How do you account for purchase commitments? This lesson prepares CPA (FAR) candidates and intermediate accounting students to handle non-cancellable purchase contracts, including when disclosure is required and when a loss must be recognized because the contract price is above current market value. If you have searched for "accounting for purchase commitments" or "loss on purchase commitment journal entry," this walkthrough is for you.

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Video Timeline & Key Concepts:
0:00 — Introduction
0:06 — What a purchase commitment is
0:28 — Why no asset or liability is recognized initially
0:37 — Cancellable versus non-cancellable contracts and disclosure
1:10 — Recognizing a loss when the contract price exceeds market price
3:26 — Example: a $6 million land lease contract for oil extraction
4:08 — Recording the loss and estimated liability
4:55 — Partially reversing a previously recorded loss

Frequently Asked Questions:

What is a purchase commitment in accounting?

A purchase commitment is a contract in which a company agrees to buy materials or assets, often before production, to secure supply or price. Because title has not yet transferred, no asset or liability is recorded when the agreement is signed.

When must a purchase commitment be disclosed?

If a purchase commitment is cancellable, no accounting action is required. If it is non-cancellable and material, the company must disclose the commitment in the notes to the financial statements so users are aware of the future obligation.

When do you recognize a loss on a purchase commitment?

A loss is recognized when the contract price is greater than the current market price of the committed goods. Under the matching principle and conservatism, the company records the loss immediately along with an estimated liability, rather than waiting until the purchase occurs.

How is the loss on a purchase commitment recorded?

The company debits a loss on purchase commitment and credits an estimated liability for the difference between the contract price and the lower market value. For example, a $6 million contract with a $5 million market value produces a $1 million recognized loss.

Can a previously recognized purchase commitment loss be reversed?

Yes. If the market price later recovers, a previously recorded loss can be partially reversed, up to the amount originally recognized. This keeps the liability aligned with the current expected loss on the commitment.

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