The matching principle requires that revenues and any related expenses be recognized together in the same period.

• To work out profit or loss of an accounting year, it is necessary to bring together all revenues and costs pertaining to that accounting year.
• In other words, expenses incurred in accounting year should be matched with the revenues earned during that year.
• The crux of the problem, therefore, is that appropriate costs must be matched against appropriate revenues.
• For this purpose, first we have to recognize the inflows (revenues) during an accounting period and the costs incurred in securing those inflows.
• Then, the sum of the costs should be deducted from the sum of the revenues to arrive at the net result of that period.
• Let us now understand how to recognize the revenues and costs is relation to an accounting period. For this purpose, the following rules are followed: Timing of revenue recognition, The timing of cost recognition

The Timing of Revenue Recognition

Revenue is recognized in the period in which it is earlier or realized. The revenue recognition is primarily based on realization principle which clearly states that in identifying revenues with a specific period one must look to the time of various transactions rather than cash inflow. Thus, 

1. In case of the sale of goods (or services) revenue is regarded as realized when sales actually take place and not when cash is received. In other words, credit sales are treated as revenue when sales are made and not when money is received from the debtors.
2. Income such as rent, interest, commission, etc. are recognized on a time basis. The revenue from such items is taken to the Profit and Loss Account of the year during which it is earned. Let us assume that the business purchased some government securities on October 1,1987 for Rs. 20,000 carrying interest at 12 per cent. The interest is payable half yearly on April 1 and October 1 every year. The first instalment of interest (Rs. 1,200) is received on April 1,1988. The Profit and Loss Account is being prepared for the year 1987 (January 1,1987 to December 31, 1987). The interest amounting to Rs. 600 earned during October 1 to December 31 must be shown as the income from interest on investments in the Profit and Loss Account for 1987 though the amount has not been received in 1987.

The Timing of Cost Recognition

The matching principle holds that the expenses should be recognized in the same period as the associated revenues. Thus

1. Cost of goods have to be matched with their sales revenue. This means that while preparing the Profit and Loss Account for a particular year, you should not take the cost of goods produced during that year but consider only the cost of goods that have actually been sold during that year. The cost of goods sold is arrived at by deducting the cost of closing stock from the cost of goods produced. You will learn about it in detail in Unit 7.
2. Expenses such as salaries, wages, interest, rent, insurance, etc., are recognized on time basis. In other words, they are related to the year in which the service is obtained or the expense is incurred, whether paid immediately or payable at a later date.
3. Costs like depreciation on fixed assets are also allocated over the periods during which the benefit is derived.

The Matching Concept thus has the following implications for ascertaining of profit or loss during a particular period. 

1. We should ensure that costs should relate to the same accounting period as the revenues. For example, when we prepare the Profit and Loss Account for 1986, we shall take into account all those incomes that were earned during 1986, and similarly consider only those costs which were incurred in 1986 only. Any costs or incomes which relate to 1985 or 1987 shall be excluded.
2. We should ensure that all costs incurred during the accounting period (whether paid or not) and all revenues earned during that year (whether received or not) are bully taken into account.
3. We should consider only those costs which relate to the revenue taken into account. That is why we consider only the cost of goods sold, and not the cost of goods produced during that period.