Solution 13.4

The relationship between the prudence and realization concepts

The intention of the prudence concept is to see that all asset values and profit figures are realistic rather than optimistic or pessimistic. The essence of the concept is to insist that revenue or profit should not be accounted for until the business is virtually certain to get it, but that a loss in an assets value is accounted for as soon as it is probable or likely. The realisation concept tells us when to recognise the profits or loss on a transaction. It states that profits or losses on transactions can only be accounted for when realisation has occurred. Realisation occurs when goods or services have been provided to the buyer who accepts liability for them. It is at this point that the business accounts for the transaction as it is virtually certain it will receive the revenues earned. Both concepts seek to ensure that transactions are accounted for on realization and hence assets and profit figures are realistic.