Which of the following accounting concept says that assets is to be recorded at their original cost?
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Historical cost is the original cost of an asset, as recorded in an entity's accounting records. Many of the transactions recorded in an organization's accounting records are stated at their historical cost. This concept is clarified by the cost principle, which states that you should only record an asset, liability, or equity investment at its original acquisition cost. Show
A historical cost can be easily proven by accessing the source purchase or trade documents. However, historical cost has the disadvantage of not necessarily representing the actual fair value of an asset, which is likely to diverge from its purchase cost over time. For example, the historical cost of an office building was $10 million when it was purchased 20 years ago, but its current market value is three times that figure. Historical Cost AdjustmentsAccording to the accounting standards, historical costs require some adjustment as time passes. Depreciation expense is recorded for longer-term assets, thereby reducing their recorded value over their estimated useful lives. Also, if the value of an asset declines below its depreciation-adjusted cost, one must take an impairment charge to bring the recorded cost of the asset down to its net realizable value. Both concepts are intended to give a conservative view of the recorded cost of an asset. Other Types of CostsHistorical cost differs from a variety of other costs that can be assigned to an asset, such as its replacement cost (what you would pay to purchase the same asset now) or its inflation-adjusted cost (the original purchase price with cumulative upward adjustments for inflation since the purchase date). 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. The ongoing replacement of historical cost by a measure of fair value is based on the argument that historical cost presents an excessively conservative picture of an organization. Image source: Getty Images The cost principle states that any asset should be recorded at the purchase price. Learn why the cost principle is an important principle for your small business. There are four basic financial reporting principles governed by generally accepted accounting principles (GAAP). These principles are designed to provide consistency and set standards throughout the financial reporting field. If you wish to be compliant with GAAP, the cost principle should be used. The cost principle maintains that the cost of an asset must be recorded at historical cost, or its original cost and should not be recorded at fair market value. We’ll explain in greater detail just what the cost principle is and how it may impact your business. Overview: What is the cost principle?Even if you’re an accounting newbie, you know the importance of assets. Assets are anything of value that your business owns. Because they are so important to your business, it’s essential to record and report their value accurately and consistently, a relatively easy process if you’re using accounting software. But whatever process you’re using to record your assets, the cost principle can help maintain consistent balance sheet reporting. The cost principle, also known as the historical cost principle states that assets should be recorded at their original cost, rather than their current market value. This is because, in many cases, the cost of an item is subjective and dependent on market conditions. For example, an asset you purchased a year ago may suddenly gain value for a variety of reasons. Maybe the manufacturer stopped making that particular item, or the item has become scarce. Maybe it has become extraordinarily popular. Whatever the reason, the cost principle maintains that the asset value remains the same as its original, or purchase, cost regardless of later changes in market value. The cost principle has little impact on current assets like your bank account; they are short-term assets with little opportunity to gain any value. However, assets such as equipment and machinery should be recorded at face value and remain on the balance sheet at their original cost. Are there exceptions to the cost principle?There are some exceptions to the cost principle, mainly regarding liquid assets such as debt or equity investments. Investments that will be converted to cash in the near future are shown on your balance sheet at their market value, rather than their historical cost. The other exception is accounts receivable, which should be displayed on your balance sheet at their net realizable balance, which is the balance that you expect to receive when the accounts receivable balances are paid. Examples of the cost principleThese examples may help you better understand the cost principle in action. Cost principle: Example 1Jim started his business in 2008, constructing a building to house his growing staff. The cost to construct the building was $300,000, but by 2020, the fair market value of the building had increased to $1.1 million. However, on Jim’s balance sheet, the cost of the building remains at $300,000. Cost principle: Example 2Laura purchased a piece of machinery for her small manufacturing plant in 2017 at a cost of $20,000. Today, Laura’s machinery is worth only $8,000, but it is still recorded on her balance sheet at the original cost, less the accumulated depreciation of $12,000 that has been recorded in the three years since its purchase.  The balance sheet displays the office equipment balance and the accumulated depreciation. Image source: Author Source: AccountingCoach.com. Cost principle: Example 3Scott’s music production company purchases the copyright to a song from an up-and-coming artist. Scott should record the newly purchased asset at the cost he paid to purchase the copyright. Because copyright is an intangible asset, the copyright cost should be amortized, rather than depreciated. Should you be using the cost principle?If you currently use accrual accounting in your business and wish to be GAAP compliant, you should be using the cost principle. Since publicly owned companies are required to be GAAP compliant, they should be using the historical cost principle as well. There are some benefits -- and a few drawbacks -- to using the cost principle, which we’ll examine next. Benefit of using the cost principle
It’s important to understand the difference between the historical cost and fair value of your assets and when to use which figure. Image source: Author Source: WallStreeMojo.com. Drawbacks of using the cost principleWhile it’s clear that using the cost principle has its advantages, there are also a few downsides as well. For instance, if your business has valuable logos or brands, they would not be reported on your balance sheet. There is an exception for intangible assets purchased from another business. Issues can also arise when selling an asset, since it would likely be sold at fair market value, not historical cost. Finally, the value of your company may be seriously undervalued based on the historical cost of assets, which can directly affect your credit rating, your ability to obtain a loan, or even your ability to sell the business. FAQs
The cost principle offers consistencyWhen it comes to accounting, small business owners, who often have no background in accounting, prefer simplicity and consistency. Using the cost principle offers both. Rather than recording the value of an asset based on fair market value, which can fluctuate widely, your assets will all be recorded at their actual cost. This ensures that the asset value reported on your balance sheet is consistent from period to period, that there is a means to verify the cost of the asset, and that asset value is not manipulated. While there are drawbacks to using the cost principle, in most cases those drawbacks are reserved for larger companies with multiple investments or volatile, short-term securities. If you're looking to make the accounting process easier for your small business, you can start by using historical cost principle accounting. Expert-picked business credit cards with rich rewards and perksCash back, travel rewards, 0% intro APR financing: all of these can be great credit card perks for business owners. But how do you find the right business credit card for you? There are tons of offers on the market today, and sifting through them to find the right one can be a big hassle. So we've done the hard work for you. Get started with one of our top business credit card picks of 2022 today. In which accounting concepts assets are recorded at cost price?The concept according to which assets are recorded in the books of accounts at the price at which they are acquired or purchased is called cost concept.
What is the cost accounting concept?Cost accounting is a form of managerial accounting that aims to capture a company's total cost of production by assessing the variable costs of each step of production as well as fixed costs, such as a lease expense. Cost accounting is not GAAP-compliant, and can only be used for internal purposes.
What requires that assets be recorded at the actual cost?The cost principle, also known as the historical cost principle states that assets should be recorded at their original cost, rather than their current market value.
In which concept the transactions are recorded at their actual cost?Under the historical cost concept, business transactions are recorded in the accounting books at the transaction price, that is, their actual cost at the time the transaction took place.
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