Question

Western Bank & Trust purchased land and a building for the lump sum of $3,000,000. To get the maximum tax deduction, Western allocated 90% of the purchase price to the building and only 10% to the land. A more realistic allocation would have been 70% to the building and 30% to the land.

Requirements

1. Explain the tax advantage of allocating too much to the building and too little to the land.
2. Was Western’s allocation ethical? If so, state why. If not, why not? Identify who was harmed.

Answer 1

ANSWER

1.

The building undergoes depreciation expense and land is not depreciated. Allocating 90% to building meant, the depreciation expense for the Western Bank & Trust would be higher.

A larger expense means lesser taxable income and your net income decreases.

2.

The allocation by the Western Bank & Trust is not ethical. As per the principle of accounting conservatism, between two alternatives, the one which does not overstate assets and income must be picked.

The stakeholders here are the Western Bank & Trust and the Government.

The Government will be harmed as they will get fewer taxes than what should have been paid by the Western Bank & Trust.

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