Matching principle
From Wikipedia, the free encyclopedia
In accounting, the matching principle indicates that when it is reasonable to do so, expenses should be matched with revenues. When expenses are matched with revenues, they are not recognized until the associated revenue is also recognized. For instance, wages paid to manufacturing workers are not recognized as expenses until the actual products are sold. When the products are sold, the expenses are recognized as cost of goods sold. Only if no connection with revenue can be established can cost be charged as expenses to the current period (e.g. office salaries and other administrative expenses).
This principle allows better evaluation of actual profitability and performance (shows how much was spent to earn revenue), and reduces noise from timing mismatch between when costs are incurred and when revenue is realized.
Contents |
[edit] Examples
Depreciation is another example of the matching principle: the cost of purchasing a fixed asset is spread over the period in which it is expected to generate revenue.
Product costs are costs which add value to inventory. These costs are capitalized (added) to inventory, and later expensed as cost of goods sold.
Period costs are costs which are expensed immediately, such as office salaries and selling expenses.
[edit] Accruals
Accruals are used to enable the matching principle to be managed. An example is that of a supplier supplying you goods in one month but not billing you until the following month. If the goods are sold in the month they were supplied there would be no matching costs i.e. no supplier invoice cost to match the sales value and calculate a profit on the goods sold. If there is no cost then you would make 100% profit in the month you sold the goods and then incur a cost in the next month where there is no matching sale.
[edit] Prepayments
Prepayments are used to enable the matching principle to be managed. An example is that of insurance. Insurance is usually charged to a company by an insurance company on an annual basis. So if the accounting period is from January to December, then only 1/12th of the insurance cost should be charged to each month rather than charge the entire annual charge to the month in which it was billed by the insurance company.
A company may pay for goods or services before they have been received. Any amounts that have been paid for goods and services not received by the end of an accounting period are shown in the balance sheet as prepayments. These amounts will not be shown as costs in the P & L. When the goods or services are received, then the amounts will be passed through the P & L and deducted from the prepayments section of the balance sheet.
[edit] Depreciation
Depreciation is used to apportion the cost of the asset over its expected lifespan. If you bought a machine for $100,000 and it has a life span of 10 years and it can produce the same amount of goods each year, you would match $10,000 of the cost of the machine to each year rather than charge $100,000 in the first year and nothing in the next 9 years. So when you sell items in each year you apportion a cost of the machine against the sales in that year. This matches costs to sales.
