Accounting for Sales Commissions
How does the commission expense get classified?
This part is easy – it is the “S” in SG&A: Selling, General and Administrative expense. SG&A includes the direct and indirect costs associated with selling a given product. Commissions are part of the direct costs that occur when the product is sold, while the salaries that sales reps earn are in the indirect costs of SG&A.
One challenge: The Matching Principle
The matching principle is the alternative to cash basis accounting, where the company recognizes the expense based on when it is paid. The matching principle states that the company will book the expense during the period when they are incurred, not necessarily when the expense actually happened. This hits sales commissions by having the company book the commission expenses when the company books the revenue from the deal the rep closed. So if the company has to hold off on booking the revenue, then they also need to hold off on booking the expenses. Commissions can then become a deferred expense.
Download the Executive Summary "Commission Expense Accounting under ASC 606 (IFRS 15)" to learn how to prepare for the new standards.
Changing laws regarding revenue recognition
In the United States, the Financial Accounting Standards Board (FASB) released a new Accounting Standards update regarding revenue recognition, which impacts how companies need to account for the associated commissions expenses. Companies will need start tracking commission expenses at a more granular level:
- The term of the contract, and how any given commission in the customer relationship benefits your company as the seller
- The right amount of time over which to amortize the expense
- The impact of all commissions paid
More information on the Revenue Recognition Requirement changes.
Getting the data in order to manage the commission expenses
When it comes to sales commission treatment, companies will need to be able to separate out the commission expenses for different revenue lines. This means that a commission for a product whose revenue is booked on schedule will need to be separated from the commission for the delivery that books its revenue on a different time frame. There are several steps to take to help with the data challenges of the new standards.
Two key points to remember:
- Commission costs should be expensed over the term for which the company receives benefits. This could be the contract term for some companies – but this isn’t the case for most companies.
- Relevant effort should not be used to determine the period of amortization of the revenue, or the matched commission expenses. It’s not a level of sales effort that determines the amortization, but the time in which the related product will be delivered.
With the new revenue recognition rules, companies need to get their data and systems in order ASAP. Managing the disparate data flows, tracking the commissions at the line-item level, and easily reporting on the different streams to match can be configured in Xactly to match the company’s needs.
Managing Commissions Under the New Revenue Recognition Standard
The vast majority of businesses are unprepared for commission expense accounting, more commonly known as the costs of obtaining a contract.