Dividing the Cost of Real Estate into Land and Building
In accounting, the cost of real estate must be divided into:
- The cost of land (because land is not depreciated)
- The cost of the structures (because these require depreciation)
Example of Dividing the Cost of Real Estate
Assume that a company purchases real estate (which includes land and a building) at a cost of $220,000. The appraisal at the time of the purchase indicates that the land has a market value of $50,000 and the building has a market value of $200,000...for a total market value of $250,000. In other words, the appraisal indicates that the land is 20% ($50,000/$250,000) of the market value, and the building is 80% ($200,000/$250,000) of the market value.
The cost principle requires that the purchase be recorded at its cost of $220,000. However, we can use the appraisal amounts as a logical way to divide up the cost of $220,000 between land and building. Here is one approach:
- Assign or allocate $44,000 to the account Land. This is 20% of the $220,000 cost.
- Assign or allocate $176,000 to the account Buildings. This is 80% of the $220,000 cost
A second approach is to compare the real estate's total cost of $220,000 to the total appraisal amount of $250,000. This shows that the total cost is 88% ($220,000/$250,000) of the total market value. Using this approach we will:
- Assign or allocate 88% of the $50,000 market value = $44,000 to the Land account
- Assign or allocate 88% of the $200,000 market value = $176,000 to the Buildings account
