Reference no: EM133731738
Case: A departmental income statement is a financial report that shows the profitability of individual departments within a larger organization (Wild & Shaw, 2019). It breaks down the revenue and expenses for each department, allowing managers to assess their performance and identify areas for improvement.
Here's a breakdown of the key aspects:
Structure: Similar to a company-wide income statement, a departmental income statement starts with revenue generated by the department. Then, it subtracts the direct costs associated with producing that revenue, such as raw materials, direct labor, and commissions. This leaves the department's gross profit. Finally, it subtracts the department's share of indirect costs to arrive at the department's net income or contribution margin.
Indirect Costs: These are expenses that cannot be directly tied to a specific department's activities. Examples include rent, utilities, and administrative salaries.
Allocating Indirect Costs: Assigning indirect costs to departments is a crucial but challenging step. There's no single "perfect" way to do it, and the chosen method should be relevant to your business (Accounting Instruction, Help & How, 2024).
As an example, let's imagine a small business with two departments: Production and Marketing. We're assuming the company rents a building of 370 square feet total (Production department - 200 sq.f.; Marketing department - 170 sq.f.). The company's annual indirect costs are $33,000.00, including rent payments of $23,000 utilities of $2,000, and administrative salaries of $8,000.
Formula to allocate rent expenses based on square feet = $23,000*(200/370) = $12,432 Production department, and Marketing department = $23,000*(170/370) = $10,568. The same allocation works for utilities: $2,000*(200/370) = $1,081 Production department, $2,000*(170/370) = $919 Marketing department. We're also assuming the company has 8 administrative employees.
The hypothetical company's departmental income statement looks like the following:
XYZ Company
Departamental Income Statement
For Year Ended December 31, 20XX
Department
Production
Marketing
Total
Revenue
$ 100,000.00
$ 50,000.00
$ 150,000.00
Direct Costs
$ 60,000.00
$ 10,000.00
$ 70,000.00
Gross Profit
$ 40,000.00
$ 40,000.00
$ 80,000.00
Indirect Costs (Total)
$ 33,000.00
Rent
$ 12,432.00
$ 10,568.00
$ 23,000.00
Utilities
$ 1,081.00
$ 919.00
$ 2,000.00
Administrative Salaries (Based on Number of Employees)
$ 5,000.00
$ 3,000.00
$ 8,000.00
Total Departmental Expenses
$ 18,513.00
$ 14,487.00
$ 33,000.00
Net Income (Contribution Margin)
$ 21,487.00
$ 25,513.00
$ 47,000.00
Looking at this departmental income statement, we can see that the marketing department generated 50% of the Production department's revenue. However, the gross profit for both departments is the same. After allocating all expenses (including indirect expenses), the contribution margin of the marketing department is higher than the production department's.