Definition: The realization principle dictates that revenue should be recognized when it is earned, regardless of when cash is received.
Role in Adjusting Entries: Adjusting entries help record revenue at the point when a company has fulfilled its obligations (e.g., delivering goods or providing services), not when cash is exchanged. For example, if services are provided but payment is due later, an adjusting entry recognizes the revenue in the current period.
Definition: The matching principle requires that expenses be recorded in the same period as the revenues they help generate.
Role in Adjusting Entries: Adjusting entries ensure that expenses incurred in earning revenues are recognized in the same period. This applies to situations like depreciation, prepaid expenses, or accrued wages, where the expense needs to be matched to the revenue even if payment happens later.
Adjusting entries ensure that the financial statements accurately reflect the period in which revenues were earned and the related expenses incurred.
Without these adjustments, financial statements might understate or overstate earnings by failing to match costs with the revenues they generate or by delaying revenue recognition until cash is received.