In accounting, the cost at which an asset is acquired originally is referred as historical cost. Whereas cost is defined as the value of resources sacrificed, consumed or given up to obtain any other resource, service, or asset. Historical cost principle requires that assets should be kept in the books of account at their historical costs (cost of acquisition) regardless of increases in their fair values. For example, an entity purchased a piece of land in 1995 for $25,000. After 35 years, its fair value has been increased to $200,000. The accountant has not accounted for this increase in fair value and has kept the carrying value of land at $25,000. Is he right? YES!! Historical cost principle restricts the accountant to record any upward adjustment in the value of land and requires that land should be kept at its historical cost.
Purpose of this principle is to maintain consistency in accounting and to avoid any unreasonable management estimates. However, there are some exceptions to the historical cost principle. Where the fair value of assets can be determined reasonably, as in the case of equity and debt securities being traded on the stock exchanges, such assets are allowed and in most accounting standards, are required to be carried at their fair values. But this should be treated as an exception to the general historical cost principle, as most of the items are carried at their historical costs and not at their fair values.
It must be noted that historical cost principle prevents upward adjustments in the values of assets. However, it does not mean that an asset should not be depreciated or impaired. Normal fixed assets are carried at their historical costs less accumulated depreciation and accumulated impairment. Similarly, intangibles are carried at their historical costs less accumulated amortization and accumulated impairment.