What it means
When a company buys property, the accounts separate the land from the building, because they are treated differently. A building wears out over time, so its cost is spread over its useful life as depreciation.
Land is assumed to last indefinitely, so its cost stays on the balance sheet unchanged unless it is impaired. The cost recorded for land is broader than the headline price.
It normally includes legal fees, title searches, surveys, real estate agent commissions, transfer taxes and any unpaid property taxes the buyer takes on. It also includes the cost of getting the site ready, such as clearing, grading, draining and demolishing an old structure that is not wanted.
If an old building is knocked down to make way for a new one, its demolition cost is generally added to the land cost, reduced by any money received from selling scrap or salvage. This surprises many people, who assume demolition should be an expense.
The logic is that the spend was necessary to prepare the site for its new use. Where land and a building are bought together for one price, the cost must be split between them.
The usual approach is to allocate the price in proportion to their appraised values. A higher share given to land means less depreciation each year and therefore higher profit, which is why auditors and tax authorities look at the split carefully.
Land cost matters in property development, retail expansion, manufacturing and any business that owns its premises. It is also the base figure for later decisions on impairment, sale and tax.
Land improvements such as car parks, fences and landscaping are recorded separately, because they wear out and are depreciated. Land held for a different purpose follows slightly different rules.
If it is held to earn rent or for price growth it may be classed as investment property, and if it is held for sale in the ordinary course of business it may be classed as inventory. The classification decides whether the cost stays on the balance sheet, is revalued, or flows to cost of sales when the land is sold.
In practice
Real-world examples
Example 1
A grocery chain buys a site for a new store at $3,500,000. It adds legal fees, transfer tax and the cost of clearing trees and levelling the ground. All of these costs go into the land account, and the store building itself is recorded separately.
Example 2
A manufacturer buys an existing factory and the land it stands on for $9,000,000. A valuer says the land is worth $2,700,000 and the building $6,300,000. Finance allocates 30% of the price to land, 2,700,000 / 9,000,000 = 30%, and depreciates only the building.
Example 3
A hotel group pays $400,000 to build a car park on its land. The finance team records this as a land improvement rather than land, because the surface will wear out. The car park is depreciated over its useful life.
Think of it
Buying land is like buying a used car. The sticker price is just the beginning. You also have to pay for insurance, road tax, and a mechanic to fix the brakes before you can legally drive it.
Formula
Calculation
Land cost = Purchase price + Closing and legal costs + Site preparation costs - Salvage proceeds
A company buys a plot for $1,200,000 and pays an $18,000 legal fee and $12,000 for a title search and survey. It then spends $70,000 demolishing an old warehouse and receives $10,000 from selling the scrap steel. Land cost is 1,200,000 + 18,000 + 12,000 + 70,000 - 10,000 = $1,290,000. This amount is recorded as land, with no annual depreciation.Case study
Seen in the real world
Stonebridge Developments is an illustrative, fictional property company that bought an old industrial plot to build apartments. The purchase price was $4,000,000, and the finance team initially recorded only that figure as land. Later they paid for soil testing, removal of contaminated earth, legal fees and demolition, which together came to about $620,000.
The auditors reminded the team that costs necessary to prepare the site belonged in the cost of the land or the development, not in the profit and loss account. Reclassifying them kept the first-year profit from being understated by an illustrative $620,000. The episode taught the team to set up project codes at the start of every site purchase.
Watch out
Common mistakes
- Recording only the purchase price and expensing legal fees, surveys and site preparation that belong in the land cost.
- Depreciating land, which is normally not depreciated because it is assumed to have an unlimited life.
- Lumping land and building together instead of splitting the price, which distorts depreciation and profit.
Questions
People also ask
Is land cost ever depreciated?
Not normally, although land improvements with a limited life, such as paving and fencing, are depreciated.
Can land cost change after purchase?
It stays at cost unless the land is impaired, sold or revalued where the accounting framework permits revaluation.
What happens if land is bought for investment rather than use?
It may be classified as investment property, with different accounting rules, so the intended use at purchase matters.