The widespread use of ASC 606 as a compliance standard can confuse business leaders who are not familiar with what the standard entails. Properly adopting the standard affects revenue operations leaders because it has an influence on the way revenue metrics are calculated. The good news is that the standard defines five steps for businesses to follow to help them achieve accurate and correct revenue recognition. The bad news is that the steps can seem vague to the uninitiated.
Changing regulations can trigger cultural shifts within business teams. Business leaders must therefore understand how accounting standards will change the way their organization conducts accounting activities. Here’s what you need to know about the five steps for recognizing revenue and how they apply to the software industry.
What is ASC 606?
ASC 606 refers to an accounting standard introduced by the Financial Accounting Standards Board (FASB) in May 2014. Prior to its introduction, each industry used a unique standard to recognize revenue. ASC 606 was designed to be industry neutral and can therefore be used as an accounting standard for businesses that operate in multiple or across different domains. Public and private American businesses have been required to adopt the standard since December 2017 and December 2018 respectively.
5 Important Steps for Software Companies to Accurately Recognize Revenue
Step 1 – Identify the Contract
A contract establishes that two parties intend to make a transaction, who they are, what that transaction will entail, and the details of payment. It should clearly outline the obligation each party has regarding the delivery of goods or services.
Step 2 – Identify Performance Obligations
For software companies that use a subscription model, this involves understanding what service the customer wants, how much they will pay, and how long their access to the service will persist for that price. This step also delineates whether services are sold as a bundle or will be invoiced separately.
Step 3 – Determine the Transaction Price
Next, finance teams must determine the transaction price for each contract. SaaS businesses can sometimes have different price tiers, promotions, concessions, and product combinations. This step helps finance teams finalize and formalize the transaction price for the individual contract and product combination. It must reflect both cash and non-cash considerations. For software businesses, this can include free value-added services or discounted trial periods.
Step 4 – Allocate the Transaction Price
While goods-centric businesses typically recognize revenue upon delivery of a product, SaaS businesses receive recurring revenue tied to continuous service or product delivery. SaaS companies can choose to split their total contract value across the delivery of the service in accordance with the performance obligations set out previously.
Step 5 – Recognize Revenue
Once the performance obligations are met and payment is made, SaaS companies can then recognize the revenue for that period. These steps help software businesses standardize their accounting practices across different customer types, product offerings, and payment structures.
What the Widespread Adoption of ASC 606 Means for SaaS Revenue Teams
RevOps and Finance Teams Must Allocate Sufficient Time and Resources to Review All Contracts and Know How ASC 606 Applies to All Contracts
The extent to which businesses must adjust existing accounting processes differs for each organization. ASC 606 aims to standardize accounting standards across industries and some businesses would naturally have processes that are already aligned with its requirements. It is important that financial teams are aware of the amount of work they must do to become compliant with the new standard. These evaluations can require a significant amount of time and resources. Each company contract must be reviewed for finance teams to fully understand the implications of adopting the ASC 606 standard.
Finance Leaders Should Be Aware of the Additional Disclosures Required by the New Standard
While ASC 606 requires non-compliant businesses to adjust their revenue recognition processes in many ways, disclosures are the most common point of confusion for finance teams. The new standard demands additional disclosures that finance teams might not have had to make under previous industry-specific standards.
The authorities regularly audit accounting documents to ensure compliance with the latest standards and regulations. Businesses are usually given an opportunity to resolve any discrepancies or respond to questions from the authorities, typically presented in comment letters. These comment letters are then made publicly available. A review of comment letters related to ASC 606 related audits found disclosures to be an area where businesses are regularly lacking. Finance teams must remain knowledgeable about the disclosures required under this standard and ensure that they make them in the appropriate manner.
Revenue and Finance Leadership Teams Must Design and Execute a Transition Plan to Ensure Continuous ASC 606 Compliance
Like any other form of organizational change, adapting to a new accounting standard demands structure and planning. Finance teams always have established methods, processes, and standards that they rely on. Adapting to a new standard requires them to reevaluate each of these processes and modify them for the new standard. This can sometimes result in lapses in compliance during periods of transition. These lapses can then leave unresolved issues and discrepancies in financial statements. Leadership teams that remain involved in the design and execution of a transition plan can personally ensure that these issues are addressed early in the transition process.
ASC 606 was designed to bring consistency and clarity to a previously fragmented regulatory environment, which benefits both regulators and businesses that operate within its jurisdiction. However, like any other regulation, it requires financial teams to evaluate and adjust their existing financial processes to ensure compliance with the new standard.
If you would like to learn how many RevOps partner with finance teams to manage revenue recognition while maintaining compliance with a regularly evolving regulatory landscape, schedule a demo with us today. And if you found this article helpful, help spread the word by sharing it on social media!