Everything your subscription business needs to know about ASC 606 revenue recognition
Technology changes constantly. Consumer demands, economic trends, and even supply chain pressures (and how businesses adapt to them) change at a regular, if not surprising, pace. Other fields don't change all that often. When they do, it can be a confusing time for business leaders and experts.
Consider accounting, for instance. Accountants follow a set of rules, standards, and practices to do their job. For at least 100 years, they've followed one standard for recognizing revenue from contracts. Then, in 2018, the Financial Accounting Standards Board (FASB), which is in charge of establishing the standards for all accounting professionals and the companies who follow these principles, and the International Accounting Standards Board (IASB) issued a new standard that changes revenue recognition rules.
The new standard, called ASC 606, is a hot topic for accountants. Partly because their rules and procedures don't change all that 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, have to comply as well.
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. The good news is that Recurly's revenue recognition for subscription services makes this more manageable.
First, let's break down what ASC 606 means for subscription-based business leaders like yourself.
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 takes into account the costs SaaS businesses incur during the different stages of a customer lifecycle. Crucially, it allows businesses to account for the costs related to machine hours, labor hours, and incremental revenue changes.
Comparing revenue sources across industries wasn't an easy endeavor because cash flows differently in a business depending on your industry. ASC 606 directly impacts recurring revenue businesses more than retailers who, for example, sell a t-shirt and receive revenue before the receipt prints. 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.
When it comes to revenue recognition for subscription services, ASC 606 deals with the transfer of control, so revenue is recognized when a product or service with a contractual obligation to deliver is transferred to the subscriber.
Why do we have to comply with ASC 606?
The goal behind ASC 606 is to offer a framework for businesses that serve both business models. In the end, it makes financial reporting and revenue recognition more consistent across industries.
Another major change is that ASC 606 requires more comprehensive disclosures than the standards accountants followed before. The ASC stands for “Accounting Standards Codification", and when you're tracking actual revenue generation as your subscription business ebbs and flows, the ASC 606-10-20 revenue standard offers more than a series of criteria for revenue recognition.
It's a flexible framework that 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're able to 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.
Public entities have been adapting to the new revenue standard since 2018. Accountants at private companies have had to start changing their revenue recognition methods to be in compliance by 2020. Today, the Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) now require ASC 606 compliance for all companies.
Essentially, ASC 606 creates clear criteria for revenue recognition that makes it easy for all companies to be consistent with accounting practices.
What are the five steps of the ASC 606 revenue recognition standard?
Companies complying with ASC 606 follow a five-step model for revenue recognition. 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.
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 have to have a signature. What does matter is the enforceability of the contract, which decides how and when the revenue stream is recognized.
Identify the performance obligation. This refers to the distinct performance obligations, the actual products or services your business promises to provide according to the contract. In this step, you set down the distinct, independent performance obligations of each contract. Identifying those distinctions is important because a series of dependent service deliveries are treated as one performance obligation.
Determine the transaction price. Calculate the transaction price of the contract and predict the total amount the company is entitled to receive from the customer. Transaction prices can include non-cash transactions and variable considerations such as discounts, add-ons, mid-cycle upgrades or downgrades, plus any price concessions your business offers.
Allocate the transaction price to the performance obligations. Here's where a subscription business shows a different focus on revenue than a conventional business. The transaction price will be allocated among the performance obligations. In a contract with more than one product or service being provided, it's essential to distinguish the selling price of each distinct product or service, plus the revenue or discount to be allocated to each product or service. ASC 606 revenue recognition offers different methods for different circumstances to allocate the transaction price, which includes revenue, discounts, etc.
Recognize revenue as the performance obligation(s) is/are satisfied. Now, you've got each contract with its own 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?
These five steps cover the gamut of revenue recognition with contracts. While the five steps of the ASC 606 revenue recognition standard seem simple, we should point out that the new standard offers a robust series of criteria and guidance for accounting for unrecognized revenue, as well as identifying separate revenue streams.
While the framework makes sense, implementing it can be a challenge. 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. Not every CEO worries about improvement in revenue accounting, but complying with ASC 606 can actually boost your business insights while giving your team a firm grasp of changes in revenue over time.
So how can your subscription business adopt these changes, comply with the complex disclosure reporting, and identify revenue in all the various scenarios your business model may have?
At Recurly, simplifying the complex is always the goal.
How does Recurly help businesses comply with ASC 606?
Streamlining as much as possible to make necessary processes scalable and efficient is a huge contributor to subscription success. That's why a seamless integration with the right platform can make that even more feasible.
With Recurly revenue recognition, we’re turning revenue recognition automation into a reality for Recurly customers.
Recurly Revenue Recognition stays updated with the latest changes in accounting standards, including ASC 606. Those automatic updates roll over to Recurly customers, automatically incorporating the criteria for revenue recognition, showing your unrecognized revenue, and making it easier for your team to track revenue over time.
As Recurly offers customers more and more flexibility in their pricing models, we recognize that you have a growing need for revenue recognition automation.
Recurly revenue recognition's enhanced capabilities offer businesses the tools they need. Our platform simplifies and helps our customers comply with revenue reporting processes from ASC 606 and IFRS 15.
Read more: Simplifying revenue recognition for companies with subscription and recurring revenue models
Recurly revenue recognition has become a truly all-in-one solution for subscription management, recurring billing, and revenue recognition for subscription services. Recurly customers can benefit from:
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
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 like Recurly ensures that business standards are understood and met with the expertise that is vital to compliance needs.
Grow faster, smarter, and stronger with Recurly.