Department refers to activity centre (profit or cost centre) usually located in the same roof but carrying distinct type of activities.
Department accounting or departmental accounting is a system of financial accounting which is used in the organizations whose all works are done through their different departments or departmental stores. Departmental accounts are prepared separately for each department and trial balance will also be prepared. Departmental P&l account is prepared to ascertain the profit or loss of each department separately and at the end of the year it is transferred to General profit and loss account of the whole organisation.
Objectives of departmental accounting
The main objects of preparing such accounts are:
a) To have comparison of the results of a particular department with previous year and also with the other departments of the same concern;
b) To help the proprietor in formulating policy to expand the business on proper lines so as to optimize the profits of the concern;
c) To allow departmental managers’ commission on the basis of the profits of their departments; and
d) To generate information, which may be helpful for planning, control, and evolution of performance of each department and for taking various managerial decisions?
Advantages of Department Accounts
The main advantages of Departmental accounting are as follows:
a) It provides an idea about the affairs of each department.
b) It helps to evaluate the performance of each department.
c) It helps to reward the Departmental mangers and staff on the basis of performance.
d) It facilitates control over the working of each department.
e) It helps to compare the result of one department with those of other departments.
f) It helps the management to formulate the right business policies for the various departments.
g) It will help in the preparation of departmental budgets.
h) It helps to calculate stock turnover ratio of each department.
Types of Department
There are two types of department
a) Dependent Department
b) Independent Department
Dependent department are those which transfer goods from one department to another department for further processing. Here, the output of one department becomes the input for the other department. These transfers may be done at cost or pre-decided market 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 profit element. This is done by the passing the following entry:
Profit and Loss A/c Dr.
To Stock Reserve A/c
Independent Department is those departments which work independently of each other and have negligible inter departmental transfer.
A departmental organization can record its transactions in two ways:
a) Unitary method: - Under this method, the accounts of each department are kept separately. The results of the various departments are finally combined together in one general P & L account.
b) Tabular or columnar method: - Under this method, the accounts of each department are kept in columnar form with a separate column for each department and also with a separate column for the total. The tabular method is more popular and is adopted by almost all the departmental undertaking.
Under this method, at the end of the accounting year, Trading and P & L account (columnar) is prepared with separate amount column for each of the department and also for the total. The trading and P & L of a departmental organization kept in the columnar basis is called Departmental Trading and P & L account. In trading account, opening stock, purchases, direct expenses and Gross profit are debited and sales and closing stock credited. Indirect expenses have to be apportioned between the departments and debited to the P&L account.
Allocation of Expenses and Incomes
The following table (in summary form) will help to know the proper basis for apportionment of some important expenses among various departments.
a) Sales expenses as traveling salesman, salary and commission, selling expenses after sales service, discount allowed, bad debts, freight outwards, provision for discount on debtors, sales manager’s salary and other benefits etc.
b) All expenses relating to building as rent, rates, taxes, air conditioning expenses, heating, insurance building etc.
d) Insurance on stock
e) Insurance on plant & machinery
f) Group insurance premium
h) Depreciation, Renewals & Repairs
i) Canteen expenses, Labour welfare expenses
j) Works manager’s salary
k) Carriage inwards
a) Sales of each department
b) Area or value of floor space
c) Light points
d) Average stock carried
e) Value of plant & machinery
f) Direct wages
g) H.P or H.P x Hours worked
h) Value of assets in each department
i) No. of employees
j) Time spent in each department
k) Purchases of each department
Allocation of incomes
Common incomes should be allocated among different departments on the following basis:
a) Discount received and reserve for discount on creditors: - They should be allocated on the Basis of net purchases of each department.
b) Commission earned on sales: - It should be allocated on the basis of net sales of each department.
c) Other incomes: - Such as dividend received, transfer fees etc can be allocated equally. Alternatively, they can be credited to General P & L account.
Inter departmental transfers
Transfer of goods or services by one department to another department are called inter departmental transfers. When one department transfers goods to another department, the transaction should be considered as a sale for the supplying department and a purchase for the receiving department. As such, the supplying department should be credited and the receiving department should be debited with the value of goods supplied.
Similarly, when one department renders service to another department, the department rendering the service should be credited and the department receiving the service should be debited with the value of service rendered.
Goods may be transferred either at cost price or at selling price. If goods are transferred at selling price by the transferor department and such goods are unsold at the end of the accounting year by the transferee department, then profit charged on such unsold goods by the transferor department is treated as unrealized profit and it should be debited to the general profit and loss account as stock reserve. In the balance sheet stock reserve should be deducted from closing stock. If unrealized profit is contained in the opening stock, such reserve should be credited to the general profit and loss account.
Calculation and Treatment of Unrealized Profit
To calculate Stock Reserve, the following steps must be followed:
Step 1: Calculate the value of IDT (inter Department transfer) by using the following formula:
Closing Stock of Transferor dept x IDT / Total Direct expenses excluding op stock
Step 2: The value of step 1 denotes the Value of IDT stock included in Transferee dept. Now calculate the GP (Gross Profit) ratio at which transferor dept sells goods to transferee. i.e. this amount is at selling price. GP ratio is to be calculated on SP to eliminate Unrealized Profit i.e. St. reserve with the help of following formula:
GP ratio on sales = (Gp of Transferor Dept / Total sales) /100
Where Total sales = Normal sales + IDT sales
Step 3: Result of Step 1 x Result of Step 2
Treatment: The following journal entry is to be passed to eliminate the amount of unrealized profit:
General P & L A/c
To Stock Reserve A/c
Note: In next year the stock reserve of current year will become realised and to be credited to P & L a/c
Distinction between Departmental Accounts and Branch Accounts
The main distinctions between Departmental Accounts and Branch Accounts are given below:
Basis of Distinction
a) Maintenance of Accounts
All accounts are maintained at one place & departmental trading and profit and loss account is prepared accordingly
In case of branch, all branch accounts are kept at Head Office except cash, customers and stock registers are maintained at branch. But in case of independent branch all accounts are kept at branch and a branch prepares its own trading and Profit & Loss Account.
b) Allocation of Common Expenses
Departments are not geographically separated from each other, so problem of allocation of common expenses among different departments arises.
As branches are geographically separated from each other so the problem of allocation of common expenses among different branches does not arises.
c) Adjustments & Reconciliation of Accounts
The question of adjustments and reconciliation of accounts does not arise in departmental accounts
In case of independent branch some adjustments and reconciliation of head office and the branch accounts are required to be done at the end of the year.
d) Problem of foreign currency
The problem of conversion of foreign currency into home currency does not arise.
The problem of conversion of foreign branch figures may arise at the time of finalization of accounts of head office.