Accounting of inter departmental transactions
Why separate Accounting for each department
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.
Advantages of Keeping Departmental Accounting
There are many advantages of keeping departmental accounts.
First of all, 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.
The growth potential of a department as compared to others can be evaluated. On such an evaluation, the management can focus on its higher productivity.
It helps the management to determine the justification of capital out lay in each department
It helps to calculate stock turnover ratio of each department separately, and thus the efficiency of each department can be revealed.
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 organization usually divides the work in various departments, which is done on the principle of division of labor. Each department prepares its separate accounts to judge its individual performance. This can improve efficiency of each and every department of the organization.
Methods of Keeping Departmental Accounts
There are two methods of keeping departmental accounts
The first method is to keep accounts 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
The other method is to keep accounts in separate set of books. 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.
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 organization is interested in determining the separate departmental net profit in addition to the gross profit.
Rent, rates and taxes, repairs and maintenance, insurance of building shall be allocated based on the
Floor area occupied by each department (if given) otherwise on time basis Lighting and Heating expense s(e.g .,energy expenses)shall be allocated based on the
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 shall be allocated based on the Sales of each department.
Carriage inward/Discount received shall be allocated based on the Purchases of each department
Wages/Salaries shall be allocated based on the Time devoted to each department
Depreciation, insurance, repairs and maintenance of capital assets shall be allocated based on the Value of assets of each department otherwise on time basis
Administrative and other expenses, e.g., salaries of managers, directors, common advertisement expenses, etc. shall be allocated based on the
Time basis or equally among all departments
Labour welfare expenses shall be allocated based on the Number of employees in each department
PF/ESI contributions shall be allocated based on the Wages and salaries of each department
There are two types of departments: Dependent and Independent Departments.
Departments which work in dependently of each other and haven eligible inter-department transfers are called Independent Departments.
Departments that 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.
Whenever goods are transferred from or one department to another provides services, 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.
Goods and services may be charged by one department to another usually on either of the following its Cost, current market price or cost plus percentage of 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.
Unrealized 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 by apportioning the profit included in the transfer price with the proportion of transfer price of unsold stock to the transfer price.
At the end of the accounting year, the profit and loss will be debited and the stock reserve will be credited.
In the beginning of the next accounting year, the aforesaid journal entry will be reversed.
Hence, the departmental accounts becomes a helpful tool in the growth of the business.
Once it is used efficiently, the management will find it abundantly useful as each department will be evaluated, thereby, ensuring the business growth
Lima Tax Consultant is expert in designing and exceuting departmental accounts. For any assistance contact info@limagcc.com or visit limagcc.com