- Accounting rules state that transactions should only be recorded in the books at historical cost
- We call this rule the historical cost convention
- A convention is another name for a rule
- The Historical Cost Convention is a principle in accounting that states that assets and liabilities should be recorded at their original cost, rather than their current market value. This principle is based on the idea that historical cost is a more reliable and objective measure of an asset’s or liability’s value.
The following are the key points of the Historical Cost Convention:
- Assets and liabilities are recorded at their original cost, not their current market value.
- Cost includes all expenses incurred to acquire the asset or assume the liability.
- The cost is adjusted for inflation.
- The value of the asset or liability is not re-evaluated unless it is sold or retired.
- A company purchases a piece of equipment for $100,000. The equipment is recorded on the company’s balance sheet at $100,000, even if the equipment’s market value has increased or decreased since the purchase.
- A company borrows $1,000,000 from a bank. The liability is recorded on the company’s balance sheet at $1,000,000, even if interest rates have changed since the loan was taken out.