Inventory purchased by head office and shipped to branches for sale may be invoiced to the branch at cost or more than cost (generally a fixed retail price). Billing of goods shipped by the parent company to the branches at cost reduces the parent company’s inventory by the same amount that the inventory was originally recorded in its accounting books. The transfer is not considered a sale and therefore does not generate gross profit for the parent company. Branches receive goods at cost price and make a gross profit when they sell them.
When the accounting records of the branches are kept by the central office, the information in the documentation of the central office is complemented with the information obtained from the declarations of the branch. In practice, the returns from the branches will be summarized monthly and recorded in the corresponding account of the branch in the ledgers of the head office.
Where there are several branches, a separate account should be kept for each one, although in a manual system this can be done in the form of columns for the sake of simplicity. In the books of the head office, the sales and other accounts will be distinguished by the name of the branch.
The following are typical accounts provided in a centralized accounting system: (1) Branch inventory account, (2) Branch debtors account (if the branch sells goods on credit), (3) Bank branch and petty cash or accounts of cash and (4) Profit and loss account of the branch.
When the parent company’s business account is prepared, the cost of goods shipped to the branches is deducted from the parent company’s purchases. If this is not done, the purchases of the head office will comprise the purchases of the head office and the branches. This overestimation of the purchase will result in an overestimation of the head office cost of sales and consequently an understatement of the head office gross profit percentage.
Since inventory is generally valued at cost in a company’s financial statements, the method of invoicing goods to branches at cost is the easiest to apply, since both head office and branch inventory are shown at cost. Therefore, no further adjustment is required.
In the decentralized accounting system, transactions between the parent company and the branch are recorded in the books of both. When the branch keeps its own books, the accounting entries will be similar in many respects to those made by a sole trader. However, the branch’s capital is provided by the head office and is therefore generally recorded by the branch as a credit to the ‘head office account’, with a corresponding debit on the head office books to the “branch account XX”.
The head office account in the branch’s ledgers and the “branch account” in the head office’s books are therefore reciprocal accounts, that is, equivalent accounts kept in different sets of accounts. ledgers and have identical but opposite balances.
After recording all transactions, adjustments, and closing entries in both sets of books, the balance of the head office account in the branch’s ledgers should be the same as the balance of the branch’s account in the ledgers. head office ledger (unless any transactions between head office and branch have not been recorded in a single set of ledgers).