Deferred Commission Journal Entry
Deferred Commission is the commission that company already paid to a third party but has not yet recorded as an expense.
Commission expense is the amount of cash that the company spends on the agency to get the project. The company needs to spend to agency or someone to lead the customer to them. The company pays a commission when someone brings the customers to purchase the goods or services. It is the expense that company pays to get the sale. Without this expense, the company will not able to make sale.
In some projects such as construction, company will spend more than one accounting period to finish it. Based on the accounting principle, they only record the revenue when work is performed for the customer. So basically, the construction company will split the revenue over the construction period.
Based on the accounting matching principle, the sale and its expense that lead to revenue need to record in the same period. So the commission which is the expense of the project has to allocate based on the revenue as well. It is the reason why company requires to record deferred commission and amortize it over the project period.
Company will record deferred commission as the assets on the balance sheet. At the end of each accounting period, they simply reverse it to the commission expense. It is almost impossible to allocate based on the revenue percentage, so we can use the straight line to allocate it.
Deferred Commission Journal Entry
When the company pays for the commission, they have to record cash outflow and debit commission expenses. However, the company cannot record commission expenses yet if the related project takes more than one accounting period to complete. The commission is the cost to acquire the project, so it must be allocated based on the project life. The journal entry is debiting deferred commission and credit cash paid.
The journal entry will increase deferred commission which is the asset account on balance sheet.
At the end of the accounting period, the company needs to amortize the deferred commission to the commission expense present on the income statement. The journal entry is debiting commission expense and credit deferred commission.
The transaction will reduce the deferred commission from balance sheet to the income statement. At the end of project, the deferred commission will be zero.
Deferred Commission Journal Entry Example
ABC is a construction company. During the year, company acquires one new project it expects to construct within 3 years. The company spends $ 30,000 on the commission to acquire the project. Please prepare journal entry for deferred commission.
ABC spend a commission $ 30,000 to acquire the construction project. It is part of the project cost. However, we can’t record it as an expense when the payment is made. Based on accounting principles, we have to match revenue and expense. We have to record them as assets and amortize them over the period of 3 years.
The journal entry is debiting deferred commission $ 30,000 and credit cash $ 30,000.
Deferred commission will present as an asset on the balance sheet.
At the end of the first year, ABC has to record commission expenses and reduce the deferred commissions. The journal entry is debiting commission expense $ 10,000 ( $ 30,000 / 3 years ) and credit deferred commission.