Capitalizing Sales Commissions Under ASC 340-40 (ASC 606)

The test is whether the cost is incremental: would you have incurred it if the contract hadn't been signed? A commission paid because a specific deal closed is incremental. Costs you'd pay regardless are not, such as base salaries, general marketing or bonuses tied to broad company metrics rather than to obtaining contracts.

Points to check with your CPA:

• Commission on new contracts usually qualifies.
• Bonuses and accelerators tied directly to signing contracts may qualify, while ones based on overall profit often don't.
• Payroll taxes on commissions are commonly treated with them, so ask how to handle that.
• Commission paid on renewals is treated separately, since it may be commensurate with the initial commission or not.
• Costs you'd incur even if you lost the deal, such as travel to pitch, are expensed.

If the period over which you'd amortize the capitalized cost is one year or less, you may choose to expense the commission as incurred instead. Many companies with month-to-month or annual contracts use this and avoid tracking an asset.

The choice is a policy election, applied consistently to similar contracts, and it depends on the period of benefit. It doesn't automatically follow from the contract length. If a commission on a one-year contract is expected to benefit the company beyond that, for example through expected renewals, the amortization period could exceed one year. Ask your CPA to document the basis for the election.

Say a rep earns a $12,000 commission on a three-year contract worth $180,000 in total, recognized evenly. The amortization period is three years, so the expedient doesn't apply. In this example, straight-line amortization puts $4,000 a year, or about $333 a month, into expense while the balance sits on the balance sheet as a contract cost asset.

Now suppose the same customer is expected to renew, and the renewal commission is much smaller than the initial one. In this example, because the renewal commission isn't commensurate with the first one, the initial commission may relate to the whole expected customer relationship, and the amortization period could be longer than three years. Determining that period requires judgment about expected renewals, so document the assumption and revisit it.

Also plan for impairment. If the contract is canceled or the customer stops paying, part or all of the asset may need to be written off. Clawbacks affect this too, so see the commission clawback policy guide.

Keep a register with one line per deal:

1. Customer and contract, with start and end dates.
2. Commission amount paid, and any payroll taxes tied to it.
3. Whether the commission is capitalized or expensed under your policy.
4. Amortization period and schedule.
5. Any cancellation, downgrade or renewal that changes the period.
6. Reconciliation to the general ledger each month.

A spreadsheet works for a small number of deals, but it becomes fragile with many contracts or plan changes. Commission software such as CaptivateIQ and QuotaPath calculates payouts and can produce data your accountant can use, but it doesn't make accounting decisions. Confirm what reports and exports each provides. The commission software comparison shows how they differ, and sales bonus accruals under ASC 340-40 covers bonus timing.

Bring specifics rather than asking "are we compliant?" Ask:

• Which of our commission and bonus components meet the incremental-cost test?
• Should we use the one-year expedient, and how do we document it?
• What amortization period fits our contracts, given renewal expectations and how renewal commissions are structured?
• How should we treat payroll taxes on commissions?
• How do we test for impairment when customers cancel?
• What disclosures and audit evidence will lenders, investors or an acquirer expect?

Contract terms feed the answers, so involve whoever manages deals. A well-run deal desk and a clean quote-to-cash process make the data easy to produce, since contract dates, terms and amounts are recorded once and consistently.