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Get a clear explanation of ASC 606 contract assets, how they work, and practical tips for accurate revenue recognition and financial reporting.
For high-volume businesses, contracts are rarely simple. They often involve multiple deliverables, variable pricing, and evolving timelines, making revenue recognition a significant challenge. One of the trickiest parts of this process is correctly identifying and managing contract assets. These aren't just another line item on the balance sheet; they represent the value of your fulfilled promises to customers before you have the unconditional right to payment. A clear grasp of ASC 606 contract assets is fundamental for any company looking to automate its financial processes, close the books faster, and maintain a clear, auditable trail of its revenue streams from contract to cash.
If you’re working with ASC 606, you’ve probably come across the term “contract asset.” It sounds technical, but the idea behind it is pretty straightforward. Think of it as a placeholder for revenue you've earned but can't yet bill for. This situation happens when your contract has specific conditions that need to be met before you can send an invoice, even if you've already delivered part of the goods or services. For example, maybe you’ve completed the first phase of a three-phase project, but the contract states you can only invoice after the entire project is finished. You’ve done the work for phase one, so you need to recognize that revenue now, not later.
Understanding contract assets is key to ensuring your financial statements are accurate and compliant. It’s a direct result of the core principle of ASC 606: recognizing revenue when you transfer control of goods or services to a customer. Sometimes, the timing of that transfer doesn't line up perfectly with your right to invoice. That gap is precisely where contract assets come into play, bridging the space between completing your work and getting the unconditional right to be paid for it.
So, what exactly makes something a contract asset? It boils down to one key idea: a conditional right to payment. A contract asset is the money your company expects to receive for work it has already completed, but you can't officially bill for it yet. This is because some condition in the contract—other than just the passage of time—still needs to be met. For instance, you might have to deliver a second piece of software before you can invoice for the first one. You've earned the revenue for that first piece, and that value is recorded as your contract asset. This is a crucial concept in our guide to ASC 606 contract assets.
Contract assets fit neatly into the five-step revenue recognition model of ASC 606. You record a contract asset when you’ve fulfilled a performance obligation (Step 5), but your right to payment is still conditional. Essentially, you've done the work and recognized the revenue on your income statement, but you can't record an account receivable because you don't have an unconditional right to the cash yet. Once that final condition is met—say, the project is fully complete—the contract asset flips over and becomes a receivable on your balance sheet. It’s a crucial step for accurate financial reporting.
At first glance, contract assets and accounts receivable seem like two sides of the same coin. Both represent money your company is owed for work you’ve completed. However, under ASC 606, the distinction between them is critical for accurate financial reporting. The key difference boils down to one simple question: Is your right to get paid conditional or unconditional?
Think of it this way: Accounts receivable is a straightforward IOU. You’ve delivered the goods or services, sent the invoice, and are simply waiting for the payment terms to run their course. A contract asset is more like an "IOU, once..." where you've done part of the work but can't bill for it until another condition is met. Understanding this nuance is essential because it affects how you present your company’s financial health on the balance sheet and ensures you remain compliant. Getting this wrong can lead to misstated financials, which can cause headaches during an audit and give stakeholders a skewed view of your performance. It’s a small detail with big implications for your financial integrity.
The main thing separating a contract asset from accounts receivable is the nature of your right to payment. A contract asset exists when your company has performed work for a customer but your right to get paid is conditional on something other than the passage of time. For example, you might complete the first milestone of a large project, but the contract states you can only invoice the client after the second milestone is also finished. That right to payment for the first milestone is a contract asset until the second one is done.
On the other hand, accounts receivable represents an unconditional right to payment. You’ve fulfilled your obligation, and the only thing required before you get paid is for time to pass. The moment a right to payment becomes unconditional, a contract asset is reclassified as accounts receivable.
Because of their different risk profiles, contract assets and accounts receivable cannot be combined on the balance sheet. They must be presented as separate line items, usually within current assets. This separation gives investors, lenders, and other stakeholders a clearer, more transparent view of your company’s financial position. It highlights the portion of your revenue that is still tied to future performance or events.
When you record a contract asset, you also recognize the corresponding revenue on your income statement, aligning with the core principles of ASC 606. Having your contract assets listed separately from accounts receivable is not just good practice; it’s a requirement for compliance. This ensures your financial statements accurately reflect the timing and conditions associated with your revenue streams.
Knowing when to recognize a contract asset is all about timing and conditions. It’s not as simple as just completing the work. Under ASC 606, you record a contract asset when you've delivered a good or service to a customer but don't yet have an unconditional right to payment. Think of it as a middle step: you've earned the revenue, but you can't send the invoice just yet because another condition needs to be met first.
This distinction is a cornerstone of the ASC 606 framework, ensuring that your financial statements accurately reflect your performance and the nature of your customer agreements. Getting this timing right is crucial for compliance and gives a clearer picture of your company's financial health. It separates what you've earned from what you can actually bill for, which is a key piece of information for investors, auditors, and your own internal planning.
The starting point for recognizing a contract asset is fulfilling a performance obligation. In simple terms, you’ve done the work you promised. However, the key difference is that your right to get paid for that work depends on something other than just the passage of time. For example, maybe your contract states you can only invoice after the entire project is complete, even though you’re delivering it in phases. Once you complete the first phase, you’ve earned that revenue and can recognize a contract asset for its value. You've held up your end of the bargain, but a future event—like project completion—is holding up the invoice.
Once you've identified a contract asset, you need to report it correctly on your balance sheet. Contract assets are typically listed as a separate line item within your current assets. This isn't just for show; it’s a critical distinction for financial transparency. Separating them from standard accounts receivable signals that their collection is conditional. This helps stakeholders understand potential risks and the nature of your revenue streams. Having a system that integrates with your ERP and accounting software is key to making sure these assets are categorized and reported correctly without manual headaches.
Contracts often include multiple promises, like software implementation, training, and ongoing support. For these multi-element arrangements, you first have to identify each distinct performance obligation. Next, you allocate the total contract price across each of those promises. As you complete each one, you recognize the corresponding revenue. If payment for that completed part is still conditional on another part being finished, the amount you've earned becomes a contract asset. This process can get complicated fast, which is why many businesses use an automated system to manage these allocations and ensure compliance.
Measuring a contract asset isn’t a one-and-done task. It’s a process that starts with an initial valuation and continues with regular reviews to make sure the number on your balance sheet is accurate. Getting this right is essential for a clear picture of your company’s financial health. The initial value is tied to the performance obligations you’ve fulfilled, but that value can change over time depending on various factors, most notably the customer’s credit risk.
The key is to establish a consistent and reliable method for both the initial measurement and ongoing assessments. This often requires pulling data from different systems—like your CRM and accounting software—to get a complete view of the contract and customer relationship. Having seamless data integrations is a huge advantage here, as it ensures your assessments are based on real-time, accurate information. Without a solid process, you risk misstating your assets and making decisions based on faulty financials.
When you first recognize a contract asset, its value is based on the revenue you’ve earned but cannot yet unconditionally bill for. Think of it this way: you’ve delivered goods or services to a customer, but your right to payment still depends on fulfilling another part of the contract. According to accounting guidance, this creates a contract asset rather than a standard receivable.
For example, imagine your company signs a $20,000 contract to deliver a software license and provide implementation services. You deliver the license first (a distinct performance obligation), but the contract states you can only invoice the full amount after the implementation is complete. Once you deliver the license, you can recognize a contract asset for that portion of the revenue, even though you can't send the bill just yet.
Once a contract asset is on your books, you need to regularly assess it for impairment. In simple terms, impairment is the risk that you won’t be able to collect the full amount you’re owed from the customer. This isn't just good business sense; it's a requirement. You have to periodically review your contract assets to determine if their value has declined due to credit losses.
This ongoing measurement ensures that your balance sheet doesn't overstate the true value of your assets. If a customer’s financial situation deteriorates or a dispute arises, the recoverable amount of the contract asset might be less than what you initially recorded. Ignoring this could lead to compliance issues and a skewed view of your company’s financial stability.
The process for assessing impairment is guided by another standard, ASC 326, which deals with credit losses. This rule requires you to estimate expected losses over the entire life of a financial instrument, including contract assets. You can’t wait for a loss to be certain; you have to proactively assess the risk of non-payment from the moment the asset is recognized.
Your company needs to establish a consistent method for this evaluation. If you identify a high risk that a customer won't pay, you must record an impairment loss, which reduces the contract asset's carrying value on your balance sheet. As we explain in our guide to ASC 606 contract assets, this forward-looking approach helps ensure your financial statements reflect a more realistic economic position.
Applying the ASC 606 standard can feel like you’re solving a puzzle. While the five-step model provides a clear framework, putting it into practice often reveals a few common hurdles that can trip up even the most diligent finance teams. These challenges aren't signs of failure; they're a normal part of adapting to a more detailed and principle-based accounting standard. The key is to know what they are so you can prepare for them.
Most businesses grapple with the same core issues: figuring out exactly what promises they’ve made to customers, dealing with pricing that isn't fixed, and trying to pull accurate data from multiple software systems that don’t talk to each other. On top of that, customer contracts are rarely static—they evolve, and every change needs to be accounted for correctly. Understanding these specific pain points is the first step toward building a revenue recognition process that is both compliant and efficient. These aren't just theoretical problems; they have real-world impacts on your financial statements, affecting everything from your balance sheet to your income statement. Getting them right is essential for accurate reporting, passing audits, and making informed business decisions. Let's break down each of these challenges so you can tackle them head-on.
One of the first stumbling blocks is identifying all the distinct performance obligations in a contract. A performance obligation is simply a promise you've made to provide a good or service to your customer. The challenge lies in contracts where you’re delivering multiple things. For example, if you sell a software subscription that includes implementation services and technical support, are those three separate promises or one combined package? Getting this wrong can throw off the timing of your revenue recognition, so it’s crucial to carefully analyze your contracts to separate each distinct promise you need to fulfill for the customer.
Figuring out the transaction price seems simple until you encounter variable consideration. This includes things like discounts, rebates, performance bonuses, or any other element that could make the final price change. For instance, you might offer a client a bonus if a project is completed early or a discount for renewing their contract. Under ASC 606, you have to estimate the most likely amount you'll receive and include it in the transaction price from the start. This requires a reliable method for forecasting these variables, which can be especially tricky for businesses with complex pricing structures or long-term contracts.
For many companies, contract and billing information lives in different places. Your sales team might use a CRM, your operations team a project management tool, and your finance team an accounting platform. When these systems don't communicate, you're left piecing together data manually to track revenue. This not only takes a huge amount of time but also opens the door to errors. To accurately track contract assets and recognize revenue correctly, you need a single source of truth. This is where seamless integrations between your various platforms become essential for creating a reliable and automated workflow.
Business relationships change, and so do contracts. A customer might upgrade their subscription, add new services, or change the scope of a project. Each of these contract modifications requires you to revisit your accounting. You may need to re-evaluate your performance obligations, reallocate the transaction price, and adjust your revenue recognition schedule accordingly. Without a systematic process, managing these changes can become a significant administrative burden. Staying on top of modifications is critical for maintaining accurate financial records and ensuring you remain compliant with ASC 606 as your customer relationships evolve.
Recognizing contract assets isn't just an accounting exercise; it has a real and visible effect on your financial statements. From the balance sheet to the income statement, these assets change the way you report performance and financial health. Understanding these impacts is key to maintaining transparency with investors, lenders, and other stakeholders, ensuring everyone has a clear picture of your company's revenue and future cash flows. It’s all about showing not just what you’ve earned, but also the conditions attached to those earnings.
Your balance sheet is the primary home for contract assets, but they don’t just get lumped in with your other receivables. Under ASC 606, contract assets must be listed separately from accounts receivable. This distinction is crucial because it signals that your right to payment is still conditional on something other than the passage of time. By separating them, you provide a clearer picture of your assets, highlighting which ones are unconditional (accounts receivable) and which ones still have a hurdle to clear before you can send an invoice. This transparency helps stakeholders accurately assess collection risks and understand the true nature of your current assets.
When you recognize a contract asset on the balance sheet, you also recognize the corresponding revenue on the income statement. This is a core principle of accrual accounting: you record revenue when it's earned, not just when cash comes in the door. So, while a new contract asset makes your revenue numbers look good, it doesn't immediately impact your cash flow statement. Cash only hits your bank account after the conditions are met, the asset becomes an account receivable, and your customer pays the invoice. This can create a temporary gap between reported profit and actual cash on hand, which is an important factor in financial planning.
Introducing contract assets can shift key financial ratios that analysts and lenders use to evaluate your business. For example, your current ratio (current assets divided by current liabilities) might change. Since contract assets are typically classified as current assets, they can make your liquidity position appear stronger. However, savvy investors will look closer, as contract assets aren't as liquid as cash or standard receivables. How a company classifies these items can significantly affect how its financial health is viewed, so it’s important to be prepared to explain the nature of these assets to stakeholders.
Transparency is non-negotiable when it comes to contract assets. ASC 606 requires you to provide clear and detailed explanations in the notes of your financial statements. You can’t just list a number on the balance sheet and call it a day. Companies must provide detailed explanations about the nature of their contract assets, any significant changes during the period, and when they expect those assets to be reclassified as receivables. This narrative gives context to the numbers, helping stakeholders understand the timing and risks associated with your recognized revenue. Think of it as telling the full story behind the figures.
Managing contract assets under ASC 606 can feel like a puzzle, especially when you're dealing with complex agreements and shifting timelines. The challenges are real—from correctly identifying performance obligations to handling contract modifications on the fly. But they are entirely manageable with a proactive approach. Getting this right isn't just about staying compliant; it's about gaining a crystal-clear view of your company's financial health, which allows you to make smarter, more strategic decisions.
Instead of reacting to issues as they come up, you can build a solid framework that supports your team and scales with your business. The key is to combine clear internal rules with the right tools and consistent team communication. By focusing on a few core areas, you can turn potential accounting headaches into a streamlined process that strengthens your financial operations. Below are four practical steps you can take to get control over your contract assets and build a more resilient revenue recognition process.
Your first line of defense is a clear and detailed accounting policy specifically for contract assets. Think of this as the official playbook for your team. It should outline exactly how to identify, measure, and document contract assets according to ASC 606. Create detailed policies for how to account for contract assets and train your staff on them. This isn't a one-time task; you should plan to update these rules regularly as your business offerings evolve or as accounting standards change. A well-defined policy eliminates guesswork, ensures consistency across your finance team, and makes onboarding new members much smoother.
If you're still tracking contract assets in spreadsheets, you're spending too much time on manual work and opening the door to costly errors. It’s time to switch from spreadsheets to an automated system. Automation is essential for preventing errors, staying compliant with ASC 606, and getting an up-to-date view of your financials. An automated platform can handle complex calculations, manage data from different sources, and provide the real-time insights you need to run your business effectively. If you're ready to see how this works, you can schedule a demo to get a firsthand look at a more efficient process.
Revenue recognition is a team sport. The details of a sales contract directly impact how the finance team recognizes revenue, which is why everyone needs to be on the same page. Regularly train your finance, sales, and legal teams so they all understand the rules and how to apply them. When your sales team understands how contract terms affect revenue timing, they can structure deals that are healthier for the business. Likewise, when your legal team is aware of the accounting implications, they can draft stronger agreements. Consistent training ensures everyone is working toward the same goal: clean, compliant, and accurate financial reporting.
When it comes to an audit, your documentation is your best friend. Maintaining detailed records of all contracts and any changes is non-negotiable. This goes beyond just storing the final signed agreement. Your records should include all amendments, addendums, and relevant communications that modify the scope or price of the original contract. This creates a clear and complete audit trail that justifies your accounting treatment for every contract asset. Getting into this habit saves an incredible amount of stress and time down the road, ensuring you’re always prepared to back up your numbers.
Managing contract assets effectively is more than just a compliance task—it's a strategic move that strengthens your financial health. By adopting a few key practices, you can reduce risk, simplify your reporting, and gain a clearer view of your company's future. Let's walk through three essential habits that will help you stay on top of your contract assets and make smarter business decisions.
Think of a contract asset as a promise of future payment. But what if that promise is at risk? That's where impairment, or "credit loss," comes in. You need to regularly check if there's a chance your customer might not be able to pay what they owe. This isn't a one-and-done task; it's an ongoing assessment to ensure the value on your balance sheet is realistic. Staying proactive about this helps you recognize potential losses early and keeps your financial statements accurate and compliant. It’s a crucial step in understanding the true value of the assets you hold, which you can learn more about on our HubiFi blog.
If you're still using spreadsheets to track contract assets, you're creating unnecessary headaches. Manual processes are slow, prone to human error, and make it tough to get a real-time financial picture. When auditors come knocking, you need clear, detailed documentation explaining what your contract assets are and when you expect them to convert to cash. An automated system removes the guesswork and risk. By centralizing your contract data, you can ensure consistency, pass audits with confidence, and provide the transparent reporting that stakeholders expect. Good integrations with your existing tools are key to making this process seamless.
Contract assets offer a valuable glimpse into your future revenue, but they can also signal a delay in cash flow. A high balance often means you're doing a lot of work upfront before you can send an invoice. While this reflects earned revenue, it doesn't put cash in the bank. By closely monitoring your contract assets, you can better predict when that money will actually arrive. This visibility is essential for accurate cash flow forecasting, helping you plan for expenses and growth. When you understand the story your contract assets are telling, you can make more informed strategic decisions. If you want to see how to get this level of clarity, you can always schedule a demo with our team.
Can you give me a simple, real-world example of when a contract asset is created? Of course. Imagine you're a marketing agency hired to complete a three-month project for $30,000, but the contract states you can only send the final invoice upon project completion. After the first month, you've completed one-third of the work and have technically earned $10,000. Since you can't bill for it yet, that $10,000 is recorded as a contract asset on your balance sheet. It represents the value you've delivered that is waiting on a future condition to be met before you can invoice.
What is the specific trigger that turns a contract asset into an accounts receivable? The trigger is the moment your right to payment becomes unconditional. This happens when the final condition in the contract—other than just the passage of time—is met. Using the previous example, once you complete the entire three-month project, the condition is fulfilled. At that exact point, the contract asset is reclassified as an accounts receivable. You can now send the invoice, and the only thing standing between you and the cash is waiting for the payment terms to pass.
What should I do if I'm worried a customer won't be able to pay for the work related to a contract asset? This is a great question, and it touches on the concept of impairment. You are required to regularly assess whether you'll be able to collect the full value of your contract assets. If a customer's financial situation changes or a dispute arises, you need to estimate the potential loss. This means you may have to record an impairment loss, which reduces the asset's value on your balance sheet to a more realistic figure. It’s a proactive way to ensure your financials aren't overstating the value of what you expect to collect.
My contract and billing data are in different systems. How does that affect managing contract assets? When your data lives in separate places, like a CRM for contracts and an accounting platform for billing, it creates a lot of manual work and a high risk of error. You might miss a contract modification or miscalculate the value of a fulfilled obligation. This makes it incredibly difficult to get an accurate, real-time view of your contract assets. To manage them effectively, you need a single source of truth where all this information comes together automatically, ensuring your financial reporting is both accurate and efficient.
Why is it so important to list contract assets separately on my balance sheet? Separating contract assets from accounts receivable provides crucial transparency to anyone reading your financial statements, like investors or lenders. It tells them exactly how much of your owed money is a straightforward IOU (accounts receivable) versus how much is still tied to future performance or other conditions (contract assets). This distinction helps them better understand the timing and potential risks associated with your future cash flows, giving them a much clearer and more honest picture of your company's financial position.
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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