AE 112 | MIDTERM REVIEWER 9.

Limited Right to Dispose of Interest in the

Partnership
Reminder: A partner may dispose of his investment in the
“The secret to getting ahead is getting partnership only with the consent of the other partners.
started.”
10. Right to Dispose of Share in Profits
A partner may dispose of his right to share in profits on the
NATURE AND FORMATION OF A PARTNERSHIP investment in the partnership even without the consent of the
other parties.
Partnership – voluntary association of two or more
persons for the purpose of conducting a business for
11. Income Taxes
profit.
Partnerships, except general professional partnerships,
are subject to tax rate of 30% of taxable income (R.A.
Characteristics of a Partnership
9337).
1. Essentially a Contract
Partner’s Equity Accounts
The partnership contract is called the Article of
Accounting for partnerships are much like for sole
Partnership. It specifies all the rights, duties and
proprietorships, the difference lies in the number of
obligations of the partners among themselves.
partner’s equity accounts because each partner has a
capital and withdrawal account.
2. Voluntary Association
Starting a partnership is voluntary and no one should be
The following distinguish a partnership from other
forced to join a partnership and partners cannot be
types of entities:
forced to accept another person as a partner.

3. Mutual Agency
Partnership is owned by Proprietorship is owned
The act of every partner is the act of all the partner. two or more individuals. by only one individual.
A partnership is A corporation is
4. Limited Life created by agreement created by the
Many events may cause the dissolution of a partnership between the parties. operation of law.
making its life limited (Admission of new partner, death,
insolvency, incapacity, withdrawal of a partner, Advantages and disadvantages of a partnership
expiration of the term specified in the partnership
agreement). ADVANTAGE DISADVANTAGE
Ease of formation Easily dissolved/Limited life
5. Separate Legal Personality Shared Unlimited liability
A partnership has a juridical personality separate and responsibility of
distinct from that of each of the partners. running the
business.
6. Unlimited Liability Flexibility in Conflict among partners
All the partners are liable with their separate properties decision making.
for all obligations contracted by the partnership, except Greater capital Lesser capital compared to
for the limited partner whose liability is only restricted compared to sole a corporation
to his capital contribution. proprietorship.
Relative lack of A partnership (other than a
7. Joint Ownership of All Partnership Properties regulation by the general professional
Property contributed to the government as partnership) is taxed like a
partnership is owned by the partnership by virtue of its compared to corporation.
juridical personality. corporations.

8. Joint Ownership of Profits

All partners are entitled to share in the profits of the
company. Losses are also to be borne by all the partners
except for the industrial partner.
The following are the major considerations in the LUCA PACIOLI, DRAWINGS
accounting for the equity of a partnership
Temporary withdrawals Share in profit including
Formation – accounting for initial investments to the partnership salaries, interest, and
Operations – division of profits or losses
Dissolution – admission of a new partner and withdrawal, bonus (this may be
retirement or death of a partner. debited directly to
Liquidation – winding up of affairs capital)

FORMATION Share in losses (this may

Partnership may be formed under the following
arrangements:
Two or more individuals for the first time
The owner of an existing sole proprietorship and an
individual.
be debited directly to
capital)
The drawings account is a nominal account that is
closed to the related capital account at the end of the
period. This account is a contra equity account and has
a normal debit balance.

Two or more existing sole proprietorship, 3. Receivable from/Payable to a partner

VALUATION If a partner withdraws a substantial amount of money

with the intention of repaying it, the debit should be to
Valuation of assets and liabilities contributed: Loans Receivable – Partner account instead of to
Partner’s Drawing account. This account is classified
Type of Measurement separately from the other receivables of the
contribution partnership.
Cash and cash Face value/amount (PAS 7)
equivalents A partner may lend amounts to the partnership in
Non-cash Assets Agreed Values, in the absence excess of his intended permanent investment. These
of agreement, Fair Market advances should be credited to Loans Payable – Partner
Value. account and not to Partner’s Capital account classified
Inventory Net realizable value (estimated among the liabilities but separate from liabilities to
selling price less cost to outsiders.
complete and sell), if lower
than cost (PAS 2) ILLUSTRATION: FORMATION OF A PARTNERSHIP –
Industry Memorandum Entry VALUATION OF CAPITAL
Donna and Cariaga formed a partnership. The following
Partner’s ledger accounts are their contributions:

1. Capital accounts Donna Cariaga

LUCA PACIOLI, CAPITAL Cash 100, 000 -
 Permanent  Initial AR 50, 000 -
withdrawals Investment Inventory 80, 000 -
 Share in losses  Additional Land 50, 000
investment Building 120, 000
 Debit balance  Share in profit Total 230, 000 170, 000
of drawings
account Note Payable 60, 000
Donna, Capital 170, 000
Cariaga, Capital 170, 000
The capital account is a real account and has a normal Total 230, 000 170, 000
credit balance.
2. Drawings accounts
Additional Information: (This is where the fun begins)
Included in Account Receivable is an account amounting to P20, 000 which is deemed uncollectible.

The inventory has an estimated selling price of P100, 000 and estimated cost to sell of P10, 000.

An unpaid mortgage of P10, 000 on the land is assumed by the partnership.

The building is under-depreciated by P25, 000

The building also has an unpaid mortgage amounting to P15, 000, but the mortgage is not assumed by the partnership.
Cariaga agreed to settle the mortgage using her personal fund.

The note payable is stated at face amount. A proper valuation requires the recognition of a P15, 000 discount on note
payable.

Donna and Cariaga shall share in profits and losses 60% and 40% respectively.

Requirement:

Compute for the adjusted balances of the partner’s capital account.

Donna Cariaga Partnership

Cash 100, 000 - 100, 000
Accounts Receivable (50K – 20K) 30, 000 - 30, 000
Inventory 80, 000 - 80, 000
Land 50, 000 50, 000
Building (120K – 25K) 95, 000 95, 000
Total 210, 000 145, 000 355, 000
Note Payable, net (60K – 15K) (45, 000) (45, 000)
Mortgage Payable - Land (10, 000) (10, 000)
Total 165, 000 170, 000 300, 000

The unpaid mortgage on the building is not included because it is not assumed by the partnership.

The compound entry to record the initial investments of the partners in the partnership are as follows:

PARTICULARS DEBIT CREDIT

DATE Cash 100,000
Accounts Receivable 30, 000
Inventory 80, 000
Land 50, 000
Building 95, 000
Discount on note 15, 000
payable
Note Payable 60, 000
Mortgage Payable 10, 000
Donna, Capital 165, 000
Cariaga, Capital 135, 000
Assume that a partner’s capital shall be increased accordingly by contributing additional cash to bring the partners’
capital balances proportionate to their profit or loss ratio. Which partner should provide additional cash and how much
is the additional cash contribution?

Using the capital of Donna, let us determine if Cariaga’s Using the capital of Cariaga, let us determine if Donna’s capital
capital contribution has any deficiency. contribution has any deficiency.

Donna, Capital 165, 000 Cariaga, Capital 135, 000

Divided by: Profit sharing ratio of Donna 60% Divided by: Profit sharing ratio of Cariaga 40%
Total 275, 000 Total 337, 500
Multiply by: Cariaga’s Profit sharing ratio 40% Multiply by: Donna’s Profit sharing ratio 60%
Minimum capital required of Cariaga 110, 000 Minimum capital required of Donna 202, 500
Cariaga’s capital 135, 000 Donna’s capital 165, 000
Deficiency on Cariaga’s capital - Deficiency on Donna’s capital 37, 500

Donna should provide additional cash contribution of P37, 500 to

make his contribution proportionate to his profit or loss ratio.

Now, let’s talk about Bonus on initial investment!

An accounting problem exists when a partner’s capital account is credited for an amount greater than the fair value of
his contribution.

For instance, a partnership agreement may allow a certain partner who is bringing in expertise or special skill to the
partnership to have a capital credit greater than the fair value of his contributions.

In such case, the additional credit to the partner’s capital is a deduction from the capital of other partners. This
accounting method is called the “bonus method.”

ILLUSTRATION: BONUS METHOD

Gretchen and Marjorie agreed to form a partnership. Gretchen contributed P40, 000 cash while Marjorie contributed equipment with fair
value of P100, 000. However, due to the expertise that Gretchen will be bringing to the partnership, the partners agreed that they should
initially have an equal interest in the partnership capital.

Requirement:

Provide the journal entry to record the initial investments of the partners. Solution:

Actual Contribution Bonus Method

Gretchen 40, 000 (140, 000 x 50%) 70, 000
Marjorie 100, 000 (140, 000 x 50%) 70, 000
Total 140, 000 140, 000

PARTICULARS DEBIT CREDIT

DATE Cash 40,000
Equipment 100, 000
Gretchen, Capital 70, 000
Marjorie, Capital 70, 000

The bonus given to Gretchen, i.e., P30, 000 (P70, 000 capital credit – P40, 000 actual contribution)
is treated as a reduction to the capital credit of Marjorie.
AE 112 | MIDTERM REVIEWER WITHDRAWAL OF A PARTNER

PARTNERSHIP OPERATION Purchase of interest by remaining partners:

Profit and Loss shall be shared according to:
Agreed Ratio
If there is no agreement of distribution of loss but there
is agreement of ratio of profit, same with profit.
If there is no stipulation, it shall be proportionate of
they have contributed.
The debited amount of withdrawing partner will be
distributed and credited to remaining partners
according to P/L Ratio.

The consideration given to the withdrawing partner is
ignored and not recorded in partnership books.

Total capital remains the same.
There is no gain or loss.

Industrial partners do not absorb loss. RETIREMENT/DEATH OF A PARTNER

Salaries Purchase of interest by partnership:

This could be in fractional year.
 Adjust the capital (e.g. Profit/Loss, Revaluation,
Withdrawals) before retirement.
Always given to partners, regardless of the result of
operation.
If the settlement is greater than the capital of retiring
partner, there is bonus to retiring partner.
Interest

This could be in fractional year.
If the settlement is lower than the capital of retiring
partner, there is bonus to retiring partner.
Always given to partners, regardless of the result of

operation. The settlement is recorded in the books of partnership.
Partnership capital is decreased.
Bonus 
Given if there is profit only. There is no gain or loss.

If profit after salaries and interest is a loss, it is not In a situation of a death of a partner, a liability account
given. should be credited with the amount of settlement.

B = Bonus INCORPORATION OF A PARTNERSHIP

P = Profit
I = Interest Partners’ capital balances are adjusted because of
revaluation and profit or loss.
S = Salaries 
Br = Bonus Rate Determine the par value of a share and then determine
the number of shares to distributed to each partners
Bonus after bonus who will become stockholders.
= − +


If the adjusted capital is greater than the total par
Bonus based on Profit after Interest, Salaries, and Bonus value of shares issued, there will be share premium
− −
=( − − )− +
credited.
Bonus based on Profit after Interest and Salaries
=( − − )
 PARTNERSHIP DISSOLUTION

As mentioned on the characteristics of a partnership, it has a limited life, in the sense that the partnership agreement
can be easily dissolved.

Dissolution is the change in the relation of the partners caused by any partner being disassociated from the business.

Dissolution is different from liquidation. Liquidation is the termination of business operations or the winding up of
affairs. Partnership dissolution does not necessarily terminate the business. The business continues until the remaining
partners decide to liquidate the business. If the business ius continued after dissolution, new articles of partnership
should be drawn up.

The following are the major considerations in the accounting for partnership dissolution:

Admission of a partner

Withdrawal, retirement or death of a partner

Incorporation of partner

ADMISSION OF A PARTNER

The admission of a new partner may be effected either through:

Purchase of an interest from present partners

Investment of assets in the partnership

By purchase:

There is no gain or loss.

Transfer between capital accounts only.
Payment happened between the partners and is not recorded in the books of the partnership.
The amount of the capital before admission is the same after admission.

If there is a revaluation, only the old partners receive gain on their capital.

By investment:

Any payment is recorded in the partnership books.

Transaction is between new partner and partnership.
No gain or loss.

The amount of total capital is changed (agreed capital).

If the credited amount of capital of new partner is greater than his investment, there is a bonus. The excess will be
debited to old partners’ capital accounts according to P/L ratio.

If the credited amount of capital of new partner is lower than his investment, there is a bonus to the old partners. The
excess will be credited to old partners’ capital accounts according to P/L ratio.
A. PURCHASE OF AN INTEREST FROM PRESENT PARTNERS

Illustration:

On June 30 of the current year, Bong and Jinggoy have capital balances of P120, 000 and P180, 000 and divide profits
and losses in the ratio of 6:4, respectively. On this date, Janet is admitted as a new partner.

The entry to record the admission of Janet and the resulting capital balances and profit and loss ratio of the partners
immediately after the admission of Janet, under the independent cases provided below:

Case 1: Purchase of Interest from one partner at book value

Assume Janet purchased one half of the interest of Bong for P60, 000.

Bong, Capital 60, 000

Janet, Capital 60, 000
To record the admission of Janet
The resulting capital balances and profit and loss ratio of the partners will be:

Old Capital New Capital Old New

Transfer P/L Ratio Transfer P/L Ratio
Bong 120, 000 (60, 000) 60, 000 60% 30% 30%
Jinggoy 180, 000 180, 000 40% 40%
Janet 60, 000 60, 000 30% 30%
Total 300, 000 300, 000 100% 100%
Since Janet purchased ½ of the interest of Bong, she gets ½ of both the capital and share of Bong.

Case 2: Purchase of Interest from all partners at book value

Assume Janet purchased one half of the interest in the partnership P150, 000.

Bong, Capital 60, 000

Jinggoy, Capital 90, 000
Janet, Capital 150, 000
To record the admission of Janet

The resulting capital balances and profit and loss ratio of the partners will be:

Old Capital New Capital Old New

Transfer P/L Ratio Transfer P/L Ratio
Bong 120, 000 (60, 000) 60, 000 60% 30% 30%
Jinggoy 180, 000 (90, 000) 90, 000 40% (20%) 20%
Janet 150, 000 150, 000 50% 50%
Total 300, 000 300, 000 100% 100%

Since Janet purchased ½ of the interest of both partners, she gets ½ of both the capital and profit share of both parties.

Case 3: Purchase of Interest from all partners at more than book value

Janet purchased ½ of the interest in the partnership for P175, 000.

Bong, Capital 60, 000

Jinggoy, Capital 90, 000
Janet, Capital 150, 000
To record the admission of Janet

NOTE: The difference of P25, 000 between the purchase price and book value of the interest purchased is considered a
personal profit of Bong and Jinggo, and thus not recognized by the partnership. The excess of P25, 000 is divided
between Bong and Jinggoy based on their original partner’s profit and loss ratio, computed as follows;

Bong Jinggoy Total

Interest Sold 60, 000 90, 000 150, 000
Excess (6:4) 15, 000 10, 000 25, 000
Total Payment 75, 000 100, 000 175, 000
Case 4: Purchase of Interest from all partners at less than book value

Janet purchased ½ of the interest in the partnership for P140, 000.

NOTE: The loss amounting to 10, 000 between the purchase price and book value of the interest purchased is considered a personal loss of
Bong and Jinggo, and thus not recognized by the partnership. Only the transfer of capital is to be reflected in partnership books. The loss of
P10, 000 is divided between Bong and Jinggoy based on their original partner’s profit and loss ratio, computed as follows;

Bong Jinggoy Total

Interest Sold 60, 000 90, 000 150, 000
Excess (6:4) 6, 000 4, 000 (10, 000)
Total Payment 54, 000 86, 000 140, 000

B. ADMISSION BY INVESTMENT

When a new partner is admitted by means of investment of cash or other non-cash assets, there is an increase in the
partnership tangible assets.

Definition of terms:

Contributed Capital – the new investment of the partners, both old and new, to the partnership.
Agreed Capital – the amount of new capital set by the partners for the partnership.
Total Agreed Capital – the new total capital of the partnership.

Total Contributed Capital – sum of the capital balances of the old partners (net asset investment) and the contribution
of the new partner.

Illustration 1:

The following are the capital account balances and P/L ratios of the partner in AUCONA Partnership as of July 1, 20x1:

Capital P/L Ratios

Accounts
S, Capital 150, 000 60%
L, Capital 250, 000 40%
Total 400, 000 100%

On July 1, 20x1, U was admitted to the partnership when he acquired 20% interest in the net assets and profits of the
firm for a P100, 000 investments. The net assets of the firm as of this date approximate their fair values.

Case 1: Credit to capital equal to investment

U’s Capital is credited at an amount equal to his contribution.

Cash 100, 000

U, Capital 100, 000
To record the admission of U

Note:

Under the investment in partnership, the consideration paid by the new partner is recorded in the partnership books
that results into an increase in the partnership capital.

400, 000 + 100, 000 = P500, 000.
Case 2: Credit to capital is less than the investment

U’s Capital is credited for P80, 000, the journal entry is:

Cash 100, 000

U, Capital 80, 000
S, Capital {(100, 000 – 80, 000) x 40% } 8, 000
L, Capital {(100, 000 – 80, 000) x 60% } 12, 000
To record the admission of U

Note:

Under the “Bonus method,” any decrease (or increase) in the capital of the new partner is treated as an addition (or
deduction) to the capital of the existing partners, allocated based on their old profit and loss sharing ratio.

Case 3: Credit to capital is greater than the investment

U’s Capital is credited for P130, 000, the journal entry is:

Cash 100, 000

S, Capital {(130, 000 – 100, 000) x 40% } 12, 000
L, Capital {(130, 000 – 100, 000) x 60% } 18, 000
U, Capital 130, 000
To record the admission of U

Case 4: Assuming that the “goodwill method” was used in Case 3, the entry would be as follows:

Cash 100, 000

Goodwill 30, 000
U, Capital 130, 000
To record the admission of U

The equity structure of the new partnership after the admission of U is analyzed as follows:

Case 1 Case 2 Case 3 Case 4

Bonus Method Bonus Method Goodwill Method
S, Capital 150, 000 158, 000 138, 000 150, 000
L, Capital 250, 000 262, 000 232, 000 250, 000
U, Capital 100, 000 80, 000 130, 000 130, 000
Total 500, 000 500, 000 500, 000 530, 000

Notice that whether or not an entity uses the “Bonus Method,” the total capital remains the same after the admission of
the new partner. That is, the total capital is equal to the net assets before the admission plus the fair value of new
partner’s contribution.

However, if the goodwill method is used, the total capital of the partnership would after the admission is understated.

Illustration 2: Amount of investment

The financial position of AB Partnership shows the following information as of July 1, 20x1.
Cash 12, 000
Receivable from A 8, 000
Equipment 390, 000
Total 410, 000

Payable to B 10, 000

A, Capital 150, 000
B, Capital 250, 000
Total 410, 000

On July 1, 20x1, the partners decide to admit C as a new partner with 20% interest. The net assets of the firm as of this
date approximate their fair values.
Requirement: If no bonus shall be allowed, how much should C invest in the partnership?
Solution:

A, Capital 150, 000

B, Capital 250, 000
Total Capital of the existing partnership 400, 000
Divided by: (100% - 20% interest of C) ____80%
Total Capital of the new partnership 500, 000
Multiply by: Interest of C 20%
Investment of C 100, 000

Notice that the receivable and payable accounts to the partners do not affect the computations above because the
business is continued even after the partnership dissolution. The accounts are carried over to the books of the new
partnership.

Illustration 3: Bonus Method

The following are the capital account balances and P/L ratios of the partners in AB Partnership as of July

1, 20x1.
Capital P/L Ratios
Accounts
A, Capital 150, 000 40%
B, Capital 250, 000 60%
Total 400, 000 100%

On July 1, 20x1, C was admitted to the partnership when he invested equipment with a historical cost of 100, 000 and
fair value of P80, 000 to the partnership for a 20% interest. The net assets of the firm as of this date approximate their
fair values.
Requirements:
If the bonus method is used to record the admission of C into the relationship, how much is the credit to C’s capital
account?

Solution: Total capital before the admission of C 400, 000

Fair value of contribution of C 80, 000
Total Capital after the admission of C 480, 000
____20
Multiply by: Interest of C %
Credit to C’s capital account 96, 000

The entry to record the admission of C is as follows:

 Equipment 80, 000
A, Capital {(96, 000 – 80, 000) x 40% } 6, 400
B, Capital {(96, 000 – 80, 000) x 60% } 9, 600
C, Capital 96, 000
To record the admission of U
b. Capital balances after admission of C

A, Capital 143, 600

B, Capital 240, 400
C, Capital 96, 000
Total capital of new partnership 400, 000

c. New profit or loss ratios

A (100% - 20%) x 40% 32%

B (100% - 20%) x 60% 48%
C 20%

NOTE: Please master the basic concepts and make sure to read what is taught in your book. Solve the
theories and problems provided in your book to practice what you have learned. Also, let us avoid
invalidation during the exam, always make sure to shade first the necessary information (Prof. code, Class
code, Class number) before anything else. God bless and review well!
 AE 111 REVIEWER
CASH AND CASH EQUIVALENTS

CASH – In accounting, cash includes money in the form of currency and coins, negotiable
instruments in the form of checks and money orders acceptable by the bank for immediate credit
and bank deposits whether in a savings or current account.
CASH EQUIVALENTS – Under PAS 7, cash equivalents are short-term and highly liquid
investment that are readily convertible into cash and so near their maturity that they present
insignificant risk in changes in value because of changes in interest rates.
BANK RECONCILIATION - A statement that that settles the difference between the bank
statement balance and the cash balance per book which is the current balance in the checkbook of
the depositor.
BOOK RECONCILING ITEMS – Includes credit memos, debit memos and errors that need to be
corrected or adjusted by the depositor in order for the balance per book to reconcile with the
adjusted balance.
BANK RECONCILING ITEMS – Includes deposits in transit, outstanding checks and errors.
CERTIFIED CHECKS – Checks that have been accepted by the bank and where the drawer’s
account has been debited but the money has yet to be withdrawn by the payee. The funds are now
held by the bank on behalf of the payee and the check is no longer outstanding.
PETTY CASH FUND – Money set aside to pay small and recurring expenses where it will be
inefficient to settle such payments by issuing checks. Accounting for petty cash involves an Imprest
Fund System that is more commonly used due to its efficiency and convenience rather than the
Fluctuating Fund System that requires each disbursement to be recorded.
IMPREST CONTROL SYSTEM – Implemented as a control system where all cash receipts is
including checks to be deposited intact and all cash disbursements be made by the issuance of a
check. Although a petty cash fund will also be used to settle small expenses.

Cash includes the following items plus adjustments:

Undeposited currency and coins

Checks and money orders held unless the checks are post-dated, defective or stale. Such items
shall still be included as receivables.

Unrestricted bank deposits, however checks that have been recorded as payments that have not
been delivered or post-dated must be restored back to the bank deposits’ balance with a
corresponding liability for the payment that was made.

Funds on hand and deposits that are for current use and have been restricted for a liability that is
classified as “current”. This includes petty cash fund, payroll fund and funds for taxes and
dividends as mentioned in PAS 1.

Special Items of Cash

Bank Overdraft – A credit or negative balance in the bank account of the depositor resulting from
an issuance of a check that exceeds the amount of the deposit.

As a rule an overdraft shall be classified as a current liability and not offset against current
accounts with a positive or debit balance.
As an exception, if the overdraft is in a bank where there are other accounts that have a positive
balance and those accounts are sufficient to cover the overdraft, the total cash shall be shown net
of the overdraft.
Compensating Balance Agreement – Part of or deposits that a bank can use to offset an existing
loan. However, compensating balances can also describe a minimum amount of the deposit that a
depositor agrees to maintain in order to guarantee future credit availability.

In the case of deposits that a bank can use to offset a loan, the assumption is that this amount is
legally restricted to withdrawal and therefore excluded from cash, however in cases that it still
remains to be unrestricted, the compensating balance shall be part of cash. If the compensating
balance is legally restricted the following rules shall be followed:

The related loan is short-term: The compensating balance shall be part of current assets but
separately from cash.
The related loan is long-term: The compensating balance is part of noncurrent assets as an
investment.

An informal agreement to maintain a minimum amount of deposit will not be legally restricted and
therefore included in cash.

Time Deposits – Bank savings account that earns interest but not subject to immediate withdrawal
or check issuance. A notice must be submitted by the depositor for the withdrawal of funds and
interest earned shall be forfeited.

Time deposits are excluded from cash because of their restriction on availability as funds and are
classified as investments and shall follow these specific classifications:

Cash equivalents if the original term is 3 months or less.
Short term investments if the original term is more than 3 months to 1 year
Long-term investments if the original term is more than 1 year.

Cash Equivalents – The three important characteristics for cash equivalents as mentioned in PAS
7 are short-term, highly liquid and near maturity. In other words, short-term debt instruments with
low risk (also low yield) and acquired 3 months or less from maturity date shall be considered as
cash equivalents.

Examples include Treasury Bills, Bonds and Notes, Time Deposits, Certificate of deposits and
Bankers Acceptances and Commercial Papers.

Example of Adjusted Balance Reconciliation

Bank Book
Unadjusted Balance X Unadjusted Balance X
Deposit in transit + Credit memo* +
Outstanding checks (-) Debit memo** (-)
Errors +/(-) Errors +/(-)
Adjusted balance X Adjusted balance X

*Credit memos include collections by the bank; interest credited by the bank and matured time
deposits transferred to the current account.

**Debit memos include NSF checks, bank service charges and authorized bank debits
RECEIVABLES

A receivable is the right to receive cash, another asset (goods) or services

Receivables may be current or noncurrent and trade or nontrade

The rules on current and noncurrent classification are discussed in detail under PAS 1 and are also
based on the receivable as either trade or nontrade

Trade receivables arise from the sale of goods or services to customers and in the form of
accounts receivable or notes receivable while nontrade receivables are receivables from all other
types of transactions like advances to officers and employees and advances to other entities.

Accounts receivable arise from credit sales. The amount to be recorded as accounts receivable from
sales on account shall be the “Invoice Price” which is the amount after deducting trade discounts
from the List Selling Price. Take note that trade discounts are not accounted for and are ignored for
recording purposes.

Example: An item is sold to a credit customer under terms of 2/15 and net 30, FOB shipping point
terms with a list selling price of P2,000,000 with trade discounts of 20% and 10%. The Invoice price
is computed as follows:

List selling price 2,000,000

Less: 20% trade discount 400,000
Net 1,600,000
Less: 10% trade discount 160,000
Invoice price 1,440,000

As mentioned the entry will not include the total trade discount of P560,000 (400,000 + 160,000)

but instead only the P1,440,000 amount will be recorded as follows:

Accounts Receivable 1,440,000

Sales 1,440,000

The following transactions also affect accounts receivable in computing for the ending balance:

ACCOUNTS RECEIVABLE
+ Credit Sales (-) Sales returns and allowances
+ Recovery of accounts written off (-) Sales discounts
(-) Collections including recovery
(-) Write off
(-) Factored accounts

The write off for accounts receivable under the allowance method is recorded by:

Allowance for doubtful accounts xx

Accounts Receivable xx
So therefore the recovery or the collection on an accounts receivable that already has been written
off cannot be recorded by simply debiting cash and crediting accounts receivable. The entry for the
write off must be reversed and before recording the collection with the following two entries:
Accounts Receivable xx

Allowance for doubtful accounts xx

Allowance for doubtful accounts xx

Accounts Receivable
Combining the two entries will be more efficient by:

Cash xx

Allowance for doubtful accounts xx

The ending balance of accounts receivable shall be presented as part of current assets
under the heading of “trade and other receivables” at the Net Realizable Value (expected
cash value) or “amortized cost”

The net realizable shall be computed after deducting an allowance for the following:
Sales returns – Value of merchandise expected to be returned by customers as a result in
error of deliveries and defects

Sales discounts – Value of price savings to customers expected to pay within the discount
period and take advantage of the cash discount.

Freight charges – Amount of freight charges collected by the shipper from the buyer even
though the shipment was under FOB destination terms. This amount shall not be remitted by
the buyer hence deducted from the receivable.

Doubtful accounts – Allowance for expected uncollectability that is an inherent risk from
selling on credit.

Allowance Method vs. Direct Write-off Method

Allowance Direct Write-off

Application Generally Accepted Non-GAAP

Expense and Increase
Accounts considered doubtful Not accounted for
the Allowance
Debit expense and
Write-off Debit Allowance and Credit AR
Credit AR
Debit AR and
Recovery Debit AR and credit Allowance
credit expense

The computation for the doubtful accounts expense which is an adjusting entry and the
allowance for doubtful accounts will be as follows:

Beginning balance X
Write off (X)
Recovery X
Balance before adjustment X
Doubtful accounts expense X
Ending balance X

There are 3 methods in estimating doubtful accounts:

The percentage of net credit sales method which will provide the amount of doubtful
accounts expense for the year and therefore is a method that emphasizes proper matching
of doubtful accounts against sales. This amount will then be added to the balance before
adjustment, the total of the two will then be the amount of allowance at yearend or after
adjustment.

The percentage of accounts receivable method will provide the amount of required
allowance for doubtful accounts and just like its counterpart the “Aging Method”, the amount
of doubtful accounts expense will be worked back as an adjustment to the amount of
required allowance.
The Aging of accounts receivable method that is arguably the most accurate of all three
methods since an analysis is made and each classification of accounts receivable is
multiplied by a specific rate of the estimate of uncollectability. Naturally older accounts
receivable are more likely to be uncollectible compared to newer or more recent sales.