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Get clear on contract asset vs accounts receivable. Learn the key differences, how each impacts your books, and tips for accurate financial reporting.
If you’ve ever completed a project milestone but had to wait to send the invoice, you’ve encountered the exact scenario that separates a contract asset from an account receivable. It’s a common situation, but one that requires careful accounting to stay compliant. A contract asset is your right to payment for work you’ve already performed, but that right is conditional on completing another task. An account receivable is an unconditional right to payment. This guide will explore the nuances of the contract asset vs accounts receivable relationship, showing you how to identify, manage, and report each one correctly on your financial statements.
Getting your head around accounting terms can feel like learning a new language. A "contract asset" is one of those terms that sounds more complicated than it is. Think of it as an IOU you can't cash in just yet. It represents the value of work you've completed for a client, but for which you don't have the green light to send an invoice. It’s a crucial concept for accurately tracking revenue, especially for businesses with multi-part projects or long-term contracts. Let's break down what that means for your books.
At its core, a contract asset is your company's right to get paid for goods or services you've already delivered. The catch? This right is conditional, meaning you have to do something else before you can officially ask for the money. For example, if your contract requires you to deliver two software modules but you can only invoice after both are complete, you have a contract asset after delivering the first one. That earned-but-not-billable amount is your contract asset, and you recognize it on your balance sheet right away.
A contract asset appears on your books in that specific window of time after you've performed some work but before you can send a bill. Imagine you're a consulting firm hired for a two-phase project. The contract states you get paid after the final presentation. Once you hand over the completed market research, you've fulfilled a performance obligation. You've earned that revenue according to accounting rules, so you need to record it. Since you can't issue an invoice yet, you record it as a contract asset to accurately reflect the value you've provided.
The defining feature of a contract asset is that the condition for payment is tied to your future performance, not just the passage of time. You have another milestone to hit or another product to deliver. This is completely different from an accounts receivable, where you've done everything required and are simply waiting for the payment term to pass. With a contract asset, the ball is still in your court. This distinction is crucial under modern revenue recognition standards, which require companies to accurately represent their financial position.
Now let's talk about a term you’re probably much more familiar with: accounts receivable (AR). While it’s a standard entry on any balance sheet, understanding exactly when and how to record it is crucial for accurate financial reporting, especially when you’re dealing with complex contracts. Unlike a contract asset, which is tied to your ongoing performance, accounts receivable represents a straightforward, unconditional right to get paid for something you’ve already delivered.
Think of it as an IOU from your customer. You’ve done your part, sent the invoice, and now you’re just waiting for the payment to arrive. This distinction is more than just accounting jargon; it directly impacts how you manage your cash flow and report your financial health. Getting this right ensures your financial statements accurately reflect the money you’re owed, giving you a clear picture of your short-term liquidity. For businesses with high transaction volumes, misclassifying receivables can quickly lead to compliance headaches and skewed financial metrics. That's why nailing down the basics of AR is the first step toward building a more robust and reliable accounting process.
At its core, accounts receivable is the money owed to your business for goods or services that have been delivered or used but not yet paid for by customers. When you see AR on a balance sheet, it represents a clear, unconditional right to receive cash. The "unconditional" part is key—it means the only thing required for you to get paid is the passage of time until the invoice due date.
You’ve fulfilled your performance obligation completely, and there are no other conditions to meet. This makes AR a current asset, as you typically expect to collect the cash within a year. Properly managing your AR is fundamental to maintaining healthy cash flow and ensuring your revenue recognition practices are sound.
You should record accounts receivable the moment your right to payment becomes unconditional. This typically happens once you've completed your performance obligation under the contract and have the legal right to bill your customer. For example, if you sell a software subscription, you might recognize AR once you’ve provided access for the billing period and sent the invoice.
The trigger is simple: if you've done the work and can send a bill without any other strings attached, it's time to record it as accounts receivable. This clear-cut process is why many businesses find AR easier to manage than contract assets. Automating this process can help you close your books faster and with greater accuracy, which is something we can help you explore in a demo.
While most people think of AR as just customer invoices, it can be broken down into two main categories: trade receivables and non-trade receivables. Understanding the difference is important for organizing your financials correctly.
Trade receivables are the most common type and arise directly from your primary business activities—the sale of goods or services to customers. If you run a consulting firm, your invoices for completed projects are trade receivables.
Non-trade receivables come from sources outside of your core operations. This could include interest earned on investments, tax refunds owed to your company, or loans made to employees. Separating these helps provide a clearer view of your operational performance, a process made much simpler with seamless data integrations.
At first glance, contract assets and accounts receivable look pretty similar. Both represent money your company is owed for work you’ve completed, and both show up as assets on your balance sheet. But when you dig into the details, especially under revenue recognition rules like ASC 606, you’ll find they tell two very different stories about your revenue and cash flow. The key distinction comes down to one simple question: Is your right to get paid conditional or unconditional?
Understanding this difference is more than just an accounting exercise. It impacts how you report your financials, assess risk, and forecast your company’s health. Getting it right ensures your books are accurate and compliant, giving you a true picture of where your business stands. Let’s break down the specifics so you can confidently tell them apart.
The biggest difference between a contract asset and accounts receivable is timing. A contract asset comes into play when you've earned revenue by fulfilling part of a contract, but you can't send an invoice just yet. Your right to payment depends on something else happening first.
Imagine you’re a consulting firm hired for a two-phase project. You’ve completed Phase 1, so you’ve earned that revenue. However, your contract states you can only bill the client after Phase 2 is also delivered. That earned-but-not-billable revenue is recorded as a contract asset. It’s your money, but you have to complete another step before you can officially ask for it.
This brings us to the core concept: conditional versus unconditional rights. An account receivable is an unconditional right to payment. This means you’ve fulfilled all your obligations, and the only thing standing between you and the cash is the passage of time—like waiting for a 30-day payment term to end. You’ve sent the invoice (or have the right to), and now you're just waiting to get paid.
A contract asset, on the other hand, represents a conditional right to payment. Your right to that money is conditioned on completing another performance obligation. Until you deliver Phase 2 of the project, you can’t invoice. Once you do, that contract asset flips over and becomes a receivable. This distinction is a cornerstone of modern revenue recognition standards.
Because of their nature, these two assets carry different types of risk. With a contract asset, you’re facing "performance risk." There’s still a chance you might not be able to complete the remaining work, which could jeopardize your ability to collect payment. Your team needs to perform successfully to convert that asset into cash.
Accounts receivable carries "credit risk." You’ve already done all the work. The risk now shifts to your customer. Will they pay their invoice on time, or will they default? This difference is critical for accurate cash flow forecasting. You can’t count on cash from a contract asset in the same way you can for an outstanding invoice.
Both contract assets and accounts receivable are listed on the asset side of your balance sheet, but they shouldn't be lumped together. According to accounting rules, if your right to payment is unconditional (meaning only time needs to pass), it must be presented as a receivable. If it’s conditional on future performance, it’s a contract asset.
Separating them gives anyone reading your financial statements a clearer picture of your financial position. It shows how much revenue is tied to completed work versus work that still has dependencies. Getting this right is much easier when your systems can automatically classify revenue streams, which is where seamless data integrations become invaluable.
One common point of confusion is how to handle potential losses. While a contract asset isn't technically a "financial instrument" in the same way a receivable is, you still have to assess it for impairment. This means you need to consider whether you’ll be able to collect the money once you eventually bill for it.
For example, if you learn that your client is facing financial trouble while you’re still working on their project, the value of your contract asset might be impaired. You can’t just assume you’ll collect 100% of the value. You have to regularly evaluate the collectibility of both your contract assets and your receivables to keep your financial reporting accurate.
Keeping your financial reporting accurate isn't just about following rules; it's about maintaining the health and integrity of your business. When it comes to revenue, specific accounting standards set the guidelines. For businesses that rely on customer contracts, two of the most important are ASC 606 and ASC 310.
Understanding these standards is the first step toward compliance. They dictate how and when you can recognize revenue and how you should account for the assets that come from your customer agreements, like contract assets and accounts receivable. Getting this right ensures your financial statements are accurate, which is crucial for passing audits, securing funding, and making sound strategic decisions. With the right systems in place, you can manage these complexities and keep your focus on growth. You can find more helpful articles on our HubiFi Blog.
ASC 606 is the main framework for recognizing revenue from contracts with customers. Its goal is to make sure companies recognize revenue when they transfer goods or services, in an amount that reflects what they expect to receive. This standard introduced the terms "contract asset" and "contract liability" to the balance sheet.
A contract asset appears when you've delivered on part of your contract, but your right to get paid is still conditional on something other than the passage of time—for instance, you might need to complete another project milestone. This is different from a receivable, which is an unconditional right to payment. The official guidance on presentation helps clarify how these items should appear on your financial statements.
While ASC 606 deals with recognizing revenue, ASC 310 provides guidance on accounting for receivables, including how to handle potential credit losses. A key part of this is the Current Expected Credit Loss (CECL) model, which applies to both trade receivables and contract assets.
Before you can even record revenue, ASC 606 requires you to determine if it's probable that you'll collect the payment you're entitled to. This is the "collectibility threshold." ASC 310 then steps in to help you estimate and account for any expected losses on those amounts. It ensures you're not overstating the value of your assets by considering potential non-payment from the start. You can learn more about how this applies to trade receivables and contract assets.
It’s not enough to assume you’ll collect most of what you’re owed. The CECL model requires you to proactively estimate and account for credit losses you expect to incur. This means looking at your receivables and contract assets and figuring out how much might not get collected.
To do this effectively, you should group assets with similar risk profiles. For example, you might group customers by industry, geographic location, or credit score. Contract assets carry their own unique risks since they represent unbilled amounts that are conditional on future performance. Accurately forecasting these potential losses is critical for maintaining a healthy balance sheet and providing a realistic picture of your company's financial position.
The difference between contract assets and accounts receivable is especially important in certain industries. If your business involves long-term projects or complex contracts, you're likely to see contract assets on your books frequently. This is common in sectors like software-as-a-service (SaaS), construction, engineering, and telecommunications.
In these fields, revenue is often recognized over time as performance obligations are met, rather than all at once. This makes proper tracking and compliance with ASC 606 essential. Understanding the specific nuances of your industry's revenue cycles will help you stay compliant and manage your financials more effectively. HubiFi offers a range of integrations that can help businesses in these sectors automate and streamline their revenue recognition processes.
Okay, so you understand the difference between a contract asset and accounts receivable. Now comes the important part: managing them effectively. Staying on top of these assets isn't just about good bookkeeping; it's about maintaining the financial health of your business and ensuring you stay compliant. A solid management process helps you get paid on time, forecast cash flow accurately, and breeze through audits. It all comes down to having clear systems in place for your contracts, from the moment they're signed to the final payment. Let's walk through the key steps to build a process that works.
Think of internal controls as the guardrails for your financial processes. They’re the checks and balances you put in place to prevent errors and catch issues before they become major problems. This can be as simple as separating duties—for example, the person who sends invoices shouldn't be the same person who approves payments. Requiring approvals for contract changes or credit memos is another great control. Using technology can also be a huge help here. Automated workflows ensure that steps aren't missed and that every action is documented, creating a clear trail. Strong controls give you confidence that your financial data is accurate and secure.
Not all payments are straightforward. Sometimes, the amount you’re owed depends on usage, performance, or other factors that can change over time. This is common in SaaS or service-based businesses. It's also important to correctly handle payments received before you've delivered the goods or services. This creates "deferred revenue," which is a liability, not an asset. According to accounting rules, you generally don't need to estimate credit losses on these advance payments. The key is to only recognize revenue—and the corresponding asset—as you fulfill your obligations to the customer. This prevents you from overstating your income and keeps your books clean.
It’s pretty common for the scope of a project to change, and with it, the contract terms. While these modifications are often necessary for business, they can make your accounting records complicated. A simple change in price or deliverables means you have to go back and reassess the entire revenue arrangement. You’ll need to determine if it’s a brand-new contract or a modification of the existing one, which affects how you recognize revenue moving forward. Having a clear process for documenting and approving any contract modifications is crucial. This ensures everyone is on the same page and your financial reporting accurately reflects the new agreement.
If there’s one rule to live by in accounting, it’s this: document everything. Meticulous record-keeping is your best friend, especially when it comes to audits. You need to keep detailed records of all contracts, any changes made to them, and the key decisions you made about recognizing contract assets. This includes the original agreement, all amendments, relevant emails, and notes explaining your accounting judgments. This documentation serves as the evidence behind the numbers on your financial statements. A well-organized system not only makes passing an audit smoother but also provides a valuable history that can inform future business decisions.
Properly reporting your contract assets and accounts receivable is more than just a compliance checkbox—it’s about providing a clear and accurate picture of your company's financial health. Getting the presentation and disclosures right helps investors, lenders, and your own leadership team understand the story behind the numbers. Here’s how to handle the reporting so you can stay compliant and prepared for any scrutiny.
Under current accounting rules (ASC 606), contract assets and liabilities appear on your balance sheet when your performance and the customer's payment are out of sync. If you’ve done work but don’t have an unconditional right to payment yet, you record a contract asset. If you’ve received payment before completing the work, you record a contract liability.
It's important to present these correctly. If a single contract results in both a contract asset and a liability, you should net them together. You also need to separate these items into "current" (expected to be resolved within one year) and "non-current" categories to clarify your short-term and long-term financial position.
Transparency is key when it comes to financial disclosures. You can’t just list a number for contract assets on your balance sheet and call it a day. You need to provide detailed explanations in the notes of your financial statements that give context to the figures.
This includes describing the services you provided that led to the contract asset, explaining any significant changes in the asset balance from one period to the next, and stating when you expect to recognize the revenue and receive payment. The goal is to give anyone reading your financials a complete understanding of the nature, amount, and timing of your revenue.
Understanding the difference between a contract asset and a receivable is crucial for assessing risk. A contract asset carries what’s known as "performance risk"—the risk that you might not complete the remaining obligations under the contract. An account receivable, on the other hand, primarily carries "credit risk," which is the risk that your customer simply won't pay.
Even though a contract asset isn't technically a financial instrument, you still have to evaluate it for impairment. This means you must estimate any expected credit losses and set aside a loss allowance for your contract assets, just as you would for your trade receivables, to ensure your balance sheet is realistic.
When audit time rolls around, expect your contract assets and related estimates to be under the microscope. Auditors are paying close attention to how companies are applying revenue recognition standards, and they will focus on the judgments and estimates you make. Your internal processes for managing these accounts will be thoroughly reviewed.
One critical area of judgment is determining whether a lower expected payment is due to an "implicit price concession" or "incremental credit risk." A price concession affects how you recognize revenue, while credit risk impacts your allowance for losses. Documenting how you make these decisions is essential for a smooth audit and demonstrates strong financial reporting controls.
Managing contract assets and accounts receivable isn't just about tracking numbers; it's about actively managing the risks that come with them. A solid strategy protects your cash flow and keeps your financial reporting accurate. By being proactive, you can spot potential issues before they become major problems, ensuring your business stays on solid ground. Here are a few key areas to focus on to build a resilient financial process.
Before you even think about recognizing revenue, you need to ask a critical question: Is it likely you'll get paid? This is the core of evaluating credit risk. ASC 606 requires you to determine if you'll collect most of the money you're owed from a customer. This is sometimes called the "collectibility threshold." Establishing a clear process for assessing customer creditworthiness upfront is a non-negotiable first step. It helps you avoid booking revenue that you may never actually receive, which keeps your financial statements grounded in reality.
It's helpful to understand that contract assets and receivables carry different kinds of risk. A contract asset comes with "performance risk," meaning you still have obligations to fulfill before you can bill the client. The risk here is that something could go wrong during the project, jeopardizing future payment. An account receivable, on the other hand, primarily has "credit risk"—the work is done, but the customer might not pay. Distinguishing between these two helps you get a clearer picture of your company's financial health and the specific risks tied to your revenue streams.
Manually tracking every contract detail is a recipe for errors. This is where automation becomes your best friend. By setting up clear, automated rules for how you recognize, measure, and report on contract assets, you create a consistent and reliable system. This isn't just about software; it's about defining your internal policies and using technology to enforce them. When your team is trained on a standardized process supported by the right tools, you reduce manual work and the risk of human error. A system with seamless integrations can pull data from your CRM and ERP, ensuring everyone is working with the same accurate information.
Compliance isn't a "set it and forget it" activity. As your business grows and contracts evolve, your processes need to adapt. Continuous monitoring is key to staying on top of your obligations under standards like ASC 606. This often requires collaboration across different departments. Your sales team finalizes the contract, your project managers track performance, and your finance team handles the accounting. Getting these teams to work together to track and report information correctly is crucial. Regular reviews and open communication channels ensure that everyone is aligned and that your financial data is always accurate and audit-ready.
Can you give me a simple, real-world example of a contract asset turning into an accounts receivable? Of course. Imagine you're a graphic designer hired to create a branding package for $5,000. The contract states you can invoice in two equal parts: once after delivering the logo concepts, and the final amount after delivering the complete style guide. After you send over the logo concepts, you've earned $2,500, but you can't bill for it yet. That $2,500 is a contract asset. Once you deliver the final style guide, you've fulfilled all your obligations. At that moment, the entire $5,000 becomes an accounts receivable, and you can send the final invoice.
What happens if a customer pays me for a project before I even start the work? That's a great question, and it's the opposite of a contract asset. When a customer pays you upfront, you record that cash as a "contract liability," often called deferred or unearned revenue. It's considered a liability because you now owe your customer goods or services. As you complete the work and fulfill your performance obligations, you'll gradually reduce that liability and recognize the revenue you've earned.
Why is it so important to separate these two on my balance sheet? Can't I just group them together? While they both represent money you're owed, separating them tells a much clearer story about your company's financial position. Keeping them distinct shows investors, lenders, or even your own leadership team how much of your future income is tied to work you still need to complete versus how much is simply waiting to be collected. This distinction is also a key requirement under modern accounting standards, so getting it right is essential for staying compliant and passing an audit.
Which is riskier for my business to have—a lot of contract assets or a lot of accounts receivable? Both carry risk, but it's a different kind of risk. A high balance of contract assets points to "performance risk," meaning you have a lot of work to complete before you can get paid. The danger here is that project delays or other issues could prevent you from ever invoicing. A high balance of accounts receivable points to "credit risk," meaning you've done the work, but your customers are slow to pay or might not pay at all. Neither is ideal, but they signal different operational challenges you need to address.
My business is still small. Do I really need to worry about these detailed rules? Even if you're just starting out, building good financial habits now will save you major headaches down the road. Correctly classifying your assets from the beginning creates a strong foundation for growth. When the time comes to apply for a loan, bring on investors, or go through your first audit, having clean, accurate, and compliant books will make the process infinitely smoother. It’s about setting your business up for long-term success.
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.