Final answer:
The cost of the land purchased by a firm, upon which a building is torn down, is capitalized as it represents a fixed cost and is considered a long-term asset.
Step-by-step explanation:
When a firm buys land on which there is a building, and the building is torn down to construct a new building on the land, the correct accounting treatment is to capitalize the cost of the land. This is because the land represents a fixed cost and an asset for the firm that will presumably benefit the firm for a long period of time. The cost of the land is not expensed immediately, added to the building cost, or subtracted from the building cost. It is considered a separate asset on the company's balance sheet.
The recognition of fixed assets like land is crucial in determining the profitability and financial status of a business. Factors of production, which include land, influence business decisions significantly. For example, in industrial site location analysis, the cost of land can determine whether a site is viable for something as substantial as a factory.