Purchase commitment definition
/What is a Purchase Commitment?
A purchase commitment is a firm commitment to acquire goods or services from a supplier. Companies enter into purchase commitments in order to lock in a particular price, and sometimes also to lock in the production capacity of a supplier, which can be used as a defensive tool to keep competitors from using the production capacity.
The commitment may cover purchase orders placed over a broad span of time (known as a master purchase order), or it may only apply to a single purchase to be made. The commitment is usually for a fixed price, or uses a sliding pricing scale, depending on the number of units purchased. A purchase commitment is considered binding on both parties, and so could be used as the basis for a legal action by either one. A legal action is most likely when the price point that the parties have agreed to diverges over time from the market rate, so that one party is placed in a disadvantageous position and wants to terminate the contract. A legal dispute is especially likely when one party expects to be at a pricing disadvantage for an extended period of time.
Documentation of a Purchase Commitment
A purchase commitment is typically documented in the form of a purchase order, on which is stated a specific number of units that a supplier is authorized to ship, along with the price the buyer is authorized to pay, and the date by which the buyer expects delivery.
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Loss Reporting Under Purchase Commitments
If the commitment cannot be cancelled, and is for a specific number of units at a fixed price, the buyer should report a loss if the market price of the items stated in the commitment drop below the price stated in the contract.