Cost concept of accounting
The cost concept of accounting states that all acquisition of items (such as assets or things needed for expending) should be recorded and retained in books at cost. Thus, if a balance sheet shows an asset at a certain value it should be assumed that this is its cost unless it is categorically stated otherwise.
Under this concept, an asset should be recorded on its cost in which it was purchased regardless of its market value e.g. If a building is purchased for $5,00,000, it will continue to appear in the books at that figure irrespective of its market value. Under this concept stability in prices of assets while recording is achieved. There are also some limitations of this concept e.g. in case of inflation there will be an overstatement of net profit etc. Above all its limitations this concept is considered to be the best one when compared with alternatives.
The cost of an item may well be different from its true value but since ascertainment of true value would be judgmental and therefore subjective, stating assets at historical cost is generally accepted as fairway of maintaining records.
Following the cost concept means that unless there are special reasons for doing otherwise cost of an item should be assumed to be its true value and that all accounting entries should be made at cost.
For example, a business buys a building worth $1,00,000 in cash. In the accounting records, the value of the building will be entered at its cost price, i.e. $1,00,000. After four years, the value of the building goes up to $5,00,000. However, the accounting records would continue to show the value of the building at the cost price of $1,00,000 less depreciation.
Historical cost is verifiable. It represents the cost that was objectively agreed upon the buyer and the seller. Hence the basic objective of the cost concept is the measurement of accurate and reliable profits and losses for a business over a period of time. However, some accountants have argued that in today’s inflationary environment, the gaining popularity, as is evidenced by many large companies, who now prepare supplementary information after taking into account the changes in the purchasing power. Nevertheless, historical cost continues to be used for the preparation of the primary financial statements.