What is a contract?

Definition

A contract is the signed agreement between a business and a customer that both sides are bound to follow. On the books, this is not a journal and not a ledger account.

A bookkeeping shop taking on a florist for monthly close uses that paper so the fee, the close date, and what is included are already agreed. Signing does not bill anyone and does not record a sale.

It does not hit the Income Statement the day both sides sign. Revenue waits until the work is earned, and cash waits until later bills collect.

Stay with the binding agreement when you read it. The scope write-up, the later bill, and a deposit each belong on other pages.

Where it shows up

P&L: Related to nothing until the contracted work is earned.

Balance Sheet: Related to nothing sitting as an account until billed, deposited, or earned.

Cash flow: Related to nothing until invoices on that contract collect.

See also: Statement Of Work · Bookings · Revenue Recognition

When you look at your Income Statement, the agreement does not print as a line. Revenue shows up only as the monthly close work is earned, not on the day the florist signs.

The Balance Sheet does not hold a contract account. Signing does not create a receivable, a deposit, or a liability by itself.

On the Statement of Cash Flows, cash does not move at the signature. Cash moves when bills on that work are collected.

Bookings is the signed value for the period, whether or not you have billed it yet. Backlog is the signed work still waiting to be delivered or earned.

How it works

A typical path starts with a conversation about monthly close. The shop and the florist agree what will be done, when it is due, and what it costs.

That agreement is written and signed. Until both sides sign, there is a proposal, not a binding deal.

Once it is signed, revenue recognition follows the work, not the signature date. A $400 monthly close fee is earned as each month is closed, not as a lump the day the florist signs.

If the florist later wants payroll added, that extra work is outside the original agreement. A signed amendment is what changes the price and the scope.

Do not post a journal that says "contract." The journal comes later, when the work is billed, when a deposit arrives, or when the work is earned.

Customer deposits and accounts receivable are later balances. They sit on other pages even when they point back to this agreement.

A credit application may sit in the same customer file. Payment terms and a credit limit are the later rules for how large an unpaid pile this agreement is allowed to create.

Example

Ledger & Bloom is a bookkeeping shop. A neighborhood florist asks for monthly close, and both sides sign a one-year agreement at $400 a month.

The signed value is $4,800 for the year. That figure is bookings for the shop, not a bill and not earned performance yet.

Nothing hits cash, receivables, or revenue on signing day. The florist has promised to pay as months are closed; the shop has promised to close them.

When March close is done, the shop bills $400 against that agreement. If the florist had paid $1,200 up front for three months, cash would go up and deferred revenue would hold $1,200 until those months are closed.

If they had only shaken hands on "about $400," there would be no signed price to bill against. The first bill would then be arguing about the deal instead of collecting on it.

Common mix-ups

This agreement is not the same as a statement of work. The statement of work describes the scope, deliverables, and price; this page is the paper that binds both sides to that deal.

This agreement is not a quote. A quote is a priced proposal before anyone has agreed; this page is what both sides signed.

This agreement is not an invoice. The agreement sets what may be billed; the invoice is the later document that actually bills a month or a milestone.

Related terms

• Statement Of Work: The document describing the scope, deliverables, and price of an engagement.
• Change Order: A signed amendment adding or altering scope and price on a job.
• Bookings: The contract value signed in a period, whether or not it has been billed.
• Revenue Recognition: The rules for deciding when earned revenue may be recorded.
• Payment Terms: The agreed deadline and conditions for paying an invoice.
• Credit Application: The form a customer completes to be approved for terms.
• Credit Limit: The maximum balance a customer is allowed to carry on account.
• Net 30: Payment terms requiring the full invoice to be paid within thirty days.
• Backlog: Signed work that has not yet been delivered or recognized as revenue.
• Deferred Revenue: Cash collected from customers before the work is delivered.
• Purchase Order: The document authorizing a purchase from a vendor at agreed terms.