Cost Concept: Recording Assets at Their Historical Cost

The cost concept in accounting states that assets should be recorded at their original purchase price, not their current market value. This principle ensures that financial statements remain reliable, objective, and free from frequent market-based adjustments.

BOOK A FREE DEMO

Glossary

What is the Cost Concept in Accounting?

The cost concept requires businesses to record and report assets based on the amount paid to acquire them, including all costs necessary to bring the asset to its intended use (such as purchase price, shipping, and installation). This original amount is known as the historical cost and remains on the books even if the market value changes.

Features of the Cost Concept

Historical Recording: Assets are recorded at their original cost, not at estimated or current market values.
Objectivity: The recorded cost is based on verifiable documents like invoices or receipts, ensuring accuracy.
Consistency: The historical cost remains constant, providing stability and comparability in financial reporting.
Basis for Depreciation: Depreciation is calculated on the original cost, allowing systematic expense recognition over time.

Characteristics of the Cost Concept

Reliance on Documentary Evidence: Every recorded cost must be supported by valid source documents such as purchase bills or agreements.
Stable Measurement: Historical cost does not fluctuate with market volatility, ensuring consistent records.
Matching with Revenues: The original cost provides a stable base for matching expenses like depreciation against revenues.
Non-Recognition of Market Value Changes: Unless required by specific accounting standards (like revaluation), market price changes do not affect the recorded value.

Examples of Cost Concept

Real Estate Purchase: A company buys a building for ₹50 lakh. Even if the market value rises to ₹80 lakh, it remains recorded at ₹50 lakh in the balance sheet , less accumulated depreciation.
Equipment Acquisition: Machinery bought for ₹10 lakh with an installation cost of ₹1 lakh is recorded at ₹11 lakh, regardless of later market fluctuations.
Furniture Purchase: A desk purchased for ₹20,000 stays at this cost even if its resale value drops to ₹5,000 after several years.

Advantages of the Cost Concept in Accounting

Objectivity and Reliability: Historical cost is backed by actual transactions and documents, eliminating personal bias.
Simplicity and Consistency: Recording assets at purchase price keeps accounting straightforward and financial statements comparable across periods.
Audit-Friendly: Verifiable purchase records make it easier for auditors to confirm asset values.
Foundation for Depreciation: Provides a clear, fixed base for calculating depreciation over the asset’s useful life.

Limitations of the Cost Concept in Accounting

Ignores Market Changes: Assets may be undervalued or overvalued if market prices change significantly.
Not Ideal for Inflationary Economies: Historical cost can distort financial statements when the purchasing power of money decreases over time.
Excludes Intangible Value: The concept may fail to capture the true worth of intangible assets such as brand reputation or intellectual property.
Potential Misleading Valuation: Investors may not see the current fair value of assets, which can impact investment decisions.

Conclusion

The cost concept ensures that assets are recorded at their historical purchase price, providing consistency, reliability, and verifiability in financial statements. While it simplifies accounting and supports accurate depreciation, it does not reflect current market values or inflation. Despite these limitations, the cost concept remains a cornerstone of accounting because it promotes objective and standardized financial reporting.

Vineet Goyal

Chartered Accountant

MRN No.: 411502

City: Delhi

I am a chartered accountant with over 14 years of experience. I understand income tax, GST, and balancing financial records. I analyze financial statements and tax codes effectively. However, I also have a passion for writing, which is different from working with numbers. Recently, I started writing articles and blog posts. My goal is to make finance easier for everyday people to understand.

Frequently Asked Questions

Why are assets recorded at their historical cost according to the cost concept?

Because historical cost provides verifiable, objective evidence of value, ensuring accuracy and consistency in financial statements.
What are the main features of the cost concept in accounting?

Assets are recorded at purchase price, supported by documentary evidence, and remain unchanged except for depreciation or impairment.
Can you provide examples illustrating the cost concept?

Yes, land purchased for ₹50 lakh remains on the books at ₹50 lakh even if market value rises, and machinery bought for ₹10 lakh stays recorded at that cost despite price fluctuations.
What are the advantages of applying the cost concept?

It offers simplicity, objectivity, and reliability, making auditing easier and ensuring consistent reporting.
What are the limitations or drawbacks of the cost concept?

It ignores market value changes, can distort figures during inflation, and doesn’t capture intangible asset values.
How does the cost concept affect financial reporting and asset valuation?

Financial statements reflect the original purchase price of assets, ensuring consistency but not necessarily showing current market worth.

View all FAQs