Unit 3
DEPARTMENTAL ACCOUNTS
Departmental Accounting refers to maintaining accounts for one or more branches or departments of the company. Revenues and expenses of the department are recorded and reported separately. The departmental accounts are then consolidated into accounts of the head office to prepare financial statements of the company.
The departmental stores are the example of large-scale retail selling just under a single roof. Different departments involve in different goods to be sold out. To calculate the net result of the whole organization, full-fledged trading, and profit, and loss account are to prepare. But to evaluate individual department, it will be creditworthy to prepare individual trading and profit and loss account.
For example, a textile mill which is having head office and factory. Separate accounts are maintained for production facilities and then the final results are sent to the head office which then incorporates by the head office in their accounts. Maintenance of separate accounts for each branch of a bank or financial institution also falls under the category of departmental accounting. The bank then prepares its financial statement after consolidating accounts of all branches.
A departmental accounting system is an accounting information system that records the activities and financial information about the department. Departmental Accounting is a vital one for large prosperous business organizations. It controls wastage & misusing, compensates the employee in terms of profit and commission, compares performance and progress of year to year or department to department or similar type of firm to firm.
Meaning of Departmental Accounting:
Where a big business with diverse trading activities conduct under the same roof the same usually divide into several departments and each department deals with a particular kind of goods or service. For example, a textile merchant may trade in cotton, woolen and jute fabrics. The overall performance for this type of business depends, however, on departmental efficiency.
As a result, it is desirable to maintain accounts in such a manner that the result of each department can be known—together with the result as a whole. The system of accounting follows for this; the purpose knows as Departmental Accounts. This system of accounting helps the proprietors to:
- Compare the results among the different departments together with the previous results thereof,
- Formulate policy to extend or to develop the enterprise in the proper line; and
- Reward the departmental managers based on departmental results.
The Concept of Departmental Accounting:
Departmentalization enables big firms to determine the areas needing special attention to the achievement of overall objectives. The units or departments needing more funds and more attention than others and the one(s) contributing more toward goal attainment could be identified with good departmentalization. The purpose is basically to find out the performance and capability of the units or departments to make adjustments for the achievement of the firm’s objectives.
Each unit, department or subsidiary gives the free use of some of the assets of the firm and some responsibilities which can be profit-making, revenue generation or cost control. As expenses incur by the firm on behalf of all its departments, indirect expenses are to apportion to the departments, if each department is to present a financial statement or if the statement is to prepare by the company on a departmental basis.
Departmental accounting is about the preparation of final accounts taking into consideration divisional performance before the overall performance. With that system of accounting, companies that departmentalize can easily conclude as they are very well’ performing units, averagely or moderately performing units. Departmental accounting aims at separating the several activities of a business to compare results and to assist the proprietors/owners in formulating policies.
The main objectives of departmental accounting are:
- To check out an interdepartmental performance.
- To evaluate the performance of the department with the previous period result.
- The gross profit of each department can ascertain.
- Unprofitable departments will reveal.
- The result of operations can use to determine the remuneration of managers of each department.
- The progress of each department can monitor for appropriate actions to take.
- To help the owner formulating the right policy for the future.
- To assist the management in deciding to drop or add a department.
- It helps in determining the commission of the department manager when it links to profit achieved by their department.
- It can help the management in deciding which department should develop more and which should close to maximize the profitability of the whole company.
- To provide detail information about the entire organization, and.
- To assist management for cost control.
- It also helps in allocating costs to various departments and therefore helps in better control of the cost of the departments of the company.
- For a company that is dealing with multiple products, it is much easier to control and monitor several departments based on the products they sell rather than controlling it as one single business.
Departmental accounts are prepared in such a manner that all desired information is available and departmental profit can correctly make.
There are two methods:
- Where the individual set of books maintains, and.
- Where all departmental accounts maintain columnar- wise collectively.
They are as explained below:
Where Individual Set of Books are maintained:
Under this method, the accounts of each department independently maintain. The departmental results of all the departments collect and take into consideration to find out the net result of the organization.
Where All Departmental Accounts are maintained Columnar-Wise Collectively:
A Departmental Trading and Profit and Loss Account open for each department in a columnar form together with a separate column for ‘Total’ to ascertain the individual result of the different departments and also as a whole. But the Balance Sheet prepares in a combining form.
And to incorporate the purchase and sale of goods, the subsidiary books and also the nominal accounts into the ledger must be ruled out with extra columns for each department in arriving at the desired departmental figures to prepare departmental final accounts. If there is a larger volume of cash purchase and cash sales, the Cash Book also must maintain separate columns for cash purchases and cash sales of various departments.
The most significant advantages of departmental accounts are:
- Individual results of each department can know which helps to compare the performances among all the departments, i.e., the trading results can compare.
- Departmental accounts help to understand or locate the success, failure, rates of profit, etc.
- It helps the management to make a proper plan of action, policies to increase profit after analyzing the results of the operation of various departments.
- Departmental accounting helps us to understand which department should be expanded further or which one should close down as per the results of the operation.
- It also helps to encourage a healthy competitive spirit among the various departments which, ultimately, helps to increase profits of the firm as a whole.
- For additions or alterations of various departments, departmental accounts help a lot as it supplies the necessary information.
- As detailed information about the firm is available from departmental accounting the users of accounting information, particularly, the auditors and investors widely benefit.
- Since departmental accounting presents separate departmental results, the Performance, of a successful department encourages the management, employees and increases the motivation of the staff as a whole.
- The percentage of gross profit on sales and stock turnover ratio of each department helps to make a comparative study among all departments.
Preparation of final accounts of a departmentalized business requires the following:
- That the gross profit or loss and the net profit or loss of each department determine separately before taking. The totals to the appropriate account or the balance sheet of the business, and.
- That there should be some bases of apportioning gains and expenses to the departments or units of the business. And, that should be done as fair and equitable as possible.
Sometimes control accounts have to resort to determine the creditors’ or debtors’ value to the business. In any case, as the departmental values show the total figures, for the business as a whole, are, to sum up.
Expenses should be allocated among different departments on a rational basis while preparing departmental accounts.
Individual Identifiable Expenses: Expenses incurred specially for a particular department are charged directly thereto, e.g., insurance charges of stock held by the department.
Common Expenses: Common expenses, the benefit of which is shared by all the departments and which are capable of precise allocation are distributed among the departments concerned on some equitable basis considered suitable in the circumstances of the case.
Allocation of Expenses
Sr No | Expenses | Basis of Allocation |
1. | Rent, rates and taxes, repairs and maintenance, insurance of building | Floor area occupied by each department (if given) otherwise on time basis |
2. | Lighting and Heating expenses (e.g., energy expenses) | Consumption of energy by each department |
3. | Selling expenses, e.g., discount, bad Debts, selling commission, freight outward, travelling sales manager’s Salary and other costs | Sales of each department |
4. | Carriage inward/ Discount received | Purchases of each department |
5. | Wages/Salaries | Time devoted to each department |
6. | Depreciation, insurance, repairs and Maintenance of capital assets | Value of assets of each department Otherwise on time basis |
7. | Administrative and other expenses, e.g., salaries of managers, directors, Common advertisement expenses, | Time basis or equally among all Departments |
8. | Labour welfare expenses | Number of employees in each department |
9. | PF/ESI contributions | Wages and salaries of each department |
Note: There are certain expenses and income, most being of financial nature, which cannot be apportioned on a suitable basis; therefore they are recognised in the combined Profit and Loss Account, for example, interest on loan, profit/loss on sale of investment, etc.
Appropriateness of some of the apportionment methods – key points:
- It can be a very subjective process.
- The best way to apportion costs base on the greatest benefit- i.e. the department who gets the greatest benefit from the cost must take the greatest amount of the cost.
- This makes the apportionment process very time consuming and expensive.
- The more appropriate basis may be for depreciation to base on the book value of assets in each department.
- Insurance of the assets based on the book value of the assets.
There are two types of departments: Dependent and Independent Departments.
Independent Departments
Departments which work independently of each other and have negligible inter- department transfers are called Independent Departments.
Dependent Departments
Departments which transfer goods from one department to another department for further processing are called dependent departments. Here, the output of one department becomes the input for the other department. These transfers may be done at cost or some pre-decided selling price. The price at which this is done is known as transfer price. In these departments, unloading is required if the transfer price is having a profit element. The method of eliminating unrealised profit will be discussed later.
Whenever goods or services are provided by one department to another, their cost should be separately recorded and charged to the department benefiting thereby and credited to that providing the goods or services. The totals of such benefits (inter-departmental transfers) should be disclosed in the departmental Profit and Loss Account, to distinguish them from other items of expenditure.
Basis of Inter-Departmental Transfers
Goods and services may be charged by one department to another usually on any of the following three bases:
(i) Cost,
(ii) Current market price,
(iii) Cost plus agreed percentage of profit.
Elimination of Unrealised Profit
When profit is added in the inter-departmental transfers the loading included in the unsold inventory at the end of the year is to be excluded before final accounts are prepared so as to eliminate any anticipatory (internal) profit included therein.
Stock Reserve
Unrealised profit included in unsold stock at the end of accounting period is eliminated by creating an appropriate stock reserve by debiting the combined Profit and Loss Account. The amount of stock reserve will be calculated as:
Transfer price of unsold stock × Profit included in transfer price
Transfer price
Journal Entry
At the end of the accounting year, the following journal entry will be passed for elimination of unrealised profit (creation of stock reserve):
Profit and Loss Account Dr.
To Stock Reserve
(Being a provision made for unrealised profit included in closing stock)
In the beginning of the next accounting year, the aforesaid journal entry will be reversed as under:
Stock Reserve Dr.
To Profit and Loss Account
(Being provision for unrealised profit reversed.)
Disclosure in Balance Sheet
The unsold closing stock acquired from another department will appear on the assets side of the balance sheet as under:
(An extract of the assets side of the balance sheet)
Current assets xxx
Stock xxx
Less: Stock reserve xxx
Xxx
