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Chapter 5
Corporate Liquidation & Reorganization
PROBLEM 1: TRUE OR FALSE
1. TRUE – see solution below
2. TRUE
Total assets @ realizable value (200 x 75%) 150
Total priority claims (300 x ¼) (75)
Net free assets 75
Total non-priority claims (300 x 3/4) 225
Estimated recovery of non-priority
33.33%
claims

3. FALSE
 (40 asset @ carrying amt. x 75%) = 30 realizable value;
 30 realizable value vs. 36 loan = loan is partially secured;
 30 secured + (6 x 33.33% see computation above) = 32

4. FALSE
 (20 asset @ carrying amt. x 75%) = 15 realizable value;
 15 realizable value vs. 15 note = note is fully secured;
 Mr. B can expect full payment of the note

5. TRUE – shareholders are paid last; if the unsecured non-

priority creditors can only expect to recover 1/3 of their
claims, the shareholders will recover nothing.

PROBLEM 2: MULTIPLE CHOICE – THEORY

1. D
2. B
3. D
4. A
5. A

PROBLEM 3: EXERCISE
1. Solutions:
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Requirement (a): Statement of affairs

Available for
Realizable
Book values ASSETS unsecured
values
creditors
Assets pledged to fully secured creditors:
5,000,000 Land and building 5,200,000
Loan payable (4,000,000)
Interest payable (30,000) 1,170,000

Assets pledged to partially secured creditors:

600,000 Equipment, net 400,000 -

Free assets:
80,000 Cash 80,000
440,000 Accounts receivable 334,400
200,000 Note receivable 200,000
- Interest receivable 20,000
1,060,000 Inventory 820,000
20,000 Prepaid assets - 1,454,400
Total free assets 2,624,400
Less: Unsecured liabilities
(810,000)
with priority (see below)
Net free assets 1,814,400
Estimated deficiency (squeeze)
(2,592,000 – 1,814,400) 777,600
7,400,000 2,592,000

Unsecured
LIABILITIES AND Realizable
Book values non-priority
EQUITY values
liabilities
Unsecured liabilities with priority:
- Administrative expenses 60,000
50,000 Accrued salaries 50,000
700,000 Current tax payable 700,000
Total unsecured liabilities
810,000
with priority -

Fully secured creditors:

4,000,000 Loan payable 4,000,000
Interest payable 30,000 -

Partially secured creditors:

600,000 Note payable 600,000
Equipment, net (400,000) 200,000

Unsecured creditors
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Accrued expenses, net of

392,000 392,000
accrued salaries
2,000,000 Accounts payable 2,000,000 2,392,000
Total unsecured creditors 2,592,000

(342,000) Shareholders' equity - -

7,400,000 2,592,000

Requirement (b): Estimated deficiency

777,600 (see statement above)

or (Alternative solution)
Total assets at realizable values 7,054,400
Total liabilities at settlement amounts (7,832,000)

Estimated deficiency (777,600)

Requirement (c): Estimated recovery percentage

Net free assets

Estimated recovery percentage
Total unsecured
of unsecured creditors without =
liabilities without
priority
priority

1,814,400 ÷ 2,592,000 = 70%

Requirement (d): Mr. A’s recovery

500,000 x 70% = 350,000

2. Solutions:
Requirement (a):
i. opening journal entry
Jan. Cash 80,000
1,
20x1
Accounts receivable 440,000
Note receivable 200,000
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Inventory 1,060,000
Prepaid assets 20,000
Land 1,000,000
Building 4,000,000
Equipment 600,000
Estate deficit (squeeze) 342,000
Accrued expenses 442,000
Current tax payable 700,000
Accounts payable 2,000,000
Note payable 600,000
Loan payable 4,000,000

ii. journal entry for new assets and liabilities

Jan. Interest receivable 20,000
1,
20x1
Estate deficit 20,000
Jan. Estate deficit 30,000
1,
20x1
Interest payable 30,000

iii. compound journal entry for the transactions

Jan. Cash 1,486,000(a
1 to )
June
Accrued expenses (acc. salaries only)
30, Current tax payable 50,000
20x1 Note payable 700,000
Loan payable 600,000
Interest payable 4,000,000
Accounts receivable 30,000 440,000
Note receivable 200,000
Interest receivable 20,000
Inventory (1.06M x 50%) 530,000
Prepaid assets 20,000
Land 1,000,00
Building 0
Equipment 4,000,00
Estate deficit (squeeze) 0
600,000
56,000
(a)
(75% x 440K) + (20K + 180K) + 590K + 5.2M + 440K – 50K – 700K – (4M +
30K) – 440K – 54K = 1,486,000

Requirement (b):
ASSETS
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Assets to be realized: Assets realized:

Accounts receivable 440,000 Accounts receivable 330,000
Note receivable 200,000 Note receivable 180,000
Inventory 1,060,000 Interest receivable 20,000
Prepaid assets 20,000 Inventory 590,000
Land and building 5,000,000 Land and building 5,200,000
Equipment, net 600,000 Equipment 440,000
Total 7,320,000 Total 6,760,000

Assets acquired: Assets not realized:

530,00
Interest receivable 20,000 Inventory 0

LIABILITIES
Liabilities liquidated: Liabilities to be liquidated:
Accrued expenses 50,000 Accrued expenses 442,000
Current tax payable 700,000 Current tax payable 700,000
Interest payable 30,000 Accounts payable 2,000,000
Loan payable 4,000,000 Note payable 600,000
Note payable 440,000 Loan payable 4,000,000
Total 5,220,000 Total 7,742,000

Liabilities not liquidated: Liabilities assumed:

Accrued expenses 392,000 Interest payable 30,000
Accounts payable 2,000,000
Total 2,392,000

SUPPLEMENTARY ITEMS
Supplementary expenses: Supplementary income:
Administrative
54,000
Expenses -
Net gain during the
56,000
Period
15,062,000 15,062,000

Requirement (c):
Cash
Beg. bal. 80,000
Assets 6,760,00 5,220,00
realized 0 0 Liabilities liquidated
Administrative
54,000 expenses
1,566,00
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Requirement (d):

Estate deficit
opening 342,000
new 30,00 20,00
liability 0 0 new asset
56,00
0 transactions
296,00
0 end.

ASSETS = LIABILITIES + EQUITY

1,566,00 (squeeze 2,392,00 (start
Cash Liabilities not liq.
0 ) 0 )
Assets not (296,000
real. 530,000 Estate deficit )
2,096,00
Total 2,096,000 Total 0
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PROBLEM 4: MULTIPLE CHOICE – COMPUTATIONAL

1. A
Solution:
Net free assets
Estimated recovery percentage
Total unsecured
of unsecured creditors without =
liabilities without
priority
priority

Total assets at realizable values 2,880,000

Less: Unsecured creditors with priority (480,000)
Fully secured creditors (1,050,000)
R.V. of assets pledged to partially sec. creditors (300,000)
1,050,00
Net free assets 0
Divide by: Total unsecured creditors w/o priority:
Unsecured creditors without priority 1,400,000
Deficiency of assets pledged to partially secured
350,000
creditors (300K – 650K)
1,750,00
Total unsecured creditors without priority 0
Estimated recovery % of unsecured cr. w/o priority 60%

2. C {300K realizable value of the asset pledged as security +

[(650K – 300K) x 60%} = 510,000

3. A
Solution:
Cash 100,000
Accounts receivable (600K x 60%) 360,000
Inventory (1.56M x 50%) 780,000
Land and building 2,300,000
Equipment, net (400K - 70K refurbishment) 330,000
Total assets @ realizable values 3,870,000

Accounts payable (a) 1,157,000

Income tax payable (amt. payable on tax amnesty) 780,000
Note payable 1,000,000
Loan payable 1,200,000
Interest payable (80K + 70K) 150,000
Estimated liquidation costs 120,000
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SSS, PhilHealth & Pag-IBIG 160,000

Total liabilities @ expected net settlement amounts 4,567,000

Estimated deficiency (697,000)

(a)
Accounts payable @ book value 1,600,000
Discount (23,000)
Waived (420,000)
Accounts payable @ expected settlement amt. 1,157,000

4. C
Solution:
Cash 100,000
Accounts receivable (600K x 60%) 360,000
Inventory (1.56M x 50%) 780,000
Land and building 2,300,000
Equipment, net (400K - 70K refurbishment) 330,000
Total assets @ realizable values 3,870,000

Note & interest (realizable value of equpt.) 330,000

Loan payable 1,200,000
Interest payable on loan 70,000
Total secured claims 1,600,000

Total free assets 2,270,000

5. A
Solution:
Net free assets
Estimated recovery percentage
Total unsecured
of unsecured creditors without =
liabilities without
priority
priority
= 1,210,000 (see below) ÷ 1,907,000 (see below) = 63.45%

330,000 realizable value of equipment + (750,000 unsecured see

below x 63.45%) = 805,875 recoverable amount

(1,000,000 + 80,000) – 805,875 = 274,125

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Available for
Realizable
Book values ASSETS unsecured
values
creditors
Assets pledged to fully secured creditors:
2,000,000 Land and building 2,300,000
Loan payable (1,200,000)
Interest payable (70,000) 1,030,000

Assets pledged to partially secured creditors:

400,000 Equipment, net (400K – 70K) 330,000 -

Free assets:
100,000 Cash 100,000
600,000 Accts. receivable (600K x 60%) 360,000
1,560,000 Inventory (1.56M x 50%) 780,000 1,240,000
Total free assets 2,270,000
Less: Unsecured liabilities
(1,060,000)
with priority (see below)
Net free assets 1,210,000
Estimated deficiency (squeeze)
(1,907,000 – 1,210,000) 697,000
4,660,000 1,907,000

Unsecured
LIABILITIES AND Expected
Book values non-priority
EQUITY settlement
liabilities
Unsecured liabilities with priority:
120,00
-
Liquidation costs 0
SSS, PhilHealth & Pag- 160,00
-
IBIG 0
900,000 Income tax payable 780,000
Total unsecured liabilities 1,060,00
with priority 0 -

Fully secured creditors:

1,200,000 Loan payable 1,200,000
- Interest payable 70,000 -

Partially secured creditors:

1,000,00
1,000,000
0 Note payable
- Interest payable 80,000
Equipment, net (330,000) 750,000
 P a g e | 10

Unsecured creditors without priority:

1,600,000 Accounts payable 1,157,000(a) 1,157,000
Total unsecured creditors without priority 1,907,000

(40,000) Shareholders' equity - -

4,660,000 1,907,000

(a)
Accounts payable @ book value 1,600,000
Discount (23,000)
Waived (420,000)
Accounts payable @ expected settlement amt. 1,157,000

6. B - 90,000 x 63.45% see above = 57,105

7. C
Solution:
Net free assets
Estimated recovery percentage
Total unsecured
of unsecured creditors without =
liabilities without
priority
priority
Estimated recovery % = 520,000 ÷ 650,000 (a)
Estimated recovery % = 80%

(a)

Suppliers Expected net settlement amounts

Athena
Co. (600K - 100K) 500,000
80K representing
Riley Co. goods 80,000
Naia Co. (120K - 50K) 70,000
Total 650,000

8. C
Solution:
Assets to be realized
Accounts receivable 600,000
Inventory 900,000
Equipment, net 400,000
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Total 1,900,000

Assets acquired -

Assets realized
[(600K x 90%) -
Accounts receivable
108K] 432,000
Inventory [(900K x 1/2) x 80%] 360,000
Equipment, net (380K - 50K) 330,000
Total Total 1,122,000

Assets not realized

Accounts receivable (600K x 10%) 60,000
Inventory (900K x 1/2) 450,000
Total 510,000

Liabilities to be liquidated
Accounts payable 1,600,000
Loan payable 1,500,000
Total 3,100,000

Liabilities assumed
Employee termination
benefits 100,000
Total 100,000

Liabilities liquidated
Accounts payable 100,000
Loan payable 1,000,000
Employee termination
benefits 80,000
Total 1,180,000
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Liabilities not liquidated

Accounts payable (1.6M - .1M) 1,500,000
Employee termination
benefits (100K - 80K) 20,000
Total 1,520,000

Supplementary expenses
Liquidation costs 50,000

Supplementary income
Sale of scrap materials 10,000

9. A
Solution:
Debits Credits
1,900,00 1,122,00
Assets to be realized Assets realized
0 0
Assets acquired - 510,000 Assets not realized
1,180,00 3,100,00
Liabilities liquidated Liabilities to be liq.
0 0
1,520,00
Liabilities not liquidated 100,000 Liabilities assumed
0
Supplementary expenses 50,000 10,000 Supplementary inc.
4,650,00 4,842,00
Totals Totals
0 0
Net gain - excess of Cr. over
192,000
Dr.

10. B
Solution:
Estate deficit
Opening (2M - 3.1M) 1,100,000
New liability - employee 100,000 192,000 Net gain (see above)
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termination
1,008,000 end.
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PROBLEM 5: FOR CLASSROOM DISCUSSION

1. Solutions:

Requirement (a):
Assets pledged to fully secured creditors:
Land 1,300,000

Assets pledged to partially secured creditors:

Equipment - net 150,000

Total assets at realizable value 2,100,000

Less: Secured creditors:
Fully secured - Loan payable (750,000)
Partially secured - Note payable (up to the RV of equipt. only) (150,000)
Total free assets 1,200,000
Less: Unsecured creditors with priority:
Estimated administrative expenses (180,000)
Salaries payable (800,000)
Net free assets 220,000

OR
Excess of the RV of land over loan payable 550,000
Cash 200,000
Accounts receivable 450,000
Total free assets 1,200,000
Less: Unsecured liabilities with priority:
Estimated administrative expenses (180,000)
Salaries payable (800,000)
Net free assets 220,000

Requirement (b):

Unsecured liabilities with priority:

Administrative expenses 180,000
Salaries payable 800,000
980,000

Fully secured creditors:

Loan payable 750,000

Partially secured creditors:

Notes payable 500,000
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Unsecured liabilities without priority:

Note payable - excess (500K – 150K RV of equipment) 350,000
Accounts payable 700,000
1,050,000

Requirement (c):
Net free assets (see above) 220,000
(1,050,000
Unsecured liabilities without priority (see above) )
Deficiency to unsecured non-priority creditors (830,000)

OR
Total assets at realizable value 2,100,000
Total liabilities at settlement amt. (2.75M + 180K adm. Exp.) (2,930,000)
Estimated deficiency to unsecured non-priority
creditors (830,000)

Requirement (d):

Net free assets

Estimated recovery percentage
Total unsecured
of unsecured creditors without =
liabilities without
priority
priority

= 220,000 ÷ 1,050,000 = 20.95%

Requirement (e):
500,000 x 20.95% = 104,750
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Requirement (f):
BYE-BYE CORPORATION
STATEMENT OF AFFAIRS
AS OF JANUARY 1, 20X1
Available for
Book Realizabl unsecured
values ASSETS e values creditors
Assets pledged to fully secured creditors:
1,000,000 Land 1,300,000
Loan payable (750,000) 550,000

Assets pledged to partially secured creditors:

600,000 Equipment - net 150,000
Notes payable (500,000) -

Free assets:
200,000 Cash 200,000
500,000 Accounts receivable 450,000 650,000
Total free assets 1,200,000
Less: Unsecured liabilities
with priority (see
below) (980,000)
Net free assets 220,000
Estimated deficiency
(squeeze) 830,000
2,300,000 Totals 1,050,000

Unsecured
Book Realizabl non-priority
values LIABILITIES e values liabilities
Unsecured liabilities with priority:
- Administrative expenses 180,000
800,000 Salaries payable 800,000 -

Fully secured creditors:

750,000 Loan payable 750,000 -

Partially secured
creditors:
500,000 Notes payable 500,000
Equipment - net (150,000) 350,000

Unsecured creditors:
700,000 Accounts payable 700,000 700,000

(450,000) Shareholders' equity - -

2,300,000 Totals 1,050,000
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2. Solutions:
Requirement (a):
i. opening journal entry
Jan. Cash 200,000
1,
20x1
Accounts receivable 500,000
Equipment – net 600,000
Land 1,000,000
Estate deficit (squeeze) 450,000
Accounts payable 700,000
Salaries payable 800,000
Notes payable 500,000
Loan payable 750,000

ii. journal entry for new assets and liabilities

Jan. Estate deficit 30,000
1,
20x1
Interest payable 30,000

iii. journal entries for the transactions

(a) Cash 280,000
Estate deficit 120,000
Accounts receivable 400,000
(b) Cash 150,000
Estate deficit 450,000
Equipment 600,000

Notes payable 500,000

Cash 150,000
Estate deficit 350,000
(c) Cash (1.5M – 100K) 1,400,000
Land 1,000,000
Estate deficit 400,000

Loan payable 750,000

Interest payable 30,000
Cash 780,000
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(d) Accounts payable (700K x ½) 350,000

Salaries payable (800K x ¼) 200,000
Cash 550,000
(e) Estate deficit 240,000
Cash 240,000

Requirement (b):
ASSETS
Assets to be realized: Assets realized:
Accounts receivable 500,000 Accounts receivable 280,000
Equipment, net 600,000 Equipment 150,000
Land 1,000,000 Land 1,400,000
Total 2,100,000 Total 1,830,000

Assets acquired: Assets not realized:

100,00
- Accounts receivable 0

LIABILITIES
Liabilities liquidated: Liabilities to be liquidated:
Accounts payable 350,000 Accounts payable 700,000
Salaries payable 200,000 Salaries payable 800,000
Note payable 150,000 Note payable 500,000
Loan payable 750,000 Loan payable 750,000
Interest payable 30,000
Total 1,480,000 Total 2,750,000

Liabilities not liquidated: Liabilities assumed:

Accounts payable 350,000 Interest payable 30,000
Salaries payable 600,000
Total 950,000

SUPPLEMENTARY ITEMS
Supplementary expenses: Supplementary income:
Liquidation costs 240,000 -
Net loss for the year 60,000
4,770,000 4,770,000

Requirement (c):
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Cash
Beg. bal. 200,000
Assets 1,830,00 1,480,00
realized 0 0 Liabilities liquidated
Administrative
240,000 expenses
310,000

OR
Cash
Beg. bal. 200,000
(a) 280,000
(b) 150,000 150,000 (b)
1,400,00
(c) 0 780,000 (c)
550,000 (d)
240,000 (e)
310,000

Requirement (d):

Estate deficit
opening 450,000
new 30,00
-
liability 0 new asset

transactions 60,000
*
540,00
0 end.

* From journal entries (a) to (e): 120K + 450K – 350K – 400K + 240K =
60K net debit

OR
Estate deficit
opening 450,000
new 30,00
liability 0
(a) 120,000
(b) 450,000 350,000 (b)
 P a g e | 20

(e) 240,000 400,000 (c)

540,00
0 end.

 RECONCILIATION:
ASSETS = LIABILITIES + EQUITY
(squeeze (start
Cash 310,000 Liabilities not liq. 950,000
) )
100,00 (540,000
Assets not real. 0 Estate deficit )
Total 410,000 Total 410,000