matching principle


  • Accrued expenses[edit] For example, goods supplied by a vendor in one accounting period, but paying for them in a later period results in an accrued expense that prevents
    a fictitious increase in the receiving company’s value equal to the increase in its inventory (assets) by the cost of the goods received, but unpaid.

  • For example, when the accounting periods are monthly, an 11/12 portion of an annually paid insurance cost is added to prepaid expenses, which are decreased by 1/12 of the
    cost in each subsequent period when the same fraction is recognized as an expense, rather than all in the month in which such cost is billed.

  • [2] Expense vs. cash timing Two types of balancing accounts exist to avoid fictitious profits and losses that might otherwise occur when cash is paid out not in the same accounting
    periods as expenses are recognized, because expenses are recognized when obligations are incurred regardless when cash is paid out according to the matching principle in accrual accounting.

  • Without such accrued expense, a sale of such goods in the period they were supplied would cause the unpaid inventory (recognized as an expense fictitiously incurred) to effectively
    offset the sale proceeds (revenue), resulting in a fictitious profit in the period of sale, and in a fictitious loss in the latter period of payment, both equal to the cost of goods sold.

  • Cash can be paid out in an earlier or later period than obligations are incurred (when goods or services are received), and related expenses are recognized that result in
    the following two types of accounts: • Accrued expense: Expense is recognized before cash is paid out.

  • Similarly, cash paid out for (the cost of) goods and services not received by the end of the accounting period is added to the prepayments to prevent it from turning into
    a fictitious loss in the period cash was paid out and into a fictitious profit in the period of their reception.

  • Deferred expenses (or prepaid expenses or prepayment) is an asset, such as cash paid out to a counterpart for goods or services to be received in a latter accounting period
    when fulfilling the promise to pay is acknowledged, the related expense item is recognized, and the same amount is deducted from prepayments.

  • It shares characteristics with deferred income (or deferred revenue) with the difference that a liability to be covered latter is cash received from a counterpart, while goods
    or services are to be delivered in a latter period, when such income item is earned, the related revenue item is recognized.

  • Examples • Accrued expense allows one to match future costs of products with the proceeds from their sales before paying out such costs.

  • An example is an obligation to pay for goods or services received from a counterpart, while cash for them is to be paid out in a later accounting period when its amount is
    deducted from accrued expenses.

  • The company recognizes the commission as an expense incurred immediately in its current income statement to match the sale proceeds (revenue), so the commission is also added
    to accrued expenses in the sale period to prevent it from otherwise becoming a fictitious profit.

  • The not-yet-recognized portion of such costs remains as prepayments (assets) to prevent such cost from turning into a fictitious loss in the monthly period it is billed, and
    into a fictitious profit in any other monthly period.

  • • Deferred expense (prepaid expense) allows one to match costs of products paid out and not received yet.

  • Period costs, such as office salaries or selling expenses, are immediately recognized as expenses (and offset against revenues of the accounting period).

  • Prepaid expenses are not recognized as expenses but as assets until one of the qualifying conditions is met, resulting in a recognition as expenses.

  • Conversely, cash basis accounting calls for recognizing an expense when the cash is paid, regardless of when the expense was incurred.

  • • Depreciation matches the cost of purchasing fixed assets with revenues generated by them by spreading such costs over their expected useful life span.


Works Cited

[‘1. Accounting Principles by Wild, Shaw, Chiappetta
2. ^ Libby, Robert; Libby, Patricia; Short, Daniel (2011). Financial Accounting. McGraw-Hill. p. 111. ISBN 978-0-07-768523-2.
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