Good Day,

If possible, could some one please explain in detail the pros and cons of the Historical Cost Principle and how it can be good for business recording and how it can be a problem in regards to selling a business. In addition would utilizing the GAAP or the International Finance Accounting Standard Board be more useful. I am new to accounting and a pretty good overview on this topic.

I have developed the following answer to my question above, is it possible if you can tell me if I am answering this correctly?

My answer.

Discuss the drawbacks of recording assets in the books of account following the historical cost principle.

According to text, Historical cost states, that assets should be recorded at their actual cost, measured on the date of the purchase as the amount of cash paid plus the dollar value of all non-cash consideratives (other assets, privileges, or rights) also given in exchange." (Harrison, Horngren, & Thomas, 2013)

In essence, the historical cost is a rule established in accounting that requires one to list all assets (valuables, equipment, property, land, resources, supplies, etc.) at their original cost, at the date of purchase, onto the balance sheet. All assets listed onto the balance sheet must faithfully represent (must be accurately recorded and present an error free picture of the transaction taken place on the day of business) the business conducted on that day.

The historical cost principle represents the original transaction of the asset and is considered reliable. Reliable in terms of its purchase history, however, the historical cost (original cost) of the asset does not represent the current value of the asset.

For instance, If John purchased property on October 11, 1982 for $10,000. $10,000 would be recorded onto the balance sheet. In 2017, John still owns the property and decides he'd like to know what the value of the property is as of today's date (fair value); John has the property appraised and the property value has increased (35 years) and is now worth $50,000. Because John still owns this property, the original cost of $10,000 would still be recorded.

The original cost ($10,000) of the land presents a true reflection of the business transaction that took place in 1982. Although it has increased in value, the new fair value would not be recorded onto the balance sheet because it consist of estimates and opinions.

Studies have shown that the General Accepted Accounting Principles (GAAP) require that all owners report all historical cost principle. The drawback to recording assets onto the books of accounting following the historical cost principle because the information recorded is unreliable and presents a bias presentation of the balance sheet.

Harrison, W. T., Horngren, C. T., & Thomas, C. W. (2013). Financial accounting. Boston: Pearson.