Is Sales Commission a Period Cost or a Product Cost?
Clarify sales commission's true accounting nature: Is it a period or product cost? Understand its classification and impact on financial reporting.
Sales commission represents a payment to a salesperson for generating revenue, typically calculated as a percentage of sales. In accounting, sales commission is classified as a period cost. This means it is expensed in the accounting period it is incurred, rather than being attached to the cost of goods produced.
Understanding Period Costs and Product Costs
Businesses classify expenses into two main categories: period costs and product costs. Period costs are those not directly tied to the manufacturing or acquisition of goods for sale. These costs are expensed in the income statement during the period they arise, regardless of when any related products are sold. Examples of period costs include administrative salaries, marketing expenses, and office rent.
Product costs, in contrast, are directly associated with the production of goods and are considered “inventoriable” costs. These include direct materials, direct labor, and manufacturing overhead. Product costs are initially recorded as assets on the balance sheet as inventory. They only become an expense, specifically Cost of Goods Sold (COGS), when the related goods are sold.
Sales Commission as a Period Cost
Sales commission is categorized as a period cost because it is incurred at the time a sale is made, acting as a selling expense. It does not contribute to the manufacturing or acquisition cost of the product itself. Therefore, sales commission is expensed immediately in the period it is earned, typically when the sale transaction takes place.
The rationale for this classification is that sales commissions are part of the effort to generate revenue, not the cost to create the product. For instance, a commission is paid whether the product was manufactured yesterday or a year ago. It is a cost of the sales activity, aligning with expenses like advertising or general administrative overhead, which are also period costs. This treatment ensures that the expense is matched to the revenue it helps generate within the same accounting period.
Impact on Financial Reporting
Classifying sales commission as a period cost has clear implications for a company’s financial statements. On the income statement, sales commissions are recognized as an expense in the period they are incurred. They typically appear under Selling, General, and Administrative (SG&A) expenses, which are reported below the Cost of Goods Sold. This placement means sales commissions affect operating income and net income for that specific period.
Period costs like sales commissions do not appear on the balance sheet. They are expensed immediately, preventing them from inflating inventory values. This immediate expensing provides a transparent view of the costs associated with sales activities in a given period, ensuring that profitability is accurately reflected.