Accounts Notes: Accounting principles and Policies

Wednesday 16 March 2011

Accounting principles and Policies

7. Cost Concept:
Accounting to this concept:

As asset is recorded in the books at the price, which is paid to acquire it, and
This cost is the basis for all subsequent accounting for that asset.

For example, if a plot of land is purchased for Rs. 1,50,000 then as per this concept, the asset will be recorded in the books at Rs. 1,50,000, even if its market value at that time is Rs. 2,00,000. In case a year later, the market value of this asset comes down to Rs. 1,00,000 it will continue to be shown at Rs. 1,50,000 and not at
Rs. 1,00,000.
The cost concept does not mean that the asset will always be shown at cost. It has also been started above that cost becomes the basis for all future accounting for the asset. It means that asset is recorded at cost at the time of its purchase, but it may systematically be reduced in its value by charging depreciation.

Advantage: Cost concept has the advantage of bringing objectivity in the preparation and presentation of financial statements. In the absence of this concept, the figures shown in the accounting records would have depended on the subjective views of a person.

Drawbacks: However if cost concept is followed in the following situations, then the financial statements will not depict the true and fair position of the business:-

In case of inflationary trend in the price of the assets (such as land), the historical cost does not have relevance. For example, suppose during the financial year, an asset is purchased for Rs. 50,000 and at the end of financial year, its market value is Rs. 2,00,000. In the financial statements, the assets will be shown at Rs. 50,000, which will not depict the true and fair view of the land.
In case, asset does not have any acquisition value, (for example, assets acquired by the firm by way of gift), such asset will not be shown in the financial statement, if cost concept is followed, because nothing is paid for it. This will adversely affect the concept of true and fair view.