Basket (Lump-sum) Purchases: Videos & Practice Problems

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

When purchasing a group of fixed assets together, such as land and a building, it's essential to allocate the total cost appropriately to each asset. This process is known as a lump sum purchase or basket purchase. Accurately assigning costs is crucial because land is not depreciated, while buildings are subject to depreciation. If the initial costs are misallocated, it can lead to incorrect depreciation calculations.

Typically, when assets are bought together, a discount is applied compared to their individual fair market values. To allocate the total purchase price among the assets, the relative sales value method is employed, which involves three key steps:

1. Determine the total fair market value (FMV): Calculate the combined fair market value of all assets. For example, if the land is valued at $300,000 and the building at $2,700,000, the total FMV is $3,000,000.
2. Calculate the percentage of total FMV for each asset: Divide the fair market value of each asset by the total FMV. In this case, the land represents 10% of the total value ($300,000 / $3,000,000), while the building accounts for 90% ($2,700,000 / $3,000,000).
3. Allocate the purchase price: Multiply the total amount paid by the percentage calculated for each asset. If the total payment is $2,800,000, then the land would be recorded at $280,000 (10% of $2,800,000), and the building would be recorded at $2,520,000 (90% of $2,800,000).

After determining the allocated costs, the journal entry to record the purchase would involve debiting the land and building accounts for their respective amounts and crediting the cash account for the total payment made. In this example, the journal entry would be:

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

This method ensures that the costs are accurately reflected in the financial records, allowing for proper depreciation calculations in the future.

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