In Part I of our series on ASC 606 we gave you a closer look at the new revenue recognition standards for all companies reporting under US GAAP. We also highlighted how these changes would affect sales commissions accounting practices which revealed a greater necessity for a move away from manual incentive compensation calculations and accounting. Some key take-away points you might have missed from the previous post also highlighted the challenges related to aligning contract acquisition costs in a complex contract environment. Read Part I here.
At the conclusion of our previous blog, we left you with this question - how can my organization meet the sales incentive accounting challenges introduced by the ASC 606 standard?
Across our customer base, Intangent has uncovered two popular strategies for handling the migration to ASC 606 standards.
The Portfolio Approach: A Top-Down View
Many organizations that write multi-year business are adopting a portfolio approach to ASC 606 sales incentive expense amortization. These organizations take the view that in any given period, a significant majority of new business can be grouped together in portfolios – large groups of contracts with similar characteristics that also exhibit similar behaviors when paying sales incentives. Strong candidates for the portfolio approach are businesses that execute contract portfolios that are homogenous in nature:
- Similar contract length
- Similar contract features
- Similar contract revenue recognition schedules
In addition, it’s vital that each contract portfolio can be tied to how sales reps are paid commissions or bonuses. This requires a clear link between a seller’s individual component payouts and the portfolio of business being written.
The portfolio approach is relatively easy to put in place because it can be accounted for using all of the data that you’re already producing to meet your incentive payment needs and your revenue recognition needs.
Keep in mind before you rush off and decide to adopt this strategy, be aware that there are limitations which may make the portfolio approach incompatible with your business. For example, if a sales rep is paid a commission bonus for new business, but the contracts involved reflect different durations such as 3-, 4- and 5-year deals then there is no clear link between the sales incentive paid and the contract portfolio itself. Another limitation is the inability to introduce contract modifications for individual contracts into the contract portfolio.
To meet these challenges, businesses must consider a contract-level approach instead.
The Contract-Level Approach: A Bottom-Up View
Where the portfolio approach takes a top-down view, the contract-level approach does the complete opposite and uses a bottom-up system for accounting. Unlike top-down, bottom-up relates sales incentives paid to the specific contract in question.
Contract-level is compatible with all types of businesses. However, it does require data that may not currently exist in your business such as:
- All sales incentives must be calculated at the contract (transactional) level
- Contract modifications must be captured and routed to the revenue recognition engine
- Sales incentives related to contract modifications must be similarly related to the contract
The primary challenge of the contract-level approach is that it tends to produce an abundance of data. Instead of crunching numbers at a high level, each detail record must be recorded and then aggregated upwards into the general ledger. Even generating the data at this level can be difficult for both revenue recognition and for transactional-level incentive calculations without the use of software applications such as contract management, configure price quote, and incentive compensation management systems.
The primary advantage of using contract-level is that it allows for complete flexibility with future incentive programs, contract types, and team configurations. The data is collected at the lowest level, which can always be aggregated to match with revenue recognition schedule. In addition, if accounting rules change, the business adds new contract types, or a new company is acquired, managing this change in a bottom-up environment is simpler.
Remember, to meet US GAAP compliance all public companies must adhere to the ASC 606 standard by January 1, 2018, and all private companies by January 1 2019. Interested in understanding how your business can meet the ASC 606 accounting standards for sales incentives? Talk to Intangent today!