CHAPTER-TWO

Accounting for
Branches and Head
office
PREPARED BY: HASSEN MUSTEFA
 Objectives of this Chapter

After studying this chapter, you should be able to:

Describe segments of a business enterprise, primarily
branches and divisions
Prepare working paper for combined financial
statements
Prepare combined financial statements for home office
and branches
Understand the basic procedures for reconciliation of
reciprocal accounts
Record transaction between branches

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 Branches & Divisions
Definition
As a business enterprise grows, it may establish one or
more branches to market its products over a large
territory.
Branches and divisions are separate economic entities
from their home office.
However, they are not separate legal entities from their
home office.
Branch is a business unit located at some distance from
Home Office which carries merchandise obtained from the
home office, makes sales, approves customers’ credit, and
makes collections from it’s customers.
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 Branches & Divisions
 Division is a segment of a business entity which
generally has more autonomy than a branch.
 Accounting for a division not operated as a separate
corporation is similar to that of branches.
 Accounting for a division operated as a separate
corporation is different from that of branches and
will be discussed in latter chapter (3).
 Consolidated financial statements are required for
these business organizations.

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 Cont.…
Difference between Branches and Divisions
Characteristics Branch Division
Degree of
low high
autonomy
Set of accounting Required by HO Required by the
records and branches division
Transactions
Branch Division
approved by
Accounting entity Yes Yes
Legal entity No May or may not
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 Accounting System for a Branch
Accounting methods used by branches and home
office includes;
Reciprocal ledger accounts/(home office/investment
in branch)
Expenses incurred by home office and allocated to
branches
Alternative methods of billing merchandise shipments
to branches
Separate financial statements for branch and for
home office

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 Accounting System for a Branch

 Combined financial statements for home office and

branch
 Journal entries for operations of a branch
 Working paper for combined financial statements
 Treatment of beginning inventories priced above cost
 Reconciliation of reciprocal ledger accounts
 Transaction between branches

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 Reciprocal Ledger Accounts
Investment in Branch Account

A non-current asset account used by the home office(HO)

to record any transactions with the branches.
Investment in Branch Account
Dr Cr
Assets provided to the branch Assets received from the
by the HO branch

NI reported by the branch NL reported by the branch

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 Reciprocal Ledger Accounts
Home Office ledger account
A quasi-ownership equity account used by the branch to
record any transactions with the home office.

Home Office Ledger Account

Dr Cr
Assets sent by the branch to the Assets provided by the HO to
HO or to other branches the branch
NL reported by the branch NI reported by the branch

 At the end of an accounting period when the branch closes

its accounting records, the Income Summary account is
closed to the Home Office account.
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 Other Accounts
On the branch On the HO
Item accounting records accounting records
Dr Cr Dr Cr
Plant assets Inv’t in Plant
Plant
acquired by the HO HO account Branch Asset
Asset
for a branch’s usage account
Plant asset is HO Cash or Plant asset Inv’t in
acquired by a liability account: branch
branch for its usage account branch
Expense incurred by Expense HO account Inv’t in Expense
HO and allocated to account Branch account
Branches account
 Alternative Methods of Billing Merchandise
Shipments to Branches
 Three alternative methods are available to the home office
in billing the merchandise shipped to the branches:
a) Billed at home office cost,
b) Billed at a percentage above home office cost (cost +
mark-up), and
c) Billed at the branch’s retail selling price.
 Shipment of merchandise to a branch does not constitute a
sale because ownership title has not changed.
 Advantages and Disadvantage

Advantages Disadvantage
Billed at the home Widely used because of Attributes all gross
office cost its simplicity profits of the business to
the branches
Billed at a Able to allocate a Branch NI understated
percentage above reasonable gross profit and the ending
inventories overstated
home office cost to the home office
Billed at the Increase internal No gross profit assigned
branch’s retail control over to the branches
selling price inventories at
branches
 Separate Financial Statements for Branch and
for Home Office (for internal use only)
 To review the operating results and financial
position of the branch, management of the
enterprise may prepare a separate income statement
and balance sheet.
 Combined financial Statements for Home Office
and Branch (for external use)
 Combined financial statements should be prepared
for external users.
 A starting point in preparation of a combined
balance sheet would be the adjusted trial balances of
the home office and of the branch.
 The reciprocal ledger accounts are eliminated because
they have no significance when the branch and
home office report as a single entity.
 Cont.…

 In preparing the combined financial statements, the

following accounts should be eliminated:
a) Reciprocal ledger accounts
b) Any intra-company profits or losses
c) Any receivables and payables between the home office
and the branch (or between two branches).
 The rest of accounts are just summed together for
the combined financial statements.

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 Example I
Assume that Garad PLC bills merchandise to Hawassa Branch at
home office cost and that Hawassa Branch maintains complete
accounting records and prepares financial statements. Both the
home office and the branch use the perpetual inventory system.
Equipment used at the branch is carried in the home office
records. Expenses, such as advertising and insurance, incurred
by the home office on behalf of the branch, are billed to the
branch.
Transactions and events during the first year (2013) of
operations of Hawassa Branch are summarized below:

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 Cont.….
1. Cash of Br.1,000 was forwarded by the home office
to Hawassa Branch.
2. Merchandise with a home office cost of Br.60,000
was shipped by the home office to Hawassa
Branch.
3. Equipment was acquired by Hawassa Branch for
Br.500, to be carried in the home office accounting
records. (Other plant assets for Hawassa Branch
generally are acquired by the home office.)
4. Credit sales by Hawassa Branch amounted to
Br.80,000; the branch’s cost of the merchandise
sold was Br.45,000.
5. Collections of trade accounts receivable by
Hawassa Branch amounted to Br.62,000.
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 Cont.…
6. Payments for operating expenses by Hawassa
Branch totaled Br.20,000.
7. Cash of Br.37,500 was remitted by Hawassa
Branch to the home office.
8. Operating expenses incurred by the home office
and charged to Hawassa Branch totaled Br.3,000.

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 Example

Home Office Accounting Hawassa Branch Accounting

Records Journal Entries: Records Journal Entries:
1.Inv’t in HB……… 1,000 Cash…………. 1,000
Cash……………….............. 1,000 Home Office………. 1,000

2. Investment in HB…. 60,000 Inventories……. 60,000

Inventories…............... 60,000 Home Office……… 60,000
3. Equipment-HB……..500 Home Office…… 500
Investment in HB…..……... 500 Cash………………..… 500
4. None A/R…… 80,000
CGS……. 45,000
Sales………………... 80,000
Inventories……….. 45,000
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 Example
Home Office Accounting
Records Journal Entries:
5. None
6. None
7. Cash……….. 37,500
Investment in HB... 37,500
8. Investment in HB…. 3,000
Op/Expenses…..…….. 3,000
Hawassa Branch Accounting
Records Journal Entries:
Cash…………...... 62,000
A/Receivable…………… 62,000
Op/Expenses…….. 20,000
Cash…………….. 20,000
Home Office…… 37,500
Cash……………… 37,500
Op/Expenses…… 3,000
Home Office………. 3,000
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 Example
 Two Reciprocal Ledger Accounts (prior to adjusting and
closing entries):
Investment in Hawassa Branch

Date Explanation Debit Credit Balance

2013  Cash sent to branch 1,000 1,000 Dr
 Merchandise billed to
branch at HO cost 60,000 61,000 Dr
 Equipment acquired by
branch, carried in home
office accounting records
 Cash received from 500 60,500 Dr
branch
 Operating expenses 37,500 23,000 Dr
billed to branch 3,000 26,000 Dr

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 Example
Home Office
Date Explanation Debit Credit Balance
2013  Cash received from HO 1,000 1,000 Cr
 Merchandise received
from HO 60,000 61,000 Cr
 Equipment acquired 500 60,500 Cr
 Cash sent to HO 37,500 23,000 Cr
 Operating expenses
billed by HO 3,000 26,000 Cr

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Working Paper for Combined financial Statements
 A working paper for combined financial statements
has three distinct purposes:
1) To eliminate any intra-company profits or losses,
2) To eliminate the reciprocal accounts, &
3) To combine ledger accounts balances for like revenues,
expenses, assets, and liabilities.

Elimination Entry
Home office account……….26,000
Investment in Hawassa branch…………26,000

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 Cont.…

 Assume that the Hawassa Branch’s ending

inventories of Br.15,000 at the end of 2013 had been
verified by a physical count.
 All the year-end adjusting entries had been made.
 The working paper begins with the adjusted trial
balance of the home office and Hawassa Branch.
 Income taxes are ignored in this illustration.
 The following working paper is based on the transactions
illustrated earlier and additional assumed data for the
home office trial balance.

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Cont…

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Combined Financial Statements -Example I
Garad PLC
Income Statement
For Year Ended December 31, 2013

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 Cont.…
Garad PLC
Statement of Retained Earnings
For Year Ended December 31, 2013

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 Cont….
Garad PLC
Balance Sheet
December 31, 2013

20-28
 Garad PLC
Balance Sheet
 Cont.…
Home Office Adjusting and Closing Entries and
Branch Closing Entries Performed on 12/31/2013
(Perpetual Inventory System):
HO: Adjusting and Closing Hawassa Branch : Closing
Entries: Entries:

Sales……………….. 80,000
CGS…….............................. 45,000
None Op/Expenses……………. 23,000
Income Summery……… 12,000
Investment- HB….. 12,000 Income Summery….. 12,000
Income-HB…..….............. 12,000 Home Office…………….. 12,000
Income: HB…………. 12,000
None
Income Summery……… 12,000
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 Example II: Billing of Merchandise to Branches at Prices
above Home Office Cost
 Similar information as in the previous example, except that
the home office bills merchandise shipped to Hawassa branch at
50% markup of the cost, or 331/3% of billed price.
GP = NS-CGS….GP=0.5 CGS= CGS=2GP
GP=NS-2GP…..NS=3GP----GP=0.333NS or GP=33.33% OF NS.
Thus, 50% Above home office cost means 33.33% above billed price.
Exercise: Find the billed price, If the home office bills
merchandise shipped to branch at 40% markup of the cost?
 Thus, the shipment of merchandise costing $60,000 will be
recorded at the home office and branch as follows:
 60,000 + (0.5*60,000) = 90,000
 Cont.…
Journal entries for shipments to branch at prices above home
office cost
(Perpetual inventory system):

HO: Adjusting and Closing Hawassa Branch : Closing

Entries: Entries:
Investment- HB….. 90,000 Inventory……….. 90,000
Inventories…..…............. 60,000 Home Office…………….. 90,000
AFOVI……………….……... 30,000
 Thus, the balances of both the Investment in Hawassa
Branch account and Home Office account will be $56,000,
instead of $26,000 due to the inventory mark up of $30,000.
 AFOVI=Allowance For Over Valuation of Inventory. It is
Unrealized gain.
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 Working paper when billings to branches are at
cost plus mark-up
 When the home office bills merchandise shipments to
branches at prices above home office cost, preparation
of working paper for combined financial statement is
facilitated by an analysis of the flow of merchandise to
a branch, such as the following for Hawassa Branch of
Garad PLC.

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Cont…

20-34
 Cont.…
Garad PLC
Flow of Merchandise for Hawassa Branch
During 2013
Billed Home Markup
Price Cost
Beginning
inventories 0 0 0
Add: Shipments
from home office 90,000 60,000 30,000
CGAS 90,000 60,000 30,000
Less: Ending
inventories 22,500 15,000 7,500
Cost of goods
sold 67,500 45,000 22,500
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Cont…

20-36
Cont…

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 HO and Branch adjusting and closing entries

 Branch Closing Entries-The closing entries for

the branch at the end of 2013 are as follows:
Sales…………………………………....80,000
Income Summary……………………...10,500
Cost of Goods Sold…………………………..67,500
Operating Expenses………………………….23,000
To close revenue and expense ledger accounts
Home Office……………….................10,500
Income Summary……………………………10,500
To close the net loss in the Income Summary account to the Home
Office account

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 Cont.…
 After the closing entries, the Home Office ledger
account should have a balance of Br.45,500.
 Note: Home Office balance prior to the closing
entries equals Br.56,000. Br.56,000-net loss of
Br.10,500 = Br.45,500 (net loss decreases Home
Office credit balance).

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 Cont.…
Home Office Adjusting and Closing Entries
Income- HB………........................ 10,500
Investment in HB………………………… 10,500
To record net loss reported by branch

AFOVI- HB………………………….. 22,500

Realized Gross Profit- HB…................... 22,500
To reduce allowance to amount by which ending inventories of branch
exceed cost.

Realize Gross Profit: HB…………… 22,500

Income: HB…………................................ 10,500
Income Summary……….......................... 12,000
To close branch net loss and RGP to Income Summary ledger account
(Income tax effects are disregarded.)
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 Cont.….
After posting the above entries, the account balance
for the following accounts is:
Investment in HB =45,500(debit)*
AFOVI- HB =7,500(credit)**
Realized Gross Profit: HB =0
Income: HB =0
* Balance prior to the above entries equals Br.56,000. Br.56,000- 10,500
(net loss of the branch reduces the debit balance of the Investment
account) = Br.45,500.
** Br.30,000-22,500 = Br.7,500.

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 Periodic Inventory System

 When a periodic inventory system is adopted,

inventory account cannot be used for the shipments
of merchandise between the home office and the
branch.
 Accounts such as “Shipments to Branch” (used by
the home office) and “Shipments from Home Office”
(used by the branch) are used.

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 Transactions between Branches

 Reading Assignment (Larsen.

Advanced Accounting)

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 END OF
CHAPTER
2