The matching principle is an international accounting principle, which means that all the revenues should be attributed to the period of sale, delivery of goods and provision of services and that only those expenses are recorded in the reporting period that led to the inflow of that money. The following rule applies here: if the costs incurred lead to future benefits, they are recorded as assets; if they lead to ongoing benefits – as expenses; if they do not lead to any benefits – as losses. Thus, its definition dictates that efforts be linked with accomplishments.
Why should a company adhere to the matching principle when recording transactions? It plays an important role in the accounting practice of any business and carries many benefits.
- Thanks to the matching principle, a consistency in financial statements is reached.
- This principle allows for real-time analysis of the financial expenses and revenues.
- Using this principle will show just how well the business has done financially and how effectively the company’s management has allocated its resources.
- The matching principle reinforces the accrual basis of accounting, which is required by the generally accepted accounting principles (GAAP).
Applying the principle
It is often difficult to determine whether a certain expense has resulted in current revenue. Therefore, there are special techniques used with the matching principle: the distribution of costs over time in a special way (e.g. the distribution of the initial cost of fixed assets through depreciation) and the allocation of costs in whole to the period.
Let us explain this principle in more detail:
- An expense is recognized after the income that was received as a result of expenses is recognized and earned. The cost of a product sold, for instance, is recognized as an expense in the income statement only after the proceeds from the sale of that product are recognized.
- If expenses cause income to be received over several reporting periods and the relationship between income and expenses cannot be clearly determined or determined indirectly, expenses are recognized by reasonably allocating them between periods.
- An item is recognized as an expense for the reporting period if the corresponding item will not bring future economic benefits to the organization or if the future economic benefits do not meet the criteria for reflecting the asset on the Balance sheet. So, for example, if at some point it becomes obvious that investments will never justify themselves, that is, the costs will not bring income at all, then the expense is recognized immediately in the current accounting period.
Note that due to different rules for calculating profit for tax purposes and financial reporting purposes, these two figures can differ significantly for the same company.
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Author: Charles Lutwidge