Best Practices in SaaS Revenue Recognition

~ 7 min read | June 29

Revenue is probably the most crucial metric for any business. You can’t sustain a business without revenue over the long term. And that is why revenue recognition is a critical part of accounting for every business, especially for those that report earnings to investors or other stakeholders.

However, there are some revenue recognition best practices that all subscription businesses should follow while they report their numbers. We will explore those in this article.

Revenue Recognition for SaaS

But first, let’s understand why revenue recognition is especially important for subscription businesses. A SaaS business charges customers upfront for services that will be delivered over a period of time. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS), both dictate that businesses cannot claim a revenue to be theirs, until and unless they render the service for that amount to the customer.

So, SaaS businesses have to track the money that flows in their account, and how much of it is actually recognized.

ASC 606: What it Means for SaaS

Created jointly by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB), ASC 606 has an overarching framework that covers all bases for SaaS revenue recognition.

The 5-step process for revenue recognition under ASC 606 is:

  1. Identify the 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 performance obligation is satisfied

For a detailed explanation of each of these steps with examples, check out this guide for SaaS revenue recognition.

Best Practices for Revenue Recognition

It can be incredibly tempting to recognize the entire contract amount as revenue at once and look good in front of the stakeholders and investors, without having the service delivered. However, businesses need to be prudent and avoid showing revenue on paper as being the same as what is in hand. Here are some best practices that subscription companies can follow for their revenue recognition process. Feel free to jump off directly to any of the sections below:

Using Deferred Revenue Account for Better Revenue Recognition

A classic method to recognize revenue dictates the use of a common account called deferred revenue, which is fundamentally a routing account. So whenever an invoice is raised, you always route it through the deferred revenue account.

For any accounting entry we pass, we need to take into consideration two accounts – the debit and the credit account. Say for example you’re billing an enterprise customer $12000 in the month of January. In that case, you debit your account receivable of $12000, and you credit that amount into the deferred revenue account.

This deferred revenue, thus, becomes the control account. A control account only contains summary amounts and is a general ledger account. The control account has the correct balance which can be useful to prepare a company’s financial statements.

What businesses typically do after billing is book receivables of $12000 and sales of $12000, with the assumption that a sale of $12000 has happened. However, in case of an annual contract, the revenue that can be recognized is not $12000 at the end of one month, but $1000.

In such a case, they would:

  • Reverse the $11000 from the sales account into the deferred revenue account.
  • Keep only $1000 in the sales account.

The Best Practice:

Revenue Recognition for Annual Plan

  • Use ‘deferred revenue’ as a routing account. 
  • Whenever you raise an invoice or credit note, the impact should always be on the deferred revenue
  • When you want to recognize your revenues, you move $1000 from deferred revenue into the sales account.

This is a classic methodology that should be followed for revenue recognition, i.e., always routing it through a control account, so that, at any given point of time, you don’t miss out overlooking the control account.

Head here to see an exhaustive list of revenue recognition scenarios for SaaS with examples.

Bad Debts and Receivables Accounting

You recognize that your customer has to pay you money the minute you have invoiced them. But there could be a situation where a customer ends up not paying, even after the due date. This can happen for multiple reasons, such as bankruptcy, trade dispute, or fraud. Once you deem the amount as irrecoverable, that receivable has to be ‘written off’. 

If you write-off a receivable, it is moved to an account called bad debts in the expense account. When it is reported, this amount is adjusted against your revenue numbers. 

How?

$12000 towards a customer, in the month of January. However, the customer is not able to pay the amount after repeated dunning requests. The amount is deemed uncollectible in April and is written off as bad debt.

In your financial statement, you will look like you have a revenue of $12000, along with the other expenses, and the same $12000 will be shown in your bad debt expense too. But if one were to look at the revenues alone, it could look like the revenues have been overstated.

The Best Practice:

  • Set off the bad debt expense with your revenue recognized every month

Revenue Recognition for Full Write-off

  • This allows you to get a more realistic and less inflated view of your actual revenues.
  • As prudence practice, businesses must ensure that the receivables are not overstated in the financial statements. This can be done with a journal entry to write off bad debt:

journal entry for write off

  • This credit entry ensures that the receivables balance is ‘nil’ as in this case, the amount is deemed irrecoverable.
  • The debit entry ensures that the irrecoverable revenue is not recognized in the income statement.

Discount Accounting

Discounts are used very commonly in SaaS. Discounts may be offered during promotions, for paying upfront, or for buying in large volumes. In accounting terms, this is known as “Discounts Allowed”. Discounts Allowed are reported on the debit side of the Profit and Loss statement. According to ASC 606, discounts constitute a separate performance obligation.

Let’s see the example of a ‘prompt payment discount’. Fictitious Ltd signed on a customer ‘A’ at a price of $15000 on credit. Fictitious Ltd has a 30 day Net-D payment period and they have offered the customer a 5% discount on prompt payment.

The Best Practice:

  • If the customer pays within the stipulated period and is eligible to avail the discount, the journal entry should look like this:

Discount accounting journal entry

  • For prudent practice, it makes sense to set off discounts against revenues. This can be done by deducting the sales discounts from the gross revenue. The result is ‘net sales’ that is reported on the income statement.
  • This will help you avoid skewing the revenue numbers in your financial reports.

Revenue Analysis

In revenue accounting, it is useful to classify and track revenues from different channels. This will help you understand what the distribution of revenue and deferred revenue looks like across channels and how you can use it to make decisions.

Typically for a SaaS business, revenue analysis can be done for the following channels:

  1. Subscription Revenue
    • By Subscription:
      1. Plan-based / Fixed revenue
      2. Metered Revenue
    • By Customer:
      1. Plan-based / Fixed revenue
      2. Metered Revenue
    • By Plan:
      1. Plan-based / Fixed revenue
      2. Metered Revenue
  2. Revenue from other sources:
    • Partnerships in the form of revenue share
    • Referrals

Disclosure Requirements

Disclosure requirements enlist certain explanatory information to be included in your financial statements. This helps maintain transparency and clarity for anyone who is reading the statements. Some of the disclosure requirements are:

  1. Disclosure of the portion of the revenue that is yet to be recognized subject to the fulfillment of remaining performance obligations
  2. Methods and assumptions used to estimate variables and potential reversed revenue
  3. Any changes incurred during the accounting period

However, these disclosure requirements differ for private and public companies.

For SaaS companies, recurring billing and revenue recognition should go hand in hand. Chargebee uncomplicates revenue recognition by using the billing platform as the single source truth, enabling seamless management recurring billing along with revenue reporting for fast-growing startups to public companies. Talk to us to know how Chargebee can automate your revenue recognition.

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Nupura Ughade

Of the House Slytherin, First of Her Name, Content Marketer @ Chargebee, and an Admirer of All Things Nerdy