Question

Novak Company signed a long-term noncancelable purchase commitment with a major supplier to purchase raw materials in 2026 at a cost of $911,500. At December 31, 2025, the raw materials to be purchased have a market value of $863,400. In 2026, Novak paid $911,500 to obtain the raw materials which were worth $863,400.

a) $48,100 loss on the transaction
b) $48,100 gain on the transaction
c) $911,500 loss on the transaction
d) $911,500 gain on the transaction

Answer 1

Novak Company incurs a $48,100 loss on the transaction as it paid $911,500 for raw materials that had a market value of $863,400 at the time of purchase.

Step-by-step explanation:

The question revolves around a common business scenario where Novak Company has entered into a purchase commitment but the market value of the raw materials has declined by the time of purchase. The key point here is that Novak Company still has to pay the agreed price of $911,500 even though the current market value is $863,400. This represents a loss for Novak Company because they have to pay more for the raw materials than they are worth on the market at the point of purchase.

To determine the impact of this transaction on Novak Company's financials, we must compare the cost to the current market value. The loss is calculated by subtracting the market value of the raw materials from the cost paid:

$911,500 (cost paid) - $863,400 (market value) = $48,100 loss.

Hence, the correct option is: a) $48,100 loss on the transaction.

An example to understand this concept better could be: If a company has sales revenue of $1 million, and spends $600,000 on labor, $150,000 on capital, and $200,000 on materials, the firm's accounting profit would be calculated as revenue minus total expenses. In this case, the accounting profit would be $50,000 ($1 million - $600,000 - $150,000 - $200,000).