Quick Summary
- Assets are recorded at their original purchase price, not current market value
- Total cost includes purchase price plus all expenses to make asset usable
- Book values remain constant and do not change with market fluctuations
- Provides objectivity and verifiability through documented evidence like receipts
- Important for WAEC/NECO exams – frequently appears in theory and practical questions
What is the Cost Concept in Accounting?
The cost concept is a fundamental accounting principle that tells us how to value assets when we record them in business books. It says that when you buy any asset – whether a building, vehicle, equipment, or inventory – you should record it at exactly what you paid for it, plus any extra money spent to get it ready for use.
Let’s use a simple example. Imagine you buy a commercial bus for your transport business in Lagos. You pay ₦8,000,000 for the bus. Then you spend ₦200,000 repainting it with your company colors and ₦150,000 for vehicle registration at the motor licensing office. According to the cost concept, you record this bus in your books at ₦8,350,000 (₦8,000,000 + ₦200,000 + ₦150,000).
Here is the important part: even if the bus value increases to ₦9,000,000 after one year because of scarcity in the market, your accounting books still show ₦8,350,000. And if the bus value drops to ₦7,000,000 because of wear and tear, your books still show ₦8,350,000. The recorded cost never changes unless you sell the asset or it gets completely damaged.
Components of Asset Cost
When calculating the cost of an asset under the cost concept, you must include several elements:
Purchase Price: This is the actual amount paid to buy the asset. If you buy a grinding machine for ₦450,000, this is your starting point.
Transportation Cost: Money spent to bring the asset from where you bought it to your business location. If you paid ₦25,000 to transport the grinding machine from Onitsha to your shop in Enugu, add this amount.
Installation Charges: Expenses for setting up the asset. For the grinding machine, if you pay an engineer ₦30,000 to install and test it, include this cost.
Legal Fees: Any legal costs related to buying the asset. When buying land, you pay lawyer fees for documentation. These fees are part of the land cost.
Customs Duty and Taxes: For imported assets, customs duty paid at the port becomes part of the asset cost. If you import equipment and pay ₦100,000 customs duty, add it to the equipment cost.
Testing and Trial Costs: Expenses for testing whether the asset works properly before full use. This could include test materials or technical inspection fees.
What NOT to Include:
Some expenses are NOT part of asset cost:
- Regular maintenance and repairs after the asset is in use
- Running costs like fuel, electricity, or staff salaries
- Interest on loans taken to buy the asset (unless specific accounting rules apply)
- Penalties or fines paid during purchase
Detailed Examples of the Cost Concept
Example 1: Office Equipment
Bello Trading Company buys a photocopying machine. Here are the costs:
- Machine price: ₦350,000
- Transportation from Kano to Sokoto: ₦15,000
- Installation by technician: ₦20,000
- Test papers and trial: ₦5,000
Total cost recorded in books = ₦350,000 + ₦15,000 + ₦20,000 + ₦5,000 = ₦390,000
This ₦390,000 remains in the books. If the machine’s market value rises to ₦450,000 next year, the books still show ₦390,000. If the value drops to ₦300,000, the books still show ₦390,000.
Example 2: Building Purchase
A company buys a warehouse in Port Harcourt:
- Purchase price: ₦15,000,000
- Legal fees for title documents: ₦500,000
- Renovation before use: ₦800,000
- Land survey charges: ₦200,000
Total cost = ₦15,000,000 + ₦500,000 + ₦800,000 + ₦200,000 = ₦16,500,000
Even if property prices in that area double after three years, this warehouse remains at ₦16,500,000 in the accounting books.
Example 3: Inventory/Stock
A supermarket imports goods:
- Goods cost: ₦2,000,000
- Shipping from China: ₦300,000
- Customs duty at Lagos port: ₦250,000
- Transportation to warehouse: ₦50,000
Cost of inventory = ₦2,000,000 + ₦300,000 + ₦250,000 + ₦50,000 = ₦2,600,000
Why Use the Cost Concept?
The cost concept provides several benefits that make accounting more reliable:
Objectivity and Verifiability: When you record assets at cost, you can prove the amount with documents. The invoice shows ₦500,000 paid for furniture. Everyone can verify this fact. But if you tried to record furniture at “current value,” different people would estimate different amounts, causing confusion and disputes.
Prevents Manipulation: Without the cost concept, business owners could exaggerate asset values to make their company look richer than it really is. The cost concept stops this dishonesty because you can only record what you actually paid, proven by receipts.
Simplicity: It is easy to apply. You simply add up all costs from receipts and invoices. You do not need to hire expensive valuers to estimate current market prices every year.
Consistency: Using cost allows comparison across different time periods. If you record all assets at cost, you can compare your 2023 and 2024 financial statements meaningfully.
Tax Purposes: Government tax officials accept cost-based records because they can verify actual payments through bank statements and receipts. This makes tax calculations clear and acceptable to authorities like FIRS (Federal Inland Revenue Service).
Comparison: Cost Concept vs Market Value
| Cost Concept (Historical Cost) | Market Value Approach |
|---|---|
| Records assets at original purchase price | Records assets at current selling price |
| Value stays constant over time | Value changes with market conditions |
| Objective – based on actual receipts | Subjective – based on estimates |
| Easy to verify with documents | Requires professional valuers |
| May not reflect true current worth | Shows realistic current worth |
| Example: Land bought 10 years ago at ₦2M still shows ₦2M | Example: Same land now valued at ₦10M shows ₦10M |
| Widely accepted accounting standard | Used for some investments only |
Limitations of the Cost Concept
While useful, the cost concept has significant weaknesses that WAEC often tests:
Ignores Inflation: Money loses value over time due to inflation. Equipment bought for ₦1,000,000 ten years ago would cost ₦3,000,000 today, but the books still show ₦1,000,000. This makes old assets appear cheaper than they really are.
Understates True Business Worth: A company that bought land in Lekki Phase 1 for ₦5,000,000 in 2005 still shows this amount, even though the land is now worth ₦50,000,000. This makes the business appear less wealthy than it actually is.
Misleading for Decision Making: Business owners making decisions based on historical costs may make mistakes. If you want to replace old equipment, knowing its original cost does not help you plan for the current replacement price.
Not Useful for Market Comparison: When comparing two companies, one with old assets at historical cost and another with new assets looks unfairly different. The financial statements do not reflect the true situation.
Problem with Donated Assets: If someone gives your business a free generator, what cost do you record? The cost concept struggles with gifts and donations since no money was paid.
Common WAEC/NECO Exam Mistakes
WAEC Chief Examiners Report Key Issues:
- Confusing cost with market value: Many students write that cost concept means recording at “current value” or “selling price.” Wrong! It specifically means original purchase cost, not current market price.
- Incomplete cost calculations: Students forget to add transportation, installation, and other expenses. Remember: cost = purchase price + ALL expenses to make asset ready for use.
- Wrong expense inclusion: Students add running costs like fuel, repairs, and salaries to asset cost. These are expenses, not part of the asset cost.
- Stating instead of explaining: When questions say “explain,” students just write “assets are recorded at cost” without details. You must elaborate with examples and reasons.
- Not mentioning limitations: Questions asking for “advantages and disadvantages” often receive only advantages. Always read carefully and answer all parts.
- Poor calculation presentation: In practical questions, students write answers without showing workings. Always show step-by-step calculations for full marks.
Practice Questions
Multiple Choice Questions (MCQs)
1. According to the cost concept, assets should be recorded at:
A. Current market value
B. Selling price
C. Original cost of acquisition ✓
D. Estimated future value
2. Which of the following is included when calculating the cost of an asset?
A. Repair costs after one year of use
B. Transportation cost to bring asset to business location ✓
C. Fuel costs for running the asset
D. Interest on loan taken to buy asset
3. A machine was bought for ₦500,000. Transportation cost was ₦20,000 and installation was ₦30,000. The recorded cost should be:
A. ₦500,000
B. ₦520,000
C. ₦530,000
D. ₦550,000 ✓
4. Which is a limitation of the cost concept?
A. It provides objectivity
B. It is easy to verify
C. It ignores changes in asset value over time ✓
D. It prevents manipulation of records
Essay Questions
Question 1 (10 marks):
(a) Define the cost concept as used in accounting. (2 marks)
(b) List four components that make up the cost of an asset. (4 marks)
(c) State two advantages and two disadvantages of using the cost concept. (4 marks)
Examiner’s Tip: For part (a), write a complete definition in 1-2 sentences mentioning “original purchase price” and “expenses to make ready for use.” For part (b), simply list four components like “purchase price, transportation cost, installation charges, legal fees” – one mark each. For part (c), clearly separate advantages from disadvantages with headings.
Question 2 (12 marks):
Musa Transport Limited bought a new bus for its business. The following costs were incurred:
– Purchase price: ₦6,500,000
– Transportation from manufacturer: ₦150,000
– Registration and licensing: ₦180,000
– Repainting in company colors: ₦120,000
– Initial fuel for test drive: ₦15,000
– Driver’s salary for first month: ₦80,000
Required:
(a) Calculate the cost at which the bus should be recorded in the accounting books. Show all workings. (6 marks)
(b) Explain why some items are excluded from the asset cost. (3 marks)
(c) State three reasons why the cost concept is important in accounting. (3 marks)
Examiner’s Tip: For part (a), list each item separately and show addition clearly. Exclude items like driver salary (running cost) and initial fuel (operating expense). For full marks, you must state which items are excluded and why. In part (b), explain that running costs and operating expenses are not part of asset cost because they don’t make the asset ready for use – they are ongoing expenses. Part (c) requires three distinct points about importance.
Question 3 (8 marks):
Distinguish between the cost concept and the money measurement concept, giving one practical example of each. (6 marks + 2 marks)
Examiner’s Tip: “Distinguish” means show clear differences. Write separate paragraphs: Cost concept deals with WHAT VALUE to record assets (original cost vs market value), while money measurement concept deals with WHETHER to record items (only monetary transactions recorded). Give examples: Cost concept example – “Equipment bought for ₦200,000 stays at ₦200,000 even if value rises.” Money measurement example – “Employee skills cannot be recorded because they have no agreed monetary value.”
Memory Aids
Remember “COST”:
- C – Constant value in books (never changes)
- O – Original purchase price used
- S – Supporting expenses added (transport, installation)
- T – True documentation required (receipts, invoices)
What to Include in Asset Cost (The “5 Ts”):
- Transportation cost
- Taxes and customs duty
- Testing and trial expenses
- Technical installation fees
- Title/legal documentation costs
What to Exclude (The “3 Rs”):
- Running costs (fuel, electricity)
- Repairs and maintenance (after asset is in use)
- Regular salaries (staff operating the asset)
Quick Formula:
Asset Cost = Purchase Price + Bringing Costs + Installation + Legal Fees
Related Topics
Understanding the cost concept connects to other important accounting topics:
- Depreciation: Learn how the original cost of assets is systematically reduced over their useful life through depreciation charges.
- Monetary Concept: Study how cost concept works together with monetary measurement to record business transactions.
- Prudence Concept: Understand when accountants might record values below cost to be conservative.
- Fixed Assets Accounting: See how cost concept applies specifically to recording land, buildings, equipment, and vehicles.
- Asset Revaluation: Learn the special circumstances when assets can be revalued above their original cost.