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Correction
Signing an ordinary purchase contract does not by itself require the buyer to record inventory and a liability. Check what each party has performed and when the buyer controls the goods under the contract's terms.
Distinguish a commitment from a recorded purchase
Recognition means including an item and its amount in the financial statements. For an ordinary purchase, recognition usually waits until the seller delivers the goods or otherwise performs.
Why the wrong answer seems reasonable
A signed order matters to the business. Managers reserve money for it, and a cash forecast may treat the amount as committed. The contract may also be legally enforceable. Those facts make the signature date important, but they do not show that the buyer already controls the goods or presently owes the price.
Where it goes wrong
Harbor Design is a design-services corporation. It signs a cancellable $3,000 purchase order for drafting supplies on Monday. The vendor delivers the supplies on Wednesday, and the company pays $1,000 on Friday. The contract requires payment after delivery.
On Monday, the vendor still has the supplies and the company still has its cash. Recording Supplies and Accounts Payable would report goods that the company does not yet control. The company records the purchase on Wednesday:
When the company pays $1,000 on Friday, Cash and Accounts Payable each decrease by $1,000. The company still owes the vendor $2,000.
Check your answer
Look at what each party has done by the date you chose. If neither side has performed, an entry for the full exchange needs more support than the signed contract alone. Use the delivery terms to determine control; the goods' physical location alone does not settle who controls them.
What to do instead
- Read the performance and payment terms.
- Identify what each party has performed by the reporting date.
- Ask whether the company now controls an asset or has a present obligation.
- Record the purchase when the seller delivers the supplies and the company takes on the obligation to pay under the stated terms.
This ordinary purchase example does not decide the accounting for guarantees or loss-making purchase commitments. Check the applicable guidance for those cases, including disclosure requirements. Do not extend this example into a rule that every signed contract is either always recorded or never recorded.
When this mistake may appear
- A company signs a purchase order or other contract before either party performs.
- The signed amount is committed in a budget or cash forecast.
Your work may contain this mistake if:
- You record Inventory and Accounts Payable on the signature date even though the seller has not delivered anything.
- You use the contract date without checking when each party must perform.