Question

A computer was sold for $5,000 after it had been used for 3 years. Originally the computer was purchased at $10,000, with a 5-year useful life and $1,000 salvage value. Assume the computer is depreciated under straight line method,which of the following statements correctly describes the computer sale? Assets and stockholders' equity both decrease by $400. Assets and stockholders' equity both increase by $5,000. Assets and stockholders' equity both increase by $400. O Assets decrease $5,000 and stockholders' equity is not affected.

Answer 1

Answer: Option-C: Assets and stockholders' equity both increase by $400 Workings: Under straight-line method, Annual depreciation expense = Depreciable cost / Useful life of the asset Cost of the asset $10,000 Less: Salvage value $1,000 Depreciable cost $9,000 ($10000 - $1000] Useful life of the asset, in years 5 years Annual depreciation expense $1,800 ($9000 / 5 years] Number of years asset is used 3 years Accumulated depreciation for 3 years $5,400 ($1800 x 3 years) So, book value at the end of 3 years $4,600 ($10000 - $5400 --> Cost minus Accum. depreciation] Sale value at the end of 3 years $5,000 Gain on sale of computer in year-3 $400 --> Difference between $5000 and $4600 (It is considered as gain because sale value is higher than book value at the time of sale) From the above calculation, it is clear that firm will collect $5,000 at the time of sale and so firm's cash asset will increase by $5,000. However, computer asset will decrease by book value of $4,600 at the time of sale and as a result, there will be net increase in total assets by $400. On the other hand, gain on sale of computer in year-3 will increase stockholders' equity value by $400. So, Option-(C) is the correct answer.