Navigating Revenue Recognition Methods in SaaS: An Exhaustive Guide

Revenue recognition methods under ASC 606 and IFRS 15 determine when and how businesses record revenue in financial statements.

Imagine a customer signing up for HubSpot's annual plan and paying $12,000 upfront. That's a significant cash flow boost for HubSpot, but can they immediately recognize the $12,000 as revenue?

Under ASC 606 and IFRS 15, businesses can only recognize revenue when they deliver value to the customer. For HubSpot, the entire $12,000 can’t be counted as revenue on day 1—it must be spread out over the year as they provide the service.

Why does this matter?

The revenue recognition method you choose impacts your financial statements, investor confidence, and compliance. Understanding these rules ensures you don't overstate earnings, report accurately, and make informed business decisions.

Let's break down six key revenue recognition methods.

What’s the difference between revenue recognition, distribution, and redistribution methods?

Revenue distribution refers to how deferred revenue is allocated over a contract period, such as evenly across periods, prorated by days, or with specific adjustments for the first and last periods.Deferred revenue is money received for services or goods yet to be delivered, recorded as a liability until recognized as revenue. The contract period defines the time this revenue is earned and recognized. 

Revenue redistribution involves redistributing deferred revenue due to contract changes, such as revised start or end dates. Examples include straight-line, front-loaded, and back-loaded distribution.

You can read more about revenue distribution and redistribution methods here.

6 Common revenue recognition methods

ASC 606 outlines several revenue recognition methods, each suited to different business models:

1. Sales-basis method 

The sales-basis method is a form of point-in-time revenue recognition widely used in businesses where revenue is directly tied to sales transactions. Under ASC 606, revenue is recognized when control of goods or services transfers to the customer—typically at the point of sale.

Let’s take Apple's App Store as an example. When a customer buys an app for $10, Apple doesn’t recognize the full $10 as revenue because a portion goes to the developer. Instead, Apple applies the sales-based revenue recognition method, recognizing only its commission (typically 30%) as revenue.

How Apple’s App Store recognizes revenue:

Journal entries for Apple:

• When a customer buys the app, Apple initially records the transaction as deferred revenue:

Note: "Dr." stands for Debit, and "Cr." stands for Credit. Debit (Dr.) increases assets or expenses, or decreases liabilities or equity. Credit (Cr.) increases liabilities, equity, or revenue, or decreases assets or expenses.

• When Apple transfers payment to the developer, after a set period, Apple recognizes its commission as revenue and records a payable to the developer:

2. Percentage-of-completion method

The percentage-of-completion method is commonly used for long-term projects where revenue is recognized gradually as the project progresses. Under ASC 606, revenue is recognized based on the percentage of the project completed, which is determined by comparing the costs incurred to date with the total estimated costs or another method of measuring progress.

Take Microsoft as an example of revenue recognition over time, specifically looking at their Azure cloud services contracts. Microsoft enters into long-term contracts with clients to provide cloud computing resources and software development. These contracts often span several months or even years. Under the percentage-of-completion method, Microsoft would recognize revenue as the services delivered over time based on the progress in fulfilling the contract terms.

Suppose Microsoft signs a contract to provide $1,000,000 in cloud services over 12 months. After the first quarter, Microsoft has completed 25% of the project's milestones and services. According to the percentage-of-completion method, Microsoft would recognize 25% of the total contract value as revenue at this point.

How Microsoft recognizes revenue:

Journal entries for Microsoft:

• When Microsoft receives an upfront payment of $200,000 from the client:

At this point, Microsoft records the upfront payment as deferred revenue.

• After completing 25% of the work (i.e., $250,000 worth of services), Microsoft recognizes revenue for the completed portion. At the end of the first quarter, the journal entry will be:

3. Completed-contract method 

The completed-contract method is best suited for short-term projects or cases where measuring progress is difficult. Revenue is recognized only when the contract is fully completed, and all obligations have been fulfilled. This method is often used for contracts with a defined, singular deliverable.

Recently, SpaceX signed a $50 million contract with the U.S. government to develop mission-critical software for a new satellite launch. The contract states that SpaceX will only be paid upon full completion and successful software testing.

How SpaceX recognizes revenue:

Journal entries for SpaceX:

• Year 1: When SpaceX incurs $20M in development costs but recognizes no revenue yet, the company would record the following:

No revenue has been recognized yet, so there is no journal entry for revenue.

• Year 2: When SpaceX incurs an additional $15M in costs, no revenue is recognized:

No revenue has been recognized yet, so there is no journal entry for revenue.

• Year 3 (Project Completion): Once the software is fully delivered and tested, SpaceX recognizes the total revenue of $50M as the contract is complete. The journal entry at this point would be:

4. Installment method

The installment method is commonly used by businesses that sell high-ticket items with extended payment plans. Revenue is recognized incrementally as payments are received rather than at the point of sale. This method is ideal for transactions where the customer is paying over time and the seller is uncertain about the collectibility of the full amount.

Let’s consider a tech company, like Tesla, selling a car for $50,000 to a customer who pays in installments over 12 months. Since Tesla will receive payments over time, it doesn’t recognize the entire $50,000 as revenue upfront. Instead, it recognizes revenue as the payments are made.

How Tesla recognizes revenue:

Journal entries for Tesla:

• When a customer buys a car for $50,000, Tesla records the initial sale:

• When Tesla receives the first installment payment ($4,167), it recognizes the corresponding revenue:

• For each subsequent installment payment, the same journal entry is repeated until the full payment is received:

5. Cost of recovery method

The cost of recovery method is used when there is a high risk of delayed or uncertain payments. Under ASC 606, revenue is not recognized until all costs associated with delivering goods or services have been fully recovered. This method is commonly applied when payment is uncertain or delayed, and the seller needs to ensure it has covered its costs before recognizing any revenue.

An example is Dell, which sells expensive servers to clients on installment-based payment plans. These transactions often come with delayed payments or uncertain schedules, so revenue is only recognized after the seller has recovered its costs.

Imagine Dell sells a server to a client for $50,000, with a production cost of $30,000. The client agrees to pay in installments over 12 months.

How Dell recognizes revenue:

Journal entries for Dell:

• When the server is sold but not fully paid:

Dell initially records the transaction as deferred revenue.

• As the cost is recovered through payments:

Once Dell has recovered the $30,000 cost, it can recognize the revenue.

• Remaining payments are recognized as revenue:

After recovering the cost, Dell can recognize the remaining $20,000 as revenue as payments are received.

6. Accrual method

The accrued revenue method recognizes revenue when earned, not when the payment is received. This approach is beneficial for transactions involving prepayments, such as subscriptions or contracts where goods or services are delivered over a period of time. It ensures that in a service type business, revenue is recognized in the period when the service is provided, matching the related expenses.

Consider a customer subscribing to Amazon Web Services (AWS) for a cloud hosting package. The customer agrees to pay $1,200 upfront for 12 months of service. Using the accrual method, AWS will recognize $100 of revenue each month, as the service is delivered evenly over the year.

How AWS recognizes revenue:

Journal entries for AWS Subscription:

• At the time of the initial payment (when the subscription is sold)

AWS receives $1,200 upfront for the 12-month subscription. Instead of recognizing it as revenue right away, the payment is recorded as a liability (deferred revenue) because the service will be delivered over time.

• At the end of each month (recognition of revenue as the service is delivered)

AWS recognizes $100 as earned revenue (1/12th of the $1,200 subscription). The deferred revenue liability is reduced by $100, and the same amount is recognized as revenue.

• At the end of the year (when all revenue has been recognized)

AWS recognizes the final $1,200 in revenue, clearing the deferred revenue balance and leaving no remaining liability for the subscription.

What happens if your company doesn’t follow the right revenue recognition method?

In a recent webinar we hosted, ‍Viraj Patel, CFO at Signeasy, spoke to our co-founders on the consequences of choosing the incorrect revenue recognition method:

1. Inaccurate performance assessment and misvaluation

Misstated revenue—either overstated or understated—can create unexplained spikes or dips in financials, making it difficult to track real business performance. Analysts, investors, and executives may misinterpret growth trends, leading to incorrect company valuation and misguided strategic decisions.

2. Loss of investor confidence

Investors rely on accurate financials to assess risk and potential returns. Erratic or misleading revenue figures can make a company appear volatile or unpredictable, deterring investment. 

3. Reduced transparency for creditors

Lenders and creditors assess financial health before extending credit. If revenue is misstated, debt repayment capacity appears unclear, leading to higher borrowing costs or loan rejections. Poor financial transparency can classify a company as high risk, limiting access to capital or triggering stricter lending terms.

4. Regulatory and legal risks

Non-compliance with ASC 606 or IFRS 15 can result in audit failures, legal penalties, and reputational damage. Public companies risk SEC investigations if financial statements are misleading, which can lead to fines, restatements, or even lawsuits. Auditors may flag discrepancies, leading to time-consuming corrections and increased compliance costs.

5. Internal inefficiencies and poor decision-making

Inaccurate revenue tracking affects budgeting, forecasting, and resource allocation, leading to wasted spending or missed growth opportunities. Finance teams spend excessive time reconciling errors rather than focusing on strategic initiatives. Leadership may misallocate resources due to distorted financial data, impacting hiring, expansion, and operational planning.

How do you determine the best rev rec method for your business?

1. Start with understanding industry norms and your business model. Industries often have preferred methods based on regulatory requirements or customary practices; for example, retail typically employs the sales-basis method, recognizing revenue at the point of sale. 
2. Evaluate your contractual obligations when transferring goods or services to customers. This will help guide the selection of methods to fulfill performance obligations over time. 
3. Consider the timing and predictability of your revenue streams. Methods such as installments may be suitable if your business receives payments over an extended period, allowing revenue recognition to match cash inflows. 
4. Assess how each method impacts your financial statements. Techniques like the completed contract method can lead to revenue fluctuations, influencing profitability metrics and management decisions.
5. Ensure compliance with ASC 606 guidelines, which have a structured revenue recognition framework.

Zenskar supports all revenue recognition methods

Irrespective of your revenue recognition method, Zenskar automatically adjusts revenue schedules, giving you maximum flexibility to handle your unique revenue recognition scenarios.

• It starts by breaking down contracts into performance obligations, from simple subscriptions to complex multi-element arrangements, to recognize revenue exactly as obligations are met.
• Zenskar lets you create flexible schedules for every revenue type—deferred, unbilled, and unearned and adjust them without disrupting your existing records.
• To match your revenue policies, you can set up straight-line, exact days, fixed periods, milestones, or usage-based recognition methods.

Unlike other rev rec tools, Zenskar decouples revenue recognition from billing, ensuring your revenue performance obligations are independent of invoiced items. This provides a more reliable and precise view of financial performance—helping businesses like Yembo eliminate revenue leakage by 100%. You can take an interactive product tour to see us in action, or book a custom demo to see how Zenskar can help you automate revenue recognition.

Frequently Asked Questions

1. What is the most common revenue recognition method?

Here are the 5 standard revenue recognition methods outlined in the ASC 606 framework:

1. Sales-basis method: Recognizes revenue at the point of sale.
2. Percentage of completion method: Recognizes revenue based on project milestones.
3. Completed contract method: Recognizes revenue after contract fulfillment.
4. Cost of recovery method: Recognizes revenue only after recovering all costs.
5. Installment method: Recognizes revenue as payments are received.

2. Are the revenue recognition methods industry-specific?

Yes, industries follow preferred methods based on regulatory requirements and business models. For example, SaaS companies typically use the accrual method, while construction firms use the percentage-of-completion method.

3. How does each revenue recognition method affect the financial statements?

Revenue recognition affects financial statements by influencing reported income and tax obligations.

4. What are the five steps of revenue recognition?

The process of revenue recognition involves five key steps —-

1. Identify the contract
2. Identify separate performance obligations
3. Determine the transaction price
4. Allocate transaction price to performance obligations
5. Recognize revenue when each performance obligation is satisfied

5. When should revenue be recognized?

Revenue should be recognized when control of goods/services transfers to the customer, typically at a point in time or over time, per ASC 606's five-step model for performance obligations.