Historical cost

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In accounting terminology, historical cost describes the original cost of an asset at the time of purchase or payment as opposed to its market value (saleable value, replacement value or value in present or alternative use). Economists use opportunity costs to distinguish an opportunity forgone from the accounting cost or historical cost recorded in accounting records.

Historical cost principle

In accounting, the historical cost principle dictates that most assets and liabilities should be recorded at their historical cost. It is one of the 4 main principles in the U.S. generally accepted accounting principles (GAAP). For example, a tract of land which was purchased 50 years ago for $10,000 may be worth $1 million today but it will be recorded on the balance sheet at its historical cost: $10,000. Historical cost principle is used because of its reliability and freedom of bias when compared to fair market value principle. However, historical cost does not always provide relevant information. Thus there is an increasing pressure to use fair market value. Today most securities and debts are recorded at market value. In contrast to US GAAP, under UK GAAP firms may revalue assets based on appraised market values. This can result in the recognition of unrealized gains as income.

Computation of historical cost for fixed assets.

Historical cost is the actual purchase price plus incidental costs incurred in getting the fixed asset in a condition and position ready for initial use / commercial production.

• Land: Purchase price + legal fees + costs on leveling, grading, draining, clearing + mortgages, liens, encumbrances + additional permanent improvements (e.g. pavements, sewers, landscaping) - any proceeds from getting the land ready for its intended use (e.g. sale of cleared timber or materials from demolished buildings).

• Building: Purchase price + legal fees + and costs incurred in respect of major improvements / alterations / betterments.

• Machinery: Purchase price (net) + freight + shipping + loading & unloading + installation charges + commissioning (expenses on trial run and experimental production).
• Furniture & Fixtures: Purchase price (net) + installation charges.
• Vehicles: Purchase price + registration charges + cost incurred on accessories.

Special cases

• Discounts should be considered a reduction in the purchase price, whether taken or not.
• If an asset has been received in consideration of issuing shares / bonds or notes payable, historical cost is recorded at fair market value of shares / bonds or notes payable. For example: machinery is bought in return of 10,000 shares which are traded in the market for $12. Historical cost of the machinery is $120,000.
• If a group of assets are purchased for a single lump sum, the cost paid is allocated among various assets on the basis of their fair market value.
• If an asset has been received in exchange for another non-monetary asset, historical cost is recorded as the fair market value of the asset given up or the asset acquired whichever is more evident.

Costs after acquisition

In general, costs incurred to improve an asset should be capitalized (that is, added to the historical price), whereas expenditures that simply maintain a given level of services should be treated as ordinary expenses. In order for cost to be capitalized, one of these conditions must be met:

• the useful life of the asset must be increased
• the quality of units produced from the asset must be increased
• the quantity of units produced must be increased.