What is the Main Accounting Issue?

INSTRUCTIONS:

RESEARCH EXERCISES

Answer the required questions for each of the following exercises. You do not need to use the memo format.

Exercise 1. The Ryan Corporation

The Ryan Corporation is a real estate development company. In addition to developing raw land, it constructs and rehabilitates office buildings, which it then sells. Ryan recently acquired the building of a failed savings and loan company for $5 million. The building has been vacant since last year when the government declared the S&L to be insolvent and sold its assets to another, healthier one. Ryan bought the building with the intention of gutting much of the interior, remodeling it into a modern, "class A" building, and then selling it.

Because the building was constructed a number of years ago, lead pipes were installed for its plumbing system. Because lead pipes have been found to contaminate the water they carry, the government has deemed them to be a health hazard and adopted regulations requiring their removal and replacement whenever a building is renovated. Ryan was aware of the regulation when negotiating for the building`s purchase. The total cost of remodeling the building will be $4 million, of which $500,000 is for removal of the lead pipes and replacement with copper plumbing. The remodeling will not increase the building`s expected useful life, although it will enhance its rental value. Ryan has been a client of your firm, Honest Abe CPA, and you are assigned to help Ryan on how to account for the cost of removing and replacing the plumbing system.