Picture two software companies that close the exact same $2,400 deal in the same quarter. One reports a $2,400 expense the day the contract is signed. The other reports $100. Both did nothing wrong. The difference is whether they correctly applied a single, often-misunderstood accounting rule about sales commissions—and that rule can swing an operating margin by several percentage points.
If your business pays commissions to win customers, ASC 340-40 decides whether that money hits your income statement all at once or gets spread out over years. Getting it wrong is one of the most common findings in audits of subscription companies. Getting it right makes your financials tell a truer story. Here is how the rule works, when it applies, and how to keep the books for it.
What ASC 340-40 Actually Governs
ASC 340-40 is the U.S. GAAP standard titled "Other Assets and Deferred Costs—Contracts with Customers." It is the companion to the better-known ASC 606, the revenue recognition standard. Both came out of the same FASB project, and they work as a matched pair: ASC 606 tells you when to recognize revenue, and ASC 340-40 tells you how to account for the costs you incur to win and deliver that revenue.
The logic is the matching principle. ASC 606 forces revenue from a multi-year contract to be spread over the service period instead of booked upfront. ASC 340-40 does the parallel thing on the cost side. If you pay a large commission to land a three-year contract, that commission produces three years of benefit. So instead of expensing it immediately, you record it as an asset and amortize it as the benefit is consumed. Cost and revenue move together.
ASC 340-40 splits contract costs into two buckets:
- Costs to obtain a contract—principally sales commissions. This is the focus here.
- Costs to fulfill a contract—setup, onboarding, and implementation work. We'll touch on this at the end.
The standard defines the incremental costs of obtaining a contract as costs the entity incurs to win a contract that it would not have incurred if the contract had not been obtained. The textbook example, named in the standard itself, is a sales commission. And the core rule uses the word "shall": a company must capitalize these incremental costs as an asset when it expects to recover them. Capitalization is mandatory, not a policy choice—with one narrow exception we'll cover below.
The "But-For" Test: Which Costs Are Incremental
Everything turns on a counterfactual question: Would this cost have been incurred only because the contract was obtained? If the company would have spent the money regardless of whether the deal closed, the cost is not incremental and must be expensed as it is incurred.
Costs that qualify—capitalize them
- Sales commissions paid for closing a specific deal. The canonical example.
- Bonuses and "spiffs" paid contingent on signing a particular contract.
- Referral fees paid to a third party for an introduction that produced a contract.
- Payroll taxes and benefits attributable to a capitalized commission—the employer's share of FICA computed on the commission dollars, and the 401(k) match calculated on those same dollars. These ride along with the commission because they would not exist but for it.
- Legal fees, but only if payment is contingent on successfully closing the contract—a true success fee.
Costs that do not qualify—expense them as incurred
- Salaries of sales staff. Paid whether or not any particular deal closes.
- Travel costs to pitch or deliver a bid. Incurred even when the deal is lost.
- Bid and proposal costs.
- Advertising and general marketing.
- Non-contingent legal fees—payable regardless of outcome.
- Discretionary manager bonuses based on overall profitability or subjective evaluations. This is general compensation, not tied to an identifiable contract.
The discriminating question never changes: did the dollar get spent because of this specific contract, or would it have been spent anyway?
One subtlety catches people off guard. If a commission is contingent on the salesperson staying employed for a period after signing—a 12-month vesting or clawback condition—part of that payment may be compensation for ongoing service rather than for obtaining the contract. That service-related portion is not incremental. If, instead, the employee keeps the commission no matter what, the full amount is incremental.
What about manager override commissions?
ASC 340-40 treats commissions the same regardless of rank. An "override" or "commission on a commission" paid to a sales manager is capitalizable if it would not have been incurred had the underlying contract not closed. A manager's override calculated as a percentage of a subordinate's signed deal is incremental—capitalize it alongside the front-line commission. The line is crossed only when the manager's pay is untethered from specific contracts, such as a discretionary bonus for hitting a department margin target. That is general compensation, and it gets expensed.
The Hardest Part: How Long to Amortize
Once you've capitalized the commission, you amortize it on a systematic basis that tracks the transfer of goods or services to the customer. The period is the period over which the entity expects to recover the asset—and here is the part that trips up almost everyone: that period can extend beyond the initial contract term to include anticipated renewals.
A common instinct is to amortize over the customer's full expected life. Another common instinct is to use the initial contract term. Both are wrong as defaults. The correct period depends on a specific test.
The renewal commission "commensurate" test
When a contract renews and the renewal generates a new commission, you ask one question: is the renewal commission commensurate with the initial commission? "Commensurate" means corresponding in proportion—judged relative to the value transferred (the contract value), not the effort the salesperson expended.
If the renewal commission IS commensurate—say the initial deal pays a 5% commission and the renewal also pays roughly 5% on a similar-value contract—then the initial commission relates only to the initial contract. You amortize the initial commission over the initial contract term only. Each renewal generates its own commission, separately capitalized and amortized over the renewal period. Spreading the initial commission over a longer horizon here would be wrong.
If the renewal commission is NOT commensurate—the initial deal pays 5% but renewals pay nothing, or pay a much smaller rate like 1% on a similar-value contract—then the initial commission is effectively buying the entire customer relationship, including future renewals. You amortize it over the longer expected period of benefit, which may approach the full expected customer life.
A simple disproportion example: a $5,000 initial commission against a $3,500 renewal commission on equal-value contracts. Not commensurate. The initial cost is spread over the total benefit period, renewals included.
For most SaaS and subscription companies, renewal commissions are smaller than initial commissions, so the answer is "not commensurate," and amortization periods land in the range of three to five years, derived from historical churn and cohort analysis—not from the often one-year initial contract term.
If your churn experience changes, you update the amortization period. That update is a change in accounting estimate under ASC 250: applied prospectively, no restatement.
The One-Year Practical Expedient
There is one escape hatch. ASC 340-40 permits a company to expense incremental costs of obtaining a contract as incurred if the amortization period of the asset that would otherwise be recognized is one year or less.
A few rules govern the expedient:
- It is an accounting policy election. It must be applied consistently to similar contracts and disclosed.
- It applies at the contract level, not cost by cost.
- It is unavailable if any performance obligation in the contract extends beyond 12 months. A 13-month contract cannot use it, even barely.
In practice, most SaaS companies cannot use the expedient. Their retention patterns imply multi-year customer lives, so the amortization period exceeds one year and capitalization is required. The expedient is realistically available only to businesses with genuinely short, non-renewing contracts.
Bookkeeping: The Deferred Commission Asset
Companies track this with a deferred commission schedule (also called deferred contract costs), usually maintained per contract: the commission amount, capitalization date, amortization period, monthly amortization, accumulated amortization, and net book value. On the balance sheet the asset is split into a current portion (amortizing within 12 months) and a non-current portion.
Example: straight-line over a two-year term
A SaaS company signs a 24-month contract and pays a rep a $2,400 commission. Renewal commissions are not commensurate, and the expected benefit period equals the 24-month term, so amortization is $2,400 ÷ 24 = $100 per month.
At signing—capitalize the commission:
| Account | Debit | Credit |
|---|---|---|
| Deferred Commission Asset | $2,400 | |
| Cash | $2,400 |
Each month for 24 months—amortize:
| Account | Debit | Credit |
|---|---|---|
| Commission Expense | $100 | |
| Deferred Commission Asset | $100 |
After 12 months the asset carries at $1,200; after 24 months it is fully amortized. If the company also owes 7.65% employer FICA on the commission ($183.60) plus an attributable 401(k) match, those amounts are added to the capitalized asset and amortized on the same schedule.
Example: customer-life amortization
A $10,000 commission on a 5-year contract, where the company expects two-year renewals (a 7-year total expected customer life) and renewal commissions are not commensurate: capitalize the full $10,000 and amortize over 84 months—roughly $119 per month—rather than over the 60-month initial term.
This per-contract discipline is exactly where plain-text, scriptable accounting earns its keep. A deferred commission schedule is just a structured set of recurring entries, and when your ledger is readable text under version control, you can generate the monthly amortization postings programmatically, diff them, and audit every change—rather than wrestling with an opaque spreadsheet that no one can fully reconcile.
Don't Forget Impairment
The deferred commission asset must be tested for impairment. You recognize a loss to the extent the carrying amount exceeds the remaining consideration you expect to receive for the related goods and services, minus the related costs not yet expensed.
Two details matter. The "remaining consideration" figure includes expected renewals and extensions with the same customer. And once an impairment loss is recognized, it cannot be reversed in a later period. If a contract is modified or a customer shows churn signals, that can be the trigger to test.
Costs to Fulfill: A Quick Contrast
Separate from costs to obtain, costs to fulfill a contract—think implementation, onboarding, and setup labor—are capitalized only if all three conditions are met: the costs relate directly to a contract, they generate or enhance resources used to satisfy future performance obligations, and they are expected to be recovered. General and administrative overhead, idle capacity, and abnormal waste are never capitalized as fulfillment costs. A sales commission is a cost to obtain; the work to stand the customer up is a cost to fulfill. Different test, but both produce a contract cost asset amortized over the benefit period.
The Mistakes Auditors Find Most Often
- Not capitalizing at all—still expensing commissions immediately as a "policy" when the amortization period exceeds a year and no expedient applies.
- The wrong amortization period—defaulting to the initial contract term when renewal commissions are not commensurate, or defaulting to customer life when they are. Customer life must never be assumed.
- Ignoring renewal commissions—never running the commensurate analysis at all.
- Confusing incremental and non-incremental costs—capitalizing salaries, travel, or profitability bonuses; or, the reverse error, omitting legitimate items like manager overrides and the payroll taxes attributable to capitalized commissions.
- Misapplying the one-year expedient—using it on a contract with an obligation past 12 months, or applying it inconsistently.
- Forgetting the fringe—capitalizing the bare commission but leaving out attributable FICA and benefits.
- Static periods—failing to update the estimate when churn experience changes.
- Skipping the impairment test entirely.
Why This Matters Beyond Compliance
Capitalizing commissions changed how growth-stage subscription companies look on paper. Before ASC 606 and 340-40 took effect (for public companies, periods beginning after December 15, 2017), most subscription businesses expensed commissions the moment they were paid. A big new customer meant a big immediate hit.
Now that hit is spread over the benefit period. A fast-growing company's near-term operating margin looks healthier because today's commission expense reflects deals signed over the past several years rather than the surge of deals signed this quarter. That is not a loophole—the expense still flows through, just later and more smoothly.
It does, however, create a gap that investors and quality-of-earnings reviewers watch carefully. The cash to pay commissions goes out the door when the deal is signed, hitting operating cash flow, while the GAAP expense trails behind. The deferred commission balance on the balance sheet represents future expense you've already funded in cash. If you're raising money or selling the business, expect a diligence team to recompute your deferred commission schedule line by line.
Keep Your Finances Organized from Day One
Whether you're capitalizing commissions, tracking deferred revenue, or simply trying to know where your cash went, accounting rules like ASC 340-40 reward businesses that keep clean, granular, auditable records. The hard part is rarely the rule itself—it's maintaining a per-contract schedule that ties to the general ledger month after month.
Beancount.io provides plain-text accounting that gives you complete transparency and control over your financial data—every entry readable, every change version-controlled, no black boxes and no vendor lock-in. That makes recurring schedules like deferred commissions easy to generate, review, and audit. Get started for free and see why developers and finance professionals are switching to plain-text accounting.