INTRODUCTION TO PARTNERSHIP ACCOUNTING

Partnership – a contract whereby two or more persons bind themselves to contribute
money, property or industry into a common fund with the intention of dividing the profit among themselves (Article 1767 of the Civil Code of the Philippines).

Characteristics of a Partnership
1. Mutual agency – any partner may act as an agent of the partnership in conducting its affairs. Each partner has an equal right to act for the partnership and to enter into contracts binding upon it, as long as he acts within the normal scope of business operations. 2. Limited life – a partnership may be dissolved at any time by action of the partners or by operation of law. The withdrawal, death, retirement, bankruptcy, incapacity of a partner and the admission of a new partner dissolves the partnership. 3. Unlimited liability – the personal assets of a general partner may be used to satisfy the claims of the creditors of the partnership if the partnership assets are not enough to settle the liabilities to outsiders upon liquidation. 4. Co-ownership of property – properties contributed to the partnership are owned by the partnership. Properties invested by a partner cease to be his own personal property. 5. Co-ownership of profit – a partner has the right to share in partnership profits. The partners are entitled to share in the firm’s profits as a return on their investment. 6. Legal entity – a partnership has a legal personality separate and distinct from that of each of the partners. A partnership may, therefore, acquire property in its own name and may enter into contracts.

Advantages of a Partnership
1. It is easy to form and to dissolve. A partnership is ended whenever there are changes in the ownership structure such as withdrawal of a partner or admission of a new partner. 2. Greater amount of capital may be raised compared to a sole proprietorship. The source of capital investment comes from 2 or more persons.

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3. There is relative freedom and flexibility in decision-making compared to a corporation. Decisions are effected simply by agreement among the partners without the formalities necessary under a corporation. 4. It is better managed because business affairs are supervised by more than one person. Better management results from the combined experience and ability of several individuals. 5. The unlimited liability of a general partner makes it reliable from the point of view of creditors.

Disadvantages of a Partnership
1. The unlimited liability of a partnership deters many from investing in a partnership. 2. There is lack of business continuity because it can be easily dissolved. 3. There is difficulty in transferring ownership interest because ownership interest in the partnership cannot be transferred without the consent of all the partners. 4. Limited amount of capital may be raised compared to a corporation. 5. There is likelihood of dissension and disagreement when each of the partners has the same authority in the management of the firm.

Kinds of Partnerships
1. According to activity a. Service – main activity is the rendering of services b. Merchandising or Trading – main activity is the purchase or sale of goods c. Manufacturing – main activity is the production of goods

2. According to liability

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a. General – one consisting of general partners who are liable prorate and sometimes solidarily with their separate property for partnership liabilities. b. Limited – one consisting of one or more general partners and one or more limited partners. “LTD” is added to the name of the partnership. 3. According to object a. Universal partnership of all present property – one in which the partners contribute all the property which actually belong to each of them, at the time of the constitution of the partnership, to a common fund with the intention of dividing the same among them as well as the profits which they may acquire therewith. All assets contributed to the partnership and subsequent acquisitions become common partnership assets. b. Universal partnership of profits – one which comprises all that the partners may acquire by their industry or work during the existence of the partnership and the usufruct of movable or immovable property which each of the partners may possess at the time of the institution of the contract. The original movable or immovable property contributed do not become common partnership assets. c. Particular partnership – one which has for its object determinate things, their use or fruits or a specific undertaking or the exercise of a profession of vocation.

Kinds of Partners
a. According to Investment 1. Capitalist – one who contributes capital in money or property. 2. Industrial – one who contributes industry, labor, skill or service. 3. Capitalist-Industrial – one who contributes money, property and industry b. According to Liability 1. General – one whose liability to third persons extends to his private property 2. Limited – one whose liability to third persons is limited only to the extent of his capital contribution to the partnership. c. According to Participation 1. Nominal- a partner in name only. 2. Secret – one who takes active part in the business but whose connection with the partnership is concealed or unknown to the public.

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3. Silent – one who does not participate actively in the management of partnership affairs. 4. Managing Partner – one who manages actively the business of the partnership

Articles of Co-Partnership – agreement in writing among the partners governing
the nature and terms of the partnership contract. This agreement is the framework within which the partners are to operate or conduct partnership business – from formation to operations then to the eventual dissolution and liquidation of the partnership. Observations of these details will help minimize, if not eliminate, the confusion and disputes that may arise between or among the partners. The written agreement among the partners governs the formation, operation and dissolution of the partnership and is required to be registered with SEC. It contains the following information: 1. The name of the partnership; 2. The names, addresses of the partners, classes of partners stating whether the partner is a general or a limited partner; 3. The effective date of the contract; 4. The purpose and principal place of business of the business; 5. The capital of the partnership stating the contributions of each of the partners; 6. The rights and duties of each of the partners; 7. The manner of dividing profit or loss among the partners; 8. The conditions under which the partners may withdraw money or other assets; 9. The manner of keeping the books of accounts; 10. The causes for dissolution and the provision for arbitration in settling disputes.

Features of Partnership Accounting
1. Plurality of capital and drawing accounts – there will be as many capital accounts and as many drawing accounts as there are partners 2. Partner’s loans – partners may advance money to the partnership in the form of loans when the business is in need of additional funds.

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3. Partner’s borrowings – the partnership may advance money to partners other than withdrawals in the form of loans. 4. Partner’s salaries – partners are paid salaries for services rendered in the conduct of partnership business. 5. Interest on investment – interest is allowed to earn on the asset investment of the partners. 6. Division of profit and losses – net profit or net loss is to be divided among the partners based on their agreement.

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PARTNERSHIP FORMATION
Accounting entries to record the formation of a partnership will depend upon how the partnership is formed. A partnership may be formed in the following ways, namely: 1. Formation of a partnership for the first time by individuals. 2. Conversion of a sole proprietorship to a partnership a. A sole proprietor allows another individual who has no business of his own to join the business. b. Two or more sole proprietors form a partnership.

General Guidelines
1. Cash investments are recorded using their face values. 2. Non-cash asset investment is recorded at the current fair value of the property at the time of investment. Independent professional appraisals should be made to determine the fair value. Fair value is the amount to be obtained when the asset is sold at the present time in its present condition. 3. Accounts receivable are recorded in the books of the partnership at gross amount. Allowance for bad debts is carried forward to the partnership. 4. Depreciable property assets are recorded in the books of the partnership at carrying value. Accumulated depreciation is not carried forward to the partnership. 5. When a sole proprietorship is converted into a partnership, the following books may be used: a. Books of the sole proprietorship may be used as books of the partnership. b. Books of the sole proprietorship will be closed and a new set of books will be used for the partnership.

Two Kinds of Partnership Formation
1. Formed by individuals

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Cash investment Non-cash asset investment

Cash X, Capital Asset X, Capital Note: Use the fair market value of the asset.

xxx xxx xxx xxx

Non-cash asset investment with assumption of liability

Asset Liability X, Capital Note: Debit the asset account using its fair market value; credit the liability account using the loan balance to be assumed by the partnership; and credit the capital account of the partner using the net amount.

xxx xxx xxx

Service or Industry

Memo Entry Mr. X is admitted as an industrial partner with a ____ share in profits.

2. Sole proprietorship(s) converted into a partnership – accounting procedures are as follows: a. Adjust the books of the sole proprietorship(s). Increase in value Asset of an asset X, Capital without a contraasset account Decrease in value of an asset without a contra asset account Increase in value of an asset with a contra X, Capital Asset

xxx xxx

xxx xxx

Contra- asset X, Capital

xxx xxx

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asset account Decrease in value of an asset with a contra asset account Increase in value of a liability Decrease in value of a liability X, Capital Contra- asset xxx xxx

X, Capital Liability Liability X, Capital Note: These adjustments are similar to the year-end adjusting entries. Only, replace the nominal accounts with the Owner, Capital account.

xxx xxx xxx xxx

b. Close the books of the sole proprietorship(s). Closing entry Contra-asset Liabilities X, Capital Assets

xxx xxx xxx xxx

c. Record the investment of the partners in the books of the partnership – assume new set of books. Opening entry Assets xxx 8

To record investment of sole proprietor

Allowance for Bad Debts Liabilities X, Capital Notes: 1. Accounts receivable is taken at gross amount; allowance for bad debts is carried over in the books of the partnership. 2. Depreciable property assets are recorded at carrying value; accumulated depreciation is not carried over in the books of the partnership.

xxx xxx xxx

Classroom Exercises
1. A partnership is formed by four (4) individuals who make the following investments: Partner A Cash of P100,000 Partner B Land costing P150,000 with a fair market value of P200,000 Partner C Delivery van costing P350,000 on which there is an outstanding liability of P50,000 to be assumed by the new business. Partner D Labor/skills with a 10% share in profits. Prepare journal entries to record the investment of the partners.

2. Joey is operating an ice cream parlor. She admits Audi as a partner in her business. Accounts in the ledgers of Joey’s business as of December 31, 20x8 show the following balances:

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Cash Accounts receivable Merchandise Inventory Office equipment Total assets Accounts Payable Notes Payable Joey, Capital Total liabilities and owner’s equity

P 6,000 120,000 180,000 20,000 P326,000 P32,000 30,000 264,000 P326,000

For purposes of establishing the interest of Audi, the following adjustments are agreed upon. a. An allowance for bad debts of 2% of accounts receivable is to be set up. b. The merchandise inventory is to be valued at P202,000. c. Office equipment is to be depreciated by 10% of its cost. d. Prepaid expense of P6,500 and accrued expenses of P4,000 are to be recognized. Audi will invest cash to give her a 1/3 interest in the partnership. Prepare all necessary journal entries in the books of Joey. Prepare all necessary entries in the books of the partnership. Assume new set of books.

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PARTNERSHIP OPERATIONS
Accounting Cycle of a Partnership – same as in sole proprietorship
1. 2. 3. 4. 5. 6. 7. 8. Prepare journal entries Post to ledgers Prepare a trial balance Prepare adjusting entries Prepare financial statements Prepare closing entries Prepare a post-closing trial balance Prepare reversing entries

Special Concerns
I. Journal entries – same as in sole proprietorship except for the following transactions which are peculiar to a partnership: a. Partners’ loans – partner lends money to partnership Cash xxx Accounts/Loans/ xxx Notes Payable or Due to Partner or Loan from Partner b. Partners’ borrowings from partnership – partnership lends money to partners Accounts/Loans/ xxx Notes Receivable or Due from Partner or Loan to Partner Cash xxx II. Financial statements – the same as in sole proprietorship except: a. Balance Sheet or Statement of Financial Position– the owner’s equity section is labeled Partners’ Equity b. Income Statement – an additional section called Division of Profit and Loss is included. This profit distribution provides a full analysis of the distribution of earnings which is presented at the bottom of the partnership income statement. c. Statement of Changes in Partners’ Equity – a statement that reports the changes that have taken place in partners’ equity during the period. Each

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partner is provided a column heading which explains details of the changes in their equity account. III. Closing entries – drawing accounts are not automatically closed to the capital accounts; drawing accounts are closed to the capital accounts only if agreed upon in the articles of co-partnership.

Rules for Dividing Profit and Loss
1. As to Capitalist Partner a. Division of Profit 1. In accordance with agreement. 2. In the absence of an agreement, division of profits is in accordance with capital contributions. b. Division of Loss 1. In accordance with agreement. 2. If only the division of profits is agreed upon, then the division of losses will be the same as the agreement on division of profits. 3. In the absence of an agreement, division of losses is in accordance with capital contribution. 2. As to Industrial Partner a. Division of Profit 1. In accordance with agreement. 2. In the absence of an agreement, the industrial partner shall receive a just and equitable share of the profits. b. Division of Loss 1. In accordance with agreement. 2. In the absence of an agreement, the industrial partner shall have no share in the losses. Net income is viewed as a return for 1. services rendered (salaries) 2. capital investment (interest) 3. entrepreneurial ability or managerial skills (bonus) Methods of Dividing Net Income 1. Equally 2. Arbitrary Ratio a. Fractions b. Percentages

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c. Ratio and Proportion 3. Capital Ratio a. Original/Initial investment b. Beginning capital balance c. Ending capital balance d. Average capital – most equitable method 4. Allowing Salaries, Interest and Bonus – considered as part of the distribution of net income a. Salaries – to give recognition to the ability, experience or time devoted by a partner to the business. b. Interest - to give recognition to differences in the capital contribution given in proportion to the period such capital was actually used. c. Bonus – incentive/special compensation given to a partner for superior income realized. It is usually based on net income.

General Guidelines
1. Partner salary allowances, interest allowances on capital account balances and bonus are not expenses in the determination of partnership net income. 2. The provision on salaries and interest must be enforced regardless of whether operating results is a profit or loss. 3. results is a profit. The provision on bonus is enforced only when operating

4. If the partnership agreement specifies that income is to be divided based on partners’ capital balances but fails to specify how capital balances are to be computed, the average capital balances should be used if it can be computed. If not, the original capital balances should be used.

Capital Account of a Partner
Partner, Capital Debit Permanent Withdrawals Credit Initial Investment Additional Investments

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Pro-forma Entries
To distribute net income To distribute net loss Income Summary A, Drawing B, Drawing A, Drawing B, Drawing Income Summary xxx xxx xxx xxx xxx xxx

Classroom Exercises
1. Assume ABC Partnership earned a net income of P120,000 for the year. Three partners A, B and C will share in the net income. Their capital accounts are as follows: A, Capital 9/1 30,000 1/1 50,000 6/1 10,000 3/1 B, Capital 20,000 1/1 C, Capital 1/1 4/1 70,000

30,000 10,000

Prepare the entry to distribute net income among the three partners assuming: a. Net income is divided equally. b. Net income is divided as follows: A – ½; B – ¼; C – ¼. c. Net income is divided as follows: A – 50%; B – 30%; C – 20%. d. Net income is divided as follows: 3:2:1 e. Net income is divided based on original/initial capital contribution which were as follows: A – P20,000; B – P30,000; C – P10,000. f. Net income is divided based on beginning capital balances. g. Net income is divided based on ending capital balances. h. Net income is divided based on average capital.

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2. Assume the same given information in No. 1. Prepare the entry to divide net income if net income is to be divided as follows: a. Interest of 10% on beginning capital balances. b. Annual salaries of P5,000 to A and P4,000 to B. c. Bonus to Partner C amounting to P16,000. d. Remainder to be divided – 50:30:20. 3. Using the same given information in No. 2, prepare the entry to divide net income if net income is P35,000 only. 4. Using the same given information in No. 2, prepare the entry to close income summary if the partnership incurred a net loss of P60,000 for the year.

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PARTNERSHIP DISSOLUTION WITHOUT LIQUIDATION
Dissolution
1. The change in the relation of the partners caused by any partner ceasing to be associated in the carrying out of the business. 2. The termination of the life of an existing partnership.

Dissolution of an old partnership may be followed by:
1. the formation of a new partnership – new partnership continues the business activities of the dissolved partnership without interruption. 2. liquidation – termination of business activities and winding up of partnership affairs preparatory to going out of business.

Conditions resulting to partnership dissolution
1. Admission of a new partner 2. Withdrawal of a partner due to retirement, death, incapacity, bankruptcy or voluntary withdrawal 3. Incorporation of a partnership

Admission of a New Partner
1. The consent of all the partners is necessary. 2. Upon the admission of a new partner, a new agreement covering partners’ interests, profit and loss sharing and other considerations should be drawn because the dissolution of the original partnership cancels the old agreement. 3. There is a need to update the capital balances of the partners by a. determining profit share of each partner from the last balance sheet date to dissolution date. b. revaluing/ adjusting partnership assets and liabilities using a temporary account called the Capital Adjustment account. The Capital Adjustment

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account is closed to the partners’ capital accounts using their profit and loss ratio.

Pro- forma Entries
Determine profit Share of partners Income Summary A, Drawing B, Drawing A, Drawing B, Drawing A, Capital B, Capital Increase in value of an asset without a contraasset account Decrease in value of an asset without a contra asset account Increase in value of an asset with a contra asset account Decrease in value of an asset with a contra asset account Increase in value Asset Capital Adjustment xxx xxx xxx xxx xxx xxx xxx xxx xxx

Capital Adjustment Asset

xxx xxx

Contra- asset Capital Adjustment

xxx xxx

Capital Adjustment Contra- asset

xxx xxx

Capital Adjustment

xxx

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of a liability Decrease in value of a liability

Liability Liability Capital Adjustment Note: These adjustments are similar to the year-end adjusting entries. Only, replace the nominal accounts with the Capital Adjustment account. xxx

xxx xxx

Close the Capital adjustment account

Capital Adjustment A, Capital B. Capital OR A, Capital B, Capital Capital Adjustment Note: The Capital Adjustment account is divided among the partners based on their profit and loss ratio.

xxx xxx xxx xxx xxx xxx

Types of Admission of a New Partner
1. By purchase of interest from one or more of the old partners a. It is considered as a personal transaction between the selling partner and the buyer who becomes a new partner. b. The cash paid by the buyer is not recorded in the books of the partnership for this is a personal transaction between the selling partners and the buyer. c. The gain or loss arising from the sale of interest is not recorded in the partnership books. It is considered as a personal gain or loss of the selling partner. d. It merely involves a transfer of capital of the selling partner to the capital of the buying partner.

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e. There is no increase in total assets and no increase in total partners’ equity. 2. By investment or asset contribution in the partnership a. It is a transaction between the partnership and the incoming partner. b. It involves the investment of assets by new partner into the partnership. c. Total assets and total partners’ equity will increase.

d. Record the admission of the new partner based on the following procedures:  Record the investment (contributed capital) of the new partner.  Determine the agreed capital of the new partner. This is computed as follows:
Total Agreed Capital of the Firm x % of Interest of New Partner

 Compare the contributed capital and the agreed capital of the new partner. Record goodwill or bonus, if there is any.

Pro-forma Entries
By purchase of interest By Investment A, Capital C, Capital Cash Non-cash asset C, Capital xxx xxx xxx xxx xxx

Bonus

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1. It is an amount partners are willing to allow as additional credit to a partner’s capital in excess of his actual capital contribution. 2. It is a transfer of capital from one partner to another. 3. Bonus may be recognized only when total agreed capital of the firm is equal to its total contributed capital.

Pro-forma Entries
Bonus to old partners Bonus to new partner C, Capital A, Capital B, Capital A, Capital B, Capital C, Capital Note: Bonus is divided among the old partners using profit and loss ratio. xxx xxx xxx xxx xxx xxx

Vague Problems
1. New partnership agreement fails to specify the total agreed capital capitalization of the new partnership after the admission of a new partner. 2. In the absence of expressed agreements, either the bonus or the goodwill method may be used.

Special Terms
1. Agreed capital (AC) – new capitalization of the new partnership which will be equal to total contributed capital. 2. Contributed capital (CC) – the sum of the investments or contributions of the new and old partners. 3. Fraction of interest – this is the interest or equity of a partner expressed in fraction 4. Percentage of interest – this is the interest or equity of a partner expressed in percentage.

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Withdrawal of a Partner
There is a need to update the capital balances of the partners by 1. determining profit share of each partner from the last balance sheet date to dissolution date. 2. revaluing/ adjusting partnership assets and liabilities using a temporary account called the Capital Adjustment account. The Capital Adjustment account is closed to the partners’ capital accounts using on their profit and loss ratio.

Types of Withdrawal of a Partner
1. Purchase of interest by another partner or an outsider a. It is considered a personal transaction between the buying and selling partners. b. It involves the transfer of the withdrawing partners’ capital to the capital account of the buying partner. 2. Purchase of interest by the partnership a. It is considered a transaction between the partnership and the outgoing partner. b. It involves a decrease in partnership assets or increase in partnership liabilities.

Pro-forma Entries
By purchase of interest by another person By purchase of interest by the partnership (a) Equal to carrying Amount C, Capital Cash/Liability xxx xxx C, Capital A, Capital xxx xxx

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(b) More than carrying amount

A, Capital B, Capital C, Capital C, Capital Cash/Liability

xxx xxx xxx xxx xxx xxx xxx xxx xxx

(c) Less than Carrying amount

C, Capital Cash/Liability A, Capital B, Capital

Classroom Exercises
1. The records of ABC Partnership show the following balances at year-end: ABC Partnership Trial Balance December 31, 200x P15,000 10,000 P800 25,000 1,000 3,200 10,000 15,000 20,000 P50,000

Cash Accounts receivable Allowance for bad debts Office furniture Accumulated depreciation Accounts payable A, Capital B, Capital C, Capital Total

P50,000

A, B, C divide profit and loss equally. With the consent of all the partners, Mr. D is admitted as a new partner. The following adjustments are agreed upon: a. Allowance for bad debts should be 10% of accounts receivable. b. Office furniture should be 10% depreciated. c. Accrued expenses amounting to P1,300 should be recorded. Prepare entries to adjust the accounts of the partnership. Prepare the entry to record the admission of Partner D under the following independent assumptions: a. Mr. D purchases ½ of the interest of Partner B for  P7,000

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 P5,000  P9,000 b. Mr. D invests P8,000 cash. c. Mr. D invests sufficient cash to give him 25% interest in the firm. 2. Assume the adjusted capital balances of the following partners are as follows: Partner A Partner B Assume A & B divide profit and loss equally. P50,000 100,000

Prepare the entry(ies) to record the admission of Mr. C under the following independent assumptions: a. Mr. C is admitted by investing P 50,000 for a capital credit of 20% of the agreed capitalization of P200,000. b. Mr. C is admitted by investing P50,000 for a capital credit of 30% of the agreed capitalization of P200,000. c. Mr. C invests P60,000 for a ¼ interest in the firm. d. Mr. C invests P60,000 for a ½ interest in the firm. 3. Assume that the updated capital balances of the partners are as follows: Partner A Partner B Partner C P50,000 100,000 150,000

A, B and C share profit and loss 3:2:3. Partner A withdraws from the partnership. Prepare all the necessary journal entries under the following independent assumptions: a. With the consent of Partners B and C, Partner A withdraws from the partnership by selling his entire interest to Partner D for P50,000 cash. b. Partnership purchases entire interest of Mr. A for P50,000. c. Partnership purchases entire interest of Mr. A for P60,000. d. Partnership purchases entire interest of Mr. A for P35,000.

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PARTNERSHIP DISSOLUTION WITH LIQUIDATION
Dissolution with Liquidation
1. A partnership is liquidated when its business operations are completely terminated or ended. 2. It may be caused by any of the following factors: a. The purpose for which the partnership was organized has been accomplished. b. The term/period covered by the partnership contract has terminated. c. The firm became bankrupt. d. The partners mutually agree to close the business. 3. Partnership assets are sold. 4. Partnership creditors are paid. 5. Remaining assets are distributed to the partners as a return of their investments. 6. The purpose of accounting during this period is to have an equitable distribution of partnership assets to creditors and partners.

Definition of Terms
1. Dissolution – the termination of the life of the partnership. 2. Liquidation – the process of winding up a business which normally consists of conversion of assets into cash, payment of liabilities and distribution of remaining among the partners. 3. Realization – the process of converting non-cash assets into cash. 4. Receiver – the person assigned to take care of liquidation. 5. Gain on realization – the excess of the selling price over the carrying amount of the assets sold through realization. 6. Loss on realization – the excess of the carrying amount over the selling price of the assets sold through realization. 7. Capital deficiency – the excess of a partner’s share on losses over his capital balance. 8. Deficient partner – a partner with a debit balance in his capital account. 25

9. Right of offset – the legal right to apply part or all of the amount owing to a partner on a loan balance against a deficiency in his capital account resulting from losses in the process of liquidation. 10. Partner’s interest – the sum of a partner’s capital, loan balance net of advances to the partnership. 11. Solvent partner – personal assets of the partner exceed his personal liabilities. 12. Insolvent partner – personal assets of the partner are less than his personal liabilities. 13. Statement of Liquidation – an accounting statement summarizing the winding up of the business affairs of the partnership.

Types of Liquidation
1. Lump-sum liquidation – This is a process whereby the distribution of cash to the partners is done only after all the non-cash assets have been realized, the total amount of gain or loss on realization is known, and all liabilities have been made. 2. Installment method – This is a process whereby assets are realized on a piecemeal basis and cash is distributed to partners on a periodic basis as it becomes available even before converting all assets into cash.

Procedures in Lump Sum Liquidation
1. Finish the accounting cycle. a. Adjust the books. b. Determine the net income and close the net income to partners’ capital accounts. c. Close all nominal accounts. 2. Sell non-cash assets and distribute gain or loss on realization among partners using profit and loss ratio. a. Any difference between the selling price and carrying amount of the sold assets shall be recorded in an account called Gain or Loss on Realization. b. The Gain or Loss on Realization account shall be closed to the partners’ capital accounts using profit and loss ratio. c. Gain on realization increases the capital balance of a partner while a loss on realization decreases the capital balance of a partner. 3. If partner’s capital balance results in a debit balance (deficient balance), the following may happen: 26

a. If a partner has a loan balance – exercise the right of offset (apply the loan balance against the debit balance). b. If there is no loan or if capital balance still results in a debit balance:  If partner is solvent – deficient partner pays.  If partner is insolvent – deficient partner is unable to pay; the remaining partners will absorb the deficiency. The absorption of deficiency will be based on residual profit and loss. 4. Cash is to be distributed in the following order of priority: a. Those owing to partnership creditors. b. Those owing to partners with respect to loans. c. Those owing to partners with respect to capital. Note that the final distribution of cash to partners is made based on the partners’ capital balances and not on any ratio. 5. When cash is not sufficient to pay creditors, the solvent general partners shall contribute the difference using their loss ratio.

Pro-forma Entries
Realization of asset at a gain Cash Allowance for bad debts Accumulated depreciation Gain or loss on realization Asset Cash Allowance for bad debts Accumulated depreciation Gain or loss on realization Asset Gain or loss on realization A, Capital B, Capital OR A, Capital B, Capital Gain or loss on realization 27 xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx

Realization of asset at a loss

Close gain or loss on realization

Note: Gain or loss on realization is closed to partners’ capital accounts using profit and loss ratio. Payment of partnership debts Payment of partner’s loan Return of partners’ capital Liabilities Cash Liability – Partner Cash A, Capital B, Capital Cash Note: Return of capital is based on partners’ final capital balances. Liability – Partner A, Capital Cash A, Capital B, Capital C, Capital A, Capital xxx xxx xxx xxx xxx xxx xxx

Right of offset Payment of deficient partner Absorption of deficiency

xxx xxx xxx xxx xxx xxx xxx

Pro-forma Statement of Liquidation (Lump-Sum Method)
Name of Partnership Statement of Liquidation Date Covered by the Liquidation
Cash Profit & loss ratio Balances before realization Realization of non-cash assets and distribution of gain or loss on realization Noncash assets Liabilities Loans Payable, Partner A A, Capital B, Capital C, Capital

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Balances Payment of liabilities Balances Payment of partner’s loan Balances Return of partners’ capital

Special Notes
1. Make sure that the balances before liquidation show equality of debits and credits. This will always be true after each liquidation transaction. 2. Maintain two columns for the debits – one for cash and one for non-cash assets. 3. Maintain separate columns for liabilities to outside creditors and liabilities to partners. 4. Gain on realization increases capital while loss on realization decreases capital. 5. Figures in parentheses represent reduction in the account. 6. Double rule all columns when all columns are brought to zero balance.

Classroom Exercises
ABC Partnership has the following balance sheet: ABC PARTNERSHIP Balance Sheet December 31, 200x Assets Cash Furniture and fixtures Less: Acc. depreciation Total Assets Liabilities Accounts Payable Loans Payable – A Loans Payable – B Partners’ Equity A, Capital B, Capital P40,000 P250,000 50,000 P70,000 20,000 10,000 P40,000 50,000 200,000 P240,000

P100,000

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C, Capital Total Equities P&L ratio is 5:3:2.

50,000

140,000 P240,000

Prepare a statement of liquidation and journal entries under the following independent cases: 1. Case 1 – Furniture and fixtures is sold for P140,000. 2. Case 2 – Furniture and fixtures is sold for P110,000. 3. Case 3 – Furniture and fixtures is sold for P70,000.

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INSTALLMENT LIQUIDATION
1. Frequently, partnership liquidation does not take place on a single date.

2. The sale of all of the assets of a partnership is not instantaneous but may extend over several months. 3. When this happens, the partners may prefer to receive the amounts due to them in a series of installments rather than wait until all assets have been converted to cash. 4. Installment payments to partners are proper provided that measures are taken to insure that all creditors are paid in full and that there is no over distribution to one or more of the partners.

Nature of Installment Liquidation
1. Non-cash assets are sold on a piecemeal basis over an extended period of time. 2. Cash realized is immediately distributed to partners after fully satisfying creditors’ claims or after setting aside sufficient cash for these liabilities. 3. Cash distribution to partners is considered as if it were the last because total gain or loss on realization is not yet determined. 4. Remaining unsold assets must be treated as a complete loss. 5. Debit balances in capital and potential capital deficiencies are assumed uncollectible. 6. Partners’ interests are reduced by cash distributions to a balance proportionate to the partners’ profit and loss ratio. 7. Succeeding cash distributions are then based on the profit and loss ratio.

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Installment Liquidation Procedures
1. Cash is distributed to partners even before fully realizing non-cash assets and determining total gain or loss on realization. 2. Restricted interest, in the accompanying schedule to determine amounts to be paid to partners, shall consist of: a. remaining unsold assets; b. cash withheld for possible expenses; c. debit balances in capital. 3. Considerable care is required to insure an equitable distribution of cash to the partners. The Statement of Liquidation is usually supported by a Schedule of Safe Payments. This schedule is prepared periodically based on the following considerations. a. Each installment of cash is distributed as if no more cash is forthcoming. b. Cash is distributed to a partner only if he has an excess credit balance in his partnership interest (capital and loan balance) after absorption of his share of the maximum possible loss that may occur. The possible loss consists of the following:  total value of remaining non-cash assets  cash withheld to pay for liquidation expenses and unrecorded liabilities  a debit balance in a capital account. c. Payments to partners based on a schedule of safe payments bring at some point in the liquidation, the partners’ capital to the profit and loss ratio.

Pro-forma Schedule of Safe Payments
ABC Partnership Schedule of Safe Payments – Month Schedule 1 Partner A Capital balance Partner B Partner C

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Loan balance Total interest Possible loss Payment to partners

Classroom Exercise
The partners of ABCD Partnership share profits and losses as follows: A – 50%; B20%; C – 20% and D – 10%. On December 31, 200x, the partners agree to liquidate the partnership. The balances of their accounts are as follows: Cash Non cash assets Liabilities B, loan A, capital B, capital C, capital D, capital P10,000 80,000 6,000 2,000 20,000 29,000 23,000 10,000

The following data relate to the realization of non-cash assets: January February March Carrying amount Cash realized P54,000 P30,000 24,000 18,000 2,000 1,000

Prepare the statement of liquidation with supporting schedule of safe payments for ABCD Partnership.

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INTRODUCTION TO CORPORATION ACCOUNTING
Corporation – an artificial being created by operation of law having the rights of
succession and the power, attributes and properties expressly authorized by law or incident to its existence.

Characteristics of a Corporation
1. Separate legal entity – A corporation is an artificial being with a personality separate from that of its individual owners. 2. Created by operation of law – A corporation is generally created by operation of law. The mere agreement of the parties cannot give rise to a corporation. 3. Rights of succession – A corporation continues to exist notwithstanding the withdrawal, death, insolvency or incapacity of the individual owners. Changes in the ownership structure do not dissolve a corporation. 4. Powers, attributes, properties expressly authorized by law – Being a creation of law, a corporation can only exercise powers provided by law and powers which are incidental to its existence. 5. Ownership divided into shares – Proprietorship in a corporation is divided into units known as shares of stocks. 6. Board of Directors (BOD) – Management of the business is vested in a board of directors elected by the stockholders. The BOD is the governing body or decision-making body of the corporation.

Comparison between Partnership and Corporation
Partnership Formed by 2 persons. Starts with agreement among partners; may be formed orally. Unlimited liability Limited life Transfer of equity of a partner needs the consent of other partners. Corporation Formed by 5 persons Starts with the issuance of a certificate of incorporation issued by SEC Limited liability Unlimited life Stocks can be transferred from one stockholder to another without getting

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the consent of the other stockholders. Partner is an agent of the partnership. Stockholders do not act as agents of the corporation.

Advantages of a Corporation
1. The corporation’s power of succession enables it to enjoy a continuous existence. 2. The continuity of corporate existence enables it to obtain a strong credit line. 3. Bigger source of capital may be raised because many individuals invest funds in the corporation. 4. Stockholders enjoy limited liability. Their liability to corporate debts extends only to their investment in the corporation. 5. Shares of stocks may be transferred without the consent of the other stockholders.

Disadvantages of a Corporation
1. It is not easy to form because of complicated legal and documentary requirements. 2. The limited liability of the stockholders weakens or limits its credit capacity. 3. It is subject to more governmental requirements. 4. There is possibility of abuse of power by the Board of Directors. 5. It is subject to more taxes.

Types of Corporation
1. 2. benefit. Public – a corporation formed to render government service Private – a corporation formed for a private purpose, aim or

3. Quasi-public – a private corporation which is given a franchise to perform functions of a public character. 4. laws. Domestic – a corporation that is organized under Philippine

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5. other countries.

Foreign - a corporation that is organized under the laws of

6. Stock – a corporation in which the capital is divided into shares of stock and is authorized to distribute dividends to the holders of such shares. A stock certificate is a physical evidence of the shares of stock. Stock corporations are generally profit-oriented. 7. Non-stock - a corporation in which capital comes from fees or contributions given by individuals. No part of its income is distributed as dividends and any profit shall be used to further the purpose(s) of the corporation. Non-stock corporations are generally non-profit in nature. 8. many investors. Open – a corporation whose ownership is widely held by

9. Closely held or family – a corporation in which 50% or more of its stock is owned by five persons or less.

Components of a Corporation
1. Incorporators – persons who originally formed the corporation and whose names appear in the Articles of Incorporation. They must be 5 but not more than 15 natural persons. They should not artificial persons. 2. of a stock corporation. Stockholders or shareholders – owners

3. Members – persons who gave fees or contributions to a non-stock corporation. 4. Corporators – persons who compose the corporation whether as stockholders or members. 5. Promoters – persons who undertake the necessary steps and procedures to organize the corporation. 6. Subscribers – persons who agreed to buy shares of stock but will pay at a later date. 7. Underwriters – persons who undertake to sell the shares of stocks to the general public.

Organizing a Corporation
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The process of organizing a corporation consists of three stages: 1. Promotion – makes preliminary arrangements and solicits subscription to raise sufficient capital for the business. The following are the preincorporation requirements: o At least 25% of the authorized capital stock must be subscribed. o At least 25% of total subscriptions must be paid. 2. Incorporation – formalizes organization of the corporation by filing with SEC the necessary documentary requirements such as articles of incorporation and treasurer’s affidavit attesting compliance to the pre-incorporation requirements. Upon approval, SEC issues a certificate of incorporation, the date of which is considered as the date of registration or incorporation.

3. Commencement of the business – the business should start its business within two years from the date of incorporation. Costs incurred in connection with the formation of the corporation are recorded as expense. Examples of organization costs are filing fees, cost of printing stock certificates, promoters’ commission and legal fees. The following account titles may be used in recording organization costs:     Pre-operating Costs Pre-operating Expenses Organization Expense Organization Costs

Articles of Incorporation
The Articles of Incorporation enumerates the powers and limitations conferred upon the corporation by the government. It includes the following information: 1. 2. 3. 4. 5. 6. The name of the corporation; The purpose or purposes for which the corporation is formed; The place of the principal office of the corporation; The term of existence of the corporation, not exceeding 50 years; The names, nationalities and addresses of the incorporators; The names of the directors who will serve until their successors are duly elected and qualified in accordance with the by-laws;

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7. The authorized capital stock, the classes of stocks to be issued and the number of each class of stock indicating the par value if there is any; 8. The amount of subscription to the capital stock, the names of the subscribers and the number of shares subscribed by each; 9. The total amount paid on the subscriptions and the amount paid by each subscriber on his subscription.

By-Laws
The by-laws of a corporation contain provisions for the internal administration of the corporation. The by-laws should be filed within one month from the date of issuance of the certificate of incorporation. The by-laws normally include the following:

1. The date, place and manner of calling the annual stockholders’ meeting; 2. The manner of conducting meetings; 3. The circumstances which may permit the calling of special meetings of the stockholders; 4. The manner of voting and the use of proxies; 5. The manner of electing the directors; 6. The term of office of the directors; 7. The authority and duties of the directors; 8. The manner of selecting the corporate officers; 9. The procedures for amending the articles of incorporation and by-laws.

Corporate Books and Records
The corporation generally maintains the following books of accounts and records: 1. 2. 3. 4. Journals and Ledgers; Minute books for meetings of stockholders; Minute books for meetings of Board of Directors; Stock and Transfer Book - contains records of all stocks, names of stockholders, amount paid and unpaid, any sale or transfer of stock.

Kinds of Shares

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1. Par Value –a share of stock that is given a definite or fixed value in the articles of incorporation. 2. No Par Value – a share of stock that has no fixed value; it may not be issued for less than P5. 3. Common or Ordinary shares –the basic issue of shares. The common or ordinary share entitles the holder to the following basic rights: a. b. c. d. Right to vote in stockholders’ meeting; Right to share in corporate profits (dividends); Right to share in corporate assets upon liquidation; Right to purchase additional shares of stocks in the event that the corporation increases its capital stock (pre-emptive right).

4. Preferred or Preference share - entitles the holder to some specific preferences over the common or ordinary share such as a. Preference as to payment of dividends; b. Preference as to distribution of assets upon liquidation.

Terms Peculiar to a Corporation
1. Authorized shares – refers to the maximum number of shares which a corporation may issue (as set forth in the Articles of Incorporation). 2. Issued shares – shares which are issued to stockholders which at present may or may not be in the hands of the stockholder. 3. Unissued shares – shares which have never been issued and are available for issuance. 4. Outstanding shares – shares of stocks issued to stockholders or subscribers whether fully or partially paid except for treasury shares. 5. Treasury shares - shares which have been issued and fully paid for but subsequently reacquired by the issuing corporation. 6. Subscribed shares – shares which investors have contracted to acquire.

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CORPORATION ACCOUNTING Capital Stock Transactions
Basic Capital Stock Transactions
There are 5 basic capital stock transactions: 1. Authorization –records the maximum number of shares a corporation is authorized to issue. 2. Sale – a stockholder buys stocks and pays immediately in full. Stock certificate is issued to the stockholder. 3. Subscription –a subscriber enters into a contract to buy shares of stock. 4. Collection – a subscriber pays his subscription. 5. Issuance of certificate – if a subscription is fully paid, a stock certificate is issued to the subscriber.

Capital Stock
Capital stock may be paid by the stockholder or subscriber in the form of 1. cash 2. property – record the value of the property using the following amounts: a. fair value of the property received b. fair value of the shares of stock, whichever is clearly determinable; c. par value of the shares of stock 3. labor or services – record the cost of the labor or services using the fair value of the services rendered. Capital stock may be issued 1. at par 2. at a premium – at an amount more than the par value Capital stock cannot be issued at a discount or an amount less than par. When the value assigned to the asset received is overstated, the stock issued is called watered stock. The overstatement is done to comply with the requirement of the law that the stock should not be issued at less than its par value.

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International Accounting Standards (IAS) Terms
Below is a table showing the elements of a shareholders’ equity with their equivalent IAS terms: Old Terms Capital stock Subscribed capital stock Common stock Preferred stock Additional paid in capital Retained earnings (deficit) Retained earnings appropriated Revaluation surplus Treasury stock Stock dividends New IAS Terms Share capital Subscribed share capital Ordinary share capital Preference share capital Share premium Accumulated profits (losses) Appropriation reserve Revaluation reserve Treasury share Bonus issue

Accounting Methods to Record Capital Stock Transactions
1. Memo entry method 2. Journal entry method

Pro-forma Entries – Par Value Share Subscribed or Sold at Par
Transaction
Authorization Sale Subscription Collection Issuance of certificate

Memo Entry Method
Authorized to issue _____ shares with a par value of P___. Cash Share capital xxx xxx

Journal Entry Method
Unissued share capital xxx Authorized share capital xxx Cash Unissued share capital xxx xxx

Subscriptions receivable xxx Subscribed share capital xxx Cash xxx Subscriptions receivable xxx Subscribed share capital Share capital xxx xxx

Subscriptions receivable xxx Subscribed share capital xxx Cash xxx Subscriptions receivable xxx Subscribed share capital xxx Unissued share capital xxx

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Classroom Exercise
Journalize the following transactions under the memo entry method and the journal entry method.

1. 2. 3. 4. 5. 6. 7.

ABC Corporation is authorized to issue 4,000 shares with a par value of P100. Received subscription for 1,000 shares at par. Collected the subscription in full. Issued stock certificate for 1,000 shares. Received subscription for 2,000 shares at par. Received partial payment on the above subscription, P150,000. Sold 500 shares at par.

Pro-forma Entries – Par Value Share Subscribed or Sold at a Premium
Transaction
Authorization Sale

Memo Entry Method
Authorized to issue _____ shares with a par value of P___. Cash Share capital Share premium xxx xxx xxx

Journal Entry Method
Unissued share capital xxx Authorized share capital xxx Cash Unissued share capital Share premium xxx xxx xxx

Subscription

Subscriptions receivable xxx Subscribed share capital xxx Share premium xxx Cash xxx Subscriptions receivable xxx Subscribed share capital Share capital xxx xxx

Subscriptions receivable xxx Subscribed share capital xxx Share premium xxx Cash xxx Subscriptions receivable xxx Subscribed share capital Unissued share capital xxx xxx

Collection Issuance of certificate

Special Notes
1. Under sale and subscription, the debit to subscriptions receivable and cash is computed as follows: Subscriptions receivable = subscribed shares x subscription price Cash = sold shares x selling price. 2. Subscribed Share Capital is always credited par.

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3. Share Capital is always credited at par.

Classroom Exercise
Journalize the following transactions under the memo entry method and the journal entry method.

1. ABC Corporation is authorized to issue 100,000 shares with a par value of P10 per share. 2. Received subscriptions for 1,000 shares at P12 per share. 3. Received partial payment on the subscription, P5,000. 4. Sold 2,000 shares at P 11 per share. 5. Collected the subscription in full.

Accounting for Two Classes of Shares
1. The two classes of shares are common or ordinary shares and preferred or preference shares. 2. 3. rate. 4. Ordinary shares entitle the holder to the four basic rights of a shareholder. Preference share is generally issued with par value and with a dividend Voting right is frequently given exclusively to ordinary shareholders.

5. The pro-forma entries to record capital stock transactions for two classes of shares are the same. However, the account titles must be labeled as to whether it is ordinary or preference. 6. The following account titles may be used. Preference Subscriptions receivable – preference Subscribed share capital – preference Share premium- preference Share capital - preference

Ordinary Subscriptions receivable - ordinary Subscribed share capital - ordinary Share premium- ordinary Share capital - ordinary

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Accounting for No Par Shares
1. 2. No par shares do not have a definite or fixed value. No par shares are recorded using the memo entry method only.

3. The entire consideration received by the corporation for its no par value shares shall be treated as capital and shall not be liable for distribution as dividends. 4. Preference shares which are preferred as to assets can be issued only with par value. 5. Banks, trust companies, public utilities, buildings and loan associations, insurance companies cannot issue no-par shares. 6. No par value shares may not be issued at an amount less than P5 per share. 7. While no par value shares do not carry a nominal value in the certificate, a selling price may be assigned. This value is called stated value. Stated value should not be less than P5 per share.

Pro-forma Entries: No Par Value Shares (Memo Entry Method only)
Transaction
Authorization Sale

No Stated Value
Authorized to issue _____ shares, no par. Cash Share capital, no par xxx xxx

With Stated Value
Authorized to issue _____ shares, no par with a stated value of P___. Cash Share capital , no par Share premium xxx xxx xxx

Subscription

Subscriptions receivable xxx Subscribed share capital xxx Cash xxx Subscriptions receivable xxx Subscribed share capital xxx

Subscriptions receivable xxx Subscribed share capital xxx Share premium xxx Cash xxx Subscriptions receivable xxx Subscribed share capital xxx

Collection Issuance of certificate

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Share capital, no par

xxx

Share capital, no par

xxx

Classroom Exercise
Journalize the following transactions assuming (a) there is no stated value; (b) there is a stated value of P10. 1. 2. 3. 4. 5. ABC Corporation was authorized to issue 100,000 shares, no par. Received subscriptions for 70,000 shares at P12 per share. Received full collection on the above subscription. Issued stock certificates. Sold for cash 10,000 shares at P11 per share.

Legal Capital
Legal capital is that portion of the paid in capital arising from issuance of capital stock which cannot be returned to the stockholders in any form during the lifetime of the corporation. The amount of legal capital is determined as follows:  In the case of par value stock, legal capital is the aggregate par value of the shares issued and subscribed.  In the case of no par value stock, legal capital is the total consideration received from shareholders including the excess over the stated value.

Contributed Capital
Contributed capital represents the amount invested or contributed by owners. It is also known as paid in capital. This amount is composed of  Share capital  Represents the contribution equal to the par value or stated value of the stock purchased by the shareholders or  The total contribution by the shareholders in case of no par share, no stated value share capital  Share premium  Represents contribution in excess of the par or stated value of the share capital  Arises also from various share capital transactions and other transactions with shareholders  Treasury shares 46

 Stock dividends  Donated shares

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CORPORATION ACCOUNTING Delinquent Subscription
When a subscriber fails to pay his subscription on the call date, the corporation sends several notices to remind him of his obligation. If these notices are ignored by the subscriber, his subscription is declared delinquent. The delinquent subscription is offered for sale in a public auction. 1. The sale of the delinquent subscription is issued to the highest bidder. 2. The highest bidder is the one who is willing to pay the unpaid balance of the subscription plus accrued interest plus all expenses related to the sale and is willing to receive the smallest number of shares. 3. Once the subscription is fully paid, all subscribed shares are issued. Shares are first given to the highest bidder. The excess shares are given to the defaulting subscriber. 4. If there is no bidder, all of the delinquent shares will be issued in the name of the corporation. Such shares are considered treasury shares. The defaulting subscriber does not get any share of stock.

Pro-forma Entries – Short Method
Subscription Partial collection Subscriber defaults and corporation declares the subscription as delinquent Costs incurred in connection with delinquency sale Subscriptions receivable Subscribed share capital Cash Subscriptions receivable No entry xxx xxx xxx xxx

Receivable from highest bidder Cash

xxx xxx

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Highest bidder pays Stock certificates are issued

Cash Receivable from highest bidder Subscriptions receivable Subscribed share capital Share capital OR

xxx xxx xxx xxx xxx

If there is no bidder

Treasury shares Receivable from highest bidder Subscriptions receivable Subscribed share capital Share capital

xxx xxx xxx xxx xxx

Classroom Exercise
Journalize the following transactions: 1. Mr. A subscribed 1,000 shares of X Corporation common shares with a par value of P10. 2. Mr. A paid P6,000 cash as partial payment. 3. The corporation declared the above subscription as delinquent. 4. Incurred advertising costs of P300. 5. Bidders in the public auction were as follows: Mr. R – 450 shares Mr. S – 455 shares Mr. T – 445 shares The highest bidder paid the balance of the subscription plus advertising costs. 6. Stock certificates were issued.

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CORPORATION ACCOUNTING Incorporating a Partnership
A partnership may incorporate to enjoy the advantages of a corporation. It is good accounting practice that a new set of books is used by the new corporation.

Accounting Procedures
Books of the Partnership 1. Finish the accounting cycle. 2. Revalue the assets and liabilities using the Capital Adjustment account. 3. Close the balance of the Capital Adjustment account to the partners’ capital accounts in accordance with their P&L ratio. Books of the Corporation 1. Record authorized capital stock. 2. Record the subscription of incorporators. 3. Record the transfer of the assets and liabilities of the partnership to the corporation. This serves as the payment of the subscription of the partners who became incorporators.  Accounts receivable is transferred at gross amount.  Depreciable assets are transferred at carrying amount. 4. Record the issuance of shares to incorporators.

4. Close the accounts of the partnership except the capital accounts. 5. Record the receipt of shares. 6. Record distribution of shares.

Pro-forma Entries: Books of the Partnership
Increase in value of an asset without a contraasset account Decrease in value of an asset without a contra asset account Increase in value of an asset with a contra asset account Asset Capital Adjustment xxx xxx

Capital Adjustment Asset

xxx xxx

Contra- asset Capital Adjustment

xxx xxx

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Decrease in value of an asset with a contra asset account Increase in value of a liability Decrease in value of a liability

Capital Adjustment Contra- asset Capital Adjustment Liability Liability Capital Adjustment Note: These adjustments are similar to the year-end adjusting entries. Only, replace the nominal accounts with the, Capital Adjustment account.

xxx xxx xxx xxx xxx xxx

Close the Capital Adjustment account

Capital Adjustment A, Capital B. Capital OR A, Capital B, Capital Capital Adjustment Note: The capital adjustment account is closed to the partners’ capital account using profit and loss ratio.

xxx xxx xxx xxx xxx xxx

Close the accounts of the partnership

Allowance for bad debts Accumulated depreciation Liabilities Receivable from ____Corporation Assets Shares of ____ Corporation Receivable from ___ Corp. A, Capital B, Capital Shares of ____ Corp. Note: The debits to the partners’ capital accounts represent their final capital balances.

xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx

Receipt of shares of the new corporation Record distribution of shares and close partners’ capital accounts.

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Pro-forma Entries: Books of the New Corporation
Authorization Subscription Transfer of partnership assets and liabilities Authorized to issue _____ shares with a par value of P ___. Subscriptions receivable Subscribed share capital Assets Liabilities Allowance for bad debts Subscriptions receivable Subscribed share capital Share capital xxx xxx xxx xxx xxx xxx xxx xxx

Issuance of stock certificates

Classroom Exercise
The trial balance of AB Partnership as of December 31, 200x is shown below: AB Partnership Trial Balance December 31, 200x Debit P20,000 70,000 190,000 40,000 20,000 40,000 100,000 150,000 P320,000

Credit P10,000

Cash Accounts receivable Allowance for bad debts Merchandise inventory Store equipment Acc. depreciation – store equipment Accounts payable A, Capital (40%) B, Capital (60%) Totals

P320,000

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The following adjustments are agreed upon: 1. Accounts receivable is 80% collectible. 2. Merchandise inventory should be valued at P200,000. 3. Store equipment should be ¾ depreciated. Other information: 1. AB Partnership decides to incorporate as ABC Corporation with authorized shares of 50,000 at P100 par value.. 2. Partners A and B subscribes 2,460 shares at P100 par. 3. Mr. C subscribes 5,000 shares at par and makes a 25% down payment. 4. Mr. D exchanges a piece of land with a fair value of P304,000 for 3,040 shares. 5. Mr. E subscribes 2,000 shares at par and makes a 30% down payment.

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CORPORATION ACCOUNTING Treasury Shares
The issuing corporation sometimes reacquires shares issued to stockholders. Such shares are held in the name of the corporation and these are called treasury shares. The corporation may reissue these shares at some future date.

Reasons for Acquiring Treasury Shares
1. 2. 3. 4. 5. 6. To obtain stock to be used in the acquisition of plant assets. To improve earnings per share by reducing the number of shares outstanding. To invest excess cash temporarily. To support the market price of the stock. To increase the ratio of liabilities to shareholders’ equity. To obtain shares for conversion of other securities such as preference shares.

Two Accounting Methods to Record Treasury Shares
1. Cost method – This is the method prescribed under Philippine accounting standards. 2. Par value method

Two Kinds of Treasury Shares
1. Reacquisition by purchase – under the cost method a. Treasury shares are recorded at cost. b. When treasury shares are reissued or sold at more than cost, the indicated gain is credited to an account called “Share Premium - Treasury Shares”. c. When treasury shares are reissued or sold at less than cost, the indicated loss is debited to  Share Premium - Treasury Shares (until exhausted)  Retained earnings

Pro-forma Entries

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Reacquisition by Purchase Reissue at more Cost Reissue at less than cost

Treasury shares Cash Cash Treasury shares Share premium - treasury shares Cash Share premium – treasury shares Retained earnings Treasury shares

xxx xxx xxx xxx xxx xxx xxx xxx xxx

2. Reacquisition by donation Pro-forma Entries Reacquisition by Donation Sale of donated Shares Received ___ shares from Mr. A as donation. Cash Share premium - donated capital xxx xxx

Special Notes
1. Treasury shares do not have the status of outstanding shares. 2. Treasury shares do not entitle the holder to the rights of a shareholder. 3. Treasury share is not viewed as an asset (investment in trading securities) but as a reduction to total corporate capital. 4. To protect creditors, the law requires that a portion of retained earnings shall be restricted equal to the cost of the treasury shares. 5. Retained earnings is the account which holds the accumulation of the net earnings of the corporation.

Classroom Exercises
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1. The following transactions occurred a. XYZ Corporation bought 6,000 shares from a stockholder at P105 per share. b. 1,000 treasury shares were re-issued at P105. c. 1,000 treasury shares were re-issued at P120. d. 3,500 treasury shares were re-issued at P100. e. The remaining treasury shares were sold the following accounting period at P100 per share. 2. Stockholder A donated 40 shares to ABC Corporation. Later, the donated shares were sold at P220 per share. Required: Record the above transactions. Use cost method.

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CORPORATION ACCOUNTING Retained Earnings
The retained earnings account holds the accumulation of the net earnings or losses of a corporation. It represents capital of the corporation arising from its operations. It is the account that is used to close the Income Summary account of a corporation. Retained Earnings Debit Net loss Appropriations for treasury shares, contingencies, plant expansion, etc. Declaration of dividends Losses from sale of treasury shares The retained earnings account has a normal credit balance. A debit balance in the retained earnings account is called a deficit. Net income Reversal of appropriations Credit

Appropriation of Retained Earnings
1. The entire amount of retained earnings may be presumed to be unrestricted as to dividend declaration unless restrictions are indicated in the financial statements. 2. The intention of appropriation is to limit the available amount of retained earnings available for dividend declaration. Appropriation does not mean that funds are set aside for a specific purpose. 3. Appropriations of retained earnings may be based on the following:  Legal requirement  Contractual requirement  Voluntary or discretionary on the part of management 4. A portion of retained earnings may be appropriated/reserved/earmarked for a specific purpose. Examples are  when a company reacquires its own shares (treasury shares);  when a corporation has a pending lawsuit and there is a possibility of losing a case; 57

 when there is a plan for plant expansion. 5. When the cause for restriction no longer exists, the appropriation is not necessary anymore. A reversing entry is prepared restoring the amount of appropriation back to the unrestricted balance.

Pro-forma Entries
Net income Net loss Appropriation Reversal of appropriation Income summary Retained earnings Retained earnings Income summary Retained earnings Appropriated for ________ Appropriated for _______ Retained earnings xxx xxx xxx xxx xxx xxx xxx xxx

Classroom Exercises
1. Assume the following 20x1 P10,000 net income 20x2 5,000 net loss 20x3 20,000 net income 20x4 18,000 dividends declared 20x5 25,000 net income Assume that there is no other transaction which affected retained earnings. Compute the balance of the retained earnings account as of December 31, 20x5. 2. Assume the following 20x1 P10,000 net income 20x2 8,000 net loss 20x3 5,000 net loss 20x4 6,000 net loss Assume that there is no other transaction which affected retained earnings. Compute the balance of the retained earnings account as of December 31, 20x4.

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CORPORATION ACCOUNTING Dividends
Two Kinds of Dividends
1. Dividends out of earnings – distribution to shareholders of corporate earnings in proportion to the number of shares held by them; also known as return on investment. 2. Dividends out of capital – a return of shareholders’ invested capital (liquidating dividends); also known as return of investment.

Special Notes
1. The power to declare dividends is vested upon the board of directors. 2. Dividends shall be paid out of unrestricted or free retained earnings. 3. The following shares are entitled to receive dividends: a. all issued and outstanding shares b. all subscribed par value shares 4. The following shares are not entitled to receive dividends: a. unissued shares b. subscribed no par shares c. treasury shares 5. Dividends may be in the form of a. Cash – distributable in the form of cash. This is the most common type of dividend. b. Property – payable in assets other than cash such as investment in trading securities and merchandise inventory. c. Scrip –consists of a written promise to pay certain amounts at a future date. The payment normally includes the principal amount and an interest at a specified rate. d. Stock – distributable in the form of corporation’s own shares.

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6. There are three dates to consider a. Date of declaration – this is the date when the board of directors approved the resolution to distribute dividends. The liability to shareholders is recorded on this date. b. Date of record – this is the date when the company determines who are entitled to receive dividends. No entry is required on this date. Stocks are selling dividends-on prior to this date and are selling ex-dividends the day following this date. c. Date of distribution – this is the date when the dividends are distributed to the shareholders. ABC CORPORATION Notice of Cash Dividends Notice is hereby given that in a special meeting of the Board of Directors of ABC Corporation held on February 25, 200x, a cash dividend of P3.00 per share was approved by the Board of Directors payable on March 31, 200x to stockholders of record as of March 7, 200x. Signature

Stock Dividends/Bonus Issue
1. The corporation declares stock dividends when it wishes to declare dividends but at the same time retain the net assets of the business. 2. For a corporation to declare stock dividends, there should be a. unrestricted retained earnings; b. available original and unissued shares which may be issued as stock dividends. 3. This type of dividend does not affect total assets and total stockholders’ equity. 4. It only involves transfer of amount from retained earnings to contributed capital. 5. It does not change the percentage interest of a stockholder in the business. 6. There are two kinds of stock dividends a. Small stock dividend – a stock dividend representing less than 20% of the outstanding shares. Retained earnings is debited for the fair market value of the stock on the date of declaration. 60

b. Large stock dividend – a stock dividend representing 20% or more of the outstanding shares. Retained earnings is debited for the par or stated value of the stock. 7. The account Stock Dividends Distributable or Stock Dividends Payable is credited for the par or stated value of the shares to be distributed regardless of whether the stock dividend is small or large. a. This account is not a current liability because it will not be settled through the use of current assets. b. It is shown as an addition to capital stock outstanding. Pro-forma Entries – Small Stock Dividend (less than 20%) Date of declaration Retained earnings Stock dividends distributable Share premium - stock dividends Note: The share premium account is credited for the excess of the fair market value over its par or stated value. Date of record Date of distribution No entry Stock dividends distributable Share capital xxx xxx xxx xxx xxx

Pro-forma Entries – Large Stock Dividend ( 20% or more) Date of declaration Date of record Date of distribution Retained earnings Stock dividends distributable No entry Stock dividends distributable Share capital xxx xxx xxx xxx

Classroom Exercise

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Share Capital – Authorized to issue 20,000 shares at P100 par; 10,000 shares issued and outstanding Share premium Retained earnings Assume a. b.

P 1,000,000 500,000 750,000

10% stock dividend was declared and market value is P150 per share. 50% stock dividend and market value is P150 per share.

Required: Prepare all the necessary journal entries.

Cash Dividends
1. Cash dividends is dividends that is distributable in the form of cash. 2. For a corporation to declare cash dividends, there should be a. free or unrestricted retained earnings b. sufficient cash 3. Cash dividends decrease corporate assets and total shareholders’ equity. 4. Cash dividends may be expressed as follows a. % of par value b. an amount per share c. arbitrary amount 5. The account Cash Dividends Payable is classified as a current liability. 6. Dividends for preference shares shall depend on the type of preference share issued by the corporation. Preference shares may be a. Cumulative – entitles the holder to the receipt of previous years’ unpaid dividends (dividends in arrears/passed dividends/back dividends) before any payment can be made to ordinary shareholders. b. Non-cumulative – entitles the holder to the receipt of current dividends but not on the previous years’ unpaid dividends. c. Participating – entitles the holder to the receipt of additional dividends after holders of both preference and ordinary shares have been paid up to the current year’s dividends.

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d. Non- participating –entitles the holder to the receipt of dividends up to the current period only. All excess dividends are given to holders of ordinary shares.

Pro-forma Entries
Date of declaration Date of record Date of distribution Retained earnings Cash dividends payable – preference Cash dividends payable – ordinary No entry Cash dividends payable – preference Cash dividends payable – ordinary Cash xxx xxx xxx xxx xxx xxx

Classroom Exercises
1. The board of directors of XYZ Corporation declared on March 1, 200x a 10% cash dividend payable on May 30, 200x to shareholders of record on April 30, 200x. Issued and outstanding shares are 20,000 shares with a par value of P30 per share. 2. Assume the same given information in No. 1 but the cash dividend declared is P10 per share. 3. ABC Corporation has the following shares issued and outstanding 10% Preference Share Capital 1,000 shares with a P200 par value Ordinary Share Capital 3,000 shares with a P100 par value The board of directors declared a cash dividend of P80,000 this year. No dividend was declared last year. Assume a. b. c. d. Preference is non-cumulative and non-participating Preference is cumulative and non-participating Preference is non-cumulative and participating Preference is cumulative and participating.

Required: Journalize the above transactions.

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STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
Statement of Changes in Shareholders’ Equity – a required basic statement
that shows the movements in the elements or components of the shareholders’ equity.

Shareholders’ Equity – represents the residual interest of the shareholders in the
assets of the corporation after satisfying all liabilities.

Components
1. Share Capital
a. b. c. d. Preference Share Ordinary Share Subscribed Share Capital less Subscriptions Receivable Stock Dividends Distributable

2. Reserves
a. b. c. d. Share Premium Revaluation Reserve Unrealized Increase/Decrease in Value of Available for Sale Securities Foreign Currency Translation Reserve

3. Retained Earnings
a. Appropriation b. Free 4. Treasury Shares (-) An entity shall present a statement of changes in equity showing the following:  Net income or loss for the period  Each item of income and expense that is recognized directly in equity.  The effects of changes in accounting policies and correction of errors affecting retained earnings.  Transactions with equity holders such as issuance of shares and dividend distribution.  Balance of retained earnings at the beginning and end of the period and the changes therein.  Reconciliation between the carrying amount of each class of share capital and each reserve at the beginning and end of the period separately disclosing each change.

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CORPORATION ACCOUNTING Book Value Per Share and Earnings Per Share
BOOK VALUE PER SHARE (BVPS)
It is the amount that would be paid on each share assuming the company is liquidated and the amount available to shareholders is exactly the amount reported as shareholders’ equity.

FORMULAS IN COMPUTING BVPS
1. One class of stock BVPS = Total Shareholders’ Equity Number of shares outstanding

2. Two classes of stock BVPS (Preference Share) BVPS (Ordinary Share) = Preference Shareholders’ Equity Number of preference shares outstanding Ordinary Shareholders’ Equity Number of ordinary shares outstanding

=

SPECIAL NOTES
1. Where there are treasury shares and subscribed share capital, the capital stock outstanding is computed as follows: Shares xx xx xx xx xx Amount P xx xx P xx xx P xx

Share Capital issued Add: Share Capital subscribed Sub-total Less: Treasury shares at par Amount and shares outstanding

2. Treasury shares shall be treated as retired shares. Any gain on retirement 65

is credited to Share Premium and loss on retirement is debited first to Share Premium and then to Retained Earnings. 3. In computing for stock outstanding, the Subscriptions Receivable balance is NOT deducted from Subscribed Capital Stock.

EARNINGS PER SHARE (EPS)

___________________________________________
The earnings per share figure is the amount attributable to every share of ordinary share outstanding during the period. The objective of the basic earning earnings per share information is to provide a measure of the interest of each ordinary share of an entity in the performance of the entity over the reporting period. It is not necessary to compute earnings per share for preference shares because there is a definite rate of return for such share.

Two presentations of earnings per share
1. Basic earnings per share 2. Diluted earnings per share

Enterprises required to disclose earnings per share
1. The presentation of earnings per share is required for enterprises whose ordinary shares or potential ordinary shares are publicly traded and by enterprises that are in the process of issuing ordinary shares or potential ordinary shares in the public securities market. Note: share. Nonpublic enterprises are not required to present earnings per

Uses of earning per share
a. It is a determinant of the market price of ordinary shares. b. It is a “ measure of performance”. c. It is the basis of dividend policies of the company.

Simple Capital Structure VS Complex Capital Structure
1. Simple Capital Structure – means that the corporation has only ordinary and nonconvertible preference shares.

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2. Complex Capital Structure – means that the corporation has one or more instruments outstanding that could result in issuance of additional ordinary shares.

BASIC EARNINGS PER SHARE
1. Basic EPS – considers only ordinary shares issued and outstanding. 2. The Basic Equation:

Net Income
Ordinary Shares Outstanding or

Net Income – Preference Dividend
Weighted Average Ordinary Shares Outstanding Notes: • • The net income is equal to the amount after deducting dividends on preference shares. If the preference share is cumulative, the preference dividend for the current year only is deducted from the net income, whether such dividend is declared or not. If the preference share is non-cumulative, the preference dividend for the current year is deducted from the net income only if there is a declaration. Stock dividend is recognized retroactively, meaning, it is treated as a change from the date the original shares are issued.

• •

Pro- forma computations of Weighted Average Shares
1.

Date

Shares Months Outstanding

MonthShares

Weighted Average = Total Month-Shares / 12

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2. Date

Shares

Stock Dividend

Months Outstanding

MonthShares

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