What effect does the purchase of land for cash have when you're working out your accounting ledger? Accounting for land is complicated, and the answer could impact your books for the entire duration that you own a parcel. If you're purchasing with cash, you may specifically be interested to know about the ways that purchasing land for cash can impact an owner's equity.
To get a simplified answer, you must ask one pivotal question. Is land an asset or equity? Take a look at the basics of accounting and how purchasing land for cash impacts owner equity.
Is Land an Asset or Equity on a Ledger?
When you purchase land for cash, you're actually participating in an asset exchange transaction. The simple definition of an asset exchange transaction is an exchange where one asset is exchanged for another. In the case of land for cash, you're providing the full cash asking price for a parcel in exchange for full and immediate ownership of the parcel. As a result, the total assets listed actually remain the same following the conclusion of the transaction.
While cash is considered a liquid asset that gets categorized as a "current" asset, land is considered a "long-term" asset. This slight nuance in categorization doesn't impact the relationship between the two assets in terms of how they're treated on a ledger.
Does Land Purchase Impact Equity?
Paying full cash for land is really a "swap" of one asset for another asset of equal value. Due to the fact that the cash and the land have interchangeable values in this scenario, there is no net effect on the ledger. If you're curious about the order that current assets are listed on a balance sheet, it's helpful to know that total assets are typically placed in the first section of a company's balance sheet.
Considerations to When Managing Accounting with Cash For Land
Generally, you're looking at an even value swap when paying cash for land. This means that a company maintains a steady balance sheet with no change in relation to the exchange of cash for land. However, changes in the value of the land over time can create the need for adjustment.
As a rule, land does not depreciate in value. That means that a company will maintain the historical value of the cash price for the land for the entire length of time that the land stays under the company's ownership.
In some cases, it's necessary to go back to revalue a parcel of land in the event that its value sees a significant dip. While rare, this does sometimes happen due to wild fluctuations in a particular real estate market. In other cases, depletion can be necessary if value-adding features are removed from a property after the point of purchase.
Does Buying Land with a Loan Impact Owner’s Equity?
The short answer is that it doesn’t impact equity. The reason for this is that the debt incurred through the purchase of the land is balanced out by the acquisition of the land on the ledger. Like a cash purchase, this is a "swap" transaction.
This "balancing act" remains consistent throughout the life of the loan because the company owns more of the land as the company's cash decreases with each payment. This creates a consistent scenario where cash out versus the value coming in results in both getting canceled out.
Adam Luehrs is a writer during the day and a voracious reader at night. He focuses mostly on finance writing and has a passion for real estate, credit card deals, and investing.