Accounting Entry When Signing a Contract
Merely signing a contract does not by itself require a journal entry. In other words, signing a contract for a future transaction does not mean the company is increasing or decreasing an asset or a liability at the time of the signing. Of course, if cash or some other asset is exchanged at the time of the signing, it will have to be recorded.
While a journal entry is not required at the time the contract is signed, significant commitments that are contained in the contract must be disclosed in the notes to the financial statements of the parties to a noncancelable contract.
Examples of No Entry When Signing a Contract
Assume that an electric utility signs a noncancelable contract with a coal company to purchase 100 million tons of coal to be delivered over a one-year period that will begin in three months. On the day the contract is signed, the electric utility does not own any of the coal specified in the contract, nor does it owe for any of the coal, since the coal will not be delivered for at least three months. When the first trainload of coal arrives at the electric utility at least three months later, the utility will record the purchase of only the coal that has arrived and the related account payable.
Likewise, on the day the contract is signed, the coal company does not have a sale of the coal specified in the contract, and it does not have a receivable from the electric utility. Three months later, when the first shipment of coal is delivered to the utility, the coal company will record a sale of the coal and a related account receivable.
If the commitments made by the utility and the coal company are significant, those commitments must be disclosed in the notes to the financial statements of both the utility and the coal company.