The Accounting Standards Codification (ASC) 606 revenue recognition requirements made compliance significantly more complicated for subscription businesses when compared to the previous generally accepted accounting principles (GAAP). But don’t get discouraged—there are a few different ways you can simplify your subscription-based revenue recognition while complying with the ASC 606 guidelines.
Before we get into the simplification tips, however, let’s quickly review what ASC 606 actually is and how it affects revenue recognition models for SaaS subscription businesses.
ASC 606 was created to enforce consistency in the revenue recognition process. Under this standard, revenue can only be recognized as “earned” when goods or services are actually rendered (i.e. performance obligations are met) rather than when:
- the sale is made,
- the invoice is created, or
- the money is collected.
So, while traditional businesses that only make one-time sales were largely unaffected by this change, subscription businesses have had to adapt. And even though the standard has been in place for all businesses since 2019, it’s still causing confusion and headaches for plenty.
As a basic example, let’s say a customer purchases an annual software subscription for $12,000 and pays the entire amount upfront. Under ASC 606, you cannot recognize the full revenue amount right away. Rather, you can recognize $1,000 once the first month of services is complete, leaving $11,000 in deferred revenue. Each subsequent month, you can recognize another $1,000 until the full amount has been recognized at the end of the 12-month contract.
Of course, this becomes exponentially more complex when you factor in hundreds or thousands of clients, variable milestone amounts and timelines, the need to recognize revenue on a more frequent basis (weekly or potentially daily in some cases), and so forth.
According to the Dean Dorton CPA and business advisory firm, “Revenue management—especially with ASC 606—creates unacceptable levels of complexity and variability that often overmatch the resources and expertise of many finance teams.”
That’s when these four tips to simplify your ASC 606 compliance become essential:
1. Know your performance obligations and timelines
First, identify and define the performance obligations for your subscription business and determine approximately how long it will take to meet them—for every product or service your business sells. Performance obligations are typically time-based, usage-based, or dependent on specific deliverables.
The software subscription example above is time-based, with each month of service counting as an individual performance obligation.
However, if your business provides something like cloud storage, your performance obligations will likely be usage-based with variable amounts due based on how much storage a customer uses. In this case, you’ll need to estimate the revenue associated with each performance obligation.
If you offer specific deliverables at various times throughout a subscription service term, then your performance obligations would be based on when each milestone is delivered and how much each one costs. For example, if you are building a website for a client, you might have individual milestones/performance obligations for:
- delivering the wireframes,
- completing initial development,
- launching the site, and
- subsequent monthly maintenance and monitoring.
No matter how you decide to structure your performance obligations, it’s crucial to define and standardize them and have a good idea of when you’ll hit them. This framework will help your accounting team stay organized and on top of revenue recognition.
2. Identify necessary data fields
It’s also important to identify the data you need to collect from each customer in order to best help your accounting team. Especially in cases where you need to estimate revenue for your performance obligations, having as much data as possible will be helpful. But, the exact data fields you need will depend on your specific business model and the products or services you offer.
Jim Neesen, Managing Partner at Connor Group, says, “This will be collaborative with your accounting team. This is where you start to go upstream and say, ‘Okay, what’s all the information we have to capture from the customer as part of closing the deal to make sure we can come up with the calculation for the 606 revenue?’”
As with everything in business, data drives the best decisions—and having the right data available is absolutely essential.
3. Invest in a billing tool with a flexible catalog
ASC 606 requires that you consider variable price considerations, including coupons, discounts, proration, rebates, contract modifications, price changes, one-time startup or cancellation fees, and other incentives.
Unfortunately, not all businesses or billing tools have the capability to account for these variances (especially one-time charges), which generally means they have to use a workaround. Often, this involves creating a separate subscription for the amount of the one-time charge, and then removing it from the customer’s account before the next billing cycle.
This can cause numerous potential issues, including:
- confusion for the customer,
- manual billing errors,
- artificially inflated churn rates, and, most relevantly,
- inaccurate financial reporting—it’s not necessarily an ASC 606-compliant accounting method.
However, a billing tool that includes a flexible catalog allows you to accurately account for these anomalies easily and seamlessly—without resorting to sketchy workarounds or invalidating your analytics.
4. Automate your revenue recognition
Speaking of tools, hands-down the easiest way to simplify your ASC 606 compliance is to automate the entire process by selecting a tool that handles billing, invoicing, receiving payments, and revenue recognition.
In regards to the ‘unacceptable levels of complexity’ previously mentioned, the folks at Dean Dorton went on to say, “Faced with these hurdles, companies are looking to automate revenue management processes to gain efficiency, strengthen compliance, and improve visibility. To accomplish this, successful businesses rely on cloud-based financial management software.”
Yes—but you’ll need to do some research first. Xavier Sanchez, Senior Manager at CFGI, advises, “There should be a lot of upfront diligence on choosing your revenue recognition software. For successful implementation, you need to make sure the business is involved and the accountants are involved. Also, loop in the IT department to make sure that your choice is a viable solution.”
Look for a tool that supports all four revenue recognition methods (immediate, manual, fixed interval, and milestone) to cover your bases with ASC 606 compliance. Even if you don’t use all four methods now, you may need to use them in the future.
Once you’ve checked in with all of your relevant departments, invested in a suitable automated solution, and implemented it, you’ll need to input the information that you gathered from tips one and two: your performance obligations and timelines, and your necessary data fields. But, since it’s automated, you only have to worry about this once (or as often as you change your performance obligations) rather than with each new contract.
Recognize revenue in your sleep
With your automated revenue recognition tool up and running, you can sit back and enjoy the benefits: hours (if not days) less work for your accounting team as well as the virtual elimination of manual errors and accidental non-compliance.
The complexity of most modern SaaS subscription businesses and the stringent requirements of ASC 606 make it simply impossible for accounting teams to keep up manually. But the implementation of an integrated, automated, ASC 606-compliant billing and revenue recognition software will free up your accounting team to work on higher-level, more strategic projects and enable you to effortlessly scale your subscription business.