When it comes to understanding accounting, there are a number of essential core concepts; the matching principle is one of the most important of these fundamental concepts to have a firm grasp of.
The matching principle refers to the imperative for a company to announce any and all of its income statement expenses within the same period as any of the revenues that they are directly related to. Revenues that an income statement expense might be related to include any capital that is gained from the selling of goods and/or services.
The cost of goods
One of the main expenses that must be matched with the earnings made from sales is the cost of any goods sold (COGS). Though the cost of goods is important, not every single expense is categorized as directly relatable to the actual amount signifying earnings from sales.
In any circumstance where the expense itself has no cause/effect relationship with sales, there might be a special allocating of a certain expense to any moments in time when that expense has been used; this is referred to as systematic allocation. In the event that a company purchases a piece of CRM software for $12,000 that is expected to be used for 12 months, then every $1000 of expense for each month up until twelve months have elapsed will be matched to the monthly income statement.
Relationship with commissions
To put the principle in perspective, a relevant hypothetical scenario could involve any employee’s earned commission and the impact of such on the company’s sales as a while.
If employees who earn 20% commission are collectively responsible for the grand total of the amount that the company profits from sales, then their commissions might be arranged as payable on the 30th of whatever the next month might be; in this hypothetical scenario, $100,000 in sales would equate to the payment of $20,000 to each commission-earning employee on the 30th of the subsequent month following the sales that they made.
In addition to the commissions being payable on the the 30th of the next month, it could also be reasonably expected that there will be an preceding adjustable entry with credit towards Commissions Payable and debit toward Commission Expense.
The accrual basis
Understanding the principle is made easier with a fundamental understanding of accrual accounting. The accrual basis is the exact foundation upon which the principle of same-earning-period revenue reporting is based.
The accrual basis is in contrast to the cash basis, in which the revenue is only reported upon the time at which the earnings are received by the commissioned agent. The accrual basis mandates that any and all revenue reports are explicitly synchronized with related expenses and only reported when those expenses themselves have occurred, regardless of when the commission itself is paid to the agent entitled to it.
The matching principle is essentially a way for companies to go about accounting for their expenses in a more organized fashion. Every expense is categorized and accounted for its relationship to the amount of capital gained through sales, which is essential for developing the right perspective on just how profitable the company’s actions have been.