Question

Explain the method generally used to allocate the cost of a lump-sum purchase to the individual assets acquired. please answer in your own words, do not use the outside resources.

Answer 1

Assets are the values and things the company is owned which provides the benefits in form of future cash inflow or usage for the company. Each assets should be recorded seperately as an when acquired and needs to be distinguished as per the nature of assets, its usage and availability.

Lumpsum purchases of assets means acquiring two or more assets at a single price either as composition assets or different class of assets. For example. Land and buildings are acquired as a composite assets , and acquiring plant, land , equipment etc at a single lumpsum price.

Here in case of lumpsum purchases the price actually paid is less than if buyer individually so it saves costs of the company, now the purchase of lumpsum assets needs to be bifurcated using the fair value approach of the acquired assets. i.e the assets acquired needs to be adjusted based on the proportion of fair value of assets acquired.

Here the fair value from independent valuers is established and totalled for all the assets acquired, then proportionally for each assets the total cost of acquired assets is distributed in fair value proportion.

For example if land and building is acquired for $ 600,000 in lumpsum, so the bifurcation of cost will be made on fair value basis, let fair value of land = $ 500000, and fair value of Building = $ 300000 then the bifurcation of the cost will be as follows:

Total the fair value = $500000 + 300000 = $ 800,000, then proportionally allocate the cost of assets based on fair value as

Cost of assets = lumpsum price × fair value of assets/ total fair value.

For land cost = $ 600000 × 500000/800000 = $ 375000.

For building cost = $ 600000 × 300000/ 800000 = $ 225000.