Question

Your client found three suitable sites, each having certain unique advantages, for a new plant. To thoroughly investigate the advantages and disadvantages of each site, one-year options were purchased for an amount equal to 5% of the contract price of each site. The costs of the options cannot be applied against the contracts. Before the options expire, one of the sites was purchased at the contract price of $60,000. The option on this site had cost $3,000. The two options not exercised had cost $3,500 each.

Required: Present arguments in support of recording the cost of the land at each of the following amounts:
a. $60,000
b. $63,000
c. $70,000

Answer 1

The correct answer is option a. Different accounting arguments exist for recording the cost of land as $60,000, $63,000, or $70,000, with GAAP usually favoring the historical purchase price, which in this case is $60,000, excluding the option costs.

Step-by-step explanation:

When recording the cost of land for accounting purposes, different arguments can be presented for various recording amounts based on the underlying accounting principles.

• Recording at $60,000 - Following the historical cost principle, the land would be recorded at its contract price without considering the option cost or alternatives, as the transaction amount is the actual price paid.
• Recording at $63,000 - One could argue for this value considering the actual cash outflow for this particular land, which includes $60,000 for the purchase price plus the $3,000 spent on the option.
• Recording at $70,000 - This approach considers the total costs incurred, including the options not exercised. One could argue that all three options were part of the decision-making process for the purchase, rendering their cost relevant.

However, generally accepted accounting principles (GAAP) tend to favor recording at the historical purchase price of $60,000, as it reflects the outlay for the asset itself.