Module 1 To 6 Accounting For Special Transactions

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
Partnerships are a popular form of business because profits
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
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
paid or assumed by the partnership by 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
 The accurate determination of periodic net
than to the partner's drawing account. On the other
income and its distribution to the partners is
hand, an advance to the partnership by a partner with
still the primary objective of the accounting
the assumption of its ultimate repayment by the
process.
partnership is viewed as a loan rather than as an
 Net income is computed in the usual manner,
increase in the capital account. This type of transaction
that is matching revenues and expenses, then
is credited to the Loan's payable or notes payable if the
credited to the individual capital accounts.
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
partners, and in time spent on partnership duties by the  That if no agreement is made between

individual partners, and among the partners, profits and
losses are to be divided according to
their original capital contributions.
Division of Profits and Losses
The partnership law provides that profits and losses of 1.3 DISSOLUTION/CHANGES IN OWNERSHIP
INTEREST
the partnership are to be divided in accordance with the
partners agreement. If no agreement is made between Partnership Dissolution/Changes in Ownership
Interest
and among the partners, profits and losses are to be
divided according to their original capital contributions.  Partnership dissolution is defined as “the
Should the partners agree to divide the profits only, change in the relation of the partners caused by
losses, if any are to be divided in the same manner as any partner ceasing to be associated in the
that of dividing profits. However, should the partners carrying on as distinguished from the winding
agree to divide losses only, profits, if any shall be up of the business.
divided by the partners according to capital  Accounting for partnership is influence by the
contributions. propriety theory, which views a partnership not

as a distinct entity but rather, as a group of
The ratio in which the partnership profits and losses are
individual investors.
divided is known as the profit and loss ratio. The many
 Accounting for partnership is influence by the
possible methods of dividing net income or loss among
propriety theory, which views a partnership not
partners can be summarized as follows:
as a distinct entity but rather, as a group of
1. Equally individual investors.
2. In an unequal or arbitrary ratio  Revaluation of Assets Approach
3. In the ratio of partners capital account balances  Asset book values are increased to
on a particular date, or in the ratio of average their fair values
capital account balances during the year.  The old partners’ capital accounts
4. Allowing interest on partners' capital account are increased for their respective
balances and dividing the remaining net income share of the increase in the book
or loss in a specified ratio. values of the assets
5. Allowing salaries to partners and dividing the  The partnership’s total resulting
remaining net income or loss in a specified ratio capital reflects the prior capital
6. Bonus to managing partner based on net balances plus the amount of asset
income.
revaluation plus the new partner’s synonymous. A partnership is said to be dissolved when
investment the original association for the purposes of carrying on
 Record Unrecorded Goodwill activities has ended. A partnership is said to be
 Unrecorded goodwill is recorded liquidated when the business is terminated. Thus, a
 The old partners’ capital accounts partnership may be dissolved without being liquidated.
are increased for their respective While dissolution may result to liquidation of a
shares of the goodwill partnership, liquidation always results to dissolution.
 The partnership’s total resulting
Partnership dissolution due to changes in ownership
capital is now equal the prior
interests occurs for variety of reasons. These can be
capital balances plus the goodwill
summarized as follows:
recognized plus the new partner’s
investment. 1. Admission of a partner
 Use the Bonus Method 2. Retirement of a partner

3. Death of a partner
 This method is used when the
4. Incorporation of a partnership
partners do not wish to record
adjustments in asset accounts or In most cases, when a change in ownership occurs, the
recognize goodwill. market values of individual partnership assets and liabilities
 The old partners’ capital accounts are different from their book values. These differences can be
are increased for their respective accounted for by recording them on the partnership books
x`shares of the bonus paid by the either by adjusting the assets and liabilities - in many cases,
new partner. by adjusting the partners' capital accounts.
 The partnership’s total resulting
capital account equals the prior
1.3.1 ADMISSION OF A NEW PARTNER
capital balances plus the new
Admission of a New Partner
partner’s investment.
An existing partnership may admit a new partner with the
A partnership rests upon a contractual foundation, consent of all the partners. When a new partner is admitted,
therefore, the life span of a partnership may be the partnership is dissolved and a new partnership is formed.
somewhat uncertain since it depends on the moods and Upon the admission of a new partner, a new agreement
relationships of the partners. Any circumstances which covering partners' interests, profit and loss sharing and other
cause the technical termination of a partnership may consideration should be drawn because the dissolution of the
lead to the partnership's permanent dissolution and original partnership cancel the original agreement.
liquidation, if the partners so agree, Dissolution and The admission of a new partner may occur in either of two
liquidation in relation to the partnership are not ways, namely:
1. Purchase of all or part of the interest of one or more transaction between the selling partners and the buyer.
of the existing partners. The gain or loss arising from the sale of interest is not to
2. Investment of assets in the partnership by the be recorded in the partnership books.
incoming partner.
1.3.1.2 BY INVESTMENT
1.3.1.1 BY PURCHASE OF INTEREST
New Partner Invests in Partnership
Purchase of Interest from One or More Partners
A new partner may acquire interest in the partnership
One or more partners may sell their portion of the
by investing in the business. In this case, the partnership
business to an outside party. This type of transaction is
receives the cash or other assets, thereby increasing its
common in operations that rely primarily on monetary
total assets as well as the total capital. This method of
capital rather than on the business expertise of the
admission is a transaction between the partnership and
partners.
the incoming partner. Three cases may exist when a
The partner in making the transfer of ownership can new partner invests in partnership:
actually convey the following rights:
Case 1: The new partner's investment (contributed
1. The right of co-ownership in the business capital) equals the new partner's proportion of the
property. This right justifies the partnership partnership's book value (agreed value)
drawings from the business as well as the
Case 2: The new partner's investment is more than the
settlement paid at liquidation or at the time of
new partner's agreed capital. This indicates that the
partners' withdrawal.
partnership's prior net assets are undervalued on the
2. The right to share in profits and losses.
books.
3. The right to participate in the management of
the business. Case 3: The new partner's investment is less than the
new partner's agreed capital. This suggests that the
When an incoming partner purchases a portion or all of
partnership's prior net assets are overvalued on its
the interests of one or more of the original partners, the
books.
partnership assets remain unchanged and no cash or
other assets flow from the new partner to the The following steps/procedures may be used in
partnership. This transaction is recorded by opening a determining how to account for the admission of a new
partner:
capital account for the new partner and decreasing the
capital accounts of the selling partners by the same 1. Compute the new partner's proportion of the
amount. The cash paid by the buyer is not recorded in partnership's book value (agreed capital) as
the books of the partnership for this is a personal follows:
Agreed Capital = Prior Capital of Old Partners +  If the present partner directly acquire the
Investment of the New Partner x % of Capital to retiring partner’s interest, the only entry on the
New Partner
partnership’s books is to record the transfer of
2. Compare the new partner's contributed capital with
capital.
his or her agreed capital to determine the
 If the partnership acquires the interest of the
procedures to be followed in accounting for his or
retiring partner, the partnership must pay the
her admission.
retiring partner an amount equal to his interest
Case 1: Investment = Agreed Capital or less than his interest.
 No revaluation or bonus
The interest of the retiring partner is usually measured
Case 2: Investment cost > Agreed Capital by his capital balance, increased or decreased by his
 Revalue net assets up to fair value and share in the following adjustment:
allocate to old partners.

1. Profit or loss from the partnership
 Allocate bonus to old partners.
operations from the last closing date to the
Case 3: Investment cost < Agreed Capital date of his/her retirement.

2. Changes in the valuation of all assets and
 Revalue net assets down to fair value and
liabilities (book values to fair values)
allocate to old partners.
 Recognize goodwill brought in by new Death or Incapacity of a Partner
partner.
In the event of the death of a partner, the estate of the
 Assign bonus to new partner
deceased partner is entitled to receive the amount of
his interest in the partnership at the date of his death,
1.3.2 WITHDRAWAL, RETIREMENT OR DEATH
OF A NEW PARTNER The deceased partner's capital is adjusted using his
Withdrawal or Retirement of a Partner profit and loss share percentage for changes in asset
values arising from revaluation of assets and for the
 When a partner retires or withdraws from the
profit from the date the books were last closed. The
partnership, the partnership is dissolved, but
balance of his capital account after considering the
the remaining partners may continue operating
necessary adjustments should be transferred to a
the business.
liability account pending settlement.
 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
1.3.3 INCORPORATION OF A PARTNERSHIP 3. Record the distribution of stocks to the partners in

settlement of the balances of their capital accounts.
Incorporation of a Partnership
When a partnership is converted into a corporation, the 1.4 LIQUIDATION

corporation takes over the assets and assume the Partnership Liquidation
liabilities of the partnership in exchange for shares of
Liquidation of a partnership means winding up the
stocks. The stocks received by the partnership are
business usually by (objectives):
distributed in settlement of their interest. The partners
now become stockholders of the newly formed  Convert the partnership assets to cash
corporation. (realization of assets)

 To pay off partnership obligations
The accounting procedures in recording the
 Distribute cash and any unrealized assets to the
incorporation of the partnership will depend on
individual partners. As a general rule, the cash
whether the original books of the partnership will be
should be distributed as follows:
continued by the corporation or new books will be o First, to outside creditors
opened. o Second, to partners for loan accounts
o Third, to partners for capital accounts.
Partnership Books Retained. If the partnership book are
retained, the steps to be taken are as follows: The purpose of accounting during this period is to have
an equitable distribution of partnership cash to
1. Revalue the assets and recognize goodwill, if any
2. Close the partner's capital accounts to the corporate creditors and partners. Hence, it is no longer income
capital accounts determination that is the focus of accounting but rather,

the computation of gains or losses on realization of
New Books Opened for the Corporation. If new books
assets which are to be subsequently allocated among
are to e opened, the old partnership books must be
the partners, the payment of liabilities in accordance
closed. The accounting procedures may be outlined as
with law and the final distribution of cash to partners.
follows:
There are certain rules that should be followed in the
In the Books of the Partnership:
liquidation of the partnership namely:
1. Revalue the assets (and any other items agreed on)
1. Always allocate and close gains or losses to the
in accordance with the agreed transfer values.
partners' capital accounts prior to distribution
2. 2 Record the transfer of assets and liabilities to the
corporation and the receipt of capital stocks by the any cash to partners.
partnership. 2. When the business is liquidated, the partner is

entitled to an amount depending upon his
capital contribution, his drawing, his share in payment is made to the partners for their
the net income or loss from operations before total interest.
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
assets had been realized and cash had been
greater than positive factors, the partners will have a
distributed to partnership creditors and
deficiency (debit balance) and he must pay the
partners.
partnership the amount of such deficiency, Failure to do
so would mean that his fellow partners would bear
1.4.1 LUMP-SUM METHOD
more than their contractual share in losses and they will
Lump-Sum Liquidation
consequently receive less than their equities in the
business. A lump-sum liquidation of a partnership is one in which
all the assets are converted into cash within a very short
A debit balance in the partner's capital account may be
time, outside creditors are paid, and single lump-sum
caused by losses incurred in the realization of assets or
payment is made to the partners for their total
by prorata absorption of an uncollectible deficit of a
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 cash discount for prompt payment of any remaining
into 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
receivables may be sold to a factor. A factor is a b. If the deficient partner is solvent, make
business that specializes in acquiring accounts him invest cash to eliminate his
receivables and immediately paying cash to the seller of deficiency.
the receivables. The partnership records the sale of the c. If the deficient partner is insolvent, let
receivables, as it would any other asset. the other partners absorb his deficiency
5. Payment to partners (in order of priority)
Before any distribution may be made to the partners,
a. Loan accounts
either liabilities to outside creditors must be paid in full
b. Capital accounts
or the necessary funds may be placed in an escrow
account. The escrow agent, usually a bank, uses the
1.4.2 INSTALLMENT METHOD
funds only for payment of the partnership liabilities.
Installment Liquidation
Expenses of Liquidation. During the liquidation process,
Involves the selling of some assets, paying liabilities of
expenses are usually incurred, such as legal and
the partnership, dividing the available cash to the
accounting expenses and advertising cost of selling the
partners, selling additional assets and making further
assets. These expenses are allocated to partners' capital
payments to partners. This process continues until all
accounts in their profit and loss ratio.
the assets have been sold and all cash has been
Liquidation Procedures. The following procedure may distributed to the creditors and to partners.
be used in lump-sum liquidation.
Procedures for Liquidation by Installment
1. Realization of assets and distribution of gain or
The following are the accounting procedures that may
loss on realization among the partners based on
be followed in liquidating a partnership by installments.
the profit and loss ratio.
2. Payment of expenses 1. Record the realization of assets and distribute
3. Payment of liabilities the realized gains or losses among the partners
4. Elimination of partner's capital deficiencies. If using profit and loss ratio.
after the distribution of loss on realization, a 2. Pay liquidation expense and unrecorded
partner incurs a capital deficiency (i.e. partner's liabilities, if there are any and distribute these
share of realization loss exceeds his capital among the partners using the profit and loss
credit) this deficiency must be eliminated by ratio.
using one of the following methods, in order of 3. Pay the liabilities to outsiders.
priority. 4. 4, Distribute cash to partners after possible
a. If the deficient partner has a loan future losses have been apportioned to
balance, exercise the right of offset,
partners or in accordance with a cash the partners is absorbed by the other partners as additional
distribution program. possible loss to them because he is presumed unable to pay

anything to the firm.
*Eliminate any capital deficiency only before final
payments to partners. Cash Withheld
The cash set aside in a separate fund is not a factor in

Periodic Computation of Safe Payments to Partners
computing possible loss. It is the cash set aside to insure
The Statement of partnership liquidation is usually payments of potential liquidation expenses, which may
supported by a schedule of safe installment payments be incurred and unrecorded liabilities may be
to partners, simply called Schedule of Safe Payments, discovered. This cash withheld is added to the total
prepared periodically. According to the schedule, each remaining non-cash assets to obtain the maximum
installment of cash is distributed as if no more cash is possible loss needed in the computation of safe
forthcoming, either from sale of assets or from installment payment. Also cash available for distribution
collection of deficiencies from partners. Cash is to the partners for the period is net of the cash
therefore, distributed to a partner only if he has an withheld.
excess credit balance in his partnership interest (i.e.
Unrecorded liabilities are obligations which are
capital account or capital and loan account combined)
discovered or incurred during the liquidation. These are
after absorption of his share of the maximum possible
allocable to the partners according to their profit and
loss that may occur. The possible loss (hypothetical loss)
loss sharing agreement.
consists of the following:
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
B, Capital xx
SUMMARY: MODULE 1
CAPITAL INTEREST VS. PROFIT AND Case 2: Purchase of interest from all partners
LOSS INTEREST Assumption 1 Purchase at Book Value
Capital Interest is a claim against the net assets of the
Assumption 2 Purchase at more than Book Value
partnership as shown by the balance in the partner’s
Alternative 1: BOOK VALUE APPROACH
capital account, while Interest in Profit or
Loss determines how the partner’s capital interest will Amount paid xx
increase or decrease as a result of subsequent Less: BV of interest acquires xx
operations.
Excess xx
ASSIGNMENT OF AN INTEREST TO A Alternative 2: REVALUATION APPROACH

THIRD PARTY Goodwill xx
A. Revaluation Approach
A, Capital xx
--- The use of fair values provides an equitable B, Capital xx
measure of each partner’s capital interest in the
partnership. Amount paid -------------------------- xx
--- Basis of valuation is fair value Less: BV interest Acquired --------- (xx)
--- Results in a marked departure from the Excess ------------------------------------ xx
historical principle Divided by: Interest Acquired ------ xx
Revaluation of Asset Upward ------ xx

B. Absence of Revaluation

--- This approach would retain the historical
A, Capital (old + goodwill*interest acquires) xx
cost/changing value (BOOK VALUE APPROACH).
B, Capital (old + goodwill*interest acquires) xx
ADMISSION OF A NEW PARTNER F, Capital xx
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,
A, Capital xx while, in Revaluation approach, same format but it is
downward.
 Prefer Book Value if Profit and Loss interest >

capital interest, otherwise, use revaluation
approach.
INCORPORATION OF A PARTNERSHIP
2. Admission by Investment Partnership Books are Retained
Any gain or loss are recognized on sales subsequent to 1. Change in assets and liability values in the
recording the admission will be allocated on the basis of partner’s interest prior to corporation
the new profit and loss ratio. 2. The change in the form of proprietorship. A
revaluation account may be debited to losses
TCC = TAC - No Adjustment
and credited with gains from revaluation, and
TCC > TAC - overstatement of the asset or diminution in the balance may subsequently be closed into
partner’s capital the capital accounts in the Profit and Loss Ratio.
TCC < TAC - unrecorded net assets or the required New books for the corporation.
additional investment in partner’s capital
In Accounting Record of Partnership
CC = AC - No transfer of capital
CC > AC - Capital transfer or bonus to old partners

1. Prepare J.E. for revaluation of assets,
including recognition of goodwill.

CC < AC - Additional Capital credit (either bonus or
goodwill) from the old partners.
2. Record any cash withdrawal necessary to
adjust parties’ capital account balances to round

TOTAL AGREED CAPITAL XX
amounts
LESS: TOTAL CONTRIBUTED CAPITAL XX
DIFFERENCE XX 3. Record the transfer of assets and liabilities
to the corporation, the receipt of the corporation’s

In bonus, if there’s a revaluation of assets, they cannot common stock by partnership, and the distribution
recognize. But if revaluation method is used, they of the common stock to the partners in settlement of
affected the partner’s capital account. the balances of their capital accounts.
In the absence of approach to be used, bonus approach In the Accounting Records of the Corporation
should apply. 1. Record the acquisition of assets and liabilities

from the partnership at current fair values.
2. Record the issuance of common stock at current set off against any balance existing in
fair value in payment of the obligation to the his/her loan account.
partnership. 5. Liquidation expenses. Certain cost incurred

during the liquidation process should be
treated as a reduction of the proceeds from
the sale of non-cash asset. Other liquidation
costs should be treated as expenses.
6. Marshalling of assets. This doctrine is
applied when the partnership and/or one or
PARTNERSHIP LIQUIDATION
more of the partners are insolvent.
The phase of partnership operations which begins after
7. Distribution of cash or other assets to
dissolution and ends with the termination of a
partners.
partnership activities referred to as "winding up the
affairs." LUMP-SUM LIQUIDATION
BASIC PROCEDURES IN LIQUIDATION Is one in which all assets are converted into cash within
PROCEDURES FOR MINIMIZING INEQUITIES a very short time, creditors are paid, and a single, lump-
AMONG PARTNERS sum payment is made the partners for their capital
1. Sharing Gains and Losses. When a interest.
partnership is liquidated, the books should

1. Realization and distribution of gain or loss
be adjusted and have closed the net profit
to all partners on the basis of profit and loss
or loss for the period in the manner they
ratio.
have agreed in the partnership agreement.
2. Payment of liquidation expenses, if any.
2. Advance planning when the partnership is
3. Payment of liabilities to third parties.
formed.
4. Elimination of capital deficiencies.
3. Rules on setoff- Partnership Loans
5. Payment to partners (in order)
(Receivable) to the partners
a. loan accounts
4. Rules on set off- Partner (Payable) loans to b. capital accounts
the partnership—depends upon the
INSTALLMENT LIQUIDATION
situation.
Is a process of realizing some assets, paying creditors,
 Legal doctrine of setoff- whereby a deficit paying the remaining available cash to partners,
balance in partner’s capital account may be realizing additional assets, and making additional cash
payment to partners.
A. SCHEDULE OF SAFE PAYMENTS overcome by preparing cash distribution

plan at the start of the liquidation process.
A.1. Assume total loss on all remaining non-cash
assets. Provide all possible losses, including potential B. CASH PRIORITY PROGRAM

liquidation cost and unrecorded liabilities.
1. Ranking the Partners
Possible Loss = amount of unrealized non-cash assets + 2. Total interest(equity) account=balance of the
amount of cash withheld (i.e., unrecorded unpaid capital account + loan receivable (-)/loan payable
expenses, and anticipated liquidation expenses) (+) to the partner
3. Loss Absorption / Power / Abilities / Potential /
A.2. Assume that partners with a potential capital
Maximum Loss Absorbable = Total Interest
deficit will be unable to pay anything to the partnership
Account / Profit and Loss assigned Ratio
(assume to be personally insolvent)
VULNERABILITY RANKINGS
 Hypothetical or assumed deficit balance is
allocated to the partners who have credit Lowest absorption abilities is the most vulnerable to
balances using profit and loss ratio. This partnership losses.
portion is the maximum potential loss on

LIMITATION OF CASH PRIORITY PROGRAM
non-cash assets.
 Any capital deficiencies that may result in
other partners as a result of a maximum
1. The program is operable only after outside
creditors have been paid in full.

loss on non-cash assets.
 Schedule of Safe Payments is effective
method of computing the amount of safe
2. Reflects only the order in which cash
distribution to partners will be made if cash is

payments to partners and preventing
available to distribute
excessive payments on any partners.
 It is inefficient, if numerous installment
distributions are made to partners.
3. The sequence of distribution of cash in the
program coincides with the sequence that would

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

information about the current financial position of the
Corporate Liquidation company. The Statement of Affairs is not a going
This process can be initiated by the company by filing a concern report, it is an important planning report for
voluntary petition with the Securities and Exchange the anticipated liquidation of a company. Thus,
Commission (SEC). T he corporation is given three years historical cost figures are not relevant. The various
from the date of approval within which to wind up its parties concerned desire information that reflects 1) the
affairs. net realizable value of the debtor's assets and 2) the

ultimate application of these proceeds to specific
The Securities and Exchange Commission may appoint a liabilities.
receiver or a trustee following the filing of a petition for
liquidation or bankruptcy. The duties of the receiver in a
The assets and liabilities are reported according to the 2.2 STATEMENT OF DEFICIENCY
classifications relevant to liquidation. Consequently,
assets are classified into three categories as follows: The balances of the Stockholder's equity account
depend on the amount of free assets available. If there
1. Assets pledged to fully secured creditors is a deficiency of assets to satisfy unsecured creditors,
all claims of equity holders are extinguished. Only if
‒ Certain assets can be pledged as security for a
particular liability and the estimated realizable value there are free assets in excess of unsecured liabilities
of the assets equals or exceeds the amount of the can stockholders share any distributions.
liability. Such assets may also yield resources to
cover unsecured liabilities 2.3 STATEMENT OF REALIZATION AND
LIQUIDATION
Ex. The building with an estimated realizable of
P3,000,000 which secures a P2,000,000 mortgage
Statement of Realization and Liquidation
liability, is an example of an asset pledged to a fully
This statement shows a complete record of the
secured creditor. After the mortgage is paid, P1,000,000
transaction of the receiver for a period of time. It
remains for unsecured creditors.
structure is similar to a T account and is composed of
2.
three elements: asset transactions, and income/loss
Assets pledged to partially secured transactions.
creditors – Other assets that are pledged as security
The first duty of the receiver is to realize the assets, that
for a particular liability. Partial payment of the
is to covert the non-cash assets into cash so that the
liability will utilize the entire asset value; nothing will
be left for the unsecured liabilities. creditors can be paid. The process of realization may be
done in several ways, some assets may be realized by
Ex. The equipment with an estimated realizable value of
normal operations, such as the continuing collections of
P30,000 which secures a P50,000 note payable, is an
receivables from customers. Other assets can be
example of an asset pledged to a partially secured
realized by sale. During realization, gains and losses on
creditor.
asset sales may occur, expenses may be incurred and
3. Free Assets ‒ Assets that is not pledged as

revenues can be earned. The realization activities may
be presented in T account format.
security for any particular liability, and thus available
to meet the claims of priority liabilities and The second task of the receiver is to liquidate the
unsecured creditors. Free assets also include the liabilities, that is to make full or partial settlement with
value of assets pledged to fully secured creditors in the creditors. Again, gains or losses may occur in the
excess of the related liability. process of liquidation, as may expenses or revenues.
The liquidation activities may also be presented in T

account format.

Statement of Realization and Liquidation
(+) Assets to be Realized ‒ identifies the individual 2.4 DETERMINATIONS OF THE ORDER OF
PRIORITY OF CLAIMANTS OF COMPANY
assets to which the trustee has taken title from the
ASSETS SUBJECT TO LIQUIDATION
debtor.
The liabilities of the company are classified into four
(+) Assets Acquired ‒ itemized the assets categories as follows:
discovered from operating activities during the
1. Unsecured Liabilities with Priority ‒ When
period.
creditor has no lien on any specific assets of the
(−) Assets Realized ‒ identifies proceeds received debtor corporation but its claims rank ahead of
other unsecured liabilities in the order of
from the conversion of specific assets.
payment, the claim are considered unsecured
(−) Assets Not Realized ‒ identifies the assets liabilities with priority. These liabilities, in order
remaining with the trustee at the end of the to priority are:
reporting period. a. Administrative expenses of the receiver

b. Unpaid employee's salaries and wages,
(−) Liabilities Liquidated ‒ identifies specific and benefit plans
c. taxes
liabilities paid by the trustee. 2. Fully Secured Creditors - For these liabilities,
the creditor has a lien on specific assets, whose
(−) Liabilities not Liquidated ‒ reflects those that
estimated realizable value equals or exceed the
remain to be paid by the trustee.
amount of the liability.
(+) Liabilities to be Liquidated ‒ identifies the
Ex. A bank holds a P2,000,000 mortgage on a building of
liabilities that the trustee took responsibility at the
a debtor corporation and the building has an estimated
date of appointment. realizable value of P3,000,000. The mortgage is
therefore, fully secured and the bank is referred to as a
(+) Liabilities Incurred ‒ reflects those that remains
fully secured creditor.
to be paid by the trustee.
3. Partially Secured Creditors ‒ In some cases, the
(+) Supplementary Charges (excluding assets losses creditor has a lien on specific assets but the
and write-offs) estimated realizable value of those assets is less
than the amount of the liability.
(+) Supplementary Credits (revenue excluding
gains on assets realization and liability settlements) 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 P30,000. This note is partially secured and the
finance company is referred to as a 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.
Ex. 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.
partially secured creditors, and unsecured

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

3. Unsecured Liabilities with Priority ‒ have priority
directed by the court
2. Realizes free assets of the debtor’s estate under the law (Section 50 Insolvency Law).
3. Pay cash to unsecured creditors
4. Unsecured Liabilities (General Creditors) ‒ have no
Role of Accountant ‒ concerned with proper reporting
collateral relating to their indebtedness.
of the financial condition of the debtor and adequate
accounting and reporting for the trustee. Estimated recovery % or dividend to general
unsecured creditors = net free assets/total
unsecured creditors
Statement of Affairs ‒ financial condition prepared for a
corporation entering into the stage of liquidation or
Statement of Realization and Liquidation ‒ an activity
bankruptcy.
statement progress toward the liquidation of a debtor’s
Assets state. It shows the actual transactions that transpired

during the period covered.
1. Assets Pledged with Fully Secured Creditors ‒
expected to realize an amount at least sufficient
to satisfy the related debt.
2. Assets Pledged with Partially Secured
Creditors ‒ expected to realize an amount
below the related debt.
3. Free Assets ‒ are not pledged and are available
to satisfy the claims of creditors with priority,
recognized in installments over the period of the

contract on the basis of cash collection.
MODULE 3 ‒ REVENUE FROM
Gross Profit is Recognized at the Time of Sale
CONTRACTS WITH CUSTOMERS
Many companies treat a sale on installment in exactly
3.0 REVENUE FROM CONTRACTS WITH
CUSTOMERS the same way as they treat any other sale on account.
The Account Receivable account is debited and the
An installment sales contract is a special type of credit
Sales account is credited for the full price when the sale
arrangement which provides for a series of payments
is made. The treatment is not different from that
over a period of months or years. Installment sales are
employed for regular sales on credit. Gross profit is
widely used by dealers in real estate, home appliances
recognized at the period of sale, the point at which
and cars. Since the seller must wait for a considerable
goods have been delivered to the customers and a
period of time to collect the full amount it exposes the
definite amount of receivables have been acquired.
seller to a greater risk of non-collection considering that
customers who avail of this plan are generally weaker in Gross Profit is Recognized in the Period in which
financial condition. Furthermore, the credit standing of
Cash is Collected
a customer may change significantly during the period
covered by an installment contract. This is a special method of accounting for installment
sales whereby gross profit is recognized in the periods
In view of this greater risk of non-collection, the seller
in which the installment receivables are collected
should protect himself by adopting a form of contract
instead of in the periods in which receivables are
which enable him to repossess the property if the buyer
created. The amount of cash collections then become
fails to make all the agreed installment payments.
the basis for gross profit recognition.
Methods of Gross Profit Recognition on

3.1 FIVE-STEPS MODEL FRAMEWORK
Installment Sales
Accounting Requirements for Revenue
The determination of the net income on installment
sales is one of the more complicated problems because The Five-Step Model Framework
the amounts of recoveries and the related costs and The core principle is that an entity will recognize
expenses are seldom known in the period when the sale revenue to depict the transfer of promised goods or
is made. Two general approaches may be used in the services to customers in an amount that reflects the
recognition of gross profit on installment sales: 1) the consideration to which the entity expects to be entitled
gross profit (excess of sales price over cost of sales) is in exchange for those goods or services. This core
recognized at the time of sale and 2) the gross profit is principle is delivered in a five-step model framework:
 Identify the contract(s) with a customer The standard provides detailed guidance on how to
 Identify the performance obligations in the account for approved contract modifications. If certain
contract conditions are met, a contract modification will be
 Determine the transaction price accounted for as a separate contract with the customer.
 Allocate the transaction price to the If not, it will be accounted for by modifying the
performance obligations in the contract accounting for the current contract with the customer.
 Recognize revenue when (or as) the entity Whether the latter type of modification is accounted for
satisfies a performance obligation. prospectively or retrospectively depends on whether
the remaining goods or services to be delivered after
Application of this guidance will depend on the facts
the modification are distinct from those delivered prior
and circumstances present in a contract with a
to the modification.
customer and will require the exercise of judgment.
3.1.2 STEP 2: IDENTIFY THE PERFORMANCE

3.1.1 STEP 1: IDENTIFY THE CONTRACT WITH
OBLIGATIONS IN THE CONTRACT
THE CUSTOMER
At the inception of the contract, the entity should
A contract with a customer will be within the scope if all
assess the goods or services that have been promised to
the following conditions are met:
the customer, and identify as a performance obligation:
 the contract has been approved by the parties a good or service (or bundle of goods or services) that is
to the contract; distinct; or a series of distinct goods or services that are
 each party’s rights in relation to the goods or substantially the same and that have the same pattern
services to be transferred can be identified; of transfer to the customer.
 the payment terms for the goods or services to
A series of distinct goods or services is transferred to
be transferred can be identified;
the customer in the same pattern if both of the
 the contract has commercial substance; and
following criteria are met:
 it is probable that the consideration to which
the entity is entitled to in exchange for the  each distinct good or service in the series that
goods or services will be collected. the entity promises to transfer consecutively to
the customer would be a performance
If a contract with a customer does not yet meet all of
obligation that is satisfied over time (see
the above criteria, the entity will continue to re-assess
below); and
the contract going forward to determine whether it
 a single method of measuring progress would
subsequently meets the above criteria.
be used to measure the entity’s progress
towards complete satisfaction of the
performance obligation to transfer each distinct Where a contract contains elements of variable
good or service in the series to the customer. consideration, the entity will estimate the amount of
variable consideration to which it will be entitled under
A good or service is distinct if both of the following
the contract. Variable consideration can arise, for
criteria are met:
example, as a result of discounts, rebates, refunds,
 the customer can benefit from the good or credits, price concessions, incentives, performance
services on its own or in conjunction with other bonuses, penalties or other similar items. Variable
readily available resources; and consideration is also present if an entity’s right to
 the entity’s promise to transfer the good or consideration is contingent on the occurrence of a
service to the customer is separately future event.
identifiable from other promises in the contract.
The standard deals with the uncertainty relating to
Factors for consideration as to whether a promise to variable consideration by limiting the amount of
transfer goods or services to the customer is not variable consideration that can be recognized.
separately identifiable include, but are not limited to: Specifically, variable consideration is only included in
the transaction price if, and to the extent that, it is
 the entity does provide a significant service of
highly probable that its inclusion will not result in a
integrating the goods or services with other
significant revenue reversal in the future when the
goods or services promised in the contract;
uncertainty has been subsequently resolved.
 the goods or services significantly modify or
customize other goods or services promised in However, a different, more restrictive approach is
the contract; applied in respect of sales or usage-based royalty
 the goods or services are highly interrelated or revenue arising from license of intellectual property.
highly interdependent. Such revenue is recognized only when the underlying
sales or usage occur.
3.1.3 STEP 3: DETERMINE THE TRANSACTION
PRICE 3.1.4 STEP 4: ALLOCATE THE TRANSACTION
PRICE TO THE PERFORMANCE OBLIGATIONS
The transaction price is the amount to which an entity
IN THE CONTRACTS
expects to be entitled in exchange for the transfer of
goods and services. When making this determination, Where a contract has multiple performance obligations,
an entity will consider past customary business an entity will allocate the transaction price to the
practices. performance obligations in the contract by reference to

their relative standalone selling prices. If a standalone
selling price is not directly observable, the entity will directly or indirectly. These include, but are not limited
need to estimate it. to:
 Adjusted market assessment approach  using the asset to produce goods or provide
 Expected cost plus a margin approach services;
 Residual approach (only permissible in limited  using the asset to enhance the value of other
circumstances). assets;
 using the asset to settle liabilities or to reduce
Any overall discount compared to the aggregate of
expenses;
standalone selling prices is allocated between
 selling or exchanging the asset;
performance obligations on a relative standalone selling
 pledging the asset to secure a loan; and
price basis. In certain circumstances, it may be
 holding the asset.
appropriate to allocate such a discount to some but not
all of the performance obligations. An entity recognizes revenue over time if one of the following
criteria is met:
Where consideration is paid in advance or in arrears,
 the customer simultaneously receives and
the entity will need to consider whether the contract
consumes all of the benefits provided by the
includes a significant financing arrangement and, if so,
entity as the entity performs;
adjust for the time value of money. A practical
 the entity’s performance creates or enhances
expedient is available where the interval between
an asset that the customer controls as the asset
transfer of the promised goods or services and payment
is created; or
by the customer is expected to be less than 12 months.
 the entity’s performance does not create an
asset with an alternative use to the entity and
3.1.5 STEP 5: RECOGNIZE REVENUE WHEN
(OR AS) THE ENTITY SATISFIES A the entity has an enforceable right to payment
PERFORMANCE OBLIGATION for performance completed to date.
Revenue is recognized as control is passed, either over If an entity does not satisfy its performance obligation
time or at a point in time. over time, it satisfies it at a point in time. Revenue will
therefore be recognized when control is passed at a
Control of an asset is defined as the ability to direct the
certain point in time. Factors that may indicate the
use of and obtain substantially all of the remaining
point in time at which control passes include, but are
benefits from the asset. This includes the ability to
not limited to:
prevent others from directing the use of and obtaining
the benefits from the asset. The benefits related to the  the entity has a present right to payment for
asset are the potential cash flows that may be obtained the asset;
 the customer has legal title to the asset; consideration and constraint guidelines set out in Step 3
 the entity has transferred physical possession of of the Five-Steps Model Framework. The entity also
the asset; recognizes a refund liability and an asset for any goods
 the customer has the significant risks and or services that it expects to be returned.
rewards related to the ownership of the asset;
An entity applies the accounting guidance for a sale with
and
right of return when a customer has a right to:
 the customer has accepted the asset.
 a full or partial refund of any consideration
3.2
paid;
 a credit that can be applied against amount
owed, or that will be owed, to the entity; or
 another product in exchange (unless it is
another product of the same type, quality,
condition and price - e.g., exchanging a red
sweater for a white sweater)
An entity does not account for its stand-ready obligation

to accept returns as a performance obligation.
In addition to product returns, the guidance also applies

OTHER REVENUE RECOGNITION ISSUES
to services that are provided subject to a refund.
The guidance does not apply to:
 exchanges by a customer of one product for

another of the same type, quality, condition and
price; and
 returns of faulty goods or replacements, which
are instead evaluated under the guidance on
3.2.1 SALE WITH A RIGHT OF RETURN warranties.
Under the standard, when an entity makes a sale with a The entity updates its measurement of the refund
right of return, it recognizes revenue at the amount to liability and return asset at each reporting date for
which it expects to be entitled by applying the variable

changes in expectations about the amount of the 3.2.2 WARRANTIES

refunds. It recognizes adjustments to the:
Under the standard, an entity accounts for a warranty
 refund liability as revenue; and (or part of a warranty) as a performance obligation if
 return asset as an expense the warranty is distinct, including:
 the customer has an option to purchase the

warranty separately; or
 additional services are provided as part of the
warranty.
Otherwise, warranties are accounted for under the

provision’s standard.
Applying Guidance on Warranties
Under the standard a warranty is considered a

performance obligation if it is distinct under the Step 2
criteria. If the customer has an option to purchase the
good or service with or without warranty, then the
warranty is a distinct service. If the warranty includes a
service beyond assuring that the goods comply with
agreed specifications, then it is distinct.
When a warranty is not sold separately, the warranty or

option of it may still be a performance obligation it if
provides the customer with a service in addition to the
assurance that the product complies agreed
specifications. A warranty that covers only a product's
compliance with agreed specifications (an assurance
warranty) is accounted for under the provision’s
standard.
If the warranty - or part of it - is considered to be a

performance obligation, then the entity allocates a
portion of the transaction price to the service
performance obligation by applying the requirements in 3.2.3 PRINCIPAL VERSUS AGENT

Step 4 model. CONSIDERATIONS
If an entity provides a warranty that include both an When another party is involved in providing goods
assurance element and a service element and the entity services to a customer, an entity evaluates the nature of
cannot reasonably account for them separately, then it its promise to the customer. If an entity obtains control
accounts for both of the warranties together as a single of another party's goods or services before transferring
performance obligation. control to the customer, then the entity's promise is to

provide the goods or services itself. Therefore, the
entity is acting as a principal.
However, if the entity does not control the good or

service before it is transferred to the customer, then the
entity is acting as an agent and arranges for that good
or service to be provided by another party.
An entity identifies each specified good or service to be

transferred to the customer and determines whether it
is a principal or agent for each one. An entity may be a
principal for some goods and services and an agent for
others in a contract to transfer multiple goods or
The extended warranty is a performance obligation services.
because it can be purchased separately and distinct

based on the Step 2 criteria.
The component of the standard warranty that provides

assurance that the product compiles with stated
specifications is an assurance-type warranty, and
therefore is not a performance obligation. As a
consequence, M accounts for the standard warranty
under the provisions standard when control of the
product transfer to the customer.
3.2.4 NON-REFUNDABLE UP-FRONT FEES entity's product or service (e.g., to renew a membership
or service contract or order an additional product).
Some contracts include non-refundable up-front fees
that are paid at or near contract inception - e.g., joining
fees for health club membership, activation fees for
telecommunication contracts and set-up fees for
outsourcing contracts. The standard provides guidance
on determining the timing or recognition for these fees.
An entity assesses whether the non-refundable up-front

fees relates to the transfer of a promised good or
service to the customer.
In many cases, even though a non-refundable up-front

fee relate to an activity that the entity is required to
undertake to fulfill the contract, that activity does not
result in the transfer of a promised good or service to
the customer. Instead, it is an administrative task.
3.2.5 LICENSING
If the activity does not result in the transfer of a
A license of IP establishes a customer’s right to the IP of
promised good or service to the customer, then the up-
another entity. Examples of IP includes:
front fee is an advance payment for performance
 software and technology;
obligations to be satisfied in the future and is
 franchises:
recognized as revenue when those future goods or  patents, trademarks, and copyrights;
services are provided.  films, music and video games; and
 scientific compounds.
If the up-front fee give rise to a material right for future
goods or services, then the entity attributes all of it to
the goods and services to be transferred, including the
material right associated with the up-front payment.
The non-refundable up-front fee results in a contract

that includes a customer option that is a material right if
it would probably impact the customer's decision on
whether to exercise the option to continue buying the
3.2.6 REPURCHASE ARRANGEMENTS
An entity has executed a repurchase agreement if it

sells an asset to a customer and promises, or has the
option, to repurchase it. If the repurchase agreement
meets the definition of a financial instrument, then it is
outside the scope of the standard. If not, then the
repurchase agreement is in the scope of the standard
and the accounting for it depends on its type, e g. a
forward, call option or put option and on the
repurchase price.
3.2.7 CONSIGNMENT ARRANGEMENTS
An entity may deliver goods to another party but retain

control of the goods, e.g., it may deliver a product to a
dealer or distributor for sale to an end customer. These
types of arrangements are called "consignment
arrangements" and do not allow the entity to recognize
revenue on delivery of the products to the
intermediary.
3.2.8 BILL-AND-HOLD ARRANGEMENTS
When an entity bills a customer fro a product that it

transfers at a point in time, but retains physical
possession of the product until it is transferred to the 3.3 FINANCIAL STATEMENT PRESENTATION
customer at a future point in time. This might occur to
Contracts with customers will be presented in an
accommodate a customer's lack of available space for
entity’s statement of financial position as a contract
the product or delays in production schedules.
liability, a contract asset, or a receivable, depending on
To determine when to recognize revenue, an entity the relationship between the entity’s performance and
needs to determine when the customer obtains control the customer’s payment.
of the product. Generally, this occurs at shipment or
A contract liability is presented in the statement of
delivery to the customer, depending on the contract
financial position where a customer has paid an amount
terms.
of consideration prior to the entity performing by
transferring the related good or service to the
customer.
Where the entity has performed by transferring a good

or service to the customer and the customer has not yet
paid the related consideration, a contract asset or a
receivable is presented in the statement of financial
position, depending on the nature of the entity’s right
to consideration. A contract asset is recognized when
the entity’s right to consideration is conditional on An entity should aggregate or disaggregate disclosures
something other than the passage of time, for example to ensure that useful information is not obscured.
future performance of the entity. A receivable is
recognized when the entity’s right to consideration is SUMMARY: MODULE 3
unconditional except for the passage of time.
Contract assets and receivables shall be accounted for Revenue Recognition: Installment Sales &
in accordance with the standard. Any impairment Revenue from Contracts with Customers
relating to contracts with customers should be
measured, presented and disclosed in accordance with Related Terms:
the standard. Any difference between the initial  Revenue ‒ gross inflow of economic benefits
recognition of a receivable and the corresponding during the period.
amount of revenue recognized should also be presented o arises in the course of the ordinary-
as an expense, for example, an impairment loss. including sales, fees, interest, dividends,
royalties, and rent.
Disclosures
 Gain ‒ represent increases in economic benefit
The disclosure objective stated is for an entity to
and such are no different in nature from
disclose sufficient information to enable users of
revenue.
financial statements to understand the nature, amount,
 Ordinary Activities ‒ core business operations
timing and uncertainty of revenue and cash flows
arising from contracts with customers. Therefore, an Revenue are realized when goods and services are
entity should disclose qualitative and quantitative exchanged for cash or claims to cash (receivables).
information about all of the following: "REVENUE ARE EARNED WHEN THE ENTITY HAS
SUBSTANTIALLY ACCOMPLISHED WHAT IT MUST
 its contracts with customers; DO TO BE ENTITLED TO THE BENEFITS
 the significant judgments, and changes in the REPRESENTED BY THE REVENUE."
judgments, made in applying the guidance to

 Regular Sales ‒ either cash sales or credit sales.
those contracts; and  Installment Sales ‒ payment of periodic
 any assets recognized from the costs to obtain installment.
or fulfill a contract with a customer.
Entities will need to consider the level of detail Method of Gross Profit Recognition
necessary to satisfy the disclosure objective and how  Time of Sale/ Sale Basis (Accrual Basis) ‒ profit
much emphasis to place on each of the requirements. is recognized in the period in which the sale is
made.
 Time of Collection ‒ profit is recognized in the JOURNAL ENTRY

period in which cash is collected. The gross Repossessed Merchandise xx
profit is deferred, then it is realized when
Deferred Gross Profit xx
collections are made.
Loss on Repossession xx
Installment Accounts Receivable xx
When a perpetual inventory system is maintained, the

account repossessed merchandise should be debited to
The installment sales method of accounting normally Merchandise Inventory-Repossessed
implies the deferral gross profit but the recognition of
 Trade-in ‒ is recorded at the value allowed.
selling and administrative expenses in the period of
 Over-allowance ‒ a reduction in sales price
their incurred.
Allocation of Cost of Goods Sold
Use lump-sum is usually used for any cases.
 NRV = Estimated Selling Price - (Recondition +

cost to sell)
Uncollectible Allowance Accounts Written-off:

GUIDELINES IN REPOSSESSION Doubtful Acct. Expense xx
1. Repossession may also be recorded as Deferred Gross Profit xx
estimated cash purchase.
Installment A/R xx
2. When published prices are not available, NRV
less normal profit may be used.

Interest on Installment Sales Contracts
1. Long-end interest ‒ interest is computed based

on the balance of the unpaid principal balance
between installment period
2. Short-End Interest ‒ interest is computed on
the installment due, from the date the contract
was entered into until the date of the
installment payment.
Computation of Realized Gross Profit
Current Year Sales: Gross Profit/ Installment Sales
Prior year’s Sales: Deferred-Gross Profit-Beg. Of Current

Year/Installment AR-beginning of the current year
will be met or exceeds; and the amount of the incentive

MODULE 4 ‒ LONG – TERM
payment can be measured reliably.
CONSTRUCTION CONTRACTS
Contract Revenue Contract Costs
Contract costs are costs that relate directly to the

Revenue from long-term construction contracts is
specific contract; are attributable to contract activity in
measured at the fair value of the consideration received
general and can be allocated to the contract; and are
or receivable. This includes the initial amount of
specifically chargeable to the customer under the terms
revenue agreed in the contract. This amount may
of the contract. Examples of contract costs are:
increase or decrease from one period to the next.
a. Site labor costs, including site supervision
Example
b. Costs of materials used in construction
a. A contractor and customer may agree to change c. Depreciation of plant and equipment used on
the scope of the work to be performed under the contract
the contract. Such as, changes in the d. Costs of moving plant, equipment and materials
specifications design of the asset and changes in to and from the contract site
the duration of the contract. e. Costs of hiring plant and equipment
b. The amount of revenue agreed may increase as f. Costs of design and technical assistance
a result of cost escalation clauses. g. The estimated costs of rectification and
c. The amount of contract revenue may decrease guarantee work, including expected warranty
as a result of penalties arising from delays costs
caused by the contractor in the completion of h. Claims from third parties
the contract; or i. Insurance
j. Construction overheads
d. When the contract price involves a fixed k. General administrative costs and development
price per unit of output, contract revenue costs for which reimbursement is specified in
increases as the number of units is increased. the terms of the contract
Construction revenue may also include incentive Type of Contract Costs

payments to the contractor for early completion of the Contract costs can be broken down into two categories:
contract when the contract is sufficiently advanced that cost incurred to date and estimated costs to complete.
it is probable that the specified performance standards
Cost Incurred to Date
These include pre-contract costs and costs incurred prices expected to be in effect when the costs are
after contract acceptance. Pre-contract costs are costs incurred. The latest estimates should be used to
incurred before a contract has been entered into, with determine the progress toward completion.
the expectation that the contract will be accepted and
Accounting for contract costs is similar to accounting for
these costs will hereby be recoverable through billings.
inventory. Costs as incurred would be recorded in the
The criteria for recognition of such costs are:
Construction in Progress account. Construction in
1. They are capable of being identified separately Progress account would include both direct and indirect
2. They can be measured reliably costs but would usually not include general and
3. It is probable that the contract will be obtained administrative expenses or selling expenses since they
are not normally identifiable with a particular contract
Pre-contract costs include costs of architectural designs,
and should therefore be expensed.
cost of securing the contract and any other costs that
are expected to be recovered if the contract is Methods of Construction Accounting
accepted. Contract costs incurred after the acceptance
Percentage of Completion Method
of the contract are costs incurred toward the
This method is to be used when the outcome of the
completion of the project and are also capitalized in the
construction contract can be estimated reliably, that is,
Construction in Progress (CIP) account. The contract
the estimate of costs to complete and the extent of
does not have to be identified before the capitalization;
progress toward completion of long-term contracts are
it is only necessary that there be an expectation of the
reasonably dependable.
recovery of the costs. Once the contract has been
accepted, the pre-contract costs become contract costs Measuring the Percentage of Completion
incurred to date. However, if the pre-contract costs are
already recognized as an expense in the period in which The stage of completion of a contract may be
they are incurred, they are not included in contract determined in a variety of ways. The enterprise uses the
costs when the contract is obtained in a subsequent method that measures reliably the work performed.
period. Depending on the nature of the contract, the methods

may include:
Estimated Costs to Complete
1. Input Measures
These are the anticipated cost of materials, labor,
2. Output Measures
subcontracting costs and indirect costs (overhead)
required to complete a project at a scheduled time. Input Measures (Cost to Cost Method)
They are composed of the same elements as the original This method is used if the contract calls for one large
total estimated contract costs and would be based on project rather than several separate projects. Under this
method the degree of completion is determined by revenue provided under the contract should be
computing the ratio of the costs already incurred to the recognized.
total estimated costs to complete the project. The
Zero Profit Method (Cost Recovery Method)
percentage of completion is then applied to the
estimated gross profit (contract price less total This method is described as the percentage of
estimated costs) to determine the gross profit to be completion method based on a zero-profit margin.
recognized to date. Some of the costs incurred, Under this method, revenue is recognized in an amount
particularly in the early stages of the contract should be exactly equal to costs incurred until reasonable
excluded in using this method, because they do not objective estimates of the percentage of completion are
relate directly to the work performed on the contract. available.
These includes such items as payments to
Performance during the period is included in the
subcontractors in advance for work that has set to be
Statement of Comprehensive Income, although the
performed, fabricated materials that has been delivered
method does not affect net income because revenue
to the contract site but not yet installed, used or applied
and costs recognized are equal. The zero-profit margin
during the contract performance, unless the material
approach indicates to financial statement users the
have been made specifically for the contract. However,
volume of the company's business while deferring the
this estimation is required in reporting income,
recognition of gross profit until more reliable estimates
regardless of how the percentage of completion is
of the degree of completion can be made.
computed.
Output Measures (Units of Delivery) 4.1 JOURNAL ENTRIES AND DETERMINATION

OF REVENUE, COSTS AND GROSS PROFIT
The progress is based on the results achieved. Under
this method revenue is recognized when certain phases
of the project are completed and accepted by the
buyer. This method is useful in contracts for the
construction of several condominium units. Income is
recognized when a particular unit is completed and
delivered and accepted by the buyer although the entire
project is not yet finished. Thus, if a construction
company signs a contract for ten condominium units
and completes three units at the end of the first year
and accepted by the buyers, then 30% of the total
considerations used in this determination is whether

the performance obligation is satisfied at a point in time
(when) or over a period of time (as). This determination
should be made for each performance obligation at the
inception of a contract and is determined based on the
method the entity transfers control of the promised
goods or services to a customer. The guidance assumes
the performance obligation is satisfied at a point in
time, unless any one of the following criteria are met:
 The customer simultaneously receives and

consumes the benefits provided by the
entity’s performance as the entity performs.
 The entity’s performance creates or
enhances an asset that the customer
controls as the asset is created or enhanced.
 The entity’s performance does not create an
asset with an alternative use to the entity,
and the entity has an enforceable right to
payment for performance completed to
date.
Whereas the first condition is primarily focused on

delivery of services, the next two are focused on the
creation or enhancement of goods, although the criteria
could be applied to either in certain circumstances.
To clarify, customers simultaneously receive and

4.1.1 OVERTIME consume benefits generally if the asset is transferred in
Recognizing Revenue at a Point in Time or Over a intervals where the delivery of individual service is
Period of Time distinct and identifiable. The specific example in the

guidance is a cleaning service. The second condition
The last step of the Five-Steps Model Framework
relates primarily to work-in-process assets and if/when
addresses at what time revenue from contracts with
the rights to the asset is controlled by the customer
customers should be recognized. One of the principal
throughout the process. In this case the asset would Input Method
have value to the customer at some point during the
As indicated by the title, this method measures the level
creation or enhancement process. An example might be
of effort the entity has put into satisfying the
software development where the customer may have
performance obligation in relation to the total.
control of the related asset even though the
Examples include resources consumed, labor hours
development process is not complete. The final
expended, costs incurred, time elapsed, or machine
condition could be determined either by the product
hours used. Costs included in this method should be
itself or the contract terms. For example, the contract
tailored to exclude those costs that are not incurred
terms could specifically exclude the vendor from using
directly in satisfaction of the performance obligation.
the asset elsewhere, as in a trademark. Alternatively,
the product itself could simply have no alternative use, The entity should elect the measurement method that
such as a custom-built machine. most accurately reflects its progress toward satisfaction
of the performance obligation. Once elected, the entity
should apply that method in measuring the satisfaction
of similar performance obligations in similar
circumstances.
Period of Time
If any one of the above criteria are met, the 4.1.1.2 OUTPUT METHOD
performance obligation is considered to be satisfied
Output Method
over a period of time. For performance obligations
satisfied over a period of time, states that revenue Under this method, the entity would measure
should recognized “by measuring the progress toward completion of the total performance obligation either in
complete satisfaction of that performance obligation.” relation to the total obligation that has been satisfied or
Further, the guidance describes two methods for in relation to what remains to be satisfied. Examples
measuring such progress, the “input method” and the provided include surveys of performance completed to
“output method.” The entity should only measure date, appraisals of results achieved, milestones reached,
satisfaction of the performance obligation over a period time elapsed, and units produced or units delivered.
of time if the entity has reliable information from which

4.1.2 POINT IN TIME
to reasonably measure its progress toward completing
the performance obligation under one of these Point in Time
methods. Once the determination has been made that the
performance obligation has been satisfied at a point in
4.1.1.1 INPUT METHOD time, the next step is to determine at what point in time
the obligation is satisfied. The guidance does not
provide a distinct set of criteria for when the The gross amount due from customers for contract
performance obligation is satisfied but does provide the work is the net amount of:
following factors to be considered in this determination.
a. Costs incurred plus recognized profits; less
 The entity has a present right to payment for
b. The sum of recognized losses and progress
the asset
billings for all contracts in progress for which
 The customer has legal title to the asset
costs incurred plus recognized profits (less
 The entity has transferred physical possession
recognized losses) exceeds progress billings.
of the asset
 The customer has the significant risks and The gross amount due to customers for contract work is
rewards of ownership of the asset the net amount;
 The customer has accepted the asset
a. Cost incurred plus recognized profits; less
These factors are points of consideration in b. The sum of recognized losses and progress
determining when control of the related asset billings for all contracts in progress for which
progress billings exceed costs incurred plus
passes to the customer. Transfer of control could
recognized profits (less recognized losses).
result from a combination of factors depending on
the facts and circumstances of the contract. 4.3 FINANCIAL STATEMENT PRESENTATION
Alternatively, a number of these factors could be
Financial Statement Presentation
present but if the customer still did not have
An enterprise should present:
control of the asset, the performance obligation may
a. The gross amount due from customers for
not be satisfied. For example, in consignment contract work as an asset; and
arrangements the customer may have accepted and b. The gross amount due to customers for
contract work as a liability
taken physical possession of the goods but control is not
deemed to have been transferred until the goods are
Disclosure
sold by the consignor.
1. Disclosures relating to all contracts:
In determining when control has been transferred, the
a. Aggregate amount of contract revenue
entity should consider the assets at which point in time
recognized in the period.
the customer has the ability to direct the use of—and
b. Methods used in determination of
obtain substantially all the benefits of—that asset.
contract revenue recognized in the
4.2 GROSS AMOUNT DUE FROM / TO period.

CUSTOMERS 2. Disclosure relating to contracts in progress:
a. Methods used in determination of
stage of completion (of contracts in

progress)
b. Aggregate amount of costs
incurred and recognized profits (net of

recognized losses) to date
c. Amounts of advances received (at
statement of financial position date)
d. Amount of retentions (at
statement of financial position date)

 Are attributable to contract activity in

SUMMARY: MODULE 4
general and can be allocated to the
Long-Term Contracts contract.
A construction contract is a contract specifically  Chargeable to the customers
negotiated for the constructed of an asset or a Cost that relates directly:

combination of an assets that are closely interrelated or
1. Site labour costs
interdependent in terms of their design technology, and
function or their ultimate use or purpose. 2. Materials used
3. Depreciation
Types of Construction Contract
4. Moving PPE
1. Fixed Price Contract
5. Hiring PPE
 Agreed to a fixed price
 Subject to cost escalation clauses 6. Design and technical assistance
2. Cost Plus Contract
7. Rectification and guarantee work
 Reimbursed for allowed or otherwise
defined costs plus a % of these costs or a 8. Claims from third parties
fixed fee.
 Construction Revenue ‒ total amount of Percentage-of-Completion Method

consideration receivable under the contract.  An application of the accrual assumption
 Variation ‒ instruction by the customers for a  Avoids the mismatch between costs being
change in the scope of the work to be recognized as they are incurred and
performed under the contract. revenue only being recognized when the
 Incentive Payment ‒ additional amounts paid contracts is completed.
to the contractor is specified are met or
I. Input Measures
exceeded.

 Claims ‒ an amount that the contractor seeks to
collect from the customers or another party as Based on an established or assumed relationship
reimbursement for costs not included in the between a unit of input and productivity.
contract price. a. Cost-to-Cost Method ‒ degree of

completion is determined by comparing
Construction Contracts
costs already incurred with the most
 Relate directly to the specific contract recent estimates of total costs expected
to complete the project.
b. Effort-Expended Method ‒ based on

some measure of work performed.
II. Output Measure
 are measured in terms of results achieved.

It was based on units produced.
Cost-Recovery Method
1. Recognize Revenue only to the extent of
contract costs incurred in which are expected to be

recoverable;
2. Recognize contract costs as an expense in
the period they are incurred.
Financial Statements Presentations
 Current Assets ‒ Total costs incurred on the

contract, less progress billings
 Current Liability ‒ Progress Billings less total cost

incurred on the contract
 General Administrative Expense ‒ charge to income

in the period when they occur.
 Contract Retention ‒ guarantee the completion of

the contract in satisfying manner (Current Assets)
for these services and must be willing to accept the

MODULE 5 ‒ FRANCHISE
franchisor's control over operations.
OPERATIONS – FRANCHISOR’S
POINT OF VIEW 5.1 JOURNAL ENTRIES AND DETERMINATION
OF REVENUE, COSTS AND GROSS PROFIT
5.0 FRANCHISE OPERATIONS
Franchise Operations
A franchise generally involves the grant from one party

(franchisor) to another party (franchisee), the right to
sell the granting party's goods or services. Each party
contribute resources.
The franchisor contributes his trade name, products,

company's reputation and trademarks. He also imparts
his expertise and on continuing basis provides guidance
and duties on the manner in which the franchisee must
operate his establishment. The franchisee on the other
hand, provides operational capital and managerial
operational resources required for the operation of the
franchised business.
Revenue Recognition - Initial Franchise Fees
The relation of these parties is covered by a franchise
agreement which outlines the rights and responsibilities The problem of recognizing revenue with regard to
initial franchise fees, generally results from two issue:
of each party, describes the marketing practices to be
followed, details the contribution of each party and sets 1. The point at which the fee is to be considered
certain standards of operating procedures which both earned; and
parties agree to perform. 2. The assurance of collectability of any unpaid

portion of the fee, if the total initial franchise
Franchising gives the franchisor the opportunity to
fee is not paid in full.
distribute his product and or services with minimum
investment in the franchised outlet. Franchisee is able The following accounting principle and procedures are
to own his business, reap financial rewards and benefit to be used in the recognition of revenue from the initial
fro the agreement by way of assistance and guidance franchise fee:
from the franchisor. The franchisee, however must pay

1. Revenue from the initial franchise fee should be 2. Gross Profit Method ‒ If the collectibility of the
recognized on the consummation of the unpaid portion of the franchise fee is not
transaction, which occurs when all material reasonably assured.
services or conditions of the sale have 3. Cost Recovery Method ‒ This method should be
been substantially performed. Substantial used in exceptional cases that is when the initial
performance by the franchisor occurs when the franchise fee is collectible over an extended
following conditions are met: period and the collectibility of the unpaid
a. The franchisor is not obligated in any portion of the initial franchise fee is uncertain.
way (trade practice, law, intent or
Revenue Recognition - Continuing Franchise Fees
agreement) to refund cash already
received or forgive unpaid debt. Continuing Franchise Fee is usually collected from the
b. The initial services required of the franchisee at the end of each month base on a certain
franchisor by contract or otherwise percentage of their monthly sales. Continuing franchise
have been substantially performed. fees are recognized as revenue when actually earned
c. No other material conditions or and receivable from the franchisee.
obligations exist.
5.1.1 INITIAL FRANCHISE FEE
2. Direct franchise costs of initial services
rendered by the franchisor shall be deferred Franchise Fees
until related revenue is recognized. These costs Franchise agreement usually requires franchisee to
should not exceed anticipated related revenue. make payments, called the franchise fee to the
Indirect costs that occur on a regular basis franchisor in consideration for the reputation, skill
should be expensed when incurred. products and services contributed by the franchisor.
It is assumed that substantial performance occurs when There are two types of franchise fees, namely;
the franchisee actually commences operations of the 1. Initial Franchise Fee

franchise. Once substantial performance is achieved, 2. Continuing Franchise Fee
revenue from the initial franchise fee should be
recognized using the following methods: Initial Franchise Fee
This represents initial payment for establishing the

1. Accrual Basis ‒ This method is used when the
franchise agreement and for providing certain initial
initial franchise fee is collectible over extended
services associated with the agreement. The initial
period of time and the collectibility of the
franchise fee may be payable immediately in cash or for
unpaid portion of the franchise fee is
an extended period of time. The initial services
reasonably assured.
rendered by the franchisor prior to the opening of the and land and building. In those circumstances, the
franchisee's operations usually include the following: portion of the fee applicable to the tangible assets shall
be based on the fair value of the assets and may be
a. Assistance in site selection for the
recognized before or after recognizing the portion
construction of the building
applicable to the initial services. For example, when the
b. Supervision of the construction activity,
portion of the fee relating to the sale of specific tangible
which involves obtaining financing, designing
assets is objectively determinable, it would be
building and supervising contractor
appropriate to recognize that portion when their titles
c. Assistance in the acquisition of signs, fixtures
pass, even though the balance of the fee relating to
and equipment
services is recognized when the remaining services or
d. Provision of bookkeeping and advisory
conditions in the franchise agreement have been
services
substantially performed or satisfied.
e. Provision of employee and management
training Although a franchise agreement may specify portions of
f. Provision of quality control the total fee that relate to specific services to be
g. Provision of advertising and promotion provided by the franchisor, the services usually are
interrelated to such an extent that the amount
5.1.2 CONTINUING FRANCHISE FEE,
applicable to each service cannot be segregated
BARGAIN PURCHASE OPTION, AND
objectively. The fee shall not be allocated among the
COMMINGLED REVENUE
different services as a means of recognizing any part of
Continuing Franchise Fee the fee for services as revenue before all the services
This represent continues payment to the franchisor for have been substantially performed unless actual
providing specific future services, such as advertising transaction prices are available for individual services;
and for the continued use of intangible rights by the for example, through recent sales of the separate
franchisee. These fees are usually based on the specific services.
operations of franchises.
Bargain Purchase Option
Commingled Revenue The franchisee may purchase some or all of the
The franchise agreement ordinarily establishes a single equipment or supplies necessary for its operations from
initial franchise fee as consideration for the franchise the franchisor. Sometimes, the franchisee is given the
rights and the initial services to be performed by the right to make bargain purchases of equipment or
franchisor. Sometimes, however, the fee also may cover supplies for a specified period or up to a specified
tangible property, such as signs, equipment, inventory, amount, when the initial franchise fee is paid. If the
bargain price is lower than the selling price of the same
product to other customers or if the price does not 5.1.4 OPTION TO PURCHASE THE FRANCHISE
provide the franchisor a reasonable profit on the OUTLET
equipment or supply sales, then a portion of the initial
Option to Purchase the Franchise Outlet
franchise fee shall be deferred and accounted for as an
adjustment of the selling price when the franchisee A franchise agreement may give the franchisor an
purchases the equipment or supplies. The portion option to purchase the franchisee's business. For
deferred shall be either (a) the difference between the example, a franchisor may purchase a profitable
selling price to other customers and the bargain franchised outlet as a matter of management policy, or
purchase price or (b) an amount sufficient to cover any purchase a franchised outlet that is in financial difficulty
cost in excess of the bargain purchase price and provide or unable to continue in business to preserve the
a reasonable profit on the sale, as appropriate reputation and goodwill of the franchise system. If such
an option exists, the likelihood of the franchisor's
5.1.3 REPOSSESSED FRANCHISE acquiring the franchised outlet shall be considered in
accounting for the initial franchise fee. If at the time the
Repossessed Franchise
option is given, an understanding exists that the option
A franchisor may recover franchise rights through
will be exercised or it is probable that the franchisor
repossession if a franchisee decides not to open an
ultimately will acquire the franchised outlet, the initial
outlet. If, for any reason, the franchisor refunds the
franchise fee shall not be recognized as revenue but
consideration received, the original sale is canceled, and
shall be deferred. When the option is exercised, the
revenue previously recognized shall be accounted for as
deferred amount shall reduce the franchisor's
a reduction in revenue in the period the franchise is
investment in the outlet.
repossessed. If franchise rights are repossessed but no
refund is made, (a) the transaction shall not be regarded 5.2 CONSIGNMENT SALES
as a sale cancellation, (b) no adjustment shall be made
Consignment Sales
to any previously recognized revenue, (c) any estimated
uncollectible amounts resulting from unpaid receivables In some arrangements the delivery of the goods by the
shall be provided for, and (d) any consideration retained manufacturer (wholesaler) to the dealer (retailer) is not
for which revenue was not previously recognized shall considered to be full performance and a sale because
be reported as revenue. the manufacturer retains title to the goods. This

specialized method of marketing certain types of
products makes use of a device known as a
consignment. Under this arrangement, the consignor
(manufacturer) ships merchandise to the consignee
(dealer), who is to act as an agent for the consignor in

selling the merchandise. Both consignor and consignee
are interested in selling - the former to make a profit or Cost of goods shipped on consignment
develop a market, the latter to make a commission on

the sales.
 Expenses related to consignment incurred by
Accounting for Consignment Sales the consignor
A modified version of the sales basis (regular sales) of

revenue recognition is used by the consignor. That is,
 Reimbursable expenses related to
consignment paid by the consignee

revenue is recognized only after the consignor receives
b. Inventory on Consignment account
notification of sale and the cash remittance from the
is credited for:
consignee.
 Cost of goods returned by the consignee
The merchandise is carried throughout the consignment  Cost of consignment sales and expenses
as the inventory of the consignor, separately classified relating to consignment
as Merchandise inventory on Consignment. It is not

2. Consignment transaction not recorded separately
recorded as an asset on the consignee's books. Upon
‒ consignment transactions are treated like a regular
sale of the merchandise, the consignee has liability for
type of sales. Determination of consignment profit is
the net amount. The consignor periodically receives
not required since it is already part of the profit of the
from the consignee an account sales that shows the
entire entity.
merchandise received, merchandise sold, expenses
B. Consignee
chargeable to the consignment and the cash remitted.
Revenue then is recognized by the consignor. 1. Consignment transactions recorded separately
‒ under this method, two accounts are needed to be
The following are procedures in consignment sales
maintained in relation to consignment transactions:
transaction
a. Consignor receivable account is:
A. Consignor
o debited for expenses paid by the
1. Consignment transactions recorded separately ‒ this
consignee but chargeable to the
method determines consignment profit separate from
consignor
regular sales. An inventory account called as inventory
o credited when remittance is made to
on Consignment is used to record transactions in
the consignor
relation to consignment.
b. Consignor payable account is
a. Inventory on Consignment account o credited for the sales by the consignee
is debited for:
o debited when remittance is made by

the consignor b. Advising on income, real estate, and other
3. Consignment transactions not recoded taxes

separately ‒ consignment transaction is treated
like a regular type of sales. Determination of c. Advising on local regulations of the
consignment profit is not required since it is franchisee business
already part of the profit of the entire entity. 6. Provision of employee and management
training
SUMMARY: MODULE 5 7. Provision of quality control
A Franchise Agreement involves the granting business

Substantial Performance ‒ no remaining obligation to
rights by the franchisor to a franchisee that will operate
refund any cash received or excuse any non-payment of
the franchise outlet in a certain geographical location.
a note.
Initial Franchise Fee ‒ recorded as revenue only when

 performed all the initial services required under
and as the franchisor makes “substantial performance” the contract
of the services it is obligated to perform and collection
General Rule: 90% OR MORE OF THE SERVICES
of the fee is reasonably assured. REQUIRED
The franchisor provides the franchisee with the 3 Conditions to Recognize Initial Franchise Fee
following services: a. Services

b. Period of refund
1. Assistance in site location
c. Collectibility
a. Analyzing the location
b. Negotiating the lease Journal Entries
2. Evaluation of potential income
A. Initial Franchise Fee ‒ Interest Bearing Note
3. Supervision of construction income
1. Performed all material services, the refund has
4. Supervision of construction activity
expired, collectability is assured.
a. Obtaining financing
b. Designing building Cash
c. Supervising contractor while building

N/R
Franchise Revenue
5. Provision of bookkeeping and advisory services 2. Refund has expired and collectability of the note is
a.
reasonably assured, not substantially performed all
Setting up franchisee’s records material services.
Cash Unearned Franchise Revenue

N/R Subsequently, collectability is assured.
Unearned Franchise Revenue
Subsequently; when it is performed all services:
Franchise Revenue
Franchise Revenue B. Initial Franchise Revenue ‒ Non-Interesting Fee
3. Substantially performed all services and the 1. Reasonable expectation that the down payment
collectability of the note is reasonably assured, but the may be refunded, substantial future services
refund period has not expired. remain to be performed
Cash Cash
N/R N/R
Unearned Franchise Revenue Unearned Interest Income (Discount on N/R)
Subsequently; the refund period has expired: Franchise Revenue
Unearned Franchise Revenue 2. If the probability of refunding the initial

franchise fee is extremely low, future services
Revenue from Franchise to be provided to the franchisee is minimal,
collectability of the note is reasonably is
assured, substantial performance has occurred
4. Substantially Performed all services, refund period
has expired, but the collectability of the note is not Cash
reasonably assured - use installment method
N/R
Unearned Interest Income
Cash
Franchise Revenue
N/R
Franchise Revenue 3. Initial down payment is not refundable,
represents a fair measure of the services
already provided, significant amount of services
Subsequently, it recognizes it over period of time: still to be performed, collectability of the note is
reasonably assured.
Cash
Franchise Revenue
N/R
5. Refund has expired, substantially performed all Unearned Interest Income
services, no basis for estimating the collectability of the
Franchise Revenue
note (uncertain) - use cost-recovery method.
Cash
4. Initial down payment is not refundable, and no

future services are required by the franchisor,
collection of the note is uncertain
Cash
Franchise Revenue
**when the collection of the note is extremely

uncertain, revenue through gross profit is recognized by
means of cash collection using the cost recovery
method.
5. Same case in #4 but the initial down payment is

refundable or substantial services are yet to be
performed.
Cash
Franchisor’s Costs - match related costs and revenues

by reporting them as a component of income in the
same accounting period.
 ordinarily defer direct costs

Indirect cost should expense immediately
Continuing Franchise Fees ‒ received in continuing

rights granted by the franchise agreement and for
providing such service.
 it should be reported as revenue when they are

earned and receivable from the franchisee,
unless a portion of them has been designated
for a particular purpose.
MODULE 6 ‒ ACCOUNTING FOR

HOME OFFICE, BRANCH AND 6.1 TRANSACTIONS ON THE BOOKS OF THE
HOME OFFICE AND THE BRANCH
AGENCY TRANSACTIONS
Reciprocal (Intracompany) Accounts
6.0 HOME OFFICE, BRANCH AND AGENCY
TRANSACTIONS Transactions with outside parties are recorded in the
Sales Agency and Branch Distinguished usual manner. Transactions between the home office
and a branch are recoded in intracompany accounts.
While both sales agency and the branch office are These accounts are reciprocal accounts between the
vehicles for enlarging sales volume, they exhibit a home office and the branch. When the books of both
number of significant operational differences. A sales the home office and the branch are completely up to
agency usually caries a line of samples or displays date, the balance in a reciprocal account on the home
merchandise but does not carry stocks of it. Orders are office books will be equal but opposite that of the
taken from customers and sent to the home office for related reciprocal account on the branch books. For
approval of credit. The home office then ships that example, if a reciprocal account on the home office
merchandise directly to customers. The receivable books has a P50,000 debit balance, the related
accounts are maintained in the home office which also reciprocal account on the branch books should have a
performs the collection function. A working fund for credit balance on the same amount.
sales agency expenses is provided by the home office
and replenished when exhausted. No other cash is The reciprocal account on the books of the home office
handled by the sales agency. often is called Investment in Branch or Branch Current,

while the reciprocal account on the branch books may
On the other hand, branch office normally carries stocks be labeled Home Office or Home Office Current. When a
of merchandise, which may be obtained solely from company has several branches, a separate investment
home office or a portion may be purchased from account for each branch is maintained on the home
outside suppliers. The branch makes usual warranties office books.
with respect to quality, makes collections of accounts
receivable and functions in most respect as an The balance of the Investment in Branch account shows
independent business unit. the extent of the home office's investment in a

particular branch. The reciprocal Home Office account
A branch may be restricted until it is a little more than a on the books of the branch represents the home office's
sales agency. A sales agency can be expanded until it equity in the separate financial statements of the
resembles a branch. branch.
The balances of the two reciprocal accounts are when the merchandise are received, which can be
adjusted for the same inter-company transactions. The several days after the shipment by the home office.
account balances are increased for asset transfers from Another example of a transaction which causes
the home office to the branch and decreased for asset different balances in the two accounts is the remittance
transfers from the branch to the home office. of cash by the branch to the home office. Entry on the
Adjustments to the accounts are also made for profits branch books of the cash remittance is not recorded by
and losses of the branch, with branch profits increasing the home office while the cash is still in transit. The lack
the account balances and branch losses leading to the of agreement between the reciprocal accounts poses no
decrease. Note that increases in home office's problem during the accounting period. However, at the
Investment in Branch account are accomplished with end of the accounting period, the reciprocal accounts
debit entries and decreases with credit entries. The must be brought into agreement before combined
opposite is true with respect to the Branch Home Office financial statements are prepared.
account.
The data to be considered in reconciling the two
6.2 RECONCILIATION OF RECIPROCAL accounts may be classified as follows:

ACCOUNTS
The Investment in Branch account on the home office 1. Debits in the Investment in Branch account
books and the Home Office account on the branch without corresponding credits in the Home Office
books are reciprocal accounts and theoretically, should account.
have the same balance at the end of the accounting
period. However, this condition seldom exists in 2. Credits in the Investment in Branch account
practice because of bookkeeping or mechanical errors without corresponding debits in the Home Office
such as duplication of entries, slides and transpositions account.
3.
on either set of books that have occurred or certain
transactions may already have been recoded by one Debits in the Home Office account without
office and not yet by the other or there is a time lag corresponding credits in the Investment in Branch
between the recording of the same transaction on the account.
4.
home office and branch books.
Credits in the Home Office account without
The home office, for example debits Investment in
corresponding debits in the Investment in Branch
Branch account immediately upon the shipment of account.
merchandise to the branch. The branch, on the other
hand, credits Home Office account only at a later time
5.
MERCHANDISE AT COST OR AT BILLED
Bookkeeping or mechanical errors on either PRICE)
set of books.
Merchandise Shipments to Branch - Billed at a price in
Excess of Cost
6.3 PREPARATION OF INDIVIDUAL AND
COMBINED FINANCIAL STATEMENTS
The home office may prefer to bill merchandise to
Separate Financial Statements branches at cost plus an arbitrary percentage, otherwise
known as billed price. Under this method, the branch
Normally the branch prepared its own financial
manager is not given complete information concerning
statements so that the management of the home office
the actual cost of merchandise shipped.
can review and evaluate the operating results and
financial position of the branch. The home office also Hence, upon receipt of merchandise from the home
prepares its own financial statements so that it may office, the branch records the charges that are listed on
appraise independently the results of its own operation the invoice accompanying the goods.
and its own financial position.
When billings to the branch exceed cost, the profits
Combined Financial Statements determined by the branch will be less than actual
profits. The inventories reported by the branch are
In the preparation of combined financial statements for
overstated in as much as they were valued based on the
the company, the accounts of the home office and its
billed price, not at their cost.
branches are combined. Reciprocal or intracompany
account balances must be eliminated because they 6.5 ACCOUNTING FOR AGENCY
relate to activities within the company rather than TRANSACTIONS
activities between the company and outside parties.
Accounting for Agencies
To facilitate the preparation of combined financial
The accounting process for the operation of a sales
statements, a working paper normally is used to
agency does not introduce any new accounting problem
combine the accounts of the home office and its
because a sales agency is simply an extension of existing
branches, and to eliminate the reciprocal accounts. All
sales territories. A sales agency neither keeps a
eliminations are only made in the working paper, not o
complete set of books nor uses a double entry system
the separate books of the units being combined
of accounts. Ordinarily, a record of sales to customers
6.4 SPECIAL PROCEDURES IN HOME OFFICE and a list of cash payments supported by vouchers are
AND BRANCH TRANSACTIONS (INTER – sufficient. An imprest system is usually adopted by the
BRANCH TRANSFER OF CASH AND home office for the working fund of the sales agency.
The entries made by the home office depend on

whether sales agency net income is determined
separately or not separately. If the home office wants to
determine the net income of each of its sales agencies
separately, it must maintain in the general ledger
distinct revenue and expense accounts in the name of
the sales agency. For example, Sales - Sales Agency,
Rent Expense - Sales Agency. The cost of goods sold of
each agency must also determine. If the perpetual
inventory system is used, shipments to customers of the
sales agencies are debited to Cost of Goods Sold - Sales
Agency and credited to Merchandise Inventory. On the
other hand, if the periodic inventory system is
maintained, shipments to sales agency customers are
recorded by debiting Cost of Goods Sold - Sales agency
and crediting Shipment of Merchandise - Sales Agency.
At the end of the accounting period, the account
Shipments of Merchandise - Sales Agency is deducted
from the total beginning inventory and purchases to
determine the cost of goods available for sale by the
home office for its own operations.
If the home office elects not to determine separately

the sales agency net income, the transactions of the
sales agency are recorded in the home office's own
revenue and expense accounts. Upon closing the books,
the Income summary shows the results of both
operations.
When the home office transfers fixed assets to sales

agencies the home office debits an appropriate asset
account identified with the sales agency (Ex. Furniture
and Fixtures - Sales Agency) and credits the appropriate
asset account.
Separate Branch Accounting System
Reflecting this greater degree of autonomy, the branch

SUMMARY: MODULE 6
typically maintains its own separate accounting system,
Branch or Agency while the agency does not. In fact, it is the home office
Depending on its objectives, the enterprise may adopt which records all agency transactions in the former’s
the form of either a branch or an agency. Both are part accounting system.
of a central organization and while they conduct

Such maintenance of separate accounting records by
operations away from their home office, they are not a
the branch and the home office facilitates more
separate legal entity from the latter.
effective control over operations and enables top
The key difference between the two lies in their degree management to better assess branch performance and
of autonomy or independence. For instance, a sales make strategic business decisions for the company.
agency typically does not stock inventory, but only

Accounting for Branch Operations
displays merchandise, takes orders and arranges for
The accounting transactions recorded by the branch are
delivery of the merchandise. In other words, the agency
generally of the following types:
merely acts on behalf of the home office (H.O.), with the
latter handling the other aspects of operations such as  External transactions or transactions with
purchase of merchandise, advertising, and granting of parties external to the company as a legal
entity (e.g. customers, suppliers, creditors,
credit.
utility companies)
The branch, however, has a greater degree of autonomy  Internal transactions
o within the branch
and thus operates more independently of the home
o with other branches of the company
office than the agency, primarily in the following o with home office
aspects:
The recording by the branch of its external transactions
 Provision of a wider range of services to and those which by nature affect only the branch (i.e.
customers or clientele internal transactions within the branch) is done using
 Exercise of greater management decision- the regular accounts and journal entries. However, in
making recording the branch’s transactions with the H.O.,
 Handling of more aspects of business certain intra-company accounts will have to be created
operations, such as stocking of inventory, filling and used. Likewise, inter-branch transactions or
of customers’ orders, credit and collection transactions of the branch with another branch are
 Maintenance of a separate accounting system usually coursed or cleared through the H.O. using intra-
company accounts.
At the end of the accounting period, the branch “Investment in Branch” account is shown in the asset
prepares its own financial statements based on the section of the H.O. balance sheet. However, in the
balances of its accounts, but only for internal reporting preparation of the financial statements of the company
purposes. These branch financial statements still have as a whole, these intra-company accounts are
to be combined with those of the H.O. for external eliminated since they pertain to internal activities which
reporting purposes, in such a way that the resulting do not concern the external users of the reports.
reports reflect the financial condition and results of
Common Intra-company Transactions
operations of the company as a single entity.
The following are the most common transactions
Intra-company Accounts between the branch and H.O. which are recorded by
At the time of the establishment of the branch, the both, using the intra-company accounts mentioned
following typical intra-company accounts are created in above:
the books of accounts or records of the branch and
 Transfer of assets from H.O. to the branch and
home office:
vice versa (e.g., cash, fixed assets, merchandise
 Branch Books of Accounts inventory)
o “Home Office” account

 Recognition of branch income or loss (after
closing of revenue and expense accounts by the
branch to its “Income Summary” account)
 Home Office Books of Accounts
 Recording of expenses incurred by the branch
o “Investment in Branch” account (one account
for each branch) but billed to and paid by the H.O. (e.g.,
purchase of office supplies by the H.O. for the
The intra-company accounts “Home Office” and
branch)
“Investment in Branch” are reciprocal accounts,
 Allocation of expenses by the H.O. which are
meaning they are inversely related to or opposite each
chargeable to the branch (e.g., branch’s share
other. The “Home Office” account has a normal credit
of the cost of advertising undertaken by H.O. for
balance, while the “Investment in Branch” account has a
the company)
normal debit balance. Whatever authorized transaction
 Inter-branch transactions (e.g., personal
is recorded in one account should also be recorded in
accounts of branch employees for collection,
the other account. Provided all transactions are
transfers of fixed assets, authorized expenses
recorded, both accounts should have the same or equal
incurred by a branch employee in another
balance.
branch)
The “Home Office” account appears in the equity
section of the branch balance sheet, while the
Reconciliation of Investment in Branch and Home

Office Accounts
As discussed above, the balances of the “Home Office”

and “Investment in Branch” accounts should be equal or
the same. In reality, however, because of timing
differences and recording errors, these two accounts
rarely balance. There is therefore a need to periodically
prepare a reconciliation of these two accounts to
determine the reconciling items and record the
necessary adjustments through appropriate journal
entries in either or both of the books of the branch and
H.O.

Module 1 To 6 Accounting For Special Transactions

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Module 1 To 6 Accounting For Special Transactions

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Technological Institute of the Philippines

ACCTG 028 ‒ ACTCY31S1

1. Separate legal personality – partnership has

a) Permanent withdrawal of capital

a) Partnership obligations assumed or

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

1.1 FORMATION individual capital accounts. However, the treatment

partners, and in time spent on partnership duties by the  That if no agreement is made between

agree to divide losses only, profits, if any shall be up of the business.

contributions. propriety theory, which views a partnership not

1. Equally individual investors.

2. In an unequal or arbitrary ratio  Revaluation of Assets Approach

on a particular date, or in the ratio of average their fair values

or loss in a specified ratio. values of the assets

 Use the Bonus Method 2. Retirement of a partner

allocate to old partners.

Case 3: Investment cost < Agreed Capital date of his/her retirement.

1.3.3 INCORPORATION OF A PARTNERSHIP 3. Record the distribution of stocks to the partners in

When a partnership is converted into a corporation, the 1.4 LIQUIDATION

corporation. (realization of assets)

capital accounts determination that is the focus of accounting but rather,

partnership. 2. When the business is liquidated, the partner is

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

distribution program. possible loss to them because he is presumed unable to pay

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

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

Additional loss may also accrue to the partners when a debit

ASSIGNMENT OF AN INTEREST TO A Alternative 2: REVALUATION APPROACH

--- Results in a marked departure from the Excess ------------------------------------ xx

historical principle Divided by: Interest Acquired ------ xx

Revaluation of Asset Upward ------ xx

ADMISSION OF A NEW PARTNER F, Capital xx

1. Admission by Purchase Interest

 Prefer Book Value if Profit and Loss interest >

CC > AC - Capital transfer or bonus to old partners

including recognition of goodwill.

adjust parties’ capital account balances to round

DIFFERENCE XX 3. Record the transfer of assets and liabilities

to the corporation, the receipt of the corporation’s

should apply. 1. Record the acquisition of assets and liabilities

fair value in payment of the obligation to the his/her loan account.

partnership. 5. Liquidation expenses. Certain cost incurred

1. Sharing Gains and Losses. When a interest.

partnership is liquidated, the books should

A. SCHEDULE OF SAFE PAYMENTS overcome by preparing cash distribution

assets. Provide all possible losses, including potential B. CASH PRIORITY PROGRAM

balances using profit and loss ratio. This partnership losses.

portion is the maximum potential loss on

creditors have been paid in full.

distribution to partners will be made if cash is

program coincides with the sequence that would

reorganization or debt restructuring. affairs is prepared for the corporation to provide

affairs. net realizable value of the debtor's assets and 2) the

3. Free Assets ‒ Assets that is not pledged as

The liquidation activities may also be presented in T

Statement of Realization and Liquidation

reporting period. a. Administrative expenses of the receiver

the equipment has an estimated realizable value of

4. Unsecured Creditors ‒ All other liabilities for

Ex. There is a note payable to the finance company

partially secured creditors, and unsecured

1. Continue operating the debtor’s business if