The initial cost of an asset is referred to as its “historical cost” in accounting. For the purpose of financial reporting, the asset’s value is calculated using this cost, which is documented in the accounting records. An asset’s historical cost and present market worth aren’t necessarily the same. For inflation or other changes in the buying power of money, this cost is not altered. The historical cost principle is based on the conservative principle, which states that assets shouldn’t be recorded at valuations that are more than their recoverable amount (the amount that could be realized from selling the asset).
Both managerial accounting and financial accounting make use of the historical cost concept. The creation of financial accounts in financial accounting involves the utilisation of historical cost. Historical costs are employed in management accounting when making decisions about things like capital budgeting. An essential component of GAAP is the historical cost concept (generally accepted accounting principles). Guidelines set known as GAAP controls financial reporting. IAS also includes a codification of the historical cost concept (International Accounting Standards).
A corporation may spend $100,000 on an item of equipment, for instance. The salvage value of the equipment, which has a 10-year usable life, is estimated to be $10,000. The equipment would have historically cost $100,000. However, the corporation would only get $50,000 if the equipment were to be utilized for five years before being sold. The past cost would not be an accurate indicator of the equipment’s value in this situation.
The foundation for include assets and liabilities in the accounting records is the historical cost concept. According to this rule, assets and liabilities should be valued at their original purchase price. The sum of money used to purchase an object is known as its historical cost. Any costs needed to prepare the asset for usage are also included in this cost. A corporation may spend $1 million on a building, for instance. The structure is located on property that costs $500,000 to purchase. The building’s construction will cost $500,000 to complete. The structure was originally estimated to cost $1 million.
Importance
The historical cost principle is important because it provides a consistent basis for valuing assets and liabilities. If assets and liabilities were documented at their current market value, the values would fluctuate from period to period and would make it difficult to compare financial statements from one period to another.
Examples
Some examples of historical cost are:
- The cost of land is the original purchase price, plus any associated costs such as legal fees.
- The cost of a building is the original purchase price, plus the cost of any renovations or additions.
- The cost of machinery is the original purchase price, plus the cost of any modifications or repairs.
- The cost of vehicles is the original purchase price, plus the cost of any repairs or modifications.
- The cost of inventory is the original purchase price, plus the cost of any consignment or other charges incurred to get the inventory to the company’s premises.