Revenue Recognition for SaaS and/or Term Subscription Businesses
Revenue Recognition, commonly referred to as rev rec or revenue rec, is an accounting principle and a process for reporting revenues by recognizing the monetary value of a transaction or contract over a period of time as the revenue is “earned.” The method of allocation and the period of time are determined by rules, guidelines, and findings from organizations such the Financial Accounting Standards Board (FASB) and the SEC.
Revenue recognition is an issue that arises when delivering solutions to the marketplace using term subscriptions or perpetual licenses. It is recommended that all companies with term subscriptions, private or public, understand the important concepts and adopt a process for financial reporting based on revenue recognition as early as practical.
Conceptually, revenue recognition is easy to understand. For example, a $120,000 annual subscription fee might simply be recognized as $10,000 per month during the subscription period.
In practice, revenue recognition can be extremely complicated as standards boards and regulatory agencies have established complex rules and guidelines to rein in on aggressive revenue recognition actions taken to inflate actual corporate performance of public companies. Revenue recognition can become extremely complex when you bundle services or support with your subscription, commit to delivery of any non-standard functions/capabilities, or when you agree to some customer acceptance criteria (“out clauses”).
The topic is too broad, too technical, and too complicated to cover in any depth in the SaaSpedia. There are hundreds and hundreds of pages written on the topic, mainly for CPAs who typically arbitrate the topic and issues for you.
Preparing for ASC 606?
That said, here are a few extremely important revenue recognition bullets:
- Valuation of your company is impacted by, if not solely determined by, your historic revenue performance.
- If a customer license (via perpetual or subscription license) includes any software modification or customization, revenue recognition will be impacted.
- If you bundle professional services with your customer license (via perpetual or subscription license), revenue recognition is likely impacted.
- If you bundle support with your customer license (via perpetual or subscription license), revenue recognition can be impacted.
- Simply separating contract components (referred to as “contract elements”) doesn’t necessarily affect an “unbundling.”
- How your contract is worded can make a HUGE difference in how revenue is recognized.
- The recognition of revenue for elements within a single contract may not match the line items in that contract. In other words, the allocation of the total revenue of a contract across the different elements within the contract may be made in a manner that is different from your contract under the concept of VSOE – Vendor Specific Objective Evidence.
- How an investor or strategic acquirer calculates your revenue may differ dramatically from how you report revenue. In the end, how they calculate revenue is the only thing that matters!
- There are complex rules and guidelines that determine how revenue is to be recognized, however, there remains a dimension of subjectivity in determining how exactly your company will recognize your revenue. In the end, your auditor will have the final say.
- The more you know about revenue recognition, the better your record keeping, the more you adhere to contracts and terms that simplify revenue recognition, and the more consistency you achieve in your customer licensees, the lower the risk of a disconnect between your revenue recognition methods and results and those of a strategic investor or acquirer.
How do you project revenues in a SaaS or subscription business?
Revenue Recognition Concepts – Video Overview
Revenue recognition for SaaS and subscription businesses, Parts I and II
Preparing for ASC 606?
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