It is necessary to allocate a lump sum payment to individual items in order to record a fair portion of the lump sum in each of the proper general ledger accounts.
For instance, let's assume that a corporation made a lump sum payment of $450,000 in order to acquire a building, the land on which the building sits, and also some equipment. The lump sum payment means that the total cost of $450,000 has to be allocated among three general ledger accounts: Land, Buildings, and Equipment. The allocation must be done in a logical manner for the following reasons:
- the portion of the lump sum cost that is recorded in the Land account will not be depreciated
- the portion of the lump sum cost that is recorded in the Buildings account might be depreciated over a 25-year period, and
- the portion of the lump sum cost that is recorded in the Equipment account might be depreciated over 7 years.