If a balance sheet is heavily weighted towards long-term assets, as is the case in a capital-intensive industry, there is a greater risk that the balance sheet will not accurately reflect the actual values of the assets recorded on it. Though depreciation, amortization, and impairment charges are used to bring these items into approximate alignment with their fair values over time, the cost principle leaves little room to revalue these items upward. The cost principle is less applicable to long-term assets and long-term liabilities. Related AccountingTools CoursesĬost Principle for Long-Term Assets and Liabilities The cost principle is not applicable to financial investments, where accountants are required to adjust the recorded amounts of these investments to their fair values at the end of each reporting period. Using the cost principle for short-term assets and short-term liabilities is the most justifiable, since an entity will not have possession of them long enough for their values to change markedly prior to their liquidation or settlement. Cost Principle for Short-Term Assets and Liabilities How the cost principle is applied depends on the situation, as noted below. Thus, this lower of cost or market concept is a crushingly conservative view of the cost principle. However, this variation does not allow the reverse - to revalue an asset upward. A variation on the concept is to allow the recorded cost of an asset to be lower than its original cost, if the market value of the asset is lower than the original cost. The cost principle requires one to initially record an asset, liability, or equity investment at its original acquisition cost. The principle is widely used to record transactions, partially because it is easiest to use the original purchase price as objective and verifiable evidence of value.
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