Commission accruals and revenue recognition: what SaaS and e-commerce founders need to know

The Principles of Sales Commission Accounting and Revenue Recognition

When a record-breaking sales month is followed by a confusingly low profit margin, the culprit is often how sales commissions are recorded. For early-stage SaaS and E-commerce founders, managing financials often means focusing on immediate cash flow. This leads many to expense the entire commission payment the moment it goes out the door. While common, this practice creates a distorted picture of your company’s financial health and clashes with modern accounting standards like ASC 606 and IFRS 15. For related guidance, see our hub on benefits accounting and accruals.

Understanding how to account for sales commissions under revenue recognition rules is not just about compliance for a future audit. It’s about gaining a true, stable view of your profitability and unit economics. For startups in the US and UK, correctly applying these principles transforms lumpy, unpredictable financial statements into a clear and reliable tool. This clarity is essential for making strategic decisions about hiring, marketing spend, and runway management.

The Core Principle: Matching Expenses to Revenue

The guiding principle behind modern revenue recognition is the "matching principle." In simple terms, expenses should be recognized in the same period as the revenue they helped generate. A sales commission is a direct cost of acquiring a customer contract. Since that contract delivers revenue over many months or years, the commission expense should also be spread out, or amortized, over that same period. This ensures that each reporting period reflects the true profitability of your customer relationships.

Instead of being an immediate hit to your Profit & Loss (P&L) statement, the commission payment is first recorded as an asset on your Balance Sheet. This asset is typically called “Deferred Contract Costs” or “Capitalized Commissions.” Each month, as you recognize revenue from the customer, you also move a portion of that asset to the P&L as an expense. This process perfectly matches costs with the revenue they create.

Accounting standards ASC 606 (US GAAP) and IFRS 15 require sales commissions to be treated as a 'cost to obtain a contract' and amortized over the period the customer benefits from the contract.

This approach prevents the financial whiplash of seeing a massive expense in one month and artificially inflated profits in the next. It provides a stable, predictable view of your margins, which is exactly what investors and leadership teams need to see. For detailed standards, see Deloitte's guidance on the costs of obtaining a contract.

How to Account for Sales Commissions Under Revenue Recognition: A Practical Example

Misstating margins by expensing commissions upfront is one of the most common financial reporting mistakes in growing startups. It creates volatility that masks the true performance of the business. When you pay a large commission in one month for a multi-year deal, your P&L for that month looks terrible. Subsequent months then appear artificially profitable because they include revenue without the associated cost of sale. This makes it impossible to accurately assess metrics like Customer Acquisition Cost (CAC) payback period.

Let’s consider a synthetic example. Imagine your SaaS company closes a new $12,000 annual contract in January. You pay the sales representative a 10% commission, or $1,200, that same month.

The Wrong Way: Expensing Commissions Upfront

If you expense the full $1,200 commission in January, your P&L for that single contract looks dangerously front-loaded. Your January report shows $1,000 in revenue but a $1,200 commission expense, resulting in a $200 loss for that customer. For the next eleven months, the reports show $1,000 in revenue with zero associated commission expense, which dramatically inflates your margins and hides the real cost of that revenue stream.

The Right Way: Amortizing Commission Expenses

The correct approach under both US GAAP and IFRS is to defer the $1,200 and amortize it over the 12-month contract term. You first capitalize the $1,200 payment as an asset on your balance sheet. Then, each month, you recognize $100 in commission expense ($1,200 divided by 12 months). This method correctly matches the $100 expense to the $1,000 of revenue recognized each month, providing a consistent and accurate view of the contract’s profitability from start to finish.

Here is how the gross profit for that single contract compares across the first three months:

• Upfront Method Profit: January shows a ($200) loss, while February and March each show an artificially high $1,000 profit.
• Amortized Method Profit: January, February, and March each show a stable and accurate $900 profit.

To implement this, the finance team makes a recurring monthly journal entry. The correct journal entry to amortize commission expense is: Debit: Commission Expense (P&L), Credit: Deferred Contract Costs (Balance Sheet). This simple entry reduces the asset on your balance sheet and recognizes the proportional expense on your P&L. You can see a sample deferred commission journal entry for more detail.

Scaling Your Commission Tracking for Startups: From Spreadsheets to Software

Scrambling at the end of each month because you lack a reliable system to track, schedule, and amortize commissions is a significant operational drag. The reality for most Pre-Seed to Series B startups is more pragmatic: you do not need enterprise software from day one. The key is to adopt a system that matches your current scale and complexity, allowing for accuracy without unnecessary overhead.

The Startup Progression Model

For companies just starting to formalize their sales incentive accruals, a spreadsheet is the most practical first step. A good rule of thumb is that the threshold for starting with a spreadsheet system is for companies under $3M ARR or at the Pre-Series A stage. This approach, often called a sub-ledger, allows you to manage the details outside of your primary accounting software like QuickBooks or Xero. This keeps your general ledger clean and focused on high-level entries.

A simple spreadsheet sub-ledger for tracking commission amortization should include the following columns:

• Customer Name
• Contract Sign Date
• Contract Term (Months)
• Total Commission Paid
• Monthly Amortization Amount
• Opening Balance (Start of Month)
• Current Month Amortization
• Closing Balance (End of Month)

Each month, you sum the Current Month Amortization column for all active contracts. This total is the number you use for your single monthly journal entry in your bookkeeping system. This process prevents month-end chaos by systematizing the calculation and ensuring nothing is missed.

As you scale, this manual process becomes cumbersome and prone to error. The threshold for evaluating automated software is typically when a company is approaching its first audit or a Series A funding round. At this stage, the risk of misstatement and the manual overhead justify investing in a dedicated platform. These tools connect directly to your CRM (like Salesforce) and billing systems (like Stripe) to automate the entire deferral and amortization schedule, reducing errors and saving valuable time.

Managing the Impact on Cash Flow and Tax Reporting

One of the biggest mental hurdles for founders is the difference between accounting profit and actual cash. With commission amortization, your P&L might show a healthy profit, but the cash for that commission payment left your bank account months ago. This distinction between GAAP/IFRS profitability and cash flow is vital for accurate runway management.

When you pay a $1,200 commission in January, your cash balance decreases by $1,200 immediately, even though your P&L only shows a $100 expense. Your statement of cash flows will correctly reflect this cash outflow, but it is crucial not to mistake a smooth P&L for a smooth cash position. A scenario we repeatedly see is founders overestimating their available cash because they are only looking at their accrual-based P&L.

The separation between accounting rules and cash reality extends to taxes. While accounting standards dictate amortization for financial reporting, tax regulations can be different. For example, for tax purposes, early-stage companies in the US may often deduct the full commission when paid. This creates a temporary difference between your "book" income (for investors) and your "taxable" income (for the government).

This means you might report a small commission expense on your GAAP financial statements but deduct the entire cash payment on your tax return, lowering your taxable income for that year. In the UK, the rules under FRS 102 may align more closely with IFRS 15, but differences can still exist. This creates what is known as a deferred tax liability or asset on your balance sheet. Navigating this complexity is not a DIY task; it requires guidance from a qualified accountant or fractional CFO who understands both sets of rules. You can review the full IFRS 15 standard for more on contract costs.

A Founder's Checklist for Implementing Sales Incentive Accruals

Implementing proper sales commission accounting under modern revenue recognition standards is a mark of financial maturity. It provides investors, auditors, and your own leadership team with a clear, consistent view of your company’s performance. Here are the actionable steps to take.

1. Adopt the Accrual Mindset
   First, commit to the matching principle. Stop expensing large commission payments upfront. Treat them as a cost to obtain a contract that should be recognized over the life of that contract. This shift in thinking is the foundation for accurate financial reporting and reliable unit economics.
2. Build Your Initial System
   If you are under $3M ARR, start with a well-organized spreadsheet. Create a simple amortization schedule that tracks each commission payment, its amortization period, and the monthly expense. This sub-ledger will be your source of truth for the single journal entry you make in QuickBooks or Xero each month. For more on this, review our guide on bonus accrual monthly recognition.
3. Know When to Upgrade
   As your company approaches its first audit or a Series A round, the risk and complexity demand a more robust solution. This is the time to evaluate automated software. The pattern across SaaS and E-commerce clients is consistent: manual tracking becomes unsustainable as deal volume and sales team size increase.
4. Evaluate the Right Tools
   When you are ready to upgrade, you will find tools generally fall into two categories. Commission-specific platforms like CaptivateIQ are hyper-focused on automating complex commission calculations and payments. Broader revenue operations platforms like Maxio or SaaSOptics manage the entire revenue lifecycle, including commission amortization.
5. Separate Profit from Cash
   Finally, never forget that your P&L is not your bank account. Use a dedicated cash flow forecast to manage your runway and understand the immediate impact of large commission payouts. Lean on an accountant to manage the important differences between your book accounting for investors and your tax accounting for the government.

Continue at our hub for broader guidance on related topics: benefits accounting and accruals.

Frequently Asked Questions

Q: What happens if a customer churns before their contract ends?
A: If a customer cancels their contract early, any remaining unamortized commission on your balance sheet related to that contract should be expensed immediately. This correctly reflects that the future economic benefit of the asset (the deferred commission cost) has been lost and aligns the cost with the premature end of the revenue stream.

Q: Does commission amortization apply to all sales compensation?
A: It primarily applies to incremental costs of obtaining a contract, meaning commissions that would not have been incurred if the contract was not signed. Base salaries and non-contingent bonuses are typically expensed as incurred. However, performance bonuses tied directly to securing specific contracts usually require amortization under ASC 606 and IFRS 15.

Q: Over what period should I amortize sales commissions?
A: Commissions should be amortized over the period the company expects to provide services to the customer. This often corresponds to the initial contract term. If you have strong data showing a high likelihood of renewals, you may be able to justify amortizing the costs over a longer period, including expected renewals.

Q: Is sales commission accounting different for SaaS and E-commerce?
A: The principle is the same, but the application differs. For a SaaS business with a multi-year contract, amortization is straightforward. For an E-commerce business, a commission on a single sale is typically expensed immediately because the revenue is recognized at the point of sale. The matching principle is still met.