For subscription-based businesses (and for traditional businesses that are beginning to sell products and services by subscription), revenue recognition has always brought unique challenges. As more businesses move to on-demand models, they’re being forced to look at revenues and expenses differently. No longer are sales viewed as one-time transactions, with revenue recognized when the customer takes delivery of a product or is invoiced for a service.
Subscription-based relationships complicate the task of recognizing revenue because they usually involve contractual relationships with customers on a regular and ongoing basis, sometimes lasting several years. For many software-as-a-service (SaaS) companies, this means measuring recurring revenue using non-GAAP metrics like annual contract value (ACV), annual recurring revenue (ARR) and total contract value (TCV).
This is just the beginning. Changes in accounting standards, which have been in the works for several years, will impact how organizations recognize revenue received via contracts with customers. The changes result from a decision by the U.S.-based Financial Accounting Standards Board (FASB) and its Brussels-based counterpart, the International Accounting Standards Board (IASB), to align their respective accounting standards, including the guidelines for revenue recognition. After a series of delays and roadmap changes on both sides, the new framework is set to go into effect for annual reporting periods starting after Dec. 15, 2017 for publicly traded companies, and a year later for privately held companies.
Prudent CFOs know better than to think those deadlines are far off in the future. They know that if you have any recurring revenue aspect to your business, you’ll need to get to work now to understand what these new changes mean for your financial planning, budgeting and forecasting processes. The most prepared companies, in fact, will already have those new processes in place before they’re required.
Recognizing recurring, contract-based revenue can be complex, particularly under the “harmonized” reporting standard. For instance, the new, customer-focused principle of revenue recognition concentrates on when the customer gains control over key aspects of a good or service. This can occur in phases over time, yet it’s up to the company to define when customers receive sufficient levels of service in exchange for consideration as agreed to in the contract. In addition, subscription sales contracts often incorporate formal or implied performance obligations. Under the merged standard, each of those milestones may represent a fraction of revenue to be recognized over time. And a reclassification in how expenses are matched to revenues could mean that costs previously recognized over the life of the customer contract may now need to be expensed at the contract’s start.
These are just some of the considerations that subscription-based companies must face as they make sense of these new accounting guidelines. In future blogs, we’ll look at the five steps of recognizing contract-based revenue, how modern tools connect revenue recognition with FP&A, and real-world examples of how this all might work.