What is Departmental Accounts?
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.
Table of Content
- 1 What is Departmental Accounts?
- 2 Advantages of Departmental Accounting
- 3 Objectives of Departmental Accounting
- 4 Types of Departments
- 5 Methods of Departmental Accounting
Advantages of Departmental Accounting
The main advantages of departmental accounting are as follows:
- Evaluation of performance
- Growth potential of each department
- Justification of capital outlay
- Judgement of efficiency
- Planning and control
Evaluation of performance
The performance of each department can be evaluated separately on the basis of trading results. An endeavour 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.
Objectives of Departmental Accounting
Some major objectives of departmental accounting are explained as follows:
- To evaluate performance
- To evaluate growth potential of different departments
- To justify capital outlays
- To judge efficiency
- To plan and control
To evaluate performance
Using the results of departmental accounting, the relative performance and profits generated by each department can be determined. These results help in comparing the relative financial position of each department.
To evaluate growth potential of different departments
When the accounting results of different departments are found, the growth potential of a department as compared to others can be determined. At times, the commission or incentives of managers and staff persons of departments depends upon the relative performance of their department. Departmental accounting helps in determining the incentives of employees.
To justify capital outlays
Departmental accounting helps the management to gain an understanding of how much capital is employed in each department. Based on the performance of each department, the management decides how much capital they have to spend on each of them. In other words, departmental accounting helps in monitoring and regulating the performance of each department and preparing departmental budgets.
To judge efficiency
Departmental accounting helps in calculating the stock turnover ratio of each department which, in turn, helps in judging the efficiency of each department separately.
To plan and control
Departmental accounting provides cost and profit values for each department which helps in maintaining better planning and control of these departments.
Types of Departments
With respect to departmental accounting, there are two types of departments, which are:
These are those departments that hardly transfer any resources to other departments or need any resource from the other departments. Their functions are isolated and they are independent from the other departments. For example, the legal department or research department.
These are those departments where there is inter-departmental transfer of resources and the activities are close knit. For example, production and purchase departments, operations and production departments and sales and marketing departments.
One department’s output becomes the other department’s input. This has to be accounted at a transfer price, which means it does not have an element of profit, but done on cost price and the value added by the department on it.
However, it is necessary to maintain departmental accounts for both dependent and independent departments as monitoring performance of each is essential. The only difference is that independent departments accounting will be less complicated than dependent departments due the inter-departmental transfers.
Methods of Departmental Accounting
Departmental accounting can be done by two methods, which are explained as follows:
Separate books for each department
Under this method, each department is treated as an independent individual unit and individual set of books are maintained for each department. The expenses and revenue of each department are calculated at the end of the accounting period in the overall stores books.
This type of accounting involves high cost as each department requires an individual accountant to maintain these books. This is followed by large organisations such as Reliance, Tata, Hindustan Unilever, etc.
For some organisations, it is mandatory to maintain department-wise accounts. For example, insurance companies.
Accounts of all departments kept in one common book
Under this method, individual columns are made in the common books of accounts for each department. Large organisations cannot use this method as the number of columns will become quite large and will create confusions. This method is suitable for smaller organisations which do not have a lot of accounting transactions.
In such small organisations, the central accounting of the organisation can be maintained in a columnar form. In this method, separate columns are maintained in the accounting books for sales, purchases, stock expenses, etc. Till now, you have seen different ledgers of sales and purchases.
However, large number of transactions take place on a daily basis, then, separate subsidiary books are maintained by the business.
Let us now present a sample purchase book.
Further, to get the department-wise gross profit, a trading account is made in a similar columnar form. In the above example, you have product wise. We can also create the same for different departments such as purchase department, production department, finance department, and sales and marketing department.