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The matching principle is a principle of accounting used to record revenues and expenses. It mandates that a company record expenses alongside earnings. Ideally, they should both occur at the same moment for the most precise tracking. This principle acknowledges that firms incur expenses in order to generate income.
What is the Matching Principle in the realm of accounting?
The matching principle is particularly crucial to the accrual accounting approach. The matching principle stipulates that comparable revenues and expenses should occur in the same period. This is done to establish a connection between the costs of an item or revenue and its benefits.
Illustration of Matching Principle
The expense must correspond to the period in which it occurred, not the period in which bills were paid. For instance, if a company pays sales representatives a 10% commission at the end of each month. If the company generates $50,000 in sales during the month of December, the commission of $5,000 will be paid in January of the following year.
Some companies adhere to the matching principle. On their December income statement, these companies detail commission expenses. Other businesses employ the cash method of accounting. In this instance, the commission is reported in January, which is the payout month. The option is to disclose the expense in December, when it was actually incurred.
In addition to commissions, additional examples of matching principles include:
- Depreciation
- Compensation
- Employee benefits
What benefits does the matching principle present?
Businesses largely adhere to the matching concept to guarantee financial statement consistency. Instances include the income statement, the balance sheet, etc.
Recognizing expenses at the incorrect time can significantly affect financial statements. It is possible for a company’s financial condition to be erroneous. The matching principle enables companies to avoid overstating profits for a given period.
For instance, identifying expenses early than necessary reduces net profits. Recognizing an expense after the fact may result in an inflated net income.
Using the matching concept is advantageous for certain financial aspects of a corporation. Long-term assets depreciate with time. The matching concept permits the distribution and matching of an item during its useful life in order to balance the cost over time.
What challenges does the matching principle present?
This idea is a useful tool when revenues and expenditures are distinct. However, costs may apply to many revenue streams or vice versa. When there is no clear relationship between expenses and revenues, account teams must develop estimations. For instance, you may purchase office supplies for your staff, such as pens, notebooks, and printer ink. These expenses are essential, yet they may not correlate with revenue.
Consider purchasing a new building for your firm on a greater scale. It is impossible to determine whether a larger space or a better location increases revenue. Are employees more productive? Is it simpler for clients to reach your establishment? There is no clear connection between these criteria and the construction of a new structure. As a result, firms frequently seek to stretch the cost of the construction over several years or decades.
A company invests $20 million on a new location with the hope that it will endure 10 years. The company then allocates $20 million in expenditures over a ten-year period. If there is a loan, the expense may include any associated fees and interest charges. This payment will continue even if the company spends the entire $20 million in advance.
