Part II Partnerhsip Corporation

5Chapter 9
PARTNERSHIP FORMATION
Introduction
As a business grows it may be necessary to involve additional people either to obtain access
to more capital or to provide expertise. One way of introducing additional people is to form a
partnership. A partnership is formed when two or more persons carry on a business for profit
as co-owners. A partnership is an unincorporated association of two or more individuals to
carry on, as co-owners, a business with the intention of dividing the profits among
themselves. When a partnership is formed each partner introduces capital. The capital
introduction might be in cash form or non-cash form such as equipment, machinery, buildings,
or accounts receivable. If the capital is introduced in no- cash form, it is always brought into
the partnership at fair value.
Lesson 1: Nature of Partnership
Definition of Partnership
The Philippine Civil Code provides for a definition of a partnership as follows: Art. 1767. By
the contract of partnership two or more persons bind themselves to contribute money,
property, or industry to a common fund, with the intention of dividing the profits among
themselves.
A partnership is formed when two or more individuals own the business. The Civil Code of
the Philippines treats a partnership as a juridical person, which means its legal personality is
separate from that of its business owners. There are two kinds of partnership: general and
limited
Characteristics of a Partnership
1. Ease of formation – as compared to corporations, the formation of a partnership
requires less formality.
2. Separate legal personality – the partnership has a juridical personality separate and
distinct from the partners. The partnership can transact and acquire properties in its
name.
3. Mutual agency – the partners are agents of the partnership for the purpose of its
business. As such, a partner may legally bind the partnership to a contract or
agreement that is in line with the partnership’s operations.
4. Co-ownership of property – each partner is a co-owner of the properties invested in
the partnership and each has an equal right with his partners to possess specific
partnership property for partnership purposes. However, a partner has no right to
possess a partnership property for any other purpose without the consent of his
partners.
5. Co-ownership of profits – each partner is entitled to his share in the partnership
profit. A stipulation which excludes one or more partners from any share in the profits
or losses is void.
6. Limited life – a partnership is dissolved:
i. By the express will of any partner.
ii. By the termination of a definite term stipulated in the contract.
iii. By any event which makes it unlawful to carry out the partnership.
iv. When a specific thing which a partner had promised to contribute to the
partnership perishes before the delivery.
v. Expulsion, death, insolvency, or civil interdiction of a partner.
7. Transfer of ownership – in case of dissolution, the transfer of ownership, whether to
a new partner or existing partner, requires the approval of the remaining partners.
8. Unlimited liability – each partner, including industrial ones, may be held personally
liable for partnership debt after all partnership assets have been exhausted. If a
partner is personally insolvent, his share in the partnership debt shall be assumed by
the other insolvent partners.
➢ A partnership in which all partners are individually liable is called a general
partnership.
➢ A partnership in which at least one partner is personally liable is called a
limited partnership. A limited partnership includes at least one general
partner who maintains unlimited liability. The other, called limited partners,
may limit their liability up to the extent of their contributions to the partnership.
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Advantages and Disadvantages of a partnership
Advantage Disadvantage
▪ Ease of formation ▪ Limited life/ easily dissolved
▪ Shared responsibility of running the ▪ Unlimited liability
business
▪ Flexibility in decision making ▪ Conflict among partners
▪ Greater capital compared to sole ▪ Lesser capital compared to a
proprietorship corporation
▪ Relative lack of regulation by the ▪ A partnership (other than a general
government as compared to a professional partnership) is taxed like
corporation. a corporation.
Accounting for partnerships

The Conceptual Framework for Financial Reporting and the PFRSs are applicable to all
reporting entities regardless of the type of organization. Thus, most accounting procedures
used for each type of business organizations are also applicable to partnerships. The main
distinction lies on the accounting for equity. The following are the major considerations in
accounting for partnership equity:
a. Formation – accounting for initial investments to the partnership.
b. Operations – division of profits or losses
c. Dissolution – admission of a new partner and withdrawal, retirement or death of a
partner.
d. Liquidation – winding-up of partnership affairs.
Lesson 2: Accounting for Partnership Formation
A contract of partnership is consensual. It is created by the mere agreement of the partners

which may be constituted in any form, oral or written. However, certain provisions in the Civil
Code require that a partnership agreement must be made in a public instrument and recorded
with the Securities and Exchange Commission when:
a. Immovable property or real rights are contributed to the partnership; or
b. The partnership has a capital of P3,000 or more
A partnership’s legal existence begins from the execution of the contract, unless otherwise
stipulated.
Valuation of contributions of partners
Art. 1787 of the Civil Code states that “when the capital or part thereof which a partner is
bound to contribute consists of goods, their appraisal must be made in the manner prescribed
in the contract of partnership, and in the absence of stipulation, it shall be made by experts
chosen by the partners, and according to current prices, the subsequent changes thereof
being for the account of the partnership.
The term “appraisal” as used in the Civil Code suggests valuation of capital
contributions at fair value. Accordingly, all assets contributed to (and related liabilities
assumed by) the partnership are initially measured at fair value.
Fair value is the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement date.
(PFRS 13).
When measuring the contributions of the partners, the following additional guidelines
from the PFRSs shall be observed:
Type of contribution Measurement

Cash and cash equivalent Face amount (PAS 7)
Inventory Lower of cost and Net Realizable value
(PAS 2)
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Each partner’s capital account is credited for the fair value of his net contribution (i.e.,
asset contribution less any liability assumed by the partnership). No contribution shall be
valued at an amount that exceeds the contribution’s recoverable amount. Each partner’s
contribution shall be adjusted accordingly before recognition in the partnership’s books.
➢ Recoverable amount – is the higher between an asset’s fair value less cost to sell
and value in use.
A partner’s subsequent share in profits share in profits (losses) shall also be credited
(debited) to his capital account. Likewise, permanent withdrawals of capital are debited to the
partner’s capital account. Temporary withdrawals may be debited to the partner’s drawings
account. The sum of the balance in the partners’ individual capital accounts represents the
total equity of the partnership.
Partners’ Ledger accounts
The partners’ ledger accounts are:
a. Capital accounts
b. Drawing accounts
c. Receivable from/Payable to a partner
Capital and Drawing Accounts
Separate capital and drawing accounts are established for each partner, e.g., “S. Ty, Capital”
and “S. Ty, Drawings”. The equity accounts are used to record the following:
S. Ty, Capital S. Ty, Drawings
Dr. Cr.
Dr. Cr.
▪ Temporary ▪ Recurring
▪ Permane ▪ Initial withdrawals reimbursable
nt investm during the costs paid by
withdraw ent period the partner
als of ▪ Temporary
capital funds held to be
▪ Share in ▪ Addition remitted to the
losses al partnership
investm
ents
▪ Debit ▪ Share in
balance profits
of
drawings
account
The drawing account is a nominal account that is closed to the related capital account
at the end of the period. This account is a contra equity account and has a normal debit
balance.
Receivable from/ Payable to a partner – The partnership may enter into a loan transaction
with a partner. The loan extended by the partnership to a partner is recorded as a receivable
from a partner, while a loan obtained by the partnership from a partner is recorded as a
payable to the partner.
Accounting for the formation of a partnership
Accounting entries to record the formation will depend upon how the partnership is
formed. A partnership may be formed in several ways, namely:
1. Formation of a partnership for the first time.
2. Conversion of a sole proprietorship to a partnership.
a. A sole proprietor allows another individual, who has no business of his own to
join his business.
b. Two or more sole proprietors form a partnership.
3. Admission of a new partner (This is discussed in later chapter)
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Illustration: Formation of partnership – Valuation of capital
A and B formed a partnership. The following are their contributions:
A B
Cash 100,000 -
Account Receivable 50,000 -
Inventory 80,000 -
Land 50,000
Building 120,000
Total 230,000 170,000
Note payable 60,000
A, capital 170,000
B, capital 170,000
Total 230,000 170,000
Additional Information:
▪ Included in accounts receivable is an account amounting to P20,000 which is deemed
uncollectible.
▪ The inventory has an estimated selling price of P100,000 and estimated costs to sell
of P10,000.
▪ The partnership assumed a P10,000 unpaid mortgage on the land.
▪ The building is under-depreciated by P25,000.
▪ There is an unpaid mortgage of P15,000 on the building which B agreed to settle
using his personal funds.
▪ The note payable is stated at face amount. A proper valuation requires the
recognition of a P15,000 discount on note payable.
▪ A and B shall share in profits and losses on a 60:40 ratio respectively.
Requirement (a): Compute for the adjusted balances of the partners’ capital accounts.
Solution:
A B Partnership
Cash 100,000 - 100,000
Accounts receivable (50k-20k) 30,000 - 30,000
Inventory ( at cost, the lower 80,000 80,000
amount)
Land 50,000 50,000
Building (120k-25k) 95,000 95,000
Total 210,000 145,000 355,000
Note payable, net (60k-15k) (45,000) (45,000)
Mortgage payable – land (10,000) (10,000)
Adjusted capital balances 165,000 135,000 300,000
The unpaid mortgage on the building is not included because it is not assumed by the
partnership.
Journal entry:
Date Cash 100,000

Accounts receivable 30,000
Inventory 80,000
Land 50,000
Building 95,000
Discount on note payable 15,000
Note payable 60,000
Mortgage payable 10,000
A, capital 165,000
B, capital 135,000
Requirement (b): Assume that a partner’s capital shall be increased accordingly by
contributing additional cash to bring the partner’s capital balances proportionate to their profit
and loss ratio. Which partner should provide additional cash and how much is the additional
cash contribution?
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Solution: Using A’s capital first, let us determine if B’s capital contribution has any deficiency.
A, capital 165,000
Divide by: Profit (loss) sharing ratio of A 60%
Total 275,000
Multiply by: B’s profit (loss) sharing ratio 40%
Minimum capital required of B 110,000
B’s capital 135,000
Deficiency in B’s capital contribution -
❖ Conclusion: B’s contribution has no deficiency.
Now using B’s capital, let us determine if A’s capital contribution has any deficiency.
B, capital 135,000
Divide by: Profit (loss) sharing ratio of A 40%
Total 337,500
Multiply by: A’s profit (loss) sharing ratio 60%
Minimum capital required of A 202,500
A’s capital 165,000
Deficiency in A’s capital contribution 37,500
❖ Conclusion: Partner A shall contribute additional cash of P37,500 to make his
contribution proportionate to his profit sharing ratio.
Reconciliation:
A’s contribution (165k + 37.5k additional contribution) 202,500
B’s contribution 135,000
Adjusted total contributions 337,500
➢ 337,500 × 60% = 202,500 A’s adjusted contribution
➢ 337,500 × 40% = 135,000 B’s contribution
Lesson 3: Bonus on Initial Investments
An accounting problem exists when a partner’s capital account is credited for an

amount greater than the fair value of his contributions.
For instance, a partnership agreement may allow a certain partner who is bringing in
expertise or special skill to the partnership to have a capital credit greater than the fair value
of his contributions. In such case, the additional credit to the partner’s capital (i.e., the ‘bonus’)
is accounted for as a deduction from the capital of the other partners. This accounting
method is called the “bonus” method.
Although, the credit to the partner’s capital may vary due to a ‘bonus,’ the
corresponding debit to the asset account must still be equal to the fair value of the
contribution. The difference between the amounts credited and debited is treated as
adjustment to the capital accounts of the other partners.
Illustration: A and B agreed to form a partnership. A contributed P40,000 cash while B
contributed equipment with fair value of P100,000. However, due to the expertise that A will
be bringing to the partnership, the partners agreed that they should initially have an equal
interest in the partnership capital.
Requirement: Provide the journal entry to record the initial investments of the partners.
Actual contributions Bonus method
A 40,000 (140,000 × 50%) 70,000
B 100,000 (140,000 × 50%) 70,000
Total 140,000 140,000
Date Cash 40,000
Equipment 100,000
A, Capital (40,000 + 30,000 70,000
bonus) 70,000
B, Capital (100,000 – 30,000
bonus)
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Notes:
➢ The bonus given to A, i.e., P30,000 (P70,000 capital credit P40,000 actual
contribution) is treated as a reduction to the capital credit of B.
➢ After applying the bonus method, the total capital of the partnership is still equal to
the fair value of the partners’ contributions. The debits to “Cash” and “Equipment” are
equal to their fair values. Only the amounts credited to the partners’ capital accounts
have varied.
Summary:
Asset contribution of a Liability assumed by the Credit to the partner’s

partner partnership capital account
➢ Initially recorded at ➢ Initially recorded at ➢ Either at:
fair value fair value a. fair value (no
bonus);
b. above fair value
(bonus to the
partner); or
c. below fair value
(bonus to the other
partner(s))
Variations to the bonus method

A partnership agreement may stipulate a certain ratio to be maintained by the partners
representing their specific interests in the equity of the partnership. This stipulation may give
rise to adjustments to the initial contributions of the partners. Since technically there is no
“bonus” being given to a certain partner any increase or decrease to the capital credit of a
partner is not deducted from his co-partners’ capital accounts. Instead, the capital
adjustments is accounted for as either:
a. Cash settlement among the partners: or
b. Additional investment or withdrawal of investment of a partner
The following illustrations are variations to the bonus method:
Illustration 1: Cash settlement between partners.
A, B and C formed partnership. Their contributions are as follows:
A B C
Cash 40,000 10,000 100,000
Equipment 80,000 _
Totals 40,000 90,000 100,000
Additional information:
▪ The equipment has an unpaid mortgage of P20,000, which the partnership assumes
to repay.
▪ The partners agreed to equalize their interests. Cash settlements among the partners
are to be made outside the partnership.
Requirements:
a. Which partner(s) shall receive cash payment from the other partner(s)?
b. Provide the entry to record the contributions of the partners.
Solutions: Requirement (a):
A B C Partnership
Cash 40,000 10,000 100,000 150,000
Equipment 80,000 80,000
Mortgage Payable (20,000) (20,000)
Net Contribution 40,000 70,000 100,000 210,000
Equal interests (210,000/3) 70,000 70,000 70,000 210,000
Cash Receipt (Payment) (30,000) 0 30,000 0
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❖ Answer: C shall receive P30,000 from A.
Requirement (b):
Date Cash 150,000

Equipment 80,000
Mortgage payable 20,000
A, Capital 70,000
B, Capital 70,000
C, Capital 70,000
Notes:
❖ The cash settlement among the partners is not recorded in the partnership’s books
because this is not a transaction of the partnership but rather of the partners among
themselves.
❖ The partnership’s capital of P210,000 remains the same after the cash settlement.
Again, what varied are only the credits to the partners’ capital accounts.
Illustration 2: Additional investment (withdrawal of investment)

A and B agreed to form a partnership. The partnership agreement stipulates the following:
• Initial capital of P140,000.

• A 60:40 interest in the equity of the partnership, respectively.
Partner A contributed P100,000 cash while B contributed P40,000 cash.
Requirement: Which partner shall provide additional investment (or withdraw part of his
investment) in order to bring the partners’ capital credits equal to their respective interests in
the equity of the partnership?
Solution:
Agreed initial capital P140,000
A’s required capital balance (140,000 x 60%) 84,000
B’s required capital balance (140,000 x 40%) 56,000
A B Totals
Actual contributions 100,000 40,000 140,000
Required capital balance 84,000 56,000 140,000
Additional (Withdrawal) (16,000) 16,000 -
 Answer: A shall withdraw P16,000 from his initial contribution while B shall make an
additional investment of P16,000.
Lesson 4: Sole Proprietor and Another Individual Forming a Partnership
An individual who has no business of his own may join another individual who is
already operating his own business. Under this type of formation, both the assets and
liabilities of the sole proprietor are transferred to the newly formed partnership. Normally, the
partners agree on the revaluation of some of the assets before the transfer. The journal
entries to record this type of formation will depend on whether the books of the sole
proprietorship are to be used for the newly formed partnership or new books are to be
opened.
Case 1. Sole Proprietorship's Books are Retained for the Partnership. If the books of the
sole proprietorship are to be retained for the partnership, the following accounting procedures
may be used in recording the formation of the partnership:
1. Adjust the assets of the sole proprietor in accordance with the agreement. Adjustments
are to be made to his capital account.
2. Record the investment of the other partner.
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Case 2. New Books are Opened for the Partnership. If new books are to be opened for the
partnership, the following procedures may be used in recording the formation of the
partnership.
Books of the Sole Proprietor:
1. Adjust the assets of the sole proprietor according to the agreement. Adjustments are to
be made to his capital account.
2. Close the books.
Books of the Partnership:
1. Record the investment of the sole proprietor (i.e., his assets and liabilities).
2. Record the investment of the other partner.
Illustration: Assume that Sansa has been operating a retail store for a number of years. A
statement of financial position on July 1, 2018 is prepared for Sansa Company as follows:
Sansa Company
Statement of Financial Position
July 1, 2018
Assets
Cash 60,000
Inventory 70,000
Equipment 40,000
Less: Accumulated depreciation 4,000 36,000
Total Assets 216,000
Liabilities and Equity

Accounts Payable 86,000
Sansa, Capital 130,000
Total liabilities and equity 216,000
Sansa needs additional capital to meet the increasing sales and offers Arya an interest in the
business. Sansa and Arya agree to form a partnership to be known as Snow Partnership.
Sansa’s business is audited and its net assets are appraised. The audit and appraisal shows
the following:
1. Allowance for bad debts of P5,000 is to be provided.
2. Inventory is to be recorded at its market value of P80,000.
3. The equipment has a fair value of P35,000.
4. P2,000 of accounts payable has not been recorded.
Sansa and Arya prepare and sign articles of co-partnership that include all significant
operating policies. On July 1, 2018, Arya contribute P100,000 cash for a 1/3 capital interest.
The Snow Partnership is to acquire all of Sansa’s business and assume its liabilities.
Sole Proprietorship’s Books are Retained for the Partnerships. If the books are to be
retained, the following are the journal entries to record the formation of the partnership:
Books of Sansa (Now the Partnership Books)
July 1, 2018
(1) Inventory 10,000
Accumulated depreciation- Equipment 4,000
Equipment 5,000
Allowance for bad debts 5,000
Accounts payable 2,000
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Sansa, capital 2,000
To adjust assets and liabilities of Sansa.
(2) Cash
Arya, capital 100,000
To record investment of Arya. 100,000
After the formation, the statement of financial position of the newly formed partnership is:
Snow Partnership
July 1, 2016
Assets
Cash P160,000
Accounts receivable P50,000
Less: Allowance for bad debts 5,000 45,000
Inventory 80,000
Equipment 35,000
Total assets P320,000
Accounts payable P 88,000
Sansa capital 132,000
Arya, capital 100,000
Total liabilities and equity P320,000
New Books are Opened for the Partnership. If new books are to be used for the
partnership, the following accounting procedures may be used to record the formation of the
partnership:
Books of Sansa:
1. Adjust the assets and liabilities of Jose according to the agreement. Adjustments are
made to his capital account.
2. Close the books.
New books of the Partnership:
1. Record the investments of Sansa. Her assets and liabilities.
2. Record the cash investment of Arya.
Using the procedures, the journal entries to record the formation of the partnership are:
Books of Sansa (Sole Proprietorship):
July 1, 2018
(1) Inventory 10,000
Accumulated depreciation- Equipment 4,000
Equipment 5,000
Sansa, capital 2,000
To adjust assets and liabilities of Sansa.
(2) Accounts payable 88,000
Cash 60,000
Inventory 80,000
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Equipment 35,000
To close all the adjusted balances of the accounts.
New Books of the Partnership
2018 July 1
(1) Cash 60,000
Inventory 80,000
Equipment 35,000
To record investments of Sansa
(2) Cash
Arya, Capital 100,000
To record cash investment of Pedro. 100,000
Lesson 5: Two Proprietors Forming a Partnership
The accounting procedures described in the preceding section are also applicable
when two or more businesses join together to form a partnership. There should be an
agreement on the determination of the partners' interest in the partnership. It is also important
that the partners agree on the values of the assets to be assigned and the liabilities to be
assumed by the partnership. Books of one of the sole proprietorship m ay be used for the
newly formed partnership or a new set of books may be opened.
Illustration. Assume that on June 30, 2016, Gerry and Henry, competitors in business,
decide to consolidate their business to form a partnership to be called GH Partnership. The
statement of financial position of Gerry and Henry on this date are presented below.
Gerry Company
June 30, 2016
Assets
Cash P 5,000
Accounts Receivable 10,000
Merchandise inventory 8,000

Furniture and fixtures 6,000
Total assets P 29,000
Gerry Capital 26,000
Total liabilities and equity 29,000
Henry Company
June 30, 2016
Assets
Cash P 4,000
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Total assets P 31,000
Henry capital 25,000
Total liabilities and equity P 31,000
The conditions agreed by the partners for purposes of determining their interests in the
partnership are presented below:
a. 10% of accounts receivable is to be set up as uncollectible in each book.
b. Merchandise inventory of Henry is to be increased by P1,000.
c. The furniture and fixtures of Gerry and Henry are to be depreciated by P600 and P900
respectively.
Books of Henry are used as the Partnership Books. If the books of Henry are to be used
as the partnership books, the accounting procedures to record the formation of the
partnership are:
Books of Gerry
1. Adjusted the accounts of Gerry as agreed. Adjustments are made to his capital
account.
2. Close the books.
Books of Henry (Now the partnership books)
1. Adjust the accounts of Henry as agreed. Adjustments are made to his capital account.
2. Record the investment of Gerry, his adjusted assets and liabilities.
The journal entries to record the formation of the partnership, using the above accounting
procedures are:
Books of Gerry
2016 June 30
(1) Gerry capital 1,600
Accu. depreciation – furniture and fixtures 600
To record adjustments of assets
Accu. Depreciation – furniture and fixtures 600
Gerry capital 24,400
Cash 5,000
To close the books.
Books of Henry (Now the books of the partnership)
2016 June 30
(1) Merchandise inventory 1,000
Henry capital 700
Allowance for bad debts 800
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To adjust assets of Henry.
(2) Cash 5,000
Allowance for debts 1,000
To record investments of Gerry.
New Partnership Books will be used. If new books are to be opened for the partnership, the
following accounting procedures may be used to record the formation of the partnership.
Books of Gerry and Henry
1. Adjust the accounts of Gerry and Henry according to their agreement. Adjustments are
to be made to their capital accounts.
2. Close the books.
New Book of the Partnership

1. Record the investments of Gerry, his adjusted assets and liabilities.
2. Record the investments of Henry, his adjusted assets and liabilities.
Using the accounting procedures, the journal entries to record the formation of the partnership
under this assumption are:
Books of Gerry – 2016 June 30
(1) Gerry capital 1,600
To record adjustments of assets.

Cash 5,000
To close the books.
Books of Henry
2016 June 30
(1) Merchandise inventory 1,000
Henry capital 700
Accumulated depreciation – furn. & fixt. 900
To record adjustments of assets

Accumulated depreciation – furn. & fixt. 900
Cash 4,000
To close the books.
New Books of the Partnership
2016 June 30
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(1) Cash 5,000
To record the investments of Gerry.
(2) Cash 4,000

To record the investments of Henry
Take note that the Furniture and Fixtures accounts are recorded net of the accumulated
depreciation.
The statement of financial position of the partnership after the formation is as follows:
Illustration 1-4
GH Partnership
June 30, 2016
Assets
Cash P9,000
Accounts receivable P18,000
Less: Allowance for bad debts 1,800 16,200
Total assets P57,700
Accounts payable P9,000
Total liabilities and equity P57,700
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Review Questions and Exercises
I – Essay
1. What is partnership? How does it differ from a sole proprietorship business?
2. What are the characteristics of a partnership?
3. How is the contribution of a partner recorded in the partnership books?
II – True or False. Instruction: Write T if the statement is true or correct of F is the

statement is false or incorrect.
1. The accounting for assets and liabilities of a partnership business is different from that
of a sole proprietorship or a corporation.
2. A partnership is relatively easy to form but also easy to dissolve.
3. Mr. A contributed land with historical cost of P1M and fair value of P2M to a
partnership business. Mr. A’s contribution shall be valued at P1M in the partnership
books.
4. A bonus given to a partner is treated as a reduction to the capital account (2) of the
other partner (s).
5. Ms. B contributed equipment with carrying amount of P100 and fair value of P200 to a
partnership. No bonus is given to any partner. In the partnership’s books, equipment
is debited for P200 but B’s capita account is credited for P100.
6. Mr. C contributed land with fair value of P1M to a partnership. The land has an unpaid
mortgage of P2M which the partnership agreed to assume. The valuation of Mr. C’s
net contribution is P1.2M.
Fact pattern:
Mr. D and Ms. E formed a partnership. D contributed P200, while E contributed P100. The
partners’ respective interests in the partnership are 60% and 40%. The initial credits to the
partners’ capital accounts are to be adjusted using the bonus method to reflect the partners’
respective interests.
7. The balance of D’s capital account after the formation is P180.
8. The bonus given to E is P40.
Fact pattern:
Piw and Pie agreed to form a partnership. Piw contributed cash of P200 while Pie will be
contributing her expertise. The partnership agreement stipulates that Piw and Pie shall have
equal interests in both the initial capital of the partnership and in subsequent partnership profit
and losses.
9. The cash contribution of Piw shall be debited for P200 but the net credit to Piw’s
capital account shall be P100.
10. Immediately after partnership formation, the balance of Pie’s capital account is zero.
III – PROBLEMS
1. Sunny and Gloomy contributed the following in the formation of a partnership
business:
Sunny Gloomy
Cash 180,000 -
Accounts receivable 100,000 -
Inventory 160,000 -
Land (at historical cost) 340,000
Total 440,000 340,000
Additional information:
• Only 60% of the accounts receivable is recoverable.

• The net realizable value of the inventory is P120,000. Sunny acquired the inventory on
account; the partnership will assume the unpaid balance of P60,000.
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• The land has a fair value of P600,000.
Requirement: Provide the journal entry.
2. Use the information in problem 1. Sunny and Gloomy agreed to share in profits and
losses based on 30:70 ratio. A partner with deficient contribution shall provide
additional cash in order for his capital balance to reflect his profit and loss sharing
ratio.
Requirement: Provide the entry to record the additional investment of the partner with
deficient contribution.
3. Use the information in problem 1. Sunny and Gloomy agreed to have equal credits to
their capital accounts. The bonus method shall be used.
Requirements:
a. Provide the compound journal entry.
b. Provide the simple journal entries.
their capital accounts. Cash settlement is to be made between the partners for the
adjustments on their capital balances.
Requirement: Describe how the cash settlement should be made and how it would be
accounted for in the partnership books.
their capital accounts. Additional investment or partial withdrawal shall be made by a
partner from the partnership for any adjustment to his capital balance.
Requirement: Which partner should make an additional investment and which partner should
make a withdrawal?
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Chapter 10
PARTNERSHIP OPERATIONS
Introduction:
The manner a partnership operates is basically the same as that of a sole proprietorship
when we speak of accounting principles involved and assumptions as well. The same steps of
accounting process are also followed from Journalizing up to preparation of Reversing
Entries.
Learning Objectives:
1. Discuss the various accounts in partnership which we do not have under sole
proprietorship.
2. State the items that affect the division of a partnership’s profits or losses among the
partners.
3. Compute for the share of a partner in the partnership’s profit or loss.
Lesson 1: Division of Profits and Losses
The partners share in partnership profits or losses is in accordance with their

partnership agreement
Art 1797 of the Philippines Civil Code provides the following additional rules in the
profit or loss sharing of partners:
• If only the share of each partner in the profits has been agreed upon, the share of each in
the losses shall be in the same proportion.
• In the absence of stipulation, the share of each partner in the profits and losses shall be in
proportion to what he may have contributed, but the industrial partner shall not be liable for
the losses. As for the profits, the industrial partner shall receive such share as may be just
and equitable under the circumstances. If besides his service he has contributed capital,
he shall also receive a share in the profits in proportion to his capital.
➢ An industrial partner is one who contributes service to the partnership rather than cash
or other non-cash assets to the partnership.
➢ A capitalist partner is one who contributes cash or other non-cash assets to the
partnership.
➢ A partner who contributes both services and cash or other non-cash asset is both an
industrial and a capitalist partner.
• The designation of losses and profits cannot be entrusted to one of the partners (Art.
1798). A stipulation which excludes one or more partners from any share in the profits or
losses is void (Art. 1799).
In additional to profit or loss sharing, the partnership may also stipulate any of the
following:
a. Salaries – normally, an industrial partner receives salary in addition to his share in
the partnership’s profit as compensation for his services to the partnership.
b. Bonuses – the managing partner ma bay entitled to a bonus excellent management
performance. Unlike for salaries, a partner is entitled to a bonus only if the
partnership earns profit. The partner is not entitled to any bonus if the partnership
incurs loss.
c. Interest on capital contributions – the partnership agreement may stipulate the
capitalist partners are entitled to an annual interest on their capital contributions.
The items above are normally provided first to the respective partners and any
remaining amount of the profit or loss is shared among the partners based on their stipulated
profit or loss ratio
Illustration 1: Salaries
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A and B’s partnership agreement provides for annual salary allowances of P50,000 for A and
P30,000 for B. The salary allowances are to be withdrawn throughout the period and are to be
debited to the partners’ respective drawing accounts.
Case 1: With remaining profit – different P/L ratios

The partners share profits equally and losses on a 60:40 ratio. The partnership earned profit
of P100,00 before salary allowances.
Requirements:
a. Compute for the respective shares of the partners in the profit.
b. Provide the journal entries
Solution:
Requirement (a):
A B Total
Amount being allocated 1000,000
Allocation:
1. Salaries 50,000 30,000 80,000
2. Allocation of remaining profit
(100K profit – 80k salaries) =20k
(20k x 50%;(20k x 50%) 10,000 10,000
20,000
As allocated 60,000 40,000 100,000
Notes:
➢ Salaries are provided first and the remaining amount is allocated based on the profit
sharing ratio.
➢ The sum of amounts allocated to the partners is equal to the amount being allocated (i.e.,
60k + 40K = 100K).
Requirement (b):
A, Drawings 50,000
Monthly B, Drawings 30,000
entries Cash 80,000
To record the withdrawal of salary
allowances
Income summary 100,000
Year-end A, Capital 60,000
entry B, Capital 40,000
To record the distribution of profit
A, Capital 50,000
Year-end entry B, Capital 30,000
A, Drawings 50,000
B, Drawings 30,000
To close the drawings accounts
Case 2: No remaining profit – different P/L ratios

The partners profits equally and losses on a 60:40 ratio. The partnership earned profit of
P70,000 before salary allowances.
Requirement: Compute for the respective shares of the partners in the profit.
Solution:
A B Total
Allocation:
1. Salaries 50,000 30,000 80,000
2. Allocation of remaining loss
(70k profit – 80k salary) = -10k
(-10k x 60%);(-10k x 40%) (6,000) (4,000)
(10,000)
As allocated 44,000 26,000 70,000
After the salaries are provided, the remaining amount is negative (i.e.,loss); thus, It
is allocated based on the stipulated loss ratio of 60:40.
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Case 3: No P/L ratio
The partnership agreement does not state how profits and losses are to be provided. A
contributed P10,000, while B contributed P20,000. The partnership earned profit of P95,000
before salary allowances.
Solution:
A B Total
Amount being allocated
95,000
Allocation:
1. Salaries 50,000 30,000 80,000
(95k profit – 80k salaries) = 15k
(15k x 10k/30k*);(15k x 20k/30k*) 5,000 10,000
15,000
As allocated 55,000 40,000 95,000
*The fractions are derived from the partners’ respective contributions.
Lesson 2: Bonus as Part of Profit/Loss Distribution
Illustration 2: Bonus
A and B’s partnership agreement stipulates the following:
• Annual salary allowances of P30,0000 for A and P10,000 for B.
• Bonus to A of 10% of the profit after partner’s salaries and bonus.
• The profit and loss sharing ratio is 60:40.
Case 1: With profit

The partnership earned profit of P106,000 before deductions for salaries and bonus.
Solution:
A B Total
106,000
Allocation:
1. Salaries 30,000 10,000 40,000
2. Bonus after bonus(a) 6,000 6,000
(106k – 40k – 6k) = 60k
(60K x 60%);(60K x 40%) 36,000 24,000 60,000
As allocated 72,000 34,000 106,000
(a)The bonus is computed as follows:

Profit before salary and bonus 106,000
Salaries (40,000)
Profit after salaries but before the deduction of bonus 66,000
The bonus scheme is “bonus after bonus”. The formula is as follows:

B = P - P
1 +Br
Where: B = bonus
P = profit bonus and tax
Br = bonus rate
B = 66,000 - 66,000
1+10%
B = 66,000 - 60,000
B = 6,000
Case 2: With loss
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The partnership incurred loss of P5,000 before deduction for salaries and bonus.
Requirements:
a. Compute for the respective shares of the partners in the profit.
b. By what amount did A’s capital amount change
Solutions:
Requirement (a):
A B Total
(5,000)
Allocation:
1. Salaries 30,000 10,000 40,000
2. Bonus after bonus (b) - - -
3. Allocation of remaining loss
(-5k – 40k) = -45k
(-45k x 60%);(-45k x 40%) (27,0000) (18,000) (45,000)
As allocated 3,000 (8,000) (5,000)
(b)No bonus is allocated because the partnership incurred loss. However, salaries are
nonetheless provided because salaries are compensation for service rendered.
Requirement (b):
A’s capital increases by P3,000. Notice that a partner’s capital can increase despite of
partnership loss. The entry to record the allocation of loss is as follows:
Year-end B, Capital 8,000

entry Income summary 5,000
A, Capital 3,000
Illustration 2.1: Bonus – With limit

• First, A shall receive 10% of profit up to P100,000 and 200% over P100,00
• Second, B shall receive 5% of the remaining profit over P150,000.
• Any reminder shall be shared equally
The partnership earned profit of P280,000
Solution:
A B Total
280,000
Allocation:
1. Bonus to A
First 100k:(100k x 10%) 10,000 10,000
Over 100k:[(280k – 100k) x 20% 36,000 36,000
2. Bonus to B on remaining profit
(280k – 10k – 36k – 150k) x 5% 4,200 4,200
(280k – 10k – 36k – 4.2k) / 2 114,900 114,900 229,800
As allocated 160,900 119,100 280,000
Illustration 2.2: Bonus – choice of profit sharing scheme

Mr. A, a partner in ABC Co., is deciding on whether to accept salary of P8,000 or a salary of
P5,000 plus a bonus of 10% of profit after deducting salaries and bonus. The salaries of the
other partners amount to P20,00.
Requirement: At what amount of profit would Mr. A be indifferent between the choices?
Solution:
An algebraic expression is developed from the two choices above.
Let: X = profit after salaries and bonus
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10%X = bonus after bonus
Choice #1 Choice #2
8,000 salary = 5,000 salary + 10%X
X is computed from the equation above as follows:
8,000 = 5,000 + 10%X
10%X = 8,000 – 5,000
X = 3,000 / 10%
X = 30,000
Profit after salaries and bonus(X) 30,000

Multiply by: Bonus rate 10%
Bonus 3,000
Profit after salaries and bonus 30,000
Add back: Salaries (5k to Mr. A + 20k to other partners) 25,000
Add back: Bonus 3,000
Profit before salaries and bonus 58,000
If the partnership’s profit is P58,000, it does not matter whether Mr. A chooses to
receive a salary of P8,000 or a salary of P5,000 plus a 10% bonus because he will receive
the same amount.
Lesson 3: Interest on Capital
Illustration 3: Interest on capital

• Annual salary allowance of P50,000 for A.
• Interest of 10% on the weighted average capital balance of B.
• The partners share profits and losses on a 60:40 ratio.
➢ The partnership earned profit of P100,00.
➢ The movements in B’s capital accounts are as follows:
B, Capital
Beg.
July 31 withdrawal 60,000 April 1 additional investment
Sept. 30 additional investment
30,000 20,000 Dec. 31 additional investment
End.
40,000
Requirement: Compute for the respective shares of the partners
in the profit. 10,000
Solution:
The weighted average balance 100,000 of B’s capital account is
computed as follows:
Months
Outstanding / Total Weighted
Months in average
Balances a year
Beg. Balance 60,000 12/12 60,000

April 1 additional investment 20,000 9/12 15,000
July 31 withdrawal (30,000) 5/12 (12,500)
Sep. 30 additional investment 40,000 3/12 10,000
Dec. 31 additional investment 10,000 0/12 -
Weighted average capital balance 72,500
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A B Total
Allocation:
1. Salaries 50,000 - 50,000
2. Interest on weighted ave. capital - 7,250 7,250
balance (72.5k x 10%)
(100k – 50k – 7.250) = 42,750
(42,750 x 60%);(42.750 x 40%) 25,650 17,100 42,750
As allocated 75,650 24,350 100,000
Illustration 3.1: Interest in Capital and Bonus

• Monthly salary of P5,000 for A.
• 20% bonus to A, based on profit before deduction of salary, interest and bonus.
• 10% interest on weighted average capital of B.
➢ The partnership reported profit of P30,000, net of salary, interest and bonus.
➢ B’s weighted average capital balance is P100,000.
Requirement: How much is the bonus of A?

Solution:
Profit after salary, interest and bonus 30,000
Add back: annual salary(5,000 x 12 mos.) 60,000
Add back: interest capital (100k x 10%) 10,000
Profit before annual salary and interest but after bonus 100,000
Profit before annual salary and interest but after bonus 100,000
Divide by: (100% less 20% bonus rate) 80%
Profit before salary, interest and bonus 125,000
Multiply by: Bonus rate 20%
Bonus (‘bonus before bonus’ scheme) 25,000
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I – TRUE OR FALSE. Write T if the statement is True and F if the statement is false.
1. According to the law, if no profit or loss sharing ratio has been agreed upon, the
partners shall share equally.
2. Mr. A and Ms. B formed a partnership. Mr. A contributed P1M cash, while Ms. B will
contribute her services. Mr. A is a capitalist partner, while Ms. B is an industrial
partner.
Fact pattern:
You and I are partners. We share in profits equally. Because I am the managing partner, I am
entitled to a 20% bonus computed on profit before deducting the bonus.
3. If our partnership earned a profit of P1M (before deducting my bonus), your share
would be P500,000
4. If our partnership incurs loss of P1M, your share would be negative P400,000
5. Normally, partners are entitled to salaries for the services they have rendered to the
partnership business only if the business earns profit.
Fact pattern:
He and She are partners, with 60% and 40% interest in partnership profit, respectively. He is
entitled to P2M annual salary.
6. If the partnership earned a P12M profit before deducting He’s salary, She’s share
would be P4M.
7. If the partnership incurs P8M loss before deducting He’s salary, She’s share will be
negative P4M.
Fact pattern:
A and B formed a partnership. The partnership agreement stipulates the following:
• Annual salary allowances of P50 for A and P30 for B.
• Any remaining amount of profit or loss shall ne divided equally.
8. During the period the partnership earned profit of P100 before salary allowances. A’s
share in the partnership profit is P10.
9. During the period the partnership incurred loss of P100 before salary allowances. A’s
share in the partnership loss is –P40.
10. Mr. C, the managing partner in ABC Co. is entitled to a 20% bonus profit after
partners’ salaries and bonus. ABC Co. reported profit of P360 after deducting the
partners’ salaries but before deducting Mr. C’s bonus. Mr. C’s bonus is P80.
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II – PROBLEM 2: MULTIPLE CHOICE. Encircle the letter corresponding to your answer.
1. How should the partners in a business partnership share in the profits or losses of the
partnership?
a. Equally.
b. At whatever basis of allocation that the dominating partner deems reasonable.
c. In accordance with the partnership agreement.
d. Based on “rock, paper, scissors;” winner takes all.
2. According to the Philippine Civil Code, if only the share of each partner in the profits has
been agreed upon, the share of each in the losses shall be
a. In equal amounts.
b. In equal amounts, but excluding the industrial partner.
c. In proportion to the partners’ contributions.
d. The same as the sharing in profits.
3. According to the Philippines Civil Code, in the absence of a stipulation on the sharing of
profits or losses, partnership profits and losses shall be shared by the partners
a. Equally.
b. In accordance with the partnership agreement.
c. In proportion to what the partners may have contributed.
d. In proportion to what the partners may have contributed, but the industrial partner
shall not be liable for the losses.
4. Which of the following is not a component of the formula used to distribute partnership profits
to partners?
a. Salary allocation to those partners working.
b. After all other allocation, the remainder divided according to the profit and loss
sharing ratio.
c. Interest on the average capital investment.
d. Interest on notes to partners.
5. When allocating a partnership loss to the partners which of the following items is provided
first?
a. Salaries.
b. Bonuses to partners.
c. Interest on the capital contribution of an industrial partner.
d. All of these.
III – Problems
1. Partners A and B share in profits and losses equally after salaries of P100,000 for A and
P60,000 for B. The business earned profit of P200,000 before deduction for the salaries.
Requirements:
a. Compute for the partners’ respective shares in the profit.
b. Provide the journal entries (the salaries are withdrawn periodically).
2. A and B’s partnership agreement provides for annual salary allowance of P160,000 for A and
P80,000 for B. Profits are shared equally, while losses on a 60:40 ratio. The partnership earned
profits of P200,000.
Requirements: Compute for the respective shares of the partners in profit.
3. A and B’s partnership agreement state the following:

• Annual salaries of P96,000 for A and P60,000 for B.
• 10% bonus to A, based on profit after salaries and bonus.
• P/L ratio of 60:40.
The partnership earned profit of P200,000 before salaries and bonus.
4. A and B’s partnership agreement provides for an annual salary allowance of P100,000 for A
and 10% interest on the weighted average capital balance of B. the remainder is shared on a
60:40 ratio, respectively. During the period, the partnership earned profit of P200,000. B’s capital
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account had a beginning balance of P120,000. B made additional investment of P40,000 on April
1, P80,000 on Sept. 30, and P20,000 on Dec. 31, and made drawings of P60,000 on July 31.
Requirement: Compute for the respective shares of the partners in profit.
balance.
5. The partnership agreement of A and B states the following:

• Monthly salary of P10,000 for A.
• 20% bonus to A, before deduction for salary, interest and bonus.
• 10% interest on the weighted average capital of B.
• Balance is shared equally.
B’s weighted average capital balance is P200,000. The partnership reported profit of P60,000 for
the year, net of salaries, bonus and interest.
Requirement: Compute for A’s share in the profit.
6. A and B’s partnership started operations on July 1, 20x1. The partnership agreement requires
A and B to maintain average capital balance of P200,000 and P300,000, respectively. A 10%
annual interest is to be computed on any excess or deficiency. Any remaining amount of profit or
loss is to be shared on a 60:40 ratio. The partnership incurred loss of P120,000 in 20x1. The
average capital balances in 20x1 were P200,000 for A and P220,000 for B.
Requirement: Compute for respective shares of the partners in the loss.
7. A and B formed a partnership and began operations on March 1, 20x1. A invested P200,000
cash, while B invested equipment with a book value of P600,000 and a fair value of P360,000. On
August 31, 20x1, A invested additional cash of P40,000. The partnership agreement stipulates
the following:
• Monthly salary allowance of P4,000 and P20,000 to A and B, respectively, recognized as
expenses.
• 20% bonus on profit before salaries and interest but after bonus to B.
• 12% annual interest on the beginning capital of A.
• Balance equally.
The monthly salaries are withdrawn by the partners at each month-end. The partnership earned
profit of P420,000 during the period before deductions for bonus and interest.
Requirement: Compute for the ending balances of each of the partner’s capital accounts
Chapter 11
PARTNERHSHIP DISSOLUTION
Introduction
A contact of partnership is one of a mutual trust and confidence that one has the right to choose
his associates. Thus, when a new partner is admitted in an existing partnership, it is always with
the common knowledge and consent of all existing partners. The admission of a new partner
automatically dissolves the existing partnership. It must be clearly understood, however, that
dissolution in this premise refers only to the cancellation of the previous Articles of Co-partnership
executed by the old partners in favor of a new contract dawn by both the new and old partners.
Hence, a new partnership is formed.
Learning Objectives: After finishing this module, the student should be able to:
1. Define partnership dissolution and distinguish its types.

2. Account for admission of a new partner by purchase of interest and by investment.
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3. Explain the concept of the bonus method.
4. Make entries for adjustments made when a partner is admitted, withdraws or retires from
a partnership.
Partnership Dissolution
As defined in Article 1828 of the Civil Code, partnership dissolution is “the change in the
relation of the partners caused by any partner ceasing to be associated in the carrying out of the
business”. Partnership dissolution is of two kinds:
1. Dissolution by change in ownership structure which covers the following:

a. Admission of a new partner in the existing partnership
b. Retirement or withdrawal of a partner
c. Death, bankruptcy or incapacity of a partner
d. Incorporation of a partnership
2. Dissolution with liquidation
Here, the partnership will stop to operate. It is the end of the life of the
partnership and the business focuses on the following activities:
a. Sale or conversion of non-current assets into cash

b. Paying its liabilities
c. Distribution of cash and the remaining unsold assets to individual
partners
Lesson 1: Admission of a New Partner in an Existing Partnership
Admission of a new partner is of two types: by purchase of interest and by investment.
Purchase of interest.
A new partner can be admitted in an existing partnership by allowing him to purchase the
whole interest or a portion thereof from one or more of the existing partners. The term “interest”
refers to a partner’s equity or capital in the partnership which comprises of his original investment,
his share in partnership’s profits or losses and his withdrawals. The new partner is referred to as
the “buying partner” and the old or existing partners as the “selling partner(s)”.
Under this type of admission of a new partner, the following are observed:
➢ The transaction is personal in nature between the selling partner and the buying partner.
The partnership is not involved as far as money matters are concerned.
➢ Money paid by the buying partner personally goes to the selling partner for the interest
sold.
➢ The only concern of the partnership is to record the transfer of interest from the selling
partner/s to the buying partner. The amount of interest transferred will be equal to the
book value of the interest sold, the entry in the books of the partnership will remain the
same regardless of the amount that the buying partner will pay to the selling partner/s.
➢ The transaction will not increase or decrease the capitalization of the partnership before
and after admission.
Illustration:
Case 1 – Purchase of a portion of interest from one partner only.
Let us assume that Jon and Bran are partners with capital balances of P60,000 and P80,000
respectively. They shared profits and losses equally. Hodor is admitted in the partnership by
allowing him to purchase 1/3 of Jon’s interest under the following assumptions:
Assumption 1 – Hodor pays P20,000 (at book value)
2 – Hodor pays P15,000 (less than its book value)
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3 – Hodor pays P25,000 (more than its book value)
The entry to record the admission of Hodor in the partnership under assumptions 1, 2, and 3 is:
Jon, Capital P20,000
Hodor, Capital P20,000
To transfer 1/3 interest of Jon to Hodor
Under all assumptions, it is Jon who personally receives the money from Hodor. Jon has a
personal loss of P5,000 under assumption 2 and personal gain under assumption 3. The total
partnership capitalization of P140,000 did not change before and after admission of Hodor.
Before admission After Admission:

Jon, Capital P60,000 P40,000
Bran, Capital 80,000 80,000
Hodor, Capital 20,000
Total Capital 140,000 140,000
Case 2 – Purchase of one whole interest from one partner
When a new partner purchased one whole interest of one of the existing partners, the
selling partner ceases to be a partner.
Let as assume the given example in case 1 but this time, Hodor is admitted in the
partnership by purchasing the whole interest of Jon. The journal entry is:
Jon, Capital 60,000
To transfer the whole interest of Jon to Hodor
Case 3 – Purchase of portion of interest from more than one partner

Using the same example, assume that Hodor is admitted to the partnership by allowing
him to purchase ½ of Jon and ¼ of Bran’s interests. The journal entry is:
Jon, Capital 30,000

Bran, Capital 20,000
To transfer interests of Jon and Bran to Hodor
Case 4 – Purchase of whole interest from all partners.

Using the same example, assume that Hodor purchased all interests of Jon and Bran.
The entry is:
Jon, Capital 60,000
Bran, Capital 80,000
When all partners allow the whole of their interests in the partnership to be purchased by one
person, the transaction tantamounts to selling of the partnership business. In this case, the
partnership business in converted into a sole proprietorship.
Lesson 2: Admission by Investment
In this type of admission, the transaction is between the new partner and the partnership.
The contribution or investment of the new partner increases both assets and capitalization of the
partnership.
The following scenarios may occur when a new partner invests in a partnership:
1. The new partner’s investment is equal to his/her capital credit, which may be determined
by multiplying the new partner’s interest with the partnership’s net assets (total capital)
after the admission.
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2. The new partner’s investment is greater than his/her capital credit. The excess
contribution is treated as bonus to the old partners to compensate for their past efforts
in establishing the business. The bonus is accounted for as an increase in the old
partner’s capital and a decrease in the new partner’s capital.
3. The new partner’s investment is less than his/her capital credit. The deficiency is treated
as a bonus to the new partner (possibly because he/she is bringing expertise or
special skills into the business). The bonus is accounted for as an increase in the new
partner’s capital.
Note: Bonus is not an account title so it cannot be debited or credited. It has th effect of
decreasing the capital balance of the partner giving the bonus and increasing the capital
balance of the partner receiving the bonus.
Illustration:
The capital account balance of partners Jamie and Ned who shared profit and loss of 70% and
30%, respectively, were as follows:
Jamie, Capital 60,000
Ned, Capital 40,000
100,000
Cersie is admitted in the partnership by allowing her to invest cash of P30,000. The journal entry
for the admission of Cersie is;
Cash 30,000
Cersie, Capital 30,000
After the admission of Cersie, cash increased by 30,000 while the capitalization of the new
partnership becomes P130,000.
Assume that the agreement among Jamie, Ned and Cersie provides that Cersie is to
make an investment that will give her a 20% interest in the new firm. In this case, the combined
capital of the old partners (100,000) represents 80% of the new capital. Therefore, the incoming
partner should invest P25,000 for a 20% interest computed as follows:
P100,000 divided by 80% P125,000

Deduct total capital of old partners 100,000
Investment of Cersie for a 20% interest 25,000
The journal entry is:

Cash 25,000
The Bonus Method
Bonus to New Partner . Using the same illustration in admission by purchase of interest, let us
assume that Cersie is to be admitted in the Partnership of Jamie and Ned by investing P50,000
for a ½ interest in the total agreed capitalization of P150,000. Total agreed capitalization is equal
to the contributions of Jamie, Ned and Cersie respectively (60,000 + 40,000 + 50,000). Cersie’s
capital credit is P75,000 (P150,000 x ½) while her contribution is only P50,000. Hence, she gets a
bonus of P25,000 from Jamie and Ned. The journal entry would be:
Cash 50,000
To record investment of Cersie
Jamie, Capital (70%) 17,500

Ned, Capital (30%) 7,500
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To record bonus to Cersie
Bonus to Old Partners
Using the same illustration, let us assume that Cersie is to be admitted by investing P50,000 for a
¼ interest in the new firm. Inasmuch as the contribution of Cersie exceeds her capital credit of
P37,500 (150,000 x ¼ ) by P12,500, the excess represents bonus to be given to the old partners.
The journal entry would be:
Cash 50,000

Jamie, Capital 8,750
Ned, Capital 3,750
Neither the New Partner nor Old Partners receives Bonus
Using the same illustration, let us assume that Cersie is admitted in the partnership by investing
P50,000 for a 1/3 interest in the new firm capital of P150,000. Her investment is equal to her
capital credit of P50,000. Hence, no bonus is given. The journal entry would be:
Cash 50,000
Lesson 3: Withdrawal or Retirement/Death, Bankruptcy or Incapacity of a Partner
When a partner withdraws or retire from the partnership and ceased to be a partner, he books of
the partnership should be updated as of the date of withdrawal or retirement. These include
revaluation of assets, recognition of liability, etc., so that the capital of the withdrawing partner
can be fairly established before he ceases to be a partner.
The basic accounting problems involved are as follows:
1. Sale of interest to an outsider

2. Sale of interest to one or more of the remaining partner/s
3. Sale of interest to the partnership
a. At book value
b. More than the book value (bonus to retiring partner)
c. Less than the book value (bonus to remaining partner/s)
4. Journal entry in the partnership books
Sale of Interest to an Outsider
Under this, the transaction is handled similar to admission of partner by purchase of interest. The
payment or consideration is received by the withdrawing partner and not by the partnership
because the transaction is personal in nature.
Illustration: The partner’s capital account balances after adjustments in preparation for the
withdrawal of one of the partners are shown below:
Ty 40,000
Go 20,000
Wang 30,000
They shared profit and loss equally. Wang decides to withdraw from the partnership and that is
interest is sold to Meng, an outsider, with the consent of the other partners. Regardless of how
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much Wang receives from Meng, the only entry in the book of the partnership is to record the
capital transfer as follows:
Wang, Capital 30,000

Meng, Capital 30,000
The capital of the partnership remains at P90,000.
Sale of Interest to One or More of the Remaining Partners
Using our illustrative problem, let us assume that Wang sells his interest to the remaining
partners instead to Meng; ½ to Ty and the other half to Go. Regardless of how much Wang
receives from Ty and Go, the journal entry to record the sale of Wang’s interest is
Wang, Capital P30,000

Ty, Capital P15,000
Go, Capital P15,000
Sale of Interest to the Partnership
The transaction will result to decrease in the assets of the partnership because of the cash being
paid out to the withdrawing partner. Correspondingly, the capital of the withdrawing partner will
become zero. Hence, the total capitalization of the partnership will decrease in an amount equal
to the withdrawing partner’s interest. The sale may be at book value, more than or less than the
book value.
Illustration: Using the same data as the previous example and assuming that Wang withdraws
from the partnership and his interest being sold to the partnership itself. Assume the following:
1. The partnership pays P30,000 which is equal to Wang’s interest being sold. The journal
entry is:
Wang, Capital P30,000
Cash P30,000
The total partnership capital decreased by P30,000.
2. The partnership pays P35,000 which is more than Wang’s interest. The excess payment
may be treated as a bonus. The journal entry is:
Ty, Capital 2,500
Go, Capital 2 ,500
Cash 35,000
The bonus given to Wang decrease the capital of the remaining partners based on their
P/L ratio.
3. The partnership pays P25,000 which is less than Wang’s interest. The willingness of the
withdrawing partner to sell his interest at a loss could mean that he is giving bonus to the
remaining partners. The journal entry is:
Ty, Capital 2,500
Go, Capital 2,500
Cash 25,000
The bonus given by the withdrawing partner increases the capital balances of the
remaining partners which is shared by them based on their P/L ratio.
Death, Bankruptcy or Incapacity of a Partner
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When a partner dies, becomes bankrupt (insolvent) or incapacitated, the existing partnership is
dissolved. The dissolution may result to either liquidation or operations will continue with a new
partnership contract. There are two things to be established at the time of these events. These
are:
a. Revaluation of assets and other adjustments necessary.

b. Determination of profit or loss from the last closing date up to the date of death,
bankruptcy or incapacity of a partner.
Illustration:
Ba, Ka , and Da are partners who shared profits and losses equally. Da died on June 1, 2019.
If the annual calendar accounting period is followed, the last closing date was December 31,
2018. The books of the partnership should be adjusted from January 1, 2019 to June 1, 2019 so
that profit or loss from operations can be properly determined and Da’s capital interest can be
established. Let us assume that Da’s capital balance as of December 31, 2018 was P45,000.
After closing all the nominal accounts, the Income and Expense Summary account showed a
credit balance of P15,000 which represents profit from January 1, 2019 to June 1, 2019. A journal
entry to distribute profit is made as follows:
Income & Expense Summary P15,000

Ba, Capital 5,000
Ka, Capital 5,000
Da, Capital 5,000
The capital account balance of Da is P50,000 after his share of profit. If Da’s interest is
given to his heirs, the journal entry is:
Da, Capital P50,000
Cash P50,000
Assuming that Ga, is heir, doesn’t want to withdraw Da’s share in the partnership, then a
new contract will be executed considering that Ga is a new partner. The only entry in the book of
the partnership is to transfer the interest of Da to Ga as follows:
Da, Capital P50,000

Ga, Capital P50,000
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Review Questions and Exercise s
I – Essay
1. What is dissolution? What are the conditions that may lead to a partnership dissolution?
2. Differentiate between admission by purchase of interest and by investment.
3. Can a partner be admitted in an existing partnership without the consent of other
partners? Why?
4. How is bonus accounted for in connection to admission of a new partner by investment?
5. When a partner withdraws or retires from the partnership, will the partnership be
automatically liquidated? Explain.
6. Why is it necessary for the partnership books to be adjusted in preparation for a partner’s
withdrawal? Will the same thing be done when a partner dies?
II – True or False. Instruction: Write “T” if the statement is correct and “F” if incorrect.
_______1. Only admission of a new partner by purchase of interest necessitates adjustments on

non-current assets into its fair market value.
_______2. There can be a partnership dissolution without liquidation but no liquidation can take
place without first having the partnership dissolved.
_______3. When a partner is admitted in an existing partnership, it is always with the common
knowledge and consent of all the existing partners.
_______4. The amount of money that the selling buying partner pays to the selling partner will
go to the partnership and not to the partners concerned.
_______5. Admission by investment will not affect the capitalization of the partnership before
and after the admission.
_______6. When the existing partners give bonus to the new partner, the existing partners’
capital accounts are debited.
_______7. When the newly admitted partner gives bonus to the old partners, the old partners’
capital accounts are credited.
_______8. When the old partners receive bonus, the bonus is divided among them based on
their respective profit or loss ratio.
_______9. Bonus refers to the transfer of capital from one partner to another in consideration for
the good reputation or earning capacity.
_______10. Partnership dissolution is entirely similar to partnership liquidation.
_______11. The partnership is dissolved when such partnership changes its name and address of
its location.
_______12. A contract of partnership is one of a mutual trust and confidence that one has the
right to choose his associates.
_______13. When whole interest in the partnership is being sold to one person, this transaction
tantamounts to conversion of a partnership into sole proprietorship.
_______14. When one is already admitted in the existing partnership, he will start to share the
partnership obligations as of that date.
_______15. Total contributed capital refers to the amount of new capita set by the partners.
_______16. When a partner retires from the partnership, he has no option other than to sell his
share to the partnership.
_______17. A withdrawing or retiring partner cannot sell his interest to any other person without
informing first the other partners.
_______18. When a partner sells his share of interest to his co-partner, the transaction is
personal in nature and will not involve the partnership.
_______19. The heir of the partner who dies can automatically take his place upon his death and
this does not give way to dissolution with liquidation.
_______20. Insolvency of a partnership is where its remaining assets are confined to the
settlement of its obligation resulting in its inability to go on with normal operations.
III – Exercise Problems
A. Fact:
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The net assets of ABC Co. consists of the following: A (20%), P100,000; B(30%),
P150,000; and C (50%), P200,000. The net assets are fairly valued.
Use the facts given above to answer the seven independent cases below:
1. D acquires half of C’s capital for P120,000.
2. D acquires 25% of A, B , and C’s capital interests for P150,000.

Requirements:
a. Provide the journal entry.
b. How much are the capital balances of the partners after the admission of D?
c. How much is the gain or loss to be recognized in the partnership books?
d. How will A, B, and C divide the P150,000 payment of D, and how much are the
personal gains or losses of A, B, and C?
3. (Ignore the previous assumption regarding the net assets being fairly valued). D acquires
25% of A, B, and C’s capital interests for P150,000. The carrying amount of the
partnership’s net assets as if this date approximates fair value except for equipment with
carrying amount of P680,000 and fair value of P830,000.
Requirements:
a. Prepare the journal entries.
b. Determine the capital balances of the partners after the admission of D.
4. D invests P112,500 for a 20% interest in the net assets and profits of the partnership.
5. D invests P180,000 cash for a 20% interest in the net assets and profits of the
partnership. The partners use the bonus method.
Requirements:
a. Provide the journal entry to record D’s admission.
b. Compute for the partners’ respective capital balances after D’s admission.
c. Compute for the revised profit and loss sharing ratio of the partners after D’s
admission.
6. D invests P100,000 cash for a 20% interest in the net assets and profits of the
partnership. The partners use the bonus method.
Requirements:
7. D invests equipment with a historical cost of P200,000 and fair value of P160,000 for a
20% interest in the net assets and profits of the partnership. The partners use the bonus
method.
Requirements:
B. Solve the cases below:

Fact: A, B, and C are partners with the following P/L ratio and capital balances: A (60%)
P100,000; B (30%) P60,000; and C (10%) P20,000.
Case 1: D purchases ½ of A’s capital interest for P70,000. Provide the journal entry.
Case 2: D purchases 20% interest in the partnership from A, B, and C for P60,000.
Provide the journal entry and determine the capital balances of the partners after
admission of D.
Case 3: D invests P70,000 cash for a 20% interest in the partnership. Provide the journal
entry and determine the capital balances and P/L ratio of the partners after D’s
admission.
Case 4: D wants to infuse capital to the partnership for a 10% interest in the partnership.
The partners determine the net assets are fairly valued except for land carried at
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P365,000 but has a fair value of P410,000. If no bonus is to be given to any partner, how
much is D’s required investment?
Case 5: C withdraws from the partnership and sells his interest to B for P30,000. Provide
the journal entry and determine the capital balances and P/L ratio of the remaining
partners after C’s withdrawal.
Case 6: C retires and the partnership settles his interest for P32,000. Provide the journal
entry and determine the capital balances and P/L ratio of the remaining partners after C’s
retirement.
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Chapter 12
DISSOLUTION WITH LIQUIDATION OF PARTNERSHIP
Introduction:
Liquidation of partnership means the termination of partnership. It means that the firm
will not operate further. In liquidation process, all the assets (inventory and fixed assets) are sold
for cash either more than their book value or less than their book value. The profit or loss arises,
if any, from the sale of assets are recorded in the realization account. Then accounts receivable
are collected from customer (equal to book value or less than value) and payments are paid to
the suppliers. Again the differences, if any, are recorded in the realization account. The
realization (profit or loss) is transferred to the partners’ capital account. If partners’ capital account
shows negative balance after the distribution of realization, it is necessary to know that the
partner is solvent or insolvent. If the partner is solvent, he/she can contribute cash from his
private sources. But if the partner is insolvent, he/she cannot contribute cash and his/her loss will
have to be distributed among the other partners.
1. Discuss the liquidation process involved.

2. State the order of priority in the settlement of claims in cases of liquidation.
3. Account for the liquidation of a partnership.
Lesson 1: The Liquidation Process
Liquidation is the termination of business operations or the winding up affairs. It is a process by

which:
1. Assets are converted into cash,

2. Liabilities are settled, and
3. Any remaining amount is distributed to the owners.
Liquidation may be either voluntary (e.g., per agreement of partners of a solvent partnership) or
involuntary (e.g., bankruptcy)
Conversion of non-cash assets into cash
The conversion of non-cash assets into cash is referred to as “realization” while the
settlement of claims of creditors and owners is referred to as “liquidation”. The winding up
process starts with the conversion of non-cash assets into cash.
Settlement of Claims
The available cash of the partnership is used to settle claims in the following order of priority:
1. Outside creditors
2. Inside creditors
3. Owner’s capital balances
Definition of Terms
Gain on realization – the excess of the selling price or proceeds from the sale of non-cash
assets over its book value.
Loss on realization – the excess of the book value of non-cash assets over the selling price or
proceeds.
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Capital deficiency – the excess of a partner’s share of realization loss over his capital credit.
Deficient partner – is a partner who develops a debit balance in his capital account after his
share or realization loss. This means his capital credit could not absorb his share of realization
loss.
Solvent partner – is a deficient partner who is capable of paying to other partners or to the
partnership his capital deficiency.
Insolvent Partner – is a deficient partner who is not capable of paying his capital deficiency due
to personal bankruptcy.
Partner’s Loan – the amount of money borrowed by the partnership from the partner. It is the
liability of the partnership to the partners extending the loan.
Right of offset – is an established legal doctrine that a deficient partner can exercise to partly or
fully apply his loan to the partnership against his capital deficiency in the process of liquidation.
Theoretical loss – refers to the balance of the non-cash assets that were not yet sold during the
liquidation period. This occurs in liquidation by installment.
Types of Liquidation
1. Liquidation by Lump Sum or Total

2. Liquidation by installment or Piecemeal
Lesson 2: Liquidation by Lump Sum
Under this type of liquidation, the non-cash assets are realized in one setting only. The payment
of partnership’s liabilities and distribution of cash settlement of the partner’s loan and capital
balances are done once.
Liquidation Procedure. The following procedure may be used in lump-sum liquidation.

1. Realization of assets and distribution of gain or loss on realization among the partners
based on the profit and loss ratio.
2. Payment of expenses.
3. Payment of liabilities.
4. Elimination of partner's capital deficiencies. If after the distribution of loss on realization a
partner incurs a capital deficiency (i.e., partner's share of realization loss exceeds his
capital credit), this deficiency must be eliminated by using one of the following methods in
order of priority.
a. If the deficient partner has a loan balance, exercise the right of offset.
b. If the deficient partner is solvent, make him invest cash to eliminate his
deficiency.
c. If the deficient partner is insolvent, let the other partners absorb the deficiency
5. Payment to partners (in order of priority):
a. Loan accounts
b. Capital accounts
Statement of Partnership Liquidation
For convenience in determining the results of the liquidation process in an expedient

manner, a working paper od prepared before entries are finally made in the general journal and
posted to the ledger. This working paper is called “Statement of Partnership Liquidation.
To illustrate:
The noncash assets of ABC Company are carried on the balance sheet at $65,000. Partners
Andy, Samantha, and Kim sell these noncash assets for $75,000, creating a gain of $10,000
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($75,000 – $65,000). Andy, Samantha, and Kim's income-sharing ratio is 2:2:1. They each
currently have $25,000 in their capital accounts, and the cash balance is $15,000.
Step 1: Sale of Assets—$75,000 including a gain of $10,000 ($65,000 + $10,000)
Step 2: Division of Gains
Andy $4,000 ($10,000 \times× 40%)
Samantha $4,000 ($10,000 \times× 40%)
Kim $2,000 ($10,000 \times× 20%)
Step 3: Payment of Liabilities—$5,000
Step 4: Distribution to Partners—The remaining $85,000 cash is distributed to the partners

according to their capital balances.
Distribution of Cash after Gains to Partners
S.
A. Potts K. Foxx Total
Stevenson
Capital before liquidation $25,000 $25,000 $25,000 $75,000
Distribution of gains $4,000 $4,000 $2,000 $10,000
Capital after gains $29,000 $29,000 $27,000 $85,000
A statement of partnership liquidation is a financial statement that provides a visual summary

of the partnership liquidation.
❖ Statement of Partnership Liquidation – Gain
This statement of partnership liquidation provides a visual summary of the partnership liquidation
that shows gain realized by the partners. For example, Andy's gain is a 40% share of $29,000.
Several journal entries record the liquidation: sales of assets, division of gain, payment of
liabilities, and distribution of cash to partners.
Step 1: Sale of Assets
Sale of Assets in Partnership Journal Entry
Date Description Debit Credit
Jan. 1 Cash $75,000
Noncash Assets $65,000
Gain on Realization $10,000
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Step 2: Division of Gain
Division of Gain between Partners Journal Entry
Jan. 1 Gain on Realization $10,000
Andy Potts, Capital (Member's Equity) $4,000
Samantha Stevenson, Capital (Member's Equity) $4,000
Kim Foxx, Capital (Member's Equity) $2,000
Step 3: Payment of Liabilities
Payment of Liabilities Journal Entry
Jan. 1 Liabilities $5,000
Cash $5,000
Step 4: Distribution of Cash to Partners
Distribution of Cash to Partners Journal Entry
Jan. 1 Andy Potts, Capital (or Member's Equity) $29,000
Cash $85,000
Note:
Partners' equity accounts receive whatever gains or losses incurred during a liquidation, based
on an agreed-upon ratio.
Step 1: Sale of Assets—$50,000 with a loss realization of $15,000
Step 2: Division of Losses
Andy $6,000 ($15,000 \times× 40%)
Samantha $6,000 ($15,000 \times× 40%)
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Kim $3,000 ($15,000 \times× 20%)
Step 4: Distribution of Cash to Partners—The remaining $60,000 cash is distributed to the

partners according to their capital balances.
Distribution of Cash after Losses to Partners
S.
Stevenson
Distribution of Loss ($6,000) ($6,000) ($3,000) ($15,000)
Capital after Losses $19,000 $19,000 $22,000 $60,000
The statement of partnership liquidation reflects the loss for each partner.
❖ Statement of Partnership Liquidation - Loss
The statement of partnership liquidation provides a visual summary of the partnership liquidation,
noting the loss realization for the partners. For example, Andy's share of the loss is $6,000.
Several journal entries are made to record the liquidation: sale of assets, division of loss,
payment of liabilities, distribution of cash to partners.
Jan. 1 Cash $50,000
Loss on Realization $15,000
Step 2: Division of Loss
Division of Loss between Partners Journal Entry
Jan. 1 Andy Potts, Capital (Member's Equity) $6,000
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Cash $5,000
Step 4: Distribution of Cash to Partners
Distribution of Cash to Partners Journal Entry
Cash $60,000
Calculations and Journal Entries for Capital Deficiency
A partnership may have a claim against a partner(s) called a deficiency, which must be calculated
and recognized.
By eliminating all the assets and liabilities, the only remaining accounts on the books are equity
accounts of the partners and the corresponding cash balance used to distribute cash to the
partners. A deficiency is a claim that the partnership has against a partner. The loss and
distribution of that loss to the partner(s) results in a debit balance in a partner's capital account.
Step 1: Sale of Assets—$2,000 with a loss of $63,000
Andy $25,200 ($63,000 \times× 40%)
Samantha $25,200 ($63,000 \times× 40%)
Kim $12,600 ($63,000 \times× 20%)
Step 4: Distribution of Cash to Partners—The remaining cash of $12,000 is distributed to the

partners according to their capital balances.
132
Distribution of Cash with Deficiencies to Partners
S.
Stevenson
Distribution of Loss ($25,200) ($25,200) ($12,600) ($63,000)
Capital after Losses ($200) ($200) $12,400 $12,000
Andy's and Samantha's distribution of losses caused their capital balance to go into a deficit.
Therefore, they owe the partnership $200 each. Assuming they both pay the deficit, the cash
would go up by $400, which would allow the partnership to be able to pay newest partner Kim her
entire capital balance.
A statement of partnership liquidation reflects deficiency and provides a visual summary of the
partnership liquidation.
❖ Statement of Partnership Liquidation-Deficiency
Jan. 1 Cash $2,000
Division of Loss between Partners Journal Entry
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Cash $5,000
Step 4a: Receipt of Deficiencies
Receipt of Deficiencies Journal Entries
Jan. 1 Cash $400
Andy Potts, Capital (Member's Equity) $200
Samantha Stevenson, Capital (Member's Equity) $200
Step 4b: Distribution of Cash to Partners
Cash to Partners Journal Entry
Jan. 1 Kim Foxx, Capital (Member's Equity) $12,400
Cash $12,400
Note: If the deficient partners do not pay the deficiency, there will not be enough cash on hand to
pay the capital accounts of the other partners. If the deficiency is uncollected, the loss will be
divided among the remaining partnership accounts based on the income-sharing ratio.
Illustration 2: This given problem will illustrate insolvency of deficient partner and the
exercise of the right of offset
Partners Te, Go and Wang who shared profits and losses of 30%, 40% and 30% respectively
have finally decided to liquidate their business. The Statement of Financial Position before
liquidation on October 31 is presented below:
134
Non-cash assets were realized as follows:
Non-cash Assets Realized for Gain (Loss)

Accounts Receivable 10,000 7,000 (3000)
Merchandise 20,000 25,000 5,000
Furniture and Equipment 30,000 32,000 2,000
Total 60,000 64,000 4,000
I – Loss on Realization with Capital Deficiency and Right of offset Exercised
Assume: Non-cash assets of P60,000 were sold for P25,000 or at a realization loss of P35,000.
Journal Entries:
1) Sale of non-cash assets and distribution of realization loss based on P/L ratio.
Cash 25,000
Te, Capital 10,500
Go, Capital 14,000
Non-cash assets 60,000
2) Payment of liabilities
Cash 20,000
3) Go’s Loan account is offset against his capital deficiency
Go, Loan 2,000
Go, Capital 2,000
4) Payment of partner’s loan
Go, Loan 1,000
Cash 1,000
5) Cash distribution to partners based on their actual capital balances
Te, Capital 7,500
Wang, Capital 500
Cash 8,000
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II – Loss on realization with capital deficiency, right of offset, deficient partner is not
insolvent
Assume: Non-cash assets of P60,000 were sold for P21,000 or at a realization loss of P39,000.
Journal Entries:
1) Sale of non-cash assets and distribution of realization loss

Cash 21,000
Te, Capital 11,700
Go, Capital 15,600
2) Payment of liabilities
Cash 20,000
3) Go’s loan account is offset against his capital deficiency
Go, Loan 3,000
Go, Capital 3,000
4) Capital deficiency of Go and Wang who are insolvent absorbed by Te.
Te, Capital 1,300
Go, Capital 600
Wang, Capital 700
5) Cash distribution to partners based on their actual capital balances.
Te, Capital 5,000
Cash 5,000
Note: If deficient partners are solvent, they are going to make good of their deficiency by
contributing cash to the partnership. The journal entry would be:
Cash 1,300
Go, Capital 600
Wang, Capital 700
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Lesson 3: Liquidation By Installment
Frequently, partnership assets are not realized through an instantaneous sale but in
a piecemeal fashion. In other words, the liquidation of some business may extend over several
months. When this happens the partners may prefer to receive the amounts due to them in a
series of installments rather than wait until all assets have been converted to cash. Installment
payments to partners are proper provided that measures are taken to insure that all creditors are
paid in full and that there is no over-distribution to one or more of the partners.
Installment liquidation involves the selling of some assets, paying the liabilities of the
partnership, dividing the available cash to the partners, selling additional assets and making
further payments to partners. This process continues until all the assets have been sold and all
cash has been distributed to the creditors and to the partners.
The basic problem involved is how to equitably distribute cash to partners after
payment of its liabilities when there are still unsold non-cash assets and their realization gains
and losses could not be determined yet which also affect the cash payments to partners. The
problem of equitable distribution of cash to partners after payment of liabilities can be resolved
under these two methods or approaches of cash distribution:
1. Theoretical loss method
2. Loss absorption ability approach
Theoretical Loss Approach – Under this approach, a “Schedule of Cash Payments” is prepared
everytime there is cash available for distribution. It considers the following:
1. The unsold non-cash assets are treated as a “theoretical loss” or a “total loss” and is
charged against the combining capital and loan balances of the partners based on their
P/L ratio.
2. A partner whose combined capital and loan balances could not fully absorb his share of
the theoretical loss will develop a capital deficiency and he is assumed to be personally
insolvent. His capital deficiency will be absorbed by other partners with capital credit
balances as an “additional loss” based on the P/L ratio.
3. Only partners with capital credit and loan balances combined after absorbing their share
of the theoretical loss and additional loss can receive the cash available for distribution
equal to the amount of his combined capital credit and loan balances that appeared in the
Schedule of Cash Payment. The amount is being referred to as “Safe Payment”.
Illustration: Partners Sy, Tan, and Co who shared profits and losses in the ratio of 50:20:30
respectively, finally decided to liquidate their partnership. The post-closing trial balance before
liquidation is presented below:
STC PARTNERSHIP
Post-Closing Trial Balance
As of June 20A
Debit Credit
Cash 15,000
Sy, Loan 5,000
Sy, Capital 20,000
Tan, Capital 15,000
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Co, Capital 30,000
Total 84,000 84000
The non-cash assets were realized as follows:
Months Non-cash
Realized Assets Realized for Gain (Loss)
1st installment July 10,000 5,000 (5,000)
2nd installment August 40,000 11,000 (29,000)
3rd installment September 19,000 10,000 (9,000)
Total 69,000 26,000 (43,000)
The following are the Statement of Partnership Liquidation and Schedule of cash payment to
support the distribution of cash as it becomes available.
After the 1st installment, there is cash available for distribution of P6,000. The problem is how to
determine who among the partners will receive the P6,000 cash. The following Schedule of Cash
Payment will resolve the problem.
138
The statement of partnership liquidation will be continued showing the distribution of P6,000 cash
to Co and the realization of non-cash assets of P40,000 for P11,000 during the second
installment.
After the second realization, there is again a problem on who will receive the cash available for
distribution of P11,000. Another schedule of cash payment is prepared to equitably distribute the
available cash as presented below:
The theoretical loss during the 2nd installment is P19,000 determined as follows:
Total non-cash assets before realization 69,000

less: book value of the non-cash assets that were sold on:
1st installment 10,000
2nd installment 40,000 50,000
Theoretical loss during the 2nd installment 19,000
The cash available for distribution of P11,000 will be given to Tan, P3,800 and Co, P7,200 as per
schedule of cash payment.
The statement of Partnership Liquidation will be continued showing the distribution of P11,000
cash available.
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During the 3rd and final cash distribution there is no need to prepare Schedule of Cash Payment.
Loan is paid ahead of capital.
A completed Statement of Partnership Liquidation is presented below:
A summary of Cash Payments to partners can be prepared as shown on the following page:
140
STC PARTNERSHIP
Summary of Cash Payment
Total Sy Tan Co
1st cash available 6,000 6,000
2nd cash available 11,000 3,800 7,200
Final Cash for Distribution 10,000 3,500 2,600 3,900
Total 27,000 3,500 6,400 17,100
Loss Absorption Ability Approach
Under this approach, a cash priority program is prepared even before liquidation takes place.
With this program, the partners will know in advance who among them will have the priority to
receive cash as it becomes available for distribution after paying partnership outside creditors.
This method will produce the same result as that of theoretical loss approach.
The steps under this method will be applied using the same data as that of the other method
Step 1 Determine the partners’ capital and loan balances before realization or liquidation. The
amounts are usually taken from either the Statement of Financial Position or Post-closing
Trial Balance as of the date it is prepared for that purpose.
Step 2 Divide the individual partner’s combined capital and loan balances by their respective
profit and loss ratio. The quotient represents their respective ability to absorb possible
loss or theoretical loss.
Incorporating steps 1 and 2, the partial picture of cash priority program is shown below:
STC PARTNERSHIP
Cash Priority Program
June 30, 20A
Loss Absorption
Balances Cash Payments
Sy Tan Co
Sy Tan Co Total 50% 20% 30%
Balances before realization:
Capital 20,000 15,000 30,000
Loan 5,000
Total partners' interest 25,000 15,000 30,000
Divide by P/L ratio 50% 20% 30%
Loss Absorption Ability 50,000 75,000 100,000
Step 3 Rank the partners based on their individual loss absorption ability. The partner with the
highest loss absorption ability is given the first priority to receive cash. Deduct the amount
of Co’s excess over Tan of P25,000 from less loss absorption so that Co’s loss
absorption balance will be leveled off to that of Tan in the amount os P75,000. At this
point, the loss absorption balances of Co and Tan have been leveled to P75,000. Their
respective absorption balances will be deducted by their excess over Sy in the amount of
P25,000 so that all of them will have a uniform loss absorption balance of P50,000. This
is the process of extinguishment. The extinguishment procedure will be shown as part of
the cash priority program.
141
50% 20% 30%
Sy Tan Co
Loss absorption ability 50,000 75,000 100,000
Excess of Co over Tan (25,000)
Balance 50,000 75,000 75,000
Excess of Co and Tan over Sy (25,000) (25,000)
50,000 50,000 50,000
Step 4 Multiply the excess of one partner over the other by its P/L ratio. The product represents
the amount of cash she expects to receive. The calculation is shown below:
Excess of Co over Tan 25,000

x 30%
Tan's share of cash 7,500
Excess of Co and Tan over Sy

Co's Share of cash 25,000 x 30% 7,500
Tan's Share of cash 25,000 x 20% 5,000
Total share of Co and Tan 12,500
CASH PRIORITY PROGRAM
Combining steps 1 to 4, the cash priority program is prepared as follows:
Cash Priority Program

June 30, 20A
Loss Absorption Balances Cash Payments
Sy Tan Co
Sy Tan Co Total 50% 20% 30%
Balances before realization:
Capital 20,000 15,000 30,000
Loan 5,000
Total partners' interest 25,000 15,000 30,000
Divide by P/L ratio 50% 20% 30%
Loss Absorption Ability 50,000 75,000 100,000
Extinguishment
Excess of Co over Tan (25,000) 7,500 7,500
Balance 50,000 75,000 75,000
Excess of Co and Tan over
Sy (25,000) (25,000) 12,500 5,000 7,500
50,000 50,000 50,000 20,000 5,000 15,000
Cash available for distribution in excess of

P20,000 50% 20% 30%
Interpretation:
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Before the liquidation process takes place, the program tells us already who among the partners
will be given priority over cash as it becomes available for distribution. The program tells us the
following:
• The first cash available of P7,500 should be given to Co.

• Of the next cash available of P12,500, P5,000 is given to Tan and P7,500 to Co.
• That if cash available for distribution is exactly 20,000, the share of Tan is P5,000 while
the share of Co is P15,000 and Sy will not receive anything.
• If cash available for distribution will exceed 20,000, the excess will be divided among the
three of them based on their respective P/L ratio.
Application of the Cash Priority Program to our Illustrative Program
Assume the non-cash asset will be realized as follows:
Months Realized Book Value Cash Realization Loss on Realization
July 10,000 5,000 5,000

August 40,000 11,000 29,000
September 19,000 10,000 9,000
69,000 26,000 43,000
The cash available for distribution is computed as follows:

Cash Balance before liquidation P15,000
Add: Cash realization in July installment 5,000
Total P20,000
Less: Payment of Liabilities 14,000
1st cash available for distribution – July P 6,000
2nd cash available for distribution – August 11,000
3rd cash available for distribution – September 10,000
Total Cash Available for Distribution to partners P27,000
Schedule of Cash Distribution
(Based on Cash Priority Program)
PARTNERS
50% 20% 30%
Total Sy Tan Co
1. First cash available of P6,000 is
given to Co P 6,000 P 6,000
2. Second cash available of
P11,000: P1,500 is given to Co to
satisfy her claim of P7,500. The 1,500 1,500
P9,500 remainder is divided
between Tan and Co at the ratio of
2:3 9,500 P 3,800 5,700
3. Third cash available of P10,000:
What has been distributed so far
was P17,000. To comply with the
cash priority program of distributing
the P20,000, P3,000 of the
P10,000 is given to Tan and Co on
the ratio of 2:3
3,000 1,200 1,800
CASH DISTRIBUTED AS PER P 20,000 P- P 5,000 P 15,000
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PROGRAM
4. The excess of P7,000 (cash
available is P27,000 and P20,000
is distributed as per program) is
distributed on P/L ratio 5:2:3
7,000 3,500 1,400 2,100
ACTUAL CASH FOR P 27,000 P 3,500 P 6,400 P 17,100
DISTRIBUTION
Based on the above Schedule, cash was distributed such as:

Sy receives P 3,500
Tan receives 6,400
Co receives 17,100
Total P27,000
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Review Questions and Exercise s
I – Essay
1. Differentiate dissolution from liquidation.

2. Differentiate realization loss from theoretical loss.
3. Differentiate a deficient partner from an insolvent partner.
4. State the order of payment in liquidation process according to Partnership Law.
5. Differentiate liquidation by lump sum and liquidation by installment
II - True or False
Instruction: Write “T” if the statement is correct and “F” if incorrect.
_____1. Liquidation refers to payment of all partnership’s obligations during the

process of dissolution.
_____2. When non-cash assets are sold less than the book value, the sale results to a
gain on realization.
_____3. During the liquidation process, the partnership will focus on terminal activities.
_____4. Example of terminal activities are the sale of non-cash assets, payment of
partnership’s creditors and distribution of excess cash to partners.
_____5. Right offset is an established legal doctrine that a deficient partner can exercise
to partly or fully apply his loan account to the partnership against his capital deficiency in
the process of liquidation.
_____6. Theoretical loss refers to the balance of non-cash assets that were not sold
during the liquidation process.
_____7. The first step of the liquidation process is the sale of the non-cash assets and
distribution of realization gain or loss.
_____8. Any partner who may develop a debit balance in his capital account may
exercise the right offset.
_____9. In every partnership liquidation, a general partner’s separate/personal asset can
be subjected to claims from creditors after the partnership assets are exhausted.
_____10. When non-assets are sold more than a book value, the sale results to a loss on
realization.
_____11. Realization on its simplest term means dissolution with liquidation.
_____12. Solvent partner is a deficient part who is capable of paying his capital deficiency.
_____13. A partner who develops a debit balance after distribution of realization loss may
contribute additional cash to the partnership.
_____14. A partner who is declared insolvent, his capital deficiency will be absorbed by the
remaining partners with credit balances based on profit and loss sharing ratio.
_____15. In partnership liquidation, partner’s loan account and the obligation of the
partnership to outsiders need to be separated although these are both liabilities.
_____16. There can be no liquidation unless the business has to be dissolved.
_____17. In the order of payments, payment to outside creditors ranks second in priority
than payment to partner’s loan.
_____18. The statement of partnership liquidation is prepared first before journalizing and
posting processes take place in the book of the partnership.
_____19. The statement of partnership liquidation is patterned after the fundamental
accounting equation, A = L + OE.
_____20. The loss absorption ability refers to the maximum loss that the partners could
absorb.
_____21. The journal entry needed in the right of offset is to debit the capital account of the
deficient partner and credit to loan account of the said partner.
_____22. In liquidation by installment, the main problem is how to equitably distribute cash
as it becomes available while some non-cash assets are waiting to be sold.
_____23. In liquidation by installment, the distribution of cash could not be a problem if said
cash will not be distributed as it becomes available but has to wait until the whole
liquidation process is through.
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_____24. The problem of equitable distribution of cash to the partners can be resolved by
preparing the “cash safety payment schedule”.
_____25. When partners A, B, and C which has a profit and loss sharing ratio of 2:3:5, and
B is insolvent in the liquidation process, the theoretical loss will be absorbed by A and C
in a fractional share of 2/7 and 5/7.
III – Problems
1. The following data were taken from Tagum Trading on June 30, 20A prior to liquidation:
Debit Balances Credit Balances

Cash P 13,000 Liabilities P 20,000
Non-cash 70,000 Benigno Sorima, Loan 10,000
Benigno Sorima, Capital 5,000
Merry Chris Ceniza, Capital 25,000
Dina Rovelero, Capital 23,000
P 83,000 P 83,000
The partners share profits and losses in the ratio 3:3:4.
The non-cash items were realized as follows:

Installment Non-cash Realized for
1st P 30,000 P 10,000
2nd 6,000 4,000
3rd 34,000 30,000
Cash is to be distributed as it becomes available.
Required:
a. Statement of Partnership Liquidation

b. Schedule of Cash Payment
c. Journal entries to record the liquidation process
d. Cash Priority Program
2. After opening sometime, the partners Vincent Clarin, Rita Namoc and Rolando Martinez have
decided to dissolve and liquidate their partnership business. The partner’s share profit and loss in
the ratio of 2:2:1. The Financial Position prepared at the eve of dissolution is presented below.
PYRAMID Enterprises
October 31, 20A
Assets
Cash P 8,000
Accounts Receivable P 10,000
Allowance for Doubtful Accounts 1,000 9,000
Merchandise 30,000
Furniture and Fixtures P 150,000
Accumulated Depreciation 53,000 97,000
Total P 144,000
Liabilities and Capital

Accounts Payable P 44,800
V. Clarin, Loan 2,000
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R, Namoc, Loan 3,200
Martninez, Capital 38,000
V, Clarin, Capital 24,000
R, Namoc, Capital 32,000
Total P 144,000
Case 1 – The non-cash assets were realized for P74,000.
Case 2 – The non-cash assets were realized for P68,000. Deficient partner was solvent.
Case 3 – The non-cash assets were realized for P68,000. Deficient partner was insolvent.
Case 4 – The non-cash assets were sold for P68,000. Distribution of available cash is
a) Before eliminating capital deficiency

b) After eliminating capital deficiency
Required: Prepare a Statement of Partnership Liquidation under each of the four cases
above.
3. The capital and loan balances of the partners of Star Hardware prior to liquidation were as
follows:
CAPITAL LOAN P/L RATIO

Deogracia Corpuz P60,000 P 5,000 30%
Thelma Cuidadno 80,000 40%
Jesus Luntao 50,000 20,000 30%
Required:
1. Prepare a Cash Priority Program

2. Based on the program, determine how much each of the partner will receive assuming
that cash available for distribution is:
a) P8,000 b) P20,000
Chapter 13
CORPORATION: NATURE AND FORMATION
Introduction:
In our study with sole proprietorship and partnership, we assumed that the partnership is
regarded as an entity that is separate and distinct from the owner/s. In a corporate form of
business organization, this assumption turns into a reality because a corporation is an artificial
person. It has a legal personality and as such, it can transact business under its own name, can
hold and dispose property, can sue and it can be sued to court.
After studying this module, the student should be able to:
1. Define what a corporation is.
2. Discuss the nature and formation of a corporation.
3. Explain the various terminologies of a corporate entity.
4.
Lesson 1 – Nature of a Corporation
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Definition of a Corporation
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.
Characteristics of a corporation:
1. Separate legal entity – Under its own name, a corporation has a separate and distinct
legal personality from its shareholders. It may take, hold, or dispose property under its
corporate capacity it may enter into contract, can sue and be sued to court. As a creation
of law, it cannot be established easily by mere agreement of parties like in the case of
partnership. It comes into existence upon granting of authority by the state.
2. Transferable unit of ownership – The ownership of a corporation is divided into units

called “shares” which can be transferred from one person to another without the consent
of other shareholders.
3. Limited liability of shareholders – This means that the shareholders are liable only of
the corporation’s debts on the extent of their capital contributions.
4. Continuity of existence – The corporation has the capacity for continued existence
because it has the right of succession as evidenced by the transferability of its shares.
5. Governing body – Because there will be hundreds or thousands of shareholders, it will

be difficult for each one of them to partake in managing the business. Thus, they elect
among themselves to form a governing body called “Board of Directors”, who will
formulate the policies of the corporation. The corporation law provides that the number of
board of directors be not less than five but not more than fifteen.
Advantages and Disadvantages of a Corporation
Advantage Disadvantage
✓ A stockholder who is not a member of ✓ Your “say” on corporate affairs
the corporation’s board of directors is depends on the number of shares you
relieved from managerial own. Those who own more shares are
responsibilities. Only the stockholders the bosses and enjoy large share of
that are elected as members of the the corporation’s profits.
board and those they hire or appoint
are tasked with managerial
responsibilities. This can be an
advantage because a regular investor
does not need to work for the
corporation to earn income.
✓ Limited liability of the owners because ✓ A corporation is more difficult and more
stockholders are liable for corporate costly to form because there are more
debts only up to the amount they have formal business requirements.
invested.
✓ Greater capital and ease in raising ✓ Greater extent of government

additional funds because a corporation regulation and higher taxes.
can issue shares to a wider extent of
investors.
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✓ If the corporation is listed you can ✓ Profits are not easily distributed to the
easily transfer your shares to other owners. You have to wait for the board
investors by selling them in the stock of directors to declare dividends before
market. you get your share in the profits of the
corporation.
✓ Unlimited life, in the sense that the

withdrawal, retirement, death or
insanity of one of the stockholders
does not dissolve the corporation.
Classification of Corporation
1. As to Purpose
a) Public Corporation – is one that is forms or organized to govern a portion of the
state. Examples are barangays, municipalities, cities and provinces.
b) Private Corporation – is one that is formed for some private purpose, benefit,
aim or end.
c) Quasi-Public Corporation - is a private corporation which is given a franchise
to perform public duties but is organized for profits like bus and airlines, light and
power, telephone companies, etc.
2. As to law of creation
a) Domestic Corporation – is one that is organized under the Philippine laws.
b) Foreign Corporation – is one that is organized under any law other than the
Philippines.
3. As to membership holdings
a) Stock Corporation – is a private corporation organized for profit. Its capital is
divided into share of stock and is authorized to distribute corporate profits on the
basis of shares held.
b) Non-stock Corporation – is a private corporation organized “not for profit”. If by
incident it generates profits, such profits should be spent ot continue attaining the
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objectives of its creation. Examples are civic, religious, social, charitable
institution, etc.
4. As to admission of shareholder
a) Open Corporation – is one in which any person is welcomed to become a
shareholder.
b) Closely-held Corporation – is one in which ownership is limited to selected
persons or maybe family members. Any corporation may be incorporated as
close corporation, except mining or oil companies, stock exchanges, banks,
insurance companies, public utilities, educational institutions and corporations
declared to be vested with public interest.
5. As to other purpose
a) Ecclesiastical Corporation – is one which is organized for religious purposes.
b) Lay Corporation – is one which is organized for a purpose other than religious
purposes.
Who Composes a Corporation?

1. Corporators – are those who compose the corporation whether as shareholders or
members. Hence, Corporators include incorporators, shareholders or members.
2. Incorporators – are those who originally formed the corporation who executed and
signed the Articles of Incorporation. They must be natural persons as distinguished from
artificial persons.
3. Shareholders – are owners of a stock corporation. They may be natural persons or
artificial persons.
4. Members – they are owners of a non-stock corporation.
5. Promoters – they are those who undertake to form a group of persons interested in
organizing a corporation. They procure subscriptions or capital for the corporation.
6. Board of directors – a governing body formed out of the shareholders. This acts as the
policy-making body of the corporation. This is composed of not less than 5 but not more
than eleven shareholders or members duly elected from among themselves.
7. Subscribers – they are natural or artificial persons who have agreed to buy original and
unissued stocks of the corporation.
Lesson 2: Formation of a Corporation
Who may form a corporation? Only natural persons of not less than 5 but not more than 15, all
of legal age and majority of whom are residents of the Philippines may form a private corporation
for any lawful purpose or purposes. Each of the incorporators of stock corporation must own at
least one (1) share capital of the corporation.
Stages in the Formation of a Corporation
Organization Stage. This is the stage where persons who do preliminary arrangements made by
the incorporators will come in. a tentative working organization is set up and the procurement of
subscriptions and capital for the corporation is done. The persons involved are referred to as
‘”Promoters”.
Incorporation Stage. The Corporation Code of the Philippines provides that the Securities and
Exchange Commission (SEC) shall not accept registration of Articles of Incorporation of any
share corporation unless notarized and accompanied by affidavit executed by the Corporate
Treasurer that at least 25% of the authorized share capital has been subscribed and that at
least 25% of the total subscription has been fully paid in actual cash or property. In no case,
shall the paid-up capital be less than P5,000. This is the pre-incorporation requirement.
When the 25% of the subscription payment is made in cash, an additional requirement by SEC on
bank certificate to attest that deposit has been made through bank in favor of said corporation.
Once the pre-incorporation requirements are already complied with and after paying the required
incorporation fees, the SEC will now approve the Articles of Incorporation and issue the
150
“Certificate of Incorporation”. This is the birth of a corporation. On this date, the corporation
acquires its own juridical personality.
Commencement Stage. During its first organizational meeting, the shareholders formulate and
adopt the by-laws of the corporation. Said by-laws shall be filed with the SEC within 1 month after
the Certificate of Incorporation has been issued.
Shareholders then elect among themselves their Board of Directors. The election of corporate
officers such as the President, Treasurer, Secretary and other officers is entrusted to the Board of
Directors as may be provided for in the by-laws.
Articles of Incorporation
As provided in the Corporation Code, the Articles of Incorporation must contain the
name of the corporation, specific purpose/s for which the corporation is formed, location or
principal place of business, term of which a corporation is to exist, names, nationalities and
residences of incorporators and directors, authorized share capital with number of shares into
which it is divided and par value, etc. A sample form is provided below.
By-Laws
By-laws refer to the rules and regulations adopted by the corporation administering as internal
government. By-laws as provided for by Section 47 of the Corporation Code include among
others the following:
1. Time, place and manner of calling and conducting regular and special meetings of
directors or trustees and of shareholders and members.
2. The manner of voting and use of proxies.
3. The manner of electing the Board of Directors.
4. Qualifications, duties and compensation of directors or trustees, officers and employees.
5. Procedure of amending Articles of Incorporation and By-laws, etc.
Corporate Records
Generally, a corporation uses and keeps the same accounting books as the other forms of
business organizations. In addition to the general journal, ledger, and others, a corporation keeps
the following records:
1. Minutes books – The minutes of all meetings of shareholders or members and that of
Board of Directors of Board or Trustees are recorded by the corporate secretary in this
book. Some recorded events in this book are the sources of entries in the accounting
books such as the declaration of dividends, purchase and sale of treasury shares, etc.
2. Stock and transfer book – this book principally records the stock issuances and
cancellations. It consists three books, which are:
a) Subscriber’s ledger – this is actually a subsidiary ledger for the controlling
account, Subscription Receivable, in the general ledger.
b) Shareholder’s Journal – this shows the list of shareholders with the
corresponding share certificate number in numerical sequence and shares
issued to them including share certificate that were cancelled.
c) Shareholder’s Ledger – this is a subsidiary ledger for Share Capital account in
the general ledger. The total number of shares indicated in the shareholder’s
Journal and the Share Capital account in the general ledger is the same.
Samples are presented below:
151
SHAREHOLDER'S JOURNAL
Certificate Cancelled Certificatet Issued
Ledger No. of Left by Ledger Number Total No.
Date Transferred Folio Cert. No. Shares Signature Transferred Folio Cert. No. of Shares of Shares Received
SHAREHOLDER'S LEDGER
NAME:
ADDRESS:
Ce rti fi ca te d Ca nce l l e d Ce rti fi ca te I s s ue d
Journa l Ce rti fi ca te No. of Journa l Ce rti fi ca te No. of

Da te Fol i o No. Sha re s Da te Fol i o No. Sha re s
SUBSCRIBER'S LEDGER
NAME:
ADDRESS:
Sha re Subs cri bed Sha re Pa yments
Jouna l No. of Journa l No. of

Da te Fol i o Sha res Va l ue Da te Fol i o Sha res Va l ue
Organization Costs
Organization costs are expenditures incurred while in the process of organizing a corporation.
These include expenses during promoters’ meeting with other prospective incorporators,
attorney’s fees, filing and publication fee, cost of printing stock certificate, stock and transfer
book, corporate seal, accounting and legal fees related to stock issuances before the start of
corporate operations. Under the Philippine Accounting Standards (PAS) No. 38, Intangible
Assets, Organization costs or pre-operating costs are charged to expense in the period incurred.
Rights of Shareholders
Shareholders have four basic rights namely:
1. To vote and attend annual shareholder’s meeting.

2. To share in the distribution of corporate profit (dividends out of earnings).
3. To share in distribution of assets upon corporate liquidation (liquidating dividends).
4. To purchase additional shares in the event that corporation issues additional share
capital. This is to maintain the percentage ownership of the shareholders. The right of the
shareholder to be given priority to acquire additional shares is called “Preemptive Right”.
Share (Stock) Certificate
A shareholder’s ownership in the corporation is determined by the number of shares he owns and
is evidenced by a document called share certificate. This certificate can only be issued to the
individual shareholders who have fully paid his subscription. This is signed by the president or
152
vice-president of the corporation, counter signed by the secretary and sealed with the seal of the
corporation.
Legal Capital of a Corporation
The legal capital of a corporation is that portion of the paid-in capital arising from share issuance
which must remain untouched an unimpaired in protection of corporate creditors. As such, it
cannot be returned to shareholders in any form during the lifetime of the corporation except, when
a liquidation happens and only after the debts have been paid.
In case of a par value shares, legal capital is the aggregate par value shares off all issued and
subscribed shares, in case of no par value share, it is the total consideration received by the
corporation for its issuance to the shareholder including the excess of issue price over the stated
value.
Trust Fund Doctrine
This is a legal principle that prohibits a private corporation to distribute its legal capital to the
shareholders for the protection of corporate creditors during the lifetime of the corporation.
Lesson 3: The Shareholder’s Equity
Shareholders’ Equity
This is defined as the residual interest of the owners in the assets of the corporation as a
business entity, measured by the excess of assets over liabilities. Simply, it refers to the capital
section of a corporation, thus, follows the modified basic accounting equation as:
Shareholders’ Equity = Total Assets – Total Liabilities
The components of a Shareholders’ Equity are as follows:
1. Share capital
2. Subscribed share capital
3. Subscription receivable
4. Share premium or Additional paid-in capital
5. Revaluation surplus or reserve
6. Accumulated Profits or Losses or Retained Earnings
7. Treasury shares
The tern “Share Capital” includes:
Authorized Share Capital – refers to the maximum amount fixed by the corporate charter or
articles of incorporation to be subscribed and pain-in by the shareholders. The equivalent number
of shares are called “Authorized Shares”. A corporation may increase its authorized shares by
amending the articles of incorporation.
Subscribed share capital – represents the amount of shares which have been subscribed but
not yet fully paid. The equivalent number of shares are called “Subscribed Shares”.
Issued Share Capital – this represents the amount of shares which have been fully paid and the
share certificates have been issued. The equivalent number of shares are called “Issued Shares”.
Unissued Share Capital – this represents that part of the corporation’s authorized share capital
for which share certificates have not yet been issued but are available for issuances in the future.
Treasury Share – this represents a corporation’s own share which have been issued but later
acquired not for the purpose of cancellation or retirement. This share is issued but not
outstanding. The equivalent number of shares are called “Treasury Shares”.
153
Outstanding Share Capital – this refers to the Issued Share Capital which are still in the hands
of the shareholders. The equivalent number of shares are called “Outstanding Shares”. Issued
share may not be the same as outstanding shares when there are treasury shares because
treasury shares are deducted from outstanding shares.
Shareholders’ Equity: Its Sub-sections
Based on PAS no. 1, shareholders’ equity is composed of the following sub-sections:
1. Contributed Capital – this is the first sub-section which consists the following elements:
a. Share Capital – this refers to the portion of the paid-in capital representing the
amount of the total par or stated value of the shares issued.
b. Subscribed Share Capital – this refers to the portion of the share capital that a
prospective investor agreed to subscribe but not yet fully paid and therefore still
unissued. Subscribed share capital is to be deducted by the subscription
receivable before the difference is added to share capital.
c. Subscription Receivable – this refers to the unpaid portion of the Subscribed
share capital.
2. Reserve – this is the second sub-section and consists of the following:
a. Share Premium reserve – it is otherwise known as “additional paid-in capital”
representing the paid-in capital in excess of the par value or stated value, excess
of the sales proceeds of treasury stock over cost donated capital and other
premiums in relation to the retirement of shares.
b. Revaluation reserve – also called “Revaluation Increment in Property” or “Asset
Revaluation Reserve”. This is the excess of the value of plant assets as a result
of appraisal over net book value.
c. Accumulated Profits and Losses reserve – it is the portion of the Accumulated
Profits and Losses that is appropriated for plant expansion, purchase of treasury
shares, etc. If reverted back to unappropriated profits and losses, it can be
available for dividend declaration.
3. Accumulated Profits and Losses – previously known as Retained Earnings, this
account represents the cumulative income and expense from the start of operation to the
present. This account has been increased or decreased due to results of periodic income
or loss, prior period adjustments known as fundamental errors, dividend distribution,
changes in accounting principle, etc. This refers to the portion of Accumulate profits and
losses that can be declared as dividends.
The accumulated profits and losses are computed as follows
Accumulated Profits and Losses, Beginning Pxx

Add (deduct): Prior period adjustments"
Fundamental errors Pxx
Effect of change in accounting policy xx xx
Accumulated Profits and Losses as restated Pxx
Add (deduct): Profit and Loss for the period xx
Total Pxx
Less: Dividends Declared xx
Accumulated Profits and Losses, Ending Pxx
The Shareholders’ Equity may be presented on the following pro-forma:
154
SHAREHOLDERS' EQUITY
Contibuted Capital:
Share Capital Pxx
Subscribed Share Capital Pxx
Less: Subscription Receivable xx xx Pxx
Reserves:
Share Premium in excess of par value xx
Share Premium from Treasury Shares xx
Appropriated Accumulated profit and
and losses for treasury share acquisition xx
Revaluation Increment in Property xx xx
Accumulated Profits and Losses (Unrestricted) xx

Total Pxx
Less: Treasury Shares (at cost) xx
Total Shareholders' Equity Pxx
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I – Essay
1. What is a corporation?
2. What are the three basic stages constituting the formation of a corporation?
3. What is a share certificate? When can it be issued?
4. What is the legal capital of a corporation?
5. What is the “trust fund” doctrine?
II – True or False. Instruction: Write “T” if the statement is correct and “F” if incorrect.
_____1. A corporation is not a real person but the law assumes it as a person, so that it can
perform practically business functions.
_____2. The SEC is prohibited by law to register a corporation engaged solely in the practice
of public accounting.
_____3. A corporation is taxed at 35% income tax rate.
_____4. CPAs are prohibited from being a shareholder of any share corporation.
_____5. A corporation is formed by at least five (5) but not more than fifteen (15) members.
_____6. Authority of the corporation to operate has to be granted by the state.
_____7. A corporation can be formed by mere agreement among shareholders.
_____8. There is no law prohibiting a corporation to acquire or buy shares from another
corporation.
_____9. A corporation can be an incorporator of another corporation.
_____10. Shareholders are not liable to corporate obligations in excess of their legal capital.
_____11. The legal capital of a corporation represents the paid in capital or the amount invested
by the stockholders.
_____12. A corporation may exist for more than 50 years.
_____13. Death of a shareholder will dissolve the corporation.
_____14. Shares cannot be transferred without the consent of the other shareholders.
_____15. A share certificate can be issued to those subscribers who partially paid their
subscriptions.
_____16. The Board of Directors shall exercise the corporate powers of a corporation.
_____17. A corporation acquires its own juridical personality by the time the SEC issues the
Certificate of Incorporation.
_____18. Any corporation may be incorporated as closely-held except corporations declared to
be vested with public interest.
_____19. An incorporator of a share corporation must own or be a subscriber to at least one (1)
share capital of that corporation.
_____20. Issued shares is always equal to outstanding shares.
III – Multiple Choice Questions. Instruction: Encircle the letter of the corresponding correct
answer
1. Which of the following is not an attribute of a corporation?

a. An artificial being created by the operation of law.
b. Having the rights of succession
c. Have the powers, attributes and properties expressly authorized by law or
incident to its existence
d. Have limited liability of shareholders
2. These refer to the rules and regulations adopted by the corporation in administering its
internal government.
a. Articles of incorporation c. By-laws
b. Minutes of meeting d. Books of accounts
3. The corporate charter refers to
a. Share (stock) and transfer book c. By-laws
b. Articles of incorporation d. Corporate name
4. The governing body of a corporation is called
a. Board of directors c. Incorporators
b. Shareholders d. Subscribers
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5. Owners of a stock corporation are called
a. Underwriter c. Promoters
b. Subscriber d. Shareholders
6. Ownership in a corporation is represented by its share capital which is divided into units
called
a. Shares c. Paid-in capital
b. Par value d. Share certificate
7. Refers to the maximum amount fixed by corporate charter to be subscribed and paid-in
by the shareholder.
a. Authorized share capital c. Unissued share capital
b. Subscribed share capital d. Treasury share
8. Refers to the issued share capital and still in the hands of the shareholders
a. Unissued share capital c. Outstanding share capital
b. Authorized share capital d. Subscribed share capital
9. The ownership in shares of a corporation is evidenced by a document called –
a. Shares c. Stock warrants
b. Share (stock)) certificate d. By-laws
10. Cost and expenses incurred before and during the corporate formation such as attorney’s
fees, printing cost certificate, incorporation fees, etc. –
a. Promoters’ cost c. Incorporation cost
b. Organization cost d. Project cost
Chapter 14
ACCOUNTING FOR SHARE CAPITAL TRANSACTIONS
Introduction
A stock corporation may issue shares of one or two classes. These are “preference” and
“ordinary” shares. Ordinary shares may be issued “with par value” or “no par value” shares. No
par value shares may be “with stated value” or “no stated value”. Preference share will always
have a stated par value as required by law.
After studying this module, the student should be able to: rec
1. Differentiate ordinary from preference shares as well as par value and no par value
shares.
2. Make entries both in memorandum and journal entry form of recording share capital
transactions.
3. Record issuances of par value, below and above par value shares.
4. Account for subscriber default in his subscription.
Lesson 1: Basic Concepts of Share Capital
Classes of Share Capital

To attract investors, some corporations issue two classes of shares which are:
a. Ordinary Shares
It is called ordinary because ordinary shareholders have the same rights and privileges
and have no preference over one another. An ordinary shareholder is assured of an
equal pro-rata division of profit. When there is only one class of shares issued, it is
understood to be an ordinary share.
157
b. Preference shares Preference share entitles the owner preference in the distribution of
dividends and/or in the distribution of assets of the corporation in an event of a
liquidation. Preference on dividends however, does not mean that the shareholders are
assured or guaranteed to receive dividends but are given preference over ordinary
shareholders when there is declaration by the Board of Directors.
Share capital may also be issued with Par Value or No Par Value
• Par Value Share – this has a nominal value stated on the face of the share certificate
and fixed in the Articles of Incorporation. The Corporation Code of the Philippines
prohibits the issuance of a share less than its par value. When the share is issued for
cash at less than par value or stated value, the share is issued at a discount. The
discount is not considered as a loss to the issuing corporation but the shareholder is
considered liable. This is called a “discount liability” of a shareholder.
• No par value share – has no par or nominal value printed on the Share Certificate or
stated in the Articles of Incorporation. It may be sold at any of the following amounts:
1. At the amount prescribed in the Articles of Incorporation.
2. At the amount fixed by the Board of Directors pursuant to authority conferred in
the Articles of Incorporation.
3. At the amount approved by a majority of shareholders entitled to vote at a
meeting called for the purpose.
Lesson 2: MEMORANDUM ENTRY AND JOURNAL ENTRY METHODS
There are two methods in accounting for Share Capital. These are the Memorandum Entry and
Journal Entry Methods. If the problem is silent as to what method will be used, it is the
memorandum entry method.
There are four basic transactions involved wherein both methods can be clearly distinguished
from each other as to recording of these transactions. These are:
1. Authorization as to number of shares with par value

2. Subscription to share capital
3. Collection of subscription receivable
4. Issuance of share certificate
Comprehensive Illustration:
On January 1, 2020, Arch Corporation is authorized to issue 5,000 shares of 8%

Preference Shares at a par value of P100 per share and 20,000 shares of Ordinary Shares at a
par value of P50 per share. The following were the incorporators who have made the 25%
subscriptions and 25% paid-up requirements:
25% Paid-up
25% Subscription Requirement
Preference Ordinary Preference Ordinary
E. Detoya 25,000 50,000 6,250 12,500
A. Go 25,000 50,000 6,250 12,500
M. Espocia 25,000 50,000 6,250 12,500
R. Berhay 25,000 50,000 6,250 12,500
C. Ventic 25,000 50,000 6,250 12,500
Total P125,000 P250,000 P31,250 P62,500
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Authorization of Share Capital - Upon the corporate formation, the corporation records the
classed and number of shares as approved by the SEC and as stated in the Articles of
Incorporation.
MEMORANDUM ENTRY METHOD JOURNAL ENTRY METHOD

Notations are made and written across the top
of the share capital ledger as follows: Jan. 1, 2020
Preference Share Capital Unissued Share Capital-P 500,000

2020, Jan. 1 Unissued Share Capital-O 1,000,000
Authorized to issue 5,000 shares at a par value Authorized Share Capital-P 500,000
of P100 Authorized Share Capital-) 1,000,000
To record authorization of shares
Ordinary Share Capital

2020, Jan. 1
Authorized to issue 20,000 shares at a par value
of P50
Subscription of Shares
Subscription is a binding agreement whereby an investor agrees to acquire certain number of

Unissued Shares which may be paid in full or in an installment basis. As a common practice, a
corporations comply only the subscription and paid-in requirement so it can operate immediately.
Both the memorandum and journal entry methods record the same as follows:
Subscription Receivable-P 125,000

Subscription Receivable-O 250,000
Subscribed Share Capital-P 125,000
Subscribed Share Capital-O 250,000
To record the 25% subscription of the incorporators
Collection of Subscription Receivable
Both the memorandum entry and journal entry method will record the same journal entry for the
collection of the 25% pre-incorporation requirement.
Cash 93,750
To record the 25% paid up requirement
Assume that on January 30, 2020, E. Detoya has paid in full his subscription balance and
collected P56,250 broken down as:
Preference Share (25,000 – 6,250) 18,750

Ordinary Share (50,000 – 12,500) 37,500
The journal entry is:
Cash 56,250
159
To record full collection from Mr. Detoya's
subscription balance
Issuance of Share Certificate
Share certificates are issued only upon full payment of subscription. In our illustrative problem,
only Mr. Detoya has made a full payment of his subscription. Arch Corporation will issue share
certificate to Detoya equivalent to the number of shares he subscribed and a corresponding entry
in the book is made as follows:
Memorandum entry
Subscibed Share Capital - P Share Capital - P

Jan. 30 P25,000 Jan. 30 P25,000
Subscibed Share Capital - O Share Capital - O

Jan. 30 P50,000 Jan. 30 P50,000
Journal Entry Method
Subscribed Share Capital - P 25,000

Subscribed Share Capital - O 50,000
Unissued Share Capiatl - O 25,000
Unissued Share Capiatl - P 50,000
To record full payment of Detoya and
issuance of share certificate
To summarize, memorandum and journal entry methods differ in the recording of Authorization
of Shares and Issuance of Share Certificate only. The Shareholders’ Equity section of the
Statement of Financial Position differs only on the manner of its presentation:
Under the Memorandum Entry Method
Contributed Capital:
Share Capital:
8% Preference Shares, P100 par, 5,000 shares authorized
250 shares issued 25,000
Subscribed Shares Capital 100,000
Less: Subscription Receivable 75,000 25,000
Issued and Subscribed 50,000
Ordinary Shares, P50 par, 20,000 shares authorized,

1,000 shares issued 50,000
Subscribed Share Capital 200,000
160
Total P150,000
Under the Journal Entry Method
Share Capital:
8% Preference Shares, P100 par, 5,000 shares authorized 500,000
Less: Unissued Share Capital 475,000
Issued Share Capital 25,000
Subscribed Shares Capital 100,000
Ordinary Shares, P50 par, 20,000 shares authorized 1,000,000

Less: Unissued Share Capital 950,000
Issued Share Capital 50,000
Total P150,000
The data shown in the shareholders’ equity section are taken from the account balances after
posting the above entries to the general ledger. You are encouraged to do posting using the T-
account.
Lesson 3: ACCOUNTING FOR PAR VALUE SHARES (On Subscription Basis)
Subscription is recorded by debiting Subscription Receivable account at subscription

price and crediting Subscribed Share Capital at par value. Any amount of difference between the
Subscription Receivable and Subscribed Share Capital is credited to “Share Premium or
Additional Paid-in Capital” if the shares were issued above the par value.
If shares are issued below the par value, the amount of difference is debited to
“Discount on Share Capital”.
Illustration: MM Corporation has Authorized Share Capital of P100,000 at P50 par value per
share. MEMO entry is used in recording transactions.
Case 1 – Subscribed at Par Value
Assume: 100 shares were subscribed at par value. Collected 30% down payment and balance
collected after 10 days.
Subscription entry:
161
Subscription Receivable 5,000
Partial Collection:
Cash 1,500
Full Collection:
Cash 3,500
Issuance of Certificate

Share Capital 5,000
Case 2 – Subscribed at P60 per share (Above the par value). Using the same assumption as
case 1.
Subscription entry:
Subscription Receivable (100 x P60) 6,000

Subscribed Share Capital (100 x P50) 5,000
Share Premium (100 x P10) 1,000
Partial Collection:
Cash 1,800
Subscription Receivable (6,000 x 30%) 1,800

Full Collection:
Cash 4,200

Share Capital 5,000
Case 3 – Subscribed at P40 (below Par). Using the same assumption as case 1.
Subscription entry:
Subscription Receivable (100 shares x P40) 4,000

Discount on Share Capital 1,000
Partial Collection:
Cash 1,200
Full Collection:
Cash 2,800
162

Share Capital 5,000
Case 4 – Sale of Share for Cash
Assume that 100 shares were issued for cash at par value.
Cash 5,000
Share Capital 5,000
Assume that 100 shares were issued for cash at P60 per share.
Cash 6,000
Share Capital (100 shares x P50) 5,000
Share Premium (100 shares x P10) 1,000
Assume that shares were issued for cash at P40 per share.
Cash 4,000
Discount on Share Capital 1,000
Share Capital 5,000
Accounting for Shares Issued for Non-Cash Consideration
Based on the provision of the Corporation Code of the Philippines and in conformity with the
Accounting Standards, the following rules should be observed when share capital is issued for
non-cash consideration.
Rule 1 – If issued for tangible, intangible property and service, the share capital is recorded
at the amount equal to the following order of priority:
a) Fair market value of the non-cash consideration received.

b) Fair market value of the share capital issued.
c) Par value of the share capital issued.
Illustration:
Apple corporation issued 1,000 shares with par value of P100 per share in exchange
for a parcel of land with a fair market value of P130,000. The fair market value per share is P110.
The entry to record the issuance of share capital is:
Land 130,000
Share Capital 100,000
Share Premium 30,000
Rule 2 – If issued for outstanding liability, the share capital is recorded at par value and
not in an amount equal to the liability set-off.
Illustration:
Apple corporation issued its 1,000 shares with a par value of P100. The outstanding obligation
amounts to P120,000. The entry to record the issuance of share capital is:
Loans Payable 120,000
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Note: Only outstanding liability can be paid through issuance of shares as the Corporation Code
prohibits a corporation from issuing a share in exchange for promissory note or future services.
Rule 3 – If issued in exchange for other equity securities, the measurement is equal to the
following order of priority.
a. Fair market value of the other equity securities received.

b. Fair market value of the share capital issued.
c. Par value of the share capital issued.
Illustration:
Apple Corporation issued its 1,000 shares at par value of P100 in exchange for
Orange, Inc. 1,000 equity shares. The fair market value of Apple’s share is P120 while that of
Orange is P110. The entry to record the issuance of share capital is:
Investment in Stock-Orange, Inc. (@ FMV) 110,000

Rule 4 – If issued in exchange for services received, the measure should be the value of such
services.
Illustrate:
Atty. Bugtas was given 60 shares of Apple Corporation which has a par value of P100 and a fair
market value of P130 for the services rendered in the process or organization. The journal entry
is:
Legal fees 7,800

Share Capital 6,000
Share Premium 1,800
SHARE ISSUANCE EXPENSE
Share issuance expense is direct cost to sell share capital which normally includes the following:
a. Professional fees – accountant’s and attorney’s fees

b. Underwriting fees or commission
c. Cost of printing share certificate
d. Filing fees with the SEC
e. Cost of advertising the issuance
f. Documentary stamp tax
The share issuance expense shall be charged to share premium depending on what stage they
occur.
1. If incurred during the organization stage, it shall be first charged against Share Premium.
If Share Premium is not sufficient, then the excess shall be charged to “Organizational
Expense Account”
Illustration:
164
Sand Corporation is authorized to issue 10,000 shares at a par value of P100 per share.
After complying with the SEC requirement and approval of Articles of Incorporation, a day
after, two shareholders acquired 1,500 shares at P130 per share.
Details of Cash
25% x 10,000 x P100 x 25% 62,500
1,500 shares x P100, Share Capital 150,000
1,500 shares x P30, Share Premium 45,000
P257,000
The corporation incurred a total issuance expenses of P80,000. The journal entries are
as follows:
Cash 62,500
Payment of 25% subscription
Cash 195,000
Sale of 300 shares at a premium

Organization Expense 35,000
Cash 80,000
Payment of Organization Cost
2. If incurred during operational stage, it shall be charged against Share Premium. If the
Share Premium is not sufficient then the excess is charged against corporate income.
Illustration:
Sand Corp. has incurred a share issuance expense of P15,000 during the second
year of its operation. The corporation was able to issue 300 shares at premium of P140
per share (par value if P100). The journal entry is:

Share Issuance Expense 3,000
Cash 15,000
Payment of Organization Cost
3. If the cost is recurring or indirect in nature, it shall be charged to corporate income.

Examples are cost of maintaining capital records and administrative salaries. Upon
incurrence of the expense, the pro-forma journal entry is:
Salaries Pxx
Cash Pxx
Salary of employee administering share issuance
Lesson 4: Accounting for No Par Value Shares
165
The Accounting Standards provide that:
“shares without par value (No Par) may not be issued for a consideration less than the value of
five pesos (P5.00) per share, the entire consideration received by the corporation for its par value
shares shall not be treated as capital and shall not be available for distribution as dividends.”
No par value shares may be “with stated value” or “no stated value”. Our illustrations on
accounting for no par value shares will use the memorandum entry method only.
Issuance of No Par, With Stated Value
1. Issued for Cash

No Par Value shares may be issued equal, more than or less than its stated value.
Illustration:
Stormborn Corporation issued for cash 3,000 ordinary shares with stated value of P25
per share.
Case 1 – Issued at P25 per share.
Cash 75,000
Ordinary shares 75,000
Issuance of shares at stated value
Case 2 – Issued at P30 per share
Cash 90,000
Ordinary Shares 75,000
Share Premium in Excess of Stated Value 15,000
Shares Issued above P10 above stated value
Case 3 – Issued at P20 per share.
Cash 60,000
Discount on Ordinary Share 15,000
Ordinary Share 75,000
Shares Issued above P10 above stated value
2. Issued for Non-cash consideration

When shares are issued for non-cash asset, the asset should be recorded at its fair
market value or the fair market value of the shares issued whichever is more clearly
determinable. If the market value of both non-cash asset and share are not known, an
appraisal of the asset must be made, otherwise, the asset will be recorded at the stated
value of the share.
Issuance for No Par Value, No Stated Value
When No Par, No Stated Value shares are issued, no Share Premium is being recognized. In
case of cash sales, the entire amount received on the sale of said shares shall be credited to the
“Ordinary Share Capital” account.
Case 1 – Issued for Cash
To illustrate: Stanis Corporation issued 500 shares of No Par Value, No Stated Value. The
shares were issued for P10 per share.
Cash 5,000
166
Ordinary shares 5,000
Issued 500 shares at P10 per share
Case 2 – Issued for non-cash consideration.Here, the asset account is debited and Share
Capital is credited for the market value od the asset received or fair market value of shares
issued, whichever is more clearly determinable. If market values of both the asset and the share
are not known, an appraisal of the asset must be made.
Illustration:
Coco Corporation issued 1,000 shares of no par, no stated value in exchange of land. The market
value of the share was P20. The journal entry is
Land 20,000
Issued 1,000 shares in exchange for land
Assume that the market value of land was P35,000 and the market value of share is not known.
Land 35,000
Issued 1,000 shares in exchange for land
Lesson 5: Delinquent Subscription
Subscriptions may be collected in an installment at stated “call dates”. When a subscriber cannot
pay the balance of his subscription after calls have been made or after several notices have been
sent to him by the corporation, the subscriber is said to be in “default”. His total subscribed
shares become delinquent shares and the board of directors may order to sell the shares in a
public auction. Section 67 of the Corporation Code provides that “ if within 30 days from the said
date, no payments made, all stocks covered by said subscription shall thereupon become
delinquent and shall be subjected to sale”.
The person or the bidder who is willing to pay the unpaid balance of the subscription plus accrued
interest and other expenses incurred to sell the shares of at least number of shares is called the
“highest bidder”. The delinquent shares are sold to him and certificates if shares are issued upon
receipt of payment from him.
Illustration:
Lee Minho subscribes 100 of ordinary share at a par value of P10 per share in King
Corporation and made a down payment equal to 30% of subscription price.
Journal entry ro record subscription

Journal Entry to record collection

Cash 300
Subscription Receivable 300
Lee Minho later defaulted. His subscription for 100 shares are considered as delinquent.
Journal entry to record the delinquency of Lee Minho

Receivable from the Highest Bidder 700
167
Subscription Receivable 700
King Corporation advertises the auction sale of these delinquent shares and incurs expenses of
P200.
Journal entry to record payment of expenses

Receivable from Highest Bidder 200
Cash 200
Three bids were received after three days. Carla Estrada is willing to pay the subscription balance
of P700 plus expenses of 300 in exchange for 96 shares. Vice Ganda bids in exchange of 90
shares while Kim Chiu bids for 94 shares. The highest bidder is Vice Ganda.
Journal entry to record payment of the highest bidder

Cash 900
The subscription is already considered as fully paid and share certificate that’s good for 100
shares will be issued to both Lee Minho (10 shares) and Vice Ganda (90 shares).
Journal entry to record the issuance of certificates

Share Capital 1,000
When there is only one bidder, the corporation may or may not accept the bid offered. The
corporation may itself bid for the delinquent shares. The shares acquired by the corporation under
this circumstance are considered as Treasury Shares. The journal entry will be:
Treasury Shares 900

Journal entry to record the issuance of certificates

Share Capital 1,000
Lesson 6: INCORPORATION OF A PARTNERSHIP BUSINESS
When a partnership business is converted into a corporation, the partnership contract is

dissolved. The assets of the partnership are adjusted to conform with the current or fair market
values. All liabilities must be recognized. The net assets are transferred to the corporation and
the corporation will issue number of shares equal to the amount of net assets being transferred.
The manner of how the partnership book is adjusted is similar to when a sole proprietorship is
converted into a partnership or the adjustments made in the partnership book prior to the
admission of a new partner. The following procedures will guide you in the process of
incorporating a partnership business.
Step 1 In the partnership book
Revalue the assets and recognize all liabilities by way of adjusting entries as of the
date of incorporation. (This is not shown anymore in our illustration).
168
Record the transfer of the adjusted value of the assets and liabilities which are termed
as “net assets” is debited to Receivable from ______ Corporation account. The
amount of this account is equal to the adjusted capital balances of all partners. At this
point, all partnership accounts are already closed except the accounts of the partners.
Step 3 In the book of the corporation
The corporation prepares an entry to record the authorization to issue shares. The
receipts of partnership assets and liabilities are then recorded. For fixed assets of
property and equipment account, only the “net book value” is carried in the book of the
corporation. The corporation will then issue shares equal to the value of the
partnership net assets and corresponding share certificate.
Record the receipts of the shares and distribute the shares to the partners who are
now incorporators of the new corporation.
Illustration:
The following were the account balances of GOT Partnership after adjustments in preparation for
its incorporation.
Debit Credit
Cash 70,000
Allow. For doubtful accounts 5,000
Merchandise 115,000
Delivery equipment 120,000
Accum. Depreciation 40,000
Robert, Capital 80,000
Ned, Capital 40,000
Jon, Capital 60,000
Tyrion, Capital 50,000
Ramsey, Capital 70,000
Total 365,000 365,000
GOT Corporation is authorized to issue 5,000 ordinary shares with par value of P100
per share.
Step 1 – The revaluation of assets and recognition of liabilities are recorded.
Step 2 – In the partnership book, record the transfer of assets and liabilities as:
Allowance for doubtful accounts 5,000

Accumulated depreciation 40,000
Receivable from GOT Corporation 300,000
Cash 70,000
169
Merchandise 115,000
Delivery Equipment 120,000
Step 3 – In the book of the corporation, the following entries are recorded
a) To record the authorization (assuming using the MEMO entry method)

Ordinary Share Capital
Authorized to issue 5,000 shares at a par value

of P100 per share
b) To record subscription equal to net assets of P300,000
Subscription Receivable P300,000

Subscribed Share Capital P300,00
c) To record receipts of assets and assumption of liabilities
Cash 70,000
Merchandise 115,000
Delivery Equipment 80,000
Allowance for Doubtful Accounts 5,000
d) To record issuance of share certificate to the partners who are now incorporators.
Subscribed Share Capital P300,000

Ordinary Share Capital P300,00
Step 4 – In the partnership book, the final entry is the closing of their respective capital accounts
to Receivable from GOT Corporation representing distribution of their respective shares.
Robert, Capital 80,000

Ned, Capital 40,000
Jon, Capital 60,000
Tyrion, Capital 50,000
Ramsey, Capital 70,000
Receivable from GOT Corporation 300,000
170
I – Essay
1. What are the classes of shares that a corporation may issue?

2. Distinguish the two methods of accounting for share capital.
3. When a share is sold above its par value, to what account do we charge the amount of
difference? If below par?
4. How is the highest bidder of a delinquent share determined?
II – True or False Instruction: Write “T” if the statement is correct and “F” if incorrect.
_____1. A stock corporation is a public corporation organized for profit.

_____2. When there is one class of stock issued by a corporation it is always understood to
be preference shares.
_____3. Ordinary and Preference shareholders have the same rights and both enjoy the same
privileges especially in distribution of dividends.
_____4. The legal share capital of a corporation is divided into units called “shares”.
_____5. Preference shareholders are assured or guaranteed dividends at the end of the year.
_____6. A par value share has a nominal value stated on the face of the share certificate.
_____7. The Corporation Code of the Philippines prohibits the issuance of share at less than
its par value.
_____8. When a share is issued below its par value, the share is said to be “watered share”.
_____9. The director of officer consenting the sale of stock below its par value will be held
solidarity liable with shareholder’ concerned to the corporation and creditors for the
difference between the fair value received at the time of issuance of the share and the
par.
_____10. The memorandum entry and journal entry are the two methods of accounting for
share capital transactions.
_____11. Memorandum differs from journal entry method as far as authorization and issuance
of certificate are concerned.
_____12. Subscription is the bonding agreement or a contract whereby an investor agrees to
acquire a certain number of unissued share which may be paid in full or in an installment
basis.
_____13. The pre-incorporation requirement state that 25% of Authorized Share Capital must be
subscribed.
_____14. The subscription requirement is understood to mean that each of the incorporators be
required to subscribe 25% in equal proportion and contribute equally to meet the 25% of
paid-up requirement.
_____15. Share certificate are issued upon full payment of incorporators subscription balance
only.
_____16. When the share is sold at more than the pair value, the difference is “share premium”,
which is then a credit.
_____17. When the share is sold less than the pair value, the difference is “discount on share
capital”, which is then a debit.
_____18. When the share is sold either premium or discount, the debit is always equal to the
subscription price of the share.
_____19. The highest bidder is a person who is willing to pay the unpaid balance of the
delinquent subscription plus accrued interest with the “least” number of shares.
_____20. When a subscriber failed to pay his subscription balance after lawful calls and notices
have been sent to him, all sales covered in the said subscription will be considered
“delinquent”.
_____21. When a corporation is authorized to issue ordinary and preference shares; a proper
distinction of these share should be made from the authorization up to the issuance of share
certificate.
_____22. When a shareholder transfers his share to another investor, the corporate assets
changed.
_____23. A corporation cannot accept non-cash assets as payment of its subscription.
_____24. When a memorandum entry is used, the account share capital is created upon
issuance of shares.
171
_____25. Under journal entry method, the amount of share capital issued is determine by
deducting the balance of unissued share capital account from the balance of the authorized
share capital.
_____26. Partnership net assets that are transferred to the corporation should be recorded in
the new corporation’s book at their book value.
III – Problems
1. ALS Corporation is authorized to issue 10,000 ordinary shares at P100 par value per share. On
July 2, 20A the six (6) incorporators have subscribed to 2,500 shares at par value and paid
P62,500 of the subscription. Other transactions follow:
July 15- On this day, corporation fees, printing cost of share certificates and other incidental
cost of its incorporation that were paid are recorded, P15,000.
16 Neria Asperga subscribed to 100 ordinary shares at P105 per share and made down
payment of P4,500.
18 Narvin Lachica subscribed to 100 ordinary shares at P110.
20 Rogelio Macabenta purchased for cash 150 ordinary shares at par.
25 Elizabeth Palma Gil, one of the incorporators, paid her subscription balance in full and
a share certificate for 200 shares was issued:
200 shares subscribed at P100 P20,000
Less: 25% subscription payment 5,000
Balance 15,000
27 Issued 300 ordinary shares to Alex Jandoc in exchange for a piece of land which has
a fair market value of P40,000.
29 Issued 100 ordinary shares to Atty. Gilbert Abellera in exchange for his professional
services in the process of its incorporation in the amount of P15,000.
30 Received cash of P35,000 from the incorporators as partial payment of their

subscription balances.
31 Neria Asperga paid the subscription balance in full and a share certificate is issued.
Required: 1. Record the foregoing transactions including authorization by using Journal Entry
and Memo Entry Method.
2. On March 2, 20A, Raja Buayan Marketing Corporation was authorized to issue 2,000 ordinary
shares with a par value of P1,000 per share.
20A March
3- Received subscriptions from the following incorporators as well as the 25% paid-up
requirement:
Cypres Mercedito Boquecosa - 100 shares
Jose Recon Tano - 200 shares
Everon Joseph Santos - 100 shares
Duke Anthony Abella - 50 shares
172
Perpetua Peras - 50 shares
5- Tano and Santos paid their subscriptions balances in full and share certificates were
issued to them.
6- Received subscription of 30 shares from Alfredo Yao at par value and collected 20%
of his subscription.
20B
Aug. 15- After all lawful calls and notices, Alfredo Yao defaulted and all his subscribed shares
were declared delinquent and were advertised for public auction.
16- Advertising expense paid by the corporation amounted to P5,000.
20- At the public auction, Conrado Baugbog was the highest bidder for 25 ordinary shares,
he pays the balance of the subscription plus advertising cost.
21- The share certificates were issued.
Required:
1. Entries in the book of the corporation from the authorization up to the defaulting
subscriber.
2. Entries assuming nobody bids and the corporation reacquired the shares (Treasury
Shares).
173
Chapter 15
ACCUMULATED PROFITS AND LOSSES, DIVIDENDS, AND TREASURY SHARES
Introduction:
Throughout the lifetime of the corporation, it may earn profit or incur losses. For a sole
proprietorship and partnership type of business organizations, such profits and losses are closed
to the capital account every end of the accounting period. Profits may be withdrawn by the sole
proprietor or may be distributed to the partners every depending on their sharing agreement. For
a corporation, this may be a different case because profit and losses from the start of its business
operation up to present reporting period are accumulated and not closed to the equity accounts.
The accumulated profits and losses may be appropriated for further use such as plant expansion,
acquisition of treasury shares and others or it may be declared as dividends.
At the end of this chapter, the student should be able to
1. Explain the nature of accumulated profits and losses, dividends and treasury shares.
2. Record entries for appropriation and reverse the appropriation of accumulated profits and
losses, declaration and payment of dividends.
3. Compute dividends given to ordinary and preference shareholders.
4. Record treasury share transactions.
Lesson 1: ACCOUNTING FOR ACCUMULATED PROFITS AND LOSSES
Nature of Accumulated Profits and Losses

In a corporate form of business organization, the Income and Expense Summary account is
closed to “Accumulated Profits and Losses” account and not to Share Capital account. Although
the Share Capital account is the legal capital of the corporation, it is not increased by profits
realized or decreased by losses incurred by the corporation. It is because creditors of the
corporation must be protected and the contribution of shareholders represented by share
premium must be kept intact. Basically, the Accumulated Profits and Losses has a normal
balance of a credit. It is credited when there is profit and debited when there is loss.
To Illustrate:
At the end of 20A, Lucky Strike Corporation made a profit of P150,000. In this, the income and
Expense Summary account will show a credit balance P150,000. Profit is transferred to
Accumulated Profits and Losses by debiting Income and Expense Summary and crediting
Accumulated Profits and Losses account shown below:
Income and Expense Summary P150,000

Accumulated Profits and Losses P150,00
To close profit to Accumulated Profits and Losses
If, however, Lucky Strike Corporation made a loss of P150,000 instead, the Income and Expense
Summary account will show a debit balance of P150,00. Loss is transferred to Accumulated
Profits and Losses by debiting Accumulated Profits and Losses and crediting Income and
Expense Summary account as shown below:

Income and Expense Summary P150,00
To close loss to Accumulated Profits and Losses
The Accumulated Profits and Losses account usually debited and credited for the following:
ACCUMULATED PROFITS AND LOSSES
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a) Loss for the period a) Profit for the period
b) Dividends declared b) Reversal of Appropriation
c) Appropriation for plant expansion,
contingencies, etc.
Accumulated Profits and Losses is also affected by prior period’s adjustments. This is being
debited for prior period’s adjustments that affect the income and expense resulting to decrease
in profit and credited for prior period’s adjustment that affects the income and expense resulting
to increase in profit. The errors from prior period that require adjustments to the accumulated
profits and losses account is presently known as “Fundamental Errors”. This will be taken up in
higher accounting course.
Shareholders will able to get their shares of the corporation’s accumulated profit by means of
“Dividends” as declared registers a debit balance, Accumulated Profits and Losses is said to be
“Deficit”, which means that a accumulation of losses is bigger than the accumulation of profit.by
the Board of Directors. Therefore, dividends declared will decrease the balance of the
Accumulated Profits and Losses account.
Accumulated Profits and Losses may either have a debit or a credit balance at the end of any
given period. As mentioned earlier, this account has a normal balance of a credit. When it
registers a debit balance, it is said to be “deficit”.
Illustration 2 – Accumulated Profits and Losses with a Credit Balance
The operating results of Chinatown Corporation from the start of operations in 20A to 20D were:
20A Profit P80,000

20B Profit 90,000
20C Loss ( 40,000)
20D Profit 60,000
20D Dividends Declared 50,000
The ledger of Accumulated Profits and Losses will have the following postings:
Accumulated Profits and Losses

20C Loss P40,000 P 80,000 20A Profit
20D Dividends 90,000 20B Profit
Declared 50,000 60,000
P90,000 P 230,000 20D Profit
P 140,000* credit balance
The credit balance in the Accumulated Profits and Losses account is presented in the
Shareholders’ Equity section of the Statement of Financial Position as follows:
Share Capital:
Ordinary Shares, authorised to issue 5,000 shares
Par value, P100. Issued 3, 000 shares P300,000
Share Premium on Ordinary Shares 15,000
Total Contributed Capital P315,000
Accumulated Profits and Losses 140,000*
175
Total Shareholders’ Equity P455,000
Illustration 2 Accumulated Profits and Losses with a Debit Balance
The opening results of Chinatown Company from the start of its operations in 20A to 20D were:
20A Profit P70,000

20B Profit 40,00
20B Dividends Declared 60,000
20C Loss (80,000)

20D Loss (20,000)
The ledger of Accumulated Profits and losses will have the following postings:
20B Dividends
P 70,000 20A Profit
Declared P 60,000 40,000 20B Profit
20C Loss 80,000
20D Loss 20,000
P160,000 P 110,000
debit balance P 50,000
The debit balance in the Accumulated Profits and losses account is presented in the
Shareholders’ Equity section of the Statements of Financial Position as Follows:
Share Capital:
Ordinary Share, authorized to issue 5,000 shares
par value, P100. Issued 3,000 shares P 300,000
Total Contributed Capital P 315,000
Accumulated Profits and Losses (Deficit) ( 50,000)

Total Shareholders’ Equity P 265,000
Note: Shareholders’ Equity decreases when there is an Accumulated Profits and Losses deficit.
ACCUMULATED PROFITS AND LOSSES DEFICIT
The Accounting Standards Provide:
“A deficit in Accumulated Profits and Losses account should not be presented as an asset. When
a deficit exceeds the total of the other capital account balances, the caption “CAPITAL
DEFICIENCY” is used instead of “SHAREHOLDERS’ EQUITY” in the main heading of the liability
side of the Statement of Financial Position”.
To illustrate:
Let us assume the following corporate data:
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Ordinary Shares, authorize to issue 5,000 shares
par value, P100. Issued 3,000 shares, P300,000.
Share Premium on Ordinary Capital, P15,000 and Accumulated
Profits and Losses is with 350,000 deficit.
The would-be Shareholders’ Equity section of the Statement of Financial Position is presented on
below:
Capital Deficiency
Share Capital:
par value, P100. Issued 3,000 shares P 300,000
Total Contributed Capital P 315,000
Accumulated Profits and Losses (Deficit) (350,000)
Total Capital Deficiency P 35,000
ACCUMULATED PROFITS AND LOSSES: Appropriated and Unappropriated
A credit balance in the Accumulated Profits and Losses account which represents Accumulated
Profits and Losses cannot all be declared as dividends and the same cannot be also be
distributed to shareholders as their respective shares of the corporation’s accumulated profits and
losses. Restrictions are imposed as a legal requirement, voluntary act of the Board of Directors or
contractual. This resulted to have two types of Accumulated Profits and Losses, namely:
1. Appropriated or Restricted Accumulated Profits and Losses – This is the portion of

Accumulated Profits and Losses account appropriated for purchase of treasury shares,
plant expansion and other contingencies. This is not available for dividend declaration.
2. Unappropriated of Free Accumulated Profits and Losses – This is a portion of

Accumulated Profits and Losses account which can be declared as dividends.
The Accounting Standards provide:
“Appropriated Accumulated Profits and Losses should be clearly distinguished from

Unappropriated Accumulated Profits and Losses”.
As a legal requirement, the law provides that a corporation should have an adequate amount of
Accumulated Profits and Losses in order to acquire its own shares. The corporation, therefore,
should appropriate from its Accumulated Profits and Losses an amount equal to the cost ot the
treasury shares acquired.
To illustrate:
If a corporation which has an accumulated profit of P200,000 purchased its shares for
P80,000, the corporation is not permitted to declare and pay more than P120,000 dividends. The
amount of P80,000 must be earmarked or appropriated so as not to impair the corporation’s
legal capital. Therefore, of the P200,00 Accumulated Profits and Losses, P80,000 is being
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referred to as “Appropriated or Restricted Accumulated Profits and Losses” while the balance of
P120,000 is what is being to as “Unappropriated or Free Accumulated Profits and Losses”.
The Journal Entry to Record Appropriation is:

Accumulated Profits and Losses Appropriated
for treasury shares P80,000
When the treasury shares are reissued or resold, the appropriation is being reverted back to
Unappropriated or Free Accumulated Profits and Losses which can already be available for
dividend declaration.
The Journal Entry to Revert Appropriation is:

Appropriated for Treasury Shares P80,000
Appropriated Profits and losses can also be appropriated through voluntary act of the Board of
Directors so as not to impair the corporation’s working capital.
To illustrate:
The corporation is planning to construct a building. To avoid the impairment of

working capital because the amount involved is big enough, the Board of
Directors by way of an approved resolution makes an appropriation from its
Accumulated Profits and Losses for the said purpose. Assuming that the amount
appropriated is P500,000, the entry to record the appropriation is:
Appropriated for Building Construction P500,000
As soon as the construction is finished, the appropriated portion is reverted back to the
Unappropriated Accumulated Profits and Losses by the following journal entry:

Appropriated for Building Construction P500,000
In the Shareholders’ Equity section of the Statement of Financial Position, the Accumulated
Profits and Losses Account with both Appropriated and Unappropriated portions is shown in the
following proforma:
Accumulated Profits and Losses:
Appropriated for:
Acquisition of Treasury of Shares Pxx
Building Construction xx Pxx
Unaapropriated or Free xx
Total Accumulated Profits and Losses Pxx
Lesson 2: DIVIDENDS
DEFINITION AND NATURE OF DIVIDENDS

Dividends refer to shareholders’ share of a corporation’s accumulated profits from its operations.
These are referred to as “dividends out of earnings”. It is the Board of Directors who declares
dividends through approved resolutions and is announced so that the shareholders would know.
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Such declaration becomes mandatory on their part if a corporation has a sufficient amount of
Unrestricted Accumulated Profits and Losses and sufficient cash to pay in case of cash dividend.
Section 43 of the Corporation Code of the Philippines as quoted in the Accounting Standards
provides that:
“Share Corporations are prohibited from retaining surplus profits in excess of one
hundred (100%) percent of their Paid-in Share Capital, except when justified by the
circumstances”.
Dividends can also be declared out of a corporation’s capital after payment of the corporation’s
creditors. This is an event wherein the corporation is facing liquidation. These dividends are being
referred to as “liquidating dividends”. Our discussion will be centered on “dividends out of
earnings”.
IMPORTANT DATES TO REMEMBER ON DIVIDEND DECLERATION

A corporation may declare dividends in form of cash, shares, scrip or liability and property. In any
dividend declaration, there are three (3) important dates to remember, namely:
1. DATE OF DECLARATION – These is the date when the Board of Directors approved the
resolution to distribute dividends. On this date, the liability Dividends Payable is recorded
and Accumulated Profits and Losses are decreased.
2. DATE OF SHAREHOLDERS OF RECORD – this is the date the share and transfer book
is closed to determine who are the shareholders are of such date who are entitled to
receive dividends. On this date, the list of shareholders is prepared. No journal entry is
required.
3. DATE OF PAYMENT – this is the date when dividends are actually distributed. On this
date, the liability Dividends Payable is paid and assets decrease in case of cash or
property dividends.
WHAT SHARES ARE ENTITLED TO RECEIVE DIVIDENDS?

All “Outstanding Shares” are entitled to receive dividends. Outstanding Shares refers to shares
that were issued fully paid and at the time of dividend declaration are still in the possession of the
shareholders.
All subscribed par value shares”, provided they are not delinquent are also entitled to receive
dividends. This is because the subscription agreement once entered becomes binding. It cannot
be revoked or cancelled. Hence, Subscribed Par Value Shares are considered as legally issued
from the time of subscription and as such, acquire all time rights of shareholders. They are
entitled to vote and receive dividends.
DIVIDENDS AND DELINQUENT SUBSCRIPTION

As explained earlier, all Subscribed Par Value Shares are entitled to receive dividends provided
they are not delinquent. In case these Subscribed Par Value Shares are “delinquent” this is what
is going to happen:
“Cash Dividends due on delinquent shares shall first be applied to the unpaid balance of the
subscription plus expenses”. For instance, if the would-be share in dividend is P10,000 but has a
subscription balance plus expenses of P12,000, the shareholders could not receive the cash
dividend. But in the given case, the subscription balance plus expenses amounts to P6,000 only,
the shareholder will receive P4,000 cash dividend.
“Share Dividends shall be withheld from a delinquent shareholder until he pays his subscription
balance in full”.
CASH DIVIDENDS
Cash dividend declaration may be expressed as follows:
1. As a certain percentage of par or stated value
2. As a certain peso amount per share
Regardless of how it may be expressed, the proforma journal entries upon declaration and
payment would be:
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UPON Accumulated Profits and Losses Pxx
DECLARATION Cash Dividends Payable Pxx
Effect: Accumulated Profits and Losses balance will be reduced and corporation’s obligations
will be recognized.
Cash Dividends Payable when not yet paid as of Statement of Financial Position date is
presented as “Current Liability”
To illustrate
The Board of Directors of Buhangin Corporation at their meeting on August 1,
20A has declared a 10% cash dividend to shareholders of record on Sept. 30
payable on Oct. 31, 20A. 10,000 shares were issued and outstanding with
par value of P50 per share.
Computation of Dividends
Issued and Outstanding Shares 10,000
x Par Value Per Share P 50
Share Capital P500,000
x % of Dividends Declared 10%
Amount of Dividends Declared P 50,000
========
The other way of computing cash dividend is:
Par Value Per Share P 50

x % of Dividends Declared 10%
Dividends Declared Per Share P 5
x No. of Shares Outstanding 10,000
Amount of Dividends Declared P 50,000
=========
Journal Entries
Date of Accumulated Profits and Losses P50,000

Declaration Cash Dividends Payable P50,000
Aug. 1, 20A
Date of No entry. A list of shareholders is

Record prepared on record as of Sept. 30
Sept. 30,20A
Date of Cash Dividends Payable P50,000

Payment Cash P50,000
Oct. 31, 20A
If for example, Mr. B is one of the shareholders on record on September 30 with 100
shares, his share of the dividend is P500 (100 shares x P5 per share).
Assuming that the 10,000 shares issued and outstanding, 10,000 shares were reacquired
by Buhangin Corporation as of September 30, the shares outstanding are 9,000 shares. Dividend
is computed as follows:
Issued and Outstanding Before Treasury Shares 10,000

Less Treasury Shares 1,000
Issued and Outstanding After Treasury Shares 9,000
x Dividend Per Share P 5
Amount of Dividends Declared P45,000
=======
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Remember, only outstanding shares are entitled for dividends and treasury shares are not
outstanding.
CASH DIVIDENDS WHEN THERE ARE TWO CLASSES OF SHARES
When cash dividends are declared for two classes of shares, Cash Dividends Payable account
should indicate as to “Cash Dividends Payable-Preference Share” or “Cash Dividends Payable-
Ordinary Share”. The dividend requirement on preference share must be paid before any
payment can be made to ordinary shareholders. In other words, the preference share is given
priority over ordinary shares in dividend payment. The amount of cash dividend on each class of
share will depend on the kind of description of the preference, so as preference share may be:
1. Cumulative and Non-Participating

2. Non-cumulative and Non-Participating
3. Cumulative and Fully Participating
4. Non-cumulative and Fully Participating
The journal entry to record the declaration and payment of cash dividends will be similar to a case
where there is only a single class of share except the word ordinary or preference is indicated:
Upon Accumulated Profits and Losses Pxx
Declaration Cash Dividends Payable- Pref. Pxx
Cash Dividends Payable-Ordinary Pxx
Upon Cash Dividends Payable-Preference Pxx

Payment Cash Dividends Payable-Ordinary Xx
Cash Pxx
To illustrate
The following data were taken from the records of Banahaw Corporation
10% Preference Share, P100 par, 1,000 shares
Were issued and outstanding P100,000
Ordinary Shares, P50 par, 3,000 shares were
issued and outstanding. 150,000
Accumulated Profits and Losses:
Appropriated for Plant Expansion P 80,000
Unappropriated or Free 120,000 200,000
Of the Unappropriated or Free Accumulated Profits and Losses of P120,000, P90,000 was
declared as cash dividends in 20A. No cash dividends were declared and paid in the past two
years.
1. PREFERENCE SHARES ARE CUMULATIVE AND NON-PARTICIPATING
Cash Dividend is distributed as follows:
Preference Ordinary
Total Shares Shares
Preference Dividends:
Arrears – P100,000 x 10% x 12 yrs. P20,000 P 20,000
Current – P100,000 x 10% x 1 yr. 10,000 10,000
Ordinary Dividends:
Balance all to Ordinary (90,000 less P30,000) P60,000 _________ P60,000
As Distributed P90,000 P 30,000 P60,000
Explanation:
a) The basis in distributing dividends is share capital. Hence, 1,000 shares x P100 par value
x 10% description of the preference shares = P10,000.
b) If preference share are cumulative, passed dividends or dividends in arrears are included
for distribution plus current year’s dividend, computed as follows.
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Arrears: P10,000 x 2 years = P20,000
Current: 10,000 x 1 yr. = 10,000
Preference Shares P30,000
======
c) Since the preference shares are non-participating, the balance of P60,000 will all go to
ordinary shares, computed as follows:
P 90,000 - Amount of Dividends Declared
30,000 - Distributed to Preference Shareholders
P 60,000 - For Distribution to Ordinary Shareholders
d) A sample distribution to shareholders is presented below:
Preference Ordinary_
Share in Dividends P 30,000 P 60,000
÷ Shares Outstanding 1,000 shares 3,000 shares
Dividends Per Share P 30 P 20
======== ========
This means that for every share of preference shares that a shareholders own, his share is P30
and P20 each for the ordinary share. If for instance, Mr. A, a shareholder owns 50 shares of
preference and 100 ordinary shares, his share on the P30,000 preference share dividends is
P1,500 and his share on the P60,000 ordinary share dividends is P2,000 as computed below:
Preference Shares Ordinary Shares
Number of Share he owns 50 shares 100 shares

x Dividend per share P30 P20__
His Share in Dividends P1,500 P2,000
2. PREFERENCE SHARE ARE NON-CUMULATIVE AND NON-PARTICIPATING

Preference Ordinary
Total Shares Shares
Preference Share Dividends:

Current Year – P100,000 x 10% x 1 yr. P10,000 P 10,000
Ordinary Share Dividends:

Balance all to Ordinary 80,000 _________ P80,000
As Distributed P90,000 P 10,000 P80,000
======= ======= ======
Distributed as Dividends P10,000 P80,000
÷ Shares Outstanding 1,000 shrs. 3,000 shrs.
Dividends Per Share P 10 P 26.67
======= =======
Explanation:
a) Preference Shares are non-cumulative. Therefore, only current year’s dividend is paid in
the amount of P10,000. Passed dividends or dividends in arrears are not paid anymore.
b) The balance of P80,000 (P90,000 – P10,000) is all given to ordinary shareholders.
3. PREFERENCE SHARES ARE CUMULATIVE AND FULLY PARTICIPATING
Preference Ordinary
Total Shares Shares

Arrears – P100,000 x 10% x 2yrs. P20,000 P 20,000
Current – P100,000 x 10% x 1 yr. 10,000 10,000

P150,000 x 10% x 1 yr. 15,000 15,000
Balance for Participation, P45,000
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Preference: P100,000/250,000 x 45,000 18,000 18,000
Ordinary: P150,000/250,000 x 45,000 27,000 _________ 27,000
As Distributed P90,000 P48,000 P42,000
====== ====== ======
Distributed Dividends P48,000 P42,000
Dividends Per Share P 48.00 P 14.00
===== =====
Explanation:
a) The Preference Shares are cumulative. Therefore, dividends in arrears of P20,000 and
current year’s dividends of P10,000 are paid.
b) Since Preference Shares are participating, the balance of P60,000 could not all be given
to Ordinary. Instead, Ordinary shares are given the same rate for one year based on
share capital. Hence, P150,000 x 10% = P15,000.
c) The balance of P45,000 (P90,000 – P45,000) is divided between Preference and
Ordinary on a pro-rata basis.
4. PREFERENCE SHARES ARE NON-CUMULATIVE AND FULLY PARTICIPATING

Preference Ordinary
Total Shares Shares

Current – P100,000 x 10% x 1 yr. 10,000 10,000

Current Year - P150,000 x 10% x 1 yr. 15,000 15,000
Balance for Participation, P65,000
Preference: P100,000/250,000 x 65,000 26,000 26,000

Ordinary: P150,000/250,000 x 65,000 39,000 _________ 39,000
As Distributed P90,000 P36,000 P54,000
====== ====== ======
Distributed Dividends P36,000 P42,000
Dividends Per Share P 36.00 P 18.00
===== =====
Explanation:
a) Preference Shares are non-cumulative so that only current year’s dividend of P10,000 is
paid.
b) Because preference shares are fully participating, the ordinary share is given the rate for
one year based on share capital. Hence, P150,000 x 10% = P15,000.
c) The balance of P65,000 is divided between preference and ordinary shares on pro-rata
basis.
SHARE DIVIDENDS
When share dividends are declared, we have to consider not only the sufficiency of the
Unappropriated Accumulated Profits and Losses but also the sufficiency of the original and
unissued shares which are to be distributed as dividends. Treasury shares cannot be distributed
as share dividends although there were once issued and outstanding and reacquired by the
issuing corporation. The declaration of the share dividends requires approval of shareholders
representing not less than two thirds (2/3) of the outstanding share capital at a regular meeting
called for the purpose.
Share Dividends should be recorded on the rate declared and this calls for the issuance of
“certificate of shares” upon distribution. The proforma journal entries are as follows:
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Declaration Share Dividends Distributable Pxx
Upon
Payment Share Dividends Distributable Pxx
Share Capital Pxx

Take note that the account title being used is “Share Dividends Distributable” and not
“Share Dividends Payable”. Share Dividends are not payable out of the current assets of the
corporation declaring it but instead a Share Capital account. Hence, the appropriate account title
is “Share Dividends Distributable”. When share dividends are not yet distributed as of Statement
of Financial Position date, Share Dividends Distributable account is shown in the Shareholders’
Equity section of the Statement of Financial Position.
Presented below is the Share Capital component of a Shareholders’ Equity in the

Statement of Financial Position showing the Share Dividends Distributable account.
Share Capital:
Ordinary Shares, authorized to issue ________
shares, par value, P________. Issued and
outstanding, ___________ shares Pxx
Add Share Dividends Distributable xx
Total Share Capital Pxx
Share Dividends are usually declared as:

1. A certain percent of total number of shares entitled to receive dividends:
To illustrate:
Kalayaan Corporation has P10,000 shares issued and outstanding when it
declares 25% share dividends. The number of shares that will be issued to
shareholders as share dividends will be 2,500 shares, computed as follows:
Outstanding Shares 10,000
x % of dividends declared 25%
Share Dividends Declared 2,500 shares
Each share outstanding is entitled to a share dividend of .25 or ¼ of a share

(2,500/10,000). If for example, Mr. X is a holder of 500 shares, the additional shares he
will receive as share dividends is 125 shares computed as follows:
500 Number of Shares held
x .25 Share dividends per share
125 Additional share he will receive
Or 500 shares x 25% = 125 shares. The holdings of Mr. X in Kalayaan Corporation have
increased to 625 shares.
2. A certain number of shares per share held.

To illustrate:
Bato Corporation declares a share dividend of “one-for-five”. One-for-five means,
one additional share is issued as share dividend for every five (5) shares
outstanding. This is actually equivalent to 20% share dividend (1/5 = 20%). If
there are 20,000 shares outstanding, the additional shares to be issued as share
dividend will be 4,000 shares (20,000/5 shares = 4,000 shares). If Mr. Y is a
holder of 1,000 shares, the additional shares that he will receive as share
dividend will be 200 shares. The holdings of Mr.Y in Bato Corporation has
increased to 1,200 shares.
When share dividends are declared, Accumulated Profits and Losses is said to have been
capitalized because the portion of Accumulated Profits and Losses is transferred to Share
Capital. The amount debited to Accumulated Profits and Losses may or may not be the same
amount credited to Share Capital pursuant to what has been provided for the Accounting
Standards which categorizes corporation issuing share dividends as follows:
SMALL SHARE DIVIDENDS
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- For Corporations who declare a share dividend of less than 20% of the previously
outstanding share, the Accumulated Profits and Losses account is to be cspitalized at
fair market value upon the date of declaration.
To illustrate:
Magara Corporation, a corporation with listed shares, declares a 10% share
dividend (less than 20%). It has 10,000 shares issued and outstanding with par
value of P100. On the date of declaration, the market value per share is
P105.
The amount of Accumulated Profits and Losses to be transferred to Share

Capital is based on P105 per share which is the market value and not at P100,
its par value. The number of shares to be issued as share dividends is 1,000
shares (10,000 shares x 10%).
The required Journal Entries are as Follows:
Upon Accumulated Profits and Losses (1,000 x P105) P105,000

Declaration Share Dividends Distributable (1,000 x P100) P100,000
Share Premium from Share Dividends (1,000 x P5) 5,000
Upon Share Dividends Distributable P100,000

Distribution Share Capital P100,000
LARGE SHARE DIVIDENDS

- In an event wherein this corporation declared a share dividend of more than 20% of
the previously outstanding share, the Accumulated Profits and Losses account is to
be capitalized at par value upon declaration.
To illustrate:
Let us assume that Magara Corporation, instead declares a 25% share dividend,
the number of shares to be issued as dividend is 2,500 shares (10,000 shares x 25%).
The required journal entries are as follows:
Upon Accumulated Profits and Losses

Declaration (2,500 x P100) P250,000
Share Dividends Distributable (1,000 x P100) P250,000
Upon Share Dividends Distributable P250,000

Distribution Share Capital P250,000
LIQUIDATING DIVIDENDS
Liquidating Dividends are those dividends declared and paid out of capital. In other words,
Liquidating Dividends are return of capital to investing shareholders.
SHARE SPLITS
“Share Split” is a corporate practice wherein it reduces its par value or stated value per share
which corresponds to increase in the number of total shareholding. This in effect will not change
the balance of Shareholders’ Equity account. One of the reasons why corporation do this, it is
because the Board of Directors sometimes believes that at a lower price of share capital would
attract more investors to the corporation.
To illustrate:
Mahogany Corporation has 20,000 ordinary shares issued and outstanding at a par value
of P100 for P2,000,000. The Board of Directors finally decided to “split” the shares “five
for one”.
185
This means that a shareholder will receive 5 shares with a new par value of P20.00 for
each share held computed as follows:
20,000 share
x 5 (5 for 1)
100,000 shares x P20 (1/5 x P100) = P2,000,000
As we see, the ordinary shares issued and outstanding of P2,000,000 before the split
remain unchanged after the split of P2,000,000 also but the number of ordinary shares
issued and outstanding increases from 20,000 to 100,000 and the par value was reduced
from P100 down to P20 par value per share.
SCRIP DIVIDENDS
Scrip Dividends are actually deferred cash dividends. These are being declared when a
corporation has sufficient Unrestricted Accumulated Profits and Losses to warrant declaration but
does not have enough cash to pay dividends. Scrip Dividends are written promise to pay a certain
amount of money at future date. When interest-bearing, interest is paid at maturity date.
To illustrate:
Banana Corporation declares 10% dividends on 5,000 ordinary shares, par value of P100
in one year at 12% interest rate. The entries to record both declaration and payment are:
Upon Accumulated Profits and Losses P50,000

Declaration Scrip Dividends Payable P50,000
Upon Scrip Dividends Payable P50,000

Distribution Interest Expense 6,000
Cash P56,000
Scrip Dividends Payable if not yet paid is presented as a Current Liability in the Statement of
Financial Position.
PROPERTY DIVIDENDS
Property Dividends are dividend declared which are payable in terms of non-cash assets.
Usually, securities like shares and bonds that are required by the issuing corporation from other
corporation are being distributed as property dividends.
The Accounting Standards provide:
“Dividends Payable in non-cash assets (other than stocks) should be changed to
Accumulated Profits and Losses at cost or net book value of the non-cash assets
distributed”.
To illustrate:
RFM Corporation owns 3,000 shares in DEF Corporation at a cost of P10 per
share. When RFM declared dividends, these DEF shares were distributed to
shareholders instead of its own assets. These entries to record declaration
payment are as follows:
Upon Accumulated Profits and Losses P30,000

Declaration Dividends Payable in Shares P30,000
of DEF Corporation
Upon Dividends Payable in Shares

Distribution of DEF Corporation P30,000
Investment in Share of DEF Corporation P30,000
186
The account credited upon payment is “Investment in Share of DEF Corporation” because the
entry to record the acquisition of these 3,000 shares of DEF Corporation is regarded as its
investment. The entry made in the book of RFM Corporation in acquiring these 3,000 shares was:
Investment in Share of DEF Corporation P30,000
Cash P30,000
Hence, when disposed of, the account credited was the investment account.
The Accounting Standards provides that, “Treasury Shares may be reissued dividends, in which
case the cost of the shares should be charged to Retained Earnings”.
Moreover, Corporation Code of the Philippines, Section V, paragraph 3 states that,
“Treasury shares may be declared as property dividends to be issued out of the Retained
Earnings previously used to support their acquisition, provided that the amount of said
Retained Earnings has not been impaired by losses. Any declaration and issuance of
treasury shares as property dividends shall be disclosed and properly designated as
property dividends in the books of the corporation and in its financial statements”.

Declaration Property Dividends Payable Pxx
Upon Property Dividends Payable Pxx

Distribution Treasury Shares Pxx
Lesson 3: TREASURY SHARES

______________________________________________________________________
Definition and Nature of Treasury Shares
Treasury Shares are corporation’s own shares which are already issued and fully paid for by
shareholders, were later reacquired but not cancelled.
To illustrate:
Lambada Corporation has 5,000 issued and outstanding shares, Mr. Cruz is one
of the shareholders for 100 shares. Lambada Corporation reacquired these 100 shares.
The reacquired shares are called “Treasury Shares”.
These are four (4) basic requirements in order for a share to become Treasury Shares.
They are as follows:
1. It should be the corporation’s own share
2. It has been issued and fully paid already
3. It is reacquired by the issuing corporation
4. It is reacquired not for the purpose of cancellation
Treasury Shares, though they are reacquired are not considered as Assets of the issuing
corporation because a corporation cannot own a part of itself. When these treasury shares are in
the possession of the issuing corporation, these have no more voting rights, nor does it have a
preemptive right to participate in additional issuance of shares and not entitled to dividends
because a corporation cannot recognize income through dealing with itself.
If corporation has more than one class of share, the Treasury Share account should indicate the
class as “Treasury Share-Ordinary” or “Treasury Share-Preference”.
ACQUISITION OF TREASURY SHARES

Treasury shares may be acquired by purchase, redemption, donation or through some other legal
means. However, as provided in the corporation code, “no corporation shall redeem, repurchase,
or reacquire its own shares of whatever class, unless it has an adequate amount of
Unappropriated or Unrestricted Accumulated Profits and Losses to support the cost of the said
shares.”
187
To illustrate:
Let us assume that the Shareholders’ Equity of Mango Corporation is as follows:
Ordinary Share P500,000
Accumulated Profits and Losses 100,000
In this example, the corporation can purchase its own shares up to the extent of the Accumulated
Profits and Losses balance of P100,000. If the treasury shares were acquired at a cost of
P100,000, the Shareholders’ Equity of Mango Corporation will appear as follows:
Ordinary Shares P500,000
Total P600,000
Less Treasury Shares 100,000
Shareholders’ Equity P500,000
After the acquisition of treasury shares, the Accumulated Profits and Losses of P100,000
can no longer be available for dividend declaration, otherwise the legal capital of P500,000 will be
reduced to P400,000 which is violation to the “Trust Fund Concept”.
Cost Method of Accounting for Treasury Shares

The most common method of accounting for the purchase of treasury shares is the “Cost
Method”. This method conforms to the Accounting Standards which provides:
“Treasury Shares should be recorded at cost irrespective of these are acquired below or
above par value. The cost of Treasury shares for non-cash consideration is usually
measured by the recorded amount of the non-cash assets surrendered”.
The cost of treasury shares should be shown in the Statement of Financial Position as a
reduction from the Shareholders’ Equity.
To illustrate:
Let as assume that Silvertown Corporation has the following capital account balances:
Share Capital
Ordinary Share, authorized to issue
1,000 shares, par value, P100 issued 900 shares P90,000
On Septemeber 1 Silvertown Corporation acquire its own shares of 200 at P105.
A) The Journal entry to record the acquisition is:

Treasury Share P21,000
Cash P21,000
To record acquisition of 200
shares of Treasury Share at P105
B) An entry is then prepared to appropriate a portion of the Accumulated Profits and
Losses for the acquisition of the treasury shares is presented below:
Accumulated Profit and Losses
To record appropriation of Accumulated
Profits and Losses for acquisition of Treasury Shares.
The Accumulated Profits and Losses of P50,000 is now broken down into:
Accumulated Profits and Losses Appropriated

for Treasury Shares P21,000
Accumulated Profits and Losses Free or Unrestricted 29,000
Total Accumulated Profits and Losses P50,000
The amount of P21,000 representing the Appropriated or Restricted portion of Accumulated

Profits and Losses cannot be available for dividend distribution. If there are no other restrictions in
188
the Accumulated Profits and Losses, P29,000 representing Free or Unrestricted Accumulated
Profits and Losses portion is available for dividend distribution. The acquisition of the treasury
shares did not impair the P90,000 legal capital of the corporation.
C) The Shareholders’ Equity of the Silvertown Corporation is presented as follows:

Share Capital
par value, P100. Issued 900 shares, of which
200 shares in the treasury P 90,000
Total Contributed Capital P100,000
Accumulated Profit and Losses:
Appropriated for Treasury Share P21,000
Unappropriated or Free 29,000 50,000
Total Contributed Capital and Accumulated Profits
and Losses P150,000
Less: Treasury Shares at cost 21,000
After the acquisition of 200 shares of Treasury Shares, the number of shares outstanding had
decreased to 700 shares (900-200). The 200 shares which are already called Treasury Shares
have no voting rights and not included in computing dividends.
The Shareholders’ Equity is composed of Total Contributed Capital and Accumulated Profit and
Losses. Therefore, the Shareholders’ Equity before deducting cost of Treasury Shares is
P150,000.
D) If the Treasury Shares are sold, the appropriation of Accumulated Profits and
Losses will be reverted back to unappropriated Accumulated Profits and Losses in
an amount equal to the “cost” of the treasury shares regardless of what price
these are sold.
To illustrate:
Assuming that of 200 Shares of the treasury shares, 150 shares were sold, to revert the
Appropriated back to unappropriated, the journal entry is:
Accumulated Profit and Losses P15,750
To revert appropriation of Accumulated Profits
and Losses to Free. (150 shares x P105).
If the balance of 50 shares in the treasury will be sold, another entry to revert the
appropriation is done in the amount of P5,250 (50 shares x P105). By this time, the whole
amount of P21,000 (P15,750 plus P5,250) is reverted to Unappropriated or Free
Accumulated Profits and Losses. Hence, can already be declared as dividends.
SALE OR ISSUANCE OF TREASURY SHARES
The corporation may sell its treasury shares at any price or even below par provided it is
reasonable price approved by the Board of Directors. The distinction between Unissued Shares
and Treasury Shares is of great importance when shares are sold because Treasury Share can
be sold at a discount while the Unissued Shares cannot.
The Accounting Standards provides:
“Upon resale (Reissuance) of the treasury shares, the Treasury Share account is credited
for cost. Gains on such sales shall be credited to or Share Premium on Treasury Shares
transactions for that class of share. Losses shall be charged against Share Premium but
only to the extent of previous net gains from sales or charges to Accumulated Profits and
189
Losses. Gains and Losses of Treasury share should not be credited or charged to
income”
To have an easy understanding and clearer picture of the sale of treasury shares transaction, let
us continue with the use of the same illustrative problem, Silvertown Corporation.
To illustrate:
Silvertown Corporation has acquired 200 shares of treasury shares at P105
when the par value was P100 per share. The cost of treasury shares is P21,000
(200 shares x P105). The 200 shares were sold as follows:
30 shares for P105 (at cost)
70 shares for P120 (above cost)
100 shares for P100 (below cost)
A – Sold at cost – 30 shares were sold for P105
Cash P3,150
Treasury Shares P3,150
To record 30 shares of Treasury Shares sold
for P105 per share.
B – Sold above cost – 70 shares were sold for P120
Cash P8,400
Share Premium – Treasury Share Transaction 1,050
To record 70 shares of Treasury Shares sold
P120 per share computed as follows:
Proceeds from Sale (70 shares x P120) P8,400

Less: Cost of Treasury Shares (70 shares x P105) 7,350
Gain (Credited to Share Premium – Treasury Share Transaction) P1,050
C – Sold below cost – 100 shares were sold for P100

Cash P10,000
Share Premium – Treasury Share Transaction 500
To record cost of 100 Treasury Shares Sold
for P100 per share computed below:
Proceeds from Sale (100 shares x P100) P10,000
Loss: (Dr. to Share Premium – Treasury Share Transaction) P 500 )
The loss was debited to Share Premium – Treasury Share Transaction because the gain was
credited to the said account. The amount of Share Premium that will be shown in the
Shareholders’ Equity will be P550 as shown in the T-account below:
Share Premium – Treasury Share
Loss P500 P1,050 Gain
P 550
In an event wherein the amount of loss will be bigger than the amount of gain, the amount of
difference is charge to Accumulated Profits and Losses.
Computation:
Proceeds from sale (100 shares x P80) P8,000
Loss P2,500
Journal Entry:
Cash P8,000
Share Premium – Treasury Share transactions 1,050
190
shares for P80 per share
Again, Accounting Standards partly provide:

“Losses shall be charged against Share Premium but only to the extent of previous net
“gains’otherwise “losses” should be charged to Accumulated Profits and Losses”.
Since the amount of loss is P2,500 and net gain is P1,050, only P1,050 of the P2,500 loss can be
charged against Share Premium-Treasury Share Transaction account. The difference of P1,450
is charged to Accumulated Profits and Losses. The Share Premium account will be closed while
Accumulated Profits and Losses account balance will be decreased as it is being debited.
Note:
If there are two classes of shares, Ordinary and Preference, the Share Premium account will be
shown separately as “Share Premium – Treasury Share Ordinary” or “Share Premium – Treasury
Share Preference”. This is because the Treasury Share account of each class should also be
separately shown in the Shareholders’ Equity.
RETIREMENT OF TREASURY SHARES

The Accounting Standards provide that,
“ If a corporation’s Share Capital is retired, the Share Capital account is reduced by its
par value. The number of shares issued is reduced by the share retired”. The Treasury
share account is credited at cost. If retirement results a gain (that is, the par value
exceeds the cost), such gain shall be credited to Share Premium relating to the same
issue. If retirement results to a loss (cost exceeds par value), such loss should be debited
to the following accounts in the order given:
a) Share Premium to the extent of the credit when the share was issued;
b) Share Premium from previous Treasury Share Transactions (Sales or retirement) of the
same class of share and
c) Accumulated Profits and Losses
To illustrate:
Share Capital
Ordinary Share, authorized to issue
2,000 shares, par value, P100. Issued
1,000 shares of which, 200 shares are
in treasury P100,000
Share Premium 5,000
Contributed Capital P105, 000
Assume:
The cost of Treasury Share was P90 per share or amounting to P18,000.
Isolation of Data:
1. The premium or Share Capital is P5.00 per share (P5,000/1,000) shares
2. The Par value of the Treasury Share is P100 per share while the cost of treasury
share is P90.
JOURNAL ENTRY TO RETIRE TREASURY SHARE:

(Retirement Results in a Gain)
Share Capital-Ordinary (200 shares x P100) P20,000
Treasury Shares (200 x P90) P18,000
Share Premium from Retirement of Share 3,000
Assume: The cost of treasury share is P110.
JOURNAL ENTRY TO RETIRE TREASURY SHARE:

(Retirement Results in a Loss)
Share Capital-Ordinary (200 shares x P100) P20,000
191
Accumulated Profits and Losses (Difference ) 1,000
Treasury Share (200 shares x P110) P22,000
DONORS SHARE
Donor Share are treasury shares. These are shares issued by the corporation, were
fully paid but were later given back by shareholders to said corporation in a form of
donation. Since these do not cost anything to the corporation when acquired, the
receipt of the donated shares is recorded by a memorandum entry only in the
Treasury Share account in the General Ledger. When sold, the proforma journal
entry is:
Cash Pxx
Share Premium from Donated Capital Pxx
I – Essay
1. What is Accumulated Profits and Losses account? When is it increased? Decreased?
2. What is dividend?
3. Enumerate the important dates in dividend declaration?
4. What are treasury shares?
5. What is the difference between a treasury share and unissued share?
II – True or False
Instruction: Write “T” if the statement is correct and “F” if incorrect.
_____1. The accumulated profit and losses of a corporate entity is called “Accumulated
Profits and Losses” account.
_____2. Accumulated Profits and Losses account has a normal balance of a debt.
_____3. A “deficit” is a debit balance in the Accumulated Profits and Losses account.
_____4. Accumulated Profits and Losses is said to be in “deficit” when the accumulation
of losses exceed the accumulation of profit at the end of the year.
_____5. When accumulation profits and losses “deficit” exceeds the total of other capital
account balances, the caption “Capital Deficiency” instead of “Shareholders’ Equity” is
used.
_____6. Deficiency in Accumulated Profits and Losses balance will decrease the
Shareholders’ Equity.
_____7. Unappropriated Accumulated Profits and Losses is that portion of Accumulated
Profits and Losses that is appropriated for the purchase of treasury share, plant
expansion and other contingencies.
_____8. As legal requirement, the law provides that a corporation should have an
adequate amount of Unappropriated Accumulated Profits and Losses in order to acquire
its own shares.
_____9. When treasury shares are reissued or resold, the appropriation is beign reverted
back to Unappropriated Accumulated Profits and Losses which can be available for
dividend distribution.
_____10. The dividends that the shareholders may receive representing the corporation’s
accumulated profit from operation is what we referred to as “dividends out of earnings”.
_____11. Cash dividends decrease the Shareholders’ Equity balance.
_____12. Dividends are always distribution of profits.
_____13. Share corporations are prohibited from retaining surplus profits in excess of
100% of their Paid-in Share Capital, except when justified by the circumstance.
_____14. The date of declaration is the date when liability “Dividends Payable” is paid and
assets decrease in case of cash or property dividends.
_____15. Subscribed Par Value shares are entitled to receive dividends provided they are
no delinquent.
192
_____16. The Declaration of Share Dividends requires approval of shareholders
representing not less than two-thirds (1/2) of the outstanding share capital at a regular
meeting called for the purpose.
_____17. Share dividends payable will result to increase Accumulated Profits and Losses
and decreases share capital.
_____18. In a share dividend distribution, the assets of the corporation are not affected.
_____19. Trust fund doctrine is where legal capital of the corporation is held intact for the
protection with the creditors.
_____20. Treasury share is an asset of the issuing corporation.
III – Problems
1. The Accumulated Profits and Losses account showed a credit balance o P165,000 on January
1, 20B after closing the books of accounts on December 31, 20A, end of the fiscal year. The
following errors were discovered after closing:
a) Accrued salaries not recorded, P15,000
b) Merchandise Inventory Dec. 31 was understated by P4,000
c) Depreciation was overstated by P2,000
d) Expired portion of Prepaid Insurance not recorded, P5,000.
Required:
1. Compute the corrected Accumulated Profits and Losses balance, January 1, 20B
2. Prepare the necessary adjusting entries to correct the Accumulated Profits and Losses
account
2. Bacolod Sugarland Corporation has an Accumulated Profits and Losses balances of P950,000
on January 1, 20A. At the end of 20A, the corporations’ net profit was P170,000. During the early
part of 20A, the following appropriations to Accumulated Profits and Losses were made:
a)For Plant Expansion P260,000
b)For Treasury Share 90,000
A cash dividend of P100,00 was declared and paid during 20A.
Required:
1. Journal entry to close 20A Net Profit to Accumulated Profits and Losses.
2. Journal entry to record Appropriation of Accumulated Profits and Losses.
3. Journal entry to declare and pay dividends.
4. Prepare Schedule of Accumulated Profits and Losses for the year ended December 31,
20A.
5. If the middle part of 20B, the plant expansion is completed, what is the necessary journal
entry to return the Appropriation to Accumulated Profits and Losses, Free or
Unappropriated?
3. The records of Marco Polo Corporation showed the following data:

Ordinary Shares, par value P1,000, 8,000 share authorized,
5,000 share issued and outstanding P5,000,000
Subscribed Share Capital –Ordinary (500 shares) 500,000
Treasury Shares – Ordinary (200 shares at cost) 200,000
Accumulated Profits and Losses 1,500,000
Required:
Given the journal entries to record the declaration and payment of dividends under each
of the following independent assumption:
a. a 20% cash dividend
b. a cash dividend of P25.00 per share
c. a 10% share dividends to be capitalized at P1,200 market value
d. a 20% share dividend to be capitalized at par value
4. Casablanca, Inc. Shareholders’ Equity section was presented below:

Share Capital:
Ordinary Share, P100 par, 2,500 shares authorized,
193
1,500 shares issued and outstanding P 150,000
Total Share Capital P 172,500
Total Shareholders’ Equity P 232,500
On August 1, 20A, the Board of Directors declared a cash dividend of P12.00 per share which
were paid on September 1, 20A. On December 1, 20A, the Board declared a 10% (small
dividend) and the shares was P130 on December 1, 20A and P140 on December 15, 20A.
Required: Prepare journal entries for these dividend transactions.
5. The following corporate data were taken from the records of Negros Grains, Incorporated.
7% Preference Share, P50 par – 2,000 share were issued.
Ordinary Share, P100 par – 3,000 shares were issued
Accumulated Profits and Losses, P110,000
P80,000 is declared as cash dividends, no dividends were declared in the past two (2)
years.
Required:
1. Pro-forma journal entries to record the declaration and payment of cash
dividends when there are two classes of shares being issued.
2. Prepare a Schedule of Cash Dividends Distribution showing the dividends per
share assuming that preference shares are:
a. Non-cumulative and Non-participating
b. Cumulative and Non-participating
c. Non-cumulative and Fully Participating
d. Cumulative and Fully Participating
194

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5Chapter 9

Accounting for partnerships

Lesson 2: Accounting for Partnership Formation

A contract of partnership is consensual. It is created by the mere agreement of the partners

Type of contribution Measurement

Date Cash 100,000

Lesson 3: Bonus on Initial Investments

An accounting problem exists when a partner’s capital account is credited for an

Asset contribution of a Liability assumed by the Credit to the partner’s

Variations to the bonus method

Date Cash 150,000

Illustration 2: Additional investment (withdrawal of investment)

• Initial capital of P140,000.

Lesson 4: Sole Proprietor and Another Individual Forming a Partnership

Liabilities and Equity

Lesson 5: Two Proprietors Forming a Partnership

Merchandise inventory 8,000

New Book of the Partnership

(2) Accounts payable 3,000

(2) Accounts payable 6,000

(2) Cash 4,000

II – True or False. Instruction: Write T if the statement is true or correct of F is the

• Only 60% of the accounts receivable is recoverable.

Lesson 1: Division of Profits and Losses

The partners share in partnership profits or losses is in accordance with their

Case 1: With remaining profit – different P/L ratios

Case 2: No remaining profit – different P/L ratios

Lesson 2: Bonus as Part of Profit/Loss Distribution

Case 1: With profit

(a)The bonus is computed as follows:

The bonus scheme is “bonus after bonus”. The formula is as follows:

Case 2: With loss

Year-end B, Capital 8,000

Illustration 2.1: Bonus – With limit

Illustration 2.2: Bonus – choice of profit sharing scheme

Profit after salaries and bonus(X) 30,000

Lesson 3: Interest on Capital

Illustration 3: Interest on capital

Beg. Balance 60,000 12/12 60,000

Illustration 3.1: Interest in Capital and Bonus

Requirement: How much is the bonus of A?

3. A and B’s partnership agreement state the following:

Requirement: Compute for the respective shares of the partners in profit.

5. The partnership agreement of A and B states the following:

Requirement: Compute for respective shares of the partners in the loss.

1. Define partnership dissolution and distinguish its types.

1. Dissolution by change in ownership structure which covers the following:

a. Sale or conversion of non-current assets into cash

Lesson 1: Admission of a New Partner in an Existing Partnership

Admission of a new partner is of two types: by purchase of interest and by investment.

Case 1 – Purchase of a portion of interest from one partner only.

Assumption 1 – Hodor pays P20,000 (at book value)

2 – Hodor pays P15,000 (less than its book value)

Jon, Capital P20,000

Hodor, Capital P20,000

To transfer 1/3 interest of Jon to Hodor

Before admission After Admission:

Case 3 – Purchase of portion of interest from more than one partner

Jon, Capital 30,000