Cost Basis

What is a Cost Basis?

Cost basis means the at-cost purchase price of an asset, including the incidental expenses, which is used to calculate tax arising from the gain or loss of an asset due to differences between the cost and current market price.

Cost Basis Calculation Formula

Cost basis followed by accounting standard and cost of an asset generally includes the following Cost = Purchase Price + Installation expenses incidental expenses related to the purchase of an asset + Duty + Fee.

Example of Cost Basis Calculations

Cost basis can be determined differently under the following calculation examples.

#1 – Fixed Asset Purchase

Cost basis is calculated by the purchase price, installation expenses, expenses incurred for bringing an asset to their location and conditions. For example, X purchases machinery worth $ 10000, commission paid of $ 200. Transportation expenses are $ 100. The repair cost is $ 100; installation labor charges $ 100, duty, and taxes $50. The total cost of a fixed assetFixed AssetFixed assets are assets that are held for the long term and are not expected to be converted into cash in a short period of time. Plant and machinery, land and buildings, furniture, computers, copyright, and vehicles are all examples.read more will be

$10000+$200+$100+$100+$100+$50=$ 10550.

#2 – Inventory

Cost is calculated differently for different levels of stock, such as For raw materials, the cost is calculated on the purchase price of materials. For Finished stock, the cost is calculated by adding raw materials and conversion costsConversion CostsConversion cost is incurred by any manufacturing entity in converting its raw material into finished goods sold in the market and includes labour cost and other applied overheads like factory overheads and administrative overhead. Conversion cost = manufacturing overheads + direct labourread more.

#3 – Investment

Types of Cost Basis

There are three types of cost basis methods that are followed in the organization.

Cost-Basis

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For eg:
Source: Cost Basis (wallstreetmojo.com)

#1 – FIFO Method

#2 – LIFO Method

This method is also known as last in first out accountingLast In First Out AccountingLIFO (Last In First Out) is one accounting method for inventory valuation on the balance sheet. LIFO accounting means inventory acquired at last would be used up or sold first.read more, and let’s consider the above example under this method organization will consider 5 stocks sold out of 2nd February.

#3 – Weighted Average Cost Method

This method records the value of the stock on an average cost basis. This method generally followed in mutual funds. Suppose 4 units purchased @$10 and 6 units purchased at $20.

The calculation will be [(4×$10)+(6× $20)]/4 units + 6 units = $16 average cost per unit.

Advantages

In this case, as per cost basis, the cost of assets will be $ 20000 because it is related to the purchase of assets. However, it will not include $ 500 to the cost of the asset because it is not related to the asset.

Disadvantages

  • A cost basis does not indicate the actual price of the asset.
  •  Suppose X purchased an asset which of $ 10000 and the same asset purchased by Y at $ 12000
  •  As we can see, the cost of the same asset different is for X and Y for recording purposes.

Limitations

  • It is challenging for a large organization to identify and track the record of each item purchase date and which stock was purchased is to consider for sale.
  • Under Cost basis, the sale price of a stock one of an organization can be cost price for another organization.
  • For example, X sold stock to Y at $ 1000, which is the cost for Y. However, it is the sale price for X. Due to this reason how one can identify what the actual cost of a stock is.

Important Points

  • As per Accounting Standard change in method of
  • Cost basis is a change in accounting estimate; proper disclosure is required to notes to the accounts.
  • Any profit or loss arising due to change in method has to charge to profit and loss accounts.

Conclusion

The method of basis cost recording has to decide at the beginning of the financial year and consistently has to follow throughout the year. The company requires maintaining proper documentation for all purchases for quality and adequate control purposes.

This article has been a guide to What is a Cost Basis & its Definition. Here we discuss how to calculate cost basis along with examples, types, advantages, and disadvantages. You can learn more about from the following articles –