Sales commission accounting overview: what is ASC 606?

Sales commission accounting is the process by which organizations manage their commission-related finances. Accounting for commission expenses gives you a more holistic view of your finances. Therefore, it’s essential to determine how to include commission expenses in income statement reports for more accurate financial reporting.

But many businesses still struggle to adequately account for commissions, especially large companies with multiple commission types. Regardless of company size, failing to account for commissions, or misreporting them, can lead to a massive headache down the road.

In this high-level ASC 606 guide, we’ll cover:

  • The fundamentals of sales commission expense recognition under the standard
  • How it differs from previous standards (its significance)
  • How you can more easily amortize commissions with CaptivateIQ

The fundamentals

The Financial Accounting Standards Board (FASB) establishes financial standards and is an excellent resource for learning more about sales commission accounting. By remaining up to speed with FASB’s latest guidelines, you can help ensure adequate financial reporting and improve business operations all around.

The Generally Accepted Accounting Principles (GAAP) issued by FASB are designed to promote greater transparency in financial reporting and are thus important for businesses wanting to improve how they manage their finances.

ASC 606 is one of FASB’s most important — and recent — standards.

According to FASB’s Accounting Standards Updates, ASC 606 went into effect for public businesses for annual reporting periods beginning after December 15, 2017, and it went into effect for private businesses for annual reporting periods beginning after December 15, 2019*.

As this is the current standard for revenue recognition under GAAP, all organizations that follow GAAP and enter into contracts with customers to transfer goods or services must comply. Organizations subject to ASC 606 must also understand the impact of this standard and how to best implement it into their revenue recognition practices.

What’s the purpose of ASC 606?

In a nutshell, this standard outlines how businesses that follow GAAP are to handle revenue recognition. It’s designed to standardize the process of accounting for and recording revenues.

ASC 606 made three critical changes to the existing revenue recognition model:

1

How contracts are defined:

It more clearly defines contracts with customers so income can be easily accounted for later

2

When to recognize revenue:

It explains when to recognize revenue, providing a more flexible definition of what’s considered a transfer of goods or services.

3

How much is recognized:

Revenue can now be easily amortized in subscription or scheduled payment models.

Moreover, businesses are no longer required to have a strict signed agreement to recognize revenue. Instead, businesses can acknowledge revenue once they have delivered enough of a good or service to satisfy a contractual agreement.

How the new standard differs from ASC 605

The change from ASC 605 to ASC 606 helps to make revenue recognition more standard across all industries. And there are several notable changes.

ASC 605 gave businesses the option to expense or capitalize their sales commissions. ASC 606 only lets businesses capitalize commissions. This spreads revenue out since commissions will be amortized. In other words: Immediate revenue will increase in the sale period, but the commission being amortized means that revenue is less in the long term until the commission has been entirely accounted for.

Additionally, ASC 605 made it so software sales could only be split into two revenue parts — one for support and one for the product itself. ASC 606 makes it easier to define a multitude of revenue parts.

ASC 605 required companies to record variable revenue as it happened. ASC 606 requires estimating variable revenues for the product life cycle. This means recognizing more revenue upfront.

ASC 606 doesn’t include sell-through revenue recognition. So under ASC 606, businesses must now recognize revenue when they sell to a reseller (instead of when the reseller delivers the product to a customer). Businesses will need to estimate returns and price changes when recording initial revenue.

In short, the most significant change from ASC 605 to 606 is that businesses now recognize more upfront revenue and will see expenses spread out since commission is amortized.

How ASC 606 compares to IFRS 15

While the ASC 606 and IFRS 15 standards generally follow the same five steps, there are some notable differences: one of the main ones being that IFRS 15 is for international businesses.

Contract Costs: IFRS 15 allows for the limited reversal of impaired contract acquisition or fulfillment costs, which is prohibited under ASC 606.

Non-Cash Transaction Price Measurement: Under ASC 606, non-cash transaction price must be measured at fair value when the contract begins. IFRS 15 has no specific date for measurement and fair value can be considered at a reasonable time.

Transaction Price Sales Tax: Under ASC 606, all sales tax must be presented on a net basis. Under IFRS 15, companies can evaluate if third parties collect sales taxes on a jurisdiction-by-jurisdiction basis.

Shipping and Handling: Under ASC 606, shipping and handling are treated as fulfillment activities after the customer has control of the goods. Revenue and costs are recognized upon transfer. Under IFRS 15, the company decides if shipping and handling is a distinct performance obligation. Revenue is allocated to shipping and handling, which is deferred until the obligation is met (if it’s determined to be a performance obligation).

Completed Contract Definition: Under ASC 606, the contract is complete if all revenue is recognized under legacy GAAP. Under legacy IFRS, it completes when all goods and services are transferred, regardless of revenue recognition status.

Interim Disclosures: ASC 606 is similar to annual disclosure for interim disclosures. IFRS 15 has fewer disclosure requirements.

Sales Outside of Ordinary Activities: Under IFRS 15, the measurement and derecognition guidance applies to nonfinancial assets like property, plant, equipment, or intangible assets. Under ASC 606, the contract existence, separation, measurement, and derecognition guidance applies to nonfinancial assets and in-substance nonfinancial assets (as scoped in ASC 610-20). The key difference between ASC 606 and IFRS 15 is that many more nonfinancial assets will be included under ASC 606 than IFRS 15, as the former follows guidance that nonfinancial assets would not follow under IFRS 15.

Onerous Contracts: Under IFRS 15, onerous contracts are accounted for under provisions, contingent liabilities, and contingent assets. There is no general guidance under ASC 606.

Remaining Performance Obligations Disclosures: Under IFRS 15, there is disclosure relief in two situations: if the contract is one year or less or if the entity qualifies for the practical expedient to recognize revenue in the amount that it has the right to invoice. ASC 606 has the same disclosure relief situations in addition to two more: It is a sales or usage-based royalty for a license of intellectual property or meets the criteria to be allocated entirely to a wholly unsatisfied performance obligation.

What is ASC 340?

ASC 606’s guidance for how companies must report revenue recognition also changed ASC 340 — and that’s where the commissions accounting rules live. ASC 340 is promoted by FASB and addresses how costs incurred by means of obtaining or fulfilling contracts with customers should be accounted for. It includes four subtopics:

1

Overall,

2

Capitalized advertising costs,

3

Insurance contracts that do not transfer insurance risk, and

4

Other assets and deferred costs — contracts with customers.

ASC 340 targets matching the time at which costs are incurred with the time that revenue is recognized. The timing may not be for the actual contract closed; it can be for an estimated customer life as well.

Now, let's briefly explore how companies can record commission journal entries.

How to book a commission journal entry

Journal entries for sales commission expenses are generally simple to record as most companies classify them as selling expenses.

A deferred commission journal entry can likewise help track deferred commissions or commissions that have been capitalized but are not recognized as costs yet.

Event Debit Credit
1
Commission costs to be paid out of commission software
Commission expense Wages payable, taxes payable, bonus payable, accrued balances for items not paid out
2
Deferral of commissions
Prepaid/deferred commissions - short-term Commission expense
3
Amortization of commissions
Commission amortization expense Prepaid/deferred commissions - short-term
4
Long-term, short-term sweeps
Prepaid/deferred commissions - long-term entry Prepaid/deferred commissions - short-term

How is ASC 606 implemented?

When you pursue a new ASC 606 implementation, there are several steps that you should follow. These include the following, and they'll vary according to the size and other conditions of your business.

1

Identify the contract with a customer

2

Identify any performance obligations in the agreement

3

Determine the transaction price

4

Allocate the transaction price

5

Recognize revenue

Now, let’s dig into each.

Identify the contract with a customer: ASC 606 removes the need for a signed contract, but the rights and obligations outlined should be enforceable. Under ASC 606, there are certain parts that are essential to any contract, including:

  • The agreement has been approved by all parties involved.
  • All parties are committed to the fulfillment of their obligations.
  • Each party has identifiable rights.
  • Payment terms have been laid out and identified.
  • The contract has commercial substance.
  • Collectibility is likely.

Once your contract has been identified, you need to determine the performance obligations.

Identify any performance obligations in the agreement: The performance obligations of your contract need to be clearly outlined. In most cases, performance obligations simply refer to the transfer of goods and services. A good or service must also be distinct.

Determine the transaction price: In this step, you simply need to determine the transaction price for each performance obligation. This is the amount that your business will expect to receive for your delivered goods and services. Variable considerations such as discounts or rebates also must be factored in.

Allocate the transaction price: If you have more than one performance obligation in the contract, you must allocate your transaction price to each obligation. SaaS, for instance, would typically be considered a continuous obligation, so the price would likely need to be allocated throughout the service agreement.

Recognize revenue: Once your obligations are satisfied, you can recognize your revenues. In addition, revenue can be recognized over a period if you have a continuous contract.

What SMBs need to know

The process of adopting ASC 606 can be complex and challenging. So businesses that already have experience with earlier versions of the revenue recognition rules might face a smaller learning curve than those that have never dealt with this type of accounting before.

For small, private businesses that follow GAAP, the first thing to know about ASC 606 is that for non-public companies, it applies to every fiscal year after December 15, 2019*. That means small businesses subject to ASC 606 should have already implemented the standard into their accounting or be working on implementing it as soon as possible.

Get peace of mind with  CaptivateIQ

Revenue recognition needs to be more flexible and modernized to give companies a clearer picture so they can more accurately keep track of their finances. CaptivateIQ has worked closely with CPAs to design a solution that helps organizations produce detailed, audit-ready reports and work papers.

Our automated platform enables you to leverage advanced data and analytics to help generate accurate revenue and commission reports for any ERP or Data Warehouse. In addition, CaptivateIQ is committed to protecting your personal data and embraces relevant laws on data privacy and security, such as GDPR and CCPA.

Even if you have already implemented ASC 606, CaptivateIQ can help you adhere to best practices and better stay on top of FASB’s standards, making it an excellent solution for companies of all sizes. You shouldn’t have to spend hours managing spreadsheets and hundreds of amortization tables!

Ready to capitalize and defer your commissions under ASC 606 standards without spending inordinate amounts of time? Request a demo to speak to one of our experts today about how CaptivateIQ can help you achieve ASC 606 compliance!

Notes:
*In June 2020, FASB issued
Accounting Standards Update 2020-05. This deferred the effective date of ASC 606 for private businesses — therefore permitting private businesses that had not yet issued their financial statements reflecting the adoption of ASC 606 as of June 3, 2020 — to adopt ASC 606 for annual reporting periods beginning after December 15, 2019 (early adoption permitted).

This content is for informational purposes only and should not be construed as financial, accounting, tax, legal, or compliance advice or guidance. Please consult a professional adviser for guidance on your specific situation.