Judul : Historical Cost
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Historical Cost
Historical costs are original costs incurred in the past to acquire assets.
The convention of historical costs states that assets must be recognized at the cost when they are purchased.
Explanation
Assets must be rated in accounting books.
Should assets be recognized at historical costs, market values, replacement values or the value of their potential business?
Historical costs are clearly the most objective, reliable and verifiable values.
The convention of historical costs requires assets to be recorded at their historical value unless it is wiser to rate them lower (for example due to impairments).
Historical costs are the default values attributed to assets.
Example
This machine was acquired 5 years ago worth 10,000.
New machines with the same specifications are worth 40,000 today due to inflation.
The current market value of the machine in its current condition is 6,000.
The machine is depreciated using a straight-line basis for the useful life of 10 years.
Using historical cost conventions, what is the value of the machine net book today?
Solution
Net book value = cost - accumulated depreciation
= 10,000 - (10,000 x 5/10)
= 5,000
Machine Value uses a historical cost of 10,000.
Replacement value (i.e. 40,000) and fair value (i.e. 6,000) cannot be considered in the valuation.
Exception
The history of convention fees does not apply to certain types of assets such as financial instruments (eg cash, accounts receivable, investment in shares).
A number of assets that are generally valued at historical costs (such as property) may be valued at different times (for example, market values) if certain conditions are met (for example, the market value of assets that can be determined reliably and available).
IFRS and PSAK provide specific guidance on evaluating different types of assets.
Limitations
The main limitation of historical costs is relevance.
The basis of historical accounting costs fails to take into account the exact economic costs of using assets.
This effect uses the basis of historical costs as an example.
Company A bought a $ 100,000 factory on January 1, 2006, which has a 10-year useful life.
Company B bought a similar factory for $ 200,000 as of December 31, 2010.
Depreciation used by the straight-line method.
At the end of the reporting period on December 31, 2010, company B's balance sheet will show a fixed asset of $ 200,000 while financial report A will show a $ 50,000 asset (net depreciation).
The above scenario presents an accounting anomaly. Even though factories are presented in financial statements A is able to produce economic benefits worth 50% compared to company B. This is done at historical costs which are only equal to 25% of its value.
In addition, depreciation fees charged on A financial statements (i.e. $ 10,000 p.a.) do not reflect the opportunity cost of factory use (i.e. $ 20,000 p.a.). As a result, during the useful life of the asset, it will incur a depreciation of $ 100,000 in the financial statements despite the fact that the cost of maintaining the productive capacity of assets will continue to increase.
If company A distributes all profits as dividends, it will not have enough resources to replace the existing plant at the end of its useful life. Therefore, the use of historical costs can result in reports of profits that are not sustainable in the long term
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