Matching principle

From CEOpedia | Management online

Matching principle requires that in order to ensure commensurability of revenues and related costs to assets or liabilities of a given reporting period, they should include costs or revenues related to future periods and costs that have not yet been incurred in this reporting period. Therefore, the entity should qualify incurred costs (and revenues) to those that affect the financial result of the current period and to future reporting periods. The effect of applying the matching principle is, inter alia, making active accruals of costs in relation to those expenses incurred that relate to future reporting periods. The subject of accruals may be operating expenses and financial costs. Operating expenses settled over time include, among others[1]:

  • costs of motor and property insurance,
  • costs of major overhauls of fixed assets,
  • rent costs paid in advance for future years,
  • costs of pre-paid magazine subscriptions,
  • the initial fee incurred when concluding the operating lease agreement,
  • annual fees for perpetual usufruct of land,
  • costs of ongoing development works, if they are successful and will be included in intangible assets.

On the other hand, financial costs settled in time include, among others:

  • the difference between a higher buy-back price and a lower selling price issued by bond units,
  • costs of interest paid in advance on loans and advances received for current purposes.

Making passive accruals of costs

The matching principle obliges also to make passive accruals of costs. They concern costs not yet incurred (liabilities arising in future reporting periods), which are related to the current reporting period. Passive accruals of costs are made in the amount of probable liabilities falling into the current reporting period, resulting in particular from:

  • from the services provided to the entity by the counterparties of the entity, and the liability amount can be estimated reliably
  • from the obligation to perform, related to current operations, future employee benefits, including retirement benefits, as well as future benefits to unknown persons, the amount of which can be estimated reliably, although the date of the liability is not yet known, including warranty repairs and warranty for sold products of long-term use.

Other accounting principles

In addition to the matching principle, there are many other accounting principles that should be applied. Here are a few of them[2]:

  1. Conservatism principle - is one of the overriding principles of accounting, which requires valuation of the assets of the entity and sources of their origin, so as not to distort the financial result.
  2. Consistency principle - consists in applying the adopted method of conduct in subsequent years, in order to ensure the comparability of subsequent reporting periods.
  3. Cost principle - business should record their assets, liabilities and equity at the original cost at which they were bought or sold.
  4. Going concern principle - according to this principle, it is assumed that the entity will run a business in the near future, does not intend to cease it or is not forced to liquidate or significantly reduce its activity.

Examples of Matching principle

  • Depreciation: The matching principle requires that businesses should record depreciation expense in the period in which the associated asset is used to generate revenue. This is because the revenue generated by the asset should be matched with the cost of the asset. The depreciation expense should be recorded in the same accounting period as the revenue to ensure that the revenues and expenses are matched.
  • Wages and Salary: According to the matching principle, wages and salaries are recorded in the accounting period in which the employee worked for the company. This is done to ensure that the wages and salaries are matched with the revenue that is generated from the services that the employees provide.
  • Rent: According to the matching principle, rent should be recorded in the period in which it is due. This is done to ensure that the cost of the rent is matched with the revenue generated from the use of the property in that period.

Advantages of Matching principle

The main advantages of applying the matching principle are:

  • The matching principle helps to accurately assess the financial performance of a business by recognizing costs and revenues in the same period. This helps to ensure that expenses are accurately matched to the revenues they generate and that any costs or revenues related to future periods are excluded from the current period's financial statements.
  • It also helps to ensure that costs are allocated to the periods in which they are incurred, which can provide a more accurate picture of the business's financial performance.
  • The matching principle also helps to ensure that the costs of a specific asset or liability are properly accounted for in the current period and that any future costs related to it are excluded. This helps to ensure that the costs are appropriately allocated over the life of the asset or liability.
  • Finally, the matching principle helps to improve decision making by providing more accurate information about the financial performance of a business. This can help managers to make more informed decisions about the operations of the business and how to allocate resources.

Limitations of Matching principle

The matching principle is a useful tool when determining a company's financial position, but it has its limitations. These include:

  • The principle can be difficult to apply when dealing with intangible assets, as it can be difficult to accurately determine the useful life of these assets.
  • It can be difficult to accurately predict future revenue streams, as customer demand and market conditions can change over time.
  • The principle can be difficult to apply when dealing with irregular expenses, such as marketing costs, as it can be difficult to accurately determine their effect on the current period's financial results.
  • It can be difficult to determine the fair value of assets and liabilities, which can affect the accuracy of the financial statements.
  • It can be difficult to accurately match costs and revenues between different accounting periods, as some expenses may be delayed or incurred prior to the associated revenue being generated.

Other approaches related to Matching principle

The other approaches related to the matching principle include:

  • The systematic allocation of costs, which involves the allocation of a proportional amount of cost to each period in which the cost is incurred.
  • The use of depreciation methods to spread the cost of an asset over its useful life.
  • The recognition of revenue when it is earned, not when it is received.
  • The recognition of expenses when they are incurred, not when they are paid.
  • The use of accrual accounting to recognize revenue and expenses in the period they are earned.

In summary, the matching principle requires that costs and revenue should be recognized in the same period they are incurred, in order to ensure commensurability of revenues and related costs to assets or liabilities of a given reporting period. Other approaches related to the matching principle include the systematic allocation of costs, the use of depreciation methods, the recognition of revenue when it is earned, and the recognition of expenses when they are incurred.


Matching principlerecommended articles
Time period conceptTemporary accountDisposal of fixed assetsCost principlePeriodicity conceptAccounting conceptsAnnual BasisAccrual methodChange in accounting estimate

References

Footnotes

  1. Delves, L. M., & Hall, C. A. (1979).An implicit matching principle for global element calculations. IMA Journal of Applied Mathematics, 23(2), 223-234.
  2. Daske, H. (2006).Economic Benefits of Adopting IFRS or US‐GAAP-Have the Expected Cost of Equity Capital Really Decreased?. Journal of Business Finance & Accounting, 33(3‐4), 329-373.

Author: Magdalena Lewicka