In order to comply with the generally accepted accounting principles, companies must determine the exact time when revenue and expenses occur. This is the basis of the GAAP matching principle, which recognizes exactly when the revenue and expenses are incurred and allows companies to gain an accurate analysis of current accounts at any point during the accounting period. The principle is part of the accrual basis of accounting.
Significance of the Matching Principle
Any company that makes its financial statements publicly available must follow GAAP standards; the matching principle is one of the fundamental guidelines established by the Financial Accounting Standards Board.This process is different than the principles of cash accounting where the total amount of the revenue or expenses are recorded regardless of when they actually have an impact on the business’s cash flow. The GAAP matching principle helps to provide a clear and accurate picture of actual cash on hand, revenue generated and expenses incurred at a specific point in time.
Matching Expenses and Revenue
In order to minimize errors and provide accurate reporting of accounts throughout the accounting period, companies can recognize expenses and revenue as they occur within a giving period of time. The GAAP matching principle recognizes expenses when they are incurred, and when they distinguish between deferred and accrued revenue in order to determine its actual value for the business at a certain point in time.
Timing Differences in Revenue and Expenses
There are four different types of timing differences that must be factored into the final reporting of revenue and expenses. Accrued revenues are recognized before the cash from a sale is received; this is similar to a prepaid expense where the revenue is posted to the accounting records before the company has the cash in its accounts. An accrued expense is incurred as soon as the goods or services are received, but no cash has been paid to the vendor. Deferred expenses are considered to be an asset because the amounts of the services or goods are not paid out until the invoice. Deferred income or deferred revenue is considered to be a liability and not an asset until the cash is received. Making sure various accounts are posted with consideration to these timing differences ensures that the GAAP matching principle is in effect.
Benefits of the Matching Principle
Companies that comply with the GAAP matching principle can accurately evaluate their performance over a given accounting period because all expenses are matched with the corresponding revenue. These values can determine the exact return on investment for specific expenses, and also determine the actual profitability of certain initiatives such as investing in new operational equipment or when buying advertising.
Matching Principle Misconceptions
The GAAP matching principle does not always make it easy to forecast the future benefit of certain investments or expenses such as advertising and marketing. In these cases, the accountant must post the item as an expense for the period that the ad or campaign was initiated. A separate revenue and expense matching graph may be created to determine the return on investment.