Assume that an investment group owns a high-rise, oceanfront condominium building that it rents unfurnished to tenants. The group purchased the building five years ago from a construction company. At that time, it expected the building to have a useful life of 40 years. Explain the procedures you might follow as the investor group's accountant to ascertain the measurement amount for this building
under each of the following approaches:
a. Acquisition cost.
b. Adjusted acquisition cost (reduced for services already consumed).
c. Current replacement cost.
d. Net realizable value.
e. Fair value.
a. Acquisition Cost. The contract between the investors and the construction company as well as canceled checks provide evidence as to the acquisition cost.
b. Adjusted acquisition cost. Adjusted acquisition cost differs from the amount in Part a. by the portion of acquisition cost applicable to the services of the asset consumed during the first five years. There are several generally accepted methods of computing this amount (discussed in Chapter 10). A review of the accounting records for the building should indicate
how the firm calculated this amount.
c. Current Replacement Cost. There are at least two possibilities for ascertaining current
replacement cost. One alternative is to consult a construction company to determine the cost of constructing a similar building (that is, with respect to location, materials, and size). The accountant would then adjust the current cost of constructing a new building downward to reflect the used condition of the five-year-old building. The current replacement cost amount could be reduced by 12.5% (= 5/40) if the asset's service potential decreases evenly with age. The actual economic decline in the value of the building during the first five years is likely to differ from 12.5% and, therefore, some other rate is probably appropriate. A second alternative for ascertaining current replacement cost is to consult a real estate dealer to determine the cost of acquiring a used building providing services similar to the building that the investors own. The accountant might encounter difficulties in locating such a similar building.
d. Net realizable value. The accountant might consult a local real estate dealer to ascertain the current market price, net of transactions cost, at which the investors might sell the building. There is always the question as to whether an interested buyer could be found at the quoted price. The accountant might also use any recent offers to purchase the building received by the investors.
e. Fair value. The accountant might use the amount described in Part d. but exclude transactions cost when measuring fair value. The accountant might also measure fair value using the present value of the future net cash flows based on estimated rental receipts and operating expenses (excluding depreciation) for the building's remaining 35-year life. These cash flows are then discounted to the present using an appropriate rate of interest. The inputs to the fair value measurement are those that a market participant would use.
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