Historical Cost Concept: Advantages and Disadvantages

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Historical Cost Concept


Historical cost concept is an accounting concept that states that all assets in the financial statement should be reported based on their original cost, at the time of purchase. Example: James buys a building for $2,000,000 ten years ago, the value of the building now is $3,000,000 but in James's accounting records, the building is still recorded as $2,000,000 (less depreciation). Historical cost is the original cost of an asset, as recorded in an entity's accounting records. A historical cost can be easily proven by accessing the purchase documents. The historical cost concept is clarified by the cost principle, which states that you should only record an asset, liability, or equity at its original cost. Historical cost is still a central concept for recording assets, though fair value is replacing it for some types of assets, such as marketable investments. What is the advantage of using historical cost on the balance sheet for property, plant and equipment?

The main advantage of using historical cost on the balance sheet for fixed assets is that historical cost can be verified. Generally, the cost at the time of purchase is documented with evidence such as invoices, receipts and etc. Historical costs helps to distinguish an asset’s original cost from its replacement cost, current cost, or inflation-adjusted cost.

Furthermore, the historical cost of plants and equipment are used to determine the amount of depreciation expense reported on the income statement. The provision of depreciation is also reported as a deduction from the assets’ historical costs reported on the balance sheet. The use of historical cost is also a disadvantage to those users of the financial statements who want to know the current values.

Historical cost values can relate to transactions that could be as long as 100 years old. Some businesses have old equipment and old stocks (inventories) that are still working well...
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