Question

Prophet Company signed a long-term purchase contract to buy timber from the U.S. Forest Service at \(300 per thousand board feet. Under these terms, Prophet must cut and pay \)6,000,000 for this timber during the next year. Currently, the market value is \(250 per thousand board feet. At this rate, the market price is \)5,000,000. Jerry Herman, the controller, wants to recognize the loss in value on the year-end financial statements, but the financial vice president, Billie Hands, argues that the loss is temporary and should be ignored. Herman notes that market value has remained near $250 for many months, and he sees no sign of significant change. Instructions (a) What are the ethical issues, if any? (b) Is any particular stakeholder harmed by the financial vice president’s decision? (c) What should the controller do?

Short answer

All the requirements are mentioned in the following steps.

Step-by-step solution

Ethical issues

(a) The ethical issue is related to recording the loss on purchase commitment. Per the accounting standard, a loss should be recorded when the market value decreases. However, in the correct way, this loss should be recorded at the time of exercising the purchase commitment.

Effect on stakeholders

(b) An unrealized loss must be recorded in the financial statement since it is material. If it is not reported, it will affect the stakeholders’ decision, as it indicates the material misstatement in the financial statement.

Controllers’ action

(c) The controller should recognize the unrealized holding gain or loss- income of $1,000,000 in the book of account. The controller should recognize the unrealized holding gain or loss by taking the difference between the contract price of $5,000,000 and the market price of $6,000,000.

The following journal entry is to be recorded:

Description	Debit	Credit
Unrealized Holding Gain or Loss—Income	$1,000,000
Estimated Liability on Purchase Commitments		$1,000,000
(Being unrealized holding gain or loss)