DEF Inc. entered into a non-cancellable commitment to purchase raw materials in the amount of $30,000 on December 31^st, 2010. Replacement cost was estimated at $25,000 on November 30^th, 2010 and this amount was not expected to change. Which of the following statements is correct? A) This is an onerous contract. A loss must be accrued in the amount of $5,000. B) This is not an onerous contract. A loss must be accrued in the amount of $5,000. C) This is an onerous contract. However, the $5,000 loss should only be disclosed in the financial statements and not accrued. D) This is not an onerous contract.

Question

Quizplus · Accepted Answer

An onerous contract is a contract where the expected costs of fulfilling the obligations under the contract exceed the economic benefits expected to be received. In this case, the replacement cost of the raw materials is estimated at $25,000, which is less than the committed purchase price of $30,000. Therefore, DEF Inc. has entered into an onerous contract. As a result, a loss must be accrued in the amount of the difference between the committed purchase price and the estimated replacement cost, which is $5,000. Therefore, choice A is correct. Choice B is incorrect because it states that the contract is not onerous, which is not true. Choice C is incorrect because even though the contract is onerous, a loss must be accrued and not just disclosed in the financial statements. Choice D is incorrect because the contract is onerous.

DEF Inc Entered into a Non-Cancellable Commitment to Purchase Raw Materials