Historical Cost Concept
Historical cost is the value of a resource given up or a liability incurred to acquire an asset/service at the time when the original transaction occurred. This does not increase subsequently when the value of the asset appreciates.
Historical cost concept is a basic accounting principle that has traditionally guided how assets are recorded in the books. This is changing lately, with a greater emphasis in accounting standards, on fair valuation and impairment testing.
When an asset is measured at historical cost, it is initially recorded at the original price paid, and in subsequent periods when there is an appreciation in the value of the asset, the increase is not recognized and the value of the asset stays at the original amount depending on any depreciation and impairment that may have been charged.
The argument for using historical costs is that accounting is concerned with past transactions and that the information and reports that accounting generates need to be consistent and comparable. Because fair values may be highly volatile and judgmental, therefore comparability and consistency many be reduced if values of the assets were to change from period to period.
- 100 units of an item were purchased one month back for $10 per unit. The price today is $11 per unit. The inventory shall appear on balance sheet at $1,000 and not at $1,100.
- The company built its ERP in 2008 at a cost of $40 million. In 2010 it is estimated that the present value of the future benefits attributable to the ERP is $100 million. The ERP shall stand on balance sheet at its historical costs less accumulated depreciation and not at $100 million.
As stated above, the concept of historical cost is important because market values may change so often that allowing reporting of assets and liabilities at current values would distort the whole fabric of accounting, degrading comparability and making accounting information unreliable. Lately however, there has been trend of moving towards fair valuation with improved techniques for determining market values.