Accounting for Contract Signing Bonuses
Talented employees can make the difference between a business that just squeaks by and a business that’s preparing to expand. Finding and hanging onto the key employees who will help you realize your business vision requires a number of different tools. Signing bonuses is one of them. After handing off the check, you’ll have to account for the expense on your income statement. Knowing how to account for contract signing bonuses minimizes their effect on your bottom line.
The generally accepted accounting principles, or GAAP, dictate how companies present revenue and expenses on their financial statements. You typically offer a contract signing bonus to entice someone into signing on to a contract, which might extend several years. When the contract extends more than one year, GAAP requires that you spread the expense of the bonus out over the length of the contract. The difference between what you deducted as an expense and the cash you handed over remains on your balance sheet as an asset.
The Internal Revenue Service approaches contract signing bonuses in a similar manner as financial accounting rules do. Tax law treats signing bonuses as a capital expenditure with a useful life equal to the life of the contract. So you cannot deduct the full signing bonus on your taxes the year you pay it. Instead, you must deduct it evenly over its useful life. So if you pay a $50,000 signing bonus for a 10-year contract, you can deduct $5,000 each year.
A signing bonus often has strings attached. Many businesses include a forfeiture clause with the bonus. Forfeiture clauses give you the right to get some or all of your money back if the person you paid breaks the contract early. For example, a signing bonus in a four-year employment contract might have a clause that stipulates the employee must pay the bonus back if he leaves his position within two years of starting. You would increase cash and decrease the signing bonus asset, recognizing revenue if the person forfeits more than the signing bonus asset.
In some cases you might receive a signing bonus from a vendor or supplier. While the contract might call it a signing bonus, you account for the payment as a kickback. The payment decreases your expense related to the contract evenly over the life of the contract. For example, say you enter into a contract agreeing to pay a supplier $100,000 per year for five years and the contract includes a $25,000 signing bonus. You record a supply expense of $95,000 per year for that supplier.