Question

During the prior fiscal year, Carla Vista Corp. signed a long-term noncancellable purchase commitment with its primary supplier to purchase $2.14 million of raw materials. Carla Vista paid the $2.14 million to acquire the raw materials when the raw materials were only worth $1.67 million. Assume that the purchase commitment was properly recorded. What is the journal entry to record the purchase

Answer 1

First Carla Vista must record unrealized holding loss due to the purchase commitment:

Dr Unrealized holding gain/loss 470,000

Cr Estimated liability on purchase commitment 470,000

When the purchase is actually carried out, the journal entry should be:

Dr Raw materials inventory 1,670,000

Dr Estimated liability on purchase commitment 470,000

Cr Accounts payable (or cash) 2,140,000

Step-by-step explanation:

If a company enters a noncancelable purchase commitment, if the market price of the goods is lower than the contract price, the company must record a loss. On the other hand, if the market price is above the contract price, it results in a contingency gain until the gain is recognized when the purchase is actually done.