Contract Related Assets and Liabilities
There are several situations that give rise to contract related assets and liabilities when working with the government. According to section 912-310-25 (page 14) Recognition of the Financial Accounting Standards Board’s (FASB) accounting standards, receivables from the U.S. government may include billed and unbilled amounts. Unbilled amounts arise if sales or revenues cannot be billed yet under terms of the contract or if unit prices for items shipped have not been determined. The unearned or unbilled balance is the difference between the revenue that should be recognized (earned) and billings posted on the contract or task. Therefore, unearned and unbilled amounts should be appropriately recorded as contract related assets and liabilities.
Five Common Contract Related Assets and Liabilities:
- Timing Differences
- Rate Variances
- Costs in Excess of Billings
- Billings in Excess of Costs
- Retainage
Timing Differences
Timing Differences typically occur due to differences in a contractors close cycle and their accounting process. These differences may cause revenue to be computed, earned, and posted before the month-end books are closed. Invoices may be generated and posted subsequent to the actual month in which the transaction was incurred. The posting of these invoices may cause unbilled balances. In a case such as this, subsequent billings should offset any unbilled receivables. These amounts should be billed as soon as possible in accordance with contractual terms.
Rate Variances
Rate variances exist when actual indirect rates are different from provisional or target rates. If the actual rates are greater than the provisional rates, an unbilled receivable balance will show on the company’s balance sheet, indicating that the company is not billing as much as they should. If the actual rates are less than the provisional rates, a liability will show on the company’s balance sheet and the company will be obligated to return money to the government on a cost reimbursable type contract. In some instances, it can take several years before the final costs are determined by the government which may cause delays with a contractor closing out the contract.
Costs in Excess of Billings
Costs in Excess of Billings/Unbilled Receivables represents work performed on the contract that has not yet been billed to the government. Similar to timing differences, these amounts should be billed as soon as possible in accordance with contractual terms.
Billings in Excess of Costs
Billings in Excess of Costs/Unearned Revenue are the billings to date which have not yet been recognized as contract revenue. These billings may or may not be allowed based on the terms of the contract.
Retainage
Retainage issues arise when the government or prime contractors withhold fees from a contract. The government or prime contractor may retain a portion of the amount due to the contractor until the contract is completed in a manner that is satisfactory to them.
Contract related assets and liabilities are an area of focus for many auditors due to the increased risk of material misstatement in the financial statements. Therefore, it is important to work with your accountant to reconcile these accounts on a regular basis.
Contributed by Natasha A. Smith, CPA
FAQs
Contract asset: The entity's right to payment in exchange for goods or services that the entity has transferred to a customer. Contract liability: The entity's obligation to transfer goods or services to a customer.
What are contract liabilities under ASC 606? ›
Contract liabilities represent an entity's obligation to transfer goods or services to a customer. Examples include: Billings in excess of costs and earnings (i.e., deferred or unearned revenue), net of conditional retainage receivable. Retainage payables.
What is the difference between contract liabilities and deferred income? ›
The difference between the deferred revenue and contract liability is that the contract liability compares the invoiced due amount with the revenue, while the deferred revenue compares the invoice amount with the revenue.
Can contract assets and liabilities be netted? ›
PwC response
We believe when contracts are combined and accounted for as a single contract, the presentation guidance should be applied to the combined contract. Contract assets and liabilities should therefore be presented net as either a single contract asset or a contract liability.
What are the three examples of contractual liability? ›
Types of Contractual Liability
- Property leases . A landlord may require a tenant to provide indemnity against damages should anyone get injured on the premises.
- Construction agreements . ...
- Equipment leases . ...
- Easem*nts .
Although IFRS 15 uses the terms 'contract asset' and 'contract liability', these might also be referred to using different terminology such as 'accrued income' and 'deferred income' respectively.
What is the difference between a contract asset and a receivable? ›
A contract asset is recognized when an entity has satisfied a performance obligation but cannot recognize a receivable until other obligations are satisfied. While a contract asset represents a right to payment that is conditional on further performance, a receivable represents an unconditional right to payment.
What is excluded from ASC 606? ›
Includes, but is not limited to, disaggregation of revenue, credit loss recognized from contract with customer, judgment and change in judgment related to contract with customer, and asset recognized from cost incurred to obtain or fulfill contract with customer. Excludes insurance and lease contracts.
Are contract liabilities considered debt? ›
Are contract liabilities considered debt? Contract liabilities are not considered as debt in the traditional sense. They represent an obligation to perform a service or deliver a product in the future, as prepayments have been received from customers.
Is contract liability the same as unearned revenue? ›
Definition: Contract liability refers to the legal responsibility arising from the terms and conditions of a contract, where one party is bound to deliver specific tasks or services for another party, while deferred revenue, also known as unearned revenue, represents an advance payment received by a company for goods ...
A contract liability is defined in ASC 606-10-45-2 as “an entity's obligation to transfer goods or services to a customer for which the entity has received consideration (or an amount of consideration is due) from the customer.” A refund liability, however, represents the customer's conditional right to consideration ...
Is accrued income same as contract asset? ›
Is accrued or unbilled revenue considered a contract asset? Not necessarily. Just because an invoice has not yet been issued does not automatically classify the asset as a contract asset.
Are contract liabilities a financial liability? ›
In most cases, contract liabilities are NOT discharged by the payment of cash. Instead, they are discharged by the delivery of non-monetary items, whether goods or services in line with the contract. It means that contract liabilities are NON-monetary.
What is the asset and liability rule? ›
In simple terms, assets are what a company owns, and liabilities are what a company owes to other parties. Assets put money into a company, whereas liabilities take money from the company. Assets increase the value of a company's equity while liabilities decrease it.
Why was ASC 606 created? ›
ASC 606, or Accounting Standards Codification 606, is a set of accounting rules that governs how companies recognize revenue from contracts with customers. It provides a standardized framework for revenue recognition, ensuring consistency and comparability across industries.
What are the liabilities of a contract? ›
A contract liability is an entity's obligation to transfer goods or services to a customer for which the entity has received consideration (or an amount of consideration is due) from the customer.
What type of assets are contracts? ›
A contract asset would exist when an entity has a contract with a customer for which revenue has been recognized (i.e., goods or services have been transferred to the customer) but customer payment is contingent on a future event (e.g., satisfaction of additional performance obligations).
What are the 3 items of a contract? ›
The 3 basic elements of an agreement: offer, acceptance and...
- you can revoke an offer before someone accepts it but you must let the person know;
- if you reject an offer, it is no longer available for acceptance; and.
- if you make a counter offer then that is the same as your rejection of the original offer.
In a contract asset, the remaining rights exceed the remaining performance obligations, whereas in a contract liability, the remaining performance obligations are equal to the remaining rights.
