Basket (Lump-sum) Purchases - Online Tutor, Practice Problems & Exam Prep

When purchasing multiple fixed assets together, known as a lump sum or basket purchase, it's essential to allocate costs accurately. This is crucial for assets like land and buildings, as land is not depreciated while buildings are. The relative sales value method involves three steps: calculating total fair market value, determining each asset's percentage of that total, and applying these percentages to the total payment made. This ensures correct initial costs for each asset, impacting future depreciation and financial statements.

Basket (Lump-sum) Purchases

Sometimes we might buy a group of fixed assets together. We're going to have to assign a cost to each of those fixed assets. So let's see what we do when we have these lump sum purchases. These are usually called lump sum purchases. Sometimes you'll see them called a basket purchase of assets. Okay? And this is usually when we buy, a lot of times it's going to be buying land with a building attached to it, right? You're buying land and a building. So you can't just say one account for land and building. No, we need to assign a cost to the land and assign a cost to the building. And this is especially important when we're dealing with land and building, right? Because land is not depreciated. But the building is, right? The building is depreciated. So if we don't get the initial cost of each of these correctly, well the depreciation is going to be different, right? So we want to make sure we get this right. So the thing that happens here is that when we do a lump sum purchase, when we buy the land and the building or buy a bunch of assets together, we're generally going to get a discount, right? This is kind of like a wholesale kind of thing. We're buying a bunch of things. We're going to get a discount from the fair value of each asset separately. So if we had paid for the land by itself, and then the building by itself, we would have paid the fair value for each. But since we are buying everything together, we are going to get some sort of slight discount. Right? So how do we arrange how much goes to the land, how much goes to the building? Well, we're going to use what's called the relative sales value method. Okay? It's this 3 step method that I've got right here. Okay? So remember, we're going to pay some amount of cash and we're going to have to split that up. Well, it could be cash or maybe we'll sign a note payable or something. But whatever. We're going to pay some amount. And we need to split up that amount that we paid between the different assets that we bought. Okay? So here's the 3 step process. The first thing we need to do is find the total market value of what we purchased, right? This could be how much was the land worth by itself? How much was the building worth by itself? We need to add all of those things together. That's the first step. Next, we need to find the percentage of the total fair market value for each asset purchase. So how much of that total market value was the land? How much of that total market value was the building? Last but not least, we need to take that percentage that we just calculated in step 2 and we're going to multiply it by the total amount that we actually paid since we paid a little bit less. We're going to say, okay since the land was, say, 20% of the total value, well that means that 20% of what we paid goes to the land. Okay? So let's go ahead and we'll do this example and we'll see how this relative sales value method works. So we've got Buy It All Company. The Buy It All Company purchased a plot of land with a building dollars So that's what they paid for it, right? They paid 2.8 $1,000,000 The appraiser indicated that the fair market value of the land was $300,000 and the building's fair market value was $2,700,000 So you could already see that. We got a discount, right? The building and the land were more than what we paid of 2,800,000. So what is the journal entry to record the combined purchase of the land and building? Well, let's go ahead and fill out this little table. It's going to be an easy way to understand what we're doing, how we're doing our 3 steps. And actually, let me scroll up and keep those 3 steps on the screen right there. Cool? Alright. Let's go ahead and do it. So let's start with each asset. Let's go ahead and label each one. We had land and we had the building. Okay. So we had land and the building. So let's start with the fair market value of each, right? Notice step 1 is telling us to find the total fair market value of what we purchased. So it tells us the land had a fair market value of 300,000. The building had a fair market value of 2 point 7,000,000. So what's the total fair market value? Well, we got to add those together, right? 300,000 plus 2,700,000 that comes out to a total market value of 3,000,000. So that's what we purchased, right? $3,000,000 worth of stuff and how much did we pay? We only paid 2,800,000. Okay? So step 1 is done. This is the total fair market value. FMV stands for fair market value. So total fair market value was 3,000,000. So what was the percentage of the total fair market value for each? Well, what we're going to have to do is take the fair market value of each asset divided by the total. So let's do it for land first. For land, its value was 300,000 out of the 3,000,000, alright? So it was 300,000 out of the 3,000,000. Well, how much is that? 300,000 divided by 3,000,000 that comes out to 10%, right? 10%, it'll give you 0.1 as a percentage that's 10%. And what about the building? Well, the building was 2,700,000 out of the 3,000,000, right? So we're finding the percentage that each made up of that total fair market value. So if the first one was 10%, well, this one's obviously 90%, right? But you can confirm that in your calculator. It comes out to 0.9, 90%. Alright? So that's step 2. We found the percentage of the total fair market value that each one has. So what was the total payment made? Well, in both cases, this was the total payment, right? All right. So the initial cost of each asset, well we just have to multiply our percentage times the total payment made. So we're going to multiply across here. So 10% times the 2,800,000. Well, that's going to come out to 280,000, right? Let me get out of the way here so you see everything. 10% times 2,800,000, so this is the math that we're doing right here. 10% times 2,800,000, that is 280,000 and that's going to be the cost of the land. Notice the fair market value was 300,000 but it's only gonna be on our books for 280,000 because that's essentially what we paid for it. Now let's see what the building's worth. The building is gonna be 90% times at 2,800,000 and that comes out to 2,520,000. And notice if we add these two numbers together, the the 280,000 and the 2,520,000, you add those together and it comes out to our full payment of 2,800,000, right? So there we go, that gives us what the initial cost of each one is. So let's go ahead and write down under here, let's make the journal entry. I'll make it over here, on the right hand side. So we had land, right? We're gonna debit land because we received land, and we're gonna debit building because we received a building. And what are we gonna credit? Well, we paid with cash so we're going to credit cash to get rid of the cash and what's going to be the land? The land is going to be 280,000 The building is gonna be 2,520,000 and the cash is 2,800,000 as a credit, right? The actual amount that we paid, well that's the cash that we have to get off of our books with the credit. So that's our journal entry right there. Notice, we use the fair market values to find the percentage of the total payment that we're gonna put towards each asset. Alright? So now that you guys saw how to do a basket purchase, why don't you guys try it in this next problem, alright? Let's do it now.

The Cutting Corner paid $640,000 for a basket purchase of land, building, and equipment. At the time of the purchase, the land had a market value of $224,000, the building's market value was $455,000 and the equipment's market value was $21,000. If the business put $240,000 as a down payment while signing a note payable for the remainder of the $640,000 purchase price, what would be the journal entry to record the basket purchase?

The Cutting Corner paid $640,000 for a basket purchase of land, building, and equipment. At the time of the purchase, the land had a market value of $224,000, the building's market value was $455,000, and the equipment's market value was $21,000. If the business put $240,000 down as a down payment while signing a note payable for the remainder of the $640,000 purchase price, what would be the journal entry to record the basket purchase? With these basket purchases, the first thing we need to do is find the total fair market value of what we bought, then find the proportion that each asset had of that total fair market value. So let's start with that total fair market value, for land, building, and equipment respectively as $224,000, $455,000, and $21,000. We have a total fair market value of $700,000 worth of assets, but we only paid $640,000, which means we got a discount. Now, we need to figure out how to proportion this out. We take each asset and divide it by the total fair market value. This gives us: Land: 224 700 , which equals approximately 32%, Building: 455 700 , which equals about 65%, Equipment: 21 700 , which is close to 3%. Adding these up confirms they make up 100% of the assets. Next, we multiply these percentages by the purchase price to find out the value attributed to each. The breakdown is as follows: Land: 0.32×640,000 = $204,800 Building: 0.65×640,000 = $416,000 Equipment: 0.03×640,000 = $19,200 The journal entry to record this transaction will include debits and credits as follows: Debit Land: $204,800 Debit Building: $416,000 Debit Equipment: $19,200 Credit Cash: $240,000 (down payment) Credit Note Payable: $400,000 (remainder of the purchase) Adding all debits and credits should balance to the total paid of $640,000, which validates our calculations for this basket purchase transaction.

Here’s what students ask on this topic:

What is a basket purchase in accounting?

A basket purchase, also known as a lump sum purchase, occurs when multiple fixed assets are bought together for a single price. This often happens with assets like land and buildings. The total purchase price must be allocated to each asset based on their relative fair market values. This allocation is crucial because different assets may have different depreciation rules, such as land not being depreciated while buildings are. The relative sales value method is typically used to determine the initial cost of each asset, ensuring accurate financial reporting and depreciation calculations.

Why is it important to allocate costs in a basket purchase?

Allocating costs in a basket purchase is important because different assets have different accounting treatments, especially regarding depreciation. For example, land is not depreciated, but buildings are. If costs are not allocated correctly, it can lead to inaccurate financial statements and improper depreciation calculations. This can affect the company's financial health and tax obligations. The relative sales value method helps ensure that each asset's cost is accurately recorded, reflecting its fair market value proportionally to the total purchase price.

How do you calculate the total fair market value in a basket purchase?

To calculate the total fair market value in a basket purchase, you need to determine the individual fair market values of each asset included in the purchase. For example, if you buy land and a building together, you would find the fair market value of the land and the fair market value of the building separately. Then, you add these values together to get the total fair market value. This total is used in the relative sales value method to allocate the purchase price proportionally to each asset.

What is the relative sales value method in basket purchases?

The relative sales value method is a three-step process used to allocate the total purchase price of a basket purchase to individual assets. First, calculate the total fair market value of all assets purchased. Second, determine the percentage of the total fair market value that each asset represents. Third, multiply these percentages by the total purchase price to allocate the cost to each asset. This method ensures that each asset's cost is recorded accurately, reflecting its proportionate share of the total purchase price.

Can you provide an example of a journal entry for a basket purchase?

Sure! Let's say a company purchases land and a building together for $2,800,000. The fair market value of the land is $300,000, and the building is $2,700,000. Using the relative sales value method, the land represents 10% of the total fair market value, and the building represents 90%. Therefore, the cost allocated to the land is $280,000 (10% of $2,800,000), and the building is $2,520,000 (90% of $2,800,000). The journal entry would be:

Debit Land $280,000
Debit Building $2,520,000
Credit Cash $2,800,000