Reporting expenses at the same time as the related revenues Show
What is the Matching Principle?The matching principle is an accounting concept that dictates that companies report expenses at the same time as the revenues they are related to. Revenues and expenses are matched on the income statement for a period of time (e.g., a year, quarter, or month).  Example of the Matching PrincipleImagine that a company pays its employees an annual bonus for their work during the fiscal year. The policy is to pay 5% of revenues generated over the year, which is paid out in February of the following year. In 2018, the company generated revenues of $100 million and thus will pay its employees a bonus of $5 million in February 2019. Even though the bonus is not paid until the following year, the matching principle stipulates that the expense should be recorded on the 2018 income statement as an expense of $5 million. On the balance sheet at the end of 2018, a bonuses payable balance of $5 million will be credited, and retained earnings will be reduced by the same amount (lower net income), so the balance sheet will continue to balance. In February 2019, when the bonus is paid out there is no impact on the income statement. The cash balance on the balance sheet will be credited by $5 million, and the bonuses payable balance will also be debited by $5 million, so the balance sheet will continue to balance. Download CFI’s Matching Principle template to see how the numbers work on your own! Benefits of the Matching PrincipleThe matching principle is a part of the accrual accounting method and presents a more accurate picture of a company’s operations on the income statement. Investors typically want to see a smooth and normalized income statement where revenues and expenses are tied together, as opposed to being lumpy and disconnected. By matching them together, investors get a better sense of the true economics of the business. It should be mentioned though that it’s important to look at the cash flow statement in conjunction with the income statement. If, in the example above, the company reported an even bigger accounts payable obligation in February, there might not be enough cash on hand to make the payment. For this reason, investors pay close attention to the company’s cash balance and the timing of its cash flows. Challenges with the Matching PrincipleThe principle works well when it’s easy to connect revenues and expenses via a direct cause and effect relationship. There are times, however, when that connection is much less clear, and estimates must be taken. Imagine, for example, that a company decides to build a new office headquarters that it believes will improve worker productivity. Since there’s no way to directly measure the timing and impact of the new office on revenues, the company will take the useful life of the new office space (measured in years) and depreciate the total cost over that lifetime. For example, if the office costs $10 million and is expected to last 10 years, the company would allocate $1 million of straight-line depreciation expense per year for 10 years. The expense will continue regardless of whether revenues are generated or not. Another example would be if a company were to spend $1 million on online marketing (Google AdWords). It may not be able to track the timing of the revenue that comes in, as customers may take months or years to make a purchase. In such a case, the marketing expense would appear on the income statement during the time period the ads are shown, instead of when revenues are received. Additional resourcesThank you for reading this guide to understanding the accounting concept of the matching principle. CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)T® designation, created to help transform anyone into a world-class financial analyst. To continue learning and advancing your career, these additional CFI resources will be useful:
Does expense recognition principle matches expenses with revenues?The expense recognition principle states that expenses should be recognized in the same period as the revenues to which they relate. If this were not the case, expenses would likely be recognized as incurred, which might predate or follow the period in which the related amount of revenue is recognized.
What does the expense recognition principle match?The expense recognition principle is a concept that outlines when a business's expenses are recognized in the company's financials. Typically, the expense recognition principle involves expenses being recognized and recorded in the same period as the revenues associated with those expenses (under accrual accounting).
Which accounting principle requires that expenses be matched with revenues?Matching principle is an accounting principle for recording revenues and expenses. It requires that a business records expenses alongside revenues earned. Ideally, they both fall within the same period of time for the clearest tracking. This principle recognizes that businesses must incur expenses to earn revenues.
What is the expense recognition principle quizlet?The expense recognition principle requires that expenses be matched to revenues; expenses are recognized in the period when they helped generate revenues. The historical cost principle states that when assets are purchased, they should be recorded at cost, not that efforts be matched with results.
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The expense recognition principle requires that expenses be matched with revenues.
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