Question

The Old Fix-It is a company specializing in the restoration of old homes. To showcase its work, the company purchased an old Victorian home in downtown Pittsburg, Kansas on January 2, 2006. The original home was purchased for $125,000. A new heating and air-conditioning system was added for $30,000. The house was completely rewired and re-plumbed at a cost of $50,000. Custom cabinets were added, and the floors and trim were refurbished to their original condition, at a cost of $75,000.

The project was such a success, that Old Fix-It decided on January 2, 2010, to sell the home for $175,000. At the time of sale, the accumulated depreciation account balance was $74,667. Mark Gibson, the president of Old Fix-It, decided that the $50,000 gain over purchase price was appropriate, and so he agreed to sell the showcase house. Only afterward did he learn that Old Fix-It had a loss of almost $30,000 on the sale. Mark does not believe that a loss is possible. "We sold that house for more than we paid for it," he said. "I know we put some money in it, but we had depreciated it for four years. How in the world can we have a loss?"

Required: (be sure to show computations supporting your explanations)

Explain why Mr. Gibson thought he had a $50,000 profit.

Explain why the company reported approximately a $30,000 loss.

Answer 1

Mr. Gibson thought he had $50,000 profit based on following simple calculation:

Purchase Price =$125000

Selling price=$175000

Profit=(175000-125000)=$50,000

However, there was actually a loss. Mr Gibson did not take into account the expenses incurred on the home for restoration.

The cost of home should include expenses on restoration.

Purchase cost	$125,000
Heating and air-conditioning system	$30,000
Rewiring and re-plumbing cost	$50,000
Custom cabinet and floors	$75,000
Total cost of the home	$280,000

There has been depreciation for four years. Total accumulated depreciation=$74,667

A	Total cost of home	$280,000
B	Accumulated depreciation	$74,667
C=A-B	Book value at the time of sale	$205,333
D	Selling price	$175,000
E=D-C	Profit/(loss)	($30,333)

Though depreciation was charged for four years, amount spent on restoration was higher than depreciation charged