Why is it important to ensure correct allocations in accounting?

In accounting, allocating transactions refers to the process of distributing or

assigning costs, revenues, or other financial entries to specific accounts or

categories. This allocation is crucial for accurately recording financial information and

ensuring that transactions are correctly reflected in the financial statements.

Below are some common scenarios where allocation of transactions is necessary:

Revenue Allocation:

In cases where revenue is earned from different sources or products, allocation

ensures that each source or product is credited with the correct amount of revenue

earned.

It is also necessary to correctly allocate the income received by customers and

clients. When sales transactions are incorrectly allocated, it could lead to the

revenue of a company being over-or-understated to SARS. The income transactions

have an impact on the profit of a company, and ultimately affects the amount of tax

payable to SARS.

Cost Allocation:

Companies often incur costs that benefit multiple departments or projects. Allocating

these costs involves distributing them based on a reasonable method that reflects

how each department or project contributed to or benefited from the cost.

All companies need to purchase goods or pay for services that allow them to

generate income, and these costs need to be accounted for. If the cost of sales

transactions is allocated incorrectly, the gross profit of the company will be incorrect,

which will lead to incorrect management accounts being used to base strategic

decisions on.

Expense Allocation:

Certain expenses, such as insurance premiums or rent, may cover multiple periods.

Allocating these expenses involves distributing them over the periods they benefit.

Companies incur expenses that are not directly related to the services they provide

or products they sell, and these need to be allocated to the correct accounts.

Expenses like rent, or fuel for vehicles are necessary to any company, and if these

expenses are allocated correctly, the profit of the company will reflect accurately.

Business Services. Com had an experience with a client, where the client captured

their own accounting, and Business Services. Com was appointed to review the work

and ensure accuracy. The accountant picked up that the allocations were not done

correctly according to the International Financial Reporting Standards. The

accountant advised the client of the errors and assisted in correcting the allocations.

Not only was the profit of the company lowered, but the correct allocations had a

significant impact on the amount of VAT that the client had to pay over to SARS. The

client realised the importance of correct allocations in accounting, as it saved the

client roughly R50,000 in VAT and taxes. The client was thankful that Business

Services. Com could assist in accurately distributing the income and expenses that

they incurred.