What Is the Matching Principle and Why Is It Important?

gaap matching principle

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gaap matching principle

With such a prominent difference in approach, dozens of other discrepancies surface throughout the standards. The chart below includes only a couple of the variations that may affect how a business reports its financial information. While the United States does not require IFRS, over 500 international SEC registrants follow these standards. These figures provide an excellent example of how the inclusion of non-GAAP earnings can affect the overall representation of a company’s success. The first column indicates GAAP earnings, the middle two note non-GAAP adjustments, and the final column shows the non-GAAP totals.

Matching Principle for the Cost of Goods Sold

A company acquires production equipment for $100,000 that has a projected useful life of 10 years. It should charge the cost of the equipment to depreciation expense at the rate of $10,000 per year for ten years, so that the expense is recognized over the entirety of its useful life. 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. 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. For example, when managing revenue, matching principle usage ensures that any expense incurred in the production of that revenue is properly accounted for in the month that the revenue is generated.

According to the revenue recognition principle, revenue must be recognized and recorded on the income statement when it’s earned or realized. Businesses don’t have to wait for the cash payment to be received to record this sales revenue. An example of revenue recognition would be a contractor recording revenue when a single job is complete, even if the customer doesn’t pay the invoice until the following accounting period. The matching principle is an important concept in accounting that requires expenses to be recorded and matched with related revenues in the same reporting period. This matching of expenses and revenues impacts the balance sheet in a few key ways.

Overview: What is the matching principle?

Rather than immediately expensing costs as they are incurred, costs are capitalized on the balance sheet and gradually expensed over time as revenues are earned. There are situations in which using the matching principle can be a disadvantage. It requires additional accountant effort to record accruals to shift expenses across reporting periods.

If revenues and expenses are mismatched across periods, the financials may tell an inaccurate earnings story. But with proper matching, managers can correctly assess performance trends over time. This facilitates data-driven decisions about pricing, budgets, growth plans, and more. Overall, the matching principle is crucial for providing investors, management, and other stakeholders an accurate picture of a company’s financial health and performance over a period of time. It is a key reason why accrual accounting is encouraged under accounting frameworks like GAAP and IFRS.

Examples of the Matching Principle

The matching principle is part of the Generally Accepted Accounting Principles (GAAP), based on the cause-and-effect relationship between spending and earning. It requires that any business expenses incurred must be recorded in the same period as related revenues. In other words, it formally acknowledges that business must spend money in order to earn revenue. You must use adjusting entries at the end of an accounting period to ensure your business’s revenues and expenses are accounted for correctly. The matching principle states that you must report an expense on your income statement in the period the related revenues were generated. It helps you compare how much you made in sales with how much you spent to make those sales during an accounting period.

gaap matching principle

Without GAAP, accountants could use misleading methods to paint a deceptive picture of a company or organization’s financial standing. The revenue recognition principle states that the businesses recognize gaap matching principle and record revenue when it is earned irrespective of when they receive the payment. Consequently, the company does not have to wait for the payment from the clients to record and recognize the revenue.

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