Preparation for the new Revenue Recognition Standard (ASC 606 / IFRS 15) has taken on greater urgency. The commission accounting standard has been in effect for public companies since December 2017. The deadline for private companies to implement is December 2018. Subtopic 340-40, known as “the incremental costs of obtaining a contract,” has a huge effect on how companies' commission accounting.
At our CompCloud on the Road event in Austin, Xactly customers participated in a commissions accounting roundtable to discuss lessons learned and tips for transition.
To help you prepare and transition smoothly, here are three steps to estimate your commission accounting amortizations.
Step 1: Evaluate the Compensation Strategy
Examine the products and services you sell.
Under the commission accounting standard, there's no need to amortize if your offering is a one-time point of sale because there’s no capitalization. However, many POS transactions still have a financial tail that will require capitalization, i.e. for ongoing maintenance and support. Take car sales, for example. Imagine an auto company sells a car and the deal includes a multi-year service plan. ASC 606 commission accounting requires any associated commission expenses to be amortized.
A solution or service renewed or supported over a period longer than a year does not require the amortization of commission expenses.
Take time to understand the fiscal strategy behind your commission policy.
Sales incentive strategy isn’t an area of expertise for most accountants, but to comply with the new standard, accounting needs to understand why base and variable pay vary across compensation plans. Recognize the behaviors you’re trying to drive with different sales commissions.
Determine which plans have longer-term returns.
Identify the commission plans with payments that you expect will have value beyond the current year. These are your sales commissions that are potentially amortizable, representing your input for the amortization process.
Step 2: Evaluate How You Determine the Amortization Period
The new standard follows a principle-based approach – a big change for U.S. accountants accustomed to rule-based systems. Perhaps no area of the standard requires greater judgment than determining the amortization period.
To build a plan for the amortization period, accounting should evaluate the long-term benefits of the commission being paid. They must also identify the inputs that provide the basis of that benefit. Then, for each input, organizations must decide the typical amortization period based on contract term and anticipated lifecycle, (i.e. how long do you expect to do business with a customer above and beyond the contract term.)
There are obvious inputs and less obvious inputs that can be very complex.
In the SaaS model, companies identify some inputs easily, such as the original contract term and anticipated renewals that extend the customer life.
Product turnover is a less obvious input. For example, if customers bought your product two years ago, it may not be what you’re offering today. The product itself may be obsolete, as can happen with technology products like computers and smartphones. Therefore, because what you sold two years ago may no longer be what you’re offering today, this can be a limiting factor for the amortization period.
That is, even though your customer lifetime maybe longer, if the technology turnover is shorter, it can affect the input for estimating the amortization period.
Step 3: Evaluate How You Determine the Amortization Method
You don’t need to amortize expenses evenly; however, you need to make a case for your amortization methodology. For example, if you determine that the amortization period is 24 months, you could expense 1/24th each month, but it doesn’t necessarily have to be that way. Companies may expense 2/3 the first year and 1/3 the second. Regardless, whatever path companies choose, they must be able to justify the rationale behind making that decision.
Portfolio expensing is another possible option. You may be able to group or “bucket” commissions by product type, region, or go-to-market team, and assign an amortization life for each bucket. However, to follow this approach requires a high sales volume. If you only have a few big deals a quarter, it won’t work, as there’s too much variability in the contracts and the delivery periods.
Your Customer Lifetime Affects Your Commission ROI
Why is this change required? When a company provides a sales rep with variable compensation, they can be paying the rep to bring in a customer for longer than the initial contract term. Businesses don’t expect to have customers for just one year; they expect to retain customers for a longer period of time. In fact, the time you retain a customer determines your ROI on that commission payment.
Many companies assume this portion of the standard does not apply to them. Rather, they think ASC 606 applies only to software-as-a-service (SaaS) businesses. That’s incorrect. Unless you’re selling a one-time POS product or service, the standard likely affects your commission expense accounting.
Making Commission Accounting & Amortization Easier
Xactly is helping companies transition and adhere to ASC 606 commission accounting standards by automating commission expense accounting. Learn more about how Xactly CEA can simplify ASC 606 compliance and improve sales performance management.