According to cost concept, all assets will record on the basis of their purchasing value. This purchasing value will be called book value. Every year's balance sheet will show the asset on its book value. Because we have bought the asset in past time, so, we will also called this cost as historical cost.
There will not any effect of changes in the market value of any asset. For example, we have made building in 2011 with the cost of Rs. 4,00,000 but due to increasing the price of cement and other raw material, cost has increased upto Rs. 8,00,000. But our balance sheet will show the value of building Rs. 4,00,000. This concept also allows to make the provision for depreciation and showing it in the liability side. It also allows to deduct current year depreciation from respected fixed asset if we do not make the provision for depreciation accounting. It is necessary to show the correct value of fixed asset in the balance sheet.
There are also exceptions of cost concept.
1. Because we show inventory at the cost value or realizable value which ever is less. So, on inventory, this concept will not apply.
2. On investment, this concept will not apply. Because value of shares and Gold and other investments in mutual funds change fastly, so, it is the duty of accountant to show these investments on their market value.
Logic Behind Cost Concept
There will not any effect of changes in the market value of any asset. For example, we have made building in 2011 with the cost of Rs. 4,00,000 but due to increasing the price of cement and other raw material, cost has increased upto Rs. 8,00,000. But our balance sheet will show the value of building Rs. 4,00,000. This concept also allows to make the provision for depreciation and showing it in the liability side. It also allows to deduct current year depreciation from respected fixed asset if we do not make the provision for depreciation accounting. It is necessary to show the correct value of fixed asset in the balance sheet.
There are also exceptions of cost concept.
1. Because we show inventory at the cost value or realizable value which ever is less. So, on inventory, this concept will not apply.
2. On investment, this concept will not apply. Because value of shares and Gold and other investments in mutual funds change fastly, so, it is the duty of accountant to show these investments on their market value.
Logic Behind Cost Concept
- Every year, market price of assets change, if we changes our assets on this market price basis, there will decrease the trust on the balance sheet. Sometime, there are small period fluctuations, due to this, there may be big decrease in the price. All investors feel risk of their investments and sell their shares fastly. Company type business will stop within two days. If we show it on the basis of historical cost, balance sheet's fixed assets shows almost same price, this factor will increase the goodwill of company at long run.
- I compare this concept with water. In some area, we drink water free of cost and in some area, we have to pay Rs. 15 to Rs. 20 per bottle. But water is water. Its value for human body will be same. Thirsty person can tell its real value. In the market, different fixed asset's value is different. Different person may tell different value. No one is expert. If you carry your car in the car market. Ask 100 car dealers for its value. All's answer will be different. So, it is most difficult to calculate the current or market value of any asset. So, better is to follow the cost concept in accounting.
Related : Cost Concepts
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