Accrual concept vs matching principle
- 1. Which one should we follow?
- 2. Issue covered • Accounting basis • Accrual concept with examples • Matching principle with example • Understanding basic difference between these two
- 3. Accounting basis Normally business organizations use one of two basic accounting basis. Either cash basis or accrual basis. Some business houses use hybrid system, which is a mixer of cash basis or accrual basis. But accrual basis is better than the other two system.
- 4. Definition of Accrual concept Business transactions are recorded when they occur and not when the related payments are received or made. This concept is called accrual basis of accounting.
- 5. Examples Example-1 A company sells TVs to its customers on cash and credit also. Cash and accrual methods will view the sells events differently. The revenue generated by the sale of the TV will only be recognized by the cash method when the money is received by the company. If the TV is sold on credit, this revenue will not be recognized until cash is received under cash basis. But under accrual basis both the cash and credit sales will be recognized as sales as the transactions have been made.
- 6. Examples Example-2 An airline sells its tickets days or even weeks before the flight is made. Under cash basis, revenue is recognized as soon as tickets are sold. But under accrual method, it does not record the revenue immediately because the flight, the event on which the revenueis based, has not occurred yet. Revenue will be recognized when flight would be made. Example-3 Under accrual basis, a business records its utility bills as soon as it receivesthem and not when they are paid, because the service has already been used. The company ignores the date when the payment will be made. Separate entry will be made at the time of payment. But under cash basis, this will not be recorded as expense until bills are paid off.
- 7. Matching principle- Definition The matching principle directs a company to report an expense on its income statement in the period in which the related revenues are earned.
- 8. Example let's assume that a company's sales are made entirely through sales representatives (reps) who earn a 10% commission. The commissions are paid on the 15th day of the month following the calendar month of the sales. For instance, if the company has Tk. 600,000 of sales in December, the company will pay commissions of Tk. 60,000 on January 15. The matching principle requires that Tk. 60,000 of commissions expense be reported on the December income statement along with the related December sales of Tk. 600,000. If the company does not follow the matching principle, it might report the Tk. 60,000 of commissions expense in January rather than in December. That means profit of December will be overstated. A retailer's or a manufacturer's cost of goods sold is another example of an expense that is matched with sales to no the gross profit. Other expenses of the accounting period need to be charged in the income statement to know the net profit.
- 9. Conclusion From the above discussion, we understand that when any transaction occurred it has to be recorded immediately. So it is a continues process and related with recording of transactions. Whereas, matching principle says that you have to match the revenue and the related expenses for a particular accounting period in the income statement to see the performance i.e. profit/loss of the organization in that period. So it is related with measurement of the organization’s performance,
- 10. So………. Accrual basis tells about the timing of recording of a transaction Whereas, matching principle guides how the performance of and business organization is determined.