Question

On July 10, 2018, Johnson Corporation signed a purchase commitment to purchase inventory for $320,000 on or before February 15, 2019. The company's fiscal year-end is December 31. The contract was exercised on February 1, 2019, and the inventory was purchased for cash at the contract price. On the purchase date of February 1, the market price of the inventory was $334,000. The market price of the inventory on December 31, 2018, was $299,000. The company uses a perpetual inventory system.
    
How much loss on purchase commitment will Johnson recognize in 2018?

Answer 1

Solution-

The market price of inventory on Dec 31, 2018 is $299,000. But, it is agreed to purchase for $320,000. Hence, Johnson Company would recognize $21,000 ($320,000 - $299,000) as loss on purchase commitment.

So Johnson will recognize in 2018 $21,000 loss on purchase commitment.

Answer 2

Solution: Loss on Purchase Commitment in 2018

Key Details:

• Purchase Commitment Date: July 10, 2018 (contract to buy inventory for $320,000 by February 15, 2019).

• Fiscal Year-End: December 31, 2018.

• Market Prices:

• Dec 31, 2018: $299,000

• Feb 1, 2019 (purchase date): $334,000

• 
  

Step 1: Determine if a Loss Exists at Year-End (Dec 31, 2018)

Under ASC 330 (Accounting for Inventory), a loss on a purchase commitment must be recognized if:

The market price at year-end is lower than the contract price, and the decline is not temporary.

• Contract Price: $320,000

• Market Price (Dec 31, 2018): $299,000

• Loss Calculation:

  $$\text{Loss}=\text{Contract Price}-\text{Market Price}=320,000-299,000=\mathrm{\$}21,000$$

Step 2: Journal Entry on December 31, 2018

Recognize the loss in 2018 since the market price dropped below the contract price:

Dr. Loss on Purchase Commitment (Expense)  $21,000  
    Cr. Estimated Liability on Purchase Commitment  $21,000

Step 3: Subsequent Recovery (Feb 1, 2019)

• Market Price Rises to $334,000:
  The loss recognized in 2018 is not reversed because the recovery occurred in a new fiscal year (GAAP prohibits reversing losses for increases in market price after year-end).

• 
  

Answer:

Johnson Corporation will recognize a $21,000 loss on purchase commitment in 2018.