5 Step Process to Recognize Revenue using ASC 606
By their very nature, SaaS business revenue models are complex as they operate on subscription models, as opposed to single transactions. Given that these models can vary from a plan-based approach to a usage-based or metered approach, it’s easy to see how revenue recognition can be complicated and prone to errors.
To help simplify this process, ASC 606 has prescribed the following five steps to revenue recognition:
For growing SaaS and subscription businesses, accounting and finance teams have challenges in dealing with increased complexity due to:
- High volume transactions
- Plan changes (upgrades and downgrades) and other modifications
- Multiple performance obligations such as the subscription services, implementation and training
- Discounts, coupons and rebates
Let’s break down each step along with the challenges for recognizing revenue with manual processes at each stage — and how automation solves each.
1. Identify the Contract
It’s pretty typical for arrangements with customers to be covered under multiple contract documents and verbal promises or common business practices that all constitute “one agreement.” For example, a SaaS vendor may provide separate contracts for the software access and support services and also verbally agree to provide implementation services for free.
Under ASC 606, the essential parts of any contract include:
- Approval and commitment by both parties
- Each party’s rights regarding the goods and services
- Payment terms
- Commercial substance
- Collectibility is probable
Having one system that captures all relevant contract terms is essential in dealing with subscription businesses due to the high volume of transactions and contract modifications. A comprehensive revenue subledger will interface with CRM and other source systems to be that one source of truth for revenue.
2. Identify Performance Obligations
Performance obligations are promises made to a customer that are separate and distinct within the context of the contract. For SaaS companies, this may include subscription, implementation services, training, hardware, or other professional services. Sometimes, CRM systems are not configured to capture all performance obligations in a contract.
For example, if a vendor gives away implementation services for free, they may never be noted in the CRM system and thus, the accounting and finance team would be required to manually track new deals in order to allocate fees to these multiple performance obligations.
Identifying all performance obligations in an arrangement can take time and tracking arrangements manually can be difficult. An automated revenue subledger can be configured to recognize new sales and allocate a portion of the transaction fee to implementation without manual intervention.
3. Determine the Transaction Price
Determining the transaction price requires estimating the net revenue expected over the contract term. In some cases, the transaction price is not easily determined because of volume discounts, rebates, and other forms of variable consideration. There can be a high degree of judgment and estimation in determining the transaction price for different products and services. Accounting and finance teams are tasked with estimating the arrangement fee, establishing stand-alone selling price (SSP), and recording revenue in amounts that are not subject to a substantial risk of a reversal in future periods.
With automation, you can have your pricing plans at your fingertips and ensure that your revenue recognition is aligned for every transaction without manually adjusting sales data. This ensures the consistent application of accounting policies and avoids the risk of errors or misstatements common in manual processing.
4. Allocate the Transaction Price
Unlike other businesses operating on a single transaction, SaaS product delivery is recurring via subscriptions. These recurring charges create what’s known as a continuous performance obligation, in which a share of the overall arrangement fee is recognized over the subscription period. If performed manually, this process grows exponentially with a company’s increase in sales. Additionally, transactions may often include other performance obligations such as integration services, training, or equipment that must be valued separately and recognized as they are delivered to a customer. .
With automation, the transaction price is allocated to each performance obligation based upon predefined rules sent in a SSP Library. This way, the accounting and finance team avoids manually calculating allocations outside the accounting system and maintaining voluminous spreadsheets to keep track of monthly revenue, deferred revenue, and unbilled receivables.
5. Recognize Revenue As the Performance Obligation is Satisfied
Revenue is recognized as performance obligations are satisfied either at a given point in time or over time. For manual processes, errors can be made in estimating delivery dates or manually calculating progress to completion. If you’ve ever managed financial reporting, you understand how each manual error made during the revenue recognition process is like tossing a needle into a haystack that you’ll eventually have to find.
That’s why revenue and financial reporting teams must work together, so that you know when, how, and to what extent your performance obligations are satisfied. Instead of searching for what went wrong in the past, you can make forward-looking projections with the peace of mind of knowing that the numbers in front of you are both accurate and complete.
Undoubtedly managing revenue recognition manually is time-intensive, tedious, and costly, especially for SaaS-based businesses, given the complexities surrounding recurring billing and revenue recognition. To simplify, you need a software solution that automates end-to-end revenue recognition and empowers your finance team to become a strategic partner for business growth.
Useful Read: A Whitepaper on ASC 606 Revenue Recognition and Implementation
This ultimate guide to ASC 606 will help you understand, implement, and automate ASC 606 revenue recognition.
What to look for in a Revenue Recognition software?
Any technology solution you are considering for revenue recognition should be compliant with ASC 606 and or IFRS 15. Apart from these basic requirements, here are few additional factors to consider in evaluating an ideal revenue recognition software: ,
- Provide visibility through GAAP and SaaS reporting and analytics
- Manage modifications arising mid-cycle such as upgrades, downgrades and cancellations
- Seamless integration with billing and collections to ensure completeness of data
Having a tool that satisfies these requirements facilitates efficiency in the accounting close process, accurate revenue reporting and allows management to be forward-looking in order to make data-driven decisions.
Put Revenue Recognition Challenges in the Past
With many moving parts and new changes introduced now and then, a company’s accounts departments could spend many hours of manual labor to ensure proper reporting. But, a revenue recognition software makes life easier for everyone due to the following reasons,
Helps access all the data in one place
A good revenue recognition platform helps you understand where your business stands. The right software will not only help you recognize revenue in the most complicated billing scenarios in less time but it would also help you maximize your revenue by giving you an end-to-end picture of the entire process.
Chargebee goes one step further in reporting by understanding your global needs. It takes into account contract modifications and provides well-organized reports for each currency that your business handles. It lifts the pressure off your accounting teams by providing a summary report from tracking to summarising all your payments and receivables.
Ease of implementation
Implementing new software into your existing systems might be a bit of a hassle. Integrations make this easier. For this reason, Chargebee offers direct integration with a range of third-party systems including Salesforce, Stripe, Hubspot, Xero, Quickbook, Intacct, and Netsuite to sync subscriptions and related data such as invoices and credit notes, products, and transaction prices.
More flexibility in billing operations to boost revenue operations
Relying on an accounting firm to keep your financial reports tidy would do just that. Building your revenue recognition system might not only be time-consuming but might also make your activities rigid in the sense that every time a new change happens, you would have more work apart from just recognizing revenue. A good revenue recognition software would be easy to manage and would run well on its own. It could also be configured based on your specifications making it more flexible among the other options for recognizing revenue.
With a robust revenue recognition solution like Chargebee RevRec, your accounting and finance team can be unburned from mundane tasks and spend more time in value-added activities. Schedule a demo with one of our revenue recognition specialists to find out how Chargebee RevRec can help your business.