Macro to MicroImplementing Commissions Accounting

Requirements under ASC 606August 2017

• Specialized Professional Services Firm

• Technical Accounting, IPO Services, Financial Operations, M&A

• Big 4 alumni (top 25% performers) and industry executives

• 54% market share of Bay Area IPOs, 45 IPOs past 3 years

• Over 40,000 hours of consulting with clients on ASC 606, 15%

on systems automation work

About Connor Group

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Agenda

1. Overview of accounting requirements

2. Key areas of judgment

3. Common adoption and implementation issues

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Accounting Requirements: Origination Costs

• Costs to obtain a contract with a

customer that are both:

Incremental costs only

incurred if the contract

is obtained, and

Costs are expected to

be recovered

• Costs that would be expensed

over less than 1 year may be

expensed immediately

Common Examples:

Sales commissions

Third-party commissions

Related payroll taxes

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Accounting Requirements: Fulfillment Costs

Common Examples:

Direct labor and materials

Allocated costs

Costs incurred solely

because from into the

contract

Billable costs

• Costs to fulfill a contract that:

Are not covered by other GAAP

Relate directly to a specific contract (or anticipated contracts)

Generate or enhance resources used to satisfy current or future

performance obligations

Are expected to be recovered

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Accounting Requirements: Recognition of Expense

Recognition Type Origination Fulfillment

As incurred Not capitalized Not capitalized

Capitalized,

over contract termCommensurate

Over period of benefitCapitalized,

over estimated lifeNon-commensurate

Commission incurred today

Assess whether this

would be commensurate

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Key Judgements: When are commissions commensurate?

Company A commissions overview:

1. 4% of average annual recurring revenue (ARR) for contracts with new customers. 1% of the average ARR upon contract renewals

2. 4% of the average ARR for the additional ARR in contract upsells

3. 2% of all non-recurring services (such as setup fees or professional services)

4. 10% of all sales to referred customers is paid to a channel partner for lead referrals made to the company

5. Lead generation receives $100 for a “quality lead” and 1% of average ARR on new contracts

Are you buying a relationship

or cash flows?

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Key Judgements: Estimated life of non-commensurate commission assets?

Key Considerations:

• Estimated customer life (churn

analysis)

• Already-existing estimates of related

assets, including: Capitalized software or internal-use

software

Acquired developed technology and

customer relationships

• Stratification by business unit or

customer types

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Key Judgements: Do your commissions include substantive service conditions?

Capitalized commissions are costs solely

incremental to origination.

• Commissions may have a substantive

condition that would preclude capitalization:

Management incentive plans that include

target stock prices and EPS include

Amounts that require the continued service of

the employee for a significant period of time

Commission payouts that are significantly

deferred

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Key Judgements: Capitalize commissions based on cumulative targets?

Approach 1

Record commissions for the

incremental contract

Approach 2

Accrue commissions at a

blended rate

Company Policy Election

Common examples:

• Rate increases prospectively as

sales tiers are met

• Payment made upon achieving

cumulative targets (a given

number of contracts or sales

volume)

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Key Judgements: Capitalize commissions based on cumulative targets (Cont.)?

Approach 1: As Incurred

Sales Rate Commission

- 1% -

500,000 2% 10,000

500,000 3% 15,000

1,000,000 25,000

Approach 2: Blended Rate

Estimated

Total Sales Rate Commission

1,000,000 1% 10,000

2,000,000 2% 40,000

4,000,000 3% 120,000

7,000,000 2.43% 170,000

Period

Sales Rate Commission

1,000,000 2.43% 24,286

Example: ABC Co. pays commissions

based on the total contract value. As

total sales increase, the salesperson

prospectively receives a higher

commission rate. At the beginning of the

month, Salesperson A had $2,500,000

of sales, and is expected to sell

$7,000,000 in the commission period.

How do you treat $1,000,000 of

incremental sales?

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Adoption and Implementation Issues: Matching revenue and expenses

One of the primary objectives is to match the expense with the

timing of revenue recognition

Relatively straightforward for contract-life assets (i.e., when commensurate commissions)

Example Software:

ABC Co. sells a three-

year term license for

$510,000, co-terminous

PCS for $240,000, and

professional services of

$200,000 (delivered in

the first quarter).

Example SaaS:

ABC Co. sells a three-

year subscription service

for $800,000 and

professional services of

$200,000 (delivered in

the first quarter).

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Adoption and Implementation Issues: Matching revenue and expenses (Cont.)

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Adoption and Implementation Issues: Matching revenue and expenses (Cont.)

• When commissions are not

commensurate they are

amortized over an “estimated

life”.

• In order to estimate revenue

recognition beyond the

contractual term you must

estimate expected

contractual renewals

• May also need to consider that

those expected renewals may

have additional capitalized

commissions costs

Two acceptable approaches:

1. Ignore renewal commissions in thetreatment of the initial commission

2. Factor renewal commissions in the treatment of the initial commission

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Adoption and Implementation Issues: Matching revenue and expenses (Cont.)

Treat initial commission separately

Commission Year 1 Year 2 Year 3 Year 4 Year 5 Total

Initial 3-yr term 6,000 6,000 6,000 6,000 6,000 30,000

1-yr renewal - - - 5,000 - 5,000

1-yr renewal - - - - 5,000 5,000

Total life 6,000 6,000 6,000 11,000 11,000 40,000

Consider future commissions

Commission Year 1 Year 2 Year 3 Year 4 Year 5 Total

Lifetime asset 3,000 3,000 3,000 3,000 3,000 15,000

Initial 3-yr term 5,000 5,000 5,000 - - 15,000

1-yr renewal - - - 5,000 - 5,000

1-yr renewal - - - - 5,000 5,000

Total life 8,000 8,000 8,000 8,000 8,000 40,000

Example:

• ABC Co. pays $30,000

in commissions for a

three-year subscription

service that is

recognized as revenue

ratably over the

contractual term.

• ABC Co. estimates the

life of the commissions

asset as 5 years.

• ABC Co. expects to pay

commission of $5,000

per year of renewal

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Adoption and Implementation Issues: Asset-Level Approaches

• Are your commission accruals made at the contract- or line item-level?

• Do different commissions rates exist for different types of sales line

items?

• e.g., non-recurring professional services vs. recurring services

or licenses

• Allocate commission costs to POBs:

• Relative to SSP

• Specific mapping of calculated accruals to specific POBs

• Revenue automation constraints can be significant

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Adoption and Implementation Issues: Portfolio Approaches

• Portfolio approaches are not

required to exactly match asset-

level calculations

• Important to keep in mind that

estimated life is a “large numbers”

concept

actual experience below

expectations

may be offset by other

observations

above expectations

Specific contract impairments

would

be less common

Commission type

• Not capitalized

• Contract term

• Estimated life

Revenue timing

• Immediate

• Over time (ratable)

• Other measure (hours incurred, etc)

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Adoption and Implementation Issues: Portfolio Approaches

• Map period commissions to appropriate amortization buckets

• Determine appropriate amortization methods for performance obligations

• Match commission types with revenue recognition types

• Populate period “asset schedules” for new commissions

• Ongoing amortization and reconciliations over lifetime of assets

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Adoption and Implementation Issues: Adoption Period

Today

2011 2012 2013 2014 2015 2016 2017 2018

Adoption date

1/1/2018

Quarter end under

ASC 606

3/31/2018

Financial statements presented

1/1/2016

Revenue contracts

1/1/2013

Commissions contracts

1/1/2011

Revenue and commissions

contracts (modified)

1/1/2015

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Adoption and Implementation Issues: Adoption Period (cont.)

• Availability and reliability of commissions data for historical periods

• Changes to commissions plans over time that may result in different

historical accounting requirements

• The longer the estimated life, then more commissions data is needed

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Thank You! Questions?

A Premier Professional

Services Advisory Firm

Connor Group professionals deliver to our

global clients Technical Accounting, IPO

support, Mergers and Acquisitions, and

Financial Operations services from our

bases in Silicon Valley, San Francisco,

New York, Salt Lake City and Europe.

Thought Leaders

Since 2006

Jacob SperryJacob.Sperry@connorgp.com

Jacob is a Director in Connor Group’s

Technical Accounting and IPO Services

practice. One of the firm’s leaders in ASC

606, he is assisting multiple clients with

their implementation of the new standard’s

requirements. Jacob also has extensive

experience with debt and equity financing,

share-based compensation, consolidation,

and other complex accounting topics under

both US GAAP and IFRS. Jacob leads

clients through IPO preparation and filings,

acquisition accounting, audit readiness,

and other transactions.

Jacob is a frequent presenter at internal

and external events on a variety of topics

including ASC 606. Prior to joining Connor

Group, Jacob was a Manager in PwC’s

Financial Instruments, Structured Products

and Real Estate Group, and also worked

as a Postgraduate Technical Assistant with

the Financial Accounting Standards Board.

Jacob is a licensed CPA in New York.