Matching Principle of Accounting

The matching principle means that the expenses entered into the debit side of the accounts should have a corresponding credit entry (as required by the double-entry bookkeeping system of accounting) in the same period, irrespective of when the actual transaction is made. All the expenses should be recorded in the period's income statement in which the revenue related to that expense is earned.

The matching principle of accounting dictates that expenses should be recognized in the same period as the corresponding revenue they generate. By aligning income and expenses, the matching principle ensures a more realistic portrayal of a company's profitability, facilitating smart decision-making and providing stakeholders with a transparent view of the financial health of the business.

The matching principle of the accounting system is, which follows a dual-entry bookkeeping system. Using this principle, the accounting system gives a very clear picture of mainly the company's current assets and current liabilities, which helps investors and other financial analysts understand the worth of the company and how well it is being operated. With the help of quite some ratios, the company's performance is determined, which helps investors decide on investments.

By adhering to the matching principle concept, companies aim to portray a realistic depiction of their profitability, steering away from distortions that might arise from recognizing expenses unrelated to the revenue generated in a given period.

This practice provides a more faithful representation of the financial health of the business, facilitating better decision-making by management and offering stakeholders a transparent view of the company's operations.

In practical terms, if a company incurs expenses to generate revenue in a specific accounting period, the matching principle ensures that these costs are recognized in the same period, even if the actual payment occurs later.

This principle is especially crucial in industries with extended revenue recognition cycles, as it guards against the misrepresentation of short-term financial performance. Ultimately, the matching principle upholds the integrity of financial statements, enhances comparability, and aids in evaluating the long-term sustainability and success of a business.

Let us understand the goals of these principles through the points below.

• The primary goal of the matching principle is to accurately measure a company's profitability by aligning expenses with the revenue they help generate.
• By matching expenses to the revenue, they contribute to generating, the matching principle prevents distortions in financial statements. This helps avoid the misrepresentation of a company's short-term financial performance.
• Promotes consistency in financial reporting by ensuring that costs are systematically allocated to the periods in which they are incurred. This consistency aids stakeholders in making reliable comparisons across different accounting periods.
• Facilitates informed decision-making by providing management with an accurate reflection of the costs associated with revenue generation. This enables executives to make strategic decisions based on a clear understanding of the company's financial performance.
• The matching principle of accounting upholds the accrual accounting method, emphasizing the importance of recognizing expenses when incurred rather than when the payment is made.
• Ultimately, the matching principle aims to enhance stakeholder trust by ensuring that financial statements present a true and fair view of a company's financial health.

Let us now understand the practicality of the matching principle of accounting through the examples below.

#1 - Accrued Expenses

For some work, you hired contract laborers and agreed to pay them $1000. The work is done in July. However, the laborers are paid in August. What is the cost accounted for in July?

This recording of such accrued expenses (irrespective of actual payment made or not) and matching it with the related revenue is known as the Matching Principle of accounting. Please note that in the matching principle of accounting, the actual payment date doesn’t matter; It is important to note when the work was done. In this case study, the work was completed in July.

#2 - Interest Expenses

Let us say that you borrow $100,000 from a bank to start your business. The annual interest that you agree to pay is, say, 5%. The interest payment is made at the end of the year in December. What is the interest expense accounted for in July?

You will pay a total interest of $100,000 x 5% = $5,000. It would help to match the interest expense to each month's revenue.

Interest expense to be recorded for 1 month (July) = $5000/12 = $416.6

#3 - Depreciation Expense

On July 1, let’s assume that you buy machinery worth $30,000, and its useful life is five years. How will you record expenses for this transaction in July?

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. Depreciation expense is required by the basic accounting principle known as the matching principle of accounting.

For recording depreciation expense as per the matching principle of accounting, you can calculate the yearly depreciation (straight line depreciation method) = 30,000/5 = $6000 per year. With this depreciation expense charged for July = $6000/12 = $500

Example #4

• John started a window washing services business on Dec 18^th by investing his equity of $10,000.
• He bought the tools required for the business, worth $3,000, on Dec 20^th.
• John hired two helpers who his company directly employs at the rate of $4,000/person/month as of Dec 21^st.
• He received a contract for window washing on Dec 22^nd to be performed on Dec 23^rd, for which the client paid him $500 on Dec 22^nd and would pay him the remaining $2,000 on Dec 27^th after the end of festivities.
• He received another contract on Dec 23^rd to be carried out on Jan 5^th, for which the client paid him $1,500 in advance.
• He paid salaries to the two helpers of $8,000 on Jan 2^nd, as the company pays its workers after the end of the month.

Now, we can prepare journal entries on Dec 31^st for the above example as per the illustration below:

• Hence it is seen from the illustration that the actual expense date for payment of wages is Jan 2^nd, but a temporary entry is made in the books of accounts on the Dec 31^st when it is supposed to be paid since it is the close of that month in which the helpers worked for John's company. If the complete entry is referred to regarding the wages to be paid, it is seen that the amount under Wages Payable gets netted off on Jan 2^nd after the actual transaction is made.
• Another matching principle example can be considered of the service income received on Dec 27^th. However, a temporary entry is made on Dec 22^nd since John received the contract on this date, and as on that day, he needs to show the supposed value of the transaction (even though the actual transaction takes place on a future date).
• Similarly, the contract to be carried out on Jan 2^nd is a future date event. However, the contract was received on Dec 23^rd, and cash was paid on this date. Hence it needs to be entered as of Dec 23^rd.

The matching principle concept is closely related to accrual accounting. Rather it requires the accrual system to be followed very stringently. The term “accrual” in accounting means anything accrued for a particular period until it gets paid on a future date.

Hence, this principle equates the total credits with total debits (or total expenses with the total income) as of a particular period. There are temporary account labels created like Wages Payable, Accounts Payable, Interest Payable, Accounts Receivable and Interest Receivable, etc., which get net off when the actual transaction is made.

These accounts hold no amount until and unless a new transaction is completed on a future date. So, the balance sheet generated after the actual transaction will not reflect these accounts, as the amount in these accounts gets net off with the supposed account. In the balance sheet, these accounts (if they have a reasonable amount entered) are listed under Current Assets or Current Liabilities based on the nature of the account.

A very good example of the accrual system is the coupon payment on bonds (or, for that matter, any investment which pays returns based on a particular frequency). The coupon to be paid by the bond issuer gets accumulated from the date of issue until paid. Hence, in the issuer's book of account, some amount pertains to the coupon to be paid to investors monthly. It is called the accrued interest for the investor (and has relative terms concerning other regular return-paying investments).

The matching principle and revenue recognition are actually interconnected. Together, they contribute to a more accurate and meaningful representation of a company's financial performance. However, we need to understand their implications to understand their intricacies completely.

Matching Principle

• Dictates that expenses should be recognized in the same period as the revenue they help generate.
• Aims to align the recognition of costs with the benefits derived, contributing to the accrual basis of accounting.
• Ensures a more accurate representation of a company's profitability by preventing the mismatch of expenses and revenue in financial statements.

Revenue Recognition

• It involves the proper accounting of revenue when it is earned and realizable, irrespective of when the payment is received.
• Complements the matching principle by ensuring that revenue is recognized in the period when it is earned and associated with the goods or services provided.
• Upholds the accrual accounting method, providing a more comprehensive and accurate portrayal of a company's financial performance over time.

This article has been a guide tto what is Matching Principle. Here we explain its goals, examples, significance, and compare it with revenue recognition. You may learn more about accounting from the below articles –

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