Accrual accounting is the system by which you recognize your expenses when you become liable for them, that is, when they are incurred. Likewise, you recognize income when you earn it. In either case, recognition does not wait upon the payment or receipt of cash. Accrual accounting is preferred over the simpler cash method of accounting. In the context of federal taxation, the Internal Revenue Service requires accrual accounting for most businesses.
The matching concept is not an alternative to accrual accounting but an outgrowth of it. The matching principle requires the matching of expenses with corresponding revenues. For example, a company that pays commissions to its sales force would match the payment of commissions with the revenues from sales: both are recognized in the same period. For instance, Christmas season sales in December 2010 might result in sales commissions that are paid in January 2011. Under the less sophisticated cash system, this would mean that the the sales revenue is booked to the fourth quarter of 2010, and the expense is booked to the first quarter of 2011. Matching applies both in the context of tax accounting and financial accounting.
Internal Revenue Code
Tax law in the United States mandates matching in several contexts. Section 267 of the Internal Revenue Code, for example, prohibits any deduction of a loss on the sale of property unless that loss is matched with the payee's income item. Indeed, as the "Journal of Accountancy" noted in October 2006, tax law "has broadened tax matching beyond the traditional matching of revenue and expenses to include payer/payee matches," that is, to match the income of one taxpayer with the deductible expense of another. On the other hand, there are many instances in which matching, as a general rule, does not apply for tax purposes. The "Journal of Accountancy" cautions that certified public accountants "must pay careful attention to the laws and regulations that govern these situations," which are complicated and changing.
The principle of matching is, to an extent, embedded in the foundations of double-entry bookkeeping, even at the level of a day-to-day journal. Basic accounting convention requires that every journal entry have an offset. Every entry of $100 on the debit side of a journal will occasion one or more entries on the credit side, such as when materials purchased for inventory are matched with the cash expended to purchase them.
To ensure the desired matching of expenses and revenues at the end of a period, an accountant will typically make certain "adjusting entries." For example, assume your business purchased one year of liability insurance in a lump sum on January 1. The journal entry on January 1 is a debit for the acquisition of an asset and a credit for the expenditure of the cash ($1,200). At the end of that month, you have now consumed 1/12 of the value of that asset. You make an adjusting entry debiting the insurance expense by 1/12, in this case $100, and credit (decrease the value of) the balance sheet asset by the same amount. Thus, the portion of the insurance expense that is actually used in February ends up on the books for February, matched with February revenues.
Christopher Faille is a finance journalist who has been writing since 1986. He has written for HedgeWorld and The Federal Lawyer and is the author of books including "The Decline and Fall of the Supreme Court." Faille received his Juris Doctor from Western New England College.