How to Lump Purchases When Valuing PP&E
Adding intrigue to the mix when valuing property, plant, and equipment (PP&E), sometimes a company buys a bunch of different assets for a lump-sum price. A good example is a real estate transaction that includes all existing equipment within the four walls of the building. The purchaser has to allocate purchase price among land, building, and equipment.
Three valuation approaches are useful for lump-sum purchase allocation:
Market approach: Uses the price of similar assets in an open marketplace
Income approach: Uses expected future cash flows from the assets.
Cost approach: Uses the current replacement cost of the assets.
The company uses the valuation approach that most fairly represents the value of the assets and the transaction.
Walking through an example, imagine that Joe’s $100,000 land purchase includes a small outbuilding and a forklift. Similar forklifts have a price tag of $1,500, the outbuilding costs $14,500, and the land has a fair value of $98,000. The total value of the purchased assets is $114,000 ($1,500 + $14,500 + $98,000). The following figure shows how the purchase price of $100,000 is allocated among land, building, and equipment.