Matching of expenses in financial reporting : a matching function approach

Purpose – The purpose of this study is to introduce a matching function approach to analyze matching in financial reporting. Design/methodology/approach – The matching function is first analyzed analytically. It is specified as a multiplicative Cobb-Douglas-type function of three categories of expenses (labor expense, material expense and depreciation). The specified matching function is solved by the generalized reduced gradient method (GRG) for 10-year time series from 8,226 Finnish firms. The coefficient of determination of the logarithmic model (CODL) is compared with the linear revenue-expense correlation coefficient (REC) that is generally used in previous studies. Findings – Empirical evidence showed that REC is outperformed by CODL. CODL was found independent of or weakly negatively dependent on the matching elasticity of labor expense, positively dependent on the material expense elasticity and negatively dependent on depreciation elasticity. Therefore, the differences in matching accuracy between industries emphasizing different expense categories are significant. Research limitations/implications – The matching function is a general approach to assess the matching accuracy but it is in this study specified multiplicatively for three categories of expenses. Moreover, only one algorithm is tested in the empirical estimation of the function. The analysis is concentrated on tenyear time-series of a limited sample of Finnish firms. Practical implications – The matching function approach provides a large set of important information for considering the matching process in practice. It can prove a useful method also to accounting standardsetters and other specialists such as managers, consultants and auditors. Originality/value – This study is the first study to apply the new matching function approach.