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The Matching Principle

Income determination or measurement of income is a matter of matching the revenues earned during the accounting period with the expenses that were incurred in the process of earning this revenue. Accountants call their attempt to match revenues against the appropriate expenses as matching concept. The realization and accrual concepts have been essentially developed due to the need to match expenses with revenues since the realization concept determines the basis for revenue recognized while accrual concept is concerned with the period in which the revenues and expenses are to be related. It means that after the revenue has been measured or determined (in money terms only) for a given accounting period, the expenses (expired cost) incurred to earn that revenue must be deducted to calculate net income. The term matching, therefore, refers to a close relationship that exists between certain expired costs and revenues realized as a result of incurring those costs. The essence of the matching is that revenues and expenses shown in an Income Statement must refers to some goods transferred or services rendered to the customers in a given accounting period for which the income is to be calculated or measured. The following two aspects of matching must be carefully considered:

(i)    Where possible, the revenues of a particular accounting period should be related to expenses directly associated in obtaining the revenues. It may occur only when revenues and expenses can be separately in obtaining the revenues. It may occur only when revenues and expenses ca be separately identified and in such a case the association is direct e.g., association of sales revenues and cost of the goods sold.

(ii)    Another aspect of the matching principle is: If revenue is deferred because it is regarded as not yet earned, all elements of expenses related to such deferred revenue must be deferred also and vice-versa.

There is not much difficulty where the expenses can be directly associated with the revenues but trained judgment is frequently needed for estimates where direct association is not possible. In this category are included cost of fixed assets. The costs in such cases must be carefully allocated with their services benefits. There is still another category of expenses which cannot be traced to particulars goods or services generating revenues, e.g., salaries of the manager or administrative staff. The best course is to charge these expenses in the Income Statement of the accounting period in which they are incurred. Such expenses are designated as period expenses as distinct from those expenses known as product expenses which can be related to products. The justification for the matching concept arises from the accounting period concept. The profits for the accounting period are calculated after deducting costs of the period from the revenues of the same period. Which revenues should be included, is determined using the realization principle. Any costs which cannot be associated with the future revenues are written off as they are incurred. Limitation: Theoretically, the matching of costs with revenues appears to be simple one. But in practice this concept poses certain problems which need expert judgment o the accountant. Some of the limitations are discussed as:

1. It is often impossible to determine what benefits have been or remain to be derived from certain cost outlays.

2. A second problem is that arising fro the joint costs. It means a cost outlay which benefits two or more different products in such a way that the proportionate benefit derived by each must be fixed arbitrarily,

The accountant has to make estimates in respect of the cost allocation for fixed assets, the costs of which do not vary proportionately with production or sales volume.  Any miscalculation in this regard would upset the determination of income for different periods.

Inventory valuation on the cost or market whichever is lower basis could result in the understatement of profits in succeeding period.

 5. Similarly items for which estimates are made e.g. doubtful debts and discounts can result in improper matching of costs where these estimates are not carefully made. 6. Further, unexpected and non-trading revenues such as those resulting from subsidies form government or interest on investments, gain on the sale of assets, etc. distort the income determination since there is no corresponding expense for these items in the Income Statement.

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