Question

The accounting profession has employed the matching concept to determine what to report in the income statement and to determine how to measure items reported in the income statement. This concept implies that expenses should be measured directly, and thus balance sheet measures are residuals. The matching concept is therefore an income statement approach to the measurement and reporting of revenues and expenses.

SFAC No. 5 defined earnings as the change in net assets exclusive of investments by owners and distributions to owners, a capital maintenance concept of earnings measurement. Under this concept, assets and liabilities would be measured directly, and changes to them would flow through the income statement. Thus the SFAC No. 5 definition of earnings represents a balance sheet approach to the measurement and report of revenues and expenses.

Required:

a. Describe and discuss the matching concept and its importance to income reporting.

b. Give 4 specific examples of how the matching concept is used in practice.

c. Describe and discuss the balance sheet approach and its importance to income reporting.

d. Give 4 specific examples of how balance sheet measurements affect the measurement and reporting of earnings.

Answer 1

a. The Matching Concept is an accounting concept whereby any firm describes incomes and related expenses in the same accounting period. Firms entries into revenues, along with the expenses that brought them. The purpose of the matching concept is to avoid misstating earnings for a period.

b. For Examples:-

(1) infortech buys a new piece of equipment for Rs 100,000 in 2018. This machine has a useful life of 5 years. This means that the machine will produce products for at least 5 years into the future. According to the matching principle, the machine cost should be matched with the revenues it creates. Thus, the machine is depreciated over its 5-year useful life instead of being fully expensed in 2018.

(2) A Company produces picture frames and sells them to wholesalers like other companies. A pays its employees Rs. 8 0 an hour and sells every frame produced by its employees. Since the payroll costs can be directly linked back to revenue generated in the period, the payroll costs are expensed in the current period.

(3) A has sold hardware appliances for 10 years in a small town. It purchases a large appliance from wholesalers for Rs. 5,000 and resells it to a local restaurant for Rs. 8,000. At the end of the period, B Appliance should match the Rs. 5,000 cost with the Rs.8,000 revenue.

(4)  A hospital pays Rs 10,000 per month to 5 of its doctors. Monthly sales are Rs 500,000. Rs 50,000 worth of monthly salaries should be matched with Rs 500,000 of revenue generated.

c.

A balance sheet Approach is a financial statement includes a company's assets, liabilities and owners' or shareholders' equity on a particular date. A balance sheet approach examines the accounts on a company's balance sheet.

d. for example

Earnings management is a function of manipulating accruals, so it use the magnitude of accruals as a proxy for earnings quality: the higher the total accruals as a percentage of assets, the greater earnings quality. Accruals can be either a reflection of earnings manipulation or justnormal accounting estimations based on future business expectations. It is difficult todetermine which one is driving the accruals, but there is evidence that the size of accruals can be used as a rough measure for earnings manipulation.