Cost accounting makes it easy for small business owners to track the value of the assets on their books. A key element of this practice is the cost principle: the idea that you should value your assets based on what you initially paid for them, rather than their current market value. This will help you throughout
the accounting cycle, as you won’t need to repeatedly adjust the value of the assets on your balance sheet as they fluctuate through the year. And if any of that sounds confusing, don’t worry – just refer to our guide on the accounting equation! Now, let’s take a deeper look at the role the cost principle
plays on your balance sheet so that your small business accounting process is as seamless as possible. One of the underlying accounting principles, along with the
conservatism principle and the consistency principle, the cost principle states that your assets will be recorded on your small business’ books at whatever their cash value was at the time they were acquired. This means that the asset amounts recorded on your
financial statements will be their actual value, as opposed to their current market value. Why use the original acquisition cost of assets? For one, this will ensure that an objective and verifiable cost is recorded on the books. This will protect your small business in the event that the
market value of your asset drops below your original purchase price. Correct use of the cost principle will also lessen the burden of the accounting proceess on you as a small business owner! Win-win! Although the cost principle requires you to record the original acquisition cost of your assets, you will still need to factor in something called
depreciation for certain assets. In short, depreciation recognizes that the value of your long-term assets decreases over time. Let’s look at an example of this:
Some Issues with the Cost PrincipleThere are a few problems that come up when a small business owner applies the cost principle. If your company has any valuable logos or brand names, you wouldn’t be able to reflect their asset value on your balance sheet. Imagine a content creator, for example – there is an ‘intangible’ value to their brand. Use of the cost principle wouldn’t allow them to truly reflect the value of their small business in the event that they were looking to secure a loan, or raise new capital. Not exactly ideal – but exactly why small business accounting software exists! Short-Term vs Long-Term AssetsAnother key element of small business accounting is understanding the nature, or time-length, or the assets that you own. Luckily, small business accounting software makes this easy. Just remember the two essential asset categories that we described above – and stick to these two simple rules to eliminate any accounting challenges down the line:
ConclusionIt’s always smart to use small business accounting software that automates these processes. Luckily, products like TrulySmall make the user experience seamless. Trust in the best small business accounting software, so that you can focus on doing the work that led you to owning your own business in the first place! The cost principle is an accounting principle that requires assets, liabilities, and equity investments to be recorded on financial records at their original cost. Process your expenses and manage your company assets with Debitoor invoicing software. Try it free for 7 days. According to the cost principle, transactions should be listed on
financial records at historical cost – i.e. the original cash value at the time the asset was purchased – rather than the current market value. The cost principle is also known as the historical cost principle and the historical cost concept. The cost principle, appreciation, and depreciationIt is common for an asset’s price to diverge from its historical cost; however, because the cost principle specifies that financial records should not be adjusted, you should always follow specific processes to account for any changes. Appreciation is an increase in the value of an asset. Appreciation is treated as a gain and the difference in value should be recorded as ‘revaluation surplus’. For example, a company purchases an office for £100,000 in 2012. In 2018, the property is valued at £120,000. Rather than changing entries in accounting records to reflect the new market value, the difference in price should be credited to an equity account called ‘revaluation surplus’. Depreciation is the decrease in the value of an asset. There are several different ways to account for depreciation but, in general, depreciation is treated as a loss and is expensed throughout the asset’s useful life. For example, a laptop is purchased for £1,000. It expected to have a useful life of 5 years and a residual value of £200. The balance sheet continues to report the value of the laptop as £1,000, but £160 is expensed to a depreciation account each year of its useful life. Advantages and disadvantages of the cost principleThe cost principle is considered one of the fundamental guidelines for bookkeeping and accounting; however, it is fairly controversial. As such, accounting standards are starting to move away from the cost principle. According to critics of the cost principle, it's main disadvantage is lack of accuracy. Because assets appreciate and depreciate, financial records which follow the cost principle are unlikely to accurately reflect a business’s actual financial position. The cost principle also means that some valuable, non-tangible assets are not reported as assets on the balance sheet. For example, goodwill, brand identity, and intellectual property can add a lot of value to a business but, because they are built up over time, they do not have an initial purchase price to record on financial statements. On the other hand, advantages of the cost principle include:
Exceptions to the cost principleAccording to some accounting standards, particular assets, liabilities, and equity investments are exempt from the cost principle. For example:
What is the principle that assets should be recorded at their original cost to the company?The cost principle, also known as the historical cost principle states that assets should be recorded at their original cost, rather than their current market value. This is because, in many cases, the cost of an item is subjective and dependent on market conditions.
Which accounting principle states that purchase of assets must be recorded at its acquisition price?The historical cost principle states that a company or business must account for and record all assets at the original cost or purchase price on their balance sheet.
Which concept shows the value of assets at the cost of acquisition?A historical cost is a measure of value used in accounting in which the value of an asset on the balance sheet is recorded at its original cost when acquired by the company.
How is the cost principle recorded?The cost principle means items need to be recorded as the actual price paid. It is the same way when a buyer buys products, and the recording is done based on the price paid. In short, the cost principle is equal to the amount paid for each transaction.
|
