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Matching Principle is the basic accounting principle which requires prepayments to be included in the final accounts. The Principle states that an expense should be recorded in the period in which it occurs.
Let me explain it with an example:
XYZ Ltd. placed an order for a service worth SAR. 1000. They paid half of the amount in advance and the rest will be paid after the service is delivered. The year end is in the end of the current month and the service is scheduled for the next month.
Here, we can see that at the time of preparing the final accounts, the SAR. 1000 for the service has not been incurred for XYZ Ltd. since the service is not provided yet. XYZ has already paid SAR. 500 for an expense that has not been incurred yet. Therefore, there is a need to add an asset, "prepaid expense" since it cannot be shown as an expense. This amount will be credited and the expense account debited after the service is done.
We cannot expense the SAR. 500 at the time it is paid since matching principle doesn't allow an expense to be recorded unless it has been incurred.
The Journal Entries would be as follows:
At the time of Prepayment:
Dr. Prepaid Expenses 500
Cr. Cash 500
At the time after service is delivered:
Dr. Expenses 1000
Cr. Cash 500
Cr. Prepaid Expenses 500
