A business will often pay a manager’s commission based on a percentage of its profits. It is usual to take into account the expense of the commission in arriving at the profits used to calculate the commission.
Manager’s Commission Formula
It appears that we need to know the profit after the commission in order to calculate the commission itself. In order to do this we need to first express the profit after commission in terms of the profit before commission as follows:
Profit after commission = Profit before commission - Commission Profit after commission = Profit before commission - Profit after commission x Commission % Rearranging we get Profit after commission = Profit before commission / (1 + Commission %)
The commission calculation is now based on the profit before commission using the manager’s commission formula as follows:
Commission Calculation Example
Suppose a business pays a manager a 4% commission based on its profits after expenses including the commission. If the profits before the commission are 11,700 then using the formula we can calculate the commission as follows
Commission = Profit before commission x Commission % / (1 + Commission %) Commission = 11,700 x 4% / (1 + 4%) = 450
Using the formula the manager’s commission for the accounting period is calculated as 450.
To show that the formula is correct we can now use this commission value (450) to verify that it is in fact 4% of the profits after commission as originally required.
Profit after commission = Profit before commission - Commission Profit after commission = 11,700 - 450 = 11,250 Commission % = Commission / Profit after commission Commission % = 450 / 11,250 = 4%
Manager’s Commission Expense Accounting
The commission is an expense of the business which is recorded with the following journal entry.
The journal shown above debits the commission expense account which represents the cost to the business. The credit entry to commission payable reflects the liability of the business to pay the commission.
It should be noted that if the commission relates to an employee, the commission expense would need to be accounted for as a payroll expense and income tax deducted accordingly. Further information on the posting of payroll costs can be found in our payroll accounting post.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.