Historical cost – What is historical cost?
Historical cost is the original cost of an asset. It is a key feature of accounting and bookkeeping, as outlined by the cost principle.
With invoicing software, you can easily keep track of your business assets and calculate the depreciation over time or usage. Read more on our article: ‘Managing assets in Debitoor’.
The term historical cost distinguishes the original cost of an asset from other types of costs, including:
- Replacement cost: the amount the same asset would cost today. Replacement cost is sometimes referred to as current cost.
- Inflation-adjusted cost: the value of the asset increased to reflect inflation since the original purchase date.
- Market value: the estimated amount an asset could be sold for, based on how much a buyer would be likely to pay the seller.
The historical cost of an asset can easily be found by referring to sales documents such as invoices or receipts.
The cost principle and historical cost
The cost principle is an accounting guideline which states that assets, liabilities, and equity investments should be recorded at their original - or historical - cost on a company’s financial reports.
‘Original cost’ refers to the initial cost of the asset at the time it was purchased, plus any costs required to get the asset fit-for-purpose.
Historical cost example
As an example, let’s say that Sam purchased a new piece of machinery for the business. He purchased the machine for £13,000.
On his invoicing software, he marked the expense as an asset and inputted the details for straight-line depreciation because the machine will lose value over time. He estimates a useful life of 10 years and after that, the machine will be worth £3,000.
The historical cost is £13,000, what he originally purchased the machine for. He saves his receipt for future reference and records this on his accounting reports.
Historical cost and accounting standards
In the UK, there are two main sets of accounting regulations: the IFRS Standards and the UK GAAP. Both the IFRS and the UK GAAP have specific guidelines for the treatment of assets, and both have different interpretations of historical cost.
According to the UK GAAP, most assets should be reported at historical cost and should not be remeasured to fair value. The only exception is investment property, which must be reported at fair value.
Under the IFRS, assets are usually recorded at historical cost. The only exceptions are PP&E, investment property, biological assets, and certain financial instruments which can be reported according to fair or market value.
Historical cost in financial reports
According to the cost principle, accounting records should report assets at their historical cost; however, it is fairly common for financial reports to show a value that is not the historical cost. This is because the market value of an asset is likely to diverge from the historical cost, making it necessary to adjust the recorded price of an asset.
Historical cost vs. fair value
Historical cost is the purchase price of an asset, whereas fair value is the estimated market price of an asset.
The fair value of an asset is the current price you could potentially sell the asset for. It can fluctuate often, whereas the historical cost does not.
The fair value is used to determine the value of a businesses assets if they were to sell them to potential buyers.
Advantages and disadvantages of historical cost accounting
Historical cost accounting is the process of recording the historical cost of an asset on your financial records. Some advantages to this may include:
- The cost can be verified using the purchase invoice or receipt
- Straightforward process and no need for estimates
- Does not record gains until an asset is actually sold
Some disadvantages to historical cost accounting may include:
- Current value of assets not recorded on financial reports
- Does not reflect the loss of value due to inflation
- Potential to overstate asset values if the asset was purchased several years ago and has since decreased in value
Historical cost in Debitoor
Keep track of your assets with Debitoor invoicing software. When you create an expense, you will be given the option to mark it as an asset. You can then enter the historical cost and decide whether to apply depreciation.
Every time you create an expense, add a payment, or send an invoice, your accounting reports will update in real-time. You will always have an accurate representation of your business finances from any device with an internet connection.