The matching principle states that expenses should be recognized and recorded when those expenses can be matched with the revenues those expenses helped to generate. In other words, expenses shouldn’t be recorded when they are paid. Expenses should be recorded as the corresponding revenues are recorded. This matches the revenues and expenses in a period. In this sense, the matching principle recognizes expenses as the revenue recognition principle recognizes income.
In general, there are two types of costs: product and period costs. Product costs can be tied directly to products and in turn revenues. Period costs, on the other hand, cannot.
Period costs do not have corresponding revenues. Administrative salaries, for example, cannot be matched to any specific revenue stream. These expenses are recorded in the current period.
The matching principle also states that expenses should be recognized in a “rational and systematic” manner. This is the key concept behind depreciation where an asset’s cost is recognized over many periods.
In short, the matching principle states that where expenses can be matched with revenues, we should do so because the benefits of an asset or revenue should be linked to the costs of that asset or revenue.
– Angle Machining, Inc. buys a new piece of equipment for $100,000 in 2015. This machine has a useful life of 10 years. This means that the machine will produce products for at least 10 years into the future. According to the matching principle, the machine cost should be matched with the revenues it creates. Thus, the machine is depreciated over its 10-year useful life instead of being fully expensed in 2015.
– Bajor Art Studio produces picture frames and sells them to wholesalers like Michaels and Hobby Lobby. Bajor pays its employees $20 an hour and sells every frame produced by its employees. Since the payroll costs can be directly linked back to revenue generated in the period, the payroll costs are expensed in the current period.
– Big Appliance has sold kitchen appliances for 30 years in a small town. It purchases a large appliance from wholesalers for $5,000 and resells it to a local restaurant for $8,000. At the end of the period, Big Appliance should match the $5,000 cost with the $8,000 revenue.