Contract Liability
AdvancedA contract liability is a company's obligation to provide goods or services to a customer for which it has already received payment, or for which payment is due.
When customers pay in advance, the company has not yet earned the revenue. It records a contract liability, which is reduced as the goods or services are delivered and the revenue is recognised.
For example, a software company receives 12,000 at the start of the year for an annual subscription. It records a contract liability of 12,000. Each month, as it provides the service, it recognises 1,000 of revenue and reduces the liability by the same amount.
Contract liabilities are commonly called deferred revenue or unearned revenue, and these older terms are still widely used. Under the revenue standards of IFRS and US GAAP, contract liability is the formal term.
A rising contract liability can be a healthy sign for subscription businesses, as it reflects customers paying in advance for future services, providing cash before costs are incurred. Analysts often watch changes in deferred revenue alongside reported revenue to judge future sales.
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