Deferred commissions under ASC 606: contract costs, explained
The short version: under ASC 340-40, a sales commission paid to win a contract usually has to be capitalized as an asset and amortized, not expensed on day one, unless a one-year practical expedient applies. Here's how the mechanics work, with journal entries.
What counts as a "deferred commission"
ASC 340-40-25-1 requires an entity to recognize as an asset the incremental costs of obtaining a contract with a customer, if it expects to recover those costs. "Incremental" means the cost would not have been incurred if the contract had not been won (ASC 340-40-25-2) — the textbook example is a sales commission paid only because the deal closed. Costs you'd have incurred regardless, like a sales manager's base salary, are expensed as usual (ASC 340-40-25-3) unless they're explicitly chargeable to the customer whether or not the contract is won.
The one-year practical expedient
Capitalization isn't automatic. ASC 340-40-25-4 lets an entity expense the incremental cost when incurred, as a practical expedient, if the amortization period of the asset it would otherwise recognize is one year or less. Elect this and it has to apply consistently to every contract that qualifies across the entity — no cherry-picking which short contracts get the treatment.
Amortizing a capitalized commission (worked example)
When capitalization applies, the asset is amortized on a systematic basis consistent with how the related goods or services transfer to the customer (ASC 340-40-35-1), usually straight-line unless a different pattern is evident. The part most people miss: the amortization period isn't automatically the initial contract term. If renewal commissions aren't proportional to the initial commission, the asset has to be amortized over the customer's expected life, including anticipated renewals, not just the first contract.
Example: a company pays a $24,000 commission on a new 4-year contract. Renewal commissions are token amounts, not proportional to the original commission, and the company expects two further 4-year renewals based on history — a 12-year expected customer life.
- At contract inception: Dr Capitalized contract cost asset $24,000 / Cr Cash (or commission payable) $24,000.
- Each year for 12 years: Dr Amortization expense (contract costs) $2,000 / Cr Capitalized contract cost asset $2,000 ($24,000 ÷ 12 years).
If instead that $24,000 related to a contract with no expected renewals and an amortization period of one year or less, the practical expedient would let the company skip all of this and record Dr Commission expense $24,000 / Cr Cash $24,000 on day one.
Testing the asset for impairment
At each reporting period, compare the asset's carrying amount to the remaining consideration the entity expects to receive for the goods or services the asset relates to, minus the remaining direct costs still expected to be incurred to provide them (ASC 340-40-35, Subsequent Measurement). If the carrying amount is higher, the excess is an impairment loss recognized immediately in profit or loss.
Example: a capitalized contract cost asset has a $10,000 carrying amount. The entity now expects only $50,000 of remaining consideration under the contract, against $45,000 of remaining direct fulfillment costs — a $5,000 net recoverable amount.
- Dr Impairment loss (contract costs) $5,000 / Cr Capitalized contract cost asset $5,000 (carrying amount $10,000 minus recoverable $5,000).
Unlike some other long-lived asset impairment models, this one has no comeback: once recognized, an impairment loss on a contract cost asset cannot be reversed in a later period, even if the outlook improves.
Source: FASB Accounting Standards Codification, ASC 340-40-25 (Recognition) and ASC 340-40-35 (Subsequent Measurement), Other Assets and Deferred Costs — Contracts with Customers.