It’s the 21st century, and the digital economy is king. More importantly, it has fueled the rise of the subscription economy. If the statistics by Zuora Research are anything to go by, this trend is hardly surprising. Today’s consumers want flexibility and variety: think Netflix, Amazon, and Spotify. Everyone wants choices.
Too busy to shop? You can have your groceries delivered to you. Want to learn a foreign language? Sign up for classes at hundreds of reputable online schools. How about movies? If you want choices, it’s Amazon Prime or Netflix hands down. The digitization of business shows no signs of stopping. In fact, Gartner predicts that more than 80% of software providers will switch to subscription-based business models by 2020.
So, what does this have to do with ASC 606 compliance? Plenty: subscription-based businesses will be most affected by the new law. So, it’s imperative that private (and public) companies take immediate steps to comply with the new law.
The 5 Important Steps In Complying With ASC 606
- Determine the terms of the contract with the customer. Contractual obligations must be clearly stated i.e. payment terms and transfer of control clearly defined. Here, there is a further complexity for SaaS or cloud-based businesses: they must decide whether contractual upgrades or downgrades constitute modifications or new agreements.
- Identify the performance obligations in the contract. These obligations must be accounted for separately. Goods and services are considered distinct if customers can benefit from them separately.
- Determine the transaction price. This is simply the amount the consumer agrees to pay in exchange for goods and services. The complexity arises, however, when businesses offer recurring discounts, rebates, or incentives. In this step, variable considerations must be included in the transaction price.
- Allocate the transaction price. In this step, you’ll take the transaction price in #3 and allocate them to the separate performance obligations.
- Recognize revenue when the performance obligation has been satisfied. Under ASC606, subscription companies must decide whether they will recognize revenue up-front or over time.
Why Companies Must Start The Process Now
#1 Compliance May Involve Many Complexities
Many industries will be affected by the new law, including telecommunications, construction, information technology, and automotive. Businesses must decide how they will handle warranties, usage-based pricing, and multiple contractual variables. These considerations certainly complicate the subscription billing process. Additionally, revenue from unrealized (whether full or partial) performance obligations must be reported as “deferred.”
Another complication arises when sales teams earn commissions for obtaining contracts. Under the new law, businesses can no longer expense sales commissions; they must be amortized (a form of capitalization).
#2 Businesses Must Handle Larger Data Volumes Under The Law
According to Ventana Research, 68% of businesses use spreadsheets exclusively to manage their sales compensation and commission process. However, an overwhelming 61% admit that spreadsheets are inefficient and prone to errors.
In light of this, manual processes will prove inadequate in handling the large data volumes under the new law. In fact, commission amortization is a data-intensive two-step process. First, commission costs must be determined for each “distinct” performance obligation. Here, commissions earned by every member of a sales team must be accounted for.
Second, the commission cost must be recognized with the related revenue. This is to ensure that the commission amortization and revenue recognition schedules match.
#3 Revenue Recognition Errors Can Result In Decreased Investor Confidence
For SaaS businesses, the new law further complicates their relationship with investors. Venture capitalists may now dispense with using backlog disclosures as a primary metric of financial performance. Due to the variables in a SaaS contract, they may choose to focus on ASC 606 ARR (Annual Recurring Revenue) disclosures instead. So, revenue recognition errors and/or non-compliance with ASC 606 are likely to reflect poorly on businesses.
#4 Non-compliance Can Delay IPOs
According to ASC 606, private companies and emerging growth companies have until January 2019 to comply with the law. However, public companies that delay compliance may find themselves at a disadvantage when it comes to their IPO (Initial Public Offering) launches. In terms of market viability, the grace period for emerging companies is illusory at best. It is far better to comply, sooner rather than later.
For you, the process need not be an overwhelming one. With Sage Intacct, you get automated efficiency and thorough compliance with ASC 606, all without the pain of spreadsheet management. So, contact us: you have nothing to lose and everything to gain from simplified perfection.
Are You ASC 606 Ready?
Explore more on the guidelines to ASC 606 readiness and how to business risks through compliance in our special edition eBook:
6 Rules for ASC 606 Readiness.