I had an accounting / accrual related question on which I needed your opinion. It’s to do with matching principle. My company pays commissions to it’s sales reps. The payment of commission is dependent on full payment by client. i.e. if I bill the client $1,000 in January but I receive this $1,000 in May, I will pay $50 (5% commission) only in May. If I don’t realize this $1,000, I will not pay the sales rep. My question is when I do my January P&L, do I accrue for the $50 or do I wait till May to accrue for it? Opinion 1: In accordance with the matching principle, we need to recognize expenses in the same period in which the related revenues are earned. Hence, the $50 should be recognized in January. Opinion 2: The expense accrues / becomes payable only after realization of the $1000. Thus, payment of the $50 is contingent upon receipt of the $1,000. Hence, for January this will be a contingent liability and not an actual liability. For May, this becomes an actual liability and I will accrue for this $50 only in May. Please could you let me know your views. Much appreciated. Thank you.
Matching Principle - Commissions
Answers
If the company's experience is that full payment eventually USUALLY comes in then use Opinion 1 method.
If experience is that full payment RARELY comes in, go with a cash method - Opinion 2 method.
Yes, you need to match the costs to the period where the performance occurred. In your case, the sales rep is receiving a commission for a sale closing in January, therefore the cost should be recorded in this period. And yes, like Maple said, this is contingent on if payment usually comes in.
If collection is a problem, then you need to assess (make an estimate) of how much commission you will likely pay out in the future (across all sales reps commissions incurred in January). For example, if you generally collect on 80% of sales, then you should probably take a haircut of 20% on your commission accrual.