Advance Ch2

Chapter 2
Accounting for Branches and

Combined Financial Statements
1
Branches and Divisions
 Branches and divisions are separate

economic and accounting entities
from their home office. However, they
are not separate legal entities from
their home office.
2
Branches and Divisions (contd.)
 Branch: a business unit located at
some distance from the home office.
This unit carries merchandise
obtained from the home office, makes
sales, approves customers’ credit,
makes collections from its customers,
and remits cash received.
3
 Divisions: a segment of a business
entity which generally has more
autonomy than a branch. Accounting
for a division not operated as a
separate corporation (i.e., subsidiary
company) is similar to that of
branches.
4
 Divisions: Accounting for a division
operated as a separate corporation is
different from that of branches and
will be discussed in latter chapters.
Consolidated financial statements are
required for these business
organizations.
5
Start-up Costs of Opening New Branches
 Based on Statement of “Reporting on

the Costs of Start-up Activities”, all
start-up costs, including costs
associated with organizing a branch
or division should be expensed in the
accounting period in which the costs
are incurred.
6
Accounting System for a Branch
 Two alternative systems:
1. The branch does not maintain a
complete set of accounting
records. The home office serves only
as an accounting and control center
for the branches.
7
Accounting System for a Branch (contd.)
2. The branch maintains a complete

set of accounting records
consisting of journal entries and
ledger accounts. Financial
statements are prepared by the
branch account and forwarded to the
home office.
8
 Distinct features of decentralized accounting
system [i.e. branch maintains its own
accounting records.]
1. Reciprocal [intracompany] ledger accounts
2. Acquisition of plant assets
3. Allocation [apportionment] of home office
expenses
4. Billing merchandise shipments
5. Consolidation of financial statements
9
Reciprocal Ledger Accounts Used by the Branch
and Home Office
 Home Office Ledger Account:
This account is used by the branch to
account for all transactions with the home
office. It is credited for all cash,
merchandise or other assets provided by
the home office to the branch. It is debited
for all cash, merchandise, or other assets
sent by the branch to the home office or to
other branches.
10
and Home Office (contd.)
 Home Office Ledger Account:
This account represents the net
investment by the home office in the
branch. At the end of a period, the
balance of Income Summary account
of a branch is closed to the Home
Office account.
11
 Investment in Branch Ledger Account:
This account is a reciprocal ledger account

(to Home Office account) used by the home
office to account for any transactions with
the branches. It is debited for cash,
merchandise and services provided to the
branch by the home office and for the net
income reported by the branch.
12
 Investment in Branch Ledger Account:
It is credited for cash, or other assets
received from the branch, and for net
losses reported by the branch.
 Thus, this account reflects the equity
method of accounting. Home office
usually maintains one investment
account for each branch.
13
Decentralized Accounting for Branches
Branch
2
14
Acquisition of Plant Assets Used in Branch
 If a plant asset is acquired by the

home office for a branch’s usage
and the accounting record for the
plant asset is maintained by the
home office, the accounting
treatments are:
15
(contd.)
 For the home office:
Plant asset (various)-branch…..xxx

Cash or a liability a/c……………….xxx

For the branch: no entry.
16
(contd.)
 If a plant asset is acquired by a
branch for its usage but the
accounting record for this plant
asset is maintained by the home
office, the accounting treatments
are:
17
(contd.)

For the branch:
Home Office………………………xxx
Cash or a liability a/c……..…………..xxx

For the home office:
Plant asset (various)-branch……xxx

Investment in Branch…………………xxx
18
Branch Fixed Assets
H. Office
H. Office Accounted
H. Office
Branch
Fixed Purchase
Asset
H. Office
Branch Accounted
Branch
Accounting for Branches 19

Expense Incurred by Home Office and
Allocated to Branches
 The home office may acquire plant
assets and insurance for these assets.
These plant assets are carried in the
home office accounting record but used
by branches.

The home office may pay some taxes on
behalf of branches, and arrange for
advertising that benefits all branches.
20
Allocated to Branches (contd.)
 These expenses are usually allocated
to branches in determining net income
of branches.

These expenses include deperciation
expense for the plant assets
purchased by home office but used by
branches.
21
Allocated to Branches (contd.)

If the home office chooses to allocate these
expenses to branches, the accounting
treatments are:
a. For the home office:
Investment in Branch…..xxx
Expense (various)…………xxx
b. For the branch:
Expense (various)……….xxx
Home Office………………..xxx
22
Interest Charged by the Home office on the Capital
Invested in Branches

When the home office serves only as an
accounting and control center without
any sales, most or all of its expenses
may be allocated to the branches.

In addition, the home office may charge
each branch interest on the capital
invested in each branch.
23
Interest Charged by the Home office on the Capital
Invested in Branches (contd.)
 Such interest revenue recognized by

the home office should be offset with
the interest expense recognized by the
branches in the combined financial
statements.
24
Alternative Methods of Billing Merchandise
Shipments to Branches
 Three alternative methods are available to
the home office in billing the merchandise
shipped to the branches:
a. billed at the home office cost,
b. billed at a percentage above the home
office cost, and
c. billed at the branch’s retail selling
price.
25
Alternative Methods of Billing Merchandise
Shipments to Branches
Home Office
Investments in branch………………………. xxx
Inventories/ Shipments to branch ………………......xxx
Allowance for overvaluation of inventories-branch..xxx
Branch Office
Inventories/Shipments from HO……………. xxx
Home Office……………………………………….....xxx
26
Billed at the home office cost:
 Strength: widely used because of its
simplicity
 Weakness: attributes all gross profits

of the business to the branches.
27
Billed at a percentage above home office cost:

Strength: is able to allocate a
reasonable gross profit to the home
office.

Weakness: the net income reported by
the branch may be understated and the
ending inventories at branch are
overstated for the enterprise as a
whole.
28
Billed at a percentage above home office cost:
(contd.)
 Thus, for the combined financial
statement, the home office must
eliminate the excess of billed prices
over cost (intracompany profits).
29
Billed at branch retail selling prices:
 Strength: to increase the internal
control over inventories at branches.
 Weakness: no gross profit assigned to

the branches and the branch’s net loss
will equal its operating expenses.
30
Separate Financial Statements for Branch and for
Home Office (for internal use only)
 Separate financial statements for
branches should be prepared so that
management can evaluate the
performance of each branch.
 The branch’s financial statements may
be revised by the home office to include
the allocated expenses incurred by the
home office.
31
Separate Financial Statements for Branch and for
Home Office (for internal use only) (contd.)
 Also, the financial statements of
branches should be revised to
eliminate any intracompany profits on
merchandise shipments or interest
charge on capital investments.
32
Combined financial Statements for Home
Office and Branch (for external use)
 For investors, the home office and
branches are a single business entity.
 Thus, combined financial statements
should be prepared for external users.
 A four-column work sheet paper is
used to facilitate the preparation of the
combined financial statement.
33
Office and Branch (for external use)(contd.)
 In preparing the combined financial
statements, the following accounts
should be eliminated:

a. Reciprocal ledger accounts
 b. Any intracompany profits or losses.

34
 c. Any receivables and payables
between the home office and the
branch (or between two branches).

 The rest of accounts are just summed
together for the combined financial
statements.
35
Decentralized Accounting for Branches
36
 Example I: Journal entries for
operations of a branch when
merchandise is billed at the cost of the
home office with a perpetual inventory
system.
37
Combined financial Statements for Home Office and Branch
(for external use)(contd.)
Example I: (contd.)

Assume that A Company bills
merchandise to Mason Branch at
home office cost and that M Branch
maintains complete accounting
records and prepares financial
statements.

Both the home office and the branch
use the perpetual inventory system.
Equipment used at the branch is
carried in the home office records.
38
Example I: (contd.)
 Expenses, such as advertising and
insurance, incurred by the home office
on behalf of the branch, are billed to
the branch.
 Transactions and events during the
first year (2015) of operations of M
Branch are summarized below (start-
up costs are disregarded):
39
Example I: (contd.)
1. Cash of $1,000 was forwarded by the
home office to M Branch.
2. Merchandise with a home office cost of
$60,000 was shipped by the home office to
M Branch.
3. Equipment was acquired by M Branch for
$500, to be carried in the home office
accounting records. (Other plant assets for
M Branch generally are acquired by the
home office.)
40
Example I: (contd.)
4. Credit sales by M Branch amounted to
$80,000; the branch’s cost of the
merchandise sold was $45,000.
5. Collections of trade accounts receivable by
M Branch amounted to $62,000.
6. Payments for operating expenses by M
Branch totaled $20,000.
41
Example I: (contd.)
7. Cash of $37,500 was remitted by M Branch
to the home office.
8. Operating expenses incurred by the home
office and charged to M Branch totaled
$3,000.
42
Example I: (contd.)

These transactions and events are
recorded by the home office and by M
Branch as follows:
Home Office Accounting M Branch Accounting

Records Journal Entries: Records Journal Entries:
1.Investment in Mason Cash 1,000
Branch 1,000
Cash 1,000 Home Office 1,000
43
Example I: (contd.)
2. Investment in Mason Inventories 60,000
Branch 60,000
Inventories 60,000 Home Office 60,000
3. Equipment: Mason Home Office 500
Branch 500
Investment in Mason Cash 500
Branch 500
44
Example I: (contd.)
Home Office Accounting M Branch Accounting Records
Records Journal Entries: Journal Entries:
4. None Trade Accounts
Receivable 80,000
Cost of Goods Sold 45,000
Sales 80,000
Inventories 45,000
45
Example I: (contd.)
5. None Cash 62,000
Trade
Account
Receivable 62,000
6. None Operating
Expenses 20,000
Cash 20,000
46
Example I: (contd.)
7. Cash 37,500 Home Office 37,500
Investment in Mason Cash 37,500
Branch 37,500
8. Investment in Mason Operating
Branch 3,000 Expenses 3,000
Operating Home Office 3,000
Expenses 3,000
47
Example I: (contd.)

Two Reciprocal Ledger Accounts (prior to adjusting
and closing entries):
Investment in M Branch
Date Explanation Debit Credit Balance
1999 Cash sent to branch 1,000 1,000 dr
Merchandise billed to
branch at home office cost 60,000 61,000 dr

Equipment acquired by
branch, carried in home

office accounting records 500 60,500 dr
Cash received from branch 23,000 dr
37,500
Operating expenses billed
to branch 3,000 26,000 dr
48
Example I: (contd.)
Home Office
1999 Cash received from home
office 1,000 1,000 cr

Merchandise received from
home office 60,000 61,000 cr

Equipment acquired 500 60,500 cr
Cash sent to home office 37,500 23,000 cr
Operating expenses billed
by home office 3,000 26,000 cr
49
Working Paper for Combined financial Statements--
Example I
 The following working paper for
combined financial statements serves
three purposes:
1) to eliminate any intracompany profits
or losses,
2) to eliminate the reciprocal accounts, &
3) to combine ledger accounts balances
of home office and branches.
50
Example I (contd.)
 Assume that the M Branch’s ending
inventories of $15,000 at the end of
2015 had been verified, the following
work sheet is based on the transactions
and events illustrated on pages 40-44.
With additional assumed data for the
home office trial balance.
51
Example I (contd.)
 All the year-end adjusting entries
(except the home office entries on page
60) had been made.
 The working paper begins with the
adjusted trial balance of the home office
and M Branch.
 Income taxes are ignored in this
illustration.
52
Example I (contd.)
A COMPANY
Working paper for combined Financial
Statements of Home office and M Branch.
For Year Ended December 31,2015
(Perpetual Inventory System: Billing at Cost)
53
Example I (contd.)
Adjusted Trial Balances
Home Mason
Office Branch Eliminations Combined
Dr (Cr) Dr(Cr) Dr (Cr) Dr (Cr)
Income Statement
Sales (400,000) (80,000) (48,000)
Cost of goods sold 235,000 45,000 280,000
Operating expenses 90,000 23,000 113,000
Net Income (to
statement of retained 75,000 12,000 87,000
earnings below)
Totals -0- -0- -0-
54
Example I (contd.)
Statement of Retained Home Mason Eliminations Combined
Earnings Office Branch
Retained earnings, Jan. (70,000) (70,000)
1, 2015
Net(income) (from
incomes statement (75,000) (12,000) (87,000)
above)
Dividends declared 40,000 40,000
Retained earnings,
Dec.31,2015 (to 117,000
balance sheet below)
Totals -0-
55
Example I (contd.)
Home M Branch Eliminations Combined
Balance Sheet Office
Cash 25,000 5,000 30,000
Trade accounts
receivable (net) 39,000 18,000 57,000
Inventories 45,000 15,000 60,000
Investment in Mason
Branch 26,000 (a) (26,000)
Equipment 150,000 150,000
Accumulated
depreciation of (10,000) (10,000)
equipment
56
Example I (contd.)
(contd.) Dr (Cr) Dr(Cr) Dr (Cr) Dr (Cr)
Trade accounts payable (20,000) (20,000)
Home Office (26,000) (a) (26,000)
Common stock, $10 par (150,000) (150,000)
Retained earnings
(from statement of
retained earnings
above) (117,000)
Totals -0- -0- -0- -0-
(a) To eliminate reciprocal ledger account balances
* the elimination appears in the working paper only
57
Combined Financial Statements -- Example I
A COMPANY
Income Statement
For Year Ended December 31, 2015
Sales $ 480,000
Cost of goods sold 280,000
Gross margin on sales $ 200,000
Operating expenses 113,000
Net Income $ 87,000
Basic earnings per share of common
stock $
5.80
58
(contd.)
A COMPANY
Statement of Retained Earnings
Retained earnings, beginning of year $ 70,000

Add: Net income 87,000
Subtotal $ 157,000
Less: Dividends ($2.67 per share) 40,000
Retained earnings, end of year $ 117,000
59
(contd.)
A COMPANY
Balance Sheet
December 31, 2015
Assets
Cash $ 30,000
Trade accounts receivable (net) 57,000
Inventories 60,000
Equipment $150,000
Less: Accumulated depreciation 10,000 140,000
Total assets $287,000
60
(contd.)
A COMPANY
Balance Sheet (contd.), December 31, 2015
Liabilities & Stockholders’ Equity
Liabilities
Trade accounts payable $20,000
Stockholders’ equity
Common stock, $10 par,
15,000 shares authorized, issued,
and outstanding $150,000
Retained earnings 117,000 267,000
Total liabilities & stockholders’
equity $287,000
61
Home Office Adjusting and Closing Entries and Branch
Closing Entries Performed on 12/31/2015 (perpetual
inventory system):

Records Adjusting and Closing Entries:
Closing Entries:
None Sales 80,000
Cost of Goods Sold
45,000
Operating
Expenses 23,000
Income Summary
12,000
62
Home Office Adjusting and Closing Entries and Branch
Closing Entries Performed on 12/31/2015 (perpetual
inventory system): (contd.)

Records Adjusting and Closing Entries:
Closing Entries:
Investment in M Income
Branch 12,000 Summary 12,000
Income: Mason Home Office 12,000
Branch 12,000
Income: M None
Branch 12,000
Income
Summary 12,000
63
Example II: Billing of Merchandise to Branches at
Prices above Home Office Cost
 Similar information as in the previous
example, except that the home office
bills merchandise shipped to M branch
at 50% markup of the cost.
 Thus, the shipment of merchandise
costing $60,000 will be recorded at the
home office and branch as follows:
64
Prices above Home Office Cost (contd.)
 Journal entries for shipments to branch at
prices above home office cost (perpetual
inventory system):
Investment in Mason
Branch 90,000 Inventories 90,000
Inventories 60,000 Home Office 90,000
Allowance for
Overvaluation of
Inventories: Mason
Branch 30,000
65
 Thus, the balances of both the
Investment in M Branch account
and Home Office account will be
$56,000, instead of $26,000 due to
the inventory mark up of $30,000.
66
A COMPANY
Flow of Merchandise for Mason Branch During 2015
Billed Home Markup (50% of
Price Office Cost;33 1/3 % of
Cost Billed Price)
Beginning
inventories
Add: Shipments
from home office $90,000 $60,000 $30,000
Available for sale $90,000 $60,000 $30,000
Less: Ending
inventories 22,500 15,000 7,500
Cost of goods
sold $67,500 $45,000 $22,500
67
Working Paper for Example II
A COMPANY
Working paper for combined Financial
Statements of Home office and M Branch
For Year Ended December 31,2015
(Perpetual Inventory System: Billing above
Cost)
68
Working Paper for Example II (contd.)
Home M Branch
Office Eliminations Combined
Income Statement
Sales (400,000) (80,000) (48,000)
Cost of goods sold 235,000 67,500 (a) (22,500) 28,000
Net Income(loss) (to
statement of retained 75,000 (10,500) (b) 22,500 87,000
earnings below)
Totals -0- -0- -0-
69

Statement of Retained Home M Branch Eliminations Combined
Earnings Office
Retained earnings, Jan. (70,000) (70,000)
1, 2015
Net(income) loss (from
incomes statement (75,000) 10,500 (b) (22,500) (87,000)
above)
Dividends declared 40,000 40,000
Retained earnings,
Dec.31,2015 (to 117,000
balance sheet below)
Totals -0-
70
Cash 25,000 5,000 30,000
Trade accounts
receivable (net) 39,000 18,000 57,000
Inventories 45,000 22, 500 (a) (7,500) 60,000
Investment in M Branch
56,000 (c) (56,000)
Allowance for
overvaluation of
inventories: M Branch
(30,000) (a) 30,000
Equipment 150,000 150,000
71
(contd.) Dr (Cr) Dr(Cr) Dr (Cr) Dr (Cr)
Accumulated
depreciation of
inventories: Mason
Branch (10,000) (10,000)
Trade accounts payable (20,000) (20,000)
Home Office (56,000) (c) (56,000)
Common stock, $10 par (150,000) (150,000)
Retained earnings(from
statement of retained (117,000)
earnings above)
Totals -0- -0- -0- -0-
72
Branch Closing Entries and Home office Adjusting
and Closing Entries (when billing at above the cost)
 Branch Closing Entries--The closing
entries for the branch at the end of 2015 are
as follows:
Sales 80,000
Income Summary 10,500
Cost of Goods Sold 67,500
Operating Expenses 23,000
To close revenue and

expense ledger accounts
73
(contd.)
Home Office 10,500

To close the net loss in the

Income Summary account to
the Home Office account
74
(contd.)
 After the closing entries, the Home
Office ledger account should have a
balance of $45,500.
 Note: Home Office balance prior to the
closing entries equals $56,000.
$56,000-net loss of $10,500 = $45,500
(net loss decreases Home Office credit
balance).

75
(contd.)
Home Office Adjusting and Closing Entries
Income: M Branch 10,500

Investment in M 10,500
Branch
To record net loss reported by
branch
76
(contd.)
(contd.)
Allowance for Overvaluation
of Inventories: M Branch 22,500
Realized Gross Profit:
M Branch Sales 22,500
To reduce allowance to
amount by which ending
inventories of branch exceed
cost.
77
(contd.)
(contd.)
Realize Gross Profit: M 22,500
Branch Sales
To close branch net loss and
realized gross profit to Income
Summary ledger account
(Income tax effects are
disregarded.)
78
(contd.)

After posting the above entries, the account
balance for the following accounts is:
Investment in M Branch =45,500(debit)*
Allowance for Overvaluation of =7,500(credit)**
Inventories: M Branch
Realized Gross Profit: M Branch =0
Income: M Branch =0
* Balance prior to the above entries equals $56,000. $56,000- 10,500
(net loss of the branch reduces the debit balance of the Investment
account) = $45,500.
** $30,000-22,500 = $7,500. 79
(contd.)
 Similar working paper eliminations as
on page 66-69 will be prepared for the
following year (i.e., year 2016) when
continuing with the perpetual inventory
system with a price markup.
80
Combined Financial Statements -- Example II
A COMPANY
Income Statement
Sales $ 480,000
Cost of goods sold 280,000
Gross margin on sales $ 200,000
Net Income $ 87,000
Basic earnings per share of common
stock $
5.80
81
I(contd.)
A COMPANY
Statement of Retained Earnings
Retained earnings, beginning of year $ 70,000

Add: Net income 87,000
Subtotal $ 157,000
Less: Dividends ($2.67 per share) 40,000
Retained earnings, end of year $ 117,000
82
(contd.)
A COMPANY
Balance Sheet
December 31, 2015
Assets
Cash $ 30,000
Trade accounts receivable (net) 57,000
Inventories 60,000
Equipment $150,000
Less: Accumulated depreciation 10,000 140,000
Total assets $287,000
83
(contd.)
A COMPANY
Balance Sheet (contd.), December 31, 2015
Liabilities & Stockholders’ Equity
Liabilities
Trade accounts payable $20,000
Stockholders’ equity
Common stock, $10 par,
15,000 shares authorized, issued,
and outstanding $150,000
Retained earnings 117,000 267,000
Total liabilities & stockholders’
equity $287,000
84
Periodic Inventory System

When a periodic inventory system is
adopted, inventory account cannot be
used for the shipments of merchandise
between the home office and the
branch.

Accounts such as “Shipments to M
Branch” (used by the home office) and
“Shipments from Home Office” (used by
the branch) are used.
85
Periodic Inventory System (contd.)
Example:
 Example:
Continue with the A Company for a second
year of operations (2016) but using the
periodic inventory system for both the home
office and M Branch.
The beginning inventories for 2016 were
carried by M Branch at $22,500 (home office
cost is $15,000 due to a 50% markup by the
home office).
86
Example: (contd.)
 Assume that during 2016, the home office
shipped merchandise to M Branch that cost
$80,000 and M was billed at $120,000.
 During 2016, M Branch sold $150,000
merchandise that was billed at $112,500.
 The journal entries to record the shipments
and sales at a price above home office cost
under the periodic inventory system are as
follows:
87
Example: (contd.)
Investment in M Shipments from Home
Branch 120,000 Office 120,000
Home Office 120,000
Shipments to M
Branch 80,000
Allowance for
Overvaluation of
Inventories: M
Branch 40,000
None Cash (or Trade Accounts
Receivable) 150,000
Sales 150,000
88
Example: (contd.)

The branch inventories at the end of 2016 amounted to
$30,000. The flow of merchandise for M Branch of year
2016 summarized below:
A COMPANY
Flow of Merchandise for Mason Branch During 2016
Billed Home Markup (50% of
Price Office Cost;33 1/3 % of
Cost Billed Price)
Beginning
inventories $22,500 $15,000 $7,500
Add: Shipments
from home office 120,000 80,000 40,000
Available for sale $142,500 $95,000 $47,500
Less: Ending
inventories (30,000) (20,000) (10,000)
Cost of goods
sold $112,500 $75,000 $37,50089
Example: (contd.)

The activities for the branch for 2016 are reflected
in the following two home office ledger accounts
and the reciprocal Home Office ledger account of
the branch: Investment in M Branch
2016 Balance, Dec. 31, 2015 45,500 dr
Merchandise billed to branch
at markup of 50% above

home office cost, or 33 1/3
% of billed price 120,000 165,500dr
Cash received from branch
113,000 52,500 dr
Operating expenses billed to
branch 4,500 57,000 dr

90
Example: (contd.)
Allowance for Overvaluation of Inventories:
M Branch
2016 Balance, Dec. 31, 7,500 cr
2015
Markup on
merchandise
shipped to branch
during 2016 (50% of
cost) 40,000 47,500 cr
91
Example: (contd.)
Home Office
2016 Balance, Dec. 31,
2015 45,500 cr
Merchandise
receivable from
home office 120,000 165,500 cr
Cash sent to home
office 113,000 52,500 cr
Operating expenses
billed by Home office 4,500 57,000 cr

92
Example: (contd.)
 The working paper for combined financial
statements under the periodic inventory
system is as follows:
Income Statement Office
Dr (Cr) Dr (Cr) Dr (Cr) Dr (Cr)
Sales (500,000) (150,000) (650,000)

Inventories, Dec. 31,
2015 45,000 22,500 (b) (7,500) 60,000
Purchases 400,000 400,000
Shipments to M -0-
Branch 93
Example: (contd.)
Income Statement Office
(contd.)
Shipments from home -0-

office 120,000 (a120,000
Inventories, Dec.
31,2016 (70,000) (30,000) (c) 10,000 (90,000)
Net Income( to
statement of retained
earnings below) 85,000 10,000 (d) 37,500 132,500
Totals -0- -0- -0- 94
Example: (contd.)
Statement of Home M Branch Eliminations Combined
Retained Earnings Office
Retained earnings,
Dec. 31, 2015 (117,000) (117,000)
Net Income (from
income statement
above) (85,000) (10,000) (d) (37,500) (132,500)
Dividends declared 60,000 27,500 60,000
Retained earnings,
Dec. 31, 2016 (to
balance sheet below) 85,000 10,000 189,500
Totals -0- 95
Example: (contd.)
Cash 30,000 9,000 39,000

Trade accounts
receivable (net) 64,000 28,000 92,000
Inventories, Dec. 31,
2016 70,000 30,000 (c) (10,000) 90,000
Allowance for
overvaluation of
inventories : M Branch (a) 40,000 -0-
(47,500) (b) 7,500
Investment in M
Branch 96
Example: (contd.)
Home M Branch Elimination Combined
Balance Sheet Office s
(contd.)
Equipment 158,000 158,000

Accumulated
depreciation of
equipment (15,000) (15,000)
Trade Account payable (24,500) (24,500)
Home office (57,000) (e) 57,000
Common stock, $10 par (150,000) (150,000)
Retained earnings
(from statement of
retained earnings 97
Example: (contd.)
(a) To eliminate reciprocal ledger accounts
for merchandise shipments.
(b) To reduce beginning inventories of
branch to cost
(c) To reduce ending inventories of branch to
cost.
(d) To increase income of home office by
portion of merchandise markup that was
realized by branch sales.
(e) To eliminate reciprocal ledger account
balances.
98
Branch Closing Entries and Home Office Adjusting and
Closing entries for the home office (with billing at above the
cost and using a periodic inventory system):

Branch Closing Entries:
(1)Inventory (ending) 30,000

Cost of Goods Sold 112,500*
Inventory (beg.) 22,500
Shipments from
Home Office 120,000

CGS=22,500+120,000-30,000
99
cost and using a periodic inventory system):(contd.)
(2)Sales 150,000
CGS 112,500
(3) Income Summary 10,000

Home Office 10,000
100

Home Office Adjusting (1 and 2) and
Closing Entries (3) :
(1) Investment in Branch 10,000

(2) Allowance for Overvaluation

of Inventories 37,500
Realized Gross Profit :
M Branch 37,500
101
(3) Realized Gross Profit 37,500

102
 Balances of Investment in M Branch,

Allowance for Overvaluation of
Inventories, Realized Gross Profit,
Income: M Branch and Home Office
accounts after the above adjusting and
closing entries are:
103
 Investment in M Branch
= $67,000 (dr.)
(57,000+10,000)

 Allowance for Overvaluation of
Inventories
= $10,000 (cr.) (47,500 -37,500)
104

Realized Gross Profit
=$0 (37,500- 37,500)


Income: M Branch
= $0 (10,000-10,000)


Home Office (a reciprocal account of
Investment)
= $67,000 (cr.) (57,000+10,000)
105
Reconciliation of Reciprocal Ledger Accounts

At the end of an accounting period, the
balance of the Investment in Branch ledger
account in the records of the home office
may be different from that of the Home
Office ledger account of the branch.

This is because some transactions may
have been recorded by the home office but
not the branch office.
106
(contd.)
 Example: Assume that the home office
and branch accounting records of
Mercer Company contain the following
data on 12/31/15:
107
(contd.)
Investment in Arvin Branch
(in accounting records of Home office)
2015
Nov. 30 Balance 62,500 dr
Dec. 10 Cash received from
branch 20,000 42,500 dr
27 Collection of branch
trade accounts 1,000 41,500 dr
receivable
29 Merchandise
shipped to branch 8,000 49,500 dr
108
(contd.)
Home Office
(in accounting records of Arvin Branch)
2015
Nov. 30 Balance 62,500 cr
Dec. 7 Cash sent to home
office 20,000 42,500 cr
28 Acquired equipment 3,000 39,500 cr
30 Collection of home
office trade accounts 2,000 41,500 cr
receivable
109
Mercer Co.-HO & Arvin Branch
December 31, 20X1
Home Investment in
Office Branch
(Branch (HO Books)
Books)
Balances Before Adjustments Br.41,500 Br.49,500
Add: Shipments in Transit 8,000
Collection of HO A/R @ Branch 2,000
Less: Collection of Branch A/R @ HO
(1,000)
Purchase of Equipment to be (3,000)
accounted @HO
Adjusted Balances 48,500 Br.48,500

(contd.)
 The following adjusting entries are
recorded prior to the preparation of the
working paper for the combined
financial statements (assuming a
perpetual inventory system)

111
(contd.)

For Arvin Branch:

1.Home Office 1,000
Trade Accounts
Receivable 1,000

2.Inventory 8,000
Home Office 8,000
112
(contd.)

For Mercer Home Office:

1.Equipment: Arvin Brach 3,000
Investment in Branch: Arvin
3,000

2.Investment in Branch: Arvin 2,000
Trade Accounts Receivable 2,000
113
(contd.)
 The balance of Investment in Branch: Arvin
ledger account at the home office equals:
$ 49,500 (dr.)
- 3,000 (cr.)
+ 2,000 (dr.)
$ 48,500 (dr.)
114
(contd.)

After posting the above adjusting
entries:

The balance of Home Office ledger account
at Arvin Branch equals:
$ 41,500 (cr.)
- 1,000 (dr.)
+ 8,000 (cr.)
$ 48,500 (cr.)
115
Transactions between Branches

When it is necessary to transfer
merchandise or assets from one branch
to another branch, Home Office Ledger
account is used by the branches.

The home office will transfer the
inventory (or assets) from investment in
one branch to another branch.

Any excess freight costs incurred for
the transfer between branches should
be expensed.
116
Transactions between Branches (contd.)

Example:
The home office shipped merchandise
costing $8,000 to K Branch and paid freight
costs of $500.
A week later, the home office instructed K
Branch to transfer this merchandise to D
Branch. K paid $400 for the transfer.
If the merchandise had been shipped directly
from the home office to D, the freight costs
would have been $600.
117

Journal entries for these transactions are:

In Accounting Records of Home Office:
Investment in K Branch 8,500
Inventory 8,000
Cash 500
Investment in D Branch 8,600

Excess Freight Expense 300
Investment in K Branch 8,900
118
Interbranch Transactions (contd.)
. Freight cost=$500
Home K
Office Branch
Dandii Branch
Freight Cost Freight cost

$600 $400
D
Branch


In Accounting Records of K Branch:
Freight In (or Inventory) 500
Inventories 8,000 Home
Office 8,500
Home Office 8,900

Inventories 8,000 Freight-in
500 Cash 400
120
 In Accounting Records of D Branch:

Inventories 8,000 Freight-in (or
Inventories) 600 Home Office
8,600
121
Freight Costs on Merchandise Shipments to Branch
• The cost of transporting merchandise to its final sale

location can be an important element of the cost of
merchandise inventoried and sold. Accordingly, freight
costs on merchandise shipped between home office
and branch locations should be included in branch
inventory and cost of goods sold measurements.
122
Freight Costs on Merchandise Shipments to Branch
• Merchandise cost should not include excessive

freight charges from the transfer of merchandise
between a home office and its branches or
between branch locations.
• If the branch returns half the merchandise
received from the home office because it is
defective, or because of a shortage of inventory
at the home office location, the home office cost
of the merchandise should not include the freight
charges to or from the branch.
123
Freight Costs on Merchandise Shipments & Inter
Branch Transactions
Example 1: Freight Costs on Merchandise Shipments from

HO to Branch
Assume that merchandise is shipped from a home office to
its branch at 125% of the Br. 10,000 home office cost and
that the home office pays Br. 500 freight costs.
Journal Entries on Books of Home Office
Investment in Branch ………………………………….13,000
Shipments to Branch…………………………………….. 10,000
Allowance for Over. of Inventories: Branch……… 2,500
Cash …………………………………………………………………..500
124
Branch Transactions
Journal Entries on Books of Branch

Shipments from Home Office 12,500
Freight-In on Home Office Shipments 500
Home Office 13,000
 If half the merchandise remains unsold at year-end, cost
of branch sales is reported at Br. 6,500, and the branch
inventory is priced at its Br. 6,250 home office cost, plus
Br. 250 freight-in. Branch inventory and cost of goods sold
are reported in the same amount if the branch pays the
transportation costs, but the freight transaction is not
recorded on the home office books.
125
Branch Transactions
Example 2: Freight Costs on Merchandise Shipments from

Branch to HO
Assuming that the branch pays Br.250 to return half of the
merchandise to the home office, the branch and home
office entries are:
 Journal Entries on Books of Home Office
Shipments to Branch 5000
Allowance for Over. Inventories: Branch 1250
Loss on excessive freight charges 500
Investment in Branch 6750
126
Branch Transactions
Journal Entries on Books of Branch

Home Office 6750
Shipments from Home Office 6250
Freight-In on Home Office Shipments 250
Cash 250
Total freight charges on the merchandise are charged to a
home office "loss on excessive freight charges" account
because the freight charges represent management
mistakes or inefficiencies. Therefore, they are not
considered normal operating or freight expenses.
127

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Chapter 2

Accounting for Branches and

 Branches and divisions are separate

 Based on Statement of “Reporting on

2. The branch maintains a complete

 Investment in Branch Ledger Account:

This account is a reciprocal ledger account

 If a plant asset is acquired by the

Plant asset (various)-branch…..xxx

Plant asset (various)-branch……xxx

Accounting for Branches 19

 Such interest revenue recognized by

 Weakness: attributes all gross profits

 Weakness: no gross profit assigned to

Home Office Accounting M Branch Accounting

branch at home office cost 60,000 61,000 dr

branch, carried in home

to branch 3,000 26,000 dr

office 1,000 1,000 cr

home office 60,000 61,000 cr

by home office 3,000 26,000 cr

Retained earnings, beginning of year $ 70,000

Home Office Accounting M Branch Accounting Records

Home Office Accounting M Branch Accounting Records

Adjusted Trial Balances

To close revenue and

Home Office 10,500

To close the net loss in the

Income: M Branch 10,500

Retained earnings, beginning of year $ 70,000

at markup of 50% above

branch 4,500 57,000 dr

billed by Home office 4,500 57,000 cr

Sales (500,000) (150,000) (650,000)

Shipments from home -0-

Cash 30,000 9,000 39,000

Equipment 158,000 158,000

(1)Inventory (ending) 30,000

(3) Income Summary 10,000

(1) Investment in Branch 10,000

(2) Allowance for Overvaluation

(3) Realized Gross Profit 37,500

 Balances of Investment in M Branch,

Accounting for Branches 110

Investment in D Branch 8,600

Freight Cost Freight cost

Accounting for Branches 119

Home Office 8,900

 In Accounting Records of D Branch:

• The cost of transporting merchandise to its final sale

• Merchandise cost should not include excessive

Example 1: Freight Costs on Merchandise Shipments from

Journal Entries on Books of Branch

Example 2: Freight Costs on Merchandise Shipments from

Journal Entries on Books of Branch

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