Definition
The term lump sum purchase refers to an agreement that involves a single price paid for a bundle, or group, of assets. Since the lump sum purchase can involve several asset classes, it's necessary to allocate the price paid to each asset so the purchase can be accurately reflected on the company's balance sheet.
Explanation
It's fairly common for a company to purchase a group of assets, and not explicitly identify the price paid for each item as part of the purchase agreement. The classic example would be the purchase of a building. The buyer may have paid one price for the building, land, and equipment inside the structure.
The accountant's challenge is to assign book values to each asset type. This can be accomplished using an appraisal of each item's fair market value and assigning a pro rata share of the purchase price to each. This information can be refined if the seller provides the remaining book value of each asset to the buyer.
Example
Company A has entered into an agreement to purchase a call center from Company XYZ. As part of the agreement, Company A is entitled to the land, office building, as well as the telecommunications equipment. Company A has negotiated a lump sum purchase price of $30,000,000.
In this example, we'll assume the assets are of three types: telecommunications equipment, building, and land. Company A's insurance appraiser indicated the land is valued at $2,000,000, the building at $34,000,000 and the telecommunications equipment at $4,000,000. With this information the following allocation was performed by Company A's accounting department:
Fair Market Value | % of Total | Allocation of Lump Sum | |
Land | $2,000,000 | 5.0% | $1,500,000 |
Building | $34,000,000 | 85.0% | $25,500,000 |
Equipment | $4,000,000 | 10.0% | $3,000,000 |
Totals | $40,000,000 | 100.0% | $30,000,000 |
Related Terms
Also known as a statement of financial position, the balance sheet is used to show the financial health of a company at a particular point in time. The balance sheet consists of assets, liabilities, and owner's equity in the company. It is one of the four key financial statements issued by public companies.
Moneyzine EditorNovember 6th, 2024- The financial accounting term property, plant, and equipment is used to describe assets of a long lasting nature, which are used in the normal operation of the company. The most common types of property, plant, and equipment are land, buildings, and machinery.Moneyzine EditorSeptember 21st, 2023
The financial accounting term cost of equipment refers to the asset valuation method that applies to equipment appearing on a company's balance sheet. The cost of equipment would include all expenses associated with the acquisition of the equipment as well as those needed to ready it for use by the company.Moneyzine EditorJanuary 12th, 2024
The financial accounting term cost of land refers to the asset valuation method that applies to land appearing on a company's balance sheet. The cost of land would include all expenses associated with the acquisition of the property, as well as those needed to ready it for use by the company.Moneyzine EditorJanuary 12th, 2024
The financial accounting term cost of buildings refers to the asset valuation method that applies to buildings appearing on a company's balance sheet. The cost of buildings would include all expenses associated with the acquisition or construction of the building to ready it for use by the company.Moneyzine EditorSeptember 19th, 2023- The financial accounting term self-constructed assets refer to those built by the company and appearing on its balance sheet. The cost of self-constructed assets would include direct costs such as materials and labor associated with its construction. Companies can optionally allocate a portion of indirect costs to the asset too.Moneyzine EditorSeptember 21st, 2023
The financial accounting term deferred payment contract refers to an agreement to purchase an asset using a long-term credit arrangement. Accountants need to understand the terms of a deferred payment contract since they can be used to value an asset appearing on the company's balance sheet.Moneyzine EditorSeptember 19th, 2023
The financial accounting term interest costs during construction refers to the financing charges incurred during the creation or acquisition of assets such as property, plant, and equipment. Companies can capitalize interest costs if they are material, otherwise they should be expensed.Moneyzine EditorJanuary 22nd, 2024
