Contract Assets and Contract Liabilities (IFRS 15)

Contract asset is recognised when a performance obligation is satisfied (and revenue recognised), but the payment is conditional not only on the passage of time. The other conditions attached to realising that recognised contract asset usually relate to entity’s fulfilment of other performance obligations in the contract. Contract assets are different from trade receivables, because trade receivables represent an unconditional right to receive payment. A right to receive payment is unconditional if only the passage of time is required before payment is due (IFRS 15.105, 107-108). The significance of the distinction between contract asset and receivable is that the contract asset carries not only the credit risk, but other risks as well (e.g. performance risk). Unconditional right to payment may arise both before and after a customer is billed. See the example below.

Some entities label their capitalised contract costs as ‘contract assets’, which is incorrect and can be misleading in my opinion. See also the discussion on accrued and unbilled revenue below.

Example: contract asset and trade receivable in a telecommunications company

A telecommunications company enters into a contract with a customer who purchases a smartphone and a 24-month voice plan. The customer must pay $100 for the smartphone in 30 days and $30 per month for the voice plan during next 24 months. Therefore, total transaction price in the contract amounts to $820 ($100 + 24 x $30). Telecommunications company considers the smartphone and voice plan to be separate performance obligations. $340 is allocated to the smartphone and the remaining $480 to the voice plan. When the contract is signed and the smartphone is provided to the customer, the telecommunications company records the following entries:

Trade receivable$100
Contract Asset$240

As we can see, $340 of revenue is recognised when the smartphone is provided to the customer (this is the transaction price allocated to this performance obligation, which does not need to be the same as the price stated in the contract). However, only $100 is unconditionally due (to be paid within 30 days), and the remaining $240 is conditional on the voice plan provided by the company in the future (the customer won’t have to pay if the company stops providing telecommunications services).  Thus, $240 is recognised as a contract asset.

When the invoice for $30 for the first month of voice plan is issued, the following entries are made:

Trade receivable$30
Contract Asset$10
Revenue (voice plan)$20

A customer sees $30 on his invoice as a payment due for the voice plan, but from the company’s perspective, $10 is a partial repayment of the contract asset (relating to the smartphone), and only $20 relate to the voice plan. Analogous entries are made every month which results in the contract asset being fully transferred to receivables and repaid by the customer.

See the extract from IFRS financial statements of Vodafone Group Plc:

Contract assets in Vodafone Group

Is accrued/unbilled revenue a contract asset? Not necessarily! The mere fact that the invoice has not been issued yet does not mean that we’re talking about a contract asset here. If the invoice has not been issued at the reporting date only because e.g. exact amount was not yet known, or the A/R accountant was late, but the right to payment is unconditional – this is a receivable, not a contract asset (IFRS 15.105, BC323-326).

Contract liability is recognised when a payment for customer is due (or already received, whichever is earlier) before a related performance obligation is satisfied (IFRS 15.106). See the example below.

Example: contract liability and trade receivable

Entity A enters into a contract with a customer to manufacture and deliver 100 products for a total consideration of $1m. The contract states that the customer will be billed in advance for 30% of the contract value and the payment must be made within 30 days of signing the contract.

The following entries are recorded by Entity A:

1/ The invoice for 30% of the contract value is issued to the customer:

Trade receivable$0.3m
Contract liability$0.3m

2/ The customer pays the invoice

Trade receivable$0.3m

3/ Products are delivered to the customer and the invoice is issued for the remaining amount

Trade receivable$0.7m
Contract liability$0.3m

Contract assets are subject to impairment requirements of IFRS 9. These requirements relate to measurement, presentation and disclosure with respect to impairment (IFRS 15.107). Specifically, entities are required to recognise expected credit losses on their contract assets.

See other pages relating to IFRS 15:

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