Matching Principle

The matching principle is the accounting concept that expenses should be recorded in the same period as the revenues they helped to produce. Rather than recognizing a cost when cash is paid, a business records it when the related benefit is used up in earning revenue. The result is that each period's net income reflects the revenue earned in that period and the costs of earning it, which gives a more accurate picture of performance than simply counting cash in and cash out.

The principle is a central part of accrual basis accounting and works alongside revenue recognition: first the business decides when revenue is earned, then it matches the related expenses to that period. It is not used under the cash basis of accounting, where expenses are recorded when paid.

Expenses are matched in three ways, depending on how closely they are linked to revenue:

• Direct association: costs that relate directly to specific sales, such as cost of goods sold and sales commissions, are recognized when the sale is recognized.
• Systematic allocation: costs of assets that benefit several periods, such as buildings, equipment and prepaid insurance, are spread over those periods through depreciation, amortization or the gradual expensing of prepayments.
• Immediate recognition: costs with no clear future benefit, such as most advertising, administrative salaries and research costs, are expensed in the period incurred.

To apply the principle, accountants record adjusting entries at the end of each period. These include accruing expenses that have been incurred but not yet paid, such as wages and interest, and deferring costs that have been paid but not yet used, such as prepaid rent.

A company buys a delivery van for $60,000 in January, expecting to use it for five years. Expensing the full cost in year one would make that year look much worse than the following four, even though the van helps earn revenue in all five. Instead, the company records depreciation of $12,000 a year, matching the cost of the van to the revenue it helps generate.

In another case, a retailer pays its sales staff a 5 percent commission, settled in the month after each sale. December sales are $400,000, so commissions of $20,000 will be paid in January. Under the matching principle, the company records the $20,000 as December commissions expense, with an accrued liability, rather than in January when the cash is paid. Without the accrual, December profit would be overstated by $20,000 and January profit understated by the same amount.

A third common case is warranties. A manufacturer that sells products with a two-year warranty estimates future repair costs and records a warranty expense and liability in the period of the sale, rather than waiting until repairs are made.

Matching was a cornerstone of accounting theory for much of the twentieth century, but the conceptual frameworks of the FASB and IASB now give priority to the definitions of assets and liabilities. Under these frameworks, a cost can be deferred only if it meets the definition of an asset, meaning it is expected to bring future economic benefits. Matching is therefore treated as a result of recognizing assets and liabilities properly rather than as an independent rule. This approach prevents companies from deferring costs simply to smooth profits, which earlier practice sometimes allowed.

Many costs cannot be linked precisely to particular revenues, so allocation methods such as straight-line depreciation are estimates and can be somewhat arbitrary. Some costs that clearly support future revenue, such as most research and development and brand-building advertising, must be expensed immediately under US GAAP, so matching is imperfect. Common errors include recording supplier invoices in the month they arrive rather than the month goods or services were received, ignoring accrued wages at period end, and expensing prepaid annual costs such as insurance all at once. Problems of this kind are among the issues auditors check when testing cut-off, and they are closely connected to the cost principle and the broader set of accounting principles that underpin GAAP.