Fin621 GDB No. 2 idea solution December 2011

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Answer

Cost Principle

From an accountant’s point of view, the term “cost” refers to the amount spent (cash or the cash equivalent) when an item was originally obtained, whether that purchase happened last year or thirty years ago. For this reason, the amounts shown on financial statements are referred to as historical cost amounts.



Because of this accounting principle asset amounts are not adjusted upward for inflation.



In fact, as a general rule, asset amounts are not adjusted to reflectany type of increase in value. Hence, an asset amount does not reflect the amount of money a company would receive if it were to sell the asset at today’s market value. (An exception is certain investments in stocks and bonds that are actively traded on a stock exchange.) If you want to know the current value of a company’s long-term assets, you will not get this information from a company’s financial statements—you need to look elsewhere, perhaps to a third-party appraiser.