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Saturday, December 26, 2009

The Accruals Concept or Matching Concept

The accruals concept states that revenue and costs must be recognized as they are earned or incurred, not as money is received or paid. They must be matched with one another so far as their relationship can be established or justifiably assumed, and debit with in the profit and loss account of the period to which they relate.

Financial Reporting Standards also stipulates that financial statements must be prepared under the accruals concept. This concept is a cornerstone of present day financial statements.

Essentially, the accruals concept states that, in computing profit, revenue earned must be matched against the expenditure incurred in earned it.

The companies act gives legal recognition to the accruals concept, stating that, all income and charges relating to the financial year to which the accounts relate shall be taken into account, without regard to the date of receipt or payment. This has the effect, as we have seen, of requiring business to take credit for sales and purchases when made, rather than when paid for, and also carry unsold stock forward in the balance sheet rather than to deduct its cost from profit for the period.


If company Y makes 20 shirts at a cost of 100$ and sells them for 200$, she makes a profit of 100$. However, if company Y had only sold 18 shirts, it would have been incorrect to charge its profit and loss account with the cost of twenty shirts, as it still has 2 shirts in stock. If it intends to sell them in June it is likely to make a profit on the sale. Therefore, only the purchase cost of 18 shirts 90$ should be matched with its sales revenue, leaving it with a profit of 90$.


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