Cost basis represents the value of an asset or other item for tax purposes. Determining cost basis depends on the item in question and the amount of information involved. For example, cost basis can relate to a physical asset sold for scrap or investments sold by an investor, depending on the item in question. A few ways for determining cost basis include assets adjusted for depreciation, FIFO (first in, first out), and the average cost of investments. Accountants must follow current laws and accounting standards when reviewing cost basis.
Assets go onto a company’s accounting ledger at its historical cost. Depreciation is an accounting figure that represents the use of the item, with the result a correlating expense on the income statement. Determining the cost basis for the asset comes from the historical price plus any improvements less corresponding depreciation. Companies that compute these figures themselves probably need to have an accountant review the process. This ensures the company does not incur any additional tax liability when selling or disposing of these items in the open market.
Investments have a different method or methods for determining cost basis. In some cases, an investor may purchase several shares of stock or other items at different costs. The cost basis at tax time then depends on the value of items remaining on hand at a given point of time. Here, either the FIFO or average cost method will be appropriate. Investors can most likely select whichever method will work best for situation at hand when determining cost basis.
FIFO typically applies to inventory valuation. Investors can use the concept for determining cost basis, however. Using this method, the investor deducts the shares purchased first when selling bits of stock. Therefore, the shares purchased later make up the cost basis when taken as an aggregate figure. This often results in the highest cost basis if the share purchased last cost the most, though it can also work in reverse if the share price was lower during later acquisitions.
Average cost methods for determining cost basis are somewhat different than the FIFO method. Here, an individual or company adds together all purchases of an investment or other item. Then, dividing the total cost by the total quantity gives a per-unit cost. Multiplying any items sold by the per-unit costs and subtracting them from the total original value provides the cost basis. For investments, adjustments may be necessary for stock splits, dividends, or other distributions for both the average cost basis method and the FIFO method.
