Accounting for
ACCCOUNTING FOR
PARTNERSHIP and CORPORATION
PARTNERSHIP
2014 edition
and
CORPORATION
GLORIA J. TOLENTINO-BAYSA, Ed. D
Certified Public Accountant
Fellow, Royal Institute of Singapore
Diplomate, Philippine Academy of Professionals in Business Education
ASAIHL Fellow, National University of Singapore
MBE, Polytechnic University of the Philippines
BSC-Accounting, Philippines College of Commence
Graduate School Professional Lecturer
Polytechnic University of the Philippines
2014 edition
Formerly
Vice-President for Finance
Assistant to the Vice-President for Academic Affairs
Dean, College of Accountancy and Law
Director, Budget Services
Polytechnic University of the Philippines
CPA Reviewer
Center for Review and Professional Development, Inc.
University of the East
MA. CONCEPCION Y. LUPISAN
Certified Public Accountant
Master of Science in Accountancy, De La Salle University
BSC-Accounting, Polytechnic University of the Philippines
Formerly
Dean, College of Business, Entrepreneurship and Accountancy
Miriam College
Gloria J. Tolentino-Baysa
Ma. Concepcion Yamat Lupisan
Special Lecturer
Polytechnic University of the Philippines
San Sebastian College
University of Santo Tomas
CPA Reviewer
Center for Review and Professional Development, Inc.
Miriam College
De La Salle University – Manila
TABLE OF CONTENTS
Chapter
1
2
3
4
5
Title
6
7
8
9
Review of the Accounting Process
Nature and Formation of a partnership
Partnership Operations
Partnership Dissolution
Change in Capital Structure by Withdrawal, Retirement, Death or Incapacity
of a Partner
Partnership Liquidation (Lump-Sum)
Installment Liquidation
Organization and Formation of a Corporation
Operations, Dividends, Book Value Per Share, and Earnings Per Share
10
11
12
Share Capital Transactions Subsequent to Original Issuance
Financial Reporting and Analysis
Introduction
Page
Chapter 1 – Review of the Accounting Process
DEFINITION and NATURE OF ACCOUNTING
CHAPTER 1
REVIEW OF THE ACCOUNTING PROCESS
LEARNING OBJECTIVES
1.
2.
3.
4.
5.
Understand the definition of accounting and identify the users of accounting information.
Identify and explain the steps in the accounting process.
Prepare adjusting entries and understand the rationale for their preparation.
Prepare closing entries and understand the rationale for their preparation.
Explain the advantages of preparing reversing entries and identify adjusting entries that may be
reversed.
Accounting is defined as a service activity. Its function is to provide quantitative information,
primarily financial in nature, about economic entities that is intended to be useful in making
economic decisions.
Accountants render services by providing information about economic entities that is measured
in terms of money. These entities are either profit-oriented (business entities or business
enterprises) or not-for-profit entities. Generally, all parties who have interest in an entity,
whether direct or indirect, are called stakeholders. These stakeholders who use accounting
information are grouped into two, namely:
1.
External users – they are groups or individuals who are not directly concerned with
the day-to-day operations of the entity but are indirectly related to the said entity. They
include creditors, investors, prospective creditors and investors, government and the
public. They make decisions that affect their relationship to the entity.
2.
Internal users – they are the management personnel in all levels within an entity who
are responsible for the planning and control of the operations and therefore, they have
access to the day-to-day operations of the entity. They make decisions that affect the
internal operations of the entity.
PREVIEW OF THE CHAPTER
ACCOUNTING PROCESS
(A Review)
Accounting and Users
Of Accounting
Information
•
•
•
Definition and nature
of accounting
Internal Users
External Users
Accounting Process
Adjusting Entries
•
•
•
•
•
•
•
•
•
•
•
Documentation
Journalizing
Posting
Preparation of trial balance
Compilation of data for
adjustments
Preparation of work sheet
Preparation of financial
statements
Preparation of adjusting and
closing entries
Preparation of post-closing
trial balance
Preparation of reversing
entries
•
Accruals
Deferrals Prepayments
Depreciation
Uncollectible accounts
Inventory
•
•
•
Income
Expenses
Drawing
•
•
•
Closing Entries
Reversing Entries
•
•
Accruals
Deferrals Prepayments
Generally, the reports provided by accountants are expressed and measured in financial or
money terms; these reports are called financial reports and are of various types. One type of
financial reports are the general-purpose financial statements. The Conceptual Framework for
Financial Reporting issued by the Financial Reporting Standards Council (FRSC) identifies
existing and potential investors, lenders and other creditors as the primary users of generalpurpose financial statements. Other users include regulators and members of the public other
than investors, lenders and other creditors. The following are some of the users of financial
information and the use of such information in the decision that they make.
1.
Investors – they are concerned with the risk inherent in, and return provided by their
investments. They need information to help them determine whether they should make
additional investment, hold or sell their investments. Shareholders (owners or
investors in a corporation) need information
2. Lenders – they are interested in information that enable them to determine whether
their loans, and the interest attaching to them, will be paid when due.
3. Suppliers and other trade creditors - they are interested in information that enable
them to determine whether amounts owing to them will be paid when due.
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Chapter 1 – Review of the Accounting Process
4. Employees – they are interested in the information about the stability and profitability
of their employers. They are also interested in information that will enable them to
assets the ability of their employers to provide renumeration, retirement benefits and
employment opportunities.
Debit
Increase in asset
Decrease in liability
Decrease in equity due to
•
withdrawal by owner/s
•
decrease in income
•
increase in expense
•
•
•
5. Customers – they are interested in information about the continuance of an entity,
especially when they have a long-term involvement with, or are dependent on the
entity.
•
•
•
Credit
Decrease in asset
Increase in liability
Increase in equity due to
•
additional investment by owner/s
•
increase in income
•
decrease in expense
THE ACCOUNTING CYCLE
6. Governments and their agencies – they are interested in the allocation of resources
Business
and therefore, the activities of entities. They also require information so that they can
regulate the activities of entities determine taxation policies and as the basis for
national income and similar statistics.
Transaction
7. Public – they are interested in information about the trends and recent developments
Preparation of reversing
entries
Documentation
in the prosperity of the entity and the range of its activities.
ACCOUNTING PROCESS
Accounting process refers to the procedures or series of steps undertaken to come up with the
information reported in the financial statements. The accounting process is also referred to as
the accounting cycle.
The accounting process is divided into two phases, namely: (1) the recording phase and (2) the
summarizing phase. These two phases and the steps under each phase are discussed in the
succeeding paragraphs.
•
•
Journalizing
General Journal
Special Journals
Preparation of post-closing
trial balance
•
•
Posting
General Ledger
Subsidiary ledgers
Journalizing and posting of
adjusting and closing
entries
RECORDING PHASE
The recording phase includes collecting information about economic transactions and the
recording of these transaction in the appropriate accounting records. A transaction is an
economic event that changes an asset, a liability, or an equity account balance; hence, it must be
recorded. Accounting records, on the other hand, include business documents, journals, and
ledgers.
Transactions are recorded in terms of debits and credits (double-entry system). Debit is the left
side of an account while credit is the right side of an account. Following are the rules of debits
and credits.
2|Page
Preparation of a trial
balance
•
•
Compilation of data for
adjustments
•
•
Preparation of financial
statements
Statement of Financial
Position (Balance Sheet)
Statement of Comprehensive
Income
Statement of Cash Flows
Statement of Changes in
Equity
Chapter 1 – Review of the Accounting Process
Key Points:
•
If a work sheet is not prepared, the adjusting entries must be journalized and posted before
the financial statements can be prepared. This is because the basis for the preparation of the
financial statements are the updated balances of the accounts in the general ledger.
•
The cycle is a continuing process and steps may overlap during an accounting period.
The recording phase is composed of the following steps:
1.
2.
Documentation – this is the process of preparing or receiving appropriate business
documents. Business documents are original source materials which serve as evidence of
transactions. They include official receipts, sales invoices, purchase invoices, credit
memoranda, and debit memoranda.
SUMMARIZING PHASE
The summarizing phase includes the steps necessary for the preparation of periodic summary
reports. This phase includes the following steps:
4.
Journalizing – this is the process of recording transactions for the first time in the
accounting books called journals. This is the reason why the journals are called books of
original entry. Transactions are recorded based on the documents prepared or received in
number (1) above.
The company may use a general journal and one or more special journals. The general
journal is the most flexible type of journal where almost types of transactions that are usual
and that occur frequently or on a repetitive basis the most common types of special journals
are the sales journal, purchases journal, cash receipts journal, and cash disbursements
journal.
3.
illustrate, let us assume that Bountiful Merchandising reports accounts receivable from
customers totaling to P2,500,000. This total amount of P2,500,000 is reflected in the
Accounts Receivable account in the general ledger. The names of customers and the amount
due from each of them are found in the subsidiary ledger, A general ledger account that has
a supporting subsidiary ledger is called a control account.
Posting – this is the process of transferring the recorded transactions in the journal to the
accounts in the ledger. A ledger is a group of related accounts and is called book if final
entry. The objective of posting is to classify the effects of transactions on specific asset,
liability, equity, income, and expenses accounts.
A company many maintain both a general ledger and subsidiary ledgers depending upon its
needs. The general ledger is the principal ledger which contains all the accounts that are
reported in the financial statements, namely: assets, liabilities, equity, income, and expenses.
It also includes contra and adjunct accounts with positive balances such as Accumulated
Depreciation (deducted from Property, Plant and Equipment). Discount on Notes Payable
(deducted from Notes Payable). Sales Discount (deducted from Sales), and Purchases
Discounts (deducted from Purchases). Adjunct accounts are accounts set up to record
additions to related accounts such as Freight-In (added to Purchases).
The subsidiary ledgers contain details of some general ledger account balances. For
example, the Accounts Receivable and Accounts Payable account balances are found in the
general ledger. The compositions of their balances are found in the subsidiary ledger. To
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Preparing a trial balance – this is the process of preparing a summary of the balances of
the accounts in the general ledger known as the trial balance. After all transactions are
posted, the balance of each account is determined. Asset, expense, and temporary capital
account such as Drawing have normal debit balances; liability, equity, and income accounts
have normal credit balances.
A trial balance is prepared to prove the equality of debits and credits but is does not indicate
the accuracy of work done. As discussed in a previous accounting subject, there are errors
in recording that will not cause inequality in the trial balance. An example of this is debiting
or crediting an incorrect account such as a debit to Accounts Receivable erroneously debited
to Noted Receivable. Another example is failure to record a transaction or recording the
same transaction twice. The preparation of trial balance is normally done in the work sheet.
5.
Compiling adjusting fata – this is the process of gathering and putting together various
data necessary to update the balances of certain accounts in the books of the company.
Adjustments based on compiles data are then recorded before the financial statements are
prepared. These adjustments are necessary so that income and expenses will be reported in
the period they are earned and incurred, respectively; hence, profit will not be misstated.
The most common types of adjusting data are the following:
a.
Accrued expense – this is an expense incurred but not yet paid as of the statements of
financial position (balance sheet_ date, such as interest accrued on notes payable.
Another example is accrued salaries of employees. An accrued expense is unpaid as of
the statement of financial position date but is matched against income or earnings for
the current period. Adjustment for accrued expense is recorded as follows:
Expense
xxx
Payable
xxx
Example 1 – The ABC Company has an outstanding 90-day, 12% note payable dated
December 1, 2014 amounting to P200,000. The interest is payable upon maturity of the
note. The company’s accounting period or financial year is the calendar year, that is,
Chapter 1 – Review of the Accounting Process
January 1 to December 31, 2014 (that is, December 1 to December 31). The adjusting
entry to record the accrued interest is as follows:
Interest Expense
2,000
Interest Payable
2,000
P200,000 x 12% x 30/360’ = P2,000
Example 2 – DEF Company pays salaries every Friday, the end of a five-day work week.
The total salaries for the week ending January 3, 2015 is P150,000.
In this case, the P150,000 salaries for the week ending January 3, 2015 is for the
services rendered by employees on December 30, December 31, January 1, January 2,
and January 3. Therefore, the company has accrued salaries for two (2) days as of
December 31, 2014. The adjusting entry to record the accrued salaries is as follows:
Salary Expense
60,000
Salaries Payable
60,000
P150,000 x 2/5 = P60,000
b.
c.
Accrued income – this is income earned but not yet received or collected as of the
statement of financial position (balance sheet) date, such as accrued interest on notes
receivable. An accrued income is not yet collected but is matched with expenses for the
current period. The adjusting entry to record accrued income is as follows:
Receivable
xxx
Income
xxx
period, the unexpired or unused portion of the asset is transferred to an asset account.
The comparative entries to record payment and subsequent adjustment at the end of
the accounting period under the two methods are presented on the next page.
1.
To record the initial payment of expense
ASSET METHOD
EXPENSE METHOD
Prepaid Expense
xxx
Expense
xxx
Cash
xxx
Cash
xxx
2.
To record adjustment at the end of the accounting period
ASSET METHOD
EXPENSE METHOD
Expense
xxx
Prepaid Expense
xxx
Prepaid Expense
xxx
Expense
xxx
(Amount recorded is the expired or
used portion of the prepayment)
(Amount recorded is the unexpired or unused portion of
the prepayment)
Example 4: On May 1, 2014, JKL Company paid insurance premium of P30,000 covering a period
of one year beginning on this date. The entries to record the payment on May 1 and the adjusting
entry on December 31 under the two methods are presented below:
ASSET METHOD
2014
May 1
Prepaid Insurance
Cash
30,000
Insurance Expense
Prepaid Insurance
P30,000 x 8/12= P20,000
20,000
30,000
Example 3 – GHI Company received a 3-month, 12% note dated December 1, 2014
amounting to P100,000. Interest is receivable upon maturity of the note.
Dec. 31
As of December 31, 2014, interest for one month (that is, December 1 to December 31)
is already earned but not yet collected. The adjusting entry to record the accrual of
interest income is as follows:
Interest Receivable
1,000
Interest Income
1,000
P100,000 x 12% x ½ = P1,000
The expired portion of the insurance premium is for the period May 1 to December 31, 2014, or a
period of eight (8) months.
Prepaid expense – this is an expense paid or acquired in advance such as insurance
premium. Other examples are rent paid in advance and office supplies purchased. The
adjustment relating to prepaid expense at the end of the accounting period depends on
the method used in recording the initial payment or acquisition.
There are two methods of recording prepayments, namely: the asset method and the
expense method. Under the asset method, the payment or purchase is initially debited
to an asset account. At the end of the accounting period, the expired or used portion of
the asset is transferred to an expense account. Under the expense method, the payment
or purchase is initially debited to an expense account. At the end of the accounting
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20,000
EXPENSE METHOD
2014
May 1
Dec. 31
Insurance Expense
Cash
30,000
Prepaid Insurance
Insurance Expense
P30,000 x 4/12 = P10,000
10,000
30,000
10,000
The unexpired portion of the insurance premium is 4 months; that is, 12 months less the expired
portion of eight (8) months.
Chapter 1 – Review of the Accounting Process
d.
Unearned/income – this is income already but not yet earned as of the statement of
financial position (balance sheet0 date, such as rental income collected in advance or
subscription received in advance. Unearned income is also known as deferred income.
Like prepaid expense, the adjustment for unearned income at the end of the accounting
period depends on how the initial receipt of cash is recorded.
The receipt of the advance payment may be recorded using the liability method or the
income method. Under the liability method, the collection is initially credited to a
liability account; at the end of the accounting period, the earned portion of the income
is transferred to an income account; at the end of the accounting period, the unearned
portion of the income is transferred to a liability account. The following are
comparative entries to record the receipt if cash and the adjustment at the end of the
accounting period under the two methods:
1.
To record the initial receipt of cash
LIABILITY METHOD
Cash
xxx
Unearned Income
xxx
INCOME METHOD
Cash
xxx
Income
xxx
2.
To record adjustment at the end of the accounting period
LIABILITY METHOD
INCOME METHOD
Unearned Income
xxx
Income
xxx
Income
xxx
Unearned Income
xxx
(Amount recorded is the earned
(Amount recorded is the unearned
Portion of the prepayment)
portion of the prepayment)
Example 5: On September 1, 2014, MNO Company received P240,000 representing
rental of an office space for one year beginning on this date, the entries to record the
receipt of payment on September 1 and the adjusting entry on December 31 under the
two methods are presented below:
Dec. 31 Unearned Rent
Rent Income
P240,000 x 4/12 = P80,000
240,000
240,000
80,000
80,000
The earned portion is the rent for the period September 1 to December 31 or four (4)
months.
5|Page
240,000
240,000
Dec. 31 Rent Income
Unearned Rent
P240,000 x 4/12 = P80,000
160,000
160,000
The unearned portion is the rent for the eight (8) months; that is, twelve (12) months less
the earned portion of four (4) months.
e.
Depreciation of property, plant and equipment and other cost allocation –
depreciation is defined in PAS 16 as the systematic allocation of the depreciable amount
of an item or property, plant and equipment over its useful life. Depreciable amount is
the cost of an asset, or other amounts substituted for cost, less its residual value. The
entry to record depreciation expense is as follows:
Depreciation Expense
Accumulated Depreciation
xxx
xxx
The depreciation expense for the period is determined using any of the acceptable
methods identified in PAS 16 – straight-line method, diminishing balance method, and
units of production method. The straight-line method will be used in the illustration
and problems in this chapter and in all the other chapters of this book. The other
methods will be discussed in higher accounting subjects. Under the straight-line
method, the annual depreciation expense is computed as follows:
𝑫𝒆𝒑𝒓𝒆𝒄𝒊𝒂𝒕𝒊𝒐𝒏 𝒆𝒙𝒑𝒆𝒏𝒔𝒆/𝒚𝒆𝒂𝒓 =
𝑪𝒐𝒔𝒕 − 𝑹𝒆𝒔𝒊𝒅𝒖𝒂𝒍 𝒗𝒂𝒍𝒖𝒆
𝑬𝒔𝒕𝒊𝒎𝒂𝒕𝒆𝒅 𝒖𝒔𝒆𝒇𝒖𝒍 𝒍𝒊𝒇𝒆 (𝒊𝒏 𝒚𝒆𝒂𝒓𝒔)
If the asset is used for less than a year, the proportionate expense should be calculated,
unless the company adopts a different policy such as providing half-year depreciation
in the year of acquisition of the asset.
LIABILITY METHOD
2014
Sept. 1 Cash
Unearned Rent
INCOME METHOD
2014
Sept. 1 Cash
Rent Income
The account “Accumulated Depreciation” is a contra asset account; it is reported in the
statement of financial position as a deduction from the related property, plant and
equipment account.
Other cost allocation includes amortization of intangible assets like franchise and
patents. This topic is being discussed in higher accounting subjects.
Chapter 1 – Review of the Accounting Process
Example 6: PQR Company acquired an office equipment on October 1, 2013 for
P310,000. The asset has an estimated useful life of 5 years and an estimated residual
value of P10,000. The entries to record depreciation expense in 2013 and 2014 are
presented on the next page.
2013
Dec. 31 Depreciation Expense
Accumulated Depreciation
(P310,000 – P10,000)/5 yrs. x 3/12
15,000
The account “Allowance for Uncollectible Accounts” is a contra asset account; it is
reported on the statement of financial position as a deduction from Accounts
Receivable.
Example 7: STU Company’s trial balance dated December 31, 2014, contains the
following information:
Accounts receivable
P 350,000 debit
Allowance for uncollectible accounts
2,000 credit
Sales
1,850,000 credit
15,000
Depreciation expense for 2013 is for three months that is, October 1 to December 31, 2013.
Estimated uncollectible accounts amounted to P6,050.
2014
Dec. 31 Depreciation Expense
Accumulated Depreciation
(P310,000 – P10,000)/5 yrs.
The entry to record uncollectible accounts expense follows:
Uncollectible Accounts Expense
Allowance for Uncollectible Accounts
60,000
60,000
Required allowance balance
Allowance balance before adjustment – credit
Uncollectible account expense for the period
Depreciation expense for 2014 is for one year or twelve (12) months.
f.
Uncollectible accounts – these represents customers’ accounts that may no longer be
collected or that may possibly become bad debts. PAS No. 39 provides that trade
accounts receivable should be reported in the statement of financial position at
amortized cost. Amortized costs is defined as the amount at which the receivable is
measured at the time it was first recognized minus any payments and minus any
reduction (directly through the use of an allowance account) for uncollectibility. The
entry to record estimated uncollectible account is as follows:
Uncollectible Accounts Expense
Allowance for Uncollectible Accounts
g.
4,050
4,050
P6,050
2,000
P4,050
Inventory – adjustment for inventory is necessary if the periodic inventory system is
used. Under the periodic inventory system, the company does not record the physical
movement of goods. Purchases of goods are recorded in the nominal account
“Purchases”. The reduction in inventory resulting from sale is not reflected in the books.
Thus, the balance of the Inventory account shown in the company’s trial balance
represents inventory at the beginning of the period. Because of this, adjusting entries
are necessary to reflect the inventory at the end of the period.
xxx
xxx
PAS No. 39 requires a careful assessment of the collectability of the receivables
(classified as financial assets). Several considerations have to be taken into account,
which will be discussed thoroughly in higher accounting subject. For purposes of
discussion in this book, the estimated uncollectible amount will be provided.
The amount of uncollectible accounts expense that will be reported in the income
statement is computed as follows:
Required allowance balance
P xxx
Allowance balance before adjustment
(+ debit balance/ - credit balance)
xxx
Uncollectible accounts expense for the period
P xxx
There are two methods of recording adjustments related to inventories. Under the first
method, two entries are prepared: (1) to transfer the beginning inventory balance to
the Income Summary account and (2) to establish ending inventory balance. The
entries are as follows:
1.
2.
To transfer beginning inventory balance to Income Summary
Income Summary
xxx
Inventory (or Merchandise Inventory)
xxx
To record ending inventory balance
Inventory (or Merchandise Inventory)
Income Summary
xxx
xxx
Under the second approach, a separate cost of goods sold account is set up and the
entry to record the adjustment is as follows:
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Chapter 1 – Review of the Accounting Process
Inventory (or Merchandise Inventory), end
Purchases Returns and Allowances
Purchases Discounts
Cost of Goods Sold
Inventory (or Merchandise Inventory), beg
Purchases
Freight-In
xxx
xxx
xxx
xxx
revalued amounts and gain (loss) from change in fair value of investments classified as
available for sale.
8.
xxx
xxx
xxx
The balance of the Cost of Goods Sold account is closed to Income Summary
as part of the normal closing entries.
6.
Preparing a work sheet/end-of-period spreadsheet – this step is optional but it facilitates
the preparation of the financial statements. A work sheet is a working paper which contains
the data in the trial balance, the adjustments complied in step 5, and the developed income
statement and statement of financial position data. Normally, four pairs of columns are
maintained to achieve the purpose by which the work sheet is prepared. The first pair of
amount columns is for the trial balance data; the second pair is for the adjustments; the third
pair is for the income statement data; and the fourth pair is for the statement of financial
position data. In some cases, another pair of columns for adjusted trial balance is added
following the adjustments columns and preceding the income statement columns. Working
papers are usually prepared by using a computer spreadsheet program such as Microsoft’s
Excel.
Adjusting and closing the books – the adjustments that were recorded in the work sheet
are now formally recorded in the general journal and posted to the accounts in the general
ledger. The balances of the nominal (temporary) accounts, which consist of income,
expense, and drawing accounts, are then closed to Income Summary account. The balance
of the Income Summary account is then transferred to the owner’s equity (capital) account.
A debit balance in the Income Summary account represents a loss while a credit balance
represents a profit. Lastly, the balance of the owner’s drawing account is closed to owner’s
equity (capital) account. When the closing process is completed, all nominal counts will have
zero balances.
Following are the po-forma closing entries prepared at the end of the accounting period:
1. To close the balances of income accounts
Revenue/Income
xxx
Income Summary
xxx
2.
3.
7.
Preparing the financial statements – after the work sheet is completed, the financial
statements are prepared. The data reported in the statements are taken from the completed
work sheet. However, if a work sheet is not prepared, the adjusting data must be journalized
and posted before the financial statements can be prepared. This is because the data
reported in the statements are taken from the updated balances of the accounts in the
general ledger. The financial statements are described as the end product of the accounting
process.
An entity may prepare a single statement of comprehensive income or two separate
statements – a statement of income and a statement of other comprehensive income. Other
comprehensive income includes items of unrealized gains and losses that are not reported
as part of profit or loss, such as revaluation surplus arising from reporting of plant assets at
7|Page
xxx
xxx
To close the balance of Income Summary account (credit balance)
Income Summary
xxx
Capital
xxx
To close the balance of Income Summary account (debit balance)
Capital
xxx
Income Summary
xxx
4.
PAS 1 provides that a complete set of financial statements shall consist of the following:
1. Statement of financial position (balance sheet)
2. Statement of comprehensive income
3. Statement of cash flows
4. Statement of changes in owner’s equity
5. Notes
To close the balance of expense accounts
Income Summary
Expenses
9.
To close the balance of the drawing account
Capital
Drawing
xxx
xxx
Preparing a post-closing trial balance – the step is done after all the balances of nominal
accounts have been closed, that is, their balances were reduced to zero. Therefore, a postclosing trial balance contains only the real accounts (assets, liabilities, and equity); the
balances of these accounts are carried forward to the next accounting period. A post-closing
trial balance is prepared to check the equality of debits and credits after journalizing and
posting the closing entries.
Chapter 1 – Review of the Accounting Process
10. Reversing the accounts – certain adjusting entries recorded at the end of the accounting
period are reversed at the beginning of a new accounting period. These adjustments include
accrued expenses method and deferred revenues or income recorded under the revenue
method.
summarizing phases. The three steps under the recording phase are the following: (1)
preparing or receiving the appropriate documents (documentation), (2) journalizing the
transactions, and (3) posting the recorded transactions to the accounts in the ledger. The
seven (7) steps under the summarizing phase are as follows: (1) preparing the trial balance,
(2) compiling the data for adjustments, (3) preparing the work sheet (optional), (4)
preparing the financial statements, (5) adjusting and closing the books, (6) preparing a postclosing trial balance, and (7) preparing reversing entries for certain adjusting entries
(optional).
The preparation of reversing entries is optional but it facilitates the recording of expense
payments and revenue receipts in the new period in the usual manner. This means that
expense payments are recorded as a debit to an expense account and a credit to cash;
revenue receipts are recorded as a debit to cash and a credit to revenue or income account.
The adjustments that will be reversed if reversing entries are prepared and the pro-forma
reversing entries prepared at the beginning of a new accounting period are as follows:
1. Accrued Expense
Payable
xxx
Expense
xxx
2.
3.
4.
Accrued Income
Income
Receivable
xxx
Prepaid expense – expense method
Expense
Prepaid Expense
xxx
Deferred revenue or income – revenue method
Unearned Income
Income
xxx
Preparing adjusting entries and understand the rationale for preparing them.
Adjusting entries are prepared at the end of the accounting period to update the balances of
the accounts in the general ledger prior to the preparation of the financial statements. This
will enable the preparers of the financial statements to present fairly the financial position
and the results if operations of an entity during a given period because all transactions that
have affected the elements of the financial statements are recognized during the period.
Data that requires adjustments include the following: (1) accrued expense, (2) accrued
income, (3) prepaid expense, (4) unearned income, (5) depreciation and other cost
allocation, (6) uncollectible accounts receivable, and (7) inventory recorded using the
periodic inventory system.
4.
Prepare closing entries and understand the rationale for preparing them. Closing
entries are prepared for nominal accounts to reduce their balances to zero at the end of the
accounting period. Nominal accounts include the following: income accounts, expense
accounts, and temporary equity accounts, such as the drawing account of the owner in a sloe
proprietorship form a business organization.
5.
Explain the advantage of preparing the reversing entries and identify adjusting entries
that may be reversed. Reversing entries are prepared at the beginning of a new accounting
period for the following adjustments: (1) accrued expense, (2) accrued income, (3) prepaid
expenses recorded under the expense method and (4) unearned income recorded under the
income method. The preparation of reversing entries is optional but it facilitates the
recording of expense payment and revenue receipts during the new accounting period in
the usual manner.
xxx
xxx
xxx
REVIEW of the LEARNING OBJECTIVES
1.
Understand the definition of accounting and identify the users of accounting
information. Accounting is a service activity. Its function is to provide quantitative
information, primarily financial in nature, about economic entities, that is intended to be
useful in making economic decisions. The users of accounting information are grouped into
external users and internal users. The users of financial statements include present and
potential investors, employees, lender, suppliers and other trade creditors, customers,
governments and their agencies, and the public. They use the financial statements to make
informed decisions.
2.
Identify and explain the steps in the accounting process. The accounting process (also
called the accounting cycle) is composed of ten (10) steps, two of which are optional. These
steps are grouped into two phases, namely: (1) the recording phase, and (2) the
8|Page
3.
Chapter 1 – Review of the Accounting Process
GLOSSARY of ACCOUNTING TERMINOLOGIES
Accounting – a service activity. Its function is to provide quantitative information, primarily
financial in nature, about economic entities that is intended to be useful in making economic
decisions.
Accounting process – also known as accounting cycle. It includes a series of steps that are
performed to come up with the information reported in the financial statements.
Accrued expense – expense incurred but not yet paid as of the statement of financial position
date. Accrued expense is not paid but is matched against earnings for the current period.
Real accounts – also known as permanent accounts. They are accounts whose balances are
carried forward to the next accounting period and they include asset, liability, and equity
accounts.
Reversing entries – entries prepared at the beginning of a new accounting period to reverse
certain adjusting entries. They are prepared to facilitate the recording of expense payments and
revenue receipts during the new accounting period in the usual manner.
Special journals – journals used to record repetitive or frequently occurring transactions. They
include sales journal, purchase journal, cash receipts journal and cash disbursements journal.
Subsidiary ledger – a ledger that provides details of a general ledger account.
Accrued income – income earned but not yet received or collected as of the statement of financial
position date. Accrued revenue is uncollected but is matched against expense for the current
period.
Trial balance – a list of general ledger accounts with their corresponding balances. It proves the
equality of debits and credits.
Closing entries – entries prepared at the end of the accounting period that reduce the balances
of nominal accounts to zero.
Unearned income – also known as deferred income. This is income collected but not yet earned
or realized. Unearned income is collected but is not matched against expense for the current
period.
Depreciable amount – the cost of an item of property, plant and equipment, or other amount
substituted for cost, minus its residual value.
DISCUSSION QUESTIONS
General journal – the most flexible type of journal. All transactions may be recorded in the
general journal.
1.
What is accounting and what is its purpose? What is role in decision-making?
2.
Who are the users of accounting information and what is the relevance of the information
to the various types of decisions that they make? Who are the users of financial statements
and what are their information needs?
Journals – also known as books of original entry. They include both general journal and special
journals.
3.
What are the steps in the accounting process? What is the importance of each step and how
is it related to the other steps in the process?
Ledgers – also known as books of original entry. They include both general and subsidiary
ledgers.
4.
Why are journals called books of original entry?
5.
Distinguish between (a) a general journal and special journals, and (b) a general ledger and
subsidiary ledger.
6.
Does the trial balance prove the accuracy of accounting work done? Explain your answer.
7.
What are the common types of adjusting data? Why do we prepare adjusting entries?
General ledger – principal ledger that contains all the accounts reported in the financial
statements.
Nominal accounts – also known as temporary accounts. They are accounts whose balances are
reduced to zero at the end of the accounting period. Nominal accounts include revenue or income
accounts, expense accounts, and temporary equity accounts, such as drawing account.
Prepaid expense – expense paid or acquired in advance; expense paid or incurred but not yet
incurred or consumed Prepaid expense has been paid or acquired as of the statements of
financial position date but is not matched against earnings for the current period.
Post-closing trial balance – a trial balance prepared after closing the books. The post-closing
trial balance contains real accounts only.
9|Page
Chapter 1 – Review of the Accounting Process
8.
Why do accountants prepare work sheet even if its preparation is optional?
9.
Enumerate and discuss the components of a complete set of financial statements.
10. If reversing entries are made, which adjusting entries would be reversed?
MULTIPLE CHOICE QUESTIONS
MC 1-1 Adjusting entries normally involve
a. real accounts only
b. nominal accounts only
c. real and nominal accounts
d. neither real nor nominal account
MC 1-2 The balance in an unearned income account represents an amount
Earned
Collected
a.
Yes
Yes
b.
Yes
No
c.
No
No
d.
No
Yes
MC 1-3 An accrued expense can be best described as an amount
a. paid and matched with earnings for the current period
b. paid and not matched with earnings for the current period
c. not paid and matched with earnings for the current period
d. not paid and not matched with earnings for the current period
MC 1-4 Which of the following accounts could appear in an adjusting entry, closing entry and
reversing entry?
a. Accumulated depreciation
b. Depreciation Expense
c. Interest revenue
d. Salaries payable
MC 1-5 Closing entries ultimately will affect
a. Cash account
b. Owner’s capital account
c. Total assets
d. Total liabilities
10 | P a g e
MC 1-6 Probably, the last account to be listed on a post-closing trial balance would be
a. Income summary
b. Interest expense
c. Interest revenue
d. Owner’s capital
MC 1-7 Which of the following is not considered in computing net cost of purchases?
a. Purchases
b. Purchases returns and allowances
c. Transportation paid on goods purchased
d. Transportation paid on goods shipped to customers
MC 1-8 Which of the following accounts would appear on a worksheet for a merchandising
company uses the periodic inventory system?
a. Cost of goods sold
b. Income summary
c. Purchase returns & allowances
d. All of these
MC 1-9 After all adjusting entries are posted, the balances of all asset, liability, income and
expense accounts correspond exactly to the amounts in the
a. financial statements
b. post-closing trial balance
c. unadjusted trial balance
d. worksheet trial balance
MC 1-10 Insurance Expense account has a balance of P108,000 before adjustment. This amount
represents insurance premium for three months beginning November 1, 2014. Based
on these data, the prepaid insurance that should be reported in the December 31, 2014
statements of financial position is
a. P-0b. P 36,000
c. P 72,000
d. P108,000
MC 1-11 A P50,000 purchases on account was paid after the expiration of the 2% discount
period. They entry to record the payment would include
a. debit to accounts payable for P50,000
b. credit to accounts payable for P49,000
c. debit to purchases discount for P1,000
d. credit to cash for P49.000
Chapter 1 – Review of the Accounting Process
MC 1-12 Prior to adjustments, Supplies Expense account has a balance of P13,500. Adjustment
data gathered shows that supplies inventory on hand at year-end amounted to P5,500.
The amount of supplies to be shown in the income statement is
a. P-0b. P 5,500
c. P 8,000
d. P13,500
MC 1-13 Rent Income account has a credit balance of P240,000 composed of the following:
a. Rental for three months March 31, 204, P45,000
b. A credit of P195,000 representing advance rental payment for one year beginning
April 1, 2014
The December 31 adjusting entry will require a debit to Rent Income and a credit to
Unearned Rent of
a. P45,000
b. P48,750
c. P191,250
d. P195,000
MC 1-14 The Giveaway Enterprises reported an allowance for uncollectible accounts of P16,000
(credit) at December 31, 2014, before any adjustment. At the end of the year, the
company reports accounts receivable pf P80,000, 3% of which is estimated to be
uncollectible. The adjusting entry required at December 31, 2014 would be
a. Uncollectible Accounts Expense
8,000
Allowance for Uncollectible Accounts
8,000
b.
c.
d.
Uncollectible Accounts Expense
Allowance for Uncollectible Accounts
16,000
Uncollectible Accounts Expense
Allowance for Uncollectible Accounts
24,000
Uncollectible Accounts Expense
Allowance for Uncollectible Accounts
40,000
16,000
24,000
40,000
MC 1-15 Assuming that ending merchandise inventory was P10,000 less than the beginning
merchandise inventory of P125,000 and that the net purchases was P450,000, how
much was the cost of goods sold?
a. P0
b. P335,000
c. P460,000
d. P565,000
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Chapter 2 – Nature and Formation of a Partnership
CHAPTER 2
NATURE AND FORMATION OF A PARTNERSHIP
LEARNING OBJECTIVES
1.
2.
3.
4.
Define and discuss the nature of a partnership – its characteristics, advantages and disadvantages
Identify the different kinds of partnership and the classes of partners.
Discuss the requirements in the formation of a partnership.
Discuss accounting for partners’ initial investments in a partnership
PREVIEW OF THE CHAPTER
PARTNERSHIP
(Nature and Formation)
Nature of a
Partnership
•
•
•
Characteristics
Advantages
Disadvantages
Formation of a Partnership
•
•
•
•
Kinds of partnerships
Classes of partners
Articles of Co-Partnership
Registration requirements
1.
Mutual agency. Any partner may act as agent of the partnership in conducting its affairs.
2.
Unlimited liability. The personal assets (assets not contributed to the partnership) of any
partner may be used to satisfy the partnership creditors’ claims upon liquidation, if
partnership assets are not enough to settle the liabilities to outsiders.
3.
Limited life. A partnership may be dissolved at any time by action of the partners or by
operation of law.
4.
Mutual participation in profits. A partner has the right to share in partnership profits.
5.
Legal entity. A partnership has legal personality separate and distinct from that of each of
the partners.
6.
Co-ownership of contributed assets. Property contributed to the partnership are owned
by the partnership by virtue of its separate legal personality.
7.
Income tax. Partnerships, except general professional partnerships (i.e., those organized
for the exercise of profession like CPAs, lawyers, engineers, etc.) are subject to the 30%
income tax.
Accounting for
Partners’ Initial
Investments
•
•
•
Cash contributions
Non-cash asset
contributions
Contribution of
industry
DEFINITION
A partnership is defined in Article 1767 of the Civil Code of the Philippines as “a contract
whereby two or more persons bind themselves to contribute money, property, or industry into
a common fund with the intention of dividing profits among themselves.”
12 | P a g e
CHARACTERISTICS OF A PARTNERSHIP
ADVANTAGES OF A PARTNERSHIP
1.
It is easy and inexpensive to organize, as it is formed by a simple contract between two or
more persons.
2.
The unlimited liability of the partners makes it reliable from the point of view of creditors
3.
The combined personal credit of the partners offers better opportunity for obtaining
additional capital than does a sole proprietorship.
4.
The participation in the business by more than one person makes it possible for a closer
supervision of all the partnership activities.
5.
The direct gain to the partners is an incentive to give close attention to the business.
6.
The personal element in the characters of the partners is retained.
Chapter 2 – Nature and Formation of a Partnership
DISADVANTAGES OF A PARTNERSHIP
1.
The personal liability of a partner for firm debts deters many from investing capital in a
partnership.
2.
A partner may be subject to personal liability for the wrongful acts or omissions of his/her
associates.
3.
It is less stable because it can easily be dissolved.
4.
There is divided authority among the partners.
5.
There is constant likelihood of dissension and disagreement when each of the partners has
the same authority in the management of the firm.
KINDS OF PARTNERSHIPS
1.
b.
3.
4.
b.
5.
Universal partnership of all profit – one which comprises all that the partners
may acquire by their industry or work during the existence of the partnership and
the usufruct of movable or immovable property which each of the partners may
possess at the time of the institution of the contract.
b.
Partnership assets consists of assets acquired during the life of the partnership
and only the usufruct or use of assets contributed at the time of partnership
13 | P a g e
6.
Partnership with a fixed term – one in which the term or period for which the
partnership is to exist is agreed upon. It may also refer to a partnership formed for a
particular undertaking and upon the expiration of that terms or completion of the
particular undertaking the partnership is dissolved; unless continued by the partners.
As to representation to others
a. Ordinary partnership – one which actually exists among the partners and also as to
third persons.
All assets contributed to the partnership and subsequent acquisitions become
common partnership assets.
2.
Limited partnership – one formed by two or more persons having as members one or
more general partners and one or more limited partners, who as such are not bound by
the obligations of the partnership. The word “LIMITED” or “LTD” is added to the name
of the partnership to inform the public that it is a limited partnership.
As to duration
a. Partnership at will – one for which no term is specified and is not formed for a
particular undertaking or venture and which may be terminated any time by mutual
agreement of the partners or the will of one partner alone.
Non-trading partnership – one which is organized for the purpose of rendering
services.
As to object
a. Universal partnership
1. Universal partnership of all present property – one in which the partners
contribute, at the time of the constitution of the partnership, all the properties
which actually belong to each of them into a common fund with the intention of
dividing the same among themselves as well as the profits which they may acquire
therewith.
Particular partnership – one which has for its object determinate things, their use or
fruits, or a specific undertaking or the exercise of a profession or vocation.
As to liability of partners
a. General co-partnership – one consisting of general partners who are liable prorate
and sometimes solidarity with their separate property for a partnership liabilities.
b.
As to activity
A. Trading partnership – one whose main activity is the manufacture and sale or the
purchase and sale of goods.
B.
2.
formation. The original movable or immovable property contributed do not
become common partnership assets.
Partnership by estoppel – one which in reality is not partnership but is considered as
one only in relation to those who, by their conduct or omission are precluded to deny
or disprove the partnership’s existence.
As to legality of existence
a. De jure partnership – one which failed to comply with one or more od the legal
requirements for its establishment.
b.
De facto partnership – one which failed to comply with one or more of the legal
requirements for its establishment.
Chapter 2 – Nature and Formation of a Partnership
7.
As to publicity
a. Secret partnership – one wherein the existence of certain persons as partners is not
made known to the public by any of the partners.
b.
Open partnership – one wherein in the existence of certain persons as partners is
made known to the public by the members of the firm.
2.
Dormant partner – one who does not take active part in the management of the
business and is not known to the public as a partner; he is both a silent and a secret
partner.
PARTNERSHIP CONTRACT
As to contribution
a. Capitalist partner – one who contributes capital in cash (money) or property.
A partnership is created by an oral or a written agreement. Since partnerships are required to be
registered with the Office of the Securities and Exchange Commissions, it is necessary that the
agreement be in writing. In this case, misunderstandings and disputes among the partners
relative to the nature and terms of the contract may be avoided or minimized. The written
agreement between or among the partners governing the formation, operation and dissolution
of the partnership is referred to as the Articles of Co-Partnership.
b.
Industrial partner – one who contributes industry, labor, skill, talent or service
The Articles of Co-Partnership contains the following information:
c.
Capitalist-industrial partner – one who contributes cash, property, and industry.
1.
2.
CLASSES OF PARTNERS
1.
e.
As to liability
a. General partner – one whose liability to third persons extends to his separate (private)
property.
b.
Limited partner – one whose liability to third persons is limited only to the extent of
his capital contribution to the partnership.
3.
As to management
a. Managing partner – one who manages actively the business of the partnership
b. Silent partner – one who does not participate in the management of the partnership
affairs.
4.
Other classifications
a. Liquidating partner – one who takes charge of the winding up of partnership affairs
upon dissolution
b.
Nominal partner – one who is not really a partner, not being a party to the partnership
agreement, but is made liable as a partner for the protection of innocent third persons
c.
Ostensible partner – one who takes active part in the management of the firm and is
known to the public as a partner in the business
d.
Secret partner – one who takes active part in the management of the business but
whose connection with the partnership s concealed or unknown to the public.
14 | P a g e
The name of the partnership.
The names and addressed of the partners, classes of partners, stating whether the partner
is a general or a limited partner;
3. The effective date of the contract;
4. The purpose or purposes and principal office of the business;
5. The capital of the partnership stating the contributions of individuals partners, their
description and agreed values;
6. The rights and duties of each partner;
7. The manner of dividing net income or loss among the partners, including salary allowance
and interest on capital;
8. The conditions under which the partners may withdraw money or other assets for personal
use:
9. The manner of keeping the books of accounts;
10. The causes for dissolution; and
11. The provision for arbitration in settling disputes.
ORGANIZING A PARTNERSHIP
Before a partnership can operate legally, it has to comply first with certain registration
requirements which are summarized below:
Place of Registration
Securities and Exchange
Commission
Department of Trade and
Industry
Requirements for
Registration
Articles of Co-Partnership
Filled SEC registration form
Articles of Co-Partnership
SEC Certificate
Certificates Issued
SEC Certificate
Certificate of Registration of
Business Name (renewable
every five years)
Chapter 2 – Nature and Formation of a Partnership
City or Municipal Mayor’s
Office
Bureau of Internal Revenue
Certificate of Registration of
Business Name
SEC Registration
Articles of Co-Partnership
Social Security System
Filled SSS Application form
List of employees
SEC Registration
Employer Data Record or ERI
Form
Business Permit or License
Philippine Health Insurance
Corporation
Home Mutual Development
Fund (PAG-IBIG Fund)
SEC Registration
Articles of Co-Partnership
Mayor’s Permit and License to
Operate (renewable annually)
BIR Registration No.
Partnership’s Tax Identification
Number (TIN)
Registration of books, invoices,
and official receipts
SSS Certificate of Membership
SSS Employer ID Number
PhilHealth Employer Number
(PEN) and the Certificate of
Registration
PhilHealth Identification
Number (PIN) and Member
Data Record (MDR) for
concerned employees
HMDF Certificate of
Membership
HMDF Employer ID
Number
ACCOUNTING FOR PARTNERSHIPS
PLURALITY OF CAPITAL AND DRAWING ACCOUNTS. Accounting for a partnership differs
from other forms of business organizations with regard to capital accounts. In a partnership,
there should be as many capital accounts and as many drawing accounts as there are partners
(that is, one capital account and one drawing account is maintained for each partner).
1.
2.
3.
CAPITAL ACCOUNT
Debit
Credit
Permanent withdrawal (decrease) of
1. Original investment by a partner
capital
Share in partnership loss from
operations
2.
Debit balance of drawing account closed
to capital
3.
1.
2.
OPENING ENTRIES
Partners may contribute cash, property, or industry to the partnership. Appropriate asset
accounts are debited for the assets contributed and partners’ capital accounts are credited for
the total amount of assets contributed.
If the asset contributed is in the form of cash, it is recorded on the partnership books at face
value; If the asset contributed is in the form of property or non-cash asset, it is recorded at
agreed value, or in the absence of an agreement, at fair market value. When industry is
contributed into the partnership, a memorandum entry is prepared.
PARTNERSHIP FORMATION
FORMATION A: TWO OR MORE PERSONS FORM A PARTNERSHIP FOR THE FIRST TIME ALL
PARTNERS ARE NEW IN THE BUSINESS.
1.
Cash Contributions only (Capitalist Partners)
Abad and Alba agreed to form a partnership by contributing P600,000 cash each.
The entry to record the contributions in the partnership is:
Additional investment by a partner
Share in partnership profits from
operations to be added to capital
DRAWING ACCOUNT
Debit
Credit
Personal withdrawal by a partner
1. Share in partnership profits from operations
(this may be credited directly to the
partner’s capital account)
Share in partnership loss from operations
(this may be debited directly to the
partner’s capital account)
Cash
1,200,000
Abad, Capital
Alba Capital
2.
600,000
600,000
Cash and Non-cash Contributions (Capitalist Partners)
Abdon and Anton made the following contributions in the partnership:
15 | P a g e
Chapter 2 – Nature and Formation of a Partnership
Cash
Inventories
Equipment
Abdon
P 600,000
300,000
Anton
P 200,000
500,000
The entry to record the contributions of the partners follows:
Cash
Inventories
Equipment
Abdon, Capital
Anton, Capital
3.
Alternatively, a Capital Adjustment Account may also be used. The balance of this account, after
recording all the necessary adjustments, is transferred to the capital accounts.
800,000
300,000
500,000
900,000
700,000
Contributions in the form of Cash, Non-cash Assets, and Industry (Capitalist and Industrial
Partners)
Alma, Anna, and Adela formed a partnership. Alma contributed P600,000 cash, Anna
contributed P300,000 cash and equipment valued at P450,000; Adela is an industrial
partner to contribute her special skills and talents to the partnership. Profit or loss is to be
shared equally among the partners.
The entry to record the contributions of partners Alma and Anna follows:
Cash
Equipment
Alma, Capital
Anna, Capital
When individual set of books are kept by each partner or by any one of the partners, entries are
made on the separate books of the partners for adjustments to the recorded values. These
adjustments are made through the capital account. The capital account is credited for increases
in the value of net assets and is debited for decreases in the value of net assets.
900,000
450,000
600,000
750,000
The entry to record the contribution of partner Adela follows:
Adela is admitted into the partnership as an industrial partner to share one-third in the
partnership profit.
Illustrative Problem A: Aguilar and Angeles formed a partnership wherein Aguilar is to
contribute cash while Angeles is to transfer the assets and liabilities (net assets) of his business.
Account balances on the books of Angeles are as follows:
Debit
Credit
Cash
300,000
Accounts Receivable
450,000
Inventories
240,000
Accounts Payable
90,000
Angeles, Capital
900,000
The partners agreed on the following conditions:
1.
An allowance for uncollectible accounts of P22,000 is to be established.
2.
The inventories are to be valued at their current replacement cost pf P270,000.
3.
Prepaid expenses of P12,000 and accrued expenses of P5,000 are to be recognized.
4.
Angeles is to be credited for an amount equal to the net assets transferred.
5.
Aguilar is to contribute sufficient cash to have an equal interest in the partnership.
Assumption 1 – The partnership will use the books of the sole proprietor
The following procedures should be followed in accounting for this type of formation:
FORMATION B: A SOLE PROPRIETOR AND AN INDIVIDUAL FORM A PARTNERSHIP
Usually, one of the prospective partners is already engaged in business prior to the
formation of the partnership. In such a case, the partner may transfer his/her assets and
liabilities (net assets) to the partnership at agreed values or a fair market values if there are
no agreed values. The partnership may either: (1) use the books os the sole proprietor, or
(2) open a new set of books.
However, it is a common practice that a new set of books are opened for any new business
undertaking.
16 | P a g e
1.
2.
Adjust the books of the sole proprietor to bring account balances to agreed values.
Record the investment of the other partner.
The adjusting entries necessary upon partnership formation in order to arrive at the agreed
values, are recorded through the capital accounts of the partners. However, a capital adjustment
account may also be used and its balance is transferred to the capital accounts after all
adjustments in net assets are made.
The following rules will be helpful in making the necessary adjusting entries:
Debit asset and credit capital for increases in asset values
Chapter 2 – Nature and Formation of a Partnership
Debit capital and credit asset for decreases in asset values
Debit capital and credit liabilities for increases in liability balances
Debit liabilities and credit capital for decreases in liability balances
Expenses Payable
Angeles, Capital
To record the investment of Angeles
In the case of contra asset accounts, the following rules shall apply:
Debit contra asset account and credit capital for increases in asset values
Debit capital and credit contra asset account for decreases in asset values
b.
Hence, the information on the partnership of Aguilar and Angeles will be accounted for as
follows:
Alternatively, a compound entry may be prepared to record the investment of the two partners.
Step 1: Adjust the books of the sole proprietor Angeles to agreed values
a.
b.
c.
Angeles, Capital
Allowance for Uncollectible Accounts
22,000
Inventories
Angeles, Capital
30,000
Prepaid Expenses
Expenses Payable
Angeles, Capital
12,000
22,000
The balance of the capital account of Angeles after the three adjusting entries are posted is
P915,000 (P900,000 – P22,000 = P30,000 + 7,000).
Step 2: Record the investment of the other partner, Aguilar
Cash
Aguilar Capital
915,000
915,000
Assumption 2 – the partnership will open a new set of books
When a new set of books are opened for the partnership, the entry required on the new books of
the firm is the recording of the investment of the partners at agreed values. The opening entries
on the new partnership books using the data given in Illustrative Problem A are shown on the
next page.
a.
Cash
Accounts Receivable
Inventories
Prepaid Expenses
Allowance for Uncollectible Accounts
Accounts Payable
17 | P a g e
300,000
450,000
270,000
12,000
22,000
90,000
915,000
Angeles, Capital
Allowance for Uncollectible Accounts
22,000
Inventories
Angeles, Capital
30,000
c.
Prepaid Expenses
Expenses Payable
Angeles, Capital
12,000
d.
Angeles, Capital
Expenses Payable
Accounts Payable
Allowance for Uncollectible Accounts
Cash
Accounts Receivable
Inventories
To close the books of Angeles
b.
5,000
7,000
915,000
Entries to adjust and close the accounts are made in the separate books of the sole proprietor
but not in the new books of the partnership. Using the same illustrative problem, the adjusting
and closing entries on the books of Angeles are as follows:
a.
30,000
Cash
Aguilar, Capital
To record the investment of Aguilar
5,000
915,000
22,000
30,000
5,000
7,000
915,000
5,000
90,000
22,000
300,000
450,000
270,000
12,000
FORMATION C: TWO OR MORE SOLE PROPRIETORS FORM A PARTNERSHIP
When all the prospective partners are already in business, they made decide to transfer their
asset and liabilities (net assets) to the partnership at values agreed upon or at fair market values,
in the absence of agreed values. The partnership may either: (1) use the of one of the sole
proprietors, or (2) open a new set of books for the partnership. As mentioned earlier, however,
it is more common to open a new set of books for the partnership.
Illustrative Problem B: Antonio, owner of Antonio Variety Store, and Albano, owner of Albano
Trading decided to combine their businesses on July 1, 2014. Each is to transfer business assets
Chapter 2 – Nature and Formation of a Partnership
and liabilities (net assets) at agreed values. Statements of financial positions for the two
proprietors are presented below.
1.
2.
Antonio Variety Store
Statement of Financial Position
July 1, 2014
Assets
Cash
Accounts Receivable
P 72,000
Less Allowance for Uncollectible Accounts
6,000
Merchandise Inventory
Store Equipment
P 600,000
Less Accumulated Depreciation
30,000
Total Assets
Liabilities and Capital
Accounts Payable
Antonio, Capital
Total Liabilities and Capital
The partners agreed on the following conditions:
P
Partners’ capital in the partnership shall be equal to the adjusted net assets transferred.
Adjustments are to made as follows:
a. Allowance for Uncollectible Accounts shall be P7,200 and P30,000, respectively.
b. Inventors are to be valued at 120% of their recorded values.
c. Both store and delivery equipment are 5% depreciated.
120,000
Assumption 1 – The partnership will use the books of one of the sole proprietors
66,000
330,000
The procedures to be followed under his assumption are similar to the procedures discussed
under Formation B – Assumption 1. Thus, if the books of Albano Trading will be used by the
partnership, the following procedures will be followed:
570,000
P 1,086,000
132,000
954,000
P 1,086,000
1.
2.
Adjust the books of Albano Trading to bring the balances of accounts to agreed values
Record the investment of Antonio.
a.
Albano, Capital
Allowance for Uncollectible Accounts
P30,000 – P21,000 = P9,000
P
b.
Albano Trading
Statement of Financial Position
July 1, 2014
c.
Assets
Cash
P
30,000
Accounts Receivable
P 300,000
Less Allowance for Uncollectible Accounts
21,000
279,000
Merchandise Inventory
1,260,000
Delivery Equipment
P 480,000
Less Accumulated Depreciation
6,000
474,000
Total Assets
P 2,043,000
Liabilities and Capital
Accounts Payable
P 333,000
Albano, Capital
1.710,000
Total Liabilities and Capital
P 2,043,000
9,000
9,000
Merchandise Inventory
Albano, Capital
P1,260,000 x 20% = P252,000
252,000
252,000
Albano, Capital
Accumulated Depreciation – Delivery Equipment
Delivery Equipment
P480,000 x 5% = P24,000
P474,000 – (P480,000 x 95%) = P18,000
18,000
6,000
24,000
Step 2: Record the investment of Antonio
a.
Cash
Accounts Receivable
Merchandise Inventory (P330,000 x 120%)
Store Equipment (P600,000 x 95%)
Allowance for Uncollectible Accounts
Accounts Payable
Antonio, Capital
120,000
72,000
396,000
570,000
7,200
132,000
1,018,800
The adjustments on the account balances of Antonio Variety Store are not taken up on the books
of Albano Trading which are now the partnership books. Instead the following adjusting and
closing entries are prepared on the separate books of Antonio Variety Store:
18 | P a g e
Chapter 2 – Nature and Formation of a Partnership
a.
b.
c.
Antonio, Capital
Allowance for Uncollectible Accounts
P7,200 – P6,000 = P1,200
Merchandise Inventory
Antonio, Capital
P330,000 x 20% = P66,000
Allowance for Uncollectible Accounts
Accumulated Depreciation – Store Equipment
Accounts Payable
Antonio, Capital
Cash
Accounts Receivable
Merchandise Inventory
Store Inventory
1,200
1,200
66,000
66,000
7,200
30,000
132,000
1,0181800
A statement of financial position prepared immediately after the formation of the partnership of
Antonio and Albano is shown below.
120,000
72,000
396,000
600,000
Assumption 2: The partnership will use a new set of books
When a new set of books are opened for the partnership, entries are prepared to record the
investment of the partners at agreed valued. The opening entries on the new partnership books
using the data given in Illustrative Problem B are shown below:
a.
b.
Cash
Accounts Receivable
Merchandise Inventory (P330,000 x 120%)
Store Equipment (P600,000 x 95%)
Allowance for Uncollectible Accounts
Accounts Payable
Antonio, Capital
To record the investment of Antonio
120,000
72,000
396,000
570,000
Cash
Accounts Receivable
Merchandise Inventory (P1,260,000 x 120%)
Delivery equipment (P480,000 x 95%)
Allowance for Uncollectible Accounts
Accounts Payable
Albano, Capital
To record the investment of Albano
30,000
300,000
1,512,000
456,000
7,200
132,000
1,018,800
Antonio and Albano
Statement of Financial Position
July 1, 2014
Assets
Cash
Accounts Receivable
P 372,000
Less Allowance for Uncollectible Accounts
37,200
Merchandise Inventory
Store Equipment
Delivery Equipment
Total Assets
Liabilities and Capital
Accounts Payable
Antonio, Capital
Albano, Capital
Total Liabilities and Capital
P
150,000
334,800
1,908,000
570,000
456,000
P 3,418,800
P
465,000
1,018,800
1,935,000
P 3,418,800
Goodwill Resulting from the Acquisition of a Sole Proprietorship by a Partnership
30,000
333,000
1,935,000
The new partnership may prepare a separate entry for each partner’s contribution as shown
above or a compound entry that shows the contributions of all the partners.
19 | P a g e
Key Points. In the opening entry, the plant assets are recorded net of depreciation. The account
accumulated depreciation is not carried on the partnership books. The net amount, being the
agreed value, represents the cost of the plant assets to the partnership and such amount becomes
the basis for future depreciation by the partnership. On the other hand, both accounts receivable
and the corresponding allowance for uncollectible accounts are recorded on the partnership
books. The allowance for uncollectible accounts is carried on the specific accounts receivable
which are deemed worthless, such must be written off and removed permanently from the
outstanding accounts receivable.
The acquisition of a sole proprietorship/s by a partnership or formation of a partnership by a
sole proprietorship and an individual or among two or more sole proprietorships may involve
the recognition of goodwill. The goodwill shall be the result of the acquisition by the new
partnership of the net assets of the sole proprietorship/s. When the capital credit exceeds the
agreed value or fair value of the net assets acquired by the new partnership from the sole
proprietorship, the excess is treated as goodwill. The adjustment for the goodwill increases the
capital of the sole proprietor.
PFRS 3 does not allow the amortization of goodwill acquired in a combination and instead
requires the goodwill to be tested for impairment annually, or more frequently, if events or
changes in circumstances indicate that the asset might be impaired.
Chapter 2 – Nature and Formation of a Partnership
CAPITAL SHARE DIFFERENT FROM CAPITAL CONTRIBUTION
REVIEW of LEARNING OBJECTIVES
Prior to recording partners’ initial contributions to the partnership, the individual partners must
first agree not only on the valuation of the net asset contributions but also on their capital share.
The capital share of each partner is the percentage of equity that each of them will have in the
net assets of the newly formed partnership. Generally, the capital share of a partner is
proportionate to his/her capital contribution. However, in recognition of intangible factors such
as partners’ special expertise, established clientele or necessary business connections, partners
may agree to a division of capital that is not proportionate to their capital contributions. This
situation will give rise to provision of bonus on initial investments.
1.
Define and discuss the nature of a partnership – its characteristics, advantages, and
disadvantages. A partnership is a contract whereby two or more persons bind themselves
to contribute money, property, or industry into a common fund with the intention of
dividing profits among themselves. A partnership has the following characteristics: (1)
mutual agency; (2) unlimited liability; (3) limited life; (4) mutual participation in profits; (5)
legal entity; (6) co-ownership of contributed assets; and (7) subject to income tax. A
partnership is easy and inexpensive to organize, it is more reliable on the viewpoint of the
creditor, enabling it to obtain more capital because of the unlimited liability of the partners,
and there is close supervision of all its activities because of the direct gain to the partners of
a successful operation. However, a partnership is less stable and there is divided authority
among the partners. In addition, because of the characteristics of mutual agency, a partner
may be subject to personal liability for the wrongful acts or omissions of his associates.
2.
Identify the different kinds of partnerships and the classes of partners. Partnerships are
classified as (1) trading or nontrading; (2) universal or particular; (3) general or limited; (4)
partnership at will or with a fixed term; (5) ordinary or partnership by estoppel; (6) de jure
or de facto; and (7) secret or open. Partners are classified as (1) capitalist, industrial or
capitalist-industrial; (2) general or limited; (3) managing or silent; and (4) liquidating,
nominal, ostensible or secret.
3.
Discuss the requirements in the formation of a partnership. A partnership may be
organized by an oral or written agreement. The written agreement which governs the
formation, operation and dissolution of a partnership is known as the Articles of CoPartnership. A new partnership has to comply with certain registration requirements by the
different government agencies before it can operate legally.
4.
Discuss accounting for partners’ initial investments in a partnership. A partner may
contribute cash, non-cash assets, or industry into the partnership. Cash contribution is
credited to a partner’s capital account at face value; non-cash asset contribution is recorded
at agreed value or at fair market value, in the absence of agreed value; and a contribution in
the form of industry or service is recorded by means of memorandum entry.
Illustrative Problem C: Alfonso and Afable formed a partnership by contributing P500,000 and
P600,000, respectively. Journal entries to record the investment of the partners under two
approaches are as follows:
1.
Full investment approach
Cash
Alfonso, Capital
Afable, Capital
1,100,000
500,000
600,000
Assuming the partners agreed to have equal capital in the partnership, it is presumed that part
of the contribution of Afable is given as bonus to Alfonso in exchange for the intangible advantage
that Alfonso will be bringing to the partnership.
2.
Bonus approach
Cash
Alfonso, Capital
Afable, Capital
(P500,000 + P600,000)/2 = P550,000
1,100,000
550,000
550,000
LOAN RECEIVABLE AND LOAN PAYABLE. Aside from the contributions, partners may also
advance money to the partnership in the form of loan when the business is in need of additional
funds. Loans made by partners to the partnership, which are payable immediately by the
partnership and are usually with interest, are recorded in the account Loan Payable or Due to
Partners. This account is reported in the statement of financial position as a liability.
On the other hand, the partnership may advance money to partners, other than withdrawals, in
the form of loans. These loans, which are payable immediately by the partners and are usually
with interest, are recorded in the account Loan Receivable or Due from Partners. This account is
reported in the statement of financial position as an asset.
GLOSSARY of ACCOUNTING TERMINOLOGIES
Articles of Co-Partnership – a written agreement among the partners which governs the
formation, operation, and dissolution of the partnership.
Capitalist Partner – a partner who contributes capital in the form of money or property.
20 | P a g e
Chapter 2 – Nature and Formation of a Partnership
Capitalist Industrial Partner – a partner who contributes capital in the form of money or
property and industry.
Industrial Partner – a partner who contributes industry, labor, skill, talent or service.
Partnership – a contract whereby two or more persons bind themselves to contribute money,
property, or industry into a common fund with the intention of dividing profits among
themselves.
Statement of Financial Position – a statement that reports the assets, liabilities, and equity of
an entity and which shows its financial position or condition at a given date. It is also known as
balance sheet.
MULTIPLE CHOICE
MC 2-1 Which of the following best describes the attributes of a partnership?
a. Limited life of the business and limited liability of partners
b. Limited life of the business and unlimited liability of partners
c. Unlimited life of the business and limited liability of partners
d. Unlimited life of the business and unlimited liability of partners
MC 2-2 When a partner withdraws cash or other assets, the drawing account is
a. Debited
b. Credited
c. debited and credited
d. not affected
MC 2-3 All of the following affect a partner’s capital account except
a. additional investment
b. payment of a liability
c. partnership net income or loss
d. withdrawal of the partner
MC 2-4 Which of the following are kinds of partnerships according to liability of partners?
a. General co-partnership
b. Limited partnership
c. Industrial partnership
d. A and B only
MC 2-5 Which of the following relate to the capital share of a partner in a partnership?
a. The percentage of equity that a partner has on the net assets
b. Proportionate to a partner’s capital contribution
21 | P a g e
c.
d.
May not be proportionate to capital contribution due to bonus
All of these
MC 2-6 On April 1, 2014, Apple and Ayme formed a partnership with each contributing the
following assets:
Apple
Ayme
Cash
P 120,000
P
80,000
Machinery and equipment
100,000
340,000
Building
900,000
Furnitures and fixtures
40,000
The building is subject to a mortgage loan of P300,000, which is to be assumed by the
partnership. On April 1, 2014, the balance in Ayme’s capital account should be
a.
b.
c.
d.
P 980,000
P 1,020,000
P 1,280,000
P 1,320,000
MC 2-7 Aster and Armie are forming a partnership by combining their business. Their books
show the following:
Aster
Amie
Cash
P
72,000
P
30,000
Accounts Receivable
150,000
108,000
Merchandise Inventory
240,000
156,000
Furnitures and fixtures
330,000
102,000
Prepaid Expenses
63,000
21,000
Accounts Payable
366,000
144,000
Aster, Capital
489,000
Amie, Capital
273,000
It has been agreed to recognize uncollectible accounts of P7,500 and P5,400 to each
party, respectively, and that the furniture and fixtured of Amie are under depreciated
by P9,000. If each partner’s share in equity is to be equal to the net assets invested, the
capital accounts of Aster and Amie would be
a. P489,000 and P273,000 respectively.
b. P484,500 and P276,600 respectively.
c. P481,500 and P258,600 respectively.
d. P855,000 and P417,000, respectively.
MC 2-8 A business owned by Antonia was short of cash and Antonia decided to form a
partnership with Andrea, who was able to contribute cash twice the interest of Antonia
in the new partnership. The assets contributed by Antonia appeared as follows in the
statement of financial position of her business: cash, P9,000; accounts receivable,
Chapter 2 – Nature and Formation of a Partnership
P189,000 with allowance for uncollectible accounts of P6,000; merchandise inventory,
P420,000; and store equipment, P150,000 with accumulated depreciation of P15,000.
Antonio and Andrea agreed that the allowance for uncollectible accounts was
inadequate and should be P12,000. They also agreed that the fair value for the
inventory is P460,000 and for the store equipment is P140,000. The cash contributed
by Andrea into the partnership was
a. P 747,000
b. P 786,000
c. P1,572,000
d. P1,576,000
MC 2-9 Almeda and Asistio are combining their separate business to form a partnership. Cash
and non-cash assets are to be contributed for a total capital of P600,000. The non-cash
assets to be contributed and the liabilities to be assumed are as follows:
Accounts Receivable
Merchandise Inventory
Equipment
Accounts Payable
Almeda
BV
FMV
P 40,000
P 30,000
60,000
90,000
120,000
100,000
30,000
30,000
BV
P 40,000
80,000
20,000
Asistio
FMV
P 80,000
120,000
20,000
The partner’ capital accounts are to be equal after all the contribution of assets and the
assumption of liabilities. The amount of cash to be contributed by Almeda is
a. P100,000
b. P110,000
c. P210,000
d. P300,000
MC 2-10 Using the information in MC 2-9, the total assets of the partnership is
a. P340,000
b. P360,000
c. P630,000
d. P650,000
MC 2-11 Using the information in MC 2-9, and assuming the excess capital credit over the fair
value of the net assets transferred to the partnership is recognized as goodwill, how
much is the goodwill to be credited to Asistio?
a. P120,000
b. P150,000
c. P180,000
d. P300,000
22 | P a g e
MC 2-12 Amable and Aguila entered into a partnership on February 1, 2014 by investing the
following assets:
Amable
Aguila
Cash
P 40,000
Merchandise Inventory
P 90,000
Land
130,000
Equipment
30,000
Furniture and Fixtures
200,000
The agreement between Amable and Aguila provides that profits and losses are to be
divided 60% and 40% respectively, and that the partnership is to assume the P100,000
mortgage on the land. If Aguila is to receive capital credit equal to the full amount of his
net assets invested, how much is his capital balance upon partnership formation?
a. P 10,000
b. P 150,000
c. P 160,000
d. P 400,000
MC 2-13 Using the information in MC 2-12 and assuming that Aguila invests P100,000cash and
the partners are to have equal interest in the partnership, the total capital of the
partnership is
a. P240,000
b. P250,000
c. P490,000
d. P590,000
MC 2-14 Using the information in MC 2-12 and assuming that the capital of the partners is
proportionate to their profit and loss ratio, the bonus upon partnership formation is
a. P6,000 to Amable
b. P6,000 to Aguila
c. P10,000 to Amable
d. P10,000 to Aguila
MC 2-15 The Agulto and Acejas Partnership was formed on October 1, 2014. At the date, the
following assets were contributed:
Agulto
Acejas
Cash
P 600,000
P 280,000
Merchandise Inventory
440,000
Building
800,000
Furniture and Fixtures
120,000
The building is subject to a mortgage loan of P320,000 which is to be assumed by the
partnership. The partnership agreement provides that Agulto and Acejas share on
Chapter 2 – Nature and Formation of a Partnership
profit and loss of 25% and 75% respectively. Agulto’s capital account at October 1, 2014
should be
a. P 400,000
b. P 720,000
c. P1,200,000
d. P1,520,000
MC 2-17 Using the information in MC 2-16 and assuming that the partnership agreement
provides that the partners initially should have an equal interest in partnership capital,
Acejas’ capital account on October 1, 2014 should be
a. P 480,000
b. P 720,000
c. P 960,000
d. P1,200,000
MC 2-18 Using the information in MC 2-17, the effect of the bonus on capital of the partners is
a. Xero
b. P200,000
c. P240,000
d. P480,000
MC 2-19 Using the information in MC 2-17, the effect of the bonus on capital of the partners is
Agulto
Acejas
a.
increase
increase
b.
increase
decrease
c.
decrease
increase
d.
decrease
decrease
MC 2-20 Using the information in MC 2-16, and assuming that capital shall be proportionate to
the partners’ profit and loss ratio, the required capital of Acejas is
a. P 520,000
b. P 720,000
c. P1,200,000
d. P1,440,000
23 | P a g e
Chapter 3 – Partnership Operations
At the end of the accounting period, adjustments are made for merchandise inventory, accruals,
prepayments, provision for uncollectible accounts, and provision for depreciation. Profit or loss
is determined in the usual manner, that is, by matching periodic income and expenses.
CHAPTER 3
PARTNERSHIP OPERATIONS
However, special problems are encountered in accounting for partnership operation. These
problems include:
LEARNING OBJECTIVES
1.
2.
3.
Discuss the closing entries in a partnership and differentiate then from the closing entries in a sole
proprietorship.
Identify and discuss the different methods and rules of dividing partnership profits and losses
among partners.
Discuss and understand the preparation of financial statements of a partnership.
PREVIEW OF THE CHAPTER
•
•
•
•
Revenue and gains
Expenses and losses
Partners’ share in
profits and losses
Partners’ drawing
Distribution of Partnership
Profits and Losses
•
•
•
•
•
•
Equally
Arbitrary ratio
Capital ratio
Interest on capital
Salary allowance
Bonus
Preparation of
Financial Statements
•
•
•
Statement of
Income/Statement of
Comprehensive Income
Statement of
Financial Position
Statement of Changes
in Partners’ Equity
NATURE OF PARTNERSHIP OPERATION
Accounting for partnership operations is essentially the same as accounting for the operations of
a sole proprietorship. Sale of merchandise on account is debited to Accounts Receivable and
credited to Sales Collection of accounts is debited to Cash and credited to Accounts Receivable.
The purchase of merchandise on account is recorded by a debit to Purchases and credit to
Accounts Payable. Payments of accounts is debited to accounts payable and credited to Cash.
Payment of expenses is debited to Expenses and credited to Cash.
24 | P a g e
Closing entries of a partnership
Distribution of profits and losses
Preparation of a work sheet
Preparation of financial statements
a. Statement of income/statement of comprehensive income
b. Statement of financial position
c. Statement of changes in partner’s equity
CLOSING ENTRIES OF A PARTNERSHIP
PARTNERSHIP
OPERATIONS
Closing Entries
1.
2.
3.
4.
The procedures for the preparation of closing entries for a partnership are similar to that of a
sole proprietorship. First, all revenue and other nominal accounts with credit balances (such as
Purchase Discounts and Purchases Returns and Allowances) are debited and Income Summary
is credited. Second, Income Summary is debited and all expense and other nominal accounts with
debit balances (such as Sales Discounts and Sales Returns and Allowances) are credited. Third,
the balance of the Income Summary account, which represents profit or loss of the partnership,
is transferred either to the drawing accounts or directly to the capital accounts of the partners.
Finally, the balance of the drawing account of each partner is transferred to his/her capital
account.
The balance of the Income Summary account is transferred to the drawing accounts of the
partners if the partners’ intention is to keep the capital account intact for investments and
permanent a profit and its balance is transferred to the drawing accounts of the partners based
on their profit and loss sharing ratio, The entry is as follows:
Income Summary
A, Drawing
B, Drawing
xxx
xxx
xxx
Any resulting credit balance in the drawing account of a partner may be withdrawn by the
partner or reinvested into the firm. If the balance in the drawing account is withdrawn in cash,
the entry is as follows:
A, Drawing
Cash
xxx
xxx
Chapter 3 – Partnership Operations
However, if the partner decides to reinvest into the firm this balance in his drawing account, the
entry is as follows:
A, Drawing
A, Capital
xxx
xxx
A debit balance in the Income Summary account represents a loss and its balance is transferred
to the drawing accounts of the partners based on their profit and loss sharing ration. The entry
is as follows:
A, Drawing
B, Drawing
Income Summary
xxx
xxx
xxx
The resulting debit balance in the drawing account of a partner is charged against his capital with
the following entry:
A, Capital
A, Drawing
xxx
DISTRIBUTION OF PROFITS AND LOSSES
To make distribution of partnership profits and losses equitable, the following factors are
considered:
1. Services rendered by the partners to the partnerships
2. Amount of capital contributed by the partners to the business
3. Entrepreneurial ability or managerial skill of the partners
To distribution or division of profits and losses may be expressed in several ways as follows:
1. by percentage
2. by fraction
3. by decimal
4. by ratio
Illustration: Alba and Bueno are partners sharing profits and losses based on their capital
contributions of P100,000 and P300,000, respectively. Their profit and loss sharing can be
expressed as follows:
xxx
On the other hand, the balance of the Income Summary account may be transferred directly to
the capital accounts of the partners if the partners’ intention is to make the profit or loss a part
if permanent capital. It should be noted, however, that either treatment will result to the same
net effect on partners’ ending capital balances. All illustrations in this chapter pertaining to
distribution of profit or loss are recorded directly to the capital accounts with the assumption
that partners intend to make their respective share on the profit or loss as a direct part of their
permanent capital.
A credit balance in the Income Summary account represents a profit and its balance is
transferred to the capital accounts of the partners based on their profit and loss sharing ratio.
The entry is as follows:
Income Summary
A, Capital
B, Capital
xxx
xxx
xxx
A debit balance in the Income Summary account represents a loss and its balance is transferred
to the capital accounts of the partners based on their profit and loss sharing ratio. The entry is as
follows:
A, Capital
xxx
B, Capital
xxx
Income Summary
xxx
25 | P a g e
1.
By percentage
Alba
Bueno
25%
75%
(P100,000/P400,000)
(P300,000/P400,000)
2.
By fraction
Alba
Bueno
1/4
3/4
(P100,000/P400,000)
(P300,000/P400,000)
3.
By decimal
Alba
Bueno
.25
.75
(P100,000/P400,000)
(P300,000/P400,000)
4.
By ratio
Alba and Bueno
1:3
RULES FOR DIVIDING PROFITS AND LOSSES
The following is the list of rules in the division of profits and losses of the partnership based on
the provision of the New Civil Code:
1.
As to Capitalist Partners
a. Division of profits
1. in accordance with agreement
2. in the absence of an agreement, division of profits is in accordance with capital
contributions
b.
Division of losses
1. in accordance with agreement
Chapter 3 – Partnership Operations
2.
3.
if only division of profits is agreed upon, the division of losses will be the same as
the agreement on the division of profits
in the absence of an agreement, division of losses is in accordance with capital
contributions
Interest is allowed to partners for the use of invested capital. Interest as agreed by the
partners shall be allowed in proportion over the period such capital was actually used.
Moreover, the interest shall be provided whether the profit is sufficient or insufficient or
there is a net loss unless otherwise agreed upon by the partners.
5.
2.
As to Industrial Partners
a. Division of profits
1. in accordance with agreement
2. in the absence of an agreement, the industrial partner shall receive a just and
equitable share of the profits and the capitalist partners shall receive profits in
accordance with their capital contribution.
b.
Division of losses
1. in accordance with agreement
2. in the absence of an agreement, the capitalist-industrial partner in his/her
character as industrial partner shall have no share in the losses, but in his/her
character as a capitalist partner will share in proportion to the capital contribution
Salaries are allowed to partners as compensation for their devoted in the business, Salaries
as agreed by the partners shall be allowed in proportion to the time the partners actually
rendered services to the firm. Such salaries shall be provided whether the profit is sufficient
or insufficient or there is net a loss unless otherwise agreed upon by the partners.
6.
Bonus to managing partner and the balance on agreed ratio – this method allows a
bonus, as an incentive, to the managing partner. It is usually a percentage of the profit.
Bonus, therefore, is allowed only when there is a profit. It may be computed using any one
of the following as basis:
a. Bonus is based on profit before deducting bonus and income tax
b. Bonus is based on profit after deducting bonus but before deducting income tax
c. Bonus is based on profit after deducting income tax but before deducting bonus
d. Bonus is based on profit after deducting both bonus and income tax
7.
Interest on capital, salaries to partners, bonus to managing partner, and the balance
on agreed ratio.
Profits and losses in general shall be divided in accordance with the agreement among the
partners. In the absence of an agreement, the partners shall share in the profits in proportion to
their capital contributions after satisfying the share of the industrial partner on such profit.
METHODS OF
AGREEMENT
1.
2.
3.
4.
DISTRIBUTING
PROFITS
BASED
ON
PARTNERS’
Equally – it is simple to apply but does not give due recognition on the disparity of capital
contributions nor does it recognize the time and effort that a partner may devote in running
the firm’s business operations.
Arbitrary ratio (Percentage, Decimal, Fraction, Ratio) – it is simple to apply but does not
give recognition on the disparity of capital contributions nor does it recognize the time and
effort that a partner may devote in running the firm’s business operations.
Capital ratio (Original, Beginning, Ending, Average)- this method recognizes the
differences in the capital contributions but does not take into account the time and effort
that a partner may devote I running the firm’s business operations.
Interest on capital and the balances on agreed ratio – this method recognizes the
differences in the capital contributions but does not take into account the time and effort
that a partner may devote in running the firm’s business operations.
26 | P a g e
Salary allowances to partners and the balance on agreed ratio – this method recognizes
the time and effort that a partner may devote in running the firm’s business operations but
does not take into consideration the differences in capital contributions.
Illustrative Problem A: The following data are available in the books of Calma and David
Partnership for the year 2014.
May
Jan. 1 – Dec. 31
Calma, Capital
P100,000
Jan. 1
Apr. 1
Oct. 1
Calma, Drawing
P300,000
Balance
Balance – P3,150,000
P2,500,000
250,000
500,000
Chapter 3 – Partnership Operations
David, Capital
P150,000
Jan. 1
50,000
Sept. 1
June 1
Dec. 1
Jan. 1 – Dec. 31
Case 4 – Profit is divided 20% and 80% to Calma and David
Balance
Balance – P1,800,000
P1,500,000
500,000
David, Drawing
225,000
Income Summary
Calma, Capital
David, Capital
P600,000 x 20% = P120,000
P600,000 x 89% = P480,000
600,000
120,000
480,000
Case 5 – Profit is allocated based on the beginning capital ratio
Income Summary
Dec. 31
P 600,000
Twelve cases will be illustrated using the given data. Cases 1-10 will show sufficient profit. Case
11 will show insufficient profit, and Case 12 shows a loss.
Case 1 – Profit is divided equally
Income Summary
Calma, Capital
David, Capital
P600,000 / 2 = P300,000
27 | P a g e
375,000
225,000
Case 6 – Profit is allocated based on the ending capital ratio
300,000
300,000
450,000
150,000
The ending capital balances of the partners are computed as follows:
Calma
David
Beginning balances
P2,500,000
P1,500,000
Additional investment
750,000
500,000
Drawing
( 100,000)
( 200,000)
Ending balances
P3,150,000
P1,800,000
600,000
600,000
600,000
381,820
218,180
Key Points. Withdrawals deducted for purposes of determining ending capital balances are the
debit entries in the capital accounts of each pf the partners (see partners’ accounts shown I the
previous page). The credit entries in the drawing accounts are not considered in computing
ending capital for the purpose of establishing the ratio.
Case 3 – Profit is divided in the ratio of 1:2 to Calma and David
Income Summary
Calma, Capital
David, Capital
P600,000 x 1/3 = P200,000
P600,000 x 2/3 = P400,000
600,000
Income Summary
Calma, Capital
David, Capital
P600,000 x 315/495 = P381,820
P600,000 x 180/495 = P218,180
Case 2 – Profit is divided 3/4 and 1/4 to Calma and David
Income Summary
Calma, Capital
David, Capital
P600,000 x 3/4 = P450,000
P600,000 x 1/4 = P150,000
Income Summary
Calma, Capital
David, Capital
P600,000 x 25/40 = P375,000
P600,000 x 15/40 = P225,000
600,000
200,000
400,000
Case 7 – Profit is allocated based on the average capital ratio
Income Summary
600,000
Calma, Capital
David, Capital
P600,000 x 2,745,830/4,320,830 = P381,290
P600,000 x 1,575,000/4,320,830 = P2818,710
381,290
218,710
Chapter 3 – Partnership Operations
Average capital ratio is a method of dividing profits based on the amount of capital invested and
the time during which such capital is actually used in the business.
The following steps are to be followed in determine the average capital of each partner using the
peso month method; thus, arriving at the average capital ratio:
1.
2.
3.
Multiply beginning capital by the number of months that it remained unchanged.
Determine each new capital balance in chronological order and multiply by the number of
months it remained unchanged.
Add the products which represent peso months and divide the total the total by twelve (12)
to obtain the average monthly capital.
By following the steps given, the average capital of each partner can be calculated as follows:
Calma, Capital
Period
Jan. 1 – Mar. 31
Apr. 1 – Apr. 30
May 1 – Sept 30
Oct. 1 – Dec. 31
Capital Balance
P2,500,000
2,750,000
2,650,000
3,150,000
No. of Mos.
Unchanged
3
1
5
3
12
Peso Months
P 7,500,000
2,750,000
13,250,000
9,450,000
P32,950,000
Average Capital
P1,500,000
1,350,000
1,850,000
1,800,000
5
3
3
1
12
P 7,500,000
4,050,000
5,550,000
1,800,000
P18,900,000
P2,745,830
1,575,000
P4,320,830
Cases 1 to 7 provide for division of profits using a single allocation procedure. However, there
are instances when the partnership agreement may provide for a combination of several
allocation procedures (multiple bases of profit allocation) to be used in the distribution of profit.
Since partnerships specify a profit distribution to be followed to whatever extent possible, most
agreements specify that the entire process is to be completed and any remainder is to be
allocated in the profit and loss ratio. The following case are used to illustrate various multiple
allocation procedures.
28 | P a g e
Income Summary
Calma, Capital
David, Capital
600,000
378,000
222,000
The distribution of profits may be recorded separately as follows:
Income Summary
Calma, Capital
David, Capital
Interest on ending capital.
495,000
Income Summary
Calma, Capital
David, Capital
Remaining income divided 60%, 40%.
105,000
Division of profit
David, Capital
Jan. 1 – May. 31
June 1 – Aug. 31
Sept. 1 – Nov. 30
Dec. 1 – Dec. 31
Case 8 – Each partner is allowed 10% interest on ending capital and the remaining profit
is divided 60%. 40%.
Interest on ending capital
P3,150,000 x 10%
P1,800,000 x 10%
Remainder – 60%, 40%
P105,000 x 60%
P105,000 x 40%
Total
315,000
180,000
63,000
42,000
Calma
P315,000
David
Total
P180,000
P495,000
42,000
P222,000
105,000
P600,000
63,000
P378,000
Case 9 – David is allowed salaries of P500,000 and the remaining profit is divided in the
ratio of 1:4
Income Summary
Calma, Capital
David, Capital
Division of profit
Salaries
Remainder – 1:4
P100,000 x 1/5
P100,000 x 4/5
Total
600,000
20,000
580,000
Calma
P 20,000
P 20,000
David
P500,000
Total
P500,000
80,000
P580,000
100,000
P600,000
Chapter 3 – Partnership Operations
Case 10 – David, the managing partner, is allowed a bonus of 20% of profit BEFORE bonus
and income tax and the remainder is divided in the ratio of beginning capital.
Case 12 – Assume the same agreement as in Case 11 except that instead of a prodit, the
partnership has incurred a loss of P100,000. The allowance for salaries and interest will still
be provided, thereby resulting in a total loss to be divided as agreed.
Using the income tax rate of 30%, the partnership income before income tax is P857,143 that is,
net profit of P600,000 divided by 70%.
Income Summary
Calma, Capital
David, Capital
Division of profit
Bonus – P857,143 x 20%
Remainder:
P428,571 x 25/40
P428,571 x 15/40
Total
600,000
Calma
P267,857
P267,857
David, Capital
Calma, Capital
Income Summary
267,857
332,143
David
P171,429
Total
P171,429
267,587
P332,143
428,571
P600,000
Division of profit
Case 11 – The partners are allowed P5,000 and P10,000 weekly salaries, respectively,
10% interest on average capital, and the remainder is divided in the ratio of 2:3.
Income Summary
Calma, Capital
David, Capital
Division of profit
Salaries to partners
P 5,000 x 52
P10,000 x 52
Interest on average capital
P2,745,830 x 10%
P1,575,000 x 10%
Remainder – (P612,080)
P612,080 x 2/5
P612,080 x 3/5
Total
600,000
289,750
310,250
Calma
P260,000
274,580
(244,830)
P289,750
David
Total
P520,000
P780,000
157,500
432,080
(367,250)
P310,250
(612,080)
P600,000
The sum of the salary allowance and interest allowed on the average capital of the partners
exceeded the profit of P600,000 resulting in a negative remainder (loss or deficit). Such loss is
distributed in the profit and loss sharing agreement.
29 | P a g e
9,750
100,000
Calma
Salaries to partners
P 5,000 x 52
P10,000 x 52
Interest on average capital
P2,745,830 x 10%
P1,575,000 x 10%
Remainder – (P1,312,080)
P1,312,080 x 2/5
P1,312,080 x 3/5
Total
Other assumptions on the computation of bonus shall be illustrated later in the chapter.
109,750
P260,000
274,580
(524,830)
P 9,750
David
Total
P520,000
P780,000
157,500
432,080
(787,250)
P109,750
(1,312,080)
P100,000
The allocation of partnership profit follows the order of the profit sharing agreement in
allocating the bonus, the salary allowances, the interests and the remainder to individual
partners.
The bonus is computed on the basis of the partnership profit as the concept of “partnership
profit” is generally understood in accounting practice. Partners may, however, intend for salary
and interest allowances to be deducted in determining the base for computing the bonus. In such
case, no bonus is allowed if there is insufficient profit after distribution of salaries and interests.
The interests of the partners may not be apparent when technical accounting terms are used; so
the partnership agreement should be precise in specifying measurement procedures to be used
in determining the amount of a bonus.
Illustrations on the computation of bonus using other assumptions. The same data in Illustrative
Problem A shall be used. Bonus rate is 20%.
1.
Bonus is based on profit after deducting bonus but before deducting income tax.
B
B
B + .20B
B
B
= .20 x (P857,143 – B)
= P171,428 – 020B
= P171,428
= P171,428 / 1.20
= P142,857
Chapter 3 – Partnership Operations
2.
Bonus is based on profit before deducting bonus after deducting income tax
B
= .20 (P857,143 – T)
and P250,000 to Tomas, 10% interest on capital and the balance will be divided equally. Income
is to be allocated by first giving priority to interest on invested capital and then on salary
allowance. Partnership net income for the year is P600,000.
T
= .30 x P857,143
= P257,143
The following is the division of the P600,000 profit in accordance with the order of priority
provision.
Substituting for T in the first equation and solving for B
,
B
B
B
= .20 (P857,143 – P257,143)
= .20 x P600,000
= P120,000
Key Points. The bonus was not deducted from the profit subject to income tax. The bonus
being computed is not an expense but a distribution of profit after income tax.
3.
Bonus is based on profit after deducting bonus and income tax
B
= .20 (P857,143 – B – T)
T
= .30 x P 857,143
= P257,143
Substituting for T in the first equation and solving for B
B
B
B
B = .20B
B
B
= .20 (P857,143 – B – P257,143)
= .20 (P600,000 – B)
= P120,000 - .20 B
= P120,000
= P120,000/1.20
= P100,000
Key Points. In the preceding example, bonus is treated as a distribution of partnership profit,
and therefore such bonus is not deductible as an expense in determining the amount of taxable
profit. The same is true for salaries and interest allowed on capital.
In some instances, the partners may agree not to use a residual sharing ratio in the event profits
did not exceed the total of the salary and interest allowances. In this case, the partners must agree
on the priority of the various features. If the partnership agreement gives salary allowances
priority over interest on capital balances, then profit would first apply to salaries and the
balances would be divided in the ratio of interest allowance and vice-versa.
Illustrative Problem B: Santos and Tomas are partners with capital balances of P315,000 and
P180,000, respectively. The profit and loss agreement provides salaries of P500,000 to Santos
30 | P a g e
Santos
Interest on capital
P315,000 x 10%
P180,000 x 10%
Salaries (ratio of 50:25)
Total
Tomas
Total
P 18,000
367,000
P 385,000
P 49,500
550,500
P 600,000
P 31,500
183,500
P 215,000
The entry to record the distribution of the profit is as follows:
Income Summary
Santos, Capital
Tomas, Capital
600,000
215,000
385,000
SPECIAL PROFIT ALLOCATION METHODS
Some partnerships distribute profits on the basis of other criteria. For example, most public
accounting firms distribute profits on the basis of partnership units. A new partner acquires a
certain number of units and additional units are assigned by a firmwide compensation
committee based on:
•
obtaining new clients;
•
providing the firm with specific areas of industrial expertise;
•
serving as a managing partner of a local office; or
•
accepting a variety of other responsibilities
Other partnerships devise profit distribution plans that the reflect the earnings of the
partnership. For example, some medical or dental firms allocate profits on the basis of billed
services. Other criteria may include number or size of clients, years of service within the firm, or
the partner’s position within the firm.
PREPARATION OF WORK SHEET
At the end of each accounting period, the partnership bools are adjusted and closed and financial
statements are prepared. In order to classify accounting data in a convenient and orderly manner
and to facilitate the preparation of financial statements, a work sheet is prepared. The form or
columns of the work sheet may vary depending on the needs of the company. The following
Chapter 3 – Partnership Operations
illustrative problem will use the simplest form of work sheet with emphasis not on the form but
the underlying principles and procedures in preparing such work sheet.
Illustrative Problem C: The trial balance for EXCELLENCE COMPANY as at December 31, 2014
is presented.
Debit
1,900,000
625,000
1,125,000
Credit
50,000
1,250,000
1,500,000
155,000
200,000
500,000
375,000
1,250,000
3,125,000
250,000
5,000,000
50,000
75,000
2,412,500
100,000
62,500
125,000
825,000
362,500
25,000
10,680,000
17,500
10,680,000
Data for adjustments as of December 31, 2014:
a.
b.
c.
d.
Merchandise inventory, P1,000,000
Depreciation of furniture and equipment, 10% per year, 40% of which is considered part of
general expenses
Unpaid sales salaries, P25,000
Accrued interest on notes receivable, P2,500
31 | P a g e
Accrued interest on notes payable, P1,500
Allowance for uncollectible accounts to be increased to P112,500
Unused supplies: office – P10,000, store – P15,000
Income tax, 30% profit before income tax
The Articles of Co- Partnership contain the following provisions regarding the division of profits
and losses:
EXCELLENCE COMPANY
Trial Balance
December 31, 2014
Cash
Notes Receivable
Accounts Receivable
Allowance for Uncollectible Accounts
Merchandise Inventory
Furniture and Equipment
Accumulated Depreciation
Notes Payable
Accounts Payable
Flores, Capital
Flores, Drawing
Garcia, Capital
Garcia, Drawing
Sales
Sales Returns and Allowances
Sales Discounts
Purchases
Purchases Returns and Allowances
Purchases Discounts
Freight-In
Selling Expenses
General Expenses
Interest Income
Interest Expense
e.
f.
g.
h.
1.
2.
3.
Annual salaried of P400,000 and P500,000, respectively.
Interest of 10% on beginning capital
The remainder is divided in the ratio of 3:2
A work sheet prepared for the partnership and the related statement of financial position and
income statement are presented on the next pages. The statement of changes in partners’ equity
is presented below.
EXCELLENCE COMPANY
Statement of Changes in Partners’ Equity
For the Year Ended December 31, 2014
Equity, January 1
Add Profit for 2014:
Salaries
Interest on beginning capital
Balance – 3:2 (P747,050)
P747,050x 3/5
P747,050x 2/5
Total share in profit
Total
Less Withdrawals
Equity, December 31
Flores
P1,250,00
Garcia
Total
P 400,000
125,000
P 500,000
312,500
P 900,000
437,500
( 298,820)
P 513,680
P3,638,680
250,000
P3,388,680
( 747,050)
P 590,450
P4,965,450
405,000
P4,560,450
( 448,230)
P 76,770
P1,3261770
155,000
P1,171,770
Chapter 3 – Partnership Operations
EXCELLENCE COMPANY
Work Sheet
For the Year Ended December 31, 2014
Adjustments
Trial Balance
Debit
Cash
Notes Receivable
Accounts Receivable
Credit
Debit
Credit
Statement of Income
Debit
Statement of Financial Position
Credit
Debit
1,900,000
1,900,000
625,000
625,000
1,125,000
Allowance for Uncollectible Accounts
1,125,000
50,000
Merchandise Inventory
1,250,000
Furniture and Equipment
1,500,000
Credit
f. 62,500
112,500
1,250,000
1,000,000
1,000,000
1,500,000
Accumulated Depreciation
200,000
Notes Payable
500,000
500,000
Accounts Payable
375,000
375,000
1,250,000
1,250,000
Flores, Capital
Flores, Drawing
350,000
155,000
Garcia, Capital
Garcia, Drawing
b. 150,000
155,000
3,125,000
3,125,000
250,000
Sales
250,000
5,000,000
5,000,000
Sales Returns and Allowances
50,000
50,000
Sales Discounts
75,000
75,000
2,412,500
2,412,500
Purchases
Purchase Returns and Allowances
Purchase Discounts
Freight-In
125,000
Selling Expenses
825,000
General Expenses
362,500
Interest Income
Interest Expense
100,000
62,500
62,500
125,000
b. 90,000
c. 25,000
b. 60,000
f. 62,500
17,500
25,000
10,680,000
32 | P a g e
100,000
925,000
g. 10,000
475,000
d. 2,500
e. 1,500
10,680,000
g. 15,000
20,000
26,300
Chapter 3 – Partnership Operations
Salaries Payable
c.25,000
Interest Receivable
25,000
d. 2,500
Interest Payable
2,500
e. 1,500
Supplies on Hand
1,500
g. 25,000
Income Tax Expense
h. 253,050
Income Tax Payable
253,050
h. 253,050
519,550
Profit
25,000
519,550
253,050
5,592,050
6,182,500
Computation of income tax and profit:
Total credit per income statement before income tax
Total debit per income statement before income tax
Profit before tax
Income tax (P843,500 x 30%)
Profit
33 | P a g e
6,182,500
6,582,500
590,450
P 6,182,500
5,339,000
P 843,500
253,050
P 590,450
5,992,050
590,450
6,182,500
6,582,500
6,582,500
Chapter 3 – Partnership Operations
Cost of Goods Available for Sale
Less Merchandise Inventory, December 31
Cost of Sales
EXCELLENCE COMPANY
Statement of Income
For the Year Ended December 31, 2014
Net Sales
Cost of Sales
Gross Profit
Other Operating Income - Interest
Operating Expenses:
Selling
General
Operating Profit
Interest Expense
Profit before Tax
Income Tax Expense (30%)
Profit for the Period
Schedule
1
2
P4,875,000
2,625,000
P2,250,000
20,000
P 925,000
475,000
(1,400,000)
P 870,000
( 26,500)
P 843,500
( 253,050)
P 590,450
Division of profit
Salaries
Interest on beginning capital
Balance – 3:2 (P747,050)
P747,050 x 3/5
P747,050 x 2/5
Total share in profit
Flores
P 400,000
125,000
Garcia
P 500,000
312,500
Total
P 900,000
437,500
( 298,820)
P 513,680
( 747,050)
P 590,450
( 448,230)
P
76,770
Schedule 1 – Net Sales
Sales
Less: Sales Returns and Allowances
Sales Discounts
Net Sales
P50,000
75,000
34 | P a g e
125,000
P4,875,000
Key Points. The Statement of Income of a partnership is similar to that of a sole proprietorship
except that it includes a schedule showing the division or distribution of profit to partners.
EXCELLENCE COMPANY
Statement of Financial Position
December 31, 2014
Cash Assets:
Cash
Notes Receivable
Accounts Receivable
Less Allowance for Uncollectible Accounts
Interest Receivable
Merchandise Inventory
Supplies
P 1,250,000
P100,000
62,500
P 2,412,500
125,000
P 2,537,500
162,500
2,375,000
Assets
P1,125,000
112,500
Furniture and Equipment
Less Accumulated Depreciation
P1,900,000
625,000
1,012,500
2,500
1,000,000
25,000
P4,565,000
P1,500,000
350,000
1,150,000
Total Assets
Current Liabilities
Notes Payable
Accounts Payable
Salaries Payable
Interest Payable
Income Tax Payable
Total Liabilities
Flores, Capital
Garcia, Capital
Total Partners’ Equity
Total Liabilities and Partners’ Equity
Schedule 2 – Cost of Sales
Merchandise Inventory, January 1
Net Purchases
Purchases
Add Freight-In
Total
Less: Purchase Returns and Allowances
Purchases Discounts
P5,000,000
P 3,625,000
1,000,000
P 2,625,000
P5,715,000
Liabilities
P 500,000
375,000
25,000
1,500
253,050
Partners Equity
P1,171,770
3,886,680
P1,154,550
4,560,450
P5,715,000
Chapter 3 – Partnership Operations
CORRECTIONS IN PROFIT ERRORS AND OMISSIONS PRIOR RO
DISTRIBUTION
The partnership books may show an incorrect profit because of errors and omissions. Such
include failure to record prepaid expenses, accrued expenses, accrued income, unearned income
and also overstatement or understatement in purchases, inventories, and depreciation. The
reported profit should be corrected before it is distributed to the partners. The required
corrections may be summarized as follows:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Unrecorded prepaid expenses
Unrecorded accrued expenses
Unrecorded accrued income
Unrecorded unearned income
Overstatement of inventories
Understatement of inventories
Overstatement of purchases
Understatement of purchases
Overstatement of depreciation
Understatement of depreciation
Correction to profit of current year for
errors made in
Prior Year
Current Year
+
+
+
+
+
+
+
+
none
+
none
-
The corrected profit for 2014 based on a 30% income tax rate shall be computed as follows:
Reported profit
Corrections:
Unrecorded accrued expense, 2013
Unrecorded unearned income, 2013
Overstatement of ending inventory, 2014
Unrecorded purchases, 2014
Unrecorded prepaid expenses, 2013
Total corrections before income tax
4.
5.
Accrued expenses not recorded at the end of 2013
Overstatement of 2014 ending inventory
Goods received and inventories in 2014 but the related
purchases not recorded
Income received in advance (unearned income), not
recorded at the end of 2013
Prepaid expenses not recorded at the end of 2013
P
5,000
48,000
Hannah
Ines
Julian
Karina
20% x 80%
30% x 80%
50% x 80%
=
=
=
16%
24%
40%
20%
100%
The corrected profit shall be divided among partners as follows:
Hannah
Ines
Julian
Karina
P358,800 x 16%
P258,800 x 24%
P358,800 x 40%
P358,800 x 20%
P57,408
86,112
143,520
71,760
P358,800
CAPITAL BALANCES RATIO ADJUSTED TO PROFIT AND LOSS RATIO
While it is usual that capital ratios do not equal profit and loss ratios; yet, partners may decide
to bring their capital balances into their profit and loss ratio. This can be accomplished through
either of the following:
20,000
1.
10,000
3,000
2.
3.
35 | P a g e
( 39,200)
P358,800
The distribution of the corrected profit shall be based on the new profit and loss ratios computed
as follows:
Illustrative Problem D. Hannah, Ines, and Julian are partners sharing profits on a 2:3:5 ratio.
On January 1, 20014. Karina was admitted into the partnership with a 20% share in profits. The
old partners shall continue to participate in profits in proportion to their original ratios.
1.
2.
3.
P 5,000
10,000
(48,000)
(20,000)
( 3,000)
P(56,000)
x 70%
Total corrections after income tax
Corrected profit
It is understood that the tax implications of these corrections are properly accounted for
particularly if the partnership is not a general profession partnership.
For the year 2014, the partnership books showed a profit of P398,000. It was ascertained,
however, that the following errors were made:
P398,000
The capital balances are to be brought into the profit and loss ratio by payments outside
of the firm among the partners and where the total firm capital is to remain the same.
The capital balances are to be brought into the profit and loss ratio by the lowest
possible additional cash investment in the firm by the partners.
The capital balances are to be brought into the profit and loss ratio by the lowest
possible additional cash investment or cash withdrawal from the firm by the partners.
Chapter 3 – Partnership Operations
Illustrative Problem E. Lopez, Martin, and Nunag are partners whose original capital balances
were in their profit and loss ratio. On December 31, 2014, capital balances are as follows:
Lopez
Martin
Nunag
P400,000
200,000
400,000
20%
30%
50%
Capital balances
Required capital
Add’l investment (withdrawals)
Partners want to bring their capital balances into the profit and loss ratio.
Assumption 1. Capital balances are to be brought into the profit and loss ratio by payments
outside of the firm among partners and with the total firm capital to remain the same.
Capital balances
Required capital
Cash received (paid)
P400,000
200,000
P200,000
P200,000
300,000
(P100,000)
Assumption 3. Capital balances are to be brought into the profit and loss by the lowest possible
additional investment or cash withdrawal from the firm by the partners.
P400,000
500,000
(P100,000)
P1,000,000
1,000,000
-
200,000
Lopez, Capital
Cash
Martin, Capital
Capital balances
Required capital
Additional investment
Lopez
P400,000
400,000
-
Martin
P200,000
600,000
P400,000
Nunag
P400,000
1,000,000
P600,000
1,000,000
Martin, Capital
Nunag, Capital
36 | P a g e
400,000
600,000
240,000
200,000
40,000
Discuss the closing entries in a partnership and differentiate them from the closing
entries in a sole proprietorship. The closing entries of a partnership are almost similar to
those of a sole proprietorship. However, the profit or loss of the partnership is transferred
to the individual drawing account or capital account of the partners and is distributed
according to the profit and loss sharing agreement.
2.
Identify and discuss the different methods and rules of dividing partnership profits and
losses to the partners. The distribution of partnership profits and losses to the partners
may be expressed in any of the following ways: (1) by percentage; (2) by fraction; (3) by
decimal; or (4) by ratio. The Civil Code of the Philippines provides rules on how partnership
profits and losses be divided among the partners. As a general rule, profits or losses should
be divided among with the partners’ agreement. In the absence of an agreement, the division
shall be made in accordance with capital contributions. To give recognition to the services
rendered by the partners or to the differences in the amount contributed in the partnership
or to the entrepreneurial ability or managerial skill of the partners, salaries, interest and
bonuses may be allowed to partners part of the division of profits and losses.
3.
Discuss and understand the preparation of financial statements of a partnership. The
financial statements are prepared after the work sheet is completed (or after journalizing
and posting the adjusting entries if a work sheet is not prepared). These financial statements
include the income statement, the statement of financial position, and the statement of
changes in partners’ equity. The income statement includes a schedule showing the division
of the partnership profit or loss to the partners. The owners’ equity section of the statement
of financial position is called “Partners’ Equity’ and it shows capital balances of individual
P400,000 / 20% = P2,000,000; P200,000 / 30% = P666,666
P400,000 / 50% = P800,000
Cash
Total
P1,000,000
800,000
P 200,000
1.
Total
P1,000,000
2,000,000
P1,000,000
In order to bring the capital balances into the profit and loss ratio by the lowest possible
additional cash investment, use as basis for determining the required capital, the capital of Lopez
divided by his profit share (P400,000/20% equals P2,000,000(. The required entry on the books
of the partnership is as follows:
Nunag
P400,000
400,000
REVIEW of the LEARNING OBJECTIVES
100,000
100,000
Assumption 2. Capital balances are to be brought into the profit and loss ratio by the lowest
possible cash investment in the firm by the partners.
Martin
P200,000
240,000
P 40,000
In order to bring the capital balances into the profit and loss ratio by the lowest possible
additional cash investment or cash withdrawal from the firm by the partners, use as basis for
determining the required capital, the capital of Nunag divided by his profit share (P400,000 /
50% equals P800,000.) The required entry on the books of the partnership is as follows:
For the capital balances to be brought into the profit and loss ratio and total firm capital to remain
the same, Martin and Nunag have to pay Lopez P100,000 each. The entry required on the
partnership books is as follows:
Lopez, Capital
Martin, Capital
Nunag, Capital
Lopez
P400,000
160,000
(P240,000)
Chapter 3 – Partnership Operations
partners. The statement of changes in partners’ equity shoes the division of profit or loss to
the partners, the amount of withdrawals during the period, and the partners’ capital
balances at the end of the period.
GLOSSARY of ACCOUNTING TERMINOLOGIES
Average capital – the amount of capital invested by a partner determined by the time during
which such capital is actually used in the business.
Bonus – an incentive normally given to the managing partner in recognition of managerial or
entrepreneurial skill or ability. It is usually a percentage of profit.
Interest on capital – incentive given to partners to give recognition to the differences in
capital contributions and is computed in proportion to the period such capital was actually
used.
Salary allowances – compensation given to partners in proportion to the time devoted to the
business.
Statement of Changes in Partners’ Equity – a statement showing the division of partnership
profit or loss to the partners, additional investments made by partners, the amount of
withdrawals of individual partners, and the ending capital balances.
MULTIPLE CHOICE
MC 3-1 Banayo and his very close friend Buendia formed a partnership on January 1, 2014 with
Banayo contributing P160,000 cash and Buendia contributing equipment with a book
value of P64,000 and a fair value of P48,000, and inventory items with a book value of
P24,000 and a fair value of P32,000. During 2014, Buendia made additional investment
of P16,000 on April 1, and P16,000 on June 1. On September 1, withdrew P40,000.
Banayo had no additional investment nor withdrawals during the year. The average
capital balance of Buendia at the end of the fiscal year 2014 is
a. P72,000
b. P80,000
c. P88,000
d. P96,000
MC 3-2 Banas and Belda are partners who share profits equally and losses in a 2:1 ratio. If they
have beginning capital balances of P120,000 and P118,000, made no additional
investments nor withdrawals, and suffered an unprofitable year with loss of P48,000,
their capital balances will be:
Banas
Belda
a.
P 40,000
P 80,000
b.
88,000
102,000
c.
120,000
118,000
d.
152,000
134,000
MC 3-3 Bernardo and Belo formed a partnership in the year 2014. The partnership agreement
provides for annual salary allowances of P110,000 for Bernardo and P90,000 for Belo.
The partners share profits equally and losses in a 60:40 ratio. The partnership had
profit of P180,000 for the year 2014 before any allowance to partners. What amount
should be credited to each partner’s capital account as a result of the distribution of the
partnership profit?
Bernardo
Belo
e.
P 98,000
P 82,000
f.
100,000
80,000
g.
96,000
84,000
h.
90,000
90,000
MC 3-4 Bunag, Belen, and Bustos are partners in an accounting firm. Their capital account
balances at year-end were P180,000, P220,000, and P100,000, respectively. They share
profits and losses on a 4:4:2 ratio, after considering the following items:
a. Bustos is to receive a bonus of 10% of profit after bonus.
b. Interest of 10% shall be paid on that portion of a partner’s capital in excess of
P200,000
c. Salaries of P20,000 and P24,000 shall be paid to partners Bunag and Bustos,
respectively.
37 | P a g e
Chapter 3 – Partnership Operations
Assuming a profit of P220,000 for the year, the total profit share of Bustos is
a. P38,800
b. P50,800
c. P54,800
d. P74,800
MC 3-5 Banta, Berba, and Borja formed a partnership on January 1, 2014. They had the
following initial investments: Banta – P200,000; Berba – P300,000; Borja – P450,000.
The partnership agreement states that profits and losses are to be shared equally by
the partners after consideration is made for the following:
a. Salary allowance of P120,000 for Banta, P96,000 for Berba and P72,000 for Borja.
b. Average partners’ capital balances during the year shall be allowed 10% interest.
Additional information:
a. ON June 30, 2014, Banta invested an additional P120,000.
b. Borja withdrew P140,000 from the partnership on September 30, 2014.
c. Share on the remaining partnership profit was P10,000 for each partner.
How much is the total interest on average capital balances of the partners?
a. P 95,000
b. P 97,500
c. P 107,500
d. P115,250
MC 3-6 Using the information in MC 3-5, partnership profit at December 31, 2014 before
salaries, interest and partners’ share on the remainder is
a. P395,500
b. P399,500
c. P415,500
d. P423,250
MC 3-7 Using the information in MC 3-5, the total partnership capital on December 31, 2014 is
a. P 950,000
b. P 970,000
c. P1,345,500
d. P1,365,500
MC 3-8 On January 1, 2014, Besa, Bascom Buan, and Baduel formed the BF TRADING, a
partnership with capital contributions as follows: Besa – P150,000; Basco – P75,000;
Buan – P75,000; and Baduel – P60,000. The partnership agreement stipulates that each
partner shall receive a 5% interest on capital contributed and that Besa and Basco shall
receive salaries (chargeable as expenses of the business) of P15,000 and P9,000,
respectively. The agreement further provides that Buan shall receive a minimum of
P7,500 per annum and Baduel a minimum of P18,000, which is inclusive of amounts
38 | P a g e
representing interest and their respective share in partnership profits. The balance of
the profits shall be distributed among that partners in the ratio of 3:3:2:2.
What amount must be earned by the partnership in fiscal year, before any charge for
interest and partners’ salaries, in order that Besa may receive an aggregate of P37.500
including interest, salary, and share of profits.
a. P92,000
b. P97,000
c. P50,000
d. P90,000
MC 3-9 Using the information in MC 3-8, the total profit share of Buan is
a. P 7,500
b. P13,750
c. P19,400
d. P37,500
MC 3-10 Using the information in MC 3-8, the total profit share of Baduel is
a. P13,000
b. P13,500
c. P18,000
d. P19,400
MC 3-11 The partnership agreement between Banaria and Bertol stipulates that Banaria is to
receive a 20% bonus on profits before bonus with residual profit and loss to be
apportioned in the ratio of 2:3 respectively. Which partner has greater advantage when
the partnership has a profit and when it incurs a loss.
Profit
Loss
a.
Bertol
Banaria
b.
Banaria
Bertol
c.
Banaria
Banaria
d.
Bertol
Bertol
MC 3-12 Bulan, Bustos, and Bucao formed a partnership o January 1, 2014 and contributed
P150,000, P200,000, and P250,000, respectively. The Articles of Co-Partnership
provide that the operating income be shared among the partners as follows: As salary:
Bulan – P24,000; Bustos P18,000; Bucao – P12,000; interst of 12% on the average
capital during 2014 of the three partners; the remainder will be divided in the ratio of
2:4:4, respectively.
Additional information:
a. Operating income for the year ended December 31,2014 is P180,000.
b. Bulan contributed additional capital of P30,000 on July 1, and made drawing of
P10,000 on October 1.
Chapter 3 – Partnership Operations
c.
d.
Bustos contributed capital of P20,000 on August 1 and made withdrawal of
P10,000 on October 1.
Bucao made withdrawal of P30,000 on November 1.
The division of the P180,000 operating income is
Bulan
Bustos
Bucao
a.
P53,760
P62,520
P59,720
b.
P35,200
P70,400
P70,400
c.
P53,980
P63,660
P62,360
d.
P53,180
P62,060
P60,760
MC 3-13 Using the information in MC 3-12, the partners’ capital balances on December 31, 2014
are
Bulan
Bustos
Bucao
a.
P223,980
P273,660
P282,360
b.
P179,760
P229,520
P239,520
c.
P189,860
P239,360
P269,360
d.
P223,180
P272,060
P280,760
MC 3-14 Briones, Belen and Burgos are partners with average capital balances during 2014 of
P945,000, P447,300 and P324,700, respectively. The partners receive 10% interest on
their average capital balances, salaries of P224,650 to Briones and P165,250 to Burgos,
any residual profit or loss is divided equally.
In 2014, the partnership had a net loss of P251,248 before the interest and salaries to
partners.
What are the changes in the capital balances of Briones and Burgos?
Briones
Burgos
a.
P81,688 decrease
P62,474 decrease
b.
P56,716 increase
P64,916 increase
c.
P58,952 increase
P35,070 increase
d.
P60,534 increase
P80,896 decrease
39 | P a g e
Chapter 4 – Partnership
CHAPTER 4
PARTNERSHIP DISSOLUTION
LEARNING OBJECTIVES
1.
2.
3.
Define partnership dissolution and identify the condition giving rise to it.
Understand the accounting procedures to record the admission of a new partner by purchase.
Understand the accounting procedures to record the admission of a new partner by investment.
PREVIEW OF THE CHAPTER
•
•
•
•
Admission of a new
partner
Retirement of a
partner
Death, incapacity, or
bankruptcy of a
partner
Incorporation of a
partnership
•
Sale of interest a book value
Sale of interest at less than
book value
Sale of interest at more than
book value
Admission by
Investment
•
Liquidation. This refers to the termination of the business activities carried on by the
partnership and the winding up of a partnership affair preparatory to going out of
business.
Dissolution, therefore, does not always result to liquidation although liquidation is always
preceded by dissolution.
•
1.
2.
3.
4.
Admission of a new partner
Retirement or withdrawal of a partner
Death, incapacity or bankruptcy of a partner
Incorporation of a partnership
Capital credit equal to
capital contribution
Capital credit not equal
to capital contribution
Accounting for admission of a new partner is discussed in this chapter. Accounting for
retirement, withdrawal, incapacity or bankruptcy and death of a partner is discussed in the next
chapter.
•
•
ADMISSION OF A NEW PARTNER
Bonus method
Asset revaluation
method
PARTNERSHIP DISSOLUTION
Dissolution is defined in Article 1825 of the Civil Code of the Philippines as the change in the
relation of the partners caused by any partner ceasing to be associated in the carrying out of
the business.
Dissolution refers to the termination of the life of an existing partnership. The dissolution of an
old partnership may be followed by:
40 | P a g e
2.
The following conditions will result to partnership dissolution by a change in ownership
structure:
Admission by Purchase
•
•
The formation of a new partnership. This is known as dissolution by change in
ownership structure. The new partnership continues the business activities of the
dissolved partnership without interruption.
CONDITIONS RESULTING TO PARTNERSHIP DISSOLUTION
PARTNERSHIP
DISSOLUTION
Causes of Dissolution
1.
A new partner, with the consent of all the partners, may be admitted in an existing partnership.
Upon admission of a new partner, the firm is automatically dissolved and a new partnership is
formed. All the partners draw a new contract, Articles of Co-Partnership. The admission of a new
partner gives rise to the following accounting problems:
1.
Determination of the profit or loss from the beginning of the accounting period to the
date of admission of anew partner and the distribution of such profit or loss to the old
partners.
2.
Correction of accounting errors in prior periods like overstatement or understatement
of inventories, excessive depreciation charges and failure to provide adequately for
doubtful accounts.
3.
Revaluation of accounts which may call for the restatement of the existing assets of the
partnership to appraise or fair market values and recognition of unrecorded liabilities
Chapter 4 – Partnership
of the firm. All adjustments to the accounts give rise to profit or loss; such adjustments
are recorded in the partnership books as increase or decrease in capital shared
according to partners’ profit.
4.
Case 1a – Purchase at book value from one partner only. Cordero purchases a 1/5 interest
from Coloma by paying P20,000.
Closing of the partnership books.
TYPES OF ADMISSION OF A NEW PARTNER
Coloma, Capital
Cordero, Capital
P100,000 x 1/5 = P20,000
A new partner may be admitted into a partnership by:
1.
2.
Purchase of interest from one or more of the original (old) partners; or
Investment or asset contributions to the partnership
ADMISSION BY PURCHASE
With the consent of all the partners, a new partner may be admitted in an existing partnership
by purchasing a capital equity interest directly from one or more of the old partners. Terms such
as purchases, sells, pays, bought, sold and transferred indicate admission by purchase.
The sale to a new partner of an old partner’s interest in an existing partnership is a personal
transaction between the selling partner and the buying partner. The amount paid by the partner
who purchases an interest goes personally to the partner who sells his or her interest; the
amount paid does not go to the partnership.
The only entry required on the partnership books is the recording of the transfer of capital from
the capital account of the selling partner to that of the buying partner. The amount of capital
transferred will be equal to the book value of the interest sold regardless of the amount paid. The
pro-form entry is:
(Name of seller), Capital
(Name of buyer), Capital
xxx
xxx
The purchase price of the interest sold to the new partner may be:
1.
2.
3.
equal to the book value of interest sols
less than the book value of interest sold
more than the book value of interest sols
The new partner may pay more than or less than the book value of the interest sold by the old
partner resulting in a gai or loss in the transaction. This gain or loss, however, is a personal gain
or loss of the selling partner and not of the partnership. Therefore, no gain or loss is recognized
in the partnership books.
41 | P a g e
Illustrative Problem A: Coloma and Claudio are partners with capital balances of P100,000 and
P50,000, respectively. They share profits and losses equally. Cordero is a new partner
20,000
20,000
The P20,000 paid by the new partner Cordero to the old partner Coloma should not be reflected
in the partnership books because the said amount goes directly to Coloma. What is recorded in
the partnership books is the transfer of 1/5 of the capital of Coloma to Cordero. The amount paid
in the purchase is equal to the book value of the acquired 1/5 interest; hence, the sale of interest
does not give rise to gain or loss to Coloma.
Case 1 b- Purchase at book value from more than one partner. Cordero purchases 1/5
interest from the old partners by paying P30,000.
Coloma, Capital
Claudio, Capital
Cordero, Capital
P100,000 x 1/5 = P20,000
P 50,000 x 1/5 = P10,000
20,000
10,000
30,000
The P30,000 paid by Cordero to Coloma and Claudio should not be reflected in the partnership
books because the said amount goes directly to Coloma and Claudio. What is recorded in the
partnership books is the transfer of 1/5 of the capital of the old partners Coloma and Claudio
(P20,000 and P10,000, respectively) to the new partner Cordero. The admission of the new
partner, by purchasing a 1/5 interest from the old partners at book value, does not result in a
gain or loss to the old partners.
Case 2 – Purchase at less than book value. Cordero purchases 1/5 interest form the old
partners by paying P25,000.
Coloma, Capital
Claudio, Capital
Cordero, Capital
P100,000 x 1/5 = P20,000
P 50,000 x 1/5 = P10,000
20,000
10,000
30,000
The P25,000 paid by Cordero to Coloma and Claudio should not be reflected in the partnership
books because the said amount was paid directly to the partners. What is recorded in the
partnership books is the transfer of 1/5 of the capital of the old partners (P20,000 and P10,000,
Chapter 4 – Partnership
respectively) to the new partner. The difference of P5,000 is a personal loss of the selling (old)
partners.
Step 4 - Add the share of each partner on the asset revaluation to their capital balances to get
the capital balance after the asset revaluation.
Case 3 – Purchase at more than book value. Cordero pays P40,000 for a 1/5 interest of the old
partners.
Coloma, Capital
20,000
Claudio, Capital
10,000
Cordero, Capital
30,000
Step 5 - Compute the amount of interest transferred by the old partners to the new partner
based on their capital after the asset revaluation.
The P40,000 payment made by Cordero to Coloma and Claudio should not be reflected in the
partnership books. What is recorded in the books of the partnership is the transfer of 1/5 of the
capital of the old partners to the new partner. The P10,000 excess payment is a personal gain of
Coloma and Claudio.
Key Points. In the preceding four cases, 1a, 1b, 2 and 3, the transfer of capital from the old
partners to the new partner is recorded at book value regardless of the amount paid. Payments
at less than book value and at more than book value are recorded as if they were made at book
value.
In addition, the four cases shows that the total partnership capital v=before and after the
admission of the new partner are the same Thus, the total partnership capital of P150,000 before
the admission of Cordero is also the total partnership capital after his admission. Therefore, the
admission of a new partner by purchase will not affect the total assets and the total capital of the
partnership.
ASSET REVALUATION UPON ADMISSION OF A NEW PARTNER BY
PURCHASE
Revaluation of assets of the old partnership, however, is generally undertaken prior to the
admission of a new partner. The effect of the asset revaluation is carried to the capital accounts
of the old partners. The adjusted capital of the old partners becomes the basis for the interest
transferred to the new partner.
The procedures under this approach are as follows:
Step 1 - Compute the new partnership capital using as basis the amount to be paid by the
incoming partner and his fraction of interest.
Step 2 - Deduct the capital of the old partnership from the capital of the new partnership. The
difference is the asset revaluation.
Step 3 - Allocate the asset revaluation among the old partners in accordance with their residual
profit and loss sharing agreement.
42 | P a g e
Step 6 - Prepare the entry to record the admission of the new partner.
To illustrate, assume the same data in Illustrative Problem A where Coloma and Claudio are
partners with capital balances of P100,000 and P50,000, respectively. The share profits and
losses equally. Cordero is a new partner who purchases a 1/5 interest from Coloma and Claudio
paying P40,000. However, before the admission of Cordero, partnership assets are to be revalued
using as basis the amount to be paid by Cordero.
Solution:
Step 1 - The new partnership capital is equal to the amount paid by the incoming partner
divided by his fraction of interest.
New partnership capital = P40,000 ÷ 1/5 = P200,000
Step 2 - The amount of asset revaluation is equal to the new partnership capital less old
partnership capital.
Asset revaluation = P200,000 - P150,000 = P50,000
Step 3 - The allocation of the amount of the asset revaluation among the old partners is
as follows: P50,000 /2 = P25,000 per partner.
Step 4 - The capital balances of the old partners after asset revaluation is equal to their old
capital balances plus their share on asset revaluation.
Capital balances before revaluation
Share on asset revaluation
Capital balances after revaluation
Coloma
P100,000
25,000
P125,000
Claudio
P50,000
25,000
P 75,000
Step 5 - The amount of interest transferred by the old partners to the new partner based on the
new capital balances (capital balances alter asset revaluation)
Coloma
Claudio
Capital balances after revaluation
P125,000
P75,000
Interest transferred
1/5
1/5
Capital transferred to Cordero
P 25,000
P15,000
Chapter 4 – Partnership
STEP 6 - The journal entries to record the evaluation of asset and the admission of Cordero are
as follows:
Other Assets
50,000
Coloma, Capital
25,000
Claudio, Capital
25,000
Coloma, Capital
25,000
Claudio, Capital
15,000
Cordero, Capital
40,000
ADMISSION BY INVESTMENT
The admission of a new partner by investment is a transaction between the original partnership
and the new partner. The use f the terms like invests and contributes represent admission of a
new partner by investment. The investment of the new partner increases the total assets and the
total capital of the partnership. The entry to record the admission of the new partner depends
upon the capital interest credited to the partners’ accounts.
Using the information in the example given, the total contributed capital is P400,000, the sum of
the old partner’s contribution of P300,000 and the new partner’s contribution of P100,000.
Bonus – it is the transfer of capital from one partner to another. A bonus to the old partners is
given by the new partner. It is a reduction in the capital of the new partner and an increase in the
capital of the old partners. The capital accounts of the old partners are credited according to their
profit and loss ratio. A bonus to the new partner is given by the old partners. It is a reduction in
the capital of the old partners and an increase in the capital of the new partner. The capital
account of the new partner is credited and the capital accounts of the old partners are debited
according to their profit and loss ratio.
The following procedures will be helpful in the computation and determination of the ownership
of bonus:
DEFINITION OF TERMS
Agreed Capital (AC) – it is the amount of new capital set by the partners for the partnership. It
may be equal to, more than, or less than the total contributions of the partners. Other terms used
for agreed capital are: new firm capital, total capital and agreed capitalization. The terms of the
admission of a new partner may indicate the agreed capital. If agreed capital is not indicated, it
can be computed in either of two ways:
1.
Multiply agreed capital (AC) by the fraction of interest of the new partner. The result is
the capital credit of the new partner in the new partnership.
2.
Compare the capital credit with the investment of the new partner.
a.
If the capital credit is more than the investment of the new partner, the difference
is bonus to the new partner.
b.
If the capital credit is less than the investment of the new partner, the difference is
bonus to the old partners.
Investment of the new partner divided by the new partner’s fraction of interest; or
Investment of the old partners (equal to the net assets or capital of the partnership)
divided by the old partners' fraction of interest.
Asset Revaluation - necessary adjustment in asset values upon admission of a new partner. The
adjustment in assets may be determined as the difference between the agreed capital and the
total contributed capital. Generally, asset revaluations upon partnership formation relate only to
the partners of the old partnership.
Example: Corpus and Carlos are partners with capital balances of P150,000 each. Cabral invests
P100,000 for a 2/5 interest in the new partnership. The agreed capital of the new partnership is
determined as follows:
Capital Credit - it is the interest or equity of a partner in the firm. It is computed by multiplying
agreed capital by the fraction of interest of a partner
1.
2.
Computation 1 -
The new partner’s investment used as a basis
P100,000 ÷ 2/5 = P250,000
PROBLEMS RELATING TO ADMISSION OF A NEW PARTNER BY
INVESTMENT
Computation 2 -
The old partners' investment used as a basis
P300,000 ÷ 3/5 = P500,000
Situations relating to admission of a new partner by investment may fall under any of the
following:
Total Contributed Capital (CC) - it is the investment of all the partners, both old and new, to the
partnership. It is the sum of the capital balance of the old partners (net asset investment) and the
contribution of the new partner.
43 | P a g e
1.
Agreed capital is given. When agreed capital is given, the admission of a new partner by
investment will give rise to any of the following cases:
a. No Bonus, no Asset Revaluation
b. Bonus to old partners, no Asset Revaluation
c. Bonus to new partner, no Asset Revaluation
Chapter 4 – Partnership
d.
Asset Revaluation, no Bonus
2.
Agreed capital is not given. When agreed capital is not given, the problem calls for two
alternative solutions:
a. Bonus method
b. Asset revaluation method
3.
Agreed capital is not given but the basis for its computation is indicated in the terms of
admission.
4.
The amount of contribution of the new partner is not given.
5.
No fraction of interest for either the new or old partners is given.
Step 3
Determine if there is bonus.
a. Compute for the capital credit of the new partner
AC x fraction of interest, P400,000 x 1/4 = P100,000
b. Write this amount in the AC column of the new partner.
c. Compare the new partner's AC with his CC. In this case, AC and CC are the same,
therefore, there is no bonus.
Step 4
The above table will be completed as follows:
a.
AC or capital credit of the old partners
AC x fraction of interest (4/4 - ¼ = ¾ )
P400,000 x ¾ = P300,000
b.
A completed table appears as follows:
The following are the illustrations of the various problems involving admission of a new partner
by investment.
Old
New
P
AGREED CAPITAL IS GIVEN
Illustrative Problem B: Calmer and Castro are partners with capital balances of P200,000 and
P100,000, respectively. They share profits and losses equally Conde is to be admitted in the
partnership.
Case 1 – No Bonus, no Asset Revaluation. Conde invests P100,000 for a ¼ interest in the agreed
capital of P400,000.
Cash
Condo, Capital
100,000
Step 2
Fill in the given data in the table.
a. Partners, old and new.
b. AC column, with the total written first
c. CC column
AC
Old
New
P 400,000
P
P
CC
300,000
100,000
400,000
Compare AC and CC. In this case, AC = CC
(400,000=P400,000), therefore, there is no asset revaluation.
44 | P a g e
c.
AC
300,000
100,000
400,000
P
P
CC
300,000
100,000
400,000
Conclusion based on the table
(i)
AC = CC, therefore, there is no asset revaluation
(ii)
New partner: AC = CC, therefore, there is no bonus
(iii)
Old partners: AC = CC, therefore, there is no bonus either
In actual problem solving, only one table is prepared. The missing items are filled a they are
needed.
Case 2 – Bonus to the old partners, no Asset Revaluation. Conde invests P100,000 for a 1/5
interest in the new firm capitalization of P400,000.
100,000
Solution:
Step 1
P
Cash
Conde, Capital
100,000
Condo, Capital
Calma, Capital
Castro, Capital
20,000
100,000
10,000
10,000
These entries were made to show clearly the transfer of capital iron the new partner to the old
partners. However, a compound entry may also be prepared as follows:
Cash
Condo, Capital
Calma. Capital
Castro, Capital
100,000
80,000
10,000
10,000
Chapter 4 – Partnership
Solution:
Step 1
Fill in the table as in Case l. The completed table after Steps I to 4 is shown below:
Old
New
AC
P 320,000
80,000
P 400,000
CC
P 300,000
100,000
P 400,000
Bonus
P 20,000
(20,000)
-
Step 2
Compare AC and CC. In this case, AC = CC (P400,000 = P400,000) Therefore, there is no
asset revaluation but there may be bonus.
Step 3
Determine if there is bonus.
a. Compute for the capital credit of the new partner.
AC x fraction of interest, P400,000 x 1/5 = P80,000.
b. Write this amount in the AC column of the new partner.
c. Compare the new partner's AC with his CC. In this case, his AC < CC (P80,000 P100,000); therefore, the decrease in his contributed capital represents bonus to
the old partners.
Step 4
Complete the table by filling in the missing figures.
a. AC or capital credit of the old partners.
AC x fraction of interest,
P400,000 x 4/5 = P320.000 or
CC + Bonus to the old partners
P300,000 + P20,000 = P320,000
The bonus is shared by the old partners according to their profit and loss sharing
ratio.
b. A completed table is shown in Step I.
c. Conclusion based on the table:
(i)
AC = CC, therefore, there is no asset revaluation.
(ii)
New partner: AC < CC, therefore, he gives the bonus.
(iii)
Old partners: AC > CC, therefore, they receive the bonus shared according
to their profit and loss ratio.
Case 3 – Bonus to new partner, no Asset Revaluation. Condo invests P60,000 for a 1/4 interest
in the total capitalization of P360,000.
Cash
Calma, Capital
Castro, Capital
Conde, Capital
45 | P a g e
60,000
15,000
15,000
90,000
Solution:
Step 1 Fill in the table as in Cases 1 and 2. The completed table after Steps l to 4 is shown
below:
AC
CC
Bonus
Old
P 270,000
P 300,000
P (30,000)
New
90,000
60,000
30,000
P 360,000
P 360,000
Step 2
Compare AC and CC. In this case, AC = CC (P360,000 = P360,000).
Therefore, there is no asset revaluation but there may be bonus.
Step 3
Determine if there is bonus.
a. Compute for the capital credit of the new partner.
AC x fraction of interest; P360,000 x 1/4 = P90 000
b. Write this amount in the AC column of the new part
c. Compare the new partner's AC with his CC. In this case, his AC > CC (P90,000 P60,000; therefore, the increases in his contributed capital represents bonus from
the old partners
Step 4
Complete the table filling in the missing figures.
a. AC or capital credit of the old partners.
AC x fraction of interest
P360,000 x 3/4 = P270,000 or
CC – Bonus to old partners
P300,000 - P30,000 = P270,000
The bonus given to the new partner is shared by the old partners according to their
profit and loss sharing ratio.
b.
A completed table is shown in Step 1
Case 4 – Positive Asset Revaluation, no Bonus. Conde invests P100,000 for a 1/5 interest in
the agreed capital of P500,000.
Other Assets
Calma, Capital
Castro, Capital
Cash
Conde, Capital
100,000
50,000
50,000
100,000
100,000
Solution:
Step 1 Fill in the table as in Cases 1 to 3, The completed table after Steps 1 to 4 is shown below:
Chapter 4 – Partnership
Old
New
AC
P 400,000
100,000
P 500,000
CC
P 300,000
100,000
P 400,000
Asset
Revaluation
P 100,000
P 100,000
Old
New
AC
P 240,000
60,000
P 300,000
CC
P 300,000
60,000
P 360,000
Asset
Revaluation
(P 60,000)
P 60,000
Step 2
Compare AC and CC. In this case, AC > CC (P500,000 > P400,000).
Therefore, there is a positive asset revaluation.
Step 2
Compare AC and CC. In this case, AC < CC (P300,000 < P360,000).
Therefore, there is a negative asset revaluation.
Step 3
Determine if there is bonus.
a. Compute for the capital credit of the new partner.
AC x fraction of interest; P500,000 x 1/5 = P100,00.
b. Write this amount in the AC column of the new partner.
c. Compare the new partner's AC with his CC. In this case. his
AC = CC (P100,000 = P100,000); therefore, there is no bonus.
Step 3
Determine if there is bonus. .
a. Compute for the capital credit of the new partner.
AC x fraction of interest; P300,000 x 1/5 = P60,000.
b. Write this amount in the AC column of the new partner.
c. Compare the new partner's AC with his CC. In this case, his
AC = CC (P60,000 = P60,000), therefore, there is no bonus.
Step 4
Complete the table by filling in the missing figures.
a. AC or capital credit of the old partners.
AC x fraction of interest
P500,000 x 4/5 = P400,000 or
CC + Asset Revaluation
P300,000 + P100,000 = P400,000
b. A completed table is shown in Step l.
c. Conclusion based on the table:
(i)
AC > CC, therefore, there is u positive asset revaluation
(ii)
New partner: AC = CC. therefore, there is no bonus.
(iii)
Old partners: AC > CC, therefore, they are credited for the
asset revaluation shared according to their profit and loss ratio.
Step 4
Complete the table by filling in the missing figures.
a. AC or capital credit of the old partners.
AC x fraction of interest
P300,000 x 4/5 = P240,000 or
CC – Asset Revaluation
P300,000 - P60,000 = P240,000
b. A completed table is shown in Step l.
c. Conclusion based on the table:
(i) AC < CC, therefore, there is a negative asset revaluation.
(ii) New partner: AC = CC, therefore, there is no bonus.
(iii) Old partners: AC < CC, therefore, they are charged for the asset revaluation
shared according to their profit and loss ratio.
Case 5 – Negative Asset Revaluation, No bonus. Conde invests P60,000 for a 1/5 interest in the
agreed capital of P300,000.
Calma, Capital
Castro, Capital
Other Assets
30,000
30,000
Cash
60,000
Conde, Capital
60,000
60,000
Solution:
Step 1
below:
Fill in the tables as in Cases 1 to 4. The completed table after Steps 1 to 4 is shown
46 | P a g e
In the succeeding illustrations, the tables are summarized for easier comparison.
AGREED CAPITAL IS NOT GIVEN
There are cases when the contributions and the fractions of interest of the new partner
are given, but the agreed capitalization of the new firm is not specified. When such a
situation exists, the admission of the new partner is recorded using any of these two
methods:
1.
2.
Bonus method
Asset Revaluation method
Chapter 4 – Partnership
BONUS METHOD (AC = CC)
1.
Under this method. the agreed capitalization of the new partnership is equal to the total amount
of contribution of all the partners. both old and new. No asset revaluation is recognized but there
will be a transfer of capital called bonus. Bonus in the new partner is given by the old partner.
Bonus to the old partner. Bonus comes from the new partner.
Bonus Method
Cash
100,000
Conde, Capital
Calma, Capital
Castro Capital
80,000
15,000
5,000
ASSET REVALUATION METHOD
An asset revaluation is made to properly value the assets of the partnership prior to admission
of a new partner. An asset revaluation will result to either an increase or decrease in the recorded
amount of the partnership assets and partners' capital. An asset revaluation increase (positive
asset revaluation) indicates that some partnership assets are undervalued. On the other hand. an
asset revaluation decrease (negative asset revaluation) indicates that some partnership assets
are overvalued. Under the asset revaluation method, the balances of partnership assets and the
partners' capital must be adjusted prior to the admission of a new partner. These adjustments
must be recorded prior to recording the admission of the new partner.
Old (4/5)
New (1/5)
AC
P 320,000
80,000
P 400,000
CC
P 300,000
100,000
P 400,000
Bonus
P 20,000
(20,000)
-
The agreed capital of the partnership is equal to capital contribution. The capital credit of
the old and new partners are computed as follows:
New = P400,000 x 1/5 = P 80,000
Old = P400.000 x 4/5 = P 320,000
POSITIVE ASSET REVALUATION METHOD (AC ˃ CC)
A positive asset revaluation increases the old partnership assets and the capital accounts of the
old partners. The increase is shared by the old partners based on their profit and loss sharing
ratio. Here. the agreed capitalization of the new partnership is more than the total amount of
contribution of both the old and new partners.
Under this method, the agreed capitalization is computed as follows:
AC = New partner’s CC ÷ new partner’s fraction of interest
NEGATIVE ASSET REVALUATION METHGD (AC < CC)
A negative asset revaluation decreases the old partnership assets and the capital accounts of the
old partners. The decrease is shared by the old partners based on their profit and loss sharing
ratio. Here, the agreed capitalization of the new partnership is less than the total amount of
contribution of both the old and new partners.
The agreed capitalization is computed under this method in the same manner as in positive asset
revaluation
Illustrative Problem C. Conde invests P100,000 for a 1/5 interest in the partnership of Calma
and Castro. The contributions of Calma and Castro are P200,000 and P100,000 respectively, and
they share profits and losses I the ration of 3:1. After the admission of Conde, profits and losses
will be divided equally.
47 | P a g e
The capital credit of the new partner is less than his capital contribution, therefore, the new
partner gives the bonus. The bonus is shared by the old partners according to their profit
and loss ratio.
2.
Positive Asset Revaluation Method
Other Assets
Calma, Capital
Castro, Capital
100,000
Cash
Conde, Capital
100,000
75,000
25,000
AC
Old (4/5)
New (1/5)
P 400,000
100,000
P 500,000
100,000
CC
P 300,000
100,000
P 400,000
Revaluation
P 100,000
P 100,000
Chapter 4 – Partnership
The agreed capital of the new partnership is computed by dividing the new partner's
contribution by his fraction of interest (P100,000 ÷ 1/5 = P500,000).
An agreed capital of more than the contributed capital indicated that there is an understatement
in some assets of the partnership upon the admission of a new partner. The agreed capital of
P500,000 when compared with the contributed capital of P400,000 indicates a P100,000
increase in assets and capital for the asset understatement. The AC or capital credit of the old
partners which is P400,000 (P500,000 x 4/5) is P100,000 more than their contributed capital.
Therefore, the old partners are credited for the revaluation of assets. The old partners share on
the revaluation of assets according to their profit and loss ratio.
Illustrative Problem D: Conde invests P80,000 for a 1/4 interest in the partnership of Calma and
Castro. The contributions of Calma and Castro are P200,000 and P100,000 respectively, and they
share profits and losses in the ratio of 3:1. After the admission of Conde, profits and losses will
be divided equally.
1.
Bonus Method
Cash
Calma, Capital
Castro, Capital
Conde, Capital
Old (3/4)
New (1/4)
80,000
11,250
3,750
CC
P 300,000
80,000
P 380,000
Old (3/4)
New (1/4)
80,000
80,000
AC
P 240,000
80,000
P 320,000
CC
P 300,000
80,000
P 380,000
The agreed capital of the new partnership is computed by dividing the new partner's
contribution by his fraction of interest (P80,000 + ¼ = P320,000).
An agreed capital that is less than the contributed capital indicates that there is an overstatement
in some assets of the partnership upon the admission of a new partner. The agreed capital of
P320,000 when compared with the contributed capital of P380,000 indicates a P60,000
reduction in assets and capital for the asset overstatement. The AC or capital credit of the old
partners which is P240,000 (P320,000 x ¾) is P60,000 less than their contributed capital.
Therefore, the old partners are charged for the revaluation of assets. The old partners share on
the revaluation of assets according to their profit and loss ratio.
(P15,000)
15,000
-
In Illustrative Problem C, Conde is given a 1/5 interest in the partnership and a 1/3 share of
profits upon admission. Both the bonus method and the asset revaluation method can be used in
determining the required interest for the new partner but the two methods may not offer the
same ultimate results. Based on the information and assumptions given, the comparison between
the bonus method and the asset revaluation method may be illustrated as shown below.
Asset
Revaluation
The agreed capital of the partnership is equal to capital contribution. The capital credit of
the old and new partners are. computed as follows:
New = P380,000 x ¼ = P95,000
Old = P380,000 x ¾ = P285,000
The capital credit of` the new partner is greater than his capital contribution, therefore, he
receives the bonus. The bonus is shared by the old partners according to their profit and
loss ratio.
2.
Negative Asset Revaluation Method
Calma, Capital
Castro, Capital
Other Assets
48 | P a g e
(P60,000)
(P60,000)
COMPARISON OF BONUS AND ASSET REVALUATION METHOD
95,000
AC
P 285,000
95,000
P 380,000
Cash
Conde, Capital
45,000
15,000
60,000
Balances under the bonus method
Balances under the asset revaluation
method
Share on the additional depreciation
on asset revaluation (equally)
Balances after the add’l depreciation
on asset revaluation
Net advantage (disadvantage) of
using the asset revaluation method
Calma,
Capital
Castro,
Capital
Conde,
Capital
P 100,000
P 215,000
P 275,000
P 105,000
P 125,000
P 80,000
P 100,000
(100,000)
( 33,333)
( 33,333)
( 33,334
P 241,667
P 26,667
P
91,667
(P 13,333)
P
66,666
(P 13,334)
Based on the above analysis, Calma will prefer the asset revaluation method while Castro and
Condo will prefer the bonus method.
Chapter 4 – Partnership
AGREED CAPITAL Is NOT GIVEN BUT BASIS FOR ITS COMPUTATION IS INDICATED
IN THE TERMS OF ADMISSION
Using the same data in Illustrative Problem D where Calma and Castro have capital balances of
P200,000 and P100,000, respectively and sharing profits and losses in the ratio of 3:1, Conde
invests P100,000 in the firm and is credited for P50,000 which is to be 1/8 of the new firm capital.
The entry to record the admission of Conde into the partnership is
Cash
100,000
Conde, Capital
Calma, Capital
Castro, Capital
AC
P 350,000
50,000
P 400,000
Old (7/8)
New (1/8)
50,000
37,500
12,500
CC
P 300,000
100,000
P 400,000
P 50,000
(50,000)
-
THE AMOUNT OF THE CONTRIBUTION OF THE NEW PARTNER IS NOT GIVEN
Example 1: Calma and Castro have capital balances of P200.000 and P100,000, respectively.
They share profits and losses in the ratio of 3:1. Conde invests sufficient amount for 1/3 interest.
The journal entry to record the admission of Condo follows:
Example 2: Coral, Cielo, and Camu are partners with capital balances of P 112,000, P 130,000,
and P 58,000, respectively, sharing profits and losses equally. Cueva is admitted as a new
partner bringing with him his expertise and good reputation. He is to invest cash for a 25%
interest in the assets of the partnership which includes a credit of P18,750 for bonus upon the
admission.
The journal entry to record the admission of the new partner is as follows:
Cash
Coral, Capital
Cielo, Capital
Camu, Capital
Cuevas, Capital
75,000
6,250
6,250
6,250
93,750
Follow the same procedures as in Example 1. The P18,750 bonus given by the old partners to the
new partner has to be deducted first from the total capital of the old partners to get their 75%
interest. Thus:
P112,000 = P130,000 + P58,000 – P18,750 = P281,250
P281,250 / 75% = P375,000
,
The amount to be contributed by the new partner is computed by deducting the P18,750 bonus
received from the old partners from the 25% interest acquired from the old partners. Thus:
P375,000 x 25% = P93,750
P93,750 – P18,750 = P75,000
FRACTION OF INTEREST IS NOT GIVEN
150,000
Conde, Capital
150,000
Solution:
Computations similar to those made in the previous cases are no longer necessary. To arrive at
the amount to be contributed by the new partner.
1. the new firm capital (AC) is computed by dividing the old partners' contributions by
their fraction of interest (P300,000 ÷ 2/3) = P450,000, and
49 | P a g e
the investment of the new partner is computed by multiplying the AC by his fraction of
interest (P450,000 x 1/3 = P150,000). Conde has to invest P 150,000 in order to have a
1/3 interest in the firm.
Solution:
The agreed capital is not given but the basis for its computation is indicated in the problem. The
new partner is to be credited for P50,000 which is 1/8 of the new firm capital. Thus, P50,000 ÷
1/8 = P400,000 agreed capital. The agreed capital of (P400,000) is equal to total contributed
capital, therefore, there is no asset revaluation. But there might be bonus. The capital credit of`
the new partner is less than his contribution, therefore, he gives the bonus. The bonus is shared
by the old partners in their profit and loss ratio.
Cash
2.
Conde invests P50,000 in the firm. However, upon his admission
P10,000 bonus is allowed by the old partners.
The entry to record the admission of the new partner is:
Cash
50,000
Calma, Capital
7,500
Castro, Capital
2,500
Conde, Capital
60,000
Chapter 4 – Partnership
REVIEW of the LEARNING OBJECTIVES
1.
Define partnership dissolution and identify the conditions giving rise to it. Partnership
dissolution is a change in the relation of the partners caused by any partner ceasing to be
associated in the carrying out of the business. Dissolution of a partnership may be caused
by any of the following conditions: (1) admission of new partner; (2) retirement or
withdrawal of a partner; (3) death, incapacity or bankruptcy of a partner, or (4)
incorporation of a partnership.
2.
Understand the accounting procedures to record the admission of a new partner by
purchase. A new partner may be admitted into the partnership by purchasing a capital
equity interest from one or more of the old partners. Admission of a new partner by
purchase represents a transfer of capital from the old partner/partners to the new partner.
The transfer of capital is recorded at the book value of the interest sold regardless of the
amount paid for the interest. Any gain or loss indicated in the transaction is a personal gain
or loss of the selling partner. Asset revaluation, however, may be undertaken by the old
partnership before admission of a new partner. In such a case, a positive or negative asset
revaluation will always accrue to the old partners.
3.
Understand the accounting procedures to record the admission of a new partner by
investment. The admission of a new partner by investment is a transaction between the
original partnership and the new partner. The new partner's contribution increases the total
assets and the total capital of the partnership. When the capital contribution of the new
partner is not equal to his capital credit in the new partnership or when the capital
contributions of the old partners is not equal to their capital credit in the new partnership.
the difference is accounted for by any of the following methods: (1) bonus method (bonus
to the old partners from the new partner or bonus to the new partner from the old partners);
(2) asset revaluation method either positive or negative revaluation.
MULTIPLE CHOICE
MC 4-1 If the total contributed capital exceeds the agreed capital with the new partner’s
investment is the same as his capital credit, then the admission of the new partner
involved a
a. bonus to new partner
b. bonus to old partners
c. negative asset revaluation
d. positive asset revaluation
MC 4-2 If the agreed capital is equal to the total contributed capital with the capital credit and
contribution of the old and new partners being the same, there exists
a. asset revaluation and bonus
b. negative asset revaluation
c. no asset revaluation and no bonus
d. positive asset revaluation
MC 4-3 If the capital credit of the new partner is less than his contribution with no adjustment
in asset values. then the admission resulted in a
a. bonus to the old partners
b. bonus to the new partner
c. no bonus
d. both A and B
MC 4-4 Calibo and Camos are partners with capital balances of P60,000 and P80,000 and
sharing profits and losses 40% and 60% respectively. If Cueva is admitted as partner
paying P50,000 in exchange for 50% of Calibo's equity, the entry in the partnership
books should be as follows:
a. Calibo. Capital
50,000
Cueva, Capital
50.000
b. Calibo, Capital
30,000
Cueva, Capital
30,000
c. Cash
45,000
Other Assets
15,000
Cueva, Capital
50,000
d. Cash
50.000
Calibo, Capital
15,000
Cueva, Capital
45.000
MC 4-5 Chan, Ching, and Chen are partners who share profits and losses in the ratio of 5:3:2
respectively. They agree to sell Chat 25% of their respective capital and profits and
losses ratio for a total payment directly to the partners in the amount of P140,000. They
agree that asset revaluation of P60,000 is to be recorded prior to the admission of Chat.
The condensed statement of financial position of the CCC Partnership is presented on
the next page.
50 | P a g e
Chapter 4 – Partnership
Assets
Cash
P 60,000
Other Assets
540,000
P 600,000
Liabilities and Capital
Liabilities
P 100,000
Chan, Capital
250,000
Ching, Capital
150,000
Chen, Capital
100,000
Total Liabilities and Capital
P 600,000
The capitals of Chan, Ching, and Chen respectively after the payment and admission of
Chat are
a. P187,500; P112,500; P 75,000
b. P210,000; P126,000; P 84,000
c. P280,000; P168,000; P112,000
d. P250,000; P150,000; P100,000
MC 4-6 C2 Partnership had a net income of P24,000 for the month ended September 30,2014.
Carreon purchased an interest in the C2 Partnership of Calvo and Calma by paying Calvo
P72,000 for half of his capital and half of his 50% profit sharing interest. At this time,
the capital balance of Calvo was P96,000 and the capital balance of Calma was
P168,000. Carreon should receive a credit to this capital account of
a. P36,000
b. P48,000
c. P72,000
d. P84,000
MC 4-8 On May 1, 2014, the business accounts of Cordova and Constancio appear below:
Cordova
Cash
Account Receivable
Inventories
Land
Buildings
Furniture and Fixtures
Other Assets
Equities
Accounts Payable
Notes Payable
Cordova, Capital
Constancio, Capital
P 100,000
260,000
P 360,000
Liabilities
Chan, Capital
Ching, Capital
Chen, Capital
Total Liabilities and Capital
P 80,000
120,000
80,000
80,000
P 360,000
All the partners agree to admit Cua as 1/6 partner in the partnership without any asset
revaluation nor bonus. Cua shall contribute assets amounting to
a. P 20,000
b. P 56,000
c. P 70,000
d. P120,000
51 | P a g e
11,000
234,536
120,035
603,000
50,345
2,000
P 1,020,916
P 178,940
200,000
641,976
P
22,354
567,890
260,102
428,267
34,789
3,600
P 1,317,002
P 243,650
345,000
728,352
P 1,317,002
Cordova and Constancio agreed to form a partnership contributing their respective
assets and equities subject to the following adjustments:
b.
c.
Cash
Other Assets
P
P 1,020,916
a.
MC 4-7 Cheng, Chavez and Chato are partners sharing profits and losses in the ratio of 4:3:3,
respectively. The condensed statement of financial position of their partnership as of
December 1, 2014 is presented below
Constancio
Assets
Accounts Receivable of P20,000 in Cordova’s books and P35,000 in Constancio’s
are uncollectible
Inventories of P5,500 and P6,700 are worthless in Cordova’s and Constancio’s
respective books.
Other Assets of P2,000 and P3,600 in Cordova’s and Constancio’s respective books
are to written off.
The capital accounts of the partners after the adjustments will be
Cordova
Constancio
a.
P614,476
P683,052
b.
P615,942
P717,894
c.
P640,876
P712,345
d.
P613,576
P683,350
MC 4-9 Using the information in MC 4-8, how much assets does the partnership have?
a. P2,237,918
b. P2,265,118
c. P2,337,918
d. P2,365,218
Chapter 4 – Partnership
MC 4-10 Using the information in MC 4-8, how much assets does the partnership have?
a. P2,237,918
b. P2,265,118
c. P2,337,918
d. P2,365,218
MC 4-11 Using the information in MC 4-8 and assuming after Cuyugan's admission, the profit
and loss sharing ratio was agreed to be 40:40:20 based on capital credits, how much
should the cash settlement be between Cordova and Constancio?
a. P32,272
b. P32,930
c. P33,602
d. P34,288
MC 4 -12Using the information in MC 4-8 and assuming that during the first year of operations
the partnership earned an income of P325,000 and that this was distributed in the
agreed manner. Assuming further that drawings were made in these amounts: Cordova,
P50,000, Constancio, P65,000, and Cuyugan, P28,000, how much are the capital
balances of the partners after the first year?
a.
b.
c.
d.
P750,627
P728,764
P757,915
P743,121
P735,177
P713,764
P742,315
P727,827
P372,223
P361,382
P375,837
P368,501
MC 4-13 Conrado, Cosio Cosme are partners whose and capital balances and share in profits are
as follows:
Conrado
P250,000
50%
Cosio
150,000
25%
Cosme
100,000
25%
Cueto is admitted into the partnership by paying P60,000 for 1/3 of the share in equity
of Cosio and by contributing P200,000. The partners agree to the total capitalization to
P750,000, 1/3 Of which is Cueto's capital credit. Cueto's share in net income is also l/3
and the old partners are to divide net income in the old ratio among themselves.
The profit and loss sharing, ratio among Conrado, Cosio and Cosme after the admission
of Cueto is
a. 50%, 25%, 25%, respectively
b. 30%, 15%, 15%, respectively
c. 2/6, 1/6, 1/6, respectively
d. 1/3, 1/3, 1/3, respectively
52 | P a g e
MC 4-14 Using the information in MC 4-13, the amount of the asset revaluation is
equal to
a. P 15,000
b. P 50,000
c. P120,000
d. P200,000
MC 4-15 Using the information in MC 4-13, the capital balances of the old partners after the
admission of Cueto are
a. P250,000, P150,000, P100,000, respectively
b. P275,000, P112,500, P112,500, respectively
c. P250,000, P200,000, P100,000, respectively
Chapter 5 – Change in Capital Structure by Withdrawal, Retirement, Death or Incapacity of a Partner
CHAPTER 5
CHANGE IN CAPITAL STRUCUTRE BY WITHDRAWAL,
RETIREMENT, DEATH OT INCAPACITY OF A
PARTNER
2.
3.
The partnership may allow any of its partners to withdraw ore retire from the firm. The business
may continue after such withdrawals; on the other hand, the interest of retiring or withdrawing
partner may be:
1.
2.
3.
LEARNING OBJECTIVES
1.
CHANGE IN CAPITAL STRUCTURE BY WITHDRAWAL OR RETIREMENT OF
A PARTNER
Discuss and understand the accounting procedures in recording the retirement or withdrawal of
a partner by sale of interest to a new partner or to the continuing or remaining partners.
Discuss and understand the accounting procedures in recording the retirement or withdrawal of
a partner by sale of interest to the partnership
Discuss and understand the accounting procedures in recording the dissolution of a partnership
due to death or incapacity of a partner.
PREVIEW OF THE CHAPTER
Sold to a new partner (outsider)
Sold to the continuing (remaining) partners
Sold to the partnership
SALES OF INTEREST TO A NEW PARTNER
With the consent of the remaining partners, the retiring partner may sell his interest to an
outsider. The sale is recorded in the same manner as in the admission of a new partner by
purchase. The partnership recognizes only the transfer of capital interest from the retiring
partner to the new partner.
SALE OF INTEREST TO CONTINUING PARTNERS
The interest of the retiring partner maybe acquired by any of the continuing partners. The
transaction is recorded in the same manner as in the sale of interest to a new partner The
partnership recognizes only the transfer of capital interest from the retiring partner to the
acquiring planner or partners.
CHANGE IN
CAPITAL STRUCTURE
SALE OF INTEREST TO THE PARTNERSHIP
Retirement or
Withdrawal
Sale of Interest to a
New Partner or
Continuing Partners
•
•
•
Equal to capital
interest
At less than capital
interest
At more than capital
interest
Retirement or Withdrawal
Sale of Interest to the
Partnership
•
•
Death or Incapacity of a
Partner
•
Equal to capital interest
At less than or more than
capital interest
•
•
Bonus method
Asset Revaluation
method
•
Equal to capital
interest
At less than or more
than capital interest
• Bonus method
• Asset
Revaluation
Method
A retiring partner may sell his capital interest to the continuing partners through the
partnership. The partnership has the obligation to make payment to the retiring partner
either by:
1. payment in cash;
2. transfer of noncash assets; or
3. recognition of a liability for the full or the balance of the unpaid interest of the retiring
partner.
The purchase price or amount of settlement by the partnership to the retiring partner may be:
1. equal to the interest of the retiring partner (at book value)
2. less than the interest of the retiring partner (at less than book value)
3. more than the interest of the retiring partner (at more than book value)
When the payment to the retiring partner is less than or more than his capital interest, the
Difference between the purchase price and the capital interest may be accounted for using:
1. bonus method
2. asset revaluation method
53 | P a g e
Chapter 5 – Change in Capital Structure by Withdrawal, Retirement, Death or Incapacity of a Partner
ACCOUNTING PROBLEMS INVOLVED IN THE RETIREMENT OF A PARTNER
The interest in the partnership of a retiring partner must be established upon his retirement. A
partner's interest in the partnership is affected by his investments, withdrawals, share on
partnership profits or losses, loans to the partnership and loans from the partnership. Following
are the accounting problems involved in determining the capital interest of a retiring partner:
Illustrative Problem A: The statement of financial position of the partnership of Dy, David and
Diaz on December 31, 2014 follows:
Assets
Cash
Other Assets
P 110,000
30,000
Liabilities and Capital
Liabilities
Dy, Capital
David, Capital
Diaz, Capital
Total Liabilities and Capital
P 20,000
20,000
40,000
60,000
P 140,000
1.
Determination of the profit or loss from the beginning of the accounting period to the date
of withdrawal or retirement and the distribution of such profit or loss.
2.
Closing of the partnership books.
3.
Correction of accounting errors in prior periods like overstatement or understatement of
inventories, excessive depreciation charges and failure to provide adequately for doubtful
accounts.
The partners share profits and losses in the ratio of 4:2:4. On July l, 2015, Diaz asked to be allowed
to withdraw from the partnership. The partners decided to close the books as of this date so as
to determine the capital interest of Diaz. Profit for the six months ended amounted P60,000 while
drawings of Dy, David and Diaz amount to P4,000, P6,000 and P2.000, respectively. Profits and
losses are to be shared equally after the retirement of Diaz.
4.
Revaluation of partnership assets to current values.
The following entries will be prepared prior to the retirement of Diaz from the partnership:
5.
Recording of bonus brought about by the retirement of a partner.
6.
Settlement of the interest of the retiring partner.
P 140,000
a.
CALCULATION OF RETIRING PARTNER'S INTEREST
The interest of a retiring partner must be established upon retirement, as mentioned earlier. The
following are considered in the determination of such interest: investments, withdrawals, share
in profits and losses to the date of retirement, loans, advances and the revaluation of partnership
assets to current values.
The following schedule will be helpful in determining the interest of a retiring partner:
Investments
Withdrawals
+
Share in partnership profits to date of retirement or
Share in partnership losses to date of retirement
+
Loans and advances to the partnership or
Loans and advances from the partnership
+
Revaluation of assets increasing their recorded values or
Revaluation of assets decreasing their recorded values
Interest upon retirement
54 | P a g e
b.
Income Summary
Dy, Capital
David, Capital 24,000
Diaz. Capital 12,000
Net income from Jun. l to June 30 24,000
divided in the ratio of 4:2:4
Dy, Capital
David, Capital
Diaz, Capital
Dy, Drawing
David, Drawing
Diaz, Drawing
60,000
24,000
12,000
24,000
4,000
6,000
2,000
4,000
6,000
2,000
After considering the preceding entries, the capital interest of the partners as of July 1, 2015 may
now be computed as follows:
Diaz
Dy
David
Capital balance, Dec. 31, 2014
P60,000
P20,000
P40,000
Share in Profit from Jan. 1 – June 30
24,000
24,000
12,000
Withdrawals
( 2,000)
( 4,000)
( 6,000)
Capital balance, July 1, 2015
P82,000
P40,000
P46,000
The entries to record the retirement of Diaz using several assumptions are illustrated below and
on the succeeding pages.
Chapter 5 – Change in Capital Structure by Withdrawal, Retirement, Death or Incapacity of a Partner
Assumption 1 – Sale of interest to a new partner. Diaz sold his interest to Duque for P 100,000.
Diaz, Capital
Duque, Capital
82.000
82,000
The gain of P18,000 (P100,000 - P82,000) is a personal gain of Diaz since the sale of the interest
to an outsider is a personal transaction between the buying partner and Diaz.
Assumption 2 – Sale of interest to the continuing partners. Diaz sold his interest to Dy and
David for P75,000, the interest being divided equally by the remaining partners. Profits and
losses after the retirement of Diaz will be divided equally.
Diaz, Capital
Dy, Capital
David, Capital
82,000
Diaz, Capital
Cash
Dy, Capital
David, Capital
P6,000 x 4/6 = P4,000
P6,000 x 2/6 = P2,000
82,000
76,000
4,000
2,000
The bonus of P6,000 is shared by the remaining partners in accordance with their original profit
and loss ratio of 4:2.
Asset Revaluation Method
41,000
41,000
The loss of P7,000 (P75,000 – P82,000) is a personal loss of Diaz since the sale of the interest to
Dy and David is personal transaction among the partners.
Assumption 3 - Sale of interest to the partnership. Diaz sold his interest to the partnership.
The partners agreed to make immediate cash settlement to the retiring partner. Profits and
losses after the retirement of Diaz will be divided equally.
Case A - Settlement to retiring partner is equal to his capital interest. The
partnership paid Diaz P82,000.
Diaz, Capital
Cash
Bonus Method
Dy, Capital
David, Capital
Diaz, Capital
Other Assets
6,000
3,000
6,000
15,000
The difference of P6,000 is only a portion of the asset revaluation. The total amount of asset
revaluation is calculated by dividing the difference of P6,000 by the retiring capital balances of
the partners will be computed as follows:
Dy
David
Diaz
= P15,000 x 4/10 = P6,000
= P15,000 x 2/10 = P3,000
= P15,000 x 4/10 =P6,000
82.000
82,000
After the preceding entry, the capital balance of Diaz is P76,000 and payment to him will be
recorded as follows:
This settlement involves no bonus nor asset revaluation
Case B – Settlement is less than the capital interest of the retiring partner (at less than book
value). The partnership paid Diaz P76,000 which is P6,000 less than his capital interest of
P82,000.
The difference between the amount of payment and the capital interest of Diaz may now be
considered as:
1.
Bonus to the remaining partners (Bonus Method)
2.
Asset Revaluation reducing the capital accounts of all the partners
(Asset Revaluation Method)
The entries to record the retirement of Diaz using the two alternative solutions follow:
55 | P a g e
Diaz, Capital
Cash
76,000
76,000
A compound entry may be made as follows:
Dy, Capital
David, Capital
Diaz, Capital
Cash
Other Assets
6,000
3,000
82,000
76,000
15,000
Case C – Settlement is more than the capital interest of the retiring partner (at more than
book value). The partnership paid Diaz P85,000 which is P3,000 more than his capital interest
of P82,000.
Chapter 5 – Change in Capital Structure by Withdrawal, Retirement, Death or Incapacity of a Partner
The difference between the amount if payment and the capital interest of Diaz may now be
considered as:
1.
2.
Bonus from the remaining partners (Bonus Method)
Asset Revaluation increasing the capital accounts of all the partners
(Asset Revaluation Method)
The entries to record the retirement of Diaz using the two alternative solutions follow:
7,500
82,000
85,000
3,000
1,500
COMPARISON BETWEEN the BONUS AND ASSET REVALUATION METHOD
The two methods discussed may offer different results as to capital balances of the remaining
partners because of the effect on depreciation of the asset revaluation.
Bonus Method
Diaz, Capital
Dy, Capital
David, Capital
Cash
82,000
2,000
1,000
85,000
P3,000 x 4/6= P2,000
P3,000 x 2/6 = P1,000
The bonus of P3,000 is shared by the remaining partners in accordance with their original profit
and loss ration of 4:2.
Asset Revaluation Method
Other Assets
Dy, Capital
David, Capital
Diaz, Capital
7,500
3,000
1,500
3,000
The difference of P3,000 is only a portion of the asset revaluation of the partnership. The total
amount of asset revaluation is calculated by dividing of P3,000 by the retiring partner’s fraction
of interest or P3,000 ÷ 4/10 = P7,500. Thus, the increase in the capital balances of the partners
will be computed as follows:
Dy
= P7,500 x 4/10 = P3,000
David = P7,500 x 2/10 = P1,500
Diaz = P7,500 x 4/10 = P3,000
After the entry recording the asset revaluation, the capital balance of Diaz is P85,000 and
payment to him will be recorded as follows:
Diaz, Capital
85,000
Cash
85,000
A compound entry may be made as follows:
56 | P a g e
Other Assets
Diaz, Capital
Cash
Dy, Capital
David, Capital
To illustrate the effects of the bonus and asset revaluation method, we will use the information
under Assumption 3 – Case C, i.e., the payment to the retiring partners is more than his capital
interest. The schedule below shows the comparison between the bonus and the asset revaluation
method:
Assets
Dy,
David,
Revaluation
Capital
Capital
Balances after retirement of Diaz under the
bonus method
P 38,000 P 45,000
Balances after retirement of Diaz under the asset
revaluation method
P 7,500
P 43,000 P 47,500
Depreciation on asset revaluation (divided equally)
(7,500)
(3,750)
(3,750)
Balances after depreciation
P 39,250 P 43,750
Net advantage (disadvantage) of using the
bonus method
(P 1,250)
P 1,250
Based on the above analysis, David will prefer the bonus method while Dy will prefer the asset
revaluation method.
CHANGE IN CAPITAL STRUCTURE BY DEATH OR INCAPICITY OF A
PARTNER
The death or incapacity of a partner legally dissolves the old partnership since a partner ceases
to associated in the carrying of the business. The remaining partners may continue operations
based on a new contract or Articles of Co-Partnership. The interest of the deceased OI
incapacitated partner must be determined by the partnership in order to make necessary
settlement with his legal representatives. In case the business is continued without immediate
settlement, the legal representative of' the deceased is considered. as an ordinary creditor and is
to receive an amount equal to the interest and profits attributable to this interest.
The following accounting problems are encountered in case of death or incapacity of a
Partner:
Chapter 5 – Change in Capital Structure by Withdrawal, Retirement, Death or Incapacity of a Partner
1.
Determination of the profit or loss from the beginning of the accounting period to the date
of death or incapacity and the distribution of such profit or loss.
2.
Closing of the books of the partnership. Partnership agreement, however, may provide that
the books need not be closed and net income for the fraction of the accounting period to the
date of death or incapacity be determined.
3.
Correction of prior year's income, if there is any.
4.
Revaluation of partnership assets to arrive at current values.
5.
Recording of bonus.
6.
Settlement of the interest of the deceased or incapacitated partner.
The above problems are similar to those of withdrawal or retirement of a partner. Thus,
accounting for settlement to the deceased or incapacitated partner is the same as that of
withdrawal or retirement.
REVIEW of the LEARNING OBJECTIVES
1.
Discuss and understand the accounting procedures in recording the retirement or
withdrawal of a partner by sale of interest to a new partner or to the continuing or
remaining partners. A retiring partner may sell his interest to a new partner or to the
remaining partners. The sale of interest is a personal transaction between or among the
partners and any indicated gain or loss is a personal gain or loss of the retiring partner.
However, before recording the sale, the capital interest of the retiring partner should be
updated. The sale is then recorded by transferring the capital interest of the retiring partner
to the acquiring partner.
2.
Discuss and understand the accounting procedure in recording the retirement or
withdrawal of a partner by sale of interest to the partnership. The retiring partner may
sell his capital interest to the partnership, which then pays the former either in cash or in
the form of noncash assets. The capital interest of the retiring partner should be established
on the date of his retirement. The partnership may p ay him an amount that is equal to his
capital interest, at more than his capital interest, the difference may be accounted under
any of the following methods: (1) bonus method (either to the retiring partner or to the
remaining partners); or (2) asset revaluation accruing to all the partners.
3.
Discuss and understand the accounting procedures in recoding the dissolution of a
partnership due to death or incapacity of a partner. The dissolution of a partnership due to
death or incapacity of a partner is accounted for in almost the same manner as in the
57 | P a g e
retirement of a partner. Thus, the capital interest of the partner up to the date of his
incapacity or death should be established. Settlement is then made to the heirs of the partner
or to the legal representatives at an amount that may be equal to the partner’s capital
interest, at more than the capital interest, or at less than the capital interest. When the
settlement is not equal to the deceased or incapacitated partner’s capital interest, the
difference is accounted for under any of the following methods: (1) bonus method; or (2)
asset revaluation method.
GLOSSARY of ACCOUNTING TERMINOLOGIES
Bonus method – a case in retirement or death of a partner wherein the excess of amount paid
over the capital interest of the retiring or deceased partner is recorded as at decrease in the
capital balances of the remaining partners (bonus to retiring or deceased partner from the
remaining partners), the excess of the retiring or deceased partner’s capital interest over the
amount paid to him is recorded as an increase in the capital balances of the remaining partners
(bonus to the remaining partners from the retiring or deceased
partner).
Retired or deceased partner's interest – the capital interest of the partner on date of retirement
or death. It is determined share in profits and losses withdrawals, revaluation of partnership
assets to current values. death, loans, advances and the
Asset revaluation method – the asset revaluation is recorded prior to recoding the settlement
with the retiring or deceased partner. The asset revaluation is determined by dividing the
difference between the retiring or deceased partner’s capital interest and the amount of
settlement by his profit and loss sharing ratio.
Chapter 6 – Partnership Liquidation (Lump-Sum)
CHAPTER 6
PARTNERSHIP LIQUIDATION (LUMP-SUM)
LEARNING OBJECTIVES
1.
2.
3.
4.
Define Partnership liquidation and identify its causes.
Discuss the various problems encountered in partnership liquidation.
Identify and differentiate the two types of partnership liquidation.
Discuss and understand the accounting procedures under lump-sum liquidation
Nature of Partnership
Liquidation
•
1.
2.
3.
4.
1.
Determination of the profit or loss from the beginning of the accounting period to the
date of liquidation and the distribution of such profit or loss.
2.
Closing of the partnership books;
3.
Correction of accounting errors in prior periods like overstatement or understatement
of inventories, excessive depreciation charges, and failure to provide adequately for
doubtful accounts; and
Accounting Procedures in
Lump-Sum Liquidation
•
•
•
•
Realization
Distribution of gain or loss on
realization
Payment to creditors
Distribution of cash to partners
In partnership liquidation, the assets and liabilities of the partnership are directly intertwined
with those of the individual partners' personal assets and liabilities because of the unlimited
liability of each partner. The priorities for creditors' claims against the assets available to pay the
partnership liabilities involve two concepts: the marshaling of assets and the right of offset.
Marshaling of assets involves the order of creditors' rights against the partnership's assets and
the personal assets of the individual partners. The order in which claims against the
partnership's assets will be marshaled is as follows:
1.
2.
INTRODUCTION
Dissolution of a partnership does not mean the formal termination of a business. Dissolution of
a partnership can be recognized as a change in the capital structure of a business as a new unit.
Partnership dissolution calling for the winding up of business affairs, called liquidation, shall be
discussed in this chapter. Here, the association of the partners for purposes of carrying activities
in the usual manner is considered ended. Partners can only engage in activities lending to final
settlement of business affairs.
58 | P a g e
The accomplishment of the purpose for which the partnership was organized.
The termination of the term/period covered by the partnership contract.
The bankruptcy of the firm.
The mutual agreement among the partners to close the business
Accounting problems involved in the liquidation of a partnership include:
PARTNERSHIP
LIQUIDATION
Definition
Causes if liquidation
Accounting problems in
partnership liquidation
Types of liquidation
• Lump-Sum
• Installment (piece-meal)
A partnership liquidated when its business operations are completely terminated or ended.
The partnership assets are sold, the partnership creditors are paid, and the remaining assets, if
any, are distributed to the partners as a return of their investments.
Partnership dissolution with liquidation may be caused by any of the following factors:
PREVIEW OF THE CHAPTER
•
•
•
DISSOLUTION WITH LIQUIDATION
3.
partnership creditors other than partners,
partners' claims other than capital and profits, such as loans payable and accrued
interest payable; and
partners' claim to capital or profits, to the extent credit balances in capital accounts.
The order of claims against the personal assets of the individual partners is as follows:
1.
2.
personal creditors of individual partners, and
partnership creditors on unpaid partnership liabilities regardless of a partner's capital
balance in the partnership.
Chapter 6 – Partnership Liquidation (Lump-Sum)
Right of offset involves offsetting a deficit in a partner’s capital (debit balance in the capital
account of a partner) against the loan payable to that partner. The loan payable to a partner has
a higher priority in liquidation than a partner's capital balance but a lower priority than liabilities
to outside creditors.
DEFINITION OF TERMS
Dissolution – the termination of a partnership as a going concern; it is the termination of the life
of a partnership.
Winding up – the process of settling the business or partnership affairs, it is synonymous to
liquidation.
Termination - the point in time when all partnership affairs are ended.
Liquidation - the interval of time between dissolution and termination of partnership affairs; it
is also the process of winding up a business which normally consists of conversion of assets into
cash, payment of liabilities and distribution of remaining cash among the partners.
Realization -the process of converting non-cash assets into cash.
Gain on realization - the excess of the selling price over the cost book value of the assets
disposed or sold through realization.
Loss on realization - the excess of the cost or book value over the selling price of the assets
disposed or sold through realization.
Capital deficiency - the excess of a partner's share on losses over his capital.
Deficient partner - a partner with a debit balance in his capital account after receiving his share
on the loss on realization.
Right of offset - the legal right to apply part or all of the amount owing to a partner on a loan
balance against deficiency in his capital account resulting from losses in the process liquidation.
Partner’s interest – the sum of a partner’s capital, loan balance and advances to the partnership.
2.
Liquidations by installment or piece-meal liquidation. This is a type of liquidation
whereby assets are realized on a piecemeal basis and cash is distributed to partners on a
periodic basis as it becomes available, that is, even before all non-assets are converted into
cash.
PROCEDURES IN LUMP-SUM LIQUIDATION
When a partnership is to be liquidated, the books should be adjusted and balances of nominal
accounts are closed. The resulting profit or loss for the period is transferred to the partners’
capital account. Advances and withdrawals are closed to capital accounts since cash settlement
shall be based on the partners’ capital account balances. The partnership is then ready to proceed
with liquidation as follows:
1.
Sale of non-cash assets and distribution or allocation of gain or loss on realization among
the partners according to their residual profit and loss ratios (salary and interest factors
disregarded) unless liquidation ratios are specified in the partnership agreement.
2.
Distribution of cash to creditors and partners. In this procedure, the provisions of the
marshaling of assets and the exercise of the right of offset are applied.
Liquidation expenses may be incurred to facilitate the immediate realization of non-cash assets.
Payment of liquidation expenses reduces cash and is recorded as a deduction from partners’
capital based on the partner’s profit and loss ratios.
When realization of assets in the course of liquidation results in a loss, the loss is carried to the
capital accounts of the partners as a deduction. If a partner’s capital account results in a debit
balance (known as capital deficiency), after the distribution of loss on realization, such can be
offset against any loan balance of the partner to the partnership. The amount to be offset shall be
the lower of the amount of the loan or the amount of the deficiency.
Cash can be distributed to partners before or after the elimination of the deficiency. If cash is
distributed after the elimination of the deficiency,
1.
a.
b.
TYPES OF LIQUIDATION
1.
Lump-sum liquidation or liquidation by totals. This is a type of liquidation whereby the
distribution of cash to the partners is done only after all the non-cash assets have been
realized, the total amount of gain or loss on realization is known, and ll liabilities have been
paid.
59 | P a g e
Capital deficiency is eliminated by
2.
Making additional cash investment, if the deficient partner is solvent.
Charging the deficiency as additional loss to the remaining partners, if the deficient
partner is insolvent.
Cash available for distribution is then paid to partners to apply first on loan then
on capital
Key Points. The final distribution of cash to partners is made based on partners’ capital
balances and not on any ratio.
Chapter 6 – Partnership Liquidation (Lump-Sum)
If cash is distributed to partners before eliminating the deficiency:
1.
Cash available for distribution is paid to partners based on an accompanying schedule
to determine amounts to be paid to partners.
2.
Deficient partners may
Case
(a) If solvent, make additional cash investment to be paid to partners as second cash
distribution, or the deficient partner may make direct cash settlement to the other
partners.
(1)
The other assets were sold for P140,000.
(2)
The other assets were sold for P100,000.
(3)
The other assets were sold for P74,000.
(4)
The other assets were sold for P68,000. Deficient partner was solvent.
(5)
The other assets were sold for P68,000. Deficient partner was insolvent.
(6)
The other assets were sold for P68,000. Distribution of available cash is:
a. Before eliminating capital deficiency; and
b. After eliminating capital deficiency
(b) If insolvent, the deficiency shall be absorbed by the other partners as additional
loss according to their profit and loss ratio.
Instructions:
The personal status of partners (that is, personal assets and personal liabilities) is sometimes
provided in the problem to indicate that a partner is solvent or insolvent. When personal assets
exceed personal liabilities, the partner is solvent to the extent of the excess. When personal
assets are less than personal liabilities, the partner is insolvent.
STATEMENT OF LIQUIDATION
Encina, Endrada, and Elina
Statement of Financial Position
December 1, 2014
P 8,000
136,000
P 144,000
60 | P a g e
2.
Present journal entries to record the liquidation process.
1.
Make sure that the balances before liquidation show equality of debits and credits. This will
always be true after each liquidation transaction.
2.
Maintain two columns only for the debits. These are cash and other assets regardless of
whether the assets were given itemized like cash, receivables, inventory, supplies,
equipment, etc. Non-cash assets are classified as “other assets.”
3.
Gain on realization increases capital while loss on realization decreases capital.
4.
Figures in parenthesis for each liquidation transaction represent reduction in the account.
5.
Double rule when all columns are brought to zero balance.
Illustrative Problem A:
Assets
Prepare a statement of liquidation for each of the cases. For case 6, prepare also a
schedule of cash distribution.
Points of emphasis in the preparation of the statement of liquidation
The statement of liquidation is a statement prepared to summarize the liquidation process. It is
the basis of the journal entries made to record liquidation. This statement presents in working
paper form the effect of the liquidation on the statement of financial position. It shows the
conversion of assets into cash, the allocation of gain or loss on realization, and the distribution of
cash to creditors and partners.
Cash
Other Assets
1.
Liabilities and Equity
Liabilities
P 44,800
Endrada, Loan
2,000
Elina, Loan
3,200
Encina, Capital
38,000
Endrada, Capital
224,000
Elina, Capital
32,000
Total Liabilities and Equity
P 144,000
Chapter 6 – Partnership Liquidation (Lump-Sum)
Case 1 – The other assets were sold for P140,000. (Gain on realization, no capital deficiency)
Encina, Endrada, and Elina
Statement of Liquidation
December 1 – 31, 2014
Loan
Cash
Other
Assets
Liabilities
Endrada
Encina
2 (40%)
Capital
Endrada
2 (40%)
Elina
1 (20%)
P 8,000
P 136,000
P 44,800
P
2,000
P
3,200
P 38,000
P 24,000
P 32,000
140,000
P 148,000
(136,000)
-
P 44,800
P
2,000
P
3,200
1,600
P 39,600
1,600
P 25,600
800
P 32,800
P
2,000
P
3,200
P 39,600
P 25,600
P 32,800
(3,200)
(39,600)
(25,600)
(32,800)
Elina
Profit and loss ratio
Balances before
liquidation
Sales of assets and
distribution of gain
Balances
Payment of liabilities
(44,800)
(44,800)
Balances
P 103,200
-
-
Payment to partners
(103,200)
-
-
(2,000)
The other assets with a book value of P136,000 were sold for P140,000 resulting in a P4,000 gain on realization distributed among the partners in their 2:2:1 ratio.
The entries to record the liquidation process are:
(c) Payment to partners
(a) Realization of assets and distribution of gain on realization, 2:2:1
Cash
Other Assets
Encina, Capital (4,000 x 2/5)
Endrada, Capital (4,000 x 2/5)
Elina, Capital (4,000 x 1/5)
140,000
136,000
1,600
800
(b) Payment of liabilities
Liabilities
Cash
61 | P a g e
44,800
44,800
Endrada, Loan
Elina, Loan
Encina, Capital
Endrada, Capital
Elina, Capital
Cash
2,000
3,200
39,600
25,600
32,800
103,200
Chapter 6 – Partnership Liquidation (Lump-Sum)
Case 2 – The other assets were sold for P100,000. (loss on realization, no capital deficiency)
Encina, Endrada, and Elina
Statement of Liquidation
December 1 – 31, 2014
Loan
Cash
Other
Assets
Liabilities
Endrada
Elina
Profit and loss ratio
Encina
2 (40%)
Capital
Endrada
2 (40%)
Elina
1 (20%)
Balances before
liquidation
Sales of assets and
distribution of loss
Balances
P 8,000
P 136,000
P 44,800
P
2,000
P
3,200
P 38,000
P 24,000
P 32,000
100,000
P 108,000
(136,000)
-
P 44,800
P
2,000
P
3,200
(14,400)
P 23,600
(14,400)
P 9,600
(7,200)
P 24,800
Payment of liabilities
(44,800)
Balances
P 63,200
-
-
P
2,000
P
3,200
P 23,600
P 9,600
P 24,800
Payment to partners
(63,200)
-
-
(3,200)
(23,600)
(9,600)
(24,800)
(44,800)
(2,000)
The other assets with a book value of P136,000 were sold for P100,000 resulting in a loss on realization of P36,000 that can be fully absorbed by the capital balances of all the partners.
The entries to record the liquidation process are:
(a) Realization of assets and distribution of loss on realization, 2:2:1
Cash
Encina, Capital (36,000 x 2/5)
Endrada, Capital (36,000 x 2/5)
Elina, Capital (36,000 x 1/5)
Other Assets
100,000
14,400
14,400
7,200
136,000
(b) Payment of liabilities
Liabilities
Cash
62 | P a g e
44,800
44,800
(c) Payment to partners
Endrada, Loan
Elina, Loan
Encina, Capital
Endrada, Capital
Elina, Capital
Cash
2,000
3,200
23,600
9,600
24,800
63,200
Chapter 6 – Partnership Liquidation (Lump-Sum)
Case 3 – The other assets were sold for P74,000. (Loss on realization, capital deficiency, right of offset)
Encina, Endrada, and Elina
Statement of Liquidation
December 1 – 31, 2014
Loan
Cash
Other
Assets
Liabilities
Endrada
Elina
Profit and loss ratio
Encina
2 (40%)
Capital
Endrada
2 (40%)
Elina
1 (20%)
Balances before
liquidation
Sales of assets and
distribution of loss
Balances
P 8,000
P 136,000
P 44,800
P
2,000
P
3,200
P 38,000
P 24,000
P 32,000
74,000
P 82,000
(136,000)
-
P 44,800
P
2,000
P
3,200
(24,800)
P 13,200
(24,800)
(P 800)
(12,400)
P 19,600
Payment of liabilities
(44,800)
Balances
P 37,200
P
2,000
P
3,200
P 13,200
(P 800)
P 19,600
Offset of loan against the
debit balance in the
capital of Endrada
Balances
Payment to partners
(44,800)
-
-
( 800)
P 37,200
-
-
(37,200)
-
-
P
1,200
800
P
(1,200)
3,200
P 13,200
-
P 19,600
(3,200)
(13,200)
-
(19,600)
The other assets with a book value of P136,000 were sold for P74,000 resulting in a loss on realization of P62,000. The distribution of the loss on realization resulted in a debit balance in the
capital of Endrada. The right of offset can be exercised in as much as Endrada has a loan to the partnership.
The entries to record the liquidation process are:
(c) Offset of loan against capital deficiency
(a) Realization of assets and distribution of loss on realization, 2:2:1
Cash
Encina, Capital (62,000 x 2/5)
Endrada, Capital (62,000 x 2/5)
Elina, Capital (62,000 x 1/5)
Other Assets
Endrada, Loan
Endrada, Capital
74,000
24,800
24,800
12,400
136,000
63 | P a g e
44,800
800
(d) Payment to partners
(b) Payment of liabilities
Liabilities
Cash
800
44,800
Endrada, Loan
Elina, Loan
Encina, Capital
Elina, Capital
Cash
1,200
3,200
13,200
19,600
37,200
Chapter 6 – Partnership Liquidation (Lump-Sum)
Case 4 – The other assets were sold for P68,000. Deficient partner invests additional cash before cash distributions to partners. (Loss on realization, capital deficiency, deficient
partner is solvent)
Encina, Endrada, and Elina
Statement of Liquidation
December 1 – 31, 2014
Loan
Cash
Other
Assets
Liabilities
Endrada
Elina
Profit and loss ratio
Encina
2 (40%)
Capital
Endrada
2 (40%)
Elina
1 (20%)
Balances before
liquidation
Sales of assets and
distribution of loss
Balances
P 8,000
P 136,000
P 44,800
P
2,000
P
3,200
P 38,000
P 24,000
P 32,000
68,000
P 76,000
(136,000)
-
P 44,800
P
2,000
P
3,200
(27,200)
P 10,800
(27,200)
(P 3,200)
(13,600)
P 18,400
Payment of liabilities
(44,800)
Balances
P 31,200
P
2,000
P
3,200
P 10,800
(P 3,200)
P 18,400
(44,800)
-
-
Offset of loan against the
debit balance in the
capital of Endrada
Balances
P 31,200
-
-
Additional investment
by Endrada
Balances
1,200
P 32,400
-
-
-
(32,400)
-
-
-
Payment to partners
( 2,000)
-
2,000
P
3,200
P 10,800
(P 1,200)
P 18,400
P
3,200
P 10,800
1,200
-
P 18,400
(3,200)
(10,800)
-
(18,400)
The other assets with a book value of P136,000 were sold for P68,000 resulting in a loss on realization of P68,000. The distribution of the loss on realization resulted in a debit balance in the
capital of Endrada that cannot be fully absorbed by his loan. The deficient partner cancels his deficiency by making additional cash investment. By doing so, the partnership will satisfy all its
liabilities including the other partner’s equities.
64 | P a g e
Chapter 6 – Partnership Liquidation (Lump-Sum)
The entries to record the liquidation process are:
(a) Realization of assets and distribution of loss on realization, 2:2:1
Cash
Encina, Capital (68,000 x 2/5)
Endrada, Capital (68,000 x 2/5)
Elina, Capital (68,000 x 2/5)
Other Assets
68,000
27,200
27,200
13,600
136,00
(b) Payment of liabilities
Liabilities
Cash
44,800
44,800
(c) Offset of loan against capital deficiency
Endrada, Loan
Endrada, Capital
2,000
2,000
(d) Deficient partner who is solvent makes additional cash investment
Cash
Endrada, Capital
1,200
1,200
(e) Payment to partners
Elina, Loan
Encina, Capital
Elina, Capital
Cash
65 | P a g e
3,200
10,800
18,400
32,400
Chapter 6 – Partnership Liquidation (Lump-Sum)
Case 5 – The other assets were sold for P68,000. Deficient partner is insolvent and his deficiency is shared by the other [artners before cash distribution. (Loss on realization, capital
deficiency, right of offset, deficient partner is insolvent)
Encina, Endrada, and Elina
Statement of Liquidation
December 1 – 31, 2014
Loan
Cash
Other
Assets
Liabilities
Endrada
Elina
Profit and loss ratio
Encina
2 (40%)
Capital
Endrada
2 (40%)
Elina
1 (20%)
Balances before
liquidation
Sales of assets and
distribution of loss
Balances
P 8,000
P 136,000
P 44,800
P
2,000
P
3,200
P 38,000
P 24,000
P 32,000
68,000
P 76,000
(136,000)
-
P 44,800
P
2,000
P
3,200
(27,200)
P 10,800
(27,200)
(P 3,200)
(13,600)
P 18,400
Payment of liabilities
(44,800)
Balances
P 31,200
P
2,000
P
3,200
P 10,800
(P 3,200)
P 18,400
(44,800)
-
-
Offset of loan against the
debit balance in the
capital of Endrada
Balances
P 31,200
-
-
Additional loss to
partners for the
deficiency of Endrada
shared 2:1
Balances
P 31,200
-
-
(31,200)
-
-
Payment to partners
( 2,000)
-
-
2,000
P
3,200
P 10,800
(P 1,200)
P 18,400
P
3,200
(800)
P 10,000
1,200
-
(400)
P 18,000
(3,200)
(10,000)
-
(18,000)
The distribution of the P68,000 loss on realization resulted in a debit balance in the capital account of Endrada that cannot bet fully absorbed by his loan. Failure od the deficient partner to
cancel his deficiency is to be regarded as additional loss, allocated to the remaining partners in their profit and loss ratio. Encina and Elina share on the deficiency of Endrada in the ratio 2:1. The
respective share on the deficiency is computed as follows:
Encina
Elina
66 | P a g e
P1,200 x 2/3
P1,200 x 1/3
=
=
P800
P400
Chapter 6 – Partnership Liquidation (Lump-Sum)
The entries to record the liquidation process are:
(a) Realization of assets and distribution of loss on realization, 2:2:1
Cash
Encina, Capital (68,000 x 2/5)
Endrada, Capital (68,000 x 2/5)
Elina, Capital (68,000 x 1/5)
Other Assets
68,000
27,200
27,200
13,600
136,000
(b) Payment of liabilities
Liabilities
Cash
44,800
44,800
(c) Offset of loan against capital deficiency
Endrada, Loan
Endrada, Capital
2,000
2,000
(d) Capital deficiency of insolent partner absorbed as additional loss by remaining partners
Encina, Capital (1,200 x 2/3)
Elina, Capital (1,200 x 1/3)
Endrada, Capital
800
400
1,200
(e) Payment to partners
Elina, Loan
Encina, Capital
Elina, Capital
Cash
67 | P a g e
3,200
10,000
18,000
31,200
Chapter 6 – Partnership Liquidation (Lump-Sum)
Case 6 – The other assets were sold for P68,000. Additional cash investment by deficient partner is to be made as second cash distribution partners. All available cash is immediately
distributed to partners requiring a schedule to accompany the statement of liquidation in order to determine amounts to be paid to partners. (Loss on realization, capital deficiency,
right of offset, and cash distributions)
Encina, Endrada, and Elina
Statement of Liquidation
December 1 – 31, 2014
Loan
Cash
Other
Assets
Liabilities
Endrada
Elina
Profit and loss ratio
Encina
2 (40%)
Capital
Endrada
2 (40%)
Elina
1 (20%)
Balances before
liquidation
Sales of assets and
distribution of loss
Balances
P 8,000
P 136,000
P 44,800
P
2,000
P
3,200
P 38,000
P 24,000
P 32,000
68,000
P 76,000
(136,000)
-
P 44,800
P
2,000
P
3,200
(27,200)
P 10,800
(27,200)
(P 3,200)
(13,600)
P 18,400
Payment of liabilities
(44,800)
Balances
P 31,200
P
2,000
P
3,200
P 10,800
(P 3,200)
P 18,400
Offset of loan against the
debit balance in the
capital of Endrada
Balances
Payment to partners
-
-
( 2,000)
P 31,200
Payments to partners
per schedule
Balances
Additional investment
of Endrada
Balances
(44,800)
-
-
-
(31,200)
P
2,000
P
3,200
P 10,800
(3,200)
(10,000)
(P 1,200)
P 18,400
(18,000)
-
-
-
-
P
800
(P 1,200)
P
400
1,200
1,200
-
-
-
-
P
800
1,200
-
P
400
(1,200)
-
-
-
-
(800)
-
(400)
The Schedule to Accompany the Statement of Liquidation shows amounts to be paid to partners. Total partners’ interest is reduced by the restricted interest for possible losses in case the
deficient partner fails to pay his deficiency. Restricted interest for possible losses shall continue up to the point when deficiencies or debit balances in capital are eliminated. When deficiencies
are eliminated. When deficiencies are eliminated, balances shall be called Free Interest – Amounts to be Paid to Partners, to apply first on loan, then on capital.
68 | P a g e
Chapter 6 – Partnership Liquidation (Lump-Sum)
(d) First cash distribution to partners, per schedule
Encina, Endrada and Elima
Schedule to Accompany Statement of Liquidation
December 1 -31, 2014
Capital balances before cash distribution
Add loan balance
Total partners’ interest
Restricted interest – possible loss of
P1,200 to Encina and Elina in the ratio
of 2:1 if Endrana fails to pay his
deficiency
Free Interest – amounts to be paid to
partners
Payment to apply on:
Loan
Capital
Cash distribution
Encina
Endrada
Elina
P10,800
(P1,200)
P10,800
(P1,200)
P18,400
3,200
P21,600
P10,000
1,200
-
P 3,200
18,000
P21,200
P10,000
P10,000
(e) Additional cash investment from deficient solvent partner
Cash
Endrada, Capital
Encina, Capital
Elina, Capital
Cash
1,200
1,200
800
400
1,200
If the deficient partner makes direct cash settlement to partners, the entry is:
(e) Encina, Capital
Elina, Capital
Endrada, Capital
800
400
1,200
CALCULATION OF CASH SETTLEMENT WITHOUT THE AID OF A
STATEMENT OF LIQUIDATION
68,000
27,200
27,200
13,600
136,000
(b) Payment of liabilities
44,800
44,800
(c) Offset of loan against capital deficiency
Endrada, Loan
Endrada, Capital
31,200
(400)
P21,200
(a) Realization of assets and distribution of loss on realization, 2:2:1
Liabilities
Cash
3,200
10,000
18,000
(f) Second cash distribution to parners
(800)
The entries to record the liquidation process are:
Cash
Encina, Capital (68,000 x 2/5)
Endrada, Capital (68,000 x 2/5)
Elina, Capital (68,000 x 1/5)
Other Assets
Elina, Loan
Eneina, Capital
Elina, Capital
Cash
2,000
2,000
Usually, liquidation problems do not require the preparation of a statement of liquidation but
calls only for the calculation of cash settlement to partners. In such cases, however, non-cash
assets have already been converted into cash, liabilities have been settles but capital remain as
to their balances before liquidation since the gain or loss on realization of non-cash assets has
not yet been carries to capital. Any difference, therefore, between the debits (available cash to
partners) and total credits (loans and capitals) is a gain or loss on realization that must first be
carried to capital before proceeding with the liquidation process.
Illustrative Problem B:
At December 31, 2014, the capital balances of the partners Ebora, Esteban, and Echavez are
P160,000; P100,000; and P20,000; respectively, sharing profits and losses in the ratio 3:2:1. The
partners decided to liquidate, and sold all the non-cash assets for P148,000 cash. After paying all
the liabilities amounting to P48,000, they still have P112,000 cash left for distribution.
The loss on realization is the excess of the credits (total capital) over the debits )cash left for
distribution).
69 | P a g e
Chapter 6 – Partnership Liquidation (Lump-Sum)
Total capital (P160,000 + P100,000 + P20,000)
Less Cash left for distributions t partners
Loss on realization of assets
liquidation (piecemeal liquidation). Under lump-sum liquidation, distribution of cash to the
partners is done only after realization of all non-cash assets, distribution of gain or loss on
realization and payment of partnership liabilities. Under installment liquidation, asset
realization is on a piece-meal basis and cash is distributed to partners as it becomes
available even if there are still unrealized non-cash assets.
P 280,000
112,000
P 168,000
Cash settlement to partners is computed as follows:
4.
Capital balances before liquidation
Loss on realization shared in the
ration of 3:2:1
Balances
Additional loss to Ebora and
Esteban for the deficiency of
Echavez shared in the ratio of 3:2
Cash settlement
Ebore
Esteban
Ecahvez
P 160,000
P 100,000
P 20,000
(84,000)
P 76,000
(56,000)
P 44,000
(28,000)
(P 8,000)
( 4,800
( 3,200)
8,000
P 71,200
P 40,800
There may be instances when the cash realized from the sale of other assets is not sufficient to
pay partnership liabilities. In such cases, remaining liabilities are satisfied by:
1.
The additional cash investment by deficient solvent partners.
2.
Direct collection by the partnership creditors from any one of the partners and the latter
making cash settlement among themselves.
REVIEW of the LEARNING OBJECTIVES
Discuss and understand the accounting procedures under lump-sum liquidation. Lumpsum liquidation requires the following procedures: (1) realization of non-cash assets (sale
of non-cash assets for cash); (2) distribution of gain or loss on realization to the partners
according to their liquidation ratio, if there is any, or according to their residual profit and
loss ratio; 93) payment of liabilities to outside creditors; and (4) distribution of cash to
partners.
GLOSSARY of ACCOUNTING TERMINOLOGIES
Capital deficiency – the excess of a partner’s share pf losses over his capital credit balance.
Deficient partner – a partner with a debit balance in his capital account after receiving his share
on the loss on realization.
Insolvent partner – a partner whose personal assets are less than his personal liabilities.
Free interest – a partner’s capital interest that is available for cash payment.
Liquidation – the winding up of the business affairs of a partnership.
Realization – the process of converting non-cash assets into cash.
1.
Define partnership liquidation and identify its causes. Partnership liquidation is the
winding up of the business affairs of a partnership; hence the business operation is
completely terminated or ended. Partnership liquidation may be caused by any of the
following: (1) accomplishment of the purpose of the partnership; (2) termination of the
term/period covered by the partnership contract; (3) bankruptcy of the partnership; and
(4) mutual agreement among the partners to close the business.
2.
Discuss the various problems encountered in partnership liquidation. The liquidation of
a partnership will give rise to the following problems: (1) determining partnership profit or
loss from the beginning of the accounting period to the date of liquidation and distributing
such profit or loss to the partners: (2) closing the partnership books; (3) correcting
accounting errors in prior periods; and (4) liquidating the business.
3.
Identify and differentiate the two types of partnership liquidation. The two types of
partnership liquidation are lump-sum liquidation (liquidation by totals) and installment
70 | P a g e
Restricted interest – a portion of a partner’s capital account balance that is restricted for
possible losses on liquidation. It is not, therefore, available for cash payment.
Right of offset – the legal right to apply all or part of a partner’s loan to the partnership against
capital deficiency.
Solvent partner – a partner whose personal assets are more than his personal liabilities.
Chapter 6 – Partnership Liquidation (Lump-Sum)
MULTIPLE CHOICE
MC 6-1 Espina, Espinosa, Esteban, and Estrellita are partners, sharing earnings in the ratio of
3:4:6:8. The balance of their capital accounts on December 31, 2014 are as follows:
Espina
P 1,000
Espinosa
25,000
Esteban
25,000
Estrellita
9,000
P 60,000
The partners decided to liquidate, and they accordingly convert the non-cash assets
into P23,200 of cash. After paying the liabilities amounting to P3,000, they have
P22,200 to divide. Assume that a debit balance in any of partner’s capital is
uncollectible. The book value of the non-cash assets amounted to:
a. P25,200
b. P45,400
c. P61,000
d. P63,000
MC 6-2 Using the information in MC 6-1, the share of Espinosa in the loss upon conversion of
the non-cash assets into cash was
a. P 5,400
b. P 7,200
c. P37,800
d. P61,000
MC 6-3 Using the information in MC 6-1, how much did Esteban get when the P22,200 was
divided?
a. P 6,432
b. P 8,320
c. P10,000
d. P14,200
MC 6-4 As of December 31, 2014, the books of 3E Partnership showed capital balances of E1 –
P40,000; E2 – P25,000; E3 – {5,000. The partners’ profits and loss ratio was 3:2:1
respectively. The partners decided to dissolve and liquidate. They sold all the non-cash
assets for P37,000 cash. After settlement of all liabilities amounting to P12,000, they
still have P28,000 cash left for distribution. The loss on realization of the non-cash
assets was:
a. P28,000
b. P40,000
c. P42,000
d. P45,000
71 | P a g e
MC 6-5 Using the information in MC 6-4, and assuming that any debit balance of partners’
capital is uncollectible, the share of El on P28,000 cash for distribution was
a. P17,800
b. P18,000
c. P19,000
d. P40,000
MC 6-6 Esper, Elor, and Este, partners are in textile distribution business sharing profits and
losses equally. On December 31, 2014, the partnership capital and partners’ drawings
are as follows:
Esper
Elor
Este
Total
Capital
P 100,000
P 80,000
P 300,000
P 480,000
Drawings
60,000
40,000
20,000
120,000
The partnership was unable to collect on trade receivables and was forced to liquidate.
Operating profit in the year 2014 amounted to P72,000 which was all exhausted
including the partnership assets. Unsettled creditors’ claim at December 31, 2014
totaled P84,000. Elor and Este have substantial private resources but Esper has no
personal assets. Loss o liquidation was
a. P360,000
b. P432,000
c. P480,000
d. P516,000
MC 6-7 Using the information in MC 6-6, the final cash distribution to Este was
a. P 78,000
b. P 84,000
c. P 108,000
d. P 162,000
MC 6-8 Escano, Ender, and Evelo are in the process of liquidating their partnership and their
account balances as of October 1, 2014 are as follows:
Debit
Credit
Cash
P 30,000
Non-cash Assets
70,000
Ender, Loan
P 14,000
Escano, Capital
10,000
Ender, Capital
35,000
Evelo, Capital
41,000
The profit and loss sharing ratio has been 4:3:3 between Escano, Ender, and Evelo,
respectively. Assuming that the partnership realized P30,000 from the sale of the noncash assets and that any deficiency is uncollectible, Ender must receive.
a. P19.000
c. P 37,000
b. P34,000
d. P 49,000
Chapter 6 – Partnership Liquidation (Lump-Sum)
MC 6-9 Using the information in MC 6-8 and assuming Escano had personal assets of P50,000
and personal liabilities of P45,000 and that the partnership realized P25,000 from the
sale of its non-cash assets, Evelo must receive:
a. P25,000
b. P26,000
c. P27,500
d. P41,000
MC 6-10 Using the information in MC 6*8 and for Escano to receive P12,000, the non-cash assets
must be sold for
a. P10,000
b. P12,000
c. P30,000
d. P75,000
MC 6-11 The following condensed statement of financial position is presented for the
partnership of Echo, Egay, and Elma, who share profits and losses in the ratio of 6:2:2,
respectively.
Cash
Other Assets
Total Assets
Assets
Liabilities and Capital
P
40,000
140,000
Liabilities
Echo, Capital
Egay, Capital
Elma, Capital
P
70,000
50,000
50,000
10,000
P
180,000
Total Liabilities & Capital
P 180,000
MC 6-12 Using the information in MC 6-11 and assuming that the other assets are sold for
P80,000; profits are shared 2:2:6, respectively; and that any deficient partner is
insolvent, the amount to be received by Egay upon liquidation is
a. P19,500
b. P25,000
c. P38,000
d. P50,000
MC 6-13 Esmer, Estrel, Ellea, and Elmer share profits in the ratio of 2:1:1. The partnership
cannot meet its obligations to creditors and dissolution is authorized on September 30,
2014. A statement of financial position for the partnership on this date shows balances
as follows:
72 | P a g e
Cash
Other Assets
Assets
Total Assets
Liabilities and Capital
P
90,000
400,000
Liabilities
Elmer, loan
Esmer, Capital
Estrel, Capital
Ellea, Capital
Elmer, Capital
P 265,000
25,000
50,000
50,000
50,000
50,000
P
490,000
Total Liabilities & Capital
P 490,000
The personal status of partners on this date is determined to be as follows:
Partners
Esmer
Estrel
Ellea
Elmer
Cash and cash value of
personal assets
P 250,000
100,000
150,000
200,000
Personal
liabilities
P 150,000
150,000
125,000
250,000
The other assets of the partnership are sold and realized P120,000. Additional
contributions by appropriate parties in meeting the claims of firm creditors were made.
The amount that will be paid to the personal creditors of Esmer would be
a. P150,000
b. P165,000
c. P222,500
d. P250,000
MC 6-14 Using the information in MC 6-13, the amount that will be paid to the personal creditors
of Estrel would be
a. P100,000
b. P142,000
c. P150,000
d. P180,000
MC 6-15 Using the information in MC 6-13, the amount that will be paid to the personal creditors
of Elmer would be
a. P200,000
b. P217,500
c. P235,000
d. P250,000
Chapter 7 – Installment Liquidation
CHAPTER 6
INSTALLMENT LIQUIDATION
4.
Explain the nature of installment liquidation.
Discuss and understand the procedures followed under installment liquidation.
Prepare a Statement of Liquidation and the Accompanying Schedule Showing How Available Cash
is to be Distributed.
Prepare a Cash Priority Program.
PREVIEW OF THE CHAPTER
Installment Liquidation
Procedures
•
•
•
Realization of assets on a
piece-meal basis
Distribution of gain or loss on
realization
Preparation of cash
distribution schedule
Distribution of available cash
(2) Restricted interest, in the Accompanying Schedule to Determine Amounts to be Paid to
Partners, shall consist of:
(a) Remaining unsold assets
(b) Cash withheld (for possible expenses)
(c) Debit balances in capital
Illustrative Problem A:
The statement of financial position of the partnership of Arias, Buendia, and Caras on December
31, 2014, when the partners decide to liquidate follows:
INSTALLMENT
LIQUIDATION
•
The liquidation procedures shall be the same as in lump sum liquidation except that:
(1) Cash I distributed to partners even before fully realizing non-cash assets and
determining total gain or loss on realization.
LEARNING OBJECTIVES
1.
2.
3.
potential capital deficiencies are assumes uncollectible. In this sense, partners’ interests are
reduced by cash distribution to a balance proportionate to the partners’ profit and loss ratios.
Succeeding cash distributions are then based on the profit and loss ratio.
Statement of
Liquidation
•
•
Schedule to accompany the
Statement of Liquidation
Cash Priority Program
• Loss absorption capacity
• Cash allocation
Assets
Cash
Other Assets
Total Assets
Liabilities and Capital
Liabilities
Aria, Loan
Arias, Capital (30%)
Buendia, Capital (40%)
Cara, Capital (30%)
Total Liabilitiesand Capital
73 | P a g e
P 250,000
70,000
200,000
30,000
150,000
P 700,000
Cash is realized on the other assets as follows, and amounts realized are distributed at the end of
each month to the appropriate parties.
Fiscal Year 2015
January
February
NATURE OF INSTALLMENT LIQUIDATION
Under the installment liquidation, non-cash assets are sold on a piece-meal basis over an
extended period of time. Cash realized is immediately distributed to partners after fully
satisfying creditors’ claims or after setting aside sufficient cash for these liabilities. In as much as
cash distributions are made before realizing all non-cash assets and the total gain or loss on
realization is not yet determined, it is necessary that each cash distribution to partners be
considered as if it were the last. Remaining unsold assets, therefore, must be treated as a
complete loss, assuming that nothing is realized on them. Also, debit balances in capital and
P 200,000
500,000
P 700,000
Asset Book Value
P 300,000
200,000
Cash Proceeds
P 260,000
230,000
Instructions:
(1) Prepare a statement of liquidation to summarize the course of liquidation. Provide
schedules in support of monthly distributions.
(2) Prepare the journal entries to record the liquidation
Chapter 7 – Installment Liquidation
Arias, Buendia and Caras
Statement of Liquidation
January to February 2015
Cash
Profit and loss ratio
Balances before liquidation
January:
Sales of assets and
distribution of loss
Balances
Payment of liabilities
Balances
Payment to partners (per
schedule)
Balances
February:
Sale of assets &
distribution of gain
Balances
Payment to partners
74 | P a g e
Other Assets
P 200,000
P 500,000
260,000
P 460,000
(250,000)
P210,000
(300,000)
P200,000
P200,000
(210,000)
P 230,000
P 230,000
(230,000)
Liabilities
Arias Loan
P 250,000
P 70,000
Arias
(30%)
P 200,000
Buendia
(40%)
P 30,000
Caras
30%
P 150,000
P 250,000
(250,000)
70,000
(12,000)
P 188,000
(16,000)
P 14,000
(12,000)
P 138,000
P 70,000
P 188,000
P 14,000
P 138,000
(70,000)
(95,000)
(45,000)
P200,000
P 93,000
P 14,000
P 93,000
(200,000)
9,000
P 102,000
(P 102,000)
12,000
P 26,000
(26,000)
9,000
P 102,000
(102,000)
Chapter 7 – Installment Liquidation
Cash
Payment to partners
Arias, Buendia, and Caras Partnership
Schedule to Accompany Statement of Liquidation
Amounts to be Paid to Partners
January 31, 2015
Capital balances before cash distribution
Add Loans
Total partners’ interest
Restricted interest – possible loss of
P200,000 if nothing is realized on
remaining unsold assets
Restricted interest – additional possible
loss of P66,000 to Arias and Caras if
Buendia is unable to pay his possibly
deficiency, shared in the ratio of 30:30
Free interest – payments to partners
Payment to apply on:
Loan
Capital
Total cash distributions
February
Arias
(30%)
P 188,000
70,000
P 258,000
Buendia
(40%)
P 14,000
Caras
(30%)
P 138,000
P 14,000
P 138,000
(60,000)
(80,000)
(60,000)
P 198,000
(P66,000)
P 78,000
(33,000)
66,000
(33,000)
P 165,000
P 45,000
75 | P a g e
230,000
Arias, Capital
Buendia, Capital
Caras, Capital
Cash
Final payment to partners
102,000
26,000
102,000
200,000
9,000
12,000
9,000
230,000
P 70,000
95,000
P 165,000
P 45,000
P 45,000
Partners may desire to determine in advances as to whom cash distributions shall be made as
cash may become available. This procedure requires the preparation of a program called Cash
Priority Program, Cash Predistribution Plan or Program of Priorities. The program is
prepared prior to liquidation, that is, before cash becomes available for distribution. Cash
realized on other assets is distributed based on the program without the need for the preparation
of the schedule previously used to accompany the statement of liquidation. The steps in the
preparation of the program are the following:
1.
Determine total partners’ interest; that is, capital balances before liquidation plus loans
by partners to the partnership less advances by the partnership to the partners.
2.
Divide total partners’ interest by their profit and loss ratio to get each partner’s loss
absorption capacity. The loss absorption capacity is the maximum amount of loss that a
partner may absorb and may eliminate any partner in any cash distribution. A partner,
therefore, with the highest loss absorption balance has the first priority on cash
distributions.
3.
Once the loss absorption balances are determined, allocations may now be made,
starting with Allocation I wherein the highest loss absorption balance is reduced to the
next highest. Each reduction in the loss absorption balance requires payment to partners
computed by multiplying the amount of reduction by the partner’s profit and loss ratio.
4.
After the partners’ loss absorption balances are made equal, cash distributions are made
in the profit and loss ratio.
Journal entries to record the liquidation:
Cash
Arias, Capital
Buendia, Capital
Caras, Capital
Other Assets
Sale of assets and distributions of loss
260,000
12,000
16,000
12,000
Liabilities
Cash
Payment to liabilities
250,000
Arias, Loan
Arias, Capital
Caras, Capital
Cash
Other Assets
Arias, Capital
Buendia, Capital
Caras, Capital
Sale of assets and distribution of gain
PROGRAM OF CASH DISTRIBUTION
Based on the schedule, the January payments to partners shall be made to partners Arias and
Caras which shall apply first on the loan and then on capital.
January
210,000
300,000
250,000
70,000
95,000
45,000
Chapter 7 – Installment Liquidation
Arias, Buendia, and Caras Partnership
Cash Priority Program
January 1, 2015
Arias
Buendia
Caras
P200,000
P30,000
P150,000
P270,000
P30,000
P150,000
30%
40%
30%
Loss absorption capacity
P900,000
P75,000
P500,000
Allocation I: Cash to Arias reducing his
loss absorption balance to an amount
reported for Caras; reduction of P400, 000
requires payment of 30% x P400,000
(400,000)
Capital balances before liquidation
Add Loans
Total partners’ interest
Divided by the profit % loss ratio
Caras
P120,000
P75,000
P500,000
(425,000)
127,500
To Caras, 30% x P425,000
(425,000)
P75,000
P75,000
Allocation III: Further cash distributions
Are to be made in the profit and loss ratio
A summary of the information provided by the cash priority program follows:
After fully satisfying liabilities:
1.
The first P120,000 cash available to partners should be paid to Arias.
2.
The next P255,000 should be paid to Arias and Caras in the ratio 30:30.
3.
Amounts in excess of P375,000 should be paid to Arias, Buendia, and Caras in the profit and
loss ratio of 30:40:30.
76 | P a g e
Payments to
Buendia
70,000
P500,000
Allocation II: Cash to Arias and Caras to
reduce their loss absorption balances
to amount reported for Buendia; reduction of
P425,000 requires payments as follows:
To Arias, 30% x P425,000
Arias
P75,000
P127,500
P247,500
-
P127,500
Chapter 7 – Installment Liquidation
Application of the cash priority program on the installment distribution upon liquidation of the
partnership of Arias, Buendia, and Caras shall be:
Installment Distribution
January 31, 2015
Cash Available
Allocation I – Payable to Arias
Allocation II – Payable to Arias
And Caras, 30:30
Amount
P 210,000
120,000
P 90,000
Arias
Buendia
-
1.
Explain the nature of installment liquidation. Under installment liquidation, the
realization of non-cash assets takes place over an extended period of time. However, cash
realized is immediately distributed to creditors and partners even if there are still unsold
non-cash assets.
2.
Discuss and understand the procedures followed under installment liquidation. The
procedures under installment liquidation are basically the same as those under lump-sum
liquidation except that cash is distributed to partners, it is considered as if it were the last
so as to avoid any overpayment to any of the partners.
3.
Prepare a Statement of Liquidation and the Accompanying Schedule Showing How
Available Cash is to be Distributed. The statement of liquidation is basically similar to the
one prepared under lump-sum liquidation except that it covers a longer period of time. In
addition, an accompanying schedule is prepared every time cash is distributed. Such
schedule shows how available cash is to be distributed to partners.
4.
Prepare a Cash Priority Program. A cash priority program is a program prepared prior to
liquidation so that partners may determine of the cash priority program follows these steps:
(1) determining total partners’ interest; (2) determining partners’ loss absorption capacity;
(3) determining allocation of cash as it becomes available. When a cash priority program is
prepared, a schedule accompanying the statement of liquidation need not be prepared.
Caras
P120,000
45,000
P 165,000
REVIEW of the LEARNING OBJECTIVES
P 45,000
P 45,000
Installment Distribution
February 28, 2015
Cash available
Allocation II – Balance
P255,000 – P90,000 payable
to Arias and Caras, 30:30
Allocation III – Payable to Arias,
Buendia and Caras, 30:40:30
Amount
P 230,000
Arias
165,000
P 82,500
P 65,000
19,500
P 102,000
Buendia
Caras
P 82,500
P 26,000
P 26,000
19,500
P 102,000
Key Points. The same amount of cash distributions per accompanying schedule to the statement
of liquidation were arrived at in January and February. Also, when cash available for distribution
is not sufficient to cover an allocation, the partners, share such insufficient cash on the basis of
their profit and loss ratio.
There may be instances wherein in the gain or loss related to the sale of individual assets during
the course of liquidation is difficult to determine. In such cases, no gain or loss is recognized on
realization and cash is recorded equal in amount to the book value of the assets sold. The total
gain or loss on realization is recognized in the final realization of assets and it is the difference
between the cash realized and the book value of the remaining assets sold. Such gain or loss then
carries to capital.
77 | P a g e
GLOSSARY of ACCOUNTING TERMINOLOGIES
Installment liquidation – realization of non-cash assets on a piece-meal basis.
Partner’s loss absorption capacity – the maximum amount of loss that a partner may absorb
without incurring capital deficiency.
Chapter 8 - Organization and Formation of a Corporation
DEFINITION OF A CORPORATION
CHAPTER 8
ORGANIZATION AND FORMATION
OF A CORPORATION
CHARACTERISTICS OF A CORPORATION
LEARNING OBJECTIVES
1.
2.
3.
4.
5.
6.
7.
8.
A corporation is an artificial being created by operation of law, having the right of succession and
the powers, attributes and properties expressly authorized by law or incident to its existence.
(Section 1, Corporation Code of the Philippines.)
Define a corporation and identify its characteristics.
Identify and discuss the advantages and disadvantages of a corporate form of organization.
Identify and discuss the various classes of corporation.
Identify the components of a corporation and the steps in organizing it.
Identify the different types of records that are maintained by a corporation.
Identify and differentiate the two classes of share capital (capital stock) in exchange for various
considerations.
Identify the measurement bases in the issuance of share capital (capital stock) in exchange for
various considerations.
Record transactions relating to issuance of share capital using the memorandum entry method
and the journal entry method.
PREVIEW OF THE CHAPTER
1.
Separate legal entity – artificial being. A corporation is an artificial being with a
personality that is separate from that of its individual owners. Thus, it may, under its
corporate name, take, hold or convey property to the extent allowed by law, enter into
contracts, and sue or be sued.
2.
Created by operation of law. A corporation is generally created by operation of law. The
mere agreement of the parties cannot give rise to a corporation.
3.
Right of succession. A corporation has the right of succession. Irrespective of the death,
withdrawal, insolvency, or incapacity of the individual members or shareholders, and
regardless of the transfer of their interest or share capital, a corporation can continue its
existence up to the period of time stated in the articles of incorporation but not exceed fifty
years.
4.
Powers, attributes, properties authorized by law. A corporation has only the powers,
attributes and properties expressly authorized by law or incident to its existence. Being a
mere creation of law, a corporation can only exercise powers provided by law and those
powers which are incidental to its existence.
5.
Ownership divided into shares. Proprietorship in a corporation is divided into units
known as share capital. The buyers of this share capital are called shareholders or
stockholders and are considered owners of the business.
6.
Board of directors. Management of the business is vested in a board of directors elected by
the shareholders. The board of directors is the governing body or decision-making body of
the corporation. The Corporation Law provides that the number of directors be not less than
five but not more than fifteen.
CORPORATION
Nature of a
Corporation
•
•
•
•
•
•
•
•
Characteristics
Advantages
Disadvantages
Classes of corporation
Components of a
corporation
Steps in organizing a
corporation
Rights of a stockholder
Corporate records
Classes of Share Capital
•
•
•
•
•
78 | P a g e
Ordinary share capital
(common)
Preference share capital
(preferred)
•
Cumulative
•
Noncumulative
•
Participating
•
Nonparticipating
•
Convertible
•
Redeemable
Par value share capital
Stated share value share
capital
No-par, no stated value share
capital
Issuance of Share
Capital
•
•
•
Methods of recording
•
Memo entry
•
Journal entry
Considerations in
exchange for share
capital
•
Cash
•
Non-cash assets
•
Services
Share capital
subscription
•
Subscription
default
ADVANTAGES OF A CORPORATION
1.
The corporation enjoys continuous existence because of its power of succession.
2.
The corporation has the ability to obtain a strong credit line because of continuity of
existence.
Chapter 8 - Organization and Formation of a Corporation
3.
Large scale business undertakings are made possible because many individuals can invest
their funds in the enterprise.
4.
The liability of its Investors or shareholders is limited to the extent of their investment in
the corporation.
5.
The transfer of shares can be effected without the need for prior consent of other
shareholders.
6.
Its smooth operation is guaranteed because of centralized management.
b.
2.
3.
DISADVANTAGES OF A CORPORATION
1.
It is not easy to organize because of complicated legal requirements and high costs in its
organization.
2.
The limited liability of its shareholders may weaken its credit capacity.
3.
It is subject to rigid governmental control.
4.
It is subject to more taxes.
5.
Its centralized management restricts a more active participation by shareholders in the
conduct of corporate affairs.
The following is a list of the common classes of corporations:
1.
As to Membership Holdings
a. Stock corporation – a private corporation in which the capital is divided into shares of
stock and is authorized to distribute corporate earnings to holders on the basis of
shares held. The owners of a stock corporation are called stockholders or shareholders.
79 | P a g e
b.
Private corporation – a corporation that is organized for a private benefit, aims on end.
c.
Quasi-public corporation - a private corporation which is given a franchise to perform
functions of a public character. Classified under this type are the so-called public utility
corporations such as MERALCO and PLDT.
As to Compliance of Law
a. De jure corporation – a corporation which exists in both law and fact. It exists in law
because it has complied with all the legal requirements; it exists in facts because it
actually operates as a corporation.
5.
De facto corporation – a corporation which only exists only in fact but not in law. It
does not exist in law because of non-compliance with certain legal requirements.
As to Law of Creation
a. Domestic corporation – a corporation that is organized under Philippine laws.
b.
CLASSES OF CORPORATION
Corporations are generally classified according to purpose, membership holdings, compliance of
law. law of creation, extent of membership or other basis of classification. Generally, profitoriented corporations are open, private and stock corporations. Nonprofit corporations are
public and private non-stock corporations.
As to Purpose
a. Public corporation – a corporation that is organized to govern a portion of the state
(e.g. municipalities, provinces) .
b.
4.
Non-stock corporation – a private corporation in which capital comes from fees paid
by individuals composing it. The owners of non-stock corporation are called members.
Foreign corporation – a corporation that is organized under the laws of other
countries.
As to Extent of Membership
a. Open corporation – a corporation whose ownership is widely held by many investors,
usually a private stock corporation.
b.
Closely-held corporation or family corporation – a private corporation in which 50%
or more of its stock owned by five (5) persons or less.
Other types of corporations include parent or holding corporations, subsidiary corporations,
ecclesiastical corporations and lay corporations which are themselves classified into other
groups.
COMPONENTS OF A CORPORATION
1.
Incorporators – they are the persons who originally formed the corporation and whose
names appear in the Articles of Incorporation, They must be natural persons as
distinguished from artificial persons.
Chapter 8 - Organization and Formation of a Corporation
2.
Corporators – they are the persons who compose the corporation whether as shareholders
or members.
3.
Stockholders or shareholders – they are the corporators of a stock corporation.
4.
Members – they are the corporators of a non-stock corporation.
5.
Promoters – they are the persons who undertake to (a) form a company based on a given
project, (b) set it going, and (c) take the necessary steps to accomplish the purpose for which
the corporation is organized.
6.
Subscribers – they are the persons who have agreed to take the original, unissued shares
but will pay at a later date. They may be incorporators or not and they may eventually
become shareholders the moment the full payment of their subscriptions is made.
7.
Underwriters – they are those who undertake to dispose of the shares to the general public.
Costs incurred during incorporation, such as filing fees, cost of printing stock certificates,
promoters' commission and legal fees, are known as organization costs or pre-operating costs.
Under PAS 38 Intangible Assets, organization or pre-operating costs are charged to expense in
the period incurred.
ARTICLES OF INCORPORATION
The Articles of Incorporation enumerate the powers and limitations conferred upon the
corporation by the government. It includes the following information:
1.
2.
3.
4.
5.
6.
7.
ORGANIZING A CORPORATION
The process of organizing a corporation generally consists of three stages which normally
require the aid of legal, competent advisers. These three stages are discussed below.
1.
2.
3.
Promotion – the incorporators make preliminary arrangements to set up a tentative
working organization and to solicit subscriptions to raise sufficient capital for the business.
Incorporation – the process of formalizing the organization of the corporation. This stage
includes:
a. Drafting of the articles of incorporation which must be duly executed and
acknowledged before a notary-public.
b.
Filing of the articles of incorporation with the Securities and Exchange Commission
(SEC) together with the statement showing that at least 25% of the total authorized
share capital (also known as authorized capital stock) has been subscribed and that at
least 25% of the total subscriptions have been paid.
c.
After the required fees have been paid and upon approval of the articles of
incorporation, the SEC issues a certificate of incorporation, the date of which being
considered as the date of registration or incorporation.
Commencement of the business – the business should start its operations within two
years from the date of incorporation. Failure to do so will automatically dissolve the
corporation without the need for a hearing.
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8.
9.
the name of the corporation;
the purpose or purposes for which the corporation is formed;
the place of the principal office of the corporation;
the term of existence of the corporation. not exceeding fifty years;
the names, nationalities. and addresses of the incorporators;
the names of the directors who will serve until their successors are duly elected and
qualified in accordance with the by-laws;
the authorized share capital (authorized capital stock), the classes of share capital (stocks)
to be issued, and the number of shares and terms of each class indicating the par value per
share, if there is any;
the amount of subscriptions to the share capital (capital stock), the names of the subscribers
and the number of shares subscribed by each; and
the total amount paid on the subscriptions to the share capital (capital stock) and the
amount paid by each subscriber on his subscription.
BY-LAWS
The by-laws of the corporation supplement the articles of incorporation. It contains provisions
for the internal administration of the corporation. The corporate by-laws normally include the
following:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
the date, place and manner of calling the annual shareholders` (stockholders') meeting;
the manner of conducting meetings;
the circumstances which may permit the calling of special meetings of the shareholders;
the manner of voting and the use of proxies;
the manner of electing the directors and the number of directors;
the term of office of the directors;
the authority and duties of the directors;
the manner of selecting the corporate officers;
the authority and responsibilities of the officers;
the procedure for amending the articles of incorporation; and
the procedure for amending the by-laws.
Chapter 8 - Organization and Formation of a Corporation
CORPORATE RECORDS
The corporation generally maintains the following records to keep track of its various
transactions:
1.
2.
3.
4.
5.
record of all business transactions (journals, ledgers, vouchers, and other supporting
documents).
minutes of all meetings of directors
minutes of all meetings of shareholders (stockholders).
Stock and transfer book
a. Shareholders’ (stockholders’) ledger – chronological and numerical record of
stock certificates issued.
b. Shareholders’ *stockholders’) ledger – alphabetical record of individual
shareholders.
c. Subscribers’ ledger – alphabetical record of individual subscribers.
optional and supplementary records
SHARE CAPITAL (CAPITAL STOCK)
Share capital is also known as capital stock. It is the amount fixed by the corporate charter to be
subscribed Land paid in or secured to be paid in by the shareholders of a corporation either in
money or in property. labor or services upon the organization of the corporation or afterwards;
and upon which it is to conduct its operations.
CLASSES OF SHARE CAPITAL
A corporation may issue two classes of share capital. namely, ordinary share capital (common
stock) and preference share capital (preferred stock). When a single class of share capital is
issued, it is an ordinary share capital. Ordinary share capital entitles the holder to an equal or
pro-rata division of profits without any preference or advantage over any class of shares.
Preference share capital, on the other hand, entitles the holder to enjoy priority as to distribution
of dividends and distribution of assets upon corporate liquidation. Dividends are corporate
profits distributed to its shareholders.
Unless otherwise stated in the contract, all shareholders have the same basic rights.
These rights are as follows:
1. to share in the distribution of corporate profit;
2. to share in the distribution of assets upon corporate liquidation;
3. to vote in shareholders' meeting; and
4. to maintain one’s ownership interest in the corporation through purchase of additional
shares when a new share capital is issued. This is known as the preemptive right.
81 | P a g e
If a corporation issues both preference and ordinary share capital, the articles of incorporation
or the corporate by-laws should state the special features of each class of share capital.
Both preference and ordinary share capital may be issued with par, without par but with stated
value, or without par and without stated value.
A par value share capital has a nominal or face value stated on the face of the stock certificate
and in the articles of incorporation.
A no-par but with stated value share capital has a nominal value stated in the articles of
incorporation but not on the face of the stock certificate.
A no-par, no stated value share capital has no nominal value stated either in the articles of
incorporation nor on the face of the stock certificate.
In our Corporation Code, a no-par share capital is to be issued for a consideration of not less than
five pesos (P5.00)
PREFERENCE SHARE CAPITAL (PREFERRED STOCK)
A preference share capital is generally issued with a par value and a dividend rate. The holders
of preference shares have priority as to distribution of dividends and as to distributions of assets
in the event of corporate liquidation. However, this does not mean that the holders are assured
of regular receipt of dividends; rather, this means that dividend requirements on preference
shares must first be met before any payment can be made to holders of ordinary shares.
A corporation may issue more than one class of preferences shares. Generally, preference shares
may be classified as follows:
1.
Cumulative preference shares – entitle the holders to the receipt of previous years’ unpaid
dividends (i.e., dividends in arrears) before any payment can be made to ordinary
shareholders upon dividend declaration. This means that if dividend is not declared in a
particular year, the right to such dividend is not lost but carried forward to a subsequent
year.
2.
Non-cumulative preference shares – entitles the holders to the receipt of current
dividends but not on the previous year’s unpaid dividends. This means that if dividend is
not declared in a particular year, the right to such dividend is lost.
3.
Participating preference share – entitle the holders to the receipt of additional dividend
after holders of both preference and ordinary shares have been paid up to the current year's
dividend. This means that the holders of preference shares have the right to share in extra
dividends.
Chapter 8 - Organization and Formation of a Corporation
JOURNAL ENTRY METHOD
Participating preference shares may be fully participating or participating only up to a certain
amount or percentage.
4.
Unissued XXX Share Capital
Authorized XXX Share Capital
Nonparticipating preference share – entitle the holders to the receipt of dividends up to
the current period only. All extra dividends are given to holders of ordinary shares.
5.
Convertible preference shares – entitle the holders the option to exchange the shares for
some other securities of the issuing corporation, normally ordinary shares.
6.
Redeemable preference shares – entitle the issuing corporation the option to redeem or
call the shares at a certain call price.
ORDINARY SHARE CAPITAL (COMMON STOCK)
An ordinary share capital or common stock represents residual ownership equity. The holders
of this class of share capital carry the greatest risk, however, they ordinarily share in earnings to
the greatest extent if the corporation is successful. Although the right to vote is a basic right of
all shareholders, it is frequently given exclusively to ordinary shareholders as long as dividends
are paid regularly to preference shareholders.
xxx
The total amount recorded is computed by multiplying authorize shares by the par or
stated value of the share capital. Thus, this method cannot be used if the share capital is
a no-par and no-stated value stock.
The entry to record authorized share capital is made in the general journal ad is then posted to
the share capital account in the general ledger. If more than one class of share capital are issued,
a separate entry is made for each class of share capital and a separate account for each class in
maintained in the general ledger.
The memorandum entry method enjoys popularity in use compared with the journal entry
method. For problem solving purposes, the memorandum entry method will be used if there is
no specification as to which will be used.
Illustrative Problem A: The Joyful Company was organized on January 1, 1014 with authorized
share capital as follows:
AUTHORIZED SHARE CAPITAL
The maximum number of shares (both preference and ordinary shares) that a corporation may
issue is termed as authorized shares. The authorized share capital (authorized capital
stock) is determined by multiplying the authorized shares by the par or stated value of the share
capital.
xxx
10,000 shares of 10% preference share capital with par value of P100 per share
200,000 shares of ordinary share capital with a par value of P10 per share
The entries to record authorized share capital and the subsequent posting to the general ledger
under each method are illustrated below:
Case 1 – The memorandum entry method is use.
A corporation cannot issue shares more than the authorized shares stated in the articles of
incorporation. However, it may increase its authorized and shares and authorized share capital
by amending its articles of incorporation
2014
Jan. 1 Authorized to issue 10,000 shared of 10% preference share capital with a par value of
P100 per share
Authorized share capital may be recorded under the journal entry method or the memorandum
entry method. The entries under the two (2) methods to record authorized share capital are
presented below and on the next page,
MEMORANDUM ENTRY METHOD
Authorized to issue xxx shares of xxx share capital with a par value of Pxxx.
82 | P a g e
1 Authorized to issue 200,000 shares of ordinary share capital with a par value of P10
per share.
The two entries are then posted to the accounts in the general ledger as follows:
10% Preference Share Capital
2014
Jan. 1
Authorized to issue 10,000
shares, par value P100
Ordinary Share Capital
2014
Jan. 1 Authorized to issues 200,000
shares, par value P10
Chapter 8 - Organization and Formation of a Corporation
ISSUANCE OF PAR VALUE SHARE
Case 2 – The journal entry method is used.
2014
Jan, 1
1
Unissued Preference Share Capital
Authorized Preference Share Capital
1,000,000
Unissued Ordinary Share Capital
Authorized Ordinary Share Capital
2,000,000
As discussed earlier, a par value share has a nominal value stated on the face of the stock
certificate. The following rules shall apply in the issuance of this class of share capital.
1,000,000
2,000,000
These entries are then posted to the accounts in the general ledger as follows:
Authorized Preference Share Capital
2014
Jan. 1 1,000,000
Unissued Preference Share Capital
2014
Jan. 1 1,000,000
Authorized Ordinary Share Capital
2014
Jan. 1 2,000,000
Unissued Ordinary Share Capital
2014
Jan. 1 2,000,000
Posting to the accounts in the general ledger is very important so that the corporations will be
able to monitor shares issued and avoid the issuance of shares more than what is authorizes.
ISSUANCE OF SHARE CAPITAL
A share capital may be issued in exchange for cash, non-cash assets, services, liability or other
form of securities. It may be sold also on a subscription basis. A share capital issued to a
shareholder is called an outstanding share. The major issue on issuance of share capital is the
basis for measurement of the transaction. The discussion of the measurement standards will be
based on the provisions of PRFS 2 Share-Based Payment and will be limited to issuance of share
capital to non-employees. The issuance of share capital to employees (such as share options and
share appreciation rights) will be discusses in financial accounting.
A shareholders’ (stockholders’) ledger is used to maintain records affecting the shareholding of
each shareholder such as transfer or sale of share capital. Shares issued to shareholder, on the
other hand, are recorded in the stock certificate book.
Share capital issued are recorded in the share capital account maintained for each class of share
capital. The discussions in the succeeding paragraphs are focused on the issuance of various
classes of shares in exchange for various considerations.
83 | P a g e
ISSUANCE FOR CASH. A share capital may be issued for cash equal to its par value, above par
value, or below par value. If cash received is equal to its par value, Cash is debited and Share
Capital or Unissued Share Capital is credited.
If the share capital is sold or issued above is par value. Cash is debited for the amount received,
Share Capital or Unissued Share Capital is credited at par value, and Share Premium or Paid-in
Capital in Excess of Par is credited for the excess of cash received over par value.
If the share capital is sold or issued below its par value. Cash is debited for the amount received.
Share Capital or Unissued Share capital is credited at par value, and Discount on Share Capital is
debited for the excess of par value over the amount of cash received. Under the Corporation Code
of the Philippines, however, the original issuance of share capital at a discount is not allowed,
Therefore, problems involving discounts are used in the book for illustration purposes only
Illustrative Problem B: The Happy Corporation was organized on January 1, 2014 and is
authorities to issue 100,000 shares of P10 par value ordinary shares. Subsequently, 25,000
shares were sold.
The entries to record the sale of shares under the two methods of recording share capital using
three independent cases are presented below and on the next page.
MEMORANDUM ENTRY METHOD
Case 1 – The issuance price is P10 (at par)
Cash
Ordinary Share Capital
25,000 sh x P10 = P250,000
250,000
250,000
Case 2 – the issuance price is P15 (above par)
Cash
Ordinary Share Capital
Ordinary Share Premium
25,000 sh x P15 = P375,000
25,000 sh x P10 = P250,000
25,000 sh x P 5 = P125,000
375,000
250,000
125,000
Chapter 8 - Organization and Formation of a Corporation
Case 3 – The issuance price is P8 (below par)
Cash
Discount on Ordinary Share Capital
Ordinary Share Capital
25,000 sh x P 8 = P200,000
25,000 sh x P 10 = P250,000
25,000 sh x P 2 = P 50,000
200,000
50,000
250,000
ISSUANCE IS EXCHANGE FOR NON-CASH ASSETS OR PROPERTY. When a share capital is issued
in exchange for non-cash assets, the asset received is recorded at its fair value (also known as
direct measurement), unless the fair value cannot be estimated reliably. If the fair value of the
asset received cannot be estimated reliably, it will be recorded at the fair value of the share
capital issued, also known as indirect measurement (PFRS 2, par. 10). The fair value of the asset
received shall be determined at the date the entity received the asset (PFRS 2, par. 13)
Upon issuance of the stock, Share Capital or Unissued Share Capital is credited at pat value. The
excess of the value assigned to the asset received over the par value of the stock issued is credited
to Share Premium or Additional Paid-in Capital, or Share Capital in Excess of Par. To reiterate,
original issuance of share capital at less than its par value is prohibited under our Corporation
Code.
JOURNAL ENTRY METHOD
Case 1 – the issuance price is P10 (at par)
Cash
Unissued Ordinary Share Capital
25,000 sh x P 10 = P250,000
250,000
250,000
In some instances, the value assigned to the asset received is overstated or understand. When
the value assigned to the asset received in exchange for share capital is overstated, the share
capital issued is called watered share capital. The overstatement is done to comply with the
requirement of the law that the share capital should not be issued at less than its par value. When
the value of the asset received is understated, the share capital said to contain secret reserves.
Case 2 – the issuance price is P 15 (above par)
Cash
Unissued Ordinary Share Capital
Ordinary Share Premium
25,000 sh x P 15 = P375,000
25,000 sh x P 10 = P250,000
25,000 sh x P 5 = P125,000
375,000
250,000
125,000
Illustrative Problem C: The Happy Corporation issued 10,000 shares of its P10 par ordinary
share capital in exchange for land. The entries to record the issuance of the share capital under
the memorandum entry method using three independent cases are given on below and on the
next page.
Case 1 – The land has a fair value of P175,000.
Land
Case 3 – The issuance price is P8 (below par)
Cash
Discount on Ordinary Share Capital
Ordinary Share Capital
175,000
Ordinary Share Capital
Ordinary Share Premium
10,000 sh x P10
= P 100,000
P175,000 – P100,000 = P 75,000
200,000
50,000
250,000
It should be noted that the basic difference between the memorandum entry method and the
journal method is the account to be credited upon issuance of the share capital.
Case 2 – The land had no known market value. The fair value of ordinary share capital on the
date of exchange is P15.
Land
Under the memorandum entry method, the Share Capital account is credited upon issuance of
the stock. The balance of this account represents the amount of capital stock or share capital
issued to shareholders.
Under the journal entry method, the Unissued Share Capital account is credited upon issuance
of the share capital thereby reducing the balance of this account. The balance of this account
represents the amount of authorized share capital not yet issued and is deducted from the
balance of Authorized Share Capital account to determine the amount of share capital already
issued to shareholders.
84 | P a g e
100,000
75,000
150,000
Ordinary Share Capital
Ordinary Share Premium
100,000
50,000
If the journal entry method is used instead of the memorandum entry method. Unissued Ordinary
Share Capital should have been credited instead of Ordinary Share Capital.
Chapter 8 - Organization and Formation of a Corporation
1.
ISSUANCE IN EXCHANGE FOR SERVICES RENDERED. When a share capital is issued in exchange
for services rendered, the services received is recorded at its fair value (also known as direct
measurement), unless the fair value cannot be estimated reliably. If the fair value of the services
received cannot be estimated reliably, it will be recorded at the fair value of the share capital
issued, also known as indirect measurement (PFRS 2, par. 10). The fair value of the services
received shall be determined at the date the other party renders the services. (PFRS 2, par. 13).
To record the receipt of subscription
a.
b.
IF the shares are issued for services rendered during incorporation, Pre-Operating Expenses is
debited. Share Capital or Unissued Share Capital is credited at par value; Share Capital in Excess
of Par, or Additional Paid-in Capital or Share Premium is credited for any excess of the value
assigned to pre-operating expenses and the par value of the share capital.
Illustrative Problem D: The Happy Corporation issued 1,000 shares P10 par ordinary share
capital in payment for the services of the lawyer rendered during incorporation.
Pre-Operating Expenses
25,000
Ordinary Share Capital
Ordinary Share Premium
1,000 sh x P10
= P 10,000
P25,000 – P10,000 = P 15,000
2.
xxx
xxx
xxx
xxx
To record collection of subscription from subscribers.
10,000
15,000
Cash
Share Capital Subscription Receivable
3.
xxx
xxx
To record issuance of stock certificate upon full payment of subscription
Case 2 – There is no known fair market value for the services of the lawyer. The fair market value
of the ordinary share capital issued is P15 per share.
Share Capital Subscribed
Share Capital (or Unissued Share Capital)
xxx
xxx
15,000
10,000
5,000
= P 15,000
= P 10,000
= P 5,000
Illustrative Problem E: On June 3, 2014, the Happy Corporation received subscription for 5,000
shares of its P10 par value ordinary share capital at P15. A down payment of 25% was received
and the balance was paid in fully on July 4, 2014. The entries to record these transactions using
the memorandum entry method are presented on the next page.
2014
June 3
SALE OF SHARE CAPITAL ON A SUBSCRIPTION BASIS. Subscription is a contract between a
subscriber (buyer of share capital) and a corporation (seller or issuer of share capital) whereby
the former purchases shares of stock of the latter with the payment to be made at a later date.
The corporation issues the corresponding stock certificate upon full payment of subscription.
This practice is a means of encouraging subscribers to pay their unpaid subscription on time.
Sale of share capital on a subscription basis generally involves three major transactions – (1)
receipt of subscriptions, (2) collection from subscribers, and (3) issuance of stock certificate upon
full payment of subscription. Entries required for these transactions are given below.
85 | P a g e
Subscription price is above par value
Share Capital Subscription Receivable
Share Capital Subscribed
Share Premium
Receivable = shares subscribed x SP
Subscribed = shares subscribed x PV
Premium = shares subscribed x (SP-PV)
xxx
It should be noted that the Share Capital Subscribed account is always credited at par value,
regardless of the subscription price.
Case 1 – The services of the lawyer is valued at P25,000.
Pre-Operating Expenses
Ordinary Share Capital
Ordinary Share Premium
1,000 sh x P 15
1,000 sh x P 10
1,000 sh x P 5
Subscription price (SP) is equal to par value (PV)
Share Capital Subscription Receivable
Share Capital Subscribed
Shares subscribed x PV = Pxxx
June 3
Ordinary Share Capital Subscription Receivable
Ordinary Share Capital Subscribed
Ordinary Share Premium
5,000 sh x P15 = P 75,000
5,000 sh x P10 = P 50,000
5,000 sh x P 5 = P 25,000
75,000
Cash
Ordinary Share Capital Subscription Receivable
P75,000 x 25 % = P 18,750
18,750
50,000
25,000
18,750
Chapter 8 - Organization and Formation of a Corporation
July 4
4
Cash
Ordinary Share Capital Subscription Receivable
P75,000 x 75 % = P 56,250
56,250
Ordinary Share Capital Subscribed
Ordinary Share Capital
50,000
56,250
50,000
The entries on June 3 may be recorded in a compound entry as follows:
June 3
Ordinary Share Capital Subscription Receivable
Cash
Ordinary Share Capital Subscribed
Ordinary Share Premium
Cash
Ordinary Share Capital
25,000 sh x P10 = P250,000
250,000
250,000
Case 2 – The issuance price is P15 (above stated value)
56,250
18,750
50,000
25,000
ISSUANCE OF NO-PAR, BUT WITH STATED VALUE SHARE CAPITAL
A Share capital without par value but with a stated value has a nominal value stated in the articles
of incorporation but not on the face of the stock certificate.
The same rules discussed in the issuances of share capital with a par value are applicable. The
account Share Capital in Excess of Stated Value may be used instead of the account Share
Premium or Share Capital in Excess of Par.
ISSUANCE FOR CASH. A share capital may be sold for cash at its stated value, at more than stated
value, or at less than stated value. If cash received is equal to stated value, Cash is debited and
Share Capital or Unissued Share Capital is credited.
If the share capital is sold or issued at more than its stated value, Cash is debited for the amount
received, Share Capital or Unissued Share Capital is credited at stated value, and Paid-in Capital
in Excess of Stated Value is credited for the excess of cash received over stated value.
If the share capital is sold or issued at less than its stated value, Cash is debited for the amount
received, Share Capital or Unissued Share Capital is credited at stated value, and Discount on
Share Capital is debited for the excess of stated value over the amount of cash received. Under
the Corporation Code of the Philippines, however, the original issuance of share capital at a
discount is not allowed. Therefore, problems involving discounts are used in the book for
illustration purposes only.
Illustrative Problem F: The Happy Corporation was organized on January 1, 2014 and is
authorized to issue 100,000 shares of P10 stated value ordinary share capital. Subsequently,
25,000 shares were sold.
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The entries to record the sale of share capital under the memorandum entry method of recording
share capital using three independent cases are as follows:
Case 1 – The issuance price is P 10 (at stated value)
Cash
Ordinary Share Capital
Ordinary Share Capital in Excess of Stated Value
25,000 sh x P15 = P375,000
25,000 sh x P10 = P250,000
25,000 sh x P 5 = P125,000
375,000
250,000
125,000
Case 3 – The issuance price is P8 (below stated value)
Cash
Discount on Ordinary Share Capital
Ordinary Share Capital
25,000 sh x P 8 = P200,000
25,000 sh x P10 = P250,000
25,000 sh x P 2 = P 50,000
200,000
50,000
250,000
If the journal entry method is used instead of the memorandum entry method. Unissued Share
Capital will be credited instead of Ordinary Share Capital.
ISSUANCE IN EXCHANGE FOR NON-CASH ASSETS OR PROPERTY. When a share capital is issued
in exchange for non-cash assets, the asset received is recorded at its fair value (also known as
direct measurement), unless the fair value cannot be estimated reliably. If the fair value of the
asset received cannot be estimated reliably, it will be recorded at the fair value of the share
capital issued, also known as indirect measurement (PFRS 2, par. 10). The fair value of the asset
received shall be determined at the date the entry received the asset (PFRS 2, par. 13).
Upon issuance of the share capital, Share Capital or Unissued Share Capital is credited at stated
value. The excess of the value assigned to the asset received over the stated value of the share
capital issued is credited to Share Capital in Excess of Stated Value.
Illustrative Problem G: The Happy Corporation issued 10,000 shares of its P10 stated value
ordinary share capital in exchange for land. The entries to record the issuance of the share capital
under the memorandum entry method using three independent cases are given below:
Chapter 8 - Organization and Formation of a Corporation
Cash 2 – There is no known fair market value for the services of the lawyer. The fair market value
of the ordinary share capital issued is P15 per share.
Case 1 – The land has a market value of P175,000.
Land
Ordinary Share Capital
Ordinary Share Capital in Excess of Stated Value
10,000 sh x P10
= P 100,000
P175,000 – P100,000 = P 75,000
Pre-Operating Expenses
Ordinary Share Capital
Ordinary Share Capital in Excess of Stated Value
1,000 sh x P15
= P 15,000
1,000 sh x P10
= P 10,000
1,000 sh x P 5
= P 5.000
175,000
100,000
75,000
Case 2 – The land has no known market value. The fair market value of ordinary share capital on
the date of exchange is P15.
Land
Ordinary Share Capital
Ordinary Share Capital
10,000 sh x P15 = P 150,000
10,000 sh x P10 = P 100,000
10,000 sh x P 5 = P 50,000
150,000
100,000
50,000
If the journal entry method is used instead of the memorandum entry method, Unissued Ordinary
Share Capital should have been credited instead of Ordinary Share Capital.
ISSUANCE IN EXCHANGE FOR SERVICS RENDERED. When a share capital is issued in exchange
for services rendered, the services received is recorded at its fair value (also known as direct
measurement), unless the fair value cannot be estimated reliably. If the fair value of the services
received cannot be estimated reliably, it will be recorded at the fair value of the share capital
issued, also known as indirect measurement (PFRS 2, par. 10). The fair value of the services
received shall be determined at the date the other party renders the services. (PFRS 2, par. 13).
IF the shares are issued for services rendered during incorporation, Pre-Operating Expenses is
debited, Share Capital or Unissued Share Capital is credited at stated value; Share Capital in
Excess of Stated Value or Additional Paid-in Capital is credited for any excess of the value
assigned to pre-operating expenses over the stated value of the share capital.
Illustrative Problem I: On June 3, 2014, the Happy Corporation received subscription for 5,000
shares of its P10 stated value ordinary share capital at P15. A down payment of 25% was received
and the balance was paid in full on July 4, 2014. The entries to record these transactions using
the memorandum entry are presented below and on the next page.
2014
June 3
3
July 4
Pre-Operating Expenses
Ordinary Share Capital
Ordinary Share Capital in Excess of Stated Value
1,000 sh x P10
= P 10,000
P25,000 – P10,000 = P15,000
87 | P a g e
4
Ordinary Share Capital Subscription Receivable
Ordinary Share Capital Subscribed
Ordinary Share Capital in Excess of Stated Value
5,000 sh x P15 = P 75,000
5,000 sh x P10 = P 50,000
5,000 sh x P 5 = P 25,000
75,000
Cash
Ordinary Share Capital Subscription Receivable
P75,000 x 25% = P 18,750
18,750
Cash
Ordinary Share Capital Subscription Receivable
P75,000 x 75% = P 56,250
56,250
Ordinary Share Capital Subscribed
Ordinary Share Capital
50,000
25,000
10,000
15,000
10,000
5,000
SALE OF SHARE CAPITAL ON A SUBSCRIPTION BASIS. The sale of stock with stated value on a
subscription basis is recorded in the same manner as that of a stock with a par value, except for
the account credited for the excess of the subscription price over the stated value of stock. The
account Share Capital in Excess of Stated Value is credited instead of Share Premium, or
Additional Paid-in Capital, or Share Capital in Excess of Par.
Illustrative Problem H: The Happy Corporation issued 1,000 shared od P10 stated value
ordinary share capital in payment for the services of the lawyer rendered during incorporation.
Case 1 – The services of the lawyer is valued at P25,000.
15,000
The entries on June 3 may be recorded in a compound entry.
50,000
25,000
18,750
56,250
50,000
Chapter 8 - Organization and Formation of a Corporation
ISSUANCE OF NO-PAR, NO STATEDVALUE SHARE CAPITAL
When a share capital has no par value and no stated value, the value assigned to the consideration
received is the same amount credited to the Share Capital account.
ISSUANCE FOR CASH. When a no-par, no stated value stock is issued for cash, Cash is debited and
Share Capital is credited for the value of the cash consideration received.
Illustrative Problem J: The Happy Corporation was organized on January 1, 2014 and is
authorized to issue 100,000 shares of no-par, no stated value ordinary share capital.
Subsequently, 25,000 shares were sold at P15 per share.
The entry to record the sale follows:
Cash
Ordinary Share Capital
25,000 x P15 = P375,000
Pre-Operating Expenses
Ordinary Share Capital
375,000
Case 1 – The land has a market value of P175,000.
175,000
175,000
Case 2 – The land has no known market value. The fair market value of ordinary share capital on
the date of exchange is P15.
150,000
25,000
25,000
Case 2 – There is no known fair market value for the services of the lawyer. The fair market value
of the ordinary share capital issued is P15 per share.
Pre-Operating Expenses
Ordinary Share Capital
15,000
15,000
SALE OF SHARE CAPITAL ON A SUBSCRIPTION BASIS. The sale of no stated value share capital
on a subscription basis is recorded in the same manner as that od share capital with a apar value
or with stated value stock, except that the entire subscription price is credited to the Share
Capital account.
Illustrative Problem M: On June 3, 2014, the Happy Corporation received subscription for 5,000
shares of its no-par, no stated value ordinary share capital at P15. A down payment of 25% was
received and the balance was paid in full on July 4, 2014. The entries to record these transactions
using the memorandum entry method follow:
2014
June 3
150,000
If the share capital has no par and no stated value, only the memorandum entry method can be
used.
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Illustrative Problem L: The Happy Corporation issued 1,000 shared of its ordinary share capital
in payment for the services of the lawyer rendered during incorporation.
375,000
Upon issuance of the shares, Share Capital is credited for the value assigned to the asset received.
Land
Ordinary Share Capital
If the shares are issued for services rendered during incorporation. Pre-Operating Expenses is
debited and Share Capital or Unissued Share Capital is credited for the value assigned to the
services rendered.
Case 1 – The services of the lawyer is valued at P25,000.
ISSUANCE IN EXCHANGE FOR NON-CASH ASSETS OR PROPERTY. When a share capital is issued
in exchange for non-cash assets, the asset received is recorded at its fair value (also known as
direct measurement), unless the fair value cannot be estimated reliably. If the fair value of the
asset received cannot be estimated reliably, it will be recorded at the fair value of the share
capital issued, also known as indirect measurement (PFRS 2, par. 10). The fair value of the asset
received shall be determined at the date the entity received the asset (PFRS 2, par. 13).
Land
Ordinary Share Capital
ISSUANCE IN EXCHANGE FOR SERVICES RENDERED. When a share capital is issued in exchange
for services rendered, the services received is recorded at its fair value (also known as direct
measurement), unless the fair value cannot be estimated reliably. If the fair value of the services
received cannot be estimated reliably, it will be recorded at the fair value of the share capital
issued, also known as indirect measurement (PFRS 2, par. 10). The fair value of the services
received shall be determined at the date the other party renders the services. (PFRS 2, par. 13).
3
Ordinary Share Capital Subscription Receivable
Ordinary Share Capital Subscribed
5,000 sh x P15 = P 75,000
75,000
Cash
Ordinary Share Capital Subscription Receivable
P75,000 x 25% = P 18,750
18,750
75,000
18,750
Chapter 8 - Organization and Formation of a Corporation
July 4
Cash
Ordinary Share Capital Subscription Receivable
P75,000 x 75% = P 56,250
56,250
Ordinary Share Capital Subscribed
Ordinary Share Capital
75,000
56,250
If there is no bidder, all of the delinquent shares will be issued in the name of the corporation.
Such shares are considered treasury shares and the following entries will be made, after making
the entries (a) and (b) above.
c.
4
d.
When the share capital issued have no par and have no stated value, only the memorandum entry
can be used in recording the stock transactions.
SUBSCRIPTION DEFAULTS
When a subscriber fails to pay his obligations after the corporation has sent several notices to
him, his subscribed shares are declared delinquent shares. His subscription is declared
delinquent subscription. Such delinquent subscription is then offered for sale in a public auction
and delinquent shares are issued to the highest bidder. The highest bidder is the one who is
willing to pay the unpaid subscription plus any expense incurred I connection with the
delinquency sale and is willing to receive the lease number of shares.
The following entries are made in relation to subscription defaults and issuance of stock
certificates.
b.
c.
d.
Upon default
Receivable from Highest Bidder
Share Capital Subscription Receivable
xxx
Costs incurred in connection with the delinquency sale
Receivable from Highest Bidder
Cash
xxx
xxx
xxx
Upon receipt of payment from highest bidder
Cash
Receivable from Highest Bidder
xxx
Upon issuance of certificates of stock
Share Capital Subscribed
Share Capital (or Unissued Share Capital)
xxx
xxx
xxx
All subscribed shares are issued. Shares are first given to the highest bidder, The excess, if any,
are given to the defaulting subscriber.
89 | P a g e
xxx
Share Capital Subscribed
Share Capital (or Unissued Share Capital)
xxx
xxx
75,000
The entries on June 3 may be recorded in a compound entry.
a.
Treasury Share Capital
Receivable from Highest Bidder
xxx
Illustrative Problem N: On June 15, 2014, the Happy Corporation received subscription for
2,000 shares of its P10 par value ordinary share capital at P15. A down payment of 60% was
received. The final payment was due on August 15, 2014, although several notices were sent to
the subscriber, no payment has been received. On August 31, the subscription was declared
delinquent and was offered for sale in a public auction. On September 6, expenses of P500 were
incurred in connection with the delinquency sale. On September 21, payment was received from
the highest bidder and shares were issued – 1,500 to the highest bidder and 500 to the defaulting
subscriber.
The entries to record the foregoing transactions using the memorandum entry method follow:
2014
June 15 Ordinary Share Capital Subscription Receivable
Ordinary Share Capital Subscribed
Ordinary Share Premium
2,000 sh x P15
= P 30,000
2,000 sh x P10
= P 20,000
2,000 sh x P 5
= P 10,000
30,000
15 Cash
Ordinary Share Capital Subscription Receivable
P30,000 x 60%
= P 18,000
18,000
Aug. 31 Receivable from Highest Bidder
Ordinary Share Capital Subscription Receivable
P30,000 x 40%
= P 12,000
12,000
Sept. 6
Receivable from Highest Bidder
Cash
20,000
10,000
18,000
12,000
500
500
21 Cash
Receivable from Highest Bidder
12,50
21 Ordinary Share Capital Subscribed
Ordinary Share Capital
20,000
12,500
20.000
Chapter 8 - Organization and Formation of a Corporation
INCORPORATING A SOLE PROPRIETORSHIP OR A PARTNERSHIP
A sole proprietorship or a partnership may decide to incorporate to enjoy the advantages of
being a corporation. The books of the old organization may be used by the new corporation after
giving effect to changes that may have taken place; or a new set of records may be opened. It is a
common practice, however, than a new set of books is used by the new organization.
GOODWILL RESULTING FROM THE ACQUISITION OF A PARTNERSHIP BY
A CORPORATION (INCORPORATION OF A PARTNERSHIP)
The acquisition of a partnership by a corporation or incorporation of a partnership may involve
the recognition of goodwill. The goodwill shall be result of the acquisition by the new corporation
of the net assets of the partnership. It is the excess of the market value of the capital share issued
to the former partners in the partnership over the fair value of net assets transferred by the
partnership into the corporation. The adjustment for the goodwill increases the capital of the
former partners.
PFRS 3 prohibits the amortization of goodwill acquired in a combination and instead requires
the goodwill to be tested for impairment annually, or more frequently, if events or changes in
circumstances indicate that the asset might be impaired.
BOOKS OF THE OLD PARTNERSHIP ARE RETAINED
If the books of the partnership are retained, the following steps in recording the incorporation
will be followed:
1.
Revalue the net assets of the partnership (i.e. assets and liabilities). Adjustments in asset
and liability balances may be reported through a revaluation account called Capital
Adjustment Account or recorded directly to the capital accounts of the partners.
2.
Recognize goodwill. The total value of the share capital to be issued is compared with the
adjusted fair value of the net assets received from the partnership. The excess of the total
value of the share capital over the adjusted fair value of net assets is payment for goodwill.
3.
In case a revaluation account is used, close the balance of Capital Adjustment Account to the
capital accounts of the partners in accordance with their profit and loss ratio.
4.
Record the authorized share capital of the new corporation.
5.
Record the issuance of share capital to the partners.
6.
Record any necessary distribution of cash to the partners.
90 | P a g e
7.
Record the issuance of share capital to other incorporators or shareholders (stockholders).
NEW BOOKS ARE OPENED FOR THE CORPORATION
If a new set of books is opened for the corporation, the following shall be recorded in the
corporation books;
1.
2.
3.
authorized share capital.
issuance of share capital for the net assets transferred by the partnership.
issuance of share capital to other incorporators
Entries are also prepared on the partnership books to record the following:
1.
2.
3.
4.
5.
6.
revaluation of net assets.
recognition of goodwill, if any.
closing the balance of Capital Adjustment Account to partners’ capital accounts.
Receipt of share capital to partners.
distribution of share capital to partners.
distribution of cash to partners, if there is any.
Illustrative Problem O: Roberto and Remedios are partner sharing profits and losses in the
ratio of 3:2. They decide to retire from active participation in their business so they form a
corporation to take over the net assets of the partnership. The statement of financial position of
the partnership just prior to incorporation on January 1, 2014 is presented below.
Roberto and Remedios Partnership
Statement of Financial Position
January 1, 2014
Assets
Cash
Accounts Receivable
Less Allowance for Uncollectible Accounts
Merchandise Inventory
Equipment
Less Accumulated Depreciation
Total Assets
Liabilities and Equity
Accounts Payable
Expenses Payable
Roberto, Capital
Remedios, Capital
Total Liabilities and Equity
P 45,000
P 75,000
3,000
P 90,000
30,000
72,000
25,500
60,000
P 202,500
P 60,000
15,000
90,000
37,500
P 202,500
Chapter 8 - Organization and Formation of a Corporation
Step 3
The corporation is organized as the WINNER CORPORATION and is authorized to issue 10,000
shares of ordinary share capital, par value P10. Twenty-five thousand (25,000) shares are sold
for P20. The corporation takes over the partnership assets other than cash and assumes
partnership liabilities in exchange for 12,000 shares.
Capital Adjustment Account
Roberto, Capital
Remedios, Capital
P77,100 + P20,400 = P 97,500
P97,500 x 3/5
= P 58,500
P97,500 x 2/5
= P 39,000
The following adjustments are to be made before taking over the net assets:
a.
b.
c.
The inventories are to be stated in their market value of P45,000.
The allowance for uncollectible accounts is to be increased to P5,400.
Equipment is to be recorded at its current value of P120,000.
Close the balance of Capital Adjustment Account to partners’ capital accounts.
Step 4
97,500
58,500
39,000
Record authorized share capital of the corporation
Authorized to issue 10,000 shares of P10 par value ordinary share capital
The ordinary shares will be distributed as follows: Roberto, 9,000 shares; Remedios, 3,000
shares. Cash will be distributed based on the capital balances of the partners after distribution
of the shares. The ordinary share capital are selling at P15 per share on this date.
Step 5
Roberto, Capital
Remedios, Capital
Ordinary Share Capital
Ordinary Share Premium
9,000 shares x P15
3,000 shares x P15
12,000 shares x P10
12,000 shares x P 5
Assumption 1 – The books of the partnership will be used by the new corporation
Step 1
Revalue the net assets of the partnership
a.
b.
c.
Step 2
Merchandise Inventory
Capital Adjustment Account
Capital Adjustment Account
Allowance for Uncollectible Account
Accumulated Depreciation
Equipment
Capital Adjustment Account
19,500
19,500
2,400
2,400
Step 6
30,000
30,000
Net assets before adjustment
(P202,500 – P60,000 – P15,000)
Add Net adjustments
(P 19,500 – P2,400 + P60,000)
Net assets after adjustment
Less Cash
Net assets excluding cash
(P12,000 shares x P 15)
Goodwill
91 | P a g e
135,000
45,000
120,000
60,000
= P 135,000
= P 45,000
= P 120,000
= P 60,000
Record the distribution of cash to partners
Roberto, Capital
Remedios, Capital
Cash
P90,000 = P58,500 – P135,000 = P 13,500
P37,500 + P39,000 – P 45,000 = P 31,500
60,000
Recognize goodwill
Goodwill
Capital Adjustment Account
Record issuance of share capital to partners
20,400
13,500
31,500
45,000
Assumption 2 – New books are opened for the corporation.
20,400
Partnership Books
P 127,500
77,100
P 204,600
45,000
P 159,600
180,000
P 20,400
Step 1
Revalue the net assets of the partnership
a.
b.
Merchandise Inventory
Capital Adjustment Account
Capital Adjustment Account
Allowance for Uncollectible Accounts
19,500
19,500
2,400
2,400
Chapter 8 - Organization and Formation of a Corporation
c.
Step 2
Accumulated Depreciation
Equipment
Capital Adjustment Account
NEW CORPORATION’S BOOKS
30,000
30,000
60,000
Step 1
Authorized to issue 100,000 shares of P10 par value ordinary share capital.
Recognize goodwill
Goodwill
Step 2
20,400
20,400
Step 3
Step 4
58,500
39,000
5,400
60,000
15,000
120,000
60,000
REVIEW of the LEARNING OBJECTIVES
180,000
60,000
15,000
5,400
1.
Define a corporation and discuss its characteristics. A corporation is defined as an
artificial being created by operation law, having the right of succession and the powers,
attributes and properties expressly authorized by law or incident to it s existence. It has the
following characteristics: (1) it is a separate legal entity with a personality of its own; (2) it
is created by operation by law; (3) it has the right of succession; (4) it has the powers,
attributed, and properties authorized by law; (5) its ownership is divided into shares known
as share capital; and (6) its management is vested in a board of directors elected by the
shareholders.
2.
Identify and discuss the advantages and disadvantages of a corporate form of
organization. A corporation has the following advantages: (1) it enjoys a continuous
existence because of its power of succession; (2) it can obtain a strong credit line because of
its continuous existence; (3) there are more investors enabling it to raise more funds; (4)
investors have limited liability; (5) share capital are transferable without the need for
consent of other shareholders; and (6) its has smooth operation because of centralized
management. On the other hand, organizing and operating a corporate type of organization
has the following disadvantages; (1) it is subject to more government control; (2) it is
subject to more taxes; (3) it is costly to organize; (4) its credit capacity is weakened by the
limited liability of the shareholders; and (5) there is a more restrictive participation by
shareholders in the conduct of corporate affairs because management is vested in the board
of directors.
45,000
75,000
120,000
20,400
Record the distribution of share capital to partners
Roberto, Capital
Remedios, Capital
Winner Corp. Ordinary Share Capital
9,000 shares x P15 = P 135,000
3,000 shares x P 15 = P 45,000
Step 6
97,500
75,000
45,000
120,000
20,400
Record the receipt of share capital from the new corporation
Winner Corp. Ordinary Share Capital
Accounts Payable
Expenses Payable
Allowance for Uncollectible Accounts
Merchandise Inventory
Accounts Receivable
Equipment
Goodwill
Step 5
Recognize the issuance of share capital in exchange for the net assets of the
partnership
Accounts receivable
Merchandise Inventory
Equipment
Goodwill
Allowance for Uncollectible Accounts
Accounts Payable
Expenses Payable
Ordinary Share Capital
Ordinary Share Premium
Close the balance of Capital Adjustment Account to partners’ capital accounts
Capital Adjustment Account
Roberto, Capital
Remedios, Capital
P77,100 + P20,400 = P 97,500
P97,500 x 3/5
= P 58,500
P37,500 x 2/5
= P 39,000
Record authorized share capital of the corporation
135,000
45,000
180,000
Record the distribution of cash to partners
Roberto, Capital
Remedios, Capital
Cash
P90,000 + P58,500 – P135,000 = P 13,500
P37,500 = P39,000 – P 45,000 = P 31,500
92 | P a g e
13,500
31,500
45,000
Chapter 8 - Organization and Formation of a Corporation
3.
Identify and discuss the various classes of corporation. Corporations may be classified
into (1) stock or non-stock corporations; (2) public, private or quasi-public corporations;
(3) de jure or de facto corporations; (4) domestic or foreign corporations; and (5) open or
closely-held corporations.
4.
Identify the components of a corporation and the steps in organizing a corporation. A
corporation has seven components and these are the following: (1) incorporators (2)
corporators (3) stockholders or shareholders (4) members (5) promoters (6) subscribers;
and (7) underwriters. The process of organizing a corporation is composed of three stages,
namely; (1) promotion; (2) incorporation, which includes the drafting of the articles of
incorporation and its subsequent filing with the Securities and Exchange Commission, and
(3) commencement of business.
5.
6.
7.
8.
Identify the different types of records that are maintained by a corporation. To be able
to keep track of the transactions of the corporation, the following records are generally
maintained: journals, ledgers, minutes of all meeting of board of directors, minutes of
meeting of shareholders; and stock and transfer book.
number of shares that may be issued and the par or stated value of each share or an
indication that the shares have no par and no stated value. Subsequent issuance of the share
capital requires a credit to the Share Capital account. Under the journal entry method, the
authorized share capital of the corporation is recorded by debiting Unissued Share Capital
and crediting Authorized Share Capital for the total par value or stated value of the
authorized shares. Subsequent issuance requires a credit to unissued Share Capital account.
Ordinary or preference shares may be issued in exchange for cash, for non-cash assets, for
services, for extinguishment of liabilities or in exchange for another form of securities. Share
capital may also be issued on a subscription basis. However, when a subscriber fails to pay
his subscription, such subscription becomes delinquent and will be subject to bidding.
GLOSSARY of ACCOUNTING TERMINOLOGIES
Authorized share capital (authorized capital stock) – the total par value or stated value of the
authorized shares. It is determined by multiplying the authorized shares by the par or stated
value of the share capital.
Identify and differentiate the two classes of share capital that may be issued by a
corporation. Share capital is the amount fixed by the corporate charter to be subscribed and
paid in by the shareholders. Share capital can either be ordinary or preference share capital.
Both ordinary and preference share capital can be issued with a par value, without par but
with stated value, or without par and without stated value.
Authorized shares – the maximum number of shares of share capital that may be issued by a
corporation.
Identify the measurement bases in the issuance of share capital in exchange for various
considerations. Share capital may be issued in exchange for (a) cash, (b) non-cash assets,
or (c) services. When a share capital is issued for cash, the share capital is measured by
amount of cash received. When a share capital is issued in exchange for non-cash assets, the
asset received is recorded at its fair value (also known as direct measurement ), unless the
fair value cannot be estimated reliably, it will be recorded at the fair value of the share
capital issued, also known as indirect measurement (PFRS 2, par. 10). When a share capital
is issued in exchange for services rendered, the services received is recorded at its fair value
(also known as direct measurement), unless the fair value cannot be estimated reliably. If
the fair value of the services received cannot be estimated reliably, it will be recorded at the
fair value of the share capital issued, also known as indirect measurement (PFRS 2, par. 10)
Delinquent subscription – a subscription where a subscriber fails to pay in full after repeated
demand by the corporation.
Record transactions relating to issuance of share capital using the memorandum entry
method and the journal entry method. The recording of authorized share capital and
subsequent issuance may be recorded using the memorandum entry method or the journal
entry method. Under the memorandum entry method, the authorized share capital of the
corporation is recorded by means of a memorandum entry indicating the authorized
93 | P a g e
Corporation – an artificial being created by operation of law, having the right of succession and
the powers, attributes and properties expressly authorized by law or incident to its existence.
Highest bidder – a bidder who is willing to pay the entire unpaid subscriptions plus any expenses
that may be incurred in connection with the delinquency sale and is willing to take the least
number of shares declared as delinquent.
Issued share capital (issued capital stock) – a share capital (stock) paid for in full and for which
the related stock certificate is issued.
Ordinary share capital (common stock) – entitles the holder to an equal or pro-rata division of
profits without any preference or advantage over any class of shares. The shareholders are often
referred to as “residual equity holders” because they obtain what is left after all the claims of
other parties have been met.
Par value – nominal or face value stated on the face of the share certificate and in the articles of
incorporation.
Chapter 8 - Organization and Formation of a Corporation
MULTIPLE CHOICE
Preference share capital (preferred stock) – entitles the holder to enjoy priority as to
distribution of dividends and distribution of assets upon corporate liquidation.
Pre-Operating expenses (organization costs) – costs incurred in organizing a corporation and
prior to its operations such as registration cost and orienting cost of stock certificate.
Share capital (capital stock) – amount fixed by the corporate charter to be subscribed and paid
in or secured to be paid in by the shareholders.
Stated value – nominal value stated in the articles of incorporation but not on the face of the
stock certificate.
Subscribed shares – share capital sold on a subscription basis that have not yet been paid in full
and for which the related stock certificates have not been issued.
MC 8-1 Cream Corporation was organized on January 1, 2014 with authorized capital of
P2,000,000 consisting of 100,000 ordinary shares, P20 par value. Subsequently,
incorporators subscribed for 25,000 shares at P24. How much must be paid up upon
subscription to comply with the requirement of the Securities and Exchange
Commission (SEC)?
a. P600,000
b. P125,000
c. P500,000
d. P150,000
MC 8-2 Beige Co. was authorized to issue 10,000 preference shares, P100 par value and
200,000 no-par ordinary shares. Subscription for 4,000 preference shares was received
at P110 with a down payment of 25%. What entry should be made in the books of Beige
Co. to record the receipt of subscription?
a. Preference Share Capital Subscription Ree’l
440,000
Preference Share Capital Subscribed
400,000
Preference Share premium
40,000
b.
c.
d.
Preference Share Capital Subscription Ree’l
Preference Share Capital Subscribed
440,000
Preference Share Capital Subscription Ree’l
Preference Share Capital Subscribed
400,000
Preference Share Capital Subscribed
Preference Share Capital Subscription Ree’l
400,000
440,000
400,000
400,000
MC 8-3 Using the information in MC 8-2, how much was the down payment received by Beige
Co. as a result of the subscription?
a. P10,000
b. P11,000
c. P100,000
d. P110,000
MC 8-4 Last September 6, 2014, Brown Co. issued 2,000 shares of its P10 par value ordinary
share capital in exchange for a piece of land to be held for a future plant site. Brown
Co.’s ordinary share capital was listed and traded at P27 per share on the same date.
The land has no known market value. How much is the increase in ordinary share
premium resulting from this exchange.
a. P0
c. P 34,000
b. P 20,000
d. P40,000
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Chapter 8 - Organization and Formation of a Corporation
MC 8-5 Violet Corp. was organized on January 1, 2014 with authorized capital of 100,000
ordinary shares, P20 par value. During 2014, Violet Co. had the following transactions
affecting the shareholders’ equity.
Jan. 10
Issued 25,000 shares at P22 per share.
Mar. 25 Issued 1,000 shared for legal service when the fair value was P24
per share.
Sept. 30 Issued 5,000 shares for a piece of equipment when the value was
P26 per share.
How much is the balance of the ordinary share capital account as of September 30?
a. P 620,000
b. P 674,000
c. P 700,000
d. P 704,000
MC 8-6 Using the information in MC 8-5, what amount should be reported as ordinary share
premium?
a. P50,000
b. P54,000
c. P64,000
d. P84,000
MC 8-7 Aqua Corp. was incorporated on June 1, 2014 with an authorized 250,000 share of nopar ordinary share capital, stated value P15 and 10,000 shares of 10% preference share
capital, par value P50. Transactions affecting company’s share capital as of June 30,
2014 were as follows:
June
June
1
Issued 50,000 ordinary shares for cash at P15 per share.
5
Issued 50,000 ordinary shares in exchange for assets with total
market value of P900,000.
15
Received subscriptions for 100,000 ordinary shares at p30 and for
5,000 preference shares at P55.
25
Received full payment for subscriptions received on June 15 and the
corresponding stock were issued.
What is the total paid-in capital excess of par and stated value for both ordinary and
preference shares?
95 | P a g e
a.
b.
c.
d.
P 25,000
P 300,000
P 1,650,000
P 1,675,000
MC 8-8 Using the information in MC 8-7, how much is the total shareholders’ equity?
a. P 3,250,000
b. P 4,500,000
c. P 4,675,000
d. P 4,925,000
MC 8-9 Lavender Corp. issued 20,000 ordinary shares, par value P15 in exchange for an
equipment. At the date of exchange, the shares are selling at P20 and no fair value is
known for the equipment. How will exchange be recorded on the books of Lavender
Corp.?
a. Equipment
400,000
Ordinary Share Capital
400,000
b.
Equipment
Ordinary Share Capital
Ordinary Share Premium
400,000
c.
Equipment
Ordinary Share Capital
Gain on Exchange
400,000
d.
Equipment
Ordinary Share Capital
300,000
300,000
100,000
300,000
100,000
300,000
MC 8-10 Indigo Corp. has authorized 200,000 shares of P30 per value ordinary share capital and
5,000 shares of P50 par, 9% preference share capital. On June 3, 2014, the company
issued 100,000 ordinary shares and 3,000 preference shares both at par. Which of the
following is the correct journal entry in recording the transaction?
a. Cash
3,600,000
Ordinary Share Capital
3,000,000
Preference Share Capital
600,000
b.
Cash
Ordinary Share Capital
Preference Share Capital
1,540,000
1,000,000
540,000
c.
Ordinary Share Capital
Preference Share Capital
Income from Sale of Share Capital
3,000,000
600,000
3,600,000
Chapter 8 - Organization and Formation of a Corporation
d.
Cash
Ordinary Share Capital
Preference Share Capital
3,150,000
3,000,000
150,000
MC 8-11 Javier and Edralin are partners. They decide to incorporate their business and are
recording the incorporation of the new business. Javier has a P35,000 capital account
balance, while Edralin has a P26,400 balance. Javier receives 7,500 shares and Edralin
received 6,000 shares of P4 par ordinary share capital.
The correct entry to record the issuance of ordinary shares, assuming the corporation
will use the books of the partnership is
a. Javier, Capital
35,000
Edralin, Capital
26,400
Ordinary Share Capital
61,400
b.
c.
d.
Javier, Capital
Edralin, Capital
Ordinary Share Capital
Ordinary Share Premium
35,000
26,400
Javier, Capital
Edralin, Capital
Gain on Incorporation
35,000
26,400
Javier, Capital
Edralin, Capital
Asset Revaluation Account
35,000
26,400
54,000
7,400
61,400
61,400
MC 8-12 The shareholders’ equity of Cecille Corp. revealed the following on June 30, 2014.
Preference share, P100 par value
P230,000
Preference share premium
80,500
Ordinary share, P15 par value
525,000
Ordinary share premium
275,000
Ordinary share subscribed
5,000
Retained earnings
190,000
Notes payable
400,000
Subscription receivable – ordinary
40,000
How much is the legal capital of the corporation?
a. P 760,000
b. P 775,000
c. P1,115,000
d. P1,305,500
96 | P a g e
MC 8-13 Using the information in MC 8-12, how much is the additional paid-in capital?
a. P355,500
b. P360,500
c. P400,500
d. P800,500
MC 8-14 Using the information in MC 8-12, how much is the total shareholders’ equity?
a. P1,305,500
b. P1,345,500
c. P1,704,500
d. P1,745,500
MC 8-15 On April 1, 2014, Friends Corp. a newly formed company had the following shares
issued and outstanding:
Preference share: P50 par, 6,000 shares originally issued at P100
Ordinary share, P20, 20,000 shares originally issued at P60
Friends shareholders’ equity should report preference share capital, ordinary share
capital and paid-in capital in excess of par, respectively at
a. P600,000,
P1,200,000,
0
b.
600,000,
400,000,
800,000
c.
300,000,
1,200,000,
300,000
d.
300,000
400,000,
1,100,000
Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
CHAPTER 9
OPERATIONS, DIVIDENDS, BOOK VALUE
PER SHAREEE, and EARNINGS PER SHARE
LEARNING OBJECTIVES
1.
2.
3.
4.
5.
6.
Explain the preparation of work sheet, adjusting entries, and closing entries for a corporation.
Explain the components of the shareholders’ equity section of the statement of financial position
(balance sheet).
Prepare the financial statements of a corporation, specifically the statement of changes in
shareholders’ equity.
Identify the different types of dividends and compute amount of dividends to be distributed to
preference and ordinary shareholders.
Compute book value and earnings per share.
Identify and explain the different types of retained earnings appropriations. -
PREVIEW OF THE CHAPTER
CORPORATE OPERATIONS and
FINANCIAL STATEMENTS
Steps in the
Accounting Cycle
•
•
•
•
Work sheet
Financial statements
•
Statement of
financial position
•
Income statement
•
Statement of
comprehensive
income
•
Statement of
changes in
shareholders’ equity
•
Statement of cash
flows
Adjusting entries
Closing entries
97 | P a g e
Shareholders’ Equity
•
•
•
Contributed Capital
•
Share Capital
•
Additional Paid-in
Capital
Retained Earnings
•
Appropriated
•
Unappropriated
Capital maintenance
adjustments
•
Revaluation surplus
Dividends, Book Value
and Earnings per Share
•
•
•
Dividends
•
Cash
•
Scrip
•
Property
•
Stock
Book value per share
•
One class of share
capital
• Two classes of share
capital
Earnings per share
• One classes of share
capital
• Two classes of share
capital
ACCOUNTING CYCLE OF A CORPORATION
The accounting cycle of a corporation is essentially the same as that of a sole proprietorship and
a partnership. Transactions, such as purchase and sale of merchandise and payment of expenses
and liabilities, are recorded in the same manner as that of the two other forms of business
organizations.
At the end of the accounting period, the results of operations of the corporation and its financial
position are determined and the following problems are normally encountered:
1.
2.
3.
Preparation of a worksheet
Preparation of financial statements
a. Statement of financial position (balance sheet)
b. Income statement
c. Statement of comprehensive income
d. Statement of changes in shareholders’ equity
e. Statement of cash flows
Preparation of adjusting and closing entries
PREPARATION OF A WORK SHEET
A work sheet is a working paper that facilitated the preparation of financial statements.
However, before it can be prepared and completed, data for adjustments must first be compiled.
These items requiring adjustments are also the same items discussed in Chapter 1 and 3. For
purposes of illustration, these will be discussed again in this chapter. Data requiring adjustments
at the end of the accounting period include:
1. Accrued expense
2. Accrued income
3. Prepaid expense
4. Unearned or deferred income
5. Uncollectible accounts
6. Depreciation and other cost allocation
7. Income tax
The work sheet normally contains eight columns; however, there are instances when ten
columns are used because of the addition of a pair of column for Retained Earnings.
PREPARATION OF FINANCIAL STATEMENTS
Financial statements are the end product of the accounting process. The information contained
therein is taken from the completed work sheet. PAS 1 (revised 2010) provides that a complete
set of financial statement shall be composed of the following:
Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
1.
2.
3.
4.
5.
This section should include a description of each class of share capital such as the par or
stated value, authorized shares, number of shares issued, and dividend rights in case of
preference share capital.
Statement of financial position (balance sheet)
Statement of comprehensive income (or a separate statement of income and statement
of other comprehensive income
Statement of changes in equity
Statement of cash flows
Notes
The statemen of comprehensive income reports gains and losses not reported as part of profit or
loss but are shown as adjustments to the total equity. These items include gain (loss) from
changes in fair value of available for sale securities and revaluation surplus arising form
revaluation of property, plant and equipment.
The Securities and Exchange Commission (SEC) requires that the corporation submits to state
Commission within 15 days from the end of the first three months of operations a statement of
cash flows covering a period of three months from the date of registration. The statement must
shown in sufficient detail the sources of cash and how these are disbursed. The paid-up capital
must be disbursed only in connection with the business for which the corporation was organized
and no amount shall be disbursed as loans or advances to shareholders or officers of the
corporation.
Share capital subscription receivables that are not currently collectible are shown as
deduction from share capital, subscribed.
If the journal entry method of recording share capital transactions is used, issued share
capital is determined by deducting the balance of Unissued Share Capital account from the
Authorized Share Capital account.
2.
Additional Paid-In Capital – this section reports investment by shareholders in excess of
the par or stated value of the share capital. It includes paid-in capital in excess of par value
or stated value (share premium) of both preference and ordinary share capital.
It also includes donated capital and other paid-in capital items arising from various share
capital transactions. These different share capital transactions are discussed in Chapter 10.
RETAINED EARNINGS (EARNED SURPLUS) – The Retained Earnings balance represents
undistributed earnings of the corporation. It represents capital of the corporation arising from
its operations. The balance of the account is generally divided into two part, as follows:
The preparation of the statement of cash flows is discussed in Chapter 11 of this book.
STATEMENT OF FINANCIAL POSITION (BALANCE SHEET)
The statement of financial position (balance sheet) reports the financial condition of a company
as of a particular date. It contains the assets, liabilities and equity of the business. The assets and
liabilities should be properly classified as current or noncurrent. The equity section of the
statement of financial position of a corporation is called shareholders’ equity or stockholders’
equity and is generally composed of Contributed Capital and Retained Earnings. In some
instances, a corporation may have capital maintenance adjustment accounts such as revaluation
surplus and net unrealized gain or loss on long term investments that are shown separately in
the equity section.
CONTRIBUTED CAPITAL. The Contributed Capital represents corporate capital arising from
investment by shareholders. It is further divided into two sections:
1.
Share Capital or Capital Stock – this also known as legal capital. This section reports both
preference (preferred_ and ordinary (common) share capital issued, subscribed and
distributable as dividends, stated at par or stated value. In case of share capital without par
value nor stated value, the amount reported is the total value of consideration received in
exchange for the shares.
98 | P a g e
1.
Appropriated retained earnings – it is the portion of Retained Earnings set aside for a
specific purpose.
2.
Unappropriated retained earnings – it is the portion of Retained Earnings available for
distribution as dividends to the shareholders. It is normally described as “unrestricted
earnings”
The Retained Earnings account has a normal credit balance. A debit balance in the account is
called a deficit.
STATEMENT OF COMPREHENSIVE INCOME
The statement of comprehensive income is composed of two part: profit or loss for the period
and other comprehensive income. The first part reports revenue and gains realized and expenses
and losses incurred during a period. The excess of revenue and gains over expenses and losses is
profit the excess of expenses and losses over income and gains is loss. The second part reports
items of gains and losses which are not required by other PASs and PRFSs to be recognized I
profit or loss. Examples are changes in revaluation surplus when property, plant and equipment
are reported using the revaluation model and gains and losses arising from changes in fair value
of available-for-sale securities.
Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
An essential part of the statement of comprehensive income prepared for a corporation is the
earnings per share amount that is reported below the profit figure. The concepts and principles
relating to earnings per share calculation as provided in PAS 33 shall be discussed in this chapter.
•
PAS 1 (revised 2010_ also permits the presentation of comprehensive income in two
statements: an income statement of other comprehensive income
For the purpose of this book, the option of preparing two separate statements will be adopted;
however, the statement of comprehensive income is not included in the illustration and
discussion. A detailed discussion of this statement is covered in the last part of financial
accounting that deals with the preparation of financial statements.
STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
The statement of changes in shareholders’ equity is one of the basic financial statements that
should be prepared. This statement reports transactions or items that cause changes in
shareholders’ equity account balances. For a corporation that is neither a subsidiary nor a parent,
and for which there are no changes in accounting policy or correction of error, the statement
shows the following.
•
the profit or loss for the period
•
other comprehensive income
•
capital share transactions with shareholders and distributions to shareholders
(issuance of share capital and dividends)
•
the balance of retained earnings at the beginning and end of the period and the
movement during the period.
PREPARATION OF ADJUSTING AND CLOSING ENTRIES
After the financial statements are prepared, adjusting and closing entries must be journalized
and posted. The adjusting entries of a corporation are similar to those of a sole proprietorship
and partnership. No special problems are encountered in the preparation of adjusting entries.
Closing entries, on the other hand, consist of the following:
1.
2.
3.
Closing the balances of revenue accounts to Income Summary
Closing the balances of expense accounts to Income Summary
Closing the balance of Income Summary to Retained Earnings
a.
Profit (Income Summary has a credit balance)
Income Summary
Retained Earnings
99 | P a g e
xxx
xxx
b.
Loss (Income Summary has a debit balance)
Retained Earnings
Income Summary
xxx
xxx
Illustrative Problem A: The trial balance of the Bright Corp. as of December 31, 2014 is
presented below; the data requiring adjustments as of December 31, 2014 are presented on the
next page.
Bright Corp.
Trial Balance
December 31, 2014
Cash
Notes Receivable
Accounts Receivable
Allowance for Uncollectible Accounts
Merchandise Inventory
Store and Office Supplies
Prepaid Insurance
Office Equipment
Accumulated Depreciation – Office Equipment
Store Equipment
Accumulated Depreciation – Store Equipment
Notes Payable
Accounts Payable
1,932,000
750,000
2,827,500
30,000
450,000
112,500
54,000
1,875,000
187,500
2,850,000
285,000
375,000
487,500
2,000,000
4,750,000
375,000
900,000
787,500
7,050,000
10% Preference Share Capital, P100 par, 100,000 shares authorized
Ordinary Share Capital. P10 par, 500,000 shares authorized
Preference Share Premium
Ordinary Share Premium
Retained Earnings
Sales
Sales Returns and Allowances
Purchases
Purchases Returns and Allowances
Sales Salaries
Delivery Expense
Miscellaneous Selling Expense
Office Salaries
Rent Expense
Utilities Expense
Miscellaneous Administrative Expenses
Interest Income
150,000
3,750,000
75,000
900,000
180,000
105,000
675,000
375,000
247,500
79,500
10,500
17,313,000
17,313,000
Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
Data requiring adjustments as of December 31, 2014:
a. Inventories: Merchandise – P750,000
b. Supplies used: office – P30,000; store – P62,500
c. Unexpired insurance – P24,000
d. Accrued interest o notes receivable, P5,500
e. Accrued sales salaries, P45,000; office salaries, P25,000
f. Estimated uncollectible accounts at the end of the year amounted to P168,000
g. Depreciation on store and office equipment, 5% per year
h. Income tax rate is 35%
The equity balances as of January 1, 2014 are as follows:
10 % Preference Share Capital
Ordinary Share Capital
Preference Share Premium
Ordinary Share Premium
Retained Earnings
On January 10, the following transactions have taken place:
•
5,000 preference shares were issued at P105
•
75,000 ordinary shares were issued at P15
100 | P a g e
P 1,500,000
4,000,000
350,000
525,000
787,500
Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
Cash
Notes Receivable
Accounts Receivable
Allowance for Uncollectible Accounts
Merchandise Inventory
Store and Office Supplies
Prepaid Insurance
Office Equipment
Accumulated Depreciation – Office Equipment
Store Equipment
Accumulated Depreciation – Store Equipment
Notes Payable
Accounts Payable
10% Preference Share Capital, P100 par
Ordinary Share Capital. P10 par
Preference Share Premium
Ordinary Share Premium
Retained Earnings
Sales
Sales Returns and Allowances
Purchases
Purchases Returns and Allowances
Sales Salaries
Delivery Expense
Miscellaneous Selling Expense
Office Salaries
Rent Expense
Utilities Expense
Miscellaneous Administrative Expenses
Interest Income
101 | P a g e
BRIGHT CORPORATION
Work Sheet
For the Year Ended December 31, 2014
Trial Balance
Adjustments
Debit
Credit
Debit
Credit
1,932,000
750,000
2,827,500
30,000
e. 138,000
450,000
112,500
a.
92,500
54,000
b.
30,000
1,875,000
187,500
f.
93,750
2,850,000
285,000
f. 142,500
375,000
487,500
2,000,000
4,750,000
375,000
900,000
787,500
7,050,000
150,000
3,750,000
75,000
900,000
c. 45,000
180,000
105,000
675,000
c. 25,000
375,000
247,500
79,500
10,500
b.
5,500
17,313,000
17,313,000
Income Statement
Debit
Credit
450,000
750,000
7,050,000
150,000
3,750,000
75,000
945,000
180,000
105,000
700,000
375,000
247,500
79,500
16,000
Statement Financial Position
Debit
Credit
1,932,000
750,000
2,827,500
168,000
750,000
20,400
24,000
1,875,000
281,250
2,850,000
427,500
375,000
487,500
2,000,000
4,750,000
375,000
900,000
787,500
Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
Office Supplies Expense
Store Supplies Expense
Insurance Expense
Interest Receivable
Salaries Payable
Uncollectible Accounts Expense
Depreciation Expense – Office Equipment
Depreciation Expense – Store Equipment
Income Tax Expense
Income Tax Payable
a.
a.
b.
c.
30,000
62,500
30,000
5,500
30,000
62,500
30,000
5,500
d. 70,000
e. 138,000
f. 93,750
f. 142,500
g. 123,675
695,925
g. 123,675
695,925
Profit
Computation of income tax and profit:
Total credit per income statement before income tax
Total debit per income statement before income tax
P 7,891,000
7,478,750
Profit before tax
Income tax (P412,250 x 30%)
P
Profit
103 | P a g e
70,000
138,000
93,750
142,500
123,675
412,250
123,675
P 288,575
7,602,425
288,575
7,891,000
7,891,000
11,034,000
7,891,000
11,034,000
123,675
10,745,425
288,575
11,034,000
Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
Bright Corporation
Income Statement
For the Year Ended December 31, 2014
Schedule
Net Sales
1
P 6,900,000
Cost of Merchandise Sold
2
3,375,000
Gross Profit
P3,525,000
Other Operating Income – Interest
16,000
Selling Expense
(1,435,000)
Administrative Expenses
(1,693,750)
Profit before Tax
P 412,250
Income Tax
123,675
Profit for the year
P 288,575
Schedule 1 – Net Sales
Sales
Less Sales Returns and Allowances
Net Sales
Schedule 2 – Cost of Merchandise Sold
Merchandise Inventory, Jan. 1
Purchases
Less Purchases Returns and Allowances
Cost of Merchandise Available for Sale
Less Merchandise Inventory, Dec. 31
Cost Merchandise Sold
Schedule 3 – Selling Expenses
Sales Salaries
Delivery
Store Supplies
Depreciation – Store Equipment
Miscellaneous
Total Selling Expenses
Schedule 4 – Administrative Expenses
Office Supplies
Rent
Utilities
Uncollectible Accounts
Depreciation – Office Equipment
Office Supplies
Insurance
Miscellaneous
104 | P a g e
P 7,050,000
150,000
P 6,900,000
P 450,000
P 3,750,000
75,000
Bright Corp.
Statement of Financial Position
December 31, 2014
Assets
Current Assets:
Cash
Notes Receivable
Accounts Receivable
Less Allowance for Uncollectible Accounts
Interest Receivable
Merchandise Inventory
Store and Office Supplies
Prepaid Insurance
Noncurrent Assets:
Office Equipment
Less accumulated Depreciation
Store Equipment
Less Accumulated Depreciation
Total Assets
P2,827,500
168,000
P1,875,000
281,250
P2,850,000
427,500
P1,932,000
750,000
2,659,500
5,500
750,000
20,000
24,000
P6,141,000
P1,593,750
2,422,500
4,016,250
P10,157,250
Liabilities
3,675,000
P 4,125,000
750,000
P 3,375,000
P 945,000
180,000
62,500
142,500
105,000
P 1,435,000
P 700,000
375,000
247,500
138,000
93,750
30, 000
30,000
79,500
P 1,693,750
Current Liabilities:
Notes Payable
Accounts Payable
Salaries Payable
Income Tax Payable
Total Liabilities
P375,000
487,500
70,000
123,675
P1,056,175
Shareholders’ Equity
Contributed Capital:
Share Capital:
10% Preference shares, P100 par, 100,000
shares authorized, 2,000 shares issued
and outstanding
Ordinary share, P10 par, 500,000 shares
authorized, 475,000 shares issued
and outstanding
Additional Paid-in Capital:
Preference Share Premium
Ordinary Share Premium
Total Contributed Capital
Retained Earnings
Total Shareholders’ Equity
Total Liabilities and Shareholders’ Equity
P2,000,000
4,750,000
P 375,000
900,000
P6,750,000
1,275, 000
P8,025,000
1,076,075
9,101,075
P10,157,250
Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
31
Bright Corp.
Statement of Changes in Shareholders’ Equity
For the Year Ended December 31, 2014
Balance, January 1
Issuance of preference shares
(5,000 shares x P105)
Issuance of ordinary shared
(75,000 shares x P15)
Profit for the year
Balances, December 31
2014
Dec.
Preference
Share
Capital
P1,500,000
Ordinary
Share
Capital
P4,000,000
Preference
Share
Premium
P350,000
500,000
25,000
750,000
P2,000,000
P4,750,000
Ordinary
Share
Premium
P525,000
Retained
Earnings
31
31
31
31
P787,500
31
375,000
P900,000
31
31
31
Income Summary
Merchandise Inventory
450,000
Merchandise Inventory
Income Summary
750,000
P1,076,075
450,000
750,000
Office Supplies Expense
Store Supplies Expenses
Store and Office Supplies
30,000
62,500
Insurance Expense
Prepaid Insurance
30,000
Interest Receivable
Interest Income
Sales Salaries
Office Salaries
Salaries Payable
31
92,500
30,000
31
5,500
Income Summary
Sales Returns and Allowances
Purchases
Sales Salaries
Delivery Expense
Miscellaneous Selling Expense
Office Salaries
Rent Expense
Utilities Expense
Miscellaneous Administrative Expenses
Office Supplies Expense
Store Supplies Expense
Insurance Expense
Uncollectible Accounts Expense
Depreciation Expense – Office Eqt.
Depreciation Expenses – Store Eqt.
Income Tax Expense
7,152,425
Sales
Purchases Returns and Allowances
Interest Income
Income Summary
7,050,000
75,000
16,000
Income Summary
Retained Earnings
5,500
1
70,000
138,000
Depreciation Expense – Office Eqt.
Depreciation Expense – Store Eqt.
Accumulated Depr. – Office Eqt.
Accumulated Depr. – Store Eqt.
93,750
142,500
1
138,000
93,750
142,500
150,000
3,750,000
945,000
180,000
105,000
700,000
375,000
247,500
79,500
30,000
62,500
30,000
138,000
93,750
142,500
123,675
7,141,00
288,575
288,575
Reversing Entries
2015
Jan.
45,000
25,000
Uncollectible Accounts Expense
Allowance for Uncollectible Accounts
105 | P a g e
123,675
Closing Entries
2014
Dec.
Adjusting Entries
31
123,675
Note: Adjustments for inventories may also be included as part of closing entries.
288,575
P375,000
Income Tax Expense (P412,250 x 30%)
Income Tax Payable
Interest Income
Interest Receivable
Salaries Payable
Sales Salaries
Office Salaries
5,500
5,500
70,000
45,000
25,000
Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
DIVIDENDS
Cash Dividends Payable
Cash
To record payment of dividends
Dividends are distribution to shareholders of corporate earnings in proportion to the number of
shares held by them. Distributions may take the form of (1) cash, (2) non-cash assets, (3) notes
or other evidence of corporate indebtedness, and 94) shares of the company’s own share capital.
*Alternatively, the account Dividends Payable may be used.
Dividends previously described are paid out of accumulated earnings of the corporation. They
may also be paid as a return of shareholders’ invested capital. This type of dividends are called
liquidating dividend. However, discussion in this book will be limited to dividends representing
distributions of corporate earnings.
The power to declare dividends is vested upon the board of directors; however, they have to
observe legal requirements governing the maintenance of legal or stated capital. Dividend
declaration is normally announced to be made known to the shareholders.
The following dates are essential in formal dividend announcement or statement.
1.
Date of declaration – this is the date when the board of directors approved the resolution
to distribute dividends. The liability of the corporation to the shareholders is recorded on
this date.
2.
Date of shareholders of record – this is the date when the company determines the
shareholders who are entitled to the receipt of declared dividends. No entry is required on
this date; however, a list of registered shareholders is made as of the close of business on
this date. Share capital are selling dividends-on prior to this date and are selling exdividends the day following this date.
3.
Date of payment or distribution – this is the date when dividends declared are paid or
distributed to the shareholders. The liability recognized on the date of declaration is
cancelled or extinguished on this date.
CASH DIVIDENDS
Cash dividends are dividends that are distributable in the form of cash. This is the most common
type of dividend. The following entries are made to record the declaration and subsequent
payment:
Retained Earnings
Cash Dividends Payable*
To record the declaration of dividends
xxx
xxx
xxx
xxx
If the dividends declared are still unpaid as of the statement of financial position date, the balance
of the account Cash Dividends Payable is reported as a current liability.
The amount of cash dividends declared-should not exceed the amount of cash reported on the
statement of financial position or cash needed for current operations. For instance, Retained
Earnings may have a balance of P1,000,000 but the cash balance is only P500,000, the
corporation can distribute cash dividends of not more than P500,000. Another form of dividend
may be declared for the remaining undistributed earnings.
Cash dividends may either be:
1.
Peso dividend – a cash dividend expressed in peso amount. The peso dividend multiplied
by the number of outstanding share of the corporation equals the total amount of Retained
Earnings declared as cash dividends. On the other hand, the peso dividend multiplied by the
number of capital shares held by a shareholder equals the total amount of cash dividends to
be received by the shareholder.
2.
Percentage dividend – a cash dividend expressed in percentage. The dividend percentage
multiplied by the par value or stated value of the capital share equals the peso dividend.
Alternatively, the percentage dividend multiplied by the total par value or total stated value
of the capital share equals the total amount of Retained Earnings declared as cash dividends.
For example, the dividend on a 10% preference share with a par value P100 is equal to P10
(i.e., P10 x 2,000 shares).
Illustrative Problem B: Fortune Corp. has 10,000 shares of P100 par value ordinary share
capital outstanding as of December 1, 2014. On this date, the Board of Directors declared a cash
dividend of P10.00 per share to shareholders of record of December 30,2014 payable on January
15, 2015.
2014
Dec
2015
Jan.
1
15
Retained Earnings
Dividends Payable
10,000 sh @ P10 = P100,000
100,000
Dividends Payable
Cash
100,000
100,000
100,000
The Dividends Payable account will be reported in the December 31, 2014 statement of financial
position as a current liability.
106 | P a g e
Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
SCRIP DIVIDENDS
The accounts Scrip Dividends Payable and Interest Payable will be reported in the December 31,
2014 statement of financial position as current liabilities
Scrip dividends are, in fact, deferred cash dividends. A scrip dividend is declared when the
corporation has sufficient Retained Earnings balance but not sufficient funds at that time for a
cash dividend. Scrip dividends consist of a written promise to pay certain amounts at some future
date. The payment normally includes the principal amount and an interest at a specified date.
The entries to record the declaration and subsequent payment of scrip dividends follow:
Retained Earnings
xxx
Scrip Dividends Payable
To record the declaration of dividends
Scrip Dividends Payable
xxx
Interest Expense
xxx
Cash
To record payment of dividends plus interest.
xxx
xxx
PROPERTY DIVIDENDS
Dividends distributed in the form of non-cash assets are known as property dividend. Property
distributed normally takes the form of assets that can be easily divided or allocated among
shareholders such as stocks of other companies owned by the corporation. According to IFRIC
17 Distribution of Non-Cash Assets to Owners, the following rules shall apply in accounting for
distribution of non-cash assets to owners as dividends:
•
An entity shall measure a liability to distribute noncash assets as a dividend to its
owners at the fair value of the assets to be distributed (par. 11)
This means that Retained Earnings and Property Dividends Payable will
be recorded at the fair value of the assets to be distributed.
•
Illustrative Problem C: Fortune Corp. has 10,000 shares of P100 par value ordinary share
capital outstanding as of October 31, 2014. On this date, the Board of Directors declared a
deferred cash dividend of P10,000 per share to shareholders of record of November 30, 2014.
Promissory notes dated December 1, 2014 were issued on the same date. The notes mature
within six months plus interest of 12% per annum. The corporation paid its shareholders on
March 31, 2015.
The entries to record the declaration of dividends, the accrual of interest at year-end, the
reversing entry at the beginning of the new accounting period and the payment to shareholders
are as follows:
2014
Oct.
Dec.
2015
Jan.
March
•
31
31
1
31
107 | P a g e
Retained Earnings
Scrip Dividends Payable
10,000 sh @ P10.00 = P100,000
100,000
Interest Expense
Interest Payable
P100,000 x 12% x 1/12 = P1,000
1,000
Interest Payable
Interest Expense
1,000
Scrip Dividends Payable
Interest Expense
Cash
P100,000 x 12% x 4/12 = P4,000
100,000
1,000
At the end of each reporting period and at the date of settlement, the entity shall review
and adjust the carrying amount of the dividend payable, with any changes in the
carrying amount of the dividend payable, with any changes in the carrying amount of
the dividend payable recognized in equity as adjustments to the amount of the
distribution (par. 13)
This means that Retained Earnings and Property Dividends Payable
balances will be adjusted for the change in the previously recorded fair
value of the assets.
The required valuation/measurement of the assets to be distributed at
the end of each reporting period as provided in related PAS or PFRS
should also be applied.
When an entity settles the dividend payable, it shall recognize the difference, if any, between
the carrying amount of the assets to be distributed and the carrying amount of the dividend
payable in profit or loss (par 14).
This means that the difference between the carrying amount of the
Property Dividends Payable and the carrying amount of the assets to be
distributed as gain or loss to be reported in the statement of
comprehensive income.
The entry to record the declaration of dividends is as follow:
1,000
100,000
4,000
104,000
Retained Earnings
Property Dividends Payable
To record the declaration of individuals
xxx
xxx
The entry to record the distribution of dividends under three independent cases shall be as
follows:
Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
1.
The carrying amount of the payable and the carrying amount of the assets are the same
Property Dividends Payable
xxx
Assets
xxx
To record distribution of property dividend
2.
The carrying amount of the payable is greater than the carrying amount of the assets
Property Dividends Payable
xxx
Assets
xxx
Gain on Distribution of Non-Cash Assets
xxx
3.
The carrying amount of the payable is less than the carrying amount of the assets
Property Dividends Payable
xxx
Loss on Distribution of Non-Cash Assets
xxx
Assets
xxx
For purpose of discussion in this book, the illustration, exercises and problems will involve assets
with carrying value equal to their book value:
Illustrative Problem D: Fortune Corp. has 10,000 shares of P100 par value ordinary share
capital outstanding as of December 1, 2014. ON this date, the Board of Directors declared a
property dividend distributable to shareholders of record of December 30, 2014 payable on
January 15, 2015. The corporation will distribute five shares of Lucky Corp. for every share of
Fortune Corp. owned by the shareholders. Each share of Lucky Corp. has a carrying value of P10
on the date of declaration, which is also its fair value on the date of declaration and on the date
of distribution.
The entries to record the declaration of property dividend follow:
2014
Dec.
2015
Jan.
1
15
Retained Earnings
Property Dividends Payable
10,000 sh x 5 @ P10 = P500,000
500,000
Property Dividends Payable
Investment in Lucky Corp. Stocks
500,000
500,000
A share capital dividend (stock dividend) is a distribution to shareholders in the form of
corporation’s own share capital (stock). Thus, when Fortune Corp. distributes Fortune Corp.
shares to its shareholders, it is distributing share capital or stock dividends.
This type of dividend does not affect total assets and total shareholders’ equity, rather it simply
represents a transfer of capital from retained earnings to contributed capital. Hence, total
shareholders’ equity before and after the declaration and distribution of share capital dividends
are the same, On the other hand, retained earnings is decreased while contributed capital is
increased as a result of the declaration and distribution of share capital dividends.
In recording the declaration of a share capital dividend, a distinction should be made between a
small and a large stock dividend. A share capital dividend presenting less than 20% of the
outstanding shares is considered a small share capital dividend. A share capital dividend
representing 20% or more of the outstanding shares is considered a large share capital dividend.
Under a small share capital dividend, retained earnings is debited for the fair value of the share
capital on the date of declaration; under a large share capital dividend, retained earnings is
debited for the par or stated value of the share capital.
The entries to record the declaration and distribution of share capital dividend, both small and
large, follow:
Small Share Capital Dividend
Retained Earnings
Share Capital Dividends Distributable
Paid-In Capital from Share Capital Dividends
xxx
Share Capital Dividends Distributable
Share Capital (or Unissued Share Capital)
To record the distribution of stock dividends
xxx
xxx
xxx
xxx
Large Share Capital Dividend
500,000
It should be noted that the declaration and payment or distribution of cash dividends, scrip
dividends and property dividends do not affect the corporation’s number capital shares issued
and outstanding. This means that the total number of capital shares issued and outstanding
before the dividend declaration and payment or distribution shall be the same as total number
of capital shares issued and outstanding after the dividend declaration and payment or
distribution. However, there is a decrease in the total assets and total retained earnings of the
corporation.
108 | P a g e
SHARE CAPITAL DIVIDENDS (STOCK DIVIDENDS)
Retained Earnings
Share Capital Dividends Distributable
To record the declaration of dividends
xxx
Share Capital Dividends Distributable
Share Capital (or Unissued Share Capital)
TO record the distribution of stock dividend
xxx
xxx
xxx
Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
The account Share Capital (Stock) Dividend Distributable is credited for the par or stated value
of the shares to be distributed regardless of whether the share capital dividend is small or large.
This account is reported on the statement of financial position under the shareholders’ equity
section as part of Contributed Capital. It is properly shown as an addition to the share capital
outstanding.
The account Paid0In Capital from Share Capital Dividend is credited for the excess of the fair
market value of the share over its par or stated value. This account is reported on the statement
of financial position under the shareholders’ equity section as part of additional paid-in capital.
Illustrative Problem E: Fortune Corp. has 10,000 shares of P100 par value ordinary share
capital outstanding as of December 1, 2014. On this date, the Board of Directors declared a share
capital dividend distributable to shareholders of record of December 30, 2014 payable on
January 15, 2015. The fair market value of Fortune Corp. share capital on December 1 is P105;
on December 30, P110; on January 15, P106.
The declaration and distribution of share capital dividends, whether small or large, increases the
number of capital shares outstanding.
In all of the different types of dividends discussed, it should be noted that only the outstanding
capital shares are entitled to dividends.
DIVIDENDS ON PREFERENCE SHARES
When dividends are paid, the dividend requirements on preference shares must be paid before
any payment can be made to ordinary shareholders. The required dividends depend upon the
type of preference shares issued by the corporation.
The preference shares may be:
1.
Cumulative - preference shareholders are entitled to the payment of past years’ unpaid
dividends or dividends in arrears before the payment of current year’s dividends.
The entries to record the declaration and distribution of share capital dividend using two
independent cases are presented below:
2.
Noncumulative - preference shareholders are not entitled to payment of dividends in
arrears; they are entitled to current year’s dividends only.
Case 1 – A share capital dividend of 10% was declared
3.
Participating - preference shareholders are entitled to additional dividends after the
payment of regular dividends to both the preference and ordinary shareholders.
2014
Dec.
2015
Jan.
1
15
Retained Earnings
Share Capital Dividends Distributable
Dividend
10,000 sh x 10% @ P105= P500,000
10,000 sh x 10% @ 100 = P100,000
10,000 sh x 10% @ 5 = P 5,000
105,000
Share Capital Dividends Distributable
Ordinary Share Capital
100,000
However, if the preference shares are participating up to a certain percentage only, a
comparison should be made between the maximum allowed participation and the
amount based on full participation. The amount given to the preference shareholders
is the lower of the two amounts.
100,000
Case 2 – A share capital dividend of 30% was declared
2014
Dec.
2015
Jan.
1
15
109 | P a g e
If the preference shares are fully participating, then the excess dividend is allocated
proportionately to the two classes of share capital based on their total par value.
100,000
5,000
Retained Earnings
Share Capital Dividends Distributable
Dividend
10,000 sh x 30% @ P100= P300,000
300,000
Share Capital Dividends Distributable
Ordinary Share Capital
300,000
300,000
5,000
300,000
4.
Nonparticipating - preference shareholders are not entitled to any dividend in excess
of the regular rate. Hence, the dividends on preference shares is limited only to the
regular rate even if the amount of dividend distributions increases. The entire dividend
balance after the preference shareholders get their regular dividend rate is given to the
ordinary shareholders.
Illustrative Problem F: The Fortune Corp. declared and paid cash dividends for the last three
years as follows: 2012 - P120,000; 2013 - 200,000; 2014 - 300,000 shareholders. No dividends
were paid for two years prior to 2012. The capital structure of the company for the last three
years follows:
10% Preference share capital, P100 par, 5,000 shares outstanding
Ordinary share capital, P50 par, 5,000 shares outstanding
P500,000
250,000
Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
The annual dividend requirement on preference shares is P50,000 or P10 per share (i.e. P100
par x 10% x 5,000 shares outstanding). At the beginning of 2012, dividends are in arrears (unpaid
dividends of prior years) for two years.
The distribution of dividends to the preference and ordinary shareholders under different
independent cases are presented below and on the next pages.
Case 1 - The preference shares are noncumulative and nonparticipating.
Preference shares
Ordinary shares – balance
Total dividends
Dividends per share:*
Preference shares
Ordinary shares
*Total dividends ÷ outstanding shares
2012
P 50,000
70,000
P 120,000
2013
P 50,000
150,000
P 200,000
2014
P 50,000
250,000
P 300,000
P
P
P
10,00
14.00
10,00
30,00
10,00
50,00
Note: Since the preference shares are noncumulative, the dividends in arrears are ignored and
preference shareholders are entitled to the current year’s dividend only. Since the shares are also
nonparticipating, the entire balance is given to ordinary shareholders, preference shares are not
entitled to any dividend in excess of the 10% rate. Hence, the dividend per share on preference share
is limited to P10 only, even if the total amount of distributed dividends increases.
Case 2 - The preference shares are cumulative but non participating
2012
Dividends in arrears:
P50,000 x 2
Current dividends:
Required
Available
In arrears, end of 2008
Total dividends
Dividends per share
2013
Dividends in arrears
Current dividends
Balance – to ordinary shareholders
Total dividends
Dividends per share
110 | P a g e
Preference
Ordinary
Total
P 100,000
------
P 100,000
20,000
------
20,000
P 50,000
20,000
P 30,000
P 120,000
P ------
P
P ------
24.00
Preference
P 30,000
50,000
P 80,000
P 16.00
Ordinary
----------120,000
P 120,000
P 24.00
P 120,000
Total
P 30,000
50,000
120,000
P 200,000
2014
Current dividends
Balance – to ordinary shareholders
Total dividends
Dividends per share
Preference
P 50,000
P 50,000
Ordinary
P -----250,000
P 250,000
P
P
10,00
Total
P 50,000
250,000
P 300,000
50,00
Note: Since the preference shares are cumulative, they are entitled to the payment of dividends in
arrears. However, since they are nonparticipating, they are not entitled to any dividend in excess of
the current year’s dividends.
Case 3 - The preference shares are noncumulative but fully participating.
2012
Regular dividends:
Preference
Ordinary – P50 x 10% x 5,000 sh
Balance – P45,000
Preference 500/750 x P45,000
Ordinary – 250/750 x P45,000
Total dividends
Preference
Ordinary
Total
P 50,000
P 25,000
P 75,000
P 80,000
15,000
P 40,000
45,000
P 120,000
Dividends per share
P
P
2013
Regular dividends:
Preference
Ordinary – P50 x 10% x 5,000 sh
Balance – P125,000
Preference 500/750 x P125,000
Ordinary – 250/750 x P125,000
Total dividends
Dividends per share
Preference
2014
Regular dividends:
Preference
Ordinary – P50 x 10% x 5,000 sh
Preference
Balance – P45,000
Preference 500/750 x P45,000
Ordinary – 250/750 x P45,000
Total dividends
Dividends per share
30,000
16.00
P 50,000
8.00
Ordinary
Total
P 25,000
P 75,000
41,667
P 66,667
P 13.33
125,000
P 200,000
83,333
P 133,333
P 26.67
Ordinary
Total
P 50,000
P 25,000
P 75,000
75,000
P 100,000
P 20.00
225,000
P 300,000
150,000
P 200,000
P 40.00
Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
Note: Since the preference shares are noncumulative they are entitled to current year 's dividends
only and since they are fully participating, they are entitled to additional dividends after payment
of regular dividends to both preference and ordinary shareholders. The regular dividend on
ordinary shares is based on the dividend rate on preference shares. The excess dividend is allocated
proportionately to the two classes of capital shares based on their total par value.
Case 4 - The preference shares are cumulative and fully participating
2012
Dividends in arrears:
P50,000 x 2
Current dividends:
Required
Available
In arrears, end of 2008
Total dividends
Dividends per share
Preference
Ordinary
Total
P 100,000
------
P 100,000
P 50,000
20,000
P 30,000
20,000
------
P 120,000
P ------
P
P ------
24.00
P 120,000
Preference
P 30,000
50,000
P 143,333
P 28.67
31,667
P 56,667
P 11.33
95,000
P 200,000
2014
Current (regular) dividends
Balance – to ordinary shareholders
Preference 500/750 x P225,000
Ordinary – 250/750 x P225,000
Total dividends
Preference
P 50,000
Ordinary
P 25,000
Total
P 75,000
P 25,000
Total
P 30,000
70,000
63,333
150,000
P 50,000
75,000
P 250,000
P
P
40,00
225,000
P 300,000
20,00
Note: Since the preference shares are both cumulative and fully participating, they are entitled to
the receipt of dividends in arrears and also to the receipt of additional dividends after payment of
regular dividends to both preference and ordinary shareholders.
111 | P a g e
2012
Regular dividends:
Preference
Ordinary – P50 x 10% x 5,000 sh
Balance – P45,000
Preference 500/750 x P45,000
Ordinary – 250/750 x P45,000
Total dividends
Preference
Ordinary
Total
P 50,000
P 25,000
P 75,000
P 80,000
15,000
P 40,000
45,000
P 120,000
Dividends per share
P
P
2013
Regular dividends:
Preference
Ordinary – P50 x 10% x 5,000 sh
Balance – P125,000
Preference
30,000
16.00
8.00
20,000
2013
Dividends in arrears
Current dividends
Balance – P95,000
Preference 500/750 x P95,000
Ordinary – 250/750 x P95,000
Total dividends
Dividends per share
Dividends per share
Ordinary
Case 5 - The preference shares are noncumulative but participating up to an additional
8%. This means that the maximum participation of preference shares on the excess dividends is
P40,000 (i.e., 8% of P500,000).
Ordinary
P 50,000
Preference 500/750 x P125,000 = P83,333*
P 25,000
P 75,000
125,000
P 200,000
40,000
Ordinary – P 125,000 – P 40,000
Total dividends
P 90,000
85,000
P 110,000
Dividends per share
P
P
2014
Regular dividends:
Preference
Ordinary – P50 x 10% x 5,000 sh
Balance – P225,000
Preference 500/750 x P225,000 = P150,000*
Ordinary – P 225,000 – P 40,000
Total dividends
Dividends per share
*P40,000 is the lower amount
Total
18.00
Preference
22.00
Ordinary
Total
P 50,000
P 25,000
P 75,000
185,000
P 210,000
P 42.00
225,000
P 300,000
40,000
P 90,000
P 18.00
Note: Since the preference shares are participating up to a certain percentage only, a comparison
should be made between the maximum allowed participation and the amount based on full
participation. The amount to be given to the preference shareholders is the lower of the two
amounts. Alternatively, the amount to be allocated to the preference shares is computed by
multiplying the total par value of the preference shares of the lower of the full participation rate or
the maximum participation rate. The full participation rate is computed as follows:
Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
Excess dividends to be distributed
𝐹𝑢𝑙𝑙 𝑝𝑎𝑟𝑡𝑖𝑐𝑖𝑝𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒 =
Total par value of reference and ordinary shares
Using the data in Case 5, the full participation rate for 2012, 2013 and 2014 are as follows:
2012
2013
2014
45,000/750,000
125,000/750,000
225,000/750,000
6.00%
16.67%
30.00
Illustrative Problem G: On December 31, 2014, the shareholders' equity section of the
statement of financial position of Lucky Corp. appears as follows:
10% Preference share capital, P100 par, 50,000 shares
Ordinary share capital, P20 par, 200,000 shares
Preference share premium
Ordinary share premium
Retained earnings
Total shareholders’ equity
P 5,000,000
4,000,000
1,500,000
1,200,000
5,800,000
P 17,500,000
Hence, in 2012, the 6% rate will be used: in 2013 and 2014 the 7% rate will be used.
Dividends on preference shares are in arrears for two years, including the current year
BOOK VALUE PER SHARE
Case 1 - The preference shares are noncumulative; liquidation value is P110 per share.
Book value per share is the peso equity in corporate capital of each capital share. It is the amount
that would be paid on It each share owned by shareholder in case of corporate liquidation
assuming the amount available to shareholders is exactly the same as the total shareholders'
equity.
Total shareholders’ equity
Less Equity identified with preference shares
Liquidation value = 50,000 sh x P110
Equity identified with ordinary shares
The calculation of book value per share depends on how many classes of share capital are
outstanding. If there is only one class of share capital outstanding, book value per share is
calculated by dividing the total shareholders' equity by the number of shares outstanding.
Subscribed shares, if any, should be added to the outstanding shares.
Book value per share:
Preference = P5,500,000/50,000
Ordinary = P12,000,000/200,000
When more than one class of share capital are outstanding, the rights of the different classes of
shareholders should be taken into consideration. Preference shareholders have priority over
ordinary shareholders as to distribution of assets upon corporate liquidation.
Thus, the equity identified with the preference share capital should be determined first. The
balance of the shareholders' equity after deducting the equity of preference shareholders
represents the equity of the ordinary shareholders. Equity identified with each class of share
capital divided by the number of shares outstanding yields the book value per share.
EQUITY IDENTIFIED WITH PREFERENCE SHARE CAPITAL. The equity of the holders of
preference shares generally consists of the liquidation value of the share and any claim on
dividends. Liquidation value of the share capital reference the amount payable to preference
shareholders for every share owned in case of corporate liquidation. It is usually equal to or more
than the par value of the share capital.
EQUALLY IDENTIFIED WITH ORDINARY SHARE CAPITAL. The equity of the holders of
ordinary share capital, also known as residual equity, is the excess of total shareholders’ equity
over the equity identified with preference share capital. It represents the amount available to
ordinary shareholders in case of corporate liquidation.
112 | P a g e
P 17,500,000
5,500,000
P 12,000,000
P 110.00
P 60.00
Case 2 – The preference shares are cumulative; liquidation value is P110 per share.
Total shareholders’ equity
Less Equity identified with preference shares
Liquidation value = 50,000 sh x P110
Div. in arrears = P5,000,000 x 10% x 2
Equity identified with ordinary shares
Book value per share:
Preference = P6,500,000/50,000
Ordinary = P11,000,000/200,000
P 17,500,000
P 5,500,000
1,000,000
6,500,000
P 11,000,000
P 130.00
P 55.00
EARNINGS PER SHARE
The earnings per share (EPS) is the amount earned during a given period on each ordinary share
outstanding. PAS 33 provides the guidelines in the computation of both basic and dilutive
earnings per share. However, this chapter is focused only on the computation of basic EPS.
The provisions of PAS 33 shall be applied in the computation of earnings per share of the
following entities:
Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
1.
2.
3.
those whose ordinary shares or potential ordinary shares are publicly traded
those that are in the process of issuing ordinary shares or potential ordinary shares
those that voluntarily disclose earnings per share
Case 1 – The company has 20,000 ordinary shares outstanding.
EPS =
P450,000/20,000
P22.50
Case 2 – The company has the following share capital outstanding:
The earnings per share information is presented in the statement of comprehensive income, even
if the amount is negative.
A potential ordinary share is a financial instrument or other contract that may entitle its holders
to ordinary shares, such as ordinary share warrants and convertible preference shares. A holder
of convertible preference shares is given the privilege of exchanging the preference shares for
ordinary shares.
Basic earnings per share shall be computed as follows:
1.
5,000 shares of 10% preference share capital, par value P100
20,000 shares of ordinary share capital, par value P20
The preference shares are cumulative; no dividends were declared during the period.
Profit
Less Dividends on cumulative preference shares
5,000 sh x P100 x 10%
Profit attributable to ordinary shares
P450,000
EPS = P400,000/20,000
P 20.00
50,000
P400,000
There is only one class of share capital outstanding (that is, ordinary shares)
EPS = Profit / outstanding ordinary shares
Case 3 – The company has the following share capital outstanding:
2.
There are two classes of share capital outstanding tat is, ordinary shares and preference
shares)
Profit or loss per income statement
Less Dividends on preference shares
(Total par value of preference shares x dividend rate)
Profit attributable to ordinary shares
xxx
xxx
xxx
5,000 shares of 10% preference share capital, par value P100
20,000 shares of ordinary share capital, par value P20
The preference shares are non-cumulative; no dividends were declared during the
period.
EPS = P450,000/20,000
Earnings per share
(Profit attributable to ordinary shares/outstanding shares)
xxx
If the preference shares are cumulative, the dividends required for the period will be
deducted, whether they are declared or not. However, if the preference shares are noncumulative, only dividends declared in respect of the period will be deducted.
The earnings per share figure is very useful to investors prospective investors in evaluating the
results of operations of a business in order to make investment decisions. It is also considered as
a significant determinant of the market price of the share capital.
Illustrative Problem H: For the year ended December 31, 2014, the Brilliant Corp. reported
profit of P450.000.
Earnings per share computation will be made using three independent cases.
113 | P a g e
P 22.50
APPROPRIATION OF RETAINED EARNINGS
As mentioned in the earlier part of this chapter, Appropriated Retained Earnings is that portion
of retained earnings set aside for a special or specific purpose. Appropriation of retained
earnings reduces the amount available for distribution as dividends to shareholders. However,
the total retained earnings remains unchanged.
There are three types of appropriations to Retained Earnings which are acceptable and these are
discussed in the succeeding paragraphs.
APPROPRIATIONS TO REPORT LEGAL RESTRICTIONS ON RETAINED EARNINGS. When a
company requires its own shares, the law requires that Retained Earnings equal to the cost of
the shares reacquired (known as treasury shares) be appropriated or set aside. This is done to
maintain at original or stated balances the resources of the business and the shareholders'
equity. The appropriated balance is reverted to unappropriated classification upon reissuance of
the reacquired shares.
Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
APPROPRIATIONS TO REPORT CONTRACTUAL RESTRICTIONS O RETAINED EARNINGS.
Agreements with creditors or shareholders may provide for retention of a portion of Retained
Earnings within the company. The appropriations of Retained Earnings is made to protect the
interest of creditors and shareholders and to assure redemption of the securities they hold. The
appropriation balance is reverted back to unappropriated balance upon payment of the
obligation. Examples of appropriations under this classification are Appropriation for Bond
Redemption and Appropriation for Preference Share Capital Redemption.
APPROPRIATIONS TO REPORT DISCRETIONARY ACTION BY THE BOARD OF DIRECTORS IN
THE PRESENTATION OF RETAINED EARNINGS. A portion of the Retained Earnings may be
presented in a manner disclosing the actual use or planned use in the future of the resources as
authorized by the board of directors Examples of appropriations under this classification are
Appropriation for Plant Expansion and Appropriation for General Contingencies.
Surplus. These accounts are reported separately from Contributed Capital and Retained
Earnings.
3.
Prepare the financial statements of a corporation, specifically the statement of changes
in shareholders’ equity. A corporation has also four basic financial statements, (balance
sheet or statement of financial position, income statement, statement of cash flows, and
statement of changes in shareholders’ equity that shows transactions that have caused an
increase or a decrease in Total Shareholders’ Equity during the period, such as distribution
of dividends and profit for the year.
4.
Identify the different types of dividends and compute amount of dividends to be
distributed to preference and ordinary shareholders. Dividends are distribution of
corporate income to the shareholders. Dividends may be distributed of corporate income to
the shareholders. Dividends may be distributed in the form of cash, non-cash assets or
shares of stock of the corporation. On the date of declaration, Retained Earnings account is
debited, thereby reducing its balance. The amount debited to Retained Earnings depends on
the type of dividend declared. When two classes of share capital are outstanding, the total
amount of dividends declared should be allocated properly talking into account the type of
preference shares outstanding.
5.
Discuss the computation of book value per share and earnings per share. Book value per
share is the peso equity in corporate capital of each share capital. It represents the amount
that a shareholder will receive for every share owned in case of corporate liquidation. If
there is only class of share capital outstanding, it is computed by dividing the total
shareholders’ equity by the total number of outstanding shares. When there are two classes
of share capital outstanding, the equity identified with the preference shares must be
determined first and deducted from the total shareholder’s equity to get the equity
identified with ordinary shares. Book value per share is then computed by dividing the
equity identified with each class of stock by the total number of outstanding shares per class.
The pro form entries to record the appropriation of Retained Earnings and its subsequent
cancellation follow:
a.
b.
Retained Earnings
Retained Earnings Appropriated for ………
Appropriation of retained earnings
xxx
Retained Earnings Appropriated for ……
xxx
Retained Earnings
Cancellation of appropriation to retained earnings
xxx
xxx
REVIEW OF THE LEARNING OBJECTIVES
1.
Explain the preparation of work sheet, adjusting entries, and closing entries for a
corporation. The work sheet prepared for a corporation is similar to the work sheet
prepared for a sole proprietorship and a partnership. It normally contains eight columns
and is prepared to facilitate the preparation of financial statements. The adjusting entries
include adjustment for income tax which is 35% of profit before income tax. In a corporation,
the income or loss of the company is transferred to Retained Earnings, which is also a
capital account.
2.
Explain the components of the shareholders’ equity section of the statement financial
position. The capital section of the statement of financial position (balance sheet) of a
corporation is called "Shareholders’ Equity" section. lt is generally composed of the
following: (1) Contributed Capital, which represents capital arising from contributions by
shareholders and is subdivided into Share Capital and Additional Paid-in Capital; and (2)
Retained Earnings, which represents capital arising from operations of the business. In
some instances, corporations may have capital adjustment accounts such as Revaluation
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The earnings per share (EPS) is the amount earned during a given period on each ordinary
share outstanding. When there is only one class of share capital outstanding, it is computed
by dividing the net income or the profit of the company by the number of outstanding
ordinary shares. When there are two classes of share capital outstanding, the earnings
allocated to the ordinary shares is first computed by deducting the earnings identified with
the preference shares. The earnings per share is then calculated by dividing the earnings
allocated to the ordinary shares by the number of outstanding ordinary shares.
6.
Identify and explain the different types of retained earnings appropriations.
Appropriation of Retained Earnings is setting aside a portion of Retained Earnings for a
specific or special purpose and such appropriation reduces the amount of Retained Earnings
available to shareholders as dividends. Retained Earnings may be appropriated for the
following purposes: (1) to meet legal requirements; (2) to meet contractual requirements;
and (3) to meet discretionary action by the board of directors.
Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
GLOSSARY OF ACCOUNTING TERMINOLGIES
Additional paid-in Capital – corporate capital arising from investment by shareholders in
excess of the par or stated value of the share capital.
Appropriated Retained Earnings – Retained Earnings set aside for a specific purpose, hence,
not available for dividend distribution.
Book value per share – peso equity in corporate capital of each share of stock. It is the amount
that a shareholder would receive for every share owned in case of corporate liquidation.
Cash dividends – dividends distributable in the form of cash
Contributed Capital – corporate capital arising from investment by shareholders
Dividends – distribution of corporate earnings to shareholders
Dividends in arrears – unpaid dividends in prior years
Earnings per share – amount earned during a given period on each ordinary share outstanding
Property dividends – dividends distributable in the form of non-cash assets
Retained Earnings – corporate capital arising from operations of the business. Its balance
represents undistributed earnings of the company. It is also known as “earned surplus”
Share capital dividends – dividends distributable in the form of a corporations’ own share
capital
Unappropriated Retained Earnings – retained earnings available for dividend distribution to
shareholders
MULTIPLE CHOICE
MC 9-1 Which of the following statements is not correct regarding the appropriations of
Retained Earnings?
a. Appropriations of Retained Earnings do not change the total amount of Retained
Earnings.
b. Appropriation of Retained Earnings reflect funds set aside for a designated
purpose, such as plant expansion.
c. Appropriations of Retained Earnings can be made as result of a contractual
requirement.
d. Appropriations of Retained Earnings can be made at the discretion of the board
of directors.
MC 9-2 When a portion of shareholders’ original investment is returned in the form of a
dividend, it is called a (an)
a. compensating dividend
b. liquidating dividend
c. property dividend
d. equity dividend
MC 9-3 Share capital dividends declared but not yet distributed as of the statement of
financial position date should be reported as a (an)
a. current liability
b. addition to share capital outstanding
c. reduction in total shareholders’ equity
d. noncurrent liability
MC 9-4 A company declared a cash dividend on its ordinary share capital in December 2014,
payable in January 2015. Retained Earnings would
a. increase on the date of declaration
b. not be affected on the date of declaration
c. not be affected on the date payment
d. decrease on the date of payment
MC 9-5 On March 20, 2014, AAA Corp. declared the distribution of the following dividend to
its shareholders of record as of March 31, 2014.
Investment in 100 shares of BBB Corp. stock, carrying value and fair value,
P600,000
The entry to record the declaration of the property dividend would include a debit to
Retained Earnings of
a. P 600,000
b. P 650,000
c. P 850,000
d. P1,575,000
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Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
MC 9-6 The shareholders/ equity section of GGG Corp. as of December 31, 2014 contained the
following accounts:
Ordinary Share Capital, 25,000 shares authorized,
10,000 shares issued and outstanding
Ordinary Share Premium
Retained Earnings
P 30,000
40,000
80,000
P 150,000
GGG’s board of directors declared a 10% stock dividend on April 1, 2015 when the
market value of the share capital was P7 per share. Accordingly, 1,000 new shares were
issued. All of GGG’s shares has a par value of P3 per share. GGG incurred a loss of
P12,000 for the first three months.
What is the balance of the Retained Earnings accounts as of April 1, 2015?
a. P61,000
b. P64,000
c. P68,000
d. P73,000
MC 9-7 The JJJ Corporation has the following classes of share capital outstanding as of
December 31, 2014:
Ordinary Share Capital, P20 par value, 20,000 shares outstanding,
Preference Share Capital, 6%, P100 par value, cumulative, 2,000
shares outstanding
No dividends were paid on preference shares for 2012 and 2013. On December 31,
2014, a total cash dividend of P200,000 was declared.
How much dividends will be received by ordinary shareholders?
a. P
0
b. P164,000
c. P176,000
d. P188,000
MC 9-8 Using the information in MC 9-7, how much dividends will be received by preference
shareholders?
a. P 12,000
b. P 24,000
c. P 36,000
d. P200,000
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MC 9-9 The shareholders’ equity of NNN Comp any on December 31, 2014 follows:
10% Preference Share Capital, P100 par
Ordinary Share Capital, P60 par
Preference Share Premium
Ordinary Share Premium
Retained Earnings
Total Shareholders’ Equity
P 500,000
3,000,000
50,000
250,000
300,000
P4,100,000
Preference shares are cumulative with dividends in arrears for 5 years at the beginning
of 2010 and with a liquidation value of P120.
What is the book value per share of preference share capital?
a. P100
b. P120
c. P170
d. P180
MC 9-10 Using the information in MC 9-9, what is the book value per share of ordinary share
capital?
a. P60
b. P64
c. P65
d. P70
MC 9-11 On April 8, 2014, Cordillera Corp. declared and issued a 25% ordinary share capital
dividend. Prior to this date, Cordillera had 20,000 shares of P2 par value ordinary share
that were both issued and outstanding. The carrying value of each share of stock is P20
at the time of declaration of the dividend.
As a result of the share capital dividend, how much will be debited to retained Earnings?
a. P 10,000
b. P 40,000
c. P 75,000
d. P 100,000
MC 9-12 Using the information in MC 9-11, what is the effect of the share capital dividend on
total shareholders’ equity?
a. Decreased by P40,000
b. Decreased by P10,000
c. Increased by P100,000
d. Did not change
Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
MC 9-13 The adjusted trial balance of ZZZ Corp. on December 31, 2014 includes the following
account balances:
Dividends Payable
Ordinary Share Capital (P5 par, 500,000 shares authorized)
Ordinary Share Capital Subscribed (10,000 shares)
Ordinary Share Premium
10% Preference Share Capital (25,000 shares authorized,
12,000 shares outstanding)
Preference Share Premium
Retained Earnings Appropriated for Contingencies
Retained Earnings Appropriated for Bond Retirement
Retained Earnings – Unappropriated
Ordinary Share Capital Dividends Distributable
Paid-in Capital from Share Capital Dividend
P 40,000
750,000
25,000
50,000
300,000
30,000
150,000
100,000
450,000
105,000
63,000
What is the number of ordinary shares issued and outstanding?
a.
5
b. 150,000
c. 500,000
d. 750,000
MC 9-14 Using the information in MC 9-13, what is the par value for each preference share
capital?
a. P10
b. P12
c. P25
d. P40
MC 9-15 Using the information in MC 9-13, what is the market value for each ordinary share
capital upon the declaration of the share capital dividend?
a. P 5
b. P 8
c. P 10
d. P 25
MC 9-16 Using the information in MC 9-13, how much is the total amount of retained Earnings?
a. P100,000
b. P150,000
c. P450,000
d. P700,000
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MC 9-17 Using the information in MC 9-13, what is the total amount of Share Capital?
a. P1,050,000
b. P1,075,000
c. P1,138,000
d. P1,180,000
MC 9-18 Using the information in MC 9-13, what is the total amount of Contributed Capital?
a. P1,050,000
b. P1,323,000
c. P1,363,000
d. P2,063,000
MC 9-19 Using the information in MC 9-13, what is the total amount of Retained Earnings
available for dividend distribution?
a. 450,000
b. P550,000
c. P600,000
d. P700,000
MC 9-20 Using the information in MC 9-13, what is the total amount of shareholders’ equity?
a. P1,363,000
b. P2,000,000
c. P2,023,000
d. P2,063,000
Chapter 10 – Share Capital Transactions Subsequent to Original Issuance
CHAPTER 10
SHARE CAPITAL TRANSACTIONS
SUBSEQUENT TO ORIGINAL ISSUANCE
LEARNING OBJECTIVES
1.
2.
Identify and explain the various share capital transactions subsequent to original issuance.
Explain the methods of acquiring and accounting for treasury shares.
PREVIEW OF THE CHAPTER
SHARE CAPITAL RETIREMENT
Share capital may be reacquired and formally retired by the issuing corporation. Such
retirements calls for the cancellation of the stock certificate, cancellation of the share capital
account and the cancellation of the related additional paid-in capital from the original issuance
of the stock. If the retirement price is greater than the original issuance price, Retained Earnings
is debited for the difference. On the other hand, if the retirement price is less than the original
issuance price, Paid-in Capital from the Retirement of Share Capital is credited for the difference.
The difference between the retirement price and the original issuance price of the share capital
retired should not be recognized as a gain or loss. The excess of the original issuance price over
the retirement price of the share capital should not be credited to Retained Earnings.
The retirement of share capital will reduce both the number of shares issued and the number of
shares outstanding.
Illustrative Problem A: The shareholders’ equity section of the statement of financial position
of CBA Co. contains the following;
SHARE CAPITAL
TRANSACTIONS
Preference share capital, P100 par, 10,000 shares
Preference share premium
Retained earnings
•
•
•
•
Share Capital Transactions
Other Than Acquisition of
Treasury Shares
Retirement
Conversion of preference
shares into ordinary shares
Share (Stock) split
Recapitalization
Treasury Shares
•
•
Acquisition
• By purchase
• By donation
Method of Accounting
• Cost Method
TYPES OF SHARE CAPITAL TRANSACTIONS
When a share capital (capital stock) is fully paid, a stock certificate is issued to the shareholder
and the stock becomes outstanding. Subsequent to the original issuance, various capital share
transactions may take place. These transactions may cause a change in total shareholders’
equity of the company or in the number of shares outstanding. These share capital transactions
include the following:
1. Share capital retirement
2. Share capital reacquisition
3. Conversion of preference shares into ordinary shares
4. Share (stock) split
5. Recapitalization
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P1,000,000
250,000
800,000
Based on the above data, the original issuance price of each preference share is P125, that is, the
par value of P100 per share and share premium of P25 per share (P250,000/10,000 shares).
One thousand (1,000) shares of preference share capital were reacquired and retired. Entries to
record the retirement using two independent cases follow:
Case 1 – The retirement price is P110
Preference Share Capital
Preference Share Premium
Cash
Paid-In Capital from Retirement
Of Preference Shares
1,000 sh x P100=P 100,000
1,000 sh x P25 =P 25,000
1,000 sh x P110=P 110,000
1,000 sh x P15 =P 15,000
100,000
25,000
110,000
15,000
Chapter 10 – Share Capital Transactions Subsequent to Original Issuance
Case 2 – The retirement price is P130 per share
Preference Share Capital
Preference Share Premium
Retained Earnings
Cash
1,000 sh x P100=P 100,000
1,000 sh x P25 =P 25,000
1,000 sh x P5 =P 5,000
1,000 sh x P130 =P 130,000
100,000
25,000
5,000
130,000
The balance of the treasury shares account is reported as a deduction from the sum of total
contributed capital and retained earnings.
The reacquisition of a company’s own shares reduces the number of outstanding shares but
does not affect the number of issued shares. Treasury shares are not entitled to receipt of
dividends because they are not outstanding. Retained Earnings, however, must be appropriated
equal to the cost of the treasury shares acquired.
Illustrative Problem B: The shareholders’ equity of JJJ Corp. included the following items:
Ordinary share capital, P20 par, 50,000 shares
Ordinary share premium (P5 per share)
Retained earnings
The debit to retained Earnings of P5,000 or P5.00 for every share retired is the excess of the
retirement price of P130 over the original issuance price of P125.
SHARE CAPITAL REACQUISITION (TREASURY SHARES)
The issuing corporation sometimes reacquires shares issued to shareholders either by purchase
or donation. Such shares are being held in the name of the corporation and they are called
treasury shares. The company may reissue these shares at some future date as deemed
necessary.
On September 1, 2014, 1,000 shares were reacquired at P24. On September 30, 700 shares were
reissued at P30.
Entries to record the foregoing and the shareholders’ equity section of the statement of financial
position as of September 30 are presented below and on the next page.
2014
Sept.
1
The practice of reacquiring one’s own capital share is done for the following reasons:
1.
2.
3.
4.
5.
6.
To obtain shares to be used in acquiring plant assets.
To improve earnings per share by reducing the number of shares outstanding
To invest excess cash temporarily.
To support the market price of the share capital.
To increase the ratio of liabilities to shareholders’ equity.
To obtain shares for conversion to other securities such as preference share capital.
1
30
REACQUISITION BY PURCHASE
Treasury shares may be acquired by purchase and the reacquisition will be accounted for using
the cost method.
Under the cost method, the reacquired shares are viewed as capital elements awaiting ultimate
disposition. Treasury shares are recorded at cost. When the shares are reissued at more than
cost, the indicated gain is credited to an additional paid-in capital account Paid-In Capital from
Sale of Treasury Shares. When the shares are reissued at less than cost, the indicated loss is
debited to the following accounts in the order shown below:
(a) additional paid-in capital from treasury share transactions of the same class of share
capital, and
(b) retained earnings
119 | P a g e
P1,000,000
250,000
500,000
30
Treasury Shares
Cash
1,000 sh x P24 = P24,000
24,000
Retained Earnings
Retained Earnings Appropriated for
Treasury Shares
24,000
Cash
Treasury Shares
Paid-In Capital from Sale of Treasury
Shares
700 sh x P30 = P21,000
700 sh x P24 = P16,800
700 sh x P6 = P 4,200
21,000
Retained Earnings Appropriated for
Treasury Shares
Retained Earnings
24,000
24,000
16,800
4,200
16,800
18,800
Chapter 10 – Share Capital Transactions Subsequent to Original Issuance
CONVERSION OF PREFERENCE SHARES INTO ORDINARY SHARES
Shareholders’ Equity
Contributed Capital:
Ordinary Share Capital, P20 par, 50,000 shares
issued, 49,700 shares outstanding, 300 shares in
treasury
Ordinary Share Premium
Paid-in Capital from Sale of Treasury Shares
Retained Earnings:
Retained Earnings Appropriated for Treasury Shares
Unappropriated Retained Earnings
Total Contributed Capital and Retained Earnings
Less Treasury Shares, at cost (300 @ P24)
Convertible preference shares can be converted into ordinary shares at the option of the holder.
This type of preference share capital can be sold at a higher price but a lower dividend rate
because of its conversion privilege.
P1,000,000
250,000
4,200
P
7,200
492,800
Total Shareholders’ Equity
P1,254,200
500,000
P1,754,200
7,200
P1,747,000
REACQUISITION BY DONATION
Treasury shares may be acquired through donation by shareholders. This practice is done by
shareholders to enable the company to increase its working capital and at the same time
maintain their proportionate ownership interests.
Upon receipt of capital shares as donation, a memorandum entry is made stating the number of
shares received. Subsequent sale of donated shares is recorded by debiting Cash and crediting
Donated Capital or Paid-In Capital from Donated Shares for the entire proceeds.
Alternatively, the receipt and the subsequent sale of the donated shares may be recorded as
follows:
Upon receipt
Treasury Shares
xxx
Donated Capital
xxx
(amount recorded is the fair value of the shares on the date of donation)
Upon sale of donated shares at more than recorded cost
Cash
Treasury Shares
Paid-in Capital from Sale of Treasury Shares
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xxx
xxx
xxx
The accounting for conversion of preference shares into ordinary shares is similar to retirement
of share capital. Account balances related to the preference shares converted are cancelled and
the issuance of ordinary shares is recorded. An indicated fain from conversion is credited to PaidIn Capital from Conversion of Preference Shares into Ordinary Shares; an indicated loss from
conversion is debited to Retained Earnings.
Illustrative Problem C: The LMN Corporation’s shareholders’ equity contains the following:
Ordinary Share Capital, P10 par, 50,000 shares
Ordinary Share Premium
10% Preference share capital, P100 par, 5,000 shares
Preference share premium
Retained earnings
P 500,000
100,000
500,000
50,000
750,000
On July 15, 1,000 preferences shares were converted into ordinary shares.
Case 1 – Twenty ordinary shares were issued for every preference share
Preference Share Capital
Preference Share Premium
Retained Earnings
Ordinary Share Capital
1,000 sh x P100
1,000 sh x P10
1,000 sh x 20 sh x P10
P200,000 – P110,000
100,000
10,000
90,000
200,000
=
=
=
=
P100,000
P 10,000
P200,000
P 90,000
Case 2 – Eight ordinary shares were issued for every preference share
Preference Share Capital
Preference Share Premium
Ordinary Share Capital
Paid-in Capital from Conversion of
Preference Share into Ordinary Shares
1,000 sh x P100
= P100,000
1,000 sh x P10
= P 10,000
1,000 sh x 20 sh x P10 = P200,000
P200,000 – P110,000 = P 90,000
100,000
10,000
80,000
30,000
Chapter 10 – Share Capital Transactions Subsequent to Original Issuance
Just like in the retirement of share capital and acquisition of treasury shares, no gain or loss is
recognized on the conversion of preference shares into ordinary shares.
SHARE (STOCK) SPLITS AND REVERSE SHARE (STOCK) SPLITS
When the market price of the shares is high and the corporation feels that a lower price will result
in a wider distribution of ownership, it may authorize the replacement of outstanding shares by
a larger number of shares. The increase in the number of shares outstanding in this manner is
called share (stock) split or share split-up. For instance, 10,000 ordinary shares with a par
value of P10 are replaced by 20,000 ordinary shares with a par value of P5. This type of
transaction is described as a share split of 2 for 1 - two new shares are issued in exchange for one
old share. The par value is subsequently reduced to P5 (i.e, P10/2)
The reverse procedure, that is, the replacement of shares outstanding by a smaller number of
shares with an increase in the par value, is called reverse share split or a share split down.
This is desirable when the market price of the shares is low and it is felt that assigning a higher
price for the shares offers certain advantages. For instance, 10,000 ordinary shares with a par
value of P10 are replaced by 5,000 ordinary shares with a par value of P20. This type of
transaction is described as a share split of 1 for 2 - one new share is issued in exchange for two
old shares. The par value is subsequently increased to P20(i.e. P10 x 2).
accounts related to the new issue and the cancellation of account balance related to the old issue.
(Capital restructuring will be discussed in a higher accounting subject.)
Illustrative Problem D: The shareholders’ equity of Quezon Co. contains the following:
Ordinary share capital. P20 par, 50.000 shares
Ordinary share premium
Retained earnings
Case 1 - The original issue is replaced by a no-par share capital with a stated value of P20
Ordinary Share Capital. P20 par
Ordinary Share Premium
Ordinary Share Capital, P10 stated value
Paid-In Capital from Exchange of Par
for No-Par Share Capital
Ordinary Share Capital, P20 par
Ordinary Share Capital, P15 par
Paid-in Capital from Reduction in Par
Value of Ordinary Shares
250,000
1,000,000
750,000
250,000
100,000
1.
Identify and explain the various share capital transactions subsequent to original
issuance. Share capital transactions subsequent to original issuance include the following:
(1) share capital retirement; (2) share capital reacquisition; (3) conversion of preference
shares into ordinary shares, (4) share (stock) split, and (5) recapitalization. Two major rules
apply on all these transactions: (1) no gain or loss is reported in the income statement
arising from these transactions, and (2) indicated loss on share capital transactions may be
charged against retained earnings, but indicated gain cannot be credited to retained
earnings. Indicated gain should be credited to additional paid-in capital. 2
2.
Explain the methods of acquiring and accounting for treasury shares. Treasury shares
are shares issued to the shareholders and subsequently reacquired by the corporation with
the intention of reissuing them. Treasury shares may be acquired either by purchase or by
donation. Transaction’s relating to treasury shares shall be accounted for using the cost
method. Under the cost method, treasury shares is reported on the statement of financial
position as a deduction from total shareholders' equity.
RECAPITALIZATION
Corporate recapitalization takes place when an entire issue of share capital is changed by
appropriate action of the corporation. The typical types of recapitalization are as follows:
Change from par to no-par share. capital and vice-versa
Reduction in the par or stated value of share capital.
Recapitalization is normally undertaken to establish an additional paid-in capital account that
will be used in capital restructuring. This type of transaction requires the setting up of capital
121 | P a g e
1,000,000
REVIEW of the LEARNING OBJECTIVES
100,000
It should be noted that a share split will not affect total shareholders' equity nor total share
capital. It will simply change the number of shares outstanding and the par value per share of
stock.
1.
2.
1,000,000
250,000
Case 2 - Each capital share is exchanged for a new share with a par value of P15
A share split is recorded by a memorandum entry. The entry should state the new number of
shares and the new par value of the shares. Alternatively, a journal entry may be prepared
canceling the old issue and recording the new issue. Using the example in the first paragraph, the
share split of 2 for l may be recorded as follows:
Ordinary Share Capital, P10 par
Ordinary Share Capital, P5 par
P1,000,000
250,000
500,000
Chapter 10 – Share Capital Transactions Subsequent to Original Issuance
GLOSSARY of ACCOUNTING TERMINOLOGIES
Convertible preference shares – preference shares that can be converted into ordinary shares
at the option of the shareholder.
Recapitalization – change in the capital structure of a corporation by reducing the par or stated
value of share capital or by exchanging par value for no-par value share capital or vice-versa.
Reverse share split – replacement of outstanding shares by a smaller number of shares with a
proportionate increase in the par or stated value of the share capital. It is also known as share
split-down.
Share split – replacement of outstanding shares by a greater number of shares with a
proportionate decrease in the par or stated value of the share capital It is also known as share
split-up.
Treasury shares – capital shares issued to shareholders and subsequently reacquired by the
corporation with the intention of reissuing them.
MULTIPLE CHOICE
MC 10-1 The following information was abstracted from the accounts of the Jimenez Corp. at
year-end:
Total profit since incorporation
P420,000
Total cash dividends paid
130,000
Proceeds from sale of donated shares
45,000
Total value of stock dividends distributed
30,000
Excess of proceeds over cost of treasury
shares sold
70,000
What should be the balance of Retained Earnings?
a. P260,000
b. P290,000
c. P305,000
d. P335,000
MC 10-2 Jamier Corp. was organized on January 2, 2014, with authorized capital of 100,000
shares of P10 par ordinary share capital. During 20l4, Jamier had the following
transactions affecting shareholders' equity.
Jan. 7 - Issued 40,000 shares at P12 per share.
Dec. 2 - Purchased 6,000 treasury shares at P13 per share.
Profit for the year amounted to P300,000. shareholders' equity as of December 31,
2014?
a. P640,000
b. P702,000
c. P708,000
d. P720,000
MC 10-3 On December 10, Joshua Co. split its share capital on a 5-for-2 when the market value
was P60 per share. Prior to the split Joshua had 200,000 shares of P15 par value share
capital. What is the par value of the share capital after the split?
a. P3.00
b. P6.00
c. P15.00
d. P26.000
MC 10-4 Using the information in MC 10-3, how many shares are outstanding after the split?
a.
200,000
b.
300,000
c.
500,000
d. 1,000,000
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Chapter 10 – Share Capital Transactions Subsequent to Original Issuance
MC 10-5 During the fiscal year 2014, Jezuel Corp. issued for P110 per share 15,000 shares of
P100 par value convertible preference share capital. One preference share is
convertible into three ordinary shares with a par value of P25. On November 15, 2014,
all of the preference shares were converted into ordinary shares. The market value of
the ordinary shares on the conversion date was P40 per share.
What amount should be credited to the ordinary share capital account as a result of
conversion of preference shares into ordinary shares?
a. P1,125,000
b. P1,500,000
c. P1,650,000
d. P1,800,000
MC 10-6 Joros Corp, was organized on January 1, 2012, at which date it issued 100,000 shares of
P10 par ordinary share capital at P15 per share. For the period 2012 to 2014, the
company reported profit of P450,000 and paid Cash dividends of P230,000. On January
10, 2014, the company purchased 6,000 of its own shares at P12 per share. On
November 20, 2014, Joros sold 4,000 treasury shares at P8 per share. What is the total
shareholders' equity on December 31, 2014?
a. P1,680,000
b. P1,688,000
c. P1,704,000
d. P1,720,000
MC 10-7 Using the information in MC 10-6, the reissuance of the treasury shares resulted in a
a. credit to Retained Earnings of P16,000
b. debit to Retained Earnings of P16,000
c. credit to PIC from Sale of Treasury Shares of P16,000
d. debit to PIC from Sale of Treasury Shares of P16,000
MC 10-8 Jabar Corp. holds 10,000 ordinary shares, par value P10, as treasury shares, which was
purchased in year 2013 at a cost of P120,000. On December 8, 2014, Jabar sold all the
10,000 shares for P210,000. The sale would result in a credit to Paid-in Capital from
Sale of Treasury Shares in the amount of
a. P 90,000
b. P110,000
c. P120,000
d. P210,000
123 | P a g e
MC 10-9 ABC Corp. reported the following in its statement of shareholders' equity on January 1,
2014:
Ordinary share, P5 par value, 200,000 shares
authorized, 100,000 shares issued
Additional paid-in capital
Retained earnings
Total contributed capital and retained earnings
Less Treasury shares, 5,000 shares at cost
Total shareholders' equity
The following events occurred in 2014:
May 1
1,000 treasury shares were sold for P10 000
July 9
10,000 shares previously unissued for P12 per share.
Oct. 15 There was a 2-for-1 share split
How many shares are issued and outstanding at December 31, 2014?
a. 220,000 and 216,000
b. 220,000 and 212,000
c. 110.000 and 106.000
d. 100,000 and 95,000
MC 10-10 On December 29, 2013. Blue Company was registered at the Securities and Exchange
Commission with 100,000 authorized ordinary shares of P100 par value. The following
were Blue’s transactions:
Dec. 29, 2013 Issued 40,000 shares at P105 per share.
May 14, 2014 Purchased 600 of its ordinary shares at P110 per share
Aug. 9, 2014 400 treasury shares were sold at P95 per share
Dec. 31 2014 Profit P830,000, cash dividends paid P200,000
What is the total shareholder' equity of Blue company on December 31, 2014?
a. P 4,352,000
b. P 4,802,000
c. P 4,820,000
d. P10,602,000
Chapter 11 – Financial Reporting and Analysis
General purpose financial statements are financial statements that are intended to meet the
common needs of users who are not in position to demand reports customized to their specific
information needs.
CHAPTER 11
FINANCIAL REPORTING AND ANALYSIS
LEARNING OBJECTIVES
1.
2.
3.
4.
5.
Explain the nature of the financial statements and the over-all considerations in their preparation
and presentation.
Identify and explain the components of a complete set of financial statements.
Explain and appreciate the importance of the statement of cash flows.
Describe and explain the classification of cash flows and the methods of presenting cash flows from
operating activities.
Explain and appreciate the different types of ratio analysis
•
Objective, definition
and nature of financial
statements
Overall consideration
in the preparation of
financial statements
Financial Statements and
their Elements
•
•
•
•
•
•
Statements of financial
position
Statement of comprehensive
income
Statement of changes in
equity
Statement of cash flows
Notes
Financial Statement
Analysis
•
Ratio analysis
•
•
•
Liquidity ratios
Solvency ratios
Profitabilityratios
INTRODUCTION
As discussed in Chapter 1, there are two main groups of users of accounting information; (1)
internal users and (2) external users. The external users do not have access to the day to day
operations of an entity; hence, they rely heavily on the financial reports provided to them. It is
very important, therefore, that these reports be reliable and timely so that those who use them
can make sound decisions and reasoned choices among alternative courses of action.
The field of accounting that specializes in giving reports to external users is financial accounting.
The financial reports that are given to them are called general-purpose financial statements.
124 | P a g e
The objective of general purpose financial statements is to provide information about the
financial position, financial performance and cash flows of an entity that is useful to a wide range
of users in making economic decisions.
Financial statements are a structured representation of the financial position and Financial
performance of an entity. They show the assets, liabilities and equity of an entity as of a
particular dale. They also show the income earned and expenses incurred by an entity during a
given period.
FINANCIAL
REPORTING and ANALYSIS
•
OBJECTIVE OF FINANCIAL STATEMENTS
DEFINITION AND NATURE OF FINANCIAL STATEMENTS
PREVIEW OF THE CHAPTER
Financial Reporting
The presentation of financial statements is guided by PAS 1 which sets out the basis for the
presentation of financial statements to ensure the comparability with previous periods and with
other entities. PAS 1 also identities the minimum content of what should be included in the
financial statements and the guidelines as to their structure.
Financial statements are the end product of the accounting process. The financial statements
are the final output of the accounting process. They can be prepared only after the transactions
have been processed and the necessary adjusting entries are journalized and posted.
Financial statements show the results of the management’s stewardship of the resources
entrusted to in. The owners of an entity entrust to management the utilization of company
resources to achieve both short-term and long-term goals of the entity. They are expected to
maximize the earnings potential of these resources and provide rate of return on their use that
is acceptable to the investors and other stakeholders. The financial statements show the
performance of management vis-à-vis the expectations of the investors or owners.
Financial statements are the means by which the information accumulated and processed
in financial accounting is periodically communicated to those who use it. The stakeholders
of an entity are informed of the financial position and the performance of an entity through the
financial statements.
The preparation and presentation of financial statements is a responsibility of
management. The Board of Directors reviews and approves the financial statements before
these are submitted to the shareholders of the entity. A management’s representation letter is
attached to the published financial statements.
Chapter 11 – Financial Reporting and Analysis
COMPONENTS OF FINANCIAL STATEMENTS
According to PAS 1 (revised (2011), a complete set of financial statements comprises:
•
•
•
•
•
a statement of financial position (balance sheet)
a statement of comprehensive income (alternatively, an entity may prepare a separate
income statement and a separate statement of other comprehensive income)
a statement of changes in equity
a statement of cash flows; and
notes, comprising a summary of significant accounting policies and other explanatory
notes.
Some entities, however, present other reports in addition to those stated above. Examples are
the following:
•
•
a financial review by management that describes and explains the main features of the
entity's financial performance and financial position and the principal uncertainties it
faces;
environmental reports and value added statements, particularly in industries in which
environmental factors are significant and when employees are considered an
important user group.
These reports, which are presented outside of the financial statements, are outside of the scope
of PAS 1.
OVERALL CONSIDERATIONS IN THE PREPARATION AND PRESENTATION
OF FINANCIAL STATEMENTS
PAS 1 identifies eight (8) basic considerations when preparing and presenting financial
statements. These considerations are described briefly below.
Fair presentation and compliance with PFRSs/ IFRSs. Financial statements shall present fairly
the financial position, performance and cash flows of an entity. Fair presentation requires the
faithful representation of the effects of transactions other events and conditions in accordance
with the definitions and recognition criteria for assets, liabilities, income and expenses set out in
the Framework. The application of PFRSs/IFRSs, with additional disclosure when necessary, is
presumed to result in financial statements that achieve fair presentation. (PAS 1, par. 15)
Going concern. Financial statements shall be prepared on a going concern basis unless
management either intends to liquidate the entity or to cease trading, or has no realistic
alternative but to do so. This means that an entity is assumed to have a continuity of life, unless
there is an evidence to the contrary. Any uncertainties that may cast doubt as to the ability of the
125 | P a g e
entity to continue as a going concern, however, should be properly disclosed. An example of
application of going concern is the use of accrual basis of accounting. (PAS 1, par. 25)
Accrual basis of accounting. An entity shall prepare its financial statements, except for cash flow
information, using the accrual basis of accounting. Under the accrual basis of accounting, income
and expenses are recognized in the period in which they relate rather than when the cash is
received or paid. For example, sales on account made in 2014 that will be collected in 2015 is
recognized as sales in 2014. An insurance premium paid in 2014 covering the period 2015 is
recognized as expense in 2015; the payment is recognized as prepaid expense at the end of 20l4
(PAS 1, par. 27)
Frequency of reporting. An entity shall present a complete set of financial statements (including
comparative information) at least annually. An entity chooses its own annual accounting period
- it can adopt the calendar year or adopt a fiscal year. The calendar year starts January 1 and ends
December 31. The adoption of a fiscal year may depend on the nature of business or operations
of the entity. A school, for instance, may adopt an accounting period that starts June 1 and ends
May 31 with the start and end of one school year. (PAS 1 par.36)
Materiality and aggregation. Each material class of similar items shall be presented separately
in the financial statements. Items of dissimilar nature or function shall be presented separately
unless they are immaterial. For example, cash on hand and cash deposited in various banks may
be aggregated and reported under a single line item "Cash on hand and in banks" but trade
receivables are presented separately from nontrade receivables because of their dissimilar
nature. An entity with several prepaid items which are immaterial in amount may present these
prepayments under the line item "prepaid expenses". (PAS 1, par. 29)
Offsetting. As a general rule, assets and liabilities, and income and expenses, shall not be offset
unless required or permitted by a Standard or an Interpretation. Offsetting is deducting the
balance of an asset account from the balance of a liability account and reporting only the net
amount in the statement of financial position or deducting the balance of an income account from
the balance of an expense account and reporting only the net amount in the statement of
comprehensive income. For instance, bonds payable balance of P5 million is deducted from bond
sinking fund balance of P3 million reporting only the net amount of P2 million for bonds payable
or deducting uncollectible accounts of P1 million from sales of P75 million and reporting only
the net sales of P74 million. As general rule, these offsetting examples are not allowed. (PAS 1,
par. 32) However, some Standards may allow offsetting, such as the following: (PAS 1, par. 34)
•
Gains and losses on disposal of non-current assets, including investments and
operating assets, are reported by deducting from the proceeds on disposal the carrying
amount of the asset and related selling expense. For example, an old equipment with a
carrying amount of P250,000 was sold for P300,000 with related disposal costs of
P20,000. The carrying amount of P250,000 is deducted from the proceeds from
disposal of P280,000 and a gain of P30,000 is reported in the statement of
comprehensive income.
Chapter 11 – Financial Reporting and Analysis
•
•
Gains and losses from a group of similar transactions are reported on a net basis, for
example, foreign exchange gains and losses or gains and losses arising on financial
instruments held for trading.
Consistency of presentation. To aid comparability of financial statements of one period with
other periods (inter comparability) or of one entity with other entities (inter comparability), the
presentation and classification of financial statements shall be retained from one period to the
next unless:
•
it is apparent, following a significant change in the nature of the entity's operations or
a review of its financial statements, that another presentation or classification would
be more appropriate having regard to the criteria set for the selection and application
of accounting policies in PAS 8; or
•
a Standard or Interpretation requires a change in presentation.
An entity changes the presentation of financial statements only if the changed presentation
provides information that is reliable and is more relevant to users of the financial statements and
the revised structure is likely to continue, so that comparability is not impaired. (PAS 1, par. 45)
Comparative information. Comparative information shall be disclosed in respect of the
previous period for all amounts reported in the financial statements. Comparative information
shall be included for narrative and descriptive information when it is relevant to an
understanding of the current period's financial statements. As a minimum requirement, financial
statements for two dates or two periods must be presented for Comparative purposes.
If adjustments to prior periods have been made as a result of a change in accounting policy or of
correction of errors, a statement of financial conditions as of the beginning of the period should
be presented. (PAS 1, par. 38)
The statement of financial position has the following three primary elements:
•
assets;
•
liabilities; and
•
equity
These three elements are discussed in details in the succeeding paragraphs.
ASSETS
Definition and characteristics. Assets are defined in the Conceptual Framework for Financial
Reporting, paragraph 4.4, as resources controlled by the entity as a result of past events and from
which future economic benefits are expected to flow to the entity.
An asset has the following characteristics:
•
It is controlled by an entity – the entity has the right to obtain and control the benefits
expected from the use of the asset. In determining the existence of an asset, the right of
ownership of an asset is not essential. For instance, in the case of finance lease, the
property is owned by the lessor but is reported as an asset by the lessee.
•
It is a result of past event – the asset arises from transaction which occurred in the
past.
•
It represents future economic benefits – the asset has the potential to contribute,
directly or indirectly, to the flow of cash and cash equivalents to the entity. Paragraph
4.10 of the Framework states that the economic benefits may flow to the entity in
various ways, as follows:
•
the asset may be used singly or in combination with other assets in the
production of goods or services to be sold by the entity
•
the asset may be exchanged for other assets
•
the asset may used to settle a liability
•
the asset may be distributed to the owners of the entity.
•
It has a cost or value – the asset has a cost or a value that is measured in terms of
money.
STATEMENT OF FINANCIAL POSITION (BALANCE SHEET)
The objective of the statement of financial position is to report financial condition or position of
an entity at a particular date. It shows the entity's assets, liabilities, and equity at a point of time.
The statement of financial position is very useful to the financial statement users. It describes the
resources of the entity that are available sources of future cash flows, such as short-term
investments, receivables and inventories. It contains information that is useful in assessing the
liquidity and solvency of an entity. Liquidity is the entity’s ability to pay its obligations or
liabilities which are currently due. Solvency is the entity's ability to pay both its current and
noncurrent obligations. However, the statement of financial position has certain limitations as
follows:
•
There is no consistency as to the basis of measurement - some assets are reported at
historical cost while other assets are reported at fair value. For example, property, plant
and equipment may be reported at historical cost while long-term investments and
investment property are reported at fair value.
126 | P a g e
There are some company assets which are not reported on the balance sheet - these
include employees of an entity, self-generated intangible assets such as mastheads and
brand names (PAS 38 Intangible Assets).
Recognition. An asset is recognized when
•
it is probable that the future economic benefits will flow to the entity; and
•
the asset has a cost or value that can be measured reliable.
Chapter 11 – Financial Reporting and Analysis
Classification. Assets are classified or grouped according to common characteristics, such as
operating and non-operating assets, financial and non-financial assets and current and
noncurrent assets. The most dominant form of distinction is the current versus the non-current
classification of both assets and liabilities.
•
Trade notes and accounts receivables. Trade receivables are those arising from sale
of goods or services. These receivables are always reported as current assets because
they are expected to be realized in cash within one year or within the normal operating
cycle. Accounts receivable are unsecured open accounts and are usually due in 30 to 60
days, depending on the credit terms offered to customers. Notes receivable are
evidenced by written promise to pay a certain amount of money at a certain date.
•
Nontrade notes and accounts receivable. These are receivables arising from sources
other than sale of goods or services, such as share subscription receivable, interest
receivable, deposit with supplier for future delivery of goods. Nontrade notes and
accounts receivable are reported as current assets if they are due within one year.
•
Inventories. Inventories are assets: (a) held for sale in the ordinary course of business;
(b) in the process of production for such sale; or (c) in the form of materials or supplies
to be consumed in the production process or in the rendering of services. In a
merchandising company, its inventory includes merchandise acquired for sale. In a
manufacturing company, its inventories include finished goods, work in progress, and
raw materials. In a service company, its inventory includes work in progress. If the
company’s inventories include biological assets, they are reported as a separate line
item.
•
Prepaid expense. Prepaid expenses are expenses obtained or paid in advance, such as
office and store supplies, prepaid insurance and prepaid rent. However, if the
prepayment covers a period of more than one year, a portion of the prepayment is
noncurrent asset. For instance, if an entity paid rent three years in advance the
prepayment for the next two years is reported as non-current asset.
Current assets. PAS 1, paragraph 66 states that an asset shall be classified as current when it
satisfies any of the following criteria:
•
•
•
it is expected to be realized in, or is intended for sale or consumption in, the entity's
normal operating cycle (e.g. trade receivables, inventories and prepaid expenses);
it is held primarily for the purpose of trading (e.g. trading securities);
it is expected to be realized within twelve months after reporting period (e.g. non trade
receivables collectible within one year); or it is cash or a cash equivalent (as defined in
PAS 7 Statement of Cash Flows) unless it is restricted from being exchanged or used to
settle a liability for at least twelve months after the balance sheet date (e.g. cash on hand
and in bank, certificates of time deposits with a term of three months or less).
The normal operating cycle of an entity refers to the period of time necessary to convert cash to
inventories, inventories to receivables, and receivables back to cash. In the case of a
manufacturing company, it refers to the period of time necessary to convert cash to and raw
materials, raw materials to finished product, finished product to receivables, and receivables
back to cash. This period can be equal to, shorter than, or longer than one year. When the normal
operating cycle of an entity is not clearly identifiable, it is assumed to be twelve (12) months or
one year.
Current assets normally include the following:
•
Cash and cash equivalents. Cash is anything that can be used as a medium of exchange
and which is acceptable by bank at face value upon deposit. Cash includes cash on hand
and in banks that is available for current operations. Cash may be in the form of bills
and coins, personal checks, manager's checks, cashier's checks, bank drafts, and money
orders. Cash on hand includes undeposited collections, petty cash fund and change
fund. Cash in bank includes cash in savings and checking accounts.
Cash equivalents are short-term, highly liquid investments that are readily convertible
to known amounts of cash and which are subject to an insignificant risk of changes in
value. Normally, an investment qualifies as cash equivalent when it matures in three
months or less from the date of acquisition. An example of cash equivalent is time
deposit with a term of three months or less.
•
Short-term investments. These are liquid investments that do not qualify as cash
equivalents, such as time deposit with a term of more than three months and
investment in equity or debt securities intended to be disposed within twelve (12)
months.
127 | P a g e
Non-current assets. PAS 1 states that all assets that do not qualify as current assets are noncurrent assets. Non-current assets include long-term investments, property, plant and
equipment, intangible assets, and investment property.
•
Long-term investments. Long-term investments include investment in equity and debt
securities of other corporations, land held for speculation, and cash set aside for special
purposes (such as bond sinking fund). These assets are classified as non-current
because management does not intend to convert them into cash within one year.
•
Properly, plant, and equipment. Property, plant and equipment defined in PAS 16, par.
6 as tangible items that are: (a) held for use in production or supply of goods or services
or for administrative purposes; and (b) are expected to be used during more than one
period. Examples of assets under this classification are land, buildings, store and office
equipment, delivery equipment, and machinery.
•
Intangible assets. Intangible assets are defined in PAS 38, par. 8 as identifiable nonmonetary assets without physical substance. Intangible assets include copyright,
franchise, and patents. A copyright is a right granted to an author or an artist for the
Chapter 11 – Financial Reporting and Analysis
•
exclusive publication of a book or work of art. A franchise is a right granted to an entity
to operate a specific type of business using a particular trade name. A patent is a right
granted to inventor for the exclusive use of a formula.
•
•
Investment property. Investment property is defined in PAS 40, par 5 as or both) hold
(by the property (land or a buildings - or part pf a building - or both) held (by the owner
or by the lessee under a finance lease) to earn rentals or for capital appreciation or both,
rather than for:
•
use in the production or supply of goods or services or for administrative
purposes; or
•
sale in the ordinary course of business.
Recognition. A liability is recognized in the balance sheet
•
when it is probable that an outflow of resources embodying economic benefits will
result from the settlement of a present obligation; and
•
the amount at which the settlement will take place can be measured reliably.
An example of investment property is a building that is being leased to others in
exchange for a fair rental.
Classification. Liabilities be classified as financial and non-financial liabilities or current and
non-current. Financial liabilities include notes and accounts payable.
Other non-current assets. These are assets that do not fall under any of the above
classification. Other non-current assets include deferred tax assets and other long-term
prepaid expenses.
Current Liabilities. According to paragraph 69 of PAS 1, a liability shall be classified as current
when it satisfies any of the following criteria:
•
it is expected to be settled in the entity’s normal operating cycle
•
it is held primarily for the purpose of trading:
•
it is due to be settles within twelve months after the reporting period; or
•
the entity does not have an unconditional right to defer settlement of the liability for
at least twelve months after the reporting period.
LIABILITIES
Definition and Characteristics. Liabilities are defined in the Conceptual Framework for
Financial Reporting, par. 4.4 as present obligations of an entity arising from past events, the
settlement of which is expected to result in an outflow from the entity of resources embodying
economic benefits.
An obligation is a duty or responsibility to act or perform in a certain way. Such obligation may
be legally enforceable as a consequence of a binding contract or statutory requirement, such as
amounts payable for goods and services received. Obligation may also arise from normal
business practice, custom and a desire to maintain good business relations or act in an equitable
manner, such as obligation for product warranty.
A liability has the following characteristics:
•
It is a present obligation. The obligation is a present obligation that arises only when
an asset acquired is delivered or an entity enters into an irrevocable agreement to
acquire an asset. A liability does not arise from a future commitment, such as decision
by management to acquire asset in the future.
•
It is expected to be settled by giving up resources embodying economic benefits in
order to satisfy the claim of the other party. The settlement of a present obligation
may occur in any of the following ways:
•
payment of cash;
•
transfer of other assets;
•
provision of services;
•
replacement of that obligation with another obligation; or
•
conversion of the obligation into equity
It is a result of a past activity. A liability is a result of a transaction that has taken place,
such as purchase of goods on account. As stated earlier, it does not arise from a future
commitment.
128 | P a g e
Current liabilities normally include the following:
•
Trade notes and accounts payable. Trade payable are those arising from purchase of
goods and services on account. Notes payable are written promises to pay cash at some
future date. Accounts payable are obligations to suppliers of goods or services
purchased on open account.
•
Nontrade notes and accounts payable. These are payables arising form sources other
than purchase of goods and services, such as short-term borrowings from banks and
customers’ accounts with debit balances.
•
Unearned revenues. Unearned revenues represent cash received for goods or services
to be provided in a future period, such as rent received six months in advance and
subscription for magazines or books received one year in advance.
•
Accrued liabilities. Accrued liabilities represent obligation for expenses already
incurred but will not be paid until the subsequent accounting period. Examples of
accrued liabilities are taxes payable, salaries payable, and interest payable.
•
Currently maturing portion of long-term debt. This is the portion of a long-term debt
that is maturing within the next twelve months from the balance sheet date.
Chapter 11 – Financial Reporting and Analysis
Non-current liabilities. PAS 1 states that all liabilities that do not qualify as current are classified
as non-current. Noncurrent liabilities include long-term notes, bonds payable, mortgage payable
and deferred income tax liability. The payment terms, interest rates, and other details that enable
readers of financial statements evaluate the impact of the non-current liabilities on future cash
flows are disclosed in the notes.
EQUITY
Definition. Equity is defined in the Conceptual Framework for Financial Reporting as the
residual interest in the assets of the entity after deducting all its liabilities. The equity of an entity
is composed of the cumulative amount of investments and profit from operations, less any
withdrawals or distribution of dividends and losses form operations.
Components. The components of the equity section of the statement of financial position
depends on the type of business organization. In a single proprietorship and partnership, the
equity section shows the capital account of the owner and the partners, respectively. The capital
account balance represents the cumulative amount of investments and profit, less withdrawals
and losses form operations.
In a corporation, the equity section of the statement of financial position is called Shareholders’
Equity or Stockholders’ Equity. The shareholders; equity is generally composed of Contributed
Capital and Retained Earnings. In some instances, a corporation may have capital maintenance
adjustments accounts such as revaluation surplus and net unrealized gain or loss on long term
investments that are shown separately in the equity section. These two components of the
corporate equity were mentioned in Chapter 9 of this book.
PAS 1 does not specify a specific format or arrangement of the three elements when presented
in the statement of financial position. However, in the Philippines, the common practice is to
present these elements as follows: current assets followed by non-current assets; current
liabilities followed by non-current liabilities; and equity accounts after liabilities. A different
arrangement may be followed by an entity depending on its nature of business.
INFORMATION TO BE PRESENTED ON THE FACE OF THE STATEMENT OF FINANCIAL
OPSITION (BALANCE SHEET) OR IN THE NOTES
Pas 1, PAR 54, prescribes that as a minimum, the face of the statement of financial position
(balance sheet) shall include line items that present the following amounts:
a.
b.
c.
d.
e.
property, plant and equipment;
investment property;
intangible assets;
financial assets (excluding amounts shown under (e), (h), and (i);
investments accounted for using the equity method;
129 | P a g e
f.
g.
h.
i.
j.
biological asses;
inventories;
trade and other receivables;
cash and cash equivalents;
the total assets classified as held for sale and assets included in disposal groups
classifies s held for sale;
k. trade and other payables;
l.
provisions;
m. financial liabilities (excluding amounts shown under (j) and (k);
n. liabilities and assets for current tax, as defined in PAS 12 Income Taxes;
o. deferred tax liabilities and deferred tax assets as defined in PAS 12;
p. non-controlling interests, presented within equity; and
q. issued capital and reserves attributable to owners of the parent
An entity shall disclose, either on the face of the statement of financial position (balance sheet)
or in the notes, further subclassification of the line items presented, classifies in a manner
appropriate to the entity’s operations. The details provided in the subclassification may depend
on the requirements of the PFRSs and on the size, nature, and function of the amounts involved.
Some examples follow:
•
•
•
•
•
items of property, plant and equipment are disaggregated into classes, such as land,
buildings and equipment;
receivables are disaggregated into amounts receivable from trade customers,
receivables from related parties, prepayments and other amounts,
inventories are subclassified such as merchandise inventory or finished goods
inventory, work in process inventory, and raw materials inventory;
provisions are disaggregated into provisions for employee benefits and other items;
and
equity capital and reserves are disaggregated into various classes, such as contributed
capital and additional paid-in capital
Form of the Statement of Financial Position (Balance Sheet). The statement of financial
position may be prepared using the report form or the account form. Under the report form, the
elements of the balance sheet are presented similar to a presentation of report. The statement
starts with the Assets, followed by the Liabilities and then the Capital of the owner or the capital
of the partners or the shareholders’ equity in a corporate form of organization. Under the account
form, the Assets are presented on the left side of the statement while the Liabilities and Equity
are presented on the right side of the statement. The account from is normally used when an
entity maintains a great number of balance sheet accounts. Figures 11.2 and 11.2 show proforma balance sheet using the two forms discussed above.
Chapter 11 – Financial Reporting and Analysis
Assets
ABC Company
Statement of Financial Position
December 31, 20XX
Current assets:
Cash
Short-term investments
Notes and accounts receivable
Pxxx
Less Allowance for uncollectibles
xxx
Other receivables
Inventories
Prepaid expenses
Total current assets
Long-term investments:
Investment in equity securities
Pxxx
Investment in funds
xxx
Property, plant and equipment:
Land
Pxxx
Buildings (net of acc. depreciation)
xxx
Equipment (net of acc. depreciation) xxx
Biological assets
Intangible assets:
Patent
Pxxx
Franchise
xxx
Investment property
Other assets:
Deferred tax assets
Total assets
Pxxx
xxx
xxx
xxx
xxx
xxx
Pxxx
xxx
xxx
xxx
Liabilities
Current liabilities:
Notes payable
Accounts payable
Short-term bank loan
Income tax payable
Accrued liabilities
Unearned revenue
Current portion of long-term debt
Total current liabilities
Non-current liabilities
Notes payable
Mortgage payable
Bonds payable, net of discount
Deferred tax liability
Pxxx
xxx
xxx
xxx
xxx
xxx
xxx
Pxxx
Pxxx
xxx
xxx
xxx
xxx
Pxxx
xxx
xxx
Pxxx
Total liabilities and shareholders’ equity
Pxxx
Figure 11.1 Pro-form Statement of Financial Position – Account Form
ABC Company
Statement of Financial Position
December 31, 20xxx
Assets
Current assets:
Cash
Short-term investments
Notes and accounts receivable
Less Allowance for uncollectibles
Other receivables
Inventories
Prepaid expenses
Total current assets
Long-term investments:
130 | P a g e
Pxxx
xxx
P xxx
xxx
Pxxx
xxx
Pxxx
xxx
xxx
xxx
Pxxx
xxx
xxx
xxx
xxx
Pxxx
Liabilities
Shareholders’ Equity
Contributed capital:
Share capital
Pxxx
Additional paid-in capital
xxx
Total contributed capital
Pxxx
Retained earnings
xxx
Total shareholders’ equity
xxx
xxx
Investment in equity securities
Investment in funds
Property, plant and equipment:
Land
Buildings (net of acc. depreciation)
Equipment (net of acc. depreciation)
Biological assets
Intangible assets:
Patent
Franchise
Investment property
Other assets:
Deferred tax assets
Total assets
xxx
xxx
xxx
xxx
Pxxx
Current liabilities:
Notes payable
Accounts payable
Short-term bank loan
Income tax payable
Accrued liabilities
Unearned revenue
Current portion of long-term debt
Total current liabilities
Non-current liabilities:
Notes payable
Mortgage payable
Bonds payable, net of discount
Deferred tax liability
Total liabilities
Shareholders’ Equity
Contributed capital:
Share capital
Additional paid-in capital
Total contributed capital
Retained earnings
Total shareholders’ equity
Total liabilities and shareholders’ equity
Figure 11.2 Pro-forma Statement of Financial Position – Report Form
Pxxx
xxx
xxx
xxx
xxx
xxx
xxx
Pxxx
Pxxx
xxx
xxx
xxx
xxx
Pxxx
Pxxx
xxx
Pxxx
xxx
xxx
Pxxx
Chapter 11 – Financial Reporting and Analysis
INCOME STATEMENT
The income statement shows the performance of an entity at a given period of time. The
statement reports the income earned and the expenses incurred at a particular period of time.
The objective of the statement of income statement is to provide information about the
performance of an entity that is useful to a wide range of users in making economic decisions.
The measure of performance is the profit or loss of an entity.
The income statement has two elements: income and expenses.
INCOME
Definition. Income is defined in paragraph 4.25 of the FRSC Conceptual Framework for
Financial Reporting as increases in economic benefits during the accounting period in the form
of inflows or enhancements of assets or decreases of liabilities that result in increases in equity
participants refer to the investments by owners of the entity. Such investments should not be
considered income of the entity.
Income encompasses both revenue and gains. Revenue arises in the course of the ordinary
activities of an entity and is referred to by a variety of different names including sales, fees,
interest, dividends, royalties and rent. Gains are increases in economic benefits arising from
peripheral or incidental activities, such as those arising from sale of plant assets and sale of
investments. Gains are generally reported net of related expenses. For example, the gain on sale
of equipment is the amount remaining after deducting the carrying amount and other disposal
costs from selling price of the asset.
refer to withdrawals by the sole proprietor/partners or distribution of dividends to the
shareholders. Such distributions are not considered expenses of the entity.
Expenses encompass both losses and expenses that arise in the course of the ordinary activities
of the entity, such as cost of sales, wages, depreciation, supplies, and utilities. Losses represent
other items that meet the definition of expenses and may, may or not, arise in the course of the
ordinary activities of the entity. Losses include those resulting from disasters such as fire and
flood, and those arising from disposal of non-current assets. Losses are normally reported bet of
related income.
Expenses also include unrealized losses, such as those arising from the effects of increases or
decreases in the foreign exchange rate in respect of borrowings of an entity in that currency.
Recognition. Paragraph 4.49 of the FRSC Conceptual Framework states that expenses are
recognized in the income statement when a decrease in future economic benefits related to a
decrease in an asset or an increase of a liability has arisen that can be measured reliably.
Therefore, the recognition of expenses occurs simultaneously with the recognition of an increase
in liabilities or a decrease in assets.
Expenses are recognized under one of the following expense recognition principles:
•
Direct matching (associating cause and effect). When costs can be associated with
revenue, such costs are charged to expense in the period in which the related revenue
is recognized. Examples are cost of goods sold, sales commission expense and warranty
expense.
•
Systematic and rational allocation. When costs cannot be associated with revenue
but can be associated with future periods, such costs are charged to expense over the
periods benefited. Examples are depreciation of plant assets, amortization of intangible
assets, and allocation of insurance premium over the covered period.
•
Immediate recognition. When an expenditure produces no future economic benefits
or when, and to the extent that, future economic benefits do not qualify, or cease to
qualify, for recognition in the balance sheet as an asset, such expenditure is recognized
immediately as an expense. Examples are repairs and maintenance and advertising
expense.
Income also includes unrealized gains, such as those arising from revaluation of marketable
securities and those arising from increases in the carrying amount of long-term assets.
Recognition. According to paragraph 4.47 of the FRSC Conceptual Framework, income is
recognized in the income statement when an increase in future economic benefits related to an
increase in an asset or a decrease of a liability has arisen that can be measured reliably.
Therefore, the recognition of income occurs simultaneously with the recognition of increases in
assets or decreases in liabilities. PAS 18 Revenue provides a more specific concepts on the
recognition of income arising from various transaction.
EXPENSES
Definition. Paragraph 4.25 of the FRSC Conceptual Framework for Financial Reporting
defines expenses as decreases in economic benefits during the accounting period in the form of
outflows or depletions of assets or incurrences of liability that result in decreases in equity, other
than those relating to distributions to equity participants. Distributions to equity participants
131 | P a g e
Chapter 11 – Financial Reporting and Analysis
Figure 11.3 and 11.4 show pro-forma income statement using two methods.
INFORMATION TO BE PRESENTED ON THE FACE OF THE STATEMENT OF COMPREHENSIVE
INCOME STATEMENT
ABC Company
Income Statement
For the Year Ended December 31, 20xx
PAS 1, par. 82, states that as a minimum, the face of the income statement shall include line items
that present the following amounts for the period:
a. revenue;
aa. gains and losses arising from the derecognition of financial assets measured at
amortized cost;
b. finance cost;
c. share of the profit or loss of associates and joint ventures accounted for using the equity
method;
ca. If a financial asset is classified so that it is measures at fair value, any gain or loss arising
from a difference between the previous carrying amount and its fair value at the
reclassification date (as defined in PFRS 9);
d. tax expense;
e. a single amount comprising the total of
i.
the post-tax profit of discontinued operations and
ii.
the post-tax gain or loss recognized on the measurement to fair value less costs to
sell or on the disposal of the assets, or disposal group(s) constituting the
discontinued operations;
f. profit or loss;
g. each component of other comprehensive income classified by nature (excluding
amounts in h;
h. share of other comprehensive income of associates and joint ventures accounted for
using the equity method; and
i.
total comprehensive income
If an entity prepares a separate income statement, only items a to f will be presented in the
statement; items g to I will be presented in the separate statement of comprehensive income.
Classification of expenses in the income statement. PAS 1 states that an entity may present
an analysis of its expenses using the nature of expense method or the functional method.
Nature of expense method. Under this method, expenses are aggregated in the income
statement according to their nature and are not reallocated among various functions within the
entity. Examples of groupings of expenses under this method are: depreciation, purchases of raw
materials, employee costs, and advertising costs.
Function of expense or cost of sales method. Under this method, expenses are classified
according to their function as part of cost of sales, costs of distribution (selling expenses), or
administrative activities (general or administrative expenses). This method can provide more
relevant information to users than the nature of expense method.
Revenue
Other income
Increase (decrease) in merchandise inventory
Net purchases of merchandise
Employee benefit expense
Depreciation expense
Amortization expense
Supplies expense
Utilities expense
Other expense
Finance costs (interest expense)
Share of profit of associate
Profit before tax
Income tax expense
(xxx)
Profit for the period
Pxxx
Figure 11.3 Pro-forma Income Statement – Nature of Expense Method
ABC Company
Income Statement
For the Year Ended December 31, 20xx
Revenue
Cost of sales:
Inventory, beginning
Net purchases
Cost of goods available for sale
Less Inventory, end
Gross profit
Other income
Distribution costs (selling expenses)
Administrative expenses
Other expenses
Finance costs (interest expense)
Share of profit of associates
Profit before tax
Income tax expense
Profit for the period
Figure 11.4 Pro-forma Income Statement – Function of Expense Method
132 | P a g e
Pxxx
xxx
(xxx)
(xxx)
(xxx)
(xxx)
(xxx)
(xxx)
(xxx)
(xxx)
(xxx)
xxx
Pxxx
Pxxx
Pxxx
xxx
Pxxx
xxx
xxx
Pxxx
xxx
(xxx)
(xxx)
(xxx)
(xxx)
xxx
Pxxx
(xxx)
Pxxx
Chapter 11 – Financial Reporting and Analysis
Notes:
•
•
•
•
The revenue section represents from the major activity of the entity, that is, sale of
goods for merchandising or trading company and sale of service for a service company.
Other income includes interest income and gain from sale of assets other than
inventories, such as gain from sale of investment.
Other expenses include loss from sale of assets other than inventories, such as loss from
sale of equipment.
The share of profit of associates is the share of the entity in the reported profit of an
investee company called associate. Accounting for investment in associate is a topic to
be discussed in financial accounting.
STATEMENT OF COMPREHENSIVE INCOME
The statement of comprehensive income reports items of income and expenses which are not
required by other PASs and PRFs to be recognized in profit or loss. Examples are changes in
revaluation surplus when property, plant and equipment are reported using the revaluation
model and gains and losses arising from changes in fair value of available-for-sale securities.
The following information is required to be presented in the statement of comprehensive income
reported separately form the income statement:
•
•
•
•
•
profit or loss shown in the income statement;
share of other comprehensive income of associates and joint ventures accounted for
using the equity method;
each components of other com prehensive income classified by nature;
total comprehensive income; and
the total comprehensive income attributable to non-controlling interest and that
attributable to owners of the parent.
PAS 1 permits the presentation of comprehensive income in a single statement of comprehensive
income 9combined income statement and statement of comprehensive income).
STATEMENT OF CHANGES IN EQUITY
PAS 1, par. 106, requires an entity to present a statement of changes in equity that should include
the following:
•
•
•
total comprehensive income for the period, showing separately the amount due to
owners of the parent and to non-controlling interest;
for each component of equity, the effect of retrospective application or retrospective
restatement recognized in accordance with PAS 8; and
for each component of equity, a reconciliation of the carrying amount at the beginning
and at the end of the period, separately disclosing changes resulting from:
133 | P a g e
•
•
•
profit or loss;
other comprehensive income; and
transactions with owners in their capacity as owners, showing separately
contributions by and distributions to owners and changes in ownership
interests in subsidiaries that do not result in a loss of control.
The preparation of the statement is also discussed in Chapter 9 of this book.
STATEMENT OF CASH FLOWS
The statement of cash flows is one of the basic components of a complete set of financial
statements. The objective of the statement of cash flows is to provide information about the cash
receipts and cash disbursements of an entity that occurred during a period. The statement
summarizes the transactions that caused a change in the cash balance during a reporting period.
A cash flow statement provides the following benefits as stated in PAS 7, par. 4:
•
•
•
it provides information that enables the users to evaluate the changes in the assets of
an entity, its financial structure and its ability to affect the amounts and timing of cash
flows in order to adapt to changing circumstances and opportunities;
it provides information that is useful in assessing the ability of the entity to generate
cash and cash equivalents and enable users to develop models to assess and compare
the present value of the future cash flows of different entities;
it enhances the comparability of the reporting of operating performance by different
entities because it eliminates the effects of using different accounting treatments for
the same transactions and events.
CLASSIFICATION OF CASH FLOWS
Cash flows are classified to make the statement more meaningful to the investors and creditors
by enabling them to determine the type of transaction that gave rise to each cash flow. Cash flows
are categorized into three: (a) operating activities; (b) investing activities; and (c) financing
activities.
Operating activities. Cash flows from operating activities are derived from the principal
revenue-producing activities of an entity. They represent the cash inflows and outflows of cash
that resulted from activities reports in the income statement. Thus, this classification of cash
flows includes the elements of income statement reported on a cash basis rather than an accrual
basis. Fir instance, cash flows form sales show the amount of cash received from customers
during the period from sales that were made in prior or current period od for future sales.
Chapter 11 – Financial Reporting and Analysis
Cash received from (cash inflow)
•
customers for sale of goods and services
•
royalties, fees, commissions
•
interest on loans receivable
•
dividends from investment
•
Cash paid for (cash outflow)
•
purchase of inventory
•
salaries and wages
•
interest on loans payable
•
income taxes
Table 11.1 – Sample transactions or activities giving rise to cash flows from operating activities.
Investing activities. Cash flows from investing activities include cash inflows and outflows of
cash related to the acquisition and disposition of long-term assets used in the operations of the
business and investment assets.
Cash received from (cash inflow)
•
sale of long-term investment
•
sale of plant assets
•
repayment of loans made to others
Cash paid for (cash outflow)
•
purchase of long-term investments
•
purchase of plant assets
•
loans to identified employees
Table 11.2 – Sample transactions or activities giving rise to cash flows from investing activities
Financing activities - Cash flows from financing activities include cash inflows from borrowings
and contributions by investors and cash outflows for repayment of loans, retirement of share
capital, acquisition of treasury shares and payment of cash dividends.
Cash received from (cash inflow)
•
bank loan
•
issuance of share capital
•
reissuance of treasury shares
Cash paid for (cash outflow)
•
payment of bank loan
•
retirement of share capital
•
acquisition of treasury shares
•
dividends
Table 11.3 – Sample transactions or activities giving rise to cash flows from financing activities
Methods of presenting cash flows from operating activities. There are two methods of
presenting the cash flows from operating activities: the direct method and the indirect method.
Direct method. Under the direct method, the major classes of gross receipts and gross cash
payments are disclosed in the statement. The information about these major classes may be
obtained either:
•
from the accounting records of the entity; or
•
by adjusting sales, cost of sales (interest and similar income and interest expense and
similar charges for a financial institution) and other items in the income statement for:
•
•
changes during the period in inventories and operating receivables and
payables;
other non-cash items; and
other items for which cash effects are investing and financing cash flows
Indirect method. Under the indirect method, the met cash flow from operating activities is
determined by adjusting profit or loss for the effects of;
•
•
•
changes during the period in inventories and operating receivables and payables;
non-cash items such as depreciation, provisions, deferred taxes, and unrealized foreign
currency gains and losses; and
all other items for which the cash effects are investing or financing cash flows.
ABC Company
Statement of Cash Flows
For the Year Ended December 31, 20xx
Cash flow from operating activities:
Cash receipts from customers
Cash paid to suppliers
Cash paid to employees
Cash paid for various operating expenses
Cash generated from operations
Interest paid
Income taxes paid
Net cash flow from operating activities
Cash flows from investing activities:
Collection for note receivable
Proceeds from sale of equipment
Proceeds from sale of long-term investment
Purchase of property, plant, and equipment
Loans made to employees
Net cash flows from investing activities
Cash flows from financing activities:
Proceeds of bank loan
Proceeds from issuance of share capital
Repayment of bank loan
Purchase of treasury shares
Payment of dividends
Net cash flows from financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at the beginning of the period
Cash and cash equivalents at the end of the period
Figure 11.5 Pro-forma Statement of Cash Flow – Direct method
134 | P a g e
Pxxx
(xxx)
(xxx)
(xxx)
Pxxx
(xxx)
(xxx)
Pxxx
Pxxx
xxx
xxx
(xxx)
(xxx)
xxx
Pxxx
xxx
(xxx)
(xxx)
(xxx)
(xxx)
Pxxx
xxx
Pxxx
Chapter 11 – Financial Reporting and Analysis
Illustrative Problem A
ABC Company
Statement of Cash Flows
For the Year Ended December 31, 200x
Cash flows from operating activities:
Profits before taxes
Adjustments for:
Depreciation
Investment income
Interest expense
Operating income before working capital changes
Increase in trade receivables
Decrease in inventories
Decrease in prepaid expenses
Increase in accrued revenue
Increase in trade payables
Increase in unearned revenue
Decrease in accrued expenses
Cash generated from operations
Interest paid
Income taxes paid
Net cash received (paid) from operating activities
Cash flows from investing activities:
Collection for note receivable
Proceeds from sale of equipment
Proceeds from sale of long-term investment
Purchase of property, plant and equipment
Loans made to employees
Net cash flows from investing activities
Cash flows from financing activities
Proceeds of bank loan
Proceeds from issuance of share capital
Repayment of bank loan
Purchase of treasury shares
Payment of dividends
Net cash flows from financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at the beginning of the period
Cash and cash equivalents at the end of the period
Figure 11.5 Pro-forma Statement of Cash Flow – Indirect method
135 | P a g e
ABC Company reported the following cash receipts and cash payments
for the year 2014:
Cash receipts:
Proceeds from sale of equipment
Proceeds of bank loan
Collection from customers
Proceeds from issuance purchases
Cash payments:
To suppliers for merchandise purchases
For purchase of machinery
For interest
For bank loan
For dividends
For income taxes
For operating expenses
Pxxx
xxx
(xxx)
xxx
Pxxx
(xxx)
xxx
xxx
(xxx)
xxx
xxx
(xxx)
Pxxx
(xxx)
(xxx)
P 80,000
200,000
600,000
60,000
390,000
97,500
22,500
50,000
39,000
66,000
100,000
The cash and cash equivalent balance at the beginning of the year is
P120,000.
A statement of cash flow using the direct method is shown below
Pxxx
Pxxx
xxx
xxx
(xxx)
(xxx)
xxx
Pxxx
xxx
(xxx)
(xxx)
(xxx)
(xxx)
Pxxx
xxx
Pxxx
ABC Company
Statement of Cash Flow
For the Year Ended December 31, 2014
Cash flows from operating activities:
Cash received from customers
P600,000
Cash paid to suppliers for merchandise purchases
(390,000)
Cash paid for operating expenses
(100,000)
Cash generated from operations
P110,000
Interest paid
(22,500)
Income taxes paid
(66,000)
Net cash received from operating activities
Cash flows from investing activities:
Proceeds from sale of equipment
P 80,000
Cash paid to purchase of machinery
(97,500)
Net cash received from (used in) investing activities
Cash flows from financing activities:
Proceeds from issuance of share capital
P 60,000
Proceeds of bank loan
200,000
Cash paid for dividends
(39,000)
Net cash received from (used in) financing activities
Net increase in cash and cash equivalent
Cash and cash equivalent, January 1, 2014
Cash and cash equivalent, December 31, 2014
P 21,500
(17,500)
221,000
P225,000
120,000
P345,000
Chapter 11 – Financial Reporting and Analysis
ABC Company
Statement of Cash Flow
For the Year Ended December 31, 2014
Illustrative Problem B
ABC Company provides the following income statement for the year 2014:
Sales
Cost of sales
Gross profit
Depreciation expense
Salaries expense
Other operating expenses
Interest expense
Profit before taxes
Income taxes
Profit
Cash flows from operating activities:
Profit before taxes
Add (deduct):
Depreciation expense
Interest expense
Operating income before working capital changes
Increase in accounts receivable
Decrease in inventory
Increase in prepaid other expense
Increase in accounts payable
Cash generated from operations
Interest paid
Income taxes paid
Net cash provided by (used in) operating activities
Cash flows from investing activities:
Proceeds from sale of equipment
Collection of loans receivable
Purchase of equipment
Net cash received from (used in) investing activities
Cash flows from financing activities:
Proceeds from issuance of share capital
Repayment of bank loan
Payment of dividend
Net cash received from (used in) financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents, January 1, 2014
Cash and cash equivalents, December 31, 2014
P4,180,000
2,275,000
P1,905,000
(190,000)
(600,000)
(437,500)
(61,000)
P 616,500
(184,950)
P 431,550
In addition, the following balance sheet information is available:
Accounts receivable
Inventory
Prepaid other expenses
Accounts payable
12.31.14
P275,000
310,000
27,000
245,000
Additional information:
•
Income taxes paid amounted to P60,000
•
Interest paid amounted to P62,500
•
Proceeds from sale of equipment at carrying value, P50,000
•
Cash paid to purchase an equipment, P75,000
•
Collection of loans receivable, P100,000
•
Proceeds from issuance of share capital, P80,000
•
Repayment of bank loan, P150,000
•
Payment of dividends, P50,000
•
Cash and cash equivalent, January 1, 2014, P350,000
12.31.13
P127,500
325,000
23,500
225,000
190,000
61,000
P682,550
(147,500)
15,000
(3,500)
20,000
P566,550
(62,500)
(60,000)
P444,050
P 50,000
100,000
(75,000)
P 75,000
P 80,000
(150,000)
(50,000)
(120,000)
P399,050
350,000
P749,050
Notes:
•
A statement of cash flow using the indirect method is presented on the next page.
P431,550
•
The cash and cash equivalent at December 31, 2014 is the amount that is reported in the
December 31, 2014 balance sheet,
The direct and the indirect methods differ only in the presentation of the cash flows from
operating activities section; the investing and financing activities sections are presented
similarly under the two methods.
A more in-depth analysis of transactions that should be presented in the statement of cash flows
is discussed in intermediate accounting. In this chapter, the details of cash receipts and cash
payments are given for problem solving purposes.
136 | P a g e
Chapter 11 – Financial Reporting and Analysis
NOTES TO FINANCIAL STATEMENTS
Notes to financial statements include narrative descriptions or more detailed analyses of
amounts shown on the face of the financial statements. The notes include information required
and encourages to be disclosed by PASs and PFRSs and other disclosures necessary to achieve
fair presentation,
Notes are considered an integral part of the financial statements which contains the following
information:
•
the basis of preparation of the financial statements and the specific accounting policies
used;
•
Accounting policies are the specific principles, bases, conventions, rules and
practices applied by an entity in preparing and presenting financial
statements.
•
information required by PFRSs that is not presented elsewhere in the financial
statements; or
•
additional information that is not presented elsewhere in the financial statements, but
is relevant to an understanding of any of them.
Notes must present information in a systematic order and cross referenced to statement of
financial position, statement of comprehensive income (or income statement if presented
separately), statement of changes in equity and statement of cash flows. Following is the
recommended order of presentation of information in the notes stated in PAS 1, par.114:
•
statement of compliance with PFRS;
•
summary of significant accounting policies applied;
•
supporting information for items presented in the statement of financial position and
of comprehensive income (or in the income statement If presented separately), and
in the statement of changes in equity and of cash flows, in the order in which each
statement and each line items is presented; and
•
other disclosures, including:
•
contingent liabilities (PAS 37) and unrecognized contractual commitment;
and
•
non-financial disclosures, such as the entity’s financial risk management
objectives and policies (PFRS 7)
The following should also be disclosed by management:
•
Management judgements made in applying accounting policies with significant effects
on amounts recognized
•
Key assumptions concerning the future and key resources of estimation uncertainty
that have a significant risk of causing material adjustments to carrying amount of
assets and liabilities within the next financial year
137 | P a g e
Other required disclosures include:
•
Company information:
•
Domicile, legal form, country of incorporation, address
•
Description of nature operations and activities
•
Name of parent enterprise
•
Name of ultimate parent enterprise of the group
•
Amount of dividends proposed or declared before the financial statements were
authorized amount per share
•
Amount of any cumulative preference dividends not recognized
FINANCIAL STATEMENT ANALYSIS
Financial statements provide information into the entity’s current status and lead to the
development of policies and strategies for the future.
RATIO ANALYSIS
Ratios express the mathematical relationships between on quantity and another, in terms of a
rate, a proportion or a percentage. For example, the ratio of gross profit to sales is 60% or the
ratio of current among selected financial statement data. Ratios are used to evaluate the
financial health and performance of a company. To make them more meaningful, however,
three types of comparisons may be made:
•
Intra company comparisons – comparing one period with another period, such as
comparing 2014 with 2013
•
Intercompany comparisons – comparing one company with another company or with
other companies in the same industry.
•
Industry average comparison – comparing an entity’s computed ratios with industry
standards.
Ratios can be grouped into the following; liquidity ratios, solvency ratios, and liquidity ratios.
Each of these is discussed below.
Liquidity ratios measures the short-term ability of the entity to pay its maturing obligations and
to meet unexpected needs for cash. The measures that can be used to determine the liquidity of
an entity are the current ratio, the quick, or acid-test ratio, the current cash debt coverage ratio,
the receivables turnover ratio, and the days in inventory.
Solvency ratios measure the ability of the entity to survive over a long period of time, that is, its
ability to pay interest as it come due and to repay the face value of obligations or debt at maturity.
The measures that can be used to determine the solvency of an entity are the debt at maturity.
The measures that can be used to determine the solvency of an entity are the debt to total assets
ratio, the time interest earned ratio, the cash debt coverage ratio and free cash flow.
Chapter 11 – Financial Reporting and Analysis
Profitability ratios measure the profit or operating success of an entity for a given period of
time. An entity’s ability or inability to generate profit has several consequences – it affects an
entity’s liquidity position and its ability to grow; hence, affecting its liability to obtain loans and
o attract investors. The measures that can be used to determine the profitability of an entity are
the return on ordinary shareholder’s equity ratio, the return on assets ratio, the profit margin
ratio, the asset turnover ratio, the earnings per share, the price-earnings ratio, and the payout
ratio.
Measures liquidity
receivables.
Receivable turnover
ratio
Net credit sales
Average trade receivables (net)
Measures the collection
efficiency of the entity.
A summary of these ratios, the formula to calculate them and their uses are presented below and
on the next pages.
Ratio
LIQUIDITY RATIOS
Formula
Purposes of the ratio
Average collection
period
365 days
Receivable turnover ratio
Measures short-term debt
paying ability.
Current ratio
Current assets
Current liabilities
The ratio expresses the
relationship of current assets
to current liabilities. It
presents the amount of
current assets available for
every peso current liability.
Cash, short term investment
and net receivables
Current liabilities
The ratio represents the
amount of quick assets
available for every peso of
current liability.
Measures an entity’s ability
to pay off its current
liabilities in a given year of
operations.
Current cash debit
coverage ratio
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Net cash provided by
operating activities
Average current liabilities
The ratio represents the
amount of cash available
from current operations for
every peso of current liability
The
computed
period
indicates
the
average
number of days before
receivables are collected.
Measures liquidity of
inventory
Inventory turnover
ratio
Cost of goods sold
Average inventory
The ratio measures the
number of times, on average,
inventory is sold during the
period.
Measures the sales efficiency
of the entity.
Measures immediate shortterm liquidity.
Quick or acid-test
ratio
The ratio measures the
number of times, on average,
receivables are collected
during the period.
Number of days in
inventory
365 days
Inventory turnover ratio
The computed number of
days indicates the length of
time spent before
inventories are sold to
customers.
Chapter 11 – Financial Reporting and Analysis
Ratio
SOLVENCY RATIOS
Formula
Purposes of the ratio
Ratio
PROFITABILITY RATIOS
Formula
Measures
total
assets
provided by creditors
Debt to total assets
Debt to equity ratio
Total liabilities
Total assets
Total liabilities
Total owner’s equity
The ratio indicates the
degree
of
financial
leveraging.
It
provides
indication of the ability of an
entity to survive losses
without
impairing
the
interest of its creditors.
Measures the percentage of
total liabilities to total equity
Cash debt to coverage
ratio
Net cash provided by
operating activities
Average total liabilities
Measures an entity’s ability
to repay its total liabilities in
a given year of operations
Times interest earned
Profit before interest
charges and taxes
Interest charges
Measures ability to meet
interest payments as they
come due
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Purposes of the ratio
Measures profit generated by
each peso of sales.
The amount of profit generated
by every peso of sales. It can
also be interpreted as the
percentage of profit generated
in relation to net sales.
Profit margin on sales
Profit
Net sales
Rate of return on
assets
Profit
Average total assets
Measures overall profitability of
assets
Earnings per share
Profit minus earnings attributed
to preference shares
Average outstanding ordinary
shares
Measures profit earned for each
ordinary share capital
Price-earnings ratio
Market price of share capital
Earnings per share
Measures the ratio of the
market price per share to
earnings per share
Payout ratio
Cash dividends
Profit
Measures
percentage
of
earnings distributed in the form
of cash dividends
Asset turnover ratio
Net sales
Average total assets
Measures the effectiveness of
asset utilization
Chapter 11 – Financial Reporting and Analysis
revaluation surplus when property, plant, and equipment are reported using the revaluation
model and gains and losses arising from changes in fair value of available-for-sale securities.
REVIEW of the LEARNING OBJECTIVES
1.
Explain the nature of the financial statements and the over-all considerations in their
preparation and presentation.
•
Financial statements are a structured representation of the financial position and
financial performance of an entity.
•
Financial statements are the end product of the accounting process
•
Financial statements show the results of the management’s stewardship of the
resources entrusted to it.
•
Financial statements are the means by which the information accumulated and
processed in financial accounting is periodically communicated to those who use it.
•
The preparation and presentation of financial statements is a responsibility of
management.
The statement of changes in equity reports transactions affecting the various equity
accounts, such as the profit or loss for the period, dividends declared, additional issuances
of share capital, and acquisition of treasury shares.
The statement of cash flows provides information about the cash receipts and cash
disbursements of an entity that occurred during a period. It summarized the transactions
that caused a change in the cash and cash equivalents balance during a reporting period.
The notes include narrative descriptions or more detailed analyses of amounts shown on
the face of the financial statements.
3.
Explain and appreciate the importance of the statement of cash flows. The statement of
cash flows provide the following benefits:
•
it provides information that enables the users to evaluate the changes in the assets of
an entity, its financial structure and its ability to affect the amounts and timing of cash
flows in order to adapt to changing circumstances and opportunities;
•
it provides information that is useful in assessing the ability of the entity to generate
cash and cash equivalents and enable users to develop models to assess and compare
the present value of the future cash flows of different entities;
•
it enhances the comparability of the reporting of operating performance by different
entities because it eliminates the effects of using different accounting for the same
transactions and events.
4.
Describe and explain the classification of cash flows and the methods of presenting cash
flows from operating activities. Cash flows are classified to make the statement more
meaningful to the investors and creditors by enabling them to determine the type of
transaction that gave rise to each cash flow. Cash flows are categorized into three: (a)
operating activities; (b) investing activities; and (c) financing activities)
The over-all considerations in the preparation and presentation of financial statements are
as follows:
•
Fair presentation and compliance with PFRS
•
Going concern
•
Accrual basis of accounting
•
Frequency of reporting
•
Materiality and aggregation
•
Offsetting
•
Consistency of presentation
•
Comparative information
2.
Identify and explain the components of a complete set of financial statements. A
complete set of financial statements is composed of the following: (1) statement of financial
position (balance sheet), (2) income statement, (3) statement of comprehensive income, (4)
statement of cash flows, (5) statement of changes in equity, and (6) notes and other
disclosures. Alternatively, a single statement of income and comprehensive income may be
prepared.
The statement of financial position shows the entity’s assets, liabilities, and equity at a point
in time. The statement of financial position has the following three primary elements: assets,
liabilities and equity.
The income statement shows the performance of an entity at a given period. It reports the
income earned and the expenses incurred at a particular period of time. The statement has
two primary elements: income and expenses.
The statement of comprehensive income reports items of income and expenses which are
not required by other PASs and ORFSs to be recognized in profit or loss, such as changes in
140 | P a g e
Operating activities. Cash flows from operating activities are derived from the principal
revenue-producing activities of an entity.
Investing activities. Cash flows from investing activities include cash inflows and outflows
of cash related to the acquisition and disposition of long-term assets used in the operations
od the business and investment assets.
Financing activities. Cash flows from financing activities include cash inflows from
borrowings and contributions by investors and cash outflows for repayment of loans,
retirement of share capital, acquisition of treasury shares and payment of cash dividends.
Chapter 11 – Financial Reporting and Analysis
Cash flows from operating activities may be presented using the direct method or the
indirect method. Under the direct method, the major classes of gross receipts and gross cash
payments are disclosed in the statement. Under the indirect method, the net cash flow from
operating activities is determined by adjusting profit or loss for the effects of non-cash
revenue and expense items and gain and losses.
5.
Explain and appreciate the types of ratio analysis. Ratios express the mathematical
relationships between one quantity and another, in terms of a rate, a proportion, or a
percentage. For example, the ratio of gross profit to sales is 45% or the ratio of current assets
to current liabilities is 2:5:1. Ratio analysis expresses the relationship among selected
financial statement data. Ratios are used to evaluate the financial health and performance
of a company.
Ratios can be grouped into the following: liquidity ratios, solvency ratios, and liquidity
ratios. Each of these is discussed below.
Liquidity ratios measure the short-term ability of the entity to pay its maturing obligations
and to meet unexpected needs for cash. Solvency ratios measure the ability of the entity to
survive over a long period of time, that is, its ability to pay interest as it come due and to
repay the face value of obligations or debt at maturity. Profitability ratios measure the profit
to operating success of an entity for a given period of time. An entity’s ability or inability to
generate profit has several consequences – it affects an entity’s liquidity position and its
ability to grow; hence, affecting its ability to obtain loans and to attract investors.
141 | P a g e
Chapter 12 – Introduction to Cost Accounting
NATURE OF COST ACCOUNTING
CHAPTER 12
INTRODUCTION TO COST ACCOUNTING
LEARNING OBJECTIVES
1.
2.
3.
4.
Explain the nature of cost accounting and differentiate a manufacturing company from a service
company and a merchandise company.
Identify the elements of manufacturing costs.
Explain the manufacturing cycle and prepare journal entries to record various transactions
related to the cycle.
Prepare a statement of Cost of Goods Manufactured and Sold
COST ACCOUNTING
•
•
•
Users of cost
accounting
Uses of cost
accounting
Manufacturing firm
distinguished from a
service firm and a
merchandise firm
Elements of Manufacturing
Costs
•
•
•
•
•
Direct materials
Direct labor
Factory overhead
Prime cost
Conversion cost
•
•
•
•
•
142 | P a g e
Though cost accounting is usually considered only to apply to manufacturing operations, every
type and size of organization should benefit from its use. It informs management promptly with
the cost of rendering a particular service, buying and selling a product, and producing a product.
Cost accounting principles, therefore, may be applied by financial institutions, transportation
companies, churches, schools, governmental units, as well as the non-manufacturing activities of
manufacturing firms.
COMPARISON OF SERVICE, MERCHANDISING AND MANUFACTURING
ORGANIZATIONS
PREVIEW OF THE CHAPTER
Nature of Cost
Accounting
Cost accounting, which is a specialized field of accounting, emphasizes the determination and
control of costs. It is concerned primarily with the costs of manufacturing processes and of
manufactured products. Cost determination, also known as product costing, deals with
measuring the resources used to complete an activity or unit of output. Cost control, on the other
hand, is management’s way of efficiently dealing with the activities that incur costs.
Manufacturing
Cycle
Purchase and
requisition of raw
materials
Recording, payment
and distribution of
factory payroll
Payment and accrual
of factory overhead
Cost of Goods
Manufactured
Preparation of the
Statement of the
Goods Manufactured
and Sold
Providing a service to a client in an accounting firm or repairing a television set in a repair shop
has strong similarities to manufacturing tables and chairs in spite of different physical settings.
In a service industry, resources are brought together to provide the service, just as they are
brought together to create a product in a factory environment.
Differences in measuring profits for the various types of organizations are largely a function of
inventoried costs. Service firms have only supplies in inventories. Merchandising firms buy and
sell products and hold merchandise inventories. Manufacturing firms buy materials and convert
these inputs into saleable products. Inventories in a manufacturing firm include the following:
1.
2.
3.
Raw materials inventory – yet-to-be used materials
Work in process inventory – partially completed products
Finished goods inventory – completed and ready-to-sell products
ELEMENTS OF MANUFACTURING COST
A manufacturing company differs primarily from a merchandise company from the standpoint
of converting or transforming the goods purchased, called raw materials, into another form of
product before selling them. The process of converting or transforming materials into another
form is called the manufacturing process. The manufacturing process involves the three cost
elements. Direct materials, direct labor and factory overhead. The sum of these three cost
elements is the manufacturing cost, often called production cost or factory cost.
Chapter 12 – Introduction to Cost Accounting
Direct materials include all the materials that form an integral part of the finished product
whose value is relatively high and that can be included directly in calculating the cost of the
product. Examples are the lumber and steel used to make classroom tablet chairs. On the other
hand, materials needed for the completion of a product but do not form an integral part of the
finished product or whose amount is so minimal may be classified as indirect materials.
Direct labor is labor expenses to convert direct material into a finished product. It has to be
traceable to the final product though need not be relatively high in amount. Example is the wage
of the machine operator cutting and assembling the lumber and steel used in the production of
classroom tablet chairs. The salary of a supervisor which cannot be traced to a product is
indirect labor.
Raw Materials Purchases
Indirect Materials
Vouchers payable
2.
3.
4.
Factory overhead, also called manufacturing overhead, manufacturing expenses or factory
burden, includes all manufacturing cost other than direct materials and direct labor. It includes
indirect materials, indirect labor and all other costs that cannot be charged directly to specific
products or job order.
Example of indirect materials are factory supplies and lubricants. Examples of indirect labor are
supervision, inspection, salaries of factory clerks, janitors and security guards, defective and
experimental work. Examples of other indirect costs are factory rent, depreciation of machinery
and factory building, maintenance and repairs, heat light and power, employee factory payroll
taxes, small tools and other miscellaneous factory overhead.
1.
Purchase and receipt of raw materials and indirect materials on account
143 | P a g e
Freight and handling cost of materials
Freight-in
Vouchers Payable
xxx
Return of defective materials to suppliers
Vouchers payable
Purchase Returns and Allowances
xxx
Payment of account within the discount period
Vouchers Payable
Cash
Purchase Discounts
xxx
xxx
xxx
xxx
xxx
Requisition of raw materials for production and indirect materials for factory use
No entry
6.
Return to storeroom of excess raw materials from production and indirect
No entry
7.
Recording to payroll
Direct Labor
Indirect Labor
Administrative Salaries
Sales Salaries
Withholding Taxes Payable
SSS Contributions Payable
Medicate Contributions Payable
Pag-ibig Contributions Payable
Vouchers Payable
Cost accounting consists of a system that is concerned with precise recording and measurement
of cost elements as they originate and flow through the production processes. There are two
accounting systems that may be employed by manufacturing firms, namely: (1) Cost system or
perpetual inventory system, and (2) Non-cost system or periodic inventory system. The
manufacturing process and the physical arrangement of the factory are the basis for determining
the cost accumulation procedures.
Assuming the use of the voucher system, the following are the pro-forma journal entries in the
manufacturing cycle.
xxx
5.
MANUFACTURING CYCLE
The non-cost system or inventory system will be used to illustrate the entries in the
manufacturing cycle. Under this system, there is no detailed flow of cost in the manufacturing
process. The inventory of raw materials, work in process and finished goods are determined
based on physical count of quantities on hand at the end of the accounting period. These
inventories, together with the purchases, labor and overhead are used to compute for the cost of
materials used in production, cost of goods manufactured and transferred to finished goods, and
cost of goods sold during the period.
xxx
xxx
8.
9.
Payment of payroll
Vouchers Payable
Cash
Recording of employer’s payroll taxes
Factory Payroll Taxes
Administrative Payroll Taxes
Sales Payroll Taxes
SSS Contributions Payable
Medicare Contributions Payable
Pag-ibig Contributions Payable
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
Chapter 12 – Introduction to Cost Accounting
d.
10. Recording of other factory costs incurred
Repairs and Maintenance – Factory
Utilities – Factory
Vouchers Payable
xxx
xxx
11. Payment of other accounts
Vouchers Payable
Cash
xxx
xxx
e.
xxx
12. Transfer of completed work to finished goods storeroom
No entry
13. Sale of finished goods on account
Accounts receivable
Sales
xxx
f.
14. Recording of returns by customers
Sales Returns and Allowances
Accounts Receivable
xxx
15. Collection of accounts receivable within the discount period
Cash
Sales Discounts
Accounts Receivable
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
b.
c.
Adjustment for factory depreciation
Depreciation Expense – Machinery
Depreciation Expense – Factory Building
Accumulated Depreciation – Machinery
xxx
xxx
Adjustment for other factory costs
Miscellaneous Factory Overhead
Accrued Expenses
xxx
144 | P a g e
xxx
xxx
xxx
xxx
xxx
xxx
xxx
To close beginning inventory balances
Manufacturing Summary
Raw Materials Inventory, beginning
Work in Process Inventory, beginning
To record ending inventory balances
Raw Materials Inventory, end
Work in Process Inventory, end
Manufacturing Summary
xxx
xxx
xxx
xxx
xxx
xxx
xxx
c.
b.
Adjustment for income taxes
Income Taxes
Income Tax Payable
xxx
xxx
xxx
a.
Adjustment for accrual of payroll
Direct Labor
Indirect Labor
Administrative Salaries
Sales Salaries
Accrued Payroll
Adjustment for other expense
Doubtful Accounts Expenses
Miscellaneous Administrative Expenses
Miscellaneous Selling Expenses
Allowance for Doubtful Accounts
Accrued Expenses
xxx
xxx
17. Closing entries. A Manufacturing Summary account is used to summarize all the transactions
affecting the computation of cost of goods manufactured. The account is debited to close the
balances of raw materials beginning inventory, work in process beginning inventory and all
other manufacturing accounts. On the other hand, the account is credited to set up the
balances of raw materials ending inventory, and work in process ending inventory. The
closing entries at the end of the accounting period of the company shall consist of the
following:
16. Adjusting entries. Adjustment to update the balances of accounts at the end of the fiscal
period may include the following:
a.
Adjustment for office and store depreciation
Depreciation Expenses – Office Building
Depreciation Expense – Store Building
Accumulated Depreciation – Office Building
Accumulated Depreciation – Store Building
xxx
xxx
To close the balances of other manufacturing accounts
Manufacturing Summary
Purchases Returns and Allowances
Purchases Discounts
Raw Materials Purchases
Freight-in
Direct Labor
Indirect Materials
Indirect Labor
Factory Payroll Taxes
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
Chapter 12 – Introduction to Cost Accounting
Repairs and Maintenance – Factory
Utilities – Factory
Depreciation Expense – Machinery
Depreciation Expense – Factory Building
Miscellaneous Factory Overhead
d.
e.
xxx
xxx
xxx
xxx
xxx
To close the beginning inventory balance of finished goods
Income Summary
Finished Goods Inventory, beginning
xxx
To record the ending inventory balance of finished goods
Finished Goods Inventory, end
Income Summary
xxx
xxx
xxx
f.
To close the balance of Manufacturing Summary (which represents cost of goods
manufactured) and the balances of all other revenue and expense accounts
Sales
xxx
Manufacturing Summary
xxx
Sales Discounts
xxx
Sales Returns and Allowances
xxx
Administrative Salaries
xxx
Administrative Payroll Taxes
xxx
Doubtful Accounts Expense
xxx
Depreciation Expense – Office Equipment
xxx
Miscellaneous Administrative Expenses
xxx
Sales Salaries
xxx
Sales Payroll Taxes
xxx
Depreciation Expense – Store Equipment
xxx
Miscellaneous Selling Expenses
xxx
Income Taxes
xxx
Income Summary
xxx
g.
To close the balance of Income Summary to Retained Earnings
Income Summary
xxx
Retained Earnings
145 | P a g e
xxx
REPORTING RESULTS OF OPERATIONS
The result of operations of a manufacturing enterprise is reported in the conventional financial
statements. These statements summarize the flow of accounts and revenues, show the financial
position at the end of the fiscal period, and report the sources of cash inflows and cash outflow
during the fiscal period.
In the income statement, the Cost of Goods Sold is shown on one figure, Although, this procedure
is followed in published reports, internal users need additional information. Therefore, a
supporting schedule of the Cost of Goods Manufactured is usually prepared. A pro-forma
Statement of Cost of Goods Manufactured and Sold that contains all possible items is presented
below.
Luzon Manufacturing Company
Statement of Cost of Goods Manufactured and Sold
For the Year Ended December 31, 2014
Direct Materials:
Raw Materials Inventory, beginning
Pxxx
Raw Materials Purchases
Pxxx
Add Freight-in
xxx
Delivered Cost of Materials Purchases
Pxxx
Less: Purchase Returns and Allowances
Pxxx
Purchase Discounts
xxx
xxx
xxx
Materials Available for Use
Pxxx
Less: Indirect Materials Used
Pxxx
Materials Inventory, end
xxx
xxx
Direct Materials Used
Pxxx
Direct Labor
xxx
Factory Overhead:
Indirect Materials
Pxxx
Indirect Labor
xxx
Factory Payroll Taxes
xxx
Depreciation – Machinery and Factory Building
xxx
Utilities – Factory
xxx
Repairs and Maintenance
xxx
Miscellaneous Factory Overhead
xxx
xxx
Total Manufacturing Cost
Pxxx
Add Work in Process, beginning
xxx
Total Cost of Work Put into Process
Pxxx
Less Work in Process, end
xxx
Cost of Goods Manufactures
Pxxx
Add Finished Goods, beginning
xxx
Cost of Goods Available for Sale
Pxxx
Less Finished Goods, end
xxx
Cost of Goods Sold
Pxxx
Chapter 12 – Introduction to Cost Accounting
3.
Explain the manufacturing cycle and prepare journal entries to record various
transactions related to the cycle. The manufacturing cycle starts with the purchase of raw
materials and ends with the completion of goods. Direct materials issued to production,
direct labor cost and factory overhead costs go to work in process. Cost of goods completed
during the period are transferred from work in process to finished goods while the cost of
finished goods sold are transferred from the finished goods to cost of goods sold.
4.
Prepare a Statement of Cost of Goods Manufactured and Sold. The Statement of Cost of
goods Manufactured and Sold is prepared as a supporting schedule to the amount presented
on the income statement. The statement shows the total manufacturing cost incurred, the
total cost of work put into process, the total cost of goods manufactured during the period,
the total cost of goods available for sale, and the total cost of goods sold during the period.
The sum of direct materials, direct labor and factory overhead is total manufacturing cost or
factory cost. The sum of direct materials and direct labor, however, is called prime cost; the
sum of direct labor and factory overhead is called conversion cost. Manufacturing cost is
different from cost of goods manufactured because the latter considers work in process
beginning and work in process ending inventories. Cost of goods manufactured, therefore, is the
cost of the completed products during an accounting period.
In the Statement of Financial Position (balance sheet) of a manufacturing enterprise, the current
asset section is expanded to show the Inventories of Finished Goods, Work in Process and Raw
Materials. The balance in the Finished Goods account represents the total cost incurred in
manufacturing goods that are completed but still on hand (unsold) at the end of the period. The
balance of the Work in Process account includes all manufacturing costs incurred to date for
goods that are in various stages of production (not yet completed). The balance of the Raw
Materials account represents the cost of all materials purchased and on hand and to be used in
the manufacturing process (to be used in production) including raw materials, prefabricated
parts and other factory materials and supplies.
REVIEW of the LEARNING OBJECTIVES
1.
2.
Explain the nature of cost accounting and differentiate a manufacturing company from
a service company and a merchandising company. Cost accounting is concerned with the
determination and control of costs. Although cost accounting is considered applicable to
manufacturing operations, it is also applied to non-manufacturing industries such as
financial institutions, transportation companies and schools. A service firm is engaged
primarily in the rendering of services while a merchandising firm is engaged in the buying
and selling of merchandise. A manufacturing firm, on the other hand, is engaged in the
purchase and processing of raw materials into finished goods. The three firms also differ in
the classes of inventories maintained. A service firm has operating supplies inventory; a
merchandising firm has merchandise inventory; a manufacturing firm has three classes of
inventories, namely: (1) raw materials, (2) work in process, and (3) finished goods.
Identify the elements of manufacturing costs. There are three elements of manufacturing
costs, namely; (1) direct materials, (2) direct labor, and (3) factory overhead. Direct
materials from an integral part of the finished product and whose value is relatively high.
Direct labor can be traced to the finished product and is incurred to convert direct materials
into finished goods. Factory overhead included all indirect costs incurred in the production
of raw materials into finished goods. Factory overhead included all indirect costs incurred
in the production of raw materials into finished goods. These costs include indirect
materials and indirect labor. Direct materials plus direct labor is prime cost; direct labor
plus factory overhead is conversion cost.
146 | P a g e
GLOSSARY of ACCOUNTING TERMINOLOGIES
Conversion costs – sum of direct labor and factory overhead.
Direct labor – labor used to convert materials into finished product and that can be traced to
the finished product.
Direct materials – materials that form an integral part of a finished product and of relatively
high value and is included in the calculation of the cost of the product.
Factory overhead – manufacturing expenses or factory burden other than direct materials and
direct labor. Factory overhead includes indirect materials and indirect labor.
Prime cost – sum of direct materials and direct labor.
Total manufacturing cost – the sum of direct materials, direct labor and factory overhead.
Work in process – an account used to record manufacturing costs; it represents work put into
process and not yet completed as of the end of the reporting period.