Understanding a contract asset

Definition

A contract asset is a right to payment that still depends on something other than the passage of time. It is not accounts receivable yet, because a remaining performance, a milestone, or a customer sign-off still has to happen.

On the books, this is a current asset on the Balance Sheet. Revenue may already be on the P&L, but you cannot send the invoice until that extra condition is met.

Ordinary AR only needs time to pass until the customer pays. This asset needs one more event before it can even be billed.

Where it shows up

Balance Sheet: Located in the current assets section.

P&L: Related to revenue recognized before you can invoice.

Cash flow: Decreases in this account, reported cash from operating activities increases.

See also: Unbilled Receivables · Revenue Recognition · Accounts Receivable

When you look at your Balance Sheet, a contract asset sits in current assets, near accounts receivable. Some packs print it as its own line; others bury it in a catch-all until the amount is material.

A high balance usually means a lot of recognized work is still waiting on a milestone, an inspection, or another performance. A low balance can mean you bill as soon as performance is complete, or that jobs are small enough to invoice in one step.

The profit and loss statement does not list this asset as a line. The related revenue is already on the P&L if you recognized it; converting to AR later does not record that revenue again.

On the Statement of Cash Flows, this account is a working-capital item. When it decreases because you invoiced and then collected, reported cash from operating activities increases.

The supporting file is the contract and the job progress, not an open invoice. Until the extra condition is met, there is nothing for an aging report to track.

How it works

A contract sets what you will deliver and when you may bill. Revenue recognition follows performance, which can run ahead of the right to invoice.

You debit this asset and credit revenue as you complete the work you have earned. Cash has not moved, and accounts receivable has not opened, because you still cannot send the bill.

The extra condition is the point of the account. It might be a signed inspection, a remaining deliverable, or another performance obligation in the same contract.

When that condition is met, you debit accounts receivable and credit the contract asset. The right to payment now depends only on the passage of time, so the balance becomes ordinary AR.

From there, aging, collections, and cash application follow the invoice. This account should be back to zero for that slice of the job.

Progress billing and percentage-of-completion schedules often sit behind the estimate. Stay with the asset: it is earned revenue you cannot invoice yet because something besides time is still outstanding.

If you posted the amount to accounts receivable before you had the right to bill, the aging would show a fake invoice. Keep this asset separate until the extra step is done.

Example

A general contractor finishes the framing on a small addition. The contract says the contractor cannot invoice that phase until the owner signs off on the inspection, and the framing earned to date is $20,000.

The contractor records:

Debit: Contract asset $20,000

Credit: Construction revenue $20,000

The contract asset (an asset) and revenue both go up by $20,000. Cash has not moved, and there is no invoice yet.

The Balance Sheet is larger on the asset side. The profit and loss statement now shows $20,000 of construction revenue that was earned before billing was allowed.

The owner signs the inspection the next week. The contractor then records:

Debit: Accounts receivable $20,000

Credit: Contract asset $20,000

The contract asset falls back to zero, and accounts receivable rises by $20,000. The P&L does not record the framing a second time.

Common mix-ups

A contract asset is not accounts receivable. AR is a right that depends only on time; this asset still needs another event before you can invoice.

A contract asset is not the same as unbilled receivables. Unbilled usually means the work is done and only the invoice is missing; this asset means something besides sending the bill still has to happen.

A contract asset is not deferred revenue. Deferred revenue is cash collected before performance; this asset is performance recognized before you may bill.

Related terms

• Unbilled Receivables: Revenue earned but not yet invoiced to the customer.
• Revenue Recognition: The rules for deciding when earned revenue may be recorded.
• Deferred Revenue: Cash collected from customers before the work is delivered.
• Accounts Receivable: Money customers owe the business for goods or services already delivered.
• Percentage Of Completion: Recognizing revenue in proportion to how much of a job is finished.
• Progress Billing: Invoicing a customer in stages as work is completed.
• Contract: The binding agreement that sets what will be delivered and what will be paid.
• Balance Sheet: A statement showing what a business owns, what it owes, and what is left for owners at a single point in time.