Question

Pearl Company has been having difficulty obtaining key raw materials for its manufacturing process. The company therefore signed a long-term noncancelable purchase commitment with its largest supplier of this raw material on November 30, 2020, at an agreed price of $402,800. At December 31, 2020, the raw material had declined in price to $367,300.

What entry would you make on December 31, 2020, to recognize these facts?

Answer 1

Pearl Company would recognize an unrealized loss on December 31, 2020, for the decline in the raw material price with a debit to a loss account and a credit to an asset account, reflecting the difference from the purchase commitment price.

Step-by-step explanation:

On December 31, 2020, Pearl Company recognizes a loss due to the decline in raw material price from the agreed purchase commitment price to the current market price. The accounting entry would involve debiting a loss account and crediting an asset account for the difference between the purchase commitment price and the market price.

The journal entry on December 31, 2020, would be:

• 
  
• Debit Loss on Purchase Commitment for $35,500
• 
  
• Credit Inventory or Raw Materials on Purchase Commitment for $35,500

This entry reflects the unrealized loss on the commitment because the contracted price is higher than the current market price of the raw material.