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What is Historical Cost?
Historical cost is an accounting principle that records assets and liabilities at their original purchase price, rather than their current market value. It provides consistency and objectivity in financial reporting.
Definition
Historical cost is the original monetary value of an asset or liability at the time it is acquired or incurred.
Key Takeaways
- Assets are recorded at purchase price, not market value.
- Provides reliability and verifiability in accounting records.
- May understate or overstate current economic value over time.
Understanding Historical Cost
Under the historical cost principle, companies record transactions based on the actual amount paid or received. This method avoids subjective estimates and market volatility, making financial statements easier to verify and audit.
However, historical cost does not reflect changes in market value caused by inflation, depreciation, or appreciation. As a result, financial statements may not fully represent the current economic reality of assets such as land, buildings, or long-held equipment.
Despite its limitations, historical cost remains a foundational concept in accounting standards worldwide.
Real-World Example
A company purchases land for $500,000 in 2005. Even if the land is worth $2 million today, it continues to be reported at $500,000 (less any impairment) under historical cost accounting.
Importance in Business or Economics
Historical cost matters because it:
- Ensures consistency and comparability in financial reporting
- Reduces manipulation from subjective valuations
- Supports auditability and regulatory compliance
Types or Variations
- Historical Cost Accounting — Full reliance on original cost
- Modified Historical Cost — Historical cost adjusted for depreciation or impairment
Related Terms
- Fair Value Accounting
- Depreciation
- Impairment
Sources and Further Reading
Quick Reference
- Based on original transaction value
- Objective and verifiable
- May diverge from market value
Frequently Asked Questions (FAQs)
Why do accountants use historical cost?
Because it is reliable, objective, and easy to verify.
Does historical cost reflect inflation?
No, it ignores changes in purchasing power over time.
Is historical cost still relevant today?
Yes, though often supplemented with fair value disclosures.
