Converting to subscription-based business — or adding subscriptions — is one of the foremost trends in the enterprise market. However, it does bring regulatory challenges that can catch finance teams off guard.
When the ASC 606 standard was announced, many companies knew it would transform how they account for everything from commission expenses and sales comp plans to revenue and contracts. The ultimate goal of this new accounting standard was simple enough. Give investors a structured view of a business’s performance and health that is more easily comparable across multiple industries.
However, in the world of accounting and finance, implementing ASC 606 (or IFRS 15 for companies outside the US) has been a particularly thorny challenge for subscription-based businesses – especially if they employ commissioned-based sales pros working under complex compensation plans.
Further complicating the matter is the fact that subscription-based businesses also typically rely on complex contracts that embody long-term relationships rather than one-time, short-term transactions. That’s because customers add and change subscriptions and products change. As the business changes and grows, accounting complexities, like co-terminating add-ons and mixed element arrangements, can quickly overwhelm the people and processes you have in place. Here’s how:
- Greater data volumes – When you’re amortizing expenses, like commissions and support, for subscription businesses, the amount of data you’ll face will make it virtually impossible to manage amortization manually. For instance, a detailed amortization schedule could be required for every person who gets compensated on every performance obligation tied to every contract a business engages in. We’re talking exponentially more data.
- Slower period closings – Since you need to capitalize and amortize expenses, as well as recognize deferred revenue, it will be a major impediment to timely period closings without additional resources. Organizations using manual solutions might require an additional 1.5 resources just to support the expense-accounting process changes tied to the period close.
- Consolidating customer transactions – ASC 606 requires organizations to house all customer transactions under a single contract. But software and technology companies often use several contracts (subscriptions) for a single customer, so this can be overwhelming. Ideally, your accounting system should be 'contract aware' so that contract management capabilities are built-in.
While it can feel overwhelming at times,we offer three recommendations to help you improve your ASC 606 compliance posture:
1. Understand your contract types
Start with an in-depth contract review. Analyze all standard contract clauses across on-premise and cloud-based subscription revenue streams. Involve people from across product, professional services, and sales operations and document your revenue recognition decisions and policies in detail for future reference.
This will help you see all of your interdependent software performance obligations across all contracts and determine when to start taking revenue. You might want to look at both average customer lifecycle and average product lifecycle to determine how long you can keep expenses on your books.
2. Make smart bundling decisions
The concept of multiple performance obligations (MPO) is one of the more complicated requirements of ASC 606. An MPO occurs when you bundle things like professional services, support, software delivery, and other performance agreements that could be sold independently. Lay MPO groundwork first by determining the standalone fair value pricing for each SKU. Then, it’s a relatively straightforward process to use a full price list to allocate revenue appropriately across your bundles. It’s a good idea to get your auditors’ input during this early stage. They can give an early sign-off based on comparable work they’ve done with companies with similar revenue scenarios.
3. Prepare for special cases
In many companies, ASC 606 actually adds a little discipline to the sales process and a little structure to revenue accounting practices. But be ready for a range of advanced requirements, including expense amortization over variable periods, variable consideration pricing, contract modifications for revenue schedules or cancellations, and more.
As for estimating variable consideration, it’s only required in rare cases. Typically, you invoice a customer for work completed – you don't have to think about variable consideration. You simply recognize the amount that’s invoiced, even if there's no way of knowing what the amount will be up front. But for sales-based or usage-based pricing, you only recognize revenue when the sales or usage occurs (when the actual performance obligation is satisfied).
Bringing subscriptions, compliance and technology together
As your number of contracts expands, trying to handle ASC 606 demands manually grows into a mountain of overwhelming tasks. Thankfully, modern financial technology can help. If companies have the right software, they can split revenue recognition from billing, amortize expenses across performance obligation delivery, and combine appropriate obligations for concise customer billing. Companies can then automate many of the complexities brought on by ASC 606 and stay GAAP compliant.
To learn more about streamlining your implementation of ASC 606, check out this handy Sage Intacct ASC 606 Resource Page.