Cost Principle

Introduction

It is one of the important accounting principles and is the basis of many accounting requirements set out in either of generally accepted accounting principles or alternatively International financial reporting standards. The cost principle requires that the elements of the financial statements that is assets, liabilities or the investments should be reported and valued at the historical cost at the time of their acquisition and recognition. In the recent developments of the accounting standards, cost principle has been significantly replaced by the fair value.

Explanation

The application of the cost principle can be effectively observed in relation to the acquisition of the certain plant asset. The asset would be recognized at the outright purchase price in the books of the organization. This is referred to as the cost model in the international accounting standard # 16. Let’s say the asset has the useful life of the 10 years and the organization finds it reasonable to depreciate the same using the straight-line depreciation method. In the absence of the salvage value, the outright purchase price would be depreciated over the 10 years time period.

Adjustments to the Cost

The cost that would be capitalized increases if the plant asset has appeals non-refundable taxes and duties in addition to the handling and installation charges. The cost principle requires to include all such costs in the cost of the asset being acquired. When the cost is adjusted for the duties and costs, the depreciable amount is again computed by subtracting the salvage from the total cost recognized. The depreciation expense would then be computed as per the management policy of recongisation of the depreciation expense. The opposite to the cost principle (cost model) is the revaluation model which requires the specific plant asset to be checked if there is an increase in its value as a result of the active market.

Intangible assets and the cost principle

The international financial reporting standards require that brand names that are acquired and purchased can be recognized at the cost likewise the plant assets however the brand names that are internally generated cannot be recognized as such.

When It is appropriate to switch to the Fair value

There must be active market along with the quotes prices for the asset that is considered for the option of valuing on the fair value. For example, the equity investment of the company that comprises of the shares that have active trading on the recognized stock exchange market. In such a case, it is appropriate to value the investment at the fair value instead of the historical cost and the cost principle may be departed.

Conclusion

The cost principle requires that the elements of the financial statements that is assets, liabilities or the investments should be reported and valued at the historical cost at the time of their acquisition and recognition. In the recent developments of the accounting standards, cost principle has been significantly replaced by the fair value. The application of the cost principle can be effectively observed in relation to the acquisition of the certain plant assets as well as the brand names and other intangible assets. When any asset has an active market, it is  a  approach to switch to the fair value model from the cost principle model.