Contract assets and contract liabilities

Contract assets

A contract asset is a conditional right to receive 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.

Both contract assets and contract liabilities arise after a company has identified the performance obligations in a contract and allocated the transaction price to each one, following the ASC 606 five-step revenue recognition model.

A contract asset is a conditional right to consideration - collecting it still depends on satisfying the remaining performance obligations in the contract. Once the right becomes unconditional (typically once all performance obligations are satisfied), the contract asset is reclassified to accounts receivable, an unconditional right where only the passage of time stands between the company and payment.

Example: contract asset lifecycle

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

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

The $100 and $50 amounts reflect the $150 transaction price allocated to each performance obligation based on its stand-alone selling price. The total consideration of $150 is due only upon the completion of the live session.

The revenue from PO1 is recognized at the point when the student initially subscribes since the course materials are delivered and consumed immediately, while PO2 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

Contract liabilities

A contract liability is the obligation to transfer goods or services to a customer for which the company has already received consideration (or has an unconditional right to it). It’s commonly called unearned revenue, and the account represents the company’s responsibility to deliver goods or services it has already been paid for.

Example: contract liability

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 performance obligation has been satisfied. The journal 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