BM2012 – Accounting for Special Transactions

Table of Contents
(Week 1) Nature of Partnership and Partnership Formation ...................................................................................................... 2
Nature of Partnership .............................................................................................................................................................. 2
Partnership Formation............................................................................................................................................................. 2
Valuation of Partners’ Contributions ................................................................................................................................... 2
Accounting for Initial Investment ......................................................................................................................................... 3
(Week 2) Partnership Operation and Dissolution........................................................................................................................ 3
Partnership Operation ............................................................................................................................................................. 3
Rules in the Division of Profits and Losses ........................................................................................................................ 3
Partnership Dissolution ........................................................................................................................................................... 4
Admission of a New Partner ............................................................................................................................................... 4
Withdrawal of A Partner ...................................................................................................................................................... 5
(Weeks 3-4) Partnership Liquidation ........................................................................................................................................... 5
Definition of Partnership Liquidation ....................................................................................................................................... 5
Lumpsum Liquidation .............................................................................................................................................................. 5
Installment Liquidation ............................................................................................................................................................ 6
(Week 6) Corporate Liquidation .................................................................................................................................................. 7
Statement of Affairs................................................................................................................................................................. 7
Step-by-Step Procedures in Preparing Statement of Affairs .............................................................................................. 7
Classification of Liabilities in Statement of Affairs .............................................................................................................. 7
Deficiency Statement .......................................................................................................................................................... 8
Statement of Realization and Liquidation ............................................................................................................................... 8
(Week 8) Construction Contracts ................................................................................................................................................ 8
Definition of a Construction Contract ...................................................................................................................................... 8
Core Principle of PFRS 15 ...................................................................................................................................................... 8
Methods for Measuring Progress ............................................................................................................................................ 8
Cost-to Cost Method ............................................................................................................................................................... 9
(Week 9) Franchise Operations – Franchisor’s Perspective .................................................................................................... 10
Accounting for Franchise ...................................................................................................................................................... 10
Franchise Fees ..................................................................................................................................................................... 10
(Week 11) Consignment Sales ................................................................................................................................................. 11
Consignment arrangements.................................................................................................................................................. 11
Revenue of Consignor and Consignee ................................................................................................................................. 11
(Weeks 12-13) Installment Sales .............................................................................................................................................. 12
Installment Sales Method ...................................................................................................................................................... 12
Installment Receivable and Deferred Gross Profit................................................................................................................ 12
Repossession........................................................................................................................................................................ 12
Trade-ins ............................................................................................................................................................................... 13
(Week 15) Accounting for Home Office and Branch Transactions ........................................................................................... 13
Transactions Between the Home Office and The Branch .................................................................................................... 13
Shipments to Branch and Shipments from Home Office ...................................................................................................... 14
Allocation of Expenses .......................................................................................................................................................... 14
Combined Financial Statements ........................................................................................................................................... 14
Reconciliation of Reciprocal Accounts .................................................................................................................................. 14
Special Problems .................................................................................................................................................................. 15
Allowance for Overvaluation of Branch Inventory ............................................................................................................ 15
True Net Income of the Branch ........................................................................................................................................ 16

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 BM2012 – Accounting for Special Transactions

(Week 1) Nature of Partnership and Partnership Formation

Nature of Partnership

Partnership is a contract between two (2) or more persons who engage in a business undertaking wherein
they contribute money, property, or professional expertise to a common fund, intending to divide the profits
among themselves.

Characteristics of Partnership
a. The partnership is easy to form since at least two (2) persons can just have a mere agreement,
whether in oral or written form, to create a partnership.
b. The partnership has a separate legal personality in which the partnership has the legal capacity to
enter into contracts and execute transactions in its own name.
c. The partners in the partnership all have equal responsibility in running the partnership.
d. The partners in the partnership own the properties invested in the partnership.
e. The partners in the partnership all share in the profits or losses of the partnership.
f. The partnership can easily be dissolved in certain circumstances.
g. The transfer of a partner’s capital to another partner or a third-party person requires the consent of
the other partners.
h. The partners can be held personally liable for the liabilities of the partnership.

Advantages of a Partnership
• A partnership can easily be formed.
• A partnership has more means of obtaining funds than a sole proprietorship.
• Decision-making among the partners can easily be made.
• The partnership is less regulated by the government than corporations.

Disadvantages of a Partnership
• The personal liability for partnership debts deters many from investing capital in a partnership
• A partner may be subject to personal liability for the wrongful acts of his associates
• The partnership can easily be dissolved.
• The partners generally have unlimited liability.
• Likelihood of dissension and disagreement between partners.
• The tax rate applied to partnership businesses (except general professional partnership) is the
same with the corporations.

Partnership Formation
A partnership is formed as a consensual contract. It is created by the mere agreement of the partners,
whether in oral or written form. However, when real properties are contributed or invested to the partnership
or when the total partnership capital is P3,000 or more, the partnership agreement must be in writing
according to the Philippine Civil Code Articles 1771 and 1772.

Valuation of Partners’ Contributions

Partners are credited based on the value of assets contributed. If such assets are subject to liabilities that
are assumed by the partnership, then the partners are to be credited for net assets contributed.
a. Cash contributions are valued at face value (its fair value). Foreign currency denominated cash
contributions are valued based on exchange rates on the date of contribution. However, cash
deposited in a bankrupt or closed bank is valued at its estimated recoverable amount (net realizable
value).
b. Non-cash contributions are valued at their fair market value. Normally, the partners agreed to value
non-cash assets at fair market value.
c. Account receivables transferred to the partnership are to be recorded at gross amount
accompanied by the corresponding allowance for bad debts.
d. Fixed assets transferred to the partnership are to be recorded at fair market value. Accumulated
depreciation is not carried forward in the books of the partnership.

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Accounting for Initial Investment

Partners may contribute cash, property, or industry to the partnership. Assets contributed are debited to the
appropriate asset account and credited to the capital account of the partner. When contributions are in the
form of services, a memorandum entry is prepared.

1. Net Investment Method – The partners are credited for the amount of the net assets invested (fair
value of assets less fair value of liabilities). This will happen if the contribution ratio is equal to the
capital ratio.
2. Bonus Method – This method is used to address the accounting problem wherein a partner’s
capital account is credited for an amount different from the fair value of his contributions. Normally,
the capital account credited exceeds the fair value of the contribution (Capital Credited > FV of
Contribution). This is also known as the transfer of capital method.

(Week 2) Partnership Operation and Dissolution

Partnership Operation
A partnership is formed as a consensual contract. It is created by the mere agreement of the partners,
whether in oral or written form. However, when real properties are contributed or invested to the partnership
or when the total partnership capital is P3,000 or more, the partnership agreement must be in writing
according to the Philippine Civil Code Articles 1771 and 1772.

Rules in the Division of Profits and Losses

Partnership’s profits or losses should be distributed to the partners under the partnership agreement.

The partners may agree that the profit or loss be distributed equally or proportionate to the partners’
beginning capital balances, ending capital balances, average capital balances, or original capital balances.

If there is no agreement among the partners or if the agreement lacks some details, the following rules
should be applied according to the Philippine Civil Code:
• If only the share in the profits was agreed upon, the share in the losses shall be in the same
proportion.
• If there is no agreement as to the share in both profits and losses, then such share shall be in
proportion to the partner’s contribution/capital.
• Industrial partners shall not share in the losses but may share in the profits as just and equitable.
• If the partner is a capitalist-industrial partner, his share in the profits shall be in proportion to his
contribution/capital.

The partnership agreement may also stipulate the following:

a. Salaries – Salary allowances given to the partners are included in the computation of each
partner’s share in the profit or loss. These are always part of the computation of their P/L shares,
whether the partnership earns a profit or incurs a loss. These are given to partners proportionate
to time devoted to the organization.

b. Bonuses – This becomes part of the computation of each partner’s share in the profit only if the
partnership earns a profit. If the partnership incurs a loss, the bonus should not be included in the
computation. The bonus may be calculated using an algebraic equation. The following are the
different formulas that may be used using an algebraic equation:
1) Bonus based on profit before bonus and taxes
2) Bonus based on profit after bonus but before tax: B = Bonus rate x (profit - B)
3) Bonus based on profit after tax but before bonus: B = Bonus rate x (profit – T)
4) Bonus based on profit after bonus and tax: B = Bonus rate x (profit – B – T)
Where: B = bonus, T= income tax

c. Interest on Capital Contributions – Same with salary allowances, these are always part of the
computation of each partner’s share in the profit or loss, whether the partnership earns a profit or

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incurs a loss. This can be computed based on beginning capital balances, ending capital balances,
or average capital balances.

The items above are normally computed first and allocated to the partners before the remaining amount
of P/L is shared by the partners using the agreed P/L ratio.

Partnership Dissolution
Partnership dissolution is the change in the partnership’s capital structure that results from the following:
1. Admission of a new partner
2. Withdrawal of a partner
3. Retirement of a partner
4. Death of a partner
5. Incorporation of a partnership

Admission of a New Partner

“Admission of a new partner” occurs when a person other than the existing partners of the partnership
joins the partnership. It may be transacted either through:

1. Purchase of interest in the partnership; or

2. Investment in the partnership

Admission of a new partner by purchase of interest

A new partner joins the partnership by purchasing a portion or all of the capital of at least one (1) of the
existing partners. As a result of the purchase of interest by the new partner, the partnership’s capital
structure has been changed. A portion or all of the capital balance of an existing partner or some of the
existing partners have been transferred to the new partner’s capital account. This change is the one being
focused on in accounting for partnership dissolution.

Admission by Investment
It occurs when a new partner joins the partnership by investing an asset to the partnership. The new partner
may either invest cash or property in the partnership. As a result of the new partner's investment, the
partnership’s capital structure also changes, just like in the admission by the purchase of interest. The only
difference is that the partnership’s total capital has increased in admission by investment because of the
new partner’s investment.

Bonus Method
It is used to account for the difference between the amount of partner’s investment and the amount of
capital credited. In other words, the total agreed capital is different from the total contributed capital. The
total agreed capital is the sum of all the old partners’ capital balances and the agreed interest or capital
of the new partner. The total contributed capital is the sum of all the old partners’ capital balances and
the new partner’s investment or contribution.

• When the amount credited to the new partner’s capital account exceeds the new partner’s
investment or contribution, the difference is treated as a bonus to the new partner.
• When the amount credited is lower than the investment or contribution, the difference is treated as
a bonus to the old partners.

Revaluation Method
It is used when the fair values of the assets contributed to the partnership differ from its book values and
when the total agreed capital is equal to the total contributed capital. In this method, the assets should be
restated to their fair values by the time they are carried over in the books of the partnership. The difference
between the fair value of the assets and their book values will be allocated as an adjustment to the old
partners’ capital accounts.
• If the fair value is higher than the book value, the difference will be added to the capital balances
of the old partners.

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• Otherwise, the difference will be deducted from the capital balances of the old partners.

Note that this difference is not a bonus; it is only an adjustment to the old partners’ capital balances due to
the revaluation of assets.

Like the previous explanation in the bonus method, the bonus will only occur when the total agreed capital
is different from the total contributed capital. A bonus to the new partner will be provided if his capital credit
(new partner’s capital account) is higher than his agreed interest or capital. On the other hand, a bonus to
the old partners will be provided if the new partner’s capital credit is lower than the new partner’s agreed
interest or capital. (Note: The agreed interest or capital of the new partner is normally the acquired interest
of the new partner.)

Withdrawal of a Partner
This occurs when an existing partner decides to end his relationship with the partnership. In other cases,
the partner retires from practicing his profession in the partnership.

The partner’s withdrawal affects the accounting records of the partnership in the following cases:

1. The withdrawing partner sells his interest to the remaining partners.

2. The withdrawing partner decides to pull out his interest/investment/capital from the partnership.

(Weeks 3-4) Partnership Liquidation

Definition of Partnership Liquidation

Partnership liquidation refers to either a voluntary or involuntary discontinuance of a business resulting in
the required sale of partnership assets and payment of partnership liabilities. It is also called “winding up
of affairs.” The purpose of partnership liquidation is to aid in the termination of the partnership’s business.
It can also serve as documentation or proof of the business termination.

The partnership liquidation generally has the following procedures (in order of priority):
1. Realization of non-cash assets or the conversion of non-cash assets into cash.
2. Payment of partnership liabilities.
3. Distribution of the remaining cash to the partners.

Lumpsum Liquidation
Procedures in Lump-Sum Liquidation (in order)
1. Realize or sell the non-cash assets. Allocate the gain or loss on sale to the partners using the profit
or loss ratio.
2. Pay liquidation expenses.
3. Pay partnership liabilities to outside creditors.
4. Eliminate any capital deficiencies among the partners’ capital accounts. (Capital deficiency is the
negative amount in the capital account balance of the partner) The capital deficiency should be
eliminated by applying one of the following, in order of priority:
a. If the deficient partner has an existing loan balance (payable to partner account), exercise
the right of offset against his capital only up to the extent of his deficiency.
b. If the deficient partner is personally solvent, the deficient partner should invest cash in
eliminating the deficiency.
c. If the deficient partner is personally insolvent, the other partners should absorb the capital
deficiency.
If the problem is silent or no indication regarding the personal status of the partner, it is
assumed that the deficient partner is insolvent.

5. Distribute cash to the partners (in order of priority)

a. Loan accounts (payable to partner account)
b. Capital accounts

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Installment Liquidation
There are instances when liquidation of partnership is done over a series of installments. This occurs when
the other assets are being sold partially over a period of time. In this case, each partial sale of the other
assets will need a liquidation statement to determine how much of the available cash as an installment
period can be distributed to the partners.

Two (2) Methods of Installment Liquidation

1. Safe Payment Schedule – This method is used to determine the safest amount of cash distributed
to the partners as of an installment period. This method prevents the overpayment of cash to the
partners.

Loss on partial sale of other assets P xxx

Add: Actual liquidation expenses xxx
Total actual loss on realization P xxx

Carrying amount of unsold assets P xxx

Estimated future liquidation expenses xxx
Reserved or retained cash for incidental expenses xxx
Total maximum possible loss P xxx

X Y Z
Loan account (if any) P xxx P xxx P xxx
Capital balance before liquidation xxx xxx xxx
Total interest on Jan. 1 xxx xxx xxx
Allocation of gain or loss on partial sale of assets xxx (xxx) xxx (xxx) xxx (xxx)
Balance before payment xxx xxx xxx
Allocation of maximum possible loss (xxx) (xxx) (xxx)
1st installment payment xxx xxx xxx

The safe payment schedule should start with the computation of the total interest of the partners at
the beginning of an installment period. The total interest of a partner is composed of the loan
balance (the payable to partner account) and the capital account balance. The gain or loss on
realization of non-cash assets should then be allocated to each of the partners’ total interest using
the P/L ratio. The maximum possible loss will then be deducted from the balance after the allocation
of gain or loss on realization. After the allocation of maximum possible loss, the first installment
payments to the partners are determined.

In all cases, when the final installment arrives, only the total actual loss on realization during the
last installment should be computed. The maximum possible loss is no longer required to be
computed in the final installment.

The 2nd safe payment schedule is a continuation of the 1st safe payment schedule. After distributing
the first installment payments, the balances of the partners' interests will now be the beginning,
total interests of the partners for the second installment. Then the loss on sale of remaining assets
at the second installment will be allocated to the partners using the P/L ratio. Afterward, the final
installment payments will be determined.

2. Cash Priority Program – This method is used to determine who among the partners should be
paid first using the available cash as of an installment period.
The first thing that needs to be done when using the cash priority program is the computation of
the Maximum Loss Absorption Capacity (MLAC) of the partners. The MLAC is used to determine
who among the partners should be paid first.

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The equalization of MLAC is performed to determine the specific amounts of cash that need to be
distributed first to the priority partners. Looking at the table of the Cash Priority Program at the right
side of the equalization, the specific amounts of cash are plotted. These specific amounts are
computed by multiplying the P/L ratio of the priority partner to the differences that are computed in
the equalization table. These specific amounts will be applied to the actual distribution of the
available cash.

(Week 6) Corporate Liquidation

Same with partnership liquidation, corporate liquidation involves the termination of the business, resulting
in the necessary liquidation of the corporation’s assets and the settlement of its liabilities. The corporation
is normally insolvent when its owners decide to liquidate. Insolvency means that the total liabilities exceed
the total assets. When total liabilities exceed the total assets, the corporation struggles to pay its liabilities.

Statement of Affairs
Step-by-Step Procedures in Preparing Statement of Affairs
1. Restate the amounts reported in the statement of financial position into realizable values.
2. Identify the assets and liabilities according to different classifications.
3. Compute for the estimated recovery percentage.
Prepare the Statement of Affairs.

Classification of Assets in Statement of Affairs

1. Assets pledged to fully secured creditors – These are assets that can fully cover the entire amount
of the liabilities to which they are pledged. Example: A land with a realizable value of P2,000,000 is
pledged to liability with a settlement amount of P1,500,000. The said land is an asset pledged to fully
secured creditors since its realizable value of P2,000,000 can fully pay the liability with an amount of
P1,500,000.
2. Assets pledged to partially secured creditors – These are assets that can pay the liabilities to which
they are pledged but only to a certain extent. Example: A land with a realizable value of P2,000,000 is
pledged to a liability with a settlement amount of P2,500,000. The said land is an asset pledged to
partially secured creditors since its realizable value of P2,000,000 is not enough to cover the entire
amount of the liability of P2,500,000.
3. Free assets – These are assets that are not pledged to any liability. Since they are not pledged to any
liability, they are available for distribution to the unsecured creditors and shareholders in the order of
priority (creditors first, before the shareholders).

Classification of Liabilities in Statement of Affairs

1. Unsecured liabilities with priority – These are unsecured liabilities required to be settled for the
liquidation to push through. In other words, even if they are not secured with pledged assets, they
should still be settled first before any other liability. Example: The professional fees of the lawyers who
processed the liquidation should be paid first.
2. Fully secured liabilities – These are liabilities that are entirely covered by the pledged assets.
Example: A pledged asset has covered the accounts payable with a settlement amount of P2,000,000
with realizable value of P3,000,000. The said accounts payable is a fully secured liability since its
settlement amount of P2,000,000 can be fully paid by the asset’s realizable value of P3,000,000.
3. Partially secured liabilities – These are liabilities that the pledged assets cannot fully cover. Example:
A pledged asset has covered the accounts payable with a settlement amount of P2,000,000 with a
realizable value of P1,500,000. The said accounts payable is covered by the pledged asset but only to
the extent of P1,500,000.
4. Unsecured liabilities without priority – These are liabilities that are not secured with any pledged
asset. In other words, these are liabilities that will only be paid after all the priority liabilities and secured
liabilities are paid.

Estimated recovery percentage is used to determine the estimated amount that can be recovered or
collected by the unsecured creditors without priority.

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𝑁𝑒𝑡 𝑓𝑟𝑒𝑒 𝑎𝑠𝑠𝑒𝑡𝑠

𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑟𝑒𝑐𝑜𝑣𝑒𝑟𝑦 𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 =
𝑇𝑜𝑡𝑎𝑙 𝑢𝑛𝑠𝑒𝑐𝑢𝑟𝑒𝑑 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 𝒘𝒊𝒕𝒉𝒐𝒖𝒕 𝑝𝑟𝑖𝑜𝑟𝑖𝑡𝑦

𝑁𝑒𝑡 𝑓𝑟𝑒𝑒 𝑎𝑠𝑠𝑒𝑡𝑠 = 𝑇𝑜𝑡𝑎𝑙 𝑓𝑟𝑒𝑒 𝑎𝑠𝑠𝑒𝑡𝑠 − 𝑇𝑜𝑡𝑎𝑙 𝑢𝑛𝑠𝑒𝑐𝑢𝑟𝑒𝑑 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 𝒘𝒊𝒕𝒉 𝑝𝑟𝑖𝑜𝑟𝑖𝑡𝑦

Deficiency Statement
This statement is prepared to accompany the Statement of Affairs. It summarizes the sources of deficiency
such as:
• Losses on realization (net of gains on realization)
• Additional liabilities and liquidation expenses
• Losses to be borne by owners (Total shareholders’ equity)

Statement of Realization and Liquidation

The presentation of a Statement of Realization and Liquidation is almost similar to the concept of a T-
Account. In the statement of realization and liquidation, the T-Account pertains to the “Estate” account with
a normal credit balance. If it has a credit balance, there is a net income. Otherwise, it has a net loss. This
T-Account is maintained by the Trust or Receiver to which the liquidation process is entrusted.

The “Estate” Account

Assets acquired
Assets to be realized
Liabilities liquidated
Liabilities not liquidated
Supplementary expenses
Net loss
Assets realized
Assets not realized
Liabilities to be liquidated
Liabilities assumed
Supplementary income
Net income

(Week 8) Construction Contracts

Definition of a Construction Contract

A construction contract is a contract wherein one party constructs an asset as a service rendered for a
customer. This contract is prevalent among construction companies or what we normally call “contractors”.
These contractors normally construct buildings for their customers.

The construction of an asset in a construction contract is normally completed on a long-term basis since
structures like buildings cannot be constructed in a short period of time.

The accounting issue in construction contracts mainly pertains to the timing of recognition for the revenues
and costs by the contractor. Since the construction is completed over a long period of time, several
accounting periods are affected.

Core Principle of PFRS 15

The core principle of IFRS 15 requires a company to recognize revenue in a way that reflects the pattern
in which goods or services are transferred to customers, at an amount that reflects the consideration the
company expects to be entitled in exchange for those goods or services. As in the sale of goods, the five
(5) steps in applying PFRS 15 are:
1. Identifying the contract with customers.
2. Identifying the performance obligations.
3. Determining the transaction price.
4. Allocating the transaction price to the performance obligations.
5. Recognizing revenue as (or when) performance occurs.

Methods for Measuring Progress

Input method. Accounting for revenues and costs in construction contracts uses input methods. These
input methods involve using the efforts and resources that have been exerted to construct the asset to
account for the revenues and costs. Meaning, the revenues, and costs will be recognized to the extent of

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the efforts and resources that have been exerted (Millan, 2020). If the entity’s efforts or inputs are expended
evenly throughout the performance period, it may be appropriate to recognize revenue on a straight-line
basis.

Output method. This method recognizes revenue based on the direct measurement of the value to the
customer of the goods or services transferred to date relative to the remaining goods or services promised
under the contract. Output methods include surveys of performance completed to date, appraisal of results
achieved, milestones reached, time elapsed, and units produced or delivered.

Cost-to Cost Method

The cost-to-cost method is the most commonly used input method in accounting for the revenues and
costs in construction contracts. This method involves estimating the construction stage using the proportion
of the total construction costs incurred as of the end of the accounting period to the total estimated
construction costs (Millan, 2020).

Percentage of Completion (POC). This is used when the outcome of a construction contract can be
estimated reliably.

𝐶𝑜𝑠𝑡 𝑖𝑛𝑐𝑢𝑟𝑟𝑒𝑑 𝑡𝑜 𝑑𝑎𝑡𝑒

𝑃𝑂𝐶 =
𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 𝑎𝑡 𝑐𝑜𝑚𝑝𝑙𝑒𝑡𝑖𝑜𝑛

The cost incurred to date refers to the cumulative construction costs incurred from the start of the project
up to an end of a certain accounting period.

The total estimated construction costs or total cost at completion refer to the total projected
construction costs for the entire project. It can also be calculated by summing up the total construction costs
incurred as of the end of the accounting period and the total estimated construction costs to complete.

Under cost to cost method, contract revenue, contract cost, and income or profit to be reported in the
income statement are determined as follows:

𝐶𝑜𝑛𝑡𝑟𝑎𝑐𝑡 𝑟𝑒𝑣𝑒𝑛𝑢𝑒 𝑓𝑜𝑟 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑦𝑒𝑎𝑟 = (𝐶𝑜𝑛𝑡𝑟𝑎𝑐𝑡 𝑝𝑟𝑖𝑐𝑒 𝑥 𝑃𝑂𝐶) − 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 𝑝𝑟𝑒𝑣𝑖𝑜𝑢𝑠𝑙𝑦 𝑟𝑒𝑐𝑜𝑔𝑛𝑖𝑧𝑒𝑑

𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡 = 𝐶𝑜𝑛𝑡𝑟𝑎𝑐𝑡 𝑟𝑒𝑣𝑒𝑛𝑢𝑒 − 𝑐𝑜𝑛𝑡𝑟𝑎𝑐𝑡 𝑐𝑜𝑠𝑡𝑠

The construction contract costs are equal to the actual costs incurred during the year, not including the
contract costs related to future activity, such as construction materials purchased but not yet consumed
during construction.

Mobilization Fee
Mobilization costs are indirect costs of construction. It includes all associated costs for relocating staff
manpower to the project site; transporting equipment and small tools and consumables to the site;
premiums paid for performance and payment bonds including coinsurance and reinsurance agreements as
applicable; and other items as required by the contract.

Retention Fee
Retention fee is a percentage, usually in the order of 5-10% of the value of the work already completed,
withheld by the owner for the contractor to reach substantial completion of the project.

Anticipated Contract Loss

When it is probable that the contract costs will exceed total contract revenue, the expected loss should be
recognized as an expense immediately.

Loss to be reported this year = Anticipated loss + All profit recognized previously

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(Week 9) Franchise Operations – Franchisor’s Perspective

Accounting for Franchise

PFRS 15 defines a license as one that establishes a customer’s rights to an entity's intellectual property.
Examples of licenses of intellectual property include:
a. Software and technology
b. Motion pictures, music, and other forms of media and entertainment
c. Franchises
d. Patents, trademarks, and copyrights.

Franchise is a contract wherein two (2) parties engage in a franchising agreement where one acts as a
franchisor or the one who grants the other party (franchisee) the right to use or sell certain products, the
right to use certain trademarks or perform certain services within a particular geographical location.

The franchisor should first identify the franchise fees to be collected from the franchisee. The franchisee
should pay franchise fees to cover the franchisor’s services related to the rendering of the franchise
package to the franchisee.

The specific provision of the standards that deal with the accounting for a franchise can be found on the
licensing topic of PFRS 15.

Under the licensing section of PFRS 15, the promise to grant the license must be determined first whether
the license of Intellectual Property (IP) is distinct or not because PFRS 15 includes specific application
guidance for distinct licenses of IP.

• For licenses that are not distinct, an entity will follow the general requirements in the standards to
account for all promises as a single performance obligation (that contains a license and at least one
other good or service).

• For distinct licenses of IP, the promise to grant a license is treated as a separate performance
obligation from other promises in the contract. An entity must determine whether the license transfers
to the customer at a point in time or over time by considering the nature of the promise to the customer.
The standard states that entities provide their customers with either:

o A right to access the entity's intellectual property as it exists throughout the license period,
including any changes to that intellectual property, which is recognized as revenue over time.
Therefore, the consideration received is recognized as revenue over the license period.
o A right to use the entity's intellectual property as it exists at the point in time when the license
is granted, which is recognized as revenue at a point in time. Therefore, the consideration
received is recognized as revenue at the time the license is provided.

Franchise Fees
1. Initial franchise fee – This is the franchisee's initial fee to avail of the franchise. It is like a down
payment in a normal trade transaction. It is normally paid when the franchisor and franchisee sign the
franchise agreement are normally non- refundable. However, some franchise agreement allows initial
franchise fees to be paid over an extended period of time and provide for the right of the refund up to
a certain amount.

Initial services include:

a. Assistance in site selection leased negotiation, financing, and supervision of construction
activity
b. Initial training in all facets of operating a business
c. Assistance with staff recruitment and training
d. Access to preferential purchasing arrangements the franchisor has put in place
e. Provision of accounting, information, and quality control systems
f. Advertising and promotion

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g. Preparations for and execution of the grand opening

2. Continuing franchise fees – This is the payment being made by the franchisee to the franchisor
periodically. This can also be called royalty fees and normally computed based on a percentage of
sales made by the franchisee. These fees may include management fees, training fees, accounting
services fees, marketing services funds, and renewal funds.

3. Sale of equipment and other tangible assets – In some franchises, equipment or a certain asset will
be necessary for the franchise operation. The franchisor can provide this asset to the franchisee for a
fee.

(Week 11) Consignment Sales

Consignment arrangements
Under a consignment arrangement, the consignor delivers the goods to another party, i.e., the consignee,
who undertakes to sell the goods to end customers on behalf of the consignor.

The consignor recognized revenue only when the consignee sells the consigned goods to end customers
because it is only at this point that the consignor relinquishes control over the goods. Accordingly, the
consigned goods remain in the consignor’s inventory until they are sold. The consignee records the
consigned goods by means of memorandum entries.

Freight and other incidental costs that the consignor incurs in transferring the goods to the consignee are
capitalized as the cost of the consigned goods. Repair costs for damages during shipment and storage and
other maintenance costs are charged as an expense. If the consignee shoulders the freight and other
incidental costs, the consignee treats the costs as receivable from the consignor if the costs are
reimbursable; otherwise, the consignee recognizes them as an expense.

Revenue of Consignor and Consignee

The consignee earns income based on the commission given by the consignor. It is normally expressed as
a percentage of sales made by the consignee. In other arrangements, the consignee purchases the goods
from the consignor simultaneously with the sale to the end customer. In the latter case, the consignee earns
income by mark-up on the final selling price. In some other arrangements, the consignee earns both a
commission and a mark-up.

Typically, the commission is deducted from the amount remitted to the consignor. However, in cases where
the commission is paid in advance to the consignee, the consignor records the commission as receivable
and not a cost of inventory. When the related goods are sold to the end customer, the consignor
derecognizes the receivable and recognizes the commission expense.

When the consigned goods are sold to end customers:

• The consignor recognizes revenue at the gross amount of consideration, i.e., the selling price
agreed with the consignee.
• The consignee recognizes revenue at the commission or fee to which it is entitled.

Sample proforma computation:

Sales P xxx
Cost of Goods Sold xxx
Freight in allocated to sold units xxx
Gross Profit P xxx
Freight out xxx
Advertising expense xxx
Commission expense xxx
Net income P xxx

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Sales P xxx
Freight out xxx
Advertising expense xxx
Commission expense xxx
Amount remitted to consignor P xxx

(Weeks 12-13) Installment Sales

Installment Sales Method

In the installment sales method, the gross profit is initially deferred until collections are made. This is
because of the uncertainty in the collectability of the customers’ payments. Realized gross profit is
computed by multiplying the gross profit rate to the collections from customers.

Realized gross profit (RGP) = Collections x Gross profit rate based on sales

Take note that the gross profit rate should always be based on sales, not on cost. If the gross profit rate is
based on cost, it must be converted to gross profit based on sales before computing the realized gross
profit.

Computation of Gross Profit Rate (GPR) based on Sales

𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
𝐺𝑃𝑅 𝑜𝑛 𝑠𝑎𝑙𝑒𝑠 =
𝑆𝑎𝑙𝑒𝑠

or

𝐷𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡, 𝑒𝑛𝑑

𝐺𝑃𝑅 𝑜𝑛 𝑠𝑎𝑙𝑒𝑠 =
𝐼𝑛𝑠𝑡𝑎𝑙𝑙𝑚𝑒𝑛𝑡 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒, 𝑒𝑛𝑑

Installment Receivable and Deferred Gross Profit

Installment Accounts Receivable DGP (IAR x GP rate)

Beg xxx xxx Collections Collections xxx xxx Beg
Inst. Sales xxx xxx Defaults Defaults xxx xxx Inst. Sales
xxx Write-off Write-off xxx
End xxx xxx End

Repossession
In some circumstances, goods sold under the installment sales arrangement may be subsequently
repossessed. This normally occurs when the customer defaults in payment. The accounting procedures for
the repossession are as follows:
a. The repossession is journalized by debiting an inventory account measured at fair value. The fair
value under the installment sales method may either be the:
i. Appraised value of the repossessed goods; or
ii. Estimated selling price of the repossessed goods net of reconditioning costs and
normal profit margin.
b. The installment accounts receivable and deferred gross profit related to the repossessed good are
derecognized upon repossession.
The difference between the installment accounts receivable and the combined amount of the fair value of
repossessed goods and deferred gross profit will be treated as gain or loss on repossession

Pro-forma entry for loss on repossession:

Inventory xxx
Deferred gross profit xxx
Loss on repossession (balancing figure) xxx
Installment accounts receivable xxx

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The loss on repossession is computed by calculating the difference between the related installment
accounts receivable balance and the combined amount of inventory and deferred gross profit.

Trade-ins
A seller may accept a trade-in of old merchandise from a buyer as part of the payment for the sale of new
merchandise. Trade-ins under the installment sales method are accounted for as follows:

a. A traded-in merchandise is debited to inventory at fair value. The fair value under the installment
sales method may either be the:
i. Appraised value of the traded-in merchandise; or
ii. Estimated selling price of the traded-in merchandise less reconditioning costs and
normal profit margin.
b. The seller gives the buyer a trade-in value for the old merchandise. The trade-in value is the amount
treated as part payment of the new merchandise being sold. There is no accounting problem if the
trade-in value is equal to the fair value in (a) above. Otherwise, the seller shall recognize an over-
allowance or under-allowance.
• If trade-in value > fair value = Over-allowance (debited)
• If trade-in value < fair value = Under-allowance (credited)

Note: The over-allowance is deducted from the sale price, while under-allowance is added to the
sale price when computing the gross profit rate.

Pro-forma entry:
Inventory – Traded-in (at fair value) xxx
Over-allowance (Trade-in value > FV) xxx
Installment receivable (balancing figure) xxx
Installment Sale xxx
Under-allowance (Trade-in value < FV) xxx

(Week 15) Accounting for Home Office and Branch Transactions

Transactions Between the Home Office and The Branch

Although not a separate legal entity, a branch is a separate business unit. Accordingly, a branch records
its transactions and prepares its financial statements regularly. Even though the home office and each
branch maintain separate books, all accounts are combined for external reporting so that the external
financial statements will represent the company as a single economic enterprise. The only peculiar
accounting procedures are the following:
a. Recording the transactions between the home office and the branch; and
b. Preparing the combined financial statements of the home office and branch.

For internal reporting purposes, the transactions between a home office and branch are recorded using the
following reciprocal accounts:

“Investment in Branch” account “Home Office” account

• Maintained in the Home
Office’s books as an asset.
• It shows the extent of the
home office’s investment in a
particular branch
• Maintained in the Branch’s
books as equity.
• It represents the home
office’s equity in the branch

The reciprocal nature of the Investment in Branch and the Home Office accounts, and how they are affected
by various transactions, can be shown as follows:

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Investment in branch
(a) Assets transferred to the branch xxx xxx (b) Assets received from branch
(c) Liabilities and expenses incurred xxx (e) Branch loss
or paid by HO on behalf of the branch xxx
(d) Branch profit xxx

Home Office
(b) Assets transferred to home xxx xxx (a) Assets received from home office
office
(e) Branch loss xxx xxx (c) Liabilities and expenses incurred
or paid by HO on behalf of the branch
xxx (d) Branch profit

Shipments to Branch and Shipments from Home Office

1) The balance of the Shipments to Branch account is subtracted from the total of beginning inventory
and purchases in the computation of the home office’s cost of goods sold for the period. This
reduces the total goods available for sale and avoids an overstatement of the cost of goods sold.
2) The Shipments from Home Office account on the branch books is included in the computation of
the branch’s cost of goods sold as an addition to purchases; it increases the branch’s total goods
available for sale.
3) The home office’s Shipments to Branch account and the branch’s Shipment from Home Office
account are nominal accounts and therefore closed at the end of the period to Income Summary
account together with the other revenue and expense accounts.
4) Freight costs incurred in shipping merchandise from the home office to a branch become part of
the cost of the branch inventory.

Allocation of Expenses
Branch expenses incurred and paid by the branch are recorded directly on the branch's books in the usual
manner. However, the home office may allocate expenses to a branch. These allocated expenses might
be of several types:
a. Expenses incurred by the branch but paid by the home office.
b. Expenses incurred by the home office on behalf of the branch include depreciation on branch
equipment carried on the home office books.
c. Allocation of expenses incurred by the home office, for example, a portion of the cost of general
advertising.

Combined Financial Statements

The home office and its branch(es) are viewed as a single reporting entity for external reporting; thus, the
home office's and its branches’ individual financial statements are combined when preparing the entity’s
general-purpose financial statements. Combined financial statements are prepared by:
a. Adding together similar items of assets, liabilities, income, and expenses; and
b. Eliminating the reciprocal and other interoffice accounts.

To facilitate the preparation of combined financial statements, a working paper normally is used to combine
financial statements for a company with branch operations.

Reconciliation of Reciprocal Accounts

The reconciliation shall be made if the balances of the reciprocal accounts are not equal. The procedures
are like those used when preparing bank reconciliation. Generally, reconciling items can be classified as
follows:

a. Transfers-in-transit. There may be asset transfers between the home office and branch that the
intended recipient has not yet recorded at the financial statement date. For example, the branch
has not yet received or recorded a shipment of inventory from the home office. The reconciling
entry is to debit the Shipments from Home Office account, and a credit to Home Office.

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b. Unrecorded debit and credit memos.

A debit memo sent by the home office to the branch means the home office has debited
(increased) the Investment in Branch account. Thus, the corresponding entry to be made in the
branch books is a credit (increase) to the Home Office account.

The opposite applies to a credit memo. For instance, the home office collects accounts receivable
on behalf of the branch and records the transaction as a debit to Cash and credit to Investment in
Branch. Therefore, to notify the branch of the transaction, a credit memo is sent to the branch. The
branch will record the credit memo as a debit to Home Office and credit to accounts receivable.

A debit memo sent by the branch to the home office means the branch has debited (decreased)
the Home Office account. Thus, the corresponding entry to be made in the home office books is a
credit (decrease) to the Investment in Branch account.

The opposite applies to a credit memo. For instance, the branch returns damages inventory to the
home office and records the transaction as a debit to Home Office and credit to Shipments from
Home Office. Therefore, to notify the home office of the transaction, a credit memo is sent to the
home office. The home office will record the credit memo as a debit to Shipment to Branch account,
and credit to Investment in Branch.

c. Errors. Errors such as omissions in recording, double recording, mathematical mistakes, and the
like can result in a disparity between the reciprocal accounts.

Special Problems

The home office may prefer to bill merchandise to branches at the above cost, i.e., cost-plus mark-up,
otherwise known as billed price. Under this method, the branch manager is not given complete information
concerning the actual cost of merchandise shipped. Thus, the branch records the charges listed on the
invoice accompanying the goods at the billed price rather than the cost upon receipt of merchandise from
the home office. Note that this is only for internal reporting purposes. Its purpose is to consider the home
office’s contribution to profit through its central functions (such as procurement, manufacturing, marketing,
etc.) when comparing the company's profitability.

When billings to the branch exceed the cost, the profits determined by the branch will be less than actual
profits. The inventories reported by the branch are overstated in as much as they were valued based on
the billed price, not at their cost. The home office must consider such in summarizing the branch operations.
When shipments are billed at cost, the branch’s gross profit is attributed solely to the branch. On the
contrary, when shipments are billed at above cost, a portion of the branch’s gross profit is attributed to the
home office.

Allowance for Overvaluation of Branch Inventory

Allowance for overvaluation of branch inventory (also called allowance for mark-up) represents the mark-
up on shipments from the home office. This account is adjusted by the home office at the end of the period
to recognize the portion of the mark-up that is realized. After adjustment, any balance of this account
represents the mark-up associated with the branch ending merchandise inventory coming from the home
office.

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True Net Income of the Branch

The true profit of the branch is computed by simply restating the merchandise received from the home office
to their original costs. Alternatively, the true profit of the branch can be computed by adding the realized
mark-up to the individual profit. The realized mark-up is the mark-up on the shipments sold to external
parties.

Sales P xxx
Cost of goods sold:
Beginning inventory P xxx
Shipment from home office, at cost xxx
Purchases xxx
Freight in xxx
Total goods available for sale P xxx
Ending inventory, at cost (xxx) (xxx)
Gross profit of the branch P xxx
Operating expenses (xxx)
True profit of the branch P xxx

Unadjusted balance of AFOBI P xxx

Adjusted balance of AFOBI (xxx)
Realized mark-up P xxx

Branch profit P xxx

Realized mark-up xxx
True branch profit P xxx

The adjusted balance of AFOBI is the mark-up on ending inventory.

When combined or consolidated financial statements are prepared, the AFOBI account is eliminated
together with the Shipments accounts to remove the mark-ups and restate the branch’s cost of goods sold
and ending inventory to their original costs.

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