Accounting Concepts - 4. Cost Concept:
According to the cost Concept, an asset acquired by a concern is recorded in the books of accounts at cost (i.e., at the price actually paid for acquiring the asset). The market price of the asset is ignored, and it is it's cost price that forms the basis for all subsequent accounting for that asset.
It should be noted that the cost Concept is of special significance only for fixed assets. This is because, it is only the fixed assets that are shown in the balance sheet at cost, of course, less depreciation, if any. Current assets are not affected by this concept. That is why, current assets are shown in the balance sheet at cost or market price, whichever is lower, though they are acquired at cost.
The significance of the cost concept is as follows:
(a) The cost concept signifies that the fixed assets of a business are, ordinarily, recorded in its books of accounts at their cost prices (i.e., the prices paid for their acquisition), and not at their current market prices. Suppose buildings worth Rs.10,00,000 are purchased by a concern for Rs.8,00,000, the buildings are recorded in the books of the concern only at their cost price of Rs.8,00,000, and not at their market price of Rs.10,00,000.
(b) From the cost concept, it naturally follows that, if a concern has not paid anything for an item, i.e., an asset, which it has, then, that item is, usually, not recorded in its books. It is for this reason that goodwill (i.e., good reputation) built by a business is, usually, not recorded in its books as an asset. Of course, if a concern has paid something for goodwill on the acquisition of the business from another concern, then, goodwill will appear in its books at the cost price.
Recording of an asset in the books of the business at its cost price is justified on many grounds. First, cost price is the actual price that is agreed upon by both the parties to a contract, i.e., the purchaser and the seller. So, there is some objectivity. Secondly, this practice contributes to true accounting records. Thirdly, the cost concept prevents a concern from giving arbitrary value to an asset. Lastly, the cost price of an asset is stable, while the market price of an asset is variable.
According to the cost Concept, an asset acquired by a concern is recorded in the books of accounts at cost (i.e., at the price actually paid for acquiring the asset). The market price of the asset is ignored, and it is it's cost price that forms the basis for all subsequent accounting for that asset.
It should be noted that the cost Concept is of special significance only for fixed assets. This is because, it is only the fixed assets that are shown in the balance sheet at cost, of course, less depreciation, if any. Current assets are not affected by this concept. That is why, current assets are shown in the balance sheet at cost or market price, whichever is lower, though they are acquired at cost.
The significance of the cost concept is as follows:
(a) The cost concept signifies that the fixed assets of a business are, ordinarily, recorded in its books of accounts at their cost prices (i.e., the prices paid for their acquisition), and not at their current market prices. Suppose buildings worth Rs.10,00,000 are purchased by a concern for Rs.8,00,000, the buildings are recorded in the books of the concern only at their cost price of Rs.8,00,000, and not at their market price of Rs.10,00,000.
(b) From the cost concept, it naturally follows that, if a concern has not paid anything for an item, i.e., an asset, which it has, then, that item is, usually, not recorded in its books. It is for this reason that goodwill (i.e., good reputation) built by a business is, usually, not recorded in its books as an asset. Of course, if a concern has paid something for goodwill on the acquisition of the business from another concern, then, goodwill will appear in its books at the cost price.
Recording of an asset in the books of the business at its cost price is justified on many grounds. First, cost price is the actual price that is agreed upon by both the parties to a contract, i.e., the purchaser and the seller. So, there is some objectivity. Secondly, this practice contributes to true accounting records. Thirdly, the cost concept prevents a concern from giving arbitrary value to an asset. Lastly, the cost price of an asset is stable, while the market price of an asset is variable.
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