The matching principle is an accounting principle which states that expenses should be recognised in the same reporting period as the related revenues. Track and manage your expenses and revenues all in one place with Debitoor invoicing and accounting software. Try it free for 7 days. In practice, the matching principle combines accrual accounting (wherein
revenues and expenses are recorded as they are incurred, no matter when cash is received) with the revenue recognition principle (which states that revenues should be recognised when they are earned or realised, no matter when cash is received). The matching principle is not used in cash accounting, wherein revenues and expenses are only recorded when cash changes hands. The matching principle a basic accounting principle that is adhered to in order to ensure consistency in a company's financial statements: i.e. the income statement, balance sheet, etc. If expenses are
recognised at the wrong time, the financial statements may be greatly distorted: in turn jeopardising the quality of the statements and providing an inaccurate representation of the financial position of the business. For example: Certain business financial elements benefit from the use of the matching principle. Assets (specifically long-term assets) experience depreciation and the use of the matching principle ensures that matching is spread out appropriately to balance out the incoming cash
flow. The matching principle allows an asset to be distributed and matched over the course of its useful life in order to balance the cost over a given period. Debitoor has aimed to make matching as simple as possible by automating the process. By subscribing to one of our larger plans you can upload a bank statement that will then match each payment
to the corresponding invoice or expense. If you connect your PayPal Business account, each payment will be recorded directly to your Debitoor account and matched automatically.Why matching is important
Benefits of the matching principle
Matching and Debitoor
- Accounting & Finance
Understand the Matching Principle in Accrual Accounting
The Matching Principle states the expenses of a company must be recognized in the same period as when the corresponding revenue was “earned.” Per the
matching principle, expenses are recognized once the income resulting from the expenses is recognized and “earned” under accrual accounting standards.What is the Matching Principle?
Table of Contents
- Matching Principle in Accrual Accounting
- Matching Principle Impact
- Revenue and Expense Recognition
- Importance of the Matching Principle
- Matching Principle – Excel Template
- Matching Principle Example Calculation
Matching Principle in Accrual Accounting
The matching principle, a fundamental rule in the accrual-based accounting system, requires expenses to be recognized in the same period as the applicable revenue.
For instance, the direct cost of a product is expensed on the income statement only if the product is sold and delivered to the customer.
In contrast, cash-basis accounting would record the expense once the cash changes hands between the parties involved in the transaction.
However, the matching principle matches expenses with the revenue they helped generate, as opposed to being recorded in the period the actual cash outflow was incurred.
Matching Principle Impact
Revenue and Expense Recognition
The purpose of the matching principle is to maintain consistency in the core financial statements — in particular, the income statement and balance sheet.
The general guidelines under the matching principle are as follows:
- Expenses must be recognized on the income statement in the same period as when the coinciding revenues were earned.
- Expenditures that provide benefits for more than one year should be allocated across the asset’s useful life assumption.
- Expenses not directly tied to revenue production should be expensed immediately in the current period.
Importance of the Matching Principle
The matching principle stabilizes the financial performance of companies to prevent sudden increases (or decreases) in profitability which can often be misleading without understanding the full context.
As we observed in our simple modeling exercise, depreciation distributes the total CapEx over the course of its expected life span to balance out the expenses and prevent misrepresentations of profitability on the income statement.
While accrual accounting is not a flawless system, the standardization of financial statements encourages more consistency than cash-based accounting.
Standardized financials depicting normalized performance provide the most utility for operators and investors, rather than lumpy trends which make it more challenging to recognize patterns in a company’s margins and breakdown of expenses/expenditures.
Matching Principle – Excel Template
We’ll now move to a modeling exercise, which you can access by filling out the form below.
Matching Principle Example Calculation
One of the most straightforward examples of understanding the matching principle is the concept of depreciation.
When a company acquires property, plant & equipment (PP&E), the purchase — i.e. capital expenditures (CapEx) — is considered to be a long-term investment.
PP&E, unlike current assets such as inventory, has a useful life assumption greater than one year.
Now, if we apply the matching principle discussed earlier to this scenario, the expense must be matched with the revenue generated by the PP&E.
To “spread” the total CapEx across the useful life assumption, the standard approach is called “straight-line depreciation,” which is defined as the uniform allocation of the expense across the number of years that the asset is expected to bring positive monetary benefits.
Let’s say a company just incurred $100 million in CapEx to purchase PP&E at the end of Year 0.
If we assume a useful life assumption of 10 years and straight-line depreciation with a residual value of zero, the annual depreciation comes out to $10 million.
Straight-Line Depreciation
- Annual Depreciation = PP&E Value / Useful Life Assumption
- Annual Depreciation = $100m / 10 Years = $10m
As shown in the screenshot below, the CapEx outflow is shown as negative $100 million, which is an outflow of cash used to increase the PP&E balance.
However, rather than the entire CapEx amount being expensed at once, the $10 million depreciation expense appears on the income statement across the useful life assumption of 10 years.
If the CapEx was expensed as incurred, the abrupt $100 million expense would distort the income statement in the current period — in addition to upcoming periods showing less CapEx spending.
But by utilizing depreciation, the CapEx amount is allocated evenly until the PP&E balance reaches zero by the end of Year 10.