Cost and Realisation Concepts
Cost (Historical Cost) Concept
Assets are recorded at their original purchase price — the amount actually paid at the time of acquisition — plus any costs directly necessary to make the asset usable (e.g. delivery, installation, legal fees for a property purchase).
Why historical cost?
- Objective — the purchase price is a verifiable fact supported by an invoice; there is no subjectivity
- Reliable — figures are not subject to opinion or estimation at initial recognition
- Practical — straightforward to apply consistently
Consequences:
- Asset values on the SFP may become out of date over time (property bought 20 years ago may be recorded at a fraction of its current market value)
- Depreciation is charged on historical cost, reducing to net book value (NBV)
- Revaluation of non-current assets is permitted but only infrequent — once revalued, the class of asset must be kept up to date
Realisation Concept
Income is recorded in the accounts only when the legal right to receive it has been established — this normally occurs when goods are delivered or services are rendered, and legal title passes to the buyer.
Realisation does not require cash receipt. A credit sale is realised at the point of delivery, not when the customer pays.
Sale or return example:
- A business sends goods to a customer on a "sale or return" basis
- The customer has not yet accepted the goods — legal title has not passed
- Income must not be recorded yet; the goods remain in inventory at cost
- Only when the customer notifies acceptance is the sale realised and income recorded
Key distinction from accruals:
- Realisation determines when income can first be recognised (has the right arisen?)
- Accruals determines which period that recognised income belongs to
Exam trap: Do not confuse realisation with cash receipt. Income can be realised (and therefore recorded) before cash is received — this is a credit sale. Cash receipt alone does not trigger realisation if no right to the income has been earned.