historical cost basis

Examples of historical cost basis in the following topics:

• Impact of Inflation on Financial Statement Analysis

  • In most countries, primary financial statements are prepared on the historical cost basis of accounting without regard either to changes in the general level of prices.
  • Many of the historical numbers appearing on financial statements are not economically relevant because prices have changed since they were incurred.
  • Hence, adding cash of $10,000 held on December 31, 2002, with $10,000 representing the cost of land acquired in 1955 (when the price level was significantly lower) is a dubious operation because of the significantly different amount of purchasing power represented by the two identical numbers.
  • Inflation accounting, a range of accounting systems designed to correct problems arising from historical cost accounting in the presence of inflation, is a solution to these problems.

• Balance Sheets

  • Securities and real estate values are listed at market value rather than at historical cost or cost basis.

• Limitations of the Balance Sheet

  • The three limitations to balance sheets are assets being recorded at historical cost, use of estimates, and the omission of valuable non-monetary assets.
  • There are three primary limitations to balance sheets, including the fact that they are recorded at historical cost, the use of estimates, and the omission of valuable things, such as intelligence.
  • Fixed assets are shown in the balance sheet at historical cost less depreciation up to date.
  • The historical cost will equal the carrying value only if there has been no change recorded in the value of the asset since acquisition.
  • Historical cost is criticized for its inaccuracy since it may not reflect current market valuation.

• Seasonal Production

  • Playing it safe and have certain items in stock ahead of time can avoid opportunity costs.
  • The downside is it will cost money to keep them (both require appropriate temperature conditions, for example).
  • There are a number of ways to do this utilizing existing historical sales data as well as data from external research on the industry itself.
  • There are countless models and methods of organizing seasonal data to determine, but from the managerial frame mostly analysts preferred distribution of data should ultimately communicate the same correlations (or lack thereof) for differences in sales on a monthly basis.
  • If too much of a perishable good is ordered, not only will it cost the organization in unnecessary inventory fees, but also adds the risk of never been sold at all (a complete sunk cost at that point).

• Understanding the Cost of Money

  • The cost of money is the opportunity cost of holding money instead of investing it, depending on the rate of interest.
  • The concept of the cost of money has its basis, as does the subject of finance in general, in the time value of money.
  • The cost of any decision includes the cost of the most forgone alternative.
  • The cost of money is the opportunity cost of holding money in hands instead of investing it.
  • The cost of money is the opportunity cost of holding money in hands instead of investing it.

• Reporting of Financial Statement Analysis

  • Historical cost principle: requires companies to account and report based on acquisition costs rather than fair market value for most assets and liabilities.
  • This way of accounting is called accrual basis accounting.
  • If no connection with revenue can be established, cost may be charged as expenses to the current period (e.g., office salaries and other administrative expenses).
  • Depreciation and Cost of Goods Sold are good examples of the application of this principle.
  • Information disclosed should be enough to make a judgment while keeping costs reasonable.

• Optimal Capital Structure Considerations

  • The Modigliani-Miller theorem, proposed by Franco Modigliani and Merton Miller, forms the basis for modern thinking on capital structure (though it is generally viewed as a purely theoretical result, since it disregards many important factors in the capital structure decision).
  • However, as with many theories, it is difficult to use this abstract theory as a basis to evaluate conditions in the real world, where markets are imperfect and capital structure will indeed affect the value of the firm.
  • Actual market considerations when dealing with capital structure include bankruptcy costs, agency costs, taxes, and information asymmetry.
  • A company's securities typically include both debt and equity; therefore, one must calculate both the cost of debt and the cost of equity to determine a company's cost of capital.
  • At some point, however, the cost of issuing new debt will be greater than the cost of issuing new equity.

• Market Value vs. Book Value

  • For assets, the value is based on the original cost of the asset less any depreciation, amortization, or impairment costs made against the asset.
  • An asset's initial book value is its its acquisition cost or the sum of allowable costs expended to put it into use.
  • Assets such as buildings, land, and equipment are valued based on their acquisition cost, which includes the actual cash price of the asset plus certain costs tied to the purchase of the asset, such as broker fees.
  • Ways of measuring the value of assets on the balance sheet include: historical cost, market value or lower of cost or market.
  • Historical cost is typically the purchase price of the asset or the sum of certain costs expended to put the asset into use.

• Dangers Involved in Inventory Management

  • The scope of inventory management also concerns the fine lines between replenishment lead time, carrying costs of inventory, asset management, inventory forecasting, inventory valuation, inventory visibility, future inventory price forecasting, physical inventory, available physical space for inventory, quality management, replenishment, returns, and defective goods and demand forecasting.
  • In addition, excessive inventory incurs extra handling costs and holding costs.
  • When items are required on a breakdown basis and find out that there is not enough stock as a result of reducing it, this could lead to loss of production.
  • Inventory control - inventory cost elements (holding cost, order cost, total)Parameters: Order-cost (C) 10, demand (D) 1000, holding cost (i) 20% (of price), price (p) 10 => EOQ = 100

• Depreciation

  • Depreciation refers to the allocation of the cost of assets to periods in which the assets are used.
  • Generally the cost is allocated, as a depreciation expense, among the periods in which the asset is expected to be used.
  • Depreciation is generally recognized under historical cost systems of accounting.
  • Generally this involves four criteria: cost of the asset, expected salvage value (residual value of the asset), estimated useful life of the asset, and a method of apportioning the cost over such life.
  • The company will then expense a portion of original cost in equal increments over that period.