At December 31, 2017, Stellar Company has outstanding non-cancelable purchase commitments for...

Question:

At December 31, 2017, Stellar Company has outstanding non-cancelable purchase commitments for 39,000 gallons, at $3.54 per gallon, of raw material to be used in its manufacturing process.

The company prices its raw material inventory at cost or market, whichever is lower.

Part 1: Assuming that the market price as of December 31, 2017, is $3.19, record the journal entry.

Part 2: Give the entry in January 2018, when the 39,000-gallon shipment is received, assuming that the situation given in (b2) above existed at December 31, 2017, and that the market price in January 2018 was $3.19 per gallon.

Prepare the journal entry for when the materials are received in January 2018.

Purchase Commitment:

A purchase commitment is a contract to buy a certain amount of goods in the future at an agreed fixed price. The buyer will still have to pay the fixed price even if the market value of the goods differ.

Answer and Explanation:

Part 1:Let us compute the unrealized holding gain or loss of the purchase commitment.

Cost 39,000 x $3.54 $138,060
Market value 39,000 x $3.19 $124,410
Unrealized holding loss (gain) $13,650

The unrealized loss is $13,650. The journal entry on December 31, 2017 is:

Debit Credit
Unrealized loss $13,650
Estimated liability on purchase commitment $13,650


Part 2: Under non-cancellable purchase commitment, the amount of cash to be paid is the cost of the raw materials on December 31, 2017. However, the value of raw material is the market value on January 1, 2018. The difference is deducted from the estimated liability on purchase commitment.

  • Raw materials = $39,000 x $3.19 = $124,410

The journal entry on January 2018 is:

Debit Credit
Raw materials $124,410
Estimated liability on purchase commitment $13,650
Cash $138,060

Learn more about this topic:

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The Lower of Cost or Market of Inventory: Definition & Method

from Accounting 101: Financial Accounting

Chapter 6 / Lesson 15
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