Dorsey Co. has expanded its operations by purchasing a parcel of land with a bui

Question

Dorsey Co. has expanded its operations by purchasing a parcel of land with a building on it from Bibb Co. for $93,000. The appraised value of the land is $30,000, and the appraised value of the building is $106,000. Explain why, for income tax purposes, management of Dorsey Co. would want as little of the purchase price as possible allocated to land. (Select all that apply.) _ Land is current asset _ Land is not a depreciable asset. _ Land value will not reduce taxable income. _ Land is a depreciable asset. _ Land value reduces taxable income.

Explanation / Answer

(b) You want to minimize the amount of the purchase price allocated to land because land cannot be depreciated. A building has some definite useful life, so it can be depreciated, and whatever depreciation amount you come up with can be expensed, reducing your income tax liability. I want to preface the rest by saying I'm not well-acquainted with all the intricacies of GAAP to give you a perfect answer, just my opinion. Take what I say only as a guide. a. You cannot account for something being worth more than you paid for it until you sell it. This would result in a gain, of course, but only then. The appraisal is just an estimate. I believe you should be free to allocate $80,000 to the building and $10,000 to land, in accordance with what I stated in (b). c. I do not believe it would be appropriate for you to carry land with an appraised value of up to $20,000 at the full purchase price of $90,000. The $10,000 cost to raze the building is a separate transaction. In this case, you could restructure the original entry to DR Building $70,000 DR Land $20,000 CR Cash $90,000 This way you preserve as much value (for balance sheet purposes). When you raze the building, you would then be destroying $70,000 worth of value. This would be a cut to equity. DR Owner's Equity $70,000 CR Building $70,000 When you raze the building, DR Demolition Expense $10,000 CR Cash $10,000 For (c), I would not think that you could record any more for land than the maximum appraisal value of $20,000. You have the choice of $10-$20,000 -- so choose $20,000. d. In cost accounting you can only make entries based upon what you pay for something. You could buy a new Ferrari for $1. Even if the Ferrari is worth $1,000,000, you must carry it on your books at $1. What Bibb Co. paid has nothing to do with you. Just think about it. What if they paid $20 for it in 1899? What if they paid $20,000,000 for it in 1999? None of this is relevant to you. It's NOT WHAT YOU PAID FOR IT. Dorsey Co. only is using the appraisal values to HELP decide how to ALLOCATE the cost. Dorsey can only base their book values on what they paid (maximum $90,000).

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