Revenue recognition rules might go down as one of the most “accounting-iest” concepts out there. You’re telling me that after a customer pays money for something just sold, specific rules need to be followed to record that revenue correctly in the financial statements? Well, if you report your financial statements on an accrual basis (and you should be if you are a growing company), the answer to that question is “yes.”
An Accounting 101 definition of revenue recognition simply dictates that a company cannot recognize revenue until the goods being sold or the services being provided have been delivered to the customer. Software has always been more complicated from a revenue recognition perspective, so much so that PwC had to release a 300 page “user friendly” guide to assist. Fortunately, that guide is more aimed at large, public companies with complex software licensing, not smaller, private companies with a subscription based revenue model.
Subscription based software revenue recognition is pretty simple: you must recognize the total amount the customer pays evenly over the term of contract. Let’s break this down using the same dollar amount a customer pays over three different contract terms. Say a customer pays $1,200 to use your software over these three different terms:
- Monthly contract – The $1,200 can generally be recognized in full right when invoiced or charged since the customer will have access to use the software for the next 30 days.
- Quarterly contract – You will have to recognize $400 a month for the three month term of the contract.
- Annual contract – You will have to recognize $100 a month for the twelve month term of the contract.
As you can see, this isn’t nearly as scary as it sounded earlier in the blog. However, this is where the pain kicks in: how do you actually make this happen in your accounting software? For as great as Quickbooks might be at providing a cheap and effective accounting solution, it cannot automate this task. So here are your options:
- Set up recurring journal entries on the front end. This requires multiple tedious steps and also presents a reconciliation nightmare if a human error occurs somewhere along the way or something changes. Not scalable.
- Create a revenue recognition worksheet in excel. This is better, but it still requires additional work to build and maintain if you want to scale it. Not to mention, there is still a risk of error if one measly formula goes out of whack. Not 100% scalable.
- Pay minimum of $12,000 a year for a clunky enterprise accounting software to automate. Nope.
Here’s where ProRata saves the day. ProRata integrates with Quickbooks to automatically create and record the correct revenue recognition journal entries for each contract. The real beauty of this is that ProRata sets up this automation upon creation of the customer invoice — no extra steps needed! ProRata can be so powerful for a growing company by saving time, eliminating reconciliation headaches, and improving financial statement accuracy.
Proper revenue recognition is a necessary evil for a growing subscription based company. But this evil becomes less daunting when you have the power of automation at your fingertips.