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How to Estimate Amortization Under ASC 606: Sales Commissions & Incentives

All privately-held entities, including SaaS companies and other subscription-based business models, are now under new revenue recognition guidelines as outlined in ASC 606. The Financial Accounting Standards Board’s updated framework requires more detailed and comprehensive disclosure than previously required. And, within this new standard, you’ll need to know how to estimate amortization.

Here, we’ll look at precisely how amortization estimates work based on the new principles that must be followed.

  • The Fundamentals of Amortization
  • How ASC 606 Has Changed Commission Accounting
  • What These Changes Look Like on Paper
    • How Long SaaS Commissions Should be Amortized
  • Final Thoughts

First, Let’s Make Sure You Fundamentally Understand Amortization

In connection to business loans and assets, amortization is the act of spreading the costs of an intangible asset or loan over the duration of the lifetime of that asset or loan. For this purpose, let’s discuss assets. In addition to measurable intangibles like software, companies should report amortization expenses for assets such as trademarks, licenses, copyrights, and patents.

For example, if an operating license costs $150 and lasts for three years, the amortization for the expense would be $50 per year. Unfortunately, not all instances are as simple as this.

Next, How Has ASC 606 Changed Commission Accounting for Companies?

In the case of sales commissions and incentives, ASC 606 has had a notable impact on the accounting process. Let’s look at how it used to work and compare that to what it looks like under the new 5-step revenue recognition standards.

Before ASC 606, Commissions were accounted for as direct expenses. In other words, 100% of sales commissions, bonuses, and incentive pay for staff and contractors could be calculated and directly expensed at the end of the year or reporting period. While not synonymous with payroll expenses, these costs were a straightforward expense. Now, the process is different.

Since the new revenue recognition standards are in effect, companies must report these types of “intangible” assets as forecasted estimates. Each period, as the estimates evolve based on performance and company spending, they must be accounted for.

If a company fails to comply, this may be perceived as earnings management or “cooking the books.” In worst-case scenarios, the Securities and Exchange Commission (SEC) will issue fines. And, in some cases, punitive measures for this type of financial records manipulation can cause a business to go belly-up. So, companies must comply.

Note: Earnings management should not be confused with an On-Target Earnings Model, which is intended to help companies stay on track.

So, How Does This Change Translate on Paper?

Accountants will see two key changes to the way they calculate commissions and similar expenses.

  1. The commission paid on a sales order must be amortized across a defined number of years.
  2. Unanticipated customer churn events lead to an adjustment to accounting.

Ultimately, this will create more work and can be overwhelming for those who haven’t yet gotten the hang of it. What used to calculate as straightforward expenses will now require additional monthly steps for forecasting as well as adjustments based on unexpected changes.

Monthly journal entries prior to ASC 606 were simple:

  1. DR: Sales commission expense = $xx,xxx
  2. CR: Bank account balance = $xx,xxx

The new process requires an additional two steps each month. The example below assumes a 36 month amortization period.

  1. Adjusting journal to reflect 606 recognition of the expense - calculated as follows.
    1. DR: Asset = $total commission payable - $total commission payable / 36
    2. CR: Sales commissions expense = $total commission payable - $total commission payable / 36
  2. Scheduled journal to amortize the existing book of commission paid on opportunities - calculated as follows.
    1. DR: Sales commission expense $total current asset value / 36
    2. CR: Asset $total current asset value / 36

How Long Should Commissions be Amortized for SaaS and Other Subscription-Model Operations?

Since ASC 606 affects SaaS and other subscription models, let’s translate the information for this industry. There are two main schools of thought regarding amortization periods for SaaS.

  • Five to six-year amortization periods
  • 36-month amortization periods

Companies leaning toward longer amortization periods may have it easier since this portion of their accounting will be disrupted less often. But, those that opt for shorter periods will have a more accurate picture of true amortized assets. And, by the time three years have passed, a SaaS product will have most likely evolved into something completely new for even long-time platform users.

Final Thoughts

Use what you’ve learned here to improve your accounting based on the ASC 606 framework. And, if you need a little help, you can count on Performio. Our platform already collects the granular data you need to implement complex accounting practices.

Automate your sales commissions accounting, even for complicated compensation plans. Request a demo today.

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