Welcome ASC 606/IFRS 15!
Originally posted January 2019 and updated January 2021
This is one of the most complicated pieces of accounting, like ever. But it wasn’t always like this.
Before 2018 (for Public companies) and 2019 (for Private ones), commission expenses were recognized in the period incurred. So, if you owed $2,400 of commissions related to a deal that closed in June 2019, you would call that a June 2019 expense (even though payroll may not have gone until July 2019.)
There were a few SaaS companies who got a little fancy and would recognize the expense over the contract period. In our earlier example, if the contract that earned that $2,400 commission was from June 1, 2019 to May 31, 2020, the company would recognize about $200 of expense each month to match the timing of the revenue.
Isn’t ASC 606 a revenue thing?
While billed as new revenue guidance, ASC 606/IFRS 15’s far more challenging changes come in the new standards related to costs incurred to obtain and fulfill signed contracts. These costs, including commissions, must be amortized over a period over benefit, up to an estimated customer lifetime.
There’s some nuance in this (if you really want to nerd out, jump down this rabbit hole.) The high level is:
Commissions will haunt you on the balance sheet for YEARS.
The intention of the new accounting rule is to make businesses look more comparable.
In SaaS, we pay relatively high commissions rates on new business because we understand that our new customers will probably renew for years to come. Today, contrasted with a non-SaaS business, our cost of sales in year 1 looks really high, but in future periods looks artificially low.
So what do I do?
The two most important things to get started are to:
- Read your comp plans, and understand if your sales/service/exec teams paid based on deals closing. We recommend writing out the algebraic formula of how people are paid to see if you can trace a commission back to a specific deal closing.
- Build a cohort analysis spreadsheet to learn customer lifetimes.
These two pieces are the most important building blocks that help you explain all the unique parts of business to your auditors.
As for the painful amortization schedules? We got you covered.