For the first time in 100 years, the standards governing revenue recognition have changed. In 2018, the Financial Accounting Standards Board (FASB), which establishes the standards for all accounting professionals and companies who follow these principles, and the International Accounting Standards Board (IASB) issued a new standard that changes revenue recognition rules.

ASC 606, is a hot topic for accountants. Partly because their rules and procedures don't change often, so complying means changing revenue recognition methods. Public businesses have had to comply for a few years, but now private companies with annual reporting periods that started after December 15, 2019, must also comply.

It's also a hot topic because ASC 606 is a powerful upgrade to the financial reports for SaaS businesses (as well as any other business that uses contracts with customers). After all, separating actual income from deferred revenue is more difficult in the subscription industry. 

Let's break down what ASC 606 means for subscription-based business.

What is ASC 606 and why does it matter?

ASC 606 sets a single, industry-agnostic revenue standard for identifying revenue streams using a five-step process. It covers the money earned from contracts with customers and considers the costs SaaS businesses incur during the different stages of a customer lifecycle.

Comparing revenue sources across industries wasn't easy because cash flows differently in a business depending on your industry. ASC 606 plays a significant role in guiding how businesses recognize revenue. 

Accurately determining the transaction price, considering variable elements, and identifying and allocating revenue to distinct performance obligations within subscription contracts is vital. 

Contrary to traditional business models where service delivery happens at the moment of the transaction, subscription services recognize revenue when the cash, per the contract, has been earned and not just collected.

For subscription businesses, the transaction price is typically the total consideration expected over the contract term–including all fees, charges, and variable considerations, such as usage-based fees or discounts.

Additionally, subscriptions have multiple performance obligations within a contract, and revenue recognition typically occurs over time because services are delivered continuously.

Why do you have to comply with ASC 606?

Compliance is key for all entities to build trust and accountability with stakeholders. The ASC 606 standard creates clear revenue recognition criteria that make it easy for all companies to be consistent with accounting practices. 

While core principles of financial compliance are universal, the regulatory environment and revenue recognition models can create challenges for nonprofit organizations and public and private companies. 

Nonprofits, for example, face unique tax-exempt regulations, public companies must meet stringent securities regulations, and though private companies have more flexibility, they must adhere to accounting standards. 

ASC 606 requires more comprehensive disclosures than the standards accountants followed before. Still, its flexible framework allows your team to account for the uncertainty of revenue and deal with complex revenue scenarios. 

Now, when your accountants talk about the comparability of revenue recognition, you can rest assured they can reach a point where they can compare apples to apples because non-profit, private, and public companies all follow the same principles for revenue recognition.

What are the five steps of the ASC 606 revenue recognition standard?

These steps set the principles for revenue recognition in an annual reporting period for any business, regardless of industry or business model. As a subscription-based business owner, you'll notice how this framework makes room for companies just like yours.

ASC 606 5-step process
  1. Identify the contract. Any valuable contract for products or services to customers that include obligations and enforceable rights counts as a contract for ASC 606. You don't necessarily need a signature, but you need to define payment terms and the enforceability of the contract clearly.

  2. Identify the performance obligation. This refers to the distinct performance obligations and the products or services your business promises to provide. Identifying those distinctions is important because a series of dependent service deliveries are treated as one performance obligation.

  3. Determine the transaction price. Calculate the contract's transaction price and predict the total amount the company is entitled to receive from the customer. Transaction prices can include non-cash transactions, variable considerations such as discounts, add-ons, mid-cycle upgrades or downgrades, and any price concessions your business offers.

  4. Allocate the transaction price to the performance obligations. Here's where a subscription business focuses differently on revenue. In a contract with more than one product or service, it's essential to distinguish the selling price for each product or service and the revenue allocated to each. ASC 606 revenue recognition offers different methods for allocating the transaction price, including revenue, discounts, etc.

  5. Recognize revenue as the performance obligation(s) is/are satisfied. Now, you have each contract with its obligations and set financial values to each obligation. All that's left is to recognize months of revenue as you serve your customers.

The need for each step in the ASC 606 revenue recognition standard depends on the business, but this is a great baseline to follow for compliance.

Where do I even begin to implement ASC 606?

While the five steps of the ASC 606 revenue recognition standard seem simple, implementing it can become a challenge. Additionally, the timing of revenue recognition can impact financial statements and have legal and tax consequences. 

Recognizing revenue too early can lead to

  • Overstated revenue: It inflates a company's reported revenue figures, making it appear more profitable than it is.

  • Legal and regulatory issues: It can be considered fraudulent accounting, and violations of accounting standards can result in fines or penalties.

  • Tax implications: If a business pays taxes on income it hasn't earned yet, it may face tax issues and penalties.

Recognizing revenue too late can lead to

  • Understated revenue: It makes the business appear less profitable, affecting investor perceptions and the ability to secure financing.

  • Cash flow problems: The company may not have access to the revenue it has already earned for current expenses.

  • Compliance issues: Non-compliance can result in financial restatements and associated costs.

When you're worried about turning in the right financial statements to the IRS with the right ASC 606-10-20 revenue recognized, that's when you want to pick the ideal revenue recognition software for your business.

Check this out: Five recognition must-haves for DTC subscriptions

How does Recurly help businesses comply with ASC 606?

More flexibility and personalization create the need for revenue recognition automation. Subscription companies with complex revenue streams, such as different pricing tiers, billing frequencies, or contract terms, with high transaction volumes, or planning to scale, really benefit from automated revenue recognition systems. 

Automated revenue recognition helps streamline operations, reduce errors, and ensure accurate financial reporting. And Recurly makes this a reality for our customers.

Our revenue recognition solution stays updated with the latest changes in accounting standards, including ASC 606. Those automatic updates roll over to our customers, automatically incorporating the criteria for revenue recognition, showing unrecognized revenue, and making it easier for accounting teams to track revenue over time.

Inside the automated revenue recognition process in Recurly

To grow limitlessly, recurring revenue businesses must be ready to adapt to evolving revenue recognition principles quickly.

Partnering with a subscription management and recurring billing platform ensures that business standards are understood and met with the expertise that is vital to compliance needs. Recurly’s all-in-one solution offers:

  • Lower costs and a streamlined tech stack

  • Improved revenue visibility, reporting accuracy, and predictability

  • Accelerated financial closes

  • Reduced compliance risks

  • Support for changing business and accounting requirements

Direct-to-consumer subscription businesses must approach revenue recognition differently. Revenue recognition software is the answer for any growth-minded business looking to automate subscription revenue accounting.

With high-velocity, high-volume customer contracts and seemingly endless contract modifications, revenue recognition standards such as ASC-606–and IFRS-15 for businesses operating abroad–can easily become more complicated.

Check out this checklist with five revenue recognition must-haves for DTC subscription businesses.