How Matching Principle Work in Accounting?
The matching principle works by aligning expenses with the revenues they help generate within the same accounting period.
1. Recognition of Revenue: When revenue is earned, it is recognized in the income statement for the period in which it is earned, regardless of when the cash is actually received. This means that revenue is recorded when the goods are delivered or services are performed, and the right to receive payment is established.
2. Recognition of Expenses: Expenses are recognized in the same period as the revenues they help generate. For example, if a company sells a product, the cost of goods sold associated with that product (such as the cost of materials and labor) is recognized as an expense in the same period as the revenue from the sale.
3. Accrual Basis Accounting: The matching principle is typically applied under the accrual basis of accounting, where transactions are recorded when they occur, regardless of when the cash is exchanged. This contrasts with cash basis accounting, where transactions are recorded only when cash is received or paid.
4. Adjusting Entries: At the end of an accounting period, adjusting entries may be required to ensure that revenues and expenses are properly matched. For example, if a company has incurred expenses but hasn’t yet received the corresponding invoice, an adjusting entry may be needed to recognize the expense in the current period.
5. Consistency and Comparability: By consistently applying the matching principle, financial statements become more comparable over different periods, allowing stakeholders to better evaluate a company’s performance and financial position.