How Contract Assets and Contract Liabilities Are Reported on the Balance Sheet

Contract assets and contract liabilities arise from revenue recognition rules under IFRS 15 and ASC 606, reflecting the timing differences between when revenue is recognized and when cash is billed or collected. A contract asset represents the company’s right to consideration for goods or services already provided but not yet billed, while a contract liability represents an obligation to deliver goods or services for which payment has already been received. Their presentation on the balance sheet ensures that the financial statements capture the true economic position of customer contracts.

·····

.....

What contract assets represent

A contract asset arises when revenue is recognized for performance obligations that have been satisfied, but the company cannot yet bill the customer. This situation occurs when revenue recognition depends on progress toward completion rather than invoicing milestones.

For example, if a construction firm has completed 40 percent of a project worth 1,000,000 but can only bill once 50 percent is complete, it recognizes 400,000 of revenue. The unbilled receivable of 400,000 is recorded as a contract asset.

Contract assets are similar to accounts receivable but are conditional on future performance, not just the passage of time.

·····

.....

What contract liabilities represent

A contract liability arises when a customer prepays or the company bills in advance of fulfilling performance obligations. This represents an obligation to deliver goods or services in the future.

For example, if a software company bills a client 120,000 for a one-year license upfront, it records a contract liability. Each month, 10,000 of revenue is recognized, reducing the liability as performance obligations are satisfied.

Contract liabilities are similar to deferred revenue but tied specifically to performance obligations under the contract.

·····

.....

Presentation on the balance sheet

Contract assets and contract liabilities are generally presented as separate line items under current or non-current categories, depending on when settlement is expected.

Example:

• Current Assets:

  • Accounts Receivable: 250,000

  • Contract Assets: 400,000

• Current Liabilities:

  • Accounts Payable: 300,000

  • Contract Liabilities: 120,000

This presentation highlights both the unbilled rights to revenue and the obligations to deliver goods or services already paid for.

·····

.....

Journal entries for contract assets and liabilities

When recognizing revenue before billing:

• Debit: Contract Asset 400,000

• Credit: Revenue 400,000

When billing the customer:

• Debit: Accounts Receivable 400,000

• Credit: Contract Asset 400,000

When receiving cash before revenue is earned:

• Debit: Cash 120,000

• Credit: Contract Liability 120,000

As performance obligations are met:

• Debit: Contract Liability 10,000

• Credit: Revenue 10,000

These entries ensure accurate timing of revenue and obligations.

·····

.....

Standards under IFRS and US GAAP

• IFRS 15: Defines contract assets and contract liabilities as part of the five-step revenue recognition model, requiring recognition when one party has performed but not yet received unconditional rights to consideration.

• US GAAP (ASC 606): Mirrors IFRS requirements, emphasizing symmetry between the right to consideration (contract asset) and obligations to transfer goods or services (contract liability).

Both frameworks require clear disclosure of balances and movement in contract assets and liabilities during the reporting period.

·····

.....

Impact on financial performance and analysis

Contract assets and liabilities affect liquidity and working capital analysis. Large contract assets may indicate aggressive revenue recognition ahead of billing, while large contract liabilities suggest heavy upfront payments or subscriptions.

For instance, SaaS companies often report significant contract liabilities due to annual billing cycles. Analysts track changes in contract balances to assess revenue growth, customer prepayments, and future performance obligations.

·····

.....

Disclosures required for contract assets and liabilities

Both IFRS and US GAAP require disclosure of:

• Opening and closing balances of contract assets and liabilities.

• Revenue recognized from beginning contract liabilities.

• Performance obligations yet to be satisfied.

• Significant judgments in determining timing of satisfaction.

These disclosures provide transparency about how much reported revenue relates to past billings versus new obligations.

·····

.....

Operational considerations

Contract assets and liabilities are central to industries with long-term contracts, subscriptions, or milestone-based billing, such as construction, aerospace, and software. Effective management of contract balances ensures smooth cash flow, accurate forecasting, and compliance with revenue recognition rules. For investors, analyzing these balances helps evaluate the sustainability of revenue, customer payment behavior, and the company’s ability to fulfill its contractual obligations.

·····

.....

FOLLOW US FOR MORE.

DATA STUDIOS

.....[datastudios.org]