What are the Accounting Rules for Selling Web-based Subscriptions? —CRM Buyer

There’s No Accounting for the Subscription Economy 

It’s taken over 10 years to get the idea of the subscription economy into our noggins, but we’ve barely started internalizing what it takes to support it and report on it as a business, reports Dennis Pombriant at CRM Buyer.

Add “Accounting” for 32 Points and a Triple Score

“Wall Street types are very accustomed to companies selling products rather than subscriptions,” he reports. But “subscriptions have a mixed bag of revenue recognition ideas that challenge the status quo”:

 . . . Subscriptions as a way of doing business are just about everywhere; they’re not just in tech anymore. For instance, if you want, you can get your clothing as a subscription, and not only that but men (who as a group are notoriously lazy shoppers) have sites dedicated just to them. You know the trend has arrived when something like men’s clothing is available as a subscription.

Nonetheless, we’ve more or less glossed over everything below the waterline in this new approach to business. It’s taken over 10 years to get the idea of the subscription economy into our noggins, but we’ve barely started internalizing what it takes to support it and report on it as a business.

. . . . Product companies don’t have much when it comes to reliably forecasting future revenue streams, but subscription companies are just bristling with information. Take the Salesforce revenue numbers from last week’s earnings call as an example, and here is where I am indebted to Tzuo for his insights:

• Quarterly revenue of US$632 Million, up 38 percent year-over-year
• Full-year revenue of $2.27 billion, up 37 percent year-over-year
• Deferred revenue of $1.38 billion, up 48 percent year-over-year
• Unbilled deferred revenue of $2.2 billion, up from $1.5 billion year-over-year

If you are reading this (thank you very much), you have at least an intuitive understanding of revenue, but deferred and deferred and unbilled revenue deserve explanation, because who really cares about unbilled deferred revenue — isn’t that complete vapor?

As Tien Tzuo said to me, think of it this way: You do a deal with a company in which you agree to supply your service for three years for $36,000, or $1,000 per month, and you agree to invoice once annually, in advance, for $12,000. At the very beginning, then, you have $24,000 in unbilled deferred revenue and, since you bill in advance, you also have $11,000 in deferred revenue and $1,000 in real live revenue which you can recognize.

This $1,000 is also known as “MRR,” or “monthly recurring revenue.” Theoretically, if you add up all the MRRs on the books you can get very close to the forecast for the quarter. But there’s also an upside possibility that you’ll sell something else. If you do and you invoice for it, you’ll add to that pile of money. Unfortunately, there is also a possibility that some of your MRR will go away either because the customer quit or because they didn’t renew or whatever. We know this as “churn,” so you really need to discount the MRR by the churn rate to get a better sense. Life would be simpler if we could all agree on using a metric called the “annual recurring revenue,” but curiously, ARR doesn’t exist yet.

AccountingWeb weighs in on the issue, reporting that KPMG Addresses Tax Issues Associated with Working in the Cloud:

In a recent paper entitled, ‘Tax in the Cloud’, the Big Four firm grappled with the fundamental principles involved and practical implications for businesses and their advisers.

“Most tax rules were written at a time when physical goods or services were traded, largely in the same country,” said Mike Camburn, indirect tax partner at KPMG in the UK. “With Cloud transactions, determining what is actually being traded, between whom and where is becoming a real challenge.”

Read more about the KPMG analysis of Classification, Jurisdiction, and Transfer Pricing.