Chapter 25 Departmental Accounting

Copyright © Houghton Mifflin Company. All rights reserved.24 | 2 Neiman Marcus Operates the Specialty Retail Stores segment (Neiman Marcus stores, Bergdorf Goodman) and the Direct Marketing segment (print catalog and online operations) Focused on serving the needs of the luxury market Total FY 2006 sales = $4,040 million © Royalty-Free/Photodisc

Copyright © Houghton Mifflin Company. All rights reserved.24 | 3 Performance Objectives 1.Compile a departmental income statement extended through Gross Profit. 2.Compile a departmental work sheet. 3.Compile a departmental income statement extended through Income from Operations.

Copyright © Houghton Mifflin Company. All rights reserved.24 | 4 Performance Objectives (cont’d) 4.Apportion operating expenses among various operating departments. 5.Compile a departmental income statement extended through departmental margin.

Copyright © Houghton Mifflin Company. All rights reserved.24 | 5 Performance Objective 1 Compile a departmental income statement extended through Gross Profit. © Royalty Free PhotoDisc Blue/ Getty Images

Copyright © Houghton Mifflin Company. All rights reserved.24 | 6 Dividing Companies into Subdivisions or Departments Benefits companies with different business activities Enables the company’s management to delegate authority to departmental managers –Holds departmental managers responsible for their respective departments Enables management to measure profitability of each department

Copyright © Houghton Mifflin Company. All rights reserved.24 | 7 Why Analyze Profitability by Department Gives a more complete picture of the business Allows managers to make improvements or cut an unprofitable activity altogether Allows for expansion of departments that are doing well

Copyright © Houghton Mifflin Company. All rights reserved.24 | 8 Net Sales – Cost of Goods Sold = Gross Profit Requires separate records for each department through gross profit –Separate general ledger accounts for each, or –Apportionment of one general ledger account to the various departments Gross Profit by Departments The accounts below Gross Profit are not departmentalized.

Copyright © Houghton Mifflin Company. All rights reserved.24 | 9 Separate Accounts by Department Yields the most accurate accounting data Separate accounts for: Sales Sales Returns and Allowances Sales Discounts Purchases Purchases Returns and Allowances Purchases Discounts Freight In Merchandise Inventory

Copyright © Houghton Mifflin Company. All rights reserved.24 | 10 Performance Objective 2 Compile a departmental work sheet. © Royalty Free PhotoDisc Blue/ Getty Images

Copyright © Houghton Mifflin Company. All rights reserved.24 | 11 Departmental Work Sheet Has separate Income Statement columns for each department to facilitate the correct apportionment of revenues and expenses Has separate Income Statement columns for nondepartmental items –Hold Other Income and Other Expenses that are not directly assigned to departments Final column totals all the departments to show the overall income statement for the firm

Copyright © Houghton Mifflin Company. All rights reserved.24 | 12 Performance Objective 3 Compile a departmental income statement extended through Income from Operations. © Royalty Free PhotoDisc Blue/ Getty Images

Copyright © Houghton Mifflin Company. All rights reserved.24 | 13 The accounts below Income from Operations are not departmentalized. Requires separate records for each department through Income from Operations –Separate general ledger accounts for each, or –Apportionment of one general ledger account to the various departments Departmental Income Statement Extended Through Income from Operations

Copyright © Houghton Mifflin Company. All rights reserved.24 | 14 Performance Objective 4 Apportion operating expenses among various operating departments. © Royalty Free PhotoDisc Blue/ Getty Images

Copyright © Houghton Mifflin Company. All rights reserved.24 | 15 Apportionment of Expenses Allocating operating expenses among various operating departments Expenses that benefit different departments must be allocated to those departments. –Example: Janitorial salary expense for a janitor that cleans all departments There are many bases for apportioning expenses. –For the janitor in our example, a logical apportionment is square feet used by each department.

Copyright © Houghton Mifflin Company. All rights reserved.24 | 16 Expenses That Do Not Need to Be Apportioned Items that are clearly within a single department Examples: –A salesperson’s salary is apportioned to Sales. –Advertising expenses for each specific product are accounted for in the specific department that sold it.

Copyright © Houghton Mifflin Company. All rights reserved.24 | 17 Calculating the Percentage of Allocation When There Are Parts to the Whole © Royalty Free C Squared Studios/ Getty Images

Copyright © Houghton Mifflin Company. All rights reserved.24 | 18 Bases for Apportioning Expenses Among Operating Departments –Gross sales –Advertising space –Square footage of floor space –Amounts in the payroll register –Amounts in the equipment ledger –Many more...

Copyright © Houghton Mifflin Company. All rights reserved.24 | 19 Allocating Costs: Illustration Jones & Co. operates Department A and Department B. –Sales salaries are assigned to the appropriate department according to the payroll register. –Advertising expenses for billboard ads are allocated according to percentage of gross sales, and expenses for newspaper ads are allocated according to number of column inches each department used. –Other Expenses are allocated on reasonable allocation bases such as floor space, use of equipment, and so forth.

Copyright © Houghton Mifflin Company. All rights reserved.24 | 20 Allocating Billboard Ads: Jones & Co. Dept. A’s share of billboard ads: 70% x $1,600 = $1,120 Dept. B’s share of billboard ads: 30% x $1,600 = $480 Sales for Dept. A $560,000 Sales for Dept. B 240,000 Total Sales $800,000 Dept. A: $560,000 / $800,000 = 70% Dept. B: $240,000 / $800,000 = 30% Total Billboard Advertising Expense = $1,600 Allocation Base: Sales

Copyright © Houghton Mifflin Company. All rights reserved.24 | 21 Allocating Newspaper Ads: Jones & Co. Dept. A’s share of newspaper ads: 60% x $9,600 = $5,760 Dept. B’s share of newspaper ads: 40% x $9,600 = $3,840 Total Newspaper Advertising Expense = $9,600 Dept. A: 1,920 column inches 1,920 / 3,200 = 60% Dept. B: 1,280 column inches 1,280 / 3,200 = 40% Allocation Base: Column Inches

Copyright © Houghton Mifflin Company. All rights reserved.24 | 22 Performance Objective 5 Compile a departmental income statement extended through departmental margin. © Royalty Free C Squared Studios/ Getty Images

Copyright © Houghton Mifflin Company. All rights reserved.24 | 23 Departmental Margin The contribution that a given department makes to the income of the firm –Gross profit of a department minus the department’s direct expenses When a company breaks down its expense figures on a departmental-margin basis, its income statement indicates the contribution each department makes toward the overhead expenses incurred on behalf of the business as a whole.

Copyright © Houghton Mifflin Company. All rights reserved.24 | 24 Direct and Indirect Expenses Direct expenses –Expenses that benefit only one department and are controlled by the head of the department Example: Sales department salary Indirect expenses –Overhead expenses that benefit several departments or the business as a whole and are not under the control of any one department head Example: Property tax on real estate

Copyright © Houghton Mifflin Company. All rights reserved.24 | 25 Expenses That Are Partially Direct and Partially Indirect Example for a manufacturing firm that uses departmental accounting: –Advertising for the firm in general may be an indirect expense. –Advertising for the individual products being sold are more than likely direct expenses. Rule of thumb to identify direct expenses: –If the department were not in existence, then the expense would not be in existence.

Copyright © Houghton Mifflin Company. All rights reserved.24 | 26 Outline of Income Statement That Emphasizes Departmental Margin

Copyright © Houghton Mifflin Company. All rights reserved.24 | 27 Meaning of Departmental Margin Departmental margin is the most realistic portrayal of the profitability of a department. If the company closes the department: –The company’s income before income tax will decrease or increase by the amount of the departmental margin. –The indirect expenses that the department was covering will now have to be covered by the other departments.

Copyright © Houghton Mifflin Company. All rights reserved.24 | 28 Internet Research: Segments at Exxon Exxon reports on three operating segments. Use the Internet to identify the categories of Exxon’s operating segments. Hint: The company’s annual report (10-K) contains a section titled “Disclosures about Segments and Related Information.” Segments: Upstream, Downstream, and Chemical. The Upstream segment is organized and operates to explore for and produce crude oil and natural gas. The Downstream segment is organized and operates to manufacture and sell petroleum products. The Chemical segment is organized and operates to manufacture and sell petrochemicals. These segments are broadly understood across the petroleum and petrochemical industries.

Copyright © Houghton Mifflin Company. All rights reserved.24 | 29 When Should a Department Be Closed? As long as there is some departmental margin, the department should remain open. –Any positive departmental margin helps to cover indirect expenses! When departmental margins fall below zero, all things being equal, it may be time to shut down the department.

Copyright © Houghton Mifflin Company. All rights reserved.24 | 30 Usefulness of Departmental Margin The company can hold the head of a given department accountable for expenses directly chargeable to that department. Manufacturing companies can analyze product profitability more clearly. Companies can use the information that departmental margins provide to make better decisions about shutting down or expanding.

Copyright © Houghton Mifflin Company. All rights reserved.24 | 31 Review Question Q. What is departmental margin? A.The contribution that a given department makes to the income of the firm—gross profit of a department minus the department’s direct expenses

Copyright © Houghton Mifflin Company. All rights reserved.24 | 32 Review Question Q. What is the difference between direct and indirect expenses? A.Direct expenses benefit only one department while indirect expenses benefit several departments or the business as a whole.

Copyright © Houghton Mifflin Company. All rights reserved.24 | 33 Review Question Q. What is a logical basis for allocating utility expenses for the departments of a retail store? A.Utilities are logically allocated based on square footage of each department.

Copyright © Houghton Mifflin Company. All rights reserved.24 | 34 Review Question Q. What three forms of a departmental income statement were illustrated in this chapter? A.Extended through gross profit, extended through income from operations, extended through departmental margin

Copyright © Houghton Mifflin Company. All rights reserved.24 | 35 A.Holds departmental managers responsible for their respective departments; enables management to measure profitability of each department Review Question Q. For what reasons might a company wish to use a departmental income statement?

Copyright © Houghton Mifflin Company. All rights reserved.24 | 36 Review Question Q. How is the percentage of allocation calculated for parts to a total? Part of the Whole Whole x Total Expense to Be Apportioned = Apportionment of Total Expense for Each Department

Copyright © Houghton Mifflin Company. All rights reserved.24 | 37 Demonstration Problem As the accountants for Gel Boomerangs, we will construct an income statement showing income from operations by department. Gel Boomerangs has three departments: –Wood Boomerangs –Plastic Boomerangs –Boomerang Demonstrations

Copyright © Houghton Mifflin Company. All rights reserved.24 | 38

Copyright © Houghton Mifflin Company. All rights reserved.24 | 39

Copyright © Houghton Mifflin Company. All rights reserved.24 | 40

Copyright © Houghton Mifflin Company. All rights reserved.24 | 41 Some totals appear to be off by 1 cent due to rounding.

Copyright © Houghton Mifflin Company. All rights reserved.24 | 42 Some totals appear to be off by 1 cent due to rounding.

Copyright © Houghton Mifflin Company. All rights reserved.24 | 43 Some totals appear to be off by 1 cent due to rounding.

Copyright © Houghton Mifflin Company. All rights reserved.24 | 44 Chapter Review 1.Compile a departmental income statement extended through Gross Profit. 2.Compile a departmental work sheet. 3.Compile a departmental income statement extended through Income from Operations.

Copyright © Houghton Mifflin Company. All rights reserved.24 | 45 Chapter Review (cont’d) 4.Apportion operating expenses among various operating departments. 5.Compile a departmental income statement extended through departmental margin.