Cost Principle GAAP

Here we discuss about Cost Principle that is one of the Generally Accepted Accounting Principles (GAAP).

The Cost Principle states that assets should be recorded or valued at cost initially. It does so to show historical cost of the assets at balance sheet of the business when the asset was purchased for the first time of the company history. However, this principle restricts the company to show only original cost. So, for a company it does not mean that a company always follows this principle of GAAP and shows assets at cost only. The Entrepreneur may record assets at other than historical cost to show on balance sheet.

According To Cost Principle, the cost value will become the basis for the valuation of the assets. For Example, if the market value of the asset is increased or decreased, then the assets can be revalued at the market value.

For Example if a business purchased Land & Building for Rs.5000000, then this is the historical cost of the assets and it is to be shown in the balance sheet of the business. With the passage of time, the value of Land & Building may decrease or increase in the market. So, now the value of Land & Building may be recorded in the balance sheet according to market value if the management of the company decides to do so. But the historical cost of the assets is shown in the balance sheet of the business to show historical record and comparison of the costs of Land & Building with different Accounting Periods.

Exceptions To Cost Principle

The general rule of Cost Principle is that assets are recorded initially at their cost price but there are exceptions to this general rule in case of Inventories and Quick Assets. Quick Assets are those assets that are converted into cash very quickly. Examples of these assets are:

Inventories

In case of Inventories, the Cost Principle is Cost or Net Realizable Value (NRV) whichever is less.

Accounts Receivable

For Accounts Receivables, The Cost Principle is that Accounts Receivables are recorded at Net Realizable Value which is calculated as:

                                                                                     Rs.

Opening Accounts Receivable                                 XXX

Less: Cash Received From Customers                    (XXX)

Less: Provision For Doubtful Debts                        (XXX)

Less: Provision For Discount                                   (XXX)

                                                                              ___________

Net Closing Account Receivable                              (XXX)

Investments

In case of Investments, the management of the business decides to record the investments at market’s value, if they decide to sell or convert the investment into cash in future Accounting Periods of the business.

So, it is all about Cost Principle GAAP (Generally Accepted Accounting Principles).