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Accounting For Distributor Commissions

Mike Larkin's Profile

Accounting For Distributor CommissionsCommissions paid to distributors for sales made by the company to end users in the distributor's territory. Is a COGS (or debit to Sales) or a Selling expenses (SG&A)

 

Answers

Steve Klei
Title: CFO
Company: Jigsaw/Salesforce
(CFO, Jigsaw/Salesforce) |

I would treat as a Selling Expense and put in Sales Cost (not COGS)assuming the contract is directly with end user, the distributor is your agent, you are billing the end user and you are accounting for the revenue at gross vs net. The gross vs net evaluation is important.

I would think about this as equivalent to a sales commission to an employee.

Ragu Bhargava
Title: CFO
Company:
(CFO, ) |

Distributor commissions are generally to be treated as COGS. You might be able to record them as marketing expense. The treatment depends on how it is computed, if it is based on a percentage of revenue it is COGS. As distributors are not eemployees you cannot treat the payment as sales commission.

Robert McGee
Title: Principal
Company: Focusone Management Consulting
(Principal, Focusone Management Consulting) |

Mike -

The term "distributor" is a bit vague and would have an impact on the treatment.

Will you describe the activities the individual actually carries out?

Thanks.

Tim Northup
Title: Vice President/CFO
Company: Stiles Machinery
(Vice President/CFO, Stiles Machinery) |

I would agree with the assessment that these commissions are not a function of the COGS but rather a sales channel expense that is captured under SG&A. We operate under a similar business model and book commensurate commissions as a selling expense.

Robert McGee
Title: Principal
Company: Focusone Management Consulting
(Principal, Focusone Management Consulting) |

I have worked with two different companies that had the same function and booked as sales expense.

Otto Kubik
Title: CFO
Company:
(CFO, ) |

Assuming these are paid to 3rd parties (e.g. distributor), they are as much a COGS expense as any material added labor, OH or supplies associated with revenue generation. Typically they are a fixed percentage of EVERY sale, thus a Direct Cost of Sales.

Since they are not internal to the organization GAAP dictates they be applied directly to the sales revenue, just as you would any Price Discounts, or Returns and Allowances might be applied.

To apply them elsewhere misstates Contribution Margin, misleading the stakeholders the incremental benefit a of a sale.

Shane Patrick Connolly
Title: Chief of Staff
Company: Council District 10, City of San Jose
(Chief of Staff, Council District 10, City of San Jose) |

In my experience, I've seen these treated both ways, depending upon the circumstances. Assuming these are paid to the distributors only AFTER consideration is received (i.e. they are not paid sales on which have not cleared Accounts Receivable), and they are paid on the net amount collected and not on the gross invoicing, I believe GAAP would have us treat this as selling expense under SG&A. If the commission percentage is instead based upon the gross sales dollars and the commission is payable regardless of whether or not consideration is received (i.e. payment clears AR) and regardless of the amount actually paid, then I believe the argument for COGS treatment would be strongest.

Otto Kubik
Title: CFO
Company:
(CFO, ) |

Shane

Unfortunately seeing it done both ways doesn't make it right. GAAP is pretty clear, particularly where publicly traded corporations are concerned.

As far as it being declaired AFTER A/R IS PAID, is just wrong. Accrual accounting should force the posting at the same time as the sale. Remember there is a fundamental principal of matching expense with revenue. This may be a cash flow or a payment issue, but it isn't a supporting arguement when measuring the Contribution Margin. Timing issues are supposed to be considered and adjusted to match.

Even without considering ANY of the above accounting principals, a conservative accountant would and SHOULD post the expense in sync with the revenue stream(the Sale)to minimize the impact of any income tax liability. It isn't appropriate to temporarily overstate income, under any circumstances.

To further explain the arguement of an offset against the sales dollars, keep in mind that you have technically "discounted" the price by using a 3rd party sales agent. All discounts are supposed to be netted against Gross Sales.

If you don't believe me, ask your CPA firm partner that is signing the opinion. He may accept the SG&A approach, ignoring it as being "immaterial", but GAAP and the SEC are very clear on their view. Don't overstate sales revenue, even if offset elsewhere in the expenses, and yielding the same net income.

Shane Patrick Connolly
Title: Chief of Staff
Company: Council District 10, City of San Jose
(Chief of Staff, Council District 10, City of San Jose) |

Otto - Thanks for fleshing out your response even more fully. You make an excellent argument. Unfortunately, the treatment I described was actually prompted by the company's CPA firm partner (I had been doing things the way you describe and was required to change to what I described). I suppose even they can occasionally be mistaken!

Otto Kubik
Title: CFO
Company:
(CFO, ) |

Shane

Believe me, I understand how partners can cause confusing situations. The reality is CPA's don't always have all the answers, and can easily reverse their direction. Just remember: two wrongs don't make a right, but three lefts do.

Keith Taylor
Title: CFO
Company: Lyris, Inc.
(CFO, Lyris, Inc.) |

SHORT ANSWER: IMHO, I disagree with Otto’s answer, but agree with his logic.
3rd party Distributor Commissions are usually a selling expense because in practice they cannot be linked to the product sale TO the Distributor.
LONG ANSWER
The question is a bit misleading only because there are still some facts to flesh out before a definitive answer can be reached. Yes, GAAP requires expenses to post in the same period as the related sales are reported, in the same way that COGS is matched with the related sale regardless of when the supplier is paid. BUT, what if the ‘commission’ is paid based upon the distributor’s sales period, not when the distributor purchased the goods?

Thus, the question should be expanded to:
Should a payment made to an independent distributor deemed a “commission” be :
1. Charged against revenue (a contra-revenue charge), as a reduction in the selling price of the product
2. Included in Cost of Goods Sold, as part of the cost of product sold
3. Included in SG&A, as a selling or marketing expense

IF an independent distributor, XYZCo, purchases (as opposed to being consigned) company ABCCo’s products, at a discount to ABCCo’s MSRP, and is free to mark up and sell the product to end users at whatever price the market will bear, then any commissions owed to XYZCo should be accrued at the time of sale and accounted for as category 1 - a sales discount, netted against gross revenues, because it is deemed nothing more than a further discount to revenue (i.e., Gross vs Net Sales.)

Complexity enters into the situation when ABCCo makes a post-sale payment to XYZCo, identified as a “sales commission” that is NOT DIRECTLY tied to ABCCo’s sale of the product to XYZCo, but instead, is earned based upon XYZCO’s sale to an end user. In this situation (assuming ABCCo has not adopted the SELL-THROUGH accounting method*) then the commission is nothing more than a sales or marketing expense and should be recorded as category 3 – an SG&A expense.

* The Sell-through accounting method has been adopted by many public consumer products companies due to their complex product sales policies and programs which allow retailers very generous product return privileges, such as “stock balancing”, etc. Companies such as Garmin, for instance, only record net revenues based upon their major retailers’ sales of products (i.e., once BestBuy has sold products to their customers), and have extensive contra-revenue adjustments for these various selling programs. In this way, Garmin et al are as conservative as possible in recording NET revenues (and thus get signoff by the Accounting firm and the SEC.)

Topic Expert
Malak Kazan
Title: VP, Special Projects
Company: ERI Economic Research Institute
(VP, Special Projects, ERI Economic Research Institute) |

Having worked sales commission plans, typically a selling expense. Is a "cost" to getting the product into the customers hand NOT "producing" the product.

Jeffrey Brueggeman
Title: Director, Finance & Operations
Company: Sigmetrix
(Director, Finance & Operations, Sigmetrix) |

See next post .. new to forum.

Jeffrey Brueggeman
Title: Director, Finance & Operations
Company: Sigmetrix
(Director, Finance & Operations, Sigmetrix) |

This is not so much an answer but a clarification to what is meant by a Distributor in our case and then if defined as such what is your considered opinion.

If you define the Distributor as a Sales Representative. The Sales Representative brings the deals to us. The Sales Representative company provides sales support until the transaction is complete, but does not take the PO. The PO is sent directly to us. We in turn provide a finders fee that is termed as a commission in the contractual agreement with the Sales Representative company based on the PO received by us from the customer. I would like to add we sell CAD related software to businesses worldwide. We have considered COG for years but now we are taking another look at this. Is this black and white or a gray area in US GAAP guidelines. In case it makes a difference we are based in Texas.

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