Historical Cost

Historical Cost: Definition, Principle, and How It Works

Overview

Historical cost is an accounting measurement that records an asset on the balance sheet at its original purchase price, including any costs necessary to prepare the asset for use. It is a foundational concept in U.S. generally accepted accounting principles (GAAP) and supports conservative financial reporting by preventing the overstatement of asset values due to volatile market appreciation.

Key points

• Most long-term assets are recorded at historical cost.
• Historical cost includes purchase price plus costs to acquire and prepare the asset for use.
• Depreciation and accumulated depreciation reduce an asset’s net book value from its historical cost.
• Certain assets (e.g., marketable securities and impaired intangibles) are reported at fair value instead of historical cost.
• Historical cost aligns with the conservatism principle in accounting.

What is historical cost?

Historical cost is the cash or cash-equivalent amount paid to acquire an asset at the time of purchase. That recorded amount remains on the balance sheet even if the asset’s market value changes. For example, if a company bought a headquarters for $100,000 in 1925, the building (and land) would still be reported at that historical cost on the books, even if its current market value is much higher.

How historical cost is used

Under GAAP, fixed assets and most inventory are recorded at historical cost. Inventory is commonly reported at the lower of cost or market, so declines in market value can result in write-downs. Marketable securities held for trading or available-for-sale, and certain impaired assets, are instead reported at fair value (mark-to-market).

Calculating historical cost

Historical cost = purchase price + costs necessary to bring the asset into service.
Examples of added costs:
* Transportation and handling
* Installation and assembly
* Legal or title fees required to acquire the asset

Depreciation and accumulated depreciation

Long-lived tangible assets (buildings, machinery, vehicles) are depreciated over their useful lives to reflect wear and tear. Depreciation expense accumulates as accumulated depreciation and is subtracted from the historical cost to produce the asset’s net book value. This prevents overstating asset values and matches expense recognition to the period of use.

Asset impairment

Impairment occurs when an asset’s fair value falls below its carrying amount (net book value). Impairment write-downs reduce the asset’s carrying value and impact profit in the period the impairment is recognized. Intangible assets, such as goodwill, must be tested for impairment (often annually) and written down if their recoverable amount is below carrying value.

Mark-to-market (fair value) vs. historical cost

Mark-to-market accounting records assets at current market value, allowing the reported value to change with market conditions. This approach is useful for highly liquid or held-for-sale assets (for example, trading securities), because it provides a clearer picture of what would be received if the asset were sold immediately. Historical cost, by contrast, records the original purchase price and is less volatile.

Conservatism principle

The conservatism principle advises choosing accounting methods that avoid overstating assets or income. Historical cost supports this principle by anchoring asset values to verifiable transaction prices rather than potentially fluctuating market estimates.

Common questions

• What’s the difference between historical cost and fair market value?
  Historical cost is the original purchase price at acquisition. Fair market value is the asset’s current estimated selling price.
• Which assets are not recorded at historical cost?
  Marketable securities held for trading or available-for-sale and impaired intangible assets are commonly recorded at fair value.
• How does historical cost affect gains or losses on disposal?
  Gains or losses are determined by comparing the proceeds from disposal to the asset’s historical cost less accumulated depreciation (its net book value).

Bottom line

Historical cost is a core accounting method that records assets at their purchase price, fosters conservative reporting, and simplifies verification. While appropriate for most fixed assets, fair value measurement is required or preferred for certain liquid or impaired assets to reflect current market conditions.