Managing bad debt with Matching Principle | Dunnly

Managing Bad debts with matching principle

The matching principle plays a key role in helping accountants develop a clear and consistent income statement. The overall goal of the matching principle is to ensure an accurate calculation of the revenues in the period in which the revenues were earned. The expenses then are followed by the revenues, meaning an accurate calculation must be done for this portion of the income statement as well. For example, if we were determining a company’s earnings over the course of a quarter, we would need to make sure that the company’s revenues were calculated for that quarter, no more, no less. We would then need to do the same for the expenses. We would need to calculate the company’s expenses for those same exact three months, and ensure that there were no additional months, or months that were left out in the calculation. If there were, then net income would reflect an inaccurate amount, since net income equals revenues minus expenses. In other words, the matching principle denotes that revenues are calculated using the same criteria as expenses, such as a period in time. One of the only differences between revenues and expenses when calculating the final results is just using different amounts that are applicable to the company’s spending. A simple way to look at it is every company incurs expenses and also makes money (revenues). When trying to determine the net income for a given period of time, we must ensure that we are calculating both sides, revenues and expenses, using the same type of information. You cannot compare apples to oranges and expect to get an accurate comparison. This holds true for revenues and expenses. You cannot compare the revenues for ABC Company from October through December and the expenses from October and November and expect to get an accurate net income.

Another example where the matching principle comes into play, aside from the accounting aspect of revenues and expenses, is when an investment management company is comparing the returns of a fund between the first quarter of 2009 and the first quarter of 2010. To do this accurately in order to be able to trend the return history, the fund managers would need to calculate the returns of Fund A from January through March for 2009 and then again from January through March for 2010. If one month was either left out on both sides of this calculation, or even if one additional month was added to the mix, that would throw off the entire calculation and cause an imbalance between the two time periods that were being compared. That is why it is always important to match both sides of a calculation, no matter what you are comparing, to make certain the results will be as accurate as possible.

At the end of the day when Company ABC is calculating their revenues and expenses on their financial statement to determine how well they made out, most of the time they will come across something known as “bad debt”. We all know that debt is bad, but in this situation, the roles are reversed. Instead of the company being in debt and owing money, it is its customers who are in debt to the company and owe them money. For example, when a firm issues credit cards to its customers, before it even does so, it knows that when the income statement is reviewed, there will be some imbalances between the revenues and expenses due to those people who have not paid their bill. The company recognizes this and instead of putting stricter guidelines on the credit card qualifications, they instead accept it. They do this because they know that the higher sales volumes from the fact that their credit card rules are more lenient will outweigh the bad debt they incurred and they will still make a higher profit. This is where the matching concept comes into play. Although Company ABC knows that some people will not pay their credit card balances off and they will then assume this bad debt, they also know that they will generate higher sales because of these more lenient credentials, so the company is using foresight to “match” their revenues with their expenses.

 

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