Final answer:
The cost of a lump-sum purchase is allocated to individual assets based on their relative fair market values, ensuring the cost allocation is proportional to their value.
Step-by-step explanation:
When a company makes a lump-sum purchase that includes multiple assets, it needs to allocate the total cost among the individual assets acquired. The method typically used for this allocation is based on the relative fair market values of each asset. Here’s how:
- Determine the fair market value of each individual asset included in the lump-sum purchase.
- Calculate the total fair market value of all assets combined.
- Allocate the total cost paid for the lump sum based on the proportion of each asset’s fair market value to the total market value.
This method ensures that the cost allocated to each asset is proportional to its value. For example, if a firm purchases a bundle of assets for a lump-sum of $100,000, where Asset A is valued at $40,000 and Asset B at $60,000, Asset A would be allocated 40% ($40,000) of the purchase price, while Asset B would be allocated 60% ($60,000).
Firms use this allocation as part of their investment strategies to properly reflect the value of the assets on their balance sheets and to depreciate them accordingly over time. This systematic allocation is part of a broader financial strategy involving decisions on raising financial capital such as from early-stage investors, reinvesting profits, borrowing through banks or bonds, and selling stock.