Cost Concept (Historical Cost)   

Cost concept implies that all the assets be recorded in the books of accounts at the price paid to acquire it and this cost forms the basis for subsequent accounting for the asset. For example, if a piece of land is acquired for Rs.1 lakh, it would continue to be shown in the Balance sheet at Rs.1 lakh even when the market value of the land subsequently rises to Rs.2 lakh. Why should this be so? This is because, cost concept is closely related to going concern concept. If the land is acquired for the operation of the business and its continuous usage is expected in future, there is no reason why the cost at which it was originally recorded cannot be the basis of future accounting since it is not going to be sold anyway. Hence, the value of the assets as reported in the accounts corresponds to the market value of the asset only at the time of acquisition and at no other time.

Cost concept is used because of the intricacies involved in the accurate determination of the market value. The market value is volatile and prone to frequent changes and fluctuations because of the continual operation of market forces in an ever changing economy. Further, the market value can either be the net realizable value (price at which it can be sold) or the current replacement value (price at which it can be bought) whose choice again is not without subjective bias. Secondly, cost concept also provides important cash flow information as it represents cash or cash equivalent paid for an asset. Thirdly, cost concept has the added advantage of being objective and is verifiable. As Anthony and Reece rightly said, "Adherence to cost concept indicates a willingness on the part of accounting profession to sacrifice some degree of relevance in exchange for greater objectivity and feasibility."

However, on certain occasions the departure from the cost concept is warranted. For example, non-monetary current assets are normally valued at lower cost or market price. Similarly, the accounts receivable are recorded at their original transaction cost. Later, when bad debts are anticipated, they are valued at net realizable value after providing for bad debts anticipated. A departure from cost concept provides for more objective information to aid the users of financial statements in decision-making.