Rownan Corporation is a real estate development company. In addition to developing raw land,

Rownan Corporation is a real estate development company. In addition to developing raw land, it constructs and rehabilitates office buildings, which it then sells.

Rownan recently acquired a building of a failed business for $5 million. The building has been vacant since last year when the business was declared to be insolvent and its assets were sold. Rownan bought the building with the intention of gutting most of the interior, and then remodeling it into a “class A” building, and then selling it.

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Because the building was constructed a number of years ago, lead pipes were installed for its plumbing system. Since 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. Rownan 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.

Required:

  1. How should Rownan recognized the cost of removing and replacing the plumbing system?
  2. Assuming Rownan was not aware of either the regulation or the presence of the lead pipes, how should the company recognize the cost?
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