Historical Cost: Definition, Principle & Advantages

Instructor: Brianna Whiting

Brianna has a masters of education in educational leadership, a DBA business management, and a BS in animal science.

In this lesson, we will look at historical cost and how it is used in business. In particular, we'll examine the meaning of the term, its guiding principle and advantages. At the end of the lesson, you'll have the chance to test your own knowledge of historical cost and how

Historical Costs: A Real-Life Scenario

Imagine you are a farmer. One day, you look at all of the farmland you own and realize that two of your acres are no longer needed. They simply do not produce the crops you had expected. You then decide it is time to think about selling those two acres. In order to determine what to sell the land for, you pull up the bill of sale to look at the price you originally paid for the acres. What you are determining is the historical cost.

Historical Costs Defined

Historical cost is a term used in accounting that represents the original cost of an asset you've acquired or purchased at the time of transfer or sale. In cost accounting, the term refers to an amount of money used to buy or run a business.

It is important to understand that historical cost and cost are often used interchangeably during a transaction. Additionally, the term historical cost is used when trying to differentiate original costs from replacement or current costs. For example, if you purchased land in the year 2000 for $10,000, in 2015, the historical costs will still be $10,000, despite the fact that the price of land may have increased over time. Lastly, historical cost does not take into account the effects of inflation.

Principle of Historical Cost

Next, let's take a look of the principle of historical cost, in which the definition of the term is applied to a business or firm. For example, when business owners fill out a balance sheet, they need to report the historical cost at the time of the transaction, and not the current or replacement costs. While some countries, such as the Netherlands and the United Kingdom, may allow historical cost figures to be modified in accordance with economic, inflationary or market changes, this practice is not allowed in the United States.

While historical costs are always factual or reliable, they are not always useful. For example, the figures do not provide information about the current value is of an asset, which can be more readily determined through fair market value.

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