The Matching Principle

The matching principle is one of the fundamental principles in accounting. It is a guiding principle, not a rule, that suggests that expenses 
should be recognized in the same period as the revenues that they helped earned are recognized. More broadly, expenses should be recognized in the period that they conferred benefits to the firm. 

For example, a firm may prepay for insurance for a year starting in July. Thus the policy will provide a benefit to the firm for six months this year, and six months next year (until the following July). Applying the matching principle, we would recognize half of the insurance expense from the policy this year, and another half next year - even though we paid for the whole policy this July. 

The revenue recognition principle tells us when revenues should be recognized. The matching principle tells us when expenses should be recognized. Together, these two principles provide guidance to accountants to determine in which period earnings (that is, revenue and expenses and gains and losses together) are incorporated into the financial statements. 

According to FASB Concept Statement No. 5, expenses should be recognized in two ways:

(1) When they relate to a consumption of benefits: "Consumption of economic benefits during a period may be recognized either directly or by   relating it to revenues during the period:

     a. Some expenses, such as cost of goods sold, are matched with revenues - they are recognized upon recognition of revenues that result
         directly and jointly from the same transactions or other events as the expense. 
     b. Many expenses, such as selling and administrative salaries, are recognized duing the period in which cash is spent or liabilities are
         incurred for goods and services that are used up either simulatenously with acquisition or soon after.
     c. Some expenses, such as depreciation and insurance, are allocated by systematic and rational procedures to the periods during which the
         related assets are expected to provide benefits. 

(2) Loss or lack of future benefits: An expense or loss is recognized if it becomes evident that previously recognized future economic benefits of an asset have been reduced or eliminated, or that a liability has been incurred or increased, without associated economic benefits.¹ 

In practice, not all expenses can be known, and recognized, in the same period that they revenue they helped earned is recognized. This is why we sometimes must recognize expenses when a loss or lack of future benefit becomes apparent. However, as accountants, we try to apply the matching principle as viraciously as possible. One of the most prominent examples is the use of depreciation and ammortization to spread the expense of an asset over its useful life. In this way, only when an asset becomes impaired for an unexpected reason do we have to record an expense that doesn't match. 

It should be noted that the matching principle only applies in accrual-based accounting. In accrual based accounting, we can have accrued expenses (that is, expenses that have been incurred, but not yet paid) and deferred expenses (expenses that have been paid, but whose related benefits have not yet been consumed). Under cash-basis accounting, expenses are simply recognized when cash is paid out). 


Reference:

1. FASB CON5 - 22, 23