The matching principle requires that revenues and any related expenses be recognized together in the same period. Thus, if there is a cause-and-effect relationship between revenue and the expenses, record them at the same time. If there is no such relationship, then charge the cost to expense at once. This is one of the most essential concepts in accrual basis accounting, since it mandates that the entire effect of a transaction be recorded within the same reporting period.
Here are several examples of the matching principle:
- Commission. A salesman earns a 5% commission on sales shipped and recorded in January. The commission of $5,000 is paid in February. You should record the commission expense in January.
- Depreciation. A company acquires production equipment for $100,000 that has a projected useful life of 10 years. It should charge the cost of the equipment to depreciation expense at the rate of $10,000 per year for ten years.
- Employee bonuses. Under a bonus plan, an employee earns a $50,000 bonus based on measurable aspects of her performance within a year. The bonus is paid in the following year. You should record the bonus expense within the year when the employee earned it.
- Wages. The pay period for hourly employees ends on March 28, but employees continue to earn wages through March 31, which are paid to them on April 4. The employer should record an expense in March for those wages earned from March 29 to March 31.
Recording items under the matching principle typically requires the use of an accrual entry. An example of such an entry for a commission payment is:
In this entry, the commission expense is charged before the cash payment to the salesperson actually occurs, along with a liability in the same amount. In the following month, the company pays the commission, and records the following entry:
The cash balance declines as a result of paying the commission, which also eliminates the liability.
Because use of the matching principle can be labor-intensive, company controllers do not usually employ it for immaterial items. For example, it may not make sense to create a journal entry that spreads the recognition of a $100 supplier invoice over three months, even if the underlying effect will impact all three months. Instead, such small items are charged to expense as incurred.
If you do not use the matching principle, then you are using the cash method of accounting, where revenue is recorded when cash is received and expenses when they are paid.