Definition of Historical Cost Concept (Convention, Principle) or Cost Principle of Accounting:
Historical cost concept (convention, principle) or cost principle of accounting states and defines that, “an asset should be initially recorded at its cost of acquisition. The cost includes the actual purchase price plus incidental costs incurred in acquiring the non-current asset in a form, useful for business purposes”.
Explanation, Use and Application of Historical Cost Concept:
The term ‘cost’ is quite different from ‘market or book value’. Cost is the most objective measurement of the value of an asset and is supported by evidence of an actual transaction. All assets are initially recorded at cost but in due course of time their values reduce on account of depreciation charges. This reduce value of an asset is called book value but is usually different from its current market or replacement value.
The accountants usually value non-current assets at book value in and ignore differences in market values. This treatment is also consistent with the going concern concept of accounting.
Solved Example 1:
A business bought a piece of land ten years ago for $100000. Its market value has now appreciated to $200000.
The historical cost concept of accounting requires that the land should be shown in the balance sheet at its historic cost of $100000. The increased market value should be ignored unless business has a revaluation policy to periodically revalue its non-current assets.
Solved Example 2:
Dyson company purchased a machine for $14000. Company was paid $1100 for transportation costs and $1500 was spent on its installation. Unfortunately, it breaks down during the first month of operation and cost $1000 to repair.
Calculate its cost to be shown in the books according to the historical cost concept of accounting.