The matching principle is a standard accounting practice for documenting receipts and costs. It requires that a business monitor both its expenses and earnings. They should both fall within the same time frame for the greatest tracking. This notion recognises that businesses must make investments in order to generate revenue.
The expense must be related to the time in which it occurs rather than the period during which invoices are actually paid. For instance, suppose a company pays its salespeople a 10% commission at the end of each month. The company will pay the $5,000 commission in January of the next year if it makes $50,000 in sales in the month of December.
The matching idea is used by some companies. Some companies include commission costs in their December income statement. Cash-basis accounting is used by other businesses. Because January is the payment month in this instance, the commission is reported in January. The alternative is to report the cost when it was incurred, which is December.
Some instances of matching principles outside of commissions are:
- Employee bonuses
The matching concept is connected to another accounting tenet called the revenue recognition principle. Revenue must be reported and tracked during realization and earning. No matter when they make a payment, this still occurs. In other words, businesses don't have to wait for clients to pay them in cash before they can record sales revenue.
For instance, if you are a roofing contractor and have finished work for a client, the fees have been earned by your company. No matter when the client pays you for the work, this applies.
The financial accounts may be significantly distorted by incorrectly recognising expenses. A company's financial status could turn out to be erroneous. The matching concept aids companies in avoiding reporting false earnings for a while.
The matching idea is useful for several financial aspects of business as well. Long-term assets depreciate with time. According to the matching principle, an asset can be distributed and matched over the course of its useful life in order to balance the cost over time.
For instance, a specific piece of equipment might cost $25,000 to purchase. Businesses can spread the cost out across ten years rather than just one because it might last for ten or more years.
When costs and revenues are distinct, this approach is a useful tool. Yet, expenses may occasionally apply to a number of revenue streams, or vice versa. When there is a murky relationship between costs and revenues, account teams must guess. For instance, you may get your team office supplies like pencils, notebooks, and printer ink. Despite being necessities, these things might not be profitable.
On a wider scale, you can think about investing in a brand-new structure for your company. It's impossible to determine whether a bigger area or a better location will increase sales. Are workers producing more? Is it simpler for clients to reach your establishment? These elements and a new building have no causal connection. As a result, companies frequently decide to stretch the cost of the project across several years or decades.
Online search advertising is one illustration. To persuade potential clients to visit a business website, a marketing team creates messaging. The customer can wait several weeks, months, or even years before making a purchase. They nevertheless sowed a seed. In these situations, it is not always easy to immediately link revenue to spending. Online search ad expenses don't spread out over time; they show up within the spending period.