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Accounting Concepts - Part 2

"Accrual and Matching - the timing masters of accounting."

Continuing from Part 1, we now cover two more critical accounting concepts that determine when to record transactions.

4. Accrual Concept (Mercantile System)

"Record revenues when earned and expenses when incurred, NOT when cash changes hands."

Meaning: Transactions are recorded based on occurrence, not cash receipt/payment.

Accrual Basis vs Cash Basis

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Practical Examples

Example 1: Sales

  • Jan 15: Sold goods worth ₹1,00,000 to customer on 30-day credit
  • Accrual: Record ₹1,00,000 revenue on Jan 15 (when delivered)
  • Cash: Record when payment received (Feb 15)

Example 2: Rent

  • Dec rent ₹10,000 paid on Jan 5
  • Accrual: Record ₹10,000 expense in December (when incurred)
  • Cash: Record in January (when paid)

5. Matching Concept

"Match expenses with the revenues they help generate."

Meaning: Costs incurred to earn revenue must be recognized in the same period as the related revenue.

Purpose:

  • True profit calculation
  • Avoid overstating/understating profit
  • Fair comparison across periods

How Matching Works

Example: Amazon Delivery

  • Revenue: Sale of ₹1,000 book on Dec 15
  • Related Costs:
    • Cost of book: ₹600
    • Delivery charge: ₹50
    • Packaging: ₹20
    • Commission to seller: ₹100

Matching Concept says: All ₹770 costs must be matched with ₹1,000 revenue in December itself (when sale happened), even if some payments happen in January.

Matching in Action

Scenario: Manufacturing Company

ItemTransactionAccrual/Matching Treatment
Raw MaterialPurchased in Jan, used in production in FebExpense recorded in Feb (when used)
Factory RentFor Feb, paid in MarExpense recorded in Feb (period it relates to)
SalesGoods sold in Feb, payment in AprRevenue recorded in Feb (when sold)

Result: Feb P&L shows true profit = Matched sales with costs of producing those sales.

Real-World Application

Case Study: Flipkart's Annual Sale

Big Billion Days Sale (Oct 2023):

  • Sales: ₹10,000 Crores (Oct 10-15)
  • Advertising costs: ₹500 Crores (spent in Sept-Oct)
  • Delivery costs: ₹300 Crores (Oct-Nov)
  • Product costs: ₹6,000 Crores

Matching Concept Application:

  • All ₹6,800 Crores costs matched with ₹10,000 Crores revenue in October
  • Even though delivery payments happen in Nov, expense recorded in Oct
  • Accurate Profit = ₹10,000 - ₹6,800 = ₹3,200 Crores for Oct

Adjusting Entries for Matching

To implement Accrual and Matching, we use adjusting entries:

1. Outstanding Expenses

Expense incurred but not paid

Salary A/c                  Dr.    ₹20,000
    To Outstanding Salary A/c          ₹20,000

2. Prepaid Expenses

Expense paid but relates to future period

Prepaid Insurance A/c       Dr.    ₹6,000
    To Insurance A/c                  ₹6,000

3. Accrued Income

Income earned but not received

Accrued Rent A/c            Dr.    ₹5,000
    To Rent Income A/c                ₹5,000

4. Unearned Income

Income received but not yet earned

Commission Received A/c     Dr.    ₹3,000
    To Unearned Commission A/c        ₹3,000

Summary of All 5 Concepts

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Why These Concepts Matter

Without Accrual & Matching:

  • Company could manipulate profit by delaying/advancing cash payments
  • Different periods can't be compared
  • Investors get misleading information

With Accrual & Matching:

  • Profit reflects actual performance
  • Financial statements are reliable
  • Stakeholders can make informed decisions

Exam Tip

Question: "A company sold goods worth ₹50,000 in March 2024. Payment was received in April 2024. In which year should revenue be recorded under Accrual Concept?"

Answer: March 2024 (Year 2023-24), because revenue is recognized when goods are delivered/sold, not when cash is received.

Quiz: Accounting Concepts Part 2

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