The Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) introduced accounting standards ASC 606 and IFRS 15 to provide updated guidance on revenue recognition. The recent boom in subscription-based businesses was one of the leading causes that revealed a lack of uniformity in the old regulations.  

With the new standards in place, companies must follow a five-step approach to recognize revenue from contracts with customers: 

  1. Identify the contracts with a customer.
  2. Identify the performance obligations in the contracts.
  3. Determine the transaction price.
  4. Allocate the transaction price to the contract’s obligations.
  5. Recognize revenue as you satisfy the relevant obligations.

Example: Using an adjustment account for flat-rate annual subscription 

 

While this process seems straightforward, translating the new accounting practices to a recurring billing model can present unique challenges. For example, let’s say that a customer has recently entered a contract with you for an annual subscription at a flat rate of $18000. The customer has paid the full amount upfront; however, you cannot recognize the full amount right away because you haven’t met step five of the above process from ASC 606 and IFRS 15. 

So, what is the best practice that allows you to recognize revenue as you satisfy the relevant performance obligations? The answer is creating an adjustment account to track deferred revenue and treat the unearned income as a liability.  

What is an adjustment account?   

 

An adjustment account is a summary account in the general ledger that documents internal events rather than business transactions, allowing you to incrementally claim revenue from the contract as you complete the performance obligations. 

Returning to our example, for the first month you’d only be able to recognize $1500. The remaining $16500 must be booked into the deferred revenue account, and then for each subsequent month you’d credit the deferred revenue account and debit the sales account $1500. 

Read the full blog for more best practices and more complicated examples to help you enable compliance with ASC 606 and IFRS 15.

 

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