Explanation of Cost Principle-Accounting

Componenets of the asset side of the Federal Reserve System balance sheet from January 4, 2007 to September 25, 2008. This is the assets of all 12 Federal Reserve Banks combined as reported by the Federal Reserve. (Photo credit: Wikipedia)

Que es el principio de conservatismo?

El principio de conservatismo ayuda al contable ha decidir entre 2 alternativas .For example, if an item in inventory has a cost of $20, but it can be replaced for $15, the conservatism principle directs the account to report the item in inventory at $15 and to immediately report the loss of $5. For an asset such as inventory it means reporting the lower asset amount on the balance sheet and the lower net income amount on the income statement. From the conservatism principle comes the accountants’ the lower of cost or market rule for inventory valuation.The conservatism principle does not say that accountants are to be conservative. Accountants should be fair and objective. The conservatism principle is used to “break a tie” between two reasonable options. It is not intended to motivate accountants to beat down a company’s earnings and assets.

What is the cost principle?

The cost principle is one of the basic underlying guidelines in accounting. It is also known as the historical cost principle.
The cost principle requires that assets be recorded at the cash amount (or its equivalent) at the time that an asset is acquired. For example, if equipment is acquired for the cash amount of $50,000, the equipment will be recorded at $50,000. If the equipment will be useful for 10 years with no salvage value, the straight-line depreciation expense will be $5,000 per year (cost of $50,000 divided by 10 years). The equipment’s market value, replacement cost or inflation-adjusted cost will not affect the annual depreciation expense of $5,000. The company’s balance sheets will report the equipment’s historical cost minus the accumulated depreciation.

The cost principle also means that valuable brand names and logos that were developed through effective advertising will not be reported as assets on the balance sheet. This could result in a company’s most valuable assets not being included in the company’s asset amounts. (On the other hand, a brand name that is acquired through a transaction with another company will be reported on the balance sheet at its cost.)
If a company has an asset that has a ready market with quoted prices, the historical cost may be replaced with the current market value on each balance sheet. An example is an investment consisting of shares of common stock that are actively traded on a major stock exchange.