Matching Concept in Accounting: Definition, Challenges and Best Practices

Introduction

The matching principle in accounting is a key concept in financial reporting that ensures a company’s expenses are recognized in the same accounting period as the revenue they helped generate. This principle is essential for preparing financial statements that comply with Generally Accepted Accounting Principles (GAAP) and provide an accurate picture of a company’s financial performance.

In this blog, we’ll explore the importance of the matching principle in accounting, the steps involved in implementing it, and the common challenges associated with it.

What is the Matching Principle in Accounting 

The matching principle in accounting requires companies to record expenses in the same period as the revenues they generate. This ensures that the financial statements accurately reflect a company’s financial performance by aligning costs with the associated income within the same period, in accordance with GAAP standards.

Importance of the Matching Principle

The matching principle in accounting enables businesses to ensure compliance with accounting standards such as GAAP and ensure that their financial statements are accurate. Here are some of the key reasons that make the matching principle important for businesses: 

• Helps determine the company’s financial status by keeping financial statements consistent

The matching principle in accounting ensures that expenses are aligned with revenues in the same period, promoting consistency in financial statements and preventing the misrepresentation of financial results. This principle enhances the accuracy of a company’s financial reports, offering a reliable view of its financial position and helping stakeholders make more informed decisions.

For example, Radius Cloud sold $10,000 worth of products in December 2022 but incurred $5,000 in related expenses in January 2023. Without the matching principle, their financial statements would have been inconsistent. By recognizing those expenses in December 2022, they maintained consistency and accurately reflected the company’s financial performance.

• Allows depreciation and amortization costs to be spread out over time

The matching principle allows the cost of an asset to be spread out over its useful life by allocating a portion of the asset’s cost to each period in which it is used to generate revenue. So, instead of recognizing the entire cost of the asset as an expense in the acquired year, the cost is spread out over the number of periods that the asset is expected to be profitable. Recognizing depreciation and amortization expenses over time ensures that the asset’s cost is spread out and matched with the revenue it generates.

For example, if a company purchases machinery for $100,000 with a useful life of 10 years, it can allocate an annual depreciation expense of $10,000 using the straight-line depreciation method. This ensures that the financial statements accurately reflect the assets use and value over time. 

• Reduces the chance of reporting incorrect profits during a specific accounting period

Failure to follow the matching principle can cause inconsistencies, leading to an overstatement of profitability in one period and an understatement in another. Matching revenues and expenses promotes accurate and reliable income statements, which investors can rely on to understand a company’s profitability. 

For example, if a company mistakenly recognizes $10,000 in expenses in the current period when they belong to the next period, it would lower the net income for the current period. Conversely, delaying the recognition of $10,000 in expenses to the next period would inflate the net income for the current period. The matching principle prevents such misstatements of profits.

• Ensures compliance with GAAP

Adherence to the matching principle is not just good practice, it’s a requirement for all public companies under GAAP. The matching principle ensures that a company’s financial statements present a true and fair view of its financial health. GAAP mandates this approach to maintain consistency, reliability, and comparability across financial reports, which is essential for investors, regulators, and other stakeholders. This alignment prevents the misrepresentation of profits and losses, ensuring that financial statements are reliable and consistent from one period to the next. 

How Does the Matching Principle Work in Accounting?

Let’s take a look at a step-by-step process of how the matching principle works: 

Step1: Identify Revenue

• Determine the revenue earned within an accounting period.
• Example: A consulting firm provides services worth $20,000 in June 2024.

Step 2: Link expenses to revenue

• Identify all costs incurred to generate the revenue.
• Example: The consulting firm paid $8,000 in employee salaries, $1,000 in software subscriptions, and $500 in office supplies during June 2024.

Step 3: Record expenses in the same period

• Record the expenses in the same accounting period as the related revenue.
• Example: The $9,500 in expenses ($8,000 salaries + $1,000 subscriptions + $500 supplies) is recorded in June 2024, alongside the $20,000 revenue.

Step 4: Apply depreciation to long-term assets

• For long-term assets, allocate the cost over their useful life.
• Example: A company buys a $10,000 machine with a 5-year lifespan. Using the matching principle, it records $2,000 as depreciation expense annually over five years, matching the machine’s cost to the revenue it helps generate each year.

Step 5: Ensure the reporting is GAAP-compliant

• Follow Generally Accepted Accounting Principles to maintain accuracy.
• Example: By applying the matching principle, the consulting firm’s financial statements reflect $8,500 in net income ($20,000 revenue – $9,500 expenses- $2000 depreciation expense) for June 2024, providing an accurate snapshot of financial performance.

Challenges of the Matching Principle

The following are some of the challenges businesses might encounter while implementing the matching principle effectively:

• Increasing complexity of revenue recognition

Revenue recognition is complex due to factors such as project completion timing and revenue allocation for different product parts. Establishing a direct cause-and-effect relationship between revenue and expenses is also challenging, as business operations, multiple revenue streams, and external factors can influence revenue generation and expense levels. 

For example, Radius Cloud offers bundled offerings, such as combining software licenses with ongoing maintenance and support services. Determining the appropriate revenue allocation between the initial license sale and recurring services becomes challenging. Similarly, revenue derived from additional services like customization or consulting is intertwined with software license revenue, making it difficult to establish a direct cause-and-effect relationship between revenue and expenses.

• Challenges in matching revenues with expenses for marketing campaigns

When running a marketing campaign, a company incurs upfront expenses for advertising, promotions, and creative development. However, the revenue generated from the campaign may be realized over an extended period as customers gradually respond to the marketing efforts and make purchases. This delay makes it difficult to accurately align the timing of expenses with the corresponding revenue.

For instance, Radius Cloud runs a one-month advertising campaign with upfront expenses, but the resulting revenue from increased product sales is realized over several months as customers respond to the campaign. The mismatch in timing makes the implementation of the matching principle difficult.

• Uncertainty and timing differences

Uncertainty arises when the outcome of a transaction is uncertain, such as in cases of potential legal disputes or contingent liabilities. Timing differences occur when the recognition of revenue or expenses is spread over multiple accounting periods due to factors like long-term contracts or installment payments. Uncertainty makes it difficult to predict transaction outcomes, while timing differences can lead to discrepancies between cash flows and their recognition in financial statements.

For example, accountants must analyze contracts, change orders, and project progress reports to accurately determine when to recognize revenue and expenses. This is important due to uncertainty in project scope, unforeseen issues, and material cost fluctuations, which can cause expenses to occur at different stages of the project and revenue recognition to depend on project milestones or specific deliverables.

• Difficulty in accounting for non-cash items and non-monetary transactions

Non-cash items such as depreciation, amortization, and stock-based compensation don’t involve actual cash outflows or inflows, making it difficult to match them precisely with the related revenues. Similarly, non-monetary transactions, such as barter exchanges or transactions involving assets other than cash, further complicate the matching process. Accounting for these expenses requires careful judgment and estimation.

For example, Radius Cloud receives stock as payment, making revenue recognition tricky. Valuing the stock is complicated by its fluctuating value, requiring judgment and estimation. The stock may need to be held for a certain period before its value can be realized.

Example of the Matching Principle

Let’s take a look at a few examples of matching principles: 

Example 1: Imagine a company, ABC Sales, that pays its sales team commissions for every sale they make. In December 2023, the sales team made $100,000 in sales, which was paid out in January 2024. According to the matching principle, ABC Sales should record the commission expense in December 2023, the same period the sales revenue was earned, even though the payment was made the following month. This ensures that the financial statements for December accurately reflect the costs associated with generating that month’s revenue.

Example 2: A retail company buys $50,000 worth of inventory in November, which is then sold in December for $75,000. According to the matching principle, the cost of the inventory ($50,000) should be recorded as an expense in December, the same period the related revenue ($75,000) is recognized. This ensures that the financial statements for December accurately reflect both the revenue and the associated costs, providing a true measure of profitability for that period.

How Can HighRadius Help?

HighRadius offers a cloud-based Record to Report Software that helps accounting professionals streamline and automate the financial close process for businesses. We have helped accounting teams from around the globe with month-end closing, reconciliations, journal entry management, intercompany accounting, and financial reporting.

Our Financial Close Software is designed to create detailed month-end close plans with specific close tasks that can be assigned to various accounting professionals, reducing the month-end close time by 30%.The workspace is connected and allows users to assign and track tasks for each close task category for input, review, and approval with the stakeholders. It allows users to extract and ingest data automatically, and use formulas on the data to process and transform it. 

Our Account Reconciliation Software provides an out-of-the-box formula set that can configure matching rules and match line-level transactions from multiple data sources and create templates to automate various transaction processing required for month-end close. Our solution has the ability to prepare and post journal entries, which will be automatically posted into the ERP, automating 70% of your account reconciliation process. 

Our AI-powered Anomaly Management Software helps accounting professionals identify and rectify potential ‘Errors and Omissions’ throughout the financial period so that teams can avoid the month-end rush. The AI algorithm continuously learns through a feedback loop which, in turn, reduces false anomalies. We empower accounting teams to work more efficiently, accurately, and collaboratively, enabling them to add greater value to their organizations’ accounting processes.

FAQs

1. How does the matching principle apply to depreciation?

The matching principle applies to depreciation by allocating the cost of long-term assets over their useful lives. Instead of expensing the entire cost upfront, depreciation spreads the expense across multiple periods, matching it with the revenue the asset generates over time, ensuring accurate financial reporting.

2. What is the difference between accrual and the matching principle?

The accrual principle recognizes revenues and expenses in the period they are earned or incurred, while the matching principle requires expenses to be recognized in the same period as related revenues. The former focuses on timing, while the latter links expenses to revenues.

3. What is the revenue recognition principle?

The revenue recognition principle mandates that revenue should be recorded when it is earned, regardless of when payment is received. This means recognizing revenue when goods or services are delivered, ensuring that financial statements accurately reflect a company’s financial performance.

4. What is the relationship between the matching principle and revenue recognition?

The matching principle links expenses to the related revenues, while the revenue recognition principle requires revenue to be recognized when it’s earned. They ensure accurate financial reporting by recognizing revenue in the period it’s earned and linking expenses to the revenues it generates.

5. What is the matching principle for accrued expenses?

The matching principle requires expenses to be recognized in the period in which the related revenues are earned. Accrued expenses are recognized when incurred, regardless of payment timing. This ensures expenses are matched with revenues generated, providing accurate financial reporting.