7.1 Accounting Principles: Realisation

Realisation is a fundamental accounting principle that states that an asset should only be recognised in the accounting records when it can be converted into cash or when its value is realised. This principle focuses on the realizable value of assets, rather than their historical cost.

Understanding Realisation

The core idea behind realisation is that the true economic value of an asset is only known when it's actually sold or its value is otherwise converted into cash. This is because an asset's value can fluctuate, and its book value (historical cost less depreciation) might not reflect its current market value.

Why is Realisation Important?

• Provides a realistic view of financial position: Realisation ensures that the financial statements reflect what the business can actually obtain from its assets.
• Avoids overvaluation of assets: Prevents assets from being shown at values that are unlikely to be achieved in the future.
• Reflects economic reality: Aligns accounting with the practical reality of asset disposal.

Examples of Realisation

1. Sale of Inventory: When a business sells its inventory, the inventory is realised into cash. The cost of goods sold is recognised, and the profit or loss from the sale is recorded.
2. Sale of Fixed Assets: If a business sells a fixed asset (like machinery), the proceeds from the sale are realised. The asset is removed from the balance sheet, and any profit or loss on disposal is recorded.
3. Collection of Receivables: When a business collects money owed to it by customers (receivables), this is a realisation of the asset.

Impact on Financial Statements

Realisation directly impacts the following financial statements:

Financial Statement	Impact of Realisation
Balance Sheet	Assets are reduced when they are sold or their value is realised.
Profit and Loss Account	Profit or loss on the sale of assets is recognised. Revenue from the sale of inventory is recognised.

Relationship to other Accounting Principles

Realisation is closely related to other accounting principles, such as:

• Matching Principle: The profit or loss from the sale of an asset is matched with the period in which the asset is realised.
• Accrual Accounting: Realisation is a key part of the accrual accounting system, which recognizes revenues and expenses when they are earned or incurred, regardless of when cash changes hands.

Realisation is a crucial principle for ensuring that financial statements provide a true and fair view of a company's financial position and performance.