7. The treatment of land as stock in trade.—The treatment of land purchased by a real estate concern for development and subsequent sale will be different from that outlined above. No difficulty will be en countered in transactions of this kind if we realize the fact that the land is similar to raw material pur chased by a manufacturing concern for the manufac ture of finished products. The cost of grading, street openings, sidewalks, and sewer and water connections, all enhance the value of the property and should be capitalized. Taxes, interest on purchase-money, mortgages, and all carrying charges during the period of development may also be capitalized.
It is customary in real estate developments to keep costs by plots. Each plot is then cut up into a cer tain number of lots, and the total expense of the de velopment divided by the number of lots will be the cost per lot. When a sale is made, the proceeds of the sale are in part a realization of the capital invest ment and in part a realization of profit. In order to determine that portion which represents a return of capital and that portion which may properly be taken to the credit of the profit and loss account, it is neces sary to keep accurate costs by plots or lots.
While capital charges ordinarily cease after the property is fully developed, in order to determine the real profitableness of the undertaking it is customary to capitalize interest charges, running expenses and taxes even after the development has been completed. This is for the purpose of estimating not only the total cost to develop, but also the cost of carrying each in dividual lot. However, if this method is followed, carrying charges capitalized after operations have be gun should be offset by the creation of a suitable re serve against the possibility of the failure to realize such carrying charges when the lots are ultimately sold. Upon the subsequent sale of lots, the reserve created with respect to this particular lot, or the por tion of the general reserve created with respect to this particular lot, will be adjusted, and such portion of it as has been realized in the sales price of the lot will be released to surplus.
8. The valuation of leaseholds and leasehold rights. —With reference to leaseholds, it is important to note the length of the life of the lease. The benefit of all expenditures made either for land improvements or for buildings upon leased land, will pass ordinarily to the landlord at the expiration of the lease. Conse quently, any value paid for the lease, or any expendi ture incurred upon leased property, must be written off during the life of the lease. When a party takes
land under lease and makes extraordinary improve ments, the lease frequently is drawn with a provision in which the landlord agrees to pay a fixed sum, at the expiration of the term, to the tenant for the tenant's improvements. This factor must be taken into con sideration in valuing a leasehold.
In other cases, a firm may have sublet its lease hold rights, and the question 'of the valuation of the leasehold may arise. Ordinarily such contracts are not capitalized, and the question of their value would probably not arise except in the case of a partnership, when it might be necessary to determine the value of a deceased partner's interest. The annual income to be enjoyed from the lease, less all carrying charges, may be considered as an annuity for the number of years that the lease has to run, and from the compound interest tables the present worth of the annuity can be worked out. Any sum recoverable from the land lord at the expiration of the term of the lease may be valued by finding its present worth from the com pound interest tables at an assumed rate of interest.
9. Mineral land and timber prin ciples of valuation are difficult to apply in cases of wasting assets. Every dollar's worth of ore taken from a mine, or every gallon of oil from an oil well, reduces the value of the land for the purposes for which it was acquired. The proceeds of sales are represented in part by a return of the capital invest ment and in part by a realized profit. Because of the difficulty of arriving at these amounts, mining companies, as a rule, do not make any provision for the conservation of the capital investment, but they customarily pay out all the net proceeds of current operation as dividends.
Where the purchase of land, containing mineral wealth has been financed thru an issue of bonds, there will usually be a provision in the indenture creating a sinking fund for the ultimate redemption of the debt. It is not generally considered desirable in mining Companies to provide a reserve for exhaustion, for the reason that the creation of the reserve results in with holding large sums of cash in the company's treasury. This fund may not be safely invested in additional mineral wealth; it will draw a small rate of interest and it may be used for speculation by the board of directors or otherwise mismanaged.