What is subscription revenue recognition (rev rec)?
To maximize revenue and capture more market share, subscription businesses need to understand the revenue recognition principle. Traditionally, revenue recognition (rev rec) is a generally accepted accounting principle (GAAP) that notes how you recognize revenue.
In the case of subscription revenue accounting, revenue is only recognized and counted when the cash from a product or service, per the contract, has been earned and not just collected. In this case, any unmet balance will remain on a balance sheet as accounts receivable from the initial sale date until the date the customer makes a payment.
For example, a gardener’s services are completed by the day’s end, and $100 is expected, which means revenue is recognized after the job is completed. However, the money may not be received until weeks later and would still be considered as accounts receivable.
If your business is a subscription model, your billing platform should be your source of truth, and accurate membership rev rec contributes to the reliability of that data.
What is the revenue recognition principle?
Rev rec is a Generally Accepted Accounting Principle (GAAP) that specifies how and when you recognize revenue, helping subscription businesses separate actual income from deferred revenue. This helps subscription companies properly recognize income from an array of plan types (monthly plans vs. yearly plans), or to account for plan modifications, upgrades, downgrades, or cancellations.
The revenue recognition principle is a key feature of accrual accounting that indicates that companies recognize revenue as it is earned as part of the payment terms, and not when they receive payments.
Why is revenue recognition important for subscription billing?
Taking into consideration balance sheets to income and financial statements, revenue recognition is a subscription accounting method that offers transparency into some of the most important aspects of any business. Recognize revenue too early, and you may think you have more to invest than you do. However, failing to recognize revenue correctly may lead to missed opportunities to grow your business. Accurate membership rev rec lets you confidently speak about your subscription business’ performance and growth trajectory.
Hello and welcome. In this video, we'll introduce you to the ASC-606 revenue reporting standard.
We'll be discussing the five-step process to revenue recognition, the importance of ASC-606 compliance in subscriptions, and how to implement this standard into your business.
Let's start with the basics: what is revenue recognition?
Revenue recognition specifies how businesses should recognize revenue based on contracts with customers. It's important to note that a company can only recognize revenue from contracts when the promised goods or services are transferred to the customer as opposed to when payment is made. Accurately recognizing revenue has been a major challenge since ASC-606 went into effect, forcing numerous publicly traded companies to restate their earnings which can damage investor confidence, stock valuation, and more.
ASC-606 defines a 5 step process for recognizing revenue:
Number 1: Identify enforceable contracts for products or services to customers.
Number 2: Identify the performance obligations in the contract, basically what must be delivered in exchange for payment.
Number 3: Determine the transaction price. This can get complex fast when variable amounts come into play, like discounts or return policies.
Number 4: Allocate the transaction price across each separate performance obligation in the contract based on its relative standalone selling price, also known as SSP. This is often determined by numerous data points and calculation methods.
Number 5: Finally, you can recognize revenue as each performance obligation is satisfied.
Why is complying with ASC-606 important in subscriptions?
This standard greatly changed how subscription-based businesses recognize revenue and the associated costs, which are recognized over the estimated life of a subscriber's contract. To remain compliant, revenue cannot be recognized immediately but rather deferred until the contractual obligations are satisfied. However, this gets more complicated when customers upgrade, downgrade, or make contract modifications. Determining contractual obligations is how performance obligations are defined and satisfied in the contract. For companies with subscription fees and licenses, such as software and direct-to-consumer businesses, the impact on the amount and timing of recognition can be significant.
Considering these modifications, how can you comply with complex reporting and successfully recognize revenue?
With Recurly's revenue recognition solution, you can fully automate and streamline your revenue reporting processes. Take the guesswork out of revenue management and compliance, and improve forecasting insights across multiple revenue models.
Rev Rec methods: How does revenue recognition work?
An example of membership revenue recognition is easiest to understand when customers pay upfront, like in the case of annual subscriptions. Let’s consider a wine club that offers a $480 annual plan for subscribers to receive three bottles of wine every month. When do you recognize revenue?
If you’re wondering how to calculate membership revenue recognition, the answer is $480 annually divided by 12 months, which comes out to $40 of recognized revenue every month. Just because $480 has been paid from the get-go doesn’t mean you’ve earned every penny of that amount. For example, if the subscription had to be canceled before that year was up, you would technically owe money to that customer.
This is a subscription accounting process from the GAAP and International Financial Reporting Standards (IFRS). The GAAP and IFRS have revised their accounting standard on revenue recognition methods several times to improve the reporting of financial statements, with the latest requiring ASC 606 compliance.
What is revenue recognition under ASC 606, who does it apply to, and how is it recognized?
On May 28, 2014, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) issued the Accounting Standards Codification (ASC) 606, a new framework for companies to recognize revenue from contracts with customers across different industries and business models. ASC 606 affects all public companies and private companies that enter into contracts with customers.
The ASC 606 establishes the following model for revenue recognition:
Identify the contract with a subscriber
Identify the performance obligations
Determine the transaction price to confirm the credit terms
Allocate the transaction price
Learn more about the U.S. government's position on revenue recognition, when revenue can be reported on your company's income statements and revenue recognition standards from the Financial Accounting Standards Board.
Recurly Revenue Recognition
Recurly’s Revenue Recognition tool allows you to access a revenue schedule export for faster, more accurate subscription revenue accounting. This automation feature is ideal for subscription companies with standard revenue recognition requirements.
Subscription revenue recognition is more unique than most people’s basic understanding of rev rec. Recurring revenue, while reliable and stable revenue generation for subscription companies, makes a strong case for the time revenue is earned versus collected, especially with different subscription plans.
Recommended reading: Revenue recognition software for SaaS businesses.
Revenue recognition FAQs
When should revenue be recorded?
Contrary to traditional models where service delivery happens at the transaction moment, subscription businesses recognize revenue when the cash payments have been earned and not just collected.
Can you recognize revenue when you invoice?
Under the accrual basis or cash basis of accounting, revenue is recognized when it is earned. For subscription services during invoicing, deferred revenue is recognized or accrued once the consumer receives the service within the subscription period.
How do successful subscription businesses ensure accurate revenue recognition?
A revenue recognition platform is key for accurate and timely accounting and to monitor financial performance correctly. Successful subscription brands - from membership sites to software companies to online publications - automate and streamline accounting processes to minimize errors and ensure compliance with ASC 606 and IFRS 15 standards.
How do you record subscriptions in accounting?
The initial payment for a subscription service is typically allocated to a deferred revenue account. As each accounting period occurs and the performance obligation is met, the portion of the upfront payment for that billing period can be moved over and recorded as recognized revenue.
How to audit revenue recognition?
There are two main stages of a revenue audit: Testing the revenue accounts on your income statements and examining your accounts receivable on the balance sheet. Auditors may check for rev rec issues like side agreements and channel stuffing.