E: BRANCH ACCOUNTING

Contents
1.0 Aims and Objectives
1.1 Introduction
1.2 Overview of Branch Accounting
1.3 Objectives of Branch Accounts
1.4 Accounting Systems
1.4.1 Centralized Accounting
1.4.2 Decentralized Accounting
1.5 Branch General Ledger Accounting
1.5.1 Intra Company Accounts
1.5.2 Home Office Allocations
1.5.3 Inventory Transfer Accounts
1.5.4 Fixed Asset Accounts
1.5.5 Other General Ledger Accounts
1.6 Branch Accounting Illustrated
1.7 Combined Financial Statements: Inventory Transfer at Home Office Cost
1.7.1 Producing Financial Statements for the Branch
1.7.2 Producing Financial Statements for the Entire Company
1.8 Combined Financial Statements: Inventory Transfer Above Home Office Cost
1.9 Summary
1.10 Glossary
1.11 Answer for Check Your Progress Exercises
1.12 Model Exam Questions

1.0 AIMS AND OBJECTIVES

When you have studied this unit you should be able to:
 prepare the parallel journal entries to be recorded on the books of a home office and its
branch office.

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  record the required entries on the books of a home office and its branch office when
shipment are made to the branch under the following conditions:
a) the shipments are made at the home offices cost.
b) the shipments are made at a price that exceeds the home offices cost
 adjust the unrealized profit in branch inventory account at the end of a firm’s
accounting period.
 prepare the combined financial statements for a home office and its branch office.

1.1 INTRODUCTION

Accounting for the operation of a business can become complicated whenever geographical
separation is encountered between the various facets of the organization. This unit examines
the special procedures necessary to record transactions occurring at significant distances from
a central office. Branch accounting is analyzed with illustrative examples.

1.2 OVERVIEW OF BRANCH ACCOUNTING

The extensive use of branch operations is especially common in modern retailing where
companies attempt to attract customers by offering the convenience of numerous outlets.
Relative small companies often attempt to expand their market base by establishing additional
outlets in nearby communities. This type of internal division is not even restricted to the retail
function. Branch operations are commonly found in banking as well as in manufacturing and
other industries.

1.3 OBJECTIVES OF BRANCH ACCOUNTS

A business firm establishes branches for marketing the products or services. The parent firm
(head office) is always interested to know the trading results of its branches. For this purpose,
branch accounts are kept. The main purposes of branch accounts are as follows:
(i) Branch accounts helps to know the profit or loss of each branch.
(ii) It enables the head office to know the financial position of each branch.
(iii) It shows the requirements of goods or cash for each branch.

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 (iv) Branch account is the basis and helps the head office to control the activities of
branch.
(v) Suggestions and improvements are based on the branch accounts.

1.4 ACCOUNTING SYSTEMS

The home office must decide how to account for the activities and transactions of the
branches. Accounting systems can be categorized as either centralized or decentralized.

1.4.1 Centralized Accounting

Under a centralized accounting system, a branch does not maintain a separate general ledger
in which to record the transaction. Instead, it sends source documents on sales, purchases,
and payroll to the home office. Branches usually deposit cash receipts in local bank accounts,
which the home office draws upon. When the home office receives source documents, it
reconciles sales information with bank deposits, reviews and processes invoices for payment,
and prepares payroll checks and related payroll related records.

Centralized accounting systems are usually practical when the operations of the branches do
not involve complex manufacturing operations or extensive retailing or service activities.

1.4.2 Decentralized Accounting

Under a decentralized accounting system, a branch maintains a separate general ledger in
which to record its transactions. Thus, the branch is a separate accounting entity, even though
it is not a separate legal entity. It prepares its own journal entries and financial statements,
submitting the latter to the head office, usually on a monthly basis.

Decentralized accounting systems are common for branches that have complex manufacturing
operations or extensive retailing operations involving significant credit sales.

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1.5 BRANCH GENERAL LEDGER ACCOUNTING

1.5.1 Intra Company Accounts

A branch is established when a home office transfers cash, inventory, or other assets to an
outlying location. Because the home office views the assets transferred to the branch as an
investment, it makes the following entry:

Investment in branch - - - - - - - - - - - - - - - xx
Asset (s) - - - - - - - - - - - - - - - - - - - - xx

On receipt of the assets from the home office, the branch makes the following entry:
Asset(s) - - - - - - - - - - - - - - - - - - - - - - xx
Home office equity - - - - - - - - - - - - - - xx

The balance in the Investment in Branch account on the books of the home office always
equals the balance in the Home Office Equity account on the books of the branch. In practice,
these accounts are referred to as the Intra Company or reciprocal accounts.
accounts. At the end of
each accounting period, the branch closes its income or loss to its home office equity account.
Upon the receipt of the branch’s financial statements, the home office adjusts its Investment
in Branch account to reflect the branch’s income or loss and makes the offsetting credit or
debit to an income statement account called branch income or branch loss.
loss. As a result of
this entry and upon closing the branch income or branch loss account to retained earnings, the
branch’s income or loss is included in the home office’s retained earnings account.

1.5.2 Home Office Allocations

The home office usually arranges and pays for certain expenses that benefit the branches. The
most common example is insurance. In theory, some portion of the insurance expense should
be allocated to the various branches, so that the home office may determine the true operating
income or loss of each branch. In practice, however, allocation of home office expenses
varies widely. Numerous home offices allocate only those expenses that relate directly to the
branch operations, such as insurance. Some home offices without any revenue producing
operations of their own allocate all of their expenses to the branches.

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 Check Your Progress Exercise 1
1. What is a branch?
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2. What are the basic purposes of branch accounting?
…………………………………………………………………………………………………
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…………………………………………………………………………………………………

1.5.3 Inventory Transfer Accounts

When inventory is transferred from the home office to a branch, all that has really happened is
that the inventory has physically moved from one location in the company to another. A sale
has not occurred, because sales takes place only between the company and outside customers.
To measure the profitability of a branch, however, an intra company billing must be prepared.
The branch uses special purchase account called Shipment From Home office to record these
inventory transfers and makes the following entry:

Shipments from home office - - - - - - xx

Home office equity - - - - - - - xx

The home office uses a special contra purchases account called Shipments to Branch to record
inventory transfers. If the inventory is transferred and billed at the home office’s cost, the
home office makes the following entry:

Investment in branch - - - - - - - - - - - - - xx
Shipments to branch - - - - - - - - - - - - - - xx

The branch’s ending inventory, cost of goods sold, gross margin, and operating profit or loss
depend on the amounts of these intra company billings.

1.5.4 Fixed Asset Accounts

Some home offices require their branches-fixed assets to be recorded on the books of the
home office instead of the books of the branches. Such a procedure automatically ensures

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that uniform depreciation methods and asset lives are used for all branches. The home office
usually charges the branch for the depreciation expense of its fixed assets. It does this by
crediting accumulated depreciation and debiting the Investment in branch account instead of
debiting depreciation expense. The branch debits depreciation expense and credits the Home
office Equity account instead of crediting accumulated depreciation. When fixed assets are
recorded on the home offices books, the fixed assets pertaining to the branch must be added to
the Investment in Branch account to evaluate the profitability of branch operations in relation
to the total assets actually invested in the branch.

1.5.5 Other general ledger Accounts

The branch maintains the balance sheet and income statement accounts necessary to record
transactions that take place between (1) the home office and the branch, and (2) the branch
and its customers, creditors, and employees.

1.6 BRANCH ACCOUNTING ILLUSTRATED

Assume that TANA Company, which prepares financial reports at the end of the calendar
year, established a branch in Motta on July 1, 1998. The following transactions occurred
during the formation of the branch and its first six months of operations, ending December 31,
1998.
1. The home office sent $ 28,000 cash to the branch to begin operations.
2. The home office shipped inventory to the branch. Intra company billings totaled
$60,000, which is the home office cost. (Both the home office and the branch use a
periodic inventory system.)
3. The branch acquired merchandise display equipment, which cost $ 12,000 on July 1,
1998. (Assume that branch fixed assets are not carried on the home office books.).
4. The branch purchased inventory costing $ 43,000 from outside vendors on account.
5. The branch had credit sales of $ 85,000 and cash sales of $ 35,000.
6. The branch collected $ 44,000 on accounts receivable.
7. The branch paid outside vendors $ 28,000.

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 8. The branch incurred selling expenses of $ 15,000 and general and administrative
expenses of $ 12,000. These expenses were paid in cash when they were incurred
and include the expense of leasing the branch’s facilities.
9. The home office charged the branch $ 2,000 for its share of insurance.
10. Depreciation expense on the merchandise display equipment acquired by the branch
is $ 1,000 for the six month period. (Depreciation expense is classified as a selling
expense.).
11. The branch remitted $ 10,000 cash to the home office.
12. The branch’s physical inventory on December 31, 1998, is $ 33,000, of which $
25,000 was acquired from the home (there was no beginning inventory). The home
office’s physical inventory on December 31, 1998, is $ 150,000 (the beginning
inventory was $ 135,000). (Home office purchases were $ 285,000.). Cost of goods
sold is determined and recorded in a separate account for each accounting entity.
(Note that the year-end inventory accounts are adjusted in this entry to the year-end
physical inventory balances).
13. The branch closes its income statement accounts.
14. The home office prepares its adjusting entry to reflect the increase in the branch’s net
assets resulting from the branch’s operations. The following journal entries are
recorded by TANA Company’s home office and its Motta branch for the transactions
1 through 14.

Exhibit 1-1
Home office books Branch books
1. Investment in branch $ 28,000 1. Cash $ 28,000
Cash 28,000 Home office equity
28,000

2. Investment in branch - - - 60,000 2. Shipments

Shipments to branch 60,000 From home office 60,000
Home office equity
60,000

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3. No entry 3. Equipment 12,000
Cash
12,000
4. No entry. 4. Purchases 43,000
Accounts payable 43,000

5. No entry. 5. Cash
35,000
Accounts receivable 85,000
Sales 120,000

6. No entry. 6. Cash
44,000
Account receivable
44,000

7. No entry. 7. Accounts payable 28,000

Cash
28,000

8. No entry. 8. selling expenses 15,000

Administrative expense 12,000
Cash
27,000

9. Investment in Branch 2,000

Administrative expenses 2,000 9. Administrative expenses 2,000
Home office equity 2,000

10. No entry. 10. Selling expenses

1,000
Accumulated depreciation 1,000

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 11. Cash 10,000 11. Home office Equity 10,000
Investment in Branch 10,000 Cash
10,000

12. Inventory 15,000 12. Inventory acquired

From vendors 8,000
Shipments to Branch 60,000 Inventory acquired
From home office
25,000

Cost of goods sold 210,000 Costs of goods sold 70,000

Purchases 285,000 Shipments from home office
60,000
Purchases
43,000

13. No entry. 13. Sales

120,000
Cost of goods sold 70,000
Selling expenses
16,000
Administrative expenses 14,000
Home office equity 20,000

14. Investment in Branch 20,000 14. No entry.

Branch income 20,000

Check your progress Exercise 2

What are the two types of accounting systems in branch accounting?

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…………………………………………………………………………………………………
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1.7 COMBINED FINANCIAL STATEMENTS: INVENTORY

INVENTOR TRANSFERS AT
HOME OFFICE COST

1.7.1 Producing Financial Statements for the Branch

Before the branch prepares its closing entries and submits financial statements to the home
office, it must verify that its home office equity account and shipments from home office
account agree with the corresponding reciprocal accounts maintained by the home office. If
the accounts do not agree, there are two possible explanations:

1. A transaction by one of the accounting entities has been improperly recorded by the
other accounting entity. The accounting entity that made the error must make the
appropriate adjusting entry.
2. A transaction initiated by one of the accounting entities has been recorded by the
initiating entity but not yet by the receiving entity for example, cash transfers in transit,
inventory shipments in transit, and intra company charges. Normally, the receiving
accounting entity prepares the adjusting entry as though it has completed the transaction
before the end of the accounting period.

Exhibit-1-2
Motta branch of TANA Company
Financial statements
Income statement

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 Year ending December 31, 1998
Sales $ 120,000
Cost of goods sold (70,000)
Selling expenses (16,000)
Administrative expenses (14,000)
Net income of branch 20,000

Home office account

Year ending December 31, 1998
Account balance, January 1, 1998 $-0–
Transfers from home office:
Cash 28,000
Inventory 60,000
Expense allocations:
Administrative 2,000 90,000
Transfers to Home office:
Cash
(10,000)
Net income (above) 20,000
Account balance, December 31, 1998 100,000

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 Balance sheet
December 31, 1998
Cash $ 30,000
Accounts receivable, net 41,000
Inventory:
Acquired from vendors 8,000
Acquired from home office 25,000
Buildings and equipment, net 11,000
Total assets 115,000
Accounts payable and accruals 15,000
Home office equity (above) 100,000
Total liabilities and equity 115,000

Check your progress-3

If intra company accounts do not agree, what are some possible explanations?
…………………………………………………………………………………………………
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1.7.2 Producing Financial Statements for the Entire Company

Once financial statements for the Motta branch have been developed, TANA Company can
create a single combined set of statements for its entire organization. To achieve this
objective, the simulated union of the accounting records for TANA Company’s home office
and the Motta branch is presented in Exhibit 1-3 Generally accepted accounting principles
require that in reporting the results of operations to its shareholders, the home combine the
detail of the branch’s income or loss with the home office’s own accounts making up the net
income or loss from home office’s own operations. This is accomplished by substituting the
branch’s income statement for the branch income or loss account in the home office general
ledger. Likewise, generally accepted accounting principles require that in reporting the
balance sheet amounts to its shareholders, the home office combine the individual assets and
liabilities of both accounting entities and report the combined amounts. This is accomplished
by substituting the individual assets and liabilities of the branch for the Investment in Branch
account.

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 Exhibit 1-3
TANA Company
Work Sheet to Combine Home Office and Motta Branch
Year Ended December 31, 1998
Home Elimination
Income Statement Branch Combined
Office Dr. Cr.
Sales $380,000 $120,000 $500,000
Cost of goods sold (210,000) (70,000) (280,000)
Selling expenses (52,000) (16,000) (68,000)
Administrative expenses (59,000) (14,000) (73,000)
Interest expense (19,000) (19,000)
Branch Income 20,000 20,000 -0-
Income Before Income Taxes 60,000 20,000 20,000 60,000
Income tax (40%) (24,000) 24,000
Net Income 36,000 20,000 20,000 36,000
Statement of retained earnings
Retained earning, Jan. 1, 1998 114,000 114,000
Home office equity (pre dosing) 80,000 80,000 -0-
+ Net income 36,000 20,000 20,000 36,000
- Dividends declared (10,000) (10,000)
Balance, Dec. 31, 1998 140,000 100,000 100,000 140,000
Balance Sheet
Cash 50,000 30,000 80,000
Accounts receivable, unit 60,000 41,000 101,000
Inventory 150,000 33,000 183,000
Land 22,000 22,000
Buildings and Equipment, net 118,000 11,000 129,000
Investment in Branch 100,000 100,000 -0-
Total assets 500,000 115,000 100,000 515,000
Accounts payables and accruals 60,000 15,000 75,000
Long-term debt 200,000 200,000
Common stock 100,000 100,000
Retained earnings 140,000 140,000
Home Office Equity 100,000 100,000 -0-
500,000 115,000 140,000 515,000

1.8 COMBINED FINANCIAL STATEMENTS: INVENTORY TRANSFER ABOVE

HOME OFFICE COST

Inventory transfer can be priced at historical cost; however alternative procedures do exist. A
company can elect to record merchandise shipments at the normal sales price, at its variable
cost, at cost plus a predetermined mark up or at some other established value.

Any time transfers are made at above cost, the home office must defer recognition of the mark
up until the branch sells the inventory to its customers. To do otherwise would result in the

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recognition of profit from transferring inventory from one location to another in the company.
To serve as an example assume that the inventory transferred to the branch from the home
office in Exhibit 1.1 was marked up 20% over the home office’s cost of $60,000. In Exhibit
1.2, we assumed that the branch had a $33,000 ending inventory, of which $8,000 represented
inventory obtained from home the office. In this case the branch’s ending inventory acquired
from the home office is $30,000 ($25,000 + $5,000 mark up). Thus, the branch’s total ending
should be adjusted downward to the amount that it would be if the inventory were transferred
from the home office at cost. Ending inventory is $38,000 (30,000 + 8,000). Exhibit 1.4
shows the journal entries for the transfer of this inventory above cost, along with the
appropriate year end closing and adjusting entries. The journal entries are numbered to
correspond Exhibit 1.1, which shows inventory transfers made at the home office’s cost.

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 Exhibit 1.4
Home Office books Branch Books
2. Investment in Branch $72,000 2. Shipments from Home Office $72,000
Shipment to Branch 60,000 Home Office Equity 72,000
Unrealized Gain 12,000 Inventory Acquired from Vendors 8,000
12. Inventory 15,000 Inventory acquired from home office 30,000
Shipments to Branch 60,000 Cost of goods sold 77,000
Cost of goods sold 210,000 Shipments from home office 72,000
Purchases 285,000 Purchases 43,000
13. No entry 13. Sales 120,000
Cost of good sold 77,000
Selling expenses 16,000
Administrative expenses 14,000
Home office equity 13,000
14. Investment in Brach 13,000 14. No. Entry
Branch income 13,000
Unrealized gain 7,000
Branch Income 7,000

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When inventory transfers are made above home office’s cost, the branch’s cost of goods sold
should be adjusted downward to the amount that it would be if the inventory were transferred
from the home office at cost.

The adjustment of the branch’s cost of goods sold equals the amount of the unrealized gain that
was earned during the year and recognized by the home office. For TANA Company branch the
adjustment will be as follows:
Total unrealized gain at the time of inventory transfer to Branch ...............$12,000
...............$12,000
Unrealized gain related to ending inventory of
Branch on Dec. 31, 1998 (30,000 – 30,000/1.2) ...........................................(5,000)
...........................................(5,000)
Realized gain during the year ..........................................................................7,000
..........................................................................7,000
Likewise, the branch’s ending inventory should be adjusted. In this case the adjustment is
by the unrealized gain attributable to the ending inventory on the balance sheet date. For
TANA Company’s branch the amount equals $5,000.

Check Your Progress Exercise

When inventory is transferred from home office to branch, what account will be debited in the
books of the home office?
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1.9 SUMMARY

Many businesses have operating units in more than one location. These units may be separate
corporations, and a parent-subsidiary relationship exists between the parent company and its
affiliated companies. In other cases the operating units are not incorporated but are part of one
legal entity. In such an arrangement, each unit may be an agency of the main location (the home
office) or it may be a branch office.

A branch office may have its bookkeeping done at the home office based on transmittal forms
summarizing the daily activities of the branch. Alternatively, a branch may keep its own books
and accounts.
Shipments to a branch may be made at the home office’s cost or at an amount above its cost.

1.10 GLOSSARY

Agency: An unincorporated unit that is an office in which orders are taken and then
transmitted to the home office for processing, billing, and shipping merchandise.
Branch: An incorporated operating unit that carries a complete inventory of its own from
which it delivers merchandise to its customers.
Unrealized profit in branch inventory: The dollar amount billed to the branch above the home
office’s cost.

1.11 ANSWERS FOR CHECK YOUR PROGRESS EXERCISES

Check Your Progress Exercise 1

1. An incorporated operating unit that carries a complete inventory of its own from which it
delivers merchandise to its customers.
2. The main purposes of branch accounts are as follows:
- Branch accounts helps to know the profit or loss of each branch.
- It enables the head office to know the financial position of each branch.
- It shows the requirements of goods or cash for each branch.
- Branch account is the basis and helps the head office to control the activities of
branch.
- Suggestions and improvements are based on the branch accounts.

Check Your Progress Exercise 2

Centralized accounting and decentralized accounting.

Check Your Progress Exercise 3

A transaction by one of the accounting entities has been improperly recorded by the other
accounting entity. A transaction initiated by one of the accounting entities has been recorded by
the initiating entity but not yet by the receiving entity for example, cash transfers in transit,
inventory shipments in transit, and intra company charges.
Check Your Progress Exercise 4
Investment in Branch.
Branch.

1.12. MODEL EXAM QUESTIONS

1) The pre-closing general ledger trial balances at December 31, 19x5, for Baltimore
Company and its Atlanta branch are shown below:
Baltimore Company
General Ledger Trial Balances
December 31, 19 x 5
Home Office Branch
Dr. (Cr.) Dr. (Cr.)
Cash $36,000 $8,000
Accounts receivable 35,000 12,000
Inventory Home 70,000
Inventory Branch 15,000
Fixed Assets (net) 90,000
Investment in Branch 20,000
Accounts payable (36,000) (13,500)
Accrued expenses payable (14,000) (2,500)
Home office equity (9,000)
Capital stock (50,0000
Retained Earnings (45,000)
Home office
Sales (440,000)
Purchases 290,000
Expenses 44,000
Branch
Sales (95,000)
Purchases 24,000
Purchases from home office 45,000
Expenses 16,000
Total -0- -0-
Your audit disclosed the following:
1. On December 23, the branch manager purchased $4,000 of furniture and fixtures but failed
to notify the home office. The bookkeeper, knowing that all fixed assets are carried on the
home office books, recorded the proper entry on the branch records. It is the company’s
policy to take any depreciation on assets acquired in the last half of a year.
2. On December 27, a branch customer erroneously paid his account of $2,000 to the home
office. The bookkeeper made the correct entry on the home office books but did not notify
the branch.
3. On December 30, the branch remitted cash of $5,000 which was received by the home office
in January 19x6.
4. On December 31, the branch erroneously recorded the December allocated expenses from
the home as $500 instead of $1,500.
5. On December 31, the home office shipped merchandise billed at $3,000 to the branch, which
was received in January 19x6.
6. The entire beginning inventory of the branch had been purchased from home office. Home
office 19x5 shipments to the branch were purchased by the home office in 19x5. The
physical inventories at December 31,19x5 excluding the shipment in transit, are home office,
$55,000(at cost); and branch ;$20,000 (composed of $18,00 from home office and $2,000
from outside vendors).
7. The home office consistently bills shipments to the branch at 20%above cost .The sales
account is credited for the invoice price.

Required (Disregard income tax)

Prepare a worksheet showing Adjustments and Eliminations, Home office income statement,
Branch income statement, and Combined Balance sheet.

2. The following information came from the books and records of MM Corporation and its
branch. The balances as of December, 31, 19x2, the second year of operation’s existence.

Home office Branch

Dr.(cr.) Dr.(cr.)
Sales ($800,000)
Expenses 275,000
Shipments to branch ($300,000)
Unrealized profit in
Branch inventory (65,000)
The branch purchases all of its merchandise from the home office. The home office ships this
merchandise at 120%of its cost. The ending inventory of the branch is $60,000 at the billed
price.