Final answer:
The question deals with accounting procedures for allocating the cost of multiple assets acquired for a single purchase price. To allocate the costs, the student must calculate the proportionate share of each asset's fair value and apply that proportion to the purchase price. This calculation is important for financial reporting and informs the business's equity in assets.
Step-by-step explanation:
The student's question pertains to the allocation of a lump sum purchase price among different assets acquired, a common practice in accounting when a business, such as Red Rock Bakery, acquires multiple assets for a single, combined price. In this scenario, Red Rock Bakery purchases land, a building, and equipment at a total cost of $200,000. However, the individual estimated fair values of these assets are $105,000 for land, $180,000 for the building, and $15,000 for equipment, adding up to a total estimated fair value of $300,000.
Allocation of Purchase Price
To allocate the $200,000 purchase price, we must determine the proportion of the total fair value that each asset represents. This is done by dividing the fair value of each asset by the total fair value and then multiplying the resulting percentage by the total purchase price.
Land: ($105,000 ÷ $300,000) × $200,000 = 0.35 × $200,000 = $70,000
Building: ($180,000 ÷ $300,000) × $200,000 = 0.60 × $200,000 = $120,000
Equipment: ($15,000 ÷ $300,000) × $200,000 = 0.05 × $200,000 = $10,000
Answering Part b and c
For Freda's house, her equity is $250,000, regardless of her initial purchase price, because she has no debt against the property.
For Ben's house, since he originally borrowed $80,000 ($100,000 total price - 20% down payment) and has paid off $20,000, he owes $60,000. The current value of his house is $160,000, so his equity is $100,000 ($160,000 current value - $60,000 remaining loan).