Matching principle

Definition: The accounting rule that requires the recording of sales and the expenses that allowed those sales to happen in the same accounting period.Example: Dirtco makes a shovel that it sells to Lowes for $12. The shovel costs Dirtco $7 to make. In early March with spring approaching, Lowes orders 5,000 of them. The company ships them towards the end of the month and bills Lowes $12 * 5,000, $60,000. Around the same time, Dirtco receives bills from its suppliers for the wood and steel it purchased to make the shovels. These bills total $7 * 5,000, or $35,000.

The end of March represents the end of the calendar quarter that most companies use as a cut-off point to add up their numbers and report them to the public. If Dirtco records the $60,000 sale in March, it is also supposed to record the $35,000 of costs in March. If it didn’t the company would show a nice but inaccurate $60,000 profit in the first quarter (ie: January through March) on this sale, but an expense of $35,000 in the second quarter.

Investeach explains: What helps tremendously with the matching principle is accrual accounting. With it, a company can record an expense when it gets a bill from a supplier, even though it may be paid weeks later. In the same way, it can record a sale when it has delivered the goods and services, not when the customer actually pays.

This principle isn’t always so easy to adhere to. For example, what would Dirtco do if the end of March arrived and it still had not received invoices from its suppliers for the wood and steel it purchased to make the shovels? It might have to call the companies and ask them how much it is going to be billed!

Riddle me this:

1. Explain why the matching principle results in companies providing more accurate financial information.
2. Explain why accrual accounting allows companies to better follow the matching principle.
3. Identify what times in the year the matching principle becomes more difficult to adhered to. Explain why.

2017-10-01T18:26:15+00:00