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Accounting for Bad Debts (A Primer on the Matching Principle)

The basis of accounting is the matching principle.  It takes money (expense) to make money (revenue).  The matching principle in accounting reflects this because the expense it took to earn revenue during a period of time (referred to as the accounting period) is deducted from that revenue to equal the net income.  Accrual accounting is a generally accepted method used to record a transaction that led to an expense or revenue in which cash was not exchanged at the time of the transaction, as opposed to cash accounting that only recognizes a transaction in an accounting period in which cash is exchanged.  The accrual method provides for a broader picture of an organization’s operations because it shows all transactions as they occur.  Because a business entity (referred to as “firm” hereafter) will account for revenue generating transactions that do not include the exchange of cash, it must also account for non-cash transactions that do not in the end result in cash payment, or otherwise known as “bad debts.”

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