ASC 606 for SaaS and software companies

How is each SaaS revenue stream treated?

Why is subscription revenue recognized ratably?

A SaaS customer cannot take possession of the software; it receives access to it over the term. That is a stand-ready obligation satisfied over time, and a straight-line pattern usually depicts it best. If the customer could take the software and run it on its own servers without significant penalty, the arrangement would include a software license, recognized when control of the license passes.

Are implementation fees and setup fees separate performance obligations?

Only if the service is distinct. Implementation that configures the platform, migrates data or integrates systems may be distinct if other providers could perform it and the customer benefits from it with the subscription. Setup activities that only enable the company to provide the service, such as creating the customer's account, transfer nothing to the customer: the setup fee is an advance payment for the subscription and is recognized over the subscription period, or longer if the fee gives the customer a material right to renew without paying it again.

Example: a customer pays a $10,000 onboarding fee and $60,000 for a one-year subscription. If the onboarding is only account setup, $70,000 is recognized evenly over the year, about $5,833 a month. If it is a distinct implementation with a standalone selling price, the price is allocated between the two, as in the ASC 606 five-step model.

How are usage-based and tiered fees recognized?

Usage fees, such as charges per transaction, API call or gigabyte, are variable consideration. When they relate to a specific period of a series of distinct service periods, ASC 606 allows the variable amount to be allocated to the period in which the usage happens, so revenue is recognized as usage occurs. Volume tiers that reduce the price of future usage may be variable consideration or an option to be assessed for a material right.

What about multi-year contracts and upfront payments?

A three-year contract billed annually in advance is recognized ratably over the three years, with deferred revenue for each year billed but not yet earned. If a customer pays several years upfront, consider whether there is a significant financing component; the practical expedient lets companies ignore financing when the time between payment and performance is one year or less. Price increases built into later years are part of the transaction price and spread over the term only if they reflect a single obligation priced as a whole; otherwise each year's price is recognized in that year.

How are upgrades and additional users handled?

Adding users or upgrading mid-term is a contract modification. If the extra users are priced at their standalone selling price, they are treated as a separate contract. If they are discounted, the remaining services are usually accounted for prospectively, with the unrecognized price and the new consideration spread over the remaining term.

Common SaaS revenue recognition mistakes

• Recognizing setup fees upfront when the setup transfers nothing to the customer.
• Treating every implementation as distinct without evidence that others could perform it.
• Ignoring service level credits and refunds, which are variable consideration.
• Capitalizing commissions incorrectly; see ASC 340-40 contract costs.

To model a contract month by month, use the Revenue allocation calculator (Excel).

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