Losses on purchase commitments

Question 1

What is the required accounting for a potential loss on a Purchase Commitment when the commitment cannot be modified?

Answer 1

1. )The loss must be accrued because the loss is probable and estimable;
2. )Inventory is recorded at market, and a loss is recorded for the difference between contract and market;
3. )If contract is not executed as of the balance sheet date, loss is recognized and liability established.

Question 2

What is the required accounting for a potential loss on a Purchase Commitment when the commitment can be modified?

Answer 2

The loss is required to be footnoted as a contingent liability, but is not accrued in the accounts because the loss is not probable given that the contract can be revised.

Question 3

If a firm has a Purchase Commitment that cannot be modified and the price declines, what journal entry should be booked?

Answer 3

DR: Loss on Purchase Commitment.
CR: Liability on Purchase Commitment

Question 4

Define “Purchase Commitment”.

Answer 4

Type of commitment made when a firm commits to the purchase of materials at a set unit price.

Question 5

How do we account for the recovery of a Purchase Commitment loss?

Answer 5

A gain to the extent of the previously recognized loss.