Chapter 2

Accounting for Sales Agencies and Branch Operations

Introduction
When operations are conducted at more than a single location, the different locations may be
referred to as sales agencies, branches, plants, or by numerous other terms. Unfortunately,
terminology referring to multiple operating locations is not standardized. In addition, many
different approaches are taken in establishing internal accounting and reporting systems for
companies operating through outlaying locations.
Internal expansions’ using such forms of organizations is merely the extension of the existing
legal entity (not the creation of a new legal entity). The headquarters location of the legal entity
that establishes sales agencies, branch, or division is referred to as the home office.
Distinction between sales Agency and Branch
sales Agencies Branch
 a term applied to a business unit that  The term is used to describe a business unit located
performs only a small portion of the at some distance from the Home Office.
functions associated branch  Are economic and accounting entities, but not legal
 Are not autonomous operations, but acts entity
on behalf of the home office?  They do not have common stock, additional paid-in
 Are not accounting ,economic and legal capital, and retained earnings accounts..
entities  may carry merchandise obtained from Home Office,
 The orders typically are filled by the  Make sales, approve customers’ credit, and make
home office collections from its customers.
 carries samples of products but does not  A branch typically stocks merchandises and fills
stock inventory customers’ orders
 An agency relationship refers a contract  Usually have more autonomy and a greater range of
under which one or more persons (the services than sales agent does.
principals) engage another person (the  The extent of autonomy and responsibility of a
agents) to carry out some service on their branch varies, even among different branches of the
behalf that involves delegating some same business enterprise.
decision making authority to the agent

Accounting for Sales Agency

The term sales agency sometimes is applied to a business unit that performs only a small portion
of the functions traditionally associated with a branch.
 Orders are taken from customers and transmitted to the home office, which approves
customers’ credit and ships the merchandise directly to the customers

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 Accounts receivables are managed by the home office
 An imprest cash fund is maintained at the sales agency for payment of operating
expenses
 A sales agency does not maintain a financial accounting system but only keeps sufficient
records to conduct its business.
 Hence, no need for complete accounting records at a sales agency other than a record of
sales to customers and a summary of cash payments supported by vouchers
 Separate revenue and expense accounts may be opened by the home office for each sales
agency so as to measure its profitability
 Subsidiary ledger accounts may be used to control fixed assets and cost of goods sold by
sales agencies
Journal entries required at the home office in connection with a sales agency assuming the
perpetual inventory system is used:
Home office journal entries for s agency transactions
Transactions Home offices books (entries)
Working funds; sales agency xx
Working funds established Cash xx
shipped merchandise to sales agency for use Sample inventory; sales agency xx
as samples) Inventory (shipment to agency xx
Account receivable xx
sales made by sales agency) Sales ; agency xx
Cost of goods sold; sales agency xx
cost of merchandise sold by sales agency Inventories xx
Operating Expenses: sales Agency xx
Replenishment of working fund Cash xx
Close sales and expanses Sales ; agency xx
Cost of goods sold; agency xx
Various expanse account xx
Income ;agency xx
Close income summery account Agency income xx
Income summery xx

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 Accounting for Branch
Business firms with branches have the option either to allow
 The branch to maintain its own books and record in a decentralized accounting system or
 Account for the branch on home office’s books in a centralized accounting system. The
decision is based on what is most practical and economical.
Centralized accounting decentralized accounting
 Branch does not maintain a separate general  Branch maintains a separate general ledger in
ledger in which to record its transactions. which to record its transactions.
 It sends source documents on sales, purchases,  The branch is a separate accounting entity,
and payroll to the home office. even though it is not separate legal entity.
 Branches usually deposit cash receipts in local  It prepares its own journal entries and financial
bank accounts on which only the home office statements, submitting the latter to the home
can draw. office, usually on a monthly basis.
 Inventory and fixed assets at each branch also  common for branch’s that have complex
are recorded in the home office general ledger, manufacturing operations or extensive retailing
appropriately coded to signify the location to operations involving significant credit sales,
which they belong. where branch managers are given certain
 Journal entries pertaining to each branch’s powers for decision making regarding
transactions are then prepared and posted to the procurement, selling, advertising, staffing and
home office general ledger even purchasing of fixed assets.
 Accountants at the home office can readily  Even though the home office and each branch
prepare operating statement for each branch. maintain separate books, all accounts are
 The home office reviews operating statements combined for external reporting in such a way
for each branch and provides copies to branch that the external financial statements represent
management. the company as a single economic enterprise.
 usually practical when the operations of the  The branch maintains the balance sheet and
branch do not involve complex manufacturing income statement accounts necessary to record
operation or extensive retailing or service transactions that take place between (1) the
activities home office and the branch and (2) the branch
and its customers, creditors, and employees.
Reciprocal Accounts
Transactions with external parties are recorded in the normal manner. Transactions between the
home office and a branch also are treated in the normal manner except that they are recorded in
intra-company accounts. These accounts are reciprocal accounts between the home office and the
branch. The intra-company account on the books of the home office often is called investment
in branch. while the reciprocal account on the branch books is be labeled Home office, when a
company has more than one branch a separate investment accounts for each branch is

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 maintained on the home office books. The two accounts having equal but opposite balances are
known as reciprocal accounts.
Home Office ledger account Investment in Branch ledger account
accounting record maintained by a branch accounting record maintained by a home
credited for all merchandise, cash, or other office
resources provided by the home office it is noncurrent asset account.
Debited for all cash merchandise or other Debited for cash, merchandise, and services
asset sent to the home office or to other provided to the branch. and for net income
branches. reported by the branch.
A net income increases its credit balance and credited for the cash or other assets received
a net loss decreases this balance from the branch, and for any net loss reported
Closed by income summery accounts by the branch
reflects the equity method of accounting
To illustrate the relationship between the reciprocal ledger accounts, assume that the home office
opens a new branch in Dessie and begins branch operations by sending $30,000 cash to the
branch. The entries in the two ledgers are illustrated as follows:

Merchandise shipment to a Branch

A branch that buys and sales merchandise may be required to obtain all its merchandise from the
home office or it may be permitted to acquire some merchandise from external parties. Purchases
of merchandise from external parties are recorded by the branch in the normal manner. If, for
example, Orbit’s trading Debark branch purchases Br 50,000 from an independent wholesaler,
and the branch uses perpetual inventory system, the transactions is recorded by the branch as
follows:
Inventory 50,000
Cash (account payable) 50,000
No entry with respect to this is made on the books of the home office. When inventory is
transferred from the home office to a branch, both the home office and the branch must record
the transfer. Merchandise is transferred from the home office to a branch either at

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  original cost,
 above cost or
 At retail price.
\note; Shipment of merchandise to a branch does not constitute a sale as the ownership does not
change.
Billing at cost: the transfer of inventory is treated by both the home office and the branch in the
same way as the transfer of any other assets, assuming perpetual inventory system is used. It is
the simplest and widely used procedure, Avoids complications of unrealized gross profits on
inventories, and Attributes all gross profit to the branches even if some of the merchandise may
be manufactured by the home office.
Illustration: assume that Orbit’s home office transfers inventory with a cost of Br 80,000 to its
Bahir Dar branch. The transfer is billed at the home office cost, no markup has been added.
Billing at a percentage above cost: this may occur when the home office and each branch are
treated as profit centers for internal reporting and evaluation purposes.
When the home office incurs costs and provides a service, such as by acquiring inventory at
lower prices through volume purchases or by manufacturing the inventory, the company may
choose to allocate the profit on the sale of the inventory between the home office and the selling
branch. This can be done by billing the branch for inventory transfer at an amount greater than
the home office’s cost. The home office is credited with profit equal to the difference between its
cost and the transfer price (billed price) to the branch; this difference is referred to as the intra-
company profit. The branch’s profit is the difference between the transfer price (the branch’s
cost) and the selling price to external parties.
At the transfer date, the home office records the intra-company markup on inventory shipments
to its branches in a separate account, allowing it to defer recognition of profits on intra-company
sales until the inventory is sold to external parties by the branch, upon sale by the branch, the
home office adjusts downward the account used for deferring profit, with the offsetting credit to
an income statement account, thereby reporting as income the previously deferred profit.
Each branch normally records inventory acquired from the home office in an account separate
from inventory purchased from an external parties so that the intra-company profit can be more
easily identified.

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Generally, it is intended to allocate reasonable gross profit to the home office, under this
method, the net income reported by the branch is understated and the ending inventories are
overstated for the enterprise as a whole and Adjustments must be made to eliminate intra
company profits in preparation of combined financial statements
Example: Jupiter trading has a policy to bill merchandise shipped to branches at 50% markup of
the cost. During 2013, the home office transferred to its Debark branch inventory costing Br
80,000. On December 31, 2013, the branch reported Br 18,000 of this intra-company acquired
inventory in its balance sheet.
Investment in debark branch 120,000
Inventory 80,000
Unrealized intra-company profit 40,000
(To record shipment of merchandise by the home office)
The Br 40,000 intra-company profit is unrealized because the inventory has not been sold to an
external party. Recognition of the profit is deferred until the branch sells the merchandise
externally. The branch records receipt of the shipment with the following entry:
Inventory –from home office 120,000
Home office 120,000
(To record receipt of merchandise by branch)
A separate inventory account is established in this case to facilitate eliminating the unrealized
intra-company profit when external accounting reports are prepared for the company as a whole.
The intra-company profit would be recognized by the home office with the following year-end
adjusting entry:
Unrealized intra-company profit 34,000
Realized intra-company profit 34,000
This entry is appropriate if the company feels that the intra-company profit should be allocated to
the home office for services that has provided. Alternatively, if the intra-company profit is to be
attributed to the branch for internal reporting purposes, the intra-company profit is recognized
with the following entry on the books of the home office.
Unrealized intra-company profit 34,000
Debark branch income 34,000

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The home office’s year-end adjustments reduce the unrealized intra-company profit account by
Br 34,000 to obtain the proper year –end balance of Br 6,000.\
Billing at Retail Selling Prices
 Based on a desire to strengthen internal control over inventories
 The home office record of shipments to a branch, when considered along with sales
reported with the branch, provide a perpetual inventory stated at selling price
 Any difference with periodic physical count should be investigated promptly
Freight charges on merchandise shipments
Freight costs incurred in shipping merchandise from the home office to a branch become
part of the cost of the branch inventory. For example, assume that home office of Orbit
Trading pays Br 1,000 to transport Br 80,000 of merchandise to the Debark branch,
billing at the home office cost. The transfer is recorded by the home office with the
following entry:
Investment in debark branch 81,000
Inventory 80,000
Cash 1,000
The Debark branch records the transfer as follows:
Inventory 81,000
Home office 81,000
Home office expense allocation
Branch expenses incurred and paid by the branch are recorded directly on the books of the
branch in the usual manner; however, the home office may elect to assign expenses to a branch.
These assigned expenses might be of several types:
1. Expenses incurred by the branch but paid by the home office: for example inventory
purchased from external parties by the branch and billed to the home office.
2. Expenses incurred by the home office on behalf of the branch; for example depreciation
on branch equipment carried on the home office books, or the cost of an advertising
campaign for the branch commissioned by the home office.
3. Allocations of the costs incurred by the home office that benefit the branches; for
example, a portion of the cost of a general advertising campaign and insurance, or a
portion of the general home office overhead

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In some cases, these costs might be allocated against branch income and recorded only on the
books of the home office. Often, however, the branch to which the costs are allocated is notified
of the allocated amount and records expenses on its own books. In this way, the income
computed by the branch on its books includes all expenses deemed related to the branch.
 Home office records such allocations by:
Investment in branch account xx
Expense account xx
Crediting expense account is needed here because such expenses are initially recorded by the
home office in the normal manner, as if they related to the home office. When notified with
allocated expenses, the branch records as follows:
Applicable expense account xx
Home office account xx
The result is the same as though the home office had transferred cash to the branch and the
branch had arranged for and incurred the expenses.
Without the above entries, the home office income would be understated and the branch income
overstated. While omission of these entries has no effect on the income of the company as a
whole, the separate income amounts of the home office and branch may be important for internal
reporting purpose.
Assume that the home office of Orbit trading notified its Debark branch with the following
expense allocations:
Depreciation expense (on Debark branch assets carried on
Home office books) Br 8,000
National advertising (allocated to branches based on gross sales) Br 27,000
Total 35,000
Recognition of branch income
Income for each branch is computed periodically in the normal manner. All of a branch’s
revenue and expense accounts are closed to its income summary account. The balance of the
income summary represents the branch’s income for the period and is closed to the home office
account. When the branch’s income is reported to the home office, an entry is made on the home
office books to recognize the income of the branch and to increase the recorded amount of the
home office’s investment in the branch.

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For example, assume the Debark branch income summary account has a credit balance of Br
63,000 at the end of the period. The income summary account is closed with the following entry
on the books of the Debark branch:
Income summary 63,000
Home office 63,000
On receiving a report of Debark branch income for the period, the home office records the
following:
Investment in Debark branch 63,000
Debark branch income 63,000
These entries maintain the reciprocal relationship of the investment in Debark branch account
and the Home Office account.
Accounting for branch fixed assets
Fixed assets recorded on the books of the branch: normal procedures are followed in
accounting for branch fixed assets recorded on the books of the branch. No special procedures
are required in accounting for the purchase of fixed assets by the branch or the subsequent
depreciation of those assets. On the other hand, if the fixed assets are purchased by the home
office for the branch and the branch records the fixed assets on its books, an entry is required on
the books of both the home office and the branch.
As an illustration of this, assume that Orbits home office purchases Br 30,000 of store equipment
for Debark branch. The home office records the purchase with the following entry:
Investment in Debark branch 30,000
Cash 30,000
On receiving the asset, Debark branch records the purchase with the following entry:
Store equipment 30,000
Home office 30,000

Fixed assets recorded on the books of the home office: this procedure may provide the home
office with better control over branch fixed assets and automatically ensures that uniform
depreciation methods and assets lives are used for all branches. Branch fixed assets recorded on
the home offices are always coded or recorded in separate accounts so that they may be readily

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identified. The home office usually charges the branch for the depreciation expense of its fixed
assets.
When branch fixed assets are recorded only on the home office books, no entry is needed on the
books of the branch if the home office makes the purchase. for example, if Orbits home office
purchases Br 30,000 of store equipment for the Debark branch, and the equipment is recorded on
the books of the home office rather than the branch, the home office records the purchases as
shown below but no entry is recorded on the books of the branch.
Store equipment-Debark branch 30,000
Cash 30,000
If the branch purchases fixed assets that are recorded on the books of the home office, entries are
needed by the home office and the branch. As an example, assume that Orbit’s Debark branch
purchases Br 30,000 of store equipment to be used by the branch but carried on the home office
books. The branch records the purchase with the following entry:
Home office 30,000
Cash 30,000
The purchase is recorded by the home office as follows:
Store equipment-Debark branch 30,000
Investment in Debark branch 30,000
Because the branch purchases an asset that is carried on the home office books, the balances of
both the Home office account and Investment in Debark branch account are reduced. The
transaction is treated as if the branch had purchased equipment for the home office.
Separate Financial Statements of Branch
Before the branch prepares its closing entries and submits financial statements to the home
office, it must verify that its home office capital account agrees with the investment in branch
reciprocal account maintained by the home office. If the accounts do not agree, there are two
possible explanations:
1. A transaction initiated 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,

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 inventory shipment 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. (it would be more disruptive to have the
initiating accounting entity reverse the transaction)
These adjusting entries to bring the intra-company accounts in to agreement are absolutely
necessary for the proper preparation of combined financial statements. After making any
necessary adjustments, the branch submits an income statement, home office account, and a
balance sheet to the home office.
Financial Statements for the Company as a Whole
While a home office and its branches may maintain separate books for internal record keeping
and evaluation purposes, the external accounting reports represent the home office and its
branches as a single entity; the reporting entity is the company as a whole. Therefore, in the
preparation of the company’s financial statements, the accounts of the home office and its
branches are combined. In preparing the combined financial statements, however, the reciprocal
ledger accounts, any intra-company profit or loss, and any receivable and payables between the
home office and branches (or between two branches) should be eliminated so that the financial
statements appear as those of the single reporting enterprise. These account balances are
eliminated because they relate to activities within the company rather than activities between the
company and external parties. The rest of accounts are just summed together for the combined
financial statements.
Elimination entries
1. To eliminate the reciprocal accounts:
Home office account (pre closing balance)…………xx
Branch income……………………………………….xx
Investment in branch…………………………..xx
Eliminate intra company account (net income)
2. To eliminate realized profit
Realized profit-Branch shipments…………………xx
Cost of goods sold…………….xx
Eliminate home office profit from cost of goods sold
3. To eliminate unrealized profit

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 Unrealized Intra-company profit……………………xx
Inventory from home office...…..xx
Eliminate unrealized intra-company profit from Inventory
4. To eliminate receivable and payable between home office and branch
Payable ………………………..xx
Receivable……………………xx
Eliminate intra-company accounts
5. To eliminate inventory from Home office
Inventory……………….xx
Inventory from home office………xx
Reclassify inventory from home office
A combined worksheet
In the preparation of financial statement for the company as a whole, a working paper is used to
facilitate combining the accounts of the home office and its branches. This working paper for
combined financial statements serves to simplify the elimination of the above mentioned
accounts and to combine ledger accounts balances of home office and branches.
The combining working paper usually begins with the adjusting trial balance of the home office
and branches. The combining process, therefore, is started after the home office has made its
adjusting entry concerning the branch’s income. This approach is termed as the trial balance
approach. An alternative approach, which is not discussed here, is the financial statement
approach.
Additional Considerations
Transaction between branches
Branches sometimes transfer assets or services from one to another. While there are several ways
of accounting for such transfers, a commonly used approach is to treat the transfers as if they
went through the home office. The branches involved in an inter-branch transfer generally
account for the transfer as if they are dealing with the home office rather than with another
branch.
For example, if Orbits Debark branch transfers Br 15,000 of cash and inventory costing Br
20,000 to the Gondar branch, the Debark branch records the following entry:
Home office 35,000

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 Cash 15,000
Inventory 20,000
The Gondar branch records the transfer with the following entry:
Cash 15,000
Inventory 20,000
Home office 35,000
The transfer is recorded by the home office as follows:
Investment in Gondar Branch 35,000
Investment in Debark Branch 35,000
Unrealized profits in Beginning Branch Inventory
Intra-company profits included in a branch’s beginning inventory are recognized on the home
office books as being realized whenever the merchandise is sold by the branch. The treatment is
the sane as if the intra-company transfer had occurred in the current period. In the period in
which the branch sells the inventory to external parties, the home office reduces its unrealized
intra-company profit account and increases its Realized profit on branch shipments account
(assuming the intra-company profit is to be attributed to the home office). When financial
statements are prepared for the company as a whole, the balance of the Realized profit on Branch
shipments account is eliminated against the carrying amount of the inventory.

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