As an organisation increases in size or where an organisation intends diversifying, the company structure will often change. The resultant change will depend on the management policy and available funds. Expansion may be by establishing a system of departments or branches. Each department or branch is established as a separate profit/cost centre. Each department or branch may maintain its own full accounting system or the firm may keep all the financial accounts at head office; the ultimate objectives being to control the business and to highlight profits or losses generated within each department or branch. The net profit or loss for each branch is calculated and accumulated to arrive at the profit or loss for the whole business.
Various types of organisations may operate through departments or branches – it is not confined to one industry. Examples include: retail businesses, banks, farms, estate agents, travel agents, accountants, etc.. Exam questions tend to concentrate on retailing businesses. Whatever the business activities may be, the principles outlined may be used to prepare accounts in any situation.
In retail store accounting, all the departments may be in the same building. The overall objectives of controlling the business and calculation of the ultimate profit or loss by department is vitally important. The important aspect is the allocation and apportionment of expenses to the various departments. Direct department expenses are easily allocated to the relevant department. Indirect expenses are not as easily allocated. Indirect expenses include rent, rates and insurance on the building, lighting and fans, and telephone, canteen service, supervisor’s salary, advertising and marketing costs and general administration costs. These expenses must be apportioned on the most equitable basis to the departments. The basis of apportionment used will depend on the relationship of the expense to the benefit derived by the respective departments. The usual bases of apportionment are:
|Expense||Basis of Apportionment|
|Rent and rates||Floor area|
|Insurance||Average book value of assets insured|
|Lighting and fans||Measured units, nominal power usage or floor area|
|Canteen service||Number of employees|
|Supervisor’s salary||Time spent in respective departments or production output|
|Advertising and marketing costs||Sales value|
|General administration expenses||Number of employees or the sum of purchase costs or sales values (linked to the volume of paperwork involved)|
The accounts that the head office must incorporate into its own ledger to deal with the branch include:
- The branch inventory control account
- The branch mark-up account or the branch adjustment account
- The goods sent to branch account
- The branch cash and bank accounts
- The branch receivables accounts i.e. where the branch sells goods on credit
- The branch expense accounts
The Branch Inventory Control account is maintained at selling price. The account is debited with goods sent to the branch and credited with sales, returns to head office, losses such as wastage, pilferage and breakages or mark-down. The balance on this account should always represent the value of inventory of unsold goods at selling price.
The Branch Mark-Up Account is effectively the trading account for the branch. It is credited with the mark-up i.e. the potential gross profit on the inventory held at the branch. When goods are returned, lost, destroyed, stolen or marked-down, the mark-up account is debited accordingly, reducing the potential gross profit. At the end of the accounting period, the mark-up relating to the unsold inventory is carried forward to the next period while the difference is transferred to the main Statement of Comprehensive Income. By setting the mark-up on unsold inventory against the closing branch inventory, the closing inventory is valued at cost. This is in compliance with IAS 2 ‘Inventories’.
The Goods Sent to Branch Account is maintained at cost price. The account is credited with goods sent to the branch and is debited with returns from the branch. At the end of the accounting period, the account is closed off, transferred to Head office purchases. This is completed to reduce the head office cost of sales figure.
The Branch Cash and Bank Account are both maintained in a similar manner to the cash and bank account of the Head office. When the branch lodges money, the account is debited; when the branch or Head office pays out money, the account is credited.
The Branch Receivables Accounts are maintained in a similar manner to the receivables accounts of the Head office. When the branch sells goods on credit, the accounts are debited; when the branch receives payment from the customers, the accounts are credited.
The Branch Expense Accounts are maintained in a similar manner to the expense accounts of the Head office. When the head office records an expense on behalf of the branch or the branch itself records an expense, the account is debited; on payment of the expense, the account is credited.
Normal Wastage and Pilferage
Inevitably a small amount of inventory may have been wasted or stolen. In branch accounts this is dealt with in arriving at the branch gross profit, because it is regarded as a cost which is normally incurred when trade is being carried on.