5 Key Steps of ASC 606 for SaaS Companies
The guidelines for revenue recognition outlined under the ASC 606 standard affects all SaaS business and can be broken down into a five-step process.
- Published by Jeff Sant
on Wednesday, April 14, 2021
What Is ASC 606?
ASC 606 is the new revenue recognition standard that affects all businesses that enter into contracts with customers to transfer goods or services – public, private and nonprofit entities.
ASC 606 was first issued in 2014 by the Federal Accounting Standards Board and the International Accounting Standards Board. Over the years, the boards instituted specific guidelines for both public and private companies. 5 Key Steps of ASC 606 for SaaS Companies
The guidelines for revenue recognition outlined under the ASC 606 standard can be broken down into a five-step process.
ASC 606 follows a clear path of identifying a contract, identifying the performance obligations of the contract, determining the contract price, allocating the performance obligations, and recognizing the income as the obligation is satisfied. Let’s take an in-depth look at each of these steps.
1. Identify the Contract(s) with a Customer
Under this step, a signed agreement must be approved and committed to by the business and the customer. The contract also must be of commercial substance, outline the products or services the business will offer, and discuss the payment terms.
While this seems straight-forward, certain modifications, such as multiple contracts treated as a single contract, free-trials, handling upgrades, and add-ons, can complicate this.
2. Identify the Performance Obligations in the Contract
Performance obligation simply means that the business will transfer the goods or services to the customer. In this step, the performance obligation, whether distinct or separable, needs to be identified.
A distinct performance obligation refers to any situation where the customer can benefit from the goods or services. On the other hand, a separable performance obligation refers to any situation where the goods or services can be separately identifiable and transferred independently from other promises in the contract.
Understanding and tracking each performance obligation is crucial since revenue cannot be properly recognized until the performance obligation is met.
3. Determine the Transaction Price
The transaction price refers to the payment the business expects to receive in exchange for transferring promised goods or services to a customer. The transaction price also includes variable considerations, non-cash considerations, considerations payable to the customer, and the existence of significant financing components.
4. Allocate the Transaction Price to the Performance Obligations in the Contract
The allocation process begins with the concept of the stand-alone selling price, the price that each product and service would be sold for if it were sold on its own.
This price is determined through the analysis of historical data. It’s normally estimated by management but ultimately, it’s critical that outside auditors are in agreement with the stand-alone selling price for each product and service.
This is not as simple as identifying the multiple performance obligations included in the contract and recognizing income based on the contract price, since oftentimes performance obligations are bundled and discounted during negotiations.
Once this is determined, the total contract price is allocated to the individual products and services.
5. Recognize Revenue When (Or As) the Entity Satisfies a Performance
Once a performance obligation has been met, the entity recognizes that revenue and transfers the good or service defined in the contract to the customer.
Satisfying a performance obligation can happen in a number of ways. The first is pro-rata over the term of the contract, the second is point-in-time (e.g. delivery of software or equipment), or lastly, on a proportional performance basis (e.g. as professional services are delivered).
There’s more to ASC 606 than the above. Now that you have an overview of the new revenue recognition standards, how can you implement and apply them to your business? We answer that and more in our latest White Paper: "The Ultimate Guide to ASC 6060 Compliance."
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