Historical Cost Principle

Definition

The financial accounting term Historical Cost Principle refers to a valuation technique used in the preparation of financial statements.  The Historical Cost Principle states the value of an asset or liability is recorded on the balance sheet at its cost at the time of acquisition.

Explanation

Historical cost is a Generally Accepted Accounting Principle (GAAP) standard.  As such, this standard suggests that assets and liabilities are recorded on the balance sheet at original cost, even if the value of the asset changes over time.  This is sometimes referred to as the exchange price.

Advocates of historical cost believe this system is more objective, verifiable, and fact-based.  If there hasn't been a change in value over time, the balance sheet would also reflect the asset's true worth.  For these reasons, it's deemed by many as a reliable method for recording cost data.

The approach is often criticized for its accuracy, since the net value of an asset or liability can change over time.  In addition, the Historical Cost Principle does not specify what elements should be included in the exchange price.  For example, insurance, shipping expenses, assembly or installation can all be reasonably included in the cost of a capital asset.

While depreciation will lower the net value of an asset appearing on the balance sheet over time, there is no change to the historical cost.  A contra asset account, accumulated depreciation, is used in the calculation of the asset's net value.  In addition, there can be improvements to an asset, which increase its value.

It's important to point out that not all assets or liabilities appearing on the balance sheet are recorded at historical cost.  For example, marketable securities are typically valued at the lower of cost or market until the investment is sold.

Related Terms

FASB, GAAP, balance sheet, asset, liability, contra asset, depreciation, Revenue Recognition Principle, Full Disclosure Principle, prudent cost concept