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ARMEE JAY L. CRESMUNDO

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 AFAR 2202
CORPORATE LIQUIDATION
ARMEE JAY L. CRESMUNDO, CPA MSA


I. Corporate Liquidation
• The MAIN CONCERN of accounting problems on corporate liquidation is the
proper allocation of assets to creditors and shareholders.

• The primary difference between partnership liquidation and corporate liquidation is
the extent of liability of the owners of the business. Partners have unlimited liability.
They are required to invest extra cash to satisfy debts to creditors unless they are
insolvent. Shareholders, on the other hand, have limited liability. Limited liability
means they are only liable to the extent of their investment.

• When a corporation is liquidated, the usual case is that assets are insufficient to
satisfy amounts owed to existing creditors. Normally, liabilities are unsecured (i.e., no
collateral exist for the liability). Some liabilities, however, have collateral-assets that
may be sold to satisfy the debt.

• The following classification of assets and liabilities are relevant in corporate
liquidation:

ASSETS:
1. Assets for fully-secured liabilities (AFS) – collateral assets whose FAIR VALUE
(or realizable value) is EQUAL OR GREATER than the BOOK VALUE of the
corresponding liability.
2. Assets for partially-secured liabilities (APS) – collateral assets whose fair value
is LESS THAN the book value of the corresponding liability.
3. Free assets (FA) – assets that are not used as collateral for any liability.

LIABILITIES:
1. Fully-secured liabilities (FSL) – debts that can be paid in full using their
collateral assets
2. Partially-secured liabilities (PSL) – debts that are only partially settled after
payment using their collateral assets
3. Unsecured liabilities with priority (UWP) – debts that have no security or
collateral but have priority of settlement using free assets due to their nature.
These are usually liabilities arising from law and legal proceedings. Common
examples of unsecured liabilities with priority are taxes payable to the
government, amounts owed to employees (i.e., salaries and wages payable) and
liquidation expenses.
4. Unsecured liabilities without priority (UWOP) – debts that have no security
and have the least priority of all the liabilities. They can only be paid when there

AFAR 2202 CORPORATE LIQUIDATION 1

 are remaining free assets after settling fully secured liabilities, partially secured
liabilities, and unsecured liabilities with priority.

• The payout ratio – the payout ratio is the most crucial ratio in corporate liquidation.
It is used to determine how the remaining free assets should be allocated to the
remaining balance of liabilities. The payout ratio is founded on the concept of fair
allocation. The following is the formula to compute the payout ratio:

Payout ratio = (FA, beg. + Excess of AFS over FSL – UWP)
(UWOP + Unsettled balance of PSL)

1. Concept: Free assets plus any unused collateral is first used to settle unsecured
liabilities with priority. Any remaining assets are then allocated
PROPORTIONATELY to the unsecured liabilities without priority plus any unpaid
balance of partially secured debts.
2. The payout ratio is usually in the form of a percentage or a decimal. A payout ratio
of 60% (or 0.60) means that for every peso of remaining unpaid liabilities, 60
centavos of assets will be received as payment.

• Other things to remember:
1. When a corporation is being liquidated, the going concern is no longer applicable.
Hence, assets are valued at FAIR VALUE or REALIZABLE VALUE.
2. When a liability is interest-bearing, the unpaid (or accrued) interest and the
principal is considered to be one debt.


PRACTICE PROBLEMS

Problem 1: The following information are related to Terminal Corporation which is undergoing liquidation:

1. Bonds payable amounting to P73,600 is secured by Inventory with book value of P123,000 and net
realizable value of 2/3 of the recorded amount.
2. Of the P195,600 accounts payable, P55,000 is secured by equipment with a carrying amount of
P76,800 which is 70% realizable.
3. Building with a carrying amount of P129,000 has a net realizable value of P99,000.
4. Other unrecorded liabilities are accrued interest payable on bonds, P3,100; salaries payable, P17,400;
taxes payable, P11,600; and trustee’s fee, P8,500.
5. Cash available prior to liquidation amounts to P11,900.
6. Total assets of Terminal Corp. presented in the statement of financial position prior to liquidation
amounts to P480,000. Except for prepaid expenses and goodwill with recorded amounts of P7,600
and P22,000, respectively, remaining assets other than those whose realizable values were
mentioned above have a realizable value of 60% of the recorded amount.
7. Total liabilities of Terminal Corp. presented in the statement of financial position prior to liquidation
amounts to P380,000.

Required: Prepare a statement of affairs to facilitate the corporate liquidation.

AFAR 2202 CORPORATE LIQUIDATION 2

Problem 2: Almost Corporation is undergoing liquidation and has the following condensed statement of
financial position as of January 1, 2020:

ASSETS LIABILITIES AND EQUITY
Cash P12,000 Accrued payroll P44,000
Receivables (net) 280,000 Loans from officer 50,000
Inventory 70,000 Accounts payable 60,000
Prepaid expenses 1,000 Equipment loan payable 355,000
Plant assets 300,000 Business loan payable 180,000
Goodwill 39,000 Common stock 60,000
Deficit (47,000)
TOTAL P702,000 TOTAL P702,000

The equipment loan payable is secured by the plant assets having a book value of P300,000 and a realizable
value of P350,000. Of the accounts payable, P40,000 is secured by inventory which has a cost of P40,000 and a
liquidation value of P44,000. The balance of inventory has a realizable value of P32,000. Receivables with a
book value and market value of P100,000 and P80,000, respectively, have been pledged as collateral on the
business loan payable. The balance of the receivables has a realizable value of P150,000. Liabilities not reflected
on the balance sheet are accrued interest on equipment loan payable of P5,000; taxes payable of P6,000; and
liquidation fees payable of P4,000.

Question 1: What is the estimated deficiency to unsecured creditors?
Question 2: What amount will be received by each type of creditor at the end of the liquidation process?
(i.e., fully secured, partially secured, unsecured with priority, unsecured without priority)


Problem 3: Madigan Corp. has been undergoing liquidation since January 1. As of June 30, its condensed
statement of realization and liquidation is presented below:
ASSETS LIABILITIES REVENUE & EXPENSES:
To be realized P1,375,000 Liquidated P1,875,000 Supplementary charges P3,125,000
Acquired 750,000 Not liquidated 1,700,000 Supplementary credits 2,800,000
Realized 1,200,000 To be liquidated 2,250,000
Not realized 1,375,000 Assumed 1,625,000

Question 1: The net gain (loss) on liquidation for the 6-month period ending June 30 is:
A. P425,000 C. P250,000
B. P(325,000) D. P750,000

Question 2: What is the ending cash balance assuming that common stock and deficits have ending balances
of P1,500,000 and P500,000, respectively?
A. P425,000 C. P1,325,000
B. P575,000 D. P1,375,000


Problem 4: Citymall Inc. has declared bankruptcy and has begun to liquidate. Unsecured claims will be paid at
the rate of 40 cents on the peso. A creditor holds a noninterest-bearing note receivable from Citymall Inc. in the
amount of P65,000, collaterized by machinery with a book value of P19,500 and liquidation value of P16,250.
The total amount paid to the creditor is:
A. P16,250 C. P35,750
B. P26,000 D. P42,250

AFAR 2202 CORPORATE LIQUIDATION 3