Changes

'''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.

'''Historical cost''' is a fundamental principle of [[accounting]].

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.

Under the principle, an asset should never be valued '''''above''''' its initial acquisition cost.  The acquisition cost, though, is not limited to only the purchase price; it can also include shipping costs, sales or use tax, and costs to install the item (for example, a piece of machinery).

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.

However, if the market value of the asset falls below its original cost, it should be reduced to market value, which may be zero in some cases.

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.

Although this is done on many assets through [[depreciation]] and [[amortization]], and in some cases when [[goodwill]] is impaired, it can also occur in other cases.  As an example, a company purchases 1,000 shares of stock at $25/share.  Under historical cost, the shares are valued at $25,000.  If at year end the stock price is $30/share, the shares are not revalued, but remain on the books at original cost.  However, if the shares fall to a drastically reduced level (such as to $5/share, due to underlying problems with the entity), where the likelihood of recovery to the original cost is small, then the company should record a reduction in value.

[[Category:Accounting]]

[[Category:Accounting]]