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Laguna State Polytechnic University - Los Bartos
LIBRARY
LSPUL 300001960
advanc
ACCOUNTING
principles and pi^ocedural applications
2011 EDITION
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PEDRO p. GUERRERO
JOSE F. PERALTA
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Advanced
Accounting
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APROCEDURAI.APPROACH
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Volume i
PEDRO p. GUERRERO,B S C ,C P A
CPA Reviewer
CPAReview School ofthe Philippines(CPAR)
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JOSE P. PERALTA,BBA ,MBA , CPA
President and CPA Reviewer
Philippine School ofBusiness Administration
2011 EDITION
ACC.No
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Copyright 1979
Preface
2011
JJoF .
By
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This 2011 Edition of Advanced Accountinn
flrrnunting
courses above
ahnve the
the intermediate
mr
j- ' evel
accounting courses
recent business developments and changes in are
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PEDRO P. GUERRERO
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JOSE F. PERALTA
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partnership admission with revaluation of assets an^P^r^if"
updated to reflect
'
This edition continues to provide a stmno
.
discussion, and integrated coverage based on continuous caseofexamples.
advancedTheaccounting
topics,
clear
text is highly
illustrated
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Any copy of this book not bearing the signature
¥
of the Author on this page is unauthorized and shall
be considered as preceding from an illegal source.
•• •
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Io„g-.er„. cons,rucdon accounting and
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2onivolumes,
and
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j .for .financial
Mu'^see "^e'd^evel^n^^"^^l'° f
schedules, and financial statements so that students
V des a current
cSrontTT?
n'.' preparing for the CPA Examination
PhiUPPin^andAccounting
Standards
provides
text for students
current practices.
u t SoShe.
T through illustrations and explanations.
discussions The
of concepts
and the procedural
illustration
of these concepts
many favorable
responses
^^edural illustra?""'
instructors
confirm ourtopics
beliefinthatanclear
presentation
and
procedural
illustrations are essential to learning
the sophisticated
advanced
accounting
'
course.
ALL RIGHTS RESERVED
^
A large nu
choices, both theoretical and computational, and problems at the end of
each chapter are added t^provide the opportunity to solidify understanding of the chapter matenal
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and assess mastery of the subject matter. The end-of-chapter materials progress from simple
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exercises to more complex problems.
ISBN 971-0489-80-0 .
PEDRO P. GUERRERO
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Printed and Distributed by
JOSE E PERALTA
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2019 C. M. Recto Avenue
Manila
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Chapter 3
Partnership Dissolution-Changes in Ownership
103
Admission ofa New Partner
IM
Purchase ofInterestfrom One or More Partners
New Partner Invests in Partnership
Profit and Loss Ratios and Capital Ratios
104
107
are Different
119
Determining a New Partner's Investment Cost
Chapter 1
119
Retirement ofa Partner
Partnership: Basic Considerations and Formation
120
Death ofa Partner
123
1
Incorporation of a Partnership
2
Multiple Choices-Theoretical
129
Entity versus Proprietorship Theories
3
Multiple Choices- Computational
133
Partnership Agreement
Partner's Ledger Accounts
3
Problems
153
Definition ofa Partnership
Characteristics ofa Partnership
k
124
5
Accounting for the Formation of a Partnership
Partnership Formationfor the First Time
Initial investments
6
Chapter 4
Partnerships: Liquidation
7
Accounting Problems in Partnership Liquidation
163
7
Methods of Partnership Liquidation
Lump-Sum Liquidation
Realization ofAssets
Expenses ofLiquidation
165
7
Bonus or Goodwill on Initial Investments
Sole Proprietorship and Another Individual Form
9
a Partnership
13
Two Proprietors Form a Partnership
18
Key Observation from the Illustrations
Multiple choices-Computa lona
165
165
165
Liquidation Procedures
165
Illustration ofLump-Sum Liquidation
166
23
Multiple Choices — Theoretical
Multiple Choices- Computational
178
41
Problems
190
19
Multiple Choices-Theoretical
164
175
Problems
Chapter 2
Chapter 5
Partnerships: Liquidation by Installment
47
197
'.fi ••
Partnership Opera i
47
nsio. oncosts
48
Procedures for Liquidation by Installment
197
Periodic Computation ofSafe Payments to Partners
198
198
209
61
Illustration ofInstallment Liquidation
jancial State
65
Cash Withheld
langes m
66
Comprehensive Illustrative Problem
Preparation ofa Cash Distribution Program
Multiple Choices-Theoretical
Multiple Choices- Computational
225
Problems
235
®S's,atements
for a Partnership
the Profit and Loss Ratio
ujj,^et
Income ofPnor Period
fpartnership
Net Income
68
^'^r^^^nices
-Theoretical
"ipie
Choices-Computational
71
92
'1
IV
209
212,
221
Tr>i> ■
Chapter 6
Chapter 8
Joint Venturers
Corporations in Financial Difficulty: Reorganization and Troubled
243
Contractual Arrangement
243
Forms ofJoint Venture
244
245
312
312
316
Illustration of Troubled Debt Restructuring
245
Separate Set ofBooks ofthe Joint
246
Books ofthe Venturers
311
Plan for Reorganization
Accounting for Reorganization
Troubled Debt Restructuring
244
Venture
311
Reorganization
244
Jointly Controlled Operations
Jointly Controlled Assets
Jointly Controlled Entities
Accounting for Joint Ventures
Debt Restructuring
246
317
Multiple Choices-Theoretical
321
Multiple Choices- Computational
324
Problems
333
Comprehensive Illustration of
Accountingfor Jointly Controlled
Chapter 9
Entity
Installment Sales
247
Financial Statements
248
Alternative Method of Accounting for
Joint Venturers-No Separate Books
252
Uncompleted Joint Ventures
255
Disclosure
257
Multiple Choices — Theoretical
Multiple Choices-Computational
260
Problems
266
Methods of Gross Profit Recognition on Installment Sales
Gross Profit Recognized at the Time ofSale
which Cash is Collected
338
The Installment Method ofAccounting
258
Corporations in Financial Difficulty: Liquidation
j
337
338
Gross Profit Recognized in the Period in
Chapter 7
Insolvency
337
271
. "V-V
339
Expenses on Installment Sales
Interest on Installment Contract Receivable
340
Accounting Procedures Under Installment Method
343
340
Allocation of Cost ofGoods Sold
348
Defaults and Repossessions
350
Trade Ins
352
Alternative Procedures for Computing Realized Gross
,
271
Liquidation versus Reorganization and Debt
Restructuring
Profits for a Series of Years
272
Corporation Liquidation
212
Financial Report
272
Statement ofAffairs
272
Format ofStatement ofAffairs
Statement ofAffairs Illustrated
Estimated Amounts to be Recovered
by Each Class ofCreditors
276
355
Financial Statements Presentation
Installment Sales ofReal Estate
357
360
Multiple Choices-Theoretical
Multiple Choices-Computational
Problems
274
3^5
^61
33]
278
Accounting"and Reporting for Trustee/Receiver
Statement ofRealization and Liquidation
Multiple Choices-Theoretical
Multiple Choices-Computational
291
Problems
305
280
285
289
VU
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1
Chapter 10
'* / T
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393
Long Term Construction Contracts
Construction Contract
393
Revenue from Construction Contracts
394
Contract Costs
394
Types of Contract Costs
393
Cost incurred to data
395
Estimated costs to complete
395
Subcontractor Costs
,
:
Chapter 1
396
Partnerships: Basic Considerations
396
And Formation
Costs of Materials Purchased in Advance of
their Use
.ii iw ■,«
396
Combining and Segmenting Contracts
Computation and Recognition of Construction
397
Revenue
Illustrative Problem
398
Financial Statements Presentation
403
Anticipated Losses on Long Tenn Construction
Partnerships are a popular form of business because they are easy to form and
because they allow several individuals to combine their talents and skills in a
particular business venture. In addition, partnerships provide a means ofobtaining
404
Projects
408
more capital than a single individual can obtain and allow the sharing ofrisksfor
rapidly growing businesses. Partnerships are particularly common in the service
professions, especially law, medicine, and accounting. These professions have
408
generally not adopted the corporateform ofbusiness because oftheir long-standing
407
Under PAS J
Appendix.
^nder PAS 11
tradition of close professional association with clients and the total commitment
rjjGAAP
of the professional's association with clients and the total commitment of the
409
^^'TSiolceS'Theoretical
professional's business and personal assets to the propriety of the advice and
411
Multiple Cho
Computational
MultipleChoices-Comp
414
service given to clients.
432
Problems
Definition of a Partnership
439
440
440
"nXsnition-InMal Franchise Fees
446
'
Franchise
.Recognition - Continuing
Franchise
Fees Fees
447
= ^®SfofSupplies
447
447
447
A Tncluded in the Franchise Fee
.Assets
0 •""'""fTbeoretical
Purchas^ rj-jjeoretical
448
computational
450
460
The Partnership Law is the general governing authority for partnerships. Accountants
advising partnerships must be familiar with this law because it describes many of the
rights of each partner and of creditors during creation, operation, and liquidation of the
partnership. Article 1767 ofthe Partnership Law embodies the definition ofpartnership.
It states that "by the contract of partnership, two or more persons bind themselves to
contribute money, property or industry to a common fimd with the intention of dividing
the profits among themselves." This definition encompasses three distinct factors:
1. Association ofTwo or More Persons. The "persons" are usually individuals. Any
natural person who possesses the right to enter into a contract can become a partner.
1
Vtu
Partnerships: Basic Considerations and Organizations
Chapter I
Unlimited Liability. Each partner may be held personally liable for all the debts ofthe
partnership. All ofhis business and personal properties may be used for the settlement
To Cairy On as Co-Owners. A partnership is an aggregation ofpartners' individual
rights. This means that all partners are co-owners ofpartnership property and are
co-owners ofthe profits or losses ofthe partnership.
3.
ofpartnership liabilities. There is, however,a special type ofpartnership,called limited
BusinessforProfit. A partnership may be formed to perform any legal business,
paitnership,wherein certain partners are allowed to limit their personal liabilities to the
trade or profession, or other service. However,the partnership must attempt to
make a profit; therefore,non-profit organizations may not be partnerships.
extent oftheir capital contributions only.
Entity Versus Proprietorship Theories
Characteristics ofa Partnership
The proprietorship theory views the assets ofa business as belonging to the proprietor,
the liabilities as debts ofthe proprietor,and the income oftlie business as an increase m
Before taking up the accounting problems encountered in partnerships,it is helpful to
know the important characteristics ofthe partnership fomioforganization.
the proprietor's net worth (capital).In practice, however,proprietorship assets and
liabilities are treated separately from the personal assets and lia^)ilities ofthe propnetoi.
Thus,in practice,proprietorship are treated as separate entities,even though,in theory,
Separate Legal Personality. Article 1768 of the Partnership Law states that the
partnership has ajuridical personality separate and distinct from that ofeach ofthe
they are not.
partners. A partnership may,therefore,acquire propeity in its own name and may enter
On the other hand,small partnerships are usually viewed as a combination ot two or
more proprietorships,and the"proprietorship"theory would be the pertinent one toi
firms ofthis size. The death ofone partner would usually cause a dissolution especia y
into contracts.
Ease ofFormation. The formation ofa partnership does not require as many formalities
ifthere are only two partners.
as a corporation. The partnership may be created by oral or written agreement between
two or more persons,or merely by inferences from the implication oftheir conduct.
Despite the many similarities between partnerships and proprietorships(i.e.,
liability,dissolution upon death),partnerships are generally viewed as entities P
and apartfrom the individual partners. Assets are viewed as belonging to the p f
and not to the individual partners.Income eamed by the partnership is usua y
!to the"entity"with each partner entitled to a distributive share oft einc
as income 1
Co-ownership ofPartnership Property and Profits. All assets invested in the
paitnership become the property ofthe partnership.The right ofeach partner to possess
partnership property for partnership purposes is equal to the right ofeach ofthe other
partners. Each partner has a proprietary interest in the partnership. This interest refers
to each partner's share in the earnings and in the capital.
Partnership Agreement
limited Life. Any change in the agreement ofthe partners terminates the partnership
contract.A partnership may also expire any time when there isachange in the relationship
ofthe partners due to the death,withdrawal,bankmptcy or incapacity ofa partner. No
one can be forced against his will to continue as a partner regardless ofthe agreed terms
ofoperations. Other factors which may bring a partnership to an end are the expiration
ofthe period specified in the partnership contract and the admission ofa new partner.
Theformulation ofa partnership agreement mustbe done atthe inception oforg
ofthe partnership. This agreement is the framework within which the partners
operate or conduct partnership business-from formation to operations t en
eventual dissolution and liquidation ofthe partnership. Observations ofthese e i
help minimize,ifnot eliminate,the confusion and disputes that may arise b^ee
among the partners.The partnership agreement may be oral,implied or written.Howev ,
it is best that the business ofthe partnership be organized on the basis ofa vmi en
contract.It is not possible to cover in the partnership contract every issue which may
later arise. Among the more significant points that must be covered by die partnership
j^utualAgoncy ac partner has an equal right to act for the partnership and to enter
into contracts m i^upon it, as long as he acts within the normal scope ofbusiness
operations, ac pa
a principal as well as an agent ofthe partnership.
agreement are:
• fi^
Chapter 1
Partner's Ledger Accounts
1.
Names ofthe partners,and the name and nature ofthe partnership;
2.
The date on which the partnership contract takes effect and the duration ofthe
contract;
3.
4.
5.
6.
7.
Partnerships: Basic Considerations and Organizations
The capital to be invested by each partner,the procedure for valuing noncash
contributions,the treatment ofany contribution(whether as capital or as loan)
in excess ofagreed amounts,and the penalties for failure to contribute and
maintain the agreed amount ofcapital);
The authority,the rights and duties ofeach partner;
In a partnership,altliough it is possible to operate with only one equity accountfor each
partner,it is desirable that the following partner's accounts be maintained:
1. Capital accounts
2. Drawing or personal accounts
3. Accountfor loans to or from partners
The accounting period to be used,the nature ofaccounting records,preparation
offinancial statements,and auditing ofpartnership books.
The method ofsharing profits and losses including the frequency ofincome
Capital and drawing accounts.The original investment ofeach partner is recorded
by debiting the fair value ofthe assets invested,crediting the liabilities assumed by the
firm,and crediting the partner's capital account for the net assets contributed. Subsequent
measurement and distribution to partners.
to the original investments,transactions between the partnersliip and the partners will
The drawings or salaries to be allowed to each partner and the disposition of
result to changes in the respective partner's ownership interest. These changes are
partner's salary and drawing accounts including the penalties,ifany,for excessive
summarized in the respective partner's capital and drawing accounts.
withdrawals;and
Provision ofthe arbitration ofdisputes and the liquidation ofthe partnership at
the termination ofthe agreed time including those concerning the contingency of
a partner's death. Especially important are the rules on the valuation ofassets
including goodwill and the method ofsettlement with the estate ofa deceased
partner. Similar provisions should be made with respectto a partner's retirement.
Partnership agreements are usually with the aid ofor in consultation with lawyers and
certified public accountants. Some ofthe areas where the partners may seek the advice
ofan accountant are as follows:
1.
The determination ofthe current fair values to be assigned to the noncash assets
The ascertainment ofthe individual partner's initial interest in the partnership
capital.
3.
4.
^
,
The formulation ofthe plan for shanng m the profits or losses.
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The determination
the methods to compute
the interest ofa withdrawing
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partner as a result ofhis retirement or death. A factor to be considered in cases
ofwithdrawal is the necessity ofrevaluing the assets and recognizing intangible
asset values such as goodwill5.
and by a share in the partnei-sliip profit. A partner's equity is decreased by die withdrawa
ofcash or other assets and by a share in the partnership loss.
Normally,increases or decreases in capital that are interpreted as permanent capi a
changes are recorded directly in the capital account. Witlidrawals,which are consi
equivalent to salaries, made by the partner in anticipation ofprofits,and other mc^^
or decreases ofrelatively minor amounts are recorded in the drawing account.
end ofthe accounting period,the debit and credit balances in the drawing accoun
then closed to the respective partner's capital account. Also,during this
initially invested to the partnership.
2.
A partner's equity is increased by the additional investment ofcash or other property
The determination ofthe closing procedures to be followed,that is, whether or
notincome and withdrawals are to be closed to the capital account at the end
ofthe accounting period,thereby,increasing or decreasing the total capital.
^
profit or loss as shown by the Income Summary account is distributed in accor
with the profit and loss sharing agreement.The share ofeach partner in the pro
recorded in their respective capital account.Individual partner's capital and
balances are combined to reporting each partner's interest in the statement oi tman
IS
position.
The transactions that are usually debited and credited to partner's capital and drawing
accounts may be summarized as follows:
The capital account is credited for:
a. Original investment
b. Additional iilvestment.
c. Partner's share in the profits(sometimes this is closed to the drawing account).
/
Partnerships: Basic Considerations and Organizations
Chapter 1
Partnership Formation for the First Time-Initial Investments
The capital account is debited for:
Permanent withdrawal ofcapital.
a.
b.
c.
Debit balance ofthe drawing account at the end ofthe period.
Paitner's share in the losses(sometimes this is closed to the drawing account).
Cash Investments
Initial cash investments in a partnership are recorded in the capital accounts maintained
for each partner. For example,Abad and Besa each invests P100,000 cash in a new
partnership. The entry to record the investments would be:
The drawing account is credited for:
a.
b.
c.
7
Partnership obligations assumed or paid by the partner.
•
Personal fiinds or claims ofpartner collected and retained by the partnership.
Periodic partner's salaries depending on the accounting and disbursement procedures
200,000
Cash
agreed upon.
Abad, capital
Besa, capital
To record the investments ofAbad and Besa.
The drawing account is debited for:
Withdrawal ofassets by the partners in anticipation ofnet income,
t). Partner's personal indebtedness paid or assumed by the partnership.
Funds or claims ofpartnership collected and retained by the partner.
•c.
100,000
100,000.
Noncash Investments
When property other than cash is invested in a partnership,the noncash property is
"J
Loans to and from partners.A withdrawal by a partner ofa substantial amount with
the assumption ofits repaymentto the firm may be debited to a Receivable from partner
account rather than to the partner s drawing account. On tlie other hand,an advance to
the partnership by a partner with the assumption ofits ultimate repayment by the
partnership is viewed as a loan rather than as an increase in the capital account. This
recorded at the cuiTent fair value of the property at the time of the investment.
Theoretically,independent appraisals should be made to determine the fair value.Despite
the theoretical soundness ofthe independent appraisal procedure,the fair value on
noncash asset is detennined by agreement ofthe partners. The amountsinvolved should
be specified in the written partnership agreement.
transaction. is credited to the Loans Payable
to
Notes
lype of
w- j
— partners account or ...wv
payable ifthe loan is evidenced by a note duly signed in the name ofthe partnership
accountingforthe FORMATION OF A PARTNERSHIP
Illustration. Assume that Manny and Noynoy form a partnership for the first time.
Their investments are as follows:
'phe formation ofa partnership presents relatively few difficult accounting problems.
Accounting entries to record the formation will depend upon how the partnership is
formed- A partnership may be formed in several ways,namely:
Manny
Noynoy
(Fair Value)
(Fair Value)
P70,000
Cash
—
Merchandise inventory(cost,PI0,000)
Computer equipment(cost,P50,000)
1. Formation ofa partnership for the first time.
Total
P20,000
30,000
P50,000
P70.000
2. Conversion ofa sole proprietorship to a partnership.
a. A sole proprietor allows anotlierindividual,who has no business ofhis own
1
tojoinhis business.
■
b. Two or more sole proprietors form a partnership.
i'
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,11
3. Admission ofa new partner(This is discussed in Chapter 3).
, I.' .
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Chapter I
8
Thejournal entries to record the investments are as follows;
Cash
A decision to use one approach over the other will depend on the partner's agreement.
In the absence ofany agreement,the bonus approach is preferable over the goodwill
70,000
Manny, capital
method.Thejustification to this is discussed in detail in Chapter 3.
70.000
To record initial investment ofManny
Merchandise inventory
Computer equipment
Partnerships: Basic Considerations and Organizations
Sole Proprietor and Another Individual Form a Partnership
20,000
30,000
Noynoy, capital
To record initial investments ofNoynoy at their
fair values
An individual who has no business ofhis own mayjoin another individual who is already
50,000
Recording partners' noncash investments at their current fair value ensures that any
gains or losses on the subsequent sale ofthe property will be equitably distributed i"
in
operating his own business. Under this type offormation,both the assets and liabilities
ofthe sole proprietor are transferred to the newly formed partnership. Normally,the
partners agree on the revaluation ofsome ofthe assets before the transfer. Thejournal
entries to record this type offormation will depend on whether the books ofthe sole
proprietorship are to be usedfor the newlyformed partnership or new books are
accordance with the partnership agreement.
to be opened.
Bonus or Goodwill on Initial Investments
Illustration. Assume that Jose has been operating a retail store for a number ofyears.
A statement offinancial position on July 1,2011 is prepared for Jose Company as
Valuation problem arises when partners agree on capital interests that are not equal to
their net assets invested. For example,in the above illustration,the partners agree that
each partner is to receive equal interest, even though Manny invested P70,000 and
Noynoy contributed,P50,000 in identifiable net assets. To meet this condition, the
capital accounts ofManny and Noynoy should be adjusted using two approaches — the
bonus approach or the goodwill approach.
follows:
Illustration 1-1
Jose Company
Statement of Financial Position
July 1, 2011
Under the bonus approach no assets is recorded in the partnership books.To equalize
capital balances,capital transfer ofP10,000 from Manny to Noynoy is made.The only
entry necessary is as follows:
Assets
P 60,000
50,000
70,000
Cash
Accounts receivable
Monny capital
Noynoy capital
To accomplish equal capital interests of
P60,000 by recording a PI0,000 bonus to
Noynoyfrom Manny.
10,000
10,000
When goodwillapproach is used,tlie equalization ofcapital interests is accomplished
by
recordin^oodwill ofP20,000 with a corresponding increase in the capital account
ofNoynoy.The entry is:
Goodwill
Noynoy capital
To establish equal capital interests ofP70 000
by recording goodwill ofP20,000.
20,000
20,000
Inventory
Equipment
Less: accumulated depreciation
P40,000
4,00.0
36,000
Total assets
P216,000
Liabilities and Capital
Accounts payable
Jose capital
P 86,000
130,000
Total liabilities and capital
P216,000
Partnerships: Basic Consideratioiis and Organizations
Chapter I
10
11
After the formation,the statementoffinancial position ofthe newlyformed partnership
Jose needs additional capital to meet the increasing sales and offers Pedro an interest in
the business. Jose and Pedro agree to form a partnerehip to be known as JPPartnership,
is:
Jose's business is audited and its net assets are appraised. The audit and appraisal
Illustration 1-2
shows the following:
JP Partnership
Statement of Financial Position
1. Allowance for bad debts ofP5,000 is to be provided.
2. Inventory is to be recorded at its market value ofP80,000.
3. The equipment has a fair value ofP35,000
July 1, 2011
Assets
4. P2,000 ofaccounts payable has not been recorded.
'I
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PI60,000
Cash
Accounts receivable
Jose and Pedro prepare and sign articles ofco-partnership that include all significant
operating policies. On July 1,2011 Pedro contribute PI00,000 cash for a one-third
capital interest. The JP Partnership is to acquire all ofJose's business and assume its
1
'
5. 1
_•
1
Less: Allowance for bad debts
P50,000
5,000
'
■
Inventory
Equipment
•.
liabilities.
P320,000
Total assets
. •)
Sole Proprietorship's Books are Retainedfor the Partnerships. If the books of
Jose are to be retained,the following accounting procedures are used to record the
formation ofthe partnersliip:
Liabilities and Capital
Accounts payable
Jose capital
1. Adjust the assets and liabilities ofJose to their fair market values as agreed by
the partners. Adjustments are to be made to his capital account.
2. Record the investment ofPedro.
A-
45,000
80,000
35,000
.
Pedro capital
P 88,000
132,000
100,000
Total liabilities and capital
P320,000
if * .
-.v'
New Books are Openedfor the Partnership. If new books are to be used for the
partnership,the following accounting procedures may be used to record the formation
ofthe partnership:
Using th® above procedures,thejournal entries to record the formation ofthe partnership
are:
Books ofJose(Now the Partnership Books)
Books ofJose:
2011
1. Adjustthe assets and liabilities ofJose according to the agreement Adjustments
Julyl
d)Inventory
10.000
jlccumulated depreciation-Equipment
are made to his capital account.
4,000
Equipment
Allowancefor bad debts
Accounts payable
Jose, capital
2. Close the books.
5,000
5,000
2,000
New Books ofthe Partnership:
To adjust assets and liabilities ofJose.
(2) Cash
100,000
Pedro, capital
100,000
To record investment ofPedro.
1
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'
_
1. Record the investments ofJose. His assets and liabilities.
2. Record the cash investment ofPedro.
'
Chapter I.
12
Partnerships: Basic Considerations and Organizations
13
Using the procedures,thejournal entries to record the formation ofthe partnership are:
Two Proprietors Form a Partnership
Books ofJose(Sole Proprietorship);
The accounting procedures described in the preceding section are also applicable when
two or more proprietorshipsjoin together to form a partnership. There should be an
agreement on the determination ofthe partners'interest in the new partnership. It is also
2011
July 1
(1) Inventory
Accumulated depreciation -Equipment
Equipment
Allowancefor bad debts
Accounts payable
Jose, Capital
To adjust assets and liabilities ofJose.
important that the partners agree on the values ofthe assets to be assigned and liabilities
to be assumed by the partnership.Books ofone ofthe sole proprietorship may be used
for the newly formed partnership or a new set ofpartnership books may be used.
10,000
4,000
5,000
5,000
2,000
2,000
Illustration.Assume that on June 30,2011,Gerry and Henry,competitors in business,
deeide to consolidate their business to form a partnership to be ealled GHPartnership.
The statement offinancial position ofGerry and Henry on this date are on the next page.
Illustration 1-3
Gerry Company
Statement of Financial Position
(2) Accounts payable
Allowancefor bad debts
Jose, Capital
June 30, 2011
88,000
5,000'
132,000
Cash
Accounts receivable
Inventory
Equipment
To close all the adjusted balances ofthe accounts.
Assets
> .
P 5,000
10,000
8,000
-
6,000
Cash
60,000
50,000
80,000
35,000
]VeW Books ofthe Partnership
2011
Accounts receivable
Merchandise inventory
Furniture and fixtures
,
Total assets
' ..
P29,000
Liabilities and Capital
Accounts payable
Gerry Capital
P 3,000
26,000
Total liabilities and capital
P29,000
Henry Company
July 1
(1) Cash
Accounts receivable
Inventory
Equipment
Accounts payable
Allowancefor bad debts
Statement ofFinancial Position
60,000
50,000
80,000
35,000
June 30, 2011
Assets
88,000
5,000
132,000
Jose, Capital
To record investments ofJose.
(2) Cash
Pedro, Capital
To record cash investment ofPedro.
Accounts receivable
P4,000
8,000
Merchandise inventory
10,(»0
Cash
Furniture and fixtures
Total assets
Liabilities and Capital
Accounts payable
Henry capital
100,000
100,000
Total liabilities and capital
9,000
P31,000
P6,000
25,000
P31,000
: An
I y
Partnerships: Basic Considerations and Organizations
Chapter 1
15
m
(2) Accounts payable
Allowancefor bad debts
Accu. depreciation -furniture andfixtures
Gerry capital
The conditions agreed by the partnersfor purposesofdetermining tlieir interests in the
partnership are presented below:
a 10% ofaccounts receivable is to be set up as uncollectible m each book.
b Merchandise inventory ofHenry is to be increased by PI,000.
c The furniture and fixtures ofGerry and Henry are to be depreciated by P600
3,000
1,000
600
24,400
5,000
10,000
8,000
Cash
Accounts receivable
Merchandise inventory
Furniture andfixtures
and P900 respectively.
6,000
To close the books.
Rooks ofHenry are used as the Partnership Books. Ifthe books ofHenry are to
be used as the partnership books,the accounting procedures to record the formation of
Books ofHenry(Now the books ofthe partnership)
the partnership are:
2011
June 30
Books ofGerry
(1) Merchandise inventory
Henry capital
1 Adjustthe accounts ofGerry as agreed. Adjustments are made to his capital
account.
2. Close the books.
TJf
1 Adjustthe accounts ofHenry as agreed. Adjustments are made to his capital i
, i -t •
2 Record the investmentofGerry,his adjusted assets and liabilities.
Thejournal entries to record theformation ofthe partnership,using the above accounting
procedures are:
2011
for bad debts ^
Accu. depreciation -furniture andfixtures
To record adjustments ofassets
800
Accu. depreciation —furniture andfixtures
900
(2) Cash
Accounts receivable
Merchandise inventory
Furniture andfixtures
5,000
10,000
8,000
5,400
Accounts payable
Allowancefor bad debts
Gerry capital
To record investments of Gerry.
3,000
1,000
24,400
New Partnership Books will be used. If new books are to be opened for t e
partnership,the following accounting procedures may be used to record tlie fonnation
Books of Gerry
June 30
Allowancefor bad debts
. To adjust assets ofHenry.
Books ofHenry(Now the partnership books)
account.
■
j,000
700
ofthe partnership.
1,600
1,000
600
A
Books ofGerry and Henry
A'
1. Adjust the accounts of Gerry and Henry according to their agreement.
Adjustments are to be made to their capital accounts.
2. Close the books.
Partnerships: Basic Considerations and Organizations
17
Chapter J
16
(2) Accounts payable
Allowancefor bad debts
Accumulated depreciation —fum. andjixt.
Henry capital
New Book ofthe Partnership
1. Record the investments ofGerry,his adjusted assets and liabilities.
2. Record th? investments ofHeniy,his adjusted assets and liabilities.
6,000
800
900
24,300
Merchandise inventory
4,000
8,000
11,000
Furniture andfixtures
9,000
Cash
Accounts receivable
Using the accounting procedures,thejournal entries to record the formation ofthe
paitnership under this assumption are;
To close the books.
Books of Gerry
2011
New Books ofthe Partnership
June 30
2011
1,600
(1) Gerry capital
Allowancefor bad debts
June 30
1,000
Accu. depreciation -furniture andfixtures
To record adjustments ofassets.
600
Allowancefor bad debts
Accu. depreciation —furniture andfixtures
Furniture andfixtures
'
'x-
4
600
24,400
Gerry capital
5,000
10,000
Cash
Accounts receivable
Merchandise inventoiy
8,000
Furnitures andfixtures
6,000
To close the books.
2011
.
.
(1) Merchandise inventoiy
Henry capital
Allowancefor bad debts
Accumidated depreciation —furn. andfixt.
To record adjustments ofassets
3,000
1,000
Accounts payable
Allowancefor bad debts
Gerry capital
To record the investments ofGeny.
24,400
(2) Cash
4,000
8,000
Accounts receivable
Merchandise inventoiy
Furniture andfixtures
11,000
8,100
6,000
Accounts payable
Allowancefor bad debts
Heniy capital
To record the investments ofHenry
Books of Henry
June 30
Accounts receivable
Merchandise inventoiy
3,000
1,000
(2) Accounts payable
5,000
10,000
8,000
5,400
(1) Cash
800
24,300
1,000
700
Take note that the Furniture and Fixtures accounts are recorded net ofthe accumulated
800
depreciation.
900
;'V
* .1,
Chapter /
18
Partnerships: Basic Considerations and Organizations
The statement offinancial position ofthe partnership after the formation is as
19
MULTIPLE CHOICES-THEORETICAL
follows;
1. A partner's withdrawal ofassets from a partnership that is considered a permanent
Illustration 1-4
reduction in the partner's equity is debited to the partner's:
GH Partnership
Statement of Financial Position
a. Drawing account
b. Retained eamings account
c. Capital account
June 30,2011
Assets
P 9,000
Cash
PI8,000
1,800
Accounts receivable
d. Loan receivable account
Merchandise inventory
16,200
19,000
Furniture and fixtures
13.500
Less: Allowance for bad debts
2. The partner's drawing accounts are used:
a. To record the partner's salaries
P57,700
Total assets
b. To reduce the paitner's capital account balances at the end ofthe period.
Liabilities and Capital
Accounts payable
Gerry capital
Henry capital
c. In the same manner as the partners'loan accounts.
'
Total liabilities and capital
d. To record the partners'share ofnet income or loss for an accounting period.
P9,000
24,400
24,300
3. A partner's drawing account is:
P57,700
a. an expense account
b. a capital account
c. a contra-capital account
d. a liability account
Key ObscYvationfrom the Illustrations. Note that the partnership is an accounting
entity separate from each ofthe partners,and that the assets invested are recorded at
their current fair values at the time ofthe fonnation.No accumulated depreciation is
carried forward to the partnership. All liabilities are recognized and recorded.
4. A partnership is an association oftwo or more persons who carry on as co
owners ofa business for profit. The persons who form the partnership may be.
The capital ofthe partnersliip is the sum ofthe individual partners' capital accounts and
is also the value ofthe partnership's net assets. The fundamental accounting equation
I.
Individuals
II. Corporations
III. Fraternal nonprofit organization
(assets less liabilities equals capital)is used often in partnership accounting.
Each partner's capital interest recorded does not necessarily have to equal his capital
contribution. The partners may decide to divide the total capital equally regardless of
a. I only.
b. I and III.
the actual contributions. The key point is that the partners may allocate the capital
•»'
,
c. I,II, and III.
ontributions in any manner they desire.The accountant must be sure that all partners
d. I and II.
^ ee to the allocation and mustthen reeord it accordingly.
\ ^
I
.
■
'*
Chapter I
20
Partnerships: Basic Considerations and Organizations
5. A partnership is a(an):
1. Accounting entity,
n. Taxable entity.
21
9. Partner's interest in a partnership is generally equal to:
a. The fair value ofnet assets at dale ofcontribution.
a. I only.
b. n only.
c. Neither I or II.
d. Both I and II
6. Partner X contributed equipment to the XYZ partnership. The equipment cost,
P60,000 with accumulated depreciation ofP10,000 but had a fair value ofP70,000
at the date the partnership received it. At what amountshould the equipment be
reported?
b. The sum ofthe fair values ofthe assets the partner eontributes to the finn,
increased by any liabilities ofother partners assumed and decreased by any
personal liabilities tliat are assumed by other partners.
c. The sum ofthe bases ofthe individual assets the partner contributes to the
firm,decreased by the partner's share ofpartnership liabilities.
d. The unamortized cost ofthe assets to the partner.
10. Which ofthe following statements,concerning partnersliip is true?
a. A partnership is a legal entity,separate and distinct from the individual partners.
a.
b.
c.
d.
P70,000
P60,000
PI0,000
P50,000
7. Which ofthe following accounts can befound in the MN partnerships' general
ledger?
1. Receivable from M
n. M drawing
b. Individual partners arejointly liable for the debts and obligations ofa partnership.
c. Income tax is levied on the individual partners' shares ofthe netincome ofa
partnership and is reported in their personal tax returns.
d. All ofthe above is tme.
11. On July 1., 2011,Long and Short fomied a partnership. Long contributed cash.
Short,previouly a sole proprietor,contributed property other than cash,includmg
realty subject to a mortgage,which the partnership assumed.Short's capital account
ofJuly 1,2011,should be recorded at:
III. Mloan
a.
Short's book value ofthe property at July 1,2011.
a. I only.
b. I and II.
Short's book value ofthe property less mortgage payable at July 1,2011.
c. The fair value ofthe property less the mortgage payable at July 1,2011.
c. I, II, and III.
d. The fair value ofthe propci-ty at July 1,2011.
d. II and II.
8 Which ofthe following statements about partnership accounts is true?
b.
12. A partnership is formed by two individuals who were previously sole proprietors.
Property other than cash that is part ofthe initial im'estraent in the partnership is
recorded for financial accounting purposes at the:
Two accounts are generally maintained for each partner,a drawing account
and a capital account.
b. The drawing account is credited with the partner's withdrawals ofcash or
other assets during the period.
c. Answer(a)is correct but(b)is false.
d. Answers(a),(b),and(c)are all correct.
a.
a. Proprietor's book values or the fair value ofthe property at the date ofthe
investment,whichever is higher.
b. Proprietor's book values or the fair value ofthe property at the date ofthe
investment,wliichever is lower.
c. Proprietor's book values ofthe property at the date ofinvestment.
d. Fair value ofthe property at the date ofthe investment.
Chapter I
22
Partnerships: Basic Considerations and Organizations
13. On April 30,2011,Apple,Beny and Cherry formed a partnership by combining
their separate business proprietorships. Apple contributed P50,000 cash. Berry
contributed property with a P36,000 book value, a P40,000 original cost, and
P80,000 fair value. The partnership assumed the P35,000 mortgage attached to
MULTIPLE CHOICES - COMPUTATIONAL
1-1:
the property. Cherry contributed equipment with a P30,000 canying amount,a
P75,000 original cost,and P55,000 fair value.Thepartnei-ship agreement specifies
that profits and losses are to be shared equally but is silent regarding capital
On May 1, 2011, Jose and Pedro formed a partnership and agreed to share
profits and losses in the ratio of 3:7, respectively. Jose contributed a computer
that cost him P50,000. Pedro contributed P200,000 cash. The computer was
soldforP55,000onMay 1,2011 immediately after the fonnation oftlicpartnerehip.
Wliat amount should be recorded in Jose's capital account on formation of the
contributions.
partnership?
Which partner has the largest April 30,2011,capital account balance?
a.
a. Apple
c.
d.
- "
qlc-rlu' ■ /
d. All capital account balances are equal.
. 1 ■;
f
I
•;I "• . "i .'I A.'i(
'■ iMr-v'iC'irC
.
P55,000
b. P51,500
b. Berry
c. Cherry
23
:•
3i
1-2: Red, White, and Blue form a partnership on May 1,2011. They agree that Red
will contribute office equipment with a total fair value of P40,000; White will
contribute delivery equipment with a fair value ofP80,000; and Blue will contribute
cash. IfBlue want a one tliird interest in tire capital and profits, he should contribute
the following ofcash:
a.
b.
c.
d.
''
i'}:.. ,' ■ -'iv
P60,000
P50,000
P 40,000
P 60,000
P120,000
P180,000
1-3: Mateo and Julio formed a partnership on April 1 and contributed the following
assets:
-If-
. /■
■■
■' •
\ ^
I wi: ;
^ -i
" '' ■
■■■ , ,
:
Cash
.. '
■/'■j'i'. 1'
,
^
z':/f.;;
■ •. C:;' ■ / ■ V,
v.
./
•
j
■:
Julio
P300,000
PI 00,000
300,000
Land
■
. t
Mateo
.
The land was subject to a mortgage of P50,000, which was assumed by the
partnership. Under the partnership contract, Mateo and Julio will share profit
V'
and loss in the ratio ofone-third and two-thirds respectively. Juho's capital account
V
.
at April 1 should be:
, ■
'
' ■ ■ ■
• '<1
'Jif
, '>?!
"v V-. .
a.
b.
c.
d.
PS50,000
P300,000
P400,000
P450,000
•
ir I«r.''
.
'■ I'
a.A'" . "
■'
'
; "V
■♦:
'* •■ • ■ Oi.
Chapter 1
24
1-4:
Elsa and Perla form a new partnership. Elsa invests P300,000 in cash for her 60
percent interest in the capital and profits of the business. Perla contributes land
that has an original cost of P40,000 and a fair market value of P70,000, and a
building that has a tax basis of P50,000 and a fair market value of P90,000. The
Partnerships: Basic Considerations and Organizations
1-7:
amount of cash should Perla contribute?
1-5:
agreement specifies that profits and losses are to be shared equally but is
silent regarding capital contributions. Which partners has the largest April 30,
P 40,000
P 80,000
P110,000
PI50,000
2011, capital balance?
Anton and Bauzon formed a paitnership and agreed to divide initial capital equally,
even though Anton contributed P100,000 and Bauzon contributed P84,000 in
identifiable assets. Under the bonus method, to adjust the capital accounts,
a. P46,000
b. PI6,000
c. P 8,000
1-6:
1-8:
Reyes and Santos drafted a partnership agreement that lists the following assets
contributed at the partnership formation:
P200,000
Cash
Inventory
Building
Equipment
P300,000
150,000
400,000
-
-
150,000
BB
c.
CC
PP, RR, and SS are new CPA's and are to form a partnership. PP is to contribute
is selling computers, is to contribute cash of P25,000 and a brand new computer
with a regular selling price of P60,000 but which cost is P50,000. Partners agree
to share profits equally. The capital balances upon formation are:
a.
b.
c.
d.
P 75,000
PI10,000
P 80,000
P 83,333
RR
P80,000
P80,000
P80,000
P88,333
Santos
1-9: Maria and Nora entered into a partnership on March 1,2011 by investing the
following assets:
Maria
Cash
Merchandise Inventory
Computer Equipment
P850,000
P750,000
P550,000
P600,000
Furniture and Fixtures
-A'
'■ t
u V-. ,
if :-v
SS
P85,000
P75,000
P80,000
P88,334
—
The building is subject to a mortgage of PI 00,000, which the partnership has
assumed. The partnership agreement also specifies the profits and losses are to
be distributed evenly. What amounts should be recorded as capital for Reyes
and Santos at the formation of the partnership?
b. P350,000
P550,000
c.
d. P600,000
b.
PP
Contributed by
Reyes
Santos
a.
AA
cash of P50,000 and his computer originally costing P60,000 but has a second
hand value of P25,000. RR is to contribute cash of P80,000. SS, whose family
Zero
Reyes
P350,000
a.
d. All capital account balances arc equal
Bauzon's intangible assets should be debited for;
d.
On April 30,2011, AA, BB and CC fonned a partnership by combining their
separate business proprietorships. AA contributed cash of P50,000. BB
contributed property with a P3 6,000 book value, a P40,000 original cost, and
P80,000 fair value. The partnership accepted responsibility for the P35,000
mortgage attached to the property. CC contributed equipment with a P30,000
book value, a P75,000 original cost and P55,000 fair value. The partnership
building is subject to a P40,000 mortgage that the partnership will assume. What
a.
b.
c.
d.
25
Nora
P 30,000
-
200,000
P
90,000
160,000
•' I. 'J
•
;5l • ,
Chapter I
26
1-9: Continued
The agreement between Maria and Nora provides that profits and losses are to
be divided into 40% to Maria and 60% to Nora,and that the partnership is to
assume a liability on the computer equipment ofP60,000. The partners further
agree that Nora is to receive a capital credit equal to her profit and loss ratio.
How much cash is to be invested by Nora?
a.
b.
c.
d.
PI35,000
PI45,000
PI55,000
PI30,000
1-10: Roy,Sam and Tim decided to engage in a real estate venture as a partnership.
Roy invested P 140,000 cash and Sam provided an office and fumishings valued
at P220,000.(There is a P60,000 note payable remaining on the fumishings to
Partnerships: Basic Considerations and Organizations
27
1-12: The partnership ofPerez and Reyes was formed on March 31,2011. At that
date,Perez invested P50,000 cash and office equipment valued at P30,000.
Reyes invested P70,000 cash, merchandise valued at P110,000,and furnitures
valued at PI00,000,subject to a notes payable ofP50,000(which the partnership
assumes).The partnership provides that Perez and Reyes share profits and losses
25:75,respectively. Tlie agreement flirther provides thatthe partners should initially
have,an equal interest in the partnership capital. Under the goodwill and the
bonus method,what is the total capital ofThe partners after the fomiation?
a.
b.
c.
d.
Bonus Method
Goodwill Method
P310,000
P360,000
P300,000
P350,000
P460,00.0
P510,000
P410,000
P400,000
be assumed by the paitnership). Although Tim has no tangible assets to invest,
both Roy and Sam believe that Tim's expert salesmanship provides an adequate
investment.Tlie partneis agree to receive an equal capital interest in the partnership.
Using the bonus method, what is the capital balance ofTim?
1-13: Ruiz and Pena are combining their separate businesses to form a partnership.
Cash and noncash assets are to be contributed for a total capital ofP300,000.
The noncash assets to be contributed and the liabilities to be assumed are:
a. P 50,000
Ruiz
Pena
b. Zero
c. PI40,000
d. PI00,000
Accounts Receivable
1-11: Lara and Mifra foimed a partnership on July 1,2011 and invested the following
Equipment
Accounts Payable
assets:
Cash
Computer Equipment
Inventories
Lara
Mitra
PI30,000
P200,000
50,000
-
The computer equipment has a note payable amounting to P10,000, which was
assumed by the partnership. The partnership agreement provides that Lara and
Mitra will liave an equal capital credit. Using the goodwill method,the amount of
goodwill to be recorded upon formation ofthe partnership is:
Book
Fair
Book
Fair
value
value
value
value
P20,000
30,000
60,000
15,000
P20,000
40,000
45,000
15,000
P110,000
P120,000
PI00,000
PI30,000
—
P25,000
50,000
10,000
The partner's capital accounts should be equal after all the contribution ofassets
and the assumption ofliabilities. How much cash is to be contributed by Ruiz?
a. P150,000
b. P 60,000
c. P210,000
d. P 85,000
'
a.
b.
c.
d.
—
P20,000
40,000
10,000
1
^ > .
»
... .
5
Partnerships: Basic Considerations and Organizations
29
Chapter I
28
1-16: On September 30,2011,Lopez admits Mendez for an interest in his business.
On this date,Lopez's capital accountshows a balance ofP158,400.The following
were agreed upon before the fomiation ofthe partnership:
1-14: On March 1,2011,Cruz and Ferrer formed a partnership with each contributing
the following assets:
Cruz
P30,000
25,000
Cash
Machinery and equipment
Building
-
recognized.
P70,000
75,000
2. 5% ofthe outstanding accounts receivable ofLopez amounting to P100,000
is to be recognized as uncollectibles.
3. Mendez is to be credited with a one-third interest in the partnership and is to
225,000
10,000
Furniture and fixtures
1. Prepaid expenses ofP 17,500 and accrued expenses ofP5,000 are to be
Ferrer
—
invest cash aside from the P50,000 worth ofmerchandise.
The building,is subject to a mortgage loan ofP90,000,which is to be assumed
by the partnership. The partnership agreement provides that Cruz and Ferrer
share profits and losses 30 percent and 70 percent,respectively.
The amount of cash to be invested by Mendez and the total capital of the
partnership are:
Assuming that the partners agreed to bring their respective capital in proportion
to their respective profit and loss ratio, and using Ferrer's capital as the base,
how much cash is to be invested by Cmz?
a.
b.
c.
d.
a. P19,000
h. P30,000
c. P40,000
d. PS5,000
P32,950 and P248,850 respectively.
P55,300 and P221,200 respectively.
P82,950 and P248,850 respectively.
P32,950 and PI71,200 respectively.
1-17: Moran and Nakar entered into a partnership on Febmary 1,2011 by investing
the following assets:
1-15: The statement offinancial position as ofJuly 31,2011 for tlie business owned by
Morart
Nakar
C.Boija shows the following assets and liabilities:
PI5,000
Cash
Merchandise Inventory
P2,500
10,000
15,000
Cash
Accounts Receivable
Merchandise Inventory
Accounts Payable
15,000
Land
65,000
Building
100,000
Furniture and fixture
18,000
6,000
Fixtures
P45,000
The agreement between Moran and Nakar provides that profits and losses are
It is estimated that5% ofthe receivables may prove uncollectible. Merchandise
to be divided into 40%(to Moran)and 60%(to Nakar),and that the partners ip
inventory includes obsolete items costing P5,000 ofwhich P2,000 might still be
realized. Depreciation has never been recorded:the fixtures are two years old,
is to assume the P30,000 mortgage loan on the building.
IfNakar is to receive a capital credit equal to his profit and loss ratio,how much
have an estimated useful life of 10 years,and would cost P20,000 ifcurrently
cash must he invest?
purchased.D.Arce is to be admitted as a partner upon his investment ofP20,000
cash and PI0,000 worth, of merchandise. What is the total assets of the
a. P127,500
b. P172,500
c. P 97,500
partnership?
I
a. P70,500
b. P48,000
c. P67,500
(L P74,000
d. P 77,500
Acc.m.
.
1
'
t',
-' '
■
- ~ ■ ••
Chapter I
30
1-18: As of July 1, 2011, Flores and Garcia decided to form a partnership. Their
statements offinancial position on this date are:
Flores
Garcia
P 1,500
54,000
15,000
P 3,750
22,500
20,250
27,000
P70,500
P73,500
Accounts Payable
Flores,capital
Garcia,capital
P13,500
57,000
P24,000
Total
P70,500
Cash
Accounts receivable
Merchandise Inventory
Machinery and equipment
-
Total
-
—
1-19: Continued
On this date,the partners agree to admit Roxas as a partner. The teims ofthe
agreement are summarized below.
Assets and liabilities are to be restated as follows:
a. An allowance for possible uncollectibles ofP4,500 is to be established.
b. Inventories are to be restated at their present replacement value ofP170,000.
c. Accrued expenses ofP4,000 are to be recognized.
Ortiz,Ponce and Roxas will divide profits in tlie ratio of5:3. Capital balances of
the partners after the formation of the new partnership are to be in the
49,500
aforementioned ratio, with Ortiz and Ponce making cash settlement between
P73,500
themselves outside ofthe partnership to adjust their capitals,and Roxas investing
cash in the partnership for his interest. How much cash is to be invested by
The partners agreed that the machinery and equipment of Flores is
imderdepreciated byP1,500 and that ofGarcia byP4,500. Allowance for doubtful
accounts is to be set up amounting to P12,000 for Flores and P4,500 for Garcia.
Roxas?
The partnership agreement provides for a profit and loss ratio and capital interest
a. P60,250
b. P47,500
c. P50,000
of60% to Flores and 40% to Garcia. How much cash must Flores invest to
d. P59,375
bring the partner's capital balances proportionate to their profit and loss ratio?
a,
b,
c,
(L
P14,250
P 5,250
P17,250
P10,250
1-20: On July 1 ofthe current year,Jocson and Gomezfrom a partnership. Jocson is to
invest certain business assets at values which are yet to be agreed upon."He is to
transfer his business liabilities and is to contribute sufficient cash to bring his total
capital to P180,000,which is 60% ofthe total capital as had been agreed upon.
Details regarding the book values ofJocson's business assets and liabilities and
their corresponding valuation follow:
1-19: Ortizand Ponce are partners sharing profits in this proportion-60:40.A statement
offinancial position prepared for the partners on April 1,2011:
P 48,000
92,000
165,000
Cash
Accounts receivable
Inventories
Equipment
Accounts Payable
Ortiz, capital
Ponce, capital
P 89,000
133,000'
Allowance for doubtful accounts
Merchandise inventory
Store equipment
P70,000
Total Assets
45,000
25,000
P330,000
Total Liabilities & Capital
Accounts receivable
108,000
Less Accumulated
Depreciation
31
Partnerships: Basic Considerations and Organizations
P330,000
Accumulated depreciation - Store equipment
Office equipment
Accumulated depreciation- Office equipment
Accounts Payable
Book
Agreed
Values
Valuations
P54,000
3,600
96,600
27,000
18,000
. 18,000
9,600
48,000
P54,000
6,000
105,000
-
13,200
-
4,800
48,000
Chapter I
32
33
Partiterships: Basic Considerations and Organizations
1-20: Continued
1-22: Continued
Gomez agrees to invest cash ofP30,000 and merchandise valued at current
market price. The value ofthe merchandise to be invested by Gomez and the
amount ofcash to be invested by Jocson are;
a.
b.
c.
d.
It is agreed that for purposes of establishing Cortez's interest, the following
adjustments should be made:
1. An allowance for doubtful accounts of 2% of accounts receivable is to be
PI20,000 and P48,000 respectively.
P210,000 and P49,200 respectively.
P105,000 and P50,000 respectively.
P 90,000 and P48,000 respectively.
established.
2. Themerchapdiseinventory is to be valued at PI 60,000.
3. Prepaid expenses of P5,200 and accmed expenses of P3,200 are to be
recognized.
1-21: On April 1,2011,Ell and Emm pooled their assets to form a partnership, with
Divino invested cash ofP113,640 to give him a one-third interest in the total cajpitel of
the firm. What is the capital balance of Cortez before the admission ofDivino?
the firm to take over their business assets and assume the liabilities. Partners
capitals are to be based on net assets transferred after the following adjustments:
a.
b.
c.
d.
Emm inventory is to be increased by P3,000;an allowance for doubtful accounts
ofPI,000 and PI,500 are to be set up in books ofEll and Emm,respectively;
and accounts payable ofP4,000 is to be recognized on Ell's books.The individual
trial balances on April 1,2011,before adjustments follow:
Ell
Liabilities
Capital
Items 1-23 and 1-24 are based on the following data:
Emm
On June 30,2011 Eden and Flora formed a partnership with each contn u i
P113,000
34,500
78,500
P75,000
5,000
70,000
Assets
P227,280
P230,120
P211,200
P250,500
following assets:
Flora
Eden
Book Value
How much is the capital ofEll after the above adjustments to his books?
a. P70,000
. "I
b. P65,000
c. P68,500
d. P66,000
Office Equipment
Building-Net
P375,000
350,000
P375,000
312,000
Book Value
P875,000
872,500
3,262,500
Fair Value
P875,000
937,500
2,812,500
Furniture and Fixtures
1-22: Cortez admits Divino for a partnership interest in his business. The statement of
financial position ofCortez on November 30,2011 prior to the admission of
Divino shows the following:
Credit
Debit
Cash
Accounts receivable
Merchandise inventory
Accounts payable
Cortez, capital
Cash
Fair Value
P
?
96,000
144,000
» *. t . ^ .
■'
P49,600
?
The building is subject to a mortgage loan ofP1,125,000 which is to be
partnership. The partnership agreement provides that Eden
losses in the ratio of 30% and 70% respectively. Assuming that the partn
eapital as the base:
1-23: What is the capital account balance of Flora on June 30,2011?
' a. P3,500,000
b. P4,000,000
c. P3,937,500
d. P3,837,500
&
to
Chapter I
34
1-24: How much is the additional cash to be invested by Eden?
Partnerships: Basic Considerations and Organizations
35
1-26: Continued
a. P2,687,500
b. P2,587,000
c. P 688,000
Candy should make an additional investment(withdrawal)of:
d. P 687,000
a. P 96,000
,\' 1,
b. P 84,000
1-25: Rey,Sam,and Tim formed a partnership on May 31,2011, with the following
assets, measured at their fair market values,contributed by each partner:
Rey
Cash
Delivery equipment
Computer equipment
P60,000
900,000
51,000
Sam
P72,000
Ttm
PI80,000
219,600
15,000
PI20,000. The delivery equipment contributed by Rey has a mortgage of
P540,000 and the partnership is to assume the responsibility for the loan. The
partners agree to divide profits and losses 40% to Rey;40% to Sam;and 20%
to Tim.
The partners further agreed to bring their respective capital interest in proportion
to their profit and loss ratio.
Using the bonus method,capital transfer among partners should be made as
follows:
From Rey and Tim,P87,960, andP3,480 respectively to Sam.
From Sam to Rey,P87,960 and to Tim, P3,480.
From Sam to Tim,P3,600 andfrom Sam to Rey,P88,200.
From Rey to Tim,P3,480, andfrom Rey to Sam,P91,440.
1-26: Candy and Dandy havejust formed a partnership. Candy contributed eash of
PI26,000 and computer equipment that cost P54,000. The fair value ofthe
computer is P36,000. Candy has a notes payable on the computer ofP12,000
to be assumed by the partnership. Candy is to have 60% capital interest in the
partnership. Dandy contributed only P90,000. The profit and loss ratio ofthe
partners as agreed is equally.
Question 27 and 28 are based on thefollowing data:
On June 1,2011,May and Nora formed a partnership. May is to invest assets at
fair values. She is to transfer her liabilities and is to contribute sufficient cash to
Although Tim has contributed the most cash to the partnership,Tim did not have
the full amount ofPI80,000 available and was foree to borrow personally
a.
' b.
c.
d.
c. P(76,800)
d. P(15,000)
bring her total eapital to P210,000 which is 70% ofthe total capital ofthe
partnership. Details regarding the book values ofMay's business assets and
liabilities and their corresponding fair values are:
Fair values
Book values
Accounts receivable (net)
Inventory
Equipment
Notes payable
53,800
98,400
25,800 ■
P53,000
107,000
34,000
56,000
56,000
Nora agrees to invest cash ofP42,000 and merchandise valued at current market
price.
1-27: What is the value ofthe merchandise to be invested by Nora?
a. P48,000
b. P84,000
c. P42,000
d. P38,000
\
^
1-28: What is the amount ofcash to be invested by May:
a. P72,000
b. P62,000
c. P26,000
; .A
d. P65,000
' 0
• )'
r
\
I
Chapter I
36
1-29: Alex and Carlos formed a partnership and agi^eed to divide initial capital equally,
even though Alex contributed PI00,000 and Carlos contributed P84,000 in
identifiable assets.
Under the bonus approach to adjust the capital accounts,Carlos unidentifiable
asset should be debited for
a. P46,000
b. PI6,000
c. P 8,000
d.
P
Partnerships: Basic Considerations and Organizations
1-31: Villar and Roxas sole proprietorships formed a partnership. Villar contributed
cash ofP2,205,000 and office equipment that cost P945,000. The equipment
had been used and had been 70% depreciated,the fair value ofthe equipment is
P630,000. Villar also contributed a note payable ofP210,000 to be assumed by
the partnership. Villar is to have 60% interest in tlie paitnersliip. Roxas contiibuted
only P1,575,000 merchandise inventory at fair value. The partners' eapital should
be in conformity with their interest in the partnership. After the formation the
partners agreed to share profits and losses equally.
Assuming the use ofthe bonus metliod, which ofthe following statements is true?
a.
0
b.
1-30: Noy and Bi agreed to combine their business into a partnership. The statement
offinancial position ofNoy and Bi showed the following:
Noy
Cash
Accounts receivable - net
Merchandise inventory
Computer equipment
Furniture and fixtures
Accounts payable
37
Bi
Book Value
Fair Value
Book Value
Fair Value
PI0,000
92,000
180,000
28,800
19,200
108,000
PI0,000
92,000
216,000
24,000
18,000
108,000
P 14,000
92,000
144,000
16,200
PI4,000
92,000
150,000
14,000
-
72,000
c.
The agreed capital of Villar is P2,625,000
The total agreed capital ofthe partnership is P4,375,000
The capital of Roxas will increase by PI05,000 as a residt of the
transfer ofcapital.
There is either an investment or withdrawal ofasset.
1-32: Loren and Jamby decide to combine their businesses and form a partnerslhp on
July 1,2011.The following are their assets and liabilities on July 1,2011 before
fonnation:
Assets
Liabilities
—
Loren
Jamby
P210,750
91,500
P103,000
36,000
72,000
Agreed capitals ofNoy and Bi in the partnership are P250,000 and P200,000,
respectively. The excess over the net assets contributed to the partnership is to
be treated as goodwill.
The following agreements are made to adjusts assets and liabilities:
a.
Both partners will provide P5,000 allowance for doubtful accounts.
b.
Loren's fixed assets were over-depreciated by P1,000 and Jamby's fixed
assets were under-depreciated by P500.
Accmed expenses are to be recognized in the books ofLoren and Jamby m
Which ofthe following statements is correct?
the amount ofP1,200 and P1,000,respectively.
a. The goodwill ofNoy is P2,000
b. The goodwill ofBi is P2,000
Obsolete inventory to be written offby Loren amounts to P3,500.
e. Loren and Jamby also agreed to share profits and losses equally.
c. The total capital ofthe partnership is P438,000.
d. The total assets oft he partnership is P618,000.
What is the total asset ofthe partnership after the fonnation?
d.
a.
b.
c.
d.
P297,550
P300,750
P303,550
P298,550
V
.
Chapter I
38
1-33: Gibo and Edu each operating a separate business agreed to form a partnersliip
on July 1,2011.The assets and liabilities ofthe two sole proprietorships on tlie
Partnerships: Basic Considerations and Organizations
39
1-34: Gamett and Bryant decided to combine their businesses and form a partnership.
Below are their statements of fmancial position before the fomiation:
date offormation are as follows:
Cash
Accounts receivable
Merchandise inventory
Equipment
Accounts payable
Notes payable
Gibo
Edu
PI9,200
192,000
240,000
60,000
60,000
12,000
P72,000
144,000
216,000
72,000
96,000
Cash
Accounts receivable
Inventories
Property and equipment - net
Other assets
■
Total assets
Gamett
Bryant
P2,048,400
1,031,960
528,160
613,380
8,800
PI,098,360
2,498,716
1,144,448
852,224
15,840
P4,230,700
P5,609,588
P787,336
1,000,000
PI,072,060
-
Accounts payable
Notes payable
Mortgage payable
Garnett, capital
Bryant, capital
The partners agreed on the following adjustments:
Gibo's accounts receivable are to be taken over at book value less 15% and
Edu's accounts receivable at book value less 10%.Gibo's equipment is new and
-
•. ' •
1,440,000
2,443,364
3,097,528
Total liabilities and equity
considered adequate for the new business.Edu's equipment is disposed at90%
ofits book value.It is agreed that Gibo bear one-fourth ofthe loss resulting from
-
^
P4,230,700
P5,609,588
the sale.
Assuming Edu investsufiScientcashto give him a one-halfinterestin the partnership
after charging to Gibo's capital account his share ofthe loss on the sale by Edu of
the equipment,how much must Edu invest?
a.
b.
c.
d.
The partners agreed that the property and equipment of Garnett is
underdepreciated by P80,000 and that of Bryant is over-depreciated by
P200,000. Accounts receivable of P108,000 in Ganiett's book and P 140,000
in Bryant's book are uncollectible. The partnership decided to assume the
mortgage liability of Bryant. The partnership's agreement provides for a profit
and loss ratio and capital interest of 60% to Gamett and 40% to Bryant. Bryant
P16,800
P20,400
P12,400
P18,200
is willing to invest or withdraw cash from the partnership to comply with the
agreement.
IC ;■ ■■ •
.
i.. •
.
l/ ••
Ij.
What are the capital balances of Gamett and Bryant after the formation?
a.
b.
c.
d.
I
■
•
■ •
P2,255,364 and PI,503,576,
P2,255,364 and P3,157,528,
P6,896,292 and P4,597,528,
P6,896,292 and P3,157,528,
respectively.
respectively.
respectively.
respectively.
I,, r K'-
■
.
:'w'
+"■'
' '•
•••• • .
i ". 'V
f
'■ V '
If
Chapter I
40
Partnerships: Basic Considerations and Organizations
41
1-35; Using the data in No. 1-34, what is the total asset ofthe partnership after the
formation:
a.
b.
c.
d.
P8,058,336
P5,618,336
P6,618,336
P9,840,288
The statement offinancial position ofPedro Castro on October 1,2011 before accepting
Pablo Bunag as his partner is shown below:
Pedro Castro
1-36: Gordon and Fernando sole proprietorships decided to form a partnership on
June 1,2011.Tlie partnership will take over their assets and assume their liabilities.
As ofJune 1,2011,the net assets ofGordon and Fernando are P220,000 and
P309,375,respectively. The partners agreed on a 25:75 profit and loss ratio.
Furthermore,the partners arrive on the following agreements to revalue their
assets and liabilities:
a. Gordon's inventory is undervalued by PI 1,000.
b. An allowance for doubtful account is to be set up in the books ofGordon
and Fernando in the amount ofP2,750 and P4,125,respectively.
Statement of Financial Position
October 1,2011
Assets
Cash
Notes receivable
Accounts receivable
Less: Allowance for bad debts
P 6,000
3,000
P24,000
1,000
8,000
Merchandise Inventory
Furniture and fixture
Less Accumulated depreciation
23,000
6,000
600
Total Assets
5,400
P45,400
c. Accrued expenses ofP20,250 was not recognized in Femando's books.
Liabilities and Capital
How much cash should Gordon invest(withdraw)so that their capital interest
would be qual to their profit and loss ratio.
Notes payable
Accounts payable
Pedro Castro, capital
a.
b.
Total Liabilities and Capital
P(133,250)
P( 95,000)
c. P 133,250
d. P
95,000
P4,000
10,000
31,400
P45,400
Pablo Bunag offers to invest eash to give him a eapital credit equal to on^hal( ^
Pedro Castro's capital after giving effect to the adjustment ofthe items below.
Castro accepts the offer.
1. The merchandise is to be valued at P7,400.
2. The accounts receivable is estimated to be 95% realizable.
fiprted
3. Interest accrued on the notes receivable enumerated below is to be re
P1,000,6% dated July 1,2008.
P2,000,6% dated August 1,2008.
• .
4. Interest accrued at5% annually from April 1,2008 on the notes payable is
be recorded.
5. The flimiture and fixtures is to be valued at P4,600.
6. Office supplies on hand which have been charged to expense inthe pastamounted
to P400. These are still to be used by the partnership.
., < • ' ''
Chapter /
44
Problem 1-3: Continued
The firm ofJ. Lagman has been operating for three years,during which time profits have
been satisfactory but an additional investment is still needed both to strengthen its position
in the market and to increase its profits.
1. Prepare the necessary adjusting entries in the books ofPepe Basco.
2. Prepare the openingjournal entries in the books ofthe partnership.
Problem 1-4
In December 2011,Lagman agrees to admit Magno as an equal partner in the firm.The
Roces and Sales, who are engaged in the same type ofbusiness,agree to combine tlieir
resources and form a partnership on January 1,2011.Their post-closing trial balances
as ofJanuary 1,2011 are as follows:
CR
DR
Fixtures
Prepaid insurance
Accounts payable
Notes payable
DR
P 14,400
57,600
124,800
19,200
144,000
4,800
3,200
64,000
40,000
8,000
12,800
6,400
Allowances for bad debts
Accumulated depreciation-
Delivery equipment
Accumulated depreciationFixtures
Capital
P364,800
4,800
72,000
192,000
48,000
96,000
104,000
Accrued taxes
CR
P
12,800
8,000
80,000
161,600
88,000
195,200
P364,800
P416,000
statement offinancial position ofthe respective fiurms are as follows:
Lagman
Magna
P8,000
21,000
9,000
5,000
37,000
P5,000
13,000
15,000
3,000
9,000
P80,000
P45,000
Assets
Sales
Races
Merchandise inventory
Delivery equipment
45.
Problem 1-5
Required:
Cash
Accounts receivable
Partnerships: Basic Considerations and Organizations
Cash
Accounts receivable
Merchandise inventory
Equipment
Other assets
Total
Liabilities and Capital
Accounts payable
Notes payable
J. Lagman,capital
R. Magno,capital '
P12,000
5,000
63,000
Total
P80,000
P6,000
10,000.
29,000
P45,000
P416,000
Additional data:
Itis agreed that the partnership shall acquire the assets and assume the liabilities ofthe
businesses at thefoUowing values:
Races
Accounts receivable (net)
Fixtures(net)
Merchandise inventory
Goodwill^
P56,000
80,000
132,800
40,000
Sales
P4,800
32,000
• yt Preoare the necessaryjoumal entries in the books ofRoces,Sales,and the
gtot:
a.
b.
c.
Roces'books will be used by the partnership
Sales' books will be used by the partnership.
A new set ofbooks will be opened by the partnership.
(a) Goodwill ofP8,000 is to be allowed to Lagman.
(b) Magno's merchandise is to be valued at PI2,000.
(c) Magno's notes payable have unrecorded P300 accmed interest.
(d) Lagman is to set up an allowance for bad debts equal to one percent ofhis
accounts receivable,and Magno's accounts receivable is to be valued atP12,000
though transferred gross to the new firm.
(e) After giving effect to the above provisions, each partner is to withdraw or
contribute sufficient capital to give him an investment ofP35,000.
Required:
1. Joumal entries to close Magno's books.
2. Joumal entries to adjust the books ofLagman.
3. Joumal entries to take up Magno's investment on the books ofLagman,the
books to be retrained by the new firm.
4. Statement offinancial position ofthe new firm.
'\ '
Chapter I
46
Problem 1-6
Toledo and Ureta each operating a separate business agreed tojoin in partnership as of
July 1,2011. The account balances presented by each partner as ofthis date were as
Chapter 2
follows:
Partnership Operations
Toledo
Cash
Accounts Receivable
Merchandise
Office Equipment
P 3,200
3,200
40,000
10,000
Accounts Payable
Notes Payable
Capital
P85,200
PI0,000
2,000
73,200
P85,200
Ureta
The accounting system ofa partnership, including the classification ofaccounts
and the accounting concepts, is essentially the same as that ofotherprofit-oriented
businesses. The accurate determination ofperiodic net income and its distribution
to the partners is still the primaiy objective of the accounting process. To this
end, a partnership is treated as a separate and distinct accounting entity.
Cash
Accounts Receivable
Merchandise
Office Equipment
PI2,000
24,000
36,000
12,000
P84,000
Accounts Payable
Capital
PI6,000
68,000
Net income is computed in the usual manner, that is matching revenues and
expenses, then credited to the individual capital accounts. However, the treatment
becomes more complex because of the differences in capital contributions, in
P84,000
abilities and talents ofindividualpartners, and in time spent on partnership duties
by the individual partners.
The assets ofthe two partners were carefully examined and it was agreed that certain
The usual types ofaccounting problemsfor partnership operations are classified
adjustments be made and the above balance sheets as adjusted be the basis on which
the partnership begins operations.
asfollows:
The adjustments agreed upon are as follows:
1.
Determination ofthe proper distribution ofpartnership profits and losses among
Toledo's accounts receivables are to be taken over at a book value less 15% and
2.
Preparation offinancialstatementsfor the partnership,such as balance sheet,
3.
4.
income statement, statement ofpartners' capitals, and cash flows.
Changes in the profit and loss ratios.
Correction ofnet income (loss) ofprior years.
the partners.
Ureta's accounts receivable at book value less 10%.Toledo's office equipment is new
and is considered adequate for the new business; therefore, it is decided that Ureta
dispose ofhis equipment at the highest cash price possible and that Toledo bear onefourth ofthe loss resulting from the sale. Ureta's ofiBce equipmentis disposed ofat book
value less 10%.It is further agreed that Ureta pay sufficient cash to give him a one-half
(1/2)interest in the business after charging to Toledo's capital account his share ofthe
DIVISION OF PROFITS AND LOSSES
The partnership law provides that profits and losses ofthe partnership are to be divided
loss on the sale by Ureta ofoffice equipment.
in accordance with the partners agieement.Ifno agreement is made between and among
Required:
the partners, profits and losses are to be divided according to their original capital
1
Prepare thejournal entries on the books ofToledo and on the books ofUreta to
give effect to the agreement.
2. Open the books ofthe new partnership,making separate entries for the contributions
ofToledo and Ureta.
3. Record Ureta's cash contribution,which gives him halfinterestin the new partnership.
contributions. Should the partners agree to divide the profits only,losses,ifany are to
be divided in the same manner as that ofdividing profits. However,should the partners
agree to divide losses only, profits,ifany shall be divided by the partners according to
their original capital contributions.
47
4. Prepare a statement of financial position for the new partnership after the
consummation ofthe entire agreement.
h..'
Chapter 2
48
■■ ■ .
'■ >
:^"V.
■
■
Partnership Operations
The ratio in which partnership profits and losses are divided is known as the profit and
49
Division ofProfit and Loss Equally
loss ratio. The many possible methods ofdividing net income or loss among partners
may be summarized as follows:
This agreement to divide profits and losses is common in practice because ofits simphcity.
On December 31,2011,the net income ofP60,000 is transferred from the Income
1. Equally.
2. In an unequal or arbitrary ratio.
Summary accountto the partners' capital account by the following closing entry:
3. In the ratio ofpartners' capital account balances on a particular date,or in the ratio
ofaverage capital account balances during the year.
60,000
Income summary
4. Allowing interest on partners' capital account balances and dividing the remaining
30,000
30,000
Siy capital
Tiu capital
net income or loss in a specified ratio.
5. Allowing salaries to partners and dividing the remaining net income or loss in a
To record division ofnet incomefor 2011.
specified ratio.
6. Bonus to managing partner based on net income.
On the other hand,ifthe business operations resulted to a loss ofP10,000 during the
year,the Income Summaiy account would show a debit balance ofP10,000.The loss
These altemative methods emphasize that the value ofpersonal services rendered by
individual partners may vary widely, as may the amounts ofcapital invested by each
is transferred to the partners' capital accounts by the following closing entry.
partner. The amount and quality ofmanagerial services rendered and the amount of
5,000
5,000
Siy capital
liu capital
capital invested are also important factors to be considered in detemiining the profit
sharing agreement. Therefore,as a preliminary step, agreements should be made for
salaries to paitners and interest on their respective capital account balances. Any remaining
10,000
Income summary
To record division ofnet lossfor 2011.
profit or loss then may be divided in a specified ratio. The following series ofillustrations
will show how each ofthe methods ofdividing profits and loses may be applied.
Division ofProfit and Loss in an Arbitrary (unequal) Ratio
ILLUSTRATION OF PROFIT DISTRIBUTION
Assume that Siy and Tiu agreed to divide profits and losses in the ratio of60%to Sry
Assume that on January 1,2011,Siy and Tiu formed a partnership with an investment
and 40% to Tiu.The agreement that Siy should receive60% ofthe netincome(perhaps
ofP30,000 by Siy and P60,000 by Tiu. On December 31, 2011, after closing all
because ofgreater experience and expertise in the field or various business contacts)
income and expense accounts,the Income Summary account shows a credit balance
ofP60,000,representing the profit for the year 2011. Changes in the.capital accounts
would cause Siy to shoulder a larger share ofthe net loss ifthe partnership operate ^
during 2011 are summarized as follows:
unprofitable. Closing entry to divide the net income ofP60,000 to individual partners
capital accounts for 2011 follows:
Illustration 2-1
Changes in Partners' Capital Accounts
Capitafbalances, January 1, 2011
Additional investments, March 1
Additional investments, August 1
Withdrawal, October 1
Withdrawal, November 1
Capital balances, December 31,2011
Tiu
P40,000
20,000
20,000
P 60,000
50,000
40,000
(20,000)
36,000
24,000
Siy capital
Tiu capital
To record division ofprofit computed as follows:
Siy: 60% X P60,000 = PS6,000
Tiu: 40% xP60.000 =
—
(50,000)
24,000
H
Total
P60,000
60,000
Income summary
Siy
PI00,000
' 1" . '"I"
P60.000
Cliapler 2 .1
50
Partnership Operations
5.1
Division ofProfit and Loss in the Ratio ofPartners' Capital Account Balances
Division ofnet income on the basis of(1)original capital investments,(2)beginning
The capital contributions ofpartners are usually considered in the determination of
capital account balances,or(3)ending capital account balances may be um-easonable
ifthere are material changes in the capital accounts during the year. Use ofaverage
profit and loss sharing agreements. If partners' capital is considered in allocating
capital balances is preferable because it reflects the capital actually available for use by
partnership income,the agreement should specify whether the ratio is based on tlie
the partnership during the year.
original capital contributions, beginning capital balances,ending capital balances,or
average capital balances.In addition,several inteqiretations ofaverage capital balances
are possible,and capital balances may be detennined before or after drawing accounts
are closed to the partners' capital accounts.
Ratio of Original Capital Contributions.This ratio is used ifno agreement is made
Ratio ofAverage Capital Balances.Ifthe partnership agreement provides to divide
net income in the ratio ofaverage capital balances during the year,it should also state
the amount ofdrawings each partner may make.without affecting the capital account.
Any additional withdrawals or investments are entered directly to the partners' capital
accounts and therefore should be considered in the computation ofthe average capital
ratio.
between partners. The allocation is as follows;
Siy:
P60,000 x P30,000 / P90,000 = P20,000
The average capital balances for year can be computed using two methods(1)
simple average ofthe beginning and ending capital balances ofeach partner,or(2)the
peso month/peso day method.
Tia-
P60,000 X P60,000 / P90,000 = P40.000
Thejournal entiy to close the Income Summary account would be similar to thejournal
entiy presented on page 49.
Ratio ofBeginning Capital Balances.Assuming that the net income is divided in the
ratio ofcapital balances at the beginning ofthe year,as shown in Illustration 2-1,the net
income ofP60,000 for 2011 is divided as follows:
Siy:
P60,000 x P40,000 / PI00,000 = P24,000
Tia-
P60,000 X P60,000 / PI00,000 = P36,000
Ratio ofEnding Capital Balances. Assuming that profit or loss is to be divided in the
ratio ofcapital balances at the end ofthe year, as shown in Illustration 2-1. The net
income ofP60,000 for 2011 is divided is follows:
Siy:
Tar
P60,000 x P60,000 / PI60,000 = P22.500
P60,000 x PI00,000 / PI60,000 = P37,500
Simple Average Method. Referring to the data in Illustration 2-1,tlie average capitals
ofSiy and Tiu using this method are computed first as follows:
Siy: (P40,000 + P60,000)
Tnr (P60,000 + PI00,000)
2
2
Total
P 50,000
80,000
P130,000
The net income can now be divided as follows.
.
Siy: P^n OOP x P50,000 / P130,000 = P23,077
Tm: P60,000 x P80,000 / P130,000 = P36,923
Peso-Month /Peso-Day Method. Under this method,
balances up to the amounts specified m the agreement
dividing
determining the partners'average or year-end capital balances.For
®
partnership income,drawings in excess ofallowable amounts are'I®,?
■
partners'capital accounts in computing average capital balances.The Partners p
contract should also state whether capital account balances are to be computed to me
nearest month or to the nearest day. A common practice is to treat withdrawals and
investments made during tlie fnst halfofthe montli as ifthey were made on the first day
ofthe month,and to treat withdrawals and investments during the latter halfofthe
month as ifthey were made on lire first day ofthe following month.
•y vy-'!
.
53
Partnership Operations
Chapter 2
52
Interest Allowed on Partners' Capital with Remaining Profit or Loss Divided
in an Agreed Ratio.
Using the data in Illustration 2-1,the computation ofaverage capital balances to the
nearest month and the division ofnetincome for Siy and Tiu for 2011 are as follows:
Partnership contract may provide for interest allowances on partners' capital in order
to encourage capital investments. Remaining profits are then divided equally or in any
other specified ratio. Interest allowed to partners varies from one partner to another
due to the differences of capital contributions and balances. Partnership contract should
therefore provide that a specific interest rate shall be allowed to a partner based on his
beginning capital balances, ending capital balances, or average capital balances.
Illustration 2-2
Siy and Tiu Partnership
Computation ofAverage Capital Account Balances
Year Ended December 31,2011
Partner
Siy
Date
Average
'Capital
Capital
Fraction
Investments
Account
(Withdrawals)
Balance
ofYear
Unchanged
January 1
August 1
P40,000
20,000
20,000
October 1
(20,000)
March 1
P 40,000
60,000
80,000
60,000
Account
P
2/12
5/12
. 2/12
3/12
6,667
25,000
13,333
15,000
P 60,000
Tiu
January 1
August 1
P60,000
50,000
40,000
November 1
(50,000)
March 1
P 60,000
110,000
150,000
100,000
P 10,000
45,833
37,500
16,667
2/12
5/12
3/12
-
Using interest allowances on partners' capital account in order to achieve a reasonable
profit distribution has no effect on the computation of the net income or loss of the
partnership. Interest on partners' capital accounts is not an expense of the
Balances
2/12
partnership.
1
'I
Illustration ofAllocating Net Profit. Again refer to Siy and Tiu Partnership with a
net income of P60,000 for 2011 and capital account balances as shown in Illustration
2-1. Assume that the partnership agreement allows interest on partners' average capital
account balances at 12%, with any remaining net income or loss to be divided equally.
The net income of P60,000 for 2011 is divided as follows:'
Illustration 2-3
Schedule of Profit Distribution
PI 10,000
The net income ofP60,000 on December 31,2011 can now be divided as follows:
Siy: P60,000 x
P60,000
Siy
PI70,000
Total average capital account balances
Interest on average capital:
Siy:
P 60,000 x 12%
Tiu:
/ PI70,000 = P2hl77
P60,000 X
PI 10,000
/ P170,000 = P38.823
Totals
, ^partnership agreement ofSiy and Tiu specifies that income is to be divided
don partners'
capital balances,but fails to specify how capital balances are to be
average capital balances should be used ifit can be computed.Ifnot
Total
P13,200
P 7,200
13,200
19,800
19,800
39,600
P27,000
P33,000
P60,000
P 7,200
PI 10,000 x 12%
Remainder (P60,000 - P20,400), equally
Tiir
Tiu
The joumal entry to close the Income Summary account on December 31,2011 is
presented below:
cornpn j capUt^^ balances should be used,
Income summary
the
Siy capital
Tiu capital
To record division ofnet income.
■
■»
'■ '
• ' ■' .
(•
■
. , ■ > -1
60,000
27,000
33,000
Chapter 2
54
Jllustration ofAllocating NetLoss. As a separate case,assume that the partnership
operation results at a loss ofP10,000. Ifthe agreement provides to allow interest on
capital account balances, the provision must be enforced regardless of whether
operating results is aprofit or loss. The interest allowance is not applicable during a
loss year only ifthe partners agreement contains a specific provision requiring such
omission.Note that on the following schedule ofloss distribution,the net loss of?10,000
is increased by the allowance for interest ofP20,400 to determine the remainder of
P30,400 which is then divided equally.
55
Partnership Operations
Take note that in tlie schedule(Illustiation 2-5),Siy capital will be decreased by P3,500
while Tiu capital will be increased by P2,500. At first thought,the idea ofa business loss
ofPI,000 causing one partners' capital to increase and the other partners' capital to
decrease may appear unreasonable, but there is a sound logic to support this result.
Partner Tiu contributed substantially more capital than Partner Siy;the capital was used
in the partnership operations,therefore tlie fact that a loss was incuired is not a reason
to deny recognition ofTin's gi'eater capital contiibution.
The closing entry on December 31,2011 is:
Illustration 2-4
Schedule ofLoss Distribution
Siy capital
Siy
Tiu
■
' 3,500
Tiu capital
Total
Income summary
Interest on average capital account balances
Remainder,equally
P 7,200
(15,200)
P 13,200
(15,200)
P 20,400
(30,400)
Totals
P( 8,000)
P( 2,000)
P(10,000)
Thejoumal entry to close the Income Summary account on December 31,2011 is as
follows:
Sty capital
Tiu capital
Income summary
To record division ofnet loss of2011
2,500
1,000
To record division ofnet lossfor 2011.
Salary and Bonus Allowances
When the services rendered by the individual partners to the pailnership are not equal,
due to differing abilities ofpartners or differences in time spent on partnership ^"Siness,
it is not proper to provide for such differences thi-ough the use ofprofit and loss si g
ratios. Since profits and losses may fluctuate from year to year,a fair profit sna ^
in one year may produce an unfair division in another yeai*. The best way to
8,000
2,000
10,000
these differences is to allow salaries to a partner who devotes time to the pa ^
business. Another variation in profit and loss sharing agreements is to proviae
to the managing partner to encourage profit maximization.
In some cases,agreement allowing interest on partners'capital account balances may
result to a net increase in one partners' capital account even though operations for the
year resulted to a loss. To illustrate, assume the same conditions as in the preceding
examples exceptthat the net loss for the year is P1,000.The schedule ofloss distribution
is presented below:
Salary Allowance to Partners with Remaining Net Profit or Loss Divided u
an Agreed Ratio.
In partnership accounting,partner salary allowances like interest
account balances are notexpenses in the determination ofpartnersniP
Illustration 2-5
they are a means ofachieving a fair division ofincome among the paitnei-s
Schedule ofLoss Distribution
time and talents devoted to partnership business.
Siy
Tiu
Total
Remainder,(P20,400+ PI,000),equally
P 7,200
(10,700)
P 13,200
(10,700)
P 20,400
(21,400)
Totals
P( 3,500)
P 2,500
P( 1,000)
Interest on average capital account balances
Illustration ofAllocating NetProft Using the same data for Siy and
assume that the partnership agreement provides for an annual salary
and P20 000to Tiu,with resultant netincome or loss to be divided equally, ilie sa
g-
are paid'monthly during the year. The net income ofP60,000 for 2011 is divide as
follows:
Chapter 2
56
Illustration 2-6
Illustration 2-7
Schedule ofProfit Distribution
Schedule of Distribution of Loss
Siy
Tiu
Total
Remainder(P60,000-P50,000),equally
P30,000
5,000
P20,000
5,000
P50,000
10,000
Remainder(P50,000 + P20,000),equally
Totals
P35,000
P25,000
P60,000
Totals
Salaries
Siy
Total
P 20,000
P 50,000
(35,000)
(35,000)
(70,000)
P( 5,000)
P(15,000)
P(20,000)
Siy capital
Tiu capital
2,500
1,667
5,000
15,000
Income summary
20,000
To record division oflossfor 2011.
4,167
To record sdlaiy allovmnces to partners.
But ifpartnership agreement provides that salaries are allowed to the extent ofthe
earnings only,then no salaries are allowed when a loss occurs. Partners may also agree
to allow salaries on a pro-rata basis ifearnings are lower than the total salaries. Thus,
End of Year Closing Journal Entries:
(1) Income summary
Tiu
The entry to record the division ofloss on December 31,2011 is:
Monthly Journal Entries:
Cash
P 30,000
Salaries
Tlie followingjournal entries are required for tlie foregoing:
Siy drawing(P30,000/12)
Tiu drawing(P20,000/12)
57.
Partnership Operations
for example,ifa partnership agreement provides that salaries are allowed only to the
extent ofincome eamed,and the agreement also provides for salaries ofP24,000 and
60,000
Siy capital
Tiu capital
35,000
25,000
P36,000 to Allan and Boom respectively,a profit ofP30,000 is divided as follows:
To record division ofnet incomefor 2011.
(2) Siy capital
Tiu capital
Siy drawing
Tiu drawing
To close partners'drawing accounts.
30,000
20,000
30,000
20,000
Partnership agreement should provide not only for partners salary allowances and the
sharing ofprofits but also for the treatment ofsalaries when losses are incurred.In the
absence of an agreement, salaries are automatically allowed even when losses
Siy
(P24,000 / P60,000) x P30,000 = PI2,OOP
Tnr
(P36,000 / P60,000) x P30,000 = PI8,000
Bonus to Managing Partner Based on Net Income
N
A partnership contract may provide for a bonus to the managing partner equal to a
specified percentage ofincome. When bonuses are to be allowed,the agreement must
clearly specify the basis ofthe bonus. The computation ofthe bonus may be based on.
are incurred.
1. Net income before allowances for salaries, interest and bonus.
Illustration ofAllocating Net Loss, Continuing our illustration, assume that on
December 31, 2011 Siy and Tiu Partnership has a net loss of P20,000 before
2. Net income before allowances for salaries and interest but after deduction of
salary allowances to partners. The schedule showing the distribution ofloss is
3. Net income after allowances for salaries and interest but before bonus.
presented on the next page.
the bonus.
4. Net income after allowances for salaries,interest and bonus.
Chapter 2
58
Partnership Operations
59
Illustration. Assume that the partnership ofSiy and Tin has a net income ofP190,200
before salaries, interest and bonus to partners. The partnership contract provides for
Net Income Before Allowances for Salaries and Interest, but After Deduction
tlie following:
as shown below:
a. Salaries to Siy and Tiu,P30,000 each.
b. Interest on capital account balances:
Siy
P7,000
Tiu
of the Bonus. Using this as the base, the bonus is computed using algebraic equation
Bonus + income after bonus = P190,200
3,200
e. Bonus to Siy,20% ofnet income.
d. Remaining profit or loss after salaries,interest and bonus,equally.
Let X
=
income after bonus
0.20X
=
bonus
=
P190,200 income before bonus
Then 1.20X
X = PI90,000 / 1.20"
X
.20X
The share ofthe partners in the net income ofP190,200 using different basis ofthe
bonus is computed as follows:
=
=
PI 58,500
P31,700
Alternatively, the computation of the bonus may be as follows:
Net Income Before Allowances for Salaries,Interest and Bonus.Ifthe bonus is
computed based on the net income before salaries, interest and bonus,the bonus is
computed as follows:
Netincome before salaries,interest and bonus
PI90,200 = 120%
Net income after bonus (P190,200 / 120%)
158,500 = 100%
Bonus
P190,200
Bonus percentage
20%
P 31,700 = 20%
Under this method, for purposes of bonus computation, the bonus to Siy is treated as
P 38,040
Bonus
Net income before salaries, interest andbontis
an expense.
Under this method,bonus is not treated as an expense ofthe partnership but as a tool
ofcomputing the profit share ofthe partners.
The division ofnet income is shown in the following schedule:
Illustration 2-9
The schedule showing the division ofnet profit is presented below:
Schedule of Profit Distribution
Siy
Tiu
Total
P30,000
3,200
Remainder, equally (190,200 - P101,900)
P 30,000
7,000
31,700
44,150
44,150
P 60,000
10,200
31,700
88,300
Totals
PI 12,850
P77,350
P190,200
Illustration 2-8
Schedule ofProfit Distribution
Salary allowances
Interest allowances
Siy
Salary allowances
P 30,000
Interest allowances
Bonus to Siy
Remainder,equally
Totals
Tiu
Total
j 7,000
P30,000
3,200
38,040
40,980
40,980
P 60,000
10,200
38,040
81,960
P116,020
P74,180
PI90,200
Bonus to Siy
■r
,
••
■♦V.
■. 1
i.
f'' .-
Chapter 2
60
Partnership Operations
Net Income After Allowances for Salaries and Interest but Before Bonus.Ifthe
calculation ofthe bonus is base on the net income after salaries and interest but before
61
The schedule showing the distinbution ofprofit for 2011 is presented below:
bonus,the computation ofthe bonus is:
Illustration 2-11
Schedule of Profit Distribution
Net income before salaries, interest and bonus
PI90,200
Less: Salaries
P60,000
Interest
10.200
70.200
Bonus percentage
Total
:P30,000
3,200
Bonus to Siy
Remainder(P190,200-P90,200)
P 30,000
7,000
20,000
50,000
50,000
P 60,000
10,200
20,000
100,000
Totals
PI07,000
P83,200
PI90,200
Interest allowances
20%
P 24,000
Bonus
Tiu
Salary allowances
PI20,000
Net income before bonus
Siy
The distribution ofnetincome is shown on the following schedule:
Take note that the bonus agreement is notapplicable ifthe operation ofthe partnership
result to a net loss. In other words, when there is a net loss, the bonus provision is
disregarded.
Illustration 2-10
Schedule ofProfit Distribution
Siy
Salary allowances
Total
Tiu
P30,000
3,200
Bonus to Siy
Remainder(P190,200-P94,200)
P 30,000
7,000
24,000
48,000
48,000
P 60,000
10,200
24,000
96,000
Totals
PI09,200
P81,200
PI90,200
Interest allowances
FINANCIAL STATEMENTS FOR A PARTNERSHIP
Statement of Comprehensive Income
The form and contents ofthe statement ofcomprehensive income ofa partnership are
somewhat similar to that ofthe statement ofa sole proprietorship or a corporation.
Explanations ofthe division ofnet income among the partners may be included in the
computed on net income after deducting salaries,interest and bonus,the computation
partnership's statement ofcomprehensive income or in a note to the financial statements.
The following illustration for Siy and Tiu Partnership shows,in a condensed statement
ofthe bonus is:
ofcomprehensive income for year ended December 31,2011,the distribution ofnet
Net Income After Allowances for Salaries,Interest and Bonus.If the bonus is
income ofP190,200 as shown in Illustration 2-11.
Let X
X
X
1.20 X
X
Bonus
Illustration 2-12
20%(PI90,200-P60,000- PI0,200 • X)
P38,040 - P12,000- P2,040-.20 X
P24,000
P20,000
Allan and Boom Partnership
Statement ofComprehensive Income
Year Ended December 31,2011
Alternatively, bonus may be computed using the following approach:
Net income before salaries, interest and bonus
Less: Salaries
P60,000
Interest
10,200
PI90,200
Net income before bonus
PI20,000 = 120%
100,000 = 100%
Net income after bonus(120,000 / 120%)
,
400,000
209,800
Gross profit
Operating expenses
P
Net income
70,200
:.H1
Distribution of net income
Tiu
PI07,000
83,200
Total
PI90,200
Siy
P 20,000 = 20%
Bonus
Hp .
P2,000,000
1,600,000
Sales
Cost of sales
'I
190,200
:...: ('■■
Chapter 2
62
Partnership Operations
Statement of Changes in Partners' Equity
Illustration 2-14
Changes affecting the partners' capital accounts each year are reported in a separate
statement known as the Statement of Changes in Partners' Equity. The purpose of this
statement is to present the details that cannot be readily incorporated in the statement of
financial position. The following illustrative statement of changes in partners' equity for
Siy and Tin Partnership is based on the capital accounts presented in Illustration 2-1
and includes the division of net income presented in the statementof comprehensive
income (Illustration 2-12).
Statement of Financial Position
63
Siy and Tin Partnership
December 31,2011
Assets
Current Assets
P 62,000
74,000
Cash
Accounts receivable (net)
90,000'
Inventories
Noncurrent Assets
154,200
Properties and equipment (net)
Illustration 2-13
P380,200
Total assets
Siy and Tin Partnership
Statement of Changes in Partner's Equity
Year Ended December 31,2011
Liabilities and Partners' Equity
Current Liabilities
Capital balances, January 1
Additional investments
Withdrawals
Balances before net income and drawings
Net income (loss)
Drawings ,
Siy
Tiu
Total
P 40,000
40,000
(20,000)
P 60,000
PI 00,000
130,000
P 60,000
107,000
PI 00,000
83,200
(20,000)
(30,000)
Capital balances, December 31
PI 37,000
90,000
(50,000)
PI63,200
P 60,000
20,000
Accounts payable
Loans payable
P 80,000
Total liabilities
(70,000)
PI 60,000
190,200
(50,000)
P300,200
Partners' capital balances at the end of the year is reported in the December 31,2011
statement of financial position as illustrated in the next page.
Partners' Equity:
Siy capital
Tiu capital
PI 37,000
163,200
300,200
P380,200
Total liabilities and partners' capital
■ .
I
I
.
f
I
Ai'. i/' "A
I?'
•
•y vi- 1 ■
■
Partnership Operations
Chapter 2
64
65
Statement of Cash Flows
CHANGES IN THE PROFIT AND LOSS RATIO
A statement ofcash flows is prepared for the partnership as it is for a corporation. This
statement as explained and illustrated in intermediate accounting textbooks, presents
Partners may agree to change their profit and loss ratio. When changes in the profit and
loss ratio occur, several problems will be encountered in the determination ofpartners'
interests, among which are the following:
the net cash provided by operations,net cash provided or used in investing activities,
and net cash provided or used in financing activities. A statement ofcash flows for Siy
and Tiu Partnership including the netincome from the statement ofcomprehensive income
1. There may be a difference between the book value and tlie fair value oftangible
assets.
2. Tlie partnership might have intangibles such as goodwill that are not recorded in
in Illustration 2-12 is as follows:
the books but which must be considered in determining the fair value of the
y-.
partners' interests.
Illtistration 2-15
Statement of Cash Flows
Siy and Tiu Partnership
.
■t
jja
Year Ended December 31,2011
3. The partnership might have keep its books on a cash basis, and as a result,
there may be unrecorded assets and liabilities. These too, must be considered.
After considering the above items, two approaches can be used for a fair valuation of
Cash flows from operating activities:
the partners' interest, as follows:
PI 90,200
Net income
Adjustments to reconcile net income to net cash provided
By operating activities:
Depreciation
Changes in operating assets and liabilities
Decrease (increase) in accounts receivable
Decrease (increase) in inventories
Increase (decrease) in accounts payable
Increase (decrease) in loans payable
1.
PI 66,200
(214,200)
■
Net increase in cash
110,000
K
t '''y
62,000
( ''
Cash at beginning of year
■
Cash at end of year
■V ':
j •
Calculate the effects of all the differences between the book values and fair
values as well as the unrecorded assets and liabilities, and adjust only e
partners' capital account for the net effect.of these adjustments using the o
profit and loss ratio. Under this approach, no adjustments ofassets and habi i es
are recorded in the books of the partnership.
Illustration. Assume that Ben and Cob, sharing profits and losses
respectively, decided to change their ratio to 25% to Ben and 75% to
P 62,000
First Approach:
If the adjustment of the book value is made, the required entry would be as follows.
Land
300.000
Ben capital
Cob capital
>>■ •
.
To record the increase in the Land account and
to credit the respective partners' capital account
:v, ,
using the old profit and loss ratio.
'
,v ; .: .
'
.
I
■/ •
, ' I •
4,
As
of P50,000 but had a fair value of P350,000.
(70,000)
(50,000)
Partners'withdrawals
2.
.
also that on the date of the change, the partnership held land that was carried a
P230,000
Partners' drawings
Net cash provided by financing activities
capital account in accordance with their old profit and loss ratio.
( 74,000)
( 90,000)
Net cash provided by operating activities
Cash flows from investing activities:
Acquisition of property and equipment
Cash flows from financing activities:
Partners' investments
unrecorded assets or liabilities, if any. These should be made to the partners
60,000
60,000
20,000
Adjust all assets and liabilities t6 reflect their fair values. Also record any
■a
30,000
270,000
Chapter 2
66
Partnership Operations
67
Secondr Approach:
3. Compute the difference between the share in the profit that each partner actually
Ifno adjustments are made on the date ofthe change,the required entry would be;
4. Adjust the partners' capital accounts by the amount in No.3.
Ben capital
Cob capital
received and the share each would have received from No.2.
45,000
Illustration. Assume that in 2010, the reported net income of Dan and Eve was
P100,000 and that the partners divide profits and losses,equally.In the year 2011,they
changed the ratio to 60% for Dan and 40% for Eve. During 2011,the following errors
45,000
To credit Cob with 15%-(90% - 75%) ofP300.000
for his share increase in value of the Land account
and to charge Ben s capital account accordingly.
'iVl
in computing the 2010 net income were discovered:
a. Depreciation was understated by P20,000.
b. Prepaid expenses ofPI5,000 was omitted.
c. Accmed expenses ofP5,000 was omitted.
Let us now assume that the land was later sold for P400,000. Using the two approaches,
the gain would be divided as follows:
First Approach:
Ben;
Cob:
Using the procedures,the amount ofadjustment to the partners' capital accounts is
P50,000 X 25%
P50,000 X 75%
computed as follows:
P12,500
37,500
1. Net income per books,2010
P(20,000)
Omission ofprepaid expenses
Omission ofaccmed expenses
Second Approach:
Cob
Total
P30,000
P270,0{)0
P300,000
12,500
37,500
50,000
P42,500
P307,500
P350,000
Ben
15,000
(5,000)
2. The required adjustment to partners'capital accounts can now be determined
as follows:
Portion of gain developed subsequently,
P50,000(P400,000-P350,000),divided,
25:75
Totals
(10,000)
P 90,000
Corrected net income,2010
Portion of gain developed prior to change in
Ratio,P300,000(P350,000-P50,000),
Divided, 10:90
PI00,000
Adjustments:
Understatement ofdepreciation
P50,000
Total
2010 net income before corrections
2010 corrected net income
Total
Dan
Eve
P50,000
45,000
P50,000
45,000
PI00,000
90,000
P 5,000
P 10,000
Required reduction to capital accounts P
5,000
CORRECTION OF PARTNERSHIP NET INCOME OF PRIOR PERIOD
4. The entry to adjust the partners' capital accounts on December 31,2011 is
therefore:
The partnership may discover errors made in computing net income ofprior accounting
periods. Examples ofthese errors are: error in computing depreciation,error in inventory
valuation, and omission ofaccmed expenses.\\Tien these errors are discovered,the
Dan capital
Eve capital
Prepaid expenses
partners' capital accounts should be adjusted. The following accounting procedures
may be used:
5,000
5,000
15,000
Accrued expenses
Accumulated depreciation
1. Determine the correct net profit ofthe prior period.
2. Compute the proper share ofeach partner using the profit and loss ratio in the
year in which the error occurred.
To adjust partners'capital accountsfor
errors discovered in computing net income
of2010.
JL
<
5,000
20,000
: ' )!;-'•
Partnership Operations
Chapter 2
68
69
5. The partners' drawing accounts are used:
MULTIPLE CHOICES-THEORETICAL
a. To record the partners' salaries
1. The partnership contract provides that"net income or losses are to be distributed
in the ratio ofpartners' capital account balances."The appropriate interpretation
ofthis provision is that netincome or losses should be distributed in;
b. To reduce the partners' capital account balances at the end ofan accounting
period.
c. In the same manner as the partners' loan accounts.
d. To record the partners' share ofnet income or loss for an accounting period..
a.
b.
c.
d.
The ratio ofbeginning capital account balances.
The ratio ofaverage capital account balances.
The ratio ofending capital account balances.
The ratio oforiginal capital account balances.
6. The allocation ofan error should be based on the profit and loss ratio in effect
when:
a. The error was made.
b. The error was corrected.
2. Salaries to partners ofa partnership typically should be accounted for as:
c. The error was discovered.
d. The allocation should always be made equally.
a. A device for sharing net income.
b. An operating expense ofthe partnership.
c. Drawings by the partners from the partnership.
d. Reductions ofthe partners' capital account balances.
7. Ifthere is a provision for division of profits but not losses in the partnership
agreement,it is concluded that:
a. Losses should not be divided to the capital accounts,but matched against
3. Which ofthe following is an expense ofa partnership?
. future eamings.
^ ftc
b. Losses should be divided using the same approach as division of proms.
a. Interest on partners' capital account balances.
b. Interest on loans from partners to the partnership.
c.
c. Losses should be divided equally.
u i ps
d. Losses should be allocated according to the ratio ofcapital account balanc
Both a and b.
d. Neither a and b.
8. Partners Lim and Tan share profits in a 2:1 ratio,respectively.Each partner recei
I annual salary allowance ofP60,000.Ifthe salaries are recorded in the
4. A partners' withdrawal ofassets from a partnership that is considered a permanent
reduction in that partners' equity is debited to the partners':
an:
I partnership expense rather that treated as a division ofnet income,the o a
as a
amount allocated to each partner for salaries and net income would be:
a. Drawing accoimts
b. Retained earnings account
■i '
c. Capital account
c. More for Lim and less for Tan.
d. More ofTan and less for Lim.
d. Loan receivable account
•;
i . I 'O".
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a. Less for both Lim and Tan.
b. Unchanged for both Lim and Tan.
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Chapter 2
70
Partnership Operations
71
9. Under what circumstances can the closing ofthe income summary account result
MULTIPLE CHOICES-COMPUTATIONAL
in a debitto one partners' capital account and credits to the other partners' capital
accounts?
a. The results ofoperations are divided in a profit and loss ratio and tlie partnei-ship
sustained a loss for the period.
b. The results of operations are allocated in a profit and loss ratio and the
partnership's net income was very low.
c. The results ofoperations are divided in the average capital ratio and one
partner had a low capital balance.
d. The partnership agreement provides for interest on capital and salary allowances
and net income is less that the sum ofthe interest and salary allowances.
10. Ifthe partnership agreement provides for the division oflosses only.Profits should
2-1: The partnership contract for the Lebron and James Partnership provided that
Lebron is to receive and annual salary ofPI20,000, James is to receive an
annual salary ofP80,000,and the remaining profit or loss is to be divided equally
between the two partners. Net income ofthe Lebron and James Partnership for
the year ended December 31,2011 was P180,000. The closing entry for net
income on December 31,2011 is a debit to Income Summary for P180,000 and
credits to Lebron Capital and James Capital,respectively of:
a.P108,000 and P72,000
b.P 90,000 and P90,000
c.P120,000 and P80,000
d.P110,000 and P70,000
be divided:
2-2: The partnership contract ofthe JJ, KK and LL Partnership provided for the
a. Equally.
division ofnetincome or losses in the following manner:
b. According to beginning capital ratio.
0. According to ending capital ratio,
d. According to average capital ratio.
1. Interest at 15% on average capital account balances to each partner.
1 Bonus of20%ofincome before the bonus to JJ.
3. Remaining income or loss,equally to each partner.
TT K'K and LL Partnership for 2011 was P90,000,and the
andLL,P300,000.
Hown,uchoftheP90.000partnershipprof.tfor20Ushouldbedistributedto
r» .• ' .'
JJ?
{
a. P27,000
b. P 6,000
c. P33,000
d. P39,000
2-3: The pattnership ag^
salary allowances ™,000 to May^^^
,
each withdraw cash
^iHoSperSnWftheir salary allowances.Ifd^g2011 the partnership had
Sts in Loess of PICO,000 without regard to salary allowances and
/»r' • yj' ;•
withdrawals.May's capital in the partnership would:
■I" •'y'C ,
"It
Chapter 2
72
No. 2-3: Continued
2-4:
Partnership Operations
2-6:
a.
Increase more than Jiin's
b.
Decrease more than Jim's
c.
Increase the same as Jim'
d.
Decrease the same as Jim's
73
The partnership agreement of Rey and Serg provides that interest at 10 percent
is to be credited to each partner on the basis of average capital balances. A
summaiy of Serg Capital account for the year ended December 31,2011 is as
follows:
Balance, January 1
Additional investment, July 1
Withdrawal, August 1
Allan and Michael are partners. Their capital accounts during 2011 were as
PI 40,000
40,000
15,000
follows:
8/28
P6,000
1/1
4/3
10/31
What amount of interest should be credited to Serg capital account for 2011
Michael, Capital
Allan, Capital
P40,000
8,000
18,000
3/5
P9,000
1/1
lie
10/7
P60,000
7,000
12,000
Net income of the partnership is P39,500 for the year 2011. The partnership
agreement provides for the division of income as follows:
a.
b.
c.
d.
2-7:
P15,250
PI5,375
PI6,500
P17,250
. JR and his very close friend AJ fomied a partnership on January 1,2011 with JR
contributing P16,000 cash and AJ contributing equipment with a book value of
P6,400 and a fair value of P4,800 and inventory items with a book value of
P2,400 and fair value ofP3,200. During 2011, JR made additional investment of
PI,600 on April 1 and PI,600 on June 1, and on September 1, he withdrew
P4,000. AJ had no additional investments nor witlidrawals during the year. The
1. Each partner is to be credited 10 percent interest on his simple average
capital.
2. Any remaining income or loss is to be divided equally.
What is Michael's share of profit for the year?
average capital balance at the end of 2011 for JR is:
2-5:
a.
b.
P20,500
P14,000
c.
d.
PI 6,500
PI9,000
a. PI6,000
Fred, Greg and Henry are partners with average capital balances during 2011 of
P120,000, and P60,000, and P40,000, respectively. Partners receive 10 percent
interest on their average capital balances. After.deducting salaries of P30,000 to
Fred and P20,000 to Henry, the remaining profit or loss is divided equally.
In 2011, the partnership sustained a P33,000 loss before interest and salaries
to partners. By what amount should Fred's capital account change?
a.
b.
c.
d.
P7,000
PI 1,0 00
P35,000
P42,000
b. P 8,000
c. P16,800
d. P 7,200
2-8:
The partners of RJ and AG, share profits 3:2. However, RJ is to receive a yearly
bonus of 20 percent of the net profits after deducting said bonus, in addition to
his profit share. The partnership made a net income for the year of P24,000
before the bonus. How much profit share will RJ receive?
increase
a.
deerease
b. Plb,000
decrease
increase
PI6,000
c. P15,200
d. P14,400
.1
.
Chapter 2
74
2-9: LT and AM have capital account balances at the beginning ofthe year ofP40,000
and P45,000,respectively. They share net income and losses as follows:
1.
2.
8 percent interest on beginning capital balances
salary allowance ofP15,000 to LT and P7,500 to AM
3.
remainder in 3:2 ratio
Partnership Operations
2-11: CC,DD,and EE,doctors,agree to form a partnership and to share profits in the
ratio 5:3:2. They also agreed that EE is to be allowed a salary ofP14,000,and
that DD is to be guaranteed PI0,500 as his share ofthe profits. During the first
year ofoperation,income from fees are P90,000,while expenses total P48,000.
Whatamount ofnet income should be credited to each partners'capital account?
The partnership reported net income of?10,000 for the year,before interest and
salary allowances to partners. What are the profit share of LT and AM,
respectively?
a.
b.
c.
d.
a.
b.
c.
d.
75
P6,620, and P3,380
P6,630, and P3,380
P6,500, and P3,500
P6,000, and P4,000
CC
DD
PI4,000
P12,500
PI2,000
PI2,500
P 8,400
P10,500
P11,000
P10,500
EE
P 5,600
P19,000
P19,000
P19,500
2-12: LL,MM,and PP are partners with capitals ofP40,000,P25,000,and P15,000
2-10: Peter and Paul formed a partnership on January 2,2011,and agreed to share net
income and losses 90 percent and 10 percent,respectively. Peter invested cash
ofP250,000.Paul invested no assets but had a specialized expertise and managed
the firm full time.The partnership contract provided for the following:
respectively.The partnership agreementprovides thateach partnershall beallowed
5 percent interest on his capital, that LL shall be allowed an annual salary of
P8,500, and that MM shall be entitled to a minimum ofP14,000 per aimum
including amounts allowed as interest on capital and as share bfprofit.
after interest and salary allowances is to be divided between LL,MM,
5:3:2 respectively. Whatamount must be earned by the partnership
before charges for interest or salary ifLL is to receive an aggregate ofP20,0UU
to include interest, salary,and share ofprofit?
1. Partners'capital accounts are to be credited annually with interest at5 percent
ofbeginning capital account balances.
2. Paul is to be paid a salary ofP10,000 a month.
3. Paul is to receive a bonus of 20 percent ofincome before deduction of
salary,bonus and interest on partners' capital account balances.
4. Bonus,interest,and Paul salary are considered expenses.
The statement of comprehensive income for the year ended 2011 for the
partnership includes the following:
Expenses(including salary, interest, and bonus to Paul)
P964,500
497,000
Net income
P467,500
Revenue
a.
b.
c.
d.
P38,000
P50,000
P38,550
P35,880
2-13: RR,SS, and TT,lawyers, decide to form a partnership and agree ^
profits in the ratio 4:3:1. It is agreed,however,that RR and SS shall gu^^ntee
fees from their own clients ofP80,000 and P50,000,
first year ofoperation were rzuu,uuu which mciudea lees uu
What is Paul's bonus for 2011?
■ f-r
a. P120,000
b. P150,000
c. PI30,000
d. P 93,750
^
P95,000,and fees from clients ofSS,P40,000. Operating expenses tor the y ^
were P100,000.By what amountshould the partners'capital account mcrease.
a.
b.
c.
d.
RR
SS
TT
P62,500
P62,500
P47,500
P47,500
P25,625
P25,000
P35,625
P25,625
Pll,875
Pll,800
Pll,875
Pll,875
Chapter 2
76
2-14: The partnership agreement of AA,BB, and CC provides for the year-end
allocation ofnet income in the following order:
First, AA is to receive 10 percent ofnet income up to PI00,000 and 20 percent
over PI00,000.
Second,BB and CC each are to receive 5 percent ofthe remaining income over
P150,000.
The balance ofincome is to be allocated equally among the three partners.
The partnership's 2011 net income was P250,000 before any allocations to
partners. What amount should be allocated to AA?
a.
b.
c.
d.
77
2-16: Jose and Pedro are partners who share profits and losses in the ratio of6:4,
respectively. Jose's salary is PI00,000 and Pedro is P50,000. The partners also
are paid interest on their average capital balances.In 2011,Jose received P50,000
ofinterest and Pedro,P20,000.The profit and loss allocation is detemiined after
deductions for the salary and interest payments.IfPedro's total share ofpartnership
income was P200,000 in 2011, what was tlie total partnership income?
a.
b.
c.
d.
P475,000
PS00,000
PS45,000
P750,000
2-17: JJ and RR formed the JR partnership on January 3,2011 with cash investments
of: JJ,P120,000,and RR,P180,000.On December 31,2011 the net income of
the JR partnership was P69,600.The net income included an extraordinary gain
PI01,000
P108,000
P110,000
PI03,000
ofP12,000.
Whatis the share ofJJ in the net income ofP69,600,ifincome before extraordinary
2-15: AJ,BJ and CJ are partnersjn an accounting firm.Their capital account balances
at December 31,2011 were: AJ,P90,000; BJ,PI 10,000; CJ,P50,000. They
share profits and losses in a 4:4:2 ratio, after the following special terms:
1. Partner CJ is to receive a bonus of 10 percent ofthe net income after the
bonus.
2. Interest of 10 percent shall be paid on that portion ofpartners' capital in
excess ofP 100,000.
3. Salaries of PI0,000 and PI2,000 shall be paid to partners AJ and CJ,
respectively.
items is shared equally between JJ and RR after allowance ofa 20 percent bonus
to RR based on income before extraordinary items after the bonus.Extraordinary
items are shared on the basis oforiginal investments.
a.
b.
c.
d.
P27,840
P32,640
P28,800
P24,000
2-18: Mel and Jay are partners with capitals ofP200,000 and P120,000,respectively.
The partnership agreement provided tlie following:
1. 10 percent interest on their capital investments. ,
The income summary account for the year 2011 shows a credit balance of
P44,000. What is the profit share ofpartner CJ?
a.
b.
c.
d.
Paiinership Operations
P19,400
PI6,800
P17,800
P19,800
2. Annual salary ofP36,000 to Mel.
3. Remainder in 60:40 ratio to Mel and Jay.
What is the profit to be eamed by the partnership before charges for interest,
salary and the balance,so that Jay will received P40,000 in the remainder or the
profit after salary and interest?
fl.
b.
c.
d.
f'-'.
■ '-m
P168,000
PI38,000
P136,000
PI32,000
: ,
•, M
s
Chapter 2
Partnership Operations
2-19: DV,JE and FR form a partnership and agree to maintain average investments of
No. 2-21: Continued
78
P2,500,000,Pl,250,000,and PI,250,000 respectively. The partners agree to
divide profits and losses as follows:
1. Interest of6 percent on the excess or deficiency in the capital investments.
2. Remainder to shared in the ratio of5:3:2 to DV,JE and FR respectively.
Average investments made during the first six months were as follows: DV,
P3,000,000; JE, PI,375,000; FR, PI,000,000. A loss from operations of
P62,500 was incurred for the first six months.How is this loss distributed among
the partners?
DV
P21,875
12,500
c.
31,250
d. 18,375
a.
b.
JE
P18,375
10,000
18,750
21,875
79
The Income Summary account for the year 2011 shows a credit balance of
P360,000 before any allocations. Average capital balances for Tiger and Woods
are P240,000 and P300,000,respectively. How much profit share would Tiger
be entitled to receive?
a. P184,150
b. P181,300
c. P178,700
d. P 42,700
FR
P22,250
48,500
12,500
22,250
2-22: Clotty and Cotto are partners operating a grocery store. Their partnership
- agreement requires that profits and losses be divided as follows:
Clotty
2-20: Pete and Rico share profits after the provision ofannual salary allowances of
P14,400 and P13,200,respectively in the ratio of3:2. However,ifpartnership's
net income is insufficient to provide for said allowances in full amount,the net
income shall be divided equally between the partners. In 2011,the following
errors were discovered: Depreciation for 2011 is understated by P2,100,and
the inventory on December 31,2011 is overstated by P11,400.The partnership
Cotto
Salaries
P20,000
None
Commission on gross sales
Interest on average capital balances
None
2 percent
8 percent
Bonus
8 percent
20% of net income before
None
commission,and interest
but after salaries and bonus.
net income for 2011 was reported to be P 19,500.
Remainder
60%
40%
The capital accounts ofthe partners should be increased(decreased)by:
Gross sales for 2011 were P1,250,000.Income before deducting amounts for
cu
b,
c,
d,
Pete, P6,540; Rico,P(6,960)
Pete,(6,540); Rico, 6,960
Pete,(6,750); Rico,(6,750)
Pete,(6,960); Rico, 6,540.
salary,commission,interest,and bonus were P200,000. Average capital balances
of Clotty and Cotto are P400,000 and P420,000 respectively. What are the
profit share ofClotty and Cotto,respectively?
2-21: Tiger and Woods afe partners operating a chain ofretail stores. The partnership
agreement in dividing profits and losses provides for the following:
Salaries
Interest on average capital balances
Bonus
Tiger
Woods
P64,000
PI00,000
10%
25% of net income before
10%
None
Salaries and bonus but
after interest on capital
Remainder
30%
70%
a. Pll7,640
b. P 35,460
c. P110,640
d. P117,460
andP82,360
andP23,760
andP89,360
andP82,540
Chapter 2
Partnership Operations
2-23: Mike and Tyson are partners in a trading company.During 2011,they withdrew
their salary allowances ofP200,000 and P300,000,respectively. Profits and
losses are shared in the ratio of3:2. The income summary account before any
profit allocation has a credit balance ofP600,000.The partner's capital accounts
show tlie following:
No. 2-24: Continued
80
Mike
Tyson
Additional investments
P600,000
100,000
P400,000
200,000
Withdrawals other than salary allowances
(200,000)
(100,000)
Beginning balances
What are the capital balances ofthe partners for the year 2011 after closing
Income Summary and the Withdrawals accounts?
a. Mike,P560,000; Tyson, P540,000.
b. Mike,P360,000; Tyson, P240,000..
Interest on average capital balances
Bonuses on net income before salaries, but after
interest and bonuses
Salaries
Residual(ifpositive)
Residual(ifnegative)
King
Queen
10%
10%
25%
None
P25,000
P30,000
70%
30%
50%
50%
What are the capital balances ofthe partners on December 31,2011?
b.
c.
d.
2-24: The Statement ofComprehensive Income ofKing and Queen Partnership for
the year ended December 31,2011 show a net income ofP80,000. The capital
accounts ofthe partners for 2011 shows the following:
^
King and Queen have agreed to distribute partnership net income according to
the following plan.
a.
c. Mike,P460,000; Tyson,P340,000.
d. Mike,P760,000; Tyson,P840,000.
81
King
Queen
P94,800
P43,800
P95,800
P75,000
PI68,200
P117,200
PI69,200
P148,400
2-25: The Red and Blue are Certified Public Accountants who have been operating
their own separate practices as sole proprietors. They have decided to combine
the two fimis as a partnership on January 2,2011,contributing P100,000 cash
each plus other assets from their existing firms,and to move to a new location.
The following assets were contributed by each:
1.
2.
3.
4.
5.
King began the year with a capital balance ofP40,000.
Queen began the year with a capital balance ofP100,000.
On April 1,King invested an additional P15,000 into the partnership.
On August 1, Queen invested an additional P30,000 into the partnership.
Throughout 2011,each partner withdrew P400 per week in anticipation of
partnership net income.The partners agreed that these withdrawals are not
to be included in the computation ofaverage capital balances for purposes
ofincome distributions.
Red
Cash
Accounts receivables
Furniture and equipment
Computer and printer
PI00,000
225,000
35,000
Blue
PI00,000
190,000
>38,000
46,000
When the partnership was first organized. Red executed a P100,000 promissory
note at Cliina Bank to get the P100,000 he needed to contribute to the business.
Blue still owed P50,000 on the furniture, equipment, computer, and printer he
contributed to the firm. The partners agreed to split profits on the basis of gross
cash collections from billing generated. Diuing 2011, Red's clients paid the firm
■
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a total ofPl,500,000 and Blue's clients paid Pl,625,000. The cash expenses
for the year were P1,080,000 of which P480,000 were attributable to Red and
P600,000 to Blue. During 2011 Blue withdrew P750,000 cash for personal
needs and contributed an additional computer valued at P22,000.
Chapter 2
82
No. 2-25: Continued
The profit share ofRed for the year and the capital balance ofBlue on December
31,2011 are;
a.
b.
c.
d.
Pl,020,000
P 981,600
PI,063,400
P 981,600
and
and
and
and
P576,000, respectively
P839,400, respectively
P889,400, respectively
P709,400, respectively
Partnership Operations
2-27: Susan and Tanny formed a partnership in 2011 to operate a bookstore. Susan
contributed the initial capital while Tanny managed the business. Wth the assistance
oftheir accountant,they wrote an Articles ofPartnership agreement that contains
the following provisions:
1. Each partner is allowed to draw P1,000 in cash from the business every
month. Any withdrawal in excess ofthat figure will be accounted for as a
direct reduction to the partners' capital balance.
2. Partnership profits and losses will be allocated each year according to the
following plan:
2-26: Ray and Sam was organized and began operations on March 1,2010. On that
date,Ray invested P150,000,and Sam invested computer equipments witli current
a. Interest of 15 percent will be accrued by each partner based on the
monthly average capital balance for the year(computed withoutregard
fair values ofPI80,000.Sam also invested P60,000 cash in the partnership on
for normal drawings or current income).
November 1,2010,because ofits shortage ofcash. The partnership contract
includes the following remuneration plan:
Annual salary (recognized as operating expense)
Annual interest on average capital
Remainder
Ray
Sam
PI8,000
P24,000
10%
10%
60%
40%
The annual salaiy was to be withdrawn by each partner in 12 monthly installments.
During the year ended February 28,2011, The partnership had net sales of
P500,000, cost of goods sold ofP280,000, and total operating expenses of
P100,000(including partners'salaries expense but excluding interest on partners'
average capital account balances).Each partners made monthly cash drawings
in accordance with the partnership contract.
b. As the managing partner,Tanny is to receive creditfor a bonus equal to
20 percent ofthe year's net income.
c. Any remaining profit or loss will be divided equally between the two
partners.
Susan and Tanny begin the year of2011 with capital balances ofP150,000 and
P30,000,respectively. On April 1 ofthat year,Susan invests an additional P8,000
cash in the business, while on July 1,Tanny withdraws P6,000 in excess ofme
specified drawing allowance.The partnership reports netincome ofP30,000 tor
2011.
The capital balances ofthe partners on December 31,2011 are:
Susan
P167,675
b. P155,675
c. P158,000
d. P159,675
a.
What are the capital balances ofthe partners on February 28,2011.
Ray
P216,000
b. P198,000
P234,000
c.
d. PI80,000
a.
Sam
P294,000
P270,000
P318,000
P246,000
83
Tanny
P20,325
P26,325
PI4,000
P22,325
2-28: A partnership begins its first year ofoperations with the following capitalbalances.
Sin capital
Tan capital
Uy capital
P110,000
80,000
110,000
;»!
17
<
'
.* 'i
. »' ip'
,7f:
r.
V,
'1 .
85
Partnership Operations
Chapter 2
84
No. 2-29: Continued
No. 2-28: Continued
After the books were closed on December 31, 2011, it was discovere a
taken at December 31,2009 was understated by P8,000. What should e e
According to the partnership agreement,all profits will be distributed as follows;
depreciation had been understated by P2,000 each year and that the
Sin will be allowed an annual salary ofP20,000 with P10,000 assigned
toUy.
•
•
•
-
capital balances ofthe partners on January 1,2011?
The partners will be allocated with interest equal to 10 percent ofthe
capital balance as ofthe first day ofthe year.
The remainderwill be divided on a 5:2:3 basis,respectively.
Each partner is allowed to withdraw up to PI0,000 per year.
Jay
P68,710
P68,710
c. P66,710
d. P66,710
a.
b.
Assume that the net loss for the first year ofoperations is P20,000 with net
income ofP40,000 in the subsequent year. Assume further that each partner
Kay
Loi
P33,950
P37,950
P31,950
P35,950
P47,340
P49,340
P45,340
P47,340
2-30: Ken,Len,and Mon formed a partnership on January 1,2010,with each
withdraws the maximum amount from the business each period. Wliat is the
contributing P100,000 cash. Although the partnership agreement provided t a
balance in Sin's capital account at the end ofthe second year?
Mon receive a salary ofP5,000 per month for managing the partnership busmess.
Mon has never withdrawn any money from the partnership. Ken withdre
P20,000 in each ofthe years 2010 and 2011,and Len invested an additiona
a.
b.
c.
d.
P102,600
P104,400
P108,600
PI09,200
P40,000 in 2010 and withdrew P40,000 during 2011.Due to an oversight,t tQ
partnersliip has not rhaintained fonnal accounting records,butthe following da
as ofDecember 31,2011 is available:
2009
2010
2011
Withdrawals
Investments
PI9,000
■ P4,000 Kay
5,000 Jay
P5,000 Loi
P29,000
P647,500
Additional
Income
P22,000
Total assets
Accounts receivable
and additional investments were as follows:
Reported Net
Merchandise inventory, at cost
Computer equipment,net
Prepaid expenses
P 142,500
100,000
200,000
185,000
20,000
Cash
2-29: The partnership ofJay, Kay,and Loi was organized on January 2,2009,with
each ofthe partners contributing cash ofP30,000.Reported profits, withdrawals,
P8,000
3,000
P2,000
4,000
Loi
Kay
Loi
Kay
r
Accounts payable
Notes payable
P5,000 Jay
N
Total liabilities
P 95,000
52,500
P147,500
P6,000 Loi
Additional data
1.
The partnership contract states that partners are to be allowed 10% interest on
the beginning ofyear capital balances,that Jay is to receive a P7,000 salary
allowance,and that remaining profits are to be divided equally.
The partners agree that income for 2011 was about halfofthe total
income for the first two years ofoperations.
Although profits were not divided in 2011,the partnership agreement
provides that profits, after allowance for Mon's salary,are to be divided
each year on the basis ofbeginning ofthe year capital balances.
.L-v
fyi
Vl'K
Chapter 2
86
No. 2-30: Continued
For the year ended December 31,2011,the capital balances ofthe partners are:
Partnership Operations
87
2-32: Sam,a partner in the ST Partnership, is entitled to 40% ofthe profits and losses.
During 2011,Sam contributed land witli a fair value ofP60,000. Also during
2011,Sam had drawings ofP80,000. The balance ofSam's capital account was
PI20,000 at the beginning of2011 and PI50,000 at the end ofthe year.
Ken
a. P 93,636
b. P 80,000
c. PI00,000
d. P 93,636
Len
Mon
P141,818
P120,000
PI60,000
PI20,000
P264,546
P180,000
PI80,000
P264,546
What is the partnership's profit(loss)for 2011?
a. P(75,000)
b. P(50,000)
2-31: On January 1, 2011, Nardo, Orly and Pedro formed a partnership with the
following contributions:
P280,000
300,000
170,000
Nardo
Orly
Pedro
c. PI50,000
d. PI25,000
2-33: On January 2,2010,JT Partnership begins its operations with the following
investments:
Joe
The partnership agreement ofNardo,Orly and Pedro provides for the division
ofnet income as follows:
a. Orly,who manages the partnership is to receive a salary ofP16,500 monthly.
b. Each paidner is to be allowed interest at 15% on beginning capital.
c.
Balance is to be divided 25:30:45
On December 31,2011,after the following partners additional investments and
capital withdrawals,the partnership has a total capital ofP975,000.
Nardo
Orly
Withdrawals
P96,000
60,000
Pedro
P90,000
72,000
-
What are the capital balances ofthe partners on December 31,2011?
Nardo
P412,750
b. P 36,750
P316,750
c.
d. P398,125
cu
Orly
P484,920
P214,920
P514,920
P489,150
P80,000
40,000
According to the partnership agi-eement,all profits will be distributed as follows.
• Joe will be allowed a monthly salaiy ofP8,000 with P4,000 assigne o
• The partners will be allowed with interest equal to 10% ofthe capita
balance as ofthe first day ofthe year.
• Joe will be allowed a bonus of10% ofthe net income after bonus.^
• The remainder will be divided on the basis ofthe beginning capita o
first year and equally for the second year.
Additional
investment
Tom
Pedro
P 77,330
P(20,670)
P149,330
P 87,725
• Each partner is allowed to withdraw up to P4,000 a year.
Partnership's operation results in a net loss ofP6,000 in 2010
P22,000 in 2011.Each paitner withdraws the maximum amount eac i ye
What is the capital balance ofJoe on December 31,2011?
a. P105,900
b. P 73,900
c. Pll3,900
d. P 72,000
,
Chapter 2
88
Partnership Operations
89
2-34: Adam,a partner in the AE Partnership, has a 30% participation in partnership
profits and losses. Adam's capital account has a net decrease ofP60,000 during
the year 2011. During 2011,Adam withdraw PI30,000(charged against his
2-36: Gabriel and Hairy are partners in manufacturing business located in Quezon
City. Their profit and loss agi'eement contains the following provisions:
capital account)and contributed property valued at P25,000 to the partnership.
1. Salaries ofP35,000 and P40,000 for Gabriel and Hany,respectively.
2. A bonus to Gabriel equal to 10% ofnet income after the bonus.
3. Interest on weighted-average capital at the rate of8%.Annual drawings in
excess ofP20,000 are considered to be a reduction ofcapital for purposes
What was the net income ofAE Partnership for 2011?
a.
b.
c.
d.
PI50,000
P233,333
P350,000
P550,000
ofthis calculation.
4. Profit and loss percentages of 40% and 60% for Gabriel and Harry,
respectively.
* Capital and drawing activity ofthe partners for the year 2011 are as follows:
2-35: Cris,Paul,and Bryan,have allocated profits ofthe partnerhsip as follows:
1. Salaries of P80,000, P60,000, and P60,000 to Cris, Paul, and Bryan,
respectively.
2. All remaining profit is allocated equally among the partners.
Beginning balance
April 1
As ofJanuaiy 1,2011,the partners have agreed to reallocate 2009 and 2010
profits among the partners. The reallocation ofprofits will follow the existing
profit-sharing agreement with the addition ofa provision that interest will be
allocated to the partners based on 10% ofthe weighted-average capital balance
including the withdrawals,but excluding current-year profits. Net income for
June 1
2009 and 2010 was P500,000 and P410,000,respectively.
Paul
Pi80,000
150,000
20,000
170,000
P250,000
170,000
50,000
190,000
a. P(3,528)
b. P 3,528
c. P 2,872
d.
P
656
A, •(
I
' f
v.c
>
P
0
Harry
Capital
Harry
drawing
P60,000
P
15,000
September 1
0
20,000
30,000
Ending balance
Gabriel
Bryan
P60,000
b.
—
c.
50,000
150,000
In the reallocation ofprofits on January 1,2011,the capital ofPaul should be
increased(decreased)by:
PI20,000
20,000
November 1
a.
Capital balance, December 31,31,2008
March 31,2009, withdrawal
September 30,2009 withdrawal
January 31,2010, withdrawal
Gabriel
Drawing
PI50,000
15,000
40,000
P30,000
P100,000
P20,000
Assuming net income for 2011 ofP132,000,how much profitshould be allocated
to each partner?
Capital balances and withdrawals are as follows:
Cris
Gabriel
Capital
d.
P69,747
P70,747
P65,747
P60,000
Harry
P62,253
P61,253
P66,253
P72,000
2-37: Cory,Dory,a nd Eva own a consulting business organized as a partnership. Eva
is considering retirement firom the partnership.In order to more fairly measure
Eva's interest in capital, an audit ofthe company's first two years ofoperations
was performed in early 2011. The original partnership agreement called for Cory
to receive 10% bonus on income after the bonus,with the remaining profits or
losses to be divided as follows: Cory,30%;Dory,30%;and Eva,40%.Reported
income for 2009 was P44,000.In the second year ofoperations,the agreement
Chapter
90
Ntr. 2-37: Continued
Partnership Operations
91
2-38: On March 1,2009,Alma and Betty formed a partnership with cash investments
ofAlma,P480,000 and Betty,P240,000.
called for Cory still to receive 10% bonus on income after the bonus, but it
altered the allocation ofremaining amounts as follows: Cory,35%;Dory,35%;
and Eva, 30%. Reported income for 2010 was P42,000. The partners had
always agreed that any adjustment to reported amounts would be allocated based
on the profit and loss agreementin effect during the period to which the adjustments
relates. The audit indicated that the following items were not properly accounted
The partners agree to allocate profits and losses as follows:
1. Alma and Betty will be allowed a monthly salary ofP48,000 and P24,000,
respectively.
2. The partners will be allowed with interest of10% oftheir capital balances at
the begimiing ofeach year.
3. The remainder will be divided on the basis oftheir beginning capital for the
year ofoperation and equally for the subsequent years.
for
1. 2009:
a.
Failed to amortize(in 2010 as well)tlie business name contributed by
Cory. The fair value ofthe intangible was P50,000 and should have
been amortized over a 10-year life using straight-line amortization.
b.
c.
Failed to defer prepaid 2010 insurance premiums ofP3,000.
A capital withdrawal ofP5,000 made by Cory on July 1,2009, was
classified incorrectly as a note receivable.
d.
e.
Failed to accrue P2,000 ofemployee wages on December 31,2009.
Failed to record consulting fees ofP8,400 eamed in 2009 but billed in
4. Each partner is allowed to witlidraw up to P24,000 a year. Any withdrawal
in excess ofthe figure will be treated as direct reduction from their capital
balances.
In 2009 the partnership suffered a net loss ofP36,000.Butin 2010 they eamed
a profit ofP132,000.The paitners withdraw the maximum amount each year.
On January 2,2011a new partner Cora was admitted in the partnership for m
investment ofP400,000 for a 40% interest. No revaluation ofassets is to be
recorded. After the admission ofCora,the partners agreed to divide profits and
losses,4:2:4 to Alma,Betty,and Cora respecvtively.
2010.
On January 2,2011,what is the entry to record the admission ofCora?
2. 2010:
b.
c.
Purchases ofinventory included a computer invoiced on December
31,2010,for P4,000 but not yet received.Terms were f.o.b. destination.
The item was not inlcuded in the year-end physical inventory.
Failed to accme P8,600 ofrent expense on December 31,2010.
Failed to reverse P3,000 ofinterest income properly accrued at the
end of2009,resulting in income recognition in both years.
a.
Betty, capital
Cora, capital
b.
Cash
Alma, capital
Betty, capital
Cora, capital
Partners' unadjusted December 31,2010 capital account balances are: Cory,
P25,000; Dory,P30,000; and Eva,P28,000.
Cash
Alma, capital
c.
Cash
Goodwill
What is partner Cory's adjusted capital balances as ofDecember 31,2010?
a. P12,^00
b. P24,200
c. P23,600
d. P21,600
400,000
33,600
33,600
467,200
400,000
32,000
16,000
448,000
400,000
48,000
448,000
Cora, capital
d. Cash
Goodwill
Cora, capital
Alma, capital
Betty, capital
400,000
48,000
400,000
32,000
16,000
Chapter 2
92
93
Partnership Operations
Problem 2-2:
PROBLEMS
Robin and Hood are partners with capital accounts that had the following transactions
during 2011:
Problem 2-1
The capital accounts ofCastro and Diaz show the following facts for the fiscal year
Debit
Castro
1
Jan.
Balance
Hood
Robin
ended December 31,2011:
Diaz
P26,000
Mar.
30
Investment
3,000
May
July
10
Investment
25
Withdrawal
Dec.
31
Balance
7,000
4,000
32,000
Jan.
May
Aug.
PI6,500
.(
Balance, January 1,2011
February 28
18
Investment
5,000
^
March 31
24
Withdrawal
2,000
'.i
1
Dec. 21
Balance
Balance
Debit
PI 35,000
Credit
PI40,000
P40,000
60,000
April 30
19,500
Credit
80,000
P50,000
June 30
August 31
September 30
October 31
70,000
20,000
20,000
.
The profit and loss account shows a credit balance ofP23,800 on December 31. •
The Income Summary account has a credit balance ofP510,000.
Required:Prepare a schedule ofprofit distribution under the following independent
agreements on the division ofprofits:
1. In the ratio ofinvestments at the beginning or the fiscal period.
Required:Prepare a statement ofprofit distribution for each ofthe following independent
,1
profit-sharing agreements:
a. In the average capital ratio.
2. In the ratio of average capitals, investments and withdrawals are to be
considered as made at the beginning ofthe month ifmade before tlie middle of
the month,and are to be considered as made at the beginning ofthe following
b. Interest on average capital at 9 percent,salaries ofP60,000 to Robin and Hood,
respectively,a bonus to Robin of25 percent ofnet income after interest and salaries
month ifmade after the middle ofthe month.
but before the bonus,and the balance equally.
3. Interest of24% on average capitals, salaries to Castro and Diaz ofP36,000
and P24,000,respectively,and any balance equally.Investments and withdrawals
c. Interest at 10 percent on the amount by which the ending capital balance exceeds
are to be considered as in(2).
the beginning balance and the balance equally.
4. Allowance to Castro ofa bonus of25% ofthe net profit after bonus;interest of
10% to be allowed on the excess ofthe average investment(simple average)of
one partner overthat ofthe other,and any balance in the ratio of3:2 to Castro
and Diaz,respectively.
d. Salaries ofP80,000 and PI20,000 to Robin and Hood,respectively, a bonus to
Robin of25 percent ofnet income after salaries and the bonus,and the balance
equally.
5. Salaries of P3,000 and P2,000 a month to Castro and Diaz, respectively
provided annual earnings are sufficient to cover the allowance; ifearnings are
insufficient,the profit shall be distributed in the salary ratio; ifoperations result
in a loss,it shall be distributed equally.
■ i^
■' ■ T' '
h- A-
1
94
Chapter 2
Partnership Operations
95
Problem 2-4: Coiitiniied
I3&SSSQ9
De Villa and De Vera are partners operating a small ofchain ofgrocery stores. Their
business has grown substantially over the last five years they just amended their
partnership agreement to provide for the following distribution ofprofits and losses;
De Villa
De Vera
P30,000
None
None
2%
8%
8%
Required:For each ofthe following independent income-sharing agreements, prepare
an income distribution schedule.
a. Salaries are P15,000 to East,P20,000 to North,and P18,000 to West. East receives
a bonus of5 percent ofnet income after deducting his bonus.Interest is 10 percent
ofending capital balances. Any remainder is divided by East,North,and West in a
3:3:4 ratio. Net income was P78,960.
Salaries
Commission on gross sales
Interest on average capital balances
Bonus
b. Interest is 10 percent ofweighted average capital balances. Salaries are P24,000
to East, P21,000 to North, and P25,000 to West. North receives a bonus of 10
percent ofnet income after deducting the bonus and his salary. Any remainder is
10% ofnet income after salary, 10% of net income after
salary, commission, interest and bonus commission,
interest and bonus
l^emaShdei
50%
divided equally. Net income was P68,080.
c. West receives a bonus of20 percent ofnet income after deducting the bonus and
the salaries. Salaries are P21,000 to East, PI8,000 to North, and PI5,000 to
West.Interest is 10 percent ofbeginning capital balances.
50%
Any remainder is divided by East, North,and West in an 8:7:5 ratio. Netincome
Gross sales for 2011 were P1,000,000.Income before deducting salaries,commission,
interest and bonus was P222,000. Average capital balances were P410,000 and
was P92,940.
to I
P390,000 for De Villa and De Vera.
The partnership ofMaria,Clara,and Rita wasformed on January 2,2011.The original
Required:
a. Prepare a schedule ofincome allocation for 2011.
investments were as follows:
Maria
Clara
Rita
b. Prepare the generaljoumal entry to close the Income Summary account.
P80,000
120,000
180,000
oiiin;
According to the partnership agreement,net income or loss will be divided among the
East,North,and West are manufacturers'representative in the architecture business.
Their capital accounts in the ENW Partnership for 2011 were as follows;
East
January 1, Balances
March 1, Withdrawal
April 1,.Investment
May 1, Investment
June 1, Investment
P30,000
P40,000
9,000
West
1. Salaries ofP12,000 for Maria,PI0,000 for Clara, and P8,000 for Rita.
2. Interest of8 percent on the average capital balances of Maria, Clara
during the year.
3. Remainder divided equally.
P50,000
Additionalinformation:
7,000
.
cP7O000
1. Netincome ofthe partnersliip for the year ended December 31,2011,was1 ,
2. Maria invested an additional P20,000 in the partnership on July 1,2011.
6,000
3,000
5,000
July 1,Investment
August 1, Withdrawal
September 1, Withdrawal
September 1,Investment
North
respective partners as follows:
12,000
8,000
4,000
3. Rita withdrew P30,000 from the partnership on October 1,2011.
Hirinff
4. Maria,Clara,and Rata made regular drawings against shares ofnet income
the year ofP10,000 each.
Required:
a. Prepare schedule showing thodivision ofnet income among the partners.
b. Prepare a Statement ofChanges in Partners' Equity on December 31,2011.
g
Partnership Operations
97
Chapter 2
96
Problem 2-7: Continued
Problem 2-6
The partnership agreement of Alvin,Benny,and Celia provides that profits are to be
Operating performance and other capital transactions were as follows:
divided as follows:
Capital Transactions
1. Alvin is to receive a salary ofP20,000 for managing the partnership business.
2. Partners are to receive 10% interest on average capital balances.
3. Remaining profits are to be divided 30%,30%,and 40% to Alvin,Bemiy,and
Celia,respectively.
Net Income
(Loss)
Year-End
P16,000 during the year ended December 31,2011.Benny's capital balance on Januaiy
1,2011 was P180,000,and he invested an additional P60,000 on September 1,2011.
Celia's beginning capital balance was P220,000,and she withdrew P20,000 on July 1
but invested an additional P40,000 on October 1,2011.
Oscar
Nelson
Investment
Withdrawals
Investment
Withdrawals
P15,000
-0-0-
P17,000
17,000
19,000
P15,000
-0-0-
P7,000
7,000
9,000
Investment
Withdrawals
Dec. 31
P(5,400)
27,000
120,000
2009
2010
Alvin had a capital balance of PI 20,000 at January 1, 2011 and had drawings of
Dino
201 1
P6,000
6,000
6,000
P3,200
3,200
3,200
Required:Prepare a statement ofchanges in Partners' Equity Accounts for each ofthe
three years. Support your statement with a Schedule ofProfit Distribution for each
year.
The partnership has a net loss ofP24,000 during 2011,and the accountant in charge
allocated the net loss as follows:P400 profit to Alvin,P9,600 loss to Benny,and P 14,800
loss to Celia.
Red,White and Blue,who are accountants,agreed to combine their individual practices
Required:
1. A schedule to show the correct allocation ofthe partnership net loss for 2011.
2. A statement ofchanges in partner's equity for the year ended December 31,
2011.
3. Joumal entries to correct the books ofthe partnership at December 31,2011,
assuming that all closing entries for the year have been recorded.
Problem 2-7
Dino,Nelson and Oscar are partners in a retail appliance store. The partnership was
formed on January 2,2009 with each partner investing P45,000. They agreed that
profits and losses are to be shared as follows:
1. Divided in the ratio of40:30:30 ifnet income is not sufficient to cover salaries,
bonus and interest.
2. Net loss is to be divided equally.
3. Netincome is to be allocated as follows ifnetincome is in excess ofsalaries,bonus,
into a partnership as ofJanuary 2,2011.The partners reach agreement on the following
matters:
1. Each partner's capital contribution was the net amount ofassets and liabilities taken
over by the partnership which were as follows:
Red
White
Blue
P40,200
20,200
40,600
x, • r t •
Each partner guaranteed tlie collectibility oftheir receivables from their clients.
2. The partners decided to occupy Blue's office space until the lease expired on June
30.The montlrly rental wasP1,200,butthe partners agreed thatthis was^
rate for the space provided and that P900 monthly would be reasonab
^
agreed that the excess rent would be charged to Blue at the end ofthe gar.
.
the lease expired on June 30,2011,the partnership moved to new oiiice w
monthly rental ofP1,000.
and interest.
a. Monthly salary allowances are: Dino,P4,000; Nelson P2,000; and Oscar,
PI,000.
b. Nelson is to receive a bonus of10% ofnet income before subtracting salaries
and interest,but after subtracting the bonus.
c. Interest of8% is allocated based on the beginning of-year capital balances.
d. Any remainder is to be divided equally.
3. No salaries are to be paid to the partners. The individuals paffiiers are to receive 20
percent ofthe gross fees billed to their respective clients during the fnst year or the
partnership. After deducting operating expenses(excluding the excess rent),the
residual profit should be credited to the partners' capital accotmts in the followmg
ratios: Red,40 percent; White,40 percent; and Blue 20 percent.
Chapier 2
98
99
Partnership Operations
Problem 2-8: Continued
Problem 2-9
4. On April 1,20II, Green was admitted to the partnership. Green is to receive 20
percent oftiie fees fiom new business obtained alter April 1,after deducting expenses
applicable to the new business. Expenses(excluding the excess rent) are to be
apportioned to the new business in the same ratio that total expenses for the entire
year,other than bad debt losses, bore to the total gross fees.
5. The following information pertains to the partnership's activities in 2011
a.
Fees were billed as follows:
Red's clients
White's clients
Blue's clients
b.
P44,000
24,000
22,000
6,000
24,000
P8,600
5,000
12,400
Depreciable assets were purchased during 2011 for P10,000,on which one
halfyear's depreciation was to be taken.
c.
Cash withdrawals charge to the partners' accounts during the year were:
Red
White
Blue
Green
maintained on the aecmal basis and that tlie netincome shall be distributed to the partners
as follows:
at the beginning ofthe year.
2. Eman and Gino shall each received a commission of 10 percent ofnet income
under the cash basis accounting after deducting the normal allowance for depreciation
and the interest on capital. For this purpose,all merchandise purchased is to be
Total expenses for 2011 were P38,700,excluding depreciation and uncollectible
accounts expenses but including the total amount paid for rent. Depreciation
was to be computed at the rate of 10 percent on original cost ofthe following
depreciable assets invested by the partners on January 2,2011.
Red
Wliite
Blue
portion ofthe capital, and Eman and Gino provided important management skills and
experience. The partnership agreement specifies that the accounting records shall be
1. Each partner shall received 5 percent interest on the balance in his capital account
New clients acquired after January 2,2011
Before April 1
After April 1
Tlie Allan,Eman and Gino Partnership was formed in 2010. Allan contributed a major
PI0,400
8,800
11,600
5,000 •
d. OfRed's and White's receivables,P2,400 and P900,respectively, proved to
be uncollectible. A new client billed in March for P3,000,had been adjudged
bankrupt,and a settlement of40 cents on the peso was made.
Required: Prepare a Statement ofChanges in Partners' Equity for the year ended
December 31,2011. Show supporting computations.
regarded as an expense.
3. The net income remaining after deducting the interest on capital and commissions
due to Eman and Gino shall be distributed equally,except that'the total portion of
net income to Allan must not be less that 50 percent ofthe net income determined
under the fimi's accmal accounting system.
i
The financial statements ofthe partnership on December 31,2011 shows among others
the following:
Netincome
Allan capital
Eman capital
Gino capital
P25,000
80,000
15,000
5,000
There were no changes in the partners'capital accoimts during 2011.After the necessary
adjustments,the netincome for 2011 firom an accrual basis to a cash basis including the
deduction for depreciation is P16,120.
Required:Prepare a statement ofprofit distribution for 2011.
'''i'' t r
Chapter 2
100
Partnership Operations
101
Problem 2-10
Problem 2-11
Gary,Sonny,and Letty open an accounting practice on January 1,2011 in Cebu City.
The business is to be operated as a partnership with Gary and Sonny serving as the
senior partners because oftheir years ofexperience.To establish the business, Gary,
Sonny,and Letty contribute cash and other properties valued at P210,000,P180,000,
and P90,000,respectively.A partnership agreementis drawn up that carries the following
stipulations:
'h
The partnership ofKobe and Lebron began business on Januaiy 2,2011. Each partner
contributed tlie following assets(the noncash assets are stated at their fair values on
January 1,2011:
Lebron
Kobe
Cash
a. Personal drawings are allowed annually up to an amount equal to 10 percent ofthe
beginning capital balance for the year.
Inventories
P 600,000
800,000
P 500,000
-0-
1,300,000
1,000,000
-0-
Land
Equipment
-0-
b. Profits and losses are allocated according to the following plan:
(1) A salary allowance is credited to each partner in an amount equal to PS per
billable hour worked by that individual during the year.
(2) Interest is credited to the partners' capital accounts at the rate of 12 percent of
the average monthly balance for the year(computed without regard for current
The land was subject to a P500,000 mortgage, which the partnership assumed on
January 1,2011.The equipment was subject to an installment notes payable that had an
unpaid principal amount ofP200,000 on Januaiy 1,2011.The partnership also assumed
this notes payable. Kobe and Lebron agreed to share partnership income and losses in
the foliowing manner:
income or drawings).
(3) An annual bonus is to be credited to Gary and Sonny.Each bonus is to be 10
Interest on beginning capital balances
percent ofnetincome after subtracting the bonus,the salary allowance,and tlie
interest. Also included in the agreement is the provision that the bonus cannot
Salaries
be a negative amount.
Remainder
(4) Any remaining partnership profitorloss is to be divided evenly among all partners.
Because ofmonetary problems encountered in getting the business started,Gary invests
an additional P9,1 GO cash on May 1,2011.
The billable hours for the partners during the year are as follows:
Gary
Sonny
Letty
Required:Prepare a statement ofchanges partners' equity account for the year ending
December 31,2011 with supporting schedule ofprofit distribution.
Lebron
3%
3%
PI20,000
P120,000
60%
40%
During 2011,the following events occurred:
1.
Inventory was acquired at a cost of P300,000. At December 31, 2011, the
2.
Principal ofP50,000 was paid on the mortgage. Interest expense incurred on the
partnership owed P60,000 to its suppliers.
mortgage was P20,000,all ofwhich was paid by December 31,2011.
1,710
1,440
1,330
The partnership netincome for the year is P65,000.
Each partner withdraws the maximum allowable amountfor the year.
Kobe
Principal ofP35,000 was on the installment note. Interest expenses incurred on the
installment note was P20,000,all ofwhich was paid by December 31,2011.
Sales on account amounted to P1,550,000. At December 31,2011,customers
owed the partnership P210,000.
5.
Selling and general expenses,excluding depreciation,amounted to P340,000. At
December 31, 2011, the partnership owned P62,000 of accrued expenses.
Depreciation expenses was P60,000.
Chapter 2
102
Problem 2-11: Continued
Chapter s :■
6. Each partner withdrew P2,000 each week in anticipation ofpartnership profits.
7. The partnership's inventory at December 31,2011,was P200,000.
8. The partners allocated the net income for 2011 and closed the accounts.
t
\'
Partnerships Dissolution - Changes
in Ownership interest
Required:
a. Preparejournal entries to record the formation ofthe partnership on January 1,
2011,and to record the events that occurred during 2008.
b. Prepare the statement ofcomprehensive income for the Kobe-Lebron Partnership
for the year ended December 31,2011.
A partnership rests upon a contractual foundation, therefore, the life span of a
partnership may be somewhat uncertain since it depends on the moods and
relationships of the partners. Any circumstance which causes the technical
termination ofa partnership may lead to the partnership's permanent dissolution
and liquidation, ifthe partners so agree. Dissolution and liquidation in relation to
c. Prepare a statement of financial position for the Kobe-Lebron Partnership at
December 31,2011
partnerships are not synonymous. A partnership is said to be dissolved when the
original associationfor purposes ofcarrying on activities has ended. A partnership
is said to be liquidated when the business is terminated. Thus, a partnership may
be dissolved without being liquidated. While dissolution may result to liquidation
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ofa partnership liquidation always, results to dissolution.
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Partnership dissolution due to changes in ownership interests occurs for variety
• Cfl
ofreasons. These can be summarized as follows:
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1. Admission of a partner
2. Retirement of a partner
3. Death of a partner
4. Incorporation ofa partnership
In most cases, when a change in ownership occurs, the market values ofindividual
partnership assets and liabilities are different from their book values. These
differences can be accounted for by recording them on the partnership books
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either by adjusting the assets and liabilities — in many cases, goodwill is recorded
in the process - or by adjusting the partners' capital accounts.
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103
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Chapter 3
104
Partnership Dissolution - Changes in Ownership Interest
105
Case 1. Purchase from one partner. Assume O purchases one-half of the interest
ADMISSION OF A NEW PARTNER
of L. Regardless of the amount paid to L, the only entry required in the partnership
An existing partnership may admit a new partner with the consent of all the partners.
Wlien a new partner is admitted, the partnership is dissolved and a new partnership is
formed. Upon the admission of a new partner, a new agreement covering partners'
interests, profit and loss sharing and other consideration should be drawn because the
dissolution of the original partnership cancels the old agreement.
The admission of a new partner may occur in either of two ways, namely.
1.
2.
Purchase of all or part of the interest of one or more of the existing partners.
Investment of assets in the partnership by the incoming partner.
Purchase of Interest from One or More Partners
tl
books is:
L, Capital
O, Capital
To record admission of O.
10,000
10.000
The new set of partners will then agree on a new profit and loss ratio.
Case 2. Purchase from all the partners. Assume tlie following: (1) 0 is admitted into
the partnership for'a 50 percent interest in the profits and losses of the partnership; (2)
The old partners (L, M and N) are to retain their original capital and profit-sharing
relationships to each other and are to transfer sufficient amount (50 percent) of their
" own capital accounts to O in order to accomplish his admission as planned.
When an incoming partner purchases a portion or all of the interests of one or more of
the original partners, the partnership assets remain unchanged and no cash or other
assets flow from the new partner to the partnership. This transaction is recorded by
opening a capital account for the new partner and decreasing the capital accounts of the
selling partners by the same amount. The cash paid by the buyer is not recorded in the
books of the partnership for this is a personal transaction between the selling partners
and the buyer. The gain or loss arising from the sale of interest is not to be recorded in
the partnership books.
If O agreed to pay a total of P50,000 to L, M and N, the entry necessary to record this
transaction will appear as follows:
L, Capital
M, Capital
N, Capital
10,000
10,000
15,000
O, Capital
To record the admission of O into LMN partnership
35,000
for a 50 percent interest in the profits and losses.
Illustration. Assume the following data for the LMN Partnership on December 31,
2011:
Partners
Capitals
P&L Ratio
L
P20,000
20,000
30,000
20%
M
N
On this date, O is admitted to the partnership.
30%
50%
The above entry shows that no cash is transferred to the partnership. Moreover, the
P50,000 cash consideration passes outside of the partnership framework. The amoim
debited to the original partners' capital accounts are equal to the new partner s ra lo
multiplied by the balances of the capital account of the old partners.
There is no definite rule as to how the P50,000 cash is to be divided among the individual
partners. The following procedures are recommended for fair and equitable division o
cash among the existing partners:
1. Detemiine the amounts of capital balances to be transferred by the existing
partners.
2. Apportion any excess (or deficiency) in the original partners' profit and loss
ratio.
■rr- --
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'KIA<U • r
, Chapter 3
106
Using the procedures,the P50,000 cash paid by O is distributed to the old partners as
Partnership Dissolution - Changes in Ownership Interest
107
New Partner Invests in Partnership
follows:
A new partner may acquire interest in tlie partnersliip by investing in the business. In this
Illustration 3-1
Total
Amounts of capital transferred
Excess ofP15.000(P50,000-P35,000)divided
using the profit and loss ratio
Total cash distribution
M
L
N
P35,000
PIO.OOO
PI0,000
PI5,000
15,000
3,000
4,500
7,500
P50,000
PI3,000
PI4,500
P22,500
Alternative Method.The net assets ofthe partnership may be revalued when the
purchase ofinterest from all the partners is for an amount more than tlie interest acquired.
Thus,ifO buys 50% interest in LMN Partnership for P50,000 as in the preceding
example,and it is agreed that the net assets should be revalued,the eomputation would
case, the partnership receives the cash or other assets, thereby increasing its total assets
as well as the total capital. This method of admission is. a transaction between the
partnership and the incoming partner. Three eases may exist when a new partner invests
in a partnersliip:
Case 1.
The new partner's investment (contributed capital) equals the new
partner's proportion of the partnership's book value (agreed capital).
Case 2.
The new partner's Investment is more than the new partner's agreed
capital. This indicates that the partnership's prior net assets are undervalued on the
books or that unrecorded goodwill exists.
Case 3.
The new partner's investment is less than the new partner's agreed
capital. This suggests that the partnership's prior net assets are overvalued on its
books or that the new partner may be contributing goodwill in addition to the assets
be:
invested.
Implied value of thfc; partnership(P50,000 -h 50%)
Book value of the partnership (total capital)
P100,000
70,000
Undervaluation ofidentifiable assets(or goodwill)
P 30,000
The following steps/procedures may be used in determining how to account for the
admission of a ne\v partner:
The entries to record the admission ofO into the partnership would then be:
1. Compute the new partner's proportion of the partnership'shook value (agreed
capital) as follows:
(1) Identifiable assets(or goodwill)
L, Capital
M, Capital
N, Capital
To record the revaluation ofnet assets among the
30,000
old partners using their profit and loss ratio.
(2) L, Capital
M, Capital
N, Capital
O, Capital
To record the admission ofO into the partnership
Prior capital
6,000
9,000
15,000
Agreed capital =
of old
partners
2.
+
Investment
of the new
X
partner
Percentage of
capital to new
partner
Compare the new partner's contributed capital with his or her agreed capital to
determine the procedures to be followed in accounting for his or her admission.
Illustration 3-2 presents an overview of the three cases presented above.
13,000
14,500
22,500
3.
50,000
Determine the specific admission method. Three different methods may be tised
to account for the admission of a new partner when a difference exists methods
are: (1) revalue net assets, (2) recognize goodwill, or (3) the bonus method.
the net assets, it is necessary to prepare a cash distribution schedule since the division of
Under the revaluation of assets and goodwill recognition methods, the historical
cost bases of the partnership's net assets are adjusted during the admission of
the new partner. Some partner's may object to this departure from historical
cost and prefer to use the bonus method, which involves capital transfers among
the partners to align the total resulting capital of the partnership. Under the
cash coincides with the partners' charges to their capital accounts.
bonus method, net assets remain at their historical costs.
Note: Goodwill should nothe recorded until all identifiable assets have been adj usted
to their fair value. The debits to the old partners' capital accounts are exactly equal to
the distribution of cash as shown in Illustration 3-1. Thus, when it is decided to revalue
Partnership Dissolution - Changes in Ownership Interest
109
Chapter 3
108
Case 1. Investment Equals Proportion of the Partnership's book value (agreed
capital).
Illustration 3-2
Overview ofa Accounting for Admission ofa New Partner
Step 2: Compare Agreed Capital and
Cody invests P100,000.After the investment,the difference between the new partner's
investment and his agreed capital is computed as follows:
Step 3: Alternative Methods to Account
for Admission
Investment ofNew Partner
Casel:
1. No revaluation, goodwill, or bonus.
Investment cost = agreed capital
Case 2:
Investment cost > agreed capital
4
Investmentin partnership
New partner's proportionate book value(agreed capital):
(P300,000 + PI00,000) X 25%
P 100,000
( 100,000)
Difference
P
-0-
1. Revalue net assets up to fair value and
allocate to old partners.
2. Record unrecognized goodwill and
allocate to old partners.
3. Allocate bonus to old partners.
Since the amount ofthe investment(PI00,000)equal the new partner's 25 percent
proportionate book value(agreed capital),there is an implication that the net assets are
fairly valued. Total resulting capital equals the old partners' capital(P300,000)plus tlie
new partners' tangible investment(PI00,000). Note that the capital credit assigned to
the new partner is his share ofthe total resulting capital ofthe partnership after his
admission. The entry on the partnership's books is;
1. Revalue net assets down to fair value
2011
and allocate to old partners.
2. Recognize goodwill brought in by new
January 2: Cash
100,000
Cody, Capital
To record admission ofCodyfor one-fourth
Case 3:
Investment cost < agreed capital
partner.
3. Assign bonus to new partner.
100,000
interest upon investment ofPI00,000.
The following schedule shows the key concepts in Case 1:
Illustration;
New
New Partner's
For purposes ofthis discussion,assume that after operations during 2010,AB Partnership
Old
New
Partner's
Total
Share of total
Partners
Partner's
has a book value ofP300,000 and profit percentages on January 1,2011,as follows:
Capital
Investment
Agreed
Capital
Resulting
Capital
Resulting
Capital
P300,000
P100,000
PIOO.OOO
New partner's investment equals
his agreed capita!
•
Capital
Profit and Loss
Balance
Ratio
No revaiautions, goodwill or bonus
Andy
Bony
P200,000
100,000
60%
Case 2. New Partner's Investment More than Proportion of the Partnership
Book Value (agreed capital)
40%
Total
P300,000
100%
January 2,2011 Cody is to invest cash into the partnership. Cody will have a one-
urth interest and a 25 percentshare ofproits. Andy and Bony vyill share the remaining
ercent ofprofits in the ratio of60:40,resulting in Andy a 45 percent share ofany
fits and Bony having 30 percent.
PI 00,000
P400,000
Cody invests P110,000for a one-fourth capital interest in the partnership.The difference
between the new partner's investment and the new partner's proportionate book value
is computed as follows:
Investment in partnership
New partner's proportionate book value(agreed capital):
(P300,000+P110,000)x25%
P 110,000
Difference
P
(102,500)
7.500
Partnership Dissolution — Changes in Ownership Interest
Chapter 3
110
Illustration ofRevaluation ofAssets Approach. Assume that Cody paid a P7,500
excess over the proportionate book value because the partnership owns land with a
book value ofP40,000 but a recent appraisal indicates the land has a market value of
P70,000. Before recording the admission ofCody the land should be revalued by the
following adjusting entry:
Cody had invested PI 10,000 for an interest with a book value of PI02,500, thus
paying an excess ofP7,500 over the present book value.
Generally,an excess ofinvestment over the book value ofinterest acquired indicates
that the partnership's prior net assets are undervalued or that the partnership has some
unrecorded goodwill.Three altemative accounting treatments exist in this case;
1.
(1) Land
Andy, Capital
Bony, Capital
To revalue partnership land to market value.
Revalue assets upward.Under this altemative:
a.
Asset book values are increased to their fair values.
b.
The old partners' capital accounts are increased for their respective shares of
111
30,000
18,000
12,000
increase in the book values ofthe assets.
2.
The partnership's total resulting capital reflects the prior capital balances plus
Cody's investment ofPI 10,000 brings the partnership's total resulting capital to
the amount ofasset revaluation plus the new partner's investment.
P440,000,computed as follows:
Total capital ofold partnership
Record unrecognized good>vUl. With this method:
a. Unrecognized goodwill is recorded.
b.
Cody's investment
The old partners' capital accounts are increased for their respective shares of
The partnership's total resulting capital is now equal the pnor capital balances
plus the goodwill recognized plus the new partner's investment.
P440,000
After the revaluation ofland, Cody's interest in the total resulting capital.of ABC
Partnership(agreed capital), is equal to PI 10,000(P440,000 x .25).
Use bonus method.Basically,the bonus method is a transfer ofcapital balances
The entiy to record the admission ofCody into tlie partnership follows:
among the partners.This method is used when the partners do not wish to record
adjustments in asset accounts or recognize goodwill. Under this method:
a. The old partners' capital accounts are increased for their respeetive shares of
the bonus paid by the new partner.
110,000
Total resulting capital of ABC Partnership
the goodwill.
3.
P300,000
30,000
Revaluation ofland
(2) Cash
Cody, Capital
•
110,000
110,000
To record admission ofCodyfor one-fourth
b. The partnership's total resulting capital equals the pnor capital balances plus
capital interest in ABCPartnership.
the new partner's investment.
Illustration ofGoodwill Recognition. The new partner may be paying an excess
because ofunrecognized goodwill,indicated by the partnership's high profitability. This
is an opportunity to record unrecognized goodwill created by the old partners. Recording
unrecognized goodwill is allowed for partnership accounting because ofthe need to
establish appropriate capital equity among the partners. As noted earlier, this is an
exception to the general rule established in PAS No. 38. The partners' information
needs and specific purposes ofthe partnership's financial statementsjustify this exception.
Note:The partnership may use any one ofthe three alternatives. The decision is usually
a result ofagreements between the old partners and the new partner. Some account^ts
criticized the revaluation ofassets or recognition ofgoodwill because it results in a
departure from the historical cost principle and differs from the accepted principles in
Philippine Accounting Standard(PAS)No.38"Intangible Assets ,which prohibits
corporations from recognizing goodwill that has not been acquired by purchase.
Accountants who supportthe recognition ofgoodwill point outthat when a new partner
is admitted to the partnership, the old partnership is legally dissolved and a new
partnership isformed. Therefore,the basis ofvaluation for the new partnership is the
Unrecognized goodwill may be computed from the amount ofnew partner's investment.
For example,in this case, Cody is investing P110,000 for a one-fourth interest. The
fair value ofthe assets acquired by the newly formed partnership. Consequently,assets
goodwill is computed as follows:
should be recorded at their fair values and should include previously unrecognized
goodwill.Finally,accountants who use the goodwill or assetrevaluation rnethods ^gue
Estimated total resulting capital(P110,000 / 25%)
Total net assets (P300,000 + P110,000)
thatthe purpose ofpartnership accounting is to state fairly the relative capital equities of
the partners and this may require different accounting procedures from those used in
Goodwill
P30,000
corporations.
7. ,
J
P440,000
410,000
/
. 4-'
A .i-'i-.
Chapter 3
112
Partnership Dissolution - Changes in Ownership Interest
Note that to have goodwill the total resulting capital should be more than the total net
assets(total contributed capital). Since the basis ofcomputing the total resulting capital
is the investment ofthe new partner then the goodwill will be shared by the old paitners
The following schedule shows the key concepts for Case 2:
in their profit and loss ratio.
New Partner's
New
New
Partner's
Total
Share of Total
Partners
Partner's
Capital
Investment
Agreed
Capital
Resulting
Capital
Resulting
Capital (25%)
P300,000
PI 10,000
P102,500
Old
The entries to record goodwill and the admission ofCody are as follows;
(1) Goodwill
Andy, Capital
Bony, Capital
113
30,000
18,000
12,000
To record unrecognized goodwill.
New partner's investment more
than his proportionate book value
(agreed capital)
1.
(2) Cash
110,000
Cody, Capital
To record admission ofCody to partnership
for a one-fourth capital interest(P440,000x .25).
2.
110,000
3.
Revalue assets by increasing
land, P30.000
P440,000
PI 10,000
Recognize P30,000 goodwill to
old partners
P440,000
PI 10,000
Bonus of P7,500 to old partners
P410,000
P102,500
earnings before netincome is distributed to the partners.
Case 3: New Partner's Investment Less than Proportion of the Partnership
Book Value (agreed capital).
Assume that Cody invests P80,000 for a one-fourth capital interest in the partnership.
Illustration ofBonus Method, Under this method a portion of the new partner's
investment is transferred to the old partners to align the capital balances properly at the
The difference between the new partner's investment and the partner's proportionate
book value(agree capital) is as follows:
In future period,any impairmentloss ofgoodwill will be charged against partnership
time erfthe new partners' admission.In this case,the bonus is computed as follows:
New partner's investment
New partners proportionate book value (agreed capital);
(P300,000 + P110,000)X .25
P110,000
Bonus to old partners
P
102,500
Investment in partnership
New partner's proportionate book value (agreed capital):
(P300,000+ P80,000)X .25
P 80,000
Difference
P( 1,500)
(95,000)
7,500
The fact that Cody's investmentis less than the book value ofa one-fourth interest in the
partnership is again P410,000 (P300,000 + PI 10,000). No additional capital is
partnership indicates that the partnership net assets is overvalued or that Cody is
contributing additional value in the form ofexpertise or skills he possesses.In this case,
Cody is investing P80,000 in cash and an additional amount that may be viewed as
recognized since there is no revaluation ofassets.
goodwill.
The entry to record the admission ofCody under the bonus method is as follows:
The are three alternative approaches to account for the difference when the investment
is less than the book value acquired.The three approaches are as follows:
The excess paid by Cody is a bonus allocated to the old partners in their profit and loss
ratio of60 percent to Andy and 40 percent to Bony.The total resulting capital oftlie
Cash
110,000
Andy, Capital
Bony, Capital
Cody, Capital
To record admission ofCody with bonus to Andy and Bony.
4,500
3,000
102,500
Cody may dislike the bonus method because his capital balance is P7,500 less than his
investment in the partnership.
1. Revalue assets downward.CndQv ibis txppxodicb:
a. Asset book values are decreased to tlieir fair values.
b. The old partners' capital accounts are decreased for their respective shares of
the decrease in the values ofthe assets.
c. The partnership's total resulting capital reflects the old partner's capital balances
less the amount of the asset valuation write-down plus the new partner's
investment.
Chapter 3
114
2. Recognize goodwill brought in by the new partner. In this alternative:
a. Goodwill brought in by the new partner is recorded and ineluded in the new
partner's eapital account.
b. The old partners' capital accounts remain unchanged.
c. The partnership's total resulting capital reflects the old partners'capital balances
plus the new goodwill brought in plus the new partner's cash investment.
3. Use bonus method. Under this approach:
115
Partnership Dissolution - Changes in Ownership Interest
Illustration ofRecording Goodwillfor New Partner. The amount of goodwill
brought in by the new partner is usually determined through negotiations between the
old partners and the new partner. For example,the partners may agree that Cody's
abilities will generate excess earnings for the new partnership. They agree that Cody
should be given goodwill when hejoins the partnership in recognition ofhis anticipated
excess contribution to the partnership's future earnings. The negotiated goodwill is
recognized and is added to his tangible investment to deterniine the amount ofhis capital
credit.
a. The new partner is assigned a bonus from the old partners' capital accounts,
which are decreased for their respective shares ofthe bonus paid to the new
partner.
b. The partnership's total resulting capital is equal to the old partner's capital
balances plus the new partner's investment.
Alternatively,the amount ofgoodwill brought in by the new partner may be estimated
from the amount ofthe total capital being retained by the old partners. In this case,the
old partners are retaining 75 percent interest in the partnership and giving the new
partner;a 25 pereent capital interest. The peso amount ofthe old partners' 75 percent
interest is P300,000.Cody's investmentofP80,000 plus goodwill m^es up tlie remaining
Illustration ofRevaluation ofAssets Approach. Assume that the inventory ofthe
partnership which is curi'cntly recorded at book value ofP 140,000 has a fair market
value ofonly P80,000 because some items are obsolete. The partners agree to write
down the inventoiy to its fair value before the admission ofnew partner. The writedown
is divided between the old partners in the profit and loss ratio that existed during the
period ofthe inventory decline;60 percent to Andy and 40 percent to Bony.The write
25 percent.The estimated amount ofgoodwill brought in by Cody into tlie partnersliip
is detenriined as follows:
Total resulting capital(P300,000/.75)
Total net assets excluding goodwill(P300,000+ P80,000)
Goodwill
P400,000
( 380,000)
P 20,000
down is recorded as follows:
(1) Andy, Capital
Bony, Capital
Note that tlie total resulting eapital is eomputed using the total capital ofthe old partners
as the base.In case 2,the total resulting eapital is estimated using the investment ofthe
36,000
24,000
60,000
Inventory
To revalue inventory to itsfair value.
Note that the partnership's total capital was reduced from P300,000 to P240,000 as a
result ofthe P60,000 write-down. The value ofCody's share ofthe total resulting
capital of ABC Partnership, after the write-down is only P80,000 [(P240,000 +
new partner. The reason for this differenee is that the best available data should be used
for the total resulting capital to be more than the net assets(total eontributed capital)for
the goodwill to exist. A useful phrase to remember how to estimate goodwill is to use
the opposite partners' capital for the estimate:
Use new partner's investment to estimate goodwill to old partners, use old
partners total capital to estimate goodwill to new partner.
P80,000)X .25].
The entry to record the admission ofCody into the ABC Partnership is:
The entry to entry to record the admission ofCody in the ABC Partnership is:
(2) Cash
Cody, Capital
Cash
Goodwill
80,000
Cody, Capital
80,000
To record the admission ofCody.
Cody's recorded capital credit is equal to his investment because the total partnership
capital ofP320,000(P240,000+P80,000)now represents the partnership's fair value.
80,000
20,000
100,000
To record the admission ofCody.
Note that the total resulting capital ofthe ABC Partnership is now P400,000,with
Andy and Bony together having a 75 pereent interest and Cody having a 25 percent
interest
-kV-'i
Chapter 3
116
Illustration ofBonus Method, Cody's investment ofonly P80,000 for a one-fourth
interestin tTie ABC Partnership may be accounted for by recognizing a bonus given to
Cody from the old partners.The bonus is computed as follows:
New paitner's investment
New partner's proportionate book value (agreed capital):
(P300,000 + P80,000)X .25
Partnership Dissolution - Changes in Ownership Interest
117
Summary and Comparison ofAccountingfor Investment ofNew Partner
Illustration 3-3 presents the entries made in each ofthe three cases discussed.In addition,
the capital balance ofeach ofthe three partners immediately after the admission of
Cody is presented to the right ofthejournal entries.
P80,000
The following summarizes the alternative methods ofaccounting for the investment ofa
( 95.0001
Bonus to new partner
new partner.
PI5,000
Case 1. New partner's investment equal his proportion of the partnership's
Note that the old partners' capital accounts are reduced by P15,000 in their profit and
loss ratio of60 percent for Andy and 40 percent for Bony,and Cody's capital account
is credited for P95,000,as follows:
80,000
9,000
6,000
Cash
Andy, Capital
Bony, Capital
Cody, Capital
To record admission ofCody.
book value(agreed capital credit).
1. The new partner's capital credit equals his investment.
2. No goodwill or bonus is recorded.
Case 2. New partner's investment is more than his proportion ofthe partnership's
book value(agreed capital credit)
95,000
1. The revaluation ofan asset or recognition ofgoodwill increases the partnership s
total resulting capital.The increase is allocated to the old partners in their profit and
loss ratio.
Note that Cody's capital credit is his share Ofthe total resulting capital as shown below:
,
2. After recognition ofthe asset revaluation or unrecorded goodwill,the new partner s
capital credit equals his investment and his percentage ofthe total resulting capital.
3. Under the bonus method,the partnership's total resulting capital is the suin ofthe
(P300,000 + P80,000) X .25 - P95,000
old partnership's capital plus the investment by the new partner. The capital credit
recorded for the new partner is less than the investment but equals his percentage ot
The following schedule presents the summary ofapproaches for Case 3:
New
New partner's investment less
than his proportionate book value
(agreed capital)
1.
2.
Revalue assets by decreasing
inventory, P60,000
New
Partner's
Partners
Capital
Partner's
Investment
Agreed
Capital
P300,000
P80,000
P9,500
>
Tot^l
Resulting
Capital
New Partner's
Share of Total
Resulting
Capital (25%)
Bonus of PI5,000 to new partner
Case 3. New partner's investment is less than his proportion ofthe partnership s
book value(agreed capital credit).
1. Under the revaluation ofassets approach,the write-down ofthe assets reduced the
old partners' capital in their profit and loss ratio. The new partner's capital is then
credited for the amount ofthe investment.
P320,000
P 80,000
2. Under the goodwill method,goodwill is assigned to the new partner,and the total
resulting capital ofthe partnership is increased.The new partner's capital is credited
Recognize P20,000 goodwill
to new partner.
3.
Old
the resulting partnership capital.
P400,000
P380,000
P100,000
P 95,000
for his percentage interest in tlie total resulting capital ofthe partnership.
3. The bonus method results in a transfer ofcapital fi'om the old partners to the new
partner. The new partnership's total resulting capital equals the old partner's capital
plus tlie new paitner's investment.The new partner's capital credit is more than the
investment made but equals his percentage ofthe total resulting capital.
■-A
Illustration 3-3
-v^
Case 1; New partner's investment equals proportionate book value. Cody invests P100,000 cash
for a one-fourth capital interest.
Cash
100,000
Andy
P200,000
Cody, Capital
100,000
Bony
Cody
100,000
100.000
Total
P400.000
ratio of 20 percent and capital ratio of 30 percent, only the capital ratio is used for the
purpose of computing the implied goodwill or the bonus. However, if goodwill were
subsequently written off, then tlie profit and loss ratio is to be used.
30,000
18,000
Andy, Capital
Bony, Capital
12,000
Andy
Bony
Cody
Total
Cash
Goodwill
18,000
12,000
In some instances, the amount of cash investment the new partner should contribute is
to be determined. To solve this, the basic principle of partnership accounting is to be
applied. To illustrate, lets continue the basic example ofpartners Andy and Bony wishing
to admit Cody as a new partner. The prior partnership capital was P300,000, and
Cody invests for a one fourth interest.
Andy
Bony
Cody
P218,000
112,000
Total
P440.000
Andy
Bony
Cody
P204,500
103,000
102..50Q
Total
P410,000
Assuming the old partners, Andy and Bony, agree that the assets of partnership is be
revalued up by P30,000 to recognized the increase in the value of the land held by the
partnership. The required cash to be invested by the new paitner is computed as follows:
110,000
110,000
110,000
Cody, Capital
Bonus to old partners:
Cash
In the previous illustration, the amount ofthe new partner's investment has been provided.
110,000
30,000
Andy, Capital
Bony, Capital
Cash
P218,000
100,000
100.000
P400,000
110,000
Cody, Capital
(b) Recognize aoodwill to old partners:
(c)
Determining a New Partner's Investment Cost
Revalue assets:
Land
110,000
4,500
3,000
102,500
Andy, Capital
Bony, Capital
Cody, Capital
Revalue assets:
36,000
24,000
Inventory
Cash
60,000
PI64,000
76,000
Total
P320,000
80,000
80,000
20,000
Cody, Capital
100,000
Andy
Bony
Cody
P200,000
100,000
Total
P400.000
Andy
Bony
Cody
P191,000
94,000
9.5.000
Total
P380,000
100.000
(c) Bonus to new partner:
Cash
Andy, Capital
Bony, Capital
Cody, Capital
80,000
9,000
6,000
95,000
Required cash investment of new partner
PI 10,000
330,000
80.000
80,000
Cody, Capital
(b) Recognize goodwill to new partner:
Cash
Goodwill
Andy
Bony
Cody
P440,000
cash investment required from the new partner. For example, assume that Andy ana
Bony agree to give Cody a bonus of P15,000 for joining the partnership. The following
computations determine tlie amount ofcash investment required ofCody, the new partner.
a one-fourth capital interest.
Andy, Capital
Bony Capital
Total resulting capital (P330,000 /. .75)
Less: Old partners' capital after revaluation of land
In some cases, the amount of bonus may be detemiined before tlte detemiination ofthe
ic 3: New partner's investment less than proportionate hook value. Cody invests P80,000
(a)
Profit and Loss Ratios and Capital Ratios are Different
More often, a new partner is admitted in the partnership with a profit and loss ratio
different from the capital ratio. In our illustration, only one ratio was given, and therefore,
a choice of ratios was not required. \Vlien two ratios are given, that is, a profit and loss
Case 2: New partner's investment more than proportionate hook value. Cody invests PI 10.000
cash for one-fourth capital interest.
(a)
119
Partnership Dissolution - Changes in Ownership Interest
Chapter 3
118
Prior capital of old partners
Less: bonus given to Cody
P300,000
15,000
Capital retained by the old partners (755)
Total resulting capital (P285,000/ .75)
P285,000
380,000
Required capital credit of new partner
Less: bonus to new partner
P 95,000
15,000
Cash investment required of new partner
P 80,000
Take note tliat the new partner's cash investment can be computed simply by detennming
the amount of the capital credit that will be assigned to him and them recognizing any
bonuses that will be used to align the capital balances.
iT-
Chapter 3
120
Partnership Dissolution - Changes in Ownership Interest
Summary of Computing Goodwill and Bonus
The goodwill and bonus approaches are alternative methods for recording changes in
121
The interest ofthe retiring partner is usually measured by his capital balance,increased
or decreased by his share in the following adjustment:
partnership interests throng direct investments in^existing partnersliip. In determining
whether the goodwill or bonus method will be assigned to the old partners or the new
partner,the investment ofthe new paitner is compared to his capital credit.
1. Profit or loss from partnership operations from the last closing date to the date
Ifthere is undervaluation or overvaluation ofreeorded net assets,adjustments should
be made first before comparing the new partner's investment and capital credit to
determine goodwill or bonus.
2. Changes in tlie valuation ofall assets and liabilities(book values to fair values).
ofhis/her retirement.
Ifthe netincome or loss ofprior years were improperly computed,these should likewise
be corrected before determining the interest ofthe retiring partner.
A summary ofthe procedures used in the previous illustrations to compute the amounts
ofgoodwill and bonus for Cody's investment is as follows:
P110,000
Illustration. On January 2,2011,the capital balances and profit and loss ratio ofBee,
Cee,and Dee are as follows:
P80,000
Investment
Investment
for a One-Fourth
for a One-Fourth
Interest
Interest
Goodwill
Tothl resulting capital
P110,000
(based on Cody's
investment)
P300,000 '/t(based on old
partner's capital)
Book value of old partnership assets
+ Cody's investment
Goodwill to old partenrs
Capital
Profit and loss
Partners
Balances
Ratio
Bee
PI0,000
15,000
20,000
30%
Cee
Dee
P440,000
380,000
P 30,000
P 20,000
20%
On April 30, 2011, Bee withdraws from the partnership. The net income of the
partnership for the four months ended April 30,2011 is P 140,000.It is agreed that the
P400,000
410,000
50%
inventory costing P5,000 has market value ofP7,000 on April 30,2011.
Case 1.Settlement equals withdrawingpartner's interest. Assume that Bee agrees
Bonus
Cody's investment
Cody's agreed capital credit
PI 10,000
P 80,000
settlement with Dee on April 30,2011 are as follows:
20II
102,500
P410,000 x'/4
P380,000x'/4
Bonus to old partners
Bonus to new partner
to accept payment equal to his interest. The entries to record the adjustments and the
April 30:(1) Incotne Summary
95,000
P
14,000
7,000
4,200
2,800
Bee, Capital
Cee, Capital
Dee, Capital
To record distribution ofprofit.
7,500
P 15,000
RETIEIEMENT OF A PARTNER
(2) Inventory
Bee, Capital
Cee, Capital
Dee, Capital
To adjust inventory.
When a partner retires or withdraws from the partnership,the partnership is dissolved,
but the remaining partners may continue operating the business. The existing partners
may buy out the retiring partner either by making a direct acquisition or by having the
partnership acquire the retiring partner's interest, ifthe present partner directly acquire
the retiring partner's interest,the only entry on the partnerhisp's books is to record the
transfer ofcapital from the retiring partner to the remaining partner. Ifthe partnership
acquires the interest ofthe retiring partner,the partnership must pay the retiring partner
(3) Bee, Capital
Cash
To record settlement to Bee equal
an amount equal to his interest, more than his interest, or less than his interest.
to his adjusted capital balance.
1
2,000
1,000
600
400
18,000
18.000
f.
Chapter 5
122
Case 2. Settlement more than withdrawing partner's interest. When the
withdrawing partner is paid an amount more than his interest,three approaches can be
used,namely:
Partnership Dissolution - Changes in Ownership Interest
123
is morejustifiable, but still reliable evidence that goodwill exist is lacking. The most
satisfactory method to record the excess paymentto Bee is the Bonus method. Therefore
ifthere is no agreement regarding the method to be used,it is advisable to use the bonus
method. On the other hand ifthe partners agreed to use goodwill method and is silent
1. Record goodwill equal to the excess payment made to the retiring partner.(Partial
Goodwill Method).
whether the partial goodwill method or the total goodwill is to be used,use thepartial
goodwill method.
2. Record total implied goodwill ofthe partnership computed by dividing the excess
payment with the retiring partner's profit and loss share percentage(Total Goodwill
Method).
3. Treat the excess paymentas bonus from the remaining partners. Tliis is accomplished
by decreasing the remaining partners' capital accounts by the excess using their
profit and loss share percentages.
Case 3. Settlement less than withdrawing partner's interest. Often, particularly
in successful partnerships, withdrawals ofpartners require payments in excess of.a
partner's interest. But there are some cases wherein withdrawals require pajmient for
less than the partner's interest. In such cases,an attempt may be made to allocate the
difference to specific assets which are overstated.
Using the same data and assuming that Bee is paid P17,000 for his interest,the entry
Using the data in the preceding illustration and assuming that Bee is paid P19,500,the
will be as follows:
entries to record the settlement with Bee under each ofthe foregoing approaches are as
Bee, Capital
follows:
18,000
17,000
1,000
Cash
Identifiable Assets
1. Partial Goodwill Method
Goodwill
Bee, Capital
1,500
18,000
Ifthe causes ofthe difference are not detenninable or assignable to specific assets,then
19,500
Cash
the bonus method should be used. The entry to record the settlement with Dee isBee, Capital
2. Total goodwill Method
Goodwill(PI.500 50%)
Bee, Capital
18,000
Cash
3,000
18,000
Cee, Capital(30% X P3,000)
Dee, Capital(20% x P3,000)
17,000
Cee, Capital(3/5 x PI,000)
Dee, Capital(2/5 x PI,000)
900
. 600
600
400
To record the retirement ofBee and to divide the
resulting bonus between Cee and Dee in the ratio of3:2.
19,500
Cash
DEATH OF A PARTNER
3. Bonus Method
Bee, Capital
Cee, Capital(3/5 x PI,500)
Dee, Capital(2/5 x PI,500)
Cash
In the event ofthe death ofa partner,the estate ofthe deceased partner is
18,000
900
600
19,500
In the opinion ofthe authors,the total goodwill should not be recorded in the books of
the partnership. Serious objections exist in recording the total goodwill ofP3,000.
Because only P1,500 ofthe goodwill is included in the paymentfor Dee's interest. Its
presentation in the statement offinancial position ofthe partnership is notsupported by
either the valuation principle or reliable evidence.Perhaps the partial goodwill method
receive the amountofhis interest in the partnership at tlie date ofliis death.The deceas
partner's capital is adjusted using his profit and loss share percentage for
asset values arising from revaluation ofassets,and for the profit from the date the
were last closed. The balance ofhis capital account after considering the necessary
adjustments should be transferred to a liability account pending settlement.
The partners may agiee tliat the settlement with the estate ofthe deceased partner be
postponed until the end ofthe regular fiscal period when the books are closed,at which
time his capital account shall be credited with a share in the earnings. Various methods
may be used in determining the deceased partner's share in the net income.He may
Partnership Dissolution - Changes in Ownership Interest
Chapter 3
124
125
Reyes and Cruz
receive a pro-rata share ofthe profit from the beginning ofthe accounting period to the
date ofhis death plus interest on his capital balance from the date ofhis death to the
date ofsettlement.Ifnot,he may receive a share ofthe profit for the full period.
June 30, 2011
INCORPORATION OF A PARTNERSHIP
Assets
When a partnership is converted into a corporation,the corporation takes over the
Accounts receivable
Statement of Financial Position
P24,000
Cash
assets and assumes the liabilities ofthe partnership in exchange for shares ofstocks.
Less: Allowance for bad debts
The stock received by the partnership are distributed to the partners in settlement of '
their interest. The partners now become stockholders ofthe newly fonned corporation.
Inventories
P 56,200
1,200
Equipment
Less: Accumulated depreciation
The accounting procedures in recording the incorporation ofa partnership will depend
on whether the original books ofthe partnership will be continued by the corporation or
120,000
52,000
55,000
51,000
. 68,000
PI98,000
Total Assets
(
new books will be opened.
Liabilities & Capital
Current Liabilities:
Partnership Books Retained. Ifthe partnership books are retained,the steps to be
,
P 40,000
30,000
Notes payable
Accounts payable
taken are as follows;
1. Revalue the assets and recognize goodwill,ifany.
Total Liabilities
2. Close the partners' capital accounts to the corporate capital accounts.
'^
Capital:
Reyes, capital
Cmz,capital
New Books Openedfor the Corporation. If new books are to be opened, the old
partnership books must be closed. The accounting procedures may be outlined as
'
.
P 95,980
32,020
■ Total Liabilities and Capital
foUows:
70,000
128,000
PI98,000
In the Books ofthe Partnership:
The partners agree to make the following adjustments before the incorporation:
1. Revalue the assets(and any other items agreed on)in accordance with the
agreed transfer values.
1. Increase the allowance for bad debts account to P2,000.
2. Increase the cost ofthe inventories to its cuiTent market value ofP60,000.
2. Record the transfer ofassets and liabilities to the corporation and the receipt of
capital stocks by the partnership.
3. Increase the historical cost ofthe equipment to its reproduction cost(new)of
3. Record the distribution ofstocks to the partners in settlement ofthe balances of
PI40,000 and the accumulated depreciation to be increased to P61,000.
4. Recognize accrued expenses ofP2,200.
5. Recognize goodwill ofP20,000.
their capital accounts.
Illustration. Reyes and Cmz,partners who share profits in an 80% and 20% ratio,
organized the RC Corporation to take over the partnership business.The RC Corporation
is authorized to issue 10,000 shares ofP20 par value capital stock, of which 5,500
shares are issued at P30 a share to the partners in accordance with their adjusted
capital accounts. RC Corporation also issued 1,000 shares for cash to the other
incdrporators atP30 a share.The statement offinancial position ofthe partnership as of
June 30,2011,the date ofincorporation,is shown in the next page.
.1
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Chapter 3
126
Thejournal entries to illustrate the accounting procedures in the incorporation ofthe
Reyes and Cruz partnership using the given data appears below;
Partnership Dissolution — Changes in Ownership Interest
(2) Stocks of RC Corporation
Notes Payable
Entries in the Books of the New Corporation
165,000
40,000
.
Accounts Payable
Accrued Expenses
Allowance for Bad Debts
Accumulated Depreciation
Partnership Books Retained
127
30,000
2,200
2,000
61,000
^
24,000
56,200
60,000
140,000
20,000
Cash
Inventories
Accounts Receivable
9,000
Equipment
20,000
Inventories
Goodwill
20,000
Equipment
Allowance for Bad Debts
Accumulated Depreciation
Accrued Expenses
Reyes, Capital
Cruz, Capital
, '
•
800
9,000
2,200
29,600
7,400
Goodwill
To record transfer of assets and liabilities to RC
Corporation and the receipt of 5,500 shares of
P20 par value stock valued at P30 per share.
IT) Reyes, Capital
Cruz, Capital
To adjust assets and liabilities to agreed amounts
and to divide the net adjustment between partners
125,580
39,420
StocJ^ of RC Corporation
in an 80% and 20% ratio.
165,000
To record stock distribution to partners as follows:
Reyes, Capital
Cruz, Capital
Capital Stock
Paid-in Capital in Excess ofPar
To record issuance of 5,500 shares ofP20 par value
stock to the partners at a price ofP30 a share
(PI65,000 5,500 shares) distributed as follows:
Reyes: PI25,580 h- P30/share = 4,186 shares
Cruz: P39,420
Reyes: PI25,000 ^ P30/share = 4,186 shares
125,580
39,420
Cruz: P38,420
110,000
55,000
P30/share = 1,314 shares
Entries in the Books of the New Corporation
(1) Cash
Accounts Receivable
Inventories
P30/share = 1,314 shares
56,200
60,000
Equipment (Net)
79,000
Goodwill
20,000
New Bjooks Opened for the Corporation
Allowance for Bad Debts
Entries in the Books of the Partnership
Notes Payable
Accounts Payable
Accrued Expenses
(1) Inventories
Equipment
Goodwill
Allowance for Bad Debts
Capital Stock
9,000
20,000
Paid-in Capital in Excess ofPar
Accumulated Depreciation
Accrued Expenses
Reyes, Capital
Cruz, Capital
To adjust assets qnd liabilities according to agreement.
2,000
40,000
30,000
2,200
110,000
55,000
To record the acquisition of assets and liabilities
20,000
^
\
24,000
800
9,000
2,200
29,600
7,400
from the partnership at their adjusted values.
(2) Cash
Capital Stock
30,000
Paid-in Capital Excess ofPar
To record issuance of 1,000 shares, at P30 per share.
20,000
10,000
y
Partnership Dissolution - Changes in Ownership Interest
Chapter 3
128
The Statement offinancial position ofthe RC Corporation after recording the required
entries for the incorporation appears below.
129
MULTIPLE CHOICES - THEORETICAL
1. Which ofthe following conditions constitutes a legal dissolution of a partnership?
RC Corporation
Statement ofFinancial Position
a. Death of partner.
b. Retirement of a partner.
c. Admission of a partner.
June 30, 2011
Assets
P 54,000
Cash
P 56,200
Accounts receivable
54,200
60,000
79,000
20,000
2,000
Less Allowance for bad debts
Inventories
d.
All of the above.
■- f
v-
Equipment
Goodwill
2. When admitting a new partner into an existing partnership, any allocation ofgoodwill
to the old partners is based on.
P267,200
Total Assets
a.
The profit and loss ratio.
b.
An equal distribution among the partners.
c. The fair values of the assets each partner has contributed to the partnership.
Liabilities & Stockholders Equity
Liabilities;
Notes payable
Accounts payable
Accrued expenses
d. The relative capital balances ofthe partners.
P40,0{)0
30,000
•* v V,
3. According to the text, the recognition of goodwill in the accounting records of a
2,200
Total Liabilities
,
■,.
partnership may be appropriate for:
72,200
Stockholders' Equity:
Capital stock,P20 par value, authorized 10,000
shares, issued and outstanding, 6,500 shares
Paid-in capital in excess of par
a. The admission of a new partner for a cash investment.
b. The retirement ofan existing partner.
PI30,000
c. Either ofthe foregoing situations.
195,000
65,000
Total Liabilities & Stockholders' Equity
d. Neither ofthe foregoing.
P267,200
4. When the investment of a new partner exceeds the new partners' initial capital
balance and goodwill is not recorded, who will receive the bonus?
' '■ .
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a.
The new partner.
b. The old partners in their old profit and loss ratio.
c. The old partners in their new profit and loss ratio.
■
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d. The old and new partners in their new profit and loss ratio.
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Chapter 3
130
5. When Mr. X is admitted to the partnership, the fair value ofthe assets he contributes
exceeds his initial capital balance. If Mr. Z will retire soon from the partnership,
what method of recording Mr. X's admission should Mr. Z prefer?
a:4' vio ■
•'•••=?;-■ _•
a.
The bonus method.
b. The goodwill method.
c. Either the bonus or the goodwill method.
d. The equity method.
6. When Mr. B is admitted to the partnership, the fair value ofthe assets he contributes
exceeds his initial capital balance. In this case who gets the bonus under the bonus
method and who contributes the goodwill under the goodwill method?
4:'>r.
a.
b.
c.
d.
Mr. B gets the bonus and contributes the goodwill.
The old partners get the bonus and contribute the goodwill.
Mr. B gets the bonus, but the goodwill is contributed by the old partners.
The old partners get the bonus, but the goodwill is contributed by Mr. B.
7. Under what circumstances will the bonus and goodwill methods produce different
results in the future?
a. Ifthe new partners' percentage interest in profits and losses is the same as his
initial fractional interest in the partnership capital.
b. Ifthe new percentage interests in profits and losses of the old partners is in the
same relative proportion as their old percentage interests.
c. If any partner retires in the near future.
d. If the partnership realizes losses, rather than profits.
8. Goodwill should be recognized on the retirement of a partner from a partnership:
a. If the partnership contract provides that the retiring partner is to receive the
balance ofhis or her capital account plus anamount of goodwill.
b. If a new partner acquires from the retiring partner for cash the interest of the
retiring partner in the partnership.
c. If the retiring partner agrees to accept an amount of cash that is less than the
balance of the partners' capital account.
d.
■
K'
Under no circumstances.
Partnership Dissolution - Changes in Ownership Interest
131
9. If a partnership contract requires the computation of goodwill when a partner
retires from the partnership, the appropriate joumal entry for tlie partners' retirement
is:
a. Debits Goodwill for the entire amount computed.
b. Debits Goodwill for the retiring partners' share only.
c. Debits Retirement Expense for the retiring partners' share of the computed
goodwill.
d. Debits the continuing partners' capital accounts for a bonus to the retiring
partner.
10. When a partner retires and receives in cash less than his capital balance, how
should the difference be treated?
a. The difference should be credited to all the partners in their profit and loss
ratio.
b. The difference should be debited to all the partners in their profit and loss
ratio.
. .
c. The difference should be credited to the remaining partners in their remammg
profit and loss ratio.
d. The difference should be debited to the remaining partners in their remammg
profit and loss ratio.
11. If is the total capital of the partnership before the admission of a new partner,^
is the total capital of the partnership after the investment of a new partner, C is e
amount of the new partner's investment, and D is the amount of capital credit to
the new partner, then there is;
a. A bonus to the new partner if B = A + C and D < C.
b. Goodwill to the old partners ifB> (A+ C) and D = C.
c. Neither bonus nor goodwill if B = A —C D > C.
d. Goodwill to the new partner if B > (A + C) and D < C.
Chapter 3
132
Partnership Dissolution — Changes in Ownership Interest
12. In the LM Partnership,Laura and Maria had a capital ratio of3:1 and a profit and
loss ratio of 2:1, respectively. They used the bonus method to record Nora's
admittance as a new partner. What ratio should be used to allocate,to Laura and
Maria,the excess of Nora's contribution over the amount credited to Nora's
capital accoimt?
133
MULTIPLE CHOICES - COMPUTATIONAL
Use the following information for items 1,2, and 3:
The ALD Partnership shows the following profit and loss ratios and capital
balances:
a.. Laura and Maria's new relative capital ratio.
b. Laura and Maria's new relative profit and loss ratio.
c. Laura and Maria's old capital ratio.
Aquino
Locsin
Dizon
60%
30%
10%
P252,000
P126,000
P42,000
d. Laura and Maria's old profit and loss ratio.
The partners decide to sell Hizon 20 percent of their respective capital and profit
and loss interests for a total payment of P90,000. Hizon will pay the money
13. When Jill retired fi-om the partnership ofJill, Bill,and Hill,the final settlement of
her interest exceeded her capital balance. Under the bonus method,the excess:
directly to the other partners.
3-1:
a. Was recorded as goodwill.
b. Was recorded as an expense.
'
c. Reduced the capital balances ofBill and Hill.
d. Had no effect on the capital balances ofBill and Hill.
If the partners agree that unrecognized goodwill is to be recorded prior to the
sale of Hizon, what are the capital balances of the partners after his admission?
•'
Aquino
a.
b.
■ -V'"
1
/1- ,
c.
3i;0 i ..
d.
3-2:
P198,000
P201,600
P216,000
P255,600
Locsin
P 99,000
P100,800
PI08,000
P127,800
Dizon
Hizon
P33,000
P33,600
P36,000
P42,600
P90,000
P90,000
P90,000
P90,000
Ifthe partners agree that the bonus method is used, what are the capital balances
of the partners after Hizon's admission to the partnership?
Aquino
Locsin
Dizon
Hizon
P198,000
P201,600
P216,0 00
P255,699
P99,000
P33,000
P33,600
P36,000
P42,600
P90,000
.A •
a.
b.
c.
d.
3-3:
- '
^ "'J
■.
>
■ ■
P100,800
PI08,000
PI27,800
P84,000
POO,000
P84,000
How much cash should Aquino, Locsin, and Dizon receive, respectively from
Hizon?
a. P50,400, P25,200, and P8,400, if and only if no goodyvill h recorded.
b. P50,400, P25,200, and P8,400, whether or not goodwill is recorded.
c. P54,000, P27,000, and P9,000, if and only ifgoodwill is recorded.
d. P54,000, P27,000, and P9,000, whether or not goodwill is recorded.
t
'?rf\
:W
V.Vv" 1 ? '
1-i' i
\
Chapter 3
134
3-4: The capital accounts of Ed, Nick, and Vic are presented below with their
respective profit and loss ratio:
Ed
Nick
Vic
Partnership Dissolution - Changes in Ownership Interest
135
3-6: Banzon and Cortez are partners who share profits and losses in the ratio of6:4.
On January 1,2011 their capital balances are:
PI39,000 (1/2)
209,000 (1/3)
96,000 (1/6)
Cortez
P 80,000
20,000
Total
Pi00,000
Banzon
Tony was admitted to the partnership when he purchased directly,for P132,000
.t •
•
a proportionate interest from Ed and Nick in the net assets and profits oifthe
Dizon is to be admitted for a 20 percent interest in the partnership by direct
partnership. As a result,Tony acquired a one-fifth interest in the net assets and
profits ofthe firm. Assuming no revaluation ofassets is recorded, what is the
combined gain realized by Ed and Nick upon the sale ofa portion oftheir interests
in the partnership to Tony?
purchase from the partners for P30,000.
How should the P30,000,cash be divided between Banzon and Cortez?
a. PO
a. Banzon,PI8,000; Cortez, PI2,000.
b. Banzon,P22,000; Cortez,P 8,000.
c. Banzon,P20,000; Cortez, PI0,000.
d. Banzon,P24,000; Cortez,P 6,000.
b. P43,200
c. P62,400
d. P82,000
3-5:
Anson wishes to purchase one-fourth interest in the partnership ofBemal,Cuevas
and Diaz.The three partner's agree to sell Anson one-fourth oftheir respective
capital and profit and loss interests in exchange for a total payment ofP40,000.
The partner's capital accounts and the profit and loss ratio immediately before
the admission ofAnson are as follows:
Bemal
Cuevas
Diaz
3-7:
Perez contributed P24,000 and Cadiz contributed P48,000 to form partnership,
and they agreed to share profits in the ratio oftheir original capital contributions.
During the first year ofoperations,they made a profitofP16,290;Perez withdrew
P5,050 and Cadiz P8,000. At the start ofthe following year, they agreed to
adrtiit Gomezinto the partnership. He was to receive a one-fourth interestin the
Capital
Profit and Loss
Accounts
Ratio
capital and profits upon payment ofP30,000 to Perez and Cadiz,whose capital
P 80,000
40,000
20,000
60%
accounts were to be reduced by transfers to Gomez's capital account ofamounts
30%
10%
sufficient to bring them back to their original capital ratio.
PI40,000
100%
All assets andliabilities are fairly valued and no bonus is to be recorded upon the
admission ofAnson.Immediately after Anson's admission,what should be the
capital balances ofBemal,Cuevas and Diaz respectively?
•Ui-
How should the P30,000 paid by Gomezbe divided between Perez and Cadiz.
a. Perez,P 9,825; Cadiz, P20,l75.
b. Perez,PI5,000; Cadiz, PI5,000.
c. Perez,PI0,000; Cadiz,P20,000.
d. Perez,P 9,300; Cadiz, P20,700.
a.
b.
c.
d.
P60,000;P30,000; P15,000.
P69,000;P34,500;P16,500.
P77,000;P38,500;P19,500.
P92,000;P46,000;P22,000.
Partnership Dissolution - Changes in Ownership Interest
Chapter 3
138
3-13: June and July are partners who share profits and losses equally. The capital
accounts of June and July have tripled in five years and at present have the
following balances.
139
No. 3-15: Continued
Assuming that the new partner is given a 1/3 interest in tlie firm and the assets are
revalued. The capital balances ofthe partners after admission ofAng are:
P90,000
60,000
June
July
a.
b.
August desires to join the firm and offered to invest P50,000 for a one-third
interest. June and July declined his offer but they extended a counter-offer to
August ofP70,000 for a one-fourth interest in the capital and profits and losses
ofhe firm.IfAugust accepted their offer and bonus is recorded, what should be
the balances in the capital accounts ofJune and July after August's admission.
June
a. PI00,000
b. P120,000
c. P 97,500
d. P 90,000
c.
d.
Lim
Ong
Ang
P23,000
P23,240
P23,500
P23,000
PI8,600
PI8,760
P20,800
PI6,000
PI6,000
P16,000
PI8,600
PI8,600
3-16: Ang,Beng and Ching are partners sharing profits in the ratio of3:3:2. On June
30,their capital balances are as follows:
July
P70,000
P90,000
P67,500
P60,000
Ang
Beng
Ching
P600,000
400,000
300,000
Tlie partners agree to admit Dong on the following agreement:
3-14: Mira and Nina who share profits and losses in the ratio of3:7,are partners with
capital balances of;
1. Dong is to pay Ang P400,000 for Vi interest ofAng's interest.
2. Dong is also to invest P300,000 in the partnership.
f
Mira
Nina
P40,000
60,000
Elma is to be admitted into the partnership for 20 percent interest in the capital of
the firm. Ifassets are revalued and the capital balances ofMira and Nina after
recording the admission ofBlma are P52,000 and P88,000,respectively,the
cash paid by Elma is:
(L P35,000
b. P20,000
c. PI0,000
3. The total capital ofthe partnership is to be P2,000,000,ofwhich Dong s
interest is to be 25%.
What are the capital balances ofthe partners after the admissioii ofDong?
Ang
a. P487,500
b. 300,000
c.
d.
d. PI5,000
400,000
187,500
Ching
P425,000
300,000
300,000
125,000
partners ofML Partnership,are shown below:
On January 2,the partners decided to admit Ang as a new partner upon his
investment ofP16,000.On this date,the interest in the partnership ofLim and
Capital
Ong are as follows:
Ong
Beng
P587,500
400,000
300,000
187,500
3-17: On May 8,2011 the capital balances and profit and loss ratio ofMona and Lizaj
3-15: Lim and Ong are partners sharing profits and losses in the ratio of6:4 respectively.
Lim
^
P23,000
18,600
Mona
Liza
Profit and Loss
Balances
Ratio
PI50,000
50,000
70%
30%
r
!W^
Chapter 3
140
No. 3-17: Continued
Partnership Dissolution - Changes in Ownership interest
141
3-19: On April 27,2011,the capital accounts ofXX,YY,and ZZ shows the following
balances:
On this date,they agree to admit Alma as a partner for a 25 percent interest in
capital upon her investment ofP80,000. Mona,Liza and Alma are to share
profits in the ratio of5:3.2. Subsequently,Lomajoins the partnership by investing
P75,000 for a 20 percent interest in profits and capital. The former partners
continue sharing profits in their original ratio. Assuming the goodwill method is
used in recording the admission ofnew partners, the capital balances ofthe
partners in the new partnership are:
Liza
Mona
PI78,000
168,000
c.
150,000
d.
178,000
a.
b.
Alma
P62,000
56,000
50,000
62,000
P80,000
76,000
80,000
80,000
Lorna
P75,000
75,000
75,000
80,000
XX
YY
ZZ
P360,000
225,000
135,000
Atthis time,WW is admitted to the firm when he purchase a one-sixth interest in
the firm for P82,500. The old partners equalized their capital investments.
Afterwards,all the partners agree to divide profits and losses equally. The new
partnership closes its books on June 30,2011 reporting a profit ofP 12,600 for
two months.The partners made the following withdrawals: XX and ZZ,P750
per month; YY and WW,PI,000 per month. On June 30,2011, WW invest
enough cash to increase his capital to a one-third interest in the partnership.How
much cash is to he invested by WW?
3-18; Red White,and Blue are partners in a business,and in its profits at the respective
ratio of5:3:2. On January 5,2011,they admit Green,who is to invest in the firm
sufficient cash to have a one-third interest in the partnership capital and profits.
The following trial balance is taken from the original partnership's records:
a. PI80,755
b. PI81,075
c. P 20,000
d. P 60,333
3-20: On December 31,2011 the condensed statement offinancial position ofABC
Debit
Partnership is presented below:
PI00,000
75,000
225,000
Cash
Marketable securities
Accounts receivable
Accounts payable
Red,Capital
White,Capital
Blue, Capital
Credit
. P 80,000
175,000
100,000
45,000
,
P400,000
P90,000
Payable to A
A,Capital
B,Capital
C,Capital
P 5,000
20,750
19,250
45,000
Total
P90,000
P400,000
The securities have a market value ofP50,000,and an allowance ofP25,000
was expected to cover collection losses on the receivables.No other adjustments
ofthe net assets are considered necessary; However,the three partners among
themselves must bring the balance in their capital accounts into agreement with
their interest in profits. What amount must he invested by Green?
A, B, and C share profits and losses in the ratio of 25%, 25%, and 50^
respectively.It was agreed among die partners that A retires from the partnership
and the partnership's assets to he adjusted to their fair mai'ket value ofP102,000
as ofDecember 31,2011. The partnership would pay A P30,250 cash for his
total interest in the partnership. Wiatis the capital balance ofB after the retirement
ofA assuming the use ofthe partial goodwill method and the bonus method?
Partial Goodwill
Method
a. PI40,000.
b. PI30,000.
c. PIS5,000.
d. PI45,000.
Total assets (at cost)
a.
b.
c.
d.
P22,250
29,750
22,250
19,250
Bonus
Method
P21,750
20,750
21,700
45,000
Chapter 3
^42
3-21: Perez, Reyes,and Suarez were partners with capital balances on January 2,
2011 of?100,000,P150,000,and P200,000,respectively. Their profit and loss
ratio is 5:3:2. On July 1,2011,Perez retires from the partnership. On the date of
retirement the partnership net income is P140,000 and the partners agreed that
inventories are to be revalued at P70,000 from its original cost ofP50,000.The
partners agreed further to pay PerezP195,000 in settlement ofhis interest. Wliat
are the capital balances ofthe remaining partners after the retirement ofPerez?
Partnership Dissolution - Changes in Ownership Interest
3-23: On March 1,2009,Ahna and Betty its first year ofoperations with the following
cash investments:
Alma
Betty
PI89,000
b. P198,000
c, P207,000
d. P220,000
a.
•
P226,000
P232,000
P238,000
P226,000
Jay, capital
Kay,capital
The partners will be allowed with interest of10% oftlieir capital balances
at the beginning ofeach year.
• Tlie remainder will be divided on the bases oftheir beginning capital for
the first year ofoperation and equally for the subsequent years.
• Each partner is allowed to withdraw up to P24,000 a year. Any
withdrawal in excess ofthe figure will be treated as a direct reduction
from their capital balances.
reported the following:
Total liabilities
Alma and Betty will be allowed a monthly salary of P48,000 and
P24,000,respectively.
Suarez
3-22: Jay &Kay partnership's statement offinancial position at December 31,2010,
Total assets
PI00,000
20,000
" 40,000
40,000
On January 2,2011,Jay and Kay dissolved their partnership and transferred all
assets and liabilities to a newly formed corporation. Atthe date ofincorporation,
the fair value ofthe net assets was P 12,000 more than the carrying amount on
the partnership's books,ofwhich P7,000 was assigned to tangible assets and
P5,000 was assigned to goodwill.Jay and Kay were each issued P5,000 shares
of the corporation's PI par value common stock. Immediately following
incorporation,additional paid-in capital in excess ofpar should be credited for:
In 2009 the partnership suffered a net loss ofP36,000.But in 2010they earned
a net profit ofP132,000.The partners withdraw the maximum amount from the
partnership each year. On January 2,2011 a new partner,Cora was admitted in
the partnership for an investment ofP400,000for a40% interest. No revaluation
ofassets is to be recorded. After the admission ofCora,the partners agreed to
divide profits and losses,4:2:4,to Alma,Betty and Cora,respectively.
On January 2,2011,what is the entry to record the admission ofCora?
a.
Cash
Alma, Capital
Betty, Capital
P68,000
P70,000
€,
P77,000
P82,000
400,000
33,600
33,600
467,200
Cora, Capital
b. Cash
a.
b.
P480,000
240,000
The partners agree to allocate profits and losses as follows:
•
Reyes
143
400,000
400,000
Cora, Capital
c.
Cash
400,000
Alma, Capital
32,000
Betty, Capital
16,000
448,000
Cora, Capital
d. Cash
Cora, Capital
448,000
448,000
Chapter 3
144
Partnership Dissolution — Changes in Ownership Interest
3-24: In the early part of2011,the partners ofPete, Carlos,and Sammy went to a
local accountant seeking assistance. They had begun a new business in 2010 but
145
3-25: On August 1,2010, Maria and Ana formed a partnership. Maria contributed
inventory ofP500,000 with a fair value ofP300,000 while Ana contributed cash
ofP250,000 and a land that cost her P900,000 and a fair value ofP1,250,000.
had never used the services ofan accountant.
Pete and Carlos began the partnership by contributing P80,000 and P30,000 in
cash,respectively.Pete was to work occasionally at the business whereas Carlos
would be employed full time. They decided that year-end profits and losses
The partnership did not assume the mortgage attached to the property-worth
P250,000.
should be allocated as follows:
The partners agree to allocate profits and losses as follows:
Each partner was to be allocated 10 percent interest computed on the
beginning capital balances for the period.
A compensation allowance ofP5,000 was to go to Pete with a P20,000
1. Each partner shall received 5% interest on her beginning capital balance.
2. Maria will received a salary ofP8,000 per month for managing the business.
amount assigned to Carlos.
3. The remainder will be divided equally on the first year ofoperation and 60%
Any remaining income should be divided on a 4:6 basis to Pete and Carlos,
arid 40% on subsequent years.
respectively.
4. Maria and Ana is allowed to withdraw P5,000 per month. Any withdrawal
is treated as direct reduction"ofcapital.
In 2010,revenues totaled P90,000 with expenses reported as P64,000(not
including the compensation allowance assigned to the partners).Pete withdrew
cash ofP8,000 during the year while Carlos took out PI 1,000. In addition,
P5,000 for repairs made to Pete's home was paid by the business and charged
In 2010 the partnership has a net income ofP100,000. On July 1,2011,Paz
was admitted in the partnership byinvestingP800,000for a25%interest,goodwill
to repair expense.
is to be recorded.
On January 1,2011,a 20 percent interest in the partnership was sold to Sammy
for P43,000 cash. This money was contributed to the business with the bonus
After admission ofPaz,the partners agreed to divide profits, as follows:
method used for accounting purposes.
1. Each partnershall received 5%intereston the amountofher beginnmg capital.
Whatioumal entry should have been recorded by the partnership on January 1,
2. All partners will received a salary ofP2,000 per month.
3. The balance to be divided 45% to Maria,30% to Ana and 25% to Paz.
2011?
a.
b.
Sammy, Capital
32,000
Pete, Capital
Carlos, Capital
4,400
6,600
In 2011,the partnership earned a profit ofP300,000 evenly throughout the year.
43,000
How much is the capital balance ofMaria at December 31,2011 (rounded to
the nearest peso)?
32,000
4,400
6,600
Cash
Pete, Capital
Carlos, Capital
a. P707,623
b. P694,555
43,000
Sammy, Capital
d.
treated as a direct reduction ofcapital.
43,000
Cash
Sammy, Capital
c.
4. Each partner is allowed to withdraw P2,000 per month. Any withdrawal is
43,000
Cash
c. P670,653
d. P700,270
32,000
Cash
■i'- '
32,000
Sammy, Capital
Hi
I,,
,
, '-' V'
A-'
V "T
Partnership Dissolution - Changes in Ownership Interest
Chapter 3
146
No. 3-27 - Continued
3-26: Pedro and Mario have paitner capital balances,at book value,ofP450,000 and
P65,000 as ofDecember 31,2011.Pedro is allocated 60% ofprofits or losses,
and Mario is allocated the balance.The partners believe that tangible net assets
have a market value in excess ofbook value in the amount ofP30,000 net. The
The partnership agreement calls for the allocation ofprofits and losses as follows:
1. Salaries to A, B, and C of P30,000, P30,000, and P40,000, respectively.
P30,000 is allocated as follows:
Accounts receivable
Inventory
Warranty obligations
2.
Book Value
Market Value
PI20,000
200,000
20,000
PI02,000
258,000
30,000
147
Bonus to A of 10% of net income after the bonus.
3. Remaining amounts are allocated according to profit/loss percentages of 50%,
20%, and 30% for A, B, and C, respectively.
Unfortunately, the business finds itself in difficult times: annual profits remain flat
at approximately PI32,000, additional capital is needed to finance equipment
which is necessary to stay competitive.
They are considering admitting Wairen to the partnership in exchange for total
consideration ofP84,000 cash.In exchange for the consideration. Warren will
receive a 30% interest in capital and a 35% interest in profits.
Cora has identified Dina (D) as an individual who might be willing to acquire an
interest in the partnership. Dina is proposing to acquire a 30% interest in the
capital of the partnership and revised partnership agreement which calls for the
Ifthe goodwill suggested by the admission of Warren proved to be worthless,
allocation ofprofits as follows:
how much Wan en would be harmed?
a.
b.
c.
d.
1. Salaries to A, B, C, and D of P30,000, P30,000, P40,000, and P30,000,
P24,000
P20,000
P16,000
P28,000
respectively.
2. Bonus to D of P20,000 if net income exceeds P250,000.
10%, 30%, and 30% for A, B, C, and D, respectively.
3-27: Amor(A)Bea(B),and Cora(C)are partners in a small manufacturing firm
Assuming you are Bea's personal CPA, you have asked to provide your client
whose net assets are as follows:
Current assets
Non-current assets
Current liabilities
Non-current liabilities
A,capital
B,capital
C,capital
^
3. Remaining amounts are allocated according to profit/loss percentage of 30%,
with your opinion regarding the admission ofDina.
Book Value
Fair Value
P285,000
395,000
. 40,000
430,000
50,000
100,000
60,000
P210,000
320,000
40,000
434,000
Bea does not believe it would be worth to admit a new partner unless her allocahoii
.■•I
of income increased by a least P10,000 over that which existed under the origin
partnership agreement. What would the average annual profit of the new
partnership have to be in order for Bea to accept the idea of admitting a new
partner?
.M.
b.
c.
d.
PI40,000
PI20,000
P290,000
P2S0,000
148
Chapter 3
Partnership Dissolution - Changes in Ownership Interest
3-28: Using the data in 3-27,given the net assets ofthe original partnership, what is the
suggested purchase price that Dina should pay ofa 30% interestin the partnership?
a.
b.
c.
d.
3-30: Lina,Mina,and Nina are partners sharing profits on a 5:3:2 ratio and have the
following capital account balances: PI50,000, P90,000, and P60,000,
respectively. On January 1,2010, Olga was admitted into the partnership by
investing P40,000 with a 20% share in the profits. The old partners continue to
P24,000
P20,000
P42,000
P25,000
participate in profits proportionate to their original ratios.
For the year 2010,the partnership books showed a net profit ofP50,000. It
was disclosed,however that the following errors were made:
3-29: Andres and Berto are partners in an engineering consulting company sharing
profits and losses 40% and 60%,respectively, and their capital balances are
P110,000 and P150,000,respectively. The recorded net assets ofthe company
•
are as follows:
Working capital
Property and equipment- net
Noncurrent liabilities
Book Value
Fair Value
P240,000
80,000
. 60,000
P220,000
108,000
60,000
Unrecorded accrued expenses at year end
Inventoiy overstated
Unrecorded purchases, for which goods
Fair Value
P50,000
60,000
P40,000
50,000
P2,400
P6,200
3,000
1,800
On January 1,2011,Lina sold her interest to Mina for P100,000. After which
Mina,Nina and Olga agreed to share annual profits ofP300,000 equally among
themselves. During 2011,Mina withdrew P20,000; Nina withdrew P10,000
and Olga also withdrew P5,000.
At the end of2012,Mina decided to retire from the partnership and was paid
P425,360 cash. It was agreed that the inventory with a book value ofP50,000
would be adjusted to reflect their fair values ofP35,000 and that total goodwill is
to be recognized. Net income for the year was P195,000.
1. What is the share ofpartner Lina in the 2010 corrected net income?
In addition to the above recorded assets, Carlos feels that his business contracts
a.
b.
c.
d.
and expertise will add value to the existing partnership. Carlos has valued these
intangibles at P20,000.
If Carlos were to acquire a 30% interest in the new partnership, how much
additional cash would Carlos have to contribute to the partnership?
a.
b.
c.
d.
2010
4,000
Income received in advance not adjusted
Unused supplies not taken up at year end
Carlos is interested in merging his environmental consulting company with Andres
and Berto. Carlos' net assets to be conveyed to the partnership include the
following:
Book Value
2009
have been received and inventoried
In addition to the recorded assets,the partners feel that the company has goodwill
valued at P40,000 because the company enjoys a strong-client base and has
earnings that are consistently above industry average.
Working capital
Equipment-net
149
P12,220
P18,800
P19,220
P20,000
2. What is the capital balance ofMina on December 31,2010?
P22,000
P20,000
P25,000
P24,000
a.
b.
c.
d.
.
P101,280
P 92,880
P 88,932
P102,000
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Chapter 3
150
Partnership Dissolution - Changes in Ownership Interest
151
3-32: Maya and Rita have been partners for several years and critical values related to
their partnemhip are:
No. 3-30: Continued
3. What is the capital balance ofOlga on December 31,2011?
a.
b.
c.
d.
P151,920
P172,400
P169,110
PI73,000
Maya
Rita
Total
P80,000
PI00,000
PI80,000
Profit Allocation:
Annual salaries
Bonus on net income
Profit and loss percentages
Capital balances, December 31, 2007
4. What is the capital balance ofNina on December 31,2012?
20%
40%
P54,000
60%
P76,000
At fair value
a.
b.
c.
d.
PI 30,000
Net assets as of December 31, 2007:
P270,080
P211,920
P250,080
P249,600
PI60,000
In 2008,the partnership reported a net income ofP230,000,and each partner
received a P100,000 distribution at year-end. On January 1,2009,Hara was
3-31: Dama is considering investing in one ofseveral existing partnerships and is
attempting to consider the price to be paid for a partnership interest. In addition
to investing cash,Dama would be contributing equipment that has a fair value of
P50,000. The existing partnerships are characterized as follows;
admitted as a paitner by investing P70,000 for a 25% interest in capital. Goodwill
is recognized upon admission.Tlie profit sharing agreement was modified to also
include a salary ofP70,000 and a bonus of5% of net income for Hara. The
profit and loss percentages were also revised to 30%,45%,and 25% for Maya,
Rita,and Hara,respectively.
During 2009,the partnership recognized income ofP330,000 and distributed
Partnerships
AA
BB
CC
P80,000 to each partner during the year. On January 1,2010, Maya sold her
interest in the partnership to Rita for P200,000.The year 2010 was a transition
year for the partnership,and Rita and Hara agreed to share annual profits of
Total assets at:
Book value
Fair value(excluding goodwill)
Liabilities at book value and fair value
Interest to be acquired by new partner:
In capital
In profit and losses
P500,000
P600,000
P800,000
450,000
369,500
725,000
410,000
850,000
558,000
30%
25%
25%
25%
20%
20%
P200,000 equally between themselves. During 2010,Rita and Hara withdrew
P60,000 and P80,000,respectively,from the partnership.
Atthe beginning of2011,Rita decided to sell its interestin the partnersliip to the
partnership for P350,000. It was agreed that net assets with a book value of
P415,000 would be adjusted to reflect their fair value ofP405,000 and that the
sale would be recorded by the method whereby ohly goodwill traceable to Rita
What is the amount ofconsideration that Dama should have to convey in order
would be recognized.
to acquire an interest in each ofthe partnerships?
AA
P 34,500
b, P 84,500
a,
P105,929
d. P130,500
c,
BB
P105,000
P 20,000
PI25,000
P190,000
CC
P 73,000
P 23,000
P242,000
P292,000
Immediately after Rita's retirement, Perla purchased a 40% interest in the
partnership by contributing P75,000 cash.
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Chapter 3
152
Partnership Dissolution - Changes in Ownership Interest
153
No. 3-32 - Continued
PROBLEMS
Note that if net income is not sufficient to satisfy all provisions of the profit
agreement, the profit and loss percentages are to be used to absorb any
Problem 3-1
deficiencies.
1.
Red, White, and Blue are partners with a profit and loss ratio of 2:4:4 and credit capital
balances of P60,000, P80,000, and P60,000, respectively. Green is to be admitted
What is capital balance of Maya on December 31,2008?
into the partnership with an investment ofP75,000 for a 25 percent interest in the
a.
b.
c.
P 81,600
P157,850
P176,000
d.
P117,275
capital, profit, and losses of the firm.
Required:
a. Prepare journal entries to record the admission of Green, using:
1.
2. What is the capital balance of Rita on December 31,2009?
a.
b.
c.
Revaluation of assets
2. Bonus approach
b. Prepare journal entries to record the admission of Green if, instead of investing into
the partnership, he purchases his interest from the partners at the same P75,000,
P117,275
P296,625
P234,125
and:
d. P195,875
1. Implicit goodwill is to be recorded
2.
Bonus method is used
3. What is the capital balance of Kara on December 31,2010?
a.
P75,875
Bmno and Mario are partners with a profit and loss ratio of 6:2 and credit capital
balances of P200,000 and P300,000, respectively. Tomas is to be admitted into the
b. P95,875
c.
d.
P92,025
P78,575
partnership by investing P140,000 for a 20 percent interest in the capital, profits and
losses.
4. What is the total capital of the partnership after the admission of Perla?
Required:
a.
a. PI65,875
b. P187,500
c. PI25,500
d. P178,500
Prepare a schedule ofpartners' capital balances after the admission of Tomas, if:
1. Goodwill is not to be recorded.
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2.
3.
Goodwill is to be recorded.
Goodwill is to recorded and then written off.
-V-r
b. Prepare a schedule of partners' capital balances after the admission of Tomas.
Goodwill is to be recorded and then written off, but the new profit and loss ratio is
4:4:2 for Bruno Mario and Tomas instead of 6:2:2 as in (a) (3) above.
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Chapter 3
154
Partnership Dissolution — Changes in Ownership Interest
155
Problem 3-5: Continued
□li
Rodel and Jerry who share profits and losses in the ratio of 4:6 are partners in a
Required: For each of the following cases, prepare joumal entries to admit Cherry.
partnership with credit capital balances of P60,000 and P80,000, respectively. Barry is
to be admitted into the partnership for a 25 percent interest in the capital of the finn.
a. Cherry invests an amount of cash for a 25 percent interests in profits, losses, and
capital.
Required:
b. Cherry invests P50,000 for a 25 percent interest in the capital of the firm, and
a. Calculate the cash payment by Barry if, after the cash payment is recorded, the
c. Cherry invests P25,000 for a 25 percent interest in the capital of the firm, and
goodwill is not to be recorded.
capital balances of Rodel and Jerry are P76,000 and P104,000 and goodwill was
goodwill is not to be recorded.
d. Cherry invests P50,000 for a 25 percent interest in the capital of the firm, and
recorded.
goodwill is to be recorded.
b. Calculate the such payment by Barry if after the cash payment is recorded, the
capital balances of Rodel and Jerry are P52,000 and P68,000 and goodwill was
e. Cherry invests P25,000 for a 25 percent interest in the capital of the firm, and
goodwill is to be recorded.
not recorded.
ProbIein.3r6
The following condensed statement of financial position is presented for the partnership
of Diaz, Cruz, and Orbos, who share profits and losses in the ratio of4:3:3, respectively.
Gene and Nancy, partners in the G & N partnership have capital balances of P100,000
and P40,000 and share income in a ratio of4:1, respectively. Ellen is to be admitted into
the partnership with a 20 percent interest in the business.
Cash
Other assets
Required:
Record the admission of Brad for each of the following independent situations.
A
Total
P 40,000
710.000
P750,000
Accounts payable
Diaz, Capital
Cmz, Capital
Orbos, Capital
PI 50,000
260,000
180,000
160,000
Total
P750,000
a. Ellen invests P60,000, and goodwill is to be recorded.
b. Ellen invests P60,000. Total capital is to be P200,000.
Assume that the partnership decides to admit Santos as a new partner witha one-fourth
c. Ellen purchases the 20 percent interest by paying Gene P22,000 and Nancy
interest.
PI 1,000.
Required: For each of the following independent cases, determine the amount that
Ellen is assigned 20 percent of each Gene's and Nancy's capital accounts
Santos must contribute in cash or other assets.
d. Ellen invests P32,000. Total capital is to be PI72,000.
e. Ellen invests P32,000, and goodwill is to be recorded.
Problem 3-5
Helen and Cathy are partners with a profit and loss ratio of70:30. Their credit balance
capital accounts on January 2011 are P70,000 for Helen and P50,000 for Cathy. They
have agreed to admit Cherry as a new partner in their firm.
a. No goodwill or bonus is to be recorded.
I
b. Goodwill of P30,000 is to be recorded and allocated to the old partners.
c. A bonus of P24,000 is to be paid by Santos and allocated to old partners.
d. The old partners agree to give Santos P10,000 ofgoodwill upon admission into the
partnership.
e. The partners agree that total resulting capital should be P82,000 and no goodwill
should be recognized.
Chapter 3
156
Partnership Dissolution - Changes in Ownership Interest
157
Problem 3-9
Qli
Subas and Tony sell electronic equipment and supplies through their partnership. They
wish to expand their computer lines and decide to admit Noel to the partnership' Subas'
capital is PI00,000 Tony's capital is P80,000 and ttiey share income in a ratio of3:2.
Required:Record the admission ofNoel for each ofthe following independent situations:
a. Noel directly purchases halfofTony's investment in the partnership for P46,500.
The partnership ofAce, Jack, and Spade has been in business for 25 yeai"s. On December
31,2011. Spade decided to retire from the partnership. The partnership reported the
following capital balances for each partner at December 31,2011.
Ace, Capital
Jack, Capital
Spade, Capital
P150,000
200,000
120,000
b.^ Noel invests the amount needed to give him a one-third interest in the capital ofthe
partnership ifno goodwill or bonus is recorded.
c.
d.
e.
f
g-
The partners allocate partnership income and loss in the ratio 20:30:50.
Noel invests P56,000 for a one-fourth interest. Goodwill is to be recorded.
Subas and Tony agree that some ofthe inventory is obsolete. The inventory account
Required: Record the withdrawal of Spade under each of the following independent
is decreased before Noel is admitted Noel invests P52,000 for a one-fourtli interest.
situations.
Noel directly purchases a one-fourth interest by paying Subas P32,000 and Tony
P36,000.The land account is increased before Noel is admitted.
Noel invests P40,000 for a one-fifth interest in the total capital P220,000.
Noel invests P60,000 forpne-fifth interest. Goodwill is to be recorded.
;
a. Spade's capital interest was acquired for P150,000 by Jack in a personal transaction.
Partnership assets were not revalued, and partnership goodwill was not recognized.
b. Assume the same facts as in (a) above except that partnership goodwill applicable
to the entire business was recognized by the partnership.
c. Spade was given P180,000 of partnership cash upon retirement. Capital of the
Problem 3-8
In the ABC partnership. Andy's capital is P50,000.Benny's is P30,000 and Conny's is
P40,000.They share income in a 3:1:1 ratio. Conny is retiring from the partnership.
partnership after Spade's retirement was P290,000.
d. Spade was given P60,000 ofcash and partnership land with a fair value of P120,000.
The carrying amount of the land on the partnership books was P100,000. Capital
of the partnership after Spade's retirement was P310,000.
Required:Preparedjournal entries to record Conny's withdrawal according to each
ofthe following independent assumptions:
e. Spade was given P150,000 of partnership cash upon retirement. The portion of
goodwill attributable to Spade was recorded by the partnership.
f Assume the same facts as in (e) above except that partnership goodwill attributable
a. Conny's is paid P48,000,and no goodwill is recorded.
b. Conny's is paid P50,000,and only his share ofthe goodwill is recorded.
c. Conny's is paid P45,000,and implied goodwill is recorded.
to all the partners was recorded.
g. Due to limited cash in the partnership. Spade was given land with a fair value of
P100,000 and a note payable for P50,000. The carrying amount of the land on the
partnership books was P60,000. Capital of the partnersliip after Spade's retirement
wasP360,000.
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Chapter 3
158
Partnership Dissolution - Changes in Ownership Interest
159
Problem 3-11: Continued
On January 1,2011,Eddy decides to retire from the partnership ofCharly,Danny,and
Eddy who share profits and losses in the ratio of3:2:1 respectively, the following
condensed balance sheets presentthe account balances immediately before and,for six
independent cases,after Eddy's retirement.
The partnership contract provided the following agreement:
•
Santos will be credited annually with interest equal to 20 percent ofthe beginning
capital balance for the year.
•
Santos will also have added to his capital account 15 percent ofpartnership income
each year(without regard for tlie preceding interest figure)or P4,000,whichever is
greater. All remaining income is credited to Reyes.
Balances after Eddy's Retirement
Balances
prior to Eddy's
Accounts
Retirement
Assets:
P 90,000
200,000
10,000
Cash
Other Assets
Goodwill
Total Assets
P300,000
Case I
Case 3
Case 2
Case 4
Case 5
■ Case 6
capital balance for the year, wliichever is greater.
P 10,000
200,000
10,000
P 16,000
200,000
14,000
P 25,000
200,000
10,000
P 16,000 P 50,000
200,000
220,000
34,000
10,000
P 90,000
200,000
P220,000
P230,000
P235,000
P250,000
P300,000
P280,0q0
10,000
Liabilities and
Charly, Capital
Danny, Capital
Eddy, Capital
P 60,000
80,000
90,000
70,000
P 60,000
74,000
85,000
P 60,000
80,000
90,000
P 60,000
83,000
92,000
-0-
-0-
-0-
P300,000
P220,000
P230,000
P235,000
P 60,000 P 60,000
92,000
110,000
98,000
110,000
-0-
P 60,000
80,000
160,000
-0-
-0-
P250,000 P280,000
P300,000
Total Liabilities
and Capital
A net loss ofP10,000 is reported by the partnership during the first year ofits operation.
On January 1,2009,Paulo Cruz becomes a third partner in this business by contributing
PI5,000 cash to the partnership. Cmzreceives a 20 percent share ofthe business s
capital. The profit and loss agreement is altered as follows:
Capital
Liabilities
• Neither partner is allowed to withdraw funds from the partnership during 2008.
Tlierefore,they can each draw outP5,000 annually or 20 percent ofthe beginning
• Santos is still entitled to(1)interest on his beginning capital balance as well as(2)
the share ofpartnership incomejust specified.
• Any remaining profit or loss will be split on a 6:4 basis between Reyes and Cruz,
respectively.
Partnership income for 2009 is reported as P44,000.Each partner withdraws the full
Required:Prepare the necessaryjoumal entries to record Eddy's retirementfrom the
partnership for each ofthe six independent cases.
amount that is allowed.
On January 1,2010,Cmzfalls ill and sells his interest in the partnership(wiA the
consent ofthe other two partners)to Juan Diaz.Diaz pays P46,000 directly to Cruz.
Problem 3-11
Net income for 2010 is P61,000 with the partners again taking their full drawing
Jose Reyes is a wellknown lawyer in Manila.He wantsto start a business and convinces
Pedro Santos, a Certified Public Accountant, to contribute the capital to form a
partnership.On January 1,2008,Santos invests a building worth P52,000 and equipment
valued at PI6,000 as well as PI2,000 in cash. Although Reyes makes no tangible
contribution to the partnership,he will operate the business and be an equal partner in
the begirmmg capital balances.
allowance.
On January 1,2011,Diaz elects to withdraw from the business for personal reasons.
The partnership contract contains a provision stating that any partner may leave t le
partnership atany time and its entitled to receive cash in an amountequalto the recorded
capital balance at that time plus 10 percent.
Required:
a. Preparejoumal entries to record the preceding transactions on the assumption
thatthe bonus(or ho revaluation)method is used.Drawings need notberecorded,
although the balances should be included in the closing entries.
'c'
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Problem 3-12: Continued
Problem 3-11: Continued
;■
b.
161
Partnership Dissolution - Changes in Ownership Interest
Chapter 3
160
Preparejournal entries to record the previous transactions on the assumption
tliat the goodwill (or revaluation) method is used. Drawings need not be recorded,
although the balances should be included in the closing entries. (Round all
amounts off to the nearest peso)
Capital stock in the amount of P250,000 is to be issued in the ratio of4:3:3 for Jack, Jill
i,
and Jun. The partners are either to receive cash or to pay amounts of cash into the
partnership sufficient to bring their capital accounts into the ratio of 4:3:3 for a total
capital of P250,000. after any required revaluation of assets.
Required:
Problem 3-12
a. Prepare the j oumal entries to record the incorporation if the partnership books are
Jack, Jill and Jun are partners with a profit and loss ratio of 5:3:2. They decided to
incorporate as at January 1,2011. On that date the partnership's trial balance was as
to be continued.
b. Prepare the j oumal entry (entries) to record the incoiporation if the corporation is
follows:
to start a new set of books.
JJJ Partnership
Trial Balance
January 1,2011
Book values
Market Values
P 40,000
•26,000
34,000
P40,000
Aquino and Binay begin a partnership on January 1,2010. Aquino invests P40,000
cash and inventory costing PI 5,000 but with a current appraised value of only
PI2,000. Binay contributes equipment with a P40,000 book value and a P48,000
fair value. The partnership also accepts responsibility for a P10,000 note payable
Debits
Cash in Bank
Accounts Receivable (net of estimated uncollectibles)
Inventories
Land
20,000
Building
Equipment
50,000
80,000
Total
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owed in connection with this equipment.
26,000
60,000
60,000
70,000
60,000
The partners agree to begin operations with equal capital balances. The partnership
agreements also provide that at each year-end, profits and losses are allocated as
follows:
P250,000
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Credits
■
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,
Accounts Payable
monthly capital balance for the year.
P30,000
Loan Payable-Jill
:'
Jack - Capital
Jill-Capital
Jun —Capital
20,000
30,000 ,
40,000
60,000 ■
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to Binay.
.
business.
P250,000
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4. Each partner is allowed to withdraw P800 per month in cash from t e
• ' ' ■ -I '
50,000
Totals
It
3. Any remaining profit or loss is divided 60 percent to Aquino and 40 percen
20,000
.
' :■
of partnership income after subtracting the bonus.
2. Both partners are entitled to interest equal to 10 percent of the average
P 30,000
Accumulated Depreciation - Building
Accumulated Depreciation - Equipment
1. For managing the business, Aquino is credited with a bonus of 10 percent
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162
Chapter 3
Problem 3-13: Continued
(- ■
a
On October 1,2010,Aquino invested an additional PI2,000 cash in the business. For
2010,the partnership reported income ofP33,000.
Chapter 4
: VV"»-'
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Roxas,an employee,is allowed tojoin the partnership on January 1,2011. The new
partner invests P66,000 directly into the business for a one-third interest in the
partnerhsip.The revised partnership agreement still allows for both the bonus to Aquino
and the 10 percent interest, but all remaining profits and losses are now split40 percent
each to Aquino and Roxas With the remaining 20 percent to Binay.Roxas is also entitled
to P800 per month drawings.
Binay chooses to withdraw from the partnership afew years later. After negotiations,all
parties agree that Binay should be paid a P90,000 settlement. The capital balances on
that date were as follows:
Aquino
Binay
In this chapter, emphasis M'ill be placed on the accounting problems andprocedures
involved in the winding up (liquidation) of the partnership affairs — from the
dissolution to the effective termination ofpartnership operations. Vf'Lien the business
P800,000
78,000
72,000
Roxas
Liquidation of a partnership means winding up the business usually by selling the
assets, paying the liabilities, and distributing the remaining cash to the partners. A
business which is in the process ofconverting its assets into cash and making settlement
with creditors is said to be in liquidation. A term which is always used by a business
that is in the process ofliquidation is realization, which means the sale ofassets.
is to be liquidated, the accounts must be adjusted and closed, and the resulting
income or loss in the final period is transferred to the capital accounts of the
Required:
partners.
1. Assuming that this partnership uses the bonus method exclusively:
In the process ofpartnership liquidation, it often becomes necessary to examine
each partner'spersonal assets and liabilities in conjunction with his capital account.
a. Make all necessaryjournal entries. Entries for the monthly drawings ofthe
parmers are not required.
b. Prepare a Statement ofChanges in Partner's Equity forthe year ended December
31.2010.
A partner may have a deficiency in his personal assets, in his partnership capital
account, or in both. This chapter presents the concept that accountants must
know if they offer professional services to partnerships undergoing liquidation.
Accounting Problems in Partnership Liquidation
2. Assuming that this partnership uses the goodwill method exclusively:
a. Make all necessaryjournal entries. Again,entries for the monthly drawings are
The basic objectives of a partnership during the liquidation process are to convert the
partnership assets to cash (called realization ofassets), to pay offpartnership obligations
and to distribute cash and any unrealized assets to the individual partners. The purpose
not required.
b. Prepare a StatementofChanges in Partner's Equityfor the year ended December
of accounting during this period is to have an equitable distribution ofpartnership cash
to creditors and partners. Hence, it is no longer income determination that is the locus
of accounting but rather, the computation of gains or losses on realization of assets
which are to be subsequently allocated among tlie partners, the payment of liabilities m
31.2011.
accordance with law, and the final distribution of cash to the partners.
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164
Chapter 4
Partnership Liquidation
There are certain rules that should be followed in the liquidation ofthe partnership,
namely:
165
Methods ofPartnership Liquidation
When a partnership is to be liquidated by tlie sale ofassets,the following methods may
1. Always allocate and close gains or losses to the partners' capital accounts prior
to distributing any cash to the partners.
2. When the business is liquidated,the partner is entitled to an amount depending
upon his capital contribution, his drawing,his share in the net income or loss
from operations before liquidation,gains and losses on realization, and the
balance ofhis loan account,ifany.
be used:
-H
1. Lump-Sum Liquidation,otherwise called TotalLiquidation or Single Distribution.
2. Installment Liquidation,otherwise called Installment Distribution.
Lump-sum liquidations is discussed in detail in tills chapter while Installment liquidation
is taken in the next chapter. Chapter 5.
Each partner will receive in the final settlement the amountofhis equity in the business.
The amount ofa partner's equity is increased by the positive factors such as investment
of capital and share in the profits. It is decreased by the negative factors such as
withdrawals and share in tlie losses.Ifthe negative factors are greater than the positive
LUMP-SUM LIQUIDATION
A lump-sum liquidation ofa partnership is one in which all the assets are converted into
cash within a very short time,outside creditors are paid,and a single,lump-sum pajmient
factors,the partners will have a deficiency(debit balance)and he must pay tlie partnersliip
the amount ofsuch deficiency. Failure to do so would mean that his fellow partners
would bear more than their contractual share in losses and they will consequently receive
less than their equities in the business.
is made to the partners for their total interests.
As a general mle,the cash should be distributed as follows:
partnership's fixed assets may also be offered ata reduced price.The accounts receivab e
are usually collected by the partnership. Sometimes the partnership offers a large cas
discount for the prompt payment ofany remaining receivables whose collection may
otherwise delay the termination ofthe partnership. Alternatively,tlie receivables may e
1. First,to outside creditors.
2. Second,to partners for loan accounts.
3. Third,to partners for capital accoimts.
Realization ofAssets.Typically a partnership will experience losses on the sale ofits
assets. A partnership may have a"Going OutofBusiness"sale in which its inventoty is
marked down well below normal selling priee to encourage immediate sale. Tme
sold to a factor. A factor is a business Aatspecializes in aequiring accounts receiva es
and immediately paying cash to the seller ofthe reeeivables. The partnership reeor s
The rule indicating priority ofpartner's loan over partner's capital is supported by an
established legal doctrine called the right ofoffset. When a partner's capital account
shows a debit balance(or even a potential debit balance depending on possible losses)
and said partner has a loan account,the law permits the exercise ofthe right ofoffset by
part or all ofhis loan againstthe capital deficiency. As a result ofthe exercise oftlie right
ofoffset,paymentto some partners can be made on their capital balances even ifthere
the sale ofthe receivables,as it would any other asset.
are loans payable to the other partners.
such as legal and accounting expenses and advertising cost ofselling the assets. 1 lese
Before any distribution may be made to tlie partners,eitlier liabilities to outside
must be paid in full or the necessary funds may be placed in an escrow account,
escrow agent,usually a bank,uses tlie funds only for paymentofthe paitnereliip liabiii les.
Expenses ofLiquidation.During tlie liquidation process,expenses are usually incun ed,
expenses are alloeated to partners' eapital aecounts in their profit and loss ratio.
A debit balance in the partner's capital account may be caused by losses incurred in the
realization ofassets or by prorata absorption ofan uncollectible deficit ofa partner
whose combined capital and loan accoimts is not enough to absorb the partner's share
oftotal losses.
Liquidation Procedures.Thefollowing procedure may be used in lump-sum liquidation.
1. Realization ofassets and distribution ofgain or loss on realization among the
partners based on the profit and loss ratio.
Chapter 4
166
Partnership Liquidation
167
2. Paymentofexpenses
3. Paymentofliabilities
The following four cases illustrate the partnership liquidation concepts that are used
commonly. Each case begins with the April 27,2011, balances. The amount of cash
4. Elimination ofpartner's capital deficiencies. Ifafter the distribution ofloss on
realization,a partner incurs a capital deficiency(i.e.,partner's share ofrealization
loss exceeds his capital credit),this deficiency must be eliminated by using one
ofthe following methods,in the order ofpriority.
a. Ifthe deficient partner has a loan balance,exercise the right ofoffset.
b. Ifthe deficient partner is solvent, make him invest cash to eliminate his
deficiency.
c. Ifthe deficient partner is insolvent,letthe other partners absorb his deficiency.
5. Paymentto partners(in order ofpriority):
realized from the sale of the non-cash assets is different from each of the three cases,
a.
and the effects of the different realizations are shown in the statement of partnership
realization and liquidation presented for each case.
Case 1: Loss on Realization: Fully Absorbed by Partners' Capital Balances.
Assume that the Other Assets, P80,000, were realized at P60,000 thus resulting to the
total loss of P20,000. Hence, the distribution of cash to the partners does not present
any problem. A statement of liquidation (Illustration 4-1) to summarize the foregoing is
prepared as follows:
Loan accounts
b. Capital accounts
Illustration 4-1
DEF PARTNERSHIP
Illustration ofLump-Sum Liquidation
Statement of Liquidation
April 27, 2011
The following illustration will be used to present the lump-sum liquidation ofDEF
Partnership in which D,E,and F are partners. A condensed statement offinancial
position ofthe company on April 27,2011,the day the partners decide to liquidate the
business is presented below:
,
Assets
Cash
Others
Balances before liquidation P 20,000 P 80,000
Liabilities
P 28,000
D, Loan
P 2,000
D(40%)
Partners' Capitals
E(40%)
F(20%)
P 9,000
P 21,000
P 40,000
Realization of assets and
distribution of loss
DEF PAKENERSHIP
Statement ofFinancial Position
•Balances
April 27,2011
Payment of liabilities
Balances
Liabilities and Capital
Assets
Cash
Other Assets
P 20,000
80,000
P100,000
Payments to partners
P 28,000
2,000
9,000
21,000
40,000
Liabilities
D,loan
D,capital(40%)
E,capital(40%)
F,capital(20%)
Total Assets
-
Total Liabilities and Capital
PI00,000
Partner's drawing.
Partnership goodwill account
Receivable from partners.
Payable to partners.
(80,000)
(8,000)
80,000
(28,000)
-0-
28,000
(28,000)
52,000
P(52,000)
-0-
-0-
-0-
-0-
2,000
2,000
P(2,000)
,
D, Capital
E, Capital
F, Capital
36,000
36,000
13,000
P(13,000) P(36,000)
To record the sale of other assets and the division of loss
ofP20,000 among the partners using the P &L, ratio.
28,000
28,000
To record payment to outside creditors.
.■■r-
V- 47-' i
''f
V
13,000
80,000
Other Assets
Cash
'i?
1,000
P(1,000)
(4,000)
60,000
8,000
8,000
4,000
Cash
Liabilities
v
1,000
(8,000)
The joumal entries required to record the realization of assets and to complete the
liquidation appear below.
Note: Partners loan account is not close to partners capital account. But partner capital
balances before realization should be after closing the following account, if any;
a.
b.
c.
d.
60,000
til"
Chapter 4
168
D, Loan
2,000
1,000
13,000
36,000
D, Capital
E, capital
F, Capital
52,000
Cash
To record payment to partners equal to the amounts
reported in the partners'loan and capital accounts
Case 2: Loss on Realization Resulting Capital Deficiency to a Partner with a
Loan Account. Assume that the Other Assets were realized at P55,000 resulting to a
loss ofP25,000. After the distribution ofloss among the partners using the profit and
loss ratio,D's capital accountresults in a debit balance ofP1,000.To cancel his deficiency,
D has to exercise the right ofoffset by transferring PI,000 from his loan account to his
capital account. Tlie partners are still paid in the amounts equal to their outstanding loan
and capital balances.
Partnership Liquidation
169
Case 3:Loss on Realization Resulting Capital Deficiency to a Solvent Partner.
Assume that the Other Assets were sold for P49,500,thus,resulting to a loss ofP30,500
to be divided among the partners using the profit and Iqss ratio. After the distribution of
loss,D's capital account would result to a debit balance ofP3,200. Offsetting the entire
amount ofD's loan account against his capital account still leaves his capital account
with a debit balance ofPI,200. D has to invest additional cash to fully eliminate his
deficiency. The statement ofliquidation(Illustration 4-3)appears below.
Illustration 4-3
DEFPARTNERSHIP
Statement ofLiquidation
April 27,2011
Liabilities
D, Loan
Partners' Capital
D(40%)
E(40%)
F(20%)
P28,000
P2,000
P9,000
P21,000
P40,000
(12,200)
(12,200)
(6,100)
2,000
(3,200)
8,800
33,900
P2,000
(3,200)
8,800
33,900
(2,000)
2,000
-0-
(1,200)
8,800
33,900
8,800
(8,800)
33,900
(33,900)
Assets
Cash
Balances before liquidation
Others
P20,000
P80,000
49,500
(80,000)
69,500
(28,000)
-0-
41,500
-0-
Realization of assets and
A statement ofliquidation to summarize the foregoing is shown below:
distribution of loss
Balances
Illustration 4-2
Payment of liabilities
28,000
(28,000)
DEFPARTNERSHIP
Balances
Statement of Liquidation
April 27,2011
Liabilities
D, Loan
Partners' Capital
D(40%)
F(20%)
E(40%)
P28,000
P2,000
P9,000
P2l,000
P40,000
(10,000)
(10,000)
(5,000)
Assets
Cash
Balances before liquidation
-0-
Offset D's loan against his
capital deficiency
Others
P20,000
P80,000
55,000
(80,000)
Balances
Cash investment by D to
eliminate his capital
deficiency
41,500
-0-
-0-
1,200
1,200
Realization of assets and
distribution of loss
Balances
Payment of liabilities
Balances
75,000
-0-
28,000
(28,000)
2,000
(1,000)
1 1,000
35,000
-0-
-0-
2,000
(1,000)
1 1,000
35,000
(1,000)
1,000
1,000
(1,000)
-0-
11,000
(11,000)
35,000
(35,000)
(28,000
47,000
Offset D's loan against his
capital deficiency
Balances
Payments to partners
47,000
(47,000)
-0-
-0-
-0-
-0-
-0-
follows:
1,000
D, Capital
To record transfer ofD's loan to his capital account.
42,700
(42,700)
-0-
-0-
-0-
-0-
-0-'
-0-
The entry to record the investment ofD to eliminate his capital deficiency isCash
The entry to record the application ofD's loan to his capital deficiency would be as
D,Loan
Balances
Payments to partners
1,000
D, Capital
To record the additional investment ofD.
1,200
1,200
Case 4: Loss on Realization Resulting Capital Deficiency to an Insolvent
Partner. Let us assume that in the preceding case,partner D is personally insolvent and .
the PI,200 due from him is uncollectible. In this case, the PI,200 is to be
proportionately absorbed by E and F. E and F therefore incur additional loss. The
Statement ofLiquidation (Illustration 4-4)is completed by showing the write offof
D's debit balance as an additional loss to E and F.
Vr ■;>.
'■ ■ ' ■ ■
Chapter 4
170
800
400
1,200
To record the absorption ofD's deficiency by E and E .
Illustration. Assume that L, M and N, who share profits and loss equally, present the
following statement of financial position just prior to liquidation.
Deficiency absorbed is determined as follows;
E
F
:
:
4/6XPI,200
2/6xPl,200
171
tlie paitner or partners with capital deficiencies pay the required amounts, tlie partnership
will have enough cash to pay its liabilities in full. However, in accordance with law, the
creditors may demand payment from any partner regardless of whether his capital
account shows a debit balance (i.e., there is deficiency) or a credit balance. It should
be noted that in tenns of the relationship with creditors, the paitnership is not viewed as
a separate entity.
The entry to record the absoiption of D's deficiency by E and F is —
E, Capital
F, Capital
D, Capital
Partnership Liquidation
= P 800
=
400
L,MandN
■
'
Statement of Financial Position
PE200
March 31,2011
Liabilities and Capital
Assets
Illustration 4-4
DEF PARTNERSHIP
Statement of Liquidation
April 27, 2011
Liabilities
D, Loan
Partners' Capital
E(40%)
D(40%)
F(20%)
P28,000
P2,000
P9,000
P21,000
P40,000
(12,200)
(12,200)
(6,100)
Assets
Cash
Balances before liquidation
Other Assets
P 8,000
42,000
Total Assets
P50,000
Cash
Others
P2'0.000
P80,000
49,500
(80,000)
69,500
(28,000)
-0-
28s000
(28,000)
2,000
(3,200)
8,800
33,900
41,500
-0-
-0-
P2,000
(3,200)
8,800
33,900
(2,000)
2,000
-0-
(1,200)
8,800
33,900
1,200
(800)
(400)
8,000
(8,800)
33,500
(33,500)
L, capital
M, capital
N, capital
P33,000
9,000
5,000
3,000
Total Liabilities and Capital
P50,000
Liabilities
Realization of assets and
distribution of loss
Balances
Payment of liabilities
Balances
Offset D's loan against his
capital deficiency •
Balances
41,500
-0-
-0-
Balances
Payments to partners
'
41,500 ■
(41,500)
-0-
-0-
-0-
-0-
-0-
--0-
-0-
-0-
resulted in a loss ofP22,500 to be divided equally among the partners. The total cash of
P27,500 is paid to the creditors, leaving an unpaid amount of P5,500 (P33,000 -
P27,500). After the distribution of the P22,500 loss, partners M and N have capital
deficiencies of P2,500 and P4,500, respectively. If M and N pay the amount of their
Additional loss to E and F,
4:2
The Other Assets with a carrying value of P42,000 are sold for P19,500 cash, which
Partnership is Insolvent but Partners are Personally Solvent
If the partnership is insolvent, which means that the available cash is insufficient to pay
creditors, at least one, or perhaps, all of the partners will have deficiencies in their
capital. In any event, the total amount ofdeficiencies will exceed the unpaid liabilities. If
deficiencies totaling P7,000, the partnership will use the said amount to pay the remaining
liabilities ofP5,500 and give PI,500 to L in settlement of his equity. These transactions
are presented in the statement of liquidation in the next page (Illustration 4-5).
Chapter 4
172
Partnership Liquidation
173
Illustration. Assume that A,B and C,who share profits and losses equally,have the
followingstateinent offinancial positionjust prior to liquidation.
Illustration 4-5
L,MandN
StatementofLiquidation
March 31,2011
AjBandC
Statement ofFinancial Position
Partners Capitals
L(l/3)
M(l/3)
N(l/3)
Assets
Balances before liquidation
Cash
Others
Liabilities
P 8,000
P42,000
P33,000
19,500
(42,000)
P 9,000
P5,000
P3,000
(7,500)
(7.500)
(7,500)
April 30,2011
Liabilities and Capital
Assets
Realization of assets and
distribution of loss
Balances
Partial Payment of liabilities
Balances
Cash investment by M and N
Balances
Full payment of liabilities
Balances
Payment to partner
27,500
-0-
(27,500)
-0-
33,000
1,500
(2,500)
(4,500)
1,500
(2,500)
2,500
(4,500)
4,500
P 10,000
100,000
Total Assets
PI 10,000
(27,500)
-0-
5,500
P
7,000
7,000,
Other Assets
Cash
-0-
(5,500)
1,500
-0-
P(l,500)
-0-
5,500
(5,500)
1,500
-0-
-0-
11o0
11
1,500
-0-
-0-
P(l,500)
-0-
-0-
P 60,000
5,000
15,000
30,000
Total Liabilities and Capital
PI 10,000
Liabilities
The personal assets and liabilities ofthe partners on this date apaitfrom their equities in
the partnership are:
Partners
Partnership is Insolvent and Partners are Personally Insolvent
A
B
In the preceding illustration, we assumed that the partners were personally solvent and
therefore,able to pay their capital deficiencies. We shall now consider the case wherein
one or more ofthe partners are insolvent. The situation raises a question as to the
relative rights oftwo groups ofcreditors, namely(1)the creditors ofthe partnership,
and(2)the personal creditors ofthe partners. The relative rights ofthese two groups of
creditors are governed by the Partnership Law which provides that the assets ofthe
partnership are first available to creditors ofthe partnership,and that the personal assets
ofthe partners are first available to his personal creditors. If after the debts ofthe
partnership have been paid in full and some assets still remain in the partnership,the
creditors ofa partner have a claim against the assets ofthe partnership only to the extent
ofhis share.
A,capital
B,capital
C,capital
^
After the personal creditors ofa partner have been paid in full from his personal assets,
any remaining assetis available to partnership creditors regardless ofwhether the partner's
capital account shows a credit or a debit balance. The claims of creditors of the
partnership on the separate property ofa partner are permitted only when these creditors
are unable to obtain payment from the partnership.
C
Personal Assets
PI00,000
50,000
5,000
Personal Liabilities
P25,000
50,000
60,000
Other Assets were sold for P40,000 resulting to a loss ofP60,000. The total cash of
P50,000 is used to pay creditors,after which an unpaid amount ofP10,000 still exists.
The statement ofliquidation showing how the P10,000 impaid liabilities will be paid is
shown in the next page.
■ .V"
'vf
Partnership Liquidation
Chapter 4
-/74
Illustration 4-6
175
MULTIPLE CHOICES - THEORETICAL
A,B and C
Statement ofLiquidation
April 30,2011
1. When is a partnership legally insolvent? Assets
Balances before liquidation
Cash
Others
Liabilities
A(l/3)
P 10,000
P100,000
P60,000
P 5,000
Partners Capitals
B(l/3)
C(l/3)
P15,000
Balances
Partial Payment of liabilities
40,000
(100,000)
50,500
-0-
(50,000)
Balances
-0-
Additional investment by A
(20,000)
(20,000)
(15,000)
(5,000)
10,000
15,000
Balances
-0-
5,000
10,000 (PI 5,000)
(5,000)
10,000
10,000
-0-
5,000
Additional investment by A
2,500
Balances
Payment to partner
When the assets of the partnership plus the assets of all the partners are
2. In which order are partnership assets distributed to partners under tlie Partnership
Law?
-0- .
(5,000)
PI 0,000
a.
(10,000)
-0-
-0-
Additional loss to A and C
Balances
d.
insufficient to meet the partnership plus tlie individual partners' liabilities.
15,000
(10,000)
Balances
and at least one partner is personally insolvent.
When all the partners are personally insolvent.
(50,000)
15,000
Full payment of liabilities
c.
P30,000
(20,000)
60,000
When the partnership assets are insufficient to meet partnership liabilities.
When the partnership assets are insufficient to meet the partnership liabilities
a.
Realization of assets and
distribution of loss
b.
Capital balances, loans, profits.
b. ' Loans, profits, capital balances.
-0-
(5,000)
(2,500)
5,000
PIO.OOO
(2,500)
-0-
-0-
(2,500)
2,500
-0-
7,500
7,500
-0-
-0-
-0-
-0-
7,500
P(7,500)
-0-
-0-
-0-
-0-
c. Loans, capital balances, profits.
d. Profits, capital balances, loans.
3. In a partnership liquidation the realization losses result in a debit balance in one
partners' capital account. If this partner fails to contribute personal assets to make
up this deficit, how should the debit balance be handled by the partners?
P(7,500)
' i fi
Explanation oftransaction numbers 1 to 4:
1. Inasmuch as A is solvent,he can eliminate his capital deficiency by investing cash
for an amount equal to such.
2. B is personally insolvent so the solvent partners,A and C,will incur proportionate
additional losses to eliminate B's capital deficiency.
a.
It should be written off against partnership profits like any other bad debt.
b.
It should be allocated to all the partners in their profit and loss ratio.
c.
It should be allocated to the remaining partners in their remaining profit and
d.
It should be set up as a receivable and turned over to a collection agency.
loss ratio.
4. What is the rule of offset?
3. A is still personally solvent so he can afford to again invest cash to eliminate his
a.
capital deficiency.
4. The amount paid to C may have to be used to pay his personal creditors inasmuch
b.
as he is personally insolvent.
Receivables from partners should offset against their debit capital balances
before they receive any cash distributions.
Loans to partners should offset against their debit capital balances before they
receive any cash distributions.
c.
Loans from partners should offset against their credit capital balances before
they receive any cash distributions.
d.
I
■•'■Ah
,.yi'
Loans from partners should offset against their debit capital balances before
they receive any cash distributions.
/
.
Chapter 4
176
5. Ifa partnership is liquidated,how is the final allocation ofbusiness assets made to
the partners?
Partnership Liquidation
177
9. In the liquidation of a partnership, a loan payable to a partner."
a.
May offset against that partners' capital account balance before liquidation
commences.
,
b. Will not advance the time ofpayment to that partner during the liquidation.
c. Has tlie same priority as amounts payable to outside creditors ofthe partnership.
d. Must be closed to that partners' drawing account.
a. Equally.
b. According to the profit and loss ratio.
0. According to the final capital account balances,
d. According to the initial investment made by each ofthe partners.
6. Which ofthe following statements is tme concerning the accounting that is made
for a partnership going through liquidation?
a. Gains and losses are reported directly as increases and decreases in the
appropriate capital account.
b. A separate income statement is created just to measure the profit or loss
generated during liquidation.
c. Since gains and losses rarely occur during liquidation,no special accounting
treatment is warranted.
10. If cash payments to partners of a partnership in liquidation are delayed until all
noncash assets have been realized, any cash remaining after all partnership creditors
have been paid is distributed.
• a. According to the liquidator's best judgement.
b. In the ratio for sharing net income and losses.
c. In amounts equal to the partners' loan and capital account balances.
d.
In some other manner.
Data for Questions 11 and 12
d. Within a liquidation,all gains and losses are divided equally among the partners.
Partnership
Capital
7. .During a liquidation,a partners' capital account balance drops below zero. What
Balance
should happen?
p
F
a. The other partners should file a legal suit against the partner with the deficit
R
balance.
S
b. The partner with the highest capital balance should contribute sufficient assets
to eliminate the deficit.
c. The deficit balance should be removed from the accounting records with only
the remaining partners sharing in future gains and losses.
d. The partner with a deficit should contribute enough assets to offset the deficit
■
P, F, R, and S are partners sharing profits and losses equally. The partnership is insolvent
and is to be liquidated. The status of the partnership and each partner is as follows:
Personal Assets
Personal Liaabilities
(exclusive of
partnership interest)
(exclusive of
partnership interest)
P30,000
20,000
(40,000)
(60,000)
P200,000
60,000
160,000
2,000
P80,000
120,000
10,000
56,000
11. The partnership creditors:
a. Must seek recovery against R because she is personally solvent and has a
negative capital balance.
b. Will not be paid in full regardless of how they proceed legally because the
partnership assets are less than the partnership liabilities.
balance.
c. Will have to share F's interest in the partnership on a pro rata basis with F s
8. IfJuan,a partner with a loan receivable from a liquidating partnership,receives
less cash than the amountofthe loan during the liquidation,the paymentis recorded
personal creditors.
d. Have first claim to the partnership assets before any partner's personal creditors
have rights to the partnership assets.
with a debit to;
12. The partnership creditors may obtain recovery of their claims:
a.
a. Loan Receivable from Juan.
b. Juan capital.
c. Juan drawing.
d. Loan Payable to Juan.
•
!.
'
■-
'
In the amount of P12,500 from each partner.
b. From the personal assets of either P or F.
c. From the personal assets ofeitherR or S.
d. From the personal assets of either P or R for all or some of their claims.
r, ,■
Chapter 4
178
4-3:
MULTIPLE CHOICES-COMPUTATIONAL
4-1:
If the non-cash assets are sold for PI00,000 and the liabilities are paid, the
remaining cash should be distributed to the partners as follows:
Ping
Pang
P20,000
P26,000
P42,000
PS0,000
P40,000
P
P42,000
P 2,000
PI4,000
PS0,000
PI4,000
PI0,000
The statement offinancial position ofthe GolfPartnership,just before liquidation,
a.
is as follows;
b.
Cash
Non-cash Assets
P20,000
50,000
P24,000
20,000
16,000
10,000
Total
P70,000
Liabilities
P70,000
Total
Par, capital(50%)
Boogie,capital(30%)
Birdie,capital(20%)
179
Partnership Liquidation
c.
d.
1 1
cash should be distributed as follows:
Ping
follows: •
Par
a.
P
b.
P 2,000
P 3,000
PI5,000
c.
d.
0
Boogie
Birdie
P4,000
P2,000
P1,800
P9,000
P2,000
P2,000
Pl,200
P6,000
0
4-4: Ifthe noncash assets are sold for P70,000 and the liabilities are paid,the remaining
Pong
Pang
P35,000
P3S,200
P 8,000
P 8,000
P S,000
b. P S,600
c.
P 8,000
d. P24,000
a.
The non-cash assets are sold for P10,000 net ofliquidation expenses and the
liabilities are paid. The remaining cash should be distributed to the partners as
Pong
P
P
P
0
0
0
P8,000
4-5: The following statement offinancial position is presented for the partnership of
Colt, Mark,and Clock,who share profits and losses in the ratio of4:3:3.
Assets
Colt,loan
P 90,000
830,000
20,000
Total assets
P940,000
Cash
Other assets
Use the following information for items 4-2,4-3,and 4-4.
The statement offinancial position ofthe PPP partnership,just before liquidation,
is as follows:
Cash
Non-cash Assets
P 40,000
140,000
Total
PI 80,000
Ping,capital(60%)
Pang, capital(20%)
Pong,capital(20%)
P 70,000
50,000
50,000
10,000
Total
PI80,000
Liabilities
4-2: Ifnoncash assets are sold for P150,000 and the liabilities are paid,the remaining
cash should be distributed to the partners as follows:
Ping
P44,000
b. PS0,000
c.
P56,000
d. P72,000
a.
Pang
P48,000
PS0,000
PS2,000
P24,000
Liability and Capital
Accounts payable
Clock,loan
Colt,capital
Mark,capital
Clock,capital
P210,000
30,000
310,000
200,000
190,000
Total liabilities and capital
P940,000
Assume the partners decide to liquidate the partnership. Ifthe other assetsare
sold for P700,000, how much ofthe available cash should be distributed to
Pong
P 8,000
Colt?
PI0,000
PI2,000
P24,000
a.
b.
c.
d.
P230,000
P238,000
P258,000
P310,000
Chapter 4
180
Partnership Liquidation
4-6; The statementoffinancial position for the partnership ofJonas,Carlos,and Tomas,
whose shares ofprofits and losses are 40,50,and 10 percent,is as follows:
Inventory
P 50,000
360,000
Accounts payable
Jonas,capital
Carlos,capital
Tomas,capital
PI50,000
160,000
45,000
55,000
Total assets
P410,000
Total liabilities and equities
P410,000
Cash
4-8:
Nory and Oscar started a partnership some years ago and managed to operate
profitably for several years. Recently,however,they lost a substantial legal suit
and incurred unexpected losses on accounts receivable and inventories. As a
result, they decided to liquidate. They sold all assets and only PI8,000 was
available to pay liabilities, which amounted to P33,000. Their capital account
balances before the state ofliquidation and their profit sharing ratios are shown
below:
,
Ifthe inventory is sold for P300,000,how much should Jonas receive upon
liquidation ofthe partnership?
a.
b.
c.
d.
P23,000
P13,500
60%
40%
Oscar
cash should Nory receive?
\
c. PI,700
d. P7,000
4-9:
PI00,000
300,000
Liabilities
Ariel,capital
Bert, capital
Cesar, capital
P400,000
PI50,000
40,000
180,000
On December31,2011,the accounting records ofthe Colors Paitnership included
the following information:
Black, drawing (debit balance)
White, drawing(debit balance)
30,000
Green,loan
P400,000
Total
0
b. P7,100
4-7: The following condensed statement offinancial position is presented for the
partnership ofAriel,Bert,and Cesar,who share profits and losses in the ratio of
4:3:3,respectively:
Total
Profits-sharing ratio
Nory
a. P
Other assets
Capital account balances
Nory is personally insolvent after paying the unpaid creditors, but Oscar has
personal assets in excess ofPI00,000.In the settlement ofpartners,how much
P 48,000
P100,000
P136,000
P160,000
Cash
181
Black,capital
White,capital
Green,capital
The partners agreed to liquidate the partnership after selling the other assets for
P200,000. Upon liquidation ofthe partnership,Ariel should have received?
a.
P
' 24,000
9,000
30,000
123,000
100,500
108,000
Total assets amounted to P478,500,including P52,500cash,and liabilities totaled
P150,000.The partnership was liquidated on December 31,2011,and White
0
received P83,250 cash pursuant to the liquidation. Black, White,and Green
b. P40,000
c, P60,000
d, P70,000
,
V
share net income and losses in a 5:3:2 ratio respectively. How much should
Black and Green receive upon liquidation ofthe partnership?
■ .A.
a.
b.
c.
d.
P59,625 and PI06,875, respectively.
P59,000 and P106,000, respectively.
P85,250 and P132,500, respectively.
P85,250 and P132,500, respectively.
Chapter 4
182
4-10: Following is the statement offinancial position for the Ana,Eva, and Nora
Partnership on June 4,2011:
Partnership Liquidation
183
4-12: On June 11,2011, Moly,Nora,and Olga form a partnership investing cash of
PI5,000,PI3,500,and P4,200 respectively. The partners share profits 3:2:2
and on August 30, 2008, they have cash of PI,000, and other assets of
P
Cash
Other assets
6,000
94,000
•
PI00,000
Total
Ana,capital
Eva,capital
Nora,capital
P 20,000
4,000
27,000
39,000
10,000
P47,500; liabilities are P25,600.On this date they decide to go out ofbusiness
and sell all the assets for P30,000. Olga has personal assets ofP1,500 that may,
Total
PI00,000
a. P4,000
b. P2,040
c. P4,860
Liabilities
Eva,loan
if necessaiy, be used to meet partnership obligations. How much should be
distributed to Nora upon liquidation ofthe partnership?
The partners share net income and losses as follows: Ana,40%;Eva,40%;and
d. P
0
Nora,20%.On June 4,2008,other assets were sold for P30,700,and P20,500
had to be paid to hquidate the liabilities because ofunrecorded claims amounting
to P500. Ana and Eva are personally solvent, but Nora's personal liabilities
exceed personal assets by P6,000. How much cash should be distributed to
partners?
4-13: The RST Partnership is in the process ofliquidation. The account balances prior
to liquidation are given below:
Credits
Debits
Ana
Eva
a.
Pl,480
b.
c.
100
100
d.
1,480
PI7,480
16,100
16,100
16,100
Nora
P
0
Cash
Rita, drawing
Sara, drawing
Tita, drawing
Operating loss
2,760
0
0
4-11: The accounts ofAries,Leo,and Taurus,who share profits in a 5:3:2 ratio,are as
Loss on realization
P72,000
10,000
15,000
20,000
21,000
12,000
P40,000
8,000
25,000
49,000
18,000
10,000
Liabilities
Sara,loan
Tita, loan
Rita, capital
Sara, capital
Tita, capital
follows on December 31,2011:
The partners share profits in the following ratio: Rita, 1/6; Sara,2/6; and Tita,3/
Aries, drawing (Dr.)
Taurus, drawing (Cr.)
Receivable from Aries (Dr.)
Leo,loan
Aries, capital
Leo,capital
Taurus,capital
P10,000
4,000
6,000
12,000
49,500
37,000
32,500
6.Upon liquidation ofthe partnership,Rita should have received:
a. P
.
0
^
b. P32,000
c. P33,500
d. P35,500
4-14: Following is the statement offinancial position ofthe CPA Partnership before
Total assets amount to P 176,000,including P53,500 cash. The partnership is
realization ofassets on July 1,2011:
liquidated and Taurus ultimately receives P27,500 as his share ofcash in final
distribution. How much did Aries and Leo receives?
Aries
PI1,000
10,500
c.
12,000
d.
11,000
a.
b.
Leo
P35,000
34,500
35,500
35,500
Equipment
P 10,000
50,000
30,000
60,000
Carlo, capital
Pedro, capital
Andro,capital
P 28,000
45,000
27,000
50,000
Total
PI50,000
Total
Pf50,000
Cash
Accounts receivable
Inventory
Liabilities
■'
Chapter 4
184
No. 4-14: Continued
Pedro?
185
From January 1,2011 to July 31,2011 the partnership's net loss is PI0,000. On
July 31,2011 before realization the balance of cash is P50,000 and that of
liabilities is PI00,000.For FF to receive P80,000 in the settlement ofhis interest
upon liquidation,the non-cash assets must be sold for:
a.
b.
c.
d.
a. P 3,000
b. P21,000
c. P38,000
P
Partnership Liquidation
No. 4-16: Continued
The partners share income 40:40:20,respectively. On July 2,the partnership is
liquidated.60% ofthe receivables are collected and that inventory is sold for
P20,000. Equipment is sold for P30,000. How much is to be distributed to
d.
j
0
4-15: Mona and Liza are partners with capital balances,loan balances and profit and
P260,000
P250,000
P270,000
P200,000
4-17: CC,DD,and EE are partners sharing profits and losses in the ratio of5:3:2.
During the year their investments and withdrawals are as follows:
loss ratio as follows:
Capital
Loan
Profit and Loss
Balances
Balances
Ratio
CC
DD
P24,500
15,500
Mona
Lisa
P4,000
60%
3,500
40%
amounts to P37,500.In the settlement ofpartners,Mona and Lisa should receive:
Lisa
a.
P22,500
b.
P 1,500
P 5,400
P2S,500
PI5,000
P 1,000
P 3,600
P19,000
c.
d.
Withdrawals
P40,000
35,000
P25,000
12,500
12,500
75,000
EE
The partners decide to liquidate the partnership.The firm's liabilities amounted
to P36,000 including partners loan. After realization ofassets,cash on hand
Mona
Investment
On December 31,2011,the partners decided to liquidate the business. After
exhausting partnership assets, liabilities ofP25,000 remain unpaid. CC is
personally insolvent.The gain(loss)on realization and the amountofcash EE will
receive upon liquidation are:
a.
b.
c.
d.
(P25,000), and P37,500, respectively.
(P25,000), and PIS,500, respectively.
(P125,000), andP37,500, respectively.
(P125,000), and PI8,500, respectively.
4-18: AA,BB,CC,andDD are partners sharing profits in the ratio of3/21,4/21,6/
21,and 8/21. Their capital balances on December 31,2011 are as follows:
4'16: FF,GG,and HH decided to liquidate their partnership on July 31,2011. Their
AA
capital balances and profit and loss ratio are as follows:
BB
Capital
FF
GG
HH
CC
Profit and Loss
DD
P
500
12,500
12,500
4,500
Balances
Ratio
P100,000
120,000
40,000
40%
The partners decide to liquidate their firm and they accordingly convert the
30%
noncash assets into P11,600 cash. After paying liabilities ofP1,500,they have
P11,100 to divide. What is thq gain(loss)on realization?
30%
.f
r^-lj''.i;"
■ ■ ■"■':.o'' ' if''
Chapter 4
186
No. 4a18: Continued
a. (Pll,250)
.
n
-■
t.
.
Partnership Liquidation
No. 4-20: Continued
a.
b. P18,900
c. (P18,400)
d. (P18,900)
b.
c.
d.
LL
MM
NN
P & L Ratio
P50,000
20,000
10,000
60%
20%
20%
P250,000
P280,000
P200,000
P220,000
4-21: NN, OO, and PP form a partnership on July 1,2010 each investing cash of
P25,000. On August 1, 2010, NN was advanced PI0,000 by the firm. On
September 1, 2010, 00 made a P20,000 loan to the firm. Interest is to be
charged on advances to partners and credited on loans by partners at the rate of
6 percent. Business is unsatisfactory and the partners decide to liquidate the firm.
PP is allowed special compensation ofP2,500 for managing the sale of assets
4-19: LL, MM, and NN are partners with investments and profit and loss ratios of:
Investment
187
and settlement with creditors. On December 31,2010, all assets have been
sold, outside creditors have been paid, and cash of P35,000 is distributed to
partners. All partners are personally solvent and fmal settlement is made among
LL, as the managing partner is to be allowed a salary of P600 each month. After
eight months of operation, the partners decide to terminate the business. After
the sale of partnership assets and payments to creditors, cash of PI 0,000 is
available for distribution to the partners. No salary has yet been paid to LL. All
partners on Febmary 10,2011. In Ae final settlement:
a. NN should pay OO and PP, PI,400 each.
b. OO and PP should pay NN, P2,800 each.
c. OO should pay NN and PP, P2,800 each.
d. NN should pay 00, Pl,400.
partners are personally solvent. How much would each partner receive?
a.
b.
c.
d.
LL
MM
NN
P5,000
P9,900
P6,200
P9,920
P5,000
P5,040
P3,800
PS,040
PO
4-22: PG, JR and AJ are partners with capital balances and profit and loss ratio as
PO
PO
PO
follows:
4-20: JJ, KK, and LL, each ofwhom had personal assets well in excess oftheir personal
liabilities, decided to liquidate their partnership on June 30,2011. On this date,
PG
JR
the capital, drawing and loan account balances are as follows:
Capital
JJ
KK
LL
P70,000 .
60,000
30,000
AJ
Loans
Drawings
P30,000
PI0,000 (Cr.)
10,000 (Dr.)
10,000
■
—
The partners shares profits and losses equally. Liabilities of the partnership on
June 30,2011, exclusive ofpartners' loan were equal to 50 percent of the book
value of the assets. All the partners agreed that the assets of the partnership had
To be realized for an amount sufficient to give KK PI0,000 cash. How much
cash is to be realized from the sale of non-cash assets?
,|
Capital Balances
Profit and Loss Ratio
P350,000
250,000
350,000
20%
30%
50%
Partners agree to dissolve the business and upon liquidation, aU ofthe partnership
assets are sold and sufficient cash is realized to pay all the claims except one for
P50,000. AJ is personally insolvent, but the other two partners are able to meet
any indebtedness to the firm. On the partnership claim against the partnership,
how much should PG and JR absorb?
a.
b.
c.
d.
PG
JR
P40,000
P30,000
PI 5,000
P35,000
P10,000
P20,000
P35,000
PI 5,000
: ^.^^7 ■
Chapter 4
188
4-23; RM and ST shai-e profits 40:60,respectively. After reali2ation ofall firm assets,
ledger accounts show the following balances.
Cash
Receivable from ST
Loss on realization
P 100,000
75,000
1,225,000
Salary payable to RM
RM,capital
ST,capital
P25,000
475,000
900,000
Partnership Liquidation
189
4-25: The partners ofAG,BM,CP,and DJ who share profits and losses at 30:30:20:20,
respectively,decided to liquidate the partnership. All partnership assets are to be
converted into cash.Prior to the liquidation,the condensed statement offinancial
position is as follows:
P 100,000
1,800,000
Cash
Other assets
Both partners are personally insolventand unable to contribute to the partnership.
How would the P100,000 cash be distributed to the partners?
a.
b.
c.
d.
RM
ST
P10,000
P15,000
P40,000
P90,000
P90,000
P85,000
P60,000
P10,000
PI,900,000
Total
AG,capital
BM,capital
CP,capital
DJ,capital
P 750,000
60,000
50,000
420,000
315,000
205,000
100,000
Total
PI,900,000
Liabilities
BM,loan
DJ,loan
The other assets realize P806,000. All partners are solvent and can contribute
any additional cash to cover any deficiency. In the process of liquidation,
4-24: On January 3,2011LT,AM,ZP formed a partnership,agreeing to divide profits
2:1:1,respectively. On July 31,2011,with operations going unfavorable,the
partners decided to dissolved the firm.The following data are available.
deficiency(ies) will occur and will require additional investment as follows:
a. CP at P7,500.
b. DJ and CPfor P50,000 and P7,500, respectively.
c. DJ at P50,000.
LT
Capital contributions
Drawings (Dr.)
Net loss,July 31,2008,P30,000
AM
P50,000
15,000
15,000
P22",500
10,000
7,500
ZP
P20,000
10,000
7,500
After realization the net asset ofthe firm is valued atP65,000.In the settlement
to partners,how much should be paid to the partners?
a.
b.
c.
d.
LT
AM
ZP
P38,750
P50,000
P38,750
P 6,250
P14,375
P20,000
P20,000
Pll,875
PI7,750
Pll,875
P
P
0
0
d.
None.
4-26: On December 31,2011,the accounting records ofUy,Vi and Wi Partnership
included the following ledger account balances:
Receivable from Uy
Loan to Wi
Salary payable to Vi
P132,000
40,500
135,000
Uy,Capital
Vi, Capital
Wi,Capital
P553,500
452,500
486,000
Total assets includes cash amounting to P234,500.The partnership was liquidated
on December 31, 2011, and Uy received P351,500 cash pursuant to the
liquidation.Uy,Vi and Wishared netincome and losses in a 5:3:2 ratio,respectively.
In the settlement to partners, how much cash is paid to Vi?
a. P545,500
b. P587,500
c.
P
0
d. P542,000
..m.
Chapter 4
190
Partnership Liquidation
191
Problem 4-2
PROBLEMS
Blando and Castro decided to liquidate their partnership business on April 1,2011.
The partners had been sharing profits and losses on a 60:40 ratio. The statement of
financial position prepared on the day liquidation began was as follows:
Problem 4-1
The statementoffinancial position ofthe partnership ofRivas and Briones as ofDecember
31,2011 is as follows:
Blando and Castro
Statement of Financial Position
Rivas and Briones
April 1,2011
-
Statement of Financial Position
December 31,2011
Liabilities and Capital
Assets
Cash
Other Assets
P 20,000
200,000
Rivas, capital
Briones, capital
PI32,000
18,000
20,000
40,000
10,000
Total Liabilities and Capital
P220,000
Liabilities
Rivas loan
Briones, loan
Total Assets
Liabilities and Capital
Assets
P220,000
Cash
'
Receivables
Inventory
Other Assets (net)
P 18,000
75,000
90,000
84,000
Total Assets
P267,000
Accounts Payable
Blando, capital
Castro, capital
Castro, drawing
P 42,000
24,000
102,000
90,000
9,000
Total Assets and Liabilities
P267,000
Blando, loan
During April,one-halfofthe receivables was collected;P40,000 ofinventory was sold
at an average of75% ofbook value; other assets were sold for P40,000.
The other assets were realized for PI34,000,and all cash is disbursed. Division of
profits and losses are:
Required:Prepare a partnership liquidation statement.
Rivas
Briones
Case 1
90%
10%
Case 2
70%
30%
Case 3
50%
50%
Problem 4-3
Amp,Volt,and Watt are partners in the Electric Company and share profits in a 5:3:2
ratio. The statement offinancial position on June 30,2011 when they decide to liquidate
the business,is as follows:
Jiequired:Prepare the partnership liquidation statement and thejournal entries to
record the liquidation for each case.
Liabilities and Equities
Assets
Liabilities
Noncasb Assets
P 20,000
15,000
135,000
Total Assets
P170,000
Total Liabilities & Equities
Cash
Amp,Loan
■ .iV,
Volt, Loan
Amp,Capital
Volt, Capital
Watt, Capital
30,000
10,000
80,000
36,000
14,000
P170,000
Chapter 4
192
Partnership Liquidation
193
Problem 4-3: Continued
Problem 4-5
The noncash assets are sold for P95,000. Rather than require payments,all partners
agree to offset the receivable from Amp against his capital credit.
'
Partners JJ,KK and LL have decided to liquidate their partnerships. The partnerships
statement offinancial position reveals the following:
Required
Assets
a. Prepare a statement ofpartnership realization and liquidation.
b. Prepare the requiredjournal entries to account for the liquidation ofthe Electric
Company.
Cash
Other assets
P 50,000
Total assets
P550,000
500,000
miin.
Liabilities and Owners' Equity
Aida,Bina and Celia are partners with a profit and loss ratio of5:4;1. The partnership
was liquidated,and prior to the liquidation process,the partnership statementoffinancial
JJ, capital
KK,capital
LL,capital
P 60,000
180,000
240,000
70,000
Total liabilities and owners' equity
P550,000
Liabilities
position was as follows:
ABC Partnership
Statement of Financial Position
January 1, 2011
The partners share profits and losses in a 4:4:2 ratio and all partners are personally
Assets
solvent.LL received P98,000 in cash in full settlement for her share ofthe partnership.
Cash
Other assets
P 80,000
720,000
Total assets
P800,000
Required:
a. What was the selling price for the other assets?
b. Prepare a statement ofpartnership liquidation.
Equities
Aida-capitalP320,000
Bina-capital
Celia-capital
Total equities
Problem 4-6
The following information is provided in connection with the hquidation ofa partnership:
320,000
160,000
Profit
P800,000
Partner
and
Partnership
Capital
Loss
Balance
Personal
Personal
Ratio
Cr (Dr.)
Assets
Liabilities
30%
10
20
40
p.160,000
80,000
P200,000
120,000
160,000
80,000
P40,000
100,000
100,000
120,000
Afterthe partnership was liquidated and the cash was distributed,Bina received P128,000
BE
in cash in full settlement ofhis interest.
CC
DD
Required:
EE
a. Compute the amount ofthe realization loss on the sale ofthe other assets.
b. Prepare a statement ofpartnership liquidation.
Capital Deficiency
In.
(120,000)
(180,000)
P (60,000)
il'.:
Chapter 4
tm
195
Partnership Liquidation
194
Problem 4-6: Continued
Problem 4-7: Continued
"f.^^Indfcate the maximum amount that partnership creditors can enforce against each
The partners pay all liabilities and distribute the balance of the cash to the partners.
Assume that a deficient partner will not be able to cover his debit balance.
h
partiter's personal assets in seeking payment ofthe creditor s claims.
Assume that BB advances P60,000 to pay the partnership creditors. Prepare a
.3 4
assets.)
'f
statement of partnership liquidation. (Hint: DD must deposit P60,000 of personal
■,
Required: Prepare a statement of partnership liquidation.
Following is the statement of financial position for Art, Bea and Cid Partnership oji July
i
Say son and Zobel have been paitners in a successful business for a number of years,
nrhey decide to admit two of their employees in their partnership. After the inclusion 01
the two, the profit sharing is Sayson, 45%; Zobel, 30%; Ayala, 15% and Pefia, 10
It is agreed that Ayala and Pena are not required to make any capital contribution but it
4,2011, immediately before its liquidation:
Art, Bea and Cid Partnership
Statement of Financial Position
July 4, 2011
is provided that in the event of the sale of the assets of the business within five years,
Saysomand Zobel alone will share in the proceeds of any goodwill.
Assets
Three years after the admission of the employees into the partnership, an offer of
Cash
depressed, so the partners decide to accept the offer. After closing the books, the
Total assets
PI 85,000 is received for the non-cash assets of the partnership. Business currently is
ledger shows the following account balances:
Inventory
Land
Delivery truck - net
Building - net
Ayala, capital
i 'M
■ ">:'t
Pefia, loan
Sayson, capital
Zobel, capital
Pena, capital
PI 00,000
Cid, capital
Total liabilities and partners' capital
PI 00,000
Loan Payable to Bea
Art, capital
Bea, capital
6,000
750
63,750
14,993
The partners shared net income and losses as follows: Art, 40%; Bea, 40%; and Ci^
20%. On July 4,2011, the other assets realized P30,700, and P20,500 had to
to liquidate the liabilities because of an unrecorded trade account payable
^
and Bea were solvent, but Cid's personal liabilities exceeded personal assets by P5,0 J •
Credits
Accounts payable
Notes payable
6,000
94,000
P 20,000
4,000
27,000
39,000
10,000
Liabilities
P 15,000
21,000
26,250
37,500
PI 85,243
J -■ ■ '.a; f• i'i
P
Liabilities and Partners' Capital
Debits
Cash
Accounts receivable
Notes receivable
Other assets
P 11,250
9,000
1,500
75,345
86,498
1,650
Required:
r \ a
a. Prepare a statement of liquidation for Art, Bea and Cid Partnership on July ,
2011. Combine Bea's loan and capital accoimt balances.
.
.
b. Prepare journal entries for Art, Bea and Cid Partnership to record the liquidation
on July 4,2011.
c. How much cash would other assets have to realize on liquidation in order for Cid to
PI 85,243
receive enough cash from (he partnership to pay personal creditors in full? Assimie
that P20,500 is required to liquidate the partnership liabilities.
\ . ,
Chapter 4
196
Problem 4-9
Chapter 5
The KGB Partnership decided to liquidate the partnership as ofJune 30,2011. The
statement offinancial position ofthe partnership as ofthis date is as follows:
KGB Partnership
Partnerships Liquidation
By Installment
Statement of Financial Position
June 30, 2011
Assets
Cash
■;
Accounts receivable net (net)
'
,
, -■
P
. 11' , r.»' ' • ■
';
'
*1 ■ '
t
• v'
■?
Inventories
Property, Plant, and Equipment (net)
''
V
Total Assets
.. . .
"
Frequently, partnership assets are not realized through an instantaneous sale but
in a piecemealfashion. In other words, the liquidation ofsome business may extend
over several months. When this happens the partners may prefer to receive the
amounts due to them in a series of installments rather than wait until all assets
P 1,000,000
1
have been converted to cash. Installment payments to partners are proper provided
that measures are taken to insure that all creditors are paid in full and that there
. ■ ■ - V /
Liabilities and Partner's Capital
Accounts payable
•
G, Loan
• ^
'
t
'
'
P 480,000
60,000
I
is no overdistribution to one or more of the partners.
P 540,000
Total Liabilities
Partner's Capital;
K, Capital
G, Capital
B, Capital
Total Capital
50,000
150,000
200,000
600,000
Installment liquidation involves the selling ofsome assets, paying the liabilities of
the partnership, dividing the available cash to- the partners, selling additional
assets and makingfurther payments to partners. This process continues until all
. .
P240,000
100,000
120,000
the assets have been sold and all cash has been distributed to the creditors and to
460,000
Total Liabilities and Capital
the partners.
P 1,000,000
Procedures for Liquidation by Installment
Additional Information
1. The personal assets (excluding partnership capital and loan interests) and personal
The following are the accounting procedures that may be followed in liquidating a
liabilities of each partner as of June 30,2011, follow:
Personal assets
Personal liabilities
partnership by installments.
K
G
B
P500,000)
( 460,000)
P600,000
P700,000
( 480,000)
( 650,000)
1.
2.
2. K, G, and B share profits and losses in the ratio of20:40:40, respectively.
* ■
3.
4.
3. All the noncash assets were sold on July 4,2011, for P520,000.
4. No interest accmes on partner's loan balances.
Record the realization ofassets and distribute the realized gains or losses among
the partners using the profit and loss ratio.
Pay liquidation expenses and unrecorded liabilities, ifthere are any, and distribute
these among tlie partners using the profit and loss ratio.
.Pay the liabilities to outsiders.
Distribute cash to the partners after possible future losses have been
apportioned to partners or in accordance with a cash distribution program.
Required:
a.
Note: Eliminate any capital deficiency only before final payments to partners.
Prepare a statement of realization and liquidation for the KGB Partnership on June
30, 2011.
197
b. Prepare a schedule showing how the partners' personal assets are to be distributed
according to the Partnership Law.
i
■ ■V
Chapter 5
198
PERIODIC COMPUTATION OF SAFE PAYMENTS TO PARTNERS
In installment liquidation,cash distributions to the partners are authorized even before
all the losses that may be incurred and charged against the partners are known.
Considerable care is, therefore,required to insure an equitable distribution ofcash to
199
Partnership Liquidation By Installment
Illustration 5-1
X,Y,and Z
Statement of Financial Position
June 30, 2011
the partners.
Liabilities and Capital
Assets
The Statement ofPartnership Liquidation is usually supported by a schedule ofsafe
installment payments to paifners,simply called Schedule ofSafe Payments,prepared
periodically. According to the schedule,each installment ofcash is distributed as ifno
more cash is forthcoming,either from sale ofassets or from collection ofdeficiencies
from partners. Cash is,therefore, distributed to a partner only ifhe has an excess credit
balance in his partnership interest(i.e., capital account or capital and loan accounts
combined)after absorption ofhis share ofthe maximum possible loss that may occur.
The possible loss(hypothetical loss)consists ofthe following;
1. Total value ofremaining non-cash assets. These assets are assumed unrealizable,
P
Cash
Other Assets
5,000
155,000
PI60,000
Total
X,capital
Y,capital
Z,capital
P 40,000
30,000
40,000
50,000
Total
PI60,000
Liabilities
The following data relate to the realization ofother assets:
i.e., they can not be sold, hence,they are considered loss chargeable to the
partners.
2. Cash withheld to pay for anticipated liquidation expenses and unrecorded
habilities that may arise. The said expenses and habilities represent possible loss
to the partners because upon their payment, the amount paid is to be
correspondingly absorbed by the partners.(This is discussed further on the
July
August
September
latter part ofthis chapter.)
Book Value
Cash Realized
P 80,000
42,00033,000
P 65,000
12,000
PI5,000
18,000
21,000
P155,000
PlOfOOO
P54,000
24,000
Loss
Additional loss may also accme to the partners when a debit balance in any ofthe
capital accounts results from the foregoing allocations ofpossible loss. The deficiency
ofatiy ofthe partners is absorbed by the other partners as additional possible loss to
them because he is presumed unable to pay anything to the firm.
In July,the first month ofinstallment,the Statement ofLiquidation before the paymentto
the partners appears below:
Payment to partners based on periodic computation ofsafe payments bring,at some
point ofliquidation,the partners' capitals to the profit and loss ratio. The absence ofany
partner's deficiency after distribution ofthe possible loss signifies that the ratio ofthe
capital balances are in the profit and loss ratio.Preparation ofschedules ofsafe payments
in subsequent periods are no longer necessary because all subsequent payments can be
made based solely on the profit and loss ratio. Each partner's capital is adequate to
Illustration 5-2
absorb his share ofthe maximum remaining possible loss.
Balances before liquidations
X, V and Z
Statement of Liquidation
July 2011
Partners' Capital
Assets
Liabilities
X(I/3)
Y(l/3)
P40,000
P30,000
P40,000
P50,000
(5.000)
(5.000)
(5,000)
25,000
35,000
45,000
P25>000
P35,000
P45,000
•
Cash
Others
P 5,000
P155,000
65,000
(80,000)
70,000
75,000
Z(l/3)
Realization of assets
Illustration ofInstallment Liquidation
and distribution of loss
Balances
Case 1:Each partner has sufficient interest to absorb possible loss. X,Y,and Z,
partners sharing profits and losses equally,decide to liquidate their partnership.Prior to
the liquidation,the partnership Statement ofFinancial Position on June 30,2011 is
presented in the next page:
Payment of liabilities
f40.000)
Balances
P30,000
40,000
(40,000)
P 75,000
-0-
Chapter 5
200
Partnership Liquidation By Installment
To determine how the available cash ofP30,000 is to be distributed to the partners,a
schedule ofsafe payment is to be prepared. The calculation ofthe safe payment require
the following steps.
According to the schedule (Illustration 5-3), it is safe to pay the partners P30,000 in
July, i.e., P10,000 to Y and P20,000 to Z.The total payment to partners is equal to the
cash available for distribution according to the statement ofliquidation. After the
distribution ofavailable cash,the partners' capitals have the following balances: X,
1. Determine the total interest ofeach partner. Before cash distribution,a partner's
capital is added to the loan he granted to the firm to arrive at his interest. The total
interests ofthe partaers are computed as follows;
Capital balances
X
Y
Z
P25,000
P35,000
P45,000
Add Loan balances
Total interests
-
P35,000
P25,000; Y,P25,000(P35,000 - PI0,000); Z,P25,000(P45,000 - P20,000). The
capital balances are equal to one another and this is in accordance with the agreed
profit and loss sharing, i.e., equally,. Therefore,any further installment payments in
August and September can be safely made in the agreed profit and loss ratio without
preparing a schedule ofsafe payments.
-
-
P25,000
201
P45,000
Illustration 5-4 below shows the complete picture ofthe liquidation ofthe partnership of
X,Y and Z from July 1 to September 30,2011.
2. Compute the total possible loss of the partnership to be absorbed by each
partner. This consists ofthe total value ofremaining non-cash or other assets and
the cash withheld. Each partner absorbs a possible loss ofan amount equal to the
total possible loss multipled by his profit and loss share percentage.The necessary
computations are as follows:
Other assets (unsold)
Illustration 5-4
X,YandZ
Statement ofLiquidation
July to September 30,2011
P75,000
Assets
Cash
Add Cash withheld
P75,oqo
Total possible loss
'<ji
Balances before liquidation
July Installment:
P
Others
5,000
P155,000
65,000
(80,000)
70,000
(40,000)
75,000
30,000
75,000
Liabilities
P40,000
X(I/3)
Partners' Capitals
Y(I/3)
Z(I/3)
P 30,000
P 40,000
P 50,000
(5,000)
(5,000)
(5,000)
25,000
35,000
45,000
25,000
35,000
45,000
(10,000)
, (20,000)
25,000
25,000
25,000
(6,000)
(6,000)
(6,000)
Realization of assets
and distribution of loss
Possible loss absorbed by —
j
X :
Y :
Z :
P75,000 X 1/3
75,000 x 1/3
75,000 X 1/3
"total
=
P25,000
25,000
25,000
"J
Balances
Payment to partners
(Schedule 1)
(30,000)
-0-
75,000
24,000
(42,000)
24,000
(24,000)
33,000
-0-
33,000
Realization of assets and
distribution of loss
12,000
(33,000)
Balances
12,00.0
-0-
P(12,000)
-0-
Balances
Illustration 5-3
Schedule I
•
Balances
Payments to partners
Schedule ofSafe Payments-July
Balances
X (1/3)
Y (1/3)
Z(1/3)
P25,000
P35,000
P45,000
(25,000)
(25,000)
(25,000)
P10,000
P20,000
-0-
August Installment:
Realization of assets and
distribution of loss
-0-
-0-
fMP
P75,000
below:
Payments to partners
40,000
(40,000)
L
The schedule ofsafe payments prepared based on the above procedures is shown
Total interest
Possible loss
Balances
Payment of liabilities
19,000
19,000
19,000
(8,000)
(8,000)
(8,000)
11,000
11,000
11,000
(7,000)
(7,000)
(7,000)
0
4,000
4,000
4,000
-0-
P(4,000)
P(4,000)
P(4,000)
-0-
-0-
September Installment:
Final'payments to
partners
Chapter 5
202
Several important conclusions can be drawn from the analysis ofthe Statement of
Liquidation(Illustration 5-4). These are:
1.
2.
The order ofpayments in the statement ofliquidation is in accordance with the
order ofpriority stated in the Partnership Law,that is, payment are first made to
creditors,then to the partners.
The total installment paymentto each partner is equal to the amount ofsingle payment
computed under the lump-sum liquidation method,as illustrated below.
Partnership Liquidation By Installment
(3) Y, capital
Z, Capital
203
■
30,000
Cash
To record thefirst installment
payment to partners
August
(4) Cash
Installment Liquidation Method
X(/3)
July
August
September
Z (1/3)
8,000
4,000
P10,000
8,000
4,000
P20,000
8,000
4,000
P12,000
P22,000
P32,000
P
Total payments
r (1/3)
Lump-Sum Liquidation Method
X (1/3)
Y(l/3)
Total loss on realization,P54,000
P30,000
(18,000)
P40,000
(18,000)
(18,000)
Total payments
P12,000
P22,000
P32,000
Capital balances before liquidation
Z (1/3)
P50,000
10,000
20,000
24,000
X, Capital
Y, Capital
Z, Capital
6,000
6,000
6,000
42,000
Other assets
To record August sale ofassets and the
distribution ofloss among the partners
(5) X, Capital
Y, Capital
Z, Capital
8,000
8,000
8,000
24,000
Cash
To record the second installment payment to partners.
September
3. The ratio ofthe partners' capitals after the liquidation on July is equal to tlie profit
and loss ratio ofthe partners. When this condition exists,all subsequent installment
payments are based upon the profit and loss ratio (see August and September
installment payments in the statement ofliquidation).
(6) Cash
12,000
X, Capital
7,000
Y, Capital
Z, Capital
7,000
7,000
33,000
Other assets
Thejoumal entries for the liquidation ofthe partnership ofX,Y and Z are as follows:
To record September'sale ofassets and the distribution
ofloss among the partners.
July
(1) Cash
X, Capital
Y, Capital
Z, Capital
(7) X, Capital
Y Capital
Z, Capital
65,000
5,000
5,000
5,000
Cash
80,000
Other assets
4,000
4,000
4,000
12,000
To recordfinal payment to partners.
To record July sale ofassets and the distribution ofloss
among the partners.
(2) Liabilities
Cash
To recordfullpayment ofliabilities.
40,000
40,000
Case 2: One or morepartners have insufficient interest to absorb possible loss.
The partners ofABE & Co.share profits and losses as follows: A,50%;B,20%;C,
20%;D,10%.On March 31,2008,they agree to liquidate their partnership.Prior to
the liquidation,the partnership statement offinancial position is shown in the next page:
Chapter 5
204
ABE & Co.
Schedule 1
Statement ofFinancial Position
Schedule ofSafe Payment
March 31,2011
P 10,000
80,000
Cash
Non-cash assets
A (50%)
Liabilities and Capital
Assets
Capital balances
P6,000
2,000
20,000
29,000
23,000
10,000
Liabilities
B,Loan
A,Capital
B,Capital
C,Capital
D,Capital
Total interests
Possible loss P26,000
toB,C and D;2:2:1
The following data relate to the realization ofnon-cash assets;
Book value
Payments to partners
Cash Realized
8,000
B (20%)
C (20%,)
D (10%)
P24,200
2,000
PI8,200
P7,600
8,000
(13,000)
(5,200)
(5,000)
21,000
13,000
5,000
5,000
(2,000)
(2,000)
(1,000)
-0-
P19,000
P11,000
P4,000
26,200
18,200
(5,200) '
7,600
(2,600)
Additional possible loss
P90,000
Total
P
Loan balance
Balances
P90,000
Total
Z05
Partnership Liquidation By Installment
Loss
According to the above schedule,A shall not receive payment in April because his total
interest is not sufficient to absorb his share ofpossible loss. A's deficiency is eliminated
April
May
P54,(X)0
24,000
P30,000
18,000
P24,000
6,000
June
2,000
1,000
1,000
simply by absorption. Additional investment by the deficient partner is not necessary
P80,000
P49,000
P31,000
in the preparation ofschedule ofsafe payments.Tlierefore,the absorption ofA's deficiency
by B,C and D means additional loss proportionately chargeable to them.
In April,the first month ofinstallrnentliquidation,the statementofliquidation and schedule
ofsafe payment are as follows:
The statement ofliquidation and the supporting schedule ofsafe payment for May,to
show the complete picture ofthe liquidation process ofABE & Co. is presented in
Illustration 5-6.
Illustration 5-5
ABE and Co.
Analyzing the statement ofliquidation(Illustration 5-.6)one can conclude the following:
Statement ofLiquidation
April 2011
1. Payments are done in accordance with the Partnership Law.The partners received
Assets
Cash
Non-Cash
Liabilities B. Loan
A(50%)
Partners' Capitals
8(20%) C(20%) D(10%)
payments only after outside creditors have been paid in full.Payment to any partner
is applied first to the loan granted by him then to his capital account for the excess.
Balances before
liquidation
P10,000
P80,000
Realization of assets
and distribution
of loss
30,000
(54,000)
Balances
40,000
26,000
6,000
(6,000)
2,000
8,000
24,200
18,200
7,600
26,000
-0-
2,000
8,000
24,200
18,200
7,600
34,000
(12,000)
Payment to partners
(Schedule 1)
(34,000)
Balances
P2,000 P20,000
P29,000 P23,000 P10,000
2. A's total interest in April is not sufficient to absorb his share ofpossible loss. The
Payment of liabilities (6,000)
Balances
P6,000
-0-
to partners in April are not sufficient to bring the ratio ofthe capital balances after
-0-
-0-
the cash distribution to equal the profit and loss ratio. In May,no partner has a
deficiency, hence,the capital balances' ratio is equal to the profit and loss ratio.
(17,000) (11,000) (4,000)
(2,000)
P26,000
deficiency ofA does not only mean additional possible loss to the rest ofthe partners
but also the necessity ofpreparing a schedule ofsafe payments in May.Payments
(4,800) (4,800) (2,400)
P8,000
P7,200
P7,200
There is no longer any need to prepare a schedule ofpayments in June.Payments
to partners are in accordance witli the agreed profit and loss ratio.
P3,600
M
"
Chapter 5
206
ABE& Co.
StatementofLiquidation
April 1 to June 30,2011
Assets
Cash
Non-Cash Liabilities
B. Loan
Partners Capital
A(50%) B(20%o)
C(20%o) D(10%)
Balances before
PIO.OOO
P80,000
P6,000
P2,000
P20,000
P29,000
P23,000
The statement ofliquidation and the supporting schedule ofsafe payments are presented
below and on the next page.
P10,000
Illustration 5-7
April Installment:
Realization of
ABE«&Co.
assets and distribution
of loss
Statement ofLiquidation
April 1 to June 30,2011
Balances
207
Case 3: One or More Partners Becomes Deficient After Absorbing Additional
Possible Loss. Assume the balance sheet and the data pertaining to the realization of
non-cash assets of ABE & Co. in Case 1. The partners share profits and losses as
follows: A,60%;B,15%;C,10%;D,15%.
Illustration 5-6
liquidation
Partnership Liquidation By Installment
30,000 (54,000)
40,000
26,000
6,000
(12,000)
(4,800)
(4,800)
(2.400)
8,000
24,200
18,200
7,600
2,000
Payment of
liabilities
Assets
(6,000)
(6,000)
Cash
34,000
Balances
Payment to partners
(34,000)
(Schedule 1)
26,000
-0-
26,000
Balances
-0-
2,000
8,000
24,200
18,200
7,600
(17,000) (11,000)
(4,000)
7,200
3,600
18,000
-0-
8,000
-0-
(3.000)
(24,000)
A(60%J
Partners Capital
B(15%)
C(IO%) D(I5%)
7,200
(1,200)
(1.200)
(600)
liquidation
P10,000
P80,000
P6,000
P20,000
P29,000
P23,000
PI 0,000
(14,400)
(3,600)
(2,400)
(3,600)
2,000
5,600
25,400
20,600
6,400
2,000
5,600
25,400
20,600
6,400
P2,000
April Installment:
Realization of
assets and distribution
of loss
30,000 (54,000)
Balances
40,000
26,000
6,000
Payment of
Balances
18,000
Payments to partners
(Schedule 2)
(18,000)
2,000
Balances
2,000
-0-
-0-
-0-
5,000
6,000
6,000
3,000
(4,000)
(5,600)
(5,600)
(2,800)
-0-
1,000
-0-
400
400
200
liabilities
(6,000)
Balances
34,000
Realizatiim of
(6,000)
26,000
-0-
Payment to partners
(Schedule 1)
(34,000)
-0-
Balances
June Installment:
(17,000) (15,000)
(2,000)
26,000
-0-
5,600
8,400
5,600
6,400
(3,600)
(900)
(600)
(900)
2,000
7,500
5,000
5,500
(800)
(7,200)
(4,800)
(5.200)
1,200
300
200
300
(600)
(150)
(100)
(150)
May Installment:
assets and distribution
of loss
1,000
(2,000)
Balances
1,000
-0-
-0-
P(1,000)
-0-
-0-
(500)
(200)
(200)
(100)
-0-
500
200
200
100
-0-
P(500)
P(200)
P(200)
P(IOO)
Realization of
assets and distribution
of loss
18,000 (24,000)
Balances
18,000
Final payments to
partners
B. Loan
Balances before
(2,000)
May Installment:
Realization of
assets and distribution
ofToss
Non-Cash Liabilities
-0-
-0-
-0-
-0-
2,000
assets and distribution
of loss
1,000
(2,000)
Balances
1,000
-0-
-0-
-0-
600
150
100
150
P(1,000)
-0-
-0-
-0-
P(600)
P(150)
P(IOO)
P(150)
Balances
Schedule 2
2,000
Payments to partners
(Schedule 2)
(18,000)
-0-
Schedule ofSafe Payment- May
June Installment:
Realization of
A (50%)
B (20%)
C(20%)
D (10%)
Coital Balances
Possible loss,P2,000
P5,000
(1,000)
P6,000
(400)
P6,000
(400)
P3,000
goo)
Payments to partners
P4,000
P5,600
P5,600
P2,800
Final payments to
partners
Schedule 1 — April
Cash Withheld
Computation ofSafe Payment
Capital balances
209
Partnership Liquidation By Installment
Chapter 5
208
A(60%)
3(15%)
C(10%)
P 5,600
P25,400
2,000
P20,600
Loan balance .
D(15%)
P6,400
-
Possible loss P26,000
(15,600)
27,400
(3,900)
20,600
(2,600)
(3,900)
Balances
(10,000)
23,500
18,000
2,500
10,000
(3,750)
(2,500)
(3,750)
-0-
19,750
15,500
(1,250)
(750)
(500)
1,250
PI9,000
PI5,000
-0-
5,600
Total interests
The cash set aside in a separate fund is not a factor in computing possible loss. It is the
cash set aside to insure payments ofpotential liquidation expenses which may be
incurred, and unrecorded liabilities which may be discovered. (This is explicitly stated
in the problem.) This cash withheld is added to the total value ofthe remaining non-cash
assets to obtain the maximum possible loss needed in the computation ofsafe installment
payment. Also, cash available for distribution to the partners for the period is net of the
6,400
cash withheld.
Unrecorded liabilities are obligations which are discovered or incurred during the
liquidation. These are allocable to the partners according to their profit and loss sharing
Additional possible loss to
B,C&D;15T0:15
Balances
agreement.
■2A
COMPREHENSIVE ILLUSTRATIVE PROBLEM
Additional possible to B & C;
15:15
Payments to partners
-0-
R, S and T are partners who share profits and losses as follows: R, 50%; S, 30%; T,
20%. All partners are personally insolvent. On December 31,2011, they agree to
liquidate their partnership. The firm's Statement of Financial Position on this date is as
follows:
Schedule 2 - May
Computation of Safe Payment
R, S and T
Statement of Financial Position
A(60%)
3(15%)
C(10%)
D(15%)
P2,000
(1,200)
P7,500
(300)
P5,000
(200)
P5,500
Possible loss, P2,000
Payments to partners
P
P7,200
P4,800
P5,200
Total interests
800
December 31,2011
Liabilities and Capital
Assets
(300)
Cash
Other assets
P 5,430
61,870
Accounts payable-trade
P12,892
8,000
R, loan
20,892
Total Liabilities
R, capital
S, capital
T, capital
According to the above schedules, it is only safe for the partnership to pay B and C
P 19,000 and PI 5,000, respectively in April. A's interest is insufficient to absorb his
possible loss so he is not entitled to receive cash in April. D, on the other hand, has
sufficient interest to absorb his initial share of possible loss but not enough to absorb
more possible loss. The deficiency of A absorbed by D resulted to a greater loss to D
than his interest balance thus, D has become deficient. He is not only deprived of the
Total Assets
24.537
Total Liabilities and Capital
46.408
P67,300
The following data relate to the realization of other assets:
Cash
chance to receive cash in April but B and C are now entitled to smaller shares of any
cash distribution in April. B and C incur additional possible loss because ofD's deficiency.
Moreover, a schedule of safe payments is required in May because the ratio of the
capital balances after the cash distribution in April is not equal to the profit and loss
January
February
March
ratio.
M'lr
P67,300
PI 6,402
5,469
Book Value
Cash Realized
Loss
Withheld
P24,700
33,170
4,000
P20,120
21,000
3,700
P4,580
12,170
P3,000
300
800
-
Liquidation
Expenses Paid
PI,200
1,400
200
Unrecorded
Liabilities Paid
PI,550
200
-
The Statement of Liquidation from January 1 to March 1 2011 and the supporting
schedules of safe payments are presented in Illustration 5-8.
'M
Chapter 5
210
Illustration 5-8
Schedule 1 — January
Computation ofSafe Payment
R,S and T
Statement ofLiquidation
January to March,2011
Assets
Cash
Accounts Payable
Others
-trade
R. Loan
Partners' Capitals
R(50%)
S(30%)
T(20%)
P 12,892
P8,000
P16,402
Balances before
P 5,430
P61,870
of loss
20,120
(24,700)
Balances
25,550
37,170
P5,469
P24,537
January Installment:
Realization of assets
and distribution
Loan balances
Possible loss(P3,000+ P37,170)
12,892
8,000
(1.374)
14,112
4,095
(916)
23,621
(2,750)
Balances
22,800
37,170
Balances
Balances
9,908
8,000
(825)
12,737
3,270
37,170
-0-
8,000
12,737
3,270
(6,908)
3,000
(550)
-0-
8,000
12,737
3,270
P12,737
8,000
P 3,270
P23,071
-0-
-0-
20,737
3,270
23,071
(10,085)
(12,051)
( 8,034)
652
( 8,781)
15,037
8,781
( 2,509)
Balances
( 5,620)
-0-
Payment to partner
12,528
~
5,620
( 5,620)
-0-
-0-
P 6,908
23,071
R(50%)
S(30%)
T(20%)
P5,852
8,000
P(861)
P13,409
13,852
(861)
(1,440)
13,409
(960)
Schedule 2 — February
Computation ofSafe Payment
(6,908) .
37,170
T(20%)
23,071
(12,892)
(12,892)
Payment to partners
(Schedule 1)
12,892
(1,375)
S(30%)
( 6,272)
Additional loss to T
liabilities
R(50%)
Additional loss to R& T,5:2
Balances
(2,290)
Payments of liquidation
expenses and unrecorded
Payment of accounts
payable
Capital balances
Total interest
liquidation
211
Partnership Liquidation By Installifwnt
16,163
February Installment:
Capital balances
Realization of
Loan balance
assets and dis
tribution of loss
Balances
2L000
24,000
133.170)
4,000
(6.085)
-0-
8,000
6,652
(3.651)
(381)
(2.434)
13,729
Payments of liquidation
expenses and
unrecorded liabilities
4,000
-0-
800
4,000
-0-
distribution of loss
3.700
(4.000)
Balances
4,500
-0-
Balances
(800)
(480)
(320)
8,000
5,852
(861)
13,409
(8.000)
(1.808)
-0-
4,044
(1,600)
22,400
Total interest
Possible loss(P800+P4,000)
(2,400)
Balances
11,452
(1,644)
(2,301)
Additional loss to R & T; 5:2
2301
12,449
(657)
Payments to partners
P9,808
-0-
PI 1,792
Payments to partners
(Schedule 2)
Balances
March Installment:
Realization of assets and
(21.600)
-0-
-0-
(11.792)
(861)
1,617
(150)
(90)
(60)
3,894
(951)
1,557
Payments of Liquidation
expenses
f200)
Balances
Addition loss to
4,300
-0-
-0-
-0-
R & T: 5:2
Balances
(100)
(60)
(40)
3,794
(1,011)
1,517
(722)
4,300
-0-
-0-
-0-
3,072
P(4,300)
-0-
-0-
-0-
P(3,072)
1.011
-0-
(289)
1,228
Final payments to
partners
-0-
P(l,228)
Notice the following in the statement ofliquidation shown in Illustration 5-8:
1. Capital deficiency is eliminated only before the final payments to partners.
2. Capital deficiency increases as the liquidation continues. Although S has a capital
deficiency,he is still subject to absorb losses which the firm incurs as it is being
liquidated.
3. In the prepamtion ofschedule ofsafe payments,the deficient partner still absorbs
a portion ofthe possible loss. Hence,the debit balance ofS's interest-in the
partnership increases as he shares in the possible loss. The balance ofhis interest
at this point is then treated proportionately as additional possible loss to R and
T.
' •' ,T'
212
Partnership Liquidation By Installment
Chapter 5
213
*. 1 1
(which consists ofhis capital and loan balances)by his profit and loss percentage.
The computations are shown below.
PREPARATION OF A CASH DISTRIBUTION PROGRAM
In the preceding section,it is necessary to prepare a supporting schedule for the allocation
ofthe maximum possible loss each time an installment distribution is contemplated,that
is, until the partners' interest are in their respective profit and loss ratio. Should the
liquidation extend over a long period oftime,these calculations may become rather
frequent and bother-some such that it may be desirable to prepare in advance an
installment distribution plan or cash pre-determination plan,known as Cash Distribution
Program.This program permits the partners to determine how cash should be safety
distributed ifand when it becomes available. The preparation ofa cash distribution plan
before the actual liquidation is, therefore, an alternative to the method previously
Partner
(Capital + Loan)
P40,000
45,000
54,000
A
B
C
= Loss Absorption
Potentials
P 100,000
150,000
180,000
40%
30
30
The computations in No. 1 show that a loss ofPI00,000 would eliminate A's
capital,(including any possible offset ofa loan balance should one exist). Similarly,
a loss ofP150,000 and a loss ofP180,000 would eliminate the capitals ofB and C.
respectively.
described,that ofpreparing periodic computation ofsafe payments to the partners.
Illustration. A,B and C are partners who share profits and losses as follows: A,40%;
B,30%;C,30%.They decide to liquidate the partnership and they would like to have
an advance cash distribution plan.The statementoffinancial position prior to tire liquidation
is presented below.
Profit & loss
Share Percentage
Partner s Interest -t-
2.
Determine thepriority ofpayments to partners. The priority ofpayments is in
terms ofthe excess loss absorption potential ofa partner over another. The partner
who has the biggest loss absorption potential has the first priority. This procedure is
illustrated below.
A,B and C
Statement ofFinancial Position
June 30, 2011
Cash
Other Assets
P
8,000
192,000
Liabilities
C,loan
A,capital
B,capital
C,capital
Total Assets
Loss absorption balances
Priority I-to C
(Excess ofloss absorption potential ofC over B)
Liabilities and Capital
Assets
P200,000
Total liabilities and capital
P 61,000
4,000
40,000
45,000
50,000
P100,000
P150,000
PI80,000
(30,000)
(Excess of loss absorption potential
ofBancLC)
PI00,000
Balances
150,000
150,000
(50,000)
(50,000)
P100,000
PI00,000
Compute the amount ofcash to be paid to the partners under each priority.
This amotmtis arrived at by multiplying the partner's excess loss absorption potential
by his profit and loss share percentage. The computations are given below.
Profit and Loss
Share Percentage
Excess Loss
Absorption Potential
Priority I - to C
Priority II - to B and C
1. Compute the loss absorption potential ofeach partner. The loss absorption
potential is the maximum loss each partner can absorb and which can eliminate him
from any cash distribution. This is computed by dividing the partners' total interest
C
100,000
Balances
3.
The following procedures may be used in the preparation ofthe Cash Distribution
Program for A.B and C partnership in order to determine the order ofdistributions and
amountofpayments:
B
Priority II-to B and C
P200,000
Procedures to Prepare a Cash Distribution Program
A
To B
To C
P30,000
30%
50,000
50,000
30
Cash Payments
A (40%) B (30%) C (30%)
-
30
PI5,000
- * . {if' if
^
• I', .
Total
P 9,000
P 9,000
P15,000
15,000
30,000
P24,000
P39,000
Chapter 5
^14
Ndt^: Any amount in excess ofP39,000 available for cash distribution is
paid to the partners according to theirprofit and loss sharing agreement.
IllustraTron 5-9 Below shows the completed cash distribution program made after
applying the preceding procedures.
Partnership Liquidation By Installment
215
The computation ofinstallment payments at the end ofeach month are presented
below:
August Distribution:
Cash
P33,000
Available for distribution
Illustration 5-9
(9,000)
Priority I - C
Priority 11 - to B and C:30:30
A,B And C
B
P 9,000
(24.000)
P12,000
To B:3/6 x P24,000
Cash Distribution Program
July 1,2011
ToC:3/6jfP24,000
12,000
Payments to partners
Balances
Capital balances
A
B
P 40,000
P 45,000
Lo^n balances
P 40,000
Total Interest
Loss Absorption
potential
Priority I - to C
P100,000
'P 45,000
P150,000
C
Cash Payments
A(40%o) B(30%)
C(30%)
Cash
P 54,000
PI 80,000
100,000
P100,000
P
9,000
P 9,000
P150,000
(50,000)
P150,000
(50,000
P15,000
15,000
30,000
P100,000
P100,000
P15,000
P124,000
P39,000
P21.000
September Distribution
P 50,000
4,000
(30,000)
Priority II - to B and C
Total
PI2.000
Available for distribution
P43,000
Priority 11 - to B and C:30:30
(P30,000-P24,000)
(6,000)
To B:3/6 X P6,000
ToC:3/6xP6,000
Excess - to A,B and C;40:30:30
To A:40% xP37,000
ToB:30%xP37,000
ToC:30%xP37,000
B
P 3,000
P 3,000
(37,000)
14,800
11,100
11,100
Payments to partners
P14,800
P14,100
P14,100
Any amount in excess
of P39,000
40%
30%
30%
100%
The information provided by the cash distribution program may be summarized as
COMPREHENSIVE ILLUSTRATIVE PROBLEM
follows:
To illustrate the preparation ofa cash distribution plan,statement ofpartnership
liquidation and the related supporting schedules ofsafe payments when a more
1. The first P9,000 available for distribution to partners should be paid to C.
2. The next P30,000 should be paid to B and C in the ratio of30:30.
3. Any amountin excess ofP39,000 should be paid to A,B and C in the profit and
complicated situation arises.
accoimt balances and profit and loss ratio before liquidation are:
loss ratio of40:30:30.
Illustration, To illustrate the installment payments based on the above cash distribution
program,assume cash is available to the partners as follows:
August
September
Assume the partners ofBankmpt Company agree to liquidate their partnership on July
1,2011 because the company is having financial difficulties. The partner's capital,loan
Capital
Burgos
Corpuz
Diaz
Ebro
P33,000
43,000
P36,000
28,000
12,000
30,000
Cr.
Cr.4,000
Cr.4,000
Cr.-
* Loan to Corpuz from Bankmpt Company.
i
Loan
P14,000 Cr.
Dr» 20%
Cr. 50%
10%
P&L
Ratio
20%
Chapter 5
216
Partnership Liquidation By Installment
The partners and the creditors have agi-eed that Ebro will act as the administi-ator. Ehro
anticipates that it will take approximately tlree months to complete the liquidation. The
partners request that available cash be distributed to them at the end ofeach month.
Projected Schedule ofPayments
Payee
Consequently,Ebro prepares the Cash Distribution Program below to ensure reasonable
cash payments to partners.
Diaz
Ebro
Payments
Corpuz
Diaz
Balances
P 36,000
14,000
P'28,000
50,000
24,000
16,000
30,000
20%
20%
50%
10%
Loss absorption potential 250,000
Priority 1 - to Ebro
120,000
32,000
300,000
(50,000)
250,000
120,000
Prorlt and Loss ratio
Balances
(4,000)
Diaz
Ebro
Corpiiz
120,000
32,000
32,000
( 88,000) (88,000)
Balances
32,000
P32,000
P 5,000
250,000
13,000
120,000
(88,000)
P32,000
-
—
—
11,733
6,400
-
6,667
8,667
5,867
P140,000
P26,000
P24,000
,P 10,000
P 4,000
-
Cash Realized
'.I;
Priority 111 - to Ebro,
Burgos and Corpuz
1:2:2
P
17,333 ,
The following events took place during the three-month liquidation ofthe company: "
(130,000)
120,000
Cash withheld
P
September 30
Ebro
PI 2,000 P 30,000
4,000
Priority 11 - to Ebro and
Burgos, 1:2
(130„000)
Balances
Burgos
August 31
-
Total expected payment
Burgos
Total interest
PI30,000
3,333
Creditors
Bankrupt Company
Cash Distribution Program
July 1,2011
Add Loan balances
July 31
Burgos
Corpuz
Illustration 5-10
Capital Balances
217
17,600
8,800
P17,600
P26.800
17,600
P 32,000
Net of
Month
July
August
September
Liquidation
Expenses
PI36,000 22,000"
20,000
Book Values
ofAssets
Unrecorded
Realized
Liabilities-
PI80,000
18,000
46,000
P8,000
—
-
During the month ofAugust,Diaz contributed P5,000 to the partnership to partially
cover his capital deficiency. He was unable to make any further contribution.
Further cash distribution
The Statement ofPartnership Liquidation is presented in Illustration 5-11. Analysis of
the statement is to be done together with Illustration 5-12.
P/L ratio
On July 1,2011,the company's asset and liabilities are:
Cash
Non-cash assets
Liabilities
P 6,000
244,000
130,000
Ebro expects that the realization ofnon-cash assets will be as follows;
July
August
September
P144,000 net cash proceeds
20,000 net cash proceeds
20,000 net cash proceeds
The projected payments shown in the next page are based on his plan to set aside
P10,000 cash at the end ofJuly and P4,000 at the end ofAugust as a reserve for future
unrecorded liabilities. By the end ofSeptember,Ebro expects Aat all liquidation expenses
and unrecorded liabilities will be known so that a final distribution plan can be made.
The following should be noted in the statement ofliquidation:
(1) The actual sequence ofcash distribution is precisely in accordance with the cash
priority program (Illustration 5-10)except for the P8,000 payment ofliabilities
which were discovered in August after the cash priority program was prepared.
(2) Diaz contribution ofP5,000 cash to the partnership in August could have changed
the sequence ofpayments from that which was indicated in the cash priority program.
The program was prepared on the assumption that none ofthe partners would be
able to make additional investments to cover capital deficiencies. Diaz's P5,000
contribution strengthened his capital position which would have warranted his
participation in the cash distribution program. However,since the total available
casb was not sufficient to provide any cash payment to Diaz, the actual cash
contribution still conformed to the cash distribution program.
Partnership Liquidation By Installment
Chapter 5
218
The cash distribution plan is prepared prior to liquidation and is based upon
conservative assumption with respect to future events. Because future events may
term out to be inconsistent with those assumptions and to insure a reasonable cash
distribution, it is preferable to prepare a schedule ofsafe payments in support
of each payments.
O
o
o
-O Ci
O
O
O
oo
VO O
\o
o"
219
v*r
o
o
o
o
o
so
o
o
<3
o
o
o
<N
o§
o
o
o
o
o
o m
o m
CN m
<N <N
«o
fv|
o
o
o
o
o
s?
(N^
o'
o§
§°
§§
o
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Ci,
cs
Illustration 5-12
o
o
o
o y —V
Schedules ofSafe Payments
o
o
o
o
o
o
is
~oo
ZZ
W-)
dT
Burgos
(20%)
Corpuz
Diaz
Ebro
r20%;
(50%)
(10%)
£?S.
g rs.
vcT
Add Loan Balances
o
o
o
o
o
o
fN
CN
OO
cs
(N
Possible loss,(P64,000+ P10,000)
P29,200
P(10,000)
(4,000)
4,000
P25,600
TV
41,200
(14,800)
15,200
(6,000)
(14,800)
(37,000)
25,600
(7,400)
26,400
400
(43,000)
18,200
Additional loss to Burgos, Corpuz & Ebro,
2:2:1 (P43,000)
(17,200)
(17,200)
43,000
(8,600)
Balances
^
o
o
o
o
o
<3
§
t!
o
o
g,
<N
o
o
O
o
vo"
vo"
VO
<N
fNj
<N
<N
9,200
(16,800)
-0-
9,600
(11,200)
16,800
-0-
(5,600)
o
o
<3
o
o
o
o
O
o
C3
o
C3
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o"
o"
o
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TT
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•'T
o
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o
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o"
o
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o
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SI
'
SO I Q
o
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goj T
44
44
'a-"
CJ
o
o
o,
Balances
o
o
g
s
OO
ST
P27,200
14,000
tt"
Total interests
o
r-"
r-"
03
July Installment:
Capital balances before cash distribution
o
o
(N
o
o
o
o
o
o
o
o
I
I
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o
o
rr"
II
I
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44
44
Additional loss to Burgos and Ebro,
2:1(PI6,800)
Balances
Additional loss to Ebro
Payment to partners
(2,000)
-0-
-0-
2,000
-0-
o
o
s-s
4,000
o
o
I
og
I
I
i
o
s
s
I
(2,000)
-0-
-0-
P 2,000
o
o
rf
vo
August Installment:
o
o
o
so
I
o
o
o
I
o
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s
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so*
so"
VO
TT
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44
,1
Capital balances before cash distribution
Add Loan balances
Total interests
Possible loss(P46,000 + P4,000)
Balances
P26,400
14,000
P40,400
(10,000)
30,400
P18,400
(4,000)
14,400
(10,000)
4,400
P(7,000)
P23,200
So
a
4,000
(3,000)
(25,000)
(28,000)
(11,200)
28,000
o
o^o
o"
<N
(n"in
PI9,200
(6,800)
-0-
18,200
(5,600)
Payments to partners
g-t S
_
P14,667
-0-
-0-
P10,333
>s
Sis
«.5
o
c
a
4>
g
B
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^ 3 a>
-o
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c c
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P12,600
(2,267)
3
"5-
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•3
2"
•Aoc ?
6,800
if
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B
^ o a, a.
(4,533)
o
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cr®
Additional loss to Burgos, and Ebro
2:1(P6,800)
oo
oo
o
o
a
Balances
o
m
O
(11,200)
o
o
o
23,200
(5,000)
Additional loss to Burgos,Corpuz & Ebro,
2:2:1 (P28,000)
S-S
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1^ fT
Chapter 5
220
221
Partnership Liquidation By Installment
SUMMARY
MULTIPLE CHOICES-THEORETICAL
1. In determining partners' capital balances before liquidation,the following should be
1. In the installment liquidation ofa partnership,each instalhnent ofcash is distributed:
noted;
a)
b)
c)
d)
a.
b.
c.
d.
Payables to partners.These should be added from the partner's capital accounts.
Receivables firom partners. These should be deducted to the partners' capital.
Drawing accounts. These should be closed to the partners' capital accounts.
Partnership goodwill.This should be written offagainst partners' capital accounts
according to the profit and loss ratio.
In the partners' profit and loss ratio.
In the ratio ofpartner's capital account balances.
As agreed to by the partners.
As ifno more cash would be forthcoming.
2. In the cash distribution plan,how is tlie amount ofa cash distiibution determined?
2. Gains or losses on realization should be distributed to the partners based on the
agreed profit and loss ratio.
a. By multiplying a partners' profit and loss ratio by his pre-liquidation capital
3. Liabilities should be paid in full, or cash sufficient to ensure the payment ofall
b. By subtracting a partner's loss absorption potential from the loss absoiption
balance.
potential ofthe next strongest partner.
liabilities should be withheld.
c. By subtracting a partners' loss absoiption potential from the loss absoiption
4. After payment ofthe liabilities, partners' loan accounts should be paid subject to
,
potential ofthe next strongest partner and dividing this difference by liis profit
,
and loss ratio. .
the right ofoffset.
d. By multiplying a partners' profit and loss ratio by the difference between his
5. In determining the amount ofinstallment distribution ofcash to the partners,it is
assumed that as ofthe date ofparticular disbursement,all cash on hand(excluding
cash withheld for the payment ofliabilities and anticipated liquidation expenses)is
to be disbursed and all the remaining non-cash assets will not be realized.Ifonly
loss absorption potentialand the loss absorption potential ofthe next strongest
^
partner.
3. In the cash distribution plan which partner gets the first cash distribution?
part ofthe cash is to be paid to the partners,the amount ofthe possible future loss
is the net assets ofthe business plus the cash withheld.
6. Cash distribution to the partneirs should be made with the objective ofsystematically
bfinging the ratio ofthe partners' capital accounts in agreement with the partners'
profit and loss ratio.
7. In the event ofliquidation,ifa partner has either a credit or debit loan balance and
a.
b.
c.
d.
The partner with the largest loan balance.
The partner with the largest loss absoiption potential.
The partner with the largest capital balance.
The partner witli the largest profit and loss ratio.
4. Whatis the largest possible loss resulting from the realization ofpartnership assets
that the accountant estimates when preparing a safe payment schedule?
I
installment payments are desire^ for practical purposes the balance can be combined
with the partner's capital account since the loan account may be used to offset a
debit capital balance as discussed earlier in Chapter 4.
v.
a.
b.
c.
d.
Book value ofrecorded assets.
Book value ofrecorded non-cash assets.
Fair value ofrecorded assets.
Fair value ofrecorded non-cash assets.
.S'W
-
01,-'
(
222
Chapter 5
5. Assuming no loans from partners, how is a partners' loss absorption potential
computed?
a. Multiply her pre-liquidation capital balance by her profit and loss ratio.
b. Multiply her pre-liquidation capital balance by her fractional share ofprofits
and losses.
c. Divide her pre-liquidation capital balance by her profit and loss ratio.
d. Divide her profit and loss ratio by her pre-liquidation capital balance.
6. In the preparation ofa cash distribution plan,each partners' loss absorption is
Partnership Liquidation By Installment
223
9. In calculating the safe payment,you assume:
a. Partnership liabilities have been paid.
b. No liquidation expenses will be paid.
c.
All non-cash assets are worthless.
d. Cash on Hand can be fully distributed.
10. In the preparation ofschedule ofsafe payment to partners, cash withheld for
future liquidation expenses and utnecorded liabilities that may be discovered is
treated as:
computed by:
a. Operating expenses.
a. Dividing each partners' capital account balance by the percentage ofthat
partners' capital account balance oftotal capital ofthe partners.
b. Multiplying each partners'capital account balance by the percentage ofthat
partners' capital account balance oftotal partners' capital.
c. Dividing the total ofeach partners' capital account,plus any loan receivable
from the partnership and minus any loan payable to the partnership,by the
partners' profit and loss ratio.
b. Liabilities.
c.
Loss on realization.
d. Possible loss.
11. In accounting for partnership liquidation, cash payments to partners after all
nonpartnercreditors'claims have been satisfied,butbefore the finalcash distribution,
should be according to:
d. Some other method.
7. In the liquidation ofa partnership in installments,the profit and loss ratio is used for
cash payments to partners:
a.
b.
c.
d.
The partners' relative profit and loss ratios.
The final balances in partner capital accounts.
The partners'relative share ofthe gain or loss on liquidations.
Safe payments computation.
a. At no time.
b. Throughoutthe course ofthe liquidation.
c. Once the partners capital account balances have been reduced to the profit
12. In a partnership liquidation,the final cash distribution to the partners should be
made in accordance with the:
and loss ratio.
d. Only for asset realizations thatresultin gain.
a.
b.
8. What a cash distribution plan?
a. A guideline for the cash distributions made to partners during a liquidation.
b. A list ofthe procedures to be performed during a liquidation.
c. A determination ofthe final distribution to be made to the partners on the
settlement date.
d. A detailed list ofthe transactions that will transpire in the reorganization ofa
partnership.
c.
d.
Partners'profit and loss ratio.
Balances ofthe partners'loan and capital accoimts.
Ratio ofthe capital contributions by the partners.
Ratio ofcapital contribution less withdrawals by the partners.
v;' ■
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Chapter 5
224
MULTIPLE CHOICES-COMPUTATIONAL
5-1:
5-3:
:'""5
t
Partners DD,EE,FF,and GG share profits 50%,30%,10%,and 10%.Accounts
maintained with partnersjust prior to liquidation follow:
The statement of financial position of the firm of RJ, SJ, and TJ just before
liquidation shows the following:
P120,Q00
Assets
Advances
Loans
(DR balances)
(CR balances)
Capitals
(CR balances)
P5,000
, 10,000
P40,000
30,000
DD
EE
50,000
10,000
22,000
30,000
8,000
Liabilities
RJ,loan
RJ,capital
SJ,capital
TJ,capital
225
Partnership Liquidation By Installment
FF
GG
15,000
P4,500
2,500
25,000
At this point P18,000 is available for distribution to the partners. How much
cash is to be distributed to GG?
P120,000
Total
RJ, SJ, and TJ share profits 5:3:2 respectively. Certain assets are sold for
P80,000. Creditors are paid in full, partners are paid P20,000, and cash of
P10,000 is withheld pending future developments. How much cash is to be
distributed to the partners?
a.
b.
c.
d.
RJ
SJ
P7,000
P5,750
P5,250
P7,550
PI3,000
14,250
14,750
12,450
a. P6,62S
b. PO
c. Pll,375
d. PI2,375
The following statement offinancial position was prepared for the Tan,Lim and
Wan Partnership on March 31,2011 and relates to items 5-4 through 5-6:
TJ
—
—
Other Assets
P 25,000
180,000
Total Assets
P205,000
Cash
5-2: The statement offinancial position ofthe firm ofAR,BR,CR,and DR,just prior
to liquidation shows:
AR,loan
AR,capital
BR,capital
CR,capital
DR,capital
PI,000
5,500
5,150
6,850
4,500
AR,BR,CR,and DR share profits 4:3:2:1 respectively. Certain assets are sold
for P6,000 and this is distributed to partners. How much cash should CR receive?
b. PO
c. P2,717
d. P6,000
Tan,capital(40%)
Lim,capital(40%)
Wan,capital(20%)
P 52,000
40,000
65,000
48,000
Total Liabilities& Capital
P205,000
Liabilities
The partnership is being liquidated by the sale ofassets in installments. The first
sale ofnon-cash assets having a book value ofP90,000 realizes P50,000.
5-4: The amount ofcash each partner should receive in the first installment is:
a. Tan,PO
a. P3,283
Liabilities
Assets
—
;Lim,P 5,000; Wan,PI8,000
b. Tan,PI2,000;Lim,P13,000; Wan,P22,000
c. Tan,P27,000;Lim,P 5,000; Wan,PI8,000
d. Tan,PO
;Um,P 5,000; Wan,P22,000
m7'-
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226
Chapter 5
5-5:
IfP3,000 cash is withheld for possible liquidation expenses,how much cash
should Wan receive?
a.
b.
c.
d.
P21,000
PI7,000
P 3,000
P15,000
Partnership Liquidation By Installment
5-8: Jacob,Santos and Hervas,partners,share net income and losses in the ratio of
5:3:2.The partners decided to liquidate tlie partnership.Their statement offinancial
position prior to liquidation is:
Cash
a.
b.
c.
d.
5-7:
P 40,000
210,000
As a separate case,assume that each partner properly received some cash after
the second sale ofassets. The cash to be distributed amount to P 14,000 from
the third sale ofassets, and unsold assets with a P6,000 book value remain.
How should the PI4,000 be distributed to Tan,Lim and Wan,respectively.
:
•.'.T ■ '
'~
P5,600; P 6,500;
PS,000; P 5,000;
P
-; Pll,200;
P5,600; P 5,600;
P2,800.
P4,000.
P2,800.
P2,800.
Total Assets
Jacob
a. None
b. P32,000
c.
Liabilities & Capital
Assets
Goodwill
P 35,000
100,000
10,000
Carpio,capital
Lobo,capital
P 19,000
72,000
54,000
Total Assets
P145,000
Total Liabilities&Capital
PI45,000
Other Assets
P250,000
Liabilities
None
d. None
Santos
P35,400
P62,400
P 9,600
P27,600
The liquidator anticipates that considerable time would be required to dispose
the assets. The expenses expected to be incurred in liquidating the partnership
Cash
Other Assets
P
6,000
126,000
P 6,000
P15,000
PI
5,000
c.
d. P 5,000
Lobo
P
-
b.
P
-
P250,000
P1,000
P1,000
Total Assets
. 'r
Hervas
P45,600.
P63,600.
P28,400.
P40,400.
Liabilities & Capital
are estimated at PI0,000. At this time the amounts ofcash to be distributed
safely to each partner are:
Carpio
Total Liabilities & Capital
5-9: Following is the statement offinancial position ofABCD partnership at March
31,2011, when the partnership is to be liquidated:
Assets
a.
Jacob,capital
Santos,capital
Heivas,capital
P 60,000
8,000
40,000
72,000
70,000
Liabilities
Jacob,loan
The partnership is to be liquidated by installment. The first sale ofnon-cash
assets with a carrying amount of PI20,000 realized P90,000. Liquidation
expenses paid amounted to P2,000. How much cash should be distributed to
each partner?
When Carpio and Lobo,partners who share profit equally, were incapacitated
due to an airplane accident,a liquidator was appointed to wind up their partnership.
Their statement offinancial position before liquidation is as follows:
Cash
Liabilities & Capital
Assets
Other assets
5-6:
227
P132,000
A,capital(25%)
B,capital(25%)
C,capital(25%)
D,capital(25%)
P 12,400
12,000
14,400
9,600
16,200
12,000
37,700
17,700
Total Liabilities 8c Capital
PI32,000
Liabilities
A,loan
B,loan
D,loan"
1-
Partnership Liquidation By Installment
229
Chapter 5
228
5-11: The amount ofcash withheld for anticipated liquidation expenses and unpaid
No. 5-9: Continued
liabilities is:
During the month ofApril 20H,assets having a book value ofP18,000 are sold
at a loss ofP2,400.Liquidation expenses ofP600 are paid as well as P7,200 of
the liabilities. Ofthe liabilities shown in the balance sheet,P240 represents salary
payable to D and PI60 represents salary payable to C.On April 30,2011 cash
is to be distributed to A,B,C and D as follows:
a.
b.
c.
d.
PI4,600
P 2,000
PI6,600
PI7,600
5-12: Cena,Batista, and Lashley share profits in 5:3:2 ratio. Their capital accounts
A
-
P
-
P
prior to liquidation(which is expected to resultin substantial gains)are as follows:
D
C
B
-
a.
P
b.
Pl,950
P1,950
c.
P
-
P
-
P
d.
P
-
P
-
P9,000
Pl,950
-
P9,000
Pl,950
PI,950
P
Cena
Batista
Lashley
PI 8,000 Cr. balance
P27,000 Cr. balance
P 3,000 Dr. balance
-
The partners wish to distribute cash as it becomes available so that the capital
accounts may be brought into the profit and loss ratio as rapidly as possible.
Items 10 and 11 are based upon the following:
Who is the partner to receive the first available cash and up to how much?
A statement offinancial position for the partnership ofDy,Sy and Lee,who
share profits in the ratio of 2:1:1, shows the following balances just before
liquidation;
Cash
Other Assets
Liabilities
Dy,capital
Sy,capital
Lee,capital
P12,000
59,500
20,000
22,000
15,500
14,000
a. Cena, up to P54,000
b. Batista, up to P54,000
c. Batista, up to PI6,200
d. Lashley, up to PI6,200
5-13: Capital and loan balances for AA,BB,and CC who share profits 2:2:1,are as
followsjust before liquidation:
AA,loan
AA,capital
BB,loan
On the first month of the liquidation, certain assets are sold for P32,000.
BB,capital
Liquidation expenses ofPI,000 are paid,and additional liquidation expenses
CC,loan
are anticipated. Liabilities are paid amounting to P5,400,and sufficient cash is
CC,capital
PI0,000
15,000
5,000
30,000
10,000
10,000
retained to insure the payment to creditors before making payments to partners.
Assuming that cash ofP12,000 is available as a first distribution to partners,how
On the first payment to partners,Dy receives P6,250.
much cash is to be distributed to CC?
5-10: The total cash distributed to the partners in the first installment is:
a. P5,833
b. P2,500
P20,000
b. P12,500
a.
c. P5,667
d. P3,333
P25,000
d. PlOyOOO
c.
. .il.'A
/. ..V '
Chapter 5
230
5-14: The firm ofJJ,KX,LL,and MM decides to liquidate.Partners share profits and
losses as follows: JJ,40%;KK,35%;LL,15%;and MM,10%.The partnership
trial balance on October 1,2011 the date on which liquidation begins,follows:
, Debit
Credit
Other assets
and Cruz receive at that time?
Arce
a, P-
Cruz
P-
c. Pd, P-
Accounts payable
P9,000
18,000
30,000
60,000
64,500
54,000
30,000
JJ,loan
KK,loan
JJ,capital
KK,capital
LL,capital
MM,capital
P265,500
231
5-15: IfBello received P2,000 from the first distribution ofcash, how much did Arce
b. P3,300
P10,000
255,500
Cash
Partnership Liquidation By Instaiiment
P2,200
P2,200
P3,300
5-16: If Arce received a total ofP20,000 as a result oftire liquidation, what was the
total amount realized from the sale ofthe non-cash assets?
a. P61,900
b. P85,900
c. P73,900
d. P24,000
P265,500
5-17: IfCruz received P6,200 on the first installment ofcash, how much did Bello
Cash ofP38,100is available at the end ofOctober.How much cash is distributed
receive at that time?
to the partners?
JJ
a.
P7,350
b. PO
c.
PO
d. PO
KK
PI6,650
P7,350
P7,350
PO
LL
MM
P5,100
P5,100
P5,100
PO
PO
PI6,650
PI6,650
a. P10,000
b. PI1,700
c. P 5,000
d. P 6,200 .
Use the following data for items 5-18,5-19 and 5-20:
PO
Items 5-15 through 5-17 are based on the following:
The statement offmancial position for Monzon and Nieva Partnership on June 1,
2011 before liquidation is as follows:
the end ofa very unprofitable year,they decided to liquidate the firm.The partner's
capital account balances at this time are as follows:
Arce
Bello
Cruz
P22,000
24,900
15,000
Liabilities & Capital
Assets
Partners Arce,Bello and Cruz share profits and losses in the ratio of5:3:2. At
Cash
Other assets
P 5,000
55,000
Total Assets
P60,000
Monzon,capital(60%)
Nieva,capital(40%)
P20,000
22,500
17,500
Total Liabilities &Capital
P60,000
Liabilities
In Jime,assets with a book value ofP22,000 are sold for P18,000,creditor are
The liabilities accumulate to P30,000,includmg a loan ofPI0,000 firom Arce.
The cash balance is P6,000. All the partners are personally solvent. The
paid in full, and P2,000 is paid to partners. In July, assets with book value of
PlOjOOO are sold forP12,000,liquidation expenses ofP500 are paid and cash
ofP12,500 is paid to partners. In August the remaining assets are sold for
partners plan to sell the assets in installment.
P22,500.
Chapter 5
232
5-18: In Jxme,Nieva should receive:
Partnership Liquidation By Installment
233
No. 5-2J - Continued
On June 15.2011,assets with a book value ofP30,000 were sold for P20,000
a. P -
cash. The proceeds were used to pay offliabilities ofthe partnership. During the
balance ofJune,no additional assets were liquidated,and outside creditors began
b. P2,000
c. PI,000
d. PI,500
to pressure the partnership for payment. On July 1, the partners agreed to
contribute personal assets, to whatever extent possible,in order to eliminate
their respective capital deficits. Shortly thereafter, assets with a book value of
5-19: In July,Monzon should receive:
P30,000 and a fair value ofP23,000 were distributed to Carla.
a.
P
b. P 7,200
Assuming additional noncash assets with a book value ofP40,000 are sold in
c. P 5,300
July for P54,000,how much cash would be distributed to partner Maria?
d. PI2,000
5-20: In August,Monzon and Nieva should receive:
Monzon
P 9,000
P 9,000
b. P -
c. PI3,500
d. P20,700
P24,600
b.
P
c.
P 3,200
P20,600
d.
Nieva
a. PI3,500
a.
200
5-22: ABC Partnership engaged in real estate business had the following condensed
statement offinancial position prior to liquidation:
P
PI6,300
Assets:
5-21: Carla,Maria,and Rita are partners in a business being liquidated.The partnership
P12,000
Cash
has cash ofP8,000,noncash assets with a book value ofP96,000,and liabilities
Noncash assets
ofP63,000.The following information relates to the individual partners as of
Total assets
180.000
PI02,000
June 1,2011
Liabilities and Capital
Carla
Maria
Rita
Liabilities
IV.
Loans payable to partners
Capital balances(deficit)
P5,000
P47,000
Personal assets
Personal liabilities
Profit and loss percentage
(14,000)
10,000
5,000
15,000
6,000
P3,000
25,000
15,000
60%
20%
20%
v .;■
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,
r
Loan payable to A
A,capital(50%)
B,capital(30%)
C,capital(20%)
Total liabilities and capital'
P35,000
15,000
45,000
70,000
27.000
PI92,000
The percentages in parenthesis after the partners' capital balances represehttheir respective interests in profits and losses.
Partnership Liquidation By Installment
Chapter 3
234
5-22 - Continued
235
cut
1. Ifassets with a book value ofP30,000 were sold for P20,000,how much of
ESQSSfll
the available cash could be distributed to Paitner A?
a.
P45,000
Suarez,Tulio and Umali are partners sharing profits in the ratio of40:35:25.On December
31,2011,they agree to liquidate. A statement offinancial position prepared on this date
b.
P
follows:
c.
P 2,000
P20,000
d.
0
the available cash could be distributed to Partner A?
b.
c.
d.
P 2,000
46,000
Cash
Other Assets
2. Ifassets with a book value ofP60,000 were sold for P70,000,how much of
a.
Liabilities & Capital
Assets
tf,
Suarez,capital
Tulio,capital
Umali,capital
P5,000
P
0
Total Liabilities& Capital
P48,000
Total Assets
P35,000
P37,000
P6,000
5,000
2,500
14,450
12,550
7,500
Liabilities
Tulio,loan
Umali,loan
P48,000
The results ofliquidation are summarized below:
Cash Withheld at
3. Assuming assets with a book value ofP70,000 were sold for P50,000 and
that all available cash was distributed.For whatamount would the remaining
assets have to be sold in order for Partner B to receive a total ofP79,000
End ofMonthfor
Assets
Liquidation
Expenses
Cash
Realizations
Book Value
Realized
Estimated Future
Expenses
cash from all liquidation activities?
a.
b.
c.
d.
January
February
PI50,000
PI60,000
PI55,000
PI65,000
Pi2,000
7,000
March
15,000
April
12,000
P10,500
6,000
10,000
4,000
750
P2,000
1,250
600
500
P500
400
-
All cash available,exceptthe amount withheld for future expenses,is distributed at the
end ofeach month.
Required:Prepare a statement ofliquidation with supporting schedules.
■MTiinnnroj
Partners MB and NC have decided to liquidate their business. The ledger shows the
following account balances:
Cash
Inventory
i .- . j
P25,000
120,000
Accounts Payable
Bell, Loan (12%)
Miller, Capital
Bell, Capital
\ r
•
♦ I.J
<
PI 5,000
60,000
60,000
5,000
Chapter 5
236
Partnership Liquidation By Installment
237
Problem 5-2: Continued
MB and NC share profits and losses in a 8:2 ratio. The 12 percent note payable to NC
contains a provision that interest ceases accruing at the date the business terminates as
a going concern. During the first month ofliquidation, halfthe inventory is sold for
P40,000,and P10,000 ofthe accounts payable is paid. During the second month,the
rest ofthe inventory is sold for P30,000,and the remaining accounts payable are paid.
Cash is distributed at the end ofeach month,and the liquidation is completed at the end
ofthe second month.
Problem 5-4
X,Y and Zshare profits in the ratio of5:3:2. The following balances are obtained prior
to partnership liquidation:
Capital balances
Loan balances
Required:Prepare a statement ofpartnership realization and liquidation with a schedule
ofsafe payments for the 2-month liquidation period.
Y
Y
Z
P60,000
22,500
P45,000
15,000
P20,000
6,500
Assets are sold and cash is distributed to tlie partners in monthly installments during the
course ofliquidation as follows:
Problem 5-3
The accountantfor the Horizon Partnership prepared the statement offmancial position
below immediately prior to liquidation ofthe partnership.
January
February
March
April(final distribution)
During May 2011,assets with a carrying amount ofP105,000 were sold for amount of
P75,000 cash and all liabilities were paid; during June,assets with a carrying amount of
P61,000 were sold for P25,000 cash,and in July the remaining assets with a carrying
amount ofP114,000 were sold for P81,000 cash. The cash available at the end ofeach
month was distributed promptly.The partners shared net income and losses equally.
P 7,500
20,000
45,000
15,000
Required:
1. Prepare a program to show how cash should be distributed by the liquidator during
the entire course ofliquidation.
2. Using the program developed above,prepare schedules summarizing the payments
to be made to partners at the end ofeach month.
Horizon Partnership
Statement ofFinancial Position
April 30,2011
Assets
Cash
Other assets
Problem 5-5
P 20,000
280,000
■
Total
•
P300,000
Liabilities & Partners'Capital
Liabilities
P 80,000
SS,capital
IT,capital
PP,capital
Total
60,000
70,000
90,000
P300,000
Required:
a. Prepare a statement ofrealization and liquidation covering the entire period of
liquidation,and a supporting working paper showing the computation ofinstallment
pajnnents to partners as cash becomes available.
On January 1,2011,the partners ofAB,CD and EF who share profits and losses in the
ratio of5:3:2,respectively, decide to liquidate their partnership. The partnership trial
balance at this date is as follows:
Debit
Cash
Accounts Receivable
Inventory
Machinery and Equipment(net)
AB,Loan
Accounts Payable
corresponding to the income-sharing ratio? Ofwhatsignificance is this relationship
with respect to subsequent cash distributions to partners?
Total
b. At what point in liquidation did the partners' capital accounts have balances
P 18,000
66,000
52,000
189,000
■
30,000
P 53,000
20,000
118,000
90,000
74,000
CD,Loan
AB,Capital
CD,Capital
EF. Capital
Credit
P355,000
P355,000
,1,1
t ■ ■'
Chapter 5
238
\
;; V
Partnership Liquidation By Installment
239
Problem 5-6: Continued
Problem 5-5: Continued
t
The partners plan a program ofpiecemeal conversion ofassets in order to minimize
liquidation losses. All available cash,less an amount retained to provide for future
expenses,is to be distributed to the partners at the end ofeach month. No interest
accrues on partners'loans during Uquidation.A summary ofthe liquidation transactions
Cash Realized
Cash Distributed
from Sale ofAssets
to Partners
Cash Withheld
P40,000
35,000
P25,000
40,000
P15,000
10,000
January
February
is as follows:
Required:
January, 2011
1. P51,000 was collected on accounts receivable,the balance is uncollectible.
2. P38,000 was received for the entire inventory.
1. Prepare a program to show how cash should be distributed during the entire course
3. P2,000 liquidation expenses were paid.
4. P50,000 was paid to outside creditors, after offset ofa P3,000 credit memorandum
received on January 11,2011.
5. PI0,000 cash was retained in the business at the end ofthe month for potential
unrecorded liabilities and anticipated expenses.
ofUquidation.
2.
Using the program above, prepare schedules summarizing the payments to be made
to partners at the end ofJanuary and February. Indicate what part of the payments
are to be applied against loan balances and against capital balances.
Problem 5-7
February, 2011
6. P4;000 liquidation expenses were paid.
7. P6,000 cash was retained in the business at the end ofthe month for potential
The partnership of Bronze, Gold and Silver has asked you to visit it in winding up the
affairs ofthe business. You compile the following information.
1. The trial balance of the partnership on June 30,2011, is:
unrecorded liabilities and anticipated expenses.
March,2011
. Debit
8. P146,000 was received on sale ofall items ofmachinery and equipment.
9. P5,000 liquidation expenses were paid.
10. The P30,000 loan from Able is approved by the partners for offset against his
capital account.
11. No cash was retained in the business.
Required: Prepare a statement ofpartnership liquidation for the partnership with
schedules ofsafe payments to partners.
Problem 5-6
Partners M,N,O and P share profits in the ratio of3:3:1:1. The following balances are
Cash
Accounts Receivable (net)
Inventory
Plant and Equipment (net)
Loan to Bronze
Loan to Silver
Accounts Payable
Bronze, Capital
Gold, Capital
Silver, Capital
Total
P
Credit
6,000
22,000
14,000
99,000
12,000
7,500
P 17,000
67,000
45,000
31,500
PI 60,500
PI 60,500
obtainedjust before partnersh^ liquidation:
2. The partners share profits and losses as follows: Bronze, 50 percent; Gold, 30
M
Capital balances
Loan balances
P70,000
20,000
N
P70,000
5,000
O
P30,000
25,000
P
P20,000
15,000
Proceeds from the sale ofpartnership assets during January and February by the one in
charge of Uquidation and distribution ofcash to partners at the end ofeach month are as
follows:
percent; and Silver 20 percent.
3. The partners are considering an offer of P100,000 for the accounts receivable,
inventory, and plant and equipment as of June 30. The P100,000 will be paid to
creditors and the partners in installments, the number and amounts of which are to
be negotiated.
Required: Prepare a cash distribution plan as ofJune 30,2011, showing how much
cash each partner will receive ifthe offer to sell the assets is accepted.
- ' ^ ' -/fh .Vi^', ' ■ • ;; Chapter 5
240
Problem 5-8
Partnership Liquidation By Installment
241
Problem 5-9
Part A
The partnership of North, South, East and West was formed several years ago. Some
of the partners have recently undergone personal financial problems and decided to
terminate operations and liquidate the business. The following statement of financial
position is drawn up as a guideline for this process:
Several years ago, Dan and Red formed DR Company, a partnership. Last year, they
admitted Ben as a partner and recognized goodwill at that time. However, after failing
to gain a sufficient market ofcontinuing customers, they recently agreed to liquidate the
business. The statement of financial position, with profit and loss-sharing percentages
just prior to liquidation, is as follows:
DR Company
Cash
Accounts receivable
Inventory
Property and equipment
P 15,000
82,000
101,000
253,000
North, capital (30%)
South, capital (10%)
East, capital (20%)
West, capital (40%)
P 74,000
35,000
120,000
88,000
74,000
60,000
Total liabilities and capital
P451.000
Liabilities
East, loan
Statement of Financial Position
August 1,2011
Assets
Cash
Goodwill
P 16,000
58,000
64,000
24,000
At the time the liquidation commences, expenses of P16,000 are anticipated as being
necessary to dispose of all property.
Total Assets
PI 62,000
Required: Prepare a cash distribution plan for this partnership.
Liabilities and Capital
Accounts Payable
Total assets
P45L000
Receivables
Inventory
Dan, Loan
Part B
The following transactions transpire during the liquidation ofthe North, South, East and
west partnership:
Dan, Capital (40%)
Red, Capital (30%)
Ben, Capital (30%)
Total Liabilities and Capital
•
P58,000
16,000
26,000
45,000
17,000
PI 62,000
Of the total accounts receivable, 80 percent are collected with the rest judged as
uncollectible.
Property and equipment are sold for P150,000.
Safe payments are made.
West becomes personally insolvent. No further contributions will be forthcoming
from this partner.
All liabilities are paid.
All inventory is sold for P71,000.
Safe payments are again made.
Liquidation expenses of P11,000 are paid.
Final cash payments are made to the partners based on the assumption that all
partners other than West are personally solvent.
Required: Prepare joumal entries to record these liquidation transactions.
The loan from Dan was made to provide working capital for the partnership to operate
during the last two months.
During August 2011, the first month of liquidation, the partnership collected P30,000 of
the receivables and decided to write offP12,000 of the remaining receivables. Sales of
one-half of the book value of the inventory realized a gain of P6,000. The partners
estimate that the costs of liquidating the partnership are expected to be P4,000 for the
remainder of the liquidation process.
Required
Prepare a schedule of safe payments to partners as ofAugust 31,2011, to show how
the available cash should be distributed to partners.
Chapter 5
242
Problem 5-10
(Simulation Problem)
On January 2,2008,Jenny and Kenny formed a partnership.The following assets were
contributed by each ofthe partners:
Jenny
Cash
Inventory
Equipment
Chapter6
Kenny,
P40,000
P60,000
10,000
180,000
60,000
Joint Ventures
'•-■'Mi .;'
The equipment ofKenny is subject to a mortgage ofP50,000 which the partnership has
assumed.The partnership agreement specifies that each partner receives 10% interest
on her beginning capital balance. Jenny receives an annual salary ofP15,000;Kenny
receives an annual salary ofP20,000.The remaining profit or loss is divided using 2:3
ratio with 2 parts assigned to Jenny and 3 parts assigned to Kenny.
A joint venture is a contractual arrangement whereby two or more parties
undertake an economic activity which is subject to joint control. Control is the
power to govern the financial and operating policies of an economic activity so
as to obtain benefits from it. Joint control is the contractually agreed sharing of
During 2008,the partnership had an income ofPI85,000. Assume there were no
drawings during 2008.
A joint venture is a business entity owned, andjointly controlled by a small group
On January 2,2009,Jenny and Kenny decide to admit a new partner,Lenny,for a 1/6
of investors as a separate and specific business project organizedfor the mutual
benefit of the ownership group. Many joint ventures are short-term associations
oftwo or more parties called the venturers or investors tofulfill a specific project,
interest in the firm for P175,000.The bonus method is used to record the admission of
the new partner. After admitting the new partner the partnership agreement is amended
as follows:
control over an economic activity.
such as the development ofreal estate, joint oil drilling efforts, or thefinancing of
a motion picture effort.
Each partner receives 10% interest on her beginning capital balance. Each partner
receives an annual salary ofP20,000.The residual profit or loss is divided in a ratio
Contractual Arrangement
of30% to Jenny,50% to Kenny,and 20% to Lenny.
On December 31,2010,the partnership is dissolved. On this date, after closing the
books,the following information is available:
According to Philippine Accounting Standard (PAS) 31, if there is no contractual
arrangement to establish the joint control, the investments are not deemed to be joint
ventures.
Cash
Loan to Kenny
Other assets
Liabilities
Jenny,Capital
Kenny,Capital
Lenny,Capital
P160,000
50,000
700,000
110,000
200,000
400,000
200,000
During the month ofJanuary 2011,assets with a book value ofP180,000 were sold for
P210,000.
Required:
(1) Preparejoumal entry to record the contribution ofthe partners on Januaiy 2,2008.
(2) Preparejoumal entry to record the admission ofLenny to the partnership.
(3) Prepare a schedule ofsafe payments as ofJanuary 31,2011.
Contractual arrangements can be created in different ways. Whatever fonn, the
contractual arrangement is usually in writing and deal with the nature ofthe activities, the
appointment of the board of directors, the capital contributions by the venturers, and
the sharing of profits and losses of the joint ventures. The key thing is that no single
venturer should be in a position to control the activities.
The contractual arrangement may identify one venturer as operator or manager of the
joint venture. The manager does not control the joint venture but acts within the financial
and operating policies which have been agreed by the venturers in accordance with the
contractual annngement and delegated to the manager.
243
Chapter 6
244
Joint Ventures
FORMS OF JOINT VENTURE
Ajoint venture may be organized in many forms and structures.There are three different
forms ofjoint venture set out in PAS 31:
•
Jointly controlled operations
245
An example ofthis type ofventure is when two partiesjointly control a leased property,
each taking a share ofthe rents received and expenses incurred. Normally,this will not
involve the establishment ofa company orpartnership or any other business entity.
Each venturer control its economic benefits through its share ofthe asset.
Separate fmancial statements ofeach venturer will show:
• Jointly controlled assets
•
Jointly controlled entities
In all ofthese forms,there must be contractual arrangementthat establishedjoint control.
1. Its share ofthejoint assets, any liabilities it has incurred directly.
2. Its share ofanyjoint liabilities together with any incomefrom the sale or
usage ofits share ofthe output ofthejoint venture, and
3. Any share ofthe expenses incurred by thejoint venture.
Joint Controlled Operations
Injointly controlled operations,a separate entity is not established.Each venturer uses
its own assets,incurs its own expenses and liabilities,and raises its own financing.The
agreement between the venturers normally would set out the details ofsharing the
Since the accounting treatment ofjointly controlled assets is based on the substance of
the transaction and its economic reality.It is unlikely that separate financial statements
will be prepared for thejoint venture,although a record may be kept ofany expenses
incurred.
revenues and expenses.
Jointly Controlled Entities
An example ofthis type is when two or more venturers combine their operations,resources
and expertise to manufacture,marketand distribute a particular product.Each venturer
would pay the costs and take a share of the revenue from the sale of the product
according to the agreement. Here each venturer will show in its separate financial
Ajointly controlled entity normally involves the setting up ofa company or partnership
or other entity in which each ofthe venturers has an interest. This type ofjoint venture
formalizes the legal relationship between the venturers and limits each liability to the
amount ofthe investment in the venture.
statements:
1. The assets that it controls.
2. The liabilities that it incurs, together with the expenses that it incurs and,
3. Its share ofthe incomefrom the sale ofgoods or services.
Because thejoint venture is simply recording its own assets and liabilities and expenses
that have been incurred and its shaie ofthejoint venture income,there are no adjustments
or other consolidation procedures used in respect to these items.
Each venturer normally would contribute assets and other resources to thejointly
controlled entity. These assets are resources included in the accounting records ofthe
venturer and recognized as an investmentin thejointly controlled entity. An example
is where a local entity enters into an agreement with a foreign company to set up a
marketing company.The separate entity will bejointly controlled by thejoint venturer,
the local company and the foreign company.
Ajointly controlled entity maintainsits own accounting records and prepares and presents
financi^statements like any other enterprisesin conformity with governmentrequirements
and the Philippine Financial Reporting Standai'ds(PFRS).
Jointly Controlled Assets
ACCOUNTING FOR JOINT VENTURES
This type involves thejoint control and ownership by the venturers ofone or more
assets contributed to,or acquired for the purpose the venture is organized.Each venturer
There are two general methods ofaccounting for thejoint venture,these are(1)Separate
share in the income eamed and expenses incurred from thejointly controlled assets.
set ofbooks is maintained for thejoint venture and(2)No separate set ofbooks is
maintaned for thejoint venture.
.1 ■ ..
Chapter 6
246
247
Joint Ventures
SEPARATE SET OF BOOKS IS MAINTAINED FOR THE JOINT VENTURE
-PAS 31
Comprehensive Illustration
joint venture as expense.
On January 2,2011,Amy Company and Bea Company formed ajoint venture to buy
and sell a particular merchandise. Each invested P500,0G0 cash for a 50% interest in
thejoint venture. Amy is to act as the manager/operator ofthejoint venture. Thejoint
venture is to be called Ambe Company.
The following are accounting procedures to be used in the separate set ofbooks of
thejoint venture and the books ofthe venturer.
2011 as follows:
Normally a venturer is appointed as operator or manager ofthe joint venture. The
manager is usually paid a managementfee for such duties. The fees are treated by the
Amy Company reported the following summarized transactions ofthejoint venture for
1. Purchase merchandise on account,P600,000.
Books of the Joint Venture
2. Sold merchandise costing P280,000 on account,P400,000.
3. Collectedjoint venture accounts receivable,P300,000.
Alljoint venture transactions are recorded in thejoint venture books maintained by the
4. Purchased merchandise for cash,P150,000.
manager/venturer.The books will carry the usual accounts for assets,liabilities, capital
revenues and expenses.
'
5.
6.
7.
8.
Books of the Venturers
Soldmerchandise costing P180,000 for cash,P250,000.
Paidjoint venture expenses,PI20,000.
Paidjoint venture accounts payable,P420,000.
On December 31,profits and losses are computed and distributed among the
venturers.
Each venturer maintains an investment account"Investment in Joint Venture" on its
books for its share ofthejoint venture capital.
Thejoumal entries to record the above transactions in the separate books ofthejoint
venture and the venturers are:
PAS 31 allows two accounting treatments for an investment in thejointly controlled
entity:
1. Proportionate consolidation
Books of the Joint Venture
2. The equity method ofaccounting(PAS 28)
2011
January 2: Cash
Amy Company, Capital
Bea Company, Capital
To record the investment ofAmy
Proportionate Consolidation.
Under the proportionate consolidation method ofaccounting,the Statement ofFinancial
Position ofthe venturer includes its share ofthe net assets ofthejoint venture and the
income statement includes its share ofthe income and expenses ofthejoint venture.
Differentreporting formats may be used to present proportionate consolidation offinancial
The venturer may combine each ofits share ofthe assets and liabilities,income
and expenses ofthejointly controlled entity with similar items in its financial
statements; or
•
500,000
500,000
Company and Bea Company.
statements namely:
•
1,000,000
(1) Inventory
Accounts payable
'J
600,000
600,000
(2) Accounts receivable
Sales
The venturer may include separate line items for the same.
Cost ofsales
Inventory
Equity Method
Under this method,the Investment in Joint Venture account is debited for the initial and
(3) Cash
additional investments and for the venturer's share in profits. Withdrawals and shares of
400,000
400,000
;
280,000
280,000
200,000
300,000
Accounts receivable
losses are credited to the investment account. Each venturer records only those
(4) Inventory
transactions affecting his investmentto which he is a party.The investment account will
Cash
ndtmally have a debit balance representing the interest ofthe ventm^er.
m.
150,000
150,000
Chapter 6
248
(5) Cash
Illustration 6-2
250,000
250,000
Sales
Cost ofsales
Inventory
249
Joint Ventures
180,000
AMBE COMPANY (a joint venture)
Statement of Venturers' Capital
For Year Ended December 31,2011
180,000
(6) Expenses
120,000
(7) Accounts payable
Bea Company
Combined
Net income
P500,000
35,000
P500,000
35,000
PI,000,000
70,000
Venturers' capital, Dec. 31
P535,000
P535,000
PI,070,000
Investments, Jan. 2
120,000
Cash
Amy Company
*
420,000
420,000
Cash
Illustration 6-3
AMBE COMPANY (a joint venture)
(8) Sales
Cost ofsales
Expenses
Income summary
To close income and expenses
650,000
Statement of Financial Position
460,000
120,000
70,000
December31,2011
Assets
. .. '
Inventory
P 760,000
200,000
290,000
Total assets
PI,250,000
Cash
Accounts receivable
Income summary
70,000
Amy Company, Capital
Bea Company, Capital
35,000
35,000
FINANCIAL STATEMENTS
The condensed financial statements for thejoint venture ofAmbe Company for 2011
were as follows:
Liabilities and Venturer's Capital
Accounts payable
Amy Company, Capital
Bea Company, Capital
Total liabilities and venturers capital
P
180,000
535,000
535,000
PI,250,000
Illustration 6-1
AMBE COMPANY(ajoint venture)
Books of the Venturers
Statement ofComprehensive Income
For Year Ended December 31,2011
P650,000
Revenue
/
Cost of sales
Gross profit
190,000
120,000
Expense
Net income
Division of net income:
460,000
•
P 70,000
Under the equity method of accounting, both Amy Company and Bea Company
prepare the followingjoumal entries for the Investment in Ambe Company.
2011
Jan. 2:
Investment in Ambe Company (joint venture) 500,000
Cash
500,000
To record investment in joint venture.
.
Amy Company
Bea Company
P35,000
35,000
Total
P70,000
Dec. 31: Investment in Ambe Company (joint venture) 35,000
Investment income
To record share ofAmbe Company net income
(P70,000 X 50%o)
/■
,
"
35,000
Chapter 6
250
251
Joint Ventures
Under theproportionate share method ofaccounting,in addition to the two foregoing
journal entries,both Amy Company and Bea Company will prepare the followingjournal
entry for their respective shares ofassets,liabilities, revenues and expenses ofAmbe
Company:
Illustration 6-4
The Equity Method and
Proportionate Consolidation
Compared
J
•
■'
f
'
•'
1
Proportionate
2011:
Dec.31:
Cash (P760,000X .50)
Accounts receivable (P200,000x .50)
Inventory (P290,000 x .50)
Cost ofsales (P460,000 X .50)
,
Expenses (P120,000 x .50)
Investment income
Amy Company
(Equity Method)
380,000
100,000
145,000
230,000
60,000
Consolidation
(Amy and AMBE)
Statement ofComprehensive Income
Revenue
Investment income
35,000
Accounts payable (P180,000 x .50)
Revenue (P650,000 x .50)
Investment in Ambe Company (JV)
To record proportionate share ofjoint venture's
assets, liabilities, revenue and expenses.
AMBE Company
(Joint Venture)
90,000
325,000
535,000
P2,500,000
35,000
P 650,000
P2,825,000
Total
2,535,000
650,000
P2,825,000
Cost of of sales
Expenses
1,500,000
480,000
460,000
120,000
1,730,000
540,000
Total
1,980,000
580,000
2,270,000
70,000
P 555,000
Net income
P 555,000
Statement of Financial Position
Cash
PI,675,000
Accounts receivable
350,000
The application ofthe proportionate consolidation means thatthe Statement ofFinancial
Position ofthe venturer includes its share ofthe assets that it controlsjointly and its
share ofthe liabilities for which it isjointly responsible.The statement ofcomprehensive
Inventory
Investment in Ambe
income ofthe venturer includes its share ofthe income and expenses ofthe jointly
400,000
535,000
P
P 760,000
200,000
290,000 .
P2,055,000
controlled entity.
450,000
545,000
Total
P2,960,000
PI,250,000
P3,050,000
P 360,000
2,000,000
600,000
i 180,000
Comparative financial statements under the two methods(accounting under the equity
method and proportionate consolidation)appear in
6-4. Column 1 presents
Accounts payable
Capital stock
Retained earnings
Venture capital
450,000
2,000,000
600,000
a summary ofAmy Company's separate income statement and balance sheet,assuming
Total equities
P2,960,000
Equity Method and Proportionate Consolidation Compared
that it uses the equity method ofaccounting for its investment in Ambe Company,ajoint
venture.Ambe Company'sstatement ofcomprehensive income and statementoffianncial
position are summarized in column 2.In column 3,Amy Company has consolidated its
share(50%)ofAmbe Company's assets,liabilities,revenues and expenses(from column
1,070,000
PI,250,000
P3,050,000
PAS 31 does not recommend the use ofthe equity method because proportionate
consolidation better reflects the substance and economic reality ofa venturer's interest
2)- in other words,a proportionate consolidation.
in ajointly controlled entity,that is to say,control over tlie venturer's share ofthe future
economic benefits. Nevertheless,this standard permits the use ofthe equity method,as
Note that the P1,070,000 total venture capital is eliminated against the P535,000
investmentin Ambe Company balance,and against halfofAmbe's asset,liability,revenue
and expense account balances in the proportionate consolidation.
ah altemative treatment, when recognizing interests injointly controlled entities.
M-
253
Joint Ventures
Chapter 6
252
Books ofAmy Company(Manager)
NO SEPARATE SET OF BOOKS IS MAINTAINED FOR THE JOINT
Books ofBea Company
VENTURE
This method can be used byjoint venture involving simple business undertaking tliat last
for shortperiods.Because ofthe risks involved and the relatively short period ofduration
ofthe venture,conservatism dictates that no income is recognized until the venture is
completed.The computation and distribution ofincome to the venturers are made only
upon the completion ofthe venture and not at regular or periodic intervals except under
specific circumstances. Generally a venturer is appointed as operator or manager ofthe
joint venture.
(I) JVInventory
JV accounts payable
600,000
(2) JV accounts receivable
Joint Venture(Sales)
400,000
600,000
400,000
Joint Venture(cost ofsales) 280,000
Joint Venture inventory
280,000
(3) JVcash
(4) JVinventory
(6) Joint Venture
250,000
250,000
180,000
120,000
JV cash
(7) JVAccountspayable
Amy Company
Joint Venture
250,000
Joint Venture
180,000
280,000
150,000
JV inventory
and credits to asset and liability accounts,the usual account titles will be used with the
simple addition ofthe descriptive phrase"Joint Venture".For example.Joint Venture
Cash,Joint Venture Accounts Receivable,Joint Venture Accounts Payable,etc.
280,000
150,000
Joint venture(cost ofsales) 180,000
In the books ofthe manager/operator alljoint venture transactions that require debits
Joint Venture
Amy Company
400,000
200,000
JV cash
(5) JVcash
Joint Venture(sales)
400,000
200,000
JV accounts receivable
Under this method,all thejoint venture costs,expenses,and income transactions are
recorded in the books ofthe venturer using a Joint Venture account. This account is
debited for all costs and expenses ofthe joint venture and credited for all revenues
necessary in the computation ofthejoint venture profit or loss regardless of whom
among the venturer is responsible.
Amy Company
Joint Venture
250,000
180,000
Amy Company
Joint Venture
120,000 , Amy Company
120,000
120,000
420,000
JV cash
420,000
Illustration
(8) JVcash
Joint venture(sales)
Using thejoint venture transactions ofAmy Company and Bea Company in the previous
example,except that the venture is terminated on December 31,2011 and the unsold
inventory was sold atP320,000.Assume further,that alljoint venture accounts receivable
and payable are settled. Amy is appointed as the manager/operator ofthejoint venture.
Thejoumal entries to be recorded in the books ofAmy and Bea are as follows;
Books ofAmy(Manager)
Books ofBea Company
2008
JV cash
Cash
Bea Company
Amy Company
1,000,000
500,000
Cash
500,000
500,000
500,000
■
Amy Company
320,000
Joint Venture(cost ofsales) 290,000
JVinventory
290,000
JVcash
JVaccounts receivable
200,000
JVaccountspayable
180,000
JV Cash
Jan. 2:
320,000
200,000
180,000
320,000
320,000
Joint Venture
Joint Venture
Amy Company
290,000
290,000
Chapter 6
254
Uncompleted Joint Ventures
On December 31,2011,thejoint venture is completed and terminated.Thejoint venture
profit or loss which is equal to the balance ofthe Joint Venture account is therefore
computed and distributed to the venturers as follows:
As stated earlier,conservatism dictates that the profit or loss onjoint venture should be
computed only upon the temiination or completion ofthe venture. However,ifthe
outcome can be reasonably assured and the undertaking is stable,in nature it may be
desirable to estimate and record the portion ofthe profit or loss to date. The withdrawal
Joint Venture
(2) 280,000
(5) 180,000
(2) 400,000
(5) 250,000
(8) 320,000
■ (6) 120,000
; .
255
Joint Ventures
ofa venturer before its completion will also require the computation and distribution of
profit or loss on the date ofthe venturer's withdrawal.
(8) 290,000
870,000
Ifseparate set books is maintained for thejoint venture,the computation ofthe profit or
loss before its completion poses no special problem.It is computed in the usual manner,
that is, by closing all nominal accounts to the Income Summary account. Credit balance
970,000
100,000
represents a profit, while debit balance represents a loss.
Books ofAmy Company
Joint Venture
Books ofBea Company
100,000
Profitfrom JV
Bea Company
50,000
50,000
Joint Venture
Profitfrom JV
Amy Company
Ifno separate set ofbooks is maintained,an analysis ofthe balance ofthe Joint Venture
IOO,OO0
account in the books ofthe manager/venturer is necessary to compute the profit or loss
50,000
50,000
before the completion ofthejoint venture.
Cash settlement to the venturers is also made upon completion ofthe venture. Cash
settlement to venturers is equal to the balance ofthe venturers accounts in the separate
books ofthe venturers. A debit balance represents duefrom the venturer while a credit
balance represent due to the venturer.
Prior to the completion ofthe venture,the Joint Venture account, whether it has a debit
The entry to record the settlement the books ofthe venturers are:
the following altemative situations.
balance or a credit balance, will require adjustment at the time financial statements are
prepared. To illustrate the nature ofsuch adjustment, assume that Ramos and Santos
each invests merchandise posting PI0,000 in ajoint venture. Ramos is to act as the
manager ofthe venture.Profit or loss from the venture is to be divided equally. Assume
(a) One-halfofthe merchandise is sold for P15,000.
(b) One-halfofthe merchandise is sold for P20,000.
(c) One-halfofthe merchandise is sold for P25,000.
Books ofAmy Company
Dec.31: Bea Company, Capital
550,000
550,000
Joint Venture cash
The balance ofthe Joint Venture account and other related facts under each altemative
To record settlement to Bea.
are as follows:
Books of Bea Company
Cash
Amy Company
550,000
Balance in Joint
Inventory on Hand
Profit on Venture
Venture account
at Cost
to Date
550,000
(a) P5,000(debit)
-0(b)
(c) P5,000(credit)
To record cash settlement received.
Note that the Venturers account is closed after cash settlement among the venturers is
PI0,000 ,
10,000
10,000
P 5,000
10,000
15,000
made.
'1
"v 'i; ■ '■
'.V
4 "i i"'
'•'.<
i V;.. ,
\
. ..
;v V.
Chapter 6
256
The entries below,applicable to each ofthe three above-stated situations, adjust the
Joint Venture account to an amount equal to the cost ofthe inventory on hand and
recognize the income thus far earned from the uncompletedjoint venture.
Books ofRamos(Manager)
(a) Joint venture
Investment in joint venture
2,500
'2,500
Santos capital
(b) Joint venture
5,000
5,000
Santos capital
Philippine Accounting Standard(PAS)31 provides the following disclosure to
the financial statements.
2,500
1. A venturer should disclose the aggregate amount ofthe following contingent
2,500
Investment income
liabilities, unless the probability ofloss is remote,separately from the amount of
other contingent liabilities:
Investment in joint venture
10,000
Investment income
Disclosure
Books ofSantos
5,000
Investment income
257
Joint Ventures
i 'i ;
5,000
r
5,000
Investment income
(a) any contingent liabilities that the venturer has incurred in relation to its
interests injoint ventures and its share in each ofthe contingent liabilities
which have been incurred jointly with other venturers;
(c) Joint venture
Investment in joint venture
15,000
7,500
7,500
Investment income
Santos capital
7,500
7,500
Investment income
(b) its share ofthe contingent liabilities ofthejoint venturers themselves for
which it is contingently liable;and
(c) those contingent liabilities that arise because the venturer is contingently
In the books ofRamos,the manager/venturer,the relevant account under case(a)
would appear as follows:
liable for the liabilities ofthe other venturers ofajoint venture.
2. A venturer should disclose the aggregate amountofthe following commitments
Merchandise
Merchandise
Adjustment
(1) P10,000
(2) 10,000
5,000
(4)
Sale
in respect ofits interests injoint ventures separetely from other commitments.
Santos capital
Joint Venture
(3) P15,000
Merchandise(2)
Adjustment (4)
P10,000
2,500
(a) any capital commitments ofthe venturer in relation to its interests injoint
ventures and its share in the capital commitments that have been incurred
jointly with otlier venturers; and
Inventory
Cash
Sale
(3) P15,000
Investment (1)
(b) its share ofthe capital commitments ofthejoint ventures themselves.
PIO.OOO
3. A venturer should disclose a listing and description ofinterests in significant
InvestmentIncome
Adjustment (4)
2,500
IfRamos prepared financial statements atthis stage ofthe venture,the following balance
sheet presentation would be acceptable:
joint ventures and the proportion of ownership interest held in jointly
controlled entities. A venturer which reports its interests injointly controlled
entities using the line-by-line reporting format for proportionate consolidation
or the equity method should disclose the aggregate amounts ofeach ofthe
cuirent assets,long term assets,current liabilities,long-term liabilities,income
and expenses related to its interests injoint ventures.
Current asset
Joint venture inventory
10,000
Current liability
Payable to venturer-Santos
12,500
Chapter 6
258
MULTIPLE CHOICES-THEORETICAL
1. Ajoint venture is:
a.
b.
A contractual arrangement whereby two or more parties undertake an economic ~
activity which is subject to ajoint control.
Is a business entity owned,andjointly controlled by a small group ofinvestors
as a separate and specific business project organized for the mutual benefit of
the ownership group.
c.
Short term associations oftwo or more parties to fulfill a specific project.
259
Joint Ventures
6. When two partiesjointly control a leased property,each taking a share ofthe
rents received and expenses incurred,thejoint venture is classified as a:
a.
b.
c.
d.
Syndicate
Jointly controlled assets
Jointly controlled operations
Jointly controlled entities
7. In ajointly controlled assets type ofjoint venture each venturer should record in
it's separate financial statement:
d. All ofthe above.
2. Activities to be treated asjoint ventures should have:
a. Contractual arrangementto establishedjoint control.
b. Continuous existence.
c. Five or more investors.
d. All ofthe above.
3. Ifthe manager/venturer has the power to controlthe operations ofthejoint venture,
the venture is considered as a:
a. Partnership
b. Corporation
c. Subsidiary ofthe manager
d. Separate entity
4. Joint venture which involves the use ofthe assets and other resources ofthe venturers
a. Its share in thejointly controlled assets
b. Any liabilities which it has incurred
c. Any share in the income from the sale or use ofthe assets ofthejoint venture
d. All ofthe above
8. Ajoint venture which is organized as a corporation or a partnership is a:
a. Syndicate
b. Jointly controlled assets
c. Jointly confrolled operations
d. Jointly controlled entities
9. When a separate set ofbooks is not maintained for thejoint venture,all revenues
and expenses are debited to this account:
a. Income summary
is a:
b. Joint venture
a.
b.
c.
d.
c. Investment in Joint Venture
Syndicate
Jointly controlled operations
Jointly controlled assets
Jointly controlled entities
5. In a jointly controlled operations type ofjoint venture each venturer should
recognized in each separate financial statement:
a.
The assets that it controls.
d. Income and expense summary
10. In the books ofthe venturers,investment injoint venture is recorded using the.
a. Cost method
b. Equity method
c. Purchase method
d. Pooling ofinterest method
■iv' ; •
Its share ofany liabilitiesjointly incurred with other venturers
c. Any liabilities which it has incurred
b.
d. Its share in thejointly controlled assets
f
1
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Chapter 6
260
261
Joint Ventures
6-3:
MULTIPLE CHOICES- COMPUTATIONAL
Using the data in 6-1, assuming Aquino Company used the proportionate
consolidation method, how much is the investment income to be reported in its
Dec. 31,2011 consolidated financial statement.
6-1: On January 2,2011, Aquino Company and Villar Company formed the AV
a.
Company,a merchandisingjoint venture. Each invested P200,000 for a 50%
interest in thejoint venture.
b.
P
c.
d.
P 25,000
P 50,000
Condensed financial statements for Aquino Company,Villar Company and for
thejoint venture,AV Company are presented below:
AV Company
Aquino Co.
Income Statement:
Sales
Investment income
Total
Cost and expenses
Net income
Villar Co.
(a joint venture)
P3,000,000
125,000
P2,000,000
125,000
P1,OO0,OOO
3,125,000
1,500,000
2,125,000
1200,000
1,000,000
750,000
Pl,625,000
P 925,000
P 250,000
P3,550,000
325,000
P2,850,000
325,000
P2,000,000
P3,875,000
P3,175,000
P2,000,000
P2,100,000
1,200,000
575,000
PI,900,000
PI,000,000
275,000
PU50,000
PI25,000
Investment in AV Company
Total assets
-0-
Item 6-4 and 6-5 are based on the follomng data:
Sweet Company and Heart Company foimed a merchandising joint venture, the
Sweetheart Company. Summarized transactions of the joint venture for the year
2011 are as follows:
Cash investments by the venturers:
Sweet Company (60% interest)
Heart Company (40% interest)
Purchases of merchandise on account
Expenses paid
Sales on account (25% above cost)
Balance Sheet:
Assets
■\
P120,000
80,000
150,000
. 10,000
150,800
The contractual arrangement include profit and loss ratio of60:40 to Sweet and
Heart respectively.
Liabilities
Capital stock
Retained earnings
Venturers, Capital
Total liabilities and capital
6-4; Under the equity method, what is tlie balance oftlie Investment in Joint Venture
650,000
P3,875,000
P3,I75,000
account in the books of Heart Company on December 31,2011:
P2,000,000
a. P80,000
Under proportionate consolidation, how much is the total assets of Aquino
Company on December 31,2011?
(u
b.
c.
d.
P4,550,000
P3,875,000
PS,550,000
P6,400,000
6-2: Using the data in 6-1,the total liabilities to be reported by Wlar Company under
the equity method on December 31,2011 is:
a. Pl,900,000
b. P2,575,000
c. P3,400,000
b. P88,064
c. P80,064
d. P88,000
6-5: Under the proportionate consolidation, how much is the proportionate share of
joint venture assets to be recognized by Sweet Company on December 31,
2011?
P222,096
b. P3 70,160
c.
PI48,064
a.
d.
P
-0-
d. P3,250,000
. ) ■
Chapter 6
262
Questions 6-6 and 6-7 are based on the following data:
On April 1,2011,Robles and Sanchezformed ajoint venture to acquire and sell
a special type ofmerchandise.The contractual arrangements provide that Robles
is to manage the venture for a fee and that profits and losses are to be divided
equally.
On April 2,2011,Sanchez invests cash ofP10,000,which was used to purchase
merchandise. Robles incur expenses amounting to P500.On April 17,one half
ofthe merchandise was sold for P7,200 cash.No further transactions occurred
263
Joint Ventures
6-8: What is the net profit ofthe venture after the fee to Salas?
a.
b.
c.
d.
PI0,000
P 7,826
P 9,000
P 7,000
'V' ,
tf.7 . ' -
V '
.i.h • <
6-9: What is the total income earned by Salas?
imtil the end ofthe month.
a.
b.
c.
d.
6-6: Whatis the profit(loss)ofthe venture for the month ofApril?
a.
b.
c.
(L
PI,700
(PI,700)
(PI,000)
P2,250
P2,500
P4,000
P3,600
P4,500
6-10: Before the cash settlement is made,the balance ofthe Investment in Joint Venture
(Equity Method)accountin the book ofSabas and Salve are:
6-7: In the books ofSanchez,the Investmentin Joint Venture account(Equity Method)
on April 30,2011 would show a balance of:
a.
b.
c.
d.
a. P10,000
b. P10,850
c. P 9,150
d. Pll,250
Items 6-8 to 6-10 are based on the following data:
Salas,Sabas and Salve formed ajoint venture. The contractual arrangement
provides that Salas is to manage the venture and is to receive a fee of15% ofthe
profit after deduction ofthe fee as an expense ofthe venture.The net profit, after
the fee has been agreed to be divided as follows: Salas,25%;Sabas,40% and
Salve,35%.No separate books are used for the Joint Venture.
Sabas
Salve
P4,000
P3,500
P4,000
P3,000
P3,500
P5,500
P6,500
P5,500
Questions 6-11 and 6-12 are based on the following data:
Dante,Edwin,and Ferdie formed ajoint venture in 2010 to sell a particular
merchandise. Dante is designated as the manager ofthe venture. The venturers
agreed to divide profits and losses equally. Tlie venture is terminated on December
31,2011 even though there is still unsold merchandise. On this date,Dante's trial
balance shows the following account balances before profit or loss distribution:
After five months,thejoint venture is terminated.The trial balance prepared by
Salasshow the following balances:
Credit
Debit
P9,000
Joint Venture
Sabas,capital
Salve,capital
, ff
P500
2,000
Debit
Joint venture cash
Joint Venture
Edwin,capital
Ferdie,capital
Credit
P30,000
6,000
14,000
PI6,000
The venture has still some unsold merchandise worth P2,500. Salas agreed to
Dante receives P4,500for his share in the venture profit. Furthermore,he agrees
purchase such at cost.The fee ofSalas has not yet been t^en up.
to be charged for the unsold merchandise as ofDecember 31,2011.
v
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Chapter 6
264
f
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265
Joint Ventures
6-11: What is the cost ofthe unsold merchandise charged to Dante?
Questions 6-15 and 6-16 are based on the following data:
Jack and King formed a joint venture on January 3,2011 to buy and sell certain
merchandise. Their capital contributions and profit and loss ratios are presented
PI5,000
P 3,000
c.
PI3,500
d. P19,500
a.
b.
below:
Profit and
Contributions
6-12: In the final settlement, what is the amount due to(from)the venturers;
Dante
a.
b.
c.
d.
PI8,000
PI9,000
P39,000
P28,000
Jack
Ferdie
Edwin
P( 9,000)
P( 9,500)
P(19,000)
P( 9,500)
Cash
Loss ratio
PS,000
6,000
50%
P5,000
King
P 1,000
P20,500
PI6,000
Pll,500
50%
A summary ofthe joint ventufe activities during 2011 is as follows:
Items 6-13 and 6-14 are based on the following data:
During the year 2011,Gerry has been the manager ofajoint venture with Harry
and Isaac. It was agreed that on the completion ofthe venture,Geny is to receive
a fee of 10% ofthe venture profit after the deduction ofthe fee as an expense.
The venture is terminated on October 31,2011.On tliis date Jerry's trial balance
contains the following account balances:
Debit
Credit
P4,600
Joint venture
Harry,capital
Isaac,capital
Merchandise
P4,000
Purchases of merchandise by King
Expenses paid by King:
t L:;.f
Taxes and lieenses
400
Freight on merchandise contributed by Jack
Delivery expense on merchandise sold
300
200
Sales (all of the merchandise contributed and purchased
by Kng and one-half of those contributed by
■1'
14,000
Jack) - Selling price
M- '
The venture is terminated on December 31,2011.
P200
1,800
The contractual arrangement provides for the division ofprofit after the fee to
Gerry,as follows: 30% to Gerryy50% to Harry; and 20% to Isaac.
6-15: What is the joint venture profit (loss) on Dec. 31,2011?
a. P 4,900
b. P (750)
6-13: The fee ofGerry is
a.
b.
c.
d.
c. PI4,400
d. P 9,400
P600
P660
P260
P650
6-16: In the final settlement assuming the used of equity method, how much would
Jack receive assuming Jack took the unsold merchandise at cost?
6-14: Cash settlements received by Harry and Isaac are:
a.
a.
b.
c.
d.
Harty,P2,300;Isaac,P3,000
Harry,P3,200;Isaac,PI,200
Harry,P3,200;Isaac,P2,320
Harry,P2,800;Isaac,P3,000
PI 3,000
b.
PI 2,62 5
c.
d.
P 8,475
P 8,000
■ 1-
..'At:.:.,.
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Chapter 6
266
PROBLEMS
267
Joint Ventures
Problem 6-2: Continued
3. Expenses paid by Diaz,P39,000.
Problem 6-1
4. Cash sales,PI50,000.
5. Expenses paid from thejoint venture cash,P30,000.
Ablan and Blanco foiTned ajoint venture to buy and sell construction materials. The
contractual arrangements provide the following:
a.
b.
c.
d.
Profits and losses from the venture would be shared equally.
Separate books are kept for thejoint venture.
Blanco is to manage thejoint venture.
Equity method is used by the venturer.
The folio-wing transaetions occurred during the two months in which the venture was in
operation:
6. Ella invested merchandise worth,P20,000.
7. Fabia withdrew cash ofPI0,000.
As ofDecember 31,2011,the following assets, excluding cash, were on hand:
Merchandise
Supplies
P2,500
500
Required:Preparejoumal entries on the books ofthejoint venture and all the venturers
to record the venture transactions and the distribution ofprofit or loss,assuming the use
ofproportionate consolidation method.
1. Ablan contributed cash ofPi00,000 and Blanco contributed construction
materials costing P90,000.
2. Blanco purchased construction materials for the venture,P60,000 cash.
3. Blanco paid venture expenses,P20,000.
4. Sold all the construction materials for P200,000 cash.
5. Profit from the venture was computed and distributed to each venturer.
6. Cash settlement was made.
Required:Preparejoumal entries in the books ofthe Joint Venture and in the books of
Problem 6-3
On May 1,2011 Bueno,Castro and Duran formed ajoint venture for the sale ofcertain
merchandise. Duran is to manage the venture. Bueno was to provide fimds and Castro
was to supply merchandise to be sold by Duran. They agreed to divide phofits and
losses equally.
The venture transactions from May to June are as follows:
Ablan and Blanco.
May
1: Castro sent merchandise to Duran valued at P12,000.Freight ofP500 was
paid by Duran.
Problem 6-2
7:
On Februaiy 1, 2011 a joint venture to buy and sell a particular merchandise was
formed by Diaz,Ella,and Fabia. Contractual agreement provides that:
1. Diaz is to be the operator/manager ofthe venture.
2. Profits and losses are to be shared equally.
3. A separate books are to be maintained by the venture.
A summary ofthe venture transactions from Febmary 1 to December 31,2011 are as
Bueno sent Duran,P10,000 cash.
26: Duran purchased additional merchandise for cash worth P9,500.
30: Duran sold merchandise on account for P16,000.
June 20: Collection ofaccount,PI5,000.
27: Duran sold merchandise for cash,P9,000.
30: The venture was terminated and settlements to participants were made.
Duran agreed to take the unsold merchandise atP3,000 and is to be charged
for the uncollected accounts at face value.
follows:
1. Computer equipment were contributed by Ella and Fabia valued at P60,000
and P45,000 respectively.
2. Diaz purchased merchandise worth P80,000 and supplies worth P2,000 for
the venture.
Required:Preparejoumal entries to record the venture transactions assuming:
1. No separate set ofjoint venture books is used.
2. A separate set ofjoint venture books is used.
3. The Venturer used equity method.
(■i'
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Chapter 6
268
269
Joint Ventures
Problem 6-4: Continued
Rolex, a general contractor, entered into a joint venture to build low-cost houses with
Seiko, a plumbing contractor and Timex, an electrical contractor.
Five houses were to be constructed by the ventures in 2011. The contractual arrangements
provide the following:
1. Seiko is to be the manager of the ventuer.
2. Each venturer will bill the venture monthly for the cost of materials and labor
expenditures.
3. Drawings against the monthly billings will be made from a fimd, created by securing
a loan from Philippine National Bank (PNB) with the houses pledged as security.
4. A real estate agent will sell the houses for a 5% commission of the selling price.
5.
Net income v^ll be divided as foUlows:
Rolex
60%
Seiko
30%
Timex
10%
Required:
1. Preparejoumal entries on the books of Seiko.
2. Show how the accounts relating to the joint venture would appear in tlie interim
Statement ofFinancial Position as ofJune 30,2011 without making any attempt
to determine the profit or loss for the uncompleted joint venture.
Problem 6-5
Loren Company holds a 55 percent interest in a joint venture organized as a jointly
controlled entity. Financial statement data relating to Loren Co. and the joint venture
follow:
Loren Co.
Joint Venture
Statement of Comprehensive Income
Sales
Income from joint venture
6. Separate books are not to be maintained by the venture.
Cost of sales
On April 1, P102,000 was released by PNB to a separate bank account established
for the venture. Each of the venturer agreed to be personally liable for one-third of the
Operating expenses
P200,000
P 85,000
13.750
P213.750
P 85.000
PI 00,000
50,000
P 45,000
15,000
PI 50,000
P 60,000
P 63,750
P 25,000
P 50,000
100,000
75,000
38,500
35,000
P 20,000
40,000
50,000
P298,500
PI 20,000
P 50,000
80,000
50,000
P 20,000
30,000
loan.
Net income
The monthly transactions for the venture were:
May:
Costs incurred
Jime:
Drawings from venture bank account
Costs incurred
July:
Aug:
Drawings from venture bank account
Taxes paid by Rolex (from own fund)
Costs incurred (including taxes)
Drawings from venture bank account
Expenses paid by Rolex (from venture fund)
Costs incurred (including expenses)
Statement of Financial Position
Rolex
Seiko
P47,800
30,000
64,700
15,000
2,060
31,240
67,000
5,000
16,560
P16,300
Cash
Receivables
Timex
—
—
37,400
40,000
P9,300
10,000
13,970
45,000
.13,500
—
-
9,730
4,310
10,560
The houses were sold at a total price of P421,000. The net proceeds from the real
estate agent after commission were deposited in the venture bank account. P110,000,
P8,0C)0 ofwhich was for interest was paid to the bank as full settlement of the loan. On
August 31,2011, final settlement was made to the venturers.
Inventory
Investment in joint venture
Other assets
Accounts payable
Other liabilities
Capital stock
Retained eamings
Venturers' equity
10,000
118,500
70,000
P298,500
PI 20,000
Required: Prepare a consolidated financial statements for Loren and its interest in a
jointly controlled entity using proportionate consolidation.
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Chapter 6
270
Problem 6-6
MacDo and MacEn entered ajoint venture to subdivide a land.Inasmuch as the venture
was likely to extend over a long period oftime,separate books were maintained for the
joint venture. On June 15,2011, MacDo sent PI,000,000 to MacEn,which was to
earn 6 percent until repaid, MacEn was to manage the operations and to receive a 5
percent commission on all sales and 40 percent ofany gain resulting from the venture.
Transactions for the venture were as follows;
July 1:
MaeEn purchased the land for P2,400,000,giving a 6 percent mortgage for
P1,650,000 and cash in payment.Interest is payable semiannually,or upon •
paymentofany installment ifpaid earlier.
Aug. 1: MacDo advanced an additional P1,100,000 on the same terms,to be used
to pay for improvements.The actual cost ofthe improvements was P950,000.
Sept. 30: The mortgage was reduced by P250,000.
Oct. 31: The mortgage was reduced by P400,000.
Nov.30: The mortgage was reduced by P300,000.
Dec.31: The mortgage was reduced by P200,000. All interest was paid 3,4,5 and 6
months on installments.
Chapter 7
' .. 'a' .
Corporations in Financial
Difficulty: Liquidation
Corporations get intofinancial difficultyfor a large variety ofreasons. A company
may suffer from continued losses from operations, overextended credit to
'customers, poor management or working capital, failure to react to changes in
economic conditions, inadequate financing, and a host of other reasons for not
sustaining a viable economic position. A company's liquidity problems often become
cumulative. Failing to make a sufficient amount ofsales, a company cannot obtain
enoughfinancing, and then begins to miss debt payments, and the cycle offinancial
difficulty is underway. At this point, outside creditors may decide to exercise their
claims and demand payment oftheir debts. The debtor company has a number of
alternative courses open to it. It may take the legal remedy of bankruptcy, it may
turn its assets over to its creditors to liquidate, or it may tiy to reach an agreement
with its creditors to postpone a required payments. To structure this process, to
Sales totaling P2,600,000 had been made and collected in cash. The unsold
land at that date was inventoried at cost ofP2,205,000.
provide protection for all parties concerned, and ensure fair and equitable
Advertising,office expenses,and other expenses,in the amount ofP628,100,
exclusive ofcorhmission and interest, had been paid.
This chapter and the next chapter willdiscuss the remedies and basic accountmg
proceduresfor companies which are in financial difficulty.
All commissions earned by MacEn were paid.
Insolvency
Interests was allowed MacDo for6 1/2 months on his first contribution and
for 5 months on his second contributions; and all cash on hand in excess of
P250,000 was retumed to MacDo.
MacDo requests statements showing his share ofany gain to date and the
financial position ofthe venture.
treatment, the Insolvency Law in the Philippines
established.
A debtor corporation is considered insolvent when it is unable to pay its debts as they
come due. In the legal sense, a business enterprise is insolvent when, as defined m
Section 1045 of the Insolvency Law, its financial condition is such that the sum ofall its
debts is greater than all of its assets at fair valuation. Thus, a coporation remains solvent
as long as the fair value of its assets exceeds its liabilities, even if it cannot meet its
current obligation because of an insufficiency of liquid resources.
Debtor Corporations that are insolvent has a large number of alternatives, such as
liquidation, reorganization or debt restmcturing. This chapter will discuss coporate
liquidation while reorganization and debt restructuring will be discussed in tlie next chapter.
Required:
(a) Prepare thejournal entries for the venture books.
(b) Prepare thejournal entries for MacDo's books.
(e) Prepare the statements requested by MacDo.
.
271
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272
Corporations in Financial Difficulty: Liquidation
Chapter 7
273
Liquidation versus Reorganization and Debt Restructuring
The statement ofaffairs is not a going-concem report;it is an important planning report
for the anticipated liquidation ofa company.Thus,historical costfigures are not relevant.
The important decision ofcorporations in financial difficulty is the method by which it
The various parties concemed desire information that reflects(1)the net realizable
value ofthe debtor's assets and(2)the ultimate application ofthese proceeds to specific
will be discharged firom its obligations. One option is to liquidate the company's assets
with the proceeds being distributed to creditors. However,a very important alternative
to liquidation does exist. The debtor corporation may survive insolvency and continue
operations ifa proposal for reorganization or debt restmcturing is accepted by the
liabilities.
The assets and liabilities are reported according to the classifications relevant to
parties involved.
liquidation.
Under most reorganization plans,the creditors agree to absorb a partial loss rather than
force the insolvent company to liquidate. Before accepting such an arrangement,the
creditors mustbe convinced Aata greater return will be achieved by helping to rehabilitate
Consequently,assets are classified into three categories as follows:
1. Assets pledged tofully secured creditors. Certain assets may be pledged as
the debtor. Often,as an example,paymentofa certain percentage ofthe debtis promised
to the creditors hut usually only at some future date. One benefit associated with
reorganizations and debt restmcturing is that the creditor may be able to retain the
insolvent company as a customer.In many cases,continuation ofthis relationship is an
•n
■*
important concern ifthe debtor has historically been a good client.
i
I
CORPORATE LIQUIDATION
This process may he initiated by the company by filing a voluntary petition with the
Securities and Exchange Commission(SEC).The corporation is given tliree years from
the date ofapproval within which to wind up its affairs.
to cover unsecured liabilities. The building with an estimated realizable of
P3,000,000, which secures a P2,000,000 mortgage liability, is an example of
an asset pledged to a fially secured creditor. After the mortgage is paid,
P1,000,000 remains for unsecured creditors.
L'V,!
The Securities and Exchange Commission may appoint a receiver or a trustee following
the filing ofa petition for liquidation or bankmptcy. The duties ofthe receiver in a
hquidation focuses on the realization ofassets and the payment ofliabilities rather than
on the preservation and continuation ofthe business.In the course ofliquidation,the
receiver may continue business activity ifthat is in the interest ofan orderly liquidation.
security for a particular liability, and the estimated realizable value ofthe assets
equals or exceeds the amount ofthe liability. Such assets may also yield resources
:c
2. Assets pledged to partially secured creditors. Other assets that are pledge
as security for a particular liability and the realizable value of the assete is less
than the amount of the liability. Partial payment of the liability will utilize the
entire asset value; nothing will be left for the unsecured liabilities. The equipment
with an estimated realizable value of P30,000, which secures a P50,000 note
payable, is an example, of an asset pledged to a partially secured creditor.
3. Free Assets. Assets that is not pledged as security for any particular liabi ity,
and thus available to meet the claims ofpriority liabilities and unsecured creditors.
Free assets also include the value of assets pledged to fully secured creditor m
Financial Report
Corporation in liquidation usually prepares two classes offinancial reports.First, which
is the initial reportshows the available asset values and debts ofthe debtor corporation.
This report is known as the Statement ofAffairs. The second,is the periodic report
excess of the related liability. In example No. 1, P1,000,000 of the value o
e
building is included as free assets.
ofthe receiver known as the Statement ofRealization and Liquidation, this shows
The liabilities of the company are classified into four categories and listed in parallel
how the receiver managed the assets ofthe debtor corporation on behalfofthe creditors.
fashion on the next page.
Statement ofAffairs
Normally,at the start ofliquidation,a statement ofaffairs is prepared for the corporation
to provide information aboutthe current financial position ofthe company.
. \ ■
.•ai
i ,
..... ,
\\.'j.
* 9^
Chapter 7
274
1.
Unsecured liabilities with priority. When creditor has no lien on any specific
assets ofthe debtor corporation,but its claims rank ahead ofother unsecured
liabilities in the order ofpayment,the claims are considered unsecured liabilities
with priority. These liabilities,in order to priority are:
't
Corporations in Financial Difficulty:Liquidation
Illustration 7-1
275
'f - ■ V
No Fear Corporation
Statement of Affairs
Date
Available
2.
a. Administrative expenses ofthe receiver.
b. Unpaid employee's salaries and wages,and benefit plans.
Book
c.
Values
Taxes.
Fully secured creditors. For these liabilities,the creditor has a lien on specific
assets, whose estimated realizable value equals or exceeds the amount ofthe
liability. For example,a bank holds a P2,000,000 mortgage on a building ofa
debtor corporation, and the building has an estimated realizable value of
P3,000,000.The mortgage is,therefore,fully secured,and the bank is referred
to as a fully secured creditor.
xc
Assets
Pledged to fully secured creditors:
(list)
Less: Liabilities to fully secured creditors
Fledged to partially secured creditors:
(list)
Estimated
for
Realizable
Unsecured
Values
Creditors
Roc
xc
Roc
Roc
Free assets:
xc
3. Partially secured creditors. In some cases,the creditor has a lien on specific
(list)
xc
xc
Total free assets
xc
assets but the estimated realizable value ofthose assets is less than the amount
Less: Creditors with priority
xc
ofthe liability. For example,a finance company holds a P50,000 note secured
by equipment ofa debtor corporation, but the equipment has an estimated
realizable value ofonly P30,000.This note is partially secured,and the finance
Net free assets
xc
Estimated deficiency(to balance)
xc
Roc
company is referred to as a partially secured creditor.
Unsecured
4. Unsecured creditors. All other liabilities for which the creditor has no lien on
any specific assets ofthe debtor corporation are unsecured. This includes the
Book
unsecured portion ofthe liability to partially secured creditors. In the example
Values
above,there is a note payable to the finance company for P50,000 secured by
the equipment worth P30,000; the difference of P2(),000 is added to the
Roc
unsecured liabilities.
xc
Format ofthe Statement of Affairs
xc
The format ofthe statement ofaffairs centers on the important aspects ofliquidation
reporting. Other fomiats may be used.For example,book values are generally presented
xc
on the statement ofaffairs along with the estimated realizable values. As previously
xc
discussed,estimated realizable values are important because the company is no longer
a going concem and infonnation relating to the status ofthe various classes ofcreditors
is to be presented. However,book values are also useful because when compared to
the estimated realizable values,expected gains or losses upon liquidation are determined.
Thus,the statement ofaffairs usually appears in the format as shown in Illustration 7-1.
Liabilities and Stockholders' Equity
Liabilities with priority:
(list)
Fully secured creditors:
(list)
Partially secured creditors:
(list)
Less: Value of pledged assets
Secured and
Nonpriority
Priority Claims
Liabilities
Roc
xc
xc
xc
Roc
Unsecured creditors:
Roc
(list)
Stockholders' equity
xc
Roc
276
Chapter 7 ' .
,
Corporations in Financial Difficulty: Liquidation
277
'.41 (
Statement of Affairs Illustrated
Before the preparation of a statement of affairs, additional data must be ascertained
concerning the insolvent company and its assets and liabilities. Hence, the following
information has been accumulated about the No Fear Company:
To illustrate the preparation ofthis statement,assume that the No Fear Company has
experienced severe financial difficulties in recent times and is currently insolvent. The
company officials are trying to decide whether to seek liquidation,reorganization or
debtrestructuring. Consequently,they have asked their accountantto produce a statement
ofaffairs to assists them in formulating an appropriate strategy. Statement offinancial
position for No Fear,prepared as ifthe company were a going concem,is presented
1.
The marketable securities reported on the balance sheet has appreciated in value
since being acquired and is now worth P20,000. Dividends of P500 are currently
due from this investment.
below:
2.
3.
P12,000 of the company's accounts receivable can still be collected.
Tlie inventory held by the company can be sold for P43,000.
Illustration 7-2
4.
A refund of PI,000 will be received from the various prepaid expenses but the
June 30, 2011
5.
The land and building can still be sold for P231,000. While the equipment can only
ASSETS
6.
No Fear Company
company's intangible assets have no resale value.
Statement ofFinancial Position
be sold for P32,000.
Current assets
Cash
Marketable securities
Accounts receivable
P
Inventory
Prepaid expenses
does occur.
2,000
15,000
23,000
41,000
3,000
7.
100,000
110,000
80,000
Building
Equipment
Intangible assets
•'
\
8.
P 84,000
From the above data, the statement of affairs for No Fear Company can be prepare
as shown in Illusti-ation 7-3. The following should be specifically noted in the statement
290,000
ofaffairs:
15,000
a. The current and non current classifications usually applied to assets and liabilities
P389,000
are omitted. Since the company is on the verge of going out of business.
classification is meaningless. Instead, tlie statement is designed to separate the secur
LIABILITIESANDSTOCKHOLDERS'EQUITY
and unsecured balances.
Current liabilities:
Notes payable (secured by inventory)
Accounts payable
Accrued expenses
Interest of P5,000 on the company's long-tenn liabilities has not been accrued for
the first six months of2008.
I
Total assets
Accmed expenses include salaries of PI 2,000 and payroll taxes from wages but
not yet paid to the government total P3,000.
Property and equipment (net):
Land
Administrative expenses of P21,500 are estimated if liquidation of the company
18,000
60,000
P153,000
Long-term liabilities:
200,000
.
value, whereas liabilities are shown at the amount required for settlement.
c.
Notes payable (secured by lien on land and building)
.
b. Book values are presented on the left side ofthe schedule but only for informationa
purposes. These figures are not relevant. All assets are reported at net realiza e
P 75,000
,*
*■
The dividends receivable and the interest payable are both included in the statement,
although neither has been recorded on the balance sheet. Currently updated figures
must he disclosed within the statement of affairs.
Stockholders' equity
Capital stock
Retained earnings(deficit)
Total liabilities and stockholders' equity
d.
100,000
( 64,000)
36,000
P389,000
Liabilities having priority are individually identified with the liability section (a).
Because these claims will be paid before other unsecured creditors, the P35,500
total also is deducted directly fium the free assets (b). Although not yet incurred,
estimated administrative expenses are included in this category since such expenses
will be necessary for liquidation.
' ht A
Illustration 7-3,
e. According to this statement,ifliquidation occurs,No Fear Company expects to
have only P57,000 in free assets remaining after settling all liabilities with priority
(c).Unfortunately,the liability section shows unsecured claims with a total ofP95,000.
These creditors,therefore,face a P38,000 loss(P95,000-P57,000)ifthe company
is liquidated(d).This final distribution is often converted into an expected recovery
percentage computed as follows:
No Fear Company
Statement of Affairs
June 30,2011
Available
Book
Values
P210,000
P57,000
Net Free Assets
=
60%
P95,000
Unsecured Claims
279
Corporations in Financial Difficulty: Liquidation
Chapter 7
278
41,000
Thus,unsecured creditors can anticipate receiving only 60 percent oftheir claims.
Unsecured creditor,for example,who is owned PI,000 by this company should
anticipate collecting only P600(P1,000 x 60%)following hquidation.Fully secured
2,000
15,000
-0-
23,000
3,000
80,000
15,000
creditors,ofcourse,receive the full amount owed them,as well as those creditors
with priority claims.
Assets
Pledged with fully secured creditors:
Land and building
Less: Notes payable(long term)
Interest payable
Pledged with partially secured creditors:
Inventory
Free assets:
Cash
Marketable securities
Dividends receivable
Accounts receivable
Prepaid expenses
Equipment
Intangible assets
Estimated
for
Realizable
Unsecured
Creditors
Values
P231,000
(200,000)
P26,000
P 43,000
-0-
P
2,000
20,000
500
12,000
1,000
32,000
-0-
Less: Liabilities with priority(see a)
Class of Creditors
Referring to the statement ofaffairs in Illustration 7-3,the accountant for the No Fear
Company may prepare the summary ofestimated amounts to be recovered by each
j,
P-0-
Jv X
Computations
12,000
3,000
P 35,500
205,000
75,000
63,000
Net free assets
57,000 c
Estimated deficiency(Squeeze Figure)
38.000 d
P95,000
'100%
100%
P43,000+(P32,000 x60%)
60%
Liabilities and Stockholders' Equity'
Liabilities with prioritj':
Administiutive expenses
Salaries payable
Payroll taxes payable
Secured and
Nottpriority
Priority claims
Liabilities
P 21,500
12,000
3,000 -
36,500 (a)
Estimated
Total
Recovery
Fully secured creditors:
Notes payable(Long Term)
Interest payable
200,000
Total
205,000
200,000
-0-
Unsecured with priority
Fully secured
Partially secured
Unsecured without priority
(36,500) b
Unsecured
Book
Values
No Fear Company
Estimated Amounts to Be Recovered by Creditors
June 30,2011
Total Claims
•
P389,000
class oftheir creditors as shown below:
Class ofCreditors
67,500
93,500
Total free assets
Estimated Amounts to Be Recovered by Each
-
(5,000)
P 35,500
205,000
62,200
37,800
75,000
Partially secured creditors:
Notes payable
Less: Inventory
-
5.000
-
75,000
( 43,000)
P32,000
60,000
3,000
63,000
Unsecured creditors
Totals
P378,500
P340,500
60,000
3,000
36.000
P389,000
Accounts payable
Accmed expenses
Stockholders'equity
—
P95,000
'
■■
Chapter 7
280
Accounting and Reporting for Trustee/Receiver
Corporations in Financial Difficulty: Liquidation
1. The accounting records shown in Illustration 7-2 are adjusted to correct balances
as ofJune 30.Hence,the dividends receivable and interest payable are recognized.
Normally,the trustee opens a new set ofaccounting records. The assets and liabilities
ofthe debtor corporation are recorded in the tmstee's books at book values, rather
Estate equity
than at their net realizable values. Contra asset accounts are omitted because they are
Dividends receivable- new
not necessary in liquidation. These accounting procedures are used to keep the trustee's
accounting records as simple as possible.
The reports usually prepared by the trustee are a statement ofcash receipts and cash
disbursements,and a statement ofrealization and liquidation.
23,000
41,000
3,000
Building
Equipment
Intangible assets
Notes payable
Accounts payable
Accrued expenses
100,000
-
»
Long term notes payable
Estate equity
To record custody ofassets and liabilities ofNo
Fear Company at book values.
41,000
3.000
44,000
44,000
Cash
3. Collection is made ofthe P500 cash dividend accmed as ofJune 30. The related
investments reported at PI5,000 are then sold for PI9,600.
\
Cash
110.000
80,000
15,000
5
44,000
Inventory
Estate equity
Note payable
Accounts receivable
Inventory
Prepaid expenses
5,000
securily.
Assume that Manuel Valdez,the trustee in the liquidation ofNo Fear Company(see
Illustration 7-2),took custody ofthe assets ofNo Fear Company on June 30,2008.
The following entry should be prepared to open the tmstee's books:
2,000
15,000
500
2. The trustee expends P7,000 to sell the inventory at a price ofP51,000. The net
cash is applied to the notes payable for which the inventory had served as partial
Cash
Cash
Marketable securities
4,500
Interest payable -new
Illustration of the Accountability Technique
Land
281
20,100
15,000
Marketable securities
500
Dividends receivable
4,600
Estate equity
75,000
60,000
18,000
Accounts receivable ofP16,000 are collected. The remaining balance is written off
as bad debts.
200,000
36,000
Cash
Estate equity
16,000
7,000
23,000
Accounts receivable
After the assumption ofthe estate,the tmstee records gains, losses, and liquidation
expenses directly to the estate equity account. Any unrecorded assets or liabilities the
trustee discovers are likewise recorded in the estate equity account. All assets acquired
and liabilities incurred after the tmstee takes charge ofthe estate are identified as"new".
The transactions and events during the first month ofNo Fear Company's tmsteeship
and the relatedjoumal entries to record them in the tmstee's books are illustrated on the
next page.
5.
The tmstee deterrnines that no refund is available from any ofthe company's prepai
expenses.The intangible assets also are removed from the accounting records because
they have no cash value.
Estate equity
Prepaid expenses
Intangible assets
18,000
3,000
15,000
Corporations in Financial Difficulty: Liquidation
Chapter 7
284
Statement of Realization and Liquidation. This statement shows a complete record
of the transactions of the receiver for a period of time. Its structure is similar to a T
account, and it is composed of three elements: asset transactions, and income/loss
transactions. The structure ofT accounts for assets and liabilities with hypothetical
figures appear as follows:
The statement ofestate deficit for No Fear Company is presented below;
Illustration 7-5
No Fear Company in Trusteeship
Statement ofEstate Deficit
From July 1 to July 31,2011
Asset Account
Estate equity, July 1,2011
Adjusted for dividends and interest
Ending balance
P 36,000
(4,500)
.'
Increases
100
70
Decreases
50
80
Ending balance
)■
■
' f ■
Adjusted balance
.
Net gain(loss)on realization:
Accounts receivable written off
Prepaid expenses and intangible assets written off
Land and building
Equipment
,
Inventory
150
.*
150
4
31,500
V •
Liability Account
P( 7,000)
(18,000)
(2,000)
(38,000)
3,000
Marketable securities
(57,400)
.
(24,900)
Estate deficit, July 31,2011
(82,300)
60
40
Beginning balance
Ending balance
30
50
Increases
90
90
several ways. Some assets may be realized by normal operations, such as the continuing
collection of receivables from customers. Other assets may be realized by sale. During
P(50,800)
Balance Sheet.A balance sheet is prepared from the accoimt balances taken from the
general ledger ofthe company and is presented below:
Decreases
The above structure is to be applied to the activities of the tmstee or the receiver. The
first duty of the receiver is to realize the assets, that is, to convert the non cash assets
into cash so that creditors may be paid. The process of realization may be done in
4,600
Total
Administrative expenses paid
285
realization, gains and losses on asset sales may occur, expenses may be incurred, and
revenues may be earned. The realization activities may be presented in T aecount format
as follows:
•4'
Assets (Except Cash)
!
Illustration 7-6
Assets to be realized
No Fear Company in Trusteeship
Assets acquired-Increases
Assets realized-Decreases
Assets not realized
Balance Sheet
Income Effect ofRealization
July 31,2011
Expenses and losses
Revenues and gains
Assets
Cash
Total
Liabilities and Estate Deficit
Notes payable
Accounts payable
Accrued expenses
■
■
'L. .
• *
P 31,000
60,000
18,000
■
■
Total liabilities
Less; Estate deficit
Total
»■
P 58,200
in T account fomiat as follows:
■■
■
The second task of the receiver is to liquidate the liabilities, that is, to make full or
partial settlement with the creditors. Again, gains or losses may occur in the process of
liquidation, as may expenses or revenues. The liquidation activities may also be presented
■ - > ' '■ , ■ ■■■ 1
. ft
■
P 58,200
,■
'
•
•.
' • ■ ■ '
'
'
109,000
50,800
Liabilities
Liabilities Liquidated
Liabilities to be liquidated
Liabilities not liquidated
Liabilities incurred
Income Effect ofLiquidation
P 58,200
.
1
Expenses and losses
Revenues and gains
,
Chapter 7
286
Corporations in Financial Difficulty:Liquidation
287
The traditional format ofthe statement ofthe statement is presented in Illustration 7-7.
Alternative Format ofStatement ofRealization and Liquidation
Illustration 7-7
The traditional statement ofrealization and liquidation presented in Illustration 7-7 Avas
a complex and not too understandable accounting presentation. A form that should be
more useful to the parties concemed than the traditional statement is presented below:
No Fear Company in Trusteeship
Statement ofRealization and Liquidation
July 1,2011 to July 31,2011
Illustration 7-8
ASSETS
Assets to Be Realized:
Marketable securities
Accounts receivable
Inventory
Prepaid expenses
Land
Building
Equipment
Intangible assets
P 15,000
23,000
41,000
3,000
100,000
110,000
80,000
15.000
Total
P387,000
Marketable securities
Accounts receivable
Inventory
Prepaid expenses
Land and building
Equipment
Intangible assets
Dividends receivable
Total
P 19,600
16,000
44,000
Assets Acquired(new)
-0-
^
Dividends receivable
P
Interest payable
(5,000)
500
None
Inventory
LIABILITIES
Marketable securities
Total
P 44,000
200,000
5,000
P249,000
P 75,000
60,000
18,000
Total
P353,000
Liabilities Incurred(new)
Interest payable
Liabilities Not Liquidated:
Notes payable
Accounts payable
Accrued expenses
Liabilities to Be Liquidated:
Notes payable
Accounts payable
Accrued expenses
Long term notes payable
P
(4,500)
31,500
Assets Realized:
—
Accounts receivable
Liabilities Liquidated:
Notes payable
Long term notes payable
Interest payable
500
Adjusted balance
P330,100
Assets Not Realized:
P
P36,000
Estate Equity,June 30,2011
Adjustments:
-0-
208,000
42,000
'
^
Dividends receivable
No Fear Company in Trusteeship
Statement ofRealization and Liquidation
For the Month Ended July 31,2011
Assets Realized:
Land and building
Equipment
Prepaid expenses
Intangible assets
Book Values,
Realization
Gain
June 30
Proceeds
P 23,000
41,000
15,000
210,000
80,000
3,000
15,000
P 16,000
44,000
19,600
208,000
42,000
(loss)
P( 7,000)
-0-
-0-
3,000
4,600
( 2,000)
(38,000)
(3,000)
(15,000)
(57,400)
200,000
P5,000
31,000
60,000
Liabilities Liquidated:
Notes payable
Long term notes payable
j
Interest payable
Total
P44,000
200,000
5,000
P249,000
18,000
Administrative expenses paid
Total
(24,900)
P109,000
Estate deficit, July 31,2011
INCOME OR LOSSAND SUPPLEMENTARYITEMS
Supplementary Expenses:
Administrative expenses
Supplementary Revenues:
24,900
P770,400
Net Loss
82,300
P770,400
P(50,800)
Corporations in Financial Difficulty: Liquidation
Chapter 7
288
Closing the Books of the Trustee.
289
MULTIPLE CHOICES - THEORETICAL
The total remaining liabilities ofP109,000(all unsecured creditors)receive P.5340 on
the peso(P58,200/P 109,000)in final settlement oftheir elaims. Entries to record the
1. In corporate liquidation, the term statement of affairs refers to:
cash distribution are as follows;
a. A document containing a series of questions concerning all aspects of the
debtor's financial condition and operations.
Notes payable (P31,000 x .5340)
Accounts payable (P60,000 x .5340)
Accrued expenses(PI8,000 x .5340)
16,550
b. A financial statement prepared in lieu of a balance sheet.
32,040
9,610
c.
Both a and b.
d.
Neither a and b.
58,200
Cash
2. The number of classes of creditors in a corporate liquidation is:
To record payment ofthe unsecured
creditors.
a.
Two
The estate is now fully administered by the tmstee. The trustee makes the following
b.
Three
entry to close the books ofNo Fear Company.
c.
Four
d.
Five
Notes payable '
Accounts payable
Accrued expenses
Estate deficit
14,450
3. A category of assets that typically has zero in the Free Assets column ofa statement
27,960
8,390
50,800
of affairs is:
a. Factory supplies inventory
To close the trustee's books.
) i
h
b.
Tools
c.
Short-term prepayments
d.
None of the above
4. In a statement of affairs, assets pledged for partially secured creditors are:
a. Included with assets pledged for fully seeured creditors.
b. Offset against partially secured creditors.
c.
'■r
Included with free assets.
d. Disregarded.
f
The estimated amount available for free assets in a statement ofaffairs for a company
undergoing liquidation is equal to the assets:
a. Carrying amounts less current fair values.
b. Carrying amounts plus gain or less loss on realization.
c. Carrying amounts plus loss or less gain on realization.
.y- .
-
\ f ,
d. Cun"ent fair values less canying amounts.
290
Chapter 7
Corporations in Financial Difficulty: Liquidation
291
6. The accounting records ofa trustee in a corporation liquidation are maintained;
MULTIPLE CHOICES - COMPUTATIONAL
a.
b.
c.
d.
Under the accrual basis ofaccounting.
Under the cost basis ofaccounting.
Under an accountability teclinique.
In accordance with the bankruptcy court's order.
7-1:
..
-hi
What amount will the bank receive if unsecured creditors receive 25% of their
m
7. In the reporting ofa corporate liquidation, assets are shown at:
The Metro Bank loaned P40,000 to Ilocano Company. The loan is seemed by
inventory with a book and fair value of P50,000 and P30,000, respectively.
claims?
a.
PI 0,000
a. Present value calculated using an appropriate effective rate.
b. P30,000
b. Net realizable values.
c. Historical cost.
d. Book value.
c.
P32,500
d. P40,000
7-2: The Abra Company owes P200,000 on a note payable plus P8,000 in interest
to its bank. The note is secured by inventory with a book value of P160,000 and
8. Which ofthe following is nota liability that has priority in a liquidation?
a fair value of PI 20,000. What amount will the bank received if unsecured
a.
b.
c.
d.
Administrative expenses incurred in the liquidation.
Salary payable owed to employees.
Payroll taxes due to the government.
Advertising expense incurred before the company became insolvent.
creditors receive 75% of their claims?
a.
b. PI60,000
c.
PI80,000
d. PI86,000
9. On a statementofaffairs,how are liabilities classified?
7-3:
a. Current and non-current.
r
b. Secured and unsecured.
PI20,000
-i
c. Monetary and non-monetary.
d. Historic and futuristic.
•rw
The Red Company owes P15,000,000 on the mortgage of its building to City
Bank. The building has a net book value of P20,000,000 and a fair value of
P18,000,000. When Red company file for liquidation, it owed interest ofP90,000,
when the building is sold for P18,000,000, the interest due on the mortgage is
P200,000. What amount will the bank receive ifthe unsecured creditors received
80% oftheir claims?
10. Insolvency in corporate liquidation means:
a. Book value ofassets is greater than liabilities.
a.
b. Fair value ofassets is less than liabilities.
b. PI5,160,000
PI5,000,000
c. Inability to meet financial obligations as they come due,
c.
d. Liabilities are greater than book value ofassets.
d. PI5,200,000
PI5,178,000
Use the following data for items 7-4 and 7-5:
I&
When the Pasig Company filed for liquidation with Securities and Exchange
Commission, it prepared the following balance sheet:
■ V'
, ■••■.V.
k-IL.
1 ,A>..
f
k
Chapter 7
292
Items 7-4 & 7-5: Continued
Corporations in Financial Difficulty: Liquidation
7-7:
Current assets (net realizable value, P50,000)
Land and building (fair value,P240,000)
Goodwill(fair value,0)
P 80,000
200,000
40,000
Total assets
P320,000
Accounts payable
P160,000
200,000
100,000
(140,000)
Mortgage payable(secured by land and building)
Common stock
Retained eamings(deficit)
293
Cebuano Company has had severe financial difficulties and is considering the
possibility ofliquidation.Atthis time,the company has the following assets(stated
at net realizable value)and liabilities.
Assets (pledged against debts ofP70,000)
Assets(pledged against debts ofP130,000)
Other assets
Liabilities with priority
Unsecured creditors
PI 16,000
50,000
80,000
42,000
200,000
In liquidation, how much would be paid to the partially secured creditors?
P320,000
Total
a.
b.
c.
d.
7-4: What is the estimated deficiency to unsecured creditors?
P 70,000
b. P 90,000
c.
P120,000
d. PI40,000
a.
PI30,000
P 50,000
P 74,000
P200,000
7-8: The Moon Company has the following:
Unsecured creditors
Liabilities with priority
7-5: What percentage oftheir claims are the unsecured creditors likely to get?
P230,000
110,000
Secured liabilities:
a.
b.
c.
d.
43.75%
50%
56.25%
100%
I .' I
P
Income taxes
Notes payable (secured by land)
Accounts payable
Salary payable(evenly to two employees)
Bonds payable
Administrative expenses for liquidation
8,000
120,000
83,000
6,000
70,000
20,000
The company has the following assets:
Building and equipment
Book Value
Fair Value
P 80,000
100,000
100,000
P 33,000
90,000
110,000
How much will the holders ofnotes payable collectfollowing the liquidation?
a. ei08,000
b. P 83,000
c. P 90,000
d. P120,000
180,000
100,000
140,000
The company also has a number ofother assets that are not pledged in any way.
The creditors holding debt two want to receive at least PI42,000. For how
7-6: A company is to be liquidated and has the following liabilities:
Current assets
Land
Debt one, P210,000; value of pledged asset
Debt two,PI70,000; value of pledged asset
Debt three, PI20,000; value of pledged asset
much do these fi-ee assets have to be sold so that debttwo would receive exactly
P142,000?
a.
b.
c.
d.
P308,000
PI98,000
P340,000
P330,000
Use the following information for items 7-9 and 7-10:
The following are data provided by Trinity Company:
Assets at book value
Assets at net realizable value
Liabilities at book value:
Fully secured mortgage
Unsecured accounts and notes payable
Unrecorded liabilities:
Interest on bank notes
Estimated administrative expense
A trustee is appointed to liquidate the company.
PI00,000
75,000
40,000
45,000
250
4,000
wr
Chapter 7
294
7-9: Thejournal entry made by the trustee to record the assets and liabilities should
include an estate equity(deficit)of:
a.
b.
c.
d.
P14,250
PI4,000
P10,250
P10,000
295
7-12: Filipino Co.has been forced into bankruptcy and liquidated. Unsecured claims
will be paid at the rate ofP0.50 on the peso. Gold Co. holds a non-interest
bearing note receivable from Filipino Co.in the amountofP50,000,collateralized
by machinery with a liquidation value ofP10,000.The total amountto be realized
by Gold on this note receivable is-
7-10: The statement ofaffairs prepared by the trustee at this time should include an
estimated deficiency to unsecured creditors of:
a.
b.
c.
d.
Corporations in Financial Difficulty: Liquidation
P35,000
P31,000
P14,250
P10,000
a.
b.
c.
d.
P35,000
P30,000
P25,000
PI0,000
7-13: The statement ofaffairs for Narra Corporation shows that approximately P0.78
on the peso probably will be paid to unsecured creditors without priority. The
corporation owes Wood Company P23,000 on a promissory note,plus accrued
7-11: DWC Company filed a voluntary bankruptcy petition on August 15,2011,and
the statementofaffairs reflects the following amounts:
Book
Carrying
Value
Estimated
Current
Value
interest ofP940.Inventories with a current fair value ofP19,200 collateralize the
note payable.
Compute the amount that Wood should receive from Narra assuming that the
actual payments to unsecured creditors without priority consist of78% oftotal
claims. Round all amounts to the nearest peso.
Assets:
Assets pledged with fully secured creditors
Assets pledged with partially secured creditors
Free assets
PI50,000
90,000
210,000
PI85,000
60,000
160,000
P450,000
P405,000
fl.
b.
c.
d.
P19,200
P22,897
P33,987
P52,200
Liabilities:
Liabilities with priority
Fully secured creditors
Partially secured creditors
Unsecured creditors
P35,000
130,000
100,000
270,000
P535,000
Assume that the assets are converted into cash at the estimated current value and
the business is liquidated. How much cash will be available to pay the unsecured
nonpriority claims?
.f
v" *
a, P240,000
b. P180,000
c. P160,000
d, P125,000
7-14 to 7-17 are based on the following data taken from the statement ofaffairs
ofMM Corporation:
Assets pledge for fiilly secured liabilities
(current fair value,P75,000)
Assets pledged for partially secured liabilities
P 90,000
74,000
70,000
7,000
30,000
(current fair value,P52,000)
Free assets(current fair value,P40,000)
Unsecured liabilities with priority
Fully secured liabilities
60,000
112,000
Partially secured liabilities
Unsecured liabilities without priority
■ (iV.
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Corporations in Financial Difficulty: Liquidation
Chapter 7
296
7-14: The amount that will be paid to creditors with priority isa.
b.
c.
d.
No. 7-18:
P7,000
P6,000
P7,500
P6,200
Expected realizable values of the assets are:
,
P30,000
P32,000
P20,000
P35,000
\
Inventory
Buildings
Equipment
What is the estimated deficiency to unsecured creditors?
a.
b.
c.
d.
P52,700
P57,200
P56,200
P57,000 -
7-17: The amount to be paid to unsecured creditors is
a.
b.
c.
d.
P44,100
18,500
22,000
2,000
Accounts Receivable
■ ■H'V, !.
7-16: The amount to be paid to partially secured creditors is
a.
b.
c.
d.
Continued
Inventory with a book value ofP20,000 is a security for notes ofP10,100. The
other notes are secured by the equipment.
7-15: The amount to be paid to fully secured creditors is
a.
b.
c.
d.
'
P79,000
P65,500
P72,500
P 9,000
Items 7-19 to 7-22 are based on the following data:
Because of inability to pay its debts, the Taal Manufacturing Company has been
•
P78,200
P70,800
P72,000
P72,800
forced into bankmptcy as ofApril 30,2011. The Statement ofFinancial Position
on that date shows:
Liabilities
Assets
7-18: The following information is available concerning Mayon Inc. on the date the
company entered bankruptcy proceedings:
Cash
Accounts Receivable
Notes Receivable
Account
Balance
Per Books
P
Cash
Accounts Receivable
Inventory
Prepaid Expenses
Buildings, Net
Equipment, Net
"I'l
Common Stock .
Retained Earnings, Deficit
'
./ ^
Goodwill
Wages Payable
Taxes Payable
Accounts Payable
Notes Payable
297
1
'
,
.'
2,860
52,260
28,000
430
59,000
5,600
5,650
(2,500)
(1,810)
(79,000)
(15,150)
(72,000)
16,660
'
P . 2,700
39,350
18,500
Inventories
87,850
Prepaid Expenses
Land and Buildings
Equipment
61,250
48,800
950
Accounts Payable
Notes Payable-PNB
Notes Payable-Suppliers
Accrued Wages
Accrued Taxes
Mortgage Bond Payable
Common Stock-PlOO par
Retained Earnings
P259,400
P 52,500
15,000
51,250
1,850
4,650
90,000
75,000
(30,850)
P259,400
,fL
Additional Information:
a.
Accounts receivable of P16,I10 and notes receivable of P12,500 are
expected to be collectible. The good notes are pledged to Phil. National
Bank.
b. Inventories are expected to bring in P45,100 when sold imder bankruptcy
conditions.
c. Land and buildings have an appauised value ofP95,000. They serve as security
on the bonds.
d. The current value of the equipment, net of disposal cost is P9,000.
Corporations in Financial Difficulty:Liquidation
Chapter 7
298
7-24:
7-19: The estimated loss on asset disposition is
a. P 82,550
h. P 29,240
c. Pill,790
d. PI12,740
299
The following data were taken from the records ofBad Company who is in the
process ofliquidation:
Stockholders' equity,per books:
Capital stock
Deficit
Estimated gain on realization ofland and building
7-20: What is the estimated gain on asset disposition?
Estimated loss on realization ofassets:
Accounts receivable
Inventories
a. P45,100
b. P33,750
c.
P
0
Prepaid expenses
Equipment
d. P34,700
Goodwill
7-21: The expected recovery percentage rounded is
Estimated claims requiring settlement:
Liquidation expenses
Contingent liabilities
a. 47%
b. 50%
c.
P350,000
54,250
78,750
23,100
84,000
2,100
170,000
57,500
17,500
26,250
48%
What is the estimated deficiency to unsecured creditors?
d. 67%>
a.
b.
c.
d.
7-22: What is the estimated payment to creditors?
a. P102,500
b. P215,250
c. P118,750
d. P180,188
P 5,950
P75,950
P81,550
P 7,350
7-25: A review ofthe assets and liabilities ofthe No Good Company,in bankruptcy on
June 31,2011,discloses the following:
7-23: The following data were taken from statement ofaffairs ofCAP Company:
A mortgage payable ofP350,000 is secured by land and buildings valued at
Unsecured liabilities with priority
Stockholders'Equity
Estimated liquidation expenses
Unsecured liabilities without priority
P 122,500
441,000
55,125
1,102,500
551,250
Loss on realization ofassets
P560,000.
/
Notes payable ofP175,000 are secured by equipment valued atP140,000.
Assets other than those referred to, have an estimated value ofP157,50fr.
Liabilities other than those referred to,total P420,000,which included claims
Avith priority ofP52,500.
What is the estimated deficiency to unsecured creditors?
How much is the total free assets?
a. P 87,500
a. Pl,059,625
b. P 35,000
b. P 937,125
c. P 992,250
d. P 953,575
c. P402,500
t ^
d. P315,000
'■'i
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Chapter 7
300
7-26: A trustee has been appointed by SEC for ABU Inc., which is being liquidated.
The following transactions occurred after the assets were transferred to the trustee:
a. Sales on account by the trustee were P75,000. Cost of goods sold were
P60,000,consisting ofall the inventory transferred firom ABU.
b. The trustee sold at P12,000 worth ofmarketable securities for P10,500.
Corporations in Financial Difficulty: Liquidation
7-29: Legacy Corporation filed a bankmptcy petition on January, 2011. On March 1,
2011 the trustee provided the following information about the corporation's
financial affairs:
Assets
Book Value
Cash
Accounts receivable—net
c. Receivables collected by the trustee:
Old:P21,000 ofthe P38,000 transferred
New:P47,000
301
^
d. Recorded P16,000 depreciation on the plant assets ofP96,000 transferred
from ABU.
Old current payables:P22,000 ofthe P48,000 transferred
Trustee's expenses:P4,300
P40,000
200,000
150,000
140,000
560,000
300,000
Property and equipment-net
500,000
PI,040,000
Liabilities
Liabilities with priority claims
Unsevered accounts payable
Notes payable (secured by accounts
Receivable)
e. Disbursements by the trustee:
P40,000
Inventories
Total assets
Realizable Value
Mortgage payable (secured by all
Property and equipment)
PI 60,000
300,000
200,000
400,000
In the statement ofrealization and liquidation ofABU Inc.:
Total liabilities
How much are the total assets to be realized?
1. What is the amount expected to be available for unsecured claims without
a.
b.
c.
d.
priority?
P206,000
P168,000
PI40,000
P218,000
a. P300,000
b. PS80,000
c. PI40,000
d. P310,000
7-27: Using the data in item 7-26,how much is the total assets realized?
a.
b.
c.
<L
PI, 100,000
P153,500
P132,500
P150,500
PI43,000
2. What is the expected recovery percentage for unsecured creditors?
/.
7-28: Using the data in item 7-26,how much is the net gain(loss)?
a. P(6,800)
b. P 8,600
c. Pll,100
'^
d. P 2,500
•
.
' ■.
',
.
,'
■ ■
a.
40%
b.
21.5%
c.
22.3%
d.
41.5%
I. ■
•.
Corporatioius in FinancialDifficulty; Liquidation
Chapter 7
302
7-31: RB Manufacturing,Inc.is considering seeking reliefunder the Insolvency Law.
However,the company would prefer to engage in out-of-court activities that
No. 7-29: Continued
3. What is the total estimated paymentto creditors?
a.
b.
c.
d.
3Q3
would allow for a restructuring ofdebts in an orderly manner.Before approaching
its creditors,the company is attempting to estimate the amount ofconsideraiton"
that would be received by various classes ofcreditors ifthe company did liquidate.
P890,000
P730,000
P 45,000
P770,000
The company's assets and liabilities are as follows:
Book Value
Assets
P60,000
420,000
400,000
380,000
200,000
60,000
Cash
7-30: Thefollowing data were taken from the statement ofrealization and liquidation of
DLR Corporation for the quarter ended September 30,2011:
Assets acquired
■
Assets not realized
Liabilities to be liquidated
Liabilities assumed
Liabilities liquidated
Liabilities not liquidated
Inventoiy
Equiprnent
Land
P330,000
360,000
420,000
150,000
540,000
180,000
Assets to be realized
Assets realized
Receivables
.
Other assets
Supplementary credits
Supplementary charges
360,000
350,000
360,000
260,000
45,000
Pi,435,000
Liabilities
P280,000
600,000
500,000
180,000
12,000
24,000
Accountants payable
Notes payable - A
Notes payable - B
Mortgage payable
360,000
450,000
510,000
468,000
::
PI,520,000
Total
Realizable Value
P60,000
Accmed interest
Other liabilities
The ending balances ofcapital stock and retained earnings are P300,000 and
P120,000,respectively.
Pl,596,000
Total
Ofthe accounts payable,PI30,000 is secured by inventory which has a net
realizable value ofP150,000.Note A is secured by the balance ofinventory and
receivables. Note B is secured by equipment with a net realizable value of
P300,000,and the mortgage payable and accrued interest are secured by the
land. All ofthe other liabilities are unsecured,although P10,000 is unsecured
1. Whatis the net income(loss)for the period?
a. P(168,000)
b. P 168,000
c. P(2I0,000)
d. P 210,000
with priority over the balance.
■ '•: ■ ■
2- Whatis the ending balance ofcash?
a,
b.
C.
4.
if,
P720,000
PS60,000
P700,000
P460,000
1. How much is to be paid to fully secured creditors?
■
i ■
a. P322,000
b. P310,000
c. P130,000
d. P232,000
■•i V <
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Chapter 7
304
Corporations in Financial Difficulty: Liquidation
305
No. 7-31: Continued
SE
2. How much is to be paid to partially secured creditors?
en
a.
b.
c.
d.
P860,000
P560,000
P300,000
P660,000
The following information is available on October 31,2011 to Laguna Company,
which is having difficulty in paying its liabilities as they become due:
Carrying Amount
P
Cash
3. How much is to be paid to unsecured creditors with priority?
a.
PI0,000
b.
P
c.
d.
PI4,000
P24,000
'I
0
4. How much is to be paid to unsecred creditors without priority?
a.
b.
c.
d.
P243,000
P223,000
P183,000
P193,000
4,000
46,000
39,000
134,000
27,000
2,000
5,800
1,200
60,000
40,000
50,400
100,000
59,400
Deficit
Required:
a. Prepare a statement ofaffairs
5. How much is the total consideration to'be received in satisfaction ofNote
Payable-B?
a.
b.
c.
(L
Accounts receivable (net): Current fair value equal
to carrying amount
Inventories: Net realizable value,P18,000; pledged
on P21,000 ofnote payable
Plant assets: Current fair value,P67,400; pledged
on mortgage note payable
Accumulated depreciation
Supplies: Current fair value,PI,500
Wages payable, all earned during October 2008
Property taxes payable
Accounts payable
Notes payable, P21,000 secured by inventories
Mortgage note payable including accrued interest ofP400
Common stock,P5 par
b. Compute the estimated percentage ofclaims each group ofcreditors should
expect to receive ifLaguna Company petitions for liquidation in bankruptcy.
c. Prepare a Statement ofDeficiency to Unsecured Creditor.
P300,000
P120,300
P420,000
P420,300
niiirqT
-V
On January 1,2011,the records ofMichael Anthony,tmstee in bankruptcy for VC
Corporation,showed the following:
7"
P
Cash
Assets Not Realized:
Land
8,200
10,000
43,000
28,000
4,400
Buildings
Equipment
Patents
Liabilities Not Liquidated:
Accounts Payable
Loans Payable
80,000
40,000
26,400
Estate Deficit
.Vl ■
. v.-
-If
Chapter 7
306
Corporations in FinancialDifficulty: Liquidation
Problem 7-2: Continued
307
Problem 7-4
During January, Michael sold equipment having a book value ofP15,000 for P8,800
and sold the patents for P12,000. Michael was paid P1,300 as trustee fee and P21,000
was distributed proportionately to the creditors.
A receiver is appointed forMapayapa Corporation on November 1,2011,at which
time the following trial balance was prepared from the general ledger:
Required:Prepare a statement ofrealization and liquidation for January and a balance
sheet and statement ofestate deficit as ofJanuary 31,2011.
Trial Balance
November 1, 2011
Problem 7-3
Cash
Notes Receivable
Rizal Corporation is experiencing difficulty in paying its bills and is considering filing for
bankruptcy. Current data show:
Accounts Receivable
Merchandise inventory
Investments-cost
Expected
Book
Value
Assets
Cash
Accounts Receivable
Inventory-Materials
Inventory-Finished Goods
Prepaid Expenses
Land
Building
Trucks
Equipment
Intangibles
P
4,000
40,000
36,000
50,000
1,000
10,000
70,000
20,000
45,000
Plant and Equipment
Accumulated Depreciation
Notes Payable
Accounts Payable
Capital Stock-par value P20
Retained Earnings
Realizable
Value
P
4,000
30,000
27,000
55,000
0
Accounts Payables
Additional data:
Bank Loan
Wages Payable
Taxes Payable
Truck Loan
Mortgage Payable
Loan Payable .
Stockholder Loan
Stockholders' Equity
a.
Secured by
P 77,000
25,000
12,000
8,000
5,000
' 43,000
50,000
110,000
Accrued expenses not recorded as ofthis date,amount to P20,100,ofwhich
P6,600 is for property taxes and P7,200 is for wages for the past month.(Not
more than P600 is owed to any one employee).
80% of receivables
The investments have a market value ofP69,000 and have been pledged as
collateral on a note for P60,000.
Truck with P12,000
Accounts receivable ofPI80,000 have been assigned as security for the
BV&P3,500ERV
remainder ofthe notes payable.
Land and building
Finish goods
It is estimated that95% ofthe notes receivable,95% ofthe assigned accounts
receivables,and 75% ofthe remaining accounts receivable will be collected. A
quick sale ofthe inventory will realize P180,000 and ofthe plant,P330,000.
The corporation also owns a patent notrecorded on the books which is expected
Not subordinated
to other debt
( 38,000)
to realize PI2,000.
P292,000
Required:Prepare a statement ofaffairs.
P2,OO9,0OO
0
P292,000
Liabilities
170,000
210,000
960,000
300,000
369,000
P2,009,000
42,000
160,000
6,000
25,000
16,000
66,000
114,000
438,000
291,000
60,000
1,040,000
Required:Prepare a statement ofaffairs.
,
309
Corporations in Financial Difficulty:Liquidation
Chapter 7
308
Problem 7-6
Qji.
The balance sheet ofEvergreen Company at June 30,2011,contains the following
The carrying values and estimated fair values ofthe assets ofLexos,Inc. are;
Carrying Value
Fair Value
Building(net)
Equipment(net)
P 16,000
60,000
90,000
100,000
220,000
250,000.
P 16,000
60,000
65,000
80,000
160,000
100,000
Total
P736,000
P471,000
itans:
Assets
Cash
Accounts Receivable
Inventory
Land
Cash
Accounts receivable-net
Inventories
Land
Building - net
Machinery - net
Patent
Debts ofLexos,Inc. are:
Accounts Payable
P 95,000
Wages Payable (all have priority)
9,500
Taxes Payable
14,000
Notes Payable (secured by receivables and inventory) 190,000
Interest on Notes Payable
5,000
Bonds Payable (secured by land and building)
220,000
Interest on Bonds Payable
11,000
80,000
140,000
100,000
260,000
200,000
120,000
100,000
Total
PI,000,000
Liabilities and Stockholders' Equity
Accounts payable
Wages payable
Taxes payable
Mortgage payable
Interest on mortgage payable
Notes payable - unsecured
Interest payable - unsecured
Capital stock
Retained earnings (deficit)
P 220,000
120,000
20,000
300,000
30,000
100,000
10,000
400,000
Total
Total
P
f
1
( 200,000)
P 1,000,000
P544,000
The company is in financial difficulty,and its stockholders and creditors have requested
a statement ofaffairs for planning purposes.The following information is available:
Required:
1. The company estimates that P126,000 is the maximum amount ofcollectible
for the accounts receivable.
Prepare a schedule to calculate the net estimated amount available for general
b.
c.
^
unsecured creditors.
2. Exceptfor20% ofthe inventory items that are damaged and worth only P4,0U ,
Compute the percentage dividend to general unsecured creditors.
Prepare a schedule showing the amount to be paid each ofthe creditor groups
upon distribution ofthe P471,000 estimated to be realized.
3.
The land and building have a combined appraisal value ofP340,000 and are
4.
subject to the P300,000 mortgage and related accmed interest.
The appraised value ofthe machinery is P40,000.
5.
Wages payable and taxes payable are unsecured priority liabilities.
the cost ofother items is expected to be recovered in full.
Required:
1. Prepare a statement ofaffairs for Evergreen Company as ofJune 30,2011.
[
2. Compute the estimated settlement per peso ofunsecured creditors.
Chapter 7
310
Problem 7-7
The balance sheet ofKimerald Corporation appeared as follows on March 1,2011,
when an interim trustee was appointed by the Securities and Exchange Commission
(SEC)to assume control ofKimerald's estate.
Assets
P
Cash
Accounts receivable - net
Inventories
Land
Building - net
Intangible assets
,.*, 'Hm|H
Liabilities and Stockholders' Equity
Accounts payable
Note payable - unsecured
Deferred revenue
^
'
,l
'
Total liabilities and equity
P100,000
80,000
2,000
6,000
160,000
80,000
tvfcj;
Corporations in Financial
Difficulty: Reorganization
And Troubled Debt Restructuring
There are many reasons why a business gets sick, but they don't necessarily mean
it should be destroyed. As an alternative to dissolution and liquidation, a
. P388,000
Total assets
Wages payable
Mortgage payable
Capital stock
Retained earnings (deficit)
8,000
16,000
72,000
40,000
200,000
52,000
Chapter 8
'
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(40,000)
P388,000
corporation in financial difficulty may attempt to rehabilitate a financially
floundering business through both reorganization and troubled debt restructuring.
These are arrangements entered into with creditors to reorganize the company
and return its operation to a profitable level. While it is true that the original
owners ofa company rescued in this way are often left without anything, others
whose livelihoods depend on the company'sfortunes may come out with their
interest intact. Its suppliers still may count on the company as a customer. And
perhaps most important, many ofits employees may be able to keep thejobs that
otherwise would have been sacrificed in a liquidation. Many companies swvive
as a result ofthese remedies.
Additional information:
I. The land and buildings are pledged as security for the mortgage payable.
2. In January 2011, Kimerald received P2,000 from a customer as a payment in
advance for merchandise that is no longer marketed.
3. Activities ofthe trustee during March are summarized as follows:
a. PI5,200 is collected on the receivables.
b. Inventories are sold for P38,800.
c. Land and building bring a total ofP180,000.
<1.
Nothing is realized from the intangible assets.
e.
Administrative expenses ofP16,400 are incurred by the trustee.
Required:
I. Prepare a separate set ofbooks for the trustee to assume possession ofthe estate
and convert its assets into cash.
2.
3.
Prepare financial statements on March 31 for Kimerald in trusteeship(Statementof
Financial Position,cash receipts and disbursements,and statement ofestate deficit).
Preparejoumal entries on the trustee's booksto distribute available cash to creditors
and close the books.
This chapter will discuss the accounting procedures required in reorganization
and troubled debt restructuring. A financially troubled company as well as its
owners and creditors allface the prospect ofincurring significant losses. Thus,
the accountant must adopt financial reporting to meet many and varied
informational needs. The increase in the number offailed business under the present
economic condition has made this accounting process especially important.
REORGANIZATION
The activities and events in reorganization differ significantly from liquidation. One
important distinction is that control over the company is normally retained by the
ownership(referred to as a debtor in possession).However,tlie Securities and Exchange
Commission(SEC)may appoint a trustee because offraud,gross mismanagement by
current owners or managers,or to protect the interests ofcreditors or stockholders oi
the company.
311
.1: bi/iii
Corporations in Financial Difficulty: Reorganization And Troubled Debt Restructuring
Chapter 8
312
Plan for Reorganization
313
Illustration 8-1
Ray Company
Statement of Financial Position
The plan ofreorganization should be submitted by the management to the company's
creditors and stockholders,and to the SEC for approval.The plan mustinclude provisions
altering or modifying the interests, and rights ofthe creditors and stockholders ofthe
June 30, 2011
ASSETS
company,as well as a number ofadditional provisions. The SEC will review the plan.
Before a plan ofreorganization is confirmed by SEC,the plan must be accepted by a
majority ofthe creditors,and by stockholders owning at leasttwo-thirds ofthe outstanding
capital stock.Ifsome ofthe stockholders and creditors has not accepted the plan,the
SEC may confirm the plan if the plan is fair and equitable to the nonacceptors.
Confirmation ofthe plan ofreorganization by SEC makesthe plan binding on the debtor
P
Current Assets
Land
Building
Equipment
50,000
100,000
400,000
250,000
P. 800,000
Total assets
LIABILITIES AND STOCKHOLDERS'EQUITY
company,on all creditors and stockholders.
LIABILITffiS
Accounts payable
Accrued expenses
Note payable (due in 3 years)
Bonds payable (due in 5 years)
Accountingfor Reorganization
The accounting for a reorganization usually requiresjoumal entries for adjustments of
P 160,000
50,000
300,000
600,000
book values ofassets; reductions ofpar or stated value ofcapital stock(with recognition
ofresultant additional paid in capital for the excess ofpar value); extensions ofdue
dates and revisions ofinterest rates ofnotes payable; exchanges ofequity securities for
debt securities; and the elimination ofa retained earnings deficit. These procedures
1,110,000
lUii
result in afresh start accounting for a reorganized corporation. Because ofchanges
in the pwnershijD ofcommon stock ofsuch a company as a result ofreorganization,it is
no longer controlled by its former stockholders, and it basically is a new reporting
STOCKHOLDERS'EQUITY
Common stock, 50 shares with a PI par value
Additional paid in capital
Retained earnings (deficit)
P
Total liabilities and stockholders' equity
50,000
40,000
(400,000)
(310,000)
P 800,000
company whose assets and liabilities should be valued at current fair values and whose
stockholders' equity consists only ofpaid in capital.
Additional information
Illustration ofa Reorganization
confirmed by SEC, included the following:
Assume that Ray Company filed a petition for reorganization,rather than for liquidation,
on June 30, 2011. The Statement of Financial Position of the company before
1.
The plan of reorganization which was approved by stockholders and creditors and
Assets. The company's land has a market value ofP120,000; the building is worth
P500,000. Other assets are worth their book values. The reorganization value of
the company's assets is assumed to be PI,000,000.
reorganization is presented in the next page.
2.
Liabilities. Out of the total accounts payable, P100,000 must be paid in lull. The
balance of the accounts payable and accmed expenses will be converted into oneyear notes payable of P70,000, paying interest of 10 percent. The P300,000 note
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payable on the balance sheet will be converted into a 10-year, 8 percent note of
P100,000. These creditors will get 20,000 shares of stock that is to be turned in to
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the company by the common stockholders. Finally, the P600,000 bonds payable
will be converted into 8-year, 9 percent notes totaling P430,000. The bondholders
will also get 15,000 shares of common stock turned in by the current owners.
Chapter 8
314
3.
Stockholders'Equity. The owners ofthe common stock will return 70 percent of
their stock(35,000 shares)to the company to be issued as specified above.The
reorganization value ofthe assets is PI,000,000 and the debts ofthe company after
the proceeding total P700,000(PI00,000+ P70,000 + P 100,000 + P430,000).
Thus,stockholders' equity must be the P300,000 difference. Since shares with a
P50,000 par value would still be outstanding,additional paid in capital is adjusted
to P250,000.
Thejournal entries below correspond to the provisions ofthe reorganization plan outlined
Corporations in Financial Difficulty: Reorganization And Troubled Debt Restructuring
Bonds payable
Note payable (8 years)
Common stock (15,000 shares)
Additional paid in capital
(30% of P250,000)
Gain on debt discharge
To record exchange with gain recorded
315
600,000
430,000
15,000
75,000
80,000
for difference between book value of old
bonds and the amount recordedfor new
notes and shares ofstock.
above:
(1) Land
Building
Reorganization value in excess of
identifiable assets
Additional paid in capital
To adjust asset accounts tofresh start
accounting and to recognize excess value
as an intangible asset subject to amortization
as computed below:
Reorganization value ofassets
PI,000,000
Market value ofassets
920,000
Excess
(2) Accounts payable
Accrued expenses
Notes payable (1 year)
Gain on debt discharge
To convert liabilities to a one-year note
(4) Common stock
Additional paid in capital
To record shares of common stock returned
20,000
100,000
35,000
to the company by owners as part of the
80,000
200,000
reorganization plan.
Additional paid in capital now has a balance ofP450,000(P40,000 beginning
balance plus P200,000 for adjusting assets plus P100,000 because ofshares issued
for note plus P75,000 because ofshares issued for bonds and P35,00Crfor shares
returned by owners.)Therefore,this balance is P200,000 more than the amountto
be reported as provided in the reorganization plan. Moreover,the gain on debt
discharge account with a balance ofP200,000(P40,000+P80,000+P80,000),
must be closed.Adjusting and closing these accounts eliminate the deficit in retained
80,000
60,000
50,000
earnings.
70,000
40,000
(5) Additional paid in capital
Gain on debt discharge
Retained earnings (deficit)
To adjust additional paid in capital balance
per reorganization plan.
(3) Note payable (3 years)
35,000
300,000
Common stock (20,000 shares)
-Additional paid in capital
400,000
to correct amount, close the gain account,
100,000
20,000
Note payable (10 years)
200,000
200,000
and eliminate deficit balance.
100,000
80,000
(40% ofP250,000)
Gain on debt discharge
To record exchange with gain recordedfor
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difference between book value ofold note
.
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and the amount recordedfor new note and
shares ofstock.
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Chapter 8
316
Corporations in Financial Difficulty: Reorganization And Troubled Debt Restructuring
After posting these entries,Ray Company emerges from financial difficulty with the
following reorganized statement offinancial position.
317
The most common form of troubled debt restructuring is a modification of the debt
terms to alleviate the short term cash needs of the debtor. For example, the creditor
may reduce the current interest rate, forgive some of the accrued interest or principal,
Illustration 8-2
or modify some other term of the debt agreement. Another common form of troubled
debt restructuring is the creditor's acceptance of assets or equity with a fair value less
Ray Company
Reorganized Statement ofFinancial Position
than the amount ofthe debt, because the creditor feels it is the best altemative to maximize
recoverability ofthe receivable from the debtor in financial difiiculty.
June 30,2011
ASSETS
P
Current assets
Land
Building
,
Equipment
Reorganization value in excess of identifiable assets
50,000
120,000
500,000
250,000
80,000
Illustration of Troubled Debt Restructurings
The following illustration demonstrates the accounting for various forms of a troubled
debt restmcturing. Cookie Corporation is financially distressed and is evaluating a variety
ofrestmcturing alternatives. Following are observations about Cookie Corporation:
PI,000,000
Total
LIABILITIESAND STOCKHOLDERS'EQUITY
Accounts payable
Note payable(due in 1 year)
Note payable(due in 10 years)
Note payable (due in 8 years)
Common stock,50,000 shares,P1 par value
Additional paid in capital
Total liabilities and stockholders' equity
■
P 100,000
70,000
100,000
430,000
50,000
250,000
1.
On December 31,2011, the company has an unsecured current liability ofP30,000
to the Creditor Company, on which P3,000 interest has been accmed and is unpaid.
2.
Cookie Corporation has been negotiating with Creditor Company to restructure
the current debt of P33,000 including accmed interest. The three alternatives are
presented below:
Alternative 1; Payment of Cash in F ull Settlement of Debt. The first altemative is
PI,000,000
the immediate transfer ofP27,000 in full settlement ofthe book value of the debt. Ifthe
creditor agrees to the restructuring, the debtor recognizes a restructuring gam o
P6,000 (P33,000 - P27,000) and the creditor recognizes a restmcturing loss in the
In the above reorganized statement offinancial position,take note that;
same amoimt.
1. Its assets are presented at their fair market value.
2. Its debts are equal to the present value ofthe future cash payments.
3. No deficit balance.
TROUBLED DEBT RESTRUCTURING
An importantremedy which often aids financially distressed corporations in avoiding
dissolution and liquidation is troubled debt restructuring. A trouble debtrestructuring
occurs when a debtor having debt^related financial distress is granted a concession
pertaining to debt by the related creditor. The concession usually is granted simply
because the creditor will be better ofeconomically after granting the concession than
before.The debtor also is better offbecause ofthe receipt ofconcession.
■f:
The entry required on December 31, 2011 for Cookie Corporation, the debtor
company, is:
Notes payable
'
Accrued interest payable
30,000
3,000
Cash
Gain on restructuring of debt
To record restructuring and settlement of debt.
The gain is now typically reported as part of continuing operations.
27,000
6,000
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Chapter 8
318
Alternative 2: Payment of Noncash Assets in Settlement of Debt. In this
alternative, Cookie Corporation agrees to transfer inventory with a book value of
P45,000 and a fair value of P26,000 to Creditor Company in full settlement of the
P33,000 debt. A restructuring difference of P7,000 (P33,000 - P26,000) is to be
recognized by Cookie Corporation. When noncash assets are transferred in a restructuiing
plan, the assets must be revalued to their fair values. A gain or loss on the disposal of
assets is also recognized by the debtor. Therefore, Cookie Corporation recognizes a
loss on disposal of its inventory for the P19,000 decline in its inventory from its book
Corporations in Financial Difficulty: Reorganization And Troubled Debt Restructuring
The restructuring difference as ofthe date ofthe modification is computed by the debtor
corporation as follows:
Carrying value of the debt:
Principal
Interest
P30,000
3,000
P33,000
Total future estimated cash flows:
Future principal
value of P45,000 to its fair value of P26,000.
319
P30,000
Future contractual interest
The entry made by Cookie Corporation on December 31,2011 is:
Notes payable
Accrued interest payable
Loss on disposal of inventory
Inventory
Gain on restructuring of debt
To record restructuring and settlement of debt.
(P30,000 X .05 X 1 year)
1,500
Restmcturing difference
30,000
3,000
19,000
(31,500)
P 1,500
The entry required for Cookie Corporation, the debtor, on December 31,2011, the
45,000
7,000
Alternative 3: Modification of Terms. A common technique of debt restructuring is
to modify some of the terms of the original debt contract. Modification of terms may
include:
date of the modification ofterms agreement is:
Accrued interest payable
Notes payable (10%)
Restructured debt payable (5%)
Gain on restructuring of debt
To record restructuring of terms ofdebt.
3,000
30,000
31,500
1,500
1. deduction of the stated interest rate for the remainder of the original debt.
When Cookie Corporation repays the debt on December 31, 2012, it makes the
2. Extension of the maturity date of the original debt at a lower rate of interest.
3. Reduction ofpart of the face amount of the original debt.
following entry:
4.
Reduction in the accrued interest.
Restructured debt payable (5%)
31,500
Cash
The restructing difference is computed as the difference between the carrying or book
31,500
To record payment of restructured debt.
value of the debt and the total future estimated cash flows under the new terms. If the
carrying value of the debt is greater than the total future estimated cash flows, the
debtor corporation recognizes a gain for the restructuring difference. If the carrying
value ofthe debt is less than the total future cash flows, no gain or loss recognized and
the debtor's new effective interest rate is determined based on the amount of the
restructuring difference. The following cases illustrate these points.
Case A: Carrying Value of Debt Greater than Modified Total Future Cash
Flows-Debtor Gain Recognized. Using the same data for Cookie Corporation.
Assume that on December 31,2011, the entities agree to the following modification of
terms on the debt contract:
a. Forgive accrued interest of P3,000.
b. Reduce the interest rate from 10 percent to 5 percent,
c.
Extend the maturity for 1 additional year to December 31,2012.
Although the terms ofthe restructuring agreement specify a contractual interest rate of
5%, no interest expense is recorded.
Case B: Carrying Value of Debt Less than Modified Total Future Cash
Flows: No Gain Recognized By the Debtor. Cookie Corporation and Creditor
Company agree to the following modification of terms for the debt of P30,000 and
P3,000 of accrued interest:
1. Forgive P500 ofaccmed interest.
2. Reduce contracted interest from 10 percent to 5 percent.
3. Extendmaturityfor 1 additionalyearDecember31,2012.
if ri-4,;
Chapter 8
320
Again the restructuring difference on December 31,2011 is computed by the debtor
corporation as follows:
Carrying value ofthe debt:
Principal
MULTIPLE CHOICES ^ THEORETICAL
1. A reorganization plan,to be accepted and confirmed by SEC
P30,000
3,000
biterest
P 33,000
a. Must be accepted by all creditors.
b. May be approved by a majority o|/Greditors by number.
Total future estimated cash flows:
Future principal
Remaining accmed interest not forgiven
321
Corporations in Financial Difficulty: Reorganization And Troubled Debt Restructuring
c. May be approved by a majority ofcreditors.
P30,000
2,500
d. Required approval ofa majority as to number ofcreditors and two thirds as to
amount ofclaims ofcreditors where claims have been proved and allowed.
Future contractual interest
{P30,000 X .05 X 1 year)
1,500
Restructuring difference
(34,000)
Among other provisions,a plan ofreorganization must:
P(1,000)
a. Rank claims according to their liquidation priorities.
b. Notimpair claims ofsecured creditors.
c. Provide adequate means for the plan's execution. ,
bi this case,the debtor will not recognize a gain,because the P33,000 carrying value«of
the debt is less than the total future estimated cash flows resulting from the restructuring.
The entry required in the books ofCookie Corporation on December 31,2011 is:
Accrued interest payable
Notes payable(10%)
Restructured debtpayable(5%)
To record restructuring ofterms ofdebt.
d. Treat all claims alike.
3,000
30,000
3. Injournal entries for reorganization,the difference between the canymg amountof
a liability oftlie debtor and the amount accepted by the creditor in full settlement
33,000
ofthe liability is credited to:
a. Retained earnings(deficit)
b. Pain in capital in excess ofpar value.
c. Paid in capital from reorganization.
Note that under this approach,the restructured debt payable(5 percent)is stated at the
carrying value ofthe old note(P30,000)plus accrued interest(P3,000)even though the
creditor forgave P500 ofthe accmed interest as part ofthe restmcturing. Because the
total future estimated cash flows(P34,000) exceed the carrying value of the debt
(P33,000),no adjustments are made to the total amount ofthe carrying value ofthe
debt. The restructured payable is stated at P33,000 and a total ofPI,000 ofinterest
expense will be recognized over the term to maturity ofthe restmctured debt representing
the difference between the total ofP34,000 offuture cash flows and the P33,000
carrying value ofthe restmctured debt.
On December 31, 2011, Cookie Corporation must pay a total ofP34,000, which
includes P33,000 to extinguish the restmctured debt and P1,000 ofinterest expense.
The entry on December 31,2011,is:
Interest expense
Restructured debtpayable(5%)
Cash
To record payment ofdebt and interest expense.
1,000
33,00t)
34,000
d. Some other account.
4. The followingjoumal entry was prepared by a financially distressed company.
Additionalpaid in capital
Gain on debt discharge
Retained earnings(deficit)
i Wc
Such ajoumal entry generally is related to:
a. Liquidation only.
b. Reorganization only.
c. Troubled debt restmcturing only.
d. None ofthe above.
200,000
200,000
40,000
Chapter 8
322
Corporations in Financial Difficulty: Reorganization And Troubled Debt Restructuring
5. The Paid in Capital in Excess ofPar account ofa debtor corporation undergoing
reorganization typically is debited or credited for;
323
10. Ifthe reorganization value ofa company emerging from financial difficulty is larger
than the values that can be assigned to specific assets, what accounting is made of
the difference?
a. Costs ofreorganization.
b. Gain from discbarge ofindebtedness in reorganization.
c. Retained earnings deficit.
a.
b.
c.
d.
d. None ofthe above items.
6. What is a debtor in possession?
Because ofconservatism,the difference is simply ignored.
Tlie difference is expensed immediately.
The difference is capitalized as an intangible asset.
The difference is recorded as a professional fee.
11. For a troubled debtrestnicturing involving only modification ofterms,Misappropriate
for a debtor to recognize a gain when the carrying amount ofthe debt:
a. The bolder ofa note receivable issued by an insolvent company.
b. A fully secured creditor.
c. The ownership of an insolvent company that continues in control of the
organization during a reorganization.
a.
b.
c.
d.
d. The stockholders.
7. On a balance sheet prepared for a company during its reorganization,bow are
liabilities reported?
Exceeds the total future cash payments specified by the new temis.
Is less tlian the total future cash payments specified by the new terms.
Exceeds the present value specified by tlie new terms.
Is less than the present value specified by the new terms.
12. A client hasjoined other creditors ofJoe Company in a composition agreement
a. As current and long term.
b. As monetary and nonmonetary.
seeking to avoid the necessity ofa liquidation proceeding against Joe. Which
statement describes the compositions agreement?
c. As subject to compromise and not subject to compromise.
d. As equity related and debt related.
a. It provides for the appointment ofa receiver to take over and operate the
8. On a balance sheet prepared for a company during its reorganization, at what
balance are liabilities reported?
debtor's business.
b. It must be approved by all creditors.
.
c. It provides that the creditors will receive less than the full amount oftheir
a.
b.
c.
d.
Atthe expected amount ofthe allowed claims.
At the present value ofthe expected future cash flows.
A the expected amount ofthe settlement.
Atthe amount ofthe anticipated final payment.
claims.
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d. It provides a temporary delay, not to exceed six months, in the debtor s
obligation to repay the debts included in the composition.
9. Which ofthe following is necessary for a company to use fresh start accounting?
a. The original owners must hold at least50 percentofthe stock ofthe company
when it mergesfrom bankmptcy.
b. The reorganization value ofthe company must exceed the value ofall assets.
c. The reorganization value ofthe company mustexceed the value ofall liabilities.
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d. The original owners must hold less than 50 percentofthe stock ofthe company
when it emerges from bankruptcy.
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Corporations in Financial Difficulty: Reorganization And Troubled Debt Restructuring
Chapter 8
324
8-3:
MULTIPLE CHOICES-COMPUTATIONAL
8-1:
Using the data in 8-2, what entry should the Samar Company make on its books
to record the payment?
a.
Among the provisions ofthe plan ofreorganization confinned by SEC for Wow
b.
Company were the following:
No entry.
Accounts payable (old)
12,000
12,000
Cash
c.
Amend articles ofincoiporation to authorize 10,000 shares at 12%,PI par
preferred stock and 15,000 shares ofnew P2 par common stock. 10,000 shares
12,000
Accounts payable (old)
12,000
12,000
12,000
Trustee
d.
Trustee
Accounts payable (old)
ofthe new common stock were to be exchanged on a share-for-share basis for
all 10,000 shares ofthe P100 par common stock currently outstanding.
8-4:
325
Cebu, Inc., is indebted to Day Finance Company under a P600,000,10 percent,
5 year note dated January 1,2009. Interest, payable annually on December 31,
was paid on the December 31,2009 and 2010, due dates. However, during
2011, Cebu experienced severe financial difBculties and is likely to default on tlie
Exchange 5,000 shares ofthe PI par, 12% preferred stock (at a current fair
value ofP10 a share)to creditors for trade accounts payable totaling P52,000.
note and interest unless some concessions are made. On December 31,2011,
Pay 80 centavos on the peso for trade accounts payable totaling P62,700.
Cebu and Day signed an agreement restmcturing the debt as follows:
In recording the above provisions ofreorganization,total gain on debt discharge
Interest for 2011 was reduced to P30,000, payable March 31,2012.
Interest payment each year were reduced to P40,000 per year for 2012 and
is:
2013.
The principal amount was reduced to P400,000.
a. P14,540
b. P12,540
c. P 2,000
•
What is tlie amount of gain that Cebu should report on the debt restmctunng for
«
the year ended December 31,2011 ?
d. PI0,540
a.
8-2: When the Samar Company filed for reorganization,a tmstee was appointed. All
corporate assets were transferred to the tmstee on April 27,2011.On May 27,
2011 the tmstee paid P12,000 ofold accounts payable.
8-5:
Whatentry should the frustee on the trustee's books make to record the payment?
i
a. No entry.
b. Accounts payable (old)
■K'
12,000
12,000
Cash
c. Samar Company in trusteeship
The HuUc Company is indebted to Ape Company under at P500,000,
3-year note dated December 31,2009. Because of Hulk's financial dimculties
developing in 2011, Hulk owed accmed interest of P60,000 on the
December 31,2011. Under a troubled debt restmcturing, on December 31,
2011, Ape Company agreed to settle tlie note and accmed interest for a ttact ot
land having a fair value of P450,000. Hulk's acquisition cost of the land ^
P360,000. On its 2011 statement of comprehensive income HiUk should report
as a result of the troubled debt restmcturing.
12,000
Other income
12,000
Cash
d. Accounts payable (old)
Samar Company in trusteeship
a.
12,000
b.
12,000
c.
d.
i \ ..
(,
i.
PI20,000
b. PI50,000
c. P200,000
d. P230,000
P200,000
PI40,000
P 90,000
P 90,000
Gain or Restructuring
P
P
-0-0~
P 50,000
P110,000
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Chapter 8
326
8-6: On January 1, 2007, Cain Company purchase at par 500 ofthe P1,000 face
value,8 percentbonds ofSisa Corporation as a long-term investment.The bonds
mature on January 1,2015,and pay interest semiannually on July 1 and January
1. Sisa incurred heavy losses from operations for several years and defaulted on
the July 1,2010 and January 1,2011,interest payments.Because ofthe permanent
decline in market value of Sisa's bonds, Cain wrote down its investment to
P400,000 on December 21,2010. Pursuant to Sisa's plan ofreorganization
effected on January 1,2011,Cain received 5,000 shares ofPlOO par value,8
percent cumulative preferred stock ofSisa in exchange for the P500,000 face
value bond investment.The quoted market value ofthe preferred stock wasP70
per share on January 1,2011.
What amount ofgain(loss)should be included in the determination ofSisa's net
Corporations in Financial Difficulty: Reorganization And Troubled Debt Restructuring
327
8-8: Troy,Inc.is in serious financial trouble and enters into an agreement with Gray
Company,one its creditors. Troy has a 12 percent note payable due now to
Gray Company for PI00,000 plus PI2,000 interest. Under the terms ofthe
agreement.Gray will receive machineiy that costP60,000 and has a book value
ofP34,000 and a fair value ofP36,000. Gray agrees to forgive the accmed
interest,reduce the note to P50,000,extend the maturity date for 2 years, and
reduce the interest rate to 8 percent. Interest is due at the end ofeach year.
The gain on restructuring ofdebt to be recognized by the Troy Company in its
books is:
a.
b.
c.
d.
PI8,000
P50,000
P 2,000
P44,000
income for 2011?
Items 8-9 and 8-11 are based on the following data:
a.
P
King Company borrowed P300,000 from the Metro Bank on December 31,
2008. The interest rate was 10 percent, and interest was due and payable
December 31,ofeach year. According to the terms ofthe contract. King was
0
b. P 50,000
c. P100,000
d. P150,000
required to repay the amount borrowed on December 31,2012.Due to financial
difficulties in 2011,King was not able to pay the accmed interest on December
31,2011 (it had paid the interest in 2009 and 2010).King's debt was restmcturea
8-7: Among the provisions ofthe reorganization ofHome Company were the following:
(1) Issued 1,000 shares ofP5 par common stock in exchange for 1,000 shares
ofP100 par common stock outstanding.
(2) Issued 200 shares ofP5 par common stock(current fair value P10 a share)
for notes payable to suppliers with unpaid principal ofP2,500 and accmed
interest ofP500.
(3) Paid P8,000 to suppliers in full settlement oftrade accounts payable of
PI0,000.
in the following way:
(1) 70% ofthe December 31,2011,interest was forgiven.
(2) The interest rate was reduced to 8%.
(3) Principal ofthe debt was reduced to P260,000.
(4) The due date for the repayment of the principal was delayed un i
December 31,2013. .
8-9: What is the carrying value ofKing's debt as ofDecember 31,2011?
a. P260,000
b. P269,000
The total gain on debt discharge recorded by Home Company is:
c. P330,000
d. P300,000
a.
b:
c.
d.
P4,000
PS,000
P2,000
Pl,200
8-10: What is the total ofthe future cash flows required to liquidate the debt?
a. P290,000
V
b. P301,000
c. P310,000
■ .
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d. P260,000
V
Chapter 8
328
8-11: How much total interest expense will King report on its income statementfor the
years 2010 and 2011?
cu P60,000
b. P51,000
c. P41,000
d.
P
Item 14 and 15 are based on the following:
The following data pertains to the transfer ofreal estate pursuant to a troubled
debt restructuring by May Co.to Tanny Corp.in full liquidation ofMay's liability
to Tanny:
Carrying amountofliability liquidated
Carrying amount ofreal estate transferred
0
PI50,000
100,000
90,000
Fair value ofreal estate transferred
8-12: Good Company,as a result ofexperiencing financial difficulties, had its debt
restructured. According to the restructuring agi^eement,land ov^medby Good
329
Corporations in Financial Difficulty: Reorganization And Twubled Debt Restructuring
8-14: What amount should May report as a gain(loss)on restmcturing ofpayables?
will be transferred to the creditor in full settlement ofGood's debt which totaled
P300,000. The land originally cost P290,000 and had a fair market value of
a, P 60,000
P270,000 on the date it was transferred to the creditor. As a result ofthis debt
b. P
restmcture.Good would report which ofthe following;
c.
0
P 50,000
d. P(10,000)
a.
Loss on
Gain on
Transfer ofLand
Restructuring ofDebt
P
0
b.
P
0
c.
P20,000
P20,000
d.
PI0,000
P30,000
PI0,000
P30,000
8-15: What amount should May report is a gain(loss)on transfer ofreal estate?
a. P(10,000)
b. P
0
c. P 50,000
d. P 60,000
8-13: On October 15, 2011, Karla Corporation informed Finance Co. that Karla
would be unable to repay its PI00,000 note due on October 31. Finance Co.
agreed to accept title to Karla's computer equipment in full settlement ofthe
note.The equipment's carrying value wasP80,000 and its fair value was P75,000.
8-16: Maria Corp.entered into a troubled debt restmcturing agreement with Citibank.
Citibank agreed to accept land with a carrying amount ofP85,000 and a fair
value ofPI20,000 in exchange for a note with a carrying amount ofPI85,000.
Karla's tax rate is 30%.
What amount should Maria report as a gain from extinguishment ofdebt m its
What amounts should Karla report as the gain(loss)on the transfer ofassets,
Statement ofComprehensive Income?
and the gain on restructuring ofdebt?
a.
Transfer gain (loss)
Restructuring gain
P(5,000)
P25,000
P30,000
P20,000
b.
P
0
c.
P
0
d.
P20,000
P
CL P 65,000
b. P 35,000
c. P100,000
d. P
0
0
v--
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.
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330
Corporations in Financial Difficulty: Reorganization And Troubled Debt Restructuring
Chapter 8
8-17: Cora, Inc. is indebted to Pete under P800,000, 10% four-year note dated
December 31,2008, annual interest ofP80,000 was paid on Deeember 31,
2009 and 2010.During 2011,Cora experienced financial dififieulties and is likely
331
8-19: Asia Corporation has been experiencing difficulties servicing its long-term debt
which has a current balance of P620,000 including accrued interest. Asia is
considering two possible alternatives to restmcttire the debt.
to default unless concessions are made.On December 31,2011,Pete agrees to
restructure the debt as follows:
•
Interest ofP80,000 for 2011,due Deeember 31,2011,
was made payable Deeember 31,2012.
•
lnterestfor2012 was waived.
Alternative #1 would consist ofconveying vacant land with a fair value P350,000
and a book value of P275,000 to the creditor. In addition, Asia would make two
annual payments of P HO,000 each.
• The principal amount was reduced to P700,000.
How much should Cara report as a gain in its Statement of Comprehensive
Income for the year ended December 31,2011?
Altemative #2 would call for Asia to make five annual payments of PI35,000.
All payments are to be made at the end of the respective years.
The market rates of interest for a 2-year and 5-year note are 10% and 12%
a. PI00,000
b.
P
respectively:
0
c. P 60,000
d. P120,000
1. What is the effect on net income ofAltemative # 1, increase (decrease)?
a.
b.
c.
d.
8-18: On Deeember 31, 2009, Mike Company entered into a debt restructuring
agreement with Sure Company,which wasexperiencing financial difiBculties. Mike
restructured a PI00,000 note receivable as follows:
•
Reduced the principal obligations to P70,000.
•
Forgave P12,000 ofaccmed interest.
•
P(30,000)
P 30,000
P 20,000
P(20,000)
2. What is the effect on net income of Altemative #2, increase (decrease)?
Extended the maturity date from Deeember 31,2009 to Deeember 31,
2011.
Reduced the interest rate from 12%to 8%.Interest was payable annually
on December 31,2010 and 2011.
Present valuefactors:
Single sum,two years@8%
.85734
Single sum,two years@ 12%
.79719
Ordinary annuity,two years@8%
1.78326
Ordinary annuity,two years@ 12%
1,69006
In accordance with the agreement.Sure made payments to Mike on Deeember
31,2010 and 2011.How much interestincome should Mike report for the year
c.
d.
P(50,000)
P 50,000
significant debt and an inability to service its debt. The existing debt consists o
P20,000,000 of principal andP875,000 of accmed interest. Discussions with
the creditors have resulted in a proposed restmcturing ofdebt. The restmcturing
a. P 8,100
P
P(55,000)
P 55,000
8-20: For the last several years, Malay Corporation has encountered a declining market
for its major product line. Attempts to diversify have let to additiona
disappointments. This unfortunate set ofcircumstances has left the company with
ended December 31,2011?
b.
a.
b.
would consist ofthe following actions:
0
c. P 5,600
d. Pll,200
■i6k.
■
:
I
i
Chapter 8
332
Corporations in Financial Difficulty: Reorganization A nd Troubled Debt Restructuring
333
No. 8-20: Continued
HE
a. Exchanging preferred stock with a fair value ofP5,100,000 and a par value
ofP5,000,000 in exchange for full settlement ofP5,500,000 ofprincipal
Problem 8-1
debt.
b. Exchanging land with a value ofP4,000,000 and a hook value ofP3,000,000
in exchange for P4,500,000 ofprincipal debt.
c. The remaining debt and accrued interest would be repaid over the next 10
years with semi-annual payments due every six months.The annual stated
Under fiesh start accounting, a company is coming out ofreorganization witli the following
accounts:
Book Value
Fair Value
P80,000
200,000
300,000
300,000
330,000
20,000
P90,000
210,000
400,000
300,000
Receivables
rate would be 8.5%.
Past operating losses have resulted in a deficit in retained earnings ofP3,400,000.
In addition to the deficit,the company's equity includes common stock at par
value ofP6,000,000 and contributed capital in excess ofpar value in the amount
ofPI,000,000.
Inventory
Buildings
Liabilities
Common stock
Additional paid in capital
Retained earnings (Deficit)
(70,000)
The company's assets have a reorganization value ofP760,000. The owners of the
company before the organization have transferred 80 percent of the outstanding stock
Whatis the adjusted retained earnings(deficit)after restructuring?
to the creditors.
a.
PI,500,000
Required: Prepare the joumal entry that is necessary to adjust tlie company's records
b. P(l,500,000)
c. P(l,450,000)
d. P 1,450,000
to fresh start accounting.
QJl
On July 24,2011, tlie date the plan ofreorganization ofLuigi Company was approved
by SEC, Luigi's stockholders' equity was as follows:
Common stock, no par or stated value; authorized 100,000 shares,
issued and outstanding 60,000 shares
P580,000
Deficit
(260,000)
Included in Luigi's plan ofreorganization were the following:
: ■}
1. Authorize payment of P50,000 unrecorded administrative costs by escrow agent
\.T.
tr ,
I ' . I !*'• ?
.
. ■,
.
• /.
holding Luigi cash account.
2. Amend articles of incorporation to change common stock to P1 par from no-par,
.1" . - ..
■ ■ ■ ;/■ , 1
no-stated value stock.
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3. Exchange 10% unsecured P120,000 promissory note payable to supplier (interest
unpaid for three montlis) for a 12%, two-year promissory note in the total amount
of unpaid principal and accrued interest on the 10% note.
He*
Chapter 8
334
Corporations in Financiai Difficulty: Reorganization And Troubled Debt Restructuring
335
Problem 8-2: Continued
4.
Pay suppliers 80 centavos on the peso(from Luigi cash account)for their claims
totaling P100,000.
5. Eliminate deficit against paid-in capital resulting fi-om(2)and gain resulting firom(4).
Required:Assuming the foregoing were completed on July 24,2011,preparejoumal
entries(omit explanations)for Luigi Company on that date. Use the following ledger
account titles.
Cash
Cash with escrow agent
Common stock, no par
Common stock, PI par
Cost ofreorganization
Gain from debt discharge
Interest payable
10% note payable
12% note payable
Paid-in capital in excess of par.
Retained eamings(deficit)
Trade accounts payable
The Red Company is in the process ofemerging fi^om reorganization. The company will
apply fresh start accounting as ofDecember 31,2011. The company currently has
30,000 shares ofcormnon stock outstanding with a P240,000 par value. As part ofthe
reorganization, the owners will contribute 18,000 shares ofthis stock back to the
company. A deficit balance ofP330,000 also is being reported.
The company has the following asset accounts:
Book Value Market Value
Account receivable
Inventoiy
Land and buildings
Equipment
LOi
PI00,000
112,000
420,000
78,000
P80,000
90,000
500,000
65,000
The Jade Corporation is in the process ofgoing through reorganization. As ofDecember
31,2011,the company's accountant has determined the following infoimation.
The company's liabilities will be settled as follows: Assume that all notes will be issued
Assets:
Cash
Inventory
Land
Buildings
Equipment
Book Value
Market Value
P 23,000
45,000
140,000
220,000
154,000
P 23,000
47,000
210,000
260,000
157,000
will also get 1,000 shares ofthe stock contributed by the owners.
(2) Accrued expenses ofP35,000 will be settled with a note for P4,000.
Allowed
Claims
Expected
(4) Note payable(due 2009)ofP200,000 will be settled with a note for P50,000 and
Settlement
Accmed expenses
Income taxes payable
Note payable(due 2006, secured by land)
Note payable(due 2008)
Liabilities since the date of reorganization
Accounts payable
Note payable
Stockholders' equity
(1) Accounts payable ofP80,000 will be settled witli a note for P5,000.These creditors
(3) Note payable (due 2013) of PI00,000 was fully secured and has not been
renegotiated.
10,000 shares ofthe stock contributed by the owners.
Liabilities as of the date of reorganization
Accounts payable
at reasonable interest rates.
P 123,000
30,000
22,000
100,000
170,000
P 20,000
4,000
18,000
100,000
80,000
P 60,000
100,000
Common stock
P200,000
Retained eamings(Deficit)
(223,000)
Required:Prepare a reorganized statement offinancial position in good form.
(5) Note payable(due 2010)of?185,000 will be settled with a note for P71,000 and
7,000 shares ofthe stock contributed by the owners.
(6) Note payable(due 2011)ofP200,000 will be settled with a note for P110,000.
The company has a reorganization value ofP780,000.
Required:Prepare all ofthejoumal entries for Red Company so that the company can
emerge firom reorganization.
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Chapter 8
336
Problem 8-i5
Chapter 9
The Sun Corporation has gone through reorganization on December 31,2011.On this
date,the company has the following assets(market value is based on the discounted
future cash flows that are anticipated):
■ ;
'.
.
.V,
■
'.
y. ■•••,.
•
n
Installment Sales
I'r
»•», - ••
V
S'.-r : ■
.1.1,'
iV7;.V, f. . ■
•
Book Value Market Value
Accountreceivable
Inventory
Land and buildings
Machinery
Patents
P20,000
143,000
250,000
144,000
100,000
P18,000
111,000278,000
121,000
125,000
An installment sales contract is a special type ofcredit arrangement which provides
for a series ofpayments over a period of months or years. Installment sales are
widely used by dealers in real estate, home appliances and cars. Since the seller
must waitfor a considerable period oftime to collect thefull amount, it is customary
to provide for interest on the unpaid balance.
The company has a reorganization value ofP800,000.
The company has 50,000 shares ofP10 par value common stock outstanding. A deficit
retained earnings balance ofP670,000 also is reported. The owners will distribute
30,000 shares ofthis stock as part ofthe reorganization plan.
The company's liabilities will be settled as follows;
Accounts payable(existing at the date on which the order ofreorganization was
granted)ofP180,000 will be settled with an 8 percent,two-year note for P35,000.
Accounts payable(mcurred since the date ofreorganization was granted)ofP97,000
will be paid in the regular course ofbusiness.
An installment plan exposes the seller to a greater risk ofnon-collection considering
that customers who avail ofthis plan are generally weaker in financial condition
than those who buy on open account. Furthennore, the credit standing ofa customer
may change significantly during the period covered by an installment contract.
In view of this greater risk of non-collection, the seller should protect himself by
adopting aform ofcontract which will enable him to repossess the property ifthe
buyerfails to make all the agreed installment payments.
note for P50,000 and 15,000 shares ofthe stock contributed by the owners.
Inspite of the various safeguards, losses from installment sales are significantly
greater than thosefrom short-term credit sales. To minimize loss, the seller should
require sufficient down payment to cover the decline in the value of the property^
when it moves out of the "new merchandise " category to "old merchandise
Note payable—Metro Bank ofP350,000 will be settled with a 7 percent,eight-
category. The installment period should also be made as short as possible.
Note payable-Citibank ofP200,000 will be settled with an 8 percent,five-year
year note forP100,000 and P15,000shares ofthe stock contributed by the owners.
Methods of Gross Profit Recognition on Installment Sales
Required:
The determination ofthe net income on installment sales is one ofthe more complicated
Prepare a statement offinancial position for the Sun Corporation upon its emergence
fixjm reorganization.
i
I- . * ■
problems in installment sales accounting because the amounts of recoveries and the
related costs and expenses are seldom known in the period when the sale is made.
Accounting procedures should be developed for a reasonable matching of costs and
revenues. Two general approaches may be used in the recognition of gross profit on
337
338
Chapter 9
Installment Sales
339
installment sales(1)the gross profit(excess ofsales price over cost ofsales)is recognized
at the time ofsale; and(2)the gross profit is recognized in installments over the period
for gross profit recognition. Under this approach,several alternative procedures which
focus primarily on the recognition ofgross profit may be applied,namely:
ofthe contract on the basis ofcash collections.
Cost Recovery Method. Under this method gross profit is not recognized until
collections are equal to the amount ofcost ofgoods sold. That is, all collections both
Gross Profit is Recognized at the Time ofSale. Many companies treat a sale on
installment in exactly the same way as they treat any other sale on account.The Account
Receivable account is debited and the Sales account is credited for the full price when
the sale is made.This treatment is not different from that emploj'ed for regular sales on
credit. Gross profit is recognized at the period ofsale-the point at which goods have
been delivered to the customer and a definite amount ofreceivables has been acquired.
Accountants who favor this treatment point out that most ofthe expenses in selling
goods are incurred and recorded in the year ofsale,therefore,the revenue should also
be reported at thattime to properly match cost and revenue. However,many expenses
related to installment contract include the expenses ofaccounting,interest,repossession
and loss on defaulted contract. These expenses are incurred after the sale and are
spread over a period oftime. Thus,ifrevenue is reported at the time ofsale,the postsale expenses,theoretically,should be estimated and the liability should be recorded for
them.
This procedure will require recognition ofall expenses relating to the sales ofthe same
period so that the determination ofnet income will be a reasonable process. The yearend accounting entries to recognize these expenses would be a debit to the appropriate
expense accounts and a credit to accounts such a Liability for Post-Sale Collection and
Repossession Expenses.This liability account will be debited when the expenses relating
to the installment contract become kno\vn and are actually paid.Estimated uncollectible
accounts will be provided for in the usual manner by debiting Bad Debts and crediting
Allowance for Uncollectible Installment Contracts Receivable.
This method ofaccounting is usually employed by enterprises which make only a portion
oftheir sales on installment plan and which often sell these installment contracts to
finance companies. This method is relatively simple and is within the framework of
generally accepted accounting principles.
interest and principal portions are treated first as recoveiy ofthe property costs. After
the recoveiy ofthe flill cost, all collections are regarded as realization ofgross profit.
This defenal ofgross profit until cost is fully recovered is too conservative. This method
is probably most applicable in the sale ofservices or products ofa nature not permitting
repossession and when the customer notes have no fair market value.
Gross ProRt-Realization Method. Under this method, the first collections are
regarded as realization ofgross profit. After the recognition ofthe flill profit,all subsequent
collections are treated as recovery ofcost. This method is seldom used since it lacks
conservatism. Furthennore, it fails to take into consideration the probability tlrat
repossession during the life ofthe contract mightimpair the gross profit margin.
Installment Method. Under this method,cash collection is regarded as a partial
recovery ofcost and a partial realization ofprofit in the same proportion that these two
elements are present in the original selling price. This method aims to spread tire ^oss
profit in the installmentsale over the life ofthe contract,and to anticipate possible fmlure
to realize the full amount ofgross profit in the event ofdefaults and repossessions.
Accountants who advocate this treatment point out that it matches revenue(the gross
profit)with the expenses incurred after tire sale. This method is frequently used in practice
and is acceptable for income tax purposes. Discussions in the succeeding sections
concentrate on this metliod.
The Installment Method ofAccounting
Under the installment method ofaccounting,the difference between the selling
and the cost ofsale is recorded as deferred gross profit or unrealized ^oss profit- Tms
account is decreased periodically for the amountrecognized as revenue in the proportion
that the cash collection bears to the sales price. Simply,the amount ofgross protu
realized in a given period depends upon the gross profit rate on the sale and the cash
collections ofinstalhnent receivables. At the end ofeach period,a balance ofdeferred
gross profit account may appear in the books.This balance is equal to the gross proiit
rate multiplied by the balance ofinstallment receivables as ofthis date.
Illustration. Assume that on March 31,2008 an installment sale ofproperty
P60,000 was made. The selling price was P100,000. A down payment ofP20,000
was required,the balance payable in forty monthly payments ofP2,000 atthe end ot
each month.
Gross Profit is Recognized in the Period in which Cash is Collected. This is a
special method ofaccounting for installment sales whereby gross profit is recognized in
the periods in which the installment receivables are collected instead ofin tlie periods in
which receivables are created. The amount of cash collections then becomes the basis
The gross profit on this sale is P40,000(PI00,000- P60,000)hence,the gross profit
rate is 40%(P40,000 P100,000)ofsales price. Using the installment method,the
computations ofannual realized gross profit and deferred gross profit are shown in the
next page.
V^ ri
The interest charged to customers may be computed using one ofthe following plans:
niustration 9-1
Realized Gross Profit
Gross profit Receivable
Year
Collections
P 38,000*
24,000
24,000
14,000
2008
2009
2010
2011
I
341
Installment Sales
Chapter 9
340
X
Rate
=
40%
40
40
40
P100,000
RGP
Deferred Gross profit
Equal periodic payments fi^om customer, with a portion of each payment
Gross Profit
Balances, end
P15,200
9,600
9,600
5,600
P 62,000
38,000
14,000
P40,000
PHt4,ooa
-
x
Rate
40%
40
40
=
representing intereston the outstanding balance ofthe principal and the remainder
representing a reduction fi-om the aforementioned balance.
DGP
P24,800
15,200
5,600
Interest computed each month on tlie outstanding principal balance during the
month.
Interest computed on the installment due,fi^om the date ofthe sales contract to
the date ofthe installment payment.
-
P45,600
\ •
The fust plan is the one most widely used in practice because ofthe convenience it gives
to the customers to make monthly payments in equal amounts. Under this plan,the
outstanding principal balance decreases after each payment.As a result,in each periodic
paymentfrom the customer which is equal to those in the other periods,a portion ofthe
payment representing interest decreases because ofthe diminishing balance ofthe
outstanding principal. Conversely,the portion applicable to the principal increases.
*P20,000 down payment plus P18,000(P2,000 x 9 months)installment collections.
Expenses on Installment Sales
The deferral ofgross profitrecognition,which is the primary objective ofthe installment
method,constitutes a delayed recognition ofboth sales revenue and cost ofgoods sold.
This requires the examination ofthe consistency in the treatment ofthe related expenses.
Illustration. To illustrate the first plan(equal periodic payments)ofcomputing interest,
assume the following data:
Operating expenses incurred in making the sale are to be deferred. The matching of
revenues and expenses on installment sales applies only to those costs and expenses
necessary to and directly related with the acquisition or manufacture ofthe merchandise.
In other words,the application ofthe matching principle does not extend to other
operating expenses which are not directly related to the acquisition or manufacture of
the merchandise.While the defermentofexpense incurred in making the sales has some
theoreticaljustification for it results to a better matching ofrevenues and expenses,it is
difficult to determine the exact amount ofexpenses applicable to the installment sales
which shall be deferred.
Expenses that will be incurred in periods subsequent to the period ofsale also pose a
special problem.Take the example ofbad debts expense. Should provisions be made
for this expense? Since it is assumed that the right to repossess the goods sold affords
the seller an opportunity to recover a portion ofthe uncollectible installment receivable
at least to the extent ofthe unrecovered cost ofthe repossessed merchandise which is
implicitin the balance,then provision for estimated bad debts losses is notrequired.
' .h'
Installment sale,June 30,2011 (cost,P42,000)
Cash down payment
P60,000.00
20,000.00
Balance payable in six monthly installments plus 36 percent interest
P40,000.00
Monthly installment
P 7,383.90
Note: Sometimes,the amount ofperiodic payments is not given hence it must be
computed,as follows:
Original Balance ofInstallment Contracts Receivable
Periodic Payment =
Present Values ofAnnuity of 1 for6 periods at 3%
P40,000
Interest on Installment Contracts Receivable
Since the collection period for installment sales is usually long and may involve large
amounts ofreceivable balances, interest is often charged to customers to be paid
concurrently with each installment payment.When this exists,each installmentcollection
consists ofamounts applied to the payment ofthe outstanding balance ofthe principal
(Installment Contracts Receivable)and to the intereston installmentcontracts receivable.
5.417191
= P7,383.90
Chapter 9
342
IT
From the preceding information,six monthly payments ofP7,383.90 will folly settle the
installment contracts receivable ofP40,000 plus the 3 percent interest each month.This
343
Installment Sales
Under the installment method, only the portion of the payment applied to the principal
(Colmnn 3) is considered in the computation of realized gross profit, as shown below.
is shown inthe table below.
Table of Entries for Periodic Collections
(3)
(2)
(I)
Interest
Contracts
Collection
Income
Receivable
(Debit)
(Credit)
Credit)
(1-2)
Cash
June .30
P20,000.00
7,383.90
7,383.90
7,383.90
7,383.90
7,383.90
7,383.90
30
July 31
Aug 31
Sept 30
Oct
31
Nov 30
Dec
31
P64,303.40
215.06
P20,000.00
6,183.90
6,369.42
6,560.50
6,757.31
6,960.03
7,168.84
P4,303.40
P60,000.00
—
PI,200.00
1,014.48
823.40
626.59
423.87
(4)
Outstanding
Principal
(4-3)
31
Oct
31
31
30
Nov 30
Dec 31
P40,000.00
P33,816.10
P27,446.68
P20,886.18
P14,128.87
P 7,168.83
Gross Profit
P60.000 - P42,000
PI 8.000
Installment Sales
P60,000
P60,000
P60,000.00
40,000.00
33,816.10
27,446.68
20,886.18
14,128.87
■7,168.84
ACCOUNTING PROCEDURES UNDiER INSTALLMENT METHOD
Various accounting procedures may be used to record transactions using the installment
method but there are no significant differences in the applications of these procedures.
There are several types of items sold on the installment basis but discussions in this text
regarding installment revolve only around these two basic types of property sold on
-
installment basis, namely:
1.
2.
X
3%
=
X
3%
=
PI,200.00
Pl,014.48
X
3%
=
823.40
X
3%
=
P
626.59
X
3%
=
P
423.87
X
3%
=
P
215.06
30%
P18,000.00
Realized gross profit on the contract
■"Computation of Interest Income:
July
Aug
Sept
60,000.00
Collections applying to principal (Column 3)
Multiply by Gross profit rate:
Installment
,Bate
P64,303.40
4,303.40
Total collections, June 30 - Dec. 31 (Column 1)
Less Total interest income (Column 2)
Illustration 9-2
Installment sales ofconventional merchandise.
Installment sales of real estate:
a. By a non-dealer (Casual sales)
b. By a dealer.
The sequence of entries illustrated herein are in accordance with current accounting
, practice.
INSTALLMENT SALES OF CONVENTIONAL MERCHANDISE
The accounting procedures used for sales ofmerchandise on an installment basis should
conform with the following:
-
1. Sales, receivable and cost ofsales should be given separate account designations
by affixing the word "installment" before the account names.
2. Installment receivable and deferred gross profit accounts should be maintained
separately according to year of sale.
&
Chapter 9
344
345
Installment Sales
The entries ofFely Sales Corporation relating to regular and installment sales for 2010
and 2011, assuming the use of the perpetual inventory system, are shown below and in
the following pages.
3. Thejoumalizing process should include gross profit deferral,either at the date
ofsale or at the end ofthe period.The latter is preferable.
4. Realized gross profit on installment sales should be periodically recognized in
proportion to the current collection ofinstallment accounts receivable(net of
interest).
Illustration 9-3
January - December 2010
The accounting procedures will vary depending upon the inventory system used,either
the inventory system is perpetual or periodic.
(1) To record regular sales.
.
' :
COMPREHENSIVE ILLUSTRATIVE PROBLEM
250,000
Accounts Receivable
250,000
Sales
(2) To record installment sales.
Assume the following data summarizing the transactions for two years ofFely Sales
Corporation:
Cash
Installment Contracts Receivable - 2010
20,000
80,000
100,000 .
Installment Sales
2010
Sales
,
2011
(2) To record cost of sales.
Cost of Sales
Cost of Installment Sales
,
Regular(on account)
P250,000
P230,000
20,000
24,000
80,000
96,000
Installment-
Down payment
Balance (payable within 3 years at the start of each
month, apply 36% interest for 3 years)
Regular
120,000
60,000
Installment
Collections:
130,500
69,600
Note: If the periodic inventory system is used
Cost of Installment Sales
Shipments on Installment Sales
60,000
60,000
(4) To record collection of accounts receivable.
,
120,000
Cash
Accounts receivable
Installment contracts receivable -
120,000
130,500
Applying to interest
26,000
Applying to principal
19,000
18,000
26,000
2010 Sales:
120.000
Accounts Receivable
(5) To record collection of installment contracts receivable
2011 Sales:
Applying to interest
Applying to principal
180,000
Merchandise Inventory
n
Cost of Sales:
120,000
60,000
'
—
-■
Operating expenses paid
50,000
31,000
22,000
65,000
Accrued interest receivable, December 31
1,800
2007 Sales
2008 Sales
1,020
2,250
Cash
Installment Contracts Receivable, 2010
19,000
26,000
Interest Income
(6) To record payment of operating expenses
Operating Expenses
50,000
50,000
Cash
/
■-Oil
45,000
f4' - '
T
Chapter 9
346
(2) To record regular sales.
(7) Adjusting and closing entries, December 31, 2010
(a) To recognize accrued interest receivable for December 31, 2010
Accrued Interest Receivable
Interest Income
347
Installment Sales
Accounts Receivable
1,800
230,000
230,000
Sales
1,800
(3) To record installment sales.
Cash
(b) To set up deferred gross profit on 2010
Installment Sales
Cost ofInstallment Sales
Deferred Gross Profit. 2010
Gross profit rate = P40,000 PI00,000 = 40%
Installment Sales
60,000
40,000
Realized gross profit
Cash
'" I
15,600
15,600
130,500
Cash
Installment Contracts Receivable, 2010
Installment Contracts Receivable, 2011
97,000
26,000
22,000
49,000
Interest Income
(7) To record payment of operating expenses.
Operating Expenses
250,000
27,800
65,000
65,000
Cash
120,000
Operating Expenses
Income Summary
50,000
107,800
(8) Adjusting and closing entries, December 31, 2011:
(a) To recognize accrued interest receivable for December 31, 2011.
Accrued Interest Receivable
(f) To close result of operationsfor 2010:
3,270
Interest Income
123,400
123,400
Cost ofInstallment Sales
Deferred Gross Profit, 2011
(I) To reverse accrued interest receivable.
1,800
1,800.
3,270
(b) To set up deferred gross profit on 2011 sales.
Installment Sales
January - December, 2011
Interest Income
Accrued Interest Receivable
130,500
(6) To record collection of installment contracts receivable.
Cost of Sales
Income Summary
Retained Earnings
200,000
Accounts Receivable
(e) To close other nominal accounts
Interest Income
130,400
69,600
(5) To record collection of accounts receivable.
Income Surnmaty
Sales
120,000
«
15,600
PI5,600
(d) To close realized gross profit account.
Realized Gross Profit
24,000
96,000
(4) To record cost of sales.
Cost of Sales
Cost ofInstallment Sales
Merchandise Inventory
(c) To record realized gross profit on installment sales:
Deferred Gross Profit, 2010
15,600
Realized Gross profit
Computation:
Collections applying to principal P39,000.
Multiply by gross profit rate
40%
_
Installment Contracts Receivable 2011
100,000
Gross profit rate - P50,000 -r- 120,000 = 42%
120,000'
69,600
50,400
Chapter 9
348
(c) To record realized gross profit on installment sales.
Deferred Gross Profit, 2010
10,400
Deferred Gross Profit, 2011
19,320
Realized Gross Profit
illustration. Assume that Felipe Company sells merchandise for cash, on short-term
credit and on the installment basis. The company employs the periodic inventory method
in determining costs. At the end of2011, the following information are available:
29,720
Cash sales
Computations:
Charge sales
Collections
Applying to Principal
2010 Sales:
2011 Sales:
x
Grossprofit
Rate
P26,000
46,000
Installment sales
Realized
=
Merchandise inventory, January 1
Gross Profit
40%
42
P29,720
Based on the above data, the cost of goods sold to be allocated is computed below:
Merchandise Inventory, January 1
Add:
29,720
(e) To close other nominal accounts.
Interest Income
130,400
65,000
85,070
790,000
910,000
130,000
Less Merchandise inventory, December 31
Cost of goods sold
P780,000
Case 1. Where no additional facts are known other than the data given above, the cost
of goods sold must be allocated according to the ratio of each type of sales t,o total
sales, as follows:
(f) To close result of operations in 2011.
Retained Earnings
P725,000
30,000
35,000
Purchases
Cost of goods available for sale
230,000
' 50,470
Cost of Sales
Operating Expenses
Income Summary
Income Summary
120,000
Freight-in
Repossessed merchandise
29,720
■yi
Sales
PI 50,000
300,000
750,000
120,000
725,000
30,000
35,000
130,000
'
V.
Freight-in
Repossessed merchandise
Merchandise inventory, December 31
..V:,'
(d) To close realized gross profit account.
Realized Gross Profit
Income Summary
1
Purchases
P10,400
19320
Total
i.
349
Installment Sales
114,790
114,790
Type
of Sale
Allocation of Cost of Goods Sold
Ratio to
of Sale
Total
Allocated
Cost
A company selling on the installment plan will normally have cash sales and sales on
short-term credit. If the company employs the perpetual inventory system, the cost of
each type of sales is determined and recorded simultaneously with the recording of the
sales transaction. However, if the company uses periodic or physical inventory
method in the determination of cost, then the problem ofproper allocation of the total
Charge
150,000
300,000
15/120
30/120
P 97,500
195,000
Installment
750,000
75/120
487,500
cost of goods sold among the different types of sales will arise. The procedure to be
followed in allocating the cost of goods sold will depend upon the circumstances and
The above allocation is proper ifthe selling price ofthe merchandise is the same re^rdless
of the type of sales. Normally, however, the selling price ofthe merchandise are not the
same for different types of sales.
Cash
information available.
P
Amount
PI,200,000
P780,000
Chapter 9
350
Case 2. Assume that the selling prices for charge sales and installment sales ofFelipe
Company are higherthan cash sales price by 20% and 25%,respectively.The respective
sales figures must be expressed in terras ofthe same selling price in order to obtain a
valid ratio. The allocation ofthe cost ofgoods sold should be based on cash price as
presented below:
Type
ofSale
Cash
Charge
Installment
Amount
Amount Based
ofSales
on Cash Sales
150,000
250,000a
600,0006
P 150,000
300,000
750,000
P1,200,000
Ratio to
Total
Allocated
150/1,000
250/1,000
600/1,000
PI 17,000
195,000
468,000
Cost
The following procedures to record repossession may be used.
(1) Record the repossessed merchandise in an appropriate inventory account at its
fair value(estimated selling price less reconditioning cost and normal profit
margin)at date ofrepossession.
(2) Cancel the uncollected installment receivable balance ofthe defaulted contract.
(3) Write-ofifthe balance ofthe deferred gross profit relating to the above receivable.
P780,000
Illustration. Assume the following data with respect to a default and repossession on
April 30,2011:
Case 3. Where the mark- up or gross profit percentage on cost price or sales price is
known,the allocation will be a simple matter. Assume that Felipe Company's gross
profit rate on selling price is 25% on cash sales,35% on charge sales, and 37% on
installment sales. The allocation ofcost ofgoods sold is shown below:
Amount
The principal problem in accounting for defaults and repossessions is tlie determination
ofthe fair value ofthe merchandise at the time ofrepossession.In setting a fair value,the
objective is to choose an amountthat will allow for any reconditioning cost and provide
a nonnal gross profit on resale.
(4) Recognize the resulting gain or loss on repossession.
PI,000,000
''P300,000-120%=P250,000
*P750,000- 125%=P600,000
Type
ofBale
Gross Profit
ofSales
Rate
Allocated
Gross Profit
Cost 1/
Installment contracts receivable, 2011
P2,000
Gross profit rate, 2011 sales
Estimated market value of repossessed merchandise
PI,200
Charge
P 150,000
300,000
25%
750.000
Installment
35%
P 37,500
105,000
PI12,500
195,000
37%
277.500
472.500
P420,000
P780,000
P1,200,0001/
Sales less Gross Profit
DEFAULTS AND REPOSSESSIONS
30%
The loss on repossession may be computed as follows:
Fair market value of repossessed merchandise
Pl,200
Less Unrecovered cost -
Installment contracts receivable
Less Deferred gross profit(30% ofP2,000)
Cash
351
Installment Sales
P2,000
600
Loss on repossession
1,400
P(200)
The entry to record the repossession on April 30,2011,assuming aperiodic inventory
system,is made as follows:
Repossessed Merchandise
Deferred Gross Profit, 2011
Loss on Repossession
Installment Contracts Receivable, 2011
1,200
600
200
2,000
Ifa customer defeults on an installment contract and no further collections can be made,
fee seller may repossessfee property sold to satisfy the remaining indebtedness.Normally,
Reconditioning costs which relate to repossessed merchandise should be charged to
the repossessed merchandise is subsequently sold after incurring reconditioning costs
Repossessed Merchandise account.
^ttud at a normal profit margin. The sale should be recorded in the usual manner for
When aperpetualinventoiysystem is maintained,repossessed property is debited to
t^gularor installmentsale transactions.
MerchandiseInventory—Repossessed account.
353
Installment Sales
Chapter 9
352
A default by a;customerfollowed by the repossession ofthe merchandise may occur in
the period ofsale when the gross profit rate for the year is not yet known.Under these
circumstances,two steps may be used in recording the repossession,as follows;
1.
On the date ofthe repossession, record the repossessed merchandise in an
appropriate account with a corresponding credit to Loss on Repossession.
After the gross profit rate is established at the end ofthe period,the installment
The compulation below shows that the trade-in value is equal to its actual value.
P45,000
Trade-in value allowed to customer
Less Net realizable value of merchandise trade-in:
Estimated resale value
Less: Reconditioning cost
Normal profit margin(20% ofP70,000)
P70,000
PI 1,000
14,000
25,000
45,000
Difference
contracts receivable balance ofthe defaulted contract and the related deferred
gross profit are closed to Loss on Repossession. The realized gross profit is
The entry to record the sale ofthe new car is:
determined based on collections received prior to the default.
Merchandise Inventory — Traded-In
TRADE^NS
Companies using installmentsale plans sometimesfind it necessary to accept merchandise
traded-in as part ofthe down payment.A familiar example ofthe use oftrade-ins is the
45,000
40,000
60,000
Cash
Iristat^ient Contracts Receivable, 2011
145,000
Installment Sales
acceptance by a car dealer ofa used car as partial paymentfor a new car. As a general
rule,the actual value or the fair market value ofthe asset received as a trade-in should
When the reconditioning expense ofPI0,000 is actually incuiTed, it is charged to
be used in valuing the said item.
Merchandise Inventory-Traded-In.
The accounting procedures to record trade-in depend on certain circumstances as
discussed in the following cases:
Ifthe company is using llie perpetual inventory system,an additional entry to record
Case 1. Trade-in value is equal to actual value.Normally,trade-in value allowed to
a customer is the amountcharged to the asset traded-in provided the amount is realistic
and is indicative ofthe fair market value or netrealizable value ofthe item.ISSet realizable
cost ofsales is made,as shown below:
100,000
Cost ofInstallment Sales
Merchandise Inventory — New
100,000
value is the value ofthe old merchandise traded-in after the provisions ofexpected
reconditioning expenses cost ofdisposal and a normal profit upon its resale.
When the value assigned to the old merchandise traded-in is equal to its net realizable
value,there is no special problem involved. Merchandise Inventory-Traded-In is
debited for the trade-in value ofthe old merchandise. Cash is debited for any cash
payment accompanying the trade-in.Installment Contracts Receivable is debited for
the balance ofthe sales price,and Installment Sales is credited for the full amount ofthe
sales price.
Case 2. Trade-in value is greater than net realizable value.The seller sometimes
grants a customer a trade-in value greater than the fair market value or net reahza e
value ofthe item received from him asa specialinducementto the customer.An accounting
problem arises ifthe seller grants an over allowance on the used merchandise taken in.
Over allowance is the excess ofthe trade-in value granted over the net realizable va ue
ofthe used merchandise.The amount ofthe over allowance may be recorded either as
a charge to Over Allowance on Trade-in account or as a reduction from Installment
Sales account to anive at a valid amount for the net sales price.
Illustration. Assume that on April 1,2011,the Motor Sales Company sells a car for
an installment price ofPI45,000.The car costs PI00,000.The customer is allowed a
trade-in value ofP45,000 for his old car. He makes a down payment ofP40,000 and
the balance to be paid in twelve equal installments is P5,000 each.It is estimated that
the old car can be sold for P70,000 after incurring reconditioning expenses estimated at
P11,000.The company usually makes a gross profit of20 percent on resale.
Illustration. Assume that a stereo component with a cost ofPI2,000 is sold or
P17,000. A used stereo component is accepted as a trade-in at a valuation ofP6,0 .
The seller expects to spend P250to recondition the used merchandise before reselling
it for P5,000. The seller expects a 15% profit from the sale ofthe used merchandise.
jLL.
-
' If
• *.;• ■'
Chapter 9
354
Installment Sales
The net realizable value of the merchandise traded-in and the amount of the over
Merchandise Inventory - Traded-In is presented in the balance sheet as part of the
ending inventory. When a periodic inventory system is used, trade-ins are recorded in a
allowance may be computed as follows;
Less: Reconditioning cost expected to be incurred
Normal profit margin (15% x P5,000)
separate nominal account, Traded-In Merchandise, and this balance is added to
purchases in determining cost of goods sold at the end of the period.
P6,000
Trade-in value allowed to customer
Less Net realizable value of the merchandise traded-in:
Estimated resale value
P5,0(X)
P250
750
1,000
Alternative Procedures for Computing
4,000
Realized Gross Profit for a Series of Years
P2,000
Over allowance
In the preceding discussions, the realized gross profit is computed by multiplying the
amounts collected from the installment contract by the gross profit rate for the year in
which the contract was perfected. In certain problems for solving purposes, collections
and gross profit rates are sometimes not given. In this case, the realized gross profit can
Assuming the over allowance is charged to Over Allowance on Trade-in account and
the perpetual inventory system is used, the joumal entry to record the sale of the new
merchandise is:
Merchandijse Inventory
Over Allowance o'n Trade-in
Installment Contracts Receivable, 2011
4,000
2,000
11,000
be computed by using any of these two approaches, namely:
17,000
Installment Sales
The gross profit rate on the installment sale is computed as follows:
P17,000
•2,000
Installment sales
Less Over allowance
Net installment sales
Less cost of installment sales
Gross profit
Gross profit rate (P3,000
collections. The value of the merchandise traded-in, P4,000, is viewed as a collection
for this purpose.
Assuming the over allowance is treated as reductionfrom Installment Sales account
and the perpetual inventory system is used, the joumal entry to record the sale of the
new merchandise is:
Merchandise Inventory - Traded-In
4,000
11,000
15,000
Note: In cases wherein an under allowance results from trade-in transactions, that
is, the trade-in value allowed to customer is less than the net realizable value
ofthe merchandise traded-in, then the under allowance is treated as an addition
to the selling price ofthe new merchandise for which the old merchandise is
traded-in.
' tjIM.
•irfiV
Approach 1. Compute the collections for the current year and the gross profit
rates. Detennine first the collections during the year of accounts generated from the
different installment periods. This is done by considering the change in the balances of
the installment contracts receivable at the beginning ofthe period and at the end of the
period. At tins point, it is helpful to remember tliat the beginning balance ofthe installment
credit for the period. Any unpaid balance of the receivable pertaining to a repossessed
merchandise is deducted from the total credit of the year in which the repossessed
20%
The above rate will be applied in computing the realized gross profit on the basis of
Installment Contracts Receivable, 2011
Installment Sales
"
contracts receivable ofthe current year represents the original balance ofthe receivables
generated from installment sales made during the year. The difference between the
beginning and ending balances of installment contracts receivable represents the total
15,000
12,000
P 3,000
P15,000)
355
merchandise was sold to arrive at the credit representing collections.
Subsequently, detennine the gross profit rates on installment sales for the different years.
For the previous years, tlie gross profit rate is the result of dividing the deferred gross
profit at the beginning ofthe period by the installment contracts receivable at t if
beginning ofthe period. On the other hand, the gross profit rate of the current year is
obtained in the usual manner, that is, the gross profit is divided by the installment
sales. It must be noted that the gross profit amount used in the computation must be the
unadjusted balance, hence, it must be the total deferred gross profit arising from the
installment sales made during the year.
After the total collections and the gross profit rates have been obtained, the realized
gross profit for each installment period can now be computed. Multiply the total collections
made during the current year of the receivables of one period by the corresponding
gross profit rate.
■.
' f.-'i , t ,w<^.
Chapter 9
366
357
Installment Sales
Approach 2. Obtain the difference between the balances ofthe deferred gross
profit before and after adjustment.As discussed previously,the gross profit realized
for the period is reflected in the books only at the end of the period. Gross profit
recognition is one ofthe required adjustments at the end ofthe period. Therefore,any
decrease in the balances ofthe deferred gross profit ofa certain period before and after
the adjustment has been made represents the realized gross profit during the period.
The balance ofthe adjusted deferred gross profit ofa particular period is the product of
the gross profit rate for the period(computed as in Approach 1)and tlie ending balance
ofinstallment contracts receivable ofthe same period.
Illustration. Assume the following account balances on December 31,2011 before
adjustments have been made:
*Ifthere is a repossession in 2011 ofgoods sold in 2011,the deferred gross profit
relating to the impaid balance ofthe repossessed merchandise should be added back to
the deferred gross profit balance before adjustment at the end ofthe period.
Approach 2
Deferred gross profit before adjustment,December 31
Less Deferred gross profit, December 31 (Installment Contracts Receivable x Gross Profit Rate)
2010 Sales
2011 Sales
PI7,400
P35,000
2011
January 1
December 31
P60,000
P 30,000
70,000
17,400
35,000
100,000
Installment contracts receivable,2010
Installment contract receivable,2011
Deferred gross profit,2010
Deferred gross profit, 2011
18,000
Installment sales 2011
2010:
2011:
P30,000x30%
P70,000x35%
Realized gross profit
9,000
24,500
P 8,400
P10,500
Note: From the preceding computations,it may be observed that the realize gross
profit varies in direct proportion with collections ofinstallment contracts receivable
A repossession ofan item sold in 2010 is made during 2011.The unpaid balance at the
time ofrepossession is P2,000.
while the deferred gross profit varies in the same proportion with the installment
i. •
contracts receivable.
■
•'
t.
Approach 1
2010 Sales
2011 Sales
P60,(XX)
30,000
P100,000
70,000
Total credit for the period
Less Credit representing repossession
30,000
2,000
30,000
Credit representing collections
Multiply by Gross profit rate
28,000
30,000
30%
35%
Realized gross profit
P8,400
PI0,500
Installment contracts receivable, January I
Less Installment contracts receivable, December 31
Computation ofgross profit rates:
Deferred gross profit, January 1
PI8,000
Installment contracts receivable, January 1
P60,000
Deferred gross profit before adjustment,December 31
P35,000
Installment sales
P100,000
= 30%
2010
Financial Statements Presentation
Installment sales transactions present several problems with respect to infonnative
reporting.Like other special types oftransactions,adequacy ofdisclosuie is an important
point to consider. Because ofthis,two alternative presentations are illustrated in the
following pages using the Fely Sales Corporation data for 2011.
Statement of Comprehensive Income. In preparing an income statement for a
business with both regular and installment sales,the details to be reported depends
upon the significance ofthe installment sales in relation to the total sales revenues.Ifthe
amount ofinstallment sales is not significant,then it need not be shown as a separate
item in the statement ofcomprehensive income.Data about collections and computations
ofrealized gross profit are reported by means ofa supporting schedule.
= 35%
2011
V '
' - .j;
I I
t
' •»
I t s's ..
Chapter 9
358
359
Installment Sales
The following type ofpresentation may be appropriate;
Illustration 9-5
Fely Sales Corporation
Statement of Comprehensive Income
Illustration 9-4
Year Ended December 31,2011
Fely Sales Corporation
Statement ofComprehensive Income
(Installment Sales Shown)
Year Ended December 31,2011
(Installment Sales Not Shown)
P230,000
130,400
Sales
Cost of goods sold
Gross profit on regular sales
Add Realized gross profit on installment sales(Schedule 1)
i-
129,320
65,000
Operating income
■TV ■
Total
Sales
Cost of sales
P230,000
130,400
PI 20,000
69,600
P350,000
200,000
Gross Profit
P 99,600
50,400
31,080
PI 50,000
31,080
Realized gross profit, 2011
Add Realized gross profit on 2010
installment sales
19,320
10,400
10,400
P 29,720
129,320
65,000
64,320
50,470
Add interest income
PI 14,790
Net Income
Schedule 1
Repossessed Merchandise is an addition to Purchases in determining cost of goods
Computation ofRealized Gross Profit on Installment Sales
sold. Traded-In Merchandise is treated in the same manner. Shipments on Installment
2010
P120,000
Cost of installment sales
Gross profit on installment sales
P 40,000
P 50,400
40%
42%
P 26,000
P 46,000
Collections in 2011 applying to principal
Realized gross profit in 2011:
2010
statement as an adjustment to realized gross profit and the resulting balance is labeled
as Total Realized Gross Profit after Adjustment for Gains (Losses) on Repossession.
■ 69,600
Statement of Financial Position. With respect to statement of financial position
presentation. Installment Contracts Receivable is usually classified as part of current
assets as shown below:
Assets
Current Assets
Installment contracts receivable:
2010 sales
2011 sales
P 10,400
installment sales
(42%xP46,000)
Total
goods available for sale. Gain (Loss) on Repossession is presented in the income
installment sales
(40%xP26,000)
2011
Sales, which is used in the periodic inventory system, is deducted from the cost of
2011
PI00,000
60,000
Gross profit rate
118,920
.
Net operating income
PI 14,790
Net Income
Installment
Total realized gross profit
Operating expenses
64,320
50,470
Add interest income
Regular
Less Deferred gross profit, 2011
99,600
29,720
Total gross profit
Operating expenses
Installment sales
1
:
19,320
P 29,720
P35,000'
74,000
PI 09,000
Installment contracts receivable qualifies for inclusion under the current assets caption
On the other hand, if installment sales represent a significant portion of the total sales
revenue ofthe business, details for each type of sales may be presented separately with
such details integrated in a total column. This approach is presented in Illustration 9-5.
■n
since it accords with the accepted notion of cuuent assets as consisting of "cash and
other assets that are reasonably expected to be realized in cash or sold or consumed
during the normal operating cycle ofthe business". This treatment is accepted regardless
of the length oftime required for its collection.
L 1 -UTi',
"
A-
361
Installment Sales
Chapter 9
360
The table presented below is designed using the data pertaining to the sale ofland by
Conflicting positions have been taken regarding the proper classification ofthe Deferred
Gross Profit account. This account has been reported in the various sections ofthe
statement offinancial position. Some suggest that this balance be presented as;
Mr. Marco Ruiz.
Illustration 9-6
1.
Table ofPayments for 2011
A valuation account to be deducted from the related installment contracts
receivable.
Applying to
2. Currentliability.
Collections
Date
Interest
Applying to
Principal
Unpaid
Principal
PI00,000.00
80,000.00
77,676.21 ,
75,282.71
Oct. 1
In accordance with generally prevailing practice. Deferred Gross profit account is
classified in the liabilities section ofthe statement offinancial position as noncurrent
liability shown as follows:
Nov. 1
Dec. 1
—
P2,400.00
2,330.29
P20,000.00
2,323.79
2,393.50
Based on the obtained information and the preceding table,thejoumal entries to record
Liabilities
NoncurrentLiability:
Deferred gross profit,2010
Deferred gross profit,2011
P20,000.00
4,723.79
4,723.79
1
the transactions during 2011 are as follows:
Oct.
P 14,000
31,080
1
20,000.00
80,000.00
Cash
Notes Receivable
60,000.00
40,000.00
Land
P45,080
Deferred Gain on Sale ofLand
To record sale ofland.
Repossessed Merchandise account is presented in the Statement ofFinancial Position
as a current asset, as an inventory account. Traded-In Merchandise is likewise treated
Nov. 1
as such.
4,723.79
Cash
Notes Receivable
2,323.79
2,400.00
Interest Income(3%x PSO,000)
To record monthly collection and the
recognition ofinterest income earned
INSTALLMENT SALES OF REAL ESTATE
The accounting procedures for the installment sales ofreal estate will depend on whether
the sale is made by a non-dealer(casual sales)or by a dealer in real estate.
in October.
Dec. 1
Casual Sales
4,723.79
Cash
2,393.50
2,330.29
Notes Receivable
Interest Income(3% x P77,676.21)
To record monthly collection and the
The owner ofa real estate property may wish to sell his personal property whose value
has greatly appreciated over the years. An installment plan may be adopted on the sale.
The resulting gain from the sale is spread over several years to minimize taxation in one
recognition ofinterest income earned
year.
in November.
I
v.lrj t;'.,
31 Adjusting Entries:
Illustration. Assume that on October 1,2011 Mr. Marco Ruiz sold for PI00,000 a
parcel ofland acquired for P60,000.The contract ofsale called for a down payment of
,
(1)
2,258.48
P20,000 and the issuance ofa note for the balance. Payment ofthe balance entails
AccruedInterest Receivable
twenty four monthly installment ofP4,723.79 each starting on November 1,2011.The
Interest Income(3% x P75,282.71)
To recognize accrued interestfor December.
interest is at the annual rate of36% and is applied to the unpaid principal balance.
S:
2,258.48
■ nr-
362
Illustration: Assume the following data for the FilEstate Realty,Inc.in 2011.
(2)
Deferred Gain on Sale ofLand
Realized Gain in Sale ofLand
To record the realized gain in 2011.
363
Installment Sales
Chapter 9
9,886.92
9,886.92
Total selling price of lots
PI,000,000
Total cost of lots:
Acquisition cost
PI50,000
450,000
Improvement costs
Computation:
Collections applying to principal
Multiply by gross profit rate
(P40,000-P100,000)
P24,717.29
Realizedgain
P 9,886.92
40%
600,000
Gross Profit
P 400,000
Sales made during the year (lot no. 1)
Collections during the year including interest ofP5,000
P
35,000
12,000
Thejournal entries to record the above transactions are:
Thejournal entries forthe remaining years would follow tlie same pattem as in Illustration
9-7 provided that the buyer makes good ofhis payments as stipulated in the contract.
The preceding illustration brings forth the timing difference between the recognition of
(a) To record the acquisition cost and the improvement costs ofthe lots.
6 /:•
Land
gross profit on ordinary sales and on sales accounted for by the installment method of
accounting. Ifthe land sold by Marco Ruiz has been recorded as an ordinary sale,a
method has been used,only P9,886.92 gross profit is recognized in 2011. On the other
sale.
450,000
600,000
Cash
gross profit ofP40,000 would have been recorded in 2011.Inasmuch as the installment
hand,ifa sale ofland results to a loss,the entire loss must be recognized in the year of
PI50,000
Improvement Costs
(b) To record installment salesfor the period.
—
Installment Contracts Receivable, 2011
35,000
35,000
Installment Sale
Installment Sale of Real Estate By a Dealer
In the preceding example,we dealt with a single sale ofland on an installment plan by a
non-dealer.Now we shall consider a sale by a company engaged in buying and selling
(c) To record the related cost ofinstallment sales(60% x P35,000).
Cost ofInstallment Sales
21,000
The accounting procedures that may be followed under the installment method of
accounting for retail sale ofland must conform with the following:
5,250
15,750
Land
ofreal estate.
Improvement Costs
Computation:
1. The entire contract price applicable to the installment sale is reported as revenue
Total
on the year the sale is recorded.
Percentage
Allocated
to total
Cost
Cost ofsales including future improvement costs are charged to income ofthe
Acquisition cost
current accounting period.
PI50,000
450,000
25%
Improvement costs
75%
P 5,250
15,750
Gross profit is deferred and recognized as income ifpayments ofprincipal are
Total
P600,000
100%
P21,000
received on the installment contracts receivable.
Interest at the stated contract rate is recorded as income when received,and
the balance ofthe deferred gross profit is deducted from related installment
contracts receivable in the balance sheet.
Disclosure is made ofthe portion ofsales and contracts receivable applicable in
the installment method ofaccounting.
(d) To record collection
Cash
Installment Contracts Receivable, 2011
Interest income
12,000
7,000
5,000
■
365
Installment Sales
Chapter 9
364
MULTIPLE CHOICES - THEORETICAL
Year-end Adjusting Entries:
(e) To set up deferred gross profit.
1. A type of sale which provides for a series ofpayments over a period of time.
35,000
Installment Sales
Cost ofInstallment Sales
Deferred Gross Profit, 2011
21,000
14,000
iP.
a.
Credit sale.
b.
Auction sale.
d.
Barter sale.
Installment sale.
Gross profit rate = PI4,000 -t-PS5,000 = 40%
(f) To recognize realized gross profit.
2. In installment sale, revenue is recognized:
Deferred Gross Profit, 2011
Realized Gross Profit
2,800
ar. At the point of sale. •
b.- After the point of sale.
c. Before the point of sale.
2,800
Computation:
d.
Collection applying to principal
Multiply by Gross profit rate
P7,000
Realized gross profit
P2,800
40%
m
All of tlie above.
3. Under the cost recovery method, revenue is recognized until:
Financial Statements Presentation
as? Collections are equaj to the amount of cost of goods sold.
b. Collections are more than the cost of goods sold.
Presentation ofthe financial statements ofa real estate dealer is similar to that ofa
c. Collections are less than the cost of goods sold.
d. The selling price is collected.
company engaged in installment sales ofconventional merchandise except for the
composition and presentation ofmerchandise inventory in the statement offinancial
position,as follows:
Assets
4. Under tire gross profit realization method, first collections are regarded as
■
r
a.
Expenses.
b.
Revenue.
Cost recovery.
Merchandise inventory:
d.
P144,750
434,250
Land
Improvement costs
Return ofinvestment.
579,000
5. Under this method, cash collection is regarded as a partial recovery of cost and a
, !■
' f\'*. '^,ir
»•?!:
' ,1 -1
■
t'"'
I ■
I
I •
'• I ••
I-
-
a. Cost recovery method.
b. Gross profit realization method.
■
■■
Installment msfliod,
a.
s'
;
j; jt : ■
:
. V ".-•
'',U
.
' ^
'f . 11* -i' -'
1
■
^
■A
■ ;
None of the above.
A,.
\-
Chapter 9
366
367
Installment Sales
6. Under the installment method,the difference between the selling price and the cost
MULTIPLE CHOICES- COMPUTATIONAL
ofsale is recorded as:
9-1: Superman Company started operations on January 2, 2011. The following
information is gathered for 2011:
a. Deferred gross profit.^
b. Income.
c.
Asset.
Installment accounts receivable, December 31
d. Expense.
PI,500,000
1,050,000
Deferred gross profit, December 31 (before adjustment)
Gross profit rate based on sales
7. Under the installment method,realized gross profit is computed at the end ofeach
year by:
a. Multiplying the total collections by the gross profit rate based on cost.
Multiplying the total collections by the gross profit rate based on sales.
0. Multiplying the selling price by the gross profit rate,
d. Multiplying the cost ofsales by the gross profit rate.
8. Attime ofrepossession,repossessed merchandise is debited at its:
25%
What is the realized gross profit on sales for 2011?
a.
b.
c.
PI,350,000
Pl,125,000
P 810,000
P 675,000-
9-2: Gross profit rates ofBatman Company were 35%,33% and 30% ofsales for
2009,2010 and 2011,respectively. The following account balances are available
at the end of2011:
a. Original cost.
b. Unrecovered cost.
Year ofSale
Fairvaludafterjreconditioning cost..
d. Fair value before reconditioning cost.
Installment account receivable
2009
2010
9. Installment accounts receivable account is classified in the balance sheet under:
2011
P
6,000
61,500
195,000
Deferred grossprofit
(before adjustment)
P
7,230
60,750
120,150
What is the total realized gross profit to be rgpoifed m the Statement of
Current asset.
Comprehensive Income for the year ended December 31,2011?
b. Fixed asset.
0. Other asset,
d. Non-current set.
10. In the balance sheet,deferred gross profit account is classified as:
a.
a. P107,235
b. P102,105
c. P 61,650
d. P 97,235
9-3: The following information are obtained from the books ofaccounts ofRobin,
Current asset.
b. Deferred credits.
c. Currentliability.
Inc. on June 30,2011:
Deferred gross profit balance (After Adjustment)
^ Txing-term liability.
Total collections on installment sales
s ■■
Gross profit rate based on cost
P202,000
440,000
25%
Chapter 9
368
No. 9-3: Continued
369
Installment Sales
No. 9-6: Continued
Robin,Inc. uses the installment method ofaccounting. What is Robin's total
P1,000,000'
Installment sales
installment sales for 2011?
''Regular sales
Operating expenses
600,000
500,000^
300,000
100,000
Collections on installment sales
200,000/
Cost ofinstallment sales
a. PI,560,000
b. PI,440,000
c/ P1,450,000cL Pl,010,000
9-4:
j2ost ofregular sales
In its December 31, 2011, what amount should Casablanca, Inc. report as
deferred gross profit?
itoo ooo
BMW Corporation sells car on a three year installment sales contract. On
December 31,2011,the last day ofBMW's first year ofoperations,the results
fTJOCr ooo^
cy P400,000
p. P500,000
c. P320,000
ofoperations before adjustment are summarized below:
Sales.
PI,000,000
700,000
80,000
Cost ofinstallment sales
Operating expenses
b.
jopj^
^OO DOO
c.
PI50,000
l7A) 000
d. P120,000
9-5:
V3./ S
value ofthe merchandise is P34,000 after reconditioning cost ofP4,000. What
b.
(PI0,000)
(P14,000)
c. PI0,000
d. Loss ofPI5,000.
9-8:
In July,2010,Sta.Lucia Company who uses the installment method ofaccounting
sold land costing P90,000 for P240,000, receiving P35,000 cash as down
payment and a mortgage note for the balance payable in monthly installments.
Installment received in 2010 reduced the principal ofthe note to a balance of
P200,000. The buyer defaulted on the note at the beginning of2011 and the
property was repossessed.The property had an appraised value ofPI65,000 at
the time ofrepossession. The realized gross profit in 2010 and the gain(loss)on
repossession in 2011 amounted to:
d. (P20,000)
9-6:
X20,000
a. Gain ofP5,000.
b. Loss ofP80,000.
Q. No gain, no loss,
000
fO OOP
is the gain(loss)on repossession?
1,800',000
200,000
The repossession resulted to:
In 2011, a merchandise was sold on msta^?ment basis by MB Company for
a.
P3,00Q,O0O
2,025,000
Installment sales
Cost ofinstallment sales
Collections on installment sales x
Repossessed accounts
Fair value ofrepossessed merchandise
P80,000 at a gross profit of25% on cost. During the year,a total ofP42,500,
including interest ofP12,500 was collected on this contract.In 2011,no collection
was made on this sale,and the merchandise was repossessed. Tlie current market
X-.,
A.OO COO
were reported:
\oooooo
P220,000
P140,000
a.
SV-/
^
JJ Company sold goods on installment. For the yearjust ended,the following
The total collections during the year including interest and financing charges of
PI00,000 is P500,000. What is the net income ofBMW Corporation for the
year ended December 31,2011?
A
d. PI50,000
9-7
fwo ooo
gj[)Q coQ
Realized Gross Profit
Casablanca,Inc. which began operations on January 2,2011,appropriately
uses the installment method ofaccounting.The following information pertains to
a.
b.
c.
PI5,000
25,000
9,000
Casablanca's operations for the 2011:
d.
2,500
Gain (loss) on Repossession
(P90,000)
90,000
( 2,500)
3,500
J
370
Chapter 9
9-9:
On April 1,2011,GE Company sold for P7,000 a refrigerator which had a cost
ofP4,550.A down payment ofP750 was made with the provision that additional
payments ofP625 be made monthly thereafter. Interest was to be charged at a
monthly rate of2 percent on the unpaid balance ofthe principal; the monthly
installment was to apply first to the interest then to the balance ofthe principal.
After completing four months installmentthe customer defaulted and the refrigerator
was repossessed. At this time,the market value ofthe refrigerator(used)was
estimated to be P1,875. The gain(loss)on repossession and the realized gross
profit to be recognized in 2011 are:
Gain (loss) on Repossession
Realized Gross Profit
a.
b.
c.
(P847.98)
(P847.98)
(P562.50)
PI,137.50
d.
P 562.50
P983.78
9-11: On January 2, 2010, Mustang Company sold a car to Mr. De Jesus for
P1,050,000. On this date,the car cost P735,000. Mr.De Jesus paid P150,000'
as down-payment and signed a P900,000 interest bearing note at 10 percent.
The note was payable in three annual installments ofP300,000 beginning January
1,2011. Mr.De Jesus made a timely paymentfor the first installment on January
1,2011 ofP390,000 which included interest ofP90,000 to date ofpayment.
Mustang Company uses the installment method ofaccounting.In its December
31,2011 StatementofFinancial Position,whatamountshould Mustang Company
report as deferred gross profit?
a.
b.
c.
d.
P983.78
P875.00
9-10: Lexus Company,which began operations on January 3,2010,appropriately
used the installment method ofrevenue recognition. The following information
pertains to Lexus Company's operations for 2010 and 2011:
371
Installment Sales
PI80,000
PI53,000
P270,000
P225,000
9-12: SM Corporation started operations on January 2,2010 selling home appliances
and furniture on installment basis. For 2010 and 2011, the following data
represented operational details:
2010
2010
Sales
P300,000
2011
Installment sales
Cost of installment sales
P450,000
2011 sales
PI,200,000
720,000
PI,500,000
1,050,000
630,000
450,000
900,000
Collections on installment sales:
Collections from:
2010 sales
20!
!
100,000
—
2010 sales
50,000
150,000
2011 sales
Accounts written off:
2010 sales
2011 sales
Gross profit rates
25,000
—
30%
On January 8, 2011, an installment sale account in 2010 defaulted and the
merchandise with market value of PI5,000 was repossessed. The related
installmentreceivable balance as ofdate ofdefault and repossession wasP24,000.
75,000
150,000
40%
What is the balance ofthe Unrealized gross profit account as ofthe end of2011?
What amount should Lexus Company report as deferred gross profit in its
December 31,2011 Statement ofFinancial Position for 2010 and 2Q11 sales?
a. P112,500
b. PI25,000
c. P 75,000
(L P 80,000
."I ■
■ .V
a.
b.
c.
d.
P228,000
P218,400
P192,000
P275,000
Chapter 9
372
9-13:
Microstation,Inc. sold computer equipment on installment basis on October 1,
2011.The costto the company was P60,000 but the installment sales price was
set at P85,000.Terms ofpayment included the acceptance ofa used computer
equipment with a trade-in value ofP30,000.Cash ofP5,000 was paid in addition
to the trade-in equipment with the balance to be paid in ten(10)monthly
installments due at the end ofeach month commencing the month ofsale. The
estimated selling price ofthe used computer equipment after reconditioning cost
ofPI,250 is P25,000. A 15 percent gross profit was usual from sale of used
equipment. What is the gross profit to be realized from the 2011 collections?
a.
b.
c.
d.
P34,000
PI0,000
P 8,000
P 4,000
373
Installment Sales
9-16: Gothong,hic. sells automatic voltage regulators costing P700 at a price ofP1,200.
Cardinal Audio buys a dozen voltage regulators on installment and trade-in six
(6)ofits old units at a trade-in value ofP300 each. Gothong,Inc. spends P25 to
recondition the old units and sells them for P315. Gothong,Inc. expects a 10
percent gross profit from the sale ofused voltage regulators. How much is the
over-allowance gi-anted by Gothong,Inc. on the trade-in?
fl.
b.
c.
d.
P249
P150
P339
P189
9-17: The books ofConcepcion,Inc.show the following balances on December 31,
9-14: On December 31,2010,Jacinto Steel Inc.sold construction equipmentto Antliony
Company for P3,600,000. The equipment had cost P2,400,000. Anthony
2011:
Accounts Receivable
Company paid P600,000 cash on December 31,2010 and signed a P3,000,000
note bearing interest at 10 percent payable in five annual installments ofP600,000.
Jacinto Steel,Inc. appropriately accounted for the sale under the installment
method.On December 31,2011,Anthony Company paid P900,000 including
Deferred Gross Profit(before adjustment)
P627,500
76,000
Analysis and aging oftlie accounts receivable reveal the following:
interest ofP300,000.For the year ended December 31,2011,what total amount
ofrevenue should Jacinto Steel,Inc.recognized from the constmction equipment
Regular Accounts
sale and financing?
2010 installment accounts
2011 installment accounts
fl. P300,000
b. P200,000
c. P500,000
Sales on an installment basis in 2010 were made at 30 percent above cost,in
2011,at 33 1/3 percent above cost. Whatis the total realized gross profit for the
(L P240,000
year ended December 31,2011:
9-15: ACA Video Company sells betamax equipment.It maintains its accounting records
on a calendar year basis. On October 1,2010, ACA Video Company sold a
Beta-hifi set to Mr. Santiago. The cost ofthe set was PI8,000,and the set was
sold for P24,000. A down-payment ofP6,000 was received along with a contract
calling for the subsequent payment ofPI,000 on the first day ofeach month
starting on the following month. No interest was added to the contract. Mr;
Santiago paid the monthly installments promptly on November 1 and December
1 in 2010. He also made seven installment payments in 2011 after which he
defaulted on the contract. The set was then repossessed on November 1,2011.
Assuming the repossessed set has a fair value ofP4,000,what is die gain(loss)
on repossession to be recognized?
V I,/
•
a.
b.
c.
d.
P23,500
P52,500
P45,000
P69,750
9-18: AMG Corporation sells goods on installments basis. At year end,gross profit is
recognized in proportion to collections. Tlie following data are obtained from tlie
records ofthe AMG Corporation:
January 1
December 31
Installment receivable:
a. P(2,750)
b. P 2,750
c. P
P415,000
32,500
180,000
2009 sales
2010 sales
750
2011 sales
d. P 1,500
1.1 I >. •
P120,100
1,772,300
-
—
P337,200
2,050,450
■ .•( ■
374
Chapter 9
No. 9-18: Continued
9-20: Presented below are the information taken from the books of Four Sisters
Company:
Sales and cost ofsales for the three years are as follows:
Sales
Cost of Sales
375
Installment Sales
2009
2010
2011
PI,900,000
1,235,000
P2,160,000
1,425,600
P3,010,000
1,896,300
2010
Sales:
Regular
Installment
In 2011,the company repossessed merchandise with an estimated resale value
ofP10,500 after reconditioning costs ofP300. A P1,700 gross profit was usually
from sale ofrepossessed merchandise.The sales were made in 2010 for P27,000
on which P16,000 was collected prior to default. As collections are made the
company debits cash and credits installment accounts receivable. For defaults
and repossessions the company debits Inventory ofrepossessed merchandise
account and credits Installment accounts receivable for the unpaid balance. What
is the amount ofadjustment on the Inventory ofrepossessed merchandise to the
extent ofthe unrealized gross profit?
a. A decrease ofP2,500
b. A decrease ofP6,240
Cost ofgoods sold:
Regular
Installment
Operating expenses
d. A decrease ofP3,740
9-19: The following information pertains to sale ofreal estate by Filstate Corporation
P125,000
62,500
P187,500
100,000
75,000
31,250
25,000
112,500
45,000
31,250
100,000
37,500
137,500
25,000
62,500
Collections on accounts from:
Regular sales
Installment sales - 2010
Installment sales - 2011
-
What is the net income for the year ended December 31,2011?
a.
b.
c.
d.
c. Zero
2011
P78,I25
P93,750
P98,750
P90,625
9-21: The following data pertain to installment sales ofHeart's Store:
on December 31,2010:
Down payment,20%
Sales price:
Cash down-payment
Mortgage Payable
Cost
P
600,000
5,400,000
4,000,000
The mortgage payable is to be paid in nine annual installments ofP600,000
beginning December 31,2011 plus interest of 10 percent. The December 31,
2011 installment was paid as scheduled,together with interest ofP540,000.
Filstate Corporation uses the costrecovery method ofrevenue recognition. What
amount ofincome should Filstate Corporation recognize in 2011 from the
Installment sales:
2009
2010
2011
P545,000
785,000
968,000
Mark up on cost, 35%
Collections after downpayment are:
40% during year ofsale
35% during the year after
25% on the third year.
sale ofreal estate?
What is the balance ofDeferred Gross Profit-2010 at December 31,2010?
fl. P
a. P 97,689
b. PI31,880
c. P141,112
d. P114,063
540,000
b. None
c. P 1,040,000
(L P 740,000
'• f
■ L. . >
Chapter 9
376
9-24: SuluCompany is a dealer ofair conditioners. For the period May 1,2011 to
May 31,2011 Sulu Company gives a trade discount of10% to all its buyers. On
May 1,2011,five units ofair conditioners with a total list price ofP100,000 and
9-22: JGG Company began operations on June 1,2011. The following information
extracted from its records at year-end;
total cost of P59,800 were sold to Mr. Ramos. Sulu Company granted an
PI,093,750
1,050,000
Cost of installment sales
Cost of regular sales
Mark-up on installment sale
Mark-up on regular sales
allowance ofP10,000 for Mr.Ramos'used air conditioners as trade in although
140% of cost
33 1/3 on sales
the current market price is PI2,000.The balance was payable as follows:20%
ofthe balance paid at the time ofpurchase; the rest is payable in 10 months
starting June 1,2011. A 15% gross profit rate is usual from the sale ofsecond
Balances at December 31, 2011:
1,575,000
735,000
Installment accounts receivable
Accounts receivable
Operating expenses
hand air conditioners.
70% of realized
Gross profit
After six months ofpaying,Mr.Ramos defaulted in the payment ofDecember 1,
2011.The five units were repossessed and it would require P2,000 reconditioning
cost for each unit before it could be resold for P6,000 each.
What is the net income for the year ended December 31,2011?
a.
b.
c.
d.
P341,250
P267,750
P 90,157
PI74,000
1. How much is the gain(loss)on repossession to be recognized on December
1,2011?
a.
b.
■' \
9-23: TMT Company,which began operations on January 2,2011 appropriately
uses the installment method ofaccounting.The following data pertain to 2011
operations:
2.
Installment sales
Regular sales
Cost of regular sales
P900,000
375,000
215,000
Operating expenses
Collections(including
interest ofP24,000)
•P72,000
written-off due to
630,000
Repossessed accounts
P 3,360
P(3,360)
c.
P 1,760
d.
P(l,760)
What is the total realized gross profit under the installment method to be
adjusted on December 31,2011?
. 312,000
Installment accounts
defaults
Cost of installment sales
377
Installment Sales
44,000
100,000
a. P23,240
b. P19,040
c. P18,496
d. P22,576
Fair value of repossessed
merchandise
54,000
Reconditioning cost
4,000
What is the net income for the year ended December 31,2011?
a.
b.
c.
d.
PI51,600
PI27,600
P158,400
PI65,600
9-24: On July 10,2011,Toyota Motors,Inc. sold a new car to Mr.Sy for P850,000.
The car costs Toyota P650,625. Mr. Sy paid 25% cash down-payment and
traded his old car. Toyota granted an allowance ofP80,000 on the old car traded,
the balance payablein equal monthly installmentpayments.The monthlyinstallment
amounts to P30,000inclusive of12%intereston the unpaid balance ofthe principal
amountofobligation. The old car traded in has a selling price ofP120,000 after
,■
■ ,ti
expending reconditioning cost ofP22,500.
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Chapter 9
378
379
Installment Sales
9-26: Kia Motors sells cars both on installment and cash basis. On March 30,2011,
No. 9-24: Continued
After paying three installment, Mr. Sy suffered major financial setback
incapacitating him to continue paying. The car was subsequently repossessed.
When reacquired,the car was appraised to have a fair value ofP300,000.
Kia Motors sold a.car to Mr. Tom for P525,000 costing P414,000. A used car
is accepted as down payment,P 128,000 being allowed on the trade-in. The
used car can be resold for PI60,200 after reconditioning cost ofP7,660. The
company expects to make a 20% gross profit on the sale ofused car. The balance
ofthe sale is to be paid on a 10-month installment basis starting May 1,2011.
1. What is the gain(loss)on repossession?
Mr. tom defaulted payment starting November 1, 2011 and the car was
a.
b.
c.
(L
P(62,617.50)
P 62,617.50
P(62,716.50)
P 62,716.50
immediately repossessed. The repossessed car was appraised at a value of
P93,750 at the time ofrepossession. Kia Motors had to incur additional cost of
repairs amounting to P9,250 before the car wassubsequently resold on December
1,2011 forP128,750cashtoMr. Lim.
2. Under the installment method,how much is the realized gross pro.fit to be
1. What is the realized gross profit on December 31,2011?
recognized at the end ofthe year?
a.
b.
c.
d.
a. P 96,003
b. P 75,625
c. P100,000
d. P 90,073
P97,490
P98,990
P71,740
P47,640
2. What is the net income for the year ended December 31,2011?
9-25: Computers,Inc. sells computers on the installment basis. For the year ended
December 31,2011,the following were reported:
P525,000
13,500
112,500
180,000
108,000
Cost ofinstallment sales
Loss on repossessions
Fair value of repossessed merchandise
Account defaulted
Deferred gross profit, December 31
a.
b.
c.'
d.
P64,200
P38,450
P49,100
P40,100
9-27: My Home,Inc. sells appliances on installment basis. Below are some ofthe
infomiation from the records ofthe company.
How much was collected during the year?
a.
b.
c.
d.
Cost of sales
P210,000
P264,000
P390,000
P415,715
Gross profit on sale
2011
2010
2009
PSSO.OOO
P686,000
P596,160
32%
30%
28%
425,000
258,000
185,000
320,000
152,000
280,000
Collections on:
2011 sales
2010 sales
2009 sales
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381
Installment Sales
Chapter 9
380
No. 9-27: Continued
[m
During 2010, write-offs of2009 unpaid accounts were made amounting to
P7,200.During 2011,repossessions were made on defaulted accounts on 2010
sales for which unpaid balance amounted to P4,200. The fair value of the
repossessed merchandise is P3,800.
aijjiv
Diana's Furniture sells furniture and electronic items. The majority ofits business is ori
credit, and the following information is available relating to sales transactions for2009,
2010,and2011:
How much is the total deferred gross profit as ofDecember 31,2011?
2009
CL
b.
c.
d.
Installment sales (net of interest)
Gross profit rates
P443,680
P440,404
P428,080
P440,176
2010
2011
P104,000
PI 16,000
P121,000
38%
41%
39%
57,200
29,120
71,920
15,000
26,680
76,230
3,030
18,142
6,378
Cash collections on installment sales:
Principal - 2009
Principal-2010
Principal-2011
\\'i
9-28: SM Appliance Company uses the installment method ofaccounting.Pertinent
data from the company's records show the followin g:
Installment sales
Cost of installment sales
Interest - 2009
Interest - 2010
Si-
9,780
17,870
6,610
Interest - 2011
Required: Prepare the joumal entries for the year 2009,2010, and 2011 assuming
Diana's Furniture uses the installment sales metliod for revenue recognition and records
2009
2010
2011
P750,000
562,500
P937,500
712,500
P900,000
630,000
141,250
45,000
150,000
receivables net of interest.
Deferred gross profit, December 31:
2009
2010
-
2011
-
-
COl
-
30,000
195,000
1. How much is the total collection during 2011?
Charles Corporation has been using the cash method of revenue recognition since its
first year of operation in 2010. All sales are made on account with notes receivable
given by the customers. The Statement of Comprehensive Income for 2010 and 2011
presented the following amounts:
2010
a.
b.
P930,000
P750,000
Revenues-collection on principal
Revenues-interest
2011
P32,000
3,600
P50,000
5,500
45,200
52,020
Cost of goods purchases (includes increase in
inventory of goods on hand of P2,000 in
P250,000
d. P850,000
c.
2010andP8,000 in 2011
Whatis the total balance ofthe Installment Accounts Receivable account as
ofDecember 31,2011?
The balances due on the notes at the end of year were as follows:
2010
Notes receivable - 2010
Notes receivable - 2011
Unearned interest income - 2010
Unearned interest income - 2011
fl. P775,000
b. P750,000
c. P770,000
d. P800,000
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P62,000
7,167
2011
P36,000
60,000
5,579
8,043
71
Chapter 9
382
Problem 9-2: Continued
383
Installment Sales
Problem 9-4
Required:Give thejoumal entries for 2010 and 2011,assuming the installment sales
Apple Company sells appliances for cash and on the installment plan. Entries to record
cost ofsales are made monthly.The trial balance on December 31,2011 is as follows:
method was used rather than the cash method.
Problem 9-3
Apple Company
The statement offinancial position ofGood Buy Mart on January 1,2011 is shown
Trial Balance
below:
DecemberSl,2011
Liabilities & Equity
Assets
Cash
Merchandise Inventory
Accounts receivable
Allowance for doubtful
P 40,000
240,000
22,000
accounts
Other assets
installment sales - 2009
P 60,000
24,000
Deferred gross profit on
(2,000)
Installment contracts receivable
-2009
Installment contracts receivable
2010
Accounts Payable
Deferred gross profit on
Cash
60,000
installment sales - 2010
Capital stock
Retained earnings
58,800
406,000
151,200
140,000
200,000
P700,000
P700,000
Summary oftransactions during 2011 are:
Installment contracts receivable,2010
Installment contracts receivable, 2011
Inventory - New merchandise
Inventory - Repossessed merchandise
Accounts Payable
Deferred gross profit, 2010
Capital stock
Retained earnings
P72,600
24,000
76,000
62,000
12,000
P 48,700
21,600
100,000
42,000
212,000
150,000
165,000
Cash Sales
Installment Sales
Cost of sales
Cost of installment sales
97,500
Gain or loss on repossessions
Selling and administrative expenses
66,000
400
P575,500
P575,500
Sales:
Regular(on credit)
P600,000
200,000
476,000
260,000
114,000
210,000
Installments
Purchases of merchandise (cash)
Ending inventory(periodic basis)
Cost of installment sales
Selling expenses
Allowance for doubtful accounts
1/4 of 1% of regular sales
2009 installments accounts
2010 installment accounts
2011 installment accounts
P212,000
52,000
74,000
Cash sales
Installment contracts receivable,2010
Installment contracts receivable, 2011
18,000
Others
Collections:
Regular accounts
The accounting department has prepared the following analysis ofcash receipts for
the year:
560,000
40,000
80,000
110,000
P356,000
Total
Data pertaining to the repossession recorded during the year are summarized as
follows:
Required:
% Compute the gross profit rates of2009,2010 and,2011.
2.
Prepare thejournal entries for 2011 including the adjusting and closing entries at
December 31.
3. Prepare statementofcomprehensive income notshowing installmentsalesfor 2011.
4. Prepare a statement offmancial position as ofDecember 31,2011.
Note:Disregard interest.
2010
P4,000
Uncollected balance
Loss on repossession
Repossessed merchandise
400
2,400
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Chapter 9
384
385
Installment Sales
Problem 9-4: Continued
Problem 9-5: Continued
Required:From the trial balance and accompanying information:
(a) Compute the gross profit rate on installment sales for 2010 and 2011.
(b) Prepare adjusting and closing entries as ofDecember 31,2011 under the installment
method ofaccounting.
(c) Prepare statement ofcomprehensive income for the year ended December 31,
Merchandise sold in 2010 was repossessed in 2011. The repossession was recorded
correctly as follows:
Deferred Gross Profit, 2010
Repossessed merchandise
Loss on Repossession
2,100
3,000
900
Installment Contracts Receivable, 2010
2011.
. I.' .j
6,000
Part ofthis repossessed merchandise was sold for cash during 2011 and the sale was
recorded by a debit to Cash and a credit to Sales.
01'
The rates ofgross profit on 2010 and 2011 installment sales can be computed from the
PPG Discount Center,Inc.sells merchandise for cash and also on the installment plan.
information given above.
Entries to record cost ofgoods sold were made at the end ofeach year.
Required:
PPG Discount Center,Inc.
1. From the trial balance and the other information given above,prepare adjusting and
Trial Balance
closing entries as ofDecember 31,2011.
December 31,2011
2. Prepare statement ofcomprehensive income for the year ended December31,
Cash
Installment contracts receivable, 2010
Installment contracts receivable, 2011
Inventory, January 1,2011
Repossessed merchandise
Accounts payable
Deferred gross profit, 2010
P 50,700
■ 36,000
55,000
60,000
3,000
,
Loss on repossession
Operating expenses
tm.
The partial trial balance ofLondon Products is presented below:
P 12,000
26,600
100,000
20,000
200,000
80,000
Capital stock
Retained earnings
Regular sales
Installment sales
Purchases
2011 showing installment sales.
London Products
Partial Trial Balance
December 31,2011
Installment contracts receivable, 2011
Installment contracts receivable,2010
Installment contracts receivable,2009
Merchandise inventory
900
53,000
P438,600
P438,600
25,000
1
,■
,
Purchases
Freight-in
Repossessed merchandise
Selling expenses
Loss on repossession, 2010
Loss on repossession, 2009
Bad debts - charge sales
The inventory ofmerchandise on hand,December 31,2011 consists ofnew merchandise,
P50,000;repossessed merchandise,P2,000. There are no repossessed merchandise
on hand on January 1,2011.
The cost ofmerchandise sold under the installment plan during 2011 was P54,400.
Collections on contracts receivable during 2011 were as follows:
:
Installment contracts receivable,2010
P40,000
Installment contracts receivable,2011
P 34,000
192,000
90,000
22,000
48,000
238,000
12,000
14,000
92,000
16,000
8,000
1,000
60,000
120,000
300,000
56,000
Accounts receivable
180,000
Cash sales
Charge sales
:
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Installment sales
Unrealized profit, 2010
Unrealized profit, 2009
V
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32,000
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Chapter 9
386
387
Installment Sales
Problem 9-6: Continued
Problem 9-7: Continued
Additional information:
1.
Merchandise inventory on December 31,2011 (including new and repossessed
merchandise)was P52,000.
2. Charge sales prices and installment sales prices were higher than cash sales
prices by 20% and 25%,respectively.
3. Installment sales in 2009 and 2010 had gross profits rates of40% and 35%,
respectively.
4. The following is the summary ofthe repossession account on December 31,
2011:
Installment
FMVof
Contracts
Merchandise
Loss
receivable
Year ofSales
(Debit)
(Debit)
(Credit)
2009
P 2,000
12,000
P 8,000
16,000
P 10,000
28,000
P14,000
P24,000
P38,000
2010
Total
PI73,000
560,000
205,000
3,100,000
1,767,000
420,000
592,960
99,000
P400,000
Installment contracts receivable:
2010
2011
Cash sales of trade-ins
Installment sales
Purchases
Inventories of new merchandise, January 1
Operating expenses
Uncollectible installment contracts expenses
2,210,000
1,701,800
537,000
On Deceni ber 31,2011,the following information were obtained:
a.
b.
Required:
2. Schedule ofallocation ofcost ofgoods sold for the year ended December 31,
2010
•
5. The unrealized profit balances shown in the trial balance were the amounts as of
January 1,2011 and were not adjusted during the year.
1. Schedule ofcost ofgoods sold for the year ended December 31,2011.
2011
: r'
d.
The inventories ofnew and repossessed merchandise on hand on December 31,
2011 were P358,820 and P46,500,respectively.
When a customer defaults on a contract,the repossessed merchandise is recorded
at its approximate wholesale market value in a separate inventory account.Differences
between the unpaid balance on the contract and the wholesale value are debited to
the Uncollectible hrstallment Contracts Expense account. Repossessed merchandise
is sold on the installment plan.
The wholesale value ofrepossessed merchandise is determined as follows:
1. Merchandise repossessed during the year ofsale is valued at40% oforiginal
selling price.
2. Mercha ndise repossessed subsequent to the year ofsale is valued at 20% of
original selling price.
There were no defaulted installment contracts dirring 2010.An analysis ofinstallment
contracts defaulted and written offduring 2011 follows:
2011.
3. Statementofcomprehensive income for the year ended December31,2011 showing
gross profit earned on each type ofsale.
2010 contracts
Problem 9-7
2011 contracts
Original
Selling Price
Unpaid Contract
P195,000
110,000
P105,000
82,000
Balance
Fortune Sales Corporation began operations on January 2,2010. All sales ofnew
On January 1,2011,Fortune Sales began granting allowances on merchandise ■
merchandise are made on installmentcontracts.Due to the risks ofnoncollection.Fortune
traded in as part payment on new sales. During 2011,Fortune Sales granted trade-
Sales recognizes profit fi-om the sale ofnew merchandise under the installment method
ofaccounting and employs the periodic inventory system.The following information
were taken from the accounting records ofFortune Sales on December 31 for the
years indicated:
in allowances ofP226,000.The wholesale market value oftraded-in merchandise
Avas P158,000. All merchandise traded in during tlie year was sold for cash.
Fortune Sales used the installment method ofaccounting for merchandise sold on
the installment plan,both for financial accounting and for income tax purposes.
Chapter 9
388
389
Installment Sales
Problem 9-7: Continued
Problem 9-9
Required:
The Galaxy Investment Company was organized in January 2011 to acquire unimproved
land which are to be divided into lots for sale as homesites. Inasmuch as the project
rests on speculation,the company decided to recognize gross profits on sales oflots
1. Compute the amounts ofdeferred gross profit on installment sales on December
31,2010 and 2011.Include a supporting computation ofthe gross profit percentage
on installment sales for each year.
2. Compute the adjustment(ifany)that you would recommend for the Uncollectible
Installment Contracts Expense account on December 31,2011.
3. Prepare statement ofcomprehensive income(showing cash sales,installment sales,
and total sales)for the year ended December 31,2011.The following supporting
schedules should be prepared:
a. Unrealized gross profit on 2011 installment sales.
b. Realized gross profit on 2010 installment sales.
(after deducting any commissions payable to salesmen)in the proportion that cash
collected each year bears to the sales price:
The transactions in 2011 were as follows:
a.
Purchased for cash 12 hectares ofland for subdivision at a cost ofP4,800,000.
The land was divided into 300 lots with the remaining area devoted to streets
and other general purposes.Prices oflots according to location, as follows:
PI50,000 for A lots,PI00,000 for B lots,and P80,000 for C lots. There were
Problem 9-8
80 A lots, 100 B lots, and the remainder were C lots.
Mr. Pedro Bemal purchased two adjoining lots in 2010. Lot 1 was purchased for
P360,000 and Lot2 Was purchased for P240,000. Mr.Bemal later converted the two
lots to three lots. The cost ofthe third lot was determined by allocating a portion ofthe
cost ofthe original lots to it.
b. Costs and expenses incurred in 2011 were as follows:
Legal fees for purchasing land, surveying fees, etc.
Grading contract
Water and sewerage system contract
Paving contract
Building model home, which is to be offered for sale and is
expected to yield a profit
Advertising and promotion
General office expenses, of which one fourth is considered
The three pieces ofproperty were sold during 2010 on the following terms:
Lot
1
2
3
Sales
Date
Down
Price
ofSale
Payment
Equal
Installment Payments
P360,000
400,000
840,000
Oct. 31
P 72,000
36,000
120,000
PI2,000 every 2 months
16,000 every 3 months
50,000 every 6 months
Mar 31
June 30
P600,000
225,000
184,900
266,300
1,350,000
730,000
applicable to the period after development of the lots
has been completed
Sales manager's salary
Each installment payment is to be applied first to the accmed interest on the principal
Sales commissions
236,000
120,000
221,000
■ ■.<
amount owed at the rate of12%,the balance to a reduction ofprincipal.
c. Sales during 2011 were all at the standard prices,as follows: A lots- 26;B lotsThe buyer ofLot3 did not fulfill the contract. He failed to pay the installment due on
June 30,2010.The property was then repossessed in 2011.
32; C lots-12.
All lots were sold with a one fourth down payment except six ofthe A lots which were
Required:
'
V
colleeted in full. The notes taken were for paymentin three installments starting one year
from the date ofsale. Interest on the notes are to be ignored.
1. Preparejoumal entries to record the transactions for 2010.
2. Prepare the entry to record the realized gross profit on December 31,2010.
3. Record the repossession ofLot3 in 2011,assuming the market value is 20% less
than the original cost.
Required:Prepare in good form a statement showing the net profit ofthe company in
2011.Show the necessary supporting computations.
V
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f-y.
Chapter 9
390
391
Installment Sales
Problem 9-11
LOi
Rizal Company,on Janiiary2,2009 entered into a contract with a manufacturing company
to purchase room-size air conditioners and to sell the units on an installment plan with
collections over approximately 30-months with no interest charge.
Edward,Inc. uses the installment method ofgross profit recognition. The following
table pertains to its operations from 2009 to 2011:
For income tax purpose Rizal elected to reportincome from its sales ofair conditioners
according to the installment method.
Installment sales
Purchase and sales ofnew units were as follows:
Gross profit
Gross profit percentages
Cost ofinstallment sales
Units Purchased
Year
2009
2010
2011
Quantity
12
18
8
Quantity
P 10,000
9,000
10,500
10
20
7
2009 sales
Price Each
2010 sales
P 15,000
14,000
14,300
P50,000
P80,000
(1)
(2)
(3)
(5)
(6)
91,800
28,200
25%
(8)
2011
P
(4)
(7)
*■
25,000
20,000
10,000
50,000
45,000
10,500
(9)
2011 sales
Realized gross profit
1,100
Required: Complete the above table.
Collections on installment sales were as follows:
Collection received
2009 Sales
2010 Sales
2011 Sales
2010
Cash collections:
Unit Sold
Price Each
2009
1 Problem 9-12
2009
2010
2011
P30,000
P60,000
70,000
P60,000
115,000
21,000
The following table pertains to Jacob, Inc. which uses the cost recovery method fc
installment sales.
In 2011,4 units from 2010 sales were repossessed and sold for P725 each on the
installment plan. Atthe time ofrepossession P1,200 had been collected from the original
purchases and the units had a fair value ofP2,520,
Installment sales
Cost of installment sales
Gross profit percentage
General and administrative expenses for 2011 were P50,000. No charge has been
made against current income for an advance payment ofP10,000 on a new contract to
2009
2010
P92,000
2011
P
(1)
74,750
(2)
PI 03,000
62,830
36%
(3)
35%
27,200
48,300
36,600
12,200
Cash collections:
2009 sales
purchase air conditioners beginning January 2,2012.
2010 sales
2011 sales
Required:Assuming tliat the weighted average is used for determining the inventory
cost,including repossessed merchandise,prepare StatementofComprehensive Income
Realized gross profit on installment sales
for 2011 with the following supporting schedules.
Required: Coimplete the above table.
1. Cost ofgoods sold on installment.
2. Average unit cost ofgoods sold on installment for each year.
3. Gross profit rates for 2009,2010 and 2011.
4. Gain or loss on repossession in 2011.
I "'jr.
(5)
(6)
(4)
43,450
19,250
.1
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Chapter 9
392
Problem 9-13
The Bella Appliance Company began business on January 1,2010. The Company
decided from the beginning to grant allowances on merchandise traded in as partial
payment on installment sales. During 2011 the company granted trade-in allowances of
Chapter 10
' -",*7
P64,035. The wholesale value of merchandise traded in was P40,875. Trade-ins
Long Term \
recorded at P39,000 were sold for their wholesale value ofP27,000 during the year.
The following summary entries were made to record annual sales ofnew merchandise
Construction Contracts
and trade-in sales for 2011.
439,890
64,035
Installment accounts receivable
Trade-in inventory
503,925
Sales
27,000
12,000
Cash
Loss on trade-in inventory
Trade-in inventory
39,000
When a customer defaults on the installment accounts receivable,the merchandise is
repossesed.During 2011 the following repossessions occurred:
On 2010 contracts
On 2011 contracts
Original Sales
Unpaid Contract
Price
Balance
P37,500
24,000
P15,600
17,800
feel that the probability ofcollecting the contractpricefrom the buyer is sufficiently
high to warrant the investment of capital and labor services. Under these
conditions, the criteriafor revenue recognition are met prior to completion ofthe
contract. Recognition of revenue during the period of construction is therefore
justified in most cases. This chapter will discuss the accounting procedures to
determine the revenue to be recognized each year of construction.
Construction Contract
PAS 11 defines construction contract as contract specifically negotiated for the
construction of an asset or a comhination of assets that are closely interrelated or
The fair value ofthese goods is estimated as follows:
interdependent in terms oftheir design, technology or their ultimate purpose or use.
(a) Goods repossessed during year ofsale are valued at 50% oforiginal sales price.
(b) Goods repossessed in later years are valued at 20% oforiginal price.
Construction contract may be classified into:
Required:
1. At what values should Bella Appliance report the trade-in and repossessed inventory
at December 31,2011?
2. Give the entry that should have been made to record the repossessions of2011.
3. Give the entry that is required to correct the trade-in summary entries.
0V
Long term construction contracts are construction projects that extend thru more
than one accounting period. Usually, these are construction projects for the
government. Example ofthese projects is the construction ofwater dams, bridges,
flyover, and the metro railway transit. On many long term construction projects,
the buyer and seller (contractor) agree in advance on the contract price. In agreeing
to the contract price, the construction company must have some reasonable basis
for estimating the cost to be incurred under the contract so as to assure a satisfactory
return. In agreeing to perform the contract work, the construction company must
Fixed Price Contract. Tliis is a construction contract in which the contractor
agrees to a fixed contract price, or a fixed rate per unit ofoutput, which in-some
cases is subject to cost escalation clauses.
Cost Plus Contract. This is a construction contract in which the contractor is
reimbursed for allowable or otherwise defined costs, plus a percentage ofthese
costs or a fixed fee.
393
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394
»
Chapter 10
.
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Long Term Consiruclion Contracts
39§
Revenue from Construction Contracts
Types of Contract Costs.
Revenue from long-term construction contracts is measured at the fair value ofthe
Contract costs can be broken down into two categories: costs incurred to date and
estimated costs to complete.
consideration received or receivable. This include the initial amount ofrevenue agreed
in the contract. This amount may increase or decrease from one period to the next. For
example:
a. A contractor and a customer may agree to change the scope ofthe work to be
performed under the contract. Such as,changes in the specifications design of
the asset and changes in the duration ofthe contract.
b. The amount ofrevenue agreed may increase as a result ofcost escalation clauses.
c. The amount ofcontraet revenue may decrease as a result ofpenalties arising
from delays caused by the contractor in the completion ofthe contract; or
d. When the contract price involves a fixed price per unit ofoutput,contract revenue
increases as the number ofunits is increased.
Costs incurred to date. These include precontract costs and costs incurred after contract
acceptance. Precontract costs are costs incurred before a contract has been entered
into, with the expectation that the contract will be accepted and these costs will thereby,
be recoverable tlirough billings. The criteria for recognition of such costs are:
f ■> -
Y
incentive payment can be measured reliably.
Contract Costs
Contract costs are costs that relate direetly to the specific contract; are attributable to
contract activity in general and can be allocated to the contract; and are specifically
chargeable to the customer under the terms ofthe contract.Examples ofcontract costs
are:
a.
Site labor costs,including site supervision.
b.
Costs ofmaterials used in constmction.
c.
Depreciation ofplant and equipment used on the contract.
d.
Costs ofmoving plant,equipment and materials to and from the contract site.
e.
f
g-
Costs ofhiring plant and equipment.
Costs ofdesign and technical assistance.
The estimated costs ofrectification and guarantee work,including expected
warranty costs.
h.
Claims from third parties
Precontraet costs include costs of architectural designs, cost of securing the contract,
and any other costs that are expected to be recovered if the contract is accepted.
Contract costs incun-ed after the acceptance of the contract are costs incurred toward
the completion of the project and are also capitalized in the Constmction in Progress
(CIP) account. The contract does not have to be identified before the capitalization; it is
only necessaiy that there be an expectation of the recovery of the costs. Once the
contract has been accepted, the precontract costs become contract costs incurred to
date. However, if the precontract costs are already recognized as an expense in the
period in which they are incuiTed, they are not included in contract costs when the
contract is obtained in a subsequent period.
Estimated costs to complete. These are the anticipated cost of materials, labor,
subcontracting costs, and indirect costs (overhead) required to complete a project at a
scheduled time. They are composed ofthe same elements as the original total estimated
contract costs and would be based on prices expected to be in effect when the costs
are incurred. The latest estimates should be used to determine the progress toward
completion.
Accounting for contract costs is similar to accounting for inventory. Costs as incurred
would be recorded in the Constmction in Progress account. Constmction in Progress
Construction overheads.
account would include both direct and indirect costs but would usually not include
general and administrative expenses or selling expenses since they are not normally
General administrative costs and development costs for which reimbursement
identifiable with a particular contract and should therefore be expensed.
Insurance
Jk.
2. They can be measured reliably.
3. It is probable that ihe contract will be obtained.
i i
•v.
Construction revenue may also include incentive payments to the contractor for early
completion ofthe contract when the contract is sufficiently advanced that it is probable
that the specified perfomiance standards will be met or exceeds; and the amount ofthe
1. They are capable of being identified separately.
is specified in the terms ofthe contract.
Chapter 10
396
Subcontractor Costs
On some construction projects,the principal contractor will hire other contractors or
individuals to perform part of the constmction project. This process is called
subcontracting. The subcontractor may have important technical skills not possessed
by the principal contractor. The amount billed to the principal contractor for work done
by the subcontractor should be included in contract costs. The amount billed is directly
traceable to the project and would be included in the CIP account, similar to direct
materials and direct labor.
Cost of Materials Purchased in Advance of Their Use
Long Term Construction Contracts
397
Computation and Recognition of Construction Revenue
Detemiining the amount ofrevenue eamed is particularly difficult in the area oflongterm constmction contracts. Even ifthe revenue is collectible and eamed through
production,the amount that has been eamed and the related costs associated with the
earning process may still not be determinable. The amount ofrevenue and expenses
recognized each accounting period during tlie production process relate to the degree
ofcompletion ofthe project and to the remaining costs and effort to be incurred in
finisliing the project.
Two basic methods are used to account for long-term constmction contracts: the
percentage-of-completion method and the zero profit method.
Percentage-of-Completion Method. This method is to be used when the outcome of
Construction materials may be purchased several weeks or months before they are
actually used in constmction.Such purchases may be made to ensure availability ofthe
materials or in anticipation ofprice increases. Such costs should not be treated as costs
incurred for purposes ofcomputing the percentage ofcompletion ratio until tlie materials
have been physically used in production.
Combining and Segmenting Contracts
the construction contract can be estimated reliably, that is, the estimate ofcosts to
complete and the extent ofprogress toward completion oflong-term contracts are
reasonably dependable.
Under this method,gross profit is recognized as constmction progresses.In practice,
contractors use two basic methods to measure the progress ofthe constmction.
1.
calls for one large project rather than several separate projects. Under this
method the degree ofcompletion is determined by computing the ratio ofthe
costs already incurred to the total estimated costs to complete the project. The
For accounting purposes,a group o/contracts may be combined ifthey are so closely
related thatthey are,in substance,parts ofa single project with an overall profit margin.
A group ofcontracts,whether with a single customer or with several customers,should
be combined and treated as a single contract ifthe group ofcontracts
percentage ofcompletion is then applied to the estimated gross profit(contract
price less total estimated costs)to detemiine the gross profit to be recognized
1. Are negotiated as a single package
2. Require such closely interrelated constmction activities that they are,in effect,
to date. Some oftlie costs incuired,particularly in the early stages ofthe contract
should be excluded in using this method,because they do not relate directly to
the work performed on the contract. These include such items as payments to
part ofa single project with an overall profit margin.
3. Are performed concurrently or in a continuous sequence
subcontractors in advance for work that has set to be performed;and fabricated
materials that has been delivered to tlie contract site but not yet installed, used
or applied during contract performance,unless the materials have been made
Segmenting a contract is a process ofbreaking up a larger unit into smaller units for
accounting purposes. Ifthe project is segmented,revenues can be assigned to the
differentelements or phases to achieve different rates ofprofitability based on the relative
value ofeach element or phase to the estimated total contract revenue. A contract may
covera number ofassets. The constmction ofeach asset should be treated as a separate
constmction contract when
1.
The contractor has submitted separate proposals on the separate component
ofthe project.
2.
Each asset has been subject to separate negotiation and the contractor and
customer had the right to accept or reject part ofthe proposal relating to single
asset.
3.
515:
Input measures(cost to cost method). This method is used ifthe contract
The cost and revenues ofeach asset can be separately identified.
specifically for the contract. However,this estimation is required in reporting
income,regardless ofhow the percentage ofcompletion is computed. This
method is used throughout the chapter.
2.
Output measures(units ofdelivery). The progress is based on the results
achieved. Under this method revenue is recognized when certain phases ofthe
project are completed and accepted by the buyer. This method is useful in
contracts fortlie construction ofseveral condominium units.Income is recognized
when a particular unit is completed and delivered and accepted by the buyer,
although the entire project is not yet finished. Thus,ifa construction company
signs a contract for ten condominium units and completes three units at the end
ofthe first year and accepted by the buyers,then 30% ofthe total revenue
provided under the contract should be recognized.
Long Term Construction Contracts
Chapter 10
398
399
*Since the contract was completed and accepted in 2011, the buyer paid the
remaining balance offoe total contract amount,computed as follows:
Zero Profit Method.In cost-plus contracts,the contractor is assured ofno loss.Ifthe
contractor is protected in this manner butis unable to make reasonable estimates ofthe
percentage of completion, PAS No. 11 recommends this method. This method is
described as the percentage-of-completion method based on a zero profit margin. Under
this method,revenue is recognized in an amount exactly equal to costs incurred until
reasonable objective estimates ofthe percentage ofcompletion are available.
P5,000,000
Contract amount
Prior progress payments
P 275,000
2,100,000
2009
2010
Performance during the period is included in the Statement ofComprehensive Income,
2,375,000
Remaining balance
although the method does not effect netincome because revenue and costs recognized
are equal. The zero profit margin approach indicates to financial statement users the
P2,625,000
The computation offoe gross profit to be realized for each year under the two methods
volume ofthe company's busihess while defening die recognition ofgross profit until
more reliable estimates ofthe degree ofcompletion can be made.
are presented below:
Illustration 10-2
Illustrative Problem
Perceiitage-of-Completion Method
To illustrate the appropriate accounting procedures for the percentage-of-completion
d i' i
2009
2010
2011
P5,000,000
P5,000,000
P5,000,000
1,350,000
3,150,000
4,500,000
3,600,000
400,000
4,000,000
4,000,000
4,000,000
500,000
1,000,000
1,000,000
30%
90%
150,000
900,000
1,000,000
150,000
900,000
P 750,000
P 100,000
and zero profit methods,assumethefollowing:
(1) Total contract price
AMG Construction Company agrees to build a large ofiice building forPG Towers for
a total contract price ofP5,000,000.PG Towers will make annual payments to AMG,
but the amounts ofthese payments cannot exceed the direct costs incurred by AMG.
The contract is signed on October 1,2009 and AMG's year-end is December 31. The
contract providesPG with a final inspection rightto ensure comphance with the contract
terms prior to accepting the completed project. Illustration 10-1 below gives further
(2) Cost incurred to date
(3) Estimated costs to complete
(4) Total estimated costs
(5) Expected gross profit
Multiply by the percentage
ofcompletion (2-1-4)
-
.
100%
information aboutfoe contract.
Gross profit earned to date
Less: Gross profit earned
in prior years
Illustration 10-1
Total contract price
Total anticipated costs(at 10/2009)
Item
2009
P5,000,000
4,500,000
2010
Gross profit earned this year
-
P 150,000
Total
2011
Zero Profit Method
2009
2010
Pl,350,000
1,350,000
P2,250,000
PI,400,000
2,250,000
400,000
Cost incurred
each year
P 1,350,000
P2,250,000
P400,000
P4,000,000
Construction Revenues
Estimated costs
to complete
(at year-end)
Progress billings
each year
Progress payments
received each year
Cost incurred each year
3,150,000
400,000
400,000
2,000,000
2,600,000
5,000,000
275,000
2,100,000
2,625,000*
5,000,000
-
2011
-
Gross profit earned this year
P
P
P 1,000,000
■j
' -
Long Tenn Construction Contracts
Chapter 10
400
401
Illustration 10-3
The'eomputation in Illustration 10-2 shows that the only difference between the two methods is the
timing of the recognition of gross profit on the contract. Both methods ultimately result in the
recognition ofthe same total amount ofgross profit,P1,000,000.
Comparison of Zero Profit Method and Percentage-of-Completion Journal Entries
Journal Entries
It should be noted that under the percentage of completion method, a revised estimate of the
cumulative percentage of completion is computed each year. The percentage is applied to the
expected gross profit(which will also vary as revised estimates ofexpected costs to be incurred is
made). The difference between the cumulative gross profit and the gross profit recognized in the
previous year(s) is the current year's gross profit.
y<>.
Accounts
2009
1 Contract Signed
No entry necessary to record contract commitment
2 Costs Incurred
Construction in Progress
Cash
1,350,00
'
Accounts Receivable
Contract Billings
400,000
Cash
275,000
3 Progress Billings
The realized gross profit under the percentage ofcompletion method may also be computed using
the formula below:
4 Billing Collections
Contract Price
P5,000,000
Multiply by percentage of completion
Value of contract earned
Less: Cost incurred to date
t
90%
100%
1,500,000
1,350,000
4,500,000
3,600,000
5,000,000
4,000,000
150,000
900,000
150,000
1,000,000
900;000
Gross profit earned this year
P 750,000
P 100,000
.
-
P 150,000
5 Revenue Recognition Construction in ProgressCost of Construction
y
6 Costs Incurred
7 Progress Billings
'f
8 Billing Collections
: •
Construction in Progress
275,000
275,000
2011
10 Costs Incurred
2,000,000
Cash
2,100,000
Construction in Progress
11 Progress Billings
Accounts Receivable
i \ \,,, ,1"
12 Billing Collections
Cash
total costs incurred plus cumulative income recognized)should be equal to the amount in the
13 Revenue Recognition Constn/cp'on in Progress
Cost of Construction
account. Contract Billings(contract price).
The Construction in Project account under both methods is removed from the books by
closing the two accounts.
14 Elimination of
Inventory
Companies may employ account titles and contain other minor variations, but the procedures
illustrated here are representative of the two methods.
/I .
mil'
2,000,000
2,100,000
2,100,000
750,000
2,250,000
3,000,000
2,250,000
400,000
400,000
400,000
400,000
2,600,000
2,600,000
2,600,000
2,600,000
2,625,000
2,625,000
2,625.000
2,625,000
100,000
400,000
1,000,000
400,000
Construction Revenue
debiting Contract Billings account and crediting Construction in Progress account, thereby
2,000,000
—
2,250,000
Account Receivable
customer has been fully billed, the amount in the Construction in Progress account (actual
2,250,000
2,100,000
Contract Billings
completion.
2,250,000
2,000,000
Cash
the costs incurred each year,thereby,recognizing a zero gross profit. The total gross profit on
the contract, PI,000,000 is debited to Construction in Progress only in 2011, the year of
1,500,000
2,250,000
Construction Revenue
Actual cost incurred are debited to the Construction in Progress account under both methods.
Billings ofcustomers and collections from customer are treated identically under both methods.
Under the zero profit method,in 2009 and 2010 Construction Revenue is recognized equal to
150,000
1.350,000
2,250,000
Accounts Receivable
Contract Billings
9 Revenue Recognition Construction in Progress
Cost of Construction
From the journal entries and T-accounts, the following should be noted:
5.
400,000
1,350,000
Accounts Receivable
The accounting entries and T-accounts for each contract year using both the Percentage of
Competition and Zero Profit methods are presented in Illustration 10-3,and Illustration 10-4.
On the other hand revenue is recognized each year by debiting the Construction in Progress
account, under the percentage ofcompletion method. When the contract is completed and the
1,350.000
400,000 _
1,350,000
Cash
-f'
4.
'
275,000
Construction Revenue
Illustrative Journal Entries
1.
2
3.
1,350,000
,350,000
' \
2010
Gross profit earned to date
Less: Gross profit earned in prior years
Cr.
t.
P5,000,000 ' P5,000,000
30%
Dr.
400,000
Accounts Receivable
2011
Cr.
Event
Alternative Procedure
2010
Dr.
Date
Under the zero profit method,the recognition ofprofit is deferred until the project is completed, but
revenue is recognized equal to the total costs incurred to date in 2009 and 2010.
2009
Percentage-ofCompletion
Zero Profit Method
Contract Billings
5,000,000
Construction in Progress
500,000
1,400,000
5,000,000
5,000,000
5,000.000
Chapter 10
402
Long Term Coiistriiclion Contracts
403
FINANCIAL STATEMENT PRESENTATION
Illustration 10-4
Zero Profit Method
The resulting financial statement presentation for both methods are summarized in
Construction in Progress
Cash
(4)
275,000 1,350,000 (2)
(8) 2,100,000 2,250,000 (6)
(12) 2,625,000 1,400,000 (10)
(2) 1,350,000
Accounts Receivable
(3)
400,000
1,350,000
125,000
(6) 2,250,000
(7) 2,000,000
2,125,000
3,600,000
275,000 (4)
2,100,000 (81
Illustration 10-5 below:
Illustration 10-5
Comparison ofZero ProOt Method and Percentage-of-CompIetion Method
Financial Statement Presentation
2,100,000
25,000
(10) 400,000 5,000,000 (14)
(13)1,000,000
(1 1)2,600,000
2,625,000
December 31, 2006
Percentage
2,625,000 (12)
2,625,000
Zero Profit
Method
5,000,000 5,000,000
of
Completion
December 31. 2007
Percentage
Zero Profit
Method
of
Completion
December 31, 2008
Percentage
Zero Profit
Method
of
Completion
Statement of Financial Position
Contract Billings
Cost of Construction
Construction Revenue
Accounts Receivable
125,000
125,000
25,000
25,000
Inventory;
400,000 (3)
1,350,000 (5)
(5) 1,350,000
400,000
2,250,000 (9)
(9) 2,250,000
1,400,000 (13)
2,000,000 (7)
Progress
1,350,000
1,500,000
3,600,000
4,500,000
-0-
-0-
400,000
400,000
2,400,000
2,400,000
-0-
-0-
950,000
1,100,000
200,000
2,100,000
-0-
-0-
Statement of Comprehensive Income
Constmction Revenue
1,350,000
1,500,000
Cost of Construction
1,350,000
1,350,000
2,250,000
3,000,000
1,400,000
2,250,000
2,250,000
400,000
500,000
400,000
750,000
1,000,000
100,000
Less:
(13) 450,000
Contract Billings
(15) 5,000,000 2,600,000 (11)
5,000,000 5,000,000
Excess
Percentage of Completion Method
Construction in Progress
-0-
Construction in
2,400,000
Cash
-0■
Account Receivable
Gross Margin
150,000
1
1
I
(4)
275,000 1,350,000 (2)
(8) 2,100,000 2,250,000 (6)
(12) 2,625,000 1,400,000 (10)
I
(2) 1,350,000
f31
400.000
275.000 f41
(5)
125,000
(7) 2,000,000
2,100,000 (8)
150,000
1,500,000
(6) 2,250,000
(9) 750,000
4,500,000
(10) 400,000
•
(131
2,125,000
2.100.000
25,000
(1 1)2,600,000
5.000.000 f41
2.625.000
2,625,000 (12)
2.625.000
100,000
5,000,000 5.000.000
In the above illustration,the excess ofthe Constmction in Progress account over the
Contract Billings is treated as a current asset(due from customer). The "cumenf'
classification ofthis item is based on the operating cycle definition. An asset is current if
it is expected to be used,consumed or converted into cash within the next year(or
operating cycle,ifthe cycle exceed one year). The period ofthe accoimting cycle for
long-term contracts which frequently exceeds bne yearis typically used to identify current
assets.
Contract Billings
400,000 (3)
400,000
2,000,000 (7)
2,400,000
2,600,000 (11)
(14) 5,000,000 5,000,000
Construction Revenue
1,500,000 (5)
3,000,000 (9)
5,000,000 (13)
Cost of Construction
(5) 1,350,000
(9) 2,250,000
(13) 450,000
Ifthe contract provided for billings is in excess ofcosts incurred,the Constmction
in Progress account could be less than tlie Contract Billings accoimt.In this case,the.
difference is presented as a current liability labeled due to customers or another
appropriate title.
The percentage-of-completion method is preferable when reasonably dependable
estimates ofthe degree ofcompletion can be made because it describes the company's
transactions and events more clearly and more timely tlian does the zero profit method.
The percentage-of-completion method informs financial statement users ofthe volume
I
Chapter 10
404
ofthe economic activity ofthe company.On the other hand,the zero profit method is
based on results as finally determined and not on estimates. However,it does reflect
::urrent performance in the statement ofcomprehensive income each year by recognizing
revenue equal to the actual cost incurred.
Long Term Construction Contracts
405
The computations show that the increase in estimated cost reduce the percentage-ofcompletion in 2010 to 75%,and the cumulative gross profit at the end of2010 to
PI05,000. Since PI50,000 was already recognized as gross profit in 2009,a loss of
P45,000 would be recognized in 2010.The entries to record revenue and costs for the
three years under the percentage-of-completion method would be as follows:
Anticipated Losses on Long-Term-Construction Projects
2009
2010
Cost ofconstruction
1,350,000
Construction in progress 150,000
2,250,000
2011
In some cases,the total estimated costs is increased due to increase in the costs of
construction materials. The increase in the total estimated costs may result to a loss in
the year the estimated costs was increased,but overall,the contract resulted in a profit.
Sometimes,an increase in total estimated costs is so great tliat a loss on the entire
contract is anticipated; that is, total estimated costs are expected to exceed the total
revenue firom the contract. When a loss on the total contract is anticipated,PAS No. 11
require reporting the loss in its entirety immediately when the loss is first anticipated.
This is true under either the zero profit or the percentage-of-completion method.The
following cases will illustrate the above accounting procedures;
Case 1:Loss in the year ofrevision ofestimated costs butprofit in total contract
Revisirig the data in Illustration 10-1,assume that at the end of2010,the estimated cost
to complete was increased to PI,260,000 and this was the actual cost incurred in
'2011. The following analysis shows the computation ofthe gross profit(loss)to be
recognized each year:
2009
Contract price
2010
2011
P5,000,000
P5,000,000
P5,000,000
1,350,000
3,150,000
3,600,000
1,260,000
4,860,000
4,500,000
4,860,000
4,860,000
Expected gross profit
Percentage ofcompletion
500,000
140,000
140,000
30%
75%
100%
Gross profit earned to date
Gross profit earned in prior year(s)-
150,000
105,000
150,000
140,000
105,000
Cost incurred to data
Estimated costs to complete
Construction revenue
1,500,000
Under the zero profit method,no adjustment is necessary since the contract will result in
an overall profit. The entries would be as follows:
2009
2010
2011
Cost ofconstruction
1,350,000
Construction in progress
2,250,000
1,260,000
140,000
Construction revenue
1,350,000
2010
P5,000,000
P5,000,000
P5,000,000
1,350,000
3,150,000
3,600,000
1,500,000
5,100,000
4,500,000
5,100,000
5,100,000_
500,000
(100,000)
(100,000)
Estimated costs to complete
'
Total estimated costs
P 150,000
P( 45,000)
P
35,000
1,400,000
2009
Cost incurred to date
Gross profit(loss) recognized this year
2,250,000
Case 2: Loss in the year ofrevision oftotal estimated costs but overall loss on
the contract Assume the same data in our previous illustration, except that in 2010 the
estimated costs to complete were PI,500,000 instead ofP400,000,assume also that
actual cost equaled expected costs in 2011.The computation ofthe gross profit to be
recognized each year would be as follows:
Contract price
,
Total estimated costs
1,260,000
45,000
35,000
2,205,000
1,295,000
Expected gross profit(loss) •
Percentage of completion to date
70%
30%
I
- -V'-:
S':
\
'
I ■i. 'f: .
2011
-
100%
■<
>?■■) ■
r
Chapter 10
406
Long Term Construction Contracts
407
%
Under the Zero Profit Method, the anticipated loss is to be recognized immediately at
the end of 2010 because there is an overall loss on the contract. To record the anticipated
loss of P 100,000 on the construction contract, the following entry would be made at
The entry to record the total loss at the end of2010 would be as follows:
Cost of construction
the end of 2010:
Construction in progress (total loss)
2,250,000
Construction in progress (Loss)
100,000
2,150,000
Construction revenue
Note that the constmction in progress account under both methods would have a balance
of P3,500,000 as shown below:
At the end of 2011, the year of completion the entry would be:
•
■ 1,500,000
2009 cost
Under the Percentage ofCompletion Method the recognition of an anticipated contract
loss is more complicated. To properly recognize the entire loss in the year it is first
anticipated, the cumulative cost to be deducted from the cumulative recognized revenue
cannot be the actual cost incurred, but must be the cumulative recognized revenue plus
the total .anticipated loss. Thus, in our example, the cumulative recognized revenue at
the end of 2010 >vould be P3,500,000 (70% x P5,000,000), and the cumulative cost
at the same year would be P3,600,000 (P3,500,000 + P100,000). Since it is assume
that P150,000 profit was recognized in 2009, then the total loss to be recognized in
2010 is P250,000 (PI50,000 + PI00,000). The following computation shows the
amounts to be reported for each of the three years of the contract under the percentage
of completion method.
To Date
Construction revenue (P5,000,000 x 30%)
Cost of construction (actual cost)
Gross profit
2010:
2011:
PI,500,000
1,350.000
Percentage of Completion Method
Construction in Progress
Zero Profit Method
Construction in Progress
1,500,000
Construction revenue
2009:
2,000,000
250,000
Construction revenue
Cost of construction
Cost of construction
2,250,000
Recognized-
Recognized-
Prior Years
Current Year
—
-
PI 50,000
PI,500,000
1,350,000
PI 50,000
Construction revenue (P5,000,000 x 70%)
Cost (revenue plus total anticipated loss)
P3,500,000
3,600,000
PI,500,000
1,350,000
P2,000,000
2,250,000
Gross profit (loss)
P(100,000)
PI 50,000
P(250,000)
Construction revenue
Cost (Actual Cost)
P5,000,000
5,100,000
P3,500,000
3,600,000
P 1,500,000
1,500,000
Gross profit (loss)
P(100,000)
P(100,000)
P-
2010 cost
PI,350,000
2,250,000
100,000 2010 loss
2009:
2010:
3,600,000
Balance
cost Pl,350,000
CP
150,000
cost 2,250,000
100,000
P3,500,000
3,750,000
Balance
P250,000 2010 loss
250,000
P3,500,000
Contract Retention. To ensure the completion ofthe project satisfactorily, part ofthe
billings may not be paid to the contractor until the project is completed and accepted.
For example, if out of the total billings during the year of P1,000,000,10% is agreed
upon as contract retention, only P900,000 will he collected by the contractor. The
entry to record the collection would be:
Cash
Contract retention
Accounts receivable
900,000
100,000
1,000,000
The Contract Retention account is presented in the statement of financial position as a
current asset. Upon completion of the project, the balance of this account once paid by
the customer will be closed by debiting Cash and Crediting Contract Retention accoimt
.'A- "V
Chapter 10
408
Long Term Construction Contracts
Financial Statement Presentation Requirement under PAS 11
409
APPENDDC
1. Gross amounts due from customers should be reported as an asset. This amountis
ACCOUNTING UNDER SPECIAL SITUATIONS
the net of;
a. Costs incurred plus recognized profits,less
b. The aggregate ofrecognized losses and progress billings.
This represents,in the case ofconfract in progress,excess ofconfract costs incurred
plus recognized profits,net ofrecognized losses,over progress billings.
A number of specialized situations that are fairly common in long-term construction
contracting are not addressed by Philippine Accounting Standards (PAS) No. 11. To
provide guidance on tliese matters, the following interpretations are offered.
Joint Ventures and Shared Contracts
Gross amounts due to customers should be reported as a liability. Tliis amount is
Many contracts obtained by long-term construction companies are shared by more
than one contractor. When the owner ofthe contract puts it up for bids, many contractors
the net of:
a. Costs incurred plus recognized profits,less
form syndicates or joint ventures to bid on and obtain a confract under which each
b. Tlie aggregate ofthe recognized losses and progress billings.
This represents,in the case ofconfract work in progress,excess ofprogress billings ■
over contract costs plus recognized profits, net ofrecognized losses.
contractor could not perform individually.
Disclosure Requirements under PAS 11
When this occurs, a separate set of books is maintained for the joint venture. If the
percentages of interest for each venture are the same in more than one contract, the
joint venture might keep its records almost like another construction company. Usually,
PAS 11 prescribes a number ofdisclosures;some ofthem are for all the contracts and
the joint venture is for a single confract and ends on completion of that contract.
•
others are only for contracts in progress at the statement offmancial position.These are
summarized below:
f.
Under Pliilippine Accounting Standards (PAS 31), a venturer's interest in a joint venture
may be accounted for by either the proportionate consolidation or the equity method of
accounting. See Chapter 6 for a detailed discussion ofjoint venture accounting.
1. Disclosures relating to all contracts:
a. Aggregate amount ofcontract revenue recognized in the period.
b. Methods used in determination ofcontract revenue recognized in the period.
2. Disclosure relating to contracts in progress:
a. Methods used in determination ofstage ofcompletion(ofcontracts in progress)
b. Aggregate amount ofcosts incurred and recognized profits(net ofrecognized
losses)to date.
c. Amounts ofadvances received(at statement offinancial position date),
d Amount ofretentions(at statement offinancial position date).
Accounting for Change Orders
Qiange orders are modifications ofspecifications ofan original contract Contract revenue
and costs should be adjusted to reflect change orders that are approved by the contractor
and customer. The accounting for the change order depends on the scope and price of
the change. If the customer and contractor have agreed both the scope and price,
contract revenue and cost should be adjusted to reflect the change.
Accounting for unpriced change orders depends on their characteristics and the
circumstances in which they occur. Under the zero-profit method, costs attributable to
unpriced change orders should be deferred as contract costs if it is probable that total
■ contract costs, including costs attributable to the change orders will be recovered from
'f
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'
■
•
. .-| ,
contract revenues. Recovery should be deemed probable if the future event or events
j 'l i)
are likely to occur.
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Chapter 10
410
The following guidelines should be followed when accounting for unpriced change
orders under the percentagc-of-complction method:
1. Costs attributable to unpriced change orders should be treated as costs ofcontract
performance in tlie period incurred ifit is not probable that tlie costs will be recovered
through a change in the contract price.
2. If it is probable that the costs will be recovered, the costs should be deferred
(excluded from the cost ofcontract performance)until parties have agreed on tlie
change in contract price,or alternatively,they should be treated as costs ofcontract
performance in the period incurred,and contract revenue should be recognized to
the extent ofthe costs incurred.
411
Long Term Construction Contracts
MULTIPLE CHOICES-THEORETICAL
1. In accounting for a long temi construction conti'act using the percentage of
completion method,tlie progress billings on contract account is a:
■ I-
a.
Contra current asset account.
b. Contra noncurrent asset account.
m
c. Noncurrent liability account.
d. Revenue account.
3. Ifthe adjustment to the contract price exceeds the costs attributable to the change
order and the amount ofthe excess can be reliably estimated,and ifrealization is
probable,then the original contract price should be adjusted.
2. The computation ofthe income recognized in the second year ofa four-year
construction contract which is accounted for using the percentage ofcompletion
method is based on the:
Accounting for Contract Options
}
An addition or option to an existing contract should be treated as a separate contract if
any ofthe following circumstances exist:
a. Cumulative actual costs incuired only.
b. Incremental cost for the second year only.
0.
1.
The product or service to be provided differs significantly from the product or
Latest available estimated costs.
d. Estimated costs at tlie inception ofthe contract.
service provided under the original contract.
The price ofthe-new product or service is negotiated without regard to the original
contract and involves different economicjudgments.
3.
3. In accounting for a long-term construction contractfor which there is a projected
profit, the balance in the appropriate asset accounts atthe end ofthe first year of
The products or services to be provided under the exercised option or amendment
work using the hybrid contract method would be:
are similar to those under the original contract,but the contract price and anticipated
contract cost relationship are significantly different.
a.
Ifthe addition or option does not meetthe foregoing circumstances,the contracts should
be combined.However,ifthe addition or option does not meetthe criteria for combining,
they should be treated as change orders.
Accounting for Claims
Zero
b. The same as the percentage ofcompletion method.
c. Higher than the percentage ofcompletion method.
d. Lower than the percentage ofcompletion method.
4. When should an indicated loss on a long term contract be recognized under the
hybrid contract method and the percentage ofcompletion method,respectively?
These represent amounts in excess ofthe agreed contract price that a contractor seeks
to collectfrom customers for unanticipated additional costs.The recognition ofadditional
contract revenue relating to claims is appropriate ifit is probable thatthe claim will result
in additional revenue and ifthe amount can be estimated reliably. Ifthis is the case,
revenue from a claim should be recorded only to the extent that contract costs relating
to the claim have been incurred. Otherwise,a contingent asset for the claims should
only be disclosed.
Zero Profit
a. Immediately
b. Immediately
c. Completion ofcontract
d. Completion ofcontract
Percentage ofCompletion
Immediately
Over the life ofthe project
Over tlie life ofthe project
Immediately
Long Term Construction Contracts
Chapter 10
412
10.
5. A company uses the percentage ofcompletion method to account for a fouryear constiuction contract Which ofthe following would be used in the calculation
ofthe income recognized in the first year?
Before the year ofcompletion,under the zero profit method,the year end balance
ofthe Construction in Progress account is equal to:
a.
Progress Billing
Collections on progress billings
a. No
No
b. No
Yes
c. Yes
d. Yes
No
Yes
413
Cost incuiTcd to date
b. Cost incurred this year
c. Cost incurred to date plus gross profit eamed to date
d. Gross profit eamed to date
11.
6. In computing the percentage ofcompletion ratio,under the cost to cost metliod,
A construction company is in the middle ofa two-year constmction contract when
it receives a letter from the customer extending the contract by a year and requiring
the constmction company to increase its output in proportion ofthe number of
actual costs incurred should exclude:
years ofthe new contract to the previous contract period.
a. Costs ofmaterials used in constmction.
b. Costs ofhiring equipment.
c. Costs ofdesign and technical assistance.
d. Costs ofmaterials purchased in advance.
This is allowed in recognizing additional revenue if:
."v,
\V
a. Negotiations have reached an advanced stage and it is probable that the
customer Avill acceptthe claim.
7. The excess ofthe Construction in Progress account over the Contract Billings is
b. The contract is sufficiently advanced and it is probable that the specified
treated as:
perfomiance standards will be exceeded or met.
c. It is probable that the customer will approve the variation and the amount of
revenue arising fi'om the variation,and the amount ofrevenue can be reliably
a. Currentliability
b. Current asset
c. Other asset
measured.
d. Non current liability
d. It is probable that the customer will approve the variation and the amount of
revenue arising from the variation, whether the amount ofrevenue can be
8. The excess ofContract Billings over the Constmction in Progress account is
reliably measured or not.
treated as:
a. Currentliability
12.
A constmction company signed a contract to build a theater over a period oftwo
years,and with this contract also signed a maintenance contract for five years.
b. Current asset
c. Other asset
Both the contracts are negotiated as a single package and are closely interrelated
d. Non current liability
to each other.
9. Before the year ofcompletion,under the percentage ofcompletion method,the
year end balance ofthe Constmction in Progress account equal to:
a. Cost incurred to date
b. Cost incurred this year
c. Cost incurred to date plus gross profit eamed to date.
d. Gross profit eamed to date
The two contracts should be:
a. Combined and treated as a single contract.
b. Segmented and considered two separate contracts.
c. Recognized under tlie completed contract method.
d. Treated differently-the building contract under the completed contract and
maintenance contract under tlie percentage ofcompletion method.
Chapter 10
414
Long Term Construction Contracts
415
No. 10-3: Continued
MULTIPLE CHOICES-COMPUTATIONAL
lO-l; The following data relates to a constructionjob started by Esther Inc.
The following data relate to the progress ofthe contract:
Income recognized at December 31,2010
P600,000
3,600,000
1,200,000
Cost incurred Jan. 10,2010 thm Dec.31,2011
Total contract price
Actual cost incurred in 2011
Estimated remaining costs
Billings to customers in 2011
Collections from customers in 2011
Estimated cost to complete at Dec.31,2011
PI,000,000
200,000
400,000
300,000
100,000
How much income should FF Cruz recognize for the year ended December 31,
2011?
How much gross profit is to be recognized by Esther,Inc.?
Percentage of Completion
Method
Zero Profit Method
a.
b.
c.
P133,333
P266,667
P333,333
P20p,000
PI00,000
d.
P133,333
P200,000
-0-
a.
b.
c.
d.
10-4: D.Diaz Construction Inc. has consistently used the percentage-of-completion
method ofrecognizing income. In 2011,Diaz started work on a P3,000,000
fixed-price construction contract.The accounting records disclosed the following
data for the year ended December 31,2011:
10-2: Tower Builders,Inc.has consistently used the percentage-of-completion method
ofaccounting for constmction-type contracts.In 2010,Tower Builders started
work on a P9,000,000 fixed price construction contract that was completed in
2011.The company's accounting records disclosed the following:
December 31
Cumulative contract costs incurred
Estimated total costs at completion
2010
2011
P3,900,000
7,800,000
P6,300,000
8,100,000
How much income would Tower have recognized on this contract for the year
ended December 31,2011?
a.
b.
c.
d.
P300,000
P525,000
P600,000
P900,000
PlOOyOOO
P300,000
P600,000
P700,000
P
Costs incurred
Estimated cost to complete
Progress billings
Collections
How much loss should D.D.Diaz have recognized in 2011?
c.
P230,000
PI00,000
P 30,000
d.
P
a.
b.
0
10-5: On April 1,2010,GC Constmction Company entered into a fixed-price contract
to construct an apartment building for P6,000,000. GC appropriately accounts
this contract under the percentage-of-completion method.Infonnation relating
to the contract is as follows:
2010
10-3: F.E Cruz Construction Company has consistently used the percentage-of-
completioirmethod.On Janu^ 10,2010,FF Cruz began work on aP6,000,000
Percentage ofCompletion
Estimated costs atcompletion
construction contract. Atthe inception date,the estimated costs ofconstruction
Income recognized(cumulative)
was P4,500,000.
930,000
2,170,000
1,100,000
700,000
2011
20%
60%
P4,500,000
300,000
P4,800,000
720,000
Chapter 10
416
No. 10-5: Continued
417
No. 10-7: Continued
What is the amount ofcontract costs incurred during the year ended December
31,2011?
a.
b.
c.
d.
Long Term Construction Contracts
PI,200,000
Pl,980,000
PI,920,000
P2,880,000
Under tlie percentage-of-completions method, what amount ofthe P4,200,000
contract price is to be recognized as income in 2010 and 2011?
2010
P240,000
b. P240,000
c.
P360,000
d. P360,000
a.
10-6; GG Construction Company began a construction project on a building for
P3,000,000.The project was completed during 2011.The accounting records
disclosed the following;
2010
Progress billings during the year
Cost incurred during the year
Collections on billings during the year
Estimated cost to complete
2011
PI,100,000
900,000
700,000
1,800,000
Pl,900,000
1,800,000
2,300,000
2011
P210,000
P810,000
P90,000
P690,000
10-8: The W.W.Construction Corporation began constmction work under a three-
year contract. The contract price was P800,000. WW uses the percentage-ofcorhpletion method for financial accounting purposes. The income to be
recognized each year is based on the proportion ofcostincurred to total estimated
costs for completing the conh-act. The financial statement presentations relating
to this contract at December 31,2011 is presented below:
Statement of Financial Position
PI5,000
Accounts receivable-construction billings
Wliat is the balance ofconstruction in progress account at the end ofthe 2010.
Percentage of
Completion Method
Zero Profit Method
a.
1,000,000
b.
c.
<L
900,000
1,000,000
2,700,000
900,000
900,000
1,000,000
1,800,000
Construction in progress
Less: contract billings
Cost of uncompleted contract in excess of billings
P50,000
47,000
3,000
Statement of Comprehensive Income
Income (before tax)on the contract
recognized in 2011
V !
The amount ofcash collected in 2011 and the initial gross profit on this contract
are:
10-7: The M & M Construction company began work on a contract in 2010 and
completed the contract in 2011. The total contract price was P4,200,000.
Information conceming the contract for 2010 and 2011 is as follows:
a.
2010
Costs incurred during year
Estimated costs to complete at end of year
Billings during year
Collections during year
PI0,000
P600,000
2,400,000
720,000
400,000
.
2011
b.
P3,150,000
c.
-0-
d.
Cash
Initial
Collected
Gross Profit
P32,000
P32,000
P60,000
P30,000
P800,000
P160,000
P750,000
P790,000
3,280,000
3,000,000
■■^1:
V'-
Chapter JO
418
10-9 through 10-12 are based on the following data:
Sin Construction Co.has used the cost-to-cost percentage-of-completion method
ofrecognizing revenue,Marc Sin assumed the presidency ofthe company after
the death ofhis father, Vincent.In reviewing the records,Marc finds the following
information regarding a recently completed building projectfor which the total
Long Term Construction Contracts
419
10-13: Dwayne Company recognizes construction revenue and costs using the
percentage of completion method. During 2010, a single long-term project
begun which continued through 2011. Information on the project follows:
2010
contract was P2,000,000.
P200,000
210,000
244,000
200,000
Accounts receivable
Gross profit(loss)
Cost incurred each year
2009
2010
2011
P40,000
360,000
P140,000
P(20,000)
?
820,000
Marc wants to know how effectively the company operated during the three(3)
years on this project and,since the information is not complete,has asked for
answers to the following questions:
40-9: How much cost was incurred in 2010?
P660,000
b. P600,000
c. P560,000
d. P500,000
a.
10-10: Wftiat percentage of the project was completed by the end of 2010?
a.
Constmction costs
Constmction in progress
Partial billings on contract
60%
c.
55%
d.
79%
P600,000
384,000
728,000
840,000
What is the gross profit recognized from this long-term constinction contract?
a.
b.
c.
d.
2010
2011
P44,000
P44,000
P34,000
P34,000
P456,000
P200,000
P256,000
PI00,000
10-14: On January 2,2011, Angel Construction Company entered into a contract to
construct two projects. The following data relates to the construction period:
65%
b.
2011
Contract price
Costs incurred during 2011
Estimated cost to complete
Billings to customers
Project 1
Project 2
P420,0G0
240,000
120,000
150,000
P300,000
280,000
70,000
270,000
10-11: What was the total estimated gross profit on the project by the end of 2010?
f-
'■
a.
b.
c.
d.
P300,000
P180,000
P250,000
P350,000
10-12: What was the estimated cost of complete the project at the end of 2010?
a.
b.
c.
d.
P660,000
P500,000
P650,000
P680,000
What amount of gross profit should Angel Constmction Company report in his
2011 statement of comprehensive income under the following methods?
Percentage of
Completion Method
a.
b.
c.
d.
P
0
P(50,000)
P(10,000)
P(10,000)
Zero Profit Method
P(40,000)
P(10,000)
P
0
P(50,000)
Chapter 10
420
Long Term Construction Contracts
421
■ 1^, .
10-15: On April 1,2009,Chacha Construction Company,enters into a contract for
the construction ofa building which is estimated to cost Chacha P3,120,000.
Chacha is billing its client at cost plus 20 percent and uses the percentage of
10-17: Jasmin Corporation began constmction work in 2011 for a project with a
contract price ofP8,000,000. Jasmin Corporation uses the percentage-ofcompletion method.The financial statements for 2011 relating to the contract
shows the following:
completion method ofaccounting for constmction contracts. The following data
are obtained on the project:
P500,000
1,600,000
1,500,000
200,000
Accounts receivable
CostIncurred
Each Year
2009
2010
2011
Estimated Costs
Construction in progress
Progress billings to date
Gross profit earned in 2011
to Complete
P 546,000
998,400
1,575,600
P2,054,000
1,315,600
Compute the following for the year 2011:
I
What is the gross profit ofChacha for 2011?
a.
a. P146,640
b. P477,360
c. P237,160
b.
c.
d.
Cash
Collections
Cost Incurred
to date
PI,000,000
P7,500,000
P1,000,000
PI,400,000
PI,400,000
PI,400,000
Pl,600,000
PI,600,000
(L P624,000
10-18: Villa Builders is in the businessofconstmcting apartment buildings.Two buildings
were in progress at the beginning of2011.The status ofthese buildings at the
beginning ofthe year were as follows:
10-16: Pirma Company,is a contractorfor the constmction oflarge office buildings. At
the beginning of2011,one building is in progress.The following data described
the status ofthe building at the beginning ofthe year.
Contract price
Costs incurred to January 1,2011 (including P50,000
P6,300,000
Contract price
Cost incurred to 1/1/011
worth of materials stored at the site to be used
Estimated costs to complete
in 2012 to complete the project)
Estimated costs to complete, January 1,2011
Apartment A
Apartment B
PI,620,000
600,000
840,000
P2,520,000
1,560,000
690,000
1,425,000
4,075,000
During 2011,the following costs were incurred:
During 2011,the following data were obtained with respectto the same building:
Apartment A (estimated costs to complete
asofl2/31/011,P240,000)
Apartment B(Job completed)
P3,040,000
1,960,000
Cost incurred to date
Cost to complete,December 31,2011
How much is the realized gross profit in 2011,ifVilla uses the:
What is the realized gross profit(loss)to be reported for the year 2011 using the
percentage ofcompletion?
.f
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■
a.
b.
c.
d.
P(300,000)
P(500,000)
P 580,000
P 577,400
-
•
Percentage of
Completion Method
a.
P 97,800
b.
P 97,800
c.
P210,000
d.
P 97,800
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k. • r . ^
:
P600,000
750,000
, ^:i
Zero Profit Method
PI87,200
• r,:
0
P210,000
P210,000
Long Term Construction Contracts
Chapter 10
422.
10-19: On May 1, 2009,Nueva Builders Company obtained a contract to build a
No. 10-20: Continued
coliseum. The coliseum was to built at a total costs of P5,000,000 and is
What is the balance ofthe Construction in Progress account(net ofprogress
billings)at the end ofeach year?
scheduled for completion by May 1,2011. The contract contains a penalty
clause to the effect that the other party was to deduct PI0,000 from the
P6,000,000 contract price for each week ofdelay. Completion was delayed
five weeks.Below are data pertaining to the construction period:
a.
b.
2010
2009
c.
2011
d.
P500,000
2,000,000
400,000
Costs incurred to date
Estimated costs to complete
Cash collected
P2,340,000
260,000
4,350,000
423
2010
2008
2009
P880,000
P200,000
P200,000
P650,000
P750,000
P750,000
P(100,000)
P
0
P
P
0
P
0
0
P
0
P2,650,000
—
10-21: Yokomo Construction Company was awarded a contract to construct a new
2,975,000
Using the percentage-of-completion method,what is the realized gross profit
(loss)for the year ended December 31,2011?
sewage system for MWSS for a price ofP3,250,000. The original estimate of
the cost to complete the contract was P3,000,000. The contract provides for
periodic billings. A final billing equal to 25% ofthe contract price is to be made
1
i)
upon final inspection and acceptance by the MWSS.
a. P325,000
b. P(35,000)
c. P(10,000)
d. P240,000
t
•i
The construction record was as follows:
ri.
h ^
10-20: The Jawo Construction Company was the low bidder ofan office building
construction contract. The contract bid was P6,000,000, with an estimated
cost to complete the project ofP5,300,000.The contract was 33 months starting
January 1,2008.The company uses percentage-of-completion,cost-to-cost
method ofestimating profits. A record ofconstruction activities for the year
Progress
Billings
Actual cost
V
P3,400,000
2,550,000
200,000
P3,200,000
2,000,000
800,000
2011
0
0
PI,075,000
2,625,000
3,425,000
PI,612,500
750,000
-0-
Whatis the balance ofthe Construction in Progress account,net ofbillings in the
a. P875,000 current liability.
b. Pl,362,500 current asset.
c. P287,500 current asset.
d. P62,500 current asset.
Cash
2008
2009
2010
Estimated cost to complete
2010 Statement ofFinancial Position?
Receipts
Current Year
December 31,2009
December 31,2010
December 31,2011
2008 to 2011 follows:
Year
Cost to date
Date
A."
P3,000,000
2,000,000
600,000
400,000
10-22: The Tamiya Builders was recently awarded a P2,800,000 contract to construct
a shopping mallfor Rustan Inc.Tamiya Builders estimates it will take42 months
to complete the contract.The company uses the cost-to-cost method to estimate
profits. The following data are available for the year 2008 to 2011:
The estimated costto complete the contract at the end ofeach accounting period
Year
Actual cost each year
Estimated cost to complete
PI,300,000
660,000
480,000
340,000
P 1,360,000
780,000
'380,000
are:
2008
PI,600,000
2009
150,000
2010
0
2008
2009
2010
2011
'
. h
-0-
l.
••
r;-:y:
^ ^ ■;w"
Chapter 10
424
Long Term Construction Contracts
425
10-25: Jet Construction Company began operation on January 2,2011. During the
year, the company entered into a contract with Angel Company to construct a
manufacturing facility. At that time, Jet estimated that it would take five years to
complete the facility at a total cost of P1,800,000. The total contract price for
the construction of the facility is P2,500,000. During the year, the company
incurred P440,000 in construction costs related to the construction project.
The estimated cost to complete the contract is PI,560,000. Angel Company
No. 10-22: Continued
How much is the realized gross profit(loss)in 2010?
CL P(20,000)
b. P(62,918)
c. P 22,918
d. P(22,918)
was billed and paid 30% of the contract price subject to a 10% retention.
10-23: TheTollowing data pertains to Havaianas Buildere,Inc.which uses the percentage
ofcompletion method:
Project A
Project B
Contract price
P2,900,000
Cost incurred,2010
1,680,000
Estimated cost to complete,2010 1,120,000
Cost incurred, 2011
960,000
Estimated cost to complete,2011
-0-
P3,400,000
1,440,000
1,760,000
680,000
1,360,000
Project C
PI,700,000
320,000
960,000
863,000
117,000
Project D
Using the percentage of completion method, how much is the excess of
Construction in Progress over Contract Billings or Contract Billings over
i
Construction in Progress?
P2,000,000
-0-
a. P125,000 (current liability)
b. PI25,000 (current asset)
-0-
560,000
1,040,000
General and administrative expenses for 2010 and 2011 were PI20,000 for
each year.
PI35,000
PI35,000
c.
PI95,000
d. P369,000
a.
b.
construction of this prestigious tower.
P309,000
P489,000
P429,000
PI35,000
The details of the costs incurred to date in the first year are:
Depreciation of special plant and equipment
used in contracting to build the building
Marketing and selling costs to get the building
the percentage ofcompletion to recognize revenue. Total contract price was
P10,000,000. The following data are available from 2009 to 2011:
2009
P 200,000
1,800,000
2010
2011
P700,000
P( 100,000)
4,100,000
9
b.
c.
d.
5,000,000
10,000,000
in the city the right exposure
Total
P55,000,000
Total estimated costs to complete
P55,000,000
How much profit is to be recognized in the first year ofconstmction?
How much is the total estimated gross profit on the project by the end of2010?
PI,750,000
P2,250,000
PI,500,000
PI,166,667
P10,000,000
30,000,000
Site labor costs
Cost of construction material
10-24: Joys Constmction Company has used the cost-to-cost method ofcomputing
a.
P200,000 (current liability)
The company has signed a fixed price contract of P120,000,000 for the
2011
Realized gross profit(loss), current year
Cost incurred each year
P200,000 (current asset)
d.
10-26: Mega Constmct Inc. is executing a gigantic project of conti-acting the tallest
building in Quezon City. The project is expected to take three years to complete.
How much is tlie net income for the year ended.
2010
c.
0 J t
a. P 9,000,000
b. PI1,000,000
c. P 6,000,000
d. P 9,900,000
' •*': -
Chapter 10
426
10-27: On January 2, 2011, a fire gutted the office building of BM Construction
Company and destroyed all the files in the accountant's desk.The president of
the company has contacted you to help reconstruct the contract information.
427
Long Term Construction Contracts
L—. 10-29: Jing Construction Company started work on threejob sites during 2011. Any
costs incurred are expected to be recoverable. Data relating to the threejobs
are as follows:
The following data were taken from the salvaged files:
December 31
2009
2010
Site
Bicol
Architect's estimated cost to complete
PI2,450,000
Costs incurred
Percentage ofcompletion
Income recognized to date
P8,000,000
3,700,000
500,000
1,200,000
40%
20%o
25%
30%
10-28: Joemig Construction Company uses the percentage ofcompletion method of
accounting. The company started work on twojob sites during 2010. Data
Estimated Cost
Incurred
to Complete
P875,000
1,225,000
437,500
P656,250
175,000
175,000
P700,000
175,000
Collections
P875,000
175,0000
262,500
P875,000
175,000
175,000
What is the balance ofthe Constmction in Progress account on December 31,
2011 under tlie following methods?
a.
b.
c.
d.
Percentage of Completion
P26,250 duefrom
P26,250 current liability
P87,500 duefrom
P87,500 duefrom
Actual Cost
Estimated cost
Contract Price
Dec. 31, 2010
to complete
Zero Profit
P87,500 due to
P87,500 current asset
P26,250 due to
P26,250 current asset
P600,000
450,000
PI50,000
87,500
PI50,000
162,500
construction period many change orders are made to the original contract. All
ofthe changes were accepted by both the customer and the contractor. The
following schedule summarizes the change orders in 2011:
Cost incurred
in 2011
In 2011,Contract3 was started for a contract price ofP900,000. As ofDecember
31,2011 the following data are given:
Basic contract
Actual Cost
1/1/010 to 12/31/011
Contract 1
Contract 2
Contract 3
—
Billings
10-30: On January 2,2011,JJ Constmction Company ofMakati City enters into a
contract to constmct a 5-storey building for P40,000,000. During the
relating to the twojobs are as follows:
Contract 1
Contract 2
Aklan
Cost
Price
60%
What is the percentage ofcompletion in 2009 ofthis constmction contract?
a.
b.
c.
d.
Davao
Contract
P280,000
180,000
180,000
Estimated cost
to complete
P70,000
120,000
320,000
Change order #1
Change order #2
Change order #3
Change order #4
P8,000,000
50,000
-
300,000
125,000
Estimated costs
Contract
to complete
Price
P28,000,000
P40,000,000
50,000
50,000
300,000
125,000
-
600,000
100,000
Under the percentage of completion method, what is the gross profit to be
recognized on December 31,2011 (rounded to the nearest peso)?
What is the balance ofConstmction in Progress accoimton December 31,2011?
a.
b.
c.
d.
PI,074,000
PI,314,000
P 640,000
P 854,000
a.
b.
c.
d.
P907,830
P888,889
P909,063
P970,830
.
.■>
Chapter 10
428
10-31: On July 1,2011,North Construction Coiporation contracted to build an office
building for SM,Inc.for a total contract price ofP2,950,000. Estimated total
429
Long Term Construction Contracts
10-32: East Construction Company has two constiuction projects which commenced
in 2011. Data for the two projects are as follows:
contract costs is P2,600,000. Costs incurred to date related to the project are
as follows:
P200,000
150,000
55,000
Cost of direct materials used
Cost of direct labor,including supervision ofP50,000
Cost of indirect materials used
Cost incurred in obtaining the contract previously
70,000
120,000
written off
Depreciation of equipment used on the project
Payroll of design and technical department allocated to
Project 2
P420,000
120,000
60,000
125,000
120,000
10,000
P150,000
140,000
35,000
145,000
140,000
5,000
Contract price
Costs incurred during 2011
Estimated costs to complete
Progress billings during 2011
Collections during 2011
Expenses
1. Using the percentage of completion method, what is the net income (loss).
80,000
180,000
105,000
the contract
Insurance costs(2/3 for other project)
Costs of contracted research and development ,
Depreciation of idle equipment not used on a
• particular contract
Selling costs
General and administrative expenses specifically
for the year ended December 31,2011?
a.
b.
c.
d.
60,000
45,000
30,000
130,000
100,000
included under the term of the contract
Borrowing cost incurred during the construction period
Advances made to subcontractors
a. P125J95
b. P104,335
c. PlllyOSS
PI20,000
P150,000
P125,000
PI35,000
4 '. •
i M-
Under the zero profit method, what is the net inocme (loss) for the year
ended December 31,2011 ?
Using the percentage ofcompletion method,whatthe is the realized gross profit
to be reco^ized for 2011?
a.
P(30,000)
b.
P 30,000
c.
d.
P(25,000)
P 25,000
I
10-33: West Constructors has the following data relating to its jobs in progress:
(L P134,610
Project
Actual Cost
Estimated Cost
Contract Price
AA
PI 7,512,000
22,914,000
107,730,000
45,600,000
P350,240,000
30,552,000
143,640,000
91,200,000
P384,000,000
35,000,0000
175,000,000
99,400,000
BB
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Project 1
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Chapter 10
432
Long Term Construction Contracts
Problem 10-2:
433
Continued
PROBLEMS
Required: Prepare schedules to compute the amount of gross profit to the recognized
for the year ended December 31, 2011, and the amount to be shovm as "cost of
uncompleted contract in excess ofrelated billings" or "billings on uncompleted eontractsin excess of related costs" at December 31,2011, under eaeh ofthe following methods:
(a) Zero Profit Method
(b) Percentage-of-completion method.
Provide supporting computations.
Problem 10-1
The Builders Construction Company contracted to construct a building for P450,000.
Construction began in 2010 and the project was completed in 2011.Cost infonnation
for the project is as follows:
Costs incurred
Estimated costs to complete
2010
2011
P200,000
100,000
P120,000
Problem 10-3
PP Construction Company has contracted to build an offiee building. The construction
is scheduled to begin on January 1,2008, and the estimated time of completion is July
1,2011. The building cost is estimated to be P50,000,000 and this will be billed at
P55,000,000. The following data relate to the constmetion period.
—
Builders uses the percentage-of-completion method for recognizing income on the
contract.
Required:
Cost to date
(a) Determine the amount ofincome that the company should recognize in 2010 and
Estimated cost to complete
Progress billings to date
2011.
Cash collected to date
(b) Prove the amount ofincome you have computed in(a)by computing the total
income on the contract and comparing it with the incomes you have computed in
2008
2009
2010
2011
PI 5,000,000
35,000,000
7,000,000
P25,000,000
25,000,000
20,000,000
18,000,000
P35,000,000
15,000,000
35,000,000
30,000,000
P50,000,000
7,000,000
—
55,000,000
55,000,000
Required:
(a) Compute the estimated income for 2008,2009,2010,2011, assuming that the
percentage-of-completion method is used.
2010 and 2011.
(c) Prepare thejoumal entries required at the end ofeach year to recognize that year's
(b) Prepare the neeessary joumal entries for PP Constmction Company fc^ the year
income.
2010 and 2011.
Problem 10-2
naMHBtHHnu
R.Ramos Construction Company began operations on January 1,2011.During the
year,R.Ramos entered into a contract with LUE Company to constmcta manufacturing
facility. At that time,R.Ramos estimated that it would take five years to complete the
facility at a total cost ofP4,800,000.The total contract price for the constmction ofthe
LL Constmetion Company recognizes income under the percentage-of-completion
method on its long-tenn contracts. During 2009, the company entered in a fixed-price
contract to construct a bridge for P15,000,000. Contract costs incurred and estimated
costs to complete the bridge were:
facility is P5,800,000.
During 2011 R.Ramosincurred P1,250,000 in constmction costs related to the project.
Because ofrising material and labor costs,the estimated cost to complete the contract
at the end of2011 is P3,750,000.LUE was billed and paid 30% on the contract price
At Dec. 31,2009
AtDec.31,2010
At Dec. 31,2011
in accordance with the contract agreement.
%
•■I.J
Cumulative
Contract Costs
Incurred
to Complete
P 1,000,000
5,500,000
10,000,000
• P8,000,000
5,500,000
2,000,000
Estimated
Costs
I
IC..
Chapter 10
434
Long Term Construction Contracts
Problem 10-4: Continued
435
Problem 10-6: Continued
Required:
(a) Prepare a schedule to determine the estimated percentage ofcompletion at the end
ofeach year.(Round percentage to the nearest two decimal points.)
(b) Prepare a schedule to detemiine the amount ofincome to be recognized each year.
(c) Preparejoumal entries to record transactions for 2009 using the percentage-ofcompletion method,assuming that LL billed its clientP1,325,000 in 2009 which
P1,200,000 has been collected by the end ofthe year.
The estimated cost to complete the contract at the end ofeach accounting period is:
2009
P2,100,000
150,000
2010
-0-
2008
Required:
Problem 10-5
1. What is the revenue,cost,and gross profit recognized for each ofthe years 2008-
GG Mall builders was recently awarded a PI4,000,000 contract to constmcta shopping
mall for Rustan Inc. GG Mall Builders estimates it will take 42 months to complete the
2010 under the percentage-of-completion method?
2. Give thejoumal entries for each ofthe years 2008-2010 to record the information
contract. The company uses the cost-to-cost method to estimate profits.
from(l).
The following information details the actual and estimated costs for the year 2008-
'V
3. Give the joumal entries in 2011 to record any collections and to close out all
constmction accounts.
2011:
Actual Cost-
Estimated Cost
Year
Current Year
to Complete
2008
2009
2010
P6,500,000
3,300,000
2,400,000
1,700,000
P6,800,000
3,900,000
1,900,000
2011
Problem 10-7
The Lahar Constmction Corporation contracted with the City ofPampanga to constmct
a dam at a price ofPI6,000,000. Lahar expects to cam PI,520,000 on the contract.
The percentage-of-completion metliod is to be used and the completion stage is to be
determined by estimates made by the engineer. The following schedule summaries the
-0-
Required:
1. Compute the revenue,cost,and gross profit to be recognized for each ofthe years
2008-2011 under the percentage-of-completion method.
2. Give thejoumal entries for each ofthe years 2008-2011 to record the information
activities ofthe contract for the years 2009-2011:
from(l).
Estimated Cost
•
Year
Cost Incurred
to Complete
Engineer's
Estimate of
Completion
Billings on
Collections
Contract
on Billings
Problem 10-6
2009
The Power Constmction Company was the low bidder on a specialized equipment
contract. The contract bid was P6,000,000 with an estimated cost to complete the
project ofP5,300,000.The contract period was 33 months,beginning January 1,2008.
The company uses the cost-to-cost method to estimate profits.
2010
2011
2008
2009
2010
2011
Actual CostCurrent Year
Progress
Billings
P3,400,000
2,550,000
200,000
P3,200,000
2,000,000
800,000
-0-
-0-
P9,640,000
5,100,000
-0-
31%
58%
100%
P5,000,000
6,000,000
5,000,000
P4,500,000
5,400,00
6,100,000
Required:
A record ofconstruction activities for the years 2005-2008 follows:
Year
P4,600,000
4,500,000
5,250,000
1. Prepare a schedule showing the revenue,cost,and the gross profit eamed each
year under the percentage-of-completion method,using the engineer's estimate as
Cash
the measure ofcompletion to be applied to revenues and costs.
Receipts
2. Prepare alljoumal entries required to reflect the contract.
3. Preparejoumal entries for 2011,assuming the zero profit method is used.
4. How would thejoumal entries in(2)differ ifthe actual costs incurred were used to
calculate costfor the period instead ofthe engineer's estimate?
P3,000,000
2,000,000
600,000
400,000
.4.
Long Term Construction Contracts
Chapter 10
436
Problem 10-9
Problem 10-8
Smokey Mountain Inc.recently acquired the Triple A Builders Company.Triple A has
incomplete accounting records. On one particular project,only the information below is
Baker Construction Company was awarded a contract to constnict a new sewage
system in for MWSS for a price ofP6,500,000.The original estimate by Baker ofthe
cost to complete the contract was P6,000,000. The contract provides for periodic
progress billings. A final billing equal to 25% ofthe selling price is to be made upon fmal
inspection and acceptance by the MWSS Commission.
available.
Costs incuned during year
Estimated costs to complete
Recognize revenue
Estimated gross profit(loss)
Contract price
The construction record for the system was as follows:
Date
Dec.31,2009
,Dec.31,2010
Aug. 15,2011
437
Estimated cost to complete
Costs to date
P3,850,000
1,500,000
P2,150,000
5,250,000
6,850,000
2009
2010
20II
P200,000
450,000
220,000
P250,000
190,000
7
P
?
?
C
?
(10,000)
10,000
850,000
Because the information is incomplete,you are asked the following questions assuming
-
the percentage ofcompletion method is used,an output measure is used to estimate tlie
percentage ofcompletion,and revenue is recorded using the actual cost approach.
The construction was inspected on August 15,2009,January 15,2010,and October
1,2010,and progress billings equal to 25% ofthe selling price were made on each of
these dates. The sewage system was completed,and final inspection and acceptance
took on August 21,2011.
Required:
»■
1. How much gross profit should be reported in 2009?
Required:
2. How much revenue should be reported in 2010?
3. How much revenue should be reported in 2011?
(1) Using the percentage-of-cpmpletion method,compute the estimated income(loss)
that would be recognized during each year ofthe constmction period.
(2) Using the zero profit method,when would the income or loss on the project be
4.
5.
How much cost was incurred in 2011?
What are the total costs on the contract?
6. What would be the gross profit for 2010 ifthe cost-to-cost percentage-of-completion
method was used rather than the output measure? (Hint: Ignore the revenue amount
recognized?
shown for 2009 and gross profit amount reported for 2010.)
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Chapter 10
438
Problem 10-10
Luzon Construction Company is a contractorfor tire constmction oflarge office buildings.
Atthe beginning of2011,three buildings were in progress.The following data describe
the status ofthese buildings at the beginning ofthe year.
Chapter 11
Franchise Accounting
Contract Price
Building 1
Building 2
Building 3
P 4,000,000
9,000,000
13,150,000
Costs Incurred to
Estimated Cost to
January 1, 2011
Complete as ofJan. 1, 2011
P2,070,000
6,318,000
3,000,000
Pl,380,000
1,782,000
9,000,000
During 2011,the following costs were incurred;
Building 1:
P930,000 (estimated cost to complete as of December 31, 2011,
P750,000)
Building2: PI,800,000(job completed)
Building3: P7,400 (estimated cost to complete as of December 31, 2011,
P2,800,000)
Building4:
P800,000(contract price,P2,500,000;estimated cost to complete as of
December 31,2011,P1,200,000)
Required:
Franchising is a means ofdistributing goods or services. Today wefind a growing
number offranchising arrangement such as the service sponsor-retailer
arrangement. Included in this category are such industries and businesses as:
Ice Cream (Coney Island, Dairy Queen, andDreyers)
Food Drive Ins(McDonald's, Kentucky Fried Chicken, and Jollibee)
Restaurants (Pizza Hut, and Shakeys)
Others (Seven-Eleven stores)
A franchise generally involves the grantfrom one party (franchisor) to another
party (franchisee), the right to sell the granting party's goods or services. Each
party contributes resources.
Thefranchisor contributes his trade name, products, company's reputation and
trademarks. He also imparts his expertise and on continuing basis provides
guidance and duties on the manner in which the franchisee must operate his
establishment. Thefranchisee on the other hand,provides operating capital and
managerial operational resources requiredfor the operation ofthefranchised
1. Compute the total revenue,costs, and gross profit in 2011. Assume that Luzon
uses the cost-to-cost percentage-of-completion method,(round to two decimal
places for percentage completed.)
2. Compute the gross profit for 2011 ifLuzon uses the zero-profit method.
business.
The relation ofthese parties is covered by afranchise agreement which outlines
the rights and responsibilities ofeach part}!, describes the marketing practices to
befollowed, details the contribution ofeach party and sets certain standards oj
operating procedures which both parties agree to perform.
Franchising gives thefranchisor the opportunity to distribute his product and or
services with minimum investment in thefranchised outlet. Franchisee is able to
own his business, reapfinancial rewards and benefitfrom the agreement by way
ofassistance and guidancefrom thefranchisor. Thefranchisee, however, must
payfor these services, and must be willing to accept thefranchisor's control over
operations.
439
• •' f*c'f.
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i:Chapter 11
440
441
Franchise Accountin?
FRANCHISE FEES
Itis assumed thatsubstantial performance occur when the':^nchisee actually commence
Franchise agreement usually requires the franchisee to make payments,called the
operations ofthe francliise. Once substantial peiformance is achieved,revenue from
the initial fiunchise fee should be recognized using the following methods:
franchisefee to the franchisor in consideration for the reputation,skill,products,and
sendees contributed by the franchisor. There are two types offranchise fees,namely:
I. Initial Franchise Fee.This represents initial paymentfor establishing the franchise
a^eement,and for providing certain initial services associated with the agreement.Tlie
initial franchise fee ma}'
time.The initial services i
1. Accrual basis. This method is used when the initial franchise fee is collectible
over an extended period oftime and the collectibility ofthdunpaid portion of
the franchise fee is reasonably assured.
2. Installment method or Cost Recovery method. These methods should be
used in exceptional cases,that is, when the initial franchise fee is collectible over
an e.xtended period and the collectibility oftlie unpaid portion oftlie initial franchise
fee is uncertain. In this chapter only the installment method is to be discussed.
operations usually include the following;
a.
Assistance in site selection for the construction ofthe building.
b.
Supervision ofthe constmction activity, which involves obtaining financing,
e.
designing building,and supervising contractor.
Assistance in the acquisition ofsigns,fixtures,and equipment.
Provision ofbookkeeping and advisory services.
Provision ofemployee and management training.
f
Provision ofquality control.
c.
d.
Provision ofadvertising and promotion.
2. Continuing Franchise Fee.This represent continues payment to the franchisor
for providing specific future services,such as advertising,and for the continued use of
Illustration: To illustrate the application ofthe above procedures,assume the following
data:
Jan. 5, 2011: McDo,Inc. granted a franchise to Mr. A. De,Jesus to sell McDo
products.
The Initial franchise fee(IFF)is P10,000,000.'
Feb. to Nov.: McDo,Inc. rendered the following initial services under tlie franchise
contract:
Direct costs ofinitial services
intangible rights by the franchisee. These fees are usually based on the operations of
P2,000,000
Indirect costs ofservices
50,000
franchises.
December 1: The franchisee, Mr. A.De Jesus started business operations.
Revenue Recognition- Initial Franchise Fees
The following cases will illustrate the requiredjoumal entries to be recorded by the
The problem ofrecognizing revenue with regard to initial franchise fees,generally results
francliisor during 2011:
from two issue:(1)the point at which the fee is to be considered eamed; and(2)the
assurance ofcollectibiUty ofany unpaid portion ofthe fee,ifthe total initial franchise fee
is not paid in full.
Case 1:The initial franchise fee is paid in full when the agreement is signed
2011.The following entries would be made by the franclusor during the year 2011.
The following accoimting principle and procedures are to be used in the recognition of
Jan. 2,2011
1
10,000.000
10,000,000
Revenue from the initial franchise fee should be recognized on the consummation of
the transaction, which occurswvhen all material services or conditions ofthe sale
Feb. to Nov.:
2,000,000
50,000
Cash
occurs when the following conditions are met:
2,050,000
To record the payment offranchise costs.
a. The franchisor is not obligated in any way(trade practice,law,intent,or
agreement)to refund cash already received or forgive unpaid debt.
b. The initial services required ofthe franchisor by contract or otherwise have
been substantially performed.
Deferred cost affranchise revenue
Franchise expenses
have been substantiallyperformed. Substantial performance by the franchisor
2.
Cash
Deferred Reven uefrom IFF
To record the receipt ofthe IFF
revenue from the initial franchise fee:
December 31:
Adjusting Entries:
Cost offranchise revenue
2,000,000
2,000,000
c. No other material conditions or obligations exist.
Directfranchise costs ofinitial services rendered by the franchisor shall be deferred
Deferred cost offranchise revenue
To adjust cost offranchise revenue. .
until related revenue is recognized.These costs should notexceed anticipated related
revenue.Indirect costs that occur on a regular basis should be expensed when
Deferred revenuefrom IFF
incurred.
To recognizeftdly as revenue the initialfranchisefee.
10,000,000
Revenuefrom IFF
10,000,000
Chapter II
442
Case2.The initial franchise fee is payable as follows:P1,000,000 cash when the contract
is signed and the balance in five annual installments payable every December 31,
evidenced by a i2percentpromissory note. As discussed earlier,two methods can
be used to record franchise operations ifthe initial franchise is payable for an extended
period oftime. These methods are discussed below:
Method 1: Accrual Method.This method is used when the collectibility ofthe
note is reasonably assured.Underthis method the initial franchise fee is fully recognized
as revenue.The required entries are:
Franchise Accounting
Method 2:Installment method.This method is used when the collectibility ofthe
note is not reasonably assured.Under this method,revenue from the initial franchise fee
is recognized in proportion to cash collections. The revenue from the initial franchise fee
is determined by multiplying the collections during the year by the gross profit
rate. The pertinent entries are as follows:
2011
Jan. 5:
2011
Jan.2:
Cash
Notes receivable
Cash
Notes receivable
1,000,000
9,000,000
Deferred revenuefrom IFF
To record the initialfranchisefee.
Deferred cost offranchise revenue
Franchise expense
1,000,000
9,000,000
10.000,000
Deferred revenuefrom IFF
To record the initialfranchisefee.
10,000,000
Feb.- Nov.:
Feb.- Nov.:
443
2,000,000
50,000
Cash
Deferred cost offranchise revenue
Franchise expense
2,000,000
50,000
2,050,000
Cash
To record costs ofservices rendered.
2,050,000
To record costs ofservices rendered.
Dec.31:
Dec.31:
Cash
2,880,00j0
Notes receivable
Cost offranchise revenue
. 2,000,000
Deferred cost offranchise revenue
2,000,000
Deferred revenuefrom IFF
10,000,000
Revenuefrom IFF
To recognizedfully the initialfranchisefee
The Statement ofComprehensive Income ofthe franchisor for the year ended December
31,2011 will now appear as follows;
PI0,000,000
2,000,000
Gross profit
Expenses
8,000,000
50,000
Operating income
7,050,000
1,080,000
Interest income
Net income
P 8,130,000
1,800.000
1,080,000
Interest income
To record collection ofthefirst installment.
Adjusting Entries:
Cost offranchise revenue
Deferred cost offranchise revenue
To recognize cost offranchise revenue.
2,000,000
2,000,000
10,000,000
as revenue on December 31, since the collectibility
ofthe note is reasonable assured.
Revenue from franchise fee
Cost of franchise revenue
2,880,000
Notes receivable
1,800,000
1,080,000
Interest income (9,000,000 x 12%)
To record collection ofthefirst installment.
Adjusting Entries:
Cash
Deferred revenuefrom IFF
10,000,000
Cost offranchise revenue
Deferred grossprofitfrom IFF
To set up deferred gross profitfromfranchisefee.
Deferred grossprofitfrom IFF
2,240,000
Realized gross profitfrom IFF
To record realized gross profit computed asfollows:
Collections, excluding interest:
Down payment
First installment
Gross profit rate (P8,000,000/10,000,000)
Realized grossprofitfrom IFF
2,000,000
8,000,000
PI,000,000
1,800,000
2,240,000
P2,800,000
80%
P2,240,000
Chapter II
444
446
Franchise A ccounting
The Statement ofComprehensive Income ofthe fianchisor for the year ended December
31,2011 is presented below:
Adjusting Entries:
Unearned interest income
PI0,000,000
2,000,000
Revenue from franchise fee
Cost of franchise revenue
Deferred gross profit
Less deferred gross profit, end
8,000,000
5,760,000
Realized gross profit
Expenses
2,240,000'
50,000,.
Operating income
2,190,000
1,080,000
Interest income
Cost offranchise revenue
Deferred cost offranchise revenue
Deferred revenuefrom IFF
Cost offranchise revenue
Deferred gross profitfrom IFF
To defer gross profitfromfranchisefee.
Gross profit rate (P5,488,640 /P7,488,640)
1,000.000
9.000,000
Deferred revenuefrom IFF
To record the receipt ofinitialfranchisefee.
Computations:
Face value ofthe note
P9,000,000
Present value ofthe note
6,488,640
Unearned interest income
P2.511,360
Down payment
PI,000,000
2.511.360
7.488.640
2,000,000
5,488,640
1
73.29%
1,481,147
P2.02I,363
73.29%
Gross profit rate
P1.48I,147
Realized gross profitfrom IFF
Alternative Method:Ifthe collectibility ofthe notes receivable is not reasonably
assured,the cash basis ofrevenue recognition may also be used instead ofthe installment
method.This method is usually used when the direct costs ofthe initial services is
minimal. Under this method revenue is recognized as cash is received. Using the
data in Case 3 except that the direct cost ofinitial services is only P200,000,the
requiredjoumal entries are:
2011
Present value ofthe note
Adjusted sales value offranchise
Feb. to Nov.:
Deferred cost affranchise revenue
Franchise expense
Jan.5
6.488.640
Dec.31:
Cash
2,511,360
7,488,640
Deferred revenuefrom IFF
To record the initialfranchisefee.
2,000,000
50.000
2.050.000
Feb.- Nov.
Prepaidfranchise expense
Franchise expense
1.800.000
Cash
1.800.000
Notes receivable
1,000,000
9,000,000
Unearned interest income
P7,488,640
Cash
Cash
Notes receivable
To record costs ofservices rendered.
To record the collection ofthefirst installment.
•
t. ■
t x 'ftl.v
v.,
, l'
7,488,640
Downpayment
PI,000,000
First installment (PI,800,000-P778,637)1,021,363
reasonably assured,using the installment method ofrevenue recognition,the required
entries in the books ofthe franchisor during 2011 are:
Cash
2,000,000
1,481,147
Deferred grossprofitfrom IFF
Realized gross profitfrom IFF
To recognize realized gross profit computed asfollows:
Collections applying to principal:
P6,488,640(PI,800,000 x 3.6048). Assuming that the collectibility ofthe note is not
Notes receivable
Unearned interest income
2,000,000
To adjust cost offranchise revenue.
Case3:The initial franchise fee is payable as follows: cash ofP1,000,000 upon signing
ofthe contract and tlie balance in five equal installments every Deeember 31,evidenced
by a non-interest bearing note. Credit investigation indicates that the franchisee can
borrow money at 12% and the present value ofan ordinary annuity of 1 at 12% for 5
periods is 3.6048. Thus the present value offive payments ofP 1,800,000 would be
Jan.2,20II:
778,637
To adjust interest incomefor 2008(P6.488.640 x 12%)
P 3,070,000
Net income
778.637
Interest income
To record costs ofservices rendered.
200,000
50,000
250,000
r,
Franchise Accounting
Chapter II
446
Dec.31;
447
To record collection ofthefirst installment.
In the event that the continuing franchise fees appear to be insufficient to cover the costs
and reasonable profit ofthe franchisor for the continuing services required by the
finnchise agreement,a portion ofthe initial franchise fee,ifany,is deferred and amortized
Adjusting entries:
the costs ofthe continuing service plus a reasonable profit.
Cash
1.800.000
1.800.000
Notes receivable
over the term ofthe franchise. The amount deferred should be as sufficient to cover all
Unearned interest income
Revenue Recognition - Area Franchise Fees
778.637
Interest income
778.637
Accounting for revenue recognition from an area francliise is basically the same as that
for individual franchise fees.The only difference is thatsubstantial performance ofservices
To adjust interest income.
Deferred revenuefrom IFF
2.021.363
Revenuefrom IFF
To recognized revenuefrom the initialfranchisefee
equal to the total collections excluding interest.
Franchise expense
rendered by the franchisor is difficult to determine.The terms ofthe francliise agreement
must be used to determine when substantial performance has occurred.
2.021.363
To determine the revenue to be recognized from area franchise fees,the percentage-ofcompletion method is usually used. Under tliis method,it is necessary to deteimine tlie
cost ofservicing each individual franchise within the area and dividing this by the total
200.000
Prepaidfranchise expense
To adjust prepaid expenses.
200.000
costs ofall fiuncliises that are expected to be opened in the area.The resulting percentage
is applied to the total initial area franchise fee to detemiine the amount ofarea revenue
that is to be recognized.
Note:In the abovejournal entries,the direct costs ofservices rendered by the franchisor
was deferred by debiting Prepaid Franchise Expense account.This shall be charged to
Continuing Sale ofSupplies
fr^chise Expense account only upon recognition ofrevenue from franchise fee at the
end ofthe period.The authors favor this method because ofits simplicity.
As part ofthe continuing services provided in the franchise contract,franchisor usually
sells supplies to the franchisee.These sales are necessary to maintain uniformity in the
quahty ofthe supplies used by all ofthe franchisees.The sale is recorded by the franchisor
Revenue Recognition — Continuing Franchise Fees
in the usual manner.
Continuing franchise fee is usually collected from the franchisee at the end ofeach
mon& base on a certain percentage oftheir monthly sales. Continuing franchise fees are
recogmzed as revenue when actually earned and receivable from the franchisee. The
Tangible Assets Included in the Franchise Fee
Besides the initial services ofthe fianchisor,the initial fiancliise fee may include
ofspecific tangible property,such as inventory,signs,equipment,or real property. Tims,
required entry is as follows:
Cash
a portion ofthe initial franchise fee must be allocated to such tangible property at its fair
market value.The fair value ofthe tangible property is recognized as revenue when title
to such property passes to the franchisee,even though substantial performance has not
XXX
Revenuefrom cqntinuingfranchisefee(CFF)
XXX
occurred for other services included in the franchise agreement.
All direct and indirect costs related to continuing franchise fees are recognized as expense
by the following entry:
Option to Purchase
I i
Franchise expense
Cash
XXX
XXX
The franchise agreement may include a provision to the effect that the franchisor has an
option to purchase tlie franchise business.Iftlie option is granted at the time the francMse
agreementis signed,the initial franchise fee isto be deferred. When the option is exercised
and the fimichisor acquires the franchise business,the deferred revenue from the initial
franchise is treated as a reduction from the fitnchisor's investment.
Chapter II
448
Franchise Accounting
449
6. Continuing franchise fee is usually collected from the franchisee at the end ofeach
month. These fees are treated by the franchisor as:
MULTIPLE CHOICES- THEORETICAL
I4 Upon signing ofthe franchise contract,the franchisee is required to pay the:
a.
b.
c.
d.'
a. Continuing franchise fee.
b. Professional fee.
c. Initial franchise fee.
d Brokers fee.
Revenue
Deferred revenue
Otlier revenue
None ofthe above.
7. How is tlie recognition ofthe initial francliise fee affected ifcontinuing franchisefee
is less than continuing costs?
2. The initial franchise fee received by the franchisor should first be:
a. A portion ofthe initial fee is deferred and amortized over the tenn ofthe
f
finnchise.
a. Recognize as revenue
b. A loss is recognize.
c. An expense is recognize.
b. Deferred
c. Recognize as asset
d. Recognize as other income
d. None ofthe above.
8. When the initial franchise fee is not paid in full and the collectibility ofthe note for
the balance is not reasonably assured,the method to be used by franchisor to
3. What deterinines substantial performance for purposes ofrecognizing the initial
fiahchise fee?
recognize revenue from the initial fee is:
a.
b.
c.
d.
a. Installment metliod
When thefi:anchisee actually commence operation.
When the fi^chisee pays the initial fianchise fee in full.
When the fianchisee pays a cash down payment.
When the fianchisee signs the franchise contract.
b. Gross profit method
\
4. Whatconditions are to be metto determine fianchisor's services are substantially
performed?
a. The franchisor is not obligated in any way to refund cash already received or
forgive unpaid debt.
b. The initial services required ofthe franchisor by contract or otherwise have
been substantially performed.
c. No other material conditions or obligations exist.
d. All ofthe above.
5. Whatcosts ofinitial services are to be deferred by the franchisor?
1;.,
c. Accmal basis
d. Cost method
9. When the initial fianchise fee is not paid in full and the collectibility ofthe note for
the balance is reasonably assured,the method to be used by the franchisor to
recognize revenue from the initial franchise fee is:
a. Installment method
b. Gross profit method
c. Accmal method
d. Cash basis.
10. Pizza,Inc.grants a franchise to Mr.Manuelfor an initial franchise fee ofP1,000,000.
The agreement provides that Pizza,Inc. has the option within one year to acquire
firancliisee's business and it seems certain that Pizza,Inc. will exercise this option.
On Pizza,Inc. books,how should the initial franchise fee be recognized?
a. Deferred revenue to be amortize
a. Indirect costs.
b. Realized revenue
b. Direct costs.
c. Extraordinaiy revenue
d. Deferred revenue and as reduction from Pizza's investment when the option is
c. Period costs.
exercise.
d. Conversion costs.
%:
.
Chapter 11
450
Franchise Accounting
11-4:
MULTIPLE CHOICES-COMPUTATIONAL
11-1: On March 1,2011,Baliwag's Lechon,Inc.a franchisor,entered into franchise
agreement with Mr. Gordobe. The initial franchise fee is P500,000 ofwhich
P100,000 is payable in cash upon signing ofthe franchise agreement and the
balance evidence by a 12% promissory note. AsofDecember31,2011 the
c.
11-5: On January 2,2011,Pizza Inc. signed an agreement authorizing Ms.Janice to
operate as a fiunchisee for an initial franchise fee ofP5,000,000. Ofthis amount,
a. P500,000
P2,000,000 was received upon signing ofthe agreement and tlie balance evidence
by a 24% promissory note is due in three annual installments ofP1,000,000
each beginning December 31,2011. Ms.Janice started franchise operations
on September 1,2011 after Pizza Inc.rendered initial services required at total
costs ofP500,000. The first installment was collected on due date. The
b. PO
c. PI00,000
d. P400,000
11-2: On August 1,2011,KFC Company sells a franchise that requires an initial
franchise fee ofP5,000,000. On September 15,2011 the contract was signed
and the franchisee paid the initial franchise fee in full. On November 2,the
franchisee commenced operations after substantial services have rendered by
the franchisor at a cost ofP50,000. What is the net income from franchise fee
ofthe franchisor in its December 31,Statement ofComprehensive Income?
b.
P
c.
P4,950,000
P 50,000
d.
PO
d. PI00,000
to the franchisee. When Baliwag's Lechon,Inc. prepares its financial statements
on December 31,2011,the revenue from franchise fee to be reported is:
P5,000,000
Using the data in 11-3. Assuming the collectibility oft he note is not reasonably
assured,using the cash basis ofrevenue recognition, what is the revenue from
the initial franchise fee to be recognized by Andok's on December 31,2011?
a. PS00,000
b. P300,000
franchisor fails to render substantial services and none thus far had been rendered
a.
collectibility oftlie note is notreasonable assured.Using the installment method,
what is the realized gross profit to be recognized on December 31,2011?
a. P2,700,000
b. P4,500,000
c. P3,000,000
d. P5,000,000
0
11-6: On July 1,2011,Mr.Roxas signed an agreement to operate as a franchisee of
HotDog Inc.for an initial franchise fee ofPI,200,000. On the same date, Mr.
Roxas paid P400,000 and agree to pay the balance in four annual payments of
P200,000 beginning July J,2012. Mr.Roxas can borrow at 14% for a loan of
11-3: On July 1,2011,Ms.Tiam signed an agreement to operate as franchisee of
this type.Present and future value factors are as follows:
Andok's Lechon Manok,Inc.for an initial franchise fee ofP500,000. Ofthis
amount,P100,000 was paid upon signing ofthe franchise agi^eement and the
balance evidence by a 12% promissory note is payable in two annual payments
of P200,000 each beginning December 31, 2011. Ms. Tiam commenced
Present value of 1 at 14% for 4 periods
Future amount of 1 at 14% for 4 periods
Present value of an ordinary annuity of 1 at
14% for 4 periods
operations ofthe franchise on November 2,2011.The first installment was
collected on due date. Assuming the collectibility ofthe note is reasonably
assured, what is the revenue from franchise fee to be reported by Andok's in its
■U,. .
'December 31,2011 statement ofcomprehensive income?
interest income recorded by HotDog, Inc?
P200,000
P218,000
c. P100,000
c.
PO
d. P400,000
d.
P380,000
.
0.59
1.69
2.91
On July 1,2011, when the initial franchise fee is received, what is the uneamed
a.
b.
a. P500,000
b. PO
451
11-7:
Franchise Accounting
Chapter II
452
Using the data in 11-6. What is the deferred revenue from franchise fee to be
recorded on July 1,2011 by HotDog, Inc.?
a.
11-10: On December 31,2011, Arce Ice Cream, Inc. authorized Mr. Lee to operate
as a Franchise for an initial franchise fee of P3,000,000. Of this amount.
P1,200,000 was received upon signing of the contract, and the balance by a
non-interest bearing note, is due in three annual payments ofP600,000, beginning
December 31,2012. The present value on December 31,2011 of the three
P800,000
b. P582,000
c.
d.
11-8:
P400,000
P982,000
annual payments appropriately discounted is PI,263,900. The collectibility of
note is not reasonably assured. On December 31, 2011, Arce Ice Cream,
should record unearned interest income and deferred revenue from franchise
On January 4,2011, Selecta Ice Cream, Inc. signed an agreement authorizing
Ms. Jenny to operate as franchisee for an initial franchise fee of P500,000
fee of:
received when the agreement was signed. Ms. Jenny commenced operations
on July 1,2011, at which date all of the initial services required of Selecta Ice
Cream, Inc. hdd been performed at a cost ofP10,000. The franchise agreement
further provides that Ms. Jenny must pay monthly to Selecta Ice Cream, Inc., a
continuing franchise fee equal to 5% ofits monthly gross sales. Ms. Jenny reported
from July 1 to December 31,2011 gross sales of P400,000. On December 31,
2011, what is the net income from franchise fees to be reported by Selecta Ice
Unearned
Interest Income
b.
c.
d.
P500,000
b. P490,000
11-11:
c. P520,000
d. PS10,000
11-9:
On July 1,2011, Hot Company signed an agreement to operate as a Franchisee
ofDryer's Ice Cream Company for an initial franchise fee of PI0,000,000. On
I ■
Deferred Revenue
From Franchise Fee
P3,000,000
P2,463,900
P3,000,000
P2,463,000
P536,100
P536,100
P 63,900
P 63,900
a.
Cream, Inc.?
a.
453
On January 2,2011, Ms. Rufina got the franchise of Mario's, a known steak
house of upscale patronage. The franchise agreement provided a P1,000,000
initial fi^chise fee, payable as follows: P200,000 when the contract is signed
and the balance in four annual installments starting December 31,2011. The
cuiTent interest rate is 20%. The present value of an annuity of 1 for 4 perio^
is P2.5887. Any services to be rendered in the future is very minimal which will
the'same date. Hot Company paid P6,000,000 and agreed to pay the balance
evidence by a non-interest bearing note in four annual payments of P1,000,000,
beginning July 1,2012. The collectibility ofthe note is not reasonably assured.
Hot Cornpany can borrow at 14% for a loan of this type. The present value of
an annuity of 1 at 14% for 4 periods is P2.91. Dreyer's Company rendered
initial services so that Hot Company can start their operations. The total costs
payable monthly within the first ten days ofthe following month. The collectibility
of such services is P2,000,000. The franchisor also incurred indirect costs of
2011.
P50,000. The franchise agreement further requires the franchisee to pay
continumg fiunchise fee at 5% ofits monthly gross sales. The total sales reported
by Hot Company up to December 31,2011 is P5,000,000. Assuming the use
ohhe installment method of revenue recognition, what is the net income of
Dreyer's Ice Cream Company for the year ended December 31,2011 ?
a.
b.
c.
d.
not affect the recognition ofrevenue from the initial fr:anchise fee. The agreement
further provides a continuing fr:anchise fee of 5% on gross sales ofthe fr:Bncluse,
ofthe note is reasonably assured. The fiunchisee commenced operation on July
1,2011 and reported gross sales ofP2,000,000 from July to December 3 ,
What is the revenue from franchise fees to be reported by Mario's for the year
ended December 31,2011?
a.
b.
c.
d.
P4,630,000
PS,056,700
P4,880,000
P4,833,700
Pl,100,000
P 817,740
PI,000,000
P 300,000
> •
: '4 ,
\
L\
•i
V
^■. ...V'af '
. ^\L\
'4..;
. ■■ • 1• ''^
!
\
' . ^
Chapter II
454
11-12: On June 30,2011,Mr.Tuason entered into a franchise agreement with TM
Company to sell their products. The agreement provides for an initial franchise
fee ofP1,250,000,payable as follows:P350,000 cash to be paid upon signing
ofthe contract,and the balance in five equal annual payments every December
31,starting December 31,2011. Mr. Tuason signs 15% interest bearing note
for the balance.The agreement further provides that the franchisee must pay a
continuing franchise fee equal to 5% ofits month gross sales. On October 30,
the franchisor completed the initial services required in the contract at a costs of
P787,500 and incurred indirect costs ofP42,900.The franchisee commenced
business operations on November 2,2011. The gross sales reported to the
franchisor are; November sales,P121,000 and December sales,P147,500.
The first installment payment was made in due date.
Assuming the collectibility ofthe note is notreasonably assured,in the statement
ofcomprehensive income for the year ended December 31,2011,how much is
the net income ofTM Company?
a.
b.
c.
d.
P234,125
P301,625
P220,700
P200,825
455
11-14: On January 2,2011,Gino Services,Inc.signed an agreement authorizing Triple
8 Company to operate as a franchisee over a 20-year period for an initial
franchise fee ofP50,000 received when the agreement was signed. Triple 8
commenced operations on July 1,2011,at which date all ofthe initial services
required ofGino had been performed.The agreement also provides that Triple
8 must pay armually to Gino a continuing franchise fee equal to 5% oftheir
. gross sales. Triple 8 reported gross sales ofP400,000 for 2011.
For the year ended December 31,2011,how much should Gino Services,Inc.
record as revenue from franchise fees with respect to tlie Triple 8 franchise?
a.
b.
c.
d.
P70,000
P50,000
P45,000
P22,500
11-15: JG Company granted a franchise to Ms.Jenny. Jenny was to pay P100,000
initial franchise fee payable in five equal annual installments starting with the
paymentupon signing ofthe agreement.The franchisee wasto pay monthly 1%
11-13: On March 1,2011,Mr. Solis signed a franchise agreement with CG,Inc. CO
charged an initial fiunchise fee ofP255,000 from Mr.Solis. When the agreement
was signed,Mr. Solis paid P95,000 and signed a non-interest bearing note for
the balance. The note is to be paid in four annual installment each beginning
March 1,2012. Mr.Solis normal borrowing rate is 12%.The down paymentis
nonrefundable. Collection ofthe note is reasonably assured and the franchisor
has performed substantially all ofthe services required.Percent and future value
factors are as follows:
Present value ofPI at 12% for 4 periods
Future value ofPI at 12% for 4 periods
Present value ofan ordinary annuity ofPI at 12% for 4 periods
Franchise Accounting
0.6355
4.7793
3.0374
ofgross sales ofthe preceding month.Should the operation oftlie outlet prove
to be unprofitable,the franchise may be cancelled with whatever obligation
owing JG,in connection with the P100,000 franchise fee,waived.
The first year ofoperations generated a gross sales ofP500,000.For the first
year,JG Company earned franchise fee of:
a.
b.
c.
d.
P160,000
P 25,000
P 80,000
P100,000
How much revenue from the initial franchise fee will be reported by CG,Inc.on
its December 31,2011 statement ofcomprehensive income?
fl.
b.
c.
d.
P255,000
P121,496
P216,496
P196,680
.
,.U'
"f
V- '
'
Chapter II
456
Franchise Accounting
i-
11-16: On December 31,2011,Crispy Cream,Inc. authorized J. Guerrero to operate
11-18: On January 2, 2011, JJG Company signed an agreement to operate as a
franchisee ofFigaro,Inc.for an initial franchise fee ofP3,125,000 for 10 years.
Ofthis amount,40% was paid whent he agreement was signed and the balance
as a franchisee for an initial franchise fee ofPI,500,000. Of this amount,
P600,000 wasreceived upon signing the agreement and the balance,represented
by a note,is due in three annual payments,appropriately discounted is P720,000.
According to the agreement,the nonrefundable down payment represents a
fair measure ofthe services already performed by Crispy Cream; however,
substantial future services are required ofCrispy Cream.Collectibility ofthe
payable in four semi-annual payments beginning Jime 30,2011,JJG Company
signed a non-interest bearing note for the balance. JJG's credit rating indicates
that it can borrow money at 24 percent on the loan ofthis type. Substantial
services costing P802,500 have been rendered by Figaro Inc. The present
note is reasonable certain.
value ofan annuity ofPI at 12% for 4 periods is P3.04.
On December 31,2011, Crispy Cream would make the following entry to
record the receipt ofthe initial franchise fee:
a.
600,000
900,000
Cash
Notes receivable
1,500,000
an initial franchise fee ofP300,000.By December 31,2011,each fran^isee
had paid a nonrefundable P100,000 fee and signed a note to pay P100,()00
principal plus the marketrate ofinterest on December 31,2012,and December
1,320,000
180,000
31,2013.Experience indicates that one franchisee will default on the additional
payments.Services for the initial fee will be performed in 2012.
600,000
900,000
Notes receivable
Deferred revenuefrom IFF
Unearned interest income
\ ■
600,000
900,000
Cash
Notes receivable
Franchise revenue
What is tlie entry ofDoughnut to record the initial franchise fee on December
1,500,000
31,2011?
Jenna G has created a franchise based onthe hit movie Harry Potter. Manyjumped
on the HP bandwagon,and several franchise agreements have been signed. At
December2011 the following franchisees have open accounts with Jenna G.
Cash paid
Notes(face P500,000)
Unpaid
Services completed
Probability of collection
Continuing franchise fee
Period of refund
Cora
Ana
Bea
P100,000
P100,000
P100,000
PI00,000
200,000
455,000
275,000
350,000.
a.
25%
10%
95%
100%
Unlikely
Likely
Likely
l%ofNI
1/31/09
1%NI
1% of NI
12/31/08
l%ofNI
12/31/08
Cash
Notes receivable
c.
Cash
Notes receivable
d.
Cash
Notes receivable
Allowancefor bad debts
Franchise revenue
:5
■C
•j
A
6,300,000
6,300,000
2,100,000
4,200,000
200,000
6,100,000
Allowancefor bad debts
Unearnedfranchisefees
What is the total initial franchise fees eamed from these four franchisee at
•
2,100,000
4,200,000
Franchise revenue
December 31,2011?
(L P 600,000
b. PI,200,000
c. P 930,000
d. PI,800,000
•
2,100,000
4,200,000
Unearnedfranchisefees
. \
1
Cash
Notes receivable
Dora
Likely
2/28/09
PI,321,345.50
PI,069,031.50
PI,316,861.00
PI,338,307.00
11-19: Each ofDoughnut Company's twenty-one new franchisees contracted to pay
Unearned franchise fees
Cash
d.
a.
b.
c.
d.
180,000
600,000
720,000
Unearned franchise fees
b.
Ifthe collection ofthe note is not reasonable assured,the realized gross profit
for the year ended December 31,2011 is:
600,000 900,000'
Cash
Notes receivable
Unearned interest income
Franchise revenue
11-17:
457
2,100,000
4,200,000
200,000
6,100,000
Chapter 11
458
Franchise Accounting
11-20: Each ofthe Starbacks Company's 21 new franchise contracted to pay an initial
franchise fee ofP30,000. By December 31,20II,each franchisee had paid
non-refundable PI0,000 franchise fee and signed a note to pay PI0,000
principal plus the market rate ofinterest on December 31,2012,and December
31,2013.Experience indicates that one franchisee will default on the additional
payments. Services for initial fee will be performed in 2012.
11-22: On December 31,2011,Coffee Blends,Inc. signed an agreement authorizing
Ms.De Jesus to operate as a franchisee for an initial franchise fee ofP500,000.
Ofthis amount,P200,000 was received upon signing ofthe agreement and the
balance is due in tliree annual payments ofP100,000 each beginning December
31,2012.The agreement provides that the down payment(representing a fair
measure ofthe initial services rendered by Coffee Blends)is not refundable
although future services are yet to be performed. Ms.De Jesus'credit rating is
such that collection ofthe note is reasonably assured. The present value at
December 31,2011 ofthe three payments discounted at 14% isP232,200.
What is the amount ofthe unearned franchise fee(net)would Starbacks report
at December 31,2011?
a.
b.
c.
d.
459
P610,000
P400,000
P600,000
P630,000
What is the amount ofunearned franchise fee to be recorded by Coffee Blends,
Inc. on December 31,2011?
a. P232,200
b. PO
11-21: On January 2,2011,Jose Miguel gotthe franchise ofFigaro,*Inc.. The franchise
c. P300,000
d. P422,200
agreement provides a P500,000 initial franchise fee,payable P100,000 upon
signing ofthe franchise contract and the balance in four annual installments
11-23: On April 1,2011,KFC,Inc.entered into franchise agreement authorizing Ms.
Manalo to operate as a franchisee for an initial franchise fee ofPI,209,375
payable as follows:P590,625 cash to be paid upon sfgning ofthe franchise
starting December 31,2011. A present value using 12% as discount rate,the
four installments would approximate PI99,650.The fees once paid are not
refundable. The franchise may be cancelled subject to the provisions ofthe
agreement. Should there be unpaid franchise fees attributed to the balance of
contract and the balance in five equal annual payment every December 31
starting 2011.Ms. Manalo issued 12% interest bearing note for the balance.
The agreementfurther providesthatthefranchisee mustpay a continuing franchise
the initial franchise fee,it would become due and demandable upon cancellation.
Further,the franchisor is entitled to a5% continuing fee on gross sales payable
monthly within the first ten days ofthe following month.
fee equal to 5% ofits monthly gross sales.
■ Metro Bank guaranteed the note issued by Jose Miguel. The first year of
1. Ifthe collectability ofthe note receivable issued by Ms.Manalo is doubtful,
operations yielded gross sales of9 million.
how much is the net income on December 31,2011?
:/
On December 31,2011,how much is the eamed franchise fee?
a. P641,912.50
b. P608,175.00
a. P950,000
c. P687,475.00
b. PS50,000
c. P749,650
d. P650,000
d. P640,913.00
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Chapter II
460
Hn
Franchise A ccounting
461
Problem 11-3
Mario's Restaurant,Inc.franchises its name to different people in Metro Manila. The
Problem ll-l
On January 2,2011,Mr.A.Cion entered into a fi'anchise agreement with Jolibi,Inc. to
sell Jolibi products.The agreement provides ofan initial franchise fee ofP20,000,000,
payable as follows: P12,000,000 cash to be paid upon signing ofthe contract,and the
balance in four equal annual payments eveiy December 31. Mr. A. Cion signs 10%
interest-bearing note for the balance.The agreement furtlier provides that the franchisor
will assist the franchisee in locating the business site, designing and supervision in the
construction ofthe building,and training ofmanagementand employees.The agreement
also provides that the franchisee must pay a continuing franchise fees equal to 5% ofits
franchise agreement requires the franchisee to make an initial payment ofP1,200,000
and sign a P320,000,non-interest bearing note on the agreement date. The noteis to
be paid in annual payments ofP80,000,each beginning one year from the agreement
date. Current interest rates are to be 10%. The franchisor agrees to make market
studies,find a location,train the employees,and perform a few other relatively minor
services. The following transactions describe the relationship with Ms.Sunshine,a
firanchisee:
2010
monthly gross sales.
July I: Entered into a franchise agreement. .
On July 31,2011,the franchisor completed the initial services required in the contract
ata costs ofP2,000,000.Tlie franchisee commenced business operations on November
Sept. I: Completed a market study at a cost ofP50,000.
2,2011. The gross sales reported by the franchisee to the franchisor are: November
sales,P580,000; and December sales P720,000.
Required:Prepare all entries for 2011 in the books ofthe franchisor under the following
assumptions:
a. The collection ofthe note is reasonably assured.
b. The collection ofthe note is not reasonably assured.
Problem 11-2
Nov.15: Found suitable location. Service cost,P30,000.
I
2011
. •••
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Jan.10: Completed training program for employees,cost P50,000.
Feb. 1: Franchise outlet opened and commenced operations.
July 1: Received first annual payment.
Required:Preparejournal entries in the books ofMario's Restaurant,Inc.in 2010
and 2011 to record the above transactions including adjusting entries at December 31,
2011.
On January 5,2011,Ms.Nancy Lee signed an agreementto operate as a franehisee of
Street Pizza,Inc.for an initial franchise fee ofPI,600,000. Ofthis amount P600,000
was paid when the agreement was signed and the balance payable in five annual payments
ofP200,000 begirming December 31,2011. Ms.Lee si^ed a non-interest bearing
note for the balance. Ms.Lee's credit rating indicates that it can borrow money at20%
interest for a loan ofthis type. The present value ofan annuity ofPI at 20% for 5
periods is P2.9906. The contract includes a continuing franchise fees of5% ofthe
Triple G,Inc.sells franchises for fastfood outlets in different parts ofMindanao.One
such contract has been signed on January 10,2011. The agreement provides for an
initial franchise fee ofP6,000,000 by the franchisee at the signing ofthe contract. Tbe
franchisee's gross sales,to be collected monthly.
franchisor's initial services costs are P2,250,000,to be incurred umformly over the sw-
On November 25,2011,the franchisor substantially performed the initial services
are to be made by the franchisee,although there will be continuing franchise fees of
P180,000 per yearfor continuing services to be rendered by the fiunchisor.The normal
provided in the contract at a cost ofPI79,718.The franchisee commenced operations
on December 1, 2011. The gross sales of Ms. Lee for the month of December is
P80,000.
month period prior to tlie scheduled opening date ofJuly 15,2011.No future payments
return for thefonchisor on continuing operations involving other such frunchise outlets
is 10%.
Required:Prepare all entries on the books ofthe franchisor for 2011:
Assuming the collection ofthe note is reasonably assured.
b. Assuming the colleption ofthe note is not reasonably assured.
a.
Preparejournal entries on the books ofthe franchisor to record all transactions
through July 15,2011.Support your entries with the necessary computafions.
Chapter 11
462
Problem 11-5
Franchise Act unting
463
Generally le company's experience indicates that the continuing costs represent80%
market value. The market rate ofinterest for operations ofthis kind is
currently 1%.
oftheir fa
Ms.Jasmin Sy purchased a franchise from Goldilock,Inc. The franchise agreement
provides an initial franchise fee ofP4,500,000,payable as follows: PI,500,000 at the
date ofsigning,P2,000,000 three months after signing,and the balance one year after
.signing. The expected date ofsigning is January 2,2011. A continuing fee of2% of
gross sales is also to be paid to the franchisor. Total sales for the year reported by the
franchisee amounts to P2,000,000.
Required repare a schedule which presents tlie amounts and timing ofall income to
>
the fianch 'or over the life ofthe contract.
Problerll-7
Costs associated with the initial franchise fee are as follows:
Seven-El( en.Inc.is in the business ofselling small retail grocery outlets on a franchise
basis. Ms Jene Lim signed an agreement for such a franchise on January 12,2011 for
(a) Title to kitchen equipment,with a cost ofPI,500,000,is to be transferred to the
a term ofFcnty years. Tlie contract has the following provisions, which were agreed
franchisee on the day the agreementis signed.The fair market value oftlie equipment
between|e two parties:
.is PI,800,000.
(b) An additionalP500,000 for initial services are incurred on January 18,2011.
(a) An ir ial franchise fee ofP750,000 is to be paid in the following manner:P150,000
There are no associated continuing costs.
note T P600,000.The note is to be paid in five equal installments,each payable
■ on thpnniversary date ofthe opening.
(b) OftH initial franchise fee,a portion is for equipment and fixtures,to which title is
transfn-ed at signing ofthe agreement,and a portion is for inventory to be supplied
in ca:'at the beginning ofthe franchise and the balance is a non-interest-bearing
Required:
a. Prepare schedules in good from to determine the timing and amount ofrevenues
through December 31,2011.
b. Prepare alljoumal entries on the books ofthe franchisor to record the transactions
for the first year ofthe contract.
Problem 11-6
Max Fried Chicken,Inc. will sell a franchise to any franchisee under the following
agreement:
(a) A P2,500,000 initial franchise fee is to be made by the franchisee upon signing of
the franchise contract.
(b) The contract states that the franchisor will provide personnel for the opening ofthe
franchise and for a period ofsix months thereafter,during which time they agree to
train local personnel for takeover at the end ofthe period. The cost to the franchisor
ofthis program is estimated to be P700,000.
(c) Continuing franchise fees are to be 2% ofgross sales per year, while estimated
continuing costs are P200,000 per year for the first three years and P100,000 per
year for the remaining seven years ofthe contract.The yearly sales are estimated to
be PI,100,000 for the first five years P7,500,000 for the next three years, and
P4,500,000 for the remaining two years. The break-even point for an operation
like this is approximately P4,000,000 ofsales per year.
one|onth before the opening date ofJuly 1,2008. The cost ofequipment and
fixtjps is P50,000 and could be sold toyield a 20% gross profit ifsold on the open
marl^t- The retail value ofthe inventory is P80,000,which includes a 15% gross
profit
(c) Confauing fees are to be three-fourths ofone percent ofmonthly sales. Monthly
saleiar® expected to be P330,000 for the first four years,P450,000 for the next
12 Jars,and P500,000 for the last four years.
(d) Confaaing costs for tliis fi-anchise will be P3,000 per month for the entire contract
periJi- This amount represents the cost ofadvertisements,and supervisions. The
marjet value ofthese services is P4,000.
(e) InitiJ aosts ofservices will total P70,000,and will be incurred prior to the opening.
(f) The^anchisor has the option to discount the non-interest bearing note at any time
duriiiS the payment period. Normally,notes are discounted immediately,at rate of
io4
f
Requi,¥' Assuming that the opening occurs as scheduled, and that the note is
immediJ'®^y discounted,prepare the appropriate schedules to determine the timing and
nmounf' income to be recognized by Seven-Eleven,Inc. through December 31,
2011.
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