How Finder's Fees Work, Accounting-Wiseby
Should a finder's fee on a sale be accounted for as a cost of sale, or as a selling expense such as a commission paid to a company salesman? -—P.C., Bellevue, Wash.
The answer to your question, like nearly all accounting questions, depends upon the circumstances. First, a definition: A finder's fee can be many different things, but at its most basic, it's a fee paid to a third party who brings together a buyer and a seller. It can be calculated as a percentage of the transaction or as a flat fee.
These fees are commonly paid out as part of a merger or acquisition of a company, when a third party introduces buyer and seller and a successful transaction occurs. In that setting, such a fee would be considered a cost of the sale and would likely be written into the sales contract.
In other situations, an informal introduction to a new customer might warrant only a thank-you call or a pair of tickets to a home game.
For Unique Situations
Where finder's fees are most commonly used is in situations where unique buyers must be sought for one-of-a-kind items, says Gregg Landers, director of consulting at the San Diego office of accounting firm CBIZ (CBZ). "They're most commonly used for hard-to-find items such as in corporate acquisitions, unique pieces of property, or unique items such as antiques or collector's items," he says. "In these situations they generally should not be part of COGS [cost of goods sold] and should be considered part of SG&A [sales general and administrative fees]."
Michael M. Savoy, CPA and managing director of accounting firm Gumbiner Savett in Santa Monica, Calif., agrees. In areas other than mergers and acquisitions, "A finder's fee is exactly like a commission either paid to a salesman or someone else and is an expense of the company reported in the same period as the sale or the service is performed," he says. Since the finder's fee does not add any value to the product being sold or the service being performed, it is not added to the cost of the product or service and not treated as a cost-of-goods-sold item for tax reporting purposes, Savoy adds.
Landers says it's probably best to list a finder's fee as an "other administrative" expense, rather than a sales expense, under SG&A.
In some industries where finder's fees are very common, they could be considered a cost of goods sold. But even in those industries, some accountants might make a case for including them as part of SG&A, Landers says.
"If you're running a company, and you only pay finder's fees occasionally, listing them as a cost of goods sold will skew your gross margins and your numbers will bounce around a lot," he says. For instance, if you pay a finder's fee in two months out of 12 and account for those two instances as costs of goods sold, your numbers in those two months might be down significantly. "That's something that could send a negative signal to a banker, and would at the very least have to be explained," Landers says.
They're Regulated in Some Cases
Before you pay a finder's fee, make sure it is legal, says Robert C. Gellman, director of CBIZ's accounting, tax, and advisory services in the firm's San Diego office. "Any time someone wants to make money by getting introduced to someone, they might grease someone's palm. That might be a dinner out or some baseball tickets or cash," he says.
Generally, such payments or favors are not regulated. But in certain industries, and for companies doing business with the government, they are. A real estate agent, for instance, often pays finder's fees for sales referrals. But in many states, the person making the referral must be a licensed real estate agent in order to get any part of the fee. The same goes for the life insurance industry, Gellman says.