Technological Institute of the Philippines

ACCTG 028 ‒ ACTCY31S1

Accounting for Special Transactions

1. Separate legal personality – partnership has

MODULE 1 ‒ PARTNERSHIP a juridical personality separate and distinct
ACCOUNTING from that of each of the partners.

1.0 PARTNERSHIP ACCOUNTING 2. Ease of formation

Partnership 3. Co-ownership of Partnership Property and
profits
Partnerships are a popular form of business because they
are easy to form and because they allow several 4. Limited life

individuals to combine their talents and skills in a 5. Mutual agency – each partner has an equal
particular business venture. In addition, partnerships right to act for the partnership and to enter
provide a means of obtaining more capital than a single into contracts binding upon it, as long as he
individual can obtain and allow the sharing of risks for acts within the normal scope of business
rapidly growing businesses. Partnerships are particularly operations.
common in the service professions, especially law,
6. Unlimited liability
medicine and accounting.
The transactions that are usually debited
Distinct factors that encompass the above and credited to partner’s capital and
definition:
drawing accounts may be summarized as
1. Association of two or more persons. follows:

2. To carry on as Co-Owners.
➢ The Capital account is credited for:
3. Business for Profit
a) Original Investment
Partner's Ledger Accounts
b) Additional Investment
In a partnership, although it is possible to operate with
c) Partner's share in the profits
one equity account for each partner, it is desirable that
the following partner's accounts be maintained: ➢ The Capital account is debited for:

a) Permanent withdrawal of capital

1) Capital accounts
b) Debit balance of the drawing
2) Drawing or personal accounts account at the end of the period
3) Account for loans to or from partners c) Partner's share in the losses

Characteristics of a Partnership ➢ The Drawing account is credited for:

a) Partnership obligations assumed or

paid by the partner
 Technological Institute of the Philippines
ACCTG 028 ‒ ACTCY31S1
Accounting for Special Transactions

b) Personal funds or claims of partner ▪ All properties brought into the partnership or
collected and retained by the acquired by the partnership are partnership
partnership property.
▪ Cash investment are recorded at fair value or
c) Periodic partner's salaries
face value. Cash denominated in foreign
depending on the accounting and
currency is valued at the current exchange rate.
disbursement procedures agreed
▪ Noncash investment
upon.
The formation of a partnership presents relatively few
➢ The Drawing account is debited for:
difficult accounting problems. Accounting entries to
a) Withdrawal of assets by the record the formation will depend upon how the
partners in anticipation of net income partnership is formed as:

b) Partner's personal indebtedness a) Formation of the partnership for the first time by
paid or assumed by the partnership two or more individuals.
b) Sole proprietorship and another individual form
c) Funds or claims of partnership
a partnership
collected and retained by the partner
c) Two proprietors form a partnership
Loan to and Loan from partners

A withdrawal by a partner of a substantial amount with 1.2 OPERATION

the assumption of its repayment to the firm may be Accounting for Partnership Operations
debited to a Receivable from partner account rather than
▪ The accurate determination of periodic net
to the partner's drawing account. On the other hand, an
income and its distribution to the partners is still
advance to the partnership by a partner with the
the primary objective of the accounting process.
assumption of its ultimate repayment by the partnership
▪ Net income is computed in the usual manner,
is viewed as a loan rather than as an increase in the
that is matching revenues and expenses, then
capital account. This type of transaction is credited to the
credited to the individual capital accounts.
Loan's payable or notes payable if the loan is evidence by
a note duly signed in the name of the partnership. Net income is computed in the usual manner that is
matching revenues and expenses then credited to the

1.1 FORMATION individual capital accounts. However, the treatment

Accounting for the Formation of a Partnership becomes more complex because of the differences in
capital contributions, abilities and talents of individual
 Technological Institute of the Philippines
ACCTG 028 ‒ ACTCY31S1
Accounting for Special Transactions
partners, and in time spent on partnership duties by the
individual partners,
Division of Profits and Losses
The partnership law provides that profits and losses of
the partnership are to be divided in accordance with the
partners agreement. If no agreement is made between
and among the partners, profits and losses are to be
divided according to their original capital contributions.
Should the partners agree to divide the profits only,
losses, if any are to be divided in the same manner as that
of dividing profits. However, should the partners agree
to divide losses only, profits, if any shall be divided by the
partners according to capital contributions.
The ratio in which the partnership profits and losses are
divided is known as the profit and loss ratio. The many
possible methods of dividing net income or loss among
partners can be summarized as follows:
1. Equally
2. In an unequal or arbitrary ratio
3. In the ratio of partners capital account balances
on a particular date, or in the ratio of average
capital account balances during the year.
4. Allowing interest on partners' capital account
balances and dividing the remaining net income
or loss in a specified ratio.
5. Allowing salaries to partners and dividing the
remaining net income or loss in a specified ratio
6. Bonus to managing partner based on net
income.
▪ That if no agreement is made between
and among the partners, profits and
losses are to be divided according to their
original capital contributions.
1.3 DISSOLUTION/CHANGES IN OWNERSHIP
INTEREST
Partnership Dissolution/Changes in Ownership
Interest
▪ Partnership dissolution is defined as “the change
in the relation of the partners caused by any
partner ceasing to be associated in the carrying
on as distinguished from the winding up of the
business.
▪ Accounting for partnership is influence by the
propriety theory, which views a partnership not
as a distinct entity but rather, as a group of
individual investors.
▪ Accounting for partnership is influence by the
propriety theory, which views a partnership not
as a distinct entity but rather, as a group of
individual investors.
 Revaluation of Assets Approach
• Asset book values are increased to
their fair values
• The old partners’ capital accounts
are increased for their respective
share of the increase in the book
values of the assets
• The partnership’s total resulting
capital reflects the prior capital
balances plus the amount of asset
 Technological Institute of the Philippines
ACCTG 028 ‒ ACTCY31S1
Accounting for Special Transactions
revaluation plus the new partner’s
investment
 Record Unrecorded Goodwill
• Unrecorded goodwill is recorded
• The old partners’ capital accounts
are increased for their respective
shares of the goodwill
• The partnership’s total resulting
capital is now equal the prior
capital balances plus the goodwill
recognized plus the new partner’s
investment.
 Use the Bonus Method
• This method is used when the
partners do not wish to record
adjustments in asset accounts or
recognize goodwill.
• The old partners’ capital accounts
are increased for their respective
x`shares of the bonus paid by the
new partner.
• The partnership’s total resulting
capital account equals the prior
capital balances plus the new
partner’s investment.
A partnership rests upon a contractual foundation,
therefore, the life span of a partnership may be
somewhat uncertain since it depends on the moods and
relationships of the partners. Any circumstances which
cause the technical termination of a partnership may
lead to the partnership's permanent dissolution and
liquidation, if the partners so agree, Dissolution and
liquidation in relation to the partnership are not
synonymous. A partnership is said to be dissolved when
the original association for the purposes of carrying on
activities has ended. A partnership is said to be liquidated
when the business is terminated. Thus, a partnership
may be dissolved without being liquidated. While
dissolution may result to liquidation of a partnership,
liquidation always results to dissolution.
Partnership dissolution due to changes in ownership
interests occurs for variety of reasons. These can be
summarized as follows:
1. Admission of a partner
2. Retirement of a partner
3. Death of a partner
4. Incorporation of a partnership
In most cases, when a change in ownership occurs, the market
values of individual partnership assets and liabilities are
different from their book values. These differences can be
accounted for by recording them on the partnership books
either by adjusting the assets and liabilities - in many cases, by
adjusting the partners' capital accounts.
1.3.1 ADMISSION OF A NEW PARTNER
Admission of a New Partner
An existing partnership may admit a new partner with the
consent of all the partners. When a new partner is admitted,
the partnership is dissolved and a new partnership is formed.
Upon the admission of a new partner, a new agreement
covering partners' interests, profit and loss sharing and other
consideration should be drawn because the dissolution of the
original partnership cancel the original agreement.
The admission of a new partner may occur in either of two
ways, namely:
 Technological Institute of the Philippines
ACCTG 028 ‒ ACTCY31S1
Accounting for Special Transactions
1. Purchase of all or part of the interest of one or more
of the existing partners.
2. Investment of assets in the partnership by the
incoming partner.
1.3.1.1 BY PURCHASE OF INTEREST
Purchase of Interest from One or More Partners
One or more partners may sell their portion of the
business to an outside party. This type of transaction is
common in operations that rely primarily on monetary
capital rather than on the business expertise of the
partners.
The partner in making the transfer of ownership can
actually convey the following rights:
1. The right of co-ownership in the business
property. This right justifies the partnership
drawings from the business as well as the
settlement paid at liquidation or at the time of
partners' withdrawal.
2. The right to share in profits and losses.
3. The right to participate in the management of
the business.
When an incoming partner purchases a portion or all of
the interests of one or more of the original partners, the
partnership assets remain unchanged and no cash or
other assets flow from the new partner to the
partnership. This transaction is recorded by opening a
capital account for the new partner and decreasing the
capital accounts of the selling partners by the same
amount. The cash paid by the buyer is not recorded in
the books of the partnership for this is a personal
transaction between the selling partners and the buyer.
The gain or loss arising from the sale of interest is not to
be recorded in the partnership books.
1.3.1.2 BY INVESTMENT
New Partner Invests in Partnership
A new partner may acquire interest in the partnership by
investing in the business. In this case, the partnership
receives the cash or other assets, thereby increasing its
total assets as well as the total capital. This method of
admission is a transaction between the partnership and
the incoming partner. Three cases may exist when a new
partner invests in partnership:
Case 1: The new partner's investment (contributed
capital) equals the new partner's proportion of the
partnership's book value (agreed value)
Case 2: The new partner's investment is more than the
new partner's agreed capital. This indicates that the
partnership's prior net assets are undervalued on the
books.
Case 3: The new partner's investment is less than the
new partner's agreed capital. This suggests that the
partnership's prior net assets are overvalued on its
books.
The following steps/procedures may be used in
determining how to account for the admission of a new
partner:
 Technological Institute of the Philippines
ACCTG 028 ‒ ACTCY31S1
Accounting for Special Transactions
1. Compute the new partner's proportion of the
partnership's book value (agreed capital) as
follows:
Agreed Capital = Prior Capital of Old Partners +
Investment of the New Partner x % of Capital to
New Partner
2. Compare the new partner's contributed capital with
his or her agreed capital to determine the procedures
to be followed in accounting for his or her admission.
Case 1: Investment = Agreed Capital
▪ No revaluation or bonus
Case 2: Investment cost > Agreed Capital
▪ Revalue net assets up to fair value and
allocate to old partners.
▪ Allocate bonus to old partners.
Case 3: Investment cost < Agreed Capital
▪ Revalue net assets down to fair value and
allocate to old partners.
▪ Recognize goodwill brought in by new
partner.
▪ Assign bonus to new partner
1.3.2 WITHDRAWAL, RETIREMENT OR
DEATH OF A NEW PARTNER
Withdrawal or Retirement of a Partner
▪ When a partner retires or withdraws from the
partnership, the partnership is dissolved, but the
remaining partners may continue operating the
business.
▪ The existing partners may buy out the retiring
partner either by making a direct acquisition, OR
by having the partnership acquire the retiring
partner's interest
▪ If the present partner directly acquire the
retiring partner’s interest, the only entry on the
partnership’s books is to record the transfer of
capital.
▪ If the partnership acquires the interest of the
retiring partner, the partnership must pay the
retiring partner an amount equal to his interest
or less than his interest.
The interest of the retiring partner is usually measured
by his capital balance, increased or decreased by his
share in the following adjustment:
1. Profit or loss from the partnership
operations from the last closing date to the
date of his/her retirement.
2. Changes in the valuation of all assets and
liabilities (book values to fair values)
Death or Incapacity of a Partner
In the event of the death of a partner, the estate of the
deceased partner is entitled to receive the amount of his
interest in the partnership at the date of his death, The
deceased partner's capital is adjusted using his profit and
loss share percentage for changes in asset values arising
from revaluation of assets and for the profit from the
date the books were last closed. The balance of his
capital account after considering the necessary
adjustments should be transferred to a liability account
pending settlement.
 Technological Institute of the Philippines
ACCTG 028 ‒ ACTCY31S1
Accounting for Special Transactions
1.3.3 INCORPORATION OF A PARTNERSHIP
Incorporation of a Partnership
When a partnership is converted into a corporation, the
corporation takes over the assets and assume the
liabilities of the partnership in exchange for shares of
stocks. The stocks received by the partnership are
distributed in settlement of their interest. The partners
now become stockholders of the newly formed
corporation.
The accounting procedures in recording the
incorporation of the partnership will depend on whether
the original books of the partnership will be continued by
the corporation or new books will be opened.
Partnership Books Retained. If the partnership book are
retained, the steps to be taken are as follows:
1. Revalue the assets and recognize goodwill, if any
2. Close the partner's capital accounts to the corporate
capital accounts
New Books Opened for the Corporation. If new books are
to e opened, the old partnership books must be closed.
The accounting procedures may be outlined as follows:
In the Books of the Partnership:
1. Revalue the assets (and any other items agreed on)
in accordance with the agreed transfer values.
2. 2 Record the transfer of assets and liabilities to the
corporation and the receipt of capital stocks by the
partnership.
3. Record the distribution of stocks to the partners in
settlement of the balances of their capital accounts.
1.4 LIQUIDATION
Partnership Liquidation
Liquidation of a partnership means winding up the
business usually by (objectives):
▪ Convert the partnership assets to cash
(realization of assets)
▪ To pay off partnership obligations
▪ Distribute cash and any unrealized assets to the
individual partners. As a general rule, the cash
should be distributed as follows:
o First, to outside creditors
o Second, to partners for loan accounts
o Third, to partners for capital accounts.
The purpose of accounting during this period is to have
an equitable distribution of partnership cash to creditors
and partners. Hence, it is no longer income
determination that is the focus of accounting but rather,
the computation of gains or losses on realization of
assets which are to be subsequently allocated among the
partners, the payment of liabilities in accordance with
law and the final distribution of cash to partners.
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 distribution
any cash to partners.
2. When the business is liquidated, the partner is
entitled to an amount depending upon his
capital contribution, his drawing, his share in the
net income or loss from operations before
 Technological Institute of the Philippines
ACCTG 028 ‒ ACTCY31S1
Accounting for Special Transactions

liquidation, gains and losses on realization and 2. Installment Liquidation, otherwise called
the balance of his loan account, if any. Installment Distribution.
▪ Liquidation in installments is a process of
Each partner will receive in the final settlement the
realizing some assets, paying creditors,
amount of his equity in the business, The amount of a
paying remaining available cash to partners,
partner's equity is increased by the positive factors such
realizing additional assets and making
as investment of capital and share in the profits. It is
additional cash payment to partners.
decreased by the negative factors such as withdrawals
▪ The liquidation continues until all noncash
and share in the losses. If the negative factors are greater
assets had been realized and cash had been
than positive factors, the partners will have a deficiency
distributed to partnership creditors and
(debit balance) and he must pay the partnership the
partners.
amount of such deficiency, Failure to do so would mean
that his fellow partners would bear more than their
1.4.1 LUMP-SUM METHOD
contractual share in losses and they will consequently
Lump-Sum Liquidation
receive less than their equities in the business.
A lump-sum liquidation of a partnership is one in which
A debit balance in the partner's capital account may be
all the assets are converted into cash within a very short
caused by losses incurred in the realization of assets or
time, outside creditors are paid, and single lump-sum
by prorata absorption of an uncollectible deficit of a
payment is made to the partners for their total interests.
partner whose combined capital and loan accounts is not
enough to absorb the partner's share of total losses. Realization of Assets. Typically, a partnership will
experience losses on the sale of its assets. A partnership
Methods of Partnership Liquidation
may have a "Going Out of Business" sale in which its
When a partnership is to be liquidated by the sale of assets,
inventory is marked down well below normal selling
the following methods may be used:
price to encourage immediate sale. The partnership's

1. Lump-Sum Liquidation, otherwise called Total fixed assets may also be offered at a reduced price. The

Liquidation or Single Distribution. accounts receivable are actually collected by the

▪ A lump-sum liquidation of a partnership is partnership. Sometimes the partnership offers a large

one in which all the assets are converted into cash discount for prompt payment of any remaining

cash within a very short time, outside receivables whose collection may otherwise delay the

creditors are paid, and a single lump-sum termination of the partnership. Alternatively, the

payment is made to the partners for their receivables may be sold to a factor. A factor is a business

total interest. that specializes in acquiring accounts receivables and

immediately paying cash to the seller of the receivables.
 Technological Institute of the Philippines
ACCTG 028 ‒ ACTCY31S1
Accounting for Special Transactions

The partnership records the sale of the receivables, as it
would any other asset.
Before any distribution may be made to the partners,
either liabilities to outside creditors must be paid in full
or the necessary funds may be placed in an escrow
account. The escrow agent, usually a bank, uses the
funds only for payment of the partnership liabilities.
Expenses of Liquidation. During the liquidation process,
expenses are usually incurred, such as legal and
accounting expenses and advertising cost of selling the
assets. These expenses 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 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
1.4.2 INSTALLMENT METHOD
Installment Liquidation
Involves the selling of some assets, paying liabilities of
the partnership, dividing the available cash to the
partners, selling additional assets and making further
payments to partners. This process continues until all the
assets have been sold and all cash has been distributed
to the creditors and to partners.
Procedures 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 profit and loss ratio.
2. Pay liquidation expense and unrecorded
liabilities, if there are any and distribute these
among the partners using the profit and loss
ratio.
3. Pay the liabilities to outsiders.
4. 4, Distribute cash to partners after possible
future losses have been apportioned to partners
or in accordance with a cash distribution
program.
 Technological Institute of the Philippines
ACCTG 028 ‒ ACTCY31S1
Accounting for Special Transactions

*Eliminate any capital deficiency only before final possible loss to them because he is presumed unable to pay

payments to partners. anything to the firm.

Periodic Computation of Safe Payments to Partners Cash Withheld

The cash set aside in a separate fund is not a factor in

The Statement of partnership liquidation is usually
computing possible loss. It is the cash set aside to insure
supported by a schedule of safe installment payments to
payments of potential liquidation expenses, which may
partners, simply called Schedule of Safe Payments,
be incurred and unrecorded liabilities may be discovered.
prepared periodically. According to the schedule, each
This cash withheld is added to the total remaining non-
installment of cash is distributed as if no more cash is
cash assets to obtain the maximum possible loss needed
forthcoming, either from sale of assets or from collection
in the computation of safe installment payment. Also
of deficiencies from partners. Cash is therefore,
cash available for distribution to the partners for the
distributed to a partner only if he has an excess credit
period is net of the cash withheld.
balance in his partnership interest (i.e. capital account or
capital and loan account combined) after absorption of Unrecorded liabilities are obligations which are
his share of the maximum possible loss that may occur. discovered or incurred during the liquidation. These are
The possible loss (hypothetical loss) consists of the allocable to the partners according to their profit and loss
following: sharing agreement.

1. Total value of remaining non-cash assets. These

assets are assumed unrealizable (they cannot be
sold), hence, they are considered loss chargeable
to the partners.
2. Cash withheld to pay for anticipated liquidation
expenses and unrecorded liabilities that may
arise. The said expenses and liabilities represent
possible loss to the partners because upon their
payment, the amount paid is to be
correspondingly absorbed by the partners.

Additional loss may also accrue to the partners when a debit

balance in any of the capital accounts results from the
foregoing allocations of possible loss. The deficiency of any of
the partners is absorbed by the other partners as additional
 Technological Institute of the Philippines
ACCTG 028 ‒ ACTCY31S1
Accounting for Special Transactions

SUMMARY: MODULE 1 Case 2: Purchase of interest from all partners

CAPITAL INTEREST VS. PROFIT AND Assumption 1 Purchase at Book Value

LOSS INTEREST Assumption 2 Purchase at more than Book Value
Capital Interest is a claim against the net assets of the
Alternative 1: BOOK VALUE APPROACH
partnership as shown by the balance in the partner’s
Amount paid xx
capital account, while Interest in Profit or
Loss determines how the partner’s capital interest will Less: BV of interest acquires xx
increase or decrease as a result of subsequent Excess xx
operations.
Alternative 2: REVALUATION APPROACH

ASSIGNMENT OF AN INTEREST TO A Goodwill xx

THIRD PARTY A, Capital xx
A. Revaluation Approach B, Capital xx

--- The use of fair values provides an equitable

measure of each partner’s capital interest in the Amount paid -------------------------- xx
partnership. Less: BV interest Acquired --------- (xx)

--- Basis of valuation is fair value Excess ------------------------------------ xx

--- Results in a marked departure from the Divided by: Interest Acquired ------ xx

historical principle Revaluation of Asset Upward ------ xx

B. Absence of Revaluation
A, Capital (old + goodwill*interest acquires) xx
--- This approach would retain the historical
B, Capital (old + goodwill*interest acquires) xx
cost/changing value (BOOK VALUE APPROACH).
F, Capital xx

ADMISSION OF A NEW PARTNER

1. Admission by Purchase Interest
Case 1: Purchase of interest for one partner
Assumption 3: Purchase at less than Book Value
In Book Value approach, same format but it is a loss,
while, in Revaluation approach, same format but it is
downward.

▪ Prefer Book Value if Profit and Loss interest >

A, Capital xx capital interest, otherwise, use revaluation
approach.
B, Capital xx
 Technological Institute of the Philippines
ACCTG 028 ‒ ACTCY31S1
Accounting for Special Transactions

2. Admission by Investment 2. The change in the form of proprietorship. A

revaluation account may be debited to losses
Any gain or loss are recognized on sales subsequent to
and credited with gains from revaluation, and
recording the admission will be allocated on the basis of
the balance may subsequently be closed into the
the new profit and loss ratio.
capital accounts in the Profit and Loss Ratio.
TCC = TAC - No Adjustment
New books for the corporation.
TCC > TAC - overstatement of the asset or diminution in In Accounting Record of Partnership
partner’s capital
1. Prepare J.E. for revaluation of assets, including

TCC < TAC - unrecorded net assets or the required recognition of goodwill.

additional investment in partner’s capital
CC = AC - No transfer of capital
CC > AC - Capital transfer or bonus to old partners
2. Record any cash withdrawal necessary to adjust
parties’ capital account balances to round amounts
3. Record the transfer of assets and liabilities to the
corporation, the receipt of the corporation’s common
stock by partnership, and the distribution of the

CC < AC - Additional Capital credit (either bonus or common stock to the partners in settlement of the
goodwill) from the old partners. balances of their capital accounts.

TOTAL AGREED CAPITAL XX In the Accounting Records of the Corporation

LESS: TOTAL CONTRIBUTED CAPITAL XX 1. Record the acquisition of assets and liabilities
from the partnership at current fair values.
DIFFERENCE XX
2. Record the issuance of common stock at current
fair value in payment of the obligation to the
In bonus, if there’s a revaluation of assets, they cannot
partnership.
recognize. But if revaluation method is used, they
affected the partner’s capital account.

In the absence of approach to be used, bonus approach

should apply.

INCORPORATION OF A PARTNERSHIP PARTNERSHIP LIQUIDATION

Partnership Books are Retained The phase of partnership operations which begins after
1. Change in assets and liability values in the dissolution and ends with the termination of a
partner’s interest prior to corporation
 Technological Institute of the Philippines
ACCTG 028 ‒ ACTCY31S1
Accounting for Special Transactions

partnership activities referred to as "winding up the Is one in which all assets are converted into cash within
affairs." a very short time, creditors are paid, and a single, lump-
sum payment is made the partners for their capital
BASIC PROCEDURES IN LIQUIDATION
interest.
PROCEDURES FOR MINIMIZING INEQUITIES
AMONG PARTNERS 1. Realization and distribution of gain or loss to
1. Sharing Gains and Losses. When a all partners on the basis of profit and loss
partnership is liquidated, the books should ratio.
be adjusted and have closed the net profit or 2. Payment of liquidation expenses, if any.
loss for the period in the manner they have 3. Payment of liabilities to third parties.
agreed in the partnership agreement. 4. Elimination of capital deficiencies.
2. Advance planning when the partnership is 5. Payment to partners (in order)
formed.
3. Rules on setoff- Partnership Loans a. loan accounts
(Receivable) to the partners b. capital accounts

4. Rules on set off- Partner (Payable) loans to

INSTALLMENT LIQUIDATION
the partnership—depends upon the
Is a process of realizing some assets, paying creditors,
situation.
paying the remaining available cash to partners, realizing
▪ Legal doctrine of setoff- whereby a deficit
additional assets, and making additional cash payment to
balance in partner’s capital account may be
partners.
set off against any balance existing in his/her
loan account. A. SCHEDULE OF SAFE PAYMENTS
5. Liquidation expenses. Certain cost incurred
A.1. Assume total loss on all remaining non-cash
during the liquidation process should be
assets. Provide all possible losses, including potential
treated as a reduction of the proceeds from
liquidation cost and unrecorded liabilities.
the sale of non-cash asset. Other liquidation
costs should be treated as expenses. Possible Loss = amount of unrealized non-cash assets +
6. Marshalling of assets. This doctrine is amount of cash withheld (i.e., unrecorded unpaid
applied when the partnership and/or one or expenses, and anticipated liquidation expenses)
more of the partners are insolvent.
A.2. Assume that partners with a potential capital
7. Distribution of cash or other assets to
deficit will be unable to pay anything to the partnership
partners.
(assume to be personally insolvent)

LUMP-SUM LIQUIDATION
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ACCTG 028 ‒ ACTCY31S1
Accounting for Special Transactions

▪ Hypothetical or assumed deficit balance is 1. Ranking the Partners

allocated to the partners who have credit
balances using profit and loss ratio. This
portion is the maximum potential loss on
non-cash assets.
▪ Any capital deficiencies that may result in
other partners as a result of a maximum loss
on non-cash assets.
▪ Schedule of Safe Payments is effective
method of computing the amount of safe
2. Total interest(equity) account=balance of the
capital account + loan receivable (-)/loan payable
(+) to the partner
3. Loss Absorption / Power / Abilities / Potential /
Maximum Loss Absorbable = Total Interest
Account / Profit and Loss assigned Ratio
VULNERABILITY RANKINGS
Lowest absorption abilities is the most vulnerable to

payments to partners and preventing partnership losses.

excessive payments on any partners.

LIMITATION OF CASH PRIORITY PROGRAM
▪ It is inefficient, if numerous installment
1. The program is operable only after outside creditors
distributions are made to partners.
have been paid in full.
▪ It is deficient as a planning device because it
2. Reflects only the order in which cash distribution to
does provide information, but it can be
partners will be made if cash is available to distribute
overcome by preparing cash distribution 3. The sequence of distribution of cash in the program
plan at the start of the liquidation process. coincides with the sequence that would result if cash
were distributed using the schedule of safe payment
B. CASH PRIORITY PROGRAM
 Technological Institute of the Philippines
ACCTG 028 ‒ ACTCY31S1
Accounting for Special Transactions

The Securities and Exchange Commission may appoint a

MODULE 2 ‒ CORPORATE
receiver or a trustee following the filing of a petition for
LIQUIDATION
liquidation or bankruptcy. The duties of the receiver in a
2.0 CORPORATE LIQUIDATION liquidation focuses on the realization of assets and the
payment of liabilities rather than on the preservation and
Corporations get into financial difficulty for a large
continuation of the business. In the course of the
variety of reasons. A company may suffer from continued
liquidation, the receiver may continue business activity if
losses from operations, overextended credit to
that is in the interest of an orderly liquidation.
customers, poor management or working capital, failure
to react changes in economic conditions, inadequate Financial Report
financing and a host of other reasons for not sustaining a
Corporation in liquidation usually prepares two classes of
viable economic position.
financial reports. First, which is the initial report shows
Insolvency the available asset values and debts of the debtor
corporation. This report is known as the Statement of
A debtor corporation is considered insolvent when it is
Affairs. The second, is the periodic report of the receiver
unable to pay its debts as they come due. In the legal
known as the Statement of Realization and Liquidation,
sense, a business enterprise is insolvent when, its
this shows how the receiver managed the assets of the
financial condition is such that the sum of all its debt is
debtor corporation on behalf of the creditors.
greater than all of its assets at fair valuation. Thus, a
corporation remains solvent as long as the fair value of
2.1 STATEMENT OF AFFAIRS
its assets exceeds its liabilities, even if it cannot meet its
current obligation because of an insufficiency of liquid
Statement of Affairs

resources. Debtor Corporations that are insolvent has a
large number of alternatives, such as liquidation,
reorganization or debt restructuring.
Corporate Liquidation
This process can be initiated by the company by filing a
voluntary petition with the Securities and Exchange
Commission (SEC). T he corporation is given three years
from the date of approval within which to wind up its
affairs.
Normally, at the start of the liquidation, a statement of
affairs is prepared for the corporation to provide
information about the current financial position of the
company. The Statement of Affairs is not a going concern
report, it is an important planning report for the
anticipated liquidation of a company. Thus, historical
cost figures are not relevant. The various parties
concerned desire information that reflects 1) the net
realizable value of the debtor's assets and 2) the ultimate
application of these proceeds to specific liabilities.
 Technological Institute of the Philippines
ACCTG 028 ‒ ACTCY31S1
Accounting for Special Transactions

The assets and liabilities are reported according to the
classifications relevant to liquidation. Consequently,
assets are classified into three categories as follows:
1. Assets pledged to fully secured creditors ‒ Certain
assets can 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
claims of equity holders are extinguished. Only if there
are free assets in excess of unsecured liabilities can
stockholders share any distributions.
2.3 STATEMENT OF REALIZATION AND
LIQUIDATION
Statement of Realization and Liquidation
This statement shows a complete record of the

Ex. The building with an estimated realizable of transaction of the receiver for a period of time. It

P3,000,000 which secures a P2,000,000 mortgage liability, structure is similar to a T account and is composed of
is an example of an asset pledged to a fully secured three elements: asset transactions, and income/loss
creditor. After the mortgage is paid, P1,000,000 remains transactions.
for unsecured creditors.
The first duty of the receiver is to realize the assets, that
2. Assets pledged to partially secured creditors – Other is to covert the non-cash assets into cash so that the
assets that are pledged as security for a particular
creditors can be paid. The process of realization may be
liability. Partial payment of the liability will utilize the
done in several ways, some assets may be realized by
entire asset value; nothing will be left for the
normal operations, such as the continuing collections of
unsecured liabilities.
receivables from customers. Other assets can be realized
Ex. The equipment with an estimated realizable value of by sale. During realization, gains and losses on asset sales
P30,000 which secures a P50,000 note payable, is an
may occur, expenses may be incurred and revenues can
example of an asset pledged to a partially secured
be earned. The realization activities may be presented in
creditor.
T account format.
3. Free Assets ‒ Assets that is not pledged as security for
The second task of the receiver is to liquidate the
any particular liability, and thus available to meet the
claims of priority liabilities and unsecured creditors.
liabilities, that is to make full or partial settlement with

Free assets also include the value of assets pledged to the creditors. Again, gains or losses may occur in the
fully secured creditors in excess of the related liability. process of liquidation, as may expenses or revenues. The
liquidation activities may also be presented in T account
2.2 STATEMENT OF DEFICIENCY format.
The balances of the Stockholder's equity account depend
on the amount of free assets available. If there is a
deficiency of assets to satisfy unsecured creditors, all
 Technological Institute of the Philippines
ACCTG 028 ‒ ACTCY31S1
Accounting for Special Transactions
Statement of Realization and Liquidation
(+) Assets to be Realized ‒ identifies the individual
assets to which the trustee has taken title from the
debtor.
(+) Assets Acquired ‒ itemized the assets discovered
from operating activities during the period.
(−) Assets Realized ‒ identifies proceeds received
from the conversion of specific assets.
(−) Assets Not Realized ‒ identifies the assets
remaining with the trustee at the end of the
reporting period.
(−) Liabilities Liquidated ‒ identifies specific
liabilities paid by the trustee.
(−) Liabilities not Liquidated ‒ reflects those that
remain to be paid by the trustee.
(+) Liabilities to be Liquidated ‒ identifies the
liabilities that the trustee took responsibility at the
date of appointment.
(+) Liabilities Incurred ‒ reflects those that remains
to be paid by the trustee.
(+) Supplementary Charges (excluding assets losses
and write-offs)
(+) Supplementary Credits (revenue excluding gains
on assets realization and liability settlements)
2.4 DETERMINATIONS OF THE ORDER OF
PRIORITY OF CLAIMANTS OF COMPANY
ASSETS SUBJECT TO LIQUIDATION
The liabilities of the company are classified into four
categories as follows:
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 the order of
payment, the claim 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 exceed the
amount of the liability.
Ex. 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.
Ex. 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
 Technological Institute of the Philippines
ACCTG 028 ‒ ACTCY31S1
Accounting for Special Transactions

P30,000. This note is partially secured and the Statement of Affairs ‒ financial condition prepared for a
finance company is referred to as a partially secured corporation entering into the stage of liquidation or
creditor. bankruptcy.

4. Unsecured Creditors ‒ All other liabilities for Assets

which the creditor has no lien on any specific
1. Assets Pledged with Fully Secured Creditors ‒
assets of the debtor corporation are unsecured.
expected to realize an amount at least sufficient
This includes the unsecured portion of the
to satisfy the related debt.
liability to partially secured creditors.
2. Assets Pledged with Partially Secured

Ex. There is a note payable to the finance company Creditors ‒ expected to realize an amount below

for P50,000 secured by the equipment worth the related debt.

P30,000, the difference of P20,000 is added to the 3. Free Assets ‒ are not pledged and are available

unsecured liabilities. to satisfy the claims of creditors with priority,

partially secured creditors, and unsecured
creditors.

SUMMARY: MODULE 2 Liabilities

Insolvency ‒ it is an inability to pay off its liabilities as
1. Fully Secured Liabilities ‒ expect to be paid in full as a
they become due and demandable. In Legal View, it is as
result of their having sufficient collateral to satisfy the
a financial condition in which the sum of all debts is
indebtedness.
greater than all of its assets at a fair valuation.
2. Partially Secured Liabilities ‒ have collateral, the
Role of Creditors ‒ outside creditors appoint a trustee
proceeds of which are expected to be insufficient to
to manage the debtor’s state.
satisfy the indebtedness.

Roles of Trustees 3. Unsecured Liabilities with Priority ‒ have priority

under the law (Section 50 Insolvency Law).
1. Continue operating the debtor’s business if
directed by the court 4. Unsecured Liabilities (General Creditors) ‒ have no
2. Realizes free assets of the debtor’s estate
collateral relating to their indebtedness.
3. Pay cash to unsecured creditors

Role of Accountant ‒ concerned with proper reporting of Estimated recovery % or dividend to general
the financial condition of the debtor and adequate unsecured creditors = net free assets/total
unsecured creditors
accounting and reporting for the trustee.
 Technological Institute of the Philippines
ACCTG 028 ‒ ACTCY31S1
Accounting for Special Transactions

Statement of Realization and Liquidation ‒ an activity

statement progress toward the liquidation of a debtor’s
state. It shows the actual transactions that transpired
during the period covered