Revenue Recognition Challenges for SaaS Companies
“Recognizing revenue for a SaaS business can get quite complex because the way that the revenue is reported in the books can often be different than the way that it looks in the contract or looks at an invoice. In a world of accounting, the revenue needs to be aligned with the way the product or service is delivered. And in the case of SaaS, that’s typically along the lifecycle of a contract.
Revenue Recognition for SaaS Contracts
So let’s take, for example, a simple vanilla SaaS contract. Say you were billing the customer $1,000 per month or $12,000 a year. You might invoice that for $12,000 upfront and collect the cash up front. But that doesn’t mean you get to recognize all the revenue right away. You’ve got to recognize it in chunks throughout the life of the contract.
And that’s just a simple example. Most SaaS companies don’t just have vanilla contracts with fixed fees. They might have variable fees that are tied to the customer’s consumption of the product. They might have professional services engagements that are built on a time materials or a fixed fee basis. They might have training offerings, premium customer support, app stores, advertising and on and on and on.
And each one of those different revenue streams might be recognized differently. Some might be recognized upfront, some might be recognized ratably across the contract, some might be front-loaded, some might be back-loaded, some might be recognized at different milestones along the way.
But you’ve got to get this stuff right because sales on the income statement is one of the most highly visible metrics to investors.
Revenue Recognition Fraud
It’s also one of the ones that’s most prone to fraud and there are dozens of case studies of software companies that have doctored up the contracts or fake invoices or recognized revenue too late or recognized revenue too early. One of the most famous examples is back in the dot com era, when a company called Computer Associates became famous for having a 35-day month. So they would add a few days on to the end of their quarter in order to get a few more sales in and make their numbers for the quarter look a little better.
ASC 606 Revenue Recognition for Customer Contracts
About ten years ago, the accounting boards got together and rewrote the standards for how companies recognize revenue. And when a company makes a policy change for how they account for revenue can actually have a pretty big impact.
Revenue Recognition Halts Apple Trading
So back in 2010, Apple actually changed the way it recognized revenue for iPhones. They were originally recognizing over the length of a 24 month contract. But they changed and shifted most of it to recognize up front, and when they announced earnings, it had such a big impact that the Nasdaq actually halted trading their stock for a couple of hours until the frenzy stopped. This stuff gets really complex and there’s different opinions on how to do it. The guides from the Big Four on how to recognize revenue for software are some 700 pages in length.
But you’ve got to get this stuff right because if you don’t, it can delay IPOs, it can delay mergers and acquisitions, it can delay fundraising rounds. It can even land criminal penalties for CEO and CFO if you do it wrong.”
Learn more about Ordway’s Revenue Recognition Software.
