Question

During the current year, the Guileman Manufacturing Company signed a noncancelable contract to purchase 1,000 lbs. of a raw material at $32 per lb. during the forthcoming year. On December 31, the market price of the raw material is $26 per lb., and the selling price of the finished product is expected to decline accordingly. The financial statements prepared for the year should report...A. An appropriation of retained earnings for $6,000.B. A loss of $6,000 in the income statement.C. Nothing regarding this matter.D. A note describing the expected loss on the purchase commitment.

Answer 1

Answer:

B) A loss of $6,000 in the income statement.

Explanation:

The appropriate journal entry should be:

December 31 (recognition of loss on purchase commitments)

• Dr Loss on Purchase Commitments account 6,000
• Cr Accrued Loss on Purchase Commitments account 6,000

Since the price of raw materials lowered by $6,000, the company lost money on its purchase commitments:

Purchase commitments loss = contracted price - market value = $32,000 - $26,000 = $6,000

The loss on purchase commitments is an expense, and accrued loss on purchase commitments is a liability.