Introduction

The matching principle requires that the revenue earned in a given period be matched against the expenses of that same period, so that profit or loss can be worked out correctly. If a cost's benefit stretches across more than one accounting period, it isn't fair to charge the whole cost as an expense in the year it was incurred — that cost has to be spread across the periods it actually benefits. Depreciation, on fixed assets, deals with exactly this situation, and it is the main subject of this chapter.

There is a related idea worth noting here too. Sometimes it isn't possible to know the exact amount of a future expense with certainty. The principle of conservatism (prudence) says that instead of ignoring such costs, an adequate provision should be made and charged against the current period's profits. And separately, a business may choose to retain part of its profit within the business — as a reserve — to fund future growth, expansion, or specific needs.