ACCTG 028: ACCOUNTING FOR SPECIAL
TRANSACTIONS
Instructor: Rafael R. Veloso III, CPA, MBA
3rd Year BSA Notes
Module 1: Partnership Accounting
Partnership
Partnerships are a popular form of business because they are easy to
form and because they allow several individuals to combine their talents
and skills in a particular business venture. In addition, partnerships
provide a means of obtaining more capital than a single individual can
obtain and allow the sharing of risks for rapidly growing businesses.
Partnerships are particularly common in the service professions,
especially law, medicine and accounting.
Partner's Ledger Accounts
In a partnership, although it is possible to operate with one equity account
for each partner, it is desirable that the following partner's accounts be
maintained:
1) Capital accounts
2) Drawing or personal accounts
3) Account for loans to or from partners
A partner's equity is increased by the additional investment of cash or
other property and by a share in the partnership profit. A partner's equity
is decreased by the withdrawal of cash or other assets and by a share in
the partnership loss.
Normally, increases or decreases in capital that are interpreted as
permanent capital changes are recorded directly in the capital account.
Withdrawals, which are considered equivalent to salaries, made by the
partner in anticipation of profits and other increases or decreases of
relatively minor amounts are recorded in the drawing account. At the end
of the accounting period, the debit and credit balances in the drawing
account are then closed to the respective partner's capital account. Also,
during this period, the profit or loss as shown by the Income Summary
account is distributed in accordance with the profit and loss sharing
agreement, The share of each partner in the profit or loss is recorded in
their respective capital account. Individual partner's capital and drawing
balances are combined to reporting each partner's interest in the
statement of financial position.
The Capital account is credited for:
a) Original Investment
b) Additional Investment
c) Partner's share in the profits
The Capital account is debited for:
a) Permanent withdrawal of capital
b) Debit balance of the drawing account at the end of the period
c) Partner's share in the losses
Capital and Drawing Accounts
The original investment of each partner is recorded by debiting the fair
value of the assets invested, crediting the liabilities assumed by the firm
and crediting the partner's capital account for the net assets contributed.
Subsequent to the original investments, transactions between the
partnership and the partners will result to changes in the respective
partner's ownership interest. These changes are summarized in the
respective partner's capital and drawing accounts.
The Drawing account is credited for:
a) Partnership obligations assumed or paid by the partner
b) Personal funds or claims of partner collected and retained by the
partnership
c) Periodic partner's salaries depending on the accounting and
disbursement procedures agreed upon.
The Drawing account is debited for:
a) Withdrawal of assets by the partners in anticipation of net income
b) Partner's personal indebtedness paid or assumed by the partnership
c) Funds or claims of partnership collected and retained by the partner
Loan to and Loan from partners
A withdrawal by a partner of a substantial amount with the assumption of
its repayment to the firm may be debited to a Receivable from partner
account rather than to the partner's drawing account. On the other hand,
an advance to the partnership by a partner with the assumption of its
ultimate repayment by the partnership is viewed as a loan rather than as
an increase in the capital account. This type of transaction is credited to
the Loan's payable or Notes payable if the loan is evidence by a note duly
signed in the name of the partnership.
FORMATION
Accounting for the Formation of a Partnership
1. Formation of a partnership for the first time
2. Conversion of a sole proprietorship to a partnership
a. A sole proprietor allows an individual, who has no business of his
own to join his business.
b. Two or more sole proprietors form a partnership.
3. Admission of a new partner
Partnership formation for the First Time
 Cash Investments - initial cash investments in a partnership are
recorded in the capital accounts maintained for each partner. For
example Aldous and Baxia each invests P100,000 cash in a new
partnership. The entry to record the investments would be:
Debit
200,000
OPERATION
Accounting for Partnership Operations
Net income is computed in the usual manner that is matching revenues
and expenses then credited to the individual capital accounts. However,
the treatment becomes more complex because of the differences in
capital contributions, abilities and talents of individual partners, and in
time spent on partnership duties by the individual partners,
Division of Profits and Losses
A partnership maybe formed in several ways namely:
Account
Cash
Aldous, capital
Baxia, capital
To record impairment loss.
 Non-cash investments – when property other than cash is invested in
a partnership, the non-cash property is recorded at the current fair
value of the property at the time of the investment. The fair value on
non-cash asset is determined by agreement of the partners. The
amounts involved should be specified in the written partnership
agreement.
Credit
100,000
100,000
The partnership law provides that profits and losses of the partnership are
to be divided in accordance with the partners agreement. If no agreement
is made between and among the partners, profits and losses are to be
divided according to their original capital contributions. Should the
partners agree to divide the profits only, losses, if any are to be divided in
the same manner as that of dividing profits. However, should the partners
agree to divide losses only, profits, if any shall be divided by the partners
according to capital contributions.
The ratio in which the partnership profits and losses are divided is known
as the profit and loss ratio. The many possible methods of dividing net
income or loss among partners can be summarized as follows:
1. Equally
2. In an unequal or arbitrary ratio
3. In the ratio of partners capital account balances on a particular
date, or in the ratio of average capital account balances during the
year.
4. Allowing interest on partners' capital account balances and dividing
the remaining net income or loss in a specified ratio.
5. Allowing salaries to partners and dividing the remaining net income
or loss in a specified ratio
6. Bonus to managing partner based on net income.
DISSOLUTION/CHANGES IN OWNERSHIP INTEREST
Partnership Dissolution/Changes in Ownership Interest
A partnership rests upon a contractual foundation, therefore, the life span
of a partnership may be somewhat uncertain since it depends on the
moods and relationships of the partners. Any circumstances which cause
the technical termination of a partnership may lead to the the
partnership's permanent dissolution and liquidation, if the partners so
agree, Dissolution and liquidation in relation to the partnership are not
synonymous. A partnership is said to be dissolved when the original
association for the purposes of carrying on activities has ended. A
partnership is said to be liquidated when the business is terminated. Thus,
a partnership may be dissolved without being liquidated. While dissolution
may result to liquidation of a partnership, liquidation always results to
dissolution.
Partnership dissolution due to changes in ownership interests occurs for
variety of reasons. These can be summarized as follows:
1. Admission of a partner
2. Retirement of a partner
3. Death of a partner
4. Incorporation of a partnership
In most cases, when a change in ownership occurs, the market values of
individual partnership assets and liabilities are different from their book
values. These differences can be accounted for by recording them on the
partnership books either by adjusting the assets and liabilities - in may
cases, by adjusting the partners' capital accounts.
ADMISSION OF A NEW PARTNER
An existing partnership may admit a new partner with the consent of all
the partners. When a new partner is admitted, the partnership is
dissolved, and a new partnership is formed. Upon the admission of a new
partner, a new agreement covering partners' interests, profit and loss
sharing and other consideration should be drawn because the dissolution
of the original partnership cancel the original agreement.
The admission of a new partner may occur in either of two ways, namely:
1. Purchase of all or part of the interest of one or more of the existing
partners.
2. Investment of assets in the partnership by the incoming partner.
BY PURCHASE OF INTEREST
Purchase of Interest from One or More Partners
One or more partners may sell their portion of the business to an outside
party. This type of transaction is common in operations that rely primarily
on monetary capital rather than on the business expertise of the partners.
The partner in making the transfer of ownership can actually convey the
following rights:
1. The right of co-ownership in the business property. This right justifies
the partnership drawings from the business as well as the settlement
paid at liquidation or at the time of partners' withdrawal.
2. The right to share in profits and losses.
3. The right to participate in the management of the business.
When an incoming partner purchases a portion or all of the interests of
one or more of the original partners, the partnership assets remain
unchanged and no cash or other assets flow from the new partner to the
partnership. This transaction is recorded by opening a capital account for
the new partner and decreasing the capital accounts of the selling
partners by the same amount. The cash paid by the buyer is not recorded
in the books of the partnership for this is a personal transaction between
the selling partners and the buyer. The gain or loss arising from the sale
of interest is not to be recorded in the partnership books.
BY INVESTMENT
New partner invests in partnership
A new partner may acquire interest in the partnership by investing in the
business. In this case, the partnership receives the cash or other assets,
thereby increasing its total assets as well as the total capital. This method
of admission is a transaction between the partnership and the incoming
partner. Three cases may exist when a new partner invests in partnership:
Case 1: The new partner's investment (contributed capital) equals the
new partner's proportion of the partnership's book value (agreed value)
Case 2: The new partner's investment is more than the new partner's
agreed capital. This indicates that the partnership's prior net assets are
undervalued on the books.
Case 3: The new partner's investment is less than the new partner's
agreed capital. This suggests that the partnership's prior net assets are
overvalued on its books.
The following steps/procedures may be used in determining how to
account for the admission of a new partner:
1. Compute the new partner's proportion of the partnership's book
value (agreed capital) as follows:
Prior capital of old partners
Investment of the new partner
x capital to new partner
Agreed capital
xx
xx
%
xx
 Revalue net assets down to fair value and allocate to old partners.
 Assign bonus to new partner
3. Determine the specific admission method.
WITHDRAWAL, RETIREMENT OR DEATH OF A NEW PARTNER
When a partner retires or withdraws from the partnership, the partnership
is dissolved but the remaining partners may continue operating the
business. The existing partners may buy out the retiring partner either by
making a direct acquisition or by having the partnership acquire the
retiring partner's interest. If the present partner directly acquire the retiring
partner's interest, the only entry on the partnership's books is to record
the transfer of capital from the retiring partner to the remaining partner. If
the partnership acquires the interest of the retiring partner, the partnership
must pay the retiring partner an amount equal to his interest, more than
his interest or less than his interest.
The interest of the retiring partner is usually measured by his capital
balance, increased or decreased by his share in the following adjustment:
1. Profit or loss from the partnership operations from the last closing
date to the date of his/her retirement.
2. Changes in the valuation of all assets and liabilities (book values to
fair values)
Death of a partner
2. Compare the new partner's contributed capital with his or her agreed
capital to determine the procedures to be followed in accounting for
his or her admission.
Case 1: Investment = Agreed Capital
 No revaluation or bonus
Case 2: Investment cost > Agreed Capital
 Revalue net assets up to fair value and allocate to old partners.
 Allocate bonus to old partners.
Case 3: Investment cost < Agreed Capital
In the event of the death of a partner, the estate of the deceased partner
is entitled to receive the amount of his interest in the partnership at the
date of his death, The deceased partner's capital is adjusted using his
profit and loss share percentage for changes in asset values arising from
revaluation of assets and for the profit from the date the books were last
closed. The balance of his capital account after considering the necessary
adjustments should be transferred to a liability account pending
settlement.
INCORPORATION OF A PARTNERSHIP
When a partnership is converted into a corporation, the corporation takes
over the assets and assume the liabilities of the partnership in exchange
for shares of stocks. The stocks received by the partnership are
distributed in settlement of their interest. The partners now become
stockholders of the newly formed corporation.
The accounting procedures in recording the incorporation of the
partnership will depend on whether the original books of the partnership
will be continued by the corporation or new books will be opened.
Partnership Books Retained – if the partnership book are retained, the
steps to be taken are as follows:
1. Revalue the assets.
2. Close the partner's capital accounts to the corporate capital
accounts.
New Books Opened for the Corporation – if new books are to be
opened, the old partnership books must be closed. The accounting
procedures may be outlined as follows:
In the books of the partnership:
1. Revalue the assets (and any other items agreed on) in accordance
with the agreed transfer values.
2. Record the transfer of assets and liabilities to the corporation and the
receipt of capital stocks by the partnership.
3. Record the distribution of stocks to the partners in settlement of the
balances of their capital accounts.
LIQUIDATION
The basic objectives of a partnership during the liquidation process are to
convert the partnership assets to cash (called realization of assets), to
pay off partnership obligations and to distribute cash and any unrealized
assets to the individual partners. The purpose of accounting during this
period is to have an equitable distribution of partnership cash to creditors
and partners. Hence, it is no longer income determination that is the focus
of accounting but rather, the computation of gains or losses on realization
of assets which are to be subsequently allocated among the partners, the
payment of liabilities in accordance with law and the final distribution of
cash to partners.
There are certain rules that should be followed in the liquidation of the
partnership namely:
1. Always allocate and close gains or losses to the partners' capital
accounts prior to distribution any cash to partners.
2. When the business is liquidated, the partner is entitled to an amount
depending upon his capital contribution, his drawing, his share in
the net income or loss from operations before liquidation, gains and
losses on realization and the balance of his loan account, if any.
Each partner will receive in the final settlement the amount of his equity in
the business, The amount of a partner's equity is increased by the
positive factors such as investment of capital and share in the profits. It is
decreased by the negative factors such as withdrawals and share in the
losses. If the negative factors are greater than positive factors, the
partners will have a deficiency (debit balance) and he must pay the
partnership the amount of such deficiency, Failure to do so would mean
that his fellow partners would bear more than their contractual share in
losses and they will consequently receive less than their equities in the
business.
As a general rule, the cash should be distributed as follows:
1. First, to outside creditors
2. Second, to partners for loan accounts.
3. Third, to partners for capital accounts.
A debit balance in the partner's capital account may be caused by losses
incurred in the realization of assets or by prorata absorption of an
uncollectible deficit of a partner whose combined capital and loan
accounts is not enough to absorb the partner's share of total losses.
Methods of Partnership Liquidation
When a partnership is to be liquidated by the sale of assets, the following
methods may be used:
1. Lump-Sum Liquidation, otherwise called Total Liquidation or Single
Distribution.
2. Installment Liquidation, otherwise called Installment Distribution.
LUMP-SUM METHOD
A lump-sum liquidation of a partnership is one in which all the assets are
converted into cash within a very short time, outside creditors are paid,
and single lump-sum payment is made to the partners for their total
interests.
Realization of Assets
Typically, a partnership will experience losses on the sale of its assets. A
partnership may have a "Going Out of Business" sale in which its
inventory is marked down well below normal selling price to encourage
immediate sale. The partnership's fixed assets may also be offered at a
reduced price. The accounts receivable are actually collected by the
partnership. Sometimes the partnership offers a large cash discount for
prompt payment of any remaining receivables whose collection may
otherwise delay the termination of the partnership. Alternatively, the
receivables may be sold to a factor. A factor is a business that specializes
in acquiring accounts receivables and immediately paying cash to the
seller of the receivables. The partnership records the sale of the
receivables, as it would any other asset.
Before any distribution may be made to the partners, either liabilities to
outside creditors must be paid in full or the necessary funds may be
placed in an escrow account. The escrow agent, usually a bank, uses the
funds only for payment of the partnership liabilities.
Expenses of Liquidation
During the liquidation process, expenses are usually incurred, such as
legal and accounting expenses and advertising cost of selling the assets.
These expenses are allocated to partners' capital accounts in their profit
and loss ratio.
Liquidation Procedures. The following procedure may be used in lumpsum liquidation.
1. Realization of assets and distribution of gain or loss on realization
among the partners based on the profit and loss ratio.
2. Payment of expenses
3. Payment of liabilities
4. Elimination of partner's capital deficiencies. If after the distribution of
loss on realization, a partner incurs a capital deficiency (i.e. partner's
share of realization loss exceeds his capital credit) this deficiency
must be eliminated by using one of the following methods, in order of
priority.
a. If the deficient partner has a loan balance, exercise the right
of offset,
b. If the deficient partner is solvent, make him invest cash to
eliminate his deficiency.
c. If the deficient partner is insolvent, let the other partners
absorb his deficiency
5.
Payment to partners (in order of priority)
a. Loan accounts
b. Capital accounts
INSTALLMENT METHOD
Installment Liquidation
Involves the selling of some assets, paying liabilities of the partnership,
dividing the available cash to the partners, selling additional assets and
making further payments to partners. This process continues until all the
assets have been sold and all cash has been distributed to the creditors
and to partners.
Procedures for Liquidation by Installment
The following are the accounting procedures that may be followed in
liquidating a partnership by installments.
1. Record the realization of assets and distribute the realized gains or
losses among the partners using profit and loss ratio.
2. Pay liquidation expense and unrecorded liabilities, if there are any
and distribute these among the partners using the profit and loss
ratio.
3. Pay the liabilities to outsiders.
6. 4, Distribute cash to partners after possible future losses have been
apportioned to partners or in accordance with a cash distribution
program.
*Eliminate any capital deficiency only before final payments to partners.
Periodic Computation of Safe Payments to partners
The Statement of partnership liquidation is usually supported by a
schedule of safe installment payments to partners, simply called Schedule
of Safe Payments, prepared periodically. According to the schedule, each
installment of cash is distributed as if no more cash is forthcoming, either
from sale of assets or from collection of deficiencies from partners. Cash
is therefore, distributed to a partner only if he has an excess credit
balance in his partnership interest (i.e. capital account or capital and loan
account combined) after absorption of his share of the maximum possible
loss that may occur. The possible loss (hypothetical loss) consists of the
following:
1. Total value of remaining non-cash assets. These assets are
assumed unrealizable (they cannot be sold), hence, they are
considered loss chargeable to the partners.
2. Cash withheld to pay for anticipated liquidation expenses and
unrecorded liabilities that may arise. The said expenses and
liabilities represent possible loss to the partners because upon their
payment, the amount paid is to be correspondingly absorbed by the
partners.
Additional loss may also accrue to the partners when a debit balance in
any of the capital accounts results from the foregoing allocations of
possible loss. The deficiency of any of the partners is absorbed by the
other partners as additional possible loss to them because he is
presumed unable to pay anything to the firm.
Cash Withheld
The cash set aside in a separate fund is not a factor in computing
possible loss. It is the cash set aside to insure payments of potential
liquidation expenses, which may be incurred and unrecorded liabilities
may be discovered. This cash withheld is added to the total remaining
non-cash assets to obtain the maximum possible loss needed in the
computation of safe installment payment. Also cash available for
distribution to the partners for the period is net of the cash withheld.
Unrecorded liabilities are obligations which are discovered or incurred
during the liquidation. These are allocable to the partners according to
their profit and loss sharing agreement.
SUMMARY
Capital interest vs. Profit and Loss Interest
Capital Interest is a claim against the net assets of the partnership as
shown by the balance in the partner’s capital account, while Interest in
Profit or Loss determines how the partner’s capital interest will increase or
decrease as a result of subsequent operations.
Assignment of an interest to a Third Party
A. Revaluation Approach
 The use of fair values provides an equitable measure of each
partner’s capital interest in the partnership.
 Basis of valuation is fair value
 Results in a marked departure from the historical principle
B. Absence of Revaluation
 This approach would retain the historical cost/changing value
(BOOK VALUE APPROACH).
Admission of a New Partner
1. Admission by Purchase Interest
Case 1: Purchase of interest for one partner
Account
A, Capital
B, Capital
Debit
xx
Credit
xx
Case 2: Purchase of interest from all partners
Assumption 1 Purchase at Book Value
2. Admission by Investment
Assumption 2 Purchase at more than Book Value
Alternative 1: BOOK VALUE APPROACH
Amount paid
Less: BV of interest acquires
Excess
TCC = TAC
TCC > TAC
xx
(xx)
xx
TCC TAC
Alternative 2: REVALUATION APPROACH
Account
Goodwill
A, Capital
B, Capital
Debit
xx
Account
A, Capital (old+goodwill*interest acquires)
B, Capital (old+goodwill*interest acquires)
F, Capital
Credit
xx
xx
Amount paid
Less: BV of interest acquires
Excess
/ Interest Acquired
Revaluation of Asset Upward
CC = AC
CC > AC
CC < AC
No Adjustment
Overstatement of the asset or diminution in
partner’s capital
Unrecorded net assets or the required
additional investment in the partner’s capital
Not transfer of capital
Capital transfer or bonus to old partners
Additional Capital credit (either bonus or
goodwill) from old partners
TOTAL AGREED CAPITAL
LESS: TOTAL CONTRIBUTED CAPITAL
DIFFERENCE
xx
(xx)
xx
xx
xx
Debit
xx
Any gain or loss are recognized on sales subsequent to recording
the admission will be allocated on the basis of the new profit and
loss ratio.
xx
(xx)
xx
In bonus, if there’s a revaluation of assets, they cannot recognized. But if
revaluation method is used, they affected the partner’s capital account.
Credit
In the absence of approach to be used, bonus approach should applied.
Incorporation of a Partnership
xx
Partnership books are retained
xx
Assumption 3: Purchase at less than Book Value
In Book Value approach, same format but it is a loss, while, in
Revaluation approach, same format but it is downward.
 Prefer Book Value if Profit and Loss interest > capital
interest, otherwise, use revaluation approach.
1. Change in assets and liability values in the partner’s interest prior
to corporation
2. The change in the form of proprietorship. A revaluation account
may be debited to losses and credited with gains from revaluation,
and the balance may subsequently be closed into the capital
accounts in the Profit and Loss Ratio.
New books for the corporation
1. In accounting record of partnership
2. Prepare J.E. for revaluation of assets, including recognition of
goodwill.
3. Record any cash withdrawal necessary to adjust parties capital
account balances to round amounts
4. Record the transfer of assets and liabilities to the corporation, the
receipt of the corporation’s common stock by partnership, and the
distribution of the common stock to the partners in settlement of
the balances of their capital accounts.
In the accounting records of the corporation
1. Record the acquisition of assets and liabilities from the partnership
at current fair values.
2. Record the issuance of common stock at current fair value in
payment of the obligation to the partnership.
Partnership Liquidation
The phase of partnership operations which begins after dissolution and
ends with the termination of a partnership activities referred to as "winding
up the affairs."
Basic Procedures in Liquidation
Procedures for minimizing inequities among partners.
1. Sharing Gains and Losses. When a partnership is liquidated, the
books should be adjusted and have closed the net profit or loss for
the period in the manner they have agreed in the partnership
agreement.
2. Advance planning when the partnership is formed.
3. Rules on setoff – Partnership Loans (Receivable) to the partners
4. Rules on set off – Partner (Payable) loans to the partnership—
depends upon the situation.
 Legal doctrine of setoff – whereby a deficit balance in partner’s
capital account may be set off against any balance existing in
his/her loan account.
5. Liquidation expenses. Certain cost incurred during the liquidation
process should be treated as a reduction of the proceeds from the
sale of non-cash asset. Other liquidation costs should be treated as
expenses.
6. Marshalling of assets. This doctrine is applied when the partnership
and/or one or more of the partners are insolvent.
7. Distribution of cash or other assets to partners.
Lump-sum Liquidation
Is one in which all assets are converted into cash within a very short time,
creditors are paid, and a single, lump-sum payment is made the partner’s
for their capital interest.
1. Realization and distribution of gain or loss to all partners on the basis
of profit and loss ratio.
2. Payment of liquidation expenses, if any.
3. Payment of liabilities to third parties.
4. Elimination of capital deficiencies.
5. Payment to partners(in order)
a. loan accounts
b. capital accounts
Installment Liquidation
Is a process of realizing some assets, paying creditors, paying the
remaining available cash to partners, realizing additional assets, and
making additional cash payment to partners.
A. Schedule of Safe Payments
A.1. Assume total loss on all remaining non-cash assets. Provide all
possible losses, including potential liquidation cost and unrecorded
liabilities.
Possible Loss = amount of unrealized non-cash assets +
amount of cash withheld (i.e. unrecorded unpaid expenses,
and anticipated liquidation expenses)
A.2. Assume that partners with a potential capital deficit will be unable to
pay anything to the partnership (assume to be personally insolvent)
 Hypothetical or assumed deficit balance is allocated to the
partners who have credit balances using profit and loss ratio.
This portion is the maximum potential loss on non-cash assets.
 Any capital deficiencies that may result in other partners as a
result of a maximum loss on non-cash assets.
 Schedule of Safe Payments is effective method of computing
the amount of safe payments to partners and preventing
excessive payments on any partners.
 It is inefficient, if numerous installment distributions are made to
partners.
 It is deficient as a planning device because it does provide
information, but it can be overcome by preparing cash
distribution plan at the start of the liquidation process.
B. Cash Priority Program
1. Ranking the Partners
2. Total interest (equity) account = balance of the capital account +
loan receivable (-)/loan payable (+) to the partner
3. Loss
Absorption
Power/Abilities/Potential/Maximum
Loss
Absorbable= Total interest account/Profit and Loss assigned ratio
Vulnerability Rankings – lowest absorption abilities is the most vulnerable
to partnership losses.
Limitation of Cash Priority Program
1. The program is operable only after outside creditors have been
paid in full.
2. Reflects only the order in which cash distribution to partners will be
made if cash is available to distribute
3. The sequence of distribution of cash in the program coincides with
the sequence that would result if cash were distributed using the
schedule of safe payments
Module 2: Corporate Liquidation
Corporations get into financial difficulty for a large variety of reasons. A
company may suffer from continued losses from operations,
overextended credit to customers, poor management or working capital,
failure to react changes in economic conditions, inadequate financing and
a host of other reasons for not sustaining a viable economic position.
Insolvency
A debtor corporation is considered insolvent when it is unable to pay its
debts as they come due. In the legal sense, a business enterprise is
insolvent when, its financial condition is such that the sum of all its debt is
greater than all of its assets at fair valuation. Thus, a corporation remains
solvent as long as the fair value of its assets exceeds its liabilities, even if
it cannot meet its current obligation because of an insufficiency of liquid
resources. Debtor Corporations that are insolvent has a large number of
alternatives, such as liquidation, reorganization or debt restructuring.
Corporate Liquidation
This process can be initiated by the company by filing a voluntary petition
with the Securities and Exchange Commission (SEC). The corporation is
given three years from the date of approval within which to wind up its
affairs.
The Securities and Exchange Commission may appoint a receiver or a
trustee following the filing of a petition for liquidation or bankruptcy. The
duties of the receiver in a liquidation focuses on the realization of assets
and the payment of liabilities rather than on the preservation and
continuation of the business. In the course of the liquidation, the receiver
may continue business activity if that is in the interest of an orderly
liquidation.
Financial Report
Corporation in liquidation usually prepares two classes of financial
reports. First, which is the initial report shows the available asset values
and debts of the debtor corporation. This report is known as
the Statement of Affairs. The second, is the periodic report of the receiver
known as the Statement of Realization and Liquidation, this shows how
the receiver managed the assets of the debtor corporation on behalf of
the creditors.
STATEMENT OF AFFAIRS
Normally, at the start of the liquidation, a statement of affairs is prepared
for the corporation to provide information about the current financial
position of the company. The Statement of Affairs is not a going concern
report, it is an important planning report for the anticipated liquidation of a
company. Thus, historical cost figures are not relevant. The various
parties concerned desire information that reflects 1) the net realizable
value of the debtor's assets and 2) the ultimate application of these
proceeds to specific liabilities.
The assets and liabilities are reported according to the classifications
relevant to liquidation. Consequently, assets are classified into three
categories as follows:
1. Assets pledged to fully secured creditors - Certain assets can be
pledged as security for a particular liability and the estimated realizable
value of the assets equals or exceeds the amount of the liability. Such
assets may also yield resources to cover unsecured liabilities.
Ex. The building with an estimated realizable of P3,000,000 which
secures a P2,000,000 mortgage liability, is an example of an asset
pledged to a fully secured creditor. After the mortgage is paid, P1,000,000
remains for unsecured creditors.
2. Assets pledged to partially secured creditors - Other assets that are
pledged as security for a particular liability. Partial payment of the liability
will utilize the entire asset value; nothing will be left for the unsecured
liabilities.
Ex. The equipment with an estimated realizable value of P30,000 which
secures a P50,000 note payable, is an example of an asset pledged to a
partially secured creditor.
3. Free Assets - Assets that is not pledged as security for any particular
liability, and thus available to meet the claims of priority liabilities and
unsecured creditors. Free assets also include the value of assets pledged
to fully secured creditors in excess of the related liability.
Ex. The P1,000,000 of the value of the building is included as free assets.
(See first example)
ILLUSTRATIVE PROBLEM
To illustrate the preparation of this statement, assume that X Company
has experienced severe financial difficulties in recent times and is
currently insolvent.
Before the preparation of a statement of affairs, additional data must be
ascertained concerning the insolvent company and its assets and
liabilities. Hence, the following information has been accumulated about
the X Company:
1. The marketable securities reported on the balance sheet has
appreciated in value since being acquired and is now worth P20,000.
Dividends ofP500 are currently due from this investment.
2. P12,000 of the company's accounts receivable can still be collected.
3. The inventory held by the company can be sold for P43,000.
4. A refund of P I ,000 will be received from the various prepaid
expenses ut the company's intangible assets have no resale value.
5. The land and building can still be sold for P231 ,000. While the
equipment can only be sold for P32,OOO.
6. Administrative expenses ofP21 ,500 is estimated if liquidation of the
company does occur.
7. Accrued expenses include salaries of P12,000 and payroll taxes
from wages but not yet paid to the government total P3 ,000.
8. Interest of P5,000 on the company's long-term liabilities has not
been accrued for the first six months of 2020.
From the above data, the statement of affairs for X Company can be
prepared and the following should be specifically noted in the statement
of affairs:
liquidation. Fully secured creditors, of course, will receive the full amount
owed to them, as well as those creditors with priority claims.
a. The current and non-current classifications usually applied to assets
and liabilities are omitted. Since the company is on the verge of going out
of business. Such classification is meaningless. Instead, the statement is
designed to separate the secured and unsecured balances.
b. Book values are presented on the left side of the schedule but only for
informational purposes. These figures are not relevant. All assets are
reported at net realizable value, whereas liabilities are shown at the
amount required for settlement.
c. The dividends receivable and the interest payable are both included in
the statement, although neither has been recorded on the balance sheet.
Currently updated figures must be disclosed within the statement of
affairs.
d. Liabilities having priority are individually identified with the liability
section because these claims will be paid before other unsecured
creditors, the P35,500 total also is deducted directly from the free assets.
Although not yet incurred, estimated administrative expenses are included
in this category since such expenses will be necessary for liquidation.
e. According to this statement, if liquidation occurs, X Company expects
to have only P57,000 in free assets remaining after settling all liabilities
with priority. Unfortunately, the liability section shows unsecured claims
with a total of P95,000. These creditors, therefore, face a P38,000 loss
(P95,000-P57,000) if the company is liquidated. This final distribution is
often converted into an expected recovery percentage computed as
follows.
Expected Recovery Percentage = Net Free Assets / Unsecured Claims
P57,000 / P95,000 = 60%
Thus, unsecured creditors can anticipate receiving only 60 percent of their
claims. Unsecured creditor, for example, who is owed P1,000 by this
company should anticipate collecting only P600 (P1,000 X 60%) following
STATEMENT OF DEFICIENCY
The balances of the Stockholder's equity account depend on the amount
of free assets available. If there is a deficiency of assets to satisfy
unsecured creditors, all claims of equity holders are extinguished. Only if
there are free assets in excess of unsecured liabilities can stockholders
share any distributions.
STATEMENT OF REALIZATION AND LIQUIDATION
This statement shows a complete record of the transaction of the receiver
for a period of time. It structure is similar to a T account and is composed
of three elements: asset transactions, and income/loss transactions.
The first duty of the receiver is to realize the assets, that is to covert the
non-cash assets into cash so that the creditors can be paid. The process
of realization may be done in several ways, some assets may be realized
by normal operations, such as the continuing collections of receivables
from customers. Other assets can be realized by sale. During realization,
gains and losses on asset sales may occur, expenses may be incurred
and revenues can be earned. The realization activities may be presented
in T account format.
The second task of the receiver is to liquidate the liabilities, that is to
make full or partial settlement with the creditors. Again, gains or losses
may occur in the process of liquidation, as may expenses or revenues.
The liquidation activities may also be presented in T account format.
a. administrative expenses of the receiver
b. Unpaid employee's salaries and wages, and benefit plans
c. taxes
2. Fully secured creditors - For these liabilities, the creditor has a lien
on specific assets, whose estimated realizable value equals or exceed the
amount of the liability.
Ex. A bank holds a P2,000,000 mortgage on a building of a debtor
corporation and the building has an estimated realizable value of
P3,000,000. The mortgage is therefore, fully secured and the bank is
referred to as a fully secured creditor.
3. Partially secured creditors - In some cases, the creditor has a lien on
specific assets but the estimated realizable value of those assets is less
than the amount of the liability.
Ex. A finance company holds a P50,000 note secured by equipment of a
debtor corporation, but the equipment has an estimated realizable value
of only P30,000. This note is partially secured and the finance company is
referred to as a partially secured creditor.
4. Unsecured creditors - All other liabilities for which the creditor has no
lien on any specific assets of the debtor corporation are unsecured. This
includes the unsecured portion of the liability to partially secured creditors.
Ex. There is a note payable to the finance company for P50,000 secured
by the equipment worth P30,000, the difference of P20,000 is added to
the unsecured liabilities.
DETERMINATION OF THE ORDER OF PRIORITY OF CLAIMANTS OF
COMPANY ASSETS SUBJECT TO LIQUIDATION
The liabilities of the company are classified into four categories as follows:
1. Unsecured Liabilities with priority - When creditor has no lien on any
specific assets of the debtor corporation but its claims rank ahead of other
unsecured liabilities in the order of payment, the claim are considered
unsecured liabilities with priority. These liabilities, in order to priority are:
SUMMARY
Insolvency - it is an inability to pay off its liabilities as they become due
and demandable. In Legal View, it is as a financial condition in which the
sum of all debts is greater than all of its assets at a fair valuation.
Role of Creditors - outside creditors appoint a trustee to manage the
debtor’s state.
Roles of trustees
1. Continue operating the debtor’s business if directed by the court
2. Realizes free assets of the debtor’s estate
3. Pay cash to unsecured creditors
Role of Accountant – concerned with proper reporting of the financial
condition of the debtor and adequate accounting and reporting for the
trustee.
Statement of Affairs – financial condition prepared for a corporation
entering into the stage of liquidation or bankruptcy.
Assets
Assets pledged with fully secured creditors- expected to realize an
amount at least sufficient to satisfy the related debt.
Assets pledged with partially secured creditors- expected to realize an
amount below the related debt.
Free assets- are not pledged and are available to satisfy the claims of
creditors with priority, partially secured creditors, and unsecured creditors.
Liabilities
1. Fully secured liabilities – expect to be paid in full as a result of their
having sufficient collateral to satisfy the indebtedness.
2. Partially secured liabilities – have collateral, the proceeds of which are
expected to be insufficient to satisfy the indebtedness.
3. Unsecured Liabilities with priority – have priority under the law (Section
50 Insolvency Law).
4. Unsecured Liabilities (General Creditors) – have no collateral relating
to their indebtedness.
ESTIMATED RECOVERY % OR DIVIDEND
UNSECURED
CREDITORS
=
NET
FREE
UNSECURED CREDITORS
TO GENERAL
ASSETS/TOTAL
Statement of Realization and Liquidation – an activity statement
progress toward the liquidation of a debtor’s state. It shows the actual
transactions that transpired during the period covered
Module 3: Revenue from Contracts with
Customers
REVENUE FROM CONTRACTS WITH CUSTOMERS
An installment sales contract is a special type of credit arrangement which
provides for a series of payments over a period of months or years.
Installment sales are widely used by dealers in real estate, home
appliances and cars. Since the seller must wait for a considerable period
of time to collect the full amount it exposes the seller to a greater risk of
non-collection considering that customers who avail of this plan are
generally weaker in financial condition. Furthermore, the credit standing of
a customer may change significantly during the period covered by an
installment contract.
In view of this greater risk of non-collection, the seller should protect
himself by adopting a form of contract which enable him to repossess the
property if the buyer fails to make all the agreed installment payments.
Methods of Gross Profit Recognition on Installment Sales
The determination of the net income on installment sales is one of the
more complicated problems because the amounts of recoveries and the
related costs and expenses are seldom known in the period when the
sale is made. Two general approach may be used in the recognition of
gross profit on installment sales: 1) the gross profit (excess of sales price
over cost of sales) is recognized at the time of sale and 2) the gross profit
is recognized in installments over the period of the contract on the basis
of cash collection.
Gross Profit is Recognized at the Time of Sale
Many companies treat a sale on installment in exactly the same way as
they treat any other sale on account. The Account Receivable account is
debited and the Sales account is credited for the full price when the sale
is made. The treatment is not different from that employed for regular
sales on credit. Gross profit is recognized at the period of sale, the point
at which goods have been delivered to the customers and a definite
amount of receivables have been acquired.
Gross Profit is Recognized in the Period in which Cash is Collected
This is a special method of accounting for installment sales whereby
gross profit is recognized in the periods in which the installment
receivables are collected instead of in the periods in which receivables
are created. The amount of cash collections then become the basis for
gross profit recognition.
FIVE-STEPS MODEL FRAMEWORK
Accounting requirements for revenue
The five-step model framework
The core principle is that an entity will recognize revenue to depict the
transfer of promised goods or services to customers in an amount that
reflects the consideration to which the entity expects to be entitled in
exchange for those goods or services. This core principle is delivered in a
five-step model framework:





Identify the contract(s) with a customer.
Identify the performance obligations in the contract.
Determine the transaction price.
Allocate the transaction price to the performance obligations in
the contract.
Recognize revenue when (or as) the entity satisfies a
performance obligation.
Application of this guidance will depend on the facts and circumstances
present in a contract with a customer and will require the exercise of
judgment.
STEP 1: IDENTIFY THE CONTRACT WITH THE CUSTOMER
A contract with a customer will be within the scope if all the following
conditions are met:
 the contract has been approved by the parties to the contract;
 each party’s rights in relation to the goods or services to be
transferred can be identified;
 the payment terms for the goods or services to be transferred can be
identified;
 the contract has commercial substance; and
 it is probable that the consideration to which the entity is entitled to in
exchange for the goods or services will be collected.
If a contract with a customer does not yet meet all of the above criteria,
the entity will continue to re-assess the contract going forward to
determine whether it subsequently meets the above criteria.
The standard provides detailed guidance on how to account for approved
contract modifications. If certain conditions are met, a contract
modification will be accounted for as a separate contract with the
customer. If not, it will be accounted for by modifying the accounting for
the current contract with the customer. Whether the latter type of
modification is accounted for prospectively or retrospectively depends on
whether the remaining goods or services to be delivered after the
modification are distinct from those delivered prior to the modification.
STEP 2: IDENTIFY THE PERFORMANCE OBLIGATIONS IN THE
CONTRACT
At the inception of the contract, the entity should assess the goods or
services that have been promised to the customer and identify as a
performance obligation: a good or service (or bundle of goods or services)
that is distinct; or a series of distinct goods or services that are
substantially the same and that have the same pattern of transfer to the
customer.
A series of distinct goods or services is transferred to the customer in the
same pattern if both of the following criteria are met:
 each distinct good or service in the series that the entity promises to
transfer consecutively to the customer would be a performance
obligation that is satisfied over time (see below); and
 a single method of measuring progress would be used to measure the
entity’s progress towards complete satisfaction of the performance
obligation to transfer each distinct good or service in the series to the
customer.
A good or service is distinct if both of the following criteria are met:
 the customer can benefit from the good or services on its own or in
conjunction with other readily available resources; and
 the entity’s promise to transfer the good or service to the customer is
separately identifiable from other promises in the contract.
Factors for consideration as to whether a promise to transfer goods or
services to the customer is not separately identifiable include, but are not
limited to:
 the entity does provide a significant service of integrating the goods or
services with other goods or services promised in the contract;
 the goods or services significantly modify or customize other goods or
services promised in the contract;
 the goods or services are highly interrelated or highly interdependent.
Module 5: Franchise Operations
FRANCHISE OPERATIONS
A franchise generally involves the grant from one party (franchisor) to
another party (franchisee), the right to sell the granting party's goods or
services. Each party contribute resources.
The franchisor contributes his trade name, products, company's
reputation and trademarks. He also imparts his expertise and on
continuing basis provides guidance and duties on the manner in which the
franchisee must operate his establishment. The franchisee on the other
hand, provides operational capital and managerial operational resources
required for the operation of the franchised business.
The relation of these parties is covered by a franchise agreement which
outlines the rights and responsibilities of each party, describes the
marketing practices to be followed, details the contribution of each party
and sets certain standards of operating procedures which both parties
agree to perform.
Franchising gives the franchisor the opportunity to distribute his product
and or services with minimum investment in the franchised outlet.
Franchisee is able to own his business, reap financial rewards and benefit
fro the agreement by way of assistance and guidance from the franchisor.
The franchisee, however must pay for these services and must be willing
to accept the franchisor's control over operations.
JOURNAL ENTRIES AND DETERMINATION OF REVENUE, COSTS
AND GROSS PROFIT
Revenue Recognition - Initial Franchise Fees
The problem of recognizing revenue with regard to initial franchise fees,
generally results from two issue:
1. The point at which the fee is to be considered earned; and
2. The assurance of collectibility of any unpaid portion of the fee, if the
total initial franchise fee is not paid in full.
The following accounting principle and procedures are to be used in
the recognition of revenue from the initial franchise fee:
1. Revenue from the initial franchise fee should be recognized on the
consummation of the transaction, which occurs when all material services
or conditions of the sale have been substantially performed. Substantial
performance by the franchisor occurs when the following conditions are
met:
a. The franchisor is not obligated in any way (trade practice, law, intent or
agreement) to refund cash already received or forgive unpaid debt.
INITIAL FRANCHISE FEE
Franchise Fees
b. The initial services required of the franchisor by contract or otherwise
have been substantially performed.
Franchise agreement usually requires franchisee to make payments,
called the franchise fee to the franchisor in consideration for the
reputation, skill products and services contributed by the franchisor. There
are two types of franchise fees, namely;
c. No other material conditions or obligations exist.
1. Initial Franchise Fee
2. Direct franchise costs of initial services rendered by the franchisor shall
be deferred until related revenue is recognized. These costs should not
exceed anticipated related revenue. Indirect costs that occur on a regular
basis should be expensed when incurred.
2. Continuing Franchise Fee
Initial Franchise Fee
It is assumed that substantial performance occur when the franchisee
actually commence operations of the franchise. Once substantial
performance is achieved, revenue from the initial franchise fee should be
recognized using the following methods:
This represents initial payment for establishing the franchise agreement
and for providing certain initial services associated with the agreement.
The initial franchise fee may be payable immediately in cash or for an
extended period of time. The initial services rendered by the franchisor
prior to the opening of the franchisee's operations usually include the
following:
1. Accrual basis - This method is used when the initial franchise fee is
collectible over na extended period of time and the collectibility of the
unpaid portion of the franchise fee is reasonably assured.
a. Assistance in site selection for the construction of the building
2. Gross profit method - If the collectibility of the unpaid portion of the
franchise fee is not reasonably assured.
3. Cost Recovery method - This method should be used in exceptional
cases that is when the initial franchise fee is collectible over an extended
period and the collectibility of the unpaid portion of the initial franchise fee
is uncertain.
Revenue Recognition - Continuing Franchise Fees
Continuing franchise fee is usually collected from the franchisee at the
end of each month base on a certain percentage of their monthly sales.
Continuing franchise fees are recognized as revenue when actually
earned and receivable from the franchisee.
b. Supervision of the construction activity, which involves obtaining
financing, designing building and supervising contractor
c. Assistance in the acquisition of signs, fixtures and equipment
d. Provision of bookkeeping and advisory services
e. Provision of employee and management training
f. Provision of quality control
g. Provision of advertising and promotion
CONTINUING FRANCHISE FEE, BARGAIN PURCHASE OPTION, AND
COMMINGLED REVENUE
Continuing Franchise Fee
This represent continues payment to the franchisor for providing specific
future services, such as advertising and for the continued use of
intangible rights by the franchisee. These fees are usually based on the
operations of franchises.
Commingled Revenue
The franchise agreement ordinarily establishes a single initial franchise
fee as consideration for the franchise rights and the initial services to be
performed by the franchisor. Sometimes, however, the fee also may cover
tangible property, such as signs, equipment, inventory, and land and
building. In those circumstances, the portion of the fee applicable to the
tangible assets shall be based on the fair value of the assets and may be
recognized before or after recognizing the portion applicable to the initial
services. For example, when the portion of the fee relating to the sale of
specific tangible assets is objectively determinable, it would be
appropriate to recognize that portion when their titles pass, even though
the balance of the fee relating to services is recognized when the
remaining services or conditions in the franchise agreement have been
substantially performed or satisfied.
Although a franchise agreement may specify portions of the total fee that
relate to specific services to be provided by the franchisor, the services
usually are interrelated to such an extent that the amount applicable to
each service cannot be segregated objectively. The fee shall not be
allocated among the different services as a means of recognizing any part
of the fee for services as revenue before all the services have been
substantially performed unless actual transaction prices are available for
individual services; for example, through recent sales of the separate
specific services.
Bargain Purchase Option
The franchisee may purchase some or all of the equipment or supplies
necessary for its operations from the franchisor. Sometimes, the
franchisee is given the right to make bargain purchases of equipment or
supplies for a specified period or up to a specified amount, when the initial
franchise fee is paid. If the bargain price is lower than the selling price of
the same product to other customers or if the price does not provide the
franchisor a reasonable profit on the equipment or supply sales, then a
portion of the initial franchise fee shall be deferred and accounted for as
an adjustment of the selling price when the franchisee purchases the
equipment or supplies. The portion deferred shall be either (a) the
difference between the selling price to other customers and the bargain
purchase price or (b) an amount sufficient to cover any cost in excess of
the bargain purchase price and provide a reasonable profit on the sale, as
appropriate.
REPOSSESSED FRANCHISE
A franchisor may recover franchise rights through repossession if a
franchisee decides not to open an outlet. If, for any reason, the franchisor
refunds the consideration received, the original sale is canceled, and
revenue previously recognized shall be accounted for as a reduction in
revenue in the period the franchise is repossessed. If franchise rights are
repossessed but no refund is made, (a) the transaction shall not be
regarded as a sale cancellation, (b) no adjustment shall be made to any
previously recognized revenue, (c) any estimated uncollectible amounts
resulting from unpaid receivables shall be provided for, and (d) any
consideration retained for which revenue was not previously recognized
shall be reported as revenue.
OPTION TO PURCHASE THE FRANCHISE OUTLET
A franchise agreement may give the franchisor an option to purchase the
franchisee's business. For example, a franchisor may purchase a
profitable franchised outlet as a matter of management policy, or
purchase a franchised outlet that is in financial difficulty or unable to
continue in business to preserve the reputation and goodwill of the
franchise system. If such an option exists, the likelihood of the franchisor's
acquiring the franchised outlet shall be considered in accounting for the
initial franchise fee. If at the time the option is given, an understanding
exists that the option will be exercised or it is probable that the franchisor
ultimately will acquire the franchised outlet, the initial franchise fee shall
not be recognized as revenue but shall be deferred. When the option is
exercised, the deferred amount shall reduce the franchisor's investment in
the outlet.
CONSIGNMENT SALES
In some arrangements the delivery of the goods by the manufacturer
(wholesaler) to the dealer (retailer) is not considered to be full
performance and a sale because the manufacturer retains title to the
goods. This specialized method of marketing certain types of products
make use of a device known as a consignment. Under this arrangement,
the consignor (manufacturer) ships merchandise to the consignee
(dealer), who is to act as an agent for the consignor in selling the
merchandise. Both consignor and consignee are interested in selling the former to make a profit or develop a market, the latter to make a
commission on the sales.
Accounting for Consignment Sales
A modified version of the sales basis (regular sales) of revenue
recognition is used by the consignor. That is, revenue is recognized only
after the consignor receives notification of sale and the cash remittance
from the consignee.
account called as inventory on Consignment is used to record
transactions in relation to consignment.
a. Inventory on Consignment account is debited for:
 Cost of goods shipped on consignment
 Expenses related to consignment incurred by the consignor
 Reimbursable expenses related to consignment paid by the
consignee
b. Inventory on Consignment account is credited for:
 Cost of goods returned by the consignee
 Cost of consignment sales and expenses relating to consignment
2. Consignment transaction not recorded separately - consignment
transactions are treated like a regular type of sales. Determination of
consignment profit is not required since it is already part of the profit of
the entire entity.
B. CONSIGNEE
1. Consignment transactions recorded separately - under this method,
two accounts are needed to be maintained in relation to consignment
transactions:
The merchandise is carried throughout the consignment as the inventory
of the consignor, separately classified as Merchandise inventory on
Consignment. It is not recorded as an asset on the consignee's books.
Upon sale of the merchandise, the consignee has liability for the net
amount. The consignor periodically receives from the consignee an
account sales that shows the merchandise received, merchandise sold,
expenses chargeable to the consignment and the cash remitted. Revenue
then is recognized by the consignor.
a. Consignor receivable account is:
 debited for expenses paid by the consignee but chargeable to the
consignor.
 credited when remittance is made to the consignor
The following are procedures in consignment sales transaction:
2. Consignment transactions not recoded separately - consignment
transaction are treated like a regular type of sales. Determination of
consignment profit is not required since it is already part of the profit of
the entire entity.
A. CONSIGNOR
1. Consignment transactions recorded separately - this method
determines consignment profit separate from regular sales. An inventory
b. Consignor payable account is
 credited for the sales by the consignee
 debited when remittance is made by the consignor
SUMMARY
A franchise agreement involves the granting business rights by the
franchisor to a franchisee that will operate the franchise outlet in a certain
geographical location.
Initial Franchise Fee- recorded as revenue only when and as the
franchisor makes “substantial performance” of the services it is obligated
to perform and collection of the fee is reasonably assured.
The franchisor provides the franchisee with the following services:
1. Assistance in site location
a. Analyzing the location
b. Negotiating the lease
2. Evaluation of potential income
3 Conditions to recognize initial franchise fee
a) Services
b) Period of refund
c) Collectibility
JOURNAL ENTRIES
A. Initial Franchise fee-Interest Bearing Note
1. Performed all material services, the refund has expired, collectability is
assured.
Cash
N/R
Franchise Revenue
3. Supervision of construction income
4. Supervision of construction activity
a. Obtaining financing
b. Designing building
c. Supervising contractor while building
5. Provision of bookkeeping and advisory services
a. Setting up franchisee’s records
b. Advising on income, real estate, and other taxes
c. Advising on local regulations of the franchisee business
6. Provision of employee and management training
2. Refund has expired and collectability of the note is reasonably assured,
not
substantially
performed
all
material
services.
Cash
N/R
Unearned Franchise Revenue
Subsequently; when it is performed all services:
Unearned Franchise Revenue
Franchise Revenue
7. Provision of quality control
Substantial Performance – no remaining obligation to refund any cash
received or excuse any non-payment of a note and performed all the
initial services required under the contract
3. Substantially performed all services and the collectability of the note is
reasonably assured, but the refund period has not expired.
General Rule: 90% or more of the services required
Cash
N/R
Unearned Franchise Revenue
Subsequently; the refund period has expired:
Cash
Unearned Franchise Revenue
N/R
Revenue from Franchise
Unearned Interest Income (Discount on N/R)
Franchise Revenue
4. Substantially Performed all services, refund period has expired, but the
collectability of the note is not reasonably assured - use installment
method
Cash
2. If the probability of refunding the initial franchise fee is extremely low,
future services to be provided to the franchisee is minimal, collectability of
the note is reasonably is assured, substantial performance has occurred
Cash
N/R
N/R
Franchise Revenue
Unearned Interest Income
Unearned Franchise Revenue
Subsequently, it recognizes it over period of time:
Unearned Franchise Revenue
Franchise Revenue
5. Refund has expired, Substantially performed all services, no basis for
estimating the collectability of the note (uncertain) - use cost-recovery
method.
Franchise Revenue
3. Initial down payment is not refundable, represents a fair measure of the
services already provided, significant amount of services still to be
performed, collectability of the note is reasonably assured.
Cash
N/R
Unearned Interest Income
Cash
Franchise Revenue
Unearned Franchise Revenue
Unearned Franchise Revenue
Subsequently, collectability is assured.
Unearned Franchise Revenue
Franchise Revenue
B. Initial Franchise Revenue-Non Interesting Fee
1. Reasonable expectation that the down payment may be refunded,
substantial future services remain to be performed
4. Initial down payment is not refundable, and no future services are
required by the franchisor, collection of the note is uncertain
Cash
Franchise Revenue
**when the collection of the note is extremely uncertain, revenue through
gross profit is recognized by means of cash collection using the cost
recovery method.
5. Same case in #4 but the initial down payment is refundable or
substantial services are yet to be performed.
Cash
Unearned Franchise Revenue
Franchisor’s Costs
- match related costs and revenues by reporting them as a component
of income in the same accounting period.
- ordinarily defer direct costs
- Indirect cost should expense immediately.
Continuing Franchise Fees
- received in continuing rights granted by the franchise agreement and
for providing such service.
- it should be reported as revenue when they are earned and
receivable from the franchisee, unless a portion of them has been
designated for a particular purpose