Matching principle

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Key concepts Accounting period Accrual Constant purchasing power Economic entity Fair value Going concern Historical cost Matching principle Materiality Revenue recognition Unit of account
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In accrual accounting, the matching principle instructs that an expense should be reported in the same period in which the corresponding revenue is earned. The revenue recognition principle states that revenues should be recorded during the period in which they are earned, regardless of when the transfer of cash occurs. By recognising costs in the period incurred, a business can see how much money was spent to generate revenue, reducing "noise" from the mismatch between when costs are incurred and when revenue is realised. Conversely, cash basis accounting calls for recognising an expense when the cash is paid, regardless of when the expense was incurred.^[1]

If no cause-and-effect relationship exists (e.g., a sale is impossible), costs are recognised as expenses in the accounting period they expired i.e. when the product/service have been used up or consumed (e.g., of spoiled, dated, or substandard goods, or not demanded services). Prepaid expenses are not recognised as expenses but as assets until one of the qualifying conditions is met, resulting in a recognition as expenses. If no connection with revenues can be established, costs are recognised immediately as expenses (e.g., general administrative and research and development costs).

Prepaid expenses, such as employee wages or subcontractor fees paid out or promised, are not recognised as expenses. They are considered assets because they will provide probable future benefits. As a prepaid expense is used, an adjusting entry is made to update the value of the asset. In the case of prepaid rent, for instance, the cost of rent for the period would be deducted from the Prepaid Rent account.^[2]