This article is relevant if you are using NetSuite for drop shipments but you want superior accounting to match revenue against costs and produce accruals for timing differences.

Background

NetSuite’s drop ship capacity purchase order feature is used by many organizations that wish to avoid holding inventory and instead leverage vendors to send orders directly from a supplier.  However, there is a key challenge in applying the accounting matching principle linking revenue with related costs.  A NetSuite drop ship purchase order is driven by an item fulfillment.  Because there is no inventory in the operation, the item fulfillment produces no general ledger impact.  For these types of transactions, only the related Sales Order’s Invoice and the related Purchase Order’s Vendor Bill drive the financial impact.   Yet, day-to-day business operations may naturally produce timing differences between the invoice generation and vendor bill entry.

Due to these timing differences, the proper practice, should you desire to adopt generally accepted accounting principles (GAAP), is to produce a purchase accrual.  Yet, native NetSuite has no offer; until now.

Leverage NetSuite Special Orders to Drive Accruals

To solve the accrual problem using similar information management practices, the key is to understand NetSuite has a similar feature called Special Order Item.  However, Special Order Items generate inventory operations as they are designed for taking purchase deliveries to a warehouse, for which can then be repackaged to be distributed to the end customer.    Using a Special Order Item can be cumbersome in use because of all the extra record management.  They key is to use the NetSuite Platform to emulate the Drop Ship operation so that it becomes transparent you are using a Special Order Item.

Drive Special Order Item Purchase Orders

The first step is to devote a NetSuite location record to act as a pseudo inventory store to help drive accruals.  The location record should never actually have inventory.  See image to indicate that this location is used for the Drop Ship Purchase Accrual practice.

During Sales Order processing, instead of marking an item as a drop ship item, you select the Drop Ship Accrual location (see image).   When the sales order is saved, SuiteScript detects that it is part of the Drop Ship Purchase Accrual process and it will automatically create a linked purchase order.  See my article, “Learn the SuiteScript Pattern to Generate Target Purchase Orders from Sales Orders”,  on the power of generating your own related purchase orders from Sales Orders.

Drive Item Receipts and Linked Item Fulfillments

When the organization learns that the item has indeed been shipped to the customer by the supplier, the user will perform an Item Receipt on the Purchase Order.  Since the system detects that the item receipt is to the pseudo inventory location, special processing kicks in.  Here, on the Item Receipt, we ask the user for shipment package information which is normally only on the Item Fulfillment (see image).   The item receipt date is the date that the supplier indicated they shipped the order.   At this point, NetSuite will generate the purchase accrual with the following journal entry:

Dr  Inventory
Cr  Inventory Received Not Billed (an accrued liability)

Because we are linking the item receipt operation to an item fulfillment, we automatically generate the related item fulfillment record with a shipped status and we use the exact same date as the item receipt.  At this point, NetSuite will generate the following journal entry:

Dr  Cost of Goods Sold
Cr Inventory

The net effect of these two transactions is the following accounting:

Dr Cost of Goods Sold
Cr Inventory Received Not Billed (an accrued liability)

This accounting should please the accountants reading this article.    While not mandatory, for many of my clients, we automatically generate invoice records based on shipped item fulfillments using the ship date.  Assuming this extra feature is in place, accounting is now complete for matching revenue to costs:

Dr  Accounts Receivable
Cr Sales

Related Purchase Order Instructions to Supplier

While this accounting now is what we want, the purchase order, now referencing the pseudo inventory location, references the address of that fake location — which is not what we want.   Yet, we solve this easily without copying over the customer address information to the purchase order because we enhance the Purchase Order PDF to distribute using our Content Renderer Engine (CRE) that can easily use multiple linked saved searches to drive Advanced PDF templates.

Concept Architecture Addendum 2023

After many implementations of this model in client environments, an architecture diagram can help individuals understand the concept better.  Further, the architecture drives consideration conversations for these topics:

1. EDI/ASN Receipt Automation:  how can we have suppliers automatically indicate they have shipped products so that we can automate this flow?   Naturally, as a Systems Integrator, we smooth out these flows.
2. Automatic Invoice: Since we automate the item fulfillment in this flow, we have earned revenue.  We go further and then apply the Best Practices for Automating NetSuite Invoice Generation.
3. Landed Costs: additional costs, such as shipping, should be capitalized into inventory to improve our margins.  Thus, we drive Drive Automated Estimated NetSuite Landed Costs from Purchase Orders and we offer the [best-practice-on-shipping-charge-handling-in-netsuite-dropships].
4. Three-Way Match: many organizations are further challenged with explaining the Inventory Received Not Billed (purchase accrual) account.  We thus work with our clients on Explaining NetSuite’s Inventory Received Not Billed Account.
5. Vendor Bill Generation: some vendors do not send vendor bills timely in this flow.  We thus offer the Best Practice to Automatically Generate NetSuite Vendor Bills from Item Receipts.

Click the image to better see the architecture.

Video Demonstration

We further demonstrated these flows in our 2018 article, NetSuite DropShip Flows with Proper Accrual Accounting Demonstration.

Solve Accounting Challenges using the NetSuite Platform

This kind of challenge illustrates my firm’s core competency: the expert intersection of accounting and information technology.  Indeed, the NetSuite platform represents a space for innovation that, in the hands of individuals that understand how to invent, can drive down business operational costs while improving information reliability.     In this case, we supply the Drop Ship Purchase Accrual SuiteBundle, #124499,  and all of our solutions, to our clients to help them succeed in their operations.

If you found this article relevant, feel free to sign up for notifications to new articles as I post them. If you have a similar concern in your organization, let’s have a conversation.

Marty Zigman

Holding all three official certifications, Marty is regarded as the top NetSuite expert and leads a team of senior professionals at Prolecto Resources, Inc. He is a former Deloitte & Touche CPA and has held CTO roles. For over 30 years, Marty has produced leadership in ERP, CRM and eCommerce business systems. Contact Marty to set up a conversation.

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