88

UNIT IV – CORPORATE LIQUIDATION AND REORGANIZATION

Definition of terms

Enterprises in financial difficulty - business is unable to meet its current obligations as they come due.

Liquidity – means the firm/s ability to meet its short-term obligations

Solvency - when assets exceeded liabilities and firm’s ability to pay its obligations on the due date.

Liquidation – winding up of the affairs or termination of business operations.

Insolvency – when liabilities exceeded its assets resulting to financial difficulty in paying its debts.

Illiquidity – inability to pay debts because of lack of cash or other liquid assets.

Voluntary insolvency - the insolvent corporation voluntarily applies a petition to a court of law to be discharge from
its liabilities.
Involuntary insolvency – three or more creditors of the insolvent corporation file a petition to a court of law for
adjudication of the corporation as insolvent.

Reorganization – means the implementation of a business plan to restructure or rehabilitate a corporation with the
hope of increasing company value. It involves changing the entity’s capital structure.

Statement of Affairs – is the initial report prepared at the start of the liquidation process. it shows the financial
position of the liquidating entity- assets that are available for sale, liabilities to be settled and the claims of
the shareholders.

Assets pledged to fully secured creditors - assets with realizable value equal or greater than the realizable value
of the related liabilities for which the assets have been pledged as security.

Assets pledged to partially secured creditors - assets with realizable value less than the realizable value of the
related liabilities for which the assets have been pledged as security

Free Assets - assets that have not been pledged as security. This also includes the excess of realizable values of
assets pledged to fully secured creditors over the related liabilities for which the asset have been pledged.

Unsecured liabilities with priority – liabilities, not secured by any asset, that are mandated by law to be paid first
before any unsecured liabilities.

Unsecured liabilities without priority - all other liabilities.

Fully secured creditors – liabilities secured by assets with realizable values equal to or greater than the
realizable value of such liabilities.

Partially secured liabilities - liabilities secured by assets with realizable values less than the realizable value of
such liabilities.

Trustee in bankruptcy – person in charges of the realization of and settlement of liabilities.

Estimated deficiency = Assets at realizable value is less than liabilities at realizable value.

Estimated recovery percentage of = Net free assets

Unsecured creditors Total unsecured liabilities w/o priority
 89

CORPORATE LIQUIDATION

 Measurement basis - realizable value

 Assets - realizable value is equal to the selling price less estimated cost to sell.
 Liabilities - realizable value is the expected net settlement amount.

 Financial Reports
1. Statement of affairs
2. Statement of Realization and liquidation

 Statement of Affairs
 prepared as a given point in time for a business entering into the stage of liquidation.
 The purpose is to display the assets and liabilities and of the debtor’s enterprise from a liquidation
viewpoint , because liquidation is the outcome of the bankruptcy proceedings.
 Assets are valued at current fair values, carrying amounts are presented as memorandum basis.
 Based on estimates and it is a summary of the estimated results of a completed liquidation,

 Illustrative Problem 1: (Source: CPA review materials)

The unsecured creditors of Bankrupt Company filed a petition on July 1, 2020 to force the company into
bankruptcy. The court order for relief was granted on July 15, 2020 at which time the interim trustee was
appointed to supervise liquidation of the estate. A listing of assets and liabilities of the company as of July
15, 2020, along with the estimated realizable value is as follows:

Assets Book value Estimated realizable value

Cash 61,400 P 61,400
Accounts receivable 250,000 15% of the accounts receivable is estimated to
Allowance for bad debts (20,000) be uncollectible.
Inventories 420,000 Estimated selling price, P 340,000 which will
require additional cost of P 50,000.
Prepaid expenses 40,000 ?
Investments 180,000 P 110,000
Land 210,000 An offer of P 500,000 has been received for
Buildings, net 260,000 land buildings
Machinery and Equipment ,net 220,000 P 53,900
Goodwill 200,000 ?
Total assets 1,821,400
Liabilities and Equity
Accounts payable 670,000
Wages payable 3,400
Notes payable 160,000
Interest payable 5,000
Mortgage payable, secured by 400,000
land and building
Share capital 800,000
Share Premium 80,000
Deficit (297,000)
Total Liabilities and Equity 1,821,400

Additional information:
a. Patents completely written-off in the books in past years but with a realizable value of P 10,000.
b. The books do not show the following accruals:
Taxes P 16,400
Interest on mortgage 10,000
c. The Investment have been pledged as security for holder of the notes payable.
d. The trustee fees and other costs of liquidating the estate are estimated to be P 60,000.

Required: 1. Prepare the Statement of Affairs

 90

Solution: Bankrupt Company

Statement of Affairs
July 1, 2020
Estimated Available for
Book Assets realizable Unsecured
values Value creditors
Assets pledged to fully secured creditors:
P 470,000 Land and Building P 500,000
Less: Mortgage payable (400,000)
Interest on mortgage ( 10,000) P 90,000

Assets pledged to partially secured creditors:

180,000 Investments 110,000
Less: Notes payable ( 160,000)
Interest on notes payable ( 5,000)

Free Assets
61,400 Cash 61,400
230,000 Accounts receivable, net 212,500
420,000 Inventories 290,000
40,000 Prepaid expenses --
220,000 Machinery and Equipment, net 53,900
--- Patent 10,000
200,000 Goodwill --- 627,800
Total free assets 717,800
Less: liabilities with priority
Taxes payable ( 16,400)
Wages payable ( 3,400)
Administrative expenses (60,000)
Net free assets 638,000
________ Estimated deficiency ( 725,000– 608,000) 87,000
1,821,400 725,000

Secured Unsecured
Book Liabilities and Stockholders’ Equity priority non priority
values claims liabilities
Unsecured liabilities with priority:
---- Taxes payable 16,400
3,400 Wages payable 3,400
--- Administrative expenses 60,000
Total 79,800

Fully secured creditors:

400,000 Mortgage payable 400,000
---- Interest payable 10,000
Total 410,000

Partially secured creditors:

160,000 Notes payable 160,000
5,000 Interest payable 5,000
Total 165,000
Less investments 110,000 55,000

Unsecured creditors:
670,000 Accounts payable 670,000 670,000
Total unsecured creditors 725,000

583,000 Stockholders’ Equity ----------

1,821,400 725,000
 91

Re. 2 : Using the statement of Affairs, determine:

1. The total free assets is 717,800.

2. The net free assets is 638,000
3. The estimated deficiency to unsecured creditors = 87,000
Unsecured creditors 725,000
Net free assets 638,000 87,000

4. The expected recovery percentage of unsecured creditors should be:

88% (638,000/725,000)
5. The estimated payments to creditors should be:
a. Fully secured = 410,000
b. Partially secured = secured portion 110,000
Unsecured portion (55,000 x 88%) 48,400 158,400

c. Unsecured creditors with priority = 79,800

d. Unsecured creditors without priority = 589,600

6. The estimated payment to creditors should be:

Fully secured creditors 410,000
Partially secured creditors 158,400
Unsecured with priority 79,800
Unsecured without priority 589,600
Total estimated payment 1,237,800

7. The estimated net (gain) or loss on asset realization is: 583,600

8. The estimated net loss is: P 670,000

Solution for 7 & 8:

Estimated (gain) or loss on realization:
Accounts receivable (230,000 -212,500) 17,500
Inventory ( 420,000 – 290,000) 130,000
Prepaid expense 40,000
Investments ( 180,000 – 110,000 70,000
Land and Building (470,000 - 500,000) (30,000)
Machinery and Equipment ( 220,000 – 53,900) 166,100
Goodwill 200,000
Patent (10,000)
Estimated loss on realization 583,600
Add: unrecorded expenses
Taxes 16,400
Interest on mortgage 10,000
Administrative expenses (trustee’s fee & liq. expense 60,000 86,400
Estimated net loss 670,000
Less: Stockholders’ equity 583,000
Estimated deficiency to unsecured creditors 87,000
 92

 Statement of Realization and Liquidation

 Reports the actual liquidation results and provides an ongoing reporting of the trustee’s activities and
is updated throughout the liquidation process.
 Purpose is to inform the bankruptcy court and interested creditors of the accomplishment of the
trustee.
 It is shown like the T-account below:

Debit Credit
Assets to be realized excluding cash Assets realized
Assets acquired Assets not realized
Liabilities liquidated Liabilities to be liquidated
Liabilities not liquidated Liabilities incurred/assumed
Supplementary expenses Supplementary income

 Assets to be realized excluding cash – total non-cash assets available for disposal as of the
beginning of the period - measured at book value.
 Assets acquired - previously unrecorded asset that were recognized during period.
 Assets realized – actual net proceeds from sale of non-cash assets during period.
 Assets not realized – non-cash assets available for sale at the end of the period, at book value.
 Liabilities to be liquidated - liabilities to be settled as of the beginning of the period at book value.
 Liabilities assumed – previously unrecorded liabilities that were recognized during the period.

 Illustrative Problem: (Source: CPA review materials)

The Insolven Company had a very unstable financial condition caused by a deficiency of liquid assets. On
July 1, 2020, the following information was available:
Cash 112,000
Assets not realized:
Accounts receivable 80,000
Merchandise inventory 160,000
Investment in common stock 26,400
Land 100,000
Building 60,000
Machinery and equipment 48,000
Liabilities not liquidated:
Notes payable 244,000
Accounts payable 288,000
Salaries and wages 40,000
Taxes payable 8,000
Bank loan 180,000
Estate deficit (173,600)

During the six months period ending December 31, 2020, the trustee sold the Investment in common stock for
P 26,000, realized P 84,000 for the accounts receivable, sold merchandise inventory for P 152,000 and paid-off
P 26,000 of the bank loan and all liabilities with priorities ( salaries and wages payable, taxes payable) as well
as P 7,440 for administration expenses.

Required: . Prepare the Statement of Realization and Liquidation.

B. Determine the:
1. the estate deficit, ending December 31, 2020 should be: ___185,440
2. the net (gain) loss on realization and liquidation should be __ 11,840__
3. the cash balance, ending December 31, 2020 should be ____292,560__
 93

Solution:
Estate deficit, July 1, 2020 (173,600)
Net gain (loss) on realization
Investment in common stock ( 26,400 – 26,0000 ( 400)
Accounts receivable ( 80,000 – 84,000 4,000
Merchandise inventory ( 160,000 – 152,000) (8,000)
Total (4,400)
Administrative expenses paid ( 7,440) ( 11,840)
Estate deficit, December 31, 2020 (185,440)

Insolven Company
Statement of Cash receipts and disbursements
For the six months ended December 31, 2020

Cash balance, July 1, 2020 112,000

Add: cash receipts
investment in common stock 26,000
accounts receivable 84,000
Merchandise inventory 152,000 262,000
Total 374,000
Less: Cash disbursements
Bank loan 26,000
Salaries and wages 40,000
Taxes payable 8,000
Administrative expense 7,440 81,440
Cash balance, December 31, 2020 292,560

Insolven Company
Statement of Realization and Liquidation
For the six months ended December 31, 2020

ASSETS
Assets to be realized: Assets realized:
Accounts receivable 80,000 Investment in common stock 26,000
Merchandise inventory 160,000 Accounts receivable 84,000
Investment in common stock 26,400 Merchandise inventory 152,000
Land 100,000
Building 60,000 Assets not realized:
Machinery and equipment 48,000 Land 100,000
Building 60,000
Assets acquired -0- Machinery and equipment 48,000

LIIABILITIES
Liabilities liquidated Liabilities to be liquidated:
Bank loan 26,000 Notes payable 244,000
Salaries and wages 40,000 Accounts payable 288,000
Taxes payable 8,000 Salaries and wages 40,000
Taxes payable 8,000
Bank loan 180,000
Liabilities not liquidated:
Notes payable 244,000 Liabilities Incurred/Assumed:
Accounts payable 288,000
Bank loan ( 180,000 – 26,000) 154,000

Supplementary Items
Supplementary expense Supplementary revenue
Administrative expense 7,440 Net loss 11,840
_______ _______
Totals 1,241,840 1,241,840
 94

Alternative format:
Insolven Company
Statement of Realization and Liquidation
For the six months ended December 31, 2020

ASSETS
Assets to be realized: Assets realized:
Accounts receivable 80,000 Investment in common stock 26,000
Merchandise inventory 160,000 Accounts receivable 84,000
Investment in common stock 26,400 Merchandise inventory 152,000
Land 100,000
Building 60,000 Assets not realized:
Machinery and equipment 48,000 Land 100,000
Building 60,000
Assets acquired -0- Machinery and equipment 48,000

LIIABILITIES
Liabilities liquidated Liabilities to be liquidated:
Bank loan 26,000 Notes payable 244,000
Salaries and wages 40,000 Accounts payable 288,000
Taxes payable 8,000 Salaries and wages 40,000
Administrative expense 7,440 Taxes payable 8,000
Bank loan 180,000
Liabilities not liquidated:
Notes payable 244,000 Liabilities Incurred/Assumed:
Accounts payable 288,000 Administrative expenses 7,440
Bank loan ( 180,000 – 26,000) 154,000
Loss on realization:
Gain on realization Investment in common stock 400
Accounts receivable 4,000 Merchandise in inventory 8,000
Totals 1,245840 1,245,840

Journal entries: TRUSTEE’S BOOKS

Date Particulars PR Debit Credit
2020
July 1 Cash 112,000
Accounts receivable 80,000
Merchandise inventory 160,000
Investment in common stock 26,400
Land 100,000
Building 60,000
Machinery and equipment 48,000
Estate deficit 173,600
Notes payable 244,000
Accounts payable 288,000
Salaries and wages 40,000
Taxes payable 8,000
Bank loan 180,000
To record the transfer of custody over
assets and liabilities of Insolven Company,

Cash 262,000
Estate deficit 4,400
Accounts receivable 80,000
Merchandise inventory 160,000
Investment in common stock 26,400
To record assets realized.
 95

Bank loan 26,000

Salaries and wages 40,000
Taxes payable 8,000
Estate deficit 7,440
Cash 81,440
To record liabilities liquidated
& administrative expenses paid

REORGANIZATION

 Involves changing the entity’s capital structure.

 The control over the company is retained by the ownership – referred to as debtor in possession.
 The Sec may appoint a trustee because of mismanagement by current owners or managers or to protect
the interest of the creditors or stockholders of the company.

Types of corporate reorganization

1. Group reorganization – ownership within a group of companies changes due to new acquisitions, formation
of new holding company, buyout, takeovers, reverse acquisitions, disposal of subsidiaries , demergers and
other forms of changes in ownership.

2. Recapitalization – refers to the change in the capital structure of an entity brought about by the cancellation
of old shares and issuance of new shares as replacement. This may be accomplished through a change
(a) change from par to no-par or vice-versa; (b) by reduction of par or stated value , or (c) share splits to
reverse splits.

3. Quasi-reorganization – “fresh start accounting” - an accounting procedure whereby a financially troubled

corporation but with favorable future is permitted, but not required, to revalue its assets and liabilities and
realign its equity, subject to the provisions of relevant regulation.

4. Corporate rehabilitation – a process whereby the business of a financially troubled entity is administered by
another party in order to try to bring back the entity to its former financial condition and solvency – governed
by RA No. 10142 (Financial Rehabilitation and Insolvency Act).

5. Troubled debt Restructuring – a process whereby creditors, for economic or legal reasons related to the
debtor’s financial difficulties, grant concessions to the debtor that would not be granted in a normal
business relations. The concession arises from an agreement between the creditor and debtor or is imposed
by law or court. The creditor sustains loss and the debtor realizes accounting gain.

Types of debt restructuring:

a. Asset swap
b. Equity swap
c. Substantial modification of the terms of debt

a. Asset Swap - Transfer of assets in full settlement of an obligation-

 the debtor transfers non-cash assets to the creditor to settle an obligation.

 the difference between the carrying amount of the liability and the carrying value of the non-cash assets
transferred is recognized as gain or loss from extnguishment of debt.

 To illustrate:
Land with a book value of P 100,000 and a fair market value of P 120,000 are transferred to a creditor
in full settlement of a loan of P 130,000 plus accrued interest of P 2,000.

Journal entry (Debtor’s Books)

Loan Payable P 130,000
Accrued interest payable 2,000
Land 100,000
Gain on extinguishment of debt 32,000
assets transferred to creditor in full
settlement of debt.
 96

b. Equity Swap - Granting an equity interest in settlement of debt

 an equity securities of the company is issued to creditor in order to settle the debt
 the difference between the carrying amount of liability extinguished and the fair value of equity securities
issued or the fair value of the liability extinguished whichever is more clearly determinable is recognized
as gain or loss.

 To illustrate:
a) Preferred stock with a par value of P 20,000 and market value of P 120,000 is granted to
creditor in full settlement of a loan of P 130,000 plus accrued interest of P 2,000.

Journal entry: (Debtor’s Books)

Loan Payable P 130,000
Accrued interest payable 2,000
Preferred Stock, par P 20,000
Share Premium – preferred stock 100,000
Gain on extinguishment of debt 12,000
Preferred stock issued in full settlement
of debt.

b) Preferred stock with a par value of P 20,000 is granted to creditor in full settlement of a loan of
P 130,000 plus accrued interest of P 2,000. The fair value of the liability cancelled is
P 135, 523. ( fair value of equity securities issued is not clearly determinable)

Journal entry: (Debtor’s Books)

Loan Payable P 130,000
Accrued interest payable 2,000
Loss on extinguishment of debt 3,523
Preferred Stock, par P 20,000
Share Premium 115,523
Preferred stock issued in full settlement
of debt.

c. Modification of Debt Terms:

 terms of debt are modified in several possible ways involving interest and/or principal.
 interest concession - involve a reduction of interest rate, forgiveness of unpaid interest or a moratorium
on interest payment.

 Maturity value concession - involve an extension of the maturity date or a reduction of the amount to be
paid at maturity.

 If it results to substantial modification of terms - different terms- the existing financial liability is
extinguished and replaced by a new financial liability. it is considered substantial if the present value of
the cash flows of the new terms, discounted at the original effective interest rate, is at least 10% different
from the carrying amount of the original financial liability. The difference between the present value of
the new liability and the carrying amount of the original liability is recognized as gain or loss.

 If the modification is not substantial (less than 10% different) the existing financial liability is not
considered extinguished . it is continued to be recognized but with modified cash flows depending on
the modified terms. The new liability is not recognized. No gain or loss is recognized.

 Direct costs of modification are accounted for as follows:

a. If substantial - included in the gain or loss.
b. if not substantial – deducted from the carrying amount of the existing financial liability and
subsequently amortized using the effective interest method.
 97

 Illustrative Problem 1: (Source: Financial Accounting Volume 2 by Conrado T. Valix)

On January 1, 2020, RDE Company records show the following:
Note Payable due December 31, 2020 – 14% 5,000,000
Accrued interest payable 1,000,000

RDE was granted by the creditor the following modification on January 1, 2020:
a) The principal was reduced to P 4,000,000.
b) The creditor waived the payment of interest.
c) The new interest rate is 10% payable every December 31.
d) The maturity date was extended to December 31, 2023,

The present value of 1 at 14%for 4 periods is 0.5921 and the present value of an ordinary annuity of 1
at 14% for 4 periods is 2.9137.
solution:
PV of principal ( 4,000,000 x .5921) 2,368,400
PV of interest payments (400,000 x 2.9137) 1,165,480
Present value of the new note 3,533,880
Face value of the new note 4,000,000
Discount on note payable 466,120

Note payable – old 5,000,000

Accrued interest payable 1,000,000
Carrying amount of old liability 6,000,000
Present value of the new note 3,533,880
Gain on extinguishment of debt 2,466,120

Date Particulars PR Debit Credit

2020
July 1 Note Payable – old 5,000,000
Accrued interest payable 1,000,000
Discount on note payable 466,120
Note payable – new 4,000,000
Gain on extinguishment of debt 2,466,120
To record extinguishment of old debt

Dec. 31 Interest expense 400,000

Cash 400,000
Interest payment on the new note

31 Interest expense 94,743

Discount on note payable 94,743
Amortization of discount
2021
Dec 31 Interest expense 400,000
Cash 400,000
Interest payment on the new note

Interest expense 108,007

Discount on note payable 108,007
Amortization of discount

To compute for amortization of discount on note payable.

Date Interest paid Interest expense Discount amortization Carrying amount
(10% x 4M) (14% x d) (c) (d)
(a) (b) (b–a) ( c+d)
1/1/2020 3,533,880
12/31/2020 400,000 494,743 94,743 3,628,623
12/31/2021 400,000 508,007 108,007 3,736,630
12/31/2022 400,000 523,128 123,128 3,859,758
12/31/2023 400,000 540242 140,242 4,000,000
 98

 Illustrative Problem 2: (Source: Financial Accounting Volume 2 by Conrado T. Valix)

On January 1, 2020, RDE Company records show the following:
Note Payable due December 31, 2020 – 10% 5,000,000
Accrued interest payable 1,000,000

RDE was granted by the creditor the following modification on January 1, 2020:
a) The creditor waived the payment of interest.
b) The new interest rate is 14% payable every December 31.
c) The maturity date was extended to December 31, 2022,

The present value of 1 at 10%for 3 periods is 0.7513 and the present value of an ordinary annuity of 1
at 10% for 3 periods is 2.4869.

solution:
PV of principal ( 5,000,000 x .7513) 3,756,500
PV of interest payments (5,000,000 x 14%= 700,000 x 2.4869) 1,740,830
Present value of the new liability 5,497,330

Carrying amount of old liability 6,000,000

Present value of the new liability 5,497,330
Gain on extinguishment of debt 502,670

Date Particulars PR Debit Credit

2020
July 1 Note Payable – old 5,000,000
Accrued interest payable 1,000,000
Note payable – new 5,000,000
Premium on note payable 1,000,000
To record the modified liability

Dec. 31 Interest expense 700,000

Cash 700,000
Interest payment

31 Premium on note payable 313,000

Interest expense 313,000
Amortization of premium
2021
Dec 31 Interest expense 700,000
Cash 700,000
Interest payment on the new note

Premium on note payable 333,188

Interest expense 333,1888
Amortization of discount

Note: There is no substantial modification of terms because the gain on extinguishment is less than 10%
the carrying amount of old liability ( 502,670/6,000,000). The gain is not recognized because the
modification is not an extinguishment of the old liability. The new effective interest rate is 6.45%

The effective interest is determined through the use of financial calculator.

Financial calculator
1. Enter negative 5,000,000 (principal), press FV
2. Enter negative 700,000 (annual interest), press PMI
3. Enter 3 (maturity), press n
4. Enter 6,000,000 (old liability), press PV
5. Press comp and i%
6. Press EXE (execute)
7. The financial calculator will yield an effective interest of 6.45%.
 99

To compute for amortization of premium on note payable.

Date Interest paid Interest expense Premium amortization Carrying amount

(10% x 4M) (6.45%% x d) (c) (d)
(a) (b) (b–a) ( d-c)
1/1/2020 6,000,000
12/31/2020 700,000 387,000 313,000 5,687,000
12/31/2021 700,000 366,812 333,188 5,353,812
12/31/2022 700,000 346,188 353,812 5,000,000
 100

UNIT IV – CORPORATE LIQUIDATION AND REORGANIZATION

SELF-ASSESSMENT QUESTIONS

1. Briefly explain corporate liquidation.

2. Briefly differentiate Statement of Affairs and Statement of Realization and Liquidation

3. State the difference between:

a. Fully secured creditors and partially secured creditors

b. Unsecured creditors with priority and unsecured creditors without priority.

4. Enumerate the types of corporate reorganization.

5. What is troubled debt restructuring?

6. Briefly differentiate asset swap, equity swap and modification of debt terms.
 101

UNIT IV – CORPORATE LIQUIDATION AND REORGANIZATION

Name: ____________________ Score ____________
Section: ___________________ Date: ____________

Assignment 1: Multiple Choice: Write the your answer on the space provided before the number.

___1. A category of assets that typically has zero in the Free Asset column of a statement of affairs is:
a) Factory supplies inventory c) short-term prepayments
b) Tools d) none of the above

___ 2. In the statement of affairs, assets pledged for partially secured creditors are:
a) Included with the assets pledged for fully secured creditors
b) Offset against partially secured creditors
c) Included with free assets
d) Disregarded

___3. Insolvency in corporate liquidation means:

a) Book value of assets is greater than liabilities
b) Fair value of assets is less than liabilities
c) Inability to meet financial obligation as they come due
d) Liabilities are greater than book value of assets

___4. In corporate liquidation, assets and liabilities in the statement of affairs are measured at:
a) Book value c) fair value
b) Realizable value d) mixture of costs and values

___5. Which of the following financial statements is prepared by entities undergoing liquidation?
a) Statement of changes in net assets c) Statement of affairs
b) Statement of realization and liquidation d) a and c

___6. Which of the following is not a liability that has priority in a liquidation?
a) Administrative expense incurred in the liquidation.
b) Salary payable to employees
c) Payroll taxes payable to BIR
d) Advertising expense incurred before the company became insolvent.

___7. In the statement of affairs, liabilities are classified:

a) Current and non-current c) monetary and non-monetary
b) Secured and unsecured d) none of the above

___ 8. In corporation liquidation, the accounting records of a trustee in a are maintained:

a) Under the accrual basis of accounting
b) Under the cost basis of accounting
c) Under the accountability technique
d) In accordance with the bankruptcy court’s order.

___9. Which of the following statements is correct?

a) Involuntary insolvency occurs when the insolvent corporation voluntarily applies by petition to a
court of law, to be discharged from its liabilities.
b) Voluntary insolvency occurs when three or more creditors of the insolvent corporation file a
petition to a court of law for the adjudication of the corporation as insolvent.
c) The conceptual framework and the PFRS apply to entities undergoing liquidation.
d) The measurement bases under conceptual framework and the PFRS are not applicable to
liquidating entities.

___10. The estimated amount available for free assets in the statement of affairs is equal to:
a) Carrying amounts less current fair values
b) Carrying amounts plus gain or less loss on realization
c) Current fair values less carrying amounts
d) Carrying amount plus loss or less gain on realization
 102

IV – CORPORATE LIQUIDATION AND REORGANIZATION

Name: ____________________ Score ____________
Section: ___________________ Date: ____________

Assignment 2 – Practice
1. Nalugi Corporation, is undergoing liquidation. Relevant information on January 1, 2020 is shown below:
Assets Carrying amounts Net realizable value
Cash 200,000 200,000
Accounts receivable 500,000 450,000
Inventories 350,000 300,000
Equipment, net 400,000 150,000
Land 1,000,000 1,300,000
Total assets 2,450,000 2,100,000
Liabilities
Accounts payable 700,000 700,000
Salaries payable 500,000 500,000
Taxes payable 300,000 300,000
Notes payable 300,000 300,000
Loan payable 750,000 750,000
Total liabilities 2,550,000 2,550,000
Equity
Share capital 1,000,000
Retained earnings (deficit) (1,100,000)
Capital deficiency (100,000)
Total liabilities and equity 2,450,000

Additional information:
1. Administrative expenses expected to be incurred during the liquidation process is P 180,000.
2. The equipment is pledged as collateral security for the notes payable.
3. The land is pledged as security for the loan payable.
4. Accrued interest on loans payable amounting to P 15,000 was not reflected in the statement of
financial position.

REQUIRED:
1. Prepare the Statement of Affairs
2. Compute estimated recovery percentage
3. Assuming all the assets were sold and all liabilities were equal to their realizable value,
a. how much would Mr. Reyes , an unsecured non priority creditor, would expect to receive from
his P 300,000 claim from the company?
b. how much is the estimated payment for partially secured creditors?

Problem 2: Using the same data as in problem 1: except the winding up of the affairs of Nalugi company is
entrusted to a receiver (trustee) and the activities of the receiver for three months- January to March 31,
2020 are summarized as follows:

a. of the total accounts receivable, only P 420,000 have been collected, the remaining balance was written
off.
b. Half of the inventory was sold for P 125,000. Actual cost to sell amounted to P 3,000.
c. The land was sold for P 1,300,000 as expected.
d. the equipment was sold for P 200,000.
e. Salaries payable and taxes payable was paid in full.
g. the loan payable and interest payable was paid in full.
h. P 200,000 was paid for the notes payable. The lender waived payment for the balance.
i. actual administrative expenses paid amounted to 120,000.

REQUIRED: A. Prepare:
1. Statement of realization and liquidation
2. Statement of cash receipts and disbursements
3. Journal entries in the books of receiver
B. Determine the estate deficit.
 103

UNIT IV – CORPORATE LIQUIDATION AND REORGANIZATION

Name: ____________________ Score ____________

Section: ___________________ Date: ____________

Assignment 3 – Multiple Choice Problems. Use Yellow pad for the supporting computations.

The unsecured creditors of DISSOLVE Company filed a petition on July 1, 2020 to force the said corporation into
bankruptcy. On December 31, 2020, Club Filipino is now in the process of preparing statement of affairs. The
carrying value and estimated fair values of the assets are as follows:

Carrying value Fair value

Cash P 20,000 20,000
Accounts receivable 45,000 30,000
Inventory 60,000 35,000
Land 80,000 70,000
Building 150,000 100,000
Equipment 120,000 80,000
TOTAL 475,000 335,000

Debts of DISSOLVE Company are as follows:

Accounts payable P 60,000
Wages Payable 11,125
Taxes Payable 11,000
Notes Payable 120,000
Interests on Notes Payable 5,500
Bonds payable 150,000
Interests on Bonds payable 7,500
TOTAL 365,125

 The share capital, P 5 par P 327,000

 Estate Deficit (P 217,125)

Notes payable issued on January 1, 2020 is secured by inventory and accounts receivable. On the other hand,
bonds payable issued on January 1 is secured by land and building. All other assets are deemed as free assets.

1. How much is the Total Free Asset ?

a) 170,000 b) 120,500 c) 112,500 d) 90,375

2. How much is the net free asset ?

a) 170,000 b) 120,500 c) 112,500 d) 90,375

3. How much is the estimated deficiency too unsecured creditors?

a) (28,000) b) (28,500) c) (30,125) d) (31,025)

4. What is the estimated recovery percentage for unsecured creditors without priority?
a) 100% b) 84.36% c) 75% d) 50%

5. What is the estimated recovery percentage for unsecured creditors with priority?
a) 100% b) 84.36% c) 75% d) 50%

6. What is the estimated recovery percentage for partially secured creditors?

a) 100% b) 87.95% c) 75% d) 50%

7. How much will be paid to Accounts payable?

a) 157,500 b) 125,500 c) 105,875 d) 45,000

8. How much will be paid to Taxes payable?

a) 125,500 b) 110,375 c) 45,000 d) 11,000
 104

9. How much will be paid to Notes payable (including interest)?

a) 157,500 b) 125,500 c) 110,375 d) 45,000

10. How much will be paid to Bonds payable (excluding interest)?

a) 157,500 b) 150,000 c) 125,500 d) 110,375

For items 11 – 13:

TAFOSNA Corporation filed a voluntary petition for bankruptcy on May 31, 2020. On August 31, 2020, the
trustee provided the following information about the corporation’s financial affairs:
Book value Estimated realizable
Assets value
Cash P 40,000 P 40,000
Accounts receivable, net 200,000 150,000
Inventories 300,000 140,000
Plant assets, net 500,000 560,000
Total assets P 1,040,000

Liabilities
Liabilities for priority claims P 160,000
Accounts payable – unsecured 300,000
Notes payable secured by accounts receivable 200,000
Mortgage payable secured by all plant assets 440,000
Total liabilities P 1,100,000

11. The amount expected to be available for unsecured claims without priority:
a) P 580,000 b) P 310,000 c) P 300,000 d) P 140,000

12. The expected recovery per peso of unsecured creditors:

a) P .415 b) P .400 c) P .223 d) P .215

13. The estimated payment to creditors:

a) P 890,000 b) P 770,000 c) P 730,000 d) P 45,000

For items 14 – 17:

The following information was available on March 31, 2020 for BAGSAK Company, which they cannot pay their
when they are due:
Carrying amount
Cash P 16,000
Trade accounts receivable, net: current fair value equal to carrying
amount 184,000
Inventories, net realizable value , P 72,000; pledged on P 84,000
notes payable 156,000
Plant assets, net: current fair value P 269,600; pledged on mortgage
payable. 428,000
Supplies, current fair value, P 6,000 8,000
Wages payable, all earned during March 23,200
Property taxes payable 4,800
Trade accounts payable 240,000
Notes payable, P 84,000 secured by inventories 160,000
Mortgage payable, including interest of P 1,600 201,600
Share capital, P 5 par 400,000
Deficit 237,600

14. The estimated losses on realization of assets:

a) P 244,400 b) P 158,400 c) P 84,000 d) P 0

15. The estimated gain on realization of assets:

a) P 244,400 b) P 158,400 c) P 84,000 d) P 0
 105

16. The expected recovery percentage of unsecured creditors:

a) 98% b) 80% c) 78% d) 75%

17. The estimated deficiency to unsecured creditors:

a) P 86,000 b) P 82,000 c) P 70,000 d) 54,000

For 18 – 25:
The Bagsak Company had a very unstable financial condition caused by a deficiency of liquid assets. On
July 1, 2020, the following information was available:
Cash 82,000
Assets not realized:
Accounts receivable, net 150,000
Merchandise inventory 200,000
Investment in common stock 50,000
Land 200,000
Building, net 500,000
Equipment, net 148,000
Liabilities not liquidated:
Notes payable (secured by equipment) 200,000
Interest payable on notes 15,000
Accounts payable 500,000
Salaries and wages 80,000
Taxes payable 178,000
Bank loan (secured by land and building) 500,000
Interest payable on bank loan 50,000
Estate deficit (193,000)

During the six months period ending December 31, 2020, the trustee sold the Investment in common stock for
P 40,000, realized P 128,000 from accounts receivable, sold all merchandise inventory on account for
P 162,000 and paid-off all liabilities with priorities as well as administration expenses of P 60,000.

18. The net gain or (loss) on realization and liquidation as of December 31, 2020 is :
a) 60,000 b) P 130,000 c) ( 70,000) d) not given

19. The estate deficit as of December 31, 2020:

a) (P 323,000) b) (P 193,000) c) (P 130,000) d ) not given

20. The cash balance as of December 31, 2020:

a) P 154,000 b) P 94,000 c) 82,000 d) not given

During the three months period March 31, 2021 , the trustee sold the land for P 300,000, sold the building
P 350,000, sold the equipment for P 108,000 and paid-off the liabilities as well as administration expenses
of P 30,000.

21. The net gain or (loss) on realization and liquidation as of March 31, 2021 is :
a) P 100,000 b) (P 90,000) c) P ( 50,000) d) not given

22. The cash balance as of March 31, 2021 before cash payment to creditors and administrative expenses:
a) P 852,000 b) P 840,000 c) P 758,000 d) not given

23: Cash settlement to fully secured creditors would be:

a) P 650,000 b) P 550,000 c) P 500,000 d) not given

24. Cash settlement to partially secured creditors would be:

a) P 215,000 b) P 155,947 c) P 136,890 d) not given

25. Cash settlement to unsecured creditors without priority would be:

a) P 500,000 b) P 164,000 c) 135,091 d) not given

End
 106

UNIT IV – CORPORATE LIQUIDATION AND REORGANIZATION

Name: ____________________ Score ____________

Section: ___________________ Date: ____________

Assignment 4: Brief Exercises – Trouble Deb Resturcturing

1. WOW Company is experiencing financial difficulty and is negotiating trouble debt restructuring with its
creditors to relieve its financial stress. WOW has P 3,000,000 note payable to Megabank. The bank is
considering acceptance of an equity interest in WOW Company in the form of 200,000 ordinary shares with
a fair market value of P 12 per share. The par value of the ordinary share is P 10 per share. WOW Company
incurred total transaction costs of P 80,000 related to the issue of shares.

What is the amount of share premium to be reported by WOW in its statement of financial position as a
result of the restructuring assuming the issue of equity is a settlement of debt?

a) P 1,000,000 b) P 920,000 c) P 400,000 d) P 320,000

2. . refer to no. 1, give the journal entry in the books of WOW Company:
Date Particulars PR Debit Credit

3. TRAIL Company is threatened with bankruptcy due to the inability to meet interest payments and fund
requirements to retire P 5,000,000 notes payable with accrued interest of P 350,000. TRAIL has entered into
an agreement with the creditor to exchange equity instruments for the financial liability. The terms of exchange
are 300,000 ordinary shares with P 10 par value. The fair value of the liability is P 4,850,000.

The gain on extinguishment of debt is:

a) P 2,350,000 b) P 1,850,000 c ) ) P 500,000b d) not given (specify) _______

4. Refer to no. 3: the journal entry in the books of Trial:

Date Particulars PR Debit Credit

5. During 2020, Mane Company experienced financial difficulties and is likely to default on a P 5,000,000, 15%
three year note dated January 1, 2018 payable to Sumo Bank. On December 31, 2020, the bank agreed to
the note and unpaid interest of P 750,000 for P 4,100,000 cash payable on January 31, 2018.

What amount should be reported as gain from extinguishment of debt in the 2020 income statement?
a) P 1,650,000 b) P 900,000 c) P 750,000 d) 0
 107

6. The following data pertains to the transfer of real estate pursuant to a troubled debt restructuring by Mart Co
to Tart Company in full liquidation of Mart’s liability to Tart:
Carrying amount of note payable liquidated P 150,000
Carrying amount of real estate transferred 100,000
Fair value of real estate transferred 90,000

The journal entry in the books of Mart Company.

Date Particulars PR Debit Credit

7. Star Company has outstanding a P 6,000,000 notes payable to an investment entity. Accrued interest on this
note amounted to P 600,000.

Because of financial difficulties, the entity negotiated with the investment entity to exchange inventory of
machine parts to satisfy the debt. The inventory transferred is carried at P 3,600,000. The fair value
of the inventory is P 4,600,000. The perpetual inventory method is used.

The journal entry on the books of Star Company to record the settlement of the note payable
Date Particulars PR Debit Credit

.
8. On December 31, 2019, RDE Company records show the following:
Note Payable due December 31, 2020 – 14% 4,000,000
Accrued interest payable 500,000

RDE was granted by the creditor the following modification on January 1, 2020:
a) The principal was reduced to P 3,000,000.
b) The creditor waived the payment of interest.
c) The new interest rate is 10% payable every December 31.
d) The maturity date was extended to December 31, 2023,

The present value of 1 at 14%for 4 periods is 0.5921 and the present value of an ordinary annuity of 1
at 14% for 4 periods is 2.9137.

The journal entries on the books of Star Company on January 1, 2020, Dec. 31, 2020 and Dec. 31, 2021.

Date Particulars PR Debit Credit

End