Historical Cost

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The Framework of International Accounting Standards Board (IASB) defines historical cost as “A measurement basis according to which assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition. Liabilities are recorded at the amount of proceeds received in exchange for the obligation, or in some circumstances (for example, income taxes), at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business.”

Historical cost is a basis of measurement of elements of financial statements. Measurement is the process of determining the monetary amounts at which the elements of the financial statements are recognized and carried in the balance sheet and income statement. Usually four bases of measurement are used (1) Historical cost, (2) Current cost, (3) Realizable value, and (4) present value.

Historical cost is the most commonly used basis of measurement from these bases. It is usually used in combination with other measurement bases. For example, inventories are usually carried at the lower of cost and net realizable value, on the other hand marketable securities are usually carried at market value, and entities prefer to carry pension liabilities at their present value.

The disadvantage of the historical cost model is that it cannot deal with the effects of changing prices of non-monetary assets. Therefore, some entities prefer to use the current cost basis instead of the historical cost model.

The main advantage of the historical cost model is its simplicity and certainty. Most companies know what they paid for the assets when they purchased them. Similarly, they know what proceeds they received in exchange for their obligations. Historical cost is a very objective method because it usually does not involve subjective estimates.

The main disadvantage of this method is that the book values may be based on very outdated costs. This becomes more of a problem during periods of high inflation. Therefore, historical cost generally does not reflect the current market or fair value of an asset or liability.

When accountant should use historical cost according to IFRS?

According to International Financial Reporting Standards (IFRS), historical cost is the cost at which an asset was originally acquired. Under certain circumstances, historical cost may be used to measure certain assets, such as property, plant and equipment and inventories.

IFRS permits the use of historical cost for property, plant and equipment if the asset is not revalued or if there is no active market for the asset. Inventories may also be measured at historical cost if cost is not materially different from fair value. In addition, certain financial instruments, such as investments in equity instruments that do not have a quoted market price, may also be measured at historical cost.

In general, historical cost is used when the fair value of an asset cannot be reliably determined or when fair value would not provide useful information about the value of the asset. The use of historical cost is considered appropriate when fair value cannot be measured reliably or when fair value would not provide useful information about the asset's value.

If an entity is already using historical cost, can it switch to fair value?

Yes, an entity can change from using historical cost to fair value, but it must follow the specific requirements and guidance in IFRS.

IFRS allows companies to change their accounting policy if it provides reliable and more relevant information. However, when an entity changes an accounting policy, it must apply the new policy retrospectively unless it is impracticable to do so. Retrospective application means restating the financial statements of prior periods as if the new policy had always been applied.

When an entity changes from historical cost to fair value, it should provide a reconciliation of the carrying amounts of the affected assets and liabilities in the financial statements for previous periods and the effect of the change on the entity's income statement and other comprehensive income.

It's important to note that fair value measurement is considered more appropriate for assets and liabilities that are expected to be sold or settled in the near term and for assets and liabilities with a volatile fair value. Therefore, it's not always appropriate for all of an entity's assets and liabilities to be measured at fair value.

Quote lauraine, 17 January, 2013
for my understanding a present value is a measurement technique that can be applied to make estimates under several of the above measurement bases. can you please explain how it can be consider as a measurement basis? and if we can add the fair value and the value in use to the list of measurement bases?
kind regards
Quote Guest, 17 April, 2018
if we are concerned with purchasing of soaps and packing , labling them and selling in market . that is the cost of packing is not directly paid but we are concerned with doing so. my question is that will this cost of packing will be regarded under historical costs????

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