Question

(Acquisition, Improvements, and Sale of Realty) Tonkawa Company purchased land for use as its corporate headquarters. A small factory that was on the land when it was purchased was torn down before construction of the office building began. Furthermore, a substantial amount of rock blasting and removal had to be done to the site before construction of the building foundation began. Because the office building was set back on the land far from the public road, Tonkawa Company had the contractor construct a paved road that led from the public road to the parking lot of the office building.

Three years after the office building was occupied, Tonkawa Company added four stories to the office building. The four stories had an estimated useful life of 5 years more than the remaining estimated useful life of the original office building.

Ten years later, the land and building were sold at an amount more than their net book value, and Tonkawa Company had a new office building constructed in another state for use as its new corporate headquarters.

Instructions

1. Which of the expenditures above should be capitalized? How should each be depreciated or amortized? Discuss the rationale for your answers.
2. How would the sale of the land and building be accounted for? Include in your answer an explanation of how to determine the net book value at the date of sale. Discuss the rationale for your answer.

Short answer

1. Expenditures should be capitalized when they benefit future periods.The cost to acquire the land should be capitalized.
2. A gain should be recognized on the sale of the land and building.

Step-by-step solution

Meaning of Acquisition of cost

In accounting terms, acquisition cost alludes to acquiring a particular thing. There are three common trade contexts when it is utilized: mergers and acquisitions, fixed resources, and client acquisition

(a) Explaining the answer to the above question

When expenses have a future benefit, they should be capitalized. Land acquisition costs should be capitalized and classed as non-depreciable assets. Because tearing down the small factory prepares the land for its intended use, its cost is included in the costs of the land and should be capitalized and classified accordingly. As a result, this expense will not be depreciated as it would be if it were included in the building's capitalizable cost.

Since rock blasting and removal are necessary for erecting the structure, these expenditures should be capitalized and categorized as part of the capitalizable cost of the project. This expense should be amortized over the building's expected useful life.

The road and parking lot are both land improvements, and their expenses should be capitalized and classed separately as such. These expenses should be discounted over the expected useful lifetimes of the items.

The four additional stories are an addition; their cost should be capitalized and classed with the building's capitalizable cost. Because the life of the old office structure is less than the expected useful life of the expansion, this expenditure should be deducted over that time.

(b) Explaining the answer to the above question

Since revenue is generated anytime the earning process is finished, and a sale occurs, again should be recorded on the sale of the land and building.

The capitalized cost of the land, land improvement, and building, as established above, less the cumulative depreciation on the land improvement and building, would be the net book value at the time of sale. The difference between the selling proceeds and the net book value at the time of sale is shownagain in continuing operations in the income statement.