2. Departmentalized Profit and Cost Centers
Chapter 25
Departmentalized Profit and Cost Centers
Section 1: Profit and Cost Centers and
Departmental Accounting
Section Objectives
Chapter 24 concluded the presentation of the basic concepts of financial reporting. Chapter 25 introduces managerial accounting with emphasis on accounting information for decision-making. Section 1 of the chapter focuses on Profit and Cost Centers and Departmental Accounting
Explain profit centers and cost centers.
Prepare the Gross Profit section of a departmental income statement.
Explain and identify direct and indirect departmental expenses.
Choose the basis for allocation of indirect expenses and compute the amounts to be allocated to each department.
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© 2009 The McGraw-Hill Companies, Inc. All rights reserved.

3. Managerial Accounting
Provides financial information about business segments, activities, or products.
Supplies information on profitability of a specific department or order.
Provides data for making decisions.
This chapter shows how management can use financial statements and other financial reports to help make decisions for the future. The term “managerial accounting” refers to accounting information that is useful for making management decisions.
The income statement, studied earlier in this course, focused on past performance and overall company profitability. This statement was a part of financial reporting.
Managerial accounting provides information on products and departments to help managers determine the overall direction of the business.

4. Explain profit centers and cost centers
Objective 1
Explain profit centers and cost centers
It is important that managers and owners know which parts of the business are profitable. Objective 1 explains the difference between a profit center and a cost center.

5. QUESTION:
What is a cost center?
A cost center is a business segment that incurs costs but does not produce revenue.
ANSWER:
Cost centers are usually service providers to other parts of the business—custodial staff, maintenance staff, accounting department, human resources, etc..

6. Cost Centers Cost centers do not directly earn revenue.
Cost centers often provide services to other business segments:
Accounting department
Information systems department
Purchasing department
A cost center does not generate revenue, measurement of results for a cost center focuses on the control of expenses through budgeting.

7. A profit center is a business segment that produces revenue.
QUESTION:
What is a profit center?
A profit center is a business segment that produces revenue.
ANSWER:
Because profit centers generate revenue from which related expenses are subtracted, it is easy to obtain a net income for that department or center.

8. Profit Centers
Sells products or services to customers outside the business.
Can also be a segment of a company that provides a product to another revenue- producing segment.
Profit Centers usually sell products or services to outside customers. For example, a clothing store might have separate profit centers for the coat, dress, suit, and shoe departments. Sales and costs are accumulated for each department. A “profit” is computed for the department.
A profit center can also be a segment of a company that provides a product to another revenue-producing segment. For example, the segment of an oil company that produces crude oil from the ground can be treated as a profit center even though the oil it produces is transferred to the company’s refinery.
Accounting data is gathered and analyzed separately for each center.

9. Responsibility Accounting
Responsibility Accounting allows management to evaluate the performance of each segment of the business and assigns responsibility for its financial segments.
Responsibility Accounting allows management to evaluate the performance of each segment of the business and assigns responsibility for its financial segments.

10. Prepare the gross profit section of a departmental income statement.
Objective 2
Prepare the gross profit section of a departmental income statement.
Section 2 shows how to prepare the gross profit section of a Departmental Income Statement.

11. Why do businesses track revenue and expenses by segment?
QUESTION:
Detailed data on individual departments helps managers assess the profitability of products and department operations.
ANSWER:
Section 2 shows how to prepare the gross profit section of a Departmental Income Statement.

12. Departmentalized Operations
Departmental accounts are included in the general ledger.
Sales and purchases are recorded by department.
Merchandise inventories are counted and reported by department.
A business may choose to drop a product line or close a department based on data revealed on departmental income statements. A company with more than one type of sales or service activity needs to evaluate how each activity is contributing to the income or loss of the company. To help in this process, businesses that prepare departmental financial statements maintain separate general ledger accounts for sales, purchases, merchandise inventory, and some operating expenses for each department.

13. Departmental Accounts
in the General Ledger
Sales—Clothing
Sales—Shoes
Record all sales for the Clothing department.
Record all sales for the Shoes department.
Notice, that in this company, the company maintains different department Sales accounts in the general ledger—one for the Shoes Department and one for the Clothing Department.

14. Departmental Sales Journal
SALES JOURNAL PAGE 1   
SALES ACCOUNTS SALES TAX SALES— SALES—
DATE SLIP CUSTOMER’S POST. RECEIVABLE PAYABLE CLOTHING SHOES
NO NAME REF DEBIT CREDIT CREDIT CREDIT
2010
Jan Ashley Morgan
Robin Sullivan
Billy Wilson
Totals , , ,200.00
(111) (231) (401) (402) 
The Sales Journal also has separate Sales accounts for the two different departments.
Separate columns are kept for the two different departments.

15. Departmental Income Statement
Fifth Avenue
Income Statement (Partial)
Year Ended December 31, 2010
Clothing Shoes Total
Operating Revenue
Sales , , ,600
Less Sales Returns and Allowances , , ,500
Net Sales , , ,100
Cost of Goods Sold
Merchandise Inventory, Jan. 1, , , ,000
Purchases , , ,000
Freight In , ,700
Delivered Cost of Purchases , , ,700
Less: Purchases Returns and Allowances , ,850
Purchases Discounts , ,400
Total Deductions , ,250
Net Delivered Cost of Purchases , , ,450
Total Merchandise Available for Sale , , ,450
Less Merchandise Inventory, Dec. 31, , , ,150
Cost of Goods Sold , , ,300
Gross Profit on Sales , , ,800
Companies can create an income statement where each department’s gross profit can be seen.
Here we see a Departmental Income Statement where separate columns for the Clothing Department and the Shoes Department exist. The Clothing Department made $268,775 of gross profit and the Shoes Department generated $108,025 of gross profit. Large retailers would have far more than two departments.
Gross profit by department

16. Explain and identify direct and indirect departmental expenses.
Objective 3
Explain and identify direct and indirect departmental expenses.
There are two different types of operating expenses: direct expenses and indirect (or semidirect expenses).

17. Operating Expenses
Direct expenses can be identified directly with a department.
Indirect expenses cannot be directly related to an activity in a department.
Semidirect expenses cannot be directly assigned to individual departments, but are closely related to individual departments.
Direct expenses can be easily attributed to a department or product. A good example would be Sales Salaries Expenses.
Indirect expenses cannot be readily identified and are not closely related to activity within a department. Accountants sometimes refer to indirect expenses as “overhead costs.” These are costs that contribute to earning revenue, but are not directly associated with a particular product or department. Good examples of indirect costs would be: postage and stationary.
Semidirect expenses cannot be directly assigned to individual departments, but are closely related to individual departments. These types of expenses are allocated among the departments at the end of the accounting period. Good examples would be depreciation of store equipment and the cost of insurance for equipment and inventory.
(Some companies treat both semidirect and indirect expenses as indirect expenses.)

18. Objective 4
Choose the basis for allocation of indirect expenses and compute the amounts to be allocated to each department.
Indirect costs are allocated to departments at the end of the accounting period.

19. Allocating Semidirect and Indirect Expenses
Takes place after adjusting entries have been made and adjusted trial balance completed.
Can be based on:
percent of sales,
percent of value of merchandise inventory,
percent of space occupied.
The accountant will try to find some logical relationship between the departments and each type of expense. This will be the basis for allocation. Possible allocation bases could be based on:
percent of sales
percent of value of merchandise inventory
percent of space occupied

20. Allocating Rent Expense
QUESTION:
How is rent expense generally
allocated?
Rent expense is generally based on proportion of the square footage occupied.
Basis:
Dept Square Feet
Clothing ,400
Shoes
Total ,000 % 80 20
100
Rent
Expense Allocation
x $19,200 = $ 15,360
x $19,200 = $ 3,840
$ 19,200
In this example, Rent Expense is allocated based on the square footage of each department. The Clothing Department has 2,400 square feet out of the 3,000 feet total. That means, that 80% of the $19,200 of rent expense would be allocated to the Clothing Department. They would get $15,360 of the total rent expense.

21. Expense Allocations
Insurance: Based on the cost of the furniture, fixtures, and inventory used in the department’s operations.
Utilities: Based on square footage occupied.
The allocation bases used for Insurance, Utilities and Office Salaries are shown here:
Insurance Expense—allocated based on the cost of the furniture, fixtures, and inventory used in the department’s operations.
Utilities Expense--allocated using square footage as the basis.
Office Salaries Expense—allocated based on total sales for each department.
Office Salaries: Based on total sales for each department.

22. Nondepartmentalized Expenses
Do not apply to operations.
Are not allocated to departments.
Appear in the Other Income and Other Expenses section of the income statement.
Revenues and expenses that do not apply to operations are not allocated to the departments. For example interest expense would appear in the Other Expenses section of the income statement.
Interest income and interest expenses are not allocated to departments.

23. Departmentalized Profit and Cost Centers
Chapter 25
Departmentalized Profit and Cost Centers
Section 2: Departmental
Income Statements
Section Objectives
Section 2 of the chapter illustrates how to prepare and use a departmental income statement.
Prepare a departmental income statement showing the contribution margin and operating income for each department.
Use a departmental income statement in making decisions such as whether a department should be closed.
McGraw-Hill
© 2009 The McGraw-Hill Companies, Inc. All rights reserved.

24. Objective 5
Prepare a departmental income statement showing the contribution margin and operating income for each department.
Let’s see how to prepare a departmental income statement. Keep in mind that the general layout of the statement: Sales, less Cost of Goods Sold, less Operating Expenses (divided into direct and indirect), equals Net Income is similar to other income statements prepared in the past.

25. Departmental Income Statement
Reports net income from operations for each department after all expenses are allocated.
Highlights individual department’s financial information.
Identifies the contribution margin for each department.
The income statement for a departmentalized firm is expanded to highlight the individual departments’ financial information. A departmental income statement also identifies the contribution margin for each department.

26. Objective 6
Use a departmental income statement in making decisions such as whether a department should be closed.
A Departmental Income Statement is very helpful to management in making all kinds of business decisions.

27. Gross profit on sales – Direct expense = Contribution margin
QUESTION:
What is contribution margin?
Contribution margin is the amount that each department has earned beyond its direct costs.
ANSWER:
Contribution margin is the amount that each department has earned beyond its direct costs.
Gross profit on sales – Direct expense = Contribution margin

28. Contribution Margin
Departments with a positive contribution margin help to pay the semidirect and indirect expenses of the business.
Departments with a positive contribution margin help to pay the semi-direct and indirect costs of the business. Departments with a negative contribution margin reduce the net income (or increase the net loss) of the business as a whole. The business would be more profitable if the department with the negative contribution margin was eliminated.

29. Departmental Income Statement
Fifth Avenue
Income Statement (Partial)
Year Ended December 31, 2010
Clothing Shoes Total
Gross Profit on Sales , , ,800
Total Direct Expenses , , ,972
Contribution Margin , , ,828
Total Indirect Expenses , , ,385
Net Income from Operations , , ,443
This departmental income statement shows that the Clothing Department contributed $161,828 to help pay for the indirect costs of the business while the Shoes Department had a contribution margin of only $71,000. Net Income from Operations for each department is also easily seen. . . The Clothing Department provides almost 2/3 of the net income of the company.
Net income from operations by department

30. Limitations to Departmental Income from Operations
Difficult to determine fair allocation of semidirect and indirect expenses.
Difficult to assess outcome if certain departments were eliminated.
There are limitations to using departmental operating income. For example, it is difficult to determine each department’s fair share of semidirect and indirect expenses. Another limitation is that if a particular department were eliminated, many of the indirect expenses allocated to it would not be eliminated.

31. Contribution Margin
The concept of contribution margin provides owners and managers with valuable assistance in making decisions.
The concept of contribution margin is important to business owners and managers because it provides them with valuable assistance in making decisions. Unfortunately, contribution margin figures are not provided in traditional financial reports.
Unfortunately, contribution margin figures are not provided in traditional financial reports.

32. The Break-Even Point
A business is said to “break-even” when total revenues equal total expenses.
Another way of describing the break-even point is when the contribution margin equals fixed expenses.
Dividing the Fixed costs by the unit contribution margin will result in the number of units that need to be sold to break even.
The units can be translated into sales dollars by multiplying the result by the selling price of the unit.

33. College Accounting, 12th Edition
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College Accounting, 12th Edition
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