Matching Principle Concept in Accounting
One of the fundamental underlying principles in accounting is the matching principle. According to the matching principle, a corporation must disclose a cost on its income statement in the same period that the relevant revenues are collected.
At the end of the accounting period, it also creates a liability on the balance sheet. The matching concept is linked to the accrual accounting basis and adjusting entries.
Example of Matching Principle
The expenditure must be related to the time in which the expense happens rather than the period in which invoices are paid. For example, suppose a company pays a 10% commission to sales representatives at the end of each month.
If the firm makes $50,000 in sales in December, the $5,000 commission will be paid in January of the following year.
Advantages of Matching Principle
- The matching principle is a component of the accrual accounting technique, which provides a more accurate picture of a company’s operations on the income statement.
- Investors like to see an income statement that is smooth and normalized, with revenues and expenses linked together, rather than one that is irregular and unconnected. By combining them, investors have a better understanding of the business’s underlying economics.
- It should be noted, though, that the cash flow statement should be viewed in combination with the income statement. If the firm reported larger accounts payable liability in a month, there may not be enough cash on hand to fulfill the payment. As a result, investors pay close attention to the company’s cash position and cash flow timing.
Disadvantages of Matching Principle
On the other hand, some businesses may prefer cash accounting over accrual, in which case the matching principle may not be the best option. This notion has some drawbacks, including the following:
- When there is no direct cause-and-effect link between income and costs, it becomes more difficult.
- When linked revenue is stretched out across time, such as with marketing or advertising expenditures, it does not function as effectively.
However, these are only a few instances when it gets more difficult to utilize. Overall, understanding the matching concept is beneficial for day-to-day accounting.
Matching Principle and Revenue Recognition
Accounting matching may be thought of as a combination of accrual accounting systems and the revenue recognition principle.
According to the revenue recognition principle, revenue must be recognized and reflected on the income statement when it is generated or realized. Businesses are not required to wait for a cash payment before recording sales income.
A contractor recognizing revenue after a single task is completed, even though the client does not pay the invoice until the next accounting period, is an example of revenue recognition.
Matching Principle and Expense Recognition
The expense recognition principle is a fundamental accounting theory that states that company expenses should be recognized at the same time as the revenues connected with those expenses (and vice versa).
This is also known as the matching principle, and it is the most fundamental principle of accrual accounting.
The expense recognition principle is significant because revenue and expenses do not necessarily occur in the same period under cash accounting – salaries may be paid for labor completed in a previous period, or supplies may be purchased for activities that will generate revenue later.
Importance of Matching Principle Concept
The matching concept’s goal is to prevent undervaluing profits for a given time.
This idea is mostly used by commercial organizations to determine the genuine profit or loss during an accounting period.
This results in either an overestimation or an underestimate of profit or loss, which may not reflect the real efficiency of the firm and its operations during the relevant accounting period.
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