Offering your employees commissions encourages them to think like owners by letting them share in the profits of new business. Like other forms of compensation, when it comes time to compile your financial statements, you need to disclose sales commissions. If you prepare your financial statements according to the generally accepted accounting principles of the United States, then you operate on the accrual basis of accounting, which means you recognize the commission when the employee earns it rather than when you pay it.
Sales commissions appear on the income statement, typically listed as an operating expense. The income statement starts out with total revenues, then separates out the cost of goods sold to provide the gross profit from sales. Below gross profits, you list your operating expenses, which include wages and commissions due to employees. Accrued commissions, those that are owed to employees but have not been paid out, also appear on the balance sheet as a liability.
Accrual basis of accounting requires that business owners report the commission in the period when the employee earns the commission and the amount is set. The rules for your commission program can determine when you must record the expense. For example, if your commission program pays out at the time that an employee secures a contract, then you must record the commission expense at the time the employee turns in a signed contract. If, on the other hand, your program stipulates that commissions are paid when the customer pays on the contract, then it won’t appear on the financial statements until then.
Sales commissions typically appear as operating expenses. Occasionally, a business might offer “finder’s fees” or other commission, such as payments to employees for sales that aren’t part of normal operations. For example, an accounting firm might pay out a sales commission to an employee who was able to find a tenant to sublet the property so the firm could move to a new location without breaking its lease. The sales commission is an expense incurred outside of the normal operations, so it is listed with “other” expenses.
Some commission programs come with loss-limiting provisions, called clawbacks, that allow the business to charge employees for commissions based on a subsequent event. Especially useful for companies that offer commission payments on sales of subscriptions or have generous return policies, clawback provisions also have ramifications for your balance sheet. If your business consistently reports dividend expenses, you should subtract the amount of commission charged back to employees from the amount earned by employees during the period. When there’s not enough commission expense to offset the clawback, you should report it as income from reversed commission payments.