Companies who use a subscription model to bill customers must follow specific revenue recognition rules. Subscription revenue accounting requires revenue to be calculated differently than traditional businesses. It’s based on the interval at which the supplier has met its implicit and explicit performance obligations and at which customers pay open invoices.
Updated subscription revenue accounting requirements were put into place in 2019. These requirements are often referred to as ASC 606 revenue recognition requirements and they are broken down into five steps.
These five steps are:
• Step 1: Identify the contract with a customer
• Step 2: Identify the performance obligations in the contract
• Step 3: Determine the transaction price
• Step 4: Allocate the transaction price
• Step 5: Recognize revenue when or as the entity satisfies a performance obligation
Common ASC 606 Definition Questions:
What is a performance obligation?
- Your promised goods and services:
- The right to use your software to accomplish a task (ex: payroll, expenses, social, etc)
- Performance Obligations are explicitly stated in your Contract OR something not stated but common in your business processes
- So you really need to know what promises were stated
- And what your business practices are (what anyone in the company will do for the customer)
How is a performance obligation different for subscription revenue recognition?
- The idea is you look at each distinct performance obligation not only to identify them but to see how they individually and together help you keep and grow the customer relationship.
Growing Software as a Service (SaaS) companies and companies generating revenue from contracts with customers, such as professional services organizations (PSO), often see an almost exponential increase in complexity in meeting revenue recognition requirements as their customer count increases. Contract amendments, upsells, downsells, renewals, and other customer demands quickly outgrow spreadsheets and manual processes, leading many companies to automate revenue recognition as part of their overall subscription revenue accounting process.