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Historical versus Market Price

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Company Z had signed a long-term purchase contract to buy 20,000 board feel of timber from the British Colombia Forest Service for 250 dollars per board. Under the contract, Company Z must cut and pay $5,000,000 for this timber during the next year. Currently, the market value is $200 per board. Pat Bapp, the controller wants to recognize a $1,000,000 loss on the contract in the year-end statement, but the financial vice precedent argues that the loss is temporary, and it should be ignored. Bapp notes, however that the market value has remained near $200 for many months, and he sees no sign of significant changes.

I need help with the following points:
a) What are the ethical issues, if any?
b) Is any particular stakeholder harmed by the financial VP's solution?
c) What would you do if you were the controller?

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Solution Summary

This solution looks at historical versus market price issues, and ethical problems in accounting.

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<br>The company is paying $5,000,000 for goods that it could be purchasing at a market price of $4,000,000. This is an immediate loss that it is occurring. Even if the price of the timber increases in the future the company will still have incurred this loss since it could have paid $1,000,000 less in the past (past expenses do not change due to future price changes). You can look at the issue this way: profit = revenue - cost. As the price of the board increases the revenue will go up, but the costs will have already occurred. As such we can thus conclude that there are no ethical issues involved in recognizing the loss since the company is merely taking its losses into account. There might be some ethical issues involved in terms of when we recognize the loss. I will talk about that some more later on.
<br>Both the controller and the finance VP present credible arguments so let's analyze that a bit further. We can ...

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