How to calculate a commission

A commission is a fee that a business pays to a salesperson in exchange for his or her services in either facilitating or completing a sale. Calculating a sales commission depends on the structure of the underlying commission agreement. The following factors typically apply to the calculation:

  • Commission rate. This is the percentage or fixed payment associated with a certain amount of sale. For example, a commission could be 6% of sales, or $30 for each sale.

  • Commission basis. The commission is usually based on the total amount of a sale, but it may be based on other factors, such as the gross margin of a product or even its net profit. Management may use a profit-based commission when there are substantial differences between the profitability of different products, and it wants to give an incentive to the sales staff to sell the most profitable items. The basis may also be based on cash received from a sale, rather than from the initial sale; this is used most commonly when a company wants to involve the sales staff in collecting overdue accounts receivable. Another variation is to offer a special commission rate on inventory that management wants to eliminate from stock, usually before the inventory becomes obsolete.

  • Overrides. A different commission rate may apply if a certain target is reached. For example, the commission rate may be 2% of sales, but retroactively changes to 4% if the salesperson attains a certain quarterly sales goal.

  • Splits. If more than one salesperson is involved in a sale, then the commission is split between them. It is also possible that the manager of a sales region will earn a portion of the commissions of the salespeople working in that region.

  • Payment delay. Commissions are usually paid based on the sales from the preceding month. It can be difficult to accumulate information for a commission calculation, hence the delay in making payments.

For example, the commission plan of Mr. Smith is to earn 4% of all sales, less any returned merchandise. If he reaches $60,000 in sales by the end of the quarter, the commission retroactively changes to 5%. In the first quarter, he has $61,500 of sales, less $500 of returned merchandise. Thus, the calculation of his commission for the entire quarter is:

$61,000 Net sales x 5% Commission rate = $3,050

If commissions are not to be paid by the end of the reporting period, then the amount of commission expense is included in a reversing journal entry, along with the estimated amount of payroll taxes. This approach is only used under the accrual basis of accounting, and ensures that the expense is recorded in the same period as the sales transaction that triggered the commission.

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