Partnership Liquidation

Chapter 4
Partnership Liquidation
Liquidation of partnership means winding up the business usually by selling the assets, paying the
liabilities, and distributing the remaining cash to partners. A business which is in the process of
converting its assets into cash and making settlement with creditors is said to be in liquidation. A term
which is always used by a business that is in the process of liquidation is realization, which means the
sale of assets.
Accounting Problems in Partnership Liquidation
There are certain rules that should be followed in the liquidation of the partnership, namely:
1. Always allocate and close gains or losses to the partners’ capital accounts prior to distributing
any cash to the partners.
2. When the business is liquidated, the partner is entitled to an amount depending upon his capital
contribution, his drawings, his share in the net income or loss from operations before
liquidation, gains and losses on realization, and the balance of his loan account, if any.
As a general rule, the cash should be distributed as follows:
1. First, outside creditors.
2. Second, to partners for loan accounts.
3. Third, to partners for capital accounts.
Methods of Partnership Liquidation
When a partnership is to be liquidated by the sale of assets, the following methods, may be used:
1. Lump-Sum Liquidation, otherwise called Total Liquidation or Single Distribution.
2. Installment Liquidation, otherwise called Installment Distribution.
LUMP-SUM LIQUIDATION
A lump-sum liquidation of a partnership is one in which all the assets are converted into cash within a
very short time, outside creditors are paid, and a single, lump-sum payment is made to the partners for
their total interests.
Realization of Assets. Typically a partnership will experience losses on the sale of its assets. A
partnership may have a “Going Out of Business” sale in which its inventory is marked down well
below normal selling price to encourage immediate sale.
Expenses of Liquidation. During the liquidation process, expenses are usually incurred, such as legal
and accounting expenses and advertising cost of selling assets. These expense are allocated to partners’
capital accounts in their profit and loss ratio.
Liquidation Procedures. The following procedure may be used in lump-sum liquidation.
1. Realization of assets and distribution of gain or loss on realization among the partners based on
the profit and loss ratio.
2. Payment of expenses
3. Payment of liabilities
4. Elimination of partner’s capital deficiencies. If after the distribution of loss on realization, a
partner incurs a capital deficiency (i.e., partner’s share of realization loss exceeds his capital
credit), this deficiency must be eliminated by using one of the following methods, in the order of
priority.
a. If the deficient partner has a loan balance, exercise the right of offset.
b. If the deficient partner is solvent, make him invest cash to eliminate his deficiency.
c. If the deficient partner is insolvent, let the other partners absorb his deficiency.
5. Payment to partners (in order of priority):
a. Loan accounts
b. Capital accounts
Illustration of Lump-Sum Liquidation
The following illustration will be used to present the lump-sum liquidation of DEF Partnership in
which D, E and F are partners. A condensed statement of financial position of the company on April 27,
2016, the day the partners decide to liquidate the business is presented below:
DEF PARTNERSHIP
Statement of Financial Position
April 27, 2016
Assets Liabilities and Capital

Cash P 20,000 Liabilities P28,000
Other Assets 80,000 D, loan 2,000
D, capital (40%) 9,000
E, capital (40%) 21,000
F, capital (20%) 40,000
Total Assets P100000 Total Liabilities and Capital P100,000
Note: Partners loan account is not close to partner’s capital account. But partner capital balances
before realization should be after closing the following account, if any:
a. Partner’s drawing.
b. Partnership goodwill account.
c. Receivable from partners.
d. Payable to partners.
The following four cases illustrate the partnership liquidation concepts that are used commonly. Each
case begins with the April 27, 2016, balances. The amount of cash realize from the sale of non-cash
assets is different from each of the three cases, and the effects of the different realizations are shown in
the statement of partnership realization and liquidation presented for each case.
Case 1: Loss on Realization: Fully Absorbed by Partners’ Capital Balances.Assume that the Other
assets, P80,000, were realized at P60,000 thus resulting to the total loss of P20,000. Hence, the
distribution of cash to the partners does not present any problem. A statement of liquidation (Illustration
4-1) to summarize the foregoing is prepared as follows:
Illustration 4-1
DEF PARTNERSHIP
Statement of Liquidation
April 27, 2016
Assets Partners' Capital

Cash Others Liabilities D, Loan D(40%) E(40%) F(20%)
Balances before liquidation P20,000 P80,000 P28,000 P2,000 P9,000 P21,000 P40,000
Realization of assets and
distribution of loss 60,000 (80,000) (8,000) (8,000) (4,000)
Balances 80,000 -0- 28,000 2,000 1,000 13,000 36,000

Payment of liabilities -28,000 -28,000
Balances 52,000 -0- -0- 2,000 1,000 13,000 36,000

Payments to partners P(52,000) -0- -0- P(2,000) P(1,000) P(13,000) P(36,000)
The journal entries required to record the realization of assets and to complete the liquidation appear
below.
Cash 60,000
D, Capital 8,000
E, Capital 8,000
F, Capital 4,000
Other Assets 80,000
To record the sale of other assets and the division of loss of P20,000 among the
partners using the P & L, ratio.
Liabilities 28,000
Cash 28,000
To record payment to outside creditors.
D, Loan 2,000
D, Capital 1,000
E, Capital 13,000
F, Capital 36,000
Cash 52,000
To record payment to partners equal to the amounts reported in the partners’ loan
and capital accounts
Case 2: Loss on Realization Resulting Capital Deficiency to a Partner with a Loan Account.
Assume that the Other Assets were realized at P55,000 resulting to a loss of P25,000. After the
distribution of loss among the partners using the profit and loss ratio, D’s capital account results in a
debit balance of P1,000. To cancel his deficiency, D has to exercise the right of offset by transferring
P1,000 from his loan account to his capital account. The partners are still paid in the amounts equal to
their outstanding loan and capital balances.
A statement of liquidation to summarize the foregoing is shown below:

Illustration 4-2
DEF PARTNERSHIP
April 27, 2016

Balances 75,000 -0- 28,000 2,000 (1,000) 11,000 35,000
Payment of liabilities (28,000) (28,000)
Balances 47,000 -0- -0- 2,000 (1,000) 11,000 35,000

Offset D's loan against his
capital deficiency (1,000) 1,000
Balances 47,000 -0- -0- 1,000 -0- 11,000 35,000

Payments to partners P(47,000) -0- -0- P(1,000) -0- P(11,000) P(35,000)
The entry to record the application of D’s loan to his capital deficiency would be as follows:
D, Loan 1,000
D, Capital 1,000
To record transfer of D’s loan to his capital account
Case 3: Loss on Realization Resulting Capital Deficiency to a solvent Partner

Assume that the Other Assets were sold for P49,500, thus, resulting to a loss of P30,500 to be divided
among the partners using the profit and loss ratio. After the distribution of loss, D’s capital account
would result to a debit balance of P3,200. Offsetting the entire amount of D’s loan account against his
capital account still leaves his capital account with a debit balance of P1,200. D has to invest additional
cash to fully eliminate his deficiency. The statement of liquidation (Illustration 4-3) appears below.
Illustration 4-3
DEF PARTNERSHIP
April 27, 2016

Balances 69,500 -0- 28,000 2,000 -3,200 8,800 33,900

Balances 41,500 -0- -0- 2,000 (3,200) 8,800 33,900

Balances 41,500 -0- -0- -0- (1,200) 8,800 33,900

Cash investment by D to
eliminate his capital
deficiency 1,200 1,200
Balances 42,700 -0- -0- -0- -0- 8,800 33,900

Payments to partners P(42,700) -0- -0- -0- -0- P(8,800) P(33,900)
The entry to record the investment of D to eliminate his capital deficiency is
Cash 1,200
D, Capital 1,200
To record the additional investment of D.
Case 4: Loss on Realization Resulting Capital Deficiency to an Insolvent
Partner. Let us assume that in the preceding case, partner D is personally insolvent and the P1,200 due
from him is uncollectible. In this case, the P1,200 is to be proportionately absorbed by E and F. E and F
therefore incur additional loss. The Statement of Liquidation (Illustration 4-4) is completed by showing
the write off of D’s debit balance as an additional loss to E and F.
The entry to record the absorption of D’s deficiency by e and F is
E, Capital 800
F, Capital 400
D, Capital 1,200
To record the absorption of D’s deficiency by E and F.
Deficiency absorbed is determined as follows:
E : 4/6 x P1,200
F : 2/6 x P1,200
Illustration 4-4
DEF PARTNERSHIP
April 27, 2016

Liabilitie D,
Cash Others s Loan D(40%) E(40%) F(20%)
(12,200
distribution of loss 49,500 (80,000) ) (12,200) (6,100)
Balances 69,500 -0- 28,000 2,000 -3,200 8,800 33,900

Balances 41,500 -0- -0- 2,000 (3,200) 8,800 33,900

Balances 41,500 -0- -0- -0- (1,200) 8,800 33,900

Cash investment by D to
eliminate his capital
deficiency 1,200 (800) (400)
Balances 41,500 -0- -0- -0- -0- 8,000 33,500

P(41,500 P(33,500
Payments to partners ) -0- -0- -0- -0- P(8,000) )
Partnership is Insolvent but Partners are Personally Solvent

L,M and N
March 31, 2016
Cash P 8,000 Liabilities P33,000
Other Assets 42,000 L, Capital 9,000
M, Capital 5,000
N, Capital 3,000
Total Assets P50,000 Total Liabilities and Capital P50,000
The Other assets with a carrying value of P42,000 are sold for P19,500 cash, which resulted in a loss of
P22,500 to be divided equally among the partners. The total cash of P27,500 is paid to the creditors,
leaving an unpaid amount of P5,500 (P33,000 – P27,500). After the distribution of P22,500 loss,
partners M and N have capital deficiencies of P2,500 and P4,500, respectively. If M and N pay the
amount of their deficiencies totaling P7,000, the partnership will use the said amount to pay the
remaining liabilities of P5,500 and give P1,500 to L in settlement of his equity. These transactions are
presented in the statement of liquidation in the next page (Illustration 4-5)
Illustration 4-5
L, M and N
March 31, 2016

Cash Others Liabilities L(1/3) M(1/3) N(1/3)
Balances before liquidation P8,000 P42,000 P33,000 P9,000 P5,000 P3,000
distribution of loss 19,500 -42,000 -7,500 -7,500 -7,500
Balances 27,500 0 33,000 1,500 -2,500 -4,500

Partial Payment of liabilities -27,500 -27,500
Balances 0 0 5,500 1,500 -2,500 -4,500

Cash investment by M and N 7,000 2,500 4,500
Balances 7,000 0 5,500 1,500 0 0

Full Payment of liabilities -5,500 -5,500
Balances 1,500 0 0 1,500 0 0

Payments to partners P(1,500) 0 0 P(1,500) 0 0
Partnership is Insolvent and Partners are Personally Insolvent

Illustration. Assume that A, B and C. who share profits and losses equally, have the following
statement of financial position just prior to liquidation.
A, B and C
April 30, 2016

Cash P 10,000 Liabilies P60,000
Other Assets 100,000 A, Capital 5,000
B, Capital 15,000
C, Capital 30,000
Total Assets P110,000 Total Liabilities and Capital P110,000
The personal assets and liabilities of the partners on this date apart from their equities in the partnership
are:
Partners Personal Assets Personal Liabilities
A P100,000 P25,000
B 50,000 50,000
C 5,000 60,000
Other Assets were sold for P40,000 resulting to a loss of P60,000. The total cash of P50,000 is used to
pay creditors, after which an unpaid amount of P10,000 still exists. The statement of liquidation
showing how the P10,000 unpaid liabilities will be paid is shown in the next page.
Illustration 4-6
A, B and C
April 30, 2016
Cash Others Liabilities A(1/3) B(1/3) C(1/3)
Balances 50,000 -0- 60,000 -15,000 -5,000 10,000

Partial Payment of liabilities -50,000 -50,000
Balances -0- -0- 10,000 -15,000 -5,000 10,000

Additional investment by A 15,000 15,000
Balances 15,000 -0- 10,000 -0- -5,000 -10,000

Full Payment of liabilities -10,000 -10,000
Balances 5,000 -0- -0- -0- -5,000 -10,000

Additional loss to A and C -2,500 5,000 -2,500
Balances 5,000 -0- -0- -2,500 -0- 7,500

Additional investment by A 2,500 2,500
Balances 7,500 -0- -0- -0- -0- 7,500

Payments to partners P(7,500) -0- -0- -0- -0- P(7,500)
Explanation of transaction numbers 1 to 4:

1. In as much as A is solvent, he can eliminate his capital deficiency by investing cash for an
amount equal to such.
2. B is personally insolvent so the solvent partners, A and C, will incur proportionate additional
losses to eliminate B’s capital deficiency.
3. A is still personally solvent so he can afford to gain invest cash to eliminate his capital
deficiency.
4. The amount paid to C may have to be used to pay his personal creditors in as much as he is
personally insolvent.
Chapter 5
Partnerships Liquidation By Installment
Procedure for Liquidation by Installment
The following are the accounting procedures that may be followed in liquidating a partnership by
installments.
1. Record the realization of assets and distribute the realized gains or losses among the partners
using the profit and loss ratio.
2. Pay liquidation expenses and unrecorded liabilities, if there are any, and distribute these among
the partners using the profit and loss ratio.
3. Pay the liabilities to outsider.
4. Distribute cash to the partners after possible future losses have been apportioned to partners or
in accordance with a cash distribution program.
Note: Eliminate any capital deficiency only before final payments to partners.
Illustration of Installment Liquidation
Case 1: each partner has sufficient interest to absorb possible loss. X, Y and Z, partners sharing
profit and losses equally, decide to liquidate their partnership. Prior to the liquidation, the partnership
Statement of Financial Position on June 30, 2016 is presented in the next page:
Illustration 5-1
X, Y and Z
June 30, 2016
Assets Liabilities and Equity
Cash P5,000 Liabilities P40,000
Other Assets 155,000 X, Capital 30,000
Y, Capital 40,000
Z,Capital 50,000
Total P160,000 Total P160,000
The following data relate to the realization of other assets:

Book Value Cash Realized Loss
July P80,000 P65,000 P15,000
August 42,000 24,000 18,000
September 33,000 12,000 21,000
P155,000 P101,000 P54,000
X Y Z
Capital balances P25,000 P35,000 P45,000
Add loan balances - - -
Total interests P25,000 P35,000 P45,000
In July, the first month of installment, the Statement of Liquidation before the payment to the partners
appears below:
Illustration 5-2
X, Y and Z
July 2016

Cash Others Liabilities X(1/3) Y(1/3) Z(1/3)
Balances 70,000 75,000 40,000 25,000 35,000 45,000

Payment of liabilities -40,000 -40,000
Balances P30,000 P75,000 0 P25,000 P35,000 P45,000
To determine how the value cash of P30,000 is to be distributed to the partners, a schedule of safe
payment is to be prepared. The calculation of the safe payment require the following steps.
1. Determine the total interest of each partner. Before cash distribution, a partner’s capital is added
to the loan he granted to the firm to arrive at his interest. The total interests of the partners are
computed as follows:
2. Compute the total possible loss of the partnership to be absorbed by each partner. This consists
of the total value of remaining non-cash or other assets and the cash withheld. Each partner
absorbs a possible loss of an amount equal to the total possible loss multiplied by his profit and
loss share percentage. The necessary computations are as follows:
Other assets (unsold)
Add Cash withheld
Total possible loss
Possible loss absorbed by -
X : P75,000 x 1/3 = P25,000
Y : P75,000 x 1/3 = P25,000
Z : P75,000 x 1/3 = P25,000
Total P75,000
The schedule of safe payments prepared based on the above procedures is shown below:
Illustration 5-3
Schedule I
Schedule of Safe Payments – July
X(1/3) Y(1/3) Z(1/3)
Total interest P25,000 P35,000 P45,000
Possible loss -25,000 -25,000 -25,000
Payment to partners 0 P10,000 P20,000
According to the schedule (Illustration 5-3), it is safe to pay the partners P30,000 in July, i.e., P10,000
to Y and P20,000 to Z. the total payment to partners is equal to the cash available for distribution
according to the statement of liquidation. After the distribution of available cash, the partners’ capitals
have the following balances: X, P25,000; Y, P25,000 (P35,000 – P10,000); Z, P25,000 (P45,000 –
P20,000). The capital balances are equal to one another and this is in accordance with the agreed profit
and loss sharing, i.e., equally,. Therefore, any further installment payments in August and September
can be safely made in the agreed profit and loss ratio without preparing a schedule of safe payments.
Illustration 5-4 below shows the complete picture of the liquidation of the partnership of X, Y and Z
from July 1 to September 30, 2016.
Illustration 5-4
X, Y and Z
July to September 30, 2016

Cash Others Liabilities X(1/3) Y(1/3) Z(1/3)
July Installment:
Balances 70,000 75,000 40,000 25,000 35,000 45,000
Balances P30,000 P75,000 -0- P25,000 P35,000 P45,000
Payment to partners
(schedule 1) (30,000) (10,000) (20,000)
Balances -0- 75,000 -0- 25,000 25,000 25,000
August Installment:
Balances 24,000 33,000 -0- 19,000 19,000 19,000
Payment to partners -24,000 -8,000 -8,000 -8,000
Balances -0- 33,000 -0- 11,000 11,000 11,000
September Installment
Balances 12,000 -0- -0- 4,000 4,000 4,000
Final Payments to partners P(12,000) -0- -0- P(4,000) P(4,000) P(4,000)
Several important conclusion can be drawn from the analysis of the Statement of Liquidation
(Illustration 5-4). These are:
1. The order of payments in the statement of liquidation is in accordance with the order of priority
stated in the Partnership Law, that is payment are first made to creditors, then to the partners.
2. The total installment payment to each partner is equal to the amount of single payment
computed under the lump-sum liquidation method, as illustrated below.
Installment Liquidation Method
X(1/3) Y(1/3) Z(1/3)
July P - P10,000 P20,000
August 8,000 8,000 8,000
September 4,000 4,000 4,000
Toal payments P12,000 P22,000 P32,000
Lump-Sum Liquidation Method

X(1/3) Y(1/3) Z(1/3)
Capital balances befor liquidation P30,000 P40,000 P50,000
Total loss on realization, P54,000 18,000 18,000 18,000
Total payments P12,000 P22,000 P32,000
3. The ratio of the partners’ capitals after the liquidation on July is equal to the profit and loss of
the partners. When this condition exists, all subsequent installment payments are based upon the
profit and loss ratio (see August and September installment payments in the statement of
liquidation).
The journal entries for the liquidation of the partnership of X, Y and Z are as follows:
July
(1) Cash 65,000
X, Capital 5,000
Y, Capital 5,000
Z, Capital 5,000
Other assets 80,000
To record July sale of assets and the distribution of loss among the partners.
(2) Liabilities 40,000
Cash 40,000
To record full payment of liabilities.
(3) Y, Capital 10,000
Z, Capital 20,000
Cash 30,000
To record the first installment payment to partners
August
(4) Cash 24,000
X, Capital 6,000
Y, Capital 6,000
Z, Capital 6,000
Other assets 42,000
To record August sale of assets and the distribution of loss among the partners.
(5) X, Capital 8,000
Y, Capital 8,000
Z, Capital 8,000
Cash 24,000
To record the second installment payment to partners
September
(6) Cash 12,000
X, Capital 7,000
Y, Capital 7,000
Z, Capital 7,000
Other assets 33,000
To record September sale of assets and the distribution of loss among the partners.
(7) X, Capital 4,000

Y, Capital 4,000
Z, Capital 4,000
Cash 12,000
To record the final payment to partners.
Case 2: one or more partners have insufficient interest to absorb possible loss. The partners of
ABE & Co. share profits and losses as follows: A, 50%; B, 20%; C, 20%; D, 10%. On March 31, 2016,
they agree to liquidate their partnership. Prior to the liquidation, the partnership statement of financial
position is shown in the next page:
ABE & Co.
March 31, 2016
Non-cash assets 80,000 B, Loan 2,000
A, Capital 20,000
B, Capital 29,000
C, Capital 23,000
D, Capital 10,000
The following data relate to the realization of non-cash assets:
Book Value Cash Realized Loss

April P54,000 P30,000 24,000
May 24,000 18,000 6,000
June 2,000 1,000 1,000
P80,000 49,000 31,000
Schedule 1
Schedule of Safe Payment
A(50%) B(20%) C(20%) D(10%)
Capital balances P8,000 P24,200 P18,200 P7,600
Loan balance 2,000
Total interests 8,000 26,200 18,200 7,600
Possible loss P26,000 (13,000) (5,200) (5,200) (2,600)
Balances (5,000) 21,000 13,000 5,000
Additional possible loss to
B, C and D; 2:2:1 5,000 (2,000) (2,000) (1,000)
Payments to partner -0- P19,000 P11,000 P4,000
In April, the first month of installment liquidation, the statement of liquidation and schedule of safe
payment are as follows:
Illustration 5-5
ABE and Co.
Apr-16

Cash Non-cash Liabilities B, Loan A(50%) B(20%) C(20%) D(10%)
Balances before liquidation 10,000 80,000 6,000 2,000 20,000 29,000 23,000 10,000
distribution of loss 30,000 (54,000) (12,000) (4,800) (4,800) (2,400)
Balances 40,000 26,000 6,000 2,000 8,000 24,200 18,200 7,600

Balances 34,000 26,000 -0- 2,000 8,000 24,200 18,200 7,600

Payment to partners
(34,000
(schedule 1) ) (2,000) (17,000) (11,000) (4,000)
Balances -0- 26,000 -0- -0- 8,000 7,200 7,200 3,600
Illustration 5-6
ABE & Co.
April 1 to June 30, 2016

Liabilitie
Cash Non-cash s B. Loan A(50%) B(20%) C(20%) D(10%)
Balances before
liquidation P10,000 P80,000 P6,000 P2,000 P20,000 P29,000 P23,000 P10,000
April Installment:
Balances 40,000 26,000 6,000 2,000 8,000 24,200 18,200 7,600

Balances 34,000 26,000 -0- 2,000 8,000 24,200 18,200 7,600
Payment to partners
(schedule 1) (34,000) (2,000) (17,000) (11,000) (4,000)
Balances -0- 26,000 -0- -0- 8,000 7,200 7,200 3,600
May Installment:
distribution of loss 18,000 (24,000) (3,000) (1,200) (1,200) (600)
Balances 18,000 2,000 -0- -0- 5,000 6,000 6,000 3,000

Payment to partners
(Schedule 2) (18,000) (4,000) (5,600) (5,600) (2,800)
Balances -0- 2,000 -0- -0- 1,000 400 400 200
June Installment
distribution of loss 1,000 (2,000) (500) (200) (200) (100)
Balances 1,000 -0- -0- -0- 500 200 200 100

P(1,000
Final Payments to partners ) -0- -0- -0- P(500) P(200) P(200) P(100)
Schedule 2
Schedule of Safe Payment - May
A(50%) B(20%) C(20%) D(10%)
Possible loss P26,000 -1,000 -400 -400 -200
Payments to partner P4,000 P5,600 P5,600 P2,800
Case 3: One or More Partners Becomes Deficient After Absorbing Additional Possible Loss.
Assume the balance sheet and the data pertaining to the realization of non-cash assets of ABE & Co. in
Case 1. The partners share profits and losses as follows: A, 60%; b, 15%; C, 10%; D, 15%.
The statement of liquidation and the supporting schedule of safe payments are presented below and on
the next page.
Illustration 5-7
ABE & Co.
April 1 to June 30, 2016

Cash Non-cash Liabilitie B. Loan A(60%) B(15%) C(10%) D(15%)
s
Balances before
liquidation P10,000 P80,000 P6,000 P2,000 P20,000 P29,000 P23,000 P10,000
April Installment:
Balances 40,000 26,000 6,000 2,000 5,600 25,400 20,600 6,400

Balances 34,000 26,000 -0- 2,000 5,600 25,400 20,600 6,400
Payment to partners
(schedule 1) (34,000) (2,000) (17,000) (15,000)
Balances -0- 26,000 -0- -0- 5,600 8,400 5,600 6,400
May Installment:
distribution of loss 18,000 (24,000) (3,600) (900) (600) (900)
Balances 18,000 2,000 -0- -0- 2,000 7,500 5,000 5,500

Payment to partners
(Schedule 2) (18,000) (800) (7,200) (4,800) (5,200)
Balances -0- 2,000 -0- -0- 1,200 300 200 300
June Installment
distribution of loss 1,000 (2,000) (600) (150) (100) (150)
Balances 1,000 -0- -0- -0- 600 150 100 150

P(1,000
Final Payments to partners ) -0- -0- -0- P(600) P(150) P(100) P(150)
Schedule 1 - April
Computation of Safe Payment
A(60%) B(15%) C(10%) D(15%)
Loan balance 2,000
Total interests 5,600 27,400 20,600 6,400
Possible loss P26,000 (15,600) (3,900) (2,600) (3,900)
Balances (10,000) 23,500 18,000 2,500
Additional possible loss to
B, C and D; 15:10:15 10,000 (3,750) (2,500) (3,750)
Balances 0 19,750 15,500 -1,250
Additional possible to B & C;
15:15 (750) (500) 1,250
Payments to partner -0- P19,000 P15,000 -0-
Schedule 2 - May
A(60%) B(15%) C(10%) D(15%)
Total interests P2,000 P7,500 P5,000 P5,500
Possible loss, P2,000 -1,200 -300 -200 -300
Payments to partner P800 P7,200 P4,800 P5,200
Cash Withheld
COMPREHENSIVE ILLUSTRATIVE PROBLEM
R, S and T are partners who share profits and losses as follows: R, 50%; S, 30%; T, 20%. All partners
are personally insolvent. On December 31, 2016, they agree to liquidate their partnership. The firm’s
Statement of Financial Position on this date is as follows:
R, S and T
December 31, 2016
Cash P5,430 Accounts payable - trade P12,892
Other assets 61,870 R, Loan 8,000
Total Liabilities 20,892
R, Capital P16,402
S, Capital 5,469
T, Capital 24,537 46,408
Total Assets P67,300 Total Liabilities and Equity P67,300
The following data relate to the realization of other assets:

Book Value Cash Realized Loss Cash Withheld Liquidation Unrecorded
Expenses Paid Liabilities Paid
January P24,700 P20,120 P4,580 P3,000 P1,200 P1,550
February 33,170 21,000 12,170 800 1,400 200
March 4,000 3,700 300 200
The Statement of Liquidation from January 1 to March 1 2016 and the supporting schedules of safe
payments are presented in Illustration 5-8:
Illustration 5-8
R,S and T
January to March, 2016
Assets Accounts Payable Partners' Capital

Cash Others trade R, Loan R(50%) S(30%) T(20%)
January Installment:
distribution of loss 20,120 (24,700) (2,290) (1,374) (916)
Balances 25,550 37,170 12,892 8,000 14,112 4,095 23,621

Payments of liquidation
expenses and
unrecorded liabilities (2,750) (1,375) (825) (550)
Balances 22,800 37,170 12,892 8,000 12,737 3,270 23,071

Payment of accounts
payable (12,892) (12,892)
Balances 9,908 37,170 -0- 8,000 12,737 3,270 23,071

Payment to partners
(schedule 1) (6,908) (6,908)
Balances 3,000 37,170 -0- 8,000 12,737 3,270 16,163

February Installment:
distribution of loss 21,000 33,170 (6,085) (3,651) (2,434)
Balances 24,000 4,000 -0- 8,000 6,652 (381) 13,729

expenses and
unrecorded liabilities (1,600) (800) (480) (320)
Balances 22,400 4,000 -0- 8,000 5,852 (861) 13,409

Payment to partners
(Schedule 2) (21,600) (8,000) (1,808) (11,792)
Balances 800 4,000 -0- -0- 4,044 -861 1,617
March Installment
distribution of loss 3,700 (4,000) (150) (90) (60)
Balances 4,500 -0- -0- -0- 3,894 (951) 1,557

expenses (200) (100) (60) (40)
Balances 4,300 -0- -0- -0- 3,794 (1,011) 1,517

Addition loss to
R & T: 5:2 (722) 1,011 (289)
Balances 4,300 -0- -0- -0- 3,072 -0- 1,228

Final Payments to partners P(4,300) -0- -0- -0- P(3,072) -0- P(1,228)
Schedule 1 - January
R(50%) S(30%) T(20%)
Loan balance 8,000 -0- -0-
Total interests 20,737 3,270 23,071
Possible loss (P3,000+P37,170) (10,085) (12,051) (8,034)
Balances 652 (8,781) 15,037
Additional loss to R & T, 5:2 (6,272) 8,781 (2,509)
Balances (5,620) -0- 12,528
Additional loss to T 5,620 - (5,620)
Payments to partner -0- -0- P 6,908
Schedule 2 - February
R(50%) S(30%) T(20%)
Capital balances P5,852 P(861) P13,409
Loan balance 8,000 - -
Total interests 13,852 (861) 13,409

Possible loss (P800+P4,000) (2,400) (1,440) (960)
Balances 11,452 (2,301) 12,449

Additional loss to R & T, 5:2 (1,644) 2,301 (657)
Payments to partner P9,808 0 P11,792
PREPARATION OF A CASH DISTRIBUTION PROGRAM

Illustration. A, B and C are partners who share profits and losses as follows: A, 40%; B, 30%; C,30%.
They decide to liquidate the partnership and they would like to have an advance cash distribution plan.
The statement of financial position prior to the liquidation is presented below:
A, B and C
June 30, 2016
Other assets 192,000 C, Loan 4,000
A, Capital 40,000
B, Capital 45,000
C, Capital 50,000
Total Assets P200,000 Total Liabilities and Equity P200,000
Procedure to Prepare a Cash Distribution Program

The following procedures may be used in the preparation of the Cash Distribution Program for A, B
and C partnership in order to determine the order of distributions and amount of payments:
1. Compute the loss absorption potential of each partner.
Partner Partner's Interest ÷ Profit & loss =Loss Absorption

(Capital + Loan) Share Percentage Potentials
A P40,000 40% P100,000
B 45,000 30% 150,000
C 54,000 30% 180,000
2. Determine the priority of payments to partners.
A B C
Loss absorption balance P100,000 P150,000 P180,000
Priority I - to C
(Excess of loss absorption potential of C over B) - - (30,000)

Balances 100,000 150,000 150,000
Priority II - to B and C
(Excess of loss absorption potential of B and C) - (50,000) (50,000)
Balances P100,000 P100,000 P100,000
3. Compute the amount of cash to be paid to the partners under each priority.
Excess Loss x Profit and Loss = Cash Payments

A(40%
Absorption Potential Share Percentage ) B(30%) C(30%) Total
Priority I - to C P30,000 30% - - P9,000 P9,000
Priority II - to B and C
P15,00
To B 50,000 30% - 0 30,000
To C 50,000 30% - - 15,000 -
P15,00
0 0 24,000 39,000
Note: Any amount in excess of P39,000 available for cash distribution is paid to the partners according
to their profit and loss sharing agreement.
Illustration 5-9 Below shows the completed cash distribution program made after applying the
preceding procedures.
Illustration 5-9
A, B and C
Cash Distribution Program
July 1, 2016
Balances Cash Payments

A B C A(40%) B(30%) C(30%) Total
Loan balances 4,000
Total Interest P40,000 P45,000 P54,000
P100,00 P150,00
Loss Absorption Potential 0 0 P180,000
Priority I - to C -30,000 P9,000 P9,000
P150,00
100,000 0 P150,000
Priority II - to B and C -50,000 -50,000 P15,000 P15,000 P30,000
P100,00 P100,00 P124,00
0 0 P100,000 P15,000 0 P39,000
Any amount in excess
of P39,000 40% 30% 30% 100%
The information provided by the cash distribution program may be summarized as follows:
1. The first P9,000 available for distribution to partners should be paid to C.
2. The next P30,000 should be paid to B and C in the ratio of 30:30.
3. Any amount in excess of P39,000 should be paid to A, B and C in the profit and loss ratio of
40:30:30.
Illustration. To illustrate the installment payments based on the above cash distribution program,
assume cash is available to the partners as follows:
August P33,000
September 43,000
The computation of installment payments at the end of each month are presented below:
August Distribution:
Cash A B C
Available for distribution P33,000
Priority I - C -9,000 P9,000
Priority II - to B and C: 30:30 -24,000
To B: 3/6 x P24,000 P12,000
To C: 3/6 x P24,000 - - 12,000
Payments to partners 12,000 P21,000
September Distribution:
Cash A B C
Available for distribution P43,000
Priority II - to B and C: 30:30
(P30,000 - P24,000) -6,000
To B : 3/6 x P6,000 P3,000
To C : 3/6 x P6,000 P3,000
Excess - to A, B and C; 40:30:30 -37,000
To A: 40% x P37,000 14,800
To B: 30% x P37,000 11,100
To C: 30% x P37,000 - - 11,100
Payments to partners 14,800 14,100 14,100

Assume the partners of Bankrupt Company agree to liquidate their partnership on July 1, 2016 because
the company is having financial difficulties. The partner’s capital, loan account balances and profit and
loss ratio before liquidation are:
Capital Loan P&L Ratio
Burgos P36,000 Cr. P14,000 Cr. 20%
Corpuz 28,000 Cr. 4,000 Dr* 20%
Diaz 12,000 Cr. 4,000 Cr. 50%
Ebro 30,000 Cr. - 10%
*Loan to Corpuz from Bankrupt Company
The partners and the creditors have agreed that Ebro will act as the administrator. Ebro anticipates that
it will take approximately three months to complete the liquidation. The partners request that available
cash be distributed to them at the end of each month. Consequently, Ebro prepares the Cash
Distribution Program below to ensure reasonable cash payments to partners.
Illustration 5-10
Bankrupt Company
Cash Distribution
Program
July 1, 2016
Balances Cash Payments

Burgos Corpuz Diaz Ebro Burgos Corpuz Diaz Ebro
Add Loan balances 14,000 (4,000) 4,000 -
Total Interest 50,000 24,000 16,000 30,000

Profit and Loss ratio 20% 20% 50% 10%
Loss Absorption Potential 250,000 120,000 32,000 300,000

Priority I - to Ebro - - - (50,000) P5,000
Balances 250,000 120,000 32,000 250,000

Priority II - to Ebro
and Burgos, 1:2 130,000 - - 130,000 P26,000 13,000
Balances 120,000 120,000 32,000 120,000

Priority III - to Ebro, Burgos
and Corpuz 1:2:2 (88,000) (88,000) - (88,000) 17,600 17,600 - 8,800
Balances P32,000 P32,000 P32,000 P32,000 P17,600 P17,600 - P26,800

Further Cash Distribution
P/L ratio
On July 1, 2016, the company’s asset and liabilities are:

Cash P 6,000
Non-cash assets 244,000
Liabilities 130,000
Ebro expects that the realization of non-cash assets will be as follows:
July P144,000 net cash proceeds

August 20,000 net cash proceeds
September 20,000 net cash proceeds
The projected payments shown in the next page are based on his plan to set aside P10,000 cash at the
end of July and P4,000 at the end of August as a reserve for future unrecorded liabilities. By the end of
September, Ebro expects that all liquidation expenses and unrecorded liabilities will be known so that a
final distribution plan can be made.
Payee Jul-31 Aug-31 Sep-30

Creditors P130,000 P - P -
Burgos 3,333 17,333 11,733
Corpuz - - 6,400
Diaz - - -
Ebro 6,667 8,667 5,867
Total expected payment P140,000 P26,000 P24,000
Cash withheld P10,000 P4,000 -
The following events took place during the three month liquidation of the company:
Cash Realized Net of Book Values of Assets Unrecorded
Month Liquidation Expenses Realized Liabilities
July P136,000 P180,000
August 22,000 18,000 P8,000
September 20,000 46,000
During the month of August, Diaz contributed P5,000 to the partnership to partially cover his capital
deficiency. He was unable to make any further contribution.
The Statement of Partnership Liquidation is presented in Illustration 5-11. Analysis of the statement is
to be done together with Illustration 5-12.
Illustration 5-12
Schedule of Safe Payments
Burgos Corpuz Diaz Ebro
20% 20% 50% 10%
July Installment
Capital balances before cash distribution P27,200 P29,200 P(10,000) 25,600
Add Loan Balances 14,000 (4,000) 4,000
Total interest 41,200 15,200 -6,000 25,600
Possible loss, (P64,000 + P10,000) (14,800) (14,800) (37,000) (7,400)
Balances 26,400 400 (43,000) 18,200

Additional loss to Burgos, Corpuz & Ebro
2:2:1 (P43,000) (17,200) (17,200) 43,000 (8,600)
Balances 9,200 (16,800) -0- 9,600
Additional loss to Burgos and Ebro,
2:1 (P 16,800) (11,200) 16,800 -0- (5,600)
Balances (2,000) -0- -0- 4,000
Additional loss to Ebro 2,000 (2,000)
Payment to partners -0- -0- -0- 2,000
August Installment
Capital balances before cash distribution P26,400 P18,400 P(7,000) P23,200
Add Loan Balances 14,000 (4,000) 4,000
Total interest 40,400 14,400 (3,000) 23,200
Possible loss, (P46,000 + P4,000) (10,000) (10,000) (25,000) (5,000)
Balances 30,400 4,400 (28,000) (18,200)
Additional loss to Burgos, Corpuz & Ebro
2:2:1 (P28,000) (11,200) (11,200) (28,000) (5,600)
Balances 19,200 (6,800) -0- 12,600
Additional loss to Burgos and Ebro,
2:1 (P 6,800) (4,533) 6,800 (2,267)
Payment to partners P14,667 -0- -0- P10,333
Chapter 6
Corporations in Financial Difficulty: Liquidation
Consequently, assets are classified into three categories as follows:
1. Assets pledged to fully secured creditors. Certain assets may be pledged as security for a
particular liability, and the estimated realizable value of the assets equals or exceeds the amount
of the liability. Such assets may also yield resources to cover unsecured liabilities. The building
with an estimated realizable of P3,000,000, which secures a P2,000,000 mortgage liability, is an
example of an asset pledged to a fully secured creditor. After the mortgage is paid, P1,000,000
remains for unsecured creditors.
2. Assets pledged to partially secured creditors. Other assets that are pledged as security for a
particular liability and the realizable value of the assets is less than the amount of liability.
Partial payment of the liability will utilize the entire asset value; nothing will be left for the
unsecured liabilities. The equipment with an estimated realizable value of P30,000, which
secures a P50,000 note payable, is an example, of an asset pledged to a partially secured
creditor.
3. Free Assets. Assets that is not pledged as security for any particular liability, and thus available
to meet the claims of priority liabilities and unsecured creditors. Free assets also include the
value of assets pledged to fully secured creditors in excess of the related liability. In example
No. 1, P1,000,000 of the value of the building is included as free assets.
The liabilities of the company are classified into four categories and listed in parallel fashion on the
next page.
1. Unsecured liabilities with priority. When creditor has no lien on any specific assets of the
debtor corporation, but its claims rank ahead of other unsecured liabilities in order of payment,
the claims are considered unsecured liabilities with priority. These liabilities, in order to priority
are:
a. Administrative expenses of the receiver.
b. Unpaid employee’s salaries and wages, and benefit plans.
c. Taxes.
2. Fully secured creditors. For these liabilities, the creditor has a lien on specific assets, whose
estimated realizable value equals or exceeds the amount of the liability. For example, a bank
holds a P2,000,000 mortgage on a building of a debtor corporation, and the building has an
estimated realizable value of P3,000,000. The mortgage is, therefore, fully secured, and the bank
is referred to as a fully secured creditor.
3. Partially secured creditors. In some cases, the creditor has a lien on specific assets but the
estimated realizable value of those assets is less than the amount of the liability. For example, a
finance company holds a P50,000 note secured by equipment of a debtor corporation, but the
equipment has an estimated realizable value of only P30,000. This note is partially secured, and
the finance company is referred to as partially secured creditor.
4. Unsecured creditors. All other liabilities for which the creditor has no lien on any specific
assets of the debtor corporation are unsecured. This includes the unsecured portion of the
liability to partially secured creditors. In the example above, there is a note payable to the
finance company for P50,000 secured by the equipment worth P30,000; the difference of
P20,000 is added to the unsecured liabilities.
Format of the Statement of Affairs
Illustration 6-1
No Fear Corporation
Statement of Affairs
Date
Available for
Estimated Unsecured
Book Values Assets Realizable Values Creditors
Pledged to fully secured creditors:
Pxx (list) Pxx
Less: Liabilities to fully secured creditors xx Pxx
Pledged to partially secured creditors:
xx (list) Pxx
Free assets:
xx (list) xx xx
Total free assets xx
Less: Creditors with priority xx
Net free assets xx
Estimated deficiency (to balance) xx
Pxx Pxx
Book Secured and Unsecured Nonpriority

Values Liabilities and Stockhlders' Equity Priority Claims Liabilities
Liabilities with priority:
Pxx (list) Pxx -
Fully secured creditors:
xx (list) xx -
Partially secured creditors:
xx (list) xx
Less: Value of pledged assets xx Pxx
Unsecured creditors:
xx (list) xx
xx Stockholders' equity -
Pxx Pxx
Statement of Affairs Illustrated

To illustrate the preparation of this statement, assume that the No Fear Company has experienced
severe financial difficulties in recent times and is currently insolvent. The company officials are trying
to decide whether to seek liquidation, reorganization or debt restructuring. Consequently, they have
asked their accountant to produce a statement of affairs to assists them in formulating an appropriate
strategy. Statement of financial position for No Fear, prepared as if the company were a going concern,
is presented below:
Illustration 6-2
No Fear company
June 30, 2016
ASSETS
Current assets
Cash P2,000
Marketable securities 15,00
Accounts receivable 23,000
Inventory 41,000
Prepaid expenses 3,000 P84,000
Property and equipment (net)
Land 100,000
Building 110,000
Equipment 80,000 290,000
Intangible assets 15,000
Total assets P389,000
LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Notes payable (secured by inventory) P75,000
Accounts payable 60,000
Accrued expenses 18,000 P153,000
Long-term liabilities:
Notes payable (secured by lien on land and building) 200,000
Stockholders' equity
Capital stock 100,000
Retained earnings (deficit) (64,000) 36,000
Total liabilities and stockholders' equity P389,000
Estimated Amounts to Be Recovered by Each Class of Creditors

Referring to the statement of affairs in Illustration 6-3, the accountant for the No Fear Company may
prepare the summary of estimated amounts to be recovered by each class of their creditors as shown
below:
No Fear Company
Estimated Amounts to Be Recovered by Creditors
June 30,2016
Estimated
Class of Creditors Total Claims Computations Recovery
Unsecured with priority P35,000 100% P35,000
Fully secured 205,000 100% 205000
Partially secured 75,000 P43,000+(P32,000x60%) 62,200
Unsecured without priority 63,000 60% 37,800
Totals P378,500 P340,500
Illustration 6-3
No Fear Company
Statement of Affairs
June 30, 2016
Estimated
Realizable Available for
Book Values Assets Values Unsecured Creditors
Pledged with fully secured creditors:
P120,000 Land and building P231,000
Less: Notes payable (long term) (200,000)
Interest payable (5,000) P26,000
Pledge with partially secured
creditors:
41,000 Inventory P43,000 0
Free assets:
2,000 Cash P2,000
15,000 Marketable securities 20,000
0 Dividends receivable 500
23,000 Accounts receivable 12,000
3,000 Prepaid expenses 1,000
80,000 Equipment 32,000
15,000 Intangible assets 0 67,500
Total free assets 93,500

Less: Liabilities with priority (see a) (36,500) b
Net free assets 57000 c

Estimated deficiency (Squeeze Figure) 38000 d
P389,000 P95,000
Secured and
Priority Unsecured
Book Values Liabilities and Stockholders' Equity claims Nonpriority Liabilities
Libilities with priority:
P -0- Administrative expenses P21,500
12,000 Salaries payable 12,000
3,000 Payroll taxes payable 3,000
Total 36500 (a)
Fully secured creditors:
200,000 Notes payable (Long Term) 200,000
-0- Interest payable 5,000
Total 205,000
Partially secured creditors:
75,000 Notes payable 75,000
Less: Inventory (43,000) P32,000
Unsecured creditors
60,000 Accounts payable 60,000
3,000 Accrued expenses 3,000 63,000
36,000 Stockholders' equity
P389,000 P95,000
Accounting and Reporting for Trustee/Receiver

Normally, the trustee opens a new set of accounting records. The assets and liabilities of the debtor
corporation are recorded in the trustee’s books at book values, rather than at their net realizable values.
Contra assets accounts are omitted because they are not necessary in liquidation. These accounting
procedures are used to keep the trustee’s accounting records as simple as possible.
The reports usually prepared by the trustee are a statement of cash receipts and cash disbursements, and
a statement of realization and liquidation.
Illustration of the accountability Technique
Assume that Manuel Valdez, the trustee in the liquidation of No Fear Company (see Illustration 6-2),
took custody of the assets of No Fear Company on June 30, 2016. The following entry should be
prepared to open the trustee’s books:
Cash 2,000
Inventory 41,000
Prepaid expenses 3,000
Land 100,000
Building 110,000
Equipment 80,000
Notes payable 75,000
Accrued expenses 18,000
Long term notes payable 200,000
Estate equity 36,000
To record custody of assets and liabilities of No Fear Company at book values.
After the assumption of the estate, the trustee records gains, losses, and liquidation expenses directly to
the estate equity account. Any unrecorded assets or liabilities the trustee discovers are likewise
recorded in the estate equity account. All assets acquired and liabilities incurred after the trustee takes
charge of the estate are identified as “new”.
The transactions and events during the first month of No Fear Company’s trusteeship and the related
journal entries to record them in the trustee’s books are illustrated on the next page.
1. The accounting records shown in Illustration 6-2 are adjusted to correct balances as of June 30.
Hence, the dividends receivable and interest payable are recognized.
Estate equity 4,500

Dividends receivable – new 500
Interest payable – new 5,000
2. The trustee expends P7,000 to sell the inventory at a price of P51,000. The net cash is applied to
the notes payable for which the inventory had served as partial security.
Cash 44,000
Inventory 41,000
Estate equity 3,000
Note payable 44,000

Cash 44,000
3. Collection is made of the P500 cash dividend accrued as of June 30. The related investments
reported at P15,000 are then sold for P19,600.
Cash 20,100
Dividends receivable 500
Estate equity 4,600
4. Accounts receivable of P16,000 are collected. The remaining balance is written off as bad debts.
Cash 16,000
Estate equity 7,000
5. The trustee determines that no refund is available from any of the company’s prepaid expenses.
The intangible assets also are removed from the accounting records because they have no cash
value.

Prepaid expenses 3,000
6. The land and building are sold for P208,000 with P205,000 of this money was used to pay off
the secured creditors.
Cash 208,000
Estate equity 2,000
Land 100,000
Building 110,000

Interest payable 5,000
Cash 205,000
7. The equipment is sold for P 42,000 cash.
Cash 42,000
Equipment 80,000
8. Various administrative expenses of P24,900 are paid.

Cash 24,900
After the above entries are entered on the trustee’s books, financial statements are prepared to show the
progress of liquidation and the company’s financial position.
Statement of Cash Receipts and Disbursements.

Cash
Balance, July 1, 2016 P2,000 Notes payable P44,000
Inventory sola 44,000 Notes payable and interest 205,000
Dividends receivable 500 Administrative expenses 24,900
Marketable securities sold 19,600
Land and building sold 208,000
Equipment sold 42,000
P332,10 P273,90
0 0
Balance, July 31, 2016 P58,200
Illustration 6-4 presents the trustee’s statement of cash receipts and disbursements for the period July 1,
to July 31, 2016.
Illustration 6-4
No Fear Company
Statement of Cash Receipts and Disbursements in trusteeship
From July 1 to July 31, 2016
Cash balance, July 1, 2016 P2,000

Add: Cash receipts
Sales of inventory P44,000
Collection of dividends receivable 500
Sale of marketable securities 19,600
Collection of accounts receivable 16,000
Sale of land and building 208,000
Sale of equipment 42,000 330,100
Total 332,100
Less: Cash disbursements
Notes payable (partially secured) P44,000
L/T notes payable and interest (fully secured) 205,000
Administrative expenses (priority claim) 24,900 273,900
Cash balance, July 31, 2016 P58,200
Statement of Estate Deficit.

Estate Equity (deficit)
Adjustments for dividends and interest P4,500 July 1, 2016, balance P36,000
Accounts receivable written off 7,000 Inventory gain 3,000
Prepaid expenses and intangible assets 18,000 Marketable securities gain 4,600
Land and building loss 2,000
Equipment loss 38,000
Administrative expenses 24,900
P94,400 P43,600
July 31, 2016, balance P50,800
The statement of estate deficit for No Fear Company is presented below:
Illustration 6-5
No Fear Company Trusteedhip
Statement of Estate Deficit
From July 1 to July 31, 2016
Estate equity, July 1, 2016 P36,000
Adjusted for dividends and interest -4,500
Adjusted balance 31,500
Net gain (loss) on realization:
Accounts receivable written off P(7,000)
Prepaid expenses and intangible assets written off -18,000
Land and building -2,000
Equipment -38,000
Inventory 3,000
Total -57,400
Administrative expenses paid 24,900 -82,300
Estate deficit, July 31, 2016 P(50,800)

Illustration 6-6
No Fear Company in Trusteeship
Assets
Cash P58,200
Total P58,200
Liabilities and Estate Deficit
Notes payable P31,000
Total Liabilities 109,000
Less: Estate Deficit 50,800
Total P58,200
Statement of Realization and Liquidation. This statement shows a complete record of the
transactions of the receiver for a period of time. Its structure is similar to a T account, and it is
composed of three elements: asset transactions, and income/loss transactions. The structure of T
accounts for assets and liabilities with hypothetical figures appears as follows:
Asset Account
Ending balance 100 70 Decreases
Increases 50 80 Ending balance
150 150
Liability Account
Decreases 60 40 Beginning balance
Ending balance 30 50 Increases
90 90
The above structure is to be applied to the activities of the trustee or the receiver. The first duty of the
receiver is to realize the assets, that is, to convert the non cash assets into cash so that creditors may be
paid. The process of realization may be done is several ways. Some assets may be realized by normal
operations, such as the continuing collections of receivables from customers. Other assets may be
realized by sale. During realization, gains and losses on asset sales may occur, expenses may be
incurred, and revenues may be earned. The realization activities may be presented in T account format
as follows:
Assets (Except Cash)

Assets to be realized Assets realized-Decreases
Assets acquired-Increases Assets not realized
Income Effect of Realization

Expenses and losses Revenues and gains
The second task of the receiver is to liquidate the liabilities, that is, to make full or partial settlement
with the creditors. Again, gains or losses may occur in the process of liquidation, as may expenses or
revenues. The liquidation activities may also be presented in T account format as follows:
Liabilities
Liabilities Liquidated Liabilities to be liquidated
Liabilities not liquidated Liabilities incurred

Income Effect of Liquidation
Expenses and losses Revenues and gains
The traditional format of the statement is presented in Illustration 6-7.
Illustration 6-7
Statement of Realization and
Liquidation
July 1 to July 31, 2016
ASSETS
Assets to Be Realized: Assets Realized:
Marketable securities P15,000 Marketable securities P19,600
Accounts receivable 23,000 Accounts receivable 16,000
Inventory 41,000 Inventory 44,000
Prepaid expenses 3,000 Prepaid expenses 0
Land 100,000 Land and building 208,000
Building 110,000 Equipment 42,000
Equipment 80,000 Intangible assets 0
Intangible assets 15,000 Dividends receivable 500
Assets Acquired (new) Assets Not Realized:

Dividends receivable P500 None
LIABILITIES
Liabilities Liquidated: Liabilities to Be Liquidated:
Notes payable P44,000 Notes payable P75,000
Long term notes payable 200,000 Accounts payable 60,000
Interest payable 5,000 Accrued expenses 18,000
Liabilities Incurred:
Liabilities Not Liquidated: Interest payable P5,000
Total P109,000
INCOME OR LOSS AND SUPPLEMENTARY ITEMS
Supplementary expenses: Supplementary Revenues:
Administrative expenses 24,900 Net loss 82,300
P770,4000 P770,400
Alternative Format of Statement of Realization and Liquidation
The traditional statement of realization and liquidation presented in Illustration 6-7 was a complex and
not too understandable accounting presentation. A form that should be more useful to the parties
concerned than the traditional statement is presented below:
Illustration 6-8
Statement of Realization and
Liquidation
For the Month Ended July 31,
2016
Estate Equity, June 30,2016 P36,000

Adjustments:
Dividends receivable P500
Interest payable (5,000) (4,500)
Adjusted balance 31,500

Assets Realized:
Book Values, Realization
June 30 Proceeds Gain(loss)
Accounts receivable P23,000 P16,000 P(7,000)
Inventory 41,000 44,000 3,000
Marketable securities 15,000 19,600 4,600
Land and building 210,000 208,000 (2,000)
Equipment 80,000 42,000 (38,000)
Prepaid expenses 3,000 -0- (3,000)
Intangible assets 15,000 -0- (15,000) (57,400)
Liabilities Liquidated:
Interest payable 5,000
Total P249,000
Administrative expenses paid (24,900)
Estate deficit, July 31, 2016 P(50,800)
Closing the Books of the Trustee.
The total remaining liabilities of P109,000 (all unsecured creditors) receive P.5340 on the peso
(P58,200/109,000) in final settlement of their claims. Entries to record the cash distribution are as
follows:
Notes payable (P31,000 x .5340) 16,550

Accounts payable (P60,000 x .5340) 32,040
Accrued expenses (P18,000 x .5340) 9,610
Cash 58,200
To record payment of the unsecured creditors.
The estate is now fully administered by the trustee. The trustee makes the following entry to close the
books of No Fear Company.

Estate deficit 50,800
To close the trustee’s books.
Chapter 7
Corporations in Financial Difficulty: Reorganization and Troubled Debt Restructuring
Reorganization
Illustration of Reorganization
Assume that Ray Company filed a petition for reorganization, rather than for liquidation, on June 30,
2016. The Statement of Financial Position of the company before reorganization is presented in the
next page.
Illustration 7-1
Ray Company
June 30, 2016
ASSETS
Current assets P50,000
Land 100,000
Building 400,000
Equipment 250,000
Total assets P800,000

LIABILITIES
Accounts payable P160,000
Note payable (due in 3 years) 300,000
Bonds payable (due in 5 years) 600,000
1,110,000
STOCKHOLDERS' EQUITY
Common stock, 50 shares with a P1 par value P50,000
Additional paid in capital 40,000
Retained earnings (deficit) -400,000 -310,000
Total Liabilities and stockholders' equity P800,000
Additional information
The plan of reorganization which was approved by stockholders and creditors and confirmed by SEC,
included the following:
1. Assets. The company’s land has a market value of P120,000; the building is worth P500,000.
Other assets are worth their book values. The reorganization value of the company’s assets is
assumed to be P1,000,000.
2. Liabilities. Out of the total accounts payable, P100,000 must be paid in full. The balance of the
accounts payable and accrued expenses will be converted into one-year notes payable of
P70,000, paying interest of 10 percent. The P300,000 note payable on the balance sheet will be
converted into a 10-year, 8 percent note of P100,000. These creditors will get 20,000 shares of
stock that is to be turned in to the company by the common stockholders. Finally, the P600,000
bonds payable will be converted into 8- year, 9 percent notes totaling P 430,000. The
bondholders will also get 15,000 shares of common stock turned in by the current owners.
3. Stockholders’ Equity. The owners of the common stock will return 70 percent of their stock
(35,000 shares) to the company to be issued as specified above. The reorganization value of the
assets is P1,000,000 and the debts of the company after the proceeding total P700,000 (P100,000
+P70,000 +P100,000+P430,000). Thus, stockholder’ equity must be the P300,000 difference.
Since shares with a P50,000 par value would still be outstanding, additional paid in capital is
adjusted to P250,000.
The journal entries below correspond to the provisions of the reorganization plan outlined above:
(1) Land 20,000

Building 100,000
Reorganization value in excess of
Identifiable assets 80,000
To adjust asset accounts to fresh start accounting and to recognize excess value as an intangible
asset subject to amortization as computed below:
Reorganization value of assets P1,000,000
Market value of assets 920,000
Excess P 80,000
(2) Accounts payable 60,000

Note payable (1 year) 70,000
Gain on debt discharge 40,000
To convert liabilities to a one-year note per reorganization plan.
(3) Note payable (3 years) 300,000

Note payable (1 year) 100,000
Common stock (20,000 shares) 20,000
Additional paid in capital
(40% of P250,000) 100,000
To record exchange with gain recorded for difference between book value of old note and the
amount recorded for new note and shares of stock.
Bonds payable 600,000
Note payable (8 years) 430,000
Common stock (15,000 shares) 15,000
Additional paid in capital
(30% of P250,000) 75,000
To record exchange with gain recorded for difference between book value of old bonds and the
amount recorded for new notes and share of stock.
(4) Common stock 35,000

To record shares of common stock returned to the company by owners as part of the
reorganization plan.
(5) Additional paid in capital 200,000

Retained earnings (deficit) 400,000
To adjust additional paid in capital balance to correct amount, close the gain account, and
eliminate deficit balance.
After posting these entries, Ray Company emerges from financial difficulty with the following
reorganized statement of financial position.
Illustration 7-2
Ray Company
June 30, 2016
ASSETS
Current assets P50,000
Land 120,000
Building 500,000
Equipment 250,000
Reorganization value in excess of identifiable assets 80,000
Total P1,000,000

Accounts payable P100,000
Note payable (due in 1 year) 70,000
Common stock, 50 shares with a P1 par value 50,000
Total Liabilities and stockholders' equity P1,000,000
In the above reorganized statement of financial position, take note that:
1. Its assets are presented at their fair market value.

2. Its debts are equal to the present value of the future cash payments.
3. No deficit balance.
TROUBLED DEBT RESTRUCTURING
Illustration of troubled Debt Restructuring
The following illustrations demonstrates the accounting for various forms of a troubled debt
restructuring. Cookie Corporation is financially distressed and is evaluating a variety of restructuring
alternatives. Following are observations about Cookie Corporation:
1. On December 31, 2016, the company has an unsecured current liability of P30,000 to the
Creditor Company, on which P3,000 interest has been accrued and is unpaid.
2. Cookie Corporation has been negotiating with Creditor Company to restructure the current debt
of P33,000 including accrued interest. The three alternatives are presented below:
Alternative 1: Payment of Cash in Full Settlement of Debt. The first alternative is the immediate
transfer of P27,000 in full settlement of the book value of the debt. If the creditor agrees to the
restructuring, the debtor recognizes a restructuring gain of P6,000 (P33,000 – P27,000) and the creditor
recognizes a restructuring loss in the same amount.
The entry required on December 31, 2016 for Cookie Corporation, the debtor company, is:

Accrued interest payable 3,000
Cash 27,000
Gain on restructuring of debt 6,000
To record restructuring and settlement of debt.
The gain is now typically reported as part of continuing operations.
Alternative 2: Payment of Noncash Assets in Settlement of Debt. In this alternative, Cookie

Corporation agrees to transfer inventory with a book value of P45,000 and a fair value of P26,000 to
Creditor Company in full settlement of the P33,000 debt. A restructuring difference of P7,000
(P33,000-P26,000) is to be recognized by Cookie Corporation. When noncash assets are transferred in
a restructuring plan, the assets must be revalued to their fair values. A gain or loss on the disposal of
assets is also recognized by the debtor. Therefore, Cookie Corporation recognizes a loss on disposal of
its inventory for the P19,000 decline in its inventory from its book value of P45,000 to its fair value of
P26,000.
The entry made by Cookie Corporation on December 31, 2016 is:

Loss on disposal of inventory 19,000
Inventory 45,000
To record restructuring and settlement of debt
Alternative 3: Modification of Terms.
1. Reduction of the stated interest rate for the remainder of the original debt.
2. Extension of the maturity date of the original debt at a lower rate of interest.
3. Reduction of part of the face amount of the original debt.
4. Reduction in the accrued interest.
Case A: Carrying Value of Debt Greater than Modified Total Future Cash Flows-Debtor Gain
Recognized. Using the same data for Cookie Corporation. Assume that on December 31, 2016, the
entities agree to the following modification of terms on the debt contract:
a. Forgive accrued interest of P3,000
b. Reduce the interest rate from 10 percent to 5 percent
c. Extend the maturity for 1 additional year to December 31, 2017.
The restructuring difference as of the date of the modification is computed by the debtor corporation as
follows:
Carrying value of the debt:

Principal P30,000
Interest 3,000 P33,000
Total future estimated cash flows:

Future principal P30,000
Future contractual interest
(P30,000 x .05 x 1 year) 1,500 (31,500)
Restructuring difference P1,500
The entry required for Cookie Corporation, the debtor, on December 31, 2016, the date of the
modification of terms agreement is:

Restructured debt payable 31,500
To record restructuring of terms of debt.
When Cookie Corporation repays the debt on December 31, 2017, it makes the following entry:
Restructured debt payable 31,500

Cash 31,500
To record payment of restructured debt.
Case B: Carrying Value of Debt Less than Modified Total Future Cash Flows: No Gain
Recognized By the Debtor. Cookie Corporation and Creditor Company agree to the following
modification of terms for the debt of P30,000 and P3,000 of accrued interest:
1. Forgive P500 of accrued interest.

2. Reduce contracted interest from 10 percent to 5 percent.
3. Extend maturity for 1 additional year December 31, 2017.
Carrying value of the debt:

Principal P30,000
Interest 3,000 P33,000
Total future estimated cash flows:

Future principal P30,000
Remaining accrued interest not forgiven 2,500
Future contractual interest
(P30,000 x .05 x 1 year) 1,500 (34,000)
Restructuring difference P(1,000)

Notes payable (10%) 30,000
Restructured debt payable (5%) 33,000
To record restructuring of terms of debt
Interest expense 1,000

Restructured debt payable (5%) 33,000
Cash 34,000
To record payment of debt and interest expense
Chapter 8
Installment Sales
Methods of Gross Profit Recognition on Installment Sales
The determination of the net income on installment sales is one of the more complicated problems in
installment sales accounting because the amount of recoveries and the related costs and expenses are
seldom known in the period when the sale is made. Accounting procedures should be developed for a
reasonable matching of costs and revenues. Two general approaches may be used in the recognition of
gross profit on installment sales (1) the gross profit (excess of sales price over cost of sales) is
recognized at the time of sale; and (2) the gross profit is recognized in installments over the period of
the contract on the basis of cash collections.
Gross Profit is Recognized at the Time of Sale. Many companies treat a sale on installment in exactly
the same way as they treat any other sale on account. The Account Receivable account is debited and
the Sales account is credited for the full price when the sale is made. This treatment is not different
from that employed for regular sales on credit. Gross profit is recognized at the period of sale – the
point at which goods have been delivered to the customers and the definite amount of receivables has
been acquired.
Gross Profit is Recognized in the Period in which Cash is Collected. This is a special method of
accounting for installment sales whereby gross profit is recognized in the periods in which the
installment receivables are collected instead of in the periods in which receivables are created. The
amount of cash collections then becomes the basis for the gross profit recognition. Under this approach,
several alternative procedures which focus primarily on the recognition of gross profit may be applied,
namely:
Cost Recovery Method. Under this method gross profit is not recognized until collections are equal to
the amount of cost of goods sold.
Gross Profit Realization Method. Under this method, the first collections are regarded as realization
of gross profit.
Installment Method. Under this method, cash collection is regarded as a partial recovery of cost and a
partial realization of profit in the same proportion that these two elements are present in the original
selling price.
The Installment Method of Accounting
Illustration. Assume that on March 31, 2016 an installment sale of property costing P60,000 was
made. The selling price was P100,000. A down payment of P20,000 was required, the balance payable
in forty monthly payments of P2,000 at the end of each month.
The gross profit on this sale is P40,000 (P100,000 – P60,000) hence, the gross profit rate is 40%
(P40,000 ÷ P100,000) of sales price. Using the installment method, the computation of annual realized
gross profit and deferred gross profit are shown in the next page.
Illustration 8-1
Realized Gross Profit Deferred Gross Profit
Gross Profit Receivable Gross Profit
Year Collections x Rate = RGP Balances,end x Rate = DGP
2016 P38,000* 40% P15,200 P62,000 40% P24,800
2017 24,000 40 9,600 38,000 40 15,200
2018 24,000 40 9,600 14,000 40 5,600
2018 14,000 40 5,600 - -
P100,000 P40,000 P144,000 P45,600
*P20,000 down payment plus P18,000 (P2,000 x 9 months) installment collections.
Interest on Installment Contracts Receivable
The interest charged to customers may be computed using one of the following plans:
1. Equal periodic payments from customer, with a portion of each payment representing interest on
the outstanding balance of the principal and the remainder representing a reduction from the
aforementioned balance.
2. Interest computed each month on the outstanding principal balance during the month.
3. Interest computed on the installment payment.
Illustration. To illustrate the first plan (equal periodic payments) of computing interest, assume the
following data:
Installment sale, June 30, 2016 (cost, P42,000) P60,000.00

Cash down payment 20,000.00
Balance payable in six monthly installment plus 36 percent interest P40,000.00
Monthly installment P7,383.90
Note: Sometimes, the amount of periodic payments is not given henceit must be computed, as follows:
Original Balance of Installment Contracts Receivable

Periodic Payment = Present Value of Annuity of 1 for 6 period at 3%
P40,000
= 5.417191
= P7,383.90
From the preceding information, six monthly payments of P7,383.90 will fully settle the installment
contracts receivable of P40,000 plus the 3 percent interest each month. This is shown in the table
below.
(1) (2) (3) (4)

Installment
Cash Interest Contracts
Collection Income Receivable Credit Outstanding
Date (Debit) (Credit) (1-2) Principal (4-3)
June 30 P60,000.00
30 P20,000.00 P20,000.00 40,000.00
July 31 7,383.90 P1,200.00 6,183.90 33,816.10
Aug 31 7,383.90 1,014.48 6,369.42 27,446.68
Sept 30 7,383.90 823.40 6,560.50 20,886.18
Oct 31 7,383.90 626.59 6,757.31 14,128.87
Nov 30 7,383.90 423.87 6,960.03 7,168.84
Dec 31 7,383.90 215.06 7,168.84 0.00
64,303.40 4,303.40 60,000.00
*Computation of Interest Income:
July 31 : ₱40,000.00 x 3% = ₱1,200.00

Aug 31 : ₱33,816.10 x 3% = ₱1,014.48
Sept 30 : ₱27,446.68 x 3% = ₱823.40
Oct 31 : ₱20,886.18 x 3% = ₱626.59
Nov 30 : ₱14,128.87 x 3% = ₱423.87
Dec 31 : ₱7,168.84 x 3% = ₱215.06
Under the installment method, only the portion of the payment applied to the principal (Column 3) is
considered in the computation of realized gross profit, as shown below.
Total collections, June 30 – Dec. 31 (column 1) P64,303.40

Less Total interest income (column 2) 4,303.40
Collections applying to principal (Column 3) P 60,000.00
Multiply by Gross Profit rat:
Gross profit = P60,000 – P42,000 = P18,000

Installment Sale P60,000 P60,000 30%
Realized gross profit on the contract P18,000.00
Assume the following data summarizing the transactions for two years of Fely Sales Corporation:
2015 2016
Sales
Regular (on account) P250,000 P230,000
Installment
Down Payment 20,000 24,000
Balance (payable within 3 years at the start of each
month, apply 36% interest for 3 years) 80,000 96,000
Cost of Sales:
Regular 120,000 130,500
Installment 60,000 69,600
Collections:
Accounts receivable 120,000 130,500
Installment contract receivable
2015 Sales:
Applying to interest 26,000 18,000
Applying to principal 19,000 26,000
2016 Sales:
Applying to interest 31,000
Applying to principal 22,000
Operating expenses paid 50,000 65,000
Accrued interest receivable, December 31
2015 Sales 1,800 1,020
2016 Sales 2,250
The entries of Fely Sales Corporation relating to regular and installment sales for 2105 and 2016,
assuming the use of perpetual inventory system, are shown below and in the following pages.
Illustration 8-3
January – December 2015
(1) To record regular sales

Accounts Receivable 250,000
Sales 250,000
(2) To record installment sales.
Cash 20,000
Installment contracts receivable-2015 80,000
Installment Sales 100,000
(3) To record cost of sales.

Cost of Sales 120,000
Cost of Installment Sales 60,000
Merchandise Inventory 180,000
Note: if the periodic inventory system is used
Shipments on Installments Sales 60,000
(4) To record collection of account receivable
Cash 120,000
(5) To record collection of installment contracts receivable
Cash 45,000
Installment Contract Receivable, 2015 19,000
Interest Income 26,000
(6) To record payment of operating expenses
Operating expenses 50,000
Cash 50,000
(7) Adjusting and closing entries, December 31, 2015
(a) To recognized accrued interest receivable for December 31, 2015
Accrued Interest Receivable 1,800
(b) To set up deferred gross profit on 2015
Deferred Gross Profit, 2015 40,000
Gross profit rate = P40,000 ÷ P100,000 = 40%
(c) To record realized gross profit on installment sales:
Deferred Gross Profit 15,600
Realized Gross Profit 15,600
Computation:
Collections applying to principal P39,000
Multiply by gross profit rate 40%
Realized gross profit P 15,600
(d) To close realized gross profit account.
Income Summary 15,600
(e) To close other nominal accounts
Sales 250,000
Cost of sales 120,000
Income summary 107,800
(f) To close result of operations for 2015:

Retained Earnings 123,400
January – December, 2016
(1) To reverse accrued interest receivable.
(2) To record regular sales.
Sales 230,000
Cash 24,000
Installment Contracts Receivable 2016 96,000
(5) To record collection of accounts receivable.
Cash 130,500
(6) To record collection of installment contracts receivable.
Cash 97,000
Installment Contracts Receivable, 2015 26,000
(7) To record payment of operating expenses.
Operating Expenses 65,000
Cash 65,000
(8) Adjusting and closing entries, December 31, 2016
(a) To recognize accrued interest receivable for December 31, 2016
(b) To set up deferred gross profit on 2016 sales.
Gross profit rate = P50,000 ÷ 120,000 = 42%
(c) To record realized gross profit on installment sales.
Computations:
Collections Gross Profit Realized

Applying to Principal x Rate = Gross Profit
2015 Sales: P26,000 40% P10,400
2016 Sales: 46,000 42 19,320
Total P29,720
(d) To close realized gross profit account.

(e) To close other nominal accounts.
Sales 230,000
Operating Expenses 65,000
(f) To close result of operations in 2016.
Retained Earnings 114,790
Illustration. Assume that Felipe Company sells merchandise for cash, on short-term credit and on the
installment basis. The company employs the periodic inventory method in determining costs. At the
end of 2016, the following information are available:
Cash sales P150,000

Charge sales 300,000
Installment sales 750,000
Merchandise inventory, January 1 120,000
Purchases 725,000
Freight-in 30,000
Repossessed merchandise 35,000
Merchandise inventory, December 31 130,000
Based on the above data, the cost of goods sold to be allocated is computed below:
Merchandise Inventory, January 1 120,000
Add: Purchases P725,000
Freight-in 30,000
Repossessed merchandise 35,000 790,000
Cost of goods available for sale 910,000

Less Merchandise inventory, December 31 130,000
Cost of goods sold P780,000
Case 1. Where no additional facts are known other than the data given above, the cost of goods sold
must be allocated according to the ratio of each type of sales to total sales, as follows:
Type of Sales Amount of Sales Ratio to Total Allocated Cost

Cash P150,000 15/120 P97,500
Charge 300,000 30/120 195,000
Installment 750,000 75/120 487,500
P1,200,000 P780,000
The above allocation is proper if the selling price of the merchandise is the same regardless of the type
of sales. Normally, however, the selling price of the merchandise are not the same for different types of
sales.
Case 2. Assume that the selling prices for charge sales and installment sales of Felipe Company are
higher than cash sales price by 20% and 25%, respectively. The respective sales figures must be
expressed in terms of the same selling price in order to obtain a valid ratio. The allocation of the cost of
goods sold should be based on cash price as presented below:
Type of Sales Amount of Sales Amount Based on Cash Sales Ratio to Total Allocated Cost
Cash P150,000 P150,000 150/1,000 P117,000
Charge 300,000 250,000a 250/1,000 195,000
Installment 750,000 600,000b 600/1,000 468,000
P1,200,000 P1,000,000 P780,000
aP300,000 ÷ 120% = P250,000

bP750,000 ÷ 125% = P600,000
Case 3. Where the mark-up or gross profit percentage on cost price or sales price is known, the
allocation will be simple matter. Assume that Felipe Company’s gross profit rate on selling price is
25% on cash sales, 35% on charge sales, and 37% on installment sales. The allocation of cost of goods
sold is shown below:
Type of Sales Amount of Sales Gross Profit Rate Gross Profit Allocated Cost 1/
Cash P150,000 25% 37,500 P112,500
Charge 300,000 35% 105,000 195,000
Installment 750,000 37% 277,500 472,500
P1,200,000 P780,000
1/ Sales less Gross Profit
DEFAULTS AND REPOSSESIONS
The following procedures to record repossession may be used.

(1) Record the repossessed merchandise in an appropriate inventory account at its fair value
(estimated selling price less reconditioning cost and normal profit margin) at date of
repossession.
(2) Cancel the uncollected installment receivable balance of the defaulted contract.
(3) Write-off the balance of the deferred gross profit relating to the above receivable.
(4) Recognize the resulting gain or loss on repossession.
Illustration. Assume the following data with respect to a default and repossession on April 30, 2016:
Installment contracts receivable, 2016 P2,000

Gross profit rate, 2016 sales 30%
Estimated market value of repossessed merchandise P1,200
The loss on repossession may be computed as follows:
Fair market value of repossessed merchandise P1,200

Less Unrecoverd cost -
Installment contracts receivable P2,000
Less Deferred gross profit (30% of P2,000) 600 1,400
Loss on repossession P(200)
The entry to record the repossession on April 30, 2016, assuming a periodic inventory system, is made
as follows:
Repossessed Merchandise 1,200

Deferred Gross Profit, 2016 600
Loss on Repossession 200
Installment Contracts Rceivable,2016 2,000
Reconditioning costs which relates to repossessed merchandise should be charged to Repossessed

Merchandise account.
When a perpetual inventory system is maintained, repossessed property is debited to Merchandise

Inventory – Repossessed account.
TRADE-INS
Case 1. Trade-in value is equal to actual value. Normally, trade-in value allowed to a customer is the
amount charged to asset traded-in provided the amount is realistic and is indicative of the fair market
value or net realizable value of the item. Net realizable value is the value of the old merchandise trade-
in after the provisions of expected reconditioning expenses cost of disposal and a normal profit upon
it’s resale.
Illustration. Assume that on April 1, 2016, the Motor Sales Company sells a car for an installment
price of P145,000. The car costs P100,000. The customer is allowed a trade-in value of P45,000 for his
old car. He makes a down payment of P40,000 and the balance to be paid in twelve equal installments
is P5,000 each. It is estimated that the old car can be sold for P70,000 after incurring reconditioning
expenses estimated at P11,000. The company usually makes a gross profit of 20 percent on resale.
The computation below shows that the trade-in value is equal to its actual value.
Trade-in value allowed to customer P45,000

Less Net realizable value of merchandise trade-in:
Estimated resale value P70,000
Less: Reconditioning cost P11,000
Normal profit margin (20% of P70,000) 14,000 25,000 45,000
Difference -
The entry to record the sale of the new car is:

Cash 40,000
When the reconditioning expense of P10,000 is actually incurred, it is charged to Merchandise
Inventory – Trade-In.
If the company is using the perpetual inventory system, an additional entry to record cost of sales is
made, as shown below:

Merchandise Inventory – New 100,000
Case 2. Trade-in value is greater than net realizable value.

Illustration. Assume that a stereo component with a cost of P12,000 is sold for P17,000. A used stereo
component is accepted as a trade-in at a valuation of P6,000. The seller expects to spend P250 to
recondition the used merchandise before reselling it for P5,000. The seller expects a 15% profit from
the sale of the used merchandise.
The net realizable value of the merchandise traded-in and the amount of the over allowance may be
computed as follows:
Trade-in value allowed to customer P6,000
Less Net realizable value of merchandise traded-in:
Estimated resale value P5,000
Less: Reconditioning cost expected to be incurred P250
Normal profit margin (15% of P5,000) 750 1,000 4,000
Over allowance P2,000
Assuming the over allowance is charged to Over Allowance on Trade-In account and the perpetual
inventory system is used, the journal entry to record sale of the new merchandise is:

Over Allowance on Trade-In 2,000
The gross profit rate on the installment sale is computed as follows:
Installment Sales P17,000

Less Over allowance 2,000
Net installment slaes 15,000

Less cost of installment sales 12,000
Gross profit P3,000
Gross profit rate (P3,000 ÷ P15,000) 20%
The above rate will be applied in computing the realized gross profit on the basis of collections. The
Value of the merchandise traded-in, P4,000, is viewed as a collection for this purpose.
Assuming the over allowance is treated as reduction from Installment Sales account and the perpetual
inventory system is used, the journal entry to record the sale of the new merchandise is:
Merchandise Inventory – Traded-In 4,000

Installment Contracts Receivable 11,000
Alternative Procedures for Computing Realized Gross Profit for a Series of Years
Illustration. Assume the following account balances on December 31, 2016 before adjustments have
been made:
2016
Jan-01 Dec-31
Installment contracts receivable, 2015 P60,000 P30,000
Installment contract receivable, 2016 70,000
Deferred gross profit, 2015 18,000 17,400
deferred gross profit, 2016 35,000
Installment sales 2016 100,000
Approach 1. Compute the collections for the current year and the gross profit rates.
2015 Sales 2016 Sales

Installment contracts reaceivable, January 1 P60,000 P100,000
Less Installment contract receivable, December 31 30,000 70,000
Total credit for the period 30,000 30,000

Less Credit representing repossession 2,000
Credit representing collections 28,000 30,000

Multiply by Gross profit rate 30% 35%
Realized gross profit P8,400 P10,500
Computation of gross profit rates:

Deferred gross profit, January 1 . P180,000
2015: Installment contracts receivable, January 1 = P60,000 = 30%
Deferred gross profit before adjustment, December 31 P35,000

2016: Installment Sales = P100,000 = 35%
*If there is a repossession in 2016 of goods sold in 2016, the deferred gross profit relating to the unpaid
balance of the repossessed merchandise should be added back to the deferred gross profit balance
before adjustment at the end of the period.
Approach 2. Obtain the difference between the balances of the deferred gross profit before and
after adjustment.
2015 Sales 2016 Sales

Deferred gross profit before adjustment, December 31 P17,400 P35,000
Less Deferred gross profit, December 31 -
(Installment Contracts Receivable x Gross Profit Rate)
2015: P30,000 x 30% 9,000
2016: P70,000 x 35% 24,500
Realized gross profit P8,400 P10,500
Statement of Comprehensive Income

The following type of presentation may be appropriate:
Illustration 8-4
Fely Sales Corporation
Year Ended December 31, 2016
(Installment Sales Not Shown)
Sales P230,000
Cost of goods sold 130,400
Gross profit on regular sales 99,600
Add Realized gross profit on installment sales (schedule 1) 29,720
Total gross profit 129,320
Operating income 64,320
Add interest income 50,470
Net Income P114,790
Schedule 1
Computation of Realized Gross Profit on Installment Sales
2015 2016
Installment sales P100,000 P120,000
Cost of installment sales 60,000 69,600
Gross profit on installment sales P40,000 P50,400
Gross profit rate 40% 42%
Collections in 2016 applying to principal P26,000 P46,000

Realized gross profit in 2016:
2015 installment sales
(40% x P26,000) P10,400
2016 installment sales
(42% x P46,000) 19,320
Total P29,720
On the other hand, if installment sales represent a significant portion of the total sales revenue of the
business, details for each type of sales may be presented separately with such details integrated in a
total column. This approach is presented in Illustration 8-5.
Illustration 8-5
Fely Sales Corporation
Year Ended December 31, 2016
(Installment Sales Shown)
Regular Installment Total
Sales P230,000 P120,000 P350,000
Cost of sales 130,400 69,600 200,000
Gross profit P99,600 50,400 P150,000
Less Deferred gross profit, 2016 31,080 31,080
Realized gross profit, 2016 19,320 118,920
Add Realized gross profit on 2015 installment sales 10,400 10,400
Total realized gross profit P29,720 129,320
Net operating income 64,320
Add interest income 50,470
Net Income P114,790
Statement of Financial Position.
Assets
Current Assets
Installment contracts receivable:
2015 sales P35,000
2016 sales 74,000 P109,000
Liabilities
Noncurrent Liability:
Deferred gross profit, 2015 P14,000
Deferred gross profit, 2016 31,080 P45,080
INSTALLMENT SALES OF REAL ESTATE
Illustration. Assume that on October 1, 2016 Mr. Marco Ruiz sold for P100,000 a parcel of land
acquired for P60,000. The contract of sale called for a down payment of P20,000 and the issuance of
the note for the balance. Payment of the balance entails twenty four monthly installment of P4,723.79
each starting on November 1, 2016. The interest is at the annual rate of 36% and is applied to the
unpaid principal balance.
The table presented below is designed using the date pertaining to the sale of land by Mr. Marco Ruiz.
Date Collections Applying to Interest Applying to Principal Unpaid Principal

Oct. 1 P100,000.00
1 P20,000.00 P20,000.00 80,000.00
Nov. 1 4,723.79 P2,400.00 2,323.79 77,676.21
Dec. 1 4,723.79 2,330.29 2,393.50 75,282.71
Based on the obtained information and the preceding table, the journal entries to record the transactions
during 2016 are as follows:
Oct. 1 Cash 20,000.00

Notes Receivable 80,000.00
Land 60,000.00
Deferred Gain on Sale of Land 40,000.00
To record sale of land.
Nov.1 Cash 4,723.79

Interest Income (3% x P80,000) 2,400.00
To record monthly collection and the recognition
of interest income earned in October
Dec. 1 Cash 7,723.79

Interest Income (3% x P77,676.21) 2,330.29
To record monthly collection and the recognition
of interest income earned in November
31 Adjusting Entries:
(1)
Accrued Interest Receivable 2,258.48
Interest Income (3% x P75,282.71) 2,258.48
To recognize accrued interest for December
(2)
Deferred Gain on Sale of Land 9,886.92
Realized Gain on Sale of Land 9,886.92
To record the realized gain in 2016.
Computation:
Collections applying to principal P24,717.29
Multiply by gross profit rate
(P40,000 ÷ P100,000) 40%
Realized gain P 9,886.92
The journal entries for the remaining years would follow the same pattern as in Illustration 8-7
provided that the buyer makes good of his payments as stipulated in the contract.
Installment Sale of Real Estate by a Dealer
In the preceding example, we dealt with a single sale of land on an installment plan by a non-dealer.
Now we shall consider a sale by a company engaged in buying and selling of real estate.
The accounting procedures that may be followed under the installment method of accounting for retail
sale of land must conform with the following:
1. The entire contract price applicable to the installment sale is reported as revenue on the year the
sale is recorded.
2. Cost of sales including future improvement costs are charged to income of the current
accounting period.
3. Gross profit is deferred and recognized as income if payments of principal are received on the
installment contracts receivable.
4. Interest at the stated contract rate is recorded as income when received, and the balance of the
deferred gross profit is deducted from related installment contracts receivable in the balance
sheet.
5. Disclosure is made of the portion of sales and contracts receivable applicable in the installment
method of accounting.
Illustration: assume the following data for the FilEstate Realty, Inc. in 2016
Total selling price of lots P1,000,000

Total cost of lots:
Acquisition cost P150,000
Improvements costs 450,000 600,000
Gross profit P400,000
Sales made during the year (lot no. 1) P35,000

Collections during the year including interest of P5,000 12,000
The journal entries to record the above transactions are:
(a) To record the acquisition cost and the improvement costs of the lots.
Land P150,000
Improvement Costs 450,000
Cash 600,000
(b) To record installment sales for the period.
Installment Sale 35,000
(c) To record the related cost of installment sales (60% x P35,000)

Land 5,250
Improvement Costs 15,750
Computation:
Total Percentage to Total Allocated Cost

Acquisition cost P150,000 25% P5,250
Improvement costs 450,000 75% 15,750
Total P600,000 100% P21,000
(d) To record collection

Cash 12,000
Installment Contracts Receivable 7,000
Year-en Adjusting Entries
(e) To set up deferred gross profit.

Deferred Gross Profit 14,000
Gross Profit rate = P14,000 ÷ P35,000 = 40%
(f) To recognize realized gross profit.

Computation:
Collection applying to principal P7,000

Multiply by Gross profit rate 40%
Realized gross profit P2,800
Financial Statement Presentation
Presentation of the financial statements of a real estate dealer is similar to that of a company engaged in
installment sales of conventional merchandise except for the composition and presentation of
merchandise inventory in the statement of financial position, as follows:
Assets
Merchandise inventory:
Land P144,750
Improvement costs 434,250 579,000
Chapter 9
Long Term
Construction Contracts
(PAS 11)
Construction Contracts
PAS 11 defines construction contract as contract specifically negotiated for the construction of the asset
or a combination of assets that are closely interrelated or interdependent in terms of their design,
technology or their ultimate purpose or use.
Construction contract may be classified into:

a. Fixed Price Contract. This is a construction contract in which the contractor agrees to a fixed
contract price, or fixed rate per unit of output, which in some cases is subject to cost escalation
clauses.
b. Cost Plus Contract. This is a construction contract in which the contractor is reimbursed for
allowable or otherwise defined costs, plus a percentage of these costs or a fixed fee.
Contract Costs
Contract costs are costs that relate directly to the specific contract; are attributable to contract activity
in general and can be allocated to the contract; and are specifically chargeable to the customer under
the terms of the contract. Examples of contract costs are:
a. Site labor costs, including site supervision.
b. Costs of materials used in construction.
c. Depreciation of the plant and equipment used on the contract.
d. Costs of moving plant, equipment and materials to and from the contract site.
e. Costs of hiring plant and equipment.
f. Costs of design and technical assistance.
g. The estimated costs of the rectification and guarantee work, including expected warranty costs.
h. Claims from third parties.
i. Insurance
j. Construction overheads.
k. General administrative costs and development costs for which reimbursement is specified in the
terms of the contract.
Types of Contract Costs.
Contract costs can be broken down into two categories: costa incurred to date and estimated costs to
complete.
Costs incurred to date. These include precontract costs and costs incurred after contract acceptance.
Precontract costs are costs incurred before a contract has been entered into, with the expectation that
the contract will be accepted and these costs will thereby be recoverable through billings. The criteria
for recognition of such costs are:
1. They are capable of being identified separately.
2. They can be measured reliably.
3. It is probable that the contract will be obtained.
Estimated costs to complete. These are the anticipated costs of the materials, labor, subcontracting
costs, and indirect costs (overhead) required to complete a project at a scheduled time.
Illustrative Problem
To illustrate the appropriate accounting procedures for the percentage-of-completion and zero profit
methods, assume the following:
AMG Construction Company agrees to build a large office building for PG Towers for a total contract
price of P5,000,000. PG Towers will make annul payments to AMG but the amounts of these payments
cannot exceed the direct costs incurred by AMG. The contract is signed on October 1, 2014 and AMG’s
year-end is December 31. The contract provides PG with a final inspection right to ensure compliance
with the contract term prior to accepting the completed project. Illustration 9-1 below gives further
information about the contract.
Illustration 9-1
Total contract price P5,000,000
Total anticipated costs (at 10/2014) 4,500,000
Item 2014 2015 2016 Total
Cost incurred each year P1,350,000 P2,250,000 P400,000 P4,000,000
Estimated costs to complete (at year-end) 3,150,000 400,000 - -
Progress billings each year 400,000 2,000,000 2,600,000 5,000,000
Progress payments received each year 275,000 2,100,000 2,625,000* 5,000,000
*Since the contract was completed and accepted in 2016, the buyer paid the remaining balance of the
total contract amount, computed as follows:
Contract amount P5,000,000

Prior progress payments
2014 P275,000
2015 2,100,000 2,375,000
Remaining balance 2,625,000
The computation of the gross profit to be realized for each year under the two methods are presented
below:
Percentage-of-Completion Method
2014 2015 2016
(1) Total contract price P5,000,000 P5,000,000 P5,000,000
(2) Cost incurred to date 1,350,000 3,600,000 4,000,000
(3) Estimated costs to complete 3,150,000 400,000
(4) Total estimated costs 4,500,000 4,000,000 4,000,000
(5) Expected gross profit 500,000 1,000,000 1,000,000
Multiply by the percentage
of completion (2÷4) 30% 90% 100%
Gross profit earned to date 150,000 900,000 1,000,000
Less: Gross profit earned
in prior years 150,000 900,000
Gross profit earned this year P150,000 P750,000 P100,000
Zero Profit Method

2014 2015 2016
Construction Revenues P1,350,000 P2,250,000 P1,400,000
Cost incurred each year 1,350,000 2,250,000 400,000
Gross profit earned this year P - P - P1,000,000
Alternative Procedure
The realized gross profit under the percentage of completion method may also be computed using the
formula below:
2014 2015 2016

Contract Price P5,000,000 P5,000,000 P5,000,000
Multiply by percentage of completion 30% 90% 100%
Value of contract earned 1,500,000 4,500,000 5,000,000

Less: Cost incurred to date 1,350,000 3,600,000 4,000,000
Gross profit earned to date 150,000 900,000 1,000,000
Less: Gross profit earned in prior years - 150,000 900,000
Gross profit earned this year P150,000 P750,000 P100,000
Illustration 9-3
Comparison of Zero Profit Method and Percentage-of-Completion Journal Entries
Journal Entries
Percentage-of-
Zero Profit Method completion
Date Event Accounts Dr. Cr. Dr. Cr.
201
4 1 Contract Signed No entry necessary to record contract commitment
1,350,00 1,350,00
2 Costs Incurred Construction in Progress 0 0
1,350,00
Cash 0 1,350,000
3 Progress Billings Accounts Receivable 400,000 400,000

Contract Billings 400,000 400,000
4 Billing Collections Cash 275,000 275,000

Accounts Receivable 275,000 275,000
5 Revenue Recognition Construction in Progress 150,000

1,350,00 1,350,00
Cost of Construction 0 0
1,350,00
Construction Revenue 0 1,500,000
201 2,250,00 2,250,00

5 6 Costs Incurred Construction in Progress 0 0
2,250,00
Cash 0 2,250,000
2,000,00 2,000,00
7 Progress Billings Accounts Receivable 0 0
2,000,00
Contract Billings 0 2,000,000
2,100,00 2,100,00
8 Billing Collections Cash 0 0
2,100,00
Accounts Receivable 0 2,100,000
9 Revenue Recognition Construction in Progress 750,000

2,250,00 2,250,00
Cost of Construction 0 0
2,250,00
Construction Revenue 0 3,000,000
201
6 10 Costs Incurred Construction in Progress 400,000 400,000
Cash 400,000 400,000
2,600,00 2,600,00
11 Progress Billings Accounts Receivable 0 0
2,600,00
Contract Billings 0 2,600,000
2,625,00 2,625,00
12 Billing Collections Cash 0 0
2,625,00
Accounts Receivable 0 2,625,000
1,000,00
13 Revenue Recognition Construction in Progress 0 100,000
Cost of Construction 400,000 400,000
1,400,00
Construction Revenue 0 500,000
14 Elimination of 5,000,00 5,000,00

Inventory Contract Billings 0 0
Construction in 5,000,00
Progress 0 5,000,000
Illustration 9-4
Zero Profit Method
Cash Construction in Progress Accounts Receivable

(4) 275,000 1,350,000 (2) (2) 1,350,000 (3) 400,000 275,000 (4)
(8) 2,100,000 2,250,000 (6) 1,350,000 125,000
(12 (10
) 2,625,000 1,400,000 ) (6) 2,250,000 (7) 2,000,000 2,100,000 (8)
2,125,000 2,100,000
3,600,000 25,000
(10 (14
) 400,000 5,000,000 ) (11) 2,600,000 2,625,000 (12)
(13
) 1,000,000 2,625,000 2,625,000
5,000,000 5,000,000
Contract Billing Construction Revenue Cost of Construction

1,350,00 1,350,00
400,000 (3) 0 (5) (5) 0
2,250,00 2,250,00
400,000 0 (9) (9) 0
2,000,00 1,400,00 (13
0 (7) 0 ) (13) 450,000
2,400,00
0
(15 5,000,00 2,600,00
) 0 0 (11)
5,000,00 5,000,00
0 0
Percentage of Completion Method
Cash Construction in Progress Accounts Receivable

(4) 275,000 1,350,000 (2) (2) 1,350,000 (3) 400,000 275,000 (4)
(8) 2,100,000 2,250,000 (6) (5) 150,000 125,000
(12 (10
) 2,625,000 1,400,000 ) 1,500,000 (7) 2,000,000 2,100,000 (8)
(6) 2,250,000 2,125,000 2,100,000
(9) 750,000 25,000
(11 (12
4,500,000 ) 2,600,000 2,625,000 )
(10
) 400,000 5,000,000 (4) 2,625,000 2,625,000
(13
) 100,000
5,000,000 5,000,000
Contract Billing Construction Revenue Cost of Construction

400,000 (3) 1,350,000 (5) (5) 1,350,000
400,000 2,250,000 (9) (9) 2,250,000
(13 (13
2,000,000 (7) 1,400,000 ) ) 450,000
2,400,000
(11
2,600,000 )
(14
) 5,000,000 5,000,000
FINANCIAL STATEMENT PRESENTATION
The resulting financial statement presentation for both methods are summarized in Illustration 9-5
below:
December 31,2014 December 31, 2015 December 31, 2016

Zero Profit Percentage of Zero Profit Percentage of Zero Profit Percentage of
Method Completion Method Completion Method Completion
Statement of Financial
Position
Accounts
Receivable 125,000 125,000 25,000 25,000 -0- -0-
Inventory:
Construction
in Progress 1,350,000 1,500,000 3,600,000 4,500,000 -0- -0-
Less:
Contract
Billings 400,000 400,000 2,400,000 2,400,000 -0- -0-
Excess 950,000 1,100,000 200,000 2,100,000 -0- -0-
Statement of
Comprehensive Income
Construction
Revenue 1,350,000 1,500,000 2,250,000 3,000,000 1,400,000 500,000
Cost of
Construction 1,350,000 1,350,000 2,250,000 2,250,000 400,000 400,000
Gross Margin - 150,000 - 750,000 1,000,000 100,000
Anticipated Losses on Long-Term-Construction Projects
Case 1: Loss in the year of revision of estimated costs but profit in total contract. Revising the data
in Illustration 9-1, assume that at the end of 2015, the estimated cost to complete was increased to
P1,260,000 and this was the actual cost incurred in 2016. The following analysis shows the
computation of the gross profit (loss) to be recognized each year:
2014 2015 2016

Contract price P5,000,000 P5,000,000 P5,000,000
Cost incurred to data 1,350,000 3,600,000 4,860,000

Estimated costs to complete 3,150,000 1,260,000
Total estimated costs 4,500,000 4,860,000 4,860,000
Expected gross profit 500,000 140,000 140,000

Percentage of completion 30% 75% 100%
Gross profit earned to date 150,000 105,000 140,000

Gross profit earned in prior year(s) 150,000 105,000
Gross profit (loss) recognized this year P150,000 P(45,000) P35,000
The computations show that the increase in estimated cost reduce the percentage-of-completion in 2015
to 75%, and the cumulative gross profit at the end of 2015 to P105,000. Since P150,000 was already
recognized as gross profit in 2014, a loss of P45,000 would be recognized in 2015. The entries to
record revenue and costs for the three years under the percentage-of-completion method would be as
follows:
2014 2015 2016

Cost of Construction 1,350,000 2,250,000 1,260,000
Construction in progress 150,000 45,000 35,000
Construction revenue 1,500,000 2,245,000 1,295,000
Under the zero profit method, no adjustment is necessary since the contract will result in overall profit.
The entries would be as follows:
2014 2015 2016

Cost of Construction 1,350,000 2,250,000 1,260,000
Construction in progress 140,000
Construction revenue 1,350,000 2,250,000 1,400,000
Case 2: Loss in the year of revision of total estimated costs but overall loss on the contract.
Assume the same data in our previous illustration, except that in 2015 the estimated costs to complete
were P1,500,000 instead of P400,000, assume also that actual cost equaled expected costs in 2016. The
computation of the gross profit to be recognized each year would be as follows:
2014 2015 2016

Contract price P5,000,000 P5,000,000 P5,000,000
Cost incurred to data 1,350,000 3,600,000 5,100,000

Estimated costs to complete 3,150,000 1,500,000 -
Total estimated costs 4,500,000 4,860,000 4,860,000
Expected gross profit (loss) P500,000 P(100,000) P(100,000)
Percentage of completion 30% 70% 100%
Under the Zero Profit Method, the anticipated loss is to be recognized immediately at the end of 2015
because there is an overall loss on the contract. To record the anticipated loss of P100,000 on the
construction contract, the following entry would be made at the end of 2015:
Cost of construction 2,250,000

Construction in progress (Loss) 100,000
Construction revenue 2,150,000
At the end of 2016, the year of completion the entry would be:

Under the Percentage of Completion Method the recognition of an anticipated contract loss is more
complicated. To properly recognize the entire loss in the year it is first anticipated, the cumulative cost
to be deducted from the cumulative recognized revenue cannot be actual cost incurred, but must be the
cumulative recognized revenue plus the total anticipated loss. Thus, in our example, the cumulative
recognized revenue at the end of 2015 would be P3,500,000 (70% x P5,000,000), and the cumulative
cost at the same year would be P3,600,000 (P3,500,000 + P100,000). Since it is assume that P150,000
profit was recognized in 2014, then the total loss to be recognized in 2015 is P250,000 (P150,000 +
P100,000). The following computation shows the amounts to be reported for each of the three years of
the contract under the percentage of completion method.
Recognized- Recognized-
To Date Prior Years Current Year
2014 Construction revenue (P5,000,000 x 30%) P1,500,000 P1,500,000
Cost of construction (actual cost) 1,350,000 1,350,000
Gross profit P150,000 P150,000
2015 Construction revenue (P5,000,000 x 70%) P3,500,000 P1,500,000 P2,000,000

Cost (revenue plus total anticipated loss) 3,600,000 1,350,000 2,250,000
Gross profit (loss) P(100,000) P150,000 P(250,000)
2016 Construction revenue P5,000,000 P3,500,000 P1,500,000

Cost (Actual Cost) 5,100,000 3,600,000 1,500,000
Gross profit (loss) P(100,000) P(100,000) P -
The entry to record the total loss at the end of 2015 would be as follows:

Construction in progress (total loss) 250,000
Note that the construction in progress account under both methods would have a balance of P3,500,000
as shown below:
Zero Profit Method Percentage of Completion Method

Construction in Progress Construction in Progress
2014 cost P1,350,000 100,000 2015 loss 2014: cost P1,350,000 P250,000 2015 loss
2015 cost 2,250,000 GP 150,000
2015: cost 2,250,000
3,600,000 100,000 3,750,000 250,000
Balance P3,500,000 Balance P3,500,000
Contract Retention. To ensure the completion of the project satisfactorily, part of the billings may not
be paid to the contractor until the project is completed and accepted. For example, if out of the total
billings during the year of P1,000,000, 10% ps agreed upon as contract retention, only P900,000 will be
collected by the contractor. The entry to record the collection would be:
Cash 900,000
Contract Retention 100,000
Accounts Receivable 1,000,000
The Contract Retention is presented in the statement of financial position as a current asset. Upon
completion of the project, the balance of this account once paid by the customer will be closed by
debiting Cash and Crediting Contract Retention account.
Chapter 10
Franchise Accounting
Illustration:
Jan. 5, 2016: McDo, Inc. granted a franchise to Mr. A. De, Jesus to sell McDo products.
The Initial Franchise fee (IFF) is P10,000,000
Feb. to Nov.: McDo, Inc. rendered the following initial services under the franchise contract:
Direct costs of initial services P2,000,000
Indirect costs of services 50,000
December 1: the franchisee, Mr. A. De Jesus started business operations.
The following cases will illustrate the required journal entries to be recorded by the franchisor during
2016:
Case 1: The initial franchise fee is paid in full when the agreement is signed on July 2, 2016. The
following entries would be made by the franchisor during the year 2013:
Jan. 2, 2016 Cash 10,000,000

Deferred Revenue from IFF 10,000,000
To record the receipt of the IFF
Feb.to Nov.: Deferred cost of franchise revenue 2,000,000

Franchise expense 50,000
Cash 2,050,000
To record the payment of franchise costs.
December 31: Adjusting Entries:

Cost of Franchise revenue 2,000,000
Deferred cost of franchise revenue 2,000,000
To adjust cost of franchise revenue.

Revenue from IFF 10,000,000
To recognize fully as revenue the initial franchise fee.
Case 2: the initial franchise fee is payable as follows: P1,000,000 cash when the contract is signed and
the balance in five annual installments payable every December 31, evidenced by a 12 percent
promissory note. As discussed earlier, two methods can be used to record the franchise operations if
the initial franchise is payable for an extended period of time. These methods are discussed below:
Method 1: Accrual Method
2016
Jan.2: Cash 1,000,000
Notes receivable 9,000,000
To record the initial franchise fee.
Feb.-Nov. Deferred cost of franchise revenue 2,000,000

Cash 2,050,000
To record costs of services rendered
Dec. 31: Cash 2,880,000

Interest income (9,000,000 x 12%) 1,080,000
To record collection of the first installment.
Adjusting entries:
Cost of franchise revenue 2,000,000
Deferred revenue from IFF 10,000,000

To recognize fully the initial franchise fee as
revenue on December 31, since the collectibility
of the note is reasonable assured.
The Statement of Comprehensive Income of the franchisor for the year ended December 31, 2016 will
now appear as follows:
Revenue from franchise fee P10,000,000

Gross profit 8,000,000
Expenses 50,000
Operating income 7,050,000
Interest income 1,080,000
Net income P8,130,000
Method 2: Installment method.
2016
Jan. 5: Cash 1,000,000
Feb. to Nov.: Deferred cost of franchise revenue 2,000,000

Cash 2,050,000
To record costs of services rendered.
Dec.31 Cash 2,880,000

Adjusting entries:
To recognize cost of franchise revenue

Deferred gross profit from IFF 8,000,000
To set up deferred gross profit from franchise fee

Realized gross profit from IFF 2,240,000
To record realized gross profit computed as follows:
Collections, excluding interest:
Down payment P1,000,000
First Installment 1,800,000 2,800,000
Gross profit rate (P8,000,000/P10,000,000) 80%
Realized gross profit from IFF P2,240,000
The Statement of Comprehensive Income of the Franchisor for the year ended December 31, 2016 is
presented below:
Revenue from franchise fee P10,000,000

Deferred gross profit 8,000,000
Less deferred gross profit, end 5,760,000
Realized gross profit 2,240,000
Expenses 50,000
Operating income 2,190,000
Net income P3,070,000
Case 3: The initial franchise fee is payable as follows: cash of P1,000,000 upon signing of the contract
and the balance in five equal installments every December 31, evidenced by a non-interest bearing
note. Credit investigation indicates that the franchisee can borrow money at 12% and the present value
of an ordinary annuity of 1 at 12% for 5 periods is 3.6048. Thus the present value of five payments of
P1,800,000 would be P6,488,640 (P1,800,000 x 3.6048). Assuming that the collectibility of the note is
not reasonably assured, using the installment method of revenue recognition, the required entries in
the books of the franchisor during 2016 are:
Jan.2, 2016 Cash 1,000,000

Unearned interest income 2,511,360
To record the receipt of initial franchise fee.
Computations:
Face value of the note P9,000,000
Present value of the note 6,488,640
Unearned interest income P2,511,360
Down payment P1,000,000

Present value of the note 6,488,640
Adjusted sales value of franchise P7,488,640
Feb. to Nov. Deferred cost of franchise revenue 2,000,000

Cash 2,050,000
Dec. 31: Cash 1,800,000

To record the collection of the first installment.
Adjusting entries:
Unearned interest income 778,637
Interest income 778,637
To adjust interest income for 2016 (P6,488,640 x 12%)

To adjust cost of franchise revenue.
To defer gross profit from franchise fee.
Gross profit rate (5,488,640 / 7,488,640) 73.29%

Realized gross profit from IFF 1,481,147
To recognize realized gross profit computed as follows:
Collections applying to principal:
Down payment 1,000,000
First installment (P1,800,000-P778,637) 1,021,363 P2,021,363
Gross profit rate 73.29%
Realized gross profit from IFF P1,481,147
Alternative Method: if the collectibility of the note receivable is not reasonably assured, the cash basis
of revenue recognition may also be used instead of the installment method. This method is usually used
when the director costs of the initial services is minimal. Under this method revenue is recognized as
cash is received. Using the data in Case 3 except that the director cost of initial services is only
P200,000, the required journal entries are:
2016
Jan. 5 Cash 1,000,000
Unearned interest income 2,511,360
Feb. to Nov. Prepaid franchise expense 200,000

Cash 250,000
Dec. 31 Cash 1,800,000

Adjusting entries:
Unearned interest income 778,637
Interest income 778,637
To adjust interest income

To recognized revenue from the initial
franchise fee equal to the total collections
excluding interest.

Prepaid franchise expense 200,000
To adjust prepaid expenses.
Revenue Recognition – Continuing Franchise Fees
Continuing franchise fee is usually collected from the franchisee at the end of each month base on a
certain percentage of their monthly sales. Continuing franchise fees are recognized as revenue when
actually earned and receivable from the franchisee. The required entry is as follows:
Cash xxx
Revenue from continuing franchise fee (CFF) xxx
All direct and indirect costs related to continuing franchise fees are recognized as expense by the
following entry:
Franchise expense xxx
Cash xxx
Chapter 11

Partnership Liquidation

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Chapter 4

Assets Liabilities and Capital

Assets Partners' Capital

Balances 80,000 -0- 28,000 2,000 1,000 13,000 36,000

Balances 52,000 -0- -0- 2,000 1,000 13,000 36,000

A statement of liquidation to summarize the foregoing is shown below:

Assets Partners' Capital

Balances 47,000 -0- -0- 2,000 (1,000) 11,000 35,000

Balances 47,000 -0- -0- 1,000 -0- 11,000 35,000

Case 3: Loss on Realization Resulting Capital Deficiency to a solvent Partner

Assets Partners' Capital

Balances 69,500 -0- 28,000 2,000 -3,200 8,800 33,900

Balances 41,500 -0- -0- 2,000 (3,200) 8,800 33,900

Balances 41,500 -0- -0- -0- (1,200) 8,800 33,900

Balances 42,700 -0- -0- -0- -0- 8,800 33,900

The entry to record the investment of D to eliminate his capital deficiency is

Assets Partners' Capital

Balances 69,500 -0- 28,000 2,000 -3,200 8,800 33,900

Balances 41,500 -0- -0- 2,000 (3,200) 8,800 33,900

Balances 41,500 -0- -0- -0- (1,200) 8,800 33,900

Balances 41,500 -0- -0- -0- -0- 8,000 33,500

Partnership is Insolvent but Partners are Personally Solvent

Total Assets P50,000 Total Liabilities and Capital P50,000

Assets Partners' Capital

Balances 27,500 0 33,000 1,500 -2,500 -4,500

Balances 0 0 5,500 1,500 -2,500 -4,500

Balances 7,000 0 5,500 1,500 0 0

Balances 1,500 0 0 1,500 0 0

Partnership is Insolvent and Partners are Personally Insolvent

Assets Liabilities and Capital

Total Assets P110,000 Total Liabilities and Capital P110,000

Balances 50,000 -0- 60,000 -15,000 -5,000 10,000

Balances -0- -0- 10,000 -15,000 -5,000 10,000

Balances 15,000 -0- 10,000 -0- -5,000 -10,000

Balances 5,000 -0- -0- -0- -5,000 -10,000

Balances 5,000 -0- -0- -2,500 -0- 7,500

Balances 7,500 -0- -0- -0- -0- 7,500

Explanation of transaction numbers 1 to 4:

The following data relate to the realization of other assets:

Total interests P25,000 P35,000 P45,000

Assets Partners' Capital

Balances 70,000 75,000 40,000 25,000 35,000 45,000

Balances P30,000 P75,000 0 P25,000 P35,000 P45,000

Payment to partners 0 P10,000 P20,000

Assets Partners' Capital

Toal payments P12,000 P22,000 P32,000

Lump-Sum Liquidation Method

Total payments P12,000 P22,000 P32,000

(7) X, Capital 4,000

The following data relate to the realization of non-cash assets:

Book Value Cash Realized Loss

Assets Partners' Capital

Balances 40,000 26,000 6,000 2,000 8,000 24,200 18,200 7,600

Balances 34,000 26,000 -0- 2,000 8,000 24,200 18,200 7,600

Balances -0- 26,000 -0- -0- 8,000 7,200 7,200 3,600

Assets Partners' Capital

Balances 40,000 26,000 6,000 2,000 8,000 24,200 18,200 7,600

Balances -0- 26,000 -0- -0- 8,000 7,200 7,200 3,600