Home office, Branch and Agency Accounting

Branch and Agency distinguished

New sales outlets may be organized as sales agencies or branches. A sales agency is not a self- contained
business but rather acts only on behalf of the home office. On the other hand, a branch is a
self-contained business which acts independently, but within the bounds of company policy and subject
to the control of the home office.

The following further differentiate these two:

Sales agency Branch
 Displays merchandise and takes customers’  Carries stock of merchandise used to fill
order but does not carry stock of customers’ orders (or provides services
merchandise to fill customers’ orders. similar to those provided by the home
office).
 Customers’ orders are sent to the home  Grants credit in accordance with the
office for approval of credit. Customers company’s policies, makes normal
remit payments directly to the home office. warranties, fill customers’ order, and makes
collections on sales.
 Holds revolving cash fund provided by the  Has its own assets and liabilities and
home office that is replenished when generates its own revenues and incurs its
depleted. Not other cash funds are held. own expenses. Makes periodic remittances
to home office subject to company policy.
 Not a separate accounting entity. The only  A separate accounting entity for internal
accounting records maintained are cash reporting. It maintains its own complete set
receipts and cash disbursement books of accounting records.
necessarily to account for the revolving
fund. The main office maintains records of For external reporting, the branch’s
sales made through the agency and the financial statements are combined with the
expenses it incur. home office’s financial statements.

Accounting for an agency

Since an agency does not maintain its own separate accounting books, all of its transactions are recorded
in the books of the home office. The agency maintains a simple records (e.g., a log book) to record its
cash receipts and cash disbursements, similarly to a petty cash system.

In order to identity the transactions of the agency from other transactions, the home office may set up
specific account codes and accounts titles for the agency.

For example, the revolving fund of a certain may be an account title “Cash - Agency #1,” and designated a
code similar to the following: <101 - 103> - where the 1st digit (1) refers to assets the 2nd and 3rd digits
refer to the agency (01), the 4th digit (1) refers to “cash” and the last two digits refer to “revolving fund”
(03).

Illustration: Accounting for agency

Agency transactions Home office books
Jan. 1
Receipt of revolving fund from home office. Cash - Agency #1 1,000
Cash on hand 1,000
Jan. 1 - 31
Orders sent by agency to home office. Accounts receivable 200
Sales - Agency #1 200

Cost of sales - Agency 120

Inventory 120

Collection by home office of agency sales Cash on hand 200

Accounts receivable 200
Jan. 1 - 31 No entry
Disbursements from the revolving fund
Jan. 31
Replenishment of revolving fund Various expenses - Agency #1 50
Cash on hand 50
To determine the profit attributable to the Sales - Agency #1 200
agency, the following closing entry shall be Cost of sales 120
made: Various expenses- Agency#1 50
Income summary - Agency #1 30
Accounting for branch operations
A branch is accounted for as a separate business unit, but subject to the control of the home office. The
home office determines the degree of self-management exercised by the branch.

The branch maintains its own records and prepares its own financial statements. However, the branch’s
financial statements are combined with the home office’s financial statements when preparing general
purpose financial statements.

Combined financial statements are prepared by:

1. Adding together similar items of assets, liabilities, income and expenses, and
2. Eliminating reciprocal accounts.

Reciprocal accounts (Interoffice or Intra-company accounts)

Transactions of either the home office or the branch with external parties are recorded in the normal
way.Thus, the PFRSs apply when recording these transactions.

However, for internal reporting purposes, transactions between a home office and its branch are
recorded in reciprocal accounts, namely:
1. “Investment in branch” account (or ‘Branch current’ account)
- the home office maintains this account in its books to account for its investments in the branch.
2. “Home office” account (or ‘Home office current’ account)
- the branch maintains this account in its books to account for investments received from the
home office.

The “Investment in branch” is an asset account in the home office’s individual financial statements; while
the “Home office” is an equity account in the branch’s individual financial statements. These accounted
are eliminated when combined financial statements are prepared.

A branch is treated as a separate accounting entity for internal reporting. However, when preparing
financial statements for external reporting, the home office and its branch are viewed as a single
reporting entity. Moreover, the branch does not have a separate legal existence.

The reciprocal accounts are debited (credited) for the following:

Home Office’s books:

Investment in branch
(a) Asset transfers to
branch xx
(b) Assets received
xx from branch
(c) Profit of branch xx
(d) Loss on branch
(e) Liabilities and
expenses incurred or
paid by home office
on behalf of branch xx

Branch’s books
Home office
(a) Assets received from home
xx office
(b) Asset transfers to
home office xx
xx (c) Profit
(d) Loss xx
(e) Liabilities and expenses
incurred or paid by home
xx office on behalf of branch
Notice that for every debit in an account, there is a corresponding credit on the other account.
Therefore, these accounts must be equal at any given point of time. For instance, if the “investment in
branch” account in the home office books has a P20,000 debit balance, the “Home office” account in the
branch books must also have a corresponding P20,000 credit balance.

In case these accounts do not balance, reconciliation procedures similar to bank reconciliation, must be
performed. Adjusting entries should be made first before combined financial statements are prepared.

This is normally the case in actual practice. During your analytical procedures later on when auditing, do
check immediately if these account balance - this will save you time (not to mention from
embarrassment and sleepless nights if you commit oversight errors). Accounting for branches is very
common when auditing banks.

When an entity has more than one branch, a separate investment account for each branch is maintained
in the home office books.

Allocation of expenses
Expenses incurred and paid by the branch are recorded in the normal way. However, expenses incurred
by the home on behalf of the branch are recorded similarly to an investment (i.e., debit to investment
account and credit to home office account).
For instance, costs which are incurred centrally are allocated to the various business units within a single
company in order to have proper financial performance measurement for each of the business units.
The following are examples of costs which 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

Combined financial statements are prepared simply by: adding together similar items of assets, liabilities,
income and expenses, and eliminating the reciprocal 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
Account 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 720,000 400,000
Accumulated depreciation -equipment (72,000) (40,000)
Furniture 90,000 50,000
Accumulated depreciation -furniture (9,000) (5,000)
Accounts payable (72,000) (40,000)
Accrued expenses (45,000) (25,000)
Share capital (2,000,000)
Share premium (500,000)
Retained earnings-beg. (206,000)
Home office (827,000)
Sales (900,000) (500,000)
Depreciation expense 168,000 68,000
Utilities expense 18,000 10,000
General overhead expense 7,200 4,000
Various operating expenses 180,000 100,000
TOTAL - -
The home office and the branch have ending inventories of P270,000 and P150,000, respectively:
Requirement: Prepare the combined
a. Statement of financial position; and
b. Statement of profit or loss.
The reconciliation of reciprocal accounts
As of any given point of time, the “Investment in branch” and the “Home office” accounts must have
equal balances. If these accounts do not balance, reconciliation procedures must be performed.

Reconciling the reciprocal accounts is similar to bank reconciliation procedures. Reconciliation items
can be broadly classified into the following:

a. Transfers in-transit - at the time financial statements are prepared, there may be asset transfers
between the home office and the branch which were not yet recorded by the supposedly recipient.

For instance, there may be shipments of inventory made by home office which were not yet received
recorded by the branch by the end of reporting period. The adjusting entry would be simply a debit to
“Shipments from home office,” and probably to “Freight-in” also, and a corresponding credit to “Home
office” account.

b. Unrecorded Debit and Credit memos

A debit memo sent by the home office to the branch means that the home office has debited (increased)
the “Investment in branch” account. Therefore the corresponding entry to be made in the branch books
is a credit (increase) to the “Home office” account. The opposite applies to a credit memo.

For example, when the hone office collects account receivable on behalf of the branch, the home office
would record the transaction as a debit to cash and a credit to the “Investment in branch” account.
Therefore, to notify the branch of the transaction,the home office will send a credit memo to the
branch. The branch will in turn record the credit memo as a debit to the “Home office” account and a
credit to account receivable.

A debit memo sent by the branch to the home office means that the branch has debited (decreased) the
“Home office” account. Therefore, the corresponding entry to be made in the home office books is a
credit (decrease) to the “Investment in branch” account. The opposite applies to a credit memo.

For example, when the branch returns damaged merchandise received from the home office, the branch
would record the transaction as a debit to “Home office” account and a credit to “Shipments from home
office” account. Therefore, to notify the home office of the transaction, the branch will send a debit
memo to the home office. The home office will in turn record the debit memo as a debit to “Shipments to
branch” account and a credit to the “Investment in branch” account.

A lag in the recording of debit and credit memos can result to imbalance in the reciprocal accounts on
cut-off date.

c. Errors
Errors such as omissions in recording, double recording, mathematical mistakes, and the like can result to
imbalance in the reciprocal accounts.

Home office with several branches

As mentioned earlier, when an entity has more than one branch, separate investment accounts for each
of the branches shall be maintained in the home office books. Each branch shall maintain its own home
office account and shall record is own transaction with the home office. Transactions between a branch
and the home office will not affect the records of the other branches.

However, errors may arise if a transaction between a certain branch and the home office was
erroneously recorded by the home office to another branch’s investment account or a branch
erroneously records a transaction of another branch with the home office.

Special problems in Accounting for branch operations

In addition to the general procedures discussed earlier, the home office and branch may enter into some
transactions that would create special accounting problems. Such transactions are the following:
1. Merchandise shipments to branch billed at a price above cost
2. Inter-branch transactions

Although these transactions do not affect general purpose financial statements, they require some
special accounting for internal reporting purposes.
Shipments to branch billed at a price above cost
Billing to the branch may be made at amounts above cost, or cost plus an arbitrary percentage, also
known as the “billed price.” Information on actual costs is withheld from the branch. Thus, upon
receipt of shipments the branch records the merchandise received at the billed price, rather than at
cost.

This is solely for internal reporting purposes. So that when comparing the profitability of the business
units within the company, the home office’s contribution to the company’s profit through
procurement, manufacturing, and other functions made centrally are not disregarded.

When shipments are billed at cost, the entire gross profit earned by the branch is attributed solely to the
branch. On the other hand, when shipments are billed at above cost, a portion of the gross profit earned
by the branch is attributed to the home office.

For example, let us say your mama gives you and your little sister allowance based on your respective
grades in school. However, you are obligated to tutor little sister, help her in her home works, fetch her
from school, cook dinner, wash the dishes, do the laundry, and many more! Now, would it be fair if
mama gives you a little mark up on your allowance to compensate for your extra hard work? Yes, of
course, right? Same is true with the home office (you), the branch (little sister), and the company (the
mama).

It should be noted that a shipment to the branch, even at billed price, is not a sale. Shipments are
recognized as sale only when they are sold to external parties. Therefore, any markup on shipments
made to the branch must be eliminated when combined financial statements are prepared. This is
necessary to restate the cost of goods sold and ending inventory of the branch to their original costs.

Combined financial statements - Shipments at billed price

When combined financial statements are prepared, the markups on shipments are eliminated in order to
restate cost of goods sold and ending inventory to their original costs. This is performed by eliminating
the “shipments to branch (from home office)” accounts, together with the related “allowance” account.
The “Investment in branch” and “Home office” accounts are also eliminated.