Big businesses have different departments in their firm. Each department deals with different kinds of production processes. They provide different services to the firm and add on benefits to the firm. They all put their effort into resolving their department’s issues. For example: consider a big shoe factory.
However, the company’s main work is the production process, but it has many departments to run the big company smoothly. The shoe company divides its firm into different departments to measure the efficiencies of each department separately. By doing so, a company can examine the performance of each department separately.
The company wants every department to maintain its account books separately. During the period of fiscal time, a company’s annual report is prepared by combining each department’s report card. It significantly helps the company in fulfilling each department’s requirement.
A company can easily pay attention to those departments requiring more funds. A firm maintains several accounts for different departments, but it derives the annual result altogether. A firm can do so much with the help of Departmental Accounting. So what is departmental accounting and how does it work? In this article we will focus on what is departmental accounting, Its methods, objectives, and advantages:
What is Departmental Accounting
Departmental Accounting is an accounting method that maintains different account books for different departments running in a firm. It records the expenses and revenues of different departments separately. From time to time this method compares different department’s results with their previous results. This accounting method not only records the money but also measures the achievements of different departments. Departmental accounting checks every activity and records the financial data of each department.
The departmental accounting method is more suitable for bigger firms having a wide range of business. Single accounting fails in big firms. Because it functions as a centralized accounting system. It does not work on a divisional level, hence it fails in deriving the performance of each department. Big firms need to keep a close look at each department to know their results separately.
And the departmental accounting method allows big firms to do so. The proper functioning of this method enables firms to recognize the pros and cons of each department. It suggests the best department contributing more for the whole firm. It brings and adapts all the necessary changes that enhance the performance of each department.
Firms categories their departments on the basis of their performance i.e; well-performing, average performing, and low performing. Then the firms formulate the policies for each categorized department, according to their needs. The whole process is done in an organized way with the help of departmental accounting.
Methods of Departmental accounting
Departmental accounting provides different methods for deriving the profit and loss of each department. Firms can use any of its methods according to their ease. It provides two methods for accounting:
(a) a method that requires every department to use its own set of account books
(b) a method that uses a single account book to record every department in different columns
Both the methods are explained in detail below:
Maintaining separate account books: This method treats every department of a firm as an independent unit. It maintains the expenses and margins of each department separately. Hence, this method requires a separate account book for each department.
This method of departmental accounting is a little complex. As it maintains the performance of each department separately first. Then it joins the result of each department collectively to derive the profit of the whole firm. Its complex processes make it an expensive method of departmental accounting than others. That is why only big companies introduce this method to their firms. Many firms also use this method where the law requires them to use it. Like: it is mandatory for insurance companies to use this method of departmental accounting.
Maintaining column-wise in the same account book: This method of departmental accounting requires a single account book for every department. This method maintains the profit and loss of each department column-wise in the central account book. The central account book contains a column “Total” for deriving the result. However this technique prepares a joint form of a balance sheet, yet it is able to derive the result of an individual department.
If a firm is involved in a larger volume of cash purchase and sale, then the central account book must contain a different column for cash. And it must maintain the record of cash purchase and sale of every department. This method does not maintain a whole book-keeping system. So, small firms consider this method more easy and reliable for their organizations.
However, this method prepares a subsidiary account book to merge the purchase and sale of a product. The technique maintains subsidiary account books having different columns for different departments of a firm. Some of the subsidiary account books prepared are Purchase books, sales books, purchase return books, and sales return books.
Objectives of Departmental accounting
The overall objective of every accounting method is to make the firms more profitable. Each method aims to make the system more easy and accurate. Like all the other accounting systems, departmental accounting has all these objectives. But departmental accounting is more like divisional work. It deals with every department of a firm, so it has some additional objectives also.
Following are some of the objectives of departmental accounting:
- Its main objective is to evaluate the performance of each department of a firm.
- To compare the achieved result of a department with its previous result.
- It examines and compares the performance of different departments to measure their efficiency.
- To ascertain the gross profit of each department as well as the whole firm.
- It formulates effective plans and policies for different departments of a firm.
- It takes suitable action against issues of different departments.
- To bring a good competitive spirit that can enhance the efficiency of each department of a firm.
- To recognize the most profitable and unprofitable department in a firm. As it maintains the expenses and profits of each department.
- It identifies the unnecessary wastage of resources and production.
Advantages of departmental accounting
Many firms think a lot before applying this accounting method to their organizations. They state its objective the same as other accounting methods. And consider it unnecessary while using a single accounting system. These are the same people who fail to understand what is departmental accounting and its benefits.
Small firms may not require it, a single accounting system can handle its account books. But bigger firms have different departments, a single accounting system may not handle this. For the profitable functioning of each department, bigger firms need to implement this method in their organizations.
Some of the major advantages of departmental accounting are mentioned below:
- Compares interdepartmental performance: Departmental accounting derives the performance and achievements of different departments in a firm. This method gives the management team the facility to compare the result of each department and measure its efficiency within a firm.This method maintains a separate account book to record the revenues and expenses of each department. Maintaining a separate account book helps in better comparison among different departments. It calculates the profit and compares it with one another to measure their performance level. And then it categorizes the departments on the basis of their performance.
- Increases the profit: Most important role of this method is to increase the overall profit of a firm. Departmental accounting monitors the fund of a firm and avoids making errors and frauds. It ensures to increase the production efficiency of a firm at a low cost. This method aims to utilize the resources properly with minimum wastage. Hence, it increases the profit of a firm. Its account books help the management team in securing better future decisions and enhancing the profit.
- Helps in policy formulation: Proper policies and effective plans are important factors in making a firm profitable. Departmental accounting plays an important role in fulfilling both these factors. It gives a piece of detailed information about each department through account books. The management team analyzes the result of different account books for a better understanding. They consider the efficiencies and inefficiencies of each department and then formulate the best policies for them. These policies help in boosting the overall performance of a firm.
- Assists in expansion and shrinking of a department: Departmental accounting maintains the record of expenses and revenues generated through different departments. These revenues give ideas about the profit margin of different departments and help in recognizing the profitable and unprofitable departments of a firm.Thus this method assists the management team in deciding which department should be expanded, and which should be shut down.Departmental accounting closely observes the working efficiency of each department. It keeps a record of money circulating in different departments. It reveals the success and failure rate of different departments running within a firm.
- Gives benefits to Auditors and Investors: Departmental accounting provides required information about different departments to the auditors and investors. This method keeps the account of different departments in a relevant manner. So, the auditors can cross-check the revenues and expenses of each department and verify them.This method gives the investors fair and reliable financial data of each department. Investors get a clear view of each department’s performance and the overall profit of the firm. It also highlights the department which needs more funds for smooth running. Departmental accounting enhances the credibility of a firm account book in front of the investors.
- Helps in determining commission: Departmental accounting measures the profit earned by each department in a respective time. On the basis of these profits, it determines the commission of the managers of different departments. Managers get a high commission if the performance of their respective departments is higher than others. It assists the management team in deciding the commission of managers, as well as the wages of its respective employees.
- Enhances positive competition: Departmental accounting enhances the competitive spirit among managers and employees of different departments. This method pays according to the working efficiency of employees and managers. This method motivates the other staff members to work efficiently, and thus improves the overall performance of the firm. Since this method deals with all the different departments, other departments can learn from a successful department. Well-performing departments may give a roadmap for the better performance of low-performing departments.
Departmental accounting is a method of maintaining separate account books for different departments running under a firm. It does so to evaluate the profit and loss of each department. This method drives the attention of investors towards the fund requiring departments. It also helps the firms in keeping control over their different departments. At the end of a year, it combines the profit or loss of each department to the central profit and loss account. It combines the result to ascertain the profit or loss gained by the firm. Along with the departments, it also measures the performance of a whole firm.
The firm should apply this method with proper caution and care, as it can be a very subjective process. Firms need not only apply this method, but they also need to stick to its principles. Its principles conclude that the department making the most profit should get a higher amount of input, as compared to others. The whole process of departmental accounting may be expensive and time-consuming, but it surely benefits the company. It fulfills all the gaps between a firm and its different departments.