Hawassa University College of Business and Economics Department of Accounting and Finance

UNIT 1: ACCOUNTING FOR BRANCHES; COMBINED FINACIAL STATEMENT

INTRODUCTION

As the business of a firm grows in size it open branches in order to sell its product over some large
territories. The main objectives of keeping branch accounts is dependent on the nature of the
business and specific need of a particular branch.

The objective of keeping the branch accounts acceptable to all business are to evaluate the progress
and performance of each branch and to know the profit and loss of each branch separately. By
keeping branch accounts, we can ascertain the financial position of each branch on a particular
date and know the cash and goods requirements of various branches. It may be possible to give
concrete suggestions for the improvement in the working of various branches.

Distinguishing Agency and Branch

An agency relationship refers a contract under which on or more persons (the principals) engage
another person’s (the agents) to carry out some service on their behalf that involves delegating
some decision-making authority to the agent.
Branch is a business unit located at some distance from the home office. This unit carries
merchandise, makes sales, and makes collections from its customers.
Accounting for Sales Agency
The term sales agency sometimes is applied to a business unit that performs only a small portion
of the functions traditionally associated with a branch.
 A sales agency usually carries samples of products but does not have inventory of merchandise
 Orders are taken from customers and transmitted to the home office, which approves
customers’ credit and ships the merchandise directly to the customers
 Accounts receivables are managed by the home office
 An imprest cash fund is maintained at the sales agency for payment of operating expenses
Hence, no need for complete accounting records at a sales agency other than a record of sales
to customers and a summary of cash payments supported by vouchers
 Separate revenue and expense accounts may be opened by the home office for each sales
agency so as to measure its profitability
 Subsidiary ledger accounts may be used to control fixed assets and cost of goods sold by sales
agencies
Illustration: Journal Entries for a Sales Agency
Journal entries required at the home office in connection with a sales agency (Shashemene
Agency), assuming the perpetual inventory system is used:

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 Hawassa University College of Business and Economics Department of Accounting and Finance

Home Office
Journal entries for Shashemene agency transactions
Inventory Samples: Shashemene Agency 1,500
Inventories 1,500
To record merchandise shipped to sales agency for use as samples
Imprest Cash Fund: Shashemene Agency 1,000
Cash 1,000
To establish imprest cash fund for sales agency
Trade Accounts Receivable 50,000
Sales: Shashemene Agency 50,000
To record sales made by sales agency
Cost of Goods Sold: Shashemene Agency 35,000
Inventories 35,000
To record cost of merchandise sold by sales agency
Operating Expenses: Shashemene Agency 10,000
Cash 10,000
To replenish imprest cash fund (several checks during the period)
Sales: Shashemene Agency 50,000
Cost of Goods Sold: Shashemene Agency 35,000
Operating Expenses: Shashemene Agency 10,000
Income Summary: Shashemene Agency 5,000
To close revenue and expense accounts to a separate income summary ledger account for a
sales agency
Income Summary: Shashemene Agency 5,000
Income Summary 5,000
To close net income of sales agency to Income Summary ledger account

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 Hawassa University College of Business and Economics Department of Accounting and Finance

Objectives of Branch Accounting

The main objectives of keeping branch accounts is dependent on the nature of the business and
specific need of a particular branch. Nonetheless, the objectives of keeping the branch accounts
acceptable to all businesses includes the following:
 To know the profit or loss of each branch separately.
 To ascertain the financial position of each branch on a particular date.
 To know the cash and goods requirements of the various branches.
 To evaluate the progress and performance of each branch
 To calculate commission for payment to the managers, if based on profits of branch.
 To know the profitability of each branch and type of business for expansion of the business.
 To give concrete suggestions for the improvement in the working of the various branches.
 To meet the requirements of specific enactments as all branches of a company must keep the
accounts for audit purposes.

Types of Branches
There are different types of branches according to their nature of operations, although all branches
operate under the instructions of the head office. Broadly branches may be divided in to three
categories namely:
1) Branches which do not keep their accounting records, their accounting is wholly performed
at the Head office (Dependent Branches).
2) Branches which keep their own accounting records independently (Independent
Branches); and
3) Foreign branches
Branches which do not keep their accounting records (Dependent Branches)
 A dependent branch means a branch which does not maintain its own set of books.
 When the business policies and the administration of a branch are wholly controlled by the
head office and its accounts also are maintained by it the branch is described as Dependent
branch. Branch accounts, in such a case, are maintained at the head office out of reports and
returns received from the branch. Some of the significant types of branches that are operated
in this manner are described below:
 A branch set up merely for booking orders that are executed by the head office. Such a
branch only transmits orders to the head office;
 A branch established at a commercial center for the sale of goods (wholesale) supplied
by the head office, and under its direction all collections are made by the H.O.; and
 A branch for the retail sale of goods, supplied by the head office.
 These branches sell only those goods which are supplied by the Head office. These
branches are not allowed to make any purchases from the outside market.
 All expenses of a regular nature of the branch such as salary, rent, advertisement etc. are
paid by the Head Office.
 Some petty expenses e.g. cartage, entertainment etc. are paid by the branch manager out
of the petty cash balance. Petty cash book may be maintained by the branch either on
sample basis or on imprest system.

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 Hawassa University College of Business and Economics Department of Accounting and Finance

 Such branches are required to deposit the cash collected by them either by way of cash
sales or cash collected from debtors into the bank account opened in the name of the Head
office.
 Sales are made by the branch normally on a cash basis but sometime the branches are
permitted to sell the goods on a credit basis also.
Since these type of branches do not keep any account, accounts are maintained by the Head
Office. The system of maintaining accounts by the Head office depends on the size of the branch,
and the degree of control which the Head office wants to exercise.

Accounting for Branches which keep their own accounting records independently (Independent Branches)

A branch which maintain its own set of books is termed as an independent branch
When the size of the business is big, it is desirable that the branch maintains complete records of
its transactions. These branches are called independent branches and each independent branch
maintains comprehensive account books for recording their transactions; therefore, a separate
trial balance of each branch can be prepared. The head office maintains one ledger account for
each such branch, wherein all transactions between the head office and the branches are recorded.
Salient features of accounting system of an independent branch are as follows:

 Branch maintains its entire books of account under double entry system.
 Branch opens in its books a Head Office account to record all transactions that take place
between Head Office and branch. The Head Office maintains a Branch account to record these
transactions.
 Branch prepares its Trial Balance, Trading and profit and loss Account at the end of the
accounting period and sends copies of these statements to Head Office for incorporation.
 After receiving the final statements from branch, Head Office reconciles between the two –
Branch account in Head Office books and Head Office account in Branch books.
 Head office passes necessary journal entries to incorporate branch trial balance in its books.

Foreign Branches
 In modern times the market for a commodity does not remain confined to a particular country
but extends to other countries as well. In order to sell goods abroad branches, have to be opened
in that country; such branches are known as Foreign Branches.
 A Foreign Branch is nothing but an independent Branch located in a foreign country. One of
the important distinctions between an independent Branch located in home country and one
located in foreign country is that the latter maintains its books of accounts in the currency of
the foreign country from where it is operating its business.

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 Hawassa University College of Business and Economics Department of Accounting and Finance

Accounting for Branch

The accounting work done at each branch depends upon the policy or the accounting system of the
enterprise which may provide for a complete set of accounting records at each branch or keep all
accounting records in the home office.

A branch may, accordingly, maintain a complete set of accounting records consisting of journals
ledgers and chart of accounts similar to those of an independent business enterprise, prepare
financial statements and periodically forward to the home office.

Transactions recorded by the branch should include all controllable expenses and revenue for
which the branch manager is responsible. Expenses such as depreciation and branch plant assets
are generally maintained by the home office.

Reciprocal Accounts

The accounting records maintained by a branch include a Home Office ledger account that is
credited for all merchandise, cash, or other resources provided by the home office; it is debited
for all cash merchandise or other asset sent to the home office or to other branches. The Home
Office account is a quasi-ownership equity account that shows the net investment by the home
office in the branch. At the end of the accounting period when the branch closes its accounts, the
Income Summary account is closed to the Home Office account. A net income increases the credit
balance of the Home Office account; a net loss decreases this balance.

In the home office accounting records, a reciprocal ledger account with a title such as Investment
in Branch is maintained. This non-current asset account is debited for cash, merchandise, and
services provided to the branch by the home office, and for net income reported by the branch.
It is credited for the cash or other assets received from the branch, and for any net loss
reported by the branch. Thus, the Investment in Branch account reflects the equity method
of accounting. A separate investment account is generally maintained by the home office
for each branch.

At the end of an accounting period, the balance of the Investment in Branch X ledger account in
the accounting records of the home office may not agree with the balance of the Home Office
account in the records of Branch X, because certain transactions may have been recorded by one
office but not by the other. These balances of the reciprocal accounts must be brought into
agreement before combined financial statements are prepared.

Expenses Incurred by Home Office and Allocated to Branch

Some business enterprises follow a policy of notifying each branch of expenses incurred by the
home office on behalf of the branch. When such a policy is adopted, an expense incurred by the
home office and allocated to a branch is recorded by the home office by a debit to Investment in

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 Hawassa University College of Business and Economics Department of Accounting and Finance

Branch and credit to an appropriate expense account; the branch debits an expense account and
credits Home Office. Expenses paid by the home office and allocable to branches may be
insurance, property and other taxes, depreciation, and advertising.

Expenses of the home office may also be allocated to branches especially if the home office does
not make sales and functions only as accounting and control center. The head office may also
charge each branch interest on the capital invested there in. such expenses would not appear in the
combined income statement as they would be offset against interest revenue recorded by the home
offices
Billings of Merchandise to Branch
Three alternative methods are available to the home office for billing merchandise shipped to its
branches:
 At Cost
 At a percentage above cost
 At the retail Selling Price
Shipment of merchandise to a branch does not constitute a sale as the ownership does not change.
Billing at cost
 The simplest and widely used procedure
 Avoids complications of unrealized gross profits on inventories
 Attributes all gross profit to the branches even if some of the merchandise may be
manufactured by the home office
Billing at a percentage above cost
 Intended to allocate reasonable gross profit to the home office
 Under this method, the net income reported by the branch is understated and the ending
inventories are overstated for the enterprise as a whole
 Adjustments must be made to eliminate intra company profits in preparation of combined
financial statements
Billing at Retail Selling Prices
 Based on a desire to strengthen internal control over inventories
 The home office record of shipments to a branch, when considered along with sales
reported with the branch, provide a perpetual inventory stated at selling price
 Any difference with periodic physical count should be investigated promptly
Illustrative Journal Entries of Operation of a Branch
Assume that S Company bills merchandise to Branch X at cost and the branch maintains complete
accounting records and prepares financial statements. Both the branch and home office use the
perpetual inventory system. Equipment used at the branch is carried in home office records.
Expenses such as advertising and insurance are incurred by the home office and billed to the
branch. Summarized transactions of year 1
1. Cash of 1,000 was forwarded to Branch X

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 Hawassa University College of Business and Economics Department of Accounting and Finance

2. Merchandise with cost of 60,000 was shipped to Branch X

3. Equipment of 500 acquired by Branch X, to be carried in home office records
4. Credit sales by Branch X amounted to 80,000; the cost of merchandise sold was 45,000.
5. Collections of trade accounts receivable pf 62,000 made by Branch X.
6. Payments for operating expenses by Branch X totaled 20,000
7. Cash of 37,500 remitted to home office by Branch X
8. Operating expenses charged to Branch X by home office totaled 3,000

Home Office (S Company) Accounting Branch X Accounting Record

Records Journal Entries Journal Entries
Investment in X branch 1,000 Cash 1,000
Cash 1,000 Home Office 1,000
Investment in X branch 60,000 Inventories 60,000
Inventories 60,000 Home Office 60,000
Equipment: X branch 500 Home Office 500
Investment in X branch 500 Cash 500
Trade Account Receiva. 80,000
None entry required Cost of Goods Sold 45,000
Sales 80,000
Inventories 45,000
Cash 62,000
No entry required Trade Account Receivable 62,000
Operating Expenses 20,000
No entry required Cash 20,000
Cash 37,500 Home Office 37,500
Investment in X branch 37,500 Cash 37,500
Investment in X branch 3,000 Operating Expenses 3,000
Operating Expenses 3,000 Home Office 3,000

Transaction between Branches

Efficient operation may on occasion require that assets be transferred from one branch to another.
A branch does not carry a reciprocal account with another branch but records the transfer in the
Home Office account.

For example, if Branch A transfers merchandise to Branch B, Branch A debits Home Office and
credits Inventories, while Branch B debits Inventories and credit Home Office. The Home Office
records the transfer by debiting Investment in Branch B and crediting Investment in Branch A.

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 Hawassa University College of Business and Economics Department of Accounting and Finance

The additional freight cost due to the indirect routing does not justify increase in the carrying
amount of inventories. Only freight costs of the direct shipment from the home office are included
in inventory costs.

Illustration: The home office shipped merchandise costing 6,000 to Branch D and paid freight
costs of 400. Subsequently, the home office instructed Branch D to transfer this merchandise to
Branch E. Branch D paid 300 to carry out this order. The cost of direct shipment from home office
to E would have been 500. The journal entries in the three sets of records would be:

Home Office
Investment in Branch D 6,400
Inventories 6,000
Cash 400
To record shipment of merchandise and payment of freight costs

Investment in Branch E 6,500

Excess Freight Expense- Inter-branch Transfers 200
Investment in Branch D 6,700
To record transfer of merchandise from Branch D to Branch E under instruction of the home office

Branch D

Freight in 400
Inventories 6,000
Home Office 6,400
To record receipt of merchandise from home office with freight costs paid in advance by home
office

Home Office 6,700

Inventories 6,000
Freight in 400
Cash 300
To record transfer of merchandise to Branch E under instruction of home office and payment of
freight costs of 300

Branch E

Inventories 6,000
Freight in 500
Home Office 6,500

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 Hawassa University College of Business and Economics Department of Accounting and Finance

To record receipt of merchandise from Branch D transferred under instruction of home office and
normal freight billed by home office.

The excessive freight costs from such shipments generally result from inefficient planning of
original shipments and should not be included in inventories. If branch managers are given
authority to order transfer of merchandise between branches, the excess freight costs should be
recorded as expenses attributable to the branches.

A balance sheet for distribution to external users the financial position of the business enterprise
as a single entity. A convenient starting point in the preparation consists of the adjusted trial
balances of the home office and the branches.
The assets and liabilities of the branch are substituted for the Investment in Branch ledger account
included in the home office trial balance. Similar accounts are combined to produce a single total
amount for cash, trade receivables, and other assets and liabilities of the enterprise as a whole.

Reciprocal accounts are eliminated as they have no significance when the branch and home office
report as a single entity. The balance of the Home Office account is offset against the balance of
the Investment in Branch account.

The operating results of the enterprise (the home office and the branches) are shown by an income
statement in which the revenue and expenses of the branch are combined with the revenue and
expenses of the home office. Any intracompany profits or losses are eliminated.

Working Paper for Combined Financial Statements

A working paper for combined financial statements has three purposes:
 To combine ledger account balances like assets and liabilities
 To eliminate any intra company profits or looses
 To eliminate the reciprocal accounts
Illustration: the same data is going to be used. Assuming that all the year end routine adjustments
are made, the working paper is begun with adjusted trial balances of the home office and Branch
X.

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 Hawassa University College of Business and Economics Department of Accounting and Finance

S CORPORATION
Working Paper for Combined Financial Statements of Home Office and Branch X
For the Year Ended December 31, Year 1
(Perpetual Inventory System: Billing at Cost)
Adjusted Trial Balance Elimination Combined
Home Branch X
Office
Dr (Cr) Dr (Cr) Dr (Cr) Dr (Cr)
Income Statement
Sales (400,000) (80,000) (480,000)
Cost of Goods Sold 235,000 45,000 280,000
Operating Expense 90,000 23,000 113,000
Net Income 75,000 12,000 87,000
Total -0- -0- -0-
Statement of Retained Earning
Retained Earnings January 1 (70,000) (70,000)
Net Income (75,000) (12,000) (87,000)
Dividends 40,000 40,000
Retained Earnings December 31 117,000
Total -0-
Balance Sheet
Cash 25,000 5,000 30,000
Tarde Accounts Receivable (net) 39,000 18,000 57,000
Inventories 45,000 15,000 60,000
Investment in Branch X 26,000 (26,000)
Equipment 150,000 150,000
Accumulated Depreciation (10,000) (10,000)
Tarde Accounts Payable (20,000) (20,000)
Home Office (26,000) 26,000
Common Stock (150,000) (150,000)
Retained earnings (117,000)
Total -0- -0- -0- -0-

In the elimination column, elimination (a) offsets the balance of Investment in Branch X account
against the balance of the Home Office account. This elimination appears in the working paper
only. Combined financial statements of S Corporation prepared on the basis of the above working
paper are:

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 Hawassa University College of Business and Economics Department of Accounting and Finance

S Corporation
Income Statement
For the Year Ended Dec 31, Year 1
Sales 480,000
Cost of Goods Sold (280,000)
Gross Profit 200,000
Operating Expenses 113,000
Net Income 87,000
Earnings Per Share of Common Stock 5.80

S Corporation
Statement of Retained Earnings
For the Year Ended Dec 31, Year 1
Retained Earning, beginning of Year 70,000
Add: Net Income 87,000
Sub Total 157,000
Less: Dividends (2.67 per share) 40,000
Retained Earnings, End of Year 117,000

S Corporation
Balance Sheet
Dec 31, Year 1

Assets
Cash 30,000
Trade Account Receivables (net) 57,000
Inventories 60,000
Equipment 150,000
Less Accumulated Depreciation (10,000) 140,000
Total Assets 287,000
Liabilities and Stockholder’s Equity
Liabilities
Trade Accounts Payables 20,000
Stockholders’ Equity
Common Stock (10 Par) 150,000
Retained Earnings 117,000
267,000
Total Liabilities and Stockholders’ Equity 287,000

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 Hawassa University College of Business and Economics Department of Accounting and Finance

Shipping Merchandise to Branches at Price above Cost

As explained earlier, some businesses bill merchandise shipped to branches at cost plus a markup
percentage or retail selling prices. Because both methods involve similar modification of accounts,
a single example is used to illustrate the key points. Change one assumption of the former example
to: the home office bills merchandise shipped to branches at 50% above cost. The merchandise
shipment in the previous example is thus billed at 90,000 (60,000+50% mark up of 30,000) and
are recorded as follows:
Home Office
Investment in Branch X 90,000
Inventories 60,000
Over valuation of Inventories: Branch X 30,000
Use of the allowance account enables the home office to maintain record of unrealized gross profit
on shipments.
Branch X
Inventories 90,000
Home Office 90,000
The two reciprocal accounts at branch and head office viz. Home Office and Investment in Branch
X accounts will have balances of 56,000 before the accounts are closed and net income or loss
entered. This amount is 30,000 larger than the balance in the previous illustration because of
change in billing method.
At the end of the period, the branch will report its inventories at billed prices of 22,500
(15,000*50%). In the records of the home office, the required balance of the Allowance for
Overvaluation of Inventories: Branch X account is 7,500 (22,500-15,000); thus, this account
balance must be reduced to 7,500 from the present amount of 30,000 to represent the excess
valuation contained in the ending inventories of the branch.
Under the present assumption, the branch reports a net loss of 10,500. The adjustment of 22,500
is transferred as credit to Income: Branch X account, because it represents additional gross profit
over that reported by the branch. Thus, the actual net income for Branch X is 12,000, the same as
the previous illustration.
The following journal entries are passed in the home office records.
Income: Branch X 10,500
Investment in Branch X 10,500
To record net loss reported by branch
Allowance for Overvaluation of Inventories: Branch X 22,500
Income Barnch X 22,500
To reduce allowance to amount by which ending inventories of branch exceed cost

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 Hawassa University College of Business and Economics Department of Accounting and Finance

Income: Branch X 12,000

Income Summary 12,000
To close branch net income (as adjusted)
Working Paper when Billing to Branches at Price above Cost
S CORPORATION
Working Paper for Combined Financial Statements of Home Office and Branch X
For the Year Ended December 31, Year 1
(Perpetual Inventory System: Billing above Cost)
Adjusted Trial Elimination Combined
Balance
Home Branch X
Office
Dr (Cr) Dr (Cr) Dr (Cr) Dr (Cr)
Income Statement
Sales (400,000) (80,000) (480,000)
a
Cost of Goods Sold 235,000 67,500 (22,500) 280,000
Operating Expense 90,000 23,000 113,000
Net Income 75,000 (10,500) 22,500b 87,000
Total -0- -0- -0-
Statement of Retained Earning
Retained Earnings January 1 (70,000) (70,000)
b
Net Income (75,000) (10,500) (22,500) (87,000)
Dividends 40,000 40,000
Retained Earnings December 31 117,000
Total -0-
Balance Sheet
Cash 25,000 5,000 30,000
Tarde Accounts Receivable (net) 39,000 18,000 57,000
Inventories 45,000 22,500 (7,500)a 60,000
Investment in Branch X 56,000 (56,000)c
Allowance for Overvaluation Branch X (30,000) 30,000a
Equipment 150,000 150,000
Accumulated Depreciation (10,000) (10,000)
Tarde Accounts Payable (20,000) (20,000)
Home Office (56,000) 56,000c
Common Stock (150,000) (150,000)
Retained earnings (117,000)
Total -0- -0- -0- -0-

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 Hawassa University College of Business and Economics Department of Accounting and Finance

a) To reduce ending inventories and cost of goods sold of branch to cost, and to eliminate
balance in Allowance for Overvaluation of Inventories: Branch X ledger account.
b) To increase net income of branch by portion of merchandise markup that was realized.
c) To eliminate reciprocal ledger accounts.

RECONCILIATION OF RECIPROCAL ACCOUNTS

In a previous section, the nature of reciprocal accounts and the necessity for their reconciliation
before the combined financial statements are prepared was described. The situation is comparable
to that of reconciling the ledger account for Cash in Bank with the balance in the monthly bank
statement.
Illustration: Assume the home office and the branch accounting records contain the following
data and the balances of the Home Office account and Investment in Branch accounts on Dec 31
are 41,500 Cr. and 49,500 Dr. respectively. Comparison of the two reciprocal accounts discloses
four reconciling items.
1. A debit of 8,000 in Investment in Branch account without a related credit in Home Office
account
Merchandise shipped to branch on Dec 29 but not received at year end. Required journal
in branch accounting records:
Inventories in Transit 8,000
Home Office 8,000
To record shipment of merchandise in transit from home office
The inventories in transit must be included in inventories in hand.
2. A credit of 1,000 in the Investment in Branch account without a related debit in the Home
Office account
The home office collected trade accounts receivable of the branch. The journal entry
required in the records of the branch on Dec 31:

Home Office 1,000

Trade A/R 1,000
To record collection of accounts receivable by home office

3. A debit of 3,000 in the Home Office ledger account without a related credit in Investment
in Branch account
The branch acquired equipment for 3,000 on Dec 28 and debited Home Office as
equipment used by branch is carried in records of the home office. The journal entry
required in the records of the Home office:
Equipment: Branch X 3,000
Investment in Branch X 3,000
To record equipment acquired by branch

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 Hawassa University College of Business and Economics Department of Accounting and Finance

4. A credit of 2,000 in the Home Office ledger account without a related debit in the
Investment in Branch account
Accounts receivable of the home office was collected on Dec 30 and recorded as credit to
Home Office. Journal entry required in the records of the home office on Dec 31
Investment in Branch X 2,000
Trade Accounts Receivable 3,000
To record collection of receivable by branch

The effect of the foregoing end of year journal entries is to update the reciprocal ledger accounts
as shown below:

M Company- Home Office and Branch X

Reconciliation of Reciprocal Ledger Accounts
December 31, 19X9
Investment in Branch Home Office
Balance before adjustment 49,500 Dr 41,500 Cr
Add: 1. Merchandise shipped 8,000
4. Home Office A/R collected by Branch 2,000
Less 2. Branch A/R Collected by Home Office (1,000)
3. Equipment acquired by Branch (3,000)
Adjusted Balances 48,500 48,500

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