On January 1, Year 1, Raven Limo Service, Inc. paid $64,000 cash to purchase a limousine. The limo was expected to have a six year useful life and a $10,000 salvage value. On January 1, Year 5 the limo was sold for $30,000 cash. Assuming Raven uses straight-line depreciation, the Company would recognize a

a. $2,000 loss.

b. $2,000 gain.

c. $20,000 loss.

d. $20,000 gain.

b. $2,000 gain.

Explanation:

Data Given

Cost = $64,000

Useful Life = 6 years.

Salvage Value = $10,000

Used in Business = Year 5 - Year 1 = 4 years.

Selling Price = $30,000

Solution

The gain or loss on disposal of limousine is calculated by comparing carrying value, also known as book value, and selling price.

⇒ Gain / Loss = Carrying Value - Selling Price

where:

Carrying Value = Cost - Accumulated Depreciation

So, first of all we have to calculate the Carrying Value at the end of 4th year, or we can also say that at the start of 5th Year.

⇒ Carrying Value = 64,000 - { [ (64,000 - 10,000) / 6] * 4 } = $28,000

To calculate gain or loss, compare this calculate carrying value with the sale proceeds.

⇒ Gain or Loss = 28,000 - 30,000 = $2,000 of Gain because the company sold a limousine worth of $28,000 for $30,000.