Matching Principle – Definition
Matching principle of accounting is a natural extension of the accounting period principle. Since performance must be measured in terms of a period, it is important that revenues and costs that are included in the income statement of a particular period do really belong to that period and correspond to each other.
If we include any revenue in a particular period, we should be sure that:
- it has been earned in the period in whose income statement it has been included. This means that all resources needed to earn this revenue have been used, all steps needed to earn this revenue have been taken and there is no apparent reason for this revenue not being received by the business.
- Whatever costs have been incurred for the purpose of earning that revenue is included in the expenses for the period in which the credit for the income is taken.
According to the matching principle of accounting, the incomes or revenues of a particular period must be matched with the expenses of that particular period. Most of the businesses record their revenues and expenses on an annual basis which means regardless of their time of receipts of payments. The requirement of this concept is the allocation of cost on different accounting periods so that only relevant incomes and expenses are matched. This comparison will give the net profit or loss for that particular accounting period.
The realization and accrual concepts are essentially derived from the need to match expenses with revenues earned during an accounting period. Since all transfer of goods are considered to be sales for the period during which such transfers take place, we have to carefully trace the expenses for producing the goods actually sold, if we are to determine the profit earned out of such sales. In other words, the earnings or revenues and the expenses shown in an income statement must both refer to the same goods transferred or services rendered to customers during the accounting period.
Sometimes expenditures are incurred either in advance or subsequent to the accounting period even though they relate to expenses for goods or services sold during the current accounting period. In such cases, the careful determination of such expenses has to be made and appropriate adjustments will require to be made in order to determine the proper profits (or loss) for the current accounting period.
The matching principle, then, requires that expenses should be matched to the revenues of the appropriate accounting period and not the other way around. Consequently, the first step must be to determine what are the revenues earned during a particular accounting period and then to determine the expenses incurred in order to generate or earn the revenues during that accounting period.
The usual accounting practice is that those expenses, which cannot be traced to particular goods or services generating revenues, are charged as expenses in the income statement of the accounting period in which they are incurred. Obviously, the General Manager’s salary and that of other administrative staff cannot be related to a specific product and accordingly, have to be charged as expenses in the income statement of the accounting period in which such salaries are paid. Such expenses are called period expenses, as distinct from those expenses known as product expenses which can be related to products.
For example, if any goods have been sold in a particular period, the first test is to ensure that the goods have been delivered, or otherwise placed at the disposal of the buyer and/or their title has been passed on to the buyer so as to create a legal obligation for the buyer to pay for them.
The second aspect is that the full cost of those items must be included in that particular period’s income statement. Similarly, if a fee is earned for providing any services, the first test is to ensure that the service in question has been duly provided and the second aspect is that all expenses incurred by the business to enable it to provide that service are duly accounted for in the income statement for the period in which the credit for the fee is taken.