The matching principle is an accounting principle which states that expenses should be recognised in the same reporting period as the related revenues. Track and manage your expenses and revenues all in one place with Debitoor invoicing and accounting software. Try it free for 7 days. In practice, the matching principle combines accrual accounting (wherein
revenues and expenses are recorded as they are incurred, no matter when cash is received) with the revenue recognition principle (which states that revenues should be recognised when they are earned or realised, no matter when cash is received). The matching principle is not used in cash accounting, wherein revenues and expenses are only recorded when cash changes hands. The matching principle a basic accounting principle that is adhered to in order to ensure consistency in a company's financial statements: i.e. the income statement, balance sheet, etc. If expenses are
recognised at the wrong time, the financial statements may be greatly distorted: in turn jeopardising the quality of the statements and providing an inaccurate representation of the financial position of the business. For example:
Benefits of the matching principleCertain business financial elements benefit from the use of the matching principle. Assets (specifically long-term assets) experience depreciation and the use of the matching principle ensures that matching is spread out appropriately to balance out the incoming cash flow. The matching principle allows an asset to be distributed and matched over the course of its useful life in order to balance the cost over a given period. Matching and DebitoorDebitoor has aimed to make matching as simple as possible by automating the process. By subscribing to one of our larger plans you can upload a bank statement that will then match each payment to the corresponding invoice or expense. If you connect your PayPal Business account, each payment will be recorded directly to your Debitoor account and matched automatically. What is the Expense Recognition Principle?The expense recognition principle states that expenses should be recognized in the same period as the revenues to which they relate. If this were not the case, expenses would likely be recognized as incurred, which might predate or follow the period in which the related amount of revenue is recognized. This principle also has an impact on the timing of income taxes. In the example, income taxes will be underpaid in the current month, since expenses are too high, and overpaid in the following month, when expenses are too low. Some expenses are difficult to correlate with revenue, such as administrative salaries, rent, and utilities. These expenses are designated as period costs, and are charged to expense in the period with which they are associated. This usually means that they are charged to expense as incurred. When to Use the Expense Recognition PrincipleThe expense recognition principle is a core element of the accrual basis of accounting, which holds that revenues are recognized when earned and expenses when consumed. If a business were to instead recognize expenses when it pays suppliers, this is known as the cash basis of accounting. If a company wants to have its financial statements audited, it must use the expense recognition principle when recording business transactions. Otherwise, the auditors will refuse to render an opinion on the financial statements. Example of the Expense Recognition PrincipleA business pays $100,000 for merchandise, which it sells in the following month for $150,000. Under the expense recognition principle, the $100,000 cost should not be recognized as expense until the following month, when the related revenue is also recognized. Otherwise, expenses will be overstated by $100,000 in the current month, and understated by $100,000 in the following month. In accrual accounting, the matching principle instructs that an expense should be reported in the same period in which the corresponding revenue is earned, and is associated with accrual accounting and the revenue recognition principle states that revenues should be recorded during the period in which they are earned, regardless of when the transfer of cash occurs. By recognizing costs in the period they are incurred, a business can see how much money was spent to generate revenue, reducing "noise" from timing mismatch between when costs are incurred and when revenue is realized. Conversely, cash basis accounting calls for the recognition of an expense when the cash is paid, regardless of when the expense was actually incurred.[1] If no cause-and-effect relationship exists (e.g., a sale is impossible), costs are recognized as expenses in the accounting period they expired: i.e., when have been used up or consumed (e.g., of spoiled, dated, or substandard goods, or not demanded services). Prepaid expenses are not recognized as expenses, but as assets until one of the qualifying conditions is met resulting in a recognition as expenses. Lastly, if no connection with revenues can be established, costs are recognized immediately as expenses (e.g., general administrative and research and development costs). Prepaid expenses, such as employee wages or subcontractor fees paid out or promised, are not recognized as expenses; they are considered assets because they will provide probable future benefits. As a prepaid expense is used, an adjusting entry is made to update the value of the asset. In the case of prepaid rent, for instance, the cost of rent for the period would be deducted from the Prepaid Rent account.[2] Expense vs. cash timing[edit]Two types of balancing accounts exist to avoid fictitious profits and losses that might otherwise occur when cash is paid out not in the same accounting periods as expenses are recognized, because expenses are recognized when obligations are incurred regardless when cash is paid out according to the matching principle in accrual accounting. Cash can be paid out in an earlier or later period than obligations are incurred (when goods or services are received) and related expenses are recognized that results in the following two types of accounts:
Accrued expenses is a liability with an uncertain timing or amount, but where the uncertainty is not significant enough to qualify it as a provision. An example is an obligation to pay for goods or services received from a counterpart, while cash for them is to be paid out in a later accounting period when its amount is deducted from accrued expenses. It shares characteristics with deferred income (or deferred revenue) with the difference that a liability to be covered latter is cash received from a counterpart, while goods or services are to be delivered in a latter period, when such income item is earned, the related revenue item is recognized, and the same amount is deducted from deferred revenues. Deferred expenses (or prepaid expenses or prepayment) is an asset, such as cash paid out TO a counterpart for goods or services to be received in a latter accounting period when fulfilling the promise to pay is actually acknowledged, the related expense item is recognized, and the same amount is deducted from prepayments. It shares characteristics with accrued revenue (or accrued assets) with the difference that an asset to be covered latter are proceeds from a delivery of goods or services, at which such income item is earned and the related revenue item is recognized, while cash for them is to be received in a later period, when its amount is deducted from accrued revenues. Examples[edit]
Accrued expenses[edit]For example, goods supplied by a vendor in one accounting period, but paying for them in a later period results in an accrued expense that prevents a fictitious increase in the receiving company's value equal to the increase in its inventory (assets) by the cost of the goods received, but unpaid. Without such accrued expense, a sale of such goods in the period they were supplied would cause that the unpaid inventory (recognized as an expense fictitiously incurred) would effectively offset the sale proceeds (revenue) resulting in a fictitious profit in the period of sale, and in a fictitious loss in the latter period of payment, both equal to the cost of goods sold. Period costs, such as office salaries or selling expenses, are immediately recognized as expenses (and offset against revenues of the accounting period) also when employees are paid in the next period. Unpaid period costs are accrued expenses (liabilities) to avoid such costs (as expenses fictitiously incurred) to offset period revenues that would result in a fictitious profit. An example is a commission earned at the moment of sale (or delivery) by a sales representative who is compensated at the end of the following week, in the next accounting period. The company recognizes the commission as an expense incurred immediately in its current income statement to match the sale proceeds (revenue), so the commission is also added to accrued expenses in the sale period to prevent it from otherwise becoming a fictitious profit, and it is deducted from accrued expenses in the next period to prevent it from otherwise becoming a fictitious loss, when the rep is compensated. Deferred expenses[edit]A Deferred expense (prepaid expenses or prepayment) is an asset used to costs paid out and not recognized as expenses according to the matching principle. For example, when the accounting periods are monthly, an 11/12 portion of an annually paid insurance cost is added to prepaid expenses, which are decreased by 1/12 of the cost in each subsequent period when the same fraction is recognized as an expense, rather than all in the month in which such cost is billed. The not-yet-recognized portion of such costs remains as prepayments (assets) to prevent such cost from turning into a fictitious loss in the monthly period it is billed, and into a fictitious profit in any other monthly period. Similarly, cash paid out for (the cost of) goods and services not received by the end of the accounting period is added to the prepayments to prevent it from turning into a fictitious loss in the period cash was paid out, and into a fictitious profit in the period of their reception. Such cost is not recognized in the income statement (profit and loss or P&L) as the expense incurred in the period of payment, but in the period of their reception when such costs are recognized as expenses in P&L and deducted from prepayments (assets) on balance sheets. Depreciation[edit]Depreciation is used to distribute the cost of the asset over its expected life span according to the matching principle. If a machine is bought for $100,000, has a life span of 10 years, and can produce the same amount of goods each year, then $10,000 of the cost (i.e. $100,000/10 years) of the machine is matched to each year, rather than charging $100,000 in the first year and nothing in the next 9 years. So, the cost of the machine is offset against the sales in that year. This matches costs to sales and therefore gives a more accurate representation of the business, but results in a temporary discrepancy between profit/loss and the cash position of the business. References[edit]
See also[edit]
What accounting principle states that expenses and revenues must be recorded in the same period in which they occur?Matching principle is an accounting principle for recording revenues and expenses. It requires that a business records expenses alongside revenues earned. Ideally, they both fall within the same period of time for the clearest tracking. This principle recognizes that businesses must incur expenses to earn revenues.
What principle states that the timing of expenses be identified to the period in which they are incurred as opposed to when they are actually paid?The expense recognition principle states that expenses should be recognized in the same period as the revenues to which they relate. If this were not the case, expenses would likely be recognized as incurred, which might predate or follow the period in which the related amount of revenue is recognized.
What is the prudence principle?Prudence is an accounting practice that goes beyond the common sense of being fiscally conservative. It is the practice of ensuring that the company is not overvalued by preventing the income and assets from being overstated in the company's reporting.
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Which accounting principle states that expenses must be recorded in the same period as the income to which they correspond?
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