What is historical cost?
Historical cost is the original value of an asset. In some cases, assets and liabilities may be shown at their historical cost, like there has been no change in its value since the date of its purchase. The balance sheet value of the item may differ from the real value.
How does depreciation affect historical cost?
Depreciation affects the carrying value of an asset on the balance sheet. The historical cost will equal the carrying value. This happens if there has been no change recorded in the value of an asset since its purchase. It does not generally reflect the current market valuation.
Historical cost basis
Assets and liabilities are recorded at their purchase price when they are purchased. Generally, they are not restated for changes in values. Costs recorded in the income statement are based on the historical cost of items sold or used.
Measurement under the historical cost basis
It is standard practice to write down the value of inventory to a lower cost and net realizable value. The results will be as follow:
- A downward movement in the realizable value of inventory below cost is recognized immediately.
- An upward movement in the realizable value of inventory is not recognized until the inventory is sold.
Property, plant and equipment
Property, plant and equipment is recorded at cost under the historical cost basis. Costs include:
- Purchase price, including import duties and non-refundable purchase taxes, after deducting the trade discounts and rebates.
- Any costs that are directly attributed to bringing the asset to the location and condition necessary for it to be capable of operation. This can include site preparation, delivery, installation and even the costs of employees that are directly involved in these activities.
In IFRS, costs also includes the initial estimate of the costs of dismantling and removing the item and restoring it.
Advantages and disadvantages of historical cost
- Historical cost accounts are easy and straightforward to produce.
- The accounts do not record gains until they are realized.
- The accounts are still used in most accounting systems.
- The accounts give no indication on the current values of assets.
- The opportunity costs of use of older assets are not recorded.
- The historical cost accounts do not report or account the loss of the real value of items as a result of inflation or the gain in real value items during deflation.