5 Step Process of Revenue Recognition Model: Things to Know

Revenue is the most critical indicator of how the company performs, but complicated contracts and flexible buying choices can make it very difficult to control revenue.

The moment cash arrives from a customer in your bank account, it can be very tempting to refresh your sales line with all that sweet, sweet cash in your accounts immediately.

But cash isn't sales and it may be disastrous for your company to treat them the same. You may get cash up front but you're not getting money until you receive it. Before then, it's a liability — money your client will apply for back at any point if you don't offer the service. If you spent their money but did not deliver their service, it will spell the end of your Saas Metrics quickly.

This is the concept of revenue recognition software and for every SaaS founder to understand it is absolutely critical.

Recognition of new revenue model

The Contract Revenue Guidelines for Customers establish a 5-phase process for the reporting of contract revenue.

1.       Identify a Customer contract(s)

A defined contract is fairly simple. It's essentially a two-party agreement or more that creates obligations and rights that can be enforced when necessary. ASC 606 Guidelines refer to a customer contract which meets certain requirements in the Guidelines. ASC 606 software also allows for defined contract adjustments transparency criteria.

2.       Identify contractual compliance obligations

Contracts are then agreed to offer the customer listed in the contract a defined good or service. If the good or service is sufficiently different from each other, contract promises are handled separately. ASC 606 specifies what separates a good or a service from the other.

3.       Determine price of transaction

This step is fairly straightforward in that it defines the price to be paid to an entity after that entity delivers the good or service promised under the contract. As noted in the contract, the price may be a set amount, but it may also include other variables or come in a different form. The price can also adjust depending on results, whether the money's time value. Typically this is the case where a significant financial investment is required.

4.       Allocate the transaction price to the performance obligations in the contract

Once an obligation is met, the entity gives the agreed transaction price. This price may be based on individual selling prices as determined by the service or good defined in the contract. If that selling price is not visible, then the entity will have to estimate what it is. Prices for transactions do not always have to match the standalone price for sale. Sometimes the contract will dictate the offer of a discount along with any other variables chosen. Requirements in ASC 606 detail when these variables may be allocated to obligations by the entity.

5.       Recognize revenue when (or as) the entity satisfies a performance obligation

The Entity acknowledges that revenue and transfers to a client the good or service defined in the contract after a performance obligation has been fulfilled. Hence, that customer retains control over that good or service. The cumulative amount of the revenue is the amount already specified as decided until met by the output obligation. In order to fulfill a performance requirement, it may take several forms, either at a particular time or for some duration. In general, the transfer of the goods occurs first, while the transfer of a service typically occurs later. In cases where an obligation is fulfilled over a period of time, the entity will choose a suitable means of measuring progress on when the obligation is completed.

Naturally, the ASC 606 Implementation is more than the above. The guidelines also provide guidance on how sales should be reported with a number of specifications. The aim is to help the organization with detailed information about revenues and cash flows arising from the contracts it has with clients.