Historical Cost Convention FAQs
The Historical Cost Convention is an accounting concept that states that assets and liabilities should be reported on a company's balance sheet at their original cost, regardless of any changes in value. This method of valuation ensures consistency in financial reporting by allowing companies to compare current asset values with historical costs over time.
The Historical Cost Convention requires companies to value assets and liabilities based on their original purchase or acquisition price. This includes all related costs such as transportation, installation, and legal fees associated with acquiring the asset or liability. In addition, this convention also requires companies to adjust the value.
One of the main advantages of using the Historical Cost Convention is that it provides a reliable and consistent standard for valuing assets and liabilities across different companies. This makes it easier to compare financial statements between different companies. Furthermore, this convention provides a more accurate picture of a business’s historical performance as opposed to relying on estimated values.
One potential downside of using the Historical Cost Convention is that assets and liabilities may not be accurately reflective of their current market value. As such, it may be difficult for investors and other stakeholders to assess a company’s true financial health and performance.
Yes, one alternative method of valuing assets and liabilities is the Current Value Method. Under this method, companies value assets and liabilities based on their current market value rather than their original cost. This makes it easier to assess a company’s financial health in real-time. However, this method also requires more frequent adjustments to ensure accuracy.
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.