What is the Entry When a Contract Is Signed?

Entry When a Contract Is Signed

The accounting entry when a contract is signed can vary depending on the nature of the contract and the specific terms agreed upon. Generally speaking, signing a contract does not automatically require an accounting entry unless the contract results in an immediate obligation or right that has a financial impact. Here are a few scenarios to consider:

Revenue Contracts (e.g., Sales Contracts)

When a sales contract is signed, an accounting entry is usually not made until goods are delivered or services are rendered, in accordance with the revenue recognition principle. However, if a down payment is received, then the accounting entry might look like:

• Dr: Cash
• Cr: Unearned Revenue (or Deferred Revenue)

Expense Contracts (e.g., Lease Contracts, Service Agreements)

Similar to revenue contracts, the signing itself may not necessitate an entry. Once the service is received or the expense is incurred, an appropriate entry is made. If an advance payment is made upon signing, the entry could be:

• Dr: Prepaid Expense (or Asset if applicable)
• Cr: Cash

Loan Contracts

Upon signing a loan agreement and receiving the loan amount:

• Dr: Cash
• Cr: Notes Payable (or Loan Payable)

Employment Contracts

Generally, no entry is made upon signing an employment contract. Compensation expenses are recorded as they are incurred and as the employee renders services.

Construction or Long-term Contracts

For long-term contracts like construction projects, the accounting might be more complex and could involve the “percentage of completion method” or the “completed contract method,” depending on various factors including the length of the contract and certainty of costs.

Contingent Contracts

If the contract has contingent elements (i.e., the financial obligation is dependent on a future event), then generally no entry is made until the contingent event occurs.

In summary, the accounting entry associated with the signing of a contract depends on various factors, including the nature of the contract, whether any payment has been made or received, and the timing of the delivery of goods or services. Always consider the specific accounting standards and principles applicable to your jurisdiction when deciding on the appropriate accounting treatment.

Example of the Entry When a Contract Is Signed

Certainly! Let’s look at a simple example of a service-based revenue contract, where a web development company signs a contract with a client for a project worth $10,000. In this scenario, the client pays a 50% down payment upfront and agrees to pay the remaining amount upon completion of the project.

Accounting Entry for the Down Payment Received

Upon receiving the $5,000 down payment, the web development company would make the following accounting entry:

• Debit (Dr) Cash: $5,000
  This reflects the cash received.
• Credit (Cr) Unearned Revenue (or Deferred Revenue): $5,000
  This is a liability account, indicating that the company has a future obligation to deliver services to the client.

The journal entry would look like this:

Dr: Cash              $5,000
Cr: Unearned Revenue  $5,000

Accounting Entry When Services Are Rendered

Let’s say the project is completed in two months, and the client pays the remaining $5,000. At this point, two sets of accounting entries would be made:

1. To recognize the revenue upon project completion:

• Debit (Dr) Unearned Revenue: $5,000
  This reduces the liability account.
• Credit (Cr) Revenue: $5,000
  This recognizes the revenue that has been earned. Journal entry:

   Dr: Unearned Revenue  $5,000
   Cr: Revenue           $5,000

2. To account for the remaining payment received from the client:

• Debit (Dr) Cash: $5,000
  This reflects the cash received.
• Credit (Cr) Revenue: $5,000
  This recognizes the additional revenue. Journal entry:

   Dr: Cash     $5,000
   Cr: Revenue  $5,000

This example assumes that the revenue is recognized when the service is completely rendered, which may be the case for many service-based businesses. However, revenue recognition can be more complex for long-term contracts, or contracts where services or goods are delivered over a period of time. Always consult the applicable accounting standards for the most accurate and appropriate accounting treatment.