What it is:
How it works/Example:
For accounting purposes, it is important to identify the original cost of an asset. The original cost includes all costs associated with the purchase of an asset and putting it to use, including commissions, transportation, appraisals, and installation. Original cost is used in valuing any type of asset, including real estate, equipment, or even securities (stocks and bonds).
Original cost is calculated as follows:
Purchase Price + Fees & Commissions + Direct Transportation Costs + Installation Costs & Warranties = Original Cost
For example, for an equipment purchase of $25,000, including $1,200 in fees, $800 in shipping and delivery costs, and $3,000 for the installation and a warranty for parts and labor, the original cost would be $30,000.
Why it matters:
Original cost is used in calculating the tax basis of an asset. It is important to include all costs associated with the purchase of an item, including the purchase price, brokerage fees, commissions, warranties, appraisals, etc. These costs will increase the original cost and, as a result, reduce the potential taxable gain on the sale of the asset.
For example, in order to calculate whether there is a loss or gain for tax purposes, the tax basis of an asset equals the original cost (i.e. purchase price and all associated fees) minus the accumulated depreciation (i.e. all depreciation claimed on the asset to date).
Original Cost – Accumulated Depreciation = Tax Basis
If the original cost of a piece of equipment is $30,000 is adjusted by $15,000 in accumulated depreciation, the tax basis of the equipment is $15,000. If the equipment is sold for $20,000, then the taxable capital gain on the sale is $5,000. Using the example for original cost above, if the original cost had just included the purchase price, for example, the taxable gain would have been $10,000, resulting in a larger tax bill.