Donner Company is selling a piece of land adjacent to its business premises. An appraisal reported the market value of the land to be
111,289. The companies settled on a purchase price of
103,641. Under the cost principle, at what amount should the land be recorded in the accounting records of Focus Company
The Correct Answer and Explanation is:
Correct Answer:
The land should be recorded in the accounting records of Focus Company at 103,641.
Explanation:
According to the cost principle in accounting, assets must be recorded at their original purchase cost, not at their current market value. This principle ensures objectivity and consistency in financial reporting. The cost principle is one of the foundational concepts in generally accepted accounting principles (GAAP).
In this case, the appraisal determined that the land has a market value of 111,289. However, the buyer and seller agreed on a final purchase price of 103,641. This is the actual amount of money exchanged in the transaction, and it reflects the real cost incurred by Focus Company. Therefore, this is the amount that must be recorded in Focus Company’s accounting records.
The reason behind recording assets at cost rather than market value is to provide a reliable and verifiable figure. Market values can fluctuate due to various external factors such as economic conditions, location developments, or investor speculation. However, the purchase price is a concrete, documentable figure supported by a sales contract or invoice.
Recording the land at the agreed purchase price of 103,641 provides transparency and prevents the manipulation of asset values. If the company were to use the appraised value of 111,289 instead, it could give a misleading impression of the company’s financial position and overstate the value of its assets.
Additionally, over time, the cost of the land remains unchanged in the accounting books. Unlike buildings or machinery, land is not depreciated. Any increase or decrease in its market value will not be reflected until the land is actually sold. Until then, it remains recorded at the original cost, which in this case is 103,641.
In summary, based on the cost principle, Focus Company should record the land at 103,641, the actual amount paid to acquire it.
