The cost concept is one of the basic underlying guidelines in accounting and understanding which enables accountants to maintain the accuracy in the profession. Below article discusses the cost concept in brief.
In accounting, cost is defined as the cash amount or the cash equivalent which is given up for an asset. It includes all costs necessary to get an asset in place and ready for its intended use. To give an example, the cost of an item in inventory also includes the item's freight-in cost. As regards the cost concept, it is one of the basic underlying guidelines in accounting. It is also known as the historical cost principle. The assertion made under the cost concept is that assets should be recorded at the cash amount or its equivalent at the time when they are acquired.
In accordance with this concept, it is important to note that regardless of whether the cost or acquisition price of an asset is greater or lesser than the fair market price, but the asset is to be recorded in the accounting books at the price which is actually paid.
At this point, it is important to be aware of what the fair market price is. Fair market price is the price of something at which both a seller and a buyer are willing to make a deal. It may further be noted that it is the amount at which an asset would change hands between two parties where both have knowledge of the relevant facts.
While the cost concept is applied to above aspect, it is used when there is no involvement of cash which can be understood clearly by way of this illustration: supposing that an asset is acquired without any cost, it is not recorded in the accounting books and neither does it appear in the balance sheet. Thus, in view of this fact, it falls under one of the major limitations of the balance sheets that it does not reflect those assets that are not expressed in monetary terms, such as, intelligence, honesty, loyalty, and skills of the employees. More to the point, undoubtedly the business goodwill has a value and the established reputation of a business firm being regarded as an intangible asset. And companies could be sold for a premium price based on the established reputation. But the good will is never recorded in accounting books unless there is occurrence of an actual acquisition. While it is realized when the business is sold, it is said to be purchased when a company purchases another business.
The cost concept also signifies that any subsequent change in the market value of an asset, such as machinery or equipment, which has been acquired in the past has nothing to do with the original price of an asset, but it will continue to be shown at the acquisition price in the balance sheet- not at its present value while the asset is fully depreciated being the expired cost of the asset charged as depreciation in the profit and loss account. When an asset is fully depreciated, it is worth nothing for accounting purposes, though the asset might actually have some scrap or minimal resale value. The asset is shown in the balance sheet at the net cost – original cost less depreciation. It’s therefore in no way related to the market value or fair value of the asset. It is thus the cost concept intended to reduce the time and efforts of the accountants and eliminate the instability in the accounting system.
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