ACCOUNTING FOR BUSINESS COMBINATION

Our textbook:

INTRODUCTION

This course provides learners a comprehensive understanding of and application of the

accounting principles relating to mergers and acquisition, preparation of consolidated
financial statements, including translation of foreign operations, joint arrangements and
investment in associates, Not-for-Profit Institutions and Government Accounting.
Learners are expected to prepare journal entries to record acquisition, prepare
consolidated financial statements, and present the effects of business combination, joint
arrangement transactions and transactions between the investor and an associate in
both the separate and consolidated financial statements of the acquirer/investor.
Learners shall apply the applicable reporting requirements for the translation of foreign
operations in the consolidated financial statements of the reporting entity.

At the end of the semester, the students can:

1. have a complete understanding of the accounting theories, concepts, principles,
assumptions, policies, bases and conventions in Specialized Accounting; and
2. have the ability to integrate these fundamental valuation accounting theories,
concepts, principles, assumptions, policies, bases and conventions in any work
environment, corporate or not, so that they can immediately apply them and
become competent accountants or whatever role they may assume.

Chapter 12: (1st chapter in Advanced Financial Accounting, Vol. 2) by: Antonio J.
Dayag, 2016 Edition

Home Office and Branch Accounting: General Procedures

The establishment of an outlying selling unit may take the form of an agency or a
branch. The distinction between an agency and a branch is based upon the functions
assigned to the organization as well as the degree of independence that it assumes in
the exercise of such functions.

An agency is an organization in which:

1. It is established to display merchandise. Samples of the merchandise
offerings as well as advertising materials are provided by the home office.
 2. It does not stock merchandise to fill customer’s orders or pass on
customer’s credit.
3. Merchandise orders obtained are set to the home office for approval. If the sales
price and the credit terms are acceptable, the home office fills the orders and
ships the goods to customers.
4. It is normally provided with a working fund that is to be used for the payment
of expenses that can be more conveniently settled through the agency. The
imprest system is often adopted for the control of agency cash.
5. It has no separate accounting or business entity. The home office may bear
the responsibility for maintaining the accounts that arise out of sales, billing the
customers, and making collections. Expenses of operating the agency other than
those paid by the agency from its working fund are met by the home office.
6. Its transactions are recorded in the books of the home office either at:
a. Separate records from the home office transaction, or
b. No separate records from the home office transaction.

In contrast, a branch is an organization that:

1. Sells goods out of stock that it maintains;
2. Possesses the authority to engage in transactions as an independent
business;
3. Make sales to customers , passes on customer credit, collect receivables,
incurs expenses and performs other functions normally associated with the
operations of a separate business enterprise; and
4. Has a separate branch accounting systems similar to the systems of independent
businesses except in the manner of accounting for ownership equities and in
recording transactions between branches and the main office of the business.

ACCOUNTING FOR AN AGENCY

The typical agency does not require a complete set of books. Ordinarily, summaries of
working fund receipts and disbursements and records of sales to customers are
sufficient, which when accompanied by supporting evidence in the form of paid
vouchers are sent to the home office. When the local manager or salespeople are to be
paid according to the volume of sales completed, sale records supply this information.

Illustration 12-1 Agency Accounting

Assume that Anton Trading established a sales agency, the Junior Agency. The results
of operations are recorded separately from those of the other sales agencies. The
accounting entries prepared by the home office as a result of the establishment of
Junior Agency and their related transactions for the year 20x4, assuming the use of
periodic inventory method:

ENTRIES- AGENCY TRANSACTIONS

 20
TRANSACTIONS x4
 
1. Establishment of petty cash fund, P10,000
Working fund - Junior Agency 10,000
Cash
 
2. Shipped merchandise to agency for use as samples, P4,000
Samples Inventory - Junior Agency 4,000
Shipments to Junior Agency
 
3. Purchase of agency equipment, P20,000
Equipment - Junior Agency 20,000
Cash
 
4. Payment of salaries to employees of agency, P5,000
Salaries expense 5,000
Cash
 
5. Sales orders from agency are filled and customers are billed,
P100,000 and goods are delivered by the home office .
Accounts Receivable 100,000
Sales - Junior Agency
 
6. The following expenses were incurred out of working fund:
utilities, P2,000; advertising expense, P3,000 and other
expenses, P4,000.
NO ENTRY REQUIRED UNDER IMPREST FUND SYSTEM
 
7. End of the year adjustments:
a. Cost of goods sold identified with Junior Agency, P60,000
Cost of goods sold - Junior Agency 60,000
Shipments to Junior Agency
 
b. Depreciation expense for agency equipment, 2,000
Depreciation expense for agency equipment 2,000
Accum. Depreciation expense - equipment-Junior
Agency
 
c. Replenishment of agency's working fund
Utilities expense - Junior Agency 2,000
 Advertising expense - Junior agency 3,000
Other expenses - Junior agency 4,000
Cash
 
d. Agency samples inventory amounted to P1,000 net
realizable
value
Advertising expense - Junior agency 3,000
Samples inventory - Junior agency
 
8. Closing entries:
a. to close sales revenue account:
Sales 100,000
Income summary - Junior agency
 
b. to close cost of goods sold:
Income summary - Junior agency 60,000
Cost of goods sold
 
c. To close expense account:
Income summary - Junior agency 19,000
Salaries expense
Depreciation expense
Utilities expense
Advertising expense
Other expenses
 
d. to close the agency income summary to general income
summary
Income summary - Junior agency 21,000
Income summary
 
   
ACCOUNTING FOR BRANCHES:

Procedures:
1. A branch’s cash and merchandise and such other assets as may be needed and
supplied by the home office.
2. The branch may purchase merchandise from outsiders to satisfy certain local
needs for goods not available from the affiliated unit.
3. The branch ships merchandise, bills its customers, makes collections on
account, and deposits the sums in its bank account. The bank balance is drawn
upon making payment for purchases of goods and services.

A system is sometimes adopted whereby both the branch and the home office maintain
detailed records of branch transactions. At the end of the period the home office adjusts
and closes the branch accounts and determines the branch net income.

Records Maintained at the Branch:

Generally, the branch accounting system is maintained at the branch. The branch keeps
the books of original entry and posts to ledger records. Financial statements are
prepared by the branch periodically and are submitted to the home office. Statements
that are submitted by the branch are usually verified by the company’s internal auditors.

Reciprocal Accounts

When complete self-balancing books are kept by the branch, an account, Home Office
current takes the place of the customary capital accounts. The Home Office is a quasi-
ownership account equity that shows the net investment by the home office in the
branch.

This home office current account is credited:

1. Cash, goods, or services received from the home office, and
2. For profits resulting from branch operations.

On the other hand, the account is debited:

1. For remittances made by the branch to the home office, and
2. For losses from operations.
When the branch closes its books at the end of every accounting period, the Branch
Income summary account is closed to Income Summary Account which will eventually
be disposed to the Home Office current account. The home office in turn, keeps a
reciprocal account, called Branch current or Investment in Branch.

This noncurrent asset (Branch current or Investment in Branch) account is

debited:

1. For cash, goods, or services transferred to the branch and

2. For branch income.

Conversely, the account is credited:

1. For remittances from the branch or other assets received from the branch and
2. For branch losses.

Property, Plant and Equipment used by the Branch:

Depreciable branch assets are normally carried on the home office books. This
procedure may be followed when depreciation rates are to be uniformly applied to
certain groups of assets, whether used by the branch or the home office, and when
insurance policies are to be acquired by the Home Office for all assets.
Expenses incurred by the Home Office but charged to Branch:

Certain expenses relating to the branch operations are sometimes paid by the home
office. Branches are notified by the home office at expenses incurred in their behalf and
such charges are recorded on the branch books so that branch income statements may
provide complete summaries of the operations of the separate sales organizations.

The following guidelines should strictly be followed:

1. Certain items can be directly identified with individual branches and are
immediately charged to the branches. Such items include taxes and insurance
paid by the home office on branch assets.
2. Other charges resulting in benefits that are not directly identified with certain
branches, such as advertising for the different lines being sold, may be
summarized on the home office books and charged periodically to the branches
using equitable basis.
3. When a home office does not sell to customers but acts solely in a supervisory
capacity, it may be desirable to charge all of its expenses to branches. Expenses
that are not directly identified with branches may be combined and distributed in
total as direct charge. When charges reported on home office books are taken up
on the branch books, home office accounts should be reduced by the amounts
transferred.
4. The home office may charge the individual branches for interest and rent on the
working capital and the properties and equipment transferred to the branches.
 When such charges are made, the branch recognizes these charges as expense
items, while the home office reports corresponding revenue.

Billing Methods for Merchandise shipped to Branch:

Three alternative methods are available to the home office for billing merchandise
shipped to its branches. The shipments may be:

1. At home office cost (at original cost)

2. At billed price or a percentage above home office cost (original cost plus mark up
based on cost), or
3. At the branch’s retail selling price (mark up based on billed price).

Billing at home office cost is the simplest procedure and is widely used. It avoids the
complication of unrealized gross profit in inventories and permits the financial
statements of branches to give a meaningful picture of operation.

Illustration 12-3: Accounting for the operations of a Branch

book Branch
  Home Office s       Books    
40,00
1. Branch current 0 1. Cash 4
40,00
Cash 0 Home office – current
   
20,00
2. Equipment - branch 0 2. Home office –current 2
20,00
Branch current 0 Cash
   
32,00
3. Branch current 0 3. Shipment from Home Office 3
32,00
Shipment to branch cost 0 Home office - current
   
4. N.E. 4. Purchases
  Cash
   
  5. Cash 6
  Sales
   
6. Shipment to banch cost 2,000 6. Home office -current
 Branch current 2,000 Shipment from Home Office
   
7. N.E. Salaries 1
  Utilities
  Rent expense
  Miscellaneous
  Cash
   
30,00
8. Cash 0 . Home office -current 3
30,00
Branch current 0 Cash
   
Adjusting Entries Adjusting Entries
   
a. N. E. Salaries Expense
  Salaries Payable
   
b. Branch Current 4,000 Depreciation Expense
Accum. Depn.- Equipt Br 4,000 . Home office -current
(20,000/5 yrs.)  
                   

Home Office Books

        Branch Books        
40,00
Cash sent to Branch 0 Equipment acquired by branch
32,00
Shipment to branch 0 Shipment returns
Depreciation charged to Br 4,000 Remittance
Balance forwarded
                   
76,00
TOTAL 0 TOTAL
Balanc 24,00
e 0  

Branch Books:
        Home Office Current      
20,00
Equipment acquired by branch 0 Cash sent to branch
shipment returns 2,000 shipment from Home Office
Remittance 30,00 Depreciation charged by Home Office
 0
24,00
Balance forwarded 0  
                   
76,00
TOTAL 0 TOTAL
Balance
 
 
 
CLOSING ENTRIES - HOME OFFICE AND BRANCH
                   
c. 95,00
Sales 0 Sales
30,00
Shipments to branch 0 Merchandise Inventory, Dec. 31
25,00
Merchandise Inventory, Dec. 31 0 Purchases
40,00
Merchandise Inv., Jan. 1 0 Shipments from Home Office
90,00
Purchases 0 Salaries expense
*Salaries Expense 3,000 Utilities ex\pense
*Utilities Expense 2,000 Rent expense
*Depreciation Expense 2,500 Depreciation expense
*Miscellaneous Expense 2,500 Miscellaneous expense
10,00
Income Summary 0 Income summary
 
Branch current 4,000 Income summary
Branch Inc. Summary 4,000 Home Office current
 
Branch Inc. Summary 4,000  
Income summary 4,000  
 
14,00
d. Income summary 0  
14,00
Retained earnings 0  
 

Explanations for the transactions identified by number and adjusting and closing entries idlentified by
given in the following paragraphs:
1. Transfer of assets other than merchandise by home office to branch.
 Home Office books. When an asset other than merchandise is transferred and the asset is t
carried on branch books, the home office debits the branch account and credits the appropriate as
When the asset transferred is to be carried on the home office books, an asset account identified w
branch such as Equipment-Branch, is debited and the original asset account is credited.

Branch books. Upon receiving as asset other than merchandise that is to be carried on the
books, the branch debits the asset account and credits the home office account. No entry is requir
asset transferred is to be carried on the home office books. However, the branch would maintain a
record for this asset.

2. Purchase of assets by Branch to be carried on home office books.

Home Office books. When the home office is notified of a branch's purchase of an asset tha
carried on the books of the home office, the home office debits an appropriate asset account ident
branch and credits the branch account.

Branch books. Upon purchase of an asset that is to be carried on the home office books, th
debits the home office account and credits Cash or an appropriate liability account.

3. Transfer of merchandise by home office to branch.

Home Office books. When merchandise is transferred to the branch, the home office debits
account and credits Shipment to Branch. At the end of the period, the balance of the account Ship
Branch will be subtracted from the sum of the beginning inventory, purchases, and freight in to de
merchandise available for home office sales. When the home office maintains a perpetual inventor
appropriate inventory accounts are credited for the goods transferred to the branch.

Branch Books. When merchandise is received from the home office, the branch debits Shipment fr
Office, at cost (at billed price-Chapter 12) and credits the home office account. At the end of the pe
dise received from home office together with merchandise purchases from outsiders is added to th
inventory to determine the goods available for branch sale. If the branch maintains a perpetual inve
inventory accounts are debited for the goods acquired from the home office.

4. and 5. Transactions of branch with outsiders.

Home Office books. No entries are required oin the books for transactions involving branch
outsiders or third parties.
Branch books. Transactions with outsiders are recorded in the usual manner.

6. Returns of merchandise by branch to home office.

Home Office books. When merchandise is returned by the branchs to the home office, the h
office debits the Shipment to Branch account and credits Branch current account.

Branch books. When merchandise is returned to the home office, the branch debits the hom
current account and credits the Shipments from Home Office , at cost (at billed price - Chapter 12)
7. Transactions of branch with outsiders.
Home Office books. Upon receiving cash from the branch, the home office debits Cash and
the branch account. Receipt of an asset other than cash is recorded by a debit to an appropriate a
and a credit to the branch account.

Branch books. Upon remitting cash to the home office, the branch debits the home office a
and credit cash. Transfer of some other branch asset to the home office is recorded by a debit to h
and a credit to the appropriate asset account.

a. Adjustments of branch affecting outsiders.

Home office books. No entries are required on the books for adjustments involving bran
outsiders or third parties.

Branch books. Adjustments with outsiders are recorded in the usual manner.

b. Branch charges submitted by home office.

Home office books. When the home office charges the branch for items that are to be re
by the branch as expenses., the home office debits the branch account and credits appropriat
asset valuation, liability, expense, or revenue accounts , whichever may be appropriate: thus, i
a debit for depreciation on branch equipment carried on the home office books is accompanied
credit accumulated depreciation-equipment, branch.

Branch books. Upon notification of expenses that are to be recognized on the branch bo
the branch debits the appropriate expense accounts and credits the home office account.

c. Determination of home office net income or loss and of branch net income or loss.

Home office Net Income or Loss -

Home Office books. At the end of the period the necessary adjustments are made, and t
revenue and expense accounts are closed into the Income summary account in the usual man

Branch Net Income or Loss -

Home office books. When the branch reports net income for the period, the home office
the branch account and credits Branch Income summary. A net loss is recorded by a debit to B
Income Summary and a credit the branch account. The income account for each branch is sub
closed into the income summary account of the home office.

Branch books. At the end of the period the necessary adjustments are made, and the
revenue and expense accounts are closed into the income summary account in the usual man
The balance in the income summary account is then transferred to the home office account.
 d. Transfer of Income summary to Retained Earnings account.
Home office books. The balance in the income summary account is then transferred to t
retained earnings account.

Preparation of combined statements for Home Office and Branches

Though separate statements offer significant information to home office and branch
officials, such statements must be complied fully stating a company’s financial position
and the results of its operations.

 The financial position of the business unit in its entirety is fully presented only
when individual asset and liability items of the various branches are substituted
for the branch investment balances and combined with the home office items.
 Operating results for the business as a whole are fully presented only when
individual revenue and expense items of the various branches are substituted for
the branch net income or loss and combined with the home office data.
Stockholders, creditors and taxing authorities require combined statements. These
parties normally have little or no interest in the separate status and operating results of
individual departments or branches of a business. In combining branch data with home
office data, the elimination of certain reciprocal interoffice items is necessary:

1. In preparing a combined balance sheet, the home office account and the branch
account are eliminated, since these accounts are without significance when the
related units are recognized as a single entity.
2. In preparing a combined income statement, their accounts, Shipments from
Home Office and Shipments to Branch are eliminated, since these balances
summarize interoffice transfers that are not significant when the related units are
reported as a single entity.
3. Other interoffice revenue and expense items are also eliminated so that the
combined statement may report only the results of transactions with outsiders.

The adjusted trial balances of the two companies, the eliminating entries, and the
combined totals for the income statement and balance sheet on December 31, 20x4 are
shown in Figure 12-1. (pp 16-17).

Reconciliation of Reciprocal Accounts:

Theoretically, the balance of the reciprocal accounts, i.e., the Branch Current account
(Investment in Branch) and the Home Office Current Account should always be equal.
On the other hand, it may not show identical reciprocal balances on one occasion
because of certain interoffice data that have been recorded by one office but not by the
other. The home office, for example, debits the branch immediately upon the shipment
of merchandise to the branch. The branch, however, does not credit the home office
account until it receives the merchandise, which may be several days after shipment by
the home office. The fact that the reciprocal account balances are not identical is of no
concern during the fiscal period.

The situation is comparable to that of reconciling the ledger account for Cash in Bank
with the balance in the monthly bank statement. The lack of agreement between the
reciprocal ledger account balances causes no difficulty during an accounting period, but
at the end of each period the reciprocal account balances must be brought into
agreement before combined financial statements are prepared.

The data to be considered in reconciling the two accounts may be classified as follows:

1. Debits in the branch account without corresponding credits in the home office
account.
2. Credits in the branch account without corresponding debits in the home office
account.
3. Debits in the home office account without corresponding credits in the branch
account.
4. Credits in the home office account without corresponding debits in the branch
account.

Chapter 13: Home Office and Branch Accounting: Special Procedures

In addition to the general branch-home office relationship portrayed in the preceding

chapter, there are other interactions that generate special accounting problems. These
interactions are:

1. Merchandise shipments to the branch at amount other than cost such as:
a. Billing at a price in excess of cost, at billed price (original or home office cost
plus mark-up based on cost), and
b. At the branch’s retail selling price (mark-up based on billed price).
2. Interbranch transfer of cash.
3. Interbranch transfers of merchandise, and

Shipments from home at billed price (shipments to branch at cost plus a percentage
mark up based on home office cost, such as 115% of cost), may be intended to allocate
reasonable gross profit to the home office.

When merchandise is billed to a branch at a price above home office cost, the net
income reported by the branch is understated and the ending inventories are overstated
for the enterprise as whole. Adjustments must be made by the home office to eliminate
the excess of billed prices over cost (intracompany profits) in the preparation of
combined financial statements for the home office and branch.

Billing shipments to a branch at retail selling prices may be based on a desire to

strengthen internal control over inventories. The inventories ledger account of the
branch shows the merchandise received and sold at retail price.

Billing at a price in excess of cost, at billed price (original cost plus markup based on
cost)

 Billing by the home office may be made at some arbitrary rate above cost in
order to withhold from branch officials complete information concerning the actual
earnings from branch operations.
 Upon acquiring merchandise from the home office, the branch records the
charges that are listed on the invoices accompanying the goods.
 When billings to the branch exceed cost, the profit determined by the branch will
be less than actual profit: the inventories reported by the branch at the billed
figures will exceed cost. These factors must be recognized by the home office
and given effect upon its accounting records in summarizing branch operations.

Illustration 13-1: Accounting for billing at a price in excess of cost at billed price
(original cost plus markup on cost):

Assume the same transactions on Illustration 12-3, except that the home office bills
merchandise shipments to the branch at 25% above cost. The entries to record the
transactions for the home office and the branch will be the same with those presented in
Illustration 12-3 except for the entries (Nos. 3 and 6) showing shipments of merchandise
from the home office to the branch amounting to P40,000 (P32,000, cost + 25%
markup) and shipments returns to home office amounting to P2,500 (P2,000 + 25%
markup on cost) are recorded as follows: