![]() While the company owns the inventory, if the market value of that inventory falls below the original price paid, an accountant can adjust the value of that inventory below the price paid. This principle states that when there’s an option in reporting a transaction, you should use the option that results in lower asset amounts and/or lower net income.įor example, when a company purchases inventory, they record the cost of that inventory at the price they paid. ![]() In the example above, Company A properly reported the Service Revenue in compliance with the Revenue Recognition Principle.Ĭompany B didn’t follow the Revenue Recognition Principle and didn’t comply with GAAP accounting standards. This principle states that you should record revenue only when it’s been earned, regardless of payment received or not received.įor example, if Company A and Company B have identical financial transactions and each company received $30,000 as payment for future services to be performed next year, would it appear on the current year-end Income Statement or next year’s Income Statement?īelow are the Income Statements for Company A and Company B after receipt of the $30,000.Īccording to the Revenue Recognition Principle, even though the Service Revenue was paid this year, it won’t be earned until next year, so it should NOT appear on this year’s Income Statement. ![]() Overstated Salaries Expense and Net Income result from Company D not following the Matching Principle. Since December’s salaries are paid in January 2022, they only paid and recorded 11 months of salaries in 2021. They only recorded the amount they paid out for salaries. Properly stated Salaries Expense and Net Loss result from Company C following the Matching Principle.Ĭompany D only recorded 11 months of Salaries Expense ($44,000 ÷ $4,000/month = 11 months). Which company reported Salary Expense according to the Matching Principle?Īs mentioned in a previous post here, only Company C recorded the Salaries Expense transaction in accordance with GAAP. See the Income Statements for Company C and Company D below. ![]() This means that the Salary Expense on the Year-End Income statement will be $4,000/month x 12 months = $48,000. So December 2021 salary expense must be recorded on the 2021 Income statement. Both companies report $60,000 in service revenue.Īccording to the Matching Principle, although the salaries for December 2021 will be paid in January 2022, the salaries apply to the Service Revenue that was earned and recorded in 2021. Current month’s salaries are paid in the next month. This is the foundation of accrual basis accounting and financial accounting.įor example, Company C and Company D started business on Januand had identical financial transactions. This principle states that you should record a related expense when you record a revenue. So, grab a pen and paper, you’re going to want to take notes! 7 Accounting Principles You Must Know To Pass Accounting 101 Matching Principle These principles are so fundamental to the field of accounting that you will see them over and over again throughout your accounting coursework from financial accounting to cost accounting classes and beyond. Why? Because these principles, which are defined in GAAP (generally accepted accounting principles), guide the field of accounting. There are 7 basic accounting principles every student must know in order to pass accounting class.
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