Overcoming SAAS Revenue Recognition Accounting Challenges
What is revenue recognition, and why is it important?
Virtually everyone is in business to make money. No matter the company’s size or the industry in which they operate, there must be revenue and a method for accounting for that revenue. In the order-to-cash process, the payment and cash application process at the end of any engagement is critical to the company’s well-being. A component of the cash application process is revenue recognition or a generally accepted accounting principle (GAAP) that recognizes conditions when revenue is reported and defines how accounting should manage it.
Revenue recognition is critical to any organization working to keep accurate accounting records. For example, when a product or service is sold to a customer, the revenue is recognized upon delivery. SaaS revenue recognition accounting, while straightforward, can become more complex when there are multiple components associated with delivering goods or services to a client resulting in multiple billing cycles.
Stages of Revenue Recognition for SaaS Companies
There are two types and five stages of revenue recognition for SaaS companies.
Type 1 – Cash Basis. The cash basis type of revenue recognition realizes revenue when received or when a customer makes payment. Traditionally helpful for small enterprises, a cash basis form of revenue recognition allows the business to declare money as it enters and exits the operation, enabling them to avoid taxes on money that does not sit within an account.
Type 2 – Accrual. The accrual type of revenue recognition accounts for both revenue and expenses by the seller while not yet billed to the customer.
The five stages of revenue recognition are identified as follows:
1. Identify the contract with the customer. The initial stage outlines the criteria for forming the contract and identifies the obligations for both parties.
2. Identify performance obligations. The next stage describes the performance requirements and obligations – or deliverables – that act as benchmarks for how and when revenue will be recognized.
3. Determine the transaction price. The transaction price stage of revenue recognition lists all revenue to be accounted for, whether fixed or variable, in the SaaS revenue recognition process. With a variable component, sellers should estimate the revenue they are entitled to receive.
4. Allocate the transaction price. Each performance obligation within the contract must have a stand-alone value. If a stand-alone price cannot easily be determined for each obligation, an estimated selling price using adjusted market assessment, expected cost plus margin, or the residual method is acceptable.
5. Recognize revenue. When performance obligations are satisfied, such as the customer has possession or use of the service, revenue can be recognized. It’s important to remember that revenue can be recognized either over time or at once, with each method being mutually exclusive.
SaaS Revenue Recognition Accounting Challenges
The five-stage revenue recognition process, while straightforward, does present some accounting challenges. Businesses should be aware of possible complications when implementing this process, including the following:
When a subscription model exists
Subscription models are the norm for SaaS companies. Revenue recognition is not difficult when selling an annual subscription, as the revenue is realized upon delivery . Challenges arise when the customer cancels the subscription in the middle of the term and issues a refund. Refunds complicate how revenue is recognized.
When switching from monthly to annual
Recognizing monthly revenue is relatively easy during a monthly SaaS engagement. When an arrangement converts from a monthly to annual payment, it creates difficulty in determining when the revenue should be recognized, especially if done during an odd time of the fiscal year. When this occurs, the business must define how that revenue will be recognized, whether it will be deferred, or whether it will be prorated.
When manually tracking revenue from invoices
Manually tracking revenue from invoices to spreadsheets can be time-consuming and lead to errors and incorrect data. For companies growing their business, even the slightest mistake can have a ripple effect throughout the organization, especially when not using a reliable ERP software solution.
When not using proper SaaS software
Because subscription models are commonplace for SaaS companies, using management software that correctly tracks key metrics associated with a subscription business model is essential. Such software can track key metrics such as unbilled accrued revenue, deferred revenue, and recognizable revenue.
When customers don’t pay
Sometimes, customers don’t pay. When extensive accounts receivable and collections practices fail to produce results, the SaaS business must write off revenue, either partially or in full, as bad debt. Because the unrealized revenue is no longer collectible, the company must determine precisely how to report this.
When bundling services and features
Often, SaaS companies bundle other services with their primary offering. In addition, customers may request customization, requiring additional resources and increasing the cost of the service. The company must separate the costs and revenue obligations associated with each additional service when this occurs. This method was described in stage 4 of the revenue recognition process when companies allocate the transaction price.
Simplifying Revenue Recognition for SaaS Companies
While there are challenges to revenue recognition for SaaS companies, there are also ways to simplify it. Software specifically created for SaaS organizations provides the tools necessary to master revenue recognition. NetSuite enables businesses to automate revenue scheduling, allocation, and reporting easily. The solution creates recognition rules for each product or service category offered by a SaaS company.
NetSuite Revenue Recognition also recognizes revenue based on predefined milestones or schedules. Furthermore, it offers these capabilities while following ASC 606, IFRS15, and other accounting standards.
Steer Through Revenue Recognitions with FRC
Rapid expansion puts pressure on excel-reliant revenue processes and inefficient systems prevent seamless transactions. Instead of simply “throwing more bodies” at the issue, automating revenue and billing procedures can alleviate the possibilities for errors and enhance efficiencies.
Revenue recognition can pose significant challenges to SaaS companies. At FRC, we offer agile software solutions to tackle your high-tech company’s greatest needs. Contact us today to speak with one of our NetSuite ERP implementation specialists to simplify your revenue recognition challenges.