Why the Matching Principle is Important for Small Businesses

Being a part of GAAP – Generally Accepted Accounting Principles, the matching principle determines the causal relationship between spending and earnings. Expenses incurred for business operations (business expenses) must be accounted for in the same period as revenue derived from those operations. The matching principle is why companies under GAAP use accrual accounting. The Matching Principle applies to all types of expenses, including cost of goods sold, salaries and wages, rent, utilities, and interest. For example, if a company pays an employee in December for work performed in January, the expense should be recognized in January, the period in which the work was performed.

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In other words, you don’t need an industrial-grade eraser to make an entry. Another tool from Deskera is Deskera People that aims to expedite your regular tasks. Tasks like hiring, payroll, leaves, attendance, etc. are now a breeze owing to the tool. Dropshipping it equipment business owners can now expect to relax a bit with the platform making it convenient for them to create drop ship orders based on customer orders. Deskera also offers out-of-the-box templates that tend to uncomplicate your job with well-designed features.

Cash Flow Statement

By matching expenses with the related revenue, the Matching Principle ensures that a company’s income statement accurately reflects its profitability in a given period. If expenses were recognized in a different period than the related revenue, the income statement would not accurately reflect the company’s profitability. The requirement for this concept is the allocation of cost to different accounting periods so that only relevant incomes and expenses are matched. This comparison will give the net profit or loss for that particular accounting period. If an expense is not directly tied to revenues, the expense should be reported on the income statement in the accounting period in which it expires or is used up.

What is the Matching Principle in Accounting? [Explained]

For instance, the direct cost of a product is expensed on the income statement only if the product is sold and delivered to the customer. Like the payroll accrual, this entry will need to be reversed in May, when the actual commission expense is paid. However, the commissions are not due to be paid until May, so you will need to accrue the $4,050 for the month of April since the expense is clearly tied to the sales revenue that was earned in April. However, the commission payment will not be processed until the 15th of February.

Accounting Concepts: Matching Made Easy

For the matching principle, we relate this to the period when a product or service is recognized as being sold (revenue recognition). The matching principle applies a combination of accrual accounting as well as the concept of revenue recognition. Accrual, on the other hand, is when you recognize assets and liabilities as soon as they are incurred regardless of when cash payments occur or when cash receipts are received. If you are stuck on this point, then it may be worth reviewing the accrual accounting definition and example. The matching principle, then, requires that expenses should be matched to the revenues of the appropriate accounting period and not the other way around. – Bajor Art Studio produces picture frames and sells them to wholesalers like Michaels and Hobby Lobby.

  1. An adjusting entry would now be used to record the sales commission expense and corresponding liability in March.
  2. An example is a commission earned at the moment of sale (or delivery) by a sales representative who is compensated at the end of the following week, in the next accounting period.
  3. The matching principle in accounting is one of the basic fundamental principles in Generally Accepted Accounting Principles (“GAAP”).
  4. Both adjusted entries and the matching principle help organize information already in your books.
  5. If there’s no cause and effect relationship, then the accountant will charge the cost to the expense immediately.
  6. In the month of January, Jim’s business had sales of $9,000, which means that Jim owes his salespeople $900 in commissions for January.

When you employ the cash basis of accounting, the principle is disregarded. Because revenue recognition and the cost of goods sold are so closely related, the corporation should recognize the entire $4,000 cost as an expense in the same reporting period as the sale. There isn’t always a cause-and-effect relationship between costs and revenues. As a result of the principle, a systematic allocation of a cost to the accounting periods in which the cost is used up may be required. Suppose a business has a product which sells for 10.00 a unit and costs 4.00 a unit.

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Together with the time period assumption and the revenue recognition principle https://www.business-accounting.net/ forms a necessary part of the accrual basis of accounting. The alternative method of accounting is the cash basis in which revenue is recorded when received and expenses are recorded when paid. Not all costs and expenses have a cause and effect relationship with revenues. Hence, the matching principle may require a systematic allocation of a cost to the accounting periods in which the cost is used up. Hence, if a company purchases an elaborate office system for $252,000 that will be useful for 84 months, the company should report $3,000 of depreciation expense on each of its monthly income statements. The matching principle or matching concept is one of the fundamental concepts used in accrual basis accounting.

In order to abide by the matching principle, Jim or his accountant will need to accrue the $900 expense in January, and later reverse the commission expense in February, after it’s been paid. Jim currently employs two sales people, who receive a 10% commission on sales each month. In the month of January, Jim’s business had sales of $9,000, which means that Jim owes his salespeople $900 in commissions for January.

Because the items generated revenue, the local shop will match the cost of $1,000 with the $6,000 of revenue at the end of the accounting period. So, the expense and the revenue will be booked in September, when the revenue was generated. The revenue recognition principle states that the businesses recognize and record revenue when it is earned irrespective of when they receive the payment. Consequently, the company does not have to wait for the payment from the clients to record and recognize the revenue. When it comes to accounting, the matching principle is often considered synonymous with accrual basis accounting. However, these two terms are not interchangeable and have distinct meanings.