Many businesses prefer to award their employees by using different means, such as paying a commission on sales. The calculation formula depends on several factors.
We have prepared an article to figure out all the details. You will learn what factors impact commission. Our readers will also find an instruction on how to calculate commission based on these factors.
What Is Commission?
A commission is a fee a company needs to pay to a salesperson to reward them for their services. Typically, this fee is a motivation to sell more goods or services and thus get more revenue. The size of a commission depends on different factors, more on that further in the article.
What Influences Commission Payments?
Calculating a commission depends on several different factors. Here’s what typically impacts the size of a commission:
- Period. It’s the time taken to determine the commission. Typically, companies calculate commissions once or twice a month.
- Basis. It’s the amount in dollars based on which the accountant calculates the payment. Typically, the basis is the total amount of sales (or sold services) and could be the gross margin or net profit. In some cases, it could be the inventory value.
- Rate. It’s the fixed number or percentage linked to the number of sold goods or services.
- Override. The rate can change depending on the sales results.
- Split. The company may split the commission if two or more people contribute to sales. Some businesses also implement systems that allow area managers to make a percentage out of the sales made by the workers in this area.
- Tier. Businesses often set different rates based on the number of goods or services sold. For instance, the company offers a deal: the starting rate is 4% on the first $15,000 of sales, 6% on the next $10,000, and 7% on the rest. So, there are three tiers.
More details on how to include these factors when determining commission are described further in the article.
How To Calculate Commission Payments?
Before calculating a commission, the accountant must consider several factors and make smaller calculations. Here’s what you should do:
- Choose the commission period.
- Determine the total commission base.
- Multiply commission rate by commission base.
- Consider variable commission rates.
- Apply the tier whenever necessary.
Now let’s check the details.
Choose The Commission Period
Typically, accountants calculate commission payments on a monthly or biweekly basis. If an employer gets a salary every two weeks, the commission period is from the 1st to the 15th day of the month. For instance, a worker gets paid for sales made from August 1 to August 15.
The commission is calculated based on sales made during a preceding period. For instance, an employee gets a commission for sales made in January in February and sales made in February in March.
In some cases, companies have other types of delays when it comes to paying commission. The most common case is when businesses pay commission only upon receiving payment from their clients.
Determine The Total Commission Base
The next step is to calculate the base an employee made during a specific period. If the commission is based on the purchase price of products or services sold during a given period, and the worker sold $43,000 worth of products or services from April 1 to April 15, their total base is $43,000 for that period.
If the employee gets a different rate on different groups of products or services, the accountant should calculate the total base by product.
Suppose a worker sold an equal amount of 3 different services. These services have different commission rates. The accountant should add to an entry that the employee sold $43,000 of service A, $43,000 of service B, and $43,000 of service C.
Multiply Commission Rate By Commission Base
The next critical step is to multiply the commission rate by the base for the period. Suppose a worker made $43,000 worth of sales from April 1 to April 15. Their commission rate is 5%:
$43,000 x 0.05 (5 percent) = $2,150.
Accountants calculate commission differently for employees having different rates. More on that below.
Consider Variable Commission Rates
Some companies set different rates on products or services they sell. If a worker is paid different rates for different goods or services, the accountant should multiply each commission base by the specific rate and add the results. Here’s an example:
Suppose a worker sold $20,000 worth of services (type A), and $15,000 worth of services (type B). Service A is 4%, Service B is 6%:
- $20,000 x 0.04 = $800.
- $15,000 x 0.06 = $900.
In total, the employee made $1,700 during a given period.
Apply The Tier When Necessary
Some businesses set different rates based on the number of goods or services sold. In that case, multiply each commission base by the rate for that tier. Then add the results. Here’s an example:
The company sets a rate of 5% on the first $35,000 of revenue, and 7% on the remainder. Suppose the employee sold $42,000 worth of goods. Here’s how to calculate their payment:
- $35,000 x 0.05 = $1,750.
- $7,000 x 0.07 = $490.
In total, the employee made $2,240 during a given period. Sometimes the override rate could be applied retroactively to the entire commission base for the period.
Suppose an employee sells at a rate that increases from 5% to 6% if they sell more than $25,000 worth of goods. The 5% rate could be used on the entire earned base for the period if the employee exceeds their quota.
Commission in Accounting
If the company isn’t paying commissions by the end of the reporting period, it should include the amount of compensation expense in a reversing journal entry. The accountant should also determine the estimated amount of payroll taxes in each case.
Businesses use this plan only under the accrual accounting method. If this approach is used, then accountants should ensure to record expenses in the same period as the sales transaction which caused the commission.
