Contract liability

A contract liability records goods or services still owed to a customer for consideration received or due. It can exist before cash is collected. Under ASC 606-10-45-2 on FASB, payment before transfer creates the liability when the payment is made or becomes due, whichever is earlier.

Start with the customer advance

In a basic advance-payment arrangement, the customer pays before the company provides the promised service. Cash increases, and a liability records the service still owed. The unearned revenue article develops that introductory case with entries and a remaining-balance calculation.

As qualifying service is provided, the company reduces the liability and recognizes revenue. The amount released depends on the contract's recognition and measurement facts. Holding the cash, spending it on wages, or reaching month-end does not by itself establish that the service was provided.

Payment can be due before collection

Suppose the contract requires an unconditional payment before service begins. The due date arrives, the service remains unprovided, and the customer has not paid. Under those facts, the company records accounts receivable and a contract liability. There is no cash receipt and no revenue from performance at that date.

Later collection increases cash and reduces the receivable. The contract liability remains until qualifying performance, a refund, or another supported change reduces it. Collection does not record the liability a second time. When service is provided, the company reduces the liability and records revenue.

An invoice is evidence to inspect, not a substitute for the contract. A payment request that does not establish an unconditional amount due cannot support this entry merely because it is called an invoice.

Reconcile the obligation

Begin with the opening liability. Add qualifying advances and amounts becoming due before transfer, without counting a later collection of the same receivable again. Deduct revenue recognized as the related goods or services transfer. Identify refunds and other contract changes separately. A refund can reduce the liability and cash without creating revenue.

Reconcile each contract's rights and obligations before considering the presentation of balances. ASC 606-10-45-1 requires unconditional receivables to be presented separately. Do not cancel one customer's obligation against an unrelated customer's receivable merely to report a smaller net amount.

The payment-due-before-service worked example shows the entries and reconciles the liability, receivable, cash, and revenue. Try the independent reconciliation practice with different amounts.

Distinguish the promise from the balance

A performance obligation is a promise that must be identified for revenue accounting. A contract liability is a recognized balance for consideration received or due before the related transfer. Signing a contract with future promises does not automatically create a liability for its entire stated price.

"Deferred revenue" and "unearned revenue" can describe this balance. Those labels do not establish that cash has already arrived. Read the accounting policy and the underlying payment and performance terms.

Check collection and performance separately

A customer pays an existing receivable that was recorded with a contract liability when payment became due. Service has not begun. Which balance falls? Does the company recognize revenue or record another contract liability?

The receivable falls and cash rises. The existing contract liability remains, and the collection creates no revenue. Compare this sequence with a contract asset, where qualifying performance precedes an unconditional payment right.

Source and scope

Read ASC 606-10-45-2 on FASB for consideration received or due before transfer and ASC 606-10-45-1 for presentation. These examples assume a qualifying customer contract and established revenue-recognition conclusions. Separate guidance governs such matters as returns, contract modifications, financing, and credit losses.