5 Step Process to Recognize Revenue using ASC 606

~ 7 min read | May 27

Accounting Today calls  ASC 606 as the “biggest change to the accounting standards in the last 100 years”. Jointly developed by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB), the ASC 606 went through many revisions issuing multiple Accounting Standards Updates (ASU) which refined it to recognize revenue more consistently. 

This new revenue standard affects all existing contracts with customers as part of a private company or a public company.

Public companies were required to adapt to these standards for reporting periods beginning December 15, 2017, interim periods and annual reporting periods thereafter. For private companies, the policy’s effective date was from December 15, 2019, interim periods within annual reporting periods beginning after December 15, 2019.

ASC 606 defines flexible and robust guidance to accommodate the entire gamut of revenue recognition changes that would affect the financial statements of a company. Additionally, the new guidance would also improve the comparability of revenue recognition practices across different companies and industries.

This new standard affects 3 core areas of the revenue recognition model

  • How the business defines contracts with customers
  • How pricing and quotes for these contracts are established
  • How revenue from fulfilling these contracts is recognized

ASC 606 takes into account the lifecycle of a customer in SaaS businesses and the costs incurred by them at each of these stages such as implementation costs, training, adds ons, discounts, upgrades, downgrades, and so on.

The 5 Step process of revenue recognition

In SaaS businesses, the payment for the promised goods or services is made upfront by the customer and this ‘cash’ can only be considered as revenue as it gets earnt over the customer‘s contract period. 

 ASC 606 has a 5-step process to recognize revenue efficiently.

 

5 Step process for ASC 606

1. Identify the contract with a customer

Under ASC 606, one doesn’t need a signed contract, but any contract can be valuable with enforceable rights and obligations. The essential parts of any contract are,

  • All parties have approved the agreement
  • All parties are committed to fulfilling their obligations
  • Each party’s rights are identifiable
  • Payment terms are identified
  • The contract has commercial substance
  • Collectibility is probable

2. Identify the Performance Obligation in the contract

Performance obligation simply means a promise to transfer goods or services to the customer. In this step, any distinct services to the customer need to be identified. A good or service is distinct when,

  • the customer can benefit from the actual good or service 
  • it can be transferred independently of other performance obligations in the contract

3. Determine the transaction price

The transaction price refers to the cash and non-cash consideration that an entity is entitled to receive from the customer. This also includes any variable considerations such as price concession, volume discount, and rebates to be estimated upfront.

Components of a subscription business model

4. Allocate the transaction price

Unlike other businesses, in SaaS, the product or service delivery is recurring in nature, so there happens to be a continuous performance obligation. To tackle this, the seller can split the total amount of consideration to be recognized as revenue for each performance obligation.  

5. Recognize Revenue

Voila! The revenue is recognized once the performance obligation is fulfilled!

How to make Revenue Recognition Easy?

At the most basic level, revenue recognition under ASC 606 means revenue is recognized when the contractual obligation is met and not when the payment is made. This changes everything for the SaaS industry and it could be very stressful considering non-compliance is not an option. An intelligent revenue recognition software to track revenue would be an easy and stress-free solution.

For example, Chargebee is a revenue recognition intelligence that simplifies billing using used-case scenarios and helps manage any changes in recurring revenue such as an upgrade, downgrade, or cancellation at mid-period. The trick is, Chargebee’s deferred revenue recognition module does day-based revenue calculation to tackle these kinds of issues and also gives a detailed report for all plans, products, and currencies.

To make things even easier, we have created a guide outlining key metrics, the meaning of ASC 606 to SaaS, challenges, or revenue recognition scenarios faced in SaaS companies. Feel free to leaf through our guide here.

What to look for in a Revenue Recognition software?

Any technology solution you are considering for revenue recognition should be compliant with the ASC 606. Apart from this basic requirement, there are few checkboxes that an ideal revenue recognition software should check. They are,

  • Track contracts based on the 5-step model
  • Provide visibility through reporting
  • Manage modifications arising mid-cycle such as bonuses, refunds, etc.
  • Seamless integration with billing and collections so that revenue recognition is separated from purchase orders and invoices

How does Revenue Recognition software make life easier?

With many moving parts and new changes introduced now and then, the firm’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,

1. Helps access all the data in one place, making your billing platform the ultimate source of truth

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.

2. 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 integrates with Softrax to sync subscriptions and related data such as invoices and credit notes, products, and transaction prices from Chargebee to Softrax. This not only lets you define your revenue recognition rules through Softrax but it also makes it easier for your RevOps teams to track and group performance obligations. Additionally, it helps avoid inaccurate reporting which would lead to wider implications under the ASC 606. 

3. 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.

For example, Chargebee supports 23+ payment gateways and 100+ currencies and lets you accept payment via credit cards, Direct Debit, and digital wallets like Worldpay, Amazon Pay, and Apple Pay. With multi-currency payments, you could be worried about exchange rates but with Chargebee, you can set your exchange rate and let Chargebee do the work of keeping you up to date with any currency fluctuations.

Most importantly with a robust revenue operations system, your employees can stop working on monotonous tasks and start focusing on idea-generating to use the saved revenue in better ways. At the end of the day, revenue helps grow your business and it is vital to be up-to-date with the latest ways of managing your revenue to stay on the top of your revenue game. 

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Sinduja Pk

I am the human version of Daria Morgendorffer minus the glasses | Marketing specialist @ Chargebee