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.
SaaSOptics’ GAAP-compliant subscription revenue reports have supported thousands of closes, audits, and raises.
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.
Get Rev Rec Right.
Revenue Recognition Concepts – Video Overview
Revenue recognition for SaaS and subscription businesses, Parts I and II
What is Revenue Recognition? (video transcript from top of page)
Hi, I’m Claytone. I’m one of the founders here at SAS optics. And this is ask Claytone anything video series where I answering
your most pressing questions about SaaS, financials, and metrics. Welcome back today. We’re talking about revenue recognition
or rev rec for short what’s rev rec? I’m glad you asked revenue recognition or rev rec is an accounting principle. And in your business, a process whereby you claim the revenues from the contracts you’ve sold as you’ve earned, you know, typical SaaS is this, this has done monthly over the term of the contract as the services performed. Conceptually, that seems easy enough, but rather it can get complicated for SaaS businesses because frankly, Tory agencies and standards boards, such as the financial accounting standards board also known as the FASBI have created some very thorough and important rules and guidelines for companies to follow even B2B SaaS, the revenue recognition portion of your SaaS. Accounting can get more complex still. When you do things like bundled services and support together with your subscriptions, commit to delivery of any sort of nonstandard functions or capabilities and do common things in sales negotiated deals like offer discounts on some or all of the elements of your contract. These can give rise to the need, to do carve-outs revenue, reallocations determined, implicit and explicit performance obligations, and determining standalone selling prices. Most recently, the FASBI set forth new standards for revenue recognition outlined under the ASC 606 requirements, which is also known as the first 15 internationally set to take effect in 2021, 606 is here for all of us, but depending on the way you do business, these new standards may have a minimal or major impact on you. You will need a CPA to make sure you’re compliant but software like SaaS audits can help too. It’s one of the things we do best. So contact us, and see if we can help. So there you have it beauties that’s revenue recognition or rev rec. Join us next time for another ask Claytone Anything.
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