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ACCT 501 Chapter 4 Accounting for Branches and Combined Financial Statements.

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2 ACCT 501 Chapter 4 Accounting for Branches and Combined Financial Statements

3 Accounting for Branches2 Objectives of this Chapter n To learn the accounting and reporting for segments (i.e., branches and division) of a business entity.

4 Accounting for Branches3 Branches and Divisions n Branches and divisions are separate economic and accounting entities from their home office. However, they are not separate legal entities from their home office.

5 Accounting for Branches4 Branches and Divisions (contd.) n 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.

6 Accounting for Branches5 Branches and Divisions (contd.) n 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.

7 Accounting for Branches6 Branches and Divisions (contd.) n 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.

8 Accounting for Branches7 Start-up Costs of Opening New Branches n 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.

9 Accounting for Branches8 Accounting System for a Branch n 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.

10 Accounting for Branches9 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.

11 Accounting for Branches10 Accounting System for a Branch (contd.) n This chapter focuses on the second system that the branch maintains its own accounting records.

12 Accounting for Branches11 Reciprocal Ledger Accounts Used by the Branch and Home Office n 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.

13 Accounting for Branches12 Reciprocal Ledger Accounts Used by the Branch and Home Office (contd.) n 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.

14 Accounting for Branches13 Reciprocal Ledger Accounts Used by the Branch and Home Office (contd.) n 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.

15 Accounting for Branches14 Reciprocal Ledger Accounts Used by the Branch and Home Office (contd.) n 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.

16 Accounting for Branches15 Acquisition of Plant Assets Used in Branch n If a plant asset is acquired by the home office for a branchs usage and the accounting record for the plant asset is maintained by the home office, the accounting treatments are:

17 Accounting for Branches16 Acquisition of Plant Assets Used in Branch (contd.) n For the home office: debit a plant asset account: branch, credit cash or a liability account. n For the branch: no entry.

18 Accounting for Branches17 Acquisition of Plant Assets Used in Branch (contd.) n 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:

19 Accounting for Branches18 Acquisition of Plant Assets Used in Branch (contd.) n For the branch: debit Home Office and credit cash or a liability account. n For the home office: debit a plant asset account: branch, and credit Investment in Branch account.

20 Accounting for Branches19 Expense Incurred by Home Office and Allocated to Branches n 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. n The home office may pay some taxes on behalf of branches, and arrange for advertising that benefits all branches.

21 Accounting for Branches20 Expense Incurred by Home Office and Allocated to Branches (contd.) n These expenses are usually allocated to branches in determining net income of branches. n These expenses include depr. expense for the plant assets purchased by home office but used by branches.

22 Accounting for Branches21 Expense Incurred by Home Office and Allocated to Branches (contd.) n 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.

23 Accounting for Branches22 Interest Charged by the Home office on the Capital Invested in Branches n 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. n In additional, the home office may charge each branch interest on the capital invested in each branch.

24 Accounting for Branches23 Interest Charged by the Home office on the Capital Invested in Branches (contd.) n Such interest revenue recognized by the home office should be offset with the interest expense recognized by the branches in the combined financial statements.

25 Accounting for Branches24 Alternative Methods of Billing Merchandise Shipments to Branches n 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 branchs retail selling price.

26 Accounting for Branches25 Billed at the home office cost: n Strength: widely used because of its simplicity n Weakness: attributes all gross profits of the business to the branches.

27 Accounting for Branches26 Billed at a percentage above home office cost: n Strength: is able to allocate a reasonable gross profit to the home office. n 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.

28 Accounting for Branches27 Billed at a percentage above home office cost: (contd.) n Thus, for the combined financial statement, the home office must eliminate the excess of billed prices over cost (intracompany profits).

29 Accounting for Branches28 Billed at branch retail selling prices: n Strength: to increase the internal control over inventories at branches. n Weakness: no gross profit assigned to the branches and the branchs net loss will equal its operating expenses.

30 Accounting for Branches29 Separate Financial Statements for Branch and for Home Office (for internal use only) n Separate financial statements for branches should be prepared so that management can evaluate the performance of each branch. n The branchs financial statements may be revised by the home office to include the allocated expenses incurred by the home office.

31 Accounting for Branches30 Separate Financial Statements for Branch and for Home Office (for internal use only) (contd.) n Also, the financial statements of branches should be revised to eliminate any intracompany profits on merchandise shipments or interest charge on capital investments.

32 Accounting for Branches31 Combined financial Statements for Home Office and Branch (for external use) n For investors, the home office and branches are a single business entity. n Thus, combined financial statements should be prepared for external users. n A four-column work sheet paper is used to facilitate the preparation of the combined financial statement.

33 Accounting for Branches32 Combined financial Statements for Home Office and Branch (for external use)(contd.) n In preparing the combined financial statements, the following accounts should be eliminated: n a. Reciprocal ledger accounts n b. Any intracompany profits or losses.

34 Accounting for Branches33 Combined financial Statements for Home Office and Branch (for external use)(contd.) n c. Any receivables and payables between the home office and the branch (or between two branches). n The rest of accounts are just summed together for the combined financial statements.

35 Accounting for Branches34 Combined financial Statements for Home Office and Branch (for external use)(contd.) n 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.

36 Accounting for Branches35 Combined financial Statements for Home Office and Branch (for external use )(contd.) Example I: (contd.) n 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. n Both the home office and the branch use the perpetual inventory system. Equipment used at the branch is carried in the home office records.

37 Accounting for Branches36 Combined financial Statements for Home Office and Branch (for external use )(contd.) Example I: (contd.) n Expenses, such as advertising and insurance, incurred by the home office on behalf of the branch, are billed to the branch. n Transactions and events during the first year (1999) of operations of Mason Branch are summarized below (start-up costs are disregarded):

38 Accounting for Branches37 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.)

39 Accounting for Branches38 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 branchs 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.

40 Accounting for Branches39 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.

41 Accounting for Branches40 Combined financial Statements for Home Office and Branch (for external use )(contd.) Example I: (contd.) n These transactions and events are recorded by the home office and by Mason Branch as follows: Home Office Accounting Records Journal Entries: Mason Branch Accounting Records Journal Entries: 1.Investment in Mason Branch1,000 Cash1,000 Home Office1,000

42 Accounting for Branches41 Combined financial Statements for Home Office and Branch (for external use )(contd.) Example I: (contd.) Home Office Accounting Records Journal Entries: Mason Branch Accounting Records Journal Entries: 2. Investment in Mason Branch60,000 Inventories60,000 Home Office60,000 3. Equipment: Mason Branch500 Home Office500 Investment in Mason Branch500 Cash500

43 Accounting for Branches42 Combined financial Statements for Home Office and Branch (for external use )(contd.) Example I: (contd.) Home Office Accounting Records Journal Entries: Mason Branch Accounting Records Journal Entries: 4. NoneTrade Accounts Receivable80,000 Cost of Goods Sold45,000 Sales 80,000 Inventories 45,000

44 Accounting for Branches43 Combined financial Statements for Home Office and Branch (for external use )(contd.) Example I: (contd.) Home Office Accounting Records Journal Entries: Mason Branch Accounting Records Journal Entries: 5. NoneCash62,000 Trade Account Receivable 62,000 6. NoneOperating Expenses20,000 Cash 20,000

45 Accounting for Branches44 Combined financial Statements for Home Office and Branch (for external use )(contd.) Example I: (contd.) Home Office Accounting Records Journal Entries: Mason Branch Accounting Records Journal Entries: 7. Cash37,500Home Office37,500 Investment in Mason Branch37,500 Cash37,500 8. Investment in Mason Branch3,000 Operating Expenses3,000 Operating Expenses3,000 Home Office3,000

46 Accounting for Branches45 Combined financial Statements for Home Office and Branch (for external use )(contd.) Example I: (contd.) n Two Reciprocal Ledger Accounts (prior to adjusting and closing entries): Investment in Mason Branch DateExplanationDebitCreditBalance 1999 n Cash sent to branch n Merchandise billed to branch at home office cost n Equipment acquired by branch, carried in home office accounting records n Cash received from branch n Operating expenses billed to branch 1,000 60,000 3,000 500 37,500 1,000 dr 61,000 dr 60,500 dr 23,000 dr 26,000 dr

47 Accounting for Branches46 Combined financial Statements for Home Office and Branch (for external use )(contd.) Example I: (contd.) Home Office DateExplanationDebitCreditBalance 1999 n Cash received from home office n Merchandise received from home office n Equipment acquired n Cash sent to home office n Operating expenses billed by home office 500 37,500 1,000 60,000 3,000 1,000 cr 61,000 cr 60,500 cr 23,000 cr 26,000 cr

48 Accounting for Branches47 Working Paper for Combined financial Statements--Example I n 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.

49 Accounting for Branches48 Working Paper for Combined financial Statements--Example I (contd.) n Assume that the Mason Branchs 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.

50 Accounting for Branches49 Working Paper for Combined financial Statements--Example I (contd.) n All the year-end adjusting entries (except the home office entries on page 60) had been made. n The working paper begins with the adjusted trial balance of the home office and Mason Branch. n Income taxes are ignored in this illustration.

51 Accounting for Branches50 Working Paper for Combined financial Statements--Example I (contd.) n 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 )

52 Accounting for Branches51 Working Paper for Combined financial Statements--Example I (contd.) -0- Totals 87,00012,00075,000 Net Income (to statement of retained earnings below) 113,00023,00090,000Operating expenses 280,00045,000235,000Cost of goods sold (48,000)(80,000)(400,000)Sales Income Statement Dr (Cr) Mason Branch Home Office CombinedEliminations Adjusted Trial Balances

53 Accounting for Branches52 Working Paper for Combined financial Statements--Example I (contd.) -0-Totals 117,000 Retained earnings, Dec.31,1999 (to balance sheet below) 40,000 Dividends declared (87,000)(12,000)(75,000) Net(income) (from incomes statement above) (70,000) Retained earnings, Jan. 1, 1999 Dr (Cr) Mason Branch Home Office CombinedEliminations Adjusted Trial Balances Statement of Retained Earnings

54 Accounting for Branches53 Working Paper for Combined financial Statements--Example I (contd.) (10,000) Accumulated depreciation of equipment (a) (26,000)26,000 Investment in Mason Branch 60,00015,00045,000Inventories 57,00018,00039,000 Trade accounts receivable (net) 30,0005,00025,000Cash Dr (Cr) Mason Branch Home Office CombinedEliminations Adjusted Trial Balances Balance Sheet Equipment150,000

55 Accounting for Branches54 Working Paper for Combined financial Statements--Example I (contd.) -0- Totals (117,000) Retained earnings (from statement of retained earnings above) (150,000) Common stock, $10 par (a) (26,000)(26,000)Home Office (20,000) Trade accounts payable Dr (Cr) Mason Branch Home Office CombinedEliminations Adjusted Trial Balances Balance Sheet (contd.) (a) To eliminate reciprocal ledger account balances * the elimination appears in the working paper only

56 Accounting for Branches55 Combined Financial Statements -- Example I SMALDINO COMPANY Income Statement For Year Ended December 31, 1999 $ 5.80 Basic earnings per share of common stock $ 87,000Net Income 113,000Operating expenses $ 200,000Gross margin on sales 280,000Cost of goods sold $ 480,000Sales

57 Accounting for Branches56 Combined Financial Statements -- Example I (contd.) SMALDINO COMPANY Statement of Retained Earnings For Year Ended December 31, 1999 $ 117,000Retained earnings, end of year 40,000Less: Dividends ($2.67 per share) $ 157,000Subtotal 87,000Add: Net income $ 70,000Retained earnings, beginning of year

58 Accounting for Branches57 Combined Financial Statements -- Example I (contd.) SMALDINO COMPANY Balance Sheet December 31, 1999 $287,000Total assets 140,00010,000Less: Accumulated depreciation $150,000Equipment 60,000Inventories 57,000Trade accounts receivable (net) $ 30,000Cash Assets

59 Accounting for Branches58 Combined Financial Statements -- Example I (contd.) SMALDINO COMPANY Balance Sheet (contd.), December 31, 1999 $287,000 Total liabilities & stockholders equity 267,000117,000 Retained earnings $150,000 Common stock, $10 par, 15,000 shares authorized, issued, and outstanding Stockholders equity $20,000 Trade accounts payable Liabilities Liabilities & Stockholders Equity

60 Accounting for Branches59 Home Office Adjusting and Closing Entries and Branch Closing Entries Performed on 12/31/1999 (perpetual inventory system): Home Office Accounting Records Adjusting and Closing Entries: Mason Branch Accounting Records Closing Entries: NoneSales80,000 Cost of Goods Sold45,000 Operating Expenses23,000 Income Summary12,000

61 Accounting for Branches60 Home Office Adjusting and Closing Entries and Branch Closing Entries Performed on 12/31/1999 (perpetual inventory system): (contd.) Home Office Accounting Records Adjusting and Closing Entries: Mason Branch Accounting Records Closing Entries: Investment in Mason Branch12,000 Income Summary12,000 Income: Mason Branch12,000 Home Office12,000 Income: Mason Branch12,000 None Income Summary12,000

62 Accounting for Branches61 Example II (textbook p136-p141): Billing of Merchandise to Branches at Prices above Home Office Cost n Similar information as in the previous example, except that the home office bills merchandise shipped to Mason branch at 50% markup of the cost. n Thus, the shipment of merchandise costing $60,000 will be recorded at the home office and branch as follows:

63 Accounting for Branches62 Example II (textbook p136-p141): Billing of Merchandise to Branches at Prices above Home Office Cost (contd.) n Journal entries for shipments to branch at prices above home office cost (perpetual inventory system): Home Office Accounting Records Journal Entries: Mason Branch Accounting Records Journal Entries: Investment in Mason Branch90,000Inventories90,000 Inventories60,000Home Office90,000 Allowance for Overvaluation of Inventories: Mason Branch30,000

64 Accounting for Branches63 n Thus, the balances of both the Investment in Mason Branch account and Home Office account will be $56,000, instead of $26,000 due to the inventory mark up of $30,000. Example II (textbook p136-p141): Billing of Merchandise to Branches at Prices above Home Office Cost (contd.)

65 Accounting for Branches64 SMALDINO COMPANY Flow of Merchandise for Mason Branch During 1999 Example II (textbook p136-p141): Billing of Merchandise to Branches at Prices above Home Office Cost (contd.) $22,500$45,000$67,500 Cost of goods sold 7,50015,00022,500 Less: Ending inventories $30,000$60,000 $90,000 Add: Shipments from home office $30,000$60,000 $90,000 Beginning inventories Markup (50% of Cost;33 1/3 % of Billed Price) Home Office Cost Billed Price Available for sale

66 Accounting for Branches65 Working Paper for Example II n SMALDNO COMPANY Working paper for combined Financial Statements of Home office and Mason Branch For Year Ended December 31,1999 (Perpetual Inventory System: Billing above Cost)

67 Accounting for Branches66 Working Paper for Example II (contd.) -0- Totals 87,000 (b) 22,500 (10,500)75,000 Net Income(loss) (to statement of retained earnings below) 113,00023,00090,000Operating expenses 28,000 (a) (22,500) 67,500235,000Cost of goods sold (48,000)(80,000)(400,000)Sales Income Statement Dr (Cr) Mason Branch Home Office CombinedEliminations Adjusted Trial Balances

68 Accounting for Branches67 Working Paper for Example II (contd.) -0-Totals 117,000 Retained earnings, Dec.31,1999 (to balance sheet below) 40,000 Dividends declared (87,000)(10,500)(75,000) Net(income) loss (from incomes statement above) (70,000) Retained earnings, Jan. 1, 1999 Dr (Cr) Mason Branch Home Office CombinedEliminations Adjusted Trial Balances Statement of Retained Earnings (b) (22,500)

69 Accounting for Branches68 Working Paper for Example II (contd.) 150,000 Equipment (c) (56,000)56,000 Investment in Mason Branch 60,000 (a) (7,500) 22, 50045,000Inventories 57,00018,00039,000 Trade accounts receivable (net) 30,0005,00025,000Cash Dr (Cr) Mason Branch Home Office CombinedEliminations Adjusted Trial Balances Balance Sheet Allowance for overvaluation of inventories: Mason Branch (30,000) (a) 30,000

70 Accounting for Branches69 Working Paper for Example II (contd.) -0- Totals (117,000) Retained earnings(from statement of retained earnings above) (150,000) Common stock, $10 par (c) (56,000)(56,000)Home Office (10,000) Trade accounts payable Dr (Cr) Mason Branch Home Office CombinedEliminations Adjusted Trial Balances Balance Sheet (contd.) Accumulated depreciation of inventories: Mason Branch (20,000)

71 Accounting for Branches70 Branch Closing Entries and Home office Adjusting and Closing Entries (when billing at above the cost) n Branch Closing Entries--The closing entries for the branch at the end of 1999 are as follows: Sales80,000 Income Summary10,500 Cost of Goods Sold67,500 Operating Expenses23,000 To close revenue and expense ledger accounts

72 Accounting for Branches71 Branch Closing Entries and Home office Adjusting and Closing Entries (when billing at above the cost) (contd.) Home Office10,500 Income Summary10,500 To close the net loss in the Income Summary account to the Home Office account

73 Accounting for Branches72 Branch Closing Entries and Home office Adjusting and Closing Entries (when billing at above the cost) (contd.) n After the closing entries, the Home Office ledger account should have a balance of $45,500. n Note: Home Office balance prior to the closing entries equals $56,000. $56,000-net loss of $10,500 = $45,500 (net loss decreases Home Office credit balance).

74 Accounting for Branches73 Branch Closing Entries and Home office Adjusting and Closing Entries (when billing at above the cost) (contd.) Home Office Adjusting and Closing Entries Income: Mason Branch10,500 Investment in Mason Branch 10,500 To record net loss reported by branch

75 Accounting for Branches74 Branch Closing Entries and Home office Adjusting and Closing Entries (when billing at above the cost) (contd.) Allowance for Overvaluation of Inventories: Mason Branch 22,500 Realized Gross Profit: Mason Branch Sales22,500 To reduce allowance to amount by which ending inventories of branch exceed cost. Home Office Adjusting and Closing Entries (contd.)

76 Accounting for Branches75 Branch Closing Entries and Home office Adjusting and Closing Entries (when billing at above the cost) (contd.) Home Office Adjusting and Closing Entries (contd.) Realize Gross Profit: Mason Branch Sales 22,500 Income: Mason Branch10,500 Income Summary12,000 To close branch net loss and realized gross profit to Income Summary ledger account (Income tax effects are disregarded.)

77 Accounting for Branches76 Branch Closing Entries and Home office Adjusting and Closing Entries (when billing at above the cost) (contd.) n After posting the above entries, the account balance for the following accounts is: Investment in Mason Branch=45,500(debit)* Allowance for Overvaluation of Inventories: Mason Branch =7,500(credit)** Realized Gross Profit: Mason Branch = 0 Income: Mason Branch= 0 *Balance prior to the above entries equals $56,000. $56,000- 10,500 (net loss of the branch reduces the debit balance of the Investment account) = $45,500. ** $30,000-22,500 = $7,500.

78 Accounting for Branches77 Branch Closing Entries and Home office Adjusting and Closing Entries (when billing at above the cost) (contd.) n Similar working paper eliminations as on page 66-69 will be prepared for the following year (i.e., year 2000) when continuing with the perpetual inventory system with a price markup.

79 Accounting for Branches78 Periodic Inventory System n Textbook (p141-p144): When a periodic inventory system is adopted, inventory account cannot be used for the shipments of merchandise between the home office and the branch. n Accounts such as Shipments to Mason Branch (used by the home office) and Shipments from Home Office (used by the branch) are used.

80 Accounting for Branches79 Periodic Inventory System (contd.) Example: n Example: Continue with the Smaldino Company for a second year of operations (2000) but using the periodic inventory system for both the home office and Mason Branch. The beginning inventories for 2000 were carried by Mason Branch at $22,500 (home office cost is $15,000 due to a 50% markup by the home office).

81 Accounting for Branches80 Periodic Inventory System (contd.) Example: (contd.) n Assume that during 2000, the home office shipped merchandise to Mason Branch that cost $80,000 and Mason was billed at $120,000. n During 2000, Mason Branch sold $150,000 merchandise that was billed at $112,500. n The journal entries to record the shipments and sales at a price above home office cost under the periodic inventory system are as follows:

82 Accounting for Branches81 Periodic Inventory System (contd.) Example: (contd.) Home Office Accounting Records Journal Entries: Mason Branch Accounting Records Journal Entries: Investment in Mason Branch90,000 Shipments from Home Office120,000 Home Office120,000 Shipments to Mason Branch80,000 Allowance for Overvaluation of Inventories: Mason Branch40,000 NoneCash (or Trade Accounts Receivable)150,000 Sales150,000

83 Accounting for Branches82 n The branch inventories at the end of 2000 amounted to $30,000. The flow of merchandise for Mason Branch of year 2000 summarized below: SMALDINO COMPANY Flow of Merchandise for Mason Branch During 2000 Periodic Inventory System (contd.) Example: (contd.) Available for sale $37,500$75,000$112,500 Cost of goods sold (10,000)(20,000)(30,000) Less: Ending inventories $47,500$95,000 $142,500 Add: Shipments from home office 40,00080,000120,000 Beginning inventories Markup (50% of Cost;33 1/3 % of Billed Price) Home Office Cost Billed Price $22,500$15,000$7,500

84 Accounting for Branches83 Periodic Inventory System (contd.) Example: (contd.) n The activities for the branch for 2000 are reflected in the following two home office ledger accounts and the reciprocal Home Office ledger account of the branch: Investment in Mason Branch DateExplanationDebitCreditBalance 2000 n Balance, Dec. 31, 1999 n Merchandise billed to branch at markup of 50% above home office cost, or 33 1/3 % of billed price n Cash received from branch n Operating expenses billed to branch 120,000 4,500 113,000 45,500 dr 165,500dr 52,500 dr 57,000 dr

85 Accounting for Branches84 Periodic Inventory System (contd.) Example: (contd.) Allowance for Overvaluation of Inventories: Mason Branch DateExplanationDebitCreditBalance 2000 n Balance, Dec. 31, 1999 7,500 cr n Makeup on merchandise shipped to branch during 2000 (50% of cost)40,00047,500 cr

86 Accounting for Branches85 Periodic Inventory System (contd.) Example: (contd.) Home Office DateExplanationDebitCreditBalance 2000 n Balance, Dec. 31, 199945,500 cr n Merchandise receivable from home office120,000165,500 cr n Cash sent to home office113,00052,500 cr n Operating expenses billed by Home office4,50057,000 cr

87 Accounting for Branches86 Periodic Inventory System (contd.) Example: (contd.) n The working paper for combined financial statements under the periodic inventory system is as follows: Income Statement Adjusted Trial Balances EliminationsCombined Home Office Mason Branch Dr (Cr) Sales(500,000)(150,000)(650,000) Inventories, Dec. 31, 1999 45,00022,500(b) (7,500)60,000 Purchases400,000 Shipments to Mason Branch (80,000)(a) 80,000

88 Accounting for Branches87 Periodic Inventory System (contd.) Example: (contd.) Income Statement (contd.) Adjusted Trial Balances EliminationsCombined Home Office Mason Branch Dr (Cr) Shipments from home office 120,000(a) 80,000 Inventories, Dec. 31,2000 (70,000)(30,000)(c) 10,000(90,000) Operating expenses120,00027,500147,500 Net Income( to statement of retained earnings below) 85,00010,000(d) 37,500132,500 Totals-0-

89 Accounting for Branches88 Periodic Inventory System (contd.) Example: (contd.) Statement of Retained Earnings Adjusted Trial Balances EliminationsCombined Home Office Mason Branch Dr (Cr) Retained earnings, Dec. 31, 1999 (117,000) Net Income (from income statement above) (85,000)(10,000)(d) (37,500)(132,500) Dividends declared60,00027,50060,000 Retained earnings, Dec. 31, 2000 (to balance sheet below) 85,00010,000189,500 Totals-0-

90 Accounting for Branches89 Periodic Inventory System (contd.) Example: (contd.) Balance Sheet Adjusted Trial Balances EliminationsCombined Home Office Mason Branch Dr (Cr) Cash30,0009,00039,000 Trade accounts receivable (net) 64,00028,00092,000 Inventories, Dec. 31, 2000 70,00030,000(c) (10,000)90,000 Allowance for overvaluation of inventories : Mason Branch (47,500) (a) 40,000 (b) 7,500 Investment in Mason Branch 57,000(e) (57,000)

91 Accounting for Branches90 Periodic Inventory System (contd.) Example: (contd.) Balance Sheet (contd.) Adjusted Trial Balances Elimination s Combined Home Office Mason Branch Dr (Cr) Equipment158,000 Accumulated depreciation of equipment (15,000) Trade Account payable(24,500) Home office(57,000)(e) 57,000 Common stock, $10 par(150,000) Retained earnings (from statement of retained earnings above) (189,500) Totals-0-

92 Accounting for Branches91 Periodic Inventory System (contd.) Example: (contd.) (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 income of home office by portion of merchandise markup that was realized by branch sales. (e)To eliminate reciprocal ledger account balances.

93 Accounting for Branches92 Branch Closing Entries and Home Office Adjusting and Closing entries for the home office (with billing at above the cost and using a periodic inventory system): n Branch Closing Entries: (1)Inventory (ending)30,000 Cost of Goods Sold112,500* Inventory (beg.)22,500 Shipments from Home Office120,000 CGS=22,500+120,000-30,000

94 Accounting for Branches93 Branch Closing Entries and Home Office Adjusting and Closing entries for the home office (with billing at above the cost and using a periodic inventory system):(contd.) (2)Sales150,000 CGS112,500 Operating expenses 27,500 Income Summary 10,000 (3) Income Summary10,000 Home Office 10,000

95 Accounting for Branches94 Branch Closing Entries and Home Office Adjusting and Closing entries for the home office (with billing at above the cost and using a periodic inventory system):(contd.) n Home Office Adjusting (1 and 2) and Closing Entries (3) : (1) Investment in Branch10,000 Income: Mason Branch10,000 (2) Allowance for Overvaluation of Inventories37,500 Realized Gross Profit : Mason Branch37,500

96 Accounting for Branches95 Branch Closing Entries and Home Office Adjusting and Closing entries for the home office (with billing at above the cost and using a periodic inventory system):(contd.) (3) Realized Gross Profit37,500 Income: Mason Branch10,000 Income Summary47,500

97 Accounting for Branches96 Branch Closing Entries and Home Office Adjusting and Closing entries for the home office (with billing at above the cost and using a periodic inventory system):(contd.) n Balances of Investment in Mason Branch, Allowance for Overvaluation of Inventories, Realized Gross Profit, Income: Mason Branch and Home Office accounts after the above adjusting and closing entries are:

98 Accounting for Branches97 Branch Closing Entries and Home Office Adjusting and Closing entries for the home office (with billing at above the cost and using a periodic inventory system):(contd.) n Investment in Mason Branch =$67,000(dr.) (57,000+10,000) n Allowance for Overvaluation of Inventories =$10,000(cr.) (47,500 -37,500)

99 Accounting for Branches98 Branch Closing Entries and Home Office Adjusting and Closing entries for the home office (with billing at above the cost and using a periodic inventory system):(contd.) n Realized Gross Profit =$0(37,500- 37,500) n Income: Mason Branch =$0(10,000-10,000) n Home Office (a reciprocal account of Investment) =$67,000(cr.) (57,000+10,000)

100 Accounting for Branches99 Reconciliation of Reciprocal Ledger Accounts n At the end of an accounting period, the balance of the Investment in Branch ledger account in the records of the home office may be different from that of the Home Office ledger account of the branch. n This is because some transactions may have been recorded by the home office but not the branch office.

101 Accounting for Branches100 Reconciliation of Reciprocal Ledger Accounts (contd.) n Example (textbook p145): Assume that the home office and branch accounting records of Mercer Company contain the following data on 12/31/99:

102 Accounting for Branches101 Reconciliation of Reciprocal Ledger Accounts (contd.) DateExplanationDebitCreditBalance 1999 Nov. 30Balance62,500 dr Dec. 10Cash received from branch 20,00042,500 dr 27Collection of branch trade accounts receivable 1,00041,500 dr 29Merchandise shipped to branch 8,00049,500 dr Investment in Arvin Branch (in accounting records of Home office)

103 Accounting for Branches102 Reconciliation of Reciprocal Ledger Accounts (contd.) DateExplanationDebitCreditBalance 1999 Nov. 30Balance62,500 cr Dec. 7Cash sent to home office 20,00042,500 cr 28Acquired equipment3,00039,500 cr 30Collection of home office trade accounts receivable 2,00041,500 cr Home Office (in accounting records of Arvin Branch)

104 Accounting for Branches103 Reconciliation of Reciprocal Ledger Accounts (contd.) n The following adjusting entries are recorded prior to the preparation of the working paper for the combined financial statements (assuming a perpetual inventory system)

105 Accounting for Branches104 Reconciliation of Reciprocal Ledger Accounts (contd.) n For Arvin Branch: 1.Home Office1,000 Trade Accounts Receivable1,000 2.Inventory8,000 Home Office8,000

106 Accounting for Branches105 Reconciliation of Reciprocal Ledger Accounts (contd.) n For Mercer Home Office: 1.Equipment: Arvin Brach3,000 Investment in Branch: Arvin3,000 2.Investment in Branch: Arvin2,000 Trade Accounts Receivable2,000

107 Accounting for Branches106 Reconciliation of Reciprocal Ledger Accounts (contd.) n The balance of Investment in Branch: Arvin ledger account at the home office equals: $ 49,500(dr.) -3,000(cr.) +2,000(dr.) $ 48,500(dr.)

108 Accounting for Branches107 Reconciliation of Reciprocal Ledger Accounts (contd.) n After posting the above adjusting entries: n The balance of Home Office ledger account at Arvin Branch equals: $ 41,500(cr.) -1,000(dr.) +8,000(cr.) $ 48,500(cr.)

109 Accounting for Branches108 Transactions between Branches n When it is necessary to transfer merchandise or assets from one branch to another branch, Home Office Ledger account is used by the branches. n The home office will transfer the inventory (or assets) from investment in one branch to another branch. n Any excess freight costs incurred for the transfer between branches should be expensed.

110 Accounting for Branches109 Transactions between Branches (contd.) n Example: (textbook p146-148) The home office shipped merchandise costing $8,000 to Katti Branch and paid freight costs of $500. A week later, the home office instructed Katti Branch to transfer this merchandise to Danddi Branch. Katti paid $400 for the transfer. If the merchandise had been shipped directly from the home office to Danddi, the freight costs would have been $600.

111 Accounting for Branches110 Transactions between Branches (contd.) n Journal entries for these transactions are: n In Accounting Records of Home Office: Investment in Katti Branch 8,500 Inventory8,000 Cash 500 Investment in Danddi Branch 8,600 Excess Freight Expense 300 Investment in Katti Branch8,900

112 Accounting for Branches111 Transactions between Branches (contd.) n In Accounting Records of Katti Branch: Freight In (or Inventory) 500 Inventories8,000 Home Office8,500 Home Office8,900 Inventories8,000 Freight-in 500 Cash 400

113 Accounting for Branches112 Transactions between Branches (contd.) n In Accounting Records of Danddi Branch: Inventories8,000 Freight-in (or Inventories) 600 Home Office8,600


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