4 Ways CFOs Can Prepare for Commission Accounting Changes with ASC 606
Keeping up with regulatory changes is always a top priority for the office of the CFO. These issues have taken on even greater importance this year given the pending requirements of the new Revenue Recognition Standard. To examine the key issues and the effect on your accounting practices, Xactly is pleased to join The CFO Alliance in a webinar next month.
In the webinar, we will discuss how the standard affects the payment of commissions. Commonly referred to as the “incremental costs of obtaining a contract”, this is addressed under ‘subtopic 340-40’ in the new standard – and changes how you manage the accounting for incentives and commissions paid to anyone in your organization.
Many companies – mistakenly – don’t think this portion of the standard applies to them. There’s a misperception that the principle primarily affects software-as-a-service companies. Subsequently, the majority of organizations haven’t taken steps to prepare for the changes. But, the reality is that, if you’re paying any type of commission, you most likely have something that needs to be accounted for under the new rule – requiring, in essence, that you capitalize your commissions at inception and then expense them in a systematic way as you provide goods or services to the customer.
This is a complex issue, and everyone is struggling to understand what’s needed here in order to remain GAAP compliant. To make the process easier, I’m sharing a few recommendations.
1. Educate your team
To be effective in accounting for commissions, your accounting team first needs to understand the purpose and intent of sales commissions. The main purpose of a sales incentive is to drive desired behaviors that result in higher revenue. However, sales commissions can be applied in dozens of different ways, and commissions also vary from sales role to sales role, as well as by sales performance level.
Since your team will be working within a principle-based system under the new standard, this means that they have to make judgments to account for sales commissions – not exactly in the typical comfort zone for most accountants. To make sure the accounting team is prepared and confident, the office of the CFO needs to be sure they’re fully educated about sales.
When you consider all of the complexities, it’s also clear that the right resources need to be applied to managing this task. Consider getting someone to manage this problem for the organization. If you do so, just take care that the person you assign has enough experience to manage the requirements, i.e. this isn’t a job for payroll accounting but, rather, revenue accounting.
2. Ensure access to the right data
To meet the requirements, you now need to account for commissions to a deeper level of detail. You must monitor direct and incremental costs for each revenue contract. If your organization uses spreadsheets to track commissions, you’re probably just aggregating payments at the rep level. Now, you have to add in the customer level and, potentially, even drill down to the order level.
You need a system in place that gives you the ability to access and quickly track the right transaction details. Here’s the rub. While there are automated sales performance management (SPM) solutions that can do that for you, including Xactly, you still need to go back in time to be GAAP compliant. That’s because there’s also a two-year look-back period for 2016 and 2017. So companies need to be able to show who got paid, what was paid for, and the commission amounts per customer going back two years before the standard goes into effect.
Some of our customers are going through spreadsheets to pull all of their commissions from the past two years and transferring their numbers into a SPM system. This requires loading historical data and making recalculations. Even so, you’re still probably not going to have everything you need, as most spreadsheets don’t have data down to the customer level. That information may need to be pulled from a CRM, such as Salesforce.
3. Understand how you pay different plans
Before you can even implement a course of action, accounting must understand your company’s sales commission strategies. You need this in order to back up how you make decisions
Your accounting team needs an understanding regarding the rationale behind different variable pay levels. For example, they need to understand why one sales role, i.e. a ‘hunter’, has a higher variable pay than another, such as a ‘farmer.’
In general, the impact that the salesperson has on the buying decision influences the percentage of variable versus base pay. Additionally, there are many special commissions, such as bonuses, accelerators or SPIFs. Accounting needs to understand how they’re applied and why they matter to the business.
Each incentive plan also needs to be evaluated as to whether an element can be simply expensed. For example, 50 percent of a sales manager’s variable pay might be based what gets sold, and 50 percent on managerial capabilities. So, the variable compensation that relates to managerial capabilities can be expensed.
4. Estimate your customer lifetime
The new standard requires that amortization be “on a system basis consistent with the transfer of goods or services to the customer.” This requires accounting to expense commission costs over time. To do this, companies need to understand and be able to estimate their average customer lifetime. This requires having insight into typical anticipated recurring revenue, such as upsells and cross sells, for example.
Estimating your customer lifetime is not a one and done process. Your customer lifetime isn’t static – nor would you want it to be so. In a given year, your customer life might increase (or decrease). Your customer lifetime isn’t static, so it requires at least an annual reevaluation.
If you’re paying commissions, you need to understand the new accounting rule changes. We hope that you’ll join us to learn more and be part of the discussion at The CFO Alliance’s upcoming webinar.
Xactly has put together a number of resources to help businesses understand the new Revenue Recognition Principle and its impact on commission expense accounting. You can also contact us here.