New Revenue Recognition Rules for SaaS (ASC 606)

We recently hosted a webinar on ASC 606 with SaaSOptics and CPA Steve Sehy. This blog post is meant to summarize some key points from the presentation relative to timing and magnitude.

Timing: Private SaaS businesses need to adopt these guidelines in 2019 with a look-back to 2018. There are a few implications of this:

1. If you have one-year contracts or longer, the contracts being signed now will impact your future financials, so understanding the new guidelines and making adjustments to your contracts (if prudent) is a “right now” activity.
2. Public companies are adopting these guidelines in 2018, so we will all get to see how they are interpreting the rules before needing to do so ourselves.

Revenue Impact: The new revenue standards represent a significant transition away from software-specific, rules-driven, revenue recognition to principle-based guidance.

The new standards require, with some exceptions, the allocation of the transaction price to various performance obligations such as access to the software, upgrades, support, training, and implementation services. For most SaaS companies, the majority of these obligations will be satisfied over time and the revenue can be re-combined and recognized as it is today.

However, performance obligations that are not simply satisfied with the passage of time will cause changes in revenue recognition. Some of the likely issues will be driven by implementation services and support.

Support: if a certain number of hours are sold, then the revenue will need to be recognized as those hours are consumed, and not simply over time.
Implementation: If your company currently recognizes implementation revenue separately, and on an “as deliver” basis, this is consistent with the performance obligation and would not change. However, if your company “includes” implementation services in the overall price, you now need to break it out separately, estimate its value, and recognize it as it is performed.

Other: There are also new guidelines on training, upgrades, multi-year pricing, etc., and while these revenue streams are generally smaller and less impacted, the effect on your company depends on your arrangement with your customer.

Beyond the allocation of the transaction price, the timing of revenue recognition may change for many companies. The guidelines place more emphasis on when the customer actually has a useable product, and less emphasis on the words in the contract or when it was signed. This will have GAAP implications for implementations crossing year-end, and also impact key metrics like MRR and churn.

Costs: Unfortunately, the new guidelines may require the capitalization of some incremental selling (commissions) and implementation costs. As was the requirement to capitalize software development costs, this is a bad idea for a whole host of reasons. We recommend keeping a close eye on this provision in the public reporting companies. There is not a lot that needs to be done now to deal with this, and we think (and hope) this provision will moderate over time.

Conclusion: Private SaaS companies cannot ignore ASC 606, and some work needs to be done now to educate yourself on potential areas of impact and possible contract changes. There may be simple changes in the businesses that can reduce the impact and simplify reporting going forward. Even if you don’t foresee significant impacts, we recommend keeping an eye on continued developments in this area and watching your public counterparts as they adopt the standards. A bibliography of resources is included in the original webinar presentation.

Thanks: The principals at SaaS Capital are not CPAs, and we relied heavily on the guidance of CPAs Steve Sehy and Kari Minton for this blog post. Both are talented accountants who are very familiar with SaaS and generous with their time.

SaaS Capital

SaaS Capital® pioneered alternative lending to SaaS. Since 2007 we have spoken to thousands of companies, reviewed hundreds of financials, and funded 100+ companies. We can make quick decisions. The typical time from first “hello” to funding is just 5 weeks. Learn more about our philosophy.