Cost Principle

Cost Principle

Presented by:

Asprilla, Casallas, Medina, Melo, Navarro y Osorio.

What is the cost principle?

The cost principle is an accounting principle that records assets at their respective cash amounts at the time the asset was purchased or acquired. The cost principle means items need to be recorded as the actual price paid. It is the same way when a buyer buys products, and the recording is done based on the price paid. In short, the cost principle is equal to the amount paid for each transaction.

How is the cost principle applied?

Giving an example of the cost principle can be tricky when there is no cash involved. The challenge arises when you need to post an exchange and no cash is received. Like when a company uses its old car and changes it for a new one. The record would be the cost of the new vehicle as the cash paid and the value of the exchange vehicle.

Which is an example of cost principle?

When there is a trade-in, a company can get a great deal of a car. The car might have a value of $20,000, but they pay $15,000 for it. When recording on the balance sheet, the company will use $15,000 as the actual amount paid even though the car has a value of $20,000. When issuing an invoice, it will still be the same amount as the cash received and not the car’s value.

Why should you use the cost principle? 

Cost principle concept applies to companies that use accrual accounting but wish to be GAAP compliant. Most of the public-owned companies apply GAAP in accounting; it is a requirement that they also use historical cost principle.

What is the importance of the cost principle?

Actually this principle is very important, as there are several benefits of the cost principle, the system is more objective, trustworthy and comparable. In addition, it is easy to use. At the same time, this principle is often criticized for its inaccuracy, as the value of an asset can change over time. The cost principle may not reflect the true financial situation of the company. It is often discussed that recording assets at their current value provides a more realistic view of a company's financial situation.

Benefits of Cost Principle Concept

• This idea helps keep your balance consistent. The historical cost principle helps maintain consistency between each financial period. It becomes more practical when shared with third parties, such as lenders and investors.

• The concept of cost principle is used to verify costs. In accounting, everything is related to verification. All transactions are done using any manual ledger or accounting software, and you need to be able to verify the entry. If your ledger needs to be verified, the original sales documents will serve as evidence of the cost of goods

• According to this principle, only the settings need to be made. When using the cost principle, the possibility of cost changes is very small. Your financial statements will remain accurate and will not depend on fluctuating fair values.