Depreciation is the loss of value in assets. You distribute assets equally over time and match them to balance the cost because of the principle. Using the matching principle allows for a variety of benefits. Related: Understanding Revenue and Expense Recognition Principles Benefits of the matching principle For example, if a salesperson makes a commission off of their product sales, they invoice the customers in December to match all December costs associated with creating and delivering the products. The matching principle requires product costs to be recognized in the same timeframe as the one when a company recognizes revenue. The product cost is the total amount of cost associated with a product regarding its acquisition and production. Related: Learn About Being an Accountant Product costs You record expenses when they're incurred rather than when you receive payment. This is the case even if you don't pay the expense until the following month. For example, if the company completes work in January, the expense becomes part of the January financial statements. You record these costs as expenses on an income statement during the timeframe the company receives them. Commissions, rent, wages or office supplies are all examples of period costs. Period costs are the costs that aren't related to a product. Here are the two components of the matching principle: Period costs Matching the expenses and revenues allows investors to determine consistency in a company's financial statements. This means that you record them as they're incurred rather than when you receive payment. Because recording items requires accrual entry, the matching principle is part of the accrual accounting system. It's an accounting concept that requires you to record any cause-and-effect relationship between the expenses and revenues simultaneously. The company doesn't record expenses when they're paid, but as it receives revenue. The matching principle stipulates that a company matches expenses and revenues in the same reporting period. In this article, we define the matching principle, explain its benefits and provide examples of it in use. Businesses use the matching principle to better prepare documentation with accurate reporting. One such principle is the matching principle. GAAP allows the readers of the financial statements to review meaningful and comparable information.When businesses interpret financial statements, they prepare and calculate those statements in a certain manner to abide by proper accounting principles. When revenue is matched to expenses properly, it is useful to managers, investors and bankers to make important decisions. Since the equipment will be used to produce income over 5 years, the depreciation expense is matched properly. It could charge the cost of the equipment to depreciation expense at the rate of $10,000 per year for 5 years. There could be a situation where salary is paid in the current period, but the cash for revenue is not collected until the next period.Īnother example of the matching principle is when a corporation buys equipment for $50,000 that has a projected life of 5 years. For example, using the previous scenario, revenue would only be recorded when the cash is received. Alternatively, under the cash basis of accounting, revenues are recorded when cash is received and when expenses are paid. If the salary was not paid until after the current period, then there would be an accrual set up for wages payable as a liability. Under the matching principle, the salary expense for the related consulting services would be recorded in the same period. For example, if a corporation is providing consulting services, we have determined from the revenue recognition principle that revenue is recorded when the work is performed. Under the accrual basis of accounting, revenues are recorded in the same period as when the expenses are incurred. GAAP is basically the rule book that accountants follow when preparing financial statements. The matching principle is one of the Generally Accepted Accounting Principles (GAAP).
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