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Historical cost theory Revenue recognition theory

This theory is a foundational of accounting This theory is a key accounting principle
principle that mandates recording all assets that determines the specific conditions under
and liabilities at their original purchase cost. which revenue is recognised or recorded in
This means that once an asset is acquired the financial statements. According to this
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or a liability is incurred, it is recorded on theory, revenue should be recognised when
the financial statements at the transaction it is earned and realisable, regardless of
price, without subsequent adjustments when the cash is received. This ensures
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for changes in market value. This theory that financial statements accurately reflect
states that assets should be recorded at the company’s performance over a given
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their original purchase cost. For example: period. For example: A Tanzanian tourism
A Tanzanian manufacturing company company sells a holiday package in
purchases machinery for TZS 90 million. December 2023, with the travel occurring
According to historical cost theory, this in January 2024. The company recognizes
machinery will be recorded in the financial the revenue in January 2024 when the
statements at TZS 90 million, regardless of service is rendered, even though payment
its current market value. This theory has the was received in December 2023. This theory
following key components: has the following key components:
Original purchase cost: This is the amount Earning process: Revenue is considered
of money originally paid to acquire an asset, earned when the company has delivered
including purchase price, transportation, goods or provided services.
installation, and other related costs. Realizability: Revenue is realisable when

Objectivity and verifiability: Historical cost the company has received cash or a claim
provides a clear, objective, and verifiable to cash, which can be measured reliably.
basis for recording transactions, reducing Performance obligation: The company
the potential for manipulation. must have fulfilled its obligation to transfer
Consistency: Using historical cost ensures goods or services to the customer.
consistency in financial reporting overtime, Contract terms: The revenue recognition
making it easier to compare financial must adhere to the terms agreed upon in
statements across different periods. the contract with the customer.
Relevance and reliability: While historical
cost is reliable and verifiable, it may not Agency theory
always be relevant if the current market This theory examines the relationship
value of an asset differs significantly from between principals (owners or shareholders)
its historical cost. and agents (managers or executives) in a

Student’s Book Form Five
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