Definition
The original cost refers to the initial value or purchase price of an asset or investment, before any depreciation, amortization, or impairment costs are deducted. It includes not only the purchase cost, but also any other costs associated with acquiring, installing, and equipping the asset for use. It is an important concept in accounting, taxation, and finance.
Phonetic
The phonetic pronunciation of “Original Cost” would be: əˈrɪdʒɪnəl kɒst
Key Takeaways
Here are three important takeaways about Original Cost:
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Definition: Original cost refers to the amount paid for an asset when it was first purchased. This cost includes not just the purchase price, but also any additional expenses necessary to prepare the asset for use, like installation costs, transportation charges, and initial maintenance costs.
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Depreciation: The original cost of an asset is used as the basis for depreciation calculations. Over the asset’s useful life, its value will reduce due to wear and tear, i.e., it depreciates. This decrease is calculated based on the original cost of the asset.
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Tax Implications: The original cost is critical when determining gains or losses for tax purposes. When the asset is sold, the original cost is deducted from the selling price to determine the gain or loss on disposal, which will have tax implications.
Importance
Original cost is a crucial term in business and finance as it refers to the initial price paid to acquire an asset. This amount, which includes all costs to acquire and prepare the asset for use, such as purchase price, delivery fees, and installation expenses, becomes the basis for calculating depreciation or amortization for tangible and intangible fixed assets. It is also used to determine potential gain or loss upon the sale of an asset. Therefore, understanding the original cost is vital for accurate financial reporting, tax calculations, and strategic decision-making.
Explanation
The original cost refers to the actual cost incurred when acquiring an asset and is crucial in business for a variety of reasons. This initial expenditure is a fundamental factor when calculating depreciation costs, determining profit or loss upon selling the asset, or assessing the asset’s value over time. In such cases, the original cost serves as a benchmark, helping to evaluate the asset’s financial performance over its lifecycle. By comparing the present selling price or the depreciated worth against the initial cost of the asset, businesses can determine if their investment has accrued value or depreciated during its service.Furthermore, original costs also play a pivotal role in tax computations. Particularly, they can affect the amount of capital gains a business needs to pay when it disposes of an asset. A company subtracts its original cost from the net selling price to calculate capital gains on an asset, which is a taxable figure. In this context, the original cost is a crucial element in calculating taxable income and plays an integral part in a company’s financial planning and management.
Examples
1. Real Estate Purchase: Suppose a real estate investor purchases a commercial property for $500,000. This is the original cost or the initial purchase price he pays to acquire the property. Down the line, its market value may vary due to a number of factors, but the original cost stays at $500,000.2. Equipment or Machinery: A factory owner buys an equipment for his manufacturing plant at a price of $200,000. This priced amount is considered the original cost of the equipment irrespective of its depreciation over the years or any potential resale value in the future. 3. Stock Investment: An investor bought 100 shares of Apple Inc. at $150 per share. The original cost of this investment would be $15,000 (100 shares x $150). Over time, the value of these shares may increase or decrease, but the original cost remains $15,000 which could determine any potential profits or losses if the investor decides to sell.
Frequently Asked Questions(FAQ)
What is Original Cost?
Original Cost refers to the initial price paid or investment made to acquire an asset, including purchase price, transportation costs, installation costs or any costs that have been incurred to bring the asset into its intended state of operation.
How is Original Cost used in accounting?
In accounting, Original Cost is used as the basis for calculating depreciation, amortization and other related calculations. It is used to determine the accounting value of an asset on the balance sheet.
Is the Original Cost of an asset always constant?
No, the Original Cost of an asset can change due to improvements, upgrades or additions to the asset after its acquisition. However, regular maintenance and repairs are typically not included in the original cost.
How does Original Cost impact the profit or loss during an asset’s sale?
The difference between the sale price and the Original Cost of the asset determines the profit or loss from the sale of an asset.
What happens to the Original Cost of an asset over time?
Over time, the Original Cost of an asset is adjusted for depreciation (for fixed tangible assets) or amortization (for intangible assets). This reduced value is often referred to as the ‘book value’ of the asset.
How does Original Cost differentiate from Market Value?
Original Cost refers to the purchase price of an asset without any market influences. The Market Value, on the other hand, can fluctuate according to supply and demand, economic conditions and other factors.
Is Original Cost relevant for tax purposes?
Yes, Original Cost is a crucial element for tax purposes. It serves as the basis for calculating capital gains or losses when an asset is sold or disposed of. The tax authorities require that the Original Cost of an asset be reported for these calculations.
Related Finance Terms
- Depreciation
- Capital Expenditure
- Asset Valuation
- Book Value
- Amortization
Sources for More Information
