Matching principle is one of the basic accounting principles, which requires that revenues earned and expenses incurred to earn those revenues should be matched and recorded in the same accounting period. This principle is also stemmed from the fundament accrual concept of accounting and aims at achieving accuracy in financial reporting.
As required by accrual based accounting, revenues should be recorded when earned as further elaborated in the revenue recognition principle. To earn revenues, an entity must incur some expenses. Matching principle requires that the expenses incurred to earn the recognized revenue must also be recorded and reported in the same accounting period so that net profit or loss is accurately calculated. Only then the income statement will be giving a true and fair view of the financial performance of an entity. For instance, a company has established a policy to announce bonuses and commissions based on annual sales. Although these bonuses and commission are most likely to be paid in the next year, but as they are related to the sales of current year, so an accrual of such bonus and commission expense should be recorded using adjusting entries.
Let’s take a look at some examples related to matching principle.
- At the end of an accounting period, a company which is involved in providing IT services to its customers has completed a small project and earned $80,000. The Company outsourced some of the components of this project to a consultant at a fee of $20,000. At the reporting date, consultant has not issued invoice to the company. In this case, neither invoice has been received, nor payment is made to the consultant but as the company has earned the revenue and incurred related consultancy cost which can be measured reliably, so an accrual of $20,000 consultancy expense should be recorded in the current accounting period as per matching principle.
- A company which is involved in retail business earned revenue of $250,000 in an accounting period. It had no opening inventory, made purchases of $150,000 out of which inventory worth $20,000 was still in the warehouse and was not sold. So to match the revenue earned, only that portion of inventory should be charged as cost of sales in the income statement that has been consumed, i.e. cost of sales should be $130,000 ($150,000 – $20,000). This balance of $20,000 will be charged as expense in income statement in the next accounting period when this inventory will be sold and related revenue will be recognized.