bring the balances of certain accounts up to date if they are not already current to properly match revenues and expenses.
• Finance Strategists has an advertising relationship with some of the companies included on this website.
• The goal of this is to properly analyze a company’s performance over time rather than at one point in time.
• The matching principle, while essential, is often misunderstood or misapplied, leading to potential distortions in financial reporting.
• For example, Radius Cloud sold $10,000 worth of products in December 2022 but incurred $5,000 in related expenses in January 2023.

The matching principle ensures the information they receive is a true representation of the company’s performance, fostering trust in the company’s financial reporting practices. Matching principle is especially important in the concept of accrual accounting. Matching principle states that business should match related revenues and expenses in the same period.

• Deferred revenue and accrued liabilities are two balance sheet items heavily influenced by this principle.
• For example, a business spends $20 million on a new location with the expectation that it lasts for 10 years.
• At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content.
• For example, accruals basis of accounting requires the recognition of the estimated tax expense in the current accounting period even though the actual settlement of the provision may occur in the subsequent period.
• The image below summarizes how the matching principle is part of the accrual basis of accounting.
• Period costs, such as office salaries or selling expenses, are immediately recognized as expenses and offset against revenues of the accounting period.
• Because of this, businesses often choose to spread the cost of the building over years or decades.

If there is an inventory code mismatch between your system and the supplier’s, you can still use the matching principle to figure out your income and expenses. The supplier needs to check their records for income generated within the purchase timeframe, you check yours for expenses and match it to figure out the cost of different products. Organizations spend millions of dollars on property, employees, and marketing to reach the right people, but sometimes these expenses overshadow their generated revenue. The matching principle ensures you know whether your expenses and generated revenue are aligned at every given time. The business calculates sales commissions on a monthly basis and pays its agents in the following month. Suppose a business has a product which sells for 10.00 a unit and costs 4.00 a unit.

IFRS is a bookkeeping for llc set of accounting standards issued by the International Accounting Standards Board (IASB), while GAAP is a common set of accounting principles and guidelines used in the United States. Certain industries may have unique challenges in applying the Matching Principle, such as the construction and software development sectors, where projects often span multiple accounting periods. Determining when expenses should be recognized may involve subjectivity, leading to inconsistencies in financial reporting. For example, Radius Cloud receives stock as payment, making revenue recognition tricky. Valuing the stock is complicated by its fluctuating value, requiring judgment and estimation. The stock may need to be held for a certain period before its value can be realized.

According to the matching principle, the machine cost should be matched with the revenues it creates. Thus, the machine is depreciated over its 10-year useful life instead of being fully expensed in 2015. An adjusting entry would now be used to record the rent expense and corresponding reduction in the rent prepayment in June. The matching principle states that the cost of goods sold must be matched to the revenue. This revenue was generated by the sale of goods costing 4.00 a unit and therefore the cost of goods sold is 32,000 (8,000 units x 4.00). Companies should establish robust internal controls and policies to ensure accurate identification, recording, and allocation of expenses to revenues.