RVU Department of Accounting Advanced Financial Accounting

Chapter one
Branch and home office Accounting
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.
1.1 Over view 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.
1.2 Objectives of Branch Accounting
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.
(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.
1.3 Accounting system
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.
1.3.1. 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

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RVU Department of Accounting Advanced Financial Accounting

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.
1.3.2. 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.
1.4 . Branch General ledger Accounting

1.4.1. 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

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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.

1.4.2 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.
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.

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RVU Department of Accounting Advanced Financial Accounting

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
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.
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.
1.5 Branch Accounting Illustration
Assume that Addis Company, which prepares financial reports at the end of the calendar year,
established a branch in Dire Dawa on July 1, 2009. The following transactions occurred
during the formation of the branch and its first six months of operations, ending December 31,
2009.
1. The home office sent birr 28,000 cash to the branch to begin operations.
2. The home office shipped inventory to the branch. Intra company billings totaled birr
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 birr 12,000 on July
1, 2009 (Assume that branch fixed assets are not carried on the home office books.).
4. The branch purchased inventory costing birr 43,000 from outside vendors on
account.
5. The branch had credit sales of birr 85,000 and cash sales of birr 35,000.
6. The branch collected birr 44,000 on accounts receivable.
7. The branch paid outside vendors birr 28,000.

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8. The branch incurred selling expenses of birr 15,000 and general and administrative
expenses of birr 12,000. These expenses were paid in cash when they were incurred.
9. The home office charged the branch birr 2,000 for its share of insurance.
10. Depreciation expense on the merchandise display equipment acquired by the branch
is birr 1,000 for the six month period. (Depreciation expense is classified as a selling
expense.).
11. The branch remitted birr 10,000 cash to the home office.
12. The branch’s physical inventory on December 31, 2009, is birr 33,000, of which birr
25,000 was acquired from the home (there was no beginning inventory). The home
office’s physical inventory on December 31, 2009, is birr 150,000 (the beginning
inventory was birr 135,000). (Home office purchases were birr 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 Addis Company’s home office and its Dire Dawa branch for the
transactions 1 through 14.
Answer for Illustration
Home office books Branch books
1. Investment in branch Birr 28,000 1. Cash Birr 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

3. No entry 3. Equipment 12,000

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

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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

11. Cash 10,000 11. Home office Equity 10,000

Investment in Branch 10,000 Cash 10,000

12. Ending Inventory 150,000 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
Beg. Inventory 135,000 Purchases 43,000

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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
Branch income 20,000
Retained Earnings 20,000

1.6 Combined Financial statement: Inventory transfer at home office cost

1.6.1 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.

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RVU Department of Accounting Advanced Financial Accounting

Dire Dawa branch of Addis Company

Financial statements
Income statement
Year ending December 31, 2009
Sales Birr 120,000
Cost of goods sold (70,000)
Selling expenses (16,000)
Administrative expenses (14,000)
Net income of branch Birr 20,000

Home office account

Year ending December 31, 2009
Account balance, January 1, 2009 $-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 of the branch (above) 20,000
Account balance, December 31, 2009 100,000

Balance sheet
December 31, 2009
Cash birr 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

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1.6.2 Producing Financial Statements for the Entire Company

Once financial statements for the Dire Dawa branch have been developed, Addis 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 Addis Company’s home office
and the Dire Dawa branch is presented in as follows. 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.
ADDIS COMPANY
Work Sheet to Combine Home Office and Dire Dawa Branch
Year Ended December 31, 2009
Elimination
Income Statement Home Office Branch Combined
Dr. Cr.
Sales Br 380,000 Br 120,000 Br 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 earnings, Jan. 1, 2009 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, 2009 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

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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-
500,000 115,000 100,000 515,000

Addis Company and Dire Dawa branch

Combined Financial statements

Addis Company
Income statement
For Year ending December 31, 2009
Sales Birr 500,000
Less: Cost of goods sold (280,000)
Gross profit 220,000
Less: Operating expenses:
Selling expenses 68,000
Administrative expenses 73,000
Interest expense 19,000 160,000
Income before income tax 60,000
Less: Income tax (40%) 24,000
Net income 36,000

Addis company
Retained earnings statement
Year ending December 31, 2009
Retained earnings balance, January 1, 2009 Br114, 000
Add: Net income of the period 36,000
Less: Dividend declared 10,000
Increase in Retained earnings 26,000
Retained earnings balance on Dec31, 2009 Br 140,000

Addis Company
Balance sheet
December 31, 2009
Assets:
Cash 80,000
Accounts receivable, unit 101,000
Inventory 183,000
Land 22,000

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Buildings and Equipment, net 129,000

Total assets Br 515,000
Liabilities and stock holders’ equity:
Accounts payables and accruals 75,000
Long-term debt 200,000
Common stock 100,000
Retained earnings 140,000
Total liabilities & stock holders’ equity Br 515,000

1.7 Combined Financial statement: 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
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 Illustration 1.1 was marked up 20% over the home office’s cost of birr 60,000. In
Illustration 12, we assumed that the branch had a birr 33,000 ending inventory, of which birr
25,000 represented inventory obtained from home the office. In this case the branch’s ending
inventory acquired from the home office is birr 30,000 (br25, 000 + br5, 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 birr 38,000
(30,000 + 8,000). The journal entries for the transfer of this inventory above cost, along with
the appropriate year end closing and adjusting entries are shown as follows. The journal
entries are numbered to correspond, which shows inventory transfers made at the home
office’s cost.
Example: Record important entries based on the previous example by assuming
inventory is shipped to branch 20% above cost?

Home Office books Branch Books

2. Investment in Branch Br72,000 2. Shipments from Home Office Br72,00

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Shipment to Branch 60,000 Home Office Equity 0 72,000

Unrealized Gain 12,000 12. Inventory Acquired from Vendors
12. Inventory 15,000 Inventory acquired from home office 8,000
Shipments to Branch 60,000 Cost of goods sold 30,000
Cost of goods sold 210,000 Shipments from home office 77,000 72,000
Purchases 285,000 Purchases 43,000
13. No entry 13. Sales
Cost of goods sold 120,000 77,000
Selling expenses
16,000
Administrative expenses
14,000
Home office equity
13,000
14. No. Entry
14. Investment in Brach
13,000
Branch income
13,000
Unrealized gain
7,000
Branch Income
7,000
Branch income
20,000
Retained earning
20,000

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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 Addis Company branch the
adjustment will be as follows:
Total unrealized gain at the time of inventory transfer to Branch ............Br
............Br 12,000
Unrealized gain related to ending inventory of
Branch on Dec. 31, 2009 (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
Addis Company’s branch the amount equals birr 5,000.
1.8 Transaction between Branches
Efficient operations may on occasion require that merchandise or other assets be transferred from
one branch to another. Generally, a branch does not carry a reciprocal ledger account with
another branch but records the transfer in the Home Office ledger account. For example, if Alba
Branch debits home office and credits Inventories (assuming that the perpetual inventory system
is used). On receipt of the merchandise, Boro Branch debits Inventories and credits Home
Office. The home office records the transfer between branches by a debit to Investment in Boro
branch and a credit to Investment in Alba Branch.
The transfers of merchandise from one branch to another does justify increasing the carrying
amount of inventories by the freight costs incurred because of the indirect routing. The amount
of freight costs properly included in inventories at a branch is limited to the cost of shipping the
{}=merchandise directly from the home office to its present location. Excess freight costs are
recognized as expenses of the home office.
To illustrate the accounting for excess freight costs on inter branch transfers of merchandise,
assume the following data. The home office shipped merchandise costing Br.6, 000 to Dana
Branch and paid freight costs of Br.400. Subsequently, the home office instructed Dana Branch
to transfer this merchandise to Evan Branch. Freight costs of Br.300 were paid by Dana Branch

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to carry out this order. If the merchandise had been shipped directly from the home office to
Evan Branch, the freight costs would have been Br.500.
Required: Record journal entries required in the three sets of accounting records (assuming
that the perpetual inventory system is used) are as follows:
In Accounting Records of Home Office:
Investment in Dana Branch 6,400
Inventories 6,000
Cash 400
To record shipment of merchandise and payment of freight cost.
6,500
Investment in Evan Branch 200
Excess Freight Expense—inter branch Transfers 6,700
Investment in Dana Branch
To record transfer of merchandise from Dana Branch to Evan Branch under
Instruction of home office. Inter branch freight of Br.300 paid by Dana
Branch caused total freight costs on this merchandise to exceed direct
Shipment costs by Br.200 (Br.400 + Br.300 – Br.500 = Br.200).
In Accounting Records of Dana Branch:
Freight in (of inventories) 400
inventories 6,000
Home Office 6,400
To record receipt of merchandise from home with freight cost paid
In advance by home office.

Home Office 6,700

inventories 6,000
freight in (or inventories) 400
Cash 300
To record transfer of merchandise from Dana Branch under instruction of
home office and payment of freight costs of Br.300.

In Accounting Records of Evan Branch:

Inventories 6,000
Freight in (or inventories) 500
Home Office 6,500
To record receipt of merchandise from Dana Branch transferred under
instruction of home office and normal freight costs billed by home office.

Recognizing excess freight costs on merchandise transferred from one branch to another as
expenses of the home office is an example of the accounting principle that expenses and losses

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should be given prompt recognition. The excess freight costs from such shipments generally
result from inefficient planning of original shipments and should not be included in inventories.
In recognizing freight cost of inter branch transfers as expenses attributable to the home office,
the assumption was that the home office makes the decisions directing all shipments, if branch
managers are given authority to order transfers of merchandise between branches, the excess
freight costs are recognized as expenses attributable to the branches whose managers authorized
the transfers.

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