Removing Complexity from
Subscription Revenue Recognition

By: | Category: Compliance, ERP

With the gaining popularity of subscription-based services, many companies are investigating ways to incorporate this business model into their operations. Whether your company is seeking to add Software-as-a-Service (SaaS) to your current model, or looking to fine-tune your existing subscription processes for compliance, efficiency and effectiveness, it remains critical to understand when and how to properly recognize revenue.

In order to maintain consistency across all businesses and industries, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) issued policies (or standards) with respect to how revenues are recorded in financial statements. The current policies are known as ASC 606 or IFRS 15, respectively. Each organization should take into consideration any external factors that could affect its ability to recognize revenue for a specific period of time and ensure compliance with ASC 606/IFRS 15.

Subscription Struggles

Companies that employ a SaaS model have customers that pay for a service on a recurring basis. This means that revenue is recognized over the duration of the contract, and not necessarily when the product or service is delivered.

This model requires companies to estimate variable consideration, which includes usage fees and non-usage fees, such as setup fees, professional services, and support contracts. Variable consideration is estimated using either the expected value method or the most likely amount method.

The complexities involved in the revenue recognition process for SaaS companies have created a number of issues since the implementation of ASC 606/IFRS 15. To counter these issues, a five-step framework was created to help companies determine how and when to recognize revenue. The five steps to revenue recognition are as follows:

  1. Identify the contract with the customer.
  2. Identify the performance obligations in the contract.
  3. Determine the transaction price.
  4. Allocate the transaction price to each performance obligation on a relative stand-alone selling price basis, if necessary.
  5. Recognize revenue when (or as) the entity satisfies a performance obligation.

While these five steps may seem straight forward, many organizations run into issues even getting past the first two steps. For instance, if there are multiple elements in a contract (e.g., software and support), then how do you allocate revenue? This makes it difficult for companies to determine which contracts should be accounted for using the time-based approach or the consumption method.

Another issue is that most companies do not have a dedicated finance team who know how to apply these complicated rules correctly. If you don’t have enough – or the right – people on your team who understand these rules, it’s necessary to leverage the expertise of CFO advisory services as well as that of your preferred technology advisor, like Net at Work, to ensure proper support from your systems.

These are just two examples but, as you can see, when it comes to revenue recognition, companies following a SaaS model face significant complexity.

“As more businesses come to terms with ASC 606/IFRS 15 compliancy, technology is increasingly at the forefront. The shortcomings of spreadsheets, legacy ERP systems and even QuickBooks make reliance untenable in a SaaS environment, causing companies to seek more modern solutions”

A Modern Solution for a Modern Problem

As more businesses come to terms with ASC 606/IFRS 15 compliancy, technology is increasingly at the forefront. The shortcomings of spreadsheets, legacy ERP systems and even QuickBooks make reliance untenable in a SaaS environment, causing companies to seek more modern solutions.

Next Generation Enterprise Resource Planning (ERP), as an adaptive platform with native Artificial Intelligence (AI) and Machine Learning (ML) and accessibility beyond the browser, innately offers the type of robust financial reporting needed to ensure compliance with ASC 606/IFRS 15. These nimble operations platforms have the ability to overcome complex revenue recognition scenarios through their powerful revenue management functionalities that afford financial professionals the time to focus on other business-critical analyses. Some aspects of revenue recognition management within a Next Generation ERP solution include:

  • Multiple Performance Obligations – Robust capabilities provide configurable revenue schedules for even the most complex agreements.
  • Manage Complex Allocations – Comprehensive allocation features enable systematic compliance with ASC 606/IFRS 15.
  • Dynamic, Standalone Selling Price – Define the Standalone Selling Price (SSP) as either a constant or a dynamic formula. Leverage Standalone Selling Prices to automatically allocate arrangement consideration across all elements within the Arrangement—including support for ASC 606/IFRS 15 standards.
  • Revenue Recognition for All Industries – Supports revenue recognition over time, percentage-of-completion, and event-driven revenue plans for all industries under ASC 606/IFRS 15 requirements.

Digging Deeper

In order to properly meet ASC 606/IFRS 15 standards, revenue recognition within a SaaS environment requires organizations to make judgment calls in a number of areas where data may be limited or altogether unavailable. Through a combination of the right advisory resources and technology solutions, however, companies can arm themselves with the ability to not only satisfy these standards, but to do so in a way to maximize revenue. To learn more about SaaS model compliance with current policies, watch the webinar recording of “Ask the Experts: Breaking Down Subscription Revenue Recognition for Finance” today.