Matching Concept

May 31st, 2006 Comments off
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MATCHING CONCEPT

  • A process in which expenses are recognised in the income statement on the basis of a direct association between the costs incurred and the earning of specific items of income.

  • This process involves the simultaneous or combined recognition of revenues and expenses that result directly and jointly from the same transactions or other events.

  • This principle dictates that when it is reasonable to do so, expenses should be matched with revenues. When expenses are matched with revenues, they are not recognized until the associated revenue is also recognized.

  • This principle allows greater evaluation of actual profitability and performance (shows how much was spent to earn revenue).

FURTHER DETAILS

  • Wages paid to manufacturing laborers are not recognized as expenses until the actual products are sold. When the products are sold, the expenses are recognized as cost of goods sold.

  • Product costs are costs which add value to inventory. These costs are capitalized (added) to inventory, and later expensed as cost of goods sold.

  • Only if no connection with revenue can be established, cost can be charged as expenses to the current period (e.g. office salaries and other administrative expenses). These are period costs which are costs which are expensed immediately.

  • Depreciation is another example of the matching principle: The cost of purchasing a fixed asset is spread over the period in which it is expected to generate revenue.

ILLUSTRATION NO.1

On March 14, the company received inventory of $10,000.

On April 13, the vendor is paid in full.

On May 11, the company sold the inventory for $20,000

Question: When should the inventory become an expense?

Answer: In the month of May as the inventory was sold. We have the income of $20,000 which we need to match it with the cost of $10,000

ILLUSTRATION NO.2

Company A bought a machinery for $36,000. It expects the machinery to be able to generate incomes for a period of three (3) years. The company uses the straight line method for depreciating the machinery.

Question: What should be the annual or monthly depreciation to be expensed off to match the generation of income?.

Answer: The company should expensed off $36,000/3 years =$12,000 per annum or $1,000 per month so as to match against the income.

ILLUSTRATION NO.3

Company A bought a $12,000 yearly motor vehicle insurance from July 05 to June 06. The company year end is at 31 st December.

Question: What should the company expense into the income statement from 1 st January to 31 st December 05 pertaining to this motor vehicle insurance?

Answer: The company should expense off only half the year motor vehicle insurance relating to the period from July 05 to December 06 namely half of $12,000 = $6,000 into the income statement. This is because from January 2006 to June 2006 the motor vehicle insurance does not relate to the generating of income for that period.

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Financial Accounting

 
 

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