Commission Accounting: Ultimate Guide

Financial Automation
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If you’re an organisation that operates with commissions, then you’re aware of how chaotic commission accounting can become. Commissions create the need for many line items that often move between accounting periods.

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And, with the updated ASC 606 standards (as of 2018), commissions accounting requires accounting teams to view sales according to the lifetime customer relationship. This has led to the need for expense estimates.

We’ll take a look at all there is to know about sales commission accounting. We’ll also see how automation tools can help you better manage the commission accounting process, so you can always ensure the accuracy of your data, and in turn, your books.

Coming Up

1. What is a Commission?

2. What is Commission Accounting?

3. How to Present Commission Expenses?

4. What are the Law Changes for Revenue Recognition?

5. What is the ASC 606 Matching Principle?

6. How to Get the Right Data for Sales Commision Accounting?

7. What are the Best Practices for Commission Accounting?

8. The Bottom Line

What is a Commission?

A commission is compensation for making sales. In many instances, a commission is a percentage of the sales made. While this seems straightforward, it can become tricky when it comes to estimating the overall lifetime value of a customer relationship, as well as recognising expenses and revenues in their proper accounting period.

Companies or individuals who receive commissions will recognise the commissions as commissions revenue. On the other end of the deal is the business that pays the commission. For them, it is realised as a commissions expense.

Sales commissions are not to be considered part of the cost of a product, thus, they are not tied to the cost of goods sold or the cost of goods in inventory. They can be found in the general ledger accounts as selling expenses and on the income statement as operating expenses.

What is Commission Accounting?

When a sale is made with a commission tied to it, then commission accounting comes into play. Commission accounting helps to define how the commission will be recorded, regardless of whether it appears as a revenue or an expense.

Under the accrual basis of accounting, commissions don’t need to be received to report them as revenue. The company will document the commission as an accrual adjusting entry to report the commissions revenue on the income statement. On the balance sheet, there will be commissions receivable.

Then, when the revenue is realised, the expense is, too. This is part of the ASC 606 matching principle, which we will touch on in more detail shortly.

How to Present Commission Expenses?

Similarly, the accrual basis of accounting holds true for commissions expenses too. The adjusting journal is used to record the commissions expense on the income statement. It is also listed under commissions payable on the balance sheet.

What are the Law Changes for Revenue Recognition?

Since December 2017, public companies have been under compliance of ASC 606 (IFRS 15), whereas private companies have been under compliance since December 15, 2018.

In 2018, the Financial Accounting Standards Board (FASB) in the United States updated the Accounting Standards with regard to revenue recognition.

The ASC 606 regulation states that companies need to track commission expenses more granularly and be able to produce an audit trail to show:

  • The term of the contract
  • How the commission benefits the company as the seller
  • The impact of commissions paid
  • The amount of time in which to amortise the expense

Without ASC 606, sales commissions were allowed to be calculated at the end of the reporting period or year. This made the expense as straightforward as any.

With the ASC 606 revenue recognition standards, companies need to report commissions as forecasted estimates. The estimates depend on variables that are constantly changing, which is why it can become a tedious task to do without the aid of automation solutions.

These estimates are based on the customer relationship and expected revenue that will be generated from sales. Since the customer relationship is ever changing and affected by multiple variables, it requires up-to-date and accurate data to create estimates that are likely to occur in reality.

Given the updated standards, there is a need for two notable extra steps during each accounting period, namely adjusting journal to reflect 606 recognition of the expense, and a scheduled journal to amortise the existing book of commissions payable.

What is the ASC 606 Matching Principle?

The ASC 606 matching principle is another standard to be aware of. When the company books the revenue from a deal, only then will the commission expense be recognised.

For example, let’s say that a sales person makes a sale with a commission today. However, the company will only receive the revenue for the sale in two weeks when the goods are delivered to the customer. The expense of the sales commission is only put on the books when that same revenue is recognised. This means that commissions become a deferred expense, only to be realised at a later point in time.

How to Get the Right Data for Sales Commision Accounting?

Given the many moving parts of commission accounting, it makes sense that one of the most crucial aspects in getting it all right comes down to the data. The biggest challenges that organisations face in terms of ASC 606 commissions accounting are based around data.

Firstly, data needs to be available and detailed. Secondly, it also has to be properly managed and recorded.

Accounting teams must use historical data to forecast and make estimates with regard to customers. Keep in mind that customers can suddenly churn, which will naturally affect the estimates. Additionally, there’s the amortisation factor that requires journal entries accounting processes.

Dealing with data across spreadsheets, especially when it comes to commissions accounting, can get ugly quickly. Data may be missing, hard to locate, duplicated, or even just incorrect.

That’s why it’s of great importance to utilise data automation tools to aid in the data processing:

  • Rid your company of manual spreadsheets and implement a financial accounting software that can adequately and easily collect, manage, and cleanse your data
  • The automation solution will also provide a centralised repository for data with access controls
  • You can use this tool to automate compensation administration processes
  • This also grants you with the ease of pulling audit reports and trails within seconds

What are the Best Practices for Commission Accounting?

For starters, you can see how data automation solutions will make ASC 606 commission capitalization and accounting simple to manage.

But, to make sure that you comply with commission accounting standards, be sure to:

  • Recognise expense commissions costs within the same accounting period when revenues are realised
  • Center your amortisation schedule on when the product will be delivered and the timeline it takes for the company to receive benefits, rather than the sales effort levels
  • Find a technological partner/software-as-a-solution provider that can help you organise your data with detail and accuracy
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The Bottom Line

While there are many ins and outs of executing commission accounting, the underlying need remains the same regardless of your business, and that is, the importance of having accurate and accessible data. You can easily follow any accounting rules or make amendments for updates that may come into play if you have the proper tools available.

Financial automation solutions can collect data, securely store data, match transactions, and produce audit reports in minutes so that you can always ensure that your accounting processes are remaining compliant.

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