Companies that sell goods, technology or services usually rely on a sales staff to close deals and add new customers. Incentivizing sales teams with commissions is a long-standing practice to motivate individuals and contributors to close more deals and reap the benefits.
The evolution of the sales organization structure added additional sales staff to source and support the account executive focused on deal closing. The additional sales headcount meant more distribution of the commission pie, with different roles receiving different percentages of the total commission, which can complicate revenue recognition for accounting purposes. In this post, we breakdown commission schedules, amortization and how to revenue recognition standards of ASC 606.
Commission percentages or schedules determine the percent of the sales revenue to be paid to the associated salesperson. If you have inaccurate data or errors, it will result in amortizing too little or too much if the percentage is not correct causing inconsistencies in your financial reporting.
Companies are required to amortize commissions for tax purposes and generally accepted accounting principles (GAAP). Based on GAAP, you want to always book the commission at the time the revenue is recognized and amortized over the period of the service. Be sure you have a clear understanding of your contract terms, the typical contract lifecycle as well as any anticipated renewals.
ASC 606 is a revenue recognition standard for a cost that was incurred to obtain a customer contract, such as a commission, the commission details must be accounted for. If the commission is tied to a contract being executed and expected to be recovered by future cash receipts generated directly from the contract, then they need to capitalize on the commission at the time the deal is closed and amortize it over the period the service was delivered.
You are required to expense commission over the life the service is delivered, including potential renewals. When it comes to deferred commission, if there is a delay in delivery of the service, causing a delay in revenue recognition, then the commission expense is deferred. Oftentimes, rates vary based on different products, terms, tiers or quotas, triggering a different rate.
Make sure you review for items like correct dates and potential obsolete products, which may limit the amortization period. You must justify the way the commission expense is recorded, such as spread out by month, 50 percent upfront and 50 percent on the back end. Without insight into these breakdowns, it is nearly impossible to correctly amortize and recognize the revenue for ASC 606 standards.
You want to compute commission costs across time, which requires a commission schedule breakdown as reference point. The commission schedule is updated based on the person closing the deal or amount of reps involved, and the rate assigned to them by deal type and who rolls up is all pre-defined.
The Total Value Column represents the combined amount of commission schedule when you add up all of the salespeople’s percentage for a deal. As you move down, each deal closed by the salesperson on the left reflects their percentage. A commission schedule should be a template for you to work from as you compute your commission amortization and accruals.
Although you can certainly use Excel to get you started, trying to manage commission amortization with Excel, like any accounting or finance task, has its limitations. As data sets grow larger and more complex, the potential for errors compound. Add in the fact you are dealing with fellow employees' compensation, and a mistake as simple as pasting a value into the wrong column can result in serious miscalculations that are easy to overlook.
Excel can be the right tool for the job up to a certain point, like using a wrench to secure in a nail when a hammer isn’t readily available. Sure, it might get the job done for now, but at what cost? Did the following potentially occur:
This is precisely how Excel works for growing companies, who might require more sophisticated accounting and finance tools. Massive spreadsheets can result in simple to make, but costly errors such as: duplicate lines, wrong start month, errors in formulas across many columns, processing early terminations, incorrect rates assigned and reference errors — just to name a few.
Managing commission amortization and reporting in an FP&A Platform gives you the power to automate data wrangling efforts and eliminate the potential for manual errors. Once established, commission rate structures can be easily maintained in a Platform. With a dedicated, robust Platform, making a change to one person’s percentage will carry throughout the schedule, error free.
To infuse planning and analysis to your commission amortization, you could plan for various scenarios and forecast based on salespeople hitting their quota, and how that can impact revenue and amortization. Your management team and sales executives will be very interested in seeing the potential outcomes of these quota scenarios and how adding new salespeople might impact the top and bottom line.