Question

according to the historical cost principle, assets should be recorded in the books of account at their actual cost, measured on the date when the asset had been purchased. I'd like you to discuss potential advantages and disadvantages of recording assets in the books of account following the historical cost principle.

respond to the following question:

What are the potential advantages and disadvantages of recording assets in the books of account following the historical cost principle?

Answer 1

Advantages of recording Assets at historical value:
1.Reliable:- When asset is recorded at historical cost the value is taken from a reliable document
like Purchase agreement, invoice, payments, tax documents etc. So we can say that the amount
at which asset is recorded in balance sheet is accurate and can be relied upon
2.Depreciation/Amortization:-The historical cost is used to calculate depreciation expense, which
is shown in income statement. Also Historical cost is also necessary to calculate impairement loss
in case there is any impairement indication of any asset.
3.Simplicity:-The concept of historical cost is very simple to understand. There is no need to calculate
the fair value of the asset at each year end.
Disadvantages of recording Assets at historical value:
1.Current market value:-The main issue with the historical cost method, especially in case of Land and property
is that it does not consider the current market value of the Land and property. It is beacause of the fact that
the value of the Land appreciates as time progresses, which is why the concept of depreciation can't be applied
on these kind of asset. In such cases market value or fair value approach is better
2. Inflation and other factors:-There might be some depreciable assets whose value changes due to change
in inflation and other economic factors. However, historical cost method only records it at cost at the time of
acquisition and gradually decreases its value by way of depreciation.Under this method those change in value
of the assets are not considered.
3.Goodwill and other in-house assets:-Under historical cost method when asset is recorded at historical cost, it
requires an evidence or document by which the the value is taken.This creates a problem for in-house assets
like goodwill which is created by the entity itself. As no such readymade value is available those kind of assets
are not recorded under the historical cost method.