ASC 606: The Impact on Sales Commission
August 24, 2017
The ASC 606 regulation from the Federal Accounting Standards Board (FASB) is coming hard and fast for companies, but many don’t know where to even begin to understand the implications. For those in sales compensation or sales ops roles, this change may have huge impacts on the structure of your sales compensation rule configuration to account for new components or assessment logic in certain scenarios.
Many comp admins have reached out to me on this topic, overwhelmed by the detailed accounting and financial compliance implications described in detail all over the internet. The focus of this 2-part series is to provide some insights into the background of the ruling and considerations specifically for those in the sales compensation field regarding direct impacts to how you assess and calculate incentive compensation.
Why the Need for this New Regulation?
In the past, revenue recognition standards differed between the generally accepted accounting principles (GAAP) in the United States and the global provisions set by the International Financial Reporting Standards (IFRS). It was universally acknowledged that these rules needed to evolve due to varying ways they were being applied and loopholes they created, so the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) launched a joint initiative to better align these standard practices globally, which resulted in the 2014 publication of the new “Topic ASC 606: Revenue from Contracts with Customers”.
The ultimate objective was to outline a common way to recognize revenue for all contracts with customers across international standards. As part of that objective, there are five basic steps that must be addressed as part of this ruling:
- Identify the contracts with the customer
- Identify the separate performance obligations with the contract
- Determine the transaction price
- Allocate the transaction price to separate performance obligations
- Recognize revenue when, or as, each performance obligation is satisfied
These new regulations go into effect the fiscal year starting after December 15, 2017 for publicly traded companies and into similar effect for private companies after December 15, 2018. However, I advise that you work with your internal audit teams to ensure all details for compliancy are fully understood and planned for. Find the full details here.
What Does This Mean to Me on the Sales Comp Side?
Outside of the direct accounting compliance changes for how revenue is recognized, the implications reach into how the associated costs (i.e. commission expenses) are amortized over the expected timeframe of satisfying the performance obligations of the contract. This might be different than the actual contract or product terms. Instead of simply recognizing the commission expense in the period executed to offset the revenue, the comp admins and sales operations resources will now be responsible for helping identify and track the sales commissions and bonuses at the required level of detail to comply with new revenue recognition regulations. Now, manually tracking this data through spreadsheets will not be enough.
- Below is a sampling of key items to take note from Subtopic 340-40 of the FASB ASC 606 ruling, which focuses on the incremental costs of obtaining a contract:
- Commission expenses can continue to be recognized when incurred if the determined amortization period is one year or less.
- Commission expenses must be amortized for individual reps over the anticipated life of the customer if the contract is longer than one year, but any indirect or rolled commissions for supervisors/managers will continue to be recognized immediately regardless of the determined contract term length.
- Every time the existing rep or other rep sells to the customer again, you must evaluate if that extends the life of the customer or servicing existing life expectancy. For each additional commission calculated and paid, you must be able to quantify the impact their action did to further that customer for commission expense amortization considerations.
- Depending on the type of industry (i.e. High-Tech, Life Sciences, etc.) you work in or products sold to customers (i.e. Services, Hardware, etc.), you might need to calculate commissions down to their customer, contract, and product level to determine the correct commission expense values for amortization over the period determined through analysis as it could vary down to that level of details.
Now let’s look at the the action items to consider in order to ensure you aren’t caught off guard if your internal accounting teams require more detailed compensation-related data from your team, so you can remain compliant to these new revenue recognition rules.
How can I be most prepared?
Those in the sales compensation and sales operations space will rely mostly on internal accounting counterparts to decide as a company which methodology the organization plans to adopt for recognizing revenue. This, in turn, will impact how the sales compensation program and data requirements will be developed for the upcoming year. For the transition, there are pros and cons to each option, which they are calling a full retrospective method versus a modified retrospective method. These options include considerations for historical data restating requirements and overall data volume requirements.
The ASC 606 regulation had a broad-reaching impact on how revenue must be recognized and how associated commission expenses are tracked over time. First, the sales compensation admins and sales operations resources must be aligned with their accounting and audit teams to ensure the proper approach and methodology for compliance with this regulation are determined. Once an approach has been reviewed and vetted across all parties, the owners and administrators of the upstream incentive compensation management (ICM) calculation engines – whether home-grown or out of a box – should begin an assessment and gap analysis to determine what changes are potentially required for the transition and ongoing compliance. Consider asking these questions in the following areas:
- Do you have all the fields necessary related to your contracts or products to make the necessary assessments for commission expense recognition and amortization?
- Are you bringing in the level of transactional details necessary to meet your compliance assessment and calculation requirements?
- Based on the adoption method, how easy will it be to access the prior two years detailed historical assessment?
Calculation Logic/Assessment Rules
- Do your calculation rules for commission payment amounts currently get you to the level of detail for the required analysis or are they summarized at a higher payee level only?
- Where will the logic reside to adequately satisfy the five core contract assessment steps or if there are further contract modifications that might impact the amortization period?
- Is your data in a format that can easily be extracted and interpreted for downstream accounting teams to appropriately recognize commissions expenses in the correct period for audit compliance?
- Can you support the required dual reporting which means two sets of financial books during this transition?
Amortization Calculation Engine - what’s the link between accounting and ICM?
Once your assessments are completed internally for compliance with ASC 606 and the necessary ICM configuration changes are determined, the final solution step involves determining the commission expense amortization schedule, as it relates to the identified performance obligation period for each contract component. Based on how your organization chooses to comply with this regulation, the internal accounting team should provide the sales compensation support team with the format and data needs for this critical step, so that an outbound data extract can be designed out of the ICM solution. As far as the execution of this key step, determine if your organization has an existing revenue management module available within an out-of-the-box solution to handle the assessment of initial and any future modified contract terms. If your company doesn’t already have a revenue management solution in-house, you can consider your current ICM vendor, as many of them have introduced configured solutions to address this contract assessment and commission expense amortization use case.
I use Excel for processing commissions – should I be concerned?
Finally, if your organization is currently leveraging spreadsheets to calculate commissions rather than putting in the investment for automated tools that increase auditability and compliance, remember that spreadsheets can only be so flexible and accommodating. In my time running numerous ICM vendor selection engagements over the last 10+ years, I have seen my fair share of companies leveraging very complicated, yet sophisticated, Excel models in workbooks spanning multiple tabs with delicate formulas that took hours to write and could break with one too many rules. If you consider trying to work in new layers of contract assessment steps to stay compliant under ASC 606 guidelines, with the complexities of tiered pricing, add-ons/extensions, and discounts to be able to help provide the necessary revenue and cost results at the contract level, this is not a sustainable mode of operation. This transition should be of utmost importance to your organization if using spreadsheets as the primary ICM calculation engine.
You don’t feel informed or prepared? Join the crowd.
If you are wondering why you haven’t been getting any insights or directions from your accounting teams on the revenue recognition adoption standard leading you to assess the potential impacts of your sales compensation program, you are not alone based on the numerous informal polls and more formalized surveys that have been completed over the last year.
- During a recent webinar hosted by NetSuite, they polled the participants as to whether they were preparing for ASC 606. The results showed that 60% attending the webinar hadn’t commenced preparation for addressing the ruling, while the 27% who did had only gone as far as establishing a plan and team.
- A survey conducted by the Connor Group, a specialized professional services firm in the financial accounting sector, provides insights into the fact that most companies are still assessing which adoption method to deploy. A recent follow-up only several months ago highlights that 87% of companies surveyed hadn’t completed a full assessment.
This plight of being in the majority with those unprepared probably doesn’t give you much comfort, but you can start asking questions to ensure things are moving forward in your company as those decisions for the adoption method will impact the potential gaps identified as part of your sales compensation program assessment.
Reach out to firstname.lastname@example.org or speak with an OpenSymmetry consulting team to assess your existing sales compensation program and begin to prepare for the ASC 606 rollout.