In accordance with the expense recognition principle expenses are recorded in the period when the

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March 28, 2019

Matching principle is an accounting principle for recording revenues and expenses. It requires that a business records expenses alongside revenues earned. Ideally, they both fall within the same period of time for the clearest tracking. This principle recognizes that businesses must incur expenses to earn revenues.

Here’s everything you need to know about utilizing the matching principle in accounting:

Here’s What We’ll Cover:

What Is the Matching Concept in Accounting?

Example of Matching Principle

What Is Revenue Recognition Principle?

What Are the Benefits of Matching Principle?

What Are the Challenges of Matching Principle?

The principle is at the core of the accrual basis of accounting and adjusting entries. It is a part of Generally Accepted Accounting Principles (GAAP). The cause and effect relationship is the basis for the matching principle. If there’s no cause and effect relationship, then the accountant will charge the cost to the expense immediately.

What Is the Matching Concept in Accounting?

Matching principle is especially important in the concept of accrual accounting. Matching principle states that business should match related revenues and expenses in the same period. They do this in order to link the costs of an asset or revenue to its benefits.

Example of Matching Principle

The expense must relate to the period in which the expense occurs rather than on the period of actually paying invoices. For example, if a business pays a 10% commission to sales representatives at the end of each month. If the company has $50,000 in sales in the month of December, the company will pay the commission of $5,000 next January.

Some businesses follow the matching principle. These businesses report commission expenses on the December income statement. Other companies use a cash basis of accounting. In this case, they report the commission in January because it is the payment month. The alternative is reporting the expense in December, when they incurred the expense.

Apart from commissions, some other examples of matching principles are:

• Depreciation
• Wages
• Employee bonuses

What Is Revenue Recognition Principle?

The revenue recognition principle is another accounting principle related to the matching principle. It requires reporting revenue and recording it during realization and earning. This happens regardless of when they make a payment. In other words, businesses don’t have to wait to receive cash from customers to record the revenue from sales.

For example, if you’re a roofing contractor and have completed a job for a customer, your business has earned the fees. This is regardless of when the customer pays you for the job.

What Are the Benefits of Matching Principle?

Businesses primarily follow the matching principle to ensure consistency in financial statements. For example, the income statement, balance sheet, etc.

Recognizing expenses at the wrong time may distort the financial statements greatly. A business may end up with an inaccurate financial position of its finances. The matching principle helps businesses avoid misstating profits for a period.

For example, recognizing expenses earlier than is appropriate results in lower net income. Recognizing an expense later may result in a higher net income than actual. 

Certain financial elements of business also benefit from the use of the matching principle. Long-term assets experience depreciation. The matching principle allows distributing an asset and matching it over the course of its useful life in order to balance the cost over a period. 

For example, a piece of specialized equipment may cost $25,000. It may last for ten or more years, so businesses can distribute the expense over ten years instead of a single year.

What are the Challenges of Matching Principle? 

This principle is an effective tool when expenses and revenues are clear. However, sometimes expenses apply to several areas of revenue, or vice versa. Account teams have to make estimates when there is not a clear correlation between expenses and revenues. For example, you may purchase office supplies like pens, notebooks, and printer ink for your team. These items are necessary, but may not correlate to revenue.

On a larger scale, you may consider purchasing a new building for your business. There’s no way to tell if a larger space or better location improves revenue. Are employees more productive? Is it easier for customers to get to your business? There is no direct relationship between these factors and a new building. Because of this, businesses often choose to spread the cost of the building over years or decades. 

For example, a business spends $20 million on a new location with the expectation that it lasts for 10 years. The business then disperses the $20 million in expenses over the ten-year period. If there is a loan, the expense may include any fees and interest charges as part of the loan term. This disbursement continues even if the business spends the entire $20 million upfront. 

Another example includes online search ads. A marketing team crafts messages to entice potential customers to visit a business website. The customer may not make a purchase until weeks, months, or years later. But they planted a seed nonetheless. It’s not always possible to directly correlate revenue to spending in these cases. Expenses for online search ads appear in the expense period instead of dispersing over time.

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RELATED ARTICLES

Revenue recognition is a generally accepted accounting principle (GAAP) that identifies the specific conditions in which revenue is recognized and determines how to account for it. Typically, revenue is recognized when a critical event has occurred, when a product or service has been delivered to a customer, and the dollar amount is easily measurable to the company.

• Revenue recognition is a generally accepted accounting principle (GAAP) that stipulates how and when revenue is to be recognized.
• The revenue recognition principle using accrual accounting requires that revenues are recognized when realized and earned–not when cash is received.
• The revenue recognition standard, ASC 606, provides a uniform framework for recognizing revenue from contracts with customers.

Revenue is at the heart of all business performance. Everything hinges on the sale. As such, regulators know how tempting it is for companies to push the limits on what qualifies as revenue, especially when not all revenue is collected when the work is complete. For example, attorneys charge their clients in billable hours and present the invoice after work is completed. Construction managers often bill clients on a percentage-of-completion method.

Revenue accounting is fairly straightforward when a product is sold and the revenue is recognized when the customer pays for the product. However, accounting for revenue can get complicated when a company takes a long time to produce a product. As a result, there are several situations in which there can be exceptions to the revenue recognition principle.

Analysts, therefore, prefer that the revenue recognition policies for one company are also standard for the entire industry. Having a standard revenue recognition guideline helps to ensure that an apples-to-apples comparison can be made between companies when reviewing line items on the income statement. Revenue recognition principles within a company should remain constant over time as well, so historical financials can be analyzed and reviewed for seasonal trends or inconsistencies.

The revenue recognition principle of ASC 606 requires that revenue is recognized when the delivery of promised goods or services matches the amount expected by the company in exchange for the goods or services.

The revenue recognition principle, a feature of accrual accounting, requires that revenues are recognized on the income statement in the period when realized and earned—not necessarily when cash is received. Realizable means that goods or services have been received by the customer, but payment for the good or service is expected later. Earned revenue accounts for goods or services that have been provided or performed, respectively.

The revenue-generating activity must be fully or essentially complete for it to be included in revenue during the respective accounting period. Also, there must be a reasonable level of certainty that earned revenue payment will be received. Lastly, according to the matching principle, the revenue and its associated costs must be reported in the same accounting period.

On May 28, 2014, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) jointly issued Accounting Standards Codification (ASC) 606, regarding revenue from contracts with customers. ASC 606 provides a uniform framework for recognizing revenue from contracts with customers. The old guidance was industry-specific, which created a system of fragmented policies. The updated revenue recognition standard is industry-neutral and, therefore, more transparent. It allows for improved comparability of financial statements with standardized revenue recognition practices across multiple industries.

There are five steps needed to satisfy the updated revenue recognition principle:

1. Identify the contract with the customer.
2. Identify contractual performance obligations.
3. Determine the amount of consideration/price for the transaction.
4. Allocate the determined amount of consideration/price to the contractual obligations.
5. Recognize revenue when the performing party satisfies the performance obligation.

Generally accepted accounting principles (GAAP) require that revenues are recognized according to the revenue recognition principle, a feature of accrual accounting. This means that revenue is recognized on the income statement in the period when realized and earned—not necessarily when cash is received. The revenue-generating activity must be fully or essentially complete for it to be included in revenue during the respective accounting period. Also, there must be a reasonable level of certainty that earned revenue payment will be received. Lastly, according to the matching principle, the revenue and its associated costs must be reported in the same accounting period.

ASC 606 provides a uniform framework for recognizing revenue from contracts with customers. The old guidance was industry-specific, which created a system of fragmented policies. The updated revenue recognition standard is industry-neutral and, therefore, more transparent. It allows for improved comparability of financial statements with standardized revenue recognition practices across multiple industries.

The five steps needed to satisfy the updated revenue recognition principle are: (1) identify the contract with the customer; (2) identify contractual performance obligations; (3) determine the amount of consideration/price for the transaction; (4) allocate the determined amount of consideration/price to the contractual obligations; and (5) recognize revenue when the performing party satisfies the performance obligation.