Why Are Assets Recorded at Historical Cost?

August 1, 2023

Many companies use the historical cost principle when remeasuring nonmonetary assets. Thus, items are reported using the exchange rate in effect at the time of acquisition rather than their current market value. This approach provides a very conservative but easy-to-prove picture of an organization. Why are assets recorded at historical cost? 

What is the historical cost?

Historical cost is a fundamental measure of value used in accounting, in which the value of an asset is recorded at the price paid when the company purchased it. Historical cost accounting has certain advantages: 

  • It provides a consistent and reliable basis for accounting, making reporting of financial performance to stakeholders easier and providing a clear audit trail for transactions.  
  • It improves financial statement accuracy, simplifying financial statement comparison across different periods and companies for enhanced decision-making. 
  • It prevents overstating the value of an asset.

What is the historical exchange rate in accounting? 

Exchange rates involve the price of one currency in terms of another, fluctuating on a real-time basis according to supply and demand. The historical exchange rate is the one in effect when an asset or liability is acquired, as opposed to the current exchange rate, which bases currency translation on present market conditions and changes.  

Historical cost vs fair value

Both fair value and historical cost accounting are methods used to record an asset’s price or value. Specifically, fair value is based on assets’ current market rate, which means that market shifts may lead their value as reported in the balance sheet to increase or drop, while historical cost uses the original price paid, therefore not reflecting the true value of assets and liabilities. When assets are recorded at historical cost, not market value, there are certain limitations: 

  • It doesn’t indicate an asset’s current value. 
  • It doesn’t account for inflation and deflation. 
  • It is not a reliable indicator of a company’s ability to continue to perform at a specific level, because its assets are undervalued.  

Indeed, certain types of assets should be recorded using fair value instead of historical cost 

  • Highly liquid assets, including debt or equity investments, must be recorded at their current market value. 
  • Accounts receivable must be displayed at their net realizable value, which is the amount to be collected once a company’s debt is settled. 

Handling the difference between historical cost and value

Although the historical cost principle helps to ensure compliance with accounting standards such as the Generally Accepted Accounting Principle (GAAP) and the International Financial Reporting Standards (IFRS), it requires certain adjustments over time. Why? 

  • The more time that has passed since the original purchase date, the less accurate it is as a value measure.  
  • It is static and does not change even if the asset gains value.  

Nevertheless, there are solutions that may help in this regard, such as Talentia Asset Management software, which can improve the management of fixed assets by automating their entire lifecycle, providing a global vision and real-time monitoring. Moreover, if you require a comprehensive solution, Talentia Financial Suite will allow you to benefit from improved interactivity across finance departments.