In the case of prepaid rent, for instance, the cost of rent for the period would be deducted from the Prepaid Rent account. It should be mentioned though that it’s important to look at the cash flow statement in conjunction with the income statement. If, in the example above, the company reported an even bigger accounts payable obligation in February, there might not be enough cash on hand to make the payment. For this reason, investors pay close attention to the company’s cash balance and the timing of its cash flows. The matching principle is a part of the accrual accounting method and presents a more accurate picture of a company’s operations on the income statement.

Your https://www.bookstime.com/ pay period ends on April 24, but your next pay date is May 1. The amount of wages your employees earn between April 24 and May 1 amount to $4,150.

What Is the Matching Principle and Why Is It Important?

The following journal entry will be recorded each accounting period. This journal entry displays the rent expense for the month, while reducing the prepaid rent account. The matching principle requires a degree of estimation for certain expenses such as warranty costs, interest costs, and capital purchase expenses with an inexact useful life. Violating the matching principal can result in inaccurate financial reports when costs are not matched to the revenue they generate. The matching principle is not used in cash accounting, wherein revenues and expenses are only recorded when cash changes hands.

The fiMatching Principlet question you should ask when using the matching principle is whether or not your expenses are directly or indirectly related to generating revenue. The matching principle is one of the ten Generally Accepted Accounting Principles . And, the matching principle is the driving force of accrual accounting.

Matching Concept Vs. Accrual Accounting

They are categorized as current assets on the balance sheet as the payments expected within a year. Accrued ExpensesAn accrued expense is the expenses which is incurred by the company over one accounting period but not paid in the same accounting period. In the books of accounts it is recorded in a way that the expense account is debited and the accrued expense account is credited. You must use adjusting entries at the end of an accounting period to ensure your business’s revenues and expenses are accounted for correctly. According to the matching principle, both the commission fees and cosmetic sales must be recorded in the same accounting period.

If there’s no cause and effect relationship, then the accountant will charge the cost to the expense immediately. The company should recognize the entire $2,000 cost as expense in the same reporting period as the sale, since the recognition of revenue and the cost of goods sold are tightly linked. Several examples of the matching principle are noted below, for commissions, depreciation, bonus payments, wages, and the cost of goods sold. For example, if the office costs $10 million and is expected to last 10 years, the company would allocate $1 million of straight-line depreciation expense per year for 10 years. The expense will continue regardless of whether revenues are generated or not.

Accrued expenses

However, the matching principle matches expenses with the revenue they helped generate, as opposed to being recorded in the period the actual cash outflow was incurred. To illustrate the matching principle, let’s assume that a company’s sales are made entirely through sales representatives who earn a 10% commission. The commissions are paid on the 15th day of the month following the calendar month of the sales. For instance, if the company has $60,000 of sales in December, the company will pay commissions of $6,000 on January 15. A deferred expense is an asset used to costs paid out and not recognized as expenses according to the matching principle.