Question

In year 0, Javens Incorporated sold machinery with a fair market value of $420,000 to Chris. The machinery's original basis was $336,000 and Javens's accumulated depreciation on the machinery was $52,000, so its adjusted basis to Javens was $284,000. Chris paid Javens $42,000 immediately (in year 0) and provided a note to Javens indicating that Chris would pay Javens $63,000 a year for six years beginning in year 1.

a.) What are the amount and character of the gain that Javens will recognize in year 0?
b.) What amount and character of the gain will Javens recognize in years 1 through 6?

Answer 1

Javens Incorporated will recognize a gain of $136,000 on the sale of machinery in year 0, with part of the gain recognized immediately and part recognized over the following six years as installment payments are received. The character of the gain relates to the installment sale method. The accounting profit example provided shows a profit of $50,000, calculated by subtracting explicit costs from total revenues.

Step-by-step explanation:

The student asks about recognizing gain on the sale of machinery for Javens Incorporated. In year 0, Javens will recognize a gain equal to the difference between the fair market value of the machinery ($420,000) and its adjusted basis ($284,000), which is $136,000. This gain will be characterized as part sale and part gain on the installment sale since part of the payment is deferred. The immediate payment of $42,000 in year 0 will involve recognizing part of the gain, proportional to the payment received. In years 1 through 6, Javens will recognize a portion of the gain each year as Chris makes the annual payments of $63,000. The total gain recognized over these years will be the portion of the $136,000 gain that corresponds to the ratio of the payment received each year ($63,000) to the total contract price ($420,000).

To calculate the accounting profit for the self-check question provided, one would subtract the explicit costs (sum of labor, capital, and materials costs) from the total revenues:
Accounting profit = $1,000,000 - ($600,000 + $150,000 + $200,000) = $50,000.