Historical cost is a term that is used to describe the original cost associated with a given purchase or project. This figure is presented in the same terms as at the time of the purchase, and is not adjusted for inflation or any other contributing factor. Historical cost accounting is a method that is used in many business situations, although there are financial analysts that find relatively little value in approaching the true value of any economic item from this perspective.
One benefit to the historical cost is that it provides a beginning point to determine what effect inflation and other shifts in the economy have had on the value of the item under consideration. By comparing the current market value of the item with the historical cost, it is possible to quickly determine if depreciation has occurred, rendering the item of less value than it was at the time of purchase. At the same time, this comparison makes is easy to identify any increases in the true value of the item, even if successive periods of recession and inflation have take place since the acquisition.
In many accounting formulas, the historical cost of minor holdings is usually the same as the market value, as not attempt is made to adjust the value based on inflation or other factors. The same is true with any asset that has not been affected in a positive or negative way by changing economic conditions. Unless some significant shift in market value has taken place, there is simply no reason to go through the effort of evaluating the degree of change and updating the books accordingly.
There are a number of formulas used to adjust the historical cost and thus arrive at a figure that is thought to represent the true value of a given asset. Some are relatively simplistic and require nothing more than comparing the current market value with that original cost and adjusting the line item on the balance sheet accordingly. Other formulas are somewhat complicated, and are usually reserved for use with assets of considerable value, since the difference in current value and historical cost may be extremely small with minor assets.
While the use of historical cost is considered traditional, a trend toward allowing for the impact of various factors on the value of any given asset has become more popular. The idea is to not be bound by that original cost, but to adjust the recorded value so that it more accurately reflects the current fair market value of the asset. For some financial experts, this is the only way to truly keep records that are fully accurate, and reflective of the current financial status of an individual, business, or other entity that owns assets of some type.
