Chapter five

Accounting for Branch, and Head office

2.1) Distinguishing Sales Agency, Branch, and Division

Sales Agency:
Sales agency is a term applied to a business unit that performs only a small portion of the functions
associated branch. A sales agency usually carries samples of products but does not have an inventory of
merchandise and usually lesser degree of autonomy.

Branch:
The term Branch is used to describe a business unit located at some distance from the Home Office.
Branches are economic and accounting entities. However, branches are not legal entity. Branches may carry
merchandise obtained from Home Office, make sales, approve customers’ credit, and make collections from
its customers.

Division:
Division is a business segment or a business enterprise which generally has more autonomy than a branch.
Division may be as separate company or may not be a separate company. If the division is not a separate
company, the accounting procedures are the same as Branch. If the division is a separate company
(subsidiary company), the financial accounting requires consolidation, which will be discussed in later
topics.
Differences between Sales Agency, Branch and Division
Characteristics Sales Agency Branch Division
Degree of Autonomy Low Moderate High
Accounting Entity No Yes Yes
Legal Entity No No Possible
Economic Entity No No Possible

2.2 Accounting System 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. For example, a sales agency usually carries samples of
products but does not have an inventory of merchandise. Orders are taken from customers and transmitted to
the Home Office, which approves the customers’ credit and ships the merchandise directly to customers.
The agency’s accounts receivable are maintained at the Home Office, which also performs the collection
function. An imprest cash fund generally is maintained at the sales agency for the payment of operating
expenses. A sales agency that does not carry an inventory of merchandise, maintain receivables, or make
collections has no need for a complete set of accounting records. All that is needed is a record of sales to
customers and a summary of cash payments supported by vouchers.

If the Home Office wants to measure the profitability of each sales agency separately, it will establish in the
general ledger separate revenue and expense accounts in the name of the agency, for example, Sales: Sales
Agency; Rent Expense: Sales Agency. The cost of goods sold by each agency also must be measured.
When perpetual inventory system is used, shipments to customers by sales agency, for example, are debited
to Cost of Goods Sold: Sales Agency account and credited to Inventories account.

When the periodic inventory system is used, a shipment of goods sold by an agency may be recorded by a
debit to Cost of Goods Sold: Sales Agency and a credit to Shipments to Agencies. This journal entry is
recorded only at the end of an accounting period if a memorandum record is maintained during the period
listing the cost of goods shipped to fill sales orders received from agencies. At the end of the period the
Shipments to Agencies ledger account is offset against the total of beginning inventories and purchases to
measure the cost of goods available for sale for the Home Office in its own operations.

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Office furniture or other assets located at a sales agency may be carried in a separate ledger account by the
Home Office, or control over such assets may be achieved by use of a subsidiary ledger with a complete
record for each asset showing cost, location, and any other relevant information.

Summary of Sales Agency:

 Sales agency is sometimes applied to a business unit that performs only a small portion of the
functions associated branch.
 A sales agency usually carries samples of products but does not have an inventory of merchandise
 Orders are taken from customers and transmitted to the Home Office
 The Home Office approves the customers’ credit and ships the merchandise directly to customers. The
sales agency’s receivable are maintained by the Home Office
 The Home Office also performs collection function
 An imprest cash fund generally is maintained at sales agency for the payment of operating expenses.
 A sales agency that does not carry an inventory of merchandise, maintain receivables, or make
collections has no need for a complete set of accounting.

Illustration 2.1: Journal Entries made by Home Office to Record Sales Agency’s Transaction. The sales
agency is named Lakeview Agency
Home Office:
To record merchandise shipped to sales agency for use as samples
Inventory of Samples: Lakeview Agency................................... 1,500
Inventories.................................................................. 1,500

To establish Imprest cash fund for sales agency

Imprest Cash Fund: Lakeview Agency....................................... 1,000
Cash.................................................................................. 1,000

To record sales made by sales agency

Trade Account Receivables........................................................ 50,000
Sales: Lakeview Agency............................................ 50,000

To record cost of merchandise sold by sales agency

Cost of Goods Sold: Lakeview Agency..................................... 35,000
Inventories..................................................... 35,000

To replenish imprest cash fund which represents several checks sent to agent
Operating Expenses: Lakeview Agency..................................... 10,000
Cash.......................................................................... 10,000

To close revenue and expense accounts of sales agency to a separate Income

Summary Account
Sales: Lakeview Agency............................................................. 50,000
Cost of Goods Sold: Lakeview Agency........................... 35,000
Operating Expenses: Lakeview Agency.......................... 10,000
Income Summary: Lakeview Agency............................. 5,000

To close net income of sales agency to income summary ledger account

Income Summary: Lakeview Agency........................................ 5,000
Income Summary............................................. 5,000

2.3) Accounting System for Branch and Division

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As a business enterprise grows, it may establish one or more branches to market its products over a large
territory. The term Branch is used to describe a business unit located at some distance from the Home
Office. This unit carries merchandise obtained from the Home Office, makes sales, approves customers’
credit, and makes collections from its customers. A branch may obtain merchandise solely from the Home
Office, or a portion may be purchased from outside suppliers. The cash receipts of the branch often are
deposited in a bank account belonging to Home Office; the branch expenses then are paid from an imprest
cash fund or a bank account provided by the Home Office. As the imprest cash fund is depleted, the branch
submits a list of cash payments supported by vouchers and receives a check for a transfer from the Home
Office to replenish the fund.

The use of an imprest cash fund gives the Home Office considerable control over the cash transactions of
the branch. However, it is common practice for a large branch to maintain its own bank accounts. The extent
of autonomy and responsibility of a branch varies, even among different branches of the same business
enterprise.

A segment of a business enterprise also may be operated as division, which generally has more autonomy
than a branch. The accounting procedures for a division not organized as Separate Corporation (subsidiary
company) are similar to those used for branches. When a business segment is operated as a separate
corporation, consolidated financial statements generally are required.

Start-Up Costs of Opening New Branches

The establishment of a branch often requires the incurring of considerable costs before significant revenue
may be generated. Operating losses in the first few months are likely. In the past, some business enterprises
would capitalized and amortize such start-up costs on the grounds that such costs are necessary to successful
operation at a new location. However, most enterprise recognized start-up costs in connection with the
opening of a branch as expenses the accounting period in which the costs are incurred. The decision should
be based on the principle that net income is measured by matching expired costs with realized revenue.
Costs that benefit future accounting periods are deferred and allocated to those periods. Seldom is there
complete certainty that a new branch will achieve a profitable level of operations in later years. In
recognition of this fact, in 1998 the AICPA Accounting Standards Executive Committee issued Statement of
Position 98-5 (SOP 98-5), “Reporting on the Costs of Start-Up Activities,” which required expensing of all
start-up costs, including those associated with organizing a new entity such as a branch or division.

Accounting System for a Branch and Home Office

The accounting system of one business enterprise having branches may provide for a complete set of
accounting records at each branch; policies of another such enterprise may keep all accounting records in
the Home Office. For example, branches of drug and grocery chain stores submit daily reports and business
documents to the Home Office, which enters all transactions by branches in computerized accounting
records kept in a central location. The Home Office may not even conduct operations of its own; it may
serve only as an accounting and control center for the branches.

A branch may maintain a complete set of accounting records consisting of journals, ledgers, and a chart of
accounts similar to those of an independent business enterprise. Financial statements are prepared by the
branch accountant and forwarded to the Home Office. The number and types of ledger accounts, the internal
control structure, the form and content of the financial statements, and the accounting policies generally are
prescribed by the Home Office.

This section focuses on a branch operation that maintains a complete set of accounting records. Transactions
recorded by a branch should include all controllable expenses and revenue for which the branch manager is
responsible. If the branch manager has responsibility over all branch assets, liabilities, revenue, and
expenses, the branch accounting records should reflect this responsibility. Expenses such as depreciation
often are not subject to control by a branch manager; therefore, both the branch plant assets and the related
depreciation ledger accounts generally are maintained by the Home Office.

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2.3.1 Reciprocal Ledger Accounts
The accounting records maintained by a branch include a Home Office ledger account.
 Home Office account is credited for all merchandise, cash, or other assets provided by the Home
Office;
 Home Office account is debited for all cash, merchandise, or other assets sent by the branch to the
Home Office or to other branches.
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 an accounting period when the branch closes it accounting records, the
Income Summery 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.

In the Home Office accounting records, a reciprocal ledger account with a title such as Investment in
Branch is maintained.
 Investment in Branch is a non-current asset account, which is debited for cash, merchandise, and
services provided to the branch by the Home Office, and for net income reported by the branch.
 Investment in Branch is credited for cash or other assets received from the branch, and for net losses
reported by the branch.

Thus, the Investment in Branch account reflects the equity method of accounting. A separate investment
account generally is maintained by the Home Office for each branch. If there is only one branch, the account
title is likely to be Investment in Branch; if there are numerous branches, each account title includes a name
or number to identify each branch.

2.3.2 Expenses Incurred by Home Office and Allocated to Branches

Some business enterprises follow a policy of notifying each branch of expenses incurred by the Home
Office on the branch’s behalf. Plant assets located at a branch generally are carried in the Home Office
accounting records. If a plant asset is acquired by the Home Office for the branch, the journal entry for the
acquisition is a debit to an appropriate asset account such as Equipment: Branch and a credit to Cash or an
appropriate liability account. If the branch acquires a plant asset, it debits the Home Office ledger account
and credits Cash or an appropriate liability account. The Home Office debits an asset account such as
Equipment: Branch and credits Investment in Branch.

The Home Office also usually acquires insurance, pays property and other taxes, and arranges for
advertising that benefits all branches. Clearly, such expenses as depreciation, property taxes, insurance, and
advertising must be considered in determining the profitability of a branch. A policy decision must be made
as to whether these expense data are to be retained at the Home Office or are to be reported to the branches
so that the income statement prepared for each branch will give a complete picture of its operations. 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 a Credit to an appropriate expense ledger account; the branch debits an expense
account and credits Home Office.

If the Home Office does not make sales, but functions only as an accounting and control center, most or all
of its expenses may be allocated to the branches. To facilitate comparison of the operating results of the
various branches, the Home Office may charge each branch interest on the capital invested in that branch.
Such interest expense recognized by the branches would be offset by interest revenue recognized by the
Home Office and would not be displayed in the combined income statement of the business enterprise as a
whole.

2.3.3 Alternative Methods of Billing Merchandise Shipments to Branches

Three alternative methods area available to the Home Office for billing merchandise shipped to its branches.
The shipments may be billed:

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1. At Home Office cost,
2. At a percentage above Home Office cost, or
3. At the branch’s retail selling price
The shipment of merchandise to a branch does not constitute a sale, because ownership of the merchandise
does not change.
1. Billing shipments to a branch at Home Office cost
This is the simplest procedure and is widely used. It avoids the complication of unrealized gross profit in
inventories and permits the financial statements of branches to give a meaningful picture of operations.
However, billing merchandise to branches at Home Office cost attributes all gross profits of the enterprise to
the branches, even though some of the merchandise may be manufactured by the Home Office. Under these
circumstances, Home Office cost may be the most realistic basis for billing shipment to branches.

2. Billing shipments at a percentage above Home Office cost (such as 110% of cost)
This may be intended to allocate a reasonable gross profit to the Home Office. When merchandise is billed
to a branch at a price above Home Office cost, the net income reported by the branch is understated and
the ending inventories are over-stated for the enterprise as a whole. Adjustments must be made by the
Home Office to eliminate the excess of billed prices over cost (intracompany profits) in the preparation of
combined financial statements for the Home Office and the branch.

3. Billing shipments to a branch at branch retail selling prices

This may be based on a desire to strengthen internal control over inventories. The inventories ledger account
of the branch shows the merchandise received and sold at retail selling prices. Consequently, the account
will show the ending inventories that should be on hand at retail prices. The Home Office record of
shipments to a branch, when considered along with sales reported by the branch, provides a perpetual
inventory stated at selling prices. If the physical inventories taken periodically at the branch do not agree
with the amounts thus computed, an error or theft may be indicated and should be investigated promptly.

2.3.4 Separate Financial Statements for Branch and for Home Office
A separate income statement and balance sheet should be prepared for a branch so management of the
enterprise may review the operating results and financial position of the branch. The branch’s income
statement has no usual features if merchandise is billed to the branch at Home Office cost. However, if
merchandise is billed to the branch at branch retail selling prices, the branch’s income statement will show a
net loss approximating the amount of operating expenses. The only unusual aspect of the balance sheet for a
branch is use of the Home Office ledger account in lieu of the ownership equity accounts for a separate
business enterprise. The separate financial statements prepared for a branch may be revised at the Home
Office to include expenses incurred by the Home Office allocable to the branch and to show the results of
branch operations after elimination of any intracompany profits on merchandise shipments.

Separate financial statements also may be prepared for the Home Office so that management will be able to
appraise the results of its operations and its financial position. However, it is important to emphasize that
separate financial statements of the Home Office and of the branch are prepared for internal use only; they
do not meet the needs of investors or other external users of financial statements.

2.3.5 Combined Financial Statements for Home Office and Branch

A balance sheet for distribution to creditors, stockholders, and government agencies must show the financial
position of a business enterprise having branches as a single entity. A convenient starting point in the
preparation of a combined balance sheet consists of the adjusted trial balances of the Home Office and the
Branch.

 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 accounts receivable, and other assets and liabilities of the enterprise as a whole.

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 In the preparation of a combined balance sheet, reciprocal ledger accounts are eliminated because 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; also,
 Any receivables and payables between the Home Office and the branch (or between two branches) are
eliminated.
The operating results of the enterprise (the Home Office and all branches) are shown by an income
statement in which the revenue and expenses of the branches are combined with corresponding revenue and
expenses for the Home Office. Any intracompany profits or losses are eliminated.

2.4) Illustrative Transactions and Financial Statements for the Branch and HO

Illustration 2.2: Assume JIMMA TRADING Company bills merchandise to AGARO Branch at Home
Office cost and that AGARO 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 accounting records. Certain 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 (2005) of operations of AGARO Branch are summarized below (start-up costs
are disregarded):
1. Cash of Br 1,000 was forwarded by the Home Office to AGARO Branch.
2. Merchandise with a Home Office cost of Br 60,000 was shipped by the Home Office to AGARO
Branch.
3. Equipment was acquired by AGARO Branch for Br 500, to be carried in the Home Office
accounting records. (Other plant assets for AGARO Branch generally are acquired by the Home
Office.)
4. Credit sales by AGARO 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 AGARO Branch amounted to Br 62,000.
6. Payments for operating expenses by AGARO Branch totaled Br 20,000.
7. Cash of Br 37,500 was remitted by AGARO Branch to the Home Office.
8. Operating expenses incurred by the Home Office and charged to AGARO Branch totaled Br 3,000.
These transactions and events are recorded by the Home Office and by AGARO Branch as follows
(explanations for the journal entries are omitted):

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 Typical Home Office and Branch Transactions and Events under Perpetual Inventory System
Home Office Accounting Records AGARO Branch Accounting Records
Journal Entries Journal Entries
1. Investment in AGARO Branch.......... 1,000 Cash .............................................
1,000
................................................................
................................................................
................................................................
Cash........................................... 1,000 Home Office a/c ................... 1,000
2. Investment in AGARO Branch.......... 60,000 Inventories....................................60,000
Inventories.................................... 60,000 Home Office.......................... 60,000

3. Equipment: AGARO Branch.............

500
Home Office.................................
500
Investment in AGARO 500 Cash....................................... 500
Branch....................................................
4. None Trade Accounts Receivables........ 80,000
Sales....................................... 80,000
Cost of Goods Sold....................... 45,000
Inventories............................. 45,000
5. None Cash..............................................
62,000
T/Accounts Receivables........ 62,000
6. None Operating Expenses...................... 20,000
Cash....................................... 20,000
7. Cash....................................................
37,500 Home Office................................. 37,500
Investment in AGARO 37,500 Cash....................................... 37,500
Branch....................................................
8. Investment in AGARO Branch.......3,000 Operating Expenses......................
3,000
Operating Expenses...................... 3,000 Home Office.......................... 3,000

If a branch obtains merchandise from outsiders as well as from the Home Office, the merchandise acquired
from the Home Office may be recorded in a separate Inventory account from Home Office ledger account.
In the Home Office accounting records, the Investment in AGARO Branch ledger account has a debit
balance of Br 26,000 before the accounting records are closed and the branch net income of Br 12,000 (Br
80,000 – Br 45,000 – Br 20,000 – Br 3,000 = Br 12,000) is transferred to the Investment in AGARO Branch
ledger account, as illustrated below:

Investment in AGARO Branch Account

Date Explanation Debit Credit Balance
2005 Cash sent to branch................................................... 1,000 1,000 Dr
Merchandise billed to branch at Home Office cost... 60,000 61,000 Dr
Equipment acquired by branch, account by HO....... 500 60,500 Dr
Cash received from branch........................................ 37,500 23,000 Dr
Operating expenses billed to branch......................... 3,000 26,000 Dr

In the accounting records of AGARO Branch, the Home Office ledger account has a credit balance of Br
26,000 (before the accounting records are closed and the net income of Br 12,000 is transferred to the Home
Office account), as shown bellow:

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 Home Office Account
Date Explanation Debit Credit Balance
2005 Cash received from the office................................... 1,000 1,000 Cr
Merchandise received from Home Office................. 60,000 61,000 Cr
Equipment Acquired................................................. 500 60,500 Cr
Cash Sent to Home Office......................................... 37,500 23,000 Cr
Operating expenses billed by Home Office.............. 3,000 26,000 Cr

2.5) Working Paper for Combined Financial Statements

A working paper for combined financial statements has three purposes:
1. To combine ledger account balances for like revenue, expenses, assets, and liabilities,
2. To eliminate any intracompany profits or losses, and
3. To eliminate the reciprocal accounts
Assume that the perpetual inventories of Br 15,000 (Br 60,000 – Br 45,000 = Br 15,000) at the end of 2005
for AGARO Branch had been verified by a physical count. The working paper for JIMMA TRADING
Company is based on the transactions and events shown in the above illustration and additional assumed
data for the Home Office trial balance. All the routine year-end adjusting entries are assumed to have been
made, and the working paper is begun with the adjusted trial balances of the Home Office and AGARO
Branch. Income taxes are disregarded in this illustration.

Note that the Br 26,000 debit balance of the Investment in AGARO Branch ledger account and the Br
26,000 credit balance of the Home Office account are the balances before the respective accounting
records are closed, that is, before the Br 12,000 net income of AGARO Branch is entered in these two
reciprocal accounts. In the Eliminations column, elimination (a) offsets the balance of the Investment in
AGARO Branch account against the balance of the Home Office account. This elimination appears in the
working paper only; it is not entered in the accounting records of either the Home Office or AGARO
Branch because the sole purpose of the working paper is to facilitate the preparation of combined financial
statements.

2.5.1 Illustration on Combined Financial Statements

The following working paper provides the information for the combined financial statements (excluding a
statement of cash flows) of JIMMA TRADING Company below.

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 JIMMA TRADING COMPANY
WORKING PAPER FOR COMBINED FINANCIAL STATEMENTS OF HO AND
AGARO BRANCH
FOR YEAR ENDED DECEMBER 31, 2005
(PERPETUAL INVENTORY SYSTEM: BILLINGS AT COST)
Adjusted Trial Balance
Home Office Branch Elimination Combined
Dr (Cr) Dr (Cr) Dr (Cr) Dr (Cr)
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
Totals............................................... -0- -0- -0- -0-
Statement of Retained
Earnings
Retained Earnings, Jan.1, 2005....... (70,000) (70,000)
Net Income from above.................. (75,000) (12,000) (87,000)
Dividends Declared......................... 40,000 40,000
Retained Earnings, Dec.31,2005..... (117,000)
Totals............................................... -0-
Balance Sheet
Cash................................................. 25,000 5,000 30,000
Trade Accounts Receivables........... 39,000 18,000 57,000
Inventories....................................... 45,000 15,000 60,000
Investment in AGARO Branch....... 26,000 a (26,000)
Equipment....................................... 150,000 150,000
Accumulated Depreciation.............. (10,000) (10,000)
Trade Accounts Payable................. (20,000) (20,000)
Home Office.................................... (26,000) a 26,000
Common Stock, Br 10 par.............. (150,000) (150,000)
Retained Earnings from above........ (117,000)
Totals............................................... -0- -0- -0- -0-
(a) To eliminate reciprocal ledger account balances

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Combined Income Statement
JIMMA TRADING COMPANY
Combined Income Statement
For Year Ended December 31, 2005
Sales............................................................................................. Br 480,000
Cost of goods sold........................................................................ 280,000
Gross margin on sale.................................................................... Br 200,000
Operating expenses...................................................................... 113,000
Net income................................................................................... Br 87,000
Basic earnings per share of common stock.................................. Br 5.80
Statement of Retained Earnings
JIMMA TRADING COMPANY
Statement of Retained Earnings
For Year Ended December 31, 2005
Retained earnings, beginning of year................................................. Br 70,000
Add: Net income................................................................................ 87,000
Subtotal.............................................................................................. Br 157,000
Less: Dividends (Br 2.67 per share).................................................. 40,000
Retained earnings, end of year........................................................... Br117,000
Balance Sheet
JIMMA TRADING COMPANY
Balance Sheet
December 31, 2005
Assets:
Cash........................................................................................................Br 30,000
Trade accounts receivable (net)............................................................. 57,000
Inventories.............................................................................................. 60,000
Equipment.......................................................................
........................................................................................Br150,000
Less: Accumulated depreciation..................................... 140,000
10,000
Total assets......................................................................................... Br 287,000
Liabilities & Stockholders’ Equity:
Liabilities
Trade accounts payable Br 20,000
Stockholders’ equity
Common Stock, Br 10 par, 15,000 shares authorized,
issued, and outstanding................................................... Br150,000
Retained earnings............................................................ 117,000 267,000
Total liabilities & stockholders’ equity............................................... Br 287,000

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2.5.2 Home Office Adjusting and Closing Entries and Branch Closing Entries
The Home Office’s equity-method adjusting and closing entries for branch operating results and the
branch’s closing entries on December 31, 2005, are shown below (explanations for the entries are omitted):

Home Office Accounting Records AGARO Branch Accounting Records

Adjusting and Closing Entries Closing Entries
None Sales....................................... 80,00
Cost of Goods sold......... 45,000
Operating Expenses........ 23,000
Income Summary............ 12,000
Investment in AGARO Branch.....12,000 Income Summary................... 12,000
Income: AGARO Branch....... 12,000 Home Office................... 12,000
Income: AGARO Branch..............12,000 None
Income Summary................... 12,000

2.6) Billing of Merchandise to Branches at Prices above Home Office Cost

The Home Offices of some business enterprises bill merchandise shipped to branches at Home Office cost
plus a markup percentage (or alternatively at branch retail selling prices). Because both these methods
involve similar modifications of accounting procedures, a single example illustrates the key points involved,
using the illustration for JIMMA TRADING Company one changed assumption: the Home Office bill
merchandise shipped to AGARO Branch at a markup of 50% above Home Office cost, or 33 1/3 % of
billed price.

Under this assumption, the journal entries for the first year’s events and transactions by the Home Office
and AGARO Branch are the same as those presented on the journal entries for shipments of merchandise
from the Home Office to AGARO Branch. These shipments (Br 60,000 Cost + 50% markup on cost = Br
90,000) are recorded under the perpetual inventory system as follows:
Home Office Accounting Records AGARO Branch Accounting Records
Journal Entries Journal Entries
Investment in AGARO Branch........ 90,000 Inventories 90,00
0
Inventories.................................. 60,000 Home Office.............. 90,000
AFOVI........................... 30,000

In the accounting records of the Home Office, the Investment in AGARO Branch ledger account below now
has a debit balance of Br 56,000 before the accounting records are closed and the branch net income or loss
is entered in the Investment in AGARO Branch account. This account is Br 30,000 larger than the Br 26,000
balance in the prior illustration. The increase represents the 50% markup over cost (Br 60,000) of the
merchandise shipped to the AGARO Branch.

Investment in AGARO Branch a/c

Date Explanation Debit Credit Balance
2005 Cash sent to branch................................................... 1,000 1,000 Dr
Merchandise billed to branch at 50% over cost........ 90,000 91,000 Dr
Equipment acquired by branch, carried in HO.......... 500 90,500 Dr
Cash received from branch........................................ 37,500 53,000 Dr

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 Operating expenses billed to branch......................... 3,000 56,000 Dr

In the accounting records of AGARO Branch, the Home Office ledger account now has a credit balance of
$56,000; before the accounting records are closed and the branch net income or loss is entered in the Home
Office account, as illustrated below:
Home Office a/c
Date Explanation Debit Credit Balance
2005 Cash received from the office................................... 1,000 1,000 Cr
Merchandise received from Home Office................. 90,000 91,000 Cr
Equipment Acquired ................................................ 500 90,500 Cr
Cash Sent to Home Office......................................... 37,500 53,000 Cr
Operating expenses billed by Home Office.............. 3,000 56,000 Cr

AGARO Branch recorded the merchandise received from the Home Office at billed prices of Br 90,000; the
Home Office recorded the shipment by credits of Br 60,000 to Inventories and Br 30,000 to Allowance for
Overvaluation of Inventories (AFOVI): AGARO Branch. Use of the allowance account enables the Home
Office to maintain a record of the cost of merchandise shipped to AGARO Branch as well as the amount of
the unrealized gross profit on the shipments.

At the end of the accounting period, AGARO Branch reports its inventories (at billed prices) at Br 22,500.
The cost of these inventories is Br 15,000 (Br 22,500.1.50 = Br 15,000). In the Home Office accounting
records, the required balance of the Allowance for Overvaluation of Inventories: AGARO Branch ledger
account is Br 7,500 (Br 22,500 – Br 15,000 = Br 7,500); thus, this account balance must be reduced from its
present amount of Br 30,000 to Br 7,500. The reason for this reduction is that the 50% markup of billed
prices over cost has become realized gross profit to the Home Office with respect to the merchandise sold
by the branch. Consequently, at the end of the year the Home Office reduces its allowance for overvaluation
of the branch inventories to the Br 7,500 excess valuation contained in the ending inventories. The debit
adjustment of Br 22,500 in the allowance account is offset by a credit to the Realized Gross Profit: AGARO
Branch Sales account, because it represents additional gross profit of the Home Office resulting from sales
by the branch.

Working Paper When Billings to Branches Are at Prices above Cost

When a Home Office bills merchandise shipments to branches at prices above Home Office cost,
preparation of the working paper for combined financial statements is facilitated by any analysis of the flow
of merchandise to a branch, such as the following for AGARO Branch of JIMMA TRADING Company:

JIMMA TRADING COMPANY

Flow of Merchandise for AGARO Branch
During 2005
Billed HO Markup
Price Cost (50% of Cost)
Beginning Inventories............................................... -0- -0- -0-
Add: Shipments from Home Office Br 90,000 Br 60,000 Br 30,000
...................................................................................
Available for Sale......................................................
Br 90,000 Br 60,000 Br 30,000
Less: Ending Inventories...........................................22,500 15,000 7,500
Cost of Goods Sold...................................................
Br 67,500 Br 45,000 Br 22,500

The foregoing analysis provides in the Markup column the information needed for the Eliminations column
in the working paper for combined financial statements below:

12
 JIMMA TRADING COMPANY AND AGARO BRANCH
Working Paper for Combined Financial Statements
For The Year Ended December 31, 2005
(Perpetual Inventory System and Billings Above Cost)
Adjusted Trial
Balances
Home Office Branch Elimination Combine
d
Dr (Cr) Dr (Cr) Dr (Cr) Dr (Cr)
Income Statement
Sales................................................ (400,000) (80,000) (480,000)
Cost of Goods Sold......................... 235,000 67,500 a (22,500) 280,000
Operating Expenses........................ 90,000 23,000 113,000
Net Income (loss)............................ 75,000 (10,500) b 22,500 87,000
Totals............................................... -0- -0- -0- -0-
Statement of Retained
Earnings
Retained Earnings, Jan.1, 2005....... (70,000) (70,000)
Net Income from above.................. (75,000) 10,500 b (22,500) (87,000)
Dividends Declared......................... 40,000 40,000
Retained Earnings, Dec.31,2005..... (117,000)
Totals............................................... -0-
Balance Sheet
Cash................................................. 25,000 5,000 30,000
Trade Accounts Receivables 39,000 18,000 57,000
Inventories....................................... 45,000 22,500 a (7,500) 60,000
AFOVI............................................ (30,000) a 30,000
Investment in AGARO Branch....... 56,000 c (56,000)
Equipment....................................... 150,000 150,000
Accumulated Depreciation.............. (10,000) (10,000)
Trade Accounts Payable................. (20,000) (20,000)
Home Office.................................... (56,000) c 56,000
Common Stock, Br 10 par.............. (150,000) (150,000)
Retained Earnings from above........ (117,000)
Totals............................................... -0- -0- -0- -0-

Elimination Journal Entries:

a) To reduce ending inventories and cost of goods sold of branch to cost, and to eliminate unadjusted
balance of Allowance of Overvaluation of Inventories: AGARO Branch ledger account.
AFOVI 30,000
Cost of Goods Sold........................ 22,500
Inventory........................................ 7,500
(b) To increase income of Home Office by portion of merchandise markup that was realized by branch
sales.
Unrealized Gross Profit..............................22,500

13
 Realized Income: AGARO Branch...... 22,500
(c) To eliminate reciprocal ledger account balances
Home Office...............................................56,000
Investment in AGARO Branch............ 56,000
The working paper above differs from the working paper when merchandise shipped at Home Office cost by
the inclusion of an elimination to restate the ending inventories of the branch to cost. Also, the income
reported by the Home Office is adjusted by the Br 22,500 of merchandise markup that was realized as a
result of sales by the branch. This amount in the Eliminations column appears only in the working paper.
The amounts represent a mechanical step to aid the preparation of combined financial statements and are not
entered in the accounting records of either the Home Office or the branch.

Combined Financial Statements

Because the amounts in the Combined column of the working paper are the same as in the working paper
prepared when the merchandise shipments to the branch were billed at Home Office cost, the combined
financial statements are identical to those illustrated when merchandise is shipped at Home Office cost.

Home Office Adjusting and Closing Entries and Branch Closing Entries
The adjusting and closing entries are different. The December 31, 2005, adjusting and closing entries of the
Home Office are illustrated below assuming the merchandise is shipped 50% above Home Office cost:

Home Office Accounting Records

Adjusting and Closing Entries
1 Income: AGARO Branch (loss).......................................... 10,500
. Investment in AGARO Branch................................. 10,500
To record net loss reported by branch
2 AFOVI: AGARO Branch................................................... 22,500
. Realized Gross Profit................................................. 22,500
To reduce allowance to amount by which ending inventories of branch exceed cost
3 Realized Gross Profit: AGARO Branch Sales.................... 22,500
. Income: AGARO Branch.......................................... 10,500
Income Summary...................................................... 12,000
To close branch net loss and realized gross profit to Income Summary account

After the forgoing journal entries have been posted, the ledger accounts in the Home Office general ledger
used to record branch operations are as follows:

Investment in AGARO Branch a/c

Date Explanation Debit Credit Balance
2005 Cash sent to branch........................................................ 1,000 1,000 Dr
Merchandise billed to branch at 50% markup over 90,000 91,000 Dr
cost.................................................................................
Equipment acquired by branch, carried in HO.............. 500 90,500 Dr
Cash received from branch............................................ 37,500 53,000 Dr
Operating expenses billed to branch.............................. 3,000 56,000 Dr
Net loss for 2005 reported by branch............................. 10,500 45,500 Dr

14
End-of-Period Balance in Accounting Records of the Home Office
Allowance for Overvaluation of Inventories: AGARO Branch
Date Explanation Debit Credit Balance
2005 Markup on merchandise shipped to branch
During 2005 (50% of cost).................................................... 30,000 30,000 Cr
Realization of 50% markup on merchandise
Sold by branch during 2005...................................................
22,500 7,500 Cr

Realized Gross Profit: AGARO Branch Sales

Date Explanation Debit Credit Balance
2005 Realization of 50% markup on merchandise
sold by branch during 2005.................................................... 22,500 22,500 Cr
Closing Entries.......................................................................
22,500 -0-

Income: AGARO Branch

Date Explanation Debit Credit Balance
2005 Net loss for 2005 reported by branch..................................... 10,500 10,500 Dr
Closing Entries....................................................................... 10,500 -0-.

In the separate balance sheet for the Home Office, the Br 7,500 credit balance of the Allowance for
Overvaluation of Inventories: AGARO Branch ledger account is deducted from the Br 45,000 debit balance
of the Investment in AGARO Branch account, thus reducing the carrying amount of the investment account
to a cost basis with respect to shipments of merchandise to the branch. In the separate income statement for
the Home Office, the Br 22,500 realized gross profit on AGARO Branch sales may be displayed following
gross margin on sales, Br 165,000 (Br 400,000 sales – Br 235,000 cost of goods sold = Br 165,000).

The closing entries for the branch at the end of 2005 are as follows:
AGARO Branch Accounting Records
Closing Entries
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 HO account.

After these closing entries have been posted by the branch, the following Home Office ledger account in the
accounting records of AGARO Branch has a credit balance of Br 45,500, the same as the debit balance of
the Investment in AGARO Branch account in the accounting records of the Home Office:

Home Office
Date Explanation Debit Credit Balance
2005 Cash received from the office................................... 1,000 1,000 Cr

15
 Merchandise received from Home Office cost 90,000 91,000 Cr
...................................................................................
Equipment acquired................................................... 500 90,500 Cr
Cash sent to Home Office......................................... 37,000 53,000 Cr
Operating expenses billed to branch......................... 3,000 56,000 Cr
Net loss for 2005....................................................... 10,500 45,500 Cr

2.7) Treatment of Beginning Inventories Priced above Cost

The working paper shows how the ending inventories and the related allowance for overvaluation of
inventories were handled. However, because 2005 was the first year of operations for AGARO Branch, no
beginning inventories were involved.

Perpetual Inventory System

Under the perpetual inventory system, no special problems arise when the beginning inventories of the
branch include an element of unrealized gross profit.

Periodic Inventory System

To continue the illustration for JIMMA TRADING Company for a second year of operations (2006) to
demonstrate the handling of beginning inventories carried by AGARO Branch at an amount above Home
Office cost, assume that both the Home Office and AGARO Branch adopted the periodic inventory system
in 2006. When the periodic inventory system is used, the Home Office credits Shipments to Branch (an
offset account to Purchases) for the Home Office cost of merchandise shipped and Allowance for
Overvaluation of Inventories for the Markup over Home Office cost. The branch debits Shipments from
Home Office (analogous to a Purchase account) for the billed price of merchandise received.

The beginning inventories for year 2006 were carried by AGARO Branch at Br 22,500, or 150% of the cost
of Br 15,000 (Br 15,000 @ 1.50 = Br 22,500). Assume that during 2006 the Home Office shipped
merchandise to AGARO Branch that cost Br 80,000 and was billed at Br 120,000, and that AGARO Branch
sold for Br 150,000 merchandise that was billed at Br 112,500. The journal entries to record the shipments
and sales under the periodic inventory system are illustrated below:
Home Office Accounting Records AGARO Branch Accounting Records
Journal Entries Journal Entries
Investment in AGARO 120,000 Shipments from HO............................. 120,000
Branch............................................
Shipment to Mete 80,000 Home Office........................... 120,000
Branch............................................
AFOVI: AGARO 40,000
Branch............................................
None Cash or Trade Accounts Rec...............150,000
Sales............................................ 150,000

The inventories in a branch at the end of 2006 amounted to Br 30,000 at billed prices, representing cost of
Br 20,000 plus a 50% markup on cost (Br 20,000 @ 1.5 = Br 30,000). The flow of merchandise for
AGARO Branch during 2000 is summarized below:
JIMMA TRADING COMPANY
Flow of Merchandise for AGARO Branch
During 2006
Billed Price HO Markup (50% of cost;
Cost 33.33% of Billed Price)
Beginning inventories..........................
Br 22,5000 Br 15,000 Br 7,500
Add: Shipments from HO.........................................
120,000 80,000 40,000

16
 Available for sale...............................
Br 142,500 95,000 Br 47,500
Less: Ending inventories...........................................
(30,000) (20,000) (10,000)
Cost of goods sold .......................................
Br 112,500 Br 75,000 Br 37,500

The activities of the branch for 2006 and end-of-period adjusting and closing entries are reflected in the four
Home Office ledger accounts below.

 Investment in Branch Account

Investment in AGARO Branch Account
Date Explanation Debit Credit Balance
2006 Balance, Dec. 31, 2005.............................................. 45,500 Dr
Merchandise billed to branch at markup of 50%...... 120,00 165,500 Dr
0
Cash received from branch........................................ 113,000 52,500 Dr
Operating expenses billed to branch......................... 4,500 57,000 Dr
Net income for 2006 reported by branch.................. 10,000 67,000 Dr

 Allowance for Over Valuation of Inventories

Allowance for Overvaluation of Inventories: AGARO Branch
Date Explanation Debit Credit Balance
2006 Balance, Dec. 31, 2005.......................................................... 7,500 Cr
Markup on merchandise shipped to branch
During 2005 (50% of cost).................................................... 40,000 47,500 Cr
Realization of 50% markup on merchandise
Sold by branch during 2006...................................................
37,500 10,000 Cr

 Realized Gross Profit

Realized Gross Profit: AGARO Branch Sales
Date Explanation Debit Credit Balance
2006 Realization of 50% markup on merchandise
sold by branch during 2005.................................................... 37,500 37,500 Cr
Closing Entries.......................................................................
37,500 -0-
 Investment Income
Investment Income: AGARO Branch
Date Explanation Debit Credit Balance
2006 Net income for 200 reported by branch................................. 10,000 10,000 Cr
Closing Entries.......................................................................
10,000 -0-
In the accounting records of the Home Office at the end of 2006, the balance required in the Allowance for
Overvaluation of Inventories: AGARO Branch ledger account it Br 10,000, that is, the billed price of Br
30,000 less cost of Br 20,000 for merchandise in the branch’s ending inventories. Therefore, the allowance
account balance is reduced from Br 47,500 to Br 10,000. This reduction of Br 37,500 represents the 50%
markup on merchandise above cost that was realized by AGARO Branch during 2006 and is credited to the
Realized Gross Profit: AGARO Branch Sales account.
Home Office a/c
Date Explanation Debit Credit Balance
2005 Balance, Dec. 31, 2005.............................................. 45,500 Cr
Merchandise received from HO................................ 120,000 165,500 Cr
Cash sent to Home Office.........................................113,00 52,500 Cr
0
Operating expenses billed by HO.............................. 4,500 57,000 Cr
Net income for 2006.................................................. 10,000 67,000 Cr

17
The working paper for combined financial statements under the periodic inventory system, which reflects
pre-adjusting and pre-closing balances for the reciprocal ledger accounts and the Allowance for
Overvaluation of Inventories are as follows:

JIMMA TRADING COMPANY

Working Paper for Combined Financial Statements of Home Office and AGARO
Branch
For Year Ended December 31, 2006
(Periodic Inventory System: Billings above Cost)
Adjusted Trial Balance
Home Office Branch Elimination Combined
Dr (Cr) Dr (Cr) Dr (Cr) Dr (Cr)
Income Statement
Sales................................................ (500,000) (150,000) (650,000)
Inventories, Dec.31, 2005............... 45,000 22,500 b (7,500) 60,000
Purchases......................................... 400,000 400,000
Shipments to AGARO Branch........ (80,000) a 80,000
Shipments from Home Office......... 120,000 a (120,000)
Inventories, Dec.31, 2006............... (70,000) (30,000) c 10,000 (90,000)
Operating Expenses........................ 120,000 27,500 147,500
Net Income (loss)............................ 85,000 10,000 d 37,500 132,500
Totals............................................... -0- -0- -0- -0-
Statement of Retained
Earnings
Retained Earnings, Dec.31, 2005.... (117,000) (117,000)
Net Income from above.................. (85,000) (10,000) d (37,500) (132,500)
Dividends Declared......................... 60,000 60,000
Retained Earnings, Dec.31,2005..... (189,500)
Totals............................................... -0-
Balance Sheet
Cash................................................. 30,000 9,000 39,000
Trade Accounts Receivables(net) 64,000 28,000 92,000
Inventories (Dec.31, 2006)............. 70,000 30,000 c (10,000) 90,000
AFOVI: AGARO Branch............... (47,500) a 40,000
b 7,500
Investment in AGARO Branch....... 57,000 e (57,000)
Equipment....................................... 158,000 158,000
Accumulated Depreciation.............. (15,000) (15,000)
Trade Accounts Payable................. (24,500) (24,500)
Home Office.................................... (57,000) e 57,000
Common Stock, Br 10 par.............. (150,000) (150,000)
Retained Earnings from above........ (189,500)
Totals............................................... -0- -0- -0- -0-

18
(a) To eliminate reciprocal ledger accounts for merchandise shipments
(b) To reduce beginning inventories of branch to cost
(c) To reduce ending inventories of branch to cost
(d) To increase HO income of by portion of merchandise markup that was realized by branch sales
(e) To eliminate reciprocal ledger account balances
2.8) Reconciliation of Reciprocal Ledger Accounts
At the end of an accounting period, the balance of the Investment in Branch ledger account in the
accounting records of the Home Office may not agree with the balance of the Home Office account in the
accounting records of the branch because certain transactions may have been recorded by one office but not
by the other office. The situation is comparable to that of reconciling the ledger account for Cash in Bank
with the balance in the Monthly Bank Statement. The lack of agreement between the reciprocal ledger
account balances causes no difficulty during an accounting period, but at the end of each period the
reciprocal account balances must be brought into agreement before combined financial statements are
prepared.

Illustration 2.3:
As an illustration of the procedure for reconciling reciprocal ledger account balances at year-end, assume
that the Home Office and branch accounting records of Mercy Company and its branch Arvin Branch
contain the following data on December 31, 2003:
Accounting Records of Home Office
Investment in Arvin Branch
Date Explanation Debit Credit Balance
2003
Nov. 30 Balance (BBF)........................................................... 62,500 Dr
Dec. 10 Cash received from branch........................................ 20,000 42,500 Dr
27 Collection of branch trade accounts receivable......... 1,000 41,500 Dr
29 Merchandise shipped to branch................................ 8,000 49,500 Dr
Accounting Records of Arvin Branch
Home Office Account
Date Explanation Debit Credit Balance
2003
Nov. 30 Balance (BBF)........................................................... 62,500 Cr
Dec. 10 Cash sent to Home Office......................................... 20,000 42,500 Cr
27 Acquired equipment .................................................3,000 39,500 Cr
29 Collection of HO trade accounts receivable.............. 2,000 41,500 Cr

There might be a number of reconciling items between Investment in Branch and Home Office accounts.
These are: -
 Inventories may be in-transit
 Trade Accounts Receivables of Branch may be collected by Home Office
 Branches may acquire plant assets to be maintained by HO without the knowledge of HO
 Trade Accounts Receivables of the Home Office may be collected by the Branches

Comparison of the two reciprocal ledger accounts discloses four reconciling items, describing as follows:
1. A debit of Br 8,000 in the Investment in Arvin Branch ledger account without a related credit in the
Home Office account.
On December 29, the Home Office shipped merchandise costing Br 8,000 to the branch. The Home Office
debits its reciprocal ledger account with the branch on the date merchandise is shipped, but the branch
credits its reciprocal ledger account with the branch on the date merchandise is shipped, but the branch
credits it reciprocal account with the Home Office when the merchandise is received a few days later. The
required journey entry on December 31, 2003, in the branch accounting records, assuming use of the
perpetual inventory system, appears below:

19
 Inventories in Transit.....................................................
8,000
Home Office................................................... 8,000
To record shipment of merchandise in transit from Home Office

In taking a physical inventory on December 31, 2003, the branch must add to the inventories on hand the Br
8000 of merchandise in transit. When the merchandise is received in 2004, the branch debits Inventories and
credits Inventories in Transit.

2. A credit of Br 1,000 in the Investment in Arvin Branch ledger account without a related debit in the
Home Office account.
On December 27, trade accounts receivables of the branch were collected by the Home Office. The
collection was recorded by the Home Office by a debit to Cash and a credit to Investment in Arvin Branch.
No journal entry was made by Arvin Branch; therefore, the following journal entry is required in the
accounting records of Arvin Branch on December 31, 2003:
Home Office......................................................................1,000
Trade Accounts Receivable................................. 1,000
To record collection of account receivable by Home Office

3. A debit of Br 3,000 in the Home Office ledger account without a related credit in the Investment in
Arvin Branch account.
On December 28, the branch acquired equipment for Br 3,000. Because the equipment used by the branch is
carried in the accounting records of the Home Office. The journal entry made by the branch was a debit to
Home Office and a credit to Cash. No journal entry was made by the Home Office; therefore, the following
journal entry is required on December 31, 2003, in the accounting records of the Home Office:
Equipment: Arvin Branch.......................................................3,000
Investment in Arvin Branch...................................... 3,000
To record equipment acquired by branch.

4. A credit of Br 2,000 in the Home Office ledger account without a related debit in the Investment in
Arvin Branch account.
On December 30, trade accounts receivables of the Home Office were collected by Arvin Branch. The
collection was recorded by Arvin Branch by a debit to Cash and a credit to Home Office. No journal entry
was made by the Home Office; therefore, the following journal entry is required in the accounting records
of the Home Office on December 31, 2003:
Investment in Arvin Branch.................................................... 2,000
Trade Accounts Receivable...................................... 2,000
To record collection of accounts receivable by Arvin Branch.

The effect of the foregoing end-of-period journal is to update the reciprocal ledger accounts, as shown by
the following reconciliation:

MERCY COMPANY-HOME OFFICE AND ARVIN BRANCH

Reconciliation of Reciprocal Ledger Accounts
December 31, 2003
Investment in Arvin Home Office
Branch Account Account
Balances before adjustments...................................... Br 49,500 Dr Br 41,500 Cr
Add: (1) Merchandise shipped to branch by HO....... 8,000
(4) HO trade A/Rec collected by Branch........ 2,000
Less: (2) Branch A/Rec collected by HO................. (1,000)
(3) Equipment acquired by branch.................. (3,000)
Adjusted balances.................................................... Br 48,500 Dr Br 48,500 Cr

20
2.9) Transactions 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 MODJO Branch ships merchandise
to ADAMA Branch, MODJO Branch debits Home Office and credits Inventories (assuming that the
perpetual inventory system is used). On receipt of the merchandise, ADAMA Branch debits Inventories
and credits Home Office. The Home Office records the transfer between branches by a debit to Investment
in ADAMA Branch and a credit to Investment in MODJO Branch.

The transfer of merchandise form one to another does not 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.

Illustration 2.4:
To illustrate the accounting for excess freight costs on inter-branch transfers of merchandise, assume the
following for excess freight costs on interbranch 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 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. The journal
entries required in the three sets of accounting records (assuming that the perpetual inventory system is
used) as follows:

1. In the 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 costs
Investment in Evan Branch........................................................6,500
Excess Freight Cost–Interbranch Transfer Expense.......... 200
Investment in Dana Branch............................................... 6,700
To record transfer of merchandise from Dana Branch to Evan Branch under instruction of Home Office

Interbranch freight of Br 300 paid by Dana Branch caused total freight costs on this merchandise to exceed
direct shipment cost by Br 200 (Br 400 + Br 300 – Br 500 = Br 200).
2. In the Accounting Records of Dana Branch:
Inventories..................................................................................
6,000
Freight-In...................................................................................400
Home Office.................................................................... 6,400

To record receipt of merchandise from Home Office with freight costs paid in advance by Home Office.
Home Office...............................................................................
6,700
Inventories.................................................................... 6,000
Freight In...................................................................... 400
Cash.............................................................................. 300
To record transfer of merchandise to Evan Branch under instruction of Home Office and payment of freight
costs of Br 300.

3. In Accounting Records of Evan Branch:

Inventories.................................................................................. 6,000

21
 Freight In.................................................................................... 500
Home Office................................................................. 6,500
To record transfer of merchandise to Evan Branch under instruction of Home Office and Normal freight
costs billed by Home Office.

Recognized 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 expense and losses 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 excess freight costs of interbranch transfer 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.

22