Historical Cost

Written by Fmi.Online Friday January 6, 2023
Historical cost or historical costing is the concept that assets should be valued based on their purchase price or the money actually paid for the assets. GAAP requires that assets be reported on the balance sheet at historical cost.

Explanation :

Historical cost is the preferred method of valuing assets because it can be proven. It is easy for a company to look at the title of a piece of property and see what was paid for it. Other valuation or costing methods like replacement cost or current cost fluctuate with the market and economy. If these methods were used, the company would report the same piece of property at different values every year based on the market. This fluctuation violates the accounting concept or consistency. Historical cost values don’t change from year to year, so the consistency concept is not violated. There are some problems with the historical costing method. For instance, it doesn’t take into consideration time value of money or inflation. The historical cost concept assumes that inflation is not relevant and only values assets based on the purchase price.

In a nutshell:

  • Most long-term assets are recorded at their historical cost on a company's balance sheet.
  • Historical cost is one of the basic accounting principles laid out under generally accepted accounting principles (GAAP).
  • Historical cost is in line with conservative accounting, as it prevents overstating the value of an asset.
  • Highly liquid assets may be recorded at fair market value, and impaired assets may be written down to fair market value.
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