Inventory

Appendix 9A Transfers for

Branches

1
2 APPENDIX 9A INVENTORY TRANSFERS FOR BRANCHES

Recording Inventory Transfers to Branches

Many home offices, most notably in the retail industry, transfer inventory to their branches. Some
home offices transfer inventory to their branches at cost; others at above cost. When transfers are
made at above the home office’s cost, the unrealized intracompany profit issue discussed in Chap-
ter 9 arises. In recording inventory transfers to branches, two accounting procedures are possible
(both of which are widely used): sales treatment and nonsales treatment.

Sales Treatment
Some home offices record these transfers as sales—using the Intracompany Sales account—as if the
transfers were between a parent and a subsidiary. In such cases, the procedures to (1) prevent re-
porting these internal sales for combined reporting purposes and (2) defer any unrealized intracom-
pany profit at the combined reporting date are identical to those shown in each of the modules in
Chapter 9 for intercompany sales involving subsidiaries. Accordingly, we need not illustrate these
procedures here.

Nonsales Treatment
If sales treatment is not used, the home office’s intracompany markup is recorded in the Deferred
Profit account at the transfer date—pending sale of the inventory by the branch to an outside third
party. Upon sale by the branch, the home office adjusts the Deferred Profit account downward,
with the offsetting credit being to the Branch Income account—thereby reporting as income the
previously deferred profit.

Invoicing the Branch

Regardless of which procedure is used and regardless of whether a markup exists, an intracom-
pany billing is prepared so that the inventory can be removed from the home office books and
recorded on the branch books at the invoiced amount. Otherwise, the branch would have sales but
not cost of sales, making it impossible to meaningfully evaluate branch profitability. The remain-
der of this appendix discusses nonsales treatment.

General Ledger Journal Entries by Each Accounting Entity

Assume the following information pertaining to a home office intracompany inventory transfer at
above cost to a branch:

1. During 2006, a home office transferred inventory costing $60,000 to its branch at a transfer
price of $100,000. The $40,000 markup is 40% of the transfer price.
2. At December 31, 2006, the branch reported $20,000 of this intracompany-acquired inventory
in its balance sheet. Because the markup is 40% of the $20,000 transfer price, $8,000 of intra-
company profit must be deferred at the end of 2006. Consequently, $32,000 of the intracom-
pany profit (40% of $80,000) has been realized from a combined reporting perspective as the
result of branch inventory sales to outside parties.
3. The branch reported net income of $24,000 for 2006.
 APPENDIX 9A INVENTORY TRANSFERS FOR BRANCHES 3

Illustration 9A-1 shows the general ledger journal entries made by each accounting entity to
record the inventory transfer. Also shown are the home office’s year-end adjustments to (1) reduce
the Deferred Profit account by $32,000 to obtain the proper year-end balance of $8,000 and (2)
increase the carrying value of the home office’s Investment in Branch account for the branch’s
$24,000 of reported net income. For simplicity, we assume that each entity uses a perpetual inven-
tory system.

Review Points for Illustration 9A-1. Note the following:

1. If instead the inventory had been transferred at the home office’s cost, the branch would have
reported an additional $32,000 of net income or $56,000.
2. As a result of the home office’s two year-end adjusting entries, the Branch Income account has
a $56,000 balance—the same balance that would have existed if the inventory had been trans-
ferred at the home office’s cost in the first place.

Entries Required in Consolidation

In consolidation at December 31, 2006, the following entry is made to reduce the branch’s reported
cost of sales to the amount it would have been had the inventory been transferred at the home of-
fice’s cost:

WO R K S H E E T E N T R Y O N LY
Branch Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32,000
Cost of Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32,000

In addition, it is necessary to reclassify the $8,000 adjusted balance in the Intracompany Profit
Deferred account—an account for internal reporting purposes only—against the branch’s $20,000
of intracompany-acquired inventory as reported in the branch’s year-end balance sheet. This entry
results in reporting the inventory at the home office’s cost of $12,000—the only valid amount for
combined reporting purposes. This entry follows:

WO R K S H E E T E N T R Y O N LY
Intracompany Profit Deferred. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000
Inventory. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000

I L L U S T R AT I O N 9 A- 1 GENERAL LEDGER JOURNAL ENTRIES FOR INTRACOMPANY TRANSFERS

ABOVE COST TO BRANCH—PERPETUAL INVENTORY SYSTEM

Home Office Books Branch Books

Investment in Branch . . . . . . . . . . . . . . 100,000 Inventory . . . . . . . . . . . . . . . . . . . . . . 100,000

Inventory. . . . . . . . . . . . . . . . . . . . 60,000 Home Office Capital . . . . . . . . . . . . . 100,000
Intracompany Profit Deferred . . . . . . 40,000 To record inventory
To record inventory transferred acquired from home office.
to branch.
Intracompany Profit Deferred . . . . . . . . 32,000
Branch Income . . . . . . . . . . . . . . . . 32,000
To adjust the deferred profit account
to $8,000.
Investment in Branch . . . . . . . . . . . . . . 24,000
Branch Income . . . . . . . . . . . . . . . . 24,000
To record branch’s reported earnings.
4 APPENDIX 9A INVENTORY TRANSFERS FOR BRANCHES

In addition, the basic elimination entry is needed. Assuming that the Home Office Equity ac-
count had a preclosing balance of $60,000 at December 31, 2006, that entry is as follows:

WO R K S H E E T E N T R Y O N LY
Branch Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24,000
Home Office Capital (preclosing balance) . . . . . . . . . . . . . . . . . . . . . . . . 60,000
Investment in Branch . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84,000

The preceding three worksheet entries are posted to the combining worksheet in Illustration
9A-2.

I L L U S T R AT I O N 9 A- 2 INTRACOMPANY INVENTORY TRANSFERS ABOVE COST TO BRANCH

Home Office and Branch

Combining Worksheet as of December 31, 2006

HOME CONSOLIDATION ENTRIES

OFFICE BRANCH DR. CR. CONSOLIDATED
Income Statement (2006)
Sales . . . . . . . . . . . . . . . . . . . . . . 500,000 234,000 734,000
Cost of sales . . . . . . . . . . . . . . . . . (300,000) (110,000) 2 32,000 (378,000)
Expenses . . . . . . . . . . . . . . . . . . . (190,000) (100,000) (290,000)
Branch income . . . . . . . . . . . . . . . 56,000 24,000 1 –0–
32,000 2 }
Net Income . . . . . . . . . . . . . . . . 66,000 24,000 56,000 32,000 66,000
Statement of Retained Earnings/
Analysis of Home Office Capital
Retained Earnings, 1/1/06 . . . . . . . 100,000 n/a 100,000
Home office capital (preclosing) . . . n/a 60,000a 60,000 1 –0–
+ Net income . . . . . . . . . . . . . . . . 66,000 24,000 56,000 32,000 66,000
– Dividends declared . . . . . . . . . . . (51,000) (51,000)
Balances, 12/31/06 . . . . . . . . . . . . 115,000 84,000 116,000 32,000 115,000
Balance Sheet
Cash . . . . . . . . . . . . . . . . . . . . . . 61,000 15,000 76,000
Accounts receivable, net . . . . . . . . . 75,000 37,000 112,000
Inventory:
Vendors acquired . . . . . . . . . . . . 110,000 35,000 145,000
Intracompany acquired . . . . . . . . 20,000b 3 8,000 12,000
Intracompany profit deferred. . . . (8,000) 8,000 3 –0–
Investment branch. . . . . . . . . . . . . 84,000 1 84,000 –0–
Land . . . . . . . . . . . . . . . . . . . . . . 220,000 30,000 250,000
Buildings and equipment . . . . . . . . 500,000 150,000 650,000
Accumulated depreciation . . . . . . . . (320,000) (13,000) (333,000)
Total Assets . . . . . . . . . . . . . . . 722,000 274,000 8,000 92,000 912,000
Liabilities . . . . . . . . . . . . . . . . . . . 407,000 190,000 597,000
Common stock. . . . . . . . . . . . . . . . 200,000 200,000
Retained earnings . . . . . . . . . . . . . 115,000 115,000
Home office capital . . . . . . . . . . . . 84,000 116,000 32,000 –0–
Total Liabilities and Equity . . . . . 722,000 274,000 116,000 32,000 912,000

Proof of debit and credit postings . . . . . . . . . . . . . . . . . . . . . . . . 124,000 124,000

a
This amount is the balance in the home office capital account excluding the current year earnings ($84,000 ending balance – $24,000 of 2006 earnings).
Explanation of entries:
1 The basic elimination entry.
2 The recognized profit elimination entry.
3 The deferred profit elimination entry.
 APPENDIX 9A INVENTORY TRANSFERS FOR BRANCHES 5

Periodic Inventory System

When each accounting entity uses a periodic inventory system, the general ledger journal entries
made to record the inventory transfer are as follows:

Home Office Books Branch Books

Investment in Purchases from

Branch . . . . . . . . . . . . . . . . 100,000 Home Office . . . . . . . . . . . . 100,000
Purchases Sent Home Office
to Branch . . . . . . . . . . . . 60,000 Capital. . . . . . . . . . . . . . 100,000
Deferred Profit . . . . . . . . . 40,000

The Purchases Sent to Branch account—a contra Purchases account—and the Purchases from
Home Office account are both closed at year-end when each accounting entity prepares its adjust-
ing entry to record cost of sales and adjust its inventory balance to reflect the physical quantities
on hand.

EXERCISES FOR APPENDIX 9A

E 9A-1 Account Analysis A home office shipped inventory to its branch during 2006. The following infor-
mation has been obtained from the records of the home office and the branch at the end of 2006:
Total Resold On Hand

Purchases from home office $90,000 $18,000

Purchases sent to branch 75,000
Markup $15,000

Required 1. Complete the analysis.

2. Prepare the branch’s entry to record cost of sales, assuming that the branch purchased all of its
inventory from the home office and reported a beginning inventory of $24,000, all of which had
been sold by the end of the current year. (Assume the same markup percentage for 2005 as for
2006.)
3. Prepare an analysis of the Deferred Profit account for the year.

E 9A-2 Deferred Profit Adjustment A home office ships inventory to its branch at 125% of cost. The De-
ferred Profit account balance at the beginning of the year was $4,000. During the year, the home
office billed the branch $70,000 for inventory transfers from the home office. At year-end, the
branch’s balance sheet shows $16,000 of inventory on hand acquired from the home office.

Required 1. Determine the amount of the branch’s beginning inventory (as shown in its prior year-end fi-
nancial statements).
2. Prepare the branch’s entry to record cost of sales.
3. Calculate the year-end adjustment to the Deferred Profit account, and show the adjusting jour-
nal entry.

E 9A-3 Entries and Adjustments During 2006, a home office shipped inventory costing $55,000 to the
branch at a transfer price of $66,000. At 12/31/06 the branch reported $18,000 of this inventory
in its balance sheet. At the end of 2005, the branch reported $6,000 of intracompany-acquired in-
ventory—all of which was sold in 2006. For 2006, the branch reported $25,000 of net income in
its financial statements.

Required 1. Prepare the home office and branch journal entries to record the inventory transfer, assuming
that a perpetual inventory system is used.
2. Prepare the branch’s entry to record cost of sales for 2006.
6 APPENDIX 9A INVENTORY TRANSFERS FOR BRANCHES

3. Prepare the home office’s year-end adjusting entries relating to the Deferred Profit account and
the branch’s reported income.
4. Prepare the entry required in consolidation to report the proper amount for the branch’s cost of
sales.

E 9A-4 Reverse Analysis A home office transfers inventory to its branch at a 20% markup. During 2006,
it transferred inventory costing $80,000 to the branch. At year-end, the home office adjusted its
Deferred Profit account downward by $18,200. The branch’s year-end balance sheet shows $4,800
of inventory acquired from the home office.

Required Calculate the home office’s cost of the branch’s beginning inventory.

PROBLEMS FOR APPENDIX 9A

P 9A-1* Combining Worksheet The 12/31/06 financial statements of Homex Inc. and its branch are as fol-
lows:
Home Office Branch

Income Statement (2006)

Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 700,000 $ 200,000
Cost of sales. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (390,000) (149,000)
Selling expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (42,000) (11,000)
Administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (28,000) (4,000)
Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (40,000)
Branch income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,000
Income before Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 250,000 $ 36,000
Income tax expense @ 40% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (100,000)
Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 150,000 $ 36,000
Balance Sheet
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 90,000 10,000
Accounts receivable, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80,000 20,000
Inventory:
Acquired from vendors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180,000 10,000
Acquired from home office. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36,000
Intracompany profit deferred . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (6,000)
Fixed assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 770,000 140,000
Investment in branch. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176,000
Total Assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,290,000 $ 216,000
Payables and accruals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 200,000 $ 40,000
Long-term debt. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 350,000
Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500,000
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240,000
Home office capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176,000
Total Liabilities and Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,290,000 $ 216,000
Dividends declared during 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 110,000

Required 1. Prepare a combining statement worksheet as of 12/31/06.

2. Complete the following analysis of the branch’s inventory:
Transfers Transfers
above Cost at Cost Markup

Purchases (from vendors) . . . . . . . . . . . . . . . . . . . . . . . . . . . . $75,000 $75,000 $ –0–

Purchases from home office . . . . . . . . . . . . . . . . . . . . . . . . . .
Total Inventory Available for Sale. . . . . . . . . . . . . . . . . . . .
Less—Ending Inventory:
Acquired from vendors . . . . . . . . . . . . . . . . . . . . . . . . . . .
Acquired from home office . . . . . . . . . . . . . . . . . . . . . . . .
Cost of Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ $ $

*The financial statement information presented for problems accompanied by asterisks is also provided on Model 9BR (filename:
MODEL09BR) of the software file disk that is available with the text, allowing the problem to be worked on the computer.
 APPENDIX 9A INVENTORY TRANSFERS FOR BRANCHES 7

3. Prepare the entry that the branch made to record cost of sales.
4. Calculate the markup percentage.

P 9A-2* Comprehensive Combining Worksheet: Sales The preclosing trial balances of Homex Inc. and its
branch for the year ended 12/31/06, prior to adjusting and closing entries, are as follows:
Home Office Branch
Dr. Cr. Dr. Cr.

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 35,000 $ 10,000

Accounts receivable, net . . . . . . . . . . . . . . . . . . . . . . 80,000 50,000
Inventory, 1/1/06
Acquired from vendors . . . . . . . . . . . . . . . . . . . . . 230,000 50,000
Acquired from home office . . . . . . . . . . . . . . . . . . 20,000
Intracompany profit deferred . . . . . . . . . . . . . . . . . . . $ 25,000
Fixed assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . 870,000 90,000
Investment in branch . . . . . . . . . . . . . . . . . . . . . . . . 155,000
Payables and accruals . . . . . . . . . . . . . . . . . . . . . . . . 221,000 $ 45,000
Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400,000
Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300,000
Retained earnings, 1/1/06. . . . . . . . . . . . . . . . . . . . . 350,000
Home office capital . . . . . . . . . . . . . . . . . . . . . . . . . 115,000
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 960,000 320,000
Purchases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800,000 120,000
Purchases from home office . . . . . . . . . . . . . . . . . . . . 90,000
Purchases sent to branch. . . . . . . . . . . . . . . . . . . . . . 84,000
Selling expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . 81,000 34,000
Administrative expenses . . . . . . . . . . . . . . . . . . . . . . 54,000 16,000
Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . 35,000
$2,340,000 $2,340,000 $480,000 $480,000
Inventory per physical count on 12/31/06:
Acquired from vendors . . . . . . . . . . . . . . . . . . . . . $ 180,000 $ 20,000
Acquired from home office . . . . . . . . . . . . . . . . . . 30,000

Additional Information
1. Inventory transferred to the branch from the home office is billed at 125% of cost.
2. The home office billed the branch $15,000 for inventory it shipped to the branch on 12/28/06;
the branch received and recorded this shipment on 1/2/07.
3. The branch remitted $25,000 cash to the home office on 12/31/06; the home office received and
recorded this remittance on 1/4/07.
4. The Deferred Profit account is normally adjusted at the end of the year.
5. Income taxes are to be recorded at 40%.
6. No dividends were declared during the year.

Required 1. Prepare the year-end adjusting entries to

a. Bring the intracompany accounts into agreement. (Be sure to adjust the other accounts in the
trial balance as appropriate.)
b. Adjust the inventory accounts and record cost of sales.
2. Complete the following analysis of the branch’s inventory:
Transfers Transfers
above Cost at Cost Markup

Beginning inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ $ $
Acquired from vendors
Acquired from home office
+ Purchases (from vendors)
+ Purchases from home office . . . . . . . . . . . . . . . . . . . . . .
Total Inventory Available for Sale . . . . . . . . . . . . . . . . .
Less—Ending inventory:
Acquired from vendors . . . . . . . . . . . . . . . . . . . . . . . . .
Acquired from home office . . . . . . . . . . . . . . . . . . . . . .
Cost of Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
8 APPENDIX 9A INVENTORY TRANSFERS FOR BRANCHES

3. Prepare the following year-end adjusting entries to

a. Record the branch’s income on the home office’s books.
b. Adjust the Deferred Profit account to the proper balance.
c. Provide for income taxes.
4. Prepare the year-end closing entries for the home office and the branch.
5. Prepare a combining statement worksheet as of 12/31/06 after completing requirements 1–4.