![]() Therefore, the use of historical cost may result in reporting profits that are not sustainable in the long term. If Company A were to distribute all profits as dividends, it will not have the resources sufficient to replace its existing plant at the end of its useful life. In periods of inflation, the historical cost principle measures profits which are 2 only sufficient to maintain operating assets in monetary terms, thus. What is the Historical Cost Principle The cost principle states that an asset should always be recorded at the original buying price or cost and not the perceived value. As a result, over the course of the asset’s life, an amount of $100,000 would be charged as depreciation in A’s financial statements even though the cost of maintaining the productive capacity of its asset would have notably increased. In other words, businesses have to record an asset on their balance sheet for the amount paid for the asset. how much the raw materials can be sold for in. The historical cost principle states that businesses must record and account for most assets and liabilities at their purchase or acquisition price. If the fair market value (FMV) of the inventory i.e. Definition: The historical cost principle is an accounting guideline which states that all assets must be recorded at cash value, on the date they were. However, due to a changing market landscape and headwinds to the company’s products, customer demand has decreased. $10,000 p.a.) does not reflect the opportunity cost of the plant’s use (i.e. Let’s assume that a company has purchased raw materials (i.e. ![]() For example, if a corporation buys equipment for 50,000, it will be recorded. Moreover, the depreciation charged in A’s financial statements (i.e. 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. Assets are recorded at their original purchase price known as historical cost. Even though the plant presented in A’s financial statements is capable of producing economic benefits worth 50% of Company B’s asset, it is carried at a historical cost equivalent of just 25% of its value. ![]() The scenario above presents an accounting anomaly. Company A purchased a plant for $100,000 on 1st January 2006 which had a useful life of 10 years.Ĭompany B purchased a similar plant for $200,000 on 31st December 2010.ĭepreciation is charged on straight line basis.Īt the end of the reporting period at 31st December 2010, the balance sheet of Company B would show a fixed asset of $200,000 while A’s financial statement would show an asset of $50,000 (net of depreciation). ![]()
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