I am going to pay commissions on sales. Each sale will generate a commission of $3, but the commissions will only be paid by-weekly. I would like to allocate commissions to a liability account, and then clear it periodically against an expense account to record the cost.
How can I allocate commissions? Should I do it on the sales invoice or in the payment? Since the payment goes to a cash account and the commission is not paid until later, it does not make sense to charge it when taking payment since the balance received should not get affected.
I haven’t figured out how to allocate this so any advice would be really appreciated.
When does the commission become payable - when the sale is made or when the payment is received?
Who is the commission paid to - the customer, an employee, a third party?
Can you please be a little more precise, @whereskarlo? You have mixed together terminology on payments and balance received. And you mention payment going to a cash account, rather than being paid from one. (And what does an account being a cash account have to do with anything?) So perhaps you could describe exactly what you want happen, with numerical examples.
If worried about timing of expense then when commission is earned Dr commission expense / Cr commissions liability (could be a Journal entry). Later, when commission is paid Dr commissions liability / Cr Bank via payment transaction.
If you’re not worried about timing of commission expense and only recording when paid, then Payment would hit expense directly.
Thank you for the answers. Let me try to clarify.
I must pay a third party (sales agent) $3 for every sale of Widget A that he generates. Widget A happens to cost $20. If I sell 2 x Widget A for $40, I want to record I owe the sales agent $6. I would like this to be recorded into an appropriate liability account, so that I know how much I owe the sales agent. Periodically, I will pay the accumulated commission to the sales agent.
If the sales agent has generated $120 worth of sales of Widget A, I thus owe the sales agent $18 in commissions. When I decide to pay him $18, I want my liability to be reduced by $18 and my commissions expense account to be increased by $18.
Is there a way to record commissions like this in manager, and could it be recorded when the sale is recorded or does it require a separate entry? I was hoping to use a non-inventory item linked to the appropriate account to record commissions as they are earned by the sales agent, and pay them out later.
Thanks for the explanation. This is a straightforward situation. Begin with the understanding that your liability to the agent and your payment to them are not connected to the sale of Widget A from an accounting viewpoint, because they involve a different entity than the customer to whom you sold Widget A. So you cannot put the commission on the sales invoice. You also would not want to do that, because you do not want your customer to know about commission you owe or pay to a third party.
So, there are several steps. They are discussed under the assumption you are using accrual basis accounting:
- Create your agent(s) as suppliers. You will be purchasing orders for Widget A from them.
- Create a non-inventory item for the commission since it is the same every time. Set up the non-inventory item as something that can be purchased, with a purchase price of $3, posting to an expense account named something like Commissions paid.
- When you sell a Widget, raise a sales invoice in the name of your customer. This will debit Accounts receivable for the sale price and credit Inventory - sales for the same amount. It will also transfer the current average cost of the Widget A from Inventory on hand to Inventory - cost to record the cost of goods sold.
- At the same time, raise a purchase invoice in the name of your agent. Enter the non-inventory item for commission on it. This will have the effect of crediting Accounts payable for the agent and debiting Commissions paid. Note that this satisfies your desire to record the liability for paying the commission to the agent. Also note that the expense is recorded at the time of sale and raising of the purchase invoice because that is when it was accrued.
- If you decide you want more visibility into commissions owed, you could create a custom control account in Liabilities made up of suppliers. Name it Commissions owed. Assign all your agents to that control account. Then, commissions you owe will show separately from accounts payable to other types of suppliers.
- When you pay an agent, use a payment form. Post the payment to either Accounts payable or Commissions owed, depending on which you decide to use. This will clear the liability to the agent, but not affect the expense entry already recorded.
Let me add a word about cash basis accounting. If you use cash basis accounting, all the steps are the same, but income from your sale to your customer and the expense of your commission to your agent will not appear on the P&L until money is received or paid against the sales and purchase invoices.
Thanks @Tut for your excellent write-up, this achieves everything I desired. For bullet #3, I believe it should say “sales invoice” and not “purchase invoice” for the sake of future readers.
I find your solution easy, transparent and satisfactory. It is easy to copy a sales invoice to a purchase invoice via the “copy to” function, and the sales agent now has a “supplier” account in which I can easily see how much is owed by clicking on the “suppliers” tab. Payments are equally easy to record and everything is beautifully tracked/recorded.
I will consider using a custom liability account in case this scales up and more agents are added.
You are correct. I have edited the post. Sorry about that.
I believe you will find this is not convenient. Although sales and purchase invoices can both be copied to the other, think about what you would have to do if you copied the sales invoice to a purchase invoice:
- Select the agent as supplier
- Change the summary level Description
- Delete the Widget A item (and any other line items on the sales invoice)
- Add the commission line item
In other words, you would save time and effort by starting with a new purchase invoice rather than copying: nothing to delete or change and no possibility of accidentally forgetting to do one of those things.