Deferred revenue in SaaS

When is deferred revenue recognised?

IFRS 15 calls it a contract liability: the company's obligation to provide services for which the customer has already paid, or for which an amount of consideration is due. If a non-cancellable annual subscription makes an invoice due on 1 January, the company records a receivable and a contract liability on that date, even if the customer has not yet paid, because its right to the money is unconditional. If the customer can still cancel without penalty before the service starts, the company has no unconditional right, so it records the contract liability only when the cash arrives, as IFRS 15's Illustrative Example 38 shows. Invoices sent before they are due are usually not recorded at all. "Deferred revenue" is the label most SaaS companies use; IFRS 15 allows other descriptions as long as the nature of the balance is clear.

Deferred revenue: a year's roll-forward

A SaaS company starts the year with US$ 400 thousand of deferred revenue. During the year it bills 1,500 thousand of annual subscriptions in advance and recognises 1,420 thousand of revenue as it provides access.

All of the opening balance becomes revenue during the year, because annual subscriptions billed last year run out within twelve months; IFRS 15 requires this amount to be disclosed. The closing balance of 480 thousand is the unexpired part of subscriptions billed this year. Billings, a metric many SaaS companies report, equal revenue plus the increase in deferred revenue: 1,420 + 80 = 1,500 thousand. Because billings depend on invoicing terms, a move from annual to monthly billing lowers billings and deferred revenue without changing revenue.

What are remaining performance obligations?

IFRS 15 also requires disclosure of the transaction price allocated to performance obligations not yet satisfied, and when the company expects to recognise it. For a SaaS company, this includes deferred revenue and contracted amounts not yet billed, such as years two and three of a non-cancellable three-year deal billed annually. In the example, remaining performance obligations are 2,100 thousand: the 480 thousand of deferred revenue plus 1,620 thousand of future billings under non-cancellable contracts, of which 1,300 thousand is expected to be recognised in the next twelve months. Contracts with an original expected duration of a year or less can be left out, as can fees recognised under the right to invoice practical expedient, if the company says so. A contract the customer can cancel contributes only its enforceable period. Investors often compare the twelve-month figure with ARR.

How is deferred revenue presented?

Each contract is presented as a single net contract asset or contract liability; balances on different contracts are not offset. Deferred revenue for services more than twelve months ahead, from multi-year prepayments, is shown as non-current. Contract liabilities are kept separate from refund liabilities, which are amounts expected to be paid back to customers, and from receivables. When revenue runs ahead of billing, for example with free months at the start of a committed deal or price escalators, the contract shows a contract asset instead. Companies explain significant changes in contract balances, such as acquisitions or changes in billing terms.

Does a multi-year prepayment contain financing?

If a customer pays for three years upfront, the gap between payment and service is more than a year, so the company assesses whether the contract has a significant financing component. If it does, the contract liability accretes interest: revenue ends up higher than the cash received and an interest expense is recognised. No adjustment is needed when the gap is a year or less, under a practical expedient, or when the advance payment exists for reasons other than financing. Companies look at whether the price differs from what the customer would pay annually and at prevailing interest rates; a meaningful discount for paying upfront usually signals financing.

How is acquired deferred revenue measured?

Under IFRS 3, an acquirer recognises the contract liabilities it assumes at fair value at the acquisition date. For a SaaS subscription, fair value is usually based on the cost of providing the remaining service plus a reasonable margin on that effort, not on what the customer paid. Suppose the target has 600 thousand of deferred revenue and expects to spend 300 thousand providing the remaining service, with a 20% margin.

The reduction, often called a deferred revenue haircut, means post-acquisition revenue under IFRS is lower than the target would have reported, and many companies add it back in adjusted revenue measures. Under US GAAP, ASU 2021-08 requires the acquirer to measure acquired contract assets and liabilities under ASC 606, as if it had originated the contracts, so there is usually no haircut. See purchase price allocation.

What about tax on deferred revenue?

Some tax systems tax advance payments when they are received, or after a short deferral, while the accounts defer them. That creates a deductible temporary difference and, if recoverable, a deferred tax asset under IAS 12. Where tax follows the accounting revenue, there is no difference. See deferred tax under IAS 12.

How does US GAAP differ?

Very little for the balance itself: ASC 606 uses the same contract liability concept, the same netting by contract and similar disclosures of remaining performance obligations, with an extra optional exemption for some variable consideration. The main difference is the acquisition measurement above. See SaaS revenue recognition and SaaS accounting.

This guide is general information. It is not tax or legal advice for your situation.