Third-party sales commissions: should they be included in cost of goods sold or offset against revenue?

In the daily operations of an enterprise, paying commissions to third parties for obtaining sales leads is a common business arrangement. When such leads ultimately generate revenue, the enterprise faces an accounting treatment choice: should this commission expense be included in cost of goods sold (COGS), or treated as a deduction from revenue (i.e., net presentation, also known as a 'contra expense')? This issue involves the fundamental principles of revenue recognition and expense matching, and requires judgment based on the specific business substance and applicable accounting standards.

The core of the issue: the relationship between the nature of the expense and revenue recognition

Under International Financial Reporting Standards (IFRS) or U.S. Generally Accepted Accounting Principles (US GAAP), revenue recognition follows core principles such as 'transfer of control' or 'satisfaction of performance obligations'. Commission expenses are incremental costs incurred to obtain a contract, and their accounting treatment depends on whether they meet capitalization criteria and whether they are directly related to specific revenue.

If the commission is directly tied to a specific sales contract and that contract is expected to generate future economic benefits, then under IFRS 15 (or ASC 606), the commission may be capitalized as a contract acquisition cost and amortized over the period of revenue recognition. The amortization is typically included in selling expenses or cost of goods sold, depending on the company's accounting policy. If the commission does not meet the capitalization criteria (e.g., the contract term is less than one year), it is expensed directly in the current period.

Considerations for including in cost of goods sold (COGS)

Including the commission in COGS means treating it as a cost directly related to generating revenue. This practice is common in service industries or project-based businesses, where third-party commissions are similar to 'outsourced sales' costs and have a clear causal relationship with revenue. In this case, the commission is presented as part of COGS in the income statement, matched with revenue, thereby reflecting the gross profit level.

Considerations for treating as a deduction from revenue (net presentation)

Another view is that commissions are essentially a variation of 'variable consideration' or 'payments to customers' incurred to obtain revenue. If the third party substantially performs the sales function and the enterprise acts only as an agent, revenue should be recognized on a net basis (i.e., after deducting the commission). However, if the enterprise is the principal, the commission should not reduce revenue but should be presented as an expense.

However, in most cases, the third party merely provides sales leads and does not assume performance obligations, so the enterprise typically acts as the principal, and the commission should not directly reduce revenue. But if the contract stipulates that the commission is linked to the revenue amount and is paid to the customer (rather than an independent third party), the variable consideration provisions may apply, requiring a reduction in revenue.

Common practices and judgment factors in practice

In practice, enterprises need to make a comprehensive judgment based on the following factors:

• Contract terms:Whether the commission is directly related to a specific contract and can be separately identified.
• Business substance:Whether the third party assumes the sales function or merely provides leads.
• Accounting standard requirements:The treatment of contract acquisition costs under IFRS 15 or ASC 606.
• Industry practice:The presentation methods commonly adopted by companies in the same industry.

If the commission is an incremental cost of obtaining a contract and is expected to be recoverable, it is usually capitalized and amortized to expense (possibly included in selling expenses or COGS). If expensed directly, most companies tend to include it in selling expenses rather than reducing revenue. Treating commissions as a deduction from revenue (net presentation) is relatively rare, unless the company acts as an agent or the commission is paid to the customer.

Illustrative example

Assume a software company acquires a customer through a third-party referral, paying a commission of 50,000 yuan, with a contract amount of 1 million yuan. If the company is the principal, revenue of 1 million yuan is recognized, and the 50,000 yuan commission is treated as a selling expense (or capitalized and amortized). If the company is merely an agent, revenue is recognized on a net basis of 950,000 yuan, and the commission is not separately presented.

Conclusion and recommendations

In summary, whether third-party commissions should be included in COGS or reduce revenue has no uniform answer; it requires judgment based on specific facts and accounting standards. It is recommended that enterprises consult professional accountants and refer to the relevant guidance in IFRS 15 or ASC 606. In most cases, presenting commissions as selling expenses or COGS is more appropriate, while reducing revenue is only applicable in specific situations (such as agency models or payments to customers).

Ultimately, enterprises should ensure that the presentation in financial statements truly reflects the economic substance of the transactions and adheres to the principle of consistency.