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SaaS Revenue Recognition Concepts Guide

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Just as with Revenue Recognition – an accounting principle/ process for reporting revenue through the monetary value recognition of a transaction/ contract over a given period of time as it is “earned” – SaaS revenue recognition closely follows the principle, but tailored to cloud computing. The SEC and the FASB are some of the organizations that determine the findings, rules and guidelines that govern the method of allocation and the time period, among other things.

Revenue recognition is one of the major issues that often arise when attempting to deliver solutions to the marketplace term subscriptions. Both private and public companies with term subscriptions should understand the key concepts and adopt the most appropriate process for financial reporting, according to FASB revenue recognition, and as early as possible.

Key Considerations

The revenue recognition concept is rather easy to comprehend. For instance, a $24,000 annual subscription fee could just be recognized as $2,000 per month during the entire subscription period. But in practice, it can be very complicated as regulatory agencies and standards boards have set up strict rules and guidelines to monitor aggressive revenue recognition actions aimed at inflating actual performance of corporate and public entities. Revenue recognition can be complicated when you bundle support or services with your subscription, agree to a customer acceptance criterion, or commit to delivery non-standard capabilities/functions.

SaaS vendors face many challenges in developing suitable revenue recognition accounting policy, as the existing GAAPs do not make adequate provisions for SaaS. Customers access SaaS on a subscription basis, any additional implementation, consultation, or training services are offered in bundled arrangements, and this further complicates the revenue recognition concept.

SaaS Revenue Recognition Concepts

In the process of developing accounting policies for revenue recognition for SaaS arrangements, vendors may have to look at the guidance in SAB Topic 13.A, particularly SAB Topic 13.A.3 (f), which covers upfront fees, as well as ASC 605-25, which constitutes the multiple element revenue recognition guidance.

The ASC 985-605 software recognition guidance is inapplicable to SaaS dealings, as customers often lack the ability to possess the software in the hosting period. Upfront fees for services that have no standalone value are deferred and recognized in the period they are earned, often over the entire customer relationship period, and may extend beyond the initial term of the contract. Usage-based fees cannot be fixed or determinable because of SAB Topic 13.A, and arrangements with usage-based fees within the TPA 5100.76 scope are recognized as earned.

There are certain accounting challenges and issues that entities may have to pay attention to when developing their revenue recognition policies for SaaS sales. Under a SaaS arrangement, customer setup can be established quickly and billing done on a subscription basis for the entire contract duration.

Since cloud computing is a rather new and rapidly evolving industry, several questions on how to account for SaaS dealings often arise. This is because existing accounting standards fail to adequately provide for revenue recognition guidelines that apply to SaaS arrangements. This means that vendors have to consider various guidelines when developing their revenue recognition accounting policy to provide for SaaS arrangements. They have to consider factors such as the price structure of the arrangement and any deliverables applicable.

Determining which US GAAP to Apply in SaaS Revenue Recognition

According to ASC 985-605-55-121, a number of criteria must be met for any software element in a hosted environment to be subject to the ASC 985-605 software revenue recognition guidance:

  • The customers may exercise their contractual rights to possess the software whenever they deem fit within the hosting duration without significant penalty.
  • The customers may consider running the software on their own hardware or contracting a third party to host the software.

A SaaS setup typically offers hosted access to a software application based on a subscription fee. While some aspects of the software may be customized or configured at the inception of the SaaS arrangement, customers may not possess the software at any given time during the entire hosting period. So, SaaS vendors often find the ASC 985-605 software revenue recognition guidance inapplicable. And in the absence of appropriate guidance, these vendors consider SAB Topic 13.A when developing relevant policies for their SaaS arrangements. According to SAB Topic 13.

A revenue may be recognized only after:

  • Concrete evidence supporting an arrangement exists
  • Services have been rendered or delivered
  • The seller’s price presented to the buyer is determinable (or fixed)
  • Reasonable assurance of collectibility

The subscription arrangement terms and conditions entered into by customers, as part of the arrangement, is the evidence that an arrangement typically exists. In most cases, the price of the arrangement is fixed, charged periodically, and collectibility reasonably assured because of upfront fee payment. But since the service delivery occurs during the period of the arrangement, revenue recognition usually occur over the service duration, or over the customer relationship period (if there are certain upfront fees).

Before SaaS vendors can recognize revenue, they have to consider their hosting arrangements terms and conditions and evaluate the SAB Topic 13.A revenue recognition criteria, application of which may bring up complications, especially in a case whereby the consideration is variable or has doubtful collectibility.

Accounting for Non-refundable Upfront Fees

Under SaaS arrangements, services provided to customers are often billed to them as non-refundable upfront fees, which are often charged for any additional services that are delivered as part of a multiple-element SaaS arrangement. If this is the case, then vendors need to first assess, if any, the standalone value of each deliverable, accounted for as a different and separate accounting unit under ASC 605-25. While considerations allocated to deliverables deemed to possess standalone value are recognized over the delivery period, deliverables that have no standalone value have to be combined with others to form one unit of accounting.

Conclusion

The non-existence of US GAAP specific to SaaS prompts vendors to use their intuition and exercise significant judgment in determining various estimates that can be applied in developing revenue recognition policy, for instance, when considering relative selling prices, estimated customer relationship period, and standalone value. In SaaS revenue recognition, vendors should adequately document the factors considered in drawing a solid conclusion, as well as provide robust disclosures explaining their financial statements where necessary.

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Published at DZone with permission of Omri Erel, DZone MVB. See the original article here.

Opinions expressed by DZone contributors are their own.

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