CHAPTER 1
REVIEW OF THE ACCOUNTING PROCESS
LEARNING OBJECTIVES
1. l. Understand the definition of accounting and identify the users of accounting
information.
2. Identify and explain the steps in the accounting process.
3. prepare adjusting entries and understand 'he rationale for their preparation.
4. Prepare Closing entries and understand the rationale for their preparation.
5. Explain the advantages of preparing reversing entries and identify adjusting entries that
may he reversed.
PREVIEW OF THE CHAPTER
ACCOUNTING PROCESS
(A Review)
Accounting ang Users
of Accounting
Information



Definition and nature
of accounting
Internal Users
External Users
Accounting Process










Documentation
Journalizing
Posting
Preparation of Trial
Balance
Compilation of data
for adjustment
Preparation of Work
Sheet
Preparation of
Financial Statements
Preparation of
adjusting and closing
entries
Preparation of postclosing trial balance
Preparation of
reversing entries
Adjusting Entries





Accruals
Deferrals/Prepaym
ent
Depreciation
Uncollectible
accounts
Inventory
Closing Entry



Income
Expenses
Drawings
Reversing Entries
 Accruals
 Deferrals/Prepaym
ent
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DEFINITION and NATURE OF ACCOUNTING
Accounting is defined as a service activity. Its function is to provide quantitative
information, primarily financial in nature, about economic entities that is intended to be
useful in making economic decisions.
Accountants render services by providing information about economic entities that is
measured in terms of money. These entities are either profit-oriented (business entities or
business enterprises) or non-profit-entities. Generally, all parties who have interest in an
entity, whether direct or indirect, are called stakeholders. These stakeholders use accounting
information are grouped into two, namely:
1. External Users - they are groups or individuals who are not directly concerned with
the day-to-day operation of the entity but are indirectly related to the said entity.
They include creditors, investors, potential creditors and investors, government and
the public. They make decisions that affect their relationship to the entity.
2. Internal Users - they are the management personnel in all levels within and entity
who are responsible for the planning and control of the operations and therefore, they
have access to the day-to-day operations of the entity. They make decisions the
internal operations of the entity.
Generally, the reports provided by the accountants are expressed and measured in financial or
money terms; these reports are called financial reports and are of various types. One type of
financial reports are the general-purpose financial statements. These Conceptual Framework for
Financial Reporting issued by the Financial Reporting Standard Council (FRSC) identifies
existing and potential investors, lenders and other creditors as the primary users of generalpurpose financial statements. Other users include regulators and members of the public other than
investors, lenders and other creditors. The following are some of the users of financial
information and the use of such information in the decisions that they make.
1. Investors - they are concerned with the risk inherent in, and return provided by, their
investments. They need information to help them determine whether they should make
additional investments, hold or sell their investments. Shareholders (owners or investors
in a corporation) need information that will enable them to asses the ability of the
corporation to pay dividends.
2. Lenders - they are interested in information that enable them to determine whether their
loans, and the interest attaching to them, will be paid when due.
3. Suppliers and other trade creditors - they are interested in information that enable them
to determine whether amounts owing to them will be paid when due.
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4. Employees – they are interested in the information about the stability and profitability of
their employers. They are also interested in information that will enable them to assess the
ability of their employers to provide remuneration, retirement benefits and employment
opportunities.
5. Customers – they are interested in the information about the continuance of an entity,
especially when they have a long-term involvement with, or are dependent on, the entity
6. Government and their agencies – they are interested in the allocation of resources and,
therefore, the activities of the entities. They also require information so that they can
regulate the activities of entities, determine taxation policies and as the basis for national
income and similar statistics.
7. Public – they are interested in information about the trends and recent developments in
the prosperity of the entity and the range of its activities.
ACCOUNTING PROCESS
Accounting process refers to the procedures or series of steps undertaken to come up with the
information reported in the financial statements. The accounting process is also referred to as the
accounting cycle.
The accounting process is divided into two phases, namely; (1) the recording phase and (2)
summarizing phase. These two phases and the steps under each phase are discussed in the
succeeding paragraphs.
RECORDING PHASE
The recording phase includes collecting information about economic transactions and the
recording of these transactions in the appropriate accounting records. A transaction is an
economic event that changes an asset, a liability, or an equity account balance; hence it must be
recorded. Accounting records, on the other hand, include business documents, journals, and
ledgers.
Transactions are recorded in terms of debits and credits (double-entry system). Debit is the left
side of an account while credit is the right side of an account. Following are the rules of debuts
and credits:
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


Debit
Increase in asset
Decrease in liability
Decrease in equity due to
i.
Withdrawal by owner/s
ii.
Decrease in income
iii. Increase in expense



Credit
Decrease in asset
Increase in liability
Increase in equity due to
i. Additional investments by
owner/s
ii. Increase in income
iii. Decrease in expense
THE ACCOUNTING CYCLE
BUSINESS
TRANSACTION
DOCUMENTATION
PREPARATION OF
REVERSING ENTRIES
JOURNALIZING
 General Journal
 Special Journals
PREPARATION OF
POST-CLOSING
TRIAL BALANCE


JOURNALIZING AND
POSTING OF
ADJUSTING AND
CLOSING ENTRIES
POSTING
General Ledger
Subsidiary Ledger
PREPARATION OF A
TRIAL BALANCE
COMPILATION OF
DATA FOR
ADJUSTMENTS
PREPARATION OF
WORK SHEET/ END-OFPERIOD SPREADSHEET
PREPARATION OF
FINANCIAL
STATEMENTS
 Statement of
Financial
Position
 Statement of
Comprehensive
Income
 Statement of
Cash Flows
 Statement of
Changes in
Equity
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Key Points:


If a work sheet is not prepared, the adjusting entries must be journalized and posted
before the financial statements can be prepared. This is because the basis for the
preparation of the financial statements are the updated balances of the account in
the general ledger.
The cycle is a continuing process and steps may overlap during an accounting
period
The recording phase is composed of the following steps:
1. Documentation — this is the process of preparing or receiving appropriate business
documents. Business documents are original source materials which serve as
evidence of transactions. They include official receipts. sales invoices, purchase
invoices, credit memoranda, and debit memoranda.
2. Journalizing — this is the process of recording transactions for the first time in the
accounting books called journals. This is the reason why the journals are called
books of original entry. Transactions are recorded based on the documents prepared
or received in number (1) above.
The company may use a general journal and one or more special journals. The general is
the most flexible type of journal where almost all type of transactions can be recorded. On
the other hand, the special journals are used in recording transactions that are usual and
that occur frequently or on a repetitive basis. The types of special journals are the sales
journal, purchases journal, cash receipts journal, and cash disbursement journal.
3. Posting — this is the process of transferring the recorded transactions in the
journal to the accounts in the ledger. A ledger is a group of related accounts and is
also called the book of final entry. The objective of posting is to classify the
effects of transactions on specific asset, liability, equity, income and expenses
accounts.
A company may maintain both a ledger and subsidiary ledger depending upon its needs. The
general ledger is the principal ledger which contains all the accounts that are reported in the
financial statements, namely; assets, liabilities, equity, income, and expenses. It also
includes contra and adjunct accounts. Contra accounts are accounts established to record
deductions from related accounts with positive balances such as Accumulated Depreciation
(deducted from Property, Plant & Equipment), Discount on Notes Payable (deducted from
Notes Payable), Sales Discount (deducted from Sales), and Purchases Discount (deducted
from Purchases). Adjunct Accounts are accounts set up to record additions to related
accounts such as Freight-In (added to Purchases).
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The subsidiary ledgers contain details of some general ledgers account balances. For
example, the Accounts Receivable and Accounts Payable account balances are found in
General Ledger. The compositions of their balances are found in the subsidiary ledgers. To
illustrate, let us assume that Bountiful Merchandising reports account receivable from
customers totaling P2,500,000. This total amount of P2,5000,000 is reflected in the
Accounts Receivable account in general ledger. The names of customers and the amount due
from each of them are found in the subsidiary ledger. A general ledger account that has a
supporting subsidiary ledger is called a control account.
SUMMARIZING PHASE
4. Preparing a trial balance – this is the process of preparing a summary of
the balances of the accounts in the general ledger known as the trial
balance. After all transactions are posted, the balance of each account is
determined. Asset, Expense, and temporary capital accounts such as
Drawings have normal debit balances; Liability, Equity, and Income
accounts have normal credit balances.
A trial balances is prepared to prove the equality of the debits and credits
but it does not indicate the accuracy of work done. As discussed in a
previous accounting subject, there are errors in recording that will not
cause inequality in the trial balance. An example of this is debiting or
crediting an incorrect account such as a debit to Accounts Receivable
erroneously debited to Notes Receivable. Another example is failure to
record a transaction or recording the same transaction twice. The
preparation of a trial balance is normally done in the work sheet.
5. Compiling adjusting data - this is the process of gathering and putting
together various data necessary to update the balances of certain accounts
in the book of the company. Adjustments based on compiled data are then
recorded before the financial statements are prepared. The adjustments are
necessary so that the income and expenses will be reported in the period
they are earned and incurred, respectively: hence profit will not be
misstated. The most common types of adjusting data are the following:
a. Accrued Expense- this is an expense incurred but not yet paid as of
the statement of financial position (balance sheet) date, such as
interests accrued on notes payable. Another example is accrued
salaries of employees. An accrued expense is unpaid as of the
statement of financial position date but is matched against income or
earnings for the current period. Adjustment for accrued expense is
recorded as follows:
Expense
xx
Payable
xx
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Example: The ABC company has an outstanding 90-day, 12% note payable
dated December 1, 2014amounting to P200,000. The interest is payable upon
maturity of the note. The company’s accounting period or financial year is the
calendar year, that is, January 1 to December 31. Interest for 30 days has accrued
on the note as of December 31, 2014 (that is December 1 to December 31). The
adjusting entry to record the accrued interest is as follows:
Interest Expense
2,000
Interest Payable
2,000
P200,000 x 125 x 30/360 = P2,000
Example 2 – DEF Company pays salaries every Friday, the end of a five-day work week.
The total salaries for the week ending January 3, 2015 is P150,000.
In this case, the P150,000 salaries for the week ending January 3, 2015 is for the services
rendered by the employees on December 30, December 31, January 1, January 2, and
January 3. Therefore, the company ahs accrued salaries for two (2) days, as of January 31,
2015. The adjusting entry to record the accrued salaries is as follows:
Salary Expense
60,000
Salaries Payable
60,000
P150,000 x 2/5 = P60,000
b. Accrued Income – this is the income earned but not yet received or collected as
of the statement of financial position date, such as accrued interest on notes
receivable. An accrued income is not yet collected but is matched with expenses
for current period. The adjusting entry to record accrued income is as follows:
Receivable
xx
Income
xx
Example 3 - GHI Company received a 3-month, 12% note dated December 1, 2014
amounting P100,000. Interest is receivable upon maturity of the note.
As of December 31, 2014, interest for one month (that us, December 1 to December 31) is
already earned but not yet collected. The adjusting entry to record the accrual interest
income is as follows
Interest Receivable
Interest Income
1,000
1,000
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c. Prepaid Expense - this is an expense pair od acquired in advance such as
insurance premium. Other examples are rent paid in advance and office supplied
purchased. The adjustment relating to prepaid expense at the end of accounting
period depends on the method used in recording the initial payment or
acquisition.
There are two methods of recording prepayments, namely; the asset method and
expense method. Under the asset method, the payment or purchase is initially
debited to an asset account. At the end of the accounting period, the expired or
used portion of the asset is transferred to an expense account. Under the expense
method, the payment or purchase is initially debited to an expense account. At
the end of the accounting period, the unexpired or unused portion of the asset is
transferred to an asset account.
1. To record the initial payment of expense
ASSET METHOD
EXPENSE METHOD
Prepaid Expense
xxx
Expense
xxx
Cash
xxx
Cash
xxx
2. To record the adjustment at the end of the accounting period
ASSET METHOD
EXPENSE METHOD
Expense
xxx
Prepaid Expense
Prepaid Expense xxx
Expense
xxx
xxx
Example 4 – On Mau 1, 2014, JKL Company paid insurance premium of P30,000 covering
a period of one year beginning on this date. The entries to record the payment on May 1 and
the adjusting entry on December 31 under the two methods are presented below:
ASSET METHOD
2014
May 1
December 31
Prepaid Insurance
Cash
Insurance Expense
Prepaid Insurance
30,000
30,000
20,000
20,000
The expired portion of the insurance premium is for the period May 1 to December 31,
2014, or a period of eight (8) months
EXPENSE METHOD
2014
May 1
Insurance Expense
30,000
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December 31
Cash
30,000
Prepaid Insurance
10,000
Insurance Expense
10,000
P30,000 x 4/12 = P10,000
The unexpired portion of the insurance premium is 4 months, that is, 12 months less the
expired portion of eight (8) month
d. Unearned Income – this is income already collected but not yet earned as of the
statement pf financial position dare, such as rental income collected in advance
or subscriptions received in advance. Unearned income is also known as deferred
income. Like prepaid expense, the adjustment for unearned income at the end of
the accounting period depends on how the nitial receipt of each is recorded
The receipt of the advance payment may be recorded using the liability method or
income method. Under the liability method, the collection is initially credited to a
liability account, at the end of the accounting period, the earned portion of the
income is transferred to an income account. Under the income method, the collection
is initially credited to an income account, at the end of the accounting period, the
unearned portion of the income is transferred to a liability account. The following are
comparative entries to record the receipt of cash and the adjustment at the end of the
accounting period under two methods:
1. To record the initial receipt of cash
LIABILITY METHOD
Cash
Unearned Income
xxx
xxx
INCOME METHOD
Cash
xxx
Income
xxx
2. To record the adjustment at the end of the accounting period
LIABILITY METJOD
INCOME METHOD
Unearned Income
Income
xxx
Income
xxx
xxx
Unearned Income
xxx
Example 5 - On September 1, 2014, MNO Company received P240,000 representing rental
of an office space for one year beginning on this date. The entries to record the receipt of
payment on September 1 and the adjustinf entry on December 31 under the two methods are
presented below:
LIABILITY METHOD
2014
September 1
Cash
240,000
9
Unearned Rent
December 31
240,000
Unearned Rent
80,000
Rent Income
P240,000 x 4/12 = P80,000
80,000
The earned portion is the rent for the period September 1 to December 31 or four (4)
months
INCOME METHOD
2014
September 1
Cash
240,000
Rent Income
December 31
Rent Income
Unearned Rent
240,000
160,000
160,000
The unearned portion is the rent for eight (8) months; that is, twelve (12) months less the
earned portion of four (4) months.
e.
Depreciation of property, plat and equipment and other cost allocation –
Depreciation is defined as PAS 16 as the systematic allocation of the depreciable
amount of an item of property, plant and equipment over its useful life.
Depreciable amount is the cost of an asset, or other amounts substituted for cost,
less its residual value. The entry to record the depreciation expense is as follows:
Depreciation Expense
Accumulated Depreciation
xxx
xxx
The depreciation expense for the period is determined using any of the
acceptable methods identified in PAS 16- straight-line method, diminishing
balance method, and units of production methods. The straight-line method will
be used in the illustration and problems in this chapter and in all other chapters
of this book. The other methods will be discussed in higher accounting subjects.
Under the straight-line method, the annual depreciation expense I computed as
follows:
Depreciation expense/year = Cost – Residual Value
Estimated useful life (in years)
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If the asset is used for less than a year, the proportionate expense should be
calculated, unless the company adopts a different policy such as providing halfyear depreciation in the year of acquisition of the asset.
The account “Accumulated Depreciation” is a contra asset account; it is reported
in the statement of financial position as a deduction from the related property,
plant and equipment account.
Other cost allocation includes amortization of intangible assets like franchise and
patents. This topic is being discussed in higher accounting subjects.
Example 6 - PQR Company acquired an office equipment on October 1, 2013
for P310,000. The asset has an estimated useful life of 5 years and an estimated
residual value pf P10,000. The entries to record the expense of 2013 and 2014
are presented on the next page .
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2013
Dec 31
Depreciation Expense
15,000
Accumulated Depreciation
15,000
(P310,000 – P10,000)/5 yrs. X 3/12
Depreciation expense for 2013 is for three months; that is, October 1 to December 31, 2013
2014
Dec 31
Depreciation Expense
Accumulated Depreciation
60,000
60,000
Depreciation expense for 2014 is for one year or twelve (12) months.
f. Uncollectible accounts – these represent customer’s accounts that may no longer collected or
that may possibly become bad debts. PAS No.39 provides that trade accounts receivable should
be reported in the statement of financial position at amortized cost. Amortized cost is defined as
the amount at which the receivable is measured at the time it was first recognized minus any
payments and minus any reduction (directly or through the use of an allowance account) for
uncollectibility. The entry to record estimated uncollectible accounts is as follows:
Uncollectible Accounts Expense
Allowance for Uncollectible Accounts
xxx
xxx
PAS No. 39 requires a careful assessment of the collectability of the receivables (classified as
financial assets).
Several considerations have to be taken account, which will be discussed
thoroughly in higher accounting subject.
For purposes of discussion in this book, the
estimated uncollectible amount will be provided.
The amount of uncollectible accounts expense that will be reported in the income statement is
computed as follows:
Required allowance balance
Pxxx
Allowance balance before adjustment
(+ debit balance/ - credit balance)
xxx
Uncollectible accounts expense for the period
Pxxx
The amount “Allowance for Uncollectible Accounts” is a contra asset account; it is reported on
the statement of financial position as a deduction from Accounts Receivable.
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Example 7: STU Company’s trial balance dated December 31,2014, contains the following
information:
Accounts receivable
P 350,000 debit
Allowance for uncollectible accounts
2,000 credit
Sales
1, 850,000 credit
Estimated uncollectible accounts amounted to P6,050.
The entry to record uncollectible accounts expense follows:
Uncollectible Accounts Expense
Allowance for Uncollectible Accounts
Required allowance balance
Allowance balance before adjustment – credit
Uncollectible accounts expense for the period
4,050
4,050
P6,050
2,000
P4,050
g. Inventory – adjustment for inventory is necessary if the periodic inventory system is used.
Under the periodic inventory system, the company does not record the physical movement of
goods. Purchases of goods are recorded in the nominal account “Purchases”. The reduction in
inventory resulting from sale is not reflected in books. Thus, the balance of the Inventory account
shown in the company’s trial balance represents inventory at the beginning of the period. Because
of this adjusting entries are necessary to reflect the inventory at the end of the period.
There are two methods of recording adjustments related to inventories. Under the first method,
two entries are prepared: (1) to transfer the beginning inventory balance to the Income Summary
account and (2) to establish ending inventory balance. The entries are as follows:
1. To transfer beginning inventory balance to Income Summary
Income Summary
xxx
Inventory (or Merchandise Inventory)
xxx
2. To record ending inventory balance
Inventory (or Merchandising Inventory)
Income Summary
xxx
xxx
Under the second approach, a separate cost of goods sold account is set up and the entry to record
the adjustments is as follows:
Inventory (Merchandising Inventory), end
Purchases Returns and Allowances
Purchases Discounts
Cost of Goods Sold
Inventory (or Merchandising Inventory), beg.
Purchases
Freight-in
xxx
xxx
xxx
xxx
xxx
xxx
xxx
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The balance of the Cost of Goods Sold account is closed to Income Summary as part of
the normal closing entries.
6. Preparing a work sheet/end-of-period spreadsheet – this step is optional but it facilitates the
preparation of the financial statements. A work sheet is a working paper which contains the data
in the trial balance, the adjustments compiled in step 5, and the developed income statements and
statement of financial position data. Normally, four pairs of columns are maintained to achieved
the purpose by which the worksheet is prepared. The first pair of amount of columns is for the
trial balance data; the second pair is for the adjustments; the third pair is for the income statement
data; and the fourth pair is for the statement of financial position data. In some cases, another pair
of column for adjusted trial balance is added following the adjustments columns and preceding
the income statements columns. Working papers are usually prepared by using a computer
spreadsheet program such as Microsoft’s Excel.
7. Preparing the financial statements – after the work sheet is completed, the financial
statements are prepared. The data reported in the statements are taken from the completed work
sheet. However, if a work sheet is not prepared, the adjusting data must be journalized and posted
before the financial statements can be prepared. This is because the data reported in the
statements are taken from the updated balances of the accounts in the general ledger. The
financial statements are described as the end product of the accounting process.
PAS 1 provides that a complete set of financial statements shall consists of the following:
1. Statement of financial position (balance sheet)
2. Statement of comprehensive income
3. Statement of cash flows
4. Statement of changes in owner’s equity
5. Notes
An entity may prepare a single statement of comprehensive income or two separate statements – a
statement of income and statement of other comprehensive income. Other comprehensive income
includes items of unrealized gains and losses that are not reported as part of profit or loss, such as
revaluation surplus arising from reporting of plant assets at revalued amounts and gain (loss)
from change in fair value of investments classified as available for sale.
8. Adjusting and closing the books – the adjustments that were recorded in the work sheet are
now formally recorded in the general journal and posted to the accounts in the general ledger. The
balances of the nominal (temporary) accounts, which consist of income, expense, and drawing
accounts, are then closed to Income Summary account. The balance of the Income Summary
account is then transferred to the owner’s equity (capital) account. A debit balance in the Income
Summary account represents a loss while a credit balance represents a profit. Lastly, the
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balance of the owner’s drawing account is closed to owner’s equity (capital) account. When the
closing process is completed, all nominal accounts will have zero balances.
Following are the pro-forma closing entries prepared at the end of the accounting period:
1. To close the balances of income accounts
Revenue/Income
xxx
Income Summary
xxx
2. To close the balance of expense accounts
Income Summary
Expenses
xxx
xxx
3. To close the balance of Income Summary account (credit balance)
Income Summary
xxx
Capital
xxx
To close the balance of Income Summary account (debit balance)
Capital
xxx
Income Summary
xxx
4. To close the balance of the drawing account
Capital
Drawing
xxx
xxx
9. Preparing a post-closing trial balance – this step is done after all the balances of nominal
accounts have been closed, that is, their balances were reduced to zero. Therefore, a post-closing
trial balance contains only the real accounts (assets, liabilities and equity); the balances of these
accounts are carried forward to the next accounting period. A post-closing trial balance is
prepared to check the equality of debits and credits after journalizing and posting the closing
entries.
10. Reversing the accounts – certain adjusting entries recorded at the end of the accounting
period are reversed at the beginning of a new accounting period. These adjustments include
accrued expenses, accrued revenues or income, prepaid expenses recorded under the expense
method and deferred revenues or income recorded under the revenue method.
The preparation of reversing entries is optional but it facilitates the recording of expense
payments and revenue receipts in the new period in the usual manner. This means that expense
payments are recorded as a debit to an expense account and a credit to cash; revenue receipts are
recorded as a debit to cash and a credit to revenue or income account.
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The adjustment that will be reserved if reversing entries are prepared and the pro-forma reversing
entries prepared at the beginning of a new accounting period are as follows:
1. Accrued Expense
Payable
Expense
xxx
2. Accrued Income
Income
Receivable
xxx
3. Prepaid expense - expense method
Expense
Prepaid Expense
4. Deferred revenue or income - revenue method
Unearned Income
Income
xxx
xxx
xxx
`
xxx
xxx
xxx
REVIEW of the LEARNING OBJECTIVES
1. Understanding the definition of accounting and identify the users of accounting
information. Accounting is a service activity. Its function is to provide quantitative information,
primarily financial in nature, about economic entities, that is intended to be useful in making
economic decisions. The users of accounting information are grouped into external users and
internal users. The users of financial statements include present and potential investor,
employees, lenders, suppliers and other trade creditors, customers, governments and their
agencies, and the public. They use the financial statements to make informed decisions.
2. Identify and explain the steps in the accounting process. The accounting process (also called
the accounting cycle/ is composed of ten (10) steps, two of which are optional. These steps are
grouped into two phases, namely: (1) the recording phase, and (2) the summarizing phases. The
three steps under of recording phase are the following: (1) preparing or receiving the appropriate
documents (documentation), (2) journalizing the transactions, and (3) posting the recorded
transactions to the accounts in the ledger. The seven (7) steps under the summarizing phase are as
follows: (1) preparing the trial balance, (2) compiling the data for adjustments, (3) preparing the
worksheet (optional), (4) preparing the financial statements, and (7) preparing reversing entries
for certain adjusting entries (optional)
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3. Preparing adjusting entries and understanding the rationale for preparing them. Adjusting
entries are prepared at the end of the accounting period to update the balances of the accounts in
the general ledger prior to the preparation of the financial statements. This will enable the
preparers of the financial statements to present fairly the financial position and the results of
operations of an entity during a given period because all transactions that have affected the
elements of the financial statements are recognized during the period. Data that require
adjustments includes the following: (1) accrued expense, (2) accrued income, (3) prepaid
expense, (4) unearned income, (5) depreciation and other cost allocation, (6) uncollectible
accounts receivable, and (7) inventory recorded using the periodic inventory system.
4. Prepare closing entries and understand the rationale for preparing them. Closing entries are
prepared for nominal accounts to reduce their balances to zero at the end the accounting period.
Nominal accounts include the following: income accounts, expense accounts, and temporary
equity accounts, such as the drawing account of the owner in a sole proprietorship form of
business organization.
5. Explain the advantage of preparing the reversing entries and identify adjusting entries that
may be reversed. Reversing entries are prepared at the beginning of a new accounting period for
the following adjustments: (1) accrued expense, (2) accrued Income, (3) prepaid expense
recorded under the expense method, and (4) unearned income, recorded under the income
method. The preparation or reversing entries is optional but it facilitates the recording of expense
payment and revenue receipts during the new accounting in the usual manner.
GLOSSARY of ACCOUNTING TERMINOLIGIES
Accounting - a service activity. Its function is to provide quantitative information, primarily
financial in nature, about economic entities that is intended to be useful in making economic
decisions.
Accounting process - also as accounting cycle. It includes a series of steps that are performed to
come up with the information reported in the financial statements.
Accrued expense - expense incurred but not yet paid as of the statement of financial position
date. Accrued expense is not paid but is matched against earnings for the current period.
Accrued income - income earned but not yet received or collected as of the statement of financial
position date. Accrued revenue is uncollected but is matched against expense for the current
period.
17
Closing entries - entries prepared at the end of the accounting period that reduce the balance of
nominal accounts to zero.
Depreciable amount - the cost of an item of property, plant and equipment, or other amount
substituted for cost minus its residual value.
General journal - the most flexible type of journal. All transactions may be recorded in the
general journal.
General Ledger - principal ledger that contains all the accounts reported in the financial
statements.
Journals - also known as books of original entry. They include both general journal and special
journals.
Ledgers - also known as books of final entry. They include both general and subsidiaries ledgers.
Nominal accounts - also known as temporary accounts. They are accounts whose balances are
reduced to zero at the end of the accounting period. Nominal accounts include revenue or income
accounts, expense accounts, and temporary equity accounts, such as drawing account.
Prepaid expense - expense paid or acquired in advance; expense paid or incurred but not yet
incurred or consumed. Prepaid expense has been paid or acquired as of the statement of financial
position date but not matched against earnings for the current period.
Post-closing trial balance - a trial balance prepared after closing the books. The post-closing trial
balance contains real accounts only.
Real accounts - also known as permanent accounts. They are accounts whose balances are
carried forward to the next accounting period and they include asset, liability, and equity
accounts.
Reversing entries - entries prepared at the beginning of a new accounting period to reverse
certain adjusting entries. They are prepared to facilitate the recording of expense payments and
revenue receipts during the new accounting period in the usual manner.
Special journals - journals used to record repetitive or frequently occurring transactions. They
include sales journals, purchases journal, cash receipts journal and cash disbursements journal.
Subsidiary ledger - a ledger that provides details of a general ledger account.
Trial balance - a list of general ledger accounts with their corresponding balances. It proves the
equality of debits and credits.
18
Unearned income - also known as deferred income. This is income collected but not yet earned
or realized. Unearned income is not collected but is not matched against expense for the current
period.
DISCUSSION QUESTIONS
1. What is accounting and what is its purpose? What is its role in decision-making?
2. Who are the users of accounting information and what is the relevance of the information to
the various types of decisions that they make? Who are the users of financial statements and what
are their information needs?
3. What are the steps in the accounting process? What is the importance of each step and how it is
related to the other steps in process?
4. Why are journals are called books of entry?
5. Distinguish between (a) a general journal and special journals, and (b) a general ledger and a
subsidiary ledger.
6. Does the trial balance prove the accuracy of accounting work done? Explain your answer.
7. What are the common types of adjusting data? Why do we prepare adjusting entries?
8. Why do accounts prepare work sheet even if its preparation is optional?
9. Enumerate and discuss the components of a complete set of financial statements.
10. If reversing entries are made, which adjusting entries would be reversed?
19
EXERCISES
Exercise 1-1 (Classifying Types of Adjustments)
Classify the following items as (a) prepaid expense, (b) unearned revenue, (c) accrued revenue, or
(d) accrued expense.
1. Cash received for services not yet rendered.
2. Supplies on hand
3. Utilities owed to be paid the following month.
4. Taxes owed but payable in the next period.
5. A three-year premium paid on fire insurance policy for the buildings.
6. Cash received for use of land within the next six months.
7. Fees earned to be received the following month.
8. Rent expense owed but not yet paid.
9. Subscriptions received in advance by a magazine publisher.
10. Fees earned but unbilled.
11. Salaries owed but not yet paid.
12. Rent revenue earned but not yet paid.
13. Insurance paid.
14. Fees received but not yet earned.
15. Unpaid wages.
Exercise 1-2 (Adjusting Entries)
Give the account/s to be credited to complete the adjusting entries below:
Debit
Credit
1. Uncollectible Accounts Expense
2. Prepaid Rent
3. Offices Supplies on Hand
4. Salary Expense
5. Insurance Expense
6. Interest Receivable
7. Interest Expense
8. Rent Income
9. Depreciation Expense
10. Inventory, end
20
Exercise 1-3 (Adjusting and Reversing Entries – Prepaid Expenses and Unearned Revenues)
This following are selected transactions of the ABC Trading during the year 2014:
a. On December 1, 2014, the company received P300,000 representing rental payments for
the period December 1,2014 to November 30, 2015.
b. On March 1, 2014, an insurance premium of P90,000 was paid covering a period of one
year beginning on this date.
Instructions: Provide the necessary adjusting entries as of December 31, 2014 and appropriate
reversing entries as of January 1, 2015 assuming:
1. Transactions were originally recorded in asset and liability accounts.
2. Transactions were originally recorded in expense and revenue accounts.
Exercise 1-4 (Adjusting and Reversing Entries)
DEF Merchandising follows the policy of recording prepayments in revenue and expense
accounts and reverses appropriate adjusting entries at the beginning of the new accounting period.
The record of the business show the following:
a. On September 1, 2014, DEF borrowed P2,000,000 cash from the Bank of the Philippines
by issuing a 6% note payable in one year. The interest is payable upon maturity of the
note.
b. On February 1, 2014, DEF paid insurance premium of P72,000 covering a period of three
years beginning on this date.
c. On December 1, 2014, DEF paid P360,000 representing the rental for one year starting on
this date.
d. DEF reports accounts receivable of P1,500,000 and allowance for uncollectible accounts
of P10,000 (debit balance); P50,000 of the receivables are uncollectible
e. DEF pays all employees every Friday. The total payroll for the five-day workweek ending
January 3, 2015 is P450,000
f. DEF purchased office equipment on August 1, 2014 amounting to P120,000. On January
1, 2014, the office equipment account has a balance of P480,000. All equipment have
estimated useful life of 5 years with no residual value.
21
g. Office supplies on hand on January 1, 2014 amounted to P5,000. During this year, office
supplies of P12,500 were purchased. On December 31, 2014, there are unused supplies of
P4,500.
h. DEF subleases part of its office space for P30,000 per month. On November 1, 2014, it
received rental payments for six months starting on this date.
i. Merchandise inventory on January 1 and December 31 amounted to P180,0000 and
P220,000, respectively.
Instructions:
1. Prepare the necessary adjusting entries on December 31, 2014.
2. Prepare appropriate reversing entries as of January 1, 2015.
Exercises 1-5 (Adjusting Entries for Invetories and Closing Entries)
The following balances are found in the general ledger of GHI Sales after recording
the necessary adjusting entries, except for inventories, in the year 2014:
Purchases
2,100,000
Sales
5,000,000
Freight-in
10,000
Sales Returns
5,000
Purchase Returns
20,000
Sales Discounts
10,000
Inventory, beginning
50,000
Interest Revenue 25,000
Castro, Capital
2,000,000
Selling Expense 450,000
Castro, Drawing
500,000
Interest Expense 15,000
Administrative Expense
500,000
Accounts Payable 300,000
Accounts Receivable
1,500,000
The ending inventory based on physical count in P140,000.
Instructions:
1. Prepare the required adjusting entries for inventory under the two approaches.
2. Prepare the required closing entries as of December 31, 2014 using the approach in which
no separate cost of goods sold account in set up in adjusting the inventory balance.
Exercise 1-6 (Real Accounts)
The accountant of JKL Enterprises had just completed posting all the adjusting entries
to the appropriate ledger accounts and now wishes to close the ledger balances in
preparation for the next accounting period.
For each of the accounts listed below, indicate whether the balance should be: (a)
carried forward to the next accounting period, (b) closed by crediting the account, or
(c) closed by debiting the account.
___1. Accounts Payable
___2. Accounts Receivable
___3. Accumulated Depreciation
___11. Merchandise Inventory, beg.
___12. Merchandise Inventory, end.
___13. Notes Receivables
22
___4. Cash
___5. Freighht-in
___6. Income Summay
___7. Interest Payable
___8. Interest Revenue
___9. Lacap, Capital
___10. Lacap, Drawing
___14. Prepaid Insurance
___15. Purchase Discounts
___16. Purchases
___17. Salaries Payable
___18. Salaries
___19. Sales Discounts
___20. Sales Returns and Allowances
PROBLEMS
Problem 1-1 (Adjusting and Reversing Entries)
In analyzing the accounts of MNO Company, the information listed below are
determined on December 31, 2014, the end of the first year of operations of the
company:
a. The prepaid Insurance account shows a total of 48,000 representing the cost of a one-year
insurance policy dated October 1, 2014.
b. On November 1, Rent Revenue was credited for P270,000 representing rental for nine
months beginning on that date.
c. Supplies of P20,000 were purchased during the year and were debited to the Supplies
Expense account. On December 31, supplies of P4,500 are on land.
d. The company acquired equipment on April 1, costing P350,000. The assests have
estimated usefule life of five years without any residual value.
e. Accounts receivable balance on December 31 amounted to P1,500,000. Of this amount,
P8,000 are estimated to become uncollectible.
f. The notes receivables account has a balance of P150,000 representing a 90-day, 12 % note
received on December 1. The interest on the note is collectible upon maturity.
g. Unpaid salaries as of December 31 amounted to P155,000.
h. Merchandise inventory on December 31 is P122,000.
Instructions:
1. Prepare the necessary adjusting entries as of December 31, 2014.
2. Prepare the appropriate reversing entries as of January 1, 2015.
Problem 1-2 (Closing Entries)
The work sheet prepared at the PQR Retail Store for the year ended December 31,
2014 contains the information presented below.
Income
Statement
of
Statement
Financial Position
Debit
Credit
Debit
Credit
Merchandise Inventory
120,000
150,000
150,000
Olson, Capital
720,000
Olson, Drawing
180,000
23
Sales
Sales Returns and Allowances
Purchases
Freight-in
Purchases Returns nad Allowances
Supplies Expense
Insurance Expense
Salary Expense
Depreciation Expense
Office Expense
5,700,000
150,000
3,000,000
120,000
90,000
18,000
27,000
540,000
24,000
150,000
Instructions: From the information given above, prepare the necessary closing entries
as of December 31, 2014.
a.
b.
c.
d.
e.
f.
g.
Problem 1-3 (Effects of Adjustments on the Accounts in the Statement of Financial
Position and in the Income Statement)
STU Services adjusts and closes its books at the end of each month. On October 31,
2014 adjusting entries were prepared to record:
Interest expense that has accrued during October.
Revenue earned during October but has not been billed yet to customer.
Uncollectible accounts expense for the montth of October.
Depreciation expense for October.
The portion of insurance premium which has expired in October.
Th portion of revenue collected in advance which was earned in October.
Accrued salaries of employees at the end of October.
Instructions: Indicate the effect of each of the adjusting entries upon the major
elements of the statement of financial position and income statement. The company
records prepayements in asset and liability accounts. Organize yyour answers in
tabular form, using the column headings given and the symbols (+) for increases, (-)
for decreases, and (NE) for no effect. The answer for adjusting entry (a) is provided as
an example.
Statement of Financial
Income Statement
Positions
A
A
Li
E
R
E
P
J
s
a
q
e
x
r
E
s
bi
u
v
p
o
e
lit
i
e
e
f
t
ie
t
n
n
i
s
s
y
u
s
t
e
e
s
A
N
+
N
+
E
E
24
Problem 1-4 (Adjusting and Closing Entries)
The trial balance of VWX Advertising Agency before and after the posting of
adjusting entries is shown below:
VWX Advertising Agency
Trial Balance
December 31, 2014
Before Adjustment
Debit
Credit
288,800
Cash
Commissions Receivable
Prepaid Rent
Office Supplies
Office Equipment
Accumulated Depreciation
16,400
Notes Payable
30,000
Accounts Payable
120,000
Salaries Payable
4,800
Interest Payable
1,200
Unearned Commissions
24,000
Valdez, Capital
200,000
Valdez, Drawing
Commissions Income
175,200
Salary Expense
Rent Expense
Office Supplies Expense
Depreciation Expense
Interest Expense
After
Debit
Adjustments
Credit
288,800
7,200
84,000
12,600
36,000
120,000
19,200
36,000
14,000
30,000
120,000
32,000
200,000
32,000
32,000
160,000
60,000
64,800
36,000
6,600
2,400
1,200
571,600
556,000
556,000
571,600
Instructions:
1. From the comparative trial balances presented, prepare the seven (7) adjusting entries
made. The difference between the amounts in the “Before Adjustments” columns and the
amounts in the “After Adjustments” columns are the result of seven adjusting entries.
2. Prepare the necessary closing entries as of December 31, 2014.
3. Determine the amount of profit.
25
Problem 1-5 (Adjusting Entries)
The XYZ Realty operates with an annual accounting period that ends on December
31. The trial balance of the company at the end of the current year 2014 follows:
Cash
Accounts Receivable
Prepaid Insurance
Office Equipment
Accumulated Depreciation – Office Equipment
Automobile
Accumulated Depreciation – Automobile
260,000
Accounts Payable
Unearned Management Fees
120,000
Primo, Capital
840,000
Primo, Drawing
Management Fees Earned
Office Salaries Expense
Advertising Expense
Rent Expense
Telephone Expense
Utility Expense
1,300,000
550,000
50,000
750,000
150,000
1,300,000
110,000
350,000
3,600,000
450,000
100,000
150,000
30,000
50,000
5,080,000
5,080,000
Data for adjustments:
1. Expired insurance during the year amounted to P30,000.
2. Depreciation expense for the year: office equipment – P75,000; automobile – P260,000.
3. The balance of unearned management fees represents advance payments for six months
starting September 1, 2014.
4. Advertising expense represents a five-month advertising beginning October 1, 2014.
Instructions: Prepare the necessary adjusting entries as of December 31, 2014.
MULTIPLE CHOICE QUESTIONS
MC 1-1 Adjusting entries normally involve
a. real accounts only
c. real and nominal accounts
b. nominal accounts only
d. neither real nor nominal account
MC 1-2 The balance in an unearned income account represents an amount
Earned
Collected
a.
Yes
Yes
26
a.
b.
c.
d.
b.
Yes
No
c.
No
No
d.
No
Yes
MC 1-3 An accrued expense can be best described as an amount
paid and matched with earnings for the current period
paid and not matched with earnings for the current period
not paid and matched with earnings for the current period
not paid and not matched with earnings for the current period
MC 1-4 Which of the following accounts could appear in an adjusting entry, closing
entry and reversing entry?
a. Accumulated Depreciation
c. Interest Revenue
b. Depreciation Expense
d. Salaries Payable
MC 1-5 Closing entries ultimately will affect
a. Cash Account
c.
Total
Assets
b. Owner’s Capital Account
d. Total Liabilities
MC 1-6 Probably, the last account to be listed on a post-closing trial balance would
be
a. Income Summary
c. Interest Revenue
b. Interest Expense
d. Owner’s Capital
a.
b.
c.
d.
MC 1-7 Which of the following is not considered in computing net cost of purchases?
Purchases
Purchase Returns and Allowances
Transportation paid on goods purchased
Transportation paid on goods shipped to customers
MC 1-8 Which of the following accounts would appear on a worksheet for a
merchandising company that uses the periodic inventory system
a. Cost of Goods Sold
c. Purchase Returns and Allowances
b. Income Summary
d. All of these
MC 1-9 After all adjusting entries are posted, the balances of all assets, liability,
income and expense accounts correspond exactly to the amounts in the
a. Financial Statements
c. Unadjusted Trial Balance
b. Post-closing Trial Balance
d. Worksheet Trial Balance
MC 1-10 Insurance Expense account has a balance of P180,000 before adjustment.
This amount represents insurance premium for three months beginning November 1,
2014. Based on these data, the prepaid insurance that should be reported in the
December 31, 2014 statement of financial position is
a. P-0c. P72,000
b. P36,000
d. P108,000
27
a.
b.
c.
d.
MC 1-11 A P50,000 purchases on account was paid after the expiration of the 2%
discount period. The entry to record the payment would include
Debit to accounts payable for P50,000
Credit to accounts payable for P49,000
Debit to purchase discount for P1,000
Credit to cash for P49,000
MC 1-12 Prior to adjustments, Supplies Expense account has a balance of P13,500.
Adjustment data gathered shows that supplies inventory on hand at year-end
amounted to P5,500. The amount of supplies to be shown in the income statement is
a. P-0c. P8,000
b. P5,500
d. P13,500
MC 1-13 Rent income account has a credit balance of P240,000 composed of the
following:
a. Rental for three months ending March 31, 2014, P45,000
b. A credit of P195,000 representing advance rental payment for one year beginning Aprl
1, 2014.
The December 31 adjusting entry will require a debit to Rent Income and a credit to
Unearned Rent of
a. P45,000
c. P191,250
b. P48,750
d. P195,000
MC 1-14 The Giveaway Enterprises reported an allowance for uncollectible accounts
of P16,000 (credit) at December 31, 2014, before any adjustment. At the end of the
year, the company reports accounts receivable of P800,000, 3% of which is estimated
to be uncollectible. The adjusting entry required at December 31, 2014 would be
a. Uncollectible Accounts Expense
8,000
Allowance for Uncollectible Accounts
8,000
b. Uncollectible Accounts Expense
16,000
Allowance for Uncollectible Accounts
16,000
c. Uncollectible Accounts Expense
24,000
Allowance for Uncollectible Accounts
24,000
d. Uncollectible Accounts Expense
40,000
Allowance for Uncollectible Accounts
40,000
MC 1-15 Assuming that ending merchandise inventory was P10,000 less than the
beginning merchandise inventory of P125,000 and that the net purchases was
P450,000 how much was the cost of goods sold?
a. P-0c. P460,000
b. P335,000
d. P565,000
28
Test Material No. 1
__________________
Name
__________________________________
Year
and
Section
_________________________
Rating
Date
_______________________
Professor
___________________
TRUE or FALSE
Instructions: Encircle the letter T if the statement is true and the letter F if the
statement is false.
1. Accounting is a service activity whose function is to provide quantitative
information about economic entities.
2. The records used for the initial recording of business transactions are journals.
3. The rules for debit and credit and the normal balances of liabilities are the same
as for Capital.
4. Special journals are used to record usual and frequent transactions.
5. The preparation of work sheet eliminates the need to journalize and post
adjusting entries.
6. The accounting process consists of the recording phase and reporting phase.
7. The purpose of a trial balance is to reconcile subsidiary ledger balances with the
general ledger balances.
8. Accumulated depreciation is an example of an adjunct account.
9. The general ledger includes all accounts appearing in the financial statements,
subsidiary ledger provide details in support of certain general ledger
balances.
10. Entering a debit balance in an account as a credit will cause the trial balance to
be out of balance by an amount that is divisible by two (2).
11. Adjusting entries are made to correct errors made in the recording phase.
12. The entry to record depreciation expense is an example of an adjustment that
would be reversed if the reversing entries are made.
13. It is sometimes correct for a compound entry’s debit totals and credit totals to
be unequal.
14. The trial balance is used to prepare the statement of comprehensive income
while the general ledger is used to prepare the statement of financial
position.
15. The recording of an accrued expense will always result to an increase in an
expense account and a liability account.
16. The balances of all the accounts in the general ledger must be closed at the
end of the accounting period.
29
17. The asset and liability accounts are known as real accounts.
18. The adjusted trial balance is prepared after the financial statements are
Prepared.
19. Owner’s equity is the excess of an entity’s assets over its liabilities.
20. The general ledger account that summarizes the detailed information in a
subsidiary ledger is known as control account.
21. The balance sheet shows the financial position of a company at a given date.
22. Te difference between the debit total and the credit total in the statement of
financial position section of the work sheet represents the profit or loss during the
period.
23. Recording the expiration of a prepaid asset results in the reduction of the asset
account and an increase in a related expense account.
24. Reversing entries are prepared at the end of the accounting period.
25. Since new and revenue accounts will be opened in the subsequent accounting
Subsequent accounting period, it is no longer necessary for an entity to
post the
closing entries to the accounts in the ledger.
30
Test Material No.2
Rating _________
Name _________________________________
Year and Section ________________________
Date ____________________
Professor _________________
MULTIPLE CHOICE- Theory
Instructions: Encircle the letter that corresponds to the best answer.
1. Adjusting entries are necessary
a.
to measure properly the income for the period
b. to update the balances of the asset accounts
c.
to update the balances of liability accounts
d. for all the above reasons
2. Which of the following is a distinguishing characteristic of a contra account?
a.
It always has a credit balance
b. Its normal balance matches that of its companion account
c.
It always decreases the balance of its companion account
d. It always increases the balance of its companion account
3. The carrying amount (book value) of an item of property, plant and equipment is determined
by
a.
deducting depreciation expense during the period from the original balance of the
asset account
b. adding the contra account balance to the original balance of the asset account
c.
deducting the contra account balance from the original balance of the asset account
d. an independent appraiser
4. Recording the expiration of a prepaid expense that was originally recorded in an asset account
would require a
a.
debit to the appropriate prepaid asset account
b. debit to the appropriate expense account
c.
credit to cash
31
d. credit to accounts payable
5. An adjusting entry for unearned revenue is requires because cash is received
a.
before the revenue is earned
b. after the revenue is earned
c.
as revenue is earned
d. after the balance sheet date
6. An adjusting entry for accrued expense is required because cash is paid
a.
before the expense is incurred
b. after the expense id incurred
c.
as the expense id incurred
d. after the balance sheet date
7. An entry requiring a debit to an expense account and a credit to an asset account is an example
f an adjusting entry classified as
a.
accrued expense
b. Depreciation
c.
prepaid expense
d.
uncollectible accounts
8. The post-closing trial balance is prepared
a.
after preparing the financial statements
b. after completing the work sheet
c.
after preparing the closing entries
d. at any time in the accounting cycle
9. Depreciation is the process of
a.
saving money to the purchase of new assets
b. systematically allocating the cost of plant assets over their useful life
c.
systematically recording the current market value of plant assets
d. recording the physical deterioration of plant assets
10. Which of the following accounts would not be use in an adjusting entry?
a.
Accumulated depreciation
c.
Interest expense.
32
b.
equipment
d.
Salaries payable
11.In the accounting cycle,which step follows the preparation of financial statements?
a.
Journalize and post transactions as they occur
b. Journalize and post adjusting and closing entries
c.
Prepare the work sheet
d. Prepare a post- closing trial balance
12 .An entry requiring a debit to an expense account a credit a liability account is an example of
adjusting entry classified as
a.
accrued expense
b. Depreciation
c.
prepaid expense
d.
uncollectible accounts
13. A post-closing trial balance is prepared after
a.
combining trial balance and adjustment figures
b. preparing the financial statements
c.
completing the work sheet
d. journalizing and posting the closing entries
14. A debit column total is greater than the credit column total in the income statement section
of the worksheet. This means that
a.
mistakes were made in the preparation of the adjusted trial balance
b. the company had a profit
c.
the company had a loss
d. the Income Summary account will have a credit balance after the nominal accounts are
closed
15. Closing entries are journalized and posted before
a.
financial statements are prepared
b. adjusting entries are journalized and posted
c.
post-closing trial balance is prepared
d. work sheet is completed
33
16. Before the adjusting entries are entered on the work sheet
a.
the trial balance debit and credit column totals are not equal
b. the trial balance account balances do not reflect updated balances
c.
the post-closing trial balance must be completed
d. the financial statements are prepared
17. Nominal accounts are also called
a.
mixed accounts
b. permanent accounts
c.
real accounts
d. temporary accounts
18. Which of the following items is not found in the work sheet?
a.
Adjustments
c.
Income statement
b. General journal
d.
Statement of Financial Position
19. Which of the following items has no effect on owner’s equity?
a.
Expense
b. Land Acquired
c.
Revenue
d.
Withdrawals
20. The summarizing phase includes all of the following steps except
a.
journalizing and posting adjusting entries
b. journalizing and posting closing entries
c.
preparing the trial balance
d. transferring the recorded transactions in the journal to the accounts in the ledger
34
Test Material No.3
Rating _________
Name _________________________________
Year and Section ________________________
Date ____________________
Professor _________________
MULTIPLE CHOICE- Problems
Intructions: Encircle the letter that corresponds to your answer. Present supporting
computations in good form in a separate work sheet.
1. If the debit and credit totals of a trial balance were P240,000 and an additional entry was
recorded and posted for the purchase of P10,000 of office supplies for cash, what would be the
new debit and credit totals for the trial balance after this entry is made
a.
P230, 000
c.
P245, 000
b. P240, 000
d.
P250, 000
2. A trial balance has debit and credit totals of P240, 000. The purchase of P10,000 OF OFFICE
supplies on account was omitted from the original journal entries. After the recording and posting
of this transaction, the new debit and credit totals for the trial balance would be
a.
P230, 000
c.
P245, 000
b. P240, 000
d.
P250, 000
3. Aquino Service Company billed P1,200,000 for services to clients on account and had
expenses of P500,000 on account. Accounts receivable had a beginning balance of P120, 000 and
an ending balance of P80, 0000. How much cash did Aquino collect on accounts receivable and
what type of entry to accounts receivable was made?
a.
P740, 000, debit
c.
P1, 240, 000, debit
b. P740, 000, credit
d.
P1, 240, 000, credit
4. Bonifacio Co. pays cash for three months rent in advance, at a rate of P50,000 per month. The
balance of the Prepaid Rent account two months later would be
a.
P25, 000
c.
P100, 000
b. P50, 000
d.
P150, 000
5. Prepaid Insurance account had a beginning balance of P45, 000. At the end of the accounting
period, it had a balance of P 9, 000. Accumulated Depreciation had a beginning balance of P30,
000 and an end-of-period balance of P45, 000. The change in the account balances of these two
accounts resulted in total expenses changing by a (an)
35
a.
decrease of P36, 000
b. increase P39, 000
c.
decrease P45, 000
d.
increase of P51, 000
6. Carlos Company paid four months rent on August 1and debited Rent Expense for P80,000. On
August 31, Carlos should
a.
debit Prepaid Rent for P20, 000
b. credit Prepaid Rent for P20, 000
c.
credit Rent Expense for P20, 000
d. credit Rent Expense for P60, 000
7. Dagohoy Organizers purchased an equipment costing P100, 000 on July 1, 2014. The
equipment has an estimated useful life of 10 years with an estimated residual value of P10, 000.
The balance of the Accumulated Depreciation account on December 31, 2015 is
a.
P4, 500
b. P5, 5000
c.
P13, 500
d.
P15, 000
8. The Unearned Service Revenue account shows an adjusted end-of-year balance of P 300,000.
The adjusting entry to Unearned Service Revenue indicated P400, 000 in the service revenue
earned during the accounting period . What was the balance of the Unearned Service Revenue
account before the adjusting entry was recorded?
a.
P100, 000, credit
c.
P700, 000, credit
b. P100, 000, debit
d.
P700, 000, debit
9. Esteves Company has a P180,000, 105, 90-day note receivable outstanding at December 31.
The note is dated December 1, 2014. The appropriate adjusting entry made to record accrued
interest on the note at year-end. What is the correct reversing entry on January 1 of the following
year?
a.
Debit Interest Revenue and credit Interest Receivable , P1,500
b. Debit Interest Receivable and credit Interest Revenue, P1, 500
c.
Debit Interest Revenue and credit Interest Receivable, P4, 500
d.
Debit Interest Receivable ND CREDIT Interest Revenue, P4, 500
10. In the worksheet, the Income Statement debit column equals P700,000 and the credit column
equals P800,000. Which of the following statement id correct?
a.
The company realized a profit of P100,000 and it must be added to the Income Statement
debit column and the Statement of Financial Position credit column to complete the work
sheet.
36
b.
The company incurred a loss of P100,000 and it must be subtracted from the Income
Statement debit column and the Statement of Financial Position credit column to complete
the work sheet.
c.
The company incurred a loss of P100,000 and it must be added to the Income Statement
credit column and the Statement of Financial Position debit column to complete the work
sheet.
d.
The company realized a profit of P100,000 and it must be subtracted from the Income
Statement debit column and added to the Statement of Financial Position debit column.
11. The balances of the following accounts were closed to the Income Summary account; Salary
Expense, P50,000 debit; Cost of Goods Sold, P80,000 debit; Utility Expense P25,000 debit Sales,
P200,000 credit . The amount and the entry to close Income Summary to the Capital account
would be
a.
P45, 000 credit to the Income Summary account
b. P45,000 debit to the Income Summary account
c.
P155,000 debit to the Income Summary account
d. P200,000 credit to the Income Summary account
12. If the Income Summary Account has a credit balance of P150,000 before its balance is closed
to the Capital account, you know that
a.
revenues exceeded expenses by P50, 000
b. the company had a loss of P100, 000
c.
the company had a profit of P150, 000
d. the owner invested an additional P150, 000 in the business
13. The cost of goods sold available for sale is P1, 300, 000. The gross profit is P300, 000, net
sales amounted to P1,000,000, net purchases are P1, 100,000, and operating expenses are P220.
How much is the profit or loss of the company?
a.
P80, 000 profit
b. P80, 000 loss
c. P300, 000 profit
d. P300, 000 loss
14. On August 1, 2014, the Gabriel Company paid P36,000 in advance for a one-year insurance
policy starting on this date.Gabriel debited Insurance Expense and credited Cash for P36,000.
If adjusting entries are recorded annually, the appropriate adjusting entry at December 31,
2014 is a debit to
a.
Prepaid Insurance and a credit to Insurance Expense for P15,000
37
b. Insurance Expense and a credit to Prepaid Insurance for P15,000
c.
Prepaid Insurance and a credit to Insurance Expense for P21,000
d.
Insurance Expense and a credit to Prepaid Insurance for P21, 000
15. Using the information in No. 14 and assuming that Gabriel Company prepares reversing
entries, what is the correct reversing entry on January 1, 2015?
a.
A debit to Insurance Expense and a credit to Prepaid Insurance for P15, 000
b. A debit to Prepaid Insurance and a credit to Insurance Expense for P21,000
c.
A debit to Insurance Expense and a credit to Prepaid Insurance for P21, 000
d.
No reversing entry should be recorded
16. Jacinto Company has beginning inventory of P600, 000 and ending inventory of P700,000.
Under the periodic inventory system, the Inventory account at the end of the period would have
the following balances, respectively, before and after adjusting and closing entries
a.
P600,000 and P700,000
c. P700,000 and P600,000
b.
P600,000 and P600,000
d. P700,000 and P700, 000
17. Prepaid Insurance has an ending balance of P46,000. During the period, insurance premium
in the amount of P24,000 expired. The adjusting entry would include a debit to
a.
prepaid insurance for P22,000
b. insurance expense for P22,000
c.
prepaid insurance for P24,000
d.
insurance expense for P24,000
18. A business received cash of P300,000 in advance for service that. The cash receipt was
recorded by a debit to Cash and a credit to Unearned Revenue for P300,000. At the end of the
period , P110,000 is still unearned. The appropriate adjusting entry is
a.
debit Unearned Income and credit Income for P190,000
b. debit Unearned Income and credit Income for P110,000
c.
debit Income and credit Unearned Income for P190,000
d.
debit Income and credit Unearned Income for P110,000
38
19. The adjusted trial balance of BLP Company shows the following balances:
Debit
Cash
Credit
P500,000
Accounts Receivable
100,000
Furniture and Fixtures
150,000
Accumulated Depreciation
P 40, 000
Accounts Payable
50,000
Pelejo, Capital
250,000
Pelejo, Drawing
50,000
Service Fee
630,000
Salary Expense
100,000
Depreciation Expense
40,000
Miscellaneous Expense
30,000
P970,000
P970,000
How much is the profit and the total assets of the company?
Profit
Total Assets
a. P410,000
P710,000
b. P410,000
P750,000
c. P460,000
P710,000
d. P460,000
P750,000
20. A business received cash of P300,000 in advance for service that. The cash receipt was
recorded by a debit to Cash and a credit to Unearned Revenue for P300,000. At the end of the
period , P110,000 is still unearned. The appropriate adjusting entry is
a.
debit Unearned Income and credit Income for P190,000
b. debit Unearned Income and credit Income for P110,000
c.
debit Income and credit Unearned Income for P190,000
d.
debit Income and credit Unearned Income for P110,000
21 .Silang Company purchased equipment on November 1, 2014 by giving thir supplier a oneyear, 12% note with a face-value of P200,000. The December 31 adjusting entry related to the
note is
39
a.
debit Interest Expense and credit Cash for P4,000
b. debit Interest Expense and credit Interest Payable for P4,000
c.
debit Interest Expense and credit Interest Payable for P6,000
d.
debit Interest Expense and credit Interest Payable for P24,000
22. Before any year-end adjustments were made, the profit of Valiente Co. was P2,000,000.
However, the following adjustments were necessary: office supplies used, P30,000, services
performed for clients but not yet collected, P65,000; interest accrued on note payable, P15,000.
After recording these adjustments, the profit would be
a.
P1,890,000
c. P2,020,000
b.
P1,920,000
d. P2,050,000
23. The following adjusted account balances are token from the ledger of Roque Merchandising
Company as of December 31, 2014:
Freight-in
P70,000
Inventory, beginning
560,000
Purchases Discount
30,000
Purchases Discount and Allowances
25, 000
Purchases
1,020,000
Sales Discount
43,000
Sales Return and Allowances
37,000
Service Fee
Sales Revenue
1,915,000
100,000
A physical count revealed an ending inventory of P578,000
The adjusting entry required to closed beginning inventory will include a
1.debit to Income Summary P560,000
2. credit to Income Summary P560,000
3. debit to Inventory, P560,000
40
a.
1 only
c.
3 only
b.
2 only
d.
both 2 and 3
24. Using the information in No. 23, the adjusting entry required to record ending inventory will
include a
1. debit to Income Summary, P578,000
2. credit Income Summary, P578,000
3. debit to Inventory, P578,000
a. 1 only
c.
3 only
b. 2 only
d.
both 2 and 3
25. Using the information in No. 23 the correct entry to close the accounts with debit balances to
Income Summary account is
a. credit Income Summary, P1,732,000
b. debit Income Summary, P1,170,000
c. debit Income Summary, P1, 732,000
d. credit Income Summary, P1, 170, 00
41
Test Material No. 5
Rating:_____________
Name:
_____________________________
____
Year and Section:
_______________________
Date: ____________________
Professor:
_____________________________
____
MATCHING TYPE
Choices:
6. Accounting period
7. Accrued expenses
8. Adjunct account
9. Book value
10. Business documents
11. Business enterprises
12. Closing entries
13. Contra asset account
14. Cost of goods available for sale
15. Cost of goods sold
16. Credit
17. Debit
18. Deferral
N.
O.
P.
Q.
R.
S.
Depreciation
Financial statements
General ledger
Income summary
Nominal accounts
Post-closing trial balance
T. Posting
U. Prepaid expenses
V. Real accounts
W. Reversing entries
X. Special journals
Y. Subsidiary ledger
Z. Worksheet
Instructions: Write the letter that corresponds to be best answer.
_________
1. The end product of the accounting process.
_________ 2. Expenses already incurred but not yet paid and recorded at the end of the
accounting period.
_________
3. An account with credit balance which is deducted from an asset
account.
_________ 4. Systematic allocation of cost of an item of property, plant and equipment over
periods benefited by the use of the asset.
_________
5. An entry on the right side of an account.
_________
6. Economic entities organized for profit.
_________
7. The original source materials evidencing business transactions.
_________
8. Span of time covered by the statement of comprehensive income
42
_________
9. Merchandise inventory beginning plus purchases.
_________ 10. Journals designed in a tabular fashion to accommodate the recording of
specific types similar transactions.
_________ 11. A book of accounts that include all asset, liability, equity, income, and expense
accounts.
_________ 12. The process of classifying and grouping similar transactions in common
accounts by transferring amounts from the journals to the ledger.
_________ 13. A postponement of the recognition of an expense already paid, or of revenues
already received in advance.
_________ 14. Entries that reduce all nominal accounts to a zero balance at the end of each
accounting period.
_________
15. A working paper often used by accountants to summarize
adjusting entries.
_________ 16. The temporary account used in closing nominal accounts whose credit balance
represents net profit.
_________
17. Accounts whose balances are carried forward to the next
accounting period.
_________ 18. Entries prepare at the beginning of a new accounting period to facilitate the
recording of expense payments and revenue receipts in the usual manner.
_________ 19. A listing of all real account balances after the closing process has been
completed.
_________ 20. The difference between the accumulated depreciation account and the related
property and equipment account.
43
CHAPTER 2
NATURE AND FORMATION OF A PARTNERTSHIP
LEARNING OBJECTIVES

Define and discuss the nature of a partnership - its characteristics, advantages and
disadvantages.

Identify the different kinds of partnership and the classes of partners.

Discuss the requirements in the formation of a partnership.

Discuss accounting for partners’ initial investments in a partnership.
PREVIEW OF THE CHAPTER
PARTNER
SHIP
(Nature and
Formation)
PARTNER
SHIP
(Nature and
Formation)
Nature of a
Partnership



Characteristics
Advantages
Disadvantages




Formation of a
Partnership
Kinds of partnerships
Classes of partners
Articles of CoPartnership
Registration
requirements



Accounting for
Partners’ Initial
Investments
Cash contributions
Non-cash
contributions
Contribution of
industry
Accounting for
Partners’ Initial
Nature of a
DEFINITION
A partnership is defined in Article 1767 of the Civil Code of the Philippines as “aPartnership
contract whereby two or more persons bind themselves to contribute money,
property,
 Characteristics
or industry into a common fund with the intention of diving profits among
 Advantages
themselves.”
 Disadvantages




nFormation of a
Partnership
Kinds of partnerships
44
Classes of partners
Articles of CoPartnership
Registration
CHARACTERISTICS OF A PARTNERSHIP
1. Mutual agency. Any partner may act as agent of the partnership in conducting its
affairs.
2. Unlimited liability. The personal assets (assets not contributed to the partnership)
of any partner may be used to satisfy the partnership creditors' claim upon liquidation,
if partnership assets are not enough to settle the liabilities to outsiders.
3. Limited life. A partnership may be dissolved at any time by action of the partners
or by operation of law.
4. Mutual participation in profits. A partner has the right to share in partnership
profits.
5. Legal entity. A partnership has legal personality separate and distinct from that of
each of the partners.
6. Co-ownership of contributed assets. Property contributed to the partnership are
owned by the partnership by virtue of its separate legal personality.
7. Income tax. Partnerships, except general professional partnerships (i.e., those
organized for the exercise of professions like CPAs, lawyers, engineers, etc.) are
subject to the 30% income tax.
ADVANTAGES OF A PARTNERSHIP
1. It is easy and inexpensive to organize, as it is formed by a simple contract between
two or more persons.
2. The unlimited liability of the partners makes it reliable from the point of view of
creditors.
3. The combined personal credited of the partners offer better opportunity for
obtaining additional capital that does a sole proprietorship.
4. The participation in the business by more than one person makes it possible for a
closer supervision of all the partnership activities.
5. The direct gain to the partners is an incentive to give close attention to the business.
6. The personal element in the characters if the partners are retained.
45
DISADVANTAGES OF A PARTNERSHIP
1. The personal liability of a partner for firm debts deter many from investing capital
in a partnership.
2. A partner may be subject to personal liability for the wrongful acts or omissions of
his/her associates.
3. It is less stable because it can easily be dissolved.
4. There is divided authority among the partners.
5. There is constant likelihood of dissension and disagreement when each of the
partners has the same authority in management of the firm.
KINDS OF PARTNERSHIPS
1. As to activity
 Trading partnership— one whose main activity is the manufacture and sale or the
purchase and sale of goods.
 Non-trading partnership— one which is organized for the purpose of rendering services.
2. As to object
3. Universal partnership
8. Universal partnership of all present property— one in which the partners contribute, at the
time of the constitution of the partnership, all the properties which actually belong to each
of them into a common fund with the intention of dividing the same among themselves as
well as the profits which they may acquire therewith.
All assets contributed to the partnership and subsequent acquisitions become common
partnership assets.
9. Universal partnership of all profit— one which comprises all that the partners may acquire
by their industry or work during the existence of the partnership and the usufruct of
movable or immovable property which each of the partners may possess at the time of the
institution of the contract.
Partnership assets consist if assets acquired during the life of the partnership and only
the usufruct or use of assets contributed at the time of partnership formation. The
original movable or immovable property contributed do not become common
partnership assets.
4. Particular partnership— one which has for its object determinate things, their use or fruits,
or a specific undertaking or the exercise of a profession or vocation.
3. As to liability of partners
 General co-partnership— one consisting of general partners who are liable prorata and
sometimes solidarily with their separate property for partnership liabilities.
 Limited partnership— one formed by two or more persons having as members one or
more general partners and one or more limited partners, who as such are not bound by the
obligations of the partnership. The word "LIMITED" or "LTD." is added to the name of
the partnership to inform the public that it is a limited partnership
46



4. As to duration
iv.
Partnership at will— one for which no term is specified and is not formed for a
particular undertaking or venture and which may be terminated any time by
mutual agreement if the partners or the will of one partner alone.
v.
Partnership with a fixed term— one in which the term or period for which the
partnership is to exist is agreed upon. It may also refer to a partnership formed for
a particular undertaking and upon the expiration of that term or completion of the
particular undertaking the partnership is dissolved; unless continued by the
partners.
5. As to representation to others
Ordinary partnership— one which actually exists among the partners and also as to third
persons.
Partnership by estoppel— one which in reality is not a partnership but is considered as
one only in relation to those who, by their conduct or omission are precluded to deny or
disprove the partnership's existence.
6. As to legality of existence
iv.
De jure partnership— one which has complied with all the requirements for its
establishment.
v.
De facto partnership— one which failed to comply with one or more of the legal
requirements for its establishment.
7. As to publicity
Secret partnership— one wherein the existence of certain persons as partners is not made
known to the public by any of the partners.
47

Open partnership— one wherein the existence of certain persons as partners is made
known to the public by the members of the firm.
CLASSES OF PARTNERS
 As to contribution
 Capitalist partner- one who contributes capital in cash (money) or property.
 Industrial partner- one who contributes industry, labor, skill, talent or service.
 Capitalist-industrial partner- one who contributes cash, property, and industry.
 As to liability
 General partner- one whose liability to third persons extends to his separate (private)
property.
 Limited partner- one whose liability to third persons is limited only to the extent of this
capital contribution to the partnership.
 As to management
6. Managing partner- one who manages actively the business of the partnership.
7. Silent partner- one who does not participate in the management of the partnership affairs.
 Other classifications
f. Liquidating partner- one who takes charge of the winding up of partnership affairs
upon dissolution
g. Nominal partner- one who is not really a partner, not being a party to the partnership
agreement, but is made liable as a partner for the protection of innocent third persons.
h. Ostensible partner- one who takes active part in the management of the firm and is
known to the public as a partner in the business.
i. Secret partner- one who takes active part in the management of the business but whose
connection with the partnership is concealed or unknown to the public.
j. Dormant partner- one who does not take active part in the management of business
and is not known to the public as a partner; he is both a silent and a secret partner.
48
PARTNERSHIP CONTRACT
A partnership is created by an oral or written agreement since partnerships are
required to be registered with Office of the Securities and Exchange Commissions, it
is necessary that the agreement be in writing. In this case, misunderstandings and
disputes among the partners relative to the nature and terms of the contract may be
avoided or minimized. The writer agreement between or among the partners
governing the formation, operation, and dissolution of the partnership is referred to us
the Articles of Co-Partnership.
The Articles of Co-Partnership contains the following information:
3. The name of the partnership;
4. The names and addresses of the partners, classes of partners, stating whether the partner is
general or a limited partner;
5. The effective day of the contract;
6. The purpose or purposes and principal office of the business;
7. The capital of the partnership stating the contributions of individual partners, their
description and agreed values;
8. The rights and duties of each partner;
9. The manner of dividing net income or loss among the partners, including salary, allowance
and interest on capital;
10. The conditions under which the partners may withdraw money or other assets for personal
use;
11. The manner of keeping the books of accounts;
12. The causes for dissolution; and
13. The provision for arbitration in settling disputes.
ORGANIZING A PARTNERSHIP
Before a partnership can operate legally, it has to comply first with certain registration
requirments whichs are summarized below:
Place of
Registration
Securities and
Exchange
Commision
Department of
Trade and Industry
City or Municipal
Mayor’s Office
Requirements for
Registration
Articles of copartnership
Filled SEC
registration form
Articles of copartnership
SEC Certificate
Certificate of
registration of
Certificates Issued
SEC Certificate
Certificate of
registration of
business name
(renewable every 5
years)
Mayor’s permit
and license to
49
business name
operate (renewable
annually)
50
Place of
Registration
Bureau of Internal
Revenue
Requirements for
Registration
SEC registration
Articles of copartnership
Social Security
System
Filled SSS
application form
List of employees
Philippine Health
Insurance
Corporation
SEC registration
Employer data
record or ERI form
Business permit or
license
Home Mutual
Development Fund
(PAG-IBIG Fund)
SEC registration
Articles of copartnership
Certificates Issues
BIR registration
no.
Partnership’s tax
identification
number (TIN)
Registration of
books, invoices
and official
receipts
SSS Certificate of
membership
SSS employer ID
number
PhilHealth
employer number
(PEN) and the
certificate of
registration
PhilHealth
identification
number (PIN) and
member data
record (MDR) for
concerned
employees
HMDF certificate
of membership
HMDF employer
ID number
ACCOUNTING FOR PARTNERSHIPS
PLURALITY OF CAPITAL AND DRAWING ACCOUNTS. Accounting for a
partnership differs from other forms of business organizations with regard to capital
accounts. In a partnership, there should be as many capital accounts and as many
drawing accounts as there are partners (that is, one capital account and one drawing
account is maintained for each partner).
CAPITAL ACCOUNT
1. Permanent withdrawal (decrease)
1. Original investment by a partner
of capital
2. Share in partnership loss from
2. Additional investment by a
operation
partner
51
3. Debit balance of drawing
account closed to capital
3. Share in partnership profits from
operations to be added to capital
52
DRAWING ACCOUNT
1 Personal withdrawal by a partner
1 Share in partnership profits from
operations (this may be credited
directly to the partner’s capital
account)
2 Share in partnership loss from
operations (this may be debited
directly to partner’s capital
account)
OPENING ENTRIES
Partners may contribute cash, property, or industry to the partnership. Appropriate
asset accounts are debited for the assets contributed and partners’ capital accounts are
credited for the total amount of assets contributed.
If the asset contributed is in the form of cash, it is recorded on the partnership books
at face value; if the asset contributed is in the form of property or non-cash asset, it is
recorded at agreed value, or in the absence of an agreement, at fair market value.
When industry is contributed into the partnership, a memorandum entry is prepared.
PARTNERSHIP FORMATION
FORMATION A: TWO OR MORE PERSONS FORM A PARTNERSHIP FOR THE
FIRST TIME ALL THE PARTNERS ARE NEW IN THE BUSINESS.
3. Cash contributions only (Capitalist partners)
Abad and Alba agreed to form a partnership by contributing P600,000 cash each.
The entry to record the contributions in partnership is:
Cash
1,200,000
Abad, Capital
Alba, Capital
600,000
600,000
4. Cash and Non-cash Contributions (Capitalist partners)
Abdon and Anton made the following contributions in the partnership:
Cash
Inventories
Equipment
Abdon
P600,000
300,000
Anton
P200,000
500,000
53
The entry to record the contributions of the partners follows:
Cash
Inventories
Equipment
Abdon, Capital
Anton, Capital
800,000
300,000
500,000
900,000
700,000
3. Contributions in the form of Cash, Non-cash Assets, and Industry (Capitalist and Industrial
Partners)
Alma, Anna, and Adela formed a partnership. Alma contributed P600,000 cash. Anna
contributed P300,000 cash and equipment valued at P450,000; Adela is an industrial partner to
contribute her special skills and talents to the partnership. Profit or loss is to be shared equally
among the partners.
The entry to record the contributions of partners Alma and Anna follows:
Cash
Equipment
Alma, Capital
900,000
450,000
Anna, Capital
600,000
750,000
The entry to record the contribution of partner Adela follows:
Adela is admitted into the partnership as an industrial partner to share one-third in the
partnership profit.
FORMATIÓN B: A SOLE PROPRIETOR AND AN INDIVIDUAL FORM A
PARTNERSHIP
Usually, one of the prospective partners is already engaged in business prior to the formation of
the partnership. In such a case, the partner may transfer his /her assets and liabilities (net assets)
to the partnership at agreed values or at fair market values if there are no agreed values. The
partnership may either: (1) use the books of the sole proprietor, or (2) open a new set of books.
However, it is a common practice that a new set of books are opened for any new business
undertaking.
54
When individual set of books are kept by each partner or by any one of the partners, entries are
made on the separate books of the partners for adjustments to the recorded values. These
adjustments are made through the capital account. The capital account is
credited for increases in the value of net assets and is debited for decreases in the value of net
assets.
Alternatively, a Capital Adjustment Account may also be used. The balance of this account,
after recording all the necessary adjustments, is transferred to the capital accounts.
Illustrative Problem A: Aguilar and Angeles formed a partnership wherein Aguilar is to
contribute cash while Angeles is to transfer the assets and liabilities (net assets) of his
business. Account balances on the books of Angeles are as follows:.
Debit
Cash
Accounts Receivable
Inventories
Accounts
Payable
Angeles, Capital
Credit
300.000
450.000
240,000
90,000
900,000
The partners agreed on the following conditions:
1. An allowance for uncollectible accounts of P22,000 is to be established.
2. The inventories are to be valued at their current replacement cost of P270,000 3.
Prepaid expenses of P12,000 and accrued expenses of PS,000 are to be
recognized.
4. Angeles is to be credited for an amount equal to the net assets transferred.
5. Aguilar is to contribute sufficient cash to have an equal interest in the partnership
Assumption 1- The partnership will use the books of the sole proprietor
The following procedures should be followed in accounting for this type of formation:
1. Adjust the books of the sole proprietor to bring account balances to agreed values.
2. Record the investment of the other partner.
55
The adjusting entries necessary upon partnership formation, in order to arrive at the agreed
values, are recorded through the capital accounts of the partners. However, a capital adjustment
account may also be used and its balance is transferred to the capital accounts after all
adjustments in net assets are made.
The following rules will be helpful in making the necessary adjusting entries:
Debit asset and credit capital for increases in asset values
Debit capital and credit asset for decreases in asset values
Debit capital aid credit liabilities for increases in liability balances
Debit liabilities and credit capital for decreases in liability balances
In the case of contra asset accounts, the following rules shall apply:
Debit contra asset account and credit capital for increases in asset values
Debit capital and credit contra asset account for decreases in asset values
Hence, the information on the partnership of Aguilar and Angeles will be accounted for as
follows:
Step 1: Adjust the books of the sole proprietor Angeles to agreed values
a. Angeles, Capital
Allowance for Uncollectible
Accounts
22,000
b. Inventories
Angeles, Capital
30,000
c. Prepaid Expenses
Expenses
Angeles, Capital
12,000
22,000
30.000
Payable
5,000
7,000
The balance of the capital account of Angeles after the three adjusting entries are posted is
P915,000 ( P900,000 -P22,000 + P30,000+ 7.000).
Step 2: Record the investment of the other partner, Aguilar
Cash
915,000
Aguilar, Capital
915,000
56
Assumption 2 - The partnership will open a new set of books
When a new set of books are opened for the partnership, the entry required on the new books
of the firm is the recording of the investment of the partners at agreed values. The opening
entries on the new partnership books using the data given in Illustrative Problem A are shown
on the next page.
a. Cash
300,000
Accounts Receivable
450,000
Inventories
270,000
Prepaid Expenses
12,000
Allowance for Uncollectible
Accounts
Accounts Payable
Expenses Payable
Angeles, Capital
To record the investment of Angeles
b. Cash
915,000
Aguilar, Capital
To record the investment of Aguilar
22,000
90,000
5,000
915,000
915,000
Alternatively, a compound entry may be prepared to record the investment of the two partners.
Entries to adjust and close the accounts are made in the separate books of the sole proprietor but
not in the new books of the partnership. Using the same illustrative problem, the adjusting and
closing entries on the books of Angeles are as follows:
a. Angeles, Capital
Allowance for Uncollectible
Accounts
22.000
b. Inventories
30,000
22,000
Angeles, Capital
c. Prepaid Expenses
Expenses Payable
Angeles, Capital
30,000
12,000
5,000
7,000
57
d.
Angeles,
Capital
Expenses Payable
Accounts Payable
Allowance for Uncollectible Accounts
Cash
Accounts Receivable
Inventories
Prepaid Expenses
To close the books of Angeles
915,000
5,000
90,000
22,000
300,000
450,000
270,000
12,000
FORMATION C: Two OR MORE SOLE PROPRIETORS FORM A PARTNERSHIP
When all the prospective partners are already in business, they may decide to transfer their asset
and liabilities (net assets) to the partnership at values agreed upon or at fair market values, in
the absence of agreed values. The partnership may either: (1) use the
books of one of the sole proprietors, or (2) open a new set of books for the partnership. As
mentioned earlier, however, it is more common to open a new set of books for the partnership.
Illustrative Problem B: Antonio, owner of Antonio Variety Store, and Albano, owner of
Albano Trading decided to combine their businesses on July 1, 2014. Each is to transfer
business assets and liabilities (net assets) at agreed values. Statements of financial position for
the two proprietors are presented below.
Antonio Variety Store
Statement of Financial Position
July 1, 2014
Assets
Cash
P 120,000
Accounts Receivable
P 72,000
Less Allowance for Uncollectible
6,000 Accounts
66,000
Merchandise Inventory
Store Equipment
Less Accumulated Depreciation
Total Assets
330,000
P 600,000
30,000
570,000
P 1,086,000
Liabilities and Capital
Accounts Payable
Antonio, Capital
Total Liabilities and Capital
P 132,000
954,000
P 1,086,000
Albano Trading
Statement of Financial Positior
July 1, 2014
Assets
Cash
Accounts Receivable
P 30,000
P 300,000
58
Less Allowance for Uncollectible
21,000 Accounts
279,000
Merchandise Inventory
Delivery Equipment
P 480,000
Less Accumulated Depreciation
6,000
Total Assets
Liabilities and Capital
Accounts
Payable
Albano, Capital
Total Liabilities and Capital
1,260,000
474,000
P2,043,000
P 333,000
1,710,000
P 2,043,000
The partners agreed on the following conditions:
I. Partners' capital in the partnership shall be equal to the adjusted net assets transferred.
2. Adjustments are to be made as follows:
a. Allowance for Uncollectible Accounts shall be P7,200 and P30,000, respectively.
b. Inventories are to be valued at 120% of their recorded values
c. Both store and delivery equipment are 5% depreciated.
Assumption 1 - The partnership will use the books of one of the sole proprietors.
The procedures to be discussed under his assumption are similar to the procedures discussed
under Formation B - Assumption I. Thus, if the books of Albano Trading will be used by the
partnership, the following procedures will be followed:
l. Adjust the books of Albano Trading to bring the balances of accounts to agreed values.
2. Record the investment of Antonio.
Step 1: Adjust the books of Albano Trading
a. Albano, Capital
Allowance for Uncollectible
Accounts
P30,000 - P21,000 = P9,000
9,000
b. Merchandise Inventory
252,000
9,000
59
Albano, Capital
P 1,260,000 x 20% = P252,000
c. Albano, Capital
Accumulated
Depreciation
Delivery Equipment
Delivery Equipment
-
252,000
18,000
6,000
24,000
P480,000 x 5% = I24.00
P474,000 – (480,000 x 95%) = P18,.000
Step 2: Record the investment of Antonio
a. Cash
120,000
Accounts Receivable
72,000
Merchandise Inventory (P330.000 x 396,000
120%)
570,000
Store Equipment (P600.000 x 95%)
Allowance for Uncollectible
7,200
Accounts
132,000
Accounts Payable
1,018,800
Antonio, Capital
The adjustments on the account balances of Antonio Variety Store are not taken up on the
books of Albano Trading which are now the partnership books. Instead the following adjusting
and closing entries are prepared on the separate books of Antonio Variety Store:
a. Antonio, Capital
Allowance for Uncollectible
Accounts
P7,200-P6,000 = P 1,200
b. Merchandise Inventory
Antonio, Capital
P330,000 x 20% = P66,000
1,200
1,200
66,000
c. Allowance for Uncollectible Accounts 7,200
Accumulated Depreciation Store Equipment
30,000
Accounts Payable
132,000
Antonio, Capital
1,018,800
Cash
Accounts Receivable
Merchandise Inventory
Store Inventory
66,000
120,000
72,000
396,000
600,000
60
Assumption 2: The partnership will use a new set of books
When a new set of books are opened for the partnership. entries are prepared to record the
investment of the partners at agreed values. The opening entries on the new partnership books
using the data given in Illustrative Problem B are shown below:
a. Cash
Accounts Receivable
Merchandise Inventory (P330.000 x 120%)
Store Equipment (P600.000 x 95%)
Allowance for Uncollectible
Accounts
Accounts Payable
Antonio, Capital
To record the investment of Antonio
120,000
72,000
396,000
570,000
7,200
132,000
1,018,800
Delivery equipment (P480.000 x 95%)
b. Cash
Accounts Receivable
30,000
Merchandise Inventory (P1,260,000 x 120%)
300,000
1,512,000
456,000
Allowance for Uncollectible
30,000
Accounts
Accounts Payable
333.000
Albano, Capital
1,935,000
To record the investment of Albano
The new partnership may prepare a separate entry for each partner's contribution as shown
above or a compound entry that shows the contributions of all the partners.
Key Points. In the opening entry, the plant assets are recorded net of depreciation. The account
accumulated depreciation is not carried on the partnership books. The net amount, being the
agreed value, represents the cost of the plant assets to the partnership and such amount becomes
the basis for future depreciation by the partnership. On the other hand, both accounts receivable
and the corresponding allowance for uncollectible accounts are recorded on the partnership
books. The allowance for uncollectible accounts is carried on the partnership books because of
the possibility of collection. However, if there are specific accounts receivable which are
deemed worthless, such must be written off and removed permanently from the outstanding
accounts receivable.
A statement of financial position prepared immediately after the formation of the partnership of
Antonio and Albano is shown below.
Antonio and Albano
Statement of Financial Position
61
July 1, 2014
Assets
Cash
Accounts Receivable
Less Allowance for Uncollectible
P 150.000
P 372,000
37,200 Accounts
Merchandise Inventory
Store Equipment
Delivery Equipment
Total Assets
334,800
1,908,00
570,000
456,000
P 3,418,800
Liabilities and Capital
Accounts Payable
Antonio, Capital
Albano, Capital
Total Liabilities and Capital
P 465,000
1,018,800
1,935,000
P 3,418,800
Goodwill Resulting from the Acquisition of a Sole Proprietorship by a Partnership The
acquisition of a sole proprietorship's by a partnership or formation of a partnership by a sole
proprietorship and an individual or among two or more sole proprietorships may involve the
recognition of goodwill. The goodwill shall be the result of the acquisition by the new
partnership of the net assets of the sole proprietorship/s. When the capital credit exceeds the
agreed value or fair value of the net assets acquired by the new partnership from the sole
proprietorship, the excess is treated as goodwill. The adjustment for the goodwill increases the
capital of the sole proprietor.
PFRS 3 does not allow the amortization of goodwill acquired in a combination and
instead requires the goodwill to be tested for impairment annually, or more frequently, if
events or changes in circumstances indicate that the asset might be impaired.
CAPITAL SHARE DIFFERENT FROM CAPITAL CONTRIBUTION
Prior to recording partners' initial contributions to the partnership, the individual partners must
first agree not only on the valuation of the net asset contributions but also on their capital share.
The capital share of each partner is the percentage of equity that each of them will have in the
net assets of the newly formed partnership. Generally, the capital share of a partner is
proportionate to his/her capital contribution. However in recognition of intangible factors such
as partners' special expertise, established clientele or necessary business connections, partners
may agree to a division of capital that is not proportionate to their capital contributions. This
situation will give rise to provision of bonus on initial investments.
Illustrative Problem C: Alfonso and Afable formed a partnership by contributing P500,000
and P600,000, respectively. Journal entries to record the investment of the partners under two
approaches are as follows:
62
1. Full investment approach
Cash
1,100,000
Alfonso, Capital
Afable, Capital
500,000
600,000
Assuming the partners agreed to have equal capital in the partnership, it is presumed that part of
the contribution of Afable is given as bonus to Alfonso in exchange for the intangible advantage
that Alfonso will be bringing to the partnership.
2. Bonus approach
Cash
1,1 00,000
Alfonso, Capital
Afable, Capital
(P500,000 + P600,000) / 2 = P550,000
550,000
550,000
LOAN RECEIVABLE AND LOAN PAYABLE. Aside from the contributions, partners may
also advance money to the partnership in the form of loan when the business is in need of
additional funds. Loans made by partners to the partnership, which are payable immediately by
the partnership and are usually with interest, are recorded in the account Loan Payable or Due
to Partners. This ccount is reported in the statement of financial position as a liability.
On the other hand, the partnership may advance money to partners, other than withdrawals, in
the form of loans. These loans, which are payable immediately by the partners and are usually
with interest, are recorded in the account Loan Receivable or Due from Partners. This account
is reported in the statement of financial position as an asset.
REVIEW of LEARNING OBJECTIVES
I. Define and discuss the nature of a partnership- its characteristics, advantages, and
disadvantages. A partnership is a contract whereby two or more people bind themselves to
contribute money, property, or industry into a common find with the intention of dividing
profits among themselves. A partnership has the following characteristics: (1) mutual agency:
(2) unlimited liability: (3) limited life: (4) mutual participation in profits; (5) legal entity: (6)
coownership of contributed assets; and (7) subject to income tax. A partnership is easy and
inexpensive to organize, it is more reliable on the viewpoint of the creditor, enabling it to obtain
more capital because of the unlimited liability of the partners, and there is close supervision of
all its activities because of the direct gain to the partners of a successful operation. However, a
partnership is less stable and there is divided authority among the partners. In addition, because
63
of the characteristic of mutual agency, a partner may be subject to personal liability for the
wrongful acts or omissions of his associates.
2.
Identify the different kinds of partnerships and the classes of partners. Partnerships are
classified as (1) trading or nontrading; (2) universal or particular; (3) general on limited; (4)
partnership at will or with a fixed term: (5) ordinary or partnership by estoppel: (6) de jure or de
facto; and (7) secret or open. Partners are classified as (I) capitalist, industrial or
capitalistindustrial; (2) general or limited; (3) managing or silent; and (4) liquidating, nominal,
ostensible or secret.
3.
Discuss the requirements in the formation of a partnership. A partnership may be
organized by an oral or written agreement. The written agreement which governs the formation,
operation and dissolution of a partnership is known as the Articles of Co-Partnership. A new
partnership has to comply with certain registration requirements the different government
agencies before it can operate legally.
4.
Discuss accounting for partners' initial investments in a partnership. A partner may
contribute cash, non-cash assets, or industry into the partnership. Cash contribution is credited
to a partner's capital account at face value; non-cash asset contribution is recorded at agreed
value or at fair market value, in the absence of agreed value; and a contribution in the form of
industry or service is recorded by means of memorandum entry.
64
GLOSSARY of ACCOUNTING TERMINOLOGIES
Articles of Co-Partnership – a written agreement among the partners which governs the
formation, operation, and dissolution of the partnership.
Capitalist Partner – a partner who contributes capital in the form of money or property.
Capitalist Industrial Partner – a partner who contributes capital in the form of money or
property and industry.
Industrial Partner – a partner who contributes industry, labor, skill, talent or service.
Partnership – a contract whereby two or more persons bind themselves to contribute money,
property, or industry into a common fund with the intention of dividing profits among themselves
.
Statement of Financial Position – a statement that reports the assets, liabilities, and equity of an
entity and which shows its financial position or condition at a given date. It is also known as
balance sheet.
65
DISCUSSION QUESTIONS
1.
What is a partnership?
2.
How does a partnership differ from a sole partnership?
3.
Explain the meaning of unlimited liability of a partner for partnership debts. Is this
an advantage or a disadvantage on the part of the partnership?
4.
What is the basis for measuring the contributions or investments of partners in the
form of non-cash assets?
5.
Why is it preferable to have a written contract of partnership? What are the
contents of a typical partnership contract?
6.
What is the major difference between a general and a limited partnership? How
can they be distinguished? When a partnership is a limited partnership, does the
characteristics of
“unlimited liability” still apply? Why or why not?
7.
Why are capital accounts and drawing accounts opened for each partner?
8.
What are the steps to be followed in recording the formation of a partnership if the
books of one of the previous sole proprietors will be used?
9.
Why would a partnership decide to use the books of one of the previous sole
proprietors instead of opening new set of books?
10.
Why is the Accumulated Depreciation account not carried over to the new books
of the partnership?
66
EXERCISES
Exercise 2-1 (Cash and Non - cash Contributions)
Give the entry to record the investment of Alonzo into the partnership under each of the
following independent assumptions:
a.
Cash of P400,000.
b.
Accounts receivable of P500,000 with an allowance for uncollectible accounts of
P50,000.
c.
Inventories that cost P300,000 using the moving average method accepted by the
partnership at its FIFO value of 80% of average cost.
d.
Equipment that cost P900,000 with a book value of P300,000 after four years of
use without salvage value. The equipment should have been depreciated over a 10-year
useful life.
Exercise 2-2 (Cash and Net Asset Contributions)
Aquino and Asuncion have decided to form a partnership. Aquino invests the assets presented
below at their agreed valuation, and also transfers his liabilities to the new firm.
Ledger
Balances
P450,000
180,000
15,000
300,000
180,000
30,000
105,000
90,000
Cash
Accounts Receivable
Allowance for Uncollectible Accounts
Merchandise Inventory
Equipment
Accumulated Deprecation
Accounts Payable
Notes Payable
Asuncion agrees to invest
firm.
cash for a one
Agreed
Valuation
P450,000
180,000
10,000
270,000
125,000
——
105,000
90,000
- third interest in the
67
Instructions:
1. Prepare the entries to record the investment of Aquino and Asuncion in the
partnership’s new set of books.
2. Prepare the entries to adjust and close the balances of accounts in the books of
Aquino.
Exercise 2-3 (An Individual and a Previous Sole Proprietor)
Amores admits Andrada to a partnership interest in his business. Accounts in the ledger of
Amores on January 1, 2014, before the admission Andrada, show the following:
Cash
Accounts Receivable
Merchandise Inventory
Accounts Payable
Amores, Capital
Debit
P208,000
460,000
1,440,000
Credit
P496,000
1,612,000
It is agreed that for the purpose of establishing the interest of Amores the following adjustments
shall be made:
a.
An allowance for uncollectible accounts of P25.000 is to be established.
b.
The merchandise is to be valued at P1,600,000.
c.
Prepaid expenses of P72,000 and unrecorded liability of P102,000 are to be
recorded.
Andrada is to invest sufficient cash for an equal interest in the partnership.
Instructions:
1.
Assuming the new partnership will use the books of Amores, give the entries to
adjust the account balances of Amores and to record the investment of Andrada.
68
2.
Assuming the new partnership will open new set of books, give the entries to
record the investment of Amores and Andrada.
3.
Prepare a statement of financial position for the new partnership.
Exercise 2-4 (Cash and Non-cash Contributions: Bonus)
Aguirre Nd Aranas have decided to form a partnership. Aguirre contributes cash of P1,000,000
and Aranas contributes land with a fair market value of P800,000 and a building with a fair
market value of P1,900,000. Aranas purchased the land and building five years ago for P750,000.
Aranas’ book value of the land is P175,000 and the book value of the building is P600,000. The
P1,500,000 mortgage in the land and building is to be assumed by the partnership. The partners
agree to share profits and losses in the ration of 3:2, respectively.
Instructions: Prepare the journal entries to record the information of the prtnership under each of
the following independent assumptions:
1. Each partner is credited for full amount of net assets invested.
2. Each partner initially is to have equal interest in partnership capital.
PROBLEMS
Problem 2-1 (Cash and Net Assets Contributions)
The statement of financial position of Acosta as of December 1, 2014 is as follows:
Acosta Company
Statement of Financial Position
December 1, 2014
Assets
Cash
Notes Receivable
P
600,000
375,000
69
Accounts Receivable
Less Allowance for Uncollectible Accounts
Merchandise Inventory
Furniture and Fixture
Less Accumulated Depreciation
Total Assets
P 2,250,000
150,000
1,800,000
450,000
2,100,000
600,000
1,350,000
5,025,000
Liabilities and Capital
Notes Payable
Accounts Payable
Acosta, Capital
Total Liabilities and Capital
P
750,000
1,575,000
2,700,000
P 5,025,000
Aguas offers to invest cash to give him an equity credit equal to one-half of the equity
of Acosta after adjustments for the items below. Acosta accepted the offer.
a.
The merchandise is to be valued at P650,000.
b.
The Allowance for uncollectible accounts is P225,000.
c.
Interest accrued on notes receivable should be reflected. The note is dated
September 30, 2014 and bears interest at 6%.
d.
Interest accrued on notes payable for the period September 1 to December 1, 2014
should be recognized. The interest rate on the note is 10%.
e.
The furniture and equipment are one-third depreciated.
f.
Office supplies on hand, which have been charges to expense, amounted to
P15,000, These supplies will be used by the new partnership.
Instructions:
1.
Prepare journal entries on the books of Acosta to give effect to the partnership
formation.
2.
Prepare the statement of financial position for the new partnership.
Problem 2-2 (Two Sole Proprietorship Form a Partnership; Books of one of the Sole
Proprietors to be used by the Partnership)
70
On October 1, 2014, April and Arias decided to pool their assets and form a partnership. The firm
is to take over business assets and assume business liabilities; equities are to be based on the net
assets transferred after the following adjustments:
a.
Arias’ inventory is to be valued at P350,000.
b.
An allowance for uncollectible accounts of P9,000 and P7,500, respectively should
be set up.
c.
Accrued expenses of P21,000 are to be recognized on April’s books.
d.
Arias is to contribute sufficient cash to give a 60% interest in the new firm.
Statements of financial position for April and Arias on October 1 before adjustments are
presented below.
April
Arias
P 187,500 P 112,500
Cash
450,000
375,000
Accounts Receivable
400,000
300,000
Merchandise Inventory
250,000
300,000
Equipment
(112,500)
(37,500)
Accumulated Depreciation
P 1,175,000
P 1,050,000
Total Assets
P 345,000
P 250,000
830,000
800,000
Accounts Payable
P 1,175,000 P 1,050,000
Capital
Total Liabilities and Capital
Instructions:
1.
Give the entries to adjust and close the books of April.
2.
Give the entries required on the books of Arias upon the formation of the
partnership.
3.
Prepare a statement of financial position for the nee partnership of April and
Arias.
Problem 2-3 (Two Sole Proprietors Form a Partnership; New Books are to be opened for the
Partnership)
71
Partners Abada and Albani agreed to combine their businesses into a partnership. The statement
of financial position accounts of Abada and Albano are shown below.
Cash
Accounts Receivable
Allowance for Uncollectible
Accounts
Merchandise Inventory
Equipment
Accumulated Depreciation
Furniture and Fixtures
Accumulated Depreciation
Accounts Payable
ABADA
ALBANO
Book Value Agreed Value Book Value Agreed Value
P50,000.
P50,000.
P70,000.
P70,000
460,000.
460,000.
490,000.
490,000
30,000.
40,000.
40,000.
50,000
900,000.
180,000.
36,000.
120,000.
24,000.
540,000.
950,000.
120,000.
———
90,000.
———
540,000.
720,000.
700,000
90,000.
70,000
9,000.
———
———
———
———
———
360,000.
360,000
Instructions: Give the journal entries to record the partnership formation under each of the
following independent assumptions:
1.
A new set of books are to be opened for the partnership
2.
The books of Abada are to be used by the partnership
Problem 2-4 (Cash, Non-cash and Net Assets Contributions; Books of the Sole Proprietor to
be Used by the Partnership)
On January 1, 2014, Abante, Arevalo, and Almonte decided to form a partnership. Abante, a sole
proprietor, will transfer to the partnership his net assets, excluding cash. Arevalo will contribute
cash in an amount equal to one and a half times the investment of Abante. Almonte will
contribute a piece of land with an agreed value of P1,800,000 subject to a mortgage of P300,000
to be assumed by the partnership. The statement of financial position of Abnante is shown on the
next page.
72
Abante Company
Statement of Financial Position
January 1, 2014
Assets
Cash
Accounts Receivable
Less Allowance for Uncollectible Accounts
Merchandise Inventory
Furniture and Fixture
Less Accumulated Depreciation
Total Assets
P
P
840,000
90,000
P 1,050,000
210,000
360,000
750,000
1,200,000
840,000
P 3,150,000
Liabilities and Capital
Accounts Payable
Abante, Capital
Total Liabilities and Capital
P
450,000
2,700,000
3,150,000
The Articles of Co-Partnership executed for the purpose calls for adjustments to the assets, as
follows:
a.
The allowance for uncollectible accounts should be increased by P150,000.
b.
The inventories should be valued at P1,000,000 only.
c.
The furniture and equipment are underdepreciated by P240,000.
d.
The new partnership is to credit Abante with a capital of P2,000,000. The excess
capital credit over the fair value of the net assets transferred is to be recognized as
goodwill.
Instructions: Prepare the entries to record the partnership formation assuming
1.
The books of Abante are to be used by the partnership.
2.
New set of books are to be opened for the partnership.
Problem 2-5 (Cash, Non-cash and Net Assets Contributions)
The partnership of Abueva and Alano was formed on June 1, 2014, when they agreed to invest
equal amount of capital into the firm. Yhe investment by Abueva consists of P518,000 cash and
73
an inventory of merchandise valued at P1,152,000. Alano agreed to contribute the assets of his
business along with the transfer to the partnership of his business liabilities. Alano was credited
for goodwill for the excess of the capital credit over the agreed value of his net assets. The assets
and liabilities are shown on the next page.
Accounts Receivable
Allow. For Uncollectible Accounts
Inventory
Office Equipment (net)
Accounts Payable
Instructions:
Balances on
Agreed
Alano’s Records
Value
P 1,792,000
1,792,000
76,800
150,000
192,000
253,000
256,000
206,000
576,000
576,000
P
74
1.
Give the entries to record the investments of Abueva and Alano in the new
partnership.
2.
Prepare the beginning statement of financial position of the partnership, reflecting
the above transfers to the firm.
Problem 2-6 (Cash and Noncash Contributions)
The partnership of Agana and Ayesa was formed on September 1, 2014. At the date, the
following assets were invested:
Cash
Inventories
Land
Building
Furniture and Fixture
Agana
P 200,000
———
———
———
920,000
Ayesa
P 80,000
440,000
200,000
600,000
———
The building is subject to a mortgage loan of
P240,000, which is to be assumed by the partnership. The partnership contract provides that
Agana and Ayesa share earnings 40% and 60%, respectively.
Instructions: Compute the amount of Ayesa’s capital account at September 1, 2014 assuming
that the partnership agreement provides that:
1.
Each partner is credited for the full amount of net assets invested.
2.
The partners initially should have an equal interest in the partnership capital.
3.
The initial partnership capital is shared proportionate to the partners’ profit and
loss ratio.
MULTIPLE CHOICE
MC 2-1
Which of the following best describes the attributes of a partnership?
a.
Limited life of the business and limited liability of partners.
b.
Limited life of the business and unlimited liability of partners.
c.
Unlimited life of the business and limited liability of partners.
d.
Unlimited life of the business and unlimited liability of partners.
75
MC 2-2
When a partner withdraws cash or other assets, the drawing account is
a.
Debited
c. debited and credited
b.
Credited
d. not affected
MC 2-3
All of the following affect a partner’s capital account except
a.
additional investment
c. partnership net income or loss
b.
payment of a liability
d. withdrawal of the partner
MC 2-4 Which of the following are kinds of partnerships according to liability of partners?
a.
General co-partnership
c. Industrial partnership
b.
Limited partnership
d. A and B only
MC 2-5 Which of the following relate to the capital share of a partner in a partnership?
a.
The percentage of equity that partner has on the net assets
b.
Proportionate to a partner’s capital contribution
c.
May not be proportionate to capital contribution die to bonus
d.
All of these
MC 2-6 On April 1, 2014, Apple and Ayme formed a partnership with each contributing the
following assets:
Cash
Machinery and Equipment
Building
Furniture and Fixtures
Apple.
P 120,000
100,000
Ayme
P 80,000
340,000
900,000
40,000
The building is subject to a mortgage loan of P300,000, which is to be assumed by the
partnership. On April 1, 2014, the balance in Ayme’s capital account should be
a.
P 980,000
c. P 1,280,000
b.
P1,020,000
d. P 1,320,000
76
MC 2-7 Aser and Attie are forming a partnership by combining their businesses. Their books
show the following:
Aster
Cash
30,000
Amie
P 72,000
Accounts Receivable
150,000
Merchandise Inventory
156,000
P
108,000
240,000
Furniture and Fixtures
330,000
102,000
Prepaid Expenses
63,000
21,000
Accounts Payable
366,000
144,000
Aster, Capital
489,000
Amie, Capital
273,000
It has been agreed to recognize uncollectible accounts of P7,500 and P5,400 to each party,
respectively, and that the furniture and fixtures of Amie are under depreciated by P9.000. If each
partner's share in equity is to be equal to the net assets invested, the capital accounts of Aster and
Amie would be
a. P489,000 and P273.000 respectively.
b. P481.500 and P276,600 respectively.
c. P481,500 and P258,600, respectively.
d. P855,000 and P417.000. respectively
MC 2-8 A business owned by Antonia was short of cash and Antonia decided to form a
partnership with Andrea, who was able to contribute cash twice the interest of Antonia in the
new partnership. The assets contributed by Antonia appeared as follows in the statement of
financial position of her business: cash, P9,000; accounts receivable, P189.000 with allowance
for uncollectible accounts of P6,000; merchandise inventory, P420,000; and store equipment,
P150,000 with accumulated depreciation of P15,000.
Antonia and Andrea agreed that the allowance for uncollectible accounts was inadequate and
should be P12.000. They also agreed that the fair value the inventory is P460,000 and for the
stóre equipment is P140,000. The cash contributed by Andrea into the partnership was
a. P 747,000
c. P 1,572,000
b. P 786,000
d. P 1,576,000
MC 2-9 Almeda and Asistio are combining their separate business to form a partnership. Cash
and non-cash assets are to be contributed for a total capital of P600,000. The non-cash assets tor
be contributed and the liabilities to be assumed as follows:
Almeda
Asistio
77
BV
FMV
BV
FMV
Accounts Receivable
Merchandise Inventory
80,000
Equipment
120,000
Accounts Payable
20,000
P 40,000
P30,000
60,000
90,000
P 40,000
P
120,000
100,000
80,000
30,000
30,000
20,000
The partners capital accounts ure to he equal after all the contribution of assets and the
assumption of liabilities. The amount of cash to be contributed by Almeda is
a. P 100,000
c. P 210,000
b. P 110,000
d. P 300,000
MC 2-10. Using the information in MC 2-9 the total assets of the partnership is
a. P 340,000
c. P 630,000
b. P 360,000
d. P 650,000
MC 2-11 Using the information in MC 2-9, and assuming the excess capital credit over the fair
value of the net assets transferred to the partnership is recognized as goodwill, how much is the
goodwill to be credited to Asistio?
a. P 120,000
c. P 180,000
b. P 150,000
d. P 300,000
MC 2-12 Amable and Aguila entered into a partnership on February 1. 2014 by
investing the following assets:
Amable
Cash
Aguila
P 40,000
Merchandise Inventory
P 90,000
Land
130,000
Furniture and Fixtures
200,000
The agreement between Amable and Aguila provides that profits and losses are to be divided
60% and 40% respectively, and that the partnership is to assume the P100,000 mortgage on the
land. If Aguila is to receive capital credit equal to the full amount of his net assets invested, how
much is his capital balance upon partnership formation?
a. P 10,000
c. P 160,000
b. P 150,000
d. P 400,000
MC 2-13 Using the information in MC 2-12 and assuming that Aguila invests P100,000 cash and
the partners are to have equal interest in the partnership, the total capital of the partnership is
78
a. P 240,000
c. P 490,000
b. P 250,000
d. P 590,000
MC 2-14 Using the information in MC 2-12 and assuming that the partners is proportionate to
their profit and loss ratio, the bonus upon partnership formation is
a. P 6,000 to Amable
b. P 6,000 to Aguila
c. P 10,000 to Amable
d. P 10,000 to Aguila
IC2-15 Using the information in MC 2-14, the capital balances upon partnership formation are
Amable Aguiluz
Amable
Aguiluz
a. P 245,000 P 245,000
c. P 156,000 P 234,000
b. P 234,000 P 156,000
d. P 294,000 P 196,000
MC2-16 The Agualto and Acejas Partnership was formed on October 1, 2014. At that date, the
following assets were contributed:
Agulto
Cash
P 600,000
Acejas
P 280,000
Merchandise Inventory
440,000
Building
800,000
Furniture and equipment
200,000
The building is subject to a mortgage loan of P320,000 which is to be assumed by the
partnership. The partnership agreement provides that Agulto and Aceas share on profit and loss
of 25% and 75%, respectively. Agulto's capital account at October 1, 2014 should be
a. P 400,000
c. P 1,200,000
b. P 720,000
d. P 1,520,000
MC2-17 Using the information in MC 2-16 and assuming that the partnership agreement
provides that the partners initially should have an equal interest in partnership capital, Acejas'
capital account on October 1, 2014 should be
a. P 480,000
c. P 960,000
b. P 720,000
d. P 1,200,000
MC2-18 Using the information in MC 2-17, the bonus to be recognized in the transaction is
a. Zero
c. P 240,000
b. P 200,000
d. P 480,000
MC2-19 Using the information in MC 2-17, the effect of the bonus on capital of the partners is
Agulto
Acejas
a.
Increase
Increase
b.
Increase
Decrease
79
c.
Decrease
Increase
d. Decrease
Decrease
MC2-20 Using the information in MC 2-16, and assuming that capital shall be proportionate to
the partners’ profit and loss ratio, the required capital of Acejas is
a. P 520,000
c. P 1,200,000
b. P 720,000
d. P 1,440,000
80
Test
Rating:
Material
No.
6
Name:
Date:
Year and Section:
Professors:
TRUE or FALSE
Instructions: Encircle the letter T if the statement is true and the letter F if the statement is
false.
1. A written partnership contract is required to be prepared whenever a partnership is formed.
2. All partnerships are subject to income tax.
3. A partner's contribution in the form of industry or service is recorded by the debiting the
account "Industry."
4. In the partnership books, there are as many capital and drawing account as there are partners.
5. A partner's contribution in the form of non-cash assets should be recorded at it’s fair market
value in the absence of an agreed value.
6. A partnership is much easier and less expensive to organize than a corporation.
7. A newly organized partnership should always open a new set of books.
8. All partnerships have at least one general partner.
9. Each partner generally has the authority to enter into contracts which are binding upon the
partnership.
10. The property invested in a partnership by a partner becomes the property of the partnership.
11. Contra accounts, like Allowance for Uncollectible Accounts and Accumulated Depreciation,
on non-cash assets invested by partners are always carried on the partnership books.
12. The unlimited liability of partners for partnership debts makes the partnership more reliable
from the point of view of creditors.
13.Goodwill may be recognized upon partnership formation when the capital credited to a
partner exceeds the fair value of the net assets transferred from previous sole proprietorship
business.
14. Before a partnership can operate legally, it has to first comply with registration requirements
of the SEC, DTI BIR, SSS and Mayor's Office.
15. There is a required number of limited partners in a general co-partnership; in the same
manner that, there is a required number of general partners in a limited partnership.
16. A partnership is always owned by at least two individuals.
17. For financial reporting purposes, the personal assets and debts of a partner should be
combined with the assets and debts of the business.
18. Partners are personally liable for the liabilities of the partnership if the partnership is unable
to pay
81
19. In a partnership, an owner's equity account exists for each partner.
20. Net asset adjustments are made on a sole proprietor's books, when these are to be used as
partnership books, for the purpose of arriving at agreed values.
82
Test
Rating:
Material
No.
7
Name:
Date:
Year and Section:
Professors:
IDENTIFICATION
Instructions: Write the word or group of words that identify each of the following statements.
___________1. A partnership wherein all the partners have limited liability except for at least
one general partner.
___________2. The contribution of an industrial partner.
___________3. A partner who contributes money, property, and industry.
___________4. A characteristic of a partnership wherein any partner can act in behalf of the
partnership as long as these acts are within the scope of normal partnership activities.
___________5. A partnership which has failed to comply with one or more of the legal
requirements for its establishment.
___________6. An entry prepared when a partner contributes skill or industry into the
partnership.
___________7. A partnership organized for the purpose of rendering services.
___________8. A contract whereby two or more persons bind themselves to contribute money,
property, or industry to a common fund with the intention of dividing profits among themselves.
___________9. The value assigned to the non-cash asset contributed into partnership.
___________10. One who is not really a partner, not being a party to the partnership agreement,
but is made liable as a partner for the protection innocent third persons.
___________11. A written partnership contract which governs the formation operation and
dissolution of the partnership
___________12. A partner who has a financial interest in the firm, not known to be a partner, but
takes active part in the management of the firm.
___________13. The government body which is in charge with administration of various laws
affecting partnerships and corporations in the Philippines.
___________14. The word added to the name of the partnership to inform the public that it is a
limited partnership
___________15. A partner whose liability is limited to the extent of her/his personal contribution
into the partnership.
___________16. Amounts advanced by partners to the partnership when the business is in need
of additional funds which are immediately payable by the partnership and usually bear interest.
___________17. Each partner's percentage of equity in the net assets of a partnership.
83
___________18. The transfer of capital from one partner to another, upon partnership formation,
in recognition of intangible factors such as partners special expertise, established clientele or
necessary
business connections.
___________19. The purpose of preparing adjustments on net assets contributed by
partners into the partnership.
___________20. Partnerships which are exempt from income tax.
84
Test
Rating:
Material
No.
8
Name:
Date:
Year and Section:
Professors:
MULTIPLE CHOICE - Theory and Problems
Instructions: Encircle the letter of the best answer. Show supporting computations in good
form in a separate work sheet.
1. The Articles of Co-Partnership should contain clear provisions on all of the following except
a. taxes paid by the partnership
b. causes of partnership dissolution
c. withdrawals allowed to partners
d. profit-sharing ratio
2. The non-cash contributions of the partners to form a partnership are recorded by the
partnership at their
a. Agreed Value
c. Dissolution Value
b. Book Value
d. Original Cost
3. When a partnership cannot pay its debts with business assets, the partners
a. are not personally liable for the debts
b. have limited personal liability
c. must convert the partnership to a joint venture
d. must use their personal assets to meet the debts
4. A partner who takes active part in the business but whose connection with the
partnership is concealed to the public is known as a (an)
a. Silent Partner
c. Nominal Partner
b. Secret Partner
d. Ostensible Partner
5. A partnership which has failed to comply with one or more of the requirements for its
establishment is classified as a (an)
a. Open partnership
c. De facto partnership
b. De jure partnership
d. Secret partnership
6. Two individuals who were previously sole proprietors formed a partnership. Property other
than cash which is part of the initial investment in the partnership would be recorded for
financial accounting purposes at the
a. proprietors' book values or the fair value of the property at the date of the investment,
whichever is higher
85
b. proprietors ‘book values or the date of the fair value of the property at the date of the
investment, whichever lower
c. proprietors' book values of the property at the date of the investment
d. fair value of the property at the date of the investment
7. Anton and Almar formed a partnership, each contributing assets to the bussiness. Anton
contributed inventory with a current market value in excess of its carrying amount. Almar
contributed real estate with a carrying amount in excess of its current market value. At what
amount should the partnership
following assets?
Inventory
a. carrying amount
Real Estate
market value
b. market value
carrying amount
c. carrying amount
carrying amount
d. market value
market value
8. A partnership is formed by two individuals who were previously sole proprietors. Non-cash
assets invested would be recorded into the partnership at the proprietor's
a. carrying amount or the fair value of the property at the date of the investment, whichever is
higher
b. fair value of the property at the date of the investment
c. carrying amount or the fair value of the property at the date of the investment, whichever is
lower
d. carrying amount of the property at the date of the investment
9. Agaton joined a partnership by contributing the following: cash, P120,000 accounts
receivable, P4,000; land P240,000 cost, P400,000 fair value; and accounts payable, P16,000.
What will be the initial amount recorded in Agaton's capital account?
a. P 408,000
c. P 508,000
b. P 424,000
d. P 524,000
10. On October 1, 2014, Alba and Ang formed a partnership and agreed to share profits and
losses in the ratio of 3:7, respectively. Alba contributed cash of and a parcel of land that cost him
P200.000. Ang contributed P300,000 cash. The land has a quoted price of P360.000 on October
1, 2014. What is the amount of partnership capital on October 1, 2014?
a. P 360,000
c. P 760,000
b. P 460,000
d. P 960,000
11. On June 30, 2014, a partnership was formed by Ariston and Astoria. Ariston contributed
cash. Astoria, previously a sole proprietor, contributed non-cash assets, including a realty subject
to a mortgage, which was assumed by partnership. Astoria's capital account at June 30, 2014
should be recorded at
86
a. the fair value of the property less the mortgage payable at June 30, 2014
b. Astoria's carrying amount of the property at June 30, 2014
c. Astoria's carying amount of the property less the mortgage payable at June 30, 2014
d. the fair value of the property at June 30, 2014
12. Abada and Acosta formed a partnership. Abada contributed cash of P300,000 and an
equipment costing P600,000. Acosta contributed land costing P600,000. The current market
value of the assets are as follows: equipment P450,000; land P750,000. The partnership will
assume a P150,000 liability on the land contributed by Acosta. The capital accounts of the
partners will be credited follows:
Abada
Acosta
Abada
Acosta
a. P 900,000
P 450,000
c. P 750,000
P 600,000
b. P 300,000
P 750,000
d. P 300,000
P 600,000
13. The partnership of Alonzo and Amurao was formed on April 1, 2014. At that date the
following assets were contributed
Cash
Alonzo
Amurao
P 300,000
P 140,000
Merchandise Inventory
220,000
Building
Furniture and equipment
4,000,000
900,000
The building is subject to a mortgage loan of P1,600,000 which is to be assume by the
partnership. The partnership agreement provides that Alonzo and Amurao share on profit and
loss of 25% and 75%, respectively. Amurao's capital account at April 1, 2014 should be
a. P 900,000
c. P 2,760,000
b. P 1,200,000
d. P 4,360,000
14. Using the information in No. 13, and assuming that the partnership agreement provides that
the partners initially should have an equal interest in partnership capital, Alonzo's capital account
should be increased by
a. P 780,000
c. P 1,200,000
b. P 900,000
d. P 1,980,000
87
Chapter 2—Nature and Formation of a Partnership
15. Using the information in No. 13, the total partnership capital on April 1, 2014 is
a. P1,200,000
c. P4,740,000
b. P3,960,000
d. P5,560,000
16. Using the information in No. 14, bonus was given by
a. Amurao to Alonzo
c. the partnership
b. Alonzo to Amurao
d. nobody
17. Using the information in No. 13, and assuming that capital shall be proportionate to the
partners' profit and loss ratio, the required capital of Alonzo is
a. P900,000
c. P1,200,000
b. P990,000
d. P3,960,000
18. On April 1, 2014, Aleli, Amy and Annie formed a partnership by combining their separate
business proprietorships. Aleli contributed cash of P200,000. Amy contributed property with
a carrying amount of P144,000, original cost of P160,000, and fair value of P320,000. The
partnership accepted responsibility for the P140,000 mortgage attached to the property.
Annie contributed equipment with a carrying amount of P120,000, original cost of P300,000,
and fair value of P220,000. The partnership agreement specifies that profits and losses are to
be shared equally.
Which partner has the largest capital account balance as of April 1, 2014?
a. Aleli
c. Annie
b. Amy
d. All capital accounts are equal
19. Using the information in No. 18, the property contributed by Amy is to be recorded by the
partnership on April 1, 2014 at
a. P144,000
c. P180,000
b. P160,000
d. P320,000
20. Using the information in No. 18 and assuming capital are in the profit and loss ratio, then
there is
A. P20,000 bonus to Amy
B. P20,000 bonus from Annie
C. No bonus to Aleli
Which is correct?
a. A only
b. B only
c. A and B only
d. A, B and C
88
Chapter 2—Nature and Formation of a Partnership
Test Material No. 9
Rating ___________
Name __________________________________
Date
_________________________________ Year and Section _________________________
Professor _____________________________
PROBLEMS
Problem A
Sole proprietors Alvis and Ancheta established a partnership on December 31, 2014 sharing
profits and losses in the ratio 60% and 40%. They agreed that each would make the following
contributions:
Alvis
Cash
Land
Building
Furniture and Fixture
P
50,000
375,000
1,200,000
Ancheta
P
750,000
675,000
Accounts payable of Alvis totaling P250,000 are to be assumed by the partnership.
Instructions: Prepare the entries on December 31, 2014 to record the investments in the
partnership by Alvis and Ancheta under each of the following independent assumptions:
1. Each partner is credited for the full amount of the net assets invested.
2. Each partner initially should have an equal interest in the partnership capital.
3. Each partner receive capital credit proportionate to his profit and loss ratio.
89
Chapter 2—Nature and Formation of a Partnership
Problem B
On May 1,2014, the business accounts of Ablan and Amias appear below:
Ablan
Cash
Accounts Receivable
Merchandise Inventory
Land
Buildings
Furniture and Fixtures
Other Assets
Accounts Payable
Notes Payable
Ablan, Capital
Amias, Capital
P
55,000
1,172,680
600,175
3,015,000
-------251,725
10,000
894,700
1,000,000
3,209,880
Amias
P
111,770
2,839,450
1,300,510
-------2,141,335
173,945
18,000
1,218,250
1,725,000
3,641,760
Ablan and Amias agreed to form a partnership contributing their respective assets and liabilities
subject to the following adjustments:
a. Accounts receivable of P50,000 in Ablan's books and P75,000 in Amias’ books are
uncollectible.
b. Inventories of P27,000 and P35,000 are worthless in Ablan's and Amias
c. Other assets of P10,000 and P18,000 in Ablan's and Amias' books are to be written off.
Instructions:
1. Prepare journal entries to adjust the books of both partners.
2. Prepare journal entries to close the books of both partners.
3. Prepare journal entries on the new books of the partnership.
4. Prepare a statement of financial position for the new partnership.
90
4
CHAPTER 3
PARTNERSHIP OPERATIONS
LEARNING OBJECTIVES
1. Discuss the closing entries in a partnership and differentiate them from the closing entries
in a sole proprietorship.
2. Identify and discuss the different methods and rules of dividing partnership profits and
losses among partners.
3. Discuss and understand the preparation of financial statements of a partnership.
PREVIEW OF THE CHAPTER
PARTNERSHIP
OPERATIONS
OPERATIO
NS
Closing
Entries
 Revenue and gains
 Expenses and losses
 Partner’s share in
profits and losses
 Partner’s drawing
Distribution of
Partnership
Profits and
Losses
 Equally
 Arbitrary ratio
 Capital ratio
 Interest on capital
 Salary allowance
 Bonus
Preparation of
Financial
Statements
 Statement of Income/
Statement of
Comprehensive
Income
 Statement of Financial
Position
 Statement of Changes
in Partners’ Equity
NATURE OF PARTNERSHIP OPERATION
Accounting for partnership operations is essentially the same as accounting for the operations of
a sole proprietorship. Sale of merchandise on account is debited to Accounts Receivable and
credited to Sales. Collection of accounts is debited to Cash and credited to Accounts Receivable.
The purchase of merchandise on account is recorded by a debit to Purchases and credit to
Accounts Payable. Payment of accounts is debited to Accounts Payable and credited to Cash.
Payment of expenses is debited to Expenses and credited to Cash.
91
Chapter 3—Partnership Operations
At the end of the accounting period, adjustments are made for merchandise inventory, accruals,
prepayments, provision for uncollectible accounts, and provision for depreciation. Profit or loss
is determined in the usual manner, that is, by matching periodic income and expenses.
However, special problems are encountered in accounting for partnership operations. These
problems include:
1.
2.
3.
4.
Closing entries of a partnership
Distribution of profits and losses
Preparation of a work sheet
Preparation of financial statements
a.
Statement of income/ statement of comprehensive income
b.
Statement of financial position
c.
Statement of changes in partners' equity
CLOSING ENTRIES OF A PARTNERSHIP
The procedures for the preparation of closing entries for a partnership are similar to that of a sole
proprietorship. First, all revenue and other nominal accounts with credit balances (such as
Purchases Discounts and Purchases Returns and Allowances) are debited and Income Summary
is credited. Second, Income Summary is debited and all expense and other nominal accounts
with debit balances (such as Sales Discounts and Sales Returns and Allowances) are credited.
Third, the balance of the Income Summary account, which represents profit or loss of the
partnership, is transferred either to the drawing accounts or directly to the capital accounts of the
partners. Finally, the balance of the drawing account of each partner is transferred to his/her
capital account.
The balance of the Income Summary account is transferred to the drawing accounts of the
partners if the partners’ intention is to keep the capital account intact for investments and
permanent withdrawals of capital. A credit balance in the Income Summary account represents a
profit and its balance is transferred to the drawing accounts of the partners based on their profit
and loss sharing ratio. The entry is as follows:
Income Summary
A, Drawing
B, Drawing
xxx
xxx
xxx
Any resulting credit balance in the drawing account of a partner may be withdrawn by the
partner or reinvested into the firm. If the balance in the drawing account is withdrawn in cash,
the entry is as follows:
A, Drawing
Cash
xxx
xxx
Chapter 3—Partnership Operations
92
However if the partner decides to reinvest into the firm this balance in his drawing account, the
entry is as follows:
A, Drawing
A, Capital
xxx
xxx
A debit balance in the Income Summary account represents a loss and its balance is transferred
to the drawing accounts of the partners based on their profit and loss sharing ratio. The entry is
as follows:
A, Drawing
B, Drawing
Income Summary
xxx
xxx
xxx
The resulting debit balance in the drawing account of a partner is charged against his capital with
the following entry:
A, Capital
A, Drawing
xxx
xxx
On the other hand, the balance of the Income Summary account may be transferred directly to
the capital accounts of the partners if the partners' intention is to make the profit or loss a part of
permanent capital. It should be noted, however, that either treatment will result to the same net
effect on partners' ending capital balances. All illustrations in this chapter pertaining to
distribution of profit or loss are recorded directly to the capital accounts with the assumption that
partners intend to make their respective share on the profit or loss as a direct part of their
permanent capital.
A credit balance in the Income Summary account represents a profit and its balance is transferred
to the capital accounts of the partners based on their profit and loss sharing ratio. The entry is as
follows:
Income Summary
A, Capital
B, Capital
xxx
xxx
xxx
A debit balance in the Income Summary account represents a loss and its balance is transferred
to the capital accounts of the partners based on their profit and loss sharing ratio. The entry is as
follows:
A, Capital
B, Capital
Income Summary
xxx
xxx
xxx
Chapter 3—Partnership Operations
93
DISTRIBUTION OF PROFITS AND LOSSES
To make distribution of partnership profits and losses equitable, the following factors are
considered:
1.
2.
3.
Services rendered by the partners to the partnership
Amount of capital contributed by the partners to the business
Entrepreneurial ability or managerial skill of the partners
The distribution or division of profits and losses may be expressed in several ways as follows:
1. by percentage
2. by fraction
3. by decimal
4. by ratio
Illustration: Alba and Bueno are partners sharing profits and losses based on their capital
contributions of P100,000 and P300,000, respectively. Their profit and loss sharing can be
expressed as follows:
1.
By percentage
Alba
Bueno
25% (P 100,000 / P400.000)
75% (P300,000 / P400.000)
2.
By fraction
Alba
Bueno
1/4
3/4
(P100,000 / P400,000)
(P300,000 / P400,000)
3.
By decimal
Alba
Bueno
.25
.75
(P100,000 / P400,000)
(P300,000 / P400,000)
4.
By ratio
Alba and Bueno
1:3
RULES FOR DIVIDING PROFITS AND LOSSES
The following is the list of rules in the division of profits and losses of the partnership based on
the provisions of the New Civil Code:
1.
As to Capitalist Partners
a.
Division of profits
1.
in accordance with agreement
2.
in the absence of an agreement, division of profits is in accordance with
capital contributions
Chapter 3—Partnership Operations
b.
Division of Losses
1.
in accordance with agreement
94
2.
3.
2.
if only division of profits is agreed upon, the division of losses will be the
same as the agreement on the division of profits
in the absence of an agreement, division of losses is in accordance with capital
contributions
As to Industrial Partners
a.
Division of profits
1. in accordance with agreement
2. in the absence of an agreement, the industrial partner shall receive a just and
equitable share of the profits and the capitalist partners shall receive profits in
accordance with their capital contributions
b.
Division of losses
1. in accordance with agreement
2. in the absence of an agreement, the capitalist-industrial partner in his/her
character as industrial partner shall have no share in the losses, but in his/her
character as a capitalist partner will share in proportion to the capital
contribution
Profits and losses in general shall be divided in accordance with the agreement among the
partners. In the absence of an agreement, the partners shall share in the profits in proportion to
their capital contributions after satisfying the share of the industrial partner on such profit.
METHODS OF DISTRIBUTING PROFITS BASED ON
PARTNERS’ AGREEMENT
1.
Equally - it is simple to apply but does not give due recognition on the disparity of capital
contribution nor does it recognize the time and effort that a partner may devote in running
the firm's business operations.
2.
Arbitrary ratio (Percentage, Decimal, Fraction, Ratio) - it is simple to apply but does
not give recognition on the disparity of capital contributions nor does it recognize the
time and effort that a partner may devote in running the firm's business operations.
3.
Capital ratio (Original, Beginning, Ending, Average) - this method e differences in the
capital contributions but does not take into account the time and effort that a partner may
devote in running the firm's business operations.
4.
Interest on capital and the balance on agreed ratio - this method recognizes the
differences in the capital contributions but does not take into account the time and effort
that a partner may devote in running the firm's business operations.
Chapter 3—Partnership Operations
Interest is allowed to partners for the use of invested capital. Interest as agreed by the
partners shall be allowed in proportion over the period such capital was actually used.
95
Moreover, the interest shall be provided whether the profit is sufficient or insufficient or
there is a net loss unless otherwise agreed upon by the partners.
5.
Salary allowances to partners and the balance on agreed ratio – this method recognizes
the time and effort that a partner may devote in running the firm’s business operations but
does not take into consideration the differences in capital contributions.
Salaries are allowed to partners as compensation for their time devoted in the business.
Salaries as agreed by the partners shall be allowed in proportion to the time the partners
actually rendered services to the firm. Such salaries shall be provided whether the profit
is sufficient or insufficient or there is net a loss unless otherwise agreed upon by the
partners.
6.
Bonus to managing partner and the balance on agreed ratio - this method allows a
bonus, as an incentive, to the managing partner. It is usually a percentage of the profit.
Bonus, therefore, is allowed only when there is a profit. It may be computed using any
one of the following as basis:
a.
Bonus is based on profit before deducting bonus and income tax
b.
Bonus is based on profit after deducting bonus but before deducting income tax
c.
Bonus is based on profit after deducting income tax but before deducting bonus
d. Bonus is based on profit after deducting both bonus and income tax.
7.
Interest on capital, salaries to partners, bonus to managing partner, and the balance
on agreed ratio.
Illustrative Problem A: The following data are available in the books of Calma and David
Partnership for the year 2014.
Calma, Capital
May 1
P100,000
Jan. 1
April 1
Oct. 1
Balance
P2,500,000
250,000
500,000
Balance – P3,150,000
Calma, Drawing
Jan. 1 – Dec. 31
P300,000
96
David, Capital
June 1
P150,000
Jan. 1
Dec 1
50,000
Sep. 1
Balance
P1,500,000
500,000
Balance – P 1,800,000
David,Drawing
______________________________________________________________________________
Jan 1- Dec. 31
P225,000
Income Summary
Dec. 31
P600,000
Twelve cases will be illustrated using the given data. Cases 1-10 will show sufficient profit. Case
11 will show insufficient profi, Case 12 shows a loss.
Case 1- Profit is divided equally
Income summary
Calma, Capital
David, Capital
P600,000/2 = P300,000
600,000
300,000
300,000
Case 2- Profit is divided ¾ and ¼ to Calma and David
Income summary
Calma, Capital
David, Capital
P600,000 x ¾ = P450,000
P600,000 x ¼ = P150,000
600,000
450,000
150,000
Case 3- Profit is divided in the ratio of 1:2 to Calma and David
Income summary
Calma, Capital
David, Capital
P600,000 x 1/3 = P200,000
P600,000 x 2/3 = P400,000
600,000
200,000
400,000
Case 4- Profit is divided 20% and 80% to Calma and David
Income summary
600,000
97
Calma, Capital
David, Capital
P600,000 x 20% = P120,000
P600,000 x 80% = P480,000
120,000
480,000
Case 5- Profit is allocated based on the beginning capital ratio
Income summary
Calma, Capital
David, Capital
P600,000 x 25/40 = P375,000
P600,000 x 15/40 = P225,000
600,000
375,000
225,000
Case 6- Profit is allocated based on the ending capital ratio
Income summary
Calma, Capital
David, Capital
P600,000 x 315/495 = P381,820
P600,000 x 180/495 = P218,180
600,000
381,820
218,180
The ending capital balances of the partners are computed as follows:
Calma
David
Beginning balances
P2,500,000
P1,500,000
Additional investment
750,000
500,000
Drawing
( 100,000)
( 200,000)
Ending balances
P3,150,000
P1,800,000
Key Points. Withdrawals deducted for purposes of determining ending capital balances are the
debit entries in the capital accounts of each of the partners (see partners' accounts shown in the
previous page)These debit entries represent permanent withdrawals or decreases on capital. The
credit entries represent initial and/or additional investments.
On the other hand, the debits to the drawing accounts represent temporary withdrawals or
decreases in capital caused by the share in loss (though may be debited directly to the capital
account) or withdrawal of assets in anticipation of profits. The credit entries represent increases
in capital (may be credited directly to the capital account) caused by the share in profit. The
entries in drawing accounts are not considered in computing ending capital for the purpose of
establishing the ratio.
Case 7- Profit is allocated based on the average capital ratio
Income summary
Calma, Capital
David, Capital
P600,000 x 2,745,830/4,320,830 = P381,290
P600,000 x 1,575,000/4,320,830 = P218,710
600,000
381,290
218,710
98
Average captial ratio is a methiod of divided profit based on the amount of capital invested and
the time during which such capital is actually used in the business.
The following steps are to be followed in determining the average capital of each partner using
the peso month method, thus, arriving at the capital ratio:
1. Multiply beginning capital by the number of months that it remained unchanged.
2.Determine each new capital balance in chronological order and multiply by the number of
months it remained unchanged.
3. Add the products which represent peso months and divide the total by twelve (12) to obtain
the average monthly capital.
By the following steps given, the average capital of each partners can be calculated as follows:
Calma, Capital
Period
Jan.1 – Mar 31
Apr.1 – Apr. 30
May 1 – Sep 30
Oct. 1 – Dec 31
Capital Balances
P2,500,000
2,750,000
2,650,000
3,150,000
No. of mos.
Unchanged
3
1
5
3
12
Peso months
P7,500,000
2,750,000
13,250,000
9,450,000
P32,950,000
Average Capital
P2,745,830
David, Capital
Jan. 1 – May 31
June 1- Aug. 31
Sep. 1 – Nov. 30
Dec. 1 – Dec.31
P1,500,000
1,350,000
1,850,000
1,800,000
5
3
3
1
12
P7,500,000
4,050,000
5,550,000
1,800,000
P18,900,000
1,575,000
P4,320,830
Cases 1 to 7 provide for division of profits using a single allocation procedure. However, there
are instances when the partnership agreement may provide for a combination of several
allocation procedures (multiple bases of profit allocation) to be used in the distribution of profit.
Since partnerships specify a profit distribution to be followed to whatever extent possible, most
agreements specify that the entire process is to be completed and any remainder is to be allocated
in the profit and loss ratio. The following cases are used to illustrate various multiple allocation
procedures.
Case 8 – Each partner is allowed 10% interest on ending capital and the remaining profit is
divided 60%, 40%
99
Income Summary
Calma, Capital
David, Capital
600,000
378,000
222,000
The distribution of profits may be recorded separately as follows:
Income Summary
Calma, Capital
David, Capital
Interest on ending capital
495,000
315,000
180,000
Income Summary
Calma, Capital
David, Capital
Remaining income divided 60%, 40%
105,000
63,000
42,000
Division of Profit
Calma
Interest on ending capital
P3,150,000 x 10%
P1,800,000 x 10%
Remainder – 60%,40%
P105,000 x 60%
P105,000 x 40%
Total
David
Total
P180,000
P495,000
42,000
P222,000
105,000
P600,000
P315,000
63,000
P378,000
Case 9 – David is allowed salaries of P500,000 and the remaining profit is divided in the
ratio of 1:4
Income Summary
Calma, Capital
David, Capital
600,000
20,000
580,000
Division of profit
Calma
Salaries
Remainder -1:4
100,000 x 1/5
100,000 x 4/5
Total
David
Total
P500,000
P500,000
80,000
P580,000
100,000
P600,000
P20,000
P20,000
Case 10 – David, the managing partner , is allowed a bonus of 20% of profit BEFORE
bonus and income tax and the remainder is divided in the ratio of beginning capital
100
Using the income tax rate of 30% the partnership income before income tax is P857,143 that is,
net profit of P600,000 divided by 70%
Income summary
Calma, Capital
David, Capital
600,000
267,857
332,143
Division of profit
Calma
Bonus – P857,143 x 20%
Remainder
P428,571 x 25/40
P428,571 x 15/40
Total
David
P171,429
Total
P171,429
P267,857
P267,857
P161,587
P332,143
428,571
P600,000
Other assumption on the computation of bonus shall be illustrated later in the chapter.
Case 11- the parteners are allowed P5,000 and P10,000 weekly salaries, repectively, 10%
interest on average capital, and the remainder is divided in the ratio of 2:3.
Income summary
Calma, Capital
David, Capital
600,000
289,750
310,250
Division of profit
Calma
Salaries to partners
P5,000 x 52
P10,000 x 52
Interest on average capital
P2,745,830 x 10%
P1,575,000 x 10%
Remainder – (P612,080)
P612,080 x 2/5
P612,080 x 3/5
Total
David
Total
P260,000
520,000
780,000
274,580
157,500
432,080
(367,250)
310,250
(612,080)
P600,000
(244,830)
289,750
101
The sum of the salary allowance and interest allowed on the average capital of the partners
exceeded the profit of 600,000 resulting in a negative remainder (loss or deficit). Such loss is
distributed as provided in the profit and loss sharing agreement
Case 12 – Assume the same agreement as in Case 11 except that instead of a profit the
partnership has incurred a loss of P160,000. The allowance for salaries and interest will still
be provided, thereby resulting in a total loss to be divided as agreed.
David, Capital
Calma,Capital
Income Summary
109,750
9,750
100,000
Divison of profit
Calma
Salaries to partners
P5,000 x 52
P10,000 x 52
Interest on average capital
P2,745,830 x 10%
P1,575,000 x 10%
Remainder – (P1,112,080)
P1,112,080 x 2/5
P1,112,080 x 3/5
Total
David
Total
P260,000
520,000
780,000
274,580
157,500
432,080
(524,830)
P9,750
(787,250)
(109,750)
(1,112,080)
(100,000)
The allocation of partnership profit follows the order of the profit sharing agreement in
allocating the bonus, the salary allowances, the interests and the remainder to individual
partners.
The bonus is computed on the basis of the partnership profit as the concept of "partnership
profit" is generally understood in accounting practice.1 Partners may, however, intend for salary
and interest allowances to be deducted in determining the base for computing the bonus. In such
case, no bonus is allowed if there is insufficient profit after distribution of salaries and interests.
The interests of the partners may not be apparent when technical accounting terms are used; so,
the partnership agreement should be precise in specifying measurement procedures to be used in
determining the amount of a bonus.
Illustrations on the computation of bonus using other assumptions.,The same data is Illustrative
Problem A shall be used. Bonus rate is 20%.
1. Bonus is based on profit after deducting bonus but before deducting income tax
B
= .20(P857, 143 – B)
102
B
B-20B
B
B
= P171,428 -.20B
= P171,428
= P171,428/1.20
= P142,857
2. Bonus is based on profit after deducting bonus but after deducting income tax
B
= .20B (857,143-257,143)
T
= .30 x P857, 143
= P257, 143
Substituting for T in the first equation and solving for B
B
= .20(P857, 143 – B – T)
B
= .20 x P600, 000
B
= P120, 000
Key Points. The bonus was not deducted from the profit subject to income tax. The bonus being
computed is not an expense but a distribution of profit after income tax.
1. Bonus is based on profit after deducting bonus and income tax
B
= .20(P857, 143 – B – T)
T
= .30 x P857, 143
= P257, 143
Substituting for T in the first equation and solving for B
B
= .20B (857,143- B - 257,143)
B
= .20 (P600, 000 – B)
B
= P120, 000 - .20B
B + .20B
= P120, 000
B
= P120, 000/1.20
B
= P100, 000
Key Points. In the preceding examples, bonus is treated as a distribution of partnership profit,
and therefore such bonus is not deductible as an expense in determining the amount of taxable
profit. The same is true for salaries and interest allowed on capital.
The partnership form of business allows a wide selection of profit distribution ratios to meet the
individual desires of the partners. Ratios for profit distributions may be based on the percentage
of total partnership capital, time and effort invested in the partnership, or a variety of other
factors. Some partnerships, however, have a profit sharing ratio that is different from their loss
sharing ratio.
103
ORDER OF PRIORITY PROVISION
In some instances, the partners may agree not to use residual sharing ratio in the event profits did
not exceed the total of the salary and interests allowances. In this case, the partners must agree
on the priority of the various features. If the partnership agreement gives salary allowances
priority over interest on capital balances, then profit would first apply to salaries and the balances
would be divided in the ratio of interest allowance and vice-versa.
Illustrative Problem B: Santos and Tomas are partners with capital balances P315.000 and
P180, 000, respectively. The profit and loss agreement provides salaries of P500, 000 to Santos
and P250, 000 to Tomas, 10% interest on capital and the balance will be divided equally. Income
is to be allocated by first giving priority to interest on invested capital and then on salary
allowance. Partnership net income for the year is P600.000.
The following is the division of the P600, 000 profit in accordance with the order of priority
provision.
Santos
Tomas
Total
Interest on capital
P 315, 000 x 10%
P 31, 500
P 315, 000 x 10%
P 18, 000
P 49, 500
Salaries (ratio 50:25)
P 183, 500
P 367, 000
P 550, 500
Total
P 215, 000
P 385, 000
P 600, 000
The entry to record the distribution of the profit is as follows:
Income Summary
600, 000
Santos, Capital
215, 000
Tomas, Capital
385, 000
SPECIAL PROFIT ALLOCATION METHODS
Some partnerships distribute profits on the basis of other criteria. For example, most public
accounting firms distribute profits on the basis of partnership units. A new partner requires a
certain number of units and additional units are assigned by a firm wide compensation committee
based on:



obtaining new clients;
providing the firm with specific areas of industrial expertise;
serving as a managing partner of a local office; or
104
 accepting a variety of other responsibilities
Other partner devise profit distribution plans that reflect the earnings of the partnership. For
example some medical or dental firms allocate profits on the basis of billed services. Other
criteria may include number or size of clients, years of service within the firm, or the partner’s
position within the firm.
PREPARATON OF WORK SHEET
At the end of each accounting period the partnership books are adjusted and closed and financial
statement are prepared. In order to classify a accounting data in a convenient and orderly manner
and to facilitate the preparation of financial statement, a worksheet is prepared. The form or
columns of the worksheet may vary depending on the needs of the company. The following
illustrative problem will use the simplest form of worksheet with emphasis not on the form but
the underlying principles and procedures in preparing such worksheet.
Illustrative Problem C: the trial balance for EXCELLENCE COMPANY as at December 31,
2014 is presented on the next page.
EXCELLENCE COMPANY
Trial Balance
December 31, 2014
Cash
Notes receivable
Accounts receivable
Allowance for uncollectible accounts
Merchandise inventory
Furniture and equipment
Accumulated depreciation
Notes payable
Accounts payable
Flores, capital
Flores, drawing
Garcia, capital
Garcia, drawing
Sales
Sales return and allowances
Sales discount
Purchases
Purchases return and allowances
Purchases discount
Freight in
Selling expenses
General expenses
Interest income
Interest expense
Debit
1,900,000
625,000
1,125,000
Credit
50,000
1,250,000
1,500,000
200,000
500,000
375,000
1,250,000
155,000
3,1250,000
250,000
5,000,000
50,000
75,000
2,412,500
100,000
62,500
125,000
825,000
362,500
17,500
25,000
105
10,680,000
10,680,000
Data for adjustments as of December 31, 2014:
a. merchandise inventory, P1,00,000
b. depreciation of furniture and equipment, 10% per year, 40% of which is considered part
of general expenses.
c. Unpaid sales salaries P25,000
d. Accrued interest and notes receivable, P2,500
e. Accrued interest on note payable P1,500
f. Allowance for uncollectible accounts increased to P112,500
g. Unused supplies: office – P10,000, store – P15,000
h. Income tax, 30% of profit before income tax
106
The Articles of Co-Partnership contain the following provisions regarding the division of profit
and losses:
1. Annual salaries of P 400,000 and P 500,000, respectively.
2. Interest of 10% on beginning capital.
3. The remainder is divided in the ration of 3:2.
A work sheet prepared for the partnership and the related statement of financial position and
income statement are presented on the next pages. The statement of changes in partners' equity
is presented below.
EXCELLENCE COMPANY
Statement of Changes in Partners' Equity
For the Year Ended December 31, 2014
Equity, January 1
FLORES
GARCIA
TOTAL
P 1,250,000
P 3,125,000
P 4,375,000
P 400,000
P 500,000
P 900,000
125,000
312,500
437,500
(298,820)
(747,050)
Add Profit for 2014:
Salaries
Interest on beginning Capital
Balance- 3:2 (P747,050)
P 747,050 x 3/5
(448,230)
P747,050 x 2/5
Total share in profit
Total
Less Withdrawals
Equity, December 31
P 76,770
P 513,680
P 590,450
P 1,326,770
P 3,638,680
P 4,965,450
155,000
P 1,171,770
250,000
P 3,388,680
405,000
P 4,560,450
107
EXCELLENCE COMPANY
WORKSHEET
For the Year Ended December 31, 2014
TRIAL BALANCE
Cash
Notes Receivable
Accounts Receivable
Allowance for Uncollectible Accounts
Merchandise Inventory
Furniture and Equipment
Accumulated Depreciation
Notes Payable
Accounts Payable
Flores, Capital
Flores, Drawing
Garcia, Capital
Garcia, Drawing
Sales
Sales Return and Allowances
Sales Discounts
Purchases
Purchases Return and Allowances
Purchase Discount
Freight-In
Selling Expenses
General Expenses
Interest Income
Interest Expense
Debit
1,900,000
625,000
1,125,000
Credit
ADJUSTMENTS
Debit
50,000
Credit
STATEMENT OF
STATEMENT OF
INCOME
FINANCIAL POSITION
Debit
Credit
Debit
1,900,000
625,000
1,125,000
f. 62,500
1,250,000
1,500,000
112,500
1,250,000 1,000,000
200,000
500,000
375,000
1,250,000
Credit
1,000,000
1,500,000
b. 150,000
350,000
500,000
375,000
1,250,000
155,000
155,000
3,125,000
3,125,000
250,000
250,000
5,000,000
5,000,000
50,000
75,000
2,412,500
50,000
75,000
2,412,500
100,000
62,500
125,000
825,000
362,500
17,500
25,000
10,680,000 10,680,000
b. 90,000
b. 60,000
e. 1,500
g. 15,000
g. 10,000
d. 2,500
125,000
925,000
475,000
26,500
108
Salaries Payable
Interest Receivable
Interest Payable
Supplies on Hand
Income Tax Expense
Income Tax Payable
c. 25,000
d. 2,500
2,500
e. 1,500
g. 25,000
h. 253,050
519,500
Profit
25,000
1,500
25,000
253,050
h. 253,050
519,500 5,592,050
590,450
6,182,500
6,182,500
6,182,500
253,050
6,582,500 5,992,050
590,450
6,582,500 6,582,500
Computation of income tax and profit:
Total credit per income statement before income tax
Total debit per income statement before income tax
Profit before tax
Income tax (P 843,500 × 30%)
Profit
P 6,182,500
5, 339,000
P 843,500
253,050
P 590,450
109
EXCELLENCE COMPANY
Statement of Income
For the Year Ended December 31, 2014
Net Sales
Cost of Sales
Gross Profit
Other Operating Income- Interest
Operating Expenses:
Selling
General
Operating Profit
Interest Expense
Profit before Tax
Income Tax Expense 30%
Profit for the Period
Schedule
1
2
P4,875,000
2,625,000
P2,250,000
20,000
P925,000
475,000
(1,400,000)
P870,000
(26,500)
P843,500
(253,050)
P590,450
Division of Profit
Salaries
Interest on beginning capital
Balance- 3:2 (P747,050)
P 747,050 × 3/5
P 747,050 × 2/5
Total share in profit
Flores
P400,000
125,000
Garcia
P500,000
312,500
Total
P900,000
437,500
(298,820)
P513,680
(747,050)
P590,450
(448,230)
P76,770
Schedule 1- Net Sales
Sales
Less: Sales Returns and Allowances
Sales Discounts
Net Sales
P5,000,000
P50,000
75,000
125,000
4,875,000
Schedule 2- Cost of Sales
P1,250,000
Merchandise Inventory, January 1
Net Purchases
Purchases
Add Freight-In
Total
Less: Purchase Returns and Allowances
Purchases Discounts
Cost of Goods Available for Sale
Less Merchandise Inventory, December 31
Cost of Sales
P2,412,500
125,000
P2,537,500
P100,000
62,500
162,500
2,375,000
P3,625,000
1,000,000
P2,625,000
110
Key Points. The Statement of Income of a partnership is similar to that of a sole proprietorship
except that it includes a schedule showing the division or distribution of profit to partners.
EXCELLENCE COMPANY
Statement of Financial Position
December 31, 2014
ASSETS
Current Assets:
Cash
Notes Receivable
Accounts Receivable
P1,900,000
625,000
P1,125,000
112,500
Interest Receivable
Merchandise Inventory
Supplies
1,012,500
2,500
1,000,000
25,000
P4,565,000
Furniture and Equipment
Less Accumulated Depreciation
P1,500,000
350,000
1,150,000
Less Allowance for Uncollectible Accounts
Total Assets
P5,715,000
LIABILITIES
Current Liabilities:
Notes Payable
Accounts Payable
Salaries Payable
Interest Payable
Income Tax Payable
Total Liabilities
P500,000
375,000
25,000
1,500
253,050
P1,154,550
PARTNERS' EQUITY
Flores, Capital
Garcia, Capital
Total Partners' Equity
Total Liabilities and Partners'
P1,171,770
3,388,680
4,560,450
P5,715,000
111
CORRECTIONS IN PROFIT FOR ERRORS
AND OMISSIONS PRIOR TO DISTRIBUTION
The partnership books may show an incorrect profit because of errors and omissions. Such
include failure to record prepaid expenses, accrued expenses, accrued income, unearned income
and also overstatement or understatement in purchases, inventories, and depreciation. The
reported profit should be corrected before it is distributed to the partners. The required
corrections may be summarized as follows:
1. Unrecorded prepaid expenses
2. Unrecorded accrued expenses
3. Unrecorded accrued income
4. Unrecorded unearned income
5. Overstatement of inventories
6. Understatement of Inventories
7. Overstatement of purchases
8. Understatement of purchases
9. Overstatement of depreciation
10. Understatement of depreciation
Correction in profit of current year for
errors made in
Prior Year
Current Year
+
+
+
+
+
+
+
+
none
+
none
-
It is understood that the tax implications of these corrections are properly accounted for
particularly if the partnership is not a general professional partnership.
Illustrative Problem D: Hannah, Ines, and Julian are partners sharing profit on a 2:3:5 ratio. On
January 1, 2014, Karina was admitted into the partnership with a 20% share in profits. The old
partners shall continue to participate in profits in proportion to their original ratios.
For the year 2014, the partnership books showed a profit of P 398,000. It was ascertained,
however, that the following error were made:
1. Accrued expenses not recorded at the end of 2013
2. Overstatement of 2014 ending inventory
3. Goods received and inventoried in 2014 but the related
purchases not recorded
4. Income received in advance (unearned income), not
recorded at the end of 2013
5. Prepaid expenses not recorded at the end of 2013
P 5000
48,000
20,000
10,000
3,000
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The corrected profit for 2014 based on a 30% income tax rate shall be computed as follows:
Recorded Profit
Corrections:
Unrecorded accrued expense, 2013
Unrecorded unearned income, 2013
Overstatement of ending inventory,
Unrecorded purchases, 2014
Unrecorded prepaid expenses, 2013
Total Corrections before income tax
P 398,000
P 5,000
10,000
(48,000)
(20,000)
(3,000)
P (56,000)
× 70%
Total Corrections after income tax
Corrected profit
(39,200)
P358,800
The distribution of corrected profit shall be based on the new profit and loss ratios computed as
follows:
Hannah
Ines
Julian
Karina
20% × 80%
30% × 80%
50% × 80%
=
=
=
16%
24%
40%
20%
100%
The Corrected profit shall be divided among partners as follows:
Hannah
Ines
Julian
Karina
P358,800 × 16%
P358,800 × 24%
P358,800 × 40%
P358,800 × 20%
P 57,408
86,112
143,520
71,760
P 358,800
CAPITAL BALANCES RATIO ADJUSTED TO PROFIT
AND LOSS RATIO
While it is unusual that capital ratios do not equal profit and loss ratios; yet, partners may decide
to bring their capital balances into their profit and loss ratio. This can be accomplished through
either of the following:
1. The capital balances are to be brought into the profit and loss ratio by payments
outside of the firm among the partners and where the total firm capital is to remain the
same.
2. The capital balances are to brought into the profit and loss ratio by the lowest possible
additional cash investment in the firm by the partners.
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3. The capital balances are to be brought into the profit and loss ratio by the lowest possible
additional cash investment or cash withdrawal from the firm by the partners.
Illustrative Problem E: Lopez, Martin and Nunag are partners whose original capital
balances were in profit and loss ratio. On December 31, 2014, capital balances are as follows:
Lopez
Martin
Nunag
P 400,000
200,000
400,000
20%
30%
50%
Partners want to bring capital balances into the profit and loss ratio.
Assumption 1. Capital balances are to be brought into the profit and loss ratio by payments
outside of the firm among the partners and with the total firm capital to remain the same
Lopez
Capital Balances
P400,000
Required Capital
200,000
Cash received (paid)
P200,000
Martin
P200,000
300,000
(P100,000)
Nunag
P400,000
500,000
(P100,000)
Total
P1,000,000
1,000,000
-
For the capital balances to be brought into the profit and loss ratio and the total firm capital to
remain the same, Martin and Nunag have to pay Lopez P100,000 each. The entry required on the
partnership books is as follows:
Lopez, Capital
Martin, Capital
Nunag, Capital
200,000
100,000
100,000
Assumption 2. Capital Balances are to be brought into the profit and loss ratio by the lowest
possible cash investment in the firm by the partners.
Capital Balances
Required Capital
Additional Investment
Lopez
P400,000
400,000
-
Martin
P200,000
600,000
P400,000
Nunag
P400,000
1,000,000
P600,000
Total
P1,000,000
2,000,000
P1,000,000
P 400,000 / 20% = P 2,000,000; P 200,000 / 30% = P666,666
P 400,000 / 50% = P800,000
In order to bring the capital balances into the profit and loss ratio by the lowest possible
additional cash investment, use as basis for determining the required capital, the capital
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of Lopez divided by his profit share (P400,000/20% equals P2,000,000). The required entry
on the books of the partnership is as follows:
Cash
Martin, Capita
Nunag, Capital
1,000,000
400,000
600,000
Assumption 3. Capital Balances are to be brought into the profits and loss ratio by the lowest
possible additional investment or cash withdrawal from the firm by the partners.
Lopez
Martin
Capital Balances
P400,000
P200,000
Required capital
160,000
240,000
Add'l investment (withdrawals)
(P240,000)
P40,000
Nunag
Total
P400,000
P1,000,000
400,000
800,000
(P200,000)
In order to bring the capital balances into the profit and loss ratio by the lowest possible
additional cash investment or cash withdrawal from the firm by the partners, use as basis for
determining the required capital, the capital of Nunag divided by his profit share (P400,000/50%
equals P800,000.) The required entry on the books of the partnership is as follows:
Lopez, Capital
Cash
Martin, Capital
240,000
200,000
40,000
REVIEW of the LEARNING OBJECTIVES
1.
Discuss the closing entries in a partnership and differentiate them from the
closing entries in a sole proprietorship. The closing entries of a partnership are almost similar to
those of a sole proprietorship. However, the profit or loss of the partnership is transferred to the
individual drawing account or capital account of the partners and is distributed according to the
profit and loss sharing agreement.
2.
Identify and discuss the different methods and rules of dividing partnership profits and
losses to partners. The distribution of partnership profits and losses to the partners may be
expressed in any of the following ways: (1) by percentage; (2) by fraction; (3) by decimal; or
(4) by ratio. The Civil Code of the Philippines provides rules on how partnership profits and
losses be divided among the partners. As a general rule, profits or losses should be divided in
accordance with the partners' agreement. In the absences of an agreement, the division shall
be made in accordance with capital contributions. To give recognition to the services
rendered by the partners or to the differences in the amount contributed in the partnership or
to the entrepreneurial ability or managerial skill of the partners, salaries, interest and bonuses
may be allowed to the partners as part of the division of profit and losses.
115
3. Discuss and understand the preparation of financial statements of a partnership. The
financial statements are prepared after the work sheet is completed (or after journalizing and
posting the adjusting entries if a work sheet is not prepared). These financial statements
include the income statement, the statement of financial position, and the statement of
changes in partners' equity. The income statement includes a schedule showing the division
of the partnership profit or loss to the partners. The owners' equity section of the statement of
financial position is called "Partners' Equity" and it shows capital balances of individual
partners. The statement of changes in partners' equity shows the division of profit and loss to
the partners, the amount of withdrawals during the period, and the partners' capital balances
at the end of the period.
GLOSSARY of ACCOUNTING TERMINOLOGIES
Average Capital — the amount of capital invested by a partner determined by the time during
which such capital is actually used in the business.
Bonus — an incentive normally given to the managing partner in recognition of managerial or
entrepreneurial skill or ability. It is usually a percentage of profit.
Interest on capital — incentive given to partners to give recognition to the differences in capital
contributions and is computed in proportion to the period such capital was actually used.
Salary Allowances — compensation given to partners in proportion to the time devoted to the
business.
Statement of Changes in Partners' Equity — a statement showing the division of partnership
profit or loss to the partners, additional investments made by partners, the amount of withdrawals
of individual partners, and the ending capital balances.
116
DISSCUSSION QUESTIONS
1. What are the procedures followed in closing the books of the partnership at the end of an
accounting period?
2. What are the factors to be considered in adopting a particular plan for sharing profits among
partners?
3. What are the general rules for dividing profits among partners? For dividing losses?
4. Does an industrial partner share in both profits and losses?
5. Why are salary allowances to partners debited to Income Summary instead of Salary Expense?
Is there an instance when such salary allowances are debited to Salary Expense account? If yes,
what is that instance?
6. Pacis, Quezon and Roces share profits and losses based on their capital balances of P250,000,
P500,000, and P750,000, respectively. Show hoe the profit of P100,000 be distributed in terms of
(a) percentage; (b) fraction; (c) decimal; and (d) ratio.
7. Explain the following terms; (a) original capital; (b) beginning capital; (c) ending capital; and
(4) average capital. How do you determine the amount of each type of capital?
8. When the profit and losses agreement provides for the allowance of interest on partners’
equity and salaries to partners, why are the partners entitled to these allowances even if the
partnership operations result in a loss?
9. Why is it necessary to specify whether the withdrawal made by the partner is a withdrawal
against profit or a permanent withdrawal of a capital or a loan being extended to him/her by the
partnership?
10. What is a statement of changes in partners’ equity? What information does it show?
117
EXERCISES
Exercise 3-1 (Division of Profits using Ratios)
Borres, Buendia, and Bustos have capital balances of P250,000 and P100,000, respectively. Time
divided by the partners in the partnership follows:
Borres
Buendia
Bustos
-
three- fourths time
one-fourth time
one-half time
Instructions: Determine the participation of the partners in the profit of P600,000 if profit is
divided:
1.
2.
in the ratio of capital investments
In the ratio of time devoted in the business
Exercises 3-2 (Division of Profit; Interest on Average Capital)
Banal and Benson are partners. Their capital accounts during the fiscal year 2014were as
follows:
Banal
9/1
120,000
1/1
1,200,000
4/1
140,000
11/1
100,000
800,000
160,000
60,000
3/1
Benson
180,000
1/1
3/1
10/1
Profit opf the partnership is P250,000 for the year. The partnership agreement provides for the
division of profits as follows:
1. Each partner is to be credited 10% interest on his average capital
2. Any remaining profit or loss is to be divided equally.
Instruction: Prepare the entry to record the closing of profit to the partners’ capital accounts.
Exercise 3-3 (Division of profit; Interest on Average Capital and Salaries to Partners)
The partnership of Benito and Bunye has the following provisions in the partnership agreement:
1. A partner earns 10% interest on the excess of his average capital over the other partner.
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2. Benito and Bunye are allowed annual salaries of P300,000 and P200,000 respectively.
3. Any remaining profit or loss is to be divided in the ratio of 70:30.
The average capital of Benito is P1,000,000 and that Bunye is P600,000.
Instructions: Prepare a profit distribution schedule assuming the profit of the partnership is (a)
P700,000; and (b) P400,000
Exercise 3-4 (Division of Profit under Various Assumptions)
Blanco and Banda formed a partnership by investing P120,000 and P180,000, respectively. At
the end of its first year of operations, the partnership has realized a profit of P120,000.
Instructions: Prepare a profit distribution of profit under each of the following independent
assumptions:
1.
The partnership agreement does not mention profit sharing.
2.
Profit is divided in the ratio of the original investments.
3.
Interest at 8% is to be allowed on the original capital investments and the balance to be
dividedequally.
4.
Salaries of P54,000 and P45,000 respectively and the balance to be divided equally.
5.
Interest at 10% is to be allowed on the original capital investments, salaries of P50,000
and
P75,000 to partners, respectively and the balance to be divided in the ratio 2:3. In case of
insufficient net income, however, this has to be distributed in the salary ratio. While if
there is a
net loss, then it has to be distributed equally.
Exercise 3-5 (Division of Profit; Interest on Capital and Salaries to Partners)
Bueno and Beran have capital balances at the beginning of the year of P600,000 and P675,000,
respectively. They share profit as follows:
1. Interest of 8% on beginning capital balances
2. Salary allowances of P225,000 to Bueno and P115,000 to Beran
3. Balance in the ratio of 3:2
The partnership realized a profit of P375,000 during the current year before interest and salary
allowances to partners
119
Instructions:
1.
Show how the profit of P375,000 should be divided between Bueno and Berna.
2.
Assuming that Bueno and Beran simply agree to share a profit in 3:2 ratio with a
minimum of P175,000 guaranteed to Beran, show how the profit of P375,000 should be
divided.
Exercise 3-6 (Divisions of Profit; Interest on Capital, Salary Allowance, and Bonus to
Managing Partner)
Belen and Blanco formed a partnership on January 2, 2014 and agreed to share profit 90% and
10% respectively, Belen invested cash of P200,000. Basco invested to assets but has a
specialized expertise and manages the firm full time. There were no withdrawals during the year.
The partnership contract provides for the following:
1. Capital accounts are to be credited annually with interest at 10% of beginning capital
2. Basco is to be paid a salary of P8,000 a month.
3. Basco is to reveive a bonus of 25% of profit calculated before deduction of salary and
interest on capital accounts.
4. Bonus, interest, and basco’s salary are to be considered as expenses.
The fiscal year 2014 income statement for the partnership includes the following:
Revenue
Expenses (including salary, interest and bonus)
Profit
P701,000
P379,000
P322,000
Instructions: Determine the amount of bonus to be collected to Basco.
Exercis 3-7 (Calculation of Bonus)
Banzon is the managing partner of Power Partnership. He is given an incentive of 5% bonus on
profit The profit of the paretnership is P650,000 and income tax rate is 30%.
Instructions: Determine the amount of bonus under each of the following assumptions:
1.
Bonus is computed based on the profit before deduction for bonus and income tax.
2.
Bonus is computed based on profit after deduction for bonus but before deduction for
income tax.
3.
Bonus is computed based on profit before deduction for bonus but after deduction for
income tax.
4.
Bonus is computed based on profit after deduction for both bonus and income tax.
Exercise 3-8 (Capital Balances Ratio Adjusted to Profit and Loss Ratio)
Balbin, Bagtas, and Banta are partners sharing 40%, 35%, and 25%. Partners’ Ooriginal capital
were in this ratio but on June 30, 2014, capital balances are as follows: Balbin – P240,000,
120
Bagtas – P 200,000, and Banta – P200,000. Partners want to bring capital balances into profit
and loss ratio.
Instructions:
1.
Assuming that the capital balances are to be brought into profit and loss ratio by the
payments
outside the firms among partners, the total firm capital to remain the same, what
cash transfers are required between or among partners and what entry would be made on the
firm books?
2
Assuming that the capital balances are to be brought into profit and loss ratio by the
lowest possible cash investment in the firm by the partners, what additional investments are
required
and what entry would be made by the firm books?
3.
Assuming that the capital balances are to be brought into profit and loss ratio by the
lowest possible cash investment or cash withdrawal from the firms by the partners, what
additional
cash investments or cash withdrawals are required and what entry would be made
by the firm
books?
Exercise 3-9 (Computation of Partnership Profit)
Barte, a partner in the BBB Partnership, has a 25% participation in profit. Barte’s capital account
had a net decrease of P240,000 during the year of 2014. During 2014, Barte withdrew P520,000
(charged against his capital account) and invested in the partnership a property with a fair value
of P100,000.
Instructions: Determine the profit of the BBB Partnership for the year 2014.
121
PROBLEMS
Problem 3-1 (Division of Profit under Various Assumptions)
The capital accounts of Bondoc and Barba at the end of the fiscal year 2014 are as follows:
Bondoc, Capital
January 1
May 1
October1
Balance
Investment
Withdrawal
P60,000
Barba, Capital
January 1
April 1
Balance
Withdrawal
P30,000
P210,000
90,000
P150,000
The partnership profit for the year ended December 31, 2014 is P300,000.
Instructions: Give the journal entries to record the transfer of profit to the capital accounts under
each of the following assumptions: (Show the procedure used in calculating the respective
amounts as an explanation for each entry.)
1.
Profit is divided 60% to Bondoc and 40% to Barba.
2.
Profit is divided in the ratio of capital balances at the beginning of the period.
3.
Profit is divided in the ratio of average capital.
4.
Interest at 8% is allowed on average capital and the balance of the profit is divided
equally.
5.
Salaries of P60,000 and P48,000 are allowed to Bondoc and Barba, respectively, and the
balance
of profit is divided in the ratio of capital balance at the end of the period.
6.
Bondoc is allowed a bonus of 33 1/3% of profit after bonus, and the balance of the profit
is divided in the ratio of the average capital.
Problem 3-2 (Division of Profit under Various Assumptions)
Bernal and Burgos formed a partnership on January 1, 2014. The changes in their respective
capital balancesduring the year ended December 31, 2014 are presented on the next page During
the year, the partnership earned a profit of P350,000.
Bernal, Capital
10/31
60,000
1/1
360,000
440,000
5/31
100,000
6/30
Burgos, Capital
80,000
1/1
10/31
140,000
Instructions: Prepare the entry to record the allocation of the partnership profit to individual
capital accounts under each of the following assumptions.
1. Each partner, receives 8% interest on beginning-of-the-year capital balance and the remainder
is divided between Bernal and But, in the ratio of 3:1, respectively.
122
2. Bernal and Burgos are given annual salaries of P70,000 and P130,000, respectively. 12%
interest on the end-of-year capital balances, and the remainder is divided equally.
3. Bernal and Burgos are given salaries of P45,000 and P85,000, respectively, 12% interst on
average capital balances, and the remainder divided in the ratio of 3:1.
4. Bernal and Burgos are given salaries of P50,000 and P100,000, respectively. 10% interest on
average capital balances, and the remainder divided 40% to Bernal and 60,to Burgos.
5. Each partner receives 8% interest on beginning of-the-year capital balances and a salary of
P50,000, Bernal receives a bonus of 10% of profit after deducting interest and salaries, and the
remainder is divided in the ratio of 2:3.
Problem 3-3 (Division of Profit and Loss; Interest on Average Capital, Salaries to Partners,
and Bonus to the Managing Partner)
The partners of BBB Partnership are Bilbao, Bertol and Borja. During the current year, their
average capital balances are as follows;
Bilbao
Bertol
Borja
P560,000
P400,000
P240,000
The partnership agreement provides that partners shall receive:
1. Annual allowance of 6% of their average capital balances.
2. Salary allowance as follows: Bilbao-none; Bertol - P96,000; Boija - P80.000.
3. Berta who manages the business, is to receive a bonus of 25% of profit in excess ofP144,000
after partners' interest and salary allowances.
4. Residual profit will be divided in the ratio of 5:3:2.
Instructions: Prepare separate schedules showing how profit and loss will be divided among the
three partners under each of the following independent cases. The amount given in each case is
the profit or loss for the year that is available for distribution to partners.
1.
P50,000 loss
2.
P120,000 profit
3.
P500,000
Problem 3-4 (Division of Profit and Loss; Interest on Capital and Salaries and Bonus to
Partners)
Basa, Benito, Beltran and Bagnes own a publishing company which they operate as a
partnership. The partnership agreement includes the following:


Basa receives a salary of P400,000 and a bonus of 3% of income after all bonuses;
Benito receives a salary of P200,000 and a bonus of 2%of income after all bonuses;
123

All partners are to receive a 10% interest on their average capital balances. The average
capital balances are as follows: Basa – P100,000; Benito – P900,000; Beltran – P400,000
; Bagnes – P940,000
 Any remaining profits are to be divided equally among the partners.
Instructions:
1.
Determine how a profit of P2,100,000 would be allocated among the partners.
2.
Determine how a loss of P800,000 would be allocated among the partners.
3.
Determine how a profit P800,000 would be allocated among the partners assuming the
following priority system: Income should be allocated by first giving priority to interest
invested capital, then bonuses, then salary, and then according to the profit and loss
percentages.
on
Problem 3-5 (Division of Profit and Loss; Interest on Capital and Salaries and Bonus to a
Partner)
The condensed income statement of Balte and Bala as of December 31, 2014 follows:
Sales
Cost of sales
Gross profit
Operating expenses
Profit before taxes
Income tax (P1,700,000x30%)
Profit
P4,800,000
2,100,000
P2,700,000
1,000,000
P1,700,000
510,000
P1,190,000
The profit and loss agreement specifies that:
1.
Interest of 8% is allowed on capital balances. Capital balances is P500,000 and
P300,000, respectively, while withdrawals debited to drawing accounts during the
year are P60,000 and P100,000, respectively.
2.
Salary allowance to Balte and Bala are P120,000 and P80,000 respectively.
3.
A bonus is given to Balte equal to 20% of profit without regard to interest and
salary.
4.
Remaining profits and losses are to be divided in the ratio of capital balances.
124
Instructions:
1.
Prepare a schedule showing the distribution of profit to partners.
2.
Prepare the journal entries required to distribute profit and to close the books of
partnership.
3.
Prepare a statement of changes in partners’ equity.
Problem 3-6 (Computation of Profit; Division of Profit; Ending Capital Balance)
Brenda and Brosas entered into a partnership on May 1, 2014, investing P625,000 and P375,000,
respectively. It was agreed that Brenda, the managing partner, is to receive a salary of P150,000
per year and 10% of profit after adjustment for the salary, any remaining profit is to be divided in
the ratio of original capital. On December 31, 2014, account balances are as follows:
Debit
Accounts Payable
Accounts Receivable
Brenda, Capital
625,000
Brenda, Drawing
Brosas, Capital
375,000
Brosas, Drawing
Cash
Furniture and Fixtures
Operating Expenses
Purchases
Sales
Sales Returns and Allowance
Credit
300,000
335,000
150,000
710,000
225,000
300,000
980,000
1,525,000
25,000
125
Additional information as of December:
1. Inventories; merchandise, P305,000; supplies, P12,000
2. Prepaid taxes and insurance, P5,000
3. Accrued expenses, P17,500
4. Depreciation on furniture and fixtures, 20% per year.
Instructions:
1.
Determine the profit or loss of the partnership. Income tax rate is 30%.
2.
Prepare a schedule showing the distribution of partnership profit los loss.
3.
Determine the ending capital balances of the partners.
Problem 3-7 (Work Sheet; Financial Statements; Adjusting and Closing Entries)
The account balances in the books of Be on Top Partnership at the end of its first year of
operations on December 31, 2014 are as follows:
Accounts Payable
Accounts Receivable
Bathan, Capital
Bathan, Drawing
Buenas, Capital
Buenas, Drawing
Cash
General Expenses – Others
Interest Expense
Interest Income
Notes Payable
Notes Receivable
Purchases
Purchases Discount
Purchases Returns and Allowance
Sales
Sales Salaries
Store Furniture
Store Supplies
Taxes
756,000
186,000
600,000
144,000
489,000
54,000
582,750
756,000
26,000
21,000
360,000
120,000
4,920,000
138,000
99,000
5,100,000
480,000
222,000
36,000
36,000
126
As the person in-charge of the preparation of financial statements, you gathered the following
data that require adjustments as of December 31, 2014 and the information relating to division of
partnership profit or loss:
1. Inventories: merchandise, P1,406,000; supplies, P16,500.
2. Depreciation of store furniture, 10% a year. Additions to store furniture were made on
March 1 costing P54,000.
3. Accrued advertising, P9,500.
4. Prepaid taxes, P10,000
5. Accrued taxes, P10,500
6. Accrued interest on notes payable, P3,750
7. Accrued interest on notes receivable, P6,000
8. Uncollectible accounts receivable, P9,300
9. Income taxes, 30%
10. Bathan and Buenas agree to divide earnings as follows:
a. Interest at 10% on beginning capital balances
b. Salaries to the managing partner Bathan of P100,000
c. Remaining profit or loss to be divided equally
Instructions:
1. Prepare a ten-column worksheet.
2. Prepare an income statement, a statement of changes in partners' equity, and a statement
of financial position.
3. Prepare the adjusting and closing entries as of December 31, 2014.
Problem 3-8 (Statement of Changes in Partners' Equity)
Bacani, Badeo, and Barte formed a partnership on January 1, 2012, investing P1,000,000,
P500,000, and P400,000, respectively. The partners agree to the following distribution of profits:
1. Annual salaries are to be allowed to partners as follows:
Bacani- P96,000
Badeo- P120,000
Barte- P120,000
2. Interest is to be allowed on partners' capital as of the beginning of each year at the rate of
6%.
3. Bacani, the managing partner, is to be allowed a bonus of 20% of profit after treating as
expenses the partners' salaries, interest and bonus.
4. Profits and losses after partners' salaries, interest and bonus are to be divided equally.
The partnership fiscal year is the calendar year. Activities of the partnership for 2012, 2013 and
2014 are summarized below:
2012
Profit or loss before interest, salaries
And bonus
(P42,000)
2013
P300,192
2014
P470,000
127
Cash withdrawals:
Bacani
Badeo
Barte
P72,000
86,800
96,000
P139,600
163,200
177,200
P163,200
195,200
169,600
Instructions: Prepare a statement of changes in partners' equity covering the three-year period
ending December 31, 2014.
Problem 3-9 (Correction of Partnership Profit)
Balmes, Bambam, and Buela are partners sharing profits on a 5:3:2 ratio. On January 1, 2014,
Baguio was admitted into the partnership with a 20% share in the profits. The old partners
continue to participate in profits proportionate to their original ratios.
For the year 2014, the partnership books showed profit of P400,000. It was disclosed, however,
that the following errors were made.
2013
Accrued expenses not recorded at year-end
Inventory overstatement
Purchases not recorded, for which goods have been
received and included in the inventory
Income received in advance not adjusted
Unused supplies not taken up at year-end
2014
P24,000
P62,000
40,000
30,000
18,000
Instructions:
1. Determine the new profit and loss ratio of the old partners.
2. Prepare a schedule showing the division of the corrected partnership profit to the
partners.
MULTIPLE CHOICE
MC 3-1
MC 3-2
Banayo and his very close friend Buendia formed a partnership on January 1,
2014 with Banayo contributing P160,000 cash and Buendia contributing
equipment with a book value of P64,000 and a fair value of P48,000, and
inventory items w th a book value of P24,000 and a fair value of P32,000. During
2014, Buendia made additional investment of P16,000 on April 1, and P16,000 on
June 1. On September 1, he withdrew P40,000. Banayo had no additional
investment nor withdrawals during the year. The average capital balance of
Buendia at the end of the fiscal year 2014 is
a. P72,000
c. P88,000
b. P80,000
d. P96,000
Bañas and Belda are partners who share profits equally and losses in a 2:1 ratio. If
they have beginning capital balances of P120,000 and P118,000, made no
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additional investments nor withdrawals, and suffered an unprofitable year with
loss of P48,000, their capital balances will be:
Bañas
a. P40,000
MC 3-3
b.
88,000
102,000
c.
120,000
118,000
d.
152,000
134,000
Bernardo and Belo formed a partnership in the year 2014. The partnership
agreement provides for annual salary allowances of P110,000 for Bernardo and
P90,000 for Belo. The partners share profits equally and losses in a 60:40 ratio.
The partnership had a profit of P180,000 for the year 2014 before any allowance
to partners. What amount should be credited to each partner's capital account as a
result of the distribution of the partnership profit?
Bernardo
a. P98,000
MC 3-4
Belda
P80,000
Belo
P82,000
b.
100,000
80,000
c.
96,000
84,000
d.
90,000
90,000
Bunag, Belen, and Bustos are partners in an accounting firm. Their capital
account balances at year-end were P180,000, P220,000, and P100,000,
respectively. They share profits and losses on a 4:4:2 ratio, after considering the
following terms.
a. Bustos is to receive a bonus of 10% of profit after bonus.
b. Interest of 10% shall be paid on that portion of a partner's capital in excess of
P200,000.
c. Salaries of P20,000 and P24,000 shall be paid to partners Bunag and Bustos,
respectively.
Assuming a profit of P220,000 for the year, the total profit share of Bustos is
MC 3-5
a. P38,800
c. P54,800
b. P50,800
d. P74,800
Banta, Berba, and Borja formed a partnership on January 1, 2014. They had the
following initial investments: Banta- P200,000; Berba- P300,000; BorjaP450,000. The partnership agreement states that profits and losses are to be shared
equally by the partners after consideration is made for the following:
a. Salary allowance of P120,000 for Banta, P96,000 for Berba and P72,000 for
Borja.
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b. Average partners' capital balances during the year shall be allowed 10%
interest.
Additional information:
a. On June 30, 2014, Banta invested an additional P120,000.
b. Borja withdrew P140,000 from the partnership on September 30, 2014.
c. Share on the remaining partnership profit was P10,000 for each partner.
How much is the total interest on average capital balances of the partners?
MC 3-6
MC 3-7
MC 3-8
a. P95,000
c. P107,500
b. P97,500
d. P115,250
Using the information in MC 3-5, partnership profit at December 31, 2014 before
salaries, interest and partners' share on the remainder is
a. P395,500
c. P415,500
b. P399,500
d. P423,250
Using the information in MC 3-5, the total partnership capital on December 31,
2014 is
a. P950,000
c. P1,345,500
b. P970,000
d. P1,365,500
On January 1, 2014, Besa, Basco, Buan, and Baduel formed the B4 TRADING, a
partnership with capital contributions as follows: Besa- P150,000; BascoP75,000; and Baduel- P60,000. The partnership agreement stipulates that each
partner shall receive a 5% interest on capital contributed and that Besa and Basco
shall receive salaries (chargeable as expenses of the business) of P15,000 and
P9,000, respectively. The agreement further provides that Buan shall receive a
minimum of P7,500 per annum and Baduel a minimum of P18,000, which is
inclusive of amounts representing interest and their respective share in partnership
profits. The balance of the profits shall be distributed among the partners in the
ratio of 3:3:2:2.
What amount must be earned by the partnership in fiscal year 2014, before any
charge for interest and partners' salaries, in order that Besa may receive an
aggregate of P37,500 including interest, salary, and share of profits?
MC 3-9
a. P92,000
c. P50,000
b. P97,000
d. P90,000
Using the information in MC 3-8, the total profit share of Buan is
MC 3-10
a. P7,500
c. P19,400
b. P13,750
d. P37,500
Using the information in MC 3-8, the total profit share of Baduel is
MC 3-11
a. P13,000
c. P18,000
b. P13,500
d. P19,400
The partnership agreement between Banaria and Bertol stipulates that Banaria is
to receive a 20% bonus on profits before bonus with the residual profit and loss to
be appropriated in the ratio of 2:3, respectively. Which partner has greater
advantage when the partnership has a profit and when it incurs a loss?
Profit
Loss
Profit
Loss
130
MC 3-12
a. Bertol
Banaria
c. Banaria
Banaria
b. Banaria
Bertol
d. Bertol
Bertol
Bulan, Bustos, and Bucao formed a partnership on January 1, 2014 and
contributed P150,000, P200,000, and P250,000, respectively. The Articles of CoPartnership provide that the operating income be shared among the partners as
follows: As salary: Bulan- P24,000; Bustos- P18,000; Bucao- P12,000; interest of
12% on the average capital during 2014 of the three partners; the remainder will
be divided in the ratio of 2:4:4, respectively.
Additional information:
a. Operatinf income for the year ended December 31, 2014 is P180,000.
b. Bulan contributed additional capital of P30,000 on July 1, and made drawing
of P10,000 on October 1.
c. Bustos contributed capital of P20,000 on August 1 and made withdrawal of
P10,000 on October 1.
d. Bucao made withdrawal of P30,000 on November 1.
The division of the P180,000 operating income is
MC 3-13
MC 3-14
Bulan
Bustos
Bucao
a.
P53,760
P65,520
P59,720
b.
P35,200
P70,400
P70,400
c.
P53,980
P63,660
P62,360
d.
P53,180
P62,060
P60,760
Using the information in MC 3-12, the partners' capital balances on December 31,
2014 are
Bulan
Bustos
Bucao
a.
P223,980
P273,660
P282,360
b.
P179,760
P229,520
P239,520
c.
P189,860
P239,360
P269,360
d.
P223,180
P272,060
P280,760
Briones, Belen, and Burgos are partners with average capital balances during
2014 of P945,000, P477,300, and P324,700, respectively. The partners receive
10% interest on their average capital balances, salaries of P244,650 to Briones
and P165,250 to Burgos, any residual profit or loss is divided equally.
In 2014, the partnership had a net loss of P251,248 before the interest and salaries
to partners.
What is the change in the capital balances of Briones and Burgos?
a.
Briones
P81,688 decrease
Burgos
P62,474 decrease
b.
P56,716 increase
P64,916 increase
c.
P58,952 increase
P35,072 increase
d.
P60,534 increase
P80,896 decrease
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Test Material No. 10
Rating __________
Name ____________________________________________
Year and Section ___________________________________
Date _____________________
Professor __________________
TRUE or FALSE
Instructions: Encircle the letter T if the statement is correct and the letter F if the statement is
incorrect.
1. An adequate accounting system and an accurate measurement of income are
not needed by a partnership because the profit is divided among two or more
partners.
2. If the partners did not agree as to how profits are to be divided, then such
should be divided among the partners equally.
3. The income statement of a partnership differs from that of a single
proprietorship in only one respect: a final section is added to show the division of
the profit between or among partners.
4. Any salaries authorized for partners are regarded as a preliminary step in the
division of profits, not as an expense of the business
5. The statement of changes in partners’ equity takes the place of the capital
statement in a sole proprietorship.
6. All partnerships, just like corporations, are subject to income tax.
7. Bonus is allowed to partners only if there is a partnership profit, since bonus is
based on profit.
8. Unless otherwise agreed, allowance for salaries and interest are allowed to
partners whether there is a profit or a loss; whether the profit is sufficient or
insufficient.
9. All partners, whether capitalist or industrial, are to share on whatever
partnership profits or losses.
10. The drawing account of a partner may have a debit or a credit balance.
11. The profit of the partnership is transferred to the drawing accounts of the
partners if the intention is to keep the capital account intact for investments and
permanent withdrawals of capital.
12. A credit balance in the Income Summary account represents profit after
closing into it all the operating (nominal) accounts.
132
13. If the partnership agreement specifies a method for sharing profits, but not
losses, then losses are shared in the same proportion as profits.
14. Allowance for salaries and interest in a partnership agreement are methods of
allocating profits and losses to the partners.
15. The percentage interest in a partnership is always the same as the profitsharing ratio.
16. Profits and losses, in general, shall be divided in accordance with the
agreement among the partners.
17. Partners may intend for salary and interest allowances to be deducted in
determining the base for computing bonus. In such a case, no bonus is allowed if
there is insufficient profit after distribution of salaries and interests.
18. Salaries, interests and bonuses allowed to partners as distribution of
partnership profits are treated as partnership expenses.
19. The partnership books may show an incorrect profit because of errors and
omissions that should first be corrected before the profit distribution to the
partners.
20. In the absence of an agreement, the capitalist-industrial partner in hicharacter
as industrial partner shall have no share in the losses, but in his character as a
capitalist partner will share in proportion to his capital contribution.
133
Test Material No. 11
Rating __________
Name ____________________________________________
Year and Section ___________________________________
Date _____________________
Professor __________________
MATCHING TYPE
Choices:
A. Arbitrary ratio
J. Interest on investment
B. Average capital
K. Multiple bases of profit allocation
C. Beginning capital
L. Original capital
D. Bonus
M. Partners’ salaries
E. Capital account
N. Partnership profits
F. Capital ratio
O. Profit and loss ratio
G. Distribution of profit
P. Statement of changes in partners’ equity
H. Drawing account
Q. Worksheet
I. Income Summary
Instructions: Write the letter that corresponds to your choice.
___________ 1. Capital contributions of the partners at the commencement of the partnership.
___________ 2. A method of dividing profits which uses as basis the amount of capital invested
and the time during which such capital are actually used by the business.
___________ 3. A partnership agreement that provides for a combination of several allocation
procedures to be used in the distribution of profit.
___________ 4. To compensate for the difference in their capital contributions, partners are
allowed this item.
___________ 5. The compensation given to partners for the ability and time devoted to the
business.
___________ 6. An incentive given to the managing partner which is usually a percentage of net
income.
___________ 7. The account debited for partners’ permanent withdrawals of capital.
134
___________ 8. A ratio expressed in fraction or percentage which has no relation to the amount
of capital investment of the partners.
___________ 9. The basis or ratio in which the profits or losses are shared by the partners.
___________ 10. The entire return from the business to the partners for their time, skill, and
capital.
___________ 11. A basic financial statement which gives effect to the changes in capital
balances of the partners during a specific period.
___________ 12. A permanent part of a partnership income statement not found in that of a sole
proprietorship.
___________ 13. A temporary account used to summarize the various revenue and expenses,
the balance of which may represent profit or loss.
___________ 14. This is prepared in order to classify accounting data in a convenient and
orderly manner and facilitate the preparation of financial statements.
___________ 15. Balances in the capital accounts of partners at the start of each accounting
period.
135
Test Material No. 12
Rating ___________
Name_________________________________
Year and Section________________________
Date__________________________________
Professor______________________________
MULTIPLE CHOICE - Theory and Problems
Instructions: Encircle the letter of the best answer in good form in a separate work sheet.
Present supporting computations
1. If the partners have not drawn up any agreement, then they must share profits and losses
a. equally
b. by any means that will save taxes
c. by any appropriate ratio
d. according to capital contributions
2. Among the various options available for determining the partners' share of profit are the
following except:
a. capital contributions and service to the partnership
b. loans to the partnership
c. capital contributions
d. stated fraction or ratio
3. Partners Barona and Basilio share income in a 2:1 ratio, respectively Each partner receives an
annual salary allowance of P72,000. If the salaries are recorded in the accounts of the
partnership as an expense rather than treated as an allocation of profit, the total amount
allocated to each partner for salaries and profit would be
a. less for both Barona and Basilio
b. unchanged for both Barona and Basilio
c. more for Barona and less for Basilio
d. more for Basilio and less for Barona
4. Partners Bagobo and Bicomo share profit and loss equally after each has been credited with
annual salary allowances of P90,000 and P72,000, respectively Under this arrangement.
Bagobo will benefit by P18,000 more than Bicomo in which of the following circumstances?
a. Only if the partnership has profit of P162,000 or more for the year
b. Only if the partnership does not incur a loss for the year
c. In all profit or loss situation
d. Only if the partnership has profit of at least P18,000 for the year
5. The BB Tours Partnership earned P500,000 this year. The partners have equal capital
balances, and share profits and losses 1:3. The partners will show share in partnership profit
of
136
a.
b.
c.
d.
P250,000 each
P250,000 and P750,000, respectively
P125,000 and P375,000, respectively
P500,000 each
6. Beltran and Barba are partners who share profits equally and losses in a 2:1 ratio. Beltran and
Barba have beginning capital balances of P400.000 and P500,000 respectively, and made no
withdrawals during a period of two years. After a profitable operations on the first year with
a profit of P400,000 and an unprofitable operations on the second year with a loss of
P240,000, the capital balances of Beltran and Barba will be
Beltran
Barba
Beltran
Barba
a. P480,000
P580,000
c. P440,000 P620,000
b. P390,000
P570,000
d. P670,000 P770,000
7. Bamba and Balbina share profits and losses in the ratio of 1:2. Bamba receives a monthly
salary of P150,000. If Bamba's capital balance is P2,500,000 at the beginning of the year and
P2,000,000 at the end of the year, and annual partnership profit after salaries is P1.200.000,
then Bamba withdrew
a. P 500,000
c. P2,700,000
b. P1,300,000
d. P3,200,000
8. The BBB Company is a partnership of three musicians who play at weddings and office
parties. The partnership's profits and losses are allocated in proportion to the partners' capital
contributions. If the partners Bamboo, Banda, and Banjo have capital contributions of
P300,000, P300,000, and P500,000, respectively, what is each partner's share in the profit of
P1,100,000?
Bamboo
Banda
Banjo
a. P300,000
P300,000
P600,000
b. P300,000
P300,000
P500,000
c. P300,000
P500,000
P1,100,000
d. P366,667
P366,667
P366,667
9. Banzon and Borja are partners in B and B Enterprises. Partnership profits and losses are
allocated as follows: salaries of P160,000 and P200,000 to Banzon and Borja, respectively;
10% interest on their beginning capital balances, any remaining profit is divided equally. At
the beginning of the year, their capital balances are P360,000 and P600,000. How will the
partnership profit of P600,000 be allocated to the two partners?
Banzon
Borja
Banzon
Borja
a. P192,000
P408,000
c. P300,000 P300,000
b. P268,000
P332,000
d. P280,000 P320,000
10. Bautista, a partner in the Christian Partnership has a 20% participation in the partnership
profit and loss. Bautista's capital account had a net decrease of P240,000 during the calendar
year 2014. During 2014, Bautista withdrew P520,000 (charged against his capital account)
and contributed property valued at P100,000 to the partnership. What was the profit of the
partnership?
a. P600,000
c. P1,400,000
b. P900,000
d. P2,200,000
137
11. The partnership agreement of Bustos and Balen provides that interest at 12% per year is to be
credited to each partner on the basis of average capital balances. A summary of Balen's
capital account for the year ended December 31, 2014 is as follows:
Balance, January 1
P840,000
Additional investment, July 1
240,000
Withdrawal, August 1
90,000
Balance, December 31
990,000
What amount of interest should be credited to Balen's capital account for 2014?
a. P91,500
b. P92,500
c. P99,000
d. P110,700
12. Basilio and Bituin formed a partnership in the year 2014. The partnership agreement provides
for annual salary allowances of P220,000 for Basilio and P180,000 for Bituin. The partners
share profits equally and losses in a 60:40 ratio. The partnership had a profit of P360,000 for
the year 2014 before any allowance to partners. What amount should be credited to each
partner's capital account as a result of the distribution of the partnership profit?
Basilio
Bituin
Basilio
Bituin
a. P180,000
P180,000
c. P196,000 P164,000
b. P192,000
P168,000
d. P200,000 P160,000
13. Bucao, Basco, and Blanco share profits and losses in the ratio of 2:3:5, respectively. Their
partnership realized a profit of P900,000 during the year. Bucao, with a beginning capital
balance of P1,000,000 withdrew P200,000 during the year. Bucao's ending capital balance is
a. P980,000
c. P1,160,000
b. P1,000,000
d. P1,380,000
14. The B2 Partnership was formed on January 3, 2014. Under the partnership agreement, each
partner has an equal initial capital balance accounted for under the bonus method Partnership
profit or loss is allocated 60% to Brecia and 40% to Buan. To form the partnership, Brecia
originally contributed assets costing P300,000 with a fair value of P600,000 on January 3,
2014, while Buan contributed P200,000 in cash. Withdrawals by the partners during the
fiscal 2014 totaled P30,000 by Brecia and P90,000 by Buan. The partnership profit for fiscal
year 2014 was P450,000. Buan's initial capital balance in the partnership is
a. P200,000
c. P400,000
b. P250,000
d. P600,000
15. Using the information in No. 14, what is the ending capital of Brecia at December 31, 2014?
a. P550,000
c. P840,000
b. P640,000
d. P870,000
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Test Material No. 13
Rating ___________
Name_________________________________
Year and Section________________________
Date__________________________________
Professor______________________________
PROBLEMS
Problem A
The partnership of Beltran, Bernal, and Basco was formed on January 1, 2014. The original cash
investments were as follows:
Beltran
Bernal
Basco
P384,000
576,000
864,000
According to the partnership contract, profit or loss will be divided among the partners as
follows:
1.
Salaries of P57,600 for Beltran, P48,000 for Bernal and P38,400 for Basco.
2.
Interest of 8% on average capital balances during the year.
3.
Remaining profit will be divided equally
The profit of the partnership for the year ended December 31, 2014 was P450,000. Beltran
invested an additional P96,000 in the partnership on July I, 2014. Basco withdrew P144,000
from the partnership on October 1, 2014; and Beltran, Bernal, and Basco made regular drawings
of P48,000 each against their share of profit during the calendar year 2014
Instructions:
1.
2.
Prepare a schedule showing the division of profit among the three partners.
Prepare a statement of changes in partners’ equity for the year 2014
Problem B
Several years ago, Bilbao and Bragas formed Double B Partnership. The partnership agreement
states that each partner is to receive a salary of P20,000 per month and 5% interest on beginning
capital balances; any remainder would be divided between Bilbao and Bragas in the ratio of 2:3,
respectively. The unadjusted trial balance of the partnership as of December 31, 2014 is
presented below.
DEBITS
Cash
Accounts receivable
Merchandise Inventory, Jan.1
Furniture and Fixtures (net)
Building (net)
CREDITS
1,000,000
600,000
800,000
300,000
600,000
Accounts payable
Notes payable
Bilbao, capital
Bragas, capital
Sales
700,000
400,000
1,500,000
1,240,000
1,800,000
139
Bilbao, drawing
Bragas, drawing
Purchases
Operating expenses
200,000
240,000
1,200,000
300,000
Additional information:
1.
2.
The merchandise inventory on December 31, was P1,050,000.
Depreciation on furniture and fixtures and building is 10% and 5% of net values,
respectively
3.
On July 1, 2014, the partnership recorded a P200,000 additional capital contribution by
Bilbao. Bragas made no additional capital contributions during the year.
4.
Income tax rate is 30%.
Instructions:
1.
2.
3.
4.
Prepare the partnership statement of income for the year ended December 31, 2014.
Prepare a schedule showing the allocation of partnership profit or loss and prepare the
entry to record the partners' share in the profit (to be recorded directly in the partners'
capital accounts).
Prepare the entry to close the partners' drawing accounts as of December 31, 2014.
Prepare a statement of changes in partners' equity for the year ended December 31,
2014
140
CHAPTER 4
PARTNERSHIP DISSOLUTION
LEARNING OBJECTIVES
1.
2.
3.
Define partnership dissolution and identify the conditions giving rise to it.
Understand the accounting procedures to record the admission of a new partner by purchase.
Understand the accounting procedures to record the admission of a new partner by
investment.
PREVIEW OF THE CHAPTER
PARTNERSHIP
DISSOLUTION
Causes of Dissolution
 Admission of a new
partner
 Retirement of a
partner
 Death, incapacity, or
bankruptcy of a
partner
 Incorporation of a
partnership
Admission by Purchase
Admission by Investment
 Sale of interest at
book value
 Sale of interest at less
than book value
 Sale of interest at
more than book value
 Capital credit equal to
capital contribution
 Capital credit not
equal to capital
contribution
 Bonus method
 Asset revaluation
method
PARTNERSHIP DISSOLUTION
Dissolution is defined in Article 1825 of the Civil Code of the Philippines as the change in the
relation of the partners caused by any partner ceasing to be associated in the carrying out of the
business.
Dissolution refers to the termination of the life of an existing partnership. The dissolution of an
old partnership may be followed by:
141
1. The formation of a new partnership. This is known as dissolution by change in
ownership structure. The new partnership continues the business activities of the
dissolved partnership without interruption.
2. Liquidation. This refers to the termination of the business activities carried on the
partnership and the winding up of partnership affairs preparatory to going out of business.
Dissolution, therefore, does not always result to liquidation although liquidation is always
preceded by dissolution
CONDITIONS RESULTING TO PARTNERSHIP DISSOLUTION
The following conditions will result to partnership dissolution by a change in ownership
structure:
1.
Admission of a new partner
2.
Retirement or withdrawal of a partner
3.
Death, incapacity or bankruptcy of a partner
4.
Incorporation of a partnership
Accounting for admission of a new partner is discussed in this chapter. Accounting for
retirement, withdrawal, incapacity or bankruptcy and death of a partner is discussed in the next
chapter
ADMISSION OF A NEW PARTNER
A new partner, with the consent of all the partners, may be admitted in an existing partnership.
Upon admission of a new partner, the firm is automatically dissolved and a new partnership is
formed. All the partners draw a new contract, Articles of Co-Partnership. The admission of a
new partner gives rise to the following accounting problems:
1. Determination of the profit or loss from the beginning of the accounting period to the
date of admission of a new partner and the distribution of such profit or loss to the old
partners.
2. Connection of accounting errors in prior periods like overstatement of understatement of
inventories, excessive depreciation charges and failure to provide adequately for doubtful
accounts.
3. Revaluation of accounts which may call for the restatement of the existing assets of the
partnership to appraised or fair market values and recognition of unrecorded liabilities of
the firm. All adjustments to the accounts give rise to profit or loss; such adjustments are
recorded in the partnership books as increase or decrease in capital shared according to
partners' profit and loss ratio,
4. Closing of the partnership books.
TYPES OF ADMISSION OF A NEW PARTNER
142
A new partner may be admitted into a partnership by:
1. Purchase of interest from one or more of the original (old) partners; or
2. Investment or asset contributions to the partnership
ADMISSION BY PURCHASE
With the consent of all the partners, a new partner may be admitted in an existing partnership by
purchasing a capital equity interest directly from one or more of the old partners. Terms such as
purchases, sells, pays, bought, sold and transferred indicate admission by purchase.
The sale to a new partner of an old partner's interest in an existing partnership is a personal
transaction between the selling partner and the buying partner. The amount paid by the partner
who purchases an interest goes personally to the partner who sells his or her interest; the amount
paid does not go to the partnership.
The only entry required on the partnership books is the recording of the transfer of capital from
the capital account of the selling partner to that of the buying partner. The amount of capital
transferred will be equal to the book value of the interest sold regardless of the amount paid. The
pro-form entry is:
(Name of seller), Capital
(Name of buyer), Capital
xxx
xxx
The purchase price of the interest sold to the new partner may be:
1. equal to the book value of interest sold
2. less than the book value of interest sold
3. more than the book value of interest sold
The new partner may pay more than or less than the book value of the interest sold by the old
partner resulting in a gain or loss in the transaction. This gain or loss, however, is a
personal gain or loss of the selling partner and not of the partnership. Therefore, no gain or loss
is recognized in the partnership books.
Illustrative Problem A: Coloma and Claudio are partners with capital balances of P100,000 and
P50,000, respectively. They share profits and losses equally. Cordero is a new partner.
Case 1a – Purchase at book value from one partner only. Cordero purchases a 1/5 interest
from Coloma by paying P20,000.
Coloma, Capital
Cordero, Capital
P100,000 X 1/5 = P20,000
20,000
20,000
143
The P20,000 paid by the new partner Cordero to the old partner Coloma should not be reflected
in the partnership books because the said amount goes directly to Coloma. What is recorded in
the partnership books is the transfer of 1/5 of the capital of Coloma to Cordero. The amount paid
in the purchase is equal to the book value of the acquired 1/5 interest; hence, the sale of interest
does not give rise to gain or loss to Coloma.
Case 1b – Purchase at book value from more than one partner. Cordero purchases 1/5
interest from the old partners by paying P30,000.
Coloma, Capital
Claudio, Capital
Cordero, Capital
P100,000 X 1/5 = P20,000
P 50,000 X 1/5 = P10,000
20,000
10,000
30,000
The P30,000 paid by Cordero to Coloma and Claudio should not be reflected in the partnership
books because the said amount goes directly to Coloma and Claudio. What is recorded in the
partnership books is the transfer of 1/5 of the capital of the old partners Coloma and Claudio
(P20,000 and P10,000, respectively) to the new partner Cordero. The admission of the new
partner, by purchasing a 1/5 interest from the old partners al book value, does not result in a gain
or loss to the old partners.
Case 2 - Purchase at less than book value. Cordero purchases 1/s interest from the old partners
by paying P25,000
Coloma, Capital
Claudio, Capital
Cordero, Capital
P100,000 X 1/5 = P20,000
P 50,000 X 1/5 = P10,000
20,000
10,000
30,000
144
The P25,000 paid by Cordero to Coloma and Claudio should not be reflected in the partnership
books because the said amount was paid directly to the partners. What is recorded in the
partnership books is the transfer of 1/5 of the capital of the old partners (20,000 and 10,000,
respectively) to the new partner. The difference of 5,000 is a personal loss of the selling (old)
partners.
Case 3 – Purchase at more than book value. Cordero pays P40,000 for a 1/5 interest of the old
partners.
Coloma, Capital
20,000
Claudio, Capital
10,000
Cordero, Capital
30,000
The P40,000 payment made by Cordero to Coloma and Claudio should not be reflected in the
partnership books. What is recorded in the books of the partnership is the transfer of 1/5 of the
capital of the old partners to the new partner. The 10,000 excess payment is a personal gain of
Coloma and Claudio.
Key Points. In the preceding four cases, 1a, 1b, 2, and 3, the transfer of capital from the old
partners to the new partner is recorded at book value regardless of the amount paid. Payment at
less than book value and at more than book value are recorded as if they were made at book
value.
In addition, the four cases show that the total partnership capital before and after the admission
of the new partner are the same. Thus, the total partnership capital of P150,000 before the
admission of Cordero is also the total partnership capital after his admission. Therefore, the
admission of a new partner by purchase will not affect the total assets and the total capital of the
partnership.
ASSET REVALUATION UPON ADMISSION OF A NEW PARTNER BY PURCHASE
Revaluation of assets of the old partnership, however, is generally undertaken prior to the
admission of a new partner. The effect of the asset revaluation is carried to the capital accounts
of the old partners. The adjusted capital of the old partners becomes the basis for the interest
transferred to the new partner.
The procedures under this approach are as follows:
Step 1 – Compute the new partnership capital using as basis the amount to be paid by the
incoming partner and his fraction if interest.
Step 2 – Deduct the capital of the old partnership from the capital of the new partnership. The
difference is the asset revaluation.
Step 3 – Allocate the asset revaluation among the old partners in accordance with their residual
profit and loss sharing agreement.
145
Step 4 – Add the share of each partner on the asset revaluation to their capital balances to get the
capital balances after the asset revaluation.
Step 5 – Compute the amount of interest transferred by the old partners to the new partner based
on their capital after the asset revaluation.
Step 6 – Prepare the entry to record the admission of the new partner.
To illustrate, assume the same data in Illustrative Problem A where Coloma and Claudio are
partners with capital balances of P100,000 and P50,000, respectively. They share profits and
losses equally. Cordero is a new partner who purchases a 1/5 interest from Coloma and Claudio
paying P40,000. However, before the admission of Cordero, partnership assets are to be revalued
using as basis the amount to be paid by Cordero.
Solution:
Step 1 – The new partnership capital is equal to the amount paid by the incoming partner divided
by his fraction of interest.
New partnership capital = 40,000 ÷ 1/5 = P200,000
Step 2 – The amount of asset revaluation is equal to the new partnership capital less old
partnership capital.
Asset revaluation = 200,000 – 150,000 = 50,000
Step 3 – The allocation of the amount of the asset revaluation among the old partner is as
follows: P50,000 / 2 = P25,000 per partner.
Step 4 – The capital balances of the old partners after asset revaluation is equal to their old
capital balances plus their share on asset revaluation.
Capital balances before revaluation
Share on asset revaluation
Capital balances after revaluation
Coloma
Claudio
P100,000
P50,000
25,000
25,000
P125,000
P75,000
Step 5 – The amount of interest transferred by the old partners to the new partner is based on the
new capital balances (capital balances after asset revaluation).
Capital balances after revaluation
Interest transferred
Capital transferred to Cordero
Coloma
Claudio
P125,000
P75,000
1/5
1/5
P 25,000
P15,000
146
Step 6 - The journal entries to record the revaluation of asset and the admission of Cordero are as
follows:
Other Assets
50,000
Coloma, Capital
25,000
Claudio, Capital
25,000
Coloma, Capital
Claudio, Capital
25,000
15,000
Cordero, Capital
40,000
Capital balances after the admission of Cordero shall be:
Cordero
P100,000 + P25,000 - P25,000
Claudio
P50,000 + P25,000 - P15,000
Cordero
P100,000
60,000
40,000
ADMISSION BY INVESTMENT
The admission of a new partner by investment is a transaction between the original partnership
and the new partner. The use of the terms like invests and contributes represent admission of a
new partner by investment. The investment of the new partner increases the total assets and the
total capital of the partnership. The entry to record the admission of the new partner depends
upon the capital interest credited to the partners’ accounts.
DEFINITION OF TERMS
Agreed Capital (AC) - it is the amount of new capital set by the partners for the partnership. It
may be equal to, more than, or less than the total contributions of the partners. Other terms used
for agreed capital are: new firm capital, total capital and agreed capitalization. The terms of the
admission of a new partner may indicate the agreed capital. If agreed capital is not indicated, it
can be computed in either of two ways:
1. Investment of the new partner divided by the new partner's fraction of interest; or
2. Investment of the old partners (equal to the net assets or capital of the partnership) divided by
the old partners' fraction of interest.
Example: Corpus and Carlos are partners with capital balances of P150,000 each. Cabral invests
P100,000 for a 2/5 interest in the new partnership. The agreed capital of the new partnership is
determined as follows:
Computation 1 - The new partner's investment used as a basis
P100,000 ÷ 2/5 = P250,000
Computation 2 - The old partners' investment used as a basis
P300,000 ÷ 3/5 = P500,000
147
Total Contributed Capital (CC) – it is the investment of all the partners, both old and new, to
the partnership. It is the sum of the capital balances of the old partners (net asset investment) and
the contribution of the new partner.
Using the information in the example given, the total contributed capital is P400,000, the sum of
the old partners' contribution of P300,000 and the new partner's contribution of P100,000.
Bonus – it is the transfer of capital from one partner to another. A bonus to the old partners is
given by the new partner. It is a reduction in the capital of the new partner and an increase in the
capital of the old partners. The capital accounts of the old partners are credited according to their
profit and loss ratio. A bonus to the new partner is given by the old partners. It is a reduction in
the capital of the old partners and an increase in the capital of the new partner. The capital
accounts of the old partners are debited according to their profit and loss ratio.
The following procedures will be helpful in the computation and determination of the ownership
of bonus:
1. Multiply agreed capital (AC) by the fraction of interest of the new partner. The result is the
capital credit of the new partner in the new partnership.
2. Compare the capital credit with the investment of the new partner.
a. If the capital credit is more than the investment of the new partner, the difference is
bonus to the new partner.
b. If the capital credit is less than the investment of the new partner, the difference is
bonus to the old partners.
Asset Revaluation - necessary adjustment in asset values upon admission of a new partner. The
adjustment in assets may be determined as the difference between the agreed capital and the total
contributed capital. Generally, asset revaluations upon partnership formation relate only to the
partners of the old partnership.
Capital Credit- it is the interest or equity of a partner in the firm. It is computed by multiplying
agreed capital by the fraction of interest of a partner.
PROBLEMS RELATING TO ADMISSION OF A NEW PARTNER BY INVESTMENT
Situations relating to admission of a new partner by investment may fall under any of the
following:
148
1. Agreed capital is given. When agreed capital is given, the admission of a new partner by
investment will give rise to any of the following cases:
a. No Bonus, no Asset Revaluation
b. Bonus to old partners, no Asset Revaluation
c. Bonus to new partner, no Asset Revaluation
d. Asset Revaluation, no Bonus
2. Agreed capital is not given. When agreed capital is not given, the problem calls for two
alternative solutions.
a. Bonus method
b. Asset revaluation method
3. Agreed capital is not given but the basis for its computation is indicated in the terms of
admission.
4. The amount of contribution of the new partner is not given.
5. No fraction of interest for either the new or old partners is given.
The following are the illustrations of the various problems involving admission of a new partner
by investment.
AGREED CAPITAL IS GIVEN
Illustrative Problem B: Calma and Castro are partners with capital balances of P200,000 and
P100,000, respectively. They share profits and losses equally. Conde is to be admitted in the
partnership.
Case 1 – No Bonus, no Asset Revaluation. Conde invests P100,000 for a % interest in the
agreed capital of P400,000.
Cash
100,000
Conde, Capital
100,000
Solution:
Step 1
Fill in the given data in the table
a. Partners, old and new
b. AC column, with the total written first
c. CC column
AC
CC
149
Old
P 300,000
New
100,000
P400,000
Step 2
P 400,000
Compare AC and CC. In this case, AC = CC
(P400,000 = P400,000), therefore, there is no asset revaluation
Step 3
Step 4
Determine if there is bonus.
a. Compute for the capital credit of the new partner
AC x fraction of interest; P400,000 x 1/4 = P100,000
b. Write this amount in the AC column of the new partner.
c. Compare the new partner's AC with his CC. In this case, AC and CC are the
same, therefore, there is no bonus.
The above table will be completed as follows:
a.
AC or capital credit of the old partners
AC x fraction of interest (4/4 – 1/4 = 3/4)
P400,000 x 3/4 = 300,000
b. A completed table appears as follows:
AC
CC
Old.
P300,000
P300,000
New
P100,000
100,000
P400,000
P400,000
c. Conclusion based on the table:
(i)
AC = CC, therefore, there is no asset revaluation
(ii)
New partner: AC = CC, therefore, there is no bonus
(iii)
Old partners: AC= CC, therefore, there is no bonus either.
In actual problem solving, only one table is prepared. The missing items are filled as
they are needed.
Case 2 - Bonus to the old partners, no Asset Revaluation. Conde invests PI00,000 for a 1/5
interest in the new firm capitalization of P400,000.
Cash
100,000
Conde, Capital
Conde, Capital.
100,000
20,000
Calma, Capital
10,000
Castro, Capital
10,000
150
These entries were made to show clearly the transfer of capital from the new partner to the old
partners. However, a compound entry may also be prepared as follows:
Cash.
100,000
Conde. Capital
80,000
Calma, Capital
10,000
Castro, Capital
10,000
Solution:
Step 1
Fill in the table as in Case 1. The completed table after Steps 1 to 4 is shown below:
AC
Old
New
Step 2
CC
Bonus
P320,000
P300,000
P20,000
80,000
100,000
(20,000)
P400,000
P400,000
-
Compare AC and CC. In this case, AC = CC (P400,000 = P400,000).
Therefore, there is no asset revaluation but there may be bonus.
Step 3
Determine if there is bonus.
a. Compute for the capital credit of the new partner.
AC x fraction o interest; P400,000 x 1/5 = P80,000.
b. Write this amount in the AC column of the new partner.
c. Compare the new partner's AC with his CC. In this case, his AC < CC (P80,000 P100,000); therefore, the decrease in his contributed capital represents bonus to the old
partners.
Step 4
Complete the table by filling in the missing figures.
a. AC or capital credit of the old partners.
AC x fraction of interest: P400,000 x 4/5 = P320,000 or
CC + Bonus to the old partners; P300,000 + P20,000 = P320,000
The bonus is shared by the old partners according to their profit and loss sharing ratio.
b. A completed table is shown in Step 1.
c. Conclusion based on the table:
(i)
AC = CC, therefore, there is no asset revaluation.
(ii)
New partner: AC< CC, therefore, he gives the bonus.
(iii) Old partners: AC > CC, therefore, they receive the bonus shared according to
their profit and loss ratio
Case 3 - Bonus to new partner, no Asset Revaluation. Conde invests P60,000 for 1/4 interest
in the total capitalization of P360,000
Cash
60,000
Calma, Capital
15,000
Castro, Capital
15,000
151
Conde, Capital
90,000
Solution:
Step 1
below
Fill in the table as in Cases 1 and 2. The completed table after Steps 1 to 4 is shown
Old
New
Step 2
AC
CC
P270,000
P300,000
90,000
60,000
P360,000
P360,000
Bonus
(P30,000)
30,000
-
Compare AC and CC. In this case, AC = CC (P360,000 = P360,000).
Therefore, there is no asset revaluation but there may be bonus.
Step 3
Determine if there is bonus.
a. Compute for the capital credit of the new partner.
AC x fraction of interest; P360,000 x ¼ = P90,000.
b. Write this amount in the AC column of the new partner.
c. Compare the new partner's AC with his CC. In this case, his AC > CC (P90,000 P60,000); therefore, the increase in his contributed capital represents bonus from the old
partners.
Step 4
Complete the table by filling in the missing figures.
a. AC or capital credit of the old partners.
AC x fraction of interest
P360,000 x 3/4 P270,000 or
CC - Bonus to old partners
P300,000 - P30,000 P270,000
The bonus given to the new partner is shared by the old partners according to their profit and loss
sharing ratio.
b. A completed table is shown in Step 1.
c. Conclusion based on the table:
(i)
AC = CC, therefore, there is no asset revaluation.
(ii)
New partner: AC > CC, therefore, he receives the bonus.
(iii) Old partners: AC < CC, therefore, they give the bonus shared according to
their profit and loss ratio.
Case 4-Positive Asset Revaluation, no Bonus. Conde invests P100,000 for a 1/5 interest in the
agreed capital of P500,000.
Other Assets
100,000
Calma, Capital
50,000
Castro, Capital
50,000
Solution:
Step 1
below:
Fill in the table as in Cases I to 3. The completed table after Steps 1 to 4 is shown
152
AC
Old
d. New
Step 2
P400,000
P100,000
P500,000
СС
Asset Revaluation
P300,000
P100,000
P400,000
P100,000
____-____
P100,000
Compare AC and CC. In this case, AC > CC (P500,000 > P400,000).
Therefore, there is a positive asset revaluation.
Step 3
Determine if there is bonus.
a. Compute for the capital credit of the new partner.
AC x fraction of interest, P500,000 x 1/5 = 100,000.
b. Write this amount in the AC column of the new partner.
c. Compare the new partner's AC with his CC. In this case, his AC = CC (P100,000);
therefore, there is no bonus.
Step 4
Complete the table by filling in the missing figures.
a. AC or capital credit of the old partners.
AC x fraction of interest
P500,000 x 4/5 = P400,000 or
CC+ Asset Revaluation
P300,000 + P100,000 = P400,000
b. A completed table is shown in Step 1.
c. Conclusion based on the table:
(i)
AC > CC, therefore, there is a positive asset revaluation.
(ii)
New partner: AC = CC, therefore, there is no bonus.
(iii) Old partners: AC > CC, therefore, they are credited for the asset revaluation
shared according to their profit and loss ratio.
Case 5 - Negative Asset Revaluation, No bonus. Conde invests P60,000 for a 1/5 interest in the
agreed capital of P300,000
Calma, Capital
30,000
Castro, Capital
30,000
Other Assets
60,000
Solution:
Step 1
below:
Fill in the table as in Cases I to 4. The completed table after Steps 1 to 4 is shown
AC
Old
New
Step 2
CC
Asset Revaluation
P240,000
P300,000
(P60,000)
60,000
60,000
____-___
P300,000
P360,000
(P60,000)
Compare AC And CC. In this case, AC < CC (P300,000 < P360,000).
Therefore, there is a negative asset revaluation.
Step 3
Determine if there is bonus.
153
a. Compute for the capital credit of the new partner.
AC x fraction of interest; P300,000 x 1/5 = P60,000.
Step 4
b. Write this amount in the AC column of the new partner.
c. Compare the new partner's AC with his CC. In this case, his AC = CC (P60,000 =
P60,000); therefore, there is no bonus.
Complete the table by filling in the missing figures.
a. AC or capital credit of the old partners.
AC x fraction of interest
P300,000 x 4/5 = P240,000 or
CC- Asset Revaluation
P300,000 - P60,000 = P240,000
b. completed table is shown in Step 1.
c. Conclusion based on the table:
(i)
AC < CC, therefore, there is a negative asset revaluation.
(ii)
New partner: AC = CC, therefore, there is no bonus.
(iii)
Old partners: AC < CC, therefore, they are charged for the asset
revaluation shared according to their profit and loss ratio
In the succeeding illustrations, the tables are summarized for easier comparison.
154
AGREED CAPITAL IS NOT GIVEN
There are cases when the contributions and the fraction of interest of the new partner are given,
but the agreed capitalization of the new firm is not specified. When such a situation exists, the
admission of the new partner is recorded using any of these two methods:
1. Bonus method
2. Asset Revaluation method
BONUS METHOD (AC = CC)
Under this method, the agreed capitalization of the new partnership is equal to the total amount
of contribution of all the partners, both old and new. No asset revaluation is recognized but there
will be transfer of capital called bonus. Bonus to the new partner is given by the old partner.
Bonus to the old partners comes from the new partner.
ASSET REVALUATION METHOD
An asset revaluation is made to properly value the assets of the partnership prior to admission of
a new partner. An asset revaluation will result either an increase or decrease in the recorded
amount of the partnership's assets and the partners' capital. An asset revaluation increase
(positive asset revaluation) indicates that some partnership assets are undervalued. On the other
hand, an asset revaluation decrease (negative asset revaluation) indicates that some partnership
asset is overvalued. Under the asset revaluation method, the balances of partnership's asset and
partner's capital must be adjusted prior to the admission of a new partner. These adjustments
must be recorded prior to admission of the new partner.
POSITIVE ASSET REVALUATION METHOD (AC > CC)
A positive revaluation increases the old partnership assets and the capital accounts of the old
partners. The increase is shared by the old partners based on their profit and loss ratio. Here the
agreed capitalization of the new partnership is more than the total amount of contributions of
both the old and new partners.
Under this method, the agreed capitalization is computed as follows:
AC = New partner's CC ÷ new partner's fraction of interest
NEGATIVE ASSET REVALUATION METHOD (AC < CC )
A negative revaluation decreases the old partnership assets and the capital accounts of the old
partners. The decrease is shared by the old partners based on their profit and loss ratio. Here, the
agreed capitalization of the new partnership is less than the total amount of distribution of both
the old and new partners.
155
The agreed capitalization is computed under this method in the same manner as in positive asset
revaluation.
Illustrative Problem C: Conde invests P100,000 for a 1/5 interest in the partnership of Calma
and Castro. The contributions of Calma and Castro are P200,000 and P100,000 respectively, and
they share profits and losses in the ratio of 3:1. After the admission of Conde, profits and losses
will be divided equally.
1.
Bonus Method
Cash
100,000
Conde, Capital
Calma, Capital
Castro, Capital
Old (4/5)
New (1/5)
AC
P 320,000
80,000
P 400,000
80,000
15,000
5,000
CC
P 300,000
100,000
P 400,000
Bonus
P 20,000
(20,000) g
1
The agreed capital of the partnership is equal to the capital contribution. The capital credit of the
old and new partners is computed as follows:
New = P400,000 x 1/5 = P80,000
Old = P400,000 x 4/5 = P320,000
The capital credit for the new partner is less than his capital contribution, therefore, the new
partner gives the bonus. The bonus is shared by the old partners according to their profit and loss
ratio.
2.
Positive Asset Revaluation Method
Other Assets
Calma, Capital
Castro, Capital
100,000
Cash
100,000
75,000
25,000
Conde, Capital
Old (4/5)
New (1/5)
AC
P 400,000
100,000
P 500,000
100,000
CC
P 300,000
100,000
P 400,000
Revaluation
P 100,000
h
P 100,000 j
The agreed capital of the new partnership is computed by dividing the new partner's contribution
by his fraction of interest (100,000 ÷ 1/5 = 500,000).
An agreed capital of more than the contributed capital indicates that there is an understatement in
the some assets of the partnership upon admission of the new partner. The agreed capital of
156
P500,000 when compared with the contributed capital of P400,000 indicates a P100,000 increase
on asset and capital for the asset understatement. The AC or the capital credit of the old partners
which is P400,000 (500,000 x 4/5) is P100,000 more than their contributed capital. Therefore the
old partners are credited for the revaluation of assets. The old partners share on the revaluation
according to their profit and loss ratio.
Illustrative Problem D: Conde invests P80,000 for a 1/4 interest in the partnership of Calma
and Castro. The contributions of Calma and Castro are P200,000 and P100,000 respectively and
they share profits and losses in the ratio of 3:1. After the admission of Conde, profits and losses
will be divided equally.
1.
Bonus Method
Cash
Calma, Capital
Castro, Capital
Conde, Capital
AC
CC
Old (3/4)
P 285,000
P 300,000
New (1/4)
95,000
80,000
P 380,000
P 380,000
80,000
11,250
3,750
95,000
Bonus
(P 15,000)
15,000 g
g
The agreed capital of the partnership is equal to the capital contribution. The capital
contributions of the old and new partners are computed as follows:
New 380,000 x 1/4 = 95,000
Old 380,000 x 3/4 = 285,000
The capital credit of the new partner is greater than his capital contribution, therefore, he
receives a bonus. The bonus is shared by the old partners according to their profit and loss ratio.
2.
Negative Asset Revaluation Method
Calma, Capital
Castro, Capital
Conde, Capital
45,000
Cash
80,000
15,000
60,000
Conde, Capital
Old (3/4)
New (1/4)
AC
P 240,000
80,000
P 320,000
80,000
CC
P 300,000
80,000
P 380,000
Revaluation
(P 60,000)
f
(P 60,000) g
157
The agreed capital of the new partnership is computed by dividing the new partner's capital
contribution by his fraction of interest (80,000 ÷ 1/4 = P320,000).
An agreed capital that is less than the contributed capital indicates that there is an overstatement
in some assets of the partnership upon the admission of a new partner. The agreed capital of
P320,000 when compared with the contributed capital of P380,000 indicates a P60,000 reduction
in assets and capital for the asset overstatement. The AC or capital credit of the old partners
which is P240,000 (P320,000 x 3/4) is 60,000 less than their contributed capital. Therefore, the
old partners are charged for the revaluation of assets. The old partners share on the revaluation of
assets according to their profit and loss ratio.
COMPARISON OF BONUS AND ASSET REVALUATION METHOD
In Illustrative Problem C, Conde is given 1/5 interest in the partnership and a 1/3 share of profits
upon admission. Both the bonus method and the asset revaluation method can be used in
determining the required interest for the new partner, but the two methods may not offer the
same ultimate results. Based on the information and assumptions given, the comparison between
the bonus method and the asset revaluation method may be illustrated as shown below.
Asset
Revaluation
Balances under the bonus method
Balances under the asset
revaluation method
Share on the additional
depreciation on asset
revaluation (equally)
Balances after the add'l
depreciation on asset
revaluation
Net advantage (disadvantage) of
using the asset revaluation
method
Calma,
Capital
Castro,
Capital
P 215,000
P 105,000
P 80,000
P,100,000
P 275,000
P 125,000
P 100,000
(100,000)
(33,333)
(33,333)
-
P 241,667
P 91,667
P 66,666 g
(P 13,333)
(P 13,334) g
P 26,667
Conde,
Capital
h
(33,334) g
Based on the above analysis, Calma will prefer the asset revaluation method while Conde will
prefer bonus method.
AGREED CAPITAL IS NOT GIVEN BUT BASIS FOR ITS COMPUTATION IS
INDICATED IN THE TERMS OF ADMISSION
Using the same data in Illustrative Problem D, where Calma and Castro have capital balances of
P200,000 and P100,000, respectively and sharing profits and losses in the ratio of 3:1, Conde
invests P100,000 in the firm and is credited for P50,000 which is to be 1/8 of the new firm
capital
The entry to record the admission of Conde into the partnership is
Cash
100,000
Conde, Capital
50,000
158
Calma, Capital
Castro, Capital
Old (7/8)
New (1/8)
37,500
12,500
AC
P 350,000
P 50,000
P400,000
CC
P 300,000
P 100,000
P 400,000
Bonus
P 50,000
(50,000) f
f
The agreed capital is not given but the basis for its computation is indicated In the problem. The
new partner is to be credited for P50,000 which is 1/8 of the new firm capital. Thus, 50,000 ÷ 1/8
= P800,000 agreed capital. The agreed capital (400,000) is equal to the total contributed capital,
therefore, there is no asset revaluation. But there might be bonus. The capital credit of the new
partner is less than his contribution, therefore he gives the bonus. The bonus is share by the old
partners in ther profit and loss ratio.
THE AMOUNT OF CONTRIBUTION OF THE NEW PARTNER IS NOT GIVEN
Example 1: Calma and Castro have capital balances of P200,000 and P100,000 respectively.
They share profits and losses in the rario 3:1. Conde invests sufficient amount for a 1/3 interest.
The journal entry to record the admission of Conde follows:
Cash
150,000
Conde, Capital
150,000
Solution:
Computations similar to those who made in the previous cases are no longer necessary.
To arrive at the amount contributed by the new partner,
1. the new firm capital (AC) is computed by dividing the old partners’ contribution by
their fraction of interest (300,000 ÷ 2/3) = P450,000, and
2. the investment of the new partner is computed by multiplying AC by his fraction f
interest (P450,000 x 1/3 = P150,000). Conde has to invest P150,000 in order to have
1/3 interest in the firm.
Example 2: Coral, Cielo and Camu are partners with capital balances of P112,000, P130,000,
and 58,000, respectively, sharing profits and losses equally. Cuevas is admitted as a new partner
bringing with him his expertise and good reputation. He is to invest cash for a 25% interest in the
assets of the partnership which includes a credit of P18,750 for bonus upon admission.
The journal entry to record the admission of the new partner is as follows:
Cash
Coral, Capital
Cielo, Capital
Camu, Capital
Cuevas, Capital
75,000
6,250
6,250
6,250
93,750
159
Solution:
Follow the same procedure as in Example 1. The P18,750 bonus given by the old partners to the
new partner has to be deducted frm the total capital of the old partners to get their 75% interest.
Thus:
P112,000 + P130,000 + P58,000 – P18,750 = P281,250\
P281,000 / 75% = P375,000).
The amount to be contributed by the new partner is computed by deducting the P18,750 bonus
received from the old partners from the 25% interest acquired from the old partners. Thus:
P375,000 x 25% = P93,750
P93,750 – P18,750 = P75,000
FRACTION OF INTEREST IS NOT GIVEN
Conde invests P50,000 in the firm. However, upon his admission P10,000
bonus is allowed by the old partners.
The entry to record the admission of the new partner is:
Cash
Calma, Capital
Castro, Capital
Conde, Capital
50,000
7,500
2,500
60,000
REVIEW of the LEARNING OBJECTIVES
1. Define partnership dissolution and identify the conditions giving rise to it. Partnership
dissolution is the change in the relation of partners caused by any partner ceasing to be
associated in the carrying out of the business. Dissolution of a partnership may be caused
by any of the following conditions: (1) admission of a new partner; (2) retirement or
withdrawal of a partner; (3) death, incapacity, bankruptcy of a partner; and (4)
incorporation of a partnership.
2. Understand the accounting procedures to record the admission of a new partner by
purchase. A new partner may be admitted into the partnership by purchasing a capital
equity interest from one or more of the old partners. Admission of new partner by
purchase represents a transfer of capital from old partner/partners to the new partners.
The transfer of capital is recorded at the book value of the interest sold regardless of the
amount paid for the interest. Any gain or loss indicated in the transaction is a personal
gain or loss of the selling partner. Asset revaluation, however, may be undertaken by the
old partnership before admission of a new partner. In such case, a positive or negative
asset revaluation will always accrue to the old partners.
160
3. Understand the accounting procedures to record the admission of a new partner by
investment. The admission of a new partner by investment is a transaction between the
original partnership and the new partner. The new partner’s contribution increases the
total assets and the total capital of the partnership. When the capital contribution of the
new partner is not equal to his capital credit in the new partnership or when the capital
contributions of the old partner is not equal to their capital credit in the new partnership.,
the difference is announce for and by any of the following methods: (1) bonus method
(bonus to the old partners from the new partner or bonus to the new partner from the old
partners); (2) asset revaluation method either positive or negative revaluation.
161
GLOSSARY OF ACCOUNTING TEMINOLOGIES
Agreed Capital – the amount set by the partners as new partnership capital which may
not necessarily contributed capital.
Asset Revaluation – the necessary adjustment in assets before the admission of a new
partner because of some partnership assets which may not be properly valued.
Bonus – the transfer of capital from one partner to another partner.
Contributed Capital – the sum the net assets (capital of the old partners) of the original
partnership and the contribution of the new partner.
Partnership Dissolution – a change in the relation of the partners caused by any
partnerceasing to be associated in the carrying out of the business.
162
DISCUSSION QUESTIONS
1. What is partnership dissolution? What conditions may lead to partnership dissolution?
2. What are the types of admission of a new partner in an existing partnership? What are
similarities and differences?
3. What are the different cases that may arise in the admission of a new partner, by
purchase or interest? In the admission of a new partner by investment?
4. Differentiate asset revaluation from bonus. How do you determine if there is an asset
revaluation or there is a bonus?
5. How do you determine who receives the bonus?
6. When is an asset revaluation unusually undertaken?
7. What are the data needed in solving problems related to admission by investment?
8. What is the difference between the asset revaluation and bonus in connection with the
admission of a new partner? If you are going to join a partnership which would you
prefer?
9. When agreed capital is not given, how do you compute for it?
10. How do you determine whether the bonus method or asset revaluation method will be
preferred by a partner?
163
EXERCISES
Exercise 4 - 1 (Admission of New Partner under Various Assumptions)
Camus and Cuenco are partners who have capital balances of P90,000 and 60,000 and
who share profits 60% and 40% respectively. They agree to admit Cerda as a partner
upon his payment of P90,000.
Instructions: Give the journal entries to record each of the following independent
assumptions:
1. One-third of the capital balances of the old partners are transferred to the new partner,
Camus and Cuenco dividing the cash between themselves.
2. One-third of the capital balances of the old partners are transferred to the new partner,
Camus and Cuenco dividing cash between themselves. However, before recording the
admission of Cerda, asset revaluation is undertaken on the firm books so that Cerda’s
capital may be equal to the amount paid for the interest.
3. The cash is invested in the business asnd Cerda is credited with a ¼ interest in the
firm , the bonus method being used in reording his investment.
4.
The cash is invested in the business asnd Cerda is credited with the full amount of his
investment which is to be 25% of the firm new capital.
5. The cash is invested in the business asnd Cerda is credited for P120,000 which
includes a bonus from Camus and Cuenco.
Exercise 4 – 2 (Admission of a New Partner; Bonus and Asset Revaluation Methods)
At the end of the fiscal year 2014, the capital accounts and the profit and loss sharing ratio for
the partners for C3 Co. are presented below. At this date, it is agreed that a new partner CAnda,
is to be admitted to the firm.
Capital
P & L Ratio
Capco
P100,000
50%
Cular
80,000
30%
Cruz
60,000
20%
Instructions: For each of the following situations involving the admission of Canda into the
partnership, give the journal entry to record his admission.
1. Canda purchasesone-fourth of Cular’s interest in the firm paying P50,000.
2. Canda buys one-quarter interest in the firm for P70,000 by purchasing one-fourth of the
interest of the three partners. Asset revaluation is made prior to admission of Canad
164
3. Canda invests P115,000 and receives a one-quarter interest in capital and profits of the
business, bonus being allowed on the admission.
Exercise 4-3 (Admission of a New Partner by Purchase)
Partner Catral and Clemente are considering the admission of Conti into the partnership. Catral
and Clemente share income and loss in the ratio of 3:1, respectively. Catral's capital balance is
P480,000 and Clemente's capital balance is P360,000.
Instructions: Prepare entries to record the admission of Conti into the partnership under each of
the following independent assumptions:
1.
Conti acquired one-third of the interest of Catral paying P160,000.
2.
Conti acquired one-third of the interest of Clemente paying P70,000.
3.
Conti acquired a one-fourth interest from the old partners paying P126,000. Asset
revaluation has to be made prior to the admission of Conti.
Exercise 4-4 (Admission of a New Partner by Purchase and by Investment)
Carlos and Cruz, partners have capital balances of P200,000 and P300,000, respectively. They
admit Caparas and Carpio into the partnership. Caparas purchases one-fourth of Carlos' interest
for P56,000 and one-third of Cruz's interest for P72,000. Carpio is admitted to the partnership
with an investment of P120,000 for which he is to receive an ownership equity of P120,000.
Instructions:
(1)
(2)
Present the entries in general journal form to record the admission into the partnership of
(a) Caparas, and (b) Carpio.
What are the capital balances of each partner after the admission of Caparas and Carpio?
Exercise 4 -5 (Admission of a New Partner by Investment)
Cuenca and Claudio share profits equally and have equal investments in their partnership. The
partnership's net asset is carried on the books at P500,000. Cabral is admitted into the partnership
with a one-fourth interest in profits and net assets. Cabral pays P200,000 cash into the
partnership for his interest.
165
Instructions: Prepare journal entries to show two possible methods of recording the admission
of Cabral on the partnership books.
Exercise 4-6 (Admission of a New Partner by Investment)
The capital balances and the income and loss sharing ratio of the partners Choy, Chua, and
Cheng are as follows:
Capital
Choy
P 150,000
P & L Ratio
3/7
Chua
125,000
2/7
Cheng
100,000
2/7
The partnership has been successful and the partners have decided to invite Chiu to join them.
Chiu has been admitted into the partnership with a one-fifth capital interest for a cash investment
of P120,000
Instructions: Prepare the entries to record the admission of Chiu under the (1) bonus method
and (2) asset revaluation method.
PROBLEMS
Problem 4 - 1 (Admission of a New Partner under Various Assumptions)
Carmen and Centeno are partners with capital balances of P160,000 and P80,000. They share
profits 60%, 40%, respectively. The partners agree to admit Corrales as a member of the firm
Instructions: Give the required entries on the partnership books to record the admission of
Corrales under each of the following assumptions:
1.
Corrales purchases a l/4 interest in the firm. One-fourth of each partner's capital is to be
transferred to the new partner. Corrales pays the partners P60,000, which is divided between
them in proportion to the equities given up.
2.
Corrales purchases a 1/3 interest in the firm. One-third of each partner's capital is to be
transferred to the new partner. Corrales pays the partners P120,000, which is divided between
them in proportion to the equities given up. Before Corrales admission, asset revaluation is
undertaken and recorded on the firm books so that Corrales' 1/3 interest will be equal to the
amount of his payment.
3.
Corrales invests P120,000 for a 1/4 interest in the firm. Asset revaluation is recorded on
the firm books prior to the admission.
166
4.
Corrales invests P 120,000 for a 50% interest in the firm. Carmen and Centeno transfer
part of their capital to that of Corrales as a bonus
5.
Corrales invests P160,000 in the firm. P40,000 is to be considered a bonus to partners
Carmen and Centeno.
6.
Corrales invests P160,000 in the firm and allowed a bonus to Carmen and Centeno of
P20,000 upon his admission.
7.
Corrales invests P100,000 for a 1/4 interest in the firm. The total firm capital after his
admission is to be P340,000
8.
Corrales invests P110,000 for a 1/4 interest in the firm. The total firm capital after his
admission is to be P440,000
9.
Corrales invests P96,000 for a 1/3 interest in the firm. The total firm capital after his
admission is to be P336,000
10.
Corrales invests sufficient cash for a 1/5 interest.
Problem 4-2 (Admission of a New Partner under Various Assumptions)
Coral and Corpuz are partners with capital balances of P180,000 and P120,000, respectively.
They share profits and losses in the ratio of 4:1. They agree to admit to the partnership.
Instructions: Journalize the admission of Calma to the partnership for each of the following
independent assumptions:
1. Calma is admitted to a one-third interest in capital with a contribution of P150,000.
2. Calma is admitted to a one-fourth interest in capital with a contribution of P120,000. Total
capital of the partnership is to be P420,000
3. Calma is admitted to a one-fourth interest in capital upon contributing P60,000. The total
capital of the new partnership is to be P360,000
4. Calma is admitted to a one-fourth interest in capital by the purchase of one-fourth of the
interest of Coral and Corpuz for P82,500. Total capital of the new partnership is to be P300,000
5. Same conditions as in (4), except that the new partnership capital is to be P330,000 due to the
asset revaluation undertaken prior to the admission of Calma.
167
6. Calma is admitted to a one-fifth interest in capital upon contributing P90,000. Total capital of
the new partnership is to be P450,000.
Problem 4- 3 (Admission of a New Partner under Various Assumptions)
In 2012, Castillo and Cordova established a partnership. Their operations have been very
successful. Since Castillo devotes full-time to the business and Cordova part-time, they share
profits and losses in the ratio of 7:3, respectively. At the beginning of 2014, Coloma expressed
his interest of joining the partnership. The capital balances of Castillo and Cordova on this date
are P560,000 and P840,000, respectively.
Instructions:
1.Prepare the entries to record the admission of Coloma into the partnership under each of the
following independent assumptions
a)
Coloma invests P350,000 cash for a one-fifth interest in the partnership
b)
Coloma invests P500,000 cash for a one-fourth interest in net assets; the bonus
method is used
c)
Coloma invests P700,000 for a one-fourth interest; the asset revaluation method is
to be used.
d)
Coloma pays Castillo and Cordova a total of P550,000 for one-fourth of their
respective capital interest.
e)
Coloma pays Castillo and Cordova a total of P350,000 for one-fifth of their
respective capital. interest no asset revaluation is undertaken prior to the admission of
Coloma
2. Assuming Coloma paid a total of P600,000 to Castillo and Cordova for two-fifths of their
respective capital balances, prepare a schedule determining the amount of cash to be transferred
to Castillo and Cordova.
Problem 4-4 (Admission of a New Partner by Investment)
The following statement of financial position is for the partnership of Cortes, Canda and Cena,
who share profits and losses in the ratio of 3:2:1 respectively.
Assets
Cash
Other Assets
Total Assets
Liabilities and Capital
P 90,000
810,000
P 900,000
Liabilities
P 210,000
Cortes, Capital
420,000
Canda, Capital
Cena, Capital
240,000
30,000
Total Liabilities & Capital
P
900,000
168
Instructions:
1.
Assume that the assets and liabilities are valued fairly, and that the partnership
wishes to admit Cruz as a new partner with one-fifth interest in capital. Without
recording bonus, determine what Cruz's contribution should be.
2.
If Cruz contributes P210,000 for a one-fifth interest, determine the new capital
balances of each partner using: (a) the bonus method, and (b) the asset revaluation
method.
Problem 4-5 (Admission of a New Partner by Investment and by Purchase)
The following are the capital accounts of the partners in the 3C Store on June 30, 2014:
Capital
P & L Ratio
Ciara
P324,000
2/5
Cora
216,000
2/5
Celia
135,000
1/5
On July 1, 2014, Carla invests P90,000 in the business for a one-eight interest in net assets.
Profits are to be shared equally after the admission
Instructions:
1.
Give two alternative solutions, in journal entry form, to record Carla's admission to the
firm. Which method/solution will be preferred by Celia?
2.
Give two alternative journal entries to record Carla's admission, if instead of investing,
she purchases a one-eight interest ratably from all partners.
Problem 4- 6 (Admission of a New Partner by Investment and by Purchase)
Cabal, Cadiz, Caldea, business partners of a firm carrying their names, have agreed on a profit
and loss ratio of 20:30:50, respectively. On December 31, 2014, the books of their partnership
showed the following credit balances:
Cabal P150,000;
Cadiz P180,000;
Caldea P300,000
169
On January 1, 2015, Camo was admitted as a new partner under the following terms and conditions:
a.
Camo will share 20% in the profit and loss ratio, while the ratio of the original
partners will remain proportionately the same as before Camo's admission.
b.
Camo will pay P25,000 for 1/6 of Cadiz's share.
c.
Camo will contribute P150,000 in cash to the partnership.
d.
Total capital of the partnership after Camo's admission will be P800,000 of which
Camo's capital account will be shown as P160,000.
Instructions:
1.
Using the following suggested format, prepare a schedule showing the capital of each
partner after the admission of partner Camo.
Cabal
Cadiz
Caldez
P150,000
P180,000
P300,000
Camo
Total
Capital credit balances
before the admission of
P630,000
Camo
2. What is the profit and loss ratio of all the partners after Camo's admission?
Problem 4-7 (Admission of a New Partner by Investment; Statement of Changes in
Partners' Equity)
Corona and Calderon are partners whose capital accounts on December 31,2013, before the firm's
books are closed, are P250,000 and P150,000 respectively. The drawing account for Corona shows a
debit balance of P41,000; for Calderon, a debit balance of P34,000. The partnership agreement with
regards to profits provides that (1) each partner is to be allowed an annual salary of P45,000, and (2)
Corona is to received 60% and Calderon 40% of the profits after allowance of salaries.
The income summary account on December 31 has a credit balance of P70,000 before any entry
for the allowance of salaries, and this balance is closed into the partners’ capital accounts. The
balance of the drawing accounts is also closed into the capita accounts.
On January 2, 2014, Calixto is admitted as a partner upon the investment of P100,000 into the firm.
The partners allow a bonus on the investment so that Calixto may have a 1/3 interest in the firm.
The new agreement provides that profits are to be distributed as follows:
Corona, 35%; Calderon, 25%; and Calixto, 40%. Salaries are not allowed.
170
On December 31, 2014, the partners' drawing accounts have debit balances as follows:
Corona - P37,500; Calderon P25,000; and Calixto P34,000. The income summary account has a
P75,000 debit balance, Accounts are closed.
The partnership was sold in January, 2015 for P87,500. Cash settlement was made to the partners.
Instructions: Prepare a statement of changes in partners' equity, showing all of the changes that
took place since January 1, 2013.
171
MUTIPLE CHOICES
MC 4-1
If the total contributed capital exceeds the agreed capital with the new partner's
investment is the same as his capital credit, then the admission of the new
partner involved a
a. bonus to new partner
b. bonus to old partner
MC 4-2
If the agreed capital is equal to the total contributed capital with the capital credit
and contribution of the old and new partners being the same, there exist
a. asset revaluation and bonus
b. negative asset revaluation
MC 4-3
c. no bonus
d. both A and B
Calibo and Camos are partners with capital balances of P60,000 and P80,000
and sharing profits and losses 40% and 60% respectively. If Cueva is admitted as
partner paying P50,000 in exchange for 50% of Calibo's equity, the entry in the
partnership books should be as follows:
a.
Calibo, Capital
Cueva, Capital
b. Calibo, Capital
MC 4-5
c. no asset revaluation and no bonus
d. positive asset revaluation
If the capital credit of the new partner is less than his contribution with no
adjustment in asset values, then the admission resulted in a
a. bonus to the old partners
b. bonus to the new partner
MC 4-4
c. negative asset revaluation
d. positive asset revaluation
50,000
50,000
30,000
Cueva, Capital
30,000
c. Cash
Other Assets
Cueva, Capital
d. Cash
Calibo, Capital
Cueva, Capital
45,000
15,000
50,000
50,000
15,000
45,000
Chan, Ching, and Chen are partners who share profits and losses in the ratio of
5:3:2, respectively. They agree to sell Chat 25% of their respective capital and
profit and losses ratio for a total payment directly to the partners in the amount
of P140,000. They agree that asset revaluation of P60,000 is to be recorded prior
to admission of Chat. The condensed statement of financial position of the CCC
Partnership is presented on the next page.
172
Assets
Cash
Other Assets
Liabilities and Capital
Liabilities
P 100,000
Chan, Capital
250,000
Ching, Capital
150,000
Chen, Capital
100,000
Total Liab & Cap
600,000
P 60,000
540,000
600,000
The capitals of Chan, Ching, and Chen respectively after the payment and
admission of Chat are
MC 4-6
a. P187,500; P112,500;
P 75,000
b. P210,000; P126,000;
P 84,000
c. P280,000; P168,000;
P112,000
d. P250,000; P150,000;
P100,000
C2 Partnership had a net income of P24,000 for the month ended September 30,
2014. Carreon purchased an interest in the C2 Partnership of Calvo and Calma
by paying Calvo P72,000 for half of his capital and half of his 50% profit
sharing interest. At this time, the capital balance of Calvo was P96,000 and the
capital balance of Calma was P168,000. Carreon should receive a credit to his
capital account of
a. P36,000
b. P48,000
MC 4-7
c. P72,000
d. P84,000
Cheng, Chavez and Chato are partners sharing profits and losses in the ratio of
4:3:3 respectively. The condensed statement of financial position of their
partnership as of December 31, 2014 is presented below
Cash
P 100,000
Liabilities
P 80,000
Other Assets
260,000
Cheng, Capital
120,000
Chavez, Capital
80,000
Ching, Capital
80,000
Total Assets
P 360,000
Total L & C
P 360,000
All the partners agree to admit Cua as 1/6 partner in the partnership without any
asset revaluation nor bonus. Cua shall contribute assets amounting to
a. P 20,000
b. P 56,000
c. P 70,000
d. P 120,000
173
On May 8. 2014, the business accounts of Cordova and Constancio appear below
Cordova
Constancio
Assets
Cash
P 11,000
P 22,354
Accounts Receivable
234,536
567,890
Inventories
120,035
260,102
Land
603,000
Buildings
428, 267
Furniture and Fixtures
50,345
34, 789
Other Assets
2,000
3,600
P 1,020,916
P 1,317,002
Equities
Accounts Payable
P 178,940
P 243,650
Notes Payable
200,000
345,500
Cordova, Capital
641,976
Constancia, Capital
728,352
P 1,020,916
P 1,317,002
Cordova and Constancio agreed to form a partnership contributíng their respective
assets and equities subject to the following adjustments
a. Accounts Receivable of P20,000 in Cordova's books and P35,000 in
Constancio's are uncollectible
b. Inventories of P5,500 and P6,700 are worthless in Cordova and Constancio's respective
books.
c. Other Assets of P2,000 and P3,600 in Cordova's and Constancio's respective books are
to be written off.
The capital accounts of the partners after the adjustments
Cordova
Constancio
a. P614,476
P683,052
b. P615,942
P717,894
c. P640,876
P712,345
d. P613,576
P683,350
Using the information in MC 4-8, how much assets does the partnership have?
a. P2,237,918
c. P2,337,918
b. P2,265,118
d. P2,365,218
Using the information in MC 4-8, and assuming Cuyugan offered to join for a 20% interest in
the firm, how much cash should he contribute?
a. P324,382
c. P337,487
b. P330,870
d. P344,237
174
MC 4-11
Using the information in MC 4-8 and assuming after Cuyugan’s admission, the
profit and loss sharing ratio was agreed to be 40:40:20 based on capital credits,
how much should the cash settlement be between Cordova and Constancio?
a.
P32,272
c.
P33,602
b.
P32,930
d.
P34,288
MC 4-12
Using the information in MC 4-8 and assuming that during the first year of
operations the partnership earned an income of P325,000 and that this was
distributed in the agreed manner. Assuming further that drawings were made in
these amounts: Cordova, P50,000; Constancio, P65,000; and Cuyugan, P28,000,
how much are the capital balances of the partners after the first year?
Cordova
Constancio
Cuyugan
a.
P750,627
P735,177
P372,223
b.
P728,764
P713,764
P361,382
c.
P757,915
P742,315
P375,837
d.
P743,121
P727,827
P368,501
MC 4-13
Conrado, Cosio, and Cosme are partners whose capital balances and share in
profits are as follows:
Conrado
P250,000
50%
Cosio
150,000
25%
Cosme
100,000
25%
Cueto is admitted into the partnership by paying P60,000 for 1/3 of the share in
equity of Cosio and by contributing P200,000. The partners agree to the total
capitalization to P750,000, 1/3 of which is Cueto’s capital credit. Cueto’s share in
net income is also 1/3 and the old partners are to divide net income in the old ratio
among themselves.
The profit and loss sharing ratio among Conrado, Cosio and Cosme after the
admission of Cueto is
a.
50%, 25%, 25%, respectively
b.
30%, 15%, 15%, respectively
c.
2/6, 1/6, 1/6, respectively
d.
1/3, 1/3, 1/3, respectively
MC 4-14
Using the information in MC 4-13, the amount of the asset revaluation is equal to
a.
P15,000
c.
P120,000
b.
P50,000
d.
P200,000
175
MC 4-15
Using the information in MC 4-13, the capital balances of the old partners after
the admission of Cueto are
a.
P250,000, P150,000, P100,000, respectively
b.
P275,000, P112,500, P112,500, respectively
c.
P250,000, P100,000, P100,000, respectively
d.
P250,000, P200,000, P100,000, respectively
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Test Material No. 14
__________
Rating
Name _____________________________________ Date ___________________________
Year and Section ____________________________ Professor _______________________
TRUE or FALSE
Instructions: Encircle the letter T if the statement is true and the letter F if the statement is
false.
1. Admission of a new partner by investment will change total assets and total
capital.
2. Asset revaluation and bonus are one and the same thing.
3. When a new partner is admitted, the partnership may continue operations based
on a new contract among the partners.
4. The total assets of the partnership may increase upon admission of a new
partner by purchase of interest.
5. A new partner may be admitted into the partnership with the consent of the
majority of the old partners.
6. A partnership dissolution will always lead to a partnership liquidation.
7. Bonus to a new partner is given by the old partners.
8. If the agreed capital exceed total contributed capital, the difference may be
positive asset revaluation.
9. If the capital credit of the partner is less than his investment, the difference is
always recorded as asset revaluation.
10. The admission of a new partner in an existing partnership dissolves the old
partnership.
11. A new partner may be admitted without an investment and without the
recognition of capital interest.
177
12. The agreed capital can never be less than the total contributed capital.
13. When a new partner enters an existing partnership by purchasing a partner’s
interest, the cash paid to the selling partner for the partnership interest is always
equal to the new partner’s capital balance.
14. A bonus given to the old partners by a new partner increases the capital
account balances of the old partners.
15. Admission of a new partner by purchase of interest is a personal transaction
between the selling partner and the buying partner. Hence, any indicated gain in
the transaction is not recognized in the partnership books.
16. In the admission of a new partner by purchase, the new partner may pay more
than, less than or equal to the book value of the interest sold by any or all of the
old partners.
17. Asset revaluation may be recorded upon the admission of a new partner
whether by purchase or by investment.
18. In the admission of a new partner by investment, agreed capital must always
equal contributed capital.
19. The sale of a partner’s interest in an existing partnership is a personal
transaction between the selling partner/partners and the buying or new partner.
20. Both asset revaluation and bonus affect total assets and total capital.
178
Test Material No. 15
__________
Rating
Name _____________________________________ Date ___________________________
Year and Section ____________________________ Professor _______________________
IDENTIFICATION
Instructions: Write the word or group of words that identify each of the following statements.
________________ 1.
The term that apply to the excess of agreed capital over total
contributed capital.
________________ 2.
It can be determined by dividing the new partner’s contribution by
his fraction of interest.
________________ 3.
The transfer of capital from one partner to another.
________________ 4.
The contribution of both the new and the old partners.
________________ 5.
The change in the relation of the partners caused by any one of
them ceasing to be associated in the carrying out of the business.
________________ 6.
It represents a partner’s equity or capital in the partnership.
________________ 7.
This refers to the termination of the life of an existing partnership.
________________ 8.
It is a personal transaction between the partner who sells his
interest and a third party (buyer) who thereafter becomes a partner.
________________ 9.
The amount of new capital set by the partners for the partnership
which need not necessarily equal contributed capital.
________________ 10.
Type of admission wherein the new partner is admitted by buying
the whole interest or a portion thereof of one or more old partners.
________________ 11.
A type of admission where assets are contributed to the
partnership.
179
________________ 12.
The increase in the capital of the old partners, other than the asset
revaluation, which reduces the capital of the new partner.
________________ 13.
This refers to the termination of the business activities carried on
by the partnership.
________________ 14.
The interest or equity of a partner in the partnership upon
admission.
________________ 15.
The situation in the admission of a new partner by investment
wherein the two alternative solutions are the bonus method and the
asset revaluation method.
________________ 16.
The basis for the computation of the total partnership capital when
the amount of a new partner’s contribution has to be determined.
________________ 17.
The equity of a partner in the partnership that is usually expressed
in fraction.
________________ 18.
The decrease in the capital balances of the old partners, upon
admission of a new partner, brought about by some partnership
assets which may not be properly valued.
________________ 19.
The difference between the consideration made and the interest
transferred in admission by purchase.
________________ 20.
The basis of an old partner in evaluating whether to prefer the
bonus method or asset revaluation method in the admission of a
new partner.
180
Test Material No. 16
__________
Rating
Name _____________________________________ Date ___________________________
Year and Section ____________________________ Professor _______________________
MULTIPLE CHOICE – Theory and Problems
Instructions: Encircle the letter of the best answer. Show supporting computations in good
form in a separate worksheet.
1.
A person may become a partner in a partnership by all of the following methods except
a.
investing in the partnership with a bonus to the new partner
b.
making a loan to the partnership
c.
investing in the partnership with a bonus to the old partners
d.
purchasing a partner’s interest
2.
If a new partner purchases his interest from an old partner, the only entry on the
partnership books is a credit to the purchaser’s capital account with a debit to the
a.
bonus account
b.
cash account
c.
capital account of the selling partner
d.
capital accounts of other partners
3.
Which of the following does not result in the dissolution of a partnership?
a.
Marriage of a partner
b.
Withdrawal of a partner
c.
Addition of a new partner
d.
Death of a partner
4.
A new partner may be admitted into a partnership by any of the following except
a.
investing in the partnership
b.
purchasing preferred stock of the partnership
c.
purchasing a partner’s interest
d.
both a and c
181
5.
Cabrera, Capulong and Castor are partners with capital balances of P250,000, P150,000,
and P100,000, respectively. The partners share income and losses equally. For an
investment of P250,000 cash, Concio is to be admitted as a partner with a one-fourth
interest in capital and income. Based on this information, the amount of Concio’s
investment can best be justified by which of the following?
a.
Assets of the partnership were overvalued immediately prior to Concio’s
investment.
b.
The book value of the partnership’s net assets was less than the fair value
immediately prior to Concio’s investment.
c.
Concio’s admission into the partnership does not involve a bonus nor an asset
revaluation
d.
Concio will receive a bonus from the other partners upon his admission to the
partnership
6.
If A is the total capital of a partnership before the admission of a new partner, B is the
total capital of the partnership after the investment of new partner, C is the amount of the
new partner’s investment, and D is the amount of capital credit to the new partner, there
is
a.
neither bonus nor asset revaluation if B = A + C and D > C
b.
a bonus to the old partners if B > (A + C) and D < C
c.
a bonus to the new partner if B = A + C and D < C
d.
an asset revaluation to the old partners if B > (A + C) and D = C
7.
Cuenco and Cuizon are partners with a capital ratio of 3:1 and a profit and loss ratio of
2:1, respectively. The bonus method was used to record Calasin’s admittance as a new
partner. What ratio should be used to allocate to Cuenco and Cuizon the excess of
Calasin’s contribution over the amount credited to his capital account?
a.
Cuenco and Cuizon’s old profit and loss ratio
b.
Cuenco and Cuizon’s old capital ratio
c.
Cuenco and Cuizon’s new relative profit and loss ratio
d.
Cuenco and Cuizon’s new relative capital ratio
8.
Cunanan invests P160,000 in a partnership for a one-fifth interest. Prior to Cunanan’s
admission, the partnership had two partners with capital balances P190,000 each. If no
asset revaluation is recognized prior to Cunanan’s admission, what amount is credited to
his capital account?
a.
P15,000
c.
P120,000
b.
P50,000
d.
P200,000
182
9.
Collado’s interest in the partnership is P112,000. Cuervo buys Collado’s interest for
P120,000. How much is the capital balance of Cuervo after the purchase?
a.
P108,000
c.
P112,000
b.
P110,000
d.
P120,000
10.
Cortez, Cuerdo, and Claudio are partners with capital balances of P180,000, P100,000
and P120,000, respectively. Conde is admitted into the partnership with a one-fourth
interest upon payment of P160,000. If the old partners share profits and losses in the ratio
of 2/5, 2/5, and 1/5, then the capital account of Cortez after the admission of Conde will
show a balance of
a.
P160,000
c.
P184,000
b.
P180,000
d.
P188,000
11.
Castro contributes P120,000 for a one-sixth interest in a partnership. The total capital
balances of the partners prior to the admission of Castro is P360,000. If the no asset
revaluation is made prior to the admission of Castro, what amount is credited to the
capital account of Castro upon his admission?
a.
P80,000
c.
P120,000
b.
P96,000
d.
P160,000
12.
Conn and Cass form a partnership and have capital balances of P100,000 and P200,000,
respectively. If they agree to admit Charr into the partnership, how much will he have to
invest to have a one-third interest?
a.
P100,000
c.
P150,000
b.
P120,000
d.
P200,000
13.
Cardel desires to purchase a one-fourth capital and profit and loss interest in the
partnership of Cariaso, Carino, and Carillo. The three partners agree to sell Cardel onefourth of their respective capital and profit and loss interest in exchange for a total
payment of P200,000. The profit and loss ratio and capital balances of the partners are as
follows: Cariaso (60%) – P400,000; Carino (30%) – P200,000; and Carillo (10%) –
P100,000. If assets are to be revalued prior to the admission of Cardel, what would be the
capital balances of Cariaso, Carino and Carillo after the admission of Cardel?
a.
P300,000;P150,000;P75,000
c.
P385,000; P182,500; P97,500
b.
P345,000;P172,500;P82,500
d.
P460,000;P230,000;P110,000
14.
Based on the information in No. 13 and assuming assets are fairly valued, what would be
the capital balances of Cariaso, Carino, and Carillo after the admission of Cardel?
a.
P300,000;P150,000;P75,000
c.
P385,000; P192,500; P97,500
b.
P345,000;P172,500;P82,500
d.
P460,000;P230,000;P110,000
15.
Based on the information in No. 13 and assuming assets are fairly valued and that Cardel
purchases a one-fourth capital and profit and loss interest from Cariaso for P200,000,
183
what would be the capital balances of Cariaso, Carino and Carillo after the admission of
Cardel?
a.
P400,000;P200,000;P100,000
c.
P300,000; P150,000; P75,000
b.
P300,000;P200,000;P100,000
d.
P100,000; P50,000; P25,000
16.
Based on the information in No. 13 and assuming assets are fairly valued and that Cardel
purchases a one-fourth capital and profit and loss from the partnership paying P200,000,
what would be the capital balances of Cariaso, Carino and Carillo after the admission of
Cardel?
a.
P300,000;P150,000;P75,000
c.
P385,000; P192,500; P97,500
b.
P400,000;P200,000;P100,000
d.
P460,000;P230,000;P110,000
17.
Coral, Camus and Cerda are partners sharing profits in the ratio of 4:4:2, respectively. As
of December 31, 2013, their capital balances were P190,000 for Coral, P160,000 for
Camus, P120,000 for Cerda.
On January 1, 2014, the partners admitted Cordero as a new partner and according to
their agreement, Cordero will contribute P160,000 in cash to the partnership and also pay
P20,000 for 15% of Camus’ share. Cordero will be given a 20% share in profits while the
original partners’ share will be proportionately the same as before. After the admission of
Cordero, the total capital will be P660,000 and Cordero’s capital be P140,000.
The amount of the asset revaluation upon the admission of Cordero is
a.
P24,000
c.
P50,000
b.
P30,000
d.
P160,000
18.
Based on the information in No. 17, the bonus to Cerda upon the admission of Cordero is
a.
P8,800
c.
P22,000
b.
P17,600
d.
P44,000
19.
Based on the information in No. 17, the capital of Camus upon the admission of Cordero
is
a.
P160,000
c.
P168,600
b.
P165,600
d.
P189,600
20.
Based on the information in No. 17, the partner’s profit and loss ratio after admission of
Cordero shall be
a.
20%, 20%, 20%, 20%
c.
32%, 32%, 16%, 20%
b.
25%, 25%, 25%, 25%
d.
40%, 40%, 20%, 20%
184
Test Material No. 17
Rating __________
Name:
Date:
Year and Section:
Professor:
PROBLEMS
Problem A
Cosme, Canlas and Cura are parthers with profit and loss ratio of 30%, 50% and 20%
respectively. Their capital balances are: Cosme ⸺ P150,000; Canlas ⸺ P300,000; Cura ⸺
P50,000. Corazon is admitted into the partnership by investing P150,000.
Instructions: Compute for the amount of asset revaluation or bonus in each of the following
independent cases. Journal entries are not required. Use the space provided for the
supporting computations in good form (Exampr: No asset revaluation; Bonus to new
partner ⸺ P30,000). Corazon is allowed:
1. 1/5 interest in the partnership with a capital credit equal to his investment.
2. 1/5 interest in the partnership with total agreed capital of P650,000.
3. 30% interest in the partnership with the total agreed capital of P650,000.
4. 15% interest in the partnership with the total agreed capital of P750,000.
5. 1/5 interest in the partnership, bonus being allowed.
185
Problem B
Partners Cueva, Costal and Cison share profits and losses 4:2:4 respectively. The statement of
financial position at September 30,2014 follows:
Assets
Liabilities and Capital
Cash
P 80,000
Liabilities
Other Assets
720,000
Cueva, Capital
148,000
Costal, Capital
260,000
Cison, Capital
192,000
P800,000
P200,000
Total Liabilities and Capital
P800,000
The assets and liabilities are recorded at their current fair values. Cino is to be admitted as a new
partner with a 20% capital interest and a 20% share of profits and losses on exchange for a cash
investment. Asset revaluation or bonus will not be considered.
Instructions: Determine the amount to be the contributed by Cinco.
Problem C
Canete desires to purchase a one-fourth capital and profit and loss interest in the partnership of
Carandang, Cojuangco and Capistrano. The three partners agree to sell Canete one-fourth of their
respective capital and profit and loss interest in exchange for a total payment of P120,000. The
capital accounts and the respective percentage interests in profits and losses immediately before
the sale to Canete are as follows:
Capital
%Interest in Profit & Losses
Carandang
P 240,000
60%
Cojuangco
120,000
30%
Capistrano
60,000
10%
P 420,000
100%
Asset revaluation is to be undertaken prior to the admission of Canete.
Instructions: Determine the capital balances of Carandang, Cojuango, and Capistrano, after
the admission of Canete.
186
CHAPTER 5
CHANGE IN CAPITAL STRUCTURE BY
WITHDRAWAL, RETIREMENT, DEATH OR
INCAPACITY OF A PARTNER
LEARNING OBJECTIVES
1. Discuss and understand the accounting procedures in recording the retirement or
withdrawal of a partner by sale of interest to a new partner or to the continuing or
remaining partners.
2. Discuss and understand the accounting procedures in recording the retirement or
withdrawal of a partner by sale of interest to the partnership.
3. Discuss and understand the accounting procedures in recording the dissolution of a
partnership due to death or incapacity of a partner.
REVIEW OF THE CHAPTER
CHANGE IN
CAPITAL STRUCTURE



Retirement or
Withdrawal
Sale of Interest to a
New
Partner
or
Continuing Partner
Equal to capital interest
At less than capital
interest
At more than capital
interest


Retirement or
Withdrawal
Sale of Interest to the
Partnership
Equal to capital interest
At less than or more
than capital interest
 Bonus method
 Asser
Revaluation
Method


Death or Incapacity
of a Partner
Equal to capital interest
At less than or more
than capital interest
 Bonus method
 Asser
Revaluation
Method
187
CHANGE IN CAPITAL STRUCTURE BY WITHDRAWAL OR RETIREMENT OF A
PARTNER
The partnership may allow any of its partners to withdraw or retire from the firm. The business
may continue after such withdrawals; on the other hand, the interest of the retiring or
withdrawing partners may be:
1. Sold to a new partner (outsider)
2. Sold to the continuing (remaining) partners
3. Sold to the partnership
SALE OF INTEREST TO A NEW PARTNER
With the consent of the remaining partners, the retiring partner may sell his interest to an
outsider. The sale is recorded in the same manner as in the admission of a new partner by
purchase. The partnership recognizes only the transfed of capital interest from the retiring partner
to the new partner. Any gain or loss form the sale is a personal gain or loss of the retiring partner.
SALE OF INTEREST TO CONTINUING PARTNERS
The interest of the retiring partner ay be acquired by any of the continuing partners. The
transaction is recorded in the same manner as the sale of interest to a new partner. The
partnership recognizes only the transfer of capital interest from the retiring partner to the
acquiring partner or partners.
SALE OF INTEREST TO THE PARTNERSHIP
A retiring partner may sell his capital interest to the continuing partners through the partnership.
The partnership has the obligation to make payment to the retiring partner either by:
1. payment in cash;
2. transfer of noncash assets: or
3. recognition of a liability for the full or the balance of the unpaid interest of the retiring
partner.
The purchase price or amount of settlement by the partnership to the retiring partner may be:
1. equal to the interest of the retiring partner (at book value)
2. less than the interest of the retiring partner (at less than book value)
3. more than the interest of the retiring partner (at more than book value)
188
When the payment to the retiring partner is less than or more than his capital interest, the
difference between the purchase price and the capital interest may be accounted for using:
1. bonus method
2. asset revaluation method
ACCOUNTING PROBLEMS INVOLVED IN THE
RETIREMENT OF A PARTNER
The interest in the partnership of a retiring partner must be established upon his retirement. A
partner’s interest in the partnership is affected by his investments, withdrawals, share on
partnership profit or losses, loans to the partnership and loan from the partnership. Following are
the accounting problems involved in determining the capital interest of a retiring partner:
1. Determination if the profit or loss from the beginning of the accounting period to the date of
withdrawal or retirement and the distribution of such profit or loss.
2. Closing of the partnership books.
3. Correction of accounting errors in prior periods like overstatement or understatement of
inventories, excessive depreciation charges and failure to provide adequately for doubtful
accounts.
4. Revaluation of partnership assets to current values.
5. Recording of bonus brought about by the retirement of a partner.
6. Settlement of the interest of the retiring partner.
CALCULATION OF RETIRING PARTNER’S INTEREST
The interest of a retiring partner must be established upon retirement, as mentiones earlier. The
following are considered in the determination of such interest: investments, withdrawals, share in
profit and losses to the date of retirement, loan, advances and the revaluation of partnership
assets to current values.
189
The following schedule will be helpful in determining the interest of a retiring partner:
Investments
- Withdrawals
+ Share in partnership profit to date of retirement or
- Share in partnership losses to date of retirement
+ Loans and advances to the partnership or
- Loans and advances from the partnership
+ Revaluation of assets increasing their recorded values or
- Revaluation of assets decreasing their recorded values
Interest upon retirement
Illustrative Problem A: The statements of financial position of the partnership of Dy, David
and Diaz on December 31, 2014 follows:
Assets
Cash
Other Assets
P 110,000
30,000
P 140,000
Liabilities & Capital
Liabilities
Dy, Capital
David, Capital
Diaz, Capital
Total Liabilities and Capital
P 20,000
20,000
40,000
60,000
P 140,000
The partners share profits and losses in the ratio of 4:2:4. On July 1, 2015, Diaz asked to be
allowed to withdraw from the partnership. The partners decided to close the books as of this date
so as to determine tha capital interest of Diaz. Profit for the six months ended amounted P60,000
while drawings of Dy, David and Diaz amount to P4,000, P6,000 and P2,000, respectively.
Profits and losses are to be shared equally after the retirement of Diaz.
The following entries will be prepared prior to the retirement of Diaz from the partnership:
1.
Income Summary
60,000
Dy, Capital
David, Capital
Diaz, Capital
Net income from Jan.1 to June 30
divided in the ratio of 4:2:4
2.
24,000
12,000
24,000
Dy, Capital
4,000
David, Capital
Diaz, Capital
Dy, Drawing
David, Drawing
6,000
2,000
4,000
6,000
190
Diaz, Drawing
2,000
After considering the preceding entries, the capital interest of the partners as of July 1, 2015 may
now be computed as follows:
Capital balance, Dec. 31, 2014
Share in profit from Jan 1, - June 30
Withdrawals
Capital balance, July 1, 2015
P60,000
24,000
( 2,000)
P82,000
P20,000
24,000
( 4,000)
P40,000
P40,000
12,000
( 6,000)
P46,000
The entries to record the retirement of Diaz using several assumptions are illustrated below and
on the succeeding pages.
Assumption 1 – Sale of interest to a new partner. Diaz sold his interest to Duque for
P100,000.
Diaz, Capital
Duque, Capital
82,000
82,000
The gain of P18,000 (P100,000 – P82,000) is a personal gain of Diaz since the sale of the interest
to an outsider is a personal transaction between the buying partner and Diaz.
Assumption 2 – Sale of interest to the continuing partners. Diaz sold his interest to Dy and
David for P75,000; the interest being divided equally by the remaining partners. Profits and
losses after the retirement of Diaz will be divided equally.
Diaz, Capital
Dy, Capital
David, Capital
82,000
41,000
41,000
The loss of P7,000 (P75,000 – P82,000) is a personal loss of Diaz since the sale of the interest to
Dy and David is a personal transaction among the partners.
Assumption 3- Sale of interest to the partnership. Diaz sold his interest to the partnership. The
partners agreed to make immediate cash settlement to the retiring partner. Profits and losses after
the retirement of Diaz will be divided equally.
Case A – Settlement to retiring partner is equal to his capital interest. The partnership
paid Diaz P82,000.
Diaz, Capital
Cash
82,000
82,000
This settlement involves no bonus nor asset revaluation.
191
Case B – Settlement is less than the capital interest of the retiring partner (at less than
book value). The partnership paid Diaz P76,000 which is P6,000 less than his capital
interest of P82,000.
The difference between the amount of payment and capital interest of Diaz may now be
considered as:
1.
2.
Bonus to the remaining partners (Bonus Method)
Asset Revaluation reducing the capital accounts of all the partners
(Asset Revaluation Method)
The entries to record the retirement of Diaz using the two alternative solutions follow:
Bonus Method
Diaz, Capital
Cash
Dy, Capital
David, Capital
P6,000 x 4/6 = P4,000
P6,000 x 2/6 = P2,000
82,000
76,000
4,000
2,000
The bonus of P6,000 is shared by the remaining partners in accordance with their original profit
and loss ration of 4:2
Asset Revaluation Method
Dy, Capital
David, Capital
Diaz, Capital
Other Assets
6,000
3,000
6,000
15,000
The difference of P6,000 is only a portion of the asset revaluation. The total amount of asset
revaluation is calculated by dividing the difference of P6,000 by the retiring partner’s fraction of
interest or P6,000 ÷ 4/10 = P15,000. Thus, the reduction from the capital balances of the partners
will be computed as follows:
Dy
= P15,000 x 4/10 = P6,000
David = P15,000 x 2/10 = P3,000
Diaz = P15,000 x 4/10 = P6,000
192
After the preceding entry, the capital balance of Diaz is 76,000 and payment to him will be
recorded as follows:
Diaz, Capital
Cash
76,000
76,000
A compound entry may be made as follows:
Dy, Capital
David, Capital
Diaz, Capital
Cash
Other Assets
6,000
3,000
82,000
76,000
15,000
Case C – Settlement is more than the capital interest of the retiring partner ( at more than
book value). The partnership paid Diaz P85,000 which is P3,000 more than his capital interest of
P82,000.
The difference between the amount of payment and the capital interest of Diaz may now be
considered as:
1.
Bonus from the remaining partners ( Bonus Method)
2.
Asset Revaluation reducing the capital accounts of all the partners
(Asset Revaluation Method)
The entries to record the retirement of Diaz using the two alternative solutions follow:
Bonus Method
Diaz, Capital
Dy, Capital
David, Capital
Cash
P3,000 x 4/6 = P2,000
P3,000 x 2/6 = P1,000
82,000
2,000
1,000
85,000
The bonus of P3,000 is shared by the remaining partners in accordance with their original profit
and loss ratio of 4:2
Asset Revaluation Method
193
Other Assets
7,500
Dy, Capital
3,000
David, Capital
1,500
Diaz, Capital
3,000
The difference of P3,000 is only a portion of the asset revaluation of the partnership. The total
amount of asset revaluation is calculated by dividing the difference of P3,000 by the retiring
partner’s fraction of interest or P3,000 ÷ 4/10 = P7,5000. This, the increase in the capital
balances of the partners will be computed as follows:
Dy
=P7,500 x 4/10 = P3,000
David =P7,500 x 2/10 = P1,500
Diaz = P7,500 x 4/10 = P3.000
After the entry recording the asset revaluation, the capital balance of Diaz is P85,000 and
payment to him will be recorded as follows:
Diaz, Capital
85,000
Cash
85,000
A compound entry may be made as follows:
Other Assets
Diaz, Capital
Cash
Dy, Capital
David, Capital
7,500
82,000
85,000
3,000
1,500
COMPARISON BETWEEN the BONUS AND ASSET REVALUATION METHOD
The two methods discussed may offer different results as to capital balances of the remaining
partners because of the effect on depreciation of the asset revaluation.
To illustrate the effects of the bonus and asset revaluation method, we will use the information
under Assumption 3 – Case C, i.e., the payment to the retiring partners is more than his capita
interest. The schedule below shows the comparison between the bonus and the asset revaluation
method:
Assets
Revaluation
Balances after retirement of Diaz under the
bonus method
Balances after retirement of Diaz under the
asset revaluation method
P 7,500
Depreciation on asset revaluation method (divided equally) (7,500)
Balances after depreciation
Net advantage (disadvantage) of using the bonus method
Dy,
Capital
David
Capital
P38,000
P45,000
P43,000
(3,750)
P39,250
(P 1,250)
P47,500
(3,750)
P43,750
P 1,250
Based on the above analysis, David will prefer the bonus while Dy will prefer the asset
revaluation method.
194
CHANGE IN CAPITAL STRUCTURE BY DEATH OR INCAPACITY OF A PARTNER
The death or incapacity of a partner legally dissolves the old partnership since the partner ceases
to be associated in the carrying on of the business. The remaining partners may continue
operations based on a new contract or Articles of Co-Partnership. The interest of the deceased or
incapacitated partner must be determined by the partnership In order to make necessary
settlement with his legal representatives. In case the business is continued without immediate
settlement, the legal representative of the deceased is considered as an ordinary creditor and is to
receive an amount equal to the interest and profits attributable to this interest.
The following accounting problems are encountered in case of death or incapacity of a partner:
1. Determination of the profit or loss from the beginning of the accounting period to the
date of death or incapacity and the distribution of such profit or loss.
2. Closing of the books of the partnership. Partnership agreement, however, may provid3
that the books need not be closed and net income for the fraction of the accounting period
to the date of death or incapacity be determined.
3. Correction of prior year’s if there is any.
4. Revaluation of partnership assets to arrive at current values.
5. Recording of bonus.
6. Settlement of the interest of the deceased or incapacitated partner.
The above problems are similar to those of withdrawal or retirement of a partner. Thus,
accounting for settlement to the deceased or incapacitated partner is the same as that of
withdrawal or retirement.
REVIEW OF THE LEARNING OBJECTIVES
1. Discuss and understand the accounting procedures in recording the retirement or
withdrawal of a partner by sale of interest to a new partner or to the continuing or
remaining partners. A retiring partner may sell his interest to a new partner or to the
remaining partners. The sale of interestis a personal transaction between or among the
partners and any indicated gain or loss is a personal gain or loss of the retiring partner.
However, before recording the sale, the capital interest of the retiring partner should be
updated. The sale is then recorded by transferring the capital interest of the retiring
partner to the acquiring partner.
195
2. Discuss and understand the accounting procedure in recording the retirement or
withdrawal of a partner by sale of interest to the partnership. The retiring partner may sell
his capital interest to the partnership, which then pays the former either in cash or in the form of
noncash assets. The capital interest of the retiring partner should be established on the date of his
retirement. The partnership may pay him an amount that is equal to his capital interest, at more
than his capital interest, or at less than his capital interest. When the payment is not equal to his
capital interest, the difference may be accounted under any of the following methods: (1) bonus
method (either to the retiring partner or to the remaining partners); or (2) asset revaluation
accruing to all the partners.
3. Discuss and understand the accounting procedures in recording the dissolution of a
partnership due to death or incapacity of a partner. The dissolution of a partnership due to
death or incapacity of a partner is accounted for in almost the same manner as is the retirement of
a partner. Thus, the capital interest of the partner up to date of his incapacity or death should be
established. Settlement is then made to the heirs of the partner or to the legal representatives at
an amount that may be equal to the partner’s capital interest, at more than the capital interest, or
at less than the capital interest. When the settlement is not equal to the deceased or incapacitated
partner’s capital interest, the difference is accounted for under any of the following methods: (1)
bonus method; or (2) asset revaluation method.
GLOSSARY of ACCOUNTING TERMINOLOGIES
Bonus method - a case in retirement or death of a partner wherein the excess of amount paid
over the capital interest of the retiring or deceased partner is recorded as a decrease in the capital
balance of the remaining partners (bonus to retiring or deceased partner from the remaining
partners); the excess of the retiring or deceased partner’s capital balances of the remaining
partners ( bonus to the remaining partners from the retiring or deceased partner).
Retired or deceased partner’s interest – the capital interest of the partner on date of retirement
or death. It is determined by considering additional investment, withdrawals, share in profits and
losses to date of retirement or death, loans, advances and the revaluation of partnership assets to
current values.
Asset revaluation method - the asset revaluation is recorded prior to recording the settlement
with the retiring or deceased partner. The asset revaluation is determined by dividing the
difference between the retiring or deceased partner’s capital interest and the amount of
settlement by his profit and loss sharing ratio.
196
DISCUSSION QUESTIONS
1. What causes a change in the capital structure of a partnership?
2. What are the accounting problems involved in the retirement or withdrawal of a
partner?
3. How do you determine the interest of a withdrawing or retiring partner? Of a
deceased or incapacitated partner?
4. What are the alternatives available to the withdrawing or retiring partner as to the
settlement of his interest?
5. Identify the similarities and differences of the following:
a. Retiring partner selling his interest to a new partner
b. Retiring partner selling his interest to continuing partners
c. Retiring partner selling his interest to the partnership
6. What are the different methods of accounting for the payment to the retiring partner at
less than and at more than the book value?
7. A retiring partner’s interest is always settled in cash. True or false? Explain your
answer briefly.
8. Why is asset revaluation always accounted at its 100% value?
197
EXCERCISES
Exercise 5 – 1 (Retirement of a Partner: Sale f interest to the Partnership: Payment More
Than Capital Interest)
Dantes, Dungca and Dee are partners sharing profits in the ratio of 3:2:1, respectively Capital
accounts are P50, 000, P30, 000 and P20, 000 on December 31, 2014, When Dee decides to
withdraw. The partnership paid Dee P25, 000 for interest. Profits after the retirement of Dee are
to be shared equally.
Instruction:
1.
Give two possible entries to record Dees’ retirement.
2.
Which method is to be preferred by Dantes? What is the amount of gain to Dantes
through the use of this method as compared with the other alternative?
Exercise 5 – 2 (Retirement of a Partner: Sale of Interest to the Partnership)
Datrit, Dayag, and Diesta are partners in the Triple B partnership. Their capital balances on
October 1, 2014 are as follows: in the ratio of 3:1:1. Diesta is retiring from the partnership on
this date.
Instructions: Prepare jouranal entries to record Diesta’s Withdrawal according to each of the
following independent assumptions:
1.
Diesta is paid P90, 000 and no asser revaluation is recorded.
2.
Diesta is paid P96, 000 and asset revaluation is recorded.
Exercise 5 – 3 (Retirement of a Partner: Sale of Interest to the Partnership)
Diara is retiring from the partnership with Ditas and Dulce as of July 1, 2014 and is paid P33,
000. Their capital balances as of January 1, 2014 and share in profits are as follows:
Ditas
P 35, 000
30%
Dulce
50, 000
30%
Daria
25, 000
40%
P 110, 000
100%
198
Daria’s drawing for the first half of 2014 amounted to 4, 000 and net income for the first half of
2014 amounted to 20,000. The partners share profits and losses equally after the retirement of
Daria.
Instruction: Make the entry ot entries incidental to the retirement of Daria under each of the
following assumptions.
1.
Capital increases through Asset Revaluation account is recorded
2.
The additional payment to the retiree is a bonus from the remaining partners.
3.
Which of the two methods is to be preferred by Ditas?
Exercise 5 – 4 (Retirement of a Partner: Sale of Interest to the Continuing Partners Sale of
Interest to the Partnership)
The partners of 3D Partnership agree to the withdrawal of Dolor. Prior to the withdrawal of
Dolor, the partners had the following capital balances: Damian – P32, 000; Damaso – P48, 000;
Dolor – P40, 000. Prior to the withdrawal of Dolor, the partners shared profits and losses in the
ratio 3:5:2
Instruction: Prepare the entry on entries necessary to record the withdrawal of Dolor from the
partnership under each of the following independent assumptions:
1.
Each of the remaining partners will purchase 50% of the interest of Dolor for P25, 000.
2.
The partnership will purchase the interest of Dolor for P32, 000; bonus method is used.
3. The partnership will purchase the interest of Dolor for P46, 000; asset revaluation prior to
the retirement of Dolor being recognized.
Exercise 5 – 5 (Retirement of a Partner: Sale of Interest to the Remaining Partners; Sale of
Interest to the Partnership)
The partne4rship of Dencio, Doctore, Domingo, and Dizon has been in operation for two years
with the partners sharing profits and losses in the ratio of 40%, 20%, 20%, 20% respectively.
During the past year it has been become apparent that Domingo and Dizon are not compatible
and Domingo has decided to withdraw from the partnership as of the end of the year at the
urging of Dencio and Doctor. Domingo wants P90, 000 for his share of capital. The balances in
the capital accounts at the end of the year are:
Dencio
P
102, 000
Doctor
60, 000
Domingo
70, 000
Dizon
48, 000
199
Instruction: Prepare the journal entry for the withdrawal of Domingo under each of the
following assumption:
1. The partners agree to Dizon’s purchasing Domingo’s interest.
2. The partnership will acquire Domingo’s interest for P90, 000, which will use the bonus
method.
3. The partnership will acquire Domingo’s interest for P90, 000, which will be paid in five
annual instalments of P18, 000, plus interest of 10%. The partners feel that the price
Domingo will accept for the capital share is a fair measure of the worth of the business.
Exercise 5 – 6 (Retirement of a Partner: Sale of Interest to the Partnership)
Dimla and Distor wish to purchase the partnership interest of their partner Daza at June 30, 2014.
Partnership assets are to be used to purchase Daza,s partnership interest. The statement of
financial position for the partnership on this date shows the following:
Dimla, Distor, and Daza Partnership
Statement of the Financial Position
June 30, 2014
Liabilities and Capital
Assets
Cash
P
21, 600
Liabilities
Receivables (net)
14, 400
Dimla, Capital
48, 000
Inventory
12, 000
Distor, Capital
24, 000
Equipment (net)
54, 000
Daza, Capital
12, 000
P
102, 000
P
P
18, 000
102, 000
The partners share earnings in the ratio of 3:2:1
Instruction: Prepare the entry to record the retirement of Daza under each of the following
assumptions:
1. Daza is paid P14, 400 and the excess payment over the amount in Daza’s csapital account
is viewed as a bonus to Daza.
2. Daza is paid P9, 600 and the difference is viewed as a bonus to Dimla and Distor.
200
PROBLEMS
Problems 5 – 1 (Retirement of a Partner under Various Assumptions)
Delfin, Diokno, and Decena have been partners for over 20 years, sharing profits and losses
equally. Delfin is scheduled to retire from the partnership. Since the partnership agreement does
not include any provisions for the retirement of a partner, several alternative payments for
Delfin’s interest are being considered. The capital balances of the partners are a follows: Delfin –
P200, 000; Diokno – P250, 000; Decena – P150, 000.
Instructions: Prepare the entry or entries to record the retirement of Delfin under each of the
following independent assumptions:
1. Delfin is paid cash equal to the book value of his interest.
2. Delfin is paid P260, 000 cash for his interest; excess payment is treated as a bonus.
3. Delfin is paid P260, 000 cash for his interest; excess payment is treated as asset
revaluation.
4. Delfin is paid P160, 000 cash for his interest; excess of his capital interest over the
amount paid is treated as a bonus.
5. Delfin is paid P175, 000 cash for his interest; assets recorded in the books of the
partnership should be reduced by the amount relating to all the partners.
Problem 5 – 2 (Retirement of a Partner; Sale of Interest to the partnership; Adjustment to
Asset Values)
Dahlia is to retire from the partnership of Danao and Associates as of July 31, 2014, the end of
the fiscal year. After closing the books, the capital balances of the partners are as follows:
Danao
P
40, 000
Daylan
30, 000
Dahlia
25, 000
They share net income and losses in the ratio of 2:1:1. The partners agree that the merchandise
inventory be increased by P7, 000 and that the allowance for doubtful accounts be reduced by
P1, 000. Dahlia agrees to accept an interest bearing note for P25, 000 in partial settlement of her
ownership equity. The remainder of her claim is to be paid in cash. Danao and Daylan are to
share equally in the net income or loss of the new partnership.
201
Instructions: Presents entries in the journal form to record:
1. The adjustments of the assets to bring them into agreement with current fair price.
2. The withdrawal of Dahlia.
Problem 5 – (Retirement of a Partner; Sale Interest to the Partnership)
Partners, Damo, Dayan, Datu have capital balances of P120, 000, P70, 000, and P80, 000
respectively on December 31, 2014. The partners share profits and losses in the ratio of 3:2:5,
respectively. During the calendar year 2015, the partnership suffered a loss o P40, 000 and each
partner had withdrawn P25, 000 in cash from the partnership. Dayan is unhappy with the
operations of the partnership and has decided to withdraw as of December 31, 2015.
Instructions:
1. Determine the balance of the partners’ capital accounts prior to the withdrawal of Dayan.
2. Dayan will accept P30, 000for his interest from the partnership. Prepare the journal entry
for the withdrawal of Dayan if the reason for Dayan being willing to accept less than his
capital balance is that the inventory of the partnership is overvalued.
3. The partners agree to the partnership buying Dayan’s interest for P47, 000. Prepare
journal entries for the withdrawal of Dayan under each of the following independent
assumptions:
a. Increase in capital balances for the asset revaluation.
b. Dayan is receiving a bonus.
Problem 5-4 (Retirement of a Partner under Various Cases)
On January 1, 2014 Dancel decided to retire from the partnership of Daet, Dais, and Dancel, who
share profits and loses in the ratio 3:2:1, respectively. The condensed statement of financial
position shown on the next page presents the account balances immediately before and, for seven
independent cases, after Dancel’s retirement.
202
Accounts
Asset
Balances
prior to
Dancel’s
Retirement
Cash
Other Assets
Total Assets
Liabilities and Capital
P200, 000
P400, 000
P600, 000
Liabilities
Daet, Caoital
Dais, Capital
Dancel, Capital
Total Liabilities and Capital
P 120, 000
160, 000
180, 000
140, 000
P 600, 000
Balances after Dancel’s Retirement
Case 1
Case 2
Case 3
P 40, 000
400, 000
P440, 000
P 120, 000
148, 000
172, 000
-0P440, 000
P 200, 000
400, 000
P 600, 000
P 70, 000
400, 000
P 470, 000
P120, 000
300, 000
180, 000
-0P600, 000
P120, 000
166, 000
184,000
-0P470, 000
Case 4
Case 5
Case 6
Case 7
Cash
Other Assets
Total Assets
Liabilities and Capital
P 32, 000
468, 000
P 500, 000
P 120, 000
440, 000
P 560, 000
P 120, 000
P 200, 000
400, 000
400, 000
P 600, 000
P 600, 000
Liabilities
Daet, Capital
Dais, Capital
Dancel, Capital
Delia, Capital
Total Liabilities and Capital
P 120, 000
184, 000
196, 000
-0-0P 500, 000
P120, 000
220, 000
220, 000
-0-0P560, 000
P120, 000
160, 000
320, 000
-0-0P600, 000
Assets
P120, 000
160, 000
180, 000
-0140, 000
P600, 000
Instructions: Prepare the necessary journal entries to record the retirement of Dancel from the
partnership for each of the seven independent cases.
Problem 5 – 5 (Retirement of a Partner; Sale of Interest to the Partnership)
David, Dizon and Duque have been partners in a law office for 15 years. Dizon has decided to
retire and wishes to withdraw from the partnership. To facilitate Dizon’s withdrawal, the
partnership closed its books and prepares the statement of financial position shown below:
Assets
Cash
Accounts Receivable (net)
Books
Other Assets
150, 000
P318, 000
72, 000
120, 000
90, 000
Accounts Payable
David, Capital
Dizon, Capital
Duque, Capital
P 60,000
150, 000
240, 000
203
Total Assets
P600, 000
Total Liabilities & Capital
P600, 000
David, Dizon and Duque share profits and losses in the ratio of 3:4:3, respectively
Instructions: Prepare the necessary journal entries on the books of the partnership to record the
withdrawal of Dizon under each of the following assumptions:
1. The partnership agrees that the Books and Other Assets are undervalued by P72, 000 and P 48,
000 respectively. Dizon is to receive a lump sum cash payment.
2. Dizon is to receive P120, 000 now and P 108, 000 in monthly instalment of P12, 000 each. Use
the bonus method.
3. Dizon is to receive P180, 00 now and P18, 000 at the end of each of the nest six months.
a. Use the bonus method.
b. Use the asset revelation method.
Problem 5 – (death of a Partner; Retirement of a Partner; Statement of Changes in Partner’s
Equity)
Partners Danao, Diaz, Dolor and Dungca share profits in the ratio of 40%, 30%, 15% and 15%
respectively. The partnership agreement provides that in the event of the death of a partner, the firm
shall continue until the end of the fiscal period. Profits shall be considered to have been earned
proportionately during the period and the de3ceased partner’s capital shall be adjusted by his share of
the profit or loss to the date of death. From the date of dearth until the date of settlement with the
estate, there shall be added interest of 10% computed on the adjusted capital. The remaining partners
shall continue to divide profits in the old ratio. Payment to the estate shall be made within two years
from the date of the partner’s death. As of January 1, 2014, the capital balances of the partners were as
follows.
Danoa
Diaz
Dolor
Dungca
P 84, 000
75, 000
48, 000
45, 000
P 252, 00
Dungca died on September 30, 2014. The books of the partnership were closed as of December
31, arriving at a credit balance of P45, 000 for the income Summary account.
On December 31, 2014, Dolor notified the remaining partners that he was retiring from the
partnership and was willing to accept in settlement of his interest the balance of his capital
account after the distribution of profits less 25%.
The remaining partners accepted his offer and issued a 120-day, 10% note to Dolor in payment
of his interest.
Instruction: Make all the necessary entries to record the above transactions on the books of the
partnership and prepare the statement of partner’s equity for 2014.
204
MULTIPLE CHOICE
MC 5-1
When Delfin retired from the partnership of Delfin, Delan and Desta, the final
interest exceeded Delfin’s capital balance. Under the bonus method, the excess
a. had no effect on the capital balances of Delan and Desta
b. was recorded as asset revaluation
c. reduces the capital balances of Delan and Desta
d. was as expense
MC 5-2
The accounting treatment for the sale of the interest of a retiring partner to an
outsider or to the remaining partners in the same as
a. admission of a partner by purchase
b. admission of a partner by investment
c. sale of interest to the partnership
d. both A and B
MC 5-3
When the partnership purchases a retiring partner’s interest, the settlement to the
retiring partner includes the following except
a. cash
c. depreciation expense
b. equipment
d. notes payable
MC 5-4 The following should be considered in determining the interest of a
retiring except
a. payable to a co-partner
c. share in asset adjustment
b. receivable from the partnership
d. share in profits
MC 5-5
When a partnership purchases the interest of a retiring partner at less than book
value, there must be a
a. bonus to remaining partners
b. bonus to retiring partner
c. bonus to remaining partners/negative asset revaluation or both
d. bonus to retiring partner/positive asset revaluation or both
MC 5-6
Dayrit, a partner in an accounting firm decided to withdraw from the partnership.
Dayrit’s share of the partnership profits and losses was 30%. Upon withdrawing
from the partnership, he was paid P71,000 in final settlement of his interest. The
total of the partners’ capital accounts, before asset revaluation, prior to Dayrit’s
withdrawal wa P210,000. After his withdrawal, the remaining partners’ capital
accounts, excluding their share of the asset revaluation, totaled P160,000. The
total amount of the asset revaluation recognized was
a. P21,000
c. P70,000
b. P24,000
d. P80,000
MC 5-7
The partnership of Doctor, Dino and Dolor has reached an impasse as Dolor is no
longer willing to contribute the amount of time and effort to the partnership that
he has previously given. The partners share profits and losses in the ratio of 3:3:4,
respectively. The partners have the following capital balances just prior to Dolor’s
withdrawal from the partnership.
205
Doctor
P45,000
Dino
35,000
Dolor
25,000
If Dino purchases Dolor’s interest from Dolor from P32,000 and no asset
revaluation is recorded, the balance of Dino capital account immediately after the
withdrawal of Dolor is
a. P55,000
c. P61,000
b. P60,000
d. P67,000
MC 5-8
Using the information in MC 5-7 and assuming that the partners agree that the
partnership will purchase Dolor’s interest for P33,000 and no asset revaluation is
to be recorded, the balance of Doctor’s capital account immediately after the
withdrawal of Dolor is
a. P37,000
c. P39,600
b. P39,000.
D. P41,000
MC 5-9
Using the information in MC 5-7 and assuming the partners agree that the
partnership will purchase Dolor’s interest for P25,000 and will record no bonus
nor asset revaluation, the balance of Dino’s capital account immediately after the
withdrawal of Dolor is
a. P35,000
c. P41,000
b. P39,000
d. P43,000
MC 5-10
Using the information in MC 5-7 and assuming the partners agree that the
partnership will purchase Dolor’s interest for P33,000 and will revalue the
partnership based on the price Dolor is willing to accept for his interest in the
partnership, the balance of Dino’s capital account immediately after the
withdrawal of Dolor is
a. P39,000
c. P41,000
b. P40,000
d. P43,000
MC 5-11
The partnership of Digna, Dimla and Distor have capital account balance of:
Digna, P70,000; Dimla, P100,000; Distor, P80,000. Their profit and loss ratios are
30%, 50% and 20% respectively. With the consent and knowledge of the Digna
and Dimla, Distor sold his interest to Diesta. Distor was paid P92,000 in cash. The
new capital balances would be
Digna
Dimla
Diesta
a. P70,000
P100,000
P92,000
b. 73,800
106,000
82,400
c. 70,000
100,000
80,000
d. 70,000
100,000
172,000
MC 5-12
The statement of financial position as of June 30, 2014 for the partnership of
Dizon, Dionisio and Divino shows the following information:
Total Assets
P720,000
Dizon, Loan
P 40,000
Dizon, Capital
166,000
Dionisio, Capital
154,000
206
Divino, Capital
360,000
Total Liabilities and Capital
P720,000
It was agreed among the partners that Dizon retires from partnership and was
further agreed that the assets be adjusted to their fair value of P816,000 as of June
30, 2014. The partnership would pay Dizon P242,000 cash for Dizon’s
partnership interest and includes the payment of loan to Dizon.
Dizon, Dionisio, and Divino share profits and losses 25%, 25% and 50%
respectively. What is Divino’s capital balance after the retirement of Dizon
a. P240,000
c. P408,000
b. P400,000
d. P720,000
MC 5-13
Bianca, Mariel and Toni are partners with capital balances of P100,000, P140,000
and P180,000, respectively. They share profits and losses in the ratio of 20:40:40.
Toni decides to withdraw from the partnership receiving P220,000 including a
loan to the partnership in the amount od P10,000. Assuming the use of the asset
revaluation method, how mush is the amount of asset revaluation increase
(decrease)?
a. P30,000
c. (P30,000)
b. P75,000
d. (P75,000)
MC 5-14
Piolo, Lloyd and Sam are partners with capital balances of P40,000, P50,000 and
P60,000, respectively. They share profits and losses in the ratio 40:40:20%,
respectively. After on year, the operation resulted in a net profit of P20,000.
Withdrawals made during the year are as follows: P10,000, P5,000 and P15,000,
respectively. Sam retired from the partnership and was paid P80,000 for his
interest. Assuming no asset revaluation was recorded, the excess payment is a
a. bonus of P27,000 from the remaining partners
b. bonus of P27,000 to the retiring partner
c. bonus of P31,000 to the remaining partners
d. bonus of P31,000 to the retiring partner
MC 5-15
Using the information in MC 5-14 and assuming assets were revalued upon
retirement of Sam, the share of Piolo and Lloyd in the asset revaluation is
a. P54,000 and P27,000
c. P62,000 and P31,000
b. P54,000 and P54,000
d. P62,000 and P62,000
Test Material No. 18
Name
Year and Section
Rating
Date
Professor
TRUE or FALSE
Instructions: Encircle the letter T if the statement is true and the letter F if the
statement is false.
1. A partner who withdraw from the partnership may, without the consent of the
T
other partners, sell all or part of his interest to an outsider, to the other
partners, or to the partnership itself.
F
207
T
F
2. The death of a partner transfers his entire interest to his estate prior to
settlement by the partnership.
3. Any asset revaluation recognized upon the retirement of a partner is subjected
to depreciation on the remaining partners’ operations.
4. The withdrawal of an existing partner dissolves the partnership; but the
addition of a new partner does not.
5. Accounting for the withdrawal of a partner when one of the remaining
partners buys the retiring partners’ interest is not the same as when an outside
person buys a retiring partners’ interest.
6. The partnership must measure net income or net loss for the fraction of the
year up to the withdrawal date of withdrawing partner and allocate profit or
loss according to the existing ratio.
7. Withdrawal by a partner at less than book value of his capital interest results
in a loss to the other partners allocated according to their profit and loss ratio.
8. When a retiring partner paid more than his capital interest without recording
asset revaluation, the excess payment is treated as a bonus to the retiring
partner from the remaining partners.
9. The retirement of one of the partners automatically dissolves the partnership.
10. The sale of interest of the retiring partner to a new partner will require the
recognition of a gain or loss on the partnership books.
T 11. The determination of the capital interest of an incapacitated partner is similar
to the determination of the capital interest of retiring partner.
F
T
12. Upon death of one of the partners, the remaining partners may continue
operations based on the old Articles of Co-Partnership.
F
13. The asset revaluation at the time of retirement of one of the partners maybe
calculated by dividing the excess payment to the retiring partner ny his
fraction of interest.
F
T
T
F
14. The bonus to the retiring partner reduces the capital accounts of the remaining
partners in the partnership.
15. A retiring partners’ interest is always payable in the form of cash.
T
F
T
F
208
16. The retiring partners’ capital interest includes his share in the net income or
net loss of the partnership up to the date of retirement.
17. Loans made by the partnership to the partners, as recorded on the partnership
books, reduces the interest of the retiring partner.
18. The partnership may allow any of its partners to withdraw or retire from the
firm. After such withdrawal, the business may continue its operations.
19. The interest of retiring partner upon retirement need not be established;
anyway, the partner is already retiring.
20. Accounting for the sale of a retiring partner’s interest to the continuing
partners in the same as sale to the partnership.
Test Material No. 19
Name
Year and Section
Rating
Date
Professor
MULTIPLE CHOICE – Theory and Problems
Instructions: Encircle the letter of the best answer. Show supporting computations
in good form in a separate work sheet.
1. A partner may withdraw his interest at an amount equal to all of the following, except at:
a. book value
c. less than book value
b. future expected value
d. more than book value
2. When Alcantara retired from the partnership with Bores and Cruz, the final interest is
less than Alcantara’s capital balance. Under the bonus method, the difference
a. had no effect on the capital of Bores and Cruz
b. was recorded as asset adjustment
c. increase the capital balances of Bores and Cruz
d. was a revenue
3. A partner who withdraws his interest at book value receives assets
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a.
b.
c.
d.
equal to his capital interest
with indeterminate value
less than his capital
above his capital interest
4. The withdrawal of a partner of his interest at more than book value results in a
a. bonus from remaining partners
b. gain to remaining partners
c. loss to remaining partners
d. gain or loss depending on the tax basis
5. A partner retires from the partnership and the final settlement is more than his capital
interest. Under the bonus method, the excess
a. is recorded as an expense
b. increase the capital balances of the remaining partners
c. reduces the capital balances of the remaining partners
d. is recorded as gain
6. Daza, Diaz, and Ditas are partners with capital balances of P80,000, P120,000 and
P160,000, respectively, they share profits and losses in the ratio of 30:40:30. Diaz
decides to withdraw from the partnership. Diaz receives P150,000 in settlement of his
interest. If the bonus method is used, what is the capital balance of Ditas immediately
after the retirement of Diaz?
a. P140,000
c. P160,000
b. P145,000
d. P175,000
7. Using the information in No. 6 and assuming asset revaluation methos is used, what is
the capital balance of Ditas immediately after the retirement of Diaz?
a. P137,500
c. P190,000
b. P182,500
d. P200,000
8. Using the information in No. 6 assuming Diaz was paid P120,000, what is the capital
balance of Daza immediately after the retirement of Diaz?
a. P57,500
c. P80,000
b. P65,000
d. P95,000
9. Using the information in No. 6 assuming bonus method is used, what is the total
partnership capital immediately after the retirement of Diaz?
a. P120,000
c. P200,000
b. P130,000
d. P210,000
10. A partner retired from a partnership and received an amount which exceeds his capital
interest by P40,000. The remaining partners have profit and loss ratio of 3:1. Under the
bonus method, the excess payment will be shared by the remaining partners as follows:
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a. P24,000 and P16,000
b. P30,000 and P10,000
c. (P24,000 and P16,000)
d. (P30,000 and P10,000)
Test Material No. 20
Rating
Name
Date
Professor
Year and Section
At the end of the year 2014, the partnership of Donato, Dulay and Diones had the
following statement of financial position
Donato, Dulay and Diones Partnership
Statement of Financial Position
December 31, 2014
Assets
Cash
Receivables
Inventory
Equipment (net)
Total Assets
P110,000
50,000
40,000
70,000
P270,000
Liabilities and Capital
Liabilities
P 66,000
Donato, Capital
88,000
Dulay, Capital
60,000
Diones, Capital
56,000
Total Liabilities and Capital
P270,000
The partners share profits and losses in the ratio of 50% to Donato, 30% Dulay, and
20% to Diones. It is agreed that Diones is to withdraw from the partnership on this
date.
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Instructions: Listed below are a number of different situations involving the
retirement of Diones from the firm. For each case, prepare the entry or entries to
record the withdrawal of Diones.
1. Dulay buys one-fourth of Diones’ interest for P16,000 and Donato buys three-fourts for
P48,000
2. Diones, with the consent of the other partners, gives his equity to his friend, Dumlao,
who is accepted as a partner in the firm.
3. As analysis of the assets indicates that P8,000 of the receivables will probably prove
uncollectible and that inventories are understated by P12,000 and equipment is
understated by P26,000. It is agreed that the assets are to be adjusted accordingly and that
Diones is to be paid an amount equal to the book value of his adjusted equity.
4. Diones is paid P64,000 from the Partnership funds of his interest. The bonus indicated by
this payment is charged against the continuing partners.
5. Diones is given P20,000 cash and equipment having a book value of P52,000. The
partners agree that no revaluation of assets will be made.
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CHAPTER 6
PARTNERSHP LOUIDATION (LUMP-SUM)
LEARNING OBJECTIVES
1.
2.
3.
4.
Define partnership liquidation and identify its causes
Discuss the various problems encountered in partnership liquidation
Identify and differentiate the two types of partnership liquidation
Discuss and understand the accounting procedures under lump-sum liquidation
PREVIEW OF THE CHAPTER
PARTNERSHIP LIQUIDATION




Nature of Partnership
Liquidation
Definition
Causes of liquidation
Accounting problems in
partnership liquidation
Types of liquidation
• Lump-Sum
• Installment




Accounting Procedures in
Lump-Sum Liquidation
Realization
Distribution of gain or loss on
realization
Payment to creditors
Distribution of cash to
partners
INTRODUCTION
Dissolution of a partnership does not mean the formal termination of a business. Dissolution of a
partnership can be recognized as a change in the capital structure of a business as a new unit.
Partnership dissolution calling for the winding up of business affairs, called liquidation, shall be
discussed in this chapter. Here, the association of the partners for purposes of carrying on
activities in the usual manner is considered ended. Partners can only engage in activities leading
to final settlement of business affairs.
211
213
DISSOLUTION WITH LIQUIDATION
A partnership is liquidated when its business operations are completely terminated or ended.
The partnership assets are sold, the partnership creditors are paid, and the remaining assets, if
any, are distributed to the partners as a return of their investments.
Partnership dissolution with liquidation may be caused by any of the following factors:
1. The accomplishment of the purpose for which the partnership was organized.
2. The termination of the term/period covered by the partnership contract.
3. The bankruptcy of the firm.
4. 4 The mutual agreement among the partners to close the business.
Accounting problems involved in the liquidation of a partnership include:
1. Determination of the profit or loss from the beginning of the accounting period to the
date of liquidation and the distribution of such profit or loss.
2. Closing of the partnership books;
3. Correction of accounting errors in prior periods like overstatement or understatement of
inventories, excessive depreciation charges, and failure to provide adequately for
doubtful accounts; and
4. Liquidation of the business
In partnership liquidation, the assets and liabilities of the partnership are directly intertwined
with those of the individual partners' personal assets and liabilities because of the unlimited
liability of each partner. The priorities for creditors’ claims against the assets available to pay the
partnership liabilities involve two concepts the marshaling of assets and the right of offset.
Marshaling of assets involves the order of creditors' rights against the partnership's assets and
the personal assets of the individual partners. The order in which claims against the partnership's
assets will be marshaled is as follows:
1. partnership creditors other than partners;
2. partners' claims other than capital and profits, such as loans payable and accrued interest
payable; and
3. partners’ claim over the capital or profits, to the extent of credit balances in capital
accounts.
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The order of claims against the personal assets of the individual partners is as follows
214
1. personal creditors of individual partners; and
2. partnership creditors on unpaid partnership liabilities regardless of a partner’s capital
balance in the partnership.
Right of offset involves offsetting a deficit in a partner's capital (debit balance in the capital
account of a partner) against the loan payable to that partner. The loan payable to a partner has a
higher priority in liquidation than a partner’s capital balance but a lower priority than liabilities
to outside creditors.
DEFINITION OF TERMS
Dissolution - the termination of a partnership as a going concern; it is the termination of the life
of a partnership.
Winding up - the process of settling the business or partnership affairs; it is synonymous to
liquidation.
Termination - the point in time when all partnership affairs are ended
Liquidation- - the interval of time between dissolution and termination of partnership affairs; it
is also the process of winding up a business which normally consist of conversion of assets into
cash, payment of labilities and distribution of remaining cash among the partners.
Realization - the process of converting non-cash assets into cash.
Gain on realization - the excess of the selling price over the cost or book value of the assets
disposed or sold through realization.
Loss on realization - the excess of the cost or book value over the selling price of the assets
disposed or sold through realization.
Capital deficiency- the excess of a partner's share on losses over his capital.
Deficient partner - a partner with a debit balance in his capital account after receiving his share
on the loss on realization.
Right of offset - the legal right to apply part or all of the amount owing to a partner on a loan
balance against deficiency in his capital account resulting from losses in the process of
liquidation.
Partner's interest - the sum of a partner's capital, loan balance and advances to the partnership.
213
TYPES OF LIQUIDATION
1. Lump-sum liquidation or liquidation by totals. This is a type of liquidation whereby the
distribution of cash to the partners is done only after all the non-cash assets have been
realized, the total amount of gain or loss on realization is known, and all liabilities have been
paid.
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2. Liquidation by installment or piece-meal liquidation. This is a type of liquidation whereby
assets are realized on a piecemeal basis and cash is distributed to partners on a periodic basis
as it becomes available, that is, even before all non-assets are converted into cash.
PROCEDURES IN LUMP-SUM LIQUIDATION
When a partnership is to be liquidated, the books should be adjusted and balances of nominal
accounts are closed. The resulting profit or loss for the period is transferred to the partners'
capital account. Advances and withdrawals are closed to capital accounts since cash settlement
shall be based on the partners' capital account balances. The partnership is then ready to proceed
with liquidation as follows:
1. Sale of non-cash assets and distribution or allocation of gain or loss on realization among
the partners according to their residual profit and loss ratios (salary and interest factors
disregarded) unless liquidation ratios are specified in the partnership agreement.
2. Distribution of cash to creditors and partners. In this procedure, the provisions of the
marshalling of assets and the exercise of the right of offset are applied.
Liquidation expenses may be incurred to facilitate the immediate realization of non-cash assets.
Payment of liquidation expenses reduces cash and is recorded as a deduction from partners'
capital based on the partners' profit and loss ratios.
When realization of assets in the course of liquidation results in a loss, the loss is carried to the
capital accounts of the partners as a deduction. If a partner's capital account results in a debit
balance (known as capital deficiency), after the distribution of loss on realization, such can be
offset against any loan balance of the partner to the partnership. The amount to be offset shall be
the lower of the amount of the loan or the amount of the deficiency.
Cash can be distributed to partners before or after the elimination of the deficiency. If cash is
distributed after the elimination of the deficiency,
1. Capital deficiency is eliminated by
a.
Making additional cash investment, if the deficient partner is solvent.
214
b. Charging the deficiency as additional loss to the remaining partners, if the deficient
partner is insolvent.
2. Cash available for distribution is then paid to partners to apply first on loan then on capital
Key Points. The final distribution of cash to partners is made based on partners' capital
balances and not on any ratio.
If cash is distributed to partners before eliminating the deficiency:
216
1. Cash available for distribution is paid to partners based on an accompanying schedule to
determine amounts to be paid to partners.
2. Deficient partners may
(a) If solvent, make additional cash investment; to be paid to partners as second cash
distribution, or the deficient partner may make direct cash settlement to the other
partners.
(b) If insolvent, the deficiency shall be absorbed by the other partners as additional loss
according to their profit and loss ratio.
The personal status of partners (that is, personal assets and personal liabilities) is sometimes
provided in the problem to indicate that a partner is solvent or insolvent. When personal assets
exceed personal liabilities, the partner is solvent to the extent of the excess. When personal assets
are less than personal liabilities, the partner is insolvent.
STATEMENT OF LIQUIDATION
The statement of liquidation is a statement prepared to summarize the liquidation process. It is
the basis of the journal entries made to record liquidation. This statement presents in working
paper from the effect of the liquidation on the statement of financial position. It shows the
conversion of assets into cash, the allocation of gain or loss on realization, and the distribution of
cash to creditors and partners.
215
Illustrative Problem A:
Encina, Endrada, and Elina
Statement of Financial Position
December 1, 2014
Assets
Cash
Other Assets
Liabilities and Equity
P 8,000
136,000
P144, 000
Liabilities
Endrada, Loan
Elina, Loan
Encina, Capital
Endrada, Capital
Elina, Capital
Total Liabilities and Equity
P 44,800
2,000
3,200
38,000
24,000
32,000
P 144, 000
217
Case
(1) The other assets were sold for Pl40, 000.
(2) The other assets were sold for P100, 000.
(3) The other assets were sold for P74, 000.
(4) The other asses were sold for P68, 000. Deficient partner was solvent
(5) The other assets were sold for P68, 000. Deficient partner was insolvent.
(6) The other assets were sold for P68, 000. Distribution of available cash is:
a. before eliminating capital deficiency; and
b. after eliminating capital deficiency
Instructions:
1. Prepare a statement of liquidation for each of the cases. For case 6, prepare also a
schedule of cash distribution.
2. Present journal entries to record the liquidation process.
216
Points of emphasis in the preparation of the statement of liquidation
1. Make sure that the balances before liquidation show equality of debits and credits. This will
always be true after each liquidation transaction.
2. Maintain two columns only for the debits. These are cash and other assets regardless of
whether the assets were given itemized like cash, receivables, inventory, supplies, equipment,
etc. Non-cash assets are classified as "other assets."
3. Gain on realization increases capital while loss on realization decreases capital.
4. Figures in parenthesis for each liquidation transaction represent reduction in the account.
5. Double rule when all columns are brought to zero balance.
218
Case - The other assets were sold for P140,000. (Gain on realization, no capital deficiency)
Encina, Endrada and Elina
Statement of Liquidation
December 1 - 31, 2014
Cash
Profit and loss ratio
Balances before
P 8,000
liquidation
Sale of asset and
distribution of gain
140,000
Balances
P 148,000
Payment of liabilities
(44,800)
Balances
P 103,200
Payment to Partners
(103,200)
Other
Assets
P136,000
(136,000)
-
Loan
Liabilities
Endrada
Elina
Capital
Endrada
2(40%)
P 24,000
Elina
1(20%)
P 32,000
P 44,800
P 2,000
P 3,200
Encina
2(40%)
P 38,000
P 44,800
(44,800)
-
P 2,000
P 3,200
1,600
P 39,600
1,600
P 25,600
800
P 32,800
P 2,000
(2,000)
P 3,200
(3,200)
P 39,600
(39,600)
P 25,600
(25,600)
P 32,800
(32,800)
The other assets with a book value of P136,000 were sold for P140,000 resulting in a P4,000 gain on realization distributed among the
partners in their 2:2:1 ratio.
218
219
The entries to record the liquidation process are:
(a) Realization of assets and distribution of gain on realization, 2:2:1
Cash
140,000
Other Assets
Encina, Capital (4,000 x 2/5)
Endrada, Capital (4,000 x 2/5)
Elina, Capital (4,000 x 1/5)
136,000
1,600
1,600
800
(b) Payment of liabilities
Liabilities
Cash
44,800
44,800
(c) Payment to partners
Endrada, Loan
Elina, Loan
Encina, Capital
Endrada, Capital
Elina, Capital
Cash
2,000
3,200
39,600
25.600
32,800
103,200
.219
220
Case - The other assets were sold for P100,000. (Loss on realization, no capital deficiency)
Encina, Endrada and Elina
Statement of Liquidation
December 1 - 31, 2014
Cash
Profit and loss ratio
Balances before
P 8,000
liquidation
Sale of asset and
distribution of gain
100,000
Balances
P 108,000
Payment of liabilities
(44,800)
Balances
P 63,200
Payment to Partners
(63,200)
Other
Assets
P136,000
(136,000)
-
Loan
Liabilities
Endrada
Elina
Capital
Endrada
2(40%)
P 24,000
Elina
1(20%)
P 32,000
P 44,800
P 2,000
P 3,200
Encina
2(40%)
P 38,000
P 44,800
(44,800)
-
P 2,000
P 3,200
(14,400)
P 23,600
(14,400)
P 9,600
(7,200)
P 24,800
P 2,000
(2,000)
P 3,200
(3,200)
P 23,600
(23,600)
P 9,600
(9,600)
P 24,800
(24,800)
The other assets with a book value of P136,000 were sold for P100,000 resulting in a loss on realization of P36,000 that can be fully
absorbed by the capital balances of all the partners.
220
221
The entries to record the liquidation process are:
(a) Realization of assets and distribution of loss on realization, 2:2:1
Cash
Encina, Capital(36,000 x 2/5)
Endrada, Capital (36,000 x 2/5)
Elina, Capital (36,000 x 1/5)
Other Assets
100,000
14,400
7,200
136,000
(b) Payment of Liabilities
Liabilities
Cash
44,800
44,800
(c) Payment to partners
Endrada, Loan
Elina, Loan
Encina, Capital
Endrada, Capital
Elina, Capital
Cash
2,000
3,200
23,600
9,600
24,800
63,200
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Case 3 - The other assets were sold for P74,000. (Loss, on realization, capital deficiency, right of offset)
Encia, Endrada, and Elina
Statement of Liquidation
December 1 – 31, 2014
Cash
Other
Assets
Liabilities
Loan
Endara
Payment of
Liabilities
Balances
P 8,000
P136,00
P44,800
74,000
(136,000)
P 82,000
-
P44, 8000
(44, 800)
-
(P44, 800)
P37, 200
-
-
P 2,000
Capital
Endrada
Elina
2(40%)
2(40%)
1(20%)
P38,000
P24,000
P32,000
( 24, 800)
( 24, 800)
(12,400)
Elina
Profit and
loss ratio
Balance
before
liquidation
Sale of
assets and
distribution
of loss
Balances
Encina
P3,200
P 2,000
P 3,200
P13,200
(P 800)
P19,000
P 2, 000
P3,200
P13,200
(P 800)
P19,000
Offset of
loan against
the debit
balance in
the capital
of Endrada
Balances
P 37,200
-
-
P 1,200
P 3,200
P13,200
-
P19,000
Payment of
Partners
(37,200)
-
-
(1,200)
(3,200)
(13,200)
-
(19,000)
(800)
(P800)
The other assets with a book value of P136,000 were sold for P74,000 resulting in a loss on realization of P62,000. The distribution of the loss on
realization resulted in a debit balance in the capital of Endrada. The right of offset can be exercised in as such as Endrada has a loan to the partnership.
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Entries to record the liquidation process are:
(a)
Realization of assets and distribution of loss on realization. 2:2:1
Cash
Encina, Capital (62,000 x 2/5)
Endrada, Capital (62,000 x 2/5)
Elina, Capital (62,000 x 1/5)
Other Assets
(b)
44,800
44,800
Offset of loan against capital deficiency
Endrada, Loan
Endrada, Capital
(d)
136,000
Payment of liabilities
Liabilities
Cash
(c)
74,000
24,800
24,800
12,400
800
800
Payment to partners
Endrada, Loan
Elina, Loan
Encina, Capital
Elina, Capital
Cash
1,200
3,200
13,200
19,600
37,200
223
Case 4 – The other asset were sold for P68,000. Deficient partner invests additional cash before cash distribution to partners. (Loss on realization, capital deficiency,
deficient partner is solved)
Encia, Endrada, and Elina
Statement of Liquidation
December 1 – 31, 2014
Cash
Other Assets
Liabilities
Loan
Endara
Payment of
Liabilities
Balances
Offset of loan
against the
debit balance
in the capital
of Endrada
Balances
Additional
Investment by
Entrada
Balances
Payment of
Partners
P 8,000
P136,00
P44,800
68,000
(136,000)
P 76,000
-
P44, 8000
(44, 800)
-
(P44, 800)
P31, 200
-
-
P 2,000
Capital
Endrada
Elina
2(40%)
2(40%)
1(20%)
P38,000
P24,000
P32,000
(27,200)
(27,200)
(13,600)
Elina
Profit and loss
ratio
Balance
before
liquidation
Sale of assets
and
distribution of
loss
Balances
Encina
P3,200
P 2,000
P 3,200
P10,800
(P 3,200)
P18,400
P 2, 000
P3,200
P10,800
(P1,200)
P18,400
(2,000)
P 31,200
-
-
-
2,000
P 3,200
P10,800
1,200
(1,200)
P18,400
1,200
P 32,400
-
-
-
P 3,200
P10,800
-
P18,400
(37,200)
-
-
-
(3,200)
(10,800)
-
(18,400)
The other assets of P136,000 were sold for P68,000 resulting in a loss on realization of P68,000. The distribution of the loss on realization resulted in a debit balance in the capital
of Endrada that cannot be fully absolved by his loan. The deficient partner cancels his deficiency by making additional cash investment. By doing so, the partnership will satisfy all
its liabilities including the other partners’ equities.
224
The entries to record the liquidation process
(a)
Realization of assets and distribution of loss on realization. 2:2:1
Cash
Encina, Capital (62,000 x 2/5)
Endrada, Capital (62,000 x 2/5)
Elina, Capital (62,000 x 1/5)
Other Assets
(b)
44,800
44,800
Offset of loan against capital deficiency
Endrada, Loan
Endrada, Capital
(d)
136,000
Payment of liabilities
Liabilities
Cash
(c)
68,000
27,200
27,200
13,600
2,000
2,000
Deficient partner who is solvent makes additional cash investment
Cash
1,200
Endrada, Capital
(e)
1,200
Payment to partners
Elina, Loan
Encina, Capital
Elina, Capital
Cash
3,200
10,800
18,400
225
Case 5 – The other assets were sold for P68,000. Deficient partner is involvent and his deficiency is shared by the other partners before cash distribution (Loss on
realization, capital deficiency, right of offset, deficient partner is insolvent)
Encia, Endrada, and Elina
Statement of Liquidation
December 1 – 31, 2014
Cash
Other Assets
Liabilities
Loan
Endara
Payment of
Liabilities
Balances
Offset of loan
against the
debit balance
in the capital
of Endrada
Balances
Additional
loss to
partners for
the deficiency
of Endrada
shared, 2:1
Balances
Payment of
Partners
P 8,000
P136,00
P44,800
68,000
(136,000)
P 76,000
-
P44, 8000
(44, 800)
-
(P44, 800)
P31, 200
-
-
P 2,000
Capital
Endrada
Elina
2(40%)
2(40%)
1(20%)
P38,000
P24,000
P32,000
(27,200)
(27,200)
(13,600)
Elina
Profit and loss
ratio
Balance
before
liquidation
Sale of assets
and
distribution of
loss
Balances
Encina
P3,200
P 2,000
P 3,200
P10,800
(P 3,200)
P18,400
-
P3,200
P10,800
(P3,200)
P18,400
(2,000)
P 31,200
-
-
-
2,000
P 3,200
P10,800
(P 1,200)
(800)
1,200
P18,400
(
400)
P 31,200
-
-
-
P 3,200
P10,000
-
P18,000
(31,200)
-
-
-
(3,200)
(10,000)
-
(18,000)
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The distribution of the P68,000 loss on realization resulted in a debit balance in the capital account of
Endrada that cannot be fully absorbed by his loan. Failure of the deficient partner to cancel his
deficiency is to be regarded as additional loss, allocated to the remaining partners in their profit and loss
ratio. Encina and Elina share on the deficiency of Endrada in the ratio 2:1. Encina and Elina share on the
computed as follows:
Encina
Elina
P1,200 x 2/3 = P800
P1,200 x 1/3 = P400
The entries to record the liquidation process
(a)
Realization of assets and distribution of loss on realization. 2:2:1
Cash
Encina, Capital (68,000 x 2/5)
Endrada, Capital (62,000 x 2/5)
Elina, Capital (62,000 x 1/5)
Other Assets
(b)
44,800
2,000
2,000
Capital deficiency of insolvent partner absorbed as additional loss by remaining partners
Encina, Capital (1,200 x 2/3)
Elina, Capital (1,200 x 1/3)
Endrada, Capital
(d)
44,800
Offset of loan against capital deficiency
Endrada, Loan
Endrada, Capital
(d)
136,000
Payment of liabilities
Liabilities
Cash
(c)
68,000
27,200
27,200
13,600
800
400
1,200
Payment to partners
Elina, Loan
Encina, Capital
Elina, Capital
Cash
3,200
10,000
18,000
31,200
227
Case 6 – The other assets were sold for P68,000. Additional cash investment by deficient partnes is to be made as second cash distribution to partners. All available cash is immediately
distributed to partners requiring a schedule to accompany the statement of liquidation in order to determine amounts to be paid to partners. (Loss on realization, capital deficiency, right of
offset, and cash distribution)
Encia, Endrada, and Elina
Statement of Liquidation
December 1 – 31, 2014
Cash
Other Assets
Liabilities
Loan
Endara
Profit and loss
ratio
Balance before
liquidation
Sale of assets
and distribution
of loss
Balances
Payment of
Liabilities
Balances
Offset of loan
against the debit
balance in the
capital of
Endrada
Balances
Payment to
partners (per
schedule)
Balances
Additional
Investments by
Endrada
Balances
Payment of
Partners
P 8,000
P136,00
P44,800
68,000
(136,000)
P 76,000
-
P44, 8000
(44, 800)
-
(P44, 800)
P31, 200
-
-
P 2,000
Encina
Capital Endrada
Elina
2(40%)
2(40%)
1(20%)
P38,000
P24,000
P32,000
(27,200)
(27,200)
(13,600)
Elina
P3,200
P 2,000
P 3,200
P10,800
(P 3,200)
P18,400
P 2,000
P3,200
P10,800
(P3,200)
P18,400
( 2,000)
2,000
P 31,200
-
-
-
(31,200)
-
-
-
-
P 3,200
P10,800
(3,200)
(10,800)
-
P 800
1,200
(P 1,200)
P18,400
(P 1,200)
P 400
1,200
P 1,200
-
-
-
-
P800
-
P 400
(1,200)
-
-
-
-
(800)
-
(400)
228
The Schedule to Accompany the Statement of Liquidation shows amounts to be paid to partners. Total
partners, interest is reduced by the restricted interest possible for losses, in case the deficient partner
fails to pay his deficiency. Restricted interest for possible losses shal continue up to the point when
deficiencies or debit balances in capital are eliminated. When deficiencies are eliminated, balances shall
be called Free Interest – Amounts to be Paid to Partners, to apply first in a loan, then on capital.
Encina, Endrada and Elina
Schedule to Accompany Statement of Liquidation
December 1 – 31, 2014
Capital balances before cash distribution
Add loan balance
Total partners’ interest
Restricted interest – possible loss of
P1,200 to Encina and Elina in ratio of 2:1 if
Endrada fails to pay his deficiency
Free Interest – amount to be paid to partners
Payment to apply on:
Loan
Capital
Cash distribution
Encina
P10,800
Endrada
(P1,200)
P10,800
(P1,200)
Elina
P18,400
3,200
P21,600
(800)
P10,000
1,200
-
(400)
P21,200
P3,200
18,000
P21,200
P10,000
P10,000
The entries to record the liquidation process
(a)
Realization of assets and distribution of loss on realization. 2:2:1
Cash
Encina, Capital (68,000 x 2/5)
Endrada, Capital (62,000 x 2/5)
Elina, Capital (62,000 x 1/5)
Other Assets
(b)
68,000
27,200
27,200
13,600
136,000
Payment of liabilities
Liabilities
Cash
(c)
44,800
44,800
Offset of loan against capital deficiency
Endrada, Loan
Endrada, Capital
(d)
2,000
2,000
First cash distribution to partners, per schedule
Elina. Loan
Encina, Capital
Elina, Capital
3,200
10,000
18,000
421
Cash
(e)
31,200
Additional cash investment from deficient solvent partner
Cash
1,200
Endrada, Capital
(f)
1,200
Second cash distribution to partners
Encina, Capital
Elina, Capital
Cash
800
400
1,200
If the deficient partner makes direct cash settlement to partners, the entry is:
(e)
Encina, Capital
Elina, Capital
Endrada Capital
800
400
1,200
CALCULATION OF CASH SETTLEMENT WITHOUT THE AID OF A STATEMENT OF LIQUIDATION
Usually, liquidation problems do not require the presentation of a statement of liquidation but calls only
for the calculation of cash settlements to partners. In such cases, however, non-cash assets have already
been converted into cash, liabilities have bee settled but capital remain as to their balances before
liquidation since the gain or loss on realization of non-cash assets has not yet been carried to capital.
Any difference, therefore, between the debits (available cash to partners) and total credits (loans and
capitals) is a gain or loss on realization that must first be carried to the capital before proceeding with
the liquidation process.
Illustrative Problem B:
At December 31, 2014, the capital balances of the partners Ebora, Esteban and Echavez are P160,000;
P100,000 and P20,000; respectively, sharing profits and losses in the ratio 3:2:1. The partners decided to
liquidate, and sold all the non-cash assets for P148,000 cash. After paying all the liabilities amounting to
P48,000, they still have P112,000 cash left for distribution
422
The loss on realization is the excess of the credits (total credits) over the debits (cash left for
distribution).
Total capital (P160 000 + P100 000 + P20 000)
P 280 000
Less Cash left for distribution to partners
112 000
Loss on realization of assets
P 168 000
Cash settlement to partners is computed as follows:
Capital balances before liquidation
Loss on realization shared in the ratio
of 3:2:1
Balances
Additional loss to Ebora and Esteban
for the deficiency of Echavez shared
in the ratio of 3:2
Cash settlement
Ebora
P 160 000
Esteban
P 100 000
Echavez
P 20 000
( 84 000)
P 76 000
( 56 000)
P 44 000
( 28 000)
P 8 000
( 4800)
P 71 200
( 3 200)
P 40 800
8 000
There may be instances when the cash realized from the sale of other assets is not sufficient to
pay partnership liabilities. In such cases, remaining liabilities are satisfied by:
1. The additional cash investment by deficient solvent partners.
2. Direct collection by the partnership creditors from any one of the partners and the latter
making cash settlement among themselves.
REVIEW of the LEARNING OBJECTIVES
1. Define partnership liquidation and identify its causes. Partnership liquidation is the
winding up of the business affairs of the partnership; hence the business operation is
completely terminated or ended. Partnership liquidation may be caused by any of the
following: (1) accomplishment of the purpose of the partnership; (2) termination of the
term/period covered by the partnership contract; (3) bankruptcy of the partnership; and
(4) mutual agreement among the partners to close the business.
2. Discuss the various problems encountered in the partnership liquidation. The
liquidation of a partnership will give rise to the following problems. (1) determining
partnership profit or loss from the beginning of the accounting period to the date of
423
2
3
1
liquidation and distributing such profit or loss to the partners; (2) closing the partnership
books; (3) correcting accounting errors in prior periods; and (4) liquidating the business.
3. Identify and differentiate the two types of partnership liquidation. The two types of
partnership liquidation are lump-sum liquidation (liquidation by totals) and installment
liquidation (piecemeal liquidation). Under lump-sum liquidation, distribution of cash to
the partners is done only after realization of all non-cash assets, distribution of gain or
loss on realization and payment of partnership liabilities. Under installment liquidation,
asset realization is on a piece-meal basis and cash is distributed to partners as it becomes
available even if there are still unrealized non-cash assets.
4. Discuss and understand the accounting procedures under lump-sum liquidation.
Lump-sum liquidation requires the following procedures: (1) realization of non-cash
assets (sale of non-cash assets for cash); (2) distribution of gain or loss on realization to
the partners according to their liquidation ratio, if there is any, or according to their
residual profit and loss ratio; (3) payment of liabilities to outside creditors; and (4)
distribution of cash to partners.
GLOSSARY of ACCOUNTING TERMINOLOGIES
Capital deficiency – the excess of a partner’s share of losses over his capital credit balance.
Deficient partner – a partner with a debit balance in his capital account after receiving his share
on the loss on realization.
Insolvent partner - a partner whose personal assets are less than his personal liabilities.
Free interest - a partner’s capital interest that is available for cash payment.
Liquidation – the winding up of the business affairs of a partnership.
Realization – the process of converting non-cash assets into cash.
Restricted interest – a portion of a partner’s capital account balance that is restricted for
possible losses on liquidation. It is not, therefore, available for cash payment.
Right of offset – the legal right to apply all or part of a partner’s loan to the partnership against
capital deficiency.
Solvent partner – a partner whose personal assets are more than his personal liabilities.
2
DISCUSSION
3
424 QUESTIONS
2
1.
2.
3.
4.
5.
6.
Differentiate dissolution from liquidation.
What are the causes of partnership liquidation?
What are the types of liquidation? Differentiate one from the other.
Discuss the procedures in liquidation.
What is a statement of liquidation?
Is it true that the column headings of the statement of liquidation follow the basic
accounting equation? Why or why not?
7. What is the basis of final cash distribution to partners?
8. What is the right of offset? When can it be exercised?
9. What is the basis for dividing gains or losses on realization?
10. How may the capital deficiency of an insolvent partner be eliminated?
11. What is the order of payment of partnership liabilities?
12. What is a partner’s restricted interest? Free interest?
13. What purpose is served by the schedule of cash distribution?
14. What are the rules to be applied in case of capital deficiency?
15. Describe how loans receivable from partners and loans payable to partners are treated in
liquidation and why is that treatment necessary?
EXERCISES
Exercise 6 – 1 (Statement of liquidation; Insolvent partner)
On June 1, 2014, Encabo and Elorde, partners of E2 Partnership, decided to liquidate their
partnership. At the same time of the liquidation, the statement of financial position accounts
consisted of cash – P 25 000; non-cash assets – P 600 000; liabilities – P125 000; Encabo, capital
– P225 000; Elorde, capital – P275 000. Encabo and Alorde share profits and losses in the capital
ratio. Encabo is personally insolvent. Non-cash assets were sold for P 350 000.
Instructions: Prepare a statement of partnership liquidation.
Exercise 6 – 2 (Statement of liquidation under various assumptions)
The partner of Elias, Enrico and Ener Partnership have agreed to liquidate their partner as of
December 31, 2014. The partnership has cash of P80 000, non-cash assets of P810 000, and
liabilities of P270 000. The capital accounts of the partnership are: Elias, P60 000; Enrico, P290
000; Ener, P270 000. The partners share profits and losses in the ratio of 3:3:2, respectively. The
partnership was able to sell all the non-cash assets for P634 000 and paid P24 000 of liquidation
expenses.
Instructions:
425
2
3
3
1. Prepare a statement of liquidation assuming all partners are solvent.
2. Prepare a statement of liquidation assuming the liabilities of P270 000 include a P70 000
note payable to Elias. All partners are solvent.
3. Prepare a statement of liquidation assuming the non-cash assets of P810 000 include a
note receivable from Enrico in the amount of P110 000. The liabilities include a P70 000
note payable to Elias.
Exercise 6 – 3 (Statement of Liquidation under various cases)
The statement of financial position of the partnership of Enteng and Estrel as of December
31, 2014 shown on the next page.
Enteng and Estrel
Statement of Financial Position
December 31, 2014
Assets
Cash
Other assets
P 40 000
P 400 000
Total Assets
P 440 000
Liabilities and Equity
Liabilities
P 264 000
Enteng, loan
36 000
Estrel, loan
40 000
Enteng, Capital
80 000
Estrel, Capital
20 000
Total Liabilities & Equity
P 440 000
The other assets were realized for P268 000 and cash was disbursed. Divisions of profits and
losses are:
Case 1
Case 2
Case 3
Enteng
90 %
70 %
50 %
Estrel
10 %
30 %
50 %
Intructions: Prepare the partnership liquidation statement and journal entries to record the
liquidation for each case.
Exercise 6 – 4 (Distribution of Cash to Partners)
Esguerra, Esteban, Estrada and Eugenio are partners with capitals of P11 000, P10 300, P13
700, and P9 000 respectively. Esguerra has a loan balance of P2 000. Profits are shared in the
426
2
3
4
ratio of 4:3:2:1 by Esguerra, Esteban, Estrada and Eugenio respectively. Assets are sold,
liabilities are paid and cash of P12 000 remains.
Instructions: Show how the cash of P12 000 be distributed.
PROBLEMS
Problem 6 -1 (Statement of liquidation with Schedule of cash payments; journal entries to
record liquidation)
The statement of financial position shown below was prepared just prior to the liquidation of the
partnership of Ester, Edna, Emma, and Eva. Partners shared in the profits and losses in the ratio
of 4:2:1:1.
Ester, Edna, Emma and Eva
Statement of Financial Position
September 30, 2014
Assets
Cash
Other assets
Receivable from Ester
Total assets
P 50 000
950 000
62 500
P 1 062 500
Liabilities and Equity
Liabilities
P 450 000
Eva, loan
37 500
Ester, loan
381 250
Edna, capital
93 750
Emma, capital
50 000
Eva, capital
50 000
Total liabilities and equity P 1 062 500
Other assets are sold for P 500 000 and available cash is distributed to the proper parties. Edna is
personally insolvent, but the other partners are able to meet any personal indebtedness to the
partnership. The solvent partners make appropriate contributions to the partnership, and this cash
is distributed in final settlement.
427
2
3
5
Instructions:
1. Prepare a statement of liquidation, together with a supporting schedule if necessary.
2. Give the entries that would be made to record the liquidation of the partnership.
Problem 6 – 2 (Statement of liquidation; journal entries to record liquidation)
The partnership accounts of Eugenio, Evariso, and Esteban, who share earnings in a 5:3:2
ratio, are as follows on December 31, 2014:
Eugenio, Drawing (debit balance)
Esteban, Drawing (debit balance)
Evaristo, loan
Eugenio, capital
Evaristo, capital
Esteban, capital
P (32 000)
(12 000)
40 000
164 000
134 000
144 000
Total assets amounted to P638 000, including P70 000 cash, and liabilities toatal P200 000.
The partnership was liquidated in January 2015, and Esteban received P111 000 cash
pursuant to the liquidation.
Instructions:
1. Compute the total loss from the liquidation of the partnership.
2. Prepare a statement of liquidation.
3. Prepare the journal entries for the accounting records of the partnership to account for the
liquidation.
Problem 6 – 3 (Statement of liquidation; journal entries to record liquidation)
Estrella, Espino, and Espiritu, who share profits and losses in the ratio of 2:2:1, decided to
liquidate their partnership on December 31, 2014. Shown below is the condensed statement
of financial position prepared just prior to liquidation.
Estrella, Espino and Espiritu
Statement of Financial Position
December 31, 2014
236
428
Assets
Cash
Other assets
Total assets
Liabilities and equity
P 20 000
340 000
Liabilities
Espino, loan
Espiritu, loan
Estella, capital
Espino, capital
Espiritu, capital
P 360 000
P 112 000
5 000
8 000
95 000
60 000
80 000
Total liabilities and equity P 360 000
Instructions For each of the cases listed below, prepare a statement of liquidation assuming
that cash is realized for the other assets as indicated in each case, and that all available cash is
immediately distributed to the proper parties. Assume as additional payment to the proper
parties.
Case 1
Case 2
Case 3
Case 4
Case 5
P 250 000
P 185 000
P 170 000
P 125 000
P90 000
Problem 6 – 3 (Statement of liquidation; journal entries to record liquidation)
The Evasco-Ellor Partnership has just completed a very unprofitable year. The partners agree to
liquidate. The financial statements of the partnership have been prepared for the fiscal year
ending December 31, 2014, and the year-end statement of financial position is shown below:
429
2
3
7
Assets
Cash
P 1000
Accounts receivable
P 80 000
Less allowance for doubtful accounts
20 000
60 000
Merchandise inventory
50 000
Prepaid advertising
2 000
Machinery and equipment
P 100 000
Less accumulated depreciation
60 000
Total assets
40 000
P 153 000
Liabilities and equity
Accounts payable
P 20 000
Notes payable (due 2015)
86 000
Evasco, capital
30 000
Ellor, capital
17 000
Total liabilities and equity
P 153 000
The partners desired to complete the liquidation process as quickly as possible. Information
concerning the liquidation follows:
1. Accounts receivable equal to the net carrying value plus 20% of the estimated doubtful
accounts were collected.
2. Merchandise inventory were realized for P25 000.
3. The prepaid advertising contract has a cancellation value of P800.
4. Machinery and equipment were realized equal to 60% of their book value.
5. Unrecorded accounts payable totaling P2000 were discovered.
6. The bank charged the partnership P1000 for the paying the note earlier than the due date;
the amount is added to the note.
Evasco is personally insolvent. However, Ellor’s personal assets exceed his personal
liabilities by P4000. Evasco and Ellor share on income and losses in the ratio of 4:6,
respectively.
430
2
3
8
Instructions:
1. Prepare a schedule showing the net amount of liquidation gain or loss.
2. Prepare a statement of liquidation.
3. Give the entries to record the liquidation.
MULTIPLE CHOICE
MC 6-1 Espina, Espinosa, Esteban, and Estrellita are partners, sharing earniongs in the ratio of
3:4:6:8.
The balance of their capital accounts on December 31, 2014 are as
follows:
Espina
P 1000
Espinosa
25 000
Esteban
25 000
Estrellita
9 000
P 60 000
The partners decided to liquidate, and they accordingly convert the non-cash assets into P23
000 of cash. After paying the liabilities amounting to P3 000, they have P22 200 to divide.
Assume that a debit balance in any of partner’s capital in uncollectible. The book value of the
non-cash assets amounted to:
a.
b.
c.
d.
P 25 200
P 45 400
P 61 000
P 63 000
MC 6-2 Using the information in MC 6-1, the share of Espinosa in the loss upon conversion of
the non-cash assets into cash was
a. P 5 400
b. P 7 200
c. P 37 800
d. P 61 000
MC 6-3 Using the information in MC 6-1, how much did Esteban get when the P 22 200
was divided?
a.
b.
c.
d.
P 6 432
P 8 320
P 10 000
P 14 200
431
2
3
9
MC 6-4 As of December 31, 2014, the books of 3E Partnership showed capital balances of E1P40 000; E2-P25 000; E3-P5 000. The partners’ profit and loss ratio was 3:2:1, respectively. The
partners decided to dissolve and liquidate. They sold all the non-cash assets for P37 000 cash.
After settlement of all liabilities amounting to P12 000, they still have P28 000 cash left for
distribution. The loss on realization of the non-cash assets was:
a.
b.
c.
d.
P 28 000
P 40 000
P 42 000
P 45 000
MC 6-5 Using the information in MC 6-4, and assuming that any debit balance of partners’
capital is uncollectible, the share of E1 on P28 000 cash for distribution was:
a.
b.
c.
d.
P17 800
P18 000
P 19 000
P40 000
MC 6-6 Esper, Elor, and Este, partners are in textile distri8bution business sharing profits and
losses equally. On December 31, 2014, the partnership capital and partners; drawing are as
follows:
Capital
Drawings
Esper
P 100 000
60 000
Elor
P 80 000
40 000
Este
P 300 000
20 000
Total
P 480 000
120 000
The partnership was unable to collect on trade receivables and was forced to liquidate. Operating
profit in the year 2014 amounted to P72 000 which was all exhausted including the partnership
assets. Unsettled creditors’ claim at December 31, 2014 totaled P 84 000. Elor and Este have
substantial private resources but Esper has no personal assets. Loss on liquidation was
a.
b.
c.
d.
P 360 000
P 432 000
P 480 000
P 516 000
MC 6-7 Using the information in MC 6-6, the final cash distribution to Este was
a.
b.
c.
d.
P 78 000
P 84 000
P 108 000
P 162 000
24
0
432
MC 6-8 Escano, Ender, and Evelo are in the process of liquidating their partnership and their
account balances as of October 1, 2014 are as follows:
Cash
Non-cash assets
Ender, loan
Escano, capital
Ender, capital
Evelo, capital
Debit
P 30 000
70 000
Credit
P 14 000
10 000
35 000
41 000
The profit and loss sharing ratio has been 4:3:3 between Escano, Ender, and Evelo, respectively.
Assuming that the partnership realized P 30 000 from the sale of the non-cash assets and that any
deficiency is uncollectible, Ender must receive
a.
b.
c.
d.
P 19 000
P 34 000
P 37 000
P 49 000
MC 6-9 Using the information in MC 6-8 and assuming Escano had personal assets of P50 000
and personal liabilities of P45 000 and that the partnership realized P25 000 from the sale of its
non-cash assets, Evelo must receive:
a. P 25 000
b. P 26 000
c. P 27 000
d. P 41 000
MC 6-10 Using the information in MC 6-8 and for Escano to receive P12 000, the non-cash
assets must be sold for
a.
b.
c.
d.
P 10 000
P 12 000
P 30 000
P 75 000
240
433
Chapter 6 - Partnership Liquidation (Lump-Sum)
MC 6-11
The following condensed statement of financial position is presented for the
partnership of Echo, Egay and Elma, who share profits and losses in the ratio of
6:2:2, respectively.
Assets
Liabilities
and
Capital
Cash
P 40,000
Liabilities
P 70,000
Other Assets
140,000
Echo,Capital
50,000
Egay,Capital
50,000
Elma,Capital
10,000
Total Assets
P 180,000
Total Liabilities &Capital
P 180,000
The partners agreed to liquidate the partnership after selling the other assets.
If the other asset are sold for P80,000, how much should Echo receive upon
liquidation, assuming all the partners are solvent?
a.
P12,500
c.
P14,000
b.
P13,000.
d.
P50,000
MC 6-12 Using the information in MC 6-11 and assuming that the other assets are
sold
for P80,000; profits are shared 2:2:6, respectively; and that any deficient partner is
insolvent, the amount to be received by Egay upon liquidation is
a.
P19,500
c.
P38,000
b.
P25,000
d.
P50,000
MC 6-13
Esmer, Estrel, Ellea and Elmer share profits in the ratio of 2:1:1:1. The
partnership cannot meet its obligations to creditors and dissolution is authorized
on September 30, 2014. A statement of financial position for the partnership on
this date shows balances as follows:
Assets
Capital
Cash
P265,000
Other Assets
25,000
Liabilities
P 90,000
Liabilities
400,000
Elmer,loan
434
and
Esmer,Capital
50,000
Estrel,Capital
Ellea,Capital
Elmer,Capital
50,000
50,000
50,000
Total Assets
P490.000
P490.000
Total
Liabilities
&Capital
The personal status of partners on this date is determined to be as follows:
Cash and cash value
Personal
Partners
of personal assets
liabilities
Esmer
P 250,000
P 150,000
Estrel
100,000
150,000
Ellea
150,000
125,000
Elmer
200,000
250,000
The other assets of the partnership are sold and realized P120,000.
Additional contributions by appropriate parties in meeting the claims of
firm creditors were made. The amount that will be paid to the personal creditors
of Esmer would be
a.
P150,000
c.
P222,500
b.
P165,000
d.
P250,000
MC 6-14 Using the information in MC 6-13, the amount that will be paid to the
personal creditors of Estrel would be
MC 6-15
a.
P100,000
c.
P150,000
b.
P142,000
d.
P180,000
Using the information in MC 6-13, the amount that will be paid to the personal
creditors of Elmer would be
a.
P200,000
c.
P235,000
b.
P217,500
d.
P250,000
435
Test Material No. 21
___________
Rating
Name _________________________________ Date
__________________________
Year and Section ________________________ Professor
________________________
TRUE OR FALSE
Instructions:
Encircle the letter T if the statement is true and the letter F if
the statement is false.
1. Partnership dissolution is always followed by liquidation.
2. The final distribution of cash to the partners shall be made based on their profit and
loss sharing agreement.
3. In lump-sum liquidation, the distribution of cash to partners is made only after all the
non-cash assets have been realized, the total amount of gain or loss on realization has
been determined and distributed, and all liabilities have been paid.
4. In a statement of liquidation, there are only two classes of assets cash and other
assets.
5. After the distribution of cash to partners in a partnership liquidation, the business
would have zero assets, liabilities, and owners’ equity.
6. The liquidation ratios will always be equal to the profit and loss ratio of the partners.
7. If the deficient partner is insolvent, his deficiency will be absorbed by the other
partners distributed according to their profit and loss ratio.
8. When the personal assets of a partner exceed his personal liabilities, the partner is
considered solvent but only to the extent of the excess.
9. Non-cash assets that are not sold should be written off as a loss and such loss is
divided to the partners equally.
10. The right of offset is exercised when a partner’s capital account reports a debit
balance and he has at the same time a loan to the partnership.
11. The amount offset in exercising the right of offset shall be the amount of a partner’s
loan to the partnership or the amount of his deficiency, whichever is lower.
436
12. The loan payable to a partner has a higher priority in liquidation than a partner's
capital balance but a lower priority than liabilities to outside creditors.
13. Liquidation expenses which are incurred to facilitate the immediate realization of
non-cash assets affect cash but not capital.
14. In partnership liquidation, advances and withdrawals are closed to capital accounts
since cash settlement is based on the partners' capital account balances.
15. Personal creditors of individual partners have priority over partnership creditors in
the order of claims against the personal assets of a partner.
16. A deficient partner is automatically an insolvent partner.
17. A deficient but solvent partner has to share on the deficiency of an insolvent partner
in case of final liquidation
18. A partner with a loan to the partnership may never become a deficient partner
19. A partner's claim from the partnership, upon liquidation, increases the amount
available for the partner's personal debts.
20. In a statement of liquidation, the accounting equation is observed throughout the
liquidation process.
Test Material No. 22
___________
Rating
Name _________________________________ Date
__________________________
Year and Section ________________________ Professor
________________________
IDENTIFICATION
437
Instructions:
Write the word or group of words that identify each of the
following statements.
_____________ 1.
The account credited for loans made by the partners to the
partnership.
_____________ 2.
A liquidation in which the proceeds from all assets are fully realized
before any distribution of cash is made.
_____________ 3.
The principle that allows a partner to apply his receivable from the
partnership against a debit balance in his account.
_____________ 4.
The process of winding up a business
_____________ 5.
The process of converting non-cash assets into cash.
_____________ 6.
Amount of money advanced by the partnership to the partners.
_____________ 7.
A liquidation that is spread over a long period and the partners distribute
cash as it becomes available without waiting until all assets are realized.
_____________ 8.
A partner with a debit balance in his capital account after the transfer of
the loss on realization.
_____________ 9.
An accounting statement summarizing the winding up of the affairs of the
partnership.
_____________ 10. A partner whose personal liabilities exceed his personal assets.
_____________ 11. The order of creditors’ rights against the partnership’s assets and the
personal assets of the individual partners.
_____________ 12. The excess of a partner’s share on losses over his capital.
_____________ 13. The excess of the selling price over the cost or book value of the assets
disposed or sold through realization.
_____________ 14. Expenses incurred in order to facilitate the immediate realization of noncash assets.
_____________ 15. The manner of eliminating the capital deficiency of an insolvent partner;
after exercising the right of offset when applicable.
_____________ 16. The basis for the final distribution of cash to partners in case of liquidation
_____________ 17. They have priority over the personal assets of a partner.
_____________ 18. The manner of eliminating the capital deficiency of a solvent partner who
does not have loans to the partnership
_____________ 19. The proper treatment of a credit balance in a partner's drawing account in
the statement of liquidation.
_____________ 20. The manner of dividing gains and losses on the realization of non-cash
assets in liquidation
438
Test Material No. 23
___________
Rating
Name _________________________________ Date
__________________________
Year and Section ________________________ Professor
________________________
MULTIPLE CHOICE - Theory and Problems
Instructions:
Encircle the letter of the best answer. Present supporting
computations in good form in a separate work sheet.
1. Liquidation of a partnership includes all of the following steps, except
a. obtaining court approval
b. selling the partnership's non-cash assets
c. paying the partnership liabilities
d. distributing the remaining cash to partners
2. Settlement of a partner's personal liabilities may come from
a. personal assets
b.
partner's claim on partnership assets
c.
claims of co-partners
d.
A and B only
3. Liquidation losses would include
a. loss on realization of non-cash assets
b. liquidation expenses
c. share on the deficiency of an insolvent partner
d. all of the above
4. A capital deficiency can be eliminated by the following except
a. offsetting against a partner's loan
b. additional investment
c. selling non-cash assets at a gain
d. loss to the other partners
5. A partner's interest includes
a. capital balance
c.
A only
b. partner's loan to the partnership
d.
A and B
6. A capital deficiency in a partner's capital that is uncollectible is
a. the result of a sale of non-cash assets at a profit
b. the result of a loss in operations
439
7.
12.
13.
c. a loss to the other partners
d. a gain to the other partners
The other partners must absorb the deficiency in a partner's capital account in liquidation
because of
a. limited life and mutual agency
b. mutual agency and unlimited liability
c. limited life and co-ownership of property
d. mutual agency and partnership's taxability
8. When a partnership is liquidated, all of the following may occur, except
a. a partner erases his deficiency by declaring bankruptcy
b. the other partners absorb a partner's deficiency
c. a partner erases his deficiency by contributing property
d. a partner erases his deficiency by contributing cash
9. In the final liquidation transaction, the remaining cash is distributed to the
partners.
The partners share in the cash according to their
a. profit and loss ratio
c.
capital balances
b. Withdrawals
d.
cash balance
10. The order of partnership liquidation process is
a. sell assets, disburse cash to partners, pay liabilities
b. disburse cash to partners, pay liabilities, sell assets
c. pay liabilities, sell assets, disburse cash to partners
d. sell assets, pay liabilities, disburse cash to partners
11. In a partnership liquidation, a loss from sale of non-cash assets is allocated to the
a. partner with the lowest capital balance
b. partnership liabilities
c. partners based on their capital balances
d. partners based on the profit and loss sharing ratio
A partnership liquidates and finds an excess cash, after payment of liabilities, of
P100,000. The four partners have equal capital balances and share profits and losses
in the ratio of 10:20:30:40. The four partners will receive a final distribution
of cash
as follows:
a.
P 25,000; P 25,000; P 25,000; P 25,000;
b. P 10,000 P 20,000; P 30,000; P 40,000;
c. P 12,000; P 20,000; P 8,000; P 60,000;
d. P100,000; P100,000; P100,000; P100,000
Upon liquidation, the EE partnership realized a gain on sale of assets amounting to
P120,000. The gain is allocated to the partners, Estrada and Esteban, according to their
profit and loss ratio of 2:1. How is the gain allocated to each partner?
a. Estrada
P 60,000:,
Esteban
P
60,000
b. Estrada
P 80,000;
Esteban
P
40,000;
c. Estrada
P 40,000:,
Esteban
P
80,000
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d. Estrada
P 120,000
Esteban
P
240,000;
14. The liquidation of the partnership of Emma, Earl and Ester resulted in a
deficiency in
Emma’s capital account of P100,000. Emma can contribute only P20,000 to offset her
deficiency The partners share profits and losses in the ratio 3:3:2. Earl and Ester, who
have capital balances of P250,000 and P50,000, will absorb the deficiency as follows:
a.
Earl P0
and
Ester - P 0
b. Earl P32,000
and
Ester - 48,000
c. Earl 48,000
and
Ester - P32,000
d. Earl P 40,000
and
Ester - P 40,000
16.
17.
15. Ever, Engel and Encar are partners who share profits and losses in the ratio of
2:3:5.
The partners have decided to liquidate the partnership. Their capital accounts show the
following balances: Ever P60,000 credit; Engel - P90,000 credit; Encar P20,000 debit
after the sale of non-cash assets and the payment of all liabilities. What is the amount of
cash available for distribution:
a. P60,000
c.
P120,000
b. P90,000
d.
P130,000
The following statement of financial position is for the EEE Partnership. The partners
Emy, Ely, and Evy share profits and losses in the ratio of 5:3:2, respectivel;y.
Cash
P 60,000
Liabilities
P
140,000
Other Assets
540,000
Emy, Capital
280,000
Ely, Capital
160.000
______________
Evy, capital
20,000__
P 600,000
P 600,000
Assuming the original partners agreed to liquidate the partnership by selling
the other
assets, what should each of the respective partners receive if the other assets
are sold
for P400,000?
a.
Emy P205,000; And Ely P115,000;
Evy P 0
b.
Emy P206,000; And Ely P114,000;
Evy P 0
c.
Emy P210,000; And Ely P111,800;
Evy P 8,000
d.
Emy P280,000; And Ely P160,000;
Evy P 20,000
The statement of financial position for the partnership of Eden, Élisa, and Elma, who
share profits and losses in the ratio of 4:5:1, is as follows:
Cash
P 100,000
Accounts Payable
P 300,000
Inventory
720,000
Eden, Capital
320,000
Eli, Capital
90.000
441
______________
110,000__
P 820,000
Elma, capital
P 820,000
If the inventory is sold for P600,000, how much should Eden receive upon liquidation of
the partnership?
a. P 96.000
c.
P272,000
18.
19.
20.
b. P 200.000
d.
P320,000
Using the information No.17 and assuming the inventory is sold for P360,000,how much
should Elma receive upon liquidation of the partnership?
a. P56.000
c.
P 74,000
b. P65,000
d.
P110,000
After all non-cash assets have been converted into cash, in the liquidation of the Estacio
and Estioco Partnership, the ledger contains the following account balances:
Debit
Credit
Cash
P141,000
Accounts Payable
P96,000
Loan Payable to Estacio
45,000
Estacio,Capital
21,000
Estioco,Capital
21,000
Available cash should be distributed with P96,000 going to Accounts Payable
and
a. P45,000 to the Loan Payable to Estacio
b. P22,500 each to Estacio and Estioco
c. P24,000 to Estacio and P21,000 to Estioco
d. P21,000 to Estacio and P24,000 to Estioco
The partnership accounts of Edna,Elvira and Emma who share earnings in a 3:3:4 ratio
are as follows on December 31,2014
Edna,Drawing(debit balance)
P 30,000
Emma, Drawing (credit balance)
10,000
Elvira,Loan
50,000
Edna,Capital
160,000
Elvira,Capital
130,000
Emma,Capital
140,000
Total assets amounted to P700,000 including P80,000 cash and liabilities total P240,000.
The partnership was liquidated in January 2015 and Emma received P120,000 cash
payment in the liquidation. The loss on realization was
a. P75,000
c.
P 95,000
b. P80,000
d.
P100,000
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Chapter 6— Partnership Liquidation (Lump-sum)
Test Material No. 24
Rating
Name
Date
Year and Section
Professor
PROBLEMS
Problem A
EEE Partnership has decided to liquidate as of December 31, 2014. The statement of financial
position as of this date follows:
EEE Partnership
Statement of Financial Position
December 31, 2014
Assets
Liabilities & Capital
Cash
P 25,000
Accounts Payable.
P 240,000
Accounts Receivable (net) 75,000
Loan Payable to Empoy
30,000
Inventory
100,000
Estoy, Capital
120,000
Plant and Equipment (net) 300,000
Empoy, Capital
50,000
Eloy, Capital
60,000
P500,000
P500,000
Additional Information
1. The personal assets (excluding partnership capital and loan interest) and personal liabilities
of the partners as of December 31, 2014 are as follows:
Estoy
Empoy
Eloy
Personal assets
P250,000 P300,000 P350,000
Personal liabilities (230,000) (240,000) (325,000)
Personal net worth P 20,000 P 60,000
P 25,000
2. Estoy, Empoy and Eloy share profits and losses in the ratio of 20:40:40,
respectively.
3. According to the pratnership agreement, interest does not accrue on partners' loan balances
during the liquidation process.
4. All of the non-cash assets were sold on January 10,2015 for P260,000.
Instructions :
1. Prepare a statement of liquidation.
2. Prepare the journal entries to record the liquidation of the partnership.
3. Prepare a schedule showing hoe the partners' personal assets are to be distributed.
443
Problem B
The partners of the 3E Partnership have decide to liquidate their partnership. The partnership
statement of financial position just prior to liquidation is presented below :
Assets
Liabilities and Capital
Cash
P63,000 Liabilities
P308,500
Othes Assets
455,500 Escobar, Capital
90,000
Elloso, Capital
90,000
Echaves, Capital
30,000
P518,500
P518,500
The other assets include a note receivable from Escobar in the amount of P75,000. The liabilities
include a note payable to Elloso of P40,000 and a note payable to Echaves of P60,000. The
partners share profits and losses in the ratio of 2:2:1, respectively.
Instructions :
5. Determine the amount of cash each partner will receive for each of the following independent
assumptions:
a.
The other assets are sold for P300,000 and all the partners are solvent.
b. The other assets are sold for P270,000 and Escobar is insolvent. Escobar's net
worth, exclusiveof his interest in the partnership, is P4,000.
c. The other assets are sold for P270,000 and P24,875 pf liquidation expenses are
paid. Escobar is insolvent.
2) If the partners receive an offer of P140,000 for the business, exclusive of the cash, would they
be better off accepting the offer or liquidating under the condition in 1a above?
CHAPTER 7
INSTALLMENT LIQUIDATION
LEARNING OBJECTIVES
1. Explain the nature of installment liquidation.
444
2. Discuss and understand the procedures followed under installment liquidation.
3. Prepare a Statement of Liquidation and the Accompanying Schedule Showing How
Available Cash is to be Distributed.
4. Prepare a Cash Priority Program.
PREVIEW OF THE CHAPTER
Installment Liquidation
Procedures
 Realization of assets on a
piece-meal basis.
 Distribution of gain or loss
on realization.
 Preparation of cash distribution
schedule.
 Distribution of available cash.




Statement of
Liquidation
Schedule to accompany the
Statement of Liquidation.
Cash Priority Program
Loss absorption capacity.
Cash allocation.
NATURE OF INSTALLMENT LIQUIDATION
Under the installment liquidation, non-cash assets are sold on a piece-meal basis over an
extended period of time. Cash realized is immediately distributed to partners after fully satisfying
creditors' claims or after setting aside sufficient cash for these liabilities. In as much as cash
distributions are made before realizing non-cash assets and the total gain or loss on realization is
not yet determined, it is necessary that each cash distribution to partners be considered as if it
were the last. Remaining unsold assets, therefore, must be trusted d as a complete loss, assuming
that nothing is realized on them. Also, debit balances in capital and potential capital deficiencies
are assumed uncollectible. In this sense, partners' interests are reduced by cash distributions to a
balance proportionate to the partners' profit and loss ratios. Succeeding cash distributions are
then based on the profit and loss ratio.
The liquidation procedures shall be the same in lump sum liquidation except that:
18. Cash is distributed to partners even before fully realizing non-cash assers and
determining total gain or loss on realization.
445
19. Restricted interest, in the Acxompanying Schedule to Determine Amounts to be Paid to
Partners, shall consist of:
20. Remaining unsold assets.
21. Cash withheld (for possible expenses)
22. Debit balances in capital
Illustrative Problem A:
The statement of financial position of the partnership of Arias, Buendia and Caras on December
31,2014, when the partners decide to liquidate follows:
Assets
Cash
Other Assets
Total Assets
Liabilities and Capital
Liabilities
Arias, Loan
Arias, Capital (30%)
Buendia, Capital (40%)
Caras, Capital (30%)
Total Liabilities and Capital
P200,000
500,000
P700,000
P250,000
70,000
200,000
30,000
150,000
P700,000
Cash is realized on the other assets as follows, and amounts realized are distributed at the end of
each month to the appropriate parties.
Fiscal Year 2015 Asset Book Value Cash Proceeds
January
P300,000
P260,000
February
200,000
230,000
Instructions:
1. Prepare a statement of liquidation to summarize the course of liquidation. Provide
schedules in support of monthly distributions.
2. Prepare the journal entries to record the liquidation
446
447
Arias, Buendia and Caras Partnership
Schedule to Accompany Statement of Liquidation
Amounts to be Paid to Partners
January 31,2015
Arias Buendia Caras
(30%) (40%) (30%)
Capital balances before cash distribution
P188, 000 P 14,000 P138, 000
Add Loans
70,000
Total partners' interest
P258, 000 P 14,000 P138, 000
Restricted interest-lossible loss of
P200, 000 if nothing is realized on
remaining unsold assets
( 60,000) ( 80,000) ( 60,000)
P198, 000 (P66, 000) P78, 000
Restricted interest- additional possible
loss of P66, 000 to Arias and Caras if Buendia
is unable to pay his possible deficiency,
shared in the ratio of 30:30
( 33,000) 66,000 ( 33,000)
Free interest - payments to partners
P165, 00
P45, 000
Payment to apply on:
Loan
P 70,000
Capital
95,000
P45, 000
Total cash distribution
P165, 00
P45, 000
Based on the schedule, the January layments to partners shall be made to partner Arias and Caras
which shall apply first on the loan and then on capital.
Journal entries to record the liquidation:
January Cash
260,000
Arias, Capital
12,000
Buendia, Capital
16,000
Caras, Capital
12,000
Other assets
300,000
Sale of assets and distribution of loss.
Liabilities
250,000
Cash
250,000
Payment to liabilities.
Arias, Loan
Arias, Capital
Caras, Capital
Cash
Payment to partners.
February Cash
Other Assets
70,000
95,000
45,000
210,000
230,000
200,000
448
Arias, Capital
9,000
Buendia, Capital
12,000
Caras, Capital
9,000
Sale of assets and distribution of gain.
Arias, Capital
102,000
Buendia, Capital
26,000
Caras, Capital
102,000
Cash
230,000
Final payment to partners.
PROGRAM OF CASH DISTRIBUTION
Partners may desire to determine in advance as to whom cash distribution shall be made as cash
may become available. This procedure requires the preparation of the program called Cash
priority program, Cash Predistribution Plan or Program of Priorities. The program is prepared
prior to Liquidation, that is, before cash becomes available for distribution. Cash realized on
other assets is distributed based on the program without the need for the preparation of the
schedule previously used to accompany the statement of liquidation. The steps in the preparation
of the program are the following;
1. Determine total partners interest; that is, capital balances before liquidation plus loans
by partners to the partnership less advances by the partnership to the partners.
2. Divide total partners' interest by their profit and loss ratio to get each partners loss
absorption capacity. The loss absorption capacity is the maximum amount of loss that a
partner may absorb and may eliminate any partner in any cash distribution. A partner,
therefore, with the highest loss absorption balance has the first priority on cash
distribution.
3. Once the loss absorption balances are determined, allocation may now be made,
starting with allocation I wherein the highest loss absorption balance is reduced to the
next highest. Each reduction in the loss absorption balance requires payment to
partners computed by multiplying the amount of reduction by the partners’ profit and
loss ratio.
4. After partners loss absorption balances are made equal, cash distributions are made in
the profit and loss ratio.
Using the same information for the partnership of Arias, Buendia and Caras, the cash priority
program follows:
449
A summary of the information provided by the cash priority program follows:
After fully satisfying liabilities:
1. The first P120,000 cash available to partners should be paid to Arias.
2. The next P255, 000 should be paid to Arias and Caras in the ratio 30:30.
3. Amounts in excess of P375, 000 should be paid to Arias, Buendia, and Caras in the profit
and loss ratio of 30:40:30.
Application of the cash priority program on the installment distribution upon liquidationof the
partnership of Arias, Buendia and Caras shall be:
Installment Distribution
January 31,2015
Amount
Arias
Buendia
Cash available
P210, 000
Allocation I - Payable to Arias
120,000 P120, 000
Allocation II - Payable to Arias and
Caras, 30:30
P 90,000
45,000
45,000
P165, 000
P45, 000
Installment Distribution
February 28,2015
Amount
P230, 000
Arias
Cash available
Allocation II - Balance
P255, 000 - P90, 000 payable
to Arias and Caras, 30:30
165,000 P 82,500
Allocation III - Payable to Arias,
450
Buendia
Caras
P 82, 500
Caras
Buendia and Caras, 30:40:30 P 65,000
19,500
26,000
19,500
P102, 000 P26, 000 P102, 000
Key points. The same amount of cash distributions per accompanying schedule to the statement
of liquidation were arrived at in January and February. Also, when cash available for distribution
is not sufficient to cover an allocation, th partners share such insufficient cash on the basis of
their profit and loss ratio.
There may be instances wherein the gain or loss related to the sale of individual assets during the
course of liquidation is difficult to determine. On such cases, no gain or loss is recognized on
realization and cash is recorded equal in amount to the book value of the assets sold. The total
gain or loss on realization is recognized in the final realization of assets and it is the difference
between the cash realized and the book value of the remaining assets sold. Such gain or loss is
then carried to capital.
REVIEW of the LEARNING OBJECTIVES
1. Explain the nature of installment liquidation. Under installment liquidation, the
realization of non-cash assets takes place over an extended period of time. However, cash
451
realized is immediately distributed to creditors and partners even if there are still unsold
non-cash assets.
2. Discuss and understand the procedures followed under installment liquidation. The
procedures under installment liquidation are basically the same as those under lump-sum
liquidation except that cash is distributed to creditors and partners as it becomes
available. However, every time cash is distributed to partners, it is considered as if it were
the last so as to avoid any overpayment to any of the partners.
3. Prepare a Statement of Liquidation and Accompanying Schedule Showing How
Available Cash is to be Distributed. The statement of liquidation is basically similar to
the one prepared under lump-sum liquidation except that it covers a longer period of
time. In addition, an accompanying schedule is prepared every time cash is distributed.
Such schedule shows how available cash is to be distributed to partners.
4. Prepare a Cash Priority Program. A cash priority program is a program prepared prior
to liquidation so that partners may determine in advance as to whom cash shall be paid as
it becomes available. The preparation of the cash priority program follows these steps: (1)
determining total partners' interests; (2) determining partners' loss absorption capacity;
(3) determining allocation of cash as it becomes available. When a cash priority program
is prepared, a schedule accompanying the statement of liquidation need not be prepared.
GLOSSARY OF ACCOUNTING TERMINOLOGIES
Installment liquidation - realization of non-cash assets on a piece-meal basis.
Partners’ loss absorption capacity - the maximum amount of loss that a partner may absorb
without incurring capital deficiency.
452
DISCUSSION QUESTIONS
1. Differentiate installment liquidation from lump-sum liquidation.
2. Discuss the procedures in installment liquidation.
3. What is a partner’s loss absorption capacity? How is it computed?
4. What advantages may be derived from the preparation of a cash priority program?
5. Describe how non-cash assets and estimated liquidation expenses are treated in the schedule
accompanying the statement of liquidation.
6. describe how a debt balance in a partner’s capital account is treated in the schedule
accompanying the statement of liquidation.
EXERCISES
453
Exercise 7-1 (Distribution of Cash)
Aguilar and Bernardo share earnings in a 60:40 ratio. They have decided to liquidate their
partnership. A portion of the assets has been sold but other assets with a carrying amount of
P84,000 still must be realized. All liabilities have been paid, and cash of P40,000 is available for
distribution to partners. The capital accounts show balances of P80,000 for Aguilar and P44,000
for Bernardo.
Instructions: Determine how should the cash P40,000 be divided.
Exercise 7-2 (Safe Cash Distribution)
When Conde and Dalmacio, partners who share earnings equally, were incapacitated in an
airplane accident, a liquidator was appointed to wind up their business. The accounts showed
cash, P70,000; other assets, P220,000; liabilities, P40,000; Conde’s capital, P142,000; and
Dalmacio’s capital, P108,000. Because of the highly specialized nature of the non-cash assets,
the liquidator anticipated that considerable time would be required to dispose them. The
expenses of liquidating the business (advertising, rent, travel, etc.) are estimated at P20,000.
Instructions: Determine the amount of cash that can be distributed safely to each partner at this
point.
Exercise 7-3 (Program of Cash Distribution)
Capital and loan balances for partners Estela, Fajardo, Gomez, who share profits 40%, 40%, and
20% respectively, are as follows just before liquidation:
Estela, Loan balances
P20,000
Fajardo, Capital
P70,000
Estela, Capital
30,000
Gomez, Loan
30,000
Fajardo, Loan
20,000
Gomez, Capital
40,000
Instructions: Prepare a statement/program to show how available cash would be distributed to
the partners during the course of liquidation after creditors are paid in full. State which partner
would receive the first cash available and at what point and to what degree each of the remaining
partners would participate in cash distributions.
Exercise 7-4 (Program of Cash Distribution; Cash Distribution to Partners)
Partners Halili, Ibanez, and Jacinto have capital balances of P11,200; P113,000; and P5,800,
respectively and share profits in the ratio of 4:2:1.
454
Instructions:
1. Prepare a schedule showing how available cash will be distributed to partners as it becomes
available.
2. How much must the partnership realize om the sale of its assets if Hlili is to receive P10,000
as final settlement?
3. If Halili is personally insolvent and Ibanez receives a total of P1,800 in final liquidation of the
firm, what was the partnership loss on liquidation?
Exercise 7-5 (Cash Priority Program: Statement of Liquidation)
On January 1, 2014, partners Kho, Lagman and Magno decided to liquidate their partnership.
Prior to the liquidation, the partners had cash of P12,000, non-cash assets of P146,000, liabilities
to outsiders of P36,000 and a note payable to Partner Magno of P146,000. The capital balances
of the partners were: Kho – 36,000; Lagman – 54,000; Magno – P18,000. The partners share
profits and losses in the ratio of 3:3:4, respectively.
During January 2014, the partnership received cash of 30,000 from the sale of assets with a book
value of P38,000 and paid P3,600 of liquidation expenses. During February, the partnership
realized P44,000 from the sale of assets with a book value of P35,000 and paid liquidation
expenses of P8,400. During March, the remaining assets were sold for P36,000, The partners
agreed to distribute cash at the end of each month.
Instructions:
1. Prepare a cash priority program.
2. Prepare a statement of liquidation.
3. Prepare the necessary journal entries to record the liquidation process.
455
PROBLEMS
Problem 7-1 (Statement of Liquidation; Cash Distribution)
Noble, Orbos, Pimentel, and Quezon are partners engaged in the business of palay trading under
the name of NOPQ Trading Co. They agreed to dissolve their partnership as of January 31,
2014.
The partners agreed that distribution of cash to the partners were to be made on the last day of
each month during liquidation starting Feb. 28, 2014, provided sufficient cash was available.
Orbos was designated as the partner in charge of liquidation.
The partnership agreement provided that profits and losses were to be divided on the following
basis: Noble, 20%; Orbos, 30%, Pimentel, 30%; and Quezon, 20%.
The following was the condensed statement of financial position of the firm as of January 31,
2014:
Assets
Liabilities and Capital
Cash
P 100,320
Accounts Payable
P 21,360
Goodwill
60,000
Noble, Loan
15,000
Other Assets
133,53
Noble, Capital
24,120
Orbos, Capital
96,480
Pimentel, Capital
109,020
Quezon, Capital
Total Assets
P293,850
27,870
Total Liabilities & Capital
P293,850
Transactions during liquidation other than cash distribution to partners are summarized as
follows:
February
March
Liquidation of assets with book value of:
P66,060
P49,320
P44,850
P48,330
Paid to creditors on account
17,750
3,610
Paid liquidation expenses
8,220
7,380
Instructions: Prepare a statement and supporting schedules showing the total amount of cash
distributed to the partners at the end of February and March and the amounts received by each
456
partner in each distribution. Assume that Orbos made the distribution in such manner that
overpayment to any partner was avoided.
Problem 7-2 (Statement of Liquidation; Journal Entries)
The December 31, 2014 ledger balances of Reyes, Samson and Toledo, who share profits and
losses, 50%, 25%, 25%, respectively, appear as follows:
Cash
P 19,000
Accounts Receivable
197,000
Allowance for Uncollectible Accounts
P 6,000
Accounts Payable
77,000
Toledo, Loan
9,000
Salary Payable to Reyes
6,000
Reyes, Capital
50,000
Samson, Capital
28,000
Toledo, Capital
40,000
At this date, the firm decided to liquidate and the ensuing activities are:
January
February
March
P112,000
P36,000
P35,000
Payments in full settlement of liabilities
38,000
38,000
--
Liquidation expenses
4,400
2,800
4,000
16,000
19,000
Cash collections from customers
Cash payments to partners
remainder
Instructions:
1. Prepare the journal entries to record the liquidation of the partnership.
2. Prepare a statement of liquidation with supporting schedules of cash distributions to partners.
Problem 7-3 (Program of Cash Distribution)
Urbe, Verde, and Waje share profits in the ratio 5:3:2, respectively. Capital and loan balances
just prior to partnership liquidation are:
Capital balances
457
Urbe
Verde
Waje
P120,000
P90,000
P40,000
Loan balances
45,000
30,000
13,000
Assets are sold and cash is distributed to partners in monthly installments during the course of
liquidation as follows:
January
P 15,000
February
40,000
March
90,000
April
30,000
Instructions:
1. Prepare a program to show how cash should be distributed during the entire course of
liquidation.
2. Using the program developed in (1), prepare schedules summarizing the payments to be made
to partners at the end of each month.
3. Prepare a statement of liquidation to summarize the course of liquidation.
Problem 7-4
(Cash Distribution Schedule)
The partnership of Xavier, Yambot, and Zapanta is winding up its affairs. The partners share
profits and losses as follows: XAver, 50%; Yambot, 30% and Zapanta, 20%.
The partners are considering an offer of P100,000 for the accounts receivable, inventory, and
plant and equipments as June 30. The P100,000 would be paid to the partners in installments,
the number and amounts of which are to be negotiated.
The trial balance of the partnership on June 30,2014 is as follows:
Cash
6,000
Accounts Receivable
22,000
Inventory
14,000
Plant and Equipment
99,000
Receivable from Xavier
12,000
Receivable from Zapanta
7,500
Accounts Payable
17,000
Xavier, Capital
67,000
Yambot, Capital
45,000
Zapanta, Capital
31,500
458
160,500
160,500
Instructions: Prepare a cash distribution schedule as of June 30, 2014, showing how the
P100,000 would be distributed as it becomes available.
Problem 7-5 (Statement of Changes in Partner’s Equity)
On January 1, 2013, Fernan and Luisa agreed to combine their talents and capital and form a
partnership. Fernan contributed P20,000 cash, merchandise with a book value of P12,000 and a
market value of P20,000. Luisa gave P15,000 cash and merchandise with a book value of
P24,000 and a market value of P15,000.
On December 31, 2013, before the boos are closed, the drawing account of Fernan shows a debit
balance of P7,000; and for Luisa, debit balance, P6,000. The partnership agreement with regards
to division of profits and losses provides that each partner is to be allowed an annual salary of
P10,000 and Fernan is to receive 65% and Luisa 35% of the balance after allowance of salaries.
On January 2, 2014, Susan is admitted as a partner upon the investment of P40,000 in the firm.
Fernan and Luisa sharing in the ratio of 65:35 give a bonus to Susan so that Susan may have a
40% interest in the firm. The new agreement provides that profits and losses are to be distributed
as follows: Fernan, 35%; Luisa, 25% and Susan, 40%. Salaries are not allowed.
On December 31, 2014, the partners’ drawing accounts have debit balances as follows; Fernan,
P4,900; Luisa, P3,900; and Susan, P4,200. The Income Summary account has a P12,000 debit
balance. Accounts are closed.
In January 2015, the partners decide to liquidate. The assets are realized on a piece-meal basis
and the partners decided to distribute cash as it becomes available. In February, after creditors
are fully paid, cash of p10,000 remains available for partners. This is distributed to the proper
parties.
In April, cash realized from sale of non-cash assets is P20,000 and this is distributed to the
partners.
In May, the remaining noncash assets is solid for P30,000 and on May 31 final cash settlement is
made with partners
.Instructions: Prepare a statement of changes in partners’ equity showing all oft the changes that
took place from January 1, 2013 to May 31, 2015.
Make supporting computation and schedules when necessary. Use the format presented below.
Fernan
Luisa
2013:
Original investment
Distribution of net income (schedule 1)
Total
459
Susan
Total
Drawings
Balances, December 31
2014:
Invesment of Susan
MULTIPLE CHOICE
MC 7-1 The Following statement of financial position was prepared for the Elaine, Flor and
Gina Partnership on March 31, 2014:
Cash
P 25,000
Other Assets
Liabilities
180,000
P 52,000
Elaine, Capital (40%)
40,000
Flor, Capital (40%0
65,000
Gina, Capital (20%)
48,000
P 205, 000
P 205, 000
The partnership is being liquidated by the sale of assets in installments. The first sale of non-cash
assets having a book value of P90,000 realizes P50,000. The amount of cash each partner should
receive in the first installment is:
Elaine
Flor
Gina
a. P0
P5,000
P18,000
b. P12,000
P13,000
P22,000
c. P27,000
P 5,000
P18,000
d. P24,000
P49,000
P40,000
MC 7-3 Using the information in MC7-1 and assuming that each partner properly received the
same amount of cash in the distribution after the second sale of assets. The cash to be distributed
amounts to P14,000 from the third sale of assets, and unsold assets with a P6,000 book value
remain. How should the P14,000 be distributed to Elaine, Flor and Gina respectively?
MC 7-4 Aguas, Bernal and Coral are partners. On January 3, 2014, their capital balances and
profit and loss ration are as follows:
Capital
Profit and Loss Ratio
Aguas
P25,000
60%
Bernal
50,000
25%
Coral
60,000
15%
460
Coral withdrew P10,000 during the year. Net loss on December 31, 2014 totaled P20,000.
Hence, the partners decided to liquidate the partnership. It is uncertain how much of the assets
will ultimately yield but favorable realization is expected. It is, therefore, agreed to distribute
cash as it becomes available. There are unpaid liabilities of P5,000 and cash on hand P7,000.
The amount of non-cash assets before liquidation is:
MC 7-5 Using the information in MC 7-4, the amount to be realized by the partnership on the
sale of its assets so that Aguas will receive a total of P19,000 in the final settlement of his
interest is:
a. P 6,000
c. P103,300
b. P 9,300
d. P119,300
MC 7-6 Using the information in MC 7-4 and assuming Coral received a total of P33,000, the
amount that Bernal would have received at this point is:
a. None
c. P 5,000
b. P 2,000
d. P21,000
MC 7-7 The PAL Partnership is being dissolved. All liabilities have been paid and the
remaining assets are being realized gradually. The equity of the partners is as follows;
Partners’ Accounts
Loans to (from) Partnership
Profit and Loss Ratio
Pureza
P24,000
P6,000
3
Altura
36,000
----
3
Legarda
60,000
(10,000)
4
The second cash payment to any partner/partners under program of priorities shall be made thus:
a. To Legarda P2,00
c. to Legarda P8,000
b. To Altura P6,000
d. to Altura P6,000 and to Legarda P8,000
MC7-8 The statement of financial position of the XYZ Partnership as of December 31, 2014 is presented
below:
Assets
Cash
Other Assets
Liabilities & Capital
P 20, 000
280,000
Liabilities
Dalmacio, Loan
Dalmacio, Capital
P50,000
25,000
125,000
Dalmian, Capital
70,000
Davide, Capital
30,000
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P300,000
P300,000
Profits and loss ratio is 3:2:1 for Dalmacio, Damian, and Davide,
respectively. Other assets were realized as follows:
Date
Cash received
Book Value
January, 2015
P60,000
P90,000
February, 2015
35,000
77,000
March, 2015
125,000
113,000
Cash is distributed as assets are realized. The total loss to Dalmacio is
a. P10,000
b. P20,000
c. P30,000
d. P60,000
MC 7-9 Using the information in MC 7-8, the total cash received by Damian is
a. P15,000
c. P50,000
b. P20,000
d. P70,000
MC 7-10 Using the information in MC 7-8, the total cash received by Davide is
a. P0
c. P500
b. 200
d. 1,000
MC 7-11 The assets and equities of the FFF Partnership at the end of its fiscal year on October
31,2014 are as follows:
Assets
Liabilities & Capital
Cash
P75,000
Liabilities
Receivables-net
100,000
Loan from Fajardo
Inventory
200,000
Felix, Capital(30%)
225,000
Plant assets – net
350,000
Fojas, Capital(50%)
150,000
Loan to Fojas
Total
25,000
Fajardo, Capital(20%)
P750,000
P250,000
50,000
75,000
P750,000
The partners decide to liquidate the partnership. They estimate the nom-cash assets other than the
loan to Fojas can be converted into P500,000 cash over the two-month period ending December
31, 2014. Cash is to be distributed to the appropriate parties as it becomes available during the
liquidation process. The partner most vulnerable to partnership losses on liquidation is
a. Felix
b. Fojas
c. Felix and Fojas only
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d. Fajardo
MC7-12 Using the information in MC 7-11 and assuming that P325,000 is available for the first
distribution, is should be paid to
Priority creditors
Felix
Fojas
Fajardo
a. P300,000
P25,000
0
0
b. P300,000
P7,500
P12,500
P5,000
c. P250,000
P25,000
0
P50,000
d. P250,000
P60,000
0
P15,000
MC7-13 Using the information in MC 7-11 and assuming that a total amount of P37,500 Is
available for distribution to partners after all non-partner liabilities are paid, it should be paid as
follows
Felix
Fojas
Fajardo
a. P37,500
0
0
b. 0
P18,750
P18,750
c. P11,250
P18,750
P7,500
d. P12,500
P12,500
P12,500
MC7-14 Using the information in MC 7-11 and assuming that partner Felix received a total of
P180,000 how much must have been received by partner Fojas?
a. P0
b. P30,000
c. P50,000
d. P180,000
MC7-15 Using the information in MC 7-11 and assuming that partner Fojas received a total of
P180,000 how much must have been received by partner Fajardo?
a.
b.
c.
d.
P75,000
P147,000
P180,000
P255,000
463
Test Material No.25
Rating______
Name:_________________________
Year & Section:__________________
Date:__________________________
Prof.:__________________________
MATCHING TYPE
Choices:
a. Cash Priority Program
h. Partner's capital deficiency
b. Claims of Partner's personal creditors
i. Partner's loss absorption capacity
c. Claims of partnership creditors
j. Priority of claims
d. Dissolution
k. Profit and loss ratio
e. Installment liquidation
l. Right of offset
f. Liquidation
m. Safe payment to partners
g. Lump-sum liquidation
n. Statement of Liquidation
Instructions: Write the letter of the best answer.
____1. A liquidation in which cash is periodically distributed to partners during the liquidation
process.
____2. The sale of the partnership assets, payment of the partnership creditors, and the
distribution of remaining cash to the partners.
____3. They have priority over the claims of partnership creditors to the personal assets of
partner
____4. It presents, in working paper from, the effects of the liquidation process on the statement
of financial position accounts of the partnership.
____5. A schedule that shows how cash is to be distributed as it becomes available during the
liquidation process.
____6. The end of the normal business function of the partnership.
____7. A liquidation in which all assets are first converted into cash over a short period before
any payment is made to the creditors and to the partners.
____8. Allocated to the partners in their profit and loss sharing ratio if a deficient partner is
insolvent.
464
________9. Represent cash payments to partners which are computed on the assumption that
nothing will be realized on the remaining non-cash assets.
________10. A deficit in Garcia’s capital account is reduced to zero because the partnership has
a loan payable to Partner Garcia.
________11. It is computed by dividing the sum of a partner’s capital and loan balance by that
partner’s profit and loss sharing ratio.
________12. The order of creditor’s rights against the partnership ‘s assets and the personal
assets of each partner.
________13. A change in the legal relationship among partners.
________14. The manner of distributing available cash once partners’ loss absorption balances
have been brought to equal balances.
________15. Satisfied, upon liquidation, out of available partnership assets and individual
partner’s excess of personal assets over claims of personal creditor.
465
Test Material No.26
Rating______
Name:_________________________
Year & Section:__________________
Date:__________________________
Prof.:__________________________
MULTIPLE CHOICE – Theory and Problems
Instructions: Encircle the letter of the best answer. Present supporting computations in good
form in a separate work sheet.
1. In accounting for the liquidation of a partnership, cash payments to partners after all
outside creditors’ claims have been satisfied, but before the final cash distribution,
should be made according to
a. Safe payments computation
b. The partners’ profit and loss sharing ratio
c. The final balances in partners’ capital accounts
d. Partners’ share of the gain or loss in liquidation
2. In an installment liquidation, the final cash distribution to the partners should be made
in accordance with the
a. Ratio of capital contributions less withdrawals by the partners
b. Ratio of the original capital contributions plus additional investment
c. Balances of the partners’ loan and capital accounts
d. Partners’ profit and loss sharing ratio
3. in a partnership liquidation, gain on sale of non-cash assets is
a. allocated to the partners based on their capital balances
b. allocated to the partners based on their profit and loss sharing ratio
c. allocated to the partner with the lowest capital balance
d. allocated to partnership liabilities
4. The following financial position is for the partnership of Abril, Suarez, and Custodio,
who share profits and losses in the ration of 4:4:2, respectively.
Cash
P40,000
Liabilities
P100,000
Other assets
360,000
Abril, Capital
74,000
Suarez, Capital
130,000
Custodio, Capital
96, 000
P400,000
P400,000
466
The firm is dissolved and liquidated by selling assets in installments. If the first sale
on non-cash assets having a book value of P180,000 realizes P100,000 and all cash
available after settlement with creditors is distributed, the respective partners would
receive (rounded to the nearest peso)
Abril
Suarez
Custodio
a.
P16,000
P16,000
P8,000
b.
12,333
12,333
12,334
c.
-026,667
12,333
d.
-06,000
34,000
5. Using the same information in No. 4 except that P6,000 cash is to be withheld, the
respective partners would the receive (rounded to the nearest peso)
Abril
Suarez
Custodio
a.
P13,600
P13,600
P6,800
b.
11,333
11,333
11,334
c.
-026,667
11,333
d.
-02,000
32,000
6. Using the same information in No. 4 and assuming that each partner properly
received some cash in the distribution after the second sale, unsold assets with
P16,000 book value remain the respective partners would receive
Abril
Suarez
Custodio
a.
P9,600
P9,600
P4,800
b.
P8,000
P8,000
P8,000
c. 37/150 of P24,000
65/150 of P24,000 48/150 of P24,000
d.
-0P16,000
P8,000
7. Partners Donato, Munoz, and Torres, who share profit losses in the ratio of 3:5:2,
respectively, have decided to liquidate their partnership. At the time of liquidation,
the statement of financial position of the partnership consisted of the following
Cash
P80,000
Other Assets 240,000
Liabilities
Loan from Munoz
Donato, Capital
Munoz, Capital
Torrez, Capital
P320,000
467
P62,000
20,000
72,000
80,000
86,000
P320,000
The partners decide to prepare a cash priority program showing how much would be
distributed to partners as asset are realized. In the cash priority program, the loss
absorption capacity of each partner would be
a. Donato – P240, 000 Munoz – P160,000 Torres – P430,000
b. Donato – P200,000 Munoz – P400,000 Torres – P150,000
c. Donato – P300,000 Munoz – P350,000 Torres – P250,000
d. Donato – P240, 000 Munoz – P200,000 Torres – P430,000
8. Based on the information in No. 7 the schedule of possible losses on capital balances
would indicate that the first cash distribution, after the payment of the outside
creditors, would be distributed to and in the amount of
a. Donato in the amount of P32,000
b. Munoz in the amount of P40,000
c. Torres in the amount of P38,000
d. Torres in the amount of P20,000
9. Using the information in No. 7and assuming the first sale of assets with a book value
of P
100,000 realized P30,000 and all available cash is distributed, respective
partners would receive
a. Donato – P-0-;
Munoz – P12,000;
Torres – P36,000
b. Donato – P6,000;
Munoz – P-0-;
Torres – P42,000
c. Donato – P16,000; Munoz – P16,000;
Torres – P16,000
d. Donato – P42,000; Munoz – P-0-;
Torres – P6,000
10. Using the information in No.7 and No. 9 and assuming the second sale of other assets
with a book value of P60,000 realized P80,000 and all available cash is distributed,
the respective partners would receive
a. Donato – P27,000; Munoz – P35,000;
Torres – P18,000
b. Donato – P12,000; Munoz – P-0-;
Torres – P8,000
c. Donato – P6,000;
Munoz – P10,000;
Torres – P8,000
d. Donato – P42,000; Munoz – P-0-;
Torres – P4,000
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Test Material No.27
Rating______
Name:_________________________
Year & Section:__________________
Date:__________________________
Prof.:__________________________
PROBLEM
The partners of ASC partnership feel that it is no longer financially feasible continue operations
and have agreed to liquidate a partnership. The statement of financial position on June 30, 2014,
just prior to the start of liquidation is presented below. Partners Alfonso, Santos and Censon
share profit and loss in the ratio of 5:3:2, respectively.
Assets
Liabilities and Capital
Cash
Non-cash Assets
P100000
650,000
Total Assets
P750,000
Liabilities
Loan payable to Alfonso
Alfonso, Capital
Santos, Capital
Censon, Capital
Total Liabilities and Capital
P150,000
25,000
175,000
300,000
100,000
P750,000
Instructions:
1. Prepare a cash priority program showing how cash will be distributed to the partners as it
becomes available.
2. If the first sale of non-cash assets with a book value of P400,000 realizes P230,000 and
available cash is distributed, determine the account of cash to be distributed to each
partner.
469
Chapter 8
Organization and Formation of a Corporation
LEARNING OBJECTIVES
1. Define a corporation and identify its characteristics
2. Identify and discuss the advantages and disadvantages of a corporate form of
organization
3. Identify and discuss the various classes of corporation
4. Identify the components of a corporation and the steps in organizing it
5. Identify the different types of records that are maintained by a corporation
6. Identify and differentiate the two classes of share capital issued by a corporation
7. Identify the measurement bases in the issuance of share capital in the exchange use
considerations
8. Record transactions relating to issuance of share capital using the memorandum entry
method and the journal entry method
PREVIEW OF THE CHAPTER
CORPORATION
Nature of a Corporation
-Characteristics Advantages Disadvantages
-Classes of corporation
-Componentsof a corporation
-Steps in organizing a
corporation
-Rights of a stockholder
-Corporate records
Classes of Share Capital
-Ordinary share capital
(common)
-Preference share capital
(preferred)
-Cumulative
-Non-cumulative
-Participating
-Non-participating
-Convertible
-Redeemable
-Par value share capital
-Stated value share capital
_No-par, no stated value
share capital
470
Issuance of Share Capital
-Methods of recording
-Memo entry
-Journal entry
-Considerations in
exchange for share capital
-Cash
-Non-cash assets
-Services
-Share capital subscription
-Subscription default
DEFINITION OF A CORPORATION
A corporation is an artificial being created by operation of law, having the right of succession
and the powers attributes and properties expressly authorized by law or incident to is existence.
(Section 1, Corporate Code of the Philippines)
CHARACTERSTICS OF A CORPORATION
1. Separate legal entity - artificial being. A corporation is an artificial being with a
personality that is separate from that of its individual owners. Thus, it may, under its
corporate name, take, hold, or convey property to the extent allowed by law, enter into
contracts and sue or be sued
2. Created by operation of law. A corporation is generally created by operation of law.
The mirror agreement of the parties cannot give rise to a corporation.
3. Right of succession. A corporation has the right of succession. Irrespective of the death,
withdrawal, insolvency, or incapacity of the individual members or shareholders, and
regardless of the transfer of their interest or share capital, a corporation can continue its
existence up to the period of time stated in the articles of incorporation but not to exceed
fifty years.
4. Powers, attributes, properties authorized by law. The corporation has only the powers,
attributes, and properties expressly authorized by law or incident to its existence. Being a
mere creation of law, a corporation can only exercise powers provided by law and those
powers which are incidental to its existence.
5. Ownership divided into shares. Proprietorship in a corporation is divided into units
known as share capital. The buyers of the share capital are called shareholders or
stockholders and are considered owners of the business
6. Board of directors. Management of the business is vested in a board of directors elected
by shareholders. Board of directors is the governing body or decision making body of the
corporation. The Corporation Law provides that the number of directors be not less than
five but not more than fifteen.
ADVANTAGES OF A CORPORATION
1. The corporation enjoys continuous existence because of its power of succession.
2. The corporation has the ability to obtain a strong credit line because of continuity of
existence.
3. Large scale business undertakings are made possible because many individuals can invest
their funds in their enterprise.
471
4. The liability of its investors or shareholders is limited to the extent of their investment in the
corporation.
5. The transfer of shares can be effected without the need for prior consent of other shareholders.
6. Its smooth operation is guaranteed because of centralized management.
DISADVANTAGES OF A CORPORATION
1. It is not easy to organize because of complicated legal requirements and high costs in its
organization.
2. The limited liability of its shareholders may weaken its credit capacity.
3. It is subject to rigid governmental control.
4. It is subject to more taxes.
5. Its centralized management restricts a more active participation by shareholders in the
conduct of corporate affairs.
CLASSES OF CORPORATION
Corporations are generally classified according to purpose, membership holdings, compliance of
law, law of creation, extent of membership or other basis of classification. Generally, profitoriented corporations are open, private and stock corporations. Nonprofit corporations are public
and private non-stock corporations.
The following is a list of the common classes of corporation:
1. As to Membership Holdings
a. Stock Corporation – a private corporation in which the capital is divided into shares
of stock and is authorized to distribute corporate earnings to holders on the basis of
shares held. The owners of stock corporations are called stockholders or shareholders.
b. Non-stock Corporation – a private corporation in which capital comes from fees paid
by individuals composing it. The owners of a non-stock corporation are called
members.
2. As to Purpose
a. Public Corporation – a corporation that is organized to govern a portion of the state
(e.g. municipalities, provinces)
b. Private Corporation – a corporation that is organized for a private benefit, aim or end.
c. Quasi-public Corporation – a private corporation which is given a franchise to
perform functions of a public character. Classified under this type are the so called
public utility corporations such as MERALCO OR PLDT.
3. As to Compliance of Law
a. De jure corporation – a corporation which exists in both law and fact. It exists in law
because it has complied with all the legal requirements; it exists in fact because it
actually operates as a corporation.
b. De facto corporation – a corporation which exists only in fact but not in law. It does
not exist in law because of non-compliance with certain legal requirements.
4. As to Law of Creation
472
a. Domestic Corporation – a corporation that is organized under Philippine laws.
b. Foreign Corporation – a corporation that is organized under the laws of other
countries.
5. As to Extent of Membership
a. Open Corporation – a corporation whose ownership is widely held by many investors,
usually a private stock corporation.
b. Closely-held Corporation or Family Corporation – a private corporation in which
50% or more of its stock is owned by five (5) persons or less.
Other types of corporations include parent or holding corporations, subsidiary corporations,
ecclesiastical corporations, and lay corporations which are themselves classified into other
groups.
COMPONENTS OF A CORPORATION
1. Incorporators – they are the persons who originally formed the corporation and whose
names appear in the Articles of Incorporation. They must be natural persons as
distinguished from artificial persons.
2. Corporators – they are the persons who compose the corporation whether as shareholders
or members.
3. Stockholders or shareholders – they are the corporators of a stock corporation.
4. Members – they are the corporators of a non-stock corporation.
5. Promoters – they are the persons who undertake to (a) form a company based on a given
project, (b) set it going, and (c) take the necessary steps to accomplish the purpose for
which the corporation is organized.
6. Subscribers – they are the persons who have agreed to take original, unissued shares but
will pay at a later date. They may be incorporaters or not and they may eventually
become shareholders the moment full payment of their subscriptions is made.
7. Underwriters – they are those who undertake to dispose of the shares to the general
public.
ORGANIZING A CORPORATION
The process of organizing a corporation generally consists of three stages which normally
require the aid of legal, competent advisers. These three stages are discussed below:
1. Promotion – the incorporators make preliminary arrangements to set up a tentative
working organization and to solicit subscriptions to raise sufficient capital for the
business.
2. Incorporation – the process of formalizing the organization of the corporation. This stage
includes:
a. Drafting of the articles of incorporation which must be duly executed and
acknowledged before a notary-public.
473
b. Filing of the articles of incorporation with the Securities and Exchange Commission
(SEC) together with the statement showing that at least 25% of the total authorized
share capital (also known as authorized capital stock) has been subscribed and that at
least 25% of the total subscriptions have been paid.
c. After the required fees have been paid and upon approval of the articles of
incorporation, the SEC issues a certificate of incorporation, the date of which being
considered as the date of registration or incorporation.
3. Commencement of the business – the business should start its operations within two
years from the date of incorporation. Failure to do so will automatically dissolve the
corporation without the need for a hearing.
Costs incurred during incorporation, such as filing fees, cost of printing stock certificates,
promoters’ commission and legal fees, are known as organization costs or pre-operating costs.
Under PAS 38 Intangible Assets, organization or pre-operating costs are changed to expense in
the period incurred.
ARTICLES OF INCORPORATION
The Articles of Incorporation enumerate the powers and limitations conferred upon the
corporation by the government. It includes the following information:
1.
2.
3.
4.
5.
6.
The name of the corporation;
The purpose or purposes for which the corporation is formed;
The place of the principal office of the corporation;
The term of existence of the corporation, not exceeding fifty years;
The names, nationalities, and addresses of the incorporators;
The names of the directors who will serve until their successors are duly elected and
qualified in accordance with the by-laws;
7. The authorized share capital (authorized capital stock), the classes of share capital
(stocks) to be issued, and the number of shares and terms of each class indicating the per
value per share, if there is any;
8. The amount of subscriptions to the share capital (capital stock), the names of the
subscribers and the number of shares subscribed by each; and
9. The total amount paid on the subscriptions to the share capital (capital stock) and the
amount paid by each subscriber on his subscription.
BY LAWS
The by-laws of the corporation supplement the articles of incorporation. It contains provisions
for the internal administration of the corporation. The corporate by-laws normally include the
following:
1.
2.
3.
4.
The date, place and manner of calling the annual shareholders’ (stockholders’) meeting;
The manner of conducting meetings;
The circumstances which may permit the calling of special meeting of the shareholders;
The manner of voting and the use of proxies;
474
5. The manner of electing the directors and number of directors;
6. The term of office of the directors;
7. The authority and duties of the directors;
8. The manner of selecting the corporate officers;
9. The authority and responsibilities of the officers;
10. The procedure for amending the articles of incorporation; and
11. The procedure for amending the by-laws.
CORPORATE RECORDS
The corporation generally maintains the following records to keep track of its various
transactions:
1. Record of all business transactions (journals, ledgers, vouchers, and other supporting
documents).
2. Minutes of all meetings of directors.
3. Minutes of all meetings of shareholders (stockholders).
4. Stock and transfer book
a. Shareholders’ (stockholders’) journal – chronological and numerical record of stock
certificates issued.
b. Shareholders’ (stockholders’) ledger – alphabetical record of individual shareholders.
c. Subscribers’ ledger – alphabetical record of individual subscribers.
5. Optional and supplementary records.
SHARE CAPITAL (CAPITAL STOCK)
Share capital is also known as capital stock. It is the amount fixed by the corporate charter to be
subscribed and paid in or secured to be paid in by the shareholders of the corporation either in
money or in property, labor or services upon the organization of the corporation or afterwards;
and upon which it is to conduct its operations.
CLASSES OF SHARE CAPITAL
A corporation may issue two classes of share capital, namely, ordinary share capital (common
stock) and preference share capital (preferred stock). When a single class of share capital is
issued, it is an ordinary share capital. Ordinary share capital entitles the holder to an equal or
pro-rata division of profits without any preference or advantage over any class of shares.
Preference share capital, on the other hand, entitles the holder to enjoy priority as to distribution
of dividends and distribution of assets upon corporate liquidation. Dividends are corporate
profits distributed to its shareholders.
Unless otherwise stated in the contract, all shareholders have the same basic rights. These rights
are as follows:
1. To share in the distribution of corporate profit;
475
2. To share in the distribution of assets upon corporate liquidation;
3. To vote in shareholders’ meeting; and
4. To maintain one’s ownership interest in the corporation through purchase of additional
shares when a new share capital is issued. This is known as the preemptive right.
If a corporation issues both preference and ordinary share capital, the articles of incorporation or
the corporate by-laws should state the special features of each class of share capital.
Both preference and ordinary share capital may be issued with par, without par but with stated
value, or without par and without stated value.
A par value share capital has a nominal or face value stated in the face of the stock certificate
and in the articles of incorporation.
A no-par but with stated value share capital has a nominal value stated in the articles of
incorporation but not on the face of the stock certificate.
A no-par, no stated value share capital has no nominal value stated either in the articles of
incorporation nor on the face of the stock certificate.
In our Corporation Code, a no-par share capital is to be issued for a consideration of not less than
five pesos. (P5.00)
PREFERENCE SHARE CAPITAL (PREFERRED STOCK)
A preference share capital is generally issued with a par value and a dividend rate. The holders of
preference shares have priority as to distribution of dividends and as to distributions of assets in
the event of corporate liquidation. However, this does not mean that the holders are assured of
regular receipt of dividends; rather, this means the dividend requirements on preference shares
must first be met before any payment can be made to holders of ordinary shares.
A corporation may issue more than one calss of preference shares. Generally, preference shares
may be classified as follows:
1. Cumulative preference shares – entitle the holders to the receipt of previous years unpaid
dividends (i.e., dividends in arrears) before any payment can be made to ordinary shareholders
upon dividend declaration. This means that if dividend is not declared in a particular year, the
right to such dividend is not lost but carried forward to a subsequent year.
2. Non-cumulative preference shares – entitle the holders to the receipt of current dividends but
not on the previous years’ unpaid dividends. This means that if dividend is not declared in a
particular year, the right to such dividend is lost.
3. Participating preference shares – entitle the holders to the receipt of additional dividend after
holders of both preference and ordinary shares have been paid up to the current year’s dividend.
This means that the holders of preference shares have the right to share in extra dividends.
476
Participating preference shares may be fully participating or participating only up to a certain
amount or percentage.
4. Nonparticipating preference share – entitle the holders to the receipt of dividends up to the
current period only. All extra dividends are given to holders of ordinary shares.
5. Convertible preference shares – entitle the holders the option to exchange the shares for some
other securities of the issuing corporation, normally ordinary shares.
6. Redeemable preference shares – entitle the issuing corporation the option to reddem or call the
shares at a certain call price.
ORDINARY SHARE CAPITAL (COMMON STOCK)
An ordinary share capital or common stock represents residual ownership equity. The holders of
this class of share capital carry the greatest risk; however, the ordinarily share in earnings to the
greatest extent if the corporation is successful. Although the right to vote is a basic right of all
shareholders, it is frequently given exclusively to ordinary shareholders as long as dividends are
paid regularly to preference shareholders.
AUTHORIZED SHARE CAPITAL
The maximum number of shares (both preference and ordinary shares) that a corporation may
issue is termed as authorized shares. The authorized share capital (authorized capital stock) is
determined by multiplying the authorized shares by the par or stated value of the share capital.
A corporation cannot issue shares more than the authorized shares stated in the articles of
incorporation. However, it may increase its authorized shares and authorized share capital by
amending its articles of incorporation.
Authorized share capital may be recorded under the journal entry method or the memorandum
entry method. The entries under the two (2) methods to record authorized share capital are
presented below and on the next page.
MEMORANDUM ENTRY METHOD
Authorized to issue xxx shares of xxx share capital with a par value of Pxxx.
JOURNAL ENTRY METHOD
Unissued XXX Share Capital
xxx
477
Authorized XXX Share Capital
xxx
The total amount recorded is computed by multiplying authorized shares by the par or the stated
value of the share capital. Thus, this method cannot be used if the the share capital is a no-par
and no-stated value stock.
The entry to record authorized share capital is made in the general journal and is then posted to
the share capital account in the general ledger. If more than one class of these capitals are issued,
a separate entry is made for each class of share capital and a separate account for each class is
maintained in the general ledger.
The memorandum entry method enjoys popularity in use compared with the journal entry
method. For problem solving purposes, the memorandum entry method will be used if there is no
specification as to which method will be used.
Illustrative Problem A: The Joyful Company was organized on January 1, 2014 will be
authorized share capital as follows:
10,000 shares of 10% preference share capital with a par value of P100 per share.
200,000 shares of ordinary share capital with a par value of P10 per share.
The entries to record authorized share capital and the subsequent posting to the general ledger
under each method are illustrated below:
Case 1 – The memorandum entry method is used.
2014
Jan. 1 Authorized to issue 10,000 shares of 10% preference share capital with a par value of
P100 per share.
1 Authorized to issue 200,000 shares of ordinary share capital with a par value of P10 per
share.
The two entries are then posted to the accounts in the general ledger as follows:
Case 2 – The journal entry method is used.
2014
478
Jan. 1 Unissued Preference Share Capital
1,000,000
Authorized Preference Share Capital
1 Unissued Ordinary Share Capital
1,000,000
2,000,000
Authorized Ordinary Share Capital
2,000,000
These entries are then posted to the accounts in the general ledger as follows:
Posting to the accounts in the general ledger is very important so that the corporation will be able
to monitor shares issued and avoid the issuance of shares more than what is authorized.
ISSUANCE OF SHARE CAPITAL
A share capital may be issued in exchange for cash, non-cash assets, services, liability or other
form of securities. It may be sold also on a subscription basis. A share capital issued to a
shareholder is called an outstanding share. The major issue on issuance of share capital is the
basis for measurement of the transaction. The discussion of the measurement standards will be
based on the provisions of PRFS 2 Share-Based Payment and will be limited to issuance of share
capital to non-employees. The issuance of share capital to employees (such as share options and
share appreciation rights) will be discussed in financial accounting.
A shareholders’ (stockholders’) ledger is used to maintain records affecting the shareholding of
each shareholder such as transfer or sale of share capital. Shares issued to a shareholder, on the
other hand, are recorded in the stock certificate book.
Share capital issued are recorded in the share capital account maintained for each class of share
capital. The discussions in the succeeding paragraphs are focused on the issuance of various
classes of shares in exchange for various considerations.
479
ISSUANCE OF PAR VALUE SHARE
As discussed earlier, a par value share has a nominal value stated on the face of the stock
certificate. The following rules shall apply in the issuance of this class of share capital.
ISSUANCE FOR CASH. A share capital may be issued for cash equal to its par value, above par
value, or below par value. If cash received is equal to its par value, Cash is debited and Share
Capital or Unissued Share Capital is credited.
If the share capital is sold or issued above its par value, Cash is debited for the amount received,
Share Capital or Unissued Share Capital is credited at par value, and Share Premium or Paid-in
Capital in Excess of Par is credited for the excess of cash received over par value.
If the share capital is sold or issued below its par value, Cash is debited for the amount received,
share Capital or Unissued Share Capital is credited at par value, and Discount on share capital is
debited for the excess of par value over the amount of cash received Under the Corporation Code
of the Philippines, however, the original issuance of that capital at a discount is not allowed.
Therefore, problems involving discounts are used in the book for illustration purposes only.
Illustrative Problem B: The Happy Corporation was organized on January 1, 2014 and is
authorized to issue 10,000 shares of P10 par value ordinary shares. Subsequently, 25,000 shares
were sold.
The entries to record the sale of shares under the two methods of recording share capital using
three independent cases are presented below and on the next page.
MEMORANDUM ENTRY METHOD
Case 1 – The issuance price is P10 (at par)
Cash
250,000
Ordinary Share Capital
250,000
25,000 sh x P10 = P250,000
Case 2 – The issuance price is P15 (above par)
480
Cash
375,000
Ordinary Share Capital
250,000
Ordinary Share Premium
125,000
25,000 sh x P15 = P375,000
25,000 sh x P10 = P250,000
25,000 sh x P 5 = P125,000
481
Case 3 - The issuance price is P8 (below par)
Cash
200,000
Discount on Ordinary Share Capital
50,000
Ordinary Share Capital
250,000
25,000 sh x P 8 = P200,000
25,000 sh x P10 = P250,000
25,000 sh x P 2 = P 50,000
JOURNAL ENTRY METHOD
Case 1 - The issuance price is P10 (at par)
Cash
250,000
Unissued Ordinary Share Capital
250,000
25,000 sh x P10 = P250,000
Case 2 – The issuance price is P15 (above par)
Cash
375,000
Unissued Ordinary Share Capital
250,000
Ordinary Share Premium
125,000
25,000 sh x P15 = P375,000
25,000 sh x P10 = P250,000
25,000 sh x P 5= P125,000
Case 3 - The issuance price is P8 (below par)
Cash
200,000
Discount on Ordinary Share Capital
50,000
Ordinary Share Capital
25,000 sh x P 8 = P200,000
25,000 sh x P10 = P250,000
25,000 sh x P 2 =P 50,000
482
250,000
It should be noted that the basic difference between the memorandum entry method and the
journal entry method is the account to be credited upon issuance of the share capital.
Under the memorandum entry method, the Share Capital account is credited upon issuance of
the stock. The balance of this account represents the amount of capital stock or share capital
issued to shareholders.
Under the journal entry method, the Unissued Share Capital account is credited upon issuance
of the share capital thereby reducing the balance of this account. The balance of this account
represents the amount of authorized share capital not yet issued and is deducted from the balance
of Authorized Share Capital account to determine the amount of share capital already issued to
shareholders.
ISSUANCE IN EXCHANGE FOR NON-CASH ASSETS OR PROPERTY. When a share
capital issued in exchange for non-cash assets, the asset received is recorded at its fair value (also
known as direct measurement), unless the fair value cannot be estimated reliably. If the fair value
of the asset received cannot be estimated reliably, it will be recorded at the fair value of the share
capital issued, also known as indirect measurement (PFRS 2, par. 10). The fair value of the asset
received shall be determined at the date the entity receives the asset (PFRS 2, par. 13).
Upon issuance of the stock, Share Capital or Unissued Share Capital is credited at par value. The
excess of the value assigned to the asset received over the par value of the stock issued is
credited to Share Premium or Additional Paid-in Capital, or Share Capital in Excess of Par. To
reiterate, original issuance of share capital at less than its par value is prohibited under our
Corporation Code.
In some instances, the value assigned to the asset received is overstated or understand. When the
value assigned to the asset received in exchange for share capital is overstated, the share capital
issued is called watered share capital. The overstatement is done to comply with the requirement
of the law that the share capital should not be issued at less than its par value. When the value of
the asset received is understated, the share capital is said to contain secret reserves.
Illustrative Problem C: The Happy Corporation issued 10,000 shares of its P10 par ordinary
share capital in exchange for land. The entries to record the issuance of the share capital under
the memorandum entry method using three independent cases are given on below and on the
next page.
Case 1 - The land has a fair value of P175,000.
Land
175,000
Ordinary Share Capital
100,000
483
Ordinary Share Premium
75,000
10,000 sh x P10
= P 100,000
P175,000 - P100,000
= P 75,000
Case 2 - The land has no known market value. The fair value of ordinary share capital on the
date of exchange is P15.
Land
150,000
Ordinary Share Capital
100,000
Ordinary Share Premium
50,000
If the journal entry method is used instead of the memorandum entry method, Unissued Ordinary
Share Capital should have been credited instead of Ordinary Share Capital.
ISSUANCE IN EXCHANGE FOR SERVICES RENDERED. When a share capital is issued
in exchange for services rendered, the services received is recorded at its fair value (also known
as direct measurement), unless the fair value cannot be estimated reliably. If the fair value of the
services received cannot be estimated reliably, it will be recorded at the fair value of the share
capital issued, also known as indirect measurement (PFRS 2, par. 10). The fair value of the
services received shall be determined at the date the other party renders the services. (PFRS 2,
par. 13).
If the shares are issued for services rendered during incorporation, Pre-Operating Expenses is
debited, Share Capital or Unissued Share Capital is credited at par value; Share Capital in Excess
of Par, or Additional Paid-in Capital or Share Premium is credited for any excess of the value
assigned to pre-operating expenses and the par value of the share capital.
Illustrative Problem D: The Happy Corporation issued 1,000 shares of P10 par ordinary share
capital in payment for the services of the lawyer rendered during incorporation.
Case 1 - The services of the lawyer is valued at P25,000.
Pre-Operating Expenses
25,000
Ordinary Share Capital
10,000
Ordinary Share Premium
15,000
1,000 sh x P10
=P 10,000
P25,000 - P10,000
= P 15,000
Case 2 - There is no known fair market value for the services of the lawyer. The fair market
value of the ordinary share capital issued is P15 per share.
Pre-Operating Expenses
15,000
484
Ordinary Share Capital
10,000
Ordinary Share Premium
5,000
1,000 sh x P15
= P 15,000
1,000 sh x P10
=P 10,000
1,000 sh x P 5
= P 5,000
SALE OF SHARE CAPITAL ON A SUBSCRIPTION BASIS. Subscription is a contract
between a subscriber (buyer of share capital) and a corporation (seller or issuer of share capital)
whereby the former purchases shares of stock of the latter with the payment to be made at a later
date. The corporation issues the corresponding stock certificate upon full payment of
subscription. This practice is a means of encouraging subscribers to pay their unpaid subscription
on time.
Sale of share capital on a subscription basis generally involves three major transactions – (1)
receipt of subscription, (2) collection from subscribers, and (3) issuance of stock certificate upon
full payment of subscription. Entries required for these transactions are given below.
1.
To record the receipt of subscription
a. Subscription price (SP) is equal to par value (PV)
Share Capital Subscription Receivable
xxx
Share Capital Subscribed
xxx
Shares subscribed x PV = Pxxx
b. Subscription price is above par value
Share Capital Subscription Receivable
xxx
Share Capital Subscribed
xxx
Share Premium
xxx
Receivable
= shares subscribed x SP
Subscribed
= shares subscribed x PV
Premium
= shares subscribed x (SP-PV)
It should be noted that the Share Capital Subscribed account is always credited at par value,
regardless of the subscription price.
2. To record collection of subscription from subscribers.
Cash
xxx
Share Capital Subscription Receivable
485
xxx
3. To record issuance of stock certificate upon full payment of subscription.
Share Capital Subscribed
xxx
Share Capital (or Unissued Share Capital)
xxx
Illustrative Problem E: On June 3, 2014, the Happy Corporation received subscription for
5.000 shares of its P10 par value ordinary share capital at P15. A down payment of 25% was
received and the balance was paid in full on July 4, 2014. The entries to record these transactions
using the memorandum entry method are presented on the next page.
2014
June 3 Ordinary Share Capital Subscription Receivable
75,000
Ordinary Share Capital Subscribed
50,000
Ordinary Share Premium
25,000
5,000 sh x P15 = P 75,000
5,000 sh x P10 = P 50,000
5,000 sh x P 5 = P 25,000
June 3 Cash
18,750
Ordinary Share Capital Subscription Receivable
18,750
P75,000 x 25% = P 18,750
July 4
Cash
56,250
Ordinary Share Capital Subscription Receivable
56,250
P75,000 x 75% = P 56,250
4
Ordinary Share Capital Subscribed
50,000
Ordinary Share Capital
50.000
The entries on June 3 may be recorded in a compound entry as follows:
June 3 Ordinary Share Capital Subscription Receivable
Cash
56,250
18,750
Ordinary Share Capital Subscribed
486
50,000
Ordinary Share Premium
25,000
ISSUANCE OF NO-PAR, BUT WITH STATED VALUE SHARE CAPITAL
A share capital without par value but with a stated value has a nominal value stated in the articles
of incorporation but not on the face of the stock certificate.
The same rules discussed in the issuance of share capital with a par value are applicable. The
account Share Capital in Excess of Stated Value may be used instead of the account Share
Premium or Share Capital in Excess of Par.
ISSUANCE FOR CASH. A share capital may be sold for cash at its stated value, at more than
stated value, or at less than stated value. If cash received is equal to stated value, Cash is debited
and Share Capital or Unissued Share Capital is credited.
If the share capital is sold or issued at more than its stated value, Cash is debited for the amount
received, Share Capital or Unissued Share Capital is credited at stated value, and Paid-in Capital
in Excess of Stated Value is credited for the excess of cash received over stated value.
If the share capital is sold or issued at less than its stated value, Cash is debited for the amount
received. Share Capital or Unissued Share Capital is credited at stated value, and Discount on
Share Capital is debited for the excess of stated value over the amount of Cash received. Under
the Corporation Code of the Philippines, however, the original issuance of share capital at a
discount is not allowed. Therefore, problems in counts are used in the book for illustration
purposes only.
Illustrative Problem F: The Happy Corporation was organized on January 1, 2014 and is
authorized to issue 100,000 shares of P10 stated value ordinary share capital. Subsequently,
25,000 shares were sold.
The entries to record the sale of share capital under the memorandum entry meth recording share
capital using three independent cases are as follows:
Case 1 – The issuance price is P10 (at stated value)
Cash
250,000
Ordinary Share Capital
250,000
25,000 sh x P10 = P250,000
487
Case 2 – The issuance price is P15 (above stated value)
Cash
375,000
Ordinary Share Capital
250,000
Ordinary Share Capital in Excess of Stated Value
125,000
25,000 sh x P15 = P375,000
25,000 sh x P10 = P250,000
25,000 sh x P 5 = P125,000
Case 3 – The issuance price is P8 (below stated value)
Cash
200,000
Discount on Ordinary Share Capital
50,000
Ordinary Share Capital
250,000
25,000 sh x P 8 = P200,000
25,000 sh x P10 = P250,000
25,000 sh x P 2 = P 50,000
If the journal entry method is used instead of the memorandum entry method, Unissued Share
Capital will be credited instead of Ordinary Share Capital.
ISSUANCE IN EXCHANGE FOR NON-CASH ASSETS OR PROPERTY. When a share
capital is issued in exchange for non-cash assets, the asset received is recorded at its fair value
(also known as direct measurement), unless the fair value cannot be estimated reliably. If the fair
value of the asset received cannot be estimated reliably, it will be recorded at the fair value of the
share capital issued, also known as indirect measurement (PFRS 2, par. 10). The fair value of
the asset received shall be determined at the date the entity receives the asset (PFRS 2, par. 13).
Upon issuance of the share capital, Share Capital or Unissued Share Capital is credited at stated
value. The excess of the value assigned to the asset received over the stated value of the share
capital issued is credited to Share Capital in Excess of Stated Value.
Illustrative Problem G: Happy Corporation issued 10,000 shares of its P10 stated value
ordinary share capital in exchange for land. The entries to record the issuance of share capital
under the memorandum entry method using three independent cases are given below:
Case 1 – The land has a market value of P175,000.
Land
170,000
Ordinary Share Capital
100,000
488
Ordinary Share Capital in Excess of Stated Value
10,000 sh x P10
70,000
=P 100,000
P175,000 – P100,000 =P 75,000
Case 2 - The land has no known market value. The fair market value of ordinary share capital on
the date of exchange is P15.
Land
150,000
Ordinary Share Capital
100,000
Ordinary Share Capital in Excess of Stated Value
50,000
10,000 sh x P15 = P150,000
10,000 sh x P10 = P100,000
10,000 sh x P 5 =P 50,000
If the journal entry method is used instead of the memorandum entry method, Unissued Ordinary
Share Capital should have been credited instead of Ordinary Share Capital.
ISSUANCE IN EXCHANGE FOR SERVICES RENDERED. When a share capital is issued in
exchange for services rendered, the services received is recorded at its fair value (also known as
direct measurement), unless the fair value cannot be estimated reliably. If the fair value of the
services received cannot be estimated reliably, it will be recorded at the fair value of the share
capital issued, also known as indirect measurement (PFRS 2, par. 10). The fair value of the
services received shall be determined at the date the other party renders the services. (PFRS 2,
par. 13).
If the shares are issued for services rendered during incorporation, Pre-Operating Expense is
debited, Share Capital or Unissued Share Capital is credited at stated value; Share Capital in
Excess of Stated Value or Additional Paid-in Capital is credited for any excess of the value
assigned to pre-operating expenses over the stated value of the share capital.
Illustrative Problem H: The Happy Corporation issued 1,000 shares of P10 stated value
ordinary share capital in payment for the services of the lawyer rendered during incorporation.
Case 1 – The services of the lawyer is valued at P25,000.
Pre-Operating Expenses
15,000
Ordinary Share Capital
10,000
489
Ordinary Share Capital in Excess of Stated Value
1,000 sh x P10
= P 10,000
P25,000 - P10,000
= P 15,000
15,000
Case 2 – There is no known fair market value for the services of the lawyer. The market value of
the ordinary share capital issued is P15 per share.
Pre-Operating Expenses
15,000
Ordinary Share Capital
10,000
Ordinary Share Capital in Excess of Stated Value
5,000
1,000 sh x P15 = P 15,000
1,000 sh x P10 = P 10,000
1,000 sh x P 5 = P 5,000
SALE OF SHARE CAPITAL ON A SUBSCRIPTION BASIS. The sale of stock with stated
value on a subscription basis is recorded in the same manner as that of a stock with a par value,
except for the account credited for the excess of the subscription price over the stated value of
stock. The account Share Capital in Excess of Stated Value is credited instead of Share Premium,
or Additional Paid-in Capital, or Share Capital in Excess of Par.
Illustrative Problem I: On June 3, 2014, the Happy Corporation received subscription for 5,000
shares of its P10 stated value ordinary share capital at P15. A down payment of 25% was
received and the balance was paid in full on July 4, 2014. The entries to record these transactions
using the memorandum entry method are presented below and on the next page.
2014
June 3 Ordinary Share Capital Subscription Receivable
75,000
Ordinary Share Capital Subscribed
50,000
Ordinary Share Capital in Excess of Stated Value
25,000
5,000 sh x P15 = P 75,000
5,000 sh x P10 = P 50,000
5,000 sh x P 5 = P 25,000
3 Cash
18,750
Ordinary Share Capital Subscription Receivable
P75,000 x 25% = P 18,750
490
18,750
July 4 Cash
56,250
Ordinary Share Capital Subscription Receivable
56,250
P75,000 x 75% = P 56,250
4 Ordinary Share Capital Subscribed
50,000
Ordinary Share Capital
50,000
The entries on June 3 may be recorded in a compound entry.
ISSUANCE OF NO-PAR, NO STATED VALUE SHARE CAPITAL
When a share capital has no par value and no stated value, the value assigned to the
consideration received is the same amount credited to the Share Capital account.
ISSUANCE FOR CASH. When a no-par, no stated value stock is issued for cash, Cash is
debited and Share Capital is credited for the value of the cash consideration received.
Illustrative Problem J: The Happy Corporation was organized on January 1, 2014 and is
authorized to issue 100,000 shares of no-par, no stated value ordinary share capital.
Subsequently, 25,000 shares were sold at P15 per share.
The entry to record the sale follows:
Cash
375,000
Ordinary Share Capital
375,000
25,000 x P15 = P375,000
ISSUANCE IN EXCHANGE FOR NON-CASH ASSETS OR PROPERTY. When a share
capital is issued in exchange for non-cash assets, the asset received is recorded at its fair value
(also known as direct measurement), unless the fair value cannot be estimated reliably. If the fair
value of the asset received cannot be estimated reliably, it will be recorded at the fair value of the
share capital issued, also known as indirect measurement (PFRS 2, par. 10). The fair value of
the asset received shall be determined at the date the entity receives the asset (PFRS 2, par. 13).
491
Upon issuance of the shares, Share Capital is credited for the value assigned to the asset received
Illustrative Problem K: The Happy Corporation issued 10,000 shares of its ordinary share
capital in exchange for land. The entries to record the issuance of the share capital under the
memorandum entry method using three independent cases are given on the next under page.
Case 1 – The land has a market value of P175,000.
Land
175,000
Ordinary Share Capital
175,000
Case 2 – The land has no known market value. The fair market value of ordinary share capital on
the date of exchange is P15.
Land
150,000
Ordinary Share Capital
150,00
If the share capital has no par and no stated value, only the memorandum entry meth can be used.
ISSUANCE IN EXCHANGE FOR SERVICES RENDERED. When a share capital is issued in
exchange for services rendered, the services received is recorded at its fair value (also known as
direct measurement), unless the fair value cannot be estimated reliably. If the fair value of the
services received cannot be estimated reliably, it will be recorded at the fair value of the share
capital issued, also known as indirect measurement (PFRS 2, par 10). The fair value of the
services received shall be determined at the date the other party renders the services. (PFRS 2,
par. 13).
If the shares are issued for services rendered during incorporation, Pre-Operating Expenses is
debited and Share Capital or Unissued Share Capital is credited for the value assigned to the
services rendered.
Illustrative Problem L: The Happy Corporation issued 1,000 shares of its ordinary share capital
in payment for the services of the lawyer rendered during incorporation.
Case 1 – The services of the lawyer is valued at P25,000.
Pre-Operating Expenses
25,000
Ordinary Share Capital
25,000
Case 2 – There is no known fair market value for the services of the lawyer. The fair market
value of the ordinary share capital issued is P15 per share.
Pre-Operating Expenses
15,000
492
Ordinary Share Capital
15,000
SALE OF SHARE CAPITAL ON A SUBSCRIPTION BASIS. The sale of no stated value share
capital on a subscription basis is recorded in the same manner as that of share capital with a par
value or with stated value stock, except that the entire subscription price is credited to the Share
Capital account.
493
Illustrative Problem M: On June 3, 2014, the Happy Corporation received subscription for
5,000 shares of its no par, no stated value ordinary share capital at P15. A down payment of 25%
was received and the balance was received and the balance was paid in full on July 4, 2014. The
entries to record these transactions using the memorandum entry method follow:
2014
June 3 Ordinary Share Capital Subscription Receivable
Ordinary Share Capital Subscribed
5,000 sh x P15 = P 75,000
75,000
75,000
3 Cash
Ordinary Share Capital Subscription Receivable
P75,000 x 25% = P 18,750
June 4 Cash
18,750
18,750
56,250
Ordinary Share Capital Subscription Receivable
4
Ordinary Share Capital Subscribed
Ordinary Share Capital
56,250
75,000
75,000
The entries on June 3 may be recorded on a compound entry.
When the share capital issued have no par and have no stated value, only the, memorandum entry
can be used in recording the stock transactions.
SUBSCRIPTION DEFAULTS
When a subscriber fails to pay his obligations after the corporation has sent several notices to
him, his subscribed shares are declared delinquent shares. His subscription is declared delinquent
subscription. Such delinquent subscription is then offered for sale in a public auction and
delinquent shares are issued to the highest bidder. The highest bidder is the one who is willing to
pay the unpaid subscription plus any expense incurred in connection with the delinquency sale
and is willing to receive the lease number of shares
The following entries are made in relation to subscription defaults and issuance of stock
certificates.
a. Upon default
Receivable from Highest Bidder
Share Capital Subscription Receivable
494
b. Costs incurred in connection with the delinquency sale
Receivable from Highest Bidder
Cash
xxx
c. Upon receipt of payment from highest bidder
Cash
Receivable from Highest Bidder
xxx
d. Upon issuance of certificates of stock
Share Capital Subscribed
Share Capital (or Unissued Share Capital)
xxx
xxx
xxx
xxx
All subscribed shares are issued. Shares are first given to the highest bidder. The excess, if any,
are given to the defaulting subscriber.
If there is no bidder, all of the delinquent shares will be issued in the name of the corporation.
Such shares are considered treasury shares and the following entries will be made, after making
the entries (a) and (b) above.
c. Treasury Share Capital
Receivable from Highest Bidder
xxx
xxx
d. Share Capital Subscribed
Share capital (or Unissued Share Capital)
xxx
xxx
Illustrative Problem N: On June 15, 2014, the Happy Corporation received subscription for
2,000 shares of its P10 par value ordinary share capital at P15. A down payment 60% was
received. The final payment was due on August 15, 2014, although several notices were sent to
the subscriber, no payment has been received. On August 31 subscription was declared
delinquent and was offered for sale in a public auction On September 6, expenses of P500 were
incurred in connection with the delinquency sale. On September 21, payment was received from
the highest bidder and shares were issued -1,500 to the highest bidder and 500 to the defaulting
subscriber.
The entries to record the foregoing transactions using the memorandum entry method follow:
2014
June 15
Ordinary Share Capital Subscription Receivable
30,000
Ordinary Share Capital Subscribed
Ordinary Premium Share
2,000 sh @ P15 = P30,000
2,000 sh @ P10 = P20,000
2,000 sh @ P5 = P10,000
495
20,000
20,000
June 15
Cash
Ordinary Share Capital Subscription Receivable
18,000
18,000
P30,000 x 60% = P18,000
Aug 31 Receivable from Highest Bidder
Ordinary Share Capital Subscription Receivable
12,000
P30,000 x 40% = P12,000
12,000
Sept 6 Receivable from Highest Bidder
Cash
500
500
21
Cash
Receivable from Highest Bidder
12,500
Ordinary Share Capital Subscribed
Ordinary Share Capital
20,000
12,500
21
20,000
INCORPORATING A SOLE PROPRIETORSHIP OR A PARTNERSHIP
A sole proprietorship or a partnership may decide to incorporate to enjoy the advantages of
being a corporation. The books of the old organization may be used by the new corporation after
giving effect to changes that may have taken place; or a new set of records may be opened. It is a
common practice, however, that a new set of books is used by the new organization.
GOODWILL RESULTING FROM THE ACQUISITION OF A PARTNERSHIP BY
CORPORATION (INCORPORATION OF A PARTNERSHIP)
The acquisition of a partnership by a corporation or incorporation of a partnership may involve
the recognition of goodwill. The goodwill shall be the result of the acquisition by the new
corporation of the net assets of the partnership. It is the excess of the market value of the capital
share issued to the former partners in the partnership over the fair value of net assets transferred
by the partnership into the corporation. The adjustment for e goodwill increases the capital of the
former partners.
496
PFRS 3 prohibits the amortization of goodwill acquired in a combination and requires the
goodwill to be tested for impairment annually, or more frequently, if events instead in
circumstances indicate that the asset might be impaired.
BOOKS OF THE OLD PARTNERSHIP ARE RETAINED
If the books of the partnership are retained, the following steps in recording the incorporation
will be followed:
1. Revalue the net assets of the partnership (i.e., assets and liabilities). Adjustments in asset and
liability balances may be reported through a revaluation account called Capital Adjustment
Account or recorded directly to the capital accounts of the partners.
2.
Recognize goodwill. The total value of the share capital to be issued is compared with the
adjusted fair value of the net assets received from the partnership. The excess of the total
value of the share capital over the adjusted fair value of net assets is payment for goodwill.
3. In case a revaluation account is used, close the balance of Capital Adjustment Account to the
capital accounts of the partners in accordance with their profit and loss ratio
4. Record the authorized share capital of the new corporation.
5. Record the issuance of share capital to the partners.
6. Record any necessary distribution of cash to the partners
7. Record the issuance of share capital to other incorporators or shareholders (stockholders)
NEW BOOKS ARE OPENED FOR THE CORPORATION
If a new set of books is opened for the corporation, the following shall be recorded in the
corporation books:
1. Authorized share capital.
2. Issuance of share capital for the net assets transferred by the partnership.
3. issuance of share capital to other incorporators
Entries are also prepared on the partnership books to record the following
1.
2.
3.
4.
5.
6.
Revaluation of net assets.
Recognition of goodwill, if any
Closing the balance of Capital Adjustment Account to partners' capital accounts.
Receipt of share capital from the new corporation.
Distribution of share capital to partners.
Distribution of cash to partners, if there is any.
497
Illustrative Problem O: Roberto and Remedios are partner sharing profits and losses in the ratio
3:2. They decide to retire from active participation in their business so they form a corporation to
take over the net assets of the partnership. The statement of financial position of the partnership
just prior to incorporation on January 1, 2014 is presented below.
Roberto and Remedios Partnership
Statement of Financial Position
January 1, 2014
Assets
Cash
45,000
Accounts Receivable
Less Allowance for Uncollectible Accounts
Merchandise Inventory
Equipment
Less Accumulated Depreciation
Total Assets
P75,000
3,000
P90,000
30,000
72,000
25,500
60,000
P202,500
Liabilities and Equity
Accounts Payable
P60,000
Expenses Payable
Roberto, Capital
Remedios, Capital
Total Liabilities and Equity
15,000
90,000
37,500
202,500
The corporation is organized as the WINNER CORPORATION and is authorized to issue
10,000 shares of ordinary share capital, par value P10. Twenty-five thousand (25,000) shares are
sold for P20. The corporation takes over the partnership assets other than cash and assumes
partnership liabilities in exchange for 12,000 shares.
The following adjustments are to be made before taking over the net assets:
a. The inventories are to be stated in their market value of P45,000.
b. The allowance for uncollectible accounts is to be increased to P45,000.
c. Equipment is to be recorded at its current value of P120,000.
The ordinary shares will be distributed as follows: Roberto, 9000 shares; Remedios, 3000 shares.
Cash will be distributed based on the capital balances of the partners after distribution of the
shares. The ordinary share capitals are selling at P15 per share on this date.
498
Assumption 1 – The books of the partnership will be used by the new corporation
Step 1 Revalue the net assets of the partnership
a. Merchandise Inventory
Capital Adjustment Account
19,500
b. Capital Adjustment Account
Allowance for Uncollectible Account
2,400
c. Accumulated Depreciation
Equipment
Capital Adjustment Account
30,000
30,000
19,500
2,400
60,000
Step 2 Recognize goodwill.
Goodwill
Capital Adjustment Account
20,400
20,400
Net assets before adjustment
(P202,500 – P60,000 – P15,000)
Add Net adjustments
(P19,500 – P2,400 + P60,000)
Net assets after adjustment
Less Cash
Net assets excluding cash
Market value of share capital issued
(P12,000 shares @ P15)
Goodwill
P127,500
77,100
P204,600
45,000
159,600
180,000
P 20,000
Step 3 Close the balance of Capital Adjustment Account to partners’ capital accounts.
Capital Adjustment Account
Roberto, Capital
Remedios, Capital
P77,100 + P20,400 = P97,500
P97,500 x 3/5 = P58,500
P97,500 x 2/5 = P39,000
Step 4 Record authorized share capital of the corporation
Authorized to issue 100,000 shares of P10 par value ordinary share capital
499
97,500
58,500
39,000
Step 5 Record issuance of share capital to partners
Roberto, Capital
Remedios, Capital
Ordinary Share Capital
Ordinary Share Premium
9,000 shares x P15 = P135,000
3,000 shares x P15 = P45,000
12,000 shares x P10= P120,000
12,000 shares x P5 = P60,000
135,000
45,000
120,000
60,000
Step 6 Record the distribution of cash to partners
Roberto, Capital
Remedios, Capital
Cash
P90,000 + P58,500 – P135,000 = P13,500
P37,500 + P39,000 – P45,000 = P31,500
13,500
31,500
45,000
Step 7 Record the issuance of ordinary shares to other incorporators
Cash
Ordinary Share Capital
Ordinary Share Premium
25,000 shares x P20 = P500,000
25,000 shares x P10 = P250,000
25,000 shares x P10 = P250,000
500,000
250,000
250,000
Assumption 2 – New books are opened for the corporation.
Partnership Books
Step 1 Revalue the net assets of the partnership
a. Merchandise Inventory
Capital Adjustment Account
19,500
b. Capital Adjustment Account
Allowance for Uncollectible Accounts
2,400
c. Accumulated Depreciation
Equipment
Capital Adjustment Account
30,000
30,000
500
19,500
2,400
60,000
Step 2 Recognize goodwill.
Goodwill
Capital Adjustment Account
20,400
20,400
Step 3 Close the balance of Capital Adjustment Account to partner’s capital accounts
Capital Adjustment Account
Roberto, Capital
Remedios, Capital
P77,100 + P20,400 = P97,500
P97,500 x 3/5 = P58,500
P97,500 x 2/5 = P39,000
Step 4 Record the receipt of share capital from the new corporation
Winner Corp. Ordinary Share Capital
Accounts Payable
Expenses Payable
Allowance for Uncollectible Accounts
Merchandise Inventory
Accounts Receivable
Equipment
Goodwill
180,000
60,000
15,000
5,400
45,000
75,000
120,000
20,400
Step 5 Record the distribution of share capital to partners
Roberto, Capital
Remedios, Capital
Winner Corp. Ordinary Share Capital
9,000 shares x P15 = P135,000
3,000 shares x P15 = P45,000
135,000
45,000
180,000
Step 6 Record the distribution of cash to partners
Roberto, Capital
Remedios, Capital
Cash
P90,000 + P58,500 – P135,000 = P13,500
P37,500 + P39,000 – P45,000 = P31,500
501
13,500
31,500
45,000
NEW CORPORATION’S BOOKS
Step 1 Record authorized share capital of the corporation
Step 2 Recognize the issuance of share capital in exchange for the net assets of the
partnership.
Accounts Receivable
Merchandise Inventory
Equipment
Goodwill
Allowance for Uncollectible Accounts
Accounts Payable
Expenses Payable
Ordinary Share Capital
Ordinary Share Premium
75,000
45,000
120,000
20,400
5,400
60,400
15,000
120,000
60,000
Step 3 Record the issuance of share capital to other incorporators
Cash
Ordinary Share Capital
Ordinary Share Premium
25,000 shares x P20 = P500,000
25,000 shares x P10 = P250,000
25,000 shares x P10 = P250,000
500,000
250,000
250,000
REVIEW of the LEARNING OBJECTIVES
1. Define a corporation and discuss its characteristics. A corporation is defined as an
artificial being created by operation of law, having the right of succession and the
powers, attributes and properties expressly authorized by law or incident to its existence.
It has the following characteristics: (1) it is a separate legal entity with a personality of its
own; (2) it is created by operation by law (3) it has the right of succession:(4) it has the
powers, attributes, and properties authorized by law; (5) its ownership is divided into
shares known as share capital; and (6) its management is vested in a board of directors
elected by the shareholders.
2. ldentify and discuss the advantages a and disadvantages of a corporate form of
organization. A corporation has the following advantages: (1) it enjoys a continuous
existence because of its power of succession; (2) it can obtain a strong credit line because
of its continuous existences (3) there are more investors enabling it to raise more funds;
(4) investors have limited liability, (5) share capital are transferable without the need for
consent of other.
502
Shareholders; and (6) it has smooth operation because of centralized management. On the
other hand, organizing and operation a corporate type of organization has the following
disadvantages: (1) it is subject to more government control; (2) it is subject to more taxes;
(3) it is costly to organize’ (4) its credit capacity is weakened by the limited liability of
the shareholders; and (5) there is a more restrictive participation by shareholders in the
conduct of corporate affairs because management is vested in the board of directors.
3. Identify and discuss the various classes of corporation. Corporations may be classified
into (1) stock or non-stock corporations: (2) public, private, or quasi-public corporations;
(3) de jure o de facto corporations; (4) domestic or foreign corporations; and (5) open or
closel-held corporations
4. Identify the components of a corporation. A corporation has seven components and these are
the following: (1) incorporators (2) corporators (3) stockholders or shareholders (4) members (5)
promoters (6) subscribers; and (7) underwriters. The process of organizing a corporation is
composed of three stages, namely; (1) promotion; (2) incorporation, Which includes the drafting
of the articles of incorporation and its subsequent tiling with the Securities and Exchange
Commission; and (3) commencement of the business.
5. Identify the different types of records that are maintained by a corporation. To be able
to keep track of the transactions of the corporation, the following records are generally
maintained: journals, ledgers, minutes of meeting of board of directors, minutes of
meeting of shareholders; and stock and transfer book.
6. Identify and differentiate the two classes of share capital that may be issued by a
corporation. Share capital is the amount fixed by the corporate charter to be subscribed
and paid in by the shareholders. Share capital can either be ordinary or preference share
capital. Both ordinary and preference share capita1 can be issued with a par value,
without par but with stated value, or without par and without stated value.
7. Identify the measurement bases in the issuance of share capital in exchange for
various considerations. Share capital may be issued in exchange for (a) mi], (b) non-cash
assets, or (c) services. When a share capital is issued for cash, the share capital is
measured by the amount of cash received. When a share capital is issued in exchange for
non-cash assets, the asset received is recorded at its fair value (also known as direct
measurement), unless the fair value cannot be estimated reliably. If the fair value of the
asset received cannot be Wed reliably, it will be recorded at the fair value of the share
capital issued, also known as indirect measurement (PFRS 2, par. 1 0). When a share
capital is issued in exchange for services rendered, the services received is meted a its fair
value (also known as direct measurement), unless the fair
503
value cannot be estimated reliably. If the fair value of the services received cannot be estimated
reliably, it will be recorded at the fair value of the share capital issued, also known as indirect
measurement (PFRS 2, par. 10).
8.
Record transactions relating to issuance of share capital using the memorandum
entry method and the journal entry method. The recording of authorized share capital and
subsequent issuance may be recorded using the memorandum entry method or the journal entry
method. Under the memorandum entry method, the authorized share capital of the corporation is
recorded by means of a memorandum entry indicating the authorized number of shares that may
be issued and the par or stated value of each share or an indication that the shares have no par
and no stated value. Subsequent issuance of the share capital requires a credit to the Share
Capital account. Under the journal entry method, the authorized share capital of the corporation
is recorded by debiting Unissued Share Capital and crediting Authorized Share Capital for the
total par value or stated value of the authorized shares. Subsequent issuance requires a credit to
Unissued Share Capital account. Ordinary or preference shares may be issued in exchange for
cash, for non-cash assets, for services, for extinguishment of liabilities or in exchange for another
form of securities. Share capital may also be issued on a subscription basis. However, when a
subscriber fails to pay his subscription, such subscription becomes delinquent and will be subject
to bidding.
GLOSSARY of ACCOUNTING TERMINOLOGIES
Authorized share capital (authorized capital stock) - the total par value or stated value of the
authorized shares. It is determined by multiplying the authorized shares by the par or stated value
of the share capital.
Authorized shares - the maximum number of shares of share capital that may be issued by a
corporation.
Corporation- an artificial being created by operation of law, having the right of succession and
the powers, attributes, and properties expressly authorized by law or incident to its existence.
Delinquent subscription – a subscription where a subscriber fails to pay in full after repeated
demand by the corporation.
Highest bidder – a bidder who is willing to pay the entire unpaid subscriptions plus any
expenses that may be incurred in connection with the delinquency sale and is willing to take the
least number of shares declared as delinquent.
Issued share capital (issued capital stock) – a share capital (stock) paid for in full and for
which the related stock certificate is issued.
504
Ordinary share capital (common stock) - entitles the holder to an equal or pro-rata division of
profits without any preference or advantage over any class or shares. The shareholders are
often referred to as "residual equity holders" because they obtain what is left after all the
claims of other parties have been met.
Outstanding share capital (outstanding capital stock) - share capital (stock) issued and is in the
possession of a shareholder.
Par value - nominal or face value stated on the face of the share certificate and in the articles
of incorporation.
Preference share capital (preferred stock) -entitles the holder to enjoy priority as to
distribution of dividends and distribution of assets upon corporate liquidation.
Pre-Operating expenses (organization costs) - costs incurred in organizing a corporation and
prior to its operations such as registration cost and printing cost of stock certificate.
Share capital (capital stock) - amount fixed by the corporate charter to be subscribed and paid
in or secured to be paid in by the shareholders.
Stated value - nominal value stated in the articles of incorporation but not on the face of the
stock certificate.
Subscribed shares - share capital sold on a subscription basis that have not yet been paid in full
and for which the related stock certificates have not been issued
505
DISCUSSION QUESTIONS
1.
A, B and C are partners operating a small store for years. The partners are considering
the possible incorporation of the partnership. What are the advantages and disadvantages
offered by such a change?
2.
Differentiate: (a) stock from non-stock corporation, (b) private from public corporation;
(c) de jure from de facto corporation.
3.
What are the stages in organizing a corporation? 4. What are basic rights of a
shareholder?
5.
What are the considerations that may be received in exchange for share capital? What
are the measurement bases for such exchanges?
6.
Differentiate an ordinary share capital from a preference share capital.
7.
What are different classes of preference share capital?
8.
When does a share capital become outstanding?
9.
The DEF Corporation was organized on October 1, 2013 with authorized ordinary share
capital of 1,000 shares, P5 par value. a. How many shares must be subscribed at the time of
incorporation? b. Assuming that the minimum required subscription was received at P12, how
much subscription must be paid up?
10.
What are the steps to be followed in incorporating a partnership?
506
EXERCISES
Exercise 8- 1.( Issuance of Par Value Share Capital for Cash)
The Integrity Corporation was incorporated on January l, 2014 with authorized capital of
250,000 shares of P100 par value 10% preference share capital and 500,000 shares of P20
stated value ordinary share capital. The shares were issued during 2014 as follows.
Jan 1
Isued for cash 62,500 preference shares at par, and 125,000 ordinary shares for P25
May 1 Issued for cash 25,000 preference shares for P3,000,000.
Dec. 1 Issued for cash 25,000 ordinary shares for P600,000.
Instructions: Prepare the journal entries to record the foregoing transactions, including the
authorized share capital, assuming the use of:
a. memorandum entry method.
b. journal entry method
Exercise 8 -2 (ssuance of Par Value Share Capital for Cash, Services, and Non-cash Assets)
The Honesty Corporation was organized on April I, 2014 with authorized share capital of.
500,000 ordinary shares, par value of P20. Thereafter, the following transactions took place:
April 1
The incorporators acquired 200,000 shares at P36 per share.
25 Issued 5,000 shares for the services rendered by the lawyer during the period of
incorporation. The fair value of such services is P150,000.
May 28
Issued 15,000 shares in exchange for equipment valued at P400,000.
Instructions: Prepare joummal entries to record authorized share capital and the subsequent
ransactions assuming the corporation uses the:
a. memorandum entry method
b. joumal entry method.
507
Exercise 8-3 (issuance of Various Classes of Share Capital for Cash)
The security corp. Was organized on May 1,2014 and is authorized to issue 500k shares of
ordinary share capital. Subsequently, 250,000 shares were issued at P25 per share.
Instructions: Prepare the journal entries to record authorized share capital and the issuance of
the 250k shares using the memorandum entry method under each of the following
independent assumptions:
1. Each ordinary share has a par value of P20
2. Each ordinary share has a stated value of P15.
3. The ordinary shares have no par and no stated value.
Exercise 8-4 (Issuance of Share Capital w/ Stated Value in Exchange for various Considerations)
The Justice Corporation Is authorized to issue 500,000 shares of ordinary share capital with a
stated value P20. The ff transactions have taken place in relation to the share capital:
A. Issued 125,000 shares for cash at stated value.
B. Issued 25,000 shares to attorneys for services in securing corp. Charter and for preliminary
legal costs of organizing the corp. The value of the services was 150,000.
C. Issued 2,000 shares to the corp. Promoters. Each ordinary share is selling at P25 on this date.
D. Issued 10,000 shares in exchange for land valued at 300,000.
E. Issued for cash 50,000 shares at P24 per share.
Instructions: Prepare the journal entries to record the preceding transactions, including
authorized capital, using the memorandum entry method.
Exercise 8-5 (Issuance of Share Capital on a Subscription Basis)
On June 1, 2014, Simplicity, Inc. sold 35k shares of its P20 par value ordinary share capital on a
subscription basis at P50 per share. Simplicity received 60% down payment on the date of
subscription. On sept.8, 2014, Simplicity received the balance on the subscription and the stock
certificates were issued.
Instructions: Prepare journal entries to record the preceding transactions.
508
Exercise 8-6 ( Issuance of Share Capital on a Subscription Basis)
The Hope Corp. was organized on July 1, 2014 and is authorized to issue share capital as
follows:
50,000 shares of 10% preference share capital, P100 par
500,000 shares of ordinary share capital, P10 stated value
The following transactions took place during July:
July 1
Issued to corporations 125,000 ordinary shares at P15 per share and 12,500
preference shares at par value.
8
Issued 1,250 preference shares to corporate promoters. The value of preference
share capital on this date is P120 per share.
12
Received subscription for 75,000 ordinary shares at P20 per share w/ a down
payment of 60% of the total subscription price.
21
Issued 20,000 ordinary shares in exchange for the following:
Merchandise inventory
Land
Building
Equipment
Fair Value
P10,000
150,000
100,000
20,000
30
Received the balance due on the subscription on July 12 and shares were issued
to subscribers.
Instructions: Prepare journal entries to record the preceding transactions.
Exercise 8-7 (Issuance of Share Capital on a Subscriptio n Basic)
The Faith Co. Was organized on June 1,2014 w/ authorized capital of 500k ordinary shares w/ a
par value of P20.
The following are selected transactions of the corporation completed during September:
Sept. 1
Received subscription for 125,000 shares at P30 per share. A down payment of
40% was received from the subscribers. The balance is due in the three equal installments.
509
8 Issued 25,000 shares in exchange for land valued at P750,000.
10
Received the first installment due from the subscribers.
Sept. 20
Received the second installment due from the subscribers.
30
issued.
Received the final installment from all subscribers and shares of stock were
Instructions: Prepare journal entries to record the preceding transactions.
Exercise 8-8 (Subscription Defaults)
Patience Co. was authorized to issue 500000 ordinary shares with a stated value of P20. The
following transactions relative to the share capital took place:
a. Received subscriptions for 125,000 shares at P25 receiving a down payment of 60%
b. Received balance due from subscribers of 50,000 shares. Shares of stock were subsequently
issued.
c. Received balance due from subscribers of 60,000 shares. Shares of stock were issued to the
subscribers.
d. The subscriber of the remaining 15,000 shares failed to pay his obligation, so his subscription
was declared delinquent
e. Paid delinquency sale expenses totaling P50,000
f. Received payment from the highest bidder and shares were issued as follows: 10,000 to the
highest bidder and 5000 to the defaulting subscriber.
Instructions: Prepare the journal entries to record the preceding transactions.
PROBLEMS
Problem 8-1 (Issuance of Ordinary and Preference Shares on a Subscription Basis and
Subscription Defaults)
The following selected transactions took place at the newly formed Providence Corporation:
Aug.1
Received authorization from the SEC to issue 50,000 preference shares, P100
par value and 500,000 ordinary shares, P20 par value.
510
Aug. 2
following:
Received subscription for preference shares at P120 per share from the
Emilio
5,000shares
Bernardo
6,000
Roberto
4,000
A down payment of 30% was received.
2
Received subscription for ordinary shares at P30 per share from the following:
Lorena
100,000 shares
Morena
75,000 shares
A down payment of 20% was received.
30
The subscribers of preference shares paid another 30% of their subscriptions.
Aug. 31
Lorena paid her subscription in full and shares of stock were issued to her.
Morena paid 40% of her subscription
Sept. 21
Emilio and Bemardo paid the balance of their subscriptions and shares of stock
were issued to them.
Sept. 21
Roberto officially informed the officials of the corporation that he would not be
able to pay the balance of his subscription contract. Thus the subscription was declared
delinquent and was offered for sale in public auction.
28
Received payment from the highest bidder and shares of stock were
subsequently issued.
30 Morena paid the balance of her subscription and shares of stock were issued of her.
Instructions: Prepare journal entries to record the preceding transactions:
Problem 8- 2 (Issuance of Share Capital for Various Considerations and Subscription Defaults)
511
Fidelity Co. was authorized to issue 200,000 ordinary shares, par value P50.The transactions
that took place during the months of November and December are shown below.
Nov.2
Received subscriptions from incorporators for 50,000 shares at P60. A down
Payment of 40% was received; the balance is payable within 90 days.
5
Issued 10o,000 shares in exchange for equipment with a fair value of P700, 000.
Nov. 16 Received subscriptions for 30,000 shares at P60 with a down payment of 20%. The
balance is payable within 30 days.
28 Received the balance due from incorporators who subscribed for 35,000 shares.
The shares of stock were issued.
Dec. 16 Received the balance due from subscribers of 25,000 shares on Nov. 16. The
corresponding shares of stock were issued.
16 Declared as delinquent shares the subscription for 5,000 shares.
20 Paid advertising expenses of P15,000 relative to the delinquency sale.
26 Received payment from highest bidder and shares were issued.
Instructions:, Prepare journal entries to record the preceding transactions:
Problem 83 (Incorporation of a Partnership; New books for the Corporation)
A statement of financial position for Bautista and Bernaldo, prepared on September 30,appears
below. Partners share earnings and losses in the ratio of 3:1, respectively.
Bautista and Bernaldo
Statement of Financial Position
September 30, 2014
Assets
Cash
P 42,000 Accounts
Receivable
P 124,000
Less Allowance for Uncollectible Accounts
12,000.
112,000 Inventories
206,000 Equipment
P 600,000
Less Accumulated Depreciation
160,000
440,000 Goodwill
100,000
Total Assets
P900,000
512
Liabilities and Equity
Accounts Payable
Capital
402,000
Total Liabilities and Owner's Equity
P104,000 Bautista,
394,000 Bernaldo, Capital
P 900,000
An appraisal of the assets discloses the following fair values:
Inventories P 296.000
Equipment 520,000
Bautista and Bernaldo, together with other three friends, decided to incorporate as Rainbow
Corp. with 50,000 authorized shares of P50 par ordinary share capital. The three other
incorporators acquired 10,000 shares at P70. Bautista and Bernaldo received 14,000 shares in
exchange for the net assets of the partnership except cash. On this date, the fair value of stock
is P70 per share. Bautista agrees to take 7,500 shares and Bemaldo, 6,500 shares. The
partnership cash is then appropriately divided between the partners.
Instructions: Give the entries to record the above on the books of the new books of the
corporation.
Problems 8 - 4 (Reconstruction of Capital Stock Transaction)
The Good News Corporation was formed on April 1, 2014. There were two transactions
involving Issuance of preference shares: (1) 2,000 shares were issued in exchange for land, and
(2) 500 shares were issued for cash of P70 per share. There were also two transactions involving
issuance of ordinary shares: () 12,000 shares were issued for cash, and (2) 800 shares were
issued as payment for pre-operating expenses Selected general ledger accounts for the Good
News Corporation show the following activities for the first month of operations:
Cash
Preference Share Capital,P50 par
78,000
35,000
100,000
25,000
Pre-Operating Expenses
Preference Share Premium
5,400
50,000
10,000
513
Land
Ordinary Share Capital,P5 par
150,000
60,000
4,000
Ordinary Share Premium
18,000
1,400
514
Insructions:
1. Reconstruct the journal entries made for share capital transactions during the month of
April.
2. Determine the total number of preference and ordinary shares outstanding.
Problems 8-5 (Reconstruction of Transactions)
The Golden Rule Corporation was organized on January 1, 2014 with authorized share capital
consisting of 50,000 preference shares with a par value of P50 and 1,000,000 of no-par ordinary
shares with a stated value of P10. At December 31, 2014, the ledger included the following
balances pertaining to shareholders' equity.
Preference Share Capital
Preference Share Premium
Ordinary Share Capital
Ordinary Share Capital in Excess of Stated Value
P 1,000,000
120,000
3,000,000
4,500,000
Ten thousand preference shares were issued for equipment having a fair value of P550,000.
The remaining preference shares were issued for cash. All ordinary shares were issued for cash.
Instructions: Compute for each of the items enumerated below.
1. Number of preference shares issued for cash.
2. Price per share of preference share capital issued for cash.
3. Number of ordinary share issued.
4. Average price per share of the ordinary share capital issued for cash.
5. Total preference share premium arising from issuance in exchange for equipment.
Problem 8- 6 (Reconstruction of Transaction)
Shown below and on the next page are account balances found in the ledger of Humility
Corporation at the end of 2014:
Subscription Receivable - Preference Share
Subscription Receivable - Ordinary Share
Preference Share Capital, P50 par value, authorized,
80,000 shares
Issued
Subscribed
515
P360,000
182,000
P 1,440,000
720,000
2,160,000
Ordinary Share Capital, no par, P10 stated value,
authorized, 320,000 shares
Issued
Subscribed
Paid-In Capital in Excess of Par or Stated Value
Preference
Ordinary
P 1,360,000
280,000
1,640,000
P 216,000
328,000
544,000
Instructions: Compute for each of the items below.
1. Number of preference shares issued
2. Number of ordinary shares issued
3. Number of subscribed preference shares.
4. Number of subscribed ordinary shares.
5. Average price per share received by the corporation on its preference share capital
including subscribed shares.
6. Average price per share received by the corporation on its ordinary share capital
including subscribed shares.
7. Average amount per share that the subscribers of preference share capital have not yet
paid to the corporation
8. Average amount per share that ordinary share subscribers have already paid on their
subscriptions. Assume that ordinary shares were subscribed at P12.
516
MULTIPLE CHOICE
MC 8-1. Cream Corporation was organized on January 1, 2014 with authorized capital of
P2,000,000 consisting of 100,000 ordinary shares, P20 par value. Subsequently,
incorporators subscribed for 25,000 shares at P24. How much must be paid up upon
subscription to comply with the requirement Securities and Exchange Commission
(SEC)?
a. P600,000
c. P500,000
b. P125,000
d. P150,000
MC 8-2. Beige Co. was authorized to issue 10,000 preference shares, P100 par value and
200,000 no-par ordinary shares. Subscriptions for 4,000 preference shares was received at
P110 with a down payment of 25%. What entry should be made in the books of Beige
Co. to record the receipt of subscription?
a. Preference Share Capital Subscription Rec'l
440,000
Preference Share Capital Subscribed
Preference Share Premium
b. Preference Share Capital Subscription Rec'l
400,000
40,000
440,000
Preference Share Capital Subscribed
c. Preference Share Capital Subscription Rec'l
440,000
400,000
Preference Share Capital Subscribed
d. Preference Share Capital Subscribed
400,000
400,000
Preference Share Capital Subscription Rec'l
400,000
MC 8-3. Using the information in MC 8-2, how much was the down payment receivedby
Beige Co. as a result of the subscription?
a. P10,000
c. P100,000
b. P11,000
d. P110,000
MC 8-4. Last September 6, 2014, Brown Co. issued 2,000 shares of its P10 par value
ordinary share capital in exchange for a piece of land to be held for a future plant site.
517
Brown Co.'s ordinary share capital was listed and traded at P27 per share on the same
date. The land has no known market value. How much is the increase in ordinary share
premium resulting from this exchange?
a. P0
c. P34,000
b. P 20,000
d. P 40,000
MC 8-5. Violet Corp. was organized on January I, 2014 with authorized capital of 100,000
ordinary shares, P20 par value. During 2014, Violet Co. had the following transactions
affecting the shareholders' equity.
Jan. 10
issued 25,000 shares at P22 per share.
Mar. 25
Issued 1,000 shares for legal service when the fair value was P24
per share.
Sept. 30
Issued 5,000 shares for a piece of equipment when the value was
P26 per share.
How much is the balance of the ordinary share capital account as of September 30?
a. P620,000
b. P674,000
c. P700,000
d. P704,000
MC 8-6. Using the information in MC 8-5, what amount should be reported as ordinary
share premium?
a. P50,000
b. P54,000
c. P64,000
d. P84,000
MC 8-7. Aqua Corp. was incorporated on June 1, 2014 with an authorized 250,000 share of
no-par ordinary share capital, stated value P15 and 10,000 shares of 10% preference
share capital, par value P50. Transactions affecting company's share capital as of June 30,
2014 were as follows:
June
1
Issued 50,000 ordinary shares for cash at P15 per share
5
Issued 50,000 ordinary shares in exchange for assets with total market
value of P900,000.
June
15
Received subscriptions for 100,000 ordinary shares at P30 and for 5,000
preference shares at P55.
25
Received full payment for subscriptions received on June 15 and the
corresponding stock were issued.
What is the total paid-in capital in excess of par and stated value for both ordinary and
preference shares?
a. P 25,000
c. P1,650,000
518
b. P300,000
MC 8-8.
d. P1,675,000
Using the information in MC 8-7, how much is the total shareholders equity?
a. P3,250,000
c. P4,675,000
b. P4,500,000
d. P4,925,000
MC 8-9. Lavender Corp. issued 20.000 ordinary shares, par value P15 in exchange for an
equipment. At the date of exchange, the shares are selling at P20 and no fair value is
known for the equipment. How will the exchange be recorded on the books of Lavender
Corp.?
a. Equipment
400,000
Ordinary Share Capital
400,000
b. Equipment
400,000
Ordinary Share Capital
Ordinary Share Premium
c. Equipment
300,000
100,000
400,000
Ordinary Share Capital
Gain on Exchange
d.
300,000
100,000
Equipment
300,000
Ordinary Share Capital
300,000
MC 8-10. Indigo Corp. has authorized 200,000 shares of P30 par value ordinarys shares of
P30 par value ordinary share capital and 5,000 shares of P50 par, 9% preference share
capital. On June 3, 2014, the company issued 100,000 ordinary shares and 3,000
preference shares, both at par. Which of the following is the correct journal entry in
recording the transaction?
a. Cash
3,600,000
Ordinary Share Capital
Preference Share Capital
3,000,000
600,000
b. Cash
1,540,000
Ordinary Share Capital
Preference Share Capital
1,000,000
540,000
c. Ordinary Share Capital
3,000,000
519
Preference Share Capital
Income from Sale of Share Capital
d. Cash
600,000
3,600,000
3,150,000
Ordinary Share Capital
Preference Share Capital
3,000,000
150,000
MC 8-11. Javier and Edralin are partners. They decide to incorporate their business and are
recording the incorporation of the new business. Javier has a P35,000 capital account
balance, while Edralin has a P26,400 balance. Javier receives 7,500 shares and Edralin
receives 6,000 shares of P4 par ordinary share capital.
The correct entry to record the issuance of ordinary shares, assuming the corporation will
use the books of the partnership, is
a. Javier, Capital
35,000
Edralin, Capital
Ordinary Share Capital
26,400
61,400
b. Javier, Capital
35,000
Edralin, Capital
Ordinary Share Capital
Ordinary Share Premium
26,400
54,000
7,400
c. Javier, Capital
35,000
Edralin, Capital
Gain on Incorporation
26,400
61,400
d. Javier, Capital
35,000
Edralin, Capital
Asset Revaluation Account
26,400
61,400
MC 8-12. The shareholders' equity of Cecille Corp. revealed the following on June 30,
2014:
Preference share, PI00 par value
Preference share premium
Ordinary share, P15 par value
Ordinary share premium
Ordinary share subscribed
Retained earnings
Notes payable
Subscription receivable- ordinary
520
P230,000
80,500
525,000
275,000
5,000
190,000
400,000
40,000
How much is the legal capital of the corporation?
a P760,000
b. P775,000
c. P1,115,000
d. P1,305,500
MC 8-13. Using the information in MC 8-12, how much is the additional paid in capital?
a. P355,500
c. P400,500
b. P360,500
d. P800,500
MC 8-14. Using the information in MC 8-12, how much is the total shareholders equity?
a. P1,305,500
b. P1,345,500
c. P1,704,500
d. P1,745,500
MC 8-15. On April 1, 2014, Friends Corp., a newy formed company had the following
shares issued and outstanding:
Preference share, P50 par, 6,000 shares originally issued at P100
Ordinary share, P20 par, 20,000 shares originally issued at P60
Friends shareholders' equity should report preference share capital, ordinary share capital
and paid-in capital in excess of par, respectively at
a. P600,000,
P1,200,000,
-0-
b.
600,000,
400,000,
800,000
c.
300,000,
1,200,000,
300,000
d.
300,000,
400,000,
1,100,000
521
Test Material No. 28
Rating
Name
Date
Year and Section
Professor
TRUE or FALSE
Instructions: Encircle the letter T If the statement is True and the letter F if the statement is
False.
T F
1. All incorporators are shareholders but not all shareholders are incorporators
T F 1. A corporation, like a partnership, may be formed by the mere agreement of five or
more persons.
T F 2. The journal entry method may be used in recording authorized share capital and
other stock transactions relating to a no-par and no stated value share capital.
T F 3. The authorized shares represent the maximum number of shares that a
Corporation may issue.
T F
4. Unissued shares represent the number of shares that may still be subscribed.
T F
5. It is legal to issue share capital at par or at more than par but not at less than par.
T F 6. When share capital is issued for consideration in the form of property other than
cash, the net book value of the property is used to record the transaction.
T F 7. The highest bider is the one who is willing to pay the entire unpaid subscription
plus any expenses incurred in the delinquency sale and at the same time getting the
highest number of shares.
522
T F 8. Share capital that has been sold and issued to a shareholder is called an
outstanding share capital.
T F 9. The owners of a stock corporation are called shareholders; the owners of a nonstock corporation are called members.
T F 10.
When the memorandum entry method is used, the account Share Capital is
credited upon issuance of stocks.
T F
Under the journal entry method, the amount of share capital issued is determined
by deducting the balance of unissued share capital account from the balance of authorized
share capital account.
11.
T F 12.
When a partnership is incorporated, a new set of books should always be
opened for the new corporation.
T F 13.
Partnership net assets that are transferred to the corporation should be
recorded in the new corporations' books at their book value.
T F 14.
A stock certificate is issued to the subscriber upon full payment of his
subscription.
T F 15.
Both partnership’s owner and a corporation's owners have limited liability
for business debts.
T F 16.
Additional paid-in capital for the excess of the stock subscription price
over par or stated value is recorded at the time of subscription.
T F 17.
Organization (pre-operating) costs are expenditures associated with
incorporating a new business. Such costs should be recognized as expense in the first
year of operations.
T F 18.
A corporation issues share capital on a subscription basis that is payable in
three installments. Each time the corporation receives a payment, Share Capital account
is credited.
T F 19.
shares
Convertible preference shares allow the issuing corporation to redeem the
T F 20.
The liability of the shareholders for corporate debts is limited to the
amount of their investment.
T F
21.
A corporation is a business owned by its shareholders.
T F 22.
Directors
The management of a corporation is vested on a body called Board of
T F
Share capital subscriptions in a corporation are payable only in cash.
23.
523
T F 24.
Generally, there are only two classes of authorized share capital, the
preference share capital and the ordinary share capital.
Test Material No. 28
Rating
Name
Date
Year and Section
Professor
IDENTIFICATION
Instructions: Write the word or group of words that identify each of the following
statements.
_________________1. An artificial being created by operation of law formed by five or more
persons.
_________________2.The process of formalizing the organization of a corporation.
_________________3. A corporation organized under the Philippine laws.
_________________4. The persons who originally formed the corporation.
_________________5. Costs incurred in connection with the incorporation. They include cost of
printing stock certifications and filing fees
_________________6. A value that may be assigned to no-par stock by the board of directors of
a corporation.
_________________7. Class of share capital which entitles the holder to an equal or pro-rata
division of profits without any preference or advantage over any class of stock.
_________________8. Class of share capital which enables the holder to enjoy preferences as to
receipt of dividends.
524
_________________9.A nominal value stated on the face of the stock certificate and in the
articles of incorporation.
_________________10. It represents residual ownership equity.
_________________11.A share capital issued to a shareholder.
_________________12. A subscriber who fails to pay his subscription balance
_________________13. The minimum percentage of authorized share capital that has to be
subscribed by incorporators.
525
14. The minimum percentage of the subscription in share capital that
has to be paid by the incorporators.
15. The account credited for the excess of the subscription or issue
price over the sated value of ordinary share capital.
16. The minimum amount upon which no-par, no-stated value share
capital are to be subscribed or issued.
17. The maximum number of years life of a corporation.
18. The document evidencing share capital ownership in a corporation.
19. The account charged for all expenses relating to delinquent
subscription.
20. The asset recognized upon incorporation of a partnership which
represents the excess of the value of the share capital issued by the
corporation over the fair value of the net assets of the partnership
transferred to the new corporation.
526
Test Material No.30
Rating
Name
Date
Year and Section
Professor
MULTIPLE CHOICE – Theory and Problems
Instructions: Encircle the letter of the best answer. Show supporting computations in good form
in a separate worksheet.
1. Which of the following would not be considered a characteristic of a corporation?
a. Separate legal entity
b. Limited liability of shareholders
c. Mutual agency
d. Both a and c
2. Which of the following statements describing a corporation is not true?
a. Shareholders are the owner of the corporation
b. When ownership of a corporation changes, the corporation does not terminate.
c. Shareholders own the business and manage its day-today affairs.
d. A corporation is subject to a greater governmental regulation than a single
proprietorship or partnership.
3. The per value of a share capital
a. Is usually different from its market value
b. Is often higher for preference than for ordinary share
c. Is an arbitrary amount assigned to a share of stock
d. All of these
4. Which of the following is NOT one of the basic rights of a shareholder?
a. The right to participate in earnings.
b. The right to maintain one’s proportionate interest in a corporation.
c. The right to inspect the accounting records of the corporation.
d. The right to participate in the proceeds from the scale of corporate assets upon
liquidation of the company.
5. The ownership of share capital entitles ordinary shareholders to all of the following rights
EXCEPT:
a. Voting right
b. right to receive a proportionate share of assets in corporate liquidation
c. right to receive guaranteed dividends
d. preemptive rights
527
6. Which of the following statements about preference share capital is NOT true?
a. Preference share capital usually carries the right to vote.
b. Preference share capital dividends are usually paid prior to payment of ordinary
share capital dividends.
c. Preference share capital usually shares the right to receive assets pro-rata with the
ordinary shareholders in case of corporate liquidation.
d. In addition to being paid dividends prior to those paid to ordinary shareholders,
preference shareholders have the right to receive assets pro-rata with ordinary
shareholders in the event of corporate liquidation.
7. The maximum number of shares of stocks that the government gives a corporation
permission to issue is the
a. Granted shares
b. Authorized share
c. Issued shares
d. Outstanding shares
8. A preference share capital that may be exchanged for ordinary share capital is nown as
a. Cumulative
b. Participating
c. Non cumulative
d. Convertible
9. The cost of organizing a corporation should be
a. Expensed in the year of organization
b. Reported as an intangible asset
c. Reported as an tangible asset
d. Deducted from share capital
10. A non-cash asset received in exchange for share capital is recorded at
a. Its book value
b. Its fair market value
c. The lower of its book value or fair market value
d. The higher of its book value or fair market value
11. The entry to record the issuance of ordinary share capital for fully paid stock subscription
is
a. Memorandum entry
b. Debit Ordinary Share Capital Subscribed and credit Ordinary Share Capital
c. Debit Ordinary Share Capital Subscribed and credit Additional Paid –in Capital
d. Debit Ordinary Share Capital Subscribed and credit Subscription receivable
528
12. The issuance of shares of ordinary share capital to shareholders
a. Increases ordinary share capital authorized
b. Decreases ordinary share capital authorized
c. Increases ordinary share capital outstanding
d. Decreases ordinary share capital outstanding
13. On June 1, authorized ordinary share capital was sold on a subscription basis at a price in
excess of par value, and 40% of the subscription price was collected. On October 1, the
remaining 60% of the subscription price was collected. Ordinary Share Premium will be
credited
June 1
October 1
a. No
Yes
b. No
Yes
c. Yes
No
d. Yes
Yes
14. When there is no bidder for delinquent subscription, the subscribed shares will be
a. Issued to the delinquent subscriber
b. Issued in the name of the corporation
c. Reverted back to unsubscribed shares
d. Retained as subscribed
15. Violet Inc. issued 8,000 shares of P20 par ordinary share capital for P24 per share. In
recording this sale of share capital Violet will include a credit to
a. Gain on issuance of share capital for P32,000
b. Ordinary share capital of 192,000
c. Paid-in capital in excess of par for 32,000
d. Discount on ordinary share capital for 16,000
16. Which of the following is not typically a characteristic of preference shares?
a. Preference as to dividends
b. Preference as to voting rights
c. Cumulative and callable terms
d. Preference over ordinary shareholders during liquidation
17. When ordinary shares are issued in exchange for services or non-cash assets, the
transaction should be recorded at the
a. Par value of the ordinary shares issued
b. Fair market value of the ordinary shares issued
c. Fair market value of the services or non-cash assets received
d. Fair value of the services or non-cash assets unless the fair value of the ordinary
share is more reliably determinable
529
18. When preference shares are fully participating, this mean that ordinary shareholders
receive dividend rate equal to the preference share and
a. All excess dividends are shared proportionately between the preference and
ordinary shareholders
b. All excess dividends are given to the ordinary shareholders
c. All excess dividends go to the preference shareholders
d. The maximum participation rate is applied to the preference shares
19. Preference shares that have no claim on any prior year dividends that may have passed
a. Cumulative preference shares
b. Participating preference shares
c. Non- cumulative preference shares
d. Non- Participating preference shares
20. The securities and Exchange Commission 25%, 25% rule means that
a. At least 25% of the total authorized share capital has been subscribed
b. At least 25% of the total subscription have been paid
c. A only
d. Both A and B
Test Material No.31
Rating
530
Name
Date
Year and Section
Professor
PROBLEMS
Problem A
The Royal Blue Corporation was organized on January 1, 2014 with authorized share capital
consisting of 100,000 shares of P50 par value preference share capital and 1,000,000 shares of
no-par ordinary share capital with a stated value of P10. At December 31, 2014, the ledger
included the following balances pertaining to shareholders’ equity:
Preference Share Capital
Preference Share Premium
Ordinary Share Capital
Paid-in Capital in Excess of Stated Value – Ordinary Share
P3,000,000
300,000
5,000,000
2,500,000
Ten thousand preference shares were issued for equipment having a fair market of P550,000. The
remaining preference share capital were issued for cash. All preferred shares were issued in
January. All ordinary shares were issued for cash.
Instruction: Compute for each of the items enumerated below. Present supporting computation
in good form in a separate work sheet.
1. Number of preference shares issued for cash.
2. Price per share of preference share capital issued for cash.
3. Number of ordinary shares issued.
4. Average price per share of the ordinary share capital issued for cash.
5. Total preference share premium arising from issuance in exchange equipment.
531
Problem B
1. ABC Corp. recorded the following journal entry on August 21, 2014:
Cash
42,250
Ordinary Share Capital
Ordinary Share Premium
32,500
9,750
The explanation reads “Issued ordinary share capital for P130 per share”. What is the par
value for this share capital, and how many shares were issued?
ANSWER:
2. DEF Company issued 1,000 shares of its P50 par value ordinary share capital in
exchange for land with a book value of 40,000 and fair value of P120,000. What is the
total increase in ordinary share premium?
ANSWER:
3. Using the information in No. 2, how much should be credited to ordinary share capital
account?
ANSWER:
4. The GHI Corporation was incorporated on January 1, 2014 with the following authorized
capitalization:

40,000 shares of ordinary share capital, no par value, stated value P50 per share

10,000 shares 5% cumulative preference share capital, par value P100
During 2014, GHI issued 24,000 ordinary shares for P60 per share and 6,000 preference
shares at P120 per share. In addition, on December 10, 2014 subscription for 2,000
preference shares were taken at a purchase price of P150. A down payment 30% was
received. The full payment on these subscribed shares was received on January 5, 2014.
What should GHI report as total increase in shareholders’ equity on its December 31,
2014 Statement Financial Position?
ANSWER:
5. On June 1, JKL Company issued 8,000 shares of its P10 par ordinary share capital to
Robles for a tract of land. The stock had a fair value of P18 per share on this date. How
much is the increase in ordinary share premium a result of this transaction?
ANSWER:
532
Problem C
Shown below are account balances found in the ledger of Emerald Green Corporation at the end
of 2014:
Subscription Receivable – Preference Shares
Subscription Receivable – Ordinary Share
10% Preference Share Capital, P50 par value,
Authorized 100,000 shares
Issued
Subscribed
Ordinary Share Capital, no par, P10 stated value,
Authorized 300,000 shares
Issued
Subscribed
Paid-In Capital in Excess of Par or Stated Value
Preference Share
Ordinary Share
P 720,000
364,000
P 2,880,000
1,440,000
4,320,000
P 2,720,000
560,000
3,280,000
P 432,000
656,000
1,088,000
Instruction: Compute for each of the item shown below. Present supporting computation in good
form in a separate work sheet.
1. Number of preference share issued.
2. Number of ordinary shares issued.
3. Number of preference shares subscribed
4. Number of ordinary shares subscribed.
5. Average price per share received by the corporation on its preference share
capital including preference share capital subscribed.
6. Average price per share received by the corporation on its ordinary share
capital including subscribed ordinary share capital.
533
7. Average amount per share that the subscribers of preference share capital have
not yet paid to the corporation.
8. Average amount per share that ordinary share capital subscribers have already
paid on their subscription. Assume that ordinary share capital were subscribed
at P12.
CHAPTER 9
OPERATIONS, DIVIDENDS, BOOK VALUE PER SHARE, and EARNINGS PER
SHARE
LEARNING OBJECTIVES
1. Explain the preparation of worksheet, adjusting entries, and closing entries for a
corporation.
2. Explain the components of the shareholders’ equity section of the statement of
financial position (balance sheet).
3. Prepare the financial statement of a corporation, specifically the statement of changes
in shareholders’ equity.
4. Identify the different types of dividends and compute amount of dividends to be
distributed to preference and ordinary shareholders.
Steps in the
5. Compute book value and earnings per share.
Accounting
6. Identify and explain the different types of retained
Cycle
earnings appropriatons.
 Worksheet
PREVIEW OF THE CHAPTER
 Financial Statement
1. Statement of
CORPORATE OPERATIONS and
Financial Position
FINANCIAL STATEMENT
2. Income Statement
3. Statement of
Shareholders’
Comprehensive
Equity
Income
 Contributed Capital
4. Statement of
 Share Capital
changes in
 Additional Paid-in
shareholders’
Capital
equity
 Retained Earnings
5. Statement of cash
 Appropriated
flows
 Unappropriated
534
 Adjusting Entries
 Capital Maintenance
 Closing Entries
adjustments
 Revaluation surplus


ACCOUNTING CYCLE OF A CORPORATION
The accounting cycle of a corporation is essentially the same as that of a sole proprietorship and
a partnership. Transactions, such as purchase and sale of merchandise and payment of expenses
and liabilities, are recorded in the same manner as that of the two other forms of business
organizations.
At the end of the accounting period, the results of operation of the corporation and its financial
position are determined and the following problems are normally encountered:
1. Preparation of a work sheet
2. Preparation of financial statements
a. Statement of financial position (balance sheet)
b. Income statement
c. Statement of comprehensive income
d. Statement of changes in shareholders’ equity
e. Statement of cash flows
3. Preparation of adjusting and closing entries
PREPARATION OF A WORK SHEET
A work sheet is a working paper that facilitates the preparation of financial statements.
However, before it can be prepared and completed, data for adjustments must first be compiled.
These items requiring adjustments are also the same items discussed in Chapters 1 and 3. For
purposes of illustration, these will be discussed again in this chapter. Data requiring adjustments
at the end of the accounting period include:
1.
2.
3.
4.
5.
6.
7.
Accrued expense
Accrued income
Prepaid Expense
Unearned or deferred income
Uncollectible accounts
Depreciation and other cost allocation
Income tax
535
The work sheet normally contains eight columns; however, there are instances when ten columns
are used because of the addition of a pair of column for retained earnings.
PREPARATION OF FINANCIAL STATEMENTS
Financial statements are the end product of the accounting process. The information contained
therein is taken from the completed work sheet. PAS 1 (revised 2010) provides that a complete
set of financial statements shall be composed of the following:
1. Statement of Financial Position (balance sheet)
2. Statement of Comprehensive Income (or a separate statement of income and statement of
other comprehensive income.
536
3. Statement of changes in equity
4. Statement of cash flows
5. Notes
The statement of comprehensive income reports gains and losses not reported as a part of as
profit or loss but are shown as adjustments to the total equity. These items include gain (loss)
from changes in fair value of available for sale securities and revaluation surplus arising from
revaluation of property, plant and equipment.
The Securities of Exchange Commission (SEC) requires that corporation submits to the
Commission within 15 days from the end of the first three months of operations a statement of
cash flows covering a period of three months from the date of registration. The statement must
show in sufficient detail the sources of cash and how these are disbursed. The paid-up capital
must be disbursed only in connection with the business for which the corporation was organized
and no amount shall be disbursed as loans or advances to shareholders or officers of the
corporation.
The preparation of the statement of cash flows is discussed in Chapter 11 of this book.
STATEMENT OF FINANCIAL POSITION (BALANCE SHEET)
The statement of financial position (balance sheet) reports the financial condition of a company
as of particular date. It contains the Assets, liabilities and equity of the business. The assets and
liabilities should be properly classified as current and noncurrent. The equity section of the
statement of financial position of a corporation is called shareholders’ equity or stockholders’
equity and is generally composed of Contributed Capital and Retained Earnings. In some
instances, a corporation may have capital maintenance adjustment accounts such as revaluation
surplus and net unrealized gain or loss on long term investments that are shown separately in the
equity section.
CONTRIBUTED CAPITAL. The Contributed Capital represents corporate capital arising from
investment shareholders. It is further divided into two sections:
1. Share Capital or Capital Stock- this also known as legal capital. This section reports both
preference (preferred) and ordinary (common) share capital issued, subscribed and distributable
as dividends, stated at par or stated value. In case of share capital without par value not stated
value, the amount reported is the total value of consideration received in exchange for the shares.
This section should include a description of each class of share capital such as the par or stated
value, authorized shares, number of shares issued, and divided rights in case of preference share
capital.
Share capital subscription receivables that are not currently collectible are shown as deduction
from share capital subscribed.
537
If the journal entry method of recording share capital transactions is used, issued share capital is
determined by deducting the balance of Unissued Share Capital account from Authorized Share
Capital account.
2. Additional Paid-In Capital- this section reports investment by shareholders in excess of the
par or stated value of the share capital. It includes paid-in capital in excess of par value or stated
value (share premium) of both preference and ordinary share capital.
It also includes donated capital and other paid-in capital items arising from various share capital
transactions .These different share capital transactions are discussed in Chapter 10.
Retained Earnings (Earned Surplus). The Retained Earnings balance represents undistributed
earnings of the corporation. It represents capital of the corporation arising from its operations.
The balance of the account is generally divided into two parts, as follows:
1. Appropriated retained earnings- it is the portion of Retained Earnings set aside for a
specific purpose.
2. Unappropriated retained earnings- it is the portion of Reatained Earnings available for
distribution as dividends to the shareholders. It is normally described as “unrestricted
earnings”
The Retained Earnings account has normal credit balance. A debit balance in the account is
called a deficit.
STATEMENT OF COMPREHENSIVE INCOME
The statement of comprehensive income is composed of two parts: profit or loss for the period
and other comprehensive income. The first part reports revenue and gains realized and expenses
and losses incurred during a period. The excess of revenue and gains over expenses and losses is
profit; the excess of expenses and losses over income and gains is loss. The second part reports
items of gains and losses which are not required by other PASs and PRFSs to be recognized in
profit or loss. Examples are changes in revaluation surplus when property, plant and equipment
are reported using the revaluation model and gains and losses arising from changes in fair value
of available-for-sale securities.
An essential part of the statement of comprehensive income prepared for a corporation is the
earnings per share amount that is reported blow the profit figure. The concepts and principles
relating to earning per share calculation as provided in PAS 33 shall be discussed in this chapter.
538

PAS 1 (revised 2010) also permits the presentation of comprehensive income in two
statements: an income statement and a statement of other comprehensive income.
For the purpose of this book, the option of preparing two separate statements will be adopted;
however, the statement of comprehensive income is not included in the illustration and
discussion. A detailed discussion of this statement is covered in the last part of financial
statements.
STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
The statement of changes in shareholders’ equity is one of the basic financial statements that
should be prepared. This statement reports transactions or items that cause changes in
shareholders’ equity account balances. For a corporation that is neither a subsidiary nor a parent,
and for which there are no changes in accounting policy or correction of error, the statement
shows the following:




The profit or loss for the period
Other comprehensive income
Capital share transactions with shareholders and distributions to shareholders (issuance of
share capital and dividends)
The balance of retained earnings at the beginning and the end of the period and the
movement during the period
PREPARATION OF ADJUSTING AND CLOSING ENTRIES
After the financial statements are prepared, adjusting and closing entries must be journalized and
posted. The adjusting entries of corporation are similar to those of a sole proprietorship and
partnership. No special problems are encountered in the preparation of adjusting entries. Closing
entries, on the other hand, consist of the following:
1. Closing the balances of revenue accounts to Income Summary
2. Closing the balances of expense accounts to Income Summary
3. Closing the balance of Income Summary to Retained Earnings
A. Profit (Income Summary has a credit balance)
Income Summary
XXX
Retained Earnings
B. Loss ( Income Summary has a debit balance)
Retained Earnings
Income Summary
539
XXX
XXX
XXX
Illustrative Problem A: The trial balance of the Bright Corp. as of December 31, 2014 is
presented below; the data requiring adjustments as of December 31, 2014 are presented on the
next page.
Bright Corp.
Trial Balance
December 31, 2014
Cash
Notes Receivable
Accounts Receivable
Allowance for Uncollectible Accounts
Merchandise Inventory
Store and Office Supplies
Prepaid Insurance
Office Equipment
Accumulated Depreciation-Office Equipment
Store Equipment
Accumulated Depreciation-Store Equipment
Notes Payable
Accounts Payable
10% Preference Share Capital, P100 par, 100,000 shares authorized
Ordinary Share Capital, P10 par, 500,000 shares authorized
Preference Share Premium
Ordinary Share Premium
Retained Earnings
Sales
Sales Returns and Allowances
Purchases
Purchases Returns and Allowances
Sales Salaries
Delivery Expense
Miscellaneous Selling Expenses
Office Salaries
Rent Expense
Utilities Expense
Miscellaneous Administrative Expenses
Interest Income
1,932,000
750,000
2,827,500
30,000
450,000
112, 500
54,000
1,8 75,000
187,500
2, 850,000
285,000
375,000
487,500
2,000,000
4,750,000
375,000
900,000
787,000
7,050,000
150,000
3,750,000
75,000
900,000
180,000
105,000
675,000
375,000
247,500
79,000
17,313,000
Data requiring adjustments as of December 31, 2014:
A. Inventories: Merchandise- P750,000
B. Supplies Used: office- P30,000; store- P62,500
C. Unexpired insurance-P24,000
D. Accrued interest on notes receivable, P5,500
E. Accrued sales salaries, P45,000; office salaries, P25,000
540
10,500
17,313,000
F. Estimated uncollectible accounts at the end of the year amounted to P168,000
G. Depreciation on store and office equipment, 5% per year
H. Income tax rate is 35%
The equity balances as of January 1, 2014 are as follows:
10% Preference Share Capital
Ordinary Share Capital
Preference Share Premium
Ordinary Share Premium
Retained Earnings
On January 10, the following transactions have taken place:
 5,000 preference shares were issued at P105
 75,000 ordinary shares were issued at P15
541
P1,500,000
4,000,000
350,000
525,000
787,500
542
543
544
545
546
Closing Entries
2014
Dec.
31 Income Summary
Sales Returns and Allowances
Purchases
Sales Salaries
Delivery Expense
Miscellaneous Selling Expenses
Office Salaries
Rent Expense Utilities
Expense Miscellaneous
Administrative Expenses
Office Supplies Expense
Store Supplies Expense
Insurance Expense
Uncollectible Accounts Expense
Depreciation Expense - Office Eqt.
Depreciation Expense -Store Eqt.
Income Tax Expense
31 Sales
Purchase Returns and Allowances
Interest Income
Income Summary
31 Income Summary
Retained Earnings
7,152,425
150,000
3,750,000
945,000
180,000
105,000
700,000
375,000
247,500
79,500
30,000
62,500
30,000
138,000
93,750
142,500
123,675
7,050,000
75,000
16,000
7,141,000
288,575
288,575
Reversing Entries
2015
Jan
1 Interest Income
Interest Receivable
5,500
1 Salaries Payable
Sales Salaries
Office Salaries
70,000
5,500
45,000
25.000
547
DIVIDENDS
Dividends are distribution to shareholders of corporate earnings in proportion to the number of
shares held by them. Distributions may take the form of (1) cash, (2) non-cash assets, (3) notes or
other evidence of corporate indebtedness, and (4) shares of the company's own share capital.
Dividends previously described are paid out of accumulated earnings of the corporation They
may also be paid as a return of shareholders' invested capital. This type of dividends are called
liquidating dividend. However, discussion in this book will be limited to dividends representing
distributions of corporate earnings.
The power to declare dividends is vested upon the board of directors; however, they have to
observe legal requirements governing the maintenance of legal or stated capital Dividend
declaration is normally announced to be made known to the shareholders.
The following dates are essential in formal dividend announcement or statement
1. Date of declaration - this is the date when the board of directors approved the resolution to
distribute dividends. The liability of the corporation to the shareholder is recorded on this
date.
2. Date of shareholders of record - this is the date when the company determines the
shareholders who are entitled to the receipt of declared dividends. No entry required on this
date; however, a list of registered shareholders is made as of the close of business on this
date. Share capital are selling dividends-on prior to this date and are selling ex-dividends the
day following this date.
3.
Date of payment or distribution - this is the date when dividends declared are paid or
distributed to the shareholders. The liability recognized on the date of declaration is cancelled
or extinguished on this date.
CASH DIVIDENDS
Cash dividends are dividends that are distributable in the form of cash. This is the most common
type of dividend. The following entries are made to record the declaration subsequent payment:
Retained Earnings
xxx
Cash Dividends Payable*
To record the declaration of dividends.
Cash Dividends Payable
xxx
548
xxx
Cash
xxx
To record payment of dividends.
*Alternatively, the account Dividends Payable may be used.
If the dividends declared are still unpaid as of the statement of financial position date, the
balance of the account Cash Dividends Payable is reported as a current liability.
The amount of cash dividends declared-should not exceed the amount of cash reported on the
statement of financial position or cash needed for current operations. For instance, Retained
Earnings may have a balance of P 1,000,000 but the cash balance is only P500,000, the
corporation can distribute cash dividends of not more than P500,000. Another form of dividend
may be declared for the remaining undistributed earnings.
Cash dividends may either be:
1. Peso dividend - a cash dividend expressed in peso amount. The peso dividend multiplied by
the number of outstanding shares of the corporation equals the total amount of Retained
Earnings declared as cash dividends. On the other hand, the peso dividend multiplied by the
number of capital shares held by a shareholder equals the total amount of cash dividends to
be received by the shareholder.
2. Percentage dividend - a cash dividend expressed in percentage. The dividend percentage
multiplied by the par value or stated value of the capital share equals the peso dividend.
Alternatively, the percentage dividend multiplied by the total par value or total stat value of
the capital share equals the total amount of Retained Earnings declared as cash dividends.
For example, the dividend on a 10% preference share with a par value P100 is equal to P10
(i.e., 10% x P100). A shareholder who owns 2,000 shares is entitled to P20,000 (.e., P10 x
2,000 shares).
Illustrative Problem B: Fortune Corp. has 10,000 shares of P100 par value ordinary share capital
outstanding as of December 1, 2014. On this date, the Board of Directors declared a cash
dividend of P10.00 per share to shareholders of record of December 30, 2014 payable on January
15, 2015.
2014
Dec.
1 Retained Earnings
Dividends Payable
10,000 sh @P10=P100,000
100,000
15 Dividends Payable
Cash
100,000
100,000
2015
Jan.
100,000
The Dividends Payable account will be reported in the December 31, 2014 statement of financial
position as a current liability.
SCRIP DIVIDENDS
549
Scrip dividends are, in fact, deferred cash dividends. A scrip dividend is declared when the
corporation has sufficient Retained Earnings balance but not sufficient funds at that time for a
cash dividend. Scrip dividends consist of a written promise to pay certain amounts at some future
date. The payment normally includes the principal amount and an interest at a specified date
The entries to record the declaration and subsequent payment of scrip dividends follow:
Retained Earnings
Scrip Dividends Payable
To record the declaration of dividends.
xxx
Xxx
Scrip Dividends Payable
xxx
Interest Expense
xxx
Cash
To record payment of dividends plus interest.
Xxx
Illustrative Problem C: Fortune Corp. has 10,000 shares of P100 par value ordinary share
capital outstanding as of October 31, 2014. On this date, the Board of Directors declared a
deferred cash dividend of P10.00 per share to shareholders of record of November 30, 2014.
Promissory notes dated December 1, 2014 were issued on the same date. The notes mature
within six months plus interest of 12% per annum. The corporation paid its shareholders on
March 31, 2015.
The entries to record the declaration of dividends, the accrual of interest at year-end, the
reversing entry at the beginning of the new accounting period and the payment to shareholders
are as follows:
2014
Oct.
Dec.
31 Retained Earnings
Scrip Dividends Payable
10,000 sh @P10=P100,000
31 Interest Expense
Interest Payable
P100,000 x 12% x 1/12 = P1,000
100,000
1 Interest Payable
Interest Expense
100,000
100,000
1,000
1,000
2015
Jan.
100,000
550
March
31 Scrip Dividends Payable
Interest Expense
Cash
P100,000 x 12% x 4/12 = P4,000
100,000
4,000
104,000
The accounts Scrip Dividends Payable and Interest Payable will be reported in December 31,
2014 statement of financial position as current liabilities.
PROPERTY DIVIDENDS
Dividends distributable in the form of non-cash assets are known as property dividend. Property
distributed normally takes the form of assets that can be easily divided or allocated among
shareholders such as stocks of other companies owned by the corporation. According to IFRIC
17 Distribution of Non-Cash Assets to Owners, the following rules shall apply in accounting
for distribution of non-cash assets to owners as dividends:

An entity shall measure a liability to distribute noncash assets as a dividend to its owners
at the fair value of the assets to be distributed (par. 11)
- This means that Retained Earnings and Property Dividends Payable will be
recorded at the fair value of the assets to be distributed.

At the end of each reporting period and at the date of settlement, the entity shall review
and adjust the carrying amount of the dividend payable, with any changes in the carrying
amount of the dividend payable recognized in equity as adjustments to the amount of the
distribution (par. 13)
- This means that Retained Earnings and Property Dividends Payable balances will
be adjusted for the change in the previously recorded fair value of the assets.
- The required valuation /measurement of the assets to be distributed at the end of
each reporting period as provided in related PAS or PFRS should also be applied.

When an entity settles the dividend payable, it shall recognize the difference, if any,
between the carrying amount of the assets to be distributed and the carrying amount of
the dividend payable in profit or loss (par 14)
- This means that the difference between the carrying amount of the Property
Dividends Payable and the carrying amount of the assets to be distributed as gain
or loss to be reported in the statement of comprehensive income.
The entry to record the declaration of dividends is as follows:
551
Retained Earnings
Property Dividends Payable
To record the declaration of dividends.
xxx
xxx
The entry to record the distribution of dividends under three independent cases shall as follows:
1. The carrying amount of the payable and the carrying amount of the assets are the same
Property Dividends Payable
xxx
Assets
xxx
To record distribution of property dividend
xxx
2. The carrying amount of the payable is greater than the carrying amount of the assets
Property Dividends Payable
xxx
Assets
xxx
Gain on Distribution of Non-Cash Assets
xxx
3. The carrying amount of the payable is less than the carrying amount of the assets
Property Dividends Payable
xxx
Loss on Distribution of Non-Cash Assets
xxx
Assets
xxx
For purpose of discussion in this book, the illustration, exercises and problems will involve
assets with carrying value equal to their book value.
Illustrative Problem D: Fortune Corp. has 10,000 shares of P100 par value ordinary share
capital outstanding as of December 1, 2014. On this date, the Board of Director declared a
property dividend distributable to shareholders of record of December 30, 2014 payable on
January 15, 2015. The corporation will distribute five shares of Luck Corp. for every share of
Fortune Corp, owned by the shareholders. Each share of Luck Corp. has a carrying value of P10
on the date of declaration, which is also its fair value on the date of declaration and on the date of
distribution.
The entries to record the declaration and distribution of property dividend follow:
2014
Dec.
1 Retained Earnings
Property Dividends Payable
10,000 sh x 5 @ P10 P500,000
500,000
15 Property Dividends Payable
500,000
500,000
2015
Jan.
552
Investment in Lucky Corp. Stocks
500,000
It should be noted that the declaration and payment or distribution of cash dividends scrip
dividends and property dividends do not affect the corporation's number of capital shares issued
and outstanding. This means that the total number of capital shares issued and outstanding before
the dividend declaration and payment or distribution shall be the s as total number of capital
shares issued and outstanding after the dividend declaration and payment or distribution.
However, there is a decrease in the total assets and total retained earnings of the corporation.
SHARE CAPITAL DIVIDENDS (STOCK DIVIDENDS)
A share capital dividend (stock dividend) is a distribution to shareholders in the form of
corporation's own share capital (stock). Thus, when Fortune Corp. distributes Fortune Corp.
shares to its shareholders, it is distributing share capital or stock dividends.
This type of dividend does not affect total assets and total shareholders' equity, rather it simply
represents a transfer of capital from retained earnings to contributed capital. Hence, total
shareholders' equity before and after the declaration and distribution of share capital dividends
are the same. On the other hand, retained earnings is decreased while contributed capital is
increased as a result of the declaration and distribution of share capital dividends.
In recording the declaration of a share capital dividend, a distinction should be made between a
small and a large stock dividend. A share capital dividend representing less than 20 % of the
outstanding shares is considered a small share capital dividend A share capital dividend
representing 20 % or more of the outstanding shares is considered a large share capital dividend
Under a small share capital dividend, retained earnings is debited for the fair value of the share
capital on the date of declaration; under a large share capital dividend, retained earnings is
debited for the par or stated value of the share capital.
The entries to record the declaration and distribution of share capital dividend, both small and
large, follow:
Small Share Capital Dividend
Retained Earnings
Share Capital Dividends Distributable
Paid-In Capital from Share Capital Dividends
To record the declaration of dividends.
xxx
Share Capital Dividends Distributable
Share Capital (or Unissued Share Capital)
xxx
xxx
xxx
xxx
553
To record the distribution of stock dividends.
Large Share Capital Dividend
Retained Earnings
Share Capital Dividends Distributable
To record the declaration of dividends.
xxx
Share Capital Dividends Distributable
Share Capital (or Unissued Share Capital)
To record the distribution of stock dividends.
xxx
xxx
Xxx
The account Share Capital (Stock) Dividend Distributable is credited for the par or stated value
of the shares to be distributed regardless of whether the share capital dividend is small or large.
This account is reported on the statement of financial position under the shareholders' equity
section as part of Contributed Capital. It is properly shown as addition to the share capital
outstanding.
The account Paid-In Capital from Share Capital Dividend is credited for the excess of fair market
value of the share over its par or stated value. This account is reported on the statement of
financial position under the shareholders' equity section as part of additional paid-in capital.
Illustrative Problem E: Fortune Corp. has 10,000 shares of P100 par value ordinary share
capital outstanding as of December 1, 2014. On this date, the Board of Directors declared a share
capital dividend distributable to shareholders of record of December 30 2014 payable on January
15, 2015. The fair market value of Fortune Corp. share capital on December I is P105; on
December 30, Pl10; on January 15, P106
The entries to record the declaration and distribution of share capital dividend using two
independent cases are presented below
Case 1 - A share capital dividend of 10 % was declared.
2014
Dec.
1 Retained Earnings
Share Capital Dividends Distributable
Paid-In Capital from Share Capital
Dividend
10,000 sh x 10 % @ P105 = P105,000
10,000 sh x 10% @ P 100 = P100,000
10,000 sh x 10 % @ P 5 = P 5,000
2015
554
105,000
100,000
5,000
Jan.
15 Share Capital Dividends Distributable
Ordinary Share Capital
100,000
100,000
Case 2- A share capital dividend of 30% was declared.
2014
Dec.
1 Retained Earnings
Share Capital Dividends Distributable
10,000 sh x 30% @ P 100 = P300,000
300,000
1 Share Capital Dividends Distributable
Ordinary Share Capital
300,000
300,000
2015
Jan.
300,000
The declaration and distribution of share capital dividends, whether small or large. increases the
number of capital shares outstanding.
In all of the different types of dividends discussed, it should be noted that only the outstanding
capital shares are entitled to dividends.
DIVIDENDS ON PREFERENCE SHARES
When dividends are paid, the dividend requirements on preference shares must be paid before
any payment can be made to ordinary shareholders. The required dividends depend upon the type
of preference shares issued by the corporation.
The preference shares may be:
1. Cumulative- preference shareholders are entitled to the payment of past years' unpaid
dividends or dividends in arrears before the payment of current year's dividends.
2. Noncumulative - preference shareholders are not entitled to payment of dividends in
arrears, they are entitled to current year's dividends only.
3. Participating- preference shareholders are entitled to additional dividends after the
payment of regular dividends to both the preference and ordinary shareholders.
If the preference shares are fully participating, then the excess dividend is allocated
proportionately to the two classes of share capital based on their total par value.
555
However, if the preference shares are participating up to a certain percentage only, a
comparison should be made between the maximum allowed participation and the
amount based on full participation. The amount given to the preference shareholders is
the lower of the two amounts.
4. Nonparticipating - preference shareholders are not entitled to any dividend in excess of
the regular rate. Hence, the dividends on preference shares is limited only to the regular
rate even if the amount of dividend distributions increases. The entire dividend balance
after the preference shareholders get their regular dividend rate is given to the ordinary
shareholders.
Illustrative Problem F: The Fortune Corp. declared and paid cash dividends for the last three
years as follows: 2012 P120.000; 2013 - P200.000; 2014 - P300.000 dividends were paid for two
years prior to 2012. The capital structure of the company the last three years follows:
10% Preference share capital, P100 par, 5,000 shares outstanding
P500,000
Ordinary share capital, P50 par, 5.000 shares outstanding
250,000
The annual dividend requirement on preference shares is P50,000 or P10 per share (i.e., P100 par
x 10% x 5,000 shares outstanding). At the beginning of 2012, dividends are in arrears (unpaid
dividends of prior years) for two years.
The distribution of dividends to the preference and ordinary shareholders under different
independent cases are presented below and on the next pages.
Case 1 – The preferences shares are noncumulative and nonparticipating.
Preferences shares
Preferences shares
Ordinary shares
Total dividends
Dividends per share:*
Preference shares
Ordinary shares
*Total dividends ÷ outstanding shares
2012
P50,000
70,000
P120,000
2013
P50,000
150,000
P200,000
2014
P50,000
250,000
P300,000
P10.00
14.00
P10.00
30.00
P10.00
50.00
Note: since the preference shares are noncumulative, the dividends in arrears are ignored and
preference shareholders are entitled to the current year’s dividend only. Since the shares are
also nonparticipating, the entire balance is given to ordinary shareholders; preference shares
are not entitled to any dividend in excess of the 10%
556
rate. Hence, the dividend per share on preference share is limited to P10 only, even if the total
amount of distributed dividends increases.
Case 2 – The preference shares are cumulative but nonparticipating.
2012
Dividends in arrears:
P50,000 x 2
Current dividends:
Required
Available
In arrears, end of 2008
Total dividends
Dividends per share
Preference
Ordinary
P 100,000
-----
P 100,000
20,000
-----
20,000
P 120,000
P 24.00
P ----P -----
P 120,000
2013
Dividends in arrears
Current dividends
Balance – to ordinary shareholders
Total dividends
Dividends per share
Preference
P 30,000
50,000
Ordinary
--------P 120,000
P 120,000
P 24.00
Total
P 30,000
50,000
P 120,000
P 200,000
2014
Current dividends
Balance – to ordinary shareholders
Total
Dividends per share
Preference
P 50,000
Ordinary
P ----250,000
P 250,000
P 50.00
Total
P 50,000
250,000
P 300,000
P 50,000
20,000
P 30,000
P 80,000
P 16.00
P 50,000
P 10.00
Total
Note: Since the preference shares are cumulative, they are entitled to the payment of dividends
in arrears. However, since they are nonparticipating, they are not entitled to any dividend in
excess of the current year’s dividends.
Case 3 – The preference shares are noncumulative but fully participating.
2012
Regular dividends:
Preference
Ordinary – P50 x 10% x 5,000 sh
Balance – P45,000
Preference 500/750 x P45,000
Ordinary – 250/750 x P45,000
Total dividends
Dividends per share
Preference
Ordinary
Total
P 50,000
P 25,000
P 75,000
15,000
P 40,000
P 8.00
45,000
P 120,000
30,000
P 80,000
P 16.00
557
2013
Regular dividends:
Preference
Ordinary – P50 x 10% x 5,000 sh
Balance – P125,000
Preference 500/750 x P125,000
Ordinary – 250/750 x P125,000
Total dividends
Dividends per share
Preference
2014
Regular dividends:
Preference
Ordinary – P50 x 10% x 5,000 sh
Balance – P125,000
Preference 500/750 x P125,000
Ordinary – 250/750 x P125,000
Total dividends
Dividends per share
Ordinary
Total
P 50,000
P 25,000
P 75,000
P 133,333
P 26.67
41,667
P 66,667
P 13.33
125,000
P 200,000
Preference
Ordinary
83,333
Total
P 50,000
P 25,000
P 75,000
75,000
P100,000
P 20.00
225,000
P300,000
150,000
P 200,000
P 40.00
Note: Since the preference shares are noncumulative they are entitled to current year’s
dividends only and since they are fully participating, they are entitled to additional dividends
after payment of regular dividends to both preference and ordinary shareholders. The regular
dividend on ordinary shares is based on the dividend rate on preference shares. The excess
dividend is allocated proportionately to the two classes of capital shares based on their total par
value.
Case 4 – The preference shares are cumulative and fully participating
2012
Dividends in arrears:
P50,000 x 2
Current dividends:
Required
Available
In arrears, end of 2008
Total dividends
Dividends per share
P 50,000
20,000
P 30,000
Preference
Ordinary
P 100,000
-----
P 100,000
20,000
-----
20,000
P 120,000
P 24.00
P ----P -----
P 120,000
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Total
2013
Dividends in arrears
Current (regular) dividends
Balance – P95,000
Preference – 500/750 x P95,000
Ordinary – 250/750 x P95,000
Total dividends
Dividends per share
Preference
P 30,000
50,000
2014
Current (regular) dividends
Balance – P225,000
Preference – 500/750 x P225,000
Ordinary – 250/750 x P225,000
Total dividends
Dividends per share
Preference
P 50,000
Ordinary
P 25,000
Total
P 30,000
75,000
63,333
P143,333
P28.67
31,667
P 56,667
P11.33
95,000
P 200,000
Ordinary
P 25,000
Total
P 75,000
75,000
P100,000
P20.00
225,000
P 300,000
150,000
P200,000
P40.00
Note: Since the preference shares are both cumulative and fully participating, they are entitled
to the receipt of dividends in arrears and also to the receipt of additional dividends after
payment of regular dividends to both preference and ordinary shareholders.
Case 5 – The preference shares are noncumulative but participating up to an additional
8%. This means that the maximum participation of preference shares on the excess dividends is
P40,000 (i.e., 8% of P500,000).
2012
Regular dividends:
Preference
Ordinary – P50 x 10% x 5,000 sh
Balance – P45,000
Preference 500/750 x P45,000
Ordinary – 250/750 x P45,000
Total dividends
Dividends per share
Preference
2013
Regular dividends:
Preference
Ordinary – P50 x 10% x 5,000 sh
Balance – P125,000
Preference 500/750 x P125,000
Ordinary – 250/750 x P125,000
Total dividends
Dividends per share
Ordinary
Total
P 50,000
P 25,000
P 75,000
P 80,000
P 16.00
15,000
P 40,000
P 8.00
45,000
P 120,000
Preference
Ordinary
30,000
Total
P 50,000
P 25,000
P 75,000
85,000
P110,000
P 22.000
125,000
P 200,000
40,000
P 90,000
P 18.00
559
2014
Regular dividends:
Preference
Ordinary – P50 x 10% x 5,000 sh
Balance – P225,000
Preference 500/750 x P225,000=150,000
Ordinary – P225,000 – P40,000
Total dividends
Dividends per share
P40,000 is the lower amount
Preference
Ordinary
Total
P 50,000
P 25,000
P 75,000
185,000
P210,000
P 42.00
225,000
P300,000
40,000
P 90,000
P 18.00
Note: Since the preference shares are participating up to a certain percentage only, a
comparison should be made between the maximum allowed participation and the amount based
on full participation. The amount to be given on the preference shareholders is the lower of the
two amounts. Alternatively, the amount to be allocated to the preference shares is computed by
multiplying the total par value of the preference shares by the lower of the full participation rate
or the maximum participation rate. The full participation rate is computed as follows:
Excess dividends to be distributed
Full participation rate= Total par value of preference and ordinary pages
Using the data in Case 5, the full participation rate for 2012, 2013, and 2014 are as follows:
2012
2013
2014
45,000/750,000
125,000/750,000
225,000/750,000
6.00%
16.67%
30.00%
Hence, in 2012, the 6% rate will be used; in 2013 and 2014 the 7% rate will be used.
BOOK VALUE PER SHARE
Book value per share is the peso equity in corporate capital of each share capital. It is the amount
that would be paid on each share owned by a shareholder in case of corporate liquidation
assuming the amount available to shareholders is exactly the same as the total shareholders’
equity.
The calculation of book value per share depends on how many classes of share capital are
outstanding. If there is only one class of share capital outstanding, book value per share is
calculated by dividing the total shareholders’ equity by the number of shares outstanding.
Subscribed shares, if any, should be added to the outstanding shares.
When more than one class of share capital are outstanding, the rights of the different classes of
shareholders should be taken into consideration. Preference shareholders have priority over
ordinary shareholders as to distribution of assets upon corporate liquidation.
560
Thus the equity identified with the preference share capital should be determined first. The
balance of the shareholders’ equity after deducting the equity of preference shareholders
represents the equity of the ordinary shareholders. Equity identified with each class of share
capital divided by the number of shares outstanding yields the book value per share.
EQUITY IDENTIFIED WITH PREFERENCE SHARE CAPITAL. The equity of the holders
of preference shares generally consists of the liquidation value of the share and any claim on
dividends. Liquidation value of the share capital refers to the amount payable to preference
shareholders for every share owned in case of corporate liquidation. It is usually equal to or more
than the par value of the share capital.
EQUITY IDENTIFIED WITH ORDINARY SHARE CAPITAL. The equity of the holders of
ordinary share capital, also known as residual equity, is the excess of total shareholders’ equity
over the equity identified with preference share capital. It represents the amount available to
ordinary shareholders in case of corporate liquidation.
Illustrative Problem G: On December 31, 2014, the shareholders’ equity section of the
statement of financial position of Lucky Corp. appears as follows:
10% Preference share capital, P100 par, 50,000 shares
Ordinary share capital, P20 par, 200,000 shares
Preference share premium
Ordinary share premium
Retained earnings
Total shareholders’ equity
P 5,000,000
4,000,000
1,500,000
1,200,000
5,800,000
P 17,500,000
Dividends on preference shares are in arrears for two years, including the current year.
Case 1 – The preference shares are noncumulative; liquidation value is P110 per share.
Total shareholders’ equity
Less Equity identified with preference shares
Liquidation value = 50,000 sh x P110
Equity identified with ordinary shares
Book value per share:
Preference = P5,500,000/50,000
Ordinary = P12,000,000/200,000
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P 17,500,000
5,500,000
P 12,000,000
P 110.00
P 60.00
Case 2 – The preference shares are cumulative; liquidation value is P110 per share.
Total shareholders’ equity
Less Equity identified with preference shares:
Liquidation value = 50,000 sh x P110
Div. in arrears = P5,000,000 x 10% x 2
Equity identified with ordinary shares
P 17,500,000
P 5,500,000
1,000,000
Book value per share:
Preference = P6,500,000/50,000
Ordinary = P11,000,000/200,000
6,500,000
P 11,000,000
P 130.00
P 55.00
EARNINGS PER SHARE
The earnings per share (EPS) is the amount earned during a given period on each ordinary share
outstanding. PAS 33 provides the guidelines in the computation of both basic and dilutive
earnings per share. However, this chapter is focused only on the computation of basic EPS.
The provisions of PAS 33 shall be applied in the computation of earnings per share of the
following entities:
1. those whose ordinary shares or potential ordinary shares are publicly traded
2. those that are in the process of issuing ordinary shares or potential ordinary shares
3. those that voluntarily disclose earnings per share
The earnings per share information is presented in the statement of comprehensive income, even
if the amount is negative.
A potential ordinary share is a financial instrument or other contract that may entitle its holders
to ordinary shares, such as ordinary share warrants and convertible preference shares. A holder
of convertible preference shares is given the privilege of exchanging the preference shares for
ordinary shares.
Basic earnings per share shall be computed as follows:
1. There is only one class of share capital outstanding (that is, ordinary shares)
EPS = Profit/ outstanding ordinary shares
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2. There are two classes of share capital outstanding (that is, ordinary shares and preference
shares)
Profit or loss per income statement
Less Dividends on preference shares
(Total par value of preference shares x dividend rate)
Profit attributable to ordinary shares
xxx
xxx
xxx
Earnings per share
(Profit attributable to ordinary shares/ outstanding shares) xxx
If the preference shares are cumulative, the dividends required for the period will be
deducted, whether they are declared or not. However, if the preference shares are noncumulative, only dividends declared in respect of the period will be deducted.
The earnings per share figure is very useful to investors and prospective investors in evaluating
the results of operations of a business in order to make investment decisions. It is also considered
as a significant determinant of the market price of the share capital.
Illustrative Problem H: For the year ended December 31, 2014, the Brilliant Corp. reported
profit of P450,000.
Earnings per share computation will be made using three independent cases.
Case 1 – The company has 20,000 ordinary shares outstanding.
EPS=
P450,000/20,000
P 22.50
Case 2 – The company has the following share capital outstanding:
5,000 shares of 10% preference share capital, par value P100
20,000 shares of ordinary share capital, par value P20
The preference shares are cumulative; no dividends were declared during the period.
Profit
Less Dividends on cumulative preference shares
5,000 sh x P100 x 10%
Profit attributable to ordinary shares
P450,000
EPS = P400,000/20,000
P 20.00
563
50,000
P400,000
Case 3 – The company has the following share capital outstanding:
5,000 shares of 10% preference share capital, par value P100
20,000 shares of ordinary share capital, par value P20
The preference shares are non-cumulative; no dividends were declared during the period.
EPS= P450,000/20,000
P 22. 50
APPROPRIATION ON RETAINED EARNINGS
As mentioned in the earlier part of this chapter, Appropriated Retained Earnings is that portion of
retained earnings set aside for a special or specific purpose. Appropriation of retained earnings
set aside for a special or specific purpose. Appropriation of retained earnings reduces the amount
available for distribution as dividends to shareholders. However, the total retained earnings
remains unchanged.
There are three types of appropriations to Retained Earnings which are acceptable and these are
discussed in the succeeding paragraphs.
APPROPRIATIONS TO REPORT LEGAL RESTRICTIONS ON RETAINED EARNINGS.
When a company reacquires its own shares, the law requires that Retained Earnings equal to the
cost of the shares reacquired (known as treasury shares) be appropriated or set aside. This is done
to maintain at original or stated balances the resources of the business and the shareholders’
equity. The appropriated balance is reverted to unappropriated classification upon reissuance of
the reacquired shares.
APPROPRIATIONS TO REPORT CONTRACTUAL RESTRICTIONS ON RETAINED
EARNINGS. Agreements with creditors or shareholders may provide for retention of a portion
of Retained Earnings within the company. The appropriations of Retained Earnings is made to
protect the interest of creditors and shareholders and to assure redemption of the securities they
hold. The appropriation balance is reverted back to unappropriated balance upon payment of the
obligation. Examples of appropriations under this classification are Appropriation for Bond
Redemption and Appropriation for Preference Share Capital Redemption.
APPROPRIATIONS TO REPORT DISCRETIONARY ACTION BY THE BOARD OF
DIRECTORS IN THE PRESENTATION OF RETAINED EARNINGS. A portion of the
Retained Earnings may be presented in a manner disclosing the actual use or planned use in the
future of the resources as authorized by the board of directors. Examples of appropriations under
this classification are Appropriation for Plant Expansion and Appropriation for General
Contingencies.
564
The pro form entries to record the appropriation of Retained Earnings and its subsequent
cancellation follow:
a. Retained Earnings
xxx
Retained Earnings Appropriated for……..
xxx
Appropriation for retained earnings
b. Retained Earnings Appropriated for……..
xxx
Retained Earnings
xxx
Cancellation of appropriation to retained earnings
REVIEW of the LEARNING OBJECTIVES
1.
Explain the preparation of work sheet, adjusting entries, and closing entries for a
corporation. The work sheet prepared for a corporation is similar to the work sheet
prepared for a sole proprietorship and a partnership. It normally contains eight columns
and is prepared to facilitate the preparation of financial statements. The adjusting entries
include adjustment for income tax which is 35% of profit before income tax. In a
corporation, the income or loss of the company is transferred to Retained Earnings,
which is also a capital account.
2.
Explain the components of the shareholders’ equity section of the statement of
financial position. The capital section of the statement of financial position (balance
sheet) of a corporation is called “Shareholders’ Equity” section. It is generally composed
of the following: (1) Contributed Capital, which represents capital arising from
contributions by shareholders and is subdivided into Share Capital and Additional Paid-in
Capital; and (2) Retained Earnings, which represents capital arising from operations of
the business. In some instances, corporations may have capital adjustment accounts such
as Revaluation Surplus. These accounts are reported separately from Contributed Capital
and Retained Earnings.
3.
Prepare the financial statements of a corporation, specifically the statement of changes
in shareholders’ equity. A corporation has also four basic financial statements, balance
sheet or statement of financial position, income statement, statement of cash flows, and
statement of changes in shareholders’ equity. The statement of changes in shareholders’
equity shows transactions that have caused an increase or a decrease in Total
Shareholders’ Equity during the period, such as distribution of dividends and profit of the
year.
4.
Identify the different types of dividends and compute amount of dividends to be
distributed to preference and ordinary shareholders. Dividends are distribution of
corporate income to the shareholders. Dividends may be distributed in form of cash, noncash assets or shares of stock of the
565
corporation. On the date of declaration, Retained Earnings account is debited, thereby
reducing its balance. The amount debited to Retained Earnings depends on the type of
dividend declared. When two classes of share capital are outstanding, the total amount of
dividends declared should be allocate properly taking into account the type of preference
shares outstanding.
5.
Discuss the computation of book value per share and earnings per share. Book value
per share is the peso equity in corporate capital of each share capital. It represents the
amount that a shareholder will receive for every share owned in case of corporate
liquidation. If there is only class of share capital outstanding, it is computed by dividing
the total shareholders’ equity by the total number of outstanding shares. Book value per
share is then computed by dividing the equity identified with each class of stock by the
total number of outstanding shares per class.
The earnings per share (EPS) is the amount earned during a given period on each
ordinary share outstanding. When there is only one class of share capital outstanding, it is
computed by dividing the net income or the profit of the company by the number of
outstanding ordinary shares. When there are two classes of share capital outstanding, the
earnings allocated to the ordinary shares is first computed by deducting the earnings
identified with the preference shares. The earnings per share is then calculated by
dividing the earnings allocated to the ordinary shares by the number of outstanding
ordinary shares.
6.
Identify and explain the different types of retained earnings appropriations.
Appropriation of Retained Earnings is setting aside a portion of Retained Earnings for a
specific or special purpose and such appropriation reduces the amount of Retained
Earnings available to shareholders or dividends. Retained Earnings may be appropriated
for the following purposes: (1) to meet legal requirements; (2) to meet contractual
requirements; and (3) to meet discretionary action by the board of directors.
566
GLOSSARY of ACCOUNTING TERMINOLOGIES
Additional Paid-in Capital - corporate capital arising from investment by shareholders in
excess of the par or stated value of the share capital.
Appropriated Retained Earnings - Retained earnings set aside for a specific purpose, hence,
not available for dividend distribution.
Book value per share - peso equity in corporate capital of each share of stock. It is the amount
that a shareholder would receive for every share owned in case of corporate liquidation.
Cash Dividends - dividends distributable in the form of cash.
Contributed Capital - corporate capital arising from investment by shareholders.
Deficit - a debit balance in the Retained Earnings account.
Dividends - distribution of corporate earnings to shareholders.
Dividends in arrears - unpaid dividends in prior years.
Earnings per share - amount earned during a given period on each ordinary share outstanding.
Property Dividends - dividends distributable in the form of non-cash assets.
Retained Earnings - corporate capital arising from operations of the business. Its balance
represents undistributed earnings of the company. It is also known as "earned surplus".
Share Capital Dividends - dividends distributable in the form of corporations' own share
capital.
Unappropriated Retained Earnings - retained earnings available for dividend distribution to
shareholders.
567
371
DISCUSSION QUESTIONS
1.What are the components of the shareholders' equity section of the statement of financial
position (balance sheet)?
2.Identify and discuss the two components of contributed capital.
3.What is the purpose of preparing a statement of changes in shareholders' equity?
4.What are the three significant dates in the distribution of dividends?
5.What are the different types of dividends? How much is debited to Retained Earnings upon
declaration of each of these types of dividends?
6.How much will you distinguish a small from a large share capital (stock) dividend?
7.What are the dividends in arrears? How do they affect the allocation of dividends to preference
and ordinary shareholders if (a) preference share capitals are non-cumulative, (b) preference
share capitals are cumulative?
8.What is the significance of book value per share? How is it computed if (a) only one class of
share capital is outstanding, (b) two classes of share capital are outstanding?
9.What is earning per share? What is its significance to the shareholders? How is it computed of
(a) only one class of share capital is outstanding, (b) two classes of share capital are outstanding?
10.What are the three types of appropriations to Retained Earnings? What is the effect of an
appropriation of Retained Earnings to dividends?
568
372
EXERCISES
Exercise 9-1 (Shareholders' Equity)
Below is a partial list of account titles and balances for the ABC Company as of December 31,
2014:
Cash in Banks
Notes Receivable
10% Preference Share Capital, P100 par, cumulative 10,000 shares authorized
Ordinary Share Capital, P20 par, 100,000 shares authorized
Ordinary Share Capital Subscribed
Ordinary Share Capital Subscription Receivable (due within 6 months)
Preference Share Premium
Ordinary Share Premium
Retained Earnings
Accounts Payable
Purchases
P
320,000
24,000
400,000
1,000,000
200,000
50,000
150,000
200,000
250,000
150,000
500,000
Instructions: Prepare the shareholders' equity section of the statement of financial position.
Exercise 9-2 (Shareholders' Equity)
CDE Company has the following account balances at June 30, 2014:
Ordinary Share Capital, no-par, P10 stated value, 500,000 shares authorized, P
200,000 shares issued
Paid-in Capital in Excess of Stated Value – Ordinary Shares
Accumulated Depreciation – Machinery and Equipment
Retained Earnings
Paid-in Capital in Excess of Par – Preference Shares
Preference Share Capital Subscribed, 1,000 shares
Merchandise Inventory
Machinery and Equipment
Preference Share Capital Subscription Receivable
10% Preference Share Capital, P40 par, 40,000 shares authorized
Pre-operating costs
2,000,000
100,000
120,000
400,000
120,000
40,000
240,000
500,000
14,000
800,000
10,000
Instructions: Prepare the shareholders' equity section of the statement of financial position.
569
373
Exercise 9-3 (Cash Dividends)
The Shareholders' equity section of the statement of financial position of FGH Company shows
the following as of January 1, 2014:
Ordinary share capital, P100 stated value, 100,000 shares subscription
authorized, 40,000 shares outstanding
Ordinary shares premium
Retained Earnings
P
4,000,000
2,000,000
1,500,000
During the year, the corporation had declared the following dividends:
Mar
1
Sept
1
Declared a cash dividend of P10 per share payable on April 15 to shareholders of
record of March 31
Declared a cash dividend of P20 per share payable on Sept. 30 to shareholders of
record of Sept. 15
Instructions: Prepare necessary journal entries to record the declaration and distribution of cash
dividends.
Exercise 9-4 (Cash and Share Capital Stock Dividends)
The statement of financial position of JKL Corp. as of December 31, 2013 reports the following
shareholders' equity accounts:
Ordinary Share Capital, P50 par, 100,000 shares outstanding
Ordinary Share Premium
Retained Earnings
P 500,000,000
2,500,000
3,000,000
During 2014, the following distribution of dividends were made:
April
1
June
1
Declared a cash dividend of P2 per share payable on May 2 to shareholders of
record of April 15
Declared a 10% stock dividend distributable on July 15 to shareholders of record
of June 30. Stocks are selling on this date at P60 per share
Instructions: Record the declaration and distribution of each of the above mentioned dividends.
374
570
Exercise 9-5 (Small and Large share Capital Dividend)
The LMN Corporation has 500,000 shares of P10 par ordinary share capital outstanding as of
October 1, 2014. On this date, the Board of Directors declared a share capital dividend
distributable on November 20, 2014 to shareholders of record of October 30. The market price of
each ordinary share is P25 on October 1; P23 on October 30 and P30 on November 30.
Instructions: Prepare the entries to record the declaration and distribution of stock dividends
under each of the following independent assumptions:
1. A 15% share capital dividend was declare and issued.
2. A 50% share capital dividend was declared and issued.
Exercise 9-6 (Cash, Share Capital, and Property Dividends)
The PQR Corporation reports the following balances of January 1, 2014:
Ordinary share capital, P25 par, P2,000 shares outstanding
Ordinary share premium
Retained earnings
P
50,000
20,000
150,000
The following dividend declarations were made during the year:
Mar.
15
July
15
Oct.
15
Instruction:
Declared a cash dividend of P5 per share payable on April 15 to shareholders of
record of March 31.
Declared as dividends the stocks of Pentagon Corp. owned by PQR Corp. One
share of Pentagon Corp. stock will be distributed for every share of PQR Corp.
stock owned. The stocks of Pentagon have a carrying value of P20 per share.
Declared a 30% stock dividend distributable on December 1 to shareholders of
record of November 15. Stocks are selling on this date at P50 per share.
Record
the
declaration
and
distribution
of
the
above
dividends.
Exercise 9-7 (Allocation of Cash dividends to Preference and Ordinary Shareholders)
The STU Co. has paid dividends for the last three years as follows: 2012 – P2,500,000; 2013 –
P3,500,000; 2014 – P6,500,000. During the last three years, the company has the following
outstanding share capital: 100,000 shares of P100 par, 12% Preference Share Capital and
500,000 shares of P10 par Ordinary Shares Capital. Dividends are in arrears for two years at the
beginning of 2012.
375
571
Instructions: Calculate the amount that will be paid per share and in total on preference shares
and ordinary shares for each year under each of the following independent assumptions:
1. The preference shares are noncumulative and nonparticipating.
2. The preference shares are cumulative and nonparticipating.
3. The preference shares are noncumulative but participating.
4. The preference shares cumulative and participating.
5. The preference shares are noncumulative but participating up to an additional 8%.
Exercise 9-8 (Book Value per Share of Preference and Ordinary Share Capital)
The XYZ Corporation’s statements of financial position shows total shareholders’ equity of
P5,000,000 as of December 31, 2014.
Instructions: Compute the book value per share of each class of share capital under each of the
following independent assumptions:
1. The company has only one class of shares outstanding: 200,000 ordinary shares, par
value is P15.
2. The company has two classes of shares outstanding: 10,000 shares of P100 par preference
share capital with a liquidation value of P120 per share and 100,000 shares of P15 par
ordinary share capital.
Exercise
9-9
(Earnings
per
Share)
The YZA Corporation has 100,000 ordinary shares authorized, par value P10. As of the end of
the reporting period, 60,000 of the shares are outstanding.
Instructions: Compute the earnings per share assuming the company has a profit of:
a. P10,000
d. P150,000
b. P70,000
e. P180,000
c. P90,000
Exercise 9-10 (Earnings per Share; Two Classes of Share Capital Outstanding)
The ZAB Corporation has the following information relating to its share capital:
10% Preference shares, cumulative, P100 par value, 30,000 shares authorized,
P 2,000,000
20,000 shares outstanding
Ordinary shares, P!0 par value, 500,000 shares authorized, 300,000 shares
3,000,000
outstanding
Instructions: Compute earnings per share assuming that the reported profit of the company is
P750,000.
376
572
PROBLEMS
Problem 9-1 (Journalizing Share Capital Transaction; Shareholders’ Equity; Statement of
Changes in Shareholders’ Equity)
The BCD Corporation was organized on January 2, 2014 with authorized capital of 500,000
shares of P20 par ordinary share capital. During the first two years, the following transactions
took place:
2014
Jan.
Mar.
Mar.
Dec.
2015
Jan.
Feb.
Mar.
Dec.
2 Issued 125,000 shares to the incorporators at P25
2 Issued 62,500 shares at P30
31 Issued 25,000 in exchange for land valued at P300,000 and a building valued at
P500,000
31 The Income Summary account showed a credit balance of P750,000 and this was
transferred to the Retained Earnings account.
31 Declared cash dividends of P2.50 per share payable on January 31, 2015 to
shareholders of record of January 15, 2015.
31 Paid dividends declared on December 31.
14 Received subscription of 50,000 shares at P50, with a down payment of 40% of total
subscription.
15 Received balance due on the subscription of February 14 and shares were issued to
the subscribers.
31 The Income Summary account showed a credit balance of P2,000,000 and this was
transferred to the Retained Earnings account.
31 Declared a cash dividend of P2.00 per share and a 10% stock dividend payable on
January 15, 2016. On this date, stocks are selling at P25 per share.
Instructions:
1. Give the journal entries to record the preceding transactions.
2. Prepare the shareholders’ equity section of the statement of financial position of BCD
Corp. as of December 31, 2014.
3. Prepare a statement of changes in shareholders’ equity for the year ended December 31,
2014.
377
573
Problem 9-2 (Statement of Changes in Shareholders’ Equity)
The shareholders’ equity information for MMM Corporation and VVV Inc. are given below. The
two companies are independent.
MMM Corporation MMM Corporation is authorized to issue 200,000 ordinary shares, par
value P20. 120,000 shares were issued at P24 per share in 2013 and the remaining shares were
issued at P30 per share in 2014. The company incurred a loss of P300,000 in 2013 and earned a
profit of P800,000 in 2014. The company declared no dividends during the two-year period.
VVV Inc. VVV is authorized to issue 20,000 shares of 5% Preference Share Capital, par value
P100 and 500,000 shares of no-par, no stated value Ordinary Share Capital. In 2013, VVV issued
6,000 preference shares at P120 per share and 200,000 ordinary shares for a total of P1,400,000.
The company realized a profit of P240,000 in 2013 and distributed appropriate dividends to
preference shareholders and P.25 dividend per ordinary share. In 2014, the company issued
5,000 preference shares at P130 per share and 100,000 ordinary shares at P10 per share. VVV
realized a profit at P600,000 and distributed appropriate dividends on preference shares and P.50
dividends per ordinary share.
Instructions:
1. Prepare a statement of changes in shareholders’ equity for the two years ending
December 31, 2014 for each of the two companies.
2. Prepare the shareholders’ equity section of the statement of financial position as of
December 31, 2014 for each of the two companies.
Problem 9-3 (Work Sheet; Financial Statements of a Corporation; Adjusting and Closing
Entries)
The trial balance of DEF Corp. is presented on the next page and the additional information
needed to update the records of the company is presented below:
Additional Information:
a. Merchandise Inventor, Dec. 31
b. Inventory of Supplies as of Dec. 31
Store Supplies
Office Supplies
c. Accrued salaries as of Dec. 31
Store Supplies
Office Supplies
d. Depreciation on Equipment
P
210,000
5,000
4,000
8,000
4,000
10% per year
574
378
e.
f.
g.


Expired Insurance
Income Tax rate is 30%
Transactions with shareholders during the year are as follows
Issued 1,000 ordinary shares at P25 per share on January 6, 2010
Declared and distributed dividends of P80,000 during the year.
DEF
Trial
December 31, 2014
Cash
Accounts Receivable
Allowance for Bad debts
Merchandise Inventory, Jan. 1
Store Supplies
Office Supplies
Prepaid Insurance
Land
Office Equipment
Accumulated Depreciation
Store Equipment
Accumulated Depreciation
Accounts Payable
Ordinary Share Capital, P20 par
Ordinary Share Premium
Dividends
Retained Earnings
Sales
Sales Discount
Purchases
Purchases Returns and Allowances
Sales Salaries
Advertising Expense
Delivery Expense
Miscellaneous Selling Expense
Office Salaries
Light and Power
Miscellaneous Administrative Expense
P
18,000
Corporation
Balance
P
200,000
100,000
10,000
150,000
15,000
10,000
30,000
1,000,000
150,000
30,000
250,000
50,000
75,000
1,000,000
100,000
80,000
228,000
2,500,000
50,000
1,400,000
100,000
P
575
250,000
75,000
50,000
20,000
185,000
60,000
18,000
4,093,000
P
4,093,000
379
Instructions:
1. Prepare an eight-column work sheet.
2. Prepare a statement of financial position, a separate income statement, and a statement of
changes in shareholders’ equity.
3. Prepare adjusting and closing entries.
Problem 9-4 (Cash dividends to Preference and Ordinary Shareholders)
JKL Company distributed dividends for the last three years as follows: 2012-P450,000; 2013P750,000; 2014-P1,700,000.
Instructions: Calculate the amount that will be paid per share and in total on preference and
ordinary share capital for each year, assuming capital structures as follows:
1. 50,000 shares of P20 par Ordinary Share Capital; 20,000 of P100 par, 10%
noncumulative, fully participating Preference Share Capital.
2. 50,000 shares of P20 par Ordinary Share Capital; 20,000 of P100 par, 10% cumulative,
nonparticipating Preference Share Capital. Dividends are in arrears for two years at the
beginning of 2012.
3. 10,000 shares of P50 par Ordinary Share Capital; 10,000 of P100 par, 8% cumulative,
fully participating Preference Share Capital. Dividends are in arrears for three years at the
beginning of 2012.
4. 10,000 shares of P50 par Ordinary Share Capital; 10,000 of P100 par, 8% cumulative,
partially participating Preference Share Capital. The preference shares are participating
up to an additional 5%. Dividends are in arrears for three years at the beginning of 2012.
Problem 9-5 (Book Value per Share)
The shareholder equity of MNO Company on December 31, 2014 follows:
Ordinary Share Capital, P15 par, 100,000 shares
10% Preference Share Capital, P25 par, 10,000 shares
Ordinary Share Premium
Preference Share Premium
Retained Earnings
Total Shareholders’ Equity
576
P
P
1,500,000
250,000
200,000
150,000
200,000
2,300,000
Instructions: Compute the book valueper share on preference and ordinary shares under each of
the following assumptions:
1. Preference shares have a liquidation value of P30per share; there are no dividends in arrears.
2. The preference shares are cumulative, with dividends in arrears for 5 years (including the
current year). Upon corporate liquidation, shares are preferred as to assets up to par, and any
dividends in arrearsmust be paid before diatribution may be made to ordinary shares.
Problem 9-6 (Earnings Per Share)
Using the same information in Problem 9-5 l, compute the earnings per share assuming that the
profit of the company is
(a)
P20,000.
(c)
P120,000
(b)
P75,000.
(d)
P300,000
Problem 9-7 (Shareholder's Equity)
The adjusted trial balance of PQR Corp. on December 31, 2014 includes the following account
balances:
Dividends Payable
Income Tax Payable
Ordinary Share Capital (P10 par, 500,000 shares authorized)
Ordinary Share Capital Subscribed (10,000 shares)
Ordinary Share Premium
10% Preference Share Capital(25,00 shares authorized, 12,000
shares outstanding)
Preference Share Premium
Retained Earnings Appropriated for Contingencies
Retained Earnings Appropriated for Bond Retirement
Retained Earnings – Unappropriated
Buildings
Ordinary Share Capital Dividends Distributable
Paid-in Capital from Stock Dividend
P 80,000
50,000
3,000,000
100,000
300,000
1,200,000
120,000
250,000
300,000
600,000
800,000
350,000
105,000
Instructions: From the preceding information, prepare the shareholder's equity section as it
would appear on the statement of financial position.
MULTIPLE CHOICE
MC 9-1
Which of the following statements is not correct regarding the appropriations of
Retained Earnings?
577
a. Appropriations of Retained Earnings do not change the total amount of
Retained Earnings.
b. Appropriations of Retained Earnings reflect funds set aside for a designated
purpose, such as plant expansion.
c. Appropriations of Retained Earnings cam be made as a result of a contractual
requirement
d. Appropriations of Retained Earnings can be made at the discretion of the board
of directors.
MC 9-2
When a portion of shareholders' original investment is returned in the form of a
dividend, it is called a (an)
a. compensating dividend
b. liquidating dividend
c. property dividend
d. equity dividend
MC 9-3
Share capital dividends declared but not yet distributed as of the statement of
financial position date should be reported as a (an)
a. current liability
b. addition to share capital outstanding
c. reduction in total shareholders' equity
d. noncurrent liability
MC 9-4
A company declared a cash dividend on its ordinary share capital in December
2014, payable in January 2015. Retained Earnings would
a. increase on the date of declaration
b. not be affected on the date declaration
c. not be affected on the date of payment
d. decrease on the date of payment
MC 9-5
On March 20, 2014, AAA Corp. declared the diatribution of the following
dividend to its shareholders of record as of March 31, 2014.
Investment in 100 shares of BBB Corp. stock, carrying value and fair value,
P600,000
The entry to record the declaration of the property dividend would include a debit
to Retained Earnings of
a. P600,000
c. P850,000
b. P650,000
MC 9-6
d. P1,575,000
The shareholders’ equity section of GGG Corp. as ofDecember 31, 2014
contained the following accounts:
Ordinary Share Capital, 25,000 shares authorized,
10,000 shares issued and outstanding
Ordinary Share Premium
Retained Earnings
578
P 30,000
40,000
80,000
P 150,000
GGG’s board of directors declared a 10% stock dividend on April 1, 2010 when
the market value of the share capital was P7 per share. Accordingly, 1,000 new
shares were issued. All of GGG’s shares has a par value of P3 per share. GGG
incurred a loss of P12,000 for the first three months.
MC 9-7
What is the balance of the Retained Earnings accounts as of April 1, 2015?
c. P61,000
c. P68,000
d. P64,000
d. P73,000
The JJJ Corporation has the following classes of share capital outstanding as of
December 31, 2014:
Ordinary Share Capital, P20 par value, 20,000 shares outstanding
Preference Share Capital, 6%, P100 par value, cumulative, 2,000 shares
outstanding
No dividends were paid on preference shares for 2012 and 2013. On December
31,
2014, a total cash dividend of P200,000 was declared.
MC 9-8
MC 9-9
How much dividends will be received by ordinary shareholders?
c. P0
c. P176,00
d. P164,000
d. P188,000
Using the information in MC 9-7, how much dividends will be received by
preference shareholders?
c. P12,000
c. P36,000
d. P24,000
d. P200,000
The shareholders’ equity of NNN Company on December 31, 2014 follows:
10% Preference Share Capital, P100 par
Ordinary Share Capital, P60 par
Preference Share Premium
Ordinary Share Premium
Retained Earnings
P 500,000
3,000,000
50,000
250,000
300,000
P4,100,000
Preference shares are cumulative with dividends in arrears for 5 years at the
beginning of 2010 and with a liquidation value of P120
MC 9-10
MC 9-11
What is the book value per share of preference share capital?
a. P100
c. P170
b. P120
d. P180
Using the information in MC 9-9, what is the book value per share of ordinary
share capital?
c. P60
c. P65
d. P64
d. P70
On April 8, 2014, Cordillera Corp. declared and issued a 25% ordinary share
capital dividend. Prior to this date, Cordillera had 20,000 shares of P2 par value
579
ordinary share that were both issued and outstanding. The carrying value of each
share of stock is P20 at the time of declaration of the dividend.
MC 9-12
MC 9-13
As a result of the share capital dividend, how much will be debited to Retained
Earnings?
e. P10,000
c. P 75,000
f. P40,000
d. P100,000
Using the information in MC 9-11, what is the effect of the share capital dividend
on total shareholders’ equity?
a. Decreased by P40,000
b. Decreased by P10,000
c. Increased by P100,000
d. Did not change
The adjusted trial balance of ZZZ Corp. on December 31, 2014 includes the
following account balances:
Dividends Payable
P 40,000
Ordinary Share Capital (P5 par, 500,000 shares authorized) 750,000
Ordinary Share Capital Subscribed (10,00 shares)
25,000
Ordinary Share Premium
50,000
10% Preference Share Capital (25,000 shares authorized,
12,000 shares outstanding)
300,000
Preference Share Premium
30,000
Retained Earnings Appropriated for Contingencies
150,000
Retained Earnings Appropriated for Bond Retirement
100,000
Retained Earnings – Unappropriated
450,000
Ordinary Share Capital Dividends Distributable
105,000
Paid-in Capital from Share Capital Dividend
63,000
MC 9-14
MC 9-15
MC 9-16
MC 9-17
What is the number of ordinary shares issued and outstanding?
d. 5
c. 500,000
e. 150,000
d. 750,000
Using the information in MC 9-13, what is the par value for each preference share
capital?
a. P10
c. P25
b. P12
d. P40
Using the information in MC 9-13, what is the market value for each ordinary
share ordinary share capital upon the declaration of the share capital dividend?
4. P5
c. P10
5. P8
d. P25
Using the information in MC 9-13, how much is the total amount of Retained
Earnings?
c. P100,000
c. P450,000
d. P150,000
d. P700,000
Using the information in MC 9-13, what is the total amount of Share Capital?
a. P1,050,000
c. P1,138,000
580
MC 9-18
MC 9-19
MC 9-20
b. P1,075,000
d. P1,180,000
Using the information in MC 9-13, what is the total amount of Contributed
Capital?
c. P1,050,00
c. P1,363,000
d. P1,323,000
d. P2,063,000
Using the information in MC 9-13, what is the total amount of Retained Earnings
available for dividend contribution?
c. P450,000
c. P600,000
d. P550,000
d. P700,000
Using the information in MC 9-13, what is the total amount of shareholders’
equity?
a. P1,363,000
c. P2,023,000
b. P2,000,000
d. P2,063,000
Test Material No. 32
Rating_____________
Name _______________________________
Year and Section _______________________
Date ________________________________
Professor ____________________________
TRUE or FALSE
Instructions: Encircle the letter T if the statement is true and the letter F if the statement is
false.
T
F 1. Property dividends should be recorded at the fair value if the assets to be distributed.
T
F 2. A share capital dividend decreases retained earnings but it increases contributed
capital.
T
F 3. A share capital dividend does not change total shareholders’ equity.
T
F 4. A debit balance in the Retained Earnings account is called a deficit.
T
F 5. A share capital dividend that has been declared but not yet distributed should be
reported as a current liability.
T
F 6. An appropriation of retained earnings reduces the total amount of retained earnings.
T
F 7. The liquidation value of a preference share is always equal to its par value.
581
T
F 8. The accounting cycle of a corporation is very much different from the accounting cycle
of a partnership.
T
F 9. Book value per share is the amount earned for every capital share owned by a
shareholder.
T
F 10. Dividends may be declared even if a corporation has a deficit.
T
F 11. A cumulative preference share capital is entitled to payment of dividends in arrears.
T
F 12. Unappropriated retained earnings represents amount of cash available for dividend
distribution.
T
F 13. Appropriation of retained earnings is necessary when the corporation reacquires its
own share capital.
T
F 14. The balance of the Income Summary account is transferred to the Retained earnings
account.
T
F 15. The normal balance of Retained earnings account is credit. Therefore, it can never
have a debit a balance.
T
F 16. A deficit (or debit balance) in retained earnings means that Retained Earnings appears
in the asset section of the statement of financial position.
T
F 17. On a corporation’s statement of financial position, Ordinary Share Capital subscribed
will appear in the shareholders’ equity section rather than in the asset section.
T
F 18. Earnings per share is computed for both preference and ordinary shares.
T
F 19. “Dividends in arrears” is a term that applies to cumulative preference shares.
T
F 20. Book value of share capital is a measurement of the amount of income earned for
each share of stock.
582
Test Material No. 33
Rating_____________
Name
_________________________________
Year
and
Section
________________________
Date
___________________________________
Professor
________________________________
IDENTIFICATION
Instructions: Write theword or group of words that identify each of the following statements.
_________________1. Capital arising from investment by shareholders.
_________________2. Also known as legal capital.
_________________3. Contributions by shareholders in excess of the par or stated value of the
share capital.
_________________4. Dividends representing return of shareholders’ investment.
_________________5. A deferred cash dividend.
_________________6. Corporate earnings distributed to shareholders in the form of cash, noncash assets, or the corporation’s own shares.
_________________7. Retained earnings set aside for a specific purpose.
_________________8. Dividends distributable in the form of non-cash assets.
_________________9. A share capital dividend representing less than 20% of the outstanding
stock of the corporation.
_________________10. Unpaid dividends of prior years.
_________________11. A debit balance in the Retained Earnings account.
_________________12. The peso equity in corporate capital of each share capital.
_________________13. Retained earnings available for distribution as dividends to
shareholders.
_________________14. Capital arising from profitable operations of the corporation.
_________________15. Preference share capital that participates in the excess dividends after
paying both preference and ordinary shares their regular dividends.
_________________16. The excess of fair value over par value of share capital in a small stock
dividend.
583
________________17. The amount recorded as reduction in Retained earnings on a property
dividend declaration.
________________18. The account used for the declared but not yet distributed stock dividend.
________________19. The type of dividend that does not affect total assets and total
shareholders’ equity.
________________20. Amount earned by shareholders during a given period for each ordinary
share held.
Test Material No. 34
Rating_____________
Name_________________________________ Date
Year
and
Section ___________________________________
________________________
Professor
________________________________
MULTIPLE CHOICE
Instructions: Encircle the letter of the best answer
5. The Retained earnings account:
584
11. Has a credit balance if earnings have been greater that losses and dividends, and is
reported as part of shareholers’ equity on the statement of financial position.
12. Has a debit balance if losses have exceeded earnings, and is reported as part of assets
on the statement of financial position.
13. Represents the amount of cash available for payment of dividends if there has been
profitable operations.
14. Is a special fund for paying shareholders’ dividends on the basis of income.
6. All of the following statements pertain to dividends. Which of them is (are) true?
3. Shareholders vote each yearto declare and set the amount of the dividends to be paid.
4. Dividends Payable is a current liability in the statement of financial position of the
corporation.
5. A 10% dividend on preference share capital means that each shareholder receives a
cash dividend equal to 10% of the market value of the stock.
6. All of these statements are true.
7. Which of the following statements regarding dividends in arrears is false?
a. Dividends in arrears are not aliability to a corporation until they are declared.
b. Total dividends in arrears is one year dividend requirement on cumulative preference
share capital multiplied by the number of years in arrears.
c. Dividends in arrears must be reported in the footnotes to the financial statements.
d. Dividends in arrears may arise on both preference and ordinary share capital in any
year the dividends are not paid.
585
4. Dividends in arrears on preference shares are reported in the financial statements as a (an)
a. Liability
c. Reduction from Retained Earnings
b. Expense
d. Footnote to financial statements
5. Donated capital is reported as part of
a. Share capital
b. Additional paid-in capital
c. Appropriated retained earnings
d. Unappropriated retained earnings
6. When a small share capital dividend is declared, Regained Earnings is debited for the
a. Par value if the share capital
b. Fair market value of the share capital on the date of record
c. Fair market value of the share capital on the date of declaration
d. Fair market value of the share capital on the date of distribution
7. Cash dividends declared but not paid as of the statement of financial position date are reported as
a. Current liability
b. Deduction from cash
c. Addition to share capital
d. Addition to Additional Paid-in Capital
8. The total shareholders' equity after the declaration of stock dividend
a. Is the same as the total shareholders' equity before the declaration
b. Is greater than the total shareholders' equity before the declaration
c. Is less than the total shareholders' equity before the declaration
d. May be more than or less than the total shareholders' equity before the declaration depending
on whether the stock dividend declared is small or large
9. An appropriation of Retained Earnings
a. Leaves total Retained Earnings uncharged
b. Means that cash has been set aside for a specific purpose
c. Reduces the amount of Retained Earnings available for dividends
d. Both a and c
10. The peso equity in corporate capital for each share capital owned by a shareholder is known as
a. Book value per share
b. Dividends per share
c. Earnings per share
d. None of these
391
586
11. A corporation declared dividends on December 1 payable on January 15 to shareholders of
record of December 30. The Balance of Retained Earnings
a. Decreases on December 30
b. decreases on January 15
c. is not affected on December 30
d. is not affected on December 1
12. A corporation has experienced losses greater than profits in te past three years since
incorporation. Which of the following statements is true?
a. Retained earnings has credit balance at the end of the year.
b. Retained earnings has debit balance and is reported as an asset on the statement of
financial position.
c. Retained earnings has a debit balance and it appears as a reduction in the shareholders’
equity on the statement of financial position.
d. Retained earnings has a credit balance at the end of the third year and the corporation
may choose how to report a deficit.
13. Dividends representing a return of invested capital is reported as a (an)
a. asset
c. liability
b. contra liability
d. contra equity
15.When a corporation pays dividends, the three relevant dates for dividends occur in ths order:
a. date of record, date of declaration, date of payment
b. date of payment, date of declaration, date of record
c. date of declaration, date of payment, date of record
d. date of declaration, date of record, date of payment
16. Which of the following reduce Retained Earnings
a. Declaration of a stock dividend
b. Payment of cash dividend
c. Profit for the period
d. None of these
17. When a corporation declares a cash dividend, the entry include a
a. debit to net income
c. debit to Retained Earnings
b. credit to APIC
d. credit to Cash
392
587
18. The date when the board of directors announces the intention to pay dividends is known as
a. dividend date
c. record date
b. declaration date
d. payment date
19.Which of the following is not reported in the statement of changes in shareholder’ equity?
A. profit for the year
b. undistributed dividends declared during the year
c. interest expense
d. ordinary shares issued at more than par value
20. The type of dividend that does not affect total assets and total shareholders’ equity is
a. share capital dividend
b. property dividend
c. cash dividend
d. scrip dividend
21.Which of the following is (are) attributed to market value of share capital?
a. Share capital dividend
b. 3/30
c. date of declaration value
d. all of the above
22.When the outstanding preference share capital is multiplied by the participation rate, the
result is
a. full participation preference
b. maximum allowed participation
c. non-participating preference shares
d. cumulative preference
23. Earnings per share is computed on
a. ordinary shares only
b. preference shares only
c. both ordinary and preference shares
d. neither ordinary nor preference shares
24. Which is not correct relative to an appropriation of Retained Earnings?
a. Retained Earnings set aside for a special or specific purpose.
b. Undistributed funds for dividends declared during the year.
c. Reduction in the amount available to shareholders as dividends
d. Total retained earnings remained unchanged.
393
588
Test Material No. 35
Name___________________________________
Year and Section___________________________
Rating_______
Date____________________________________
Professor________________________________
MULTIPLE CHOICE- Problems
Instructions: Encircle the letter of the best answer. Present supporting computation in good form in a
separate worksheet.
1. ABC Corp. and DEF Inc. have Preference Share Capital outstanding. ABC has issued 3,000
shares of 5% Preference Share Capital, par value P100. DEF has issued 5,000 of 10% Preference
Share Capital , par value P120. What is the dividend per share for the preference share capital for
the two corporations?
A. P5 for ABC; P10 for DEF
c. P5 for ABD; P12 for DEF
B. P100 for ABC; P120 for DEF
d. P5 for ABC; P120 for DEF
2. The following is a list of selected account balances taken from the December 31, general
ledger og GHI Corporation:
Accounts Payable
Accounts Receivable
Ordinary Share Capital
Paid-in Capital in Excess of Par-Ordinary
Paid-in Capital in Excess of Par- Preference
Preference Share Capital
Preference Share Capital Subscribed
Retained Earnings
Subscription Receivable- Preference(current)
P 80,000
71,400
252,000
116,550
118,420
12,000
12,000
38,390
21,000
What is the total contributed capital?
A. P234,970
c. P602,970
B. P242,090
d. P614,970
3. Using information in No.2 , What is the total shareholders’ equity as of December 31?
a. P641,360
c. P662,870
b. P653,360
d.P674,360
4. A company has 400 shares of 6% preference share capital outstanding, par value is P50 per
share and market value is P80 per share. The amount of the dividends for the year on this share
capital would be
a. P12
c. P1,920
b. P1,200
d. P2,400
394
589
5. A corporation has 6,000 shares of P8 noncumulative preference shares outstanding and 12,000 ordinary
shares outstanding. At the end of the year, dividends of P180,000 were declared.
How much dividends were paid to preference and ordinary shareholders?
a. P48,000 and P132,000
c. P90,000 and P90,000
b. P60,000 and P120,000
d. none of these
6. Using information in No. 5, what is the dividend per share on preference and ordinary share capital?
a. P8 and P11
c. P15 and P7.50
c. P10 and P10
d. none of these
7. For the year ended December 31, 2014, the financial records of JKL corp. reported the following: total
revenue P801,400 ; total expense P601,100; dividends declared P25,600. What is the entry to close the
balance of Income Summary to Retained Earnings?
a. Income Summary
174,700
Retained Earnings
174,700
b. Income Summary
200,300
Retained Earnings
200,300
c. Retained Earnings
160,000
Income Summary
160,000
d. Retained Earnings
25,600
Cash Dividends Payable
25,600
8. A corporation declared a 40% share capital dividend on its 60,000 shares of P20 par ordinary shares on
a day when the market price is P50. How much was debited to Retained Earnings o the day of
declaration?
a. P24,000
c. P720,000
b. P480,000
d.P1,200,000
9. Using the information in No. 8, the peso dividend per ordinary share is
a. P8
c. P40
b. P20
d. P50
10. Using the information in No.8 and assuming the share capital dividend declared is 4/40, the amount of
Paid-in Capital from Stock Dividend is?
a. P120,000
c. P300,000
b. P180,000
d. P480,000
395
590
Test Material No. 36
Name___________________________________
Year and Section___________________________
Rating_______
Date____________________________________
Professor________________________________
The ZZZ Corp. was organized on January 1, 2014, with authorized capital of 100,000 shares of P50 par
Ordinary Share Capital. Seventy-five thousand (75,000) shares were issued for cash at P70 per share.
During the year, the company earned a profit of P1,000,000 and distriburted dividends of P750,000
Instruction: Based on the given information, compute for each of the items listed below.
________ 1. Balance of ordinary share capital account as of December 31,2014
________ 2. Total additional paid-in capital as of December 31,2014
________ 3. Total contributed capitals of December 31,2014
________ 4. Balance of Retained Earnings account as of December 31,2014
________ 5. Total shareholders’ equity as of December 31,2014
________ 6. Book value per share
________ 7. Dividend per share on ordinary share capital
________ 8. Earnings per share
396
Test Material No. 37
Rating_______
591
Name___________________________________
Year and Section___________________________
Date____________________________________
Professor________________________________
The Statement of Financial Position of AAA company reported the following:
Shareholders’ Equity
8% Preference Share Capital, P50 par value, cumulative and convertible
P 450,000
Ordinary Share Capital, P10 par value 4,000,000 shares authorized
16,000,000
Ordinary Share Premium
8,000,000
Retained Earnings
3,000,000
Total Shareholders’ Equity
P327,450,000
The company has not declared dividends for the last two years, including the current year. The market
value of the ordinary share is P75 per share. The preference shares have liquidation value of P60 per
share.
Instructions: Based on the foregoing information, compute for each of the items listed below.
________ 1.Amount of annual dividend per share on preference share
________2. Total contributed capital of the company
________ 3.Total number of preference shares issued
________ 4.Total number of ordinary shares issued
________ 5.Total dividend in arrears on preference shares
________6. Book value per share on preference shares
________ 7.Book value per share on ordinary shares
397
Test Material No. 38
Rating_______
592
Name___________________________________
Year and Section___________________________
Date____________________________________
Professor________________________________
The RRR Company has capitalizations of 20,000 shares, 6% P50 par value Preference Share Capital and
500,000 shares of P5 par value Ordinary Share Capital. On December 31, 2009, there were no dividends
in arrears. During the next five years, the company’s dividend declaration were as follows:
2010
-
P 400,000
2013
-
P 75,000
2011
-
P 225,000
2014
-
P300,000
2012
-
P 37,500
Instructions: Under each of the following assumptions, complete the schedule below which shows the
amount of dividends for each class of stock.
Case
1
The preference shares are cumulative and fully participating
Case
2
The preference shares are noncumulative and fully participating
Case
3
The preference shares are cumulative and nonparticipating
Case
4
The preference shares are noncumulative and nonparticipating
Year
Share Capital
Case 1
Case 2
Case 3
2010
Preference
_______
_______
_______
_______
Ordinary
_______
_______
_______
_______
Preference
_______
_______
_______
_______
Ordinary
_______
_______
_______
_______
Preference
_______
_______
_______
_______
Ordinary
_______
_______
_______
_______
Preference
_______
_______
_______
_______
Ordinary
_______
_______
_______
_______
Preference
_______
_______
_______
_______
Ordinary
_______
_______
_______
_______
2011
2012
2013
2015
Case 4
398
CHAPTER 10
SHARE CAPITAL TRANSACTIONS
593
SUBSEQUENT TO ORIGINAL ISSUANCE
Learning Objectives:
1. Identify and explain the various share capital transactions subsequent to original issuance.
2. Explain the methods of acquiring and accounting for treasury shares.
PREVIEW OF THE CHAPTER
SHARE CAPITAL
TRANSACITONS




Share Capital
Transactions Other than
Acquisition of Treasury
shares
Retirement
Conversion of preference share
into ordinary shares
Share (stock) split
Recapitalization


Treasury shares
Acquisition
 By purchase
 By donation
Method of Accounting
 Cost method
TYPES OF SHARE CAPITAL TRANSACTIONS
When a share capital (capital stock is fully paid, a stock certificate is issued to the shareholder and the
stock becomes outstanding. Subsequent to the original issuance, various capital share transactions may
take place. These transactions may cause a change in total shareholders’ equity or in the number of shares
outstanding. These share capital transactions include the following:
1.
2.
3.
4.
5.
Share capital retirement
2. Share capital reacquisition
Conversion of preference shares into ordinary shares
Share (stock) split
Recapitalization
390
SHARE CAPITAL RETIREMENT
594
Share capital may be reacquired and formally retired by using the issuing corporation. Such retirement
calls for the cancelation of the stock certificate, cancellation of the share capital account and the
cancellation of the related additional paid-in capital from the original issuance of the stock. If the
retirement price is greater than the original issuance price, Retained Earnings is less than the original
issuance price, Paid-in Capital from the retirement of Share Capital is credited for the difference. The
difference between the retirement price and the original issuance rice of the share capital should not be
recognized as gain or loss. The excess of the original issuance price over the retirement price of the share
capital should not be credited to Retained Earnings.
The retirement of share capital will reduce both the number of shares issued and the number of shares
outstanding.
Illustrative Problem A: the shareholders’ equity section of the statement of financial position of CBA
Co. contains the following:
Preference share capital, P100 par, 10,000shares
P1,000,000
Preference share premium
250,000
Retained Earnings
800,000
Based on the above data, the original issuance price of each preference share is P125, that is, the par value
of P100 per share and the share premium of P25 per share (P250,000/10,000shares).
One thousand (1,000) shares of preference share capital were reacquired and retired. Entries to record the
retirement using two independent cases follow:
Case 1 - The retirement price is P110
Preference Share Capital
100,000
Preference Share Premium
25,000
Cash
110,000
Paid-In Capital from Retirement
of Preference Shares
15,000
1,000sh x P100 = P100,000
1,000sh x P25 = P25,000
1,000sh x P110 = P110,000
1,000sh x P15 = P15,000
400
595
Case 2- The retirement price is P130 per share
Preference Share Capital
100000
Preference Share Premium
25000
Retained Earnings
5000
Cash
130000
1000 sh × P100= P100000
1000 sh × P25 = P25000
1000 sh × P5 = P5000
1000 sh × P130= 130000
The debit to Retained Earnings of P5000 or P5.00 for every share retired is the excess of the
retirement price of P130 over the original issuance price of P125
SHARE CAPITAL REACQUISITION (TREASURY SHARES)
The issuing corporation sometimes reacquires shares issued to shareholders either by purchase or
donation. Such shares are being held in the name of the corporation and they are called treasury
shares. The company may reissue these shares at some future date as deemed necessary.
The practice of reacquiring one's own capital share is done for the following reasons:
1. To obtain shares to be used in acquiring plant assets.
2. To improve earnings per share by reducing the number of shares outstanding.
3. To invest excess temporarily.
4. To support the market price of the share capital.
5. To increase the ratio of liabilities to shareholders equity.
6. To obtain shares for conversion to other securities such as preferen ce share capital.
REACQUISITION BY PURCHASE
Treasury shares may be acquired by purchase and the reacquisition will be accounted for using
the cost method.
Under the cost method, the reacquired shares are viewed as capital elements awaiting ultimate
disposition. Treasury shares are recorded at cost. When the shares are reissued at more than cost,
the indicated gain is credited to an additional paid-in capital account Paid-In Capital from Sale
of Treasury Shares. When the shares are reissued at more than cost, the indicated loss is debited
to the following accounts in the order shown below:
(a) Additional paid-in capital from treasury share transactions of the same class of share capital,
and
(b) Retained earnings
596
The balance of the treasury shares account is reported as a deduction from the sum of the total
contributed capital and retained earnings.
The reacquisition of a company's own share reduces the number of outstanding shares but
does not affect the number of issued shares. Treasury shares are not entitled to receipt of
dividends because they are not outstanding. Retained Earnings, however, must be appropriated
equal to the cost of the treasury shares acquired.
Illustrative Problem B: The shareholders equity of JJJ Corp. included the following items:
Ordinary share capital, P20 par, 50000 shares
P1000000
Ordinary share premium (P5 per share)
250000
Retained earnings
500000
On September 1, 2014, 1000 shares were reacquired at P24.On September 30, 700 shares were
reissued at P30. Entries to record the foregoing and the shareholders equity section of the
statement of financial position as of September 30 are presented below and on the next page.
2014
Sept.
1
Treasury shares
24000
Cash
24000
1000 sh x P24 =P24000
1
Retained Earnings
24000
Retained Earnings Appropriated for
Treasury Shares
Sept.
30
Cash
24000
21000
Treasury shares
16800
Paid-in Capital from Sale of Treasury
4200
Shares
700 sh × P30= P21000
700 sh × P24= P16800
700 sh × P6= P4200
30
Retained Earnings Appropriated for
Treasury Shares
Retained Earnings
597
16800
16800
Shareholder's Equity
Contributed Capital:
Ordinary Share Capital, P20 par, 50000 shares
issued, 49700 shares outstanding, 300 shares
in treasury
P1000000
Ordinary Share Premium
250000
Paid-in Capital from Sale of Treasury Shares
4200
P1254200
Retained Earnings:
Retained Earnings Appropriated for Treasury Shares
P7200
Unappropriated Retained Earnings
492800
500000
Total Contributed Capital and Retained Earnings
P1754200
Less Treasury Shares, at cost (300 @ P24)
7200
Total Shareholder's Equity
P1747000
REACQUISITION BY DONATION
Treasury shares may be acquired through donation by shareholders. This practice is done by
shareholders to enable the company to increase its working capital and at the same time maintain
their proportionate ownership interests.
Upon receipt of capital shares donation, a memorandum entry is made stating the number of
shares received. Subsequent sale of donated shares is recorded by debiting Cash and crediting
Donated Capital or Paid-in Capital from Donated Shares for the entire proceeds.
Alternatively, the receipt and the subsequent sale of the donated shares may be recorded as
follows:
Upon receipt
Treasury Shares
xxx
Donated Capital
xxx
(amount recorded is the fair value of the shares on the date of donation)
Upon sale of donated shares at more than recorded cost
Cash
xxx
Treasury Shares
xxx
Paid-in Capital from Sale of Treasury
xxx
598
CONVERSION OF PREFERENCE SHARES INTO ORDINARY SHARES
Convertible preference shares can be converted into ordinary shares at the option of the holder.
This type of preference share capital can be sold at a higher price but a lower dividend rate
because of its conversion privilege.
The accounting for conversion of preference shares into ordinary shares is similar to retirement
of share capital. Account balances related to the preference shares converted are cancelled and
the issuance of ordinary shares is recorded. An indicated gain from conversion is credited to
Paid-in Capital from Conversion of Preference Shares into Ordinary Shares; an indicated loss
from conversion is debited to Retained Earnings
Illustrative Problem C: The LMN Corporation's shareholder's equity contains the following:
Ordinary share capital, P10 par, 50000 shares
Ordinary share premium
10% Preference share capital, P100 par, 5000 shares
Preference share premium
Retained Earnings
On July 15, 1,000 preference shares were converted into ordinary shares.
P500000
100000
500000
50000
750000
Case 1- Twenty ordinary shares were issued for every preference share
Preference Share Capital
100000
Preference Share Premium
10000
Retained Earnings
90000
Ordinary Share Capital
200000
1000 sh × P100
= P100000
1000 sh × P10
= P10000
1000 sh × P20 sh × P10
= P200000
P200000- P110000
=P90000
Case 2 Eight ordinary shares were issued for every preference share
Preference Share Capital
Preference Share Premium
Ordinary Share Capital
Paid-in Capital from Conversion of
Preference Share into Ordinary Shares
1000 sh × P100
= P100000
1000 sh × P10 = P10000
1000 sh × 8 sh × P10 = P80000
P110000- P80000
= P30000
599
100000
10000
80000
30000
Just like in the retirement of share capital and acquisition of treasury shares, no gain or loss is
recognized on the conversion of preference shares into ordinary shares.
SHARE (STOCK) SPLITS AND REVERSE SHARE (STOCK) SPLITS
When the market price of the shares is high and the corporation feels that a lower price will
result in a wider distribution of ownership, it may authorize the replacement of outstanding
shares by a larger number of shares. The increase in the number of shares outstanding in this
manner is called share (stock) split or share split-up. For instance, 10000 ordinary shares with a
par value of P10 are replaced by 20000 ordinary shares with a par value of P5. This type of
transaction is described as a share split of 2, for 1- two new shares are issued in exchange for one
old share. The par value is subsequently reduced to P5 (i.e, p10/2)
The reverse procedure, that is, the replacement of shares outstanding by a smaller number of
shares with an increase in the par value, is called reverse share split or share split down. This is
desirable when the market price of the shares is low and it is felt that assigning a higher price for
the shares offers certain advantages. For instance, 10000 ordinary shares with a par value of P10
are replaced by 5000 ordinary shares with a par value of 20. This type of transaction is described
as a share split of 1 for 2.- one new share is issued in exchange for two old shares. The par value
is subsequently increased to P20 (ie. P10 × 2)
A share split is recorded by a memorandum entry. The entry should state the new number of
shares and the new par value of the shares. Alternatively, a journal entry may be prepared
canceling the old issue and recording the new issue. Using the example in the first paragraph, the
share split of 2 for 1 may be recorded as follows:
Ordinary Share Capital, P10 par
100000
Ordinary Share Capital P5 par
100000
It should be noted that a share split will not affect total shareholder's equity nir total
share capital. It will simply change the number of shares outstanding and the par value per share
of stock.
RECAPITALIZATION
Corporate recapitalization takes place when an entire issue of share capital is changed by
appropriate action of the corporation. The typical types of recapitalization are as follows:
1. Change from par to no-par share capital and vice versa
2. Reduction in the par or stated value of share capital
600
Recapitalization is normally undertaken to establish an additional paid-in capital account that
will be used in capital restructuring. This type of transaction requires the setting up of capital
accounts related to the new issue and the cancellation of account balance related to the old issue.
(Capital restructuring will be discussed in a higher accounting subject.)
Illustrative Problem D: The shareholders equity of Quezon Co. contains the following:
Ordinary Share Capital, P20 par, 50000 shares
P1000000
Ordinary share premium
250000
Retained Earnings
500000
Case-1 The original issue is replaced by a no-par share capital with a started value of P20
Ordinary Share Capital, P20 par
1000000
Ordinary Share Premium
250000
Ordinary Share Capital, P20 stated value
1000000
Paid-in Capital from Exchange of Par
for No- Par Share Capital
250000
Case 2- Each capital share is exchanged for a new share with a par value of P15
Ordinary Share Capital, P20 par
1000000
Ordinary Share Capital, P15 par
750000
Paid-in Capital from Reduction in Par
Value of Ordinary Shares
250000
REVIEW OF LEARNING OBJECTIVES
1. Identify and explain the various share capital transactions subsequent to original
issuance. Share capital transactions subsequent to original issuance include the following: (1)
share capital retirement; (2) share capital REACQUISITION; (3) conversion of preference shares
into ordinary shares; (4) share (stock) split; and (5) recapitalization. Two major rules apply on all
these transactions: (1) no gain or loss is reported in the income statement arising from these
transactions, (2) indicated loss on share capital transactions may be charged against retained
earnings, but indicated gain cannot be credited to retained earnings. Indicated gain should be
credited to additional paid-in capital.
2. Explain the methods of acquiring and accounting for treasury shares. Treasury shares are
shares issued to the shareholders and subsequently reacquired by the
601
corporation with the intention of reissuing them. Treasury shares may be acquired either by
purchase or by donation. Transactions relating to treasury shares shall be accounted for using the
cost method. Under the cost method, treasury shares is reported on the statement of financial
position as a deduction from total shareholders’ equity.
GLOSSARY OF ACCOUNTING TERMINOLOGIES
Convertible preference shares- preference shares that can be converted into ordinary shares at
the option of the shareholder.
Recapitalization- change in the capital structure of a corporation by reducing the par or stated
value of share capital or by exchanging par value for no-par value share capital or vice-versa.
Reverse share split- replacement of outstanding shares by a smaller number of shares with a
proportionate increase in the par or stated value of the share capital. It is also known as share
split-down.
Share split- replacement of outstanding shares by a greater number of shares with a
proportionate decrease in the par or stated value of the share capital. It is also known as share
split-up. Treasury shares- capital shares issued to shareholders and subsequently reacquired by
the corporation with the intention of reissuing them.
602
DISCUSSION QUESTIONS
1. What is the appropriate accounting treatment for (a) excess of the retirement price over
the original issuance price of share capital and (b) the excess of the original issuance
price over the retirement price of share capital?
2. Why do companies reacquire their own shares of stock?
3. Discuss the cost method of recording treasury share transactions?
4. What is the advantage of the issuance of convertible preference share capital?
5. What is the effect of the acquisition of treasury shares on total shareholder's equity?
6.
Identify and discuss the two types of share (stock) splits.
7. What is corporate recapitalization? Why is there recapitalization?
EXERCISES
603
Exercises 10-1 (Retirement of Share Capital)
The Joaquin Company showed the following balances related to an issuance of ordinary share
capital:
Ordinary Share Capital, P50 par, 200000 shares
P10000000
Ordinary Share Premium
4000000
The company retired 2000 shares of ordinary share capital.
Instructions:
1. Record the retirement of the 2000 ordinary shares under each of the following
assumptions:
a.
The retirement price is P45
b.
The retirement price is P60
2. State the number of capital shares issued and outstanding immediately after the
retirement.
Exercise 10-2 (Accounting for Treasury Shares)
The Jocson Company capital accounts as of June 30, 2014 are as follows:
Ordinary Share Capital, P25 par, 100000 shares
P2500000
Ordinary Share Premium
1000000
Retained Earnings
1500000
On this date, 5000 shares were reacquired at P20. On July 31, 3500 shares were reissued at P35
Instructions:
1. Prepare the journal entries to record the acquisition and reissuance of treasury shares.
2. Prepare the shareholders equity section of the statement of financial position as of July
31.
Exercise 10-3 (Reacquisition of Shares through Donation)
604
In 2014, the Jolo Company issued 150000 shares of its P10 par ordinary share capital at P25. In
2015, a major stockholder donated 5000 shares when the market value of the share capital is P40
per share. Subsequently, all the donated shares were sold at P50 per share.
Instructions:
1. Prepare entries to record the receipt of the donated shares and their subsequent sale using the
two alternative methods of recording.
2. State the number of capital shares issued and outstanding after the donation and after the sale
of donated shares.
Exercise 10-4 (Conversion of Preference Shares into Ordinary Shares)
The Jazam Company has 50000 shares of convertible preference share capital, par value P50 and
100000 shares of P10 par ordinary share capital. The preference shares were originally issued at
P75
On September 6, 2014 three thousand (3000) preference shares were converted into ordinary
shares.
Instructions:
1. Record the conversion of preference shares into ordinary shares assuming:
a. Each preference share is converted into 4 ordinary shares
b. Each preference share is converted into 10 ordinary shares
c. Each preference share is converted into 8 ordinary shares
2. State the number of issued and outstanding preference shares and ordinary shares for each of
the three assumptions.
Exercise 10-5 (Share Split and Reverse Share Split; Recapitalization)
On June 30, 2014, the capital accounts of Japorms Company are as follows:
Ordinary Share Capital, P20 par, 50000 shares
P1000000
Ordinary Share Premium
200000
605
Instructions:
1.
Prepare the necessary journal entry to record each of the following independent
transactions:
a.
b.
c.
d.
2.
The company undertakes a 5 for 1 share split.
The company undertakes a 1 for 4 share split.
One new ordinary share with a par value of P15 is issued in exchange for one
ordinary share with a par value of P25.
One new ordinary share with a stated value of P25 is issued in exchange for one
ordinary share with a par value of P25.
State the number of capital shares issued and outstanding for each independent
transaction.
Exercise 10-6 (Acquisition of Treasury Shares and Conversion of Preference Shares into
Ordinary Shares)
Jazul Company had the following equity balances reported in its December 31, 2013 statement
of financial position
 10,000, 10% Preference Share Capital, convertible, P100 par, P1,000,000
 500,000 Ordinary Share Capital, P5 stated value, P2,500,000
 Preference Share Premium, P200,000
 Paid-in capital in Excess of Stated Value, P1,500,000
 Retained Earnings, P1,200,000
During 2014, the following transactions relating to share capital have taken place:
a.
5,000 ordinary shares were reacquired at P10. Subsequently, 4,000 shares were
reissued at P12 per share and the 1,000 shares were reissued at P7 per share.
b.
1,000 preference shares were converted into ordinary shares. Ten ordinary shares
were issued for every preference share converted.
Instructions:
1.
Prepare journal entries to record the preceding transactions.
2.
State the number of preference shares and ordinary shares issued and outstanding.
PROBLEMS
606
Problem 10-1 (Various Share Capital Transactions)
The Jazmine Co., organized on January 1, 2014, was authorized to issue share capital as follows:
20,000 shares of 10% preference share capital, P100 par; 50,000 shares of ordinary share capital,
P50 par
During the remainder of the year, the following transactions were completed:
a.
Received subscription for 10,000 preference shares at P125 and 20,000 ordinary shares at
P60. Both subscriptions were payable 50% upon subscription; the balance is due within
thirty days.
b.
Received the final payment on subscription in (a). Issued shares of stock to the
subscribers.
c.
Reacquired 2,500 ordinary shares at P50.
d.
The holders of preference shares converted 3,000 of their shares into ordinary shares on a
share-for-share basis.
e.
Reissued 1,500 treasury shares at P65.
f.
Received 2,000 ordinary shares as donation from a major stockholder.
g.
Sold the 2,000 shares received as donation at P56 per share.
h.
Reissued remaining treasury shares at P60.
i.
All of the ordinary shares were exchanged for no-par shares with a stated value of P30.
j.
Reported profit of P1,500,000.
k.
Declared the regular cash dividend on preference share capital and a P1.00 cash dividend
on ordinary share capital.
Instructions:
1.
Give the journal entries to record the preceding transactions. (Disregard in this problem
the appropriation of retained earnings on the acquisition of treasury shares.)
2.
Prepare the shareholders’ equity section of the statement of financial position as of
December 31, 2014.
Problem 10-2 (Various Share Capital Transaction)
The capital accounts of Jayvee Co. on January 1, 2014 are as follows:
607
5%
Preference
Share
Capital,
P100
par,
P5,000,000
Preference
Share
250,000
Ordinary Share Capital, P20 par, 250,000 shares authorized,
150,000
shares
issued
and
3,000,000
Ordinary
Share
750,000
Retained
1,500,000
50,000
shares
Premium
outstanding
Premium
Earnings
Each preference share is convertible into four ordinary shares. The following transactions
affected the shareholders’ equity section of the statement of financial position during 2014:
a.
b.
c.
d.
Reacquired 5,000 ordinary shares at P16.
Preference shareholders converted 10,000 of their shares.
Issued 500 ordinary shares in settlement of a liability of P12,500.
Declared the regular dividends on preference shares and a cash dividend of P2.00 per share
on ordinary shares.
e. Reissued 2,000 treasury shares in exchange for land valued at P50,000.
f. The ordinary shares were split two for one.
g. Reported profit of P200,000 for the year.
Instructions:
1. Journalize the preceding transactions.
2. Prepare the shareholders’ equity section of the statement of financial position as of December
31, 2014.
Problem 10-3 (Various Share Capital Transactions)
Joemari Company has two classes of share capital outstanding: 10%, P50 par preference share
capital and P10 par ordinary share capital. At December 31, 2013, the following accounts were
included in the shareholders’ equity:
Preference Share Capital, 100,000 shares
5,000,000
Ordinary
Share
Capital,
10,000,000
Preference
Share
1,000,000
Ordinary
Share
5,000,000
Retained
4,500,000
608
P
1,000,000
shares
Premium
Premium
Earnings
The following transactions have affected the shareholders’ equity of the company during the year
2014:
Jan.
Feb.
June
July
Oct.
Dec.
Dec.
1
1
1
1
31
31
31
Issued 15,000 preference shares at P60 per share.
Issued 25,000 ordinary shares at P25 per share.
Issued additional ordinary shares in a 2-for 1 share split.
Reacquired 20,000 ordinary shares at P14 per share.
Reissued 15,000 treasury shares at P16 per share.
Profit for the year is P2,500,000.
Declared the regular dividend on preference shares and P1.00 dividend per share
on ordinary shares.
Instructions: Prepare the shareholders’ equity section of the statement of financial position of
the Joemari Company at December 31, 2014.
Problem 10-4 (Effects of Treasury Share Transactions on Statement of Financial Position
Accounts and on Profit)
Jerusalem Company has outstanding 100,000 ordinary shares, par value P50, that were originally
issued at P60 per share. Subsequently, the following transactions took place:
1. Purchased 10,000 treasury shares at P70 per share.
2. Reissued 4,000 of the treasury shares at P80 per share.
3. Reissued 1,000 of the treasury shares at P60 per share.
4. Retired the remaining treasury shares.
Instructions: Indicate the effect of each of the four transactions on the financial statement
categories listed in the table. Use the following codes for your answers: I = Increase; D =
Decrease; and NE = No Effect.
No.
Assets
Liabilities
Shareholders’
Equity
APIC
Retained
Earnings
Profit
1.
2.
3.
4.
Problem 10-5 (Various Share Capital Transactions; Statement of Changes in Shareholders’
Equity)
609
The Javier Company has two classes of shares outstanding, 10%, P100 par preference share
capital and P10 par ordinary share capital. During the fiscal year ending June 30, 2014, the
company was active in transaction affecting the shareholders’ equity.
The following summarizes these transactions:
Number of
Price per
Transactions
shares
share
1. Issue of preference shares
5,000
P140
2. Issue of ordinary shares
20,000
P70
3. Retirement of preference shares
1,000
P150
4. Purchase of treasury stock – ordinary shares
5,000
P80
5. Share – split (par value reduced to P5)
2 for 1
6. Reissue of treasury shares – ordinary shares
5,000
P52
Balances of accounts in the shareholders’ equity section of the June 30, 2013 statement of
financial position follows:
Preference Share Capital, 30,000 shares
Ordinary Share Capital, 100,000 shares
Preference Share Premium
Ordinary Share Premium
Retained Earnings
P3,000,000
1,000,000
1,200,000
8,000,000
2,550,000
Dividends were paid at the end of the fiscal year on the ordinary shares at P6 per share and on
the preference shares at the preference rate. Profit for the year was P750,000.
Instructions: Prepare a statement of changes in shareholders’ equity for the period July 1, 2013
to June 30, 2014.
610
MULTIPLE CHOICE
MC 10 – 1
MC 10 - 2
The following information was abstracted from the accounts of the Jimenez Corp.
at year-end:
Total profit since incorporation
P420,000
Total cash dividends paid
130,000
Proceeds from sale of donated shares
45,000
Total value of stock dividends distributed
30,000
Excess of proceeds over cost of treasury
shares sold
70,000
What should be the balance of Retained Earnings?
a. P260,000
c. P305,000
b. P290,000
d. P335,000
Jamier Corp. was organized on January 2, 2014, with authorized capital of
100,000 shares of P10 par ordinary share capital. During 2014, Jamier had the
following transactions affecting shareholders’ equity.
Jan.
Dec.
MC 10 – 3
MC 10 – 4
MC 10 – 5
7 – Issued 40,000 shares at P12 per share.
2 – Purchased 6,000 treasury shares at P13 per share.
Profit for the year amounted to P300,000. What is the amount of shareholders’
equity as of December 31, 2014?
a. P640,000
c. P708,000
b. P702,000
d. P720,000
On December 10, Joshua Co. split its share capital on a 5-for-2 when the market
value was P60 per share. Prior to the split, Joshua had 200,000 shares of P15 par
value share capital. What is the par value of the share capital after the split?
a. P3.00
c. P15.00
b. P6.00
d. P26.00
Using the information in Mc 10 – 3, how many shares are outstanding after the
split?
a. 200,000
c. 500,000
b. 300,000
d. 1,000,000
During the fiscal year 2014, Jezuel Corp. issued for P110 per share 15,000 shares
of P100 par value convertible preference share capital. One preference share is
convertible into three ordinary shares with a par value of P25. On November 15,
2014, all of the preference shares were converted into ordinary shares. The market
value of the ordinary shares on the conversion date was P40 per share.
611
MC 10 – 6
MC 10 – 7
MC 10 – 8
MC 10 – 9
What amount should be credited to the ordinary share capital account as a result
of conversion of preference shares into ordinary shares?
a. P1,125,000
c. P1,650,000
b. P1,500,000
d. P1,800,000
Joros Corp. was organized on January 1, 2012, at which date it issued 100,000
shares of P10 par ordinary share capital at P15 per share. For the period 2012 to
2014, the company reported profit of P450,000 and paid cash dividends of
P230,000. On January 10, 2014, the company purchased 6,000 of its own shares
at P12 per share. On November 20, 2014, Joros sold 4,000 treasury shares at P’8
per share. What is the total shareholders’ equity on December 31, 2014?
a. P1,680,000
c. P1,704,000
b. P1,688,000
d. P1,720,000
Using the information in MC 10 – 6, the reissuance of the treasury shares resulted
in a
a. Credit to Retained Earnings of P16,000
b. Debit to Retained Earnings of P16,000
c. Credit to PIC from Sale of Treasury Shares of P16,000
d. Debit to PIC from Sale of Treasury Shares of P16,000
Jabar Corp. holds 10,000 ordinary shares, par value P10, as treasury shares, which
was purchased in the year 2013 at a cost of P120,000. On December 8, 2014,
Jabar sold all the 10,000 shares for P210,000. The sale would result in a credit to
Paid-in Capital from Sale of Treasury Shares in the amount of
a. P90,000
c. P120,000
b. P110,000
d. P210,000
ABC Corp. reported the following in its statement of shareholders’ equity on
January 1, 2014:
Ordinary share, P5 par value, 200,000 shares
authorized, 100,000 shares issued
P 500,000
Additional paid-in capital
1,500,000
Retained earnings
516,000
Total contributed capital and retained earnings
P 2,516,000
Less treasury shares, 5,000 shares at cost
40,000
Total shareholders’ equity
P 2,476,000
The following events occurred in 2014:
May
July
Oct.
1
9
1,000 treasury shares were sold for P10,000.
10,000 shares previously unissued shares were sold
for P12 per share.
15 There was a 2-for-1 share split.
How many shares are issued and outstanding at December 31, 2014?
a. 220,000 and 216,000
c. 110,000 and 106,000
b. 220,000 and 212,000
d. 100,000 and 95,000
612
MC 10 – 10 On December 29, 2013, Blue Company was registered at the Securities and
Exchange Commission with 100,000 authorized ordinary shares of P100 par value.
The following were Blue’s transactions:
Dec. 29, 2013
May 14, 2014
Aug. 9, 2014
Dec. 31, 2014
Issued 40,000 shares at P105 per share.
Purchased 600 of its ordinary shares at P110 per share.
400 treasury shares were sold at P95 per share.
Profit P830,000, cash dividends paid P200,000.
What is the total shareholders’ equity of Blue Company on December 31, 2014?
a. P4,352,000
c. P4,820,000
b. P4,802,000
d. P10,602,000
Rating __________
613
Name ______________________________________
Year and Section _____________________________
Date ________________________
Professor ____________________
TRUE or FALSE
Instructions: Encircle the letter T if the statement is true and correct and the letter F if the
statement is false.
1. Convertible preference share capital allows the holder to exchange the shares for ordinary
shares.
2. Reacquisition of shares gives rise to a gain or loss.
3. The conversion of preference shares into ordinary shares affects total shareholders’
equity.
4. Treasury shares may be reported as assets.
5. A share (stock) split changes total shareholders’ equity.
6. The retirement of share capital requires the cancellation of the stock certificate originally
issued to the shareholders.
7. The reissuance of treasury shares increases total shareholders’ equity equal to the
reissuance price.
8. Treasury shares are not entitled to receipt of dividends because they are not considered
outstanding.
9. The acquisition of treasury shares will reduce the total amount of retained earnings.
10. Treasury shares are accounted for using the cost method.
11. A share (stock) split changes the par value of the stock but leaves total shareholders’
equity unchanged.
12. A share (stock) split is similar to a stock dividend in that both increase the number of
shares owned by each shareholder.
13. When a corporation retires its own share capital, there is usually a gain or loss on the
transaction.
614
14. When treasury shares are purchased, the Ordinary Share Capital account is debited for an
amount equal to the cost of treasury shares.
15. If treasury shares are sold at a price greater than the cost, the excess is credited to
additional paid-in capital.
16. The conversion of preference shares into ordinary shares increases total shareholders’
equity.
17. When a shareholder exchanges convertible preference shares for ordinary shares, the
difference between the par value of preference shares converted and the par value of the
ordinary shares issued is recorded by the corporation as a gain or loss on conversion.
18. A corporation does not earn a profit or incur a loss by selling or buying its own stock.
19. When a corporation reacquires its own shares of stock, the number of outstanding shares
decreases.
20. The acquisition of treasu9ry shares reduces the number of shares issued.
615
Test Material No. 40
Rating ___________
Name _______________________________
Year and Section _______________________
Date _______________________________
Professor ___________________________
IDENTIFICATION
Instructions: Write the word or the group of words that identify each of the following
statements.
___________1. Shares issued to shareholders but subsequently reacquired by the corporation.
___________2. Preference shares that can be converted into ordinary shares at the option of
the holder.
___________3. A reduction in the par or stated value of the share capital accompanied by a
proportionate increase in the number of shares outstanding.
___________4. A change in the capital structure of the corporation.
___________5. Account credited for the indicated gain on retirement of share capital.
___________6. The acceptable method of accounting for treasury shares.
___________7. Replacement of outstanding shares by a smaller number of shares with a
corresponding increase in the par or sated value of the share capital.
___________8. The account debited for the excess of the retirement price over the original
issuance price of share capital.
___________9. The effect of share split up on par or stated value.
__________10. Retained earnings set aside equal to the cost of treasury shares upon
acquisition.
__________11. The entry made to record receipt of share capital as donation.
__________12. The amount recorded as paid-in capital from donated shares upon sale of
donated capital shares.
__________13. The sum of share capital and additional paid-in capital.
__________14. The practice done by shareholders to enable the company to increase its
working capital and at the same time maintain shareholders’ proportionate
ownership interests.
__________15. The reacquisition of issued shares without the intention of reissue at some future
date.
616
Test Material No. 41
Rating ___________
Name _______________________________
Year and Section _______________________
Date _______________________________
Professor ___________________________
MULTIPLE CHOICE – Theory and Problems
Instructions: Encircle the letter of the best answer. Present supporting computations in good
form in a separate worksheet.
1.
Which of the following statements about treasury shares is (are) true?
a. Treasury shares are recorded at cost.
b. Purchase of treasury shares reduces the corporation’s total assets and total
shareholders’ equity.
c. Treasury shares are issued shares that are subsequently reacquired, hence, they are
no longer outstanding.
d. All of the above statements are true.
2. The number of treasury shares is equal to the difference between
a. issued shares and unissued shares
b. authorized shares and issued shares
c. issued and outstanding shares
d. authorized shares and unissued shares
3. At the end of the financial reporting period, ordinary shares issued would exceed ordinary
shares outstanding as a result of the
a. payment in full of the subscribed shares
b. declaration of a share capital dividend
c. declaration of a share profit
d. purchase of treasury shares
4. How would a share split affect the amount of each of the following?
share capital
shareholders’ equity
retained earnings
a. no effect
no effect
no effect
b. no effect
no effect
increase
c. increase
increase
no effect
d. decrease
decrease
decrease
5. When a corporation buys its own stock to hold as treasury shares
617
a. a gain or loss is recorded when the shares are reissued
b. the balance in ordinary share capital account remains unchanged
c. there is a new asset account on the statement of financial position, Treasury shares,
equal to the number of shares reacquired multiplied by the cost per share
d. all of the above statements are true
6. A share (stock) split will
a. have no effect on account balances
b. increase shareholders’ equity
c. decrease assets
d. decrease shareholders’ equity
7. A corporation may acquire treasury shares
a. to support the market price of the share capital
b. to obtain shares that will be used in acquiring plant assets
c. to improve earnings per share of share capital
d. for any of the above reasons
8. Treasury shares are reported as
a. contra asset
b. asset
c. contra shareholders’ equity
d. liability
9. The purchase of treasury shares decrease the number of
a. authorized shares
c. outstanding shares
b. issued shares
d. both b and c
10. A corporation has 6,000 outstanding shares of P20 par value ordinary share capital. On
March 1, 2010, the corporation announced a 4:1 share split to be completed on April 1, 2010.
What is the entry to record the share split?
a. Retained Earnings
480,000
Ordinary Share Capital
480,000
b. Retained Earnings
120,000
Ordinary Share Split Distributable
120,000
c. Retained Earnings
120,000
Ordinary Share Dividend Distributable
120,000
d. Memorandum Entry
11. Using the information in No. 10, what is the balance of Ordinary share Capital after the share
split?
a. P120,000
c. 480,000
b. 360,000
d. 600,000
618
12. The shareholders’ equity section of the statement of financial position of a corporation
includes the following balances:
10% Preference share capital, 1,000 shares issued, P100 par
P100,000
Preference share premium
30,000
Retained earnings
350,000
The corporation decided to retire 400 of the preference shares at P110 per share. What is the
gain or loss on retirement of the shares?
a. no gain or loss
c. P4,000 loss
b. P4,000 gain
d. P8,000 gain
13. A corporation has 20,000 shares of P30 par value ordinary share capital and reacquires 4,000
shares at P40 as treasury shares. What is the balance in the Ordinary Share Capital account
after the purchase of treasury shares?
a. P440,000
c. P600,000
b. P480,000
d. none of these
14. Using the information in No. 13 and assuming 1,000 of the treasury shares were sold for P70
each, what is the journal entry to record the reassurance?
a. Cash
70,000
Treasury Shares
40,000
Gain on Sale of Treasury Shares
30,000
b. Cash
70,000
Treasury Shares
40,000
Paid-in Capital from Sale of Treasury Shares
30,000
c. Cash
70,000
Treasury Shares
70,000
d. None of the above entries is correct.
15. The Jonas, Inc. has authorized capital of 10,000 ordinary shares with a par value of P40. For
the first two years of its existence, it has issued 4,000 shares to shareholders and distributed
400 shares as stock dividend. In addition, it has recently contracted subscription for 100
shares. One installment has been made on the subscribed shares. Jonas is now contemplating
the purchase of 500 shares to hold as treasury shares in order to increase the market price of
the share capital. If Jonas purchases the 500 shares as treasury shares, what will be the
number of authorized, issued and outstanding shares?
Authorized
Issued
Outstanding
a.
10,000
4,400
4,400
b.
10,000
4,400
3,900
c.
10,000
4,500
4,900
d.
9,500
4,400
3,900
424
16. Using the information in No. 15, and assume that Jonas purchases the 500 shares as treasury
shares and that the subscription has been paid in full. At this point, the corporation decided to
split the shares 2:1. What is the new number of shares authorized, issued and outstanding?
Authorized
Issued
Outstanding
a.
20,000
9,000
8,000
b.
20,000
9,000
9,000
c.
10,000
8,800
5,100
d. none of the answers are correct
17. James corporation has outstanding 10,000 shares of 10% Preference Share Capital with a par
value of P100 and 42,500 shares of P10 par value Ordinary Share Capital. The balance in the
Retained Earnings account at the end of fiscal year 2014 is P1,650,000. If James purchases
1,000 shares of its own ordinary share capital at P40 per share, what amount of Retained
Earnings is available for payment of dividends?
a. P1,610,000
c. P1,650,000
b. P1,640,000
d. none of the answers is correct
18. The June Corporation has 100,000 outstanding shares of P30, par value ordinary share capital
on January 1, 2010. The shares were issued in year 2013 for P50 per share. During 2014,
June declared a 3:1 share split. Thereafter, 15,000 shares were reacquired as treasury shares
for P15 per share. On December 31, 2014, June accepted a subscription for 5,000 ordinary
shares at P20 per share payable within 90 days. What is the balance of the account Ordinary
Share Capital at the end of 2014?
a. P2,850,000
c. P3,000,000
b. P2,900,000
d. P3,050,000
19. Using the information in No. 18, what is the total shareholders’ equity of June Corporation as
of December 31, 2014?
a. P3,000,000
c. P5,000,000
b. P4,875,000
d. P5,100,000
20. Using the information in No. 18, how many ordinary shares are outstanding as December 31,
2014?
425
461
a. 90,000
b. 285,000
c. 290,000
d. 305,000
461
462
Test Material No. 42
Rating ___________
Name _______________________________
Year and Section _______________________
Date _______________________________
Professor ___________________________
PROBLEM
The shareholders’ equity section of QQQ Corp. is presented below:
Ordinary share capital, Pts20 par value, authorized 500,000
shares, issued and outstanding 200,000 shares
Ordinary share premium
Retained Earnings
Pts 4,000,000
1,200,000
5,400,000
Instructions: Complete the given table to reflect the number of shares and balances in the
shareholders’ equity accounts after each of the following independent transactions: Present
supporting computations in good form in a separate work sheet.
(1) A 15% share dividend was declared and shares were issued; market value of the
shares on the date of declaration is P25 per share.
(2) A two-for-one share split was issued.
(3) A 100% share dividend was declared and shares were issued; market value of shares
on the date of declaration is P 25 per share.
(4) Each ordinary share was replaced by a new share with par value of P 15.
(5) Five thousand shares we retired at P 24.
Outstanding
Ordinary
Additional
Retained
Total
Shares
Share
Paid-In
Earnings
Shareholders’
Capital
Capital
Equity
(1)
_________
_________
_________
_________
_________
(2)
_________
_________
_________
_________
_________
(3)
_________
_________
_________
_________
_________
(4)
_________
_________
_________
_________
_________
(5)
_________
_________
_________
_________
_________
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463
Test Material No. 43
Rating ___________
Name _______________________________
Year and Section _______________________
Date _______________________________
Professor ___________________________
PROBLEM
The shareholders' equity of NNN Corp. is presented below:
12% Preference share capital, P100 par
Ordinary share capital, P20 par
Preference share premium
Ordinary share premium
Retained Earnings
P400,000
200,000
80,000
100,000
900,000
Instructions: Prepare the journal entries to record each of the following independent
transactions and then state the number of shares issued and outstanding.
a. Five hundred preference shares were retired at P115.
b. One thousand ordinary shares were reacquired at P25 and subsequently reissued at P28
c. One thousand preference shares were converted into ordinary shares at the rate of four
ordinary shares for every preference share.
d. Ordinary share split of four-for-one.
463
464
CHAPTER 11
FINANCIAL REPORTING AND ANALYSIS
LEARNING OBJECTIVES
1. Explain the nature of the financial statements and the over-all considerations in their
preparation and presentation.
2. Identify and explain the components of a complete set of financial statements.
3. Explain and appreciate the importance of the statement of cash flows.
4. Describe and explain the classification of cash flows and the methods of presenting cash
flows from operating activities.
5. Explain and appreciate the different types of ratio analysis.
PREVIEW OF THE CHAPTER
FINANCIAL
REPORTING and
ANALYSIS
Financial
Reporting
1. Objective, definition
and nature of financial
statements.
2. Overall consideration
in the preparation of
financial statements.
1.
2.
3.
4.
5.
Financial
Statements
and their
Elements
Statement of the
financial position
Statement of the
comprehensive
income
Statement of changes
464
in equity
Statement of cash
flows
Notes
Financial
Statement
Analysis
1. Ratio analysis
a. Liquidity
ratios
b. Solvency
ratios
c. Profitability
ratios
465
INTRODUCTION
As discussed in Chapter 1, there are two main groups of users of accounting information: (1)
internal users and (2) external users. The external users do not have access to the day to day
operations of an entit; hence they rely heavily on the financial reports provided to them. It is very
important, therefore, that these reports be realiable and timely so that those who use them can
make sound sound decisions and reason choices among alternative courses of action.
The field of accounting that specializes in giving reports to external users is financial accounting.
The financial reports that are given to them are called general-purpose financial statements.
General purpose financial statements are financial statements that are intended to meet the
common needs of users who are not in a position to demand reports customized to their specific
information needs.
The presentation of financial statements is guided by PAS 1 which sets out the basis for the
presentation of financial statements to ensure the comparability with previous periods and with
other entities. PAS 1 also identifies the minimum content of what should be included in the
financial statements and the guidelines as to their structure.
OBJECTIVE OF FINANCIAL STATEMENTS
The objective of general purpose financial statements is to provide information about the
financial position, financial performance and cash flows of an entity that is useful to a wide
range of users in making economic decisions.
DEFINITION AND NATURE OF FINANCIAL STATEMENTS
Financial statements are a structured representation of the financial position and financial
performance of an entity. They show the assets, liabilities, and equity of an entity as of a
particular date. They also show the income earned and expenses incurred by an entity during a
given period.
465
466
Financial statements are the end product of the accounting process. The financial statements
are the final output of the accounting process. They can be prepared only after the transactions
have been processed and the necessary adjusting entries are journalized and posted
Financial statements show the results of the management's stewardship of the resources
entrusted to it. The owners of an entity entrust to management the utilization of company
resources to achieve both short-term and long-term goals of the entity. They are expected to
maximize the earnings potential of these resources and provide rate of
return on their use that is acceptable to the investors and other stakeholders. The financial
statements show the performance of management vis-é-vis the expectations of the investors or
owners.
Financial statements are the means by which the information accumulated and processed in
financial accounting is periodically communicated to those who use it. The stakeholders of an
entity are informed of the financial position and the performance of an entity ‘through the
financial statements.
The preparation and presentation of financial statements is a responsibility of management.
The Board of Directors reviews and approves the financial statements before these are submitted
to the ' shareholders of the entity. A management’s representation letter is attached to the
published financial statements. .
COMPONENTS OF FINANCIAL STATEMENTS
According to PAS -1 (revised (2011), a complete set of-financial statement comprises:





a statement of financial position (balance sheet)
a statement of comprehensive income (alternatively, an entity may prepare a separate
income statement and a separate statement of other comprehensive income)
a statement of changes in equity
a statement of cash flows; and
notes, Comprising a summary of significant accounting policies and other explanatory
notes.
466
467


Some entities,. however, present other reports in addition to those stated above. Examples
are the following:
a financial review by management that describes. and explains the main features of the
entity’ 8 financial performance and financial position and the principal uncertainties it
faces;
environmental reports and value added statements, particularly in industries 'in which
environmental factors are significant and when employees are considered an important
user group.
These reports, which are presented outside of the financial statements, are outside of the
scope of PAS 1.
OVERALL CONSIDERATIONS IN THE PREPARATION AND PRESENTATION OF
FINANCIAL STATEMENTS
PAS 1 identifies eight (8) basic considerations when preparing and presenting financial
statements. These considerations are described briefly below.
Fair presentation and compliance with PFRSs / IFRSs. Financial statements shall present fairly
the financial position, performance and cash flows of an entity. Fair presentation requires the
faithful representation of the effects of transactions, other events and conditions in accordance
with the definitions and recognition criteria for assets, liabilities, income and expenses set out in
the Framework. The application of PFRSs/IFRSS, with additional disclosure when necessary, is
presumed to result in financial statements that achieve fair presentation. (PAS 1, par. 15)
Going concern. Financial statements shall be prepared on a going concern basis unless
management either intends to liquidate the entity or to cease trading, or has no realistic
alternative but to do so. This means that an entity is assumed to have a continuity of life, unless
there is an evidence to the contrary. Any uncertainties that may cast doubt as to the ability of the
entity to continue as a going concern, however, should be properly disclosed. An example of
application of going concern is the use of accrual basis of accounting. (PAS 1, par. 25)
Accrual basis of accounting. An entity shall prepare its financial statements , except for cash
flow information, using the accrual basis of accounting. Under the accrual basis of accounting,
income and expenses are recognized in the period in which they relate rather ' than when the cash
467
468
is received or paid. For example, sales on account made in 2014 that will be collected in 2015 is
recognized as sales in 2014. An insurance premium paid in 2014 covering the period 2015 is
recognized as expense in 2015; the payment is recognized as prepaid expense at the end of 2014
(PAS 1, par. 27)
Frequency of reporting. An entity shall present a complete set of financial statements (including
comparative information) at least annually. An entity chooses its own annual accounting Period it can adopt the calendar year or adopt a fiscal year The calendar year starts January 1 and ends
December 31 The adoption of a fiscal year may depend on the nature of business or operations of
the entity. A school for mstance may adopt an accounting period that starts June 1 and ends May
31 to coincide with the start and end of one school year. (PAS 1, par.36)
Materiality and aggregation. Each material class of similar items shall be presented separately
in the financial statements Items of dissimilar nature or function shall be presented separately
unless they are immaterial. For example cash on hand and cash deposited in various banks may
be aggregated and reported under a Single line item “Cash on hand and in banks” but trade
receivables are presented separately from nontrade receivables because of their dissimilar nature.
An entity with several prepaid items which are immaterial in amount may present these
prepayments under the line item “prepaid expenses”. (PAS 1, par. 29)
Offsetting. As a general rule, assets and liabilities, and income and expenses shall not be offset
unless required or permitted by a Standard or an Interpretation. Offsetting is deducting the
balance of an asset account from the balance of a liability account and reporting only the net
amount in the statement of financial position or deducting the balance of an income account from
the balance of an expense account and reporting only the net amount in the statement of
comprehensive income. For instance, bonds payable balance of P5 m1llion is deducted from
bond sinking fund balance of P3 million and reporting only the net amount of P2 million for
bonds payable or deducting uncollectible accounts of P1 million from sales of P75 million and
reporting only the net sales of P74 million. As a general rule, these offsetting examples are not
allowed (PAS 1 par 32) However some Standards may allow offsetting, such as the following:
(PAS 1, par. 34)

Gains and losses on disposal of. non-current assets, including investments and operating
assets are reported by deducting from the proceeds on disposal the carrying amount of the
asset and related selling expense. For example an old equipment with a carrying amount
of P250,000 was sold for P300,000 with related disposal costs of P20,000. The carrying
amount of P250,000 IS deducted from the proceeds from disposal of P280,000 and a gain
of P30,000 is reported in the statement of comprehensive income.
468
469

Gains and losses from a group of similar transactions are reported on a net basis, for
example, foreign exchange gains and losses or gains and losses arising on financial
instruments held for trading.
Consistency of presentation. To aid comparability of financial statement of one period with
other periods (intra comparability) or of one entity with other entities (inter comparability), the
presentation and classification of financial statement shall be retained from one period to the next
unless:

l it is apparent, following a significant change in the nature of the entity's operations or a
review of it’s financial statements, that another presentation of classification would be
more appropriate having regard to the criteria set for the selection and application of
accounting policies in PAS 8; or
 a Standard or Interpretation requires a change in presentation.
An entity changes the presentation of financial statements only if the changed presentation
provides information that is reliable and is more relevant to users of the financial statements and
the revised structure is likely to continue, so that comparability is not impaired. (PAS 1, par. 45)
Comparative information. Comparative information shall be disclosed in respect of t he
previous period for all amounts reported in the financial statements. Comparative information
shall be included for narrative and descriptive information when it is relevant to an
understanding of the current period’s financial statements. As a minimum requirement, financial
statements for two dates or two periods must be presented for comparative purposes.
If adjustments to prior periods have been made as a result of a change in accounting policy or of
correction of errors, a statement of financial condition as of the beginning of the period should be
presented. (PAS 1, par. 38)
STATEMENT OF FINANCIAL POSITION (BALANCE SHEET)
The objective of the statement of financial position is to report the financial condition or position
of an entity at a particular date. It shows the entity’s assets, liabilities, and equity-at a point in
time.
The statement of financial position is very useful to the financial statement users. It descn'bes the
resources of the entity that are available sources of future cash flows, such as short-term
investments, receivables and inventories. It contains information that is useful in assessing the
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liquidity and solvency of an entity. Liquidity is the entity’s ability to pay its obligations or
liabilities which are currently due. Solvency is the entity’s ability to pay both its current and
noncurrent obligations. However, the statement of financial position has certain limitations as
follows:

There is no consistency as to the basis of measurement- some assets are reported at
historical cost while other assets are reported at fair value. For example, property, plant
and equipment may be reported at historical cost while long-term investments and
investment property are reported at fair value.
 There are some company assets which are not reported on the balance sheet- these
include employees of an entity, self-generated intangible assets such as mastheads and
brand names (PAS 38 Intangible Assets).
The statement of financial position has the following three primary elements:
 assets;
 liabilities; and
 Equity
These three elements are discussed in details in the succeeding paragraphs.
ASSETS
Definition and characteristics. Assets are defined in the Conceptual Framework for Financial
Reporting, paragraph 4.4, as resources controlled by the entity as a result of past events and from
which future economic benefits are expected to flow to the entity.
An asset has the following characteristics:

It is controlled by an entity -the entity has the right to obtain and control the benefits
expected from the use of the asset. In determining the existence of an asset, the right of
ownership of an asset is not essential. For instance, in the case of finance lease, the
property is owned by the lessor but is reported as an asset by the lessee.

It is a result of past event - the asset arises from transaction Which occurred m the past.

It represents future economic benefits - the asset has the potential to contribute, directly
or indirectly, to the flow of cash and cash equivalents to the entity. Paragraph 4.10 of the
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F framework states that the economic benefits may flow to the entity in various ways, as
follows:
o the asset may be used singly or in combination with other assets in the
production of goods or services to be sold by the entity.
o the asset may be exchanged for other assets
o the asset may used to settle a liability
o the asset may be distributed to the owners of the entity .

It has a cost or value- the asset has a cost or a value that is measured in terms of money.
Recognition. An asset is recognized when
o it is probable that the future economic benefits will flow to the entity; and
o the asset has a cost or value that can be measured reliable.
Classification. Assets are classified or grouped according to common characteristics, such as
operating and non-operating assets, financial and non-financial assets, and current and
noncurrent assets. The most dominant form of distinction is the current versus the non-current
classification of both assets and liabilities.
Current assets. PAS 1, paragraph 66 states that an asset shall be classified as current when it
satisfies any of the following criteria:
o it is expected to be realised in, or is intended for sale or consumption in, the entity’s
normal operating cycle (e. g. trade receivables, inventories and prepaid expenses);
o it is held primarily for the purpose of trading (e. g. trading securities);
o it is expected to be realised within twelve months after reporting period (e. g. nontrade
receivables collectible within one year); or
o it is cash or a cash equivalent (as defined in PAS 7 Statement of Cash Flows) unless it is
restricted from being exchanged or used to settle a liability for at least
twelve months after the balance sheet date (e. g. cash on hand and in bank certificates of time
deposits with a term 0fthree months or less).
The normal operating cycle of an entity refers to the period of time necessary to convert
cash to inventories, inventories to receivables, and receivables back to cash. In the Case
of a manufacturing company, it refers to the period of time necessary to convert cash to
raw materials, raw materials to finished product, finished product to receivables, and
receivables back to cash. This period can be equal to, shorter than, or longer than One
Year. When the normal operating cycle of an entity is not clearly identif1able,it1S
assumed to be twelve (12) months or one year.
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Current assets normally include the following:
o Cash and cash equivalents. Cash is anything that can be used as a medium of
exchange and which is acceptable by bank at face value upon deposit. Cash
includes cash on hand and in banks that is available for current operations. Cash
may be in the form of bills and coins, personal checks, manager’s checks
cashier’s checks, bank drafts, and money orders. Cash on hand includes
undeposited collections, petty cash fund and change fund. Cash in bank includes
cash in savings and checking accounts.
Cash equivalents are short-term, highly liquid investments that 'are readily
convertible to known amounts of cash and which are subject to an insignificant
risk of changes in value. Normally, an investment qualities as cash equivalent
when it matures in three months or less from the date of acquisition. An example
of cash equivalent is time deposit with a term of three months or less.
o Short-term investments. These are liquid investments that do not qualify as Cash
equivalents, such as time deposit with a term of more than three months and
investment in equity or debt securities intended to be disposed within twelve (12)
months.
o Trade notes and accounts receivables. Trade receivables are those arising from
sale of goods or services.. These receivables are always reported as current assets
because they are expected to be realized in cash within one year or within the
normal operating cycle. Accounts receivable are unsecured open accounts and are
usually due 1n 30 to 60 days, depending on the credit terms offered to customers.
Notes receivable are evidenced by written promise to pay a certain amount of
money at a certain date.
o Nontrade notes and accounts receivable. These are receivables arising from
sources other than sale of goods or services, such as share subscription
receivable, interest receivable, deposit with supplier for future delivery of goods
Nontrade notes and accounts receivable are reported as current assets if they are
due within one year.
o Inventories. . Inventories are assets: (a) held for sale in the ordinary course of
business; (b) in the process of production for such sale; or (c) in the form of
materials or supplies to be consumed in the production process or in the rendering
of services. In a merchandising company, its inventory includes merchandise
acquired for sale. In a manufacturing company, its inventories include finished
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goods, work in process, and raw materials. In a service company, its inventory
includes work in progress. If the company’s inventories include biological assets,
they are reported as a separate line item.
o Prepaid expenses. Prepaid expenses are expenses obtained or paid in advance,
such as office and store supplies, prepaid insurance and prepaid rent However, if
the prepayment covers a period of more than one year, a portion of the
prepayment is noncurrent asset. For instance, if an entity paid rent three years in
advance, the prepayment for the first year is reported as current asset and the
prepayment for the next two years is reported as non-current asset.
Non-current assets. PAS 1 states that all assets that do not qualify as current assets
are non-current assets. Non-current assets include long-term investments, property,
plant and equipment, intangible assets, and investment property.
o Long-term investments. Long-term investments include investment in equity
and debt securities of other corporations, land held for speculation, and cash
set aside for special purposes (such as bond sinking fund). These assets are
classified as non-current because management does not intend to convert
them into cash within one year.
o Property, plant and equipment. Property, plant and equipment defined in
PAS 16, par. 6 as tangible items that are: (a) ‘held for use in the production or
supply of goods or services or for administrative purposes; and (b) are
expected to be used during more than one period. Examples of assets under
this classification are land, buildings, store and office equipment, delivery
equipment, and machinery.
o Intangible assets. Intangible assets are defined in PAS 38, par. 8 as
identifiable non-monetary assets without physical substance. Intangible assets
include copyright, franchise, and patents. A copyright is a right granted to an
author or an artist for the exclusive publication of a book or work of art. A
franchise is a right. granted to an entity to operate a specific type of business
using a particular trade name. A patent is a right granted to an inventor for the
exclusive use of a formula.
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o Investment property. Investment property is defined in PAS 40, par 5
property (land or a building or part of a building or both) held (by the owner
or by the lessee under a finance lease) to earn rentals or for capital
appreciation or both, rather than for:
o use in the production or supply of goods or services or for
administrative purposes; or
o sale in the ordinary course of business.
An example of investment property is a building that 18 being leased to others In
exchange for a fair rental.
o Other non-current assets. These are assets that do not fall under any of the above
classification. Other non-current assets include deferred tax assets and other long-term
prepaid expenses.
LIABILITIES
Definition and Characteristics. Liabilities are defined in the Conceptual Framework for
Financial Reporting, par. 4.4 as present obligations of an entity arising from past events, the
settlement of which is expected to result in an outflow from the entity of resources embodying
economic benefits.
An obligation is a duty or responsibility to act or perform in a certain way. Such obligation may
be legally enforceable as a consequence of a binding contract or statutory requirement, such as
amounts payable for goods and services received. Obligation may also arise from normal
business practice, custom and a desire to maintain good business relations or act in an equitable
manner, such as obligation for product warranty.
A liability has the following characteristics:
o It is a present obligation. The obligation is a present obligation that arise; only when an'
asset acquired is delivered or an entity enters into an irrevocable agreement to acquire an
asset. A liability does not arise from a future commitment, such as a decision by
management to acquire asset in the future.
o It is a result of a past activity. A liability is a result of a transaction that has taken place,
such as purchase of goods on account. As stated earlier, it does not an'se 30111 a future
commitment.
o It is expected to be settled by giving up resources embodying economic benefits in order
to satisfy the claim of the other party. The settlement of a present obligation may oecur
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in any of the following Ways: payment of cash; transfer of other assets; provision of
services; ' replacement of that obligation with another obligation; or conversion of the
obligation into equity
Recognition. A liability is recognized 1n the balance sheet
o When it is probable that an outflow of resources embodying economic benefits will result
from the settlement of a present obligation; and
o the amount at which the settlement will take place can be measured reliably.
Classification. Liabilities may be classified as financial and non-fmancial liabilities or current
and non-current.F1nan01al liabilities include notes and accounts payable.
Current liabilities. According to paragraph 69 of PAS l, a liability shall be classified as current
When it satisfies any of the following criteria:
o
o
o
o
it is expected to be Settled in the entity’ s normal operating cycle
it is held primarily for the purpose of trading;
it is due to be settled within twelve months after the reporting period; or
the entity does not have an unconditional right to defer settlement of the liability for at
least twelve months after the reporting period.
Current liabilities normally include the following:
o Trade notes and accounts payable. Trade payables are those arising from purchase of
goods and services on account. Notes payable are written premises to pay cash at some
future date. Accounts payable are obligations to suppliers of goods or services purchased
on open account.
o Nontrade notes and accounts payable. These are payable: arising from sources other
than. purchase of goods and services, such as short-term borrowings from banks and
customers’ accounts with debit balances.
o Unearned revenues. Unearned revenues represent cash received for goods 0! services to
be provided in a future period, such as rent received six months in advance and
subscription for magazines or books received one year in advance.
o Accrued liabilities. Accrued liabilities represent obligation for expenses already
incurred, but Will not be paid until the subsequent accounting period. Examples of
accrued liabilities are taxes payable, salaries payable, and interest payable. .
o Currently maturing portion of long-term debt. This is the portion of a long-term debt
that is maturing within the next twelve months from the balance sheet date.
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Non-current liabilities, PAS 1 states that all liabilities that do not qualify as current are
classified as non-current. Noncurrent liabilities include long-term notes, bonds payable,
mortgage payable and deferred income tax liability. The payment terms, interest rates, and
.other details that enable readers of financial statements evaluate the impact of the noncurrent liabilities on future cash flows are disclosed in the notes.
EQUITY
Definition. Equity is defined in the Conceptual Framework for Financial Reporting as the
residual interest in the assets of the entity after deducting all its liabilities. The equity of an
entity is composed of the cumulative amount of investments and profit from operations, less
any withdrawals or distribution of dividends and losses from operations.
Components. The components of the equity section of the statement of financial position
depends on the type of business organization. In a single proprietorship and partnership, the
equity section shows the capital account of the owner and the partners, respectively. The
cap1ta1 account balance represents the cumulative amount of investment and profit, less
Withdrawals and losses from operations.
In a corporation, the equity section of the statement of financial position is called
Shareholders’ Equity or Stockholders’ Equity. The shareholders’ equity is generally
composed of Contributed Capital and Retained Earnings. In some instances, a corporation
may have capital maintenance adjustment accounts such as revaluation surplus and net
unrealized gain or loss on long term investments that are shown . separately in the equity
section. These two components of the corporate equity were mentioned in Chapter 9 of this
book.
PAS I does not specify a specific format or arrangement of the three elements when
presented in the statement of financial position. However, in the Philippines, the common
practice is to present these elements as follows current assets followed by non-current assets;
current liabilities followed by non-current liabilities; and equity accounts after liabilities. A
different arrangement may be followed by an entity depending on its nature of business.
INFORMATION TO BE PRESENTED ON THE FACE OF THE STATEMENT OF
FINANCIAL POSITION (BALANCE SHEET) OR IN THE NOTES
PAS 1, par. 54, prescribes that as a minimum, the face of ' the statement of f'manc1al
position (balance sheet) shall include line items that present the following amounts:
a. property, plant and equipment;
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b.
c.
d.
e.
f.
g.
h.
i.
j.
investment property;
intangible asses;
financial assets (excluding amounts shown under (e), (h), and (i);
investments accounted for using the equity method;
biological asses;
inventories;
trade and other receivables;
cash and cash equivalents;
the total of assets classified as held for sale and assets included in disposal groups
classified as held for sale;
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k. trade and other payables;
l. provisions;
m. financial liabilities (excluding amounts shown under (j) and (k);
n. liabilities and assets for current tax, as defined in PAS 12 Income Taxes;
o. deferred tax liabilities and deferred tax assets as defined in PAS 12;
p. non-controlling interests, presented within equity; and
q. issued capital and reserves attributable to owners of the parent
An entity shall disclose, either on the face of the statement of financial position (balance sheet)
or in notes, further subclassification of the line items presented, classified in a manner
appropriate to the entity's operations. The details provided in the subclassification may depend
on the requirements of the PFRSs and on the size, nature, and functions of the amounts involved.
Some examples follow:
15. items of property, plant and equipment are disaggregated into classes, such as land,
buildings and equipment;
16. receivables are disaggregated into amounts receivable from trade customers, receivables
from related parties, prepayments and other amounts;
17. inventories are subclassified into classifications such as merchandise inventory or
finished goods inventory, work in process inventory, and raw materials inventory;
18. provisions are disaggregated into provisions for employee benefits and other items; and
19. equity capital and reserves are disaggregated into various classes, such as contributed
capital and additional paid-in capital.
Form of the Statement of Financial Position (Balance Sheet). The statement of financial
position may be prepared using the report form or the account form. Under the report form, the
elements of the balance sheet are presented similar to a presentation of report. The statement
starts with the Assets, followed by the Liabilities and then the Capital of the owner or the capital
of the partners or shareholder's equity in a corporate form of organization. Under the account
form, the Assets are presented on the left side of the statement while the Liabilities and Equity
are presented in the right side of the statement. The account form is normally used when an
entity maintains a great number of balance sheet accounts. Figures 11.1 and 11.2 show pro-forma
balance sheet using the two forms discussed above.
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ABC Company
Statement of Financial Position
December 31, 20XX
Assets
Liabilities
Current assets:
Current liabilities:
Cash
Pxxx
Short-term investments
xxx
Notes payable
Pxxx
Accounts payable
xxx
Short-term bank loan
xxx
xxx
Income tax payable
xxx
Other receivables
xxx
Accrued liabilities
xxx
Inventories
xxx
Unearned revenue
xxx
Prepaid expenses
xxx
Current portion of long-term debt
xxx
Notes and accounts receivable
Less Allowance for Uncollectibles
Pxxx
xxx
Total current assets
Pxxx
Long-term investments
Investment in equity securities
Investment in funds
Pxxx
Notes payable
xxx
xxx
Pxxx
Buildings (net of acc. depreciation)
xxx
Equipment (net of acc. depreciation)
xxx
xxx
Bonds payable, net of discount
xxx
Deferred tax liability
xxx
xxx
xxx
Shareholders' Equity
xxx Contributed capital:
Share capital
Pxxx
Additional paid-in capital
xxx
xxx
Investment property
Total contributed capital
xxx Retained earnings
Other assets:
Total shareholders' equity
Deferred Tax assets
Total assets
Mortgage payable
xxx
Intangible assets:
Franchise
Pxxx
Total liabilities
Biological assets
Patent
xxx
Non-current liabilities:
Property, plant and equipment:
Land
Total current liabilities
Pxxx
xxx
Pxxx
xxx
xxx
xxx
Pxxx Total Liabilities and Shareholders' equity
Figure 11.1 Pro-forma Statement of Financial Position - Account Form
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Pxxx
480
ABC Company
Statement of Financial Position
December 31, 20XX
Assets
Current assets:
Cash
Pxxx
Short-term investments
xxx
Notes and accounts receivable
Pxxx
Less Allowance for Uncollectibles
xxx
xxx
Other receivables
xxx
Inventories
xxx
Prepaid expenses
xxx
Total current assets
Pxxx
Long-term investments
Investment in equity securities
Pxxx
Investment in funds
xxx
xxx
Property, plant and equipment:
Land
Pxxx
Buildings (net of acc. depreciation)
xxx
Equipment (net of acc. depreciation)
xxx
Biological assets
xxx
xxx
Intangible assets:
Patent
Pxxx
Franchise
xxx
Investment property
xxx
xxx
Other assets:
Deferred Tax assets
xxx
Total assets
Pxxx
Liabilities
Current liabilities:
Notes payable
Pxxx
Accounts payable
xxx
Short-term bank loan
xxx
Income tax payable
xxx
Accrued liabilities
xxx
Unearned revenue
xxx
Current portion of long-term debt
xxx
Total current liabilities
Pxxx
Non-current liabilities:
Notes payable
Pxxx
Mortgage payable
xxx
Bonds payable, net of discount
xxx
Deferred tax liability
xxx
Total liabilities
xxx
Pxxx
Shareholders' Equity
Contributed capital:
Share capital
Pxxx
Additional paid-in capital
xxx
Total contributed capital
Pxxx
Retained earnings
xxx
Total shareholders' equity
xxx
Total liabilities and shareholders' equity
Pxxx
Figure 11.2 Pro-forma Statement of Financial Position - Report Form
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INCOME STATEMENT
The income statement shows the performance of an entity at a given period of time. The
statement reports the income earned and the expenses incurred at a particular period of time.
The objective of the statement of income statement is to provide information about the
performance of an entity that is useful to a wide range of users in making economic decisions.
The measure of performance is the profit or loss of an entity.
The income statement has two elements: income and expenses.
INCOME
Definition. Income is defined in paragraph 4.25 of the FRSC Conceptual Framework for
Financial Reporting as increases in economic benefits during the accounting period in the form
if inflows or enhancements of assets or decreases of liabilities that result in increases in equity,
other than those relating to contributions from equity participants. Contributions from equity
participants refer to the investments by owners of the entity. Such investments should not be
considered income of the entity.
Income encompasses both revenue and gains. Revenue arises in the course of the ordinary
activities of an entity and is referred to by a variety of different names including sales, fees,
interest, dividends, royalties and rent. Gains are increases in economic benefits arising from
peripheral or incidental activities, such as those arising from sale of plant assets and sale of
investments. Gains are generally reported net of related expenses. For example, the gain on sale
of equipment is the amount remaining after deducting the carrying amount and other disposal
costs from the selling price of the asset.
Income also includes unrealized gains, such as those arising from revaluation of marketable
securities and those arising from increases in the carrying amount of long-term assets.
Recognition. According to paragraph 4.47 of the FRSC Conceptual Framework, income is
recognized in the income statement when an increase in future economic benefits related to an
increase in an asset or a decrease of a liability has arisen that can be measured reliably.
Therefore, the recognition of income occurs simultaneously with the recognition of increases in
assets or decreases in liabilities. PAS 18 Revenue provides a more specific concept on the
recognition of income arising from various transactions.
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EXPENSES
Definition. Paragraph 4.25 of the FRSC Conceptual Framework for Financial Reporting defines
expenses as decreases in economic benefits during the accounting period in the form of out flows
or depletions of assets or incurrences of liability that result in decreases in equity, other than
those relating to distributions to equity participants. Distributions to equity participants refer to
withdrawals by the sole proprietor/partners or distribution of dividends to the shareholders. Such
distributions are not considered expenses of the entity.
Expenses encompass both losses and expenses that arise in the course of the ordinary activities
of the entity, such as cost of sales, wages, depreciation, supplies, and utilities. Losses represent
other items that meet the definition of expenses and may, may or not, arise in the course of the
ordinary activities of the entity. Losses include those resulting from disasters such as fire and
flood, and those arising from disposal of non-current assets. Losses are normally reported net of
related income.
Expenses also include unrealized losses, such as those arising from the effects of increases or
decreases in the foreign exchange rate in respect of borrowings of an entity in that currency.
Recognition. Paragraph 4.49 of the FRSC Conceptual Framework states that expenses are
recognized in the income statement when a decrease in future economic benefits related to a
decrease in an asset or an increase of a liability as arisen that can be measured reliably.
Therefore, the recognition of expenses occurs simultaneously with the recognition of an increase
in liabilities or a decrease in assets.
Expenses are recognized under one of the following expense recognition principles:
5. Direct matching (associating cause and effect). When costs can be associated with
revenue, such costs are charged to expense in the period in which the related revenue is
recognized. Examples are cost of goods sold, sales commission expense and warranty
expense.
6. Systematic and rational allocation. When costs cannot be associated with revenue but
can be associated with future periods, such costs are charged to expense over the periods
benefited. Examples are depreciation of plant assets, amortization of intangible assets,
and allocation of insurance premium over the covered period.
7. Immediate recognition. When an expenditure produces no future economic benefits or
when, and to the extent that, future economic benefits do not qualify, or cease to qualify,
for recognition in the balance sheet as an asset, such expenditure is recognized
immediately as an expense. Examples are repairs and maintenance and advertising
expense.
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INFORMATION TO BE PRESENTED ON THE FACE OF THE STATEMENT OF
COMPREHENSIVE INCOME STATEMENT
PAS 1, par. 82, states that as a minimum, the face of the income statement shall include line
items that present the following amounts for the period:
a. revenue;
aa. gains and losses arising from the recognition of financial assets measured at amortized
cost;
b. finance costs;
c. share of the profit or loss of associates and joint ventures accounted for using the equity
method;
ca. if a financial asset is reclassified so that it is measured at fair value, ang gain or loss
arising from a difference between the previous carrying amount and its fair value at thr
reclassification date (as defined in PFRS 9);
d. tax expense;
e. a single amount comprising the total of
i. the post-tax profit if discontinued operations and
ii. the post-tax gain or loss recognized on the measurement to fair value less costs to sell
or on the disposal of the assets or disposal group(s) constituting the discontinued
operations;
f. profit or loss;
g. each component of other comprehensive income classified by nature (excluding amounts
in h;
h. share of other comprehensive income of associates and joint ventures accounted for using
the equity method; and
i. total comprehensive income
If an entity prepares a separate income statement, only items a to f will be presented in the
statement; items g to i will be presented in the separate statement of comprehensive income
Classification of expenses in the income statement. PAS 1 states that an entity may present an
analysis of its expenses using the nature of expense method or the functional method.
Nature of expense method. Under this method, expenses are aggregated in the income
statement according to their nature and are not reallocated among various functions within the
entity. Examples of grouping of expenses under this method are: depreciation, purchases of raw
materials, employee costs, and advertising costs.
Function of expense or cost of sales method. Under this method, expenses are classified
according to their function as part of cost of sales, cost of distribution (selling expenses), or
administrative activities (general or administrative expenses). This method can provide more
relevant information to users than the nature of expense method.
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Figure 11.3 and 11.4 show pro-forma income statement using the two methods.
ABC Company
Income Statement
For the Year Ended December 31, 20XX
Revenue
Other income
Increase (decrease) in merchandise inventory
Net purchases of merchandise
Employee benefit expense
Depreciation expense
Amortization expense
Supplies expense
Utilities expense
Other expenses
Finance cost (interest expense)
Share of profit of associate
Profit before tax
Income tax expense
Profit for the period
Pxxx
xxx
(xxx)
(xxx)
(xxx)
(xxx)
(xxx)
(xxx)
(xxx)
(xxx)
(xxx)
xxx
Pxxx
(xxx)
Pxxx
Figure 11.3 Pro-forma Income Statement - Nature of Expense Method
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ABC Company
Income Statement
For the Year Ended December 31, 20XX
Pxxx
Revenue
Cost of sales:
Inventory, beginning
Net purchases
Cost of goods available for sale
Less inventory, end
Gross Profit
Other income
Distribution costs (selling expenses)
Administrative expenses
Other expenses
Finance cost (interest expense)
Share of profit of associate
Profit before tax
Income tax expense
Profit for the period
Pxxx
xxx
Pxxx
xxx xxx
Pxxx
xxx
(xxx)
(xxx)
(xxx)
(xxx)
xxx
Pxxx
(xxx)
Pxxx
Figure 11.4 Pro-forma Income Statement - Function of Expense Method
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Notes:
6. The revenue section represents revenue from the major activity if the entity, that is, sale
of goods for a merchandising or trading company and sale of services for a service
company.
7. Other income includes interest income and gain from sale of assets other than inventories,
such as gain from sale of investment.
8. Other expenses include loss from sale of assets other than inventories, such as loss from
sale of equipment.
9. The share of profit of associates is the share of the entity in the reported profit of an
investee company called associate. Accounting for investment in associate is a topic to be
discussed in financial accounting.
STATEMENT OF COMPREHENSIVE INCOME
The statement of comprehensive income reports items of income and expenses which are not
required by other PASs and PRFSs to be recognized in profit or loss. Examples are changes in
revaluation surplus when property, plant and equipment are reported using the revaluation model
and gains and losses arising from changes in fair vakue of available-for-salr securities.
The following information is required to be presented in the statement of comprehensive income
reported separately from the income statement:
8. profit or loss shown in the income statement;
9. share of other comprehensive income of associates and joint venture accounted for using
the equity method;
10. each component of other comprehensive income classified by nature;
11. total comprehensive income; and
12. the total comprehensive incime attributable to non-controlling interest and that
attributable to owners of the parents.
PAS 1 permits the presentation of comprehensive income in a single statement of comprehensive
income (combines income statement and statement of comprehensive income).
STAMENT OF CHANGES IN EQUITY
PAS 1, par. 106, requires an entity to present a statement of changes in equity that should include
the following:
7. total comprehensive income for the period, showing separately the amount due to owners
of the parent and to non-controlling interest;
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c. for each component of equity, the effect of retrospective application or retrospective
restatement recognized in accordance with PAS 8; and
d. for each component of equity, a reconciliation of the carrying amount at the beginning
and the end of the period, separately disclosing changes resulting from:
e. profit or loss;
f. other comprehensive income; and
g. transactions with owners in their capacity as owners, showing separately
contributions by and distributions to owners and changes in ownership interests in
subsidiaries that do not result in a loss of control.
The preparation of the statement is also discussed in Chapter 9 of this book.
STATEMENT OF CASH FLOWS
The statement of cash flows is one of the basic components of a complete set of financial
statements. The objective of the statement of cash flows is to provide information about the cash
receipts and cash disbursements of an entity that occurred during a period. The statement
summarizes the transactions that caused a change in the cash balance during a reporting period.
A cash flow statement provides the following benefits as stated in PAS 7, par. 4:
e. it provides information that enables the users to evaluate the changes in the assets if an
entity, its financial structure and its ability to affect the amounts and timing of cash flows
in order to adapt to changing circumstances and opportunities;
f. it provides information that is useful in assessing the ability of the entity to generate cash
and cash equivalents and enables users to develop models to assess and compare the
present value of the future cash flows of different entities;
g. it enhances the comparability of the reporting of operating performance by different
entities because it eliminates the effects of rising different accounting treatments for the
same transactions and events.
CLASSIFICATION OF CASH FLOWS
Cash flows are classified to make the statement more meaningful to the investors and creditors
by enabling them to determine the type of transaction that gave rise to each cash flow. Cash
flows are categorized into three: (a) operating activities; (b) investing activities; and (c) financing
activities.
Operating activities. Cash flows from operating activities are derived from the principal revenueproducing activities of an entity. They represent the cash inflows and outflows of cash that
resulted from activities reported in the income statement. Thus, this classification of cash flows
includes the elements of income statement reported on a cash basis rather that an accrual basis.
For instance, cash flows from sales show the amount
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of cash received from customers during the period sales that were made in prior or current period
or for future sales.
Cash received from (cash inflow)
 customers for sale of goods and services
Cash paid for (cash outflow)
 purchase of inventory

royalties, fees, commissions

salaries and wages

interest on loans receivable

interest on loans payable

dividends from investment

income taxes
Table 11.1 - Sample transactions or activities giving rise to cash flows from operating activities
Investing activities. Cash flows from investing activities include cash inflows and outflows of
cash related to acquisition and disposition of long-term assets used in operations of the business
and investment assets.
Cash received from (cash inflows)
 sale of long-term investment
Cash paid for (cash outflows)
 purchase of long-term investment

sale of plant assets

purchase of plant assets

repayment of loans made to others

loans to identified employees.
Table 11.2 - Sample transactions or activities giving rise to cash flows from investing activities.
Financing activities. Cash flows from financing activities include cash inflows from borrowings
and contributions by investors and cash outflows for repayment of loans, retirement of share
capital, acquisition of treasury shares and payment of cash dividends.
Cash received from (cash inflows)
 bank loan
Cash paid for (cash outflows)
 payment of bank loan

issuance of share capital

retirement of share capital

reissuance of treasury shares

acquisition of treasury shares

dividends
Table 11.3 - Sample transactions or activities giving rise to cash flows from financing activities
Methods of presenting cash flows from operating activities. There are two methods of
presenting the cash flows from operating activities: the direct method and the indirect method.
Direct method. Under the direct method, the major classes of gross receipts and gross cash
payments are disclosed in the statement. The information about these major classes may be
obtained either:
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
from the accounting records of the entity; or

by adjusting sales, cost of sales (interest and similar income and interest expense and
similar charges for a financial institution) and other items in the income statement for:
 changes during the period in inventories and operating receivables and payables;
 other non-cash items; and
 other items for which the cash effects are investing and financing cash flows.
Indirect method. Under the indirect method, the net cash flow from operating activities is
determined by adjusting profit or loss for the effects of:
 changes during the period in inventories and operating receivables and payables;
 non-cash items such as depreciation, provisions, deferred taxes, and realized
foreign currency gains and losses; and
 all other items for which the cash effects are investing or financing cash flows.
ABC Company
Statement of Cash Flows
For the Year Ended December 31. 200x
Cash flows from operating activities:
Cash receipts from customers
Cash paid to suppliers
Cash paid to employees
Cash paid for various operating expenses
Interest paid
Income taxes paid
Net cash flow from operating activities
Cash flows from investing activities:
Collection for note receivable
Proceeds from sale of equipment
Proceeds from sale of long-term investment
Purchase of property, plant and equipment
Loans made to employees
Net cash flows from investing activities
Cash flows from financing activities:
Proceeds of bank loan
Proceeds from issuance of share capital
Repayment of bank loan
Purchase of treasury shares
Payment of dividends
Net cash flows from financing activities
Pxxx
(xxx)
(xxx)
(xxx)
Pxxx
(xxx)
(xxx)
Pxxx
Pxxx
xxx
xxx
(xxx)
(xxx)
xxx
Pxxx
xxx
(xxx)
(xxx)
(xxx)
(xxx)
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Net increase in cash and cash equivalents
Cash and cash equivalents at the beginning of the period
Cash and cash equivalents at the end of the period
Figure 1.5 Pro-forma Statement of Cash Flow- Direct method
Pxxx
xxx
Pxxx
ABC Company
Statement of Cash Flows
For the Year Ended December 31, 200x
Cash flows from operating activities:
Profit before taxes
Adjustments for:
Depreciation
Investment income
Interest expense
Operating income before working capital changes
Increase in trade receivables
Decrease in inventories
Decrease in prepaid expenses
Increase in accrued revenue
Increase in trade payables
Increase in unearned revenue
Decrease in accrued expenses
Cash generated from operations
Interest paid
Income taxes paid
Net cash received (paid) from operating activities
Cash flows from investing activities:
Collection for note receivable
Proceeds from sale of equipment
Proceeds from sale of long-term investment
Purchase of property, plant and equipment
Loans made to employees
Net cash flows from investing activities
Cash flows from financing activities:
Proceeds of bank loan
Proceeds from issuance of share capital
Repayment of bank loan
Purchase of treasury shares
Payment of dividends
Net cash flows from financing activities
Pxxx
xxx
(xxx)
xxx
Pxxx
(xxx)
xxx
xxx
(xxx)
xxx
xxx
(xxx)
Pxxx
(xxx)
(xxx)
Pxxx
Pxxx
xxx
xxx
(xxx)
(xxx)
xxx
Pxxx
xxx
(xxx)
(xxx)
(xxx)
(xxx)
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Illustrative Problem A
ABC Copay reported the following cash receipts and cash payments for year 2014:
Cash receipts:
Proceeds from sale of equipment
Proceeds of bank loan
Collections from customers
Proceeds from issuance of share capital
Cash payments:
To suppliers for merchandise purchases
For purchase of machinery
For purchase of machinery
For bank loan
For dividends
For income taxes
For operating expenses
P80,000
200,000
600,000
60,000
390,000
97,500
22,500
50,000
39,000
66,000
100,000
The cash and cash equivalent balance at the beginning of the year is P120,000.
Net increase in cash and cash equivalents
Cash and cash equivalents at the beginning of the period
Cash and cash equivalents at the end of the period
Pigure 11.5 Pro-forma Statement of Cash Flow-Indirect method
Pxxx
xxx
Pxxx
A statement of cash flow using the direct method is shown below
ABC Company
Statement of Cash Flow
For the Year Ended December 31, 2014
Cash flows from operating activities:
Cash received from customers
Cash paid to suppliers for merchandise purchases
Cash paid for operating expenses
Cash generated from operations
Interest paid
Income taxes paid
Net cash received from operating activities
Cash flows from investing activities:
Proceeds from sale of equipment
Cash paid to purchase of machinery
Net cash received from (used in) investing activities
Cash flows from financing activities:
Proceeds from issuance of share capital
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P600,000
(390,000)
(100,000)
P110,000
(22,500)
(66,000)
21,500
P80,000
(97,500)
(17,500)
P60,000
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Proceeds of bank loan
Cash paid for dividends
Net cash received from (used in) financing activities
Net increase in cash and cash equivalent
Cash and cash equivalent, January 1, 2014
Cash and cash equivalent, December 31, 2014
200,000
(39,000)
221,000
P225,000
120,000
P345,000
Illustrative Problem B
ABC Company provides the following income statement for the year 2014:
Sales
Cost of sales
Gross profit
Depreciation expense
Salaries expense
Other operating expenses
Interest expense
Profit before taxes
Income taxes
Profit
P4,180,000
2,275,000
P1,905,000
(190,000)
(600,000)
(437,500)
(61,000)
P 616,500
(184,950)
P 431,550
In addition, the following balance sheet information is available:
12.31.14
P275,000
310,000
27,000
245,000
Accounts receivable
Inventory
Prepaid other expenses
Accounts payable
Additional information:
Income taxes paid amounted to P60,000
Interest paid amounted to P62,500
Proceeds from sale of equipment at carrying value, P50,000
Cash paid to purchase and equipment, P75,000
Collection of loans receivable, P100,000
Proceeds from issuance of share capital, P80,000
Repayment of of bank loan, P150,000
Payment of dividends, P50,000
Cash and cash equivalent, January 1, 2014, P350,000
A statement of cash flow using the indirect method is presented on the next page.
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12.31.13
P127,500
325,000
23,500
225,000
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ABC Company
Statement of Cash Flow
For the Year Ended December 31, 2014
Cash flows from operating activities:
Profit before taxes
Add (deduct):
Depreciation expense
Interest expense
Operating income before woking capital changes
Increase in accounts receivable
Decrease in inventory
Increase in prepaid other expenses
Increase in accounts payable
Cash generated from operations
Interest paid
Income taxes paid
Net cash provided by (used in) operating activities
Cash flows from investing activities:
Proceeds from sale of equipment
Collection of loans receivable
Purchase of equipment
Net cash received from (used in) investing activities
Cash flows from financing activities:
Proceeds from issuance of share capital
Repayment of bank loan
Payment of dividend
Net cash received from (used in) financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents, January 1, 2014
Cash and cash equivalents, December 31, 2014
Notes:
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P431,550
190,000
61,000
P682,550
(147,500)
15,000
(3,500)
20,000
P566.550
(62,500)
(60,000)
P444,050
P 50,000
100,000
(75,000)
P 75,000
P 80,000
(150,000)
(50,000)
(120,000)
P399,050
350,000
P749,050
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
The cash and cash equivalents at December 31, 2014 is the amount that is report in the
December 31, 2014 balance sheet.
 The direct and the indirect methods differ only in the presentation of the cash flows
from operating activities section; the investing and financing activities sections are
presented similarly under the two methods.
A more in-depth analysis of transactions that should be presented in the statement of cash flows
is discussed in intermediate accounting. In this chapter, the details of cash receipts and cash
payments are given for problem solving purposes.
NOTES TO FINANCIAL STATEMENTS
Notes to financial statements include narrative descriptions or more detailed analyses of amounts
shown on the face of the financial statements. The notes include information required and
encouraged to be disclosed by PASs and PFRSs and other disclosures necessary to achieve fair
presentation.
Notes are considered an integral part of the financial statements which contains the following
information:

the basis of preparation of the financial statements and the specific accounting policies
used;
 Accounting policies are the specific principles, bases, conventions, rules and
practices applied by an entity in preparing and presenting financial statements.
 information required by PFRSs that is not presented elsewhere in the financial
statements; or
 additional information that is not presented elsewhere in the financial statements, but is
relevant to an understanding of any of them.
Notes must present information in a systematic order and cross referenced to statement of
financial position, statement of comprehensive income (or income statement if presented
separately), statement of changes in equity and statement of cash flows. Following is the
recommended order of presentation of information in the notes stated in PAS 1, par. 114:




statement of compliance with PFRS;
summary of significant accounting policies applied;
supporting information for items presented in the statement of financial position and of
comprehensive income (or in the income statement if presented separately), and in the
statement of changes in equity and of cash flows, in the order in which each statement
and each line item is presented; and
other disclosures, including:
 contingent liabilities (PAS 37) and unrecognized contractual commitment; and
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
non-financial disclosures, such as the entity's financial risk management
objectives and policies (PFRS 7)
The following should also be disclosed by management:

Management judgments made in applying accounting policies with significant effects on
amounts recognized
 Key assumptions concerning the future and key sources of estimation uncertainty that
have a significant risk of causing material adjustments to carrying amount of assets and
liabilities within the next financial year
Other required disclosures include

Company information:
 Domicile, legal form, country of incorporation, address
 Description of nature operations and activities
 Name of parent enterprise
 Name of ultimate parent enterprise of the group
 Amount of dividends proposed or declared before the financial statements were
authorized for issue but not recognized as a distribution during the period, and the related
amount per share
 Amount of any cumulative preference dividends not recognized
FINANCIAL STATEMENT ANALYSIS
Financial statements provide information into the entity's current status and lead to the
development of policies and strategies for the future.
RATIO ANALYSIS
Ratios express the mathematical relationships between one quantity and another, in terms of a
rate, a proportion, or a percentage. For example, the ratio of gross profit to sales is 60% or the
ratio of current assets to current liabilities is 2.5:1. Ratio analysis expresses the relationship
among selected financial statement data. Ratios are used to evaluate the financial health and
performance of a company. To make them more meaningful, however, three types of
comparisons may be made:

Intra company comparisons is- comparing one period with another period, such as
comparing 2014 with 2013.
 Intercompany comparisons - comparing one company with another company or with
other companies in the same industry.
 Industry average comparison comparing an entity's computed ratios with industry
standards.
Ratios can be grouped into the following: liquidity ratios, solvency ratios, and liquidity ratios.
Each of these is discussed below.
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Liquidity ratios measure the short-term ability of the entity to pay its maturing obligations and to
meet unexpected needs for cash. The measures that can be used to determine the liquidity of an
entity are the current ratio, the quick or acid -test ratio, the current cash debt coverage ratio, the
receivables turnover ratio, the average collection period, the inventory turnover ratio, and the
days in inventory.
Solvency ratios measure the ability of the entity to survive over a long period of time, that is, its
ability to pay interest as it come due and to repay the face value of obligations or debt at
maturity. The measures that can be used to determine the solvency of an entity are the debt to
total assets ratio, the time interest earned ratio, the cash debt coverage ratio and free cash flow.
Profitability ratios measure the profit or operating success of an entity for a given period of time.
An entity's ability or inability to generate profit has several consequences - it affects an entity's
liquidity position and its ability to grow; hence, affecting its ability to obtain loans and to attract
investors. The measures that can be used to determine the profitability of an entity are the return
on ordinary shareholder’s equity ratio, the return on assets ratio, the profit margin ratio, the
earnings per share, the price-earnings ratio, and the payout ratio.
A summary of these ratios, the formula to calculate them and other uses are presented below and
on the next page.
LIQUIDITY RATIOS
Ratio
Formula
Purpose of the ratio
Measures short-term debt paying
ability
Current ratio
Current assets
Current liabilities
Quick or acid-test ratio
Cash, short-term investment, and
net receivables
Current liabilities
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The ratio expresses the relationship of
current assets to current liabilities. It
represents the amount of current assets
available for every peso of current
liability
Measures immediate short-term
liquidity
The ratio represents the amount of
quick assets available for every peso of
current liability
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Current cash debt
coverage ratio
Net cash provided by
operating activities
Average current liabilities
Measures an entity’s ability to pay off
its current liabilities in a given year of
operations
The ratio represents the amount of cash
available from current operations for
every peso of current liability
Measures liquidity of receivables
Receivable turnover
ratio
Net credit sales
Average trade receivables (net)
The ratio measures the number of
times, on average, receivables are
collected during the period
Measures the collection efficiency of
the entity
Average collection
period
365 days
Receivable turnover ratio
The computed period indicates the
average number of days before
receivables are collected
LIQUIDITY RATIOS
Ratio
Formula
Purpose of the ratio
Measures liquidity of inventory
Inventory turnover
ratio
Cost of goods sold
Inventory turnover ratio
Number of days in
inventory
365 days
Inventory turnover ratio
The ratio measures the number of
times, on average, inventory is sold
during the period
Measures the sales efficiency of the
entity
The computed number of days
indicates the length of time spent
before inventories are sold to customers
SOLVENCY RATIOS
Ratio
Formula
Purpose of the ratio
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Measures total assets provided by
creditors
Debt to total assets
Total liabilities
Total assets
Debt to equity ratio
Total liabilities
Total owner’s equity
Cash debt coverage
ratio
Net cash provided by
operating activities
Average total liabilities
Times interest
earned
The ratio indicates the degree of
financial leveraging. It provides
indication of the ability of an entity to
survive losses without impairing the
interest of its creditors
Profit before interest
charges and taxes
Interest charges
Measures the percentage of total
liabilities to total equity
Measures an entity’s ability to repay its
total liabilities in a given year of
operations
Measures ability to meet interest
payments as they come due
PROFITABILITY RATIOS
Ratio
Formula
Purpose of the ratio
Measures profit generated by each
peso of sales
Profit margin on
sales
Profit
Net sales
Rate of return on
assets
Profit
Average total assets
The amount of profit generated by
every peso of sales. It can also be
interpreted as the percentage of profit
generated in relation to net sales
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Measures overall profitability of
assets
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Rate of return on
owner’s equity
Profit
Average owner’s equity
Earnings per share
Profit minus earnings attributed to
preference shares
Average outstanding ordinary
shares
Price-earnings ratio
Market price of share capital
Earnings per share
Payout ratio
Cash dividends
Profit
Asset turnover ratio
Net sales
Average total assets
Measures profitability of owner’s
investment
Measures profit earned for each
ordinary share capital
Measures the ratio of the market price
per share to earnings per share
Measures percentage of earnings
distributed in the form of cash
dividends
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Measures the effectiveness of asset
utilization
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REVIEW of the LEARNING OBJECTIVES
1. Explain the nature of the financial statements and the over-all considerations in their
preparation and presentation.

Financial statements are a structured representation of the financial position and financial
performance of an entity.


Financial statements are the end product of the accounting process
Financial statements show the results of the management's stewardship of the resources
entrusted to it.

Financial statements are the means by which the information accumulated and the
processed in financial accounting is periodically communicated to those who use it.

The preparation and presentation of financial statements is a responsibility of
management.
The over-all considerations in the preparation and presentation of financial statements are as
follows:
 Fair presentation and compliance with PFRS
 Going Concern
 Accrual basis of accounting
 Frequency of reporting
 Materiality an aggregation
 Offsetting
 Consistency of presentation
 Comparative information
2. Identify and explain the components of a complete set of financial statements. A complete
set of financial statements is composed of the following: (1) statement of financial position
(balance sheet), (2) income statement, (3) statement of comprehensive income, (4) statement of
cash flows, (5) statement of changes in equity, and (6) notes and other disclosures. Alternatively,
a single statement of income and comprehensive income may be prepared.
The statement of financial position shows the entity's assets, liabilities, and equity at a point in
time. The statement of financial position has the following three primary elements: assets,
liabilities and equity.
The income statement shows the performance of an entity incurred at a given period. It reports
the income earned and the expenses incurred at a particular period of time. The statement has
two primary elements: income and expenses.
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The statement of comprehensive income reports items of income and expenses which are not
required by other PASs and PRFSs to be recognized in profit or loss, such it changes in
revaluation model and gains and losses arising from changes in fair value of available for sale
securities.
The statement of changes in equity reports transactions affecting the various equity accounts,
such as the profit or loss for the period, dividends declared, additional issuances of share capital,
and acquisition treasury shares.
The statement of cash flows provides information about the cash receipts and cash disbursements
of an entity that occurred during a period. It summarizes the transactions that caused a change in
the cash equivalents balance during a reporting period.
The notes include narrative descriptions or more detailed analyses of amounts shown on the face
of the financial statements.
3. Explain and appreciate the importance of the statement of cash flows. The statement of
cash flows provides the following benefits:

it provides information that enables the users to evaluate the changes in the assets of an
entity, its financial structure and its ability to affect the amounts and timing of cash flows
in order to adopt to changing circumstances and opportunities;

it provides information that is useful in assessing the ability of the entity to generate cash
and cash equivalents and enables users to develop models to assess and compare the
present value of the future cash flows of different entities;

it enhances the comparability of the reporting of operating performance by different
entities because it eliminates the effects of using different accounting treatments for the
same transactions and events.
4. Describe and explain the classification of cash flows and the methods of presenting cash
flows from operating activities. Cash flows are classified to make the statement more
meaningful to the investors and creditors by enabling them to determine the type of transaction
that gave rise to each cash flow. Cash flows are categorized into three: (a) operating activities;
(b) investing activities; and (c) financing activities.
Operating activities. Cash flows from operating activities are derived from the principal
revenue-producing activities of an entity.
Investing activities. Cash flows from investing activities include cash inflows and outflows of
cash related to the acquisition and disposition of long term assets used in the operations of the
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business and investment assets.
Financing activities. Cash flows from financing activities include cash inflows from borrowings
and contributions by investors and cash outflows for repayment of loans, retirement of share
capital, acquisition of treasury shares and payment of cash dividends.
Cash flows from operating activities may be presented using the direct method or the indirect
method. Under the direct method, the major classes of gross receipts and gross cash payments
are disclosed in the statement. Under the indirect method, the net cash flow from operating
activities is determined by adjusting profit or loss for the effects of non-cash revenue and
expense items and gain and losses.
4. Explain and appreciate the types of ratio analysis. Ratios express the mathematical
relationships between one quantity and another, in terms of a rate, a proportion, or a percentage.
For example, the ratio of gross profit to sales is 45% or the ratio of current assets to current
liabilities is 2:5:1. Ratio analysis expresses the relationship among selected financial statement
data. Ratios are used to evaluate the financial health and performance of a company.
Ratios can be grouped into the following: liquidity ratios, solvency ratios, and liquidity ratios.
Each of these is discussed below.
Liquidity ratios measure the short term ability of the entity to pay its maturing obligations and to
meet unexpected needs for cash. Solvency ratios measure the ability of the entity to survive over
a long period of time, that is, its ability to pay interest as it come due and to repay the face value
of obligations or debt at maturity. Profitability ratios measure the profit or operating success of
an entity for a given period of time. An entity's ability or inability to generate profit has several
consequences -- it affects an entity's liquidity position and its ability to grow; hence, affecting its
ability to obtain loans and to attract investors.
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DISCUSSION QUESTIONS
1. Who are responsible in the preparation of financial statements?
2. What are the components of a complete set of financial statements? Describe each of them.
3. Identify and describe the nature of the elements of financial statements.
4. What are the overall considerations in the preparation and presentation of financial
statements?
5. Why is the statement of cash flows important? How does it help financial statement users
make decisions?
6. Identify and differentiate the three types of activities that give rise to cash inflow and cash
outflow.
7. Why are ratios important? Differentiate liquidity from solvency.
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EXERCISES
Exercise 11-1 (Classification of statement of financial position accounts)
ABC Company uses the following classification in its statement of financial position:
a. Current assets.
f. Current liabilities
b. Long term investments.
g. Noncurrent liabilities
c. Property, plant and equipment
e. Other assets.
h. Contributed capital
i. Retained earnings
Instructions: For each of the following 2014 balance sheet items, use the letters above to indicate
the appropriate classification category. If the item is a contra account, place a minus sign (-)
before the chosen letter (for example: -b)
_____ 1. Office supplies
_____ 2. Buildings
_____ 3. Patent
_____ 4. Trading securities
_____ 11. Cash
_____ 12. Salaries payable
_____ 13. Ordinary shares
_____14. Held to maturity securities
_____ 5. Accumulated depreciation.
_____15. Deferred tax assets
_____ 6. Cash equivalents
_____16. Machinery
_____ 7. Unearned revenue
_____17. Franchise
_____ 8. Bond sinking fund
_____18. Bonds payable, due in 20 years
_____ 9. Prepaid insurance
_____19. Preference share
_____ 10. Interest payable
_____20. Bank loan due in 5 years
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Exercise 11-2 (Components of the statement of financial position)
CDE Company's trial balance include the following account balances at December 31, 2014, the
end of its fiscal year:
Cash
320, 000
Inventories
Accounts receivable 220,000
500,000
Accounts payable
280,000
Interest payable
60,000
Ordinary shares
1,000,000
Equipment (net 0)
Wages payable
Note payable
1,700,000
180,000
600,000
Instructions: compute for the following:
1. Total current assets
2. Total current liabilities
3. Total assets
4. Retained earnings
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Exercise 11-3 (Classification of activities in the cash flow statement)
Classify each of the following items as an operating, investing, or financing activity.
Assume all items involve cash unless otherwise stated.
1. Purchase of computer
2. Payment of salaries
3. Collection from customers
4. Purchase of merchandise
5. Sale of old equipment
6. Payment of interest on loan
7. Collection of note receivable
8. Issuance of share capital
9. Payment of dividends
10. Depreciation
Exercise 11-4 (Cash from operating activities)
EFG Company reported a profit of P500,000 in 2014. The following information were provided
by the company in relation to preparation of the statement of cash flows:
Depreciation - P50,000
Decrease in accounts receivable - P70,000
Decrease in accounts payable - P60,000
Loss on sale of equipment - P10,000
Instructions: Compute the net cash provided by operating activities using the indirect method.
466
467
Exercise 11-5 (Cash from financing activities)
The following T-account is a summary of the cash account of the GHI Corp.
Cash
Balance, Jan. 1
160,000
Receipt from customers
7,280,000
Dividends on stock investment
120,000
Proceeds from sale of equipment
720,000
Proceeds from issuance of bonds
4,000,000
Instructions:
Compute for the net cash provided
Payment for goods acquired
4,000,000
Payment for operating expenses
2,800,000
Interest paid
200,000
Taxes paid
160,000
Dividends paid
1,000,000
(used) by financing activities.
467
467
Exercise 11-6 (Ratio analysis)
The following balances were taken from the most recent statement of financial position of HIJ
Company:
Cash
P160,000
Inventories
P300,000
Other current assets 150,000
Current liabilities 600,000
Short-term investments 180,000
Accounts receivable
250,000
Instructions: Compute for the following:
1. Current ratio
2. Acid/test ratio
Exercise 11-7 (Ratio Analysis)
The following data were taken from the financial statements of JKL Corp.:
2014
2013
Accounts receivable (net), end of year
P 745,000
Accounts receivable (net), beginning of year
Net sales on account
Purchases
650,000
7,800,000
Beginning merchandise inventory
4,750,000
Ending merchandise inventory
720,000
7,000,000
1,000,000
850,000
4,600,000
1,100,000
Term for all sales is 1/10, n/45
Instructions:
1. Compute for the following:
a. Receivable turnover ratio
467
1,000,000
468
b. Average collection period
c. Inventory turnover ratio
d. Number of days in inventory
2. Evaluate the company's receivable and inventory management
Exercise 11-8 (Ratio Analysis)
The following data were taken from the financial statements of LMN Company:
2014
Net sales
2013
P6,000,000
Cost of goods sold
Net profit
4,200,000
150,000
Receivables, net
3,800,000
100,000
67,000
Merchandise inventory
Total assets
P5,500,000
67,500
1,525,000
3,500,000
1,400,000
3,000,000
Total ordinary shareholders' equity 1,260,000
1,025,000
Instructions: Compute for the following:
1. Profit margin on sales
2. Rate of return on total assets
3. Asset turnover ratio
4. Rate of return on ordinary shareholders equity
5. Gross profit rate
6. Receivable turnover ratio
7. Average collection period
468
PROBLEMS
Problem 11-1 (Classified Statement of Financial Position)
The following listed data were taken from the most recent balance sheet of NOP Corp. some of
the amounts were intentionally omitted
Cash and cash equivalents
P2,400,000
Short-term investments
3,500,000
Accounts receivable, net
5,000,000
Inventories
?
Prepaid expenses (current)
80,000
Total current assets
15,950,000
Non current receivables
1,105,000
Property, plant and equipment
Total assets
?
?
Notes payable and other short-term obligations
Accounts payable
Accrued liabilities
?
4,218,000
Other current liabilities
1,815,000
Total current liabilities
6,935,000
Non current liabilities and deferred taxes
Total liabilities
Total shareholders equity
Instructions:
1. Determine the missing amounts
312,500
?
9,560,000
13,700,000
1
2. Prepare a properly classified statement of financial position for NOP Corp.
Problem 11-2 (Statement of cash flows)
The following transactions were reported for PQR during the year 2014
Where reported
Transaction
on the statement
Cash inflow
outflow/no effect?
a. Acquired an equipment for cash
b. Paid salaries of employees
c. Recorded depreciation on the plant assets
d. Issued ordinary shares
e. Paid dividends to ordinary shareholders
f. Paid bank loan
g. Purchased merchandise on account
h. Sold merchandise on account
i. Realized a gain on sale of plant assets
j. Purchased securities classified as held-to
maturity
Instructions: Fill up the table below by indicating whether the transaction (1) should be reported
as an operating (O) activity, investing (I) activity, financing (F) activity, or as a non cash (NC)
transaction reported in a separate schedule, and (2) represents a cash inflow or cash outflow or
has no cash effect. The company uses the indirect method in presenting the cash flow from
operating activities.
Problem 11-3 (Statement of cash flows)
Present med below are the financial statements of RST Company:
2
RST Company
Comparative Statements of Financial Position
December 31
Assets
Cash
2014
P 620,000
Accounts receivable
P 400,000
760,000
Merchandise inventory
280,000
540,000
Property, plant and equipment
Accumulated depreciation
Total
2012
400,000
1,200,000
1,560,000
(600,000) (480,000)
P 2,520,000 P 2,160,000
Liabilities and shareholders' equity
Account payable
Income taxes payable
Bond payable
Ordinary share capital
Retained earnings
Total
P 580,000
P 300,000
140,000
540,000
160,000
660,000
360,000
900,000
280,000
760,000
P 2,520,000 P 2,160,000
RST Company
Income Statement
For the Year Ended December 31, 2014
3
Sales
Cost of goods sold
Gross profit
Selling expenses
Administrative expenses
Interest expense
Profit before tax
Income tax
Profit for the period
P 4,840,000
3,500,000
P 1,340,000
P 360,000
120,000
60,000
540,000
P 800,000
120,000
P 680,000
Additional information:
1. Dividends declared and paid were P540,000
2. During the year, equipment was sold for P170,000 cash. This equipment was originally
acquired for P360,000 and has a book value of P170,000 on the date of sale.
3. All depreciation expense is included in the selling expenses total
4. All sales and purchases are on account
Instructions: Prepare a statement of cash flows using the indirect method
Problem 11-4 (Ratio analysis)
The comparative financial statements of STU Inc. are presented on the next page.
4
STU Company
Comparative Statement of Financial Position
December 31
Assets
2014
2013
Current assets:
Cash
P 1,202,000
P 1,284,000
Short-term investments
1,080,000
1,000,000
Accounts receivable (net)
2,156,000
2,056,000
Inventory
2,860,000
2,310,000
P 7,298,000
P 6,650,000
12,506,000
10,406,000
P 19,804,000
P 17,056,000
P 3,400,000
P 2,908,000
870,000
840,000
P 4,270,000
P 3,748,000
Bonds payable
4,200,000
4,000,000
Total liabilities
P 8,470,000
P 7,748,000
Total current assets
Property, plant and equipment (net)
Total assets
Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable
Income taxes payable
Total current liabilities
5
Shareholders’ equity
Ordinary share capital
P 5,600,000
P 6,000,000
5,734,000
3,308,000
P 11,334,000
P 9,308,000
P 19,804,000
P 17,056,000
Retained earnings
Total shareholders’ equity
Total liabilities and shareholders’ equity
STU Company
Comparative Income Statement
For the Years Ended December 31
2014
Net sales
2013
P 38,370,000
P 35,010,000
20,110,000
19,920,000
Gross profit
P 18,260,000
P 15,090,000
Selling and administrative expenses
( 10,120,000)
( 9,580,000)
Interest expense
(
(
Cost of goods sold
Profit before tax
Income tax
Profit for the period
500,000)
380,000)
P 7,640,000
P 5,130,000
2,288,000
1,540,000
P 5,352,000
P 3,590,000
All sales were on account. Net cash provided by operating activities for 2014 was P6,040,000.
6
Instructions: Compute the following ratios for 2014 (round off answers to two decimal places):
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
Earning per share
Return on ordinary shareholders’ equity
Return on assets
Current ratio
Receivables turnover ratio
Average collection period
Inventory turnover ratio
Number of days in inventory
Number of times interest was earned
Asset turnover ratio
Debt to total assets ratio
Debt to equity ratio
Cash debt coverage ratio
Problem 11-5 (Ratio Analysis)
Selected data from the 2014 consolidated financial statements for the GHI Corp. and JKL
Company are presented below (in millions of pesos).
GHI
JKL
Total current assets
16,792
13,860
Total current liabilities
15,772
12,830
Net sales
42,088
53,942
Cost of goods sold
15,524
24,758
Profit
8,694
7,136
Average (net) receivables for the year
4,188
5,362
Average inventories for the year
2,546
2,754
Average total assets
51,748
48,802
Average ordinary shareholders’ equity
25,890
21,426
Average current liabilities
15,228
12,468
Average total liabilities
25,858
27,404
7
Total assets
54,684
50,654
Total liabilities
26,504
26,906
Income taxes
2,296
2,848
356
326
10,912
8,656
Interest expense
Cash provided by operating activities
8
Instructions (Round all computations to 2 decimal places.)
1. Compute the following liquidity ratios for 2014 for the competitor companies and comment
on
their
relative
liquidity.
a. Current ratio
b. Receivable turnover
c. Average collection period
d. Inventory turnover
e. Days in inventory
f. Current
cash
debt
coverage
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
2. Compute the following solvency ratios for the two companies and comment on their relative
solvency.
a. Debt to total assets ratio
b. Times interest earned
c. Cash debt coverage ratio
3. Compute the following profitability ratios for the two companies and comment on their
relative profitability.
a. Profit margin
b. Asset turnover
c. Return on assets
d. Return on ordinary shareholders’ equity
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
MULTIPLE CHOICE
MC 11-1
The structured financial representation of the financial position of and the
transactions undertaken by an enterprise are called
a.
b.
c.
d.
MC 11-2
The financial statement that shows the results of management’s stewardship of the
resources entrusted to it is the
a.
b.
c.
d.
MC 11-3
management
accounting managers
internal auditor
independent auditor
The financial statement that shows the financial position of an entity is the
a.
b.
c.
d.
MC 11-5
statement of financial position
income statement
statement of cash flows
capital statement
The preparation and presentation of financial statements is a responsibility of
a.
b.
c.
d.
MC 11-4
financial reports
annual reports
financial statements
financial plans
statement of financial position
income statement
statement of cash flows
capital statement
The cash flows shown in the statement of cash flows are grouped into the
following major categories:
a.
b.
c.
d.
Operating activities, investing activities and financing activities
Cash receipts, cash disbursements and noncash activities
Operating activities, investing activities and collecting activities
Direct cash flows and indirect cash flows
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
Mc 11-6
Which is an example of a cash flow from an operating activity?
a.
b.
c.
d.
MC 11-7
Which is an example of a cash flow from an investing activity?
a.
b.
c.
d.
MC 11-8
Current cash debt coverage ratio
Current ratio
Both a and b
Neither a nor b
Which measure is an evaluation of the efficiency in managing inventories?
a.
b.
c.
d.
MC 11-11
P204,000
P224,000
P248,000
P272,000
Which measure is an evaluation of a company’s ability to pay current liabilities?
a.
b.
c.
d.
MC 11-10
Receipts of cash from the insurance of bonds payable
Payment of cash to repurchase outstanding share capital
Receipt of cash from the sale of equipment
Payment of cash to suppliers for inventory
The following information for AXN Corp.: Net profit for 2014 is P264,900,
account payable increased P20,000 during the year, inventory decreased P12,000
during the year, and accounts receivable increased P24,000 during the year. Under
the indirect method, what is the net cash provided by operations?
a.
b.
c.
d.
MC 11-9
Payment of cash to lenders for interest.
Receipt of cash from sale of capital stock.
Payment of cash dividends to the company’s shareholders
None of the above
Inventory turnover ratio
Number of days in inventory
Both a and b
Neither a nor b
Which if these is not a liquidity ratio?
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
a.
b.
c.
d.
Current ratio
Inventory turnover ratio
Receivable turnover ratio
Asset turnover ratio
MC 11-12 AB Company reported net profit of P480,000; net sales of P8,000,000; and
average assets of P12,000,000 for 2014. What is the profit margin for 2014?
a.
b.
c.
d.
6%
12%
40%
200%
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
CHAPTER 12
INTRODUCTION TO COST ACCOUNTING
LEARNING OBJECTIVES
1. Discuss the nature of cost accounting and differentiate a manufacturing company from a
service company and a merchandising company.
2. Identify the elements of manufacturing costs.
3. Discuss and understand the manufacturing cycle, including the journal entries to record
various transactions related to the cycle.
4. Prepare a Statement of Cost of Goods Manufactured and Sold.
PREVIEW OF THE CHAPTER
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
NATURE OF COST ACCOUNTING
Cost accounting, which is a specialized field of accounting, emphasizes the determination and
control of costs. It is concerned primarily with the costs of manufacturing processes and
manufactured products. Cost determination, also known as product costing, deals with measuring
the resources used to complete an activity or unit output. Cost control, on the other hand, is
management’s way of efficiently dealing with the activities that incur costs.
Though cost accounting is usually considered only to apply to manufacturing operations, every
type and size of organization should benefit from its use. It informs management promptly with
the cost of rendering a particular service, buying and selling a product, and producing a product.
Cost accounting principles, therefore, may be applied by financial institutions, transportation
companies, churches, schools, governmental units, as well as the non-manufacturing activities of
manufacturing firms.
COMPARISON OF SERVICE, MERCHANDISING AND
MANUFACTURING ORGANIZATIONS
Providing a service to a client in an accounting firm or repairing a television set in a repair shop
has strong similarities to manufacturing tables and chairs in spite of different physical settings. In
a service industry, resources are brought together to provide the service, just as they are brought
together to create a product in a factory environment.
Differences in measuring profits for the various types of organizations are largely a function of
inventoried costs. Service firms have only supplies in inventories. Merchandising firms buy and
sell products and hold merchandise inventories. Manufacturing firms buy materials and convert
these inputs into saleable products. Inventories in a manufacturing firm include the following:
1. Raw materials inventory - yet-to-be used materials
2. Work in process inventory - partially completed products
3. Finished good inventory - completed and ready-to-sell products
ELEMENTS OF MANUFACTURING COST
A manufacturing company differs primarily from a merchandising company from the standpoint
of converting or transforming the good purchased, called raw materials, into another form of
product before selling them. The process of converting or transforming materials into another
form of product is called the manufacturing process. The manufacturing process involves the
three cost elements: direct materials, direct labor, and factory overhead. The sum of these three
cost elements is the manufacturing cost, often called production cost or factory cost.
Direct materials include all the materials that form an integral part of the finished product
whose value is relatively high and that can be included directly in calculating the cost of the
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
product. Examples are the lumber and steel used to make classroom tablet chairs. Materials
needed for the completion of a product but do not form an integral part of the finished product or
whose amount is so minimal may be classified as indirect materials.
Direct labor is labor expended to convert direct materials into a finished product. It has to be
traceable to the finished product though need not be relatively high in amount. Example is the
wage of the machine operator cutting and assembling the lumber and steel used in the production
of classroom tablet chairs. The salary of a supervisor which cannot be traced to a product is
indirect labor.
Factory overhead, also called manufacturing overhead, manufacturing expenses or factory
burden, include all manufacturing cost other than direct materials and direct labor. It includes
indirect materials, indirect labor and all other cost that cannot be charged directly to specific
products or job or order.
Example of indirect materials are factory supplies and lubricants. Examples of indirect labor are
supervision; inspection; salaries of factory clerks, janitors and security guards; defective and
experimental work. Examples of other indirect costs are factory rent; depreciation of machinery
and factory building; maintenance and repairs; heat, light and power; employee factory payroll
taxes; small tools and other miscellaneous factory overhead.
MANUFACTURING CYCLE
Cost accounting consists of a system that is concerned with precise recording and measurement
of cost elements as they originate and flow through the production processes. There are two
accounting systems that may be employed by manufacturing firms, namely: (1) Cost system or
perpetual inventory system, and (2) Non-cost system or periodic inventory system. The
manufacturing process and the physical arrangement of the factory are the basis for determining
the cost accumulation procedures.
The non-cost system or periodic inventory system will be used to illustrate the entries in the
manufacturing cycle. Under this system, there is no detailed flow of cost in the manufacturing
process. The inventory of raw materials, work in process and finished goods are determined
based on physical count of quantities on hand at the end of the accounting period. These
inventories, together with the purchases, labor and overhead, are used to compute for the cost of
materials used in production, cost of goods manufactured and transferred to finished goods, and
cost of goods sold during the period.
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
Assuming the use of the voucher system, the following are the pro-forma journal entries in the
manufacturing cycle.
1. Purchase and receipt of raw materials and indirect materials on account
Raw Materials Purchases
xxx
Indirect Materials
xxx
Vouchers Payable
xxx
2. Freight and handling cost of materials
Freight-in
Vouchers Payable
xxx
3. Return of defective materials to suppliers
Vouchers Payable
Purchase Returns and Allowances
xxx
4. Payment of account within the discount period
Vouchers Payable
Cash
Purchase Discounts
xxx
xxx
xxx
xxx
xxx
5. Requisition of raw materials for production and indirect materials for factory use
No entry
6. Return to storeroom of excess raw materials from production and indirect materials for
factory use
No entry
7. Recording to payroll
Direct Labor
Indirect Labor
Administrative Salaries
Sales Salaries
Withholding Taxes Payable
SSS Contributions Payable
Medicate Contributions Payable
Pag-ibig Contributions Payable
Vouchers Payable
8.
Payment of payroll
Vouchers Payable
Cash
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
9. Recording of employer's payroll taxes
Factory Payroll Taxes
Administrative Payroll Taxes
Sales Payroll Taxes
SSS Contributions Payable
Medicare Contributions Payable
Pag-ibig Contributions Payable
xxx
xxx
xxx
xxx
xxx
xxx
10. Recording of other factory costs incurred
Repairs and Maintenance Factory
Utilities - Factory
Vouchers Payable
xxx
xxx
11. Payment of other accounts
Vouchers Payable
Cash
xxx
xxx
xxx
12. Transfer of completed work to finished goods storeroom
no entry
13. Sale of finished goods on account
Accounts Receivable
Sales
xxx
14. Recording of returns by customers
Sales Returns and Allowances
Accounts Receivable
xxx
15. Collection of accounts receivable within the discount
period
Cash
Sales Discounts
Accounts Receivable
xxx
xxx
xxx
xxx
xxx
16. Adjusting entries. Adjustment to update the balances of accounts at the end of fiscal period
may include the following:
a. Adjustment for accrual of payroll
Direct Labor
Indirect Labor
Administrative Salaries
Sales Salaries
Accrued Payroll
xxx
xxx
xxx
xxx
xxx
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
b. Adjustment for factory depreciation
Depreciation Expense - Machinery
Depreciation Expense - Factory Building
Accumulated Depreciation-Machinery
Accumulated Depreciation- Factory Building
c. Adjustment for other factory costs
Miscellaneous Factory Overhead
Accrued Expenses
d. Adjustment for office and store depreciation
Depreciation Expense-Office Building
Depreciation Expense- Store Building
Accumulated Depreciation - Office Building
Accumulated Depreciation - Store Building
e. Adjustment for other expenses
Doubtful Accounts Expense
Miscellaneous Administrative Expenses
Miscellaneous Selling Expenses
Allowance for Doubtful Accounts
Accrued Expenses
f. Adjustment for income taxes
Income Taxes
Income Tax Payable
17.
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
Closing entries. A Manufacturing Summary account is used to summarize all the
transactions affecting the computation of cost of goods manufactured. The account is
debited to close the balances of raw materials beginning inventory work in process
beginning inventory and all other manufacturing accounts. On the other hand, the account
is credited to set up the balances of raw materials ending inventory, and work in process
ending inventory. The closing entries at the end of the accounting period of the company
shall consist of the following:
a. Closing of beginning inventories
Manufacturing Summary
Raw Materials Inventory, beginning
Work in Process Inventory, beginning
b. Recording of ending inventories
Raw Materials Inventory, end
Work in Process Inventory, end
Manufacturing Summary
xxx
xxx
xxx
xxx
xxx
xxx
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
c. Closing of other manufacturing accounts
Manufacturing Summary
Purchases Returns and Allowances
Purchases Discounts
Raw Materials Purchases
Freight-in
Direct Labor
Indirect Materials
Indirect Labor
Factory Payroll Taxes
Repairs and Maintenance- Factory
Utilities - Factory
Depreciation Expense- Machinery
Depreciation Expense – Factory Building
Miscellaneous Overhead
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
d. Closing of beginning inventory of finished goods
Income Summary
Finished Goods Inventory, beginning
xxx
e. Recording of ending inventory of finished goods
Finished Goods Inventory, end
Income Summary
xxx
xxx
xxx
f. Closing of the balance of Manufacturing Summary (which represents cost of goods
manufactured) and all other revenue and expense accounts
Sales
xxx
Manufacturing Summary
xxx
Sales Discounts
xxx
Sales Returns and Allowances
xxx
Administrative Salaries
xxx
Administrative Payroll Taxes
xxx
Doubtful Accounts Expense
xxx
Depreciation Expense -Office Equipment
xxx
Miscellaneous Administrative Expenses
xxx
Sales Salaries
xxx
Sales Payroll Taxes
xxx
Depreciation Expense - Store Equipment
xxx
Miscellaneous Selling Expenses
xxx
Income Taxes
xxx
Income Summary
xxx
g. Closing of the balance of Income Summary to Retained Earnings
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
Income Summary
Retained Earnings
xxx
xxx
REPORTING RESULTS OF OPERATIONS
The result of operations of a manufacturing enterprise is reported in the conventional financial
statements. These statements summarize the flow of accounts and revenues show the financial
position at the end of the fiscal period, and report the sources of cash inflows and cash outflow
during the fiscal period.
In the income statement, the Cost of Goods Sold is shown in one figure. Although this procedure
is followed in published reports, internal users need additional information. Therefore, a
supporting schedule of the Cost of Goods Manufactured is usually prepared. A pro-forma
Statement of Cost of Goods Manufactured and Sold that contains all possible includable items is
presented below.
Luzon Manufacturing Company
Statement of Cost of Goods Manufactured and Sold
For the Year Ended December 31, 2010
Direct Materials:
Raw Materials Inventory, beginning
Raw Materials Purchases
Add Freight-in
Delivered Cost of Materials Purchases
Less: Purchases Returns and Allowances
Purchases Discounts
Materials Available for Use
Less: Indirect Materials Used
Materials Inventory, end
Direct Materials Used
Direct Labor
Factory Overhead:
Indirect Materials
Indirect Labor
Factory Payroll Taxes
Depreciation - Machinery and Factory Building
Utilities -Factory
Repairs and Maintenance
Miscellaneous Factory Overhead
Total Manufacturing Cost
Add Work in Process, beginning
Total Cost of Work Put into Process
Less Work in Process, end
Cost of Goods Manufactured
Add Finished Goods, beginning
Pxxx
Pxxx
xxx
Pxxx
Pxxx
xxx
xxx
Pxxx
xxx
xxx
Pxxx
xxx
Pxxx
xxx
Pxxx
xxx
xxx
xxx
xxx
xxx
xxx
Pxxx
xxx
Pxxx
xxx
Pxxx
xxx
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
Cost of Goods Available for Sale
Pxxx
Less Finished Goods, end
xxx
Cost of Goods Sold
xxx
The sum of direct materials, direct labor and factory overhead is total manufacturing cost or
factory cost. The sum of direct materials and direct labor, however, is called rime cost; the sum
of direct labor and factory overhead is called conversion cost. Manufacturing cost is different
from cost of goods manufactured because the latter process beginning and work in process
ending inventories. Cost of fore, is the cost of the completed products during an accounting
period.
On the Statement of Financial Position (balance sheet) of a manufacturing enterprise, the current
asset section is expanded to show the Inventories of Finished Goods, Work in Process and Raw
Materials. The balance in the Finished Goods account represents the total cost incurred in
manufacturing goods that are completed but still on hand (unsold) at the end of the period. The
balance of the Work in Process account includes all manufacturing costs incurred to date for
goods that are in various stages of production (not yet completed). The balance of the Raw
Materials account represents the cost of all materials purchased and on hand and to be used in the
manufacturing process (to be used in production) including raw materials, prefabricated parts
and other factory materials and supplies.
REVIEW of the LEARNING OBJECTIVES
1. Discuss the nature of cost accounting and differentiate a manufacturing company
from a service company and a merchandising company. Cost accounting is concerned
with the determination and control of costs. Although cost accounting is considered
applicable to manufacturing operations, it is also applied to non-manufacturing industries
such as financial institutions, transportation companies and schools. A service firm is
engaged primarily in the rendering of services while a merchandising firm is engaged in
the buying and selling of merchandise. A manufacturing firm, on the other hand, is
engaged in the purchase and processing of raw materials into finished goods. The three
firms also differ in the classes of inventories maintained. A service firm has operating
supplies inventory; a merchandising firm has merchandise inventory; a manufacturing
firm has three classes of inventories, namely: (1) raw materials, (2) work in process, and
(3) finished goods.
2. Identify the elements of manufacturing costs. There are three elements of manufacturing
costs, namely: (1) direct materials, (2) direct labor, and (3) factory overhead. Direct
materials form an integral part of the finished product and whose value is relatively high.
Direct labor can be traced to the finished product and is incurred to convert direct
materials into finished goods. Factory overhead included all indirect costs incurred in the
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
production of raw materials into finished goods. These costs include indirect materials
and indirect labor. Direct materials plus direct labor is prime cost; direct labor plus
factory overhead is conversion cost.
3. Discuss and understand the manufacturing cycle, including the journal entries to
record various transactions related to the cycle. The manufacturing cycle starts with the
purchase of raw materials and ends with the completion of goods. Direct materials issued
to production, direct labor cost and factory overhead costs go to work in process. Cost of
goods completed during the period are transferred from work in process to finished goods
while the cost of finished goods sold are transferred from the finished goods to cost of
goods sold.
4. Prepare a Statement of Cost of Goods Manufactured and Sold. The Statement of Cost
of Goods Manufactured and Sold is prepared as a supporting schedule to the amount
presented on the income statement. The statement shows the total manufacturing cost
incurred, the total cost of work put into process, the total cost of goods manufactured
during the period, the total cost of goods available for sale, and the total cost of goods
sold during the period.
GLOSSARY of ACCOUNTING TERMINOLOGIES
Conversion costs - sum of direct labor and factory overhead.
Direct labor
- labor used to convert direct materials into finished product and that can be
traced to the finished product
Direct materials - materials that form an integral part of a finished product and of relatively
high value and is included in the calculation of the cost of the product.
Factory overhead - manufacturing expenses or factory burden other than direct materials and
direct labor. Factory overhead includes indirect materials and indirect labor
Prime cost
- sum of direct materials and direct labor.
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
DISCUSSION QUESTIONS
1. How many different types of organizations benefit from cost accounting and principles?
2. In what ways does a typical manufacturing company differ from a service or a
merchandising firm? In what ways are the three similar?
3. What are the three elements of manufacturing costs?
4. Define the following costs: direct materials, indirect materials, direct labor, indirect
labor, and factory overhead.
5. Distinguish prime cost from conversion cost.
6. Differentiate the income statement of a manufacturing firm from that of a service firm
and a merchandising firm.
7. How are inventories determined in the non-cost system or periodic inventory system of
accounting for manufacturing companies?
8. Differentiate the Statement of Financial Position (balance sheet) of a manufacturing firm
from that of a service firm and a merchandising firm.
9. What is cost of goods manufactured? How does it relate to cost per unit?
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
EXERCISES
Exercise 12-1 (Financial Statement Presentation)
The Liwanag Manufacturing Company does not have a cost accounting system. From its
accounting records it prepares the following financial statements on a yearly basis (a) Income
Statement; (b) Retained Earnings Statement; (c) Statement of Financial Position.
Instructions: Indicate the financial statement in which each of the items given below will appear.
Use the appropriate letter or letters.
1. Direct Labor
11. Cost of Goods Manufactured
2. Raw Materials, January 1
12. Factory Maintenance Salaries
3. Work in Process, December 31
13. Depreciation- Delivery Equipment
4. Finished Goods, January 1
14. Cost of Goods Available for Sale
5. Indirect Labor
15. Direct Materials Used
6. Cost of Operating the Billing Dept.
16. Office Supplies Used
7. Depreciation - Office Building
17. Heat and Electricity for Factory
8. Depreciation- Machinery
18. Office Supplies
9. Finished Goods, December 31
19. Repairs to Roof of Factory Building
10. Work in Process, January 1
20. Cost of Raw Materials Purchases
Exercise 12-2 (Income Statement; Cost of Goods Sold Statement)
The accounting department of Lacbay Manufacturing Company provided the following data for
the month of April, 2010.
Sales
Marketing Expenses
Administrative Expenses
Raw Materials Purchases
Factory Overhead 2/3 of direct labor costs
Direct labor
Beginning inventories:
Finished Goods
Work in Process
Raw Materials
Ending inventories:
P1,440,000
5% of sales
1 % of sales
P 720,000
P 300,000
P 140,000
160,000
120,000
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
Finished Goods
Work in Process
Raw Materials
P 204,000
300,000
170,000
Instructions:
1. Prepare an income statement for the month of April.
2. Prepare a cost of goods sold statement.
Exercise 12-3 (Calculation of Manufacturing Cost Components)
The accountant of Lazam Corporation submits the following data for the month of June, 2010.
Raw Materials Put into Process
Direct labor cost:
Department A
Department B
Factory overhead:
Department A
Department B
Inventories:
Finished Goods
Work in Process
Raw Materials
Instructions: Determine the following amounts:
1. Raw materials purchased
2. Prime costs
3. Conversion costs
4. Total manufacturing costs
5. Cost of goods manufactured
6. Cost of goods sold
P240,000
140,000
160,000
120% of direct labor cost
80% of direct labor cost
June 1
P108,000
160,000
120,000
June 30
P120,000
128,000
150,000
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
Exercise 12-4 (Calculation of Missing Amounts)
The following information is available for three companies at the end of their fiscal years:
Company A:
Finished Goods, January 1
Cost of Goods Manufactured
Sales
Gross Profit on Sales
Finished Goods, December 31
P1,200,000
7,600,000
8,000,000
40%
?
Company B:
Freight-in
Purchases Returns and Allowances
Marketing Expenses
Finished Goods, December 31
Cost of Goods Sold
Cost of Goods Available for Sale
P 40,000
160,000
400,000
380,000
2,600,000
?
Company C:
Gross Profit
Cost of Goods Manufactured
Finished Goods, January 1
Finished Goods, December 31
Work in Process, January 1
Work in Process, December 31
Sales
P192,000
680,000
90,000
104,000
56,000
76,000
?
Instructions: Determine the amounts indicated by the question marks for each company
Exercise 12-5 (Journal Entries for a Manufacturing Company)
The following are selected transactions of the Liwanag Manufacturing Corp.:
a. Materials purchased on account, P80,000.
b. Materials requisitioned: P66,000 for production and P4,000 for indirect factory use.
c. Total gross payroll was P80,000, with withholdings of 12% income tax, 7.5% SSS and P280
Medicare.
d. The wages due to the employees were paid.
e. Of the total payroll, P64,000 was direct labor and P16,000 was indirect factory
f. An additional 10% is entered for employer's payroll taxes, representing 75%
g. Various factory overhead costs totaling P36,000 were incurred on account labor SSS, 0.8%
Medicare, and 1.7% employees' compensation.
h. Other factory overhead consisted of P4,200 depreciation, P1,560 expired insurance, and
P2,500 accrued property taxes.
i. Cost of completed production transferred to finished goods storeroom, P184, 000.
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
j. Sales on account were P 160,000, 50% of which was collected. The cost of goods sold was
75% of the sales price
Instructions: Prepare journal entries to record the preceding transactions and to close the
balances of manufacturing accounts. Assume the company uses the voucher system.
Exercise 12-6 (Calculation of Missing Accounts)
For each company, find the unknown a mounts designated by numbers. Each case is
independent.
Direct Materials, Jan. 1
Direct Materials, Dec. 31
Direct Labor
Factory Overhead
Purchases of Direct Materials
Direct Materials Used
Sales
Cost of Goods Sold
Cost of Goods Manufactured
Total Manufacturing Costs
Finished Goods, Jan. 1
Finished Goods, Dec, 31
Gross Profit
Work in Process, Jan. 1
Work in Process, Dec. 31
Co. A
P 12,800
10,800
26,000
58,000
18,000
(1)
(2)
(3)
100,000
(4)
16,000
10,600
22,600
(5)
4,000
PROBLEMS
Problem 12-1 (Manufacturing Costs; Work in Process)
Co. B
(6)
9,200
16,000
15,200
14,000
(7)
67,600
44,000
(8)
43,000
8,000
10,600
(9)
9,600
(10)
Co. C
P 13,800
11,000
(11)
26,000
(12)
18,800
110,000
(13)
(14)
(15)
15,600
12,400
24,000
2,600
600
Co. D
P 3,000
(16)
12,000
(17)
16,000
11,200
80,000
34,000
36,200
36,200
12,000
(18)
(19)
(20)
5,000
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
The Libunao Furniture Corporation manufactures furniture sets for export. For the year ended
December 31, 2010, you obtained from the company's books the following information:




Work in Process, January 1, 2010 was 20% less than the work in process on December
31, 2010.
Total Manufacturing Costs added during 2010 was P3,600,000 based direct materials and
direct labor.
Manufacturing Overhead cost of the work in Process was 72% of Direct Labor Costs.
Manufacturing Overhead for the year was 25% of Total Manufacturing Costs.
Cost of Goods Manufactured was P3,400,000 ,
Instructions:
1. Determine the total cost of work in process on December 31, 2010
2. Determine the total cost of goods put into process
3. Determine the total cost of direct materials used.
Problem 12-2 (Statement of Cost of Goods Sold; Financial Statements)
The general ledger of Lamasan Company contained the following account balances as of July 1, 2010
Cash
Accounts Receivable
Finished Goods
Work in Process
Raw Materials
Vouchers Payable
Ordinary Share Capital
Retained Earnings
P200,000
120,000
70,000
36,000
100,000
36,000
400,000
90,000
The following transactions were completed during July:
a. Raw materials purchased on account, P400,000
b. Factory Overhead incurred on account, P70,000
c. Payroll for the period consisted of the following:
Direct Labor P280,000; Indirect Labor, P60,000; Sales Salaries, P50,000; and Administrative Salaries,
P30,000. Deductions from payroll were as follows: withholding taxes-P37,040 SSS premiums P16,800;
Medicare contributions P2,250; Pag-ibig funds, P12,600
d. Paid accrued payroll.
e. Employer's payroll taxes are as follows:
SSS premiums
Factory
P 17,000
Selling
P 2,500
Administrative
P 1,500
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
Medicare
Pag-ibig fund
1,200
10,200
750
1,500
300
900
f. Materials issued to production: Direct Materials P370,000; Indirect Materials- P70,000
g. Work finished and placed in stock, P820,000
h. Cost of Goods Sold, P770,000. The markup was 40% of cost
i. Cash collected from customers, P810,000
j. Payments for liabilities amounted to P440,000, other than payroll.
Instructions:
1. Prepare journal entries to record the preceding transactions including the closing entries. Assume the
use of voucher system.
2. Prepare a statement of cost of goods sold for the month of July
3. Prepare an income statement for the month ended July 31, 2010 entries.
4. Prepare a statement of financial position (balance sheet) as of July 31, 2010
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
Problem 12-3 (Manufacturing Costs; Cost of Goods Manufactured and Sold)
The Lesaca Production Company presents the following selected general ledge showing balances at
October 1, 2010.
Cash
Finished Goods
Work in Process
Raw Materials
Prepaid Insurance
Accumulated Depreciation
Accounts Payable
P 40,000
592,000
164,000
128,000
4,000
280,000
108,000
Balances at October 31, 2010 include
Accrued Payroll
Finished Goods
Work in Process
Raw Materials
A summary of transactions for the month of October follows:
a. Cash sales
b. Raw materials purchased on account
c. Direct Materials Used
d. Direct Labor
e. Factory insurance expired
f. Depreciation of factory equipment
g. Factory utility service billed on account
h. Account payable paid
i. Factory payroll paid
Instructions: Compute for the following amounts:
1. Indirect materials used
2. Indirect labor
3. Total factory overhead
4. Cost of goods manufactured
5. Cost of goods sold
P 12,000
608,000
188,000
120,000
P 420,000
168,000
156,000
64,000
1,200
6,800
12,000
196,000
88,000
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
Problem 12-4 (Calculation of Missing Amounts)
Find the missing amounts in the following manufacturing statements:
Sales
Cost of Goods Sold:
Direct Materials Inventory, Jan. 1
Add Direct Materials Purchases
Direct Materials Available for Use
Less Direct Materials Inventory, Dec. 31
Direct Materials Used
Direct Labor
Factory Overhead
Total Manufacturing Costs
Add Work in Process, Jan. 1
Less Work in Process, Dec. 31
Cost of Goods Manufactured
Add Finished Goods, Jan. 1
Cost of Goods Available for Sale
Less Finished Goods, Dec. 31
Cost of Goods Sold
Gross Profit
2008
(1)
2009
P227,400
2010
(18)
P16,000
(2)
(3)
(4)
(5)
40,000
32,000
P 106,000
24,000
(6)
(7)
(8)
P 124,000
42,000
(9)
P 98,000
(10)
40,000
P 52,000
18,000
(11)
47,000
(12)
(13)
36,000
32,600
P 127,000
(14)
P 169,000
(15)
(16)
(17)
(19)
60,000
(20)
24,600
(21)
(22)
44,800
P 181,800
(23)
44,600
P 169,800
(24)
P 206,400
(25)
P 166,400
P 93,600
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
MULTIPLE CHOICE
MC 12-1
Linsao Co. reported the following data for the year 2010: Gross Profit P192,000;
Cost of Goods Manufactured P680,000; Work in Process beginning P56,000;
Finished Goods, beginning P90,000; Work in Process, end P76,000; Finished
Goods, end - P104,000. How much is total Sales of the company for the year 2010?
с. Р868,000
d. P872,000
a. P838,000
b. P858,000
MC 12-2
The following information were taken from the books of Laygo Co.
Increase in Raw Materials Inventory
Decrease in Finished Goods Inventory
Raw Materials Purchased
Direct Labor payroll
Factory Overhead
P30,000
70,000
860,000
400,000
600,000
There was no work in process at the beginning or at the end of the year. How much
is the cost of goods sold for the year?
a. P1,900,000
b. P1,930,000
MC 12-3
c. P1,950,000
d. P1,990,000
The following information were taken from the books of Laxa Co. for the month of
December, 2010:
Direct Materials
Work in Process
Finished Goods
December 1
P72,000
36,000
108,000
Direct Materials Purchases
Direct Labor payroll
Direct Labor rate per hour
Factory Overhead per direct labor hour
Total prime cost during December is
a. P180,000
c. P288,000
b. P280,000
d. P300,000
December 31
P60,000
24,000
144,000
P168,000
120,000
15.00
20.00
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
MC 12-4
Using the information in MC 12-3, what is the total conversion cost during
December?
a. P180,000
c. P288,000
b. P280,000
d. P340,000
MC 12-5
Using the information in MC 12-3, the cost of goods manufactured during
December is
a. P436,000
c. P460,000
b. P448,000
d. P472,000
MC 12-6
The following information were reported by Lapid Company for the month
September, 2010
Direct Materials
Work in Process
Finished Goods
Direct Labor cost
Factory Overhead
Cost of Goods Sold
September 1
P80,000
50,000
120,000
September 30
P 100,000
70,000
140,000
P 240,000
216,000
756,000
The total cost of direct materials purchased during September is
a. P100,000
c. P360,000
b. P340,000
d. P440,000
MC 12-7
Using the information in MC 12-6, the cost of goods manufactured during
September is
a. P756,000
c. P796,000
b. P776,000
d. P856,000
MC 12-8
Using the information in MC 12-6 and assuming Lapid's gross profit rate of 100%
of cost, how much is September 2010 sales?
a. P 756,000
c. P1,512,000
b. P1,134,000
d. P1,890,000
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
MC12-9
The following 497 ng information were taken from the books of Laraya
Manufacturing Company for the month of June:
Direct Materials
Work in Process
Finished goods
Equipment Parts and Supplies
June 1
P 246,000
648,040
1,196,642
178,600
June 30
375,908
1,153,382
1,587.278
255,458
Purchases
Direct Labor cost
Direct labor hours
Factory Overhead rate per direct labor hour
Raw materials used in production amounted to
a. P695,812
b. P730,602
825,720
428,216
16,470
P 11.00
c. P765,394
d. P767,132
MC 12-10 Using the information in MC 12-9, the Prime Cost added to production for the
month amounted to
a. P1,124,028
c. P1,189,672
b. P1, 165,878
d. P1,213,950
MC 12-11 Using the information in MC 12-9, the Conversion Cost added to production
amounted to
a. P609,386
c. P 737,386
b. P691,836
d. P1,305,198
MC 12-12 Using the information in MC 12-9, the Total Cost of Goods Placed in Process
a. P1,689,356
c. P1,953,238
b. P1,816,512
d. P2,050,900
MC 12-13
Using the information in MC 12-9, the Cost of Goods Manufactured amounted to
a. P691,796
c. P799,856
b. P743,866
d. P839,848
MC 12-14 Using the information in MC 12-9, the Cost of Goods Sold is
a. P332,362
c. P 799,856
b. P409,220
d. P1 , 996,498
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
MC 12-15
Using the information in MC 12-9, direct labor cost per hour is
a. P11.00
b. P26.00
c. 16.47
d. P37.00
MC 12-16 The following dara were takem from the records of Lamtin My Company for the
month of October 2010:
Inventories:
Raw Materials
Work in Process
Finished Goods
October 1
October 3
?
400,000
300,000
250,000
475,000
390,000
Raw Material Purchases
Factory Overhead. 75% of Direct Labor cost
Operating expenses, 12.5% of Sales
Profit for October
Sales for the month of October is
a. P 125,000
b. P1,000,000
230,000
315,000
125,000
125,000
c. P1250.000
d. 1,500,000
MC 12-17 Using the information in MC 12-16, the cost of goods sold is
a. P140,000
c. P420,000
b. P315,000
d. P560,000
MC 12-18 Using the information in MC 12-16, the cost of goods sold is
a. P250,000
c. P 750000
b. P500,000
d. P1,000,000
MC 12-19 Using the information in MC 12-16, the cost of Raw Materials Inventory October 1
is
a. P 0
c. P280,000
b. P250,000
d. P430.000
MC 12-20
Using the information in MC 12-16, direct
materials used is
a. P180,000
b. P230,000
c. P280,000
d.P430,000
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
Test Material No. 44
Rating ____________
Name ________________________________
Year and Section _______________________
Date___________________________
Professor ______________________
TRUE or FALSE
Instructions: Encircle the letter T if the statement is true and the letter F if the statement is false.
T F
The materials, labor and overhead costs incurred to produce a product are called product
costs.
2. Marketing, selling and administrative costs are the broad classification of costs incurred by a
manufacturing company.
3. Lumber can be both a finished product and a material.
4. Product cost consists of the sum of prime cost and conversion costs.
5. Product costs are found in both service and manufacturing firms.
6. The three cost elements of manufactured goods are direct materials, direct labor and
marketing costs.
7. The salary paid to the manager in charge of a warehouse is an indirect labor.
8. Indirect materials/factory supplies are classified as administrative expenses.
9. The salary paid to factory foremen is classified as factory overhead.
10. Total manufacturing cost and cost of goods manufactured are one and the same thing.
11. Finished goods inventory is an asset, but inventories of materials and work in process are not
considered assets until production is completed.
12. The cost of indirect materials used in production is added to the manufacturing overhead
account rather than added directly to Work in Process.
13. Actual manufacturing overhead costs are charged directly to the Factory Overhead
T F
14. Marketing and administrative expenses should be added to the manufacturing
T F
T F
T F
15. All of the raw materials purchased during a period are included in the cost.
16. Any balance of the Work in Process account at the end of the period.
17. A particular product not completed at the end of the accounting period of goods
T F
T F
T F
manufactured figure should be closed to the Cost of Goods Sold account becomes
part of work in process inventory.
18. Prime costs plus conversion costs equals total manufacturing costs.
19. Rubber used in manufacturing tires is considered a direct material.
20. The depreciation of automobiles used by sales personnel is considered a factory
T F
T F
T
T
T
T
F
F
F
F
T
T
T
T
T
F
F
F
F
F
T F
1.
account as the costs are incurred
overhead account.
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
overhead.
Test Material No. 45
Rating ____________
Name ________________________________
Year and Section _______________________
Date___________________________
Professor ______________________
MATCHING TYPE
Choices:
a Product cost
b. Cost to manufacture
c. Raw Materials inventory
d. Work in Process inventory
e. Finished Goods inventory
f. Cost of Goods Sold
g. Cost of Goods Manufactured
h. Total Manufacturing Costs
i. Conversion Cost
j. Selling and Administrative Costs
k. Direct Labor
l. Direct Materials
m. Manufacturing Overhead
n. Prime Costs
Instructions: Write the letter or letters of the best answer
_____1. A cost which "attaches" to the product as it moves through the operating cycle
_____2. The total cost of all resources put into production during the period, whether completed
or not.
_____3. Direct materials plus direct labor plus factory overhead.
_____4. The amount shown on the Statement of Financial Position which represents the cost
incurred to produce goods which are not yet completed.
_____5. The cost of services of employees who work directly on the product.
_____6.The cost of goods already completed and held for sale.
_____7.The amount which represents the cost of goods made available for sale in the current
period.
_____8. Product costs.
_____ 9. Direct Labor plus Manufacturing Overhead.
_____10. Direct Labor plus Direct Materials
_____11. It represents the total costs of a firm.
_____12. Non-manufacturing costs incurred by a manufacturing firm in its operations
_____13. Goods acquired for production but not yet requisitioned to be put into process.
_____14. Alternatively called Factory Overhead or simply Overhead.
_____15. It represents the total cost of the finished goods transferred to the finished goods
storeroom during the period.
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
Test Material No. 46
Rating ____________
Name ________________________________
Year and Section _______________________
Date___________________________
Professor ______________________
MULTIPLE CHOICE- Theory
Instructions: Encircle the letter of the best answer.
1. Manufacturing costs will not include
a. indirect materials used
b. sales salaries expense
c. indirect labor costs
d. depreciation of factory equipment
2. Direct material cost is a (an)
Conversion Cost
a.
No
b.
No
c.
Yes
d.
Yes
Prime Cost
No
Yes
Yes
No
3. Direct labor cost is a (an)
Conversion Cost
a.
No
b.
No
c.
Yes
d.
Yes
Prime Cost
No
Yes
Yes
No
4. In a manufacturing cost system, factory overhead is a (an)
Conversion Cost
Prime Cost
a.
No
No
b.
No
Yes
c.
Yes
Yes
d.
Yes
No
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
5. Wages paid to factory machine operators of a manufacturing plant is an element of
Conversion Cost
Prime Cost
a.
No
No
b.
No
Yes
c.
Yes
Yes
d.
Yes
No
6. Example of factory overhead costs are
a. lubricants used for factory machinery
b. salaries of a factory superintendent
c. rags used as factory supplies
d. all of the above
7. All of the following are examples of product costs except
a. depreciation in the company's retail outlet
b. salary of the plant manager
c. insurance on factory equipment
d. rent on factory building
8. The cost of goods available for sale during a given accounting period in a manufacturing
company is
a. the beginning inventory of finished goods
b. the cost of goods manufactured during the period
c. the sum of a and b
d. none of the above
9. Issuance of direct materials is debited to
a. Factory overhead control
b. Work in process
c.Materials
d. none of the above
10. What amounts would be debited and credited to record the purchase of direct materials on
account?
a.
b.
c.
d.
Debit
Work in process
Direct materials
Raw materials
Work in Process
Credit
Direct materials
Work in Process
Vouchers Payable
Vouchers Payable
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
Test Material No. 47
Name ________________________________
Year and Section _______________________
Rating ____________
Date___________________________
Professor ______________________
MULTIPLE CHOICE-Problems
Instructions: Encircle the letter of the best answer. Present supporting computations in good
form in a separate work sheet.
1. The Lakandula Company's Cost of Goods Manufactured was P240,000 Its total sales
amounted to P720,000 and Gross Profit was P440,000. If the ending inventory of
Finished Goods was P60,000, how much is beginning inventory of Finished Goods?
a. P 20,000
c. P260,000
b. P100,000
d. P300,0000
2. For the first three months of the year 2010, Lualhati Company reported total sales of
P1,400,000 and Gross Profit of P650,00. Finished Goods at the beginning of the period
amounted to P120,000 while Finished Goods at the end of the period amounted to
P70,000. How much is Cost of Goods Manufactured?
a. P600,000
c. P460,000
b. P700,000
d. P560,000
3. During the month of April, Lucena Company reported Direct Labor of P72,000 and
Direct Labor was equal to 60% of total Prime Cost. If Total Manufacturing Cost during April
amounted to P170,000, how much is total Factory Overhead?
a. P 50,000
c. P120,000
b. P 98,000
d. P480,000
4. During the year 2010, there was no change in the beginning or ending inventory of Raw
Materials. However, the Work in Process account balance had increased by P30,000
while Finished Goods account balance had decreased by P20,000. If purchases of Raw
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
Materials amounted to P200,000 for the year, Direct Labor cost was P300,000 and
Factory Overhead was P400,000, how much is Cost of Goods Sold?
a. P490,000
c. P930,000
b. P890,000
d. P950,000
5. During the month of November, 2010, Liwanag Company used P600,000 of Direct
Materials. At November 30, 2010, Liwanag's Direct Materials Inventory was P100,000
more than it was at November 1, 2010. How much is Direct Materials purchased during
the month of November?
a. P-0c. P600,000
b. P500,000
d. P700,000
6. The following information were taken from the records of Lukban Company:
Direct Labor cost incurred
Direct Materials Used
Work in Process, beginning
Work in Process, end
Finished Goods transferred out
P500,000
220,000
100,000
600,000
340,000
How much is total Factory Overhead cost incurred?
a. P120,000
c. P1,120,000
b. P820,000
d. P1,160,000
7. The Lubao Company reported the following information for the year 2010: Gross Profit
P560,000; Finished Goods Inventory, end P240,000; and Cost of Goods Available for
Sale P360,000. How much is total Sales for the year?
a. P600,000
c. P800,000
b. P680,000
d. P920,000
8. For the month ended February 29, 2010, the following data were registered by Lumabat
Corp.:
Work in Process, beginning
600,000
Orders completed
4,800,000
Orders shipped
4,000,000
Materials requisitioned for production
3,400,000
Direct Labor cost
1,600,000
Factory Overhead
150% of direct labor cost
The Work in Process Inventory at the end of the month was
a. P1,000,000
c. P2,800,000
b. P1,400,000
d. P3,200,000
9. During the year 2010, there was no change either in the Raw Materials or the Work in
Process beginning and ending inventories. However, Finished Goods Inventory on
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
January 1 of P50,000 had increased by P30,000 on December 31. Total Manufacturing
Costs amounted to P120,000. How much is the Cost of Goods Available for Sale?
a. P170,000
c. P220,000
b. P200,000
d. P250,000
10. During the month of March, 2010, Lagmay Company incurred the following
manufacturing costs: Direct Materials P60,000; Direct Labor P80,000; and Factory
Overhead P40,000. The Cost of Goods Manufactured was P190,000 and ending Work in
Process Inventory was P30,000. How much is the beginning Work in Process Inventory?
11. a. P20,000
b. P40,000
c. P 50,000
d. P220,000
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
Test Material No. 48
Rating ____________
Name ________________________________
Year and Section _______________________
Date___________________________
Professor ______________________
PROBLEM
The following data are provided by the controller of Liwasan Corporation for the year 2010:
Cash
Accounts Receivable
Inventories:
Finished Goods
Work in Process
Raw Materials
P 480,000
696,000
Jan. 1
P 108,400
59,600
176,000
Dec 31
P 132,000
77,600
128,000
Raw Materials Purchases
Sales Discounts
Factory Overhead (excluding depreciation)
Marketing and Administrative Expenses (excluding depreciation)
Depreciation (90% manufacturing, 10% Marketing and Administrative Expenses)
Sales
Direct Labor
Freight on raw materials purchased
Rental Income
Interest on Notes Payable
Instructions: Prepare a Statement of Cost of Goods Sold.
732,000
16,000
936,000
688,400
P 232,000
3,688,000
1,047,200
13,200
128,000
32,000
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
Test Material No. 49
Rating ____________
Name ________________________________
Year and Section _______________________
Date___________________________
Professor ______________________
PROBLEM
The general ledger of Lagundi Manufacturing Company shows the beginning balances for the
following accounts:
Cásh
Accounts Receivable
Direct Materials Inventory
Factory Supplies Inventory
Work in Process Inventory
Finished Goods Inventory
P 72,000
244,000
256,000
130,000
164,000
344,000
Accumulated Depreciation
Vouchers Payable
Sales
Direct Labor cost
Factory Overhead
P 112,000
98,000
-------
Transactions for the period follow:
a. Raw Materials and Supplies purchased on account, P692,000 and P196,000, respectively
b. Direct Materials requisitioned for production, P770,000.
c. Supplies used in production, P186,000
d. Direct Labor wages paid, P98,000
e. Depreciation Expense on Factory Building and Equipment, P44,000
f. Indirect Labor wages and supervisory salaries paid, P372,000
g. Utilities Expenses paid, P52,000
h. Other Factory Expenses paid, P166,000
i. Completed production, P1,690,000.
j. Sales on account recorded, P2,524,000
k. Accounts Receivable collected, P2,390,000
l. Cost of Goods Sold, P1,740,000.
m. Cash payments made to vendors, P936,000
Instructions: Prepare the journal entries for the preceding transactions together with the closing
of the manufacturing accounts. Assume the use of the voucher system.