Contract assets and contract liabilities

Contract assets

Contract assets are conditional rights to receive a consideration from the customer.

It results primarily from the company satisfying some (but not all) of the performance obligations of a contract. Since there is a single consideration for all the performance obligations, the company must satisfy all of them before it can collect the consideration.

Once the right to receive the consideration becomes unconditional, or if all performance obligations have been satisfied, the contract assets are moved to accounts receivable as the customer is finally invoiced for the consideration of the contract.

A contract asset is a conditional right to consideration - collecting it still depends on satisfying the remaining performance obligations in the contract. Accounts receivable is an unconditional right - once the customer is invoiced, only the passage of time stands between the company and payment.

Example: Contract asset lifecycle

For example, Achievable Co. provides review services with the following performance obligations:

• Performance obligation 1 (PO1) - instruction and course materials worth $100 and
• Performance obligation 2 (PO2) - capacity to attend one live tutorial session with an expert worth $50.

The total consideration of $150 is due only upon the completion of the live session.

The revenue from PO 1 is recognized at the point when the student initially subscribes since the course materials are delivered and consumed immediately while PO 2 is satisfied as the student completes attendance to a live tutorial session.

The journal entry to record the contract asset at the time of subscription is as follows:

Account	Debit	Credit	Financial statement element
Contract asset	100		Asset
Revenue - inst. & course materials		100	Revenue
To record the satisfaction of performance obligation 1

Once the student completes a live tutorial session, the whole revenue can be invoiced as follows:

Account	Debit	Credit	Financial statement element
Accounts receivable	150		Asset
Contract asset		100	Asset
Revenue - live session		50	Revenue
To record the satisfaction of performance obligation 2

You will see that the key concept here is the recognition of revenue:

• PO1 revenue was recognized upon subscription through a contract asset account since the Company is not yet entitled to the consideration
• PO2 revenue was recognized upon completion of the live session only in which the contract asset was derecognized and transferred to accounts receivable.

Contract liabilities

Contract liabilities are simply unearned revenues.

These are amounts received in advance when the goods or services have not yet been delivered. The contract liability account represents the responsibility of the company to deliver goods and services to the customer. For example, Achievable Co. receives $15,000 in advance for a bundle that includes a product worth $10,000 and an installation service worth $5,000, before either obligation has been satisfied. The pro forma entries are presented below.

Account	Debit	Credit	Financial statement element
Cash	15,000		Asset
Contract liability		15,000	Liability
To record the receipt of cash against contract liability

Achievable Co. delivers the product right away, satisfying that performance obligation, while the installation is still pending. Only the $10,000 tied to the product can be recognized as revenue; the remaining $5,000 stays in the contract liability account until the installation is complete.

Account	Debit	Credit	Financial statement element
Contract liability	10,000		Liability
Revenue - product		10,000	Revenue
To record the revenue after satisfaction of the product performance obligation

The remaining $5,000 for the installation service stays as a contract liability until that performance obligation is satisfied too.