Deferred Revenue, Contract Liabilities and Contract Assets

Introduction

At the end of 2025, Lockheed Martin's balance sheet carried $13.0 billion of contract assets, $11.4 billion of contract liabilities and only $3.9 billion of ordinary receivables. For a company whose revenue comes from multi-year defense programs, those three lines record where each contract stands between the work done and the cash received. Contract assets are work performed that the company cannot yet bill; contract liabilities are payments received ahead of the work; receivables are bills sent and waiting to be paid.

The three balances are the balance sheet side of revenue recognition under Accounting Standards Codification (ASC) 606, the five-step model explained in revenue recognition under ASC 606. They exist because revenue follows the transfer of control while billing follows the contract's payment terms, and the two rarely move together on long contracts. Reading them tells a banker whether a company is financing its customers or being financed by them, and whether revenue is running ahead of what customers have agreed to pay so far.

ASC 606 distinguishes the balances by the nature of the company's right to payment:

Contract asset

A company's right to consideration for goods or services already transferred to a customer, when that right is conditional on something other than the passage of time, such as completing further work or reaching a billing milestone. It becomes a receivable when the right to payment becomes unconditional.

A receivable is an unconditional right to payment: only the passage of time stands between the company and the cash. A contract liability, often still called deferred or unearned revenue, is consideration received, or unconditionally due, before the company has performed. Subscription businesses mostly carry contract liabilities, the case traced in deferred revenue on the three statements; long-term contractors carry all three.

Contract liability

A company's obligation to transfer goods or services to a customer for which it has already received consideration, or for which consideration is unconditionally due. It is presented net of any contract asset on the same contract and is recognized as revenue as the company performs.

A single contract shows how one balance turns into another. Suppose a company signs a $300 contract to build equipment, recognizes revenue over time as costs are incurred, and may bill $150 at a milestone halfway through and the rest on completion:

After the first quarter, $100 of revenue has been earned but nothing can be billed, so the company carries a $100 contract asset. At the milestone, the right to $150 becomes unconditional: the contract asset turns into a receivable, along with the extra $50 earned in the quarter. Once the customer pays, the receivable becomes cash, while further work rebuilds the contract asset to $100. At completion, the final bill and payment clear everything. Had the customer paid $150 up front instead, the company would have started with a $150 contract liability and worked it down as revenue was recognized.

Netting Contract by Contract

Contract assets and contract liabilities are presented net for each contract: a single contract is either in a net asset or a net liability position at the reporting date, never both. Positions on different contracts are not offset against each other, so a company with many contracts reports gross totals of both. Receivables are presented separately from contract assets, because their risk is different: a receivable depends only on the customer's credit, a contract asset also on the company's own future performance. PwC's guide to presenting contract-related assets and liabilities sets out the presentation rules, including that companies may use other labels, such as unbilled receivables or deferred revenue, for the same balances.

Long-term contractors usually classify all three as current, even when amounts will be settled beyond twelve months, because they use their contract operating cycle as the basis for classification. The labels used in practice vary as well: "billings in excess of costs" and "costs and estimated earnings in excess of billings" are the older construction-industry names for contract liabilities and contract assets.

Contract Balances in an Acquisition

When a company is acquired, its contract balances carry over into the buyer's statements. Since Accounting Standards Update (ASU) 2021-08, a US acquirer measures acquired contract assets and contract liabilities under ASC 606, as if it had originated the contracts, rather than at fair value. Before the change, acquired contract liabilities were measured at fair value, often estimated as the cost of fulfilling them plus a profit margin and usually below the target's carrying amount. That deferred revenue haircut meant the buyer recognized less revenue from the target's backlog after closing. The current rule keeps post-deal revenue closer to what the target would have reported, which matters when comparing pre- and post-deal growth, a point traced with the rest of the closing balance sheet in how an acquisition hits the three statements.

Lockheed Martin's 2025 annual report shows the three balances at scale, together with the disclosures ASC 606 requires about how they moved:

The figures tell a coherent story. Contract assets barely moved in 2025, rising $44 million, and Lockheed expects to bill most of them during 2026. Contract liabilities rose by $1.6 billion, which the company attributes mainly to payments received in excess of revenue recognized on the C-130 and F-35 programs and at Sikorsky. During 2025 it recognized $6.3 billion of revenue out of the $9.8 billion of contract liabilities it held at the start of the year. And the contract asset balance is shown net of about $56.5 billion of progress and performance-based payments and advance payments from customers, a reminder of how much of a defense contractor's work its customers fund as it goes.

The operating cash flow statement reflects the same movements. Lockheed's growth in contract liabilities added $1.2 billion to operating cash flow in 2025, while the increases in receivables and contract assets absorbed cash. The change in each balance on the cash flow statement can differ from the change on the balance sheet, because of items such as acquisitions and reclassifications, so the balance sheet note is the better guide to what happened on the contracts themselves.

Each balance carries a different message for analysis:

The movement of contract assets relative to revenue deserves particular attention. Under over-time recognition, revenue is driven by estimates of progress, and a company that overestimates progress, or that books revenue on work customers have not agreed to fund, accumulates contract assets that may never be billed. Contract assets growing much faster than revenue, or large write-downs of contract assets when estimates are revised, are signals that revenue was recognized too early. The estimates behind over-time revenue are covered in revenue over time for long-term contracts.

For working capital analysis and valuation, all three balances belong in net working capital, and their trend determines how much cash a contractor's growth will absorb or release. The ratio approach to measuring them is explained in days sales, inventory and payables outstanding, and the industry practices of construction and engineering companies in construction and long-term contracts. In every case, the three balances answer one practical question about a contract: has the company been paid more than it has earned, or earned more than it has been paid?