An important part of the daily business for subscription-based services is keeping track and having a clear overview of their monthly and annual recurring revenue. However, companies offering subscription-based services, such as software-as-a-service (SaaS) companies, must recognize revenue a little differently than other organizations.
For example, a customer purchasing a pair of shoes from a shoe store pays upfront and immediately receives the product in full. Meanwhile, a corporate client may pay a monthly fee of $399 for HR analytics software from a SaaS company.
This means that the company is charging the client in advance for a service that hasn’t fully been delivered at the time of purchase. If the client were to cancel 2 weeks in, they wouldn’t have received the full value of their money spent.
This is why subscription-based companies cannot immediately recognize all income as revenue. However, there’s been inconsistency between industries around recognizing the difference between income and revenue, which is why revenue requirements such as ASC 606 exist.
Despite the importance of ASC 606, there’s often a lot of uncertainty around it, particularly around its implementation and ensuring compliance. In this article, we’ll explain what revenue recognition and ASC 606 is, and why it matters for your business.
What is ASC 606 and Revenue Recognition?
ASC 606—which is short for Accounting Standards Codification (ASC) as Topic 606: Revenue From Contracts With Customers—is a revenue recognition standard in line with the generally accepted accounting principles (GAAP) in the U.S.
In fact, it’s been heralded as the biggest change to accounting standards in the last century.
ASC 606’s goal is to essentially standardize financial reporting within and across industries by stipulating that income can only be recognized as revenue when the product or service’s value is received by the consumer. The contract process is broken down into 5 steps according to ASC 606:
- Identifying the contract with the customer.
- Identifying the performance obligations in the contract.
- Determining the transaction price.
- Allocating the transaction price.
- Recognizing revenue when or while the entity completes the performance obligation.
Let’s visualize this using the earlier example of the HR analytics company:
Imagine the corporate client didn’t cancel their subscription but stayed on for a full month. Two weeks in, the company wouldn’t be able to recognize the full payment of $399 as earned revenue.
Instead, according to ASC 606, they can only recognize the delivered portion, or the first 14 days, as earned revenue. The rest of the income which is yet to be delivered would be seen as deferred revenue.
The Importance of ASC 606 (and Why Software is Recommend for Managing It)
While meeting ASC 606’s compliance standards will impact various policies and ways of working in organizations, from IT to HR, there are several reasons organizations should care about using revenue recognition software to be compliant with ASC 606.
It’s a legal requirement for businesses
As of 2018, all public and privately held businesses are expected to be ASC 606 compliant. As long as you’re a business that enters into a contract or sales agreement with your customers when exchanging goods and services, the ASC 606 framework applies to you, even if your business is not-for-profit.
This means there are virtually no exceptions, so it is necessary to ensure you’re compliant.
It provides financial visibility
ASC 606-compliant revenue recognition allows external parties such as shareholders, investors, or banks to have an accurate picture of revenue earned over a certain amount of time.
Subscription-based businesses often receive new subscriptions (or income streams) daily, and with the possibility for consumers to upgrade or downgrade services, revenue recognition quickly becomes a complex beast to manage.
Lack of standardization has led to gaps in comparability, revenue reporting inconsistencies, and poor disclosure requirements, all of which ASC 606 aims to mitigate. In short, complying with ASC 606 leads to increased and more consistent financial visibility.
It’s easier to identify refunds for cancellations
Industry data shows that SaaS companies have an average churn rate of around 10%, which can translate to processing a lot of complex refunds. Splitting income into realized and deferred revenue allows your organization to efficiently process cancellations and refunds.
Sidenote: How refunds are processed will depend on the contract between you and the customer.
To keep things simple, when customers cancel their subscription, many businesses will wait until the end of the billing cycle before officially canceling the account. This ensures the business fulfills the contract in full, so there’s no need to issue a refund.
For businesses that choose to cancel subscriptions right away and issue refunds for unused services, ASC 606 requires companies to only recognize the revenue for services that were delivered (i.e., non-refunded). The refunded portion must be credited as a “refund liability.”
In either case, funds that are considered are clearly recognized.
It offers increased business intelligence
If you use a revenue recognition platform, you’ll have a single source of truth from which you can access your data, giving you powerful end-to-end insights into the inner workings of your business.
As deferred income is not yet an asset, it’s easy to have an inaccurate view of your financial standing if you’re not compliant with the latest revenue recognition standards. Not only is this useful for better revenue and cash flow predictions, it can also be used for more accurate corporate tax calculations.
Although the initial transitory phase can require a thorough evaluation of existing contracts through either a full retrospective or modified retrospective approach, compliance with the latest revenue recognition standards will have significant long-term benefits for most organizations.
Complying with ASC 606 with Stax Bill
Applying the updated revenue calculation rules can be incredibly difficult for subscription-based companies. With contract modifications such as upgrades or downgrades, various revenue streams, proration of charges, and other tricky scenarios, accurate revenue recognition may prove to be difficult when done manually. That’s why most companies opt for using scalable revenue recognition software alongside their payment processing applications.
Our all-in-one subscription and billing platform Stax Bill is the only platform on the market that’s fully compliant with ASC 606 without adding on any extra software.
Based on the dual-entry accounting system, Stax Bill automatically breaks all charges into a debit transaction (for accounts receivable) and a credit transaction (as deferred revenue). By allowing companies to set up configurable rules for each subscription agreement, companies have full control over when and how revenue is recognized.
Our data models are flexible and scale alongside you as your company grows, no matter how complex your contracts or use cases are.
What’s more, Stax Bills integrates with leading ERP solutions so all data pertaining to revenue recognition are automatically synced to your ERP. This reduces manual entry, saving time for you and your team.
By automating the entire process in the back-end, customers can easily make changes to their subscription by themselves. Of course, all revenue calculations are adjusted in real-time based on any changes.
With one single source of truth that’s easy to implement, Stax Bill’s robust revenue recognition capabilities make complying with ASC 606 as streamlined as possible.
Wrapping up
The fear of the unknown shouldn’t stop subscription-based businesses from ensuring compliance with ASC 606’s revenue recognition standards. The latest GAAP accounting rules provide consistency in financial reporting and disclosure requirements, and have redefined how and when income is recognized as revenue.
To ensure full compliance without using invaluable resources and internal manpower, businesses can opt to use revenue recognition software to automate and streamline compliance.
As the only fully ASC 606 compliant subscription and billing platform, Stax Bill makes it easy to be compliant with the latest revenue recognition standards, while having an accurate end-to-end overview of both your income and revenue in real-time. Just like it should be.
We offer powerful API integrations for true flexibility and features to empower customers to make their own payments—all with transparent pricing.
