For a SaaS subscription company, revenue recognition is one of the most important accounting standards; you are often billing for services that are 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 numbers.
In this article, we will explore what exactly revenue recognition is, and how ASC 606 established a new framework for SaaS revenue recognition.
Revenue recognition is the process of turning closed sales into revenue that is 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 AllTrails 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? Nope. You have to recognize the revenue as the service is being delivered to the customer. In the AllTrails example, you would recognize $2.50 in revenue each month from October 2021 through September 2022.
We will get into the nitty gritty of revenue recognition accounting standards in a little while. But first, let’s put the accounting standards aside for a bit, and see what revenue recognition can tell you about your SaaS company.
By creating a revenue recognition framework, you can ensure that you stay on the right side of the law—but the benefits don’t stop there. SaaS revenue recognition can also help you run your SaaS business more effectively.
Here are a couple of ways it can do that:
Through revenue recognition, you can match your revenue to the time that you are performing services. You can use that data to hire seasonal staff when you actually need them.
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.
Now it’s time to look at the accounting standard that changed revenue recognition: ASC 606.
ASC 606 is an accounting standard that became effective between December 2017 and December 2019—it provides businesses with a framework for revenue recognition. The way that we recognized revenue in the AllTrails 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:
Identify a contract with a customer.
Identify the performance obligations in the contract.
Determine the transaction price.
Allocate the transaction price.
Recognize revenue when (or as) the reporting obligation meets the performance obligation.
So, why was ASC 606 introduced?
Before ASC 606, 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 vs. revenue. But not every situation is clear-cut.
SaaS revenue recognition is fairly straightforward in most cases. But it can get a little hairy sometimes—particularly if your billing model is complicated. Here are a couple of scenarios you may encounter:
Under ASC 606, you can only record the noncelable portion of your contract as revenue. Let’s go back to the AllTrails example: in an alternate world, let’s say that AllTrials allowed customers to cancel their subscription at any point and receive a pro rata refund. In that case, the arrangement would be recorded as a daily contract, with around 8 cents of revenue being recorded 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.
To avoid getting bogged down by SasS revenue recognition, you need subscription management software that makes the process a breeze. Recurly, the leading subscription management and billing platform for SaaS, enables you to do just that.
We offer six different ways to recognize your SaaS revenue. The flexibility provided by our platform allows you to easily comply with ASC 606, and at the same time, future-proof your SaaS company from any additional updates to accounting standards.