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Chapter 4

Accounting for Branches Combined Financial Statements


The McGraw-Hill Companies, Inc. 2006

Scope of Chapter

and reporting for segments of a business enterprise, primarily branches and divisions. Branches are not separate legal entities but they are separate economic and accounting entities. Accounting procedures tailored for the special features such as reciprocal ledger accounts.

Branches & Divisions

Branch is a business unit located at some distance from Home Office. 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.

Branches & Divisions


receipts of the branch may be deposited in a bank account belonging to the home office. Branch expenses are paid from an imprest cash fund or bank account provided by home office. Branch must submit a list of cash payments supported with vouchers in order to get replenishment from home office.

Branches & Divisions


of imprest cash fund gives the home office considerable control over the cash transactions of the branch. Common practice for a large branch to maintain its own bank accounts. Extent of autonomy and responsibility of a branch varies, even among different branches of the same business enterprise.

Branches & Divisions


segment of a business enterprise may be operated as a division, which generally has more autonomy than a branch. Accounting procedures for a division (not organized as a subsidiary company) are similar to those used for branches.

Branches & Divisions


segment is operated as a separate corporation Consolidated financial statements are required. The consolidated statement is described in chapters 6 through 10.

Start-up Costs of Opening New Branches


businesses would capitalize and amortize such start-up costs on the grounds that such costs are necessary to successful operation at a new location. Most enterprises recognized start-up costs in connection with the opening of a branch as expenses of the accounting period in which the costs are incurred.

Start-up Costs of Opening New Branches


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.

Start-up Costs of Opening New Branches

Seldom is there complete certainty that a new branch will achieve a profitable level of operations in later years. 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

Business enterprise with branches may provide for a complete set of accounting records at each branch. Branch may maintain a complete set of accounting records consisting of:

Journals Ledgers Chart of accounts

Similar to those of an independent business enterprise.


Accounting System For A Branch

Branches may keep all accounting records in the home office and have the branch submit daily reports and business documents to the home office, Home office would then enter all transactions by branches in computerized accounting records. In this case, home office may not even conduct operations of its own; it may serve only as an accounting and control center for the branches.


Accounting System For A Branch

Financial statements are prepared by branch accountant and forwarded to home office. The home office usually establish policy such as - Number and types of ledger accounts - The internal control structure - Form and content of the financial statements - Accounting policies


Accounting System For A Branch


recorded by a branch should include all controllable expenses and revenue initiated by the branch If the branch manager has responsibility over all branch assets, liabilities, revenue and expenses, the branch accounting records should reflect this responsibility.

Accounting System For A Branch


such as depreciation often are not subject to control by a branch manager. Branch plant assets and the related depreciation ledger accounts generally are maintained by the home office.

Accounting System For A Branch

Reciprocal Ledger Accounts /(Home office/Investment in Branch) Expenses Incurred By Home Office And Allocated To Branches Alternative Method Of Billing Merchandise Shipments To Branches Separate Financial Statements For Branch And For Home Office Combined Financial Statements For Home Office and Branch


Accounting System For A Branch


Entries For Operations Of A Branch Working Paper For Combined Financial Statements Treatment of Beginning Inventories Priced Above Cost Reconciliation Of Reciprocal Ledger Accounts Transaction Between Branches

Reciprocal Ledger Accounts

Accounting records maintained by a branch include a Home Office ledger account This account reflects all activity between the branch and home office Home office is credited for all merchandise, cash or other assets provided by the home office; Home office is debited for all cash, merchandise, or other assets sent by the branch to the home office or the other branches.


Reciprocal Ledger Accounts

Home office account is a quasi-ownership equity account that shows the net investment by the Home Office in the branch. End of an accounting period when the branch closes its accounting records, the Income Summary account is closed to the Home Office account. Net income increases the credit balance of the Home Office account; a net loss decreases (debit) this balance.


Reciprocal Ledger Accounts

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


Reciprocal Ledger Accounts


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.


Expenses Incurred By Home Office And Allocated To Branches


a plant asset is acquired by the home office for a branch, the journal entry for the acquisition is a debit to an asset account such as Equipment:Branch and a credit to Cash or a Liability Account. The home office also usually acquires insurance, pays property and other taxes, and does advertising that benefits all branches.

Expenses Incurred By Home Office And Allocated To Branches


expense incurred by home office for a branch is recorded by home office by a debit to Investment in Branch and a credit to an appropriate expense account; Branch debits an expense account and credits Home Office.


Expenses Incurred By Home Office And Allocated To Branches


the home office does not make sales and serves only as accounting center then most or all of its expenses may be allocated to branches.


Expenses Incurred By Home Office And Allocated To Branches

Home office may charge each branch interest on the capital invested in that branch Interest expense recognized by the branches would be offset by interest revenue recognized by the home office Amounts would be netted and would not be displayed in the combined income statement


Illustration 1

a typical Home Office and Branch transactions and events (Perpetual Inventory System), the transactions and events are recorded by the Home Office and by a Branch are depicted in the following illustration. The explanations for the journal entries are omitted.


Illustration 1
Home Office Accounting Records
Journal Entries 1. Inv estment in Branch Cash 2. Inv estment in Branch Inv entories 3. Equipment : Branch Inv estment in Branch 4. None 1,000 1,000 60,000 60,000 500 500 Home Office Cash T rade Accts. Receiv ables Cost of Goods Sold Sales Inv entories Cash T rade Accts. Receiv able Operating Exps. Cash Home Office 37,500 Cash Operating Exps. 3,000 Home Office Inv entories Home Office 500 500 80,000 45,000 80,000 45,000 62,000 62,000 20,000 20,000 37,500 37,500 3,000 3,000 Cash Home Office 60,000 60,000

Branch Accounting Records

Journal Entries 1,000 1,000

5. None 6. None 7. Cash Inv estment in Branch 8. Inv estment in Branch Operating Exps. 37,500 3,000


Alternative Methods Of Billing Merchandise Shipments To Branches


alternative methods.

Billing at home office cost simplest of all. Billing at a percentage above home office cost. Billing at the branchs retail selling price.


of merchandise to a branch does not constitute a sale because ownership title has not changed


Separate Financial Statements for Branch & Home Office


separate income statement and balance sheet helps management of the enterprise to review the operating results and financial position of the branch. If the merchandise is billed at retail selling price then Branchs income statement will show loss approximating the operating expenses.


Separate Financial Statements for Branch & Home Office

The branch balance sheet will have Home Office Ledger Account instead of Ownership Equity Account. The separate financial statements prepared by branch will be revised by home office to include expenses incurred by the home office for branch and to show the results of branch operations after elimination of any intra-company profits on merchandise shipments. Separate financial statements also may be prepared for the home office so that the results of its operations and its financial position can be appraised.


Combined Financial Statements For Home Office And Branches

A balance sheet for distribution to creditors, stockholders, and government agencies. A starting point in preparation of a combined balance sheet would be the adjusted trial balances of the home office and of the branch. The reciprocal ledger accounts are eliminated because they have no significance when the branch and home office report as a single entity.


Combined Financial Statements For Home Office And Branches


and liabilities of branch are substituted for the Investment in Branch ledger (on Home Office books) Similar accounts are combined to produce a single total amount for cash, trade accounts receivable and other assets and liabilities of the enterprise


Combined Financial Statements For Home Office And Branches


balance of the Home Office account is offset against the balance of the Investment in Branch account; In addition, any receivables and payables between the home office and the branch (or between branches) are eliminated


Combined Financial Statements For Home Office And Branches


results of the enterprise 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. Intra-company profits of losses are eliminated.


Working Paper for Combined Financial Statements


combine ledger account balances for like revenue, expenses, assets and liabilities To eliminate any intra-company profits or losses To eliminate the reciprocal accounts

Working Paper for Combined Financial Statements


elimination or offsetting the balances is done, is done only on working paper. No entry is to be made in the accounting record of either Home office or branch because its only purpose is to facilitate the preparation of combined financial statements An example of a typical working paper when billing to branches is done at cost, is shown on the following slide

Illustration 2
SB C M N H O PA Y W ing Paper for C bined Financial Statem ork om ents of H e O om ffice and B ranch For Y ear E nded D ecem ber 31, 2002 (Perpetual Inventory Sys tem B : illings at C t) os A djus ted Trial B alances H eO om ffice B ranch D (C r r) D (C r r) Incom Statem e ent Sales C of goods sold ost O perating expenses N Incom (to statem of retained earnings et e ent below ) T otals Statem ent of R etained E arnings R etained e arnin beginning of year gs, N (Incom (from incom statem abov et e) e ent e) D idends decla iv red R etained e arnin end of year (to balance gs, sheet below ) T otals B alance Sheet C ash T rade accounts receiv able (net) Inv entories Inv estm in Branch ent Equipm ent Accum ulated depreciation of equipm ent T rade accounts paya ble H e office om C m stock, $ 10 par om on R etained e arnin (from sta ent of retained gs tem earnings ab e) ov T otals (400,000) 235,000 90,000 75,000 0 (80 ,000) 45,000 23,000 12,000 0

E inations lim D (C r r)

C bined om D (C r r) (480,000) 280,000 113,000 87,000 0

(70,000) (75,000) 40,000

(12 ,000)

(70,000) (87,000) 40,000 117,000 0

25,000 39,000 45,000 26,000 150,000 (10,000) (20,000) (150,000)

5,000 18,000 15,000 (26,000)

30,000 57,000 60,000 150,000 (10,000) (20,000)

(26 ,000)

26,00 0 (150,000) (117,000) 0


Illustration 3

of working paper is used when a home office transfer inventory above cost The following illustration depicts this.


Illustration 3
SBH COMPANY Working Paper for Combined Financial Statements of Home Office and Branch For Year Ended December 31, 2002 (Perpetual Inventory Sys tem: Billings above Cost) Adjusted Trial Balances Home Office Branch Dr (Cr) Dr (Cr) Income Statement Sales Cost of goods sold Operating expenses Net Income (loss) (to statement of retained earnings below) Totals Statement of Retained Earnings Retained earnings, beginning of year Net (Income) loss (from income statement abov e) Div idends declared Retained earnings, end of year (to balance sheet below) Totals Balance Sheet Cash Trade accounts receiv able (net) Inv entories Inv estment in Branch Allowance for Ov aluation of Inv erv entories: Branch Equipment Accumulated depreciation of equipment Trade accounts payable Home office Common stock, $ 10 par Retained earnings (from statement of retained earnings abov e) Totals (400,000) 235,000 90,000 75,000 0 (80,000) 67,500 23,000 (10,500) 0

Eliminations Dr (Cr)

Combined Dr (Cr) (480,000) 280,000 113,000 87,000 0



(70,000) (75,000) 40,000 10,500 (22,500)

(70,000) (87,000) 40,000 117,000 0

25,000 39,000 45,000 56,000 (30,000) 150,000 (10,000) (20,000)

5,000 18,000 22,500

(7,500) (56,000) 30,000

30,000 57,000 60,000 0

(56,000) (150,000)



150,000 (10,000) (20,000) 0 (150,000) (117,000) 0

Treatment of Beginning Inventories Priced Above Cost

1. 2.

The beginning inventories can be treated differently. Basically there are two systems to treat the beginning inventories. Perpetual Inventory System. Periodic Inventory System.


Reconciliation of Reciprocal Ledger Accounts

Balance of the Investment in Branch ledger account on the accounting records of the home office may not agree with the balance of the Home Office on the branch books Main reason certain transactions may have been recorded by one set of books office but not by the other. At the end of each period the reciprocal account balances must be brought into agreement before combined financial statements are prepared.


Transactions Between Branches


operations require that merchandise or other assets be transferred from one branch to another. Usually, a branch does not carry a reciprocal ledger account with another branch. The transfer can be recorded in Home Office ledger account and home office credits the inventories (assuming perpetual inventory system is used).

Transactions Between Branches


receipt of the inventories, the branch debits inventories and credits Home Office. Home office records the transfer between branches by a debit to Investment in recipient branch and credit to Investment in delivering branch. Excess freight costs are recognized as expenses of the home office.