Accounting principle that requires costs to be recognized after matching with the revenues earned associated with such costs i.e. the amount of costs recognized must be on equal footings with the revenues recognized. In other words costs shall be recognized at the rate at which benefits are rendered or revenue/income is earned by the entity.
This principle helps in determining:
- timing of recognition – cost will be recognized in the period in which revenues are earned against them (accrual basis)
- amount of recognition – costs will be recognized on same proportion or rate at which revenues are earned (revenue recognition)
Matching principle is also referred as cause and effect principle as it records the effects of cost only to the extent they have caused the revenue in particular period. Due to the same reason we have accrued incomes/expenses, prepaid incomes/expenses, depreciation expense, deferred recognition of government grants etc.
However, it is not always the case that costs that were associated before will stay connected or for every cost we can determine the resultant revenue. In such cases treatments will be slightly different from the usual matching doctrine.
- If cause and effect relation cannot be established any more than cost incurred will be recognised in the period it is consumed or holds no future benefit in it i.e. when it expires. Patents lost, licence cancelled, royalty withdrawn etc.
- Easier example is of finished goods held in anticipation of sales but somehow demand is lost and they will expensed when they are scraped or applied for alternative use like used in place of raw material etc.
- Yet another example can be of development costs which is now a failed project.
- If costs cannot be associated with any benefit to be rendered in future than all the cost incurred is effectively a loss and must be written of in profit and loss expense immediately. This usually is the case with the research costs and that is why recognized in profit and loss account as expense immediately. Another example is of abnormal losses.
Other important and practical examples include:
- Accrued incomes or expenses
- Prepaid incomes or expenses
- Depreciation or amortization expenses
- Government Grants
Entity has produced 1,000 units with a total cost of 100,000. However, only 900 units were sold yielding 147,680 revenue. Although actual cost incurred is 100,000 but as only 900 units are sold so cost of only 900 units will be recognized i.e. 90,000. Therefore, profit will be: 147,680 – 90,000 = 57,680