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What is a purchase commitment?

A firm purchase commitment is an agreement that is legally binding that requires a purchaser to purchase a specified amount of goods at a future point in time. If the contract price is in excess of the market price, and if losses are expected when the purchase is actually made, losses should be recognized at the time of the decline in price.

For example, if a company agreed to $5 million and now they believe they will only need to purchase $3 million of materials, then they would need to record a purchase commitment loss of $2 million.

As you can see in the visual below, since the contract resulted in a loss, we would debit estimated loss on purchase commitment for $2,000,000 and the offset is to record a liability for the estimated loss.

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