What is the Cost Principle?
The cost principle (historical cost principle) requires assets to be recorded at their original purchase price, not their current market value. This keeps accounting records objective and verifiable, even as market prices change over time.
The cost principle states that assets must be recorded and kept on the books at their original acquisition cost, rather than being adjusted upward for inflation or market appreciation, though they can still be depreciated or written down for impairment.
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Step-by-step worked examples
A company buys a building for $500,000. Five years later it's worth $650,000 on the open market. At what value should the building be recorded on the books (ignoring depreciation)?
The cost principle requires recording the original purchase price Market value changes are not reflected in the recorded amount The building remains recorded at $500,000 (less any accumulated depreciation)
Equipment costs $60,000, has a $5,000 salvage value, and a 5-year useful life. What is its book value after 2 years using straight-line depreciation?
Annual depreciation = (60,000 − 5,000) / 5 = $11,000 Accumulated depreciation after 2 years = 11,000 × 2 = $22,000 Book value = 60,000 − 22,000 = $38,000
A company purchased land for $200,000 in 2015. In 2026 similar land sells for $350,000. What amount stays on the balance sheet for this land?
Land is not depreciated The cost principle keeps it recorded at historical cost The balance sheet still shows $200,000, regardless of the $350,000 market value
Flashcards
Quick quiz
Q1.The cost principle requires assets to be recorded at:
Q2.Under the cost principle, if a building's market value rises, the company should:
Q3.Equipment costs $40,000, salvage value $0, useful life 4 years. What is the straight-line book value after 1 year?
Q4.Which asset is typically NOT depreciated under the cost principle?
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Common mistakes
Assets are updated to market value every year. — Correct: Under the cost principle, assets stay at historical cost, only reduced by depreciation or impairment.
The cost principle applies only to physical assets. — Correct: It applies to nearly all assets recorded on the balance sheet, including intangible assets acquired for a price.
Land is depreciated like buildings. — Correct: Land has an indefinite useful life and is not depreciated.
Rising market value increases reported net income. — Correct: Unrealized market gains are not recognized under the cost principle; only realized gains from an actual sale are recorded.
FAQ
What is the cost principle in accounting?
It requires assets to be recorded and kept on the books at their original acquisition cost rather than current market value.
What is the cost principle formula?
Book Value = Historical Cost − Accumulated Depreciation, where accumulated depreciation follows a method like straight-line.
What are examples of the cost principle?
Recording a building at its original purchase price even after the market value rises, and keeping land on the books at historical cost indefinitely.
How do you calculate book value under the cost principle?
Subtract accumulated depreciation (or any impairment write-down) from the historical cost; for straight-line depreciation, accumulated depreciation = ((Cost − Salvage) / Life) × Years elapsed.