Historical Cost

Historical cost is the exchange price in the transaction in which an asset was acquired.  The cost of an asset is measured by the cash paid for the asset or, in the case of a non-cash exchange, by the estimated cash equivalent of the non-cash asset exchanged. After acquisition, this cost is known as historical cost of the asset. (Historical proceeds from a liability would be the term used after the liability has been incurred.)

Historical cost is the method primarily used on a company’s balance sheet to report the value of its “non-financial” (exchange price) of an asset on its balance sheet until another exchange has taken place. Certain assets such as property, plant and equipment, are measured and reported at their historical cost adjusted for depreciation. (Certain liabilities such as bonds payable, are measured and reported at their historical proceeds adjusted for amortization.) Historical cost (historical proceeds) is used extensively as a valuation method for non-financial which has high degree of reliability.  It has been criticized; however, because some users of financial statements argue that historical cost (historical proceeds) amounts are not as relevant as the amounts reported under fair value methods.

 That is historical cost (historical proceeds) may not represent the amount of future cash inflows (or cash outflows) that the company is likely to obtain for the asset (or pay settle the liability). As result, FASB sometimes requires a company to report an asset at its fair value

Merits and demerits of historical cost

Merits

•  They are still utilized in many of the accounting. 
•  They do not post gains until they are realized.
• Historical cost accounts are easy and simple to produce.

Disadvantages

• They provide no sign of current values of the assets the company or business. 
• They do not record the opportunity costs of the use of the older assets, mainly the property that might be posted at a value based on costs incurred several years ago.
• It do not measure the loss of value of financial assets because of inflation

Questionnaire:

• What is historical cost?
• What are the merits and demerits of historical cost?