What is ASC 606 compliance and why do you need it?
Are you up at night worrying if your organization is compliant with the rules that govern financial reporting? You recognize the need to report revenue accurately but also want to make sure you’re not breaking any laws with your current reports.
Investors and PE firms gauge a SaaS organization’s revenue reports as one measure of growth potential. Organizations can miss out on investment opportunities if they are unable to report revenue accurately. Until 2014, revenue was also difficult to compare across different organizations lacking standardization for offerings such as goods or services.
Then in May of 2014, the Financial Accounting Standards Board and International Accounting Standards Board came together to deliver a new accounting standard update. This update, ASU 2014-09, and its codification, ASC 606, simplify the framework for reporting revenue.
So what is ASC 606 compliance and why do you even need it?
Our team at OpFocus is familiar with SaaS organizations like yours struggling to adapt their revenue reporting practices for ASC 606. We help our customers ensure they are following compliance by standardizing their team’s processes. Let us explain what is ASC 606 compliance and the available solutions that can make adherence automatic.
What is ASC 606 compliance?
The Accounting Standards Codification 606 or ASC 606 is a set of revenue recognition principles for accounting purposes. The Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) define ASC 606 as the next codification to “Remove inconsistencies and weaknesses in revenue requirements.”
The FASB and IASB jointly made this set of principles because of inconsistencies in the original guidance, such as “when” an organization could recognize revenue. The FASB and IASB recognized the need for more robust standards for organizations growing in complexity to efficiently and accurately report revenue.
The ASC 606 codification has many details the highlight what compliance and lack thereof look like. If you’re curious about what the entire list of repercussions is, you’re in luck! The AICPA Auditing Standards Board shared an exposure draft in February 2021 regarding fraud and noncompliance with laws and regulations for ASC 606. The draft is about twenty pages, so here’s the TL;DR—there’s a lot you want to avoid.
Note: if your organization is not in the United States, ASC 606 is known as IFRS 15 globally.
Why do SaaS companies need to be ASC 606 compliant?
Before we get to some positives of being ASC 606 compliant, we want to give you the giant flashing red light first: non-compliance with ASC 606 can have significant consequences.
Penalties for ASC 606 non-compliance
The FASB and IASB work nationally with the SEC and DOJ to monitor all non-compliance with financial laws—ASC 606 is no exception. The most severe penalties for ASC 606 non-compliance include losing your job, fines, and possibly jail time.
Taxes. If you are reporting revenue that differs from the actual amount you should report, you’re waving a red flag at the IRS. If that happens, you’ll have an audit your way and face any of the penalties above.
Benefits for ASC 606 compliance
Accurately and efficiently reporting on your revenue is beneficial for internal and external reasons. Though more may occur for your specific organization, three typical benefits of ASC 606 compliance are:
- Readiness for an IPO—if you meet ASC 606 compliance requirements, you will also adhere to an IPO’s regulatory requirements.
- Standardizing your sales cycle—adhering to ASC 606 compliance forces you to standardize the quoting process, reducing inconsistencies between contracts.
- Ability to attract investments—if you’re following ASC 606 compliance when reporting revenue, that accurate data can inform investors deciding to work with your organization.
How can a SaaS organization be ASC 606 compliant?
Before ASC 606, there were huge discrepancies between the financial reports of organizations, even in similar industries and markets. And SaaS organizations rapidly growing in complexity made comparing revenue a nightmare for financial experts.
With ASC 606 compliance, it’s easier for organizations to produce and share financial statements by optimizing the requirements for reporting revenue. The focus for this compliance is simplicity and consistency.
Any organization that enters into a contract with customers to exchange goods and services must be ASC 606 compliant. This compliance includes any private, non-profit, or public organization. With a small set of exceptions, your organization is most likely currently or planning to be ASC 606 compliant.
So what does an organization need to do to be compliant with ASC 606?
There are five steps to ensure you are compliant with the codification.
- Identify the contract with the customer.
- Identify the distinct performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price to the performance obligations in the contract.
- Recognize revenue when a performance obligation is satisfied.
Though these are the condensed steps, pages 1-11 of this guidance contains a summary with explicit details of each step. If you follow these steps, you’ll satisfy compliance.
Is complying with ASC 606 difficult?
Without the right tools in place, ASC 606 can be difficult to comply with, especially if you do everything manually.
You may be wondering exactly how much work goes into being ASC 606 compliant? Well, let’s start with a pretty compelling statistic from Salesforce. Your sales reps spend 66% of each workday on “non-selling” tasks to ensure the quotes they configure are compliant.
One requirement for ASC 606 is the need for individual SKUs to represent the components of an offering. Whether this offering is a SaaS license, professional services and fees, or ongoing support, the components must have an individual SKU. The reason to compile these SKUs is that you must represent each revenue bucket as a set of SKUs.
Without a CPQ tool, your sales reps are manually configuring quotes with each offering’s component SKUs, adding unnecessary complexity. And any time you introduce more complexity without a CPQ tool, you’re adding the additional need for review and approval. As these additional steps add up, your sales process slows down.
The biggest reason to maintain ASC 606 compliance is to avoid triggering an audit from the IRS (remember Al Capone?) However, there are some genuinely positive benefits to being ASC 606 compliant as well.
How can you make ASC 606 compliance easy to follow?
By now, you see the need for ASC 606 compliance but feel that maintaining compliance will add to your team’s workload. While financial experts can recommend solutions, revenue operations partners have the best experience guiding SaaS organizations down the path of least resistance with ASC 606 compliance.
When a SaaS organization experiences rapid growth, its once simple sales process grows increasingly complex. As this occurs, errors both from human and system complexity can occur. In this process, our team sees SaaS organizations attempt to make solutions of their own to meet ASC 606 compliance.
Often these homemade solutions involve gluing multiple tools together that will eventually break. We want to caution against making your own solution here because you’ll find yourself replacing it eventually. Anytime you have to go through a rip-and-replace task, the effort compounds to implement the correct solution.
As the ever-growing complexity of SaaS organizations continues, so too must the solutions to overcome them. One solution that is holistic in its approach is a CPQ tool.
How does a solutiuon like Salesforce CPQ support ASC 606 compliance
A solution like Salesforce CPQ supports ASC 606 compliance by enabling you to structure your quoting and proposal process with the adherence built-in. By standardizing the typically inconsistent manual work in the quoting process, you can rest easy knowing your team is compliant.
How does this look in action? Here are three examples:
- Admin: Your sales leaders and admins have to review any manual work in the quoting process for accuracy and ASC 606 compliance. By establishing clear rules in the quoting process, your leaders and admins can rest easy knowing each contract is automatically accurate and compliant.
- Sales: A sales rep can’t always predict the impact a contract full of guesswork will have on revenue, so you have to build structure. A configure price quote tool like Salesforce CPQ enables you to automate rules approval thresholds to establish consistency. These thresholds standardize the options your sales reps have to configure a quote to meet compliance standards.
- Legal: ASC 606 requires contracts to clearly state that the moment you recognize revenue, you have to provide legal terms identifying when that occurs. With Salesforce CPQ, you can set rules to automate that extra step in the quoting process with pre-approval on terms in all contracts.
Depending on your current quoting process, you can customize Salesforce CPQ to relieve many ASC 606 compliance headaches. Better, you can remove the guesswork, optimizing the entire quoting and proposal process.
Why should your organization purchase Salesforce CPQ?
Many hypergrowth SaaS organizations like Seismic find success leveraging Salesforce CPQ to facilitate rapid growth and maintain ASC 606 compliance. And so can you with the proper guidance on implementing a Salesforce CPQ solution.
You want a clean and efficient way to report revenue so that you’re compliant with ASC 606. A successful IPO, access to investors, and a faster sales cycle benefit better revenue reporting. A solution like Salesforce CPQ can offer you these benefits, but what other benefits does this tool have for your business?
With experience implementing CPQ for other rapidly growing SaaS organizations, we know every pro and con you might be weighing. If you are wondering if you should purchase a CPQ solution, let us explain the benefits of Salesforce CPQ. Learn why you would invest in a CPQ solution to automate ASC 606 compliance and scale revenue growth for your business.