Module No.

1 (Week 1 to Week 2)

Corporate Liquidation

Learning Objectives: At the end of the module, the students should be able to:

• Identify the classification of assets and liabilities in a corporate liquidation

• Compute for the Net Free Assets, expected recovery percentage and the amount of settlement for
each type of creditors under corporate liquidation
• Prepare Statement of Affairs and Statement of Realization and Liquidation

Lecture Notes:

Financially Distress Corporation are those who suffered business failure due to incompetent
management, poor operating control, inadequate financing, fraud or other unexpected adverse events in
the company.

A financially distress corporation may undergo either of the following:

a. Quasi – reorganization
b. Troubled Debt Restructuring
c. Liquidation.

Reports prepared by a corporation undergoing liquidation

1. Statement of Affairs – this statement is prepared as of a given point in time. The purpose of this
statement is to show the assets and liabilities of the debtor from a liquidation point of view. Thus, the assets
displayed in the statement of affairs are valued at net realizable value.

The following are the classification of assets and liabilities:

a. Assets pledged with fully secured creditors – the estimated cash proceeds are equal to or more than the
amount of the secured claim

b. Assets pledged with partially secured creditors – the estimated cash proceeds are less than the amount
of the secured claim

c. Free assets – any assets that has not been used to secure the payment of any of the company’s liabilities,
and also includes the excess of the realizable values of assets pledged to fully secured creditors over the
realizable values of related liabilities for which these assets have been pledged.

d. Secured liabilities – liabilities that are covered by a collateral asset. It may be categorized as fully secured
liabilities or partially secured liabilities
i. Fully secured liabilities – the realizable value of the pledged assets is equal to or more than the
amount claimed.

ii. Partially secured liabilities – these are liabilities secured by assets with a realizable value less
than the amount claimed.

e. Unsecured liabilities – thee are partially secured by assets with a realizable value less than the amount
claim. It may be either with or without priority.
i. Unsecured liabilities with priority – these are liabilities not secured by any assets, but are
mandated by law to be paid first in full ahead of any other unsecured liabilities. Examples are:
administrative Expenses, taxes, salaries and wages, benefits, liquidation expenses.

ii. Unsecured liabilities without priority – any other type of unsecured liabilities

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 Expected Recovery Percentage – is the percentage claim of unsecured liabilities and non-priority
claims to the net free assets of the corporation. The formula is shown below:

Expected Recovery Percentage = Net Free Assets / Unsecured and Non-Priority Claims

2. Statement of Realizations and Liquidation – this is the accomplishment statement of the

trustee in handling the liquidation. It is intended to show the actual transactions toward the
liquidation of the debtor’s estate.

The summary of the statement of realization and liquidation is presented as follows:

DEBITS CREDITS

Assets to be realizeda Assets realizedc

Assets acquiredb Assets not realizedd

Liabilities liquidatedg Liabilities to be liquidatede

Liabilities not liquidatedh Liabilities assumedf

Supplementary chargesi Supplementary creditsj

Net loss on realization and liquidation Net gain on realization and liquidation

The detailed explanation of the items in the statement of realization and liquidation:
a. Assets to be realized – total non-cash assets at the beginning of liquidation
b. Assets acquired – new assets acquired during the liquidation period.
c. Assets realized – the cash realized (proceeds) from the sale of non-cash during the liquidation period.
d. Assets not realized – total non-cash assets at the end of the liquidation period (remaining non-cash assets).
e. Liabilities to be liquidated – total liabilities at the beginning of liquidation
f. Liabilities assumed – new liabilities incurred during the liquidation period.
g. Liabilities liquidated – total cash payment for the liquidation of liabilities
h. Liabilities not liquidated – total liabilities at the end of the liquidation period (remaining liabilities).
i. Supplementary charges – expenses incurred during the liquidation period (excluding loss on realization
and write-off).
j. Supplementary credits – revenues earned during the liquidation period (excluding gain on assets
realization and liability settlement).

Guide in Preparation of ‘Statement of Realization and Liquidation’

A. Transactions not involving cash

i. Sales on account – it will be posted in the assets acquired for the Accounts Receivable (debit)
and credited as supplementary credits (for Sales account).
ii. Purchase on account – it will be posted in the liabilities assumed for the Accounts Payable
(credit) and debited as supplementary debits (for Purchase/Inventory account).

B. Transactions involving cash

i. Cash receipts are to be reported as assets realized or supplementary credit, whichever is
appropriate .
ii. Cash payments are to be reported as liabilities liquidated or supplementary charges,
whichever is appropriate.

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 Difference of Statement of Affairs and Statement of Realization and Liquidation

1. The ‘Statement of Realization and Liquidation’ reports the actual liquidation results while the ‘Statement
of Affairs’ is of a pro-forma nature and is based on estimates.

2. The ‘Statement of Realization and Liquidation’ provides ongoing reporting of the trustees activities
and is updated through the liquidation process, while the ‘Statement of Affairs’ is a summary of the
estimated results of a completed situation.

Process of corporation liquidation

1. Sell all Non-cash assets at fair market value
2. Pay all the liabilities.
a. Fully secured liabilities
b. Secured portion of partially secured liabilities
c. Unsecured liabilities with priority
d. Unsecured without priority and the unsecured portion of partially secured liability
using the expected recovery percentage

Sample Problems

Problem I. The Rodriguez Corporation is undergoing liquidation and has the following condensed
Statement of Financial Position as of December 31, 2020:

Assets Liabilities and Equity

Cash ₱ 1,998,500 Salaries Payable ₱ 875,000
Receivables 5,964,000 Accounts Payable 1,898,750
Merchandise Inv. 1,400,000 Bond Payable 7,000,000
Prepaid Expenses 43,750 Bank Loan Payable 3,850,000
Building (net) 6,037,500 Note Payable 1,400,000
Goodwill 962,500 Ordinary Shares 2,100,000
________ Deficit ________
Total Assets ₱ 16,406,250 Total Liab. and Equity ₱ 17,123,750

Additional information
• The bonds payable are secured by the building having a realizable value of ₱6,300,000
• Of the accounts payable, ₱1,050,000 is secured by ¼ of the receivable which is estimated
to be 20% uncollectible. The remainder in the book value of the receivables which has a
realizable value of ₱4,112,500 is used to secure the bank loan payable.
• The merchandise has a realizable value of ₱927,500
• In addition to the recorded liabilities are accrued interest on bonds payable amounting to
₱70,000 and trustee expenses amounting to ₱43,750 and taxes ₱52,500
Requirements:
a. Compute for the settlement to fully secured creditors, partially secured creditors, unsecured
creditors with priority, and unsecured creditors without priority.
b. Prepare Statement of Affairs

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Solution Requirement (a)
Step 1: Compute for the total net realizable value of assets

Assets Book Value Net Realizable Value Reference

Cash ₱ 1,998,500 ₱ 1,998,500
Receivables 5,964,000 5,305,300* second bullet
Merchandise Inv. 1,400,000 927,500 third bullet
Prepaid Expenses 43,750 ------- see note below
Building (net) 6,037,500 6,300,000 first bullet
Goodwill 962,500 ------ see note below
Total Assets ₱ 16,406,250 ₱ 14,531,300

Supporting Computation for Receivables

¼ of Receivables ₱ 1,491,000 ₱ 1,192,800 80% collectible
¾ of Receivales 4,473,000 4,112,500
₱ 5,964,000 ₱ 5,305,300

Additional note: Prepaid Expenses and Goodwill has no net realizable value because prepaid
expenses are deemed consumed, and Goodwill to be written off, hence zero.

Step 2: Classify the liabilities as fully secured, partially secured, unsecured with priority, or
unsecured without priority

Liabilities Book Value Classification Priority Non-prio

Salaries Payable ₱ 875,000 with priority 875,000
Accounts Payable 1,898,750 fully**/without prio. 1,050,000 848,750
Bond Payable 7,000,000 partially secured 6,300,000 700,000
Bank Loan Payable 3,850,000 fully secured 3,850,000
NotesPayable 1,400,000 without priority 1,400,000
Additional expenses/liabilities
Accrued interest 70,000 without priority 70,000
Trustees’ expenses 43,750 with priority 43,750
Taxes 52,500 with priority 52,500
Total 12,171,250 3,018,750

**The Accounts Payable amounting to ₱ 1,050,000 was secured by Receivable (see Step 1), since the
amount of collateral (Accounts Receivable) is greater than the amount of liability (Accounts
Payable), the liability is fully secured. Also, the remaining balance of Accounts Payable is deemed
treated as unsecured liability because it does not have collateral.

Step 3: Compute for the Net Free Assets

Total Assets at Net Realizable Value (Step 1) ₱ 14,531,300
Less: Liabilities (with security and priority) (Step 2) 12,171,250
Net Free Assets ₱ 2,360,050 ***

***Detailed illustration of payments can be seen in Step 5

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Step 4: Compute for the Expected Recovery percentage

Net Free Assets (Step 3) ₱ 2,360,050

Divide by: Unsecured liabilities (Step 2) 3,018,750
Expected Recovery Percentage 78.18%

Step 5: Pay the creditors in the following order: Fully secured creditors, Secured portion of the partially
secured creditors, unsecured creditors with priority (these steps were already done in Step 2, for
comprehensive discussion, this will be discussed again in this step), lastly unsecured portion of partially
secured creditors and unsecured creditors without priority using the expected recovery percentage.

Net Realizable Value of Assets ₱ 14,531,300

a. Payment of Fully Secured Creditors (Step 2) (@ 100%)

Portion of Accounts Payable ₱ 1,050,000
Bank Loan Payable 3,850,000
Total payment for Fully Secured Creditors ₱ (4,900,000)

b. Payment of Partially Secured Creditors (Step 2) (@100% and ER%)

Secured portion of Bonds Payable ₱ 6,300,000
Recovery of unsecured portion
Unsecured portion* ₱ 700,000
Accrued interest 70,000
Total ₱ 770,000
x ER% 78.18% 601,990*
Total payment for Partially Secured Creditors ₱ (6,901,990)
* ₱7,000,000 – 6,300,000 = ₱ 700,000 / rounded off to nearest tens

c. Payment of Unsecured creditors with priority (Step 2) (@100%)

Salaries Expenses ₱ 875,000
Trustees’ expenses 43,750
Taxes 52,500
Total payment for unsecured creditors with priority ₱ (971,250)

d. Payment of Unsecured creditors without priority (@ER %)

Unsecured Liability Book Value at ER% (78.18%)

Accounts Payable ₱ 848,750 ₱ 663,550*
Notes Payable 1,400,000 1,094,520
Total payment for unsecured creditor without priority ₱ (1,758,073)
*rounded-off to nearest tens

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Solution Requirement (b)
Step 1: Plot the Assets and Liabilities at Book Value, and Net Realizable Value/Settlement Value.
Step 2: Compute for the Estimated Deficiency to creditors by subtracting the total settlement value
of liabilities to the total net realizable value of assets.
Assets Book Value Net Realizable Value/Settlement Value
Cash ₱ 1,998,500 ₱ 1,998,500
Receivables 5,964,000 5,305,300
Merchandise Inv. 1,400,000 927,500
Prepaid Expenses 43,750 -------
Building (net) 6,037,500 6,300,000
Goodwill 962,500 ------
Total Assets ₱ 16,406,250 ₱ 14,531,300

Liabilities
Salaries Payable ₱ 875,000 ₱ 875,000
Accounts Payable 1,898,750 1,898,750
Bond Payable 7,000,000 7,000,000
Bank Loan Payable 3,850,000 3,850,000
Note Payable 1,400,000 1,400,000
Accrued interest 70,000
Trustees’ expenses 43,750
Taxes 52,500
Total Liabilities ₱ 15,023,750 ₱ 15,190,000
Estimated deficiency to creditors ₱ 658,700

Step 3: Classify Assets as Free Assets, Assets pledged to partially secured creditors or Assets pledged to
fully secured creditors

Assets Book Value Net Realizable Value Classification

Cash ₱ 1,998,500 ₱ 1,998,500 Free Asset
Receivables 5,964,000 5,305,300*
Merchandise Inv. 1,400,000 927,500 Free Asset
Prepaid Expenses 43,750 ------- Consumed
Building (net) 6,037,500 6,300,000 APPSC
Goodwill 962,500 ------ written off
Total Assets ₱ 16,406,250 ₱ 14,531,300

Supporting Computation for Receivables

¼ of Receivables ₱ 1,491,000 ₱ 1,192,800 (pledged to Accts. Payable, APFSC)
¾ of Receivales 4,473,000 4,112,500 (pledged to Bank Loan Payable, APFSC)
₱ 5,964,000 ₱ 5,305,300

Additional Analysis:
Asset pledged is greater than or equal to Liability Secured Asset pledged to Fully Secured Creditor (APFSC)
Asset pledged is less than the Liability Secured Asset pledged to Partially Secured Creditor (APPSC)
Asset has no corresponding liability Free Asset

Step 4: Classify the liabilities as fully secured, partially secured, unsecured with priority, or
unsecured without priority

This step was already done on Requirement (a), Please see step 2

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Step 5: Prepare the Statement of Affairs

Rodriguez Corporation
Statement of Affairs
December 31, 2020

Book Value Assets Est. Realizable Value Free Asset

Assets Pledged to Fully Secured Creditor
₱ 1,491,000 Receivables (1/4) ₱ 1,192,800
4,473,000 Receivables (3/4) 4,112,500
Total APFSC ₱ 5,305,300
Less: Liability to FSC
Portion of Accounts Payable ₱ 1,050,000
Bank Loan Payable 3,850,000
Totals Liability to FSC ₱ 4,900,000 ₱ 405,300

Assets Pledged to Partially Secured Creditor

6,037,500 Building ₱ 6,300,000
Total APPSC ₱ 6,300,000

Free Assets
1,998,500 Cash ₱ 1,998,500
1,400,000 Merchandise Inventory 927,500 ₱ 2,926,000
Total Free Assets ₱ 3,331,300
Less: Unsecured liability with priority 971,250
Net Free Assets ₱ 2,360,050
Less: Total unsecured liability 3,018,750
Deficit ₱ 658,700

Book Value Liabilities and Equity Creditor’s claim Unsecured Liabilities

Fully Secured Creditor
₱ 1,050,000 Portion of Accounts Payable ₱ 1,050,000
3,850,000 Bank Loan Payable 3,850,000
Totals Liability to FSC ₱ 4,900,000

Partially Secured Creditor

7,000,000 Bond Payable ₱7,000,000
0 Accrued interest 70,000
Total ₱7,070,000
Less: APPSC
Building ₱ 6,300,000 ₱ 770,000

Unsecured Creditors with Priority

875,000 Salaries Payable ₱ 875,000
0 Trustees’ expenses 43,750
0 Taxes 52,500
Total unsecured liability with priority ₱ 971,250

Unsecured Creditors without Priority

848,750 Portion of Accounts Payable ₱ 848,750
1,400,000 Notes Payable 1,400,000
Total unsecured liability without priority 2,248,750

Stockholder’s Equity
₱ 2,100,000 Ordinary shares ₱ -0- _______________________
Total unsecured liabilities ₱ 3,018,750

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Problem II. Mara Clara Corporation has been undergoing liquidation since January 1. As of June
30, its condensed statement of realization and liquidation is presented below

Assets Realized ₱ 105,000

Interest on investment 525
Purchases on account 5,250
Assets acquired 17,500
Liabilities assumed 5,250
Payments of expenses of trustees 26,250
Liabilities to be liquidated 227,500
Sales on account 17,500
Assets not realized 147,000
Liabilities not liquidated 111,475
Sales for cash 87,500
Assets to be realized 332,500
Liabilities liquidated 122,500

Requirement: Compute for the net gain(loss) on realization and liquidation

Solution
Debit Credit
Assets to be realized ₱ 322,500 ₱ 147,000 Assets not realized
Assets acquired 17,500 105,000 Assets realized
Liabilities not liquidated 111,475 227,500 Liabilities to be liquidated
Liabilities liquidated 122,500 5,250 Liabilities assumed
Payment of expenses of trustees 26,250 87,500 Sales for cash
Purchases 5,250 17,500 Sales on account
525 Interest on Investment
₱ 615,475 ₱ 590,275
Loss on realization and liquidation ₱25,200

Exercise
Problem III. The following information is related to Gutierrez Corporation, which is undergoing
liquidation:
a. Bonds Payable amounting to ₱73,600 is secured by Merchandise Inventory with book value of
₱123,600, and the net realizable value of 2/3 of the recorded amount.

b. Of the ₱195,600 Accounts Payable, ₱55,000 is secured by equipment with a carrying amount of
₱76,800 which is 70% realizable.

c. Building with carrying amount of ₱129,000 has a net realizable value of ₱99,000

d. Other unrecorded liabilities are accrued interest payable on bonds, ₱3,100; Salaries payable,
₱17,400; Taxes payable, ₱11,600; and trustee’s fee, ₱8,500.

e. Cash available prior to liquidation amounts to ₱11,900.

f. Total assets of the corporation presented in the statement of financial position prior to liquidation
amounts to ₱480,000, except for prepaid expenses and goodwill amounting to ₱7,600 and ₱22,000,
respectively, remaining assets other than those whose realizable values were mentioned above has
realizable value of 60% of the recorded amount.

g. Total liabilities of the corporation presented in the statement of financial position prior to
liquidation amounts to ₱380,000.

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Requirement: Compute for the estimated deficiency to unsecured creditors.

Problem IV. The following data are taken from the Statement of Affairs of Mobile Legends Corporation

Assets pledged to fully secured liabilities (Fair value is ₱375,000) ₱ 450,000

Assets pledged for partially secured liabilities ( Fair value is ₱260,000) 370,000
Free Assets (Current fair value is ₱200,000) 350,000
Unsecured liabilities with priority 35,000
Fully secured liabilities 150,000
Partially secured liabilities 300,000
Unsecured liabilities without priority 560,000

Requirement: Compute for the amount paid to partially secured creditor

Problem V. The following data were taken from the realization and liquidation of Spongebob Corporation
for the quarter ending September 30, 2019.
Liabilities to be liquidated ₱ 285,000 Supplementary charges ₱ 169,100
Liabilities not liquidated 210,000 Supplementary credits 192,500
Assets acquired 136,000 Liabilities liquidated 158,000
Assets to be realized 107,500 Assets realized 175,000
Liabilities assumed 83,000

The beginning capital balances of ordinary shares and retained earnings are ₱102,000 and ₱29,600,
respectively. The net income for the period was ₱87,400.

Requirement: (a) Compute for the beginning balance of cash, and (b) Compute for the ending balance of
cash

End of Module 1

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