Core Concepts of Revenue Recognition
Revenue recognition is an accounting principle and process for reporting revenue. Zuora provides revenue recognition options for subscription services through its Zuora Finance - Revenue feature. This article explains the core concepts that influence revenue recognition.
Revenue recognition allows companies to recognize the monetary value of a contract over a period of time as the revenue is realized and earned (when goods are delivered or services rendered). Businesses can differentiate and report on several types of revenue, including:
- Deferred revenue: Revenue from closed sales that have been billed but have not yet been recognized. For example, an invoice has been sent to a customer but the billing amount will not be recognized until the services or products have been delivered to customers.
- Realized revenue: Revenue representing services or products which have been delivered to customers.
SasS (Software as a Service) companies typically recognize revenue on billings over a period of time rather than all at once. The triggers and formulae that describe how revenue is recognized can vary greatly between business and product lines. In most cases, there is a defined best practice for revenue recognition around particular types of products and services.
Core Accounting and User Concepts of Revenue Recognition
You must meet the following criteria before you can recognize revenue:
- Persuasive evidence of an arrangement exists
- Delivery has occurred
- The vendor's fee is fixed or determinable
- Collecting revenue is probable
Persuasive Evidence of an Arrangement Exists
A business must have a contract or an agreement with its customer to establish clear and persuasive evidence that the customer intends and agrees to buy from the business.
In Zuora, a subscription or a subsequent amendment order usually establishes such an arrangement between the business and its customers. In addition, when you create a product rate plan charge, you can set up a revenue recognition rule based on your business requirements to show that pervasive evidence of an arrangement exists.
Delivery has Occurred
Your business needs to deliver the agreed-upon service or product before it can recognize the revenue that is associated with that delivery. In a subscription service, you distribute your service over the subscription term, and therefore you also distribute the revenue you recognize over the subscription term.
Zuora provides a variety of options to accurately calculate how much service delivery has occurred. Every subscription, rate plan charge, and invoice item has start and end dates to help you decide when service delivery has occurred and in turn find out how much revenue you can recognize.
The Vendor's Fee is Fixed or Determinable
Your business must establish a fixed or determinable price for the service it provides to your customers. Providing usage-based pricing, extended payment terms, or rights of return/refund might indicate that the price is not fixed or determinable and the price could be subject to additional revenue recognition rules. In general, if it cannot be concluded that a fee is fixed or determinable at the outset of an arrangement, revenue should be recognized as payments from customers become due.
Zuora helps you determine the price for the services that you provide, either at contract time for fixed price subscriptions, or at invoicing time for usage and variable pricing subscriptions.
Collecting Revenue is Probable
Your business cannot recognize revenue until you have received the payment, or you are reasonably assured to collect the payment. This condition varies by company and by industry. Typical collection risk levels for collecting revenue include the time of:
- cash receipt
As a first example, an enterprise software company generally will perform a great deal of due diligence prior to selling its product to a customer, making sure the customer has both a strategic need for the product and the necessary financial backings to purchase the product. In this example, the business can expect to receive payment and collecting revenue becomes probable at the time of booking.
For a second example, a consumer internet company offers self-signup for its services. Collecting revenue may not be probable until the monthly invoices are issued, which provide reasonable assurance that the customers will pay.
Sometimes, business is more risky, such as an online gaming company selling to teenagers or a mature business selling into a new geographic region. In these cases, due to the considerable and unknown risks in collecting payments, you would have a more conservative policy and collecting revenue is only assured at the time of cash receipt.
Whether your business requires the probable collection of revenue at booking time, at invoicing time, or at cash receipt time, Zuora can help you recognize revenue by giving you access to data from critical business objects such as subscriptions, invoices, and payments.