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A business entity where diversified natures of economic activities are undertaken is split into number of departments for accounting purposes. Generally it is management who will decide the number of departments in which the whole business is to be divided, but the criteria for identifying the departments in an examination question is always the separate sales/work-done revenue. Each department is considered as a profit centre, though none of the departments is separated geographically from the rest of the departments. This type of organizational subdivision creates a need for internal information about the operating results (profitability) of each department. Based upon the departmental knowledge of profitability and growth rate the management takes certain decisions e.g. pricing, costing, sales promotion, closure etc.

Allocation of Incomes and Expenses

Until unless the size of the business entity is very large, the entire book keeping system for the entity is kept by a central accounts department along with some departmental specific records e.g. sales, purchases, stocks and staff salaries etc. Rest of the operating expenses and other incomes need to be allocated among the departments based on their nature, utility, economic benefits and belongingness. For allocation and division purposes the expenses/incomes can be categorized as:

1. Separately identified
2. Obvious just ratio
3. Specific ratio/sales ratio
4. Un-allocable

Separately identified

It depends upon the size of the entity that it can separately identify its expenses with each of the department, a large entity will be incurring most of the operating expenses that are department specific e.g. carriage inward, receiving and handling, wages and salaries, electricity, telephone, repair and maintenance, entertainment, advertisement, sales promotion, selling commissions, research and development cost etc.

Obvious just ratio

Most of the expenses are allocated on the most logical basis that is obvious and also just. Nature of the expenses and nature of the business will determine the basis for division. Some important basis and expenses are given below:

Specific ratio or sales ratio

Still there are some expenses which provide economic benefits to more than one department and should be allocated but the ratio is not obvious, for such expenses a specific ratio will be determined or otherwise these will be divided in the ratio of their respective departmental sales revenue. These may include: Insurance on stock/inventory Insurance on plant and machinery Power and fuel Depreciation/Amortization

Un-allocable

These are the expenses which provide economic benefits to the business entity on the whole; these cannot be identified with a specific department. Such expenses are often incurred against financial facilities. Examples include; loss on disposal of investments, damages paid for infringement of law, interest on loan and bank overdrafts etc. There are certain financial incomes as well that cannot be identified or allocated among the department e.g. interest on investment, profit on disposal on investments, profit on fixed deposits etc. All these types of expenses and incomes are shown in a general profit and loss account where profits or losses of each department are clubbed to ascertain the operating results of the business on the whole.

Allocation of income tax expense

Unlike other operating expenses income tax expense is divided on the basis of departmental operating profits. Some students having knowledge of income tax law may possibly get confused that nevertheless there are certain expenses or losses admissible from the tax stand point that are shown in the general profit and loss account have not yet been deducted from the departmental operating results then why this income tax expense is being charged before subtracting certain expenses. Remember this is just an allocation of income tax expense (that has already been calculated) among the different departments. It has nothing to do with the calculation of taxable profit or income tax charge for the year.

Format of departmental profit and loss account Income statement For the year ended December 31, 2008

Solved Problem: From the following information of Trendy Store prepare departmental Income Statement and also compute net profit of the entity on the whole for the year ending on 31.12 2008

Following expenses cannot be traced to any particular department:

Floor space occupied ratio:

Rent Jewellery 3,500 x 1/5 = 700 Hairdressing 3,500 x 1/2 = 1,750 Clothing 3,500 x 3/10 = 1,050

Air conditioning & lighting Jewellery 2,000 x 1/5 = 400 Hairdressing 2,000 x 1/2 = 1,000 Clothing 2,000 x 3/10 = 600

Repair expenses Jewellery 4,800 x 18/54 = 1,600 Hairdressing 4,800 x 18/54 = 800 Clothing 4,800 x 18/54 = 2,400

Trendy Store

Departmental Trading and profit and Loss Accounts For the year ended 31 December 2008