From the standpoint of the head office, the problem of sales to the branches is, as mentioned above, largely a problem of policy as to whether goods shall be invoiced at absolute cost; at cost plus a small percentage for overhead expenses; at sales price, i.e., at the price at which the branch is expected to sell the commodity; or at some arbitrary figure which is designed for the purpose of keeping the branch in ignorance of the actual cost of the goods dealt in and therefore of the profit and loss upon the branch’s activities. If goods are billed to the branch at sales price and disposed of at the same price, a comparison of the branch records covering their purchases and their sales should indicate by the difference between the two the amount of stock on hand at any time; i.e., billing the goods to the branch at sales price makes the merchandise records of the branch virtually a perpetual inventory of the goods on hand. This method effects a closer check on losses and waste, for which, of course, a small allowance must always be made. One of the most serious wastes to be checked up is occasioned by too liberal weights and measures to customers. On the other hand, invoicing the goods at sales price gives the branch manager less discretion in adjusting differences with customers inasmuch as defective goods must usually be returned to the head office to secure for the branch full credit. Further, billing the goods at sales price with the purpose of securing accurate control over the branch merchandise necessitates the pursuit of an inflexible policy of sales at the billed price. Daily or weekly adjustments on account of fluctuations in the market cannot be made without losing the control over stock which the policy of billing at sales price secures. In some lines of business this is an insuperable defect.
Where merchandise is invoiced at cost the branch manager has a rather more secure hold on his customers in that he can give immediate satisfaction by making allowances and adjustments to settle difficulties as they come up. Particularly where the manager has an interest in the profits, a much greater incentive is offered him to conduct the affairs of the branch in an efficient and economical manner. This responsibility and power to make adjustments may be abused, however, and a greater degree of control can usually be secured by the head office where merchandise is billed at sales price.
As mentioned above, sometimes goods are billed to the branch at an arbitrary figure. Inasmuch as the question of control by means of a perpetual inventory does not enter into this policy, large discretion can be given the branch manager without unsatisfactory results in checking up the merchandise. He may be allowed to make whatever adjustments with customers seem advisable. Changes in selling price can be made as often as conditions demand, either at the instance of the head office or at the discretion of the manager. A policy of this sort requires a much more thorough system of report from the branch to the head office in order to give the head office a means of checking up periodically the activities of the branch.
It is well to point out that on the books of the head office sales to branches are in no sense income items and must never be recorded with regular sales to outside parties. Similarly, sales or transfers among branches are in no sense earnings. It should be noted that, to keep the head office records correct and up to date, any transfers of goods among branches should be reported immediately to the head office; better still, the authorization of the head office, except in cases of emergency, should be given before such transfers can be made.
Adjustments on Branch and Head Office Books
Head Office and Branch accounts are essentially accounts current between the head office and the various branches. At the close of the fiscal period when the results of the period’s business are being summarized, the four classes of adjustments which are sometimes necessary in the case of accounts current may have to be made. The head office may show a charge to the branch for items which the branch has not yet received at the close of the fiscal period. Similarly, the branch may have charges and credits to the Head Office account which the head office records do not show. If this condition exists, the two accounts must be reconciled in accordance with the method shown in Volume I, page 497. Almost invariably, unless a system of complete daily reports is in effect between the branch and the head office, the head office will have to wait for certain reports from the branch at the close of the fiscal period. The nature of the entries to effect these reports is given in the problem illustrated on page 532.
The chief adjustment which is needed on the head office books is brought about through the policy of charging the branch with merchandise at some other figure than cost. Where this is done, the profit and loss on the branch activities cannot be determined until true costs are taken into the accounts in place of the fictitious figures used during the current period. The basis for converting the fictitious figure into a true cost figure is, of course, a secret known only to the head office. The memorandum accounts covering the merchandising transactions with the branch furnish the basis for determining the cost of goods sold by the branch. Thus, if goods are billed at, say, 30% above cost the billed price becomes 130% of the cost. It is therefore possible to determine the cost of all goods disposed of by the branch and of those still on hand. If it is desired to merge all the branch activities with the similar activities of the head office, the only adjustment necessary at the close of the fiscal period is to convert the sum total of the inventories on hand at the various branches to a cost valuation basis and include them with the head office inventory. This gives the data needed to determine the cost of goods sold and gross profit on the combined activities of the various branches and head office.
It is usually essential that the results of trading at each branch be determined, whether or not such results be incorporated separately on the head office books. Under the assumption that they are to be set up on the records of the head office, the billed cost of the goods disposed of at each branch must be converted to a cost basis and shown transferred from the Head Office Purchases account to the Profit and Loss account with each branch. This separates the total cost of goods sold as among the various branches and the head office. When the various branch Profit and Loss accounts are credited with their respective earnings from sales, the gross profit or loss on the trading activities at the various branches will thus be shown. Similarly, the regular merchandise accounts in which have been recorded the head office merchandising activities will show the gross profit on sales made at the head office. These adjustments are made without interfering in any way with the memorandum accounts carried on the branch books and on the head office books—accounts which have no place in the balance sheet of the head office. In their stead will appear the combined inventory of goods on hand at the branch and the head office converted to a cost basis.
Example of Adjusting Entries
The character of the entry needed to effect these adjustments will now be shown, using the data of the illustrative problem shown above. Comparison of the report of inventory from the branch, $14,000, with the record of goods shipped to the branch, $77,000, shows that goods to the billed value of $63,000 were disposed of at the branch. The records in the head office show that the goods were billed to the branch at 140% of cost. Converting this figure of $63,000 on the basis of 140% of cost develops a true cost of goods sold of $45,000. This is brought onto the head office books by the following entry: