Matching Principle in AccountingDefined with Examples
The Matching Principle is an important accounting concept which states that revenues and expenses are recorded in the Income Statement on the same accounting period in which they occurred.
In the accrual basis of accounting, this is done by recording the transactions as they occur even when the actual cash from the revenue is not yet received or expenses are incurred but cash is not paid yet.
Examples of Matching Principle
When a company purchases machinery for their plant operations for $200,000 and is expected to generate revenue for the company for 10 years (useful life), the cost of the acquisition shall be. recorded as an expense over its useful life
For each year, the depreciation expense to be recorded is $20,000.
A Salesman was able to bring in $25,000 to the company for the year 2020 and is entitled to a $2,500 commission.
Even when the commission is paid in 2021, the commission expense should be recorded in 2021.
Employee bonuses depend on the performance of a company for a given period.
When companies are profitable, they are more inclined to give out bonuses to their employees.
Assuming the company has made considerable profit for the year 2020 and decided to give out a $1,000 bonus to all their employees, the bonus was paid only in the third month of the following year but was recorded in the books for the year 2020.
The bonus was recorded not for the year that the employees were paid but for the year that they earned it.
Journal Entry to Record the Accrual
In the commissions example above, the entry to record the commission expense earned by the salesman for the year 2020 is:
The Income Statement will show an increase of $2,500 due to the commissions while the Balance Sheet will also increase by $2,500 in Current Liabilities.
In 2021, when the commission is paid, the entry to record the payment is:
The payment will no longer have an impact on the Income Statement but will decrease both the payables and the cash account.
Benefits of the Matching Principle
When the company is able to match their expenses to the time when revenues are earned, it provides investors a clearer idea of the financial performance of the company and whether or not they are able operate efficiently.
The Matching Principle enables companies to be able to correctly record revenues as they are earned even when cash is not yet received and their corresponding expenses to be recorded even when they have not been paid yet.
When investors look at the financial statements of companies that accurately employ the matching principle, they look at reports that are connected and make sense.
Matching Principle is mostly concentrated on the Income Statement because it refers to the revenues and expenses.
However, when investors are looking at the Income Statement, the Cash Flow Statement should be looked at in conjunction with the Income Statement as well.
Accrual basis of accounting records revenues and expenses even when cash is not yet received or paid.
Looking at the cash flow, investors will be able to see whether there is enough cash to cover the company’s payables.
Challenges with the Matching Principle
Applying the matching principle is made easy when the revenues and expenses to be recorded are clear and easy to recognize.
But the challenge is when companies need to make estimates.
For example, a firm pays upfront in google ads for their marketing to work on improving the website search of the company to boost their revenues.
The problem with this is that when revenues come in through the ads, it will be difficult to match the expenses to when the revenue is earned from the ads.
Another example would be when a firm decides to expand operations and purchase a new factory with an expected useful life of 10 years for $5,000,000.
Over the course of its useful life, an annual depreciation expense of $500,000 will be recorded even when the firm makes revenue or not from the new factory.
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