How can you recognize revenue for SaaS?

Revenue recognition is a crucial aspect of corporate accounting, especially for software as a service (SaaS) companies. SaaS is a business model where customers pay a recurring fee to access a software application over the internet, rather than buying a license to install it on their own devices. SaaS companies face unique challenges and opportunities when it comes to recognizing revenue, as they have to account for different types of contracts, performance obligations, and customer behavior. In this article, we will explain how you can recognize revenue for SaaS using the five-step model prescribed by the accounting standards.

1 Identify the contract

The first step is to identify the contract with the customer, which is an agreement that creates enforceable rights and obligations for both parties. A contract can be written, oral, or implied by customary business practices, but it must meet certain criteria to be valid. For example, the contract must have commercial substance, the parties must approve it and commit to perform their obligations, the payment terms must be identifiable, and the collectability of the consideration must be probable.

Add your perspective

Tomi Akinwale ACCA, ACA, ACTI, B.TECH, FMVA, AAT.

Tax | Deloitte | Financial Reporting | Unlocking Your Career Potential
Report contribution
Seek professional advice: An accountant or financial expert can assist with ensuring compliance with accounting standards and implementing accurate revenue recognition practices for your specific SaaS offering.

Like
Karan Chopra

CA | Risk Management, Business Consulting | 14k+
Report contribution
Generally, any agreement that creates legally enforceable rights and obligations meets the definition of a contract. The contract could be a subscription agreement or a licensing arrangement. Further there are some conditions, all to be met for account as contract: >>The parties to the contract have approved the contract >>The entity can identify each party's rights >>The entity can identify the payment terms >>The contract has commercial substance >>It is probable that the entity will collect substantially all of the consideration entitled in exchange of services.

Like

2 Identify the performance obligations

The second step is to identify the performance obligations in the contract, which are the distinct goods or services that the SaaS company promises to deliver to the customer. A good or service is distinct if the customer can benefit from it on its own or together with other resources that are readily available, and if the SaaS company can transfer it to the customer separately from other promises in the contract. For example, a SaaS company may offer a basic subscription plan that includes access to the software, cloud storage, and customer support, which are distinct performance obligations.

Add your perspective

Karan Chopra

CA | Risk Management, Business Consulting | 14k+
Report contribution
Performance obligations are the unit of account and form the basis for how and when revenue is recognized. Identifying the performance obligations requires judgment in some situations to determine whether multiple promised goods or services in a contract should be accounted for separately or as a group. In the context of SaaS, this may include providing access to the software, support services, and updates. Clearly delineating these obligations is essential for proper revenue recognition.

Like

3 Determine the transaction price

The third step is to determine the transaction price, which is the amount of consideration that the SaaS company expects to receive in exchange for transferring the goods or services to the customer. The transaction price may vary depending on various factors, such as discounts, incentives, refunds, penalties, or variable fees. The SaaS company must estimate the transaction price using either the expected value or the most likely amount method, depending on which one better predicts the amount of consideration. The SaaS company must also adjust the transaction price for the time value of money if there is a significant financing component in the contract.

Add your perspective

Karan Chopra

CA | Risk Management, Business Consulting | 14k+
Report contribution
The transaction price is the amount of consideration expected in exchange for fulfilling the performance obligations. The transaction price includes only those amounts to which the reporting entity has rights under the present contract. In SaaS, this is often the subscription fee. However, it can also involve variable considerations like usage-based fees or discounts. You must take into account consideration that is variable, noncash consideration, and amounts payable to a customer to determine the transaction price. Assessment to be performed of whether a significant financing component exists in arrangements with customers or not.

Like

4 Allocate the transaction price

The fourth step is to allocate the transaction price to the performance obligations in the contract, based on their relative stand-alone selling prices. The stand-alone selling price is the price at which the SaaS company would sell a good or service separately to a customer. The SaaS company must use observable evidence to determine the stand-alone selling prices, such as market prices, list prices, or historical data. If there is no observable evidence, the SaaS company must use an estimation technique, such as the adjusted market assessment approach, the expected cost plus margin approach, or the residual approach.

Add your perspective

Karan Chopra

CA | Risk Management, Business Consulting | 14k+
(edited)
Report contribution
If the contract involves multiple performance obligations, the transaction price must be allocated to each. This requires determining the standalone selling prices of each obligation. For SaaS, this may involve estimating the standalone selling prices for various components. The transaction price in an arrangement must be allocated to each separate performance obligation so that revenue is recorded at the right time and in the right amounts

Like

5 Recognize revenue

The fifth and final step is to recognize revenue when (or as) the SaaS company satisfies a performance obligation by transferring a good or service to the customer. A good or service is transferred when the customer obtains control of it, which means that the customer has the ability to direct the use and obtain the benefits of the good or service. The SaaS company must determine whether it satisfies a performance obligation at a point in time or over time, depending on the nature of the contract and the good or service. For example, a SaaS company may recognize revenue over time for providing access to the software, as the customer consumes the benefits of the service throughout the subscription period.

Add your perspective

Karan Chopra

CA | Risk Management, Business Consulting | 14k+
Report contribution
Revenue recognition occurs when a performance obligation is satisfied. In the SaaS context, this typically happens over time as the customer gains access to and utilizes the software. Recognizing revenue accurately over the subscription period aligns with the principle of reflecting the transfer of control to the customer. Recognize revenue over time if any of the following criteria are met: >>The customer simultaneously receives and consumes the benefits of the SaaS service. >>The SaaS service creates or enhances an asset controlled by the customer. >>The SaaS service does not have an alternative use, and the entity has an enforceable right to payment for performance completed to date

Like

6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

Add your perspective

How can you recognize revenue for SaaS?

1

2

3

4

5

6

1 Identify the contract

2 Identify the performance obligations

3 Determine the transaction price

4 Allocate the transaction price

5 Recognize revenue

6 Here’s what else to consider

Corporate Accounting

Rate this article

Thanks for your feedback

More articles on Corporate Accounting

More relevant reading