U.S. Generally Accepted SaaS Principles

The U.S. Generally Accepted SaaS Principles (USGASP) recognizes the significance of the non-GAAP metric Annual Recurring Revenue (ARR), in offering stakeholders a comprehensive view of anticipated revenue for a full fiscal year on a run-rate basis, assuming a stable operating environment. ARR is especially relevant for rapidly expanding organizations where notable discrepancies may exist between the annualized GAAP revenue and annual run-rate topline metrics.

ARR Types & Churn

USGASP outlines the following guidelines for the calculation and presentation of ARR, categorized as follows:

ARR: Traditional run-rate revenue for standard annual recurring contracts
ARR-M: Annualized monthly contracts (MRR Annualized)
ARR-C: Calculated ARR, taking into account factors such as ramp and usage
ARR-G: Annualized GAAP Recurring Revenue
CARR: Contracted ARR
Additional Managerial Recognition
Churn

When presenting ARR, it is imperative to specify the particular category or type of ARR in accordance with US GASP (ex. ARR-G or ARR-C). This clarification is essential for ensuring that stakeholders can accurately interpret the financial metrics presented.

1. ARR

ARR refers to the annual revenue generated from recurring software or service agreements that have a minimum contractual term of twelve (12) months. These agreements must meet the minimum standards outlined here for recognition as ARR:

Minimum expectations

The contractual relationship must have a minimum term of twelve months
Contracts that are limited to consulting, onboarding, training, or professional services that are not recurring are not within the scope of this standard
Reasonable assurance of payment collection is present
The contractual obligations must not be subject to known potential breaches due to, but not limited to, the following:
1. Representations made by employees that deviate from the terms established in the agreement
2. Uncertainties related to the counterparty's ability to fulfill its obligations, including funding, product development, or internal targets
3. Reorganization proceedings or other processes that may negate the contractual agreement
The agreement must not include provisions for termination with convenience during the initial term unless the following conditions are met:
1. The inclusion of termination for convenience provisions is necessary for the agreement to be approved by the customer's procurement process (such as FAR 52.249-2).
2. There is reasonable assurance that the product will be delivered in accordance with the customer's expectations.
3. The annual revenue of the customer has surpassed the pre-determined revenue threshold set by internal controls. This provision is constructed with the intent to limit the application of convenience termination clauses predominantly to sizable establishments that require such stipulations for their procurement procedures.
4. In ARR reporting, the % that is subject to termination for convenience is footnoted
The agreement must not include acceptance criteria or feature dependencies unless the following conditions are met:
1. There is explicit approval from the departments responsible for delivering the product or features.
2. There is reasonable assurance that the product or features will be delivered within the contracted period.
ARR may be recognized at the time of dual execution of contracts, given the following condition is met: The contract start date must fall within 30 days from the date of execution. If beyond 30 days, then the contract would be recognized in CARR but not ARR
Only the recurring portion of a contract is recognized as ARR. Revenue considered as 'one time' does not contribute to ARR figures.

Churn & Additional Managerial Conditions are addressed in section 6 & 7

2. ARR-M

ARR-M is computed by annualizing the MRR generated from recurring software or service agreements. The purpose of introducing the "M" notation in ARR-M is to clearly signify to investors that the contracts are not based on an annual term. This notation aims to establish an expectation of a non-annual contract duration. Such clarification is in alignment with disclosure requirements designed to improve both transparency and comparability in financial reporting.

Minimum expectations

The existence of a renewal option and there is reasonable assurance of the continuation of the relationship.
Reasonable assurance of payment collection is present
The contractual obligations must not be subject to known potential breaches due to, but not limited to, the following:
1. Representations made by employees that deviate from the terms established in the agreement
2. Uncertainties related to the counterparty's ability to fulfill its obligations, including funding, product development, or internal targets
3. Reorganization proceedings or other processes that may negate any agreement between the company and customer
The agreement must not include acceptance criteria or feature dependencies unless the following conditions are met:
1. There is explicit approval from the departments responsible for delivering the product or features.
2. There is reasonable assurance that the product or features will be delivered within the contracted period.
ARR-M can be recognized at the time when both contracts are executed or upon the product's sign-up with comprehensive billing information provided. This recognition is conditional upon the contract's start date commencing within a 30-day period from the execution date.
To maintain the accuracy and consistency of ARR-M, it's crucial to annualize the MRR taking into account the exact number of days in the selected month in the calculation. This approach prevents the potential for overstated results due to variability in the number of days per period.

3. ARR-C

ARR-C denotes a specialized variant of ARR tailored to reflect company-specific/industry calculations. The calculation for ARR-C may incorporate considerations such as full customer onboarding, maximized utilization of services, and traditional fully ramped revenue estimations.

Minimum expectations:

Empirical Validation: The ARR-C calculations must be substantiated by a cohort analysis and historical data analysis. These supporting elements should validate that the estimates are not only plausible but also have a high likelihood of realization.
Accuracy Assessment & Adjustment: A continuous monthly evaluation process must be in place to verify the accuracy of forecasted ramps, adjustments, or estimates. The results of this assessment, specifically the accuracy levels attained, must be transparently disclosed to stakeholders. If deviations from previous analysis are quantified, it is the responsibility of the company to adjust the ARR-C to reflect the new data analysis.
Methodology Disclosure: The methodology used to calculate ARR-C must be explicitly outlined and shared with investors, either within financial reports or accompanying explanatory notes.
Internal Control Measures: Internal controls must be instituted to ensure the accuracy and consistency of ARR-C calculation and reporting. This should specify who is accountable for these calculations, the frequency with which they are reviewed, and the personnel responsible for such reviews.

4. ARR-G

ARR-G is composed of annualized recurring GAAP revenue. Please note that this represents GAAP-recognized revenue, annualized for the most recent selected period. The revenue must conform to GAAP policies, including issuances from the FASB such as ASC 606.

5. CARR

Similar policies to ARR, with exception to 1.7 in which the CARR is recognized at time of dual contract execution vs contract start date. Additionally, policies on churn deviate from ARR and are outlined in 7.1.1

6. Additional Managerial Recognition

Stair Step Contracts (SC):

SCs are multi-year agreements that include automatic step-up clauses. This is the methodology for ARR recognition:

Same Product or Service with Built-In Price Increase:
When a stairstep contract pertains to the same product or service, but includes a built-in price increase, the appropriate treatment is to calculate the average ARR over the contract's duration. This averaged amount should be recognized equally in each year of the contract. By adopting this approach, no upsell is recognized.
Inclusion of Additional Services, Seats, Usage, or Products:
If a stairstep contract incorporates clauses for additional services, seats, usage, products, or other value-adds, it is necessary to recognize an upsell. The upsell should be recognized at stair step period start

Free Period:

Often times AEs may offer a free period as a form of a discount. In this scenario the finance team needs to make a managerial decision as it may be recognized in two different ways:

If the contract is anchored on the effective discounted rate:
If for example a company enters into a 15-month contract valued at $100K, with three months offered as "free" - if at the time of renewal there is a reasonable expectation that the initial anchor point for renewal negotiations or upsell will be $80K (i.e., $100,000/15 x 12) then for the purposes of ARR recognition, the contract should be accounted for at $80K and should be recognized in alignment with the type of ARR delineated in the preceding sections.
If the contract will be anchored on the contract value over 12 months:
If for example a company enters into a 15-month contract valued at $100K, with three months offered as “free” - if at the time of renewal there is a reasonable expectations that the initial anchor point for renewal negotiations will be $100K (i.e. recognizing the 3 months as separate and allocating the $100K to the 12 months) then the contract should only be recognized at its full value of $100K after the free period has concluded in ARR (see CARR treatment below). Additionally there must be a reasonable expectation that the renewal amount will reflect the full value of the contract and will be on a 12 month contract basis going forward.

For CARR: You may recognize the full value of the contract as if it were on an annual basis, provided
1. There is no termination for convenience
2. Payment is reasonably assured
3. The free period does not exceed 3 months
  1. In a scenario where the free period exceeds 3 months and/or there is a termination-for-convenience clause and/or the contract is set to renew at the same price for the same duration, the contract should not be recognized until the free period has ended or you may recognize the contract as $/Months x 12
4. There must be a reasonable expectation that the renewal amount will reflect the full value of the contract and will be on a 12 month contract basis.

Pass Through:
In circumstances where the organization enters into a contract valued at $X, and a percentage Y% is allocated to a partner, the appropriate treatment should be as:

If the financial transaction flows from the partner to the organization, ARR should be represented as $X*(1-Y%)
Conversely, if the organization initially receives the payment and subsequently remits the allocated portion to the partner, ARR should be recorded as $X, however, it is incumbent upon the organization to explicitly disclose this methodology when presenting ARR figures

7. Churn

1. Contract Expiry

Contract expires, no renewal:
1. CARR Approach / Conservative Approach:
  Upon receiving an indication from a customer of their intent not to renew a contract, it is advisable to immediately exclude this contract from the CARR calculation. If a major contract has churned prior to contract end date, then it is recommended that a footnote is added to any presentation of ARR that does not include this amount as immediate churn.
2. Standard Approach / ARR:
  In instances where a customer indicates an intention not to renew a contract, the contract should be classified as churned either on the date of expiration if it coincides with the end of a month or quarter, or on the day following expiration for contracts that do not end at month-end or quarter-end. This methodology ensures that there is no overstatement in the ending monthly or quarterly ARR reporting.
Contract expires, in renewal:

In a situation where the customers contract has expired, the company may not be required to recognize churn immediately if the following conditions are met:
1. The renewal will have a start date that is concurrent with the end date of the expired contract
2. There is high confidence that the renewal will be duly executed within 30 days of expiration. "High confidence" shall be formally established by evaluating the rationale for the temporary lapse in contract renewal and by ascertaining that the probability of renewal is as proximate to 100% as feasible
3. In situations where the contract has expired and the renewal has a higher likelihood of not renewing, best practice is to recognize this as churn

2. Uncollectibles

Contracts with customers that are overdue by 90 days and show no indication of remedy or payment should be recognized as churned ARR.
If a company goes bankrupt and has an outstanding balance, the contract should also be recognized as churned ARR
1. In both scenarios, it is suggested that a management footnote be added to provide context for the churn.

3. Recovered

Pre-quarter end - If a contract is recognized as churn within the quarter and won-back or recovered within the same quarter:

It should be categorized as win-back or recovered ARR, with the churn remaining, if the start date of the win-back is not concurrent with the prior end date of the contract
The churn should be reversed if the start date of the win-back is concurrent with the prior end date of the contract.

Post-quarter end - If a contract is recognized as churn within the prior quarter and won-back or recovered in the current quarter:

If a contract is recognized as churn in the prior quarter and won-back or recovered in the following quarter, it should be categorized as win-back or recovered ARR

If two quarters have passed since the original churn date and the contract is won back or recovered, it is at management's discretion to determine whether this is a true win-back or new ARR, based on factors such as the counterparty, contract terms, and product delivery.

8. MRR

Monthly Recurring Revenue (MRR) is a financial metric that represents the predictable revenue a company can expect to generate from its standard monthly subscription contracts.

Accounting Policies: For the calculation and reporting of MRR, companies should adhere to the guidelines set forth above for ARR and ARR-C, with the following exception:

Any policies or clauses specifically related to annual contracts are not applicable when calculating MRR, given its monthly focus.
Additional Considerations:
1. Variable Components: If monthly contracts include variable billing components, such as usage-based fees, these should be carefully considered and appropriately included or excluded in the MRR calculation based on their predictability and recurrence
2. Internal Controls: Similar to ARR and ARR-C, internal controls should be in place to ensure the accuracy and consistency of MRR calculations. These should specify the responsible parties, review frequencies, and any verification processes.
3. Transparency and Disclosure: The methodology employed for calculating MRR should be clearly defined and disclosed in financial statements or accompanying notes for the sake of transparency and comparability.