Fixed Assets and Historical Cost Principle

Fixed assets are long-term tangible assets that are used to generate income for a business. These assets include land, buildings, equipment, machinery, vehicles, etc. Fixed assets are recorded in the balance sheet of a company and are usually recorded at their original cost. The accounting concept that requires fixed assets to be recorded at cost without considering the market price is the Historical Cost Principle.

Explanation

The Historical Cost Principle requires that fixed assets be recorded at their original cost at the time of purchase. This means that the cost of acquiring the asset, including any expenses incurred to put the asset to use, such as installation, transportation, and legal fees, are recorded as the initial cost of the asset. This cost is used to calculate the depreciation of the asset over its useful life.

The Historical Cost Principle is based on the concept that the value of an asset is determined by the price paid to acquire it. This price is considered to be objective and verifiable, unlike market prices, which can fluctuate over time due to various factors such as supply and demand, inflation, and changes in economic conditions.

Advantages of Historical Cost Principle

The Historical Cost Principle has several advantages, including:

1. Objectivity: The cost of acquiring an asset is a concrete figure that can be easily verified, making it an objective measure of the asset's value.

2. Simplicity: Recording fixed assets at cost is a simple and straightforward method of accounting.

3. Consistency: Using the same accounting method for all fixed assets ensures consistency in financial reporting.

4. Reliability: The Historical Cost Principle provides a reliable measure of an asset's value, as it is based on an actual transaction.

Conclusion

In conclusion, the Historical Cost Principle requires fixed assets to be recorded at their original cost, regardless of the market price. This principle provides a simple, objective, and reliable method of accounting for fixed assets. Companies are required to disclose the depreciation method used in their financial statements and any changes in the method that may affect the financial statements.