![]() ![]() If we include any revenue in a particular period, we should be sure of two key facts.įirst, that the revenue has been earned in the period in which it is included in the income statement. Since performance must be measured in terms of a period, it is important to ensure that revenues and costs that are included in the income statement of a particular period do really belong to that period and correspond to each other. That one decision might move a start-up company from a profit to a loss.The matching principle of accounting is a natural extension of the accounting period principle. Alternatively, they might assume the truck will last only one year, in which case they have to depreciate it at $3,000 a month. They don’t know that the truck will last exactly three years. But our accountants don’t have a crystal ball. Let’s assume our company buys a $36,000 truck in the first full month of operation and expects the truck to last three years, so we depreciate it at $1,000 a month (using a simple straight-line depreciation approach). In those few dry sentences, however, lurks a powerful tool that financial artists can put to work. ![]() ![]() All this means is that the accountants figure out how long the asset is likely to be in use, take the appropriate fraction of its total cost, and count that amount as an expense on the income statement. Depreciation is the “expensing” of a physical asset, such as a truck or a machine, over its estimated useful life. (Excerpts from Financial Intelligence, Chapter 8 – Costs and Expenses)ĭepreciation is an example of the matching principle in action. Accountants call this the matching principle-the appropriate costs should be matched to all the sales for the period represented in the income statement-and it’s the key to understanding how profit is determined. The costs and expenses on the income statement are those it incurred in generating the sales recorded during that time period. No money at all may have changed hands.Īnd the “cost” lines of the income statement? Well, the costs and expenses a company reports are not necessarily the ones it wrote checks for during that period. Never mind if the customer hasn’t paid for the product or service yet-the business may count the amount of the sale on the top line of its income statement for the period in question. When a business delivers a product or a service to a customer, accountants say it has made a sale. (Excerpts from Financial Intelligence, Chapter 5 – Profit is an Estimate)Īny income statement begins with sales. A company may pay its tax bill once a quarter-but every month the income statement includes a figure reflecting the taxes owed on that month’s profits. The matching principle even extends to items like taxes. Rather it records the cost of each cartridge on the income statement when the cartridge is sold. If an ink-and-toner company buys a truckload of cartridges in June to resell to customers over the next several months, it does not record the cost of all those cartridges in June. ![]() Here are two examples of the matching principle: Sign up for our online financial statement training and get the income statement training you need. It simply states, “Match the sale with its associated costs to determine profits in a given period of time-usually a month, quarter, or year.” In other words, one of the accountants’ primary jobs is to figure out and properly record all the costs incurred in generating sales, including the cost to make and deliver the product and the sales and administrative support.īecause of the matching principle, the expenses on the statement are not necessarily those things that we purchased that month, or even paid for that month. The matching principle is a fundamental accounting rule for preparing an income statement. ![]()
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