By Jim Donellon, CPA, MSA
Partner, Gray, Gray & Gray, LLP
How the costs of obtaining a contract are accounted for has changed. And its complicated, particularly for software and SaaS companies who compensate salespeople on a commission basis.
This new guidance aligns the costs of obtaining a contract with the timing of recognizing the revenue under such contracts. Companies now must track direct and incremental costs (assuming they are recoverable) for obtaining customer contracts, capitalize these costs as assets, and determine an expected amortization period.
The Financial Accounting Standards Board (FASB) Accounting Standards Update No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” took effect for nonpublic companies with calendar year-ends for the year ended December 31, 2019. The new standard requires the incremental costs of obtaining a contract be capitalized at inception and expensed systematically.
Starting with your December 31, 2019 financial statements, you must now account for the incremental costs of obtaining a contract – including sales commissions or bonuses tied directly to sales targets – at a deeper level of detail. Amortization of any capitalized costs to obtain contracts must be “on a systemic basis consistent with the transfer of goods or services to the customer.”
This means expensing sales commission costs over time, instead of when incurred, which is when entities historically recorded such expenses. A company must evaluate the long-term benefits of the sales commission being paid and identify the inputs that provide the basis of that benefit, then decide the typical amortization period based on contract term or anticipated customer life.
Some inputs may be easily identified, such as the original contract term and anticipated renewals that extend the customer life. However, a company is not permitted to simply default to the initial contract term or expected customer life. Documenting your methodology and judgment used for compliance is essential to meet the requirements under the new standards.
An entity may recognize the incremental costs of obtaining a contract as an expense when incurred if the amortization period of the asset that the entity otherwise would have recognized is one year or less.
If you have questions about this new standard and what is required to comply, please contact Jim Donellon of our Software & SaaS practice group at (781) 407-0300.