Is Sales Commission a Period Cost?

To measure a company's gross profit accurately, all costs must be allocated to either product costs or period costs. So, which category does sales commission fall under?

11/23/2022

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Ruben Petersen
Ruben Petersen

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Is Sales Commission a Period Cost?

Product Costs vs. Period Costs

What are Product Costs?

Product costs are all costs that are necessary to produce or acquire a product that is intended for sale. Product costs are recorded as inventory on the balance sheet when they are first incurred. Then, they are recognized as the Cost of Goods Sold (COGS) on the income statement when the product is sold and delivered to customers. Product costs are also called inventoriable costs.

There are three main categories of product costs:

  • Direct materials (DM) e.g. raw materials required to produce a product
  • Direct labor (DL) e.g. the cost of the product line workers
  • Manufacturing overhead (OH) e.g. electricity used in a factory

What are Period Costs?

Period costs are all other business costs that are not directly related to the production or acquisition of a product. Most period costs are recorded on the income statement as soon as they are incurred.

However, in some instances, period costs are first recorded as assets on the balance sheet and are only later recognized as expenses on the income statement (e.g. when they are prepaid or purchased in advance).

Examples of period costs are 

  • Selling expenses: e.g. sales commissions
  • General and administrative expenses: e.g. accounting costs
  • Non-operating expenses: e.g. interest paid on borrowed money
  Product Costs Period Costs
Definition Are directly related to the production or acquisition of a product. Are not directly related to the production or acquisition of a product.
Accounting Treatment Are recorded as inventory on the balance sheet. They are then expensed in the income statements as Costs of Goods Sold when the products are sold. Are expensed in the income statements in the period incurred.
When prepaid or purchased in advance, they are recorded on the balance sheet as assets. They are then expensed in the income statements in the period of use.
Examples Raw materials, direct labor, manufacturing overhead. Marketing expenses, office rent, sales commissions.

Is Sales Commission a Period Cost?

Sales commission is not directly related to the production of a product. Therefore sales commission is treated as period costs.

Should Sales Commissions be Expensed as Incurred?

The rules of commission expense accounting are outlined in IFRS 15 and ASC 606 (for more details please see our Amortization of Deferred Sales Commissions blog post). In order to determine whether commission should be expensed as incurred, you must answer the following question: would the commission be incurred regardless of selling the product?

This question has two possible outcomes: 

The commission is also payable without selling the product.
Example: Salesperson A receives $50 for each sales-qualified opportunity (SQO) created. Salesperson A creates a new SQO with Company C. Salesperson A receives a $50 commission.

  • The cost incurred trying to obtain the contract. Since the $50 commission is payable regardless of whether the deal closes, it needs to be expensed as incurred.

The commission is only payable if the product is sold.
Example: Salesperson B receives a 5% commission on the total value of every closed contract. Salesperson B closes a contract worth $2000 with Company C. Salesperson B receives a $100 commission.

  • The sales commission is an incremental cost to obtain the contract because the $100 commission is only payable on successfully closing the contract. Therefore, it has to be recognized on the balance sheet.

Hopefully, we've clarified how to determine whether a given commission is a period or a product cost. This should help ensure compliant accounting of your commissions and more pleasant interactions with your auditors.

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