{m}.{s}.1Historical cost convention

In depreciating assets, several different accounting concepts and conventions are being applied.

Firstly, we have the:

Historical cost convention

...transactions are recorded at their value at the time of occurence.

Thus for example:

  • Cost of sales is the original purchase price of the goods when they were bought in.
  • Assets are valued at their historical cost (as depreciated) rather than for example their resale value or replacement cost.

 

 

 

{m}.{s}.2Stable money concept

For the historical cost convention to be a useful method of presenting figures in accounts, the currency being used must be reasonably stable (stable money concept).

If the currency is not stable, historical cost accounts will not give a true picture and inflation accounting will need to be used.

Where assets are increasing in value, it is common practice in company accounts for them to be revalued. This principally applies to property.

Even though the assets have been increased in value, they must still be depreciated. The object of depreciation is to charge the cost of providing the assets against the profits of the appropriate years.

{m}.{s}.3Fixed assets and depreciation

There are certain concepts and desirable qualities which play a persuasive role in financial statements - these are also being applied.

Going concern concept

The entity will continue in existence for the foreseeable future.

If this were not the case the only value that could be placed on an asset would be its break-up value - what might be received for a quick sale.

Accruals concept

Non-cash effects of transactions and other events should be reflected in the financial statements for the accounting period in which they occur.

The cost of a fixed asset relates to many accounting periods. It is, therefore, spread over these periods and matched against the income it is helping to generate.

Comparability

There is consistency of accounting treatment of like items within each accounting period and from one period to the next.

Once a depreciation method has been selected it should be disclosed and used consistently to give comparability in accounts.