At the end of the fiscal year, Apha Airlines has an outstanding purchase commitment for the purchase of 1 million gallons of jet fuel at a price of $4.60 per gallon for delivery during the coming summer. The company prices its inventory at the lower of cost or market. If the market price for jet fuel at the end of the year is $4.25, how would this situation be reflected in the annual financial statements?
A) Record unrealized gains of $350,000 and disclose the existence of the purchase commitment.
B) No impact.
C) Record unrealized losses of $350,000 and disclose the existence of the purchase commitment.
D) Only disclose the existence of the purchase commitment.

Question

Quizplus · Accepted Answer

According to the lower of cost or market method, the inventory should be valued at the lower of its historical cost or its replacement cost. In this case, the historical cost of jet fuel is $4.60 per gallon, but the replacement cost (market price) is $4.25 per gallon, which is lower. Therefore, the unrealized losses should be recognized and recorded in the financial statements. The amount of the unrealized loss is the difference between the historical cost and the replacement cost multiplied by the quantity of the purchase commitment, which is ($4.60 - $4.25) x 1,000,000 = $350,000. The existence of the purchase commitment should also be disclosed in the footnotes to the financial statements.

At the End of the Fiscal Year, Apha Airlines Has