Homework Lance
TOPIC 4 DQ 1
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The historical cost approach is one of the basic principles used in business bookkeeping. It mainly focuses on recording an asset at its historical cost when initially purchased (Murray, 2021). In other terms, it requires an asset to be reported at its cash or the cash equivalent to the cost when it was initially purchased, including any other additional expenses incurred in ensuring the support was in the right place and is ready to be utilised. The use of the historical cost approach is not just good for accounting, but it’s mainly a standard that is supposed to be followed by public companies, that is, those companies that sell their stock on the public stock exchange. In the United States, the financial accounting standards board sets the standards called generally accepted accounting procedures (GAAP), which mainly uses the historical cost approach as the most appropriate principle.
The historical cost approach best values long-term assets on the balance sheet as it records the initial value of the asset without overstating its current deal due to various factors such as asset appreciation that may result from a volatile market (Tuovila, 2021). An example of using the historical cost approach will mainly be if one bought a car in 1970 and it was valued at $200,000, but now it’s valued at $500,000. On the other hand, asset depreciation has to be recorded to account for the wear and tear of long-lived fixed assets such as cars, buildings, and machinery. Depreciation will tend to be recorded regularly, and on the balance sheet, the annual depreciation is accumulated and recorded below the asset’s historical cost. This ensuresno overstatement of the asset’sactual value (Tuovila, 2021).
The fair market value is recorded in the balance sheet when using the historical cost approach, and the use of GAAP uses the golden market volume on the balance sheet to keep things straightforward. Thus, there will be no confusion between the fair market value and the price on the balance sheet. Companies or organisations tend to have balanced financial statements and balance sheets in compliance with GAAP. When they use the historical cost approach, they ensure that everything indicated on the balance sheet is compliant.
References
Murray, J. (2021). What Is the Historical Cost Principle? Why is it Important for My Business? The Balance Small Business. https://www.thebalancesmb.com/how-the-historical-cost-principle-affects-business-accounting-4158384
Tuovila, A. (2021). Historical Cost. Investopedia. https://www.investopedia.com/terms/h/historical-cost.asp
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