LB Ltd also sells building materials to other contractors from its warehouse and is considering setting up another retail branch in a different part of the country.
The directors have been told that the branch can be run directly through the head office or set up a separate entity, but are not sure how the accounting will work.
Required:
Explain to the directors how this transaction should be treated in the books of LB Ltd. (5 marks)
View Solution
If a branch is accounted for through the head office, tight control can be maintained. Inventory is normally transferred to the branch at selling price and the following accounts are maintained in the head office ledger:
- Branch inventory control account – goods transferred recorded at selling price.
- Branch mark-up account.
- Goods sent to branch account – goods transferred recorded at cost price.
The branch inventory account will be debited when goods are sent to the branch and credited when they are sold. At the end of the period, after adjusting for unsold inventory, the mark-up account will show the gross profit of the branch.
Under this system, branch expenses are usually paid centrally from head office.
A branch which is set up as a separate entity will keep its own full accounting records and pay its own expenses. Initial assets will be transferred to the branch from head office and transactions between the branch and the head office will go through a branch current account in the head office ledger, representing net investment in the branch, and a head office current account in the branch ledger, representing the capital provided by head office. At the end of the period these two accounts will be reconciled.
Goods will be transferred to the branch at cost or at a small mark-up, so that the branch can add its own mark-up. At the end of the period adjustments will have to be made for any goods or cash in transit and for any unrealized profit in inventory, where goods have been transferred to the branch at an amount above cost price.