Departmental Accounts

Introduction:
Departmental Accounts are accounts relating to the several departments or sections of a business drawn up with a view to ascertaining their individual performances. A business may
have a number of departments each dealing in a different type of goods. For instance,
Departmental Store is an example of large scale trading by a retail trader.
In order to carryout business more efficiently, a businessman divides his store into many
sections, each section is called a Department. In order to ascertain the profit or loss made by
each department, it is desirable to prepare separate Trading and Profit and Loss Account for
each department.
A departmental accounting system is an accounting information system that records the
activities and financial information about the department. Managers can use the financial
information from the departmental accounting system to tell how profitable and efficient each
department is.
Larger corporations can't be properly accounted for with one single, centralized accounting
system. That is why the corporation is divided into many different departments like the
shipping and receiving department, sales department, and manufacturing department. Many
companies also departmentalize based on products. For instance, Microsoft has a Windows
department, Xbox department, and Microsoft Office department.
Each one of these departments has its own accounting system to keep track of revenues and
expenses. These accounting systems also provide useful efficiency ratios for management.
Managers can use these ratios to evaluate the departments and consider merging departments
or getting rid of some departments altogether.
Managers tend to look at whether the department is a cost center or profit center. Some
departments that do not produce a profit are still worth keeping around because they share in
the interdepartmental expenses like rent and utilities.
The preparation of such Trading and Profit and Loss Account separately for each
department enables to compare the results of trading activities; in brief:

1. It enables to compare the performance of one department with that of another and to measure the progress of the department itself by comparing year-wise performance.
2. It enables to measure the profitability of each department. In the absence of departmental
accounting, if there is a loss, the businessman thinks that the whole business is at loss. Thus
he may stop the business and may start a new business, because he is unable to understand
the performance of each department. But, by preparing departmental accounts separately, the
contribution of profit made by each department can be known.
Thus a good profit- making department can be developed and the department which gives
small margin of profit or no profit can be closed down. It is also possible to check the profit
of a department, not to be eaten away by the department which makes no profit.
3. It helps in formulating new policies and to adopt new and latest techniques in the departments, thereby further profitability of the department can be expected.
4. Departmental Managers of the profit-making department can be encouraged by adopting a
method of commission on the basis of departmental profit. This step will further boost the
profit-making department.
Accounting Procedure:
There are two methods of keeping departmental accounts:
1. Independent Basis:
In this method, accounts of each department are maintained separately. Each department prepares Trading and Profit and Loss Account. Finally, the profit or loss of each department is
transferred to the (General) Profit and Loss Account for all the departments. The independent
departmental book-keeping is an expensive one.

2. Columnar Basis:
In this method, there is a single set of books. All accounts of all the departments are
maintained together, but in a columnar or tabular form. In order to enable the preparation of
departmental trading and profit and loss accounts, various subsidiary books, such as
purchases, sales, returns books, are prepared in a columnar form and this shows the record, in
detail, for each department.
The following is the specimen of a purchase book and a sales book:

The same pattern of rulings may be followed in case of other subsidiary books.
Departmental Trading and Profit and Loss Account:
When the books and accounts are maintained on a columnar basis, Trading and Profit and
Loss Account can also be prepared on columnar basis. There arises no difficulty in finding
out gross profit and net profit for each department separately. From the analytical ledger
accounts and subsidiary books department-wise figures are readily available. If an item of
expenses definitely identified with a particular department, it can be termed as direct
expenses with reference to the department.

For instance, salary of Manager and salesman of a particular department, special advertising,
separately metered electricity etc. are expenses and exclusively meant for and identified with
particular departments. Apart from this, there are some expenses termed as indirect expenses.
Certain types of expenses are not readily identifiable departmentally and the benefit of such
type of expenses goes to all departments. And such types of expenses, called joint expenses,
are incurred for the business as a whole.
For instance, rent, depreciation, selling expenses, welfare expenses, advertising etc.
Allocation of such expenses among the various departments becomes indispensable on an
equitable basis at the date of account. The important point in such cases is to fix the basis on
which the different revenue items are to be split up. It is neither possible nor desirable to subdivide all items on equal basis.
Allocation of Common Expenses:
Normally, all direct expenses are charged to the respective departments, in case of indirect or
general expenses, proper allocation among the departments must be made in order to
ascertain the profit and loss made by each department. Each department is charged with
proper business expenses. If the basis for such allocation is not specially mentioned, then the
following procedure may be followed.

Some expenses cannot be apportioned and no basis of apportionment is practicable. For instance, interest on Loan, Income Tax, Salary to General Manager, Share Transfer expenses,
Bank charges, Audit fees etc. Here these expenses can safely be transferred to General Profit
and Loss Account.
Similarly, income of general nature such as Interest on Calls-in-arrears, Interest on Investment, fees on share transfer etc. credited to General Profit and Loss Account. The
Departmental Trading Account shows the Gross Profit or Loss and Departmental Profit and
Loss Account shows the Net Profit or Loss earned or suffered by each department.
Inter-Departmental Transfers:
Goods are often supplied from one Department to another Inter-Departmental transfer. Such
transfer must be credited to Supplying Department and debited to Receiving Department. If
the transfers are made at cost price, then it can be treated as mere transfer. No further
adjustment is needed.
However, if the transfers of goods are made at selling price, then a profit is earned by the
supplying department of the same organisation. When the goods, transferred from one
department to another, still remain unsold with the transferee department, at the end of the
accounting period, there arises a necessity to eliminate the unrealised profit on such stock on

hand. This is because, so much of issuing departments profit (notional) remain unrealised
from the viewpoint of the firm as a whole. The reserve will be equal to the profit included in
respect of unsold goods at the end of closing.
The entry is:
General Profit and Loss Account Dr.
To Stock Reserve
In certain cases, the transferee department may have some stock in the beginning of the
accounting period, against which stock reserve was already created in the previous year, will
also be transferred to General Profit and Loss Account by means of Journal entry:
Stock Reserve Account Dr.
To General Profit and Loss Account
Alternatively, a single journal entry can be passed for the unrealised profit on the basis of the
difference between unrealised profit included in opening and closing stock.

Example 1:
A firm has two departments Piece goods and readymade dresses. All goods purchased by
the readymade department from Piece goods department are charged at the usual selling
price.
From the following particulars prepare departmental trading and profit and loss
accounts for the year ended Dec. 31, 2005:

The stocks in the readymade department are considered as consisting of 75% cloth supplied
from Piece goods dept. and 25% expenses and cloths from outside. The Piece goods
department earned gross profit in 2004 at the same rate as in 2005. General expenses of the
business as a whole in 2005 amounted to Rs 45,000.

Solution:

A business entity where diversified natures of economic activities are undertaken is

split into number of departments for accounting purposes. Generally it is management
who will decide the number of departments in which the whole business is to be
divided, but the criteria for identifying the departments in an examination question is
always the separate sales/work-done revenue.
Each department is considered as a profit centre, though none of the departments is

separated geographically from the rest of the departments. This type of organizational
subdivision creates a need for internal information about the operating results
(profitability) of each department. Based upon the departmental knowledge of
profitability and growth rate the management takes certain decisions e.g. pricing,
costing, sales promotion, closure etc.
Allocation of Incomes and Expenses
Until unless the size of the business entity is very large, the entire book keeping
system for the entity is kept by a central accounts department along with some
departmental specific records e.g. sales, purchases, stocks and staff salaries etc. Rest of
the operating expenses and other incomes need to be allocated among the
departments based on their nature, utility, economic benefits and belongingness.
For allocation and division purposes the expenses/incomes can be categorized as:
1. Separately identified
2. Obvious just ratio
3. Specific ratio/sales ratio
4. Un-allocable
Separately identified
It depends upon the size of the entity that it can separately identify its expenses with
each of the department, a large entity will be incurring most of the operating expenses
that are department specific e.g. carriage inward, receiving and handling, wages and
salaries, electricity, telephone, repair and maintenance, entertainment, advertisement,
sales promotion, selling commissions, research and development cost etc.
Obvious just ratio
Most of the expenses are allocated on the most logical basis that is obvious and also
just. Nature of the expenses and nature of the business will determine the basis for
division.
Specific ratio or sales ratio
Still there are some expenses which provide economic benefits to more than one
department and should be allocated but the ratio is not obvious, for such expenses a
specific ratio will be determined or otherwise these will be divided in the ratio of their
respective departmental sales revenue. These may include:
Insurance on stock/inventory

Insurance on plant and machinery

Power and fuel
Depreciation/Amortization
Un-allocable
These are the expenses which provide economic benefits to the business entity on the
whole; these cannot be identified with a specific department. Such expenses are often
incurred against financial facilities. Examples include; loss on disposal of investments,
damages paid for infringement of law, interest on loan and bank overdrafts etc.
There are certain financial incomes as well that cannot be identified or allocated
among the department e.g. interest on investment, profit on disposal on investments,
profit on fixed deposits etc.
All these types of expenses and incomes are shown in a general profit and loss account
where profits or losses of each department are clubbed to ascertain the operating
results of the business on the whole.
Allocation of income tax expense
Unlike other operating expenses income tax expense is divided on the basis of
departmental operating profits. Some students having knowledge of income tax law
may possibly get confused that nevertheless there are certain expenses or losses
admissible from the tax stand point that are shown in the general profit and loss
account have not yet been deducted from the departmental operating results then why
this income tax expense is being charged before subtracting certain expenses.
Remember this is just an allocation of income tax expense (that has already been
calculated) among the different departments. It has nothing to do with the calculation.