For a SaaS business model, revenue recognition is one of the most important accounting requirements; you often bill for services to be rendered far into the future, so the time that revenue is recognized can have a major impact on your quarterly and annual revenue models.

In this article, we will explore what exactly revenue recognition is and how ASC 606 established a new framework for SaaS revenue recognition.

What is revenue recognition software? 

Revenue recognition software is the automated process that tracks your company’s closed sales and turns them into revenue recorded on your financial statements.

To illustrate how the SaaS revenue recognition process works, here’s an example:

Let’s say you ran accounting at a subscription company, and a customer bought an annual subscription for $29.99 on October 1, 2021. Is it possible to recognize all of the $29.99 as Q4 2021 revenue?

Not really, you will have to count some of that as deferred revenue. You have to recognize the revenue as the service is being delivered to the customer–recognize $2.50 in revenue each month from October 2021 through September 2022. 

We will get into the nitty gritty of revenue recognition financial reporting standards shortly. But first, let’s put the accounting standards aside, and see what revenue recognition can tell you about your SaaS company.

What are the benefits of using revenue recognition software? 

By creating a revenue recognition framework and using software to automate the process, you can ensure that your business stays on the right side of the law—but the benefits don’t stop there. SaaS revenue management software can also help you run your business more effectively.

Here are a couple of ways it can do that:

  1. Through automation, a revenue recognition framework can enhance your product strategy by saving time for your teams. By automatic processes such as logging customer sales information, revenue management software can allow your sales representatives and accountants to focus on more important tasks.

  2. Through revenue recognition, you can match your revenue to the time you perform services. You can use that data to hire seasonal staff when you actually need them.

  3. Your MRR won’t have huge fluctuations based on the timing of your billings, so you can use it to get an accurate view of your company’s long-term growth trajectory.

  4. A revenue management framework can streamline complicated revenue calculations, ensuring your accounting team can easily manage billing, cash flow, and reduce revenue leakage. The enhanced accuracy also reduces human error in the process of calculations.

Now it’s time to look at the accounting requirements that changed revenue recognition: ASC 606 and IFRS 15.

What is ASC 606 and IFRS 15? How do they affect SaaS companies?

ASC 606 is an accounting standard that became effective between December 2017 and December 2019—it provides businesses with a framework for revenue recognition

Essentially, ASC 606 standardized how companies can capitalize on or reduce costs to get a contract. Working in tandem, IFRS 15 establishes reporting principles when accounting for business costs, including cash flow information about timing, amount, and revenue uncertainty. 

The way that we recognized revenue in the example was ASC 606 compliant—revenue was to be recognized as the services are rendered, not when the payment was completed. With ASC 606, a company has to apply five steps to meet the standard:

  1. Identify a contract with a customer.

  2. Identify the performance obligations in the contract.

  3. Determine the transaction price.

  4. Allocate the transaction price.

  5. Recognize revenue when (or as) the reporting obligation meets the performance obligation.

ASC 606 5-step process

So, why were ASC 606 and IFRS 15 introduced?

Before these standards were put in place, there were variations in how businesses in different industries recognized their revenue for similar transactions. The Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) jointly developed ASC 606 to provide a framework for businesses to recognize revenue consistently across industries. 

This gives you clarity on how to look at SaaS bookings compared to revenue streams. But not every situation is clear-cut.

What is revenue recognition with an example for SaaS?

SaaS revenue recognition is fairly straightforward in most cases. But it can get a little hairy sometimes—particularly if your pricing model is complicated. Here are a couple of scenarios you may encounter:

Under ASC 606, you can only record the noncallable portion of your contract as revenue. Let’s go back to the example–let’s say that you allowed customers to cancel their subscription at any point and receive a pro-rata refund or a refund based on what remained in their subscription policy. In that case, the arrangement would be recorded as a daily contract, with around 8 cents of revenue per day.

There are sometimes set-up fees in SaaS arrangements. With the previous accounting standard, these fees were recognized over the initial contract period or the estimated customer relationship period if longer. But the ASC 606 accounting standard only requires vendors to recognize up-front fees over a period that extends beyond the initial contract period if the customer has a “material right” to renew the contract.

Here’s a Deloitte resource that walks you through several scenarios you may encounter.

As you can tell, there are judgment calls that go into SaaS revenue recognition decisions. We recommend you speak to a trusted accountant if you have questions about a specific scenario.

How Recurly’s revenue recognition can help your business

To avoid getting bogged down by SasS revenue recognition, you need a subscription revenue management solution that makes the process a breeze. Recurly, the leading subscription management and billing platform for SaaS, enables you to do just that.

Our billing software allows for six different ways to recognize your SaaS revenue. The flexibility provided by our platform allows you to comply with ASC 606 easily and at the same time, future-proof your SaaS company from any additional updates to accounting standards.

Frequently Asked Questions

Why do you need revenue recognition software?

Using a revenue recognition software like Recurly can help your business establish standards and rules to recognize your revenue, specifically how your company and industry operate, thus optimizing and streamlining your financial planning process to foster business growth. Such softwares will save your company time and improve accuracy.

Who Uses Revenue Recognition Software?

Rev rec software is useful to many members of your business, including accountants, sales team members, financial analysts, and budget managers, to name a few. Essentially, any professional responsible for generating, managing, recording, or analyzing financial transactions and trends can benefit from revenue recognition tools.

What is U.S. GAAP for revenue recognition?

The United States Generally Accepted Accounting Practices (GAAP) for revenue recognition requires revenue to be recognized similarly to accrual accounting: The revenue should be recognized not when the cash is received but on the income statement for the period the income was earned.