What is the matching concept in accounting

ACCOUNTING

The matching concept in Accounting-By this post, we shall study in detail the important matching concept out of 12 various accounting concepts on which accounting is based. If you have a business then you should know about these important matching concepts.

What is the meaning of matching concept?

In this matching concept, all expenses matched with the revenue of that period should only be taken into consideration. In the financial statements of the organization if any revenue is recognized then expenses related to earning that revenue should also be recognized.

How can you explain the matching concept?

If you want to know the explanation of this concept then this concept is based on the accrual concept as it considers the occurrence of expenses and income and does not concentrate on actual inflow or outflow of cash. This leads to an adjustment of certain items like prepaid and outstanding expenses, unearned or accrued incomes.

It is not necessary that every expense identify every income. Some expenses are directly related to the revenue and some are time-bound.

How does matching concept work with example?

The purpose of the matching concept is to maintain consistency across a business’s income statements and balance sheets. Here’s how it works:

  1. Expenses are recorded on the income statement in the same period that related revenues are earned.
  2. Expenses not directly tied to revenues should be reported on the income statement in the same period as their use.
  3. Liabilities are recorded on the balance sheet at the end of the accounting period.

For example:- selling expenses are directly related to sales but rent, salaries, etc are recorded on an accrual basis for a particular accounting period. In other words periodicity concept has also been followed while applying the matching concept.

Mr. Titu started a cloth business. He purchased 20,000 pcs. garments @ 100₹ per piece and sold 16,000 pcs. @ 150₹ per piece during the accounting period of 12 months 1st January to 31st December 2022. He paid shop rent @ 6,000₹ per month for 11 months and paid 16,00,000₹ to the suppliers of garments and received 20,00,000₹ from the customers.

Let us see how the accrual and periodicity concepts work.

The periodicity Concept fixes up the time frame for which the performance is to be measured and financial position is to be appraised. Here, it is January 2022 – December 2022. So revenues and expenses are to be measured for the year 2022 and assets and liabilities are to be ascertained as of 31st December 2022.

Accrual Concept operates to measure revenue of 24,00,000₹ (arising out of the sale of garments 16,000 Pcs × 150₹) which accrued during 2022, not the cash received 20,00,000₹ and also the expenses correctly. Shop rent for 12 months is an expense item amounting to 72,000₹, not 66,000₹ the cash paid.

Should the accountant treat 20,00,000₹ as expenses for the purchase of merchandise? And should he treat 3,28,000₹ as profit? (Revenue 24,00,000₹-Merchandise 20,00,000₹. Shop Rent 72,000₹).

Obviously, the answer is No. Matching links revenue with expenses.

Revenue – Expenses = Profit

But this unqualified equation may create misconceptions. It should be defined as Periodic Profit = Periodic Revenue – Matched Expenses

From the revenue of an accounting period, such expenses are deducted which are expended to generate the revenue to determine the profit of that period.

In the given example revenue relates to only the sale of 16,000 pcs. of garments. So the cost of 16,000 pcs of garments should be treated as an expense.

ParticularAmountAmount
Revenue 2400000₹
– expenses-1600000₹
– rent – 72000₹-1672000₹
Profit 728000₹
LiabilityAmountAssetsAmount
Trade Payable 400000₹Inventory (4000 pcs * 100₹)400000₹
Expenses payables 6000₹Trade Receivable400000₹
Capital (for profit)728000₹Cash (cash receipt 2000000₹- cash paid 1666000₹)334000₹
Total1134000₹Total1134000₹

Thus, accrual, matching, and periodicity concepts work together for income measurement and recognition of assets and liabilities

What is the importance of matching concepts?

The matching concept is very important when preparing your financial statements:

  1. Greater accuracy when representing the company’s financial position
  2. Consistency across financial statements, including the balance sheet and income statement
  3. Depreciation costs can be distributed over time
  4. Less chance of wrong profits during a particular accounting period
  5. Recognizing expenses at the wrong time may distort the financial statements greatly. A business may end up with an inaccurate financial position of its finances. The matching principle helps businesses avoid misstating profits for a period.

Further Faqs related to matching concepts

  1. What are Accrued Expenses?

    Accrued expenses are a liability with an uncertain timing or amount, but where the uncertainty is not significant enough to qualify it as a provision. 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.

  2. What are prepaid expenses?

    A prepaid expense is an asset, such as cash paid out to a counterpart for goods or services to be received in a later accounting period when fulfilling the promise to pay is actually acknowledged, the related expense item is recognized, and the same amount is deducted from prepayments.

  3. What is the definition of a matching concept?

    The matching concept is a fundamental rule in the accrual-based accounting system, which requires expenses to be recognized in the same period as the applicable revenue.
    For instance, the direct cost of a product is expensed on the income statement only if the product is sold and delivered to the customer.

  4. What is the matching concept principle?

    The matching concept is at the heart of the accrual basis of accounting. It is important to match expenses with revenues because net income, which means the net amount earned in a period, is calculated by subtracting expenses from revenues.

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