What it means
In business, we usually record revenue when we send an invoice. However, under modern accounting rules, you should record revenue when you actually deliver value to your customer.
If you finish the first phase of a large project, but the contract states you can only invoice when the entire job is complete, you face a timing difference. This is where a contract asset appears on your balance sheet.
It represents your right to payment for goods or services transferred so far, conditional on something other than the passage of time, usually the completion of future milestones. Why does this matter for non-finance managers?
It helps you understand your true performance. If your revenue is high because of completed work, but your bank account is empty, you might have significant contract assets.
This tells you that your team is productive and earning money, but your invoicing schedule is lagging behind your progress. In practice, managing contract assets requires close coordination between your project managers and your finance team.
Project managers track the percentage of completion, while finance calculates the earned revenue. Once a milestone is reached and you finally send the invoice, the contract asset moves off your balance sheet and becomes a standard account receivable, which is money waiting to be collected.
Imagine baking a wedding cake in stages. You bake the tiers on Monday, but the contract says you only get paid when you deliver it to the venue on Saturday.
On Tuesday, you have successfully baked the tiers, so you have earned the value even though you cannot collect the cash yet.
In practice
Real-world examples
Example 1
TechCraft builds custom software for a client for $10,000. After completing the initial design phase worth $3,000, they cannot invoice until testing finishes. They record a $3,000 contract asset. If testing is delayed by a month, the asset stays on the balance sheet for that time.
Example 2
BuildRight renovates an office for an SME client for $50,000. After month one, they complete $20,000 of work. Because invoicing is tied to final sign-off, they record a $20,000 contract asset, and the finance team reviews it each month for collectability.
Example 3
GreenLeaf Agency runs a three-month marketing campaign for a large corporation worth $60,000. After month one, they record a $20,000 contract asset for the services delivered before the next billing date. At the end of month two, the asset rises to $40,000 if no invoice has been issued.
Think of it
Imagine baking a wedding cake in stages. You bake the tiers on Monday, but the contract says you only get paid when you deliver it to the venue on Saturday. On Tuesday, you have successfully baked the tiers, so you have earned the value even though you cannot collect the cash yet.
Formula
Calculation
Contract Asset = Value of Work Completed minus Amount Invoiced to Date. When revenue is recognised by percentage of completion, Revenue to Date = Contract Price x Percentage Complete.
Worked example 1. Your agency completes $15,000 worth of milestone work on a project. According to the contract terms, you have only invoiced $5,000 so far.
- Contract Asset = $15,000 minus $5,000 = $10,000
- You record $10,000 as a contract asset on your balance sheet
Worked example 2, percentage of completion. A contract is worth $60,000, the work is 40% complete, and you have invoiced $10,000.
- Revenue to date = $60,000 x 40% = $24,000
- Contract asset = $24,000 minus $10,000 = $14,000
- When the next milestone is reached and you invoice the $14,000, it moves to accounts receivableCase study
Seen in the real world
This is a fictional, illustrative scenario. Apex Digital, a mid-sized web development agency, signed a contract to build a bespoke inventory system for a retail chain for $60,000. The contract outlined three equal milestones of $20,000 each, with invoicing allowed only upon the successful delivery of each phase. By the end of the first quarter, Apex completed the design and database architecture phase, which represented the first milestone. However, the client requested a slight delay in formal sign-off while they prepared their internal team.
Because Apex completed the work, their accountant recorded $20,000 of revenue and a corresponding contract asset of $20,000 on the balance sheet. This ensured the company's quarterly financial statements accurately reflected the hard work and value delivered by the development team, even though no invoice had been sent and no cash had changed hands. Two weeks later, the client signed off, and Apex promptly issued the invoice. At that moment, the finance team moved the $20,000 from contract assets into accounts receivable, paving the way for eventual cash collection. Apex's managing director used the episode to ask project managers to report milestone sign-off dates weekly, so that the gap between work done and invoices sent was visible.
Watch out
Common mistakes
- Confusing a contract asset with an account receivable, even though receivables mean you can legally demand payment right now.
- Failing to record revenue as work is completed because the contract does not allow immediate invoicing.
- Forgetting to clear out the contract asset balance once the milestone is reached and the invoice is finally sent.
Questions
People also ask
What is the main difference between a contract asset and an account receivable?
A contract asset means you have done the work, but do not yet have the legal right to invoice. An account receivable means you have already invoiced the client and are waiting for them to pay.
Does a contract asset mean I have cash in the bank?
No. A contract asset is an accounting entry representing earned revenue. It does not mean cash has been received from your client.
What happens to a contract asset when I finally send the invoice?
It converts into an account receivable. You remove the amount from your contract asset account and add it to your accounts receivable account.