Historical cost definition
/What is Historical Cost?
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. A historical cost can be easily proven by accessing the source purchase or trade documents.
What to Include in Historical Cost
Historical cost includes the purchase price of an asset, plus any other costs incurred to bring the asset to the location and condition needed to make it function as intended. This can include a number of additional costs, including transport costs, freight in, the cost to demolish existing structures and install a concrete pad for the asset, and test it to ensure that it functions as intended.
Historical Cost vs. Fair Value
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. This is especially the case for real estate, where fair values tend to increase over the long term (depending on local market conditions). 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, because it is located in a thriving downtown area.
Historical Cost Adjustments
According 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.
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Other Types of Costs
Historical 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.
