Departmental Statements

Chapter 17

© Luby & O’Donoghue (2005)

Profit statement

Entertainment Plaza Ltd.

Ah good, profit of

€100,000

Departmental Statement

Entertainment Plaza Ltd.

Oh, the Restaurant is making a loss of

€20,000

Departmental Accounting

The overall profit figure hides the fact that the restaurant is making a loss.

A well designed system of departmental accounting will:

promote responsibility accountingan awareness of the costs, and contribution, that each department brings to the overall profit of the business.

Methods of Departmental Accounting

Gross Profit Method

• Only cost of sales (purchases adjusted for stock level changes) is deducted from departmental sales.

Departmental Profit Method

• Only the expenses attributable to, and controlled by, a department from are deducted from departmental sales.

Net Profit Method

• All the expenses of the business are deducted from departmental sales, whether they are directly related and controlled by that department or not

Gross Profit Method

The gross profit method breaks down sales, purchases and stock items into the various departments with the aim of controlling the gross profit of each department. It is the simplest of all the three methods – and common within the hospitality industry. Each department reports its gross profit which, when added together, gives the total gross profit for the organisation. From this, all the other expenses of the business are deducted to give a total net operating profit.

Gross Profit Method

Gross Profit Method

The advantages are its simplicity and the fact that sales purchases and stock levels are all within the control of the department head.

The disadvantage is that no attempt is made to associate other expenses with the department such as wages, salaries, light and heat etc. and hence there may be a lack of control over these expenses.

Departmental Profit Method

The department profit method deducts all the expenses attributable to, and controlled by, a department from departmental sales. The aim is to ascertain and control the revenues, costs and thus profits of each department. The expenses that are not directly attributable to a specific department – such as rent, rates and advertising – are charged against the total departmental profit to give a total operating profit for the organisation.

Departmental Profit Method

Departmental Profit Method

Advantages include: More information is given to management regarding the

performance of their departments. As only controllable costs are included in the calculation

of departmental profitability, this provides a form of responsibility accounting as each department manager knows what revenues and costs they are responsible for.

As this is a fairer approach to assessing management performance, it can help to motivate department heads.

Disadvantage The approach requires an elaborate accounting system to

provide the information and many smaller businesses would not have the access to such accounting systems.

Net Profit Method

All the expenses of the business are charged to each revenue producing department whether they are directly related and controlled by that department or not. Thus the departmental profit and loss account would include two categories of expenses:

Those directly related to the department. For example purchases and wages of personnel working in the departmentThose not direct related to any department but which are incurred as part of the costs of the overall organisation such as advertising, rates, rent, depreciation, administration expenses, head office expenses and general manager’s salary.

Net Profit Method

Net Profit Method

The advantages are: Profit reflects the benefit a department receives from

shared expenses such as rent and advertising. It focuses each department on net profit rather than gross

profit.  The disadvantages are: The method of apportionment can be an arbitrary

subjective process. Depending on the method of apportionment, a formerly

profitable department may now show a loss. This could lead to the department being closed down.

It may adversely managers motivation as their performance assessment is influenced by events and costs that are beyond their control.

Cost Apportionment

Cost apportionment represents the assignment of a cost (not directly related to any department) to a number of departments or cost centres. It is an indirect or shared cost which the accountant may use a subjective method of apportioning the cost to the various departmentsThe basis of apportioning costs to various departments is a matter of opinion and there is no single best objective method to use. Costs should be assigned to departments based on the principle of the 'greatest benefit‘ as long as it is cost effective to do so..

Cost Apportionment

Example

Solution