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Where are the Auditors: ASC 606 and Recognizing Subscription Billing Revenue

Since ASC 606 and IFRS 15 have taken effect, auditors, particularly in the private sector, have had a soft touch in enforcing some of the most complex portions of the guidance. Many companies moving to subscription bill models are not even aware these complexities exist. With the rise in comment letters seen in 2022, and continuing in 2023, tightening may have already begun.

 

ASC 606 Compliance in Public Companies Versus Private Companies

Because public companies have a wide range of investors with varying levels of financial expertise, they are required to file detailed financial information with the SEC, whereas private companies are not required to do so. When public companies file with the SEC, it is important to follow generally accepted accounting principles (GAAP) and the related accounting standards. This applies to all public and private companies that are legally obligated to follow GAAP, which includes adherence to ASC 606. Since the end of the COVID-19 pandemic, public companies are seeing an increase in strictness from auditors to adhere to ASC 606 standards. The number of actions involving accounting and auditing enforcement initiated by the SEC in Fiscal Year (FY) 2022 increased by 55% from FY 2021, but remained below pre-pandemic levels.

 

Figure 2 - SEC Accounting and Auditing

 

There has been the implication that auditors are more lax with auditing the complex areas of ASC 606 for private companies. There are two different rules the auditors must follow for public versus private companies: audit requirements for public companies are determined by the Public Company Accounting Oversight Board (PCAOB), whereas audit requirements for private companies are determined by the Auditing Standards Board (ASB). Moreover, because private companies do not have as many investors, may not be legally required to obtain an annual audit, and because their public information is not as readily available, some private companies bypass complex areas of the ASC 606 standard. The COVID-19 pandemic put a pause on the call to private companies to implement the changes required by ASC 606, as the FASB deferred the effective dates by one year for certain companies in June 2020 to provide relief. Since the pandemic has ended, compliance requirements that were once lax during COVID-19 are tightening, making ASC 606 compliance more pressing, even for private companies. This is especially true for private companies looking to raise capital from the public as they may be required to file financial information with the SEC through a registration statement.

 

An Increase in Financial Restatements

Of the 68 actions initiated in FY2022, 36 referred to announced restatements of financials. The percentage of FY 2022 initiated actions referring to announced restatements was at its highest level in recent years at 60%, which is 1.5 times the FY 2017 – FY 2021 average of 39%. Alarmingly, 69% of those 36 restatements alleged improper revenue recognition, which is a sharp increase over the prior fiscal year when only 40% referred to a restatement also alleged improper revenue recognition.

 

Figure 5 - SEC Accounting and Auditing

ASC 606 Compliance and Subscription Billing

The subscription billing model can complicate recognizing revenue, because the sales of the good or service is delivered over time, meaning the company must determine when each unit of revenue is earned. Complexity increases when subscriptions are sold in concert with other performance obligations, such as implementation services or training. If such orders are discounted, the guidance may require a re-allocation of revenue proportional to determined and maintained Stand-Alone Selling Prices (SSP). It may also require proportional re-allocation of revenue as changes occur to the contract, following the ASC 606 Contract Combination and Modification guidance. Further, if the subscription fee is a function of consumption or usage, the variable portion of this fee may have to be analyzed against the Variable Consideration portion of the guidance.

As subscription billing becomes a greater part of revenue, compliance in revenue recognition risk grows with compounding effects. The side effect of more subscription billing revenue is an increase in processing requirements which is costly and time consuming. The current recession focuses on pricing and agility where every dollar matters, and revenue leakage is not an option.

 

The Reliable Way to Recognize Subscription Billing

With migration to recurring revenue models being a trend that is here to stay, it is important for companies to keep their revenue processing efficient, automated, and secure.

The SOFTRAX Revenue Management System easily supports simple and complex subscription models, manages all stages of billing, and fully automates reporting under ASC 606. Subscription management software works best when it can scale, handle revenue recognition requirements, and manage different types of contracts. The SOFTRAX Revenue Management System supports all recurring billing functions in a single, multi-tenant, cloud application, making it the perfect platform to drive growth.

Contact a sales expert for a short demo of the SOFTRAX Revenue Management System today.

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