ACCCOUNTING FOR

Accounting for PARTNERSHIP and CORPORATION

PARTNERSHIP
2014 edition

GLORIA J. TOLENTINO-BAYSA, Ed. D

Certified Public Accountant

and Fellow, Royal Institute of Singapore

Diplomate, Philippine Academy of Professionals in Business Education

CORPORATION
ASAIHL Fellow, National University of Singapore
MBE, Polytechnic University of the Philippines
BSC-Accounting, Philippines College of Commence

Graduate School Professional Lecturer

Polytechnic University of the Philippines

Formerly
2014 edition Vice-President for Finance
Assistant to the Vice-President for Academic Affairs
Dean, College of Accountancy and Law
Director, Budget Services
Polytechnic University of the Philippines

CPA Reviewer
Center for Review and Professional Development, Inc.
University of the East

MA. CONCEPCION Y. LUPISAN

Certified Public Accountant

Master of Science in Accountancy, De La Salle University

BSC-Accounting, Polytechnic University of the Philippines

Formerly

Dean, College of Business, Entrepreneurship and Accountancy

Miriam College

Gloria J. Tolentino-Baysa Special Lecturer

Polytechnic University of the Philippines

Ma. Concepcion Yamat Lupisan San Sebastian College

University of Santo Tomas

CPA Reviewer
Center for Review and Professional Development, Inc.
Miriam College
De La Salle University – Manila
 TABLE OF CONTENTS
Chapter Title Page

1 Review of the Accounting Process

2 Nature and Formation of a partnership
3 Partnership Operations
4 Partnership Dissolution
5 Change in Capital Structure by Withdrawal, Retirement, Death or Incapacity
of a Partner
6 Partnership Liquidation (Lump-Sum)
7 Installment Liquidation
8 Organization and Formation of a Corporation
9 Operations, Dividends, Book Value Per Share, and Earnings Per Share

10 Share Capital Transactions Subsequent to Original Issuance

11 Financial Reporting and Analysis
12 Introduction
 Chapter 1 – Review of the Accounting Process

CHAPTER 1 DEFINITION and NATURE OF ACCOUNTING

Accounting is defined as a service activity. Its function is to provide quantitative information,
REVIEW OF THE ACCOUNTING PROCESS primarily financial in nature, about economic entities that is intended to be useful in making
economic decisions.
LEARNING OBJECTIVES
Accountants render services by providing information about economic entities that is measured
1. Understand the definition of accounting and identify the users of accounting information. in terms of money. These entities are either profit-oriented (business entities or business
2. Identify and explain the steps in the accounting process. enterprises) or not-for-profit entities. Generally, all parties who have interest in an entity,
3. Prepare adjusting entries and understand the rationale for their preparation. whether direct or indirect, are called stakeholders. These stakeholders who use accounting
4. Prepare closing entries and understand the rationale for their preparation. information are grouped into two, namely:
5. Explain the advantages of preparing reversing entries and identify adjusting entries that may be
reversed. 1. External users – they are groups or individuals who are not directly concerned with
the day-to-day operations of the entity but are indirectly related to the said entity. They
PREVIEW OF THE CHAPTER include creditors, investors, prospective creditors and investors, government and the
public. They make decisions that affect their relationship to the entity.
ACCOUNTING PROCESS
(A Review) 2. Internal users – they are the management personnel in all levels within an entity who
are responsible for the planning and control of the operations and therefore, they have
access to the day-to-day operations of the entity. They make decisions that affect the
internal operations of the entity.

Accounting and Users Accounting Process Adjusting Entries

Of Accounting • Accruals Generally, the reports provided by accountants are expressed and measured in financial or
Information • Documentation • Deferrals Prepayments money terms; these reports are called financial reports and are of various types. One type of
• Journalizing • Depreciation financial reports are the general-purpose financial statements. The Conceptual Framework for
• Posting • Uncollectible accounts Financial Reporting issued by the Financial Reporting Standards Council (FRSC) identifies
• Definition and nature
• existing and potential investors, lenders and other creditors as the primary users of general-
of accounting Preparation of trial balance • Inventory
purpose financial statements. Other users include regulators and members of the public other
• Internal Users • Compilation of data for
than investors, lenders and other creditors. The following are some of the users of financial
• External Users adjustments Closing Entries information and the use of such information in the decision that they make.
• Preparation of work sheet • Income
• Preparation of financial • Expenses
statements
1. Investors – they are concerned with the risk inherent in, and return provided by their
• Drawing investments. They need information to help them determine whether they should make
• Preparation of adjusting and
additional investment, hold or sell their investments. Shareholders (owners or
closing entries
Reversing Entries investors in a corporation) need information
• Preparation of post-closing
trial balance • Accruals
• Deferrals Prepayments 2. Lenders – they are interested in information that enable them to determine whether
• Preparation of reversing
their loans, and the interest attaching to them, will be paid when due.
entries

3. Suppliers and other trade creditors - they are interested in information that enable
them to determine whether amounts owing to them will be paid when due.

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Chapter 1 – Review of the Accounting Process

4. Employees – they are interested in the information about the stability and profitability Debit Credit
of their employers. They are also interested in information that will enable them to • Increase in asset • Decrease in asset
assets the ability of their employers to provide renumeration, retirement benefits and • Decrease in liability • Increase in liability
employment opportunities. • Decrease in equity due to • Increase in equity due to
• withdrawal by owner/s • additional investment by owner/s
• decrease in income • increase in income
5. Customers – they are interested in information about the continuance of an entity, • increase in expense • decrease in expense
especially when they have a long-term involvement with, or are dependent on the
entity.
THE ACCOUNTING CYCLE

6. Governments and their agencies – they are interested in the allocation of resources
Business
and therefore, the activities of entities. They also require information so that they can
regulate the activities of entities determine taxation policies and as the basis for Transaction
national income and similar statistics.

7. Public – they are interested in information about the trends and recent developments Documentation Preparation of reversing
in the prosperity of the entity and the range of its activities. entries

ACCOUNTING PROCESS
Journalizing
Accounting process refers to the procedures or series of steps undertaken to come up with the • General Journal Preparation of post-closing
trial balance
information reported in the financial statements. The accounting process is also referred to as • Special Journals
the accounting cycle.

The accounting process is divided into two phases, namely: (1) the recording phase and (2) the
summarizing phase. These two phases and the steps under each phase are discussed in the Posting Journalizing and posting of
succeeding paragraphs. • General Ledger adjusting and closing
• Subsidiary ledgers entries
RECORDING PHASE

The recording phase includes collecting information about economic transactions and the
recording of these transaction in the appropriate accounting records. A transaction is an Preparation of a trial Preparation of financial
balance statements
economic event that changes an asset, a liability, or an equity account balance; hence, it must be
• Statement of Financial
recorded. Accounting records, on the other hand, include business documents, journals, and Position (Balance Sheet)
ledgers. • Statement of Comprehensive
Income
Transactions are recorded in terms of debits and credits (double-entry system). Debit is the left Compilation of data for • Statement of Cash Flows
side of an account while credit is the right side of an account. Following are the rules of debits adjustments • Statement of Changes in
and credits. Equity

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Chapter 1 – Review of the Accounting Process
Key Points:
• If a work sheet is not prepared, the adjusting entries must be journalized and posted before
the financial statements can be prepared. This is because the basis for the preparation of the
financial statements are the updated balances of the accounts in the general ledger.
• The cycle is a continuing process and steps may overlap during an accounting period.
The recording phase is composed of the following steps:
1. Documentation – this is the process of preparing or receiving appropriate business
documents. Business documents are original source materials which serve as evidence of
transactions. They include official receipts, sales invoices, purchase invoices, credit
memoranda, and debit memoranda.
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
journal is the most flexible type of journal where almost types of transactions that are usual
and that occur frequently or on a repetitive basis the most common types of special journals
are the sales journal, purchases journal, cash receipts journal, and cash disbursements
journal.
3. Posting – this is the process of transferring the recorded transactions in the journal to the
accounts in the ledger. A ledger is a group of related accounts and is called book if final
entry. The objective of posting is to classify the effects of transactions on specific asset,
liability, equity, income, and expenses accounts.
A company many maintain both a general ledger and subsidiary ledgers depending upon its
needs. The general ledger is the principal ledger which contains all the accounts that are
reported in the financial statements, namely: assets, liabilities, equity, income, and expenses.
It also includes contra and adjunct accounts with positive balances such as Accumulated
Depreciation (deducted from Property, Plant and Equipment). Discount on Notes Payable
(deducted from Notes Payable). Sales Discount (deducted from Sales), and Purchases
Discounts (deducted from Purchases). Adjunct accounts are accounts set up to record
additions to related accounts such as Freight-In (added to Purchases).
The subsidiary ledgers contain details of some general ledger account balances. For
example, the Accounts Receivable and Accounts Payable account balances are found in the
general ledger. The compositions of their balances are found in the subsidiary ledger. To
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illustrate, let us assume that Bountiful Merchandising reports accounts receivable from
customers totaling to P2,500,000. This total amount of P2,500,000 is reflected in the
Accounts Receivable account in the general ledger. The names of customers and the amount
due from each of them are found in the subsidiary ledger, A general ledger account that has
a supporting subsidiary ledger is called a control account.
SUMMARIZING PHASE
The summarizing phase includes the steps necessary for the preparation of periodic summary
reports. This phase includes the following steps:
4. Preparing a trial balance – this is the process of preparing a summary of the balances of
the accounts in the general ledger known as the trial balance. After all transactions are
posted, the balance of each account is determined. Asset, expense, and temporary capital
account such as Drawing have normal debit balances; liability, equity, and income accounts
have normal credit balances.
A trial balance is prepared to prove the equality of debits and credits but is does not indicate
the accuracy of work done. As discussed in a previous accounting subject, there are errors
in recording that will not cause inequality in the trial balance. An example of this is debiting
or crediting an incorrect account such as a debit to Accounts Receivable erroneously debited
to Noted Receivable. Another example is failure to record a transaction or recording the
same transaction twice. The preparation of trial balance is normally done in the work sheet.
5. Compiling adjusting fata – this is the process of gathering and putting together various
data necessary to update the balances of certain accounts in the books of the company.
Adjustments based on compiles data are then recorded before the financial statements are
prepared. These adjustments are necessary so that income and expenses will be reported in
the period they are earned and incurred, respectively; hence, profit will not be misstated.
The most common types of adjusting data are the following:
a. Accrued expense – this is an expense incurred but not yet paid as of the statements of
financial position (balance sheet_ date, such as interest accrued on notes payable.
Another example is accrued salaries of employees. An accrued expense is unpaid as of
the statement of financial position date but is matched against income or earnings for
the current period. Adjustment for accrued expense is recorded as follows:
Expense xxx
Payable xxx
Example 1 – The ABC Company has an outstanding 90-day, 12% note payable dated
December 1, 2014 amounting to P200,000. The interest is payable upon maturity of the
note. The company’s accounting period or financial year is the calendar year, that is,
Chapter 1 – Review of the Accounting Process

January 1 to December 31, 2014 (that is, December 1 to December 31). The adjusting period, the unexpired or unused portion of the asset is transferred to an asset account.
entry to record the accrued interest is as follows: The comparative entries to record payment and subsequent adjustment at the end of
Interest Expense 2,000 the accounting period under the two methods are presented on the next page.
Interest Payable 2,000
P200,000 x 12% x 30/360’ = P2,000 1. To record the initial payment of expense
ASSET METHOD EXPENSE METHOD
Example 2 – DEF Company pays salaries every Friday, the end of a five-day work week. Prepaid Expense xxx Expense xxx
The total salaries for the week ending January 3, 2015 is P150,000. Cash xxx Cash xxx

In this case, the P150,000 salaries for the week ending January 3, 2015 is for the 2. To record adjustment at the end of the accounting period
services rendered by employees on December 30, December 31, January 1, January 2, ASSET METHOD EXPENSE METHOD
and January 3. Therefore, the company has accrued salaries for two (2) days as of Expense xxx Prepaid Expense xxx
December 31, 2014. The adjusting entry to record the accrued salaries is as follows: Prepaid Expense xxx Expense xxx
Salary Expense 60,000 (Amount recorded is the expired or (Amount recorded is the unexpired or unused portion of
Salaries Payable 60,000 used portion of the prepayment) the prepayment)
P150,000 x 2/5 = P60,000
Example 4: On May 1, 2014, JKL Company paid insurance premium of P30,000 covering a period
b. Accrued income – this is income earned but not yet received or collected as of the of one year beginning on this date. The entries to record the payment on May 1 and the adjusting
statement of financial position (balance sheet) date, such as accrued interest on notes entry on December 31 under the two methods are presented below:
receivable. An accrued income is not yet collected but is matched with expenses for the
current period. The adjusting entry to record accrued income is as follows: ASSET METHOD
Receivable xxx 2014
Income xxx May 1 Prepaid Insurance 30,000
Cash 30,000
Example 3 – GHI Company received a 3-month, 12% note dated December 1, 2014
amounting to P100,000. Interest is receivable upon maturity of the note. Dec. 31 Insurance Expense 20,000
Prepaid Insurance 20,000
As of December 31, 2014, interest for one month (that is, December 1 to December 31) P30,000 x 8/12= P20,000
is already earned but not yet collected. The adjusting entry to record the accrual of
interest income is as follows: The expired portion of the insurance premium is for the period May 1 to December 31, 2014, or a
Interest Receivable 1,000 period of eight (8) months.
Interest Income 1,000
P100,000 x 12% x ½ = P1,000 EXPENSE METHOD
2014
c. Prepaid expense – this is an expense paid or acquired in advance such as insurance May 1 Insurance Expense 30,000
premium. Other examples are rent paid in advance and office supplies purchased. The Cash 30,000
adjustment relating to prepaid expense at the end of the accounting period depends on
the method used in recording the initial payment or acquisition. Dec. 31 Prepaid Insurance 10,000
Insurance Expense 10,000
There are two methods of recording prepayments, namely: the asset method and the P30,000 x 4/12 = P10,000
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 unexpired portion of the insurance premium is 4 months; that is, 12 months less the expired
the asset is transferred to an expense account. Under the expense method, the payment portion of eight (8) months.
or purchase is initially debited to an expense account. At the end of the accounting

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Chapter 1 – Review of the Accounting Process

d. Unearned/income – this is income already but not yet earned as of the statement of INCOME METHOD
financial position (balance sheet0 date, such as rental income collected in advance or 2014
subscription received in advance. Unearned income is also known as deferred income. Sept. 1 Cash 240,000
Like prepaid expense, the adjustment for unearned income at the end of the accounting Rent Income 240,000
period depends on how the initial receipt of cash is recorded.
Dec. 31 Rent Income 160,000
Unearned Rent 160,000
The receipt of the advance payment may be recorded using the liability method or the P240,000 x 4/12 = P80,000
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 The unearned portion is the rent for the eight (8) months; that is, twelve (12) months less
is transferred to an income account; at the end of the accounting period, the unearned the earned portion of four (4) months.
portion of the income is transferred to a liability account. The following are
comparative entries to record the receipt if cash and the adjustment at the end of the e. Depreciation of property, plant and equipment and other cost allocation –
accounting period under the two methods: depreciation is defined in PAS 16 as the systematic allocation of the depreciable amount
of an item or property, plant and equipment over its useful life. Depreciable amount is
1. To record the initial receipt of cash the cost of an asset, or other amounts substituted for cost, less its residual value. The
LIABILITY METHOD INCOME METHOD entry to record depreciation expense is as follows:
Cash xxx Cash xxx
Unearned Income xxx Income xxx Depreciation Expense xxx
Accumulated Depreciation xxx
2. To record adjustment at the end of the accounting period
LIABILITY METHOD INCOME METHOD The depreciation expense for the period is determined using any of the acceptable
Unearned Income xxx Income xxx methods identified in PAS 16 – straight-line method, diminishing balance method, and
Income xxx Unearned Income xxx units of production method. The straight-line method will be used in the illustration
(Amount recorded is the earned (Amount recorded is the unearned and problems in this chapter and in all the other chapters of this book. The other
Portion of the prepayment) portion of the prepayment) methods will be discussed in higher accounting subjects. Under the straight-line
method, the annual depreciation expense is computed as follows:
Example 5: On September 1, 2014, MNO Company received P240,000 representing
rental of an office space for one year beginning on this date, the entries to record the 𝑪𝒐𝒔𝒕 − 𝑹𝒆𝒔𝒊𝒅𝒖𝒂𝒍 𝒗𝒂𝒍𝒖𝒆
𝑫𝒆𝒑𝒓𝒆𝒄𝒊𝒂𝒕𝒊𝒐𝒏 𝒆𝒙𝒑𝒆𝒏𝒔𝒆/𝒚𝒆𝒂𝒓 =
receipt of payment on September 1 and the adjusting entry on December 31 under the 𝑬𝒔𝒕𝒊𝒎𝒂𝒕𝒆𝒅 𝒖𝒔𝒆𝒇𝒖𝒍 𝒍𝒊𝒇𝒆 (𝒊𝒏 𝒚𝒆𝒂𝒓𝒔)
two methods are presented below:
If the asset is used for less than a year, the proportionate expense should be calculated,
LIABILITY METHOD unless the company adopts a different policy such as providing half-year depreciation
2014 in the year of acquisition of the asset.
Sept. 1 Cash 240,000
Unearned Rent 240,000 The account “Accumulated Depreciation” is a contra asset account; it is reported in the
statement of financial position as a deduction from the related property, plant and
Dec. 31 Unearned Rent 80,000 equipment account.
Rent Income 80,000
P240,000 x 4/12 = P80,000 Other cost allocation includes amortization of intangible assets like franchise and
patents. This topic is being discussed in higher accounting subjects.
The earned portion is the rent for the period September 1 to December 31 or four (4)
months.

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Chapter 1 – Review of the Accounting Process

Example 6: PQR Company acquired an office equipment on October 1, 2013 for The account “Allowance for Uncollectible Accounts” is a contra asset account; it is
P310,000. The asset has an estimated useful life of 5 years and an estimated residual reported on the statement of financial position as a deduction from Accounts
value of P10,000. The entries to record depreciation expense in 2013 and 2014 are Receivable.
presented on the next page.
Example 7: STU Company’s trial balance dated December 31, 2014, contains the
2013 following information:
Dec. 31 Depreciation Expense 15,000 Accounts receivable P 350,000 debit
Accumulated Depreciation 15,000 Allowance for uncollectible accounts 2,000 credit
(P310,000 – P10,000)/5 yrs. x 3/12 Sales 1,850,000 credit

Depreciation expense for 2013 is for three months that is, October 1 to December 31, 2013. Estimated uncollectible accounts amounted to P6,050.

2014 The entry to record uncollectible accounts expense follows:

Dec. 31 Depreciation Expense 60,000 Uncollectible Accounts Expense 4,050
Accumulated Depreciation 60,000 Allowance for Uncollectible Accounts 4,050
(P310,000 – P10,000)/5 yrs.
Required allowance balance P6,050
Depreciation expense for 2014 is for one year or twelve (12) months. Allowance balance before adjustment – credit 2,000
Uncollectible account expense for the period P4,050
f. Uncollectible accounts – these represents customers’ accounts that may no longer be
collected or that may possibly become bad debts. PAS No. 39 provides that trade g. Inventory – adjustment for inventory is necessary if the periodic inventory system is
accounts receivable should be reported in the statement of financial position at used. Under the periodic inventory system, the company does not record the physical
amortized cost. Amortized costs is defined as the amount at which the receivable is movement of goods. Purchases of goods are recorded in the nominal account
measured at the time it was first recognized minus any payments and minus any “Purchases”. The reduction in inventory resulting from sale is not reflected in the books.
reduction (directly through the use of an allowance account) for uncollectibility. The Thus, the balance of the Inventory account shown in the company’s trial balance
entry to record estimated uncollectible account is as follows: 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.
Uncollectible Accounts Expense xxx
Allowance for Uncollectible Accounts xxx There are two methods of recording adjustments related to inventories. Under the first
method, two entries are prepared: (1) to transfer the beginning inventory balance to
PAS No. 39 requires a careful assessment of the collectability of the receivables the Income Summary account and (2) to establish ending inventory balance. The
(classified as financial assets). Several considerations have to be taken into account, entries are as follows:
which will be discussed thoroughly in higher accounting subject. For purposes of
discussion in this book, the estimated uncollectible amount will be provided. 1. To transfer beginning inventory balance to Income Summary
Income Summary xxx
The amount of uncollectible accounts expense that will be reported in the income Inventory (or Merchandise Inventory) xxx
statement is computed as follows:
Required allowance balance P xxx 2. To record ending inventory balance
Allowance balance before adjustment Inventory (or Merchandise Inventory) xxx
(+ debit balance/ - credit balance) xxx Income Summary xxx
Uncollectible accounts expense for the period P xxx
Under the second approach, a separate cost of goods sold account is set up and the
entry to record the adjustment is as follows:

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Chapter 1 – Review of the Accounting Process

Inventory (or Merchandise Inventory), end xxx revalued amounts and gain (loss) from change in fair value of investments classified as
Purchases Returns and Allowances xxx available for sale.
Purchases Discounts xxx
Cost of Goods Sold xxx 8. Adjusting and closing the books – the adjustments that were recorded in the work sheet
Inventory (or Merchandise Inventory), beg xxx are now formally recorded in the general journal and posted to the accounts in the general
Purchases xxx ledger. The balances of the nominal (temporary) accounts, which consist of income,
Freight-In xxx 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.
The balance of the Cost of Goods Sold account is closed to Income Summary A debit balance in the Income Summary account represents a loss while a credit balance
as part of the normal closing entries. represents a profit. Lastly, the balance of the owner’s drawing account is closed to owner’s
equity (capital) account. When the closing process is completed, all nominal counts will have
6. Preparing a work sheet/end-of-period spreadsheet – this step is optional but it facilitates zero balances.
the preparation of the financial statements. A work sheet is a working paper which contains
the data in the trial balance, the adjustments complied in step 5, and the developed income Following are the po-forma closing entries prepared at the end of the accounting period:
statement and statement of financial position data. Normally, four pairs of columns are 1. To close the balances of income accounts
maintained to achieve the purpose by which the work sheet is prepared. The first pair of Revenue/Income xxx
amount columns is for the trial balance data; the second pair is for the adjustments; the third Income Summary xxx
pair is for the income statement data; and the fourth pair is for the statement of financial
position data. In some cases, another pair of columns for adjusted trial balance is added 2. To close the balance of expense accounts
following the adjustments columns and preceding the income statement columns. Working Income Summary xxx
papers are usually prepared by using a computer spreadsheet program such as Microsoft’s Expenses xxx
Excel.
3. To close the balance of Income Summary account (credit balance)
7. Preparing the financial statements – after the work sheet is completed, the financial Income Summary xxx
statements are prepared. The data reported in the statements are taken from the completed Capital xxx
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 To close the balance of Income Summary account (debit balance)
reported in the statements are taken from the updated balances of the accounts in the Capital xxx
general ledger. The financial statements are described as the end product of the accounting Income Summary xxx
process.
4. To close the balance of the drawing account
Capital xxx
PAS 1 provides that a complete set of financial statements shall consist of the following: Drawing xxx
1. Statement of financial position (balance sheet)
2. Statement of comprehensive income 9. Preparing a post-closing trial balance – the step is done after all the balances of nominal
3. Statement of cash flows accounts have been closed, that is, their balances were reduced to zero. Therefore, a post-
4. Statement of changes in owner’s equity closing trial balance contains only the real accounts (assets, liabilities, and equity); the
5. Notes 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
An entity may prepare a single statement of comprehensive income or two separate posting the closing entries.
statements – a statement of income and a statement of other comprehensive income. Other
comprehensive income includes items of unrealized gains and losses that are not reported
as part of profit or loss, such as revaluation surplus arising from reporting of plant assets at

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Chapter 1 – Review of the Accounting Process

10. Reversing the accounts – certain adjusting entries recorded at the end of the accounting
period are reversed at the beginning of a new accounting period. These adjustments include
accrued expenses method and deferred revenues or income recorded under the revenue
method.
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.
summarizing phases. The three steps under the recording phase are the following: (1)
preparing or receiving the appropriate documents (documentation), (2) journalizing the
transactions, and (3) posting the recorded transactions to the accounts in the ledger. The
seven (7) steps under the summarizing phase are as follows: (1) preparing the trial balance,
(2) compiling the data for adjustments, (3) preparing the work sheet (optional), (4)
preparing the financial statements, (5) adjusting and closing the books, (6) preparing a post-
closing trial balance, and (7) preparing reversing entries for certain adjusting entries
(optional).

The adjustments that will be reversed if reversing entries are prepared and the pro-forma 3. Preparing adjusting entries and understand the rationale for preparing them.
reversing entries prepared at the beginning of a new accounting period are as follows: Adjusting entries are prepared at the end of the accounting period to update the balances of
1. Accrued Expense the accounts in the general ledger prior to the preparation of the financial statements. This
Payable xxx will enable the preparers of the financial statements to present fairly the financial position
Expense xxx and the results if operations of an entity during a given period because all transactions that
have affected the elements of the financial statements are recognized during the period.
2. Accrued Income Data that requires adjustments include the following: (1) accrued expense, (2) accrued
Income xxx income, (3) prepaid expense, (4) unearned income, (5) depreciation and other cost
Receivable xxx allocation, (6) uncollectible accounts receivable, and (7) inventory recorded using the
periodic inventory system.
3. Prepaid expense – expense method
Expense xxx
Prepaid Expense xxx 4. Prepare closing entries and understand the rationale for preparing them. Closing
entries are prepared for nominal accounts to reduce their balances to zero at the end of the
4. Deferred revenue or income – revenue method accounting period. Nominal accounts include the following: income accounts, expense
Unearned Income xxx accounts, and temporary equity accounts, such as the drawing account of the owner in a sloe
Income xxx proprietorship form a business organization.

5. Explain the advantage of preparing the reversing entries and identify adjusting entries
REVIEW of the LEARNING OBJECTIVES that may be reversed. Reversing entries are prepared at the beginning of a new accounting
period for the following adjustments: (1) accrued expense, (2) accrued income, (3) prepaid
expenses recorded under the expense method and (4) unearned income recorded under the
1. Understand the definition of accounting and identify the users of accounting income method. The preparation of reversing entries is optional but it facilitates the
information. Accounting is a service activity. Its function is to provide quantitative recording of expense payment and revenue receipts during the new accounting period in
information, primarily financial in nature, about economic entities, that is intended to be the usual manner.
useful in making economic decisions. The users of accounting information are grouped into
external users and internal users. The users of financial statements include present and
potential investors, employees, lender, suppliers and other trade creditors, customers,
governments and their agencies, and the public. They use the financial statements to make
informed decisions.

2. Identify and explain the steps in the accounting process. The accounting process (also
called the accounting cycle) is composed of ten (10) steps, two of which are optional. These
steps are grouped into two phases, namely: (1) the recording phase, and (2) the

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Chapter 1 – Review of the Accounting Process
GLOSSARY of ACCOUNTING TERMINOLOGIES
Accounting – a service activity. Its function is to provide quantitative information, primarily
financial in nature, about economic entities that is intended to be useful in making economic
decisions.
Accounting process – also known as accounting cycle. It includes a series of steps that are
performed to come up with the information reported in the financial statements.
Accrued expense – expense incurred but not yet paid as of the statement of financial position
date. Accrued expense is not paid but is matched against earnings for the current period.
Accrued income – income earned but not yet received or collected as of the statement of financial
position date. Accrued revenue is uncollected but is matched against expense for the current
period.
Closing entries – entries prepared at the end of the accounting period that reduce the balances
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 original entry. They include both general and subsidiary
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 statements of
financial position date but is not matched against earnings for the current period.
Post-closing trial balance – a trial balance prepared after closing the books. The post-closing
trial balance contains real accounts only.
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Real accounts – also known as permanent accounts. They are accounts whose balances are
carried forward to the next accounting period and they include asset, liability, and equity
accounts.
Reversing entries – entries prepared at the beginning of a new accounting period to reverse
certain adjusting entries. They are prepared to facilitate the recording of expense payments and
revenue receipts during the new accounting period in the usual manner.
Special journals – journals used to record repetitive or frequently occurring transactions. They
include sales journal, purchase journal, cash receipts journal and cash disbursements journal.
Subsidiary ledger – a ledger that provides details of a general ledger account.
Trial balance – a list of general ledger accounts with their corresponding balances. It proves the
equality of debits and credits.
Unearned income – also known as deferred income. This is income collected but not yet earned
or realized. Unearned income is collected but is not matched against expense for the current
period.
DISCUSSION QUESTIONS
1. What is accounting and what is its purpose? What is role in decision-making?
2. Who are the users of accounting information and what is the relevance of the information
to the various types of decisions that they make? Who are the users of financial statements
and what are their information needs?
3. What are the steps in the accounting process? What is the importance of each step and how
is it related to the other steps in the process?
4. Why are journals called books of original entry?
5. Distinguish between (a) a general journal and special journals, and (b) a general ledger and
subsidiary ledger.
6. Does the trial balance prove the accuracy of accounting work done? Explain your answer.
7. What are the common types of adjusting data? Why do we prepare adjusting entries?
Chapter 1 – Review of the Accounting Process

8. Why do accountants prepare work sheet even if its preparation is optional? MC 1-6 Probably, the last account to be listed on a post-closing trial balance would be
a. Income summary
9. Enumerate and discuss the components of a complete set of financial statements. b. Interest expense
c. Interest revenue
10. If reversing entries are made, which adjusting entries would be reversed? d. Owner’s capital

MC 1-7 Which of the following is not considered in computing net cost of purchases?
MULTIPLE CHOICE QUESTIONS a. Purchases
b. Purchases returns and allowances
c. Transportation paid on goods purchased
MC 1-1 Adjusting entries normally involve d. Transportation paid on goods shipped to customers
a. real accounts only
b. nominal accounts only MC 1-8 Which of the following accounts would appear on a worksheet for a merchandising
c. real and nominal accounts company uses the periodic inventory system?
d. neither real nor nominal account a. Cost of goods sold
b. Income summary
MC 1-2 The balance in an unearned income account represents an amount c. Purchase returns & allowances
Earned Collected d. All of these
a. Yes Yes
b. Yes No MC 1-9 After all adjusting entries are posted, the balances of all asset, liability, income and
c. No No expense accounts correspond exactly to the amounts in the
d. No Yes a. financial statements
b. post-closing trial balance
MC 1-3 An accrued expense can be best described as an amount c. unadjusted trial balance
a. paid and matched with earnings for the current period d. worksheet trial balance
b. paid and not matched with earnings for the current period
c. not paid and matched with earnings for the current period MC 1-10 Insurance Expense account has a balance of P108,000 before adjustment. This amount
d. not paid and not matched with earnings for the current period 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
MC 1-4 Which of the following accounts could appear in an adjusting entry, closing entry and statements of financial position is
reversing entry? a. P-0-
a. Accumulated depreciation b. P 36,000
b. Depreciation Expense c. P 72,000
c. Interest revenue d. P108,000
d. Salaries payable
MC 1-11 A P50,000 purchases on account was paid after the expiration of the 2% discount
MC 1-5 Closing entries ultimately will affect period. They entry to record the payment would include
a. Cash account a. debit to accounts payable for P50,000
b. Owner’s capital account b. credit to accounts payable for P49,000
c. Total assets c. debit to purchases discount for P1,000
d. Total liabilities d. credit to cash for P49.000

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Chapter 1 – Review of the Accounting Process

MC 1-12 Prior to adjustments, Supplies Expense account has a balance of P13,500. Adjustment
data gathered shows that supplies inventory on hand at year-end amounted to P5,500.
The amount of supplies to be shown in the income statement is
a. P-0-
b. P 5,500
c. P 8,000
d. P13,500

MC 1-13 Rent Income account has a credit balance of P240,000 composed of the following:
a. Rental for three months March 31, 204, P45,000
b. A credit of P195,000 representing advance rental payment for one year beginning
April 1, 2014

The December 31 adjusting entry will require a debit to Rent Income and a credit to
Unearned Rent of
a. P45,000
b. P48,750
c. P191,250
d. P195,000

MC 1-14 The Giveaway Enterprises reported an allowance for uncollectible accounts of P16,000
(credit) at December 31, 2014, before any adjustment. At the end of the year, the
company reports accounts receivable pf P80,000, 3% of which is estimated to be
uncollectible. The adjusting entry required at December 31, 2014 would be
a. Uncollectible Accounts Expense 8,000
Allowance for Uncollectible Accounts 8,000

b. Uncollectible Accounts Expense 16,000

Allowance for Uncollectible Accounts 16,000

c. Uncollectible Accounts Expense 24,000

Allowance for Uncollectible Accounts 24,000

d. Uncollectible Accounts Expense 40,000

Allowance for Uncollectible Accounts 40,000

MC 1-15 Assuming that ending merchandise inventory was P10,000 less than the beginning
merchandise inventory of P125,000 and that the net purchases was P450,000, how
much was the cost of goods sold?
a. P0
b. P335,000
c. P460,000
d. P565,000

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 Chapter 2 – Nature and Formation of a Partnership

CHAPTER 2 CHARACTERISTICS OF A PARTNERSHIP

NATURE AND FORMATION OF A PARTNERSHIP 1. Mutual agency. Any partner may act as agent of the partnership in conducting its affairs.

2. Unlimited liability. The personal assets (assets not contributed to the partnership) of any
LEARNING OBJECTIVES partner may be used to satisfy the partnership creditors’ claims upon liquidation, if
partnership assets are not enough to settle the liabilities to outsiders.
1. Define and discuss the nature of a partnership – its characteristics, advantages and disadvantages
2. Identify the different kinds of partnership and the classes of partners. 3. Limited life. A partnership may be dissolved at any time by action of the partners or by
3. Discuss the requirements in the formation of a partnership. operation of law.
4. Discuss accounting for partners’ initial investments in a partnership
4. Mutual participation in profits. A partner has the right to share in partnership profits.
PREVIEW OF THE CHAPTER
5. Legal entity. A partnership has legal personality separate and distinct from that of each of
PARTNERSHIP the partners.
(Nature and Formation)
6. Co-ownership of contributed assets. Property contributed to the partnership are owned
by the partnership by virtue of its separate legal personality.

7. Income tax. Partnerships, except general professional partnerships (i.e., those organized
Nature of a Formation of a Partnership Accounting for for the exercise of profession like CPAs, lawyers, engineers, etc.) are subject to the 30%
Partnership Partners’ Initial income tax.
• Kinds of partnerships Investments
• Characteristics • Classes of partners • Cash contributions
• Articles of Co-Partnership
ADVANTAGES OF A PARTNERSHIP
• Advantages • Non-cash asset
• Disadvantages • Registration requirements contributions
1. It is easy and inexpensive to organize, as it is formed by a simple contract between two or
• Contribution of
more persons.
industry
2. The unlimited liability of the partners makes it reliable from the point of view of creditors

3. The combined personal credit of the partners offers better opportunity for obtaining
additional capital than does a sole proprietorship.
DEFINITION
4. The participation in the business by more than one person makes it possible for a closer
supervision of all the partnership activities.
A partnership is defined in Article 1767 of the Civil Code of the Philippines as “a contract
whereby two or more persons bind themselves to contribute money, property, or industry into 5. The direct gain to the partners is an incentive to give close attention to the business.
a common fund with the intention of dividing profits among themselves.”
6. The personal element in the characters of the partners is retained.

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Chapter 2 – Nature and Formation of a Partnership

DISADVANTAGES OF A PARTNERSHIP formation. The original movable or immovable property contributed do not
become common partnership assets.
1. The personal liability of a partner for firm debts deters many from investing capital in a
b. Particular partnership – one which has for its object determinate things, their use or
partnership.
fruits, or a specific undertaking or the exercise of a profession or vocation.
2. A partner may be subject to personal liability for the wrongful acts or omissions of his/her
3. As to liability of partners
associates.
a. General co-partnership – one consisting of general partners who are liable prorate
and sometimes solidarity with their separate property for a partnership liabilities.
3. It is less stable because it can easily be dissolved.
b. Limited partnership – one formed by two or more persons having as members one or
4. There is divided authority among the partners.
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
5. There is constant likelihood of dissension and disagreement when each of the partners has
of the partnership to inform the public that it is a limited partnership.
the same authority in the management of the firm.

KINDS OF PARTNERSHIPS 4. As to duration

a. Partnership at will – one for which no term is specified and is not formed for a
1. As to activity particular undertaking or venture and which may be terminated any time by mutual
A. Trading partnership – one whose main activity is the manufacture and sale or the agreement of the partners or the will of one partner alone.
purchase and sale of goods.
b. Partnership with a fixed term – one in which the term or period for which the
B. Non-trading partnership – one which is organized for the purpose of rendering partnership is to exist is agreed upon. It may also refer to a partnership formed for a
services. particular undertaking and upon the expiration of that terms or completion of the
particular undertaking the partnership is dissolved; unless continued by the partners.
2. As to object
a. Universal partnership
1. Universal partnership of all present property – one in which the partners 5. As to representation to others
contribute, at the time of the constitution of the partnership, all the properties a. Ordinary partnership – one which actually exists among the partners and also as to
which actually belong to each of them into a common fund with the intention of third persons.
dividing the same among themselves as well as the profits which they may acquire
therewith. b. Partnership by estoppel – one which in reality is not partnership but is considered as
one only in relation to those who, by their conduct or omission are precluded to deny
All assets contributed to the partnership and subsequent acquisitions become or disprove the partnership’s existence.
common partnership assets.

2. Universal partnership of all profit – one which comprises all that the partners 6. As to legality of existence
may acquire by their industry or work during the existence of the partnership and a. De jure partnership – one which failed to comply with one or more od the legal
the usufruct of movable or immovable property which each of the partners may requirements for its establishment.
possess at the time of the institution of the contract.
b. De facto partnership – one which failed to comply with one or more of the legal
Partnership assets consists of assets acquired during the life of the partnership requirements for its establishment.
and only the usufruct or use of assets contributed at the time of partnership

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Chapter 2 – Nature and Formation of a Partnership

7. As to publicity e. Dormant partner – one who does not take active part in the management of the
a. Secret partnership – one wherein the existence of certain persons as partners is not business and is not known to the public as a partner; he is both a silent and a secret
made known to the public by any of the partners. partner.

b. Open partnership – one wherein in the existence of certain persons as partners is PARTNERSHIP CONTRACT
made known to the public by the members of the firm.
A partnership is created by an oral or a written agreement. Since partnerships are required to be
registered with the Office of the Securities and Exchange Commissions, it is necessary that the
CLASSES OF PARTNERS agreement be in writing. In this case, misunderstandings and disputes among the partners
relative to the nature and terms of the contract may be avoided or minimized. The written
1. As to contribution agreement between or among the partners governing the formation, operation and dissolution
a. Capitalist partner – one who contributes capital in cash (money) or property. of the partnership is referred to as the Articles of Co-Partnership.

b. Industrial partner – one who contributes industry, labor, skill, talent or service The Articles of Co-Partnership contains the following information:

c. Capitalist-industrial partner – one who contributes cash, property, and industry. 1. The name of the partnership.
2. The names and addressed of the partners, classes of partners, stating whether the partner
is a general or a limited partner;
2. As to liability 3. The effective date of the contract;
a. General partner – one whose liability to third persons extends to his separate (private) 4. The purpose or purposes and principal office of the business;
property. 5. The capital of the partnership stating the contributions of individuals partners, their
description and agreed values;
b. Limited partner – one whose liability to third persons is limited only to the extent of 6. The rights and duties of each partner;
his capital contribution to the partnership. 7. The manner of dividing net income or loss among the partners, including salary allowance
and interest on capital;
3. As to management 8. The conditions under which the partners may withdraw money or other assets for personal
a. Managing partner – one who manages actively the business of the partnership use:
b. Silent partner – one who does not participate in the management of the partnership 9. The manner of keeping the books of accounts;
affairs. 10. The causes for dissolution; and
11. The provision for arbitration in settling disputes.
4. Other classifications
a. Liquidating partner – one who takes charge of the winding up of partnership affairs
upon dissolution
ORGANIZING A PARTNERSHIP

b. Nominal partner – one who is not really a partner, not being a party to the partnership Before a partnership can operate legally, it has to comply first with certain registration
agreement, but is made liable as a partner for the protection of innocent third persons requirements which are summarized below:

c. Ostensible partner – one who takes active part in the management of the firm and is Place of Registration Requirements for Certificates Issued
known to the public as a partner in the business Registration
Securities and Exchange Articles of Co-Partnership SEC Certificate
d. Secret partner – one who takes active part in the management of the business but Commission Filled SEC registration form
whose connection with the partnership s concealed or unknown to the public. Department of Trade and Articles of Co-Partnership Certificate of Registration of
Industry SEC Certificate Business Name (renewable
every five years)

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City or Municipal Mayor’s Certificate of Registration of Mayor’s Permit and License to

Office Business Name Operate (renewable annually) DRAWING ACCOUNT
Bureau of Internal Revenue SEC Registration BIR Registration No. Debit Credit
Articles of Co-Partnership Partnership’s Tax Identification 1. Personal withdrawal by a partner 1. Share in partnership profits from operations
Number (TIN) (this may be credited directly to the
Registration of books, invoices, partner’s capital account)
and official receipts 2. Share in partnership loss from operations
Social Security System Filled SSS Application form SSS Certificate of Membership (this may be debited directly to the
List of employees SSS Employer ID Number partner’s capital account)
Philippine Health Insurance SEC Registration PhilHealth Employer Number
Corporation Employer Data Record or ERI (PEN) and the Certificate of
Form Registration
Business Permit or License PhilHealth Identification
Number (PIN) and Member OPENING ENTRIES
Data Record (MDR) for
concerned employees Partners may contribute cash, property, or industry to the partnership. Appropriate asset
Home Mutual Development SEC Registration HMDF Certificate of accounts are debited for the assets contributed and partners’ capital accounts are credited for
Fund (PAG-IBIG Fund) Articles of Co-Partnership Membership the total amount of assets contributed.
HMDF Employer ID
Number 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
ACCOUNTING FOR PARTNERSHIPS 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.
PLURALITY OF CAPITAL AND DRAWING ACCOUNTS. Accounting for a partnership differs
from other forms of business organizations with regard to capital accounts. In a partnership, PARTNERSHIP FORMATION
there should be as many capital accounts and as many drawing accounts as there are partners
(that is, one capital account and one drawing account is maintained for each partner). FORMATION A: TWO OR MORE PERSONS FORM A PARTNERSHIP FOR THE FIRST TIME ALL
PARTNERS ARE NEW IN THE BUSINESS.

CAPITAL ACCOUNT 1. Cash Contributions only (Capitalist Partners)

Debit Credit
1. Permanent withdrawal (decrease) of 1. Original investment by a partner Abad and Alba agreed to form a partnership by contributing P600,000 cash each.
capital
The entry to record the contributions in the partnership is:
2. Share in partnership loss from 2. Additional investment by a partner
operations Cash 1,200,000
Abad, Capital 600,000
3. Debit balance of drawing account closed 3. Share in partnership profits from Alba Capital 600,000
to capital operations to be added to capital
2. Cash and Non-cash Contributions (Capitalist Partners)

Abdon and Anton made the following contributions in the partnership:

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Chapter 2 – Nature and Formation of a Partnership

Abdon Anton When individual set of books are kept by each partner or by any one of the partners, entries are
Cash P 600,000 P 200,000 made on the separate books of the partners for adjustments to the recorded values. These
Inventories 300,000 adjustments are made through the capital account. The capital account is credited for increases
Equipment 500,000 in the value of net assets and is debited for decreases in the value of net assets.

The entry to record the contributions of the partners follows: 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.
Cash 800,000
Inventories 300,000 Illustrative Problem A: Aguilar and Angeles formed a partnership wherein Aguilar is to
Equipment 500,000 contribute cash while Angeles is to transfer the assets and liabilities (net assets) of his business.
Abdon, Capital 900,000 Account balances on the books of Angeles are as follows:
Anton, Capital 700,000 Debit Credit
Cash 300,000
3. Contributions in the form of Cash, Non-cash Assets, and Industry (Capitalist and Industrial Accounts Receivable 450,000
Partners) Inventories 240,000
Accounts Payable 90,000
Alma, Anna, and Adela formed a partnership. Alma contributed P600,000 cash, Anna Angeles, Capital 900,000
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 The partners agreed on the following conditions:
shared equally among the partners.
1. An allowance for uncollectible accounts of P22,000 is to be established.
The entry to record the contributions of partners Alma and Anna follows:
2. The inventories are to be valued at their current replacement cost pf P270,000.
Cash 900,000
Equipment 450,000 3. Prepaid expenses of P12,000 and accrued expenses of P5,000 are to be recognized.
Alma, Capital 600,000
Anna, Capital 750,000 4. Angeles is to be credited for an amount equal to the net assets transferred.

The entry to record the contribution of partner Adela follows: 5. Aguilar is to contribute sufficient cash to have an equal interest in the partnership.

Adela is admitted into the partnership as an industrial partner to share one-third in the
partnership profit.
FORMATION B: A SOLE PROPRIETOR AND AN INDIVIDUAL FORM A PARTNERSHIP
Usually, one of the prospective partners is already engaged in business prior to the
formation of the partnership. In such a case, the partner may transfer his/her assets and
liabilities (net assets) to the partnership at agreed values or a fair market values if there are
no agreed values. The partnership may either: (1) use the books os the sole proprietor, or
(2) open a new set of books.
However, it is a common practice that a new set of books are opened for any new business
undertaking.
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.
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

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Debit capital and credit asset for decreases in asset values Expenses Payable 5,000
Debit capital and credit liabilities for increases in liability balances Angeles, Capital 915,000
Debit liabilities and credit capital for decreases in liability balances To record the investment of Angeles

In the case of contra asset accounts, the following rules shall apply: b. Cash 915,000
Debit contra asset account and credit capital for increases in asset values Aguilar, Capital
Debit capital and credit contra asset account for decreases in asset values To record the investment of Aguilar 915,000

Hence, the information on the partnership of Aguilar and Angeles will be accounted for as Alternatively, a compound entry may be prepared to record the investment of the two partners.
follows:
Entries to adjust and close the accounts are made in the separate books of the sole proprietor
Step 1: Adjust the books of the sole proprietor Angeles to agreed values but not in the new books of the partnership. Using the same illustrative problem, the adjusting
and closing entries on the books of Angeles are as follows:
a. Angeles, Capital 22,000
Allowance for Uncollectible Accounts 22,000 a. Angeles, Capital 22,000
Allowance for Uncollectible Accounts 22,000
b. Inventories 30,000
Angeles, Capital 30,000 b. Inventories 30,000
Angeles, Capital 30,000
c. Prepaid Expenses 12,000
Expenses Payable 5,000 c. Prepaid Expenses 12,000
Angeles, Capital 7,000 Expenses Payable 5,000
Angeles, Capital 7,000
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). d. Angeles, Capital 915,000
Expenses Payable 5,000
Step 2: Record the investment of the other partner, Aguilar Accounts Payable 90,000
Allowance for Uncollectible Accounts 22,000
Cash 915,000 Cash 300,000
Aguilar Capital 915,000 Accounts Receivable 450,000
Inventories 270,000
Assumption 2 – the partnership will open a new set of books To close the books of Angeles 12,000

When a new set of books are opened for the partnership, the entry required on the new books of FORMATION C: TWO OR MORE SOLE PROPRIETORS FORM A PARTNERSHIP
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 When all the prospective partners are already in business, they made decide to transfer their
next page. asset and liabilities (net assets) to the partnership at values agreed upon or at fair market values,
in the absence of agreed values. The partnership may either: (1) use the of one of the sole
a. Cash 300,000 proprietors, or (2) open a new set of books for the partnership. As mentioned earlier, however,
Accounts Receivable 450,000 it is more common to open a new set of books for the partnership.
Inventories 270,000
Prepaid Expenses 12,000 Illustrative Problem B: Antonio, owner of Antonio Variety Store, and Albano, owner of Albano
Allowance for Uncollectible Accounts 22,000 Trading decided to combine their businesses on July 1, 2014. Each is to transfer business assets
Accounts Payable 90,000

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and liabilities (net assets) at agreed values. Statements of financial positions for the two The partners agreed on the following conditions:
proprietors are presented below.
1. Partners’ capital in the partnership shall be equal to the adjusted net assets transferred.
Antonio Variety Store 2. Adjustments are to made as follows:
Statement of Financial Position a. Allowance for Uncollectible Accounts shall be P7,200 and P30,000, respectively.
July 1, 2014 b. Inventors are to be valued at 120% of their recorded values.
c. Both store and delivery equipment are 5% depreciated.
Assets
Cash P 120,000 Assumption 1 – The partnership will use the books of one of the sole proprietors
Accounts Receivable P 72,000
Less Allowance for Uncollectible Accounts 6,000 66,000 The procedures to be followed under his assumption are similar to the procedures discussed
Merchandise Inventory 330,000 under Formation B – Assumption 1. Thus, if the books of Albano Trading will be used by the
Store Equipment P 600,000 partnership, the following procedures will be followed:
Less Accumulated Depreciation 30,000 570,000
Total Assets P 1,086,000 1. Adjust the books of Albano Trading to bring the balances of accounts to agreed values
Liabilities and Capital 2. Record the investment of Antonio.
Accounts Payable P 132,000
Antonio, Capital 954,000 a. Albano, Capital 9,000
Total Liabilities and Capital P 1,086,000 Allowance for Uncollectible Accounts 9,000
P30,000 – P21,000 = P9,000

b. Merchandise Inventory 252,000

Albano Trading Albano, Capital 252,000
Statement of Financial Position P1,260,000 x 20% = P252,000
July 1, 2014
c. Albano, Capital 18,000
Assets Accumulated Depreciation – Delivery Equipment 6,000
Cash P 30,000 Delivery Equipment 24,000
Accounts Receivable P 300,000 P480,000 x 5% = P24,000
Less Allowance for Uncollectible Accounts 21,000 279,000 P474,000 – (P480,000 x 95%) = P18,000
Merchandise Inventory 1,260,000
Delivery Equipment P 480,000 Step 2: Record the investment of Antonio
Less Accumulated Depreciation 6,000 474,000
Total Assets P 2,043,000 a. Cash 120,000
Liabilities and Capital Accounts Receivable 72,000
Accounts Payable P 333,000 Merchandise Inventory (P330,000 x 120%) 396,000
Albano, Capital 1.710,000 Store Equipment (P600,000 x 95%) 570,000
Total Liabilities and Capital P 2,043,000 Allowance for Uncollectible Accounts 7,200
Accounts Payable 132,000
Antonio, Capital 1,018,800

The adjustments on the account balances of Antonio Variety Store are not taken up on the books
of Albano Trading which are now the partnership books. Instead the following adjusting and
closing entries are prepared on the separate books of Antonio Variety Store:

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a. Antonio, Capital 1,200 Key Points. In the opening entry, the plant assets are recorded net of depreciation. The account
Allowance for Uncollectible Accounts 1,200 accumulated depreciation is not carried on the partnership books. The net amount, being the
P7,200 – P6,000 = P1,200 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
b. Merchandise Inventory 66,000 and the corresponding allowance for uncollectible accounts are recorded on the partnership
Antonio, Capital 66,000 books. The allowance for uncollectible accounts is carried on the specific accounts receivable
P330,000 x 20% = P66,000 which are deemed worthless, such must be written off and removed permanently from the
outstanding accounts receivable.
c. Allowance for Uncollectible Accounts 7,200
Accumulated Depreciation – Store Equipment 30,000 A statement of financial position prepared immediately after the formation of the partnership of
Accounts Payable 132,000 Antonio and Albano is shown below.
Antonio, Capital 1,0181800
Cash 120,000 Antonio and Albano
Accounts Receivable 72,000 Statement of Financial Position
Merchandise Inventory 396,000 July 1, 2014
Store Inventory 600,000
Assets
Assumption 2: The partnership will use a new set of books Cash P 150,000
Accounts Receivable P 372,000
When a new set of books are opened for the partnership, entries are prepared to record the Less Allowance for Uncollectible Accounts 37,200 334,800
investment of the partners at agreed valued. The opening entries on the new partnership books Merchandise Inventory 1,908,000
using the data given in Illustrative Problem B are shown below: Store Equipment 570,000
Delivery Equipment 456,000
a. Cash 120,000 Total Assets P 3,418,800
Accounts Receivable 72,000 Liabilities and Capital
Merchandise Inventory (P330,000 x 120%) 396,000 Accounts Payable P 465,000
Store Equipment (P600,000 x 95%) 570,000 Antonio, Capital 1,018,800
Allowance for Uncollectible Accounts 7,200 Albano, Capital 1,935,000
Accounts Payable 132,000 Total Liabilities and Capital P 3,418,800
Antonio, Capital 1,018,800
To record the investment of Antonio Goodwill Resulting from the Acquisition of a Sole Proprietorship by a Partnership

b. Cash 30,000 The acquisition of a sole proprietorship/s by a partnership or formation of a partnership by a

Accounts Receivable 300,000 sole proprietorship and an individual or among two or more sole proprietorships may involve
Merchandise Inventory (P1,260,000 x 120%) 1,512,000 the recognition of goodwill. The goodwill shall be the result of the acquisition by the new
Delivery equipment (P480,000 x 95%) 456,000 partnership of the net assets of the sole proprietorship/s. When the capital credit exceeds the
Allowance for Uncollectible Accounts 30,000 agreed value or fair value of the net assets acquired by the new partnership from the sole
Accounts Payable 333,000 proprietorship, the excess is treated as goodwill. The adjustment for the goodwill increases the
Albano, Capital 1,935,000 capital of the sole proprietor.
To record the investment of Albano
PFRS 3 does not allow the amortization of goodwill acquired in a combination and instead
The new partnership may prepare a separate entry for each partner’s contribution as shown requires the goodwill to be tested for impairment annually, or more frequently, if events or
above or a compound entry that shows the contributions of all the partners. changes in circumstances indicate that the asset might be impaired.

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Chapter 2 – Nature and Formation of a Partnership

CAPITAL SHARE DIFFERENT FROM CAPITAL CONTRIBUTION REVIEW of LEARNING OBJECTIVES

Prior to recording partners’ initial contributions to the partnership, the individual partners must
first agree not only on the valuation of the net asset contributions but also on their capital share.
The capital share of each partner is the percentage of equity that each of them will have in the
net assets of the newly formed partnership. Generally, the capital share of a partner is
proportionate to his/her capital contribution. However, in recognition of intangible factors such
as partners’ special expertise, established clientele or necessary business connections, partners
may agree to a division of capital that is not proportionate to their capital contributions. This
situation will give rise to provision of bonus on initial investments.
Illustrative Problem C: Alfonso and Afable formed a partnership by contributing P500,000 and
P600,000, respectively. Journal entries to record the investment of the partners under two
approaches are as follows:
1. Define and discuss the nature of a partnership – its characteristics, advantages, and
disadvantages. A partnership is a contract whereby two or more persons bind themselves
to contribute money, property, or industry into a common fund with the intention of
dividing profits among themselves. A partnership has the following characteristics: (1)
mutual agency; (2) unlimited liability; (3) limited life; (4) mutual participation in profits; (5)
legal entity; (6) co-ownership of contributed assets; and (7) subject to income tax. A
partnership is easy and inexpensive to organize, it is more reliable on the viewpoint of the
creditor, enabling it to obtain more capital because of the unlimited liability of the partners,
and there is close supervision of all its activities because of the direct gain to the partners of
a successful operation. However, a partnership is less stable and there is divided authority
among the partners. In addition, because of the characteristics of mutual agency, a partner
may be subject to personal liability for the wrongful acts or omissions of his associates.

1. Full investment approach 2. Identify the different kinds of partnerships and the classes of partners. Partnerships are
Cash 1,100,000 classified as (1) trading or nontrading; (2) universal or particular; (3) general or limited; (4)
Alfonso, Capital 500,000 partnership at will or with a fixed term; (5) ordinary or partnership by estoppel; (6) de jure
Afable, Capital 600,000 or de facto; and (7) secret or open. Partners are classified as (1) capitalist, industrial or
capitalist-industrial; (2) general or limited; (3) managing or silent; and (4) liquidating,
Assuming the partners agreed to have equal capital in the partnership, it is presumed that part nominal, ostensible or secret.
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.
3. Discuss the requirements in the formation of a partnership. A partnership may be
2. Bonus approach organized by an oral or written agreement. The written agreement which governs the
Cash 1,100,000 formation, operation and dissolution of a partnership is known as the Articles of Co-
Alfonso, Capital 550,000 Partnership. A new partnership has to comply with certain registration requirements by the
Afable, Capital 550,000 different government agencies before it can operate legally.
(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 account is reported in the statement of financial position as a liability.
4. Discuss accounting for partners’ initial investments in a partnership. A partner may
contribute cash, non-cash assets, or industry into the partnership. Cash contribution is
credited to a partner’s capital account at face value; non-cash asset contribution is recorded
at agreed value or at fair market value, in the absence of agreed value; and a contribution in
the form of industry or service is recorded by means of memorandum entry.

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 GLOSSARY of ACCOUNTING TERMINOLOGIES
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.
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.

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Chapter 2 – Nature and Formation of a Partnership

Capitalist Industrial Partner – a partner who contributes capital in the form of money or c. May not be proportionate to capital contribution due to bonus
property and industry. d. All of these

Industrial Partner – a partner who contributes industry, labor, skill, talent or service. MC 2-6 On April 1, 2014, Apple and Ayme formed a partnership with each contributing the
following assets:
Partnership – a contract whereby two or more persons bind themselves to contribute money, Apple Ayme
property, or industry into a common fund with the intention of dividing profits among Cash P 120,000 P 80,000
themselves. Machinery and equipment 100,000 340,000
Building 900,000
Statement of Financial Position – a statement that reports the assets, liabilities, and equity of Furnitures and fixtures 40,000
an entity and which shows its financial position or condition at a given date. It is also known as
balance sheet. The building is subject to a mortgage loan of P300,000, which is to be assumed by the
partnership. On April 1, 2014, the balance in Ayme’s capital account should be

MULTIPLE CHOICE a. P 980,000

b. P 1,020,000
c. P 1,280,000
d. P 1,320,000
MC 2-1 Which of the following best describes the attributes of a partnership?
a. Limited life of the business and limited liability of partners
MC 2-7 Aster and Armie are forming a partnership by combining their business. Their books
b. Limited life of the business and unlimited liability of partners
show the following:
c. Unlimited life of the business and limited liability of partners
Aster Amie
d. Unlimited life of the business and unlimited liability of partners
Cash P 72,000 P 30,000
Accounts Receivable 150,000 108,000
MC 2-2 When a partner withdraws cash or other assets, the drawing account is
Merchandise Inventory 240,000 156,000
a. Debited
Furnitures and fixtures 330,000 102,000
b. Credited
Prepaid Expenses 63,000 21,000
c. debited and credited
Accounts Payable 366,000 144,000
d. not affected
Aster, Capital 489,000
Amie, Capital 273,000
MC 2-3 All of the following affect a partner’s capital account except
a. additional investment
It has been agreed to recognize uncollectible accounts of P7,500 and P5,400 to each
b. payment of a liability
party, respectively, and that the furniture and fixtured of Amie are under depreciated
c. partnership net income or loss
by P9,000. If each partner’s share in equity is to be equal to the net assets invested, the
d. withdrawal of the partner
capital accounts of Aster and Amie would be
a. P489,000 and P273,000 respectively.
MC 2-4 Which of the following are kinds of partnerships according to liability of partners?
b. P484,500 and P276,600 respectively.
a. General co-partnership
c. P481,500 and P258,600 respectively.
b. Limited partnership
d. P855,000 and P417,000, respectively.
c. Industrial partnership
d. A and B only
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
MC 2-5 Which of the following relate to the capital share of a partner in a partnership?
in the new partnership. The assets contributed by Antonia appeared as follows in the
a. The percentage of equity that a partner has on the net assets
statement of financial position of her business: cash, P9,000; accounts receivable,
b. Proportionate to a partner’s capital contribution
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Chapter 2 – Nature and Formation of a Partnership

P189,000 with allowance for uncollectible accounts of P6,000; merchandise inventory, MC 2-12 Amable and Aguila entered into a partnership on February 1, 2014 by investing the
P420,000; and store equipment, P150,000 with accumulated depreciation of P15,000. following assets:
Amable Aguila
Antonio and Andrea agreed that the allowance for uncollectible accounts was Cash P 40,000
inadequate and should be P12,000. They also agreed that the fair value for the Merchandise Inventory P 90,000
inventory is P460,000 and for the store equipment is P140,000. The cash contributed Land 130,000
by Andrea into the partnership was Equipment 30,000
a. P 747,000 Furniture and Fixtures 200,000
b. P 786,000
c. P1,572,000 The agreement between Amable and Aguila provides that profits and losses are to be
d. P1,576,000 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
MC 2-9 Almeda and Asistio are combining their separate business to form a partnership. Cash net assets invested, how much is his capital balance upon partnership formation?
and non-cash assets are to be contributed for a total capital of P600,000. The non-cash a. P 10,000
assets to be contributed and the liabilities to be assumed are as follows: b. P 150,000
c. P 160,000
Almeda Asistio d. P 400,000
BV FMV BV FMV
Accounts Receivable P 40,000 P 30,000 MC 2-13 Using the information in MC 2-12 and assuming that Aguila invests P100,000cash and
Merchandise Inventory 60,000 90,000 P 40,000 P 80,000 the partners are to have equal interest in the partnership, the total capital of the
Equipment 120,000 100,000 80,000 120,000 partnership is
Accounts Payable 30,000 30,000 20,000 20,000 a. P240,000
b. P250,000
The partner’ capital accounts are to be equal after all the contribution of assets and the c. P490,000
assumption of liabilities. The amount of cash to be contributed by Almeda is d. P590,000
a. P100,000
b. P110,000 MC 2-14 Using the information in MC 2-12 and assuming that the capital of the partners is
c. P210,000 proportionate to their profit and loss ratio, the bonus upon partnership formation is
d. P300,000 a. P6,000 to Amable
b. P6,000 to Aguila
MC 2-10 Using the information in MC 2-9, the total assets of the partnership is c. P10,000 to Amable
a. P340,000 d. P10,000 to Aguila
b. P360,000
c. P630,000 MC 2-15 The Agulto and Acejas Partnership was formed on October 1, 2014. At the date, the
d. P650,000 following assets were contributed:
Agulto Acejas
MC 2-11 Using the information in MC 2-9, and assuming the excess capital credit over the fair Cash P 600,000 P 280,000
value of the net assets transferred to the partnership is recognized as goodwill, how Merchandise Inventory 440,000
much is the goodwill to be credited to Asistio? Building 800,000
a. P120,000 Furniture and Fixtures 120,000
b. P150,000
c. P180,000 The building is subject to a mortgage loan of P320,000 which is to be assumed by the
d. P300,000 partnership. The partnership agreement provides that Agulto and Acejas share on

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profit and loss of 25% and 75% respectively. Agulto’s capital account at October 1, 2014
should be
a. P 400,000
b. P 720,000
c. P1,200,000
d. P1,520,000

MC 2-17 Using the information in MC 2-16 and assuming that the partnership agreement
provides that the partners initially should have an equal interest in partnership capital,
Acejas’ capital account on October 1, 2014 should be
a. P 480,000
b. P 720,000
c. P 960,000
d. P1,200,000

MC 2-18 Using the information in MC 2-17, the effect of the bonus on capital of the partners is
a. Xero
b. P200,000
c. P240,000
d. P480,000

MC 2-19 Using the information in MC 2-17, the effect of the bonus on capital of the partners is
Agulto Acejas
a. increase increase
b. increase decrease
c. decrease increase
d. decrease decrease

MC 2-20 Using the information in MC 2-16, and assuming that capital shall be proportionate to
the partners’ profit and loss ratio, the required capital of Acejas is
a. P 520,000
b. P 720,000
c. P1,200,000
d. P1,440,000

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At the end of the accounting period, adjustments are made for merchandise inventory, accruals,
CHAPTER 3 prepayments, provision for uncollectible accounts, and provision for depreciation. Profit or loss
PARTNERSHIP OPERATIONS is determined in the usual manner, that is, by matching periodic income and expenses.

However, special problems are encountered in accounting for partnership operation. These
LEARNING OBJECTIVES problems include:

1. Discuss the closing entries in a partnership and differentiate then from the closing entries in a sole 1. Closing entries of a partnership
proprietorship. 2. Distribution of profits and losses
2. Identify and discuss the different methods and rules of dividing partnership profits and losses 3. Preparation of a work sheet
among partners. 4. Preparation of financial statements
3. Discuss and understand the preparation of financial statements of a partnership. a. Statement of income/statement of comprehensive income
b. Statement of financial position
c. Statement of changes in partner’s equity
PREVIEW OF THE CHAPTER
CLOSING ENTRIES OF A PARTNERSHIP
PARTNERSHIP
OPERATIONS The procedures for the preparation of closing entries for a partnership are similar to that of a
sole proprietorship. First, all revenue and other nominal accounts with credit balances (such as
Purchase Discounts and Purchases Returns and Allowances) are debited and Income Summary
is credited. Second, Income Summary is debited and all expense and other nominal accounts with
debit balances (such as Sales Discounts and Sales Returns and Allowances) are credited. Third,
Closing Entries Distribution of Partnership Preparation of the balance of the Income Summary account, which represents profit or loss of the partnership,
Profits and Losses Financial Statements is transferred either to the drawing accounts or directly to the capital accounts of the partners.
Finally, the balance of the drawing account of each partner is transferred to his/her capital
• Revenue and gains • Equally • Statement of account.
• Expenses and losses • Arbitrary ratio Income/Statement of
Comprehensive Income The balance of the Income Summary account is transferred to the drawing accounts of the
• Partners’ share in • Capital ratio partners if the partners’ intention is to keep the capital account intact for investments and
profits and losses • Interest on capital • Statement of permanent a profit and its balance is transferred to the drawing accounts of the partners based
• Partners’ drawing • Salary allowance Financial Position on their profit and loss sharing ratio, The entry is as follows:
• Bonus • Statement of Changes
in Partners’ Equity Income Summary xxx
A, Drawing xxx
NATURE OF PARTNERSHIP OPERATION B, Drawing xxx

Any resulting credit balance in the drawing account of a partner may be withdrawn by the
Accounting for partnership operations is essentially the same as accounting for the operations of partner or reinvested into the firm. If the balance in the drawing account is withdrawn in cash,
a sole proprietorship. Sale of merchandise on account is debited to Accounts Receivable and the entry is as follows:
credited to Sales Collection of accounts is debited to Cash and credited to Accounts Receivable.
The purchase of merchandise on account is recorded by a debit to Purchases and credit to A, Drawing xxx
Accounts Payable. Payments of accounts is debited to accounts payable and credited to Cash. Cash xxx
Payment of expenses is debited to Expenses and credited to Cash.

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However, if the partner decides to reinvest into the firm this balance in his drawing account, the DISTRIBUTION OF PROFITS AND LOSSES
entry is as follows:
To make distribution of partnership profits and losses equitable, the following factors are
A, Drawing xxx
considered:
A, Capital xxx
1. Services rendered by the partners to the partnerships
2. Amount of capital contributed by the partners to the business
A debit balance in the Income Summary account represents a loss and its balance is transferred
3. Entrepreneurial ability or managerial skill of the partners
to the drawing accounts of the partners based on their profit and loss sharing ration. The entry
is as follows:
To distribution or division of profits and losses may be expressed in several ways as follows:
1. by percentage
A, Drawing xxx
2. by fraction
B, Drawing xxx
3. by decimal
Income Summary xxx
4. by ratio
The resulting debit balance in the drawing account of a partner is charged against his capital with
Illustration: Alba and Bueno are partners sharing profits and losses based on their capital
the following entry:
contributions of P100,000 and P300,000, respectively. Their profit and loss sharing can be
expressed as follows:
A, Capital xxx
A, Drawing xxx
1. By percentage Alba 25% (P100,000/P400,000)
Bueno 75% (P300,000/P400,000)
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
2. By fraction Alba 1/4 (P100,000/P400,000)
if permanent capital. It should be noted, however, that either treatment will result to the same
Bueno 3/4 (P300,000/P400,000)
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
3. By decimal Alba .25 (P100,000/P400,000)
that partners intend to make their respective share on the profit or loss as a direct part of their
Bueno .75 (P300,000/P400,000)
permanent capital.
4. By ratio Alba and Bueno 1:3
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: RULES FOR DIVIDING PROFITS AND LOSSES

Income Summary xxx The following is the list of rules in the division of profits and losses of the partnership based on
A, Capital xxx the provision of the New Civil Code:
B, Capital xxx
1. As to Capitalist Partners
A debit balance in the Income Summary account represents a loss and its balance is transferred a. Division of profits
to the capital accounts of the partners based on their profit and loss sharing ratio. The entry is as 1. in accordance with agreement
follows: 2. in the absence of an agreement, division of profits is in accordance with capital
A, Capital xxx contributions
B, Capital xxx
Income Summary xxx b. Division of losses
1. in accordance with agreement

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2. if only division of profits is agreed upon, the division of losses will be the same as Interest is allowed to partners for the use of invested capital. Interest as agreed by the
the agreement on the division of profits partners shall be allowed in proportion over the period such capital was actually used.
3. in the absence of an agreement, division of losses is in accordance with capital Moreover, the interest shall be provided whether the profit is sufficient or insufficient or
contributions there is a net loss unless otherwise agreed upon by the partners.

2. As to Industrial Partners
a. Division of profits
1. in accordance with agreement
2. in the absence of an agreement, the industrial partner shall receive a just and
equitable share of the profits and the capitalist partners shall receive profits in
accordance with their capital contribution.
b. Division of losses
1. in accordance with agreement
2. in the absence of an agreement, the capitalist-industrial partner in his/her
character as industrial partner shall have no share in the losses, but in his/her
character as a capitalist partner will share in proportion to the capital contribution
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.
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 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
METHODS OF DISTRIBUTING PROFITS BASED ON PARTNERS’ on agreed ratio.
AGREEMENT
Illustrative Problem A: The following data are available in the books of Calma and David
1. Equally – it is simple to apply but does not give due recognition on the disparity of capital Partnership for the year 2014.
contributions nor does it recognize the time and effort that a partner may devote in running
the firm’s business operations. Calma, Capital
May P100,000 Jan. 1 Balance P2,500,000
2. Arbitrary ratio (Percentage, Decimal, Fraction, Ratio) – it is simple to apply but does not Apr. 1 250,000
give recognition on the disparity of capital contributions nor does it recognize the time and Oct. 1 500,000
effort that a partner may devote in running the firm’s business operations. Balance – P3,150,000

3. Capital ratio (Original, Beginning, Ending, Average)- this method recognizes the
differences in the capital contributions but does not take into account the time and effort Calma, Drawing
that a partner may devote I running the firm’s business operations. Jan. 1 – Dec. 31 P300,000

4. Interest on capital and the balances on agreed ratio – this method recognizes the
differences in the capital contributions but does not take into account the time and effort
that a partner may devote in running the firm’s business operations.

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David, Capital Case 4 – Profit is divided 20% and 80% to Calma and David
June 1 P150,000 Jan. 1 Balance P1,500,000
Dec. 1 50,000 Sept. 1 500,000 Income Summary 600,000
Balance – P1,800,000 Calma, Capital 120,000
David, Capital 480,000
P600,000 x 20% = P120,000
David, Drawing P600,000 x 89% = P480,000
Jan. 1 – Dec. 31 225,000
Case 5 – Profit is allocated based on the beginning capital ratio

Income Summary Income Summary 600,000

Dec. 31 P 600,000 Calma, Capital 375,000
David, Capital 225,000
P600,000 x 25/40 = P375,000
P600,000 x 15/40 = P225,000
Twelve cases will be illustrated using the given data. Cases 1-10 will show sufficient profit. Case
11 will show insufficient profit, and Case 12 shows a loss. Case 6 – Profit is allocated based on the ending capital ratio
Case 1 – Profit is divided equally Income Summary 600,000
Calma, Capital 381,820
Income Summary 600,000 David, Capital 218,180
Calma, Capital 300,000 P600,000 x 315/495 = P381,820
David, Capital 300,000 P600,000 x 180/495 = P218,180
P600,000 / 2 = P300,000
The ending capital balances of the partners are computed as follows:
Calma David
Case 2 – Profit is divided 3/4 and 1/4 to Calma and David
Beginning balances P2,500,000 P1,500,000
Income Summary 600,000 Additional investment 750,000 500,000
Calma, Capital 450,000 Drawing ( 100,000) ( 200,000)
David, Capital 150,000 Ending balances P3,150,000 P1,800,000
P600,000 x 3/4 = P450,000
P600,000 x 1/4 = P150,000 Key Points. Withdrawals deducted for purposes of determining ending capital balances are the
debit entries in the capital accounts of each pf the partners (see partners’ accounts shown I the
Case 3 – Profit is divided in the ratio of 1:2 to Calma and David previous page). The credit entries in the drawing accounts are not considered in computing
ending capital for the purpose of establishing the ratio.
Income Summary 600,000
Calma, Capital 200,000 Case 7 – Profit is allocated based on the average capital ratio
David, Capital 400,000
P600,000 x 1/3 = P200,000 Income Summary 600,000
P600,000 x 2/3 = P400,000 Calma, Capital 381,290
David, Capital 218,710
P600,000 x 2,745,830/4,320,830 = P381,290
P600,000 x 1,575,000/4,320,830 = P2818,710

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Average capital ratio is a method of dividing profits based on the amount of capital invested and Case 8 – Each partner is allowed 10% interest on ending capital and the remaining profit
the time during which such capital is actually used in the business. is divided 60%. 40%.

The following steps are to be followed in determine the average capital of each partner using the Income Summary 600,000
peso month method; thus, arriving at the average capital ratio: Calma, Capital 378,000
David, Capital 222,000
1. Multiply beginning capital by the number of months that it remained unchanged.
2. Determine each new capital balance in chronological order and multiply by the number of The distribution of profits may be recorded separately as follows:
months it remained unchanged.
3. Add the products which represent peso months and divide the total the total by twelve (12) Income Summary 495,000
to obtain the average monthly capital. Calma, Capital 315,000
David, Capital 180,000
By following the steps given, the average capital of each partner can be calculated as follows: Interest on ending capital.

Calma, Capital Income Summary 105,000

Calma, Capital 63,000
No. of Mos. David, Capital 42,000
Period Capital Balance Unchanged Peso Months Average Capital Remaining income divided 60%, 40%.
Jan. 1 – Mar. 31 P2,500,000 3 P 7,500,000
Apr. 1 – Apr. 30 2,750,000 1 2,750,000 Division of profit
May 1 – Sept 30 2,650,000 5 13,250,000 Calma David Total
Oct. 1 – Dec. 31 3,150,000 3 9,450,000 Interest on ending capital
12 P32,950,000 P2,745,830 P3,150,000 x 10% P315,000
P1,800,000 x 10% P180,000 P495,000
Remainder – 60%, 40%
P105,000 x 60% 63,000
David, Capital P105,000 x 40% 42,000 105,000
Total P378,000 P222,000 P600,000
Jan. 1 – May. 31 P1,500,000 5 P 7,500,000
June 1 – Aug. 31 1,350,000 3 4,050,000
Sept. 1 – Nov. 30 1,850,000 3 5,550,000 Case 9 – David is allowed salaries of P500,000 and the remaining profit is divided in the
Dec. 1 – Dec. 31 1,800,000 1 1,800,000 ratio of 1:4
12 P18,900,000 1,575,000
P4,320,830 Income Summary 600,000
Calma, Capital 20,000
David, Capital 580,000
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 Division of profit
allocation procedures (multiple bases of profit allocation) to be used in the distribution of profit. Calma David Total
Since partnerships specify a profit distribution to be followed to whatever extent possible, most Salaries P500,000 P500,000
agreements specify that the entire process is to be completed and any remainder is to be Remainder – 1:4
allocated in the profit and loss ratio. The following case are used to illustrate various multiple P100,000 x 1/5 P 20,000
P100,000 x 4/5 80,000 100,000
allocation procedures.
Total P 20,000 P580,000 P600,000

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Case 10 – David, the managing partner, is allowed a bonus of 20% of profit BEFORE bonus Case 12 – Assume the same agreement as in Case 11 except that instead of a prodit, the
and income tax and the remainder is divided in the ratio of beginning capital. partnership has incurred a loss of P100,000. The allowance for salaries and interest will still
be provided, thereby resulting in a total loss to be divided as agreed.
Using the income tax rate of 30%, the partnership income before income tax is P857,143 that is,
net profit of P600,000 divided by 70%. David, Capital 109,750
Calma, Capital 9,750
Income Summary 600,000 Income Summary 100,000
Calma, Capital 267,857
David, Capital 332,143 Division of profit
Calma David Total
Division of profit Salaries to partners
Calma David Total P 5,000 x 52 P260,000
Bonus – P857,143 x 20% P171,429 P171,429 P10,000 x 52 P520,000 P780,000
Remainder: Interest on average capital
P428,571 x 25/40 P267,857 P2,745,830 x 10% 274,580
P428,571 x 15/40 267,587 428,571 P1,575,000 x 10% 157,500 432,080
Total P267,857 P332,143 P600,000 Remainder – (P1,312,080)
P1,312,080 x 2/5 (524,830)
P1,312,080 x 3/5 (787,250) (1,312,080)
Other assumptions on the computation of bonus shall be illustrated later in the chapter.
Total P 9,750 P109,750 P100,000

Case 11 – The partners are allowed P5,000 and P10,000 weekly salaries, respectively,
The allocation of partnership profit follows the order of the profit sharing agreement in
10% interest on average capital, and the remainder is divided in the ratio of 2:3.
allocating the bonus, the salary allowances, the interests and the remainder to individual
partners.
Income Summary 600,000
Calma, Capital 289,750
The bonus is computed on the basis of the partnership profit as the concept of “partnership
David, Capital 310,250
profit” is generally understood in accounting practice. Partners may, however, intend for salary
and interest allowances to be deducted in determining the base for computing the bonus. In such
Division of profit
case, no bonus is allowed if there is insufficient profit after distribution of salaries and interests.
Calma David Total
Salaries to partners
P 5,000 x 52 P260,000 The interests of the partners may not be apparent when technical accounting terms are used; so
P10,000 x 52 P520,000 P780,000 the partnership agreement should be precise in specifying measurement procedures to be used
Interest on average capital in determining the amount of a bonus.
P2,745,830 x 10% 274,580
P1,575,000 x 10% 157,500 432,080 Illustrations on the computation of bonus using other assumptions. The same data in Illustrative
Remainder – (P612,080) Problem A shall be used. Bonus rate is 20%.
P612,080 x 2/5 (244,830)
P612,080 x 3/5 (367,250) (612,080)
Total P289,750 P310,250 P600,000 1. Bonus is based on profit after deducting bonus but before deducting income tax.

The sum of the salary allowance and interest allowed on the average capital of the partners B = .20 x (P857,143 – B)
exceeded the profit of P600,000 resulting in a negative remainder (loss or deficit). Such loss is B = P171,428 – 020B
distributed in the profit and loss sharing agreement. B + .20B = P171,428
B = P171,428 / 1.20
B = P142,857

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2. Bonus is based on profit before deducting bonus after deducting income tax 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
B = .20 (P857,143 – T) allowance. Partnership net income for the year is P600,000.

T = .30 x P857,143 The following is the division of the P600,000 profit in accordance with the order of priority
= P257,143 provision.

Substituting for T in the first equation and solving for B Santos Tomas Total
Interest on capital
, B = .20 (P857,143 – P257,143) P315,000 x 10% P 31,500
B = .20 x P600,000 P180,000 x 10% P 18,000 P 49,500
B = P120,000 Salaries (ratio of 50:25) 183,500 367,000 550,500
Total P 215,000 P 385,000 P 600,000
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. The entry to record the distribution of the profit is as follows:

3. Bonus is based on profit after deducting bonus and income tax Income Summary 600,000
Santos, Capital 215,000
B = .20 (P857,143 – B – T) Tomas, Capital 385,000

T = .30 x P 857,143 SPECIAL PROFIT ALLOCATION METHODS

= P257,143
Some partnerships distribute profits on the basis of other criteria. For example, most public
Substituting for T in the first equation and solving for B
accounting firms distribute profits on the basis of partnership units. A new partner acquires a
certain number of units and additional units are assigned by a firmwide compensation
B = .20 (P857,143 – B – P257,143)
committee based on:
B = .20 (P600,000 – B)
• obtaining new clients;
B = P120,000 - .20 B
• providing the firm with specific areas of industrial expertise;
B = .20B = P120,000
B = P120,000/1.20 • serving as a managing partner of a local office; or
B = P100,000 • accepting a variety of other responsibilities

Key Points. In the preceding example, bonus is treated as a distribution of partnership profit,
and therefore such bonus is not deductible as an expense in determining the amount of taxable
profit. The same is true for salaries and interest allowed on capital.
In some instances, the partners may agree not to use a residual sharing ratio in the event profits
did not exceed the total of the salary and interest allowances. In this case, the partners must agree
on the priority of the various features. If the partnership agreement gives salary allowances
priority over interest on capital balances, then profit would first apply to salaries and the
balances would be divided in the ratio of interest allowance and vice-versa.
Illustrative Problem B: Santos and Tomas are partners with capital balances of P315,000 and
P180,000, respectively. The profit and loss agreement provides salaries of P500,000 to Santos
Other partnerships devise profit distribution plans that the reflect the earnings of the
partnership. For example, some medical or dental firms allocate profits on the basis of billed
services. Other criteria may include number or size of clients, years of service within the firm, or
the partner’s position within the firm.
PREPARATION OF WORK SHEET
At the end of each accounting period, the partnership bools are adjusted and closed and financial
statements are prepared. In order to classify accounting data in a convenient and orderly manner
and to facilitate the preparation of financial statements, a work sheet is prepared. The form or
columns of the work sheet may vary depending on the needs of the company. The following

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illustrative problem will use the simplest form of work sheet with emphasis not on the form but e. Accrued interest on notes payable, P1,500
the underlying principles and procedures in preparing such work sheet. f. Allowance for uncollectible accounts to be increased to P112,500
g. Unused supplies: office – P10,000, store – P15,000
Illustrative Problem C: The trial balance for EXCELLENCE COMPANY as at December 31, 2014 h. Income tax, 30% profit before income tax
is presented.
The Articles of Co- Partnership contain the following provisions regarding the division of profits
EXCELLENCE COMPANY and losses:
Trial Balance
December 31, 2014 1. Annual salaried of P400,000 and P500,000, respectively.
2. Interest of 10% on beginning capital
Debit Credit 3. The remainder is divided in the ratio of 3:2
Cash 1,900,000
Notes Receivable 625,000 A work sheet prepared for the partnership and the related statement of financial position and
Accounts Receivable 1,125,000 income statement are presented on the next pages. The statement of changes in partners’ equity
Allowance for Uncollectible Accounts 50,000 is presented below.
Merchandise Inventory 1,250,000
Furniture and Equipment 1,500,000 EXCELLENCE COMPANY
Accumulated Depreciation 200,000 Statement of Changes in Partners’ Equity
Notes Payable 500,000 For the Year Ended December 31, 2014
Accounts Payable 375,000
Flores, Capital 1,250,000
Flores, Drawing 155,000 Flores Garcia Total
Garcia, Capital 3,125,000 Equity, January 1 P1,250,00
Garcia, Drawing 250,000 Add Profit for 2014:
Sales 5,000,000 Salaries P 400,000 P 500,000 P 900,000
Sales Returns and Allowances 50,000 Interest on beginning capital 125,000 312,500 437,500
Sales Discounts 75,000 Balance – 3:2 (P747,050)
Purchases 2,412,500 P747,050x 3/5 ( 448,230)
Purchases Returns and Allowances 100,000 P747,050x 2/5 ( 298,820) ( 747,050)
Purchases Discounts 62,500 Total share in profit P 76,770 P 513,680 P 590,450
Freight-In 125,000 Total P1,3261770 P3,638,680 P4,965,450
Selling Expenses 825,000 Less Withdrawals 155,000 250,000 405,000
General Expenses 362,500 Equity, December 31 P1,171,770 P3,388,680 P4,560,450
Interest Income 17,500
Interest Expense 25,000
10,680,000 10,680,000

Data for adjustments as of December 31, 2014:

a. Merchandise inventory, P1,000,000

b. Depreciation of furniture and equipment, 10% per year, 40% of which is considered part of
general expenses
c. Unpaid sales salaries, P25,000
d. Accrued interest on notes receivable, P2,500

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EXCELLENCE COMPANY
Work Sheet
For the Year Ended December 31, 2014
Trial Balance Adjustments Statement of Income Statement of Financial Position
Debit Credit Debit Credit Debit Credit Debit Credit
Cash 1,900,000 1,900,000
Notes Receivable 625,000 625,000
Accounts Receivable 1,125,000 1,125,000
Allowance for Uncollectible Accounts 50,000 f. 62,500 112,500
Merchandise Inventory 1,250,000 1,250,000 1,000,000 1,000,000
Furniture and Equipment 1,500,000 1,500,000
Accumulated Depreciation 200,000 b. 150,000 350,000
Notes Payable 500,000 500,000
Accounts Payable 375,000 375,000
Flores, Capital 1,250,000 1,250,000
Flores, Drawing 155,000 155,000
Garcia, Capital 3,125,000 3,125,000
Garcia, Drawing 250,000 250,000
Sales 5,000,000 5,000,000
Sales Returns and Allowances 50,000 50,000
Sales Discounts 75,000 75,000
Purchases 2,412,500 2,412,500
Purchase Returns and Allowances 100,000 100,000
Purchase Discounts 62,500 62,500
Freight-In 125,000 125,000
Selling Expenses 825,000 b. 90,000 g. 15,000 925,000
c. 25,000
General Expenses 362,500 b. 60,000 g. 10,000 475,000
f. 62,500
Interest Income 17,500 d. 2,500 20,000
Interest Expense 25,000 e. 1,500 26,300
10,680,000 10,680,000

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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
519,550 519,550 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

Computation of income tax and profit:

Total credit per income statement before income tax P 6,182,500
Total debit per income statement before income tax 5,339,000
Profit before tax P 843,500
Income tax (P843,500 x 30%) 253,050
Profit P 590,450

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EXCELLENCE COMPANY Cost of Goods Available for Sale P 3,625,000

Statement of Income Less Merchandise Inventory, December 31 1,000,000
For the Year Ended December 31, 2014 Cost of Sales P 2,625,000

Schedule Key Points. The Statement of Income of a partnership is similar to that of a sole proprietorship
Net Sales 1 P4,875,000 except that it includes a schedule showing the division or distribution of profit to partners.
Cost of Sales 2 2,625,000
Gross Profit P2,250,000 EXCELLENCE COMPANY
Other Operating Income - Interest 20,000 Statement of Financial Position
Operating Expenses: December 31, 2014
Selling P 925,000
General 475,000 (1,400,000) Assets
Cash Assets:
Operating Profit P 870,000
Cash P1,900,000
Interest Expense ( 26,500) Notes Receivable 625,000
Profit before Tax P 843,500 Accounts Receivable P1,125,000
Income Tax Expense (30%) ( 253,050) Less Allowance for Uncollectible Accounts 112,500 1,012,500
Profit for the Period P 590,450 Interest Receivable 2,500
Merchandise Inventory 1,000,000
Supplies 25,000 P4,565,000
Division of profit
Furniture and Equipment P1,500,000
Flores Garcia Total Less Accumulated Depreciation 350,000 1,150,000
Salaries P 400,000 P 500,000 P 900,000
Interest on beginning capital 125,000 312,500 437,500 Total Assets P5,715,000
Balance – 3:2 (P747,050)
P747,050 x 3/5 ( 448,230) Liabilities
P747,050 x 2/5 ( 298,820) ( 747,050) Current Liabilities
Total share in profit P 76,770 P 513,680 P 590,450 Notes Payable P 500,000
Accounts Payable 375,000
Salaries Payable 25,000
Interest Payable 1,500
Schedule 1 – Net Sales Income Tax Payable 253,050
Total Liabilities P1,154,550
Sales P5,000,000
Less: Sales Returns and Allowances P50,000 Partners Equity
Sales Discounts 75,000 125,000 Flores, Capital P1,171,770
Net Sales P4,875,000 Garcia, Capital 3,886,680
Total Partners’ Equity 4,560,450

Schedule 2 – Cost of Sales Total Liabilities and Partners’ Equity P5,715,000

Merchandise Inventory, January 1 P 1,250,000
Net Purchases
Purchases P 2,412,500
Add Freight-In 125,000
Total P 2,537,500
Less: Purchase Returns and Allowances P100,000
Purchases Discounts 62,500 162,500 2,375,000

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CORRECTIONS IN PROFIT ERRORS AND OMISSIONS PRIOR RO The corrected profit for 2014 based on a 30% income tax rate shall be computed as follows:
DISTRIBUTION
Reported profit P398,000
Corrections:
The partnership books may show an incorrect profit because of errors and omissions. Such Unrecorded accrued expense, 2013 P 5,000
include failure to record prepaid expenses, accrued expenses, accrued income, unearned income Unrecorded unearned income, 2013 10,000
and also overstatement or understatement in purchases, inventories, and depreciation. The Overstatement of ending inventory, 2014 (48,000)
reported profit should be corrected before it is distributed to the partners. The required Unrecorded purchases, 2014 (20,000)
corrections may be summarized as follows: Unrecorded prepaid expenses, 2013 ( 3,000)
Total corrections before income tax P(56,000)
Correction to profit of current year for x 70%
errors made in Total corrections after income tax ( 39,200)
Prior Year Current Year Corrected profit P358,800
1. Unrecorded prepaid expenses - +
2. Unrecorded accrued expenses + - The distribution of the corrected profit shall be based on the new profit and loss ratios computed
3. Unrecorded accrued income - + as follows:
4. Unrecorded unearned income + -
5. Overstatement of inventories + - Hannah 20% x 80% = 16%
6. Understatement of inventories - + Ines 30% x 80% = 24%
7. Overstatement of purchases - + Julian 50% x 80% = 40%
8. Understatement of purchases + - Karina 20%
9. Overstatement of depreciation none + 100%
10. Understatement of depreciation none -
The corrected profit shall be divided among partners as follows:
It is understood that the tax implications of these corrections are properly accounted for
particularly if the partnership is not a general profession partnership. Hannah P358,800 x 16% P57,408
Ines P258,800 x 24% 86,112
Julian P358,800 x 40% 143,520
Illustrative Problem D. Hannah, Ines, and Julian are partners sharing profits on a 2:3:5 ratio. Karina P358,800 x 20% 71,760
On January 1, 20014. Karina was admitted into the partnership with a 20% share in profits. The P358,800
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 P398,000. It was ascertained, CAPITAL BALANCES RATIO ADJUSTED TO PROFIT AND LOSS RATIO
however, that the following errors were made:
While it is usual that capital ratios do not equal profit and loss ratios; yet, partners may decide
1. Accrued expenses not recorded at the end of 2013 P 5,000 to bring their capital balances into their profit and loss ratio. This can be accomplished through
2. Overstatement of 2014 ending inventory 48,000 either of the following:
3. Goods received and inventories in 2014 but the related
purchases not recorded 20,000 1. The capital balances are to be brought into the profit and loss ratio by payments outside
4. Income received in advance (unearned income), not of the firm among the partners and where the total firm capital is to remain the same.
recorded at the end of 2013 10,000 2. The capital balances are to be brought into the profit and loss ratio by the lowest
5. Prepaid expenses not recorded at the end of 2013 3,000 possible additional cash investment in the firm by the partners.
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.
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Illustrative Problem E. Lopez, Martin, and Nunag are partners whose original capital balances Assumption 3. Capital balances are to be brought into the profit and loss by the lowest possible
were in their profit and loss ratio. On December 31, 2014, capital balances are as follows: additional investment or cash withdrawal from the firm by the partners.

Lopez P400,000 20% Lopez Martin Nunag Total

Martin 200,000 30% Capital balances P400,000 P200,000 P400,000 P1,000,000
Nunag 400,000 50% Required capital 160,000 240,000 400,000 800,000
Add’l investment (withdrawals) (P240,000) P 40,000 P 200,000
Partners want to bring their capital balances into the profit and loss ratio.

Assumption 1. Capital balances are to be brought into the profit and loss ratio by payments In order to bring the capital balances into the profit and loss ratio by the lowest possible
outside of the firm among partners and with the total firm capital to remain the same. 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:
Capital balances P400,000 P200,000 P400,000 P1,000,000
Required capital 200,000 300,000 500,000 1,000,000 Lopez, Capital 240,000
Cash received (paid) P200,000 (P100,000) (P100,000) - Cash 200,000
Martin, Capital 40,000
For the capital balances to be brought into the profit and loss ratio and total firm capital to remain
the same, Martin and Nunag have to pay Lopez P100,000 each. The entry required on the REVIEW of the LEARNING OBJECTIVES
partnership books is as follows:
1. Discuss the closing entries in a partnership and differentiate them from the closing
Lopez, Capital 200,000 entries in a sole proprietorship. The closing entries of a partnership are almost similar to
Martin, Capital 100,000 those of a sole proprietorship. However, the profit or loss of the partnership is transferred
Nunag, Capital 100,000 to the individual drawing account or capital account of the partners and is distributed
according to the profit and loss sharing agreement.
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. 2. Identify and discuss the different methods and rules of dividing partnership profits and
losses to the partners. The distribution of partnership profits and losses to the partners
Lopez Martin Nunag Total may be expressed in any of the following ways: (1) by percentage; (2) by fraction; (3) by
Capital balances P400,000 P200,000 P400,000 P1,000,000 decimal; or (4) by ratio. The Civil Code of the Philippines provides rules on how partnership
Required capital 400,000 600,000 1,000,000 2,000,000 profits and losses be divided among the partners. As a general rule, profits or losses should
Additional investment - P400,000 P600,000 P1,000,000 be divided among with the partners’ agreement. In the absence of an agreement, the division
shall be made in accordance with capital contributions. To give recognition to the services
P400,000 / 20% = P2,000,000; P200,000 / 30% = P666,666 rendered by the partners or to the differences in the amount contributed in the partnership
P400,000 / 50% = P800,000 or to the entrepreneurial ability or managerial skill of the partners, salaries, interest and
bonuses may be allowed to partners part of the division of profits and losses.
In order to bring the capital balances into the profit and loss ratio by the lowest possible
additional cash investment, use as basis for determining the required capital, the capital of Lopez 3. Discuss and understand the preparation of financial statements of a partnership. The
divided by his profit share (P400,000/20% equals P2,000,000(. The required entry on the books financial statements are prepared after the work sheet is completed (or after journalizing
of the partnership is as follows: 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
Cash 1,000,000 changes in partners’ equity. The income statement includes a schedule showing the division
Martin, Capital 400,000 of the partnership profit or loss to the partners. The owners’ equity section of the statement
Nunag, Capital 600,000 of financial position is called “Partners’ Equity’ and it shows capital balances of individual

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partners. The statement of changes in partners’ equity shoes the division of profit or loss to MULTIPLE CHOICE
the partners, the amount of withdrawals during the period, and the partners’ capital
balances at the end of the period.
MC 3-1 Banayo and his very close friend Buendia formed a partnership on January 1, 2014 with
Banayo contributing P160,000 cash and Buendia contributing equipment with a book
value of P64,000 and a fair value of P48,000, and inventory items with a book value of
GLOSSARY of ACCOUNTING TERMINOLOGIES P24,000 and a fair value of P32,000. During 2014, Buendia made additional investment
of P16,000 on April 1, and P16,000 on June 1. On September 1, withdrew P40,000.
Average capital – the amount of capital invested by a partner determined by the time during Banayo had no additional investment nor withdrawals during the year. The average
which such capital is actually used in the business. capital balance of Buendia at the end of the fiscal year 2014 is
a. P72,000
Bonus – an incentive normally given to the managing partner in recognition of managerial or b. P80,000
entrepreneurial skill or ability. It is usually a percentage of profit. c. P88,000
d. P96,000
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 MC 3-2 Banas and Belda are partners who share profits equally and losses in a 2:1 ratio. If they
used. have beginning capital balances of P120,000 and P118,000, made no additional
investments nor withdrawals, and suffered an unprofitable year with loss of P48,000,
Salary allowances – compensation given to partners in proportion to the time devoted to the their capital balances will be:
business. Banas Belda
a. P 40,000 P 80,000
Statement of Changes in Partners’ Equity – a statement showing the division of partnership b. 88,000 102,000
profit or loss to the partners, additional investments made by partners, the amount of c. 120,000 118,000
withdrawals of individual partners, and the ending capital balances. d. 152,000 134,000

MC 3-3 Bernardo and Belo formed a partnership in the year 2014. The partnership agreement
provides for annual salary allowances of P110,000 for Bernardo and P90,000 for Belo.
The partners share profits equally and losses in a 60:40 ratio. The partnership had
profit of P180,000 for the year 2014 before any allowance to partners. What amount
should be credited to each partner’s capital account as a result of the distribution of the
partnership profit?
Bernardo Belo
e. P 98,000 P 82,000
f. 100,000 80,000
g. 96,000 84,000
h. 90,000 90,000

MC 3-4 Bunag, Belen, and Bustos are partners in an accounting firm. Their capital account
balances at year-end were P180,000, P220,000, and P100,000, respectively. They share
profits and losses on a 4:4:2 ratio, after considering the following items:
a. Bustos is to receive a bonus of 10% of profit after bonus.
b. Interest of 10% shall be paid on that portion of a partner’s capital in excess of
P200,000
c. Salaries of P20,000 and P24,000 shall be paid to partners Bunag and Bustos,
respectively.
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Assuming a profit of P220,000 for the year, the total profit share of Bustos is representing interest and their respective share in partnership profits. The balance of
a. P38,800 the profits shall be distributed among that partners in the ratio of 3:3:2:2.
b. P50,800
c. P54,800 What amount must be earned by the partnership in fiscal year, before any charge for
d. P74,800 interest and partners’ salaries, in order that Besa may receive an aggregate of P37.500
including interest, salary, and share of profits.
MC 3-5 Banta, Berba, and Borja formed a partnership on January 1, 2014. They had the a. P92,000
following initial investments: Banta – P200,000; Berba – P300,000; Borja – P450,000. b. P97,000
The partnership agreement states that profits and losses are to be shared equally by c. P50,000
the partners after consideration is made for the following: d. P90,000
a. Salary allowance of P120,000 for Banta, P96,000 for Berba and P72,000 for Borja.
b. Average partners’ capital balances during the year shall be allowed 10% interest. MC 3-9 Using the information in MC 3-8, the total profit share of Buan is
a. P 7,500
Additional information: b. P13,750
a. ON June 30, 2014, Banta invested an additional P120,000. c. P19,400
b. Borja withdrew P140,000 from the partnership on September 30, 2014. d. P37,500
c. Share on the remaining partnership profit was P10,000 for each partner.
MC 3-10 Using the information in MC 3-8, the total profit share of Baduel is
How much is the total interest on average capital balances of the partners? a. P13,000
a. P 95,000 b. P13,500
b. P 97,500 c. P18,000
c. P 107,500 d. P19,400
d. P115,250
MC 3-11 The partnership agreement between Banaria and Bertol stipulates that Banaria is to
MC 3-6 Using the information in MC 3-5, partnership profit at December 31, 2014 before receive a 20% bonus on profits before bonus with residual profit and loss to be
salaries, interest and partners’ share on the remainder is apportioned in the ratio of 2:3 respectively. Which partner has greater advantage when
a. P395,500 the partnership has a profit and when it incurs a loss.
b. P399,500 Profit Loss
c. P415,500 a. Bertol Banaria
d. P423,250 b. Banaria Bertol
c. Banaria Banaria
MC 3-7 Using the information in MC 3-5, the total partnership capital on December 31, 2014 is d. Bertol Bertol
a. P 950,000
b. P 970,000 MC 3-12 Bulan, Bustos, and Bucao formed a partnership o January 1, 2014 and contributed
c. P1,345,500 P150,000, P200,000, and P250,000, respectively. The Articles of Co-Partnership
d. P1,365,500 provide that the operating income be shared among the partners as follows: As salary:
Bulan – P24,000; Bustos P18,000; Bucao – P12,000; interst of 12% on the average
MC 3-8 On January 1, 2014, Besa, Bascom Buan, and Baduel formed the BF TRADING, a capital during 2014 of the three partners; the remainder will be divided in the ratio of
partnership with capital contributions as follows: Besa – P150,000; Basco – P75,000; 2:4:4, respectively.
Buan – P75,000; and Baduel – P60,000. The partnership agreement stipulates that each
partner shall receive a 5% interest on capital contributed and that Besa and Basco shall Additional information:
receive salaries (chargeable as expenses of the business) of P15,000 and P9,000, a. Operating income for the year ended December 31,2014 is P180,000.
respectively. The agreement further provides that Buan shall receive a minimum of b. Bulan contributed additional capital of P30,000 on July 1, and made drawing of
P7,500 per annum and Baduel a minimum of P18,000, which is inclusive of amounts P10,000 on October 1.

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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 P62,520 P59,720
b. P35,200 P70,400 P70,400
c. P53,980 P63,660 P62,360
d. P53,180 P62,060 P60,760

MC 3-13 Using the information in MC 3-12, the partners’ capital balances on December 31, 2014
are
Bulan Bustos Bucao
a. P223,980 P273,660 P282,360
b. P179,760 P229,520 P239,520
c. P189,860 P239,360 P269,360
d. P223,180 P272,060 P280,760

MC 3-14 Briones, Belen and Burgos are partners with average capital balances during 2014 of
P945,000, P447,300 and P324,700, respectively. The partners receive 10% interest on
their average capital balances, salaries of P224,650 to Briones and P165,250 to Burgos,
any residual profit or loss is divided equally.

In 2014, the partnership had a net loss of P251,248 before the interest and salaries to
partners.

What are the changes in the capital balances of Briones and Burgos?
Briones Burgos
a. P81,688 decrease P62,474 decrease
b. P56,716 increase P64,916 increase
c. P58,952 increase P35,070 increase
d. P60,534 increase P80,896 decrease

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 Chapter 4 – Partnership

1. The formation of a new partnership. This is known as dissolution by change in

CHAPTER 4 ownership structure. The new partnership continues the business activities of the
PARTNERSHIP DISSOLUTION dissolved partnership without interruption.

2. Liquidation. This refers to the termination of the business activities carried on by the
LEARNING OBJECTIVES partnership and the winding up of a partnership affair preparatory to going out of
business.
1. Define partnership dissolution and identify the condition 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. Dissolution, therefore, does not always result to liquidation although liquidation is always
preceded by dissolution.
PREVIEW OF THE CHAPTER
CONDITIONS RESULTING TO PARTNERSHIP DISSOLUTION
PARTNERSHIP
The following conditions will result to partnership dissolution by a change in ownership
DISSOLUTION structure:

1. Admission of a new partner

Causes of Dissolution
• Admission of a new
partner
• Retirement of a
partner
• Death, incapacity, or
bankruptcy of a
partner
• Incorporation of a
partnership
Admission by Purchase
• Sale of interest a book value
• Sale of interest at less than
book value
• Sale of interest at more than
book value
2. Retirement or withdrawal of a partner
3. Death, incapacity or bankruptcy of a partner
Admission by
4. Incorporation of a partnership
Investment
• Capital credit equal to Accounting for admission of a new partner is discussed in this chapter. Accounting for
capital contribution retirement, withdrawal, incapacity or bankruptcy and death of a partner is discussed in the next
• Capital credit not equal chapter.
to capital contribution
• Bonus method ADMISSION OF A NEW PARTNER
• Asset revaluation
method 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:

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:
1. Determination of the profit or loss from the beginning of the accounting period to the
date of admission of anew partner and the distribution of such profit or loss to the old
partners.
2. Correction of accounting errors in prior periods like overstatement or understatement
of inventories, excessive depreciation charges and failure to provide adequately for
doubtful accounts.
3. Revaluation of accounts which may call for the restatement of the existing assets of the
partnership to appraise or fair market values and recognition of unrecorded liabilities

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of the firm. All adjustments to the accounts give rise to profit or loss; such adjustments Illustrative Problem A: Coloma and Claudio are partners with capital balances of P100,000 and
are recorded in the partnership books as increase or decrease in capital shared P50,000, respectively. They share profits and losses equally. Cordero is a new partner
according to partners’ profit.
Case 1a – Purchase at book value from one partner only. Cordero purchases a 1/5 interest
4. Closing of the partnership books. from Coloma by paying P20,000.

TYPES OF ADMISSION OF A NEW PARTNER Coloma, Capital 20,000

Cordero, Capital 20,000
A new partner may be admitted into a partnership by: P100,000 x 1/5 = P20,000

1. Purchase of interest from one or more of the original (old) partners; or The P20,000 paid by the new partner Cordero to the old partner Coloma should not be reflected
2. Investment or asset contributions to the partnership 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
ADMISSION BY PURCHASE 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.
With the consent of all the partners, a new partner may be admitted in an existing partnership
Case 1 b- Purchase at book value from more than one partner. Cordero purchases 1/5
by purchasing a capital equity interest directly from one or more of the old partners. Terms such
interest from the old partners by paying P30,000.
as purchases, sells, pays, bought, sold and transferred indicate admission by purchase.
Coloma, Capital 20,000
The sale to a new partner of an old partner’s interest in an existing partnership is a personal
Claudio, Capital 10,000
transaction between the selling partner and the buying partner. The amount paid by the partner
Cordero, Capital 30,000
who purchases an interest goes personally to the partner who sells his or her interest; the
P100,000 x 1/5 = P20,000
amount paid does not go to the partnership.
P 50,000 x 1/5 = P10,000
The only entry required on the partnership books is the recording of the transfer of capital from
The P30,000 paid by Cordero to Coloma and Claudio should not be reflected in the partnership
the capital account of the selling partner to that of the buying partner. The amount of capital
books because the said amount goes directly to Coloma and Claudio. What is recorded in the
transferred will be equal to the book value of the interest sold regardless of the amount paid. The
partnership books is the transfer of 1/5 of the capital of the old partners Coloma and Claudio
pro-form entry is:
(P20,000 and P10,000, respectively) to the new partner Cordero. The admission of the new
partner, by purchasing a 1/5 interest from the old partners at book value, does not result in a
(Name of seller), Capital xxx
gain or loss to the old partners.
(Name of buyer), Capital xxx
Case 2 – Purchase at less than book value. Cordero purchases 1/5 interest form the old
The purchase price of the interest sold to the new partner may be:
partners by paying P25,000.
1. equal to the book value of interest sols
Coloma, Capital 20,000
2. less than the book value of interest sold
Claudio, Capital 10,000
3. more than the book value of interest sols
Cordero, Capital 30,000
P100,000 x 1/5 = P20,000
The new partner may pay more than or less than the book value of the interest sold by the old
P 50,000 x 1/5 = P10,000
partner resulting in a gai or loss in the transaction. This gain or loss, however, is a personal gain
or loss of the selling partner and not of the partnership. Therefore, no gain or loss is recognized
The P25,000 paid by Cordero to Coloma and Claudio should not be reflected in the partnership
in the partnership books.
books because the said amount was paid directly to the partners. What is recorded in the
partnership books is the transfer of 1/5 of the capital of the old partners (P20,000 and P10,000,

41 | P a g e
Chapter 4 – Partnership

respectively) to the new partner. The difference of P5,000 is a personal loss of the selling (old) Step 4 - Add the share of each partner on the asset revaluation to their capital balances to get
partners. the capital balance after the asset revaluation.

Case 3 – Purchase at more than book value. Cordero pays P40,000 for a 1/5 interest of the old Step 5 - Compute the amount of interest transferred by the old partners to the new partner
partners. based on their capital after the asset revaluation.
Coloma, Capital 20,000
Claudio, Capital 10,000 Step 6 - Prepare the entry to record the admission of the new partner.
Cordero, Capital 30,000
To illustrate, assume the same data in Illustrative Problem A where Coloma and Claudio are
The P40,000 payment made by Cordero to Coloma and Claudio should not be reflected in the partners with capital balances of P100,000 and P50,000, respectively. The share profits and
partnership books. What is recorded in the books of the partnership is the transfer of 1/5 of the losses equally. Cordero is a new partner who purchases a 1/5 interest from Coloma and Claudio
capital of the old partners to the new partner. The P10,000 excess payment is a personal gain of paying P40,000. However, before the admission of Cordero, partnership assets are to be revalued
Coloma and Claudio. using as basis the amount to be paid by Cordero.

Key Points. In the preceding four cases, 1a, 1b, 2 and 3, the transfer of capital from the old Solution:
partners to the new partner is recorded at book value regardless of the amount paid. Payments
at less than book value and at more than book value are recorded as if they were made at book Step 1 - The new partnership capital is equal to the amount paid by the incoming partner
value. divided by his fraction of interest.
New partnership capital = P40,000 ÷ 1/5 = P200,000
In addition, the four cases shows that the total partnership capital v=before and after the
admission of the new partner are the same Thus, the total partnership capital of P150,000 before Step 2 - The amount of asset revaluation is equal to the new partnership capital less old
the admission of Cordero is also the total partnership capital after his admission. Therefore, the partnership capital.
admission of a new partner by purchase will not affect the total assets and the total capital of the Asset revaluation = P200,000 - P150,000 = P50,000
partnership.
Step 3 - The allocation of the amount of the asset revaluation among the old partners is
ASSET REVALUATION UPON ADMISSION OF A NEW PARTNER BY as follows: P50,000 /2 = P25,000 per partner.
PURCHASE
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.
Revaluation of assets of the old partnership, however, is generally undertaken prior to the
admission of a new partner. The effect of the asset revaluation is carried to the capital accounts
Coloma Claudio
of the old partners. The adjusted capital of the old partners becomes the basis for the interest
Capital balances before revaluation P100,000 P50,000
transferred to the new partner.
Share on asset revaluation 25,000 25,000
Capital balances after revaluation P125,000 P 75,000
The procedures under this approach are as follows:
Step 5 - The amount of interest transferred by the old partners to the new partner based on the
Step 1 - Compute the new partnership capital using as basis the amount to be paid by the
new capital balances (capital balances alter asset revaluation)
incoming partner and his fraction of interest.
Coloma Claudio
Capital balances after revaluation P125,000 P75,000
Step 2 - Deduct the capital of the old partnership from the capital of the new partnership. The
Interest transferred 1/5 1/5
difference is the asset revaluation.
Capital transferred to Cordero P 25,000 P15,000
Step 3 - Allocate the asset revaluation among the old partners in accordance with their residual
profit and loss sharing agreement.

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STEP 6 - The journal entries to record the evaluation of asset and the admission of Cordero are Using the information in the example given, the total contributed capital is P400,000, the sum of
as follows: the old partner’s contribution of P300,000 and the new partner’s contribution of P100,000.
Other Assets 50,000
Coloma, Capital 25,000 Bonus – it is the transfer of capital from one partner to another. A bonus to the old partners is
Claudio, Capital 25,000 given by the new partner. It is a reduction in the capital of the new partner and an increase in the
Coloma, Capital 25,000 capital of the old partners. The capital accounts of the old partners are credited according to their
Claudio, Capital 15,000 profit and loss ratio. A bonus to the new partner is given by the old partners. It is a reduction in
Cordero, Capital 40,000 the capital of the old partners and an increase in the capital of the new partner. The capital
account of the new partner is credited and the capital accounts of the old partners are debited
ADMISSION BY INVESTMENT according to their profit and loss ratio.

The admission of a new partner by investment is a transaction between the original partnership
and the new partner. The use f the terms like invests and contributes represent admission of a
new partner by investment. The investment of the new partner increases the total assets and the
total capital of the partnership. The entry to record the admission of the new partner depends
upon the capital interest credited to the partners’ accounts.
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.

DEFINITION OF TERMS 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
Agreed Capital (AC) – it is the amount of new capital set by the partners for the partnership. It
is bonus to the new partner.
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
b. If the capital credit is less than the investment of the new partner, the difference is
admission of a new partner may indicate the agreed capital. If agreed capital is not indicated, it
bonus to the old partners.
can be computed in either of two ways:
Asset Revaluation - necessary adjustment in asset values upon admission of a new partner. The
1. Investment of the new partner divided by the new partner’s fraction of interest; or
adjustment in assets may be determined as the difference between the agreed capital and the
2. Investment of the old partners (equal to the net assets or capital of the partnership)
total contributed capital. Generally, asset revaluations upon partnership formation relate only to
divided by the old partners' fraction of interest.
the partners of the old partnership.
Example: Corpus and Carlos are partners with capital balances of P150,000 each. Cabral invests
Capital Credit - it is the interest or equity of a partner in the firm. It is computed by multiplying
P100,000 for a 2/5 interest in the new partnership. The agreed capital of the new partnership is
agreed capital by the fraction of interest of a partner
determined as follows:

Computation 1 - The new partner’s investment used as a basis PROBLEMS RELATING TO ADMISSION OF A NEW PARTNER BY
P100,000 ÷ 2/5 = P250,000 INVESTMENT
Computation 2 - The old partners' investment used as a basis Situations relating to admission of a new partner by investment may fall under any of the
P300,000 ÷ 3/5 = P500,000 following:

Total Contributed Capital (CC) - it is the investment of all the partners, both old and new, to the 1. Agreed capital is given. When agreed capital is given, the admission of a new partner by
partnership. It is the sum of the capital balance of the old partners (net asset investment) and the investment will give rise to any of the following cases:
contribution of the new partner. a. No Bonus, no Asset Revaluation
b. Bonus to old partners, no Asset Revaluation
c. Bonus to new partner, no Asset Revaluation
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Chapter 4 – Partnership

d. Asset Revaluation, no Bonus Step 3 Determine if there is bonus.

a. Compute for the capital credit of the new partner
2. Agreed capital is not given. When agreed capital is not given, the problem calls for two AC x fraction of interest, P400,000 x 1/4 = P100,000
alternative solutions: b. Write this amount in the AC column of the new partner.
a. Bonus method c. Compare the new partner's AC with his CC. In this case, AC and CC are the same,
b. Asset revaluation method therefore, there is no bonus.

3. Agreed capital is not given but the basis for its computation is indicated in the terms of Step 4 The above table will be completed as follows:
admission.
a. AC or capital credit of the old partners
4. The amount of contribution of the new partner is not given. AC x fraction of interest (4/4 - ¼ = ¾ )
P400,000 x ¾ = P300,000
5. No fraction of interest for either the new or old partners is given.
b. A completed table appears as follows:
The following are the illustrations of the various problems involving admission of a new partner AC CC
by investment. Old P 300,000 P 300,000
New 100,000 100,000
AGREED CAPITAL IS GIVEN P 400,000 P 400,000

Illustrative Problem B: Calmer and Castro are partners with capital balances of P200,000 and c. Conclusion based on the table
P100,000, respectively. They share profits and losses equally Conde is to be admitted in the (i) AC = CC, therefore, there is no asset revaluation
partnership. (ii) New partner: AC = CC, therefore, there is no bonus
(iii) Old partners: AC = CC, therefore, there is no bonus either
Case 1 – No Bonus, no Asset Revaluation. Conde invests P100,000 for a ¼ interest in the agreed
capital of P400,000. In actual problem solving, only one table is prepared. The missing items are filled a they are
needed.
Cash 100,000
Condo, Capital 100,000 Case 2 – Bonus to the old partners, no Asset Revaluation. Conde invests P100,000 for a 1/5
interest in the new firm capitalization of P400,000.
Solution:
Cash 100,000
Step 1 Fill in the given data in the table. Conde, Capital 100,000
a. Partners, old and new.
b. AC column, with the total written first Condo, Capital 20,000
c. CC column Calma, Capital 10,000
AC CC Castro, Capital 10,000
Old P 300,000
New 100,000 These entries were made to show clearly the transfer of capital iron the new partner to the old
P 400,000 P 400,000 partners. However, a compound entry may also be prepared as follows:

Step 2 Compare AC and CC. In this case, AC = CC Cash 100,000

(400,000=P400,000), therefore, there is no asset revaluation. Condo, Capital 80,000
Calma. Capital 10,000
Castro, Capital 10,000

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Chapter 4 – Partnership

Solution: Solution:
Step 1 Fill in the table as in Cases 1 and 2. The completed table after Steps l to 4 is shown
Step 1 Fill in the table as in Case l. The completed table after Steps I to 4 is shown below: below:
AC CC Bonus
AC CC Bonus Old P 270,000 P 300,000 P (30,000)
Old P 320,000 P 300,000 P 20,000 New 90,000 60,000 30,000
New 80,000 100,000 (20,000) P 360,000 P 360,000 -
P 400,000 P 400,000 -
Step 2 Compare AC and CC. In this case, AC = CC (P360,000 = P360,000).
Step 2 Compare AC and CC. In this case, AC = CC (P400,000 = P400,000) Therefore, there is no Therefore, there is no asset revaluation but there may be bonus.
asset revaluation but there may be bonus.
Step 3 Determine if there is bonus.
Step 3 Determine if there is bonus. a. Compute for the capital credit of the new partner.
a. Compute for the capital credit of the new partner. AC x fraction of interest; P360,000 x 1/4 = P90 000
AC x fraction of interest, P400,000 x 1/5 = P80,000. b. Write this amount in the AC column of the new part
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 -
c. Compare the new partner's AC with his CC. In this case, his AC < CC (P80,000 - P60,000; therefore, the increases in his contributed capital represents bonus from
P100,000); therefore, the decrease in his contributed capital represents bonus to the old partners
the old partners.
Step 4 Complete the table filling in the missing figures.
Step 4 Complete the table by filling in the missing figures. a. AC or capital credit of the old partners.
a. AC or capital credit of the old partners. AC x fraction of interest
AC x fraction of interest, P360,000 x 3/4 = P270,000 or
P400,000 x 4/5 = P320.000 or CC – Bonus to old partners
CC + Bonus to the old partners P300,000 - P30,000 = P270,000
P300,000 + P20,000 = P320,000
The bonus is shared by the old partners according to their profit and loss sharing The bonus given to the new partner is shared by the old partners according to their
ratio. profit and loss sharing ratio.
b. A completed table is shown in Step I.
c. Conclusion based on the table: b. A completed table is shown in Step 1
(i) AC = CC, therefore, there is no asset revaluation.
(ii) New partner: AC < CC, therefore, he gives the bonus. Case 4 – Positive Asset Revaluation, no Bonus. Conde invests P100,000 for a 1/5 interest in
(iii) Old partners: AC > CC, therefore, they receive the bonus shared according the agreed capital of P500,000.
to their profit and loss ratio.
Other Assets 100,000
Case 3 – Bonus to new partner, no Asset Revaluation. Condo invests P60,000 for a 1/4 interest Calma, Capital 50,000
in the total capitalization of P360,000. Castro, Capital 50,000
Cash 100,000
Cash 60,000 Conde, Capital 100,000
Calma, Capital 15,000
Castro, Capital 15,000 Solution:
Conde, Capital 90,000 Step 1 Fill in the table as in Cases 1 to 3, The completed table after Steps 1 to 4 is shown below:

45 | P a g e
Chapter 4 – Partnership

Asset
Asset AC CC Revaluation
AC CC Revaluation Old P 240,000 P 300,000 (P 60,000)
Old P 400,000 P 300,000 P 100,000 New 60,000 60,000 -
New 100,000 100,000 - P 300,000 P 360,000 P 60,000
P 500,000 P 400,000 P 100,000

Step 2 Compare AC and CC. In this case, AC > CC (P500,000 > P400,000). Step 2 Compare AC and CC. In this case, AC < CC (P300,000 < P360,000).
Therefore, there is a positive asset revaluation. Therefore, there is a negative asset revaluation.

Step 3 Determine if there is bonus. Step 3 Determine if there is bonus. .

a. Compute for the capital credit of the new partner.
AC x fraction of interest; P500,000 x 1/5 = P100,00.
b. Write this amount in the AC column of the new partner.
c. Compare the new partner's AC with his CC. In this case. his
AC = CC (P100,000 = P100,000); therefore, there is no bonus.
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. Step 4 Complete the table by filling in the missing figures.
a. AC or capital credit of the old partners. a. AC or capital credit of the old partners.
AC x fraction of interest AC x fraction of interest
P500,000 x 4/5 = P400,000 or P300,000 x 4/5 = P240,000 or
CC + Asset Revaluation CC – Asset Revaluation
P300,000 + P100,000 = P400,000 P300,000 - P60,000 = P240,000
b. A completed table is shown in Step l. b. A completed table is shown in Step l.
c. Conclusion based on the table: c. Conclusion based on the table:
(i) AC > CC, therefore, there is u positive asset revaluation (i) AC < CC, therefore, there is a negative asset revaluation.
(ii) New partner: AC = CC. therefore, there is no bonus. (ii) New partner: AC = CC, therefore, there is no bonus.
(iii) Old partners: AC > CC, therefore, they are credited for the (iii) Old partners: AC < CC, therefore, they are charged for the asset revaluation
asset revaluation shared according to their profit and loss ratio. 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 In the succeeding illustrations, the tables are summarized for easier comparison.
agreed capital of P300,000.
AGREED CAPITAL IS NOT GIVEN
Calma, Capital 30,000
Castro, Capital 30,000 There are cases when the contributions and the fractions of interest of the new partner
Other Assets 60,000
are given, but the agreed capitalization of the new firm is not specified. When such a
Cash 60,000
situation exists, the admission of the new partner is recorded using any of these two
Conde, Capital 60,000 methods:

Solution: 1. Bonus method

2. Asset Revaluation method
Step 1 Fill in the tables as in Cases 1 to 4. The completed table after Steps 1 to 4 is shown
below:

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Chapter 4 – Partnership

BONUS METHOD (AC = CC) 1. Bonus Method

Under this method. the agreed capitalization of the new partnership is equal to the total amount Cash 100,000
of contribution of all the partners. both old and new. No asset revaluation is recognized but there Conde, Capital 80,000
will be a transfer of capital called bonus. Bonus in the new partner is given by the old partner. Calma, Capital 15,000
Bonus to the old partner. Bonus comes from the new partner. Castro Capital 5,000

ASSET REVALUATION METHOD

AC CC Bonus
An asset revaluation is made to properly value the assets of the partnership prior to admission Old (4/5) P 320,000 P 300,000 P 20,000
of a new partner. An asset revaluation will result to either an increase or decrease in the recorded New (1/5) 80,000 100,000 (20,000)
amount of the partnership assets and partners' capital. An asset revaluation increase (positive P 400,000 P 400,000 -
asset revaluation) indicates that some partnership assets are undervalued. On the other hand. an
asset revaluation decrease (negative asset revaluation) indicates that some partnership assets
are overvalued. Under the asset revaluation method, the balances of partnership assets and the The agreed capital of the partnership is equal to capital contribution. The capital credit of
partners' capital must be adjusted prior to the admission of a new partner. These adjustments the old and new partners are computed as follows:
must be recorded prior to recording the admission of the new partner. New = P400,000 x 1/5 = P 80,000
Old = P400.000 x 4/5 = P 320,000
POSITIVE ASSET REVALUATION METHOD (AC ˃ CC)
The capital credit of the new partner is less than his capital contribution, therefore, the new
A positive asset revaluation increases the old partnership assets and the capital accounts of the partner gives the bonus. The bonus is shared by the old partners according to their profit
old partners. The increase is shared by the old partners based on their profit and loss sharing and loss ratio.
ratio. Here. the agreed capitalization of the new partnership is more than the total amount of
contribution of both the old and new partners. 2. Positive Asset Revaluation Method

Under this method, the agreed capitalization is computed as follows: Other Assets 100,000
Calma, Capital 75,000
AC = New partner’s CC ÷ new partner’s fraction of interest Castro, Capital 25,000

NEGATIVE ASSET REVALUATION METHGD (AC < CC) Cash 100,000 100,000
Conde, Capital
A negative asset revaluation decreases the old partnership assets and the capital accounts of the
old partners. The decrease is shared by the old partners based on their profit and loss sharing AC CC
ratio. Here, the agreed capitalization of the new partnership is less than the total amount of Revaluation
contribution of both the old and new partners. Old (4/5) P 400,000 P 300,000 P 100,000
New (1/5) 100,000 100,000 -
The agreed capitalization is computed under this method in the same manner as in positive asset P 500,000 P 400,000 P 100,000
revaluation

Illustrative Problem C. Conde invests P100,000 for a 1/5 interest in the partnership of Calma
and Castro. The contributions of Calma and Castro are P200,000 and P100,000 respectively, and
they share profits and losses I the ration of 3:1. After the admission of Conde, profits and losses
will be divided equally.

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The agreed capital of the new partnership is computed by dividing the new partner's Cash 80,000
contribution by his fraction of interest (P100,000 ÷ 1/5 = P500,000). Conde, Capital 80,000

An agreed capital of more than the contributed capital indicated that there is an understatement AC CC
in some assets of the partnership upon the admission of a new partner. The agreed capital of Old (3/4) P 240,000 P 300,000 (P60,000)
P500,000 when compared with the contributed capital of P400,000 indicates a P100,000 New (1/4) 80,000 80,000 -
increase in assets and capital for the asset understatement. The AC or capital credit of the old P 320,000 P 380,000 (P60,000)
partners which is P400,000 (P500,000 x 4/5) is P100,000 more than their contributed capital.
Therefore, the old partners are credited for the revaluation of assets. The old partners share on The agreed capital of the new partnership is computed by dividing the new partner's
the revaluation of assets according to their profit and loss ratio. contribution by his fraction of interest (P80,000 + ¼ = P320,000).

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
An agreed capital that is less than the contributed capital indicates that there is an overstatement
in some assets of the partnership upon the admission of a new partner. The agreed capital of
P320,000 when compared with the contributed capital of P380,000 indicates a P60,000
reduction in assets and capital for the asset overstatement. The AC or capital credit of the old
partners which is P240,000 (P320,000 x ¾) is P60,000 less than their contributed capital.
Therefore, the old partners are charged for the revaluation of assets. The old partners share on
the revaluation of assets according to their profit and loss ratio.

Cash 80,000 COMPARISON OF BONUS AND ASSET REVALUATION METHOD

Calma, Capital 11,250
Castro, Capital 3,750 In Illustrative Problem C, Conde is given a 1/5 interest in the partnership and a 1/3 share of
Conde, Capital 95,000 profits upon admission. Both the bonus method and the asset revaluation method can be used in
AC CC determining the required interest for the new partner but the two methods may not offer the
Old (3/4) P 285,000 P 300,000 (P15,000) same ultimate results. Based on the information and assumptions given, the comparison between
New (1/4) 95,000 80,000 15,000 the bonus method and the asset revaluation method may be illustrated as shown below.
P 380,000 P 380,000 -
Asset Calma, Castro, Conde,
Revaluation Capital Capital Capital
The agreed capital of the partnership is equal to capital contribution. The capital credit of
the old and new partners are. computed as follows: Balances under the bonus method P 215,000 P 105,000 P 80,000
New = P380,000 x ¼ = P95,000 Balances under the asset revaluation P 100,000 P 275,000 P 125,000 P 100,000
Old = P380,000 x ¾ = P285,000 method
Share on the additional depreciation
on asset revaluation (equally) (100,000) ( 33,333) ( 33,333) ( 33,334
The capital credit of` the new partner is greater than his capital contribution, therefore, he
receives the bonus. The bonus is shared by the old partners according to their profit and Balances after the add’l depreciation
on asset revaluation P 241,667 P 91,667 P 66,666
loss ratio.
Net advantage (disadvantage) of
using the asset revaluation method P 26,667 (P 13,333) (P 13,334)
2. Negative Asset Revaluation Method

Calma, Capital 45,000

Castro, Capital 15,000 Based on the above analysis, Calma will prefer the asset revaluation method while Castro and
Other Assets 60,000 Condo will prefer the bonus method.

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Chapter 4 – Partnership

AGREED CAPITAL Is NOT GIVEN BUT BASIS FOR ITS COMPUTATION IS INDICATED 2. the investment of the new partner is computed by multiplying the AC by his fraction of
IN THE TERMS OF ADMISSION interest (P450,000 x 1/3 = P150,000). Conde has to invest P 150,000 in order to have a
1/3 interest in the firm.
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 Example 2: Coral, Cielo, and Camu are partners with capital balances of P 112,000, P 130,000,
invests P100,000 in the firm and is credited for P50,000 which is to be 1/8 of the new firm capital. and P 58,000, respectively, sharing profits and losses equally. Cueva is admitted as a new
partner bringing with him his expertise and good reputation. He is to invest cash for a 25%
The entry to record the admission of Conde into the partnership is interest in the assets of the partnership which includes a credit of P18,750 for bonus upon the
admission.
Cash 100,000
Conde, Capital 50,000 The journal entry to record the admission of the new partner is as follows:
Calma, Capital 37,500
Castro, Capital 12,500 Cash 75,000
Coral, Capital 6,250
AC CC Cielo, Capital 6,250
Old (7/8) P 350,000 P 300,000 P 50,000 Camu, Capital 6,250
New (1/8) 50,000 100,000 (50,000) Cuevas, Capital 93,750
P 400,000 P 400,000 -
Solution:
The agreed capital is not given but the basis for its computation is indicated in the problem. The
new partner is to be credited for P50,000 which is 1/8 of the new firm capital. Thus, P50,000 ÷ Follow the same procedures as in Example 1. The P18,750 bonus given by the old partners to the
1/8 = P400,000 agreed capital. The agreed capital of (P400,000) is equal to total contributed new partner has to be deducted first from the total capital of the old partners to get their 75%
capital, therefore, there is no asset revaluation. But there might be bonus. The capital credit of` interest. Thus:
the new partner is less than his contribution, therefore, he gives the bonus. The bonus is shared P112,000 = P130,000 + P58,000 – P18,750 = P281,250
by the old partners in their profit and loss ratio. P281,250 / 75% = P375,000
,
THE AMOUNT OF THE CONTRIBUTION OF THE NEW PARTNER IS NOT GIVEN 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:
Example 1: Calma and Castro have capital balances of P200.000 and P100,000, respectively. P375,000 x 25% = P93,750
They share profits and losses in the ratio of 3:1. Conde invests sufficient amount for 1/3 interest. P93,750 – P18,750 = P75,000

The journal entry to record the admission of Condo follows:

FRACTION OF INTEREST IS NOT GIVEN
Cash 150,000
Conde, Capital 150,000 Conde invests P50,000 in the firm. However, upon his admission
P10,000 bonus is allowed by the old partners.
Solution:
The entry to record the admission of the new partner is:
Computations similar to those made in the previous cases are no longer necessary. To arrive at Cash 50,000
the amount to be contributed by the new partner. Calma, Capital 7,500
1. the new firm capital (AC) is computed by dividing the old partners' contributions by Castro, Capital 2,500
their fraction of interest (P300,000 ÷ 2/3) = P450,000, and Conde, Capital 60,000

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Chapter 4 – Partnership

REVIEW of the LEARNING OBJECTIVES MULTIPLE CHOICE

MC 4-1 If the total contributed capital exceeds the agreed capital with the new partner’s
1. Define partnership dissolution and identify the conditions giving rise to it. Partnership investment is the same as his capital credit, then the admission of the new partner
dissolution is a change in the relation of the partners caused by any partner ceasing to be involved a
associated in the carrying out of the business. Dissolution of a partnership may be caused a. bonus to new partner
by any of the following conditions: (1) admission of new partner; (2) retirement or b. bonus to old partners
withdrawal of a partner; (3) death, incapacity or bankruptcy of a partner, or (4) c. negative asset revaluation
incorporation of a partnership. d. positive asset revaluation

2. Understand the accounting procedures to record the admission of a new partner by MC 4-2 If the agreed capital is equal to the total contributed capital with the capital credit and
purchase. A new partner may be admitted into the partnership by purchasing a capital contribution of the old and new partners being the same, there exists
equity interest from one or more of the old partners. Admission of a new partner by a. asset revaluation and bonus
purchase represents a transfer of capital from the old partner/partners to the new partner. b. negative asset revaluation
The transfer of capital is recorded at the book value of the interest sold regardless of the c. no asset revaluation and no bonus
amount paid for the interest. Any gain or loss indicated in the transaction is a personal gain d. positive asset revaluation
or loss of the selling partner. Asset revaluation, however, may be undertaken by the old
partnership before admission of a new partner. In such a case, a positive or negative asset MC 4-3 If the capital credit of the new partner is less than his contribution with no adjustment
revaluation will always accrue to the old partners. in asset values. then the admission resulted in a
a. bonus to the old partners
3. Understand the accounting procedures to record the admission of a new partner by b. bonus to the new partner
investment. The admission of a new partner by investment is a transaction between the c. no bonus
original partnership and the new partner. The new partner's contribution increases the total d. both A and B
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 MC 4-4 Calibo and Camos are partners with capital balances of P60,000 and P80,000 and
contributions of the old partners is not equal to their capital credit in the new partnership. sharing profits and losses 40% and 60% respectively. If Cueva is admitted as partner
the difference is accounted for by any of the following methods: (1) bonus method (bonus paying P50,000 in exchange for 50% of Calibo's equity, the entry in the partnership
to the old partners from the new partner or bonus to the new partner from the old partners); books should be as follows:
(2) asset revaluation method either positive or negative revaluation. a. Calibo. Capital 50,000
Cueva, Capital 50.000
b. Calibo, Capital 30,000
Cueva, Capital 30,000
c. Cash 45,000
Other Assets 15,000
Cueva, Capital 50,000
d. Cash 50.000
Calibo, Capital 15,000
Cueva, Capital 45.000

MC 4-5 Chan, Ching, and Chen are partners who share profits and losses in the ratio of 5:3:2
respectively. They agree to sell Chat 25% of their respective capital and profits and
losses ratio for a total payment directly to the partners in the amount of P140,000. They
agree that asset revaluation of P60,000 is to be recorded prior to the admission of Chat.
The condensed statement of financial position of the CCC Partnership is presented on
the next page.

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Chapter 4 – Partnership

Assets Liabilities and Capital MC 4-8 On May 1, 2014, the business accounts of Cordova and Constancio appear below:
Cash P 60,000 Liabilities P 100,000
Other Assets 540,000 Chan, Capital 250,000
Ching, Capital 150,000 Cordova Constancio
Chen, Capital 100,000 Assets
P 600,000 Total Liabilities and Capital P 600,000 Cash P 11,000 P 22,354
Account Receivable 234,536 567,890
The capitals of Chan, Ching, and Chen respectively after the payment and admission of Inventories 120,035 260,102
Chat are Land 603,000
a. P187,500; P112,500; P 75,000 Buildings 428,267
b. P210,000; P126,000; P 84,000 Furniture and Fixtures 50,345 34,789
c. P280,000; P168,000; P112,000 Other Assets 2,000 3,600
d. P250,000; P150,000; P100,000 P 1,020,916 P 1,317,002
Equities
MC 4-6 C2 Partnership had a net income of P24,000 for the month ended September 30,2014. Accounts Payable P 178,940 P 243,650
Carreon purchased an interest in the C2 Partnership of Calvo and Calma by paying Calvo Notes Payable 200,000 345,000
P72,000 for half of his capital and half of his 50% profit sharing interest. At this time, Cordova, Capital 641,976
the capital balance of Calvo was P96,000 and the capital balance of Calma was Constancio, Capital 728,352
P168,000. Carreon should receive a credit to this capital account of P 1,020,916 P 1,317,002
a. P36,000
b. P48,000 Cordova and Constancio agreed to form a partnership contributing their respective
c. P72,000 assets and equities subject to the following adjustments:
d. P84,000
a. Accounts Receivable of P20,000 in Cordova’s books and P35,000 in Constancio’s
MC 4-7 Cheng, Chavez and Chato are partners sharing profits and losses in the ratio of 4:3:3, are uncollectible
respectively. The condensed statement of financial position of their partnership as of b. Inventories of P5,500 and P6,700 are worthless in Cordova’s and Constancio’s
December 1, 2014 is presented below respective books.
c. Other Assets of P2,000 and P3,600 in Cordova’s and Constancio’s respective books
Cash P 100,000 Liabilities P 80,000 are to written off.
Other Assets 260,000 Chan, Capital 120,000
Ching, Capital 80,000 The capital accounts of the partners after the adjustments will be
Chen, Capital 80,000 Cordova Constancio
P 360,000 Total Liabilities and Capital P 360,000 a. P614,476 P683,052
b. P615,942 P717,894
All the partners agree to admit Cua as 1/6 partner in the partnership without any asset c. P640,876 P712,345
revaluation nor bonus. Cua shall contribute assets amounting to d. P613,576 P683,350
a. P 20,000
b. P 56,000 MC 4-9 Using the information in MC 4-8, how much assets does the partnership have?
c. P 70,000 a. P2,237,918
d. P120,000 b. P2,265,118
c. P2,337,918
d. P2,365,218

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Chapter 4 – Partnership

MC 4-10 Using the information in MC 4-8, how much assets does the partnership have? MC 4-14 Using the information in MC 4-13, the amount of the asset revaluation is
a. P2,237,918 equal to
b. P2,265,118 a. P 15,000
c. P2,337,918 b. P 50,000
d. P2,365,218 c. P120,000
d. P200,000
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 MC 4-15 Using the information in MC 4-13, the capital balances of the old partners after the
should the cash settlement be between Cordova and Constancio? admission of Cueto are
a. P32,272 a. P250,000, P150,000, P100,000, respectively
b. P32,930 b. P275,000, P112,500, P112,500, respectively
c. P33,602 c. P250,000, P200,000, P100,000, respectively
d. P34,288

MC 4 -12Using the information in MC 4-8 and assuming that during the first year of operations
the partnership earned an income of P325,000 and that this was distributed in the
agreed manner. Assuming further that drawings were made in these amounts: Cordova,
P50,000, Constancio, P65,000, and Cuyugan, P28,000, how much are the capital
balances of the partners after the first year?

a. 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 Cosme are partners whose and capital balances and share in profits are
as follows:
Conrado P250,000 50%
Cosio 150,000 25%
Cosme 100,000 25%

Cueto is admitted into the partnership by paying P60,000 for 1/3 of the share in equity
of Cosio and by contributing P200,000. The partners agree to the total capitalization to
P750,000, 1/3 Of which is Cueto's capital credit. Cueto's share in net income is also l/3
and the old partners are to divide net income in the old ratio among themselves.

The profit and loss sharing, ratio among Conrado, Cosio and Cosme after the admission
of Cueto is
a. 50%, 25%, 25%, respectively
b. 30%, 15%, 15%, respectively
c. 2/6, 1/6, 1/6, respectively
d. 1/3, 1/3, 1/3, respectively

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 Chapter 5 – Change in Capital Structure by Withdrawal, Retirement, Death or Incapacity of a Partner

CHAPTER 5 CHANGE IN CAPITAL STRUCTURE BY WITHDRAWAL OR RETIREMENT OF

A PARTNER
CHANGE IN CAPITAL STRUCUTRE BY WITHDRAWAL,
RETIREMENT, DEATH OT INCAPACITY OF A The partnership may allow any of its partners to withdraw ore retire from the firm. The business
may continue after such withdrawals; on the other hand, the interest of retiring or withdrawing
PARTNER partner may be:

1. Sold to a new partner (outsider)

LEARNING OBJECTIVES 2. Sold to the continuing (remaining) partners
3. Sold to the partnership
1. Discuss and understand the accounting procedures in recording the retirement or withdrawal of
a partner by sale of interest to a new partner or to the continuing or remaining partners. SALES OF INTEREST TO A NEW PARTNER
2. Discuss and understand the accounting procedures in recording the retirement or withdrawal of
a partner by sale of interest to the partnership With the consent of the remaining partners, the retiring partner may sell his interest to an
3. Discuss and understand the accounting procedures in recording the dissolution of a partnership outsider. The sale is recorded in the same manner as in the admission of a new partner by
due to death or incapacity of a partner. purchase. The partnership recognizes only the transfer of capital interest from the retiring
partner to the new partner.

PREVIEW OF THE CHAPTER SALE OF INTEREST TO CONTINUING PARTNERS

CHANGE IN The interest of the retiring partner maybe acquired by any of the continuing partners. The
transaction is recorded in the same manner as in the sale of interest to a new partner The
CAPITAL STRUCTURE partnership recognizes only the transfer of capital interest from the retiring partner to the
acquiring planner or partners.

SALE OF INTEREST TO THE PARTNERSHIP

Retirement or Retirement or Withdrawal Death or Incapacity of a A retiring partner may sell his capital interest to the continuing partners through the
Withdrawal Sale of Interest to the Partner partnership. The partnership has the obligation to make payment to the retiring partner
Sale of Interest to a Partnership either by:
New Partner or • Equal to capital 1. payment in cash;
Continuing Partners • Equal to capital interest interest 2. transfer of noncash assets; or
• At less than or more than • At less than or more 3. recognition of a liability for the full or the balance of the unpaid interest of the retiring
• Equal to capital capital interest than capital interest partner.
interest • Bonus method • Bonus method
The purchase price or amount of settlement by the partnership to the retiring partner may be:
• At less than capital • Asset Revaluation • Asset 1. equal to the interest of the retiring partner (at book value)
interest method Revaluation 2. less than the interest of the retiring partner (at less than book value)
• At more than capital Method 3. more than the interest of the retiring partner (at more than book value)
interest
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
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Chapter 5 – Change in Capital Structure by Withdrawal, Retirement, Death or Incapacity of a Partner

ACCOUNTING PROBLEMS INVOLVED IN THE RETIREMENT OF A PARTNER Illustrative Problem A: The statement of financial position of the partnership of Dy, David and
Diaz on December 31, 2014 follows:
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 Assets Liabilities and Capital
partnership profits or losses, loans to the partnership and loans from the partnership. Following Cash P 110,000 Liabilities P 20,000
are the accounting problems involved in determining the capital interest of a retiring partner: Other Assets 30,000 Dy, Capital 20,000
David, Capital 40,000
1. Determination of the profit or loss from the beginning of the accounting period to the date Diaz, Capital 60,000
of withdrawal or retirement and the distribution of such profit or loss. P 140,000 Total Liabilities and Capital P 140,000

2. Closing of the partnership books. The partners share profits and losses in the ratio of 4:2:4. On July l, 2015, Diaz asked to be allowed
to withdraw from the partnership. The partners decided to close the books as of this date so as
3. Correction of accounting errors in prior periods like overstatement or understatement of to determine the capital interest of Diaz. Profit for the six months ended amounted P60,000 while
inventories, excessive depreciation charges and failure to provide adequately for doubtful drawings of Dy, David and Diaz amount to P4,000, P6,000 and P2.000, respectively. Profits and
accounts. losses are to be shared equally after the retirement of Diaz.

4. Revaluation of partnership assets to current values. The following entries will be prepared prior to the retirement of Diaz from the partnership:

5. Recording of bonus brought about by the retirement of a partner. a. Income Summary 60,000
Dy, Capital 24,000
6. Settlement of the interest of the retiring partner. David, Capital 24,000 12,000
Diaz. Capital 12,000 24,000
CALCULATION OF RETIRING PARTNER'S INTEREST Net income from Jun. l to June 30 24,000
divided in the ratio of 4:2:4
The interest of a retiring partner must be established upon retirement, as mentioned earlier. The
b. Dy, Capital 4,000
following are considered in the determination of such interest: investments, withdrawals, share
David, Capital 6,000
in profits and losses to the date of retirement, loans, advances and the revaluation of partnership
Diaz, Capital 2,000
assets to current values.
Dy, Drawing 4,000
David, Drawing 6,000
The following schedule will be helpful in determining the interest of a retiring partner:
Diaz, Drawing 2,000
Investments
After considering the preceding entries, the capital interest of the partners as of July 1, 2015 may
- Withdrawals
now be computed as follows:
+ Share in partnership profits to date of retirement or
Diaz Dy David
- Share in partnership losses to date of retirement
Capital balance, Dec. 31, 2014 P60,000 P20,000 P40,000
+ Loans and advances to the partnership or
Share in Profit from Jan. 1 – June 30 24,000 24,000 12,000
- Loans and advances from the partnership
Withdrawals ( 2,000) ( 4,000) ( 6,000)
+ Revaluation of assets increasing their recorded values or
Capital balance, July 1, 2015 P82,000 P40,000 P46,000
- Revaluation of assets decreasing their recorded values
Interest upon retirement
The entries to record the retirement of Diaz using several assumptions are illustrated below and
on the succeeding pages.

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Chapter 5 – Change in Capital Structure by Withdrawal, Retirement, Death or Incapacity of a Partner

Assumption 1 – Sale of interest to a new partner. Diaz sold his interest to Duque for P 100,000. Bonus Method

Diaz, Capital 82.000 Diaz, Capital 82,000

Duque, Capital 82,000 Cash 76,000
Dy, Capital 4,000
The gain of P18,000 (P100,000 - P82,000) is a personal gain of Diaz since the sale of the interest David, Capital 2,000
to an outsider is a personal transaction between the buying partner and Diaz. P6,000 x 4/6 = P4,000
P6,000 x 2/6 = P2,000
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 The bonus of P6,000 is shared by the remaining partners in accordance with their original profit
losses after the retirement of Diaz will be divided equally. and loss ratio of 4:2.

Diaz, Capital 82,000 Asset Revaluation Method

Dy, Capital 41,000
David, Capital 41,000 Dy, Capital 6,000
David, Capital 3,000
The loss of P7,000 (P75,000 – P82,000) is a personal loss of Diaz since the sale of the interest to Diaz, Capital 6,000
Dy and David is personal transaction among the partners. Other Assets 15,000

Assumption 3 - Sale of interest to the partnership. Diaz sold his interest to the partnership. The difference of P6,000 is only a portion of the asset revaluation. The total amount of asset
The partners agreed to make immediate cash settlement to the retiring partner. Profits and revaluation is calculated by dividing the difference of P6,000 by the retiring capital balances of
losses after the retirement of Diaz will be divided equally. the partners will be computed as follows:

Case A - Settlement to retiring partner is equal to his capital interest. The Dy = P15,000 x 4/10 = P6,000
partnership paid Diaz P82,000. David = P15,000 x 2/10 = P3,000
Diaz = P15,000 x 4/10 =P6,000
Diaz, Capital 82.000
Cash 82,000 After the preceding entry, the capital balance of Diaz is P76,000 and payment to him will be
recorded as follows:
This settlement involves no bonus nor asset revaluation
Diaz, Capital 76,000
Case B – Settlement is less than the capital interest of the retiring partner (at less than book Cash 76,000
value). The partnership paid Diaz P76,000 which is P6,000 less than his capital interest of
P82,000. A compound entry may be made as follows:

The difference between the amount of payment and the capital interest of Diaz may now be Dy, Capital 6,000
considered as: David, Capital 3,000
Diaz, Capital 82,000
1. Bonus to the remaining partners (Bonus Method) Cash 76,000
Other Assets 15,000
2. Asset Revaluation reducing the capital accounts of all the partners
(Asset Revaluation Method) 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
The entries to record the retirement of Diaz using the two alternative solutions follow: of P82,000.

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Chapter 5 – Change in Capital Structure by Withdrawal, Retirement, Death or Incapacity of a Partner

The difference between the amount if payment and the capital interest of Diaz may now be Other Assets 7,500
considered as: Diaz, Capital 82,000
Cash 85,000
1. Bonus from the remaining partners (Bonus Method) Dy, Capital 3,000
2. Asset Revaluation increasing the capital accounts of all the partners David, Capital 1,500
(Asset Revaluation Method)
COMPARISON BETWEEN the BONUS AND ASSET REVALUATION METHOD
The entries to record the retirement of Diaz using the two alternative solutions follow:
The two methods discussed may offer different results as to capital balances of the remaining
Bonus Method 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
Diaz, Capital 82,000 under Assumption 3 – Case C, i.e., the payment to the retiring partners is more than his capital
Dy, Capital 2,000 interest. The schedule below shows the comparison between the bonus and the asset revaluation
David, Capital 1,000 method:
Cash 85,000 Assets Dy, David,
P3,000 x 4/6= P2,000 Revaluation Capital Capital
P3,000 x 2/6 = P1,000 Balances after retirement of Diaz under the
bonus method P 38,000 P 45,000
The bonus of P3,000 is shared by the remaining partners in accordance with their original profit Balances after retirement of Diaz under the asset
and loss ration of 4:2. revaluation method P 7,500 P 43,000 P 47,500
Depreciation on asset revaluation (divided equally) (7,500) (3,750) (3,750)
Asset Revaluation Method Balances after depreciation P 39,250 P 43,750
Net advantage (disadvantage) of using the
Other Assets 7,500 bonus method (P 1,250) P 1,250
Dy, Capital 3,000
David, Capital 1,500 Based on the above analysis, David will prefer the bonus method while Dy will prefer the asset
Diaz, Capital 3,000 revaluation method.

The difference of P3,000 is only a portion of the asset revaluation of the partnership. The total CHANGE IN CAPITAL STRUCTURE BY DEATH OR INCAPICITY OF A
amount of asset revaluation is calculated by dividing of P3,000 by the retiring partner’s fraction
of interest or P3,000 ÷ 4/10 = P7,500. Thus, the increase in the capital balances of the partners PARTNER
will be computed as follows:
The death or incapacity of a partner legally dissolves the old partnership since a partner ceases
Dy = P7,500 x 4/10 = P3,000 to associated in the carrying of the business. The remaining partners may continue operations
David = P7,500 x 2/10 = P1,500 based on a new contract or Articles of Co-Partnership. The interest of the deceased OI
Diaz = P7,500 x 4/10 = P3,000 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
After the entry recording the asset revaluation, the capital balance of Diaz is P85,000 and settlement, the legal representative of' the deceased is considered. as an ordinary creditor and is
payment to him will be recorded as follows: to receive an amount equal to the interest and profits attributable to this interest.
Diaz, Capital 85,000
Cash 85,000 The following accounting problems are encountered in case of death or incapacity of a
Partner:
A compound entry may be made as follows:

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Chapter 5 – Change in Capital Structure by Withdrawal, Retirement, Death or Incapacity of a Partner

1. Determination of the profit or loss from the beginning of the accounting period to the date
of death or incapacity and the distribution of such profit or loss.
2. Closing of the books of the partnership. Partnership agreement, however, may provide that
the books need not be closed and net income for the fraction of the accounting period to the
date of death or incapacity be determined.
3. Correction of prior year's income, if there is any.
retirement of a partner. Thus, the capital interest of the partner up to the date of his
incapacity or death should be established. Settlement is then made to the heirs of the partner
or to the legal representatives at an amount that may be equal to the partner’s capital
interest, at more than the capital interest, or at less than the capital interest. When the
settlement is not equal to the deceased or incapacitated partner’s capital interest, the
difference is accounted for under any of the following methods: (1) bonus method; or (2)
asset revaluation method.

4. Revaluation of partnership assets to arrive at current values.

GLOSSARY of ACCOUNTING TERMINOLOGIES
5. Recording of bonus.

6. Settlement of the interest of the deceased or incapacitated partner.
The above problems are similar to those of withdrawal or retirement of a partner. Thus,
accounting for settlement to the deceased or incapacitated partner is the same as that of
withdrawal or retirement.
REVIEW of the LEARNING OBJECTIVES
1. Discuss and understand the accounting procedures in recording the retirement or
withdrawal of a partner by sale of interest to a new partner or to the continuing or
remaining partners. A retiring partner may sell his interest to a new partner or to the
remaining partners. The sale of interest is a personal transaction between or among the
partners and any indicated gain or loss is a personal gain or loss of the retiring partner.
However, before recording the sale, the capital interest of the retiring partner should be
updated. The sale is then recorded by transferring the capital interest of the retiring partner
to the acquiring partner.
Bonus method – a case in retirement or death of a partner wherein the excess of amount paid
over the capital interest of the retiring or deceased partner is recorded as at decrease in the
capital balances of the remaining partners (bonus to retiring or deceased partner from the
remaining partners), the excess of the retiring or deceased partner’s capital interest over the
amount paid to him is recorded as an increase in the capital balances of the remaining partners
(bonus to the remaining partners from the retiring or deceased
partner).
Retired or deceased partner's interest – the capital interest of the partner on date of retirement
or death. It is determined share in profits and losses withdrawals, revaluation of partnership
assets to current values. death, loans, advances and the
Asset revaluation method – the asset revaluation is recorded prior to recoding the settlement
with the retiring or deceased partner. The asset revaluation is determined by dividing the
difference between the retiring or deceased partner’s capital interest and the amount of
settlement by his profit and loss sharing ratio.

2. Discuss and understand the accounting procedure in recording the retirement or

withdrawal of a partner by sale of interest to the partnership. The retiring partner may
sell his capital interest to the partnership, which then pays the former either in cash or in
the form of noncash assets. The capital interest of the retiring partner should be established
on the date of his retirement. The partnership may p ay him an amount that is equal to his
capital interest, at more than his capital interest, the difference may be accounted under
any of the following methods: (1) bonus method (either to the retiring partner or to the
remaining partners); or (2) asset revaluation accruing to all the partners.

3. Discuss and understand the accounting procedures in recoding the dissolution of a

partnership due to death or incapacity of a partner. The dissolution of a partnership due to
death or incapacity of a partner is accounted for in almost the same manner as in the

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 Chapter 6 – Partnership Liquidation (Lump-Sum)

DISSOLUTION WITH LIQUIDATION

CHAPTER 6
A partnership liquidated when its business operations are completely terminated or ended.
PARTNERSHIP LIQUIDATION (LUMP-SUM) 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.
LEARNING OBJECTIVES Partnership dissolution with liquidation may be caused by any of the following factors:

1. Define Partnership liquidation and identify its causes. 1. The accomplishment of the purpose for which the partnership was organized.
2. Discuss the various problems encountered in partnership liquidation. 2. The termination of the term/period covered by the partnership contract.
3. Identify and differentiate the two types of partnership liquidation.
3. The bankruptcy of the firm.
4. Discuss and understand the accounting procedures under lump-sum liquidation
4. The mutual agreement among the partners to close the business

PREVIEW OF THE CHAPTER Accounting problems involved in the liquidation of a partnership include:

PARTNERSHIP 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.
LIQUIDATION
2. Closing of the partnership books;

3. Correction of accounting errors in prior periods like overstatement or understatement

of inventories, excessive depreciation charges, and failure to provide adequately for
Nature of Partnership Accounting Procedures in
doubtful accounts; and
Liquidation Lump-Sum Liquidation
In partnership liquidation, the assets and liabilities of the partnership are directly intertwined
• Definition • Realization with those of the individual partners' personal assets and liabilities because of the unlimited
• Causes if liquidation • Distribution of gain or loss on liability of each partner. The priorities for creditors' claims against the assets available to pay the
• Accounting problems in realization partnership liabilities involve two concepts: the marshaling of assets and the right of offset.
partnership liquidation • Payment to creditors
Marshaling of assets involves the order of creditors' rights against the partnership's assets and
• Types of liquidation • Distribution of cash to partners
the personal assets of the individual partners. The order in which claims against the
• Lump-Sum partnership's assets will be marshaled is as follows:
• Installment (piece-meal)
1. partnership creditors other than partners,
2. partners' claims other than capital and profits, such as loans payable and accrued
interest payable; and
INTRODUCTION
3. partners' claim to capital or profits, to the extent credit balances in capital accounts.
Dissolution of a partnership does not mean the formal termination of a business. Dissolution of
The order of claims against the personal assets of the individual partners is as follows:
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
1. personal creditors of individual partners, and
discussed in this chapter. Here, the association of the partners for purposes of carrying activities
2. partnership creditors on unpaid partnership liabilities regardless of a partner's capital
in the usual manner is considered ended. Partners can only engage in activities lending to final
balance in the partnership.
settlement of business affairs.

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Chapter 6 – Partnership Liquidation (Lump-Sum)
Right of offset involves offsetting a deficit in a partner’s capital (debit balance in the capital
account of a partner) against the loan payable to that partner. The loan payable to a partner has
a higher priority in liquidation than a partner's capital balance but a lower priority than liabilities
to outside creditors.
DEFINITION OF TERMS
Dissolution – the termination of a partnership as a going concern; it is the termination of the life
of a partnership.
Winding up – the process of settling the business or partnership affairs, it is synonymous to
liquidation.
Termination - the point in time when all partnership affairs are ended.
Liquidation - the interval of time between dissolution and termination of partnership affairs; it
is also the process of winding up a business which normally consists of conversion of assets into
cash, payment of liabilities and distribution of remaining cash among the partners.
Realization -the process of converting non-cash assets into cash.
Gain on realization - the excess of the selling price over the cost book value of the assets
disposed or sold through realization.
Loss on realization - the excess of the cost or book value over the selling price of the assets
disposed or sold through realization.
Capital deficiency - the excess of a partner's share on losses over his capital.
Deficient partner - a partner with a debit balance in his capital account after receiving his share
on the loss on realization.
Right of offset - the legal right to apply part or all of the amount owing to a partner on a loan
balance against deficiency in his capital account resulting from losses in the process liquidation.
Partner’s interest – the sum of a partner’s capital, loan balance and advances to the partnership.
TYPES OF LIQUIDATION
1. Lump-sum liquidation or liquidation by totals. This is a type of liquidation whereby the
distribution of cash to the partners is done only after all the non-cash assets have been
realized, the total amount of gain or loss on realization is known, and ll liabilities have been
paid.
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2. Liquidations by installment or piece-meal liquidation. This is a type of liquidation
whereby assets are realized on a piecemeal basis and cash is distributed to partners on a
periodic basis as it becomes available, that is, even before all non-assets are converted into
cash.
PROCEDURES IN LUMP-SUM LIQUIDATION
When a partnership is to be liquidated, the books should be adjusted and balances of nominal
accounts are closed. The resulting profit or loss for the period is transferred to the partners’
capital account. Advances and withdrawals are closed to capital accounts since cash settlement
shall be based on the partners’ capital account balances. The partnership is then ready to proceed
with liquidation as follows:
1. Sale of non-cash assets and distribution or allocation of gain or loss on realization among
the partners according to their residual profit and loss ratios (salary and interest factors
disregarded) unless liquidation ratios are specified in the partnership agreement.
2. Distribution of cash to creditors and partners. In this procedure, the provisions of the
marshaling of assets and the exercise of the right of offset are applied.
Liquidation expenses may be incurred to facilitate the immediate realization of non-cash assets.
Payment of liquidation expenses reduces cash and is recorded as a deduction from partners’
capital based on the partner’s profit and loss ratios.
When realization of assets in the course of liquidation results in a loss, the loss is carried to the
capital accounts of the partners as a deduction. If a partner’s capital account results in a debit
balance (known as capital deficiency), after the distribution of loss on realization, such can be
offset against any loan balance of the partner to the partnership. The amount to be offset shall be
the lower of the amount of the loan or the amount of the deficiency.
Cash can be distributed to partners before or after the elimination of the deficiency. If cash is
distributed after the elimination of the deficiency,
1. Capital deficiency is eliminated by
a. Making additional cash investment, if the deficient partner is solvent.
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.
Chapter 6 – Partnership Liquidation (Lump-Sum)

If cash is distributed to partners before eliminating the deficiency: Case (1) The other assets were sold for P140,000.

1. Cash available for distribution is paid to partners based on an accompanying schedule (2) The other assets were sold for P100,000.
to determine amounts to be paid to partners.
(3) The other assets were sold for P74,000.
2. Deficient partners may
(4) The other assets were sold for P68,000. Deficient partner was solvent.

(a) If solvent, make additional cash investment to be paid to partners as second cash (5) The other assets were sold for P68,000. Deficient partner was insolvent.
distribution, or the deficient partner may make direct cash settlement to the other
partners. (6) The other assets were sold for P68,000. Distribution of available cash is:
a. Before eliminating capital deficiency; and
(b) If insolvent, the deficiency shall be absorbed by the other partners as additional b. After eliminating capital deficiency
loss according to their profit and loss ratio.
Instructions:
The personal status of partners (that is, personal assets and personal liabilities) is sometimes 1. Prepare a statement of liquidation for each of the cases. For case 6, prepare also a
provided in the problem to indicate that a partner is solvent or insolvent. When personal assets schedule of cash distribution.
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. 2. Present journal entries to record the liquidation process.

STATEMENT OF LIQUIDATION
The statement of liquidation is a statement prepared to summarize the liquidation process. It is
the basis of the journal entries made to record liquidation. This statement presents in working
paper form the effect of the liquidation on the statement of financial position. It shows the
conversion of assets into cash, the allocation of gain or loss on realization, and the distribution of
cash to creditors and partners.
Illustrative Problem A:
Points of emphasis in the preparation of the statement of liquidation
1. Make sure that the balances before liquidation show equality of debits and credits. This will
always be true after each liquidation transaction.
2. Maintain two columns only for the debits. These are cash and other assets regardless of
whether the assets were given itemized like cash, receivables, inventory, supplies,
equipment, etc. Non-cash assets are classified as “other assets.”

Encina, Endrada, and Elina 3. Gain on realization increases capital while loss on realization decreases capital.
Statement of Financial Position
December 1, 2014 4. Figures in parenthesis for each liquidation transaction represent reduction in the account.

Assets Liabilities and Equity 5. Double rule when all columns are brought to zero balance.
Cash P 8,000 Liabilities P 44,800
Other Assets 136,000 Endrada, Loan 2,000
Elina, Loan 3,200
Encina, Capital 38,000
Endrada, Capital 224,000
Elina, Capital 32,000
P 144,000 Total Liabilities and Equity P 144,000

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Chapter 6 – Partnership Liquidation (Lump-Sum)

Case 1 – The other assets were sold for P140,000. (Gain on realization, no capital deficiency)

Encina, Endrada, and Elina

Statement of Liquidation
December 1 – 31, 2014

Loan
Other Capital
Cash Assets Liabilities Endrada Elina Encina Endrada Elina
Profit and loss ratio 2 (40%) 2 (40%) 1 (20%)
Balances before P 8,000 P 136,000 P 44,800 P 2,000 P 3,200 P 38,000 P 24,000 P 32,000
liquidation
Sales of assets and
distribution of gain 140,000 (136,000) 1,600 1,600 800
Balances P 148,000 - P 44,800 P 2,000 P 3,200 P 39,600 P 25,600 P 32,800
Payment of liabilities (44,800) (44,800)
Balances P 103,200 - - P 2,000 P 3,200 P 39,600 P 25,600 P 32,800
Payment to partners (103,200) - - (2,000) (3,200) (39,600) (25,600) (32,800)

The other assets with a book value of P136,000 were sold for P140,000 resulting in a P4,000 gain on realization distributed among the partners in their 2:2:1 ratio.

The entries to record the liquidation process are:

(c) Payment to partners
(a) Realization of assets and distribution of gain on realization, 2:2:1
Endrada, Loan 2,000
Cash 140,000 Elina, Loan 3,200
Other Assets 136,000 Encina, Capital 39,600
Encina, Capital (4,000 x 2/5) Endrada, Capital 25,600
Endrada, Capital (4,000 x 2/5) 1,600 Elina, Capital 32,800
Elina, Capital (4,000 x 1/5) 800 Cash 103,200

(b) Payment of liabilities

Liabilities 44,800
Cash 44,800

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Chapter 6 – Partnership Liquidation (Lump-Sum)

Case 2 – The other assets were sold for P100,000. (loss on realization, no capital deficiency)

Encina, Endrada, and Elina

Statement of Liquidation
December 1 – 31, 2014

Loan
Other Capital
Cash Assets Liabilities Endrada Elina Encina Endrada Elina
Profit and loss ratio 2 (40%) 2 (40%) 1 (20%)
Balances before P 8,000 P 136,000 P 44,800 P 2,000 P 3,200 P 38,000 P 24,000 P 32,000
liquidation
Sales of assets and
distribution of loss 100,000 (136,000) (14,400) (14,400) (7,200)
Balances P 108,000 - P 44,800 P 2,000 P 3,200 P 23,600 P 9,600 P 24,800
Payment of liabilities (44,800) (44,800)
Balances P 63,200 - - P 2,000 P 3,200 P 23,600 P 9,600 P 24,800
Payment to partners (63,200) - - (2,000) (3,200) (23,600) (9,600) (24,800)

The other assets with a book value of P136,000 were sold for P100,000 resulting in a loss on realization of P36,000 that can be fully absorbed by the capital balances of all the partners.

The entries to record the liquidation process are:

(a) Realization of assets and distribution of loss on realization, 2:2:1 (c) Payment to partners

Cash 100,000 Endrada, Loan 2,000

Encina, Capital (36,000 x 2/5) 14,400 Elina, Loan 3,200
Endrada, Capital (36,000 x 2/5) 14,400 Encina, Capital 23,600
Elina, Capital (36,000 x 1/5) 7,200 Endrada, Capital 9,600
Other Assets 136,000 Elina, Capital 24,800
Cash 63,200
(b) Payment of liabilities

Liabilities 44,800
Cash 44,800

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Chapter 6 – Partnership Liquidation (Lump-Sum)

Case 3 – The other assets were sold for P74,000. (Loss on realization, capital deficiency, right of offset)
Encina, Endrada, and Elina
Statement of Liquidation
December 1 – 31, 2014

Loan
Other Capital
Cash Assets Liabilities Endrada Elina Encina Endrada Elina
Profit and loss ratio 2 (40%) 2 (40%) 1 (20%)
Balances before P 8,000 P 136,000 P 44,800 P 2,000 P 3,200 P 38,000 P 24,000 P 32,000
liquidation
Sales of assets and
distribution of loss 74,000 (136,000) (24,800) (24,800) (12,400)
Balances P 82,000 - P 44,800 P 2,000 P 3,200 P 13,200 (P 800) P 19,600
Payment of liabilities (44,800) (44,800)
Balances P 37,200 - - P 2,000 P 3,200 P 13,200 (P 800) P 19,600
Offset of loan against the
debit balance in the ( 800) 800
capital of Endrada
Balances P 37,200 - - P 1,200 P 3,200 P 13,200 - P 19,600
Payment to partners (37,200) - - (1,200) (3,200) (13,200) - (19,600)

The other assets with a book value of P136,000 were sold for P74,000 resulting in a loss on realization of P62,000. The distribution of the loss on realization resulted in a debit balance in the
capital of Endrada. The right of offset can be exercised in as much as Endrada has a loan to the partnership.

The entries to record the liquidation process are:

(c) Offset of loan against capital deficiency
(a) Realization of assets and distribution of loss on realization, 2:2:1
Endrada, Loan 800
Cash 74,000 Endrada, Capital 800
Encina, Capital (62,000 x 2/5) 24,800
Endrada, Capital (62,000 x 2/5) 24,800 (d) Payment to partners
Elina, Capital (62,000 x 1/5) 12,400
Other Assets 136,000 Endrada, Loan 1,200
Elina, Loan 3,200
(b) Payment of liabilities Encina, Capital 13,200
Elina, Capital 19,600
Liabilities 44,800 Cash 37,200
Cash 44,800
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Chapter 6 – Partnership Liquidation (Lump-Sum)

Case 4 – The other assets were sold for P68,000. Deficient partner invests additional cash before cash distributions to partners. (Loss on realization, capital deficiency, deficient
partner is solvent)
Encina, Endrada, and Elina
Statement of Liquidation
December 1 – 31, 2014

Loan
Other Capital
Cash Assets Liabilities Endrada Elina Encina Endrada Elina
Profit and loss ratio 2 (40%) 2 (40%) 1 (20%)
Balances before P 8,000 P 136,000 P 44,800 P 2,000 P 3,200 P 38,000 P 24,000 P 32,000
liquidation
Sales of assets and
distribution of loss 68,000 (136,000) (27,200) (27,200) (13,600)
Balances P 76,000 - P 44,800 P 2,000 P 3,200 P 10,800 (P 3,200) P 18,400
Payment of liabilities (44,800) (44,800)
Balances P 31,200 - - P 2,000 P 3,200 P 10,800 (P 3,200) P 18,400
Offset of loan against the
debit balance in the ( 2,000) 2,000
capital of Endrada
Balances P 31,200 - - - P 3,200 P 10,800 (P 1,200) P 18,400
Additional investment
by Endrada 1,200 1,200
Balances P 32,400 - - - P 3,200 P 10,800 - P 18,400
Payment to partners (32,400) - - - (3,200) (10,800) - (18,400)

The other assets with a book value of P136,000 were sold for P68,000 resulting in a loss on realization of P68,000. The distribution of the loss on realization resulted in a debit balance in the
capital of Endrada that cannot be fully absorbed by his loan. The deficient partner cancels his deficiency by making additional cash investment. By doing so, the partnership will satisfy all its
liabilities including the other partner’s equities.

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Chapter 6 – Partnership Liquidation (Lump-Sum)

The entries to record the liquidation process are:

(a) Realization of assets and distribution of loss on realization, 2:2:1

Cash 68,000
Encina, Capital (68,000 x 2/5) 27,200
Endrada, Capital (68,000 x 2/5) 27,200
Elina, Capital (68,000 x 2/5) 13,600
Other Assets 136,00

(b) Payment of liabilities

Liabilities 44,800
Cash 44,800

(c) Offset of loan against capital deficiency

Endrada, Loan 2,000

Endrada, Capital 2,000

(d) Deficient partner who is solvent makes additional cash investment

Cash 1,200
Endrada, Capital 1,200

(e) Payment to partners

Elina, Loan 3,200

Encina, Capital 10,800
Elina, Capital 18,400
Cash 32,400

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Chapter 6 – Partnership Liquidation (Lump-Sum)

Case 5 – The other assets were sold for P68,000. Deficient partner is insolvent and his deficiency is shared by the other [artners before cash distribution. (Loss on realization, capital
deficiency, right of offset, deficient partner is insolvent)
Encina, Endrada, and Elina
Statement of Liquidation
December 1 – 31, 2014

Loan
Other Capital
Cash Assets Liabilities Endrada Elina Encina Endrada Elina
Profit and loss ratio 2 (40%) 2 (40%) 1 (20%)
Balances before P 8,000 P 136,000 P 44,800 P 2,000 P 3,200 P 38,000 P 24,000 P 32,000
liquidation
Sales of assets and
distribution of loss 68,000 (136,000) (27,200) (27,200) (13,600)
Balances P 76,000 - P 44,800 P 2,000 P 3,200 P 10,800 (P 3,200) P 18,400
Payment of liabilities (44,800) (44,800)
Balances P 31,200 - - P 2,000 P 3,200 P 10,800 (P 3,200) P 18,400
Offset of loan against the
debit balance in the ( 2,000) 2,000
capital of Endrada
Balances P 31,200 - - - P 3,200 P 10,800 (P 1,200) P 18,400
Additional loss to
partners for the
deficiency of Endrada
shared 2:1 (800) 1,200 (400)
Balances P 31,200 - - P 3,200 P 10,000 - P 18,000
Payment to partners (31,200) - - - (3,200) (10,000) - (18,000)

The distribution of the P68,000 loss on realization resulted in a debit balance in the capital account of Endrada that cannot bet fully absorbed by his loan. Failure od the deficient partner to
cancel his deficiency is to be regarded as additional loss, allocated to the remaining partners in their profit and loss ratio. Encina and Elina share on the deficiency of Endrada in the ratio 2:1. The
respective share on the deficiency is computed as follows:

Encina P1,200 x 2/3 = P800

Elina P1,200 x 1/3 = P400

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Chapter 6 – Partnership Liquidation (Lump-Sum)

The entries to record the liquidation process are:

(a) Realization of assets and distribution of loss on realization, 2:2:1

Cash 68,000
Encina, Capital (68,000 x 2/5) 27,200
Endrada, Capital (68,000 x 2/5) 27,200
Elina, Capital (68,000 x 1/5) 13,600
Other Assets 136,000

(b) Payment of liabilities

Liabilities 44,800
Cash 44,800

(c) Offset of loan against capital deficiency

Endrada, Loan 2,000

Endrada, Capital 2,000

(d) Capital deficiency of insolent partner absorbed as additional loss by remaining partners

Encina, Capital (1,200 x 2/3) 800

Elina, Capital (1,200 x 1/3) 400
Endrada, Capital 1,200

(e) Payment to partners

Elina, Loan 3,200

Encina, Capital 10,000
Elina, Capital 18,000
Cash 31,200

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Chapter 6 – Partnership Liquidation (Lump-Sum)

Case 6 – The other assets were sold for P68,000. Additional cash investment by deficient partner is to be made as second cash distribution partners. All available cash is immediately
distributed to partners requiring a schedule to accompany the statement of liquidation in order to determine amounts to be paid to partners. (Loss on realization, capital deficiency,
right of offset, and cash distributions)
Encina, Endrada, and Elina
Statement of Liquidation
December 1 – 31, 2014

Loan
Other Capital
Cash Assets Liabilities Endrada Elina Encina Endrada Elina
Profit and loss ratio 2 (40%) 2 (40%) 1 (20%)
Balances before P 8,000 P 136,000 P 44,800 P 2,000 P 3,200 P 38,000 P 24,000 P 32,000
liquidation
Sales of assets and
distribution of loss 68,000 (136,000) (27,200) (27,200) (13,600)
Balances P 76,000 - P 44,800 P 2,000 P 3,200 P 10,800 (P 3,200) P 18,400
Payment of liabilities (44,800) (44,800)
Balances P 31,200 - - P 2,000 P 3,200 P 10,800 (P 3,200) P 18,400
Offset of loan against the
debit balance in the ( 2,000) 2,000
capital of Endrada
Balances P 31,200 - - - P 3,200 P 10,800 (P 1,200) P 18,400
Payments to partners
per schedule (31,200) (3,200) (10,000) (18,000)

Balances - - - - - P 800 (P 1,200) P 400

Additional investment
of Endrada 1,200 1,200
Balances P 1,200 - - - - P 800 - P 400
Payment to partners (1,200) - - - - (800) - (400)

The Schedule to Accompany the Statement of Liquidation shows amounts to be paid to partners. Total partners’ interest is reduced by the restricted interest for possible losses in case the
deficient partner fails to pay his deficiency. Restricted interest for possible losses shall continue up to the point when deficiencies or debit balances in capital are eliminated. When deficiencies
are eliminated. When deficiencies are eliminated, balances shall be called Free Interest – Amounts to be Paid to Partners, to apply first on loan, then on capital.

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Chapter 6 – Partnership Liquidation (Lump-Sum)
(d) First cash distribution to partners, per schedule
Encina, Endrada and Elima
Schedule to Accompany Statement of Liquidation Elina, Loan 3,200
December 1 -31, 2014 Eneina, Capital 10,000
Elina, Capital 18,000
Encina Endrada Elina Cash 31,200

Capital balances before cash distribution P10,800 (P1,200) P18,400 (e) Additional cash investment from deficient solvent partner
Add loan balance 3,200
Total partners’ interest P10,800 (P1,200) P21,600 Cash 1,200
Restricted interest – possible loss of Endrada, Capital 1,200
P1,200 to Encina and Elina in the ratio
of 2:1 if Endrana fails to pay his (f) Second cash distribution to parners
deficiency (800) 1,200 (400)
Free Interest – amounts to be paid to Encina, Capital 800
partners P10,000 - P21,200 Elina, Capital 400
Payment to apply on: Cash 1,200
Loan P 3,200
Capital P10,000 18,000 If the deficient partner makes direct cash settlement to partners, the entry is:
Cash distribution P10,000 P21,200
(e) Encina, Capital 800
Elina, Capital 400
Endrada, Capital 1,200
The entries to record the liquidation process are:

(a) Realization of assets and distribution of loss on realization, 2:2:1 CALCULATION OF CASH SETTLEMENT WITHOUT THE AID OF A
STATEMENT OF LIQUIDATION
Cash 68,000
Encina, Capital (68,000 x 2/5) 27,200
Endrada, Capital (68,000 x 2/5) 27,200 Usually, liquidation problems do not require the preparation of a statement of liquidation but
Elina, Capital (68,000 x 1/5) 13,600 calls only for the calculation of cash settlement to partners. In such cases, however, non-cash
Other Assets 136,000 assets have already been converted into cash, liabilities have been settles but capital remain as
to their balances before liquidation since the gain or loss on realization of non-cash assets has
(b) Payment of liabilities not yet been carries to capital. Any difference, therefore, between the debits (available cash to
partners) and total credits (loans and capitals) is a gain or loss on realization that must first be
Liabilities 44,800 carried to capital before proceeding with the liquidation process.
Cash 44,800
Illustrative Problem B:
(c) Offset of loan against capital deficiency
At December 31, 2014, the capital balances of the partners Ebora, Esteban, and Echavez are
Endrada, Loan 2,000 P160,000; P100,000; and P20,000; respectively, sharing profits and losses in the ratio 3:2:1. The
Endrada, Capital 2,000 partners decided to liquidate, and sold all the non-cash assets for P148,000 cash. After paying all
the liabilities amounting to P48,000, they still have P112,000 cash left for distribution.

The loss on realization is the excess of the credits (total capital) over the debits )cash left for
distribution).
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Chapter 6 – Partnership Liquidation (Lump-Sum)
liquidation (piecemeal liquidation). Under lump-sum liquidation, distribution of cash to the
Total capital (P160,000 + P100,000 + P20,000) P 280,000 partners is done only after realization of all non-cash assets, distribution of gain or loss on
Less Cash left for distributions t partners 112,000 realization and payment of partnership liabilities. Under installment liquidation, asset
Loss on realization of assets P 168,000 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.
Cash settlement to partners is computed as follows:
4. Discuss and understand the accounting procedures under lump-sum liquidation. Lump-
Ebore Esteban Ecahvez 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
Capital balances before liquidation P 160,000 P 100,000 P 20,000 according to their liquidation ratio, if there is any, or according to their residual profit and
Loss on realization shared in the loss ratio; 93) payment of liabilities to outside creditors; and (4) distribution of cash to
ration of 3:2:1 (84,000) (56,000) (28,000) partners.
Balances P 76,000 P 44,000 (P 8,000)
Additional loss to Ebora and
Esteban for the deficiency of ( 4,800 ( 3,200) 8,000 GLOSSARY of ACCOUNTING TERMINOLOGIES
Echavez shared in the ratio of 3:2
Cash settlement P 71,200 P 40,800
Capital deficiency – the excess of a partner’s share pf losses over his capital credit balance.
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: Deficient partner – a partner with a debit balance in his capital account after receiving his share
on the loss on realization.
1. The additional cash investment by deficient solvent partners.
Insolvent partner – a partner whose personal assets are less than his personal liabilities.
2. Direct collection by the partnership creditors from any one of the partners and the latter
making cash settlement among themselves. Free interest – a partner’s capital interest that is available for cash payment.

Liquidation – the winding up of the business affairs of a partnership.

REVIEW of the LEARNING OBJECTIVES
Realization – the process of converting non-cash assets into cash.

1. Define partnership liquidation and identify its causes. Partnership liquidation is the Restricted interest – a portion of a partner’s capital account balance that is restricted for
winding up of the business affairs of a partnership; hence the business operation is possible losses on liquidation. It is not, therefore, available for cash payment.
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 Right of offset – the legal right to apply all or part of a partner’s loan to the partnership against
term/period covered by the partnership contract; (3) bankruptcy of the partnership; and capital deficiency.
(4) mutual agreement among the partners to close the business.
Solvent partner – a partner whose personal assets are more than his personal liabilities.
2. Discuss the various problems encountered in partnership liquidation. The liquidation of
a partnership will give rise to the following problems: (1) determining partnership profit or
loss from the beginning of the accounting period to the date of liquidation and distributing
such profit or loss to the partners: (2) closing the partnership books; (3) correcting
accounting errors in prior periods; and (4) liquidating the business.

3. Identify and differentiate the two types of partnership liquidation. The two types of
partnership liquidation are lump-sum liquidation (liquidation by totals) and installment

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Chapter 6 – Partnership Liquidation (Lump-Sum)
MC 6-5 Using the information in MC 6-4, and assuming that any debit balance of partners’
MULTIPLE CHOICE capital is uncollectible, the share of El on P28,000 cash for distribution was
a. P17,800
b. P18,000
MC 6-1 Espina, Espinosa, Esteban, and Estrellita are partners, sharing earnings in the ratio of
c. P19,000
3:4:6:8. The balance of their capital accounts on December 31, 2014 are as follows:
d. P40,000
Espina P 1,000
Espinosa 25,000
MC 6-6 Esper, Elor, and Este, partners are in textile distribution business sharing profits and
Esteban 25,000
losses equally. On December 31, 2014, the partnership capital and partners’ drawings
Estrellita 9,000
are as follows:
P 60,000
Esper Elor Este Total
Capital P 100,000 P 80,000 P 300,000 P 480,000
The partners decided to liquidate, and they accordingly convert the non-cash assets
Drawings 60,000 40,000 20,000 120,000
into P23,200 of cash. After paying the liabilities amounting to P3,000, they have
P22,200 to divide. Assume that a debit balance in any of partner’s capital is
The partnership was unable to collect on trade receivables and was forced to liquidate.
uncollectible. The book value of the non-cash assets amounted to:
Operating profit in the year 2014 amounted to P72,000 which was all exhausted
a. P25,200
including the partnership assets. Unsettled creditors’ claim at December 31, 2014
b. P45,400
totaled P84,000. Elor and Este have substantial private resources but Esper has no
c. P61,000
personal assets. Loss o liquidation was
d. P63,000
a. P360,000
b. P432,000
MC 6-2 Using the information in MC 6-1, the share of Espinosa in the loss upon conversion of
c. P480,000
the non-cash assets into cash was
d. P516,000
a. P 5,400
b. P 7,200
MC 6-7 Using the information in MC 6-6, the final cash distribution to Este was
c. P37,800
a. P 78,000
d. P61,000
b. P 84,000
c. P 108,000
MC 6-3 Using the information in MC 6-1, how much did Esteban get when the P22,200 was
d. P 162,000
divided?
a. P 6,432
MC 6-8 Escano, Ender, and Evelo are in the process of liquidating their partnership and their
b. P 8,320
account balances as of October 1, 2014 are as follows:
c. P10,000
Debit Credit
d. P14,200
Cash P 30,000
Non-cash Assets 70,000
MC 6-4 As of December 31, 2014, the books of 3E Partnership showed capital balances of E1 –
Ender, Loan P 14,000
P40,000; E2 – P25,000; E3 – {5,000. The partners’ profits and loss ratio was 3:2:1
Escano, Capital 10,000
respectively. The partners decided to dissolve and liquidate. They sold all the non-cash
Ender, Capital 35,000
assets for P37,000 cash. After settlement of all liabilities amounting to P12,000, they
Evelo, Capital 41,000
still have P28,000 cash left for distribution. The loss on realization of the non-cash
assets was:
The profit and loss sharing ratio has been 4:3:3 between Escano, Ender, and Evelo,
a. P28,000
respectively. Assuming that the partnership realized P30,000 from the sale of the non-
b. P40,000
cash assets and that any deficiency is uncollectible, Ender must receive.
c. P42,000
a. P19.000 c. P 37,000
d. P45,000
b. P34,000 d. P 49,000

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Chapter 6 – Partnership Liquidation (Lump-Sum)
Assets Liabilities and Capital
MC 6-9 Using the information in MC 6-8 and assuming Escano had personal assets of P50,000 Cash P 90,000 Liabilities P 265,000
and personal liabilities of P45,000 and that the partnership realized P25,000 from the Other Assets 400,000 Elmer, loan 25,000
sale of its non-cash assets, Evelo must receive: Esmer, Capital 50,000
Estrel, Capital 50,000
a. P25,000
Ellea, Capital 50,000
b. P26,000 Elmer, Capital 50,000
c. P27,500
d. P41,000 Total Assets P 490,000 Total Liabilities & Capital P 490,000

MC 6-10 Using the information in MC 6*8 and for Escano to receive P12,000, the non-cash assets The personal status of partners on this date is determined to be as follows:
must be sold for
a. P10,000 Cash and cash value of Personal
b. P12,000 Partners personal assets liabilities
c. P30,000 Esmer P 250,000 P 150,000
d. P75,000 Estrel 100,000 150,000
Ellea 150,000 125,000
Elmer 200,000 250,000
MC 6-11 The following condensed statement of financial position is presented for the
partnership of Echo, Egay, and Elma, who share profits and losses in the ratio of 6:2:2, The other assets of the partnership are sold and realized P120,000. Additional
respectively. contributions by appropriate parties in meeting the claims of firm creditors were made.
The amount that will be paid to the personal creditors of Esmer would be
Assets Liabilities and Capital a. P150,000
Cash P 40,000 Liabilities P 70,000 b. P165,000
Other Assets 140,000 Echo, Capital 50,000 c. P222,500
Egay, Capital 50,000
d. P250,000
Elma, Capital 10,000

Total Assets P 180,000 Total Liabilities & Capital P 180,000 MC 6-14 Using the information in MC 6-13, the amount that will be paid to the personal creditors
of Estrel would be
MC 6-12 Using the information in MC 6-11 and assuming that the other assets are sold for a. P100,000
P80,000; profits are shared 2:2:6, respectively; and that any deficient partner is b. P142,000
insolvent, the amount to be received by Egay upon liquidation is c. P150,000
a. P19,500 d. P180,000
b. P25,000
c. P38,000 MC 6-15 Using the information in MC 6-13, the amount that will be paid to the personal creditors
d. P50,000 of Elmer would be
a. P200,000
MC 6-13 Esmer, Estrel, Ellea, and Elmer share profits in the ratio of 2:1:1. The partnership b. P217,500
cannot meet its obligations to creditors and dissolution is authorized on September 30, c. P235,000
2014. A statement of financial position for the partnership on this date shows balances d. P250,000
as follows:

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 Chapter 7 – Installment Liquidation
potential capital deficiencies are assumes uncollectible. In this sense, partners’ interests are
reduced by cash distribution to a balance proportionate to the partners’ profit and loss ratios.
CHAPTER 6 Succeeding cash distributions are then based on the profit and loss ratio.

INSTALLMENT LIQUIDATION The liquidation procedures shall be the same as in lump sum liquidation except that:

(1) Cash I distributed to partners even before fully realizing non-cash assets and
LEARNING OBJECTIVES determining total gain or loss on realization.

1. Explain the nature of installment liquidation. (2) Restricted interest, in the Accompanying Schedule to Determine Amounts to be Paid to
2. Discuss and understand the procedures followed under installment liquidation. Partners, shall consist of:
3. Prepare a Statement of Liquidation and the Accompanying Schedule Showing How Available Cash (a) Remaining unsold assets
is to be Distributed. (b) Cash withheld (for possible expenses)
4. Prepare a Cash Priority Program.
(c) Debit balances in capital

PREVIEW OF THE CHAPTER Illustrative Problem A:

INSTALLMENT The statement of financial position of the partnership of Arias, Buendia, and Caras on December
31, 2014, when the partners decide to liquidate follows:
LIQUIDATION
Assets
Cash P 200,000
Other Assets 500,000
Total Assets P 700,000
Installment Liquidation Statement of Liabilities and Capital
Procedures Liquidation Liabilities P 250,000
Aria, Loan 70,000
• Realization of assets on a • Schedule to accompany the Arias, Capital (30%) 200,000
piece-meal basis Statement of Liquidation Buendia, Capital (40%) 30,000
• Distribution of gain or loss on • Cash Priority Program Cara, Capital (30%) 150,000
realization • Loss absorption capacity Total Liabilitiesand Capital P 700,000
• Preparation of cash • Cash allocation Cash is realized on the other assets as follows, and amounts realized are distributed at the end of
distribution schedule each month to the appropriate parties.
• Distribution of available cash
Fiscal Year 2015 Asset Book Value Cash Proceeds
January P 300,000 P 260,000
NATURE OF INSTALLMENT LIQUIDATION February 200,000 230,000

Under the installment liquidation, non-cash assets are sold on a piece-meal basis over an Instructions:
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 (1) Prepare a statement of liquidation to summarize the course of liquidation. Provide
cash distributions are made before realizing all non-cash assets and the total gain or loss on schedules in support of monthly distributions.
realization is not yet determined, it is necessary that each cash distribution to partners be
considered as if it were the last. Remaining unsold assets, therefore, must be treated as a (2) Prepare the journal entries to record the liquidation
complete loss, assuming that nothing is realized on them. Also, debit balances in capital and
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Chapter 7 – Installment Liquidation

Arias, Buendia and Caras

Statement of Liquidation
January to February 2015

Cash Other Assets Liabilities Arias Loan Arias Buendia Caras

Profit and loss ratio (30%) (40%) 30%
Balances before liquidation P 200,000 P 500,000 P 250,000 P 70,000 P 200,000 P 30,000 P 150,000
January:
Sales of assets and
distribution of loss 260,000 (300,000) (12,000) (16,000) (12,000)
Balances P 460,000 P200,000 P 250,000 70,000 P 188,000 P 14,000 P 138,000
Payment of liabilities (250,000) (250,000)
Balances P210,000 P200,000 P 70,000 P 188,000 P 14,000 P 138,000
Payment to partners (per
schedule) (210,000) (70,000) (95,000) (45,000)
Balances P200,000 P 93,000 P 14,000 P 93,000
February:
Sale of assets &
distribution of gain P 230,000 (200,000) 9,000 12,000 9,000
Balances P 230,000 P 102,000 P 26,000 P 102,000
Payment to partners (230,000) (P 102,000) (26,000) (102,000)

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Chapter 7 – Installment Liquidation
Cash 210,000
Arias, Buendia, and Caras Partnership Payment to partners
Schedule to Accompany Statement of Liquidation
Amounts to be Paid to Partners February Cash 230,000
January 31, 2015 Other Assets 200,000
Arias, Capital 9,000
Arias Buendia Caras Buendia, Capital 12,000
(30%) (40%) (30%) Caras, Capital 9,000
Capital balances before cash distribution P 188,000 P 14,000 P 138,000 Sale of assets and distribution of gain
Add Loans 70,000
Total partners’ interest P 258,000 P 14,000 P 138,000 Arias, Capital 102,000
Restricted interest – possible loss of Buendia, Capital 26,000
P200,000 if nothing is realized on Caras, Capital 102,000
remaining unsold assets (60,000) (80,000) (60,000) Cash 230,000
Final payment to partners
P 198,000 (P66,000) P 78,000
Restricted interest – additional possible
loss of P66,000 to Arias and Caras if
Buendia is unable to pay his possibly PROGRAM OF CASH DISTRIBUTION
deficiency, shared in the ratio of 30:30 (33,000) 66,000 (33,000)
Free interest – payments to partners P 165,000 P 45,000 Partners may desire to determine in advances as to whom cash distributions shall be made as
Payment to apply on: cash may become available. This procedure requires the preparation of a program called Cash
Loan P 70,000 Priority Program, Cash Predistribution Plan or Program of Priorities. The program is
Capital 95,000 P 45,000 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
Total cash distributions P 165,000 P 45,000
of the schedule previously used to accompany the statement of liquidation. The steps in the
preparation of the program are the following:
Based on the schedule, the January payments to partners shall be made to partners Arias and
Caras which shall apply first on the loan and then on capital.
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.
Journal entries to record the liquidation:
2. Divide total partners’ interest by their profit and loss ratio to get each partner’s loss
January Cash 260,000
absorption capacity. The loss absorption capacity is the maximum amount of loss that a
Arias, Capital 12,000
partner may absorb and may eliminate any partner in any cash distribution. A partner,
Buendia, Capital 16,000
therefore, with the highest loss absorption balance has the first priority on cash
Caras, Capital 12,000
distributions.
Other Assets 300,000
Sale of assets and distributions of loss
3. Once the loss absorption balances are determined, allocations may now be made,
starting with Allocation I wherein the highest loss absorption balance is reduced to the
Liabilities 250,000
next highest. Each reduction in the loss absorption balance requires payment to partners
Cash 250,000
computed by multiplying the amount of reduction by the partner’s profit and loss ratio.
Payment to liabilities
4. After the partners’ loss absorption balances are made equal, cash distributions are made
Arias, Loan 70,000
in the profit and loss ratio.
Arias, Capital 95,000
Caras, Capital 45,000

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Chapter 7 – Installment Liquidation
Arias, Buendia, and Caras Partnership
Cash Priority Program
January 1, 2015

Payments to
Arias Buendia Caras Arias Caras
Buendia
Capital balances before liquidation P200,000 P30,000 P150,000
Add Loans 70,000
Total partners’ interest P270,000 P30,000 P150,000
Divided by the profit % loss ratio 30% 40% 30%
Loss absorption capacity P900,000 P75,000 P500,000
Allocation I: Cash to Arias reducing his
loss absorption balance to an amount
reported for Caras; reduction of P400, 000
requires payment of 30% x P400,000 (400,000) P120,000
P500,000 P75,000 P500,000
Allocation II: Cash to Arias and Caras to
reduce their loss absorption balances
to amount reported for Buendia; reduction of
P425,000 requires payments as follows:
To Arias, 30% x P425,000 (425,000) 127,500
To Caras, 30% x P425,000 (425,000) P127,500
P75,000 P75,000 P75,000 P247,500 - P127,500
Allocation III: Further cash distributions
Are to be made in the profit and loss ratio

A summary of the information provided by the cash priority program follows:

After fully satisfying liabilities:

1. The first P120,000 cash available to partners should be paid to Arias.

2. The next P255,000 should be paid to Arias and Caras in the ratio 30:30.

3. Amounts in excess of P375,000 should be paid to Arias, Buendia, and Caras in the profit and
loss ratio of 30:40:30.

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Chapter 7 – Installment Liquidation
Application of the cash priority program on the installment distribution upon liquidation of the REVIEW of the LEARNING OBJECTIVES
partnership of Arias, Buendia, and Caras shall be:
1. Explain the nature of installment liquidation. Under installment liquidation, the
Installment Distribution realization of non-cash assets takes place over an extended period of time. However, cash
January 31, 2015 realized is immediately distributed to creditors and partners even if there are still unsold
non-cash assets.
Amount Arias Buendia Caras
Cash Available P 210,000 2. Discuss and understand the procedures followed under installment liquidation. The
Allocation I – Payable to Arias 120,000 P120,000 procedures under installment liquidation are basically the same as those under lump-sum
Allocation II – Payable to Arias liquidation except that cash is distributed to partners, it is considered as if it were the last
And Caras, 30:30 P 90,000 45,000 P 45,000 so as to avoid any overpayment to any of the partners.
P 165,000 - P 45,000
3. Prepare a Statement of Liquidation and the Accompanying Schedule Showing How
Available Cash is to be Distributed. The statement of liquidation is basically similar to the
Installment Distribution one prepared under lump-sum liquidation except that it covers a longer period of time. In
February 28, 2015 addition, an accompanying schedule is prepared every time cash is distributed. Such
schedule shows how available cash is to be distributed to partners.
Amount Arias Buendia Caras
Cash available P 230,000 4. Prepare a Cash Priority Program. A cash priority program is a program prepared prior to
Allocation II – Balance liquidation so that partners may determine of the cash priority program follows these steps:
P255,000 – P90,000 payable (1) determining total partners’ interest; (2) determining partners’ loss absorption capacity;
to Arias and Caras, 30:30 165,000 P 82,500 P 82,500 (3) determining allocation of cash as it becomes available. When a cash priority program is
Allocation III – Payable to Arias, prepared, a schedule accompanying the statement of liquidation need not be prepared.
Buendia and Caras, 30:40:30 P 65,000 19,500 P 26,000 19,500
P 102,000 P 26,000 P 102,000 GLOSSARY of ACCOUNTING TERMINOLOGIES

Key Points. The same amount of cash distributions per accompanying schedule to the statement
Installment liquidation – realization of non-cash assets on a piece-meal basis.
of liquidation were arrived at in January and February. Also, when cash available for distribution
is not sufficient to cover an allocation, the partners, share such insufficient cash on the basis of
Partner’s loss absorption capacity – the maximum amount of loss that a partner may absorb
their profit and loss ratio.
without incurring capital deficiency.
There may be instances wherein in the gain or loss related to the sale of individual assets during
the course of liquidation is difficult to determine. In such cases, no gain or loss is recognized on
realization and cash is recorded equal in amount to the book value of the assets sold. The total
gain or loss on realization is recognized in the final realization of assets and it is the difference
between the cash realized and the book value of the remaining assets sold. Such gain or loss then
carries to capital.

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 Chapter 8 - Organization and Formation of a Corporation
DEFINITION OF A CORPORATION
CHAPTER 8
A corporation is an artificial being created by operation of law, having the right of succession and
the powers, attributes and properties expressly authorized by law or incident to its existence.
ORGANIZATION AND FORMATION (Section 1, Corporation Code of the Philippines.)

OF A CORPORATION CHARACTERISTICS OF A CORPORATION

LEARNING OBJECTIVES 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
1. Define a corporation and identify its characteristics. corporate name, take, hold or convey property to the extent allowed by law, enter into
2. Identify and discuss the advantages and disadvantages of a corporate form of organization. contracts, and sue or be sued.
3. Identify and discuss the various classes of corporation.
4. Identify the components of a corporation and the steps in organizing it. 2. Created by operation of law. A corporation is generally created by operation of law. The
5. Identify the different types of records that are maintained by a corporation.
mere agreement of the parties cannot give rise to a corporation.
6. Identify and differentiate the two classes of share capital (capital stock) in exchange for various
considerations.
3. Right of succession. A corporation has the right of succession. Irrespective of the death,
7. Identify the measurement bases in the issuance of share capital (capital stock) in exchange for
withdrawal, insolvency, or incapacity of the individual members or shareholders, and
various considerations.
8. Record transactions relating to issuance of share capital using the memorandum entry method
regardless of the transfer of their interest or share capital, a corporation can continue its
and the journal entry method. existence up to the period of time stated in the articles of incorporation but not exceed fifty
years.
PREVIEW OF THE CHAPTER
4. Powers, attributes, properties authorized by law. A corporation has only the powers,
CORPORATION 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.

Nature of a
Corporation
• Characteristics
• Advantages
• Disadvantages
• Classes of corporation
• Components of a
corporation
• Steps in organizing a
corporation
• Rights of a stockholder
• Corporate records
Classes of Share Capital Issuance of Share 5. Ownership divided into shares. Proprietorship in a corporation is divided into units
• Ordinary share capital Capital known as share capital. The buyers of this share capital are called shareholders or
(common) • Methods of recording stockholders and are considered owners of the business.
• Preference share capital • Memo entry
(preferred) 6. Board of directors. Management of the business is vested in a board of directors elected by
• Journal entry
• Cumulative the shareholders. The board of directors is the governing body or decision-making body of
• Considerations in
• Noncumulative the corporation. The Corporation Law provides that the number of directors be not less than
exchange for share
five but not more than fifteen.
• Participating capital
• Nonparticipating • Cash
• Convertible • Non-cash assets ADVANTAGES OF A CORPORATION
• Redeemable • Services
• Par value share capital • Share capital
1. The corporation enjoys continuous existence because of its power of succession.
• Stated share value share subscription
capital • Subscription
2. The corporation has the ability to obtain a strong credit line because of continuity of
• No-par, no stated value share default
existence.
capital

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Chapter 8 - Organization and Formation of a Corporation
b. Non-stock corporation – a private corporation in which capital comes from fees paid
by individuals composing it. The owners of non-stock corporation are called members.
3. Large scale business undertakings are made possible because many individuals can invest
their funds in the enterprise. 2. As to Purpose
a. Public corporation – a corporation that is organized to govern a portion of the state
4. The liability of its Investors or shareholders is limited to the extent of their investment in (e.g. municipalities, provinces) .
the corporation.
b. Private corporation – a corporation that is organized for a private benefit, aims on end.
5. The transfer of shares can be effected without the need for prior consent of other
shareholders. 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
6. Its smooth operation is guaranteed because of centralized management. corporations such as MERALCO and PLDT.

3. As to Compliance of Law
DISADVANTAGES OF A CORPORATION a. De jure corporation – a corporation which exists in both law and fact. It exists in law
because it has complied with all the legal requirements; it exists in facts because it
actually operates as a corporation.
1. It is not easy to organize because of complicated legal requirements and high costs in its
organization. b. De facto corporation – a corporation which only exists only in fact but not in law. It
does not exist in law because of non-compliance with certain legal requirements.
2. The limited liability of its shareholders may weaken its credit capacity.
4. As to Law of Creation
3. It is subject to rigid governmental control. a. Domestic corporation – a corporation that is organized under Philippine laws.

b. Foreign corporation – a corporation that is organized under the laws of other

4. It is subject to more taxes.
countries.
5. Its centralized management restricts a more active participation by shareholders in the
5. As to Extent of Membership
conduct of corporate affairs.
a. Open corporation – a corporation whose ownership is widely held by many investors,
usually a private stock corporation.
CLASSES OF CORPORATION b. Closely-held corporation or family corporation – a private corporation in which 50%
or more of its stock owned by five (5) persons or less.
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- Other types of corporations include parent or holding corporations, subsidiary corporations,
oriented corporations are open, private and stock corporations. Nonprofit corporations are ecclesiastical corporations and lay corporations which are themselves classified into other
public and private non-stock corporations. groups.
The following is a list of the common classes of corporations:
COMPONENTS OF A CORPORATION
1. As to Membership Holdings
1. Incorporators – they are the persons who originally formed the corporation and whose
a. Stock corporation – a private corporation in which the capital is divided into shares of
names appear in the Articles of Incorporation, They must be natural persons as
stock and is authorized to distribute corporate earnings to holders on the basis of
distinguished from artificial persons.
shares held. The owners of a stock corporation are called stockholders or shareholders.

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Chapter 8 - Organization and Formation of a Corporation
Costs incurred during incorporation, such as filing fees, cost of printing stock certificates,
2. Corporators – they are the persons who compose the corporation whether as shareholders promoters' commission and legal fees, are known as organization costs or pre-operating costs.
or members. Under PAS 38 Intangible Assets, organization or pre-operating costs are charged to expense in
the period incurred.
3. Stockholders or shareholders – they are the corporators of a stock corporation.
ARTICLES OF INCORPORATION
4. Members – they are the corporators of a non-stock corporation.
The Articles of Incorporation enumerate the powers and limitations conferred upon the
5. Promoters – they are the persons who undertake to (a) form a company based on a given corporation by the government. It includes the following information:
project, (b) set it going, and (c) take the necessary steps to accomplish the purpose for which
the corporation is organized. 1. the name of the corporation;
2. the purpose or purposes for which the corporation is formed;
6. Subscribers – they are the persons who have agreed to take the original, unissued shares 3. the place of the principal office of the corporation;
but will pay at a later date. They may be incorporators or not and they may eventually 4. the term of existence of the corporation. not exceeding fifty years;
become shareholders the moment the full payment of their subscriptions is made. 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
7. Underwriters – they are those who undertake to dispose of the shares to the general public. 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 par value per
ORGANIZING A CORPORATION share, if there is any;
8. the amount of subscriptions to the share capital (capital stock), the names of the subscribers
The process of organizing a corporation generally consists of three stages which normally and the number of shares subscribed by each; and
require the aid of legal, competent advisers. These three stages are discussed below. 9. the total amount paid on the subscriptions to the share capital (capital stock) and the
amount paid by each subscriber on his subscription.
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. BY-LAWS
2. Incorporation – the process of formalizing the organization of the corporation. This stage The by-laws of the corporation supplement the articles of incorporation. It contains provisions
includes: for the internal administration of the corporation. The corporate by-laws normally include the
a. Drafting of the articles of incorporation which must be duly executed and following:
acknowledged before a notary-public.
1. the date, place and manner of calling the annual shareholders` (stockholders') meeting;
b. Filing of the articles of incorporation with the Securities and Exchange Commission 2. the manner of conducting meetings;
(SEC) together with the statement showing that at least 25% of the total authorized 3. the circumstances which may permit the calling of special meetings of the shareholders;
share capital (also known as authorized capital stock) has been subscribed and that at 4. the manner of voting and the use of proxies;
least 25% of the total subscriptions have been paid. 5. the manner of electing the directors and the number of directors;
6. the term of office of the directors;
c. After the required fees have been paid and upon approval of the articles of 7. the authority and duties of the directors;
incorporation, the SEC issues a certificate of incorporation, the date of which being 8. the manner of selecting the corporate officers;
considered as the date of registration or incorporation. 9. the authority and responsibilities of the officers;
10. the procedure for amending the articles of incorporation; and
3. Commencement of the business – the business should start its operations within two 11. the procedure for amending the by-laws.
years from the date of incorporation. Failure to do so will automatically dissolve the
corporation without the need for a hearing.

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If a corporation issues both preference and ordinary share capital, the articles of incorporation
CORPORATE RECORDS 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
The corporation generally maintains the following records to keep track of its various
value, or without par and without stated value.
transactions:
A par value share capital has a nominal or face value stated on the face of the stock certificate
1. record of all business transactions (journals, ledgers, vouchers, and other supporting
and in the articles of incorporation.
documents).
2. minutes of all meetings of directors
A no-par but with stated value share capital has a nominal value stated in the articles of
3. minutes of all meetings of shareholders (stockholders).
incorporation but not on the face of the stock certificate.
4. Stock and transfer book
a. Shareholders’ (stockholders’) ledger – chronological and numerical record of
A no-par, no stated value share capital has no nominal value stated either in the articles of
stock certificates issued.
incorporation nor on the face of the stock certificate.
b. Shareholders’ *stockholders’) ledger – alphabetical record of individual
shareholders.
In our Corporation Code, a no-par share capital is to be issued for a consideration of not less than
c. Subscribers’ ledger – alphabetical record of individual subscribers.
five pesos (P5.00)
5. optional and supplementary records
PREFERENCE SHARE CAPITAL (PREFERRED STOCK)
SHARE CAPITAL (CAPITAL STOCK)
A preference share capital is generally issued with a par value and a dividend rate. The holders
of preference shares have priority as to distribution of dividends and as to distributions of assets
Share capital is also known as capital stock. It is the amount fixed by the corporate charter to be
in the event of corporate liquidation. However, this does not mean that the holders are assured
subscribed Land paid in or secured to be paid in by the shareholders of a corporation either in
of regular receipt of dividends; rather, this means that dividend requirements on preference
money or in property. labor or services upon the organization of the corporation or afterwards;
shares must first be met before any payment can be made to holders of ordinary shares.
and upon which it is to conduct its operations.
A corporation may issue more than one class of preferences shares. Generally, preference shares
CLASSES OF SHARE CAPITAL may be classified as follows:
A corporation may issue two classes of share capital. namely, ordinary share capital (common 1. Cumulative preference shares – entitle the holders to the receipt of previous years’ unpaid
stock) and preference share capital (preferred stock). When a single class of share capital is dividends (i.e., dividends in arrears) before any payment can be made to ordinary
issued, it is an ordinary share capital. Ordinary share capital entitles the holder to an equal or shareholders upon dividend declaration. This means that if dividend is not declared in a
pro-rata division of profits without any preference or advantage over any class of shares. particular year, the right to such dividend is not lost but carried forward to a subsequent
Preference share capital, on the other hand, entitles the holder to enjoy priority as to distribution year.
of dividends and distribution of assets upon corporate liquidation. Dividends are corporate
profits distributed to its shareholders. 2. Non-cumulative preference shares – entitles the holders to the receipt of current
dividends but not on the previous year’s unpaid dividends. This means that if dividend is
Unless otherwise stated in the contract, all shareholders have the same basic rights. not declared in a particular year, the right to such dividend is lost.
These rights are as follows:
1. to share in the distribution of corporate profit; 3. Participating preference share – entitle the holders to the receipt of additional dividend
2. to share in the distribution of assets upon corporate liquidation; after holders of both preference and ordinary shares have been paid up to the current year's
3. to vote in shareholders' meeting; and dividend. This means that the holders of preference shares have the right to share in extra
4. to maintain one’s ownership interest in the corporation through purchase of additional dividends.
shares when a new share capital is issued. This is known as the preemptive right.

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JOURNAL ENTRY METHOD
Participating preference shares may be fully participating or participating only up to a certain
amount or percentage.
Unissued XXX Share Capital xxx
Authorized XXX Share Capital xxx
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.
The total amount recorded is computed by multiplying authorize shares by the par or
stated value of the share capital. Thus, this method cannot be used if the share capital is
5. Convertible preference shares – entitle the holders the option to exchange the shares for
a no-par and no-stated value stock.
some other securities of the issuing corporation, normally ordinary shares.
The entry to record authorized share capital is made in the general journal ad is then posted to
6. Redeemable preference shares – entitle the issuing corporation the option to redeem or
the share capital account in the general ledger. If more than one class of share capital are issued,
call the shares at a certain call price.
a separate entry is made for each class of share capital and a separate account for each class in
maintained in the general ledger.
ORDINARY SHARE CAPITAL (COMMON STOCK)
The memorandum entry method enjoys popularity in use compared with the journal entry
An ordinary share capital or common stock represents residual ownership equity. The holders method. For problem solving purposes, the memorandum entry method will be used if there is
of this class of share capital carry the greatest risk, however, they ordinarily share in earnings to no specification as to which will be used.
the greatest extent if the corporation is successful. Although the right to vote is a basic right of
all shareholders, it is frequently given exclusively to ordinary shareholders as long as dividends Illustrative Problem A: The Joyful Company was organized on January 1, 1014 with authorized
are paid regularly to preference shareholders. share capital as follows:

AUTHORIZED SHARE CAPITAL
The maximum number of shares (both preference and ordinary shares) that a corporation may
issue is termed as authorized shares. The authorized share capital (authorized capital
stock) is determined by multiplying the authorized shares by the par or stated value of the share
capital.
A corporation cannot issue shares more than the authorized shares stated in the articles of
incorporation. However, it may increase its authorized and shares and authorized share capital
by amending its articles of incorporation
Authorized share capital may be recorded under the journal entry method or the memorandum
entry method. The entries under the two (2) methods to record authorized share capital are
presented below and on the next page,
10,000 shares of 10% preference share capital with par value of P100 per share
200,000 shares of ordinary share capital with a par value of P10 per share
The entries to record authorized share capital and the subsequent posting to the general ledger
under each method are illustrated below:
Case 1 – The memorandum entry method is use.
2014
Jan. 1 Authorized to issue 10,000 shared of 10% preference share capital with a par value of
P100 per share
1 Authorized to issue 200,000 shares of ordinary share capital with a par value of P10
per share.

The two entries are then posted to the accounts in the general ledger as follows:
MEMORANDUM ENTRY METHOD
10% Preference Share Capital Ordinary Share Capital
Authorized to issue xxx shares of xxx share capital with a par value of Pxxx. 2014 2014
Jan. 1 Authorized to issue 10,000 Jan. 1 Authorized to issues 200,000
shares, par value P100 shares, par value P10

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Case 2 – The journal entry method is used.
2014
Jan, 1 Unissued Preference Share Capital
Authorized Preference Share Capital
1 Unissued Ordinary Share Capital
Authorized Ordinary Share Capital
These entries are then posted to the accounts in the general ledger as follows:
Authorized Preference Share Capital
2014
Jan. 1 1,000,000
Unissued Preference Share Capital
2014
Jan. 1 1,000,000
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.
1,000,000
1,000,000
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
2,000,000
Capital or Unissued Share Capital is credited.
2,000,000
If the share capital is sold or issued above is par value. Cash is debited for the amount received,
Share Capital or Unissued Share Capital is credited at par value, and Share Premium or Paid-in
Capital in Excess of Par is credited for the excess of cash received over par value.
Authorized Ordinary Share Capital
2014
If the share capital is sold or issued below its par value. Cash is debited for the amount received.
Jan. 1 2,000,000
Share Capital or Unissued Share capital is credited at par value, and Discount on Share Capital is
debited for the excess of par value over the amount of cash received. Under the Corporation Code
of the Philippines, however, the original issuance of share capital at a discount is not allowed,
Therefore, problems involving discounts are used in the book for illustration purposes only
Unissued Ordinary Share Capital
2014
Illustrative Problem B: The Happy Corporation was organized on January 1, 2014 and is
Jan. 1 2,000,000
authorities to issue 100,000 shares of P10 par value ordinary shares. Subsequently, 25,000
shares were sold.

The entries to record the sale of shares under the two methods of recording share capital using
Posting to the accounts in the general ledger is very important so that the corporations will be
three independent cases are presented below and on the next page.
able to monitor shares issued and avoid the issuance of shares more than what is authorizes.

ISSUANCE OF SHARE CAPITAL MEMORANDUM ENTRY METHOD

A share capital may be issued in exchange for cash, non-cash assets, services, liability or other Case 1 – The issuance price is P10 (at par)
form of securities. It may be sold also on a subscription basis. A share capital issued to a
shareholder is called an outstanding share. The major issue on issuance of share capital is the Cash 250,000
basis for measurement of the transaction. The discussion of the measurement standards will be Ordinary Share Capital 250,000
based on the provisions of PRFS 2 Share-Based Payment and will be limited to issuance of share 25,000 sh x P10 = P250,000
capital to non-employees. The issuance of share capital to employees (such as share options and
share appreciation rights) will be discusses in financial accounting. Case 2 – the issuance price is P15 (above par)

A shareholders’ (stockholders’) ledger is used to maintain records affecting the shareholding of Cash 375,000
each shareholder such as transfer or sale of share capital. Shares issued to shareholder, on the Ordinary Share Capital 250,000
other hand, are recorded in the stock certificate book. Ordinary Share Premium 125,000
25,000 sh x P15 = P375,000
Share capital issued are recorded in the share capital account maintained for each class of share 25,000 sh x P10 = P250,000
capital. The discussions in the succeeding paragraphs are focused on the issuance of various 25,000 sh x P 5 = P125,000
classes of shares in exchange for various considerations.

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ISSUANCE IS EXCHANGE FOR NON-CASH ASSETS OR PROPERTY. When a share capital is issued
Case 3 – The issuance price is P8 (below par) 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
Cash 200,000 asset received cannot be estimated reliably, it will be recorded at the fair value of the share
Discount on Ordinary Share Capital 50,000 capital issued, also known as indirect measurement (PFRS 2, par. 10). The fair value of the asset
Ordinary Share Capital 250,000 received shall be determined at the date the entity received the asset (PFRS 2, par. 13)
25,000 sh x P 8 = P200,000
25,000 sh x P 10 = P250,000 Upon issuance of the stock, Share Capital or Unissued Share Capital is credited at pat value. The
25,000 sh x P 2 = P 50,000 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,
JOURNAL ENTRY METHOD original issuance of share capital at less than its par value is prohibited under our Corporation
Code.
Case 1 – the issuance price is P10 (at par)
In some instances, the value assigned to the asset received is overstated or understand. When
Cash 250,000 the value assigned to the asset received in exchange for share capital is overstated, the share
Unissued Ordinary Share Capital 250,000 capital issued is called watered share capital. The overstatement is done to comply with the
25,000 sh x P 10 = P250,000 requirement of the law that the share capital should not be issued at less than its par value. When
the value of the asset received is understated, the share capital said to contain secret reserves.
Case 2 – the issuance price is P 15 (above par)
Illustrative Problem C: The Happy Corporation issued 10,000 shares of its P10 par ordinary
Cash 375,000 share capital in exchange for land. The entries to record the issuance of the share capital under
Unissued Ordinary Share Capital 250,000 the memorandum entry method using three independent cases are given on below and on the
Ordinary Share Premium 125,000 next page.
25,000 sh x P 15 = P375,000
25,000 sh x P 10 = P250,000 Case 1 – The land has a fair value of P175,000.
25,000 sh x P 5 = P125,000
Land 175,000
Case 3 – The issuance price is P8 (below par) Ordinary Share Capital 100,000
Ordinary Share Premium 75,000
Cash 200,000 10,000 sh x P10 = P 100,000
Discount on Ordinary Share Capital 50,000 P175,000 – P100,000 = P 75,000
Ordinary Share Capital 250,000
Case 2 – The land had no known market value. The fair value of ordinary share capital on the
It should be noted that the basic difference between the memorandum entry method and the date of exchange is P15.
journal method is the account to be credited upon issuance of the share capital.
Land 150,000
Under the memorandum entry method, the Share Capital account is credited upon issuance of Ordinary Share Capital 100,000
the stock. The balance of this account represents the amount of capital stock or share capital Ordinary Share Premium 50,000
issued to shareholders.
If the journal entry method is used instead of the memorandum entry method. Unissued Ordinary
Under the journal entry method, the Unissued Share Capital account is credited upon issuance Share Capital should have been credited instead of Ordinary Share Capital.
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.

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1. To record the receipt of subscription
ISSUANCE IN EXCHANGE FOR SERVICES RENDERED. When a share capital is issued in exchange
for services rendered, the services received is recorded at its fair value (also known as direct a. Subscription price (SP) is equal to par value (PV)
measurement), unless the fair value cannot be estimated reliably. If the fair value of the services Share Capital Subscription Receivable xxx
received cannot be estimated reliably, it will be recorded at the fair value of the share capital Share Capital Subscribed xxx
issued, also known as indirect measurement (PFRS 2, par. 10). The fair value of the services Shares subscribed x PV = Pxxx
received shall be determined at the date the other party renders the services. (PFRS 2, par. 13).
b. Subscription price is above par value
IF the shares are issued for services rendered during incorporation, Pre-Operating Expenses is Share Capital Subscription Receivable xxx
debited. Share Capital or Unissued Share Capital is credited at par value; Share Capital in Excess Share Capital Subscribed xxx
of Par, or Additional Paid-in Capital or Share Premium is credited for any excess of the value Share Premium xxx
assigned to pre-operating expenses and the par value of the share capital. Receivable = shares subscribed x SP
Subscribed = shares subscribed x PV
Illustrative Problem D: The Happy Corporation issued 1,000 shares P10 par ordinary share Premium = shares subscribed x (SP-PV)
capital in payment for the services of the lawyer rendered during incorporation.
It should be noted that the Share Capital Subscribed account is always credited at par value,
Case 1 – The services of the lawyer is valued at P25,000. regardless of the subscription price.

Pre-Operating Expenses 25,000 2. To record collection of subscription from subscribers.

Ordinary Share Capital 10,000
Ordinary Share Premium 15,000 Cash xxx
1,000 sh x P10 = P 10,000 Share Capital Subscription Receivable xxx
P25,000 – P10,000 = P 15,000
3. To record issuance of stock certificate upon full payment of subscription
Case 2 – There is no known fair market value for the services of the lawyer. The fair market value
of the ordinary share capital issued is P15 per share. Share Capital Subscribed xxx
Share Capital (or Unissued Share Capital) xxx
Pre-Operating Expenses 15,000
Ordinary Share Capital 10,000 Illustrative Problem E: On June 3, 2014, the Happy Corporation received subscription for 5,000
Ordinary Share Premium 5,000 shares of its P10 par value ordinary share capital at P15. A down payment of 25% was received
1,000 sh x P 15 = P 15,000 and the balance was paid in fully on July 4, 2014. The entries to record these transactions using
1,000 sh x P 10 = P 10,000 the memorandum entry method are presented on the next page.
1,000 sh x P 5 = P 5,000
2014
June 3 Ordinary Share Capital Subscription Receivable 75,000
SALE OF SHARE CAPITAL ON A SUBSCRIPTION BASIS. Subscription is a contract between a Ordinary Share Capital Subscribed 50,000
subscriber (buyer of share capital) and a corporation (seller or issuer of share capital) whereby Ordinary Share Premium 25,000
the former purchases shares of stock of the latter with the payment to be made at a later date. 5,000 sh x P15 = P 75,000
The corporation issues the corresponding stock certificate upon full payment of subscription. 5,000 sh x P10 = P 50,000
This practice is a means of encouraging subscribers to pay their unpaid subscription on time. 5,000 sh x P 5 = P 25,000

Sale of share capital on a subscription basis generally involves three major transactions – (1) June 3 Cash 18,750
receipt of subscriptions, (2) collection from subscribers, and (3) issuance of stock certificate upon Ordinary Share Capital Subscription Receivable 18,750
full payment of subscription. Entries required for these transactions are given below. P75,000 x 25 % = P 18,750

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The entries to record the sale of share capital under the memorandum entry method of recording
July 4 Cash 56,250 share capital using three independent cases are as follows:
Ordinary Share Capital Subscription Receivable 56,250 Case 1 – The issuance price is P 10 (at stated value)
P75,000 x 75 % = P 56,250
Cash 250,000
4 Ordinary Share Capital Subscribed 50,000 Ordinary Share Capital 250,000
Ordinary Share Capital 50,000 25,000 sh x P10 = P250,000

The entries on June 3 may be recorded in a compound entry as follows: Case 2 – The issuance price is P15 (above stated value)

June 3 Ordinary Share Capital Subscription Receivable 56,250 Cash 375,000

Cash 18,750 Ordinary Share Capital 250,000
Ordinary Share Capital Subscribed 50,000 Ordinary Share Capital in Excess of Stated Value 125,000
Ordinary Share Premium 25,000 25,000 sh x P15 = P375,000
25,000 sh x P10 = P250,000
25,000 sh x P 5 = P125,000
ISSUANCE OF NO-PAR, BUT WITH STATED VALUE SHARE CAPITAL
Case 3 – The issuance price is P8 (below stated value)
A Share capital without par value but with a stated value has a nominal value stated in the articles Cash 200,000
of incorporation but not on the face of the stock certificate. Discount on Ordinary Share Capital 50,000
Ordinary Share Capital 250,000
The same rules discussed in the issuances of share capital with a par value are applicable. The 25,000 sh x P 8 = P200,000
account Share Capital in Excess of Stated Value may be used instead of the account Share 25,000 sh x P10 = P250,000
Premium or Share Capital in Excess of Par. 25,000 sh x P 2 = P 50,000
ISSUANCE FOR CASH. A share capital may be sold for cash at its stated value, at more than stated If the journal entry method is used instead of the memorandum entry method. Unissued Share
value, or at less than stated value. If cash received is equal to stated value, Cash is debited and Capital will be credited instead of Ordinary Share Capital.
Share Capital or Unissued Share Capital is credited.
ISSUANCE IN EXCHANGE FOR NON-CASH ASSETS OR PROPERTY. When a share capital is issued
If the share capital is sold or issued at more than its stated value, Cash is debited for the amount in exchange for non-cash assets, the asset received is recorded at its fair value (also known as
received, Share Capital or Unissued Share Capital is credited at stated value, and Paid-in Capital direct measurement), unless the fair value cannot be estimated reliably. If the fair value of the
in Excess of Stated Value is credited for the excess of cash received over stated value. asset received cannot be estimated reliably, it will be recorded at the fair value of the share
capital issued, also known as indirect measurement (PFRS 2, par. 10). The fair value of the asset
If the share capital is sold or issued at less than its stated value, Cash is debited for the amount received shall be determined at the date the entry received the asset (PFRS 2, par. 13).
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 Upon issuance of the share capital, Share Capital or Unissued Share Capital is credited at stated
the Corporation Code of the Philippines, however, the original issuance of share capital at a value. The excess of the value assigned to the asset received over the stated value of the share
discount is not allowed. Therefore, problems involving discounts are used in the book for capital issued is credited to Share Capital in Excess of Stated Value.
illustration purposes only.
Illustrative Problem G: The Happy Corporation issued 10,000 shares of its P10 stated value
Illustrative Problem F: The Happy Corporation was organized on January 1, 2014 and is ordinary share capital in exchange for land. The entries to record the issuance of the share capital
authorized to issue 100,000 shares of P10 stated value ordinary share capital. Subsequently, under the memorandum entry method using three independent cases are given below:
25,000 shares were sold.

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Cash 2 – There is no known fair market value for the services of the lawyer. The fair market value
of the ordinary share capital issued is P15 per share.
Case 1 – The land has a market value of P175,000.
Pre-Operating Expenses 15,000
Land 175,000 Ordinary Share Capital 10,000
Ordinary Share Capital 100,000 Ordinary Share Capital in Excess of Stated Value 5,000
Ordinary Share Capital in Excess of Stated Value 75,000 1,000 sh x P15 = P 15,000
10,000 sh x P10 = P 100,000 1,000 sh x P10 = P 10,000
P175,000 – P100,000 = P 75,000 1,000 sh x P 5 = P 5.000

Case 2 – The land has no known market value. The fair market value of ordinary share capital on
the date of exchange is P15. 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
Land 150,000 the account credited for the excess of the subscription price over the stated value of stock. The
Ordinary Share Capital 100,000 account Share Capital in Excess of Stated Value is credited instead of Share Premium, or
Ordinary Share Capital 50,000 Additional Paid-in Capital, or Share Capital in Excess of Par.
10,000 sh x P15 = P 150,000
10,000 sh x P10 = P 100,000 Illustrative Problem I: On June 3, 2014, the Happy Corporation received subscription for 5,000
10,000 sh x P 5 = P 50,000 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
If the journal entry method is used instead of the memorandum entry method, Unissued Ordinary the memorandum entry are presented below and on the next page.
Share Capital should have been credited instead of Ordinary Share Capital.
2014
ISSUANCE IN EXCHANGE FOR SERVICS RENDERED. When a share capital is issued in exchange June 3 Ordinary Share Capital Subscription Receivable 75,000
for services rendered, the services received is recorded at its fair value (also known as direct Ordinary Share Capital Subscribed 50,000
measurement), unless the fair value cannot be estimated reliably. If the fair value of the services Ordinary Share Capital in Excess of Stated Value 25,000
received cannot be estimated reliably, it will be recorded at the fair value of the share capital 5,000 sh x P15 = P 75,000
issued, also known as indirect measurement (PFRS 2, par. 10). The fair value of the services 5,000 sh x P10 = P 50,000
received shall be determined at the date the other party renders the services. (PFRS 2, par. 13). 5,000 sh x P 5 = P 25,000

IF the shares are issued for services rendered during incorporation, Pre-Operating Expenses is 3 Cash 18,750
debited, Share Capital or Unissued Share Capital is credited at stated value; Share Capital in Ordinary Share Capital Subscription Receivable 18,750
Excess of Stated Value or Additional Paid-in Capital is credited for any excess of the value P75,000 x 25% = P 18,750
assigned to pre-operating expenses over the stated value of the share capital.
July 4 Cash 56,250
Illustrative Problem H: The Happy Corporation issued 1,000 shared od P10 stated value Ordinary Share Capital Subscription Receivable 56,250
ordinary share capital in payment for the services of the lawyer rendered during incorporation. P75,000 x 75% = P 56,250

Case 1 – The services of the lawyer is valued at P25,000. 4 Ordinary Share Capital Subscribed 50,000
Ordinary Share Capital 50,000
Pre-Operating Expenses 25,000
Ordinary Share Capital 10,000 The entries on June 3 may be recorded in a compound entry.
Ordinary Share Capital in Excess of Stated Value 15,000
1,000 sh x P10 = P 10,000
P25,000 – P10,000 = P15,000

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ISSUANCE IN EXCHANGE FOR SERVICES RENDERED. When a share capital is issued in exchange
ISSUANCE OF NO-PAR, NO STATEDVALUE SHARE CAPITAL for services rendered, the services received is recorded at its fair value (also known as direct
measurement), unless the fair value cannot be estimated reliably. If the fair value of the services
received cannot be estimated reliably, it will be recorded at the fair value of the share capital
When a share capital has no par value and no stated value, the value assigned to the consideration
issued, also known as indirect measurement (PFRS 2, par. 10). The fair value of the services
received is the same amount credited to the Share Capital account.
received shall be determined at the date the other party renders the services. (PFRS 2, par. 13).
ISSUANCE FOR CASH. When a no-par, no stated value stock is issued for cash, Cash is debited and
If the shares are issued for services rendered during incorporation. Pre-Operating Expenses is
Share Capital is credited for the value of the cash consideration received.
debited and Share Capital or Unissued Share Capital is credited for the value assigned to the
services rendered.
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.
Illustrative Problem L: The Happy Corporation issued 1,000 shared of its ordinary share capital
Subsequently, 25,000 shares were sold at P15 per share.
in payment for the services of the lawyer rendered during incorporation.
The entry to record the sale follows:
Case 1 – The services of the lawyer is valued at P25,000.
Cash 375,000
Pre-Operating Expenses 25,000
Ordinary Share Capital 375,000
Ordinary Share Capital 25,000
25,000 x P15 = P375,000
Case 2 – There is no known fair market value for the services of the lawyer. The fair market value
of the ordinary share capital issued is P15 per share.
ISSUANCE IN EXCHANGE FOR NON-CASH ASSETS OR PROPERTY. When a share capital is issued
in exchange for non-cash assets, the asset received is recorded at its fair value (also known as
Pre-Operating Expenses 15,000
direct measurement), unless the fair value cannot be estimated reliably. If the fair value of the
Ordinary Share Capital 15,000
asset received cannot be estimated reliably, it will be recorded at the fair value of the share
capital issued, also known as indirect measurement (PFRS 2, par. 10). The fair value of the asset
received shall be determined at the date the entity received the asset (PFRS 2, par. 13).
SALE OF SHARE CAPITAL ON A SUBSCRIPTION BASIS. The sale of no stated value share capital
on a subscription basis is recorded in the same manner as that od share capital with a apar value
Upon issuance of the shares, Share Capital is credited for the value assigned to the asset received.
or with stated value stock, except that the entire subscription price is credited to the Share
Capital account.
Case 1 – The land has a market value of P175,000.
Illustrative Problem M: On June 3, 2014, the Happy Corporation received subscription for 5,000
Land 175,000
shares of its no-par, no stated value ordinary share capital at P15. A down payment of 25% was
Ordinary Share Capital 175,000
received and the balance was paid in full on July 4, 2014. The entries to record these transactions
using the memorandum entry method follow:
Case 2 – The land has no known market value. The fair market value of ordinary share capital on
the date of exchange is P15.
2014
June 3 Ordinary Share Capital Subscription Receivable 75,000
Land 150,000
Ordinary Share Capital Subscribed 75,000
Ordinary Share Capital 150,000
5,000 sh x P15 = P 75,000
If the share capital has no par and no stated value, only the memorandum entry method can be
3 Cash 18,750
used.
Ordinary Share Capital Subscription Receivable 18,750
P75,000 x 25% = P 18,750

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If there is no bidder, all of the delinquent shares will be issued in the name of the corporation.
July 4 Cash 56,250 Such shares are considered treasury shares and the following entries will be made, after making
Ordinary Share Capital Subscription Receivable 56,250 the entries (a) and (b) above.
P75,000 x 75% = P 56,250
c. Treasury Share Capital xxx
4 Ordinary Share Capital Subscribed 75,000 Receivable from Highest Bidder xxx
Ordinary Share Capital 75,000
d. Share Capital Subscribed xxx
The entries on June 3 may be recorded in a compound entry. Share Capital (or Unissued Share Capital) xxx

When the share capital issued have no par and have no stated value, only the memorandum entry Illustrative Problem N: On June 15, 2014, the Happy Corporation received subscription for
can be used in recording the stock transactions. 2,000 shares of its P10 par value ordinary share capital at P15. A down payment of 60% was
received. The final payment was due on August 15, 2014, although several notices were sent to
the subscriber, no payment has been received. On August 31, the subscription was declared
SUBSCRIPTION DEFAULTS 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
When a subscriber fails to pay his obligations after the corporation has sent several notices to
subscriber.
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
The entries to record the foregoing transactions using the memorandum entry method follow:
and delinquent shares are issued to the highest bidder. The highest bidder is the one who is
willing to pay the unpaid subscription plus any expense incurred I connection with the
2014
delinquency sale and is willing to receive the lease number of shares.
June 15 Ordinary Share Capital Subscription Receivable 30,000
Ordinary Share Capital Subscribed 20,000
The following entries are made in relation to subscription defaults and issuance of stock
Ordinary Share Premium 10,000
certificates.
2,000 sh x P15 = P 30,000
2,000 sh x P10 = P 20,000
a. Upon default
2,000 sh x P 5 = P 10,000
Receivable from Highest Bidder xxx
Share Capital Subscription Receivable xxx
15 Cash 18,000
Ordinary Share Capital Subscription Receivable 18,000
b. Costs incurred in connection with the delinquency sale
P30,000 x 60% = P 18,000
Receivable from Highest Bidder xxx
Cash xxx
Aug. 31 Receivable from Highest Bidder 12,000
Ordinary Share Capital Subscription Receivable 12,000
c. Upon receipt of payment from highest bidder
P30,000 x 40% = P 12,000
Cash xxx
Receivable from Highest Bidder xxx
Sept. 6 Receivable from Highest Bidder 500
Cash 500
d. Upon issuance of certificates of stock
Share Capital Subscribed xxx
21 Cash 12,50
Share Capital (or Unissued Share Capital) xxx
Receivable from Highest Bidder 12,500
All subscribed shares are issued. Shares are first given to the highest bidder, The excess, if any,
21 Ordinary Share Capital Subscribed 20,000
are given to the defaulting subscriber.
Ordinary Share Capital 20.000

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Chapter 8 - Organization and Formation of a Corporation
7. Record the issuance of share capital to other incorporators or shareholders (stockholders).
INCORPORATING A SOLE PROPRIETORSHIP OR A PARTNERSHIP

A sole proprietorship or a partnership may decide to incorporate to enjoy the advantages of NEW BOOKS ARE OPENED FOR THE CORPORATION
being a corporation. The books of the old organization may be used by the new corporation after
giving effect to changes that may have taken place; or a new set of records may be opened. It is a If a new set of books is opened for the corporation, the following shall be recorded in the
common practice, however, than a new set of books is used by the new organization. corporation books;

GOODWILL RESULTING FROM THE ACQUISITION OF A PARTNERSHIP BY 1. authorized share capital.

2. issuance of share capital for the net assets transferred by the partnership.
A CORPORATION (INCORPORATION OF A PARTNERSHIP) 3. issuance of share capital to other incorporators

The acquisition of a partnership by a corporation or incorporation of a partnership may involve Entries are also prepared on the partnership books to record the following:
the recognition of goodwill. The goodwill shall be result of the acquisition by the new corporation
of the net assets of the partnership. It is the excess of the market value of the capital share issued 1. revaluation of net assets.
to the former partners in the partnership over the fair value of net assets transferred by the 2. recognition of goodwill, if any.
partnership into the corporation. The adjustment for the goodwill increases the capital of the 3. closing the balance of Capital Adjustment Account to partners’ capital accounts.
former partners. 4. Receipt of share capital to partners.
5. distribution of share capital to partners.
PFRS 3 prohibits the amortization of goodwill acquired in a combination and instead requires 6. distribution of cash to partners, if there is any.
the goodwill to be tested for impairment annually, or more frequently, if events or changes in
circumstances indicate that the asset might be impaired. Illustrative Problem O: Roberto and Remedios are partner sharing profits and losses in the
ratio of 3:2. They decide to retire from active participation in their business so they form a
BOOKS OF THE OLD PARTNERSHIP ARE RETAINED 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.
If the books of the partnership are retained, the following steps in recording the incorporation
will be followed: Roberto and Remedios Partnership
Statement of Financial Position
1. Revalue the net assets of the partnership (i.e. assets and liabilities). Adjustments in asset January 1, 2014
and liability balances may be reported through a revaluation account called Capital
Adjustment Account or recorded directly to the capital accounts of the partners. Assets
Cash P 45,000
2. Recognize goodwill. The total value of the share capital to be issued is compared with the Accounts Receivable P 75,000
adjusted fair value of the net assets received from the partnership. The excess of the total Less Allowance for Uncollectible Accounts 3,000 72,000
value of the share capital over the adjusted fair value of net assets is payment for goodwill. Merchandise Inventory 25,500
Equipment P 90,000
3. In case a revaluation account is used, close the balance of Capital Adjustment Account to the Less Accumulated Depreciation 30,000 60,000
capital accounts of the partners in accordance with their profit and loss ratio. Total Assets P 202,500
Liabilities and Equity
4. Record the authorized share capital of the new corporation. Accounts Payable P 60,000
Expenses Payable 15,000
5. Record the issuance of share capital to the partners. Roberto, Capital 90,000
Remedios, Capital 37,500
6. Record any necessary distribution of cash to the partners. Total Liabilities and Equity P 202,500

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Step 3 Close the balance of Capital Adjustment Account to partners’ capital accounts.
The corporation is organized as the WINNER CORPORATION and is authorized to issue 10,000
shares of ordinary share capital, par value P10. Twenty-five thousand (25,000) shares are sold Capital Adjustment Account 97,500
for P20. The corporation takes over the partnership assets other than cash and assumes Roberto, Capital 58,500
partnership liabilities in exchange for 12,000 shares. Remedios, Capital 39,000
P77,100 + P20,400 = P 97,500
The following adjustments are to be made before taking over the net assets: P97,500 x 3/5 = P 58,500
P97,500 x 2/5 = P 39,000
a. The inventories are to be stated in their market value of P45,000.
b. The allowance for uncollectible accounts is to be increased to P5,400. Step 4 Record authorized share capital of the corporation
c. Equipment is to be recorded at its current value of P120,000.
Authorized to issue 10,000 shares of P10 par value ordinary share capital
The ordinary shares will be distributed as follows: Roberto, 9,000 shares; Remedios, 3,000
shares. Cash will be distributed based on the capital balances of the partners after distribution Step 5 Record issuance of share capital to partners
of the shares. The ordinary share capital are selling at P15 per share on this date.
Roberto, Capital 135,000
Assumption 1 – The books of the partnership will be used by the new corporation Remedios, Capital 45,000
Ordinary Share Capital 120,000
Step 1 Revalue the net assets of the partnership Ordinary Share Premium 60,000
9,000 shares x P15 = P 135,000
a. Merchandise Inventory 19,500 3,000 shares x P15 = P 45,000
Capital Adjustment Account 19,500 12,000 shares x P10 = P 120,000
12,000 shares x P 5 = P 60,000
b. Capital Adjustment Account 2,400
Allowance for Uncollectible Account 2,400 Step 6 Record the distribution of cash to partners

c. Accumulated Depreciation 30,000 Roberto, Capital 13,500

Equipment 30,000 Remedios, Capital 31,500
Capital Adjustment Account 60,000 Cash 45,000
P90,000 = P58,500 – P135,000 = P 13,500
Step 2 Recognize goodwill P37,500 + P39,000 – P 45,000 = P 31,500

Goodwill 20,400 Assumption 2 – New books are opened for the corporation.
Capital Adjustment Account 20,400
Partnership Books
Net assets before adjustment
(P202,500 – P60,000 – P15,000) P 127,500
Step 1 Revalue the net assets of the partnership
Add Net adjustments
(P 19,500 – P2,400 + P60,000) 77,100
a. Merchandise Inventory 19,500
Net assets after adjustment P 204,600
Capital Adjustment Account 19,500
Less Cash 45,000
Net assets excluding cash P 159,600
b. Capital Adjustment Account 2,400
(P12,000 shares x P 15) 180,000
Allowance for Uncollectible Accounts 2,400
Goodwill P 20,400

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NEW CORPORATION’S BOOKS
c. Accumulated Depreciation 30,000
Equipment 30,000 Step 1 Record authorized share capital of the corporation
Capital Adjustment Account 60,000
Authorized to issue 100,000 shares of P10 par value ordinary share capital.
Step 2 Recognize goodwill
Step 2 Recognize the issuance of share capital in exchange for the net assets of the
Goodwill 20,400 partnership
20,400
Accounts receivable 75,000
Step 3 Close the balance of Capital Adjustment Account to partners’ capital accounts Merchandise Inventory 45,000
Equipment 120,000
Capital Adjustment Account 97,500 Goodwill 20,400
Roberto, Capital 58,500 Allowance for Uncollectible Accounts 5,400
Remedios, Capital 39,000 Accounts Payable 60,000
P77,100 + P20,400 = P 97,500 Expenses Payable 15,000
P97,500 x 3/5 = P 58,500 Ordinary Share Capital 120,000
P37,500 x 2/5 = P 39,000 Ordinary Share Premium 60,000

Step 4 Record the receipt of share capital from the new corporation

Winner Corp. Ordinary Share Capital 180,000 REVIEW of the LEARNING OBJECTIVES
Accounts Payable 60,000
Expenses Payable 15,000
Allowance for Uncollectible Accounts 5,400 1. Define a corporation and discuss its characteristics. A corporation is defined as an
Merchandise Inventory 45,000 artificial being created by operation law, having the right of succession and the powers,
Accounts Receivable 75,000 attributes and properties expressly authorized by law or incident to it s existence. It has the
Equipment 120,000 following characteristics: (1) it is a separate legal entity with a personality of its own; (2) it
Goodwill 20,400 is created by operation by law; (3) it has the right of succession; (4) it has the powers,
attributed, and properties authorized by law; (5) its ownership is divided into shares known
Step 5 Record the distribution of share capital to partners as share capital; and (6) its management is vested in a board of directors elected by the
shareholders.
Roberto, Capital 135,000
Remedios, Capital 45,000 2. Identify and discuss the advantages and disadvantages of a corporate form of
Winner Corp. Ordinary Share Capital 180,000 organization. A corporation has the following advantages: (1) it enjoys a continuous
9,000 shares x P15 = P 135,000 existence because of its power of succession; (2) it can obtain a strong credit line because of
3,000 shares x P 15 = P 45,000 its continuous existence; (3) there are more investors enabling it to raise more funds; (4)
investors have limited liability; (5) share capital are transferable without the need for
Step 6 Record the distribution of cash to partners consent of other shareholders; and (6) its has smooth operation because of centralized
management. On the other hand, organizing and operating a corporate type of organization
Roberto, Capital 13,500 has the following disadvantages; (1) it is subject to more government control; (2) it is
Remedios, Capital 31,500 subject to more taxes; (3) it is costly to organize; (4) its credit capacity is weakened by the
Cash 45,000 limited liability of the shareholders; and (5) there is a more restrictive participation by
P90,000 + P58,500 – P135,000 = P 13,500 shareholders in the conduct of corporate affairs because management is vested in the board
P37,500 = P39,000 – P 45,000 = P 31,500 of directors.

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3. Identify and discuss the various classes of corporation. Corporations may be classified
into (1) stock or non-stock corporations; (2) public, private or quasi-public corporations;
(3) de jure or de facto corporations; (4) domestic or foreign corporations; and (5) open or
closely-held corporations.
4. Identify the components of a corporation and the steps in organizing a corporation. A
corporation has seven components and these are the following: (1) incorporators (2)
corporators (3) stockholders or shareholders (4) members (5) promoters (6) subscribers;
and (7) underwriters. The process of organizing a corporation is composed of three stages,
namely; (1) promotion; (2) incorporation, which includes the drafting of the articles of
incorporation and its subsequent filing with the Securities and Exchange Commission, and
(3) commencement of business.
5. Identify the different types of records that are maintained by a corporation. To be able
to keep track of the transactions of the corporation, the following records are generally
maintained: journals, ledgers, minutes of all meeting of board of directors, minutes of
meeting of shareholders; and stock and transfer book.
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 capital can be issued with a par value, without par but
with stated value, or without par and without stated value.
number of shares that may be issued and the par or stated value of each share or an
indication that the shares have no par and no stated value. Subsequent issuance of the share
capital requires a credit to the Share Capital account. Under the journal entry method, the
authorized share capital of the corporation is recorded by debiting Unissued Share Capital
and crediting Authorized Share Capital for the total par value or stated value of the
authorized shares. Subsequent issuance requires a credit to unissued Share Capital account.
Ordinary or preference shares may be issued in exchange for cash, for non-cash assets, for
services, for extinguishment of liabilities or in exchange for another form of securities. Share
capital may also be issued on a subscription basis. However, when a subscriber fails to pay
his subscription, such subscription becomes delinquent and will be subject to bidding.
GLOSSARY of ACCOUNTING TERMINOLOGIES
Authorized share capital (authorized capital stock) – the total par value or stated value of the
authorized shares. It is determined by multiplying the authorized shares by the par or stated
value of the share capital.
Authorized shares – the maximum number of shares of share capital that may be issued by a
corporation.
Corporation – an artificial being created by operation of law, having the right of succession and
the powers, attributes and properties expressly authorized by law or incident to its existence.

7. Identify the measurement bases in the issuance of share capital in exchange for various Delinquent subscription – a subscription where a subscriber fails to pay in full after repeated
considerations. Share capital may be issued in exchange for (a) cash, (b) non-cash assets, demand by the corporation.
or (c) services. When a share capital is issued for cash, the share capital is measured by
Highest bidder – a bidder who is willing to pay the entire unpaid subscriptions plus any expenses
amount of cash received. When a share capital is issued in exchange for non-cash assets, the
that may be incurred in connection with the delinquency sale and is willing to take the least
asset received is recorded at its fair value (also known as direct measurement ), unless the
number of shares declared as delinquent.
fair value cannot be estimated reliably, it will be recorded at the fair value of the share
capital issued, also known as indirect measurement (PFRS 2, par. 10). When a share capital Issued share capital (issued capital stock) – a share capital (stock) paid for in full and for which
is issued in exchange for services rendered, the services received is recorded at its fair value the related stock certificate is issued.
(also known as direct measurement), unless the fair value cannot be estimated reliably. If
the fair value of the services received cannot be estimated reliably, it will be recorded at the Ordinary share capital (common stock) – entitles the holder to an equal or pro-rata division of
fair value of the share capital issued, also known as indirect measurement (PFRS 2, par. 10) profits without any preference or advantage over any class of shares. The shareholders are often
referred to as “residual equity holders” because they obtain what is left after all the claims of
8. Record transactions relating to issuance of share capital using the memorandum entry other parties have been met.
method and the journal entry method. The recording of authorized share capital and
Par value – nominal or face value stated on the face of the share certificate and in the articles of
subsequent issuance may be recorded using the memorandum entry method or the journal
incorporation.
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
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Chapter 8 - Organization and Formation of a Corporation
MULTIPLE CHOICE
Preference share capital (preferred stock) – entitles the holder to enjoy priority as to
distribution of dividends and distribution of assets upon corporate liquidation.
MC 8-1 Cream Corporation was organized on January 1, 2014 with authorized capital of
Pre-Operating expenses (organization costs) – costs incurred in organizing a corporation and P2,000,000 consisting of 100,000 ordinary shares, P20 par value. Subsequently,
prior to its operations such as registration cost and orienting cost of stock certificate. incorporators subscribed for 25,000 shares at P24. How much must be paid up upon
subscription to comply with the requirement of the Securities and Exchange
Share capital (capital stock) – amount fixed by the corporate charter to be subscribed and paid
Commission (SEC)?
in or secured to be paid in by the shareholders. a. P600,000
b. P125,000
Stated value – nominal value stated in the articles of incorporation but not on the face of the
c. P500,000
stock certificate.
d. P150,000
Subscribed shares – share capital sold on a subscription basis that have not yet been paid in full
and for which the related stock certificates have not been issued. MC 8-2 Beige Co. was authorized to issue 10,000 preference shares, P100 par value and
200,000 no-par ordinary shares. Subscription for 4,000 preference shares was received
at P110 with a down payment of 25%. What entry should be made in the books of Beige
Co. to record the receipt of subscription?
a. Preference Share Capital Subscription Ree’l 440,000
Preference Share Capital Subscribed 400,000
Preference Share premium 40,000

b. Preference Share Capital Subscription Ree’l 440,000

Preference Share Capital Subscribed 440,000

c. Preference Share Capital Subscription Ree’l 400,000

Preference Share Capital Subscribed 400,000

d. Preference Share Capital Subscribed 400,000

Preference Share Capital Subscription Ree’l 400,000

MC 8-3 Using the information in MC 8-2, how much was the down payment received by Beige
Co. as a result of the subscription?
a. P10,000
b. P11,000
c. P100,000
d. P110,000

MC 8-4 Last September 6, 2014, Brown Co. issued 2,000 shares of its P10 par value ordinary
share capital in exchange for a piece of land to be held for a future plant site. Brown
Co.’s ordinary share capital was listed and traded at P27 per share on the same date.
The land has no known market value. How much is the increase in ordinary share
premium resulting from this exchange.
a. P0 c. P 34,000
b. P 20,000 d. P40,000

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a. P 25,000
b. P 300,000
MC 8-5 Violet Corp. was organized on January 1, 2014 with authorized capital of 100,000 c. P 1,650,000
ordinary shares, P20 par value. During 2014, Violet Co. had the following transactions d. P 1,675,000
affecting the shareholders’ equity.
MC 8-8 Using the information in MC 8-7, how much is the total shareholders’ equity?
Jan. 10 Issued 25,000 shares at P22 per share. a. P 3,250,000
b. P 4,500,000
Mar. 25 Issued 1,000 shared for legal service when the fair value was P24 c. P 4,675,000
per share. d. P 4,925,000

Sept. 30 Issued 5,000 shares for a piece of equipment when the value was MC 8-9 Lavender Corp. issued 20,000 ordinary shares, par value P15 in exchange for an
P26 per share. equipment. At the date of exchange, the shares are selling at P20 and no fair value is
known for the equipment. How will exchange be recorded on the books of Lavender
How much is the balance of the ordinary share capital account as of September 30? Corp.?
a. P 620,000 a. Equipment 400,000
b. P 674,000 Ordinary Share Capital 400,000
c. P 700,000
d. P 704,000 b. Equipment 400,000
Ordinary Share Capital 300,000
MC 8-6 Using the information in MC 8-5, what amount should be reported as ordinary share Ordinary Share Premium 100,000
premium?
a. P50,000 c. Equipment 400,000
b. P54,000 Ordinary Share Capital 300,000
c. P64,000 Gain on Exchange 100,000
d. P84,000
d. Equipment 300,000
MC 8-7 Aqua Corp. was incorporated on June 1, 2014 with an authorized 250,000 share of no- Ordinary Share Capital 300,000
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, MC 8-10 Indigo Corp. has authorized 200,000 shares of P30 per value ordinary share capital and
2014 were as follows: 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
June 1 Issued 50,000 ordinary shares for cash at P15 per share. following is the correct journal entry in recording the transaction?
a. Cash 3,600,000
5 Issued 50,000 ordinary shares in exchange for assets with total Ordinary Share Capital 3,000,000
market value of P900,000. Preference Share Capital 600,000

June 15 Received subscriptions for 100,000 ordinary shares at p30 and for b. Cash 1,540,000
5,000 preference shares at P55. Ordinary Share Capital 1,000,000
Preference Share Capital 540,000
25 Received full payment for subscriptions received on June 15 and the
corresponding stock were issued. c. Ordinary Share Capital 3,000,000
Preference Share Capital 600,000
What is the total paid-in capital excess of par and stated value for both ordinary and Income from Sale of Share Capital 3,600,000
preference shares?

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MC 8-13 Using the information in MC 8-12, how much is the additional paid-in capital?
d. Cash 3,150,000 a. P355,500
Ordinary Share Capital 3,000,000 b. P360,500
Preference Share Capital 150,000 c. P400,500
d. P800,500
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 MC 8-14 Using the information in MC 8-12, how much is the total shareholders’ equity?
balance, while Edralin has a P26,400 balance. Javier receives 7,500 shares and Edralin a. P1,305,500
received 6,000 shares of P4 par ordinary share capital. b. P1,345,500
c. P1,704,500
The correct entry to record the issuance of ordinary shares, assuming the corporation d. P1,745,500
will use the books of the partnership is
a. Javier, Capital 35,000 MC 8-15 On April 1, 2014, Friends Corp. a newly formed company had the following shares
Edralin, Capital 26,400 issued and outstanding:
Ordinary Share Capital 61,400 Preference share: P50 par, 6,000 shares originally issued at P100
Ordinary share, P20, 20,000 shares originally issued at P60
b. Javier, Capital 35,000
Edralin, Capital 26,400 Friends shareholders’ equity should report preference share capital, ordinary share
Ordinary Share Capital 54,000 capital and paid-in capital in excess of par, respectively at
Ordinary Share Premium 7,400 a. P600,000, P1,200,000, 0
b. 600,000, 400,000, 800,000
c. Javier, Capital 35,000 c. 300,000, 1,200,000, 300,000
Edralin, Capital 26,400 d. 300,000 400,000, 1,100,000
Gain on Incorporation 61,400

d. Javier, Capital 35,000

Edralin, Capital 26,400
Asset Revaluation Account 61,400

MC 8-12 The shareholders’ equity of Cecille Corp. revealed the following on June 30, 2014.
Preference share, P100 par value P230,000
Preference share premium 80,500
Ordinary share, P15 par value 525,000
Ordinary share premium 275,000
Ordinary share subscribed 5,000
Retained earnings 190,000
Notes payable 400,000
Subscription receivable – ordinary 40,000

How much is the legal capital of the corporation?

a. P 760,000
b. P 775,000
c. P1,115,000
d. P1,305,500

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 Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
ACCOUNTING CYCLE OF A CORPORATION
CHAPTER 9 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
OPERATIONS, DIVIDENDS, BOOK VALUE and liabilities, are recorded in the same manner as that of the two other forms of business
organizations.
PER SHAREEE, and EARNINGS PER SHARE At the end of the accounting period, the results of operations of the corporation and its financial
position are determined and the following problems are normally encountered:
LEARNING OBJECTIVES
1. Preparation of a worksheet
1. Explain the preparation of work sheet, adjusting entries, and closing entries for a corporation.
2. Explain the components of the shareholders’ equity section of the statement of financial position
2. Preparation of financial statements
(balance sheet). a. Statement of financial position (balance sheet)
3. Prepare the financial statements of a corporation, specifically the statement of changes in b. Income statement
shareholders’ equity. c. Statement of comprehensive income
4. Identify the different types of dividends and compute amount of dividends to be distributed to d. Statement of changes in shareholders’ equity
preference and ordinary shareholders. e. Statement of cash flows
5. Compute book value and earnings per share. 3. Preparation of adjusting and closing entries
6. Identify and explain the different types of retained earnings appropriations. -
PREPARATION OF A WORK SHEET
PREVIEW OF THE CHAPTER
A work sheet is a working paper that facilitated the preparation of financial statements.
CORPORATE OPERATIONS and However, before it can be prepared and completed, data for adjustments must first be compiled.
FINANCIAL STATEMENTS These items requiring adjustments are also the same items discussed in Chapter 1 and 3. For
purposes of illustration, these will be discussed again in this chapter. Data requiring adjustments
at the end of the accounting period include:
1. Accrued expense
Steps in the Shareholders’ Equity Dividends, Book Value 2. Accrued income
Accounting Cycle • Contributed Capital and Earnings per Share 3. Prepaid expense
• Work sheet • Share Capital • Dividends 4. Unearned or deferred income
• Financial statements • Additional Paid-in • Cash 5. Uncollectible accounts
• Statement of Capital • Scrip 6. Depreciation and other cost allocation
financial position • Retained Earnings • Property
7. Income tax
• Income statement • Stock
• Appropriated
• Statement of • Book value per share
comprehensive • Unappropriated The work sheet normally contains eight columns; however, there are instances when ten
• One class of share
income • Capital maintenance capital columns are used because of the addition of a pair of column for Retained Earnings.
• Statement of adjustments
• Two classes of share
changes in • Revaluation surplus capital PREPARATION OF FINANCIAL STATEMENTS
shareholders’ equity
• Statement of cash • Earnings per share
flows • One classes of share Financial statements are the end product of the accounting process. The information contained
• Adjusting entries capital therein is taken from the completed work sheet. PAS 1 (revised 2010) provides that a complete
• Closing entries • Two classes of share set of financial statement shall be composed of the following:
capital

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Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
1. Statement of financial position (balance sheet)
2. Statement of comprehensive income (or a separate statement of income and statement
of other comprehensive income
3. Statement of changes in equity
4. Statement of cash flows
5. Notes
The statemen of comprehensive income reports gains and losses not reported as part of profit or
loss but are shown as adjustments to the total equity. These items include gain (loss) from
changes in fair value of available for sale securities and revaluation surplus arising form
revaluation of property, plant and equipment.
The Securities and Exchange Commission (SEC) requires that the corporation submits to state
Commission within 15 days from the end of the first three months of operations a statement of
cash flows covering a period of three months from the date of registration. The statement must
shown in sufficient detail the sources of cash and how these are disbursed. The paid-up capital
must be disbursed only in connection with the business for which the corporation was organized
and no amount shall be disbursed as loans or advances to shareholders or officers of the
corporation.
The preparation of the statement of cash flows is discussed in Chapter 11 of this book.
STATEMENT OF FINANCIAL POSITION (BALANCE SHEET)
The statement of financial position (balance sheet) reports the financial condition of a company
as of a particular date. It contains the assets, liabilities and equity of the business. The assets and
liabilities should be properly classified as current or noncurrent. The equity section of the
statement of financial position of a corporation is called shareholders’ equity or stockholders’
equity and is generally composed of Contributed Capital and Retained Earnings. In some
instances, a corporation may have capital maintenance adjustment accounts such as revaluation
surplus and net unrealized gain or loss on long term investments that are shown separately in
the equity section.
CONTRIBUTED CAPITAL. The Contributed Capital represents corporate capital arising from
investment by shareholders. It is further divided into two sections:
1. Share Capital or Capital Stock – this also known as legal capital. This section reports both
preference (preferred_ and ordinary (common) share capital issued, subscribed and
distributable as dividends, stated at par or stated value. In case of share capital without par
value nor stated value, the amount reported is the total value of consideration received in
exchange for the shares.
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This section should include a description of each class of share capital such as the par or
stated value, authorized shares, number of shares issued, and dividend rights in case of
preference share capital.
Share capital subscription receivables that are not currently collectible are shown as
deduction from share capital, subscribed.
If the journal entry method of recording share capital transactions is used, issued share
capital is determined by deducting the balance of Unissued Share Capital account from the
Authorized Share Capital account.
2. Additional Paid-In Capital – this section reports investment by shareholders in excess of
the par or stated value of the share capital. It includes paid-in capital in excess of par value
or stated value (share premium) of both preference and ordinary share capital.
It also includes donated capital and other paid-in capital items arising from various share
capital transactions. These different share capital transactions are discussed in Chapter 10.
RETAINED EARNINGS (EARNED SURPLUS) – The Retained Earnings balance represents
undistributed earnings of the corporation. It represents capital of the corporation arising from
its operations. The balance of the account is generally divided into two part, as follows:
1. Appropriated retained earnings – it is the portion of Retained Earnings set aside for a
specific purpose.
2. Unappropriated retained earnings – it is the portion of Retained Earnings available for
distribution as dividends to the shareholders. It is normally described as “unrestricted
earnings”
The Retained Earnings account has a normal credit balance. A debit balance in the account is
called a deficit.
STATEMENT OF COMPREHENSIVE INCOME
The statement of comprehensive income is composed of two part: profit or loss for the period
and other comprehensive income. The first part reports revenue and gains realized and expenses
and losses incurred during a period. The excess of revenue and gains over expenses and losses is
profit the excess of expenses and losses over income and gains is loss. The second part reports
items of gains and losses which are not required by other PASs and PRFSs to be recognized I
profit or loss. Examples are changes in revaluation surplus when property, plant and equipment
are reported using the revaluation model and gains and losses arising from changes in fair value
of available-for-sale securities.
Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
b. Loss (Income Summary has a debit balance)
An essential part of the statement of comprehensive income prepared for a corporation is the
earnings per share amount that is reported below the profit figure. The concepts and principles Retained Earnings xxx
relating to earnings per share calculation as provided in PAS 33 shall be discussed in this chapter. Income Summary xxx

• PAS 1 (revised 2010_ also permits the presentation of comprehensive income in two Illustrative Problem A: The trial balance of the Bright Corp. as of December 31, 2014 is
statements: an income statement of other comprehensive income presented below; the data requiring adjustments as of December 31, 2014 are presented on the
next page.
For the purpose of this book, the option of preparing two separate statements will be adopted; Bright Corp.
however, the statement of comprehensive income is not included in the illustration and Trial Balance
discussion. A detailed discussion of this statement is covered in the last part of financial December 31, 2014
accounting that deals with the preparation of financial statements.
Cash 1,932,000
STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY Notes Receivable 750,000
Accounts Receivable 2,827,500
Allowance for Uncollectible Accounts 30,000
The statement of changes in shareholders’ equity is one of the basic financial statements that
Merchandise Inventory 450,000
should be prepared. This statement reports transactions or items that cause changes in
Store and Office Supplies 112,500
shareholders’ equity account balances. For a corporation that is neither a subsidiary nor a parent,
Prepaid Insurance 54,000
and for which there are no changes in accounting policy or correction of error, the statement
Office Equipment 1,875,000
shows the following.
Accumulated Depreciation – Office Equipment 187,500
• the profit or loss for the period
Store Equipment 2,850,000
• other comprehensive income Accumulated Depreciation – Store Equipment 285,000
• capital share transactions with shareholders and distributions to shareholders Notes Payable 375,000
(issuance of share capital and dividends) Accounts Payable 487,500
• the balance of retained earnings at the beginning and end of the period and the 10% Preference Share Capital, P100 par, 100,000 shares authorized 2,000,000
movement during the period. Ordinary Share Capital. P10 par, 500,000 shares authorized 4,750,000
Preference Share Premium 375,000
PREPARATION OF ADJUSTING AND CLOSING ENTRIES Ordinary Share Premium 900,000
Retained Earnings 787,500
After the financial statements are prepared, adjusting and closing entries must be journalized Sales 7,050,000
and posted. The adjusting entries of a corporation are similar to those of a sole proprietorship Sales Returns and Allowances 150,000
and partnership. No special problems are encountered in the preparation of adjusting entries. Purchases 3,750,000
Closing entries, on the other hand, consist of the following: Purchases Returns and Allowances 75,000
Sales Salaries 900,000
1. Closing the balances of revenue accounts to Income Summary Delivery Expense 180,000
2. Closing the balances of expense accounts to Income Summary Miscellaneous Selling Expense 105,000
3. Closing the balance of Income Summary to Retained Earnings Office Salaries 675,000
Rent Expense 375,000
a. Profit (Income Summary has a credit balance) Utilities Expense 247,500
Miscellaneous Administrative Expenses 79,500
Income Summary xxx Interest Income 10,500
Retained Earnings xxx
17,313,000 17,313,000

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Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share

Data requiring adjustments as of December 31, 2014:

a. Inventories: Merchandise – P750,000
b. Supplies used: office – P30,000; store – P62,500
c. Unexpired insurance – P24,000
d. Accrued interest o notes receivable, P5,500
e. Accrued sales salaries, P45,000; office salaries, P25,000
f. Estimated uncollectible accounts at the end of the year amounted to P168,000
g. Depreciation on store and office equipment, 5% per year
h. Income tax rate is 35%

The equity balances as of January 1, 2014 are as follows:

10 % Preference Share Capital P 1,500,000

Ordinary Share Capital 4,000,000
Preference Share Premium 350,000
Ordinary Share Premium 525,000
Retained Earnings 787,500

On January 10, the following transactions have taken place:

• 5,000 preference shares were issued at P105
• 75,000 ordinary shares were issued at P15

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Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share

BRIGHT CORPORATION
Work Sheet
For the Year Ended December 31, 2014
Trial Balance Adjustments Income Statement Statement Financial Position
Debit Credit Debit Credit Debit Credit Debit Credit
Cash 1,932,000 1,932,000
Notes Receivable 750,000 750,000
Accounts Receivable 2,827,500 2,827,500
Allowance for Uncollectible Accounts 30,000 e. 138,000 168,000
Merchandise Inventory 450,000 450,000 750,000 750,000
Store and Office Supplies 112,500 a. 92,500 20,400
Prepaid Insurance 54,000 b. 30,000 24,000
Office Equipment 1,875,000 1,875,000
Accumulated Depreciation – Office Equipment 187,500 f. 93,750 281,250
Store Equipment 2,850,000 2,850,000
Accumulated Depreciation – Store Equipment 285,000 f. 142,500 427,500
Notes Payable 375,000 375,000
Accounts Payable 487,500 487,500
10% Preference Share Capital, P100 par 2,000,000 2,000,000
Ordinary Share Capital. P10 par 4,750,000 4,750,000
Preference Share Premium 375,000 375,000
Ordinary Share Premium 900,000 900,000
Retained Earnings 787,500 787,500
Sales 7,050,000 7,050,000
Sales Returns and Allowances 150,000 150,000
Purchases 3,750,000 3,750,000
Purchases Returns and Allowances 75,000 75,000
Sales Salaries 900,000 c. 45,000 945,000
Delivery Expense 180,000 180,000
Miscellaneous Selling Expense 105,000 105,000
Office Salaries 675,000 c. 25,000 700,000
Rent Expense 375,000 375,000
Utilities Expense 247,500 247,500
Miscellaneous Administrative Expenses 79,500 79,500
Interest Income 10,500 b. 5,500 16,000
17,313,000 17,313,000

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Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
Office Supplies Expense a. 30,000 30,000
Store Supplies Expense a. 62,500 62,500
Insurance Expense b. 30,000 30,000
Interest Receivable c. 5,500 5,500
Salaries Payable d. 70,000 70,000
Uncollectible Accounts Expense e. 138,000 138,000
Depreciation Expense – Office Equipment f. 93,750 93,750
Depreciation Expense – Store Equipment f. 142,500 142,500
Income Tax Expense g. 123,675 123,675
Income Tax Payable g. 123,675 123,675
695,925 695,925 7,602,425 7,891,000 11,034,000 10,745,425
Profit 288,575 288,575
7,891,000 7,891,000 11,034,000 11,034,000

Computation of income tax and profit:

Total credit per income statement before income tax P 7,891,000

Total debit per income statement before income tax 7,478,750
Profit before tax P 412,250
Income tax (P412,250 x 30%) 123,675
Profit P 288,575

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Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
Bright Corporation
Income Statement Bright Corp.
For the Year Ended December 31, 2014 Statement of Financial Position
Schedule December 31, 2014
Net Sales 1 P 6,900,000
Cost of Merchandise Sold 2 3,375,000 Assets
Gross Profit P3,525,000 Current Assets:
Other Operating Income – Interest 16,000 Cash P1,932,000
Selling Expense (1,435,000) Notes Receivable 750,000
Administrative Expenses (1,693,750) Accounts Receivable P2,827,500
Profit before Tax P 412,250 Less Allowance for Uncollectible Accounts 168,000 2,659,500
Income Tax 123,675 Interest Receivable 5,500
Profit for the year P 288,575 Merchandise Inventory 750,000
Store and Office Supplies 20,000
Schedule 1 – Net Sales Prepaid Insurance 24,000 P6,141,000
Sales P 7,050,000 Noncurrent Assets:
Less Sales Returns and Allowances 150,000 Office Equipment P1,875,000
Net Sales P 6,900,000 Less accumulated Depreciation 281,250 P1,593,750
Store Equipment P2,850,000
Schedule 2 – Cost of Merchandise Sold Less Accumulated Depreciation 427,500 2,422,500 4,016,250
Merchandise Inventory, Jan. 1 P 450,000 Total Assets P10,157,250
Purchases P 3,750,000 Liabilities
Less Purchases Returns and Allowances 75,000 3,675,000 Current Liabilities:
Cost of Merchandise Available for Sale P 4,125,000 Notes Payable P375,000
Less Merchandise Inventory, Dec. 31 750,000 Accounts Payable 487,500
Cost Merchandise Sold P 3,375,000 Salaries Payable 70,000
Income Tax Payable 123,675
Schedule 3 – Selling Expenses Total Liabilities P1,056,175
Sales Salaries P 945,000 Shareholders’ Equity
Delivery 180,000 Contributed Capital:
Store Supplies 62,500 Share Capital:
Depreciation – Store Equipment 142,500 10% Preference shares, P100 par, 100,000
Miscellaneous 105,000 shares authorized, 2,000 shares issued
Total Selling Expenses P 1,435,000 and outstanding P2,000,000
Ordinary share, P10 par, 500,000 shares
Schedule 4 – Administrative Expenses authorized, 475,000 shares issued
Office Supplies P 700,000 and outstanding 4,750,000 P6,750,000
Rent 375,000 Additional Paid-in Capital:
Utilities 247,500 Preference Share Premium P 375,000
Uncollectible Accounts 138,000 Ordinary Share Premium 900,000 1,275, 000
Depreciation – Office Equipment 93,750 Total Contributed Capital P8,025,000
Office Supplies 30, 000 Retained Earnings 1,076,075
Insurance 30,000 Total Shareholders’ Equity 9,101,075
Miscellaneous 79,500 Total Liabilities and Shareholders’ Equity P10,157,250
P 1,693,750

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 Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
31 Income Tax Expense (P412,250 x 30%) 123,675
Bright Corp. Income Tax Payable 123,675
Statement of Changes in Shareholders’ Equity
For the Year Ended December 31, 2014 Note: Adjustments for inventories may also be included as part of closing entries.

Preference Ordinary Preference Ordinary Retained Closing Entries

Share Share Share Share Earnings 2014
Capital Capital Premium Premium Dec. 31 Income Summary 7,152,425
Balance, January 1 P1,500,000 P4,000,000 P350,000 P525,000 P787,500 Sales Returns and Allowances 150,000
Issuance of preference shares
Purchases 3,750,000
(5,000 shares x P105) 500,000 25,000
Issuance of ordinary shared 375,000 Sales Salaries 945,000
(75,000 shares x P15) 750,000 Delivery Expense 180,000
Profit for the year 288,575 Miscellaneous Selling Expense 105,000
Office Salaries 700,000
Balances, December 31 P2,000,000 P4,750,000 P375,000 P900,000 P1,076,075
Rent Expense 375,000
Utilities Expense 247,500
Miscellaneous Administrative Expenses 79,500
Adjusting Entries
Office Supplies Expense 30,000
2014
Store Supplies Expense 62,500
Dec. 31 Income Summary 450,000
Insurance Expense 30,000
Merchandise Inventory 450,000
Uncollectible Accounts Expense 138,000
Depreciation Expense – Office Eqt. 93,750
31 Merchandise Inventory 750,000
Depreciation Expenses – Store Eqt. 142,500
Income Summary 750,000
Income Tax Expense 123,675
31 Office Supplies Expense 30,000
31 Sales 7,050,000
Store Supplies Expenses 62,500
Purchases Returns and Allowances 75,000
Store and Office Supplies 92,500
Interest Income 16,000
Income Summary 7,141,00
31 Insurance Expense 30,000
Prepaid Insurance 30,000
31 Income Summary 288,575
Retained Earnings 288,575
31 Interest Receivable 5,500
Interest Income 5,500
Reversing Entries
2015
31 Sales Salaries 45,000
Jan. 1 Interest Income 5,500
Office Salaries 25,000
Interest Receivable 5,500
Salaries Payable 70,000
1 Salaries Payable 70,000
31 Uncollectible Accounts Expense 138,000
Sales Salaries 45,000
Allowance for Uncollectible Accounts 138,000
Office Salaries 25,000
31 Depreciation Expense – Office Eqt. 93,750
Depreciation Expense – Store Eqt. 142,500
Accumulated Depr. – Office Eqt. 93,750
Accumulated Depr. – Store Eqt. 142,500

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Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
Cash Dividends Payable xxx
DIVIDENDS Cash xxx
To record payment of dividends
Dividends are distribution to shareholders of corporate earnings in proportion to the number of
shares held by them. Distributions may take the form of (1) cash, (2) non-cash assets, (3) notes *Alternatively, the account Dividends Payable may be used.
or other evidence of corporate indebtedness, and 94) shares of the company’s own share capital.
If the dividends declared are still unpaid as of the statement of financial position date, the balance
Dividends previously described are paid out of accumulated earnings of the corporation. They of the account Cash Dividends Payable is reported as a current liability.
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 The amount of cash dividends declared-should not exceed the amount of cash reported on the
distributions of corporate earnings. statement of financial position or cash needed for current operations. For instance, Retained
Earnings may have a balance of P1,000,000 but the cash balance is only P500,000, the
The power to declare dividends is vested upon the board of directors; however, they have to corporation can distribute cash dividends of not more than P500,000. Another form of dividend
observe legal requirements governing the maintenance of legal or stated capital. Dividend may be declared for the remaining undistributed earnings.
declaration is normally announced to be made known to the shareholders.
Cash dividends may either be:
The following dates are essential in formal dividend announcement or statement.
1. Peso dividend – a cash dividend expressed in peso amount. The peso dividend multiplied
1. Date of declaration – this is the date when the board of directors approved the resolution by the number of outstanding share of the corporation equals the total amount of Retained
to distribute dividends. The liability of the corporation to the shareholders is recorded on Earnings declared as cash dividends. On the other hand, the peso dividend multiplied by the
this date. number of capital shares held by a shareholder equals the total amount of cash dividends to
be received by the shareholder.
2. Date of shareholders of record – this is the date when the company determines the
shareholders who are entitled to the receipt of declared dividends. No entry is required on 2. Percentage dividend – a cash dividend expressed in percentage. The dividend percentage
this date; however, a list of registered shareholders is made as of the close of business on multiplied by the par value or stated value of the capital share equals the peso dividend.
this date. Share capital are selling dividends-on prior to this date and are selling ex- Alternatively, the percentage dividend multiplied by the total par value or total stated value
dividends the day following this date. 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
3. Date of payment or distribution – this is the date when dividends declared are paid or (i.e., P10 x 2,000 shares).
distributed to the shareholders. The liability recognized on the date of declaration is
cancelled or extinguished on this date.
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
CASH DIVIDENDS dividend of P10.00 per share to shareholders of record of December 30,2014 payable on January
15, 2015.
Cash dividends are dividends that are distributable in the form of cash. This is the most common
type of dividend. The following entries are made to record the declaration and subsequent 2014
payment: Dec 1 Retained Earnings 100,000
Dividends Payable 100,000
Retained Earnings xxx 10,000 sh @ P10 = P100,000
Cash Dividends Payable* xxx 2015
To record the declaration of dividends 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.
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Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
SCRIP DIVIDENDS The accounts Scrip Dividends Payable and Interest Payable will be reported in the December 31,
2014 statement of financial position as current liabilities
Scrip dividends are, in fact, deferred cash dividends. A scrip dividend is declared when the
corporation has sufficient Retained Earnings balance but not sufficient funds at that time for a PROPERTY DIVIDENDS
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. Dividends distributed in the form of non-cash assets are known as property dividend. Property
distributed normally takes the form of assets that can be easily divided or allocated among
The entries to record the declaration and subsequent payment of scrip dividends follow: 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
Retained Earnings xxx distribution of non-cash assets to owners as dividends:
Scrip Dividends Payable xxx • An entity shall measure a liability to distribute noncash assets as a dividend to its
To record the declaration of dividends owners at the fair value of the assets to be distributed (par. 11)
Scrip Dividends Payable xxx - This means that Retained Earnings and Property Dividends Payable will
Interest Expense xxx be recorded at the fair value of the assets to be distributed.
Cash xxx
To record payment of dividends plus interest. • 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
Illustrative Problem C: Fortune Corp. has 10,000 shares of P100 par value ordinary share carrying amount of the dividend payable, with any changes in the carrying amount of
capital outstanding as of October 31, 2014. On this date, the Board of Directors declared a the dividend payable recognized in equity as adjustments to the amount of the
deferred cash dividend of P10,000 per share to shareholders of record of November 30, 2014. distribution (par. 13)
Promissory notes dated December 1, 2014 were issued on the same date. The notes mature - This means that Retained Earnings and Property Dividends Payable
within six months plus interest of 12% per annum. The corporation paid its shareholders on balances will be adjusted for the change in the previously recorded fair
March 31, 2015. value of the assets.
- The required valuation/measurement of the assets to be distributed at
The entries to record the declaration of dividends, the accrual of interest at year-end, the the end of each reporting period as provided in related PAS or PFRS
reversing entry at the beginning of the new accounting period and the payment to shareholders should also be applied.
are as follows:
• When an entity settles the dividend payable, it shall recognize the difference, if any, between
2014 the carrying amount of the assets to be distributed and the carrying amount of the dividend
Oct. 31 Retained Earnings 100,000 payable in profit or loss (par 14).
Scrip Dividends Payable 100,000 - This means that the difference between the carrying amount of the
10,000 sh @ P10.00 = P100,000 Property Dividends Payable and the carrying amount of the assets to be
distributed as gain or loss to be reported in the statement of
Dec. 31 Interest Expense 1,000 comprehensive income.
Interest Payable 1,000
P100,000 x 12% x 1/12 = P1,000 The entry to record the declaration of dividends is as follow:
2015
Jan. 1 Interest Payable 1,000 Retained Earnings xxx
Interest Expense 1,000 Property Dividends Payable xxx
To record the declaration of individuals
March 31 Scrip Dividends Payable 100,000
Interest Expense 4,000 The entry to record the distribution of dividends under three independent cases shall be as
Cash 104,000 follows:
P100,000 x 12% x 4/12 = P4,000

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Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
SHARE CAPITAL DIVIDENDS (STOCK DIVIDENDS)
1. The carrying amount of the payable and the carrying amount of the assets are the same
Property Dividends Payable xxx A share capital dividend (stock dividend) is a distribution to shareholders in the form of
Assets xxx corporation’s own share capital (stock). Thus, when Fortune Corp. distributes Fortune Corp.
To record distribution of property dividend shares to its shareholders, it is distributing share capital or stock dividends.

2. The carrying amount of the payable is greater than the carrying amount of the assets This type of dividend does not affect total assets and total shareholders’ equity, rather it simply
Property Dividends Payable xxx represents a transfer of capital from retained earnings to contributed capital. Hence, total
Assets xxx shareholders’ equity before and after the declaration and distribution of share capital dividends
Gain on Distribution of Non-Cash Assets xxx are the same, On the other hand, retained earnings is decreased while contributed capital is
increased as a result of the declaration and distribution of share capital dividends.
3. The carrying amount of the payable is less than the carrying amount of the assets
Property Dividends Payable xxx In recording the declaration of a share capital dividend, a distinction should be made between a
Loss on Distribution of Non-Cash Assets xxx small and a large stock dividend. A share capital dividend presenting less than 20% of the
Assets xxx outstanding shares is considered a small share capital dividend. A share capital dividend
representing 20% or more of the outstanding shares is considered a large share capital dividend.
For purpose of discussion in this book, the illustration, exercises and problems will involve assets
with carrying value equal to their book value: Under a small share capital dividend, retained earnings is debited for the fair value of the share
capital on the date of declaration; under a large share capital dividend, retained earnings is
Illustrative Problem D: Fortune Corp. has 10,000 shares of P100 par value ordinary share debited for the par or stated value of the share capital.
capital outstanding as of December 1, 2014. ON this date, the Board of Directors declared a
property dividend distributable to shareholders of record of December 30, 2014 payable on The entries to record the declaration and distribution of share capital dividend, both small and
January 15, 2015. The corporation will distribute five shares of Lucky Corp. for every share of large, follow:
Fortune Corp. owned by the shareholders. Each share of Lucky Corp. has a carrying value of P10
on the date of declaration, which is also its fair value on the date of declaration and on the date Small Share Capital Dividend
of distribution.
Retained Earnings xxx
The entries to record the declaration of property dividend follow: Share Capital Dividends Distributable xxx
Paid-In Capital from Share Capital Dividends xxx
2014
Dec. 1 Retained Earnings 500,000 Share Capital Dividends Distributable xxx
Property Dividends Payable 500,000 Share Capital (or Unissued Share Capital) xxx
10,000 sh x 5 @ P10 = P500,000 To record the distribution of stock dividends

2015 Large Share Capital Dividend

Jan. 15 Property Dividends Payable 500,000
Investment in Lucky Corp. Stocks 500,000 Retained Earnings xxx
Share Capital Dividends Distributable xxx
It should be noted that the declaration and payment or distribution of cash dividends, scrip To record the declaration of dividends
dividends and property dividends do not affect the corporation’s number capital shares issued
and outstanding. This means that the total number of capital shares issued and outstanding Share Capital Dividends Distributable xxx
before the dividend declaration and payment or distribution shall be the same as total number Share Capital (or Unissued Share Capital) xxx
of capital shares issued and outstanding after the dividend declaration and payment or TO record the distribution of stock dividend
distribution. However, there is a decrease in the total assets and total retained earnings of the
corporation.

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Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
The account Share Capital (Stock) Dividend Distributable is credited for the par or stated value
of the shares to be distributed regardless of whether the share capital dividend is small or large.
This account is reported on the statement of financial position under the shareholders’ equity
section as part of Contributed Capital. It is properly shown as an addition to the share capital
outstanding.
The account Paid0In Capital from Share Capital Dividend is credited for the excess of the fair
market value of the share over its par or stated value. This account is reported on the statement
of financial position under the shareholders’ equity section as part of additional paid-in capital.
Illustrative Problem E: Fortune Corp. has 10,000 shares of P100 par value ordinary share
capital outstanding as of December 1, 2014. On this date, the Board of Directors declared a share
capital dividend distributable to shareholders of record of December 30, 2014 payable on
January 15, 2015. The fair market value of Fortune Corp. share capital on December 1 is P105;
on December 30, P110; on January 15, P106.
The declaration and distribution of share capital dividends, whether small or large, increases the
number of capital shares outstanding.
In all of the different types of dividends discussed, it should be noted that only the outstanding
capital shares are entitled to dividends.
DIVIDENDS ON PREFERENCE SHARES
When dividends are paid, the dividend requirements on preference shares must be paid before
any payment can be made to ordinary shareholders. The required dividends depend upon the
type of preference shares issued by the corporation.
The preference shares may be:
1. Cumulative - preference shareholders are entitled to the payment of past years’ unpaid
dividends or dividends in arrears before the payment of current year’s dividends.

The entries to record the declaration and distribution of share capital dividend using two 2. Noncumulative - preference shareholders are not entitled to payment of dividends in
independent cases are presented below: arrears; they are entitled to current year’s dividends only.

Case 1 – A share capital dividend of 10% was declared 3. Participating - preference shareholders are entitled to additional dividends after the
payment of regular dividends to both the preference and ordinary shareholders.
2014
Dec. 1 Retained Earnings 105,000 If the preference shares are fully participating, then the excess dividend is allocated
Share Capital Dividends Distributable 100,000 proportionately to the two classes of share capital based on their total par value.
Dividend 5,000
10,000 sh x 10% @ P105= P500,000 However, if the preference shares are participating up to a certain percentage only, a
10,000 sh x 10% @ 100 = P100,000 comparison should be made between the maximum allowed participation and the
10,000 sh x 10% @ 5 = P 5,000 amount based on full participation. The amount given to the preference shareholders
2015 is the lower of the two amounts.
Jan. 15 Share Capital Dividends Distributable 100,000
Ordinary Share Capital 100,000 4. Nonparticipating - preference shareholders are not entitled to any dividend in excess
of the regular rate. Hence, the dividends on preference shares is limited only to the
regular rate even if the amount of dividend distributions increases. The entire dividend
Case 2 – A share capital dividend of 30% was declared balance after the preference shareholders get their regular dividend rate is given to the
ordinary shareholders.
2014
Dec. 1 Retained Earnings 300,000 Illustrative Problem F: The Fortune Corp. declared and paid cash dividends for the last three
Share Capital Dividends Distributable 300,000 years as follows: 2012 - P120,000; 2013 - 200,000; 2014 - 300,000 shareholders. No dividends
Dividend 5,000 were paid for two years prior to 2012. The capital structure of the company for the last three
10,000 sh x 30% @ P100= P300,000 years follows:
2015
Jan. 15 Share Capital Dividends Distributable 300,000 10% Preference share capital, P100 par, 5,000 shares outstanding P500,000
Ordinary Share Capital 300,000 Ordinary share capital, P50 par, 5,000 shares outstanding 250,000

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Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
2014 Preference Ordinary Total
The annual dividend requirement on preference shares is P50,000 or P10 per share (i.e. P100 Current dividends P 50,000 P ------ P 50,000
par x 10% x 5,000 shares outstanding). At the beginning of 2012, dividends are in arrears (unpaid Balance – to ordinary shareholders 250,000 250,000
dividends of prior years) for two years. Total dividends P 50,000 P 250,000 P 300,000
Dividends per share P 10,00 P 50,00
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 cumulative, they are entitled to the payment of dividends in
Case 1 - The preference shares are noncumulative and nonparticipating. arrears. However, since they are nonparticipating, they are not entitled to any dividend in excess of
the current year’s dividends.
2012 2013 2014
Preference shares P 50,000 P 50,000 P 50,000 Case 3 - The preference shares are noncumulative but fully participating.
Ordinary shares – balance 70,000 150,000 250,000
Total dividends P 120,000 P 200,000 P 300,000 2012 Preference Ordinary Total
Dividends per share:* Regular dividends:
Preference shares P 10,00 P 10,00 P 10,00 Preference P 50,000
Ordinary shares 14.00 30,00 50,00 Ordinary – P50 x 10% x 5,000 sh P 25,000 P 75,000
*Total dividends ÷ outstanding shares Balance – P45,000
Preference 500/750 x P45,000 30,000
Note: Since the preference shares are noncumulative, the dividends in arrears are ignored and Ordinary – 250/750 x P45,000 15,000 45,000
preference shareholders are entitled to the current year’s dividend only. Since the shares are also Total dividends P 80,000 P 40,000 P 120,000
nonparticipating, the entire balance is given to ordinary shareholders, preference shares are not
entitled to any dividend in excess of the 10% rate. Hence, the dividend per share on preference share Dividends per share P 16.00 P 8.00
is limited to P10 only, even if the total amount of distributed dividends increases.

Case 2 - The preference shares are cumulative but non participating 2013 Preference Ordinary Total
Regular dividends:
2012 Preference Ordinary Total Preference P 50,000
Dividends in arrears: Ordinary – P50 x 10% x 5,000 sh P 25,000 P 75,000
P50,000 x 2 P 100,000 ------ P 100,000 Balance – P125,000
Current dividends: Preference 500/750 x P125,000 83,333
Required P 50,000 Ordinary – 250/750 x P125,000 41,667 125,000
Available 20,000 20,000 ------ 20,000 Total dividends P 133,333 P 66,667 P 200,000
In arrears, end of 2008 P 30,000 Dividends per share P 26.67 P 13.33
Total dividends P 120,000 P ------ P 120,000
Dividends per share P 24.00 P ------ 2014 Preference Ordinary Total
Regular dividends:
Preference P 50,000
2013 Preference Ordinary Total Ordinary – P50 x 10% x 5,000 sh P 25,000 P 75,000
Dividends in arrears P 30,000 ------ P 30,000 Balance – P45,000
Current dividends 50,000 ------ 50,000 Preference 500/750 x P45,000 150,000
Balance – to ordinary shareholders 120,000 120,000 Ordinary – 250/750 x P45,000 75,000 225,000
Total dividends P 80,000 P 120,000 P 200,000 Total dividends P 200,000 P 100,000 P 300,000
Dividends per share P 16.00 P 24.00 Dividends per share P 40.00 P 20.00

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Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
Case 5 - The preference shares are noncumulative but participating up to an additional
Note: Since the preference shares are noncumulative they are entitled to current year 's dividends 8%. This means that the maximum participation of preference shares on the excess dividends is
only and since they are fully participating, they are entitled to additional dividends after payment P40,000 (i.e., 8% of P500,000).
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 2012 Preference Ordinary Total
proportionately to the two classes of capital shares based on their total par value. Regular dividends:
Preference P 50,000
Case 4 - The preference shares are cumulative and fully participating Ordinary – P50 x 10% x 5,000 sh P 25,000 P 75,000
Balance – P45,000
2012 Preference Ordinary Total Preference 500/750 x P45,000 30,000
Dividends in arrears: Ordinary – 250/750 x P45,000 15,000 45,000
P50,000 x 2 P 100,000 ------ P 100,000 Total dividends P 80,000 P 40,000 P 120,000
Current dividends: Dividends per share P 16.00 P 8.00
Required P 50,000
Available 20,000 20,000 ------ 20,000
In arrears, end of 2008 P 30,000 2013 Preference Ordinary Total
Total dividends P 120,000 P ------ P 120,000 Regular dividends:
Dividends per share P 24.00 P ------ Preference P 50,000
Ordinary – P50 x 10% x 5,000 sh P 25,000 P 75,000
Balance – P125,000
2013 Preference Ordinary Total Preference 500/750 x P125,000 = P83,333* 40,000
Dividends in arrears P 30,000 P 30,000 Ordinary – P 125,000 – P 40,000 85,000 125,000
Current dividends 50,000 P 25,000 70,000 Total dividends P 90,000 P 110,000 P 200,000
Balance – P95,000
Dividends per share P 18.00 P 22.00
Preference 500/750 x P95,000 63,333
Ordinary – 250/750 x P95,000 31,667 95,000
2014 Preference Ordinary Total
Total dividends P 143,333 P 56,667 P 200,000
Regular dividends:
Dividends per share P 28.67 P 11.33 Preference P 50,000
Ordinary – P50 x 10% x 5,000 sh P 25,000 P 75,000
2014 Preference Ordinary Total
Current (regular) dividends P 50,000 P 25,000 P 75,000 Balance – P225,000
Balance – to ordinary shareholders Preference 500/750 x P225,000 = P150,000* 40,000
Preference 500/750 x P225,000 150,000 Ordinary – P 225,000 – P 40,000 185,000 225,000
Ordinary – 250/750 x P225,000 75,000 225,000 Total dividends P 90,000 P 210,000 P 300,000
Total dividends P 50,000 P 250,000 P 300,000 Dividends per share P 18.00 P 42.00
*P40,000 is the lower amount
Dividends per share P 40,00 P 20,00

Note: Since the preference shares are participating up to a certain percentage only, a comparison
Note: Since the preference shares are both cumulative and fully participating, they are entitled to
should be made between the maximum allowed participation and the amount based on full
the receipt of dividends in arrears and also to the receipt of additional dividends after payment of
participation. The amount to be given to the preference shareholders is the lower of the two
regular dividends to both preference and ordinary shareholders.
amounts. Alternatively, the amount to be allocated to the preference shares is computed by
multiplying the total par value of the preference shares of the lower of the full participation rate or
the maximum participation rate. The full participation rate is computed as follows:

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Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
Illustrative Problem G: On December 31, 2014, the shareholders' equity section of the
Excess dividends to be distributed statement of financial position of Lucky Corp. appears as follows:
𝐹𝑢𝑙𝑙 𝑝𝑎𝑟𝑡𝑖𝑐𝑖𝑝𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒 =
Total par value of reference and ordinary shares
10% Preference share capital, P100 par, 50,000 shares P 5,000,000
Using the data in Case 5, the full participation rate for 2012, 2013 and 2014 are as follows: Ordinary share capital, P20 par, 200,000 shares 4,000,000
Preference share premium 1,500,000
2012 45,000/750,000 6.00% Ordinary share premium 1,200,000
2013 125,000/750,000 16.67% Retained earnings 5,800,000
2014 225,000/750,000 30.00 Total shareholders’ equity P 17,500,000

Hence, in 2012, the 6% rate will be used: in 2013 and 2014 the 7% rate will be used. Dividends on preference shares are in arrears for two years, including the current year

BOOK VALUE PER SHARE Case 1 - The preference shares are noncumulative; liquidation value is P110 per share.

Book value per share is the peso equity in corporate capital of each capital share. It is the amount Total shareholders’ equity P 17,500,000
that would be paid on It each share owned by shareholder in case of corporate liquidation Less Equity identified with preference shares
assuming the amount available to shareholders is exactly the same as the total shareholders' Liquidation value = 50,000 sh x P110 5,500,000
equity. Equity identified with ordinary shares P 12,000,000

The calculation of book value per share depends on how many classes of share capital are Book value per share:
outstanding. If there is only one class of share capital outstanding, book value per share is Preference = P5,500,000/50,000 P 110.00
calculated by dividing the total shareholders' equity by the number of shares outstanding. Ordinary = P12,000,000/200,000 P 60.00
Subscribed shares, if any, should be added to the outstanding shares.
Case 2 – The preference shares are cumulative; liquidation value is P110 per share.
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 Total shareholders’ equity P 17,500,000
ordinary shareholders as to distribution of assets upon corporate liquidation. Less Equity identified with preference shares
Liquidation value = 50,000 sh x P110 P 5,500,000
Thus, the equity identified with the preference share capital should be determined first. The Div. in arrears = P5,000,000 x 10% x 2 1,000,000 6,500,000
balance of the shareholders' equity after deducting the equity of preference shareholders Equity identified with ordinary shares P 11,000,000
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. Book value per share:
Preference = P6,500,000/50,000 P 130.00
EQUITY IDENTIFIED WITH PREFERENCE SHARE CAPITAL. The equity of the holders of Ordinary = P11,000,000/200,000 P 55.00
preference shares generally consists of the liquidation value of the share and any claim on
dividends. Liquidation value of the share capital reference the amount payable to preference EARNINGS PER SHARE
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. 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
EQUALLY IDENTIFIED WITH ORDINARY SHARE CAPITAL. The equity of the holders of earnings per share. However, this chapter is focused only on the computation of basic EPS.
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 The provisions of PAS 33 shall be applied in the computation of earnings per share of the
ordinary shareholders in case of corporate liquidation. following entities:

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Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
Case 1 – The company has 20,000 ordinary shares outstanding.
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 EPS = P450,000/20,000 P22.50
3. those that voluntarily disclose earnings per share
Case 2 – The company has the following share capital outstanding:
The earnings per share information is presented in the statement of comprehensive income, even
if the amount is negative. 5,000 shares of 10% preference share capital, par value P100
20,000 shares of ordinary share capital, par value P20
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 The preference shares are cumulative; no dividends were declared during the period.
of convertible preference shares is given the privilege of exchanging the preference shares for
ordinary shares. Profit P450,000
Less Dividends on cumulative preference shares
Basic earnings per share shall be computed as follows: 5,000 sh x P100 x 10% 50,000
Profit attributable to ordinary shares P400,000
1. There is only one class of share capital outstanding (that is, ordinary shares)
EPS = P400,000/20,000 P 20.00
EPS = Profit / outstanding ordinary shares
Case 3 – The company has the following share capital outstanding:
2. There are two classes of share capital outstanding tat is, ordinary shares and preference
shares) 5,000 shares of 10% preference share capital, par value P100
20,000 shares of ordinary share capital, par value P20
Profit or loss per income statement xxx
Less Dividends on preference shares The preference shares are non-cumulative; no dividends were declared during the
(Total par value of preference shares x dividend rate) xxx period.
Profit attributable to ordinary shares xxx
EPS = P450,000/20,000 P 22.50
Earnings per share
(Profit attributable to ordinary shares/outstanding shares) xxx APPROPRIATION OF RETAINED EARNINGS
If the preference shares are cumulative, the dividends required for the period will be As mentioned in the earlier part of this chapter, Appropriated Retained Earnings is that portion
deducted, whether they are declared or not. However, if the preference shares are non- of retained earnings set aside for a special or specific purpose. Appropriation of retained
cumulative, only dividends declared in respect of the period will be deducted. earnings reduces the amount available for distribution as dividends to shareholders. However,
the total retained earnings remains unchanged.
The earnings per share figure is very useful to investors prospective investors in evaluating the
results of operations of a business in order to make investment decisions. It is also considered as There are three types of appropriations to Retained Earnings which are acceptable and these are
a significant determinant of the market price of the share capital. discussed in the succeeding paragraphs.

APPROPRIATIONS TO REPORT LEGAL RESTRICTIONS ON RETAINED EARNINGS. When a

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.
company requires its own shares, the law requires that Retained Earnings equal to the cost of
the shares reacquired (known as treasury shares) be appropriated or set aside. This is done to
maintain at original or stated balances the resources of the business and the shareholders'
equity. The appropriated balance is reverted to unappropriated classification upon reissuance of
the reacquired shares.

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Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
APPROPRIATIONS TO REPORT CONTRACTUAL RESTRICTIONS O RETAINED EARNINGS.
Agreements with creditors or shareholders may provide for retention of a portion of Retained
Earnings within the company. The appropriations of Retained Earnings is made to protect the
interest of creditors and shareholders and to assure redemption of the securities they hold. The
appropriation balance is reverted back to unappropriated balance upon payment of the
obligation. Examples of appropriations under this classification are Appropriation for Bond
Redemption and Appropriation for Preference Share Capital Redemption.
APPROPRIATIONS TO REPORT DISCRETIONARY ACTION BY THE BOARD OF DIRECTORS IN
THE PRESENTATION OF RETAINED EARNINGS. A portion of the Retained Earnings may be
presented in a manner disclosing the actual use or planned use in the future of the resources as
authorized by the board of directors Examples of appropriations under this classification are
Appropriation for Plant Expansion and Appropriation for General Contingencies.
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 of retained earnings
b. Retained Earnings Appropriated for …… xxx
Retained Earnings xxx
Cancellation of appropriation to retained earnings
REVIEW OF THE LEARNING OBJECTIVES
1. Explain the preparation of work sheet, adjusting entries, and closing entries for a
corporation. The work sheet prepared for a corporation is similar to the work sheet
prepared for a sole proprietorship and a partnership. It normally contains eight columns
and is prepared to facilitate the preparation of financial statements. The adjusting entries
include adjustment for income tax which is 35% of profit before income tax. In a corporation,
the income or loss of the company is transferred to Retained Earnings, which is also a
capital account.
2. Explain the components of the shareholders’ equity section of the statement financial
position. The capital section of the statement of financial position (balance sheet) of a
corporation is called "Shareholders’ Equity" section. lt is generally composed of the
following: (1) Contributed Capital, which represents capital arising from contributions by
shareholders and is subdivided into Share Capital and Additional Paid-in Capital; and (2)
Retained Earnings, which represents capital arising from operations of the business. In
some instances, corporations may have capital adjustment accounts such as Revaluation
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Surplus. These accounts are reported separately from Contributed Capital and Retained
Earnings.
3. Prepare the financial statements of a corporation, specifically the statement of changes
in shareholders’ equity. A corporation has also four basic financial statements, (balance
sheet or statement of financial position, income statement, statement of cash flows, and
statement of changes in shareholders’ equity that shows transactions that have caused an
increase or a decrease in Total Shareholders’ Equity during the period, such as distribution
of dividends and profit for the year.
4. Identify the different types of dividends and compute amount of dividends to be
distributed to preference and ordinary shareholders. Dividends are distribution of
corporate income to the shareholders. Dividends may be distributed of corporate income to
the shareholders. Dividends may be distributed in the form of cash, non-cash assets or
shares of stock of the corporation. On the date of declaration, Retained Earnings account is
debited, thereby reducing its balance. The amount debited to Retained Earnings depends on
the type of dividend declared. When two classes of share capital are outstanding, the total
amount of dividends declared should be allocated properly talking into account the type of
preference shares outstanding.
5. Discuss the computation of book value per share and earnings per share. Book value per
share is the peso equity in corporate capital of each share capital. It represents the amount
that a shareholder will receive for every share owned in case of corporate liquidation. If
there is only class of share capital outstanding, it is computed by dividing the total
shareholders’ equity by the total number of outstanding shares. When there are two classes
of share capital outstanding, the equity identified with the preference shares must be
determined first and deducted from the total shareholder’s equity to get the equity
identified with ordinary shares. Book value per share is then computed by dividing the
equity identified with each class of stock by the total number of outstanding shares per class.
The earnings per share (EPS) is the amount earned during a given period on each ordinary
share outstanding. When there is only one class of share capital outstanding, it is computed
by dividing the net income or the profit of the company by the number of outstanding
ordinary shares. When there are two classes of share capital outstanding, the earnings
allocated to the ordinary shares is first computed by deducting the earnings identified with
the preference shares. The earnings per share is then calculated by dividing the earnings
allocated to the ordinary shares by the number of outstanding ordinary shares.
6. Identify and explain the different types of retained earnings appropriations.
Appropriation of Retained Earnings is setting aside a portion of Retained Earnings for a
specific or special purpose and such appropriation reduces the amount of Retained Earnings
available to shareholders as dividends. Retained Earnings may be appropriated for the
following purposes: (1) to meet legal requirements; (2) to meet contractual requirements;
and (3) to meet discretionary action by the board of directors.
Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
MULTIPLE CHOICE
GLOSSARY OF ACCOUNTING TERMINOLGIES MC 9-1 Which of the following statements is not correct regarding the appropriations of
Retained Earnings?
a. Appropriations of Retained Earnings do not change the total amount of Retained
Additional paid-in Capital – corporate capital arising from investment by shareholders in Earnings.
excess of the par or stated value of the share capital. b. Appropriation of Retained Earnings reflect funds set aside for a designated
purpose, such as plant expansion.
Appropriated Retained Earnings – Retained Earnings set aside for a specific purpose, hence, c. Appropriations of Retained Earnings can be made as result of a contractual
not available for dividend distribution. requirement.
d. Appropriations of Retained Earnings can be made at the discretion of the board
Book value per share – peso equity in corporate capital of each share of stock. It is the amount of directors.
that a shareholder would receive for every share owned in case of corporate liquidation.
MC 9-2 When a portion of shareholders’ original investment is returned in the form of a
Cash dividends – dividends distributable in the form of cash dividend, it is called a (an)
a. compensating dividend
Contributed Capital – corporate capital arising from investment by shareholders b. liquidating dividend
c. property dividend
Dividends – distribution of corporate earnings to shareholders d. equity dividend
Dividends in arrears – unpaid dividends in prior years 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)
Earnings per share – amount earned during a given period on each ordinary share outstanding a. current liability
b. addition to share capital outstanding
Property dividends – dividends distributable in the form of non-cash assets c. reduction in total shareholders’ equity
d. noncurrent liability
Retained Earnings – corporate capital arising from operations of the business. Its balance
represents undistributed earnings of the company. It is also known as “earned surplus” MC 9-4 A company declared a cash dividend on its ordinary share capital in December 2014,
payable in January 2015. Retained Earnings would
Share capital dividends – dividends distributable in the form of a corporations’ own share a. increase on the date of declaration
capital b. not be affected on the date of declaration
c. not be affected on the date payment
Unappropriated Retained Earnings – retained earnings available for dividend distribution to d. decrease on the date of payment
shareholders
MC 9-5 On March 20, 2014, AAA Corp. declared the distribution of the following dividend to
its shareholders of record as of March 31, 2014.
Investment in 100 shares of BBB Corp. stock, carrying value and fair value,
P600,000

The entry to record the declaration of the property dividend would include a debit to
Retained Earnings of
a. P 600,000
b. P 650,000
c. P 850,000
d. P1,575,000

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Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
MC 9-9 The shareholders’ equity of NNN Comp any on December 31, 2014 follows:
MC 9-6 The shareholders/ equity section of GGG Corp. as of December 31, 2014 contained the
following accounts: 10% Preference Share Capital, P100 par P 500,000
Ordinary Share Capital, P60 par 3,000,000
Ordinary Share Capital, 25,000 shares authorized, Preference Share Premium 50,000
10,000 shares issued and outstanding P 30,000 Ordinary Share Premium 250,000
Ordinary Share Premium 40,000 Retained Earnings 300,000
Retained Earnings 80,000 Total Shareholders’ Equity P4,100,000
P 150,000
Preference shares are cumulative with dividends in arrears for 5 years at the beginning
GGG’s board of directors declared a 10% stock dividend on April 1, 2015 when the of 2010 and with a liquidation value of P120.
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 What is the book value per share of preference share capital?
P12,000 for the first three months. a. P100
b. P120
What is the balance of the Retained Earnings accounts as of April 1, 2015? c. P170
a. P61,000 d. P180
b. P64,000
c. P68,000 MC 9-10 Using the information in MC 9-9, what is the book value per share of ordinary share
d. P73,000 capital?
a. P60
MC 9-7 The JJJ Corporation has the following classes of share capital outstanding as of b. P64
December 31, 2014: c. P65
Ordinary Share Capital, P20 par value, 20,000 shares outstanding, d. P70
Preference Share Capital, 6%, P100 par value, cumulative, 2,000
shares outstanding MC 9-11 On April 8, 2014, Cordillera Corp. declared and issued a 25% ordinary share capital
dividend. Prior to this date, Cordillera had 20,000 shares of P2 par value ordinary share
No dividends were paid on preference shares for 2012 and 2013. On December 31, that were both issued and outstanding. The carrying value of each share of stock is P20
2014, a total cash dividend of P200,000 was declared. at the time of declaration of the dividend.

How much dividends will be received by ordinary shareholders? As a result of the share capital dividend, how much will be debited to retained Earnings?
a. P 0 a. P 10,000
b. P164,000 b. P 40,000
c. P176,000 c. P 75,000
d. P188,000 d. P 100,000

MC 9-8 Using the information in MC 9-7, how much dividends will be received by preference MC 9-12 Using the information in MC 9-11, what is the effect of the share capital dividend on
shareholders? total shareholders’ equity?
a. P 12,000 a. Decreased by P40,000
b. P 24,000 b. Decreased by P10,000
c. P 36,000 c. Increased by P100,000
d. P200,000 d. Did not change

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Chapter 9 – Operations, Dividends, Book Value per Share, and Earnings per Share
MC 9-17 Using the information in MC 9-13, what is the total amount of Share Capital?
MC 9-13 The adjusted trial balance of ZZZ Corp. on December 31, 2014 includes the following a. P1,050,000
account balances: b. P1,075,000
c. P1,138,000
Dividends Payable P 40,000 d. P1,180,000
Ordinary Share Capital (P5 par, 500,000 shares authorized) 750,000
Ordinary Share Capital Subscribed (10,000 shares) 25,000 MC 9-18 Using the information in MC 9-13, what is the total amount of Contributed Capital?
Ordinary Share Premium 50,000 a. P1,050,000
10% Preference Share Capital (25,000 shares authorized, b. P1,323,000
12,000 shares outstanding) 300,000 c. P1,363,000
Preference Share Premium 30,000 d. P2,063,000
Retained Earnings Appropriated for Contingencies 150,000
Retained Earnings Appropriated for Bond Retirement 100,000 MC 9-19 Using the information in MC 9-13, what is the total amount of Retained Earnings
Retained Earnings – Unappropriated 450,000 available for dividend distribution?
Ordinary Share Capital Dividends Distributable 105,000 a. 450,000
Paid-in Capital from Share Capital Dividend 63,000 b. P550,000
c. P600,000
What is the number of ordinary shares issued and outstanding? d. P700,000
a. 5
b. 150,000 MC 9-20 Using the information in MC 9-13, what is the total amount of shareholders’ equity?
c. 500,000 a. P1,363,000
d. 750,000 b. P2,000,000
c. P2,023,000
MC 9-14 Using the information in MC 9-13, what is the par value for each preference share d. P2,063,000
capital?
a. P10
b. P12
c. P25
d. P40

MC 9-15 Using the information in MC 9-13, what is the market value for each ordinary share
capital upon the declaration of the share capital dividend?
a. P 5
b. P 8
c. P 10
d. P 25

MC 9-16 Using the information in MC 9-13, how much is the total amount of retained Earnings?
a. P100,000
b. P150,000
c. P450,000
d. P700,000

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 Chapter 10 – Share Capital Transactions Subsequent to Original Issuance
SHARE CAPITAL RETIREMENT
CHAPTER 10
Share capital may be reacquired and formally retired by the issuing corporation. Such
retirements calls for the cancellation of the stock certificate, cancellation of the share capital
SHARE CAPITAL TRANSACTIONS 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
SUBSEQUENT TO ORIGINAL ISSUANCE is debited for the difference. On the other hand, if the retirement price is less than the original
issuance price, Paid-in Capital from the Retirement of Share Capital is credited for the difference.
LEARNING OBJECTIVES The difference between the retirement price and the original issuance price of the share capital
retired should not be recognized as a gain or loss. The excess of the original issuance price over
1. Identify and explain the various share capital transactions subsequent to original issuance. the retirement price of the share capital should not be credited to Retained Earnings.
2. Explain the methods of acquiring and accounting for treasury shares.
The retirement of share capital will reduce both the number of shares issued and the number of
PREVIEW OF THE CHAPTER shares outstanding.

Illustrative Problem A: The shareholders’ equity section of the statement of financial position
SHARE CAPITAL of CBA Co. contains the following;
TRANSACTIONS
Preference share capital, P100 par, 10,000 shares P1,000,000
Preference share premium 250,000
Retained earnings 800,000

Share Capital Transactions Treasury Shares Based on the above data, the original issuance price of each preference share is P125, that is, the
Other Than Acquisition of par value of P100 per share and share premium of P25 per share (P250,000/10,000 shares).
Treasury Shares • Acquisition
• Retirement • By purchase One thousand (1,000) shares of preference share capital were reacquired and retired. Entries to
• Conversion of preference • By donation record the retirement using two independent cases follow:
shares into ordinary shares • Method of Accounting Case 1 – The retirement price is P110
• Share (Stock) split • Cost Method
• Recapitalization Preference Share Capital 100,000
Preference Share Premium 25,000
Cash 110,000
TYPES OF SHARE CAPITAL TRANSACTIONS Paid-In Capital from Retirement
Of Preference Shares 15,000
When a share capital (capital stock) is fully paid, a stock certificate is issued to the shareholder 1,000 sh x P100=P 100,000
and the stock becomes outstanding. Subsequent to the original issuance, various capital share 1,000 sh x P25 =P 25,000
transactions may take place. These transactions may cause a change in total shareholders’ 1,000 sh x P110=P 110,000
equity of the company or in the number of shares outstanding. These share capital transactions 1,000 sh x P15 =P 15,000
include the following:
1. Share capital retirement
2. Share capital reacquisition
3. Conversion of preference shares into ordinary shares
4. Share (stock) split
5. Recapitalization

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Chapter 10 – Share Capital Transactions Subsequent to Original Issuance
The balance of the treasury shares account is reported as a deduction from the sum of total
Case 2 – The retirement price is P130 per share contributed capital and retained earnings.

Preference Share Capital 100,000 The reacquisition of a company’s own shares reduces the number of outstanding shares but
Preference Share Premium 25,000 does not affect the number of issued shares. Treasury shares are not entitled to receipt of
Retained Earnings 5,000 dividends because they are not outstanding. Retained Earnings, however, must be appropriated
Cash 130,000 equal to the cost of the treasury shares acquired.
1,000 sh x P100=P 100,000
1,000 sh x P25 =P 25,000 Illustrative Problem B: The shareholders’ equity of JJJ Corp. included the following items:
1,000 sh x P5 =P 5,000
1,000 sh x P130 =P 130,000 Ordinary share capital, P20 par, 50,000 shares P1,000,000
Ordinary share premium (P5 per share) 250,000
The debit to retained Earnings of P5,000 or P5.00 for every share retired is the excess of the Retained earnings 500,000
retirement price of P130 over the original issuance price of P125.
On September 1, 2014, 1,000 shares were reacquired at P24. On September 30, 700 shares were
SHARE CAPITAL REACQUISITION (TREASURY SHARES) reissued at P30.

Entries to record the foregoing and the shareholders’ equity section of the statement of financial
The issuing corporation sometimes reacquires shares issued to shareholders either by purchase
position as of September 30 are presented below and on the next page.
or donation. Such shares are being held in the name of the corporation and they are called
treasury shares. The company may reissue these shares at some future date as deemed
2014
necessary.
Sept. 1 Treasury Shares 24,000
Cash 24,000
The practice of reacquiring one’s own capital share is done for the following reasons:
1,000 sh x P24 = P24,000
1. To obtain shares to be used in acquiring plant assets.
1 Retained Earnings 24,000
2. To improve earnings per share by reducing the number of shares outstanding
Retained Earnings Appropriated for 24,000
3. To invest excess cash temporarily.
Treasury Shares
4. To support the market price of the share capital.
5. To increase the ratio of liabilities to shareholders’ equity.
30 Cash 21,000
6. To obtain shares for conversion to other securities such as preference share capital.
Treasury Shares 16,800
Paid-In Capital from Sale of Treasury 4,200
REACQUISITION BY PURCHASE Shares
700 sh x P30 = P21,000
Treasury shares may be acquired by purchase and the reacquisition will be accounted for using 700 sh x P24 = P16,800
the cost method. 700 sh x P6 = P 4,200

Under the cost method, the reacquired shares are viewed as capital elements awaiting ultimate 30 Retained Earnings Appropriated for
disposition. Treasury shares are recorded at cost. When the shares are reissued at more than Treasury Shares 16,800
cost, the indicated gain is credited to an additional paid-in capital account Paid-In Capital from Retained Earnings 18,800
Sale of Treasury Shares. When the shares are reissued at less than cost, the indicated loss is
debited to the following accounts in the order shown below:
(a) additional paid-in capital from treasury share transactions of the same class of share
capital, and
(b) retained earnings

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Chapter 10 – Share Capital Transactions Subsequent to Original Issuance
CONVERSION OF PREFERENCE SHARES INTO ORDINARY SHARES
Shareholders’ Equity
Convertible preference shares can be converted into ordinary shares at the option of the holder.
Contributed Capital:
This type of preference share capital can be sold at a higher price but a lower dividend rate
Ordinary Share Capital, P20 par, 50,000 shares
because of its conversion privilege.
issued, 49,700 shares outstanding, 300 shares in
treasury P1,000,000
The accounting for conversion of preference shares into ordinary shares is similar to retirement
Ordinary Share Premium 250,000
of share capital. Account balances related to the preference shares converted are cancelled and
Paid-in Capital from Sale of Treasury Shares 4,200 P1,254,200
the issuance of ordinary shares is recorded. An indicated fain from conversion is credited to Paid-
Retained Earnings: In Capital from Conversion of Preference Shares into Ordinary Shares; an indicated loss from
Retained Earnings Appropriated for Treasury Shares P 7,200 conversion is debited to Retained Earnings.
Unappropriated Retained Earnings 492,800 500,000
Total Contributed Capital and Retained Earnings P1,754,200 Illustrative Problem C: The LMN Corporation’s shareholders’ equity contains the following:
Less Treasury Shares, at cost (300 @ P24) 7,200
Ordinary Share Capital, P10 par, 50,000 shares P 500,000
Total Shareholders’ Equity P1,747,000
Ordinary Share Premium 100,000
10% Preference share capital, P100 par, 5,000 shares 500,000
Preference share premium 50,000
REACQUISITION BY DONATION Retained earnings 750,000

Treasury shares may be acquired through donation by shareholders. This practice is done by On July 15, 1,000 preferences shares were converted into ordinary shares.
shareholders to enable the company to increase its working capital and at the same time
maintain their proportionate ownership interests. Case 1 – Twenty ordinary shares were issued for every preference share

Upon receipt of capital shares as donation, a memorandum entry is made stating the number of Preference Share Capital 100,000
shares received. Subsequent sale of donated shares is recorded by debiting Cash and crediting Preference Share Premium 10,000
Donated Capital or Paid-In Capital from Donated Shares for the entire proceeds. Retained Earnings 90,000
Ordinary Share Capital 200,000
Alternatively, the receipt and the subsequent sale of the donated shares may be recorded as 1,000 sh x P100 = P100,000
follows: 1,000 sh x P10 = P 10,000
1,000 sh x 20 sh x P10 = P200,000
Upon receipt P200,000 – P110,000 = P 90,000
Treasury Shares xxx
Donated Capital xxx
(amount recorded is the fair value of the shares on the date of donation) Case 2 – Eight ordinary shares were issued for every preference share

Upon sale of donated shares at more than recorded cost Preference Share Capital 100,000
Cash xxx Preference Share Premium 10,000
Treasury Shares xxx Ordinary Share Capital 80,000
Paid-in Capital from Sale of Treasury Shares xxx Paid-in Capital from Conversion of
Preference Share into Ordinary Shares 30,000
1,000 sh x P100 = P100,000
1,000 sh x P10 = P 10,000
1,000 sh x 20 sh x P10 = P200,000
P200,000 – P110,000 = P 90,000

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Chapter 10 – Share Capital Transactions Subsequent to Original Issuance
accounts related to the new issue and the cancellation of account balance related to the old issue.
Just like in the retirement of share capital and acquisition of treasury shares, no gain or loss is (Capital restructuring will be discussed in a higher accounting subject.)
recognized on the conversion of preference shares into ordinary shares.
Illustrative Problem D: The shareholders’ equity of Quezon Co. contains the following:
SHARE (STOCK) SPLITS AND REVERSE SHARE (STOCK) SPLITS
Ordinary share capital. P20 par, 50.000 shares P1,000,000
When the market price of the shares is high and the corporation feels that a lower price will result Ordinary share premium 250,000
in a wider distribution of ownership, it may authorize the replacement of outstanding shares by Retained earnings 500,000
a larger number of shares. The increase in the number of shares outstanding in this manner is
called share (stock) split or share split-up. For instance, 10,000 ordinary shares with a par Case 1 - The original issue is replaced by a no-par share capital with a stated value of P20
value of P10 are replaced by 20,000 ordinary shares with a par value of P5. This type of
transaction is described as a share split of 2 for 1 - two new shares are issued in exchange for one Ordinary Share Capital. P20 par 1,000,000
old share. The par value is subsequently reduced to P5 (i.e, P10/2) Ordinary Share Premium 250,000
Ordinary Share Capital, P10 stated value 1,000,000
The reverse procedure, that is, the replacement of shares outstanding by a smaller number of Paid-In Capital from Exchange of Par
shares with an increase in the par value, is called reverse share split or a share split down. for No-Par Share Capital 250,000
This is desirable when the market price of the shares is low and it is felt that assigning a higher
price for the shares offers certain advantages. For instance, 10,000 ordinary shares with a par Case 2 - Each capital share is exchanged for a new share with a par value of P15
value of P10 are replaced by 5,000 ordinary shares with a par value of P20. This type of
transaction is described as a share split of 1 for 2 - one new share is issued in exchange for two Ordinary Share Capital, P20 par 1,000,000
old shares. The par value is subsequently increased to P20(i.e. P10 x 2). Ordinary Share Capital, P15 par 750,000
Paid-in Capital from Reduction in Par
A share split is recorded by a memorandum entry. The entry should state the new number of Value of Ordinary Shares 250,000
shares and the new par value of the shares. Alternatively, a journal entry may be prepared
canceling the old issue and recording the new issue. Using the example in the first paragraph, the
share split of 2 for l may be recorded as follows:
REVIEW of the LEARNING OBJECTIVES
Ordinary Share Capital, P10 par 100,000
Ordinary Share Capital, P5 par 100,000
1. Identify and explain the various share capital transactions subsequent to original
It should be noted that a share split will not affect total shareholders' equity nor total share
issuance. Share capital transactions subsequent to original issuance include the following:
capital. It will simply change the number of shares outstanding and the par value per share of
(1) share capital retirement; (2) share capital reacquisition; (3) conversion of preference
stock.
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
RECAPITALIZATION arising from these transactions, and (2) indicated loss on share capital transactions may be
charged against retained earnings, but indicated gain cannot be credited to retained
Corporate recapitalization takes place when an entire issue of share capital is changed by earnings. Indicated gain should be credited to additional paid-in capital. 2
appropriate action of the corporation. The typical types of recapitalization are as follows:
2. Explain the methods of acquiring and accounting for treasury shares. Treasury shares
1. Change from par to no-par share. capital and vice-versa are shares issued to the shareholders and subsequently reacquired by the corporation with
2. Reduction in the par or stated value of share capital. the intention of reissuing them. Treasury shares may be acquired either by purchase or by
donation. Transaction’s relating to treasury shares shall be accounted for using the cost
Recapitalization is normally undertaken to establish an additional paid-in capital account that method. Under the cost method, treasury shares is reported on the statement of financial
will be used in capital restructuring. This type of transaction requires the setting up of capital position as a deduction from total shareholders' equity.

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Chapter 10 – Share Capital Transactions Subsequent to Original Issuance

MULTIPLE CHOICE
GLOSSARY of ACCOUNTING TERMINOLOGIES
MC 10-1 The following information was abstracted from the accounts of the Jimenez Corp. at
Convertible preference shares – preference shares that can be converted into ordinary shares year-end:
at the option of the shareholder. Total profit since incorporation P420,000
Total cash dividends paid 130,000
Recapitalization – change in the capital structure of a corporation by reducing the par or stated Proceeds from sale of donated shares 45,000
value of share capital or by exchanging par value for no-par value share capital or vice-versa. Total value of stock dividends distributed 30,000
Excess of proceeds over cost of treasury
Reverse share split – replacement of outstanding shares by a smaller number of shares with a shares sold 70,000
proportionate increase in the par or stated value of the share capital. It is also known as share
split-down. What should be the balance of Retained Earnings?
a. P260,000
Share split – replacement of outstanding shares by a greater number of shares with a b. P290,000
proportionate decrease in the par or stated value of the share capital It is also known as share c. P305,000
split-up. d. P335,000

Treasury shares – capital shares issued to shareholders and subsequently reacquired by the MC 10-2 Jamier Corp. was organized on January 2, 2014, with authorized capital of 100,000
corporation with the intention of reissuing them. shares of P10 par ordinary share capital. During 20l4, Jamier had the following
transactions affecting shareholders' equity.

Jan. 7 - Issued 40,000 shares at P12 per share.

Dec. 2 - Purchased 6,000 treasury shares at P13 per share.

Profit for the year amounted to P300,000. shareholders' equity as of December 31,
2014?
a. P640,000
b. P702,000
c. P708,000
d. P720,000

MC 10-3 On December 10, Joshua Co. split its share capital on a 5-for-2 when the market value
was P60 per share. Prior to the split Joshua had 200,000 shares of P15 par value share
capital. What is the par value of the share capital after the split?
a. P3.00
b. P6.00
c. P15.00
d. P26.000

MC 10-4 Using the information in MC 10-3, how many shares are outstanding after the split?
a. 200,000
b. 300,000
c. 500,000
d. 1,000,000

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Chapter 10 – Share Capital Transactions Subsequent to Original Issuance
MC 10-9 ABC Corp. reported the following in its statement of shareholders' equity on January 1,
MC 10-5 During the fiscal year 2014, Jezuel Corp. issued for P110 per share 15,000 shares of 2014:
P100 par value convertible preference share capital. One preference share is Ordinary share, P5 par value, 200,000 shares
convertible into three ordinary shares with a par value of P25. On November 15, 2014, authorized, 100,000 shares issued
all of the preference shares were converted into ordinary shares. The market value of Additional paid-in capital
the ordinary shares on the conversion date was P40 per share. Retained earnings
Total contributed capital and retained earnings
What amount should be credited to the ordinary share capital account as a result of Less Treasury shares, 5,000 shares at cost
conversion of preference shares into ordinary shares? Total shareholders' equity
a. P1,125,000
b. P1,500,000 The following events occurred in 2014:
c. P1,650,000
d. P1,800,000 May 1 1,000 treasury shares were sold for P10 000
July 9 10,000 shares previously unissued for P12 per share.
MC 10-6 Joros Corp, was organized on January 1, 2012, at which date it issued 100,000 shares of Oct. 15 There was a 2-for-1 share split
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 How many shares are issued and outstanding at December 31, 2014?
10, 2014, the company purchased 6,000 of its own shares at P12 per share. On a. 220,000 and 216,000
November 20, 2014, Joros sold 4,000 treasury shares at P8 per share. What is the total b. 220,000 and 212,000
shareholders' equity on December 31, 2014? c. 110.000 and 106.000
a. P1,680,000 d. 100,000 and 95,000
b. P1,688,000
c. P1,704,000 MC 10-10 On December 29, 2013. Blue Company was registered at the Securities and Exchange
d. P1,720,000 Commission with 100,000 authorized ordinary shares of P100 par value. The following
were Blue’s transactions:
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 Dec. 29, 2013 Issued 40,000 shares at P105 per share.
b. debit to Retained Earnings of P16,000 May 14, 2014 Purchased 600 of its ordinary shares at P110 per share
c. credit to PIC from Sale of Treasury Shares of P16,000 Aug. 9, 2014 400 treasury shares were sold at P95 per share
d. debit to PIC from Sale of Treasury Shares of P16,000 Dec. 31 2014 Profit P830,000, cash dividends paid P200,000

MC 10-8 Jabar Corp. holds 10,000 ordinary shares, par value P10, as treasury shares, which was What is the total shareholder' equity of Blue company on December 31, 2014?
purchased in year 2013 at a cost of P120,000. On December 8, 2014, Jabar sold all the a. P 4,352,000
10,000 shares for P210,000. The sale would result in a credit to Paid-in Capital from b. P 4,802,000
Sale of Treasury Shares in the amount of c. P 4,820,000
a. P 90,000 d. P10,602,000
b. P110,000
c. P120,000
d. P210,000

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 Chapter 11 – Financial Reporting and Analysis
General purpose financial statements are financial statements that are intended to meet the
common needs of users who are not in position to demand reports customized to their specific
CHAPTER 11 information needs.

FINANCIAL REPORTING AND ANALYSIS 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
LEARNING OBJECTIVES other entities. PAS 1 also identities the minimum content of what should be included in the
financial statements and the guidelines as to their structure.
1. Explain the nature of the financial statements and the over-all considerations in their preparation
and presentation. OBJECTIVE OF FINANCIAL STATEMENTS
2. Identify and explain the components of a complete set of financial statements.
3. Explain and appreciate the importance of the statement of cash flows. The objective of general purpose financial statements is to provide information about the
4. Describe and explain the classification of cash flows and the methods of presenting cash flows from financial position, financial performance and cash flows of an entity that is useful to a wide range
operating activities. of users in making economic decisions.
5. Explain and appreciate the different types of ratio analysis

PREVIEW OF THE CHAPTER DEFINITION AND NATURE OF FINANCIAL STATEMENTS

Financial statements are a structured representation of the financial position and Financial
FINANCIAL performance of an entity. They show the assets, liabilities and equity of an entity as of a
REPORTING and ANALYSIS particular dale. They also show the income earned and expenses incurred by an entity during a
given period.

Financial statements are the end product of the accounting process. The financial statements
Financial Reporting Financial Statements and Financial Statement
are the final output of the accounting process. They can be prepared only after the transactions
their Elements Analysis have been processed and the necessary adjusting entries are journalized and posted.
• Objective, definition • Statements of financial • Ratio analysis
and nature of financial position • Liquidity ratios Financial statements show the results of the management’s stewardship of the resources
statements • Statement of comprehensive • Solvency ratios entrusted to in. The owners of an entity entrust to management the utilization of company
• Overall consideration income resources to achieve both short-term and long-term goals of the entity. They are expected to
• Profitability-
in the preparation of • Statement of changes in maximize the earnings potential of these resources and provide rate of return on their use that
financial statements equity ratios
is acceptable to the investors and other stakeholders. The financial statements show the
• Statement of cash flows performance of management vis-à-vis the expectations of the investors or owners.
• Notes
• 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
INTRODUCTION of an entity are informed of the financial position and the performance of an entity through the
financial statements.
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 The preparation and presentation of financial statements is a responsibility of
operations of an entity; hence, they rely heavily on the financial reports provided to them. It is management. The Board of Directors reviews and approves the financial statements before
very important, therefore, that these reports be reliable and timely so that those who use them these are submitted to the shareholders of the entity. A management’s representation letter is
can make sound decisions and reasoned choices among alternative courses of action. attached to the published financial statements.

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.
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Chapter 11 – Financial Reporting and Analysis
COMPONENTS OF FINANCIAL STATEMENTS
According to PAS 1 (revised (2011), a complete set of financial statements comprises:
• a statement of financial position (balance sheet)
• a statement of comprehensive income (alternatively, an entity may prepare a separate
income statement and a separate statement of other comprehensive income)
• a statement of changes in equity
• a statement of cash flows; and
• notes, comprising a summary of significant accounting policies and other explanatory
notes.
Some entities, however, present other reports in addition to those stated above. Examples are
the following:
• a financial review by management that describes and explains the main features of the
entity's financial performance and financial position and the principal uncertainties it
faces;
• environmental reports and value added statements, particularly in industries in which
environmental factors are significant and when employees are considered an
important user group.
These reports, which are presented outside of the financial statements, are outside of the scope
of PAS 1.
OVERALL CONSIDERATIONS IN THE PREPARATION AND PRESENTATION
OF FINANCIAL STATEMENTS
PAS 1 identifies eight (8) basic considerations when preparing and presenting financial
statements. These considerations are described briefly below.
Fair presentation and compliance with PFRSs/ IFRSs. Financial statements shall present fairly
the financial position, performance and cash flows of an entity. Fair presentation requires the
faithful representation of the effects of transactions other events and conditions in accordance
with the definitions and recognition criteria for assets, liabilities, income and expenses set out in
the Framework. The application of PFRSs/IFRSs, with additional disclosure when necessary, is
presumed to result in financial statements that achieve fair presentation. (PAS 1, par. 15)
Going concern. Financial statements shall be prepared on a going concern basis unless
management either intends to liquidate the entity or to cease trading, or has no realistic
alternative but to do so. This means that an entity is assumed to have a continuity of life, unless
there is an evidence to the contrary. Any uncertainties that may cast doubt as to the ability of the
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entity to continue as a going concern, however, should be properly disclosed. An example of
application of going concern is the use of accrual basis of accounting. (PAS 1, par. 25)
Accrual basis of accounting. An entity shall prepare its financial statements, except for cash flow
information, using the accrual basis of accounting. Under the accrual basis of accounting, income
and expenses are recognized in the period in which they relate rather than when the cash is
received or paid. For example, sales on account made in 2014 that will be collected in 2015 is
recognized as sales in 2014. An insurance premium paid in 2014 covering the period 2015 is
recognized as expense in 2015; the payment is recognized as prepaid expense at the end of 20l4
(PAS 1, par. 27)
Frequency of reporting. An entity shall present a complete set of financial statements (including
comparative information) at least annually. An entity chooses its own annual accounting period
- it can adopt the calendar year or adopt a fiscal year. The calendar year starts January 1 and ends
December 31. The adoption of a fiscal year may depend on the nature of business or operations
of the entity. A school, for instance, may adopt an accounting period that starts June 1 and ends
May 31 with the start and end of one school year. (PAS 1 par.36)
Materiality and aggregation. Each material class of similar items shall be presented separately
in the financial statements. Items of dissimilar nature or function shall be presented separately
unless they are immaterial. For example, cash on hand and cash deposited in various banks may
be aggregated and reported under a single line item "Cash on hand and in banks" but trade
receivables are presented separately from nontrade receivables because of their dissimilar
nature. An entity with several prepaid items which are immaterial in amount may present these
prepayments under the line item "prepaid expenses". (PAS 1, par. 29)
Offsetting. As a general rule, assets and liabilities, and income and expenses, shall not be offset
unless required or permitted by a Standard or an Interpretation. Offsetting is deducting the
balance of an asset account from the balance of a liability account and reporting only the net
amount in the statement of financial position or deducting the balance of an income account from
the balance of an expense account and reporting only the net amount in the statement of
comprehensive income. For instance, bonds payable balance of P5 million is deducted from bond
sinking fund balance of P3 million reporting only the net amount of P2 million for bonds payable
or deducting uncollectible accounts of P1 million from sales of P75 million and reporting only
the net sales of P74 million. As general rule, these offsetting examples are not allowed. (PAS 1,
par. 32) However, some Standards may allow offsetting, such as the following: (PAS 1, par. 34)
• Gains and losses on disposal of non-current assets, including investments and
operating assets, are reported by deducting from the proceeds on disposal the carrying
amount of the asset and related selling expense. For example, an old equipment with a
carrying amount of P250,000 was sold for P300,000 with related disposal costs of
P20,000. The carrying amount of P250,000 is deducted from the proceeds from
disposal of P280,000 and a gain of P30,000 is reported in the statement of
comprehensive income.
Chapter 11 – Financial Reporting and Analysis
• Gains and losses from a group of similar transactions are reported on a net basis, for
example, foreign exchange gains and losses or gains and losses arising on financial
instruments held for trading.
Consistency of presentation. To aid comparability of financial statements of one period with
other periods (inter comparability) or of one entity with other entities (inter comparability), the
presentation and classification of financial statements shall be retained from one period to the
next unless:
• it is apparent, following a significant change in the nature of the entity's operations or
a review of its financial statements, that another presentation or classification would
be more appropriate having regard to the criteria set for the selection and application
of accounting policies in PAS 8; or
• a Standard or Interpretation requires a change in presentation.
An entity changes the presentation of financial statements only if the changed presentation
provides information that is reliable and is more relevant to users of the financial statements and
the revised structure is likely to continue, so that comparability is not impaired. (PAS 1, par. 45)
Comparative information. Comparative information shall be disclosed in respect of the
previous period for all amounts reported in the financial statements. Comparative information
shall be included for narrative and descriptive information when it is relevant to an
understanding of the current period's financial statements. As a minimum requirement, financial
statements for two dates or two periods must be presented for Comparative purposes.
If adjustments to prior periods have been made as a result of a change in accounting policy or of
correction of errors, a statement of financial conditions as of the beginning of the period should
be presented. (PAS 1, par. 38)
STATEMENT OF FINANCIAL POSITION (BALANCE SHEET)
The objective of the statement of financial position is to report financial condition or position of
an entity at a particular date. It shows the entity's assets, liabilities, and equity at a point of time.
The statement of financial position is very useful to the financial statement users. It describes the
resources of the entity that are available sources of future cash flows, such as short-term
investments, receivables and inventories. It contains information that is useful in assessing the
liquidity and solvency of an entity. Liquidity is the entity’s ability to pay its obligations or
liabilities which are currently due. Solvency is the entity's ability to pay both its current and
noncurrent obligations. However, the statement of financial position has certain limitations as
follows:
• There is no consistency as to the basis of measurement - some assets are reported at
historical cost while other assets are reported at fair value. For example, property, plant
and equipment may be reported at historical cost while long-term investments and
investment property are reported at fair value.
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• There are some company assets which are not reported on the balance sheet - these
include employees of an entity, self-generated intangible assets such as mastheads and
brand names (PAS 38 Intangible Assets).
The statement of financial position has the following three primary elements:
• assets;
• liabilities; and
• equity
These three elements are discussed in details in the succeeding paragraphs.
ASSETS
Definition and characteristics. Assets are defined in the Conceptual Framework for Financial
Reporting, paragraph 4.4, as resources controlled by the entity as a result of past events and from
which future economic benefits are expected to flow to the entity.
An asset has the following characteristics:
• It is controlled by an entity – the entity has the right to obtain and control the benefits
expected from the use of the asset. In determining the existence of an asset, the right of
ownership of an asset is not essential. For instance, in the case of finance lease, the
property is owned by the lessor but is reported as an asset by the lessee.
• It is a result of past event – the asset arises from transaction which occurred in the
past.
• It represents future economic benefits – the asset has the potential to contribute,
directly or indirectly, to the flow of cash and cash equivalents to the entity. Paragraph
4.10 of the Framework states that the economic benefits may flow to the entity in
various ways, as follows:
• the asset may be used singly or in combination with other assets in the
production of goods or services to be sold by the entity
• the asset may be exchanged for other assets
• the asset may used to settle a liability
• the asset may be distributed to the owners of the entity.
• It has a cost or value – the asset has a cost or a value that is measured in terms of
money.
Recognition. An asset is recognized when
• it is probable that the future economic benefits will flow to the entity; and
• the asset has a cost or value that can be measured reliable.
Chapter 11 – Financial Reporting and Analysis
Classification. Assets are classified or grouped according to common characteristics, such as
operating and non-operating assets, financial and non-financial assets and current and
noncurrent assets. The most dominant form of distinction is the current versus the non-current
classification of both assets and liabilities.
Current assets. PAS 1, paragraph 66 states that an asset shall be classified as current when it
satisfies any of the following criteria:
• it is expected to be realized in, or is intended for sale or consumption in, the entity's
normal operating cycle (e.g. trade receivables, inventories and prepaid expenses);
• it is held primarily for the purpose of trading (e.g. trading securities);
• it is expected to be realized within twelve months after reporting period (e.g. non trade
receivables collectible within one year); or it is cash or a cash equivalent (as defined in
PAS 7 Statement of Cash Flows) unless it is restricted from being exchanged or used to
settle a liability for at least twelve months after the balance sheet date (e.g. cash on hand
and in bank, certificates of time deposits with a term of three months or less).
The normal operating cycle of an entity refers to the period of time necessary to convert cash to
inventories, inventories to receivables, and receivables back to cash. In the case of a
manufacturing company, it refers to the period of time necessary to convert cash to and raw
materials, raw materials to finished product, finished product to receivables, and receivables
back to cash. This period can be equal to, shorter than, or longer than one year. When the normal
operating cycle of an entity is not clearly identifiable, it is assumed to be twelve (12) months or
one year.
Current assets normally include the following:
• Cash and cash equivalents. Cash is anything that can be used as a medium of exchange
and which is acceptable by bank at face value upon deposit. Cash includes cash on hand
and in banks that is available for current operations. Cash may be in the form of bills
and coins, personal checks, manager's checks, cashier's checks, bank drafts, and money
orders. Cash on hand includes undeposited collections, petty cash fund and change
fund. Cash in bank includes cash in savings and checking accounts.
Cash equivalents are short-term, highly liquid investments that are readily convertible
to known amounts of cash and which are subject to an insignificant risk of changes in
value. Normally, an investment qualifies as cash equivalent when it matures in three
months or less from the date of acquisition. An example of cash equivalent is time
deposit with a term of three months or less.
• Short-term investments. These are liquid investments that do not qualify as cash
equivalents, such as time deposit with a term of more than three months and
investment in equity or debt securities intended to be disposed within twelve (12)
months.
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• Trade notes and accounts receivables. Trade receivables are those arising from sale
of goods or services. These receivables are always reported as current assets because
they are expected to be realized in cash within one year or within the normal operating
cycle. Accounts receivable are unsecured open accounts and are usually due in 30 to 60
days, depending on the credit terms offered to customers. Notes receivable are
evidenced by written promise to pay a certain amount of money at a certain date.
• Nontrade notes and accounts receivable. These are receivables arising from sources
other than sale of goods or services, such as share subscription receivable, interest
receivable, deposit with supplier for future delivery of goods. Nontrade notes and
accounts receivable are reported as current assets if they are due within one year.
• Inventories. Inventories are assets: (a) held for sale in the ordinary course of business;
(b) in the process of production for such sale; or (c) in the form of materials or supplies
to be consumed in the production process or in the rendering of services. In a
merchandising company, its inventory includes merchandise acquired for sale. In a
manufacturing company, its inventories include finished goods, work in progress, and
raw materials. In a service company, its inventory includes work in progress. If the
company’s inventories include biological assets, they are reported as a separate line
item.
• Prepaid expense. Prepaid expenses are expenses obtained or paid in advance, such as
office and store supplies, prepaid insurance and prepaid rent. However, if the
prepayment covers a period of more than one year, a portion of the prepayment is
noncurrent asset. For instance, if an entity paid rent three years in advance the
prepayment for the next two years is reported as non-current asset.
Non-current assets. PAS 1 states that all assets that do not qualify as current assets are non-
current assets. Non-current assets include long-term investments, property, plant and
equipment, intangible assets, and investment property.
• Long-term investments. Long-term investments include investment in equity and debt
securities of other corporations, land held for speculation, and cash set aside for special
purposes (such as bond sinking fund). These assets are classified as non-current
because management does not intend to convert them into cash within one year.
• Properly, plant, and equipment. Property, plant and equipment defined in PAS 16, par.
6 as tangible items that are: (a) held for use in production or supply of goods or services
or for administrative purposes; and (b) are expected to be used during more than one
period. Examples of assets under this classification are land, buildings, store and office
equipment, delivery equipment, and machinery.
• Intangible assets. Intangible assets are defined in PAS 38, par. 8 as identifiable non-
monetary assets without physical substance. Intangible assets include copyright,
franchise, and patents. A copyright is a right granted to an author or an artist for the
Chapter 11 – Financial Reporting and Analysis
exclusive publication of a book or work of art. A franchise is a right granted to an entity
to operate a specific type of business using a particular trade name. A patent is a right
granted to inventor for the exclusive use of a formula.
• Investment property. Investment property is defined in PAS 40, par 5 as or both) hold
(by the property (land or a buildings - or part pf a building - or both) held (by the owner
or by the lessee under a finance lease) to earn rentals or for capital appreciation or both,
rather than for:
• use in the production or supply of goods or services or for administrative
purposes; or
• sale in the ordinary course of business.
An example of investment property is a building that is being leased to others in
exchange for a fair rental.
• 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:
• It is a present obligation. The obligation is a present obligation that arises only when
an asset acquired is delivered or an entity enters into an irrevocable agreement to
acquire an asset. A liability does not arise from a future commitment, such as decision
by management to acquire asset in the future.
• It is a result of a past activity. A liability is a result of a transaction that has taken place,
such as purchase of goods on account. As stated earlier, it does not arise from a future
commitment.
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• It is expected to be settled by giving up resources embodying economic benefits in
order to satisfy the claim of the other party. The settlement of a present obligation
may occur in any of the following ways:
• payment of cash;
• transfer of other assets;
• provision of services;
• replacement of that obligation with another obligation; or
• conversion of the obligation into equity
Recognition. A liability is recognized in the balance sheet
• when it is probable that an outflow of resources embodying economic benefits will
result from the settlement of a present obligation; and
• the amount at which the settlement will take place can be measured reliably.
Classification. Liabilities be classified as financial and non-financial liabilities or current and
non-current. Financial liabilities include notes and accounts payable.
Current Liabilities. According to paragraph 69 of PAS 1, a liability shall be classified as current
when it satisfies any of the following criteria:
• it is expected to be settled in the entity’s normal operating cycle
• it is held primarily for the purpose of trading:
• it is due to be settles within twelve months after the reporting period; or
• the entity does not have an unconditional right to defer settlement of the liability for
at least twelve months after the reporting period.
Current liabilities normally include the following:
• Trade notes and accounts payable. Trade payable are those arising from purchase of
goods and services on account. Notes payable are written promises to pay cash at some
future date. Accounts payable are obligations to suppliers of goods or services
purchased on open account.
• Nontrade notes and accounts payable. These are payables arising form sources other
than purchase of goods and services, such as short-term borrowings from banks and
customers’ accounts with debit balances.
• Unearned revenues. Unearned revenues represent cash received for goods or services
to be provided in a future period, such as rent received six months in advance and
subscription for magazines or books received one year in advance.
• Accrued liabilities. Accrued liabilities represent obligation for expenses already
incurred but will not be paid until the subsequent accounting period. Examples of
accrued liabilities are taxes payable, salaries payable, and interest payable.
• Currently maturing portion of long-term debt. This is the portion of a long-term debt
that is maturing within the next twelve months from the balance sheet date.
Chapter 11 – Financial Reporting and Analysis
Non-current liabilities. PAS 1 states that all liabilities that do not qualify as current are classified
as non-current. Noncurrent liabilities include long-term notes, bonds payable, mortgage payable
and deferred income tax liability. The payment terms, interest rates, and other details that enable
readers of financial statements evaluate the impact of the non-current liabilities on future cash
flows are disclosed in the notes.
EQUITY
Definition. Equity is defined in the Conceptual Framework for Financial Reporting as the
residual interest in the assets of the entity after deducting all its liabilities. The equity of an entity
is composed of the cumulative amount of investments and profit from operations, less any
withdrawals or distribution of dividends and losses form operations.
Components. The components of the equity section of the statement of financial position
depends on the type of business organization. In a single proprietorship and partnership, the
equity section shows the capital account of the owner and the partners, respectively. The capital
account balance represents the cumulative amount of investments and profit, less withdrawals
and losses form operations.
In a corporation, the equity section of the statement of financial position is called Shareholders’
Equity or Stockholders’ Equity. The shareholders; equity is generally composed of Contributed
Capital and Retained Earnings. In some instances, a corporation may have capital maintenance
adjustments accounts such as revaluation surplus and net unrealized gain or loss on long term
investments that are shown separately in the equity section. These two components of the
corporate equity were mentioned in Chapter 9 of this book.
PAS 1 does not specify a specific format or arrangement of the three elements when presented
in the statement of financial position. However, in the Philippines, the common practice is to
present these elements as follows: current assets followed by non-current assets; current
liabilities followed by non-current liabilities; and equity accounts after liabilities. A different
arrangement may be followed by an entity depending on its nature of business.
INFORMATION TO BE PRESENTED ON THE FACE OF THE STATEMENT OF FINANCIAL
OPSITION (BALANCE SHEET) OR IN THE NOTES
Pas 1, PAR 54, prescribes that as a minimum, the face of the statement of financial position
(balance sheet) shall include line items that present the following amounts:
a. property, plant and equipment;
b. investment property;
c. intangible assets;
d. financial assets (excluding amounts shown under (e), (h), and (i);
e. investments accounted for using the equity method;
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f. biological asses;
g. inventories;
h. trade and other receivables;
i. cash and cash equivalents;
j. the total assets classified as held for sale and assets included in disposal groups
classifies s held for sale;
k. trade and other payables;
l. provisions;
m. financial liabilities (excluding amounts shown under (j) and (k);
n. liabilities and assets for current tax, as defined in PAS 12 Income Taxes;
o. deferred tax liabilities and deferred tax assets as defined in PAS 12;
p. non-controlling interests, presented within equity; and
q. issued capital and reserves attributable to owners of the parent
An entity shall disclose, either on the face of the statement of financial position (balance sheet)
or in the notes, further subclassification of the line items presented, classifies in a manner
appropriate to the entity’s operations. The details provided in the subclassification may depend
on the requirements of the PFRSs and on the size, nature, and function of the amounts involved.
Some examples follow:
• items of property, plant and equipment are disaggregated into classes, such as land,
buildings and equipment;
• receivables are disaggregated into amounts receivable from trade customers,
receivables from related parties, prepayments and other amounts,
• inventories are subclassified such as merchandise inventory or finished goods
inventory, work in process inventory, and raw materials inventory;
• provisions are disaggregated into provisions for employee benefits and other items;
and
• equity capital and reserves are disaggregated into various classes, such as contributed
capital and additional paid-in capital
Form of the Statement of Financial Position (Balance Sheet). The statement of financial
position may be prepared using the report form or the account form. Under the report form, the
elements of the balance sheet are presented similar to a presentation of report. The statement
starts with the Assets, followed by the Liabilities and then the Capital of the owner or the capital
of the partners or the shareholders’ equity in a corporate form of organization. Under the account
form, the Assets are presented on the left side of the statement while the Liabilities and Equity
are presented on the right side of the statement. The account from is normally used when an
entity maintains a great number of balance sheet accounts. Figures 11.2 and 11.2 show pro-
forma balance sheet using the two forms discussed above.
Chapter 11 – Financial Reporting and Analysis
Investment in equity securities Pxxx
ABC Company Investment in funds xxx
Statement of Financial Position Property, plant and equipment:
December 31, 20XX Land Pxxx
Assets Liabilities Buildings (net of acc. depreciation) xxx
Current assets: Current liabilities: Equipment (net of acc. depreciation) xxx
Cash Pxxx Notes payable Pxxx Biological assets
Short-term investments xxx Accounts payable xxx
Intangible assets: xxx
Notes and accounts receivable Pxxx Short-term bank loan xxx
Less Allowance for uncollectibles xxx xxx Income tax payable xxx Patent Pxxx
Other receivables xxx Accrued liabilities xxx Franchise xxx xxx
Inventories xxx Unearned revenue xxx Investment property xxx
Prepaid expenses xxx Current portion of long-term debt xxx Other assets:
Total current assets Pxxx Total current liabilities Pxxx Deferred tax assets xxx
Long-term investments: Non-current liabilities Total assets Pxxx
Investment in equity securities Pxxx Notes payable Pxxx
Investment in funds xxx xxx Mortgage payable xxx
Liabilities
Property, plant and equipment: Bonds payable, net of discount xxx
Land Pxxx Deferred tax liability xxx xxx Current liabilities:
Buildings (net of acc. depreciation) xxx Pxxx Notes payable Pxxx
Equipment (net of acc. depreciation) xxx xxx Accounts payable xxx
Biological assets xxx Shareholders’ Equity Short-term bank loan xxx
Intangible assets: Contributed capital: Income tax payable xxx
Patent Pxxx Share capital Pxxx Accrued liabilities xxx
Franchise xxx xxx Additional paid-in capital xxx Unearned revenue xxx
Investment property xxx Total contributed capital Pxxx
Current portion of long-term debt xxx
Other assets: Retained earnings xxx
Deferred tax assets xxx Total shareholders’ equity xxx Total current liabilities Pxxx
Non-current liabilities:
Total assets Pxxx Total liabilities and shareholders’ equity Pxxx Notes payable Pxxx
Mortgage payable xxx
Bonds payable, net of discount xxx
Figure 11.1 Pro-form Statement of Financial Position – Account Form
Deferred tax liability xxx xxx
Total liabilities Pxxx
ABC Company
Statement of Financial Position Shareholders’ Equity
December 31, 20xxx Contributed capital:
Assets Share capital Pxxx
Current assets: Pxxx Additional paid-in capital xxx
Cash xxx Total contributed capital Pxxx
Short-term investments Retained earnings xxx
Notes and accounts receivable P xxx Total shareholders’ equity xxx
Less Allowance for uncollectibles xxx xxx Total liabilities and shareholders’ equity Pxxx
Other receivables xxx
Figure 11.2 Pro-forma Statement of Financial Position – Report Form
Inventories xxx
Prepaid expenses xxx
Total current assets Pxxx
Long-term investments:

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Chapter 11 – Financial Reporting and Analysis
INCOME STATEMENT
The income statement shows the performance of an entity at a given period of time. The
statement reports the income earned and the expenses incurred at a particular period of time.
The objective of the statement of income statement is to provide information about the
performance of an entity that is useful to a wide range of users in making economic decisions.
The measure of performance is the profit or loss of an entity.
The income statement has two elements: income and expenses.
INCOME
Definition. Income is defined in paragraph 4.25 of the FRSC Conceptual Framework for
Financial Reporting as increases in economic benefits during the accounting period in the form
of inflows or enhancements of assets or decreases of liabilities that result in increases in equity
participants refer to the investments by owners of the entity. Such investments should not be
considered income of the entity.
Income encompasses both revenue and gains. Revenue arises in the course of the ordinary
activities of an entity and is referred to by a variety of different names including sales, fees,
interest, dividends, royalties and rent. Gains are increases in economic benefits arising from
peripheral or incidental activities, such as those arising from sale of plant assets and sale of
investments. Gains are generally reported net of related expenses. For example, the gain on sale
of equipment is the amount remaining after deducting the carrying amount and other disposal
costs from selling price of the asset.
Income also includes unrealized gains, such as those arising from revaluation of marketable
securities and those arising from increases in the carrying amount of long-term assets.
Recognition. According to paragraph 4.47 of the FRSC Conceptual Framework, income is
recognized in the income statement when an increase in future economic benefits related to an
increase in an asset or a decrease of a liability has arisen that can be measured reliably.
Therefore, the recognition of income occurs simultaneously with the recognition of increases in
assets or decreases in liabilities. PAS 18 Revenue provides a more specific concepts on the
recognition of income arising from various transaction.
EXPENSES
Definition. Paragraph 4.25 of the FRSC Conceptual Framework for Financial Reporting
defines expenses as decreases in economic benefits during the accounting period in the form of
outflows or depletions of assets or incurrences of liability that result in decreases in equity, other
than those relating to distributions to equity participants. Distributions to equity participants
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refer to withdrawals by the sole proprietor/partners or distribution of dividends to the
shareholders. Such distributions are not considered expenses of the entity.
Expenses encompass both losses and expenses that arise in the course of the ordinary activities
of the entity, such as cost of sales, wages, depreciation, supplies, and utilities. Losses represent
other items that meet the definition of expenses and may, may or not, arise in the course of the
ordinary activities of the entity. Losses include those resulting from disasters such as fire and
flood, and those arising from disposal of non-current assets. Losses are normally reported bet of
related income.
Expenses also include unrealized losses, such as those arising from the effects of increases or
decreases in the foreign exchange rate in respect of borrowings of an entity in that currency.
Recognition. Paragraph 4.49 of the FRSC Conceptual Framework states that expenses are
recognized in the income statement when a decrease in future economic benefits related to a
decrease in an asset or an increase of a liability has arisen that can be measured reliably.
Therefore, the recognition of expenses occurs simultaneously with the recognition of an increase
in liabilities or a decrease in assets.
Expenses are recognized under one of the following expense recognition principles:
• Direct matching (associating cause and effect). When costs can be associated with
revenue, such costs are charged to expense in the period in which the related revenue
is recognized. Examples are cost of goods sold, sales commission expense and warranty
expense.
• Systematic and rational allocation. When costs cannot be associated with revenue
but can be associated with future periods, such costs are charged to expense over the
periods benefited. Examples are depreciation of plant assets, amortization of intangible
assets, and allocation of insurance premium over the covered period.
• Immediate recognition. When an expenditure produces no future economic benefits
or when, and to the extent that, future economic benefits do not qualify, or cease to
qualify, for recognition in the balance sheet as an asset, such expenditure is recognized
immediately as an expense. Examples are repairs and maintenance and advertising
expense.
Chapter 11 – Financial Reporting and Analysis
Figure 11.3 and 11.4 show pro-forma income statement using two methods.
INFORMATION TO BE PRESENTED ON THE FACE OF THE STATEMENT OF COMPREHENSIVE
INCOME STATEMENT ABC Company
Income Statement
PAS 1, par. 82, states that as a minimum, the face of the income statement shall include line items For the Year Ended December 31, 20xx
that present the following amounts for the period:
Revenue Pxxx
a. revenue; Other income xxx
aa. gains and losses arising from the derecognition of financial assets measured at Increase (decrease) in merchandise inventory (xxx)
amortized cost; Net purchases of merchandise (xxx)
b. finance cost; Employee benefit expense (xxx)
c. share of the profit or loss of associates and joint ventures accounted for using the equity Depreciation expense (xxx)
method; Amortization expense (xxx)
ca. If a financial asset is classified so that it is measures at fair value, any gain or loss arising Supplies expense (xxx)
from a difference between the previous carrying amount and its fair value at the Utilities expense (xxx)
reclassification date (as defined in PFRS 9); Other expense (xxx)
d. tax expense; Finance costs (interest expense) (xxx)
e. a single amount comprising the total of Share of profit of associate xxx
i. the post-tax profit of discontinued operations and Profit before tax Pxxx
ii. the post-tax gain or loss recognized on the measurement to fair value less costs to
Income tax expense (xxx)
sell or on the disposal of the assets, or disposal group(s) constituting the
discontinued operations; Profit for the period Pxxx
f. profit or loss; Figure 11.3 Pro-forma Income Statement – Nature of Expense Method
g. each component of other comprehensive income classified by nature (excluding
amounts in h; ABC Company
h. share of other comprehensive income of associates and joint ventures accounted for Income Statement
using the equity method; and For the Year Ended December 31, 20xx
i. total comprehensive income
Revenue Pxxx
If an entity prepares a separate income statement, only items a to f will be presented in the Cost of sales:
statement; items g to I will be presented in the separate statement of comprehensive income. Inventory, beginning Pxxx
Net purchases xxx
Classification of expenses in the income statement. PAS 1 states that an entity may present Cost of goods available for sale Pxxx
an analysis of its expenses using the nature of expense method or the functional method. Less Inventory, end xxx xxx
Gross profit Pxxx
Nature of expense method. Under this method, expenses are aggregated in the income Other income xxx
statement according to their nature and are not reallocated among various functions within the Distribution costs (selling expenses) (xxx)
entity. Examples of groupings of expenses under this method are: depreciation, purchases of raw Administrative expenses (xxx)
materials, employee costs, and advertising costs. Other expenses (xxx)
Finance costs (interest expense) (xxx)
Function of expense or cost of sales method. Under this method, expenses are classified Share of profit of associates xxx
according to their function as part of cost of sales, costs of distribution (selling expenses), or Profit before tax Pxxx
administrative activities (general or administrative expenses). This method can provide more Income tax expense (xxx)
relevant information to users than the nature of expense method. Profit for the period Pxxx
Figure 11.4 Pro-forma Income Statement – Function of Expense Method

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Chapter 11 – Financial Reporting and Analysis
Notes:
• The revenue section represents from the major activity of the entity, that is, sale of
goods for merchandising or trading company and sale of service for a service company.
• Other income includes interest income and gain from sale of assets other than
inventories, such as gain from sale of investment.
• Other expenses include loss from sale of assets other than inventories, such as loss from
sale of equipment.
• The share of profit of associates is the share of the entity in the reported profit of an
investee company called associate. Accounting for investment in associate is a topic to
be discussed in financial accounting.
STATEMENT OF COMPREHENSIVE INCOME
The statement of comprehensive income reports items of income and expenses which are not
required by other PASs and PRFs to be recognized in profit or loss. Examples are changes in
revaluation surplus when property, plant and equipment are reported using the revaluation
model and gains and losses arising from changes in fair value of available-for-sale securities.
The following information is required to be presented in the statement of comprehensive income
reported separately form the income statement:
• profit or loss shown in the income statement;
• share of other comprehensive income of associates and joint ventures accounted for
using the equity method;
• each components of other com prehensive income classified by nature;
• total comprehensive income; and
• the total comprehensive income attributable to non-controlling interest and that
attributable to owners of the parent.
PAS 1 permits the presentation of comprehensive income in a single statement of comprehensive
income 9combined income statement and statement of comprehensive income).
STATEMENT OF CHANGES IN EQUITY
PAS 1, par. 106, requires an entity to present a statement of changes in equity that should include
the following:
• total comprehensive income for the period, showing separately the amount due to
owners of the parent and to non-controlling interest;
• for each component of equity, the effect of retrospective application or retrospective
restatement recognized in accordance with PAS 8; and
• for each component of equity, a reconciliation of the carrying amount at the beginning
and at the end of the period, separately disclosing changes resulting from:
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• profit or loss;
• other comprehensive income; and
• transactions with owners in their capacity as owners, showing separately
contributions by and distributions to owners and changes in ownership
interests in subsidiaries that do not result in a loss of control.
The preparation of the statement is also discussed in Chapter 9 of this book.
STATEMENT OF CASH FLOWS
The statement of cash flows is one of the basic components of a complete set of financial
statements. The objective of the statement of cash flows is to provide information about the cash
receipts and cash disbursements of an entity that occurred during a period. The statement
summarizes the transactions that caused a change in the cash balance during a reporting period.
A cash flow statement provides the following benefits as stated in PAS 7, par. 4:
• it provides information that enables the users to evaluate the changes in the assets of
an entity, its financial structure and its ability to affect the amounts and timing of cash
flows in order to adapt to changing circumstances and opportunities;
• it provides information that is useful in assessing the ability of the entity to generate
cash and cash equivalents and enable users to develop models to assess and compare
the present value of the future cash flows of different entities;
• it enhances the comparability of the reporting of operating performance by different
entities because it eliminates the effects of using different accounting treatments for
the same transactions and events.
CLASSIFICATION OF CASH FLOWS
Cash flows are classified to make the statement more meaningful to the investors and creditors
by enabling them to determine the type of transaction that gave rise to each cash flow. Cash flows
are categorized into three: (a) operating activities; (b) investing activities; and (c) financing
activities.
Operating activities. Cash flows from operating activities are derived from the principal
revenue-producing activities of an entity. They represent the cash inflows and outflows of cash
that resulted from activities reports in the income statement. Thus, this classification of cash
flows includes the elements of income statement reported on a cash basis rather than an accrual
basis. Fir instance, cash flows form sales show the amount of cash received from customers
during the period from sales that were made in prior or current period od for future sales.
Chapter 11 – Financial Reporting and Analysis
Cash received from (cash inflow)
• customers for sale of goods and services
• royalties, fees, commissions
• interest on loans receivable
• dividends from investment
Cash paid for (cash outflow)
• purchase of inventory
• salaries and wages
• interest on loans payable
• income taxes
• changes during the period in inventories and operating receivables and
payables;
• other non-cash items; and
• other items for which cash effects are investing and financing cash flows
Indirect method. Under the indirect method, the met cash flow from operating activities is
determined by adjusting profit or loss for the effects of;

Table 11.1 – Sample transactions or activities giving rise to cash flows from operating activities. • changes during the period in inventories and operating receivables and payables;
• non-cash items such as depreciation, provisions, deferred taxes, and unrealized foreign
Investing activities. Cash flows from investing activities include cash inflows and outflows of currency gains and losses; and
cash related to the acquisition and disposition of long-term assets used in the operations of the • all other items for which the cash effects are investing or financing cash flows.
business and investment assets.
ABC Company
Cash received from (cash inflow) Cash paid for (cash outflow) Statement of Cash Flows
• sale of long-term investment • purchase of long-term investments For the Year Ended December 31, 20xx
• sale of plant assets • purchase of plant assets
• repayment of loans made to others • loans to identified employees Cash flow from operating activities:
Cash receipts from customers Pxxx
Cash paid to suppliers (xxx)
Table 11.2 – Sample transactions or activities giving rise to cash flows from investing activities Cash paid to employees (xxx)
Cash paid for various operating expenses (xxx)
Financing activities - Cash flows from financing activities include cash inflows from borrowings Cash generated from operations Pxxx
and contributions by investors and cash outflows for repayment of loans, retirement of share Interest paid (xxx)
capital, acquisition of treasury shares and payment of cash dividends. Income taxes paid (xxx)
Net cash flow from operating activities Pxxx
Cash received from (cash inflow) Cash paid for (cash outflow) Cash flows from investing activities:
• bank loan • payment of bank loan Collection for note receivable Pxxx
• issuance of share capital • retirement of share capital Proceeds from sale of equipment xxx
• reissuance of treasury shares • acquisition of treasury shares Proceeds from sale of long-term investment xxx
• dividends Purchase of property, plant, and equipment (xxx)
Loans made to employees (xxx)
Net cash flows from investing activities xxx
Table 11.3 – Sample transactions or activities giving rise to cash flows from financing activities Cash flows from financing activities:
Proceeds of bank loan Pxxx
Methods of presenting cash flows from operating activities. There are two methods of Proceeds from issuance of share capital xxx
presenting the cash flows from operating activities: the direct method and the indirect method. Repayment of bank loan (xxx)
Purchase of treasury shares (xxx)
Direct method. Under the direct method, the major classes of gross receipts and gross cash Payment of dividends (xxx)
payments are disclosed in the statement. The information about these major classes may be Net cash flows from financing activities (xxx)
obtained either: Net increase in cash and cash equivalents Pxxx
• from the accounting records of the entity; or Cash and cash equivalents at the beginning of the period xxx
• by adjusting sales, cost of sales (interest and similar income and interest expense and Cash and cash equivalents at the end of the period Pxxx
similar charges for a financial institution) and other items in the income statement for:
Figure 11.5 Pro-forma Statement of Cash Flow – Direct method

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Chapter 11 – Financial Reporting and Analysis
Illustrative Problem A
ABC Company
Statement of Cash Flows ABC Company reported the following cash receipts and cash payments
For the Year Ended December 31, 200x for the year 2014:
Cash receipts:
Cash flows from operating activities: Proceeds from sale of equipment P 80,000
Profits before taxes Pxxx Proceeds of bank loan 200,000
Adjustments for: Collection from customers 600,000
Depreciation xxx Proceeds from issuance purchases 60,000
Investment income (xxx) Cash payments:
Interest expense xxx To suppliers for merchandise purchases 390,000
Operating income before working capital changes Pxxx For purchase of machinery 97,500
Increase in trade receivables (xxx) For interest 22,500
Decrease in inventories xxx For bank loan 50,000
Decrease in prepaid expenses xxx For dividends 39,000
Increase in accrued revenue (xxx) For income taxes 66,000
Increase in trade payables xxx For operating expenses 100,000
Increase in unearned revenue xxx
Decrease in accrued expenses (xxx) The cash and cash equivalent balance at the beginning of the year is
Cash generated from operations Pxxx P120,000.
Interest paid (xxx) A statement of cash flow using the direct method is shown below
Income taxes paid (xxx)
Net cash received (paid) from operating activities Pxxx ABC Company
Cash flows from investing activities: Statement of Cash Flow
Collection for note receivable Pxxx For the Year Ended December 31, 2014
Proceeds from sale of equipment xxx Cash flows from operating activities:
Proceeds from sale of long-term investment xxx Cash received from customers P600,000
Purchase of property, plant and equipment (xxx) Cash paid to suppliers for merchandise purchases (390,000)
Loans made to employees (xxx) Cash paid for operating expenses (100,000)
Net cash flows from investing activities xxx Cash generated from operations P110,000
Cash flows from financing activities Interest paid (22,500)
Proceeds of bank loan Pxxx Income taxes paid (66,000)
Proceeds from issuance of share capital xxx Net cash received from operating activities P 21,500
Repayment of bank loan (xxx) Cash flows from investing activities:
Purchase of treasury shares (xxx) Proceeds from sale of equipment P 80,000
Payment of dividends (xxx) Cash paid to purchase of machinery (97,500)
Net cash flows from financing activities (xxx) Net cash received from (used in) investing activities (17,500)
Net increase in cash and cash equivalents Pxxx Cash flows from financing activities:
Cash and cash equivalents at the beginning of the period xxx Proceeds from issuance of share capital P 60,000
Cash and cash equivalents at the end of the period Pxxx Proceeds of bank loan 200,000
Cash paid for dividends (39,000)
Net cash received from (used in) financing activities 221,000
Figure 11.5 Pro-forma Statement of Cash Flow – Indirect method Net increase in cash and cash equivalent P225,000
Cash and cash equivalent, January 1, 2014 120,000
Cash and cash equivalent, December 31, 2014 P345,000

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Chapter 11 – Financial Reporting and Analysis
ABC Company
Illustrative Problem B Statement of Cash Flow
For the Year Ended December 31, 2014
ABC Company provides the following income statement for the year 2014:
Cash flows from operating activities:
Sales P4,180,000 Profit before taxes P431,550
Cost of sales 2,275,000 Add (deduct):
Gross profit P1,905,000 Depreciation expense 190,000
Depreciation expense (190,000) Interest expense 61,000
Salaries expense (600,000) Operating income before working capital changes P682,550
Other operating expenses (437,500) Increase in accounts receivable (147,500)
Interest expense (61,000) Decrease in inventory 15,000
Profit before taxes P 616,500 Increase in prepaid other expense (3,500)
Income taxes (184,950) Increase in accounts payable 20,000
Profit P 431,550 Cash generated from operations P566,550
Interest paid (62,500)
In addition, the following balance sheet information is available: Income taxes paid (60,000)
Net cash provided by (used in) operating activities P444,050
12.31.14 12.31.13 Cash flows from investing activities:
Accounts receivable P275,000 P127,500 Proceeds from sale of equipment P 50,000
Inventory 310,000 325,000 Collection of loans receivable 100,000
Prepaid other expenses 27,000 23,500 Purchase of equipment (75,000)
Accounts payable 245,000 225,000 Net cash received from (used in) investing activities P 75,000
Cash flows from financing activities:
Additional information: Proceeds from issuance of share capital P 80,000
• Income taxes paid amounted to P60,000 Repayment of bank loan (150,000)
• Interest paid amounted to P62,500 Payment of dividend (50,000)
• Proceeds from sale of equipment at carrying value, P50,000 Net cash received from (used in) financing activities (120,000)
• Cash paid to purchase an equipment, P75,000 Net increase in cash and cash equivalents P399,050
• Collection of loans receivable, P100,000 Cash and cash equivalents, January 1, 2014 350,000
• Proceeds from issuance of share capital, P80,000 Cash and cash equivalents, December 31, 2014 P749,050
• Repayment of bank loan, P150,000
• Payment of dividends, P50,000
• Cash and cash equivalent, January 1, 2014, P350,000 Notes:

• The cash and cash equivalent at December 31, 2014 is the amount that is reported in the
A statement of cash flow using the indirect method is presented on the next page. 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.

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Chapter 11 – Financial Reporting and Analysis
NOTES TO FINANCIAL STATEMENTS
Notes to financial statements include narrative descriptions or more detailed analyses of
amounts shown on the face of the financial statements. The notes include information required
and encourages to be disclosed by PASs and PFRSs and other disclosures necessary to achieve
fair presentation,
Notes are considered an integral part of the financial statements which contains the following
information:
• the basis of preparation of the financial statements and the specific accounting policies
used;
• Accounting policies are the specific principles, bases, conventions, rules and
practices applied by an entity in preparing and presenting financial
statements.
• information required by PFRSs that is not presented elsewhere in the financial
statements; or
• additional information that is not presented elsewhere in the financial statements, but
is relevant to an understanding of any of them.
Notes must present information in a systematic order and cross referenced to statement of
financial position, statement of comprehensive income (or income statement if presented
separately), statement of changes in equity and statement of cash flows. Following is the
recommended order of presentation of information in the notes stated in PAS 1, par.114:
• statement of compliance with PFRS;
• summary of significant accounting policies applied;
• supporting information for items presented in the statement of financial position and
of comprehensive income (or in the income statement If presented separately), and
in the statement of changes in equity and of cash flows, in the order in which each
statement and each line items is presented; and
• other disclosures, including:
• contingent liabilities (PAS 37) and unrecognized contractual commitment;
and
• non-financial disclosures, such as the entity’s financial risk management
objectives and policies (PFRS 7)
The following should also be disclosed by management:
• Management judgements made in applying accounting policies with significant effects
on amounts recognized
• Key assumptions concerning the future and key resources of estimation uncertainty
that have a significant risk of causing material adjustments to carrying amount of
assets and liabilities within the next financial year
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Other required disclosures include:
• Company information:
• Domicile, legal form, country of incorporation, address
• Description of nature operations and activities
• Name of parent enterprise
• Name of ultimate parent enterprise of the group
• Amount of dividends proposed or declared before the financial statements were
authorized amount per share
• Amount of any cumulative preference dividends not recognized
FINANCIAL STATEMENT ANALYSIS
Financial statements provide information into the entity’s current status and lead to the
development of policies and strategies for the future.
RATIO ANALYSIS
Ratios express the mathematical relationships between on quantity and another, in terms of a
rate, a proportion or a percentage. For example, the ratio of gross profit to sales is 60% or the
ratio of current among selected financial statement data. Ratios are used to evaluate the
financial health and performance of a company. To make them more meaningful, however,
three types of comparisons may be made:
• Intra company comparisons – comparing one period with another period, such as
comparing 2014 with 2013
• Intercompany comparisons – comparing one company with another company or with
other companies in the same industry.
• Industry average comparison – comparing an entity’s computed ratios with industry
standards.
Ratios can be grouped into the following; liquidity ratios, solvency ratios, and liquidity ratios.
Each of these is discussed below.
Liquidity ratios measures the short-term ability of the entity to pay its maturing obligations and
to meet unexpected needs for cash. The measures that can be used to determine the liquidity of
an entity are the current ratio, the quick, or acid-test ratio, the current cash debt coverage ratio,
the receivables turnover ratio, and the days in inventory.
Solvency ratios measure the ability of the entity to survive over a long period of time, that is, its
ability to pay interest as it come due and to repay the face value of obligations or debt at maturity.
The measures that can be used to determine the solvency of an entity are the debt at maturity.
The measures that can be used to determine the solvency of an entity are the debt to total assets
ratio, the time interest earned ratio, the cash debt coverage ratio and free cash flow.
Chapter 11 – Financial Reporting and Analysis
Measures liquidity
Profitability ratios measure the profit or operating success of an entity for a given period of receivables.
time. An entity’s ability or inability to generate profit has several consequences – it affects an
entity’s liquidity position and its ability to grow; hence, affecting its liability to obtain loans and Receivable turnover Net credit sales The ratio measures the
o attract investors. The measures that can be used to determine the profitability of an entity are ratio Average trade receivables (net) number of times, on average,
the return on ordinary shareholder’s equity ratio, the return on assets ratio, the profit margin receivables are collected
ratio, the asset turnover ratio, the earnings per share, the price-earnings ratio, and the payout during the period.
ratio.
Measures the collection
A summary of these ratios, the formula to calculate them and their uses are presented below and efficiency of the entity.
on the next pages.
Average collection 365 days The computed period
LIQUIDITY RATIOS period Receivable turnover ratio indicates the average
Ratio Formula Purposes of the ratio number of days before
receivables are collected.
Measures short-term debt
paying ability. Measures liquidity of
inventory
The ratio expresses the
Current assets relationship of current assets Inventory turnover Cost of goods sold The ratio measures the
Current ratio
Current liabilities to current liabilities. It ratio Average inventory number of times, on average,
presents the amount of inventory is sold during the
current assets available for period.
every peso current liability.
Measures the sales efficiency
Measures immediate short- of the entity.
term liquidity.
The computed number of
Cash, short term investment Number of days in 365 days
Quick or acid-test The ratio represents the days indicates the length of
and net receivables inventory Inventory turnover ratio
ratio amount of quick assets time spent before
Current liabilities
available for every peso of inventories are sold to
current liability. customers.

Measures an entity’s ability

Net cash provided by
Current cash debit
operating activities
coverage ratio
Average current liabilities
to pay off its current
liabilities in a given year of
operations.
The ratio represents the
amount of cash available
from current operations for
every peso of current liability

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Chapter 11 – Financial Reporting and Analysis

SOLVENCY RATIOS PROFITABILITY RATIOS

Ratio Formula Purposes of the ratio Ratio Formula Purposes of the ratio

Measures total assets Measures profit generated by

provided by creditors each peso of sales.

The ratio indicates the The amount of profit generated

Profit
degree of financial Profit margin on sales by every peso of sales. It can
Total liabilities Net sales
Debt to total assets leveraging. It provides also be interpreted as the
Total assets
indication of the ability of an percentage of profit generated
entity to survive losses in relation to net sales.
without impairing the
interest of its creditors.
Rate of return on Profit Measures overall profitability of
assets Average total assets assets
Total liabilities Measures the percentage of
Debt to equity ratio
Total owner’s equity total liabilities to total equity
Profit minus earnings attributed
to preference shares Measures profit earned for each
Earnings per share
Net cash provided by Measures an entity’s ability Average outstanding ordinary ordinary share capital
Cash debt to coverage
operating activities to repay its total liabilities in shares
ratio
Average total liabilities a given year of operations

Measures the ratio of the

Market price of share capital
Profit before interest Measures ability to meet Price-earnings ratio market price per share to
Earnings per share
Times interest earned charges and taxes interest payments as they earnings per share
Interest charges come due

Measures percentage of
Cash dividends
Payout ratio earnings distributed in the form
Profit
of cash dividends

Net sales Measures the effectiveness of

Asset turnover ratio
Average total assets asset utilization

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Chapter 11 – Financial Reporting and Analysis
revaluation surplus when property, plant, and equipment are reported using the revaluation
REVIEW of the LEARNING OBJECTIVES model and gains and losses arising from changes in fair value of available-for-sale securities.

1. Explain the nature of the financial statements and the over-all considerations in their
preparation and presentation.
• Financial statements are a structured representation of the financial position and
financial performance of an entity.
• Financial statements are the end product of the accounting process
• Financial statements show the results of the management’s stewardship of the
resources entrusted to it.
• Financial statements are the means by which the information accumulated and
processed in financial accounting is periodically communicated to those who use it.
• The preparation and presentation of financial statements is a responsibility of
management.
The over-all considerations in the preparation and presentation of financial statements are
as follows:
• Fair presentation and compliance with PFRS
• Going concern
• Accrual basis of accounting
• Frequency of reporting
• Materiality and aggregation
• Offsetting
• Consistency of presentation
• Comparative information
2. Identify and explain the components of a complete set of financial statements. A
complete set of financial statements is composed of the following: (1) statement of financial
position (balance sheet), (2) income statement, (3) statement of comprehensive income, (4)
statement of cash flows, (5) statement of changes in equity, and (6) notes and other
disclosures. Alternatively, a single statement of income and comprehensive income may be
prepared.
The statement of financial position shows the entity’s assets, liabilities, and equity at a point
in time. The statement of financial position has the following three primary elements: assets,
liabilities and equity.
The income statement shows the performance of an entity at a given period. It reports the
income earned and the expenses incurred at a particular period of time. The statement has
two primary elements: income and expenses.
The statement of comprehensive income reports items of income and expenses which are
not required by other PASs and ORFSs to be recognized in profit or loss, such as changes in
The statement of changes in equity reports transactions affecting the various equity
accounts, such as the profit or loss for the period, dividends declared, additional issuances
of share capital, and acquisition of treasury shares.
The statement of cash flows provides information about the cash receipts and cash
disbursements of an entity that occurred during a period. It summarized the transactions
that caused a change in the cash and cash equivalents balance during a reporting period.
The notes include narrative descriptions or more detailed analyses of amounts shown on
the face of the financial statements.
3. Explain and appreciate the importance of the statement of cash flows. The statement of
cash flows provide the following benefits:
• it provides information that enables the users to evaluate the changes in the assets of
an entity, its financial structure and its ability to affect the amounts and timing of cash
flows in order to adapt to changing circumstances and opportunities;
• it provides information that is useful in assessing the ability of the entity to generate
cash and cash equivalents and enable users to develop models to assess and compare
the present value of the future cash flows of different entities;
• it enhances the comparability of the reporting of operating performance by different
entities because it eliminates the effects of using different accounting for the same
transactions and events.
4. Describe and explain the classification of cash flows and the methods of presenting cash
flows from operating activities. Cash flows are classified to make the statement more
meaningful to the investors and creditors by enabling them to determine the type of
transaction that gave rise to each cash flow. Cash flows are categorized into three: (a)
operating activities; (b) investing activities; and (c) financing activities)
Operating activities. Cash flows from operating activities are derived from the principal
revenue-producing activities of an entity.
Investing activities. Cash flows from investing activities include cash inflows and outflows
of cash related to the acquisition and disposition of long-term assets used in the operations
od the business and investment assets.
Financing activities. Cash flows from financing activities include cash inflows from
borrowings and contributions by investors and cash outflows for repayment of loans,
retirement of share capital, acquisition of treasury shares and payment of cash dividends.

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Chapter 11 – Financial Reporting and Analysis

Cash flows from operating activities may be presented using the direct method or the
indirect method. Under the direct method, the major classes of gross receipts and gross cash
payments are disclosed in the statement. Under the indirect method, the net cash flow from
operating activities is determined by adjusting profit or loss for the effects of non-cash
revenue and expense items and gain and losses.

5. Explain and appreciate the types of ratio analysis. Ratios express the mathematical
relationships between one quantity and another, in terms of a rate, a proportion, or a
percentage. For example, the ratio of gross profit to sales is 45% or the ratio of current assets
to current liabilities is 2:5:1. Ratio analysis expresses the relationship among selected
financial statement data. Ratios are used to evaluate the financial health and performance
of a company.

Ratios can be grouped into the following: liquidity ratios, solvency ratios, and liquidity
ratios. Each of these is discussed below.

Liquidity ratios measure the short-term ability of the entity to pay its maturing obligations
and to meet unexpected needs for cash. Solvency ratios measure the ability of the entity to
survive over a long period of time, that is, its ability to pay interest as it come due and to
repay the face value of obligations or debt at maturity. Profitability ratios measure the profit
to operating success of an entity for a given period of time. An entity’s ability or inability to
generate profit has several consequences – it affects an entity’s liquidity position and its
ability to grow; hence, affecting its ability to obtain loans and to attract investors.

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 Chapter 12 – Introduction to Cost Accounting
NATURE OF COST ACCOUNTING

CHAPTER 12 Cost accounting, which is a specialized field of accounting, emphasizes the determination and
control of costs. It is concerned primarily with the costs of manufacturing processes and of
manufactured products. Cost determination, also known as product costing, deals with
INTRODUCTION TO COST ACCOUNTING measuring the resources used to complete an activity or unit of output. Cost control, on the other
hand, is management’s way of efficiently dealing with the activities that incur costs.
LEARNING OBJECTIVES
Though cost accounting is usually considered only to apply to manufacturing operations, every
1. Explain the nature of cost accounting and differentiate a manufacturing company from a service type and size of organization should benefit from its use. It informs management promptly with
company and a merchandise company. the cost of rendering a particular service, buying and selling a product, and producing a product.
2. Identify the elements of manufacturing costs. Cost accounting principles, therefore, may be applied by financial institutions, transportation
3. Explain the manufacturing cycle and prepare journal entries to record various transactions companies, churches, schools, governmental units, as well as the non-manufacturing activities of
related to the cycle. manufacturing firms.
4. Prepare a statement of Cost of Goods Manufactured and Sold

PREVIEW OF THE CHAPTER COMPARISON OF SERVICE, MERCHANDISING AND MANUFACTURING

Nature of Cost
Accounting
• Users of cost
accounting
• Uses of cost
accounting
• Manufacturing firm
distinguished from a
service firm and a
merchandise firm
COST ACCOUNTING
Elements of Manufacturing Manufacturing
Costs Cycle
• Direct materials • Purchase and
• Direct labor requisition of raw
• Factory overhead materials
• Prime cost
• Recording, payment
• Conversion cost and distribution of
factory payroll
• Payment and accrual
of factory overhead
• Cost of Goods
Manufactured
• Preparation of the
Statement of the
Goods Manufactured
and Sold
ORGANIZATIONS
Providing a service to a client in an accounting firm or repairing a television set in a repair shop
has strong similarities to manufacturing tables and chairs in spite of different physical settings.
In a service industry, resources are brought together to provide the service, just as they are
brought together to create a product in a factory environment.
Differences in measuring profits for the various types of organizations are largely a function of
inventoried costs. Service firms have only supplies in inventories. Merchandising firms buy and
sell products and hold merchandise inventories. Manufacturing firms buy materials and convert
these inputs into saleable products. Inventories in a manufacturing firm include the following:
1. Raw materials inventory – yet-to-be used materials
2. Work in process inventory – partially completed products
3. Finished goods inventory – completed and ready-to-sell products
ELEMENTS OF MANUFACTURING COST
A manufacturing company differs primarily from a merchandise company from the standpoint
of converting or transforming the goods purchased, called raw materials, into another form of
product before selling them. The process of converting or transforming materials into another
form is called the manufacturing process. The manufacturing process involves the three cost
elements. Direct materials, direct labor and factory overhead. The sum of these three cost
elements is the manufacturing cost, often called production cost or factory cost.

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Chapter 12 – Introduction to Cost Accounting
Raw Materials Purchases xxx
Direct materials include all the materials that form an integral part of the finished product Indirect Materials xxx
whose value is relatively high and that can be included directly in calculating the cost of the Vouchers payable xxx
product. Examples are the lumber and steel used to make classroom tablet chairs. On the other
hand, materials needed for the completion of a product but do not form an integral part of the 2. Freight and handling cost of materials
finished product or whose amount is so minimal may be classified as indirect materials. Freight-in xxx
Vouchers Payable xxx
Direct labor is labor expenses to convert direct material into a finished product. It has to be
traceable to the final product though need not be relatively high in amount. Example is the wage 3. Return of defective materials to suppliers
of the machine operator cutting and assembling the lumber and steel used in the production of Vouchers payable xxx
classroom tablet chairs. The salary of a supervisor which cannot be traced to a product is Purchase Returns and Allowances xxx
indirect labor.
4. Payment of account within the discount period
Factory overhead, also called manufacturing overhead, manufacturing expenses or factory Vouchers Payable xxx
burden, includes all manufacturing cost other than direct materials and direct labor. It includes Cash xxx
indirect materials, indirect labor and all other costs that cannot be charged directly to specific Purchase Discounts xxx
products or job order.
5. Requisition of raw materials for production and indirect materials for factory use
Example of indirect materials are factory supplies and lubricants. Examples of indirect labor are No entry
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 6. Return to storeroom of excess raw materials from production and indirect
and factory building, maintenance and repairs, heat light and power, employee factory payroll No entry
taxes, small tools and other miscellaneous factory overhead.
7. Recording to payroll
MANUFACTURING CYCLE Direct Labor xxx
Indirect Labor xxx
Administrative Salaries xxx
Cost accounting consists of a system that is concerned with precise recording and measurement Sales Salaries xxx
of cost elements as they originate and flow through the production processes. There are two Withholding Taxes Payable xxx
accounting systems that may be employed by manufacturing firms, namely: (1) Cost system or SSS Contributions Payable xxx
perpetual inventory system, and (2) Non-cost system or periodic inventory system. The Medicate Contributions Payable xxx
manufacturing process and the physical arrangement of the factory are the basis for determining Pag-ibig Contributions Payable xxx
the cost accumulation procedures. Vouchers Payable xxx
The non-cost system or inventory system will be used to illustrate the entries in the 8. Payment of payroll
manufacturing cycle. Under this system, there is no detailed flow of cost in the manufacturing Vouchers Payable xxx
process. The inventory of raw materials, work in process and finished goods are determined Cash xxx
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 9. Recording of employer’s payroll taxes
materials used in production, cost of goods manufactured and transferred to finished goods, and Factory Payroll Taxes xxx
cost of goods sold during the period. Administrative Payroll Taxes xxx
Sales Payroll Taxes xxx
Assuming the use of the voucher system, the following are the pro-forma journal entries in the SSS Contributions Payable xxx
manufacturing cycle. Medicare Contributions Payable xxx
Pag-ibig Contributions Payable xxx
1. Purchase and receipt of raw materials and indirect materials on account
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Chapter 12 – Introduction to Cost Accounting
d. Adjustment for office and store depreciation
10. Recording of other factory costs incurred Depreciation Expenses – Office Building xxx
Repairs and Maintenance – Factory xxx Depreciation Expense – Store Building xxx
Utilities – Factory xxx Accumulated Depreciation – Office Building xxx
Vouchers Payable xxx Accumulated Depreciation – Store Building xxx

11. Payment of other accounts e. Adjustment for other expense

Vouchers Payable xxx Doubtful Accounts Expenses xxx
Cash xxx Miscellaneous Administrative Expenses xxx
Miscellaneous Selling Expenses xxx
12. Transfer of completed work to finished goods storeroom Allowance for Doubtful Accounts xxx
No entry Accrued Expenses xxx

13. Sale of finished goods on account f. Adjustment for income taxes

Accounts receivable xxx Income Taxes xxx
Sales xxx Income Tax Payable xxx

14. Recording of returns by customers 17. Closing entries. A Manufacturing Summary account is used to summarize all the transactions
Sales Returns and Allowances xxx affecting the computation of cost of goods manufactured. The account is debited to close the
Accounts Receivable xxx 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
15. Collection of accounts receivable within the discount period balances of raw materials ending inventory, and work in process ending inventory. The
Cash xxx closing entries at the end of the accounting period of the company shall consist of the
Sales Discounts xxx following:
Accounts Receivable xxx
a. To close beginning inventory balances
16. Adjusting entries. Adjustment to update the balances of accounts at the end of the fiscal Manufacturing Summary xxx
period may include the following: Raw Materials Inventory, beginning xxx
Work in Process Inventory, beginning xxx
a. Adjustment for accrual of payroll
Direct Labor xxx b. To record ending inventory balances
Indirect Labor xxx Raw Materials Inventory, end xxx
Administrative Salaries xxx Work in Process Inventory, end xxx
Sales Salaries xxx Manufacturing Summary xxx
Accrued Payroll xxx
c. To close the balances of other manufacturing accounts
b. Adjustment for factory depreciation Manufacturing Summary xxx
Depreciation Expense – Machinery xxx Purchases Returns and Allowances xxx
Depreciation Expense – Factory Building xxx Purchases Discounts xxx
Accumulated Depreciation – Machinery xxx Raw Materials Purchases xxx
Freight-in xxx
c. Adjustment for other factory costs Direct Labor xxx
Miscellaneous Factory Overhead xxx Indirect Materials xxx
Accrued Expenses xxx Indirect Labor xxx
Factory Payroll Taxes xxx

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Chapter 12 – Introduction to Cost Accounting
REPORTING RESULTS OF OPERATIONS
Repairs and Maintenance – Factory xxx
Utilities – Factory xxx The result of operations of a manufacturing enterprise is reported in the conventional financial
Depreciation Expense – Machinery xxx statements. These statements summarize the flow of accounts and revenues, show the financial
Depreciation Expense – Factory Building xxx position at the end of the fiscal period, and report the sources of cash inflows and cash outflow
Miscellaneous Factory Overhead xxx during the fiscal period.

d. To close the beginning inventory balance of finished goods In the income statement, the Cost of Goods Sold is shown on one figure, Although, this procedure
Income Summary xxx is followed in published reports, internal users need additional information. Therefore, a
Finished Goods Inventory, beginning xxx supporting schedule of the Cost of Goods Manufactured is usually prepared. A pro-forma
Statement of Cost of Goods Manufactured and Sold that contains all possible items is presented
e. To record the ending inventory balance of finished goods below.
Finished Goods Inventory, end xxx Luzon Manufacturing Company
Income Summary xxx Statement of Cost of Goods Manufactured and Sold
For the Year Ended December 31, 2014
f. To close the balance of Manufacturing Summary (which represents cost of goods Direct Materials:
manufactured) and the balances of all other revenue and expense accounts Raw Materials Inventory, beginning Pxxx
Sales xxx Raw Materials Purchases Pxxx
Manufacturing Summary xxx Add Freight-in xxx
Sales Discounts xxx Delivered Cost of Materials Purchases Pxxx
Sales Returns and Allowances xxx Less: Purchase Returns and Allowances Pxxx
Administrative Salaries xxx Purchase Discounts xxx xxx xxx
Administrative Payroll Taxes xxx Materials Available for Use Pxxx
Doubtful Accounts Expense xxx Less: Indirect Materials Used Pxxx
Depreciation Expense – Office Equipment xxx Materials Inventory, end xxx xxx
Miscellaneous Administrative Expenses xxx Direct Materials Used Pxxx
Sales Salaries xxx Direct Labor xxx
Sales Payroll Taxes xxx Factory Overhead:
Depreciation Expense – Store Equipment xxx Indirect Materials Pxxx
Miscellaneous Selling Expenses xxx Indirect Labor xxx
Income Taxes xxx Factory Payroll Taxes xxx
Income Summary xxx Depreciation – Machinery and Factory Building xxx
Utilities – Factory xxx
g. To close the balance of Income Summary to Retained Earnings Repairs and Maintenance xxx
Income Summary xxx Miscellaneous Factory Overhead xxx xxx
Retained Earnings xxx Total Manufacturing Cost Pxxx
Add Work in Process, beginning xxx
Total Cost of Work Put into Process Pxxx
Less Work in Process, end xxx
Cost of Goods Manufactures Pxxx
Add Finished Goods, beginning xxx
Cost of Goods Available for Sale Pxxx
Less Finished Goods, end xxx
Cost of Goods Sold Pxxx

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Chapter 12 – Introduction to Cost Accounting
3.
The sum of direct materials, direct labor and factory overhead is total manufacturing cost or
factory cost. The sum of direct materials and direct labor, however, is called prime cost; the
sum of direct labor and factory overhead is called conversion cost. Manufacturing cost is
different from cost of goods manufactured because the latter considers work in process
beginning and work in process ending inventories. Cost of goods manufactured, therefore, is the
cost of the completed products during an accounting period.
4.
In the Statement of Financial Position (balance sheet) of a manufacturing enterprise, the current
asset section is expanded to show the Inventories of Finished Goods, Work in Process and Raw
Materials. The balance in the Finished Goods account represents the total cost incurred in
manufacturing goods that are completed but still on hand (unsold) at the end of the period. The
balance of the Work in Process account includes all manufacturing costs incurred to date for
goods that are in various stages of production (not yet completed). The balance of the Raw
Materials account represents the cost of all materials purchased and on hand and to be used in
the manufacturing process (to be used in production) including raw materials, prefabricated
parts and other factory materials and supplies.
Conversion costs – sum of direct labor and factory overhead.
Explain the manufacturing cycle and prepare journal entries to record various
transactions related to the cycle. The manufacturing cycle starts with the purchase of raw
materials and ends with the completion of goods. Direct materials issued to production,
direct labor cost and factory overhead costs go to work in process. Cost of goods completed
during the period are transferred from work in process to finished goods while the cost of
finished goods sold are transferred from the finished goods to cost of goods sold.
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.
GLOSSARY of ACCOUNTING TERMINOLOGIES

Direct labor – labor used to convert materials into finished product and that can be traced to
REVIEW of the LEARNING OBJECTIVES
the finished product.
1. Explain the nature of cost accounting and differentiate a manufacturing company from Direct materials – materials that form an integral part of a finished product and of relatively
a service company and a merchandising company. Cost accounting is concerned with the high value and is included in the calculation of the cost of the product.
determination and control of costs. Although cost accounting is considered applicable to
manufacturing operations, it is also applied to non-manufacturing industries such as Factory overhead – manufacturing expenses or factory burden other than direct materials and
financial institutions, transportation companies and schools. A service firm is engaged direct labor. Factory overhead includes indirect materials and indirect labor.
primarily in the rendering of services while a merchandising firm is engaged in the buying
and selling of merchandise. A manufacturing firm, on the other hand, is engaged in the Prime cost – sum of direct materials and direct labor.
purchase and processing of raw materials into finished goods. The three firms also differ in
the classes of inventories maintained. A service firm has operating supplies inventory; a Total manufacturing cost – the sum of direct materials, direct labor and factory overhead.
merchandising firm has merchandise inventory; a manufacturing firm has three classes of
inventories, namely: (1) raw materials, (2) work in process, and (3) finished goods. Work in process – an account used to record manufacturing costs; it represents work put into
process and not yet completed as of the end of the reporting period.
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 from an integral part of the finished product and whose value is relatively high.
Direct labor can be traced to the finished product and is incurred to convert direct materials
into finished goods. Factory overhead included all indirect costs incurred in the production
of raw materials into finished goods. Factory overhead included all indirect costs incurred
in the production of raw materials into finished goods. These costs include indirect
materials and indirect labor. Direct materials plus direct labor is prime cost; direct labor
plus factory overhead is conversion cost.

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