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Chapter 1

The historic cost convention

11.1 Accounting coding systems

The historic cost convention gives guidance as to what value a transaction should be
recorded at.

Normally, transactions are recorded at historical cost. This is the agreed monetary
value of a transaction at the time it takes place. For example, the cost of raw
materials purchased from a supplier, or the cost of a machine purchased for use in
the business entity. It also applies to sales transactions – they will be recorded at the
agreed monetary value when the transaction takes place.

Below are the advantages and disadvantages of using historical cost as a valuation
method:

Advantages Disadvantages

 It is easily understood by most  It may not be relevant to the
people. needs of some users of financial
information who require
 It is usually easy to reliably information based upon current
identify or determine e.g. by costs and prices.
reference to a purchase invoice.
 It may become out of date,
 It is an objective basis of particularly when considering the
measurement, whereas other impact of inflation on costs over a
valuation bases such as fair value period of time.
or market value are subjective.
 It presumes that historical cost is
based upon a stable unit of
currency which enables
comparison over time; this is
probably not the case.

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