Why do we match expenses to the income they help to earn in the same period?
Explain the matching principle and the accrual basis, and why year-end adjustments are needed
A simple answer to the N(A)-Level Principles of Accounts outcome on the matching principle. What matching and the accrual basis mean, why they differ from cash, and why adjustments are needed at the year end.
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What this dot point is asking
SEAB wants you to explain the matching principle and the accrual basis, and why they make year-end adjustments necessary. This idea is the reason the income statement is more than a list of cash paid and received. The central insight is that profit must compare the income earned in a period with the expenses incurred to earn it, regardless of when the cash actually moved.
The answer
The accrual basis
Under the accrual basis, income is recorded when it is earned and expenses when they are incurred, not when cash changes hands. This contrasts with the cash basis, which records things only when cash is received or paid. At N(A)-Level we use the accrual basis, because it gives a truer picture of performance.
The matching principle
The matching principle follows from the accrual basis: the expenses charged in a period should be those that helped earn the income of that same period. If a cost benefits a later period, it is carried forward; if a cost belongs to this period but is unpaid, it is still charged now.
Why adjustments are needed
The ledger records cash as it is paid. At the year end, some of those cash figures do not match the period:
- An expense paid in advance (insurance for next year) is too high and must be reduced by a prepayment.
- An expense owed but unpaid (December wages) is too low and must be increased by an accrual.
- The cost of using non-current assets is recognised through depreciation.
- Debts that will not be paid are written off as irrecoverable.
These year-end adjustments convert the cash-based ledger into accrual-based figures so profit is fair.
Examples in context
Example 1. A magazine subscription. A business pays \1,200$ in December for a year of trade magazines starting in January. Under matching, none of this is an expense of the current year, because the benefit comes next year; the whole amount is a prepayment. This shows matching working in advance: the cost waits for the period it serves.
Example 2. An electricity bill arriving late. The December electricity bill arrives in January and is paid then. Matching requires the cost to be charged in December, when the power was used, by adding an accrual. Without it, December's profit would look too high and January's too low, which is exactly the distortion the matching principle prevents.
Try this
Q1. State what the accrual basis records expenses against. [1 mark]
- Cue. The period in which they are incurred, regardless of when cash is paid.
Q2. Rent of \3,600$ is paid for a year on 1 October; the year ends 31 December. How much is this year's expense? [2 marks]
- Cue. Three months belong to this year: \dfrac{3}{12} \times 3\,600 = \900$.
Q3. Explain why a year-end adjustment is needed for wages that are owing but unpaid. [2 marks]
- Cue. The wages were incurred this period, so matching requires them to be charged now as an accrual, even though the cash has not yet been paid.
Exam-style practice questions
Practice questions written in the style of SEAB exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
Original5 marksA business pays \1\,200$ for one year's insurance on 1 October, and its financial year ends on 31 December. (a) How much insurance expense belongs to this year? (b) Explain how the matching principle gives this answer.Show worked answer →
(a) The year runs to 31 December, so only October, November and December (3 months) belong to this year. Insurance expense = \dfrac{3}{12} \times 1\,200 = \300$.
(b) The matching principle says expenses are charged to the period in which they help earn income, not the period they are paid. Although \1,200\ relates to this year; the other \900$ is a prepayment for next year. Matching gives the true cost of running the business this period.
What markers reward: the \300$ figure from three months, and an explanation that links the charge to the period benefited rather than the period paid.
Original4 marksExplain the difference between the cash basis and the accrual basis of accounting, using an example of wages owing at the year end.Show worked answer →
Under the cash basis, income and expenses are recorded only when cash is received or paid. Under the accrual basis, they are recorded when earned or incurred, regardless of when cash moves.
Example: if wages of \500\ as a December expense (an accrual), because the work was done in December. The accrual basis gives a truer profit.
What markers reward: a clear contrast (cash when paid versus accrual when incurred), a correct example treating the unpaid wages as a December expense under accrual, and the point that accrual gives a more accurate profit.
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