Definition: Historical cost or historical costing is the concept that assets should be valued based on their purchase price or the money actually paid for the assets. GAAPrequires that assets be reported on the balance sheet at historical cost.
What Historical Cost Mean?
Historical cost is the preferred method of valuing assets because it can be proven. It is easy for a company to look at the title of a piece of property and see what was paid for it. Other valuation or costing methods like replacement cost or current cost fluctuate with the market and economy. If these methods were used, the company would report the same piece of property at different values every year based on the market. This fluctuation violates the accounting concept or consistency.
Historical cost values don’t change from year to year, so the consistency concept is not violated. There are some problems with the historical costing method. For instance, it doesn’t take into consideration time value of money or inflation. The historical cost concept assumes that inflation is not relevant and only values assets based on the purchase price.
If Big Red Car, Inc. buys a piece of land for $10,000 in 1950 to build a car lot on it, BRC, Inc. would report the land on its 1950 balance sheet at $10,000. If BRC, Inc. still owns that land in 2015, it would still be presented on the balance sheet for $10,000 even though the land could be worth $100,000 in 2015 standards. This is one of the major short falls with the historical cost concept.