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Business Accounting and Bookkeeping
What is Advantage and disadvantage of the historical cost principle?
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What is Historical cost principle?
The historical cost principle is an accounting principle that requires transactions and economic events to be valued in the financial statements at the actually dollar amounts involved when the transaction or economic event took place. For example if the market price of a teddy bear is $5.00 but you are able to bargain your way into getting it for $4.50, the historical cost principle requires that you record the teddy bear at $4.50.
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What are the advantage on historical cost accounting?
The main advantage of using historical cost on the balance sheet for property, plant and equipment is that historical cost can be verified. Generally, the cost at the time of purchase is documented with contracts, invoices, payments, transfer taxes, and so on. The historical cost of plant and equipment (not land) is also used to determine the amount of depreciation expense reported on the income statement. The accumulated amount of depreciation is also reported as a deduction from the assets' historical costs reported on the balance sheet. (In the case of impairment, some assets might be reported at less than the amounts based on historical cost.) The use of historical cost is also a disadvantage to those users of the financial statements who want to know the current values.