Question

in your own words :

1) define the matching principle as you understand it

2) discuss the importance and implication of the matching principle with regards to the financial information and the reporting process

Answer 1

1) Matching principle states that expenses pertaining to earning a specific revenue should be matched in the same period to which they relate. This principle is an important concept of accrual accounting.

I will illustrate it with a small example:

Insurance expenses are usually paid on yearly basis. For a company whose accounting year ends on December 2020 and pays insurance expenses in October 2020 for a period of 1 year. So on December 2020, on closure of books of accounts the company has only consumed the benefits for 3 months ie October, November and December. So expenses pertaining to only 3 months shall be recognised in the books of accounts whereas the payment done for remaining 9 months are recorded as current assets instead of expenses.

2) If you take an example of companies in construction services, they usually incur a huge amount of expenditure during the construction period. However, the payments could be based on certain terms. So as per the Financial reporting standards, the revenue should also be recognised based on percentage completion method ie, with respect to cost incurred upto the date.

If such practises are not done, for a construction taking place for a period 3 years and if the company starts recording only expenses during the first 3 years and revenue upon payment in 3rd year, the company will show huge losses in first 2 years and huge revenue in 3rd year. This will create a misconception even in the mind of users of financial statement. Thus matching concept is of utmost importance inorder to reflect true and fair figure in the financial statements.