5RQ - Horngren'S Financial And Managerial Accounting

Question

What is a lump-sum purchase, and how is it accounted for?

Step-by-Step Solution

Answer

Lump-sum purchase is the purchasing of assets in the groups. The accounting for this type of purchase is based on the relative-market-value method.

Step 1: Lump Sum Purchase

Lump-sum purchase is a kind of basket purchase in which several assets are purchased in a group and payment is made in a lump sum for all assets in the group.

Thus the lump sum price represents the group of assets cost and not the individual asset cost.

Step 2: Accounting for lump-sum purchase

Lump-sum purchase is accounted for based on the relative-market-value method. 

Under this method, the total cost of the group asset is divided according to their relative market value. 

For example, the lump sum amount for a group of two assets is $10,00,000 and the relative market value for asset one is $700,000 and for the second asset is $500,000. So the $10,000,000 would be allocated based on the relative value of both assets.

Asset one would be allocated 58% and second asset would be allocated 42% respectively.