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Basket (Lump-sum) Purchases quiz #1

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  • What is the relative sales value method, and how is it used to allocate costs in a lump sum (basket) purchase of assets such as land and building?
    The relative sales value method allocates the total cost of a lump sum purchase among multiple assets based on their individual fair market values. The process involves three steps: (1) determine the total fair market value of all assets purchased, (2) calculate each asset's percentage of the total fair market value, and (3) multiply these percentages by the total amount paid to assign a cost to each asset. This ensures accurate cost allocation, especially important when assets like land (not depreciated) and buildings (depreciated) are involved.
  • What is a lump sum (basket) purchase in accounting?
    A lump sum (basket) purchase is when multiple fixed assets are bought together for a single total price, requiring cost allocation to each asset.
  • Why is it important to allocate costs correctly between land and building in a basket purchase?
    It's important because land is not depreciated while buildings are, so incorrect allocation affects depreciation calculations and financial reporting.
  • What is the first step in the relative sales value method for allocating costs in a basket purchase?
    The first step is to determine the total fair market value of all assets purchased.
  • How do you calculate each asset's percentage of the total fair market value in a basket purchase?
    Divide the fair market value of each asset by the total fair market value of all assets purchased.
  • What is the final step in the relative sales value method for cost allocation?
    Multiply each asset's percentage of the total fair market value by the total amount paid to assign a cost to each asset.
  • In the example given, what were the fair market values of the land and building?
    The land had a fair market value of \$300,000 and the building had a fair market value of \$2,700,000.
  • How much of the total payment was allocated to the land and building in the example?
    The land was allocated \$280,000 (10%) and the building was allocated \$2,520,000 (90%) of the \$2,800,000 total payment.
  • What is the journal entry to record the purchase of land and building in a basket purchase?
    Debit Land for \$280,000, Debit Building for \$2,520,000, and Credit Cash for \$2,800,000.
  • Why do companies often pay less than the total fair market value in a basket purchase?
    Companies often receive a discount when buying multiple assets together, resulting in a total payment less than the sum of individual fair market values.