Chapter one

Accounting for Agency &principal, branch

&head office
• Distinguishing Agency and Branch

• An agency relationship refers a contract under which one or more

persons (the principals) engage another person (the agents) to carry out
some service on their behalf that involves delegating some decision
making authority to the agent.

• Branch is a business unit located at some distance from the home

office. This unit carries merchandise, makes sales, and makes
collections from its customers.
• Accounting for Sales Agency

 A sales agency usually carries samples of products but does not have
inventory of merchandise

 Orders are taken from customers and transmitted to the home office, which
approves customers’ credit and ships the merchandise directly to the
customers

 Account receivables are managed by the home office

 An imprest cash fund is maintained at the sales agency for payment of

operating expenses
 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
• Transaction between principals and sales agency
1) Principal firm send sample inventory of Br. 1,500 to shashemene
sales agency
2) The firm established a petty fund Br. 10,000 for operating activities of
sales agency.
3) Principal firm sold inventories at Br.50,000 on account to the
customers those comes through shashemene sales agency, the cost of
inventories sold was Br.35,000
4) The firm replenished the operating fund of Br.10,000
5) Closing entry made by principal
Accounting for Branch
• The accounting work done at each branch depends upon the policy or
the accounting system of the enterprise which may provide for a
complete set of accounting records at each branch or keep all
accounting records in the home office.
• A branch may, accordingly, maintain a complete set of accounting
records consisting of journals, ledgers and chart of accounts similar to
those of an independent business enterprise, prepare financial
statements and periodically forward to the home office.

• Transactions recorded by the branch should include all controllable

expenses and revenue for which the branch manager is responsible.
Expenses such as depreciation and branch plant assets are generally
maintained by the home office.
Reciprocal Accounts
• The accounting records maintained by a branch include a Home Office
ledger account that is credited for all merchandise`, cash, or other
resources provided by the home office; it is debited for all cash
merchandise or other asset sent to the home office or to other
branches.
Cont’d…
• The Home Office account is a quasi-ownership equity account that
shows the net investment by the home office in the branch.
• At the end of the accounting period when the branch closes its
accounts, the Income Summary account is closed to the Home Office
account.
• A net income increases the credit balance of the Home Office account;
a net loss decreases this balance.
Cont’d…
• In the home office accounting records, a reciprocal ledger account with a
title such as Investment in Branch is maintained.

• This non current asset account is debited for cash, merchandise, and services
provided to the branch by the home office, and for net income reported by
the branch. It is credited for the cash or other assets received from the
branch, and for any net loss reported by the branch.

• A separate investment account is generally maintained by the home office

for each branch.
Expenses Incurred by Home Office and Allocated to
Branches
• business enterprises follow a policy of notifying each branch of expenses incurred
by the home office on behalf of the branch.

• When such a policy is adopted, an expense incurred by the home office and
allocated to a branch is recorded by the home office by a debit to Investment in
Branch and credit to an appropriate expense account; the branch debits an
expense account and credits Home Office.

• Expenses paid by the home office and allocable to branches may be insurance,
property and other taxes, depreciation, and advertising.
Billings of Merchandise to Branches
• Three alternative methods are available to the home office for billing
merchandise shipped to its branches:
 At cost
 At a percentage above cost
 At the retail selling price
• Shipment of merchandise to a branch does not constitute a sale as the
ownership does not change.
Cont’d…
• Billing at cost
 The simplest and widely used procedure
 Avoids complications of unrealized gross profits on inventories
 Attributes all gross profit to the branches even if some of the merchandise may be
manufactured by the home office.

• Billing at a percentage above cost

 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

 Adjustments must be made to eliminate intra company profits in preparation of combined

financial statements
Cont’d..
• 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
• Illustration

• information for Operation of Branch x and home office

• Assume that S Company bills merchandise to Branch X at cost and the branch
maintains complete accounting records and prepares financial statements.

• Both the branch and home office use the perpetual inventory system.

• Equipment used at the branch is carried in home office records.

• Expenses such as advertising and insurance are incurred by the home office and
billed to the branch.
Cont’d…
• Summarized transactions of year 1

1. Cash of 1,000 was forwarded to Branch X

2. Merchandise with cost of 60,000 was shipped to Branch X

3. Equipment of 500 acquired by Branch X, to be carried in home office records

4. Credit sales by Branch X amounted to 80,000; the cost of merchandise sold was 45,000.

5. Collections of trade accounts receivable pf 62,000 made by Branch X.

6. Payments for operating expenses by Branch X totaled 20,000

7. Cash of 37,500 remitted to home office by Branch X

8. Operating expenses charged to Branch X by home office totaled 3,000

Transaction between Branches
• Efficient operation may on occasion require that assets be transferred from
one branch to another branch. A branch does not carry a reciprocal account
with another branch but records the transfer in the Home Office account.

• For example, if Branch A transfers merchandise to Branch B, Branch A

debits Home Office and credits Inventories, while Branch B debits
Inventories and credit Home Office. The Home Office records the transfer by
debiting Investment in Branch B and crediting Investment in Branch A.
Cont’d…
• The additional freight cost due to the indirect routing does not justify increase in
the carrying amount of inventories. Only freight costs of the direct shipment from
the home office are included in inventory costs.

• Illustration: The home office shipped merchandise costing 6,000 to Branch D

and paid freight costs of 400. Subsequently, the home office instructed Branch D
to transfer this merchandise to Branch E. Branch D paid 300 to carry out this
order. The cost of direct shipment from home office to E would have been 500.
The journal entries in the three sets of records would be:
Combined Financial Statements
• A balance sheet for distribution to external users the financial position
of the business enterprise as a single entity.
• A convenient starting point in the preparation consists of the adjusted
trial balances of the home office and the branches.
• The assets and liabilities of the branch are substituted for the
Investment in Branch ledger account included in the home office trial
balance.
• Similar accounts are combined to produce a single total amount for
cash, trade receivables, and other assets and liabilities of the enterprise
as a whole.
Cont’d…
• Reciprocal accounts are eliminated as they have no significance when the
branch and home office report as a single entity. The balance of the Home
Office account is offset against the balance of the Investment in Branch
account.

• The operating results of the enterprise (the home office and the branches)
are shown by an income statement in which the revenue and expenses of
the branch are combined with the revenue and expenses of the home
office. Any intracompany profits or losses are eliminated.
• Working Paper for Combined Financial Statements

• A working paper for combined financial statements has three purposes:

 To combine ledger account balances like assets and liabilities

 To eliminate any intra company profits or looses

 To eliminate the reciprocal accounts

• Illustration

• the working paper is begun with adjusted trial balances of the home
office and Branch X.
 • S CORPORATION
• Working Paper for Combined Financial Statements of Home Office and Branch X
• For the Year Ended December 31, Year 1
• (Perpetual Inventory System: Billing at Cost)
•  
• Adjusted TB Elimination Combined
• Home Off Br X

• Income statement

• Sales (400,000) (80,000) (480,000)

• Cost of Goods Sold 235,000 45,000 280,000

• Operating expenses 90,000 23,000 113,000

• Net income 75,000 12,000 87,000

• Total 0 0
Cont’d…

• Statement of RE

• Retained E Jan 1 (70,000) (70,000)

• Net income (75,000) (12,000) (87,000)

• Dividends 40,000 40,000

• Retained E Dec 31 117,000