Assets (such as cars) and liabilities (such as amounts owed to a creditor) are usually valued at their historic cost, i.e. at the price paid for them when they were originally purchased or sold. However, apart from the impact of inflation or deflation, assets and liabilities may change their value owing to such factors as wear and tear and obsolescence.
When goods are sold or purchased or sold on credit terms it is customary practice to treat them as being exchanged at the point when the legal title to the goods is transferred,
i.e. when they are realized. In modern manufacturing and trading conditions that point is not necessarily obvious and it remains a major issue that the accountancy profession is still trying to sort out.
The matching rule is illustrated in Figure 2.4.
This rule is closely related to the realization rule. Accounts are not usually prepared on the basis of cash received and cash paid during (say) a 12-month period because there is often a delay between the receipt and the payment of cash depending on the credit period given. This means that a comparison based on cash received/cash paid may
28 PART 1 INTRODUCTION TO ACCOUNTING
A contracting company divides each of its sales
be misleading when one year is compared with another. When preparing the accounts at the end of a year, therefore, it is necessary to allow for what was owed to the entity and owing by it at both the beginning and the end of the year, i.e. opening and closing debtors and creditors. This procedure often involves making an estimate of the amounts due to be received and sometimes the amounts due to be paid. Any estimate, of course, can be wrong because it is likely that some debts will not be settled. If this proves to be the case then the accounts for that year will be incorrect.
Any transaction involves someone giving something and someone else receiving it. So the basic rule is: record every