You’ve probably seen big companies with great brand recognition and sales making press releases about layoffs or shutdowns because they could not generate enough revenue. While this may seem unbelievable, it does happen more often than you think. 

Organizations spend millions of dollars on property, employees, and marketing to reach the right people, but sometimes these expenses overshadow their generated revenue. The matching principle ensures you know whether your expenses and generated revenue are aligned at every given time. 

It is an accounting principle that ensures that expenses are recorded in the same period as the revenue they help the organization generate. This principle maintains the integrity of financial statements and provides a more detailed view of the economic activity within a company during a specific reporting period.

Let’s discuss how the matching principle concept works and how to leverage it for your company’s growth.

Understanding the Matching Principle

The matching principle is a fundamental principle of accounting that governs how expenses are reported. It’s the principle that expenses incurred to generate revenue should be reported with the revenue generated. This allows for a more accurate representation of a company’s profitability by accounting for the costs of generating that revenue.

Key Elements Involved in the Matching Process:

A. Revenue Recognition

This step is to help you determine the income the company generated in a specific period. So, first, you start by identifying the specific events that make up the completion of a sale and what happens after the product/services have been transferred to the customer. 

Next, you record the negotiated sale price and any adjustments made for returns, rebates, or other items. After that record the revenue generated in the accounting ledger under the specific accounting period.

B. Expenses Recognition

This is similar to revenue recognition, only that instead of recording income, you are recording expenses. First, identify the expenses incurred while generating revenue such as production and delivery costs.

Next, calculate the company’s total expenses during the specified period and record them in the accounting ledger.

C. Periodicity

This is the step where you match the expenses and revenue generated. There are different matching techniques, but these are the most common:

• Accrual Accounting: This method identifies and records revenue when earned and expenses when incurred, regardless of when cash is received or paid. So, if there are rebates, returns, and other revenue aside from cash payments. This gives you a better picture of the company’s performance within a specific accounting period.
• Cash Accounting: This method allows you to report revenue only when you receive cash and expenses only when you pay cash. While it is easier, it may not accurately reflect your company’s performance over time.

What’s the Origin of the Matching Principle?

Initially, accounting was based on cash transactions. However, in the 15th century accrual accounting was developed to show companies’ financial performance consistently over time, which relies heavily on the principle of matching.

The matching principle became widely adopted and has evolved with the development of Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) frameworks. These frameworks provide step-by-step instructions on how the matching principle applies to different types of revenue and expense.

Application of the Matching Principle

Let’s look at the common ways you can apply the matching principle in your  accounting:

1. Cash and Credit Sales

Let’s say you are a furniture company and sold some furniture whether for cash or credit in May, the matching principle requires you to document this sale as revenue generated in May. However, for cases like subscriptions, you can break down the income into proportions to fit the matching period.

1. Expense Recognition

The matching principle helps you understand how much money you pour into running your business and identify areas for cost-effectiveness. When you match your revenue and expenses you understand if you need to cut down costs or have enough resources to scale up.

Importance in Financial Reporting

We don’t just recommend the matching principle because it’s a fancy way to do accounting, it has real-life benefits, let’s look at some of them:

1. Accurate Financial Statements

1. Contributes to Accuracy: The matching principle prevents misrepresentations of a company’s profitability. For example, if you own a branding agency and got a post-paid contract in December but do not record the income till February when you receive the payment. This would result in an understated profit in December and an overstated profit in February.
2. True Financial Picture: The matching principle takes into account the relationship between business activity and financial performance. For instance, if you spend money on advertising in a particular quarter, the matching principle makes sure that those advertising costs are offset against revenue generated from the advertising. So if your advertising doesn’t match up with your sales, it could be any indicator to slow down on promotions and go with a more organic strategy.

B. Transparency for Stakeholders

Investors, creditors, and other stakeholders rely on financial statements to make informed decisions. The matching principle ensures the information they receive is a true representation of the company’s performance, fostering trust in the company’s financial reporting practices.

Also, when your financial statements accurately reflect a company’s financial health, it boosts your investor and creditor confidence. This makes them more likely to keep funding your organization, making it easier to raise funds for growth and expansion.

Challenges and Controversies

Not everyone agrees with the matching principle because sometimes it can be hard to implement. Let’s look at some challenges you might face when implementing the matching principle:

1. Expenses/Revenue vs Matching Period

Determining the exact period to match an expense to revenue can be complex, especially for long-term contracts or service-based businesses.  For example,  allocating expenses like biannual rent or lease when your matching period is quarterly is going to be difficult.

1. Controversies in Implementation

Accounting bodies often encounter situations where strict compliance with the matching principle may not accurately reflect the economic value of a given transaction. In cases like this, you have to use other account reconciliation and auditing methods.

Case Studies

If you are not sure if the matching principle is useful for your business, here are some case studies showing how you can use it:

1. B2C Retail Company

Integrate a matching process for customer payments that matches invoices to incoming funds. This saves time, makes accounts receivable easier, and keeps your financial records accurate.

2. Inventory Code Mismatch

If there is an inventory code mismatch between your system and the supplier’s, you can still use the matching principle to figure out your income and expenses. The supplier needs to check their records for income generated within the purchase timeframe, you check yours for expenses and match it to figure out the cost of different products.

Future Trends and Adaptations for Matching Principle

There are currently hundreds of apps and software that simplify accounting, but there will be many more in the future, especially now that artificial intelligence and web3 are dominating the development landscape. Here are some of the future trends to watch out for in accounting:

A. Tech-Enabled Accounting

Machine Learning and AI can help automate data extraction, pattern recognition, and exception handling in accounting. You can also use robotic process automation (RPA) or simply bots to automate repetitive tasks like invoice and payment matching.

B. Potential Changes in Accounting Standards

Accounting principles are constantly being reviewed and updated by standard-setting bodies to keep up with business practices. So, the matching principle could be updated to reflect new standards.

Best Practices for Implementing the Matching Principle

Here are some best practices to effectively implement the matching principle in your accounting:

A. Internal Controls

• Establishing Robust Internal Controls: Implement clear procedures for expense recognition, invoice processing, and accrual accounting practices.  This helps you to minimize errors and ensure proper application of the matching principle.
• Ensuring Compliance with Accounting Standards: Depending on your industry and location follow the proper accounting standards such as the Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS).

B. Learn, Unlearn, and Relearn

Accounting standards and industry are constantly changing; the accounting standards we use now are not what was available 50-100 years ago. So, attend workshops, seminars, and conferences. You should also enroll for professional certifications. This will ensure your accounting practices match your industry standards at every given time.

Conclusion

The matching principle links the cost of generating revenue to the revenue itself. This provides a more precise view of a company’s profitability over a certain period. It also demonstrates your transparency and understanding of company finances, which builds trust with your investors and creditors.