Question

1. What is the Cost Principle?and Definition of Cost Principle

2. give 3 example of Cost Principle

3. Some Issues with the Cost Principle

4. Short-Term vs Long-Term Assets

Answer 1

1. Cost Principle

Cost principle requires to record the assets and liabilities on the balance sheet of the company at the cost at which it is acquired or borrowed. It is also known as historical cost principle.

Definition of Cost Principle

Cost principle requires to record the assets at the cash or cash equivalent amount at which it is acquired at the time of acquisition and further the amount recorded is not adjusted for the increase or decrease in market value. An exception to this is short term investment held for trading.

2. Examples of Cost Principle

(i) A machinery purchased for $50000 cash is recorded at $50000 in the balance sheet of the company.

(ii) A machinery purchased for $20000 down payment and for remaining $30000 note is signed at 6% p.a. interest rate due in 2 years. In this formal promise is made to pay the amount within a reasonable period of time and at a particular interest rate thus the machinery will be recorded at $50000.

(iii) A machinery is purchased in exchange of old machinery worth $30000, In this the machinery will be recorded at $30000.

3. Issues with cost principle

(i) Over a period of time, the value of the long term assets changes but due to the cost principle it cannot be reflected in the financial statement.

(ii) If the company develop highly valuable trademark over a period of time, it cannot report it, as it has not acquired it in any transaction. It has not paid any cost for it.

4. Short term and Long term assets

Short term assets are those assets which are to be sold or can be converted for cash within a period of one year. Example of short term assets is Inventory.

Long term assets are those assets which the company hold for a longer period than a year. Examples of long term assets are property, plant, equipment, intangible assets, long term investment held to maturity etc.