What is the Matching Principle of Accounting?

Matching Principle Examples

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#1 – Accrued Expenses

For some work, you hired contract laborers and agreed to pay them $1000. The work is done in July. However, the laborers are paid in August. What is the cost accounted for in July?

This recording of such accrued expensesAccrued 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.read more (irrespective of actual payment made or not) and matching it with the related revenue is known as the Matching Principle of accounting. Please note that in the matching principle of accounting, the actual payment date doesn’t matter; It is important to note when the work was done. In this case study, the work was completed in July.

#2 – Interest Expenses

Let us say that you borrow $100,000 from a bank to start your business. The annual interest that you agree to pay is, say, 5%. The interest payment is made at the end of the year in December. What is the interest expenseInterest ExpenseInterest expense is the amount of interest payable on any borrowings, such as loans, bonds, or other lines of credit, and the costs associated with it are shown on the income statement as interest expense.read more accounted for in July?

You will pay a total interest of $100,000 x 5% = $5,000. It would help to match the interest expense to each month’s revenue.

Interest expense to be recorded for 1 month (July) = $5000/12 = $416.6

#3 – Depreciation Expense

On July 1, let’s assume that you buy machinery worth $30,000, and its useful life is five years. How will you record expenses for this transaction in July?

For recording depreciation expense as per the matching principle of accounting, you can calculate the yearly depreciation (straight line depreciation methodStraight Line Depreciation MethodStraight Line Depreciation Method is one of the most popular methods of depreciation where the asset uniformly depreciates over its useful life and the cost of the asset is evenly spread over its useful and functional life. read more) = 30,000/5 = $6000 per year. With this depreciation expense charged for July = $6000/12 = $500

Comprehensive Example

  • John started with a window washing services business on Dec 18th by investing his equity of $10,000.He bought the tools required for the business, worth $3,000, on Dec 20th.John hired two helpers who his company directly employs at the rate of $4,000/person/month as of Dec 21st.He received a contract for window washing on Dec 22nd to be performed on Dec 23rd, for which the client paid him $500 on Dec 22nd and would pay him the remaining $2,000 on Dec 27th after the end of festivities.He received another contract on Dec 23rd to be carried out on Jan 5th, for which the client paid him $1,500 in advance.He paid salaries to the two helpers of $8,000 on Jan 2nd, as the company pays its workers after the end of the month.

Now, we can prepare journal entries on Dec 31st for the above example as per the illustration below:

  • Hence it is seen from the illustration that the actual expense date for payment of wages is Jan 2nd, but a temporary entry is made in the books of accounts on the Dec 31st when it is supposed to be paid since it is the close of that month in which the helpers worked for John’s company. If the complete entry is referred to regarding the wages to be paid, it is seen that the amount under Wages Payable gets netted off on Jan 2nd after the actual transaction is made.Another matching principle example can be considered of the service income received on Dec 27th. However, a temporary entry is made on Dec 22nd since John received the contract on this date, and as on that day, he needs to show the supposed value of the transaction (even though the actual transaction takes place on a future date).Similarly, the contract to be carried out on Jan 2nd is a future date event. However, the contract was received on Dec 23rd, and cash was paid on this date. Hence it needs to be entered as of Dec 23rd.

The significance of the Matching Principle of Accounting

The matching principle in accounting is closely related to accrual accountingAccrual AccountingAccrual Accounting is an accounting method that instantly records revenues & expenditures after a transaction occurs, irrespective of when the payment is received or made. read more. Rather it requires the accrual system to be followed very stringently. The term “accrual” in accounting means anything accrued for a particular period until it gets paid on a future date.

Hence, this principle equates the total credits with total debits (or total expenses with the total income) as of a particular period. There are temporary account labels created like Wages Payable, Accounts Payable, Interest Payable, Accounts ReceivableAccounts ReceivableAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year. read more and Interest Receivable, etc., which get net off when the actual transaction is made.

These accounts hold no amount until and unless a new transaction is completed on a future date. So, the balance sheet generated after the actual transaction will not reflect these accounts, as the amount in these accounts gets net off with the supposed account. In the balance sheet, these accounts (if they have a reasonable amount entered) are listed under Current AssetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more or Current Liabilities based on the nature of the account.

A very good example of the accrual system is the coupon payment on bonds (or, for that matter, any investment which pays returns based on a particular frequency). The coupon to be paid by the bond issuer gets accumulated from the date of issue until paid. Hence, in the issuer’s book of account, some amount pertains to the coupon to be paid to investors monthly. It is called the accrued interestAccrued InterestAccrued Interest is the unsettled interest amount which is either earned by the company or which is payable by the company within the same accounting period.read more for the investor (and has relative terms concerning other regular return-paying investments).

Final Thoughts

The matching principle of the accounting system is, which follows a dual-entry bookkeeping system. Using this principle, the accounting systemAccounting SystemAccounting systems are used by organizations to record financial information such as income, expenses, and other accounting activities. They serve as a key tool for monitoring and tracking the company’s performance and ensuring the smooth operation of the firm.read more gives a very clear picture of mainly the company’s current assets and current liabilities, which helps investors and other financial analysts understand the worth of the company and how well it is being operated. With the help of quite some ratios, the company’s performance is determined, which helps investors decide on investments.

Matching Principle of Accounting Video

This article has been a guide to Matching Principles of Accounting and its definition. Here we take matching principles examples of interest, accrued, and depreciation expenses along with their significance. You may learn more about accounting from the below articles –

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