Revenue recognition, which controls how income appears on your business’s books, affects your tax obligations, how attractive you are to investors, and more. Subscription businesses face additional complications such as recurring billing cycles, customer churn, and complex contracts.

Modern solutions can simplify this complex process while providing actionable insights into your business operations. Whether you’re dealing with ASC 606, IFRS 15, or the complexities of a diverse customer base, accurate and timely revenue recognition is an important asset. According to a 2023 Stripe survey of subscription businesses, 36% planned to move away from their homegrown accounting systems and switch to third-party billing platforms.

Below, we’ll explain why revenue recognition is important for subscription-based businesses, how these businesses can make the most of their revenue recognition practices, and how solutions such as Stripe Revenue Recognition and Stripe Billing can simplify this process.

What’s in this article?

• What is revenue recognition?
  
• Why is revenue recognition important for subscription-based businesses?
  
• Challenges in revenue recognition for subscription-based businesses
  
• Solutions for effective revenue recognition for subscription-based businesses
  
• Revenue recognition best practices for subscription-based businesses
  
• How Stripe can help
  

What is revenue recognition?

Revenue recognition is the accounting practice of recording income when a business has earned it rather than when the business receives payment. This concept is fundamental to accrual accounting and adheres to certain principles and regulatory guidelines. These rules help match revenues with the expenses incurred while generating them, making financial statements more accurate and informative.

Why is revenue recognition important for subscription-based businesses?

Revenue recognition is important for subscription-based businesses because of the recurring nature of their income. These businesses often receive payments up front for services that will be provided over an extended period—usually a monthly or yearly cadence.

Recognizing revenue correctly provides an accurate representation of financial health. For example, if a business receives a one-year subscription payment of $1,200 up front, it cannot record the full amount as revenue for the month it received the payment. Instead, the business would recognize $100 of revenue each month over the year. This method aligns the revenue with the ongoing service provided, leading to more precise financial statements.

Mistakes in revenue recognition can lead to distorted financial reports, which can mislead stakeholders and risk noncompliance—causing problems with valuation and investor relations. Taking revenue recognition seriously keeps businesses accountable to shareholders, regulators, and other stakeholders.

Challenges in revenue recognition for subscription-based businesses

For subscription-based businesses, several factors can complicate revenue recognition. These include:

• Timing of revenue recognition: Revenue recognition hinges on when a business should recognize revenue. For example, if a customer pays for a year of service up front, the business cannot recognize the entire payment as revenue immediately. Instead, the business must recognize the amount over the length of the service period, complicating accounting practices and affecting monthly and quarterly reports.

• Multiple elements in a single subscription: A single subscription package might include a variety of products or services. Businesses must split the total subscription price into individual components. For example, a software-as-a-service (SaaS) subscription might include software access, customer support, and storage space. Each element must be valued separately for accurate revenue recognition, complicating the accounting process.

• Customer churn: The loss of customers during a subscription period can cause confusion in revenue recognition. If a customer pays for an annual subscription but cancels partway through, the business must account for the returned portion of the subscription cost. This can be a complex task—and can affect financial reporting.

• Discounts and promotional offers: Many subscription-based businesses use discounts or promotions to attract customers. Recognizing revenue from these transactions can be complicated. Imagine a customer gets three months free on a one-year subscription. The business must spread the revenue evenly over the remaining nine paid months over the full year.

• Price changes: Subscription-based businesses often change their pricing strategies. For example, a business might offer lower rates for long-term contracts. When such changes occur, the business must adjust its revenue recognition methods.

• Regulatory compliance: Accounting standards such as IFRS 15 or ASC 606 have specific guidelines for recognizing revenue from contracts with customers, including subscriptions. Complying with these rules can be challenging for subscription-based businesses and can result in heavy penalties if done incorrectly.

• Handling upgrades and downgrades: Customers often change their subscription plans. For example, a customer might switch from a basic to a premium plan. This change affects the service provided and how the revenue should be recognized.

• Refunds and cancellations: Subscription-based businesses often have to deal with refunds or cancellations. This leads to a reversal of previously recognized revenue and must be correctly accounted for to maintain accurate financial statements.

• Currency fluctuations: For businesses that operate internationally, currency exchange rates can affect revenue recognition. For instance, if a customer in Spain pays in euros for a subscription, the business must convert this to its operating currency, which can cause variability in the recognized revenue because of exchange rate fluctuations.

Each of these challenges requires careful attention and specialized solutions to maintain accurate financial records. Failure to do so can lead to incorrect financial reporting, regulatory penalties, and erosion of stakeholder trust.

Solutions for effective revenue recognition for subscription-based businesses

Here are some solutions for effective revenue recognition in subscription-based businesses:

• Automated accounting software: Specialized accounting software can simplify the revenue recognition process. This software often includes features that let businesses set the timing and parameters for recognizing revenue, reducing human error and time spent on manual calculations. For example, setting up the software to automatically recognize revenue over a yearlong subscription makes monthly and quarterly reports more accurate.

• Separating elements: Breaking down subscription packages into their individual components helps in accurate revenue recognition. Best practices include specifying the value of each service or product in the subscription and allocating the total subscription price accordingly. This simplifies the accounting for multiple-element contracts and keeps financial records accurate.

• Predefined churn policies: Having a well-defined policy for customer churn can reduce the accounting burden. When a customer cancels a subscription, the business should have guidelines that cover how to handle the unused portion of the subscription fee. This helps maintain accurate financial records and minimizes confusion during audits.

• Transparent discount accounting: Businesses must account for discounts and promotional offers transparently. Spreading the revenue earned from the paid months over the entire subscription period, including any free or discounted months, can make the revenue recognition process more transparent.

• Regular review of pricing strategies: Conduct regular reviews of pricing models to keep the accounting team informed about any changes that will affect revenue recognition. This proactive step minimizes errors and ensures financial reporting remains accurate, even when pricing changes occur.

• Adherence to regulations: Strict compliance with regulatory guidelines, such as IFRS 15 and ASC 606, can prevent complications related to revenue recognition. Offering training sessions for the accounting team can help you avoid penalties and maintain trust with stakeholders.

• Detailed tracking of plan changes: Keep records of subscription changes, such as upgrades or downgrades, to simplify the revenue recognition process. If a customer moves from a basic plan to a premium one, a well-maintained tracking system simplifies the adjustments needed in revenue recognition methods.

• Defined refund policies: Having a clear refund policy can help you avoid unnecessary complications when a customer asks for a refund.

• Currency risk management: For global businesses, implementing strategies to hedge against currency risks can make revenue recognition easier. This includes contractual provisions for currency adjustments and the use of financial instruments to lock in exchange rates, minimizing variability because of currency fluctuations in recognized revenue.

Addressing these points effectively can help a subscription-based business maintain accurate financial statements while complying with relevant regulations.

Revenue recognition best practices for subscription-based businesses

• Use machine learning for automation: Machine learning algorithms can track patterns in subscription adjustments—upgrades, downgrades, or pauses—and auto-adjust revenue figures accordingly. This level of automation decreases manual errors and lightens the workload for the finance team.

• Itemize subscription elements for accurate allocation: When a subscription offers multiple features or services, businesses should break down each one into its individual monetary value. This supports precise, proportionate revenue recognition over the term of the contract. For example, if a subscription package includes a streaming service and a monthly eBook, the revenue from each component should be recognized separately based on their standalone prices.

• Use predictive models for customer churn: The unpredictability of subscription renewals is a common issue. Using predictive analytics can help businesses prepare for a realistic revenue recognition schedule. For instance, if the model shows a 10% probability of churn for a certain customer segment, factor this into revenue projections to improve financial planning.

• Explicit discounting strategy: Document seasonal or promotional discounts and factor them into revenue recognition schedules. If a yearly subscription is offered at a 20% discount during the holidays, this lowered revenue should be amortized across the full contract period.

• Scheduled reviews of pricing models: Review pricing schemes regularly, and adjust your revenue recognition methods accordingly. For instance, if there’s an industry trend toward lower subscription fees, consider this when setting prices, and make sure to reflect any changes in your revenue calculations.

• Monitoring of regulatory shifts: Stay up to date on changes in legal requirements regarding revenue recognition. A dedicated team should be responsible for integrating these updates into the accounting system as quickly as possible.

• Concrete policy for plan modifications: Subscriptions change: customers upgrade, downgrade, or sometimes pause their plans. Having a well-defined policy that states how revenue adjustments will be made in each case eliminates ambiguity and simplifies the financial tracking process.

• Detailed refund guidelines: A clearly defined and transparent refund policy will help you account for revenue loss when customers terminate their subscriptions. For example, if your policy states that customers are entitled to a 50% refund if they cancel within the first six months, this should be clearly indicated in your accounting system.

• Foreign currency hedging: For businesses that operate globally, an active hedging strategy can offset the risks of currency fluctuation, letting you recognize revenue in a consistent manner, regardless of currency fluctuations.

Incorporating these best practices can make revenue recognition a manageable and error-free process, which lets subscription-based businesses focus on growth without being hindered by financial inaccuracies or compliance issues.

How Stripe can help

Stripe makes revenue recognition for subscription-based businesses more manageable through its specialized services. Here’s how Stripe can help:

• Real-time revenue reporting: Stripe Revenue Recognition generates accurate, real-time reports that are easily customizable. Your team can use them to create a snapshot of the financial health of your subscriptions at any time, facilitating quick and informed decision-making.

• Automated compliance with ASC 606 and IFRS 15: Stripe automatically updates its accounting methodologies to stay compliant with regulations such as ASC 606 and IFRS 15, so you don’t have to adjust your internal processes to meet new standards.

• Feature-rich billing system: Stripe Billing integrates easily with Stripe Revenue Recognition, making it simpler to manage complex billing cycles, multiple subscription tiers, and metered billing. This lets you recognize revenue in a way that aligns closely with your billing practices, making your financial reports more accurate.

• Granular transaction data: Stripe provides detailed information on each transaction, including timestamps and geolocation data. This granularity creates a more nuanced revenue recognition process, with possible adjustments based on specifics such as location-based tax rules or time-based access to services.

• Smart retries and dunning management: Stripe Billing’s retry logic and dunning management capabilities minimize revenue loss from failed payments or credit card declines. Because this feature improves the reliability of revenue streams, it improves your revenue recognition process by providing stable data for forecasting and reporting.

• Multicurrency capabilities: Stripe accepts payments in over 135 currencies, minimizing the complications of recognizing revenue from international sources. This is particularly useful for global subscription businesses that want to simplify the accounting aspects of currency fluctuations.

• Scalability: As your subscription model evolves, Stripe adapts with you. Whether you’re a new business or an established enterprise, Stripe can accommodate your growth trajectory without demanding constant manual adjustments to your accounting setup.

• Account reconciliation: Stripe provides reconciliation data that correlates with your bank statements. This function simplifies account reconciliation by making it easier for your finance team to ensure your books match your bank transactions.

• Webhooks for event-driven triggers: Stripe’s webhook events can notify your accounting system when a subscription change occurs, triggering real-time adjustments in your revenue recognition calculations.

Stripe transforms revenue recognition into a simplified, accurate, and compliant process, freeing subscription-based businesses to focus on growth and expansion.