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The primary role of cost principle in accounting is to provide a stable, verifiable value for an asset. It is mostly used for items of low value. The principle is also used for short-term investments in which little value is gained or lost.
One of the most common reasons for using the cost principle in accounting is that it is a simple way to determine an approximate value. It can play a role in the assessment of assets, equity investments, and liabilities. While the principle may not provide an accurate current value, it also does not have the error margin possible with estimating value.
Also known as historical cost principle, the role of cost principle in accounting has lessened in importance due to its inaccuracy. This problem is less marked with any sort of short-term holding because there has not been enough time for the value to change significantly.
It is not common to see the cost principle in accounting for long-term investments, liabilities, or assets. This is primarily because of the change in value that happens over long periods of time. While the cost principle can be used if assets are adjusted down for depreciation, it cannot be applied to an increase in value.
The overall concept of the cost principle is that an item should not be revalued. For this reason, it has come to be viewed by many accountants as an impractical principle. The appeal of its simplicity has been diminished by the complications involved in adjusting for its inaccuracies.
Cost principle does not play a role in marketable securities. In this case, the current value of the item is always reported. This is because the value of the securities changes more frequently and dramatically than most other assets and liabilities.
When an accountant is using the cost principle, most assets on the balance sheet are recorded in this way. Though the overall balance may not be exact, the value of the items on the sheet will at least be balanced in relation to each other. If an item that has been recorded using the cost principle is sold at current market value, then the accountant will account for the difference on the balance sheet.
Cost principle is one of the generally accepted accounting principals (GAAP) in the United States. The method has been controversial due to its inaccuracy. Its simplicity is the primary reason it continues to be used.
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