 Hello and welcome to the session in which we would look at the concept of purchase commitment. What is purchase commitment? Well companies what they do is they plan ahead and as a result they might sign contract to purchase material before production start because they want to secure the material. Therefore they will enter into a contract to purchase material and that could happen a month in advance or could be a year in advance or sometime two years in advance. At this point the company don't recognize any asset or liability because no title has been transferred. However if the contract is we have to determine whether the contract is cancelable or non-cancelable. If the contract is cancelable it's water under the bridge because you can cancel it you don't have to worry about anything. If the contract to purchase is non-cancelable the minimum you have to do if the contract is material you have to disclose this to let the users of the financial statements the investors the creditors know that you have an upcoming contract a large upcoming contract. What happened if the contract to purchase which is that your purchase commitment is non-cancelable and the price of that contract is greater than the market price. What does that mean it means you sign you sign a contract to purchase something for a million dollar and that same thing now is worth 800,000 your contract price is greater than the market price well you are expecting a loss if you are expecting a loss what should you do you should record the loss you should recognize the loss in the period when such loss taking place and this is based on the matching principle you want to recognize the loss in the period that it occurs and you want to be conservative because you are expecting losses you want to anticipate the losses there as you are anticipating the losses you record the losses this topic is covered in intermediate accounting as well as the CPA exam whether you are an accounting student or a CPA candidate I strongly suggest you take a look at my website farhatlectures.com I don't replace your CPA review course I am a useful edition I explain the material differently than your CPA review course I go slower I give you more examples this is the benefit this is the difference between me and your CPA review course once you use me with your CPA review course you're going to do much much better on the exam I would say you will add 10 to 15 points because you understand the material better and here's your risk try me for one month one month of subscription to find out whether I can help you or not if not that's fine you cancel that's your maximum loss your potential gain is actually passing the exam if not for anything take a look at my website to find out how well or not well your university doing on the CPA exam I do have resources for other college courses other than intermediate accounting advanced accounting cost accounting governmental accounting all other accounting courses my CPA supplemental resources are aligned with your becker roger gleam and wiley so you can go back and forth between your CPA review course and my supplemental material I also give you the access to 1500 previously AI CPA released questions with detailed solution and some of these questions I have video recording about them video explanation there if you have not connected with me on LinkedIn please do so take a look at my take a look at my LinkedIn recommendation like this recording share it with other connect with me on Instagram Facebook Twitter and Reddit the best way to illustrate this concept is to actually work an example let's assume on January 1st X5 Adam enter into a noun cancelable contract to lease a land to extract oil for a price of 6 million so Adam's expecting there is 100,000 in the land it can can extract 100,000 barrels and the cost is $60 by the end of 20 X5 you know Adam did not have the chance to extract them because Adam was busy the price of oil the price of oil dropped and as a result the same contract is worth now 5 million simply put most likely the cost is now the price of the oil is is lower so the contract for the same piece of land is now $5 million what would Adam have to do Adam will have to debit an unrealized holding gain loss which is a loss goes to income debit that a million credit estimated liability to purchase a commitment a million so this is basically a liability and this is a loss and the loss goes on the income statement this is a loss on the income statement in 2006 in 20 X6 Adam paid for the contract now Adam would still have to pay 6 million so what would be the entry Adam will credit cash for 6 million debit purchases or inventory for 5 million and now since since Adam recognized a liability they would reduce that liability for a million because now let's assume it's a liability that's what he's well that's what he's paying for now let's assume for the sake of illustration that the lessor decided to give Adam a break and charge Adam 5.5 million for the lease rather than 6 million because oil prices drop then Adam can reverse half of that they can reverse half a million debit estimated liability debit estimated liability 500 000 in credit unrealized holding basically reducing the loss because we still have a loss it's not really again we still have a loss of 500 000 now the best way to to learn this is to work mcq's work exercises and this is what you should do go to my website farhatlectures.com again at the end of this recording I'm going to remind you if you are studying for your CPA exam or if you are an accounting student farhatlectures.com can help you tremendously I am a supplemental tool I don't replace your CPA review course I don't replace your accounting course I'm just going to give you additional resources that's going to help you understand the material better do better study hard good luck accounting is worth it the CPA exam is worth it and stay safe