How to Account for Land Improvements?
Land improvement is the additional spending which the company paid to increase the land’s usability. As we already know that land’s useful life is unlimited, however, the land improvement may last only a certain accounting period which represents its useful life.
The land improvement may have its own useful life, so it should be capitalized as a separate asset and calculated the depreciation base on the life span. The cost will be recorded in the balance sheet and depreciate in the income statement.
However, the costs of land improvement may be related to the acquisition of land and make it ready for use. The company needs to prepare land for its intended use, thus all the cost should be capitalized as part of land which will never depreciate.
Land Improvement Example
Land improvement includes the following items:
- Fence
- Driveway
- Lighting
- Landscaping
- Parking lot
Land Improvements as Part of Land
Any expense related to land should be capitalized into land cost in the balance sheet. They are the costs that bring the asset to be ready for use, so they meet the definition to be capitalized as part of the asset.
The cost of land acquisition can be broken down into two main categories: the purchase price and the costs associated with acquiring the land. The purchase price is usually the largest single expense when acquiring land, but it is important to remember that other costs can quickly add up. Other costs can include things like environmental assessments and title deep, while closing costs can include fees for surveys and appraisals. In addition, there may also be some holding costs, such as property taxes, until the land is ready to be developed. When considering the cost of land acquisition, it is important to take all of these factors into account.
All of these costs will be included in the cost of land and they will never depreciate.
For example, after purchasing the land, company A spends $ 10,000 to remove the existing building and $ 20,000 to level the land. Without removing the building and leveling the land, we will not be able to use it. These are the cost of land improvements that should be capitalized as part of land.
Land Improvements Journal Entry
The journal entry is debiting Land $ 30,000 and credit cash paid $ 30,000.
| Account | Debit | Credit |
|---|---|---|
| Land | 30,000 | |
| Cash | 30,000 |
The transaction will increase the the land on balance sheet $ 30,000. It also reduces the cash balance of $ 30,000 if the company has already made a payment to the seller.
Land Improvements as a Separate Asset
Any expense related to the land improvement produces a physical asset and they will last for a specific time period. These costs should be capitalized as a separated fixed asset in the balance sheet. And it will be depreciated over the useful life.
When it comes to capitalizing on land improvements, there are a few things to keep in mind. First, land improvements can include anything from fences and gardens to buildings and roads. Second, the value of the land improvement should be added to the value of the land itself. Third, the capitalization rate should be based on the expected return on investment from the improvement. fourth, the length of time that the improvement is expected to last should also be considered. Finally, any risks associated with the improvement should be taken into account. By taking all of these factors into consideration, you can ensure that you are properly capitalizing on the land improvements.
For example, After purchasing land, Company A spends $ 10,000 to build the fence which expects to last for 10 years. After that, they spend another $ 15,000 to build a parking lot for which will last for 5 years.
The fence and the parking lot is the separated asset with specific useful life. They will decrease the usability over time, so they should be depreciated.
- To capitalize land improvement: The journal entry is debiting land improvement $ 25,000 and credit cash $ 25,000.
| Account | Debit | Credit |
|---|---|---|
| Land Improvement | 25,000 | |
| Cash | 25,000 |
The transaction will increase the fixed assets balance by $ 25,000 on the balance sheet. It also reduces the cash balance by $ 25,000.
- To record the depreciation expense of land improvement $ 4,000 (10,000/10y + 15,000/5y)
The journal entry is debiting depreciation expense $ 4,000 and credit accumulated depreciation $ 4,000.
| Account | Debit | Credit |
|---|---|---|
| Depreciation Expense_Land Improvement | 4,000 | |
| Accumulated Deprecaiton_Land Improvement | 4,000 |
The journal entry is increasing depreciation expense by $ 4,000 and accumulated depreciation by $ 4,000. The company will require to depreciate the fixed assets until they decrease to zero.
Conclusion
The land is a crucial asset for most companies, it represents an asset with infinite life. Land improvements, on the other hand, usually have a finite life. Therefore, companies need to separate these two types of assets and depreciate them according to their policies.
Land improvements are the costs that companies incur on a plot of land to make it more usable. For example, a company might build a factory on a piece of land, or pave a parking lot. While the land itself will not depreciate, the improvements will over time. Therefore, it is important for companies to keep track of these expenses so that they can properly account for them. By doing so, they can ensure that their financial statements are accurate.