The revenue your business owns and its expenses make up the majority of data in your company books. But many small business owners using accrual accounting — a popular and beneficial method — don't know the reasoning behind when and how to record that revenue or those expenses. If you're not aware that not all revenue or expenses should be entered immediately upon receipt, then you could be making errors.
To help you keep more accurate books, here's a short guide to the matching principles of accounting for accrual-based businesses.
The Matching Principle
Generally Accepted Accounting Principles (GAAP) stipulate that both revenue and expenses for accrual businesses should be recorded on the books based on when the company effectively gets the benefit of them. This may or may not coincide with when you buy something or sell something or even when you receive or pay cash.
While many transactions are simple to find a timeline for, others can be very tricky if the money and the benefit don't easily match up. But only by matching up the company's earnings and expenses closely can you know what your business is really doing at any given time.
How to Match Revenue
So, when does your business receive the benefit of its revenue? The answer may be surprising. It is often before you even receive the cash. When you sell goods on a 30-day invoice, for example, you generally record the sale even though you haven't yet been paid. Once the business has a right to the payment clear of any encumbrances, it is constructively received.
However, if payment depends on the completion of some items, there are still encumbrances that affect the company's right to the money. So the portion affected may not be entered yet. To record it too early would make the financial statements inaccurate.
How to Match Expenses
Expenses are considered to be incurred under the matching principle when their value is used up. Most supplies, production materials, and small purchases are consumed by the company within the same accounting period. This means you can often record them when the purchase happens.
However, what happens when the asset won't be used up for many periods? For instance, you may purchase a forklift expected to have a lifespan of 7 years. In this case, the company records a portion of the expense in the form of depreciation each year. Failure to do this would inaccurately record a huge expense in one year rather than an even expense over the lifetime of the item.
Where to Learn More
Does this sound confusing to you? If so, you're not alone. The best way to learn how to apply the matching principles of GAAP in your particular situation is to work with an experienced business bookkeeping service. Make an appointment today to get started.
If you're a business owner and you don't have an accountant, you might want to consider hiring one. Accountants help business owners by handling the books, filing tax forms and managing the costs of the business. They also offer guidance to concerning important business matters. We aren't accountants, but we do have an understanding of the importance of their duties.
We've interviewed accounting professionals and they've answered all our questions about their job description and explained how their services can benefit business owners. We've compiled all this information into articles that we've posted on this site. We hope that you will read them to learn how an accountant can benefit your business.