#Historical cost principle full

Similarly, accounts receivable are presented in the balance sheet at their net realizable value. For example, investments in debt or equity instruments of other enterprises that are expected to be converted into cash in near future are shown in the balance sheet at their current market value. However, some highly liquid assets are subject to exception of historical cost concept. When a company prepares its balance sheet, most of the assets are listed at their historical cost. For example, companies computing net income or preparing balance sheet on monthly basis would have to establish a new sales value for inventory and other assets at the end of each month which is usually inconvenient.

For example, if a company uses current market value or sales value rather than historical cost, each member of accounting department is likely to suggest a different value for each asset of the company.įurther, current market or sales value is not appropriate for entities that prepare their financial statements more than once a year. Importance of historical cost conceptĪn important advantage of historical cost concept is that the records kept on the basis of it are considered consistent, comparable, verifiable and reliable.Īny valuation basis other than historical cost may create serious issues for companies. The cost of note payable to be entered in accounting records would be $12,000.

#Historical cost principle full

For example, a company acquires a tract of land at an agreed price of $12,000 and issues a note payable amounting to $12,000 for the full payment. These liabilities are normally reported at their cost. Companies issue various liabilities (such as accounts payable, bills payable, notes payable, bonds payable etc.) in exchange for goods and services. Although the market price of land has significantly increased, the amount entered in balance sheet and other accounting records would continue unchanged at the original cost of $25,000.Ī similar presentation is also required for liabilities. In a booming real estate market, the fair market value of the land five years later might be $35,000.

The company will enter $25,000 as the cost of the land in its accounting records. Historical cost is the amount that is originally paid to acquire the asset and may be different from the current market value of the asset. Let us assume, for example, that a herbal medicine company purchases a piece of land for growing herbs on it, paying $25,000 in cash. The historical cost concept (also known as cost principle of accounting) states that the assets and liabilities of a business should be presented in accounting records at their historical cost.