According to this concept the asset is recorded in the books of accounts at the price paid for it and not at its market value. For example: if a business entity purchases a building valued at $15 million from a friend for $12 million, this asset would be recorded at $12 million and not at $ 15 million, because for the business entity the cost was $12 million and not $15 million. Now the basis for all future transactions relating to this building would also be at its cost, i.e. $12 million. For example: The depreciation would be charged on $12 million and not on $15 million. Similarly when the asset is sold in future, the profit or loss on sale would be based on the cost price actually paid for it. Since the original or acquisition cost relates to past, it is also referred to as historical cost. Consequences of Cost Concept
The impact of using Cost Concept is as follows:-
1. The assets are valued at cost or book value or at the cost derived amounts 2. Items which have no cost are ignored, that is, if the business entity does not pay anything for an asset, it would appear in the books of account. The goodwill would appear in the accounts only when the enterprise has purchased the intangible asset for a price. 3. Unrealized gains, i.e., gains on unsold assets are to be ignored 4. The real value of the capital employed is not available in the Balance Sheet Justification of Cost Concept
The justification for the cost concept lies in the following arguments:- 1. The acquisition cost is highly objective because it is derived from an independent transaction between two parties i.e. the business entity and the vendor 2. The details of the original transaction can be easily verified from the documents that are exchanged at the time of purchase such as purchase invoice, title of ownership, property deed, and check books and so on. 3. When the assets are to be recorded at market value, difficulties may arise regarding which value of which market to be taken...