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Appendix 9A

Inventory

Transfers for

Branches

1

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Recording Inventory Transfers to BranchesMany home offices, most notably in the retail industry, transfer inventory to their branches. Somehome offices transfer inventory to their branches at cost; others at above cost. When transfers aremade at above the home offices cost, the unrealized intracompany profit issue discussed in Chap-ter 9 arises. In recording inventory transfers to branches, two accounting procedures are possible(both of which are widely used): sales treatment and nonsales treatment.

Sales Treatment

Some home offices record these transfers as salesusing the Intracompany Sales accountas if thetransfers were between aparent and a subsidiary. In such cases, the procedures to (1) prevent re-

porting these internal sales for combined reporting purposes and (2) defer any unrealized intracom-pany profit at the combined reporting date are identical to those shown in each of the modules inChapter 9 for intercompany sales involving subsidiaries. Accordingly, we need not illustrate theseprocedures here.

Nonsales Treatment

If sales treatment is not used, the home offices intracompany markup is recorded in the DeferredProfit account at the transfer datepending sale of the inventory by the branch to an outside thirdparty. Upon sale by the branch, the home office adjusts the Deferred Profit account downward,with the offsetting credit being to the Branch Income accountthereby reporting as income thepreviously deferred profit.

Invoicing the BranchRegardless of which procedure is used and regardless of whether a markup exists, an intracom-pany billing is prepared so that the inventory can be removed from the home office books andrecorded on the branch books at the invoiced amount. Otherwise, the branch would have sales butnot cost of sales, making it impossible to meaningfully evaluate branch profitability. The remain-der of this appendix discusses nonsales treatment.

General Ledger Journal Entries by Each Accounting Entity

Assume the following information pertaining to a home office intracompany inventory transfer atabove cost to a branch:

1. During 2006, a home office transferred inventory costing $60,000 to its branch at a transferprice of $100,000. The $40,000 markup is 40% of the transfer price.

2. At December 31, 2006, the branch reported $20,000 of this intracompany-acquired inventoryin its balance sheet. Because the markup is 40% of the $20,000 transfer price, $8,000 of intra-company profit must be deferred at the end of 2006. Consequently, $32,000 of the intracom-pany profit (40% of $80,000) has been realized from a combined reporting perspective as theresult of branch inventory sales to outside parties.

3. The branch reported net income of $24,000 for 2006.

2 APPENDIX 9A INVENTORY TRANSFERS FOR BRANCHES

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Illustration 9A-1 shows the general ledger journal entries made by each accounting entity torecord the inventory transfer. Also shown are the home offices year-end adjustments to (1) reducethe Deferred Profit account by $32,000 to obtain the proper year-end balance of $8,000 and (2)increase the carrying value of the home offices Investment in Branch account for the branchs$24,000 of reported net income. For simplicity, we assume that each entity uses a perpetual inven-tory system.

Review Points for Illustration 9A-1. Note the following:

1. If instead the inventory had been transferred at the home offices cost, the branch would havereported an additional $32,000 of net income or $56,000.

2. As a result of the home offices two year-end adjusting entries, the Branch Income account hasa $56,000 balancethe same balance that would have existed if the inventory had been trans-ferred at the home offices cost in the first place.

Entries Required in Consolidation

In consolidation at December 31, 2006, the following entry is made to reduce the branchs reportedcost of sales to the amount it would have been had the inventory been transferred at the home of-fices cost:

APPENDIX 9A INVENTORY TRANSFERS FOR BRANCHES 3

ILLUSTRATION 9A-1 GENERAL LEDGER JOURNAL ENTRIES FOR INTRACOMPANY TRANSFERSABOVE COST TO BRANCHPERPETUAL INVENTORY SYSTEM

Home Office Books Branch Books

Investment in Branch. . . . . . . . . . . . . . 100,000 Inventory . . . . . . . . . . . . . . . . . . . . . . 100,000Inventory. . . . . . . . . . . . . . . . . . . . 60,000 Home Office Capital . . . . . . . . . . . . . 100,000Intracompany Profit Deferred. . . . . . 40,000 To record inventory

To record inventory transferred acquired from home office.to branch.

Intracompany Profit Deferred . . . . . . . . 32,000Branch Income . . . . . . . . . . . . . . . . 32,000

To adjust the deferred profit accountto $8,000.

Investment in Branch . . . . . . . . . . . . . . 24,000Branch Income . . . . . . . . . . . . . . . . 24,000

To record branchs reported earnings.

WORKSHEET ENTRY ONLY

Branch Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32,000

Cost of Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32,000

In addition, it is necessary to reclassify the $8,000 adjusted balance in the Intracompany ProfitDeferred accountan account for internal reporting purposes onlyagainst the branchs $20,000of intracompany-acquired inventory as reported in the branchs year-end balance sheet. This entryresults in reporting the inventory at the home offices cost of $12,000the only valid amount forcombined reporting purposes. This entry follows:


Intracompany Profit Deferred. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000Inventory. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000

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In addition, thebasic elimination entry is needed. Assuming that the Home Office Equity ac-count had a preclosing balance of $60,000 at December 31, 2006, that entry is as follows:



Branch Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24,000Home Office Capital (preclosing balance) . . . . . . . . . . . . . . . . . . . . . . . . 60,000

Investment in Branch . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84,000

The preceding three worksheet entries are posted to the combining worksheet in Illustration9A-2.

ILLUSTRATION 9A-2 INTRACOMPANY INVENTORY TRANSFERS ABOVE COST TO BRANCH

Home Office and BranchCombining Worksheet as of December 31, 2006

HOME CONSOLIDATION ENTRIES

OFFICE BRANCH DR. CR. CONSOLIDATED

Income Statement (2006)

Sales . . . . . . . . . . . . . . . . . . . . . . 500,000 234,000 734,000Cost of sales . . . . . . . . . . . . . . . . . (300,000) (110,000) 2 32,000 (378,000)Expenses . . . . . . . . . . . . . . . . . . . (190,000) (100,000) (290,000)Branch income . . . . . . . . . . . . . . . 56,000 24,000 1 0

32,000 2

Net Income. . . . . . . . . . . . . . . . 66,000 24,000 56,000 32,000 66,000

Statement of Retained Earnings/Analysis of Home Office Capital

Retained Earnings, 1/1/06 . . . . . . . 100,000 n/a 100,000Home office capital (preclosing) . . . n/a 60,000a 60,000 1 0+ Net income . . . . . . . . . . . . . . . . 66,000 24,000 56,000 32,000 66,000 Dividends declared . . . . . . . . . . . (51,000) (51,000)

Balances, 12/31/06 . . . . . . . . . . . . 115,000 84,000 116,000 32,000 115,000

Balance Sheet

Cash . . . . . . . . . . . . . . . . . . . . . . 61,000 15,000 76,000Accounts receivable, net . . . . . . . . . 75,000 37,000 112,000Inventory:

Vendors acquired . . . . . . . . . . . . 110,000 35,000 145,000Intracompany acquired . . . . . . . . 20,000b 3 8,000 12,000Intracompany profit deferred. . . . (8,000) 8,000 3 0

Investment branch. . . . . . . . . . . . . 84,000 1 84,000 0Land . . . . . . . . . . . . . . . . . . . . . . 220,000 30,000 250,000Buildings and equipment . . . . . . . . 500,000 150,000 650,000Accumulated depreciation . . . . . . . . (320,000) (13,000) (333,000)

Total Assets . . . . . . . . . . . . . . . 722,000 274,000 8,000 92,000 912,000

Liabilities . . . . . . . . . . . . . . . . . . . 407,000 190,000 597,000Common stock. . . . . . . . . . . . . . . . 200,000 200,000Retained earnings . . . . . . . . . . . . . 115,000 115,000Home office capital . . . . . . . . . . . . 84,000 116,000 32,000 0

Total Liabilities and Equity . . . . . 722,000 274,000 116,000 32,000 912,000

Proof of debit and credit postings . . . . . . . . . . . . . . . . . . . . . . . . 124,000 124,000

a This amount is the balance in the home office capital account excluding the current year earnings ($84,000 ending balance $24,000 of 2006 earnings).

Explanation of entries:

1 The basic elimination entry.

2 The recognized profit elimination entry.3 The deferred profit elimination entry.

}

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Periodic Inventory System

When each accounting entity uses a periodic inventory system, the general ledger journal entriesmade to record the inventory transfer are as follows:

Home Office Books Branch Books

Investment in PurchasesfromBranch . . . . . . . . . . . . . . . . 100,000 Home Office . . . . . . . . . . . . 100,000

PurchasesSent Home Officeto Branch . . . . . . . . . . . . 60,000 Capital. . . . . . . . . . . . . . 100,000

Deferred Profit . . . . . . . . . 40,000

The Purchases Sent to Branch accounta contra Purchases accountand the Purchases fromHome Office account are both closed at year-end when each accounting entity prepares its adjust-ing entry to record cost of sales and adjust its inventory balance to reflect the physical quantitieson hand.

EXERCISES FOR APPENDIX 9A

E 9A-1 Account Analysis A home office shipped inventory to its branch during 2006. The following infor-mation has been obtained from the records of the home office and the branch at the end of 2006:

Total Resold On Hand

Purchases from home office $90,000 $18,000Purchases sent to branch 75,000

Markup $15,000

Required 1. Complete the analysis.2. Prepare the branchs entry to record cost of sales, assuming that the branch purchased all of its

inventory from the home office and reported a beginning inventory of $24,000, all of which hadbeen sold by the end of the current year. (Assume the same markup percentage for 2005 as for2006.)

3. Prepare an analysis of the Deferred Profit account for the year.

E 9A-2 Deferred Profit Adjustment A home office ships inventory to its branch at 125% of cost. The De-ferred Profit account balance at the beginning of the year was $4,000. During the year, the homeoffice billed the branch $70,000 for inventory transfers from the home office. At year-end, thebranchs balance sheet shows $16,000 of inventory on hand acquired from the home office.

Required 1. Determine the amount of the branchs beginning inventory (as shown in its prior year-end fi-nancial statements).

2. Prepare the branchs entry to record cost of sales.3. Calculate the year-end adjustment to the Deferred Profit account, and show the adjusting jour-

nal entry.

E 9A-3 Entries and Adjustments During 2006, a home office shipped inventory costing $55,000 to thebranch at a transfer price of $66,000. At 12/31/06 the branch reported $18,000 of this inventoryin its balance sheet. At the end of 2005, the branch reported $6,000 of intracompany-acquired in-ventoryall of which was sold in 2006. For 2006, the branch reported $25,000 of net income inits financial statements.

Required 1. Prepare the home office and branch journal entries to record the inventory transfer, assumingthat aperpetual inventory system is used.

2. Prepare the branchs entry to record cost of sales for 2006.


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3. Prepare the home offices year-end adjusting entries relating to the Deferred Profit account andthe branchs reported income.

4. Prepare the entry required in consolidation to report the proper amount for the branchs cost ofsales.

E 9A-4 Reverse Analysis A home office transfers inventory to its branch at a 20% markup. During 2006,it transferred inventory costing $80,000 to the branch. At year-end, the home office adjusted itsDeferred Profit account downward by $18,200. The branchs year-end balance sheet shows $4,800of inventory acquired from the home office.

Required Calculate the home offices cost of the branchs beginning inventory.

PROBLEMS FOR APPENDIX 9A

P 9A-1* Combining Worksheet The 12/31/06 financial statements of Homex Inc. and its branch are as fol-lows:

Home Office Branch

Income Statement (2006)Sales. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 700,000 $ 200,000

Cost of sales. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (390,000) (149,000)Selling expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (42,000) (11,000)Administrative expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (28,000) (4,000)Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (40,000)Branch income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,000

Income before Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 250,000 $ 36,000Income tax expense @ 40% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (100,000)

Net Income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 150,000 $ 36,000

Balance SheetCash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 90,000 10,000Accounts receivable, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80,000 20,000Inventory:

Acquired from vendors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180,000 10,000Acquired from home office. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36,000Intracompany profit deferred . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (6,000)

Fixed assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 770,000 140,000Investment in branch. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176,000

Total Assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,290,000 $ 216,000

Payables and accruals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 200,000 $ 40,000Long-term debt. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 350,000Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500,000Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240,000Home office capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176,000

Total Liabilities and Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,290,000 $ 216,000

Dividends declared during 2006. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 110,000

Required 1. Prepare a combining statement worksheet as of 12/31/06.2. Complete the following analysis of the branchs inventory:

Transfers Transfers

above Cost at Cost Markup

Purchases (from vendors) . . . . . . . . . . . . . . . . . . . . . . . . . . . . $75,000 $75,000 $ 0Purchases from home office . . . . . . . . . . . . . . . . . . . . . . . . . .

Total Inventory Available for Sale. . . . . . . . . . . . . . . . . . . .LessEnding Inventory:

Acquired from vendors . . . . . . . . . . . . . . . . . . . . . . . . . . .Acquired from home office . . . . . . . . . . . . . . . . . . . . . . . .

Cost of Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ $ $


*The financial statement information presented for problems accompanied by asterisks is also provided on Model 9BR (filename:

MODEL09BR) of the software file disk that is available with the text, allowing the problem to be worked on the computer.

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3. Prepare the entry that the branch made to record cost of sales.4. Calculate the markup percentage.

P 9A-2* Comprehensive Combining Worksheet: Sales The preclosing trial balances of Homex Inc. and itsbranch for the year ended 12/31/06, prior to adjusting and closing entries, are as follows:

Home Office Branch

Dr. Cr. Dr. Cr.

Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 35,000 $ 10,000Accounts receivable, net . . . . . . . . . . . . . . . . . . . . . . 80,000 50,000Inventory, 1/1/06

Acquired from vendors . . . . . . . . . . . . . . . . . . . . . 230,000 50,000Acquired from home office . . . . . . . . . . . . . . . . . . 20,000

Intracompany profit deferred . . . . . . . . . . . . . . . . . . . $ 25,000Fixed assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . 870,000 90,000Investment in branch . . . . . . . . . . . . . . . . . . . . . . . . 155,000Payables and accruals . . . . . . . . . . . . . . . . . . . . . . . . 221,000 $ 45,000Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400,000Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300,000Retained earnings, 1/1/06. . . . . . . . . . . . . . . . . . . . . 350,000Home office capital . . . . . . . . . . . . . . . . . . . . . . . . . 115,000Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 960,000 320,000Purchases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800,000 120,000Purchases from home office . . . . . . . . . . . . . . . . . . . . 90,000Purchases sent to branch. . . . . . . . . . . . . . . . . . . . . . 84,000

Selling expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . 81,000 34,000Administrative expenses . . . . . . . . . . . . . . . . . . . . . . 54,000 16,000Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . 35,000

$2,340,000 $2,340,000 $480,000 $480,000

Inventory per physical count on 12/31/06:Acquired from vendors . . . . . . . . . . . . . . . . . . . . . $ 180,000 $ 20,000Acquired from home office . . . . . . . . . . . . . . . . . . 30,000

Additional Information

1. Inventory transferred to the branch from the home office is billed at 125% of cost.

2. The home office billed the branch $15,000 for inventory it shipped to the branch on 12/28/06;the branch received and recorded this shipment on 1/2/07.

3. The branch remitted $25,000 cash to the home office on 12/31/06; the home office received andrecorded this remittance on 1/4/07.

4. The Deferred Profit account is normally adjusted at the end of the year.

5. Income taxes are to be recorded at 40%.

6. No dividends were declared during the year.

Required 1. Prepare the year-end adjusting entries toa. Bring the intracompany accounts into agreement. (Be sure to adjust the other accounts in the

trial balance as appropriate.)b. Adjust the inventory accounts and record cost of sales.

2. Complete the following analysis of the branchs inventory:

Transfers Transfers

above Cost at Cost Markup

Beginning inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ $ $Acquired from vendorsAcquired from home office+ Purchases (from vendors)+ Purchases from home office . . . . . . . . . . . . . . . . . . . . . .

Total Inventory Available for Sale . . . . . . . . . . . . . . . . .LessEnding inventory:

Acquired from vendors. . . . . . . . . . . . . . . . . . . . . . . . .Acquired from home office . . . . . . . . . . . . . . . . . . . . . .

Cost of Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


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3. Prepare the following year-end adjusting entries toa. Record the branchs income on the home offices books.b. Adjust the Deferred Profit account to the proper balance.c. Provide for income taxes.

4. Prepare the year-end closing entries for the home office and the branch.5. Prepare a combining statement worksheet as of 12/31/06 after completing requirements 14.


Documents

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