Matching Principle of Accounting

What is the Matching Principle of Accounting?

Matching Principle of Accounting provides guidance for the accounting, according to which all the expenses should be recorded in the income statement of the period in which the revenue related to that expense is earned. This means that the expenses which are entered into the debit side of the accounts should have a corresponding credit entry (as required by the double-entry bookkeeping system of accounting) in the same period, irrespective of when the actual transaction is made.

Matching Principle Examples

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Source: Matching Principle of Accounting (wallstreetmojo.com)

#1 – Accrued Expenses

Let us say that for some work, you hired contract laborers and agreed to pay them $1000. The work is done in the month of July. However, the laborers are paid in the month of August. What is the cost accounted for in July?

Please note that in matching principle of accounting, for expenses, the actual date of payment doesn’t matter; It is important to note when the work was done. In this case study, the work was completed in July.  This recording of such accrued expensesAccrued ExpensesAn accrued expense is the expenses which is incurred by the company over one accounting period but not paid in the same accounting period. In the books of accounts it is recorded in a way that the expense account is debited and the accrued expense account is credited.read more (irrespective of actual payment made or not) and matching it with the related revenue is known as the Matching Principle of accounting.

#2 – Interest Expenses

Let us say that you borrow $100,000 from a bank to start your business. The annual interest that you agree to pay is say 5%. The payment of interest is made at the end of the year in December. What is the interest expense accounted for in the month of July?

You will pay a total interest of $100,000 x 5% = $5,000. You need to match the interest expense to each month’s revenue.

Interest expense to be recorded for 1 month (July) = $5000/12 = $416.6

#3 – Depreciation Expense

On July 1, let’s assume that you buy machinery worth $30,000, and its useful life is five years. How will you record expenses for this transaction in the month of July?

The reported amounts on his balance sheet for assets such as equipment, vehicles, and buildings are routinely reduced by depreciationBuildings Are Routinely Reduced By DepreciationDepreciation of building refers to reducing the recorded cost of a building until the value of the structure either becomes zero or reaches its salvage value. In addition, it helps to map the revenue in the form of lease rental generated during the corresponding expenses.read more. Depreciation expense is required by the basic accounting principle known as the matching principle of accounting. Depreciation is used for assets whose life is not indefinite—equipment wears out, vehicles become too old and costly to maintain, buildings age and some assets (like computers) become obsolete.

For recording depreciation expense as per the matching principle of accounting, you can calculate the yearly depreciation (straight line depreciation methodStraight Line Depreciation MethodStraight Line Depreciation Method is one of the most popular methods of depreciation where the asset uniformly depreciates over its useful life and the cost of the asset is evenly spread over its useful and functional life. read more) = 30,000/5 = $6000 per year. With this depreciation expense charged for the month of July = $6000/12 = $500

Comprehensive Example

• John has started with a window washing services business on Dec 18^th by investing his own equity of $10,000.
• He has bought tools required for the business worth $3,000 on Dec 20^th.
• John hired two helpers who are directly employed by his company at the rate of $4,000/person/month as on Dec 21^st.
• He received a contract of window washing on Dec 22^nd to be performed on Dec 23^rd, for which the client paid him $500 on Dec 22^nd and would pay him the remaining $2,000 on Dec 27^th after the end of festivities.
• He received another contract on Dec 23^rd to be carried out on Jan 5^th, for which the client paid him $1,500 in advance.
• He paid salaries to the two helpers of $8,000 in total on Jan 2^nd, as the company pays its workers after the end of the month.

Now, we can prepare journal entries as on Dec 31^st for the above example as per the illustration below:

Date	Particulars	Debit	Credit
18-Dec	Cash	10,000
	Shareholder’s Equity		10,000
20-Dec	Tools Count	3,000
	Cash		3,000
22-Dec	Cash	500
	Accounts Receviable	2,000
	Service Revenue		500
	Unearned Service Revenue		2,000
23-Dec	Cash	1,500
	Unearned Service Revenue		1,500
27-Dec	Cash	2,000
	Accounts Receviable		2,000
31-Dec	Wages Expense	8,000
	Wages Payable		8,000
	Total	27,000	27,000
	Last entry in above example is made as below:
2-Jan	Wages Payable	8,000
	Cash		8,000
	Total	8,000	8,000

• Hence it is seen from the illustration that the actual expense date for payment of wages is Jan 2^nd, but a temporary entry is made in the books of accounts on the Dec 31^st when it is supposed to be paid since it is close of that month in which the helpers worked for John’s company. If the complete entry is referred to, with regards to the wages to be paid, it is seen that amount under Wages Payable gets netted off on Jan 2^nd after the actual transaction is made.
• Another matching principle example can be considered of the service income that is received on Dec 27^th. However, a temporary entry is made on Dec 22^nd, since John received the contract on this date, and as on that day,, he needs to show the supposed value of the transaction (even though the actual transaction takes place on a future date).
• Similarly, the contract which is to be carried out on Jan 2^nd is a future date event. However, the contract was received on Dec 23^rd, and cash was paid as well on this date. Hence it needs to be entered as on Dec 23^rd.

The significance of the Matching Principle of Accounting

The matching principle in accounting is closely related to the accrual accountingAccrual AccountingAccrual Accounting is an accounting method that instantly records revenues & expenditures after a transaction occurs, irrespective of when the payment is received or made. read more. Rather it requires the accrual system to be followed very stringently. The term “accrual” in accounting means anything which is accrued for a particular period until it gets paid on a future date.

Hence, this principle equates the total credits with total debits (or total expenses with the total income) as of a particular period. There are temporary account labels created like Wages Payable, Accounts Payable, Interest Payable, Accounts ReceivableAccounts ReceivableAccounts receivables refer to the amount due on the customers for the credit sales of the products or services made by the company to them. It appears as a current asset in the corporate balance sheet.read more and Interest Receivable, etc., which get net off as and when the actual transaction is made.

So, the balance sheet generated after the actual transaction made will not reflect these accounts, as the amount in these accounts gets net off with the supposed account, and these accounts hold no amount until and unless there is a fresh transaction to be completed on a future date. In the balance sheet, these accounts (if they have a valid amount entered) list under Current AssetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more or Current Liabilities based on the nature of the account.

A very good example of the accrual system is the coupon payment on bonds (or, for that matter, any investment which pays returns based on a particular frequency). The coupon to be paid, by the issuer of the bond, gets accumulated from the date of issue until paid. Hence in the issuer’s book of account, there is some amount that pertains to the coupon to be paid to investors monthly. It is called the accrued interestAccrued InterestAccrued Interest is the unsettled interest amount which is either earned by the company or which is payable by the company within the same accounting period.read more for the investor (and has relative terms concerning other regular return-paying investments).

Final Thoughts

The matching principle of the accounting system is, which follows a dual-entry bookkeeping system. Using this principle, the accounting systemAccounting SystemAccounting systems are used by organizations to record financial information such as income, expenses, and other accounting activities. They serve as a key tool for monitoring and tracking the company's performance and ensuring the smooth operation of the firm.read more gives a very clear picture of mainly the current assets and current liabilities of the company, which helps investors and other financial analysts to understand the worth of the company and how well it is being operated. With the help of quite some ratios, the company’s performance is determined, which helps investors to decide for investments.

Matching Principle of Accounting Video

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