Basket Purchase

Question: At times, two or more assets are acquired for a single price. The most common example is the purchase

of a building along with the land on which it is constructed. As has been discussed, the portion of the cost assigned

to the building is depreciated over its useful life in some systematic and rational manner. However, land does not

have a finite life. Its cost remains an asset so that there is no impact on reported net income over time. How does

an accountant separate the amount paid for land from the cost assigned to a building when the two are purchased

together?

Assume a business pays $5.0 million for three acres of land along with a five-story building. What part of this cost

is attributed to the land and what part to the building? Does management not have a bias to assign more of the

$5.0 million to land and less to the building to reduce the future amounts reported as depreciation expense?

Answer: Companies do occasionally purchase more than one asset at a time. This is sometimes referred to as

a basket purchase. For example, a manufacturer might buy several machines in a single transaction. The cost

assigned to each should be based on their relative values.

For this illustration, assume that the land and building bought for $5.0 million have been appraised at $4.5 million

and $1.5 million, respectively, for a total of $6.0 million. Perhaps the owner needed cash immediately and was

willing to accept a price of only $5.0 million. For the buyer, the land makes up 75 percent of the value received

($4.5 million/$6.0 million) and the building the remaining 25 percent ($1.5 million/$6.0 million). The cost is

simply assigned in those same proportions: $3.75 million to the land ($5.0 million × 75 percent) and $1.25 million

to the building ($5.0 million × 25 percent).