What is the matching principle?

Definition

The matching principle puts a cost in the same period as the revenue it helped produce. On the books, the Income Statement pairs the sale with the cost of making that sale, not with the day cash left for supplies.

This is a pairing rule for the Income Statement. The cost sits beside the sale it helped produce, even if cash moved in a different month.

Where it shows up

Balance sheet: Related to inventory and prepaid balances waiting until the related sale or use.

P&L: Increases expense in the same period as the related sale.

Cash flow: Related to cash moving on its own schedule; the matching entry itself does not move cash.

See also: Accrual Basis Accounting · Adjusting Journal Entry · Revenue Recognition

When you look at the Balance Sheet, inventory holds the product cost until the goods sell. The sale is what moves that cost off the statement.

The Income Statement then shows the sale and the cost of goods sold in the same month. Gross profit is readable because the two numbers arrived together.

Cash does not have to move on the sale date. Cash flow from operations is unchanged by the matching entry itself, because the goods were already paid for or will be paid later.

Prepaid expenses follow the same pairing from another angle. Insurance paid in January is spread into the months the policy actually covers.

How it works

A cost waits on the Balance Sheet while it still has unused value. Inventory, prepaid coverage, and similar balances are waiting rooms.

How matching lands on the statements:

• Hold unused cost on the Balance Sheet (inventory, prepaid, and similar)
• Record the related revenue when it is earned
• Move a slice of that cost to expense in the same period as the sale or use
• Use an adjusting entry at period end when day-to-day systems did not already post the pairing
• Keep cash dating separate; the payment date does not date the expense

When the related revenue is recorded, a slice of that cost becomes expense. For goods that sold, the slice is cost of goods sold; for a month of coverage, the slice is insurance expense.

An adjusting journal entry is often how the slice is booked at period end. Day-to-day inventory systems can post the same pairing when each sale is recorded.

Stay on matching cost to the sale. The calendar day cash moved is not what dates the expense.

An accrual records a cost that has been used even though the bill has not arrived. A deferral waits to expense a cost that was paid early; both tools exist so the pairing can hold.

The documents behind it are the sales tickets, the inventory count or the lot cost, and any prepaid schedule. Those papers show which costs belong beside which revenue.

Net income is readable only when the pairing holds. A month of sales with no product cost, or a month of product cost with no sales, misstates the leftover.

Example

Black Kettle Roasters sells $9,000 of bagged coffee in June. The beans inside those bags cost $3,000 and had been sitting in inventory.

When the bags leave, the pairing looks like this.

Debit: Cost of goods sold $3,000

Credit: Inventory $3,000

Inventory on the Balance Sheet falls by $3,000. Cost of goods sold on the Income Statement rises by $3,000 in the same month as the $9,000 sale.

June gross profit is $6,000. Paying for the beans in May did not move the $3,000 into May expense.

If the shop had expensed the beans when they were purchased, May would look heavy and June would look too rich. The sale and the bean cost would have missed each other.

Common mix-ups

The matching principle is not the same as cutoff. Cutoff dates an event to the period it happened; matching pairs a cost with the revenue it helped produce.

The matching principle is not the same as cash out the door. A May bean payment is not May expense if the bags sell in June.

The matching principle is not the same as accrual-basis accounting as a whole. Accrual-basis books use this pairing, but the method also covers when revenue itself is earned.

Related terms

• Accrual Basis Accounting: Recording revenue when earned and expenses when incurred.
• Accrual: Recording an expense or revenue when it happens rather than when cash moves.
• Deferral: Pushing recognition of a cost or revenue to a later period than the cash movement.
• Adjusting Journal Entry: An entry made at period end to record accruals, deferrals, and corrections.
• Revenue Recognition: The rules for deciding when earned revenue may be recorded.
• Cost Of Goods Sold: The direct cost of the products sold during the period.
• Prepaid Expenses: Amounts paid up front for goods or services the business has not yet used.
• Cutoff: The rule that transactions land in the period in which they actually occurred.