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Departmental Income Statements and Departmental Contribution to Overhead - YouTube
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>> [Luke Ellison]
Today, we will be discussing
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Departmental
Income Statements.
[3]
The management and evaluation
of a company's performance
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can be easier
managed
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if we divide the company
into smaller units,
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often called "departments,"
"divisions," or "segments."
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Examples include
geographic region,
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such as North America
or Europe,
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separate product lines, such
as speakers or headphones,
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or departments within
a retail store,
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such as electronics
or hardware.
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Most departments
can be classified
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as either costs
or profit centers.
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A cost center does not
generate any revenues
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and therefore is only evaluated
based on cost that it incurs.
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Examples include
manufacturing departments
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or service departments such
as accounting or purchasing.
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A profit center incurs costs
just like a cost center,
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but also generates
revenues.
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Profit centers are
evaluated based on
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both their ability
to generate revenues
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and their ability
to manage costs.
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An example might be the
electronics department
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within a superstore.
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We can create Departmental
Income Statements,
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which calculate the net
income for each profit center.
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There are three
types of expenses
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we will need
to determine
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and include on the
departmental income statements.
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First, there are
the direct expenses
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which can be traced directly
to a specific department.
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Second, indirect
expenses,
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like rent, utilities,
or advertising
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that apply to
several departments,
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must be allocated
to each department.
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This is done using
an allocation base
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that has a causal link
to each indirect expense.
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For example, utilities
might be allocated
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based on the number of square
feet the department occupies.
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Third, the service
department expenses,
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which are the
cost centers,
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get allocated to
the profit centers
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using an allocation base
for each service department.
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For example, the cost of
the accounting department
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would need to be allocated
between the profit centers,
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such as the electronics
and hardware departments.
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Let's take a look
at an example.
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Let's keep it
relatively simple
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and consider a company with
only one service department,
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which we will call
"administration,"
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and there are also
two profit centers,
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which are the hardware and
electronics departments.
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Each department's sales,
cost of goods sold,
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and direct expenses
are showing now.
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The administration
department
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doesn't have sales
or cost of goods sold
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because it is
a cost center,
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and therefore it doesn't
generate revenue.
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The company also has
two indirect expenses.
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Remember that
indirect expenses
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need to be allocated
to each department.
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The rent is allocated based
on the number of square feet
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the department
occupies,
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and the advertising costs
are allocated based
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on the dollar sales.
[147]
We will also need
to allocate the cost
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of the one service
department of administration
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to the two
profit centers.
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Administration costs
are allocated based
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on the number
of employees.
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We will determine the total
cost of administration later.
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Here is the template for our
departmental income statements.
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Remember, we only create
departmental income statements
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for profit centers,
to which we have two--
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the hardware and
electronics departments.
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The sales and cost of
goods sold are given here,
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so we can simply
copy them over
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to the departmental
income statements.
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The gross profit
is just the sales
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minus the cost
of goods sold,
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which comes to
$160,000 for hardware
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and $185,000
for electronics.
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The direct expenses of
salaries and supplies
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can also be
copied over.
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We need to take
a detour now
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to calculate how much of
the $40,000 indirect rent
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and $80,000 indirect
advertising costs
[199]
should be allocated
to each department.
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First, the rent
expense of $40,000
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is allocated based
on square feet
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and applies to all
three departments.
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Let's assume the
square feet occupied
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for the three departments
is as shown.
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We'd have to be given
this information
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somewhere in
the problem.
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We must add up the total
number of square feet
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from the three departments,
which comes to 1,000.
[224]
Then we can divide the square
feet of each department
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by the total to get
the relative percent,
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200 for administration divided
by 1,000 equals 0.2 or 20%.
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500 divided by 1,000 for
hardware is 0.5 or 50%.
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And 300 divided by 1,000
equals 0.3 or 30%.
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Of course, the percentages
add up to 100%.
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Next, we can multiply
each percentage
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by the total
rent expense,
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which is $40,000 to
get the allocated cost.
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When we multiply each
percent by $40,000,
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we get $8,000 in rent
allocated to administration,
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$20,000 allocated
to hardware,
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and $12,000 allocated
to electronics.
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The rent
allocation sum
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to the total rent
expense of $40,000.
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We can do the same
thing for advertising,
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except common sense tells us
that we shouldn't allocate
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advertising expenses to the
administration department,
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because the administration
department does not benefit
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from advertising.
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Instead, advertising
is only allocated
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to the operating departments
of hardware and electronics,
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and the allocation is done
based on sales dollars.
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So again, we add up the total
sales for the two departments--
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225,000 plus 275,000 gives us
the total sales of $500,000.
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We use these same sales
numbers previously,
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as they were given to us
in the previous slide.
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We then divide each department's
sales by the total of 500,000
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to get 45%
and 55%.
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Multiplying
each percentage
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by the total advertising
expense of $80,000
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gives us $36,000
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of advertising expense
allocated to hardware,
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and $44,000 of
advertising expense
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allocated to
electronics,
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which totals to $80,000 in
total advertising expense.
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Now, we can return to the
departmental income statements
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to update them with the indirect
cost of rent and advertising.
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Now that we have included
the indirect expenses,
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we must allocate the service
center cost of administration
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to hardware and
electronics.
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To do that, we
first must determine
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what the total costs of the
administration department is.
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Here's a
modified table
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from what we showed at the
beginning of our example,
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with just the
direct expenses
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for the administration department.
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But remember, we allocated some
of the indirect cost of rent
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to administration,
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so we must include
that here, too.
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Looking back at our
rent allocation table,
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we see that
$8,000 of rent
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should be allocated to the
administration department,
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so we can add $8,000 to our
table of administration costs.
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Totaling up the administration
costs, we get $40,000.
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We can set up a table
similar to the one we used
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to allocate rent
and advertising costs,
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to allocate the
administration costs now.
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Administration costs
are allocated
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based on the number of employees
working in each department.
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Let's assume there
are six employees
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in the hardware department,
and nine in electronics,
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totaling to 15.
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We can find the percentage
for each department,
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by taking the number
of employees, 6 or 9,
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and dividing by the total
number of employees, 15.
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This tells us that 40%
of the employees
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work in the hardware department
and 60% work in electronics.
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Multiplying the
percentages
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by the total administration
cost of $40,000,
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we get $16,000 for hardware
and $24,000 for electronics.
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The two values sum to the
total administration costs
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of $40,000.
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Now, we can
finally complete
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the departmental
income statements.
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We can fill in each
department's share
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of the administration
expenses,
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which we see here are
16,000 and 24,000.
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Totaling up
the expenses,
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we get 97,000 for hardware
and $118,000 for electronics.
[442]
Taking the gross profit and
subtracting the total expenses,
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we get the operating income
to be $63,000 for hardware
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and $67,000
for electronics.
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This completes the
departmental income statements
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for our example.
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There's just one more
thing I want to mention.
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If the goal is to
evaluate one department
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based on
performance,
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many of the
costs included
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in the departmental
income statements
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are probably
not relevant,
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because the manager and
employees in that department
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have no control
over them.
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Most notably, the
indirect costs
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and the share of
service expenses--
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these really are
uncontrollable costs.
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So instead, what we can
do is prepare a report
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based on what
is called
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the Departmental
Contribution to Overhead.
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The report begins
the same
[484]
as the departmental
income statements,
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with sales and
cost of goods sold,
[487]
but only lists the
direct expenses
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of salaries
and supplies.
[491]
Gross profit minus the
total direct expenses
[493]
equals the departmental
contribution to overhead,
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the total amount of money
each department has available
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after direct
expenses are paid
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to help cover the
overhead of the company.
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Departmental
contribution to overhead
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can be used to
evaluate whether or not
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a department should
be eliminated.
[510]
As long as the departmental
contribution to overhead
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is positive, the
department in question
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should not be
eliminated.
[516]
Okay, that wraps
up our example
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and our video relating to
departmental income statements.
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