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LEARNING OBJECTIVES
ACCOUNTING PROCESS
(A Review)
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DEFINITION and NATURE OF ACCOUNTING
1. External Users - they are groups or individuals who are not directly concerned with
the day-to-day operation of the entity but are indirectly related to the said entity.
They include creditors, investors, potential creditors and investors, government and
the public. They make decisions that affect their relationship to the entity.
2. Internal Users - they are the management personnel in all levels within and entity
who are responsible for the planning and control of the operations and therefore, they
have access to the day-to-day operations of the entity. They make decisions the
internal operations of the entity.
Generally, the reports provided by the accountants are expressed and measured in financial or
money terms; these reports are called financial reports and are of various types. One type of
financial reports are the general-purpose financial statements. These Conceptual Framework for
Financial Reporting issued by the Financial Reporting Standard Council (FRSC) identifies
existing and potential investors, lenders and other creditors as the primary users of general-
purpose financial statements. Other users include regulators and members of the public other than
investors, lenders and other creditors. The following are some of the users of financial
information and the use of such information in the decisions that they make.
1. Investors - they are concerned with the risk inherent in, and return provided by, their
investments. They need information to help them determine whether they should make
additional investments, hold or sell their investments. Shareholders (owners or investors
in a corporation) need information that will enable them to asses the ability of the
corporation to pay dividends.
2. Lenders - they are interested in information that enable them to determine whether their
loans, and the interest attaching to them, will be paid when due.
3. Suppliers and other trade creditors - they are interested in information that enable them
to determine whether amounts owing to them will be paid when due.
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4. Employees – they are interested in the information about the stability and profitability of
their employers. They are also interested in information that will enable them to assess the
ability of their employers to provide remuneration, retirement benefits and employment
opportunities.
5. Customers – they are interested in the information about the continuance of an entity,
especially when they have a long-term involvement with, or are dependent on, the entity
6. Government and their agencies – they are interested in the allocation of resources and,
therefore, the activities of the entities. They also require information so that they can
regulate the activities of entities, determine taxation policies and as the basis for national
income and similar statistics.
7. Public – they are interested in information about the trends and recent developments in
the prosperity of the entity and the range of its activities.
ACCOUNTING PROCESS
Accounting process refers to the procedures or series of steps undertaken to come up with the
information reported in the financial statements. The accounting process is also referred to as the
accounting cycle.
The accounting process is divided into two phases, namely; (1) the recording phase and (2)
summarizing phase. These two phases and the steps under each phase are discussed in the
succeeding paragraphs.
RECORDING PHASE
The recording phase includes collecting information about economic transactions and the
recording of these transactions in the appropriate accounting records. A transaction is an
economic event that changes an asset, a liability, or an equity account balance; hence it must be
recorded. Accounting records, on the other hand, include business documents, journals, and
ledgers.
Transactions are recorded in terms of debits and credits (double-entry system). Debit is the left
side of an account while credit is the right side of an account. Following are the rules of debuts
and credits:
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Debit Credit
Increase in asset Decrease in asset
Decrease in liability Increase in liability
Decrease in equity due to Increase in equity due to
i. Withdrawal by owner/s i. Additional investments by
ii. Decrease in income owner/s
iii. Increase in expense ii. Increase in income
iii. Decrease in expense
BUSINESS
TRANSACTION
DOCUMENTATION PREPARATION OF
REVERSING ENTRIES
JOURNALIZING PREPARATION OF
General Journal POST-CLOSING
Special Journals TRIAL BALANCE
JOURNALIZING AND
POSTING POSTING OF
General Ledger ADJUSTING AND
Subsidiary Ledger CLOSING ENTRIES
PREPARATION OF
FINANCIAL
PREPARATION OF A STATEMENTS
TRIAL BALANCE Statement of
Financial
Position
Statement of
Comprehensive
Income
COMPILATION OF PREPARATION OF Statement of
DATA FOR WORK SHEET/ END-OF- Cash Flows
Statement of
ADJUSTMENTS PERIOD SPREADSHEET
Changes in
Equity
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Key Points:
If a work sheet is not prepared, the adjusting entries must be journalized and posted
before the financial statements can be prepared. This is because the basis for the
preparation of the financial statements are the updated balances of the account in
the general ledger.
The cycle is a continuing process and steps may overlap during an accounting
period
2. Journalizing — this is the process of recording transactions for the first time in the
accounting books called journals. This is the reason why the journals are called
books of original entry. Transactions are recorded based on the documents prepared
or received in number (1) above.
The company may use a general journal and one or more special journals. The general is
the most flexible type of journal where almost all type of transactions can be recorded. On
the other hand, the special journals are used in recording transactions that are usual and
that occur frequently or on a repetitive basis. The types of special journals are the sales
journal, purchases journal, cash receipts journal, and cash disbursement journal.
A company may maintain both a ledger and subsidiary ledger depending upon its needs. The
general ledger is the principal ledger which contains all the accounts that are reported in the
financial statements, namely; assets, liabilities, equity, income, and expenses. It also
includes contra and adjunct accounts. Contra accounts are accounts established to record
deductions from related accounts with positive balances such as Accumulated Depreciation
(deducted from Property, Plant & Equipment), Discount on Notes Payable (deducted from
Notes Payable), Sales Discount (deducted from Sales), and Purchases Discount (deducted
from Purchases). Adjunct Accounts are accounts set up to record additions to related
accounts such as Freight-In (added to Purchases).
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The subsidiary ledgers contain details of some general ledgers account balances. For
example, the Accounts Receivable and Accounts Payable account balances are found in
General Ledger. The compositions of their balances are found in the subsidiary ledgers. To
illustrate, let us assume that Bountiful Merchandising reports account receivable from
customers totaling P2,500,000. This total amount of P2,5000,000 is reflected in the
Accounts Receivable account in general ledger. The names of customers and the amount due
from each of them are found in the subsidiary ledger. A general ledger account that has a
supporting subsidiary ledger is called a control account.
SUMMARIZING PHASE
Payable xx
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Example: The ABC company has an outstanding 90-day, 12% note payable
dated December 1, 2014amounting to P200,000. The interest is payable upon
maturity of the note. The company’s accounting period or financial year is the
calendar year, that is, January 1 to December 31. Interest for 30 days has accrued
on the note as of December 31, 2014 (that is December 1 to December 31). The
adjusting entry to record the accrued interest is as follows:
Example 2 – DEF Company pays salaries every Friday, the end of a five-day work week.
The total salaries for the week ending January 3, 2015 is P150,000.
In this case, the P150,000 salaries for the week ending January 3, 2015 is for the services
rendered by the employees on December 30, December 31, January 1, January 2, and
January 3. Therefore, the company ahs accrued salaries for two (2) days, as of January 31,
2015. The adjusting entry to record the accrued salaries is as follows:
b. Accrued Income – this is the income earned but not yet received or collected as
of the statement of financial position date, such as accrued interest on notes
receivable. An accrued income is not yet collected but is matched with expenses
for current period. The adjusting entry to record accrued income is as follows:
Receivable xx
Income xx
Example 3 - GHI Company received a 3-month, 12% note dated December 1, 2014
amounting P100,000. Interest is receivable upon maturity of the note.
As of December 31, 2014, interest for one month (that us, December 1 to December 31) is
already earned but not yet collected. The adjusting entry to record the accrual interest
income is as follows
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c. Prepaid Expense - this is an expense pair od acquired in advance such as
insurance premium. Other examples are rent paid in advance and office supplied
purchased. The adjustment relating to prepaid expense at the end of accounting
period depends on the method used in recording the initial payment or
acquisition.
There are two methods of recording prepayments, namely; the asset method and
expense method. Under the asset method, the payment or purchase is initially
debited to an asset account. At the end of the accounting period, the expired or
used portion of the asset is transferred to an expense account. Under the expense
method, the payment or purchase is initially debited to an expense account. At
the end of the accounting period, the unexpired or unused portion of the asset is
transferred to an asset account.
Example 4 – On Mau 1, 2014, JKL Company paid insurance premium of P30,000 covering
a period of one year beginning on this date. The entries to record the payment on May 1 and
the adjusting entry on December 31 under the two methods are presented below:
ASSET METHOD
2014
May 1 Prepaid Insurance 30,000
Cash 30,000
December 31 Insurance Expense 20,000
Prepaid Insurance 20,000
The expired portion of the insurance premium is for the period May 1 to December 31,
2014, or a period of eight (8) months
EXPENSE METHOD
2014
May 1 Insurance Expense 30,000
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Cash 30,000
December 31 Prepaid Insurance 10,000
Insurance Expense 10,000
P30,000 x 4/12 = P10,000
The unexpired portion of the insurance premium is 4 months, that is, 12 months less the
expired portion of eight (8) month
d. Unearned Income – this is income already collected but not yet earned as of the
statement pf financial position dare, such as rental income collected in advance
or subscriptions received in advance. Unearned income is also known as deferred
income. Like prepaid expense, the adjustment for unearned income at the end of
the accounting period depends on how the nitial receipt of each is recorded
The receipt of the advance payment may be recorded using the liability method or
income method. Under the liability method, the collection is initially credited to a
liability account, at the end of the accounting period, the earned portion of the
income is transferred to an income account. Under the income method, the collection
is initially credited to an income account, at the end of the accounting period, the
unearned portion of the income is transferred to a liability account. The following are
comparative entries to record the receipt of cash and the adjustment at the end of the
accounting period under two methods:
LIABILITY METHOD
2014
September 1 Cash 240,000
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Unearned Rent 240,000
The earned portion is the rent for the period September 1 to December 31 or four (4)
months
INCOME METHOD
2014
September 1 Cash 240,000
Rent Income 240,000
The unearned portion is the rent for eight (8) months; that is, twelve (12) months less the
earned portion of four (4) months.
The depreciation expense for the period is determined using any of the
acceptable methods identified in PAS 16- straight-line method, diminishing
balance method, and units of production methods. The straight-line method will
be used in the illustration and problems in this chapter and in all other chapters
of this book. The other methods will be discussed in higher accounting subjects.
Under the straight-line method, the annual depreciation expense I computed as
follows:
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If the asset is used for less than a year, the proportionate expense should be
calculated, unless the company adopts a different policy such as providing half-
year depreciation in the year of acquisition of the asset.
Other cost allocation includes amortization of intangible assets like franchise and
patents. This topic is being discussed in higher accounting subjects.
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2013
Dec 31 Depreciation Expense 15,000
Accumulated Depreciation 15,000
(P310,000 – P10,000)/5 yrs. X 3/12
Depreciation expense for 2013 is for three months; that is, October 1 to December 31, 2013
2014
Dec 31 Depreciation Expense 60,000
Accumulated Depreciation 60,000
Depreciation expense for 2014 is for one year or twelve (12) months.
f. Uncollectible accounts – these represent customer’s accounts that may no longer collected or
that may possibly become bad debts. PAS No.39 provides that trade accounts receivable should
be reported in the statement of financial position at amortized cost. Amortized cost is defined as
the amount at which the receivable is measured at the time it was first recognized minus any
payments and minus any reduction (directly or through the use of an allowance account) for
uncollectibility. The entry to record estimated uncollectible accounts is as follows:
PAS No. 39 requires a careful assessment of the collectability of the receivables (classified as
financial assets). Several considerations have to be taken account, which will be discussed
thoroughly in higher accounting subject. For purposes of discussion in this book, the
estimated uncollectible amount will be provided.
The amount of uncollectible accounts expense that will be reported in the income statement is
computed as follows:
Required allowance balance Pxxx
Allowance balance before adjustment
(+ debit balance/ - credit balance) xxx
Uncollectible accounts expense for the period Pxxx
The amount “Allowance for Uncollectible Accounts” is a contra asset account; it is reported on
the statement of financial position as a deduction from Accounts Receivable.
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Example 7: STU Company’s trial balance dated December 31,2014, contains the following
information:
Accounts receivable P 350,000 debit
Allowance for uncollectible accounts 2,000 credit
Sales 1, 850,000 credit
g. Inventory – adjustment for inventory is necessary if the periodic inventory system is used.
Under the periodic inventory system, the company does not record the physical movement of
goods. Purchases of goods are recorded in the nominal account “Purchases”. The reduction in
inventory resulting from sale is not reflected in books. Thus, the balance of the Inventory account
shown in the company’s trial balance represents inventory at the beginning of the period. Because
of this adjusting entries are necessary to reflect the inventory at the end of the period.
There are two methods of recording adjustments related to inventories. Under the first method,
two entries are prepared: (1) to transfer the beginning inventory balance to the Income Summary
account and (2) to establish ending inventory balance. The entries are as follows:
Under the second approach, a separate cost of goods sold account is set up and the entry to record
the adjustments is as follows:
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The balance of the Cost of Goods Sold account is closed to Income Summary as part of
the normal closing entries.
6. Preparing a work sheet/end-of-period spreadsheet – this step is optional but it facilitates the
preparation of the financial statements. A work sheet is a working paper which contains the data
in the trial balance, the adjustments compiled in step 5, and the developed income statements and
statement of financial position data. Normally, four pairs of columns are maintained to achieved
the purpose by which the worksheet is prepared. The first pair of amount of columns is for the
trial balance data; the second pair is for the adjustments; the third pair is for the income statement
data; and the fourth pair is for the statement of financial position data. In some cases, another pair
of column for adjusted trial balance is added following the adjustments columns and preceding
the income statements columns. Working papers are usually prepared by using a computer
spreadsheet program such as Microsoft’s Excel.
7. Preparing the financial statements – after the work sheet is completed, the financial
statements are prepared. The data reported in the statements are taken from the completed work
sheet. However, if a work sheet is not prepared, the adjusting data must be journalized and posted
before the financial statements can be prepared. This is because the data reported in the
statements are taken from the updated balances of the accounts in the general ledger. The
financial statements are described as the end product of the accounting process.
PAS 1 provides that a complete set of financial statements shall consists of the following:
1. Statement of financial position (balance sheet)
2. Statement of comprehensive income
3. Statement of cash flows
4. Statement of changes in owner’s equity
5. Notes
An entity may prepare a single statement of comprehensive income or two separate statements – a
statement of income and statement of other comprehensive income. Other comprehensive income
includes items of unrealized gains and losses that are not reported as part of profit or loss, such as
revaluation surplus arising from reporting of plant assets at revalued amounts and gain (loss)
from change in fair value of investments classified as available for sale.
8. Adjusting and closing the books – the adjustments that were recorded in the work sheet are
now formally recorded in the general journal and posted to the accounts in the general ledger. The
balances of the nominal (temporary) accounts, which consist of income, expense, and drawing
accounts, are then closed to Income Summary account. The balance of the Income Summary
account is then transferred to the owner’s equity (capital) account. A debit balance in the Income
Summary account represents a loss while a credit balance represents a profit. Lastly, the
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balance of the owner’s drawing account is closed to owner’s equity (capital) account. When the
closing process is completed, all nominal accounts will have zero balances.
Following are the pro-forma closing entries prepared at the end of the accounting period:
1. To close the balances of income accounts
Revenue/Income xxx
Income Summary xxx
9. Preparing a post-closing trial balance – this step is done after all the balances of nominal
accounts have been closed, that is, their balances were reduced to zero. Therefore, a post-closing
trial balance contains only the real accounts (assets, liabilities and equity); the balances of these
accounts are carried forward to the next accounting period. A post-closing trial balance is
prepared to check the equality of debits and credits after journalizing and posting the closing
entries.
10. Reversing the accounts – certain adjusting entries recorded at the end of the accounting
period are reversed at the beginning of a new accounting period. These adjustments include
accrued expenses, accrued revenues or income, prepaid expenses recorded under the expense
method and deferred revenues or income recorded under the revenue method.
The preparation of reversing entries is optional but it facilitates the recording of expense
payments and revenue receipts in the new period in the usual manner. This means that expense
payments are recorded as a debit to an expense account and a credit to cash; revenue receipts are
recorded as a debit to cash and a credit to revenue or income account.
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The adjustment that will be reserved if reversing entries are prepared and the pro-forma reversing
entries prepared at the beginning of a new accounting period are as follows:
1. Accrued Expense
Payable xxx
Expense xxx
2. Accrued Income
Income xxx
Receivable xxx
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3. Preparing adjusting entries and understanding the rationale for preparing them. Adjusting
entries are prepared at the end of the accounting period to update the balances of the accounts in
the general ledger prior to the preparation of the financial statements. This will enable the
preparers of the financial statements to present fairly the financial position and the results of
operations of an entity during a given period because all transactions that have affected the
elements of the financial statements are recognized during the period. Data that require
adjustments includes the following: (1) accrued expense, (2) accrued income, (3) prepaid
expense, (4) unearned income, (5) depreciation and other cost allocation, (6) uncollectible
accounts receivable, and (7) inventory recorded using the periodic inventory system.
4. Prepare closing entries and understand the rationale for preparing them. Closing entries are
prepared for nominal accounts to reduce their balances to zero at the end the accounting period.
Nominal accounts include the following: income accounts, expense accounts, and temporary
equity accounts, such as the drawing account of the owner in a sole proprietorship form of
business organization.
5. Explain the advantage of preparing the reversing entries and identify adjusting entries that
may be reversed. Reversing entries are prepared at the beginning of a new accounting period for
the following adjustments: (1) accrued expense, (2) accrued Income, (3) prepaid expense
recorded under the expense method, and (4) unearned income, recorded under the income
method. The preparation or reversing entries is optional but it facilitates the recording of expense
payment and revenue receipts during the new accounting in the usual manner.
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Closing entries - entries prepared at the end of the accounting period that reduce the balance of
nominal accounts to zero.
Depreciable amount - the cost of an item of property, plant and equipment, or other amount
substituted for cost minus its residual value.
General journal - the most flexible type of journal. All transactions may be recorded in the
general journal.
General Ledger - principal ledger that contains all the accounts reported in the financial
statements.
Journals - also known as books of original entry. They include both general journal and special
journals.
Ledgers - also known as books of final entry. They include both general and subsidiaries ledgers.
Nominal accounts - also known as temporary accounts. They are accounts whose balances are
reduced to zero at the end of the accounting period. Nominal accounts include revenue or income
accounts, expense accounts, and temporary equity accounts, such as drawing account.
Prepaid expense - expense paid or acquired in advance; expense paid or incurred but not yet
incurred or consumed. Prepaid expense has been paid or acquired as of the statement of financial
position date but not matched against earnings for the current period.
Post-closing trial balance - a trial balance prepared after closing the books. The post-closing trial
balance contains real accounts only.
Real accounts - also known as permanent accounts. They are accounts whose balances are
carried forward to the next accounting period and they include asset, liability, and equity
accounts.
Reversing entries - entries prepared at the beginning of a new accounting period to reverse
certain adjusting entries. They are prepared to facilitate the recording of expense payments and
revenue receipts during the new accounting period in the usual manner.
Special journals - journals used to record repetitive or frequently occurring transactions. They
include sales journals, purchases journal, cash receipts journal and cash disbursements journal.
Subsidiary ledger - a ledger that provides details of a general ledger account.
Trial balance - a list of general ledger accounts with their corresponding balances. It proves the
equality of debits and credits.
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Unearned income - also known as deferred income. This is income collected but not yet earned
or realized. Unearned income is not collected but is not matched against expense for the current
period.
DISCUSSION QUESTIONS
1. What is accounting and what is its purpose? What is its role in decision-making?
2. Who are the users of accounting information and what is the relevance of the information to
the various types of decisions that they make? Who are the users of financial statements and what
are their information needs?
3. What are the steps in the accounting process? What is the importance of each step and how it is
related to the other steps in process?
4. Why are journals are called books of entry?
5. Distinguish between (a) a general journal and special journals, and (b) a general ledger and a
subsidiary ledger.
6. Does the trial balance prove the accuracy of accounting work done? Explain your answer.
7. What are the common types of adjusting data? Why do we prepare adjusting entries?
8. Why do accounts prepare work sheet even if its preparation is optional?
9. Enumerate and discuss the components of a complete set of financial statements.
10. If reversing entries are made, which adjusting entries would be reversed?
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EXERCISES
Debit Credit
1. Uncollectible Accounts Expense
2. Prepaid Rent
3. Offices Supplies on Hand
4. Salary Expense
5. Insurance Expense
6. Interest Receivable
7. Interest Expense
8. Rent Income
9. Depreciation Expense
10. Inventory, end
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Exercise 1-3 (Adjusting and Reversing Entries – Prepaid Expenses and Unearned Revenues)
This following are selected transactions of the ABC Trading during the year 2014:
a. On December 1, 2014, the company received P300,000 representing rental payments for
the period December 1,2014 to November 30, 2015.
b. On March 1, 2014, an insurance premium of P90,000 was paid covering a period of one
year beginning on this date.
Instructions: Provide the necessary adjusting entries as of December 31, 2014 and appropriate
reversing entries as of January 1, 2015 assuming:
DEF Merchandising follows the policy of recording prepayments in revenue and expense
accounts and reverses appropriate adjusting entries at the beginning of the new accounting period.
The record of the business show the following:
a. On September 1, 2014, DEF borrowed P2,000,000 cash from the Bank of the Philippines
by issuing a 6% note payable in one year. The interest is payable upon maturity of the
note.
b. On February 1, 2014, DEF paid insurance premium of P72,000 covering a period of three
years beginning on this date.
c. On December 1, 2014, DEF paid P360,000 representing the rental for one year starting on
this date.
d. DEF reports accounts receivable of P1,500,000 and allowance for uncollectible accounts
of P10,000 (debit balance); P50,000 of the receivables are uncollectible
e. DEF pays all employees every Friday. The total payroll for the five-day workweek ending
January 3, 2015 is P450,000
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g. Office supplies on hand on January 1, 2014 amounted to P5,000. During this year, office
supplies of P12,500 were purchased. On December 31, 2014, there are unused supplies of
P4,500.
h. DEF subleases part of its office space for P30,000 per month. On November 1, 2014, it
received rental payments for six months starting on this date.
i. Merchandise inventory on January 1 and December 31 amounted to P180,0000 and
P220,000, respectively.
Instructions:
1. Prepare the necessary adjusting entries on December 31, 2014.
2. Prepare appropriate reversing entries as of January 1, 2015.
Instructions:
1. Prepare the required adjusting entries for inventory under the two approaches.
2. Prepare the required closing entries as of December 31, 2014 using the approach in which
no separate cost of goods sold account in set up in adjusting the inventory balance.
For each of the accounts listed below, indicate whether the balance should be: (a)
carried forward to the next accounting period, (b) closed by crediting the account, or
(c) closed by debiting the account.
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___4. Cash ___14. Prepaid Insurance
___5. Freighht-in ___15. Purchase Discounts
___6. Income Summay ___16. Purchases
___7. Interest Payable ___17. Salaries Payable
___8. Interest Revenue ___18. Salaries
___9. Lacap, Capital ___19. Sales Discounts
___10. Lacap, Drawing ___20. Sales Returns and Allowances
PROBLEMS
Problem 1-1 (Adjusting and Reversing Entries)
In analyzing the accounts of MNO Company, the information listed below are
determined on December 31, 2014, the end of the first year of operations of the
company:
a. The prepaid Insurance account shows a total of 48,000 representing the cost of a one-year
insurance policy dated October 1, 2014.
b. On November 1, Rent Revenue was credited for P270,000 representing rental for nine
months beginning on that date.
c. Supplies of P20,000 were purchased during the year and were debited to the Supplies
Expense account. On December 31, supplies of P4,500 are on land.
d. The company acquired equipment on April 1, costing P350,000. The assests have
estimated usefule life of five years without any residual value.
e. Accounts receivable balance on December 31 amounted to P1,500,000. Of this amount,
P8,000 are estimated to become uncollectible.
f. The notes receivables account has a balance of P150,000 representing a 90-day, 12 % note
received on December 1. The interest on the note is collectible upon maturity.
g. Unpaid salaries as of December 31 amounted to P155,000.
h. Merchandise inventory on December 31 is P122,000.
Instructions:
1. Prepare the necessary adjusting entries as of December 31, 2014.
2. Prepare the appropriate reversing entries as of January 1, 2015.
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Sales 5,700,000
Sales Returns and Allowances 150,000
Purchases 3,000,000
Freight-in 120,000
Purchases Returns nad Allowances 90,000
Supplies Expense 18,000
Insurance Expense 27,000
Salary Expense 540,000
Depreciation Expense 24,000
Office Expense 150,000
Instructions: From the information given above, prepare the necessary closing entries
as of December 31, 2014.
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Problem 1-4 (Adjusting and Closing Entries)
The trial balance of VWX Advertising Agency before and after the posting of
adjusting entries is shown below:
VWX Advertising Agency
Trial Balance
December 31, 2014
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Problem 1-5 (Adjusting Entries)
The XYZ Realty operates with an annual accounting period that ends on December
31. The trial balance of the company at the end of the current year 2014 follows:
Cash 1,300,000
Accounts Receivable 550,000
Prepaid Insurance 50,000
Office Equipment 750,000
Accumulated Depreciation – Office Equipment 150,000
Automobile 1,300,000
Accumulated Depreciation – Automobile
260,000
Accounts Payable 110,000
Unearned Management Fees
120,000
Primo, Capital
840,000
Primo, Drawing 350,000
Management Fees Earned 3,600,000
Office Salaries Expense 450,000
Advertising Expense 100,000
Rent Expense 150,000
Telephone Expense 30,000
Utility Expense 50,000
5,080,000 5,080,000
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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 c. Interest Revenue
b. Depreciation Expense d. Salaries Payable
MC 1-5 Closing entries ultimately will affect
a. Cash Account c. Total Assets
b. Owner’s Capital Account d. Total Liabilities
MC 1-6 Probably, the last account to be listed on a post-closing trial balance would
be
a. Income Summary c. Interest Revenue
b. Interest Expense d. Owner’s Capital
MC 1-7 Which of the following is not considered in computing net cost of purchases?
a. Purchases
b. Purchase 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 that uses the periodic inventory system
a. Cost of Goods Sold c. Purchase Returns and Allowances
b. Income Summary d. All of these
MC 1-9 After all adjusting entries are posted, the balances of all assets, liability,
income and expense accounts correspond exactly to the amounts in the
a. Financial Statements c. Unadjusted Trial Balance
b. Post-closing Trial Balance d. Worksheet Trial Balance
MC 1-10 Insurance Expense account has a balance of P180,000 before adjustment.
This amount represents insurance premium for three months beginning November 1,
2014. Based on these data, the prepaid insurance that should be reported in the
December 31, 2014 statement of financial position is
a. P-0- c. P72,000
b. P36,000 d. P108,000
27
MC 1-11 A P50,000 purchases on account was paid after the expiration of the 2%
discount period. The entry to record the payment would include
a. Debit to accounts payable for P50,000
b. Credit to accounts payable for P49,000
c. Debit to purchase discount for P1,000
d. Credit to cash for P49,000
MC 1-12 Prior to adjustments, Supplies Expense account has a balance of P13,500.
Adjustment data gathered shows that supplies inventory on hand at year-end
amounted to P5,500. The amount of supplies to be shown in the income statement is
a. P-0- c. P8,000
b. P5,500 d. P13,500
MC 1-13 Rent income account has a credit balance of P240,000 composed of the
following:
a. Rental for three months ending March 31, 2014, P45,000
b. A credit of P195,000 representing advance rental payment for one year beginning Aprl
1, 2014.
The December 31 adjusting entry will require a debit to Rent Income and a credit to
Unearned Rent of
a. P45,000 c. P191,250
b. P48,750 d. P195,000
MC 1-14 The Giveaway Enterprises reported an allowance for uncollectible accounts
of P16,000 (credit) at December 31, 2014, before any adjustment. At the end of the
year, the company reports accounts receivable of P800,000, 3% of which is estimated
to be uncollectible. The adjusting entry required at December 31, 2014 would be
a. Uncollectible Accounts Expense 8,000
Allowance for Uncollectible Accounts 8,000
28
Test Material No. 1 Rating
__________________
Name Date
__________________________________ _______________________
Year and Section - Professor
_________________________ ___________________
TRUE or FALSE
Instructions: Encircle the letter T if the statement is true and the letter F if the
statement is false.
1. Accounting is a service activity whose function is to provide quantitative
information about economic entities.
2. The records used for the initial recording of business transactions are journals.
3. The rules for debit and credit and the normal balances of liabilities are the same
as for Capital.
4. Special journals are used to record usual and frequent transactions.
5. The preparation of work sheet eliminates the need to journalize and post
adjusting entries.
6. The accounting process consists of the recording phase and reporting phase.
7. The purpose of a trial balance is to reconcile subsidiary ledger balances with the
general ledger balances.
8. Accumulated depreciation is an example of an adjunct account.
9. The general ledger includes all accounts appearing in the financial statements,
subsidiary ledger provide details in support of certain general ledger
balances.
10. Entering a debit balance in an account as a credit will cause the trial balance to
be out of balance by an amount that is divisible by two (2).
11. Adjusting entries are made to correct errors made in the recording phase.
29
17. The asset and liability accounts are known as real accounts.
18. The adjusted trial balance is prepared after the financial statements are
Prepared.
19. Owner’s equity is the excess of an entity’s assets over its liabilities.
20. The general ledger account that summarizes the detailed information in a
subsidiary ledger is known as control account.
21. The balance sheet shows the financial position of a company at a given date.
22. Te difference between the debit total and the credit total in the statement of
financial position section of the work sheet represents the profit or loss during the
period.
23. Recording the expiration of a prepaid asset results in the reduction of the asset
account and an increase in a related expense account.
24. Reversing entries are prepared at the end of the accounting period.
25. Since new and revenue accounts will be opened in the subsequent accounting
Subsequent accounting period, it is no longer necessary for an entity to
post the
closing entries to the accounts in the ledger.
30
Test Material No.2 Rating _________
31
d. credit to accounts payable
5. An adjusting entry for unearned revenue is requires because cash is received
a. before the revenue is earned
b. after the revenue is earned
c. as revenue is earned
d. after the balance sheet date
6. An adjusting entry for accrued expense is required because cash is paid
a. before the expense is incurred
b. after the expense id incurred
c. as the expense id incurred
d. after the balance sheet date
7. An entry requiring a debit to an expense account and a credit to an asset account is an example
f an adjusting entry classified as
a. accrued expense c. prepaid expense
b. Depreciation d. uncollectible accounts
8. The post-closing trial balance is prepared
a. after preparing the financial statements
b. after completing the work sheet
c. after preparing the closing entries
d. at any time in the accounting cycle
9. Depreciation is the process of
a. saving money to the purchase of new assets
b. systematically allocating the cost of plant assets over their useful life
c. systematically recording the current market value of plant assets
d. recording the physical deterioration of plant assets
10. Which of the following accounts would not be use in an adjusting entry?
a. Accumulated depreciation c. Interest expense.
32
b. equipment d. Salaries payable
11.In the accounting cycle,which step follows the preparation of financial statements?
a. Journalize and post transactions as they occur
b. Journalize and post adjusting and closing entries
c. Prepare the work sheet
d. Prepare a post- closing trial balance
12 .An entry requiring a debit to an expense account a credit a liability account is an example of
adjusting entry classified as
a. accrued expense c. prepaid expense
b. Depreciation d. uncollectible accounts
13. A post-closing trial balance is prepared after
a. combining trial balance and adjustment figures
b. preparing the financial statements
c. completing the work sheet
d. journalizing and posting the closing entries
14. A debit column total is greater than the credit column total in the income statement section
of the worksheet. This means that
a. mistakes were made in the preparation of the adjusted trial balance
b. the company had a profit
c. the company had a loss
d. the Income Summary account will have a credit balance after the nominal accounts are
closed
15. Closing entries are journalized and posted before
a. financial statements are prepared
b. adjusting entries are journalized and posted
c. post-closing trial balance is prepared
d. work sheet is completed
33
16. Before the adjusting entries are entered on the work sheet
a. the trial balance debit and credit column totals are not equal
b. the trial balance account balances do not reflect updated balances
c. the post-closing trial balance must be completed
d. the financial statements are prepared
17. Nominal accounts are also called
a. mixed accounts
b. permanent accounts
c. real accounts
d. temporary accounts
18. Which of the following items is not found in the work sheet?
a. Adjustments c. Income statement
b. General journal d. Statement of Financial Position
19. Which of the following items has no effect on owner’s equity?
a. Expense c. Revenue
b. Land Acquired d. Withdrawals
20. The summarizing phase includes all of the following steps except
a. journalizing and posting adjusting entries
b. journalizing and posting closing entries
c. preparing the trial balance
d. transferring the recorded transactions in the journal to the accounts in the ledger
34
Test Material No.3 Rating _________
35
a. decrease of P36, 000 c. decrease P45, 000
b. increase P39, 000 d. increase of P51, 000
6. Carlos Company paid four months rent on August 1and debited Rent Expense for P80,000. On
August 31, Carlos should
a. debit Prepaid Rent for P20, 000
b. credit Prepaid Rent for P20, 000
c. credit Rent Expense for P20, 000
d. credit Rent Expense for P60, 000
7. Dagohoy Organizers purchased an equipment costing P100, 000 on July 1, 2014. The
equipment has an estimated useful life of 10 years with an estimated residual value of P10, 000.
The balance of the Accumulated Depreciation account on December 31, 2015 is
a. P4, 500 c. P13, 500
b. P5, 5000 d. P15, 000
8. The Unearned Service Revenue account shows an adjusted end-of-year balance of P 300,000.
The adjusting entry to Unearned Service Revenue indicated P400, 000 in the service revenue
earned during the accounting period . What was the balance of the Unearned Service Revenue
account before the adjusting entry was recorded?
a. P100, 000, credit c. P700, 000, credit
b. P100, 000, debit d. P700, 000, debit
9. Esteves Company has a P180,000, 105, 90-day note receivable outstanding at December 31.
The note is dated December 1, 2014. The appropriate adjusting entry made to record accrued
interest on the note at year-end. What is the correct reversing entry on January 1 of the following
year?
a. Debit Interest Revenue and credit Interest Receivable , P1,500
b. Debit Interest Receivable and credit Interest Revenue, P1, 500
c. Debit Interest Revenue and credit Interest Receivable, P4, 500
d. Debit Interest Receivable ND CREDIT Interest Revenue, P4, 500
10. In the worksheet, the Income Statement debit column equals P700,000 and the credit column
equals P800,000. Which of the following statement id correct?
a. The company realized a profit of P100,000 and it must be added to the Income Statement
debit column and the Statement of Financial Position credit column to complete the work
sheet.
36
b. The company incurred a loss of P100,000 and it must be subtracted from the Income
Statement debit column and the Statement of Financial Position credit column to complete
the work sheet.
c. The company incurred a loss of P100,000 and it must be added to the Income Statement
credit column and the Statement of Financial Position debit column to complete the work
sheet.
d. The company realized a profit of P100,000 and it must be subtracted from the Income
Statement debit column and added to the Statement of Financial Position debit column.
11. The balances of the following accounts were closed to the Income Summary account; Salary
Expense, P50,000 debit; Cost of Goods Sold, P80,000 debit; Utility Expense P25,000 debit Sales,
P200,000 credit . The amount and the entry to close Income Summary to the Capital account
would be
a. P45, 000 credit to the Income Summary account
b. P45,000 debit to the Income Summary account
c. P155,000 debit to the Income Summary account
d. P200,000 credit to the Income Summary account
12. If the Income Summary Account has a credit balance of P150,000 before its balance is closed
to the Capital account, you know that
a. revenues exceeded expenses by P50, 000
b. the company had a loss of P100, 000
c. the company had a profit of P150, 000
d. the owner invested an additional P150, 000 in the business
13. The cost of goods sold available for sale is P1, 300, 000. The gross profit is P300, 000, net
sales amounted to P1,000,000, net purchases are P1, 100,000, and operating expenses are P220.
How much is the profit or loss of the company?
a. P80, 000 profit c. P300, 000 profit
b. P80, 000 loss d. P300, 000 loss
14. On August 1, 2014, the Gabriel Company paid P36,000 in advance for a one-year insurance
policy starting on this date.Gabriel debited Insurance Expense and credited Cash for P36,000.
If adjusting entries are recorded annually, the appropriate adjusting entry at December 31,
2014 is a debit to
a. Prepaid Insurance and a credit to Insurance Expense for P15,000
37
b. Insurance Expense and a credit to Prepaid Insurance for P15,000
c. Prepaid Insurance and a credit to Insurance Expense for P21,000
d. Insurance Expense and a credit to Prepaid Insurance for P21, 000
15. Using the information in No. 14 and assuming that Gabriel Company prepares reversing
entries, what is the correct reversing entry on January 1, 2015?
a. A debit to Insurance Expense and a credit to Prepaid Insurance for P15, 000
b. A debit to Prepaid Insurance and a credit to Insurance Expense for P21,000
c. A debit to Insurance Expense and a credit to Prepaid Insurance for P21, 000
d. No reversing entry should be recorded
16. Jacinto Company has beginning inventory of P600, 000 and ending inventory of P700,000.
Under the periodic inventory system, the Inventory account at the end of the period would have
the following balances, respectively, before and after adjusting and closing entries
a. P600,000 and P700,000 c. P700,000 and P600,000
b. P600,000 and P600,000 d. P700,000 and P700, 000
17. Prepaid Insurance has an ending balance of P46,000. During the period, insurance premium
in the amount of P24,000 expired. The adjusting entry would include a debit to
a. prepaid insurance for P22,000
b. insurance expense for P22,000
c. prepaid insurance for P24,000
d. insurance expense for P24,000
18. A business received cash of P300,000 in advance for service that. The cash receipt was
recorded by a debit to Cash and a credit to Unearned Revenue for P300,000. At the end of the
period , P110,000 is still unearned. The appropriate adjusting entry is
a. debit Unearned Income and credit Income for P190,000
b. debit Unearned Income and credit Income for P110,000
c. debit Income and credit Unearned Income for P190,000
d. debit Income and credit Unearned Income for P110,000
38
19. The adjusted trial balance of BLP Company shows the following balances:
Debit Credit
Cash P500,000
Accounts Receivable 100,000
Furniture and Fixtures 150,000
Accumulated Depreciation P 40, 000
Accounts Payable 50,000
Pelejo, Capital 250,000
Pelejo, Drawing 50,000
Service Fee 630,000
Salary Expense 100,000
Depreciation Expense 40,000
Miscellaneous Expense 30,000
P970,000 P970,000
How much is the profit and the total assets of the company?
Profit Total Assets
a. P410,000 P710,000
b. P410,000 P750,000
c. P460,000 P710,000
d. P460,000 P750,000
20. A business received cash of P300,000 in advance for service that. The cash receipt was
recorded by a debit to Cash and a credit to Unearned Revenue for P300,000. At the end of the
period , P110,000 is still unearned. The appropriate adjusting entry is
a. debit Unearned Income and credit Income for P190,000
b. debit Unearned Income and credit Income for P110,000
c. debit Income and credit Unearned Income for P190,000
d. debit Income and credit Unearned Income for P110,000
21 .Silang Company purchased equipment on November 1, 2014 by giving thir supplier a one-
year, 12% note with a face-value of P200,000. The December 31 adjusting entry related to the
note is
39
a. debit Interest Expense and credit Cash for P4,000
b. debit Interest Expense and credit Interest Payable for P4,000
c. debit Interest Expense and credit Interest Payable for P6,000
d. debit Interest Expense and credit Interest Payable for P24,000
22. Before any year-end adjustments were made, the profit of Valiente Co. was P2,000,000.
However, the following adjustments were necessary: office supplies used, P30,000, services
performed for clients but not yet collected, P65,000; interest accrued on note payable, P15,000.
After recording these adjustments, the profit would be
a. P1,890,000 c. P2,020,000
b. P1,920,000 d. P2,050,000
23. The following adjusted account balances are token from the ledger of Roque Merchandising
Company as of December 31, 2014:
Freight-in P70,000
Inventory, beginning 560,000
Purchases Discount 30,000
Purchases Discount and Allowances 25, 000
Purchases 1,020,000
Sales Discount 43,000
Sales Return and Allowances 37,000
Service Fee 1,915,000
Sales Revenue 100,000
40
a. 1 only c. 3 only
b. 2 only d. both 2 and 3
24. Using the information in No. 23, the adjusting entry required to record ending inventory will
include a
1. debit to Income Summary, P578,000
2. credit Income Summary, P578,000
3. debit to Inventory, P578,000
a. 1 only c. 3 only
b. 2 only d. both 2 and 3
25. Using the information in No. 23 the correct entry to close the accounts with debit balances to
Income Summary account is
a. credit Income Summary, P1,732,000
b. debit Income Summary, P1,170,000
c. debit Income Summary, P1, 732,000
d. credit Income Summary, P1, 170, 00
41
Test Material No. 5
Rating:_____________
MATCHING TYPE
Choices:
6. Accounting period N. Depreciation
7. Accrued expenses O. Financial statements
8. Adjunct account P. General ledger
9. Book value Q. Income summary
10. Business documents R. Nominal accounts
11. Business enterprises S. Post-closing trial balance
12. Closing entries T. Posting
13. Contra asset account U. Prepaid expenses
14. Cost of goods available for sale V. Real accounts
15. Cost of goods sold W. Reversing entries
16. Credit X. Special journals
17. Debit Y. Subsidiary ledger
18. Deferral
Z. Worksheet
Instructions: Write the letter that corresponds to be best answer.
_________ 1. The end product of the accounting process.
_________ 2. Expenses already incurred but not yet paid and recorded at the end of the
accounting period.
_________ 3. An account with credit balance which is deducted from an asset
account.
_________ 4. Systematic allocation of cost of an item of property, plant and equipment over
periods benefited by the use of the asset.
_________ 5. An entry on the right side of an account.
_________ 6. Economic entities organized for profit.
_________ 7. The original source materials evidencing business transactions.
_________ 8. Span of time covered by the statement of comprehensive income
42
_________ 9. Merchandise inventory beginning plus purchases.
_________ 10. Journals designed in a tabular fashion to accommodate the recording of
specific types similar transactions.
_________ 11. A book of accounts that include all asset, liability, equity, income, and expense
accounts.
_________ 12. The process of classifying and grouping similar transactions in common
accounts by transferring amounts from the journals to the ledger.
_________ 13. A postponement of the recognition of an expense already paid, or of revenues
already received in advance.
_________ 14. Entries that reduce all nominal accounts to a zero balance at the end of each
accounting period.
_________ 15. A working paper often used by accountants to summarize
adjusting entries.
_________ 16. The temporary account used in closing nominal accounts whose credit balance
represents net profit.
_________ 17. Accounts whose balances are carried forward to the next
accounting period.
_________ 18. Entries prepare at the beginning of a new accounting period to facilitate the
recording of expense payments and revenue receipts in the usual manner.
_________ 19. A listing of all real account balances after the closing process has been
completed.
_________ 20. The difference between the accumulated depreciation account and the related
property and equipment account.
43
CHAPTER 2
NATURE AND FORMATION OF A PARTNERTSHIP
LEARNING OBJECTIVES
Define and discuss the nature of a partnership - its characteristics, advantages and
disadvantages.
PARTNER
SHIP
(Nature and
Formation)
PARTNER
SHIP
(Nature and
Formation)
45
DISADVANTAGES OF A PARTNERSHIP
1. The personal liability of a partner for firm debts deter many from investing capital
in a partnership.
2. A partner may be subject to personal liability for the wrongful acts or omissions of
his/her associates.
3. It is less stable because it can easily be dissolved.
4. There is divided authority among the partners.
5. There is constant likelihood of dissension and disagreement when each of the
partners has the same authority in management of the firm.
KINDS OF PARTNERSHIPS
1. As to activity
Trading partnership— one whose main activity is the manufacture and sale or the
purchase and sale of goods.
Non-trading partnership— one which is organized for the purpose of rendering services.
2. As to object
3. Universal partnership
8. Universal partnership of all present property— one in which the partners contribute, at the
time of the constitution of the partnership, all the properties which actually belong to each
of them into a common fund with the intention of dividing the same among themselves as
well as the profits which they may acquire therewith.
All assets contributed to the partnership and subsequent acquisitions become common
partnership assets.
9. Universal partnership of all profit— one which comprises all that the partners may acquire
by their industry or work during the existence of the partnership and the usufruct of
movable or immovable property which each of the partners may possess at the time of the
institution of the contract.
Partnership assets consist if assets acquired during the life of the partnership and only
the usufruct or use of assets contributed at the time of partnership formation. The
original movable or immovable property contributed do not become common
partnership assets.
4. Particular partnership— one which has for its object determinate things, their use or fruits,
or a specific undertaking or the exercise of a profession or vocation.
3. As to liability of partners
General co-partnership— one consisting of general partners who are liable prorata and
sometimes solidarily with their separate property for partnership liabilities.
Limited partnership— one formed by two or more persons having as members one or
more general partners and one or more limited partners, who as such are not bound by the
obligations of the partnership. The word "LIMITED" or "LTD." is added to the name of
the partnership to inform the public that it is a limited partnership
46
4. As to duration
iv. Partnership at will— one for which no term is specified and is not formed for a
particular undertaking or venture and which may be terminated any time by
mutual agreement if the partners or the will of one partner alone.
v. Partnership with a fixed term— one in which the term or period for which the
partnership is to exist is agreed upon. It may also refer to a partnership formed for
a particular undertaking and upon the expiration of that term or completion of the
particular undertaking the partnership is dissolved; unless continued by the
partners.
5. As to representation to others
Ordinary partnership— one which actually exists among the partners and also as to third
persons.
Partnership by estoppel— one which in reality is not a partnership but is considered as
one only in relation to those who, by their conduct or omission are precluded to deny or
disprove the partnership's existence.
6. As to legality of existence
iv. De jure partnership— one which has complied with all the requirements for its
establishment.
v. De facto partnership— one which failed to comply with one or more of the legal
requirements for its establishment.
7. As to publicity
Secret partnership— one wherein the existence of certain persons as partners is not made
known to the public by any of the partners.
47
Open partnership— one wherein the existence of certain persons as partners is made
known to the public by the members of the firm.
CLASSES OF PARTNERS
As to contribution
Capitalist partner- one who contributes capital in cash (money) or property.
Industrial partner- one who contributes industry, labor, skill, talent or service.
Capitalist-industrial partner- one who contributes cash, property, and industry.
As to liability
General partner- one whose liability to third persons extends to his separate (private)
property.
Limited partner- one whose liability to third persons is limited only to the extent of this
capital contribution to the partnership.
As to management
6. Managing partner- one who manages actively the business of the partnership.
7. Silent partner- one who does not participate in the management of the partnership affairs.
Other classifications
f. Liquidating partner- one who takes charge of the winding up of partnership affairs
upon dissolution
g. Nominal partner- one who is not really a partner, not being a party to the partnership
agreement, but is made liable as a partner for the protection of innocent third persons.
h. Ostensible partner- one who takes active part in the management of the firm and is
known to the public as a partner in the business.
i. Secret partner- one who takes active part in the management of the business but whose
connection with the partnership is concealed or unknown to the public.
j. Dormant partner- one who does not take active part in the management of business
and is not known to the public as a partner; he is both a silent and a secret partner.
48
PARTNERSHIP CONTRACT
A partnership is created by an oral or written agreement since partnerships are
required to be registered with Office of the Securities and Exchange Commissions, it
is necessary that the agreement be in writing. In this case, misunderstandings and
disputes among the partners relative to the nature and terms of the contract may be
avoided or minimized. The writer agreement between or among the partners
governing the formation, operation, and dissolution of the partnership is referred to us
the Articles of Co-Partnership.
ORGANIZING A PARTNERSHIP
Before a partnership can operate legally, it has to comply first with certain registration
requirments whichs are summarized below:
49
business name operate (renewable
annually)
50
Place of Requirements for Certificates Issues
Registration Registration
Bureau of Internal SEC registration BIR registration
Revenue Articles of co- no.
partnership Partnership’s tax
identification
number (TIN)
Registration of
books, invoices
and official
receipts
Social Security Filled SSS SSS Certificate of
System application form membership
List of employees SSS employer ID
number
Philippine Health SEC registration PhilHealth
Insurance Employer data employer number
Corporation record or ERI form (PEN) and the
Business permit or certificate of
license registration
PhilHealth
identification
number (PIN) and
member data
record (MDR) for
concerned
employees
Home Mutual SEC registration HMDF certificate
Development Fund Articles of co- of membership
(PAG-IBIG Fund) partnership HMDF employer
ID number
CAPITAL ACCOUNT
1. Permanent withdrawal (decrease) 1. Original investment by a partner
of capital
2. Share in partnership loss from 2. Additional investment by a
operation partner
51
3. Debit balance of drawing 3. Share in partnership profits from
account closed to capital operations to be added to capital
52
DRAWING ACCOUNT
1 Personal withdrawal by a partner 1 Share in partnership profits from
operations (this may be credited
directly to the partner’s capital
account)
2 Share in partnership loss from
operations (this may be debited
directly to partner’s capital
account)
OPENING ENTRIES
Partners may contribute cash, property, or industry to the partnership. Appropriate
asset accounts are debited for the assets contributed and partners’ capital accounts are
credited for the total amount of assets contributed.
If the asset contributed is in the form of cash, it is recorded on the partnership books
at face value; if the asset contributed is in the form of property or non-cash asset, it is
recorded at agreed value, or in the absence of an agreement, at fair market value.
When industry is contributed into the partnership, a memorandum entry is prepared.
PARTNERSHIP FORMATION
FORMATION A: TWO OR MORE PERSONS FORM A PARTNERSHIP FOR THE
FIRST TIME ALL THE PARTNERS ARE NEW IN THE BUSINESS.
Abad and Alba agreed to form a partnership by contributing P600,000 cash each.
The entry to record the contributions in partnership is:
Cash 1,200,000
Abad, Capital 600,000
Alba, Capital 600,000
Abdon Anton
Cash P600,000 P200,000
Inventories 300,000
Equipment 500,000
53
The entry to record the contributions of the partners follows:
Cash 800,000
Inventories 300,000
Equipment 500,000
Abdon, Capital 900,000
Anton, Capital 700,000
3. Contributions in the form of Cash, Non-cash Assets, and Industry (Capitalist and Industrial
Partners)
Alma, Anna, and Adela formed a partnership. Alma contributed P600,000 cash. Anna
contributed P300,000 cash and equipment valued at P450,000; Adela is an industrial partner to
contribute her special skills and talents to the partnership. Profit or loss is to be shared equally
among the partners.
The entry to record the contributions of partners Alma and Anna follows:
Cash 900,000
Equipment 450,000
Alma, Capital 600,000
Anna, Capital 750,000
Adela is admitted into the partnership as an industrial partner to share one-third in the
partnership profit.
Usually, one of the prospective partners is already engaged in business prior to the formation of
the partnership. In such a case, the partner may transfer his /her assets and liabilities (net assets)
to the partnership at agreed values or at fair market values if there are no agreed values. The
partnership may either: (1) use the books of the sole proprietor, or (2) open a new set of books.
However, it is a common practice that a new set of books are opened for any new business
undertaking.
54
When individual set of books are kept by each partner or by any one of the partners, entries are
made on the separate books of the partners for adjustments to the recorded values. These
adjustments are made through the capital account. The capital account is
credited for increases in the value of net assets and is debited for decreases in the value of net
assets.
Alternatively, a Capital Adjustment Account may also be used. The balance of this account,
after recording all the necessary adjustments, is transferred to the capital accounts.
Debit Credit
Cash 300.000
Accounts Receivable 450.000
Inventories 240,000
Accounts Payable 90,000
Angeles, Capital 900,000
Assumption 1- The partnership will use the books of the sole proprietor
The following procedures should be followed in accounting for this type of formation:
1. Adjust the books of the sole proprietor to bring account balances to agreed values.
2. Record the investment of the other partner.
55
The adjusting entries necessary upon partnership formation, in order to arrive at the agreed
values, are recorded through the capital accounts of the partners. However, a capital adjustment
account may also be used and its balance is transferred to the capital accounts after all
adjustments in net assets are made.
The following rules will be helpful in making the necessary adjusting entries:
Debit asset and credit capital for increases in asset values
Debit capital and credit asset for decreases in asset values
Debit capital aid credit liabilities for increases in liability balances
Debit liabilities and credit capital for decreases in liability balances
In the case of contra asset accounts, the following rules shall apply:
Debit contra asset account and credit capital for increases in asset values
Debit capital and credit contra asset account for decreases in asset values
Hence, the information on the partnership of Aguilar and Angeles will be accounted for as
follows:
Step 1: Adjust the books of the sole proprietor Angeles to agreed values
b. Inventories 30,000
Angeles, Capital 30.000
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).
Cash 915,000
Aguilar, Capital 915,000
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Assumption 2 - The partnership will open a new set of books
When a new set of books are opened for the partnership, the entry required on the new books
of the firm is the recording of the investment of the partners at agreed values. The opening
entries on the new partnership books using the data given in Illustrative Problem A are shown
on the next page.
a. Cash 300,000
Accounts Receivable 450,000
Inventories 270,000
Prepaid Expenses 12,000
Allowance for Uncollectible 22,000
Accounts 90,000
Accounts Payable 5,000
Expenses Payable 915,000
Angeles, Capital
To record the investment of Angeles
b. Cash 915,000
Aguilar, Capital 915,000
To record the investment of Aguilar
Alternatively, a compound entry may be prepared to record the investment of the two partners.
Entries to adjust and close the accounts are made in the separate books of the sole proprietor but
not in the new books of the partnership. Using the same illustrative problem, the adjusting and
closing entries on the books of Angeles are as follows:
b. Inventories 30,000
Angeles, Capital 30,000
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d. Angeles, Capital 915,000
Expenses Payable 5,000
Accounts Payable 90,000
Allowance for Uncollectible Accounts 22,000
Cash 300,000
Accounts Receivable 450,000
Inventories 270,000
Prepaid Expenses 12,000
To close the books of Angeles
Illustrative Problem B: Antonio, owner of Antonio Variety Store, and Albano, owner of
Albano Trading decided to combine their businesses on July 1, 2014. Each is to transfer
business assets and liabilities (net assets) at agreed values. Statements of financial position for
the two proprietors are presented below.
Antonio Variety Store
Statement of Financial Position
July 1, 2014
Assets
Cash P 120,000
Accounts Receivable P 72,000
Less Allowance for Uncollectible 6,000 Accounts 66,000
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Less Allowance for Uncollectible 21,000 Accounts 279,000
I. Partners' capital in the partnership shall be equal to the adjusted net assets transferred.
2. Adjustments are to be made as follows:
a. Allowance for Uncollectible Accounts shall be P7,200 and P30,000, respectively.
b. Inventories are to be valued at 120% of their recorded values
c. Both store and delivery equipment are 5% depreciated.
Assumption 1 - The partnership will use the books of one of the sole proprietors.
The procedures to be discussed under his assumption are similar to the procedures discussed
under Formation B - Assumption I. Thus, if the books of Albano Trading will be used by the
partnership, the following procedures will be followed:
l. Adjust the books of Albano Trading to bring the balances of accounts to agreed values.
2. Record the investment of Antonio.
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Albano, Capital 252,000
P 1,260,000 x 20% = P252,000
a. Cash 120,000
Accounts Receivable 72,000
Merchandise Inventory (P330.000 x 396,000
120%) 570,000
Store Equipment (P600.000 x 95%)
Allowance for Uncollectible 7,200
Accounts 132,000
Accounts Payable 1,018,800
Antonio, Capital
The adjustments on the account balances of Antonio Variety Store are not taken up on the
books of Albano Trading which are now the partnership books. Instead the following adjusting
and closing entries are prepared on the separate books of Antonio Variety Store:
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Assumption 2: The partnership will use a new set of books
When a new set of books are opened for the partnership. entries are prepared to record the
investment of the partners at agreed values. The opening entries on the new partnership books
using the data given in Illustrative Problem B are shown below:
a. Cash 120,000
Accounts Receivable 72,000
Merchandise Inventory (P330.000 x 120%) 396,000
Store Equipment (P600.000 x 95%) 570,000
Allowance for Uncollectible 7,200
Accounts
Accounts Payable 132,000
Antonio, Capital 1,018,800
To record the investment of Antonio
Delivery equipment (P480.000 x 95%)
b. Cash
Accounts Receivable 30,000
Merchandise Inventory (P1,260,000 x 120%) 300,000
1,512,000 456,000
Allowance for Uncollectible 30,000
Accounts
Accounts Payable 333.000
Albano, Capital 1,935,000
To record the investment of Albano
The new partnership may prepare a separate entry for each partner's contribution as shown
above or a compound entry that shows the contributions of all the partners.
Key Points. In the opening entry, the plant assets are recorded net of depreciation. The account
accumulated depreciation is not carried on the partnership books. The net amount, being the
agreed value, represents the cost of the plant assets to the partnership and such amount becomes
the basis for future depreciation by the partnership. On the other hand, both accounts receivable
and the corresponding allowance for uncollectible accounts are recorded on the partnership
books. The allowance for uncollectible accounts is carried on the partnership books because of
the possibility of collection. However, if there are specific accounts receivable which are
deemed worthless, such must be written off and removed permanently from the outstanding
accounts receivable.
A statement of financial position prepared immediately after the formation of the partnership of
Antonio and Albano is shown below.
Antonio and Albano
Statement of Financial Position
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July 1, 2014
Assets
Cash P 150.000
Accounts Receivable P 372,000
Less Allowance for Uncollectible 37,200 Accounts 334,800
PFRS 3 does not allow the amortization of goodwill acquired in a combination and
instead requires the goodwill to be tested for impairment annually, or more frequently, if
events or changes in circumstances indicate that the asset might be impaired.
CAPITAL SHARE DIFFERENT FROM CAPITAL CONTRIBUTION
Prior to recording partners' initial contributions to the partnership, the individual partners must
first agree not only on the valuation of the net asset contributions but also on their capital share.
The capital share of each partner is the percentage of equity that each of them will have in the
net assets of the newly formed partnership. Generally, the capital share of a partner is
proportionate to his/her capital contribution. However in recognition of intangible factors such
as partners' special expertise, established clientele or necessary business connections, partners
may agree to a division of capital that is not proportionate to their capital contributions. This
situation will give rise to provision of bonus on initial investments.
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1. Full investment approach
Cash 1,100,000
Alfonso, Capital 500,000
Afable, Capital 600,000
Assuming the partners agreed to have equal capital in the partnership, it is presumed that part of
the contribution of Afable is given as bonus to Alfonso in exchange for the intangible advantage
that Alfonso will be bringing to the partnership.
2. Bonus approach
Cash 1,1 00,000
Alfonso, Capital 550,000
Afable, Capital 550,000
(P500,000 + P600,000) / 2 = P550,000
LOAN RECEIVABLE AND LOAN PAYABLE. Aside from the contributions, partners may
also advance money to the partnership in the form of loan when the business is in need of
additional funds. Loans made by partners to the partnership, which are payable immediately by
the partnership and are usually with interest, are recorded in the account Loan Payable or Due
to Partners. This ccount is reported in the statement of financial position as a liability.
On the other hand, the partnership may advance money to partners, other than withdrawals, in
the form of loans. These loans, which are payable immediately by the partners and are usually
with interest, are recorded in the account Loan Receivable or Due from Partners. This account
is reported in the statement of financial position as an asset.
I. Define and discuss the nature of a partnership- its characteristics, advantages, and
disadvantages. A partnership is a contract whereby two or more people bind themselves to
contribute money, property, or industry into a common find with the intention of dividing
profits among themselves. A partnership has the following characteristics: (1) mutual agency:
(2) unlimited liability: (3) limited life: (4) mutual participation in profits; (5) legal entity: (6)
coownership of contributed assets; and (7) subject to income tax. A partnership is easy and
inexpensive to organize, it is more reliable on the viewpoint of the creditor, enabling it to obtain
more capital because of the unlimited liability of the partners, and there is close supervision of
all its activities because of the direct gain to the partners of a successful operation. However, a
partnership is less stable and there is divided authority among the partners. In addition, because
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of the characteristic of mutual agency, a partner may be subject to personal liability for the
wrongful acts or omissions of his associates.
2. Identify the different kinds of partnerships and the classes of partners. Partnerships are
classified as (1) trading or nontrading; (2) universal or particular; (3) general on limited; (4)
partnership at will or with a fixed term: (5) ordinary or partnership by estoppel: (6) de jure or de
facto; and (7) secret or open. Partners are classified as (I) capitalist, industrial or
capitalistindustrial; (2) general or limited; (3) managing or silent; and (4) liquidating, nominal,
ostensible or secret.
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GLOSSARY of ACCOUNTING TERMINOLOGIES
Articles of Co-Partnership – a written agreement among the partners which governs the
formation, operation, and dissolution of the partnership.
Capitalist Partner – a partner who contributes capital in the form of money or property.
Capitalist Industrial Partner – a partner who contributes capital in the form of money or
property and industry.
Industrial Partner – a partner who contributes industry, labor, skill, talent or service.
Partnership – a contract whereby two or more persons bind themselves to contribute money,
property, or industry into a common fund with the intention of dividing profits among themselves
.
Statement of Financial Position – a statement that reports the assets, liabilities, and equity of an
entity and which shows its financial position or condition at a given date. It is also known as
balance sheet.
65
DISCUSSION QUESTIONS
1. What is a partnership?
2. How does a partnership differ from a sole partnership?
3. Explain the meaning of unlimited liability of a partner for partnership debts. Is this
an advantage or a disadvantage on the part of the partnership?
4. What is the basis for measuring the contributions or investments of partners in the
form of non-cash assets?
5. Why is it preferable to have a written contract of partnership? What are the
contents of a typical partnership contract?
6. What is the major difference between a general and a limited partnership? How
can they be distinguished? When a partnership is a limited partnership, does the
characteristics of
“unlimited liability” still apply? Why or why not?
7. Why are capital accounts and drawing accounts opened for each partner?
8. What are the steps to be followed in recording the formation of a partnership if the
books of one of the previous sole proprietors will be used?
9. Why would a partnership decide to use the books of one of the previous sole
proprietors instead of opening new set of books?
10. Why is the Accumulated Depreciation account not carried over to the new books
of the partnership?
66
EXERCISES
Give the entry to record the investment of Alonzo into the partnership under each of the
following independent assumptions:
a. Cash of P400,000.
b. Accounts receivable of P500,000 with an allowance for uncollectible accounts of
P50,000.
c. Inventories that cost P300,000 using the moving average method accepted by the
partnership at its FIFO value of 80% of average cost.
d. Equipment that cost P900,000 with a book value of P300,000 after four years of
use without salvage value. The equipment should have been depreciated over a 10-year
useful life.
Aquino and Asuncion have decided to form a partnership. Aquino invests the assets presented
below at their agreed valuation, and also transfers his liabilities to the new firm.
Ledger Agreed
Balances Valuation
Cash P450,000 P450,000
Accounts Receivable
180,000 180,000
Allowance for Uncollectible Accounts
15,000 10,000
Merchandise Inventory
Equipment
300,000 270,000
Accumulated Deprecation 180,000 125,000
Accounts Payable 30,000 ——
Notes Payable 105,000 105,000
90,000 90,000
Asuncion agrees to invest cash for a one - third interest in the
firm.
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Instructions:
1. Prepare the entries to record the investment of Aquino and Asuncion in the
partnership’s new set of books.
2. Prepare the entries to adjust and close the balances of accounts in the books of
Aquino.
Amores admits Andrada to a partnership interest in his business. Accounts in the ledger of
Amores on January 1, 2014, before the admission Andrada, show the following:
Debit Credit
Cash P208,000
Accounts Receivable 460,000
Merchandise Inventory 1,440,000
Accounts Payable P496,000
Amores, Capital 1,612,000
It is agreed that for the purpose of establishing the interest of Amores the following adjustments
shall be made:
Instructions:
1. Assuming the new partnership will use the books of Amores, give the entries to
adjust the account balances of Amores and to record the investment of Andrada.
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2. Assuming the new partnership will open new set of books, give the entries to
record the investment of Amores and Andrada.
Aguirre Nd Aranas have decided to form a partnership. Aguirre contributes cash of P1,000,000
and Aranas contributes land with a fair market value of P800,000 and a building with a fair
market value of P1,900,000. Aranas purchased the land and building five years ago for P750,000.
Aranas’ book value of the land is P175,000 and the book value of the building is P600,000. The
P1,500,000 mortgage in the land and building is to be assumed by the partnership. The partners
agree to share profits and losses in the ration of 3:2, respectively.
Instructions: Prepare the journal entries to record the information of the prtnership under each of
the following independent assumptions:
1. Each partner is credited for full amount of net assets invested.
PROBLEMS
Acosta Company
Statement of Financial Position
December 1, 2014
Assets
Cash P 600,000
Notes Receivable 375,000
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Accounts Receivable P 2,250,000
Less Allowance for Uncollectible Accounts 150,000 2,100,000
Merchandise Inventory 600,000
Furniture and Fixture 1,800,000
Less Accumulated Depreciation 450,000 1,350,000
Total Assets 5,025,000
Aguas offers to invest cash to give him an equity credit equal to one-half of the equity
of Acosta after adjustments for the items below. Acosta accepted the offer.
Instructions:
1. Prepare journal entries on the books of Acosta to give effect to the partnership
formation.
Problem 2-2 (Two Sole Proprietorship Form a Partnership; Books of one of the Sole
Proprietors to be used by the Partnership)
70
On October 1, 2014, April and Arias decided to pool their assets and form a partnership. The firm
is to take over business assets and assume business liabilities; equities are to be based on the net
assets transferred after the following adjustments:
a. Arias’ inventory is to be valued at P350,000.
d. Arias is to contribute sufficient cash to give a 60% interest in the new firm.
Statements of financial position for April and Arias on October 1 before adjustments are
presented below.
April Arias
P 187,500 P 112,500
Cash 450,000 375,000
Accounts Receivable 400,000 300,000
Merchandise Inventory 250,000 300,000
Equipment (112,500) (37,500)
Accumulated Depreciation P 1,175,000 P 1,050,000
Total Assets
P 345,000 P 250,000
Accounts Payable 830,000 800,000
Capital P 1,175,000 P 1,050,000
Total Liabilities and Capital
Instructions:
1. Give the entries to adjust and close the books of April.
2. Give the entries required on the books of Arias upon the formation of the
partnership.
3. Prepare a statement of financial position for the nee partnership of April and
Arias.
Problem 2-3 (Two Sole Proprietors Form a Partnership; New Books are to be opened for the
Partnership)
71
Partners Abada and Albani agreed to combine their businesses into a partnership. The statement
of financial position accounts of Abada and Albano are shown below.
ABADA ALBANO
Book Value Agreed Value Book Value Agreed Value
Cash P50,000. P50,000. P70,000. P70,000
Accounts Receivable 460,000. 460,000. 490,000. 490,000
Allowance for Uncollectible 30,000. 40,000. 40,000. 50,000
Accounts
Merchandise Inventory 900,000. 950,000. 720,000. 700,000
Equipment 180,000. 120,000. 90,000. 70,000
Accumulated Depreciation 36,000. ——— 9,000. ———
Furniture and Fixtures 120,000. 90,000. ——— ———
Accumulated Depreciation 24,000. ——— ——— ———
Accounts Payable 540,000. 540,000. 360,000. 360,000
Instructions: Give the journal entries to record the partnership formation under each of the
following independent assumptions:
Problem 2-4 (Cash, Non-cash and Net Assets Contributions; Books of the Sole Proprietor to
be Used by the Partnership)
On January 1, 2014, Abante, Arevalo, and Almonte decided to form a partnership. Abante, a sole
proprietor, will transfer to the partnership his net assets, excluding cash. Arevalo will contribute
cash in an amount equal to one and a half times the investment of Abante. Almonte will
contribute a piece of land with an agreed value of P1,800,000 subject to a mortgage of P300,000
to be assumed by the partnership. The statement of financial position of Abnante is shown on the
next page.
72
Abante Company
Statement of Financial Position
January 1, 2014
Assets
Cash P 360,000
Accounts Receivable P 840,000
Less Allowance for Uncollectible Accounts 90,000 750,000
Merchandise Inventory 1,200,000
Furniture and Fixture P 1,050,000
Less Accumulated Depreciation 210,000 840,000
Total Assets P 3,150,000
The Articles of Co-Partnership executed for the purpose calls for adjustments to the assets, as
follows:
The partnership of Abueva and Alano was formed on June 1, 2014, when they agreed to invest
equal amount of capital into the firm. Yhe investment by Abueva consists of P518,000 cash and
73
an inventory of merchandise valued at P1,152,000. Alano agreed to contribute the assets of his
business along with the transfer to the partnership of his business liabilities. Alano was credited
for goodwill for the excess of the capital credit over the agreed value of his net assets. The assets
and liabilities are shown on the next page.
Accounts Receivable
Allow. For Uncollectible Accounts
Inventory
Office Equipment (net)
Accounts Payable
Instructions:
Balances on
Agreed
Alano’s Records
Value
P 1,792,000 P
1,792,000
76,800
150,000
192,000
253,000
256,000
206,000
576,000
576,000
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1. Give the entries to record the investments of Abueva and Alano in the new
partnership.
The partnership of Agana and Ayesa was formed on September 1, 2014. At the date, the
following assets were invested:
Instructions: Compute the amount of Ayesa’s capital account at September 1, 2014 assuming
that the partnership agreement provides that:
1. Each partner is credited for the full amount of net assets invested.
2. The partners initially should have an equal interest in the partnership capital.
3. The initial partnership capital is shared proportionate to the partners’ profit and
loss ratio.
MULTIPLE CHOICE
MC 2-4 Which of the following are kinds of partnerships according to liability of partners?
a. General co-partnership c. Industrial partnership
b. Limited partnership d. A and B only
MC 2-5 Which of the following relate to the capital share of a partner in a partnership?
a. The percentage of equity that partner has on the net assets
b. Proportionate to a partner’s capital contribution
c. May not be proportionate to capital contribution die to bonus
d. All of these
MC 2-6 On April 1, 2014, Apple and Ayme formed a partnership with each contributing the
following assets:
Apple. Ayme
Cash P 120,000 P 80,000
Machinery and Equipment 100,000 340,000
Building 900,000
Furniture and Fixtures 40,000
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MC 2-7 Aser and Attie are forming a partnership by combining their businesses. 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
Furniture and Fixtures 330,000 102,000
Prepaid Expenses 63,000 21,000
Accounts Payable 366,000 144,000
Aster, Capital 489,000
Amie, Capital 273,000
It has been agreed to recognize uncollectible accounts of P7,500 and P5,400 to each party,
respectively, and that the furniture and fixtures of Amie are under depreciated by P9.000. If each
partner's share in equity is to be equal to the net assets invested, the capital accounts of Aster and
Amie would be
a. P489,000 and P273.000 respectively.
b. P481.500 and P276,600 respectively.
c. P481,500 and P258,600, respectively.
d. P855,000 and P417.000. respectively
MC 2-8 A business owned by Antonia was short of cash and Antonia decided to form a
partnership with Andrea, who was able to contribute cash twice the interest of Antonia in the
new partnership. The assets contributed by Antonia appeared as follows in the statement of
financial position of her business: cash, P9,000; accounts receivable, P189.000 with allowance
for uncollectible accounts of P6,000; merchandise inventory, P420,000; and store equipment,
P150,000 with accumulated depreciation of P15,000.
Antonia and Andrea agreed that the allowance for uncollectible accounts was inadequate and
should be P12.000. They also agreed that the fair value the inventory is P460,000 and for the
stóre equipment is P140,000. The cash contributed by Andrea into the partnership was
a. P 747,000 c. P 1,572,000
b. P 786,000 d. P 1,576,000
MC 2-9 Almeda and Asistio are combining their separate business to form a partnership. Cash
and non-cash assets are to be contributed for a total capital of P600,000. The non-cash assets tor
be contributed and the liabilities to be assumed as follows:
Almeda Asistio
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BV FMV BV
FMV
Accounts Receivable P 40,000 P30,000
Merchandise Inventory 60,000 90,000 P 40,000 P
80,000
Equipment 120,000 100,000 80,000
120,000
Accounts Payable 30,000 30,000 20,000
20,000
The partners capital accounts ure to he equal after all the contribution of assets and the
assumption of liabilities. The amount of cash to be contributed by Almeda is
a. P 100,000 c. P 210,000
b. P 110,000 d. P 300,000
MC 2-10. Using the information in MC 2-9 the total assets of the partnership is
a. P 340,000 c. P 630,000
b. P 360,000 d. P 650,000
MC 2-11 Using the information in MC 2-9, and assuming the excess capital credit over the fair
value of the net assets transferred to the partnership is recognized as goodwill, how much is the
goodwill to be credited to Asistio?
a. P 120,000 c. P 180,000
b. P 150,000 d. P 300,000
MC 2-12 Amable and Aguila entered into a partnership on February 1. 2014 by
investing the following assets:
Amable Aguila
Cash P 40,000
Merchandise Inventory P 90,000
Land 130,000
Furniture and Fixtures 200,000
The agreement between Amable and Aguila provides that profits and losses are to be divided
60% and 40% respectively, and that the partnership is to assume the P100,000 mortgage on the
land. If Aguila is to receive capital credit equal to the full amount of his net assets invested, how
much is his capital balance upon partnership formation?
a. P 10,000 c. P 160,000
b. P 150,000 d. P 400,000
MC 2-13 Using the information in MC 2-12 and assuming that Aguila invests P100,000 cash and
the partners are to have equal interest in the partnership, the total capital of the partnership is
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a. P 240,000 c. P 490,000
b. P 250,000 d. P 590,000
MC 2-14 Using the information in MC 2-12 and assuming that the partners is proportionate to
their profit and loss ratio, the bonus upon partnership formation is
a. P 6,000 to Amable c. P 10,000 to Amable
b. P 6,000 to Aguila d. P 10,000 to Aguila
IC2-15 Using the information in MC 2-14, the capital balances upon partnership formation are
Amable Aguiluz Amable Aguiluz
a. P 245,000 P 245,000 c. P 156,000 P 234,000
b. P 234,000 P 156,000 d. P 294,000 P 196,000
MC2-16 The Agualto and Acejas Partnership was formed on October 1, 2014. At that date, the
following assets were contributed:
Agulto Acejas
Cash P 600,000 P 280,000
Merchandise Inventory 440,000
Building 800,000
Furniture and equipment 200,000
The building is subject to a mortgage loan of P320,000 which is to be assumed by the
partnership. The partnership agreement provides that Agulto and Aceas share on profit and loss
of 25% and 75%, respectively. Agulto's capital account at October 1, 2014 should be
a. P 400,000 c. P 1,200,000
b. P 720,000 d. P 1,520,000
MC2-17 Using the information in MC 2-16 and assuming that the partnership agreement
provides that the partners initially should have an equal interest in partnership capital, Acejas'
capital account on October 1, 2014 should be
a. P 480,000 c. P 960,000
b. P 720,000 d. P 1,200,000
MC2-18 Using the information in MC 2-17, the bonus to be recognized in the transaction is
a. Zero c. P 240,000
b. P 200,000 d. P 480,000
MC2-19 Using the information in MC 2-17, the effect of the bonus on capital of the partners is
Agulto Acejas
a. Increase Increase
b. Increase Decrease
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c. Decrease Increase
d. Decrease Decrease
MC2-20 Using the information in MC 2-16, and assuming that capital shall be proportionate to
the partners’ profit and loss ratio, the required capital of Acejas is
a. P 520,000 c. P 1,200,000
b. P 720,000 d. P 1,440,000
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Test Material No. 6
Rating:
Name: Date:
Year and Section: Professors:
TRUE or FALSE
Instructions: Encircle the letter T if the statement is true and the letter F if the statement is
false.
1. A written partnership contract is required to be prepared whenever a partnership is formed.
2. All partnerships are subject to income tax.
3. A partner's contribution in the form of industry or service is recorded by the debiting the
account "Industry."
4. In the partnership books, there are as many capital and drawing account as there are partners.
5. A partner's contribution in the form of non-cash assets should be recorded at it’s fair market
value in the absence of an agreed value.
6. A partnership is much easier and less expensive to organize than a corporation.
7. A newly organized partnership should always open a new set of books.
8. All partnerships have at least one general partner.
9. Each partner generally has the authority to enter into contracts which are binding upon the
partnership.
10. The property invested in a partnership by a partner becomes the property of the partnership.
11. Contra accounts, like Allowance for Uncollectible Accounts and Accumulated Depreciation,
on non-cash assets invested by partners are always carried on the partnership books.
12. The unlimited liability of partners for partnership debts makes the partnership more reliable
from the point of view of creditors.
13.Goodwill may be recognized upon partnership formation when the capital credited to a
partner exceeds the fair value of the net assets transferred from previous sole proprietorship
business.
14. Before a partnership can operate legally, it has to first comply with registration requirements
of the SEC, DTI BIR, SSS and Mayor's Office.
15. There is a required number of limited partners in a general co-partnership; in the same
manner that, there is a required number of general partners in a limited partnership.
16. A partnership is always owned by at least two individuals.
17. For financial reporting purposes, the personal assets and debts of a partner should be
combined with the assets and debts of the business.
18. Partners are personally liable for the liabilities of the partnership if the partnership is unable
to pay
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19. In a partnership, an owner's equity account exists for each partner.
20. Net asset adjustments are made on a sole proprietor's books, when these are to be used as
partnership books, for the purpose of arriving at agreed values.
82
Test Material No. 7
Rating:
Name: Date:
Year and Section: Professors:
IDENTIFICATION
Instructions: Write the word or group of words that identify each of the following statements.
___________1. A partnership wherein all the partners have limited liability except for at least
one general partner.
___________2. The contribution of an industrial partner.
___________3. A partner who contributes money, property, and industry.
___________4. A characteristic of a partnership wherein any partner can act in behalf of the
partnership as long as these acts are within the scope of normal partnership activities.
___________5. A partnership which has failed to comply with one or more of the legal
requirements for its establishment.
___________6. An entry prepared when a partner contributes skill or industry into the
partnership.
___________7. A partnership organized for the purpose of rendering services.
___________8. A contract whereby two or more persons bind themselves to contribute money,
property, or industry to a common fund with the intention of dividing profits among themselves.
___________9. The value assigned to the non-cash asset contributed into partnership.
___________10. One who is not really a partner, not being a party to the partnership agreement,
but is made liable as a partner for the protection innocent third persons.
___________11. A written partnership contract which governs the formation operation and
dissolution of the partnership
___________12. A partner who has a financial interest in the firm, not known to be a partner, but
takes active part in the management of the firm.
___________13. The government body which is in charge with administration of various laws
affecting partnerships and corporations in the Philippines.
___________14. The word added to the name of the partnership to inform the public that it is a
limited partnership
___________15. A partner whose liability is limited to the extent of her/his personal contribution
into the partnership.
___________16. Amounts advanced by partners to the partnership when the business is in need
of additional funds which are immediately payable by the partnership and usually bear interest.
___________17. Each partner's percentage of equity in the net assets of a partnership.
83
___________18. The transfer of capital from one partner to another, upon partnership formation,
in recognition of intangible factors such as partners special expertise, established clientele or
necessary
business connections.
___________19. The purpose of preparing adjustments on net assets contributed by
partners into the partnership.
___________20. Partnerships which are exempt from income tax.
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Test Material No. 8
Rating:
Name: Date:
Year and Section: Professors:
MULTIPLE CHOICE - Theory and Problems
Instructions: Encircle the letter of the best answer. Show supporting computations in good
form in a separate work sheet.
1. The Articles of Co-Partnership should contain clear provisions on all of the following except
a. taxes paid by the partnership
b. causes of partnership dissolution
c. withdrawals allowed to partners
d. profit-sharing ratio
2. The non-cash contributions of the partners to form a partnership are recorded by the
partnership at their
a. Agreed Value c. Dissolution Value
b. Book Value d. Original Cost
3. When a partnership cannot pay its debts with business assets, the partners
a. are not personally liable for the debts
b. have limited personal liability
c. must convert the partnership to a joint venture
d. must use their personal assets to meet the debts
4. A partner who takes active part in the business but whose connection with the
partnership is concealed to the public is known as a (an)
a. Silent Partner c. Nominal Partner
b. Secret Partner d. Ostensible Partner
5. A partnership which has failed to comply with one or more of the requirements for its
establishment is classified as a (an)
a. Open partnership c. De facto partnership
b. De jure partnership d. Secret partnership
6. Two individuals who were previously sole proprietors formed a partnership. Property other
than cash which is part of the initial investment in the partnership would be recorded for
financial accounting purposes at the
a. proprietors' book values or the fair value of the property at the date of the investment,
whichever is higher
85
b. proprietors ‘book values or the date of the fair value of the property at the date of the
investment, whichever lower
c. proprietors' book values of the property at the date of the investment
d. fair value of the property at the date of the investment
7. Anton and Almar formed a partnership, each contributing assets to the bussiness. Anton
contributed inventory with a current market value in excess of its carrying amount. Almar
contributed real estate with a carrying amount in excess of its current market value. At what
amount should the partnership
following assets?
Inventory Real Estate
a. carrying amount market value
b. market value carrying amount
c. carrying amount carrying amount
d. market value market value
8. A partnership is formed by two individuals who were previously sole proprietors. Non-cash
assets invested would be recorded into the partnership at the proprietor's
a. carrying amount or the fair value of the property at the date of the investment, whichever is
higher
b. fair value of the property at the date of the investment
c. carrying amount or the fair value of the property at the date of the investment, whichever is
lower
d. carrying amount of the property at the date of the investment
9. Agaton joined a partnership by contributing the following: cash, P120,000 accounts
receivable, P4,000; land P240,000 cost, P400,000 fair value; and accounts payable, P16,000.
What will be the initial amount recorded in Agaton's capital account?
a. P 408,000 c. P 508,000
b. P 424,000 d. P 524,000
10. On October 1, 2014, Alba and Ang formed a partnership and agreed to share profits and
losses in the ratio of 3:7, respectively. Alba contributed cash of and a parcel of land that cost him
P200.000. Ang contributed P300,000 cash. The land has a quoted price of P360.000 on October
1, 2014. What is the amount of partnership capital on October 1, 2014?
a. P 360,000 c. P 760,000
b. P 460,000 d. P 960,000
11. On June 30, 2014, a partnership was formed by Ariston and Astoria. Ariston contributed
cash. Astoria, previously a sole proprietor, contributed non-cash assets, including a realty subject
to a mortgage, which was assumed by partnership. Astoria's capital account at June 30, 2014
should be recorded at
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a. the fair value of the property less the mortgage payable at June 30, 2014
b. Astoria's carrying amount of the property at June 30, 2014
c. Astoria's carying amount of the property less the mortgage payable at June 30, 2014
d. the fair value of the property at June 30, 2014
12. Abada and Acosta formed a partnership. Abada contributed cash of P300,000 and an
equipment costing P600,000. Acosta contributed land costing P600,000. The current market
value of the assets are as follows: equipment P450,000; land P750,000. The partnership will
assume a P150,000 liability on the land contributed by Acosta. The capital accounts of the
partners will be credited follows:
Abada Acosta Abada Acosta
a. P 900,000 P 450,000 c. P 750,000 P 600,000
b. P 300,000 P 750,000 d. P 300,000 P 600,000
13. The partnership of Alonzo and Amurao was formed on April 1, 2014. At that date the
following assets were contributed
Alonzo Amurao
Cash P 300,000 P 140,000
Merchandise Inventory 220,000
Building 4,000,000
Furniture and equipment 900,000
The building is subject to a mortgage loan of P1,600,000 which is to be assume by the
partnership. The partnership agreement provides that Alonzo and Amurao share on profit and
loss of 25% and 75%, respectively. Amurao's capital account at April 1, 2014 should be
a. P 900,000 c. P 2,760,000
b. P 1,200,000 d. P 4,360,000
14. Using the information in No. 13, and assuming that the partnership agreement provides that
the partners initially should have an equal interest in partnership capital, Alonzo's capital account
should be increased by
a. P 780,000 c. P 1,200,000
b. P 900,000 d. P 1,980,000
87
Chapter 2—Nature and Formation of a Partnership
15. Using the information in No. 13, the total partnership capital on April 1, 2014 is
a. P1,200,000 c. P4,740,000
b. P3,960,000 d. P5,560,000
16. Using the information in No. 14, bonus was given by
a. Amurao to Alonzo c. the partnership
b. Alonzo to Amurao d. nobody
17. Using the information in No. 13, and assuming that capital shall be proportionate to the
partners' profit and loss ratio, the required capital of Alonzo is
a. P900,000 c. P1,200,000
b. P990,000 d. P3,960,000
18. On April 1, 2014, Aleli, Amy and Annie formed a partnership by combining their separate
business proprietorships. Aleli contributed cash of P200,000. Amy contributed property with
a carrying amount of P144,000, original cost of P160,000, and fair value of P320,000. The
partnership accepted responsibility for the P140,000 mortgage attached to the property.
Annie contributed equipment with a carrying amount of P120,000, original cost of P300,000,
and fair value of P220,000. The partnership agreement specifies that profits and losses are to
be shared equally.
Which partner has the largest capital account balance as of April 1, 2014?
a. Aleli c. Annie
b. Amy d. All capital accounts are equal
19. Using the information in No. 18, the property contributed by Amy is to be recorded by the
partnership on April 1, 2014 at
a. P144,000 c. P180,000
b. P160,000 d. P320,000
20. Using the information in No. 18 and assuming capital are in the profit and loss ratio, then
there is
A. P20,000 bonus to Amy
B. P20,000 bonus from Annie
C. No bonus to Aleli
Which is correct?
a. A only c. A and B only
b. B only d. A, B and C
88
Chapter 2—Nature and Formation of a Partnership
PROBLEMS
Problem A
Sole proprietors Alvis and Ancheta established a partnership on December 31, 2014 sharing
profits and losses in the ratio 60% and 40%. They agreed that each would make the following
contributions:
Alvis Ancheta
Cash P 50,000 P 750,000
Land 375,000
Building 1,200,000
Furniture and Fixture 675,000
Accounts payable of Alvis totaling P250,000 are to be assumed by the partnership.
Instructions: Prepare the entries on December 31, 2014 to record the investments in the
partnership by Alvis and Ancheta under each of the following independent assumptions:
1. Each partner is credited for the full amount of the net assets invested.
2. Each partner initially should have an equal interest in the partnership capital.
3. Each partner receive capital credit proportionate to his profit and loss ratio.
89
Chapter 2—Nature and Formation of a Partnership
Problem B
On May 1,2014, the business accounts of Ablan and Amias appear below:
Ablan Amias
Cash P 55,000 P 111,770
Accounts Receivable 1,172,680 2,839,450
Merchandise Inventory 600,175 1,300,510
Land 3,015,000 --------
Buildings -------- 2,141,335
Furniture and Fixtures 251,725 173,945
Other Assets 10,000 18,000
Accounts Payable 894,700 1,218,250
Notes Payable 1,000,000 1,725,000
Ablan, Capital 3,209,880
Amias, Capital 3,641,760
Ablan and Amias agreed to form a partnership contributing their respective assets and liabilities
subject to the following adjustments:
a. Accounts receivable of P50,000 in Ablan's books and P75,000 in Amias’ books are
uncollectible.
b. Inventories of P27,000 and P35,000 are worthless in Ablan's and Amias
c. Other assets of P10,000 and P18,000 in Ablan's and Amias' books are to be written off.
Instructions:
1. Prepare journal entries to adjust the books of both partners.
2. Prepare journal entries to close the books of both partners.
3. Prepare journal entries on the new books of the partnership.
4. Prepare a statement of financial position for the new partnership.
90
4
CHAPTER 3
PARTNERSHIP OPERATIONS
LEARNING OBJECTIVES
1. Discuss the closing entries in a partnership and differentiate them from the closing entries
in a sole proprietorship.
2. Identify and discuss the different methods and rules of dividing partnership profits and
losses among partners.
3. Discuss and understand the preparation of financial statements of a partnership.
PARTNERSHIP
OPERATIONS
OPERATIO
NS
Closing Distribution of Preparation of
Entries Partnership Financial
Profits and Statements
Revenue and gains Losses Statement of Income/
Expenses and losses Equally Statement of
Partner’s share in Arbitrary ratio Comprehensive
profits and losses Capital ratio Income
Partner’s drawing Interest on capital Statement of Financial
Salary allowance Position
Bonus Statement of Changes
in Partners’ Equity
91
Chapter 3—Partnership Operations
At the end of the accounting period, adjustments are made for merchandise inventory, accruals,
prepayments, provision for uncollectible accounts, and provision for depreciation. Profit or loss
is determined in the usual manner, that is, by matching periodic income and expenses.
However, special problems are encountered in accounting for partnership operations. These
problems include:
1. Closing entries of a partnership
2. Distribution of profits and losses
3. Preparation of a work sheet
4. Preparation of financial statements
a. Statement of income/ statement of comprehensive income
b. Statement of financial position
c. Statement of changes in partners' equity
92
However if the partner decides to reinvest into the firm this balance in his drawing account, the
entry is as follows:
A, Drawing xxx
A, Capital xxx
A debit balance in the Income Summary account represents a loss and its balance is transferred
to the drawing accounts of the partners based on their profit and loss sharing ratio. The entry is
as follows:
A, Drawing xxx
B, Drawing xxx
Income Summary xxx
The resulting debit balance in the drawing account of a partner is charged against his capital with
the following entry:
A, Capital xxx
A, Drawing xxx
On the other hand, the balance of the Income Summary account may be transferred directly to
the capital accounts of the partners if the partners' intention is to make the profit or loss a part of
permanent capital. It should be noted, however, that either treatment will result to the same net
effect on partners' ending capital balances. All illustrations in this chapter pertaining to
distribution of profit or loss are recorded directly to the capital accounts with the assumption that
partners intend to make their respective share on the profit or loss as a direct part of their
permanent capital.
A credit balance in the Income Summary account represents a profit and its balance is transferred
to the capital accounts of the partners based on their profit and loss sharing ratio. The entry is as
follows:
Income Summary xxx
A, Capital xxx
B, Capital 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
93
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 partnership
2. Amount of capital contributed by the partners to the business
3. Entrepreneurial ability or managerial skill of the partners
The distribution or division of profits and losses may be expressed in several ways as follows:
1. by percentage
2. by fraction
3. by decimal
4. by ratio
Illustration: Alba and Bueno are partners sharing profits and losses based on their capital
contributions of P100,000 and P300,000, respectively. Their profit and loss sharing can be
expressed as follows:
1. By percentage Alba 25% (P 100,000 / P400.000)
Bueno 75% (P300,000 / P400.000)
2. By fraction Alba 1/4 (P100,000 / P400,000)
Bueno 3/4 (P300,000 / P400,000)
3. By decimal Alba .25 (P100,000 / P400,000)
Bueno .75 (P300,000 / P400,000)
4. By ratio Alba and Bueno 1:3
b. Division of Losses
1. in accordance with agreement
94
2. if only division of profits is agreed upon, the division of losses will be the
same as the agreement on the division of profits
3. in the absence of an agreement, division of losses is in accordance with capital
contributions
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 contributions
b. Division of losses
1. in accordance with agreement
2. in the absence of an agreement, the capitalist-industrial partner in his/her
character as industrial partner shall have no share in the losses, but in his/her
character as a capitalist partner will share in proportion to the capital
contribution
Profits and losses in general shall be divided in accordance with the agreement among the
partners. In the absence of an agreement, the partners shall share in the profits in proportion to
their capital contributions after satisfying the share of the industrial partner on such profit.
Interest is allowed to partners for the use of invested capital. Interest as agreed by the
partners shall be allowed in proportion over the period such capital was actually used.
95
Moreover, the interest shall be provided whether the profit is sufficient or insufficient or
there is a net loss unless otherwise agreed upon by the partners.
5. Salary allowances to partners and the balance on agreed ratio – this method recognizes
the time and effort that a partner may devote in running the firm’s business operations but
does not take into consideration the differences in capital contributions.
Salaries are allowed to partners as compensation for their time devoted in the business.
Salaries as agreed by the partners shall be allowed in proportion to the time the partners
actually rendered services to the firm. Such salaries shall be provided whether the profit
is sufficient or insufficient or there is net a loss unless otherwise agreed upon by the
partners.
6. Bonus to managing partner and the balance on agreed ratio - this method allows a
bonus, as an incentive, to the managing partner. It is usually a percentage of the profit.
Bonus, therefore, is allowed only when there is a profit. It may be computed using any
one of the following as basis:
a. Bonus is based on profit before deducting bonus and income tax
b. Bonus is based on profit after deducting bonus but before deducting income tax
c. Bonus is based on profit after deducting income tax but before deducting bonus
d. Bonus is based on profit after deducting both bonus and income tax.
7. Interest on capital, salaries to partners, bonus to managing partner, and the balance
on agreed ratio.
Illustrative Problem A: The following data are available in the books of Calma and David
Partnership for the year 2014.
Calma, Capital
May 1 P100,000 Jan. 1 Balance P2,500,000
April 1 250,000
Oct. 1 500,000
Balance – P3,150,000
Calma, Drawing
Jan. 1 – Dec. 31 P300,000
96
David, Capital
Balance – P 1,800,000
David,Drawing
______________________________________________________________________________
Income Summary
Dec. 31 P600,000
Twelve cases will be illustrated using the given data. Cases 1-10 will show sufficient profit. Case
11 will show insufficient profi, Case 12 shows a loss.
Key Points. Withdrawals deducted for purposes of determining ending capital balances are the
debit entries in the capital accounts of each of the partners (see partners' accounts shown in the
previous page)These debit entries represent permanent withdrawals or decreases on capital. The
credit entries represent initial and/or additional investments.
On the other hand, the debits to the drawing accounts represent temporary withdrawals or
decreases in capital caused by the share in loss (though may be debited directly to the capital
account) or withdrawal of assets in anticipation of profits. The credit entries represent increases
in capital (may be credited directly to the capital account) caused by the share in profit. The
entries in drawing accounts are not considered in computing ending capital for the purpose of
establishing the ratio.
The following steps are to be followed in determining the average capital of each partner using
the peso month method, thus, arriving at the capital ratio:
By the following steps given, the average capital of each partners can be calculated as follows:
Calma, Capital
No. of mos.
Period Capital Balances Unchanged Peso months Average Capital
Jan.1 – Mar 31 P2,500,000 3 P7,500,000
Apr.1 – Apr. 30 2,750,000 1 2,750,000
May 1 – Sep 30 2,650,000 5 13,250,000
Oct. 1 – Dec 31 3,150,000 3 9,450,000
12 P32,950,000 P2,745,830
David, Capital
Cases 1 to 7 provide for division of profits using a single allocation procedure. However, there
are instances when the partnership agreement may provide for a combination of several
allocation procedures (multiple bases of profit allocation) to be used in the distribution of profit.
Since partnerships specify a profit distribution to be followed to whatever extent possible, most
agreements specify that the entire process is to be completed and any remainder is to be allocated
in the profit and loss ratio. The following cases are used to illustrate various multiple allocation
procedures.
Case 8 – Each partner is allowed 10% interest on ending capital and the remaining profit is
divided 60%, 40%
99
Income Summary 600,000
Calma, Capital 378,000
David, Capital 222,000
Division of Profit
Calma David Total
Case 9 – David is allowed salaries of P500,000 and the remaining profit is divided in the
ratio of 1:4
Division of profit
Calma David Total
Case 10 – David, the managing partner , is allowed a bonus of 20% of profit BEFORE
bonus and income tax and the remainder is divided in the ratio of beginning capital
100
Using the income tax rate of 30% the partnership income before income tax is P857,143 that is,
net profit of P600,000 divided by 70%
Division of profit
Other assumption on the computation of bonus shall be illustrated later in the chapter.
Case 11- the parteners are allowed P5,000 and P10,000 weekly salaries, repectively, 10%
interest on average capital, and the remainder is divided in the ratio of 2:3.
Division of profit
Salaries to partners
P5,000 x 52 P260,000
P10,000 x 52 520,000 780,000
Interest on average capital
P2,745,830 x 10% 274,580
P1,575,000 x 10% 157,500 432,080
Remainder – (P612,080)
P612,080 x 2/5 (244,830)
P612,080 x 3/5 (367,250) (612,080)
Total 289,750 310,250 P600,000
101
The sum of the salary allowance and interest allowed on the average capital of the partners
exceeded the profit of 600,000 resulting in a negative remainder (loss or deficit). Such loss is
distributed as provided in the profit and loss sharing agreement
Case 12 – Assume the same agreement as in Case 11 except that instead of a profit the
partnership has incurred a loss of P160,000. The allowance for salaries and interest will still
be provided, thereby resulting in a total loss to be divided as agreed.
Divison of profit
Salaries to partners
P5,000 x 52 P260,000
P10,000 x 52 520,000 780,000
Interest on average capital
P2,745,830 x 10% 274,580
P1,575,000 x 10% 157,500 432,080
Remainder – (P1,112,080)
P1,112,080 x 2/5 (524,830)
P1,112,080 x 3/5 (787,250) (1,112,080)
Total P9,750 (109,750) (100,000)
The allocation of partnership profit follows the order of the profit sharing agreement in
allocating the bonus, the salary allowances, the interests and the remainder to individual
partners.
The bonus is computed on the basis of the partnership profit as the concept of "partnership
profit" is generally understood in accounting practice.1 Partners may, however, intend for salary
and interest allowances to be deducted in determining the base for computing the bonus. In such
case, no bonus is allowed if there is insufficient profit after distribution of salaries and interests.
The interests of the partners may not be apparent when technical accounting terms are used; so,
the partnership agreement should be precise in specifying measurement procedures to be used in
determining the amount of a bonus.
Illustrations on the computation of bonus using other assumptions.,The same data is Illustrative
Problem A shall be used. Bonus rate is 20%.
1. Bonus is based on profit after deducting bonus but before deducting income tax
B = .20(P857, 143 – B)
102
B = P171,428 -.20B
B-20B = P171,428
B = P171,428/1.20
B = P142,857
2. Bonus is based on profit after deducting bonus but after deducting income tax
B = .20B (857,143-257,143)
T = .30 x P857, 143
= P257, 143
Substituting for T in the first equation and solving for B
B = .20(P857, 143 – B – T)
B = .20 x P600, 000
B = P120, 000
Key Points. The bonus was not deducted from the profit subject to income tax. The bonus being
computed is not an expense but a distribution of profit after income tax.
1. Bonus is based on profit after deducting bonus and income tax
B = .20(P857, 143 – B – T)
T = .30 x P857, 143
= P257, 143
Substituting for T in the first equation and solving for B
B = .20B (857,143- B - 257,143)
B = .20 (P600, 000 – B)
B = P120, 000 - .20B
B + .20B = P120, 000
B = P120, 000/1.20
B = P100, 000
Key Points. In the preceding examples, bonus is treated as a distribution of partnership profit,
and therefore such bonus is not deductible as an expense in determining the amount of taxable
profit. The same is true for salaries and interest allowed on capital.
The partnership form of business allows a wide selection of profit distribution ratios to meet the
individual desires of the partners. Ratios for profit distributions may be based on the percentage
of total partnership capital, time and effort invested in the partnership, or a variety of other
factors. Some partnerships, however, have a profit sharing ratio that is different from their loss
sharing ratio.
103
ORDER OF PRIORITY PROVISION
In some instances, the partners may agree not to use residual sharing ratio in the event profits did
not exceed the total of the salary and interests allowances. In this case, the partners must agree
on the priority of the various features. If the partnership agreement gives salary allowances
priority over interest on capital balances, then profit would first apply to salaries and the balances
would be divided in the ratio of interest allowance and vice-versa.
Illustrative Problem B: Santos and Tomas are partners with capital balances P315.000 and
P180, 000, respectively. The profit and loss agreement provides salaries of P500, 000 to Santos
and P250, 000 to Tomas, 10% interest on capital and the balance will be divided equally. Income
is to be allocated by first giving priority to interest on invested capital and then on salary
allowance. Partnership net income for the year is P600.000.
The following is the division of the P600, 000 profit in accordance with the order of priority
provision.
At the end of each accounting period the partnership books are adjusted and closed and financial
statement are prepared. In order to classify a accounting data in a convenient and orderly manner
and to facilitate the preparation of financial statement, a worksheet is prepared. The form or
columns of the worksheet may vary depending on the needs of the company. The following
illustrative problem will use the simplest form of worksheet with emphasis not on the form but
the underlying principles and procedures in preparing such worksheet.
Illustrative Problem C: the trial balance for EXCELLENCE COMPANY as at December 31,
2014 is presented on the next page.
EXCELLENCE COMPANY
Trial Balance
December 31, 2014
Debit Credit
Cash 1,900,000
Notes receivable 625,000
Accounts receivable 1,125,000
Allowance for uncollectible accounts 50,000
Merchandise inventory 1,250,000
Furniture and equipment 1,500,000
Accumulated depreciation 200,000
Notes payable 500,000
Accounts payable 375,000
Flores, capital 1,250,000
Flores, drawing 155,000
Garcia, capital 3,1250,000
Garcia, drawing 250,000
Sales 5,000,000
Sales return and allowances 50,000
Sales discount 75,000
Purchases 2,412,500
Purchases return and allowances 100,000
Purchases discount 62,500
Freight in 125,000
Selling expenses 825,000
General expenses 362,500
Interest income 17,500
Interest expense 25,000
105
10,680,000 10,680,000
106
The Articles of Co-Partnership contain the following provisions regarding the division of profit
and losses:
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
107
EXCELLENCE COMPANY
WORKSHEET
For the Year Ended December 31, 2014
108
Salaries Payable c. 25,000 25,000
Interest Receivable d. 2,500 2,500
Interest Payable e. 1,500 1,500
Supplies on Hand g. 25,000 25,000
Income Tax Expense h. 253,050 253,050
Income Tax Payable h. 253,050 253,050
519,500 519,500 5,592,050 6,182,500 6,582,500 5,992,050
Profit 590,450 590,450
6,182,500 6,182,500 6,582,500 6,582,500
109
EXCELLENCE COMPANY
Statement of Income
For the Year Ended December 31, 2014
Schedule
Net Sales 1 P4,875,000
Cost of Sales 2 2,625,000
Gross Profit P2,250,000
Other Operating Income- Interest 20,000
Operating Expenses:
Selling P925,000
General 475,000 (1,400,000)
Operating Profit P870,000
Interest Expense (26,500)
Profit before Tax P843,500
Income Tax Expense 30% (253,050)
Profit for the Period P590,450
Division of Profit
Flores Garcia Total
Salaries P400,000 P500,000 P900,000
Interest on beginning capital 125,000 312,500 437,500
Balance- 3:2 (P747,050)
P 747,050 × 3/5 (448,230)
P 747,050 × 2/5 (298,820) (747,050)
Total share in profit P76,770 P513,680 P590,450
110
Key Points. The Statement of Income of a partnership is similar to that of a sole proprietorship
except that it includes a schedule showing the division or distribution of profit to partners.
EXCELLENCE COMPANY
Statement of Financial Position
December 31, 2014
ASSETS
Current Assets:
Cash P1,900,000
Notes Receivable 625,000
Accounts Receivable P1,125,000
Less Allowance for Uncollectible Accounts 112,500 1,012,500
Interest Receivable 2,500
Merchandise Inventory 1,000,000
Supplies 25,000 P4,565,000
LIABILITIES
Current Liabilities:
Notes Payable P500,000
Accounts Payable 375,000
Salaries Payable 25,000
Interest Payable 1,500
Income Tax Payable 253,050
Total Liabilities P1,154,550
PARTNERS' EQUITY
Flores, Capital P1,171,770
Garcia, Capital 3,388,680
Total Partners' Equity 4,560,450
111
CORRECTIONS IN PROFIT FOR ERRORS
AND OMISSIONS PRIOR TO DISTRIBUTION
The partnership books may show an incorrect profit because of errors and omissions. Such
include failure to record prepaid expenses, accrued expenses, accrued income, unearned income
and also overstatement or understatement in purchases, inventories, and depreciation. The
reported profit should be corrected before it is distributed to the partners. The required
corrections may be summarized as follows:
It is understood that the tax implications of these corrections are properly accounted for
particularly if the partnership is not a general professional partnership.
Illustrative Problem D: Hannah, Ines, and Julian are partners sharing profit on a 2:3:5 ratio. On
January 1, 2014, Karina was admitted into the partnership with a 20% share in profits. The old
partners shall continue to participate in profits in proportion to their original ratios.
For the year 2014, the partnership books showed a profit of P 398,000. It was ascertained,
however, that the following error were made:
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The corrected profit for 2014 based on a 30% income tax rate shall be computed as follows:
The distribution of corrected profit shall be based on the new profit and loss ratios computed as
follows:
While it is unusual that capital ratios do not equal profit and loss ratios; yet, partners may decide
to bring their capital balances into their profit and loss ratio. This can be accomplished through
either of the following:
1. The capital balances are to be brought into the profit and loss ratio by payments
outside of the firm among the partners and where the total firm capital is to remain the
same.
2. The capital balances are to brought into the profit and loss ratio by the lowest possible
additional cash investment in the firm by the partners.
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3. The capital balances are to be brought into the profit and loss ratio by the lowest possible
additional cash investment or cash withdrawal from the firm by the partners.
Illustrative Problem E: Lopez, Martin and Nunag are partners whose original capital
balances were in profit and loss ratio. On December 31, 2014, capital balances are as follows:
Partners want to bring capital balances into the profit and loss ratio.
Assumption 1. Capital balances are to be brought into the profit and loss ratio by payments
outside of the firm among the partners and with the total firm capital to remain the same
For the capital balances to be brought into the profit and loss ratio and the total firm capital to
remain the same, Martin and Nunag have to pay Lopez P100,000 each. The entry required on the
partnership books is as follows:
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.
In order to bring the capital balances into the profit and loss ratio by the lowest possible
additional cash investment, use as basis for determining the required capital, the capital
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of Lopez divided by his profit share (P400,000/20% equals P2,000,000). The required entry
on the books of the partnership is as follows:
Cash 1,000,000
Martin, Capita 400,000
Nunag, Capital 600,000
Assumption 3. Capital Balances are to be brought into the profits and loss ratio by the lowest
possible additional investment or cash withdrawal from the firm by the partners.
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:
1. Discuss the closing entries in a partnership and differentiate them from the
closing entries in a sole proprietorship. The closing entries of a partnership are almost similar to
those of a sole proprietorship. However, the profit or loss of the partnership is transferred to the
individual drawing account or capital account of the partners and is distributed according to the
profit and loss sharing agreement.
2. Identify and discuss the different methods and rules of dividing partnership profits and
losses to partners. The distribution of partnership profits and losses to the partners may be
expressed in any of the following ways: (1) by percentage; (2) by fraction; (3) by decimal; or
(4) by ratio. The Civil Code of the Philippines provides rules on how partnership profits and
losses be divided among the partners. As a general rule, profits or losses should be divided in
accordance with the partners' agreement. In the absences of an agreement, the division shall
be made in accordance with capital contributions. To give recognition to the services
rendered by the partners or to the differences in the amount contributed in the partnership or
to the entrepreneurial ability or managerial skill of the partners, salaries, interest and bonuses
may be allowed to the partners as part of the division of profit and losses.
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3. Discuss and understand the preparation of financial statements of a partnership. The
financial statements are prepared after the work sheet is completed (or after journalizing and
posting the adjusting entries if a work sheet is not prepared). These financial statements
include the income statement, the statement of financial position, and the statement of
changes in partners' equity. The income statement includes a schedule showing the division
of the partnership profit or loss to the partners. The owners' equity section of the statement of
financial position is called "Partners' Equity" and it shows capital balances of individual
partners. The statement of changes in partners' equity shows the division of profit and loss to
the partners, the amount of withdrawals during the period, and the partners' capital balances
at the end of the period.
Average Capital — the amount of capital invested by a partner determined by the time during
which such capital is actually used in the business.
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.
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DISSCUSSION QUESTIONS
1. What are the procedures followed in closing the books of the partnership at the end of an
accounting period?
2. What are the factors to be considered in adopting a particular plan for sharing profits among
partners?
3. What are the general rules for dividing profits among partners? For dividing losses?
4. Does an industrial partner share in both profits and losses?
5. Why are salary allowances to partners debited to Income Summary instead of Salary Expense?
Is there an instance when such salary allowances are debited to Salary Expense account? If yes,
what is that instance?
6. Pacis, Quezon and Roces share profits and losses based on their capital balances of P250,000,
P500,000, and P750,000, respectively. Show hoe the profit of P100,000 be distributed in terms of
(a) percentage; (b) fraction; (c) decimal; and (d) ratio.
7. Explain the following terms; (a) original capital; (b) beginning capital; (c) ending capital; and
(4) average capital. How do you determine the amount of each type of capital?
8. When the profit and losses agreement provides for the allowance of interest on partners’
equity and salaries to partners, why are the partners entitled to these allowances even if the
partnership operations result in a loss?
9. Why is it necessary to specify whether the withdrawal made by the partner is a withdrawal
against profit or a permanent withdrawal of a capital or a loan being extended to him/her by the
partnership?
10. What is a statement of changes in partners’ equity? What information does it show?
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EXERCISES
Exercise 3-1 (Division of Profits using Ratios)
Borres, Buendia, and Bustos have capital balances of P250,000 and P100,000, respectively. Time
divided by the partners in the partnership follows:
Borres - three- fourths time
Buendia - one-fourth time
Bustos - one-half time
Instructions: Determine the participation of the partners in the profit of P600,000 if profit is
divided:
1. in the ratio of capital investments
2. In the ratio of time devoted in the business
Exercises 3-2 (Division of Profit; Interest on Average Capital)
Banal and Benson are partners. Their capital accounts during the fiscal year 2014were as
follows:
Banal Benson
9/1 120,000 1/1 800,000 3/1 180,000 1/1
1,200,000
4/1 160,000 3/1
140,000
11/1 60,000 10/1
100,000
Profit opf the partnership is P250,000 for the year. The partnership agreement provides for the
division of profits as follows:
1. Each partner is to be credited 10% interest on his average capital
2. Any remaining profit or loss is to be divided equally.
Instruction: Prepare the entry to record the closing of profit to the partners’ capital accounts.
Exercise 3-3 (Division of profit; Interest on Average Capital and Salaries to Partners)
The partnership of Benito and Bunye has the following provisions in the partnership agreement:
1. A partner earns 10% interest on the excess of his average capital over the other partner.
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2. Benito and Bunye are allowed annual salaries of P300,000 and P200,000 respectively.
3. Any remaining profit or loss is to be divided in the ratio of 70:30.
The average capital of Benito is P1,000,000 and that Bunye is P600,000.
Instructions: Prepare a profit distribution schedule assuming the profit of the partnership is (a)
P700,000; and (b) P400,000
Exercise 3-4 (Division of Profit under Various Assumptions)
Blanco and Banda formed a partnership by investing P120,000 and P180,000, respectively. At
the end of its first year of operations, the partnership has realized a profit of P120,000.
Instructions: Prepare a profit distribution of profit under each of the following independent
assumptions:
1. The partnership agreement does not mention profit sharing.
2. Profit is divided in the ratio of the original investments.
3. Interest at 8% is to be allowed on the original capital investments and the balance to be
dividedequally.
4. Salaries of P54,000 and P45,000 respectively and the balance to be divided equally.
5. Interest at 10% is to be allowed on the original capital investments, salaries of P50,000
and P75,000 to partners, respectively and the balance to be divided in the ratio 2:3. In case of
insufficient net income, however, this has to be distributed in the salary ratio. While if
there is a net loss, then it has to be distributed equally.
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Instructions:
1. Show how the profit of P375,000 should be divided between Bueno and Berna.
2. Assuming that Bueno and Beran simply agree to share a profit in 3:2 ratio with a
minimum of P175,000 guaranteed to Beran, show how the profit of P375,000 should be
divided.
Exercise 3-6 (Divisions of Profit; Interest on Capital, Salary Allowance, and Bonus to
Managing Partner)
Belen and Blanco formed a partnership on January 2, 2014 and agreed to share profit 90% and
10% respectively, Belen invested cash of P200,000. Basco invested to assets but has a
specialized expertise and manages the firm full time. There were no withdrawals during the year.
The partnership contract provides for the following:
1. Capital accounts are to be credited annually with interest at 10% of beginning capital
2. Basco is to be paid a salary of P8,000 a month.
3. Basco is to reveive a bonus of 25% of profit calculated before deduction of salary and
interest on capital accounts.
4. Bonus, interest, and basco’s salary are to be considered as expenses.
The fiscal year 2014 income statement for the partnership includes the following:
Revenue P701,000
Expenses (including salary, interest and bonus) P379,000
Profit P322,000
Instructions: Determine the amount of bonus to be collected to Basco.
Exercise 3-8 (Capital Balances Ratio Adjusted to Profit and Loss Ratio)
Balbin, Bagtas, and Banta are partners sharing 40%, 35%, and 25%. Partners’ Ooriginal capital
were in this ratio but on June 30, 2014, capital balances are as follows: Balbin – P240,000,
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Bagtas – P 200,000, and Banta – P200,000. Partners want to bring capital balances into profit
and loss ratio.
Instructions:
1. Assuming that the capital balances are to be brought into profit and loss ratio by the
payments outside the firms among partners, the total firm capital to remain the same, what
cash transfers are required between or among partners and what entry would be made on the
firm books?
2 Assuming that the capital balances are to be brought into profit and loss ratio by the
lowest possible cash investment in the firm by the partners, what additional investments are
required and what entry would be made by the firm books?
3. Assuming that the capital balances are to be brought into profit and loss ratio by the
lowest possible cash investment or cash withdrawal from the firms by the partners, what
additional cash investments or cash withdrawals are required and what entry would be made
by the firm books?
Exercise 3-9 (Computation of Partnership Profit)
Barte, a partner in the BBB Partnership, has a 25% participation in profit. Barte’s capital account
had a net decrease of P240,000 during the year of 2014. During 2014, Barte withdrew P520,000
(charged against his capital account) and invested in the partnership a property with a fair value
of P100,000.
Instructions: Determine the profit of the BBB Partnership for the year 2014.
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PROBLEMS
Problem 3-1 (Division of Profit under Various Assumptions)
The capital accounts of Bondoc and Barba at the end of the fiscal year 2014 are as follows:
Bondoc, Capital
January 1 Balance P210,000
May 1 Investment 90,000
October1 Withdrawal P60,000
Barba, Capital
January 1 Balance P150,000
April 1 Withdrawal P30,000
The partnership profit for the year ended December 31, 2014 is P300,000.
Instructions: Give the journal entries to record the transfer of profit to the capital accounts under
each of the following assumptions: (Show the procedure used in calculating the respective
amounts as an explanation for each entry.)
1. Profit is divided 60% to Bondoc and 40% to Barba.
2. Profit is divided in the ratio of capital balances at the beginning of the period.
3. Profit is divided in the ratio of average capital.
4. Interest at 8% is allowed on average capital and the balance of the profit is divided
equally.
5. Salaries of P60,000 and P48,000 are allowed to Bondoc and Barba, respectively, and the
balance of profit is divided in the ratio of capital balance at the end of the period.
6. Bondoc is allowed a bonus of 33 1/3% of profit after bonus, and the balance of the profit
is divided in the ratio of the average capital.
Instructions: Prepare separate schedules showing how profit and loss will be divided among the
three partners under each of the following independent cases. The amount given in each case is
the profit or loss for the year that is available for distribution to partners.
1. P50,000 loss 2. P120,000 profit 3. P500,000
Problem 3-4 (Division of Profit and Loss; Interest on Capital and Salaries and Bonus to
Partners)
Basa, Benito, Beltran and Bagnes own a publishing company which they operate as a
partnership. The partnership agreement includes the following:
Basa receives a salary of P400,000 and a bonus of 3% of income after all bonuses;
Benito receives a salary of P200,000 and a bonus of 2%of income after all bonuses;
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All partners are to receive a 10% interest on their average capital balances. The average
capital balances are as follows: Basa – P100,000; Benito – P900,000; Beltran – P400,000
; Bagnes – P940,000
Any remaining profits are to be divided equally among the partners.
Instructions:
1. Determine how a profit of P2,100,000 would be allocated among the partners.
2. Determine how a loss of P800,000 would be allocated among the partners.
3. Determine how a profit P800,000 would be allocated among the partners assuming the
following priority system: Income should be allocated by first giving priority to interest
on invested capital, then bonuses, then salary, and then according to the profit and loss
percentages.
Problem 3-5 (Division of Profit and Loss; Interest on Capital and Salaries and Bonus to a
Partner)
The condensed income statement of Balte and Bala as of December 31, 2014 follows:
Sales P4,800,000
Cost of sales 2,100,000
Gross profit P2,700,000
Operating expenses 1,000,000
Profit before taxes P1,700,000
Income tax (P1,700,000x30%) 510,000
Profit P1,190,000
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Instructions:
1. Prepare a schedule showing the distribution of profit to partners.
2. Prepare the journal entries required to distribute profit and to close the books of
partnership.
3. Prepare a statement of changes in partners’ equity.
Problem 3-6 (Computation of Profit; Division of Profit; Ending Capital Balance)
Brenda and Brosas entered into a partnership on May 1, 2014, investing P625,000 and P375,000,
respectively. It was agreed that Brenda, the managing partner, is to receive a salary of P150,000
per year and 10% of profit after adjustment for the salary, any remaining profit is to be divided in
the ratio of original capital. On December 31, 2014, account balances are as follows:
Debit Credit
Accounts Payable 300,000
Accounts Receivable 335,000
Brenda, Capital
625,000
Brenda, Drawing
Brosas, Capital
375,000
Brosas, Drawing 150,000
Cash 710,000
Furniture and Fixtures 225,000
Operating Expenses 300,000
Purchases 980,000
Sales 1,525,000
Sales Returns and Allowance 25,000
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Additional information as of December:
1. Inventories; merchandise, P305,000; supplies, P12,000
2. Prepaid taxes and insurance, P5,000
3. Accrued expenses, P17,500
4. Depreciation on furniture and fixtures, 20% per year.
Instructions:
1. Determine the profit or loss of the partnership. Income tax rate is 30%.
2. Prepare a schedule showing the distribution of partnership profit los loss.
3. Determine the ending capital balances of the partners.
Problem 3-7 (Work Sheet; Financial Statements; Adjusting and Closing Entries)
The account balances in the books of Be on Top Partnership at the end of its first year of
operations on December 31, 2014 are as follows:
Accounts Payable 756,000
Accounts Receivable 186,000
Bathan, Capital 600,000
Bathan, Drawing 144,000
Buenas, Capital 489,000
Buenas, Drawing 54,000
Cash 582,750
General Expenses – Others 756,000
Interest Expense 26,000
Interest Income 21,000
Notes Payable 360,000
Notes Receivable 120,000
Purchases 4,920,000
Purchases Discount 138,000
Purchases Returns and Allowance 99,000
Sales 5,100,000
Sales Salaries 480,000
Store Furniture 222,000
Store Supplies 36,000
Taxes 36,000
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As the person in-charge of the preparation of financial statements, you gathered the following
data that require adjustments as of December 31, 2014 and the information relating to division of
partnership profit or loss:
1. Inventories: merchandise, P1,406,000; supplies, P16,500.
2. Depreciation of store furniture, 10% a year. Additions to store furniture were made on
March 1 costing P54,000.
3. Accrued advertising, P9,500.
4. Prepaid taxes, P10,000
5. Accrued taxes, P10,500
6. Accrued interest on notes payable, P3,750
7. Accrued interest on notes receivable, P6,000
8. Uncollectible accounts receivable, P9,300
9. Income taxes, 30%
10. Bathan and Buenas agree to divide earnings as follows:
a. Interest at 10% on beginning capital balances
b. Salaries to the managing partner Bathan of P100,000
c. Remaining profit or loss to be divided equally
Instructions:
1. Prepare a ten-column worksheet.
2. Prepare an income statement, a statement of changes in partners' equity, and a statement
of financial position.
3. Prepare the adjusting and closing entries as of December 31, 2014.
The partnership fiscal year is the calendar year. Activities of the partnership for 2012, 2013 and
2014 are summarized below:
2012 2013 2014
Profit or loss before interest, salaries
And bonus (P42,000) P300,192 P470,000
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Cash withdrawals:
Bacani P72,000 P139,600 P163,200
Badeo 86,800 163,200 195,200
Barte 96,000 177,200 169,600
Instructions: Prepare a statement of changes in partners' equity covering the three-year period
ending December 31, 2014.
Instructions:
1. Determine the new profit and loss ratio of the old partners.
2. Prepare a schedule showing the division of the corrected partnership profit to the
partners.
MULTIPLE CHOICE
MC 3-1 Banayo and his very close friend Buendia formed a partnership on January 1,
2014 with Banayo contributing P160,000 cash and Buendia contributing
equipment with a book value of P64,000 and a fair value of P48,000, and
inventory items w th a book value of P24,000 and a fair value of P32,000. During
2014, Buendia made additional investment of P16,000 on April 1, and P16,000 on
June 1. On September 1, he withdrew P40,000. Banayo had no additional
investment nor withdrawals during the year. The average capital balance of
Buendia at the end of the fiscal year 2014 is
a. P72,000 c. P88,000
b. P80,000 d. P96,000
MC 3-2 Bañas and Belda are partners who share profits equally and losses in a 2:1 ratio. If
they have beginning capital balances of P120,000 and P118,000, made no
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additional investments nor withdrawals, and suffered an unprofitable year with
loss of P48,000, their capital balances will be:
Bañas Belda
a. P40,000 P80,000
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 a profit of P180,000 for the year 2014 before any allowance
to partners. What amount should be credited to each partner's capital account as a
result of the distribution of the partnership profit?
Bernardo Belo
a. P98,000 P82,000
b. 100,000 80,000
c. 96,000 84,000
d. 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 terms.
a. Bustos is to receive a bonus of 10% of profit after bonus.
b. Interest of 10% shall be paid on that portion of a partner's capital in excess of
P200,000.
c. Salaries of P20,000 and P24,000 shall be paid to partners Bunag and Bustos,
respectively.
Assuming a profit of P220,000 for the year, the total profit share of Bustos is
a. P38,800 c. P54,800
b. P50,800 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.
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b. Average partners' capital balances during the year shall be allowed 10%
interest.
Additional information:
a. On June 30, 2014, Banta invested an additional P120,000.
b. Borja withdrew P140,000 from the partnership on September 30, 2014.
c. Share on the remaining partnership profit was P10,000 for each partner.
How much is the total interest on average capital balances of the partners?
a. P95,000 c. P107,500
b. P97,500 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 c. P415,500
b. P399,500 d. P423,250
MC 3-7 Using the information in MC 3-5, the total partnership capital on December 31,
2014 is
a. P950,000 c. P1,345,500
b. P970,000 d. P1,365,500
MC 3-8 On January 1, 2014, Besa, Basco, Buan, and Baduel formed the B4 TRADING, a
partnership with capital contributions as follows: Besa- P150,000; Basco-
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 representing interest and their respective share in partnership
profits. The balance of the profits shall be distributed among the partners in the
ratio of 3:3:2:2.
What amount must be earned by the partnership in fiscal year 2014, before any
charge for interest and partners' salaries, in order that Besa may receive an
aggregate of P37,500 including interest, salary, and share of profits?
a. P92,000 c. P50,000
b. P97,000 d. P90,000
MC 3-9 Using the information in MC 3-8, the total profit share of Buan is
a. P7,500 c. P19,400
b. P13,750 d. P37,500
MC 3-10 Using the information in MC 3-8, the total profit share of Baduel is
a. P13,000 c. P18,000
b. P13,500 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 the residual profit and loss to
be appropriated in the ratio of 2:3, respectively. Which partner has greater
advantage when the partnership has a profit and when it incurs a loss?
Profit Loss Profit Loss
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a. Bertol Banaria c. Banaria Banaria
b. Banaria Bertol d. Bertol Bertol
MC 3-12 Bulan, Bustos, and Bucao formed a partnership on 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; interest of
12% on the average capital during 2014 of the three partners; the remainder will
be divided in the ratio of 2:4:4, respectively.
Additional information:
a. Operatinf income for the year ended December 31, 2014 is P180,000.
b. Bulan contributed additional capital of P30,000 on July 1, and made drawing
of P10,000 on October 1.
c. Bustos contributed capital of P20,000 on August 1 and made withdrawal of
P10,000 on October 1.
d. Bucao made withdrawal of P30,000 on November 1.
The division of the P180,000 operating income is
Bulan Bustos Bucao
a. P53,760 P65,520 P59,720
b. P35,200 P70,400 P70,400
c. P53,980 P63,660 P62,360
d. P53,180 P62,060 P60,760
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, P477,300, and P324,700, respectively. The partners receive
10% interest on their average capital balances, salaries of P244,650 to Briones
and P165,250 to Burgos, any residual profit or loss is divided equally.
In 2014, the partnership had a net loss of P251,248 before the interest and salaries
to partners.
What is the change in the capital balances of Briones and Burgos?
Briones Burgos
a. P81,688 decrease P62,474 decrease
b. P56,716 increase P64,916 increase
c. P58,952 increase P35,072 increase
d. P60,534 increase P80,896 decrease
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Test Material No. 10 Rating __________
TRUE or FALSE
Instructions: Encircle the letter T if the statement is correct and the letter F if the statement is
incorrect.
2. If the partners did not agree as to how profits are to be divided, then such
should be divided among the partners equally.
4. Any salaries authorized for partners are regarded as a preliminary step in the
division of profits, not as an expense of the business
5. The statement of changes in partners’ equity takes the place of the capital
statement in a sole proprietorship.
8. Unless otherwise agreed, allowance for salaries and interest are allowed to
partners whether there is a profit or a loss; whether the profit is sufficient or
insufficient.
10. The drawing account of a partner may have a debit or a credit balance.
11. The profit of the partnership is transferred to the drawing accounts of the
partners if the intention is to keep the capital account intact for investments and
permanent withdrawals of capital.
12. A credit balance in the Income Summary account represents profit after
closing into it all the operating (nominal) accounts.
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13. If the partnership agreement specifies a method for sharing profits, but not
losses, then losses are shared in the same proportion as profits.
14. Allowance for salaries and interest in a partnership agreement are methods of
allocating profits and losses to the partners.
15. The percentage interest in a partnership is always the same as the profit-
sharing ratio.
16. Profits and losses, in general, shall be divided in accordance with the
agreement among the partners.
17. Partners may intend for salary and interest allowances to be deducted in
determining the base for computing bonus. In such a case, no bonus is allowed if
there is insufficient profit after distribution of salaries and interests.
19. The partnership books may show an incorrect profit because of errors and
omissions that should first be corrected before the profit distribution to the
partners.
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Test Material No. 11 Rating __________
MATCHING TYPE
Choices:
___________ 2. A method of dividing profits which uses as basis the amount of capital invested
and the time during which such capital are actually used by the business.
___________ 4. To compensate for the difference in their capital contributions, partners are
allowed this item.
___________ 5. The compensation given to partners for the ability and time devoted to the
business.
___________ 6. An incentive given to the managing partner which is usually a percentage of net
income.
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___________ 8. A ratio expressed in fraction or percentage which has no relation to the amount
of capital investment of the partners.
___________ 9. The basis or ratio in which the profits or losses are shared by the partners.
___________ 10. The entire return from the business to the partners for their time, skill, and
capital.
___________ 11. A basic financial statement which gives effect to the changes in capital
balances of the partners during a specific period.
___________ 12. A permanent part of a partnership income statement not found in that of a sole
proprietorship.
___________ 13. A temporary account used to summarize the various revenue and expenses,
the balance of which may represent profit or loss.
___________ 14. This is prepared in order to classify accounting data in a convenient and
orderly manner and facilitate the preparation of financial statements.
___________ 15. Balances in the capital accounts of partners at the start of each accounting
period.
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Test Material No. 12 Rating ___________
Name_________________________________ Date__________________________________
Year and Section________________________ Professor______________________________
Instructions: Encircle the letter of the best answer in good form in a separate work sheet.
Present supporting computations
1. If the partners have not drawn up any agreement, then they must share profits and losses
a. equally
b. by any means that will save taxes
c. by any appropriate ratio
d. according to capital contributions
2. Among the various options available for determining the partners' share of profit are the
following except:
a. capital contributions and service to the partnership
b. loans to the partnership
c. capital contributions
d. stated fraction or ratio
3. Partners Barona and Basilio share income in a 2:1 ratio, respectively Each partner receives an
annual salary allowance of P72,000. If the salaries are recorded in the accounts of the
partnership as an expense rather than treated as an allocation of profit, the total amount
allocated to each partner for salaries and profit would be
a. less for both Barona and Basilio
b. unchanged for both Barona and Basilio
c. more for Barona and less for Basilio
d. more for Basilio and less for Barona
4. Partners Bagobo and Bicomo share profit and loss equally after each has been credited with
annual salary allowances of P90,000 and P72,000, respectively Under this arrangement.
Bagobo will benefit by P18,000 more than Bicomo in which of the following circumstances?
a. Only if the partnership has profit of P162,000 or more for the year
b. Only if the partnership does not incur a loss for the year
c. In all profit or loss situation
d. Only if the partnership has profit of at least P18,000 for the year
5. The BB Tours Partnership earned P500,000 this year. The partners have equal capital
balances, and share profits and losses 1:3. The partners will show share in partnership profit
of
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a. P250,000 each
b. P250,000 and P750,000, respectively
c. P125,000 and P375,000, respectively
d. P500,000 each
6. Beltran and Barba are partners who share profits equally and losses in a 2:1 ratio. Beltran and
Barba have beginning capital balances of P400.000 and P500,000 respectively, and made no
withdrawals during a period of two years. After a profitable operations on the first year with
a profit of P400,000 and an unprofitable operations on the second year with a loss of
P240,000, the capital balances of Beltran and Barba will be
Beltran Barba Beltran Barba
a. P480,000 P580,000 c. P440,000 P620,000
b. P390,000 P570,000 d. P670,000 P770,000
7. Bamba and Balbina share profits and losses in the ratio of 1:2. Bamba receives a monthly
salary of P150,000. If Bamba's capital balance is P2,500,000 at the beginning of the year and
P2,000,000 at the end of the year, and annual partnership profit after salaries is P1.200.000,
then Bamba withdrew
a. P 500,000 c. P2,700,000
b. P1,300,000 d. P3,200,000
8. The BBB Company is a partnership of three musicians who play at weddings and office
parties. The partnership's profits and losses are allocated in proportion to the partners' capital
contributions. If the partners Bamboo, Banda, and Banjo have capital contributions of
P300,000, P300,000, and P500,000, respectively, what is each partner's share in the profit of
P1,100,000?
Bamboo Banda Banjo
a. P300,000 P300,000 P600,000
b. P300,000 P300,000 P500,000
c. P300,000 P500,000 P1,100,000
d. P366,667 P366,667 P366,667
9. Banzon and Borja are partners in B and B Enterprises. Partnership profits and losses are
allocated as follows: salaries of P160,000 and P200,000 to Banzon and Borja, respectively;
10% interest on their beginning capital balances, any remaining profit is divided equally. At
the beginning of the year, their capital balances are P360,000 and P600,000. How will the
partnership profit of P600,000 be allocated to the two partners?
Banzon Borja Banzon Borja
a. P192,000 P408,000 c. P300,000 P300,000
b. P268,000 P332,000 d. P280,000 P320,000
10. Bautista, a partner in the Christian Partnership has a 20% participation in the partnership
profit and loss. Bautista's capital account had a net decrease of P240,000 during the calendar
year 2014. During 2014, Bautista withdrew P520,000 (charged against his capital account)
and contributed property valued at P100,000 to the partnership. What was the profit of the
partnership?
a. P600,000 c. P1,400,000
b. P900,000 d. P2,200,000
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11. The partnership agreement of Bustos and Balen provides that interest at 12% per year is to be
credited to each partner on the basis of average capital balances. A summary of Balen's
capital account for the year ended December 31, 2014 is as follows:
Balance, January 1 P840,000
Additional investment, July 1 240,000
Withdrawal, August 1 90,000
Balance, December 31 990,000
What amount of interest should be credited to Balen's capital account for 2014?
a. P91,500 c. P99,000
b. P92,500 d. P110,700
12. Basilio and Bituin formed a partnership in the year 2014. The partnership agreement provides
for annual salary allowances of P220,000 for Basilio and P180,000 for Bituin. The partners
share profits equally and losses in a 60:40 ratio. The partnership had a profit of P360,000 for
the year 2014 before any allowance to partners. What amount should be credited to each
partner's capital account as a result of the distribution of the partnership profit?
Basilio Bituin Basilio Bituin
a. P180,000 P180,000 c. P196,000 P164,000
b. P192,000 P168,000 d. P200,000 P160,000
13. Bucao, Basco, and Blanco share profits and losses in the ratio of 2:3:5, respectively. Their
partnership realized a profit of P900,000 during the year. Bucao, with a beginning capital
balance of P1,000,000 withdrew P200,000 during the year. Bucao's ending capital balance is
a. P980,000 c. P1,160,000
b. P1,000,000 d. P1,380,000
14. The B2 Partnership was formed on January 3, 2014. Under the partnership agreement, each
partner has an equal initial capital balance accounted for under the bonus method Partnership
profit or loss is allocated 60% to Brecia and 40% to Buan. To form the partnership, Brecia
originally contributed assets costing P300,000 with a fair value of P600,000 on January 3,
2014, while Buan contributed P200,000 in cash. Withdrawals by the partners during the
fiscal 2014 totaled P30,000 by Brecia and P90,000 by Buan. The partnership profit for fiscal
year 2014 was P450,000. Buan's initial capital balance in the partnership is
a. P200,000 c. P400,000
b. P250,000 d. P600,000
15. Using the information in No. 14, what is the ending capital of Brecia at December 31, 2014?
a. P550,000 c. P840,000
b. P640,000 d. P870,000
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Test Material No. 13 Rating ___________
Name_________________________________ Date__________________________________
Year and Section________________________ Professor______________________________
PROBLEMS
Problem A
The partnership of Beltran, Bernal, and Basco was formed on January 1, 2014. The original cash
investments were as follows:
Beltran P384,000
Bernal 576,000
Basco 864,000
According to the partnership contract, profit or loss will be divided among the partners as
follows:
1. Salaries of P57,600 for Beltran, P48,000 for Bernal and P38,400 for Basco.
2. Interest of 8% on average capital balances during the year.
3. Remaining profit will be divided equally
The profit of the partnership for the year ended December 31, 2014 was P450,000. Beltran
invested an additional P96,000 in the partnership on July I, 2014. Basco withdrew P144,000
from the partnership on October 1, 2014; and Beltran, Bernal, and Basco made regular drawings
of P48,000 each against their share of profit during the calendar year 2014
Instructions:
1. Prepare a schedule showing the division of profit among the three partners.
2. Prepare a statement of changes in partners’ equity for the year 2014
Problem B
Several years ago, Bilbao and Bragas formed Double B Partnership. The partnership agreement
states that each partner is to receive a salary of P20,000 per month and 5% interest on beginning
capital balances; any remainder would be divided between Bilbao and Bragas in the ratio of 2:3,
respectively. The unadjusted trial balance of the partnership as of December 31, 2014 is
presented below.
DEBITS CREDITS
Cash 1,000,000 Accounts payable 700,000
Accounts receivable 600,000 Notes payable 400,000
Merchandise Inventory, Jan.1 800,000 Bilbao, capital 1,500,000
Furniture and Fixtures (net) 300,000 Bragas, capital 1,240,000
Building (net) 600,000 Sales 1,800,000
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Bilbao, drawing 200,000
Bragas, drawing 240,000
Purchases 1,200,000
Operating expenses 300,000
Additional information:
1. Prepare the partnership statement of income for the year ended December 31, 2014.
2. Prepare a schedule showing the allocation of partnership profit or loss and prepare the
entry to record the partners' share in the profit (to be recorded directly in the partners'
capital accounts).
3. Prepare the entry to close the partners' drawing accounts as of December 31, 2014.
4. Prepare a statement of changes in partners' equity for the year ended December 31,
2014
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CHAPTER 4
PARTNERSHIP DISSOLUTION
LEARNING OBJECTIVES
1. Define partnership dissolution and identify the conditions giving rise to it.
2. Understand the accounting procedures to record the admission of a new partner by purchase.
3. Understand the accounting procedures to record the admission of a new partner by
investment.
PREVIEW OF THE CHAPTER
PARTNERSHIP
DISSOLUTION
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:
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1. The formation of a new partnership. This is known as dissolution by change in
ownership structure. The new partnership continues the business activities of the
dissolved partnership without interruption.
2. Liquidation. This refers to the termination of the business activities carried on the
partnership and the winding up of partnership affairs preparatory to going out of business.
Dissolution, therefore, does not always result to liquidation although liquidation is always
preceded by dissolution
A new partner, with the consent of all the partners, may be admitted in an existing partnership.
Upon admission of a new partner, the firm is automatically dissolved and a new partnership is
formed. All the partners draw a new contract, Articles of Co-Partnership. The admission of a
new partner gives rise to the following accounting problems:
1. Determination of the profit or loss from the beginning of the accounting period to the
date of admission of a new partner and the distribution of such profit or loss to the old
partners.
2. Connection of accounting errors in prior periods like overstatement of understatement of
inventories, excessive depreciation charges and failure to provide adequately for doubtful
accounts.
3. Revaluation of accounts which may call for the restatement of the existing assets of the
partnership to appraised or fair market values and recognition of unrecorded liabilities of
the firm. All adjustments to the accounts give rise to profit or loss; such adjustments are
recorded in the partnership books as increase or decrease in capital shared according to
partners' profit and loss ratio,
4. Closing of the partnership books.
TYPES OF ADMISSION OF A NEW PARTNER
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A new partner may be admitted into a partnership by:
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:
The purchase price of the interest sold to the new partner may be:
personal gain or loss of the selling partner and not of the partnership. Therefore, no gain or loss
is recognized in the partnership books.
Illustrative Problem A: Coloma and Claudio are partners with capital balances of P100,000 and
P50,000, respectively. They share profits and losses equally. Cordero is a new partner.
Case 1a – Purchase at book value from one partner only. Cordero purchases a 1/5 interest
from Coloma by paying P20,000.
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The P20,000 paid by the new partner Cordero to the old partner Coloma should not be reflected
in the partnership books because the said amount goes directly to Coloma. What is recorded in
the partnership books is the transfer of 1/5 of the capital of Coloma to Cordero. The amount paid
in the purchase is equal to the book value of the acquired 1/5 interest; hence, the sale of interest
does not give rise to gain or loss to Coloma.
Case 1b – Purchase at book value from more than one partner. Cordero purchases 1/5
interest from the old partners by paying P30,000.
The P30,000 paid by Cordero to Coloma and Claudio should not be reflected in the partnership
books because the said amount goes directly to Coloma and Claudio. What is recorded in the
partnership books is the transfer of 1/5 of the capital of the old partners Coloma and Claudio
(P20,000 and P10,000, respectively) to the new partner Cordero. The admission of the new
partner, by purchasing a 1/5 interest from the old partners al book value, does not result in a gain
or loss to the old partners.
Case 2 - Purchase at less than book value. Cordero purchases 1/s interest from the old partners
by paying P25,000
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The P25,000 paid by Cordero to Coloma and Claudio should not be reflected in the partnership
books because the said amount was paid directly to the partners. What is recorded in the
partnership books is the transfer of 1/5 of the capital of the old partners (20,000 and 10,000,
respectively) to the new partner. The difference of 5,000 is a personal loss of the selling (old)
partners.
Case 3 – Purchase at more than book value. Cordero pays P40,000 for a 1/5 interest of the old
partners.
Coloma, Capital 20,000
Claudio, Capital 10,000
Cordero, Capital 30,000
The P40,000 payment made by Cordero to Coloma and Claudio should not be reflected in the
partnership books. What is recorded in the books of the partnership is the transfer of 1/5 of the
capital of the old partners to the new partner. The 10,000 excess payment is a personal gain of
Coloma and Claudio.
Key Points. In the preceding four cases, 1a, 1b, 2, and 3, the transfer of capital from the old
partners to the new partner is recorded at book value regardless of the amount paid. Payment at
less than book value and at more than book value are recorded as if they were made at book
value.
In addition, the four cases show that the total partnership capital before and after the admission
of the new partner are the same. Thus, the total partnership capital of P150,000 before the
admission of Cordero is also the total partnership capital after his admission. Therefore, the
admission of a new partner by purchase will not affect the total assets and the total capital of the
partnership.
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Step 4 – Add the share of each partner on the asset revaluation to their capital balances to get the
capital balances after the asset revaluation.
Step 5 – Compute the amount of interest transferred by the old partners to the new partner based
on their capital after the asset revaluation.
Step 6 – Prepare the entry to record the admission of the new partner.
To illustrate, assume the same data in Illustrative Problem A where Coloma and Claudio are
partners with capital balances of P100,000 and P50,000, respectively. They share profits and
losses equally. Cordero is a new partner who purchases a 1/5 interest from Coloma and Claudio
paying P40,000. However, before the admission of Cordero, partnership assets are to be revalued
using as basis the amount to be paid by Cordero.
Solution:
Step 1 – The new partnership capital is equal to the amount paid by the incoming partner divided
by his fraction of interest.
New partnership capital = 40,000 ÷ 1/5 = P200,000
Step 2 – The amount of asset revaluation is equal to the new partnership capital less old
partnership capital.
Asset revaluation = 200,000 – 150,000 = 50,000
Step 3 – The allocation of the amount of the asset revaluation among the old partner is as
follows: P50,000 / 2 = P25,000 per partner.
Step 4 – The capital balances of the old partners after asset revaluation is equal to their old
capital balances plus their share on asset revaluation.
Coloma Claudio
Capital balances before revaluation P100,000 P50,000
Share on asset revaluation 25,000 25,000
Capital balances after revaluation P125,000 P75,000
Step 5 – The amount of interest transferred by the old partners to the new partner is based on the
new capital balances (capital balances after asset revaluation).
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
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Step 6 - The journal entries to record the revaluation of asset and the admission of Cordero are as
follows:
Other Assets 50,000
Coloma, Capital 25,000
Claudio, Capital 25,000
Coloma, Capital 25,000
Claudio, Capital 15,000
Cordero, Capital 40,000
Capital balances after the admission of Cordero shall be:
Cordero P100,000 + P25,000 - P25,000 P100,000
Claudio P50,000 + P25,000 - P15,000 60,000
Cordero 40,000
ADMISSION BY INVESTMENT
The admission of a new partner by investment is a transaction between the original partnership
and the new partner. The use of the terms like invests and contributes represent admission of a
new partner by investment. The investment of the new partner increases the total assets and the
total capital of the partnership. The entry to record the admission of the new partner depends
upon the capital interest credited to the partners’ accounts.
DEFINITION OF TERMS
Agreed Capital (AC) - it is the amount of new capital set by the partners for the partnership. It
may be equal to, more than, or less than the total contributions of the partners. Other terms used
for agreed capital are: new firm capital, total capital and agreed capitalization. The terms of the
admission of a new partner may indicate the agreed capital. If agreed capital is not indicated, it
can be computed in either of two ways:
1. Investment of the new partner divided by the new partner's fraction of interest; or
2. Investment of the old partners (equal to the net assets or capital of the partnership) divided by
the old partners' fraction of interest.
Example: Corpus and Carlos are partners with capital balances of P150,000 each. Cabral invests
P100,000 for a 2/5 interest in the new partnership. The agreed capital of the new partnership is
determined as follows:
Computation 1 - The new partner's investment used as a basis
P100,000 ÷ 2/5 = P250,000
Computation 2 - The old partners' investment used as a basis
P300,000 ÷ 3/5 = P500,000
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Total Contributed Capital (CC) – it is the investment of all the partners, both old and new, to
the partnership. It is the sum of the capital balances of the old partners (net asset investment) and
the contribution of the new partner.
Using the information in the example given, the total contributed capital is P400,000, the sum of
the old partners' contribution of P300,000 and the new partner's contribution of P100,000.
Bonus – it is the transfer of capital from one partner to another. A bonus to the old partners is
given by the new partner. It is a reduction in the capital of the new partner and an increase in the
capital of the old partners. The capital accounts of the old partners are credited according to their
profit and loss ratio. A bonus to the new partner is given by the old partners. It is a reduction in
the capital of the old partners and an increase in the capital of the new partner. The capital
accounts of the old partners are debited according to their profit and loss ratio.
The following procedures will be helpful in the computation and determination of the ownership
of bonus:
1. Multiply agreed capital (AC) by the fraction of interest of the new partner. The result is the
capital credit of the new partner in the new partnership.
2. Compare the capital credit with the investment of the new partner.
a. If the capital credit is more than the investment of the new partner, the difference is
bonus to the new partner.
b. If the capital credit is less than the investment of the new partner, the difference is
bonus to the old partners.
Asset Revaluation - necessary adjustment in asset values upon admission of a new partner. The
adjustment in assets may be determined as the difference between the agreed capital and the total
contributed capital. Generally, asset revaluations upon partnership formation relate only to the
partners of the old partnership.
Capital Credit- it is the interest or equity of a partner in the firm. It is computed by multiplying
agreed capital by the fraction of interest of a partner.
Situations relating to admission of a new partner by investment may fall under any of the
following:
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1. Agreed capital is given. When agreed capital is given, the admission of a new partner by
investment will give rise to any of the following cases:
a. No Bonus, no Asset Revaluation
b. Bonus to old partners, no Asset Revaluation
c. Bonus to new partner, no Asset Revaluation
d. Asset Revaluation, no Bonus
2. Agreed capital is not given. When agreed capital is not given, the problem calls for two
alternative solutions.
a. Bonus method
b. Asset revaluation method
3. Agreed capital is not given but the basis for its computation is indicated in the terms of
admission.
The following are the illustrations of the various problems involving admission of a new partner
by investment.
Illustrative Problem B: Calma and Castro are partners with capital balances of P200,000 and
P100,000, respectively. They share profits and losses equally. Conde is to be admitted in the
partnership.
Case 1 – No Bonus, no Asset Revaluation. Conde invests P100,000 for a % interest in the
agreed capital of P400,000.
Cash 100,000
Conde, Capital 100,000
Solution:
Step 1 Fill in the given data in the table
a. Partners, old and new
b. AC column, with the total written first
c. CC column
AC CC
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Old P 300,000
New 100,000
P400,000 P 400,000
Step 2 Compare AC and CC. In this case, AC = CC
(P400,000 = P400,000), therefore, there is no asset revaluation
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 – 1/4 = 3/4)
P400,000 x 3/4 = 300,000
b. A completed table appears as follows:
AC CC
Old. P300,000 P300,000
New P100,000 100,000
P400,000 P400,000
c. Conclusion based on the table:
(i) AC = CC, therefore, there is no asset revaluation
(ii) New partner: AC = CC, therefore, there is no bonus
(iii) Old partners: AC= CC, therefore, there is no bonus either.
In actual problem solving, only one table is prepared. The missing items are filled as
they are needed.
Case 2 - Bonus to the old partners, no Asset Revaluation. Conde invests PI00,000 for a 1/5
interest in the new firm capitalization of P400,000.
Cash 100,000
Conde, Capital 100,000
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These entries were made to show clearly the transfer of capital from the new partner to the old
partners. However, a compound entry may also be prepared as follows:
Cash. 100,000
Conde. Capital 80,000
Calma, Capital 10,000
Castro, Capital 10,000
Solution:
Step 1 Fill in the table as in Case 1. The completed table after Steps 1 to 4 is shown below:
AC CC Bonus
Old P320,000 P300,000 P20,000
New 80,000 100,000 (20,000)
P400,000 P400,000 -
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 o interest; P400,000 x 1/5 = P80,000.
b. Write this amount in the AC column of the new partner.
c. Compare the new partner's AC with his CC. In this case, his AC < CC (P80,000 -
P100,000); therefore, the decrease in his contributed capital represents bonus to the old
partners.
Step 4 Complete the table by filling in the missing figures.
a. AC or capital credit of the old partners.
AC x fraction of interest: P400,000 x 4/5 = P320,000 or
CC + Bonus to the old partners; P300,000 + P20,000 = P320,000
The bonus is shared by the old partners according to their profit and loss sharing ratio.
b. A completed table is shown in Step 1.
c. Conclusion based on the table:
(i) AC = CC, therefore, there is no asset revaluation.
(ii) New partner: AC< CC, therefore, he gives the bonus.
(iii) Old partners: AC > CC, therefore, they receive the bonus shared according to
their profit and loss ratio
Case 3 - Bonus to new partner, no Asset Revaluation. Conde invests P60,000 for 1/4 interest
in the total capitalization of P360,000
Cash 60,000
Calma, Capital 15,000
Castro, Capital 15,000
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Conde, Capital 90,000
Solution:
Step 1 Fill in the table as in Cases 1 and 2. The completed table after Steps 1 to 4 is shown
below
AC CC Bonus
Old P270,000 P300,000 (P30,000)
New 90,000 60,000 30,000
P360,000 P360,000 -
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 ¼ = P90,000.
b. Write this amount in the AC column of the new partner.
c. Compare the new partner's AC with his CC. In this case, his AC > CC (P90,000 -
P60,000); therefore, the increase in his contributed capital represents bonus from the old
partners.
Step 4 Complete the table by filling in the missing figures.
a. AC or capital credit of the old partners.
AC x fraction of interest
P360,000 x 3/4 P270,000 or
CC - Bonus to old partners
P300,000 - P30,000 P270,000
The bonus given to the new partner is shared by the old partners according to their profit and loss
sharing ratio.
b. A completed table is shown in Step 1.
c. Conclusion based on the table:
(i) AC = CC, therefore, there is no asset revaluation.
(ii) New partner: AC > CC, therefore, he receives the bonus.
(iii) Old partners: AC < CC, therefore, they give the bonus shared according to
their profit and loss ratio.
Case 4-Positive Asset Revaluation, no Bonus. Conde invests P100,000 for a 1/5 interest in the
agreed capital of P500,000.
Other Assets 100,000
Calma, Capital 50,000
Castro, Capital 50,000
Solution:
Step 1 Fill in the table as in Cases I to 3. The completed table after Steps 1 to 4 is shown
below:
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AC СС Asset Revaluation
Old P400,000 P300,000 P100,000
d. New P100,000 P100,000 ____-____
P500,000 P400,000 P100,000
Step 2 Compare AC and CC. In this case, AC > CC (P500,000 > P400,000).
Therefore, there is a positive asset revaluation.
Step 3 Determine if there is bonus.
a. Compute for the capital credit of the new partner.
AC x fraction of interest, P500,000 x 1/5 = 100,000.
b. Write this amount in the AC column of the new partner.
c. Compare the new partner's AC with his CC. In this case, his AC = CC (P100,000);
therefore, there is no bonus.
Step 4 Complete the table by filling in the missing figures.
a. AC or capital credit of the old partners.
AC x fraction of interest
P500,000 x 4/5 = P400,000 or
CC+ Asset Revaluation
P300,000 + P100,000 = P400,000
b. A completed table is shown in Step 1.
c. Conclusion based on the table:
(i) AC > CC, therefore, there is a positive asset revaluation.
(ii) New partner: AC = CC, therefore, there is no bonus.
(iii) Old partners: AC > CC, therefore, they are credited for the asset revaluation
shared according to their profit and loss ratio.
Case 5 - Negative Asset Revaluation, No bonus. Conde invests P60,000 for a 1/5 interest in the
agreed capital of P300,000
Calma, Capital 30,000
Castro, Capital 30,000
Other Assets 60,000
Solution:
Step 1 Fill in the table as in Cases I to 4. The completed table after Steps 1 to 4 is shown
below:
AC CC Asset Revaluation
Old P240,000 P300,000 (P60,000)
New 60,000 60,000 ____-___
P300,000 P360,000 (P60,000)
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.
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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
P300,000 x 4/5 = P240,000 or
CC- Asset Revaluation
P300,000 - P60,000 = P240,000
b. completed table is shown in Step 1.
c. Conclusion based on the table:
(i) AC < CC, therefore, there is a negative asset revaluation.
(ii) New partner: AC = CC, therefore, there is no bonus.
(iii) Old partners: AC < CC, therefore, they are charged for the asset
revaluation shared according to their profit and loss ratio
In the succeeding illustrations, the tables are summarized for easier comparison.
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AGREED CAPITAL IS NOT GIVEN
There are cases when the contributions and the fraction of interest of the new partner are given,
but the agreed capitalization of the new firm is not specified. When such a situation exists, the
admission of the new partner is recorded using any of these two methods:
1. Bonus method
2. Asset Revaluation method
A negative revaluation decreases the old partnership assets and the capital accounts of the old
partners. The decrease is shared by the old partners based on their profit and loss ratio. Here, the
agreed capitalization of the new partnership is less than the total amount of distribution of both
the old and new partners.
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The agreed capitalization is computed under this method in the same manner as in positive asset
revaluation.
Illustrative Problem C: Conde invests P100,000 for a 1/5 interest in the partnership of Calma
and Castro. The contributions of Calma and Castro are P200,000 and P100,000 respectively, and
they share profits and losses in the ratio of 3:1. After the admission of Conde, profits and losses
will be divided equally.
1. Bonus Method
Cash 100,000
Conde, Capital 80,000
Calma, Capital 15,000
Castro, Capital 5,000
AC CC Bonus
Old (4/5) P 320,000 P 300,000 P 20,000
New (1/5) 80,000 100,000 (20,000) g
P 400,000 P 400,000 - 1
The agreed capital of the partnership is equal to the capital contribution. The capital credit of the
old and new partners is computed as follows:
New = P400,000 x 1/5 = P80,000
Old = P400,000 x 4/5 = P320,000
The capital credit for the new partner is less than his capital contribution, therefore, the new
partner gives the bonus. The bonus is shared by the old partners according to their profit and loss
ratio.
2. Positive Asset Revaluation Method
Other Assets 100,000
Calma, Capital 75,000
Castro, Capital 25,000
Cash 100,000
Conde, Capital 100,000
AC CC Revaluation
Old (4/5) P 400,000 P 300,000 P 100,000
New (1/5) 100,000 100,000 - h
P 500,000 P 400,000 P 100,000 j
The agreed capital of the new partnership is computed by dividing the new partner's contribution
by his fraction of interest (100,000 ÷ 1/5 = 500,000).
An agreed capital of more than the contributed capital indicates that there is an understatement in
the some assets of the partnership upon admission of the new partner. The agreed capital of
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P500,000 when compared with the contributed capital of P400,000 indicates a P100,000 increase
on asset and capital for the asset understatement. The AC or the capital credit of the old partners
which is P400,000 (500,000 x 4/5) is P100,000 more than their contributed capital. Therefore the
old partners are credited for the revaluation of assets. The old partners share on the revaluation
according to their profit and loss ratio.
Illustrative Problem D: Conde invests P80,000 for a 1/4 interest in the partnership of Calma
and Castro. The contributions of Calma and Castro are P200,000 and P100,000 respectively and
they share profits and losses in the ratio of 3:1. After the admission of Conde, profits and losses
will be divided equally.
1. Bonus Method
Cash 80,000
Calma, Capital 11,250
Castro, Capital 3,750
Conde, Capital 95,000
AC CC Bonus
Old (3/4) P 285,000 P 300,000 (P 15,000)
New (1/4) 95,000 80,000 15,000 g
P 380,000 P 380,000 - g
The agreed capital of the partnership is equal to the capital contribution. The capital
contributions of the old and new partners are computed as follows:
New 380,000 x 1/4 = 95,000
Old 380,000 x 3/4 = 285,000
The capital credit of the new partner is greater than his capital contribution, therefore, he
receives a bonus. The bonus is shared by the old partners according to their profit and loss ratio.
2. Negative Asset Revaluation Method
Cash 80,000
Conde, Capital 80,000
AC CC Revaluation
Old (3/4) P 240,000 P 300,000 (P 60,000)
New (1/4) 80,000 80,000 - f
P 320,000 P 380,000 (P 60,000) g
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The agreed capital of the new partnership is computed by dividing the new partner's capital
contribution by his fraction of interest (80,000 ÷ 1/4 = P320,000).
An agreed capital that is less than the contributed capital indicates that there is an overstatement
in some assets of the partnership upon the admission of a new partner. The agreed capital of
P320,000 when compared with the contributed capital of P380,000 indicates a P60,000 reduction
in assets and capital for the asset overstatement. The AC or capital credit of the old partners
which is P240,000 (P320,000 x 3/4) is 60,000 less than their contributed capital. Therefore, the
old partners are charged for the revaluation of assets. The old partners share on the revaluation of
assets according to their profit and loss ratio.
Based on the above analysis, Calma will prefer the asset revaluation method while Conde will
prefer bonus method.
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
Cash 100,000
Conde, Capital 50,000
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Calma, Capital 37,500
Castro, Capital 12,500
AC CC Bonus
Old (7/8) P 350,000 P 300,000 P 50,000
New (1/8) P 50,000 P 100,000 (50,000) f
P400,000 P 400,000 - f
The agreed capital is not given but the basis for its computation is indicated In the problem. The
new partner is to be credited for P50,000 which is 1/8 of the new firm capital. Thus, 50,000 ÷ 1/8
= P800,000 agreed capital. The agreed capital (400,000) is equal to the total contributed capital,
therefore, there is no asset revaluation. But there might be bonus. The capital credit of the new
partner is less than his contribution, therefore he gives the bonus. The bonus is share by the old
partners in ther profit and loss ratio.
Example 1: Calma and Castro have capital balances of P200,000 and P100,000 respectively.
They share profits and losses in the rario 3:1. Conde invests sufficient amount for a 1/3 interest.
Cash 150,000
Conde, Capital 150,000
Solution:
Computations similar to those who made in the previous cases are no longer necessary.
To arrive at the amount contributed by the new partner,
1. the new firm capital (AC) is computed by dividing the old partners’ contribution by
their fraction of interest (300,000 ÷ 2/3) = P450,000, and
Example 2: Coral, Cielo and Camu are partners with capital balances of P112,000, P130,000,
and 58,000, respectively, sharing profits and losses equally. Cuevas is admitted as a new partner
bringing with him his expertise and good reputation. He is to invest cash for a 25% interest in the
assets of the partnership which includes a credit of P18,750 for bonus upon admission.
The journal entry to record the admission of the new partner is as follows:
Cash 75,000
Coral, Capital 6,250
Cielo, Capital 6,250
Camu, Capital 6,250
Cuevas, Capital 93,750
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Solution:
Follow the same procedure as in Example 1. The P18,750 bonus given by the old partners to the
new partner has to be deducted frm the total capital of the old partners to get their 75% interest.
Thus:
P112,000 + P130,000 + P58,000 – P18,750 = P281,250\
P281,000 / 75% = P375,000).
The amount to be contributed by the new partner is computed by deducting the P18,750 bonus
received from the old partners from the 25% interest acquired from the old partners. Thus:
P375,000 x 25% = P93,750
P93,750 – P18,750 = P75,000
Conde invests P50,000 in the firm. However, upon his admission P10,000
bonus is allowed by the old partners.
Cash 50,000
Calma, Capital 7,500
Castro, Capital 2,500
Conde, Capital 60,000
1. Define partnership dissolution and identify the conditions giving rise to it. Partnership
dissolution is the change in the relation of partners caused by any partner ceasing to be
associated in the carrying out of the business. Dissolution of a partnership may be caused
by any of the following conditions: (1) admission of a new partner; (2) retirement or
withdrawal of a partner; (3) death, incapacity, bankruptcy of a partner; and (4)
incorporation of a partnership.
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3. Understand the accounting procedures to record the admission of a new partner by
investment. The admission of a new partner by investment is a transaction between the
original partnership and the new partner. The new partner’s contribution increases the
total assets and the total capital of the partnership. When the capital contribution of the
new partner is not equal to his capital credit in the new partnership or when the capital
contributions of the old partner is not equal to their capital credit in the new partnership.,
the difference is announce for and by any of the following methods: (1) bonus method
(bonus to the old partners from the new partner or bonus to the new partner from the old
partners); (2) asset revaluation method either positive or negative revaluation.
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GLOSSARY OF ACCOUNTING TEMINOLOGIES
Agreed Capital – the amount set by the partners as new partnership capital which may
not necessarily contributed capital.
Asset Revaluation – the necessary adjustment in assets before the admission of a new
partner because of some partnership assets which may not be properly valued.
Contributed Capital – the sum the net assets (capital of the old partners) of the original
partnership and the contribution of the new partner.
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DISCUSSION QUESTIONS
2. What are the types of admission of a new partner in an existing partnership? What are
similarities and differences?
3. What are the different cases that may arise in the admission of a new partner, by
purchase or interest? In the admission of a new partner by investment?
4. Differentiate asset revaluation from bonus. How do you determine if there is an asset
revaluation or there is a bonus?
7. What are the data needed in solving problems related to admission by investment?
8. What is the difference between the asset revaluation and bonus in connection with the
admission of a new partner? If you are going to join a partnership which would you
prefer?
9. When agreed capital is not given, how do you compute for it?
10. How do you determine whether the bonus method or asset revaluation method will be
preferred by a partner?
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EXERCISES
Camus and Cuenco are partners who have capital balances of P90,000 and 60,000 and
who share profits 60% and 40% respectively. They agree to admit Cerda as a partner
upon his payment of P90,000.
Instructions: Give the journal entries to record each of the following independent
assumptions:
1. One-third of the capital balances of the old partners are transferred to the new partner,
Camus and Cuenco dividing the cash between themselves.
2. One-third of the capital balances of the old partners are transferred to the new partner,
Camus and Cuenco dividing cash between themselves. However, before recording the
admission of Cerda, asset revaluation is undertaken on the firm books so that Cerda’s
capital may be equal to the amount paid for the interest.
3. The cash is invested in the business asnd Cerda is credited with a ¼ interest in the
firm , the bonus method being used in reording his investment.
4. The cash is invested in the business asnd Cerda is credited with the full amount of his
investment which is to be 25% of the firm new capital.
5. The cash is invested in the business asnd Cerda is credited for P120,000 which
includes a bonus from Camus and Cuenco.
At the end of the fiscal year 2014, the capital accounts and the profit and loss sharing ratio for
the partners for C3 Co. are presented below. At this date, it is agreed that a new partner CAnda,
is to be admitted to the firm.
Capital P & L Ratio
Capco P100,000 50%
Cular 80,000 30%
Cruz 60,000 20%
Instructions: For each of the following situations involving the admission of Canda into the
partnership, give the journal entry to record his admission.
2. Canda buys one-quarter interest in the firm for P70,000 by purchasing one-fourth of the
interest of the three partners. Asset revaluation is made prior to admission of Canad
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3. Canda invests P115,000 and receives a one-quarter interest in capital and profits of the
business, bonus being allowed on the admission.
Partner Catral and Clemente are considering the admission of Conti into the partnership. Catral
and Clemente share income and loss in the ratio of 3:1, respectively. Catral's capital balance is
P480,000 and Clemente's capital balance is P360,000.
Instructions: Prepare entries to record the admission of Conti into the partnership under each of
the following independent assumptions:
Carlos and Cruz, partners have capital balances of P200,000 and P300,000, respectively. They
admit Caparas and Carpio into the partnership. Caparas purchases one-fourth of Carlos' interest
for P56,000 and one-third of Cruz's interest for P72,000. Carpio is admitted to the partnership
with an investment of P120,000 for which he is to receive an ownership equity of P120,000.
Instructions:
(1) Present the entries in general journal form to record the admission into the partnership of
(a) Caparas, and (b) Carpio.
(2) What are the capital balances of each partner after the admission of Caparas and Carpio?
Cuenca and Claudio share profits equally and have equal investments in their partnership. The
partnership's net asset is carried on the books at P500,000. Cabral is admitted into the partnership
with a one-fourth interest in profits and net assets. Cabral pays P200,000 cash into the
partnership for his interest.
165
Instructions: Prepare journal entries to show two possible methods of recording the admission
of Cabral on the partnership books.
The capital balances and the income and loss sharing ratio of the partners Choy, Chua, and
Cheng are as follows:
The partnership has been successful and the partners have decided to invite Chiu to join them.
Chiu has been admitted into the partnership with a one-fifth capital interest for a cash investment
of P120,000
Instructions: Prepare the entries to record the admission of Chiu under the (1) bonus method
and (2) asset revaluation method.
PROBLEMS
Carmen and Centeno are partners with capital balances of P160,000 and P80,000. They share
profits 60%, 40%, respectively. The partners agree to admit Corrales as a member of the firm
Instructions: Give the required entries on the partnership books to record the admission of
Corrales under each of the following assumptions:
1. Corrales purchases a l/4 interest in the firm. One-fourth of each partner's capital is to be
transferred to the new partner. Corrales pays the partners P60,000, which is divided between
them in proportion to the equities given up.
2. Corrales purchases a 1/3 interest in the firm. One-third of each partner's capital is to be
transferred to the new partner. Corrales pays the partners P120,000, which is divided between
them in proportion to the equities given up. Before Corrales admission, asset revaluation is
undertaken and recorded on the firm books so that Corrales' 1/3 interest will be equal to the
amount of his payment.
3. Corrales invests P120,000 for a 1/4 interest in the firm. Asset revaluation is recorded on
the firm books prior to the admission.
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4. Corrales invests P 120,000 for a 50% interest in the firm. Carmen and Centeno transfer
part of their capital to that of Corrales as a bonus
6. Corrales invests P160,000 in the firm and allowed a bonus to Carmen and Centeno of
P20,000 upon his admission.
7. Corrales invests P100,000 for a 1/4 interest in the firm. The total firm capital after his
admission is to be P340,000
8. Corrales invests P110,000 for a 1/4 interest in the firm. The total firm capital after his
admission is to be P440,000
9. Corrales invests P96,000 for a 1/3 interest in the firm. The total firm capital after his
admission is to be P336,000
10. Corrales invests sufficient cash for a 1/5 interest.
Coral and Corpuz are partners with capital balances of P180,000 and P120,000, respectively.
They share profits and losses in the ratio of 4:1. They agree to admit to the partnership.
Instructions: Journalize the admission of Calma to the partnership for each of the following
independent assumptions:
3. Calma is admitted to a one-fourth interest in capital upon contributing P60,000. The total
capital of the new partnership is to be P360,000
5. Same conditions as in (4), except that the new partnership capital is to be P330,000 due to the
asset revaluation undertaken prior to the admission of Calma.
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6. Calma is admitted to a one-fifth interest in capital upon contributing P90,000. Total capital of
the new partnership is to be P450,000.
In 2012, Castillo and Cordova established a partnership. Their operations have been very
successful. Since Castillo devotes full-time to the business and Cordova part-time, they share
profits and losses in the ratio of 7:3, respectively. At the beginning of 2014, Coloma expressed
his interest of joining the partnership. The capital balances of Castillo and Cordova on this date
are P560,000 and P840,000, respectively.
Instructions:
1.Prepare the entries to record the admission of Coloma into the partnership under each of the
following independent assumptions
2. Assuming Coloma paid a total of P600,000 to Castillo and Cordova for two-fifths of their
respective capital balances, prepare a schedule determining the amount of cash to be transferred
to Castillo and Cordova.
The following statement of financial position is for the partnership of Cortes, Canda and Cena,
who share profits and losses in the ratio of 3:2:1 respectively.
168
Instructions:
1. Assume that the assets and liabilities are valued fairly, and that the partnership
wishes to admit Cruz as a new partner with one-fifth interest in capital. Without
recording bonus, determine what Cruz's contribution should be.
2. If Cruz contributes P210,000 for a one-fifth interest, determine the new capital
balances of each partner using: (a) the bonus method, and (b) the asset revaluation
method.
The following are the capital accounts of the partners in the 3C Store on June 30, 2014:
On July 1, 2014, Carla invests P90,000 in the business for a one-eight interest in net assets.
Profits are to be shared equally after the admission
Instructions:
1. Give two alternative solutions, in journal entry form, to record Carla's admission to the
firm. Which method/solution will be preferred by Celia?
2. Give two alternative journal entries to record Carla's admission, if instead of investing,
she purchases a one-eight interest ratably from all partners.
Cabal, Cadiz, Caldea, business partners of a firm carrying their names, have agreed on a profit
and loss ratio of 20:30:50, respectively. On December 31, 2014, the books of their partnership
showed the following credit balances:
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On January 1, 2015, Camo was admitted as a new partner under the following terms and conditions:
a. Camo will share 20% in the profit and loss ratio, while the ratio of the original
partners will remain proportionately the same as before Camo's admission.
b. Camo will pay P25,000 for 1/6 of Cadiz's share.
c. Camo will contribute P150,000 in cash to the partnership.
d. Total capital of the partnership after Camo's admission will be P800,000 of which
Camo's capital account will be shown as P160,000.
Instructions:
1. Using the following suggested format, prepare a schedule showing the capital of each
partner after the admission of partner Camo.
Camo
2. What is the profit and loss ratio of all the partners after Camo's admission?
Partners' Equity)
Corona and Calderon are partners whose capital accounts on December 31,2013, before the firm's
books are closed, are P250,000 and P150,000 respectively. The drawing account for Corona shows a
debit balance of P41,000; for Calderon, a debit balance of P34,000. The partnership agreement with
regards to profits provides that (1) each partner is to be allowed an annual salary of P45,000, and (2)
Corona is to received 60% and Calderon 40% of the profits after allowance of salaries.
The income summary account on December 31 has a credit balance of P70,000 before any entry
for the allowance of salaries, and this balance is closed into the partners’ capital accounts. The
balance of the drawing accounts is also closed into the capita accounts.
On January 2, 2014, Calixto is admitted as a partner upon the investment of P100,000 into the firm.
The partners allow a bonus on the investment so that Calixto may have a 1/3 interest in the firm.
The new agreement provides that profits are to be distributed as follows:
Corona, 35%; Calderon, 25%; and Calixto, 40%. Salaries are not allowed.
170
On December 31, 2014, the partners' drawing accounts have debit balances as follows:
Corona - P37,500; Calderon P25,000; and Calixto P34,000. The income summary account has a
P75,000 debit balance, Accounts are closed.
The partnership was sold in January, 2015 for P87,500. Cash settlement was made to the partners.
Instructions: Prepare a statement of changes in partners' equity, showing all of the changes that
took place since January 1, 2013.
171
MUTIPLE CHOICES
MC 4-1 If the total contributed capital exceeds the agreed capital with the new partner's
investment is the same as his capital credit, then the admission of the new
partner involved a
MC 4-2 If the agreed capital is equal to the total contributed capital with the capital credit
and contribution of the old and new partners being the same, there exist
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
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:
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
profit and losses ratio for a total payment directly to the partners in the amount
of P140,000. They agree that asset revaluation of P60,000 is to be recorded prior
to admission of Chat. The condensed statement of financial position of the CCC
Partnership is presented on the next page.
172
Assets Liabilities and Capital
Cash P 60,000 Liabilities P 100,000
Other Assets 540,000 Chan, Capital 250,000
Ching, Capital 150,000
Chen, Capital 100,000
600,000 Total Liab & Cap 600,000
The capitals of Chan, Ching, and Chen respectively after the payment and
admission of Chat are
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 his
capital account of
a. P36,000 c. P72,000
b. P48,000 d. P84,000
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 31, 2014 is presented below
Cash P 100,000 Liabilities P 80,000
Other Assets 260,000 Cheng, Capital 120,000
Chavez, Capital 80,000
Ching, Capital 80,000
Total Assets P 360,000 Total L & C P 360,000
All the partners agree to admit Cua as 1/6 partner in the partnership without any
asset revaluation nor bonus. Cua shall contribute assets amounting to
a. P 20,000 c. P 70,000
b. P 56,000 d. P 120,000
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On May 8. 2014, the business accounts of Cordova and Constancio appear below
Cordova Constancio
Assets
Cash P 11,000 P 22,354
Accounts Receivable 234,536 567,890
Inventories 120,035 260,102
Land 603,000
Buildings 428, 267
Furniture and Fixtures 50,345 34, 789
Other Assets 2,000 3,600
P 1,020,916 P 1,317,002
Equities
Accounts Payable P 178,940 P 243,650
Notes Payable 200,000 345,500
Cordova, Capital 641,976
Constancia, Capital 728,352
P 1,020,916 P 1,317,002
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MC 4-11 Using the information in MC 4-8 and assuming after Cuyugan’s admission, the
profit and loss sharing ratio was agreed to be 40:40:20 based on capital credits,
how much should the cash settlement be between Cordova and Constancio?
a. P32,272 c. P33,602
b. P32,930 d. P34,288
MC 4-12 Using the information in MC 4-8 and assuming that during the first year of
operations the partnership earned an income of P325,000 and that this was
distributed in the agreed manner. Assuming further that drawings were made in
these amounts: Cordova, P50,000; Constancio, P65,000; and Cuyugan, P28,000,
how much are the capital balances of the partners after the first year?
Cordova Constancio Cuyugan
a. P750,627 P735,177 P372,223
b. P728,764 P713,764 P361,382
c. P757,915 P742,315 P375,837
d. P743,121 P727,827 P368,501
MC 4-13 Conrado, Cosio, and Cosme are partners whose capital balances and share in
profits are as follows:
Conrado P250,000 50%
Cosio 150,000 25%
Cosme 100,000 25%
Cueto is admitted into the partnership by paying P60,000 for 1/3 of the share in
equity of Cosio and by contributing P200,000. The partners agree to the total
capitalization to P750,000, 1/3 of which is Cueto’s capital credit. Cueto’s share in
net income is also 1/3 and the old partners are to divide net income in the old ratio
among themselves.
The profit and loss sharing ratio among Conrado, Cosio and Cosme after the
admission of Cueto is
a. 50%, 25%, 25%, respectively
b. 30%, 15%, 15%, respectively
c. 2/6, 1/6, 1/6, respectively
d. 1/3, 1/3, 1/3, respectively
MC 4-14 Using the information in MC 4-13, the amount of the asset revaluation is equal to
a. P15,000 c. P120,000
b. P50,000 d. P200,000
175
MC 4-15 Using the information in MC 4-13, the capital balances of the old partners after
the admission of Cueto are
a. P250,000, P150,000, P100,000, respectively
b. P275,000, P112,500, P112,500, respectively
c. P250,000, P100,000, P100,000, respectively
d. P250,000, P200,000, P100,000, respectively
176
Test Material No. 14 Rating
__________
TRUE or FALSE
Instructions: Encircle the letter T if the statement is true and the letter F if the statement is
false.
1. Admission of a new partner by investment will change total assets and total
capital.
2. Asset revaluation and bonus are one and the same thing.
3. When a new partner is admitted, the partnership may continue operations based
on a new contract among the partners.
4. The total assets of the partnership may increase upon admission of a new
partner by purchase of interest.
5. A new partner may be admitted into the partnership with the consent of the
majority of the old partners.
8. If the agreed capital exceed total contributed capital, the difference may be
positive asset revaluation.
9. If the capital credit of the partner is less than his investment, the difference is
always recorded as asset revaluation.
10. The admission of a new partner in an existing partnership dissolves the old
partnership.
11. A new partner may be admitted without an investment and without the
recognition of capital interest.
177
12. The agreed capital can never be less than the total contributed capital.
14. A bonus given to the old partners by a new partner increases the capital
account balances of the old partners.
16. In the admission of a new partner by purchase, the new partner may pay more
than, less than or equal to the book value of the interest sold by any or all of the
old partners.
17. Asset revaluation may be recorded upon the admission of a new partner
whether by purchase or by investment.
18. In the admission of a new partner by investment, agreed capital must always
equal contributed capital.
20. Both asset revaluation and bonus affect total assets and total capital.
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Test Material No. 15 Rating
__________
IDENTIFICATION
Instructions: Write the word or group of words that identify each of the following statements.
________________ 1. The term that apply to the excess of agreed capital over total
contributed capital.
________________ 4. The contribution of both the new and the old partners.
________________ 5. The change in the relation of the partners caused by any one of
them ceasing to be associated in the carrying out of the business.
________________ 9. The amount of new capital set by the partners for the partnership
which need not necessarily equal contributed capital.
________________ 10. Type of admission wherein the new partner is admitted by buying
the whole interest or a portion thereof of one or more old partners.
179
________________ 12. The increase in the capital of the old partners, other than the asset
revaluation, which reduces the capital of the new partner.
________________ 13. This refers to the termination of the business activities carried on
by the partnership.
________________ 16. The basis for the computation of the total partnership capital when
the amount of a new partner’s contribution has to be determined.
________________ 17. The equity of a partner in the partnership that is usually expressed
in fraction.
________________ 18. The decrease in the capital balances of the old partners, upon
admission of a new partner, brought about by some partnership
assets which may not be properly valued.
________________ 19. The difference between the consideration made and the interest
transferred in admission by purchase.
________________ 20. The basis of an old partner in evaluating whether to prefer the
bonus method or asset revaluation method in the admission of a
new partner.
180
Test Material No. 16 Rating
__________
Instructions: Encircle the letter of the best answer. Show supporting computations in good
form in a separate worksheet.
1. A person may become a partner in a partnership by all of the following methods except
a. investing in the partnership with a bonus to the new partner
b. making a loan to the partnership
c. investing in the partnership with a bonus to the old partners
d. purchasing a partner’s interest
2. If a new partner purchases his interest from an old partner, the only entry on the
partnership books is a credit to the purchaser’s capital account with a debit to the
a. bonus account
b. cash account
c. capital account of the selling partner
d. capital accounts of other partners
4. A new partner may be admitted into a partnership by any of the following except
a. investing in the partnership
b. purchasing preferred stock of the partnership
c. purchasing a partner’s interest
d. both a and c
181
5. Cabrera, Capulong and Castor are partners with capital balances of P250,000, P150,000,
and P100,000, respectively. The partners share income and losses equally. For an
investment of P250,000 cash, Concio is to be admitted as a partner with a one-fourth
interest in capital and income. Based on this information, the amount of Concio’s
investment can best be justified by which of the following?
a. Assets of the partnership were overvalued immediately prior to Concio’s
investment.
b. The book value of the partnership’s net assets was less than the fair value
immediately prior to Concio’s investment.
c. Concio’s admission into the partnership does not involve a bonus nor an asset
revaluation
d. Concio will receive a bonus from the other partners upon his admission to the
partnership
6. If A is the total capital of a partnership before the admission of a new partner, B is the
total capital of the partnership after the investment of new partner, C is the amount of the
new partner’s investment, and D is the amount of capital credit to the new partner, there
is
a. neither bonus nor asset revaluation if B = A + C and D > C
b. a bonus to the old partners if B > (A + C) and D < C
c. a bonus to the new partner if B = A + C and D < C
d. an asset revaluation to the old partners if B > (A + C) and D = C
7. Cuenco and Cuizon are partners with a capital ratio of 3:1 and a profit and loss ratio of
2:1, respectively. The bonus method was used to record Calasin’s admittance as a new
partner. What ratio should be used to allocate to Cuenco and Cuizon the excess of
Calasin’s contribution over the amount credited to his capital account?
a. Cuenco and Cuizon’s old profit and loss ratio
b. Cuenco and Cuizon’s old capital ratio
c. Cuenco and Cuizon’s new relative profit and loss ratio
d. Cuenco and Cuizon’s new relative capital ratio
182
9. Collado’s interest in the partnership is P112,000. Cuervo buys Collado’s interest for
P120,000. How much is the capital balance of Cuervo after the purchase?
a. P108,000 c. P112,000
b. P110,000 d. P120,000
10. Cortez, Cuerdo, and Claudio are partners with capital balances of P180,000, P100,000
and P120,000, respectively. Conde is admitted into the partnership with a one-fourth
interest upon payment of P160,000. If the old partners share profits and losses in the ratio
of 2/5, 2/5, and 1/5, then the capital account of Cortez after the admission of Conde will
show a balance of
a. P160,000 c. P184,000
b. P180,000 d. P188,000
11. Castro contributes P120,000 for a one-sixth interest in a partnership. The total capital
balances of the partners prior to the admission of Castro is P360,000. If the no asset
revaluation is made prior to the admission of Castro, what amount is credited to the
capital account of Castro upon his admission?
a. P80,000 c. P120,000
b. P96,000 d. P160,000
12. Conn and Cass form a partnership and have capital balances of P100,000 and P200,000,
respectively. If they agree to admit Charr into the partnership, how much will he have to
invest to have a one-third interest?
a. P100,000 c. P150,000
b. P120,000 d. P200,000
13. Cardel desires to purchase a one-fourth capital and profit and loss interest in the
partnership of Cariaso, Carino, and Carillo. The three partners agree to sell Cardel one-
fourth of their respective capital and profit and loss interest in exchange for a total
payment of P200,000. The profit and loss ratio and capital balances of the partners are as
follows: Cariaso (60%) – P400,000; Carino (30%) – P200,000; and Carillo (10%) –
P100,000. If assets are to be revalued prior to the admission of Cardel, what would be the
capital balances of Cariaso, Carino and Carillo after the admission of Cardel?
a. P300,000;P150,000;P75,000 c. P385,000; P182,500; P97,500
b. P345,000;P172,500;P82,500 d. P460,000;P230,000;P110,000
14. Based on the information in No. 13 and assuming assets are fairly valued, what would be
the capital balances of Cariaso, Carino, and Carillo after the admission of Cardel?
a. P300,000;P150,000;P75,000 c. P385,000; P192,500; P97,500
b. P345,000;P172,500;P82,500 d. P460,000;P230,000;P110,000
15. Based on the information in No. 13 and assuming assets are fairly valued and that Cardel
purchases a one-fourth capital and profit and loss interest from Cariaso for P200,000,
183
what would be the capital balances of Cariaso, Carino and Carillo after the admission of
Cardel?
a. P400,000;P200,000;P100,000 c. P300,000; P150,000; P75,000
b. P300,000;P200,000;P100,000 d. P100,000; P50,000; P25,000
16. Based on the information in No. 13 and assuming assets are fairly valued and that Cardel
purchases a one-fourth capital and profit and loss from the partnership paying P200,000,
what would be the capital balances of Cariaso, Carino and Carillo after the admission of
Cardel?
a. P300,000;P150,000;P75,000 c. P385,000; P192,500; P97,500
b. P400,000;P200,000;P100,000 d. P460,000;P230,000;P110,000
17. Coral, Camus and Cerda are partners sharing profits in the ratio of 4:4:2, respectively. As
of December 31, 2013, their capital balances were P190,000 for Coral, P160,000 for
Camus, P120,000 for Cerda.
On January 1, 2014, the partners admitted Cordero as a new partner and according to
their agreement, Cordero will contribute P160,000 in cash to the partnership and also pay
P20,000 for 15% of Camus’ share. Cordero will be given a 20% share in profits while the
original partners’ share will be proportionately the same as before. After the admission of
Cordero, the total capital will be P660,000 and Cordero’s capital be P140,000.
18. Based on the information in No. 17, the bonus to Cerda upon the admission of Cordero is
a. P8,800 c. P22,000
b. P17,600 d. P44,000
19. Based on the information in No. 17, the capital of Camus upon the admission of Cordero
is
a. P160,000 c. P168,600
b. P165,600 d. P189,600
20. Based on the information in No. 17, the partner’s profit and loss ratio after admission of
Cordero shall be
a. 20%, 20%, 20%, 20% c. 32%, 32%, 16%, 20%
b. 25%, 25%, 25%, 25% d. 40%, 40%, 20%, 20%
184
Test Material No. 17 Rating __________
Name: Date:
Year and Section: Professor:
PROBLEMS
Problem A
Cosme, Canlas and Cura are parthers with profit and loss ratio of 30%, 50% and 20%
respectively. Their capital balances are: Cosme ⸺ P150,000; Canlas ⸺ P300,000; Cura ⸺
P50,000. Corazon is admitted into the partnership by investing P150,000.
Instructions: Compute for the amount of asset revaluation or bonus in each of the following
independent cases. Journal entries are not required. Use the space provided for the
supporting computations in good form (Exampr: No asset revaluation; Bonus to new
partner ⸺ P30,000). Corazon is allowed:
1. 1/5 interest in the partnership with a capital credit equal to his investment.
3. 30% interest in the partnership with the total agreed capital of P650,000.
4. 15% interest in the partnership with the total agreed capital of P750,000.
185
Problem B
Partners Cueva, Costal and Cison share profits and losses 4:2:4 respectively. The statement of
financial position at September 30,2014 follows:
Assets Liabilities and Capital
Cash P 80,000 Liabilities P200,000
Other Assets 720,000 Cueva, Capital 148,000
Costal, Capital 260,000
Cison, Capital 192,000
P800,000 Total Liabilities and Capital P800,000
The assets and liabilities are recorded at their current fair values. Cino is to be admitted as a new
partner with a 20% capital interest and a 20% share of profits and losses on exchange for a cash
investment. Asset revaluation or bonus will not be considered.
Problem C
Canete desires to purchase a one-fourth capital and profit and loss interest in the partnership of
Carandang, Cojuangco and Capistrano. The three partners agree to sell Canete one-fourth of their
respective capital and profit and loss interest in exchange for a total payment of P120,000. The
capital accounts and the respective percentage interests in profits and losses immediately before
the sale to Canete are as follows:
Capital %Interest in Profit & Losses
Carandang P 240,000 60%
Cojuangco 120,000 30%
Capistrano 60,000 10%
P 420,000 100%
Instructions: Determine the capital balances of Carandang, Cojuango, and Capistrano, after
the admission of Canete.
186
CHAPTER 5
CHANGE IN CAPITAL STRUCTURE BY
WITHDRAWAL, RETIREMENT, DEATH OR
INCAPACITY OF A PARTNER
LEARNING OBJECTIVES
187
CHANGE IN CAPITAL STRUCTURE BY WITHDRAWAL OR RETIREMENT OF A
PARTNER
The partnership may allow any of its partners to withdraw or retire from the firm. The business
may continue after such withdrawals; on the other hand, the interest of the retiring or
withdrawing partners may be:
1. Sold to a new partner (outsider)
2. Sold to the continuing (remaining) partners
3. Sold to the partnership
188
When the payment to the retiring partner is less than or more than his capital interest, the
difference between the purchase price and the capital interest may be accounted for using:
1. bonus method
2. asset revaluation method
The interest in the partnership of a retiring partner must be established upon his retirement. A
partner’s interest in the partnership is affected by his investments, withdrawals, share on
partnership profit or losses, loans to the partnership and loan from the partnership. Following are
the accounting problems involved in determining the capital interest of a retiring partner:
1. Determination if the profit or loss from the beginning of the accounting period to the date of
withdrawal or retirement and the distribution of such profit or loss.
The interest of a retiring partner must be established upon retirement, as mentiones earlier. The
following are considered in the determination of such interest: investments, withdrawals, share in
profit and losses to the date of retirement, loan, advances and the revaluation of partnership
assets to current values.
189
The following schedule will be helpful in determining the interest of a retiring partner:
Investments
- Withdrawals
+ Share in partnership profit to date of retirement or
- Share in partnership losses to date of retirement
+ Loans and advances to the partnership or
- Loans and advances from the partnership
+ Revaluation of assets increasing their recorded values or
- Revaluation of assets decreasing their recorded values
Illustrative Problem A: The statements of financial position of the partnership of Dy, David
and Diaz on December 31, 2014 follows:
The partners share profits and losses in the ratio of 4:2:4. On July 1, 2015, Diaz asked to be
allowed to withdraw from the partnership. The partners decided to close the books as of this date
so as to determine tha capital interest of Diaz. Profit for the six months ended amounted P60,000
while drawings of Dy, David and Diaz amount to P4,000, P6,000 and P2,000, respectively.
Profits and losses are to be shared equally after the retirement of Diaz.
The following entries will be prepared prior to the retirement of Diaz from the partnership:
190
Diaz, Drawing 2,000
After considering the preceding entries, the capital interest of the partners as of July 1, 2015 may
now be computed as follows:
The entries to record the retirement of Diaz using several assumptions are illustrated below and
on the succeeding pages.
Assumption 1 – Sale of interest to a new partner. Diaz sold his interest to Duque for
P100,000.
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.
The loss of P7,000 (P75,000 – P82,000) is a personal loss of Diaz since the sale of the interest to
Dy and David is a personal transaction among the partners.
Assumption 3- Sale of interest to the partnership. Diaz sold his interest to the partnership. The
partners agreed to make immediate cash settlement to the retiring partner. Profits and losses after
the retirement of Diaz will be divided equally.
Case A – Settlement to retiring partner is equal to his capital interest. The partnership
paid Diaz P82,000.
191
Case B – Settlement is less than the capital interest of the retiring partner (at less than
book value). The partnership paid Diaz P76,000 which is P6,000 less than his capital
interest of P82,000.
The difference between the amount of payment and capital interest of Diaz may now be
considered as:
The entries to record the retirement of Diaz using the two alternative solutions follow:
Bonus Method
The bonus of P6,000 is shared by the remaining partners in accordance with their original profit
and loss ration of 4:2
The difference of P6,000 is only a portion of the asset revaluation. The total amount of asset
revaluation is calculated by dividing the difference of P6,000 by the retiring partner’s fraction of
interest or P6,000 ÷ 4/10 = P15,000. Thus, the reduction from the capital balances of the partners
will be computed as follows:
192
After the preceding entry, the capital balance of Diaz is 76,000 and payment to him will be
recorded as follows:
Case C – Settlement is more than the capital interest of the retiring partner ( at more than
book value). The partnership paid Diaz P85,000 which is P3,000 more than his capital interest of
P82,000.
The difference between the amount of payment and the capital interest of Diaz may now be
considered as:
The entries to record the retirement of Diaz using the two alternative solutions follow:
Bonus Method
The bonus of P3,000 is shared by the remaining partners in accordance with their original profit
and loss ratio of 4:2
193
Other Assets 7,500
Dy, Capital 3,000
David, Capital 1,500
Diaz, Capital 3,000
The difference of P3,000 is only a portion of the asset revaluation of the partnership. The total
amount of asset revaluation is calculated by dividing the difference of P3,000 by the retiring
partner’s fraction of interest or P3,000 ÷ 4/10 = P7,5000. This, the increase in the capital
balances of the partners will be computed as follows:
Dy =P7,500 x 4/10 = P3,000
David =P7,500 x 2/10 = P1,500
Diaz = P7,500 x 4/10 = P3.000
After the entry recording the asset revaluation, the capital balance of Diaz is P85,000 and
payment to him will be recorded as follows:
Diaz, Capital 85,000
Cash 85,000
The two methods discussed may offer different results as to capital balances of the remaining
partners because of the effect on depreciation of the asset revaluation.
To illustrate the effects of the bonus and asset revaluation method, we will use the information
under Assumption 3 – Case C, i.e., the payment to the retiring partners is more than his capita
interest. The schedule below shows the comparison between the bonus and the asset revaluation
method:
Based on the above analysis, David will prefer the bonus while Dy will prefer the asset
revaluation method.
194
CHANGE IN CAPITAL STRUCTURE BY DEATH OR INCAPACITY OF A PARTNER
The death or incapacity of a partner legally dissolves the old partnership since the partner ceases
to be associated in the carrying on of the business. The remaining partners may continue
operations based on a new contract or Articles of Co-Partnership. The interest of the deceased or
incapacitated partner must be determined by the partnership In order to make necessary
settlement with his legal representatives. In case the business is continued without immediate
settlement, the legal representative of the deceased is considered as an ordinary creditor and is to
receive an amount equal to the interest and profits attributable to this interest.
The following accounting problems are encountered in case of death or incapacity of a partner:
1. Determination of the profit or loss from the beginning of the accounting period to the
date of death or incapacity and the distribution of such profit or loss.
2. Closing of the books of the partnership. Partnership agreement, however, may provid3
that the books need not be closed and net income for the fraction of the accounting period
to the date of death or incapacity be determined.
5. Recording of bonus.
195
2. Discuss and understand the accounting procedure in recording the retirement or
withdrawal of a partner by sale of interest to the partnership. The retiring partner may sell
his capital interest to the partnership, which then pays the former either in cash or in the form of
noncash assets. The capital interest of the retiring partner should be established on the date of his
retirement. The partnership may pay him an amount that is equal to his capital interest, at more
than his capital interest, or at less than his capital interest. When the payment is not equal to his
capital interest, the difference may be accounted under any of the following methods: (1) bonus
method (either to the retiring partner or to the remaining partners); or (2) asset revaluation
accruing to all the partners.
3. Discuss and understand the accounting procedures in recording the dissolution of a
partnership due to death or incapacity of a partner. The dissolution of a partnership due to
death or incapacity of a partner is accounted for in almost the same manner as is the retirement of
a partner. Thus, the capital interest of the partner up to date of his incapacity or death should be
established. Settlement is then made to the heirs of the partner or to the legal representatives at
an amount that may be equal to the partner’s capital interest, at more than the capital interest, or
at less than the capital interest. When the settlement is not equal to the deceased or incapacitated
partner’s capital interest, the difference is accounted for under any of the following methods: (1)
bonus method; or (2) asset revaluation method.
Bonus method - a case in retirement or death of a partner wherein the excess of amount paid
over the capital interest of the retiring or deceased partner is recorded as a decrease in the capital
balance of the remaining partners (bonus to retiring or deceased partner from the remaining
partners); the excess of the retiring or deceased partner’s capital balances of the remaining
partners ( bonus to the remaining partners from the retiring or deceased partner).
Retired or deceased partner’s interest – the capital interest of the partner on date of retirement
or death. It is determined by considering additional investment, withdrawals, share in profits and
losses to date of retirement or death, loans, advances and the revaluation of partnership assets to
current values.
Asset revaluation method - the asset revaluation is recorded prior to recording the settlement
with the retiring or deceased partner. The asset revaluation is determined by dividing the
difference between the retiring or deceased partner’s capital interest and the amount of
settlement by his profit and loss sharing ratio.
196
DISCUSSION QUESTIONS
4. What are the alternatives available to the withdrawing or retiring partner as to the
settlement of his interest?
6. What are the different methods of accounting for the payment to the retiring partner at
less than and at more than the book value?
7. A retiring partner’s interest is always settled in cash. True or false? Explain your
answer briefly.
197
EXCERCISES
Instructions: Prepare jouranal entries to record Diesta’s Withdrawal according to each of the
following independent assumptions:
198
Daria’s drawing for the first half of 2014 amounted to 4, 000 and net income for the first half of
2014 amounted to 20,000. The partners share profits and losses equally after the retirement of
Daria.
Instruction: Make the entry ot entries incidental to the retirement of Daria under each of the
following assumptions.
1. Capital increases through Asset Revaluation account is recorded
2. The additional payment to the retiree is a bonus from the remaining partners.
3. Which of the two methods is to be preferred by Ditas?
199
Instruction: Prepare the journal entry for the withdrawal of Domingo under each of the
following assumption:
1. The partners agree to Dizon’s purchasing Domingo’s interest.
2. The partnership will acquire Domingo’s interest for P90, 000, which will use the bonus
method.
3. The partnership will acquire Domingo’s interest for P90, 000, which will be paid in five
annual instalments of P18, 000, plus interest of 10%. The partners feel that the price
Domingo will accept for the capital share is a fair measure of the worth of the business.
Exercise 5 – 6 (Retirement of a Partner: Sale of Interest to the Partnership)
Dimla and Distor wish to purchase the partnership interest of their partner Daza at June 30, 2014.
Partnership assets are to be used to purchase Daza,s partnership interest. The statement of
financial position for the partnership on this date shows the following:
Dimla, Distor, and Daza Partnership
Statement of the Financial Position
June 30, 2014
Assets Liabilities and Capital
Cash P 21, 600 Liabilities P 18, 000
Receivables (net) 14, 400 Dimla, Capital 48, 000
Inventory 12, 000 Distor, Capital 24, 000
Equipment (net) 54, 000 Daza, Capital 12, 000
P 102, 000 P 102, 000
200
PROBLEMS
2. Delfin is paid P260, 000 cash for his interest; excess payment is treated as a bonus.
3. Delfin is paid P260, 000 cash for his interest; excess payment is treated as asset
revaluation.
4. Delfin is paid P160, 000 cash for his interest; excess of his capital interest over the
amount paid is treated as a bonus.
5. Delfin is paid P175, 000 cash for his interest; assets recorded in the books of the
partnership should be reduced by the amount relating to all the partners.
They share net income and losses in the ratio of 2:1:1. The partners agree that the merchandise
inventory be increased by P7, 000 and that the allowance for doubtful accounts be reduced by
P1, 000. Dahlia agrees to accept an interest bearing note for P25, 000 in partial settlement of her
ownership equity. The remainder of her claim is to be paid in cash. Danao and Daylan are to
share equally in the net income or loss of the new partnership.
201
Instructions: Presents entries in the journal form to record:
1. The adjustments of the assets to bring them into agreement with current fair price.
202
Balances
prior to
Dancel’s Balances after Dancel’s Retirement
Accounts Retirement Case 1 Case 2 Case 3
Asset
Cash P200, 000 P 40, 000 P 200, 000 P 70, 000
Other Assets P400, 000 400, 000 400, 000 400, 000
Total Assets P600, 000 P440, 000 P 600, 000 P 470, 000
Liabilities and Capital
Liabilities P 120, 000 P 120, 000 P120, 000 P120, 000
Daet, Caoital 160, 000 148, 000 300, 000 166, 000
Dais, Capital 180, 000 172, 000 180, 000 184,000
Dancel, Capital 140, 000 -0- -0- -0-
Total Liabilities and Capital P 600, 000 P440, 000 P600, 000 P470, 000
Instructions: Prepare the necessary journal entries to record the retirement of Dancel from the
partnership for each of the seven independent cases.
Problem 5 – 5 (Retirement of a Partner; Sale of Interest to the Partnership)
David, Dizon and Duque have been partners in a law office for 15 years. Dizon has decided to
retire and wishes to withdraw from the partnership. To facilitate Dizon’s withdrawal, the
partnership closed its books and prepares the statement of financial position shown below:
Assets
Cash P318, 000 Accounts Payable P 60,000
Accounts Receivable (net) 72, 000 David, Capital 150, 000
Books 120, 000 Dizon, Capital 240, 000
Other Assets 90, 000 Duque, Capital
150, 000
203
Total Assets P600, 000 Total Liabilities & Capital P600, 000
David, Dizon and Duque share profits and losses in the ratio of 3:4:3, respectively
Instructions: Prepare the necessary journal entries on the books of the partnership to record the
withdrawal of Dizon under each of the following assumptions:
1. The partnership agrees that the Books and Other Assets are undervalued by P72, 000 and P 48,
000 respectively. Dizon is to receive a lump sum cash payment.
2. Dizon is to receive P120, 000 now and P 108, 000 in monthly instalment of P12, 000 each. Use
the bonus method.
3. Dizon is to receive P180, 00 now and P18, 000 at the end of each of the nest six months.
a. Use the bonus method.
b. Use the asset revelation method.
Problem 5 – (death of a Partner; Retirement of a Partner; Statement of Changes in Partner’s
Equity)
Partners Danao, Diaz, Dolor and Dungca share profits in the ratio of 40%, 30%, 15% and 15%
respectively. The partnership agreement provides that in the event of the death of a partner, the firm
shall continue until the end of the fiscal period. Profits shall be considered to have been earned
proportionately during the period and the de3ceased partner’s capital shall be adjusted by his share of
the profit or loss to the date of death. From the date of dearth until the date of settlement with the
estate, there shall be added interest of 10% computed on the adjusted capital. The remaining partners
shall continue to divide profits in the old ratio. Payment to the estate shall be made within two years
from the date of the partner’s death. As of January 1, 2014, the capital balances of the partners were as
follows.
Danoa P 84, 000
Diaz 75, 000
Dolor 48, 000
Dungca 45, 000
P 252, 00
Dungca died on September 30, 2014. The books of the partnership were closed as of December
31, arriving at a credit balance of P45, 000 for the income Summary account.
On December 31, 2014, Dolor notified the remaining partners that he was retiring from the
partnership and was willing to accept in settlement of his interest the balance of his capital
account after the distribution of profits less 25%.
The remaining partners accepted his offer and issued a 120-day, 10% note to Dolor in payment
of his interest.
Instruction: Make all the necessary entries to record the above transactions on the books of the
partnership and prepare the statement of partner’s equity for 2014.
204
MULTIPLE CHOICE
MC 5-1 When Delfin retired from the partnership of Delfin, Delan and Desta, the final
interest exceeded Delfin’s capital balance. Under the bonus method, the excess
a. had no effect on the capital balances of Delan and Desta
b. was recorded as asset revaluation
c. reduces the capital balances of Delan and Desta
d. was as expense
MC 5-2 The accounting treatment for the sale of the interest of a retiring partner to an
outsider or to the remaining partners in the same as
a. admission of a partner by purchase
b. admission of a partner by investment
c. sale of interest to the partnership
d. both A and B
MC 5-3 When the partnership purchases a retiring partner’s interest, the settlement to the
retiring partner includes the following except
a. cash c. depreciation expense
b. equipment d. notes payable
MC 5-4 The following should be considered in determining the interest of a
retiring except
a. payable to a co-partner c. share in asset adjustment
b. receivable from the partnership d. share in profits
MC 5-5 When a partnership purchases the interest of a retiring partner at less than book
value, there must be a
a. bonus to remaining partners
b. bonus to retiring partner
c. bonus to remaining partners/negative asset revaluation or both
d. bonus to retiring partner/positive asset revaluation or both
MC 5-6 Dayrit, a partner in an accounting firm decided to withdraw from the partnership.
Dayrit’s share of the partnership profits and losses was 30%. Upon withdrawing
from the partnership, he was paid P71,000 in final settlement of his interest. The
total of the partners’ capital accounts, before asset revaluation, prior to Dayrit’s
withdrawal wa P210,000. After his withdrawal, the remaining partners’ capital
accounts, excluding their share of the asset revaluation, totaled P160,000. The
total amount of the asset revaluation recognized was
a. P21,000 c. P70,000
b. P24,000 d. P80,000
MC 5-7 The partnership of Doctor, Dino and Dolor has reached an impasse as Dolor is no
longer willing to contribute the amount of time and effort to the partnership that
he has previously given. The partners share profits and losses in the ratio of 3:3:4,
respectively. The partners have the following capital balances just prior to Dolor’s
withdrawal from the partnership.
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Doctor P45,000
Dino 35,000
Dolor
25,000
If Dino purchases Dolor’s interest from Dolor from P32,000 and no asset
revaluation is recorded, the balance of Dino capital account immediately after the
withdrawal of Dolor is
a. P55,000 c. P61,000
b. P60,000 d. P67,000
MC 5-8 Using the information in MC 5-7 and assuming that the partners agree that the
partnership will purchase Dolor’s interest for P33,000 and no asset revaluation is
to be recorded, the balance of Doctor’s capital account immediately after the
withdrawal of Dolor is
a. P37,000 c. P39,600
b. P39,000. D. P41,000
MC 5-9 Using the information in MC 5-7 and assuming the partners agree that the
partnership will purchase Dolor’s interest for P25,000 and will record no bonus
nor asset revaluation, the balance of Dino’s capital account immediately after the
withdrawal of Dolor is
a. P35,000 c. P41,000
b. P39,000 d. P43,000
MC 5-10 Using the information in MC 5-7 and assuming the partners agree that the
partnership will purchase Dolor’s interest for P33,000 and will revalue the
partnership based on the price Dolor is willing to accept for his interest in the
partnership, the balance of Dino’s capital account immediately after the
withdrawal of Dolor is
a. P39,000 c. P41,000
b. P40,000 d. P43,000
MC 5-11 The partnership of Digna, Dimla and Distor have capital account balance of:
Digna, P70,000; Dimla, P100,000; Distor, P80,000. Their profit and loss ratios are
30%, 50% and 20% respectively. With the consent and knowledge of the Digna
and Dimla, Distor sold his interest to Diesta. Distor was paid P92,000 in cash. The
new capital balances would be
Digna Dimla Diesta
a. P70,000 P100,000 P92,000
b. 73,800 106,000 82,400
c. 70,000 100,000 80,000
d. 70,000 100,000 172,000
MC 5-12 The statement of financial position as of June 30, 2014 for the partnership of
Dizon, Dionisio and Divino shows the following information:
Total Assets P720,000
Dizon, Loan P 40,000
Dizon, Capital 166,000
Dionisio, Capital 154,000
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Divino, Capital 360,000
Total Liabilities and Capital P720,000
It was agreed among the partners that Dizon retires from partnership and was
further agreed that the assets be adjusted to their fair value of P816,000 as of June
30, 2014. The partnership would pay Dizon P242,000 cash for Dizon’s
partnership interest and includes the payment of loan to Dizon.
Dizon, Dionisio, and Divino share profits and losses 25%, 25% and 50%
respectively. What is Divino’s capital balance after the retirement of Dizon
a. P240,000 c. P408,000
b. P400,000 d. P720,000
MC 5-13 Bianca, Mariel and Toni are partners with capital balances of P100,000, P140,000
and P180,000, respectively. They share profits and losses in the ratio of 20:40:40.
Toni decides to withdraw from the partnership receiving P220,000 including a
loan to the partnership in the amount od P10,000. Assuming the use of the asset
revaluation method, how mush is the amount of asset revaluation increase
(decrease)?
a. P30,000 c. (P30,000)
b. P75,000 d. (P75,000)
MC 5-14 Piolo, Lloyd and Sam are partners with capital balances of P40,000, P50,000 and
P60,000, respectively. They share profits and losses in the ratio 40:40:20%,
respectively. After on year, the operation resulted in a net profit of P20,000.
Withdrawals made during the year are as follows: P10,000, P5,000 and P15,000,
respectively. Sam retired from the partnership and was paid P80,000 for his
interest. Assuming no asset revaluation was recorded, the excess payment is a
a. bonus of P27,000 from the remaining partners
b. bonus of P27,000 to the retiring partner
c. bonus of P31,000 to the remaining partners
d. bonus of P31,000 to the retiring partner
MC 5-15 Using the information in MC 5-14 and assuming assets were revalued upon
retirement of Sam, the share of Piolo and Lloyd in the asset revaluation is
a. P54,000 and P27,000 c. P62,000 and P31,000
b. P54,000 and P54,000 d. P62,000 and P62,000
TRUE or FALSE
Instructions: Encircle the letter T if the statement is true and the letter F if the
statement is false.
T
1. A partner who withdraw from the partnership may, without the consent of the
other partners, sell all or part of his interest to an outsider, to the other
F partners, or to the partnership itself.
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T
F
2. The death of a partner transfers his entire interest to his estate prior to
settlement by the partnership.
6. The partnership must measure net income or net loss for the fraction of the
year up to the withdrawal date of withdrawing partner and allocate profit or
loss according to the existing ratio.
7. Withdrawal by a partner at less than book value of his capital interest results
in a loss to the other partners allocated according to their profit and loss ratio.
8. When a retiring partner paid more than his capital interest without recording
asset revaluation, the excess payment is treated as a bonus to the retiring
partner from the remaining partners.
10. The sale of interest of the retiring partner to a new partner will require the
recognition of a gain or loss on the partnership books.
T 11. The determination of the capital interest of an incapacitated partner is similar
to the determination of the capital interest of retiring partner.
F
T 12. Upon death of one of the partners, the remaining partners may continue
operations based on the old Articles of Co-Partnership.
F
13. The asset revaluation at the time of retirement of one of the partners maybe
T
calculated by dividing the excess payment to the retiring partner ny his
F fraction of interest.
14. The bonus to the retiring partner reduces the capital accounts of the remaining
T partners in the partnership.
F
15. A retiring partners’ interest is always payable in the form of cash.
T
F 208
T
F
16. The retiring partners’ capital interest includes his share in the net income or
net loss of the partnership up to the date of retirement.
17. Loans made by the partnership to the partners, as recorded on the partnership
books, reduces the interest of the retiring partner.
18. The partnership may allow any of its partners to withdraw or retire from the
firm. After such withdrawal, the business may continue its operations.
19. The interest of retiring partner upon retirement need not be established;
anyway, the partner is already retiring.
20. Accounting for the sale of a retiring partner’s interest to the continuing
partners in the same as sale to the partnership.
2. When Alcantara retired from the partnership with Bores and Cruz, the final interest is
less than Alcantara’s capital balance. Under the bonus method, the difference
a. had no effect on the capital of Bores and Cruz
b. was recorded as asset adjustment
c. increase the capital balances of Bores and Cruz
d. was a revenue
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a. equal to his capital interest
b. with indeterminate value
c. less than his capital
d. above his capital interest
4. The withdrawal of a partner of his interest at more than book value results in a
a. bonus from remaining partners
b. gain to remaining partners
c. loss to remaining partners
d. gain or loss depending on the tax basis
5. A partner retires from the partnership and the final settlement is more than his capital
interest. Under the bonus method, the excess
a. is recorded as an expense
b. increase the capital balances of the remaining partners
c. reduces the capital balances of the remaining partners
d. is recorded as gain
6. Daza, Diaz, and Ditas are partners with capital balances of P80,000, P120,000 and
P160,000, respectively, they share profits and losses in the ratio of 30:40:30. Diaz
decides to withdraw from the partnership. Diaz receives P150,000 in settlement of his
interest. If the bonus method is used, what is the capital balance of Ditas immediately
after the retirement of Diaz?
a. P140,000 c. P160,000
b. P145,000 d. P175,000
7. Using the information in No. 6 and assuming asset revaluation methos is used, what is
the capital balance of Ditas immediately after the retirement of Diaz?
a. P137,500 c. P190,000
b. P182,500 d. P200,000
8. Using the information in No. 6 assuming Diaz was paid P120,000, what is the capital
balance of Daza immediately after the retirement of Diaz?
a. P57,500 c. P80,000
b. P65,000 d. P95,000
9. Using the information in No. 6 assuming bonus method is used, what is the total
partnership capital immediately after the retirement of Diaz?
a. P120,000 c. P200,000
b. P130,000 d. P210,000
10. A partner retired from a partnership and received an amount which exceeds his capital
interest by P40,000. The remaining partners have profit and loss ratio of 3:1. Under the
bonus method, the excess payment will be shared by the remaining partners as follows:
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a. P24,000 and P16,000 c. (P24,000 and P16,000)
b. P30,000 and P10,000 d. (P30,000 and P10,000)
At the end of the year 2014, the partnership of Donato, Dulay and Diones had the
following statement of financial position
Assets
Cash P110,000
Receivables 50,000
Inventory 40,000
Equipment (net) 70,000
Total Assets P270,000
Liabilities and Capital
Liabilities P 66,000
Donato, Capital 88,000
Dulay, Capital 60,000
Diones, Capital 56,000
Total Liabilities and Capital P270,000
The partners share profits and losses in the ratio of 50% to Donato, 30% Dulay, and
20% to Diones. It is agreed that Diones is to withdraw from the partnership on this
date.
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Instructions: Listed below are a number of different situations involving the
retirement of Diones from the firm. For each case, prepare the entry or entries to
record the withdrawal of Diones.
1. Dulay buys one-fourth of Diones’ interest for P16,000 and Donato buys three-fourts for
P48,000
2. Diones, with the consent of the other partners, gives his equity to his friend, Dumlao,
who is accepted as a partner in the firm.
3. As analysis of the assets indicates that P8,000 of the receivables will probably prove
uncollectible and that inventories are understated by P12,000 and equipment is
understated by P26,000. It is agreed that the assets are to be adjusted accordingly and that
Diones is to be paid an amount equal to the book value of his adjusted equity.
4. Diones is paid P64,000 from the Partnership funds of his interest. The bonus indicated by
this payment is charged against the continuing partners.
5. Diones is given P20,000 cash and equipment having a book value of P52,000. The
partners agree that no revaluation of assets will be made.
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CHAPTER 6
PARTNERSHP LOUIDATION (LUMP-SUM)
LEARNING OBJECTIVES
1. Define partnership liquidation and identify its causes
2. Discuss the various problems encountered in partnership liquidation
3. Identify and differentiate the two types of partnership liquidation
4. Discuss and understand the accounting procedures under lump-sum liquidation
PARTNERSHIP LIQUIDATION
INTRODUCTION
Dissolution of a partnership does not mean the formal termination of a business. Dissolution of a
partnership can be recognized as a change in the capital structure of a business as a new unit.
Partnership dissolution calling for the winding up of business affairs, called liquidation, shall be
discussed in this chapter. Here, the association of the partners for purposes of carrying on
activities in the usual manner is considered ended. Partners can only engage in activities leading
to final settlement of business affairs.
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DISSOLUTION WITH LIQUIDATION
A partnership is liquidated when its business operations are completely terminated or ended.
The partnership assets are sold, the partnership creditors are paid, and the remaining assets, if
any, are distributed to the partners as a return of their investments.
Partnership dissolution with liquidation may be caused by any of the following factors:
1. The accomplishment of the purpose for which the partnership was organized.
2. The termination of the term/period covered by the partnership contract.
3. The bankruptcy of the firm.
4. 4 The mutual agreement among the partners to close the business.
Accounting problems involved in the liquidation of a partnership include:
1. Determination of the profit or loss from the beginning of the accounting period to the
date of liquidation and the distribution of such profit or loss.
In partnership liquidation, the assets and liabilities of the partnership are directly intertwined
with those of the individual partners' personal assets and liabilities because of the unlimited
liability of each partner. The priorities for creditors’ claims against the assets available to pay the
partnership liabilities involve two concepts the marshaling of assets and the right of offset.
Marshaling of assets involves the order of creditors' rights against the partnership's assets and
the personal assets of the individual partners. The order in which claims against the partnership's
assets will be marshaled is as follows:
1. partnership creditors other than partners;
2. partners' claims other than capital and profits, such as loans payable and accrued interest
payable; and
3. partners’ claim over the capital or profits, to the extent of credit balances in capital
accounts.
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The order of claims against the personal assets of the individual partners is as follows
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1. personal creditors of individual partners; and
2. partnership creditors on unpaid partnership liabilities regardless of a partner’s capital
balance in the partnership.
Right of offset involves offsetting a deficit in a partner's capital (debit balance in the capital
account of a partner) against the loan payable to that partner. The loan payable to a partner has a
higher priority in liquidation than a partner’s capital balance but a lower priority than liabilities
to outside creditors.
DEFINITION OF TERMS
Dissolution - the termination of a partnership as a going concern; it is the termination of the life
of a partnership.
Winding up - the process of settling the business or partnership affairs; it is synonymous to
liquidation.
Termination - the point in time when all partnership affairs are ended
Liquidation- - the interval of time between dissolution and termination of partnership affairs; it
is also the process of winding up a business which normally consist of conversion of assets into
cash, payment of labilities and distribution of remaining cash among the partners.
Realization - the process of converting non-cash assets into cash.
Gain on realization - the excess of the selling price over the cost or book value of the assets
disposed or sold through realization.
Loss on realization - the excess of the cost or book value over the selling price of the assets
disposed or sold through realization.
Capital deficiency- the excess of a partner's share on losses over his capital.
Deficient partner - a partner with a debit balance in his capital account after receiving his share
on the loss on realization.
Right of offset - the legal right to apply part or all of the amount owing to a partner on a loan
balance against deficiency in his capital account resulting from losses in the process of
liquidation.
Partner's interest - the sum of a partner's capital, loan balance and advances to the partnership.
213
TYPES OF LIQUIDATION
1. Lump-sum liquidation or liquidation by totals. This is a type of liquidation whereby the
distribution of cash to the partners is done only after all the non-cash assets have been
realized, the total amount of gain or loss on realization is known, and all liabilities have been
paid.
215
2. Liquidation by installment or piece-meal liquidation. This is a type of liquidation whereby
assets are realized on a piecemeal basis and cash is distributed to partners on a periodic basis
as it becomes available, that is, even before all non-assets are converted into cash.
PROCEDURES IN LUMP-SUM LIQUIDATION
When a partnership is to be liquidated, the books should be adjusted and balances of nominal
accounts are closed. The resulting profit or loss for the period is transferred to the partners'
capital account. Advances and withdrawals are closed to capital accounts since cash settlement
shall be based on the partners' capital account balances. The partnership is then ready to proceed
with liquidation as follows:
1. Sale of non-cash assets and distribution or allocation of gain or loss on realization among
the partners according to their residual profit and loss ratios (salary and interest factors
disregarded) unless liquidation ratios are specified in the partnership agreement.
2. Distribution of cash to creditors and partners. In this procedure, the provisions of the
marshalling of assets and the exercise of the right of offset are applied.
Liquidation expenses may be incurred to facilitate the immediate realization of non-cash assets.
Payment of liquidation expenses reduces cash and is recorded as a deduction from partners'
capital based on the partners' profit and loss ratios.
When realization of assets in the course of liquidation results in a loss, the loss is carried to the
capital accounts of the partners as a deduction. If a partner's capital account results in a debit
balance (known as capital deficiency), after the distribution of loss on realization, such can be
offset against any loan balance of the partner to the partnership. The amount to be offset shall be
the lower of the amount of the loan or the amount of the deficiency.
Cash can be distributed to partners before or after the elimination of the deficiency. If cash is
distributed after the elimination of the deficiency,
1. Capital deficiency is eliminated by
a. Making additional cash investment, if the deficient partner is solvent.
214
b. Charging the deficiency as additional loss to the remaining partners, if the deficient
partner is insolvent.
2. Cash available for distribution is then paid to partners to apply first on loan then on capital
Key Points. The final distribution of cash to partners is made based on partners' capital
balances and not on any ratio.
If cash is distributed to partners before eliminating the deficiency:
216
1. Cash available for distribution is paid to partners based on an accompanying schedule to
determine amounts to be paid to partners.
(a) If solvent, make additional cash investment; to be paid to partners as second cash
distribution, or the deficient partner may make direct cash settlement to the other
partners.
(b) If insolvent, the deficiency shall be absorbed by the other partners as additional loss
according to their profit and loss ratio.
The personal status of partners (that is, personal assets and personal liabilities) is sometimes
provided in the problem to indicate that a partner is solvent or insolvent. When personal assets
exceed personal liabilities, the partner is solvent to the extent of the excess. When personal assets
are less than personal liabilities, the partner is insolvent.
STATEMENT OF LIQUIDATION
The statement of liquidation is a statement prepared to summarize the liquidation process. It is
the basis of the journal entries made to record liquidation. This statement presents in working
paper from the effect of the liquidation on the statement of financial position. It shows the
conversion of assets into cash, the allocation of gain or loss on realization, and the distribution of
cash to creditors and partners.
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Illustrative Problem A:
Encina, Endrada, and Elina
Statement of Financial Position
December 1, 2014
217
Case (1) The other assets were sold for Pl40, 000.
(2) The other assets were sold for P100, 000.
(3) The other assets were sold for P74, 000.
(4) The other asses were sold for P68, 000. Deficient partner was solvent
(5) The other assets were sold for P68, 000. Deficient partner was insolvent.
(6) The other assets were sold for P68, 000. Distribution of available cash is:
a. before eliminating capital deficiency; and
b. after eliminating capital deficiency
Instructions:
1. Prepare a statement of liquidation for each of the cases. For case 6, prepare also a
schedule of cash distribution.
216
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."
4. Figures in parenthesis for each liquidation transaction represent reduction in the account.
218
Case - The other assets were sold for P140,000. (Gain on realization, no capital deficiency)
Encina, Endrada and Elina
Statement of Liquidation
December 1 - 31, 2014
The other assets with a book value of P136,000 were sold for P140,000 resulting in a P4,000 gain on realization distributed among the
partners in their 2:2:1 ratio.
218
219
The entries to record the liquidation process are:
(a) Realization of assets and distribution of gain on realization, 2:2:1
Cash 140,000
Other Assets 136,000
Encina, Capital (4,000 x 2/5) 1,600
Endrada, Capital (4,000 x 2/5) 1,600
Elina, Capital (4,000 x 1/5) 800
Liabilities 44,800
Cash 44,800
.219
220
Case - The other assets were sold for P100,000. (Loss on realization, no capital deficiency)
Encina, Endrada and Elina
Statement of Liquidation
December 1 - 31, 2014
The other assets with a book value of P136,000 were sold for P100,000 resulting in a loss on realization of P36,000 that can be fully
absorbed by the capital balances of all the partners.
220
221
The entries to record the liquidation process are:
Cash
Encina, Capital(36,000 x 2/5) 100,000
Endrada, Capital (36,000 x 2/5) 14,400
Elina, Capital (36,000 x 1/5) 7,200
Other Assets 136,000
Liabilities 44,800
Cash 44,800
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Case 3 - The other assets were sold for P74,000. (Loss, on realization, capital deficiency, right of offset)
Offset of
loan against
the debit (800) (P800)
balance in
the capital
of Endrada
Balances P 37,200 - - P 1,200 P 3,200 P13,200 - P19,000
Payment of
Partners (37,200) - - (1,200) (3,200) (13,200) - (19,000)
The other assets with a book value of P136,000 were sold for P74,000 resulting in a loss on realization of P62,000. The distribution of the loss on
realization resulted in a debit balance in the capital of Endrada. The right of offset can be exercised in as such as Endrada has a loan to the partnership.
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Entries to record the liquidation process are:
Cash 74,000
Encina, Capital (62,000 x 2/5) 24,800
Endrada, Capital (62,000 x 2/5) 24,800
Elina, Capital (62,000 x 1/5) 12,400
Other Assets 136,000
Liabilities 44,800
Cash 44,800
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Case 4 – The other asset were sold for P68,000. Deficient partner invests additional cash before cash distribution to partners. (Loss on realization, capital deficiency,
deficient partner is solved)
Offset of loan
against the
debit balance (2,000) 2,000
in the capital
of Endrada
Balances P 31,200 - - - P 3,200 P10,800 (1,200) P18,400
Additional
Investment by 1,200 1,200
Entrada
Balances P 32,400 - - - P 3,200 P10,800 - P18,400
Payment of
Partners (37,200) - - - (3,200) (10,800) - (18,400)
The other assets of P136,000 were sold for P68,000 resulting in a loss on realization of P68,000. The distribution of the loss on realization resulted in a debit balance in the capital
of Endrada that cannot be fully absolved by his loan. The deficient partner cancels his deficiency by making additional cash investment. By doing so, the partnership will satisfy all
its liabilities including the other partners’ equities.
224
The entries to record the liquidation process
Cash 68,000
Encina, Capital (62,000 x 2/5) 27,200
Endrada, Capital (62,000 x 2/5) 27,200
Elina, Capital (62,000 x 1/5) 13,600
Other Assets 136,000
Liabilities 44,800
Cash 44,800
Cash 1,200
Endrada, Capital 1,200
225
Case 5 – The other assets were sold for P68,000. Deficient partner is involvent and his deficiency is shared by the other partners before cash distribution (Loss on
realization, capital deficiency, right of offset, deficient partner is insolvent)
Offset of loan
against the
debit balance (2,000) 2,000
in the capital
of Endrada
Balances P 31,200 - - - P 3,200 P10,800 (P 1,200) P18,400
Additional
loss to
partners for
the deficiency (800) 1,200 ( 400)
of Endrada
shared, 2:1
Balances P 31,200 - - - P 3,200 P10,000 - P18,000
Payment of
Partners (31,200) - - - (3,200) (10,000) - (18,000)
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The distribution of the P68,000 loss on realization resulted in a debit balance in the capital account of
Endrada that cannot be fully absorbed by his loan. Failure of the deficient partner to cancel his
deficiency is to be regarded as additional loss, allocated to the remaining partners in their profit and loss
ratio. Encina and Elina share on the deficiency of Endrada in the ratio 2:1. Encina and Elina share on the
computed as follows:
Cash 68,000
Encina, Capital (68,000 x 2/5) 27,200
Endrada, Capital (62,000 x 2/5) 27,200
Elina, Capital (62,000 x 1/5) 13,600
Other Assets 136,000
Liabilities 44,800
Cash 44,800
(d) Capital deficiency of insolvent partner absorbed as additional loss by remaining partners
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Case 6 – The other assets were sold for P68,000. Additional cash investment by deficient partnes is to be made as second cash distribution to partners. All available cash is immediately
distributed to partners requiring a schedule to accompany the statement of liquidation in order to determine amounts to be paid to partners. (Loss on realization, capital deficiency, right of
offset, and cash distribution)
Balance before P 8,000 P136,00 P44,800 P 2,000 P3,200 P38,000 P24,000 P32,000
liquidation
Sale of assets
and distribution 68,000 (136,000) (27,200) (27,200) (13,600)
of loss
Balances P 76,000 - P44, 8000 P 2,000 P 3,200 P10,800 (P 3,200) P18,400
Offset of loan
against the debit ( 2,000)
balance in the 2,000
capital of
Endrada
Balances P 31,200 - - - P 3,200 P10,800 (P 1,200) P18,400
Payment of
Partners (1,200) - - - - (800) - (400)
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The Schedule to Accompany the Statement of Liquidation shows amounts to be paid to partners. Total
partners, interest is reduced by the restricted interest possible for losses, in case the deficient partner
fails to pay his deficiency. Restricted interest for possible losses shal continue up to the point when
deficiencies or debit balances in capital are eliminated. When deficiencies are eliminated, balances shall
be called Free Interest – Amounts to be Paid to Partners, to apply first in a loan, then on capital.
Cash 68,000
Encina, Capital (68,000 x 2/5) 27,200
Endrada, Capital (62,000 x 2/5) 27,200
Elina, Capital (62,000 x 1/5) 13,600
Other Assets 136,000
Liabilities 44,800
Cash 44,800
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Cash 31,200
Cash 1,200
Endrada, Capital 1,200
If the deficient partner makes direct cash settlement to partners, the entry is:
Usually, liquidation problems do not require the presentation of a statement of liquidation but calls only
for the calculation of cash settlements to partners. In such cases, however, non-cash assets have already
been converted into cash, liabilities have bee settled but capital remain as to their balances before
liquidation since the gain or loss on realization of non-cash assets has not yet been carried to capital.
Any difference, therefore, between the debits (available cash to partners) and total credits (loans and
capitals) is a gain or loss on realization that must first be carried to the capital before proceeding with
the liquidation process.
Illustrative Problem B:
At December 31, 2014, the capital balances of the partners Ebora, Esteban and Echavez are P160,000;
P100,000 and P20,000; respectively, sharing profits and losses in the ratio 3:2:1. The partners decided to
liquidate, and sold all the non-cash assets for P148,000 cash. After paying all the liabilities amounting to
P48,000, they still have P112,000 cash left for distribution
422
The loss on realization is the excess of the credits (total credits) over the debits (cash left for
distribution).
Total capital (P160 000 + P100 000 + P20 000) P 280 000
Less Cash left for distribution to partners 112 000
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.
1. Define partnership liquidation and identify its causes. Partnership liquidation is the
winding up of the business affairs of the partnership; hence the business operation is
completely terminated or ended. Partnership liquidation may be caused by any of the
following: (1) accomplishment of the purpose of the partnership; (2) termination of the
term/period covered by the partnership contract; (3) bankruptcy of the partnership; and
(4) mutual agreement among the partners to close the business.
2. Discuss the various problems encountered in the partnership liquidation. The
liquidation of a partnership will give rise to the following problems. (1) determining
partnership profit or loss from the beginning of the accounting period to the date of
423 2
3
1
liquidation and distributing such profit or loss to the partners; (2) closing the partnership
books; (3) correcting accounting errors in prior periods; and (4) liquidating the business.
3. Identify and differentiate the two types of partnership liquidation. The two types of
partnership liquidation are lump-sum liquidation (liquidation by totals) and installment
liquidation (piecemeal liquidation). Under lump-sum liquidation, distribution of cash to
the partners is done only after realization of all non-cash assets, distribution of gain or
loss on realization and payment of partnership liabilities. Under installment liquidation,
asset realization is on a piece-meal basis and cash is distributed to partners as it becomes
available even if there are still unrealized non-cash assets.
4. Discuss and understand the accounting procedures under lump-sum liquidation.
Lump-sum liquidation requires the following procedures: (1) realization of non-cash
assets (sale of non-cash assets for cash); (2) distribution of gain or loss on realization to
the partners according to their liquidation ratio, if there is any, or according to their
residual profit and loss ratio; (3) payment of liabilities to outside creditors; and (4)
distribution of cash to partners.
Capital deficiency – the excess of a partner’s share of losses over his capital credit balance.
Deficient partner – a partner with a debit balance in his capital account after receiving his share
on the loss on realization.
Insolvent partner - a partner whose personal assets are less than his personal liabilities.
Free interest - a partner’s capital interest that is available for cash payment.
Liquidation – the winding up of the business affairs of a partnership.
Realization – the process of converting non-cash assets into cash.
Restricted interest – a portion of a partner’s capital account balance that is restricted for
possible losses on liquidation. It is not, therefore, available for cash payment.
Right of offset – the legal right to apply all or part of a partner’s loan to the partnership against
capital deficiency.
Solvent partner – a partner whose personal assets are more than his personal liabilities.
2
DISCUSSION
424 QUESTIONS
3
2
1. Differentiate dissolution from liquidation.
2. What are the causes of partnership liquidation?
3. What are the types of liquidation? Differentiate one from the other.
4. Discuss the procedures in liquidation.
5. What is a statement of liquidation?
6. Is it true that the column headings of the statement of liquidation follow the basic
accounting equation? Why or why not?
7. What is the basis of final cash distribution to partners?
8. What is the right of offset? When can it be exercised?
9. What is the basis for dividing gains or losses on realization?
10. How may the capital deficiency of an insolvent partner be eliminated?
11. What is the order of payment of partnership liabilities?
12. What is a partner’s restricted interest? Free interest?
13. What purpose is served by the schedule of cash distribution?
14. What are the rules to be applied in case of capital deficiency?
15. Describe how loans receivable from partners and loans payable to partners are treated in
liquidation and why is that treatment necessary?
EXERCISES
425
2
3
3
1. Prepare a statement of liquidation assuming all partners are solvent.
2. Prepare a statement of liquidation assuming the liabilities of P270 000 include a P70 000
note payable to Elias. All partners are solvent.
3. Prepare a statement of liquidation assuming the non-cash assets of P810 000 include a
note receivable from Enrico in the amount of P110 000. The liabilities include a P70 000
note payable to Elias.
Exercise 6 – 3 (Statement of Liquidation under various cases)
The statement of financial position of the partnership of Enteng and Estrel as of December
31, 2014 shown on the next page.
The other assets were realized for P268 000 and cash was disbursed. Divisions of profits and
losses are:
Enteng Estrel
Case 1 90 % 10 %
Case 2 70 % 30 %
Case 3 50 % 50 %
Intructions: Prepare the partnership liquidation statement and journal entries to record the
liquidation for each case.
2
426 3
4
ratio of 4:3:2:1 by Esguerra, Esteban, Estrada and Eugenio respectively. Assets are sold,
liabilities are paid and cash of P12 000 remains.
PROBLEMS
The statement of financial position shown below was prepared just prior to the liquidation of the
partnership of Ester, Edna, Emma, and Eva. Partners shared in the profits and losses in the ratio
of 4:2:1:1.
Total assets P 1 062 500 Total liabilities and equity P 1 062 500
Other assets are sold for P 500 000 and available cash is distributed to the proper parties. Edna is
personally insolvent, but the other partners are able to meet any personal indebtedness to the
partnership. The solvent partners make appropriate contributions to the partnership, and this cash
is distributed in final settlement.
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3
5
Instructions:
1. Prepare a statement of liquidation, together with a supporting schedule if necessary.
2. Give the entries that would be made to record the liquidation of the partnership.
Problem 6 – 2 (Statement of liquidation; journal entries to record liquidation)
The partnership accounts of Eugenio, Evariso, and Esteban, who share earnings in a 5:3:2
ratio, are as follows on December 31, 2014:
Total assets amounted to P638 000, including P70 000 cash, and liabilities toatal P200 000.
The partnership was liquidated in January 2015, and Esteban received P111 000 cash
pursuant to the liquidation.
Instructions:
1. Compute the total loss from the liquidation of the partnership.
2. Prepare a statement of liquidation.
3. Prepare the journal entries for the accounting records of the partnership to account for the
liquidation.
236
428
Assets Liabilities and equity
Total assets P 360 000 Total liabilities and equity P 360 000
Instructions For each of the cases listed below, prepare a statement of liquidation assuming
that cash is realized for the other assets as indicated in each case, and that all available cash is
immediately distributed to the proper parties. Assume as additional payment to the proper
parties.
2
429 3
7
Assets
Cash P 1000
Accounts receivable P 80 000
Less allowance for doubtful accounts 20 000 60 000
Merchandise inventory 50 000
Prepaid advertising 2 000
Machinery and equipment P 100 000
Less accumulated depreciation 60 000 40 000
Total assets P 153 000
The partners desired to complete the liquidation process as quickly as possible. Information
concerning the liquidation follows:
1. Accounts receivable equal to the net carrying value plus 20% of the estimated doubtful
accounts were collected.
2. Merchandise inventory were realized for P25 000.
3. The prepaid advertising contract has a cancellation value of P800.
4. Machinery and equipment were realized equal to 60% of their book value.
5. Unrecorded accounts payable totaling P2000 were discovered.
6. The bank charged the partnership P1000 for the paying the note earlier than the due date;
the amount is added to the note.
Evasco is personally insolvent. However, Ellor’s personal assets exceed his personal
liabilities by P4000. Evasco and Ellor share on income and losses in the ratio of 4:6,
respectively.
2
430 3
8
Instructions:
1. Prepare a schedule showing the net amount of liquidation gain or loss.
2. Prepare a statement of liquidation.
3. Give the entries to record the liquidation.
MULTIPLE CHOICE
MC 6-1 Espina, Espinosa, Esteban, and Estrellita are partners, sharing earniongs in the ratio of
3:4:6:8. The balance of their capital accounts on December 31, 2014 are as
follows:
Espina P 1000
Espinosa 25 000
Esteban 25 000
Estrellita 9 000
P 60 000
The partners decided to liquidate, and they accordingly convert the non-cash assets into P23
000 of cash. After paying the liabilities amounting to P3 000, they have P22 200 to divide.
Assume that a debit balance in any of partner’s capital in uncollectible. The book value of the
non-cash assets amounted to:
a. P 25 200
b. P 45 400
c. P 61 000
d. P 63 000
MC 6-2 Using the information in MC 6-1, the share of Espinosa in the loss upon conversion of
the non-cash assets into cash was
a. P 5 400
b. P 7 200
c. P 37 800
d. P 61 000
MC 6-3 Using the information in MC 6-1, how much did Esteban get when the P 22 200
was divided?
a. P 6 432
b. P 8 320
c. P 10 000
d. P 14 200
2
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MC 6-4 As of December 31, 2014, the books of 3E Partnership showed capital balances of E1-
P40 000; E2-P25 000; E3-P5 000. The partners’ profit and loss ratio was 3:2:1, respectively. The
partners decided to dissolve and liquidate. They sold all the non-cash assets for P37 000 cash.
After settlement of all liabilities amounting to P12 000, they still have P28 000 cash left for
distribution. The loss on realization of the non-cash assets was:
a. P 28 000
b. P 40 000
c. P 42 000
d. P 45 000
MC 6-5 Using the information in MC 6-4, and assuming that any debit balance of partners’
capital is uncollectible, the share of E1 on P28 000 cash for distribution was:
a. P17 800
b. P18 000
c. P 19 000
d. P40 000
MC 6-6 Esper, Elor, and Este, partners are in textile distri8bution business sharing profits and
losses equally. On December 31, 2014, the partnership capital and partners; drawing are as
follows:
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 P 84 000. Elor and Este have
substantial private resources but Esper has no personal assets. Loss on liquidation was
a. P 360 000
b. P 432 000
c. P 480 000
d. P 516 000
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
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0
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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 P 30 000 from the sale of the non-cash assets and that any
deficiency is uncollectible, Ender must receive
a. P 19 000
b. P 34 000
c. P 37 000
d. P 49 000
MC 6-9 Using the information in MC 6-8 and assuming Escano had personal assets of P50 000
and personal liabilities of P45 000 and that the partnership realized P25 000 from the sale of its
non-cash assets, Evelo must receive:
a. P 25 000
b. P 26 000
c. P 27 000
d. P 41 000
MC 6-10 Using the information in MC 6-8 and for Escano to receive P12 000, the non-cash
assets must be sold for
a. P 10 000
b. P 12 000
c. P 30 000
d. P 75 000
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433
Chapter 6 - Partnership Liquidation (Lump-Sum)
MC 6-11 The following condensed statement of financial position is presented for the
partnership of Echo, Egay and Elma, who share profits and losses in the ratio of
6:2:2, respectively.
Assets Liabilities and
Capital
Cash P 40,000 Liabilities
P 70,000
Other Assets 140,000 Echo,Capital
50,000
Egay,Capital 50,000
Elma,Capital 10,000
Total Assets P 180,000 Total Liabilities &Capital
P 180,000
The partners agreed to liquidate the partnership after selling the other assets.
If the other asset are sold for P80,000, how much should Echo receive upon
liquidation, assuming all the partners are solvent?
a. P12,500 c. P14,000
b. P13,000. d. P50,000
MC 6-12 Using the information in MC 6-11 and assuming that the other assets are
sold
for P80,000; profits are shared 2:2:6, respectively; and that any deficient partner is
insolvent, the amount to be received by Egay upon liquidation is
a. P19,500 c. P38,000
b. P25,000 d. P50,000
MC 6-13 Esmer, Estrel, Ellea and Elmer share profits in the ratio of 2:1:1:1. The
partnership cannot meet its obligations to creditors and dissolution is authorized
on September 30, 2014. A statement of financial position for the partnership on
this date shows balances as follows:
Estrel,Capital 50,000
Ellea,Capital 50,000
Elmer,Capital 50,000
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Total Assets P490.000 Total Liabilities &Capital
P490.000
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 c. P150,000
b. P142,000 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 c. P235,000
b. P217,500 d. P250,000
435
Test Material No. 21 Rating
___________
TRUE OR FALSE
Instructions: Encircle the letter T if the statement is true and the letter F if
the statement is false.
1. Partnership dissolution is always followed by liquidation.
2. The final distribution of cash to the partners shall be made based on their profit and
loss sharing agreement.
3. In lump-sum liquidation, the distribution of cash to partners is made only after all the
non-cash assets have been realized, the total amount of gain or loss on realization has
been determined and distributed, and all liabilities have been paid.
4. In a statement of liquidation, there are only two classes of assets cash and other
assets.
6. The liquidation ratios will always be equal to the profit and loss ratio of the partners.
7. If the deficient partner is insolvent, his deficiency will be absorbed by the other
partners distributed according to their profit and loss ratio.
8. When the personal assets of a partner exceed his personal liabilities, the partner is
considered solvent but only to the extent of the excess.
9. Non-cash assets that are not sold should be written off as a loss and such loss is
divided to the partners equally.
10. The right of offset is exercised when a partner’s capital account reports a debit
balance and he has at the same time a loan to the partnership.
11. The amount offset in exercising the right of offset shall be the amount of a partner’s
loan to the partnership or the amount of his deficiency, whichever is lower.
436
12. The loan payable to a partner has a higher priority in liquidation than a partner's
capital balance but a lower priority than liabilities to outside creditors.
13. Liquidation expenses which are incurred to facilitate the immediate realization of
non-cash assets affect cash but not capital.
14. In partnership liquidation, advances and withdrawals are closed to capital accounts
since cash settlement is based on the partners' capital account balances.
15. Personal creditors of individual partners have priority over partnership creditors in
the order of claims against the personal assets of a partner.
17. A deficient but solvent partner has to share on the deficiency of an insolvent partner
in case of final liquidation
18. A partner with a loan to the partnership may never become a deficient partner
19. A partner's claim from the partnership, upon liquidation, increases the amount
available for the partner's personal debts.
IDENTIFICATION
437
Instructions: Write the word or group of words that identify each of the
following statements.
_____________ 1. The account credited for loans made by the partners to the
partnership.
_____________ 2. A liquidation in which the proceeds from all assets are fully realized
before any distribution of cash is made.
_____________ 3. The principle that allows a partner to apply his receivable from the
partnership against a debit balance in his account.
_____________ 4. The process of winding up a business
_____________ 5. The process of converting non-cash assets into cash.
_____________ 6. Amount of money advanced by the partnership to the partners.
_____________ 7. A liquidation that is spread over a long period and the partners distribute
cash as it becomes available without waiting until all assets are realized.
_____________ 8. A partner with a debit balance in his capital account after the transfer of
the loss on realization.
_____________ 9. An accounting statement summarizing the winding up of the affairs of the
partnership.
_____________ 10. A partner whose personal liabilities exceed his personal assets.
_____________ 11. The order of creditors’ rights against the partnership’s assets and the
personal assets of the individual partners.
_____________ 12. The excess of a partner’s share on losses over his capital.
_____________ 13. The excess of the selling price over the cost or book value of the assets
disposed or sold through realization.
_____________ 14. Expenses incurred in order to facilitate the immediate realization of non-
cash assets.
_____________ 15. The manner of eliminating the capital deficiency of an insolvent partner;
after exercising the right of offset when applicable.
_____________ 16. The basis for the final distribution of cash to partners in case of liquidation
_____________ 17. They have priority over the personal assets of a partner.
_____________ 18. The manner of eliminating the capital deficiency of a solvent partner who
does not have loans to the partnership
_____________ 19. The proper treatment of a credit balance in a partner's drawing account in
the statement of liquidation.
_____________ 20. The manner of dividing gains and losses on the realization of non-cash
assets in liquidation
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Test Material No. 23 Rating
___________
439
c. a loss to the other partners
d. a gain to the other partners
7. The other partners must absorb the deficiency in a partner's capital account in liquidation
because of
a. limited life and mutual agency
b. mutual agency and unlimited liability
c. limited life and co-ownership of property
d. mutual agency and partnership's taxability
8. When a partnership is liquidated, all of the following may occur, except
a. a partner erases his deficiency by declaring bankruptcy
b. the other partners absorb a partner's deficiency
c. a partner erases his deficiency by contributing property
d. a partner erases his deficiency by contributing cash
9. In the final liquidation transaction, the remaining cash is distributed to the
partners.
The partners share in the cash according to their
a. profit and loss ratio c. capital balances
b. Withdrawals d. cash balance
10. The order of partnership liquidation process is
a. sell assets, disburse cash to partners, pay liabilities
b. disburse cash to partners, pay liabilities, sell assets
c. pay liabilities, sell assets, disburse cash to partners
d. sell assets, pay liabilities, disburse cash to partners
11. In a partnership liquidation, a loss from sale of non-cash assets is allocated to the
a. partner with the lowest capital balance
b. partnership liabilities
c. partners based on their capital balances
d. partners based on the profit and loss sharing ratio
12. A partnership liquidates and finds an excess cash, after payment of liabilities, of
P100,000. The four partners have equal capital balances and share profits and losses
in the ratio of 10:20:30:40. The four partners will receive a final distribution
of cash
as follows:
a. P 25,000; P 25,000; P 25,000; P 25,000;
b. P 10,000 P 20,000; P 30,000; P 40,000;
c. P 12,000; P 20,000; P 8,000; P 60,000;
d. P100,000; P100,000; P100,000; P100,000
13. Upon liquidation, the EE partnership realized a gain on sale of assets amounting to
P120,000. The gain is allocated to the partners, Estrada and Esteban, according to their
profit and loss ratio of 2:1. How is the gain allocated to each partner?
a. Estrada - P 60,000:, Esteban - P
60,000
b. Estrada - P 80,000; Esteban - P
40,000;
c. Estrada - P 40,000:, Esteban - P
80,000
440
d. Estrada - P 120,000 Esteban - P
240,000;
14. The liquidation of the partnership of Emma, Earl and Ester resulted in a
deficiency in
Emma’s capital account of P100,000. Emma can contribute only P20,000 to offset her
deficiency The partners share profits and losses in the ratio 3:3:2. Earl and Ester, who
have capital balances of P250,000 and P50,000, will absorb the deficiency as follows:
a. Earl - P0 and Ester - P 0
b. Earl - P32,000 and Ester - 48,000
c. Earl - 48,000 and Ester - P32,000
d. Earl - P 40,000 and Ester - P 40,000
15. Ever, Engel and Encar are partners who share profits and losses in the ratio of
2:3:5.
The partners have decided to liquidate the partnership. Their capital accounts show the
following balances: Ever P60,000 credit; Engel - P90,000 credit; Encar P20,000 debit
after the sale of non-cash assets and the payment of all liabilities. What is the amount of
cash available for distribution:
a. P60,000 c. P120,000
b. P90,000 d. P130,000
16. The following statement of financial position is for the EEE Partnership. The partners
Emy, Ely, and Evy share profits and losses in the ratio of 5:3:2, respectivel;y.
Cash P 60,000 Liabilities P
140,000
Other Assets 540,000 Emy, Capital
280,000
Ely, Capital 160.000
______________ Evy, capital 20,000__
P 600,000 P 600,000
Assuming the original partners agreed to liquidate the partnership by selling
the other
assets, what should each of the respective partners receive if the other assets
are sold
for P400,000?
a. Emy - P205,000; And Ely - P115,000; Evy P 0
b. Emy - P206,000; And Ely - P114,000; Evy P 0
c. Emy - P210,000; And Ely - P111,800; Evy P 8,000
d. Emy - P280,000; And Ely - P160,000; Evy P 20,000
17. The statement of financial position for the partnership of Eden, Élisa, and Elma, who
share profits and losses in the ratio of 4:5:1, is as follows:
Cash P 100,000 Accounts Payable
P 300,000
Inventory 720,000 Eden, Capital
320,000
Eli, Capital 90.000
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______________ Elma, capital
110,000__
P 820,000 P 820,000
If the inventory is sold for P600,000, how much should Eden receive upon liquidation of
the partnership?
a. P 96.000 c. P272,000
b. P 200.000 d. P320,000
18. Using the information No.17 and assuming the inventory is sold for P360,000,how much
should Elma receive upon liquidation of the partnership?
a. P56.000 c. P 74,000
b. P65,000 d. P110,000
19. After all non-cash assets have been converted into cash, in the liquidation of the Estacio
and Estioco Partnership, the ledger contains the following account balances:
Debit Credit
Cash P141,000
Accounts Payable
P96,000
Loan Payable to Estacio 45,000
Estacio,Capital 21,000
Estioco,Capital 21,000
Available cash should be distributed with P96,000 going to Accounts Payable
and
a. P45,000 to the Loan Payable to Estacio
b. P22,500 each to Estacio and Estioco
c. P24,000 to Estacio and P21,000 to Estioco
d. P21,000 to Estacio and P24,000 to Estioco
20. The partnership accounts of Edna,Elvira and Emma who share earnings in a 3:3:4 ratio
are as follows on December 31,2014
Edna,Drawing(debit balance) P 30,000
Emma, Drawing (credit balance) 10,000
Elvira,Loan 50,000
Edna,Capital 160,000
Elvira,Capital 130,000
Emma,Capital 140,000
Total assets amounted to P700,000 including P80,000 cash and liabilities total P240,000.
The partnership was liquidated in January 2015 and Emma received P120,000 cash
payment in the liquidation. The loss on realization was
a. P75,000 c. P 95,000
b. P80,000 d. P100,000
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Chapter 6— Partnership Liquidation (Lump-sum)
Name
Date
Year and Section
Professor
PROBLEMS
Problem A
EEE Partnership has decided to liquidate as of December 31, 2014. The statement of financial
position as of this date follows:
EEE Partnership
Statement of Financial Position
December 31, 2014
Assets Liabilities & Capital
Cash P 25,000 Accounts Payable. P 240,000
Accounts Receivable (net) 75,000 Loan Payable to Empoy 30,000
Inventory 100,000 Estoy, Capital 120,000
Plant and Equipment (net) 300,000 Empoy, Capital 50,000
Eloy, Capital 60,000
P500,000 P500,000
Additional Information
1. The personal assets (excluding partnership capital and loan interest) and personal liabilities
of the partners as of December 31, 2014 are as follows:
Instructions :
1. Prepare a statement of liquidation.
2. Prepare the journal entries to record the liquidation of the partnership.
3. Prepare a schedule showing hoe the partners' personal assets are to be distributed.
443
Problem B
The partners of the 3E Partnership have decide to liquidate their partnership. The partnership
statement of financial position just prior to liquidation is presented below :
The other assets include a note receivable from Escobar in the amount of P75,000. The liabilities
include a note payable to Elloso of P40,000 and a note payable to Echaves of P60,000. The
partners share profits and losses in the ratio of 2:2:1, respectively.
Instructions :
5. Determine the amount of cash each partner will receive for each of the following independent
assumptions:
a. The other assets are sold for P300,000 and all the partners are solvent.
b. The other assets are sold for P270,000 and Escobar is insolvent. Escobar's net
worth, exclusiveof his interest in the partnership, is P4,000.
c. The other assets are sold for P270,000 and P24,875 pf liquidation expenses are
paid. Escobar is insolvent.
2) If the partners receive an offer of P140,000 for the business, exclusive of the cash, would they
be better off accepting the offer or liquidating under the condition in 1a above?
CHAPTER 7
INSTALLMENT LIQUIDATION
LEARNING OBJECTIVES
1. Explain the nature of installment liquidation.
444
2. Discuss and understand the procedures followed under installment liquidation.
3. Prepare a Statement of Liquidation and the Accompanying Schedule Showing How
Available Cash is to be Distributed.
4. Prepare a Cash Priority Program.
Installment Liquidation
Procedures
Realization of assets on a
piece-meal basis.
Distribution of gain or loss
on realization.
Preparation of cash distribution
schedule.
Distribution of available cash.
Statement of
Liquidation
Schedule to accompany the
Statement of Liquidation.
Cash Priority Program
Loss absorption capacity.
Cash allocation.
Under the installment liquidation, non-cash assets are sold on a piece-meal basis over an
extended period of time. Cash realized is immediately distributed to partners after fully satisfying
creditors' claims or after setting aside sufficient cash for these liabilities. In as much as cash
distributions are made before realizing non-cash assets and the total gain or loss on realization is
not yet determined, it is necessary that each cash distribution to partners be considered as if it
were the last. Remaining unsold assets, therefore, must be trusted d as a complete loss, assuming
that nothing is realized on them. Also, debit balances in capital and potential capital deficiencies
are assumed uncollectible. In this sense, partners' interests are reduced by cash distributions to a
balance proportionate to the partners' profit and loss ratios. Succeeding cash distributions are
then based on the profit and loss ratio.
The liquidation procedures shall be the same in lump sum liquidation except that:
18. Cash is distributed to partners even before fully realizing non-cash assers and
determining total gain or loss on realization.
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19. Restricted interest, in the Acxompanying Schedule to Determine Amounts to be Paid to
Partners, shall consist of:
20. Remaining unsold assets.
21. Cash withheld (for possible expenses)
22. Debit balances in capital
Illustrative Problem A:
The statement of financial position of the partnership of Arias, Buendia and Caras on December
31,2014, when the partners decide to liquidate follows:
Assets
Cash P200,000
Other Assets 500,000
Total Assets P700,000
Liabilities and Capital
Liabilities P250,000
Arias, Loan 70,000
Arias, Capital (30%) 200,000
Buendia, Capital (40%) 30,000
Caras, Capital (30%) 150,000
Total Liabilities and Capital P700,000
Cash is realized on the other assets as follows, and amounts realized are distributed at the end of
each month to the appropriate parties.
Fiscal Year 2015 Asset Book Value Cash Proceeds
January P300,000 P260,000
February 200,000 230,000
Instructions:
1. Prepare a statement of liquidation to summarize the course of liquidation. Provide
schedules in support of monthly distributions.
2. Prepare the journal entries to record the liquidation
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Arias, Buendia and Caras Partnership
Schedule to Accompany Statement of Liquidation
Amounts to be Paid to Partners
January 31,2015
Based on the schedule, the January layments to partners shall be made to partner Arias and Caras
which shall apply first on the loan and then on capital.
Journal entries to record the liquidation:
Liabilities 250,000
Cash 250,000
Payment to liabilities.
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Arias, Capital 9,000
Buendia, Capital 12,000
Caras, Capital 9,000
Sale of assets and distribution of gain.
Partners may desire to determine in advance as to whom cash distribution shall be made as cash
may become available. This procedure requires the preparation of the program called Cash
priority program, Cash Predistribution Plan or Program of Priorities. The program is prepared
prior to Liquidation, that is, before cash becomes available for distribution. Cash realized on
other assets is distributed based on the program without the need for the preparation of the
schedule previously used to accompany the statement of liquidation. The steps in the preparation
of the program are the following;
1. Determine total partners interest; that is, capital balances before liquidation plus loans
by partners to the partnership less advances by the partnership to the partners.
2. Divide total partners' interest by their profit and loss ratio to get each partners loss
absorption capacity. The loss absorption capacity is the maximum amount of loss that a
partner may absorb and may eliminate any partner in any cash distribution. A partner,
therefore, with the highest loss absorption balance has the first priority on cash
distribution.
3. Once the loss absorption balances are determined, allocation may now be made,
starting with allocation I wherein the highest loss absorption balance is reduced to the
next highest. Each reduction in the loss absorption balance requires payment to
partners computed by multiplying the amount of reduction by the partners’ profit and
loss ratio.
4. After partners loss absorption balances are made equal, cash distributions are made in
the profit and loss ratio.
Using the same information for the partnership of Arias, Buendia and Caras, the cash priority
program follows:
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A summary of the information provided by the cash priority program follows:
Installment Distribution
January 31,2015
Amount Arias Buendia Caras
Cash available P210, 000
Allocation I - Payable to Arias 120,000 P120, 000
Allocation II - Payable to Arias and
Caras, 30:30 P 90,000 45,000 45,000
P165, 000 - P45, 000
Installment Distribution
February 28,2015
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Buendia and Caras, 30:40:30 P 65,000 19,500 26,000 19,500
P102, 000 P26, 000 P102, 000
Key points. The same amount of cash distributions per accompanying schedule to the statement
of liquidation were arrived at in January and February. Also, when cash available for distribution
is not sufficient to cover an allocation, th partners share such insufficient cash on the basis of
their profit and loss ratio.
There may be instances wherein the gain or loss related to the sale of individual assets during the
course of liquidation is difficult to determine. On such cases, no gain or loss is recognized on
realization and cash is recorded equal in amount to the book value of the assets sold. The total
gain or loss on realization is recognized in the final realization of assets and it is the difference
between the cash realized and the book value of the remaining assets sold. Such gain or loss is
then carried to capital.
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realized is immediately distributed to creditors and partners even if there are still unsold
non-cash assets.
2. Discuss and understand the procedures followed under installment liquidation. The
procedures under installment liquidation are basically the same as those under lump-sum
liquidation except that cash is distributed to creditors and partners as it becomes
available. However, every time cash is distributed to partners, it is considered as if it were
the last so as to avoid any overpayment to any of the partners.
3. Prepare a Statement of Liquidation and Accompanying Schedule Showing How
Available Cash is to be Distributed. The statement of liquidation is basically similar to
the one prepared under lump-sum liquidation except that it covers a longer period of
time. In addition, an accompanying schedule is prepared every time cash is distributed.
Such schedule shows how available cash is to be distributed to partners.
4. Prepare a Cash Priority Program. A cash priority program is a program prepared prior
to liquidation so that partners may determine in advance as to whom cash shall be paid as
it becomes available. The preparation of the cash priority program follows these steps: (1)
determining total partners' interests; (2) determining partners' loss absorption capacity;
(3) determining allocation of cash as it becomes available. When a cash priority program
is prepared, a schedule accompanying the statement of liquidation need not be prepared.
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DISCUSSION QUESTIONS
EXERCISES
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Exercise 7-1 (Distribution of Cash)
Aguilar and Bernardo share earnings in a 60:40 ratio. They have decided to liquidate their
partnership. A portion of the assets has been sold but other assets with a carrying amount of
P84,000 still must be realized. All liabilities have been paid, and cash of P40,000 is available for
distribution to partners. The capital accounts show balances of P80,000 for Aguilar and P44,000
for Bernardo.
Instructions: Determine how should the cash P40,000 be divided.
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Instructions:
1. Prepare a schedule showing how available cash will be distributed to partners as it becomes
available.
2. How much must the partnership realize om the sale of its assets if Hlili is to receive P10,000
as final settlement?
3. If Halili is personally insolvent and Ibanez receives a total of P1,800 in final liquidation of the
firm, what was the partnership loss on liquidation?
Instructions:
1. Prepare a cash priority program.
2. Prepare a statement of liquidation.
3. Prepare the necessary journal entries to record the liquidation process.
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PROBLEMS
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partner in each distribution. Assume that Orbos made the distribution in such manner that
overpayment to any partner was avoided.
Instructions:
1. Prepare the journal entries to record the liquidation of the partnership.
2. Prepare a statement of liquidation with supporting schedules of cash distributions to partners.
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Loan balances 45,000 30,000 13,000
Assets are sold and cash is distributed to partners in monthly installments during the course of
liquidation as follows:
January P 15,000
February 40,000
March 90,000
April 30,000
Instructions:
1. Prepare a program to show how cash should be distributed during the entire course of
liquidation.
2. Using the program developed in (1), prepare schedules summarizing the payments to be made
to partners at the end of each month.
3. Prepare a statement of liquidation to summarize the course of liquidation.
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160,500 160,500
Instructions: Prepare a cash distribution schedule as of June 30, 2014, showing how the
P100,000 would be distributed as it becomes available.
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Drawings
Balances, December 31
2014:
Invesment of Susan
MULTIPLE CHOICE
MC 7-1 The Following statement of financial position was prepared for the Elaine, Flor and
Gina Partnership on March 31, 2014:
Cash P 25,000 Liabilities P 52,000
Other Assets 180,000 Elaine, Capital (40%) 40,000
Flor, Capital (40%0 65,000
Gina, Capital (20%) 48,000
The partnership is being liquidated by the sale of assets in installments. The first sale of non-cash
assets having a book value of P90,000 realizes P50,000. The amount of cash each partner should
receive in the first installment is:
Elaine Flor Gina
a. P0 P5,000 P18,000
b. P12,000 P13,000 P22,000
c. P27,000 P 5,000 P18,000
d. P24,000 P49,000 P40,000
MC 7-3 Using the information in MC7-1 and assuming that each partner properly received the
same amount of cash in the distribution after the second sale of assets. The cash to be distributed
amounts to P14,000 from the third sale of assets, and unsold assets with a P6,000 book value
remain. How should the P14,000 be distributed to Elaine, Flor and Gina respectively?
MC 7-4 Aguas, Bernal and Coral are partners. On January 3, 2014, their capital balances and
profit and loss ration are as follows:
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Coral withdrew P10,000 during the year. Net loss on December 31, 2014 totaled P20,000.
Hence, the partners decided to liquidate the partnership. It is uncertain how much of the assets
will ultimately yield but favorable realization is expected. It is, therefore, agreed to distribute
cash as it becomes available. There are unpaid liabilities of P5,000 and cash on hand P7,000.
MC 7-5 Using the information in MC 7-4, the amount to be realized by the partnership on the
sale of its assets so that Aguas will receive a total of P19,000 in the final settlement of his
interest is:
a. P 6,000 c. P103,300
b. P 9,300 d. P119,300
MC 7-6 Using the information in MC 7-4 and assuming Coral received a total of P33,000, the
amount that Bernal would have received at this point is:
a. None c. P 5,000
b. P 2,000 d. P21,000
MC 7-7 The PAL Partnership is being dissolved. All liabilities have been paid and the
remaining assets are being realized gradually. The equity of the partners is as follows;
The second cash payment to any partner/partners under program of priorities shall be made thus:
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P300,000 P300,000
Profits and loss ratio is 3:2:1 for Dalmacio, Damian, and Davide,
respectively. Other assets were realized as follows:
Date Cash received Book Value
January, 2015 P60,000 P90,000
The partners decide to liquidate the partnership. They estimate the nom-cash assets other than the
loan to Fojas can be converted into P500,000 cash over the two-month period ending December
31, 2014. Cash is to be distributed to the appropriate parties as it becomes available during the
liquidation process. The partner most vulnerable to partnership losses on liquidation is
a. Felix b. Fojas c. Felix and Fojas only d. Fajardo
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MC7-12 Using the information in MC 7-11 and assuming that P325,000 is available for the first
distribution, is should be paid to
Priority creditors Felix Fojas Fajardo
a. P300,000 P25,000 0 0
b. P300,000 P7,500 P12,500 P5,000
c. P250,000 P25,000 0 P50,000
d. P250,000 P60,000 0 P15,000
MC7-13 Using the information in MC 7-11 and assuming that a total amount of P37,500 Is
available for distribution to partners after all non-partner liabilities are paid, it should be paid as
follows
Felix Fojas Fajardo
a. P37,500 0 0
b. 0 P18,750 P18,750
c. P11,250 P18,750 P7,500
d. P12,500 P12,500 P12,500
MC7-14 Using the information in MC 7-11 and assuming that partner Felix received a total of
P180,000 how much must have been received by partner Fojas?
a. P0
b. P30,000
c. P50,000
d. P180,000
MC7-15 Using the information in MC 7-11 and assuming that partner Fojas received a total of
P180,000 how much must have been received by partner Fajardo?
a. P75,000
b. P147,000
c. P180,000
d. P255,000
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Test Material No.25 Rating______
Name:_________________________ Date:__________________________
Year & Section:__________________ Prof.:__________________________
MATCHING TYPE
Choices:
a. Cash Priority Program h. Partner's capital deficiency
b. Claims of Partner's personal creditors i. Partner's loss absorption capacity
c. Claims of partnership creditors j. Priority of claims
d. Dissolution k. Profit and loss ratio
e. Installment liquidation l. Right of offset
f. Liquidation m. Safe payment to partners
g. Lump-sum liquidation n. Statement of Liquidation
Instructions: Write the letter of the best answer.
____1. A liquidation in which cash is periodically distributed to partners during the liquidation
process.
____2. The sale of the partnership assets, payment of the partnership creditors, and the
distribution of remaining cash to the partners.
____3. They have priority over the claims of partnership creditors to the personal assets of
partner
____4. It presents, in working paper from, the effects of the liquidation process on the statement
of financial position accounts of the partnership.
____5. A schedule that shows how cash is to be distributed as it becomes available during the
liquidation process.
____6. The end of the normal business function of the partnership.
____7. A liquidation in which all assets are first converted into cash over a short period before
any payment is made to the creditors and to the partners.
____8. Allocated to the partners in their profit and loss sharing ratio if a deficient partner is
insolvent.
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________9. Represent cash payments to partners which are computed on the assumption that
nothing will be realized on the remaining non-cash assets.
________10. A deficit in Garcia’s capital account is reduced to zero because the partnership has
a loan payable to Partner Garcia.
________11. It is computed by dividing the sum of a partner’s capital and loan balance by that
partner’s profit and loss sharing ratio.
________12. The order of creditor’s rights against the partnership ‘s assets and the personal
assets of each partner.
________13. A change in the legal relationship among partners.
________14. The manner of distributing available cash once partners’ loss absorption balances
have been brought to equal balances.
________15. Satisfied, upon liquidation, out of available partnership assets and individual
partner’s excess of personal assets over claims of personal creditor.
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Test Material No.26 Rating______
Name:_________________________ Date:__________________________
Year & Section:__________________ Prof.:__________________________
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The firm is dissolved and liquidated by selling assets in installments. If the first sale
on non-cash assets having a book value of P180,000 realizes P100,000 and all cash
available after settlement with creditors is distributed, the respective partners would
receive (rounded to the nearest peso)
Abril Suarez Custodio
a. P16,000 P16,000 P8,000
b. 12,333 12,333 12,334
c. -0- 26,667 12,333
d. -0- 6,000 34,000
5. Using the same information in No. 4 except that P6,000 cash is to be withheld, the
respective partners would the receive (rounded to the nearest peso)
Abril Suarez Custodio
a. P13,600 P13,600 P6,800
b. 11,333 11,333 11,334
c. -0- 26,667 11,333
d. -0- 2,000 32,000
6. Using the same information in No. 4 and assuming that each partner properly
received some cash in the distribution after the second sale, unsold assets with
P16,000 book value remain the respective partners would receive
Abril Suarez Custodio
a. P9,600 P9,600 P4,800
b. P8,000 P8,000 P8,000
c. 37/150 of P24,000 65/150 of P24,000 48/150 of P24,000
d. -0- P16,000 P8,000
7. Partners Donato, Munoz, and Torres, who share profit losses in the ratio of 3:5:2,
respectively, have decided to liquidate their partnership. At the time of liquidation,
the statement of financial position of the partnership consisted of the following
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The partners decide to prepare a cash priority program showing how much would be
distributed to partners as asset are realized. In the cash priority program, the loss
absorption capacity of each partner would be
a. Donato – P240, 000 Munoz – P160,000 Torres – P430,000
b. Donato – P200,000 Munoz – P400,000 Torres – P150,000
c. Donato – P300,000 Munoz – P350,000 Torres – P250,000
d. Donato – P240, 000 Munoz – P200,000 Torres – P430,000
8. Based on the information in No. 7 the schedule of possible losses on capital balances
would indicate that the first cash distribution, after the payment of the outside
creditors, would be distributed to and in the amount of
a. Donato in the amount of P32,000
b. Munoz in the amount of P40,000
c. Torres in the amount of P38,000
d. Torres in the amount of P20,000
9. Using the information in No. 7and assuming the first sale of assets with a book value
of P 100,000 realized P30,000 and all available cash is distributed, respective
partners would receive
a. Donato – P-0-; Munoz – P12,000; Torres – P36,000
b. Donato – P6,000; Munoz – P-0-; Torres – P42,000
c. Donato – P16,000; Munoz – P16,000; Torres – P16,000
d. Donato – P42,000; Munoz – P-0-; Torres – P6,000
10. Using the information in No.7 and No. 9 and assuming the second sale of other assets
with a book value of P60,000 realized P80,000 and all available cash is distributed,
the respective partners would receive
a. Donato – P27,000; Munoz – P35,000; Torres – P18,000
b. Donato – P12,000; Munoz – P-0-; Torres – P8,000
c. Donato – P6,000; Munoz – P10,000; Torres – P8,000
d. Donato – P42,000; Munoz – P-0-; Torres – P4,000
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Test Material No.27 Rating______
Name:_________________________ Date:__________________________
Year & Section:__________________ Prof.:__________________________
PROBLEM
The partners of ASC partnership feel that it is no longer financially feasible continue operations
and have agreed to liquidate a partnership. The statement of financial position on June 30, 2014,
just prior to the start of liquidation is presented below. Partners Alfonso, Santos and Censon
share profit and loss in the ratio of 5:3:2, respectively.
2. If the first sale of non-cash assets with a book value of P400,000 realizes P230,000 and
available cash is distributed, determine the account of cash to be distributed to each
partner.
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Chapter 8
Organization and Formation of a Corporation
LEARNING OBJECTIVES
CORPORATION
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DEFINITION OF A CORPORATION
A corporation is an artificial being created by operation of law, having the right of succession
and the powers attributes and properties expressly authorized by law or incident to is existence.
(Section 1, Corporate Code of the Philippines)
CHARACTERSTICS OF A CORPORATION
1. Separate legal entity - artificial being. A corporation is an artificial being with a
personality that is separate from that of its individual owners. Thus, it may, under its
corporate name, take, hold, or convey property to the extent allowed by law, enter into
contracts and sue or be sued
2. Created by operation of law. A corporation is generally created by operation of law.
The mirror agreement of the parties cannot give rise to a corporation.
3. Right of succession. A corporation has the right of succession. Irrespective of the death,
withdrawal, insolvency, or incapacity of the individual members or shareholders, and
regardless of the transfer of their interest or share capital, a corporation can continue its
existence up to the period of time stated in the articles of incorporation but not to exceed
fifty years.
4. Powers, attributes, properties authorized by law. The corporation has only the powers,
attributes, and properties expressly authorized by law or incident to its existence. Being a
mere creation of law, a corporation can only exercise powers provided by law and those
powers which are incidental to its existence.
5. Ownership divided into shares. Proprietorship in a corporation is divided into units
known as share capital. The buyers of the share capital are called shareholders or
stockholders and are considered owners of the business
6. Board of directors. Management of the business is vested in a board of directors elected
by shareholders. Board of directors is the governing body or decision making body of the
corporation. The Corporation Law provides that the number of directors be not less than
five but not more than fifteen.
ADVANTAGES OF A CORPORATION
1. The corporation enjoys continuous existence because of its power of succession.
2. The corporation has the ability to obtain a strong credit line because of continuity of
existence.
3. Large scale business undertakings are made possible because many individuals can invest
their funds in their enterprise.
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4. The liability of its investors or shareholders is limited to the extent of their investment in the
corporation.
5. The transfer of shares can be effected without the need for prior consent of other shareholders.
6. Its smooth operation is guaranteed because of centralized management.
DISADVANTAGES OF A CORPORATION
1. It is not easy to organize because of complicated legal requirements and high costs in its
organization.
2. The limited liability of its shareholders may weaken its credit capacity.
3. It is subject to rigid governmental control.
4. It is subject to more taxes.
5. Its centralized management restricts a more active participation by shareholders in the
conduct of corporate affairs.
CLASSES OF CORPORATION
Corporations are generally classified according to purpose, membership holdings, compliance of
law, law of creation, extent of membership or other basis of classification. Generally, profit-
oriented corporations are open, private and stock corporations. Nonprofit corporations are public
and private non-stock corporations.
The following is a list of the common classes of corporation:
1. As to Membership Holdings
a. Stock Corporation – a private corporation in which the capital is divided into shares
of stock and is authorized to distribute corporate earnings to holders on the basis of
shares held. The owners of stock corporations are called stockholders or shareholders.
b. Non-stock Corporation – a private corporation in which capital comes from fees paid
by individuals composing it. The owners of a non-stock corporation are called
members.
2. As to Purpose
a. Public Corporation – a corporation that is organized to govern a portion of the state
(e.g. municipalities, provinces)
b. Private Corporation – a corporation that is organized for a private benefit, aim or end.
c. Quasi-public Corporation – a private corporation which is given a franchise to
perform functions of a public character. Classified under this type are the so called
public utility corporations such as MERALCO OR PLDT.
3. As to Compliance of Law
a. De jure corporation – a corporation which exists in both law and fact. It exists in law
because it has complied with all the legal requirements; it exists in fact because it
actually operates as a corporation.
b. De facto corporation – a corporation which exists only in fact but not in law. It does
not exist in law because of non-compliance with certain legal requirements.
4. As to Law of Creation
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a. Domestic Corporation – a corporation that is organized under Philippine laws.
b. Foreign Corporation – a corporation that is organized under the laws of other
countries.
5. As to Extent of Membership
a. Open Corporation – a corporation whose ownership is widely held by many investors,
usually a private stock corporation.
b. Closely-held Corporation or Family Corporation – a private corporation in which
50% or more of its stock is owned by five (5) persons or less.
COMPONENTS OF A CORPORATION
1. Incorporators – they are the persons who originally formed the corporation and whose
names appear in the Articles of Incorporation. They must be natural persons as
distinguished from artificial persons.
2. Corporators – they are the persons who compose the corporation whether as shareholders
or members.
3. Stockholders or shareholders – they are the corporators of a stock corporation.
4. Members – they are the corporators of a non-stock corporation.
5. Promoters – they are the persons who undertake to (a) form a company based on a given
project, (b) set it going, and (c) take the necessary steps to accomplish the purpose for
which the corporation is organized.
6. Subscribers – they are the persons who have agreed to take original, unissued shares but
will pay at a later date. They may be incorporaters or not and they may eventually
become shareholders the moment full payment of their subscriptions is made.
7. Underwriters – they are those who undertake to dispose of the shares to the general
public.
ORGANIZING A CORPORATION
The process of organizing a corporation generally consists of three stages which normally
require the aid of legal, competent advisers. These three stages are discussed below:
1. Promotion – the incorporators make preliminary arrangements to set up a tentative
working organization and to solicit subscriptions to raise sufficient capital for the
business.
2. Incorporation – the process of formalizing the organization of the corporation. This stage
includes:
a. Drafting of the articles of incorporation which must be duly executed and
acknowledged before a notary-public.
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b. Filing of the articles of incorporation with the Securities and Exchange Commission
(SEC) together with the statement showing that at least 25% of the total authorized
share capital (also known as authorized capital stock) has been subscribed and that at
least 25% of the total subscriptions have been paid.
c. After the required fees have been paid and upon approval of the articles of
incorporation, the SEC issues a certificate of incorporation, the date of which being
considered as the date of registration or incorporation.
3. Commencement of the business – the business should start its operations within two
years from the date of incorporation. Failure to do so will automatically dissolve the
corporation without the need for a hearing.
Costs incurred during incorporation, such as filing fees, cost of printing stock certificates,
promoters’ commission and legal fees, are known as organization costs or pre-operating costs.
Under PAS 38 Intangible Assets, organization or pre-operating costs are changed to expense in
the period incurred.
ARTICLES OF INCORPORATION
The Articles of Incorporation enumerate the powers and limitations conferred upon the
corporation by the government. It includes the following information:
1. The name of the corporation;
2. The purpose or purposes for which the corporation is formed;
3. The place of the principal office of the corporation;
4. The term of existence of the corporation, not exceeding fifty years;
5. The names, nationalities, and addresses of the incorporators;
6. The names of the directors who will serve until their successors are duly elected and
qualified in accordance with the by-laws;
7. The authorized share capital (authorized capital stock), the classes of share capital
(stocks) to be issued, and the number of shares and terms of each class indicating the per
value per share, if there is any;
8. The amount of subscriptions to the share capital (capital stock), the names of the
subscribers and the number of shares subscribed by each; and
9. The total amount paid on the subscriptions to the share capital (capital stock) and the
amount paid by each subscriber on his subscription.
BY LAWS
The by-laws of the corporation supplement the articles of incorporation. It contains provisions
for the internal administration of the corporation. The corporate by-laws normally include the
following:
1. The date, place and manner of calling the annual shareholders’ (stockholders’) meeting;
2. The manner of conducting meetings;
3. The circumstances which may permit the calling of special meeting of the shareholders;
4. The manner of voting and the use of proxies;
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5. The manner of electing the directors and number of directors;
6. The term of office of the directors;
7. The authority and duties of the directors;
8. The manner of selecting the corporate officers;
9. The authority and responsibilities of the officers;
10. The procedure for amending the articles of incorporation; and
11. The procedure for amending the by-laws.
CORPORATE RECORDS
The corporation generally maintains the following records to keep track of its various
transactions:
1. Record of all business transactions (journals, ledgers, vouchers, and other supporting
documents).
2. Minutes of all meetings of directors.
3. Minutes of all meetings of shareholders (stockholders).
4. Stock and transfer book
a. Shareholders’ (stockholders’) journal – chronological and numerical record of stock
certificates issued.
b. Shareholders’ (stockholders’) ledger – alphabetical record of individual shareholders.
c. Subscribers’ ledger – alphabetical record of individual subscribers.
5. Optional and supplementary records.
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2. To share in the distribution of assets upon corporate liquidation;
3. To vote in shareholders’ meeting; and
4. To maintain one’s ownership interest in the corporation through purchase of additional
shares when a new share capital is issued. This is known as the preemptive right.
If a corporation issues both preference and ordinary share capital, the articles of incorporation or
the corporate by-laws should state the special features of each class of share capital.
Both preference and ordinary share capital may be issued with par, without par but with stated
value, or without par and without stated value.
A par value share capital has a nominal or face value stated in the face of the stock certificate
and in the articles of incorporation.
A no-par but with stated value share capital has a nominal value stated in the articles of
incorporation but not on the face of the stock certificate.
A no-par, no stated value share capital has no nominal value stated either in the articles of
incorporation nor on the face of the stock certificate.
In our Corporation Code, a no-par share capital is to be issued for a consideration of not less than
five pesos. (P5.00)
1. Cumulative preference shares – entitle the holders to the receipt of previous years unpaid
dividends (i.e., dividends in arrears) before any payment can be made to ordinary shareholders
upon dividend declaration. This means that if dividend is not declared in a particular year, the
right to such dividend is not lost but carried forward to a subsequent year.
2. Non-cumulative preference shares – entitle the holders to the receipt of current dividends but
not on the previous years’ unpaid dividends. This means that if dividend is not declared in a
particular year, the right to such dividend is lost.
3. Participating preference shares – entitle the holders to the receipt of additional dividend after
holders of both preference and ordinary shares have been paid up to the current year’s dividend.
This means that the holders of preference shares have the right to share in extra dividends.
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Participating preference shares may be fully participating or participating only up to a certain
amount or percentage.
4. Nonparticipating preference share – entitle the holders to the receipt of dividends up to the
current period only. All extra dividends are given to holders of ordinary shares.
5. Convertible preference shares – entitle the holders the option to exchange the shares for some
other securities of the issuing corporation, normally ordinary shares.
6. Redeemable preference shares – entitle the issuing corporation the option to reddem or call the
shares at a certain call price.
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Authorized XXX Share Capital xxx
The total amount recorded is computed by multiplying authorized shares by the par or the stated
value of the share capital. Thus, this method cannot be used if the the share capital is a no-par
and no-stated value stock.
The entry to record authorized share capital is made in the general journal and is then posted to
the share capital account in the general ledger. If more than one class of these capitals are issued,
a separate entry is made for each class of share capital and a separate account for each class is
maintained in the general ledger.
The memorandum entry method enjoys popularity in use compared with the journal entry
method. For problem solving purposes, the memorandum entry method will be used if there is no
specification as to which method will be used.
Illustrative Problem A: The Joyful Company was organized on January 1, 2014 will be
authorized share capital as follows:
10,000 shares of 10% preference share capital with a par value of P100 per share.
200,000 shares of ordinary share capital with a par value of P10 per share.
The entries to record authorized share capital and the subsequent posting to the general ledger
under each method are illustrated below:
478
Jan. 1 Unissued Preference Share Capital 1,000,000
Authorized Preference Share Capital 1,000,000
These entries are then posted to the accounts in the general ledger as follows:
Posting to the accounts in the general ledger is very important so that the corporation will be able
to monitor shares issued and avoid the issuance of shares more than what is authorized.
479
ISSUANCE OF PAR VALUE SHARE
As discussed earlier, a par value share has a nominal value stated on the face of the stock
certificate. The following rules shall apply in the issuance of this class of share capital.
ISSUANCE FOR CASH. A share capital may be issued for cash equal to its par value, above par
value, or below par value. If cash received is equal to its par value, Cash is debited and Share
Capital or Unissued Share Capital is credited.
If the share capital is sold or issued above its par value, Cash is debited for the amount received,
Share Capital or Unissued Share Capital is credited at par value, and Share Premium or Paid-in
Capital in Excess of Par is credited for the excess of cash received over par value.
If the share capital is sold or issued below its par value, Cash is debited for the amount received,
share Capital or Unissued Share Capital is credited at par value, and Discount on share capital is
debited for the excess of par value over the amount of cash received Under the Corporation Code
of the Philippines, however, the original issuance of that capital at a discount is not allowed.
Therefore, problems involving discounts are used in the book for illustration purposes only.
Illustrative Problem B: The Happy Corporation was organized on January 1, 2014 and is
authorized to issue 10,000 shares of P10 par value ordinary shares. Subsequently, 25,000 shares
were sold.
The entries to record the sale of shares under the two methods of recording share capital using
three independent cases are presented below and on the next page.
Cash 250,000
Ordinary Share Capital 250,000
25,000 sh x P10 = P250,000
480
Cash 375,000
Ordinary Share Capital 250,000
Ordinary Share Premium 125,000
25,000 sh x P15 = P375,000
25,000 sh x P10 = P250,000
25,000 sh x P 5 = P125,000
481
Case 3 - The issuance price is P8 (below par)
Cash 200,000
Cash 250,000
Cash 375,000
Cash 200,000
482
It should be noted that the basic difference between the memorandum entry method and the
journal entry method is the account to be credited upon issuance of the share capital.
Under the memorandum entry method, the Share Capital account is credited upon issuance of
the stock. The balance of this account represents the amount of capital stock or share capital
issued to shareholders.
Under the journal entry method, the Unissued Share Capital account is credited upon issuance
of the share capital thereby reducing the balance of this account. The balance of this account
represents the amount of authorized share capital not yet issued and is deducted from the balance
of Authorized Share Capital account to determine the amount of share capital already issued to
shareholders.
Upon issuance of the stock, Share Capital or Unissued Share Capital is credited at par value. The
excess of the value assigned to the asset received over the par value of the stock issued is
credited to Share Premium or Additional Paid-in Capital, or Share Capital in Excess of Par. To
reiterate, original issuance of share capital at less than its par value is prohibited under our
Corporation Code.
In some instances, the value assigned to the asset received is overstated or understand. When the
value assigned to the asset received in exchange for share capital is overstated, the share capital
issued is called watered share capital. The overstatement is done to comply with the requirement
of the law that the share capital should not be issued at less than its par value. When the value of
the asset received is understated, the share capital is said to contain secret reserves.
Illustrative Problem C: The Happy Corporation issued 10,000 shares of its P10 par ordinary
share capital in exchange for land. The entries to record the issuance of the share capital under
the memorandum entry method using three independent cases are given on below and on the
next page.
Case 1 - The land has a fair value of P175,000.
Land 175,000
Ordinary Share Capital 100,000
483
Ordinary Share Premium 75,000
10,000 sh x P10 = P 100,000
P175,000 - P100,000 = P 75,000
Case 2 - The land has no known market value. The fair value of ordinary share capital on the
date of exchange is P15.
Land 150,000
Ordinary Share Capital 100,000
Ordinary Share Premium 50,000
If the journal entry method is used instead of the memorandum entry method, Unissued Ordinary
Share Capital should have been credited instead of Ordinary Share Capital.
If the shares are issued for services rendered during incorporation, Pre-Operating Expenses is
debited, Share Capital or Unissued Share Capital is credited at par value; Share Capital in Excess
of Par, or Additional Paid-in Capital or Share Premium is credited for any excess of the value
assigned to pre-operating expenses and the par value of the share capital.
Illustrative Problem D: The Happy Corporation issued 1,000 shares of P10 par ordinary share
capital in payment for the services of the lawyer rendered during incorporation.
484
Ordinary Share Capital 10,000
Ordinary Share Premium 5,000
1,000 sh x P15 = P 15,000
Sale of share capital on a subscription basis generally involves three major transactions – (1)
receipt of subscription, (2) collection from subscribers, and (3) issuance of stock certificate upon
full payment of subscription. Entries required for these transactions are given below.
It should be noted that the Share Capital Subscribed account is always credited at par value,
regardless of the subscription price.
Cash xxx
Share Capital Subscription Receivable xxx
485
3. To record issuance of stock certificate upon full payment of subscription.
Illustrative Problem E: On June 3, 2014, the Happy Corporation received subscription for
5.000 shares of its P10 par value ordinary share capital at P15. A down payment of 25% was
received and the balance was paid in full on July 4, 2014. The entries to record these transactions
using the memorandum entry method are presented on the next page.
2014
Cash 18,750
486
Ordinary Share Premium 25,000
A share capital without par value but with a stated value has a nominal value stated in the articles
of incorporation but not on the face of the stock certificate.
The same rules discussed in the issuance of share capital with a par value are applicable. The
account Share Capital in Excess of Stated Value may be used instead of the account Share
Premium or Share Capital in Excess of Par.
ISSUANCE FOR CASH. A share capital may be sold for cash at its stated value, at more than
stated value, or at less than stated value. If cash received is equal to stated value, Cash is debited
and Share Capital or Unissued Share Capital is credited.
If the share capital is sold or issued at more than its stated value, Cash is debited for the amount
received, Share Capital or Unissued Share Capital is credited at stated value, and Paid-in Capital
in Excess of Stated Value is credited for the excess of cash received over stated value.
If the share capital is sold or issued at less than its stated value, Cash is debited for the amount
received. Share Capital or Unissued Share Capital is credited at stated value, and Discount on
Share Capital is debited for the excess of stated value over the amount of Cash received. Under
the Corporation Code of the Philippines, however, the original issuance of share capital at a
discount is not allowed. Therefore, problems in counts are used in the book for illustration
purposes only.
Illustrative Problem F: The Happy Corporation was organized on January 1, 2014 and is
authorized to issue 100,000 shares of P10 stated value ordinary share capital. Subsequently,
25,000 shares were sold.
The entries to record the sale of share capital under the memorandum entry meth recording share
capital using three independent cases are as follows:
Cash 250,000
Ordinary Share Capital 250,000
25,000 sh x P10 = P250,000
487
Case 2 – The issuance price is P15 (above stated value)
Cash 375,000
Ordinary Share Capital 250,000
Ordinary Share Capital in Excess of Stated Value 125,000
25,000 sh x P15 = P375,000
25,000 sh x P10 = P250,000
25,000 sh x P 5 = P125,000
Case 3 – The issuance price is P8 (below stated value)
Cash 200,000
Discount on Ordinary Share Capital 50,000
Ordinary Share Capital 250,000
25,000 sh x P 8 = P200,000
25,000 sh x P10 = P250,000
25,000 sh x P 2 = P 50,000
If the journal entry method is used instead of the memorandum entry method, Unissued Share
Capital will be credited instead of Ordinary Share Capital.
Upon issuance of the share capital, Share Capital or Unissued Share Capital is credited at stated
value. The excess of the value assigned to the asset received over the stated value of the share
capital issued is credited to Share Capital in Excess of Stated Value.
Illustrative Problem G: Happy Corporation issued 10,000 shares of its P10 stated value
ordinary share capital in exchange for land. The entries to record the issuance of share capital
under the memorandum entry method using three independent cases are given below:
Land 170,000
Ordinary Share Capital 100,000
488
Ordinary Share Capital in Excess of Stated Value 70,000
10,000 sh x P10 =P 100,000
P175,000 – P100,000 =P 75,000
Case 2 - The land has no known market value. The fair market value of ordinary share capital on
the date of exchange is P15.
Land 150,000
Ordinary Share Capital 100,000
Ordinary Share Capital in Excess of Stated Value 50,000
10,000 sh x P15 = P150,000
10,000 sh x P10 = P100,000
10,000 sh x P 5 =P 50,000
If the journal entry method is used instead of the memorandum entry method, Unissued Ordinary
Share Capital should have been credited instead of Ordinary Share Capital.
If the shares are issued for services rendered during incorporation, Pre-Operating Expense is
debited, Share Capital or Unissued Share Capital is credited at stated value; Share Capital in
Excess of Stated Value or Additional Paid-in Capital is credited for any excess of the value
assigned to pre-operating expenses over the stated value of the share capital.
Illustrative Problem H: The Happy Corporation issued 1,000 shares of P10 stated value
ordinary share capital in payment for the services of the lawyer rendered during incorporation.
489
Ordinary Share Capital in Excess of Stated Value 15,000
1,000 sh x P10 = P 10,000
P25,000 - P10,000 = P 15,000
Case 2 – There is no known fair market value for the services of the lawyer. The market value of
the ordinary share capital issued is P15 per share.
SALE OF SHARE CAPITAL ON A SUBSCRIPTION BASIS. The sale of stock with stated
value on a subscription basis is recorded in the same manner as that of a stock with a par value,
except for the account credited for the excess of the subscription price over the stated value of
stock. The account Share Capital in Excess of Stated Value is credited instead of Share Premium,
or Additional Paid-in Capital, or Share Capital in Excess of Par.
Illustrative Problem I: On June 3, 2014, the Happy Corporation received subscription for 5,000
shares of its P10 stated value ordinary share capital at P15. A down payment of 25% was
received and the balance was paid in full on July 4, 2014. The entries to record these transactions
using the memorandum entry method are presented below and on the next page.
2014
June 3 Ordinary Share Capital Subscription Receivable 75,000
Ordinary Share Capital Subscribed 50,000
Ordinary Share Capital in Excess of Stated Value 25,000
5,000 sh x P15 = P 75,000
5,000 sh x P10 = P 50,000
5,000 sh x P 5 = P 25,000
3 Cash 18,750
490
July 4 Cash 56,250
Ordinary Share Capital Subscription Receivable 56,250
P75,000 x 75% = P 56,250
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.
Cash 375,000
Ordinary Share Capital 375,000
25,000 x P15 = P375,000
491
Upon issuance of the shares, Share Capital is credited for the value assigned to the asset received
Illustrative Problem K: The Happy Corporation issued 10,000 shares of its ordinary share
capital in exchange for land. The entries to record the issuance of the share capital under the
memorandum entry method using three independent cases are given on the next under page.
Land 175,000
Ordinary Share Capital 175,000
Case 2 – The land has no known market value. The fair market value of ordinary share capital on
the date of exchange is P15.
Land 150,000
Ordinary Share Capital 150,00
If the share capital has no par and no stated value, only the memorandum entry meth can be used.
If the shares are issued for services rendered during incorporation, Pre-Operating Expenses is
debited and Share Capital or Unissued Share Capital is credited for the value assigned to the
services rendered.
Illustrative Problem L: The Happy Corporation issued 1,000 shares of its ordinary share capital
in payment for the services of the lawyer rendered during incorporation.
Case 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.
492
Ordinary Share Capital 15,000
SALE OF SHARE CAPITAL ON A SUBSCRIPTION BASIS. The sale of no stated value share
capital on a subscription basis is recorded in the same manner as that of share capital with a par
value or with stated value stock, except that the entire subscription price is credited to the Share
Capital account.
493
Illustrative Problem M: On June 3, 2014, the Happy Corporation received subscription for
5,000 shares of its no par, no stated value ordinary share capital at P15. A down payment of 25%
was received and the balance was received and the balance was paid in full on July 4, 2014. The
entries to record these transactions using the memorandum entry method follow:
2014
June 3 Ordinary Share Capital Subscription Receivable 75,000
Ordinary Share Capital Subscribed 75,000
5,000 sh x P15 = P 75,000
3 Cash
Ordinary Share Capital Subscription Receivable 18,750
P75,000 x 25% = P 18,750 18,750
When the share capital issued have no par and have no stated value, only the, memorandum entry
can be used in recording the stock transactions.
SUBSCRIPTION DEFAULTS
When a subscriber fails to pay his obligations after the corporation has sent several notices to
him, his subscribed shares are declared delinquent shares. His subscription is declared delinquent
subscription. Such delinquent subscription is then offered for sale in a public auction and
delinquent shares are issued to the highest bidder. The highest bidder is the one who is willing to
pay the unpaid subscription plus any expense incurred in connection with the delinquency sale
and is willing to receive the lease number of shares
The following entries are made in relation to subscription defaults and issuance of stock
certificates.
a. Upon default
Receivable from Highest Bidder
Share Capital Subscription Receivable
494
b. Costs incurred in connection with the delinquency sale
Receivable from Highest Bidder xxx
Cash xxx
All subscribed shares are issued. Shares are first given to the highest bidder. The excess, if any,
are given to the defaulting subscriber.
If there is no bidder, all of the delinquent shares will be issued in the name of the corporation.
Such shares are considered treasury shares and the following entries will be made, after making
the entries (a) and (b) above.
Illustrative Problem N: On June 15, 2014, the Happy Corporation received subscription for
2,000 shares of its P10 par value ordinary share capital at P15. A down payment 60% was
received. The final payment was due on August 15, 2014, although several notices were sent to
the subscriber, no payment has been received. On August 31 subscription was declared
delinquent and was offered for sale in a public auction On September 6, expenses of P500 were
incurred in connection with the delinquency sale. On September 21, payment was received from
the highest bidder and shares were issued -1,500 to the highest bidder and 500 to the defaulting
subscriber.
The entries to record the foregoing transactions using the memorandum entry method follow:
2014
June 15 Ordinary Share Capital Subscription Receivable
30,000
Ordinary Share Capital Subscribed 20,000
Ordinary Premium Share 20,000
2,000 sh @ P15 = P30,000
2,000 sh @ P10 = P20,000
2,000 sh @ P5 = P10,000
495
June 15 Cash 18,000
Ordinary Share Capital Subscription Receivable
18,000
P30,000 x 60% = P18,000
21 Cash 12,500
Receivable from Highest Bidder
12,500
496
PFRS 3 prohibits the amortization of goodwill acquired in a combination and requires the
goodwill to be tested for impairment annually, or more frequently, if events instead in
circumstances indicate that the asset might be impaired.
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
If a new set of books is opened for the corporation, the following shall be recorded in the
corporation books:
Entries are also prepared on the partnership books to record the following
497
Illustrative Problem O: Roberto and Remedios are partner sharing profits and losses in the ratio
3:2. They decide to retire from active participation in their business so they form a corporation to
take over the net assets of the partnership. The statement of financial position of the partnership
just prior to incorporation on January 1, 2014 is presented below.
Assets
Cash 45,000
The following adjustments are to be made before taking over the net assets:
The ordinary shares will be distributed as follows: Roberto, 9000 shares; Remedios, 3000 shares.
Cash will be distributed based on the capital balances of the partners after distribution of the
shares. The ordinary share capitals are selling at P15 per share on this date.
498
Assumption 1 – The books of the partnership will be used by the new corporation
Goodwill 20,400
Capital Adjustment Account 20,400
Step 3 Close the balance of Capital Adjustment Account to partners’ capital accounts.
Authorized to issue 100,000 shares of P10 par value ordinary share capital
499
Step 5 Record issuance of share capital to partners
Cash 500,000
Ordinary Share Capital 250,000
Ordinary Share Premium 250,000
25,000 shares x P20 = P500,000
25,000 shares x P10 = P250,000
25,000 shares x P10 = P250,000
Partnership Books
500
Step 2 Recognize goodwill.
Goodwill 20,400
Capital Adjustment Account 20,400
Step 3 Close the balance of Capital Adjustment Account to partner’s capital accounts
Step 4 Record the receipt of share capital from the new corporation
501
NEW CORPORATION’S BOOKS
Step 2 Recognize the issuance of share capital in exchange for the net assets of the
partnership.
Cash 500,000
Ordinary Share Capital 250,000
Ordinary Share Premium 250,000
25,000 shares x P20 = P500,000
25,000 shares x P10 = P250,000
25,000 shares x P10 = P250,000
502
Shareholders; and (6) it has smooth operation because of centralized management. On the
other hand, organizing and operation a corporate type of organization has the following
disadvantages: (1) it is subject to more government control; (2) it is subject to more taxes;
(3) it is costly to organize’ (4) its credit capacity is weakened by the limited liability of
the shareholders; and (5) there is a more restrictive participation by shareholders in the
conduct of corporate affairs because management is vested in the board of directors.
3. Identify and discuss the various classes of corporation. Corporations may be classified
into (1) stock or non-stock corporations: (2) public, private, or quasi-public corporations;
(3) de jure o de facto corporations; (4) domestic or foreign corporations; and (5) open or
closel-held corporations
4. Identify the components of a corporation. A corporation has seven components and these are
the following: (1) incorporators (2) corporators (3) stockholders or shareholders (4) members (5)
promoters (6) subscribers; and (7) underwriters. The process of organizing a corporation is
composed of three stages, namely; (1) promotion; (2) incorporation, Which includes the drafting
of the articles of incorporation and its subsequent tiling with the Securities and Exchange
Commission; and (3) commencement of the business.
5. Identify the different types of records that are maintained by a corporation. To be able
to keep track of the transactions of the corporation, the following records are generally
maintained: journals, ledgers, minutes of meeting of board of directors, minutes of
meeting of shareholders; and stock and transfer book.
6. Identify and differentiate the two classes of share capital that may be issued by a
corporation. Share capital is the amount fixed by the corporate charter to be subscribed
and paid in by the shareholders. Share capital can either be ordinary or preference share
capital. Both ordinary and preference share capita1 can be issued with a par value,
without par but with stated value, or without par and without stated value.
7. Identify the measurement bases in the issuance of share capital in exchange for
various considerations. Share capital may be issued in exchange for (a) mi], (b) non-cash
assets, or (c) services. When a share capital is issued for cash, the share capital is
measured by the amount of cash received. When a share capital is issued in exchange for
non-cash assets, the asset received is recorded at its fair value (also known as direct
measurement), unless the fair value cannot be estimated reliably. If the fair value of the
asset received cannot be Wed reliably, it will be recorded at the fair value of the share
capital issued, also known as indirect measurement (PFRS 2, par. 1 0). When a share
capital is issued in exchange for services rendered, the services received is meted a its fair
value (also known as direct measurement), unless the fair
503
value cannot be estimated reliably. If the fair value of the services received cannot be estimated
reliably, it will be recorded at the fair value of the share capital issued, also known as indirect
measurement (PFRS 2, par. 10).
8. Record transactions relating to issuance of share capital using the memorandum
entry method and the journal entry method. The recording of authorized share capital and
subsequent issuance may be recorded using the memorandum entry method or the journal entry
method. Under the memorandum entry method, the authorized share capital of the corporation is
recorded by means of a memorandum entry indicating the authorized number of shares that may
be issued and the par or stated value of each share or an indication that the shares have no par
and no stated value. Subsequent issuance of the share capital requires a credit to the Share
Capital account. Under the journal entry method, the authorized share capital of the corporation
is recorded by debiting Unissued Share Capital and crediting Authorized Share Capital for the
total par value or stated value of the authorized shares. Subsequent issuance requires a credit to
Unissued Share Capital account. Ordinary or preference shares may be issued in exchange for
cash, for non-cash assets, for services, for extinguishment of liabilities or in exchange for another
form of securities. Share capital may also be issued on a subscription basis. However, when a
subscriber fails to pay his subscription, such subscription becomes delinquent and will be subject
to bidding.
504
Ordinary share capital (common stock) - entitles the holder to an equal or pro-rata division of
profits without any preference or advantage over any class or shares. The shareholders are
often referred to as "residual equity holders" because they obtain what is left after all the
claims of other parties have been met.
Outstanding share capital (outstanding capital stock) - share capital (stock) issued and is in the
possession of a shareholder.
Par value - nominal or face value stated on the face of the share certificate and in the articles
of incorporation.
Preference share capital (preferred stock) -entitles the holder to enjoy priority as to
distribution of dividends and distribution of assets upon corporate liquidation.
Share capital (capital stock) - amount fixed by the corporate charter to be subscribed and paid
in or secured to be paid in by the shareholders.
Stated value - nominal value stated in the articles of incorporation but not on the face of the
stock certificate.
Subscribed shares - share capital sold on a subscription basis that have not yet been paid in full
and for which the related stock certificates have not been issued
505
DISCUSSION QUESTIONS
1. A, B and C are partners operating a small store for years. The partners are considering
the possible incorporation of the partnership. What are the advantages and disadvantages
offered by such a change?
2. Differentiate: (a) stock from non-stock corporation, (b) private from public corporation;
(c) de jure from de facto corporation.
3. What are the stages in organizing a corporation? 4. What are basic rights of a
shareholder?
5. What are the considerations that may be received in exchange for share capital? What
are the measurement bases for such exchanges?
9. The DEF Corporation was organized on October 1, 2013 with authorized ordinary share
capital of 1,000 shares, P5 par value. a. How many shares must be subscribed at the time of
incorporation? b. Assuming that the minimum required subscription was received at P12, how
much subscription must be paid up?
506
EXERCISES
The Integrity Corporation was incorporated on January l, 2014 with authorized capital of
250,000 shares of P100 par value 10% preference share capital and 500,000 shares of P20
stated value ordinary share capital. The shares were issued during 2014 as follows.
Jan 1 Isued for cash 62,500 preference shares at par, and 125,000 ordinary shares for P25
Instructions: Prepare the journal entries to record the foregoing transactions, including the
authorized share capital, assuming the use of:
Exercise 8 -2 (ssuance of Par Value Share Capital for Cash, Services, and Non-cash Assets)
The Honesty Corporation was organized on April I, 2014 with authorized share capital of.
500,000 ordinary shares, par value of P20. Thereafter, the following transactions took place:
25 Issued 5,000 shares for the services rendered by the lawyer during the period of
incorporation. The fair value of such services is P150,000.
Instructions: Prepare joummal entries to record authorized share capital and the subsequent
ransactions assuming the corporation uses the:
507
Exercise 8-3 (issuance of Various Classes of Share Capital for Cash)
The security corp. Was organized on May 1,2014 and is authorized to issue 500k shares of
ordinary share capital. Subsequently, 250,000 shares were issued at P25 per share.
Instructions: Prepare the journal entries to record authorized share capital and the issuance of
the 250k shares using the memorandum entry method under each of the following
independent assumptions:
Exercise 8-4 (Issuance of Share Capital w/ Stated Value in Exchange for various Considerations)
The Justice Corporation Is authorized to issue 500,000 shares of ordinary share capital with a
stated value P20. The ff transactions have taken place in relation to the share capital:
A. Issued 125,000 shares for cash at stated value.
B. Issued 25,000 shares to attorneys for services in securing corp. Charter and for preliminary
legal costs of organizing the corp. The value of the services was 150,000.
C. Issued 2,000 shares to the corp. Promoters. Each ordinary share is selling at P25 on this date.
D. Issued 10,000 shares in exchange for land valued at 300,000.
E. Issued for cash 50,000 shares at P24 per share.
Instructions: Prepare the journal entries to record the preceding transactions, including
authorized capital, using the memorandum entry method.
On June 1, 2014, Simplicity, Inc. sold 35k shares of its P20 par value ordinary share capital on a
subscription basis at P50 per share. Simplicity received 60% down payment on the date of
subscription. On sept.8, 2014, Simplicity received the balance on the subscription and the stock
certificates were issued.
508
Exercise 8-6 ( Issuance of Share Capital on a Subscription Basis)
The Hope Corp. was organized on July 1, 2014 and is authorized to issue share capital as
follows:
July 1 Issued to corporations 125,000 ordinary shares at P15 per share and 12,500
preference shares at par value.
12 Received subscription for 75,000 ordinary shares at P20 per share w/ a down
payment of 60% of the total subscription price.
Fair Value
Merchandise inventory P10,000
Land 150,000
Building 100,000
Equipment 20,000
30 Received the balance due on the subscription on July 12 and shares were issued
to subscribers.
The Faith Co. Was organized on June 1,2014 w/ authorized capital of 500k ordinary shares w/ a
par value of P20.
The following are selected transactions of the corporation completed during September:
Sept. 1 Received subscription for 125,000 shares at P30 per share. A down payment of
40% was received from the subscribers. The balance is due in the three equal installments.
509
8 Issued 25,000 shares in exchange for land valued at P750,000.
30 Received the final installment from all subscribers and shares of stock were
issued.
Patience Co. was authorized to issue 500000 ordinary shares with a stated value of P20. The
following transactions relative to the share capital took place:
a. Received subscriptions for 125,000 shares at P25 receiving a down payment of 60%
b. Received balance due from subscribers of 50,000 shares. Shares of stock were subsequently
issued.
c. Received balance due from subscribers of 60,000 shares. Shares of stock were issued to the
subscribers.
d. The subscriber of the remaining 15,000 shares failed to pay his obligation, so his subscription
was declared delinquent
f. Received payment from the highest bidder and shares were issued as follows: 10,000 to the
highest bidder and 5000 to the defaulting subscriber.
PROBLEMS
Problem 8-1 (Issuance of Ordinary and Preference Shares on a Subscription Basis and
Subscription Defaults)
The following selected transactions took place at the newly formed Providence Corporation:
Aug.1 Received authorization from the SEC to issue 50,000 preference shares, P100
par value and 500,000 ordinary shares, P20 par value.
510
Aug. 2 Received subscription for preference shares at P120 per share from the
following:
Emilio 5,000shares
Bernardo 6,000
Roberto 4,000
A down payment of 30% was received.
2 Received subscription for ordinary shares at P30 per share from the following:
Lorena 100,000 shares
Morena 75,000 shares
A down payment of 20% was received.
Aug. 31 Lorena paid her subscription in full and shares of stock were issued to her.
Morena paid 40% of her subscription
Sept. 21 Emilio and Bemardo paid the balance of their subscriptions and shares of stock
were issued to them.
Sept. 21 Roberto officially informed the officials of the corporation that he would not be
able to pay the balance of his subscription contract. Thus the subscription was declared
delinquent and was offered for sale in public auction.
28 Received payment from the highest bidder and shares of stock were
subsequently issued.
30 Morena paid the balance of her subscription and shares of stock were issued of her.
Problem 8- 2 (Issuance of Share Capital for Various Considerations and Subscription Defaults)
511
Fidelity Co. was authorized to issue 200,000 ordinary shares, par value P50.The transactions
that took place during the months of November and December are shown below.
Nov.2 Received subscriptions from incorporators for 50,000 shares at P60. A down
Payment of 40% was received; the balance is payable within 90 days.
5 Issued 10o,000 shares in exchange for equipment with a fair value of P700, 000.
Nov. 16 Received subscriptions for 30,000 shares at P60 with a down payment of 20%. The
balance is payable within 30 days.
28 Received the balance due from incorporators who subscribed for 35,000 shares.
The shares of stock were issued.
Dec. 16 Received the balance due from subscribers of 25,000 shares on Nov. 16. The
corresponding shares of stock were issued.
Assets
Cash P 42,000 Accounts
Receivable P 124,000
Less Allowance for Uncollectible Accounts 12,000. 112,000 Inventories
206,000 Equipment P 600,000
Less Accumulated Depreciation 160,000 440,000 Goodwill
100,000
Total Assets P900,000
512
Liabilities and Equity
Accounts Payable P104,000 Bautista,
Capital 394,000 Bernaldo, Capital
402,000 Total Liabilities and Owner's Equity P 900,000
Inventories P 296.000
Equipment 520,000
Bautista and Bernaldo, together with other three friends, decided to incorporate as Rainbow
Corp. with 50,000 authorized shares of P50 par ordinary share capital. The three other
incorporators acquired 10,000 shares at P70. Bautista and Bernaldo received 14,000 shares in
exchange for the net assets of the partnership except cash. On this date, the fair value of stock
is P70 per share. Bautista agrees to take 7,500 shares and Bemaldo, 6,500 shares. The
partnership cash is then appropriately divided between the partners.
Instructions: Give the entries to record the above on the books of the new books of the
corporation.
The Good News Corporation was formed on April 1, 2014. There were two transactions
involving Issuance of preference shares: (1) 2,000 shares were issued in exchange for land, and
(2) 500 shares were issued for cash of P70 per share. There were also two transactions involving
issuance of ordinary shares: () 12,000 shares were issued for cash, and (2) 800 shares were
issued as payment for pre-operating expenses Selected general ledger accounts for the Good
News Corporation show the following activities for the first month of operations:
78,000 100,000
35,000 25,000
5,400 50,000
10,000
513
Land Ordinary Share Capital,P5 par
150,000 60,000
4,000
18,000
1,400
514
Insructions:
1. Reconstruct the journal entries made for share capital transactions during the month of
April.
2. Determine the total number of preference and ordinary shares outstanding.
The Golden Rule Corporation was organized on January 1, 2014 with authorized share capital
consisting of 50,000 preference shares with a par value of P50 and 1,000,000 of no-par ordinary
shares with a stated value of P10. At December 31, 2014, the ledger included the following
balances pertaining to shareholders' equity.
Preference Share Capital P 1,000,000
Preference Share Premium 120,000
Ordinary Share Capital 3,000,000
Ordinary Share Capital in Excess of Stated Value 4,500,000
Ten thousand preference shares were issued for equipment having a fair value of P550,000.
The remaining preference shares were issued for cash. All ordinary shares were issued for cash.
Instructions: Compute for each of the items enumerated below.
1. Number of preference shares issued for cash.
4. Average price per share of the ordinary share capital issued for cash.
5. Total preference share premium arising from issuance in exchange for equipment.
515
Ordinary Share Capital, no par, P10 stated value,
authorized, 320,000 shares
Issued P 1,360,000
Subscribed 280,000 1,640,000
Paid-In Capital in Excess of Par or Stated Value
Preference P 216,000
Ordinary 328,000 544,000
516
MULTIPLE CHOICE
MC 8-1. Cream Corporation was organized on January 1, 2014 with authorized capital of
P2,000,000 consisting of 100,000 ordinary shares, P20 par value. Subsequently,
incorporators subscribed for 25,000 shares at P24. How much must be paid up upon
subscription to comply with the requirement Securities and Exchange Commission
(SEC)?
a. P600,000 c. P500,000
b. P125,000 d. P150,000
MC 8-2. Beige Co. was authorized to issue 10,000 preference shares, P100 par value and
200,000 no-par ordinary shares. Subscriptions for 4,000 preference shares was received at
P110 with a down payment of 25%. What entry should be made in the books of Beige
Co. to record the receipt of subscription?
a. Preference Share Capital Subscription Rec'l 440,000
Preference Share Capital Subscribed 400,000
Preference Share Premium 40,000
MC 8-3. Using the information in MC 8-2, how much was the down payment receivedby
Beige Co. as a result of the subscription?
a. P10,000 c. P100,000
b. P11,000 d. P110,000
MC 8-4. Last September 6, 2014, Brown Co. issued 2,000 shares of its P10 par value
ordinary share capital in exchange for a piece of land to be held for a future plant site.
517
Brown Co.'s ordinary share capital was listed and traded at P27 per share on the same
date. The land has no known market value. How much is the increase in ordinary share
premium resulting from this exchange?
a. P0 c. P34,000
b. P 20,000 d. P 40,000
MC 8-5. Violet Corp. was organized on January I, 2014 with authorized capital of 100,000
ordinary shares, P20 par value. During 2014, Violet Co. had the following transactions
affecting the shareholders' equity.
Jan. 10 issued 25,000 shares at P22 per share.
Mar. 25 Issued 1,000 shares for legal service when the fair value was P24
per share.
Sept. 30 Issued 5,000 shares for a piece of equipment when the value was
P26 per share.
How much is the balance of the ordinary share capital account as of September 30?
a. P620,000 c. P700,000
b. P674,000 d. P704,000
MC 8-6. Using the information in MC 8-5, what amount should be reported as ordinary
share premium?
a. P50,000 c. P64,000
b. P54,000 d. P84,000
MC 8-7. Aqua Corp. was incorporated on June 1, 2014 with an authorized 250,000 share of
no-par ordinary share capital, stated value P15 and 10,000 shares of 10% preference
share capital, par value P50. Transactions affecting company's share capital as of June 30,
2014 were as follows:
June 1 Issued 50,000 ordinary shares for cash at P15 per share
5 Issued 50,000 ordinary shares in exchange for assets with total market
value of P900,000.
June 15 Received subscriptions for 100,000 ordinary shares at P30 and for 5,000
preference shares at P55.
25 Received full payment for subscriptions received on June 15 and the
corresponding stock were issued.
What is the total paid-in capital in excess of par and stated value for both ordinary and
preference shares?
a. P 25,000 c. P1,650,000
518
b. P300,000 d. P1,675,000
MC 8-8. Using the information in MC 8-7, how much is the total shareholders equity?
a. P3,250,000 c. P4,675,000
b. P4,500,000 d. P4,925,000
MC 8-9. Lavender Corp. issued 20.000 ordinary shares, par value P15 in exchange for an
equipment. At the date of exchange, the shares are selling at P20 and no fair value is
known for the equipment. How will the exchange be recorded on the books of Lavender
Corp.?
a. Equipment 400,000
Ordinary Share Capital 400,000
b. Equipment 400,000
Ordinary Share Capital 300,000
Ordinary Share Premium 100,000
c. Equipment 400,000
Ordinary Share Capital 300,000
Gain on Exchange 100,000
d. Equipment 300,000
Ordinary Share Capital 300,000
MC 8-10. Indigo Corp. has authorized 200,000 shares of P30 par value ordinarys shares of
P30 par value ordinary share capital and 5,000 shares of P50 par, 9% preference share
capital. On June 3, 2014, the company issued 100,000 ordinary shares and 3,000
preference shares, both at par. Which of the following is the correct journal entry in
recording the transaction?
a. Cash 3,600,000
Ordinary Share Capital 3,000,000
Preference Share Capital 600,000
b. Cash 1,540,000
Ordinary Share Capital 1,000,000
Preference Share Capital 540,000
519
Preference Share Capital 600,000
Income from Sale of Share Capital 3,600,000
d. Cash 3,150,000
Ordinary Share Capital 3,000,000
Preference Share Capital 150,000
MC 8-11. Javier and Edralin are partners. They decide to incorporate their business and are
recording the incorporation of the new business. Javier has a P35,000 capital account
balance, while Edralin has a P26,400 balance. Javier receives 7,500 shares and Edralin
receives 6,000 shares of P4 par ordinary share capital.
The correct entry to record the issuance of ordinary shares, assuming the corporation will
use the books of the partnership, is
a. Javier, Capital 35,000
Edralin, Capital 26,400
Ordinary Share Capital 61,400
MC 8-12. The shareholders' equity of Cecille Corp. revealed the following on June 30,
2014:
Preference share, PI00 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
520
How much is the legal capital of the corporation?
a P760,000 c. P1,115,000
b. P775,000 d. P1,305,500
MC 8-13. Using the information in MC 8-12, how much is the additional paid in capital?
a. P355,500 c. P400,500
b. P360,500 d. P800,500
MC 8-14. Using the information in MC 8-12, how much is the total shareholders equity?
a. P1,305,500 c. P1,704,500
b. P1,345,500 d. P1,745,500
MC 8-15. On April 1, 2014, Friends Corp., a newy formed company had the following
shares issued and outstanding:
Preference share, P50 par, 6,000 shares originally issued at P100
Ordinary share, P20 par, 20,000 shares originally issued at P60
Friends shareholders' equity should report preference share capital, ordinary share capital
and paid-in capital in excess of par, respectively at
a. P600,000, P1,200,000, -0-
b. 600,000, 400,000, 800,000
c. 300,000, 1,200,000, 300,000
d. 300,000, 400,000, 1,100,000
521
Test Material No. 28 Rating
Name Date
Year and Section Professor
TRUE or FALSE
Instructions: Encircle the letter T If the statement is True and the letter F if the statement is
False.
T F 1. All incorporators are shareholders but not all shareholders are incorporators
T F 1. A corporation, like a partnership, may be formed by the mere agreement of five or
more persons.
T F 2. The journal entry method may be used in recording authorized share capital and
other stock transactions relating to a no-par and no stated value share capital.
T F 3. The authorized shares represent the maximum number of shares that a
Corporation may issue.
T F 4. Unissued shares represent the number of shares that may still be subscribed.
T F 5. It is legal to issue share capital at par or at more than par but not at less than par.
T F 6. When share capital is issued for consideration in the form of property other than
cash, the net book value of the property is used to record the transaction.
T F 7. The highest bider is the one who is willing to pay the entire unpaid subscription
plus any expenses incurred in the delinquency sale and at the same time getting the
highest number of shares.
522
T F 8. Share capital that has been sold and issued to a shareholder is called an
outstanding share capital.
T F 9. The owners of a stock corporation are called shareholders; the owners of a non-
stock corporation are called members.
T F 10. When the memorandum entry method is used, the account Share Capital is
credited upon issuance of stocks.
T F 11. Under the journal entry method, the amount of share capital issued is determined
by deducting the balance of unissued share capital account from the balance of authorized
share capital account.
523
T F 24. Generally, there are only two classes of authorized share capital, the
preference share capital and the ordinary share capital.
Name Date
Year and Section Professor
IDENTIFICATION
Instructions: Write the word or group of words that identify each of the following
statements.
_________________1. An artificial being created by operation of law formed by five or more
persons.
_________________2.The process of formalizing the organization of a corporation.
_________________3. A corporation organized under the Philippine laws.
_________________4. The persons who originally formed the corporation.
_________________5. Costs incurred in connection with the incorporation. They include cost of
printing stock certifications and filing fees
_________________6. A value that may be assigned to no-par stock by the board of directors of
a corporation.
_________________7. Class of share capital which entitles the holder to an equal or pro-rata
division of profits without any preference or advantage over any class of stock.
_________________8. Class of share capital which enables the holder to enjoy preferences as to
receipt of dividends.
524
_________________9.A nominal value stated on the face of the stock certificate and in the
articles of incorporation.
_________________10. It represents residual ownership equity.
_________________11.A share capital issued to a shareholder.
_________________12. A subscriber who fails to pay his subscription balance
_________________13. The minimum percentage of authorized share capital that has to be
subscribed by incorporators.
525
14. The minimum percentage of the subscription in share capital that
has to be paid by the incorporators.
15. The account credited for the excess of the subscription or issue
price over the sated value of ordinary share capital.
16. The minimum amount upon which no-par, no-stated value share
capital are to be subscribed or issued.
526
Test Material No.30 Rating
Name Date
Instructions: Encircle the letter of the best answer. Show supporting computations in good form
in a separate worksheet.
527
6. Which of the following statements about preference share capital is NOT true?
a. Preference share capital usually carries the right to vote.
b. Preference share capital dividends are usually paid prior to payment of ordinary
share capital dividends.
c. Preference share capital usually shares the right to receive assets pro-rata with the
ordinary shareholders in case of corporate liquidation.
d. In addition to being paid dividends prior to those paid to ordinary shareholders,
preference shareholders have the right to receive assets pro-rata with ordinary
shareholders in the event of corporate liquidation.
7. The maximum number of shares of stocks that the government gives a corporation
permission to issue is the
a. Granted shares
b. Authorized share
c. Issued shares
d. Outstanding shares
8. A preference share capital that may be exchanged for ordinary share capital is nown as
a. Cumulative
b. Participating
c. Non cumulative
d. Convertible
9. The cost of organizing a corporation should be
a. Expensed in the year of organization
b. Reported as an intangible asset
c. Reported as an tangible asset
d. Deducted from share capital
10. A non-cash asset received in exchange for share capital is recorded at
a. Its book value
b. Its fair market value
c. The lower of its book value or fair market value
d. The higher of its book value or fair market value
11. The entry to record the issuance of ordinary share capital for fully paid stock subscription
is
a. Memorandum entry
b. Debit Ordinary Share Capital Subscribed and credit Ordinary Share Capital
c. Debit Ordinary Share Capital Subscribed and credit Additional Paid –in Capital
d. Debit Ordinary Share Capital Subscribed and credit Subscription receivable
528
12. The issuance of shares of ordinary share capital to shareholders
a. Increases ordinary share capital authorized
b. Decreases ordinary share capital authorized
c. Increases ordinary share capital outstanding
d. Decreases ordinary share capital outstanding
13. On June 1, authorized ordinary share capital was sold on a subscription basis at a price in
excess of par value, and 40% of the subscription price was collected. On October 1, the
remaining 60% of the subscription price was collected. Ordinary Share Premium will be
credited
June 1 October 1
a. No Yes
b. No Yes
c. Yes No
d. Yes Yes
14. When there is no bidder for delinquent subscription, the subscribed shares will be
a. Issued to the delinquent subscriber
b. Issued in the name of the corporation
c. Reverted back to unsubscribed shares
d. Retained as subscribed
15. Violet Inc. issued 8,000 shares of P20 par ordinary share capital for P24 per share. In
recording this sale of share capital Violet will include a credit to
a. Gain on issuance of share capital for P32,000
b. Ordinary share capital of 192,000
c. Paid-in capital in excess of par for 32,000
d. Discount on ordinary share capital for 16,000
16. Which of the following is not typically a characteristic of preference shares?
a. Preference as to dividends
b. Preference as to voting rights
c. Cumulative and callable terms
d. Preference over ordinary shareholders during liquidation
17. When ordinary shares are issued in exchange for services or non-cash assets, the
transaction should be recorded at the
a. Par value of the ordinary shares issued
b. Fair market value of the ordinary shares issued
c. Fair market value of the services or non-cash assets received
d. Fair value of the services or non-cash assets unless the fair value of the ordinary
share is more reliably determinable
529
18. When preference shares are fully participating, this mean that ordinary shareholders
receive dividend rate equal to the preference share and
a. All excess dividends are shared proportionately between the preference and
ordinary shareholders
b. All excess dividends are given to the ordinary shareholders
c. All excess dividends go to the preference shareholders
d. The maximum participation rate is applied to the preference shares
19. Preference shares that have no claim on any prior year dividends that may have passed
a. Cumulative preference shares
b. Participating preference shares
c. Non- cumulative preference shares
d. Non- Participating preference shares
20. The securities and Exchange Commission 25%, 25% rule means that
a. At least 25% of the total authorized share capital has been subscribed
b. At least 25% of the total subscription have been paid
c. A only
d. Both A and B
530
Name Date
PROBLEMS
Problem A
The Royal Blue Corporation was organized on January 1, 2014 with authorized share capital
consisting of 100,000 shares of P50 par value preference share capital and 1,000,000 shares of
no-par ordinary share capital with a stated value of P10. At December 31, 2014, the ledger
included the following balances pertaining to shareholders’ equity:
Ten thousand preference shares were issued for equipment having a fair market of P550,000. The
remaining preference share capital were issued for cash. All preferred shares were issued in
January. All ordinary shares were issued for cash.
Instruction: Compute for each of the items enumerated below. Present supporting computation
in good form in a separate work sheet.
4. Average price per share of the ordinary share capital issued for cash.
531
Problem B
1. ABC Corp. recorded the following journal entry on August 21, 2014:
Cash 42,250
Ordinary Share Capital 32,500
Ordinary Share Premium 9,750
The explanation reads “Issued ordinary share capital for P130 per share”. What is the par
value for this share capital, and how many shares were issued?
ANSWER:
2. DEF Company issued 1,000 shares of its P50 par value ordinary share capital in
exchange for land with a book value of 40,000 and fair value of P120,000. What is the
total increase in ordinary share premium?
ANSWER:
3. Using the information in No. 2, how much should be credited to ordinary share capital
account?
ANSWER:
4. The GHI Corporation was incorporated on January 1, 2014 with the following authorized
capitalization:
40,000 shares of ordinary share capital, no par value, stated value P50 per share
During 2014, GHI issued 24,000 ordinary shares for P60 per share and 6,000 preference
shares at P120 per share. In addition, on December 10, 2014 subscription for 2,000
preference shares were taken at a purchase price of P150. A down payment 30% was
received. The full payment on these subscribed shares was received on January 5, 2014.
What should GHI report as total increase in shareholders’ equity on its December 31,
2014 Statement Financial Position?
ANSWER:
5. On June 1, JKL Company issued 8,000 shares of its P10 par ordinary share capital to
Robles for a tract of land. The stock had a fair value of P18 per share on this date. How
much is the increase in ordinary share premium a result of this transaction?
ANSWER:
532
Problem C
Shown below are account balances found in the ledger of Emerald Green Corporation at the end
of 2014:
Instruction: Compute for each of the item shown below. Present supporting computation in good
form in a separate work sheet.
5. Average price per share received by the corporation on its preference share
capital including preference share capital subscribed.
6. Average price per share received by the corporation on its ordinary share
capital including subscribed ordinary share capital.
533
7. Average amount per share that the subscribers of preference share capital have
not yet paid to the corporation.
8. Average amount per share that ordinary share capital subscribers have already
paid on their subscription. Assume that ordinary share capital were subscribed
at P12.
CHAPTER 9
OPERATIONS, DIVIDENDS, BOOK VALUE PER SHARE, and EARNINGS PER
SHARE
LEARNING OBJECTIVES
1. Explain the preparation of worksheet, adjusting entries, and closing entries for a
corporation.
2. Explain the components of the shareholders’ equity section of the statement of
financial position (balance sheet).
3. Prepare the financial statement of a corporation, specifically the statement of changes
in shareholders’ equity.
4. Identify the different types of dividends and compute amount of dividends to be
Steps in the distributed to preference and ordinary shareholders.
Accounting 5. Compute book value and earnings per share.
Cycle 6. Identify and explain the different types of retained
Worksheet earnings appropriatons.
Financial Statement PREVIEW OF THE CHAPTER
1. Statement of
CORPORATE OPERATIONS and
Financial Position FINANCIAL STATEMENT
2. Income Statement
3. Statement of
Comprehensive Shareholders’
Equity
Income
Contributed Capital
4. Statement of
changes in Share Capital
Additional Paid-in
shareholders’
equity Capital
5. Statement of cash Retained Earnings
flows Appropriated
Adjusting Entries 534 Unappropriated
Closing Entries Capital Maintenance
adjustments
Revaluation surplus
ACCOUNTING CYCLE OF A CORPORATION
The accounting cycle of a corporation is essentially the same as that of a sole proprietorship and
a partnership. Transactions, such as purchase and sale of merchandise and payment of expenses
and liabilities, are recorded in the same manner as that of the two other forms of business
organizations.
At the end of the accounting period, the results of operation of the corporation and its financial
position are determined and the following problems are normally encountered:
1. Preparation of a work sheet
2. Preparation of financial statements
a. Statement of financial position (balance sheet)
b. Income statement
c. Statement of comprehensive income
d. Statement of changes in shareholders’ equity
e. Statement of cash flows
3. Preparation of adjusting and closing entries
PREPARATION OF A WORK SHEET
A work sheet is a working paper that facilitates the preparation of financial statements.
However, before it can be prepared and completed, data for adjustments must first be compiled.
These items requiring adjustments are also the same items discussed in Chapters 1 and 3. For
purposes of illustration, these will be discussed again in this chapter. Data requiring adjustments
at the end of the accounting period include:
1. 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
535
The work sheet normally contains eight columns; however, there are instances when ten columns
are used because of the addition of a pair of column for retained earnings.
536
3. Statement of changes in equity
4. Statement of cash flows
5. Notes
The statement of comprehensive income reports gains and losses not reported as a part of as
profit or loss but are shown as adjustments to the total equity. These items include gain (loss)
from changes in fair value of available for sale securities and revaluation surplus arising from
revaluation of property, plant and equipment.
The Securities of Exchange Commission (SEC) requires that corporation submits to the
Commission within 15 days from the end of the first three months of operations a statement of
cash flows covering a period of three months from the date of registration. The statement must
show in sufficient detail the sources of cash and how these are disbursed. The paid-up capital
must be disbursed only in connection with the business for which the corporation was organized
and no amount shall be disbursed as loans or advances to shareholders or officers of the
corporation.
The preparation of the statement of cash flows is discussed in Chapter 11 of this book.
537
If the journal entry method of recording share capital transactions is used, issued share capital is
determined by deducting the balance of Unissued Share Capital account from Authorized Share
Capital account.
2. Additional Paid-In Capital- this section reports investment by shareholders in excess of the
par or stated value of the share capital. It includes paid-in capital in excess of par value or stated
value (share premium) of both preference and ordinary share capital.
It also includes donated capital and other paid-in capital items arising from various share capital
transactions .These different share capital transactions are discussed in Chapter 10.
Retained Earnings (Earned Surplus). The Retained Earnings balance represents undistributed
earnings of the corporation. It represents capital of the corporation arising from its operations.
The balance of the account is generally divided into two parts, as follows:
1. Appropriated retained earnings- it is the portion of Retained Earnings set aside for a
specific purpose.
2. Unappropriated retained earnings- it is the portion of Reatained Earnings available for
distribution as dividends to the shareholders. It is normally described as “unrestricted
earnings”
The Retained Earnings account has normal credit balance. A debit balance in the account is
called a deficit.
538
PAS 1 (revised 2010) also permits the presentation of comprehensive income in two
statements: an income statement and a statement of other comprehensive income.
For the purpose of this book, the option of preparing two separate statements will be adopted;
however, the statement of comprehensive income is not included in the illustration and
discussion. A detailed discussion of this statement is covered in the last part of financial
statements.
539
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 1,932,000
Notes Receivable 750,000
Accounts Receivable 2,827,500
Allowance for Uncollectible Accounts 30,000
Merchandise Inventory 450,000
Store and Office Supplies 112, 500
Prepaid Insurance 54,000
Office Equipment 1,8 75,000
Accumulated Depreciation-Office Equipment 187,500
Store Equipment 2, 850,000
Accumulated Depreciation-Store Equipment 285,000
Notes Payable 375,000
Accounts Payable 487,500
10% Preference Share Capital, P100 par, 100,000 shares authorized 2,000,000
Ordinary Share Capital, P10 par, 500,000 shares authorized 4,750,000
Preference Share Premium 375,000
Ordinary Share Premium 900,000
Retained Earnings 787,000
Sales 7,050,000
Sales Returns and Allowances 150,000
Purchases 3,750,000
Purchases Returns and Allowances 75,000
Sales Salaries 900,000
Delivery Expense 180,000
Miscellaneous Selling Expenses 105,000
Office Salaries 675,000
Rent Expense 375,000
Utilities Expense 247,500
Miscellaneous Administrative Expenses 79,000
Interest Income 10,500
17,313,000 17,313,000
540
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%
541
542
543
544
545
546
Closing Entries
2014
Dec. 31 Income Summary 7,152,425
Sales Returns and Allowances 150,000
Purchases 3,750,000
Sales Salaries 945,000
Delivery Expense 180,000
Miscellaneous Selling Expenses 105,000
Office Salaries 700,000
Rent Expense Utilities 375,000
Expense Miscellaneous 247,500
Administrative Expenses 79,500
Office Supplies Expense 30,000
Store Supplies Expense 62,500
Insurance Expense 30,000
Uncollectible Accounts Expense 138,000
Depreciation Expense - Office Eqt. 93,750
Depreciation Expense -Store Eqt. 142,500
Income Tax Expense 123,675
31 Sales 7,050,000
Purchase Returns and Allowances 75,000
Interest Income 16,000
Income Summary 7,141,000
31 Income Summary 288,575
Retained Earnings 288,575
Reversing Entries
2015
Jan 1 Interest Income 5,500
Interest Receivable 5,500
547
DIVIDENDS
Dividends are distribution to shareholders of corporate earnings in proportion to the number of
shares held by them. Distributions may take the form of (1) cash, (2) non-cash assets, (3) notes or
other evidence of corporate indebtedness, and (4) shares of the company's own share capital.
Dividends previously described are paid out of accumulated earnings of the corporation They
may also be paid as a return of shareholders' invested capital. This type of dividends are called
liquidating dividend. However, discussion in this book will be limited to dividends representing
distributions of corporate earnings.
The power to declare dividends is vested upon the board of directors; however, they have to
observe legal requirements governing the maintenance of legal or stated capital Dividend
declaration is normally announced to be made known to the shareholders.
The following dates are essential in formal dividend announcement or statement
1. Date of declaration - this is the date when the board of directors approved the resolution to
distribute dividends. The liability of the corporation to the shareholder is recorded on this
date.
2. Date of shareholders of record - this is the date when the company determines the
shareholders who are entitled to the receipt of declared dividends. No entry required on this
date; however, a list of registered shareholders is made as of the close of business on this
date. Share capital are selling dividends-on prior to this date and are selling ex-dividends the
day following this date.
3. Date of payment or distribution - this is the date when dividends declared are paid or
distributed to the shareholders. The liability recognized on the date of declaration is cancelled
or extinguished on this date.
CASH DIVIDENDS
Cash dividends are dividends that are distributable in the form of cash. This is the most common
type of dividend. The following entries are made to record the declaration subsequent payment:
548
Cash xxx
To record payment of dividends.
*Alternatively, the account Dividends Payable may be used.
If the dividends declared are still unpaid as of the statement of financial position date, the
balance of the account Cash Dividends Payable is reported as a current liability.
The amount of cash dividends declared-should not exceed the amount of cash reported on the
statement of financial position or cash needed for current operations. For instance, Retained
Earnings may have a balance of P 1,000,000 but the cash balance is only P500,000, the
corporation can distribute cash dividends of not more than P500,000. Another form of dividend
may be declared for the remaining undistributed earnings.
Cash dividends may either be:
1. Peso dividend - a cash dividend expressed in peso amount. The peso dividend multiplied by
the number of outstanding shares of the corporation equals the total amount of Retained
Earnings declared as cash dividends. On the other hand, the peso dividend multiplied by the
number of capital shares held by a shareholder equals the total amount of cash dividends to
be received by the shareholder.
2. Percentage dividend - a cash dividend expressed in percentage. The dividend percentage
multiplied by the par value or stated value of the capital share equals the peso dividend.
Alternatively, the percentage dividend multiplied by the total par value or total stat value of
the capital share equals the total amount of Retained Earnings declared as cash dividends.
For example, the dividend on a 10% preference share with a par value P100 is equal to P10
(i.e., 10% x P100). A shareholder who owns 2,000 shares is entitled to P20,000 (.e., P10 x
2,000 shares).
Illustrative Problem B: Fortune Corp. has 10,000 shares of P100 par value ordinary share capital
outstanding as of December 1, 2014. On this date, the Board of Directors declared a cash
dividend of P10.00 per share to shareholders of record of December 30, 2014 payable on January
15, 2015.
2014
Dec. 1 Retained Earnings 100,000
Dividends Payable 100,000
10,000 sh @P10=P100,000
2015
Jan. 15 Dividends Payable 100,000
Cash 100,000
The Dividends Payable account will be reported in the December 31, 2014 statement of financial
position as a current liability.
SCRIP DIVIDENDS
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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 Xxx
To record the declaration of dividends.
Illustrative Problem C: Fortune Corp. has 10,000 shares of P100 par value ordinary share
capital outstanding as of October 31, 2014. On this date, the Board of Directors declared a
deferred cash dividend of P10.00 per share to shareholders of record of November 30, 2014.
Promissory notes dated December 1, 2014 were issued on the same date. The notes mature
within six months plus interest of 12% per annum. The corporation paid its shareholders on
March 31, 2015.
The entries to record the declaration of dividends, the accrual of interest at year-end, the
reversing entry at the beginning of the new accounting period and the payment to shareholders
are as follows:
2014
Oct. 31 Retained Earnings 100,000
Scrip Dividends Payable 100,000
10,000 sh @P10=P100,000
Dec. 31 Interest Expense 1,000
Interest Payable 1,000
P100,000 x 12% x 1/12 = P1,000
2015
Jan. 1 Interest Payable 100,000
Interest Expense 100,000
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March 31 Scrip Dividends Payable 100,000
Interest Expense 4,000
Cash 104,000
P100,000 x 12% x 4/12 = P4,000
The accounts Scrip Dividends Payable and Interest Payable will be reported in December 31,
2014 statement of financial position as current liabilities.
PROPERTY DIVIDENDS
Dividends distributable in the form of non-cash assets are known as property dividend. Property
distributed normally takes the form of assets that can be easily divided or allocated among
shareholders such as stocks of other companies owned by the corporation. According to IFRIC
17 Distribution of Non-Cash Assets to Owners, the following rules shall apply in accounting
for distribution of non-cash assets to owners as dividends:
An entity shall measure a liability to distribute noncash assets as a dividend to its owners
at the fair value of the assets to be distributed (par. 11)
- This means that Retained Earnings and Property Dividends Payable will be
recorded at the fair value of the assets to be distributed.
At the end of each reporting period and at the date of settlement, the entity shall review
and adjust the carrying amount of the dividend payable, with any changes in the carrying
amount of the dividend payable recognized in equity as adjustments to the amount of the
distribution (par. 13)
- This means that Retained Earnings and Property Dividends Payable balances will
be adjusted for the change in the previously recorded fair value of the assets.
- The required valuation /measurement of the assets to be distributed at the end of
each reporting period as provided in related PAS or PFRS should also be applied.
When an entity settles the dividend payable, it shall recognize the difference, if any,
between the carrying amount of the assets to be distributed and the carrying amount of
the dividend payable in profit or loss (par 14)
- This means that the difference between the carrying amount of the Property
Dividends Payable and the carrying amount of the assets to be distributed as gain
or loss to be reported in the statement of comprehensive income.
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Retained Earnings xxx
Property Dividends Payable xxx
To record the declaration of dividends.
The entry to record the distribution of dividends under three independent cases shall as follows:
1. The carrying amount of the payable and the carrying amount of the assets are the same
Property Dividends Payable xxx
Assets xxx
To record distribution of property dividend xxx
2. The carrying amount of the payable is greater than the carrying amount of the assets
Property Dividends Payable xxx
Assets xxx
Gain on Distribution of Non-Cash Assets xxx
3. The carrying amount of the payable is less than the carrying amount of the assets
Property Dividends Payable xxx
Loss on Distribution of Non-Cash Assets xxx
Assets xxx
For purpose of discussion in this book, the illustration, exercises and problems will involve
assets with carrying value equal to their book value.
Illustrative Problem D: Fortune Corp. has 10,000 shares of P100 par value ordinary share
capital outstanding as of December 1, 2014. On this date, the Board of Director declared a
property dividend distributable to shareholders of record of December 30, 2014 payable on
January 15, 2015. The corporation will distribute five shares of Luck Corp. for every share of
Fortune Corp, owned by the shareholders. Each share of Luck Corp. has a carrying value of P10
on the date of declaration, which is also its fair value on the date of declaration and on the date of
distribution.
The entries to record the declaration and distribution of property dividend follow:
2014
Dec. 1 Retained Earnings 500,000
Property Dividends Payable 500,000
10,000 sh x 5 @ P10 P500,000
2015
Jan. 15 Property Dividends Payable 500,000
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Investment in Lucky Corp. Stocks 500,000
It should be noted that the declaration and payment or distribution of cash dividends scrip
dividends and property dividends do not affect the corporation's number of capital shares issued
and outstanding. This means that the total number of capital shares issued and outstanding before
the dividend declaration and payment or distribution shall be the s as total number of capital
shares issued and outstanding after the dividend declaration and payment or distribution.
However, there is a decrease in the total assets and total retained earnings of the corporation.
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To record the distribution of stock dividends.
The account Share Capital (Stock) Dividend Distributable is credited for the par or stated value
of the shares to be distributed regardless of whether the share capital dividend is small or large.
This account is reported on the statement of financial position under the shareholders' equity
section as part of Contributed Capital. It is properly shown as addition to the share capital
outstanding.
The account Paid-In Capital from Share Capital Dividend is credited for the excess of fair market
value of the share over its par or stated value. This account is reported on the statement of
financial position under the shareholders' equity section as part of additional paid-in capital.
Illustrative Problem E: Fortune Corp. has 10,000 shares of P100 par value ordinary share
capital outstanding as of December 1, 2014. On this date, the Board of Directors declared a share
capital dividend distributable to shareholders of record of December 30 2014 payable on January
15, 2015. The fair market value of Fortune Corp. share capital on December I is P105; on
December 30, Pl10; on January 15, P106
The entries to record the declaration and distribution of share capital dividend using two
independent cases are presented below
2015
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Jan. 15 Share Capital Dividends Distributable 100,000
Ordinary Share Capital 100,000
The declaration and distribution of share capital dividends, whether small or large. increases the
number of capital shares outstanding.
In all of the different types of dividends discussed, it should be noted that only the outstanding
capital shares are entitled to dividends.
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.
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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.
Illustrative Problem F: The Fortune Corp. declared and paid cash dividends for the last three
years as follows: 2012 P120.000; 2013 - P200.000; 2014 - P300.000 dividends were paid for two
years prior to 2012. The capital structure of the company the last three years follows:
10% Preference share capital, P100 par, 5,000 shares outstanding P500,000
Ordinary share capital, P50 par, 5.000 shares outstanding 250,000
The annual dividend requirement on preference shares is P50,000 or P10 per share (i.e., P100 par
x 10% x 5,000 shares outstanding). At the beginning of 2012, dividends are in arrears (unpaid
dividends of prior years) for two years.
The distribution of dividends to the preference and ordinary shareholders under different
independent cases are presented below and on the next pages.
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%
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rate. Hence, the dividend per share on preference share is limited to P10 only, even if the total
amount of distributed dividends increases.
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.
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2013 Preference Ordinary Total
Regular dividends:
Preference P 50,000
Ordinary – P50 x 10% x 5,000 sh P 25,000 P 75,000
Balance – P125,000
Preference 500/750 x P125,000 83,333
Ordinary – 250/750 x P125,000 41,667 125,000
Total dividends P 133,333 P 66,667 P 200,000
Dividends per share P 26.67 P 13.33
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.
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2013 Preference Ordinary Total
Dividends in arrears P 30,000 P 30,000
Current (regular) dividends 50,000 P 25,000 75,000
Balance – P95,000
Preference – 500/750 x P95,000 63,333
Ordinary – 250/750 x P95,000 31,667 95,000
Total dividends P143,333 P 56,667 P 200,000
Dividends per share P28.67 P11.33
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.
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2014 Preference Ordinary Total
Regular dividends:
Preference P 50,000
Ordinary – P50 x 10% x 5,000 sh P 25,000 P 75,000
Balance – P225,000
Preference 500/750 x P225,000=150,000 40,000
Ordinary – P225,000 – P40,000 185,000 225,000
Total dividends P 90,000 P210,000 P300,000
Dividends per share P 18.00 P 42.00
P40,000 is the lower amount
Note: Since the preference shares are participating up to a certain percentage only, a
comparison should be made between the maximum allowed participation and the amount based
on full participation. The amount to be given on the preference shareholders is the lower of the
two amounts. Alternatively, the amount to be allocated to the preference shares is computed by
multiplying the total par value of the preference shares by the lower of the full participation rate
or the maximum participation rate. The full participation rate is computed as follows:
Using the data in Case 5, the full participation rate for 2012, 2013, and 2014 are as follows:
Hence, in 2012, the 6% rate will be used; in 2013 and 2014 the 7% rate will be used.
Book value per share is the peso equity in corporate capital of each share capital. It is the amount
that would be paid on each share owned by a shareholder in case of corporate liquidation
assuming the amount available to shareholders is exactly the same as the total shareholders’
equity.
The calculation of book value per share depends on how many classes of share capital are
outstanding. If there is only one class of share capital outstanding, book value per share is
calculated by dividing the total shareholders’ equity by the number of shares outstanding.
Subscribed shares, if any, should be added to the outstanding shares.
When more than one class of share capital are outstanding, the rights of the different classes of
shareholders should be taken into consideration. Preference shareholders have priority over
ordinary shareholders as to distribution of assets upon corporate liquidation.
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Thus the equity identified with the preference share capital should be determined first. The
balance of the shareholders’ equity after deducting the equity of preference shareholders
represents the equity of the ordinary shareholders. Equity identified with each class of share
capital divided by the number of shares outstanding yields the book value per share.
EQUITY IDENTIFIED WITH PREFERENCE SHARE CAPITAL. The equity of the holders
of preference shares generally consists of the liquidation value of the share and any claim on
dividends. Liquidation value of the share capital refers to the amount payable to preference
shareholders for every share owned in case of corporate liquidation. It is usually equal to or more
than the par value of the share capital.
EQUITY IDENTIFIED WITH ORDINARY SHARE CAPITAL. The equity of the holders of
ordinary share capital, also known as residual equity, is the excess of total shareholders’ equity
over the equity identified with preference share capital. It represents the amount available to
ordinary shareholders in case of corporate liquidation.
Illustrative Problem G: On December 31, 2014, the shareholders’ equity section of the
statement of financial position of Lucky Corp. appears as follows:
Dividends on preference shares are in arrears for two years, including the current year.
Case 1 – The preference shares are noncumulative; liquidation value is P110 per share.
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Case 2 – The preference shares are cumulative; liquidation value is P110 per share.
The earnings per share (EPS) is the amount earned during a given period on each ordinary share
outstanding. PAS 33 provides the guidelines in the computation of both basic and dilutive
earnings per share. However, this chapter is focused only on the computation of basic EPS.
The provisions of PAS 33 shall be applied in the computation of earnings per share of the
following entities:
1. those whose ordinary shares or potential ordinary shares are publicly traded
2. those that are in the process of issuing ordinary shares or potential ordinary shares
3. those that voluntarily disclose earnings per share
The earnings per share information is presented in the statement of comprehensive income, even
if the amount is negative.
A potential ordinary share is a financial instrument or other contract that may entitle its holders
to ordinary shares, such as ordinary share warrants and convertible preference shares. A holder
of convertible preference shares is given the privilege of exchanging the preference shares for
ordinary shares.
1. There is only one class of share capital outstanding (that is, ordinary shares)
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2. There are two classes of share capital outstanding (that is, ordinary shares and preference
shares)
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 non-
cumulative, only dividends declared in respect of the period will be deducted.
The earnings per share figure is very useful to investors and prospective investors in evaluating
the results of operations of a business in order to make investment decisions. It is also considered
as a significant determinant of the market price of the share capital.
Illustrative Problem H: For the year ended December 31, 2014, the Brilliant Corp. reported
profit of P450,000.
Earnings per share computation will be made using three independent cases.
The preference shares are cumulative; no dividends were declared during the period.
Profit P450,000
Less Dividends on cumulative preference shares
5,000 sh x P100 x 10% 50,000
Profit attributable to ordinary shares P400,000
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Case 3 – The company has the following share capital outstanding:
The preference shares are non-cumulative; no dividends were declared during the period.
As mentioned in the earlier part of this chapter, Appropriated Retained Earnings is that portion of
retained earnings set aside for a special or specific purpose. Appropriation of retained earnings
set aside for a special or specific purpose. Appropriation of retained earnings reduces the amount
available for distribution as dividends to shareholders. However, the total retained earnings
remains unchanged.
There are three types of appropriations to Retained Earnings which are acceptable and these are
discussed in the succeeding paragraphs.
564
The pro form entries to record the appropriation of Retained Earnings and its subsequent
cancellation follow:
a. Retained Earnings xxx
Retained Earnings Appropriated for…….. xxx
Appropriation for retained earnings
b. Retained Earnings Appropriated for…….. xxx
Retained Earnings xxx
Cancellation of appropriation to retained earnings
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corporation. On the date of declaration, Retained Earnings account is debited, thereby
reducing its balance. The amount debited to Retained Earnings depends on the type of
dividend declared. When two classes of share capital are outstanding, the total amount of
dividends declared should be allocate properly taking into account the type of preference
shares outstanding.
5. Discuss the computation of book value per share and earnings per share. Book value
per share is the peso equity in corporate capital of each share capital. It represents the
amount that a shareholder will receive for every share owned in case of corporate
liquidation. If there is only class of share capital outstanding, it is computed by dividing
the total shareholders’ equity by the total number of outstanding shares. Book value per
share is then computed by dividing the equity identified with each class of stock by the
total number of outstanding shares per class.
The earnings per share (EPS) is the amount earned during a given period on each
ordinary share outstanding. When there is only one class of share capital outstanding, it is
computed by dividing the net income or the profit of the company by the number of
outstanding ordinary shares. When there are two classes of share capital outstanding, the
earnings allocated to the ordinary shares is first computed by deducting the earnings
identified with the preference shares. The earnings per share is then calculated by
dividing the earnings allocated to the ordinary shares by the number of outstanding
ordinary shares.
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GLOSSARY of ACCOUNTING TERMINOLOGIES
567
371
DISCUSSION QUESTIONS
1.What are the components of the shareholders' equity section of the statement of financial
position (balance sheet)?
6.How much will you distinguish a small from a large share capital (stock) dividend?
7.What are the dividends in arrears? How do they affect the allocation of dividends to preference
and ordinary shareholders if (a) preference share capitals are non-cumulative, (b) preference
share capitals are cumulative?
8.What is the significance of book value per share? How is it computed if (a) only one class of
share capital is outstanding, (b) two classes of share capital are outstanding?
9.What is earning per share? What is its significance to the shareholders? How is it computed of
(a) only one class of share capital is outstanding, (b) two classes of share capital are outstanding?
10.What are the three types of appropriations to Retained Earnings? What is the effect of an
appropriation of Retained Earnings to dividends?
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372
EXERCISES
Instructions: Prepare the shareholders' equity section of the statement of financial position.
Ordinary Share Capital, no-par, P10 stated value, 500,000 shares authorized, P 2,000,000
200,000 shares issued
Paid-in Capital in Excess of Stated Value – Ordinary Shares 100,000
Accumulated Depreciation – Machinery and Equipment 120,000
Retained Earnings 400,000
Paid-in Capital in Excess of Par – Preference Shares 120,000
Preference Share Capital Subscribed, 1,000 shares 40,000
Merchandise Inventory 240,000
Machinery and Equipment 500,000
Preference Share Capital Subscription Receivable 14,000
10% Preference Share Capital, P40 par, 40,000 shares authorized 800,000
Pre-operating costs 10,000
Instructions: Prepare the shareholders' equity section of the statement of financial position.
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373
Ordinary share capital, P100 stated value, 100,000 shares subscription P 4,000,000
authorized, 40,000 shares outstanding
Ordinary shares premium 2,000,000
Retained Earnings
1,500,000
During the year, the corporation had declared the following dividends:
Mar 1 Declared a cash dividend of P10 per share payable on April 15 to shareholders of
record of March 31
Sept 1 Declared a cash dividend of P20 per share payable on Sept. 30 to shareholders of
record of Sept. 15
Instructions: Prepare necessary journal entries to record the declaration and distribution of cash
dividends.
Instructions: Record the declaration and distribution of each of the above mentioned dividends.
374
570
Exercise 9-5 (Small and Large share Capital Dividend)
The LMN Corporation has 500,000 shares of P10 par ordinary share capital outstanding as of
October 1, 2014. On this date, the Board of Directors declared a share capital dividend
distributable on November 20, 2014 to shareholders of record of October 30. The market price of
each ordinary share is P25 on October 1; P23 on October 30 and P30 on November 30.
Instructions: Prepare the entries to record the declaration and distribution of stock dividends
under each of the following independent assumptions:
1. A 15% share capital dividend was declare and issued.
2. A 50% share capital dividend was declared and issued.
375
571
Instructions: Calculate the amount that will be paid per share and in total on preference shares
and ordinary shares for each year under each of the following independent assumptions:
1. The preference shares are noncumulative and nonparticipating.
2. The preference shares are cumulative and nonparticipating.
3. The preference shares are noncumulative but participating.
4. The preference shares cumulative and participating.
5. The preference shares are noncumulative but participating up to an additional 8%.
Exercise 9-8 (Book Value per Share of Preference and Ordinary Share Capital)
The XYZ Corporation’s statements of financial position shows total shareholders’ equity of
P5,000,000 as of December 31, 2014.
Instructions: Compute the book value per share of each class of share capital under each of the
following independent assumptions:
1. The company has only one class of shares outstanding: 200,000 ordinary shares, par
value is P15.
2. The company has two classes of shares outstanding: 10,000 shares of P100 par preference
share capital with a liquidation value of P120 per share and 100,000 shares of P15 par
ordinary share capital.
Exercise 9-9 (Earnings per Share)
The YZA Corporation has 100,000 ordinary shares authorized, par value P10. As of the end of
the reporting period, 60,000 of the shares are outstanding.
Instructions: Compute the earnings per share assuming the company has a profit of:
Exercise 9-10 (Earnings per Share; Two Classes of Share Capital Outstanding)
The ZAB Corporation has the following information relating to its share capital:
10% Preference shares, cumulative, P100 par value, 30,000 shares authorized, P 2,000,000
20,000 shares outstanding
Ordinary shares, P!0 par value, 500,000 shares authorized, 300,000 shares 3,000,000
outstanding
Instructions: Compute earnings per share assuming that the reported profit of the company is
P750,000.
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572
PROBLEMS
2014
Jan. 2 Issued 125,000 shares to the incorporators at P25
Mar. 2 Issued 62,500 shares at P30
Mar. 31 Issued 25,000 in exchange for land valued at P300,000 and a building valued at
P500,000
Dec. 31 The Income Summary account showed a credit balance of P750,000 and this was
transferred to the Retained Earnings account.
31 Declared cash dividends of P2.50 per share payable on January 31, 2015 to
shareholders of record of January 15, 2015.
2015
Jan. 31 Paid dividends declared on December 31.
Feb. 14 Received subscription of 50,000 shares at P50, with a down payment of 40% of total
subscription.
Mar. 15 Received balance due on the subscription of February 14 and shares were issued to
the subscribers.
Dec. 31 The Income Summary account showed a credit balance of P2,000,000 and this was
transferred to the Retained Earnings account.
31 Declared a cash dividend of P2.00 per share and a 10% stock dividend payable on
January 15, 2016. On this date, stocks are selling at P25 per share.
Instructions:
1. Give the journal entries to record the preceding transactions.
2. Prepare the shareholders’ equity section of the statement of financial position of BCD
Corp. as of December 31, 2014.
3. Prepare a statement of changes in shareholders’ equity for the year ended December 31,
2014.
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573
Problem 9-2 (Statement of Changes in Shareholders’ Equity)
The shareholders’ equity information for MMM Corporation and VVV Inc. are given below. The
two companies are independent.
MMM Corporation MMM Corporation is authorized to issue 200,000 ordinary shares, par
value P20. 120,000 shares were issued at P24 per share in 2013 and the remaining shares were
issued at P30 per share in 2014. The company incurred a loss of P300,000 in 2013 and earned a
profit of P800,000 in 2014. The company declared no dividends during the two-year period.
VVV Inc. VVV is authorized to issue 20,000 shares of 5% Preference Share Capital, par value
P100 and 500,000 shares of no-par, no stated value Ordinary Share Capital. In 2013, VVV issued
6,000 preference shares at P120 per share and 200,000 ordinary shares for a total of P1,400,000.
The company realized a profit of P240,000 in 2013 and distributed appropriate dividends to
preference shareholders and P.25 dividend per ordinary share. In 2014, the company issued
5,000 preference shares at P130 per share and 100,000 ordinary shares at P10 per share. VVV
realized a profit at P600,000 and distributed appropriate dividends on preference shares and P.50
dividends per ordinary share.
Instructions:
1. Prepare a statement of changes in shareholders’ equity for the two years ending
December 31, 2014 for each of the two companies.
2. Prepare the shareholders’ equity section of the statement of financial position as of
December 31, 2014 for each of the two companies.
Problem 9-3 (Work Sheet; Financial Statements of a Corporation; Adjusting and Closing
Entries)
The trial balance of DEF Corp. is presented on the next page and the additional information
needed to update the records of the company is presented below:
Additional Information:
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378
e. Expired Insurance P 18,000
f. Income Tax rate is 30%
g. Transactions with shareholders during the year are as follows
Issued 1,000 ordinary shares at P25 per share on January 6, 2010
Declared and distributed dividends of P80,000 during the year.
DEF Corporation
Trial Balance
December 31, 2014
Cash P 200,000
Accounts Receivable 100,000
Allowance for Bad debts 10,000
Merchandise Inventory, Jan. 1 150,000
Store Supplies 15,000
Office Supplies 10,000
Prepaid Insurance 30,000
Land 1,000,000
Office Equipment 150,000
Accumulated Depreciation 30,000
Store Equipment 250,000
Accumulated Depreciation 50,000
Accounts Payable 75,000
Ordinary Share Capital, P20 par 1,000,000
Ordinary Share Premium 100,000
Dividends 80,000
Retained Earnings 228,000
Sales 2,500,000
Sales Discount 50,000
Purchases 1,400,000
Purchases Returns and Allowances 100,000
Sales Salaries 250,000
Advertising Expense 75,000
Delivery Expense 50,000
Miscellaneous Selling Expense 20,000
Office Salaries 185,000
Light and Power 60,000
Miscellaneous Administrative Expense 18,000
P 4,093,000 P 4,093,000
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379
Instructions:
1. Prepare an eight-column work sheet.
2. Prepare a statement of financial position, a separate income statement, and a statement of
changes in shareholders’ equity.
3. Prepare adjusting and closing entries.
576
Instructions: Compute the book valueper share on preference and ordinary shares under each of
the following assumptions:
1. Preference shares have a liquidation value of P30per share; there are no dividends in arrears.
2. The preference shares are cumulative, with dividends in arrears for 5 years (including the
current year). Upon corporate liquidation, shares are preferred as to assets up to par, and any
dividends in arrearsmust be paid before diatribution may be made to ordinary shares.
Instructions: From the preceding information, prepare the shareholder's equity section as it
would appear on the statement of financial position.
MULTIPLE CHOICE
MC 9-1 Which of the following statements is not correct regarding the appropriations of
Retained Earnings?
577
a. Appropriations of Retained Earnings do not change the total amount of
Retained Earnings.
b. Appropriations of Retained Earnings reflect funds set aside for a designated
purpose, such as plant expansion.
c. Appropriations of Retained Earnings cam be made as a result of a contractual
requirement
d. Appropriations of Retained Earnings can be made at the discretion of the board
of directors.
MC 9-3 Share capital dividends declared but not yet distributed as of the statement of
financial position date should be reported as a (an)
a. current liability
b. addition to share capital outstanding
c. reduction in total shareholders' equity
d. noncurrent liability
MC 9-4 A company declared a cash dividend on its ordinary share capital in December
2014, payable in January 2015. Retained Earnings would
a. increase on the date of declaration
b. not be affected on the date declaration
c. not be affected on the date of payment
d. decrease on the date of payment
MC 9-5 On March 20, 2014, AAA Corp. declared the diatribution of the following
dividend to its shareholders of record as of March 31, 2014.
Investment in 100 shares of BBB Corp. stock, carrying value and fair value,
P600,000
The entry to record the declaration of the property dividend would include a debit
to Retained Earnings of
a. P600,000 c. P850,000
b. P650,000 d. P1,575,000
MC 9-6 The shareholders’ equity section of GGG Corp. as ofDecember 31, 2014
contained the following accounts:
Ordinary Share Capital, 25,000 shares authorized,
10,000 shares issued and outstanding P 30,000
Ordinary Share Premium 40,000
Retained Earnings 80,000
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P 150,000
GGG’s board of directors declared a 10% stock dividend on April 1, 2010 when
the market value of the share capital was P7 per share. Accordingly, 1,000 new
shares were issued. All of GGG’s shares has a par value of P3 per share. GGG
incurred a loss of P12,000 for the first three months.
No dividends were paid on preference shares for 2012 and 2013. On December
31,
2014, a total cash dividend of P200,000 was declared.
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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?
e. P10,000 c. P 75,000
f. P40,000 d. P100,000
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
MC 9-13 The adjusted trial balance of ZZZ Corp. on December 31, 2014 includes the
following account balances:
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b. P1,075,000 d. P1,180,000
MC 9-18 Using the information in MC 9-13, what is the total amount of Contributed
Capital?
c. P1,050,00 c. P1,363,000
d. P1,323,000 d. P2,063,000
MC 9-19 Using the information in MC 9-13, what is the total amount of Retained Earnings
available for dividend contribution?
c. P450,000 c. P600,000
d. P550,000 d. P700,000
MC 9-20 Using the information in MC 9-13, what is the total amount of shareholders’
equity?
a. P1,363,000 c. P2,023,000
b. P2,000,000 d. P2,063,000
TRUE or FALSE
Instructions: Encircle the letter T if the statement is true and the letter F if the statement is
false.
T F 1. Property dividends should be recorded at the fair value if the assets to be distributed.
T F 2. A share capital dividend decreases retained earnings but it increases contributed
capital.
T F 5. A share capital dividend that has been declared but not yet distributed should be
reported as a current liability.
T F 6. An appropriation of retained earnings reduces the total amount of retained earnings.
T F 7. The liquidation value of a preference share is always equal to its par value.
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T F 8. The accounting cycle of a corporation is very much different from the accounting cycle
of a partnership.
T F 9. Book value per share is the amount earned for every capital share owned by a
shareholder.
T F 12. Unappropriated retained earnings represents amount of cash available for dividend
distribution.
T F 13. Appropriation of retained earnings is necessary when the corporation reacquires its
own share capital.
T F 14. The balance of the Income Summary account is transferred to the Retained earnings
account.
T F 15. The normal balance of Retained earnings account is credit. Therefore, it can never
have a debit a balance.
T F 16. A deficit (or debit balance) in retained earnings means that Retained Earnings appears
in the asset section of the statement of financial position.
T F 18. Earnings per share is computed for both preference and ordinary shares.
T F 20. Book value of share capital is a measurement of the amount of income earned for
each share of stock.
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Test Material No. 33 Rating_____________
Name Date
_________________________________ ___________________________________
Year and Section Professor
________________________ ________________________________
IDENTIFICATION
Instructions: Write theword or group of words that identify each of the following statements.
_________________9. A share capital dividend representing less than 20% of the outstanding
stock of the corporation.
_________________15. Preference share capital that participates in the excess dividends after
paying both preference and ordinary shares their regular dividends.
_________________16. The excess of fair value over par value of share capital in a small stock
dividend.
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________________17. The amount recorded as reduction in Retained earnings on a property
dividend declaration.
________________18. The account used for the declared but not yet distributed stock dividend.
________________19. The type of dividend that does not affect total assets and total
shareholders’ equity.
________________20. Amount earned by shareholders during a given period for each ordinary
share held.
Name_________________________________ Date
Year and Section ___________________________________
________________________ Professor
________________________________
MULTIPLE CHOICE
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11. Has a credit balance if earnings have been greater that losses and dividends, and is
reported as part of shareholers’ equity on the statement of financial position.
12. Has a debit balance if losses have exceeded earnings, and is reported as part of assets
on the statement of financial position.
13. Represents the amount of cash available for payment of dividends if there has been
profitable operations.
14. Is a special fund for paying shareholders’ dividends on the basis of income.
6. All of the following statements pertain to dividends. Which of them is (are) true?
3. Shareholders vote each yearto declare and set the amount of the dividends to be paid.
4. Dividends Payable is a current liability in the statement of financial position of the
corporation.
5. A 10% dividend on preference share capital means that each shareholder receives a
cash dividend equal to 10% of the market value of the stock.
6. All of these statements are true.
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4. Dividends in arrears on preference shares are reported in the financial statements as a (an)
a. Liability c. Reduction from Retained Earnings
b. Expense d. Footnote to financial statements
6. When a small share capital dividend is declared, Regained Earnings is debited for the
a. Par value if the share capital
b. Fair market value of the share capital on the date of record
c. Fair market value of the share capital on the date of declaration
d. Fair market value of the share capital on the date of distribution
7. Cash dividends declared but not paid as of the statement of financial position date are reported as
a. Current liability
b. Deduction from cash
c. Addition to share capital
d. Addition to Additional Paid-in Capital
10. The peso equity in corporate capital for each share capital owned by a shareholder is known as
a. Book value per share
b. Dividends per share
c. Earnings per share
d. None of these
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586
11. A corporation declared dividends on December 1 payable on January 15 to shareholders of
record of December 30. The Balance of Retained Earnings
a. Decreases on December 30
b. decreases on January 15
c. is not affected on December 30
d. is not affected on December 1
12. A corporation has experienced losses greater than profits in te past three years since
incorporation. Which of the following statements is true?
a. Retained earnings has credit balance at the end of the year.
b. Retained earnings has debit balance and is reported as an asset on the statement of
financial position.
c. Retained earnings has a debit balance and it appears as a reduction in the shareholders’
equity on the statement of financial position.
d. Retained earnings has a credit balance at the end of the third year and the corporation
may choose how to report a deficit.
15.When a corporation pays dividends, the three relevant dates for dividends occur in ths order:
a. date of record, date of declaration, date of payment
b. date of payment, date of declaration, date of record
c. date of declaration, date of payment, date of record
d. date of declaration, date of record, date of payment
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18. The date when the board of directors announces the intention to pay dividends is known as
a. dividend date c. record date
b. declaration date d. payment date
19.Which of the following is not reported in the statement of changes in shareholder’ equity?
A. profit for the year
b. undistributed dividends declared during the year
c. interest expense
d. ordinary shares issued at more than par value
20. The type of dividend that does not affect total assets and total shareholders’ equity is
a. share capital dividend
b. property dividend
c. cash dividend
d. scrip dividend
22.When the outstanding preference share capital is multiplied by the participation rate, the
result is
a. full participation preference
b. maximum allowed participation
c. non-participating preference shares
d. cumulative preference
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Test Material No. 35 Rating_______
Name___________________________________ Date____________________________________
Year and Section___________________________ Professor________________________________
Instructions: Encircle the letter of the best answer. Present supporting computation in good form in a
separate worksheet.
1. ABC Corp. and DEF Inc. have Preference Share Capital outstanding. ABC has issued 3,000
shares of 5% Preference Share Capital, par value P100. DEF has issued 5,000 of 10% Preference
Share Capital , par value P120. What is the dividend per share for the preference share capital for
the two corporations?
A. P5 for ABC; P10 for DEF c. P5 for ABD; P12 for DEF
B. P100 for ABC; P120 for DEF d. P5 for ABC; P120 for DEF
2. The following is a list of selected account balances taken from the December 31, general
ledger og GHI Corporation:
Accounts Payable P 80,000
Accounts Receivable 71,400
Ordinary Share Capital 252,000
Paid-in Capital in Excess of Par-Ordinary 116,550
Paid-in Capital in Excess of Par- Preference 118,420
Preference Share Capital 12,000
Preference Share Capital Subscribed 12,000
Retained Earnings 38,390
Subscription Receivable- Preference(current) 21,000
What is the total contributed capital?
A. P234,970 c. P602,970
B. P242,090 d. P614,970
3. Using information in No.2 , What is the total shareholders’ equity as of December 31?
a. P641,360 c. P662,870
b. P653,360 d.P674,360
4. A company has 400 shares of 6% preference share capital outstanding, par value is P50 per
share and market value is P80 per share. The amount of the dividends for the year on this share
capital would be
a. P12 c. P1,920
b. P1,200 d. P2,400
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589
5. A corporation has 6,000 shares of P8 noncumulative preference shares outstanding and 12,000 ordinary
shares outstanding. At the end of the year, dividends of P180,000 were declared.
7. For the year ended December 31, 2014, the financial records of JKL corp. reported the following: total
revenue P801,400 ; total expense P601,100; dividends declared P25,600. What is the entry to close the
balance of Income Summary to Retained Earnings?
a. P24,000 c. P720,000
b. P480,000 d.P1,200,000
9. Using the information in No. 8, the peso dividend per ordinary share is
a. P8 c. P40
b. P20 d. P50
10. Using the information in No.8 and assuming the share capital dividend declared is 4/40, the amount of
Paid-in Capital from Stock Dividend is?
a. P120,000 c. P300,000
b. P180,000 d. P480,000
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590
Test Material No. 36 Rating_______
Name___________________________________ Date____________________________________
Year and Section___________________________ Professor________________________________
The ZZZ Corp. was organized on January 1, 2014, with authorized capital of 100,000 shares of P50 par
Ordinary Share Capital. Seventy-five thousand (75,000) shares were issued for cash at P70 per share.
During the year, the company earned a profit of P1,000,000 and distriburted dividends of P750,000
Instruction: Based on the given information, compute for each of the items listed below.
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591
Name___________________________________ Date____________________________________
Year and Section___________________________ Professor________________________________
Shareholders’ Equity
8% Preference Share Capital, P50 par value, cumulative and convertible P 450,000
Ordinary Share Capital, P10 par value 4,000,000 shares authorized 16,000,000
The company has not declared dividends for the last two years, including the current year. The market
value of the ordinary share is P75 per share. The preference shares have liquidation value of P60 per
share.
Instructions: Based on the foregoing information, compute for each of the items listed below.
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592
Name___________________________________ Date____________________________________
Year and Section___________________________ Professor________________________________
The RRR Company has capitalizations of 20,000 shares, 6% P50 par value Preference Share Capital and
500,000 shares of P5 par value Ordinary Share Capital. On December 31, 2009, there were no dividends
in arrears. During the next five years, the company’s dividend declaration were as follows:
2012 - P 37,500
Instructions: Under each of the following assumptions, complete the schedule below which shows the
amount of dividends for each class of stock.
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CHAPTER 10
SHARE CAPITAL TRANSACTIONS
593
SUBSEQUENT TO ORIGINAL ISSUANCE
Learning Objectives:
1. Identify and explain the various share capital transactions subsequent to original issuance.
2. Explain the methods of acquiring and accounting for treasury shares.
SHARE CAPITAL
TRANSACITONS
When a share capital (capital stock is fully paid, a stock certificate is issued to the shareholder and the
stock becomes outstanding. Subsequent to the original issuance, various capital share transactions may
take place. These transactions may cause a change in total shareholders’ equity or in the number of shares
outstanding. These share capital transactions include the following:
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594
Share capital may be reacquired and formally retired by using the issuing corporation. Such retirement
calls for the cancelation of the stock certificate, cancellation of the share capital account and the
cancellation of the related additional paid-in capital from the original issuance of the stock. If the
retirement price is greater than the original issuance price, Retained Earnings is less than the original
issuance price, Paid-in Capital from the retirement of Share Capital is credited for the difference. The
difference between the retirement price and the original issuance rice of the share capital should not be
recognized as gain or loss. The excess of the original issuance price over the retirement price of the share
capital should not be credited to Retained Earnings.
The retirement of share capital will reduce both the number of shares issued and the number of shares
outstanding.
Illustrative Problem A: the shareholders’ equity section of the statement of financial position of CBA
Co. contains the following:
Based on the above data, the original issuance price of each preference share is P125, that is, the par value
of P100 per share and the share premium of P25 per share (P250,000/10,000shares).
One thousand (1,000) shares of preference share capital were reacquired and retired. Entries to record the
retirement using two independent cases follow:
Cash 110,000
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Case 2- The retirement price is P130 per share
Preference Share Capital 100000
Preference Share Premium 25000
Retained Earnings 5000
Cash 130000
1000 sh × P100= P100000
1000 sh × P25 = P25000
1000 sh × P5 = P5000
1000 sh × P130= 130000
The debit to Retained Earnings of P5000 or P5.00 for every share retired is the excess of the
retirement price of P130 over the original issuance price of P125
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The balance of the treasury shares account is reported as a deduction from the sum of the total
contributed capital and retained earnings.
The reacquisition of a company's own share reduces the number of outstanding shares but
does not affect the number of issued shares. Treasury shares are not entitled to receipt of
dividends because they are not outstanding. Retained Earnings, however, must be appropriated
equal to the cost of the treasury shares acquired.
Illustrative Problem B: The shareholders equity of JJJ Corp. included the following items:
Ordinary share capital, P20 par, 50000 shares P1000000
Ordinary share premium (P5 per share) 250000
Retained earnings 500000
On September 1, 2014, 1000 shares were reacquired at P24.On September 30, 700 shares were
reissued at P30. Entries to record the foregoing and the shareholders equity section of the
statement of financial position as of September 30 are presented below and on the next page.
2014
Sept. 1 Treasury shares 24000
Cash 24000
1000 sh x P24 =P24000
1 Retained Earnings 24000
Retained Earnings Appropriated for
Treasury Shares 24000
Sept. 30 Cash 21000
Treasury shares 16800
Paid-in Capital from Sale of Treasury 4200
Shares
700 sh × P30= P21000
700 sh × P24= P16800
700 sh × P6= P4200
30 Retained Earnings Appropriated for
Treasury Shares 16800
Retained Earnings 16800
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Shareholder's Equity
Contributed Capital:
in treasury P1000000
Retained Earnings:
REACQUISITION BY DONATION
Treasury shares may be acquired through donation by shareholders. This practice is done by
shareholders to enable the company to increase its working capital and at the same time maintain
their proportionate ownership interests.
Upon receipt of capital shares donation, a memorandum entry is made stating the number of
shares received. Subsequent sale of donated shares is recorded by debiting Cash and crediting
Donated Capital or Paid-in Capital from Donated Shares for the entire proceeds.
Alternatively, the receipt and the subsequent sale of the donated shares may be recorded as
follows:
Upon receipt
Treasury Shares xxx
Donated Capital xxx
(amount recorded is the fair value of the shares on the date of donation)
Upon sale of donated shares at more than recorded cost
Cash xxx
Treasury Shares xxx
Paid-in Capital from Sale of Treasury xxx
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CONVERSION OF PREFERENCE SHARES INTO ORDINARY SHARES
Convertible preference shares can be converted into ordinary shares at the option of the holder.
This type of preference share capital can be sold at a higher price but a lower dividend rate
because of its conversion privilege.
The accounting for conversion of preference shares into ordinary shares is similar to retirement
of share capital. Account balances related to the preference shares converted are cancelled and
the issuance of ordinary shares is recorded. An indicated gain from conversion is credited to
Paid-in Capital from Conversion of Preference Shares into Ordinary Shares; an indicated loss
from conversion is debited to Retained Earnings
Illustrative Problem C: The LMN Corporation's shareholder's equity contains the following:
Ordinary share capital, P10 par, 50000 shares P500000
Ordinary share premium 100000
10% Preference share capital, P100 par, 5000 shares 500000
Preference share premium 50000
Retained Earnings 750000
On July 15, 1,000 preference shares were converted into ordinary shares.
Case 1- Twenty ordinary shares were issued for every preference share
Preference Share Capital 100000
Preference Share Premium 10000
Retained Earnings 90000
Ordinary Share Capital 200000
1000 sh × P100 = P100000
1000 sh × P10 = P10000
1000 sh × P20 sh × P10 = P200000
P200000- P110000 =P90000
Case 2 Eight ordinary shares were issued for every preference share
Preference Share Capital 100000
Preference Share Premium 10000
Ordinary Share Capital 80000
Paid-in Capital from Conversion of
Preference Share into Ordinary Shares 30000
1000 sh × P100 = P100000
1000 sh × P10 = P10000
1000 sh × 8 sh × P10 = P80000
P110000- P80000 = P30000
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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.
It should be noted that a share split will not affect total shareholder's equity nir total
share capital. It will simply change the number of shares outstanding and the par value per share
of stock.
RECAPITALIZATION
Corporate recapitalization takes place when an entire issue of share capital is changed by
appropriate action of the corporation. The typical types of recapitalization are as follows:
1. Change from par to no-par share capital and vice versa
2. Reduction in the par or stated value of share capital
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Recapitalization is normally undertaken to establish an additional paid-in capital account that
will be used in capital restructuring. This type of transaction requires the setting up of capital
accounts related to the new issue and the cancellation of account balance related to the old issue.
(Capital restructuring will be discussed in a higher accounting subject.)
Illustrative Problem D: The shareholders equity of Quezon Co. contains the following:
Ordinary Share Capital, P20 par, 50000 shares P1000000
Ordinary share premium 250000
Retained Earnings 500000
Case-1 The original issue is replaced by a no-par share capital with a started value of P20
Ordinary Share Capital, P20 par 1000000
Ordinary Share Premium 250000
Ordinary Share Capital, P20 stated value 1000000
Paid-in Capital from Exchange of Par
for No- Par Share Capital 250000
Case 2- Each capital share is exchanged for a new share with a par value of P15
Ordinary Share Capital, P20 par 1000000
Ordinary Share Capital, P15 par 750000
Paid-in Capital from Reduction in Par
Value of Ordinary Shares 250000
1. Identify and explain the various share capital transactions subsequent to original
issuance. Share capital transactions subsequent to original issuance include the following: (1)
share capital retirement; (2) share capital REACQUISITION; (3) conversion of preference shares
into ordinary shares; (4) share (stock) split; and (5) recapitalization. Two major rules apply on all
these transactions: (1) no gain or loss is reported in the income statement arising from these
transactions, (2) indicated loss on share capital transactions may be charged against retained
earnings, but indicated gain cannot be credited to retained earnings. Indicated gain should be
credited to additional paid-in capital.
2. Explain the methods of acquiring and accounting for treasury shares. Treasury shares are
shares issued to the shareholders and subsequently reacquired by the
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corporation with the intention of reissuing them. Treasury shares may be acquired either by
purchase or by donation. Transactions relating to treasury shares shall be accounted for using the
cost method. Under the cost method, treasury shares is reported on the statement of financial
position as a deduction from total shareholders’ equity.
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.
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DISCUSSION QUESTIONS
1. What is the appropriate accounting treatment for (a) excess of the retirement price over
the original issuance price of share capital and (b) the excess of the original issuance
price over the retirement price of share capital?
5. What is the effect of the acquisition of treasury shares on total shareholder's equity?
EXERCISES
603
Exercises 10-1 (Retirement of Share Capital)
The Joaquin Company showed the following balances related to an issuance of ordinary share
capital:
Ordinary Share Capital, P50 par, 200000 shares P10000000
Ordinary Share Premium 4000000
The company retired 2000 shares of ordinary share capital.
Instructions:
1. Record the retirement of the 2000 ordinary shares under each of the following
assumptions:
a. The retirement price is P45
b. The retirement price is P60
2. State the number of capital shares issued and outstanding immediately after the
retirement.
Exercise 10-2 (Accounting for Treasury Shares)
The Jocson Company capital accounts as of June 30, 2014 are as follows:
Ordinary Share Capital, P25 par, 100000 shares P2500000
Ordinary Share Premium 1000000
Retained Earnings 1500000
On this date, 5000 shares were reacquired at P20. On July 31, 3500 shares were reissued at P35
Instructions:
1. Prepare the journal entries to record the acquisition and reissuance of treasury shares.
2. Prepare the shareholders equity section of the statement of financial position as of July
31.
Exercise 10-3 (Reacquisition of Shares through Donation)
604
In 2014, the Jolo Company issued 150000 shares of its P10 par ordinary share capital at P25. In
2015, a major stockholder donated 5000 shares when the market value of the share capital is P40
per share. Subsequently, all the donated shares were sold at P50 per share.
Instructions:
1. Prepare entries to record the receipt of the donated shares and their subsequent sale using the
two alternative methods of recording.
2. State the number of capital shares issued and outstanding after the donation and after the sale
of donated shares.
Instructions:
1. Record the conversion of preference shares into ordinary shares assuming:
a. Each preference share is converted into 4 ordinary shares
b. Each preference share is converted into 10 ordinary shares
c. Each preference share is converted into 8 ordinary shares
2. State the number of issued and outstanding preference shares and ordinary shares for each of
the three assumptions.
On June 30, 2014, the capital accounts of Japorms Company are as follows:
Ordinary Share Capital, P20 par, 50000 shares P1000000
Ordinary Share Premium 200000
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Instructions:
1. Prepare the necessary journal entry to record each of the following independent
transactions:
2. State the number of capital shares issued and outstanding for each independent
transaction.
Exercise 10-6 (Acquisition of Treasury Shares and Conversion of Preference Shares into
Ordinary Shares)
Jazul Company had the following equity balances reported in its December 31, 2013 statement
of financial position
a. 5,000 ordinary shares were reacquired at P10. Subsequently, 4,000 shares were
reissued at P12 per share and the 1,000 shares were reissued at P7 per share.
b. 1,000 preference shares were converted into ordinary shares. Ten ordinary shares
were issued for every preference share converted.
Instructions:
2. State the number of preference shares and ordinary shares issued and outstanding.
PROBLEMS
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Problem 10-1 (Various Share Capital Transactions)
The Jazmine Co., organized on January 1, 2014, was authorized to issue share capital as follows:
20,000 shares of 10% preference share capital, P100 par; 50,000 shares of ordinary share capital,
P50 par
During the remainder of the year, the following transactions were completed:
a. Received subscription for 10,000 preference shares at P125 and 20,000 ordinary shares at
P60. Both subscriptions were payable 50% upon subscription; the balance is due within
thirty days.
b. Received the final payment on subscription in (a). Issued shares of stock to the
subscribers.
d. The holders of preference shares converted 3,000 of their shares into ordinary shares on a
share-for-share basis.
i. All of the ordinary shares were exchanged for no-par shares with a stated value of P30.
k. Declared the regular cash dividend on preference share capital and a P1.00 cash dividend
on ordinary share capital.
Instructions:
1. Give the journal entries to record the preceding transactions. (Disregard in this problem
the appropriation of retained earnings on the acquisition of treasury shares.)
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5% Preference Share Capital, P100 par, 50,000 shares
P5,000,000
Preference Share Premium
250,000
Ordinary Share Capital, P20 par, 250,000 shares authorized,
150,000 shares issued and outstanding
3,000,000
Ordinary Share Premium
750,000
Retained Earnings
1,500,000
Each preference share is convertible into four ordinary shares. The following transactions
affected the shareholders’ equity section of the statement of financial position during 2014:
2. Prepare the shareholders’ equity section of the statement of financial position as of December
31, 2014.
Problem 10-3 (Various Share Capital Transactions)
Joemari Company has two classes of share capital outstanding: 10%, P50 par preference share
capital and P10 par ordinary share capital. At December 31, 2013, the following accounts were
included in the shareholders’ equity:
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The following transactions have affected the shareholders’ equity of the company during the year
2014:
Instructions: Prepare the shareholders’ equity section of the statement of financial position of
the Joemari Company at December 31, 2014.
Jerusalem Company has outstanding 100,000 ordinary shares, par value P50, that were originally
issued at P60 per share. Subsequently, the following transactions took place:
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The Javier Company has two classes of shares outstanding, 10%, P100 par preference share
capital and P10 par ordinary share capital. During the fiscal year ending June 30, 2014, the
company was active in transaction affecting the shareholders’ equity.
Dividends were paid at the end of the fiscal year on the ordinary shares at P6 per share and on
the preference shares at the preference rate. Profit for the year was P750,000.
Instructions: Prepare a statement of changes in shareholders’ equity for the period July 1, 2013
to June 30, 2014.
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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
Profit for the year amounted to P300,000. What is the amount of shareholders’
equity as of December 31, 2014?
a. P640,000 c. P708,000
b. P702,000 d. P720,000
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 c. P15.00
b. P6.00 d. P26.00
MC 10 – 4 Using the information in Mc 10 – 3, how many shares are outstanding after the
split?
a. 200,000 c. 500,000
b. 300,000 d. 1,000,000
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.
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What amount should be credited to the ordinary share capital account as a result
of conversion of preference shares into ordinary shares?
a. P1,125,000 c. P1,650,000
b. P1,500,000 d. P1,800,000
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 P’8
per share. What is the total shareholders’ equity on December 31, 2014?
a. P1,680,000 c. P1,704,000
b. P1,688,000 d. P1,720,000
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 the year 2013 at a cost of P120,000. On December 8, 2014,
Jabar sold all the 10,000 shares for P210,000. The sale would result in a credit to
Paid-in Capital from Sale of Treasury Shares in the amount of
a. P90,000 c. P120,000
b. P110,000 d. P210,000
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 P 500,000
Additional paid-in capital 1,500,000
Retained earnings 516,000
Total contributed capital and retained earnings P 2,516,000
Less treasury shares, 5,000 shares at cost 40,000
Total shareholders’ equity P 2,476,000
How many shares are issued and outstanding at December 31, 2014?
a. 220,000 and 216,000 c. 110,000 and 106,000
b. 220,000 and 212,000 d. 100,000 and 95,000
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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:
What is the total shareholders’ equity of Blue Company on December 31, 2014?
a. P4,352,000 c. P4,820,000
b. P4,802,000 d. P10,602,000
Rating __________
613
Name ______________________________________ Date ________________________
Year and Section _____________________________ Professor ____________________
TRUE or FALSE
Instructions: Encircle the letter T if the statement is true and correct and the letter F if the
statement is false.
1. Convertible preference share capital allows the holder to exchange the shares for ordinary
shares.
3. The conversion of preference shares into ordinary shares affects total shareholders’
equity.
6. The retirement of share capital requires the cancellation of the stock certificate originally
issued to the shareholders.
7. The reissuance of treasury shares increases total shareholders’ equity equal to the
reissuance price.
8. Treasury shares are not entitled to receipt of dividends because they are not considered
outstanding.
9. The acquisition of treasury shares will reduce the total amount of retained earnings.
10. Treasury shares are accounted for using the cost method.
11. A share (stock) split changes the par value of the stock but leaves total shareholders’
equity unchanged.
12. A share (stock) split is similar to a stock dividend in that both increase the number of
shares owned by each shareholder.
13. When a corporation retires its own share capital, there is usually a gain or loss on the
transaction.
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14. When treasury shares are purchased, the Ordinary Share Capital account is debited for an
amount equal to the cost of treasury shares.
15. If treasury shares are sold at a price greater than the cost, the excess is credited to
additional paid-in capital.
16. The conversion of preference shares into ordinary shares increases total shareholders’
equity.
17. When a shareholder exchanges convertible preference shares for ordinary shares, the
difference between the par value of preference shares converted and the par value of the
ordinary shares issued is recorded by the corporation as a gain or loss on conversion.
18. A corporation does not earn a profit or incur a loss by selling or buying its own stock.
19. When a corporation reacquires its own shares of stock, the number of outstanding shares
decreases.
20. The acquisition of treasu9ry shares reduces the number of shares issued.
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Test Material No. 40 Rating ___________
IDENTIFICATION
Instructions: Write the word or the group of words that identify each of the following
statements.
___________2. Preference shares that can be converted into ordinary shares at the option of
the holder.
___________3. A reduction in the par or stated value of the share capital accompanied by a
proportionate increase in the number of shares outstanding.
___________4. A change in the capital structure of the corporation.
___________5. Account credited for the indicated gain on retirement of share capital.
___________6. The acceptable method of accounting for treasury shares.
___________7. Replacement of outstanding shares by a smaller number of shares with a
corresponding increase in the par or sated value of the share capital.
___________8. The account debited for the excess of the retirement price over the original
issuance price of share capital.
___________9. The effect of share split up on par or stated value.
__________10. Retained earnings set aside equal to the cost of treasury shares upon
acquisition.
__________11. The entry made to record receipt of share capital as donation.
__________12. The amount recorded as paid-in capital from donated shares upon sale of
donated capital shares.
__________13. The sum of share capital and additional paid-in capital.
__________14. The practice done by shareholders to enable the company to increase its
working capital and at the same time maintain shareholders’ proportionate
ownership interests.
__________15. The reacquisition of issued shares without the intention of reissue at some future
date.
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Test Material No. 41 Rating ___________
Instructions: Encircle the letter of the best answer. Present supporting computations in good
form in a separate worksheet.
3. At the end of the financial reporting period, ordinary shares issued would exceed ordinary
shares outstanding as a result of the
a. payment in full of the subscribed shares
b. declaration of a share capital dividend
c. declaration of a share profit
d. purchase of treasury shares
4. How would a share split affect the amount of each of the following?
share capital shareholders’ equity retained earnings
a. no effect no effect no effect
b. no effect no effect increase
c. increase increase no effect
d. decrease decrease decrease
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a. a gain or loss is recorded when the shares are reissued
b. the balance in ordinary share capital account remains unchanged
c. there is a new asset account on the statement of financial position, Treasury shares,
equal to the number of shares reacquired multiplied by the cost per share
d. all of the above statements are true
10. A corporation has 6,000 outstanding shares of P20 par value ordinary share capital. On
March 1, 2010, the corporation announced a 4:1 share split to be completed on April 1, 2010.
What is the entry to record the share split?
a. Retained Earnings 480,000
Ordinary Share Capital 480,000
b. Retained Earnings 120,000
Ordinary Share Split Distributable 120,000
c. Retained Earnings 120,000
Ordinary Share Dividend Distributable 120,000
d. Memorandum Entry
11. Using the information in No. 10, what is the balance of Ordinary share Capital after the share
split?
a. P120,000 c. 480,000
b. 360,000 d. 600,000
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12. The shareholders’ equity section of the statement of financial position of a corporation
includes the following balances:
10% Preference share capital, 1,000 shares issued, P100 par P100,000
Preference share premium 30,000
Retained earnings 350,000
The corporation decided to retire 400 of the preference shares at P110 per share. What is the
gain or loss on retirement of the shares?
a. no gain or loss c. P4,000 loss
b. P4,000 gain d. P8,000 gain
13. A corporation has 20,000 shares of P30 par value ordinary share capital and reacquires 4,000
shares at P40 as treasury shares. What is the balance in the Ordinary Share Capital account
after the purchase of treasury shares?
a. P440,000 c. P600,000
b. P480,000 d. none of these
14. Using the information in No. 13 and assuming 1,000 of the treasury shares were sold for P70
each, what is the journal entry to record the reassurance?
a. Cash 70,000
Treasury Shares 40,000
Gain on Sale of Treasury Shares 30,000
b. Cash 70,000
Treasury Shares 40,000
Paid-in Capital from Sale of Treasury Shares 30,000
c. Cash 70,000
Treasury Shares 70,000
d. None of the above entries is correct.
15. The Jonas, Inc. has authorized capital of 10,000 ordinary shares with a par value of P40. For
the first two years of its existence, it has issued 4,000 shares to shareholders and distributed
400 shares as stock dividend. In addition, it has recently contracted subscription for 100
shares. One installment has been made on the subscribed shares. Jonas is now contemplating
the purchase of 500 shares to hold as treasury shares in order to increase the market price of
the share capital. If Jonas purchases the 500 shares as treasury shares, what will be the
number of authorized, issued and outstanding shares?
Authorized Issued Outstanding
a. 10,000 4,400 4,400
b. 10,000 4,400 3,900
c. 10,000 4,500 4,900
d. 9,500 4,400 3,900
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16. Using the information in No. 15, and assume that Jonas purchases the 500 shares as treasury
shares and that the subscription has been paid in full. At this point, the corporation decided to
split the shares 2:1. What is the new number of shares authorized, issued and outstanding?
Authorized Issued Outstanding
a. 20,000 9,000 8,000
b. 20,000 9,000 9,000
c. 10,000 8,800 5,100
d. none of the answers are correct
17. James corporation has outstanding 10,000 shares of 10% Preference Share Capital with a par
value of P100 and 42,500 shares of P10 par value Ordinary Share Capital. The balance in the
Retained Earnings account at the end of fiscal year 2014 is P1,650,000. If James purchases
1,000 shares of its own ordinary share capital at P40 per share, what amount of Retained
Earnings is available for payment of dividends?
a. P1,610,000 c. P1,650,000
b. P1,640,000 d. none of the answers is correct
18. The June Corporation has 100,000 outstanding shares of P30, par value ordinary share capital
on January 1, 2010. The shares were issued in year 2013 for P50 per share. During 2014,
June declared a 3:1 share split. Thereafter, 15,000 shares were reacquired as treasury shares
for P15 per share. On December 31, 2014, June accepted a subscription for 5,000 ordinary
shares at P20 per share payable within 90 days. What is the balance of the account Ordinary
Share Capital at the end of 2014?
a. P2,850,000 c. P3,000,000
b. P2,900,000 d. P3,050,000
19. Using the information in No. 18, what is the total shareholders’ equity of June Corporation as
of December 31, 2014?
a. P3,000,000 c. P5,000,000
b. P4,875,000 d. P5,100,000
20. Using the information in No. 18, how many ordinary shares are outstanding as December 31,
2014?
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a. 90,000
b. 285,000
c. 290,000
d. 305,000
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PROBLEM
Instructions: Complete the given table to reflect the number of shares and balances in the
shareholders’ equity accounts after each of the following independent transactions: Present
supporting computations in good form in a separate work sheet.
(1) A 15% share dividend was declared and shares were issued; market value of the
shares on the date of declaration is P25 per share.
(2) A two-for-one share split was issued.
(3) A 100% share dividend was declared and shares were issued; market value of shares
on the date of declaration is P 25 per share.
(4) Each ordinary share was replaced by a new share with par value of P 15.
(5) Five thousand shares we retired at P 24.
Outstanding Ordinary Additional Retained Total
Shares Share Paid-In Earnings Shareholders’
Capital Capital Equity
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PROBLEM
Instructions: Prepare the journal entries to record each of the following independent
transactions and then state the number of shares issued and outstanding.
a. Five hundred preference shares were retired at P115.
b. One thousand ordinary shares were reacquired at P25 and subsequently reissued at P28
c. One thousand preference shares were converted into ordinary shares at the rate of four
ordinary shares for every preference share.
d. Ordinary share split of four-for-one.
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CHAPTER 11
FINANCIAL REPORTING AND ANALYSIS
LEARNING OBJECTIVES
1. Explain the nature of the financial statements and the over-all considerations in their
preparation and presentation.
4. Describe and explain the classification of cash flows and the methods of presenting cash
flows from operating activities.
FINANCIAL
REPORTING and
ANALYSIS
INTRODUCTION
As discussed in Chapter 1, there are two main groups of users of accounting information: (1)
internal users and (2) external users. The external users do not have access to the day to day
operations of an entit; hence they rely heavily on the financial reports provided to them. It is very
important, therefore, that these reports be realiable and timely so that those who use them can
make sound sound decisions and reason choices among alternative courses of action.
The field of accounting that specializes in giving reports to external users is financial accounting.
The financial reports that are given to them are called general-purpose financial statements.
General purpose financial statements are financial statements that are intended to meet the
common needs of users who are not in a position to demand reports customized to their specific
information needs.
The presentation of financial statements is guided by PAS 1 which sets out the basis for the
presentation of financial statements to ensure the comparability with previous periods and with
other entities. PAS 1 also identifies the minimum content of what should be included in the
financial statements and the guidelines as to their structure.
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 date. They also show the income earned and expenses incurred by an entity during a
given period.
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Financial statements are the end product of the accounting process. The financial statements
are the final output of the accounting process. They can be prepared only after the transactions
have been processed and the necessary adjusting entries are journalized and posted
Financial statements show the results of the management's stewardship of the resources
entrusted to it. The owners of an entity entrust to management the utilization of company
resources to achieve both short-term and long-term goals of the entity. They are expected to
maximize the earnings potential of these resources and provide rate of
return on their use that is acceptable to the investors and other stakeholders. The financial
statements show the performance of management vis-é-vis the expectations of the investors or
owners.
Financial statements are the means by which the information accumulated and processed in
financial accounting is periodically communicated to those who use it. The stakeholders of an
entity are informed of the financial position and the performance of an entity ‘through the
financial statements.
The preparation and presentation of financial statements is a responsibility of management.
The Board of Directors reviews and approves the financial statements before these are submitted
to the ' shareholders of the entity. A management’s representation letter is attached to the
published financial statements. .
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Some entities,. however, present other reports in addition to those stated above. Examples
are the following:
a financial review by management that describes. and explains the main features of the
entity’ 8 financial performance and financial position and the principal uncertainties it
faces;
environmental reports and value added statements, particularly in industries 'in which
environmental factors are significant and when employees are considered an important
user group.
These reports, which are presented outside of the financial statements, are outside of the
scope of PAS 1.
PAS 1 identifies eight (8) basic considerations when preparing and presenting financial
statements. These considerations are described briefly below.
Fair presentation and compliance with PFRSs / IFRSs. Financial statements shall present fairly
the financial position, performance and cash flows of an entity. Fair presentation requires the
faithful representation of the effects of transactions, other events and conditions in accordance
with the definitions and recognition criteria for assets, liabilities, income and expenses set out in
the Framework. The application of PFRSs/IFRSS, with additional disclosure when necessary, is
presumed to result in financial statements that achieve fair presentation. (PAS 1, par. 15)
Going concern. Financial statements shall be prepared on a going concern basis unless
management either intends to liquidate the entity or to cease trading, or has no realistic
alternative but to do so. This means that an entity is assumed to have a continuity of life, unless
there is an evidence to the contrary. Any uncertainties that may cast doubt as to the ability of the
entity to continue as a going concern, however, should be properly disclosed. An example of
application of going concern is the use of accrual basis of accounting. (PAS 1, par. 25)
Accrual basis of accounting. An entity shall prepare its financial statements , except for cash
flow information, using the accrual basis of accounting. Under the accrual basis of accounting,
income and expenses are recognized in the period in which they relate rather ' than when the cash
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is received or paid. For example, sales on account made in 2014 that will be collected in 2015 is
recognized as sales in 2014. An insurance premium paid in 2014 covering the period 2015 is
recognized as expense in 2015; the payment is recognized as prepaid expense at the end of 2014
(PAS 1, par. 27)
Frequency of reporting. An entity shall present a complete set of financial statements (including
comparative information) at least annually. An entity chooses its own annual accounting Period -
it can adopt the calendar year or adopt a fiscal year The calendar year starts January 1 and ends
December 31 The adoption of a fiscal year may depend on the nature of business or operations of
the entity. A school for mstance may adopt an accounting period that starts June 1 and ends May
31 to coincide with the start and end of one school year. (PAS 1, par.36)
Materiality and aggregation. Each material class of similar items shall be presented separately
in the financial statements Items of dissimilar nature or function shall be presented separately
unless they are immaterial. For example cash on hand and cash deposited in various banks may
be aggregated and reported under a Single line item “Cash on hand and in banks” but trade
receivables are presented separately from nontrade receivables because of their dissimilar nature.
An entity with several prepaid items which are immaterial in amount may present these
prepayments under the line item “prepaid expenses”. (PAS 1, par. 29)
Offsetting. As a general rule, assets and liabilities, and income and expenses shall not be offset
unless required or permitted by a Standard or an Interpretation. Offsetting is deducting the
balance of an asset account from the balance of a liability account and reporting only the net
amount in the statement of financial position or deducting the balance of an income account from
the balance of an expense account and reporting only the net amount in the statement of
comprehensive income. For instance, bonds payable balance of P5 m1llion is deducted from
bond sinking fund balance of P3 million and reporting only the net amount of P2 million for
bonds payable or deducting uncollectible accounts of P1 million from sales of P75 million and
reporting only the net sales of P74 million. As a general rule, these offsetting examples are not
allowed (PAS 1 par 32) However some Standards may allow offsetting, such as the following:
(PAS 1, par. 34)
Gains and losses on disposal of. non-current assets, including investments and operating
assets are reported by deducting from the proceeds on disposal the carrying amount of the
asset and related selling expense. For example an old equipment with a carrying amount
of P250,000 was sold for P300,000 with related disposal costs of P20,000. The carrying
amount of P250,000 IS deducted from the proceeds from disposal of P280,000 and a gain
of P30,000 is reported in the statement of comprehensive income.
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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.
The objective of the statement of financial position is to report the financial condition or position
of an entity at a particular date. It shows the entity’s assets, liabilities, and equity-at a point in
time.
The statement of financial position is very useful to the financial statement users. It descn'bes the
resources of the entity that are available sources of future cash flows, such as short-term
investments, receivables and inventories. It contains information that is useful in assessing the
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liquidity and solvency of an entity. Liquidity is the entity’s ability to pay its obligations or
liabilities which are currently due. Solvency is the entity’s ability to pay both its current and
noncurrent obligations. However, the statement of financial position has certain limitations as
follows:
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.
It is controlled by an entity -the entity has the right to obtain and control the benefits
expected from the use of the asset. In determining the existence of an asset, the right of
ownership of an asset is not essential. For instance, in the case of finance lease, the
property is owned by the lessor but is reported as an asset by the lessee.
It is a result of past event - the asset arises from transaction Which occurred m the past.
It represents future economic benefits - the asset has the potential to contribute, directly
or indirectly, to the flow of cash and cash equivalents to the entity. Paragraph 4.10 of the
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F framework states that the economic benefits may flow to the entity in various ways, as
follows:
o the asset may be used singly or in combination with other assets in the
production of goods or services to be sold by the entity.
o the asset may be exchanged for other assets
It has a cost or value- the asset has a cost or a value that is measured in terms of money.
Current assets. PAS 1, paragraph 66 states that an asset shall be classified as current when it
satisfies any of the following criteria:
o it is expected to be realised in, or is intended for sale or consumption in, the entity’s
normal operating cycle (e. g. trade receivables, inventories and prepaid expenses);
o it is held primarily for the purpose of trading (e. g. trading securities);
o it is expected to be realised within twelve months after reporting period (e. g. nontrade
receivables collectible within one year); or
o it is cash or a cash equivalent (as defined in PAS 7 Statement of Cash Flows) unless it is
restricted from being exchanged or used to settle a liability for at least
twelve months after the balance sheet date (e. g. cash on hand and in bank certificates of time
deposits with a term 0fthree months or less).
The normal operating cycle of an entity refers to the period of time necessary to convert
cash to inventories, inventories to receivables, and receivables back to cash. In the Case
of a manufacturing company, it refers to the period of time necessary to convert cash to
raw materials, raw materials to finished product, finished product to receivables, and
receivables back to cash. This period can be equal to, shorter than, or longer than One
Year. When the normal operating cycle of an entity is not clearly identif1able,it1S
assumed to be twelve (12) months or one year.
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o Cash and cash equivalents. Cash is anything that can be used as a medium of
exchange and which is acceptable by bank at face value upon deposit. Cash
includes cash on hand and in banks that is available for current operations. Cash
may be in the form of bills and coins, personal checks, manager’s checks
cashier’s checks, bank drafts, and money orders. Cash on hand includes
undeposited collections, petty cash fund and change fund. Cash in bank includes
cash in savings and checking accounts.
Cash equivalents are short-term, highly liquid investments that 'are readily
convertible to known amounts of cash and which are subject to an insignificant
risk of changes in value. Normally, an investment qualities as cash equivalent
when it matures in three months or less from the date of acquisition. An example
of cash equivalent is time deposit with a term of three months or less.
o Short-term investments. These are liquid investments that do not qualify as Cash
equivalents, such as time deposit with a term of more than three months and
investment in equity or debt securities intended to be disposed within twelve (12)
months.
o Trade notes and accounts receivables. Trade receivables are those arising from
sale of goods or services.. These receivables are always reported as current assets
because they are expected to be realized in cash within one year or within the
normal operating cycle. Accounts receivable are unsecured open accounts and are
usually due 1n 30 to 60 days, depending on the credit terms offered to customers.
Notes receivable are evidenced by written promise to pay a certain amount of
money at a certain date.
o Nontrade notes and accounts receivable. These are receivables arising from
sources other than sale of goods or services, such as share subscription
receivable, interest receivable, deposit with supplier for future delivery of goods
Nontrade notes and accounts receivable are reported as current assets if they are
due within one year.
o Inventories. . Inventories are assets: (a) held for sale in the ordinary course of
business; (b) in the process of production for such sale; or (c) in the form of
materials or supplies to be consumed in the production process or in the rendering
of services. In a merchandising company, its inventory includes merchandise
acquired for sale. In a manufacturing company, its inventories include finished
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goods, work in process, and raw materials. In a service company, its inventory
includes work in progress. If the company’s inventories include biological assets,
they are reported as a separate line item.
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o Other non-current assets. These are assets that do not fall under any of the above
classification. Other non-current assets include deferred tax assets and other long-term
prepaid expenses.
LIABILITIES
Definition and Characteristics. Liabilities are defined in the Conceptual Framework for
Financial Reporting, par. 4.4 as present obligations of an entity arising from past events, the
settlement of which is expected to result in an outflow from the entity of resources embodying
economic benefits.
An obligation is a duty or responsibility to act or perform in a certain way. Such obligation may
be legally enforceable as a consequence of a binding contract or statutory requirement, such as
amounts payable for goods and services received. Obligation may also arise from normal
business practice, custom and a desire to maintain good business relations or act in an equitable
manner, such as obligation for product warranty.
A liability has the following characteristics:
o It is a present obligation. The obligation is a present obligation that arise; only when an'
asset acquired is delivered or an entity enters into an irrevocable agreement to acquire an
asset. A liability does not arise from a future commitment, such as a decision by
management to acquire asset in the future.
o It is a result of a past activity. A liability is a result of a transaction that has taken place,
such as purchase of goods on account. As stated earlier, it does not an'se 30111 a future
commitment.
in any of the following Ways: payment of cash; transfer of other assets; provision of
services; ' replacement of that obligation with another obligation; or conversion of the
obligation into equity
Recognition. A liability is recognized 1n the balance sheet
o When it is probable that an outflow of resources embodying economic benefits will result
from the settlement of a present obligation; and
o the amount at which the settlement will take place can be measured reliably.
o Nontrade notes and accounts payable. These are payable: arising from sources other
than. purchase of goods and services, such as short-term borrowings from banks and
customers’ accounts with debit balances.
o Unearned revenues. Unearned revenues represent cash received for goods 0! services to
be provided in a future period, such as rent received six months in advance and
subscription for magazines or books received one year in advance.
o Currently maturing portion of long-term debt. This is the portion of a long-term debt
that is maturing within the next twelve months from the balance sheet date.
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Non-current liabilities, PAS 1 states that all liabilities that do not qualify as current are
classified as non-current. Noncurrent liabilities include long-term notes, bonds payable,
mortgage payable and deferred income tax liability. The payment terms, interest rates, and
.other details that enable readers of financial statements evaluate the impact of the 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 from operations.
Components. The components of the equity section of the statement of financial position
depends on the type of business organization. In a single proprietorship and partnership, the
equity section shows the capital account of the owner and the partners, respectively. The
cap1ta1 account balance represents the cumulative amount of investment and profit, less
Withdrawals and losses from operations.
In a corporation, the equity section of the statement of financial position is called
Shareholders’ Equity or Stockholders’ Equity. The shareholders’ equity is generally
composed of Contributed Capital and Retained Earnings. In some instances, a corporation
may have capital maintenance adjustment accounts such as revaluation surplus and net
unrealized gain or loss on long term investments that are shown . separately in the equity
section. These two components of the corporate equity were mentioned in Chapter 9 of this
book.
PAS I does not specify a specific format or arrangement of the three elements when
presented in the statement of financial position. However, in the Philippines, the common
practice is to present these elements as follows current assets followed by non-current assets;
current liabilities followed by non-current liabilities; and equity accounts after liabilities. A
different arrangement may be followed by an entity depending on its nature of business.
b. investment property;
c. intangible asses;
d. financial assets (excluding amounts shown under (e), (h), and (i);
e. investments accounted for using the equity method;
f. biological asses;
g. inventories;
h. trade and other receivables;
i. cash and cash equivalents;
j. the total of assets classified as held for sale and assets included in disposal groups
classified as held for sale;
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l. provisions;
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;
An entity shall disclose, either on the face of the statement of financial position (balance sheet)
or in notes, further subclassification of the line items presented, classified in a manner
appropriate to the entity's operations. The details provided in the subclassification may depend
on the requirements of the PFRSs and on the size, nature, and functions of the amounts involved.
Some examples follow:
15. items of property, plant and equipment are disaggregated into classes, such as land,
buildings and equipment;
16. receivables are disaggregated into amounts receivable from trade customers, receivables
from related parties, prepayments and other amounts;
17. inventories are subclassified into classifications such as merchandise inventory or
finished goods inventory, work in process inventory, and raw materials inventory;
18. provisions are disaggregated into provisions for employee benefits and other items; and
19. equity capital and reserves are disaggregated into various classes, such as contributed
capital and additional paid-in capital.
Form of the Statement of Financial Position (Balance Sheet). The statement of financial
position may be prepared using the report form or the account form. Under the report form, the
elements of the balance sheet are presented similar to a presentation of report. The statement
starts with the Assets, followed by the Liabilities and then the Capital of the owner or the capital
of the partners or shareholder's equity in a corporate form of organization. Under the account
form, the Assets are presented on the left side of the statement while the Liabilities and Equity
are presented in the right side of the statement. The account form is normally used when an
entity maintains a great number of balance sheet accounts. Figures 11.1 and 11.2 show pro-forma
balance sheet using the two forms discussed above.
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ABC Company
Statement of Financial Position
December 31, 20XX
Assets Liabilities
Current assets: Current liabilities:
Cash Pxxx Notes payable Pxxx
Short-term investments xxx Accounts payable xxx
Notes and accounts receivable Pxxx Short-term bank loan xxx
Less Allowance for Uncollectibles xxx xxx Income tax payable xxx
Other receivables xxx Accrued liabilities xxx
Inventories xxx Unearned revenue xxx
Prepaid expenses xxx Current portion of long-term debt xxx
Total current assets Pxxx Total current liabilities xxx
Long-term investments Non-current liabilities:
Investment in equity securities Pxxx Notes payable Pxxx
Investment in funds xxx xxx Mortgage payable xxx
Property, plant and equipment: Bonds payable, net of discount xxx
Land Pxxx Deferred tax liability xxx xxx
Buildings (net of acc. depreciation) xxx Total liabilities xxx
Equipment (net of acc. depreciation) xxx xxx Shareholders' Equity
Biological assets xxx Contributed capital:
Intangible assets: Share capital Pxxx
Patent Pxxx Additional paid-in capital xxx
Franchise xxx xxx Total contributed capital Pxxx
Investment property xxx Retained earnings xxx
Other assets: Total shareholders' equity xxx
Deferred Tax assets xxx
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ABC Company
Statement of Financial Position
December 31, 20XX
Assets
Current assets:
Cash Pxxx
Short-term investments xxx
Notes and accounts receivable Pxxx
Less Allowance for Uncollectibles xxx xxx
Other receivables xxx
Inventories xxx
Prepaid expenses xxx
Total current assets Pxxx
Long-term investments
Investment in equity securities Pxxx
Investment in funds xxx xxx
Property, plant and equipment:
Land Pxxx
Buildings (net of acc. depreciation) xxx
Equipment (net of acc. depreciation) xxx xxx
Biological assets xxx
Intangible assets:
Patent Pxxx
Franchise xxx xxx
Investment property xxx
Other assets:
Deferred Tax assets xxx
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INCOME STATEMENT
The income statement shows the performance of an entity at a given period of time. The
statement reports the income earned and the expenses incurred at a particular period of time.
The objective of the statement of income statement is to provide information about the
performance of an entity that is useful to a wide range of users in making economic decisions.
The measure of performance is the profit or loss of an entity.
INCOME
Definition. Income is defined in paragraph 4.25 of the FRSC Conceptual Framework for
Financial Reporting as increases in economic benefits during the accounting period in the form
if inflows or enhancements of assets or decreases of liabilities that result in increases in equity,
other than those relating to contributions from equity participants. Contributions from equity
participants refer to the investments by owners of the entity. Such investments should not be
considered income of the entity.
Income encompasses both revenue and gains. Revenue arises in the course of the ordinary
activities of an entity and is referred to by a variety of different names including sales, fees,
interest, dividends, royalties and rent. Gains are increases in economic benefits arising from
peripheral or incidental activities, such as those arising from sale of plant assets and sale of
investments. Gains are generally reported net of related expenses. For example, the gain on sale
of equipment is the amount remaining after deducting the carrying amount and other disposal
costs from the selling price of the asset.
Income also includes unrealized gains, such as those arising from revaluation of marketable
securities and those arising from increases in the carrying amount of long-term assets.
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EXPENSES
Definition. Paragraph 4.25 of the FRSC Conceptual Framework for Financial Reporting defines
expenses as decreases in economic benefits during the accounting period in the form of out flows
or depletions of assets or incurrences of liability that result in decreases in equity, other than
those relating to distributions to equity participants. Distributions to equity participants refer to
withdrawals by the sole proprietor/partners or distribution of dividends to the shareholders. Such
distributions are not considered expenses of the entity.
Expenses encompass both losses and expenses that arise in the course of the ordinary activities
of the entity, such as cost of sales, wages, depreciation, supplies, and utilities. Losses represent
other items that meet the definition of expenses and may, may or not, arise in the course of the
ordinary activities of the entity. Losses include those resulting from disasters such as fire and
flood, and those arising from disposal of non-current assets. Losses are normally reported net of
related income.
Expenses also include unrealized losses, such as those arising from the effects of increases or
decreases in the foreign exchange rate in respect of borrowings of an entity in that currency.
Recognition. Paragraph 4.49 of the FRSC Conceptual Framework states that expenses are
recognized in the income statement when a decrease in future economic benefits related to a
decrease in an asset or an increase of a liability as arisen that can be measured reliably.
Therefore, the recognition of expenses occurs simultaneously with the recognition of an increase
in liabilities or a decrease in assets.
Expenses are recognized under one of the following expense recognition principles:
5. Direct matching (associating cause and effect). When costs can be associated with
revenue, such costs are charged to expense in the period in which the related revenue is
recognized. Examples are cost of goods sold, sales commission expense and warranty
expense.
6. Systematic and rational allocation. When costs cannot be associated with revenue but
can be associated with future periods, such costs are charged to expense over the periods
benefited. Examples are depreciation of plant assets, amortization of intangible assets,
and allocation of insurance premium over the covered period.
7. Immediate recognition. When an expenditure produces no future economic benefits or
when, and to the extent that, future economic benefits do not qualify, or cease to qualify,
for recognition in the balance sheet as an asset, such expenditure is recognized
immediately as an expense. Examples are repairs and maintenance and advertising
expense.
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PAS 1, par. 82, states that as a minimum, the face of the income statement shall include line
items that present the following amounts for the period:
a. revenue;
aa. gains and losses arising from the recognition of financial assets measured at amortized
cost;
b. finance costs;
c. share of the profit or loss of associates and joint ventures accounted for using the equity
method;
ca. if a financial asset is reclassified so that it is measured at fair value, ang gain or loss
arising from a difference between the previous carrying amount and its fair value at thr
reclassification date (as defined in PFRS 9);
d. tax expense;
e. a single amount comprising the total of
i. the post-tax profit if discontinued operations and
ii. the post-tax gain or loss recognized on the measurement to fair value less costs to sell
or on the disposal of the assets or disposal group(s) constituting the discontinued
operations;
f. profit or loss;
g. each component of other comprehensive income classified by nature (excluding amounts
in h;
h. share of other comprehensive income of associates and joint ventures accounted for using
the equity method; and
i. total comprehensive income
If an entity prepares a separate income statement, only items a to f will be presented in the
statement; items g to i will be presented in the separate statement of comprehensive income
Classification of expenses in the income statement. PAS 1 states that an entity may present an
analysis of its expenses using the nature of expense method or the functional method.
Nature of expense method. Under this method, expenses are aggregated in the income
statement according to their nature and are not reallocated among various functions within the
entity. Examples of grouping of expenses under this method are: depreciation, purchases of raw
materials, employee costs, and advertising costs.
Function of expense or cost of sales method. Under this method, expenses are classified
according to their function as part of cost of sales, cost of distribution (selling expenses), or
administrative activities (general or administrative expenses). This method can provide more
relevant information to users than the nature of expense method.
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Figure 11.3 and 11.4 show pro-forma income statement using the two methods.
ABC Company
Income Statement
For the Year Ended December 31, 20XX
Revenue Pxxx
Other income xxx
Increase (decrease) in merchandise inventory (xxx)
Net purchases of merchandise (xxx)
Employee benefit expense (xxx)
Depreciation expense (xxx)
Amortization expense (xxx)
Supplies expense (xxx)
Utilities expense (xxx)
Other expenses (xxx)
Finance cost (interest expense) (xxx)
Share of profit of associate xxx
Profit before tax Pxxx
Income tax expense (xxx)
Profit for the period Pxxx
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ABC Company
Income Statement
For the Year Ended December 31, 20XX
Revenue Pxxx
Cost of sales:
Inventory, beginning Pxxx
Net purchases xxx
Cost of goods available for sale Pxxx
Less inventory, end xxx xxx
Gross Profit Pxxx
Other income xxx
Distribution costs (selling expenses) (xxx)
Administrative expenses (xxx)
Other expenses (xxx)
Finance cost (interest expense) (xxx)
Share of profit of associate xxx
Profit before tax Pxxx
Income tax expense (xxx)
Profit for the period Pxxx
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Notes:
6. The revenue section represents revenue from the major activity if the entity, that is, sale
of goods for a merchandising or trading company and sale of services for a service
company.
7. Other income includes interest income and gain from sale of assets other than inventories,
such as gain from sale of investment.
8. Other expenses include loss from sale of assets other than inventories, such as loss from
sale of equipment.
9. The share of profit of associates is the share of the entity in the reported profit of an
investee company called associate. Accounting for investment in associate is a topic to be
discussed in financial accounting.
STATEMENT OF COMPREHENSIVE INCOME
The statement of comprehensive income reports items of income and expenses which are not
required by other PASs and PRFSs to be recognized in profit or loss. Examples are changes in
revaluation surplus when property, plant and equipment are reported using the revaluation model
and gains and losses arising from changes in fair vakue of available-for-salr securities.
PAS 1, par. 106, requires an entity to present a statement of changes in equity that should include
the following:
7. total comprehensive income for the period, showing separately the amount due to owners
of the parent and to non-controlling interest;
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The statement of cash flows is one of the basic components of a complete set of financial
statements. The objective of the statement of cash flows is to provide information about the cash
receipts and cash disbursements of an entity that occurred during a period. The statement
summarizes the transactions that caused a change in the cash balance during a reporting period.
A cash flow statement provides the following benefits as stated in PAS 7, par. 4:
e. it provides information that enables the users to evaluate the changes in the assets if an
entity, its financial structure and its ability to affect the amounts and timing of cash flows
in order to adapt to changing circumstances and opportunities;
f. it provides information that is useful in assessing the ability of the entity to generate cash
and cash equivalents and enables users to develop models to assess and compare the
present value of the future cash flows of different entities;
g. it enhances the comparability of the reporting of operating performance by different
entities because it eliminates the effects of rising different accounting treatments for the
same transactions and events.
CLASSIFICATION OF CASH FLOWS
Cash flows are classified to make the statement more meaningful to the investors and creditors
by enabling them to determine the type of transaction that gave rise to each cash flow. Cash
flows are categorized into three: (a) operating activities; (b) investing activities; and (c) financing
activities.
Operating activities. Cash flows from operating activities are derived from the principal revenue-
producing activities of an entity. They represent the cash inflows and outflows of cash that
resulted from activities reported in the income statement. Thus, this classification of cash flows
includes the elements of income statement reported on a cash basis rather that an accrual basis.
For instance, cash flows from sales show the amount
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of cash received from customers during the period sales that were made in prior or current period
or for future sales.
Cash received from (cash inflow) Cash paid for (cash outflow)
customers for sale of goods and services purchase of inventory
Table 11.1 - Sample transactions or activities giving rise to cash flows from operating activities
Investing activities. Cash flows from investing activities include cash inflows and outflows of
cash related to acquisition and disposition of long-term assets used in operations of the business
and investment assets.
Cash received from (cash inflows) Cash paid for (cash outflows)
sale of long-term investment purchase of long-term investment
Table 11.2 - Sample transactions or activities giving rise to cash flows from investing activities.
Financing activities. Cash flows from financing activities include cash inflows from borrowings
and contributions by investors and cash outflows for repayment of loans, retirement of share
capital, acquisition of treasury shares and payment of cash dividends.
Cash received from (cash inflows) Cash paid for (cash outflows)
bank loan payment of bank loan
dividends
Table 11.3 - Sample transactions or activities giving rise to cash flows from financing activities
Methods of presenting cash flows from operating activities. There are two methods of
presenting the cash flows from operating activities: the direct method and the indirect method.
Direct method. Under the direct method, the major classes of gross receipts and gross cash
payments are disclosed in the statement. The information about these major classes may be
obtained either:
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by adjusting sales, cost of sales (interest and similar income and interest expense and
similar charges for a financial institution) and other items in the income statement for:
changes during the period in inventories and operating receivables and payables;
other non-cash items; and
other items for which the cash effects are investing and financing cash flows.
Indirect method. Under the indirect method, the net cash flow from operating activities is
determined by adjusting profit or loss for the effects of:
changes during the period in inventories and operating receivables and payables;
non-cash items such as depreciation, provisions, deferred taxes, and realized
foreign currency gains and losses; and
all other items for which the cash effects are investing or financing cash flows.
ABC Company
Statement of Cash Flows
For the Year Ended December 31. 200x
ABC Company
Statement of Cash Flows
For the Year Ended December 31, 200x
ABC Copay reported the following cash receipts and cash payments for year 2014:
Cash receipts:
Proceeds from sale of equipment P80,000
Proceeds of bank loan 200,000
Collections from customers 600,000
Proceeds from issuance of share capital 60,000
Cash payments:
To suppliers for merchandise purchases 390,000
For purchase of machinery 97,500
For purchase of machinery 22,500
For bank loan 50,000
For dividends 39,000
For income taxes 66,000
For operating expenses 100,000
The cash and cash equivalent balance at the beginning of the year is P120,000.
Net increase in cash and cash equivalents Pxxx
Cash and cash equivalents at the beginning of the period xxx
Cash and cash equivalents at the end of the period Pxxx
Pigure 11.5 Pro-forma Statement of Cash Flow-Indirect method
Illustrative Problem B
ABC Company provides the following income statement for the year 2014:
Sales P4,180,000
Cost of sales 2,275,000
Gross profit P1,905,000
Depreciation expense (190,000)
Salaries expense (600,000)
Other operating expenses (437,500)
Interest expense (61,000)
Profit before taxes P 616,500
Income taxes (184,950)
Profit P 431,550
Additional information:
Income taxes paid amounted to P60,000
Interest paid amounted to P62,500
Proceeds from sale of equipment at carrying value, P50,000
Cash paid to purchase and equipment, P75,000
Collection of loans receivable, P100,000
Proceeds from issuance of share capital, P80,000
Repayment of of bank loan, P150,000
Payment of dividends, P50,000
Cash and cash equivalent, January 1, 2014, P350,000
A statement of cash flow using the indirect method is presented on the next page.
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ABC Company
Statement of Cash Flow
For the Year Ended December 31, 2014
Notes:
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The cash and cash equivalents at December 31, 2014 is the amount that is report in the
December 31, 2014 balance sheet.
The direct and the indirect methods differ only in the presentation of the cash flows
from operating activities section; the investing and financing activities sections are
presented similarly under the two methods.
A more in-depth analysis of transactions that should be presented in the statement of cash flows
is discussed in intermediate accounting. In this chapter, the details of cash receipts and cash
payments are given for problem solving purposes.
Notes to financial statements include narrative descriptions or more detailed analyses of amounts
shown on the face of the financial statements. The notes include information required and
encouraged to be disclosed by PASs and PFRSs and other disclosures necessary to achieve fair
presentation.
Notes are considered an integral part of the financial statements which contains the following
information:
the basis of preparation of the financial statements and the specific accounting policies
used;
Accounting policies are the specific principles, bases, conventions, rules and
practices applied by an entity in preparing and presenting financial statements.
information required by PFRSs that is not presented elsewhere in the financial
statements; or
additional information that is not presented elsewhere in the financial statements, but is
relevant to an understanding of any of them.
Notes must present information in a systematic order and cross referenced to statement of
financial position, statement of comprehensive income (or income statement if presented
separately), statement of changes in equity and statement of cash flows. Following is the
recommended order of presentation of information in the notes stated in PAS 1, par. 114:
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Intra company comparisons is- comparing one period with another period, such as
comparing 2014 with 2013.
Intercompany comparisons - comparing one company with another company or with
other companies in the same industry.
Industry average comparison comparing an entity's computed ratios with industry
standards.
Ratios can be grouped into the following: liquidity ratios, solvency ratios, and liquidity ratios.
Each of these is discussed below.
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Liquidity ratios measure the short-term ability of the entity to pay its maturing obligations and to
meet unexpected needs for cash. The measures that can be used to determine the liquidity of an
entity are the current ratio, the quick or acid -test ratio, the current cash debt coverage ratio, the
receivables turnover ratio, the average collection period, the inventory turnover ratio, and the
days in inventory.
Solvency ratios measure the ability of the entity to survive over a long period of time, that is, its
ability to pay interest as it come due and to repay the face value of obligations or debt at
maturity. The measures that can be used to determine the solvency of an entity are the debt to
total assets ratio, the time interest earned ratio, the cash debt coverage ratio and free cash flow.
Profitability ratios measure the profit or operating success of an entity for a given period of time.
An entity's ability or inability to generate profit has several consequences - it affects an entity's
liquidity position and its ability to grow; hence, affecting its ability to obtain loans and to attract
investors. The measures that can be used to determine the profitability of an entity are the return
on ordinary shareholder’s equity ratio, the return on assets ratio, the profit margin ratio, the
earnings per share, the price-earnings ratio, and the payout ratio.
A summary of these ratios, the formula to calculate them and other uses are presented below and
on the next page.
LIQUIDITY RATIOS
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LIQUIDITY RATIOS
SOLVENCY RATIOS
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PROFITABILITY RATIOS
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Market price of share capital Measures the ratio of the market price
Price-earnings ratio
Earnings per share per share to earnings per share
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1. Explain the nature of the financial statements and the over-all considerations in their
preparation and presentation.
Financial statements are a structured representation of the financial position and financial
performance of an entity.
Financial statements are the end product of the accounting process
Financial statements show the results of the management's stewardship of the resources
entrusted to it.
Financial statements are the means by which the information accumulated and the
processed in financial accounting is periodically communicated to those who use it.
The preparation and presentation of financial statements is a responsibility of
management.
The over-all considerations in the preparation and presentation of financial statements are as
follows:
The statement of financial position shows the entity's assets, liabilities, and equity at a point in
time. The statement of financial position has the following three primary elements: assets,
liabilities and equity.
The income statement shows the performance of an entity incurred at a given period. It reports
the income earned and the expenses incurred at a particular period of time. The statement has
two primary elements: income and expenses.
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The statement of comprehensive income reports items of income and expenses which are not
required by other PASs and PRFSs to be recognized in profit or loss, such it changes in
revaluation model and gains and losses arising from changes in fair value of available for sale
securities.
The statement of changes in equity reports transactions affecting the various equity accounts,
such as the profit or loss for the period, dividends declared, additional issuances of share capital,
and acquisition treasury shares.
The statement of cash flows provides information about the cash receipts and cash disbursements
of an entity that occurred during a period. It summarizes the transactions that caused a change in
the cash equivalents balance during a reporting period.
The notes include narrative descriptions or more detailed analyses of amounts shown on the face
of the financial statements.
3. Explain and appreciate the importance of the statement of cash flows. The statement of
cash flows provides the following benefits:
it provides information that enables the users to evaluate the changes in the assets of an
entity, its financial structure and its ability to affect the amounts and timing of cash flows
in order to adopt to changing circumstances and opportunities;
it provides information that is useful in assessing the ability of the entity to generate cash
and cash equivalents and enables users to develop models to assess and compare the
present value of the future cash flows of different entities;
it enhances the comparability of the reporting of operating performance by different
entities because it eliminates the effects of using different accounting treatments for the
same transactions and events.
4. Describe and explain the classification of cash flows and the methods of presenting cash
flows from operating activities. Cash flows are classified to make the statement more
meaningful to the investors and creditors by enabling them to determine the type of transaction
that gave rise to each cash flow. Cash flows are categorized into three: (a) operating activities;
(b) investing activities; and (c) financing activities.
Operating activities. Cash flows from operating activities are derived from the principal
revenue-producing activities of an entity.
Investing activities. Cash flows from investing activities include cash inflows and outflows of
cash related to the acquisition and disposition of long term assets used in the operations of the
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Financing activities. Cash flows from financing activities include cash inflows from borrowings
and contributions by investors and cash outflows for repayment of loans, retirement of share
capital, acquisition of treasury shares and payment of cash dividends.
Cash flows from operating activities may be presented using the direct method or the indirect
method. Under the direct method, the major classes of gross receipts and gross cash payments
are disclosed in the statement. Under the indirect method, the net cash flow from operating
activities is determined by adjusting profit or loss for the effects of non-cash revenue and
expense items and gain and losses.
4. Explain and appreciate the types of ratio analysis. Ratios express the mathematical
relationships between one quantity and another, in terms of a rate, a proportion, or a percentage.
For example, the ratio of gross profit to sales is 45% or the ratio of current assets to current
liabilities is 2:5:1. Ratio analysis expresses the relationship among selected financial statement
data. Ratios are used to evaluate the financial health and performance of a company.
Ratios can be grouped into the following: liquidity ratios, solvency ratios, and liquidity ratios.
Each of these is discussed below.
Liquidity ratios measure the short term ability of the entity to pay its maturing obligations and to
meet unexpected needs for cash. Solvency ratios measure the ability of the entity to survive over
a long period of time, that is, its ability to pay interest as it come due and to repay the face value
of obligations or debt at maturity. Profitability ratios measure the profit or operating success of
an entity for a given period of time. An entity's ability or inability to generate profit has several
consequences -- it affects an entity's liquidity position and its ability to grow; hence, affecting its
ability to obtain loans and to attract investors.
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DISCUSSION QUESTIONS
2. What are the components of a complete set of financial statements? Describe each of them.
4. What are the overall considerations in the preparation and presentation of financial
statements?
5. Why is the statement of cash flows important? How does it help financial statement users
make decisions?
6. Identify and differentiate the three types of activities that give rise to cash inflow and cash
outflow.
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EXERCISES
ABC Company uses the following classification in its statement of financial position:
Instructions: For each of the following 2014 balance sheet items, use the letters above to indicate
the appropriate classification category. If the item is a contra account, place a minus sign (-)
before the chosen letter (for example: -b)
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CDE Company's trial balance include the following account balances at December 31, 2014, the
end of its fiscal year:
3. Total assets
4. Retained earnings
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1. Purchase of computer
2. Payment of salaries
4. Purchase of merchandise
9. Payment of dividends
10. Depreciation
EFG Company reported a profit of P500,000 in 2014. The following information were provided
by the company in relation to preparation of the statement of cash flows:
Depreciation - P50,000
Instructions: Compute the net cash provided by operating activities using the indirect method.
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The following T-account is a summary of the cash account of the GHI Corp.
Cash
Balance, Jan. 1 160,000 Payment for goods acquired
Receipt from customers 4,000,000
7,280,000 Payment for operating expenses
Dividends on stock investment 2,800,000
120,000 Interest paid 200,000
Proceeds from sale of equipment Taxes paid 160,000
720,000 Dividends paid 1,000,000
Proceeds from issuance of bonds
Instructions: Compute for the net cash provided
4,000,000 (used) by financing activities.
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The following balances were taken from the most recent statement of financial position of HIJ
Company:
1. Current ratio
2. Acid/test ratio
The following data were taken from the financial statements of JKL Corp.:
2014 2013
Instructions:
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The following data were taken from the financial statements of LMN Company:
2014 2013
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PROBLEMS
The following listed data were taken from the most recent balance sheet of NOP Corp. some of
the amounts were intentionally omitted
Inventories ?
Total assets ?
Accounts payable ?
Instructions:
The following transactions were reported for PQR during the year 2014
maturity
Instructions: Fill up the table below by indicating whether the transaction (1) should be reported
as an operating (O) activity, investing (I) activity, financing (F) activity, or as a non cash (NC)
transaction reported in a separate schedule, and (2) represents a cash inflow or cash outflow or
has no cash effect. The company uses the indirect method in presenting the cash flow from
operating activities.
RST Company
December 31
RST Company
Income Statement
Sales P 4,840,000
Additional information:
2. During the year, equipment was sold for P170,000 cash. This equipment was originally
acquired for P360,000 and has a book value of P170,000 on the date of sale.
The comparative financial statements of STU Inc. are presented on the next page.
4
STU Company
Comparative Statement of Financial Position
December 31
Current assets:
Current liabilities:
Shareholders’ equity
STU Company
Comparative Income Statement
For the Years Ended December 31
2014 2013
All sales were on account. Net cash provided by operating activities for 2014 was P6,040,000.
6
Instructions: Compute the following ratios for 2014 (round off answers to two decimal places):
Selected data from the 2014 consolidated financial statements for the GHI Corp. and JKL
Company are presented below (in millions of pesos).
GHI JKL
1. Compute the following liquidity ratios for 2014 for the competitor companies and comment
on their relative liquidity.
a. Current ratio
b. Receivable turnover
c. Average collection period
d. Inventory turnover
e. Days in inventory
f. Current cash debt coverage
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
2. Compute the following solvency ratios for the two companies and comment on their relative
solvency.
a. Debt to total assets ratio
b. Times interest earned
c. Cash debt coverage ratio
3. Compute the following profitability ratios for the two companies and comment on their
relative profitability.
a. Profit margin
b. Asset turnover
c. Return on assets
d. Return on ordinary shareholders’ equity
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
MULTIPLE CHOICE
MC 11-1 The structured financial representation of the financial position of and the
transactions undertaken by an enterprise are called
a. financial reports
b. annual reports
c. financial statements
d. financial plans
MC 11-2 The financial statement that shows the results of management’s stewardship of the
resources entrusted to it is the
a. management
b. accounting managers
c. internal auditor
d. independent auditor
MC 11-4 The financial statement that shows the financial position of an entity is the
MC 11-5 The cash flows shown in the statement of cash flows are grouped into the
following major categories:
MC 11-8 The following information for AXN Corp.: Net profit for 2014 is P264,900,
account payable increased P20,000 during the year, inventory decreased P12,000
during the year, and accounts receivable increased P24,000 during the year. Under
the indirect method, what is the net cash provided by operations?
a. P204,000
b. P224,000
c. P248,000
d. P272,000
a. Current ratio
b. Inventory turnover ratio
c. Receivable turnover ratio
d. Asset turnover ratio
MC 11-12 AB Company reported net profit of P480,000; net sales of P8,000,000; and
average assets of P12,000,000 for 2014. What is the profit margin for 2014?
a. 6%
b. 12%
c. 40%
d. 200%
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
CHAPTER 12
INTRODUCTION TO COST ACCOUNTING
LEARNING OBJECTIVES
1. Discuss the nature of cost accounting and differentiate a manufacturing company from a
service company and a merchandising company.
3. Discuss and understand the manufacturing cycle, including the journal entries to record
various transactions related to the cycle.
Cost accounting, which is a specialized field of accounting, emphasizes the determination and
control of costs. It is concerned primarily with the costs of manufacturing processes and
manufactured products. Cost determination, also known as product costing, deals with measuring
the resources used to complete an activity or unit output. Cost control, on the other hand, is
management’s way of efficiently dealing with the activities that incur costs.
Though cost accounting is usually considered only to apply to manufacturing operations, every
type and size of organization should benefit from its use. It informs management promptly with
the cost of rendering a particular service, buying and selling a product, and producing a product.
Cost accounting principles, therefore, may be applied by financial institutions, transportation
companies, churches, schools, governmental units, as well as the non-manufacturing activities of
manufacturing firms.
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:
A manufacturing company differs primarily from a merchandising company from the standpoint
of converting or transforming the good purchased, called raw materials, into another form of
product before selling them. The process of converting or transforming materials into another
form of product is called the manufacturing process. The manufacturing process involves the
three cost elements: direct materials, direct labor, and factory overhead. The sum of these three
cost elements is the manufacturing cost, often called production cost or factory cost.
Direct materials include all the materials that form an integral part of the finished product
whose value is relatively high and that can be included directly in calculating the cost of the
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
product. Examples are the lumber and steel used to make classroom tablet chairs. Materials
needed for the completion of a product but do not form an integral part of the finished product or
whose amount is so minimal may be classified as indirect materials.
Direct labor is labor expended to convert direct materials into a finished product. It has to be
traceable to the finished product though need not be relatively high in amount. Example is the
wage of the machine operator cutting and assembling the lumber and steel used in the production
of classroom tablet chairs. The salary of a supervisor which cannot be traced to a product is
indirect labor.
Example of indirect materials are factory supplies and lubricants. Examples of indirect labor are
supervision; inspection; salaries of factory clerks, janitors and security guards; defective and
experimental work. Examples of other indirect costs are factory rent; depreciation of machinery
and factory building; maintenance and repairs; heat, light and power; employee factory payroll
taxes; small tools and other miscellaneous factory overhead.
MANUFACTURING CYCLE
Cost accounting consists of a system that is concerned with precise recording and measurement
of cost elements as they originate and flow through the production processes. There are two
accounting systems that may be employed by manufacturing firms, namely: (1) Cost system or
perpetual inventory system, and (2) Non-cost system or periodic inventory system. The
manufacturing process and the physical arrangement of the factory are the basis for determining
the cost accumulation procedures.
The non-cost system or periodic inventory system will be used to illustrate the entries in the
manufacturing cycle. Under this system, there is no detailed flow of cost in the manufacturing
process. The inventory of raw materials, work in process and finished goods are determined
based on physical count of quantities on hand at the end of the accounting period. These
inventories, together with the purchases, labor and overhead, are used to compute for the cost of
materials used in production, cost of goods manufactured and transferred to finished goods, and
cost of goods sold during the period.
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
Assuming the use of the voucher system, the following are the pro-forma journal entries in the
manufacturing cycle.
5. Requisition of raw materials for production and indirect materials for factory use
No entry
6. Return to storeroom of excess raw materials from production and indirect materials for
factory use
No entry
7. Recording to payroll
Direct Labor xxx
Indirect Labor xxx
Administrative Salaries xxx
Sales Salaries xxx
Withholding Taxes Payable xxx
SSS Contributions Payable xxx
Medicate Contributions Payable xxx
Pag-ibig Contributions Payable xxx
Vouchers Payable xxx
8. Payment of payroll
Vouchers Payable xxx
Cash xxx
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
16. Adjusting entries. Adjustment to update the balances of accounts at the end of fiscal period
may include the following:
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:
In the income statement, the Cost of Goods Sold is shown in one figure. Although this procedure
is followed in published reports, internal users need additional information. Therefore, a
supporting schedule of the Cost of Goods Manufactured is usually prepared. A pro-forma
Statement of Cost of Goods Manufactured and Sold that contains all possible includable items is
presented below.
Direct Materials:
Raw Materials Inventory, beginning Pxxx
Raw Materials Purchases Pxxx
Add Freight-in xxx
Delivered Cost of Materials Purchases Pxxx
Less: Purchases Returns and Allowances Pxxx
Purchases 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
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 Manufactured Pxxx
Add Finished Goods, beginning xxx
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
On the Statement of Financial Position (balance sheet) of a manufacturing enterprise, the current
asset section is expanded to show the Inventories of Finished Goods, Work in Process and Raw
Materials. The balance in the Finished Goods account represents the total cost incurred in
manufacturing goods that are completed but still on hand (unsold) at the end of the period. The
balance of the Work in Process account includes all manufacturing costs incurred to date for
goods that are in various stages of production (not yet completed). The balance of the Raw
Materials account represents the cost of all materials purchased and on hand and to be used in the
manufacturing process (to be used in production) including raw materials, prefabricated parts
and other factory materials and supplies.
2. Identify the elements of manufacturing costs. There are three elements of manufacturing
costs, namely: (1) direct materials, (2) direct labor, and (3) factory overhead. Direct
materials form an integral part of the finished product and whose value is relatively high.
Direct labor can be traced to the finished product and is incurred to convert direct
materials into finished goods. Factory overhead included all indirect costs incurred in the
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
production of raw materials into finished goods. These costs include indirect materials
and indirect labor. Direct materials plus direct labor is prime cost; direct labor plus
factory overhead is conversion cost.
3. Discuss and understand the manufacturing cycle, including the journal entries to
record various transactions related to the cycle. The manufacturing cycle starts with the
purchase of raw materials and ends with the completion of goods. Direct materials issued
to production, direct labor cost and factory overhead costs go to work in process. Cost of
goods completed during the period are transferred from work in process to finished goods
while the cost of finished goods sold are transferred from the finished goods to cost of
goods sold.
4. Prepare a Statement of Cost of Goods Manufactured and Sold. The Statement of Cost
of Goods Manufactured and Sold is prepared as a supporting schedule to the amount
presented on the income statement. The statement shows the total manufacturing cost
incurred, the total cost of work put into process, the total cost of goods manufactured
during the period, the total cost of goods available for sale, and the total cost of goods
sold during the period.
Direct labor - labor used to convert direct materials into finished product and that can be
traced to the finished product
Direct materials - materials that form an integral part of a finished product and of relatively
high value and is included in the calculation of the cost of the product.
Factory overhead - manufacturing expenses or factory burden other than direct materials and
direct labor. Factory overhead includes indirect materials and indirect labor
DISCUSSION QUESTIONS
1. How many different types of organizations benefit from cost accounting and principles?
4. Define the following costs: direct materials, indirect materials, direct labor, indirect
labor, and factory overhead.
6. Differentiate the income statement of a manufacturing firm from that of a service firm
and a merchandising firm.
7. How are inventories determined in the non-cost system or periodic inventory system of
accounting for manufacturing companies?
9. What is cost of goods manufactured? How does it relate to cost per unit?
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
EXERCISES
The Liwanag Manufacturing Company does not have a cost accounting system. From its
accounting records it prepares the following financial statements on a yearly basis (a) Income
Statement; (b) Retained Earnings Statement; (c) Statement of Financial Position.
Instructions: Indicate the financial statement in which each of the items given below will appear.
Use the appropriate letter or letters.
1. Direct Labor 11. Cost of Goods Manufactured
2. Raw Materials, January 1 12. Factory Maintenance Salaries
3. Work in Process, December 31 13. Depreciation- Delivery Equipment
4. Finished Goods, January 1 14. Cost of Goods Available for Sale
5. Indirect Labor 15. Direct Materials Used
6. Cost of Operating the Billing Dept. 16. Office Supplies Used
7. Depreciation - Office Building 17. Heat and Electricity for Factory
8. Depreciation- Machinery 18. Office Supplies
9. Finished Goods, December 31 19. Repairs to Roof of Factory Building
10. Work in Process, January 1 20. Cost of Raw Materials Purchases
The accounting department of Lacbay Manufacturing Company provided the following data for
the month of April, 2010.
Sales P1,440,000
Marketing Expenses 5% of sales
Administrative Expenses 1 % of sales
Raw Materials Purchases P 720,000
Factory Overhead 2/3 of direct labor costs
Direct labor P 300,000
Beginning inventories:
Finished Goods P 140,000
Work in Process 160,000
Raw Materials 120,000
Ending inventories:
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
Instructions:
1. Prepare an income statement for the month of April.
The accountant of Lazam Corporation submits the following data for the month of June, 2010.
June 1 June 30
Finished Goods P108,000 P120,000
Work in Process 160,000 128,000
Raw Materials 120,000 150,000
Instructions: Determine the amounts indicated by the question marks for each company
j. Sales on account were P 160,000, 50% of which was collected. The cost of goods sold was
75% of the sales price
Instructions: Prepare journal entries to record the preceding transactions and to close the
balances of manufacturing accounts. Assume the company uses the voucher system.
For each company, find the unknown a mounts designated by numbers. Each case is
independent.
PROBLEMS
The Libunao Furniture Corporation manufactures furniture sets for export. For the year ended
December 31, 2010, you obtained from the company's books the following information:
Work in Process, January 1, 2010 was 20% less than the work in process on December
31, 2010.
Total Manufacturing Costs added during 2010 was P3,600,000 based direct materials and
direct labor.
Manufacturing Overhead cost of the work in Process was 72% of Direct Labor Costs.
Manufacturing Overhead for the year was 25% of Total Manufacturing Costs.
Cost of Goods Manufactured was P3,400,000 ,
Instructions:
1. Determine the total cost of work in process on December 31, 2010
2. Determine the total cost of goods put into process
3. Determine the total cost of direct materials used.
The general ledger of Lamasan Company contained the following account balances as of July 1, 2010
Cash P200,000
Accounts Receivable 120,000
Finished Goods 70,000
Work in Process 36,000
Raw Materials 100,000
Vouchers Payable 36,000
Ordinary Share Capital 400,000
Retained Earnings 90,000
Instructions:
1. Prepare journal entries to record the preceding transactions including the closing entries. Assume the
use of voucher system.
2. Prepare a statement of cost of goods sold for the month of July
3. Prepare an income statement for the month ended July 31, 2010 entries.
4. Prepare a statement of financial position (balance sheet) as of July 31, 2010
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
The Lesaca Production Company presents the following selected general ledge showing balances at
October 1, 2010.
Cash P 40,000
Finished Goods 592,000
Work in Process 164,000
Raw Materials 128,000
Prepaid Insurance 4,000
Accumulated Depreciation 280,000
Accounts Payable 108,000
MULTIPLE CHOICE
MC 12-1 Linsao Co. reported the following data for the year 2010: Gross Profit P192,000;
Cost of Goods Manufactured P680,000; Work in Process beginning P56,000;
Finished Goods, beginning P90,000; Work in Process, end P76,000; Finished
Goods, end - P104,000. How much is total Sales of the company for the year 2010?
a. P838,000 с. Р868,000
b. P858,000 d. P872,000
MC 12-2 The following information were taken from the books of Laygo Co.
Increase in Raw Materials Inventory P30,000
Decrease in Finished Goods Inventory 70,000
Raw Materials Purchased 860,000
Direct Labor payroll 400,000
Factory Overhead 600,000
There was no work in process at the beginning or at the end of the year. How much
is the cost of goods sold for the year?
a. P1,900,000 c. P1,950,000
b. P1,930,000 d. P1,990,000
MC 12-3 The following information were taken from the books of Laxa Co. for the month of
December, 2010:
December 1 December 31
Direct Materials P72,000 P60,000
Work in Process 36,000 24,000
Finished Goods 108,000 144,000
MC 12-4 Using the information in MC 12-3, what is the total conversion cost during
December?
a. P180,000 c. P288,000
b. P280,000 d. P340,000
MC 12-5 Using the information in MC 12-3, the cost of goods manufactured during
December is
a. P436,000 c. P460,000
b. P448,000 d. P472,000
MC 12-6 The following information were reported by Lapid Company for the month
September, 2010
September 1 September 30
Direct Materials P80,000 P 100,000
Work in Process 50,000 70,000
Finished Goods 120,000 140,000
MC 12-7 Using the information in MC 12-6, the cost of goods manufactured during
September is
a. P756,000 c. P796,000
b. P776,000 d. P856,000
MC 12-8 Using the information in MC 12-6 and assuming Lapid's gross profit rate of 100%
of cost, how much is September 2010 sales?
a. P 756,000 c. P1,512,000
b. P1,134,000 d. P1,890,000
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
MC12-9 The following 497 ng information were taken from the books of Laraya
Manufacturing Company for the month of June:
June 1 June 30
Direct Materials P 246,000 375,908
Work in Process 648,040 1,153,382
Finished goods 1,196,642 1,587.278
Equipment Parts and Supplies 178,600 255,458
Purchases 825,720
Direct Labor cost 428,216
Direct labor hours 16,470
Factory Overhead rate per direct labor hour P 11.00
MC 12-10 Using the information in MC 12-9, the Prime Cost added to production for the
month amounted to
a. P1,124,028 c. P1,189,672
b. P1, 165,878 d. P1,213,950
MC 12-11 Using the information in MC 12-9, the Conversion Cost added to production
amounted to
a. P609,386 c. P 737,386
b. P691,836 d. P1,305,198
MC 12-12 Using the information in MC 12-9, the Total Cost of Goods Placed in Process
a. P1,689,356 c. P1,953,238
b. P1,816,512 d. P2,050,900
MC 12-13 Using the information in MC 12-9, the Cost of Goods Manufactured amounted to
a. P691,796 c. P799,856
b. P743,866 d. P839,848
MC 12-15 Using the information in MC 12-9, direct labor cost per hour is
a. P11.00 b. P26.00
c. 16.47 d. P37.00
MC 12-16 The following dara were takem from the records of Lamtin My Company for the
month of October 2010:
October 1 October 3
Inventories:
Raw Materials ? 250,000
Work in Process 400,000 475,000
Finished Goods 300,000 390,000
MC 12-19 Using the information in MC 12-16, the cost of Raw Materials Inventory October 1
is
a. P 0 c. P280,000
b. P250,000 d. P430.000
TRUE or FALSE
Instructions: Encircle the letter T if the statement is true and the letter F if the statement is false.
T F 1. The materials, labor and overhead costs incurred to produce a product are called product
costs.
T F 2. Marketing, selling and administrative costs are the broad classification of costs incurred by a
manufacturing company.
T F 3. Lumber can be both a finished product and a material.
T F 4. Product cost consists of the sum of prime cost and conversion costs.
T F 5. Product costs are found in both service and manufacturing firms.
T F 6. The three cost elements of manufactured goods are direct materials, direct labor and
marketing costs.
T F 7. The salary paid to the manager in charge of a warehouse is an indirect labor.
T F 8. Indirect materials/factory supplies are classified as administrative expenses.
T F 9. The salary paid to factory foremen is classified as factory overhead.
T F 10. Total manufacturing cost and cost of goods manufactured are one and the same thing.
T F 11. Finished goods inventory is an asset, but inventories of materials and work in process are not
considered assets until production is completed.
T F 12. The cost of indirect materials used in production is added to the manufacturing overhead
account rather than added directly to Work in Process.
T F 13. Actual manufacturing overhead costs are charged directly to the Factory Overhead
account as the costs are incurred
T F 14. Marketing and administrative expenses should be added to the manufacturing
overhead account.
T F 15. All of the raw materials purchased during a period are included in the cost.
T F 16. Any balance of the Work in Process account at the end of the period.
T F 17. A particular product not completed at the end of the accounting period of goods
manufactured figure should be closed to the Cost of Goods Sold account becomes
part of work in process inventory.
T F 18. Prime costs plus conversion costs equals total manufacturing costs.
T F 19. Rubber used in manufacturing tires is considered a direct material.
T F 20. The depreciation of automobiles used by sales personnel is considered a factory
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
overhead.
MATCHING TYPE
Choices:
a Product cost h. Total Manufacturing Costs
b. Cost to manufacture i. Conversion Cost
c. Raw Materials inventory j. Selling and Administrative Costs
d. Work in Process inventory k. Direct Labor
e. Finished Goods inventory l. Direct Materials
f. Cost of Goods Sold m. Manufacturing Overhead
g. Cost of Goods Manufactured n. Prime Costs
8. The cost of goods available for sale during a given accounting period in a manufacturing
company is
a. the beginning inventory of finished goods
b. the cost of goods manufactured during the period
c. the sum of a and b
d. none of the above
10. What amounts would be debited and credited to record the purchase of direct materials on
account?
Debit Credit
a. Work in process Direct materials
b. Direct materials Work in Process
c. Raw materials Vouchers Payable
d. Work in Process Vouchers Payable
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
MULTIPLE CHOICE-Problems
Instructions: Encircle the letter of the best answer. Present supporting computations in good
form in a separate work sheet.
1. The Lakandula Company's Cost of Goods Manufactured was P240,000 Its total sales
amounted to P720,000 and Gross Profit was P440,000. If the ending inventory of
Finished Goods was P60,000, how much is beginning inventory of Finished Goods?
a. P 20,000 c. P260,000
b. P100,000 d. P300,0000
2. For the first three months of the year 2010, Lualhati Company reported total sales of
P1,400,000 and Gross Profit of P650,00. Finished Goods at the beginning of the period
amounted to P120,000 while Finished Goods at the end of the period amounted to
P70,000. How much is Cost of Goods Manufactured?
a. P600,000 c. P460,000
b. P700,000 d. P560,000
3. During the month of April, Lucena Company reported Direct Labor of P72,000 and
Direct Labor was equal to 60% of total Prime Cost. If Total Manufacturing Cost during April
amounted to P170,000, how much is total Factory Overhead?
a. P 50,000 c. P120,000
b. P 98,000 d. P480,000
4. During the year 2010, there was no change in the beginning or ending inventory of Raw
Materials. However, the Work in Process account balance had increased by P30,000
while Finished Goods account balance had decreased by P20,000. If purchases of Raw
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
Materials amounted to P200,000 for the year, Direct Labor cost was P300,000 and
Factory Overhead was P400,000, how much is Cost of Goods Sold?
a. P490,000 c. P930,000
b. P890,000 d. P950,000
5. During the month of November, 2010, Liwanag Company used P600,000 of Direct
Materials. At November 30, 2010, Liwanag's Direct Materials Inventory was P100,000
more than it was at November 1, 2010. How much is Direct Materials purchased during
the month of November?
a. P-0- c. P600,000
b. P500,000 d. P700,000
6. The following information were taken from the records of Lukban Company:
Direct Labor cost incurred P500,000
Direct Materials Used 220,000
Work in Process, beginning 100,000
Work in Process, end 600,000
Finished Goods transferred out 340,000
7. The Lubao Company reported the following information for the year 2010: Gross Profit
P560,000; Finished Goods Inventory, end P240,000; and Cost of Goods Available for
Sale P360,000. How much is total Sales for the year?
a. P600,000 c. P800,000
b. P680,000 d. P920,000
8. For the month ended February 29, 2010, the following data were registered by Lumabat
Corp.:
Work in Process, beginning 600,000
Orders completed 4,800,000
Orders shipped 4,000,000
Materials requisitioned for production 3,400,000
Direct Labor cost 1,600,000
Factory Overhead 150% of direct labor cost
9. During the year 2010, there was no change either in the Raw Materials or the Work in
Process beginning and ending inventories. However, Finished Goods Inventory on
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
10. During the month of March, 2010, Lagmay Company incurred the following
manufacturing costs: Direct Materials P60,000; Direct Labor P80,000; and Factory
Overhead P40,000. The Cost of Goods Manufactured was P190,000 and ending Work in
Process Inventory was P30,000. How much is the beginning Work in Process Inventory?
11. a. P20,000
b. P40,000
c. P 50,000
d. P220,000
Chapter 12 – Introduction to Cost Accounting [pages 481-508]
PROBLEM
The following data are provided by the controller of Liwasan Corporation for the year 2010:
Cash P 480,000
Accounts Receivable 696,000
Inventories:
Jan. 1 Dec 31
Finished Goods P 108,400 P 132,000
Work in Process 59,600 77,600
Raw Materials 176,000 128,000
PROBLEM
The general ledger of Lagundi Manufacturing Company shows the beginning balances for the
following accounts:
Instructions: Prepare the journal entries for the preceding transactions together with the closing
of the manufacturing accounts. Assume the use of the voucher system.