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Revenue recognition plays an important role in business accounting. It’s a generally accepted accounting principle (GAAP) that deals with how and when a business should recognize its revenue.
And it only gets complicated with custom and mixed pricing plans for B2B SaaS. This makes recognizing revenue a challenging process.
So, how do you get it right for your SaaS business?
That’s where revenue recognition scenarios and rules like IFRS 15 and ASC 606 come into play. They give you a framework to work with.
Let’s understand all about it in detail.
Revenue Recognition Scenarios
First things first—let’s figure out the various scenarios of revenue recognition.
1. Immediately on Receiving Payment
In this method, the revenue is recognized as soon as you receive the payment. It’s typically best suited for one-time purchases like selling a software solution.
2. After Payment is Received
This method is most commonly used in SaaS and it recognizes the revenue as the service is delivered. For instance, if you’ve sold an annual subscription, you’ll divide the amount by 12 and recognize each part every month.
3. Before Payment is Received
You can also recognize the revenue before you receive the payment. It’s one of the key concepts of accrual accounting where you recognize the revenue when you perform the service or sell the product, even though you may receive the payment for it later.
Revenue Recognition Standards
Now that you know about how revenue is recognized, let’s understand the two main standards dealing with revenue recognition.
IFRS (International Financial Reporting Standards) 15
It’s an international accounting standard that outlines how companies record revenue. IFRS 15 came into effect from 1st January 2018 and impacts how businesses report their revenues in financial statements.
Businesses operating in countries that use IFRS have to follow this standard to remain compliant.
ASC (Accounting Standards Codification) 606
Like IFRS 15, ASC 606 deals with revenue recognition for companies in the United States. It was issued by the Financial Accounting Standards Board (FASB) and came into effect for public companies from 15th December 2017 and private ones from 15th December 2018. SaaS companies need to follow ASC 606 standards to remain compliant.
Additionally, US businesses that operate internationally would be required to use both ASC 606 and IFRS 15 to remain compliant in multiple jurisdictions.
How to Recognize Revenue Under IFRS 15 and ASC 606
While ASC 606 and IFRS 15 have some minute differences, the process of recognizing revenue is very similar.
Here are the steps involved.
1. Identify Contract with the Customer
To start, there are a few criteria that should be met when your SaaS enters into a contract with a client.
- Both parties have approved the contract in any mode (writing, verbally, or otherwise) and are committed to abide by its terms.
- Rights of both the parties are identified and recognized by each.
- The SaaS business and client have identified and agreed to the payment terms.
- Contract must have commercial substance.
- Your SaaS will collect payment from the client for the services it offers.
2. Identify Performance Obligations
Next, you have to identify your performance obligations. These are essentially the promises your SaaS makes to transfer services to the client for the given time period.
You have to specify each performance obligation that can be transferred individually to the client. A performance obligation can be:
- Single service or its bundle that’s distinctly identifiable
- A series of services that are similar and have the same pattern for transfer
Additionally, your performance obligation should satisfy the below criteria:
- The client should be able to benefit from your services on their own or in combination with other resources they have available.
- Your promise to transfer the service to the client is distinctly identifiable from the other promises in the contract.
3. Determine the Transaction Price (TP)
This stage involves setting a price for the transaction between your SaaS and the client. The transaction price here would be the cash and non-cash compensation that your SaaS will receive for providing the services to your client.
While setting the transaction price, you should also account for any discounts, pricing customizations, and other adjustments
An important thing to note here is that the transaction price isn’t always the price set in the contract. Instead, it’s the expectation of what you’ll receive. If it’s variable, you’d have to estimate it by either using the expected value or the most likely amount.
4. Allocate Transaction Price to Performance Obligations
In this step, you have to allocate your transaction price your entity expects to each performance obligation. This is particularly important for SaaS businesses as the performance obligations are spaced out over a time period.
In such a case, your transaction price has to be deferred and allocated correctly. This could, however, be challenging and that’s why you should consider using a platform like Younium.
And if you have multiple performance obligations, the key is to find your standalone selling price (SSP). For that, you can use one of the following methods:
- Adjusted Market Assessment Approach
- Expected Cost Plus Margin Approach
- Residual Approach
5. Recognize Revenue On Satisfying Each Performance Obligation
The last step in revenue recognition through IFRS 15 and ASC 606 is to recognize your revenue as you satisfy each performance obligation.
For a SaaS business, you would have to do this over time as the performance obligation will be satisfied during the entire course of the subscription.
So, if you’ve signed up a client for an annual subscription, you would have to attribute each month’s payment to the respective monthly accounting period. You must not recognize the entire lump sum when it’s received.
FAQsQ1. What is the ASC 606 revenue recognition rule?
ASC 606 is a revenue recognition standard that includes a set of rules and guidelines businesses in the United States have to follow to report their revenues.Q2. What are the 5 steps of revenue recognition under ASC 606?
The 5 steps of revenue recognition under ASC 606 are:
- Identify contract with customer
- Identify performance obligations
- Determine transaction price
- Allocate transaction price to performance obligations
- Recognize revenue on satisfying each performance obligation
IFRS 15 is the section that deals with revenue recognition. The guidelines state that the business will recognize revenue based on the transfer of the performance obligation to the client and should reflect that.Q4. Does ASC 606 apply to IFRS?
No, ASC 606 is a standard that’s specific to the United States, while IFRS 15 applies to companies in countries that use the IFRS accounting standards.Q5. How does ASC 606 affect revenue?
ASC 606 affects how you report your revenue in financial statements as you have to follow the accrual revenue recognition principle.
In the complex world of revenue recognition for B2B SaaS companies, having a reliable subscription management solution like Younium is invaluable. These solutions offer a seamless way to track and manage subscriptions, ensuring compliance with revenue recognition standards such as IFRS 15 and ASC 606. They assist in automating the allocation of revenue to performance obligations and streamline the entire process.
Younium, for example, simplifies revenue recognition and ensures that your SaaS business remains compliant with these critical accounting standards. By leveraging Younium B2B SaaS companies can confidently navigate the complexities of revenue recognition, forecasting revenue and focusing on their core business while adhering to the latest accounting regulations. Younium's subscription management capabilities make it easier than ever for businesses to manage revenue recognition efficiently.
That wraps up our step-by-step guide to revenue recognition for IFRS 15 and ASC 606. Follow these steps to ensure your SaaS remains compliant with these standards.
Finally, make sure you use the right software solutions that help you simplify revenue recognition. Get a demo of Younium to see how it can elevate your subscription management.