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Matching Concept in Accounting

What is the Matching Concept?

The matching principle is an accounting principle that governs how revenues and expenses are recorded. It necessitates that a company keeps track of its expenses as well as its revenues. The matching concept implies that expenditure incurred during an accounting cycle should match revenue collected during that timeframe.

The concept of adjustment in accounting applies to accrual accounting. Accrual accounting follows the practice of matching revenues, i.e., the money earned from selling a product, with expenses, i.e., the cost of manufacturing. It simply means that revenue and production expenses must be computed simultaneously in the accounting period. As a result of the matching concept accounting, the organization's income statement will reflect the associated cost of revenues and income for that time and avoid misstated earnings.

With The Period and Product Costs, Understand the Matching Concept

  • Period Expenditures: Commissions, office supplies, and rent are costs that are not immediately related to the product. They are only referenced when they occur in the statement. According to the accounting matching principle, expenses should be documented when the amount is incurred, not when it is paid.
  • Commission If an employee earns x % of commission on sales in the current month and the commission is paid the following month, the transaction is recorded in the current month.
  • Product cost: Product cost is incurred while creating the cost. The accrual or matching principle states that we should calculate the cost of producing a commodity simultaneously as we calculate the income from sold commodities. For example, if a seller sells 300 books in January, the cost of those 300 copies must be compared to the revenue in January to determine the profit or loss.
  • Employee Bonuses are based on an employee's performance during the financial year and are paid the following year.
  • Depreciation if a corporation purchases a machine with an 8-year life span. The cost of equipment is then depreciated at a rate of cost per year in depreciation expenses.

Accounting Example of the Matching Concept

Assuming a corporation produces 50 bottles for Rs. 5000, it sells 30 bottles for Rs. 120 each. Then they earn a profit of Rs. 600 in the resulting period. The total revenue of a company produces by 3600, where the total production cost of Rs. 5000. So in the matching concept, we have to recognize both revenue and expenses to avoid ascertaining profit or loss during an accounting period. So, in this, we have seen that company has invested Rs. 5000 in production, generating revenue of Rs. 3600 in an accounting period.

Facts about Matching Concept

Accrual accounting encompasses the concept of matching in accounting. Many students are perplexed by the difference between the two accounting concepts. In addition, the accounting concept of matching might be dual.

While matching primary accounting accurately portrays the organization's finances, it frequently overlooks the consequences of inflation. To avoid errors, one must take into account the various elements.

Explanation of Matching Concept

The principle of matching is the basic idea of accrual accounting, which states that income and associated costs must match over the same period. Also, the cost should be related to the period incurred, not the period paid. For example, suppose a corporation uses power for the entire month of January but pays its account in February.

Therefore, if the company used "cash-based accounting", it might have recognized the expense in February because it paid in cash in February. However, under "accruals accounting," the firm must record the power charge in January rather than February because the item was incurred in January. One of the most important ideas in accrual accounting is the principle of matching. The matching idea states that the expenses documented in a company's financial accounts must be matched to the revenues made during the same period.

  • Revenues recognition:This method of accounting for revenues and expenses ensures that the total effect of a transaction is disclosed in the same reporting period. Another consideration is when to record both income and expenses.
  • Expenses recognition:Revenues must be recognized by a company when it is certain that it has earned those revenues by completing its share of the agreement and that the other party will likewise fulfill its payment obligations.
  • Expenditures must be recognized at the time of occurrence, and associated income must be recognized regardless of the outflow of cash or equivalent.

For example

  • A company's policy is to pay every sales representative a 1% bonus on the company's quarterly sales. If the company has four sales representatives, each of whom made Rs.100,000 in sales in the first quarter of the year, they each receive a Rs.1,000 bonus. Since there are four of them, the company's total incentive expense will be Rs.4,000 (4 × Rs.1000). For example, if the bonus paid in May falls into the second quarter of the year, the matching principle requires the company to recognize the cost in the first quarter instead of the second quarter.
  • A law firm pays a Rs. 4,000/month fixed-wage to six of its consultants because this expense is related to revenues achieved in the first quarter. The same law firm made Rs. 230,000 and Rs. 180,000 in revenue in June and July, respectively. Since the salaries are constant, the cost for the two months would be the same Rs. 24,000 (Rs. 4,000x 6) However, in June and July, profits would be Rs. 206,000 (Rs. 230,000 - Rs. 24,000) and Rs. 156,000 (Rs. 180,000 - Rs. 24,000), respectively. The salary expense is matched to the revenue earned for each month.

Importance of Matching Concept

The matching concept is crucial for organizations to disclose their financial results properly.

Importance of the matching concept

Businesses must report their financial results properly. Its primary goal is to eliminate the possibility of profit misstatement for a given period. Expense-income matching works under the basic income statement equation, so:

Companies cannot generate sales or revenue without incurring raw material costs, labor costs, marketing costs, selling, administrative, and other miscellaneous costs, so they display only income for a specific period. The costs responsible for generating that revenue can change the appearance of the financial statements by overestimating or underestimating the company's revenue, leading to wrong decisions by the end-user of those financial statements.

The Difficulty of Matching Concept

This principle can be easily applied when there is a direct causal relationship between income and expenditure. However, this relationship may not be that easy.

For example, a company may decide to construct a new office building to increase employee productivity. There is no direct way to attribute these costs to increased profits by increasing employee productivity. As a result, the company amortizes the cost of the building over its useful life.

Another case in point is a business that pays for online marketing. The increased incremental revenue resulting from the marketing effort cannot be directly allocated with the cost because both the timing and amount are unknown. Online marketing costs are recognized as costs in the income statement for the period in which the ad is displayed, not when you receive the resulting revenue.

Examples of Matching Concept

Few more detailed examples of the matching concept are as follows: -

  1. In its Thailand factory, Apple spends Rs. 100,000 on machinery. The device has a useful life of 10 years and is expected to produce mobile phones for at least that long. Therefore, according to the matching principle, it is wise and systematic to depreciate over the machine's useful life.
  2. In a small town, Dawlance Trading Company sells kitchen appliances. The company buys Rs. 6,000 worth of inventory and sells it to a local restaurant for Rs. 9,000. The Dawlance Trading Company needs to adjust inventory costs to sales at the end of the accounting period.
  3. General Electric earns Rs. 60 million in revenue during an accounting period. They decide to declare and pay a dividend. Even if you do not expect to pay the bonus until the next year, the company will recognize this cost and the corresponding income.
  4. Sales representatives for Company XYZ earn a 10% commission on sales. Commissions are paid on the 15th in the middle of the month. In March 2020, the company's sales were Rs. 80,000, and the total commissions paid on March 15th were Rs. 8,000, of which Rs. 3,000 were related to the previous month.
    • The Rs.3,000 carry forward fee from the previous month must be debited and credited in cash.
    • The Rs.5,000 remaining commission paid out is for commissions on sales made this month through March 15th.
    • The fee for this month from the 15th to the 30th, when the adjustment entry is made, is Rs.3,000.

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