Contract Assets and Contract Liabilities
Gireesh Kumar, Partner
IFRS 15 “Revenue from Contract with customers” is a complex standard at least for few industry sectors like, those entities primarily in contracts with multiple performance obligations or those that deal with contracts that span multiple periods. Since its introduction, many accountants have confusion on the accounting treatment of certain elements of this standard, especially on how to account for contract assets and contract liabilities.
A contract asset is recognized when an entity satisfied its performance obligation in the contact with customer, i.e. work done and revenue recognized, but the entity will be able to bill the customer only after it satisfies other performance obligations in the same contract. The right to receive the payments against contract assets are conditional on future performance of the entity. Contract assets are different from accounts receivables, as accounts receivables have unconditional right to receive payment.
Impairment on contract assets
In accordance with paragraph 107 of IFRS 15, Since a contract asset is a right to consideration in exchange for goods or services that the entity has transferred to a customer, it is a financial asset and the entity shall assess a contract asset for impairment in accordance with IFRS 9 “Financial Instruments”. Therefore, the entities are required to recognize the expected credit loss on their contract assets in line with the provisions of IFRS 9.
A contract liability is the obligation of an entity to transfer goods or services and is recognized when a payment from a customer is due or received before a related the performance obligation not satisfied as per the terms of contract with the customer (Refer para 106 of IFRS 15). In another words, a contract liability arises when an entity has invoiced the customer or received payment from them, but the related work not yet completed in accordance with the performance obligation on the contract and the invoices or payments exceed the revenue recognized to date.
IFRS 15 does not prohibiting the entities from using alternative descriptions in the statement financial position other than the standard words ‘contract asset’ and ‘contract liability. However, whatever terminology is used, entities must make sure that they are accounted for as being distinct from accounts receivables which will arise when an invoice has been issued.
Decision tree on Contract Assets and Contract Liabilities
Practical example 1
Coders, a software trading Company, enters a contract with a customer who purchase a software license from them along with 24-month monthly support plan. The customer must pay CU2,000/- for the software license within one month after the commencement of contact and CU500/- per month for the monthly support during next 24 months. The total transaction price as per contract is CU14,000/- (CU2,000/- + CU500x24). Coders considers the software license and monthly support plan as separate performance obligation and the standalone prices for each obligation are CU6,800 and CU7,200 respectively. Following are the entries recorded in the books of accounts of Coders:
- Upon signing of contract and software license provided to the customer:
- Performance obligation satisfied – CU6,800/- (software license provided to customer)
- Amount due unconditionally – CU2,000/- (to be paid in one month)
- Payment due on Conditional – CU4,800/- (monthly support plan provided in future)
- When the invoices for CU500/-for the first month of monthly support issued:
- Amount due from customer – CU500/-
- Partial repayment of software license – CU200/- (from Coders’ perspective)
- Amount related to monthly support plan – CU300/- (from Coders’ perspective)
Practical example 2
Signage LLC entered into a contract with their customer to create and deliver a sign board of the customer based on the specifications provided by them. The consideration agreed in the contract is CU50,000/-. As per the terms of the contract the customer will be invoiced in advance for a 50% of the contract value and the balance upon the completion of the obligation by delivering the sign board. All payment should be made within 30 days after the invoice date.
Entries in the books of Signage LLC:
- For the invoice of 50% advance:
- For receipt from customer:
- Delivery of sign board and balance invoice:
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