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Revenue recognition, explained

Revenue is recognized as you deliver what the customer is paying for, not when the invoice goes out or the cash lands.

Section
US GAAP
Mentioned in
14 pages
Illustration only. No real figures.

What it means

ASC 606 is the US GAAP standard for revenue, the money a company earns by selling to customers. The core idea is that you record revenue as you hand over what the customer bought, at the amount you expect to be paid. Sending the invoice doesn't create revenue, and neither does receiving the cash.

"Recognize" is accounting's word for putting an amount into the financial statements. Revenue recognition is simply the question of when revenue shows up on the P&L, and how much.

The standard runs in five steps. Identify the contract. Identify each distinct promise in it, called a performance obligation, such as software access and a separate training package. Work out the price after discounts and credits, then allocate it across the promises. Finally, recognize each piece as it's delivered, either at a point in time or over a period.

A subscription is delivered evenly, so its revenue is spread evenly across the term. Anything invoiced ahead of delivery waits on the balance sheet as deferred revenue.

On January 1 Acme invoices $12,000 for a non-cancellable one-year plan, due on receipt. Because the contract can't be cancelled and payment is due, Acme already has a right to the money. It records a $12,000 receivable and $12,000 of deferred revenue. Revenue so far is zero.

On January 31 one month of service has been delivered, so $1,000 moves from deferred revenue to revenue. The same happens every month through December. When the customer pays, cash goes up and the receivable goes away, and revenue doesn't change at all.

ASC 340-40 is the companion standard for the cost of winning a contract, such as sales commissions. ARR is an operating metric and won't match GAAP revenue month to month. Diligence teams usually ask for both, with a bridge between them.

Why it matters. A $12,000 annual plan billed in January is $1,000 of revenue a month for twelve months. Book it all in January and your monthly revenue, growth rate and margins get restated in diligence.

Try it with your numbers

Change any number. The working below updates as you type.

Allocate the price across the promisesAllocated price = Transaction price × (Standalone price of the promise ÷ Sum of standalone prices)
$

What the customer pays, after discounts and credits.

$
$
mo

Allocated to software access

$9,600.00

How it’s worked out

  1. 1Sum of standalone prices$12,000.00 + $3,000.00$15,000.00
  2. 2Software access$12,000.00 × $12,000.00 ÷ $15,000.00$9,600.00
  3. 3Training package$12,000.00 × $3,000.00 ÷ $15,000.00$2,400.00
  4. 4Software revenue each month$9,600.00 ÷ 12$800.00
PromiseStandalone priceAllocatedRecognized
Software access$12,000.00$9,600.00Over 12 months
Training package$3,000.00$2,400.00When delivered
Total$15,000.00$12,000.00

The bundle is $3,000.00 cheaper than buying each piece alone, so the discount is shared in proportion to standalone price.

The entry, worked

On January 1 Acme invoices a customer $12,000 for a non-cancellable one-year subscription, due on receipt. No service has been delivered yet.

Invoicing a non-cancellable annual planBalanced
AccountDebitCredit
Accounts receivable$12,000.00
Deferred revenue$12,000.00
Total$12,000.00$12,000.00

The contract can't be cancelled and payment is due, so Acme books the receivable now against deferred revenue, which becomes revenue at $1,000 a month.

Common questions

When do I recognize revenue for a monthly SaaS subscription?

Over the month the service is provided. For a monthly plan billed at the start of the month, that usually means revenue in the month it's billed.

Is a setup fee revenue on day one?

Usually not. If the setup doesn't give the customer a separate service, the fee is combined with the subscription and recognized over the period the customer benefits.

Does ARR come from ASC 606?

No. ARR is an operating metric, not a GAAP measure. GAAP revenue and ARR often differ, and investors look at both.

Where it comes up

The glossary entries, founder guides and lessons on this site that use the term and link here.

Read further

Works in your QuickBooks Online or Xero file

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General information for US companies, not tax, legal or accounting advice. Check the specifics with a CPA before you act on them.