SaaS Revenue Recognition Accounting & ASC 606 Rules

The goal of the revenue recognition guidance is to standardize the revenue policies utilized by businesses. External organizations, such as analysts and investors, can compare the income statements of different companies in the same industry because of this standardization. We’ll use an example to illustrate how plan upgrades affect SaaS revenue recognition. Let’s assume that mid-way through the contract year, say June 15th, your client requests a plan upgrade that would take their annual payment from $12,000 to $24,000. Revenue recognition for June would be $1,500 ($500 for the first 15 days of June and $1,000 for the last 15 days of June).

For instance, some packages come with marketing incentives at the time of subscription. This could be, for instance, an add-on feature for a specific premium package, not available in other plans. You’ll need to determine which of these are a part of your direct costs. Revenue is generally recorded when a product is delivered or service fulfilled, as opposed to when money is received. With these, clients can choose the features they need and pay only for those. This reduces the chances of clients canceling subscriptions due to a lack of suitable plans.

Revenue Recognition for Shift in Annual to Monthly Plan Cycle

The U.S. Securities and Exchange Commission states that any revenue generation through SaaS subscription services must be categorized as non-refundable up-front fees in financial accounts. The fifth and final step is to recognize revenue as the company satisfies its performance obligations. This can be done either at a point in time or over time, depending on the nature of the goods or services being transferred to the customer.

• The contract between you and the customer determines how you calculate revenue recognition adjustments.
• With such plans, clients get to choose features according to their specific needs, and the costs for these would be unique in each case.
• The ASC 606 can be seen as an enlarged version of IFRS 15 that makes the process of revenue recognition for subscription businesses easier.
• You invoice the customer $12,000 for a one-year subscription on January 1.
• Under ASC 606, your company cannot recognize all $120,000 as revenue upfront.
• As indicated in the following discussion, the series guidance will result in Dashboard combining the 365 distinct daily promises into a single performance obligation for purposes of applying ASC 606.
• With traditional software acquisition, revenue recognition wasn’t recurrent as software updates were few.

We’ve seen it before, what makes SaaS different when it comes to revenue recognition is the fact that they are subscription-based. CFOs must be able to separate the grain from the chaff, in other words, they must be able to allocate each revenue in order to be able to recognize it properly in their financial statements. Recognizing revenue can become even more complex with the various packages, add-ons, and contract specificities your SaaS company might offer. You may have already billed the customer for the services, but they fail to make payment. For example, if the new plan includes additional features, then your cost of providing those features increases. Using the same criteria, revenue recognition for June would be $1,500 ($1,000 for the first 15 days of June and $500 for the last 15 days of June).

Bookings

The revenue recognized over the months is the same as that of an annual plan, where the revenue recognized per month is $1000. In this scenario, the revenue from each month can be recognized in the same month. In the case of cancellation without refund, the customer cancels the services from Help! At the beginning of April, but contractually, is not entitled to a complete or partial refund.

Booking is a forward-looking metric that typically indicates the value of a contract signed with a prospective customer for a given period of time. In a nutshell, bookings signify the commitment from your customers to pay you money for the service you provide. If the revenue recognition has already happened, it’s written off as bad debt. Here, you’ll have to determine the point when the performance obligation of the contract is satisfied. If you’re unable to measure the progress of your performance obligation, ASC 606 provides that revenue recognition be done based on the extent to which you’ve incurred costs.

Revenue Recognition Scenarios for an SaaS Company

When a contract contains the right to make additional purchases, a SaaS provider must determine whether those purchases represent material rights. A material right results when the SaaS provider offers an optional benefit that the customer would not have received without entering into the contract. A customer entered into a one-year contract with Lab, initially for three user licenses. Three months later, the customer requested that a fourth user be added to the contract and paid a pro-rata fee of $750 once the additional user credentials were provided by Lab. As indicated in the following discussion, the series guidance will result in Dashboard combining the 365 distinct daily promises into a single performance obligation for purposes of applying ASC 606.

Often, your SaaS accounting is outsourced to a bookkeeper or accountant who is not familiar with the SaaS business model. Your accountant compiles your financial statements but does the accounting on a cash basis or quasi-cash basis. Let’s assume saas accounting that a customer has opted for the annual plan priced at $12000 per annum starting from January and is billed $1000 per month. Even if they are charged the entire $12000 upfront, only $1000 gets recognized for the services provided in January.

Evaluating Professional Services Associated with the SaaS Agreement

Subscription revenue recognition is an important part of running a SaaS business or any other subscription-based business. While the process is straightforward for a traditional business model, it gets complicated for subscription-based business models, which tend to have different pricing models too. Assuming similar rates, at the end of March, you’ll still recognize $24 as revenue for March, but debit it to unbilled accounts receivables. You’ll not debit your accounts receivable, though, as you haven’t invoiced this payment yet. The transaction price is supposed to depict the value your company feels entitled to for providing goods and services as promised in the contract.

• When a contract contains the right to make additional purchases, a SaaS provider must determine whether those purchases represent material rights.
• By the end of April, you’ll recognize the full amount of $62 as revenue and debit it to accounts receivable.
• In this article, we will discuss SaaS revenue recognition, cash accounting vs. accrual accounting, ASC 606, and why revenue recognition matters for SaaS startups.
• For most SaaS businesses, recurring revenue generated from subscriptions is the primary driver of growth … and of enterprise value.
• Here are reasons why the subscription model is effective for SaaS businesses.
• The cash basis and accrual basis of accounting are two principal methods used to record transactions.
• You can choose payment methods that are less expensive than international wire transfers.

As you’ll see, though, the formulas become quite complex to handle the different date logic. However, with long-term subscriptions, you invoice a customer for a one-year subscription, but you can’t recognize that revenue instantly on the income statement. You must park the revenue on your balance sheet as a deferred revenue liability. Of course, there are so many new nuances with ASC 606 that I will assume that you are pure play SaaS. Under proper SaaS revenue recognition, your accountant will invoice the customer for $12,000.

Revenue Recognition is Straightforward for Many Traditional Companies

The Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) jointly developed ASC 606 to provide a framework for businesses to recognize revenue consistently across industries. In recording revenue recognition, you must have a clearly determined transaction price. This amount could be a fixed or variable, based on time to completion or other performance factors, or a combination of the two. However you determine your transaction price, it must be clearly recorded.

• Recognize revenue when (or as) the entity satisfies a performance obligation.
• Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee (“DTTL”), its network of member firms, and their related entities.
• Similarly, the software is simply made available to the customer without specific services rendered.
• Instead, a renewal commission is commensurate with an initial commission if the two commissions are reasonably proportionate to the respective contract values (e.g., both are 2% of the amounts invoiced to customers).
• This means that you can only recognize revenue for services and products delivered, even if you receive payment upfront.
• To that end, we have identified the following insights that SaaS providers may find helpful related to revenue recognition along the customer lifecycle.

Let’s assume that a customer has opted for the annual Pro Plan priced at $12000 per annum starting from January. This step enlists all the considerations that have to be taken while establishing the transaction price. Unbilled revenue is revenue that is recognized but is not yet billable to the customer due to billing schedules or certain billing milestones noted in a contract. Unbilled Revenue is treated as an asset (a receivable) until the customer is able to be billed. Revenue recognition is important for SaaS businesses because the amount of revenue that may be earned in a given period may not relate to the amount billed or cash collected. If the revenue was deferred, then the deferred revenue account will be cleared as well.