A business is activity is fluid, like water, which means you can't have revenue without taking on some expenses. And business activity doesn't stop just because the year ends, because of that, we have a handy dandy matching principle. This thing is great, it means when a business earned revenue, money during the reporting period, all expenses spent during the same reporting period should be matched up and factored into the same financial statement. Let's listen to one of my experts. [SOUND] >> The matching principle is one of those concepts that we tend to forget sometimes, but we really need to be thinking about. The whole idea around the matching principle is that we want to match expenses and income to the period that it's relevant to. So when is the income earned in the expenses incurred related to each other? And that's really helpful when we are doing books for our clients so that if they for example, received in a big contract and it's $100,000, then when are those expenses incurred? And if we're able to match those together, it helps them really understand what their real profit is in that situation. It's important also because of things like payroll, so when we think about payroll, when is the matching happening? Is it when it was paid, or when that pay period happens? And so understanding when to record transactions and and things like that, that's really helpful for the client. One of the ways that the matching principle can also be used is based on the types of things that we're able to do in certain accounting programs. So for example, can we match income and expenses by entity, for example, a customer or a project. That is really helpful also because many times clients are not able to see those things together very easily. It could also be based on lines of business where we're matching income and expenses by line of business, in addition to matching it across periods when we're talking about it from a true accounting standpoint. But as bookkeepers, there's multiple ways that we can talk about that matching principle, and so thinking through that and helping the client understand that is really helpful as you're advising them. And going beyond just the data entry mindset of what it used to be to be a bookkeeper to now being really much more in a position to advise our clients, and provide reports that are really meaningful to them that also help them run their business. So as we're running reports, thinking through how the client will get this data, what they will do with that data, how they will see the income and the expenses together in potentially the same period, or related to the same project, or customer, or business structure, or business line, revenue line. All of those things can be really helpful and really provide more insight for the clients. >> So why does this all matter? If you don't match up your expenses with your revenue, then your books are going to be often unreliable. They like that pizza dropped coming out of the shop last night, chaos one month it looks like you're rolling in dough, the next you're up to your eyeballs and expenses. There'd be no way to tell what's going on, yes I still ate it, and yes it was still good. Here, let me give you an example, let's say Lou decides to sell lawn mowers, the big kind. A few months ago he bought one from a whole seller for $5000, and sold it the other day to a customer for $8000, at the end of his reporting period now that he sold it, he needs to match up the $5,000 expense with the $8,000 revenue he generated. That way everything in his books is on the up and up, yeah let's take a look at how it's done in QuickBooks. [SOUND] So now we're going to talk a little bit about deferred expenses or the matching principle. Basically what we need to do is record a cost that's related to income in the same period. So we can truly see the profitability on that product or service in real time in the same period. So I'm any demo this using the inventory feature in QuickBooks online because it kind of does it for you. So first of all we're going to buy some pens and then we're going to sell some pens. Let's say we buy the pens in December or January, and let's say we're going to sell the pens in March. So I don't want to go ahead and enter in expense when I'm buying my pen, and book it in January to cost a good sold, because then it would show up cost to get sold, put it right there, wait, put it right, cost of goods sold. Put it right there, and let's just date this January 31, so that's the day we bought it. So this is putting straight to the category or account on the chart of accounts, cost of goods sold. And I let's say I spent $50 buying my pens okay, this would show up on the profit and loss statement in January. So I'm going to hit save and close, so if I look at costs of goods sold, my expense is on January 31st and it's showing the $50 here. So if I sell those pens in March, my cost is in January, so when I run the March profit and loss statement, I'm showing less cost than I really should. I need to pull these this $50 to March without changing the date that I bought these pens. So let's go ahead and drill into the actual expense I just entered. And instead of using the category area on this expense form, I'm actually going to pull the pen products right onto this purchase, and in this case, there are $5 each, and I'm going to order 10 of those. Okay, so that is my $50, and so I can trash can this row, wait, that's going straight to my profit and loss statement in January. This entry recognizes that this is an inventory item, and QuickBooks online will do something automatically. When you buy inventory, it doesn't go to cost of goods sold, it goes to the inventory asset account. We now own 10 pens right, so we bought them and we're going to resell them later. Inventory knows to actually book this as an asset, so it's not going to go to the profit and loss today. So I'm going to hit save and then I'm going to open the transaction journal. If you click more and go to the transaction journal, it'll show the debits and credits underlying this expense that I defend. And so you can see it is coming out of the company checking account on January 31st, but the debit is not hitting cost of goods sold, it's hitting inventory asset, which then is showing up on our balance sheet. Not going to show up on the profit and loss yet, so how do I get it from the balance sheet down to the profit and loss statement? Well, first of all, let me take you back to the balance sheet, and I'm going to take you, let me run the report again. You've got to refresh the other browser tab, and I'm going to go to inventory asset. And in here, my purchase on January 31st right here is showing up as an expense for $50. Not an expense, sorry, it's on an expense form but it's showing up in my asset listing for the inventory we have on hand. Okay so how do you get rid of inventory? You sell it, so let's sell some pens. I'm going to go to my invoice, And we'll pull in a customer, just pick somebody and we're going to sell a couple of pens here, and we sell them for $8 each. They are taxable, but let's just say this is a wholesaler, we're selling it just marking them up and reselling them. So let's sell all 10 of them, so this is an $80 dollar invoice. So we bought them for 50, we're selling them from 80, we're making a little money here. As soon as I hit save here, QuickBooks online is going to do something really cool because it's an inventory item, it's going to pull $50 out of inventory asset off the balance sheet, and down to cost of good sold on the date of the sale. So let's sell this in March, let's say it's March 1st okay, as soon as I sell this, cost of goods sold is going to show up and it's also going to record the income, and the receivable. So a lot happens when you sell an inventory item in QuickBooks, I'm going to hit save. Let's take a look at that transaction journal, and see all the magic behind the scenes. So we'll take a look at the transaction journal and look at all this magic going on in the background. So what we want is we want the income to show in March and we want the cost to show in March. And this is letting us know that it is happening, the invoice is dated 3 1, but a lot is happening in the background. First of all, it's recognizing the income in March, so accounts receivable has been debited, and sales of product income have been credited. So that's the income on the profit and loss statement, then because it's an inventory item, QuickBooks online knows to pull that value of the cost we bought them for $5 each. The cost came off the balance sheet from the inventory with this credit entry, and we debited cost of goods sold. So now we're showing the revenue of $80 and the $50 cost in the same period. And that's what the matching principle is all about. So when we run the profit and loss statement, and we're looking at 2020, let me go and change it to this month, and hit run report. We are seeing revenue here which would have our $80 invoice, and then cost of goods sold is going to show the $50 of costs, even though we purchased it back in back in January. So I'm going to click through and you can see the invoice has created a $50 cost of good sold, even though it's not an expensive form. Kind of funny? But that is the matching principle in action, and inventory does it automatically in QuickBooks online.
