In accounting, the matching principle simply means matching revenues with expenses. The matching principle is the most obvious difference between cash and accrual based accounting. How so? In cash based accounting, revenues and expenses are recognized when cash is received or paid out. Accrual based accounting determines that revenues and expenses should be recognized at the time of the transaction or economic event regardless of cash inflows or outflows. Why would you take the time to determine whether you have a recognizable economic transaction instead of just following the money? The reason will become clear with a brief example.
Suppose you are a small business with a few employees. The matching principle directs you to recognize the cost of your employees’ labor during the period they actually worked; this may or may not coincide with when you paid them. Additionally, commissions on sales should be booked in the period the sales were made as opposed when commissions were paid. Following the matching principle allows you to more accurately track profitability and provides valuable information to business owners and investors for decision making.
Although the matching principle provides greater accuracy, can it be violated? In short – yes, sometimes it does not make sense to implement the matching principle. To make that determination, consider the concept of materiality. Materiality is both a judgmental and monetary measurement of significance. To illustrate, suppose you are a multimillion dollar company and have purchased a scanner for $1,000 that has an estimated useful life of 5 years. The matching principle would tell you to spread the cost of the scanner over those five years to which it will provide benefit or be in service. To a company of that size and revenue, $1,000 is immaterial and thus you can decide that this purchase is below your materiality threshold and expense it entirely upon purchase.
It is important to set up company standards for materiality threshold and establish discipline in accrual based accounting. Using the matching principle gives you a clear picture of how your business is performing period over period. TGG Accounting provides best practice tools and implementation strategies to help move your business and finances to the next level. Call us today.Written by: Andrea Murray TGG Accounting