The new FASB and IASB revenue recognition standard taking effect this year will radically alter how sales commission expense accounting is done in the United States. So, you would expect most business leaders to be heads down trying to understand the new regulations and preparing for it.
You’d be at least half right.
According to a PwC study, nearly 80 percent of financial executives surveyed said they are studying how they’ll be affected by Accounting Standards Update (ASC 606) after the looming December 15 compliance deadline for public companies. But few are ready to implement it, with 52 percent saying they haven’t chosen between the two adoption methods for shifting financial reporting to the new system.
Now is the time to urge any business client who is selling something to get their arms around the new standard because it has the potential to affect every entity’s day-to-day account and, possibly, the way business is executed through contracts with customers, according to the American Institute of Certified Public Accountants (AICPA).
To get your clients on the right path, it will be important to first understand why they might be delaying decisions about ASC 606. No doubt, some businesses take the risky view that they can ignore new regulations until penalties ensue and force them to comply. A just-as likely culprit, however, may be that the new revenue recognition edict will dramatically alter sales compensation accounting, making it infinitely more complex – and companies simply don’t know where to start.
ASC 606 is all about how companies document incremental costs for obtaining and maintaining customer contracts. In the past, accountants typically booked these commissions and other costs as expenses at the time of sale or over the life of the contract. Either way worked so long as they were consistent.
But with the new standard, incremental costs of contracts must be analyzed and pre-determined to the best of a company’s ability and then capitalized at inception and then amortized and expensed systematically with the delivery of goods or services throughout the life-cycle of the client. This means constantly tracking and updating commissions over time. This task becomes especially difficult in the current cloud era, as customers might be adding new license seats or services on a monthly (yes, monthly) basis. So as you can imagine, that could get pretty tedious and laborious if there is not a proper accounting system in place.
Not to mention, most accountants aren’t familiar with the ins-and-outs of sales compensation models. So, here are three steps you can suggest they take right away to get ready for ASC 606:
- Get a Grip on Compensation Data
About 85 percent of companies still track sales commissions, incentives and other incremental costs the old-fashioned way – with spreadsheets. For super small businesses, that might be fine. But for any growing organization, that could quickly crumble under the weight of ASC 606.
Why? Because the sheer volume of transactions most accounting departments will have to track is going to explode, and they’ll be required to record that information with far more detail and accuracy. For example, accounting professionals typically equate sales incentives with payroll. Moving forward, these commissions and other associated costs of acquiring and maintaining customer contracts will be forecasted and capitalized.
To help with this first step in preparing for ASC 606, your business clients should be investing in sales performance management software. These solutions automate the taxing process of complying with ASC 606 – not to mention a host of other benefits.
- Determine How to Estimate the Value of Commissions
Most accountants deal in black-and-white. Numbers. Precise mathematical or algorithmic are reflections of financial facts. Right?
Under ASC 606, things suddenly become gray because the accountant will be in the uncomfortable position of having to forecast incremental revenues, including commissions, based on what they (or sales reps) think each contract will be worth over time. Of course, nobody can possibly be precise with something like this. Calculations fluctuate. So, accountants will need to make adjustments as changes occur and fresh contractual data comes their way.
Given this uncertainty, establish a method early-on for when your clients pay commissions and help them build that into their accounting system. As you might guess, this can be an extremely complicated process – but one that is greatly simplified by selecting the right cloud-based tools.
- Define an Amortization Approach
It will also be critical to help your clients determine the amortization approach they should take – and encourage them to stick with it.
The new standard says amortization must be “on a systemic basis consistent with the transfer of goods or services to the customer.” This means that in addition to accruing commission costs as assets, accountants will need to expense them over time.
To make this happen, businesses must gather all the pertinent and accurate information in order to enable their accounting team to assess associated costs and properly manage the amortization schedule. In the ASC 606 world, this will require some detailed analysis, solid estimations, the ability to track the effect of subsequent transactions and diligence in making long-term mathematical calculations to amortize incremental costs.
Setting an amortization strategy in place – in advance – can guide, support and streamline those activities. And again, sales compensation software can help simplify these processes.
But make no mistake about it, none of this preparation will be easy. In fact, a recent Intacct ASC 606 Readiness Study found 40 percent of finance professionals say it will be painful. And that pain is “palpable enough” that 40 percent of these execs also said they would rather stand in line at the DMV, 36 percent would prefer sitting in two hours of traffic and 30 percent would sooner burn the roof of their mouths with pizza than deal with these standards.
All of this underscores the importance of reminding business clients they’re going to have to do it sometime, and the longer they wait the more painful it could be in the end. With the right strategic plan and sales compensation software in place, businesses can meet this new standard in stride.
For more resources on helping your clients understand the new Revenue Recognition Principle and its effect on commission expense accounting, please click here.
Steve Giusti, CPA, is Vice President and Controller for Xactly Corp., a provider of enterprise-class, cloud-based, incentive compensation solutions for employee and sales performance management.