Assets and expenses are recorded in the books of account at their actual cost to the business. Cost is the amount originally aid in arm’s length transactions. Cost concept which is closely related to going concern assumption, therefore, implies, that an asset is recorded in the accounting records at a price paid for it including all incidental expenses like installation charges, legal expenses etc. Since the original or acquisition cost relates to past, it is referred to as historical cost. It is the basis of valuation of the assets in the financial statements. The word ordinarily is used since there are certain situations in which accounting records are changed to reflect changes in market values e.g., in the case of investments and inventories. It means that Balance Sheet will continue to show the assets at their original cost or acquisition price and not at their present worth or market value. There are however two exceptions to this general rule:

(i) The cost concept does not meant that assets continue to be recorded at their original price for as long as the business owns them. Their cost is steadily reduced systematically called depreciation. Thus, we can restate the cost concept by emphasizing that the cost concept means original cost less depreciation. It may be added that the depreciation has no relationship with market value or the real worth of the asset to the company.

(ii) The cost concept does not create problem of value or real worth in the case of current assets, that is, the assets which are held by the business enterprises for a short time. Their market values are practically in correspondence with the acquisition cost e.g., cash, readily marketable securities, the sums receivable from the debtors, inventories held for a short period etc. It may be added that sometimes the values of the fixed assets undergo upward to downward revision, as a matter of practical necessity. Such revaluations have to be disclosed according to Schedule VI (part I) of the Companies Act in terms of the amount and date of the revaluation for a subsequent period of five years. The consequences of effects of cost principle are: (i) assets are valued at cost or cost derived amounts (e.g., cost minus depreciation) (ii) items which have no cost are ignored, that is, if the business entity does not pay anything for an asset, it would not appear in the books of account. The goodwill  would appear in the accounts only when the enterprise has purchased this intangible asset for a price; (iii) unrealized gains are ignored, (iv) the real value of the capital employed in the business is not available in the balance sheet. The justification for the cost concept lies in the following arguments: (a) the acquisition cost is highly objective because it is derived from an independent transaction between two parties i.e., the business entity and the vendor; (b) the details of the original transaction can be easily verified from the documents that are exchanged at the time of purchase such as purchase invoice, title of ownership, property deed, cheques and so on; (c) when the assets are to be recorded at market price, the difficulties are: which market and the opinions of the experts. The value of the same asset may vary from one market to another. The opinions of the experts are also not the same. The valuation by one expert will not be the same as that of another. These values cannot be verified by independent sources; (d) a ‘market value’ or ‘current value’ of assets may change every day with the result that it would require the accountant to keep track up-and-down of the market price and experts opinions. The accountant will have to alter the values frequently. It would be very detrimental of the confidence of the investors and creditors; (e) the going concern concept assumes that the business entity will continue its activity indefinitely and thus eliminate the necessity of using current values or liquidation values for asset valuation; (f) the cost of recording current values would be so time consuming and expensive and the sources for determination of present value would be so widespread that it would be extremely difficult to record present values and change them continuously. In sum, adherence to cost concept provides objectivity and makes it feasible to record an asset without too much effort. These two factors – objectivity and feasibility – exert so much influence that the element of relevance is pushed to the background.
The limitations or drawbacks of the cost principle are: (i) items having no cost are ignored. Thus the knowledge and technological skill built inside the enterprise, a favorable location, brand name and reputations of the business as time goes would find no place in the assets of a business entity; (ii) the money-measurement assumption which assumes that purchasing power of the rupee is stable, is a major limitation of the cost concept. In times of inflation, the income figure is seriously distorted because depreciation based on historical costs of earlier years is charged against revenues at current prices. Similarly the values of the assets acquired at different times over a period during which the purchasing power of the rupee has changed cannot be properly added in the balance sheet to provide meaningful results; (iii) the actual information needed by management, investors, creditors etc. may be current values of assets and therefore values based upon historical cost may not be useful for their purposes.

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