Original cost (also called cost basis or historical cost) is the total amount paid to acquire an asset and put it into service. It’s the number recorded on the balance sheet as the asset’s initial value and is the starting point for calculating depreciation, carrying value, and taxable basis when the asset is sold.
Key concept in one line
Original cost = purchase price + all capitalizable costs necessary to acquire and prepare the asset for use (net of discounts).
Components: what to include (and what to exclude)
Include (capitalizable costs)
– Purchase price (net of trade-in allowances and purchase discounts)
– Sales taxes and import duties directly related to the purchase
– Freight, transportation and delivery charges
– Installation, assembly, testing and setup costs
– Commissions and broker fees tied to the purchase
– Site preparation or modifications required to make the asset usable
– Legal, appraisal, or title fees required to acquire the asset
– Capitalized interest (when applicable, e.g., construction of a long-lived asset)
– Costs of significant improvements or additions that extend useful life (these increase basis when made)
Exclude (expense immediately)
– Ordinary repairs and maintenance that merely keep the asset operating
– Routine warranties or service contracts for future maintenance (unless they’re part of the cost to make the asset operational)
– Training costs for employees (unless required to commission the asset and directly attributable)
– Operating supplies used after the asset is placed in service
Basic formulas
– Original cost (initial basis) = sum of purchase price and capitalizable costs
– Accumulated depreciation = total depreciation recorded to date
– Carrying value (book value) = original cost − accumulated depreciation
– Adjusted basis (tax) = original cost + capital improvements − accumulated depreciation (for tax)
– Gain/(loss) on sale = sale proceeds − carrying value (book) or sale proceeds − adjusted tax basis (tax)
Short numeric example
– Purchase price: $20,000
– Fees (broker): $1,000
– Shipping/delivery: $700
– Installation and required warranty/setup costs: $3,000
Original cost = $20,000 + $1,000 + $700 + $3,000 = $24,700
If accumulated depreciation = $14,700:
Carrying value = $24,700 − $14,700 = $10,000
If sold for $15,000 → gain on sale = $15,000 − $10,000 = $5,000
Accounting journal entries (typical)
1) On acquisition (assume cash purchase):
Debit Equipment (asset) 24,700
Credit Cash (or Accounts Payable) 24,700
2) Periodic depreciation (example: annual):
Debit Depreciation Expense xx
Credit Accumulated Depreciation xx
3) On sale (sold for $15,000 with accumulated depreciation $14,700):
Debit Cash 15,000
Debit Accumulated Depreciation 14,700
Credit Equipment 24,700
Credit Gain on Sale of Asset 5,000
Original cost vs tax basis and differences to watch for
– Initial tax basis usually equals original cost. Over time, tax basis is adjusted for capital improvements, dispositions, and tax depreciation (which may differ from book depreciation because tax rules use different methods, e.g., MACRS in the U.S.).
– Book (GAAP) carrying value uses book depreciation methods chosen by the company; tax basis uses tax depreciation rules. This creates temporary differences used in deferred tax accounting.
– Capital improvements increase basis; routine repairs do not.
– Trade-in situations: basis may rely on the fair value of the asset received or given up; special rules can apply.
Practical steps: how to determine and document original cost
1. Gather supporting documents:
• Purchase invoice, contracts, receiving reports
• Shipping bills, freight invoices
• Sales tax and duties invoices
• Installation, testing, and setup invoices
• Broker/commission invoices, appraisal fees, legal fees
2. Identify capitalizable items:
• Ask: Is this cost necessary to acquire the asset and prepare it for its intended use? If yes, capitalizable.
3. Subtract discounts:
• Net the purchase price for any cash discounts, rebates, or trade-in allowances.
4. Create (or update) fixed-asset record:
• Asset description, serial number, location, vendor, purchase date, original cost, useful life, depreciation method, salvage value, department/responsibility, invoice numbers.
5. Decide capitalization policy threshold:
• Have a clear company policy (e.g., capitalize items above $1,000; expense below) to ensure consistent treatment.
6. Record the acquisition and set up depreciation schedule:
• Choose depreciation method and useful life consistent with accounting policy and tax rules.
7. Retain documentation for audits and tax filings:
• Keep all supporting invoices and work orders.
Best practices for businesses
– Maintain a fixed-asset register and reconcile it periodically to the general ledger.
– Establish and document a capitalization policy and useful-life schedules.
– Distinguish between repairs (expense) and improvements (capitalize).
– Track accumulated depreciation separately for each asset.
– Review assets for impairment if events indicate carrying value may not be recoverable.
– Coordinate with tax advisors to apply correct tax depreciation rules and optimize tax position.
– On disposals, document sale agreements, proceeds, and removal of asset from records.
Common pitfalls and how to avoid them
– Capitalizing routine maintenance: establish written policy and examples for staff.
– Omitting small but capitalizable charges (freight, installation): use invoice checklists.
– Misclassifying capital improvements as repairs: require approvals for capital expenditures and keep job sheets.
– Losing supporting documentation: implement document retention and scanning procedures.
Quick FAQ
Q: Are sales taxes always capitalized?
A: If sales tax is directly related to buying the asset, it’s typically capitalized as part of the asset cost. Confirm with tax rules applicable in your jurisdiction.
Q: How do trade-ins affect original cost?
A: Often the cost recorded is the cash paid plus the fair value of the asset given up (or fair value of new asset), subject to specific accounting and tax rules.
Q: Does original cost change after upgrades?
A: Significant improvements that extend useful life or increase capacity are capitalized and increase the asset’s basis. Routine maintenance is expensed.
Regulatory and guidance notes
– Under U.S. GAAP, historical cost is the typical basis for initial measurement of property, plant and equipment (subject to impairment testing thereafter).
– For U.S. tax depreciation rules, see IRS Publication 946 (How To Depreciate Property) for MACRS methods and special rules.
References and further reading
– Investopedia — “Original Cost” (definition and examples):
– IRS Publication 946 — How to Depreciate Property
Editor’s note: The following topics are reserved for upcoming updates and will be expanded with detailed examples and datasets.