Historical Cost: Definition, Principle, and How It Works

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Corporate Finance

Accounting

By
Alicia Tuovila
Updated May 22, 2022

Reviewed by
Margaret James
Fact checked by
Yarilet Perez

Investopedia / Joules Garcia

What Is a Historical Cost?

A historical cost is a measure of value used in accounting in which the value of an asset on
the balance sheet is recorded at its original cost when acquired by the company. The
historical cost method is used for fixed assets in the United States under generally
accepted accounting principles (GAAP).

Key Takeaways

Most long-term assets are recorded at their historical cost on a company's balance
sheet.

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 Historical cost is one of the basic accounting principles laid out under generally
accepted accounting principles (GAAP).
Historical cost is in line with conservative accounting, as it prevents overstating the
value of an asset.
Highly liquid assets may be recorded at fair market value, and impaired assets may
be written down to fair market value.

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Historical Cost

Understanding Historical Costs

The historical cost principle is a basic accounting principle under U.S. GAAP. Under the
historical cost principle, most assets are to be recorded on the balance sheet at their
historical cost even if they have significantly increased in value over time. Not all assets
are held at historical cost. For example, marketable securities are recorded at their fair
market value on the balance sheet, and impaired intangible assets are written down from
historical cost to their fair market value.

Valuing assets at historical cost prevents overstating an asset's value when asset
appreciation may be the result of volatile market conditions. For example, if a company's
main headquarters, including the land and building, was purchased for $100,000 in 1925,
and its expected market value today is $20 million, the asset is still recorded on the
balance sheet at $100,000.

Asset Depreciation
Furthermore, in accordance with accounting conservatism, asset depreciationmust be
recorded to account for wear and tear on long-lived assets. Fixed assets, such as buildings
and machinery, will have depreciation recorded on a regular basis over the asset's useful
life. On the balance sheet, annual depreciation is accumulated over time and recorded
below an asset's historical cost. The subtraction of accumulated depreciation from the
historical cost results in a lower net asset value, ensuring no overstatement of an asset's
true value.

Asset Impairment vs. Historical Cost

Independent of asset depreciation from physical wear and tear over long periods of use,
an impairment may occur to certain assets, including intangibles such as goodwill. With
asset impairment, an asset's fair market value has dropped below what is originally listed
on the balance sheet. An asset impairment charge is a typical restructuring cost as
companies reevaluate the value of certain assets and make business changes.

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For example, goodwill must be tested and reviewed at least annually for any impairment.
If it is worth less than carrying value on the books, the asset is considered impaired. If it
has risen in value, no change is made to historical cost. In the case of impairment, the
devaluation of an asset based on present market conditions would be a more conservative
accounting practice than keeping the historical cost intact. When an asset is written off
due to asset impairment, the loss directly reduces a company's profits.

Mark-to-Market vs. Historical Cost

The mark-to-market practice is known as fair value accounting, whereby certain assets are
recorded at their market value. This means that when the market moves, the value of an
asset as reported in the balance sheet may go up or down. The deviation of the mark-to-
market accounting from the historical cost principle is actually helpful to report on held-
for-sale assets.

An asset's market value can be used to predict future cash flow from potential sales. A
common example of mark-to-market assets includes marketable securities held for
trading purposes. As the market swings, securities are marked upward or downward to
reflect their true value under a given market condition. This allows for a more accurate
representation of what the company would receive if the assets were sold immediately,
and it is useful for highly liquid assets.

What Is Historical Cost?

Historical cost is the price paid for an asset when it was purchased. Historical cost is a
fundamental basis in accounting, as it is often used in the reporting for fixed assets. It is
also used to determine the basis of potential gains and losses on the disposal of fixed
assets.

What Is the Difference Between Historical Cost and Fair Market

Value??
Historical cost is the cash or cash equivalent value of an asset at the time of acquisition.
Fair market value is the current value of that asset. Imagine if someone were to have
purchased an acre of land 10 years ago for $10,000 and that land is now worth $20,000.
The historical cost is $10,000, and the fair market value is $20,000.

How Are Historical Costs Used in Accounting?

GAAP requires that certain assets be accounted for using the historical cost method. Fixed
assets are recorded at their cost at the time of purchase. Inventory is also usually recorded
at historical cost, though inventory may be recorded at the lower of cost or market.

How Do I Calculate Historical Cost?

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Historical cost is often calculated as the cash or cash equivalent cost at the time of
purchase. This includes the purchase price and any additional expenses incurred to get
the asset in place and prepared for use.

What Is the Conservatism Principle?

The conservatism principle in accounting dictates that estimates, uncertainty, and
financial record-keeping should be done in a manner that does not intentionally overstate
the financial health of an organization. Historical cost is one way of adhering to the
conservatism principle, as companies must report certain assets at cost and have a more
difficult time exaggerating the value of the asset.

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