What Is The Matching Principle?

In other words, it formally acknowledges that business must spend money in order to earn revenue. It does matter what type of accounting method you employ when using the matching principle. Only the accrual accounting method is able to use the matching principle, since cash accounting does not use the revenue recognition principle that accrual accounting uses. In order to properly use the matching principle for your prepaid expenses, you will record a recurring journal entry in the amount of $1,250 each month for the next 12 months. For example, let’s say your company purchases inventory in January with the intention of selling it later in the year. Under the matching principle, you would not record the cost of the inventory as an expense in January.

• Because of this, businesses often choose to spread the cost of the building over years or decades.
• Not all costs and expenses have a cause and effect relationship with revenues.
• According to the matching principle, both the commission fees (expenses) and cosmetic sales (related revenue) must be recorded in the same accounting period.
• In order to properly account for these wages in the correct month (April), you will need to accrue payroll expenses in the amount of $4,150.

If Jim didn’t accrue the $900 in January, his sales of $9,000 would be reported in January, and the related commission expense would be reported in February. However, the commission payment will not be processed until the 15th of February. In order to abide by the matching principle, Jim or his accountant will need to accrue the $900 expense in January, and later reverse the commission expense in February, after it’s been paid.

Benefits of the Matching Principle

The matching principle allows for consistency in financial reporting, working off the premise that business expenses are required in order to generate revenue. In conclusion, the matching principle is an important part of accounting that all business owners should be aware of. By adhering to this principle, you will get a more accurate picture of your business’ profitability and make your financial statements more comparable to tother businesses in your industry. To illustrate the matching principle, let’s assume that a company’s sales are made entirely through sales representatives (reps) who earn a 10% commission. The commissions are paid on the 15th day of the month following the calendar month of the sales. For instance, if the company has $60,000 of sales in December, the company will pay commissions of $6,000 on January 15.

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Hence, the matching principle may require a systematic allocation of a cost to the accounting periods in which the cost is used up. According to the revenue recognition principle, revenue must be recognized and recorded on the income statement when it’s earned or realized. Businesses don’t have to wait for the cash payment to be received to record this sales revenue. An example of revenue recognition would be a contractor recording revenue when a single job is complete, even if the customer doesn’t pay the invoice until the following accounting period.

It requires reporting revenue and recording it during realization and earning. In other words, businesses don’t have to wait to receive cash from customers to record the revenue from sales. The matching principle is the accounting rule that requires expenses to be matched with revenues. This means that expenses must be recognized in the same period as the revenues they help generate.

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Depreciation expense reduces income for each period that the expense is recorded. This accrual reflects the correct amount of payroll expenses for the month of April. This entry will What Is The Matching Principle And Why Is It Important? need to be reversed in May, or May payroll expenses will be overstated. Designed to be used with accrual accounting, the matching principle is never used in cash accounting.

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Because of this, businesses often choose to spread the cost of the building over years or decades. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. Now, if we apply the matching principle discussed earlier to this scenario, the expense must be matched with the revenue generated by the PP&E.

One example of the matching principle is when a company records the cost of an asset over its useful life. This matches the expense of the asset with the revenues that it generates. Company XYZ sales are made by sales representatives who take a 10% commission. The commissions are paid in the middle of each month, i.e. 15th day of each month. The company sales are $80,000 in March 2020 and the total commissions paid on 15th March amount to $8,000 out of which $3,000 are related to the previous month. By contrast, if the company used the cash basis of accounting rather than accrual, they would record the revenue in November and the commission in December.

The matching principle is a key accounting concept that requires expenses to be matched with revenues. This means that when revenue is earned, the related expenses must also be incurred in order to show the true profitability of a company. The matching principle is important because it provides accurate information about a company’s financial performance. The matching principle is a fundamental accounting concept which states that expenses should be matched with the revenue they are related to when preparing financial statements. This helps ensure accuracy and allows businesses to more accurately track their performance over time. If you’ve ever studied accounting, you’re likely familiar with the concept of the matching principle.