Understanding the Matching Principle in Modern Accounting


The Matching Principle applies to all types of expenses, including cost of goods sold, salaries and wages, rent, utilities, and interest. For example, if a company pays an employee in December for work performed in January, the expense should be recognized in January, the period in which the work was performed. The matching principle states that the cost of goods sold must be matched to the revenue.

Matching Principle – Excel Model Template

Assume we have sold the goods to our customers amount $70,000 for the month of December 2016. In December 2016, the salesman could earn 2,000$, but the commission payment will be payable in January of the following year. Another example is that the salesman in your company could earn some commission due to their sales performance. Sometimes store can’t collect the money and have to write off the receivable as a bad debt because it will never be collected. An adjusting entry would now be used to record the rent expense and corresponding reduction in the rent prepayment in June. One of the most straightforward examples of understanding the matching principle is the concept of depreciation.

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The purpose of the matching principle is to maintain consistency in the core financial statements — in particular, the income statement and balance sheet. The matching principle also states that expenses should be recognized in a “rational and systematic” manner. This is the key concept behind depreciation where an asset’s cost is recognized over many periods. Businesses primarily follow the matching principle to ensure consistency in financial statements.

It purchases a large appliance from wholesalers for $5,000 and resells it to a local restaurant for $8,000. At the end of the period, Big Appliance should match the $5,000 cost with the $8,000 revenue. For example, a business spends $20 million on a new location with the expectation that it lasts for 10 years. The business then disperses the $20 million in expenses over the ten-year period. If there is a loan, the expense may include any fees and interest charges as part of the loan term.

If the revenue and cost of goods sold are increasing inconsistently, then neither of these two-figure probably have some problem. Double Entry Bookkeeping is here to provide you with free online information to download blank balance sheet templates help you learn and understand bookkeeping and introductory accounting. My Accounting Course  is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers. For example, if you’re a roofing contractor and have completed a job for a customer, your business has earned the fees. The cumulative benefits of LIFO relative to FIFO are known as the LIFO reserve. Get instant access to video lessons taught by experienced investment bankers.

Since the payroll costs can be directly linked back to revenue generated in the period, the payroll costs are expensed in the current period. Certain financial elements of business also benefit from the use of the matching principle. The matching principle allows distributing an asset and matching it over the course of its useful life in order to balance the cost over a period.

  • 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).
  • The matching principle also states that expenses should be recognized in a “rational and systematic” manner.
  • For instance, the direct cost of a product is expensed on the income statement only if the product is sold and delivered to the customer.
  • In the long run, it would also put American firms in those industries (like equipment manufacturing and oil and gas) in a worse position relative to international competitors.
  • Similarly, if a company incurs expenses to produce a product in December, those expenses should also be recognized in December, the period in which the revenue was generated.
  • Misjudging these criteria can result in overstated or understated liabilities, skewing the balance sheet.

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In most cases there are only two things accountants need to know in order get started with the principle, namely revenues and expenses. It can take a bit of expertise to isolate and allocate each of these, especially in more complex corporate settings, but once they’ve been set apart getting started is relatively straightforward. The accountant or other financial professional basically matches each financial gain to the costs it took to get there. As a concept it is used in many different settings to help professionals keep track of what is going in and what is coming out, and it can help companies and businesses make sound financial decisions.

  • The matching principle, a fundamental rule in the accrual-based accounting system, requires expenses to be recognized in the same period as the applicable revenue.
  • Businesses primarily follow the matching principle to ensure consistency in financial statements.
  • By applying the matching principle, these businesses ensure their financial statements offer a realistic portrayal of their financial position.
  • The principle is at the core of the accrual basis of accounting and adjusting entries.
  • For example, if a company uses a building to generate revenue, the cost of the building must be recognized over the useful life of the building and matched with the related revenue.

In short, the matching principle states that where expenses can be matched with revenues, we should do so because the benefits of an asset or revenue should be linked to the costs of that asset or revenue. 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. The LIFO inventory method allows companies to deduct the cost of inventory at the price of the most recently acquired items and assumes that the last inventory purchased is the first to be sold. It is important to match expenses with revenues because net income, i.e. the net amount earned in a period, is calculated by subtracting expenses from revenues.

Reflecting Two Philosophies of Income

While LIFO inventory accounting may be a less widely understood part of the tax code, it is a sound structural component and brings companies closer to deducting their real cost of goods sold (COGS). There are some exceptions to the Matching Principle, particularly when it comes to long-term assets and liabilities. For example, the cost of a long-term asset, such as a building or a piece of equipment, is typically recognized over the useful life of the asset, rather than in the period in which it was acquired. Similarly, long-term liabilities, such as bonds or loans, are typically recognized over the life of the liability.

Relationship With Business Transactions

Doing so is moderately complex, making it difficult for smaller businesses without accountants to use. For example, it can be difficult to determine the impact of ongoing marketing expenditures on sales, so it is customary to charge marketing expenditures to expense as incurred. Together with the time period assumption and the revenue recognition principle the matching principle forms a necessary part of the accrual 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. Suppose a business produces a faulty batch of 500 units of a product which sells for 6.00 a unit and costs 2.00 a unit.

The matching principle is one of the accounting principles that require, as its name, the matching between revenues and their related expenses. This means that the machine will produce products for at least 10 years into the future. According to the matching principle, the machine cost should be matched with the revenues it creates.

The Internal Revenue Code (IRC) includes provisions requiring the matching of income and expenses for tax purposes. Section 451, which deals with income recognition, and Section 461, covering deductions, emphasize the importance of consistent application of the matching principle. This is especially relevant for industries like construction, where the percentage-of-completion method allows revenue and expenses to be recognized as a project progresses rather than upon completion.

By allocating expenses related to long-term assets over time, the principle ensures consistent representation of assets’ book value. Deferred revenue and accrued liabilities are two balance sheet items heavily influenced by this principle. Deferred revenue, representing advance payments for goods or services yet to be delivered, must be matched with corresponding expenses. Similarly, accrued 4 inventory valuation methods used by ecommerce businesses liabilities, such as wages payable, are recognized when incurred, ensuring the balance sheet captures all obligations, even those not yet paid. The matching principle states that expenses should be recognized and recorded when those expenses can be matched with the revenues those expenses helped to generate. In this sense, the matching principle recognizes expenses as the revenue recognition principle recognizes income.

Matching Principle of Accounting Video Explanation

Expenses for online search ads appear in the expense period instead of dispersing over time. However, sometimes expenses apply to several areas of revenue, or vice versa. Account teams have to make estimates when there is not a clear correlation between expenses and revenues. For example, you may purchase office supplies generally accepted industry practices like pens, notebooks, and printer ink for your team.

This information can be used to make strategic decisions about pricing, marketing, and resource allocation. Administrative salaries, for example, cannot be matched to any specific revenue stream. One factor behind the decline of LIFO usage over time is the economy-wide shift away from goods and toward services. In the long run, it would also put American firms in those industries (like equipment manufacturing and oil and gas) in a worse position relative to international competitors. The corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits.


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