Adv CH Onefor 3rd Year
Adv CH Onefor 3rd Year
Adv CH Onefor 3rd Year
Chapter One
Accounting for Sales Agency, Branch, and Division
Chapter Outline:
Defining and Distinguishing Sales Agency, Branch, and Division
Accounting for sales agency
Accounting for branch and reciprocal accounts
Reconciliation reciprocal accounts
Transaction between branches
Combined financial statements of Home Office and Branches
Chapter objectives:
After completing this chapter, you would be able:
Account for sales agency transactions
Account for 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
Comprehend the basic procedures for reconciliation of reciprocal accounts
Record transactions between branches
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
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.
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.
To replenish imprest cash fund which represents several checks sent to agent
Operating Expenses: Lakeview Agency.....................................10,00
0
Cash.......................................................................... 10,000
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.
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.
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.
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. 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.
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.
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.
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):
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.......... 60,00 Inventories....................................
60,00
0 0
Inventories.................................... 60,00 Home Office.......................... 60,00
0 0
3. Equipment: AGARO Branch.............
500 Home Office.................................
500
Investment in AGARO 500 Cash....................................... 500
Branch....................................................
4. None Trade Accounts Receivables........
80,00
0
Sales....................................... 80,00
0
Cost of Goods Sold.......................
45,00
0
Inventories............................. 45,00
0
5. None Cash..............................................
62,00
0
T/Accounts Receivables........ 62,00
0
6. None Operating Expenses......................
20,00
0
Cash....................................... 20,00
0
7. Cash....................................................
37,50 Home Office.................................
37,50
0 0
Investment in AGARO 37,50 Cash....................................... 37,50
Branch.................................................... 0 0
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:
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.
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 90,000
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.
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.
The foregoing analysis provides in the Markup column the information needed for the
Eliminations column in the working paper for combined financial statements below:
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:
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:
The closing entries for the branch at the end of 2005 are as follows:
AGARO Branch Accounting Records
Closing Entries
Sales.......................................................................................
80,00
0
Income Summary...................................................................
10,50
0
Cost of Goods Sold...................................................... 67,500
Operating Expenses..................................................... 23,000
To close revenue and expense ledger accounts
Home Office...........................................................................
10,50
0
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
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
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:
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
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.
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:
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:
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:
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.
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.