The GAAP rules for accounting haven’t changed very much over the years, despite the many advances in technology which change the dynamics of accounting. Specifically, the industry of SaaS software has nuances and complex details in accounting.
Since companies are now accepting payments on a monthly subscription, the GAAP principles were in need of change on when to recognize revenue and will be taking affect shortly in the new year. SaaS companies are unique in that they don’t accept payments the way a typical manufacturing or services company would. Instead of accepting payments once the goods or services are delivered, there are many more factors at play, such as implementation and training on the software.
The International Standards Board and Financial Accounting Standards Board created new requirements for subscription based companies to recognize revenue. For a public company, the new standards apply beginning after December 15th 2017. For private companies, the new revenue standards begin after December 15th 2018.
Since SaaS companies have a longer delivery time than most companies, due to implementation and training. For example, Company A may pay a company for Company B’s software. However, Company A needs a modification made that takes Company B a month to develop. Then, Company B needs to install the software and integrate it to Company A’s other business software, which takes another month. Finally, Company B spends 2 months training Company A on how to use the new software. Although the software was delivered, it took 4 months to complete the final transaction.
There are five steps for recognizing revenue under the new standards:
- Identify the contract with a customer
- Identify the performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price to the performance obligations in the contract
- Recognize revenue as the reporting organization satisfies a performance obligation
According to Chuck Mulford, Invesco chair and professor of accounting at the Scheller College of Business, Georgia Institute of Technology and explained by Nicholas Stern, managing editor of Business Credit magazine, the new regulations will better help SaaS companies understand pricing, what they’re doing for their customers and what each piece of their work is worth. The new standard will allow businesses to be more careful in recognizing when the revenue is earned.
“By doing that, they’ll better understand a sale and have a more consistent view of what needs to be collected,” Mulford explained.