Sales Commission Accounting: Guide to ASC 606

June 4, 2024
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Sales commission accounting has its fair share of rules. If you’re looking to better understand your sales commission accounting treatment or see how to calculate commission income using automation solutions, then you’re in the right place.

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In this article, we will answer basic questions like, “What is commission income?” and then look at revenue recognition for commission income so you can ensure your books are always accurately reflecting your team’s sales and commissions.

Coming Up

1. What are Sales Commissions?

2. What are the Basics of Accounting for Sales Commissions?

3. What are the Different Types of Sales Commissions?

4. How to Calculate Sales Commissions?

5. How to Record Sales Commissions in Accounting?

6. How to Record Sales Commissions as an Expense?

7. How to Record Sales Commissions as Income?

8. What is the Impact of ASC 606 on Sales Commissions?

9. Why the Need for ASC 606 Regulation on Sales Commissions?

10. How to be Prepared for ASC 606 Regulation?

11. Excel vs Automation for Processing Commissions?

12. The Bottom Line

What are Sales Commissions?

Sales commissions refer to compensation paid for making a sale. They are usually a percentage of the sale that is then added on top of one’s base salary.

Sales commissions are a great tool because they serve to align the incentives of both the company and the employee. Both the salesperson and the business benefit from generating revenue. With sales commissions, salespeople can gain more control over how much they earn and their efforts are tied to compensation.

What are the Basics of Accounting for Sales Commissions?

To prepare for sales commission accounting, there are a few basics that should be laid out. These include:

  1. Defined Structure: What type of commission are you going to pay out? Will it be a straightforward commission or a base salary plus commission, for example? 
  1. Sales Data: There must be an accurate way to record every sale that’s being made by every person on the sales team. Recorded sales data should include: what was sold and the terms of the sale. 
  1. Calculations: The calculations are defined by the commission structure, sales volume, and products sold. Sales representatives know what they earn based on these calculations. 
  1. Recordkeeping: Once commissions are calculated, it’s imperative to store them in the accounting system as a journal entry to document the commissions expense. 
  1. Payments: Stick to a schedule for when sales representatives will be paid their commissions. 

When you implement a sales commission accounting software, all of these elements are managed consistently and accurately.

What are the Different Types of Sales Commissions?

Since defining a commission structure is the basis of any commissions schedule, let’s look at the different types of sales commissions. 

1. Straight Commission

In the case where there is no salary and sales representatives only earn commission, it’s considered a 100% commission position. This means that their pay isn’t guaranteed, it’s fully based on their performance. 

2. Tiered Sales Commission

For organizations that want to motivate their sales team and top producers, a tiered sales commission could be the way to go. It’s set up such that representatives who surpass a specified threshold will earn higher commission rates. This type of commission is also called multipliers, multiple rate, or escalators. 

3. Base Salary and Commission

A popular commission structure is that of base salary, plus commission. In this case, sales team members earn a set salary, and then an additional commission on top of that for making sales or hitting targets. 

4. Gross-Margin Commission

Gross-margin commissions take into account a business’ profits from a sale as part of the commission calculation. Thus, a sales rep earns commission based on the total revenue collected rather than accruing commissions based on the contract value. 

5. Single-Rate Sales Commission

A fixed-rate, or single-rate, sales commission is variable pay that is based on a fixed percentage of every deal that’s closed. 

How to Calculate Sales Commissions?

Knowing how to calculate sales commissions is based on several factors, which span:

  • Commission Structure: From the list above, it’s clear to see there are different types of commission structures. Whichever one your business employees will dictate how commissions are calculated.
  • Sales volume: When salespeople sell more, they tend to earn higher commissions. 
  • Sales terms: It’s possible for the commission calculations to be based on the terms of the sale. For example, are you calculating off of weekly, monthly, or annual sales volume?
  • Product Sold: The commission rate may depend on the type of product or good that was sold. 

How to Record Sales Commissions in Accounting?

When it comes to accounting for sales commissions, the way you execute will depend on whether you use the cash basis or accrual basis method.

For the sake of this article and the ASC 606 regulation, we will be focused on the accrual basis method. The accrual basis recognizes the revenue when it is billed and earned, regardless of when the cash is paid or received.

So, if your salesperson makes a sale today, but only gets their commission check during next month’s pay day, you will be recognizing the revenue at the time of the sale this month.

How to Record Sales Commissions as an Expense?

Sales commissions are a selling-related expense, and as such, they are considered an operating expense. This is the case if the sales relate to the company’s core activities. If they are not part of the core activities, then they can be recorded under “other expenses.”

In most cases, the operating expense of a sales commission will be categorized under SG&A (selling, general, and administrative).

Sales commissions are considered an expense if your company is paying out commissions to a third-party (i.e. salesperson). If your company is earning commission, then it’s considered revenue (we’ll touch on this in more detail in the next section).

Another important thing to note is that sales commissions should never be recorded as the cost of a product. Lastly, as part of the ASC 606 accounting regulations, you need to correlate each commission to a customer and may need to be able to amortize the expense.

How to Record Sales Commissions as Income?

When a company earns a sales commission, it is revenue. This could be the case when a business makes sales on behalf of another business.

If the commissions are part of the company’s core operations, then the commissions earned are considered operating revenue. If it’s not part of the core operations, then it’s recorded as other income.

As is the case when commissions are paid, commissions are recorded as soon as they are earned under the accrual basis of accounting.

What is the Impact of ASC 606 on Sales Commissions?

The Federal Accounting Standards Board (FASB) introduced a revenue recognition standard called ASC 606 which was initiated some years back. With the main goal of creating a common way to recognize revenue for contracts with customers that adhere to international standards, the regulations have had great effects on accounting for sales commissions.

Along with the compliance impact, the regulation calls for those accounting for sales commissions to identify and track commissions with immense detail.

In effect, managing commissions across manual spreadsheets will not be enough. ASC 606 calls for commission expenses to be amortized over the anticipated life of the customer when the contract is longer than a year.

You can imagine how this could become complicated quickly when data is decentralized, especially given that there’s forecasting involved. Moreso, when a new sale is made to the same customer, the team must then figure out if this will affect the overall life of the customer, thereby affecting the amortization schedule.

Why the Need for ASC 606 Regulation on Sales Commissions?

You may be wondering why the ASC 606 regulation came to be in the first place because it seems to complicate the process of sales commission accounting. While it does complicate the process manually, you can utilize an automation solution to make it easy again.

Before this regulation, the revenue recognition standards for sales commission accounting were not aligned between the United States’ generally accepted accounting principles (GAAP) and the International Financial Reporting Standards (IFRS).

In response, the FASB and International Accounting Standards Board (IASB) jointly created this initiative to unite the accounting standards globally.

How to be Prepared for ASC 606 Regulation?

To ensure that you are adhering to ASC 606 regulation, there are some key considerations to be aware of.

Sales teams and compensation administrators need to be connected and communicative with the accounting and audit teams. For starters, it’s important to document and standardize the processes within your organization for dealing with sales commission accounting.

From there, you’ll want to take a look at these key factors:

1. Data

Make sure that you have all the required data from sales and commissions. This data should answer questions regarding the sale itself, commission amount, amortization schedule, expected life of the customer, etc.

2. Calculations

Review your calculation rules to make sure that they provide the necessary level of detail for analysis.

3. Reporting

Can your data easily be transformed into reports and interpreted by those who are not directly involved in the sales commission accounting process?

4. Security

Is your data being securely stored? Can it be accessed by those who need access? Are there historical data points for reference so that you can accurately determine the expected life of a customer tied to any commission?

These are some of the main concerns and necessities you’ll need to take care of when adhering to ASC 606 regulation, without having to get too deep into the technicalities. Financial automation solutions take care of all these considerations for you.

Excel vs Automation for Processing Commissions?

Excel can be a powerful tool, but it has its fair share of limitations. And, as data and the amount of commissions grow, the more complicated it will become to take care of it via spreadsheets.

A data automation tool can manage complex commission reporting at scale, without sacrificing the accuracy of the data. Software solutions will allow you to calculate commissions effectively, improve relations with your sales team (and in turn, customers), simplify the administration of sales commission accounting, and make it easy to run reports or audits.

Sales commission accounting becomes simple with an automation solution. It provides for a centralized system of secured data. The tool will be able to collect data from disparate systems, store data, and transform it into reports and easily understandable dashboards for users to access.

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The Bottom Line

ASC 606 regulations have been in practice for years. Many organizations struggle with sales commission accounting, especially when executing processes manually and trying to remain compliant.

Instead, your business can leverage a financial automation tool that can handle sales commission accounting and adhere to all regulations, whether they stay the same or change in time.

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