When we talk about implementing subscription billing and other complex or usage-based billing models, we focus on the parts of the quote-to-cash process that involve the customer—from billing methods, to the usage and rating process, to invoicing and payments, and finally collections.

For companies selling subscription services that are delivered over time, it is as important to understand how revenue should be reported in financial statements that may need to be audited by public accountants. Revenue recognition, the process used to determine the amount of revenue to be reported, is regulated in the US by Generally Accepted Accounting Principles (GAAP) and internationally by International Financial Reporting Standards (IFRS).

The general principle is that revenue should be recognized as it is earned — not when the invoice is issued or when payment is collected. A spreadsheet is sufficient to calculate revenue recognition when selling low volume subscriptions or non-subscription products where revenue is earned as soon as the product is delivered. When high volume subscription and usage-based services are sold, automated revenue recognition becomes more important.

And to make matters more complicated, revenue recognition is a highly regulated practice, requiring businesses to comply with regulatory standards issued in the US as Generally Accepted Accounting Principles (GAAP) and internationally as International Financial Reporting Standards (IFRS). In 2018, US GAAP began the process of conforming to the IFRS standards for revenue recognition under a set of rules referred to as ASC 606. By the end of 2021, all public and private companies should have converted to these new standards.

What Is ASC 606?

This set of rules, whose full name is ASC 606: Revenue from Contracts with Customers, offers a standardized model of how companies across most industries should recognize revenue. Fortunately, the rule still allows companies to work with auditors to support their specific pricing models. After all, because revenue recognition requirements have traditionally been so varied and inflexible, even correctly reported revenue under the previous rules has often fallen short of representing a company's financial activity fairly.

We dive deeper into ASC 606 in this blog post. The core principle to emphasize is that companies must recognize a contract's total transaction price as obligations are fulfilled to the customer, in an amount per obligation proportionate to the relative market value of the goods and services that comprise those obligations.

The 5-Step Revenue Recognition Framework

These guidelines involve five steps to help companies make judgments about how to recognize revenue most accurately:

Identify the contract with the customer

A contract, in this context, is defined in the usual way: an enforceable agreement outlining rights and obligations between two or more parties. If a contract does not exist, or if an agreement doesn't technically qualify as a contract, revenue recognition is not regulated by these rules.

Identify the performance obligations in the contract

The second step is about identifying when goods and services are expected to be delivered to a customer. Generally, goods and services are part of the same performance obligation if they must be delivered together in order to be useful to the customer. Defining performance obligations and the goods and services assigned to them is fairly subjective and will vary based on an individual company’s offerings. both those outlined explicitly in the contract and those a customer might expect due to expectations set during previous engagements. Several issues, including warranties, nonrefundable upfront fees, rights of return, and others, may affect the evaluation of performance obligations.

Determine the overall transaction price for the contract

The overall transaction price sounds relatively straightforward—the amount of money a company expects to receive in exchange for the goods and services provided to the customer. However, warranties, rights of return, and other non-cash considerations, as well as financing arrangements may need to be included in the transaction price. Instead of just talking about the money a company expects to receive under a contract, we are concerned with the total consideration to be received.

Allocate the transaction price to the performance obligations

This is where the money is in this regulation, pun totally intended. The rule calls for the allocation of the transaction price to the performance obligations based on the relative Standalone Selling Price of the goods and services sold. ASC 606 offers a variety of methods for estimating standalone prices.

Recognize revenue when as performance obligations are satisfied

Finally, revenue is recognized as performance obligations are satisfied. ASC 606 allows for all the traditional revenue recognition methods such as onetime, straight line, percentage of completion, etc. ASC 606 includes guidance on determining when “control” of a product or service has been transferred to a customer, whether an obligation is satisfied over time, and other variables that could affect this final step of the process.

Keeping Your Business Compliant

There's a lot to digest regarding ASC 606 compliance. Still, the biggest takeaway is that these regulations raise the stakes on automated revenue recognition, as compliance failures could lead to significant financial consequences. As such, many companies have had to reevaluate their billing technology to implement systems that allow for efficient, accurate, and compliant revenue recognition practices on various billing models.

There are plenty of companies out there offering out-of-the-box software solutions that claim to be ASC 606 compliant, but with most complex billing scenarios, it's not as easy as a one-size-fits-all approach. The real question in evaluating a revenue recognition solution is whether the software is flexible enough to be tailored to a company’s specific revenue recognition criteria, empowering them to perform at scale. The Gotransverse platform is designed with that kind of flexibility in mind, and we take pride in helping our clients ease the burden of compliance with the latest revenue standards. Learn more about our revenue recognition engine here, or schedule a demo here to see it today!