The "I Hate Numbers" podcast explores the accounting matching concept, also known as accrual accounting, in finance and accounting. In this episode, we explore what the matching concept is, how it applies, and why it's essential. We also explore its impact on financial statements, providing practical examples for clarity.

What Is the Matching Concept?

The matching concept ensures that expenses recorded in the same period as the revenues they help generate, offering a clearer picture of financial performance. Various sectors, including non-profits and private companies, use it. Essentially, the matching concept helps understand a business's true financial state over a specific period.

Why Do We Use it?

Accurate Financial Reporting:

We use the matching concept to produce financial statements that reflect true business performance. Accordingly, matching expenses with revenues provides a more accurate financial picture.

Consistency:

Equally important, the matching concept promotes consistent financial reporting. By applying the same rules consistently, businesses can compare their performance over different periods more effectively.

Decision Making:

With accurate financial information, businesses can make informed decisions. Additionally, matching expenses with revenues allows us to assess profitability and make better decisions.

Compliance and Regulation:

Lastly, accounting standards such as GAAP and IFRS require the use of the matching concept. Businesses must follow these guidelines to ensure their financial statements comply with regulations.

Applying the Concept

Revenue Recognition:

We record revenue when we earn it, not when we receive the cash. For example, if we provide a service in December and receive payment in January, we record the revenue in December

Expense Recognition:

Expenses are recorded when incurred. Suppose we receive a utility bill in January for December's consumption. We record the expense in December, when the obligation arose.

Examples of the Matching Concept

Wages and Salaries:

We pay employees in January for December's work. However, we record the expense in December.

Advertising Costs:

Suppose we run an advertising campaign in November and receive the bill in December, paying it in January. Thus, the expense is recorded in November.

Sales Commissions:

If a sales commission is earned in March but paid in April, we record it as a March expense.

Impact on Financial Statements

Income Statement:

The income statement shows revenues and expenses over a period. Hence, matching expenses with revenues provides an accurate picture of profitability.

Balance Sheet:

The balance sheet shows assets and liabilities. Correspondingly,  this is where accrued expenses and prepayments are reflected.

Cash Flow Statement:

The cash flow statement reconciles the difference between profit and cash flow. Though the matching concept does not directly impact cash flow, it helps explain discrepancies between profit and cash flow.

Conclusion

Altogether, the matching concept is crucial for accurate and consistent financial reporting. It allows us to track financial performance, comply with standards, and make informed decisions.

Listen to the "I Hate Numbers" podcast for more insights into accounting principles like the matching concept and how they can help manage and grow your business effectively. Additionally, don't forget to check out the upcoming launch of the Numbers Know How business community, supported by I Hate Numbers. This community will offer valuable resources and support for your business. Listen to the I Hate Numbers podcast for more tips and insights to help you stay motivated and succeed in your business.

In the world of accounts and finance, there are a number of different rules, regulations, and concepts that are used. One of the most important concepts that are used is called the matching concept. There's a name. The matching concept is also known as accruals accounting. And in this week's I Hate Numbers podcast, I'm going to be looking at why we use the matching concept, what it is, how it's applied in practice, give you some examples and also talk about the impact on the various financial statements.

You're listening to the I Hate Numbers podcast with Mahmood Reza. The I Hate Numbers podcast mission is to help your business survive and thrive by you better understanding and connecting with your numbers. Number love and care is what it's about. Tune in every week. Now here's your host Mahmood Reza.

Let's crack on with the podcast. Now, the matching concept, as I said at the beginning is also known as accruals accounting. It's a fundamental principle. It's a fundamental building block in accounting, and it ensures that your expenses are recorded in the same time period as the revenues that are generated. In simpler terms, it means that costs

are matched with the income that are produced. And this approach provides a clearer and more accurate picture of your business's financial performance over a specific period. And this concept is applied in not for profit sectors, charities, public sector, private companies, and the like. So it's a universal concept that's applied across all different sectors.

Now we've said this idea of time period here, when businesses want to understand and measure their financial performance, typically, they refer to a financial performance over, say, the last week, the last couple of months, the last year, when they're looking forward, they're again measuring performance over a period of time.

So it's important we understand and what income has been generated in that time period against the costs that have also been incurred. So as a minimum, we can work out whether we've generated profit or sadly generated a loss. Let's look at the next question. Why do we use the matching concept at all? It'd be far simpler to look at the movements on a bank account to look at the differences between those two, but that would give you a fundamentally misleading position.

One of the reasons we use the matching concept is for accurate financial reporting. If we can match, and we're not talking about dating here, expenses with revenues, your business can produce financial statements. That will typically and more accurately reflect the true financial performance. Now this helps a number of stakeholders from yourself as a business owner, investors, other stakeholders such as banks, lenders of finance, understand how well the business is doing.

Another reason as to why we use the matching concept is consistency. Now the matching concept promotes consistency in its financial reporting. By applying the same rules consistently over time, businesses can get a true understanding or a comparable look at their performance over different time periods much more easily.

There are other reasons why we use the matching concept. Decision making is another reason. With accurate financial information, which is critical for making those informed business decisions, we can ensure that when expenses are recorded in the same period as the revenues they generate, your business can better assess its profitability

and make better informed decisions. Now I'm going to pick up this example of revenues later on, but as a spoiler alert, revenues are not the same as the money that leaves your bank account and expenses are not necessarily when the money leaves your bank account either. That would be a far simpler situation, but it would be a very distorted position,

nevertheless. Whatever reason why we use the matching concept is compliance and regulation with accounting standards. Now accounting standards are a framework by which businesses, when they prepare their statutory accounts, when they present certain financial transactions, there's a guideline and a framework and how they're presented.

Now, the UK businesses are required to follow generally accepted accounting principles. If you want a mnemonic to share with your friends, talk to your finance team about we use the term GAP, G double A P. If you're operating on the international stage, you might be using international financial reporting standards abbreviated to no surprise there

I F R S. Now, both of these frameworks require the use of the matching concept to ensure financial statements are prepared correctly. I would add also that they're contained within the Companies Act and the Companies Act stipulates that you have to apply accounting standards and to make sure that accruals accounting is used within.

Now another consideration to take on board is how do we actually apply the matching concept. Now the matching concept is applied in several ways depending on the type of business you have and the transactions involved. Let me share some examples with you. Now let's look at revenue recognition. That's a very officious term used in the accounting world saying when your transaction occurs, where you generate revenue, which you might also know, by the way, in conversational speakers, turnover, sales, fees, or income.

When do we actually include it in our financial statements? Well, we'll record revenue when we earn it, not when we get that money into our bank accounts. Commercially and sensibly, the sooner we get the cash from our customers, the better. But there are going to be situations where we provide services. So as a consulting company,

we might provide workshops, training facilities, we might be a theater that rents out space, we might be putting on a variety of events and activities where we don't get the cash from the customer straight away. If you're a manufacturer, you may be selling products to a customer, your wholesaler, your distributor, but you may not get the cash immediately.

Now revenue is recorded when we generate it, when we earn it, not when we get the money banked. So let's say for example your business provides a service, let's say it's a training course it provides. It provides that course in December, the invoice is raised in December, but you don't get the money into your bank account until the following January.

The revenue is recorded however in December. Now, likewise, when it comes to expenses, expenses are recognised, which is shorthand for saying that's when they enter the financial statements when they are incurred, when you have that legal obligation to pay your supplier, not when the money leaves your bank account to settle the bill with the supplier.

Now, likewise, imagine your business receives a utility bill in the month of January. Reflecting the utilities you've consumed in the month of December. Now that bill is recorded in the month of December. That's when the obligation arose. The fact you haven't settled it until January does not negate that impact.

Now, one other example of matching, and I'm going to deal with this on a separate podcast is the idea of depreciation. Now, all I'm going to say for depreciation is a) it has nothing to do with assets losing value. Okay. Number two, all it does, it represents the cost of that item, typically like fixtures, equipment, plant, machinery, and the like, spread over the period of expected use.

And that is just an application of matching. Now you may come across, either as a business owner, somebody who's involved as a budget holder, a senior management team, a business owner themselves, the idea of pre payments and accruals. Weird terms, I know. Now, for example, we make some payments like insurances or subscriptions.

We pay that money today, but it relates to those services spreading into the future. If you have, for example, a financial year that ends in December and you've got an insurance bill that lands on your desk running from November to the following November, well, only some of that insurance cost will be recorded in that financial year that you're looking at.

The balance of it that does not reflect these expenses is recorded as an asset in your accounts is called a prepayment. Likewise, there may be bills that you haven't received for services that have been performed, goods that have been purchased. If you don't have those bills come in, then we accrue those.

Anybody who's ever been involved in a financial year-end situation, we have that situation where accountants and the finance team are asking you, are there staff that you've hired? Are the bills that haven't come through the system yet we need to be aware of so we can accrue for that as well. Now let me give you a few more examples to share of the matching concept.

Let's look at wages and salaries. Now you may have a situation where you pay your employees on the first day of each month. For the last month's work. It's quite common that we pay in arrears, so the wages for December may actually be paid out in January. Now under the matching concept, the expense for those wages is recorded in the month of December.

That's when the workers perform their task, even though the physical payment comes out the following month is irrelevant. As far as recording the expense is concerned, December is the month. They perform their work, they've earned that pay. Imagine advertising costs. Now you run a campaign for advertising, brand awareness perhaps, to encourage people to buy products from you or services in November.

You don't get the invoice from the agents until December. And you actually make the payment in the month of January. That expense of advertising is recorded in November, because that's when you incurred the obligation. Ideally, you're going to be matching it, if you can, with any income or benefits that may be generated in that same month of November.

I want to apply a last example, and that's the idea of sales commissions. Now, you may have a sales force, and you pay them a commission on what they sell. That commission for that sale is made in March, but you don't actually pay the commission until the following month. You want to check everything is in order.

You may have a rule that says actually payments are made in arrears. So the commission is recorded in March because that's when the obligation arose to that sales person. The fact it’s paid in April is not relevant to whether you record that as an expense. Now folks, the last thing I want to talk about now is how that matching concept is used in the financial statements.

Now, as a reminder, the three main financial statements that we tend to come across are the profit and loss account or income statement as it's commonly called these days, the balance sheet, sometimes called a statement of financial position if you want to enter the international lexicon and finally the cash flow statement. Let's look at each one in turn.

Now, when it comes to the income statement or profit and loss account or income and expenditure, this statement shows the company's revenues and expenses over a specific time frame. So if we imagine your financial year runs from the 1st of January to the end of December, one of the documents that will be produced at the end of that year will be the profit and loss or income statement that covers the activity between the 1st of Jan and the 31st of December.

When you match, compare those expenses with revenues, then the income statement will give you an accurate picture of the company's profitability or possible loss. The second statement is the balance sheet, which is purely a snapshot. It's a listing document, showing the assets and the liabilities of the company, of your business.

And accrued and prepaid expenses will appear within the balance sheet. If you've got items, expenses that you've accrued, i.e. you've not received the bill, you know you've got an obligation for, say, electricity, staffing costs, goods that have been purchased, that accrual will be classified as a liability.

And a liability is just a debt. The organisation has to settle that at some point. Prepayments, on the other hand, by the way, are seen as the opposite and they'll be classified as assets of the business. That insurance cost that relates to the next financial year, you'll be using that service, albeit there’s no cost or cash to pay out for. The last one is the cash flow statement.

Now the matching concept does not have a direct impact on the cash flow statement, but it does help reconcile and explain the difference between your net profit from your income statement and the cash flow itself. So when you look at how much cash flow you're generating from your underlying operations, and you compare it to the profitability, you might be thinking, hang on, those two numbers aren't quite the same.

Those adjustments for accruals and prepayments are part of that reconciliation exercise. So folks, what can we conclude? Well, we can conclude the matching concept is a fundamental foundation stone, the cornerstone of accurate and consistent financial reporting. When we ensure that expenses are recorded in the same period as they are generated,

Remember, cash has nothing to do with this, then we can produce financial statements that we have confidence in, that truly reflect the underlying financial performance. This helps with better decision making, consistency, and making sure that we behave ourselves and comply with accounting standards. For non-financial people, understanding this matching content gives us wonderful insights

in how we can track our performances, manage our finances, and explain the dichotomy between cash and profitability. Folks, I hope you found this podcast useful. Hope you got some benefit out of that. I'd love to hear your thoughts and comments. Share with those who you feel would benefit. And please do check out the show notes as we launch, or coming up to our launch, of the Numbers Knowhow Business Community, where not only will you get access to a great community, like-minded individuals, you've got access to specialist resources, you get access to directories, learning, and the like.

You'll find it a great way to grow, nurture your business, whether it's a small business, an arts and social enterprise, or a coaching business. Until next week, folks, happy matching. We hope you enjoyed this episode and appreciate you taking the time to listen to the show. We hope you got some value. If you did, then we'd love it if you shared the episode.

We look forward to you joining us next week for another I Hate Numbers episode.