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Explain why the historical cost principle is used to account for long-lived assets and how the cost basis is determined. Discuss - Essay Example
Finance & Accounting
Pages 4 (1004 words)
Historical cost principle, asset impairment and depreciation Name Institution How historical cost principle is used to account for long-lived assets Historical cost principle values assets at the original cost of acquisition. The concept takes into consideration the purchasing cost of an asset…
The GAAP mainly relies on consistency of data conveyed by business financial records. Since historical methods does not depend on the speculated market prices, rather a real transaction that occurred, the cost is regarded as most reliable. For this reason, the historical cost principle is best used for reporting long-lived assets. It is the best method for reporting assets whose disposal may not be done in the near future. Examples of these assets include land, buildings, fixture, equipment and natural resources such as mineral deposits, oil wells and timber tracks. Under the historical cost principle, assets are recorded at acquisition cost as indicated on the balance sheet. In accounting for purchases of long-term assets, interest expense is subtracted from the original cost or cost of acquisition. The book value of long-term assets can be calculated by getting the accumulated depreciation subtracted from acquisition cost. To estimate an asset’s useful life, important variables such as acquisition cost, depreciation expense per year and salvage value should be determined. The following methods are used to estimate asset’s useful life; straight-line depreciation method, production method and double (declining) methods. ...