MARY THE QUEEN COLLEGE OF PAMPANGA INC.

Gapan-Olongapo Road, Guagua, Pampanga 2003

Module No – Title : MO1 – Home Office and Branch Accounting

Time Frame : 1 week – 3 hrs

1. Overview
This learning material provides an overview of home office and branch accounting. To have a fair knowlege of the
accounting for the transactions of home office and its branches and prepare separate and combined financial
statements.

2. Desired Learning Outcomes

At the end of the learning session, you should be able to
A. Reconcile differences between the reciprocal accounts
B. Prepare individual and combined financial statements
C. Account for special procedures in home office and branch accounting and special transactions in agency
transactions

3. Content/Discussion

Agency Accounting

Focus notes:

 The MAIN CONCERN of accounting problems on agency accounting is the computation of the agency
net income or loss for a particular period and inventoriable costs of the goods held by the agency

 It is important to differentiate an agency from a branch. The following are the key differences:

AGENCY BRANCH

Cash and sales books only; Complete set of financial

Financial records
no financial statements statements and schedules

Relatively bigger; composed

Size of entity and human Relatively smaller; composed
of managers, supervisors,
resource of a few sales agents
and rank-and-file employees

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All decisions are made by Operating decisions are
Autonomy
the home office delegated to the branch

Not considered to be a Considered to be a distinct

Accounting entity
separate accounting entity accounting entity

 Agency accounting is a relatively easier topic in Advanced Accounting since it is simply the extended
application of basic and financial accounting concepts to a sales agency.

 Important things to remember when solving agency accounting problems:

a. The gross sales of an agency is equal to the amount of sales that has been invoiced or filled by the
home office. Orders taken by the agency but not filled up by the home office are ignored.
b. When getting net sales, sales discounts may be obtained using the formula:
Sales discounts = cash collections, net of discounts / (100% - % of discount) x % of discount
c. The working fund of a sales agency is accounted for like a petty cash fund.
d. To get the cost of goods sold pertaining to agency sales, the cost ratio is multiplied by the GROSS
SALES, not net sales.
e. Samples inventory is not part of cost of goods sold. They are prepaid expenses and amortized
systematically in the passage of time.
 MARY THE QUEEN COLLEGE OF PAMPANGA INC.
Gapan-Olongapo Road, Guagua, Pampanga 2003

Illustration: Accounting for agency

Agency transactions Home office books
Jan. 1
Receipt of revolving fund from home office. Cash – Agency #1 1,000
Cash 1,000

Jan. 1 - 31
Orders sent by agency to home office for Accounts receivable
processing. Sales – Agency #1

200 200
Cost of sales – Agency #1 120
Inventory
120
Collection by home office of agency sales. Cash
200
Accounts receivable 200

Jan. 1 - 31 ords
Disbursements from the revolving fund No entry in H.O. books. The agency the
rec disbursements in its ‘log book’.

Jan. 31
Replenishment of the revolving fund Various expenses – Agency #1 50
Cash
50
To determine the profit attributable to the Sales – Agency #1 200
agency, the home office makes the following Cost of sales – Agency #1
120
closing entry: Various expenses – Agency #1
50
Income summary – Agency #1 30

Practice Problem – Agency Accounting:

Problem 1: On October 1, 2015, the Eastwood Main Office established a sales agency in Pasay City. The Page2
following information is made available to you:

 The main office sent samples of its merchandise amounting to P42,000 and a working fund amounting to
P360,000 was established. The samples sent were intended to last until June 1, 2016.
 During the first two months of operations, the agency transmitted to the home office sale of goods costing
P1,458,000, but the home office were not able to fill-up 25% of the said transmitted sales orders.
 Collections from customers amounted to P369,705, net of 2% sales discount.
 Payments made by the agency during October and November were as follows: annual rent of P288,000,
advertising expense worth P28,000 and utilities amounting to P36,000.
 The agency also purchased an equipment worth P45,000 which will be depreciated at 20% per annum.
 The gross profit rate on sales agency order is 20% of sales.

Net income of the agency for the two months ended November 30, 2015 is:

A. P149,375 B. P134,330 C. P87,155 D. P141,830

Home Office and Branch Accounting

Introduction

 The MAIN CONCERN of accounting problems on home office and branch accounting is the preparation
of the COMBINED FINANCIAL STATEMENTS of the home office and its branches.

 Although branches are controlled by the home office, branches are considered to be separate entities with
separate books. However, for external reporting purposes, the home office and the branches are considered to
 MARY THE QUEEN COLLEGE OF PAMPANGA INC.
Gapan-Olongapo Road, Guagua, Pampanga 2003

be a single entity. The separate financial statements of the home office and the branches are combined and
amounts are adjusted or eliminated to comply with the appropriate financial reporting framework.

 The following are the common types of problems for home office and branch accounting:

1. Reconciliation of reciprocal accounts – reconciling the “Asset” account in the books of the home
office and the “Equity” account in the books of the branch.
2. Interoffice transfers of inventory at above cost – transfer of inventory from the home office to the
branch at above original cost.
3. Inter-branch transfers – transfers of inventory and other assets among branches.
Illustration: Accounting for branch operations

Initial investment
1. Home office establishes a branch for an initial investment of ₱1,000,000 in cash.
Home office books Branch books
Investment in branch 1M Cash 1M
Cash 1M Home office 1M

Property carried in branch books – Branch acquisition

2. Branch acquires equipment for ₱400,000 to be carried in the branch books.
Home office books Branch books
Equipment 400K
No entry Cash 400K

Property acquired by the branch and carried in its books is recorded in the regular manner. No entry is made in
the home office books. The recording of the subsequent depreciation follows the same manner. Assume a
subsequent depreciation of ₱40,000:
Home office books Branch books
Depreciation expense 40K
No entry
Accumulated depreciation 40K

Property carried in home office books – Branch acquisition

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3. Branch acquires equipment for ₱200,000 to be carried in the home office books.
Home office books Branch books
Equipment 200,000 Home Office 200,000
Investment in Branch 200,000 Cash 200,000

Property acquired by the branch but carried in the books of the home office is recorded as reduction to both the
“investment in branch” and “home office” accounts. The branch recognizes the subsequent depreciation expense
as it uses the equipment, but the home office records the accumulated depreciation. Assume a subsequent
depreciation of ₱20,000:
Home office books Branch books
Investment in branch 20K Depreciation expense 20K
Accumulated depreciation – Branch 20K Home office 20K

One reason for having the asset recorded in the home office books but the branch maintains the physical
possession and use is to facilitate the computation of depreciation when the entity uses the ‘group method’ or
‘composite method’ of depreciation.

Property carried in branch books – Home office acquisition

4. Home office acquires furniture for P50,000 to be carried in the branch books.
Home office books Branch books
Investment in Branch 50k Furniture 50K
Cash 50K Home Office
50k
 MARY THE QUEEN COLLEGE OF PAMPANGA INC.
Gapan-Olongapo Road, Guagua, Pampanga 2003

Assume a subsequent depreciation of P5,000:

Home office books Branch books
Depreciation expense 5K
No entry Accumulated Depreciation 5K

Property carried in home office books –

Home off ice acquisition
5. Home office acquires furniture for P30,000 to be carried in the home office books, but the
maintains physical possession and use. branch
Home office books Branch books
Furniture - Branch 30K
Cash 30K No entry

A subsequent depreciation of P3,000:

Home office books Branch books
Investment in branch 3K Depreciation expense 3K
Accumulated depreciation – Branch 3K Home office 3K

Transfer of inventories – freight paid by home office

6. Home office transfers inventory worth P150,000 to the branch. Home office pays freight of P10,000.
Home office books Branch books
Investment in branch 160K Shipments from HO 150K
Shipments to branch 150K Freight-in 10K
Cash 10K Home office 160K

The “Shipments from home office” account is similar to the “Purchases” account and is used under a periodic
inventory system. Under a perpetual inventory system, the “Inventory” account may be used in lieu of the
“Shipments from home office (to branch)” and freight-in accounts.

Transfer of inventories – freight paid by branch

7. Home office transfers inventory worth P80,000 to the branch. Branch pays freight of P6,000.
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Home office books Branch books
Investment in branch 80K Shipments from HO 80K
Shipments to branch 80K Freight-in 6K
Home office
80K
Cash 6K

Regardless of whoever pays the freight (the home office or the branch), the freight forms part of the branch’s
inventory.

Purchase of inventories – acquisition from outside parties

8. Branch purchases inventory worth P40,000 on account from a supplier. Branch pays freight of P2,000.
Home office books Branch books
Purchases 40K
Freight-in 2K
Accounts payable
No entry 40K
Cash 2K

Transactions with external parties are recorded in the regular manner.

Revenue
9. Branch makes total sales of P500,000 on account
Home office books Branch books
Accounts receivable 500K
No entry
Sales 500K
 MARY THE QUEEN COLLEGE OF PAMPANGA INC.
Gapan-Olongapo Road, Guagua, Pampanga 2003

Collection
10. Branch collects P400,000 from accounts receivable.
Home office books Branch books
Cash 400K
No entry
Accounts receivable 400K

Remittance to home office

11. Branch remits P300,000 cash ons to
collecti ho me office.
Home office books Branch books
Cash 300K Home office 300K
Investment in branch 300K Cash 300K

Allocation of expenses
Expenses incurred by the branch are recorded in the regular manner. However, expenses incurred by the home
office on behalf of the branch are recorded similar to an investment.

For instance, costs incurred centrally are allocated to the various business units within the company in order to
properly measure the financial performance of each business unit. The following are examples of costs that may
be allocated to the branch: a. Cost of maintaining information systems
b. Cost of contracts signed on a company level, e.g., security, pest control, insurance, advertising, and the like
c. Depreciation computed under the group or composite method of depreciation
d. Other general overhead costs

12. Branch incurs salaries expense of P100,000, one-fourth of which remains unpaid.
Home office books Branch books
Salaries expense 100K
No entry Cash 75K
Salaries payable 25K

13. Home office allocates P10,000 s e and P4,000 advertising expense to the
utilitie expens b ranch. Page5
Home office books Branch books
Investment in branch 14K Utilities expense 10K
Utilities expense 10K Advertising expense 4K
Advertising expense 4K Home office 14K

Individual financial statements

The trial balance of the branch as of this point is shown below:
Dr. Cr.
Cash 417,000
Accounts receivable 100,000
Shipments from home office 230,000
Purchases 40,000
Freight-in 18,000
Equipment 400,000
Accumulated depreciation - equipment 40,0
00
Furniture 50,000
Accumulated depreciation – furniture 5,0
00
Accounts payable 40,000
Salaries payable 25,000
Home office 827,0
00
Sales 500,0
 MARY THE QUEEN COLLEGE OF PAMPANGA INC.
Gapan-Olongapo Road, Guagua, Pampanga 2003

00
Depreciation expense 68,000
Salaries expense 100,000
Utilities expense 10,000
4,000 Advertising expense
1,437,000 1,437,000 Totals

The branch’s individual statement of profit

The branch has ending inventory of P150,000
. or loss for the period is prepared as
follows:
Sales 500,0
00
Cost of goods sold:
Inventory, beg. -
Shipments from home office 230,000
Purchases 40,000
Freight-in 18,000
Total goods available for sale 288,000
Inventory, end. (150,000) (138,000)
Gross profit 362,0
00
Depreciation expense (68,00
0)
Salaries expense (100,00
0)
Utilities expense (10,00
0)
Advertising expense (4,000)
Profit for the period 180,0
00

Closing entries:

14. To close the branch’s nominal accounts to the income summary account:
Home office books Branch books
Sales 500K Page6
Inventory 150K
Shipments from HO
Purchases 230K
Freight-in 40K
Depreciation expense 18K
No entry 68K
Salaries expense 100K
Utilities expense 10K
Advertising expense 4K
Income summary 180K

15. To close the branch’s profit to the reciprocal accounts:

Home office books Branch books
Investment in branch 180K Income summary 180K
Income summary - branch 180K Home office 180K

Now, let us reconcile the reciprocal accounts.

HOME OFFICE BOOKS BRANCH
BOOKS
Investment in200,000
branch (3) (3) 200,000
Home office
(1) 300,000 1,000,000
(11) (11)
1,000,000 300,000
(1)

1,007,000 1,007,000
 MARY THE QUEEN COLLEGE OF PAMPANGA INC.
Gapan-Olongapo Road, Guagua, Pampanga 2003

(3) 20,000 20,000 (3) (4) 50,000 50,000 (4)

(5) 3,000 3,000 (5)
(6) 160,000 160,000 (6)
(7) 80,000 80,000 (7)
(13) 14,000 14,000 (13)
(15) 180,000 180,000 (15)

The individual statement of financial position of the branch is prepared as follows:

ASSETS 417,00
Cash 0
Accounts receivable 100,00
0
Inventory 150,00
0
Equipment 400,00
0
Accumulated depreciation – equipment (40,00)
Furniture 50,000
Accumulated depreciation – furniture (5,000)
Total assets 1,072,00
0

LIABILITIES AND EQUITY

Accounts payable 40,000
Salaries payable 25,000
Home office 1,007,00
0
Total liabilities and equity 1,072,00
0

Combined financial statements

The home office and its branch(es) are viewed as a single reporting entity for external reporting (and also a
single legal entity). Thus, the individual financial statements of the home office and its branch(es) are combined

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when preparing the entity’s general purpose financial statements. Combined financial statements are prepared by:
a. Adding together similar items of assets, liabilities, income and expenses; and
b. Eliminating the reciprocal and other interoffice accounts.

Illustration: Combined financial statements

The trial balances of ABC Co.’s home office and branch are shown below:
ABC Co.
Trial balance
December 31, 20x1
Home office Branch
Dr. (Cr.) Dr. (Cr.)
Cash 1,100,000 417,000
Accounts receivable 180,000 100,000
Inventory, beg. 650,000 -
Shipments from home office 230,000
Purchases 72,000 40,000
Freight-in 22,000 18,000
Shipments to branch (230,000)
Investment in branch 827,000
Equipment 720,000 400,00
0
Accumulated depreciation – equipment (72,000) (40,000
)
Furniture 90,000 50,000
 MARY THE QUEEN COLLEGE OF PAMPANGA INC.
Gapan-Olongapo Road, Guagua, Pampanga 2003

Accumulated depreciation – furniture (9,000) (5,000)

Accounts payable (72,000) (40,000
)
Salaries payable (45,000) (25,000
)
Share capital (2,000,000)
Share premium (500,000)
Retained earnings – beg. (206,200)
Home office (827,00
0)
Sales (900,000) (500,000
)
Depreciation expense 168,000 68,000
Salaries expense 180,000 100,00
0
Utilities expense 18,000 10,000
Advertising expense 7,200 4,000
Totals - -

The home office and the branch have ending inventories of P270,000 and P150,000, respectively.

Requirement: Prepare the combined statement of financial position and combined statement of profit or loss.

Solution:
ABC Co.
Working paper for combined financial statements
December 31, 20x1
Home office Branch Elimination Combined
Dr. (Cr.) Dr. (Cr.) Dr. (Cr.) Dr. (Cr.)
Cash 1,100,000 417,000 1,517,000
Accounts receivable 180,000 100,000 280,000
Inventory, beg. 650,000 - 650,000

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Shipments from HO 230,000 (230,000)b -
Purchases 72,000 40,000 112,000
Freight-in 22,000 18,000 40,000
Shipments to branch (230,000) 230,000b -
Investment in branch 827,000 (827,000)a -
Equipment 720,000 400,000 1,120,000
Accum. dep. - equipt. (72,000) (40,000) (112,000)
Furniture 90,000 50,000 140,000
Accum. dep. – furniture (9,000) (5,000) (14,000)
Accounts payable (72,000) (40,000) (112,000)
Salaries payable (45,000) (25,000) (70,000)
Share capital (2,000,000) (2,000,000
)
Share premium (500,000) (500,000)
Retained earnings – beg. (206,200) (206,200)
Home office (827,000) 827,000a -
Sales (900,000) (500,000) (1,400,000
)
Depreciation expense 168,000 68,000 236,000
Salaries expense 180,000 100,000 280,000
Utilities expense 18,000 10,000 28,000
Advertising expense 7,200 4,000 11,200
Totals - - - -
 MARY THE QUEEN COLLEGE OF PAMPANGA INC.
Gapan-Olongapo Road, Guagua, Pampanga 2003

The elimination entries are as follows:

(a) Home office 827,000
Investment in branch 827,000
(b) Shipments to branch 230,000
Shipments from home office 230,000

The combined statement of profit or loss is prepared as follows:

ABC Co.
Statement of profit or loss
For the year ended December 31, 20x1

Sales 1,400,0
00
Cost of goods sold:
Inventory, beg. 650,000
Purchases 112,000
Freight-in 40,000
Total goods available for sale 802,000
Inventory, end. (270,000 + 150,000) (420,000) (382,000)
Gross profit 1,018,0
00
Depreciation expense (236,000
)
Salaries expense (280,000
)
Utilities expense (28,000)
Advertising expense (11,200)
Profit for the period 462,800

The combined profit can be reconciled as the sum of the individual profits of the home office and the branch. The
profit of the home office is computed as follows:
Sales 900,0
00
Page9
Cost of goods sold:
Inventory, beg. 650,000
Purchases 72,000
Shipments to branch (230,000)
Freight-in 22,000
Total goods available for sale 514,000
Inventory, end. (270,000 + 150,000) (270,000) (244,000)
Gross profit 656,0
00
Depreciation expense (168,00
0)
Salaries expense (180,00
0)
Utilities expense (18,00
0)
Advertising expense (7,200)
Profit for the period 282,8
00
P282,800 profit of home office + P180,000 profit of branch = P462,800 combined profit.

The combined statement of financial position is as follows:

ABC Co.
Statement of Financial Position
As of December 31, 20x1
 MARY THE QUEEN COLLEGE OF PAMPANGA INC.
Gapan-Olongapo Road, Guagua, Pampanga 2003

ASSETS
Cash 1,517,000
Accounts receivable 280,000
Inventory (270,000 home office + 150,000 branch) 420,000
Equipment 1,120,000
Accumulated depreciation – equipment (112,000)
Furniture 140,000
Accumulated depreciation – furniture (14,000)
Total assets 3,351,000

LIABILITIES AND EQUITY

Accounts payable 112,000
Salaries payable 70,000
Share capital 2,000,000
Share premium 500,000
Retained earnings (206,200 beg. + 462,800 combined profit) 669,000
Total liabilities and equity 3,351,000

Reconciliation of Reciprocal Accounts

Focus notes:

 One way of understanding reciprocal accounts in home office and branch accounting is looking at the home
office as an “investor” and the branch as the “investee”. The investor recognizes an ‘investment account’
(an asset) in its books, while the investee increases its equity account to recognize the ownership of the
investor. Applying the accounting equation, it follows that any movement in the asset account should have a
corresponding increase or decrease in the equity account. The same concept is applied in reciprocal accounts
for home office and branches.

 When a home office establishes a branch, it transfers cash, inventory and other assets to the latter. It is as if
the home office “invested” its assets in the branch. Thus, when the home office credits the assets transferred
in its books, it debits an investment account. The investment account is commonly labeled as “Investment in

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Branch X” or “Branch Current – X”, where X is the name or location of the branch.

Reciprocally, the branch records the assets received from the home office and credits an equity account. The
equity account is labeled as “Home office – Current”. This is the only equity account of the branches (i.e. no
retained earnings, share capital, APIC, etc.). Since equity represents ownership, the existence of the Home
Office – Current account in the books of the branch simply means that the home office ‘fully owns’ the branch.
Profit or loss is also closed to this account.

The accounting relationship of the Investment in Branch account in the books of the home office and the Home
Office – Current account in the books of the branch are further illustrated below:

Investment in Branch (Asset) Home Office – Current (Equity)

Dr. Cr. Dr. Cr.

(1) Asset transfers to (1) Asset transfers from (1) Assets transfers (1) Asset transfers
branch branch to Home Office from Home Office

(2) Net income of the (2) Net loss of the (2) Net loss of the (2) Net income of the
branch branch branch branch

(3) Allocation of expense (3) Allocation of income (3) Allocation of (3) Allocation of
to branch to branch income from Home expense from Home
Office Office

The illustration above simply means that the balance of the Investment in Branch/Branch Current (BC)
and Home Office – Current (HOC) accounts SHOULD BE EQUAL at any given point in time. However,
due to (1) ERRORS and (2) TIMING DIFFERENCES in recording, they are usually unequal. These errors and
 MARY THE QUEEN COLLEGE OF PAMPANGA INC.
Gapan-Olongapo Road, Guagua, Pampanga 2003

timing differences result to what we call “reconciling items”. These items are identified to adjust the balances of
the reciprocal accounts and, ultimately, to equate them. The process is similar to preparing a bank
reconciliation.

 Reconciling items exist for one or more of the following scenarios:

1. The BC account is debited, but no corresponding credit is made in the HOC account. Example:
Inventory is transferred to the branch, but the inventory is still in transit or is not recorded by the
branch.
2. The BC account is credited, but no corresponding debit is made in the HOC account. Example:
Inventory from the home office is returned by the branch, but the branch failed to record the
transaction.
3. The HOC account is debited, but no corresponding credit is made in the BC account. Example:
Cash is remitted by the branch to the home office, but the home office has not yet recorded or received
the remittance.
4. The HOC account is credited, but no corresponding debit is made in the BC account. Example:
The branch already recorded its net income, but the home office was not notified.

 Debit and Credit Memos – Every time you encounter debit and credit memos in your computation, think of it
this way: Whoever issued the memo is the one who debits or credits the reciprocal account in his or
her books and is trying to notify the other party about it.
 The following table is useful to facilitate your reconciliation:

BC HOC
Unadjusted balance Xxx xxx
Reconciling item #1 Xxx -
Reconciling item #2 - xxx
Reconciling item #3 _(xxx)_ _(xxx)_
Adjusted balance xxx Xxx

Practice problems – Reconciliation of Reciprocal Accounts

Problem 1: Good Buy Trading Co, operates a branch in Bacolod. At close of the business on December 31,
2015, the Home Office account in the books of the Bacolod branch showed a credit balance of P2,784,300. The
interoffice accounts were in agreement at the beginning of the year. For purposes of reconciling the interoffice
accounts, the following facts were ascertained:
Page11
a. On December 29, 2015, the branch sent a check for P13,500 to its suppliers. The branch erroneously
recorded the transaction as a remittance to the home office and sent a copy of the debit memo to the
home office. The home office recorded this upon receiving the debit memo on January 4, 2016.
b. The home office allocated promotions and insurance expense totalling P18,000 to Bacolod branch. The
home office inadvertently charged the said expense to Davao branch. Bacolod branch had not entered
the allocation at year-end.
c. Home office debit memo for P20,700 regarding transfer of funds was recorded twice by the branch by
debiting its reciprocal account.
d. A branch customer remitted P15,000 to the home office. The home office recorded this as a cash
collection of its own receivable on December 23, 2015. Upon notification on the same year, the branch
debited the amount to Receivable from Home Office and credited its reciprocal account.
e. A P105,000 shipment, charged by home office to Bacolod branch, was actually sent to and retained by
Leyte branch.
f. The home office failed to take up a P12,000 credit memo from the branch.
g. Branch insurance premiums of P9,600 were paid by the home office. The home office debited Insurance
expense and credited Cash in its books. The branch recorded the amount as a liability.
h. Inventory costing P39,000 was sent to the branch by the home office on December 12, 2015. The branch
recognized a liability by crediting Accounts Payable upon the receipt of the inventory.
i. Freight charge of P12,600 on merchandise shipped to the branch was paid by the home office and was
recorded in the branch books as P1,260.
j. A branch customer remitted P63,000 to the home office. The home office recorded this cash collection on
December 28, 2015. Upon receiving a credit memo, the branch recorded the transaction twice on
December 30, 2015.

The unadjusted balance of the branch current account as of December 31, 2015 is:
 MARY THE QUEEN COLLEGE OF PAMPANGA INC.
Gapan-Olongapo Road, Guagua, Pampanga 2003

A. P2,970,840 B. P3,075,240 C. P3,051,240 D. P2,962,140

Problem 2: Tolomia Inc. operates a branch in Zamboanga City. At the end of the year, the investment account in
the books of the home office shows a balance of P600,000. The home office current account in the books of the
branch shows a balance of P385,680. The following reconciling items were discovered:

a. The branch made a profit of P40,400 for the month of December, but the home office erroneously
recorded it as P44,720.
b. The branch has not received the cash in the amount of P100,000 sent by the home office. The home
office debited “Other expense” for this transfer.
c. The home office has billed the branch the amount of P150,000 for merchandise, which was in transit on
December 31.
d. Supplies of P18,000 was returned by the branch to the home office. The home office failed to record the
receipt of the supplies.
e. The branch accounts receivable for P42,000 was collected by the home office. The home office failed to
notify the branch.

What is the adjusted balance of the reciprocal accounts?

A. P593,680 B. P635,680 C. P677,680 D. P577,680

Interoffice Transfers of Inventory at Above Cost

Focus notes:

 The MAIN CONCERN of accounting problems involving interoffice transfers of inventory at above cost
is the computation of the TRUE NET INCOME of the branch and the COMBINED NET INCOME after
ELIMINATING ANY OVERVALUATION OF COST OF GOODS SOLD (COGS).

 Remember that the UNDERLYING CONCEPT OF THE COMBINED FINANCIAL STATEMENTS is that the
HOME OFFICE and the BRANCH are viewed as a SINGLE ENTITY. To wit, all the transactions of the branch
are also transactions of the home office.

 It is a common practice for home offices to transfer inventory to its branches since the products and customers Page12
of the two are identical. Although a branch may purchase inventory directly from third-party suppliers, majority
of its inventory comes from the home office’s stockroom.

When inventory transfers are made AT COST, the computation of the combined COGS is the outright sum of
the COGS of the home office and the branch in their separate books (i.e. SIMPLY ADD THE TWO). This is
because when the branch sells the inventory to end customers, the branch’s cost of goods sold is the same
amount that would have been recorded by the home office had it sold the same inventory.

However, when the home office bills inventory transfers at ABOVE ORIGINAL COST, something peculiar
happens. First, the home office records an allowance valuation account. This valuation account represents the
mark-up on cost. On the other end of the transfer, the branch records the receipt of the inventory in its
separate books at its NEW COST (i.e. BILLED PRICE / cost + mark-up). This is illustrated in the pro-forma
journal entries below:

Home office books Branch books

Branch-current xx Shipments from HO (@BP) xx

Shipments to branch (@cost) Home office - current xx
xx Allowance account xx
Allowance account xx

 So what now, you ask? Here’s the thing. When the inventory is sold to end customers, the branch computes
its cost of goods sold USING THE BILLED PRICE. The result is a “hidden” overstatement of cost of goods sold
and a corresponding understatement of net income. Because of this, the computation of the combined cost of
goods sold is no longer a “simply add the two” procedure. There is a need to eliminate any overstatement of
 MARY THE QUEEN COLLEGE OF PAMPANGA INC.
Gapan-Olongapo Road, Guagua, Pampanga 2003

cost of goods sold to compute the true net income of the branch and ultimately to properly compute the
combined net income of the branch and its home office.

 The following table is commonly used to facilitate your computation of the overstatement of cost of goods sold
in the books of the branch:

At Billed At True Mark-up Meaning of the line items in the

Price (BP) Cost (Allowance “Mark-up” Column
)
Beg. inv. from HO xxx xxx xxx <- the beginning balance of the
allowance account in the books of
the home office
Interoffice _xxx_ _xxx_ _xxx_ <- the increase in the allowance
shipments account due to interoffice shipments
during the period
Available for sale xxx xxx xxx <- the UNADJUSTED value of the
allowance
Ending inv. from _(xxx)_ _(xxx)_ _(xxx)_ <- the ADJUSTED value of the
HO allowance
Cost of goods sold xxx xxx xxx <- the REALIZED allowance, which
also represents the overstatement of
the branch’s COGS and
understatement of the branch’s net
income

The table is founded on three fundamental concepts: (1) the COGS formula, (2) basic algebra, and (3) billed
price less the true cost is equal to the mark-up. Due to the mathematical relationships of the variables in the
table above, the computation of the overstatement of COGS becomes easier and more efficient. Just
remember to back it up with your basic accounting knowledge.

Practice problems – Billings of Inventory at Above Cost

Problem 1: Home office bills its branch for merchandise shipments at 130% of cost. The following are some of
the account balances on the books of home office and its branch as of December 2015:

Home Office Books Branch Books

Inventory, January 1 P35,000 P101,500
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Shipments from Home Office 263,900
Purchases 1,575,000 350,000
Shipments to Branch 253,750
Branch Inventory Allowance 91,875
Sales 2,000,000 1,360,000
Operating Expenses 507,500 192,500

Per physical count, the ending inventory of the branch is P73,500 including goods from outside purchases of
P48,475; the ending inventory of the home office is P210,000.

What is the (1) amount of the unrealized profit in the separate books of the home office on January 1, 2016; (2)
the branch beginning inventory in 2015 that came from outside purchases; and (3) the cost of goods available for
sale of the branch?

A. P21,000 ; P48,475 ; P715,400 C. P21,000 ; P33,250 ; P781,375

B. P15,750 ; P33,250 ; P781,375 D. P15,750 ; P48,475 ; P715,400

What is the (1) total ending inventory to be shown in the combined financial statements and (2) the combined net
income for the year?

A. P277,725 ; P957,950 C. P277,725 ; P942,725

B. P328,475 ; P942,725 D. P328,475 ; P957,950

Problexm 2: For the year 2015, Stark Co.’s home office ships goods to its branch in Winterfell at 120% above
cost. The reciprocal account in the income statement of the home office amounted to P237,500. The balance of
the valuation account is P375,000 before adjustment. Of the beginning inventory of the branch, 93,000 came from
outsiders while the remaining amount came from the home office with a cost of P360,000. The branch purchased
 MARY THE QUEEN COLLEGE OF PAMPANGA INC.
Gapan-Olongapo Road, Guagua, Pampanga 2003

goods from its own suppliers during the year amounting to P125,200. The ending inventory of the branch as
reported in the combined statement of financial position is P345,000. The branch income as reported in the
combined financial statements and as reported in the branch’s books are P201,125 and P120,750, respectively.
How much is the cost of goods sold to be reported in the branch’s income statement for the year ended
December 31, 2015?

A. P790,500 B. P514,500 C. P551,075 D. P470,700

Problem 3: The home office transfers inventory to its branch at a 25% mark-up above cost during 2015. This was
lower by 15% compared to the mark-up on cost last year. In 2015, the reciprocal account in the income statement
of the branch amounts to P300,000. At year-end, the home office adjusted its valuation account downward to
P16,000. The home office is aware that the cost of goods sold of the branch in its separate books is overstated by
P70,000.

What is the ending inventory per branch books at the end of 2014?

A. P91,000 B. P65,000 C. P80,000 D. P64,000

Inter-branch Transfers

Focus notes:

 MAIN CONCERN: Computation of the balances of the reciprocal accounts after inter-branch transfers are
made.

 Other than transfers between the home office and the branch, branches can also transfer assets (usually cash
and inventory) with each other per instruction of the home office. These transfers have corresponding
increases or decreases in the reciprocal accounts in the books of the home offices and the branches. To
record these transfers, the following pro-forma entries are made in the books of the transferor branch,
transferee branch and the home office:

Branch A (Transferor Branch) Branch B (Transferee Branch) Home Office

HO-Current Asset transferred Branch current-B

xxx xxx xxx
Asset transferred HO-current Branch current-A Page14
xxx xxx xxx

Note that the logic behind the journal entries above is to record the transfer AS IF the transfer is from the home
office directly to Branch B.

 What is ‘excess freight’? Excess freight may arise when total freight from inter-branch transfers of inventory
differs from the “what-should-have-been” freight had the transfer been made directly from the home office to
the transferee branch (i.e. the final branch recipient). In essence, it represents the opportunity cost or foregone
savings of the home office for not directly transferring the said inventory to the final branch recipient.

The computation of excess freight is pretty much straightforward. To illustrate, assume that the home office
transferred inventory to Branch A. The freight for this transfer is P100. Afterwards, the home office instructed
Branch A to transfer the inventory to Branch B. The freight for this second transfer is P200. Had the goods
been transferred directly from the home office to Branch B, the freight would have been P250. Therefore,
excess freight is P50 (i.e. P100+P200–P250 = P50).

The tricky part is in journalizing the inter-branch transfers of inventory with excess freight and identifying the
balance of the reciprocal accounts after the said transfers. To do this properly and efficiently, the following
rules should be remembered:

1. Who records the freight-in account? Freight-in is ALWAYS recorded by the one who RECEIVES the
inventory, whether he/she paid for the freight or not.

2. Who pays for the freight? The payment of freight depends on the freight terms. In inter-branch
transfers, there are two common freight terms:
 MARY THE QUEEN COLLEGE OF PAMPANGA INC.
Gapan-Olongapo Road, Guagua, Pampanga 2003

a. Freight prepaid – the one who SENDS the inventory pays for the freight
b. Freight collect – the one who RECEIVES the inventory pays for the freight.

3. At what amount should the freight-in be recorded in the books of the final branch recipient? The
amount of the debit to freight-in that is recorded by the final branch recipient is the “SHOULD-HAVE-
BEEN” freight had the transfer been made directly from the home office.

4. At what amount should the reciprocal accounts be debited or credited? After journalizing the
inventory transfer along with the freight-in and its payment, the “balancing” debit or credit is the reciprocal
account.

Practice problems – Inter-branch Transfers

Problem 1: Tywin Company has a branch in Casterly Rock and Kings Landing. The reciprocal accounts between
the home office and the branches were in agreement at the beginning of 2015. However, at December 31, 2015,
the following balances are found in the books of the home office:

Investment in Casterly Rock Branch – P186,500

Investment in Kings Landing Branch – P84,000

Data for reconciliation of the reciprocal accounts are as follows:

a. On December 29, 2015, the home office has instructed Casterly Rock to transfer P74,000 cash to Kings
Landing. Casterly Rock’s branch recorded this transaction immediately. Upon receipt, Kings Landing
branch has recorded this transfer at P47,000. The home office, however, has not yet recorded this inter-
branch transaction as of the end of the year.
b. Tywin has transferred goods costing P28,900 to Casterly Rock and paid P2,500 shipping cost on
December 16, 2015. Casterly Rock shipped all of these goods to Kings Landing upon instruction of the
home office on December 30. Shipping cost is P3,600 freight collect. Had the goods been shipped directly
to Kings Landing from the home office, only P5,000 freight cost will be incurred. The inter-branch
shipment was not recorded by the branches and the home office as well.
c. Casterly Rock has collected cash of P5,750 from one of Kings Landing branch’s customers. This
transaction is not yet recorded by the latter and the home office.
d. The home office has already allocated P11,000 and P9,000 of expenses to Casterly Rock and Kings
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Landing, respectively. The branches are not yet notified.
e. Casterly Rock remitted P14,300 cash to the home office on December 12, 2015. The home office failed to
record this remittance.
f. Kings Landing branch returned goods costing P6,850 to the home office. The goods were shipped on
December 19 and received on December 24, but no entries have been made in the home office books.

What is the unadjusted balance of the HO-Current account in Casterly Rock’s books and Kings Landing’s books,
respectively?

A. P52,150 B. P87,200 C. P107,250 D. P92,950

What is the unadjusted balance of the HO-Current account in Kings Landing?

A. P236,250 B. P122,000 C. P115,150 D. P84,850

Problem 2: On September 1, 2015, Alabang Main Office established two branches: Ortigas and Makati branches.
The following transactions occurred for 2015:

a. The home office transferred P320,000 worth of cash and P1,400,000 worth of inventory to its Ortigas
branch. The home office transfers merchandise to its branch at a mark-up of 25% above cost.
b. The home office instructed Ortigas to transfer 75% of the goods and cash received to Makati.
c. In addition, on October 1, 2015, shipments from home office were received by Ortigas amounting to
P500,000 at cost and the branch paid freight costs amounting to P26,000.
d. 60% of the said shipments were sold to outsiders.
e. On November 1, 2015, Ortigas transferred 50% of the remaining October shipments from Alabang to
Makati, with Makati branch paying freight costs of P10,000.
 MARY THE QUEEN COLLEGE OF PAMPANGA INC.
Gapan-Olongapo Road, Guagua, Pampanga 2003

f. Had the merchandise been shipped from Alabang to Makati City branch, only P7,600 worth of freight
would have been incurred.

How much is the balance of the Makati branch account on the Home Office books?

A. 1,675,100 B. 1,012,300 C. 1,387,600 D. 1,395,200

Problem 3: Diana Corporation has two branches to which merchandise is transferred at cost plus 20%, plus
freight charges. On November 30, 2015, Diana shipped merchandise that cost P5,500 to its Cebu branch, and
the P200 shipping charge was paid by Diana. On December 15, 2015, the Ilocos branch encountered an
inventory shortage, and the Cebu branch shipped the merchandise to the Ilocos branch at a freight cost of P160
paid by the Cebu branch. Shipping charges from the home office to the Ilocos branch would have been P175. If
the merchandise is unsold at year end, at what amount will the inventory be recorded in the (1) books of the
branch and (2) consolidated books?

A. P6,775; P5,675 B. P6,575; P5,475 C. P6,930; P5,500 D. P6,950; P5,850

Theories
1. In the separate statement of financial position of the home office, the branch account shall be presented
as
a. Asset account
b. Liability account
c. Equity account
d. Income account

2. In the separate statement of financial position of the branch, the home office account shall be presented
as
a. Asset account
b. Liability account
c. Equity account
d. Income account

3. Which of the following transactions will increase the normal balance of the home office account in the
book of the branch?
a. Debit memo received from the home office
b. Payment of the home office’s liability by the branch
c. Net loss recognized by the branch
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d. Collection of the branch’s receivable by the home office

4. Which of the following transactions will decrease the normal balance of the Pasay branch account in the
book of the home office?
a. Net income recognized by Pasay branch
b. Collection by Panay branch of Pasay branch’s receivable
c. Debit memo received by the home office from Panay branch
d. Credit memo received by the home office from Pasay branch

5. Which of the following is the best reason why the net income reported by the branch is less than the net
income computed by the home office concerning the branch’s operation?
a. Overstatement of goods in the beginning inventory of the branch for the goods coming from the
home office.
b. Understatement of goods in the beginning inventory of the branch for the goods coming from the
outside supplier.
c. Understatement of cost of goods sold reported by the branch for the goods coming from the
outside supplier.
d. Overstatement of cost of goods sold reported by the branch for the goods coming from the home
office.

References:

Millan, Z.V. (2020). Accounting for Business Combinations. Baguio City, Philippines: Bandoline Enterprise
Dayag, A.J. (2021). Advanced Accounting Vol. 2. Manila, Philippines: Lajara Publishing House
Ferrer, Rodiel (2021). AFAR Summary Notes