1. Acquisition Cost of Assets

Let's talk about acquisition costs. Now, if you'll remember, we're supposed to record our assets on the balance sheet at their historical cost, right? So how are we supposed to know what that historical cost actually is? Is it the price that we paid? Is it the price that we paid plus the commissions that we paid? That's what we're trying to figure out when we're looking at acquisition costs. We're trying to figure out what all costs can we actually associate with this asset. So of all of these costs that we have around the asset, which ones can we say, "Yes, those belong to the assets," and which one can we say, "No, those are just operating expenses.

You don't really get to call that part of the acquisition cost of the asset"? So that's what we're trying to figure out here. And you have to kind of start at a broad level, because this requires a lot of judgment. So at a very broad level, it's all costs that are normal and necessary to acquire and prepare the asset for its intended use.

So it's every cost that is normal, meaning not out of the ordinary, every cost that is ordinary, and every cost that is ordinary and necessary, meaning we have to pay the cost in order to get the asset ready for its intended use. So I would recommend remembering this, because in the situations where you come across one that you don't know or you don't recognize, you need to ask yourself, "Is this cost normal, in that is it ordinary? Is this an expected cost? Is it necessary? Do we have to pay this cost? If it's both normal and necessary, then does it prepare the asset for its intended use?"

So when you run across one you don't understand, apply these three things, and that will help you figure out whether you can add it into the acquisition cost or whether it's just an expense. Let's start with land. So for land, there are a bunch of costs, and the first one is obviously the purchase price.

You're gonna have to pay for the land, and whatever you pay for it becomes part of the acquisition cost. Now, with land, you'll also see land preparation costs. And this is when you have something like an old building on the land that you need to get rid of to prepare it for its intended use. So if you're gonna try to build on the land, you have to remove the old decrepit buildings that are there so that it can be used for your intended use, which is building another building. Now, when you knock down a building, you can sell some of that stuff for salvage. So if you knock down a five-story brick building, you can sell some of those bricks for money, and that's the salvage.

So these two go together. You knock down a warehouse, that costs you money, but then you can sell bits and pieces of that warehouse, and that gets you money. So you have to take those two together. And this is often called razing. So if you see on your test a building was razed, so it'll say, "Razing," or, "You had to raze a building," that means knock down to the ground, basically bulldoze. So if you see these two words, that's what this means. You're getting rid of a building. So you'll see something like, "Cost, $10,000 to get rid of the building. Proceeds from salvage were $1,000."

So you add the cost of the preparation, and you take out the cost of whatever money you got back for salvage. And then there are a lot of fees that I kind of lump under transactional fees, maybe legal, maybe transactional, but it's stuff like sales commissions. That's normal, and it's necessary. You have to pay your realtor, so you have to add in sales commissions. Then you have stuff like back taxes. So if you buy a piece of land, and the previous owner didn't pay $10,000 in taxes, when you buy it, you're gonna have to pay the back taxes to bring that up.

Then you can also include any title costs. So you can include title fees and title insurance. And title fees and title insurance ensure that you own the land cleanly, that no one else has a claim to it. You own the title to the land. And then you can add in any other legal fees that are normal and necessary to get the land to its intended use. Now, what you wanna look out for here, especially on this land prep one, especially when you see land preparation, you need to be careful, because there could be stuff like sidewalks and parking lots.

But you don't get to count that as part of your land acquisition costs, because sidewalks and parking lots are gonna fall under a different category called land improvements, because these have to be maintained by the company, and more importantly, they have a useful life. So we're gonna separate those and depreciate them on their own. So when you see land prep, you need to be careful and think, the things that they're doing to the land, do they have a useful life? Is this some sort of land improvement, or is this just a preparation for building, or is it a preparation for land improvements? This is where a lot of people get in trouble.

They like to add sidewalks and parking lots and lampposts and all this stuff to land preparation, when really that goes under land improvements. So let's just talk about land improvements. Land improvements are things that are semi-permanent. They feel permanent, but they have a useful life, like the sidewalk and like the parking lot that we talked about above. A useful life, and they're improvements that the company must maintain.

So unlike land, land has an unlimited useful life. Land is just gonna keep on being useful forever. So we don't ever depreciate land, but land improvements we do depreciate because they have a useful life. So this is, like I said above, this is sidewalks, parking lots, lampposts, even some landscaping has a useful life, and the company must maintain it. So if it fits these two categories, then put that into land improvements. If it feels like land, but it has a useful life, that's a pretty good indication that that's a land improvement. And the acquisition cost here is pretty simple. It's just what you paid for it.

There's really not a whole lot. Like up here, you had all these different costs, but for land improvement, there's really not a lot to talk about. Now with buildings, there's a little bit more. With buildings, you have the price you paid, again, then you also have closing costs.

And closing costs can be some of these same things right here. So some of these things can be your closing costs. So again, you've got your purchase price and then some transactional or some legal stuff that you have to pay for. So just like above, you've got broker's fees or sales commissions, anything around the transaction of actually closing the deal. You're gonna see a lot of these show up in the acquisition cost of buildings because there are a lot of people involved when it comes to buying a building. And then the next one you're gonna see is remodeling costs.

So with remodeling costs, that falls under bringing it up to its intended use. It is a normal and necessary expense required to get the building to its intended use. So we capitalize that as part of the building and then depreciate it over the life of the building as well. There's one other that is only sometimes. Sometimes you're gonna do interest. Now, the only time that you're gonna capitalize interest is if you are constructing the building. So if you're actually building the building, then you get to capitalize your interest costs to be a part of your building cost. So the typical situation when you're constructing a building is you take out a construction loan.

So you take out a construction loan upon which you're paying interest. The whole time you have that construction loan, you're paying interest on the money that you borrowed. Then when you're finally done, you pay off the construction loan by taking out a more traditional mortgage. And so what we're saying here is when you are constructing the building, you get to capitalize your interest expense as a part of your building expense. So you get to capitalize that and then depreciate that over the life of the building.

And the last one is equipment. Now, equipment is relatively straightforward. You've got the price you paid, but then you have to take out any discounts because you didn't pay the discount. So if you have an invoice price of $1,000, but then you paid early and got a $10 discount, you don't get to capitalize the whole $1,000 into the equipment account. You only get to capitalize the $990 because you didn't pay that $10. The invoice said $1,000, but it also said discount of $10. So take out any discounts and then also add on any sales tax because that is necessary and required. It's normal and it's necessary to pay sales tax when you buy a piece of equipment.

So those are all pretty straightforward. The next two can take some thought. It's freight-in, so what you paid to get it there, and installation. These two are required to get the machine to your warehouse or your office or whatever it is. They are normal and they are necessary. You have to pay to get it there. And before you can actually use the machine, it has to be installed. So you get to capitalize these things into the equipment account just as if it was part of the invoice price. Because if your intended use for a giant copy machine is to make copies, well, then getting it to your office and paying the Xerox guy to install it, those are normal and necessary costs in order to prepare the asset for its intended use.

The last little oddball is you've got trial runs. So if you're a manufacturing company and you get a $100,000 piece of equipment delivered, you're gonna spend some money on trial runs to make sure that it's working as expected. And any of those costs you incurred during that trial run, you also get to capitalize. So all of these things together make up the acquisition cost of a piece of equipment. The invoice price, easy enough. Discounts, the amount of money that you didn't actually pay. Sales tax, the money required by the state when you buy something. Freight-in and installation are required to get the piece of equipment to your premises and have it installed and be working properly.

And then trial runs ensure that after it's there and installed, it actually works. So all of those things together go into the equipment account as part of your acquisition cost. And there's one I wanna point out. When you see installation, if you see the thing was damaged during installation and you had to pay to repair it, you don't get to count this one. If you damaged it when you were installing and you have now some repair fee, that's just an operating expense. You broke the thing and now you have to pay to repair it. That is not normal and necessary. That's abnormal. That's an infrequent occurrence.

So that doesn't count under our definition. Now, all this stuff requires some practice and it requires some memory. So make sure you're familiar with what all of these things mean. But overall, I want you to remember costs that are normal and necessary to prepare the asset for its intended use. And as you go through, ask yourself, is this normal and necessary? Is this ordinary? Does this happen a lot? Do I have to do this thing? And that will help guide you when you see ones that you're not expecting on the test.