UNIT IV – CORPORATE LIQUIDATION AND REORGANIZATION

Activity 1 – Problems
1. Nalugi Corporation, is undergoing liquidation. Relevant information on January 1, 2020 is shown below:

Assets Carrying amounts Net realizable value

Cash 200,000 200,000
Accounts receivable 500,000 450,000
Inventories 350,000 300,000
Equipment, net 400,000 150,000
Land 1,000,000 1,300,000
Total assets 2,450,000 2,100,000

Liabilities
Accounts payable 700,000 700,000
Salaries payable 500,000 500,000
Taxes payable 300,000 300,000
Notes payable 300,000 300,000
Loan payable 750,000 750,000
Total liabilities 2,550,000 2,550,000

Equity
Share capital 1,000,000
Retained earnings (deficit) (1,100,000)
Capital deficiency (100,000)
Total liabilities and equity 2,450,000

Additional information:

1. Administrative expenses expected to be incurred during the liquidation process is P 180,000.

2. The equipment is pledged as collateral security for the notes payable.
3. The land is pledged as security for the loan payable.
4. Accrued interest on loans payable amounting to P 15,000 was not reflected in the statement of
financial position.

REQUIRED:

1. Prepare the Statement of Affairs

2. Compute estimated recovery percentage
3. Assuming all the assets were sold and all liabilities were equal to their realizable value,
a. how much would Mr. Reyes , an unsecured non priority creditor, would expect to receive from
his P 300,000 claim from the company?
b. how much is the estimated payment for partially secured creditors?

Req. 2: estimated recovery percentage = 510,000 = 60%

850,000

3. a) Mr. Reyes will receive = 300,000 x 80% = 180,000.

b) estimated payment for partially secured creditors:
Secured portion - Equipment P 150,000
Unsecured portion = 150,000 x 60% 90,000 P 240,000
Req. 1 : Nalugi Company
Statement of Affairs
January 1, 2020

Estimated Available for

Book values Assets realizable Unsecured
Value creditors
Assets pledged to fully secured creditors:
P 1,000,000 Land P 1,300,000
Less: Loan payable (750,000)
Interest payable (10,000) 540,000

Assets pledged to partially secured creditors:

400,000 Equipment 150,000
Less: Notes payable ( 300,000)

Free Assets
200,000 Cash 200,000
500,000 Accounts receivable, net 450,000
350,000 Inventories 300,000 950,000
Total free assets 1,490,000
Less: liabilities with priority
Salaries payable (500,000)
Taxes payable (300,000)
Administrative expenses (180,000)
Net free assets 510,000
________ Estimated deficiency ( 850,000 – 510,000) 340,000
2,450,000 850,000

Secured Unsecured
Book values Liabilities and Stockholders’ Equity priority non priority
claims liabilities
Unsecured liabilities with priority:
500,000 Salaries payable 500,000
300,000 Taxes payable 300,000
--- Administrative expenses 180,000
Total 980,000

Fully secured creditors:

750,000 Loan payable 750,000
---- Interest payable 10,000
Total 760,000

Partially secured creditors:

300,000 Notes payable 300,000
Less Equipment 150,000 150,000

Unsecured creditors:
700,000 Accounts payable 700,000 700,000
Total unsecured creditors 850,000

( 100,000) Stockholders’ Equity --

2,450,000 850,000
 Problem 2: Using the same data as in problem 1: The winding up of the affairs of Nalugi company is entrusted
to a receiver (trustee) and the activities of the receiver for three months- January to March 31, 2020
are summarized as follows:

a. of the total accounts receivable, only P 420,000 have been collected, the remaining balance was written
off.
b. Half of the inventory was sold for P 125,000. Actual cost to sell amounted to P 3,000.
c. The land was sold for P 1,300,000 as expected.
d. the equipment was sold for P 200,000.
e. Salaries payable and taxes payable was paid in full.
g. the loan payable and interest payable was paid in full.
h. P 200,000 was paid for the notes payable. The lender waived payment for the balance.
i. actual administrative expenses paid amounted to 120,000.

REQUIRED: A. Prepare:
1. Statement of realization and liquidation
2. Statement of cash receipts and disbursements
3. Journal entries in the books of receiver

B. Determine the estate deficit.

Solution: 1:

Nalugi Company
Statement of Realization and Liquidation
For the three months ended March 31, 2020

ASSETS
Assets to be realized: Assets realized:
Accounts receivable 500,000 Accounts receivable 420,000
Inventory 350,000 Inventory 122,000
Land 1,000,000 Land 1,300,000
Equipment 400,000 Equipment 200,000

Assets acquired -0- Assets not realized:

Inventory 175,000

LIIABILITIES
Liabilities liquidated Liabilities to be liquidated:
Salaries payable 500,000 Accounts payable 700,000
Taxes payable 300,000 Notes payable 300,000
Loan payable 750,000 Salaries payable 500,000
Notes payable 200,000 Taxes payable 300,000
Interest payable 10,000 Loan payable 750,000

Liabilities not liquidated: Liabilities Incurred/Assumed:

Accounts payable 700,000 Interest payable 10,000

Supplementary Items
Supplementary expense Supplementary revenue
Administrative expense 120,000 Net loss 53,000
_______ _______
Totals 4,830,000 4,830,000
REq. 2:
Nalugi Company
Statement of Cash receipts and disbursements
For the three months ended March 31, 2020

Cash balance, January 1, 2020 200,000

Add: cash receipts
Accounts receivable 420,000
Inventory 122,000
Land 1,300,000
Equipment 200,000 2,042,000
Total 2,242,000
Less: Cash disbursements
Loan payable 750,000
Interest payable 10,000
Salaries payable 500,000
Taxes payable 300,000
Notes payable 200,000
Administrative expense 120,000 1,880,000
Cash balance, December 31, 2020 362,000

Req. 3:

Estate deficit, July 1, 2020 (100,000)

Net gain (loss) on realization
Accounts receivable ( 500,000 – 420,000) ( 80,000)
Inventory ( 175,000 – 122,000) ( 53,000)
Land ( 1,000,000 – 1,300,000) 300,000
Equipment ( 400,000 – 200,000) ( 200,000)
Total ( 33,000)
Net gain (loss) on settlement of liabilities (300,000 – 200,000) 100,000
Administrative expenses paid (120,000)
Net loss during the period (53,000)
Estate deficit, March 31, 2020 (153,000)

Journal entries: TRUSTEE’S BOOKS

Date Particulars PR Debit Credit

2020
July 1 Cash 200,000
Accounts receivable 500,000
Inventory 350,000
Land 1,000,000
Equipment 400,000
Estate deficit 100,000
Notes payable 300,000
Accounts payable 700,000
Salaries payable 500,000
Taxes payable 300,000
Loan payable 750,000
To record the transfer of custody over
assets and liabilities of Nalugi Company,
Cash 2,042,000
Estate deficit 33,000
Accounts receivable 500,000
Inventory 175,000
Land 1,000,000
Equipment 400,000
To record assets realized.

Notes payable 300,000

Cash 200,000
Estate deficit 100,000
To record payment of note

Loan payable 750,000

Interest payable 10,000
Salaries payable 500,000
Taxes payable 300,000
Estate deficit 120,000
Cash 1,680,000
To record liabilities liquidated
& administrative expenses paid
 UNIT IV – CORPORATE LIQUIDATION AND REORGANIZATION

Activity 2 – Multiple Choice Problems. With supporting computations.

The unsecured creditors of DISSOLVE Company filed a petition on July 1, 2020 to force the said corporation into
bankruptcy. On December 31, 2020, Club Filipino is now in the process of preparing statement of affairs. The
carrying value and estimated fair values of the assets are as follows:

Carrying value Fair value

Cash P 20,000 20,000
Accounts receivable 45,000 30,000
Inventory 60,000 35,000
Land 80,000 70,000
Building 150,000 100,000
Equipment 120,000 80,000
TOTAL 475,000 335,000

Debts of DISSOLVE Company are as follows:

Accounts payable P 60,000

Wages Payable 11,125
Taxes Payable 11,000
Notes Payable 120,000
Interests on Notes Payable 5,500
Bonds payable 150,000
Interests on Bonds payable 7,500
TOTAL 365,125

 The share capital, P 5 par P 327,000

 Estate Deficit (P 217,125)

Notes payable issued on January 1, 2020 is secured by inventory and accounts receivable. On the other hand,
bonds payable issued on January 1 is secured by land and building. All other assets are deemed as free assets.

1. How much is the Total Free Asset ?

a) 170,000 b) 120,500 c) 112,500 d) 90,375

solution:
Free Assets
Land and building 170,000
Bonds payable plus interest 157,500 12,500
Cash 20,000
Equipment 80,000
Total free assets 112,500
Less: wages payable 11,125
Taxes payable 11,000 22,125
Net free assets 90,375

2. How much is the net free asset (NFA)?

a) 170,000 b) 120,500 c) 112,500 d) 90,375

3. How much is the estimated deficiency too unsecured creditors?

a) (28,000) b) (28,500) c) (30,125) d) (31,025)
solution: (C)
Net free assets 90,375
Unsecured creditors:
Notes payable plus interest 125,500
Less: Accounts receivable & inventories 65,000
Unsecure portion 60,500
Accounts payable 60,000
Total unsecured 120,500
Estimated deficiency to unsecured creditors 30,125

4. What is the estimated recovery percentage for unsecured creditors without priority?
a) 100% b) 84.36% c) 75% d) 50%

= 90,375/120,500 = 75%

5. What is the estimated recovery percentage for unsecured creditors with priority?
a) 100% b) 84.36% c) 75% d) 50%

6. What is the estimated recovery percentage for partially secured creditors?

a) 100% b) 87.95% c) 75% d) 50%

Secured portion 65,000

Unsecured portion ( 60,500 x 75%) 45,375
Expected recovery 110,375
Divide by book value ( 120,000 + 5,500) 125,,500
Percentage 87.95%

7. How much will be paid to Accounts payable?

a) 157,500 b) 125,500 c) 105,875 d) 45,000

= 60,000 x 75% = 45,000

8. How much will be paid to Taxes payable?

a) 125,500 b) 110,375 c) 45,000 d) 11,000

9. How much will be paid to Notes payable (including interest)?

a) 157,500 b) 125,500 c) 110,375 d) 45,000

10. How much will be paid to Bonds payable (excluding interest)?

a) 157,500 b) 150,000 c) 125,500 d) 110,375

For items 11 – 13:

TAFOSNA Corporation filed a voluntary petition for bankruptcy on May 31, 2020. On August 31, 2020, the trustee
provided the following information about the corporation’s financial affairs:

Book value Estimated realizable

Assets value
Cash P 40,000 P 40,000
Accounts receivable, net 200,000 150,000
Inventories 300,000 140,000
Plant assets, net 500,000 560,000
Total assets P 1,040,000

Liabilities
Liabilities for priority claims P 160,000
Accounts payable – unsecured 300,000
Notes payable secured by accounts receivable 200,000
Mortgage payable secured by all plant assets 440,000
Total liabilities P 1,100,000
 11. The amount expected to be available for unsecured claims without priority:
a) P 580,000 b) P 310,000 c) P 300,000 d) P 140,000

Solution:
Free Assets
Plant assets 560,000
Mortgage payable 440,000 120,000
Cash 40,000
Inventories 140,000
Total free assets 300,000
Less: liability with priority 160,000
Net free assets 140,000

Unsecured liability:
Notes payable ( 200,000 – 150,000) 50,000
Accounts payable 300,000
Total unsecured without priority 350,000

12. The expected recovery per peso of unsecured creditors:

a) P .415 b) P .400 c) P .223 d) P .215

= 140,000/350,000 = .40

13. The estimated payment to creditors:

a) P 890,000 b) P 770,000 c) P 730,000 d) P 45,000

Solution:
Fully secured:
Mortgage payable 440,000
Partial secured:
Secured portion 150,000
Unsecured portion ( 50,000 x 40%) 20,000 170,000
Unsecured creditors ( 300,000 x 40%) 120,000
Unsecured with priority 160,000
Total estimated payment to creditors 890,000

For items 14 – 17:

The following information was available on March 31, 2020 for BAGSAK Company, which they cannot pay their
when they are due:
Carrying amount
Cash P 16,000
Trade accounts receivable, net: current fair value equal to carrying
amount 184,000
Inventories, net realizable value , P 72,000; pledged on P 84,000
notes payable 156,000
Plant assets, net: current fair value P 269,600; pledged on mortgage
payable. 428,000
Supplies, current fair value, P 6,000 8,000
Wages payable, all earned during March 23,200
Property taxes payable 4,800
Trade accounts payable 240,000
Notes payable, P 84,000 secured by inventories 160,000
Mortgage payable, including interest of P 1,600 201,600
Share capital, P 5 par 400,000
Deficit (237,600)
 14. The estimated losses on realization of assets:
a) P 244,400 b) P 158,400 c) P 84,000 d) P 0

Solution:
Inventories, net realizable value , P 72,000; ( 156,000 – 72,000) 84,000
Plant assets, net: current fair value P 269,600; ( 428,000 – 269,600) 158,400
Supplies, current fair value, P 6,000 ( 8,000 – 6,000) 2,000
Estimated loss on realization 244,000

15. The estimated gain on realization of assets:

a) P 244,400 b) P 158,400 c) P 84,000 d) P 0

16. The expected recovery percentage of unsecured creditors:

a) 98% b) 80% c) 78% d) 75%

= 246,000 / 328,000 = 75%

Solution:
Cash P 16,000
Trade accounts receivable 184,000
Plant assets ( 269,600 – 201,600) 68,000
Supplies 6,000
Total free assets 274,000
Unsecured with priority:
Wages payable, all earned during March 23,200
Property taxes payable 4,800 28,000
Total 246,000
Unsecured without priority
Notes payable, (P 160,000 – 72,000) 88,000
Trade accounts payable 240,000 328,000
Estimated deficiency to unsecured creditors 82,000

17. The estimated deficiency to unsecured creditors:

a) P 86,000 b) P 82,000 c) P 70,000 d) 54,000

For 18 – 25:

The Bagsak Company had a very unstable financial condition caused by a deficiency of liquid assets. On
July 1, 2020, the following information was available:
Cash 82,000
Assets not realized:
Accounts receivable, net 150,000
Merchandise inventory 200,000
Investment in common stock 50,000
Land 200,000
Building, net 500,000
Equipment, net 148,000
Liabilities not liquidated:
Notes payable (secured by equipment) 200,000
Interest payable on notes 15,000
Accounts payable 500,000
Salaries and wages 80,000
Taxes payable 178,000
Bank loan (secured by land and building) 500,000
Interest payable on bank loan 50,000
Estate deficit (193,000)
During the six months period ending December 31, 2020, the trustee sold the Investment in common stock for
P 40,000, realized P 128,000 from accounts receivable, sold all merchandise inventory for P 162,000 and
paid-off all liabilities with priorities as well as administration expenses of P 60,000.

18. The net gain or (loss) on realization and liquidation as of December 31, 2020 is :
a) 60,000 b) P 130,000 c) ( 70,000) d) not given

Gain or (loss) on realization and liquidation:

Accounts receivable, net ( 150,000 - 128,000) (22,000)
Merchandise inventory ( 200,000 – 162,000) (38,000)
Investment in common stock ( 50,000 – 40,000) (10,000)
Net loss on realization (70,000)
Administrative expenses (60,000)
Net loss on realization and liquidation (130,000)
19. The estate deficit as of December 31, 2020:
a) (P 323,000) b) (P 193,000) c) (P 130,000) d ) not given

Solution:
Estate deficit, July 1, 2020 193,000
Add loss 130,000
Estate deficit as of December 31, 2020 323,000

OR:
Cash 94,000
Assets not realized
Land 200,000
Building, net 500,000
Equipment, net 148,000 848,000
Total 942,000
Less: liabilities not liquidated
Notes payable (secured by equipment) 200,000
Interest payable on notes 15,000
Accounts payable 500,000
Bank loan (secured by land and building) 500,000
Interest payable on bank loan 50,000 1,265,000
Estate deficit (323,00)

20. The cash balance as of December 31, 2020:

a) P 154,000 b) P 94,000 c) 82,000 d) not given

Cash balance, July 1, 2020 82,000

Add: Cash realized from non cash assets 330,000
Total 412,000
Less: cash payment for liabilities and administration expenses 318,000
Cash balance as of December 31, 2020 94,000

During the three months period March 31, 2021 , the trustee sold the land for P 300,000, sold the building
P 350,000, sold the equipment for P 108,000 and paid-off the liabilities as well as administration expenses
of P 30,000.
21. The net gain or (loss) on realization and liquidation as of March 31, 2021 is :
a) P 100,000 b) (P 90,000) c) P ( 50,000) d) not given

Gain or (loss) on realization

Land ( 200,000 – 300,000) 100,000
Building, net ( 500,000 – 350,000) (150,000)
Equipment, net ( 148,000 – 108,000) (40,000)
Net loss on realization ( 90,000)

22. The cash balance as of March 31, 2021 before cash payment to creditors and administrative expenses:
a) P 852,000 b) P 840,000 c) P 758,000 d) not given

Cash balance, December 31, 2020 94,000

Add: Cash realized from non cash assets 758,000
Cash balance before payment to creditors and adm. Expenses 852,000
Less: payment to fully secured creditor (550,000)
Payment for administration expenses (30,000
Payment for partially secured portion (108,000)
Cash balance available for unsecured creditors 164,000

23: Cash settlement to fully secured creditors would be:

a) P 650,000 b) P 550,000 c) P 500,000 d) not given

= Bank loan + interest = 550,000

24. Cash settlement to partially secured creditors would be:

a) P 215,000 b) P 155,947 c) P 136,890 d) not given

Notes payable + interest = 215,000

Secured portion 108,000
Unsecured portion (107,000 x 27.018%) 28,909
Cash settlement with partially secured 136,909

25. Cash settlement to unsecured creditors without priority would be:

a) P 500,000 b) P 164,000 c) 135,091 d) not given

Accounts Payable = 500,000 x 27.0181% = 135,091

Recovery percentage for unsecured creditors: 164,000/607,000 = 27.0181%

 UNIT IV – CORPORATE LIQUIDATION AND REORGANIZATION

Activity 3 : Brief Exercises – Trouble Deb Restructuring. With Supporting computations.

1. WOW Company is experiencing financial difficulty and is negotiating trouble debt restructuring with its
creditors to relieve its financial stress. WOW has P 3,000,000 note payable to Megabank. The bank is
considering acceptance of an equity interest in WOW Company in the form of 200,000 ordinary shares with
a fair market value of P 12 per share. The par value of the ordinary share is P 10 per share. WOW Company
incurred total transaction costs of P 80,000 related to the issue of shares.

What is the amount of share premium to be reported by WOW in its statement of financial position as a
result of the restructuring assuming the issue of equity is a settlement of debt?

a) P 1,000,000 b) P 920,000 c) P 400,000 d) P 320,000

Solution
FV od shares issued ( 200,000 x 12) 2,400,000
Par value of share issued ( 200,000 x 10) 2,000,000
Share premium 400,000
Less transactions cost related to issuance of shares 80,000
Share premium 320,000

2. . refer to no. 1, give the journal entry in the books of WOW Company:

Date Particulars PR Debit Credit

Notes payable 3,000,000
Share capital 2,000,000
Share Premium 400,000
Gain on extinguishment of debt 600,000
Issuance of 200,000 shares

Share Premium 80,000

Cash 80,000
Transaction costs related to shares
Issued.

3. TRAIL Company is threatened with bankruptcy due to the inability to meet interest payments and fund
requirements to retire P 5,000,000 notes payable with accrued interest of P 350,000. TRAIL has entered into
an agreement with the creditor to exchange equity instruments for the financial liability. The terms of exchange
are 300,000 ordinary shares with P 10 par value. The fair value of the liability is P 4,850,000.

The gain on extinguishment of debt is:

a) P 2,350,000 b) P 1,850,000 c ) ) P 500,000b d) not given (specify) ________

Solution:
Notes payable 5,000,000
Accrued interest payable 350,000
Carrying value of liability 5,350,000
Fair value of the liability 4,850,000
Gain on extinguishment of debt 500,000
 4. Refer to no. 3: the journal entry in the books of Trial:
Date Particulars PR Debit Credit
Notes payable 5,000,000
Accrued interest payable 350,000
Share capital 3,000,000
Share Premium 1,850,000
Gain on extinguishment of debt 500,000
Issuance of 300,000 shares

5. During 2020, Mane Company experienced financial difficulties and is likely to default on a P 5,000,000, 15%
three year note dated January 1, 2018 payable to Sumo Bank. On December 31, 2020, the bank agreed to
the note and unpaid interest of P 750,000 for P 4,100,000 cash payable on January 31, 2021.

What amount should be reported as gain from extinguishment of debt in the 2020 income statement?
a) P 1,650,000 b) P 900,000 c) P 750,000 d) 0

6. The following data pertains to the transfer of real estate pursuant to a troubled debt restructuring by Mart Co
to Tart Company in full liquidation of Mart’s liability to Tart:

Carrying amount of note payable liquidated P 150,000

Carrying amount of real estate transferred 100,000
Fair value of real estate transferred 90,000

The journal entry in the books of Mart Company.

Date Particulars PR Debit Credit

Notes payable 150,000
Land 90,000
Gain on extinguishment of debt 60,000
To record extinguishment of debt.

7. Star Company has outstanding a P 6,000,000 notes payable to an investment entity. Accrued interest on this
note amounted to P 600,000.

Because of financial difficulties, the entity negotiated with the investment entity to exchange inventory of
machine parts to satisfy the debt. The inventory transferred is carried at P 3,600,000. The fair value
of the inventory is P 4,600,000. The perpetual inventory method is used.

The journal entry on the books of Star Company to record the settlement of the note payable

Date Particulars PR Debit Credit

Notes payable 6,000,000
Accrued interest payable 600,000
Inventory 4,600,000
Gain on extinguishment of debt 2,000,000
To record extinguishment of debt.
8. On December 31, 2019, RDE Company records show the following:
Note Payable due December 31, 2020 – 14% 4,000,000
Accrued interest payable 500,000

RDE was granted by the creditor the following modification on January 1, 2020:
a) The principal was reduced to P 3,000,000.
b) The creditor waived the payment of interest.
c) The new interest rate is 10% payable every December 31.
d) The maturity date was extended to December 31, 2023,

The present value of 1 at 14%for 4 periods is 0.5921 and the present value of an ordinary annuity of 1
at 14% for 4 periods is 2.9137.
The journal entries on the books on January 1, 2020, December 31, 2020 and December 31, 2021.
solution:
PV of principal ( 3,000,000 x .5921) 1,776,300
PV of interest payments (300,000 x 2.9137) 874,110
Present value of the new note 2,650,410
Face value of the new note 3,000,000
Discount on note payable 349,590

Note payable – old 4,000,000

Accrued interest payable 500,000
Carrying amount of old liability 4,500,000
Present value of the new note 2,650,410
Gain on extinguishment of debt 1,849,590

Date Particulars PR Debit Credit

2020
Jan 1 Note Payable – old 4,000,000
Accrued interest payable 500,000
Discount on note payable 349,590
Note payable – new 3,000,000
Gain on extinguishment of debt 1,849,950
To record extinguishment of old debt

Dec. 3 Interest expense 300,000

1
Cash 300,000
Interest payment on the new note

3 Interest expense 71,057

1
Discount on note payable 71,057
Amortization of discount
2021
Dec 3 Interest expense 300,000
1
Cash 300,000
Interest payment on the new note

Interest expense 81,005

Discount on note payable 81,005
Amortization of discount

To compute for amortization of discount on note payable.

Date Interest paid Interest expense Discount amortization Carrying amount
(10% x 4M) (a) (14% x d) (b) (c) ( b – a ) (d) ( c + d )
1/1/2020 2,650,410
12/31/2020 300,000 371,057 71,057 2,721,467
12/31/2021 300,000 381,005 81,005 2,802,472
12/31/2022 300,000 392,346 92,346 2,894,818
12/31/2023 300,000 405,182 105,182 3,000,000