The Matching Principle
The concept of matching in accounting and finance is based on the relationship of the revenue and expense that demonstrate the cause and effect relationship between them. It requires to match the costs incurred in a specific time period with the revenue of that time period.
The matching principle is one of the fundamental concepts of accrual accounting. The accrual accounting concept recognizes income at the time when it is earned and recognizes the expense when it is incurred; used, or consumed. Both of the accounting guidelines; IFRS and GAAP recommend accrual accounting to record the revenue and expense of an organization. Because it provides a clear and accurate view of the business operations and revenue earned of the company. It helps shareholders, creditors, and other stakeholders to understand and predict the company's financial performance.
We might say that the concept of accrual accounting stems from the matching principle. The principle states that "all the expenses incurred in a specific time period must be recognized in the income statement of that time period in which the income is earned".
Application of Matching Principle
Some of the applications of the matching principle in accounting are listed below:
- The deferrals of prepaid expenses and accrued expenses are charged to the revenue of the current period.
- The recognition of depreciation of the property, plant, and equipment with the revenue of the period in which they are utilized for generating revenue.
- The recognition of the cost of goods sold under the revenue earned in a specific financial period. It requires matching the manufacturing or inventory cost of the product with the revenue of the financial period when it is sold.
- the matching of tax expense with the taxable income of the specific period that sometimes results in little differences and creates deferred taxes. FAS 109 (Accounting for income taxes) and IAS 12 (Income taxes) requires accounting for taxable income.
Example of Matching Principle
Assume that ABC Company has purchased an insurance policy of €1200 for a year on the June 5th, 2020. At the year-end (so December 2020), the company earned €100.000.
Although the company purchased an insurance policy for 12 months in 2020, it will report the insurance policy used for 7 months in the income statement. Because the entire insurance policy has not been used in the year 2020. Only the used portion of the insurance will be matched with the income of the year. Let's see a demonstration in the following table.
Book: Principles of Accounting Volume 1 - Financial Accounting (2019) by Mitchell Franklin, Patty Graybeal, Dixon Cooper
Book: Accounting: The basis for business decisions - 11th edition by Robert F. Meigs, Jan R. Williams, Susan F. Haka, and Mark S. Bettner
Article: Accrual Accounting Concept in IFRS and GAAP by Finance Train.