Explain The Preferred Use Of Historical Cost As The Basis Fo

Explain The Preferred Use Of Historical Cost As The Basis For Recordin

Explain the preferred use of historical cost as the basis for recording property and equipment and intangible assets as provided by our authors. Minimum requirements include a 3-page APA 7 formatted paper with a title page, content page, and reference page, using the APA 7 Format Made Simple template. The content should be substantial and meet the minimum content requirements specified by the instructor.

Paper For Above instruction

The historical cost principle is a fundamental concept in accounting which asserts that assets should be recorded at their original purchase price. This valuation method has been widely adopted because of its simplicity, reliability, and objectivity, making it the preferred basis for recording property, equipment, and intangible assets. This essay explores the reasons why historical cost is favored in accounting practices, particularly in relation to property, plant, and equipment (PP&E), as well as intangible assets, and discusses its advantages and limitations.

Historical cost is defined as the original monetary amount paid to acquire an asset at the time of purchase. This includes the purchase price plus any additional costs necessary to bring the asset into usable condition, such as transportation, installation, and testing costs (Warren, Reeve, & Duchac, 2019). The use of historical cost as a valuation measure is rooted in its objectivity and verifiability, which are critical for ensuring consistent financial reporting. Since the purchase transaction is supported by documentation such as invoices and contracts, the reported value is based on actual, rather than estimated, figures.

One of the primary reasons for the preference of historical cost is its reliability. Because it is based on actual transactions, the recorded value is verifiable and not subject to bias or subjective judgments, unlike fair value assessments that may fluctuate based on market conditions. This reliability favors the use of historical cost for property and equipment, which tend to be held for long periods and are not frequently revalued. The stability of recorded values aids in providing consistent, comparable financial statements across periods, which is essential for stakeholders such as investors, creditors, and regulators (Kieso, Weygandt, & Warfield, 2020).

Another advantage lies in the simplicity of the historical cost approach. It is straightforward to implement since it involves recording assets at their initial purchase price. Changes in market value resulting from inflation, deflation, or market fluctuations are not reflected unless a specific impairment occurs, which companies must recognize if the asset’s carrying amount exceeds its recoverable amount (International Accounting Standards Board [IASB], 2020). This simplicity reduces complexity in accounting processes and limits subjective judgments, thus decreasing the potential for manipulation or error.

Furthermore, historical cost provides comparability across firms and time periods. Since assets are recorded at their original cost, financial statements from different companies or periods can be analyzed and compared more easily, facilitating investment decisions and financial analysis. This comparability is especially important in capital-intensive industries where property, plant, and equipment constitute significant portions of assets (Blake, 2018).

However, critics argue that historical cost may not always represent the current value of assets, especially in times of significant inflation or deflation. Assets like property may appreciate considerably over time, but their recorded value remains static. This discrepancy might distort a company’s financial position, potentially leading to undervaluation of assets and overstatement of income when assets are subsequently disposed of or revalued (Khan & Jain, 2017). Nevertheless, many accounting standards, such as U.S. GAAP and IFRS, incorporate rules for impairment and revaluation of assets when necessary, though revaluation is often limited to specific asset types like investment properties.

The preference for historical cost also extends to intangible assets, such as patents or trademarks, which are initially recognized at their acquisition cost. These assets often lack active markets or observable prices for subsequent revaluation, making valuation at acquisition cost the most practical and justifiable approach. The use of historical cost ensures consistency in recognizing and reporting intangible assets, although amortization and impairment are required to reflect their consumption or potential declines in value over time (Chen & Su, 2021).

In conclusion, the historical cost principle remains the preferred method for recording property, equipment, and intangible assets due to its objectivity, reliability, simplicity, and comparability. While it does not always reflect the current market value, its verifiability and consistency make it a practical and widely accepted basis for financial reporting. Nevertheless, recognizing the limitations of historical cost, accounting standards provide mechanisms for impairment and revaluation, ensuring that financial statements present a fair view of an entity’s financial position.

References

• Blake, J. (2018). Accounting principles and financial statement analysis. Journal of Financial Reporting, 12(3), 45-59.
• International Accounting Standards Board (IASB). (2020). Conceptual Framework for Financial Reporting. IASB.
• Khan, M. Y., & Jain, P. K. (2017). Financial Management. Tata McGraw-Hill Education.
• Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2020). Intermediate Accounting (16th ed.). Wiley.
• Chen, S., & Su, Z. (2021). Intangible assets recognition and measurement: An accounting perspective. Accounting Horizons, 35(2), 133-147.
• Warren, C. S., Reeve, J. M., & Duchac, J. (2019). Financial Accounting (14th ed.). Cengage Learning.