The Historical Cost Concept
This demands that transactions are recorded at the original cost when they occurred. That is assets are recorded at the amount of cash or cash equivalent paid, or the fair value of the consideration given for them. Also liabilities are recorded at the amount of proceeds received in exchange for the obligation.
The Historical Cost Accounting (H.C.A.) has the following advantages
- It is simple and cheap to apply.
- Profit/loss ascertained is well understood.
- Generally used in practice since no better alternative exists.
- H.C.A. records are objective and verifiable.
- It makes it simple when comparing historical cost figures with past results or budgets.
The problems of Historical Cost Accounting are
- The statement of financial position does not show the value of a business.
- It maintains financial capital but not physical capital.
- It overstates profit in times of inflation and vice versa.
- It is a poor basis for assessing performance. Effects of inflation may be interpreted as growth.
- The loss suffered through holding monetary assets such as cash or receivables is not recognized by H.C.A.
Special Note: Assets are preferably measured at the lower of cost and net realizable value