Recognising revenue in your subscription business
Deferring revenue and tracking it over the life cycle of your subscriptions
If you’ve never dealt with revenue recognition from a recurring billing perspective, moving your business towards subscription offerings can be challenging.
If your subscription model is founded on the principle of upfront payments whilst you deliver good and services over a longer period of time, tracking the revenue correctly is an integral part of your business model.
Let’s look at a simple example: We provide a monthly boxed subscription service to our customers at $10 a month, paid annually in advance. Customers pay $ 120 for the year and we have a small sign-up fee of $ 5. We receive payment of $ 125. We can’t recognise the entire $125 as revenue because we’re still to deliver the 12 boxes from their annual subscription. According to IFRS standards, at signup we can only recognise the $5 sign-up fee, even though we’ve received the full year’s subscription payment upfront ($125).
What does deferred revenue look like?
From an Accounting perspective our ledger entries look like this:
Account Debit Credit
Accounts Receivable 125.00
Earned Revenue 5.00
Deferred Revenue 120.00
Following the AR entries, a credit is then written to the cash or bank account. Once we’ve delivered our box for the first time, we can say that we’ve fulfilled month one of this contract and we can recognise the value of month one which is $10:
Account Debit Credit
Earned Revenue 110.00
Deferred Revenue 10.00
Every month that we continue to fulfil the contract, $10 moves from the deferred revenue to the earned revenue, decreasing our liability and increasing our earned revenue.
Keep in mind that different businesses could have different recognition schedules and you might need to accrue revenue on a daily or monthly basis depending on the accuracy you require. If your model is based on month-to-month payments with immediate cancellation, you’ll likely be managing accruals daily in order to facilitate more efficient and accurate cancellations. You also need to factor in VAT calculations at the time of invoicing and this could differ depending on your country and your customer’s country.
Why do subscription businesses track this?
Generally Accepted Accounting Principles (GAAP) encourage companies to track revenue in this manner as it provides visibility to external parties that might need access to financials statement like your bank, investors, board of directors or shareholders. Corporate tax calculations can be impacted by the amount of deferred revenue carried into future periods. Deferred revenue is a liability because it’s dependent on your business to deliver the contracted services or goods. Refunds for cancellation, especially for annual subscriptions makes handling this much more efficient if you’re accurately tracking deferred revenue.
What are my options for tracking deferred revenue?
Some businesses use manual spreadsheets or standalone revenue recognition software. Neither are ideal as manual calculations are error-prone and standalone systems aren’t centralised within your Financials solution. Dynamics 365 Finance and Supply Chain has built-in revenue recognition and if combined with Bluefort’s License and Subscription App (LISA), you have a powerful solution that not only recognises revenue at the appropriate times, but also fully automates subscription billing and purchasing process across various plan types and models.
In order to ramp-up your subscription business, tracking revenue accurately will play a big role in how successful you are in making the shift to recurring revenue.
When you consider a technology road map for your subscription model, you need to focus on customer billing, the complexities of your subscription and the related financials with your business strategy in mind. Contact us here for a meaningful discussion about supportive technologies that drive subscription success.