What is subscription revenue recognition?
Revenue recognition, commonly known as rev rec, is a Generally Accepted Accounting Principle (GAAP) that specifies how and when you should recognize revenue.
The GAAP and International Financial Reporting Standards (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.
This standard helps subscription businesses separate actual income from deferred revenue–and properly recognize income from an array of plan types, and contract modifications such as upgrades, downgrades, or cancellations.
In this article we’ve compiled the most frequently asked questions about revenue recognition for subscription businesses: what is it, how it works, why is it important, and more. Let’s dive in!
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.
ASC 606: Setting the rules for rev rec in subscriptions
Back in 2014, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) issued the Accounting Standards Codification (ASC) 606.
This new framework guides companies to recognize revenue from contracts with customers across different industries and business models. It affects all public and private companies that enter into contracts with customers.
The ASC 606 establishes the following model for revenue recognition:
Identify the contract: Any valuable contract that includes obligations and enforceable rights counts.
Identify the performance obligation: The distinct performance obligations and the products or services you promise to provide.
Determine the transaction price: Calculate the contract's transaction price and predict the total amount you’re entitled to receive.
Allocate the transaction price to the performance obligations: Distinguish the selling price for each product or service and the revenue allocated to each.
Recognize revenue as the performance obligation(s) is/are satisfied: Recognize months of revenue as you serve your customers.
When should revenue be recorded in subscriptions?
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. 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.
Revenue recognition example
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? 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.
Why is revenue recognition important for subscription billing?
Taking into consideration balance sheets to income and financial statements, revenue recognition offers transparency into some of the most important aspects of any business. Accurate membership rev rec lets you confidently speak about your subscription business’ performance and growth trajectory.
However, failing to recognize revenue correctly may lead to missed opportunities to grow your business. Recognize revenue too early, and you may think you have more to invest than you do.
How do successful subscription businesses ensure accurate revenue recognition?
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.
A revenue recognition platform is key for accurate, timely accounting and monitoring 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.
Recurly’s Revenue Recognition ensures streamlined and automated compliance with multiple revenue reporting standards with an enterprise-grade, fully configurable solution. Our solution allows you to access a revenue schedule export for faster, more accurate subscription revenue accounting.