Historical cost

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Historical cost is a fundamental principle of accounting. It is that no asset should ever be valued at more than its historical cost. However, the asset can be reduced if its value is impaired below the level of historical cost.

Consider a car dealership that buys a car from someone for $10,000. The dealer believes he can sell it for $12,000 but the car must be carried on his books for no more than $10,000. The dealer will not recognize (record in the books) any profit until it is realized.

Suppose the dealer buys another car for $8,000. He does so knowing he must spend $2,000 in repairs, but if he does so, he will be able to sell it for $12,000. He will first record the purchase for $8,000 and add the cost of repairs as they are incurred.

Let us suppose the repairs actually cost $5,000. If the best he can sell the car for is $12,000 than the car must be written down to that value.

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