The matching principle accounting uses is a guideline that states that expenses and revenues record together based on the period they happen. Regardless of whether the business defines the period as a year, quarter, or month, they should all reconcile together.
1. What Is the Matching Principle in Accounting?
The matching principle is an accounting term that dictates that expenses should be recorded in the same period as their related revenues. In a way, this is an organizational method of accounting than the standard cash accounting method. The expense recognition principle matches the matching principles well.
There are some terms to understand first before the matching principle starts to make sense:
- Accrual method: A method of accounting that recognizes income as when work finishes, not on the receipt of cash
- Cash method: A method of accounting that treats cash receipt as income, not the completion of work
- Expense: Costs associated with the operations of a business need to generate revenue
- Revenue: Income generated by business activities
- Journal entry: An entry into a log of expenses and revenues into their appropriate accounts during an accounting period.
With these definitions, it’s clear that the matching principle needs a business to follow an accrual method to use it. If the business can’t record the entire log of expenses and revenues for a process, the matching principle does not work because the time scale isn’t known.
2. Examples of the Matching Principle
Accountants need an accrual entry to use the matching principle. Without this accrual entry, the matching principle is incomplete. A lack of defined revenues and expenses means that accrual entries cant exist. To better understand this principle, here are some examples of how the matching principle forms a complete accrual entry:
Wages
The recorded payroll should go into an April wages accrual entry when a pay period ends but the payday isn’t until a later month. This way, the wages earned by your employees show in your accounting logs that they were acquired in the previous month.
When the next payday arrives, these values will need to be assessed to see that overstatements don’t occur.
Depreciation
Depreciation is the loss of value in an asset over time. Since business assets tie into revenue streams, their depreciation over time will need to be linked to those revenues the assets assist in.
For example, there might be some moving parts that erode over time see use in the production of goods. As those parts help generate revenue, accountants recorded the depreciation alongside revenue. This practice accounts for the loss in value for the asset over time.
Commissions for Sales
Sales teams tend to be paid both a salary and a commission. These commissions should be recorded at the same time as the sales that the sales team makes. This way, their commissions track alongside the revenues brought into the company.
Prepaid Expenses
Predictable, ongoing expenses such as rents, service fees, or license fees paid out in full at the beginning of the year or preset period. While it might be easier to log these expenses at the beginning of the period as one lump sum, breaking that expense across the revenue generated during the period is more accurate.
3. What is the Revenue Recognition Principle?
The revenue recognition principle is an accounting principle that states that revenue should be recorded and treated as earned by the business regardless of which cash transactions occur. This way, the record of the revenue for the project or period it is associated with exists.
For example, if a project for a client has been completed and delivered, but the client hasn’t paid yet, it’s acceptable to record that revenue for the project. Your business will be able to note that revenue and route it as needed once it arrives. By setting this revenue ahead of time, the journal entries stay up to date ahead of time.
4. Benefits of the Matching Principle
The main benefit of using the matching principle is to create consistent finance reporting for the business. Loading together expenses in one month might skew perception to where those reviewing the finances think that the beginning of the year is overly expensive or that one quarter did far better than it should have.
This benefit is essential for businesses with third parties that they report their finances to, such as boards or shareholders. These individuals want to see consistent growth or proof that the company isn’t failing. Grouping together expenses in one month gives a false impression that things aren’t being managed well.
Finally, the matching principle is the best way to account for asset depreciation and maintenance costs within their associated revenue streams. The prices are built into the revenue stream rather than setting a general maintenance budget to use on projects as needed. By doing this practice, the money is available when needed to fix issues when they come up.
5. Challenges With the Matching Principle
It’s easiest to use the matching principle when there is a direct link between revenues and expenses in a certain timeframe. Salaries, maintenance costs, and recurring expenses track back to their associated revenue streams. But, some of these expenses don’t have this link.
For example, it’s not possible to make revenue predictions when opening up a new location. The new location could do well, poor, or somewhere between. Instead, the recorded expense of this new location would be an ongoing expense and have no revenue known.
Marketing budgets can be hard to match, as well.
While online ads can lead to sales, it’s hard to know how much in sales one ad will bring. Instead, this budget would again be a recorded expense with no known cost. Marketing analytics at a later date could provide an estimate, but knowing the values is tough in the beginning.
Conclusion
Now you’ll know what is the matching principle for everyday use. If your business can use the accrual method of accounting, then the matching principle is necessary to keep journal entries coherent. For businesses that don’t have a dedicated finance team, this can be an arduous task. These businesses might need to find an accountant that can help them sort through their finances and match everything appropriately.