A Better Way to Amortise and Allocate Expenses

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 International Financial Reporting Standards (IFRS) 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 recognised until the merchandise they relate to is sold, which could be weeks or months after it was initially purchased. Other expenses may be recognised incrementally over several months or years, a process known as amortisation. Examples of amortised 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 amortised.

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). Organisations 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-organised chart of accounts simplifies this process, allowing the accounting department to associate a given expense, say a vendor invoice, to a specific cost centre, like marketing. But it isn't always this straightforward. Some expenses need to be allocated to multiple cost centres.

Allocation & Amortisation in Practice

Rent is a perfect example. Suppose a company with 100 employees spread across five departments leases 3,000 metres 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 IFRS and tax accounting rules. In this case, allocating rental expenses by square metres would be more appropriate.

Correctly allocating and amortising expenses can be challenging, particularly for companies that rely heavily on manual accounting processes. For instance, many companies use spreadsheet-based schedules to manage amortisation 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 amortised. Calculation errors can also result in expenses being allocated incorrectly. And because amortised 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 amortisation and allocations.

NetSuite Automates Allocation and Amortisation

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

With NetSuite, you can automatically allocate expenses and other financial transactions across the business proportionately using headcount, floor space, 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.

Amortisation schedules enable automated amortisation of expenses over time and the ability to streamline processes such as the amortisation of prepaid expenses. You can select from a choice of standard amortisation 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 recognised. Schedules can also be linked to jobs to amortise expenses in proportion to a job’s percentage of completion.