Key Takeaways
- Total initial amount paid for an asset.
- Includes purchase price plus direct costs.
- Used as basis for depreciation or amortization.
- Recorded for objectivity and consistency in accounting.
What is Original Cost?
Original cost, also known as historical cost, is the total amount paid to acquire an asset, including the purchase price plus all directly attributable expenses needed to prepare it for use. This concept plays a crucial role in accounting under GAAP, ensuring assets are recorded objectively and consistently.
It forms the baseline value on financial statements and serves as the foundation for calculating depreciation and amortization.
Key Characteristics
Understanding original cost involves recognizing its core attributes:
- Comprehensive: Includes purchase price plus costs like shipping, installation, commissions, and warranties.
- Objective: Supported by verifiable documentation, making it reliable for accounting purposes.
- Historical Basis: Reflects the cost at acquisition, not current market value or replacement cost.
- Depreciation Foundation: Used to calculate depreciation, adjusting asset value over time, factoring in salvage value when applicable.
- Tax Relevance: Establishes the tax basis for assets, influencing taxable gains or losses.
How It Works
Original cost aggregates all expenses directly related to acquiring and preparing an asset, such as legal fees, transportation, testing, and installation. These costs are capitalized, meaning they are recorded as part of the asset’s value rather than expensed immediately.
This value remains on the balance sheet and serves as the starting point for calculating depreciation or amortization over the asset’s useful life. Accounting for original cost helps mitigate obsolescence risk by accurately reflecting the asset’s historical investment, even if market conditions change.
Examples and Use Cases
Original cost applies across various industries and asset types, demonstrating its broad utility:
- Manufacturing Equipment: A company buys machinery from Cost with added shipping and installation fees, totaling the original cost used for depreciation.
- Airlines: Delta factors in purchase price plus commissions and warranty costs when recording new aircraft assets.
- Professional Services: Firms may include legal and consulting fees when acquiring intangible assets such as patents or licenses.
- Accounting Practices: Certified professionals from CPA firms often review original cost to ensure compliance and accurate tax reporting.
Important Considerations
While original cost offers a verifiable and standardized valuation method, it does not account for market fluctuations or deterioration beyond normal depreciation. You should be aware that over time, an asset’s book value may diverge significantly from its current worth or replacement cost.
When managing assets, it’s essential to balance original cost accounting with awareness of T-account adjustments and practical implications for financial analysis and tax planning.
Final Words
Original cost reflects the full investment to acquire and prepare an asset for use, providing a clear basis for depreciation or amortization. Review your purchase documents carefully to ensure all direct costs are included for accurate financial reporting.
Frequently Asked Questions
Original cost, also known as historical cost, is the total initial amount paid to acquire an asset, including the purchase price plus all directly attributable expenses necessary to prepare the asset for use, such as shipping, installation, commissions, and taxes.
Original cost is calculated by adding the purchase price of the asset to all directly attributable costs like transportation, installation, testing, commissions, warranties, and sales taxes required to make the asset operational.
Expenses included in original cost cover the purchase price plus costs directly related to acquiring and preparing the asset, such as shipping, installation, legal fees, testing, commissions, appraisals, warranties, and sales taxes.
No, ongoing maintenance costs are not included in original cost since they are post-acquisition expenses and do not directly contribute to preparing the asset for its intended use.
Original cost is important because it provides an objective, verifiable basis for recording assets on the balance sheet and serves as the starting point for calculating depreciation or amortization over the asset’s useful life.
No, original cost reflects the historical purchase price plus direct costs, not the current market value, inflation, or obsolescence, which is a limitation when assessing an asset’s present worth.
Yes, original cost applies to tangible assets like machinery and buildings, as well as intangible assets such as patents, and sometimes to liabilities and equity investments.
Original cost is based on the historical purchase price and direct costs, providing objectivity and consistency, whereas fair value reflects the current market price and can be more subjective and market-dependent.
