Presentation Of Contract Assets And Contract Liabilities

An important component of Accounting Standards Codification (ASC) 606 is guidance on the proper presentation of balance sheet items generated when parties perform in revenue-related contracts. An entity performs by transferring goods or providing services to a customer, and a customer performs by paying consideration to an entity. When one of the parties satisfies its obligation, the performance can be reflected in the financial statements as a contract asset or contract liability.
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While exhibiting similarities to prior guidance relating to accounting forconstruction- and production-type contracts, the concepts of contract assetsand contract liabilities are new. Furthermore, under ASC 606, contract assets and contract liabilities may be recognized for all types of contracts.

A contract asset is an entity’s right to payment for goods and services already transferred to a customer if that right to payment is conditional on something other than the passage of time. For example, an entity will recognize a contract asset when it has fulfilled a contract obligation but must perform other obligations before being entitled to payment. This is in contrast to a receivable, which is the right to payment that is unconditional, except for the passage of time. Therefore, a receivable is not a contract asset, and each is presented separately (ASC 606-10-45-3).

A contract liability is an entity’s obligation to transfer goods orservices to a customer at the earlier of (1) when the customer prepaysconsideration or (2) the time that the customer’s consideration is due for goods and services the entity will yet provide (ASC 606-10-45-2).

Generally, contract assets and contract liabilities are based on past performance. The key to determining which to recognize is ascertaining which party acted first. For example, when a customer prepays, the receiving entity records a contract liability—an obligation that must be fulfilled to “earn” the prepaid consideration. Once the entity performs by transferring goods or services to the customer, the entity can then recognize revenue and adjust the liability downward (ultimately to zero). The proper accounting for a contract liability is very similar to treatment for deferred or unearned revenue.

There is a possible exception to the past performance rule: in the case of non-cancellable contracts, an entity may actually record a contract liability before payment has been received. Suppose an entity and its customer enter into a contract to deliver goods and agree on dates for payments. Assume the date for a customer’s prepayment arrives, but the customer fails to pay on time, and the entity has not yet delivered goods. The entity recognizes a receivable because non-cancellable contract payments are treated as guaranteed. In this circumstance, recognition of the receivable is based on the contract’s payment schedule. It is not linked to the timing of revenue recognition. In conjunction with the receivable, the entity will also recognize a contract liability to deliver goods. This liability will be reversed and revenue will be recognized once the entity fulfills the performance obligation by delivering goods to the customer.

It should be noted, however, that there is a general resistance to “grossing up” the balance sheet. If a payment is due and has not been made, a company will likely consider other factors in determining whether recognizing the receivable is appropriate (e.g., concerns about the relationship with the customer, enforceability of the arrangement, or collectability of the enforcement).

Receivables and contract assets are both subject to impairment testing in accordance with ASC 310-10-35 (Receivables – Subsequent Measurement). When there is a difference between a receivable linked to a contract liability and the associated revenue later recognized, the refundable amount is treated as an expense (ASC 606-10-45-4). Impairment losses on receivables or contract assets from contracts with customers are presented separately from other impairment losses.

Entities are not required to use the terms “contract asset” and “contract liability” (606-10-45-5). For example, contract assets may be termed as unbilled receivables or progress payments to be billed. Contract liabilities might be described as deferred revenue, unearned revenue, or a refund liability.


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