October 14, 2022 October 14, 2022/ Steven Bragg
The matching principle requires that revenues and any related expenses be recognized together in the same reporting period. Thus, if there is a cause-and-effect relationship between revenue and certain expenses, then record them at the same time. In some cases, it will be necessary to conduct a systematic allocation of a cost across multiple reporting periods, such as when the purchase cost of a fixed asset is depreciated over several years. If there is no cause-and-effect relationship, then charge the cost to expense at once.
This is one of the most essential concepts in accrual basis accounting, since it mandates that the entire effect of a transaction be recorded within the same reporting period. Doing so ensures that the reporting of profits is not artificially accelerated or delayed in any reporting period. Instead, when revenues are reported, all associated expenses are also reported at the same time.
Examples of the Matching Principle
Several examples of the matching principle are noted below, for commissions, depreciation, bonus payments, wages, and the cost of goods sold.
Matching Principle for Commissions
A salesman earns a 5% commission on sales shipped and recorded in January. The commission of $5,000 is paid in February. You should record the commission expense in January, so that the expense is recognized in the same month as the associated sale.
A company acquires production equipment for $100,000 that has a projected useful life of 10 years. It should charge the cost of the equipment to depreciation expense at the rate of $10,000 per year for ten years, so that the expense is recognized over the entirety of its useful life.
Matching Principle for Employee Bonuses
Under a bonus plan, an employee earns a $50,000 bonus based on measurable aspects of her performance within a year. The bonus is paid in the following year. You should record the bonus expense within the year when the employee earned it.
Matching Principle for Wages
The pay period for hourly employees ends on March 28, but employees continue to earn wages through March 31, which are paid to them on April 4. The employer should record an expense in March for those wages earned from March 29 to March 31.
Matching Principle for the Cost of Goods Sold
A company sells 50 units of a product for $5,000. The cost of the goods sold for these units is $2,000. The company should recognize the entire $2,000 cost as expense in the same reporting period as the sale, since the recognition of revenue and the cost of goods sold are tightly linked.
Accounting for the Matching Principle
Recording items under the matching principle typically requires the use of an accrual entry. An example of such an entry for a commission payment is:
| Debit | Credit | |
| Commission expense | 5,000 | |
| Accrued expenses | 5,000 |
In this entry, the commission expense is charged before the cash payment to the salesperson actually occurs, along with a liability in the same amount. In the following month, the company pays the commission, and records the following entry:
| Debit | Credit | |
| Accrued expenses | 5,000 | |
| Cash | 5,000 |
The cash balance declines as a result of paying the commission, which also eliminates the liability.
Advantages of the Matching Principle
There are several advantages to using the matching principle. 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. 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.
Disadvantages of the Matching Principle
There are situations in which using the matching principle can be a disadvantage. It requires additional accountant effort to record accruals to shift expenses across reporting periods. Doing so is moderately complex, making it difficult for smaller businesses without accountants to use. There are also cases in which there is no cause-and-effect relationship between revenues and expenses, making it difficult to decide whether to spread expense recognition across several reporting periods, and how much to charge to expense in each period. 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.
When to Use the Matching Principle
Because use of the matching principle can be labor-intensive, company controllers do not usually employ it for immaterial items. For example, it may not make sense to create a journal entry that spreads the recognition of a $100 supplier invoice over three months, even if the underlying effect will impact all three months. Instead, such small items are charged to expense as incurred. Doing so makes better use of the accountant’s time, and has no material impact on the financial statements.
Is the Matching Principle Used Under the Cash Basis of Accounting?
In short, no. 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.
October 14, 2022/ Steven Bragg/
There’s a common concept in business that you have to spend money to make money. The matching principle offers a way to recognize this idea in accounting. So, what is the matching principle in accounting, and when is it used?
Understanding the matching principle
The matching principle is part of the Generally Accepted Accounting Principles (GAAP), based on the cause-and-effect relationship between spending and earning. It requires that any business expenses incurred must be recorded in the same period as related revenues. In other words, it formally acknowledges that business must spend money in order to earn revenue.
Accrual accounting is based on the matching principle, which defines how and when businesses adjust the balance sheet. If there is no cause-and-effect relationship leading to future related revenue, then the expenses can be recorded immediately without adjusting entries.
How the matching concept in accounting works
The purpose of the matching principle is to maintain consistency across a business’s income statements and balance sheets. Here’s how it works:
Expenses are recorded on the income statement in the same period that related revenues are earned.
Liabilities are recorded on the balance sheet at the end of the accounting period.
Expenses not directly tied to revenues should be reported on the income statement in the same period as their use.
When expenses are recognized too early or late, it can be difficult to see where they result in revenue. This can potentially distort financial statements and give investors an unclear view of the overall financial position. For example, if you recognize an expense too early it reduces net income. On the other hand, if you recognize it too late, this will raise net income.
What is revenue recognition?
You could look at the matching concept in accounting as a blend of accrual accounting methods and the revenue recognition principle.
According to the revenue recognition principle, revenue must be recognized and recorded on the income statement when it’s earned or realized. Businesses don’t have to wait for the cash payment to be received to record this sales revenue. An example of revenue recognition would be a contractor recording revenue when a single job is complete, even if the customer doesn’t pay the invoice until the following accounting period.
Matching principle example
To better understand how this concept works in the real world, imagine the following matching principle example.
A cosmetics company uses sales representatives, who earn a 10% commission on their sales at the end of each month. For the month of November, the company earned $100,000 in sales, and they will pay their sales reps $10,000 in resulting commission fees in December.
According to the matching principle, both the commission fees (expenses) and cosmetic sales (related revenue) must be recorded in the same accounting period. This means that both should be recorded in the November income statement.
By contrast, if the company used the cash basis of accounting rather than accrual, they would record the revenue in November and the commission in December.
Matching principle benefits
There are several benefits to using the matching principle when preparing your financial statements:
Consistency across financial statements, including the balance sheet and income statement
Greater accuracy when representing the company’s financial position
Less chance of misstating profits during a particular accounting period
Depreciation costs can be distributed over time
Matching principle limitations
On the other hand, some businesses might choose the cash accounting method instead of accrual, in which case the matching principle might not be the best choice. There are some limitations to this concept, including the following:
More challenging when there is no direct cause-and-effect relationship between revenues and expenses
Doesn’t work as well when related revenue is spread out over time, as with marketing or advertising costs
Still, these are limited situations where it becomes more difficult to use. Overall, it’s a good idea to understand the matching principle for the purpose of day-to-day accounting.
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