Financial Accounting - Departmental Accounts

 

Financial Accounting

Departmental Accounts

 

Part A: Discussion of basic theories in regard to maintenance of departmental accounts explaining –

(1)  Why determining department-wise profit or loss is important from managing the entire business point of view;

(2)  What are the different methods of keeping departmental accounts;

(3)  How different business expenses are allocated and apportioned among the departments;

(4)  Bases for apportionment of different business expenses among the departments; and

(5)  How inter-departmental transfers are accounted for.

 

Part B: Six Illustrations with Solutions.

Part A

Introduction

 

Departmental accounts are generally prepared by the businesses having different departments selling different types of goods or carrying on different activities under the same roof. Each department is treated as a separate profit centre, though none of the departments is separated geographically from the rest of the departments. This type of organisational subdivision creates a need for internal information about the operating results of each department. Different departments selling different products or carrying on different activities may have different profitability, growth rate and degree of risk necessitating managerial decisions in regard to pricing of goods and/or services, closure of any one or more departments, introduction of any promotional scheme in any one or more departments, etc. These managerial decisions can be taken only on the basis of the internal information about the operating results of each department in terms of profitability, growth rate and degree of risk. Therefore, it is clear that, actions to be taken to improve the overall profitability of the business enterprise cannot be properly considered until the departmental profits and losses are known and analysed by the top managers.

 

Methods of keeping departmental accounts

 

There are two methods of keeping departmental accounts:

(a)        Where separate set of books are kept for each department; and

(b)        Where accounts of all the departments are kept together on columnar books.

 

WHERE SEPARATE SET OF BOOKS ARE KEPT FOR EACH DEPARTMENT

 

This method of accounting is employed when the size of the organisation is very large. Under this method, each department is regarded as a separate unit and accounts are kept independently. At the end of the year the trading results of all the departments are combined to get the trading results of the organisation as a whole. This method is rarely used and is also very expensive in operation.

 

WHERE ACCOUNTS OF ALL THE DEPARTMENTS ARE KEPT TOGETHER ON COLUMNAR BOOKS

 

This method of accounting is employed when the size of the organisation is small. Under this method, the entire book keeping system for the business as a whole is generally kept by a central accounts department on columnar books. The central accounts department usually maintains analytical or columnar Purchase and Sales Day Books to distinguish between the purchases and sales of different departments.

 

Allocation and apportionment of business expenses among the departments

 

Expenses directly related to a particular department should be allocated to that department directly. On the other hand, expenses which are not directly related to any particular department should be apportioned among various departments on some suitable basis. For example, expenses which have a direct relation with the sales should be apportioned on the basis of net sales, whereas other business expenses should be apportioned on some other logical basis or bases. The nature of the expense and the nature of the business will determine the basis for apportionment of expenses. The bases for apportionment of some important expenses are given below:

 

Bases for apportionment of some important expenses

Sl. No.	Expenses	Bases
1.	(a) Travelling salesman’s salary and commission (b) Selling expenses (c) After-sales service (d) Discount allowed to debtors (e) Freight outwards (f) Provision for discount on debtors (g) Sales manager’s salary and other benefits (h) Carriage outwards (i) Advertisement exp.	Sales of each department
2.	(a) Rent, rates and taxes (b) Air conditioning expenses (c) Heating	Floor area or value of floor space
3.	Lighting	Light points
4.	Insurance on stock	Average stock held
5.	Insurance on building	Floor area
6.	Insurance on plant and machinery	Value of plant and machinery
7.	Group insurance premium	Direct wages
8.	Power	HP or (HP × Hours worked) [HP stands for Horse Power]
9.	(a) Depreciation (b) Repairs and renewals	Value of assets in each department
10.	(a) Canteen expenses (b) Labour welfare expenses	Number of employees
11.	Works manager’s salary	Time spent in each department
12.	(a) Discount received from creditors (b) Carriage inwards	Purchases of each department

 

Non-operating losses and expenses (e.g. loss on sale of assets or investments, damages payable for the infringement of law, interest on bank loan etc.) and Non-operating gains and incomes (e.g. profit on sale of assets or investments, dividends received, interest received etc.) cannot be apportioned among different departments on a suitable basis. Therefore, departmental profits or losses should be arrived at after considering operating expenses and incomes only. Moreover, there are certain incomes and expenses which are not related to any specific department, rather they might be earned or expended at corporate level (usually termed as corporate level incomes and expenses). Therefore, total of departmental profits or losses should be adjusted with respect to all the non-operating expenses and incomes as well as all the corporate level expenses and incomes in order to arrive at the net profit or net loss of the business as a whole.

 

Inter-departmental transfer

 

Sometimes prices are charged for goods or services transferred by one department to another department. Since each department is considered as a separate profit centre, it is necessary to have separate records for inter-departmental transfer. At the end of every week or month, the transfer is recorded by passing the following journal entry:

 

Date	Particulars		LF	Dr. (Rs)	Cr. (Rs)
1	Receiving Dept.	Dr
	To Supplying Dept.
	(Goods transferred at transfer price)

 

Inter-departmental transfer at cost price

 

Under cost-based transfer pricing, the price may be based on actual cost, total cost or standard cost. Marginal cost is also sometimes used as a basis of ascertaining the transfer price. Standard cost is preferred to actual cost since the inefficiencies of one department should not be passed on to another department.

 

Inter-departmental transfer at market price

 

To avoid passing on inefficiencies of one department to another department, market-based transfer prices may be used. It does not give any advantage to either the selling department or the buying department, compared to trading with the outsiders. The market-based transfer price usually includes a profit margin over the cost price.

 

If the goods are transferred by one department to another department at a profit and at the end of the accounting year such goods, partly or wholly, are included in the unsold stock of the later, an appropriate adjustment must be made for unrealised profit on such stock. The necessary journal entries for this are as follows:

Date	Particulars		LF	Dr. (Rs)	Cr. (Rs)
1	General P/L A/c	Dr
	To Prov. for unrealised profit on cl. stock A/c
	(Provision for unrealised profit on closing stock created)
2	Prov. for unrealised profit on op. stock A/c	Dr
	To General P/L A/c
	(Provision for unrealised profit on opening stock created)

 

Part B

Financial Accounting

Departmental Accounts

Selected Problems

 

Illustrations: 1

Snow White Ltd has two departments — Cloth and Garment. Garments are made by the Firm itself out of cloth supplied by the Cloth Department at its usual selling price. From the following figures, prepare Departmental Trading and Profit and Loss Accounts and General Profit and Loss Account for the year ended 31^st March 2021.

Particulars	Departments
	Cloth (Rs)	Garment (Rs)
Op. Stock (1.4.20)	3,00,000	50,000
Purchases	20,00,000	15,000
Sales	22,00,000	4,50,000
Transfer to Garment Dept.	3,00,000	–
Manufacturing expenses	–	60,000
Selling expenses	20,000	6,000
Cl. Stock (31.3.21)	2,00,000	60,000

 

The Stock in the Garment Department may be considered as consisting of 75% Cloth and 25% other items. The Cloth Department earned Gross Profit at the rate of 15% during the year 2019–20. General Expenses of the business as a whole came to Rs 1, 10,000.

 

Click here for Solution: 1 in PDF

Illustrations: 2

Aladdin & co. has two departments P & Q. Department P sells goods to department Q at normal selling prices. From the following particulars, prepare departmental Trading & P/L Account for the year ended 31.03.2021 and also ascertain the net profit to be transferred to Balance Sheet:

Particulars	Departments
	P (Rs)	Q (Rs)
Op. Stock (1.4.20)	5,00,000	–
Purchases	28,00,000	3,00,000
Sales	30,00,000	20,00,000
Transfer from P	–	8,00,000
Wages	3,50,000	2,00,000
Travelling exp.	20,000	1,60,000
Cl. Stock (31.3.21)	8,00,000	2,09,000
Printing & Stationery	30,000	25,000

 

The following expenses incurred for both the departments were not apportioned between the departments:

Salaries Rs 3,30,000, advertisement expenses Rs 1, 20,000; general expenses Rs 5, 00,000. Depreciation is to be charged @ 30% on the machinery worth Rs 96,000.

 

The advertisement expenses of the departments are to be apportioned in the turnover ratio. Salaries and depreciation are to be apportioned in the ratio 2:1 and 1:3 respectively. General expenses are to be apportioned in the ratio 3:1.

 

 Click here for Solution: 2 in PDF

 

Illustrations: 3

Samudra & Co, a Partnership Firm, has three departments viz. K, L and M which are under the charge of the Partners B, C and D respectively. The Consolidated P&L Account is given below:

Profit and Loss Account

Particulars	Rs	Particulars	Rs
Op. Stock	81,890	Sales	4,00,000
Purchases	2,65,700	Discount received	800
Salaries & Wages	48,000	Cl. Stock	89,000
Rent	10,800
Selling exp.	14,400
Discount allowed	1,200
Depreciation	750
Net Profit	67,060
	4,89,800		4,89,800

From the above Account and the following additional information, prepare:

a)       Departmental P/L Accounts,

b)       General P/L A/c of Samudra & Co. &

c)        P/L Appropriation A/c for the year ended 31^st March, 2021.

1.           Break up of Opening Stock Department wise is: K – Rs 37,890; L – Rs 24,000 and M – Rs 20,000.

2.           Total Purchases were as under: K – Rs 1, 40,700; L – Rs 80,600; M – Rs 44,400.

3.           Salaries and Wages include Rs 12,000 wages of Department M. The balance Salaries should be apportioned to the three departments as 4:4:1.

4.           Rent is to be apportioned in the ratio of floor space which is as 2:2:5.

5.           Selling Expenses and Discount Allowed are to be apportioned in the ratio of Turnover.

6.           Depreciation on assets should be equally charged to the three departments.

7.           Sales made by the three departments were: K – Rs 1, 80,000; L – Rs 1, 30,000 and M – Rs 90,000.

8.           Break up of Closing Stock Department wise is: K – Rs 45,100; L – Rs 22,300 and M – Rs 21,600. The Closing Stock of Department M includes Rs 5,700 goods transferred from Department K. However, Opening Stock does not include any goods transferred from other departments.

9.           Departments K and L sold goods worth Rs 10,700 and Rs 600 respectively to Department M.

10.  Discounts received are traceable to Departments K, L and M as Rs 400; Rs 250 and Rs 150 respectively.

11.  Partners are to share the profits as under: (a) 75% of the Profits of Departments K, L and M to the respective Partner in Charge, (b) Balance Profits to be credited as 2:1:1.

 

Click here for Solution: 3 in PDF

Illustrations: 4

Pooma Ltd. has 2 departments M & S. From the following particulars, prepare Departmental P/L Account & Consolidated P/L Account for the year ended 31^st March, 2021.

 

Particulars	M (Rs)	S (Rs)
Opening Stock	20,000	12,000
Purchases	92,000	68,000
Carriage Inwards	2,000	2,000
Wages	12,000	8,000
Sales (including inter departmental transfer)	1,40,000	1,12,000
Purchased Goods transferred:
By S to M	10,000	–
By M to S	–	8,000
Finished Goods transferred:
By M to S	35,000	–
By S to M	–	40,000
Return of Finished Goods:
By M to S	10,000	–
By S to M	–	7,000
Closing Stock:
Purchased Goods	4,500	6,000
Finished Goods	24,000	14,000

 

Purchased Goods have been transferred at their respective departmental Purchase Cost & Finished Goods at Departmental Market Price. 20% of Finished Stock (Closing) at each Department represented Finished Goods received from the other Department.

 

Click here for Solution: 4 in PDF

Illustrations: 5

Department X sells goods to Department Y at a profit of 25% on cost & to Department Z at a profit of 10% on cost. Department Y sells goods to X & Z at a profit of 15% & 20% on sales, respectively.

 

Department Z charges 20% & 25% profit on cost to Department X & Y, respectively.

 

Department Managers are entitled to 10% Commission on Net Profit subject to unrealised profits on Departmental sales being eliminated.

 

Departmental profits after charging manager’s commission, bur before adjustment of unrealised profits are:

X = Rs 36,000; Y = Rs 27,000; Z = Rs 18,000

 

Stocks lying at different departments at the year-end are as under:

Particulars	X (Rs)	Y (Rs)	Z (Rs)
Transfer from Dept. X	–	15,000	11,000
Transfer from Dept. Y	14,000	–	12,000
Transfer from Dept. Z	6,000	5,000	–

 

Find out the correct Departmental Profits after charging Managers’ Commission.

 

Click here for Solution: 5 in PDF

Illustrations: 6

The following details are available in respect of a business for a year.

Dept.	Op. Stock	Purchases	Sales
X	120 units	1,000 units	1,020 units at Rs 20 each
Y	80 units	2,000 units	1,920 units at Rs 22.5 each
Z	152 units	2,400 units	2,496 units at Rs 25 each

The total value of purchases is Rs 1, 00,000. It is observed that the rate of Gross Profit is the same in each department.

 

Prepare Departmental Trading Account for the above year.

Click here for Solution: 6 in PDF