The cost is the amount the company originally paid out to purchase the asset, whereas, the fair market value is the expected amount that the asset will sell for. It will have two kinds of value – cost and fair market value. How the Historical Cost Principle WorksĪ business asset is something of value that a company purchases or acquires. Net realizable value is the amount of cash that the company expects to receive when these receivable accounts are paid. Accounts receivables have to be shown on a net realizable value on the balance sheet. The logic behind this is that these assets are more short term in nature and valuing them on a fair value basis or current value will give an accurate prediction of future cash flows of the company and will facilitate the users of financial statements in making operational level decisions.įor instance, investments in debt or equity securities are recorded on a current market value basis as they are expected to be converted to cash in the near future. However, some highly liquid assets need to be recorded at fair market value. When a company prepares its balance sheet, most of its assets will be recorded at historical cost. There are some exceptions to the historical cost principle which need to be mentioned. It will also be highly inconvenient for those companies that prepare their financial statements more frequently such as monthly. This will increase subjectivity and reduce the consistency and reliability of the financial statements. If the records are kept on a fair value basis, this would create serious concerns for the company as each member of the accounting department will value the assets differently. Verifiable: All the cost figures will be a hundred per cent verifiable as there will be records available for the transactions of the purchase or acquisition of various assets.Comparable: It will be easier to compare the value of the assets when doing a comparative analysis of the various assets.It will not change, and users of the financial statements will get an accurate picture of the business every time. Reliable: The process of recording the assets or liabilities on the balance sheet will always remain the same. ![]() ![]() Records that are kept based on the historical cost principle are usually considered to be more consistent, reliable, verifiable, and comparable. ![]() Put simply, once the asset is recorded at its original cost on the balance sheet, it cannot be adjusted for any changes in its market value. It states that businesses must record and account for assets and liabilities at their historical cost or original cost at the time of its purchase or acquisition by a company. The historical cost principle is one of the basic concepts of accounting and bookkeeping.
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