The new ASC 606 accounting laws have organizations across the globe scrambling to restructure their revenue recognition processes. These recent changes affect the way your accounting team accrues commission expenses, requires adjustments to sales compensation plans, evaluates revenue, and handles contracts. Organizations that sell subscription software need to be particularly careful to ensure correct adoption.
The current ASC 606 five-step process is as follows:
- Step One: Identify Contract
- Step Two: Identify & Separate Performance Obligations
- Step Three: Determine Transaction Price
- Step Four: Allocate Transaction Price
- Step Five: Recognize Revenue
There are many aspects of SaaS arrangements to consider: subscription services, implementation services, fees, service agreements, and consulting services. And with ASC 606 and the expected accounting treatment, currently it’s pretty simple – all software revenue is recognized in tiers over the contract period.
So, if you have a client with a three-year subscription, and their annual fees are $7,000 for the first year, $9,000 for the second year and $11,000 for the third year, currently, the revenue is recognized evenly over the contract (in this case $9,000) But, with the existence of contingent revenue caps, at year one it caps the revenue at the $7,000 actually earned. The remaining $2,000 of continent revenue is not recognized under the current accounting guidance.
With the ASC 606 changes, the contingent revenue cap is no longer applicable. It would change year one to $7,000 with a contract asset of $2,000. Contract assets are money that is earned but cannot yet invoice for.
Here are three ways ASC 606 is challenging for the SaaS industry:
- Increase in data volume – A highly-overlooked implication of amortizing commissions for SaaS businesses is the explosive growth of data volumes. The amount of data that the new standard introduces make manual management of commissions nearly impossible.
- Consistent month-end close processes are a challenge – Because organizations need to capitalize and amortize their commissions to comply with the standard, it is difficult to meet already aggressive month-end close deadlines without additional resources.
- Changes of any kind affect sales value – This has got to be the most frustrating part – Any change to a customer characteristic can affect the value of an associated sales event. This means under the new standards, companies are no longer only reporting on the state of accounts receivable, but also on the state of the companies as well.
Recently, CPA Practice Advisor reported that nearly 70% of the respondents were not prepared for or correctly handling the ASC 606 changes.
This content was originally posted here.
Recommended Next Read
Boost your revenue forecasting: tips and tricks for SaaS CFOs