Principle of historical cost in accounting | Definition and specific examples

The historical cost principle in accounting is an important factor that helps companies accurately assess their financial situation and make appropriate business decisions. In this article, 1C Vietnam will present detailed information related to the historical cost principle, including definitions, specific examples and effective applications in accounting.

1. What is the historical cost principle in accounting?

Original price is the purchase price or cost of an asset, commodity or product. The historical cost principle is one of seven principles applied in the Vietnamese accounting regime. So what exactly is the original cost principle in accounting?

1.1. Definition of cost principle

The historical cost principle is an accounting principle that requires assets to be recorded at their actual purchase price, including costs associated with acquiring and putting the asset into use. The cost of the asset can be determined by the amount paid, by an equivalent amount, or by the fair value of the asset at the time of recognition.

1.2. The importance of the cost principle

The historical cost principle is one of four basic financial reporting principles used by all accounting professionals and businesses. This principle is important for those who read a balance sheet or analyze a company's books (records).

• Reliable: The cost principle is an objective measure of the actual cost of the asset. This type of price is not affected by changes in market prices, avoiding unnecessary fluctuations in financial statements.
• Comparable: The historical cost of similar assets can be compared easily, which helps managers' decision making.
• Verifiable: The historical cost principle in accounting can often be verified by documents such as invoices and vouchers. This is a favorable condition that allows ensuring the accuracy of financial reports.

1.3. Example of cost principle

To clearly understand the historical cost principle in accounting, refer to the specific example below:

On January 20, 2024, company A purchased 1 fixed asset X to serve the business management department. Purchase price without tax is 130 million VND. Shipping cost 20 million includes tax, installation cost 14 million includes tax. However, as of January 27, 2024, the market value of that fixed asset is 170 million VND.

So according to the original cost principle, the price of fixed asset depending on market fluctuations although the value of fixed asset X later increased to 170 million VND according to market fluctuations.

2. Formula for calculating original cost according to accounting principles

The original price of the asset is calculated according to the following formula:

Original price = Purchase price according to invoice + Taxes + Directly related costs - Discounts and discounts (if any)

In particular, directly related costs are costs incurred to bring the asset into a ready-to-use state, including:

• Site preparation costs.
• Initial shipping and handling costs.
• Installation and test running costs (except for product recalls and scrap due to test runs).
• Upgrade costs.
• Registration fee (for cars).
• Expert fees and other directly related costs.

3. Apply the principle of historical cost in accounting

The historical cost principle is one of the basic accounting principles stipulated in Vietnamese Accounting Standards VAS No. 1. This principle stipulates that assets must be recorded at their original cost, including purchase price, expenses, and costs. Transportation costs, installation costs, etc. The original price of the asset cannot be changed unless otherwise specified in specific accounting standards.

According to the principle of original cost, when an enterprise incurs an economic transaction to purchase fixed assets, tools or raw materials, the value of these accounting objects is determined and recorded at their original cost. , not updated according to fluctuating market value.

For example, if a business buys a car for 1 billion VND, the value of that car will be recorded on the balance sheet as 1 billion VND, regardless of market price fluctuations. that car.

4. Compare the principle of original price and market price

Historical cost and fair market value are two important concepts in accounting, used to value assets and liabilities.

Historical cost is the value of money or cash equivalents that a business paid to purchase an asset. This value is recorded on the business's financial statements and does not change over time, even if the market value of that asset increases or decreases.

Market price is the value for which an asset could be sold in a normal transaction between well-informed and willing market participants. This value may change over time, reflecting current market conditions.

For example, a business buys a plot of land for 100 million VND in 2022. If the market value of this land in 2024 increases to 200 million VND, then the fair market value is 200 million VND. However, the original price of this land is still 100 million VND.

The historical cost principle in accounting plays an important role in ensuring the honesty, objectivity and consistency of information. This principle helps managers accurately evaluate the financial and economic situation of the enterprise. To support the financial management and accounting process, businesses today look for comprehensive management software, typically 1C:Company Management software. This is a smart and comprehensive business management solution, which highlights the features of controlling income and expenditure, tracking loans and automatically calculating the amount of profit and loss that needs to be paid in each period. Contact 1C Vietnam immediately for advice!