According to the matching principle of accounting expenses of the same period must be compared to or deducted from the income of that period to ascertain profitability. It is the matching principle which requires the use of accrual basis of accounting to avoid factious profits and losses over a specific period. According to the matching principle expenses are recognized as obligations become due instead of the time they are actually paid. Further it envisages that revenue is to be recognized as it is earned instead the time when it is actually received.
Above phrases reveal that matching principle is the zenith of two important principles of accounting i.e. accrual accounting and revenue recognition. Matching principle emphasize that only those expenses should be compared with the income of the period which are incurred to generate the revenues for that period. It is the matching principle which generates two broader types of expenses and revenues which are:
Accrued expenses – expenses are recognized as they become due or when goods are transferred and services rendered by the vendors and they are equalized with the revenue for which they were incurred to generate.
Prepaid expenses – they are not recognized at the time of payment because such expenses are incurred in advance and are not used to generate current period revenue. For the time being they are to be recognized as assets and will be used to offset against revenues of the period they are meant to generate.
Accrued income – revenues are recognized as they become due or when goods are transferred and services rendered to the customer and they are equalized with the expenses for which they were generated.
Unearned income – they are not recognized at the time of receipt because such incomes are received in advance. For the time being they are to be recognized as liabilities.