It governs how a business should account for its expenses. Therefore, only reporting revenues for a given period without showing the costs that brought those revenues could distort the face of financial statements by either overstating or understating a company's profits, leading to overstatement or understatement. This is because a company cannot generate sales or revenues without paying expenses like the cost of labor, raw materials, marketing expenses, selling expenses, administrative expenses, or other miscellaneous expenses.

Revenues earned - incurred costs = Net earned profits. Under the 'Income Statement' fundamental equation, matched expenses and revenues operate as follows: Its major goal is to eliminate any risk of misrepresentation over time. The concept is critical for organizations to report their financial results properly. The product costs generally include the direct material, direct labor, traceable variable, and traceable fixed costs to the product that is being manufactured. The accrual or matching principle states that we should simultaneously calculate the cost of producing a commodity as we calculate the income from sold commodities.įor example, if a salesperson sells 200 copies of a book in January, the cost price of those 200 copies must be matched with the January income to determine the profit or loss. Product costs refer to the expenses incurred during the product's manufacturing. Therefore, expenses must be documented in the timeframe of their occurrence rather than when the amount is paid according to the accounting matching concept. When they occur, they are merely referenced in the statement. Or, we can say period costs are those expenses not expensed for producing the good or service. So therefore, these costs aren't directly linked to the product or service. Let us define period and product costs to clarify the matching concept further.Ĭommissions, office supplies, and rent are examples of period costs that aren't directly related to the product. For some time, revenues and expenses are matched on the income statement (e.g., a year, quarter, or month). The principle is an accounting concept that requires businesses to report expenses simultaneously as the revenues to which they are linked.

Instead, when revenues are reported, they are disclosed along with all associated expenses. This ensures that profit reporting is not artificially expedited or delayed at any time throughout the reporting period. If no cause-and-effect relationship exists, charge the cost right away.īecause it requires that the complete effect of a transaction be recorded within the same reporting period, this is one of the most important ideas in accrual basis accounting. In some circumstances, such as when the purchase cost of a fixed asset is depreciated over several years, a systematic allocation of a cost across numerous reporting periods will be required. Record them simultaneously if revenue and certain expenses have a cause-and-effect relationship. Revenues and related expenses must be recognized under the same reporting period. If the cost of that item in the future cannot be identified as a benefit, it should be charged to the expense as soon as possible. If an item isn't directly related to revenue, it should be mentioned in the income statement in the prevailing accounting period in which it expires or is depleted. This is because the accrual basis of accounting and correcting entries is linked to the principle. This principle is one of the most crucial accounting concepts under the accrual basis of accounting. According to the matching principle, a corporation must disclose an expense on its income statement in the same period as the relevant revenues. The matching concept is one of the most fundamental accounting principles.

Define matching principle