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If a business consists of several independent activities, or is divided into several departments, for carrying on separate functions, its management is usually interested in finding out the working results of each department to ascertain their relative efficiencies. This can be made possible only if departmental accounts are prepared. Departmental accounts are of great help and assistance to the managements as they provide necessary information for controlling the business more intelligently and effectively. It is also helpful in readily identifying all types of wastages, e.g., wastage of material or of money; Also, attention is drawn to inadequacies or inefficiencies in the working of departments or units into which the business may be divided.
2. ADVANTAGES OF DEPARTMENTAL ACCOUNTING
The main advantages of departmental accounting are as follows:
- Evaluation of performance: The performance of each department can be evaluated separately on the basis of trading results. An endeavor may be made to push up the sales of that department which is earning maximum profit.
- Growth potential of each department: The growth potential of a department as compared to others can be evaluated.
- Justification of capital outlay: It helps the management to determine the justification of capital outlay in each department.
- Judgement of efficiency: It helps to calculate stock turnover ratio of each department separately, and thus the efficiency of each department can be revealed.
- Planning and control: Availability of separate cost and profit figures for each department facilitates better control. Thus, effective planning and control can be achieved on the basis of departmental accounting information.
Basically, an organisation usually divides the work in various departments, which is done on the principle of division of labour. Each department prepares its separate accounts to judge its individual performance. This can improve efficiency of each and every department of the organisation.
3. METHODS OF DEPARTMENTAL ACCOUNTING
There are two methods of keeping departmental accounts:
Accounts of all departments are kept in one book only
To prepare such accounts, it will be necessary first, for the income and expenditure of department to be separately recorded in subsidiary books and then for them to be accumulated under separate heads in a ledger or ledgers. This may be done by having columnar subsidiary books and a columnar ledger.
Separate set of books are kept for each department
A separate set of books may be kept for each department, including complete stock accounts of goods received from or transferred to other departments or as also sales.
Nevertheless, even when separate sets of books are maintained for different departments, it will also be necessary to devise a basis for allocation of common expenses among the different departments, if an organisation is interested in determining the separate departmental net profit in addition to the gross profit.
4. BASIS OF ALLOCATION OF COMMON EXPENDITURE AMONG DIFFERENT DEPARTMENTS
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
|Rent, rates and taxes, repairs and maintenance, insurance of building
||Floor area occupied by each department (if given) otherwise on time basis
|Lighting and Heating expenses (e.g., energy expenses)
||Consumption of energy by each department
|Selling expenses, e.g., discount, bad debts, selling commission, freight outward, travelling sales manager’s salary and other costs
Sales of each department
|Carriage inward/ Discount received
||Purchases of each department
||Time devoted to each department
|Depreciation, insurance, repairs and maintenance of capital assets
Value of assets of each department otherwise on time basis
|Administrative and other expenses, e.g., salaries of managers, directors, common advertisement expenses, etc.
Time basis or equally among all departments
|Labour welfare expenses
||Number of employees in each department
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.
5. TYPES OF DEPARTMENTS
There are two types of departments: Dependent and Independent Departments.
Departments which work independently of each other and have negligible inter- department transfers are called Independent 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 is being discussed in the succeeding para.
6. INTER-DEPARTMENTAL TRANSFERS
Whenever goods are transferred from 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 either of the following three bases:
- Current market price,
- 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 yet unrealized (internal) profit included therein.
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
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)
|Less: Stock Reserve
7. MEMORANDUM STOCK AND MEMORANDUM MARK UP ACCOUNT METHOD
This method is generally used to have an appropriate control on stock movement of various departments. Please note that the departments prepare only memorandum accounts and hence these are just control accounts. Under this method every department maintains:
- A Memorandum Stock Account which records all stock movements: opening balance, purchases, stock transfers, shortages and sales. It is prepared at selling price (i.e. even the purchases and opening / closing balances are adjusted by adding the mark-up), and
- A Memorandum Mark-up Account which is prepared for loading or mark- up on cost (selling price – cost price) in the memorandum stock account.
Various accounting adjustments that are required to be made under this method are as follows:-
- Opening stock is recorded on the debit side of the Memorandum Stock A/c at selling price (Cost + Mark-up) and the respective Mark-Up is noted on the credit side of the Mark-Up Account. Accordingly, any Mark-down (lowering of cost) will have reverse impact.
- Similarly, any purchases (debit) or stock transfers (debit or credit) are also recorded at selling price itself in the Memorandum Stock Account and its corresponding mark-up is recorded in the Memorandum Mark-up A/c.
- Any sales are credited to the Memorandum Stock A/c and they are anyways at selling price and hence no loading is required and no mark-up is required to be noted in the Mark-up A/c accordingly.
- Any theft or shortage or loss of stock is also credited to the Memorandum Stock A/c at its cost-plus mark-up i.e. at selling price and the corresponding mark-up is debited to the Memorandum Mark-up Account.
- Management may decide to make an ad-hoc amount of mark up on any of the stock and accordingly the adjustment has to be recorded in both the memorandum accounts. Similarly, if the selling price of any goods is reduced below its normal selling price, the reduction ‘marked down’ is adjusted both in the Stock Account and the Departmental Mark-up Account.
- At the end of the period, mark-up on the closing stock (which shall be the balancing figure of Memorandum Stock A/c) is also recorded in the Memorandum Mark-up A/c. Accordingly, the balance remaining in the Mark- up A/c should reflect profit or loss for the period (which can also be verified by calculating the mark-up % on sales).