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Get clear answers on ASC 606 contract assets—what they are, how to recognize them, and tips for accurate reporting and compliance in your business.
In business, timing is everything—especially when it comes to recognizing revenue. You often complete work for a client long before you’re contractually allowed to send an invoice. Maybe you have to hit another project milestone or wait until a final deliverable is complete. So, what do you do with the revenue you’ve clearly earned but can’t yet bill for? You can’t just ignore it. This exact scenario is why the accounting standard introduced the concept of ASC 606 contract assets. They are a crucial tool for ensuring your financial statements accurately reflect the value you’ve delivered in a given period, even when billing schedules don't align.
If you're working to align your accounting with ASC 606, you've likely come across the term 'contract asset.' It's a key concept that helps you accurately report revenue. A contract asset represents your right to payment for goods or services you've already delivered, but where that payment is conditional on something other than just the passage of time. Let's break down what that means for your business and your books.
A contract asset arises from a specific timing mismatch. It happens when you've delivered goods or services, but you don't yet have an unconditional right to bill the customer. That 'unconditional' part is key. Your right to payment might depend on completing another project milestone or delivering a final component. For example, if a contract states you can only invoice after completing two phases of a project, you'd record a contract asset for the value of the first phase once it's done. This shows you've earned the revenue, even if you can't bill for it yet.
Contract assets are directly tied to the core principle of ASC 606: recognizing revenue when it's earned. When you record a contract asset, you also recognize the same amount in revenue on your income statement. This reflects that you've satisfied a performance obligation under the contract, even if the cash isn't coming in yet. It ensures your financial statements accurately show the value you've delivered in a given period, preventing revenue from being understated just because of billing schedules. This gives a truer picture of your company's performance.
Properly identifying contract assets is more than just an accounting exercise—it's crucial for compliance and financial clarity. As a core component of ASC 606, getting them right is essential for passing audits. These assets appear on your balance sheet, providing a clear view of revenue you've earned but can't yet invoice. Misclassifying them as accounts receivable can distort your financial health, impacting everything from cash flow projections to strategic decisions. Accurate tracking ensures your financials tell the complete story of your revenue journey.
At first glance, contract assets and receivables look like two sides of the same coin. Both represent money you’re owed for work you’ve done, and both show up on your balance sheet as assets. But under ASC 606, there’s a critical distinction that can significantly impact your financial reporting. The key difference boils down to one simple question: Is your right to get paid conditional or unconditional?
Getting this right isn't just about compliance; it’s about accurately reflecting your company's financial health. Misclassifying these items can skew key metrics that investors, lenders, and your own leadership team rely on to make important decisions. Let's break down exactly what sets them apart so you can handle them with confidence.
The main thing separating a contract asset from a receivable is conditionality. A receivable is an unconditional right to payment. This means the only thing standing between you and the cash is the passage of time. You've done the work, you've sent the invoice, and now you're just waiting for the payment terms (like net 30) to run their course. There are no other hoops to jump through.
A contract asset, on the other hand, represents a conditional right to payment. You’ve transferred goods or services to a customer, but something else still needs to happen before you can bill them. Maybe you need to complete another phase of the project or hit a specific milestone. Your right to that payment is contingent on fulfilling another performance obligation, not just waiting for the calendar to flip.
You recognize a contract asset as soon as you've completed work for a customer but before you have the unconditional right to invoice them. Think of it as an "unbilled receivable." For example, if you’re a software company that gets paid after completing two project milestones, you’d recognize a contract asset after finishing the first milestone. You've earned the revenue, but you can't send the bill just yet.
Once you hit that second milestone and the right to payment becomes unconditional, you can reclassify the contract asset as a receivable. At that point, you can issue the invoice, and the clock starts ticking on payment. The key distinction is that a receivable's collection is only dependent on time, while a contract asset requires another action or event to occur.
How you present these items on your balance sheet matters. ASC 606 is clear that you must present any unconditional rights to payment separately as a receivable. You can't just lump contract assets and receivables together under one line item. This separation gives anyone reading your financial statements a clearer picture of your assets and when you can expect to convert them to cash.
While they are shown separately, the standard does allow for netting at the individual contract level. This means if you have both a contract asset and a contract liability with the same customer under the same contract, you can present the net amount. This presentation of contract assets helps avoid cluttering the balance sheet while still providing an accurate financial snapshot.
This isn't just an exercise for your accounting team. The way you classify these items has real-world consequences for your business. Lenders, for example, look closely at your accounts receivable to assess your liquidity. Misclassifying a conditional contract asset as an unconditional receivable could inflate your ratios and give a misleading impression of your short-term financial stability.
For industries like construction or professional services, getting this right is especially important. Incorrect classification can impact everything from your ability to secure a loan to your compliance with debt covenants. It affects the financial ratios that stakeholders use to judge your performance, so ensuring accuracy is key to maintaining trust and making sound strategic decisions.
Contract assets pop up on your balance sheet when there’s a timing mismatch between your work and your invoicing. Simply put, you’ve earned revenue by performing a service or delivering a product, but you don’t yet have an unconditional right to bill the customer for it. This isn't a sign of a problem; it's a normal part of business, especially for companies with multi-step projects or complex contracts. The key is that your right to payment is conditional on something else happening first—like completing another phase of the project or hitting a specific milestone.
Under ASC 606, recognizing this earned-but-not-billable revenue is mandatory. It ensures your financial statements accurately reflect the value you’ve delivered to date. Think of it as a placeholder that says, "We've done the work, and we're waiting for the green light to send the invoice." This situation is common across many industries, from construction to software-as-a-service (SaaS). Understanding the specific scenarios that trigger a contract asset is the first step to managing them correctly and maintaining ASC 606 compliance.
At the heart of any contract is a "performance obligation"—a promise to deliver a good or service to a customer. A contract asset is created when you fulfill one of these promises, but the contract states you can't bill for it yet. Your right to payment is conditional on completing another, future performance obligation. For example, imagine you’re a marketing agency hired to create a new website and run a three-month ad campaign. The contract states you get paid in one lump sum after the ad campaign ends. As you complete the website design (fulfilling the first obligation), you’ve earned revenue, but you can't invoice until the campaign is over. That earned revenue is recorded as a contract asset.
The core difference between a contract asset and an account receivable comes down to one question: is your right to payment conditional or unconditional? If you've delivered a service but need to complete another task before you can bill, you record a contract asset. Once that condition is met, the contract asset becomes an unconditional right to consideration, and you can reclassify it as an account receivable. At that point, the only thing standing between you and the cash is the passage of time until the payment due date. This distinction is critical for accurate financial reporting.
Contract assets are especially common in industries with long-term projects. In construction, a builder might complete the foundation of a house but can only bill the client after the framing is also complete. The value of the foundation work is a contract asset. Another classic example is "retainage," where a client holds back a percentage of each payment until the entire project is finished and approved. That retained amount is a contract asset. Similarly, a software company might get paid in installments based on development milestones. The work completed between milestones generates a contract asset until the next billing trigger is hit.
Contracts aren't always set in stone. Change orders, scope modifications, and extensions can all introduce new performance obligations or alter the terms of payment. When a contract is modified, you might perform additional work before you’re contractually allowed to invoice for it. This new work creates a contract asset. For instance, if a client asks for an additional feature halfway through a software development project, the work you do on that feature before the next official billing date would be recognized as a contract asset. This is why it’s so important to track not just the original contract terms but all subsequent modifications as well.
Getting a handle on contract assets means knowing exactly when to record them and how to value them over time. It’s not just about plugging a number into your balance sheet when a contract is signed. Instead, it’s a dynamic process that requires you to follow specific rules for initial recognition, ongoing measurement, and potential impairment. Think of it as a lifecycle: you identify the asset, assess its value regularly, and adjust as needed. This ongoing attention is what separates a contract asset from a simple accounts receivable entry.
This process is crucial for staying compliant with ASC 606 and giving you a true picture of your company’s financial health. When your financials are accurate, you can make smarter strategic decisions. Getting this right prevents audit headaches and ensures your reporting is trustworthy. For businesses with high transaction volumes, managing this manually can be a huge challenge. Keeping track of every performance obligation and its corresponding asset value across thousands of contracts is prone to error. This is where automated solutions come in to streamline the entire process, ensuring accuracy from recognition to disclosure. Let's walk through the key steps you need to follow to manage these assets correctly and keep your books clean.
You recognize a contract asset when your company has fulfilled a performance obligation, but your right to payment is still conditional. In simple terms, you’ve done some of the work, but you can’t send an invoice just yet because something else needs to happen first—like completing another phase of the project or delivering the rest of the goods. This is the key difference from a receivable, which represents an unconditional right to payment. The moment you’ve earned the right to get paid without any other strings attached, that contract asset turns into a receivable.
A contract asset’s value isn’t set in stone. You need to regularly check it for potential "credit losses," which is the accounting way of saying you need to assess the risk that the customer might not pay. This isn't just a gut feeling; there are specific accounting rules for this process, outlined in Subtopic 326-20. The goal is to make sure the value reported on your balance sheet is realistic and reflects the amount you actually expect to collect. This ongoing assessment is a critical part of managing your contract assets responsibly and maintaining accurate financials.
Impairment happens when it becomes clear that you won't be able to collect the full value of a contract asset. Maybe the customer is facing financial trouble, or there’s a dispute over the work completed. Whatever the reason, if you determine that the asset is impaired, you need to act. The next step is to record an impairment loss on your income statement. This adjusts the asset's value on your balance sheet to a more realistic number and ensures your financial statements aren't overstating your company's assets. It’s a necessary step for accurate financial reporting.
How you present contract assets on your balance sheet matters. ASC 606 is very clear: you must list contract assets separately from accounts receivable. You can’t lump them together or use contract assets to offset other liabilities. This separation provides a clearer picture of your financial position, showing stakeholders exactly how much of your future income is unconditional (receivables) versus conditional (contract assets). Proper disclosure is a cornerstone of compliance and transparency. Using systems that integrate your data correctly helps ensure these items are always categorized and reported the right way.
Once you’ve identified and recorded a contract asset, the work isn’t over. Managing these assets is an ongoing process that’s crucial for maintaining accurate financials and staying compliant. It requires a proactive strategy to track your obligations, assess risks, and ensure the asset’s value is correctly stated on your balance sheet. Think of it as tending to a garden; you can’t just plant the seeds and walk away. You need to water, weed, and monitor growth to get the results you want. By putting the right systems in place, you can protect your company’s financial health and make the entire process much smoother for your team.
Strong internal controls are your first line of defense against errors and inaccuracies. These are essentially the rules and procedures you establish to ensure your financial reporting is reliable. For contract assets, this means implementing checks and balances, like separating the duties of employees who track performance obligations from those who handle billing. Regular reconciliations are also key to confirming that your records match reality. Leveraging technology can make these controls more robust and efficient, creating a system that catches discrepancies before they become major problems. These practices aren't just about following rules; they're about building a trustworthy financial reporting process.
Every contract asset carries some degree of "performance risk"—the chance that you won't be able to fulfill the remaining obligations in your contract. It’s your responsibility to continuously assess these risks. Are there potential roadblocks that could prevent you from completing the work? Are the project requirements clear? Staying on top of these questions is vital because failing to meet your contractual duties can jeopardize future revenue and damage your relationship with the customer. Proactively managing performance risk ensures that your contract assets have a clear path to becoming unconditional receivables, which is the ultimate goal.
Just because you’ve earned revenue doesn’t mean the cash is in the bank. A contract asset is still subject to the risk that the customer may not pay. That’s why you must regularly evaluate your contract assets for potential "credit losses." This involves looking at each customer’s payment history and financial stability to determine the likelihood of a default. This assessment is critical for presenting an honest picture of your company’s financial health. Overstating the value of your assets can lead to poor business decisions and compliance issues, so it’s a step you can’t afford to skip.
Manually tracking performance obligations, calculating asset values, and performing reconciliations across hundreds or thousands of contracts is a recipe for burnout and human error. This is where automation changes the game. By implementing a system that handles these tasks for you, you can streamline the entire management process. An automated solution ensures consistent ASC 606 compliance and reduces the tedious workload on your finance team. With seamless integrations connecting your data sources, you get a clear, real-time view of your contract assets, allowing your team to focus on strategic analysis instead of manual data entry.
Managing contract assets isn't just about recording a number on the balance sheet and calling it a day. It’s an ongoing process that requires attention from the moment a contract is signed until the final payment is received. A solid management lifecycle ensures your financial statements are accurate, your audits go smoothly, and you have a clear picture of your company's financial health. Without a system in place, you risk misstating revenue, facing compliance issues, and making business decisions based on flawed data.
The key is to create a repeatable, transparent process that connects your sales, operations, and finance teams. When everyone understands their role in tracking performance, billing, and documenting changes, you can avoid the last-minute scrambles that often happen at month-end. This lifecycle approach turns a complex accounting requirement into a streamlined business operation. By automating these workflows, you can ensure nothing falls through the cracks and that your team can focus on strategic analysis instead of manual data entry. If you're looking to build a more robust process, our automated revenue recognition solutions can help manage the entire lifecycle for you.
The first step in managing contract assets is knowing exactly when you’ve earned them. This all comes down to tracking your performance obligations—the specific promises you’ve made to your customer. Once your team delivers a service or product, you need to determine if your right to payment is conditional or unconditional. If it’s unconditional, you have a receivable. But if your right to payment still depends on another future event or obligation, you have a contract asset. This distinction is critical, as it directly impacts how you recognize revenue and what appears on your balance sheet. Keeping a close eye on project milestones and delivery dates is essential for getting this right.
A contract asset often appears because of a timing mismatch: you've recognized revenue for work you’ve completed, but you haven't invoiced the customer for it yet. This is common in project-based work or multi-year subscriptions where billing occurs on a different schedule than performance. To manage this effectively, your revenue recognition process must be tightly integrated with your billing system. When these systems don't communicate, you can easily lose track of what’s been earned versus what’s been billed, leading to inaccurate financial reporting. Seamless integrations with your ERP and CRM are crucial for ensuring your data is consistent and reliable across the board.
Good documentation is your best friend during an audit. For every contract, you should maintain clear records that support the value and timing of your contract assets. This includes the contract itself, any amendments, and evidence of when performance obligations were satisfied. Details like conditional retainage, which is common in industries like construction, must be documented at the individual contract level to justify your accounting treatment. Keeping organized, accessible records not only ensures compliance but also provides a clear trail for anyone reviewing your financials, making the entire process more transparent and defensible.
Reconciliation is the final check to ensure everything adds up. You need a regular process to compare the contract asset balances on your general ledger with your underlying contract data. This helps you catch errors, identify discrepancies, and confirm that your financial statements are accurate. Misclassifying contract assets can have serious consequences, potentially affecting everything from your performance metrics to your ability to meet debt covenants. By making reconciliation a routine part of your monthly close, you can maintain confidence in your numbers and ensure your financial reporting provides a true and fair view of your business performance.
Staying compliant with ASC 606 isn't just about getting through an initial implementation; it's about building sustainable processes that keep your financial reporting accurate and reliable over the long term. Think of it as creating a strong foundation for your company's financial health. When your books are clean and your revenue recognition is sound, you can make better strategic decisions, build trust with investors, and sail through audits without breaking a sweat. It all comes down to a combination of clear internal rules, a well-informed team, and the right technology to connect the dots.
Managing contract assets correctly is a huge piece of this puzzle. Without a solid system, it’s easy for things to fall through the cracks, leading to misstated financials and compliance headaches. The key is to be proactive. By establishing clear guidelines for how your business identifies, measures, and reports on contract assets, you create a repeatable framework for success. This approach not only satisfies accounting standards but also gives you a clearer view of your company's performance. If you're feeling overwhelmed by the details, getting some expert guidance can help you build a compliant and scalable process from the ground up.
The first step toward consistent compliance is creating clear, documented policies. This isn't just about having rules; it's about ensuring everyone on your team handles contract assets the same way every time. Your policies should define exactly how your company identifies performance obligations and determines when a contract asset should be recognized.
According to ASC 606, you need to update the notes in your financial reports to explain these definitions. You also have to present contract assets and liabilities separately on your balance sheet—you can’t just net them out. Creating an internal playbook that outlines these rules, with specific examples relevant to your business, will help your team apply them correctly and keep your reporting consistent.
Great policies are only effective if your team understands and follows them. Since revenue recognition touches multiple departments, it’s crucial that everyone is on the same page. Your sales team needs to know how contract terms affect the timing of revenue, while your finance team needs to apply the rules consistently. A lack of alignment can quickly lead to errors that are difficult to untangle later.
Consider holding regular training sessions to walk through your ASC 606 policies. Use real-world examples from your own business to make the concepts tangible. Providing access to helpful educational content can also empower your team to stay informed. When everyone understands their role in the process, you create a culture of accuracy and accountability.
Audits don't have to be stressful. With solid processes and documentation, you can approach them with confidence. Auditors will want to see a clear trail showing how you arrived at your contract asset figures. This means documenting how you identified performance obligations, why you determined they were satisfied, and how you calculated the asset's value.
Remember, when you recognize a contract asset, you're also recognizing revenue for work you've completed. Auditors will scrutinize this link to ensure your revenue isn't overstated. By keeping meticulous records for every contract, you can easily demonstrate your compliance and answer any questions that come your way. This preparation turns an audit from a potential crisis into a simple validation of your great work.
For businesses with high transaction volumes, managing contract assets manually with spreadsheets is a recipe for disaster. It’s too easy to make mistakes, and the process is incredibly time-consuming. ASC 606 specifically requires that you present contract assets and unconditional rights to payment (receivables) separately. When your data lives in disconnected systems, it’s easy to accidentally offset these items, leading to non-compliance.
This is where automation makes a world of difference. A system that integrates your CRM, billing platform, and accounting software ensures data flows seamlessly and accurately. It automatically applies your revenue recognition rules, preventing manual errors and ensuring contract assets are always reported correctly. This gives you a reliable, audit-proof process that scales with your business.
What's the simplest way to tell if I have a contract asset or a receivable? Ask yourself this one question: Is my right to get paid conditional on anything other than the passage of time? If you've done the work and just need to wait for the 30-day payment term to pass, you have a receivable. If you've done some work but still need to complete another project milestone before you can even send the invoice, you have a contract asset.
Why does it matter so much if I misclassify a contract asset as a receivable? It's more than just an accounting detail; it directly impacts how healthy your business appears. Lenders and investors look at your receivables to judge your short-term cash flow and stability. Classifying a conditional contract asset as an unconditional receivable can inflate these figures, giving a misleading impression of your financial strength. Getting it right ensures you, and others, are making decisions based on an accurate picture of your finances.
At what exact point does a contract asset turn into an accounts receivable? The switch happens the moment the condition for payment is removed. For example, if your contract states you can bill after completing two project phases, you have a contract asset after finishing phase one. The instant you complete phase two, that condition is met. At that point, your right to payment becomes unconditional, and you can immediately reclassify the contract asset as an accounts receivable and issue the invoice.
Are contract assets considered riskier than accounts receivable? They carry an additional layer of risk that you need to manage. An accounts receivable primarily has credit risk, which is the chance the customer won't pay. A contract asset has that same credit risk, plus performance risk—the chance that your company might not be able to fulfill the remaining conditions required to get paid. This is why it's so important to continuously monitor both the project's progress and the customer's financial stability.
My business has tons of complex contracts. How can I manage all these contract assets without getting buried in spreadsheets? Manually tracking performance obligations, billing schedules, and asset values across many contracts is incredibly challenging and prone to error. The most effective way to handle this at scale is by using an automated system. A dedicated platform can integrate with your CRM and billing tools to track everything in real-time, apply the correct accounting rules automatically, and ensure your financial reporting is always accurate and compliant.
Former Root, EVP of Finance/Data at multiple FinTech startups
Jason Kyle Berwanger: An accomplished two-time entrepreneur, polyglot in finance, data & tech with 15 years of expertise. Builder, practitioner, leader—pioneering multiple ERP implementations and data solutions. Catalyst behind a 6% gross margin improvement with a sub-90-day IPO at Root insurance, powered by his vision & platform. Having held virtually every role from accountant to finance systems to finance exec, he brings a rare and noteworthy perspective in rethinking the finance tooling landscape.
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