In the past few years, revenue recognition has become a hot topic. You might hear of it, and you know you need to follow it, but you aren’t exactly sure what it is… No worry, this article will help you understand the basic concepts of revenue recognition, along with its principles and rules for recognizing revenue.
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What is Revenue Recognition Principle?
Considering the release of Accounting Standards Codification (ASC) 606 in 2014 released by the Financial Accounting Standards Board (FASB) as a part of Generally Accepted Accounting Principles (GAAP) in the U.S., the new regulation standardized how companies should recognize revenue.
In other words, revenue recognition is an accounting principle that recognizes revenue by several acceptable methods during the reporting period. In each period of revenue recognition, all associated costs must be measured against revenue. Companies usually use the revenue recognition principle to record revenue data due to straightforward use.
In addition to that, due to its size, revenue is one of the most critical line items in the financial reports of most companies. Essentially, that’s the company’s amount from providing goods to customers, and it happens when we sell a product/service. Apparently, it may seem simple, but a performance obligation being considered fulfilled can vary based on various factors. Therefore, there are different ways companies decide whether a transaction does or doesn’t qualify as revenue.
Proper revenue recognition is a must. The revenue recognition principle is a key factor of accrual-basis accounting. This accounting principle recognizes the revenue once it is considered earned, unlike the alternative cash-basis accounting, which recognizes revenue when cash is received.
A 5-step approach for recognizing revenue – ASC 606
ASC 606 could have a massive impact on any business. Why? Because it identifies the specific conditions in which revenue is being recognized and determines how to account for it.
To accurately recognize revenue, companies must pay attention to the five steps and interpret them correctly. Luckily, ASC 606 has described this approach, which is quite simple to understand.
5-step approach:
- Identify the contract(s) with a customer
- Identify the performance obligations (promises) in the contract
- Determine the transaction price
- Allocate the transaction price to the performance obligations in the contract
- Recognize revenue when (or as) the reporting organization satisfies a performance obligation
There are different recommendations for each step. The idea behind it is if companies are following the process, they should gain a clear image of their actual revenue generation. Under ASC 606 companies can recognize revenue when goods and services are transferred to the customer.
Revenue Recognition in SaaS
Revenue recognition is an accounting method for contracts and upfront payments, situations where the customer pays in full before actually receiving the whole service. For instance, if you sell a SaaS product, you might have a customer pay upfront for an annual contract, though they receive the services of that subscription on a monthly basis. Basically, you get the money before earning it. Isn’t that cool?
Revenue recognition dictates that although you received this payment in one chunk, you can earn it only in pieces. You recognize the revenue as you provide the service and fulfill the obligations laid out in the contract.
For companies of all sizes, revenue recognition is an important concept to understand completely. It is critical for businesses to look strategically at revenue recognition policies to ensure they are compliant now and conducive to their future financing and expansion goals. To that end, advanced billing and revenue management software will help you schedule, calculate and present revenue on your financial statements accurately, automating revenue forecasting, allocation, and recognition.
What to do next?
In conclusion, accounting for revenue could be hard sometimes. However, we believe that automatization is the key. Changes to accounting for revenue are increasingly approaching. That’s why accounting/billing platforms are becoming a necessity for more and more businesses. It’s a fact that an effective accounting system can simplify even the most difficult financial process, such as revenue recognition.
As soon as your business policies introduce complex accounting, you will start looking for a platform to help you manage that. If you are looking for an accounting solution that will automatically help you track your revenue, better look at Tridens Monetization billing software.
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