Departmental Accounting System

A business is often divided into a number of departments dealing in different types of goods or services. For example, a retail store might have separate departments for clothing and shoes. Departmental accounting allows the business to prepare departmental trading and profit and loss accounts in order that it can assess the profitability of each of these departments.

The advantages of departmental accounting are that the business is able to identify the financial performance of each of its departments. By making comparisons it can identify inefficient departments and make informed managerial decisions about their future. In addition managers and staff can be given responsibility and motivated and rewarded on the basis of departmental performance.

Recording Departmental Transactions

Departmental transactions are recorded by adding additional columns to the bookkeeping special journals or day books.

Typically the special journals which need to have department columns added are the purchases journal, sales journal, purchase returns journal, sales returns journal and the cash book. Each journal book will have a separate column for each department, for example a retail store might have a columns for clothing and shoes.

The journal totals for each department are then posted to the relevant accounts in the general ledger. The general ledger can have a separate ledger account for each department using a 5 digit chart of accounts or a single account with departmental columns.

Treatment of Expenses in Departmental Accounts

In departmental accounting expenses fall into two categories.

Direct Expenses

Expenses which can be directly attributed and allocated to a department such as wages relating to employees working in the department, or electricity costs which are separately metered. The identification and allocation of expenses in departmental accounts is relatively easy to deal with and the expenses are charged directly to that department. It is important to note that these expenses are under the control of the department manager.

Indirect Expenses

Expenses which are common to all departments such as general administrative wages, rent for premises, or advertising costs. These expenses are more difficult to deal with and need to be apportioned between the various departments using a suitable basis. These expenses are not under the control of the department manager.

Departmental Accounting Methods

A departmental accounting system can be operated in a number of ways depending on the level of complexity required and the time and resources available.

Gross Profit Method

The simplest departmental accounting method is the gross profit method. This method calculates the gross profit of each department by analyzing transactions relating to sales, purchases and inventory.

Expenses of the business are then deducted from the total of the gross profits of all departments to arrive at the net profit for the business.

A typical departmental accounts format for a two department business (A and B) is shown below.

Using this method gross profit is shown by department and net profit is shown for the business as a whole.

Contribution Method

The contribution method adds a level of complexity to the gross profit method by additionally allocating expenses which can be directly associated with a department to determine a departmental contribution.

Indirect expenses of the business are then deducted from the total of the departmental contributions to arrive at the net profit of the business.

A typical departmental accounts format for a two department business (A and B) is shown below.

Using this method gross profit and contribution are shown by department and net profit is shown for the business as a whole.

Net Profit Method

The net profit method is the most complex and time consuming of the departmental accounting methods as it analyses all transactions. Indirect expenses not directly associated with a department such as rent, need to be apportioned to each department using a suitable base.

A typical departmental trading and profit and loss account format for a two department business (A and B) is shown below.

Using this method gross profit, contribution and net profit are all shown by department.

Basis for Apportioning Indirect Expenses to Departments

Using the net profit method indirect expenses need to be apportioned to departments. The most suitable base for apportioning the expenses will depend on the nature of the business and the departments involved; some common bases of apportionment are listed in the table below.

The indirect expense is then apportioned using the following formula for each base.

So for example if the building insurance expense amounted to 15,000 and department A had a floor area of 5,000 sq ft compared to the total floor area of the business of 30,000 sq ft, then the amount apportioned to Department A would be calculated as follows.

Department expense = Expense x Department base quantity / Total base quantity
Department expense = 15,000 x 5,000 / 30,000 = 2,500

The building insurance apportioned to Department A is 2,500.

Departmental Accounting Example Using the Net Profit Method

A business operates a retail store with two departments clothing and shoes. Sales and expenses which can be directly attributed are allocated to the relevant department and indirect expenses which cannot be traced to a particular department are apportioned to the revenue producing departments using a suitable base.

Information extracted from the accounting records of the business shows the following.

Apportioning Indirect Expenses to Each Department

The business has decided to apportion rent on the basis of the floor area of each department. The clothing department utilized 65% of the floor area with the balance of 35% being used by the shoes department.

Using departmental accounting the rent expense is apportioned as follows.

Rent expense = 7,000
Clothing department floor area = 65%
Shoes department floor area = 35%

Department expense = Expense x Department base quantity / Total base quantity
Clothing department rent expense = 7,000 x 65/100 = 4,550
Shoes department rent expense = 7,000 x 35/100 = 2,450

Other indirect expenses are to be apportioned using sales as a suitable base and are calculated as follows.

Other indirect expenses = 6,000
Clothing department sales = 35,000
Shoes department sales = 25,000
Total sales = 60,000

Department expense = Expense x Department base quantity / Total base quantity
Clothing other indirect expenses = 6,000 x 35,000/60,000 = 3,500
Shoes other indirect expenses = 6,000 x 25,000/60,000 = 2,500

Our apportionment calculator can be used to apportion expenses between departments by entering details of the amount of the expense and the apportionment base for up to eight expense types and six departments.

Departmental Trading and Profit and Loss Account Format

To complete the departmental accounting, the department trading and profit and loss account can now be produced in a suitable format for the business using the apportionment calculated above.

The net profit is arrived at by deducting the indirect expenses which have been apportioned 8,050 to the clothing department and 4,950 to the shoes department.

This departmental accounts format now shows the gross profit, contribution and net profit of each department.

Summary

Departmental accounting is useful when a business operates a series of distinct departments as it allows it to produce departmental trading profit and loss accounts and to determine the profitability and effectiveness of each department.

In order to use departmental accounting the special journals must be kept in a columnar form. Sales, purchases, inventory and direct expenses must be allocated to the appropriate department and indirect expenses need to be apportioned between departments.