![]() They also hypothesized that a new regulation policy to conservatively measure income will not lead the operating expenses to be less positively correlated with contemporaneous revenues. Sivakumar and Waymire (2003) used this relationship to assess the effects of new rules for depreciation accruals hypothesizing that new rules will lead to lower correlation due to restrictions on matching. The contemporaneous correlation between revenues and expenses has in previous studies been used as an indirect measure of the matching quality. Thus, poor matching can seriously distort the quality of earnings. Thirdly, the persistence of earnings will decrease with poor matching. The volatility in earnings that are poorly matched is higher because the mismatched expenses act as a noise that is not related to the economic process of creating earnings. Secondly, poor matching increases the volatility of earnings. ![]() In poor matching, some of the perfectly matched expenses get scattered across different periods, which results in a lower synchronal correlation than the underlying economic correlation of advancing expenses to produce revenues. Firstly, poor matching decreases the time-series contemporaneous correlation between revenues and expenses. Poor matching has also several implications. The quality of matching is directly related to the inverse of the noise. Thus, the mismatched expense acts as a noise. Fourthly, in a perfect matching situation, the volatility is driven entirely by economic factors.ĭichev and Tang (2008) describe poor matching introducing a random variable to represent mismatched expense being unrelated to the well-matched expense and revenue. The variance of this economic shock represents the economic volatility of the business environment. Thirdly, there exists an economic shock in every period, which is the noise in the matching relation and has a mean of zero. Secondly, deviations in earnings from the long-run mean will gradually diminish over time. Firstly, in competitive equilibrium earnings tend to gravitate toward the cost of equity capital. Perfect matching provides a series of implications. Matching is considered to be perfect in the case where all expenses can be traced directly and specifically to specific revenues. If expenses are not properly matched against the resulting revenues, it is defined as a poor matching and is regarded as a noise in the economic relation of advancing expenses to obtain revenues. 123) and state that the purpose of accounting is to properly match the expenses against the resulting revenues. The objective of this study is to introduce a novel approach to do that.ĭichev and Tang (2008) follow Paton and Littleton (1940, p. Consequently, it is of importance to investigate and improve the methods to assess the quality of matching. Therefore, an inquiry into matching can potentially provide valuable insights into the properties of accounting earnings ( Dichev and Tang, 2008). ![]() This makes also matching very important, as the accuracy of matching plays a key role in assessing earnings. Earnings are regarded as the most important output of the accounting system ( Graham et al., 2005). For the accounting period, matching thus brings in the income statement together expenses and resulting revenue enabling to assess the earnings of the firm as the difference between revenue and expenses. In the matching process, revenues are first recognized and expenses are then matched against these revenues. Matching of expenses to revenues is defined as the process of collecting all revenues which are earned during the accounting period and matching these revenues with the expenses incurred to produce those revenues. The matching principle of accounting plays in financial reporting a central role. The full terms of this licence may be seen at Anyone may reproduce, distribute, translate and create derivative works of this article (for both commercial and non-commercial purposes), subject to full attribution to the original publication and authors. This article is published under the Creative Commons Attribution (CC BY 4.0) licence. ![]() Copyright © 2019, Erkki Kalervo Laitinen.
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