This article is co-written by Peush Patel and Jagan Reddy and reposted from financialexecutives.org. Peush Patel is the Product Management Director at Zuora. Jagan Reddy co-founded Leeyo Software in 2009 and has served as President and CEO since inception.
The new guidance will cause all companies to rethink how they compute their revenue and whether it’s time to automate the process. For subscription-based businesses the challenges are further magnified.
The rise of new business models including the subscription-based economy is making proper revenue recognition more complex than ever. The shift from short-term, one-time isolated transactions to long-term, recurring customer relationships drives a host of new challenges including new data requirements, pricing structures, price billing models and accounting needs.
Now the Financial Accounting Board (FASB) and International Accounting Standards Board (IASB) have issued new guidance in the form of ASC 606/IFRS 15 that must be implemented by the 2017 fiscal reporting period. The new guidance will cause all companies to rethink how they compute their revenue and whether it’s time to automate the process. For subscription-based businesses the challenges are further magnified.
Below are the top five changes in the new standards that will affect subscription-based businesses:
1. The definition of a performance obligation (POB)
In the new standard, a POB is defined as the distinct goods or services within the realm of a contract. These are substantially the same, with the same pattern of transfer to the customer so that the POB may be satisfied at a specific point in time. Under current GAAP, one must identify if an element in an arrangement has standalone value. That element may or may not be the same as the POB in the new guidance. The answer may impact both the timing and amount of revenue to be recognized.
2. Usage-based pricing
Within the existing guidance, the price must be fixed or determinable. It can be allocated to each unit of accounting. When a customer is charged based on the usage or consumption, it is generally not allocated until realized, which may result in revenue being recorded on the entire arrangement. Under new guidance, you are expected to estimate the variable consideration and allocate the transaction price across the entire performance obligation. Revenue is recognized as each performance obligation is satisfied.
3. Subscription amendments
The accounting treatment for amendments in the new standard is prescriptive in nature, as opposed to the lack of clear guidelines for amendments in the current standards.
4. Costs to obtain a contract
It may be common practice today to expense certain costs, such as sales commissions for example, to acquire a contract. Under the new guidance, these costs must be capitalized.
5. One-time upfront charges
If you were to have a selling price, such revenue would typically be recognized over the life of the initial subscription. Yet under the new guidance, if a customer has a multi-level right to renew such a contract following the initial subscription period, then you may be required to recognize that revenue well beyond the initial subscription contract duration and/or renewal period as well.
With the complexity of ASC 606 and the deadline looming, companies should consider transitioning to an automated solution. These products can be integrated either natively through an API or through middleware to ensure that subscription-based businesses are properly accounting for revenue to comply with ASC 606 and IFRS 15.