2. Lump Sum Purchases

Let's talk about a lump sum purchase. A lump sum purchase is when a company buys two or more assets at the same time. So if they buy two or more assets at once, and they pay one price for them, we have to figure out as the accountants how to allocate that purchase price. So if a company spends $100,000 on land plus a building, we need to figure out how do we break that $100,000 down into some part towards land and some part towards the building. And the way that we do that is based on fair market value. So what happens is we get an appraisal for the land, and we get an appraisal for the building.

So we determine how much is the land worth at a fair market value, and how much is the building worth at a fair market value. So when those appraisals come back, here's what we do. We know that we paid $100,000 to buy both of them. So if the appraisals come back, and they say, "Okay, the land that you bought is worth $80,000. The building that you bought is worth $40,000." So if we get an independent appraiser, and they come back and say, "Land is worth 80, building is worth 40," we can't just go and put 80 and 40 into the account.

We can't just say, for example, cash 100, building, land, 40, 80, right? Because those don't add up. So we can't just take these fair market value estimates and assign those to the categories, right? 'Cause first of all, they don't match, and second of all, this isn't historic cost. We're basically saying we paid 120 when we really paid 100.

So what we do is we just make it a ratio and allocate the 100 that we paid based on the ratio. So what you wanna do is you wanna find out what is the value, what's the fair market value of the entire group? What's the fair market value of everything that you paid for? In this case, the fair market value would be 120 because the land is worth 80, the building is worth 40, so the fair market value of the whole thing is 120. Now, we know that we only paid 100, so what we're gonna do to find the cost of the land is we're gonna say land equals $100,000 purchase price times 80 over 120.

Because you could look at it like this. You could say the cost of the land over the cost of the whole group equals the fair market value appraisal of the land over the fair market appraisal of the entire group. Right? So we're basically just setting up this ratio, and it comes out to be, if you times this side by 100, multiply this side by 100, you come out with this equation right here. So we're applying this fair market value ratio to the purchase price to find out the value of each individual one. So this is two-thirds. 80 over 120 is two-thirds, and unfortunately, it comes out to 66,666.66.

So this becomes 66,667, two-thirds of $100,000. And the building, you can do the same way. You can say 40 of the fair market value over 120, which is the whole fair market value, times the purchase price will give us the amount that we allocate towards the building. And here, we just calculated it with two. We calculated it with land and building, but there can be way more assets than that. You could have five assets, and the process is still the same.

You come up with the total fair market value. In our case, 120 was our fair market value that we came up with. And then we took the 80 and the 40 and allocated that out, basically two-thirds and one-third like that. So we said the building was worth 40 and the land was worth 80, which totals to 120. But we know that we only spent 100, so the pie that we're working with is only 100. But we just apply the exact same ratio, and we end up with 33 and 66, or 66.7.

This is the whole process. This is all we're doing. We're coming up with a ratio and applying a ratio to the purchase price. So if you see one that has three assets, one for 30, one for 30, and one for 60, and the purchase price again was 100. So if the purchase price was 100 and the fair market values were 30, 30, and 60, well, you need to find out what is the total fair market value. The total fair market value again is 120, and then for each of your assets, you have 30, 30, and 60.

So you end up with one-fourth of the purchase price, one-fourth of the purchase price, and one-half of the purchase price. So in this one, you would split up your assets 25, 25, and 50. So you can see this is a super straightforward process. You just gotta find out how big is this fair market value pie, how big is the purchase price pie, and then divide your pies the same way.