Revenue Management: #2 How to compute revenue?
In our previous post, we discussed the revenue recognition standards under IFRS 15 and ASC 606 and the five-step model. Now, let's examine three distinct business scenarios to see how the standards and model work in practice. This will help you understand the timeline and values, as well as the challenges that lie behind them.
Scenario 1: One-time Product/Service Delivery
Imagine a custom furniture maker who takes an order in January and is paid $5000 up front for a handcrafted wall hanging that will be delivered in March. Applying the five-step logic from the previous post, the performance obligation here is fulfilled only when the wall hanging is delivered. That means the $5000 sits on the balance sheet as unearned/deferred revenue until March (promised delivery), and computation for a one-time product or service is simple. Record $5000 as recognized revenue in March in one short.
Imagine a custom furniture maker who takes an order in January and is paid $5000 up front for a handcrafted wall hanging that will be delivered in March. Applying the five-step logic from the previous post, the performance obligation here is fulfilled only when the wall hanging is delivered. That means the $5000 sits on the balance sheet as unearned/deferred revenue until March (promised delivery), and computation for a one-time product or service is simple. Record $5000 as recognized revenue in March in one short.
Service | Handcrafted Wall Hanging | |
Month | Deferred Revenue | Recognized Revenue |
January | $5000 | $0 |
February | $5000 | $0 |
March | $0 | $5000 |
Scenario 2: Subscription-based Services
Let's picture an online training application that charges $120 for a 12-month training, paid upfront in January. The seller's obligation is to provide sessions once a month. The computation here is straightforward. $120 / 12 = $10 per month. Recognition happens each month as the service is delivered throughout the subscribed period.
Service | Online Training Application | |
Months | Deferred Revenue | Recognized Revenue |
January | $110 | $10 |
February | $100 | $20 |
March | $90 | $30 |
April | $80 | $40 |
May | $70 | $50 |
June | $60 | $60 |
July | $50 | $70 |
August | $40 | $80 |
September | $30 | $90 |
October | $20 | $100 |
November | $10 | $110 |
December | $0 | $120 |
Scenario 3: Hybrid Model
Consider a marketing agency that sells a $5000 package made up of two components: a $2000 website redesign, which will be completed in two months, and $3000 of social media management spread across six months. Under the five-step approach, there are two obligations, and while recognizing the revenue, recognize each portion as its obligation is satisfied.
While computing, $2000 is recognized fully in the second month as and when the website goes live, and $3000 will be divided for the six months and recognized at $500 per month.
Service | Website Redesign | Social Media Management | ||
Months | Deferred Revenue | Recognized Revenue | Deferred Revenue | Recognized Revenue |
January | $2000 | $0 | $2500 | $500 |
February | $0 | $2000 | $2000 | $1000 |
March |
|
| $1500 | $1500 |
April |
|
| $1000 | $2000 |
May |
|
| $500 | $2500 |
June |
|
| $0 | $3000 |
The Real Challenge in Revenue Recognition
While these examples are easy to follow individually, businesses rarely operate with just one recognition rule or pattern. A software company might bill monthly for some services and yearly for others, and sell one-off onboarding sessions. A manufacturer might deliver large contracts in milestones while earning recurring revenue for maintenance contracts.
So, a single business may have a recognition period that is monthly, yearly, or sometimes quarterly. One can recognise revenue at the start of a specific service, and the other may decide to do it at the end of the period.
So, a single business may have a recognition period that is monthly, yearly, or sometimes quarterly. One can recognise revenue at the start of a specific service, and the other may decide to do it at the end of the period.
Different recognition periods, billing cycles, start and end dates, upgrades and downgrades, and other contract amendments can easily make revenue recognition a nightmare for business stakeholders.That's why businesses use revenue management tools like Zoho Billing to automate the calculation and gain accurate, detailed, and meaningful insights. These tools encapsulate the five-step model framework into repeatable calculations, so every contract is treated consistently and in compliance with global standards.
The next post'll show how a revenue management tool helps you configure recognition settings and turn these computations into audit-ready reports.
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Dear customers, We're happy to bring you the September edition of our #CommunityDigest! Keep track of your subscription KPIs right from your smartphone: Last month, we enhanced our Android mobile app to help our customers get daily updates on their business health. We got to know from a lot of customers that this has made their job much more easier because they no longer have to keep a reminder to manually check on the previous day's revenue or activations. If you have not downloaded it yet, here'sCommunity Learning Series | Digest #4 - August 2020
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