Topic 1: Corporate Liquidation

Learning Objectives

Explain the accounting for corporate liquidation.

Differentiate the classifications of assets and liabilities in the Statement of Affairs.
Determine the order of priority of claimants of company assets subject to liquidation.
Prepare Statement of Affairs, Deficiency Statement and Statement of Realization and
Liquidation.

Introduction

Corporate liquidation in the Philippines is the process of winding up of affairs or termination of

business operation, conversion of assets into cash, settlement of the obligations/liabilities and
distribution of remaining corporate assets to the owners through liquidating dividends.

Why do corporations liquidate?

Insolvency (Total Liabilities > Total Assets)
Continuous incurrence of losses
Harsh competition in the market

Measurement Basis

Since the Philippine Financial Reporting Standards (PFRSs) are applicable only to “going concern”
entities, the measurement bases thereof do not apply to entities under liquidation. The appropriate
measurements bases for liquidating entities are as follows:

Assets: Realizable Value (Estimated Selling Price - Estimated Disposal Cost/Cost to

Sell)
Liabilities: Expected Net Settlement (Principal + Interest +/- Other Adjustments)

Financial Reports

Statement of Affairs
Deficiency Statement
Statement of Realization and Liquidation

Statement of Affairs

A Statement of Affairs shows the financial position of a liquidating entity which contains the assets
that are available for sale, the claims of creditors to be settled and the claims of the owners. It is
like a regular Statement of Financial Position or Balance Sheet, but the assets are measured at
realizable values, the liabilities at expected net settlement amounts and the presentation is
different.

Assets in the Statement of Affairs are classified as follows:

Assets pledged to fully secured creditors – these are assets with realizable values equal
to or greater than the expected net settlement amount of the related liabilities for which
the assets have been pledged as security.

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 Example: Land with a realizable value of ₱5,000,000, mortgaged as security for a bank
loan of ₱2,000,000. The bank (creditor) is fully secured because it is guaranteed
full payment for the loan. After the bank is paid, the ₱3,000,000 excess is
available to unsecured creditors.

Assets pledged to partially secured creditors – these are assets with realizable values less
than the expected net settlement amounts of the related liabilities for which the assets
have been pledged as security.

Example: Automobile Equipment with a realizable value of ₱800,000 pledged as security

for a bank loan of ₱1,000,000. The bank is partially secured because it is
guaranteed only ₱800,000 out of the ₱1,000,000 loan balance. The deficiency
on the loan payment may be paid from the proceeds of sale of other assets.

Free assets – these are assets not pledged as security for liabilities which also include the
excess of assets pledged to fully secured creditors over the related liabilities.

Example: Cash of ₱20,000 available for use at the discretion of the entity. Another
example is the ₱3,000,000 excess from the land mortgaged as security to fully
secured creditor above.

Liabilities in the Statement of Affairs are classified as follows:

Fully secured creditors – these are liabilities secured by assets with sufficient realizable
values (refer to discussion on Assets pledged to fully secured creditors).

Partially secured creditors – these are liabilities secured by assets with insufficient
realizable values (refer to discussion on Assets pledged to partially secured creditors – of
the ₱1,000,000 loan, ₱800,000 is secured claim while ₱200,000 is unsecured claim).

Unsecured liabilities with priority – these are liabilities not secured by any asset but are
mandated by law to be paid first before other unsecured liabilities. Examples are:

▪ Payables for administrative expenses such as filing fees, attorney’s fees, referee’s
fees, trustee’s fees, and other direct costs of the insolvency proceedings
▪ Salaries and wages payable
▪ Taxes payable

Unsecured liabilities without priority – liabilities not secured by any asset and are not
mandated by law to be paid first before other unsecured liabilities. All other liabilities not
classifiable under the first three classification of liabilities above fall under this category.

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 Illustration: Preparation of Statement of Affairs
XYZ Corp. has filed for voluntary insolvency and is going to terminate its business operations. XYZ’s
Statement of Financial Position prior to the liquidation process is shown below:

XYZ Corp.
Statement of Financial Position
As of September 30, 2020

ASSETS
Current assets:
Cash ₱28,750
Accounts receivable 200,000
Notes receivable 50,000
Inventory 400,000
Prepaid rent 15,000
693,750
Noncurrent assets:
Land 2,000,000
Furniture and Fixtures, net 100,000
Equipment, net 200,000
Building, net 1,000,000
3,300,000
Total assets ₱3,993,750

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities:
Accrued expenses ₱200,000
Current tax payable 400,000
Accounts payable 800,000
1,400,000
Noncurrent liabilities:
Note payable (secured by Equipment) 400,000
Loan payable (secured by Land and Building) 2,500,000
2,900,000
Capital deficiency:
Share capital 400,000
Accumulated deficit (706,250)
(306,250)
Total liabilities and shareholder’s equity ₱3,993,750

Additional information:
The following were determined before the start of the liquidation process:
a. Only 70% of the accounts receivable is collectible.
b. ₱5,000 interest is receivable on the note.
c. The inventory has an estimated selling price of ₱300,000 and estimated costs to sell of ₱20,000.
d. The prepaid rent is not refundable.
e. The land and building have fair values of ₱3,000,000 and ₱800,000, respectively, but XYZ Corp.
expects to sell both assets at a package price of ₱2,800,000.
f. The equipment has an estimated net selling price of ₱150,000.
g. Administrative expenses of ₱40,000 are expected to be incurred in the liquidation process.
h. The accrued expenses include accrued salaries of ₱25,000.

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i. ₱10,000 interest is payable on the loan.
j. All the other liabilities are stated at their expected net settlement amounts.
Requirement: Prepare the statement of affairs as of January 1, 2020.

Solution:

Step 1: Restate the assets and liabilities

Assets are restated to realizable values, and liabilities to expected net settlement amounts. The
difference represents the estimated deficiency in the settlement to creditors and owners.

Book values Realizable values

Cash ₱28,750 ₱28,750
Accounts receivable 200,000 140,000 a
Notes receivable 50,000 50,000
Interest receivable - 5,000 b
Inventory 400,000 280,000 c
Prepaid rent 15,000 -d
Land and Building, net 3,000,000 2,800,000 e
Furniture and fixtures, net 100,000 100,000
Equipment, net 200,000 150,000 f
Total assets ₱3,993,750 ₱3,553,750

Accrued expenses ₱200,000 ₱200,000

Current tax payable 400,000 400,000
Accounts payable 800,000 800,000
Note payable 400,000 400,000
Loan payable 2,500,000 2,500,000
Interest payable - 10,000 i
Estimated administrative expenses - 40,000 g
4,300,000 4,350,000

Capital Deficiency (306,250) (796,250) *

Total liabilities and equity ₱3,993,750 ₱3,553,750

*Estimated deficiency (squeezed as balancing figure)

Step 2: Identify the classifications of the assets and liabilities

ASSETS
Assets pledged to fully secured creditors: Realizable value Available for unsecured
creditors
Land and building ₱2,800,000
Less: Loan payable (2,500,000)
Interest payable (10,000) ₱290,000

Assets pledged to partially secured creditors:

Equipment, net 150,000 -

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 Free Assets
Cash 28,750
Accounts receivable 140,000
Note receivable 50,000
Interest receivable 5,000
Inventory 280,000
Prepaid rent -
Furniture and fixtures, net 100,000 603,750
Total free assets ₱893,750

LIABILITIES
Fully secured creditors: Secured and Priority Unsecured Liability
Claims without Priority
Loan payable ₱2,500,000
Interest payable 10,000
2,510,000 ₱-
Partially secured creditors:
Note payable 400,000
Less: Equipment (150,000) 250,000

Unsecured liabilities with priority:

Estimated administrative expenses 40,000
Accrued salaries 25,000
Current tax payable 400,000
465,000 -
Unsecured liabilities without priority:
Accrued expenses, net of accrued salaries
(200,000 – 25,000) 175,000
Accounts Payable 800,000 975,000
Total unsecured liabilities without priority ₱1,225,000

Step 3: Compute for the estimated recovery percentage

We can now compute for the estimated recoveries of the creditors and owners. The formula for is as
follows:

Estimated recovery percentage of unsecured Net free assets

=
creditors without priority Total unsecured liabilities without priority

Total free assets ₱893,750

Less: Total unsecured liabilities with priority (465,000)
Net free assets 428,750
Divide by: Total unsecured liabilities without priority 1,225,000
Estimated recovery percentage of unsecured creditors without priority 35%

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The estimated recoveries of each class of creditor are as follows:

Total claims Recovery percentage Estimated recovery

Fully secured ₱2,510,000 100% ₱2,510,000
Partially secured 400,000 150K+ (250K x 35%) 237,500
Unsecured with priority 465,000 100% 465,000
Unsecured without priority 975,000 35% 341,250
Shareholders None 0% -
Total assets at realizable values ₱3,553,750

Step 4: Prepare Statement of Affairs

XYZ Corp.
Statement of Affairs
As of September 30, 2020

Realizable Available for

Book Values ASSETS Values unsecured creditors
Assets pledged to fully secured creditors:
₱3,000,000 Land and building ₱2,800,000
Less: Loan payable (2,500,000)
Interest payable (10,000) ₱290,000

Assets pledged to partially secured creditors:

200,000 Equipment, net 150,000 -

Free Assets
28,750 Cash 28,750
200,000 Accounts receivable 140,000
50,000 Note receivable 50,000
- Interest receivable 5,000
400,000 Inventory 280,000
15,000 Prepaid rent -
100,000 Furniture and fixtures, net 100,000 603,750
Total free assets 893,750
Less: Unsecured liability with priority (465,000)
Net free assets 428,750
Estimated deficiency (squeezed) 796,250
₱3,993,750 ₱1,225,000

Realizable Unsecured non-

Book Values LIABILITIES AND SHAREHOLDERS’ EQUITY Values priority liabilities
Fully secured creditors:
₱2,500,000 Loan payable ₱2,500,000
- Interest payable 10,000
2,510,000 ₱-
Partially secured creditors:
400,000 Note payable 400,000
Less: Equipment (150,000) 250,000

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 Unsecured liabilities with priority:
- Estimated administrative expenses 40,000
25,000 Accrued salaries 25,000
400,000 Current tax payable 400,000
465,000 -
Unsecured liabilities without priority:
Accrued expenses, net of accrued salaries
175,000 (200,000 – 25,000) 175,000
800,000 Accounts Payable 800,000 975,000
Total unsecured liabilities without priority 1,225,000

(306,250) Shareholders’ equity - -

₱3,993,750 ₱1,225,000

Deficiency Statement

A Deficiency Statement shows the estimated losses and gains by comparing the book values with
the realizable values and expected net settlement amounts of the assets and liabilities and the
estimated deficiency to unsecured creditors.

Illustration:

XYZ Corp.
Deficiency Statement
As of September 30, 2020

Estimated Losses: Estimated Gains:

Accounts receivable ₱60,000 Interest receivable ₱5,000
Inventory 120,000 Estimated deficiency to
Prepaid rent 15,000 unsecured creditors
Land and Building, net 200,000 without priority 796,250
Equipment, net 50,000
Interest payable 10,000
Estimated administrative
expenses 40,000
Capital deficiency 306,250
₱801,250 ₱801,250

Note: The amounts presented above are the differences between the book values and realizable
values as shown in the Step 1 on the preparation of the Statement of Affairs.

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Statement of Realization and Liquidation

The liquidation process may take some time before it is completed. Therefore, there is a need to
provide periodic financial reports that show information on the progress of liquidation process.
Accordingly, it is prepared at the end of each period. This statement is depicted like a T-account
as follows:

Debits
Assets to be realized
Assets acquired
Liabilities liquidated
Liabilities not liquidated
Supplementary expenses
Credits
Assets realized
Assets not realized
Liabilities to be liquidated
Liabilities assumed
Supplementary income

Illustration:
LMN Corp. is going to liquidate. A receiver/trustee will administer the liquidation. LMN’s Financial
Position on September 30, 2020 before the start of liquidation process is as follows:

Book values
Cash ₱50,000
Accounts receivable 300,000
Note receivable 80,000
Inventory 400,000
Prepaid assets 20,000
Land 2,000,000
Building, net 1,000,000
Equipment, net 200,000
Total assets ₱4,050,000

Accrued expenses ₱200,000

Current tax payable 250,000
Accounts payable 2,000,000
Note payable (secured by Equipment) 200,000
Loan payable (secured by Land and Building) 1,800,000
Total liabilities 4,450,000

Shared capital 500,000

Accumulated deficit (900,000)
Capital deficiency (400,000)

Total liabilities and equity ₱4,050,000

Additional information:
a. ₱15,000 interest is receivable on the note and ₱20,000 interest is payable on the loan.
b. Administrative expenses of ₱50,000 are expected to be incurred in the liquidation process.

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The entry on the books of the receiver/trustee to record the transfer of custody over the assets
and liabilities of LMN Corp. is as follows:

Date Account Dr Cr
September 30, 2020 Cash ₱50,000
Accounts receivable 300,000
Note receivable 80,000
Inventory 400,000
Prepaid assets 20,000
Land 2,000,000
Building 1,000,000
Equipment 200,000
Estate deficit (balancing figure) 400,000
Accrued expenses ₱200,000
Current tax payable 250,000
Accounts payable 2,000,000
Note payable 200,000
Loan payable 1,800,000

Notes:
The receiver records the assets and liabilities at book values rather than realizable values
and expected net settlement amounts.
The unrecorded interests are not included in the opening entry above. These are recorded
separately and identified as “new” assets and liabilities as follows:

Date Account Dr Cr
September 30, 2020 Interest receivable – new ₱15,000
Estate deficit ₱15,000
Estate deficit 20,000
Interest payable – new 20,000

The estimated administrative expenses are not recorded. These are recorded only when
actually paid.
Actual liquidation costs and gains and losses are subsequently recorded directly to the
“estate” account. If this account has a debit balance, it is referred to as “estate deficit;” and
“estate equity” if credit balance.

The following transactions occurred during the period:

a. Only ₱275,000 were collected on the accounts receivable. The remainder was written-off.
b. The interest on the note was collected in full, but only 80% was collected on the principal. The
remainder was written-off.
c. 3/4 of the inventory was sold for ₱350,000. A selling expense of ₱20,000 was incurred.
d. The prepaid assets were non-refundable.
e. The land and building were sold for ₱3,200,000.
f. The equipment was sold for ₱180,000.
g. Of the total accrued expenses, only the accrued salaries of ₱30,000 were paid. The balance
remains outstanding.
h. The current tax payable was paid in full.
i. The interest and the principal of on the loan were paid in full.
j. The note payable was settled for ₱150,000. The creditor canceled the balance.
k. Administrative expenses of ₱30,000 were paid.

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The following are the entries on the books of the receiver/trustee:

Reference Account Dr Cr
a. Cash ₱275,000
Estate deficit 25,000
Accounts receivable ₱300,000
b. Cash [15,000 + (80,000 x 80%)] 79,000
Estate deficit 16,000
Notes receivable 80,000
Interest receivable 15,000
c. Cash (350,000 - 20,000) 330,000
Inventory (400,000 x ¾) 300,000
Estate deficit 30,000
d. Estate deficit 20,000
Prepaid assets 20,000
e. Cash 3,200,000
Land 2,000,000
Building 1,000,000
Estate deficit 200,000
f. Cash 180,000
Estate deficit 20,000
Equipment 200,000
g. Accrued expenses 30,000
Cash 30,000
h. Current tax payable 250,000
Cash 250,000
i. Interest payable 20,000
Loan payable 1,800,000
Cash 1,820,000
j. Note payable 200,000
Cash 150,000
Estate deficit 50,000
k. Estate deficit 30,000
Cash 30,000

The statement of realization and liquidation is prepared as follows:

LMN Corp. in receivership

Statement of Realization and Liquidation
For the nine months ended September 30, 2020

ASSETS
Assets to be realized: Assets realized:
Accounts receivable ₱300,000 Accounts receivable ₱275,000
Note receivable 80,000 Note receivable 64,000
Inventory 400,000 Interest receivable 15,000
Prepaid assets 20,000 Inventory 330,000
Land and Building, net 3,000,000 Land and Building 3,200,000
Equipment, net 200,000 Equipment 180,000
Total 4,000,000 Total 4,064,000

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 Assets acquired: Assets not realized:
Interest receivable 15,000 Inventory 100,000

LIABILITIES
Liabilities liquidated: Liabilities to be liquidated:
Accrued expenses 30,000 Accrued expenses 200,000
Current tax payable 250,000 Current tax payable 250,000
Interest payable 20,000 Accounts payable 2,000,000
Loan payable 1,800,000 Note payable 200,000
Note payable 150,000 Loan payable 1,800,000
Total 2,250,000 Total 4,450,000

Liabilities not liquidated: Liabilities assumed:

Accrued expenses 170,000 Interest payable 20,000
Accounts payable 2,000,000
Total 2,170,000

SUPPLEMENTARY ITEMS
Supplementary expenses: Supplementary income:
Administrative expenses 30,000 -
Net gain during the period
(squeezed) 169,000

Total ₱8,634,000 ₱8,634,000

Alternatively, you can compute the net gain during the period through the entries in the estate
deficit account:

Estate Deficit
Debit Credit
a. ₱25,000 c. ₱30,000
b. 16,000 e. 200,000
d. 20,000 j. 50,000
f. 20,000
k. 30,000
111,000 280,000
Net gain (squeezed) 169,000
Total ₱280,000 Total ₱280,000

Primary reference used: Accounting for Special Transactions (Advanced Accounting 1) 2020 Edition
by Zeus Vernon B. Millan.

Prepared by: Thomas Edison R. Aviles, Faculty, BS Accountancy, Rizal Technological University

Note: This module shall be used for classroom purposes only and shall not be distributed for
profitable and other purposes.

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