ReSA - THE REVIEW SCHOOL OF ACCOUNTANCY

CPA Review Batch 42  October 2021 CPA Licensure Exam  Week No. 3

ADVANCED FINANCIAL ACCOUNTING & REPORTING A. Dayag  G. Caiga  M. Ngina

AFAR-03: CORPORATE LIQUIDATION

Enterprises in Financial Difficulty. Business Failure is a common phenomenon in a free enterprise
company. It may be due to a variety of reasons such as incompetent management, poor operating
control, inadequate financing, fraud, or other unexpected adverse developments. Among the inevitable
symptoms of business failure is a shortage of funds or a lack of liquidity, which results in the enterprise’s
inability to meet its current obligations as they become due.

Liquidity. Liquidity refers mainly to a firm’s ability to meet its short-term obligations, while solvency relates
to the longer time span of obligation. Both of these situations are interrelated. An auditor who examines
the financial statements of an enterprise with a history of losses and resulting financial difficulties and which
may even be in default of loan agreement covenants must, at some point, evaluate the enterprise’s ability
to survive financially. If there is evidence that the ability of the enterprise to continue as a going concern
can no longer be safely assumed, the auditor may have to qualify his or her opinion, or, in some cases
disclaim an opinion.

Insolvency. A business enterprise can be insolvent in the conventional (or equity) sense when it is unable
to pay off its liabilities as they become due. The enterprise is insolvent in the legal sense when the financial
condition is such that the sum of the entity’s debts is greater than all of such entity’s property at fair
valuation. Thus, in the legal sense, an enterprise remains solvent as long as the fair value of its assets exceeds
its liabilities, even though the enterprise cannot meet its current maturing obligations because of an
insufficiency of liquid resources.

Liquidations. When the financial position of the debtor is such that it cannot resolve its financial
difficulties by any of the following quasi-reorganization, troubled-debt restructuring, and dacion-en-pago
accounting, the corporation will have to resort to liquidation. This process may be started by the debtor
filing a debtor’s voluntary petition or creditor’s involuntary petition.

Trustee in Bankruptcy. The duties of the trustee in liquidations are similar to those in reorganization
except that the focus is on a realization of assets and liquidation of liabilities rather than on preservation
and continuation of business. In addition, the trustee must assume control over the assets of the debtor,
convert assets into cash, and liquidate the business as expeditiously as is compatible with the best interests
of affected parties. In the course liquidation, the trustee may continue business activities, if that is in the
interest of an orderly liquidation.

Accounting and Reporting for Liquidation. The basic focus of accounting for a bankrupt is that of a
“quitting concern” rather than a “going concern,” which is the usual assumption in accounting. The
statement that has been devised for that purpose is the statement of affairs, which is hypothetical or pro-
forma in nature and which represents the best estimate on the outcome of the liquidation of a debtor’s
business.

Basic Reports Prepared in Corporate Liquidation:

1. Statement of Affairs. This statement is prepared as of a given point in time for a business enterprise
entering into the stage of liquidation. The purpose of this statement is to display the assets and
liabilities and of the debtor enterprise from a liquidation viewpoint, because liquidation is the
outcome of the bankruptcy proceedings. Thus, assets displayed in the statement of affairs are
valued at current fair values; carrying amounts are presented on a memorandum basis.

2. Statement of Realization and Liquidation. This is an activity statement that is intended to show
progress, i.e., actual transactions toward the liquidation of a debtor’s estate. Its original purpose is
to inform the bankruptcy court and interested creditors of the accomplishments of the trustee.

The Statement of Realization and Liquidation differs from the Statement of Affairs in the following respects:

1. The statement of realization and liquidation reports the actual liquidation results. In contrast, the
statement of affairs is of a pro-forma nature and is based on estimates rather than actual results.

2. The statement of realization and liquidation provides an ongoing reporting of the trustee’s activities
and is updated throughout the liquidation process. The statement of affairs is a summary of the
estimated results of a completed liquidation.

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY AFAR-03
Week 3: CORPORATE LIQUIDATION

I
The unsecured creditors of Insolveca Corporation filed a petition on July 1, 20x8 to force Insolveca
Corporation into bankruptcy. The court order for relief was granted on July 10 at which time an interim
trustee was appointed to supervise liquidation of the estate. A listing of assets and liabilities of Insolveca
Corporation as of July 10, 20x8, along with estimated realizable values, is as follows:
Assets Book Value Estimated Realizable Values
Cash P 61,400 P 61,400
Accounts receivable 250,000 15% of the accounts receivable is
Allowance for D/A (20,000) estimated to be uncollectible
Inventories 420,000 Estimated selling price, P340,000
which will require additional costs of
P50,000
Prepaid expenses 40,000 ?
Investments 180,000 P110,000
Land 210,000 An offer of P500,000 has been
Buildings (net) 260,000 received for land and buildings
Machinery & equipment(net) 220,000 P53,900
Goodwill ___200,000 ?
Total Assets P1,821,400

Liabilities & Equity

Accounts payable P 670,000
Wages payable 3,400
Notes payable 160,000
Accrued interest- Notes 5,000
Mortgage payable, secured
by land and buildings 400,000
Capital stock 800,000
Additional paid-in capital 80,000
Deficit ( 297,000)
Total Liabilities & Equity P1,821,400
Additional information:
a. Patents completely written-off the books in past years but with a realizable value of P10,000.
b. The books do not show the following accruals (unrecorded expenses/additional liabilities):
Taxes…………………………………………………………………………………………P16,400
Interest on mortgage………………………………………………… 10,000
c. The investments 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 P60,000.
Determine:
1. The total free assets should be:
a. P1,831,400 c. P717,800
b. 1,821,400 d. 638,000
2. The net free assets should be:
a. P717,800 c. P638,000
b. 698,000 d. 628,000
3. The estimated deficiency to unsecured creditors should be:
a. P87,000 c. P27,000
b. 47,800 d. 7,200
4. The expected recovery percentage of unsecured creditors should be:
a. 96.00% c. 88.00%
b. 95.00% d. 86.62%
5. The estimated payment to creditors should be:
Unsecured Creditors
Fully Secured Partially Secured With priority Without Priority
a. P 410,000 P 110,000 P 79,800 P 638,000
b. 500,000 158,400 60,000 589,600
c. 410,000 165,000 79,800 670,000
d. 410,000 158,400 79,800 589,600

6. The estimated payment to creditors should be:

a. P1,324,800 c. P1,264,800
b. 1,308,000 d. 1,237,800

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY AFAR-03
Week 3: CORPORATE LIQUIDATION

7. The estimated net gain or loss on asset realization should be:

a. P583,600 c. P670,000
b. 593,600 d. 680,000
8. The estimated net loss should be:
a. P583,600 c. P670,000
b. 593,600 d. 680,000

II
Parcincor Dissolved Corporation recently petitioned for bankruptcy on January 2022 and is now in the
process of preparing a statement of affairs. On March 31, 2022, the trustee provided the following
information about the corporation’s financial affairs with the carrying values and estimated fair values of
the company are as follows:

Assets: Carrying Value Fair value

Cash P 20,000 P 40,000
Accounts receivable – net 45,000 150,000
Inventories 60,000 140,000
Land 75,000 70,000
Building (net) 180,000 100,000
Equipment (net) _ 500,000 ___80,000
Total Assets P 550,000 P 335,000

Liabilities:
Accounts payable P 60,000
Wages payable (all have priority) 10,000
Taxes payable 10,000
Notes payable (secured by and
inventory receivable) 120,000
Interest on notes payable 6,000
Bonds payable (secured by land
and building) 150,000
Interest on bonds payable 7,000
Total liabilities P 363,000
Determine:
1. What is the total amount of unsecured claims?
a. P 93,000 c. P 121,000
b. 113,000 d. 126,000

2. What is the total amount of free assets?

a. P 28,000 c. P 113,000
b. 93,000 d. 121,000

3. What amount expected to be available for unsecured creditors/claims without priority (net free assets):
a. P 93,000 c. P 121,000
b. 113,000 d. 126,000

4. What is the estimated dividend percentage or the expected recovery per peso of unsecured creditors:
a. 23% c. 77%
b. 68% d. 93%
III
The following information was available on March 31, 20x8 for Bankreport Corporation, which they cannot
pay their liabilities when they are due:
Carrying Amounts
Cash P 16,000
Trade accounts receivable (net): Current fair
value equal to carrying amount 184,000
Inventories: Net realizable value, P72,000;
pledged on P84,000 of notes payable 156,000
Plant assets: Current fair value, P269,600;
pledged on mortgage notes payable 536,000
Accumulated depreciation of plant assets 108,000
Supplies: Current fair value, P6,000 8,000

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY AFAR-03
Week 3: CORPORATE LIQUIDATION

Wages payable, all earned during March 23,200

Property taxes payable 4,800
Trade accounts payable 240,000
Notes payable, P84,000 secured by inventories 160,000
Mortgage payable, including accrued interest
of P1,600 201,600
Common stock, P5 par 400,000
Deficit 237,600

Determine:
1. The estimated losses on realization of assets:
a. P 0 c. P 158,400
b. 84,000 d. 244,400

2. The estimated gains on realization of assets:

a. P 0 c. P 158,400
b. 84,000 d. 244,400
3. The expected recovery percentage of unsecured creditors:
a. 75% c. 78%
b. 78% d. 98%
4. The estimated deficiency to unsecured creditors:
a. P 86,000 c. P 70,000
b. 82,000 d. 54,000

IV – Statement of Realization and Liquidation and Statement of Estate Deficit

The Liquid Company had a very unstable financial condition caused by a deficiency of liquid assets. On
February 4, 20x8, the following information was available:
CASH P 112,000
Assets Not Realized:
Accounts Receivable… 80,000
Merchandise inventory… 160,000
Investment in common stock 26,400
Land 100,000
Buildings 60,000
Machinery and equipment 48,000

Liabilities Not Liquidated:

Notes Payable P 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-month period ending July 31, 20x8, the trustee sold the Investment in Common Stock for
P26,000, realized P84,000 for the accounts receivable, sold the merchandise for P152,000, and paid-off
P26,000 of the bank loan and all liabilities with priorities (salaries, and wages payable, taxes payable) as
well as P7,440 for estate administration expenses.

Determine:
1. The estate deficit, ending (July 31, 20x8) should be:
a. P161,760 c. P185,440
b. P178,000 d. P189,440

2. The net (gain)loss or realization and liquidation should be:

a. P11,840 loss c. P15,840 loss
b. P1,840 gain d. P4,400 loss

3. The cash balance, ending (July 31, 20x8) should be:

a. Zero c. P188,000
b. P185,440 d. P292,56

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY AFAR-03
Week 3: CORPORATE LIQUIDATION

AFAR-03 SOLUTIONS
Problem I:
1. (c) – 717,800
2. (c) – 638,000
3. (a) – 87,000
Free Assets
Assets Pledged To Fully Secured Creditors:
Land and Buildings ……………………………………………………….. P 500,000
Less: Mortgage Payable ……………………………………………..….P 400,000
Interest Payable…………………………………………………….. 10,000 410,000 P 90,000
Free Assets:
Cash……………………………………………………………………………….. 61,400
Accounts Rec. (85% x 250,000) ……………………………………… 212,500
Invent. (340,000 – 50,000)……………………………………………… 290,000
Prepaid expenses………………………………………………………….. 0
Machinery & Equipment……………………………………………….. 53,900
Goodwill………………………………………………………………………… 0
Additional assets/unrecorded assets: Patent……………….. 10,000
Total Free Assets…………………………………………………………….. P 717,800 (1)
Less: Unsecured Cred. With Priority
Wages Payable…………………………………………………………. P 3,400
Taxes Payable………………………………………………………….. 16,400
Administrative Expenses………………………………………… 60,000 79,800
Net Free Assets………………………………………………………………. P 638,000 (2)
Unsecured Creditors Without Priority:
Asset Pledged to Partially
Secured Creditors:
Investments……………………………………………………….. P 110,000
Less: Notes Payable……………………………………………. P 160,000
Interest Payable…………………………………………. 5,000 165,000
P 55,000
Unsecured Creditors Without Priority:
Accounts Payable………………………………………………... P 670,000
Total Unsecured creditor Without Priority………………….. P 725,000
Estimated Deficiency to Unsecured Creditors……………… P 87,000 (3)
Alternative Approach to determine Estimated Deficiency to Unsecured Creditors:
Estimated (gain) loss on realization:
Accounts Receivable (230,000 – 212,500)………………………………… 17,500
Inventory (290,000 – 420,000)………………………………………………… 130,000
Prepaid expenses (0 – 40,000)………………………………………………… 40,000
Investments (110,000 – 180,000)……………………………………………… 70,000
Land and Buildings (500,000 – 470,000)……………………………………… (30,000)
Machinery and equipment (53,900 – 220,000)…………………………… 166,100
Goodwill (0 – 200,000)…………………………………………………………… 200,200
Additional/unrecorded assets: Patent (10,000 – 0)……………………… (10,000)
Estimated net loss on asset realization (7) 583,600
Add: Unrecorded Expenses:
Taxes……………………………………………………………………… 16,400
Interest on Mortgage………………………………………………. 10,000
Estimated liquidating expenses (administrative exp.) 60,000 _86,400
Estimated Net Loss……………………………………………………… (8) 670,000
Less: Stockholder’s Equity……………………………………………… 583,000
Estimated Deficiency to Unsecured Creditors……………………. (3) 87,000
4. (c) – 88% or P.88
Estimated Settlement per peso of Unsecured Creditors
Estimated Settlement per peso of
Unsecured Creditors / Est’d. Recovery = Net Free Assets/Total Unsecured Creditors
Percentage of Unsecured Creditors = P638,000/P725,000 = 88% or P.88: P1
5. -
6. (d)
7. (a) – 583,600
8. (c) – 670,000 (refer to previous page)

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY AFAR-03
Week 3: CORPORATE LIQUIDATION

IV - Statement of Estate Deficit/Method 1: Statement of Realization and Liquidation

Estate deficit, beginning 173,600
Assets Realized: Sales Price Fair Value (Gain) /Loss
Inventory 26,000 26,400 400
Accounts receivable 84,000 80,000 ( 4,000)
Merchandise inventory 152,000 160,000 __8,000 4,400
Liquidated:
PSCreditors-Bank loan………………… 26,000
Unsecured Creditors w/
Priority:
Salaries and Wages………… 40,000
Taxes……………………………… 8,000
74,000
Administrative Expenses…………… __7,440
Estate Deficit, ending………………………… 185,440
Method 2: Statement of Realization and Liquidation
Assets to be Realized: Assets to be Realized:
AR 80,000 Investment in C/S 26,000
MI 160,000 AR 84,000
Investment in C/S 26,400 MI 152,000
Land 100,000
Bldgs. 60,000 Assets Not Realized:
Machinery and Eqpt. 48,000 Land 100,000
Bldgs. 60,000
Assets Acquired -0- Machinery and Eqpt. 48,000
Liabilities Liquidated: Liabilities to be Liquidated:
Bank Loan 26,000 Notes Payable 244,000
Salaries and Wages 40,000 Accounts Payable 288,000
Taxes 8,000 Salaries and Wages 40,000
Taxes Payable 8,000
Bank Loans 180,000
Liabilities Not Liquidated Liabilities Incurred/Assumed:
Notes Payable 244,000
Accounts Payable 288,000
Bank Loans (180 – 26) 154,000
Supplementary Debit(s): Supplementary Debit(s):
Administrative Expense 7,440
Totals 1,241,840 Totals 1,230,000
Net Loss 11,840
Method 3: Statement of Realization and Liquidation
Assets to be Realized: Assets to be Realized:
AR 80,000 Investment in C/S 26,000
MI 160,000 AR 84,000
Investment in C/S 26,400 MI 152,000
Land 100,000
Bldgs. 60,000 Assets Not Realized:
Machinery and Eqpt. 48,000 Land 100,000
Bldgs. 60,000
Assets Acquired -0- Machinery and Eqpt. 48,000
Liabilities Liquidated: Liabilities to be Liquidated:
Bank Loan 26,000 Notes Payable 244,000
Salaries and Wages 40,000 Accounts Payable 288,000
Taxes 8,000 Salaries and Wages 40,000
Administrative exp. – accrued 7,440 Taxes Payable 8,000
Bank Loans 180,000
Liabilities Not Liquidated Liabilities Incurred/Assumed:
Notes Payable 244,000 Administrative expenses 7,440
Accounts Payable 288,000
Bank Loans (180 – 26) 154,000
Gain on realization: Losses on realization
AR (84,000 – 80,000) 4,000 Investment 400
MI 8,000
Totals 1,245,840 Totals 1,245,840

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