Chapter 4

1. Chapter 4 Accounting for Branches and Combined Financial Statements

2. Objectives of this Chapter • To learn the accounting and reporting for segments (i.e., branches and division) of a business entity. Accounting for Branches

3. Branches and Divisions • Branches and divisions are separate economic and accounting entities from their home office. However, they are not separate legal entities from their home office. Accounting for Branches

4. Branches and Divisions (contd.) • Branch: 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, makes collections from its customers, and remits cash received. Accounting for Branches

5. Branches and Divisions (contd.) • Divisions: a segment of a business entity which generally has more autonomy than a branch. Accounting for a division not operated as a separate corporation (i.e., subsidiary company) is similar to that of branches.   Accounting for Branches

6. Branches and Divisions (contd.) • Divisions: Accounting for a division operated as a separate corporation is different from that of branches and will be discussed in latter chapters (6-11). Consolidated financial statements are required for these business organizations. Accounting for Branches

7. Start-up Costs of Opening New Branches • Based on Statement of Position 98-5 (SOP 98-5) “Reporting on the Costs of Start-up Activities”, all start-up costs, including costs associated with organizing a branch or division should be expensed in the accounting period in which the costs are incurred. Accounting for Branches

8. Accounting System for a Branch • Two alternative systems: • 1. The branch does not maintain a complete set of accounting records. The home office serves only as an accounting and control center for the branches. Accounting for Branches

9. Accounting System for a Branch (contd.) • 2. The branch maintains a complete set of accounting records consisting of journal entries and ledger accounts. Financial statements are prepared by the branch account and forwarded to the home office.   Accounting for Branches

10. Accounting System for a Branch (contd.) • This chapter focuses on the second system that the branch maintains its own accounting records. Accounting for Branches

11. Reciprocal Ledger Accounts Used by the Branch and Home Office • Home Office Ledger Account: • This account is used by the branch to account for all transactions with the home office. It is credited for all cash, merchandise or other assets provided by the home office to the branch. It is debited for all cash, merchandise, or other assets sent by the branch to the home office or to other branches. Accounting for Branches

12. Reciprocal Ledger Accounts Used by the Branch and Home Office (contd.) • Home Office Ledger Account: • This account represents the net investment by the home office in the branch. At the end of a period, the balance of Income Summary account of a branch is closed to the Home Office account. Accounting for Branches

13. Reciprocal Ledger Accounts Used by the Branch and Home Office (contd.) • Investment in Branch Ledger Account: • This account is a reciprocal ledger account (to Home Office account) used by the home office to account for any transactions with the branches. It is debited for cash, merchandise and services provided to the branch by the home office and for the net income reported by the branch. Accounting for Branches

14. Reciprocal Ledger Accounts Used by the Branch and Home Office (contd.) • Investment in Branch Ledger Account: • It is credited for cash, or other assets received from the branch, and for net losses reported by the branch. Accounting for Branches

15. Acquisition of Plant Assets Used in Branch • If a plant asset is acquired by the home office for a branch’s usage and the accounting record for the plant asset is maintained by the home office, the accounting treatments are: Accounting for Branches

16. Acquisition of Plant Assets Used in Branch (contd.) • For the home office: debit a plant asset account: branch, credit cash or a liability account. • For the branch: no entry. Accounting for Branches

17. Acquisition of Plant Assets Used in Branch (contd.) • If a plant asset is acquired by a branch for its usage but the accounting record for this plant asset is maintained by the home office, the accounting treatments are: Accounting for Branches

18. Acquisition of Plant Assets Used in Branch (contd.) • For the branch: debit Home Office and credit cash or a liability account. • For the home office: debit a plant asset account: branch, and credit Investment in Branch account. Accounting for Branches

19. Expense Incurred by Home Office and Allocated to Branches • The home office may acquire plant assets and insurance for these assets. These plant assets are carried in the home office accounting record but used by branches. • The home office may pay some taxes on behalf of branches, and arrange for advertising that benefits all branches. Accounting for Branches

20. Expense Incurred by Home Office and Allocated to Branches (contd.) • These expenses are usually allocated to branches in determining net income of branches. • These expenses include depr. expense for the plant assets purchased by home office but used by branches. Accounting for Branches

21. Expense Incurred by Home Office and Allocated to Branches (contd.) • If the home office chooses to allocate these expenses to branches, the accounting treatments are: • a. For the home office: debit Investment in Branch account, credit expense account. b. For the branch: debit expense account, credit Home Office account. Accounting for Branches

22. Interest Charged by the Home office on the Capital Invested in Branches • When the home office serves only as an accounting and control center without any sales, most or all of its expenses may be allocated to the branches. • In additional, the home office may charge each branch interest on the capital invested in each branch. Accounting for Branches

23. Interest Charged by the Home office on the Capital Invested in Branches (contd.) • Such interest revenue recognized by the home office should be offset with the interest expense recognized by the branches in the combined financial statements. Accounting for Branches

24. Alternative Methods of Billing Merchandise Shipments to Branches • Three alternative methods are available to the home office in billing the merchandise shipped to the branches: • a. billed at the home office cost, • b. billed at a percentage above the home office cost, and • c. billed at the branch’s retail selling price. Accounting for Branches

25. Billed at the home office cost: • Strength: widely used because of its simplicity • Weakness: attributes all gross profits of the business to the branches. Accounting for Branches

26. Billed at a percentage above home office cost: • Strength: is able to allocate a reasonable gross profit to the home office. • Weakness: the net income reported by the branch may be understated and the ending inventories at branch are overstated for the enterprise as a whole. Accounting for Branches

27. Billed at a percentage above home office cost: (contd.) • Thus, for the combined financial statement, the home office must eliminate the excess of billed prices over cost (intracompany profits). Accounting for Branches

28. Billed at branch retail selling prices: • Strength: to increase the internal control over inventories at branches. • Weakness: no gross profit assigned to the branches and the branch’s net loss will equal its operating expenses. Accounting for Branches

29. Separate Financial Statements for Branch and for Home Office (for internal use only) • Separate financial statements for branches should be prepared so that management can evaluate the performance of each branch. • The branch’s financial statements may be revised by the home office to include the allocated expenses incurred by the home office. Accounting for Branches

30. Separate Financial Statements for Branch and for Home Office (for internal use only) (contd.) • Also, the financial statements of branches should be revised to eliminate any intracompany profits on merchandise shipments or interest charge on capital investments. Accounting for Branches

31. Combined financial Statements for Home Office and Branch (for external use) • For investors, the home office and branches are a single business entity. • Thus, combined financial statements should be prepared for external users. • A four-column work sheet paper is used to facilitate the preparation of the combined financial statement. Accounting for Branches

32. Combined financial Statements for Home Office and Branch (for external use)(contd.) • In preparing the combined financial statements, the following accounts should be eliminated: • a. Reciprocal ledger accounts • b. Any intracompany profits or losses. Accounting for Branches

33. Combined financial Statements for Home Office and Branch (for external use)(contd.) • c. Any receivables and payables between the home office and the branch (or between two branches). • The rest of accounts are just summed together for the combined financial statements. Accounting for Branches

34. Combined financial Statements for Home Office and Branch (for external use)(contd.) • Example I (textbook p131-p135) : Journal entries for operations of a branch when merchandise is billed at the cost of the home office with a perpetual inventory system. Accounting for Branches

35. Combined financial Statements for Home Office and Branch (for external use)(contd.)Example I: (contd.) • Assume that Smaldino Company bills merchandise to Mason Branch at home office cost and that Mason Branch maintains complete accounting records and prepares financial statements. • Both the home office and the branch use the perpetual inventory system. Equipment used at the branch is carried in the home office records. Accounting for Branches

36. Combined financial Statements for Home Office and Branch (for external use)(contd.)Example I: (contd.) • 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 (1999) of operations of Mason Branch are summarized below (start-up costs are disregarded): Accounting for Branches

37. Combined financial Statements for Home Office and Branch (for external use)(contd.)Example I: (contd.) • 1. Cash of $1,000 was forwarded by the home office to Mason Branch. • 2. Merchandise with a home office cost of $60,000 was shipped by the home office to Mason Branch. • 3. Equipment was acquired by Mason Branch for $500, to be carried in the home office accounting records. (Other plant assets for Mason Branch generally are acquired by the home office.) Accounting for Branches

38. Combined financial Statements for Home Office and Branch (for external use)(contd.)Example I: (contd.) • 4. Credit sales by Mason Branch amounted to $80,000; the branch’s cost of the merchandise sold was $45,000. • 5. Collections of trade accounts receivable by Mason Branch amounted to $62,000. • 6. Payments for operating expenses by mason Branch totaled $20,000. Accounting for Branches

39. Combined financial Statements for Home Office and Branch (for external use)(contd.)Example I: (contd.) • 7. Cash of $37,500 was remitted by Mason Branch to the home office. • 8. Operating expenses incurred by the home office and charged to Mason Branch totaled $3,000. Accounting for Branches

40. Combined financial Statements for Home Office and Branch (for external use)(contd.)Example I: (contd.) • These transactions and events are recorded by the home office and by Mason Branch as follows: Accounting for Branches

41. Combined financial Statements for Home Office and Branch (for external use)(contd.)Example I: (contd.) Accounting for Branches

42. Combined financial Statements for Home Office and Branch (for external use)(contd.)Example I: (contd.) Accounting for Branches

43. Combined financial Statements for Home Office and Branch (for external use)(contd.)Example I: (contd.) Accounting for Branches

44. Combined financial Statements for Home Office and Branch (for external use)(contd.)Example I: (contd.) Accounting for Branches

45. Combined financial Statements for Home Office and Branch (for external use)(contd.)Example I: (contd.) • Two Reciprocal Ledger Accounts (prior to adjusting and closing entries): • Investment in Mason Branch Accounting for Branches

46. Combined financial Statements for Home Office and Branch (for external use)(contd.)Example I: (contd.) • Home Office Accounting for Branches

47. Working Paper for Combined financial Statements--Example I • The following working paper for combined financial statements serves three purposes: • 1) to eliminate any intracompany profits or losses, • 2) to eliminate the reciprocal accounts, & • 3) to combine ledger accounts balances of home office and branches. Accounting for Branches

48. Working Paper for Combined financial Statements--Example I (contd.) • Assume that the Mason Branch’s ending inventories of $15,000 at the end of 1999 had been verified, the following work sheet is based on the transactions and events illustrated on pages 40-44. With additional assumed data for the home office trial balance. Accounting for Branches

49. Working Paper for Combined financial Statements--Example I (contd.) • All the year-end adjusting entries (except the home office entries on page 60) had been made. • The working paper begins with the adjusted trial balance of the home office and Mason Branch. • Income taxes are ignored in this illustration. Accounting for Branches

50. Working Paper for Combined financial Statements--Example I (contd.) • SMALDNO COMPANY • Working paper for combined Financial Statements of Home office and Mason Branch. • For Year Ended December 31,1999 • (Perpetual Inventory System: Billing at Cost) Accounting for Branches