Understanding Contract Assets and Liabilities in Construction Accounting

In the construction world, revenue isn’t earned all at once — it’s built over time, just like the projects themselves. Because of this, contractors often use the percentage-of-completion method (POC) to recognize revenue.

But along with that method comes two key balance sheet accounts that can confuse even experienced contractors: contract assets and contract liabilities.

Let’s break down what they are, how they’re calculated, and why they matter.

What Are Contract Assets and Contract Liabilities?

Under ASC 606: Revenue from Contracts with Customers, construction companies must measure progress and recognize revenue as work is performed — not necessarily when they bill or collect cash.

This timing difference between work performed, amounts billed, and cash received creates either:

• A Contract Asset → when work performed (revenue recognized) exceeds the amount billed.

• A Contract Liability → when billing exceeds the amount of work performed (revenue recognized).

• 
  

In simple terms:

• Contract Asset = “We’ve earned it, but haven’t billed it yet.”

• Contract Liability = “We’ve billed it, but haven’t earned it yet.”

  
  

The Foundation: Cost-to-Cost Method

Most construction contractors measure project progress using the cost-to-cost method, which compares costs incurred to date against total estimated costs for the job.

Formula:

Percentage Complete=Cost Incurred to DateTotal Estimated Cost\text{Percentage Complete} = \frac{\text{Cost Incurred to Date}}{\text{Total Estimated Cost}}Percentage Complete=Total Estimated CostCost Incurred to Date​

That percentage is then applied to the total contract revenue to determine how much revenue should be recognized to date.

Revenue Recognized to Date=Percentage Complete×Total Contract Price\text{Revenue Recognized to Date} = \text{Percentage Complete} \times \text{Total Contract Price}Revenue Recognized to Date=Percentage Complete×Total Contract Price

Once you’ve determined how much revenue should be recognized, you can compare it to the amounts billed to calculate the contract asset or liability.

Step-by-Step Example

Let’s walk through an example.

Project Overview

Item	Amount
Contract Price	$1,000,000
Estimated Total Cost	$800,000
Cost Incurred to Date	$400,000
Billed to Date	$350,000
Cash Collected	$300,000

Step 1: Calculate Percentage Complete

400,000/800,000=50%400,000 / 800,000 = 50\%400,000/800,000=50%

Step 2: Determine Revenue Earned to Date

1,000,000×50%=500,0001,000,000 \times 50\% = 500,0001,000,000×50%=500,000

Step 3: Compare to Billed Amounts

Description	Calculation	Result
Revenue Recognized to Date	$500,000
Less: Amount Billed	($350,000)
Contract Asset	$150,000

In this case, the contractor has performed $500,000 worth of work but has only billed $350,000.The $150,000 difference is recorded as a Contract Asset (Unbilled Revenue) on the balance sheet.

Step 4: Reverse Example — Contract Liability

If the contractor had billed $600,000 to date instead of $350,000:

Description	Calculation	Result
Revenue Recognized to Date	$500,000
Less: Amount Billed	($600,000)
Contract Liability	$100,000

Why It Matters

Accurate reporting of contract assets and liabilities provides:

• Better cash flow forecasting — knowing how much work has been earned vs. billed

• Clearer financial performance — avoids overstating or understating revenue

• Compliance with ASC 606 — required for GAAP financials and bonding

• Improved communication with sureties and banks — lenders analyze underbillings and overbillings closely

  
  

Common Mistakes Contractors Make

1. Not updating total estimated costs — inaccurate cost forecasts distort completion percentage.

2. Confusing billings with revenue — revenue is earned based on work performed, not invoices sent.

3. Ignoring change orders — pending approvals can skew revenue recognition.

4. Failing to reconcile WIP schedules — discrepancies between WIP and financial statements cause audit issues.

   
   

Pro Tip: Use a WIP Schedule

A Work-In-Progress (WIP) schedule is the backbone of contract asset/liability calculations. It summarizes:

• Contract price

• Costs to date

• Estimated costs to complete

• Billings to date

• Revenue earned

• Over/under billings

Updating this schedule monthly helps contractors track profitability and prevent unpleasant surprises at year-end.

Conclusion:

Contract assets and liabilities are essential for accurately portraying a construction company’s financial position. They tell the story of how much work has been performed versus how much has been billed — and, ultimately, how the company is managing cash and performance.

By mastering the cost-to-cost method, maintaining accurate WIP schedules, and understanding the flow of revenue recognition, contractors can stay compliant, confident, and financially strong.