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
#1 – Accrued Expenses
Let us say that for some work, you hired contract labors and agreed to pay them $1000. The work is done is the month of July, however, the labors 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 expenses (irrespective of actual payment made or not) and matching it with the related revenue is known as 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 done 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 a machinery worth $30,000 and its useful life is 5 years. How will you record expense 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 depreciation. 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 method) = 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 18th by investing his own equity of $10,000.
- He has bought tools required for the business worth $3,000 on Dec 20th.
- John hired 2 helpers who are directly employed by his company at the rate of $4,000/person/month as on Dec 21st.
- He received a contract of window washing on Dec 22nd to be performed on Dec 23rd, for which the client paid him $500 on Dec 22nd and would pay him remaining $2,000 on Dec 27th after the end of festivities.
- He received another contract on Dec 23rd to be carried out on Jan 5th for which client paid him $1,500 in advance.
- He paid salaries to the 2 helpers of $8,000 in total on Jan 2nd, as the company pays their workers after the end of the month.
Now, we can prepare journal entries as on Dec 31st for the above example as per illustration below:
- Hence it is seen from the illustration that the actual expense date for payment of wages is Jan 2nd, but a temporary entry is made in the books of accounts on the Dec 31st 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 2nd after the actual transaction is made.
- Another matching principle example can be considered of the service income that is actually received on Dec 27th however, a temporary entry is made on the Dec 22nd, since John received the contract on this date, and as on that day he needs to show the supposed value of transaction (even though the actual transaction takes place on a future date).
- Similarly, the contract which is to be carried out on Jan 2nd is a future date event, however, the contract was received on Dec 23rd and cash was paid as well on this date. Hence it needs to be entered as on Dec 23rd.
The significance of the Matching Principle of Accounting
The matching principle in accounting is closely related with the accrual system of accounting, 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 Receivable and Interest Receivable (not limited to these examples though, a lot many can be created based on the requirement of entries) which get net off as and when the actual transaction is made.
So, the balance sheet which is generated after the actual transaction is 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) are listed under Current Assets 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 accounts, there will be some amount pertaining to the coupon to be paid to the investor every month. This is called the accrued interest for the investor (and has relative terms with respect to other regular return-paying investments).
Final Thoughts
The matching principle of accounting system is which follows dual-entry bookkeeping system. Using this principle, the accounting system 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 take a decision for investments.
Matching Principle of Accounting Video
Recommended Articles
This has been a guide to what is Matching Principles of Accounting and its definition. Here we take matching principles examples of interest expenses, accrued expenses, depreciation expenses along with its significance. You may learn more about accounting from the below articles –
