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Historical Cost Accounting: Definition, Method & Advantages

Historical Cost Accounting: Definition, Method & Advantages
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  • 0:03 Historical Cost Accounting
  • 1:28 Advantages
  • 2:38 Lesson Summary
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Lesson Transcript
Instructor: Mary Rose

Mary is a CPA with a Bachelors and Masters degree in Accounting

In this lesson, you will learn about the concept of historical cost accounting, how it works and what the advantages of using this cost valuation method are.

Historical Cost Accounting

How do accounting reports value the items they report? Is it the amount you paid for it or is it the amount you could sell it for in the marketplace? There are many ways to value an item, but for accounting purposes there has to be a common method of determining the value to report for the item, particularly assets and liabilities. If a common method is not used, then comparing reports between different companies would really mean nothing, kind of like trying to compare an apple with an orange.

So for accounting purposes, the basis for most accounting valuations is known as historical cost accounting, the process of valuing items at their original or historical cost for accounting purposes. This means that the value of the item to be recorded as an asset or liability is the original amount paid for the item. As an example, if my company buys a brand new car and pays $25,000 for it, then $25,000 is the historical cost value I will record as an asset. The car's cost is always recorded as $25,000 even though we all know that when I drive the new car off the lot its value is now less than the $25,000 paid. The important piece of information is what was originally paid for the vehicle: the historical cost. What I could theoretically sell the asset for is irrelevant for our financial report purposes. What is important is what it actually costs to purchase. This is the principle of historical cost accounting.

Advantages

Why then would we record the original historical cost purchase amount as opposed to any other amount, like what we could sell the vehicle for now? One of the main things financial statements try to do is be comparable. This means that anyone should be able to take two or more different financial statements, look at the numbers, and know they're all based on the same valuation methods rather than someone's best guess.

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