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Understand contract asset vs accounts receivable, their key differences, and how to classify each for accurate financial reporting and compliance.
On your balance sheet, every line item tells a story. While both are listed as assets, the story behind a contract asset is very different from that of an account receivable. One says, "We've earned this, but we still have work to do before we can bill." The other says, "We're done, and we're just waiting for the cash." This distinction is crucial for anyone reading your financial statements, from investors to auditors. Properly separating them is a non-negotiable part of ASC 606 compliance. Let's break down the topic of a contract asset vs accounts receivable so you can tell your company's financial story with clarity and accuracy.
If you’ve ever felt a little fuzzy on the difference between a contract asset and an account receivable, you’re not alone. While they sound similar, they represent two distinct stages in your revenue cycle. Understanding this distinction is crucial for accurate financial reporting, especially under modern revenue recognition standards. Getting it right ensures your balance sheet truly reflects your company’s financial position.
Let’s break down what each term means and why the difference matters.
Think of a contract asset as a placeholder for revenue you’ve earned but can’t yet bill for. It’s your right to payment for goods or services you’ve delivered, but that right is conditional on something else happening first. You have to complete another task or hit a milestone before you can send the bill. Under standards like ASC 606, recognizing this conditional right is key. For example, if a project requires two phases for payment, the value of the first completed phase is a contract asset until you finish the second.
An account receivable, on the other hand, is much more straightforward. This is an unconditional right to receive payment from a customer. You’ve fulfilled all your obligations under the contract, and the only thing standing between you and the cash is the passage of time. Once you’ve sent the invoice, you have a legally enforceable claim to that money. Continuing our example, once you complete both project phases and send the final invoice, the contract asset becomes an account receivable. Now, you’re simply waiting for the customer to pay according to the agreed-upon terms.
The core difference comes down to one question: Is your right to get paid conditional or unconditional? If you still have work to do before you can bill, you have a contract asset. If you’ve done everything required and are just waiting for the payment due date, you have an account receivable. A common mistake is booking all earned revenue as an account receivable immediately, which can misrepresent your financials and cause audit issues. Properly distinguishing between these two items is a cornerstone of accurate revenue recognition and a clear sign of a well-managed finance function.
Understanding when to recognize a contract asset versus an account receivable is a common hurdle for finance teams, but it doesn't have to be complicated. A contract asset comes into play when you've done some of the work for a customer and earned the revenue, but you don't yet have an unconditional right to bill them for it. Think of it as a placeholder on your balance sheet that says, "We've earned this money, but we have to complete another step before we can send the invoice."
This concept is a cornerstone of modern revenue recognition standards like ASC 606. It ensures your financial statements accurately reflect the value you've delivered, even when your billing cycles don't perfectly align with your work. The key distinction lies in whether your right to payment is conditional or unconditional. If it depends on anything other than the simple passage of time—like finishing another part of the project or hitting a specific milestone—you're looking at a contract asset. Getting this right is essential for accurate financial reporting and gives you a clearer picture of your company's performance.
At the heart of every contract asset is the idea of a performance obligation. This is simply the promise you've made to a customer to provide a good or service. A contract asset appears on your books when you've fulfilled part of your promise but haven't completed everything required to issue an invoice. You've delivered value and recognized the revenue for that portion of the work, but your right to get paid is still tied to future events.
For example, you might complete the first phase of a two-part project. You've technically earned revenue for that first phase, but the contract might state you can only bill the client once the entire project is finished. That earned-but-not-yet-billable revenue is your contract asset. It’s a formal acknowledgment of the work you’ve done and the economic value you’ve created.
The defining feature of a contract asset is that your right to payment is conditional. This means something else needs to happen before you can legally demand payment from your customer. It’s not just a matter of waiting 30 days for an invoice to be due; there's a specific contractual hurdle you still need to clear. This condition could be anything from delivering the final component of a product to meeting a specific project milestone.
This is the main difference between a contract asset and an accounts receivable. With an accounts receivable, your right to payment is unconditional—the only thing standing between you and the cash is the passage of time based on your payment terms. But with a contract asset, time alone won't turn it into cash. You must first satisfy the remaining conditions outlined in your agreement with the customer.
So, how do you know when to put a contract asset on your books? The process is straightforward. After you complete a portion of the work for a customer, you need to look at your contract and ask one simple question: Is my right to payment unconditional? If the answer is yes, you have an account receivable. If the answer is no, because you still have other obligations to fulfill, you have a contract asset.
You recognize a contract asset at the moment you've earned revenue but haven't yet met all the contractual requirements to bill for it. This is a critical step for maintaining ASC 606 compliance and ensuring your financial reporting is accurate. By correctly identifying and recording contract assets, you provide a true and fair view of the revenue you've generated and the assets your company holds.
Let's make this real with a couple of examples. Imagine a construction company is hired to build a new office building. The contract is structured around three major milestones. After the company completes the foundation (milestone one), it has earned revenue for that work. However, the contract states they can only send an invoice after completing the entire framework (milestone two). The value of the completed foundation work is recorded as a contract asset until the framework is finished.
Here’s another one from the tech world: A software company signs a client for a 12-month service agreement but only bills them once per year. Each month, as the company provides its service, it earns one-twelfth of the annual fee. For the first 11 months, that earned revenue is recorded as a contract asset because the condition for billing—the passage of a full year—hasn't been met yet.
Now, let's switch gears to a term you’re likely more familiar with: accounts receivable (AR). While it might seem straightforward, understanding its specific definition under ASC 606 is key to distinguishing it from a contract asset. Unlike a contract asset, which is tied to future performance, an account receivable represents a clear, unconditional right to payment. The hard part is over; now, it’s just a matter of waiting for the cash to come in. This distinction is crucial for accurate financial reporting and maintaining a healthy cash flow.
The defining feature of an account receivable is that your right to payment is unconditional. This means the only thing standing between you and the customer’s payment is the passage of time. You’ve fulfilled your end of the bargain completely, and there are no other performance obligations left to meet. Think of it as a one-way street: the customer owes you money, and the due date on the invoice is the only remaining variable. This unconditional nature is what separates it from a contract asset, where your right to payment still depends on completing another task.
Billing is the event that typically signals the creation of an account receivable. Once you’ve delivered a service or product and sent an invoice with clear payment terms (like Net 30), you’ve established an unconditional right to that cash. For example, if you complete a consulting project and invoice your client for the full amount, that invoiced amount immediately becomes an account receivable. The client doesn’t need you to do anything else; they simply need to pay you within the agreed-upon timeframe. This clear-cut process is a cornerstone of managing your company's working capital effectively.
You should recognize an account receivable on your balance sheet the moment your right to payment becomes unconditional. This is typically when you’ve satisfied all performance obligations for that portion of the contract and have issued an invoice. For compliance with accounting standards like ASC 606, it’s essential to present accounts receivable separately from any contract assets. This separation provides a clearer picture of your company’s financial health, showing what you’re owed outright versus what you expect to earn after completing more work. Getting this classification right is fundamental for accurate revenue recognition.
To put it simply, an account receivable has a few key characteristics. It represents money owed to you by a customer for goods or services that have already been fully delivered. You have billed the customer for this amount, and your right to collect the payment is guaranteed and not dependent on any future actions from your team. The payment is expected within a typical billing cycle, and the only condition left to be met is the passage of time until the invoice due date arrives.
The switch from a contract asset to an account receivable isn't just an accounting formality; it’s a critical moment in your revenue lifecycle. This transition signifies that your right to payment has solidified, moving from a conditional promise to a straightforward obligation from your customer. Understanding this process is key to keeping your financial statements accurate and your cash flow predictable. It all comes down to meeting your contractual obligations and clearing the path to issue an invoice.
Think of the conversion from a contract asset to an account receivable as a light-switch moment. A contract asset exists when your right to payment is conditional on something other than the passage of time—like completing another phase of a project. The moment that condition is met, the switch flips. The asset is reclassified as an account receivable because your right to payment is now unconditional. All you have to do is wait for the payment due date to arrive. This reclassification is a core principle of ASC 606, ensuring revenue is recognized in line with performance.
So, what flips the switch? Usually, it’s a specific billing milestone defined in your customer contract. A contract asset represents the work you've done that you can't yet invoice for. For example, you might have completed the first of three software development sprints, but the contract states you can only bill after all three are finished. Once that final sprint is complete, you’ve hit the milestone. Your conditional right to payment becomes unconditional, and the contract asset converts to an account receivable. Tracking these milestones accurately is crucial, which is why many businesses rely on automated solutions that sync with their project management tools.
To support the reclassification from a contract asset to an account receivable, you need a clear paper trail. This isn’t just for your internal records; it’s essential for passing audits. Your documentation should prove that the conditions for payment have been fully met. This could include project completion sign-offs from the client, delivery confirmations, or internal reports verifying that a service milestone has been achieved. You should be able to provide a detailed explanation of the goods or services transferred and clearly show when and why the right to payment became unconditional. Keeping these records organized is a cornerstone of strong internal controls.
When a contract asset becomes an account receivable, the change happens entirely on the asset side of your balance sheet. One current asset (contract asset) simply gets reclassified as another current asset (account receivable). It’s important to remember that this conversion does not impact your income statement. The revenue was already recognized when you initially recorded the contract asset. This shift is about clarifying the nature of your assets. It shows investors and stakeholders that a conditional right has matured into a direct claim to cash, which provides a clearer picture of your company’s short-term liquidity and financial health. You can find more articles on financial reporting on our blog.
Understanding the difference between a contract asset and an account receivable is more than just an accounting exercise—it directly impacts your financial reporting, cash flow, and overall business strategy. Getting this right means you can present a clear picture of your company's health, stay compliant, and make smarter decisions. Let's break down what you need to manage.
When you prepare your balance sheet, you can’t just group contract assets and accounts receivable together. They need to be listed as separate line items. Why? Because they represent different levels of risk and certainty. An account receivable is an unconditional right to cash, while a contract asset is still conditional. Separating them gives investors, lenders, and other stakeholders a more transparent view of your financial position. This distinction is a key requirement for clear and compliant financial reporting, ensuring everyone understands exactly when and how you expect to get paid.
Contract assets are a direct result of the five-step revenue recognition model outlined in ASC 606. Specifically, they pop up in step five. A contract asset is created when you've fulfilled a performance obligation (i.e., you’ve delivered the goods or services) but can't yet invoice the customer because a future condition must be met. For example, maybe you need to complete another project phase before you can bill for the first one. Recognizing revenue at this stage is correct under ASC 606, but since you don't have an unconditional right to payment, you record a contract asset, not an account receivable.
Because contract assets are conditional, they carry a bit more risk than accounts receivable. Their conversion to cash isn't guaranteed and might take longer, which can affect your cash flow forecasting. You also have to consider the potential for non-payment. Under current accounting standards, you must assess your contract assets for expected credit losses. This means you need a process to evaluate the risk that a customer won't be able to pay once the conditions are met. This assessment can impact your financial statements and requires careful monitoring.
Effectively managing your working capital means keeping a close eye on your contract assets. A key practice is to regularly assess them for impairment, which is the accounting term for a potential loss in value. You need to determine if a customer is unlikely to pay the full amount. It’s also important to distinguish between a credit loss (the customer can't pay) and an implicit price concession (you effectively agreed to a lower price). Having a clear system to track and analyze these assets is crucial. Automating this process with the right integrations can help you maintain accurate records and make proactive adjustments to your financial strategy.
Getting a handle on contract assets and accounts receivable isn't just about keeping your books tidy—it's about staying compliant and protecting your business. When you correctly classify these items, you create a clear financial picture that stands up to scrutiny. This builds trust with investors, stakeholders, and auditors, all while giving you the accurate data you need to make smart decisions. Let's walk through what you need to know to keep your financial reporting accurate and reduce risk.
If your business operates in the U.S., you need to follow the revenue recognition guidelines set by ASC 606. This standard introduced the term "contract asset" to clarify how you should account for revenue when your right to payment depends on something other than the passage of time. Essentially, if you've completed work but can't send an invoice just yet, you likely have a contract asset. Properly identifying and recording these assets is a core requirement for ASC 606 compliance, ensuring your financial statements accurately reflect your performance under customer contracts.
For businesses operating internationally, the equivalent standard is IFRS 15. Much like ASC 606, IFRS 15 provides a framework for recognizing revenue and requires the proper handling of contract assets. The principles are very similar, focusing on the transfer of control of goods or services to a customer. Whether you're reporting under U.S. GAAP or IFRS, understanding the distinction between a conditional right to payment (a contract asset) and an unconditional one (an account receivable) is essential. Following these global accounting standards ensures consistency and comparability in your financial reporting, which is crucial for global operations.
When auditors come knocking, they’ll look closely at your revenue recognition processes. They will pay special attention to your judgments and estimates, especially around contract assets. Auditors want to see that you have a consistent, well-documented method for determining when a performance obligation is met and when a right to payment becomes unconditional. Having messy or unclear records can lead to difficult questions and potential adjustments. A smooth audit depends on your ability to provide a clear trail that justifies how and when you recognized revenue and classified your assets.
Strong internal controls are your best defense against compliance issues and financial misstatements. Start by establishing clear procedures for your team to follow when reviewing contracts and classifying assets. This includes separating duties, performing regular reconciliations, and maintaining detailed records of all contracts and modifications. Using technology can make this much easier. When your systems are connected, you create a single source of truth that reduces manual errors and provides clear visibility. Having seamless integrations between your CRM, ERP, and accounting software helps automate these controls and keeps your data accurate.
Understanding the distinction between a contract asset and an account receivable goes far beyond just keeping your books clean. It’s about gaining a clearer, more strategic view of your business's financial health. When you can confidently classify what you’re owed and when, you can make smarter decisions about your company’s future. This clarity affects everything from how you measure success to how you manage risk and plan for growth. Let's look at how you can use this knowledge to your advantage.
Contract assets give you a more honest look at your company’s performance by letting you report earnings based on the work you’ve actually completed, not just when the cash comes in. This is a game-changer for businesses with long-term projects or subscription models. Instead of seeing financial reports that swing wildly based on payment dates, you get a steady, realistic picture of the value you’re delivering over time. This accurate reflection of performance helps you and your stakeholders understand the true health of the business, making it easier to follow complex revenue recognition rules and report with confidence.
When you have a clear view of your contract assets and a timeline for when they will convert to accounts receivable, you can forecast future cash flow with much greater precision. This isn't just a nice-to-have; it’s essential for smart resource planning. Knowing what money is coming down the pipeline—and what conditions need to be met to secure it—helps you decide when to hire new team members, invest in equipment, or purchase inventory. By connecting your financial data across different platforms, you can create a single source of truth that turns reactive financial management into a proactive growth strategy. Having the right system integrations is key to achieving this level of visibility.
Both contract assets and accounts receivable come with risks, but they aren’t the same. Accounts receivable primarily carry credit risk—the chance that a customer simply won’t pay their invoice. Contract assets, however, are exposed to both credit risk and performance risk. Performance risk is the possibility that you won’t be able to fulfill your end of the bargain, which would prevent the asset from ever becoming an unconditional right to payment. Separating these two asset types allows you to manage each risk appropriately. You can implement stronger project controls to mitigate performance risk while using credit checks and clear payment terms to handle credit risk. This is a core part of maintaining ASC 606 compliance.
Ultimately, clear and accurate financial data empowers you to make better strategic decisions. For instance, your team needs to use good judgment to distinguish between an implicit price concession (where the actual price was lower from the start) and a credit loss (where the customer can't pay the agreed-upon price). These scenarios have different impacts on your financials. When your assets are correctly classified, you can trust your reports to guide critical choices about pricing models, contract negotiations, and customer relationships. Getting this level of clarity often starts with a solid data foundation, which is where a data consultation can help map out a path forward.
Managing contract assets and accounts receivable effectively comes down to having solid processes in place. When your team has clear guidelines and the right tools, you can handle these assets with confidence, ensuring your financial statements are always accurate and audit-ready. It’s about moving beyond just recording transactions and building a system that supports strategic financial management. By implementing a few key practices, you can create clarity, reduce risk, and empower your team to make smarter decisions. This isn't just about compliance; it's about creating a financial engine that runs smoothly and provides real-time insights into your business performance. Strong internal processes prevent revenue leakage, speed up your financial close, and give you a clear view of your cash flow. Here are the core habits that will make a real difference in your financial operations.
The first step is making sure everyone on your team can clearly distinguish between a contract asset and an account receivable. A contract asset is your right to payment for work you’ve done, but that right is still conditional on something else happening—like hitting a project milestone. In contrast, an account receivable is an unconditional right to payment, where only the passing of time is required before it's due. Getting this classification right is the foundation of accurate reporting. Create internal guides and hold regular training sessions to ensure your team can present contract assets and liabilities correctly every time. This removes guesswork and ensures consistency across your financial statements.
Contract assets require active monitoring, especially in businesses with long-term projects like software, construction, or telecom. Since they represent value you’ve delivered but can't yet bill for, you need to keep a close eye on them. Tracking these assets helps you report earnings based on the work you’ve actually completed, not just when you send an invoice. This is a core principle of handling contract assets under ASC 606. Set up a system to regularly review the status of each contract asset and the conditions that will convert it into an account receivable. This proactive approach gives you a much clearer, more accurate picture of your company’s financial health and performance over time.
Good documentation is your best friend during an audit and for internal clarity. For every contract asset, you should be able to provide a clear explanation of the goods or services that were transferred but not yet billed, and when you expect to receive payment. Standardizing this process across all contracts creates consistency and makes it easy for anyone to understand the story behind the numbers. Your documentation should be detailed enough to support your financial statements and answer any questions that might come up from stakeholders or auditors. This isn't just about ticking a box; it's about creating a transparent and defensible record of your revenue-generating activities.
When your CRM, billing platform, and accounting software don't communicate, you’re left with data silos and a high risk of manual error. Creating a single source of truth is essential for managing your assets effectively. With a unified view of your data, your team can make better judgment calls, like distinguishing between a price concession and a credit loss. HubiFi offers seamless integrations that connect your disparate systems, automating data flows and ensuring everyone is working from the same accurate information. This eliminates confusion, reduces the time spent on manual reconciliation, and gives you a reliable foundation for all your financial reporting and strategic planning.
What's the simplest way to tell a contract asset from an account receivable? Ask yourself this one question: "Can I send the bill right now?" If the answer is yes, and the only thing you're waiting on is for the payment due date to arrive, you have an account receivable. If the answer is no because you still have to finish another task or hit a milestone for the customer, you have a contract asset. It’s all about whether your right to get paid is conditional or unconditional.
Why is it so important to separate contract assets and accounts receivable? Separating them gives a much more honest picture of your company's financial health. An account receivable is a direct claim to cash, making it a very liquid asset. A contract asset, however, still has some performance risk attached to it—you have to complete more work before you can bill for it. For investors, lenders, and even your own leadership team, this distinction clarifies what cash is a sure thing versus what is still dependent on future actions, which is a key requirement under accounting standards like ASC 606.
Does creating a contract asset change my company's revenue or profit? No, it doesn't. The revenue is recognized on your income statement at the moment you earn it by completing the work, which is the same moment the contract asset is created on your balance sheet. The transition from a contract asset to an account receivable is purely a reclassification on the asset side of your balance sheet. It doesn't touch your income statement; it simply shows that a conditional asset has now become an unconditional one.
What happens to a contract asset if the project stalls or the conditions for billing are never met? This is where risk management comes in. If it becomes clear that you won't be able to meet the conditions required to convert the asset into an account receivable, you'll need to assess the contract asset for impairment. This means you have to determine if it has lost value and potentially write it down as a loss. This is why it's so important to monitor your contract assets closely and not just assume they will all eventually turn into cash.
What's the most common mistake companies make when managing these assets? The most common mistake is trying to track everything manually in spreadsheets. When your project data, contracts, and accounting software are disconnected, it’s incredibly easy to miss the moment a contract asset should be converted to an account receivable. This leads to inaccurate financial statements and a painful month-end close. Having integrated systems that create a single source of truth is the best way to avoid these errors and ensure your reporting is always accurate.
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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