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Definition and Examples of the Matching Principle

by Amelia 5 months ago in business
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Matching principle

To comply with proper accounting rules, financial statements must be calculated and prepared in a specific way when they are interpreted by firms. The matching principle is one such principle. To better prepare documentation with correct reporting, the matching concept must be used. We define the matching principle, explain its benefits, and provide instances of its application in this article.

What is the principle of matching?

A company's expenses and revenues must match in the same reporting period, according to the matching principle. In other words, expenses should be reported at the same time as revenue, not when they are paid. It's an accounting principle that any cause-and-effect link between expenses and revenues must be documented at the same time. The matching concept is part of the accrual accounting system because recording items necessitates accrual entry. This means that instead of being recorded when money is received, both are recorded as they are incurred. Investors can see consistency in a company's financial accounts by matching expenses and revenues. The two halves of the matching principle are as follows:

1. The price of a period

Period expenses are costs that are not tied to a product or are not directly associated with it. Period expenditures include commissions, rent, labour, and office supplies, to name a few. These expenses are documented as expenses on an income statement for the time period in which they occurred. If work is completed in January, for example, the expense should be recorded in January. This is true even if the expense isn't paid until the next month. Expenses must be reported at the time they are incurred, not when they are paid for.

2. The price of the product

The overall cost of acquiring and producing a product is known as the product cost. According to the matching principle, product costs must be recognised in the same timeframe as income. If a salesperson earns a commission on product sales, for example, they must pay consumers in December to cover all December costs connected with making and delivering the products.

The Matching Principle's Advantages

Using the matching concept has a number of advantages. Here are a few examples:

1. A fair distribution of resources

Assets are evenly distributed over time and matched to balance the cost because of the principle. This prevents assets from depreciating.

2. Reliable reporting

Another advantage is that the revenues and expenses were matched at the same time, resulting in more accurate reporting of a company's operating results.

3. A better understanding of the firm's profitability

Overall, the matching principle gives investors a normalised income state as well as streamlined data on a company's profitability and ability to function efficiently.

The matching principle's drawbacks

Along with its advantages, adopting the matching principle has one major drawback: it leads to erroneous reporting when estimations are utilised. In a similar vein, inflation can have an impact on how the matching principle is applied. Revenue is accrued based on current prices, while costs become outdated over time owing to variables like as depreciation.

Consider the following scenario: A bakery wants to expand its building because it believes it will benefit its business. Because there is no conclusive confirmation that the expansion would be helpful and lucrative, the bakery will deduct the total cost over the additional area's useful life. If the bakery costs $15 million and has a 15-year expected lifespan, the corporation will deduct $1 million in depreciation every year for the next 15 years. This means that costs will mount regardless of whether or not the bakery's expansion is profitable.

Examples of the principle of matching

Here are a few examples to help you understand the matching concept and its application:

Depreciation

Depreciation is the term used to describe the decline in value of an asset over time as a result of normal wear and tear. Here are some depreciation examples related to the matching principle:

example

In 2019, a corporation spends $10,000 on a new computer. The computer is anticipated to endure ten years, which means it will be able to generate initiatives for the next decade. The computer's pricing should then be matched to the revenue it generates for the company. In this case, the corporation should charge the computer's purchase price to a $1,000 annual depreciation expense, totaling ten years.

business

About the author

Amelia

We are one of the most well-known accountants in Croydon, with a diverse range of skills and experience that offers value to our clients. We've worked in commercial organisations and have firsthand business knowledge.

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