Contract asset

A contract asset is a company's right to payment for goods or services it has already delivered to a customer, when that right depends on something other than the mere passage of time, such as completing an additional milestone or performance obligation in the same contract. Under ASC 606, it sits on the balance sheet as a recognized asset even though the amount has not yet been billed or become an unconditional receivable.

For a subscription business, contract assets typically arise in contracts with multiple performance obligations bundled together, where revenue can be recognized for a delivered obligation before the business has the unconditional right to invoice for it. A subscription platform such as Recurly can help track which performance obligations have been satisfied and which billing milestones remain outstanding, which is the information finance teams need to correctly classify a balance as a contract asset rather than an account receivable.

Why contract assets matter for subscription businesses

Contract assets matter because they affect how accurately a company's balance sheet reflects the work it has actually done versus what it has actually billed. Recognizing revenue without also correctly classifying the corresponding balance as a contract asset, rather than a receivable, can distort financial reporting and cause reconciliation problems during audits.

Contract assets are also a signal worth watching operationally. A growing contract asset balance can indicate that revenue is being recognized well ahead of billing milestones, which is normal for certain contract structures but can also point to a mismatch between how a contract is structured and how quickly the business is able to invoice for delivered value.

How to use contract asset accounting effectively

Handling contract assets correctly generally involves a few consistent practices:

• Map out the distinct performance obligations in each contract and identify which ones have their own independent billing milestone versus a shared one.

• Recognize revenue as each performance obligation is satisfied, and record the corresponding balance as a contract asset if the right to bill is still conditional on something other than time.

• Reclassify a contract asset to an account receivable once the business's right to payment becomes unconditional, typically once the next billing milestone is reached.

• Reconcile contract asset balances during month-end close to confirm they reflect actual delivered-but-unbilled value, not stale or miscategorized entries.

• Review contract asset balances periodically for any indication of collectibility risk, since they represent revenue the business expects to bill and collect.

Contract asset vs contract liability

Contract assets and contract liabilities are the two balance sheet positions that can result from timing differences between revenue recognition and billing, and they point in opposite directions. A contract asset arises when a company has recognized revenue for work delivered but has not yet obtained an unconditional right to bill for it. A contract liability, commonly seen in subscription businesses as deferred revenue, arises when a company has been paid or has an unconditional right to bill before it has delivered the corresponding goods or services. In short, a contract asset means the company is ahead on delivery relative to billing, while a contract liability means it is ahead on billing relative to delivery.

Benefits and examples

Properly identifying and tracking contract assets gives a subscription business several benefits:

• More accurate balance sheet reporting, since recognized but unbilled revenue is presented correctly rather than lumped in with receivables or ignored.

• Cleaner audits, because auditors can trace the relationship between performance obligations satisfied, revenue recognized, and amounts billed.

• Earlier visibility into billing lag, since tracking contract assets shows where billing is structurally behind delivery, which can inform how future contracts are designed.

• Better cash flow forecasting, because knowing which recognized revenue is not yet billable helps finance teams project when that value will convert into invoices and cash.

As an illustrative example, imagine a company signs a contract to deliver a software implementation service and a first year of subscription access for a combined $24,000, billable only once both the implementation and the first three months of subscription service are complete. If the company completes the implementation work, valued at $10,000 of the contract, before that billing milestone is reached, it recognizes $10,000 of revenue and records a $10,000 contract asset, since it has delivered value but does not yet have an unconditional right to bill for it. Once the billing milestone is reached, that $10,000 contract asset converts to an account receivable.

Frequently asked questions

Is a contract asset the same as an account receivable? No. An account receivable represents an unconditional right to payment, meaning only the passage of time stands between the company and being able to invoice. A contract asset represents a right to payment that still depends on something else, such as completing another performance obligation.

When does a contract asset convert to a receivable? A contract asset converts to a receivable once the company's right to payment becomes unconditional, typically when the remaining contractual milestone tied to billing is reached.

Do all subscription contracts create contract assets? No. A straightforward subscription with revenue recognized ratably and billed on a matching schedule generally does not create a contract asset. Contract assets typically arise in contracts with multiple performance obligations bundled together on a billing schedule that lags delivery.

How are contract assets tested for impairment? Contract assets are generally assessed for collectibility risk similar to receivables, and a company may need to record an allowance if it becomes probable that the amount will not be collected.