A consultancy completes and delivers the first of two milestones under a contract. Under the contract's payment terms, the consultancy is entitled to invoice and collect payment for the first milestone only once it has also completed the second milestone; nothing about the first milestone's payment depends merely on the passage of time. Under ASC 606-10-45-1 through 45-3, how should the consultancy classify its right to consideration for the completed first milestone at a reporting date before the second milestone is finished?
- As a receivable, because the consultancy has already performed its obligations by completing and delivering the first milestone
- As a contract liability, because no cash has yet been received for the first milestone
- As accounts receivable, net of an allowance for doubtful accounts, consistent with general trade receivable guidance
- As a contract asset, because the consultancy's right to consideration for the completed first milestone is conditional on something other than the passage of time, namely completing the second milestone, rather than being an unconditional right to payment
Why D? And why not the others?
Correct answer: D. As a contract asset, because the consultancy's right to consideration for the completed first milestone is conditional on something other than the passage of time, namely completing the second milestone, rather than being an unconditional right to payment
ASC 606-10-45-1 through 45-3 distinguishes a contract asset from a receivable based on whether the entity's right to consideration is conditional on something other than the passage of time: a receivable exists only once the right to payment is unconditional, meaning only the passage of time is required before payment is due, whereas a contract asset exists when the entity has performed but its right to payment remains conditional on some other factor, such as completing additional work. Here, the consultancy has performed by completing the first milestone, but its right to invoice and collect for that work is expressly conditioned on also completing the second milestone, so the right is not yet unconditional and must be presented as a contract asset rather than a receivable. Calling it a receivable simply because the consultancy has performed skips the standard's actual test, which asks whether the right to payment is unconditional, not merely whether performance has occurred. A contract liability is the wrong classification entirely, since that represents an obligation to transfer goods or services for consideration already received or due from the customer, which is the opposite of the fact pattern here where the consultancy has performed but not yet been paid. Presenting the amount as accounts receivable net of a doubtful-accounts allowance misapplies general trade receivable guidance to a right that, under ASC 606's own presentation guidance, has not yet become unconditional and therefore cannot yet be a receivable at all.
Source: FASB Accounting Standards Codification: ASC 606-10-45-1 through 45-3, Revenue from Contracts with Customers — Contract Assets and Contract Liabilities