Companies sell their products and services to customers to earn revenues. These revenues help fund their operations while also generating profits. For companies that focus on profits, making revenues through operations is highly crucial. Usually, companies deliver these products to customers directly. Sometimes, however, they also need other parties to do so.
Some companies hire intermediaries to help facilitate sales to customers. These intermediaries may include retailers or wholesalers who serve as a distributor for a company’s products. In some cases, companies may also hire salespeople to sell products directly to customers. In exchange for their services, companies pay commissions in exchange.
What are Commissions?
A commission is an amount charged by one party to another to act as a broker for transactions. In most cases, it includes the service charge from salespeople to companies. It may also include brokerage fees paid to advisors or managers in other circumstances. For example, these may involve portfolio managers or investment advisors. The fee charged from these providers is known as commissions.
Usually, companies set a commission rate for every sale or transaction. In some circumstances, companies may also pay a fixed salary regardless of the number of transactions. However, the primary source of income for those brokers will be the commissions they earn. For example, companies may pay their sales force 10% of sale proceeds for each product they help sell.
Commissions are crucial in various industries. For example, in the pharmaceutical sector, companies pay their representatives to sell products to hospitals directly. The more of these products the brokers sell, the higher commissions they will earn. However, these commissions may also depend on other factors. In most circumstances, companies use sales units for payments.
Overall, commissions represent a percentage of sales paid to a broker to help facilitate transactions. In some circumstances, it may also be a fixed amount. Either way, it depends on the number of products or transactions that brokers help complete. The pay gets the benefit of making more sales while the broker receives an income in exchange.
What is Commission Income and Commission Expense?
The above points clarify what commission is. However, commission may either be an income or expense for companies. Understanding the difference between both of these is vital. The accounting for commission income and expenses also differs. Therefore, it is crucial to understand what these are.
Commission income is the income that companies or brokers earn. This income comes from customers to whom these parties provide services. Usually, the customer is a supplier of products or services. The broker or company helps deliver or sell these products to consumers. In exchange, they receive a fee based on the number of units they sell.
Commission income allows companies or brokers to earn by acting as a facilitator of transactions. As mentioned, usually, they receive a percentage of sales proceeds or a fixed amount. This amount becomes their income for the services they provide. For companies that primarily earn commissions, this income is a part of their revenues.
On the other hand, commission expense is the amount that companies or customers pay to brokers. For most companies, it includes the amount paid to service people in exchange for their services. These may consist of salespeople who facilitate sales or brokers who complete transactions. For some companies, commission expense is crucial in generating sales.
Commission expense differs from commission income due to the source. With commission expense, the source is the salespeople or brokers that provide services. Any amount paid to these parties becomes an expense on the income statement. The commission expense becomes commission income for the company or broker providing the services.
What is the Accounting for Commission Income and Expenses?
The accounting for commission income and commission expense differs due to the primary distinction between them. An explanation of the process for both of these is as below.
Accounting for Commission Income
The accounting for commission income involves recognizing any income as revenues. However, the classification of these revenues may differ based on various factors. Usually, companies that primarily earn commission income must classify these revenues under sales or operating income. For this purpose, the recognition of commission income will follow the same rules as revenues.
However, the process will differ for companies that have a primary operation other than earning commissions. These companies cannot recognize commission income as revenues. Instead, they must classify it as other income in the income statement. This classification is crucial to separate income from core operations and secondary activities.
Accounting for Commission Expenses
The accounting for commission expenses is straightforward. This process involves recognizing expenses for any fees paid to salespeople. However, the classification of these sales will differ based on the company’s policies. Usually, commission expenses fall under selling expenses for companies. However, companies may also classify it as administrative or other operating expenses.
For some companies, the commission expenses may also fall under the cost of goods sold. However, companies must be using the contribution margin income statement. These expenses will also follow the same principles as for others. For example, companies must record them under the matching and accrual principles. However, it will also depend on the company’s policies.
What are the journal entries for Commission Income and Expenses?
The journal entries for both commission income and expenses will depend on the classification. A detailed explanation of both of these is as below.
As mentioned, companies may record commission income in two ways. Firstly, if the commission income forms a part of a company’s primary operations, it falls under revenues. Therefore, companies can record it using the following journal entries.
|Commission Income (Revenues)||XXXX|
However, for companies that earn commissions from secondary activities, the same will not apply. Instead, they must classify any income from commissions as other income. These companies can use the following journal entries to record the transaction.
|Commission Income (Other Income)||XXXX|
The journal entries for commission expenses are more straightforward. However, companies must decide the classification for the expense in the accounts. As mentioned, most companies classify these expenses as selling expenses. Therefore, the journal entries will be as below.
|Commission Expense (Selling Expenses)||XXXX|
However, companies may also choose to represent these expenses as a part of administrative or other expenses. Regardless of the classification, the accounting treatment will be similar. However, the headings in the income statement will change.
A company, ABC Co., sells laptops and other electronics. The company uses a salesforce to help move these items quickly. For every product sold, ABC Co. pays its employee a $100 fixed-rate commission. During the last accounting period, the company sold 1,000 laptops. ABC Co. recorded the revenues from those laptops under its primary revenues.
ABC Co. also recorded the commission expense paid to the sales force by cash. The company classified this expense as a selling expense. The total commission expense for ABC Co. was $100,000 (1,000 laptops x $100 commission per item). Therefore, the accounting entries for those commissions were as follows.
|Commission Expense (Selling Expenses)||$100,000|
ABC Co. also received commissions from another company. ABC Co. helped the company sell 100 TVs, for which it received a commission of $5,000. However, it is not a part of ABC Co.’s primary activities. Therefore, the company recorded this amount as other income. The journal entries for the transaction were as follows.
|Commission Income (Other Income)||$5,000|
A commission is an amount paid to a broker for facilitating a sale or transaction. It may fall into commission income or expense based on the source. Usually, the accounting for commission income and expense differs based on several factors. In essence, the treatment is the same. However, the classification differs.