Historical Cost

The historical cost of an asset refers to the price at which it was first purchased or acquired. In accounting, businesses should record actual acquisition costs for assets, liabilities, and equities in balance sheets. Even if the asset appreciates, the original price of an item does not change, and hence it differs from its current market value.

The historical cost concept differs from the fair value concept, which reflects the current market value of a company's assets. Asset valuation at the original price avoids overvaluation in a dynamic market and is a good way to figure out capital expenditures. It also makes it easy for businesses to retrieve the actual pricing of items when needed quickly.

• The historical cost in accounting is the price of an asset, liability, or equity at which it was purchased or acquired for the first time and is recorded on the balance sheet.
• It aids in the avoidance of overvaluation in a volatile market and is a useful tool for calculating capital expenditures. It also makes it simple for businesses to get item pricing when needed rapidly.
• The original price differs from the fair value, which depicts a company's assets at their current market value. The former does not change even if the asset appreciates, and hence it differs from the latter.
• It is a conservative accounting concept that demands some adjustments over time.

The historical cost principle or the cost principle provides information on the cost of an asset acquired in the past. Sales and purchase documents usually reflect the original price of an asset. As per this principle, a company's balance sheet should reflect all assets, liabilities, and equity interests at their actual purchase price, no matter how much they have appreciated over time. However, they are not bound to do so as they can maintain the asset’s current value in their accounting records. Comparing the current value of an asset with its original value reveals its monetary performance over the years.

The original cost may not always indicate an asset's fair value, making the principle useless for estimating the change in value over time or due to inflation. However, like conservative accounting, it helps prevent the overvaluation of the asset in a volatile market. Therefore, the historical cost principle is one of the primary accounting methods for fixed assets under the United States Generally Accepted Accounting Principles (GAAP).

The original price can include any asset and all costs related to its acquisition. However, it does not need to be reported in the balance sheet in the case of marketable securities which are recorded with their fair value. On the other hand, impaired intangible assets can be recorded from historical to current value.

Historical cost meaning follows the conservative accounting concept and necessitates some modifications over time. Given the wear and tear expenses involved with long-term assets due to their use, the original price of those assets is recognized as depreciation expense. As a result of this depreciation expense, the asset's recorded value decreases throughout its useful life.

According to this depreciation-adjusted cost principle, if the asset's value becomes impaired and falls below its reduced recorded price, an impairment amount is levied to bring that recorded value to its net realization cost.

Suppose a company bought an office building worth $5 million 10 years ago, with its current market value is $30 million. Its balance sheet will still record this tangible asset at the original price of $5 million. The difference between the original acquisition price and the current market value illustrates how the building has become one of the best commercial facilities in town due to improved location, transportation, communication, etc. The increase in the price of the office building signals that the future market value is likely to rise, potentially attracting more people to rent or buy different floors as their office premises.

Historical cost and fair value are two phrases describing the original price of an object and its ups and downs over time. The former is the asset's actual purchase price, as recorded on the balance sheet, whereas the latter is the asset's current market value.

Fair value, also known as mark-to-market practice, fluctuates per market change. The asset's market value represents the amount of cash flow that could be generated in the future through prospective sales. Therefore, the original price of an item can be used to measure and evaluate its market performance. If the original price remains higher than the market value, the market moves downward, and vice versa.

This has been a Guide to what is Historical Cost in Accounting. Here we explain the concept of historical cost and its meaning, principles, & examples. Please have a look at the following articles to learn more –

• Historical Cost vs Fair Value
• Replacement Cost
• Backflush Costing