We all know how important it is to keep track of the money we spend, especially when running a business. After all, poor record keeping makes it difficult to manage cash flow and can have serious tax and legal implications as well. So experienced accountants review transactions carefully to make sure they're entered correctly. While this may seem like a straightforward task, under generally accepted accounting principles (GAAP) and other accrual-basis accounting standards, ensuring accuracy isn't as simple as entering the correct data. The nature of the expense impacts how it’s recorded.

According to the matching principle, for instance, inventory costs aren't recognized until the merchandise they relate to is sold, which could be weeks or months after it was initially purchased. Other expenses may be recognized incrementally over several months or years, a process known as amortization. Examples of amortized expenses include costs associated with starting a business, issuing debt or developing new products. Prepaid expenses like rent, insurance and annual subscriptions must also be amortized.

For reporting purposes, accounting rules also require expenses to be broken into different categories, like costs of goods sold (COGS) or sales, general and administrative (SG&A). Organizations often want to track costs at a more granular level as well, such as by department and/or location. Costs may also need to be assigned to various internal or customer-facing projects.

A well-organized chart of accounts simplifies this process, allowing the accounting department to associate a given expense, say a vendor invoice, to a specific cost center, like marketing. But it isn't always this straightforward. Some expenses need to be allocated to multiple cost centers.

Allocation & Amortization in Practice

Rent is a perfect example. Suppose a company with 100 employees spread across five departments leases 10,000 square feet of office space for $35,000 per month. The expense could be divided into equal parts, with $7,000 allocated to each of the company's five departments. If one of those departments only has five employees, however, then this approach wouldn't provide an accurate view of departmental operating costs.

Similarly, if a company operates multiple businesses from a single location, with one of them taking up twice as much space as the others, then allocating leasing costs equally would not only be inaccurate but would also be at odds with U.S. GAAP and tax accounting rules. In this case, allocating rental expenses by square footage would be more appropriate.

Correctly allocating and amortizing expenses can be challenging, particularly for companies that rely heavily on manual accounting processes. For instance, many companies use spreadsheet-based schedules to manage amortization because their accounting software doesn't do it for them, but this leaves room for human error. Under pressure to close the books, overworked staff may forget to record a charge one month or enter an expense that has been fully amortized. Calculation errors can also result in expenses being allocated incorrectly. And because amortized expenses are entered month after month, data entry mistakes are more likely.

If these problems aren't caught, they ultimately lead to inaccurate financial statements, upsetting investors, business leaders and other stakeholders. They can also result in higher costs due to missed tax deductions or, if deductions are overstated, fines and legal penalties. Fortunately, the risk of errors can be significantly reduced by automating amortization and allocations.

NetSuite Automates Allocation and Amortization

NetSuite helps companies record and track expenses more effectively by automating the process. Sophisticated allocations make assigning expenses proportionately using appropriate weightings easy, while amortization schedules simplify recording of expenses over time.

With NetSuite, you can automatically allocate expenses and other financial transactions across the business proportionately using headcount, square footage or other statistical data. Expenses can be entered without being assigned to specific departments, locations or other groups, and allocated later using an existing or custom formula. You can set up allocation schedules to recur on a regular basis and/or run in a specific sequence. Dashboard reminders notify you when active allocation schedules need to be processed.

Amortization schedules enable automated amortization of expenses over time and streamline processes such as the amortization of prepaid expenses. You can select from a choice of standard amortization terms or define your own custom terms. You can even define an offset to delay the start of expense recognition and set up an initial amount to be recognized. Schedules can also be linked to jobs to amortize expenses in proportion to a job’s percentage of completion.

[1] under IFRS accounting rules