What happens when an Investor who is interested in your AI Start-up and asks the question about your revenue recognition policy and you do not have any IDEA about ASC 606.
Here’s the thing most AI founders don’t realize that revenue recognition as per ASC 606 actually matters a lot, but most people don’t think about it until an investor brings it up. By that point, you might find out that your revenue numbers (the same ones you’ve been using to show your company’s growth) are actually wrong. And I don’t mean just a little off I mean you might need to go back and restate your entire financials and that is a hectic process.
The reality is, if you’re running an AI or SaaS company and you have paying customers, ASC 606 applies to you. It’s not something you can choose to ignore. If you don’t follow ASC 606, it can cause real problems when you’re trying to raise money.
We have written this guide based on our experience from guiding 25+ AI Companies. Basically, we want to make sure revenue recognition doesn’t mess up your funding round before it even gets started.
About the Author
Parth Shah, CPA is the founder of Countsure with 5+ years of hands-on experiance in Assisting AI Companies for their Accounting, Tax and Advisory needs. He has personally reviewed 100+ audit reports and exception findings across SaaS, fintech, healthcare, and e-commerce companies.
A Certified Public Accountant (US), Fellow Chartered Accountant, Registered Valuer, and holder of a Diploma in Information System Audit, Parth brings Big 4 training from Ernst and Young to his role at CountSure. He specializes in exception prevention, helping companies implement the exact controls and evidence collection processes that auditors expect.
How ASC 606 matters to AI Company and Why AI Companies Must Comply?
ASC 606 is the accounting standard that governs how companies recognize revenue. It replaced the old rules in 2018 and applies to virtually every company that has customers including your AI startup.
The standard exists because revenue recognition used to be all over the place. Some companies recognized revenue too early to make their growth look better and Some companies recognized revenue too late to hide their success. ASC 606 created one consistent framework to achieve the fair presentation.
Here’s when ASC 606 matters for your AI company:
| Contract Characteristics | ASC 606 Requirement | Reference | What This Means for You |
|---|---|---|---|
| Fixed-price software subscription only | Apply 5-step model; recognize revenue over time as service is provided | ASC 606-10-25-27 | Straightforward - recognize monthly/annually as you deliver access |
| Subscription + implementation services | Identify and separate distinct performance obligations | ASC 606-10-25-19 | Must split contract price between software and services based on standalone selling prices |
| Usage-based or variable pricing | Estimate variable consideration; apply constraint | ASC 606-10-32-11 to 32-13 | Can only recognize variable revenue to extent it's probable you won't reverse it later |
| Multi-year contracts with early termination rights | Only recognize revenue for the committed period | ASC 606-10-25-1 to 25-8 | If customer can cancel annually, treat as 1-year contract, not multi-year |
| Contracts with multiple deliverables (software + training + customization) | Allocate transaction price to each performance obligation based on standalone selling prices | ASC 606-10-32-28 to 32-41 | Need to determine what you'd charge for each piece separately, then allocate total price proportionally |
| Free trials that convert to paid | Contract doesn't exist until customer commits to pay | ASC 606-10-25-1 | Don't recognize any revenue during trial period |
The bottom line: If you have paying customers and you’re planning to raise institutional capital, you need proper ASC 606 compliance. Period.
Why? Because when investors look at your financials during due diligence, they scrutinize revenue recognition policies first. If they discover you’ve been recognizing revenue incorrectly, they’ll question everything else about your business. I’ve seen term sheets withdrawn over revenue recognition issues.
Even if you’re not fundraising right now, getting this right from the start saves massive headaches later. Restating revenue downward by 20-30% because you recognized it too aggressively? That’s a conversation no founder wants to have with their board.
The 5-Step ASC 606 Framework for AI/SaaS Companies
ASC 606 provides a five-step process for determining when and how much revenue you can recognize. Let’s walk through each step with examples relevant to AI companies.
Step 1: Identify the Contract with a Customer
This seems obvious, but it’s not always clear-cut for AI companies.
What qualifies as a contract:
- Written agreement (MSA, order form, SOW)
- Clear commitment from both parties
- Payment terms are defined
- Commercial substance exists
What doesn’t qualify yet:
- Free trials where the customer hasn’t committed to pay
- POCs (Proof of Concepts) without a follow-on agreement
- Pilots where conversion to paid is uncertain
AI company example: You offer a 30-day free trial of your computer vision API. The trial itself doesn’t create a contract. The contract starts when they click “Upgrade to Paid” and commit to your annual subscription.
Why this matters: ASC 606 suggests that Don’t start recognizing revenue during trials or POCs unless there’s a clear contract in place.
Step 2: Identify the Performance Obligations in the Contract
This is where many AI companies get tripped up. A performance obligation is a distinct promise to deliver something to the customer.
Common performance obligations in AI contracts:
- Software platform access (SaaS subscription)
- Implementation and setup services
- Data migration services
- Training sessions for the customer’s team
- Ongoing customer success support
- Custom model development
The key question: Can the customer benefit from this element on its own, or is it inseparable from other elements?
Example contract breakdown:
Your AI analytics platform contract includes:
- Annual software subscription ($60,000)
- Implementation services ($15,000)
- Quarterly training sessions ($5,000)
Analysis: These are likely three separate performance obligations because:
- The customer could use the software without implementation (they chose to buy it)
- Training is distinct and happens quarterly
- Each could theoretically be purchased separately
This matters because you’ll recognize revenue differently for each obligation.
Step 3: Determine the Transaction Price
For fixed-price contracts, this is straightforward, it’s the amount the customer agreed to pay. But AI companies often have variable pricing, which complicates things.
Variable consideration scenarios for AI companies:
- Usage-based fees (per API call, per GB processed)
- Tiered pricing with overages
- Performance bonuses
- Credits or refunds for SLA failures
The ASC 606 rule: You can only recognize variable consideration to the extent it’s “probable” that you won’t have to reverse the revenue later.
Example: Your AI platform charges $5,000/month base fee plus $0.10 per API call. Based on the customer’s historical usage during their trial, you estimate they’ll make 50,000 calls/month.
How to handle it:
- Base fee: $5,000/month is certain, recognize it
- Variable fee: Estimate $5,000/month based on historical data
- Track actual usage each month and adjust (true-up)
If usage patterns are unpredictable, recognize variable fees conservatively.
Step 4: Allocate the Transaction Price to Performance Obligations
When you have multiple performance obligations, you need to split the total contract price across them based on their “standalone selling prices.”
Using our earlier example:
Total contract: $80,000
- Software subscription: $60,000
- Implementation: $15,000
- Training: $5,000
Step 1: Determine what you’d charge for each if sold separately
- Software alone: You typically charge $60,000/year
- Implementation alone: You typically charge $20,000
- Training alone: You typically charge $8,000
Step 2: Calculate allocation percentages
- Total standalone value: $88,000
- Software: $60,000 / $88,000 = 68.2%
- Implementation: $20,000 / $88,000 = 22.7%
- Training: $8,000 / $88,000 = 9.1%
Step 3: Allocate the $80,000 contract value
- Software: $80,000 × 68.2% = $54,560
- Implementation: $80,000 × 22.7% = $18,160
- Training: $80,000 × 9.1% = $7,280
Now you know how much revenue belongs to each performance obligation.
Step 5: Recognize Revenue When (or As) You Satisfy Each Performance Obligation
This is where the rubber meets the road when do you actually record revenue?
For AI/SaaS companies, two patterns are common:
Pattern 1: Over Time (Most Common for SaaS)
Recognize revenue as you deliver value across the contract period.
Example: The $54,560 software subscription is recognized monthly over 12 months = $4,547/month
Pattern 2: Point in Time (Common for Services)
Recognize revenue when the service is complete.
Example: The $18,160 implementation fee is recognized when implementation is finished and accepted by the customer.
Putting it all together – monthly revenue recognition for the $80,000 contract:
Month 1:
• Software: $4,547 (1/12 of annual)
• Implementation: $18,160 (completed this month)
• Training: $0 (not delivered yet)
• Total Month 1 revenue: $22,707
Months 2-11:
• Software: $4,547/month
• Training: $1,820 (when quarterly training happens)
This is the proper way to recognize revenue under ASC 606, versus the incorrect approach of recognizing all $80,000 when the contract was signed.
Common ASC 606 Mistakes AI Companies Make
Let’s talk about the mistakes that trip up most AI founders. Recognizing these early helps you avoid expensive fixes later.
Mistake #1: Recognizing Everything Upfront When Customer Pays Annually
What founders do: Customer pays $60,000 upfront for annual subscription. Founder records $60,000 revenue in Month 1.
Why it’s wrong: You haven’t delivered 12 months of service yet. You’ve only delivered access for one month.
Correct approach: Record $60,000 as “deferred revenue” (a liability). Recognize $5,000/month as you deliver each month of service.
Impact on your financials:
- Inflates revenue in early months
- Creates revenue “cliff” when you run out of deferred revenue
- Makes growth metrics (MRR, ARR) misleading
- Red flag for investors during diligence
Mistake #2: Not Separating Implementation from Subscription
What founders do: Bundle implementation fees into the subscription price and recognize it all over time.
Why it’s wrong: Implementation is a distinct service delivered at a point in time, not over the contract period.
Correct approach:
- Identify implementation as separate performance obligation
- Allocate appropriate portion of contract price to it
- Recognize implementation revenue when service is complete
- Recognize subscription revenue over time
Real example: I’ve seen this mistake add $200K+ in “surprise” deferred revenue that companies didn’t know they had, forcing them to restate prior months.
Mistake #3: Guessing at Variable Revenue Instead of Using Data
What founders do: AI platform with usage-based pricing just guesses each month, or worse, waits until actual usage happens to recognize any revenue.
Why it’s wrong: ASC 606 requires you to estimate variable consideration based on expected value, not worst-case or guessing.
Correct approach:
- Use historical data to estimate usage patterns
- Recognize estimated revenue each month
- True-up to actuals when usage is known
- Document your estimation methodology
Example approach:
Month 1: Estimate based on trial usage or similar customers
Months 2-3: Use actual historical data to refine estimates
Month 4+: Pattern should be clear, use rolling average
Mistake #4: Ignoring Multi-Year Contracts
What founders do: Sign a 3-year, $180,000 contract and recognize $60,000/year.
Why this might be wrong: Depends on payment terms and cancellation rights.
Key questions:
- Is the customer committed for 3 years or is it annual renewal?
- Can they cancel without penalty?
- When do they pay (upfront, annually, monthly)?
Correct approach: Only recognize revenue for the committed period. If it’s truly a 3-year commitment with no cancellation rights, recognize over 36 months. If it’s annual renewal, recognize over 12 months per renewal.
What Investors Look For in Your Revenue Recognition ?
When investors conduct due diligence on your financials, here’s exactly what they’re checking regarding ASC 606:
- Documented Revenue Recognition Policy
Investors want to see a written policy that explains:
- How you identify performance obligations?
- How you determine transaction prices (especially variable consideration)?
- How you allocate prices across obligations?
- When you recognize revenue for each obligation type?
What it looks like: A 2-3 page memo explaining your approach with examples.
- Deferred Revenue Balance Makes Sense
Your balance sheet should show deferred revenue (money received but not yet earned). Investors will check:
Does the math work?
- If you have 100 customers at $50K/year paid annually upfront
- Deferred revenue should be around $4.2M (assuming even distribution)
- If it’s way off, something’s wrong
- Revenue Doesn’t Spike Without Customer Growth
Investors graph your revenue over time and compare it to customer acquisition. Red flags:
- Revenue jumps 40% but customer count is flat (indicates aggressive recognition)
- Huge revenue month followed by low months (upfront recognition problem)
- Revenue declining while ARR is growing (timing issues)
- Consistency Across Periods
Your revenue recognition policy should be applied consistently month after month. Changing approaches mid-year without good reason suggests either:
- You didn’t understand ASC 606 initially
- You’re manipulating revenue to hit targets
Both scenarios kill investor confidence.
- Clean Audit Trail
For every revenue transaction, you should be able to show:
- The customer contract
- Analysis of performance obligations
- Calculation of revenue allocation
- Journal entries with supporting documentation
Professional accounting firms like CountSure build these systems from day one, so you’re always investor-ready. Learn more about our ASC 606 compliance services for AI companies.
FAQs
No. Record the full payment as deferred revenue (a liability). Recognize it monthly as you deliver the service. A $60,000 annual payment becomes $5,000/month over 12 months.
No. Implementation is a separate performance obligation delivered at a point in time. Allocate a portion of the contract price to it based on standalone selling prices. Recognize implementation revenue only when the service is complete.
Estimate usage based on historical data or similar customers. Recognize estimated revenue monthly and true-up to actuals when known. Only recognize amounts you’re confident won’t be reversed later. Document your estimation methodology.
ASC 606 applies to any AI company with paying customers it’s not optional. Free trials and POCs don’t create a contract until the customer commits to pay. The contract starts when they upgrade to a paid plan. Compliance is critical if you’re planning to raise institutional capital.
Parth Shah, Managing Director
(CPA-US, FCA, RV-S&FA, DISA)
Parth Shah who is head of Accounts and Book keeping has experience of more than 10 years. A Certified Public Accountant – US, fellow Chartered Accountant, Registered Valuer and Diploma in Information System Audit.
