Historical cost

Historical cost accounting is an approach to accounting using asset values based on the actual amount on money paid for assets with no inflation adjustment. This approach is said to use the accounting principle of historical cost. It contrasts with approaches such as current cost accounting.

The term historical cost may also be used to refer to a particular cost calculated in this way.

Although the use of historical cost accounting excludes routine adjustments for inflation, the cost still needs several adjustments when calculating the book value. The most important of these are depreciation, depletion and impairment.

In addition, although current accounting standards are largely based on historical cost accounting, there are exceptions such as the use of fair value, net realisable value, and other revaluations.

There are also some complications associated with calculating the value of stocks, because they are essentially fungible and individual items are not tracked from purchase to sale. The most popular methods for calculating costs are FIFO, LIFO and average costing, with other methods such as replacement cost being used in some industries.

The main advantages of using historical costs is simplicity and certainty. The biggest disadvantage is that book values may be based on badly out of date costs. This becomes more of a problem during periods of high inflation.

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