![]() ![]() The concept of opportunity cost plays an important role in managerial decisions. When the girl so drops by the way - side one fruit and runs with the other, then the opportunity cost of the fruit she saves is the foregone alternative of the fruit she lost. Suppose a girl had two kinds of fruits- one pear and one peach, and if a bad boy is after her to seize the fruits, then the best way for the girl is to drop one fruit and run with the other, so that, she can at least save one fruit, at the cost of the other. an American Economist explains the concept of opportunity cost with reference to an example. ![]() We should know what gain by best alternative is and what loss by left alternative is.ĭevenport. When there are alternative uses of scarce resource, one should know which best alternative is and which is not. The cost principle is also known as the historical cost principle.Opportunity cost principle is related and applied to scarce resource. This is a particular problem for the users of a company's balance sheet, where many items are recorded under the cost principle as a result, the information in this report may not accurately reflect the actual financial position of a business. Thus, the cost principle yields results that may no longer be relevant, and so of all the accounting principles, it has been the one most seriously in question. In fact, if a company were to sell its assets, the sale price might bear little relationship to the amounts recorded on its balance sheet. The obvious problem with the cost principle is that the historical cost of an asset, liability, or equity investment is simply what it was worth on the acquisition date it may have changed significantly since that time. The cost principle is even less applicable under International Financial Reporting Standards, which not only permits revaluation to fair value, but also allows you to reverse an impairment charge if an asset subsequently appreciates in value. This is not entirely the case under Generally Accepted Accounting Principles, which allows some adjustments to fair value. The cost principle implies that you should not revalue an asset, even if its value has clearly appreciated over time. 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. 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.Ĭost Principle for Long-Term Assets and Liabilities ![]() 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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