Introduction to Matching Principle
When it comes to the interpretation of financial statements, there are 14 principles in accounts that govern them. All the statements must be prepared and calculated in such a way that they respect all of them. The matching concept is just one of those principles. To abide by the matching principle, accounting requires accuracy and perfection in the documentation of revenues and expenses. Although there exists no certain matching concept definition, this text will try to articulate a meticulous definition along with the real-time use of the matching principle. By the end, you will be able to grasp period cost and products cost associated with the matching concept.
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What is the Matching Concept?
The matching concept in accounting as a principle applies to accrual accounting. Accrual accounting is the process of matching revenues, i.e., the income generated through the retail of a commodity, and the expenses, i.e. the cost of production. It simply implies that revenue and production costs must be calculated during the same accounting period. Thus, the matching principle accounting says that the income statement of the organization will be reflective of the associated cost of the revenues and the income of that period.
What is the Matching Concept in Accounting?
To further explain the matching concept, let us define period costs and product costs.
Period Costs: These are the costs that are not directly linked to the product, such as commissions, office supplies, or rent. They are only mentioned in the statement when they occur. Here, expenses must be documented in the timeframe of their incurrence rather than when you pay the amount according to the matching concept in accounting.
Product Costs: Product costs are related to the expenses made for the production of the cost. The accrual or matching principle tells us to calculate the cost associated with the production of the commodity simultaneously with the revenue associated with the sold commodities. Thus, if a salesperson can sell 200 copies of a book in January, then the cost price of those 200 copies must be matched with the income for January to calculate the profit or loss.
Matching Concept in Accounting Example
Let's suppose a company produces a hundred books for the cost of four thousand. Later, it sells twenty copies for fifty rupees per unit, thereby getting revenue of two thousand rupees. The Matching principle dictates that although the total cost of production was four thousand, the profit would be twelve hundred rupees despite the revenue being 2000. In other words, in matching principle accounting, the revenue must be considered first for the given period, and then one must see the expenses incurred to produce that revenue. Thus, here it would be wrong to imply that a loss of two thousand rupees was incurred since the company invested four thousand rupees in the production of all commodities.
Fun Facts
The matching concept in accounting comes under the purview of accrual accounting. Often students get confused between the two concepts of accounting. Additionally, the matching concept accounting can have a duality. While the matching principle accounting accurately represents the finances of the organisation, it often misses the effects of inflation. Thus, one must be considerate of the factors to avoid errors.
Solved Matching Concept Example
Q. YESTER, an insurance company, tends to receive an insurance premium from its customers. The profit before tax for the year ended 2012 is rupees 1,00,00,000. The projected taxable profit amounts to rupees 11,00,000 against a current tax provision of 40% in the financial statements. The difference of rupees 1,00,000 between accounting profit and taxable profit is a result of taxable prepaid income. How much income tax expense should YESTER recognise to abide by the Matching Principle?
Ans: Difference between current tax and deferred tax. 4,40,000- 40,000= 4,00,000.
＄4,000 of the estimated current tax charge relates to prepaid income, recognised in the subsequent accounting period. Consequently, ＄4,000 must be subtracted from the tax expense calculation and matched against the accounting profit earned in the next year. Therefore, the tax expense for the year of ＄40,000 may also be derived by applying the tax rate of 40% to the profit before tax of ＄100,000.
FAQs on The Matching Concept in Accounting
1. What is the matching concept in accounting as per the CBSE syllabus?
The matching concept, also known as the matching principle, is a fundamental rule in accrual accounting. It states that all expenses incurred to generate revenue must be recognised and recorded in the same accounting period as the revenue itself. This ensures that a company's financial statements, like the Profit and Loss Account, accurately reflect the profitability of its operations for that specific period.
2. Can you provide a simple, real-life example of the matching concept?
Certainly. Imagine a retail store buys 50 shirts for ₹200 each in April. In May, it sells 30 of those shirts for ₹500 each, generating a revenue of ₹15,000 (30 shirts x ₹500). According to the matching concept, to calculate the profit for May, the revenue of ₹15,000 must be matched with the cost of the 30 shirts sold, which is ₹6,000 (30 shirts x ₹200). It would be incorrect to deduct the entire purchase cost of ₹10,000 (50 shirts x ₹200) in May.
3. What are the main advantages of applying the matching principle in financial reporting?
The matching principle offers several key benefits for accurate financial reporting:
- Accurate Profit Calculation: It prevents the overstatement or understatement of profits by ensuring that costs are directly tied to the revenues they helped generate within the same period.
- True Financial Position: It gives investors, creditors, and management a more realistic and reliable view of a company's performance.
- Consistency in Reporting: It standardises how expenses are reported, making financial statements comparable across different accounting periods.
4. On which fundamental accounting assumption is the matching concept based?
The matching concept is directly based on the Accrual Assumption of accounting. The accrual assumption dictates that financial transactions should be recognised when they occur, not when cash is actually exchanged. The matching concept is the specific application of this assumption to expenses, ensuring they are recorded when incurred to generate revenue, regardless of when they are paid for.
5. How does the matching concept differ from the revenue recognition principle?
While both are core to accrual accounting, they govern different sides of a transaction. The revenue recognition principle answers the question of *when* to record revenue (i.e., when it is earned and realised). In contrast, the matching concept answers the question of *when* to record expenses (i.e., in the same period as the revenue they helped generate). Essentially, revenue recognition identifies the income, and the matching concept identifies the costs associated with that income.
6. How does the matching concept apply to long-term assets like machinery or buildings?
For long-term assets that provide benefits over multiple years, their cost is not recorded as an expense in the year of purchase. Instead, the matching concept is applied through a process called depreciation. The total cost of the asset is systematically allocated as an expense over its estimated useful life. This way, a portion of the asset's cost is 'matched' against the revenue it helps to generate in each accounting period, providing a more accurate picture of profitability over time.
