Definition: The assets and liabilities recorded in the balance sheet with its original acquisition cost, the i.e. amount spent at the time of its acquisition are called as the Historical Cost. In other words, the historical cost is an accounting method in which the assets of the firm are recorded in the books of accounts at the same value at which it was first purchased.
The purpose behind the use of historical cost is to ascertain the total amount spent on purchasing the asset and determining the opportunity cost lost in the past. Also, the amount spent on the purchase of the asset is compared with the changes in profits and expenses incurred as a result of the purchase of such asset.
For example, if a company purchases the building worth Rs 15,00,000 in the year 2000, then the value of the building will be recorded in the balance sheet of the year 2000 at Rs 15,00,000. If the company still owns the building in the year 2016, then it will be recorded in the balance sheet of 2016 at the same value, i.e. 15,00,000 irrespective of the current market value of the building (even if the building value has increased to Rs 50,00,000, as per the current standards).
The historical cost method is the most widely used methods of accounting as it is easy for a firm to ascertain what price was paid for the asset. Also, the value of the asset remains same from year to year, thereby complying with the concept of consistency.
But, however, the historical cost method does not take into consideration the current market value of the asset and also ignores the time value of money or inflation. The historical cost is based on the assumption that the inflation is not relevant, and the asset is valued on the basis of its purchase price.