Historical Cost
Candlefocus EditorUnder Generally Accepted Accounting Principles (GAAP), assets should be recorded at their historical cost. This not only creates transparency in the accounting records, but it also helps in preventing the overstatement of asset values, as it does not factor in market trends and other external factors that may suggest a higher value for an asset. Particularly, this technique is utilized for long-term assets and non-liquid assets as they don't turnover as frequently as other assets.
An important fallacy linked to Historical Cost is that it can be too conservative and yield inaccurate financial records. It is understood that inflation and macroeconomics could affect the value of an asset, and if not taken into consideration can result in an asset being over or undervalued by a large margin. To counter this, companies might choose to adjust an assets value if it has been held for a long period of time and its current market value is significantly higher to its Historical Cost.
It is also important to note that several assets may be valued at fair market value and not at their Historical Cost. For example, highly liquid assets such as cash, accounts receivable and inventories values may change often and thus should be recorded based on the current market rate on the balance sheet, rather than at their original Historical Cost. On the other hand, impaired assets may also be written down from their original Historical Cost to reflect the current market rate.
In conclusion, Historical Cost is an accepted method of valuing assets, following the principle of conservative accounting. It includes all costs associated with an asset, excludes any costs that would impair the asset, does not factor in market trends, and is mostly used for long-term or non-liquid assets. It is also important to note that in some cases assets can be revalued at fair market rate or be written down from its original Historical Cost, to represent the current value of the asset.