MODULE IN FINANCIAL ACCOUNTING & REPORTING II

Module 1: BASIC CONSIDERATION OF PARTNERSHIP

Brief History

The idea of partnership was quite ancient. In 2200 B.C. Hammurabi, King of Babylon
provided for the regulation of partnerships. In ancient Rome, the partnership was called a societa.

It was during the middle ages in Italy that the laws of partnership began to develop.
Italian merchants operated as limited partners. Their approach was introduced throughout
Europe. The English setters brought the concept of partnership into the U.S. so, the partnership
law in the United States evolved from the English law, the Partnership Act of 1980. In the U.S.
the Uniform Partnership Act was approved in 1914 and the Uniform Limited Partnership Act in
1916.

In the Philippines, before the effectivity of the new Civil Code on August 30, 1950,
there are two types of partnerships: commercial and civil. Commercial or mercantile
partnerships were governed by the Code of Commerce. The old Civil Code governed the civil or
non-commercial partnership.

The new civil code repealed the provisions of the two codes related to mercantile and
civil partnerships. Rules from the two American Uniform Partnership Acts were incorporated
into the new Civil Code.

DEFINITION

In a contract of partnership, two or more persons bind themselves to contribute money,

property or industry to a common fund, with the intention of dividing he profit among
themselves. Two or more persons may also form a partnership for the exercise of a profession.
(Civil Code of the Philippines, Article 1767).

An association of two or more persons to carry on, as co-owners, a business for profit
(Uniform Partnership Act, Sec. 6).

The partnership has a juridical personality separate and distinct from that of each of the
partners (Civil Code of the Philippines, Article 1768). Thus, for example, where Vincent Fabella
and Wilhelmina Neis established a partnership, three persons are involved, namely: the
partnership and the partners, Fabella and Neis.

Partnerships resemble sole proprietorships, except that there are two or more owners of
the business. Each owner is called a partner. Partnerships are often formed to bring together

1 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
various talents and knowledge. Partnerships provide a means of obtaining more equity capital
than a single individual can obtain and allow the sharing of risks for rapidly growing business.

A profession is an occupation that involves a higher education or its equivalent, and

mental rather than manual labor. Strictly speaking, the exercise of a profession is not business or
enterprise for profit but the law allows two or more persons to act as partners in the practice of
their profession.

Partnership are generally associated with the practice of law, public accounting,
medicine, and other professions. Partnership of this nature are called general professional
partnerships. On the other hand, service industries, retail trade, wholesale and manufacturing
enterprise may also be organized as partnerships.

CHARACTERISTICS OF A PARTNERSHIP

The characteristics of a partnership are different from sole proprietorship already studied in basic
accounting. Some of the more important characteristics are as follows:

Mutual contribution. There cannot be partnership without contribution of money, property or

industry (i.e. work of services which may either be personal manual effort s or intellectual) to a
common fund.

Division of Profits and Losses. The essence of partnership is that each partner must share in the
profits or losses of the venture.

Co-ownership of Contribution Assets. All assets contributed into the partnership are owned by
the partnership by virtue of its separate and distinct juridical personality. If one partner
contributes an asset to the business, all partners jointly own it in a special way.

Mutual agency. Any partner can bind the other partners to a contract if he is acting within his
express or implied authority.

Limited life. A partnership has a limited life. It may be dissolved by the admission, death,
insolvency, incapacity, withdrawal of a partner or expiration of the term specified in the
partnership agreement.

Unlimited liability. All partners (except limited partners), including industrial partners are
personally liable for all debts incurred by the partnership. If the partnership cannot settle its
obligation, creditors‟ claims will be satisfied from the personal assets of the partners without
prejudice to the rights of the separate creditors of the partners.

Income Taxes. Partnerships, except general professional partnerships, are subject to tax at the
rate of 30% (per R.A. 9337) of taxable income.
2 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Partner’s Equity Accounts. Accounting for partnerships are much like accounting for sole
proprietorships. The difference lies in the number of partners‟ equity accounts. Each partner has
a capital account and a withdrawal account that serves similar functions as the related accounts
for sole proprietorship.

ADVANTAGES AND DISADVANTAGES OF A PARTNERSHIP

A Partnership offers certain advantages over a sole proprietorship and a corporation. It also has a
number of disadvantages. They are as follows:

Advantages versus Proprietorships

1. Brings greater financial flexibility to the business.

2. Combines special skills, expertise and experience of the partners.

3. Offers relative freedom and flexibility of action in decision-making.

Advantages versus Corporation

1. Easier and less expensive to organize.

2. More personal and informal.

Disadvantages of Partnership

1. Easily dissolved and thus unstable compared to a corporation.

2. Mutual agency and unlimited liability may create personal obligations to partners.

3. Less effective than a corporation in raising large amount of capital.

PARTNERSHIP DISTINGUISHED FROM CORPORATION

Manner of Creation. A partnership is created by mere agreement while a corporation is created

by operation of law.

Number of Persons. Two or more persons may form a partnership; in a corporation , not
exceeding fifteen (15). A corporation with a single stockholder is considered a One Person
Corporation.

Commencement of Juridical Personality. In a partnership, juridical personality commences

from the execution of the articles of partnership; in a corporation, from the issuance of certificate
of incorporation by Securities and Exchange Commission.

3 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Management. In a partnership, every partner is an agent of the partnership if the partners did
not appoint a managing partner; in a corporation, management is vested on the Board of
Directors.

Extent of Liability. In a partnership, each of the partners except a limited partner is liable to the
extent of his personal assets; in a corporation, stockholders are liable only to the extent of their
interest or investment in the corporation.

Right of Succession. In a partnership, there is no right of succession; in a corporation, there is

right of succession. A corporation has the capacity of continued existence regardless of death,
withdrawal, insolvency or incapacity of its directors or stockholders,

Terms of Existence. In a partnership, for any period of time stipulated by the partners; in a
corporation, shall have perpetual existence unless its article of incorporation provides otherwise.
(Sec. 11, Revised Corporation Code of the Philippines).

CLASSIFICATIONS OF PARTNERSHIPS

1. According to object:

a. Universal partnership of all present property. All contributions become part of the partnership
fund.

b. Universal partnership of profits. All that the partners may acquire by their industry or work
during the existence of the partnership and the use of whatever the partners contributed at the
time of the institution of the contract belong to the partnership. If the article of the universal
partnership did not specify its nature, it will be considered as a universal partnership of profits.

c. Particular partnership. The object of the partnership is determinate – its use or fruit, specific
undertaking, or the existence of a profession or vocation.

2. According to liability:

a. General. All partners are liable to the extent of their separate property.

b. Limited. The limited partners are liable only to the extent of their personal contributions.

3. According to duration:

a. Partnership with a fixed term or for a particular undertaking.

b. Partnership at will. One in which no term is specified and is not formed for any particular
undertaking.

4. According to purpose:
4 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
a. Commercial or trading partnership. One formed for the transaction of business.

b. Professional or non-trading partnership. One formed for the exercise of a profession.

5. According to legality of existence.

a. De jure partnership. One which has complied with all the legal requirements for its
establishment.

b. De facto partnership. One which has failed to comply with all the legal requirements for its
establishment.

KINDS OF PARTNERS

1. General partner. One who is liable to the extent of his separate property after all the assets
of the partnership are exhausted.

2. Limited partner. One who is liable only to the extent of his capital contribution. He is not
allowed to contribute industry or services only.

3. Capitalist partner. One who contributes money or property to the common fund of the
partnership.

4. Industrial partner. One who contributes his knowledge or personal service to the partnership.

5. Managing partner. One whom the partners has appointed as manager of the partnership.

6. Liquidating partner. One who is designated to wind up or settle the affairs of the partnership
after liquidation.

7. Dormant partner. One who does not take active part in the business of the partnership and is
not known as partner.

8. Silent partner. One who does not take active part in the business of the partnership though
may be known as partner.

9. Secret partner. One who takes active part in the business but is not known to be a partner by
outside parties.

10. Nominal partner or partner by estoppel. One who is actually not a partner but who
represents himself as one.

ARTICLES OF PARTNERSHIP

5 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
A partnership may be constituted orally or in writing. In the latter case, partnership agreements
are embodied in the Articles of Partnership. The following essential provisions may be
contained in the agreement:

1. The partnership name, nature , purpose and location;

2. The names, citizenship, and residences of the partners;

3. The date of formation and the duration of the partnership;

4. The capital contribution of each partner, the procedure for valuing non-cash investments,
treatment of excess contribution (as capital or as loan) and the penalties for a partner‟s failure to
invest and maintain the agreed-capital.

5. The rights and duties of each partner.

6. The accounting period to be adopted, the nature of accounting records, financial statements
and audits by independent public accountants.

7. The method of sharing profits or loss, frequency of income measurement and distribution,
including any provisions for the recognition of differences in contributions;

8. The drawings or salaries to be allowed to partners;

9. The provision for arbitration of dispute, dissolution and liquidation.

A contract of partnership is void whenever immovable property or real rights are contributed and
a signed inventory of the said property is not made and attached to a public instrument.

SEC REGISTRATION

When the partnership capital is P3,000 or more, in money or property, the public instrument
must be recorded with the Securities and Exchange Commission (SEC). Even if it not registered,
the partnership having a capital of P3,000 or more is still valid and therefor has legal personality.

The SEC shall not register any corporation organized for the practice of public accountancy (The
Philippine Accountancy Act of 2004, Sec. 28).

The purpose of the registration is to set a condition for the issuance of the licenses to engage in
business or trade. In this way, the tax liabilities of big partnerships cannot be evaded, and the
public can also determine more accurately their membership and capital before dealing with
them.

To register a partnership with the SEC, here are the basic steps to follow:

6 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
  Have your proposed business name verified in the verification unit of SEC.
The partnership name shall bear the word “Company” or “Co”. and if it‟s a limited
partnership, the word “Limited” or “Ltd”. A professional partnership may bear the word
“Company”, “Associates” or “Partners” or other similar descriptions (SEC
Memorandum Circular 5, Series 2008).

 Submit the following documents:

 Articles of Partnership
 Verification Slip for the Business Name
 Written undertaking to change business name if required
 Tax identification of each partner and/or that of the partnership
 Registration data sheet for partnership duly accomplished in 6 copies
 Other documents that may be required:
o Endorsement from other government agencies if the proposed partnership
will engage in an industry regulated by the government.
o For partnership with foreign partners: SEC form F-105, bank certificate
on the capital contribution of partners, proof of remittance of contribution
of foreign partners.
 Pay the registration/filling and miscellaneous fees: filing fee equivalent to 1/5 of 1% of
the partnership capital but not less than P1,000 and legal research fee which is 1% of the
filing fee.
 Forward documents to the SEC Commissioner for signature.

ACCREDITATION TO PRACTICE PUBLIC ACCOUNTANCY

Certified public accountants (CPAs), firms and partnerships of CPAs, engaged in the
practice of public accountancy, including the partners and staff members thereof, shall register
with the Professional Regulation Commission and the Professional Regulatory Board of
Accountancy. The registration shall be renewed every three years ( The Philippine Accountancy
Act of 2004, Sec. 31). The rules and regulations covering the accreditation for the practice of
public accountancy are specified in Annex B of the Rules and Regulations implementing
Republic Act 9298 otherwise known as the Philippine Accountancy Act of 2004.

ACCOUNTING FOR PARTNERSHIPS

Owners’ Equity Accounts

In Basic Accounting, generally accounting principles were discussed in the context of a sole
proprietorship. These accounting principles also apply to a partnership. Thus, the recording of
7 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
assets, liabilities and income and expenses is consistent for both proprietorship and partnership.
Comparing two businesses of the same nature, one organized as a sole proprietorship and another
as a partnership, there will be no marked difference in their operations.

However, differences arise between the two forms of business concerning owners; equity. For a
proprietorship, there is only a single owner. Therefore, there is only one capital account and one
drawing account. On the other hand, since a partnership has two or more owners, separate capital
and drawing accounts are established for each partner.

A partner‟s capital account is credited for his initial and additional net investments (assets
contributed less liabilities assumed by the partnership), and credit balance of the drawing account
at the end of the period. It is debited for his permanent withdrawals and debit balance of the
drawing account at the end of the period.

Typically, partners do not wait until the end of the year to determine how much of the profits
they wish to withdraw from the partnership. To meet personal living expenses, partners
customarily withdraw money on a periodic basis throughout the year. A partner‟s drawing
account is debited to reflect assets temporarily withdrawn by him from the partnership. At the
end of each accounting period, the balances in the drawing accounts are closed to the related
capital accounts.

Partners Capital Account

Debit Credit
1.Permanent Withdrawals 1. Original investment
2. Debit balance of the
drawing account at the end
of the period 2. Additional investment
3. Credit balance of the
drawing at the end of the
period

Partners Drawing Account

Debit Credit
1. Share in profit ( this may be
1. Temporary Withdrawals credited directly to Capital)

2. Share in loss (this may be

debited directly to Capital)

8 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Permanent withdrawals are made with the intention of permanently decreasing the partner‟s
capital while temporary withdrawals are regular advances made by the partners in anticipation of
their share in profit.

The use of drawing accounts for temporary withdrawals provides a record of each partner‟s
drawings during an accounting period. Hence, drawings in excess of the allowed amounts as
stated in the partnership agreement may be controlled.

Notice that the profit (or loss) is credited (or debited) either to the drawing account or to the
capital account. The choice of the account to debit or credit depends on the intention of the
partners. If they wish to maintain their capital accounts for investment and permanent
withdrawals, then profit or loss should be entered in the drawing account.

On the other hand, if the purpose of the partners is to make profit or loss part of their capital,
then the capital account should be used. In either case, the resulting partner‟s ending capital
balances will be the same.

On Sept. 6, 2007, the International Accounting Standards Board (IASB) issued revised
International Accounting Standards (IAS) No. 1, Presentation of Financial Statements. This
standard supersedes the 2003 version of IAS 1 as amended in 2005. It‟s common to encounter
“profit or loss” rather than usual “net income or net loss” as the descriptive term used in the
Statement of Comprehensive Income (the new title of the income statement per revised IAS no.
1). The balance sheet is called the Statement of Financial Position.

Loans Receivable from or Payable to Partners

If the partner allows substantial amount of money with the intention of repaying it, the debit
should be to Loans – Receivable Partner account instead of to Partner‟s Drawing account. This
account should be classified separately from the other receivables of the partnership.

A partner may lend amounts to the partnership in excess of his intended permanent investment.
These advances should be credited to Loans Payable –Partner account and liabilities to outsiders.
This distinction is important in case of liquidation. Loans payable to partners must be paid after
the claims of outside creditors have been paid in full. These loans have priority over partner‟s
equity.

PARTNERSHIP FORMATION

Valuation of Investment by Partners

9 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
The books of the partnership are opened with entries reflecting the net contribution of partners to
the firm. Assets accounts are debited for assets contributed to the partnership, liability accounts
are credited for any liabilities assumed by the partnership and separate capital accounts are
credited for the amount of each partner‟s net investment (assets less liabilities).

Partners may invest cash or non-cash assets in the partnership. When a partner invest non-cash
assets, they are to be recorded at values agreed upon by the partners. In the absence of any
agreement, the contributions will be recognized at their fair market values at the date of transfer
to the partnership.

The fair market value of an asset is the estimated amount that a willing seller would receive
from a financially capable buyer for the sale of the asset in a free market. Per International
Financial Reporting Standards (IFRS) No. 3, fair value is the price at which an asset or liability
could be exchange in a current transaction between knowledgeable, unrelated willing parties.

Adjustment of Accounts Prior to Formation

In cases when the prospective partners have existing businesses, their respective books will have
to be adjusted to reflect the fair market values of their assets or to correct misstatements in the
accounts. If the adjustments will not be made, the initial capital balances of the partners may be
inequitable.

Illustration: A reconditioned machinery invested by John Cruz was recorded incorrectly in the
partnership books at P 500,000 – its book value from the proprietorship records. If the
partnership immediately sold the machinery for its fair market value of P600,000, the resulting
P100,000 gain would increase the capital balances of both Partners John Cruz and Mike Santos.
The machinery should have been recorded at P600,000 and John Cruz Capital credited with
P600,000. Simply stated, increases in asset values accruing before formation should be for the
benefit of the contributing partner.

The adjustment of assets and liabilities prior to formation will be similar to the adjustments that
we are already familiar with. However, when the adjustment involves a debit or credit to a
nominal account, the Capital account would instead be debited or credited. This is so because the
business has ceased to be a going concern. For example, two sole proprietorship will cease
operations because their agreement to enter into a partnership. Both proprietorships have ceased
to be going concerns.

Illustration: Camille Vasquez and Alyana Villamayor formed a general professional

partnership. Alyana Villamayor will invest sufficient cash to get an equal interest in the
partnership while Camille Vasquez will transfer the assets and liabilities of her business. The
account balances on the books of Vasquez prior to partnership formation follows:

10 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Debit Credit
Cash ₱ 360,000
Accounts Receivable 600,000
Office equipment 3,000,000
Accumulated depreciation ₱ 1,200,000
Accounts Payable 310,000
Salaries Payable 50,000
Camille Vasquez, Capital 2,400,000

It is agreed that for the purpose of establishing Alyana Villamayor‟s interest, the following
adjustments were made in the books of Camille Vasquez:

1. An allowance for uncollectible accounts of 5% of accounts receivable is to be established.

2. Prepaid expenses amounting to P60,000 were omitted by the accountant. This is to be

recognized.

3. Additional salaries payable in the amount of P20,000 is to be established.

The basic accounting equation states that assets must always equal liabilities and owner‟s equity.
The basic accounting model is :

Assets = Liabilities + Owner’s Equity

Note that the assets are on the left side of the equation opposite the liabilities and owner‟s equity.
This explains why increases and decreases in assets are recorded in the opposite manner as
liabilities and owner‟s equity are recorded. The equation also explains why liabilities and capital
follow the same rules of debit and credit. The logic of debiting or crediting is related to the
accounting equation.

Accounting is based on a double-entry system which means that the dual effects of a business
transaction are recorded. A debit side entry must have a corresponding credit side entry. For
every transaction, there must be one or more accounts debited and one or more accounts
credited. Each transaction affects at least two accounts. The total debits for a transaction must
always equal the total credits.

The account type determines how increases and decreases in it are recorded. Increases in assets
are recorded by debits (left side of the account), while decreases in assets are recorded as credits
(on the right side). Conversely, increases in liabilities and owner‟s equity are recorded by
credits; decreases in liabilities and owner‟s equity are recorded by debits.

The rules of debits and credit for income and expense accounts are based on the relationship of
these accounts to owner‟s equity. Income increases owner‟s equity and expense decreases
11 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
owner‟s equity. Hence, increases in income are recorded as credits and decreases as debits.
Increases in expenses are recorded as debits and decreases as credits. These are the rules of debit
and credit.

Using the accounting equation approach analysis, the adjustments are as follows:

Assets = Liabilities + Owner's Equity

1 -P30,000 = + -P30,000
2 P60,000 = + P60,000
3 = P20,000 + -P20,000
P30,000 = P20,000 + P10,000
P30,000 = P30,000

Entries and Explanations:

1. An allowance of 5% of P600,000 or P30,000 needs to be established. The account Allowance

for Uncollectible Accounts is a contra-asset account. When this account is increased, the effect is
to decrease the related asset account. The owner‟s equity is also decreased since this provision
for uncollectible accounts is considered as an expense in the ordinary course of business.

Camille Vasquez, Capital P30,000

Allowance for Uncollectible Accounts P30,000

2. An omission to record an asset –prepaid expenses will denote that the expenses of the business
are overstated. When the expenses are overstated, profit and correspondingly the owner‟s equity
is understated. To recognize the prepaid expense, the entry will be:

Prepaid Expenses P60,000

Camille Vasquez, Capital P60,000

3. The establishment of additional salaries payable will increase liabilities. It can be deducted
that salaries expenses are understated and to correct the misstatement the owner‟s equity will be
decreased.

Camille Vasquez, Capital P 20,000

Salaries Payable P20,000

The adjustments prior to formation will entail debits or credits to asset or liability accounts. To
maintain the double entry system of accounting, a corresponding debit or credit to owner‟s

12 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
equity account will be made. The following account will serve to summarize the necessary
adjustments to the capital account:

Owner's Equity Account

Debit Credit
1. Decrease in asset 1. Increase in asset
2. Increase in liability 2. Decrease in liability
3. Increase in contra-asset 3. Decrease in contra-asset

Opening Entries of a Partnership Upon Formation

A partnership may be formed in any of the following ways:

1. Individuals with no existing partnership.

2. Conversion of a sole proprietorship to a partnership.

a. A sole proprietorship and an individual without an existing business form a

partnership.

b. Two or more sole proprietorship form a partnership.

3. Admission or retirement of a partner.

Individuals with No Existing Business Form a Partnership

The opening entry to recognize the contributions of each partner into the partnership is simply to
debit the assets contributed, and to credit the liabilities assumed and the capital account of each
partner.

Illustration.On June 1, 2020, Jane Angeles and Mark Mercado agreed to form a partnership. It is
stipulated in the partnership agreement that Angeles is to invest cash of P900,000 and Mercado is
to contribute a land with a fair market value of P 1,500,000 with P250,000 mortgage to be
assumed by the partnership. The entries are as follows:

Cash P900,000
Land 1,500,000
Mortgage Payable P250,000
Jane Angeles, Capital 900,000
Mark Mercado, Capital 1,250,000

13 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
After the formation, the statement of financial position of the partnership is:

Angeles and Mercado

Statement of Financial Position
June 1, 2020

Assets Liabilities & Owner's Equity

Cash ₱ 900,000 Mortgage Payable ₱ 250,000

Land 1,500,000 Jane Angeles, Capital 900,000
Mark Mercado, Capital 1,250,000
Total Liabilities & Owner's
Total Assets ₱ 2,400,000 Equity ₱ 2,400,000

Illustration. Suppose that Angeles and Mercado formed another partnership with Neil Ocampo.
Angeles and Mercado considered Ocampo who has a vast business network in Batangas as an
industrial partner, The partnership did not receive any asset from Ocampo. In this case, only a
memorandum entry in the general journal will be made.

A Sole Proprietor and Another Individual Form a Partnership

A sole proprietor may consider forming a partnership with an individual who has no existing
business. Under this type of formation the assets and the liabilities of the proprietorship will be
transferred to the newly formed partnership at values agreed upon by all the partners or at their
current fair prices.

Illustration: The statement of Financial Position of Kim Rodriguez on September 1, 2020 before
accepting Joy Palma as partner is shown:

Joy Palma offered to invest cash to get a capital credit equal to one-half of Kim Rodriguez,
Capital after giving effect to the adjustments. Rodriguez accepted the offer.

1. The merchandise is to be valued at P80,000.

2. The accounts receivable is estimated to be 90% collectible.
3. Interest accrued on the notes receivable will be recognized: P10,000, 12% dated June 1, 2020
and P20,000 12% dated July 1 ,2020.
4. Interest on notes payable to be accrued at 15% annually from March 1, 2020.
5. The furniture and fixtures are to be valued at P 50,000.
6. Office supplies on hand that have been charged to expenses in the month amounted to P5,000.
This will be used by the partnership.

14 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Refer to the Statement of Financial Position of Kim Rodriguez below.
Kim Rodriguez
Statement of Financial Position
September 1, 2020

Assets
Cash 100,000
Notes Receivable 30,000
Accounts Receivable 300,000

Less: Allowance for Uncollectible Accounts (20,000) 280,000

Merchandise Inventory 90,000
Furniture and Fixtures 70,000
Accumulated depreciation 10,000 60,000
Total Assets 560,000

Liabilities and Owner's Equity

Notes Payable 50,000
Accounts Payable 160,000
Kim Rodriguez, Capital 350,000
Total Liabilities & Owner's Equity 560,000

15 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Computations:
1. Merchandise Inventory, per ledger ₱ 90,000
Merchandise Inventory, as agreed 80,000
Decrease in Merchandise Inventory ₱ 10,000

2. Accounts Receivable, net per ledger ₱ 280,000

Accounts Receivable, net as agreed
(P300,000 x 90% ) 270,000
Increase in Allowance for Uncollectibles ₱ 10,000

3. Interest accrued on Notes

Receivable: Interest = Principal x Rate
x Time
On: P10,000 (P10,000 x 12% x 3/12) ₱ 300
On: P20,000 (P20,000 x 12% x 2/12) 400
Increase in Interest Receivables ₱ 700

4. Interest on Notes Payable

On P50,000 (P50,000 x 15% x 6/12) ₱ 3,750

5. Furniture and Fixtures, net per ledger ₱ 60,000

Furniture and Fixtures, net as agreed 50,000
Increase in accumulated depreciation ₱ 10,000

6. Net Effect of Adjustment on Capital:

Decrease in Merchandise Inventory -₱ 10,000
Increase in Allowance for Uncollectibles (10,000)
Increase in Interest Receivables 700
Increase in Interest Payables (3,750)
Increase in Accumulated Depreciation (10,000)
Increase in Office Supplies 5,000
Decrease in Capital -₱ 28,050

7. Furniture and Fixtures, cost per books ₱ 70,000

Furniture and Fixtures, cost as agreed 50,000
Writedown in Furnitures and Fixtures ₱ 20,000

8. Kim Rodriguez, Capital before

adjustments ₱ 350,000
Net Adjustments to Capital (28,050)
Kim Rodriguez, Capital after
adjustments ₱ 321,950
Agreed Capital credit for Joy Palma 50%
Cash Investment of Joy Palma ₱ 160,975
16 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Books of Kim Rodriguez

(1)

Kim Rodriguez, Capital P28,050

Office supplies 5,000
Interest Receivable 700
Merchandise Inventory P 10,000
Allowance for Uncollectible Accounts 10,000
Interest Payable 3,750
Accumulated depreciation 10,000
To record adjustment to restate Rodriguez’ capital

(2)
Notes Payable P50,000
Accounts Payable 160,000
Interest Payable 3,750
Allowance for Uncollectible Accounts 30,000
Accumulated Depreciation 20,000
Kim Rodriguez, Capital 321,950
Cash P100,000
Notes Receivable 30,000
Accounts Receivable 300,000
Interest Receivable 700
Merchandise Inventory 80,000
Office supplies 5,000
Furnitures and Fixtures 70,000
To close the books of Rodriguez

Books of the Partnership

(1)
Cash P100,000
Notes Receivable 30,000
Accounts Receivable 300,000
Interest Receivable 700
Merchandise Inventory 80,000
Office Supplies 5,000
Furnitures and Fixtures 50,000
Notes Payable P50,000
Accounts Payable 160,000
Interest Payable 3,750
Allowance for Uncollectible Accounts 30,000
Kim Rodriguez, Capital 321,950
To record the investment of Kim Rodriguez

17 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
(2)

Cash P160,975
Joy Palma, Capital P160,975
To record the investment of Palma.

Rodriguez and Palma

Statement of Financial Position
September 1, 2020

Assets
Cash ₱ 260,975
Notes Receivable 30,000
Accounts Receivable ₱ 300,000
Less: Allowance for Uncollectible Accounts 30,000 270,000
Interest Receivable 700
Merchandise Inventory 80,000
Office Supplies 5,000
Furnitures and Fixtures 50,000
Total Assets ₱ 696,675

Liabilities
Notes Payable ₱ 50,000
Accounts Payable 160,000
Interest Payable 3,750
Kim Rodriguez, Capital 321,950
Joy Palma, Capital 160,975
Total Liabilities & Owner's Equity ₱ 696,675

Two or Mores Sole Proprietors Form a Partnership

Illustration. On June 30, 2020, Deogracia Corpuz and Esterlina Gevera, friendly competitors in
a certain line of business, decided to combine their talents and capital to form a partnership.
Their statements of financial position are as follows:

18 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Deogracia Corpuz
Statement of Financial Position
June 30, 2020

Assets
Cash ₱ 50,000
Accounts Receivable 100,000
Merchandise Inventory 80,000
Furnitures and Fixtures 60,000
Total Assets ₱290,000

Liabilities and Owner's Equity

Accounts Payable ₱ 30,000
Deogracia Corpuz, Capital 260,000
Total Liabilities and Owner's Equity ₱290,000

Esterlina Gevera
Statement of Financial Position
June 30, 2020

Assets
Cash ₱ 40,000
Accounts Receivable 80,000
Merchandise Inventory 100,000
Delivery Equipment 90,000
Total Assets ₱310,000

Liabilities and Owner's Equity

Accounts Payable ₱ 60,000
Esterlina Gevera, Capital 250,000
Total Liabilities and Owner's Equity ₱310,000

19 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
The conditions and adjustments agreed upon by the partners for purposes of determining their
interest in the partnership are:

1. Actual count and bank reconciliation on Corpuz proprietorship‟s cash account revealed cash
short and unrecorded expenses of P3,500.

2. Establishment of a 10% allowance for uncollectible account s in each book.

3. The merchandise inventory of Gevera is to be increased by P10,000.
4. The furniture and fixtures of Corpuz are to be depreciated by P6,000.
5. The delivery equipment of Gevera is to be depreciated by P9,000.

New Books of the Partnership (required per National Internal Revenue Code)
The following procedures may be used in recording the formation of a partnership:

Books of Deogracia Corpuz and Esterlina Gevera:

1. Adjust the accounts of both parties in accordance with the agreement. Adjustments are to be
made based on their respective capital accounts.
2. Close the books.

Books of the Partnership:

1. Record the investment of Deogracia Corpuz
2. Record the investment of Esterlina Gevera

Following the procedures, the entries are:

Books of Deogracia Corpuz

(1)
Deogracia Corpuz, Capital P19,500
Cash P3,500
Allowance for Uncollectible 10,000
Accumulated Depreciation 6,000
To record adjustments to restate Corpuz‟ capital

(2)
Accounts Payable P30,000
Allowance for Uncollectible Accounts 10,000
Accumulated Depreciation 6,000
Deogracia Corpuz, Capital 240,500
Cash P46,500
Accounts Receivable 100,000
Merchandise Inventory 80,000
Furnitures and Fixtures 60,000
To close the books of Corpuz.

Books of Esterlina Gevera

20 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
(1)
Merchandise Inventory P10,000
Esterlina Gevera, Capital 7,000
Allowance for Uncollectible Accounts P8,000
Accumulated depreciation 9,000
To record adjustments to restate Gevera‟s capital

(2)
Accounts Payable P60,000
Allowance for Uncollectible Accounts 8,000
Accumulated Depreciation 9,000
Esterlina Gevera, Capital 243,000
Cash P40,000
Accounts Receivable 80,000
Merchandise Inventory 110,000
Delivery Equipment 90,000
To close the books of Gevera.

Books of the Partnership

(1)
Cash P46,500
Accounts Receivable 100,000
Merchandise Inventory 80,000
Furniture and Fixtures 54,000
Accounts Payable P30,000
Allowance for Uncollectible Accounts 10,000
Deogracia Corpuz, Capital 240,500
To record the investment of Corpuz.

(2)
Cash P40,000
Accounts Receivable 80,000
Merchandise Inventory 110,000
Delivery Equipment 81,000
Accounts Payable P60,000
Allowance for Uncollectible Accounts 8,000
Esterlina Gevera, Capital 243,000
To record the investment of Gevera.

21 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
After the formation, the statement of financial position of the newly formed partnership is:
Corpuz and Gevera
Statement of Financial Position
June 30, 2020

Assets
Cash ₱ 86,500
Accounts Receivable ₱ 180,000
Less: Allowance for Uncollectible Accounts 18,000 162,000
Merchandise Inventory 190,000
Furniture and Fixtures 54,000
Delivery Equipment 81,000
Total Assets ₱ 573,500

Liabilities and Owner's Equity

Accounts Payable ₱ 90,000
Deogracia Corpuz, Capital 240,500
Esterlina Gevera, Capital 243,000
Total Liabilities and Owner's Equity ₱ 573,500

LIMITED LIABILITY COMPANY

A limited liability company (LLC) is a hybrid form of business for it combines the best features
of partnership and a corporation. LLC is form of legal entity that provides limited liability to its
owners. In 1988, the Internal Revenue Service (IRS) of the United States of America ruled that
LLC may be treated as a partnership for tax purposes subject to conditions. As a result of this
ruling, all 50 U.S. states allow LLC.

The owners of an LLC are called members. These owners may be individuals, partnerships,
corporations or other entities. Many states even allow one-person LLCs. The members have
limited liability even if they are active in the company. This type of entity is attractive for
professional service firms because the owners will not have personal liability for the other
owners‟ malpractice.

A limited liability partnership (LLP) is very similar to an LLC except that investments in LLP is
restricted to professionals. The four major international accounting firms KPMG, Ernst &
Young, Pricewaterhouse Coopers and Deloitte Touche started as partnerships. As they grew and
the risk increased, these firms were allowed to change, by operation of law, to LLPs. The LLP
concept is different from that of limited partnership.

The accounting for LLCs is the similar for partnership. The terms “member” and “member
equity are used instead of “partner” and “partner‟s equity”.
22 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
EXERCISES:

Directions : Answer the following comprehensively.

1. Define partnership.

2. What are the essential characteristics of a partnership. Explain each.

3. Differentiate partnership from a corporation.

4. Explain the three advantages of a partnership in comparison with sole proprietorship.

5. Explain the three advantages of a partnership in comparison with corporation.

6. Identify the kinds of partnership as to object, liability, duration, purpose and legality of existence.

7. Differentiate a general partner from a limited partner.

8. Differentiate capitalist from industrial partner.

9. How dormant, secret and silent partner differ from one another.

10. Define articles of partnership.

11. Differentiate permanent withdrawals from temporary withdrawals?

12. What is meant by fair market value of an asset?

Problem 1

On February 1, 2020, Cami Reyes and Jun Cruz agreed to form a partnership. The partnership agreement
stipulates that Reyes is to invest cash of P500,000 and building of P1,200,000. Cruz agreed to contribute
land with fair market value of P2,000,000 with P250,000 mortgage to be assumed by the partnership.

1.1 Prepare the journal entries for partnership formation.

1.2 Prepare the statement of financial position of the partnership.

Problem 2 Presented below is the Statement of Financial Position of Marie Santos. Anna Velasco offered
to to invest cash to get a capital equal to one-half of Santos Capital after the necessary adjustments made.
Santos accepted the offer.

23 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Marie Santos
Statement of Financial Position
June 1, 2019

Assets
Cash ₱ 100,000
Notes Receivable 80,000
Accounts Receivable ₱ 300,000
Less: Allowance for Uncollectible account 10,000 290,000
Merchandise Inventory 70,000
Furnitures and Fixtures 80,000
Less: Accumulated depreciation 8,000 72,000
Total Assets 612,000

Liabilities and Owner's Equity

Notes Payable ₱ 75,000
Accounts Payable 222,000
Santos, Capital 315,000
Total Liabilities & Owner's Equity 612,000

Adjustments:

a. Accounts receivable is estimated to be 95% collectible.

b. Merchandise inventory is valued at P65,000.
c. Furnitures and Fixtures are to be valued at P70,000.
d. Interest on notes payable is to be accrued at 15% annually dated Jan.1, 2019.

2.1 Prepare the adjusting entries for Santos capital

2.2. Prepare the closing entries for Santos account
2.3 Prepare the journal entries for investment of Santos
2.4 Prepare the journal entries for investment of Velasco
2.5 Make a Statement of Financial Position of Santos and Velasco

Problem 3

Presented on the next page is the Statement of Financial Position of Kim Sy and Lyn Vera as of
September 30, 2020 are as follows. Kim Sy and Lyn Vera decided to combine their talents and capital to
form a partnership.

The conditions and adjustments agreed upon by the partners for purposes of determining their interests in
the partnership are the following:

a. Establishment of 5% allowance for uncollectible accounts in each book.

24 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
b. The merchandise inventory of Sy is to be decreased by P10,000 while the merchandise inventory of
Vera is to be increased by P5,000.

c. The furniture and fixtures of Sy is to be depreciated by P2,500.

d. The delivery equipment of Vera is to be depreciated by P7,500.

3.1 Prepare the adjusting entry for the book of Sy.

3.2 Prepare the closing entry for the book of Sy.

3.3. Prepare the adjusting entry for the book of Vera.

3.4 Prepare the closing entry for the book of Vera.

3.5 Prepare the opening entry for investment of Sy.

3.6 Prepare the opening entry for investment of Vera.

3.7 Make a Statement of Financial Position of the partnership.

25 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Kim Sy
Statement of Financial Position
September 30, 2020

Assets
Cash ₱ 95,000
Notes Receivable 18,000
Accounts Receivable ₱ 275,000
Less: Allowance for Uncollectible Accounts 27,500 247,500
Merchandise Inventory 50,000
Furnitures and Fixtures 55,000
Less: Accumulated depreciation 7,500 47,500
Total Assets ₱ 458,000

Liabilities and Owner's Equity

Notes Payable ₱ 80,000
Accounts Payable 150,000
Interest Payable 5,000
Sy, Capital 223,000
Total Liabilities and Owner's Equity ₱ 458,000

Lyn Vera
Statement of Financial Position
September 30, 2020

Assets
Cash ₱ 105,000
Notes Receivable 25,500
Accounts Receivable ₱ 100,000
Less: Allowance for Uncollectible Accounts 10,000 90,000
Merchandise Inventory 45,000
Delivery Equipment 60,000
Less: Accumulated depreciation 12,500 47,500
Total Assets 313,000

Liabilities and Owner's Equity

Notes Payable ₱ 60,000
Accounts Payable 25,000
Interest Payable 15,000
Vera, Capital 213,000
Total Liabilities and Owner's
26 Reference: Equity
Ballada, 313,000
W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Module 2- PARTNERS’ EQUITY IN ASSETS CONTRASTED WITH SHARE IN PROFITS OR
LOSSES

The basis on which profits or losses are shared is a matter of agreement among the partners and
may not necessarily be the same as their capital contribution ratio. The equity of a partner in the net assets
of the partnership should be distinguished from partner‟s share in profits or losses.

Illustration. “Nelson Daganta is a one-third partner” is an ambiguous statement. Daganta may have one-
third equity in the net assets of the partnership but might have a larger or smaller share in the profits or
loss of the firm. Such statement may also be interpreted to mean that Daganta is entitled to one-third of
the profit or loss, although his capital account may represent much more or much less than one-third of
the total partners‟ capital. Simply put, partners may agree on any type of profit and loss regardless of the
amount of their respective capital account balances.

FACTORS TO CONSIDER IN ARRIVING AT A PLAN FOR DIVIDING PROFITS OR LOSSES

Money, Property or Industry

Partnership profits are realized as a result of putting together the contributions – money, property
or industry – of the partners. The amount of capital invested by each partner, the amount of time each
partner devotes to the business and other contributions are the factors being considered in the formulation
of an equitable profit and loss ratio.

There are profit-sharing plans which emphasize either the value of personal services rendered by
individual partners or the amount of capital invested by each partner. Some agreements considered the
importance of both the amount and quality of managerial services rendered, and the amount of capital
invested by the partners for the success or failure of the partnership. In this case, allowances may be
provided for salaries to partners and interest on their respective capital balances as a preliminary step in
the division of profit or losses; the balance may be divided in a specified ratio. Among the other factors
which may be considered are as follows:

1. A partner has considerable personal financial resources, thus giving the partnership a strong credit
rating.

2. A partner who is well known in a profession or an industry may contribute immensely to the success of
the partnership although he may not participate actively in the operations of the partnership.

These two factors may be incorporated in the plan to arrive at a ratio by which any remaining profits or
losses are to be divided.

Illustration. Daria Tolentino and Eleanor Tan are partners in a coco water business. Partner Daria
Tolentino contributed most of the assets of the business but spends little time for its operations. On one
hand, Partner Eleonor Tan contributed less in assets but devotes her full knowledge and attention in the
partnership. To divide profits and losses based on capital contributions alone will result to iniquities. The
profit and loss sharing agreement should have considered the provision of salaries or even bonus in
recognition of the talent and time being contributed by Partner Eleanor Tan.
27 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Performance Methods

Many partnerships use profit and loss sharing arrangements that give some weight to the specific
performance of each partner to provide incentives to perform well. This allocation of profits to a partner
on the basis of performance is frequently referred to as a bonus. Examples of the use of performance
criteria are:

1. Chargeable hours. These are the total number of hours that a partner incurred on client-related
assignments. Weight may be given to hours in excess of a standard.

2. Total billings. The total amount billed to clients for work performed and supervised by a partner
constitutes total billings. Weight may be given to billings in excess of norm.

3. Write offs. Consists of uncollectible billings. Weight may be given to a write –off percentage below a
norm.

4. Promotional and civic activities. Time devoted to developing future business and enhancing the
partnership name in the community is considered promotional and civic activity. Weight may be given to
time spent in excess of a norm or to specific accomplishments resulting in new clients.

5. Profits in excess of specified levels. Designated partners commonly receive a certain percentages of
profits in excess of a specified level of earnings.

RULES FOR DISTRIBUTING PROFITS AND LOSSES

The profits and losses shall be distributed in conformity with the agreement. 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 profits and losses shall be in proportion
to what he may have contributed (according to the ratio of original capital investments or in its balances,
the ratio of capital balances at the beginning of the year), but the industrial partner may 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 aside from his services he has contributed capital, he shall also receive a share
in the profits in proportion to his capital (Civil Code of the Philippines, Article 1797). A stipulation which
excludes one or more partners from any share in the profits or losses is void. (Article 1799). The
partnership must exist for the common benefit or interest of the partners. A summary of the above legal
provisions is prepared as follows:

1. Profits

a. the profits will be divided according to partner‟s agreement.

28 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
b. if there is no agreement:

 As to capitalist partners, the profits shall be divided according to their capital contributions
(according to the ratio of original capital investments or in its absence, the ratio of capital
balances at the beginning of the year).
 As to industrial partners (if any), such share as may be just and equitable under the
circumstances, provided, that the industrial partner shall receive such share before the capitalist
partners shall divide the profits.

2. Losses

a. the losses will be divided according to partners‟ agreement.

b. if there is no agreement as to distribution of losses but there is an agreement as to profits, the losses
shall be distributed according to the profit sharing ratio.

c. in the absence of any agreement:

 As to capitalist partners, the losses shall be divided according to their capital contributions
(according to the ratio of original capital investments or in its absence, the ratio of capital
balances at the beginning of the year).
 As to purely industrial partners (if there‟s any), shall not be liable for any losses.

The industrial partner is not liable for losses because he cannot withdraw the work or labor already done
by him, unlike the capitalist partners who can withdraw their capital. In addition, if the partnership failed
to realize profits, then he has labored in vain and in a real sense, he has already contributed his share in
the loss.

CORRECTION OF PRIOR PERIOD ERRORS

Any business will from time to time discover errors made in the measurement of profit in prior
accounting periods. Good internal control and the exercise of due care should serve to minimize the
number of financial reporting errors that occur; however these safeguards cannot be expected to
completely eliminate errors in the financial statements.

Per International Accounting Standards (IAS) No. 8, Accounting Policies, Changes in Accounting
Estimates and Errors, prior period errors are omissions from and other misstatements of the entity‟s
financial statements for one or more prior periods that are discovered in the current period. Errors may
occur as a result of mathematical mistakes, mistakes in applying accounting policies, misinterpretation of
facts, fraud oversights. Examples include errors in the estimation of depreciation, errors in inventory
valuation, and omission of accruals of revenue and expenses.

Material prior periods must be restated to report financial position and results of operations as they would
have been presented had the error never taken place. The amount of the correction of a prior period error
that relates to prior periods should be reported by adjusting the opening balances of partners‟ equity and

29 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
affected assets and liabilities. The correction of a prior period error is excluded from profit or loss for the
period in which the error is discovered.

If an error resulted in an understatement of profit in previous periods, a correcting entry will be needed to
increase Capital. If an error overstated profit in prior periods, then Capital would have to be decreased.
The effect of the error correction will be divided based on the applicable profit and loss ratio.

DISTRIBUTION OF PROFITS OR LOSSES BASED ON PARTNERS’ AGREEMENT

In general, profits or losses shall be divided in accordance with the agreement of the partners. The ratio in
which profits or losses from partnership operations are distributed is recognized as the profit and loss
ratio.

The partners may agree on any of the following scheme in distributing profits or losses:

1. Equally or in other agreed ratio

2. Based on partners‟ capital contributions:

a. ratio of original capital investments

b. ratio of capital balances at the beginning of the year

c. ratio of capital balances at the end of the year

d. ratio of average capital balances

3. By allowing interest on partners‟ capital and the balance in an agreed ratio

4. By allowing salaries to partners and the balance in an agreed ratio

5. By allowing bonus to the managing partner based on profit and the balance in an agreed ratio

6. By allowing salaries, interest on partners‟ capital, bonus to the managing partner and the balance in an
agreed ratio (combination 3 to 5).

Note that the partners can agree on not using residual sharing ratio (“the balance in an agreed ratio”) if
profits do not exceed the total salary and interest allowances. In such a case, the partners must agree on
the priority of the various profit or loss distribution scheme.

Illustration. The following series of illustrations are based on the figures obtained from the Biore and
Besario Partnership which had a profit of P300,000 for the year ended December 31, 2019, the first year
of operations. The partnership contract provided that each partner may withdraw P5,000 on the last day of
each month; both partners did so during the year. The drawings are recorded by debits to the partners‟
drawing accounts and shall not be considered in the division of profit or loss. It is the intention of the
partners that each partner‟s share in the profit or loss be either credited or debited to the drawing account.
30 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Christopher Biore invested P400,000 on Jan. 1, 2019 and an additional P100,000 on April 1. Rose
Besario invested P800,000 on Jan. 1 and withdrew P50,000 on July 1. These transactions and events are
summarized in the following capital, drawing and income summary ledger accounts:

Christopher Biore, Capital Rose Besario, Capital

Jan. 1 P400,000 Jul. 1 P50,000 Jan. 1 P800,000
Apr. 1 P100,000

Christopher Biore, Drawing Rose Besario, Drawing

Jan-Dec. P60,000 Jan-Dec. P60,000

Income Summary
Dec. 31 P300,000

Equally or in other Agreed Ratio

Partnership contracts may provide that profit or loss be divided equally. The profit of P300,000 for the
Biore and Besario Partnership is transferred by a closing entry on Dec. 31, 2019, from the income
summary ledger account to the partners‟ drawing accounts.

Income Summary P300,000

Christopher Biore, Drawing P150,000
Rose Besario, Drawing 150,000
To record the division of profits.

If the partnership had a loss of P200,000 for the year ended December 31, 2019, the income summary
ledger account would have a debit balance of P200,000. This loss would be transferred to the partners‟
drawing accounts by a debit to each drawing account for P100,000 and a credit to the income summary
account for P200,000.

Christopher Biore, Drawing P100,000

Rose Besario, Drawing 100,000
Income Summary P200,000
To record the division of losses.

Assume instead that Biore and Besario share profits and losses in a ratio of 60:40 and the profit was
P300,000, the profit would be divided as follows:

Income Summary P300,000

31 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Christopher Biore, Drawing P180,000
Rose Besario, Drawing 120,000
To record the division of profits.

Computation:
Biore: 60% x P300,000 P180,000
Besario: 40% x P300,000 P120,000
P300,000

Based on Partners’ Capital Contribution

Division of partnership profits in proportion to the capital invested by each partner is most likely to be
found in partnerships in which substantial investments is the principal ingredient for success. It is
essential that the partnership contract be specific with respect to the concept of capital. Capital may refer
to either of the following:

Ratio of Original Capital Investments

Assume that the partnership agreement provides for the division of profits in the ratio of original capital
balances. The original investments of Biore and Besario are P400,000 and P800,000, respectively. The
profit of P300,000 for 2019 is divided as follows:

Income Summary P300,000

Christopher Biore, Drawing P100,000
Rose Besario, Drawing 200,000
To record division of profits.

Computation:
Biore: P300,000 x P400,000/ P1,200,000 P100,000
Besario: P300,000 x P800,000/ P1,200,000 200,000
P300,000

After the entry allocating the profits of P300,000 to Biore and Besario, are the partners supposed to
receive cash for their respective share in the profits?. No, the partners‟ share in the profits cannot be
attributed to particular asset, including cash. The entry increased the equity of Biore and Besario in all the
assets of the partnership.

Ratio of Capital Balances at the Beginning of the Year

Assume that the partnership agreement provided for the division of profits in the ratio of capital balances
at the beginning of the year. In this case, the original capital balances are also the capital balances at the
beginning of the year since the partnership is only on its first year of operations. The profit of P300,000
for 2019 is divided as follows:

Income Summary P300,000

Christopher Biore, Drawing P100,000
Rose Besario, Drawing 200,000
To record division of profits

32 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Computation:
Biore: P300,000 x P400,000/ P1,200,000 P100,000
Besario: P300,000 x P800,000/ P1,200,000 200,000
P300,000

Ratio of Capital Balances at the End of the Year

Assume that the profit is divided in the ratio of capital balances at the end of the year before drawings and
the distribution of profit. The ending balances are P500,000 for Biore and P750,000 for Besario; the
profit of P300,000 for 2019 is divided as follows:

Income Summary P300,000

Christopher Biore, Drawing P120,000
Rose Besario, Drawing 180,000
To record the division of profits.

Computation:
Biore: P300,000 x P500,000/ P1,250,000 P120,000
Besario : P300,000 x P750,000/ P1,250,000 180,000
P300,000

Ratio of Average Capital Balances

Division of profits or losses on the basis of the three preceding concepts - original capital investments;
capital balances at the beginning of the year; or capital balances at the end of the year – may prove
inequitable if there are material changes in the capital accounts during the year.

When beginning capital balances are used in allocating profits, additional investments during the year are
discouraged because the partners making such investments are not compensated in the division of profits
until the next year,

If ending capital balances are used, year-end investments are encouraged, but there is no incentive for a
partner to make any investments before year-end. In addition, amounts earlier withdrawn may be
reinvested before year-end. These considerations suggest that using average balances as a basing for
distributing profits or losses is preferable because it reflects the capital actually available for use by the
partnership during the year,

The agreement should also state the amount of drawings each partner may make. This drawings are
considered temporary and are recorded as debits to the partner‟s drawing account. Drawings within the
allowable amount will not affect the computation of the average capital balance. On the contrary drawings
in excess of the allowable amount are considered permanent reductions in capital; hence, the computation
of the average capital is affected.

In the continuing illustration for the Biore and Besario Partnership, the partners are entitled to withdraw
P5,000 monthly or a total of P60,000 per annum. Any additional withdrawals are directly debited to the
partners‟ capital accounts and therefore will affect the computation of the average capital ratio

33 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Biore and Besario
Computation of Average Capital Balances
For the Year Ended Dec. 31, 2019

Christopher Biore, Capital

Portion of the Average

Capital Account Year Capital
Date Balances Unchanged Balances

Jan. 1 P400,000 x 3/12 P100,000

Apr. 1 P500,000 x 9/12 P375,000
Average
Capital P475,000

Rose Besario, Capital

Jan. 1 P800,000 x 6/12 P400,000
Jul.1 P750,000 x 6/12 P375,000
Average
Capital P775,000

Total Average Capital Balances P1,250,000

The entry to record the division of P300,000 profits is as follows:

Income Summary P300,000

Christopher Biore, Drawing P114,000
Rose Besario, Drawing 186,000
To record the division of profits.

Computation:
Biore: P300,000 x P475,000/ P1,250,000 P114,000
Besario : P300,000 x P775,000/ P1,250,000 186,000
P300,000

By Allowing Interest on Capital and the Balance in an Agreed Ratio

In the preceding section, the plan for dividing the total profits in the ratio of partners‟ capital balances was
based on the assumption that capital investments were the controlling factor in the success of the
partnership. However, it is not always the case. Consequently, partnership may choose to allocate a
portion of the total profits in the capital ratio and the balance equally or in other agreed ratio after due
consideration of the partner‟s contributions.
34 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
To allow interest on partners‟ capital accounts balances is almost similar to dividing part of profits in the
ratio of partners‟ capital balances. If the partners agree to allow interest on capital as a first step in the
division of profit, they should specify the interest rate to be used. It should also state whether interest is to
be computed on capital balances on specific dates or on average capital balances during the year.

Partners invested in a partnership for profits, not for interest. The interest on partners‟ capital, along with
the other profit-sharing plans to be discussed in the remainder of the chapter are to be considered as mere
techniques to share partnership profits or losses equitably and not as expenses of the partnership. On the
other hand, the interest earned on loans to partners is recognized as partnership income.

Continuing the illustration of Biore and Besario Partnership with a profit of P300,000for 2019 and capital
balances already shown, assume that the partnership agreement allowed 15% on interest on average
capital balances with the balances divided equally. The profit of P300,000 for 2019 is divided as follows:

Biore Besario Total

15% Interest on Average Capital
Biore: P475,000 x 15% P71,250
Besario: P775,000 X 15% P116,250
Subtotal P187,500
Balance to be Divided Equally
[P300,000 - P187,500 = P112,500]:
Biore: P112,500 X 50% 56,250
Besario: P112,500 x 50% 56,250 P112,500
Share of Partners in Profits P127,500 P172,500 P300,000

The journal entry to close the income summary ledger account on December 31, 2019 follows:

Income Summary P300,000

Christopher Biore, Drawing P127,500
Rose Besario, Drawing 172,500
To record the division of profits.

In a related case, assume that the Biore and Besario Partnership had a loss of P10,000 for the year ended
December 31, 2019. If the partnership agreement provided for interest on capital accounts, this provision
must be honored regardless of whether operations yielded profits or not.

The loss will be shared by the partners in the same manner as the P300,000 profit. The total interest
allowance of P187,500 would still be given to the partners. The only difference is that the division of
profits or losses after the interest allowances would involve a larger negative amount of P197,500 which
will be divided equally between Biore and Besario:
Biore Besario Total
15% Interest on Average Capital
Biore: P475,000 x 15% P71,250
Besario: P775,000 X 15% P116,250
35 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Subtotal P187,500
Balance to be Divided Equally
[(P10,000) - P187,500 = (P197,500)]:
Biore: (P197,500) x 50% (98,750)
Besario: (P197,500) x 50% (98,750) (197,500)
Share of Partners in Profits (Losses) P(27,500) P17,500 P(10,000)

The journal entry to close the income summary ledger account on December 31, 2019 follows:

Christopher Biore, Drawing P27,500

Income Summary P10,000
Rose Besario, Drawing 17,500
To record the division of losses.

After initial consideration, the idea that a loss of P10,000 should cause one partner‟s capital to increase
and the other partner‟s capital to decrease may appear unreasonable. However, this result was planned
and was with good reason. Partner Besario invested more capital than Partner Biore; this capital was used
to carry out operations, and the partnership incurrence of a loss in the first year is no reason to disregard
Besario‟s larger capital investment.

Comparison of distribution based sole on capital ratios as against distribution with interest on
capital balances. There will be a significant difference between the two distribution plans if the
partnership is operating a loss. Under the capital ratio plan, the partner who invested more capital will
automatically shoulder a bigger share of the loss. This result may be considered inequitable because the
investment of capital presumably is not the cause of the loss.

Under the interest plan, the partner who invested more capital is credited (increased) for an interest on his
capital and is ultimately debited (decreased) with a lesser share of the loss; in some cases, the result may
even be a net credit (increase).

By Allowing Salaries to Partners and the Balance in an Agreed Ratio

The sharing agreement may provide variations in compensating the personal services contributed by
partners. Even among partners who devote equal service time, one partner‟s superior experience and
knowledge may command a greater share of the profit. To acknowledge the hard working or one valuable
partner, the profit sharing plan may provide for salary allowances.

The partnership agreement should be clear on the treatment of salary allowances when losses are incurred.
In the absence of an agreement to govern this situation, salary allowances will be provided even
operations yielded losses. This allowance should not be confused with salaries expense or with the
partner‟s drawing account which is debited for periodic salary allowances. The cash withdrawals will in
no way affect the division of profits; the division of profits is governed by the sharing agreement.

Partners are the partnership‟s owners; they are not employees of the business. If partners devote their time
and services to the affairs of the partnership, they are understood to do so for profit, not for salary.
Therefore, when the partners calculate the profit of the partnership, salaries to the partners are not
deducted as expenses in the statement of comprehensive income.
36 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Continuing the illustration for the Biore and Besario Partnership, assume that the partnership agreement
provided the annual salary of P100,000 to Biore and P60,000 to Besario, and the balance to be divided
equally. The profit of P300,000 for 2019 is divided as follows:
Biore Besario Total
Salary Allowances P100,000 P60,000 P160,000
Balance to be Divided Equally
[P300,000 -P160,000 = P140,000]
Biore: P140,000 x 50% 70,000
Besario: P140,000 x 50% 70,000 140,000
Share of Partners in Profits P170,000 P130,000 P300,000

The journal entry to close the income summary ledger account on December 31, 2019 follows:
Income Summary P300,000
Christopher Biore, Drawing P170,000
Rose Besario, Drawing 130,000
To record division of profits.

By Allowing Bonus to the Managing Partners Based on Profit and the Balances in an Agreed Ratio

A partnership contract may provide for a special compensation in the form of bonus to the managing
partner when the results of operations of the partnership are favorable. This allowance are given in order
to encourage the partner to maximize the profit potentials of the partnership. Bonus is being considered in
the computation of profit, rather it is a mere technique to distribute profits.

Assume that the Biore and Besario Partnership agreement provided for a bonus of of 25% of profit before
bonus to Partner Biore and the balance to be divided equally. The profit is P300,000.

Biore Besario Total

Bonus [25% x P300,000]: P 75,000 P 75,000
Balance to be Divided Equally
[P300,000 - P75,000 = P225,000]:
Biore: P225,000 x 50% 112,500
Besario: P225,000 x 50% 112,500 225,000
Share of Partners in Profits P187,500 P112,500 P300,000

The journal entry to close the income summary ledger account on December 31, 2019 follows:
Income Summary P300,000
Christopher Biore, Drawing P187,500
Rose Besario, Drawing 112,500
To record division of profits.
Assume instead that the Biore and Besario Partnership agreement provided for a bonus of 25% to Partner
Biore and the balance to be divided equally. It is understood in the wording of the agreement that the 25%
bonus will be based on the difference after deducting bonus from a certain amount. This certain amount is
the profit after considering all the operating expenses but before this bonus.
37 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Here, the P300,000 profit still includes the bonus. The difference between this profit and bonus shall be
the basis for the 25% bonus rate. Hence, profit after bonus represents 100% while the profit of P300,000
before bonus represents 125%.

Profit before Bonus P300,000 125%

Profit after bonus 240,000 100%
Bonus P60,000 25%

Biore Besario Total

Bonus P 60,000 P 60,000

Balance to be Divided Equally

[P300,000-P60,000 = P240,000]
Biore: P240,000 x 50% 120,000
Besario: P240,000 x 50% 120,000 240,000
Share of Partners in Profits P180,000 P120,000 P300,000

The journal entry to close the income summary ledger account on December 31, 2019 follows:
Income Summary P300,000
Christopher Biore, Drawing P180,000
Rose Besario, Drawing 120,000
To record the division of profits.

By Allowing Salaries, Interest on Capital, Bonus to the Managing Partner and the Balance in an
Agreed Ratio

The service contributions and capital contributions of the partners are often not equal. If the service
contributions are not equal, salary allowances can compensate for the differences. Or, when capital
contributions are not equal, interest allowances can make up for the unequal investments. When both
service or capital contributions are unequal, the allocation of profits or losses may include salary
allowances, interest on their capital balances, bonus to the managing partner, and the balance to be
divided in an agreed ratio.

Note that the provisions for salaries and interest in the partnership agreement and called allowances.
These allowances are not reported in the statement of recognized income and expense as salaries and
interest expense; they are merely means of allocating profit to the partners.

Assume that the profit for the year is P400,000 and the partnership agreement for the Biore and Besario
Partnership provided for the following:

1. Bonus to Biore of 25% of profit after salaries and interest but before bonus;
2. Annual salaries of P100,000 to Biore and P60,000 to Besario;
3. Interest on average capital balances of P71,250 and P116,750 to Biore and Besario, respectively
38 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
4. Balance to be divided in a ratio of 40:60.

Biore Besario Total

Salary Allowances P 100,000 P 60,000 P 160,000
Interest on Average Capital Balances 71,250 116,250 187,500
Bonus [25%(P400,000-P100,000-
P60,000-P71,250-P116,250)] 13, 125 13, 125
Balance to be Divided in a Ratio of
40:60 [P400,000-P160,000-P187,500-
P13,125 = P39,375]
Biore: P39,375 x 40% 15,750
Besario: P39,375 x 60% 23,625 39,375
Share of Partners in Profits P200,125 P199,875 P400,000

The journal entry to close the income summary ledger account on Dec. 31, 2019 follows:

Income Summary P400,000

Christopher Biore, Drawing P200,125
Rose Besario, Drawing 199,875
To record the division of profits.

Assume instead that the bonus to Biore is 25% of profit after salaries , interest and after bonus. The
computation of the bonus follows:

Profit before Salaries, Interest and Bonus P400,000

Less: Salaries P160,000
Interest 187,500 347,500
Profit after Salaries and Interest but before bonus P52,500 125%
Profit after Salaries and Interest and after bonus
(P52,500/125%) 42,000 100%
Bonus P10,500 25%

Biore Besario Total

Salary Allowances P100,000 P60,000 P160,000
Interest on Average Capital Balances 71,250 116,250 187,500
Bonus 10,500 10,500
39 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Balance to be Divided in a Ratio of 40:60
[P400,000-P160,000-P187,500-P10,500 =
P42,000]:
Biore: P42,000 x 40% 16,800
Besario: P42,000 X 60% 25,200 42,000
Share of Partners in Profits P198,550 P201,450 P400,000

The journal entry to close the income summary ledger account on December 31, 2019 follows:
Income Summary P400,000
Christopher Biore, Drawing P198,550
Rose Besario, Drawing 201,450
To record the division of profits.

DISTRIBUTION OF PROFIT AND LOSSES BASED ON PARTNER’S AGREEMENT

Illustration 1: Joshua Marasigan and Thomas Calingasan are partners. Marasigan and
Calingasan has initial capital investment of P800,000 and P500,000 respectively on January 1,
2020. On March 31, 2020, Calingasan invested additional capital of P100,000. Both partners
made permanent withdrawals of P75,000 each on September 30, 2020. The partnership generated
a profit of P600,000 for the year ended December 31, 2020. It is the intention of the partners that
each partner‟s share in the profit or loss be either credited or debited to the drawing account.

Equally or in Agreed Ratio

1. Assume that the partners agreed to divide the profit of P600,000 equally.

Income Summary P600,000

Joshua Marasigan, Drawing P300,000
Thomas Calingasan, Drawing 300,000
To record the division of profits.

2. Assume that the partnership suffered a loss of P400,000 for the year ended December 31, 2020
and the loss will be divided equally.

Joshua Marasigan, Drawing P200,000

Thomas Calingasan, Drawing 200,000
Income Summary P400,000
To record the division of losses.

3. Assume that the partnership agreed to divide to profit of P600,000 in a ratio of 70:30 to Joshua
Marasigan and Thomas Calingasan respectively.

Income Summary P600,000

Joshua Marasigan, Drawing P420,000
40 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Thomas Calingasan, Drawing 180,000

Computation:
Marasigan: P600,000 x 70% = P420,000
Calingasan: P600,000 x 30% = P180,000

Based on Partners’ Capital Contribution

4. Assume that the partnership agreement stipulates that the division of profit and losses will be
based on the original capital investment. The original capital investments of Marasigan and
Calingasan were P800,000 and P500,000 respectively. The profit of P600,000 for the year ended
December 31, 2020 will be divided as follows:

Income Summary P600,000

Joshua Marasigan, Drawing P369,230.77
Thomas Calingasan, Drawing 230,769.23
To record the division of profits.

Computation:
Marasigan: P600,000 x P800,000/P1,300,000 = P369,230.77
Calingasan: P600,000 x P500,000/P1,300,000 = P230,769.23

5. Assume that the partnership agreement provided that division of profits or losses will be based
on the capital balances at the beginning of the year. The profit of P600,000 will be divided as
follows.

Income Summary P600,000

Joshua Marasigan, Drawing P369,230.77
Thomas Calingasan, Drawing 230,769.23
To record the division of profits.

Computation:
Marasigan: P600,000 x P800,000/P1,300,000 = P369,230.77
Calingasan: P600,000 x P500,000/P1,300,000 = P230,769.23

6. Assume that the division of profit and losses will be based on the ratio of capital at the end of
the year. The ending capital of Marasigan is P725,000 while P525,000 for Calingasan. The
profit of P600,000 is divided as follows:

Income Summary P 600,000

Joshua Marasigan, Drawing P 348,000
Thomas Calingasan, Drawing 252,000

41 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Computation:
Marasigan: P600,000 x P725,000/P1,250,000 = P348,000
Calingasan: P600,000 x P525,000/P1,250,000 = P252,000

7. Assume that the partnership agreement provides that division of profit and losses will be based
on average capital balances.

Marasigan and Calingasan

Computation of Average Capital Balances
For the Year Ended December 31, 2020

Joshua Marasigan, Capital

Average
Date Capital Account Portion of the Capital
Balances Year Unchanged Balances
Jan. 1 P800,000 x 9/12 = P600,000
Sept. 30 P725,000 x 3/12 = 181,250
Average Capital P781,250

Thomas Calingasan, Capital

Jan. 1 P 500,000 x 3/12 = P125,000
Mar. 31 P 600,000 x 6/12 = 300,000
Sept. 30 P 525,000 x 3/12 = 131,250
Average Capital P556,250

To record the division of P600,000 profits is as follows:

Income Summary P600,000

Joshua Marasigan, Drawing P350,467.29
Thomas Calingasan, Drawing 249,532.71
To record the division of profits.

Computation:
Marasigan: P600,000 x P781,250/P1,337,500 = P350,467.29
42 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Calingasan: P600,000 x P 556,250/P1,337,500 = P 249,532.71

Illustration 2: Marc Ace and Jules Rivera formed a partnership with average capital balances of P
600,000 and P700,000 respectively. It is stipulated on the contract that partners will be given 20%
interest on the average capital balances and the remaining balances to be divided equally. Assume that the
partnership obtained a profit of P375,000.

1. By allowing interest on partner’s capital and the balance in an agreed ratio

Ace Rivera Total
20% Interest on Average Capital
balances
Ace (600,000 x 20%) 120,000
Rivera (700,000 x 20%) 140,000
Subtotal 260,000
Balance to be Divided Equally
(375,000-260,000 = 115,000)
Ace (115,000 x 50%) 57,500
Rivera (115,000 x 50%) 57,500 115,000
Total 177,500 197,500 375,000

The journal entry will be:

Income Summary P 375,000

Ace, Drawing P177,500
Rivera, Drawing 197,500
To record the division of profits.

Continuing the illustration, assume that at the end of the year, the partnership suffered a loss amounting to
P 50,000.

Ace Rivera Total

20% Interest on Average Capital
balances
Ace (600,000 x 20%) 120,000
Rivera (700,000 x 20%) 140,000
Subtotal 260,000
Balance to be Divided Equally
[(50,000)-260,000 = -310,000)]
Ace (-310,000 x 50%) (155,000)
Rivera (-310,000 x 50%) (155,000) (310,000)
Total (35,000) (15,000) (50,000)

The journal entry will be:

43 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Ace, Drawing P 35,000
Rivera, Drawing 15,000
Income Summary P 50,000
To record the division of losses.

2. By allowing salaries to partners and the Balance in an Agreed Ratio

Based on the previous illustration, assume that the partnership agreed to grant salaries to Ace and
Rivera, P40,000 and P60,000 respectively and the balance to be divided equally.
Ace Rivera Total
Salary Allowances 40,000 60,000 100,000
Subtotal
Balance to be Divided Equally
(375,000-100000= 275,000)
Ace (275000 x 50%) 137,500
Rivera(275000 x 50%) 137,500 275,000
177,500 197,500 375,000

The journal entry will be:

Income Summary P 375,000

Ace, Drawing P177,500
Rivera, Drawing 197,500
To record the division of profits.

3. By Allowing Bonus to the Managing Partner Based on profit and the Balance in an Agreed
Ratio

Assume that the partnership agreed to grant bonus, 10% of profit before bonus to Rivera, the managing
partner for the good performance results of the business. With the profit of P375,000, the distribution
will be:

Ace Rivera Total

Bonus (10% x 375,000) P37,500
Subtotal 37,500
Balance to be Divided Equally
(P375,000 -P37,500 = P337,500)
Ace: P337,500 x 50% P168, 750
Rivera: P337,500 x 50% P168, 750 P337,500
Share in Profits P168, 750 P206,250 P375,000

Income Summary P 375,000

Ace, Drawing P168,750
Rivera, Drawing 206,250
44 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 To record the division of profits.

Assume instead that the agreement for granting bonuses is 10% of profit after bonus.

Profit before bonus P375,000 .00 110%

Profit after bonus (P375,000/110%) 340,909.09 100%
Bonus 34,090.91 10%

Ace Rivera Total

Bonus 34,091 34,091
Subtotal
Balance to be Divided Equally
(375,000-34,090.91= 340,909.09)
Ace (340,909.09 x 50%) 170,455
Rivera(340,909.09 x 50%) 170,455 340,909
170,455 204,545 375,000

Income Summary P 375,000

Ace, Drawing P170,455
Rivera, Drawing 204,545
To record the division of profits.

4. By allowing salaries, Interest on Capital, Bonus to the Managing Partner and the Balance in an
Agreed Ratio

Due to good economic performance, the profit arises to P500,000. As given, Ace and Rivera had interest
on capital balances of P120,000 and P 140,000 as well as salary of P40,000 and P 60,000 respectively.
The partnership agreed that balance be divided in 40:60 for Ace and Rivera respectively. Assume that
bonus to managing partner is 10% of profit after salaries and interest but before bonus.

Ace Rivera Total

Salary Allowances 40,000 60,000 100,000
Interest on Average Capital Balances 120,000 140,000 260,000
Bonus [(10% (500,000-360000)] 14,000 14,000
Balance to be Divided in a Ratio of 40:60
(500,000-100,000-260,000-14,000 =126,000)
Ace (126,000 x 40%) 50,400
Rivera (126,000 x 60%) 75,600 126,000
Total 210,400 289,600 500,000

Income Summary P 500,000

Ace, Drawing P210,400
Rivera, Drawing 289,600
To record the division of profits.

45 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Assume instead that the bonus to Rivera, the managing partner is 10% of profit after salaries, interest
and after bonus.

Profit Before salaries, Interest and Bonus 500,000.00

Less: Salaries (100,000.00)
Interest (260,000.00)
Profit Before Salaries, Interest but Before Bonus 140,000.00 110%
Profit Before Salaries, Interest but After Bonus (140,000/1.10) 127,272.73 100%
Bonus 12,727.27

Ace Rivera Total

Salary Allowances 40,000.00 60,000.00 100,000.00
Interest on Average Capital Balances 120,000.00 140,000.00 260,000.00
Bonus 12,727.27 12,727.27
Balance to be Divided in an Agreed Ratio
(500,000 -100,000-260,000 - 12, 727.27
=127, 272.73)
Ace: 127,272.73 x 40% 50,909.09
Rivera: 127,272.73 x 60% 76,363.64 127,272.73
Share of Partners in Profits 210,909.09 289,090.91 500,000.00

Income Summary P 500,000

Ace, Drawing P210,909.09
Rivera, Drawing 289,090.91
To record the division of profits.

FINANCIAL REPORTING

Purpose of Financial Statements

Financial Statements are a structured representation with the objective of providing information
about the financial position, financial performance and cash flows of an entity that is useful to a
wide range of users in making economic decisions. Financial statements also show the results of
the management „s stewardship of the resources entrusted to it. To meet the objective, financial
statements provide information about the entity‟s assets, liabilities, equity, income and expenses,
other charges in equity and cash flows.

Overall Considerations

Fair Presentation and Compliance with International Financial Reporting Standards

(IFRS). The financial statements shall present fairly the financial position, financial performance
and cash flows of the entity. Fair presentation requires the faith representation of the effects of
46 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
the transactions, other events and conditions in accordance with the definitions and recognition
criteria for assets, liabilities, income and expenses set out in the IASBs Framework. Under IAS
No.1 (revised 2007), entities are required to make an explicit and unreserved statement of
compliance with IFRS in the notes.

Going concern. Financial statements should be prepared on a going concern basis unless
management intends to liquidate the entity or cease trading or has no realistic option but to do so.

Accrual basis of Accounting. An entity shall prepare its financial statements, except cash flow
information, using the accrual basis of accounting.

Materiality and Aggregation. An entity shall present separately each material class of similar
items. Material items that are dissimilar in nature or function should be separately disclosed.

Offsetting. An entity shall not offset assets and liabilities, income, and expenses unless required
or permitted by an IFRS.

Frequency of Reporting and Comparative Information. At least annually, an entity shall

present will equal prominence each financial statement in a complete set of financial statements
including comparative information in respect of the previous period for all amounts reported in
the current period‟s financial statements.

Consistency of Presentation. An entity shall retain the presentation and classification of items
in the financial statements in successive periods unless an alternative would be more appropriate
or an IFRS requires a change in the presentation.

Identification of the Financial Statements. An entity shall clearly identify the financial
statements and distinguish them from other information in the same published document.
International Financial Reporting Standards (IFRSs) apply only to the financial statements and
not necessarily to other information presented in an annual report, in regulatory filing or another
document.

An entity shall clearly identify each financial statement and the notes. An entity shall display the
following information prominently:

 Name of the reporting entity

 Whether the financial statements are of the individual entity or a group of entities
 The date of the end of the reporting period or the period covered by the set of financial
statements or notes
 The presentation of currency
 The level of rounding used in presenting amounts in the financial statements

47 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Complete Set of Financial Statements

Per revised International Accounting Standards (IAS) No.1, Presentation of Financial

Statements. A complete set of financial statements comprises:

a. a statement of financial position as at the end of the period;

b. a statement of comprehensive income for the period;

c. a statement of changes in equity for the period

d. a statement of cash flows for the period

e. notes, comprising a summary significant accounting policies and other explanatory

information; and

f. a statement of financial position as at the beginning of the earliest comparative period when an
entity applies an accounting policy retrospectively or makes a retrospective restatement of items
in its financial statements, or when it reclassifies items in its financial statements.

Statement of Comprehensive Income

The form and content of the income statement of the partnership resemble those of the sole
proprietorship with the exception of the presentation of the division of profits or losses at the
lower portion of the statement.

Biore and Besario

Partial Income Statement
For the Year Ended Dec. 31, 2019

Profit ₱ 300,000

Division of Profit (equally):

Partner Biore ₱ 150,000
Partner Besario 150,000
Total ₱ 300,000

The components of profit or loss may be presented either as part of a single statement of
comprehensive income or an income statement, as permitted by paragraph 81 of IAS No.1
(revised 2007). When an income statement is presented, it is part of a complete set of financial
statements and shall be displayed immediately before the statement of comprehensive income.
48 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
As a minimum, the statement of comprehensive income shall include line items that present the
following amounts for the period:

a. Revenue

b. Finance cost

c. Share of profit or loss of associates and joint ventures accounted for using the equity method;

d. Tax expense

e. A single amount comprising the total of:

i. The post-tax profit or loss of discontinued operations; and

ii. The post-tax gain or loss recognized on the measurement to fair value less costs to sell
on the disposal of the assets or disposal group(s) constituting the discontinued operations;

f. Profit or loss;

g. Each component of other comprehensive income classified by nature (excluding the amount in
(h) below)

h. Share of other comprehensive income of associates and joint ventures accounted for using the
equity method; and

i. Total comprehensive income

Statement of Changes in Equity

An entity shall present a statement of changes in equity, showing in the statement:

a. total comprehensive income for the period showing separately the total amounts attributable to
owners of the parent and to minority interests;

b. for each component of equity, the effects of retrospective restatement recognized in

accordance with IAS No. 8, Accounting Policies, Changes in Accounting Estimates and Errors;

c. the amounts of transitions of owners in their capacity as owners, showing separately

contributions by and distributions to owners; and

d. for each component of equity, a reconciliation between the carrying amount at the beginning
and the end of the period, separately disclosing each change.

The components of equity referred to above include for example, each class of contributed
equity, the accumulated balance of each class of other comprehensive income and retained
49 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
earnings (these are applicable to corporations). The amount of dividends recognize as
distributions to owners during the period, and the related amount per share, shall be presented
either in the statement of changes in equity or in notes.

In the case of Biore and Besario, as contrasted with a sole proprietorship, the number of capital
and drawing accounts has made the preparation of this statement all the more useful. Changes in
an entity‟s equity between the beginning and the end of the reporting period reflect the increase
or decrease in its net assets during the period.

Biore and Besario

Statement of Changes in Partner's Equity
For the Year Ended December 31, 2019

Biore Besario Total

Original Investment ₱ 400,000 ₱ 800,000 ₱ 1,200,000
Add: Additional Investment 100,000 - 100,000
Total 500,000 800,000 1,300,000
Less: Permanent Withdrawals 50,000 50,000
Balances 500,000 750,000 1,250,000
Add: Profit 150,000 150,000 300,000
Total 650,000 900,000 1,550,000
Less: Temporary Withdrawals 60,000 60,000 120,000
Partner's Equity, Dec. 31 ₱ 590,000 ₱ 840,000 ₱ 1,430,000

Statement of Financial Position

After all the components of the statement of comprehensive income along with the changes in
partners‟ equity for the period have been properly presented, the preparation of the statement of
financial position will present no major difficulty. The assets and liabilities will be presented in
the statement of financial position as those of a sole proprietorship but the owner‟s equity section
should exhibit separately the capital balance of P590,000 and P840,000 for Biore and Besario,
respectively.

Though some of the items are not familiar yet, per revised International Accounting Standards
(IAS) No.1, Presentation of Financial Statements, as a minimum, the face of the statement of
financial position shall include line items that present the following amounts:

a. Property, plant and equipment;

b. Investment property;

c. Intangible assets;

50 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
d. Financial assets (excluding amounts shown under e, h, and i);

e. Investment accounted for using the equity method;

f. Biological assets;

g. Inventories;

h. Trade and other receivables;

i. Cash and cash equivalents;

j. The total of assets classified as held for sale and assets included in disposal groups classified as
held for sale in accordance with IFRS 5

k. Trade and other payables;

l. Provisions;

m. Financial liabilities (excluding amounts shown under k and l);

n. Liabilities and assets for current tax, as defined in IAS 12;

o. Deferred tax liabilities and deferred tax assets as defined in IAS 12;

p. Liabilities in disposal groups classified as held for sale in accordance with IFRS 5.

q. Minority interest, presented within equity; and

r. Issued capital and reserves attributable to equity holders of the parent.

IAS No. 1 (revised 2007) does not prescribe the order or format in which an entity presents
items. The above enumeration (from Paragraph 54 of IAS No. 1, revised 2007) simply provides a
list of items that are sufficiently different in nature or function to warrant a separate presentation
in the statement of financial position.

Note that an entity makes the judgement about whether to present additional items separately on
the basis of an assessment of:

a. the nature and liquidity of assets;

b. the function of assets within the entity; and

c. the amounts, nature and timing of liabilities.

51 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Current and non-current assets and liabilities should be separately classified on the face of the
statement of financial position except when a presentation based on liquidity provides more
reliable and relevant information.

An entity shall classify an asset as current asset when it satisfies any of the following criteria:

 It expects to realize the assets, intends to sell or consume it, in its normal operating cycle;
or
 It holds the asset primarily for the purpose of trading; or
 It expects to realize the asset within 12 months after the end of the reporting period; or
 The asset is cash or a cash equivalent as defined in IAS No. 7.

All other assets are non-current. Operating cycle is the time between the acquisition of assets for
processing and their realization in cash or cash equivalents.

A liability should be classified as a current liability when it:

 is expected to be settled in the normal operating cycle; or

 is held primarily for the purpose of trading; or
 is due to be settled within 12 months after the end of the reporting period; or
 does not have an unconditional right to defer settlement of the liability for at least 12
months after the reporting period.

All other liabilities should be classified as non-current liabilities.

Statement of Cash Flows

The cash flow statement serves as a basis for evaluating the entity‟s ability to generate cash and
cash equivalents and the needs to utilize these cash flows.

The statement of cash flows provides information about the cash receipts and cash payments of
an entity during a period. It is a formal statement that classifies cash receipts (inflows) and cash
payments (outflows) into operating, investing and financing activities. This statement shows the
net increase or decrease in cash during the period and the cash balance at the end of the period; it
also helps project the future net cash flows of the entity. The discussion below gives an overview
of some important concepts involved in the preparation of the cash flow statement.

Cash Flows from Operating Activities

Operating activities generally involve providing services, and producing and delivering goods.
Cash flows from operating activities are generally the cash effects of transactions and other
events that enter into the determination of profit or loss. This cash flow can be presented using
either the direct or the indirect method.
52 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Using the direct method, the entity‟s net cash provided by (used in) operating activities is
obtained by adding the individual operating cash inflows and then subtracting the individual
operating cash outflows.

The indirect method derives the net cash provided (used in) operating activities by adjusting
profit for income and expense items not resulting from cash transactions. The adjustment begins
with profit followed by the addition of expenses and charges (e.g. depreciation) that did not
entail cash payments. Then, increases in current assets and decreases in current liabilities
involved in the determination of profit but which did not actually increase or decrease cash, are
subtracted from profit. Finally, decreases in current assets and increases in current liabilities are
added to profit to obtain net cash provided by (used in) operating activities.

Profit Pxxx
Adjustments for:
Non-Cash expenses (e.g.
Depreciation) xx
Increases in Current Asset Accounts (xx)
Decreases in Current Liability
Accounts (xx)
Decreases in Current Asset Accounts xx
Increases in Current Liability
Accounts xx
Cash Flows from Operating Activities Pxxx

For example, increases in accounts receivable from sale of services or goods represented an
increase in profit without the corresponding increase in cash- for it is still a receivable. Since
these revenues are already included in the computation of profit, the increase in accounts
receivable should be deducted from the profit figure. To illustrate further, assume that salaries
payable increased. Increase in salaries payable meant that the entity did not pay the full amount
of salaries expense for the period. The expense in the income statement, for cash flow purposes,
is overstated by the amount of unpaid salaries. If expense is overstated, then profit is understated
by the same amount; hence the increase in current liability is added to profit.

Per International Accounting Standards (IAS) No. 7, Cash Flow Statements, enterprises are
encourage to report cash flows from operating activities using the direct method but the indirect
method is acceptable. Only the direct method is illustrated here using assumed amounts. The
following are the major classes of operating cash flows using the direct method:

Cash Inflows

53 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
  receipts from sale of goods and performance of services
 receipts from royalties, fees, commissions and other revenues

Cash Outflows

 payments to suppliers of goods and services

 payments to employees
 payments for taxes
 payments for interest expense
 payments for other operating expenses

Cash Flows from Investing Activities

Investing activities include making and collecting loans; acquiring and disposing of investments
in debt or equity securities; and obtaining and selling of property and equipment and other
productive assets.

Cash Inflows

 receipts from sale of property and equipment

 receipt from sale of investments in debt or equity securities
 receipts from collections on notes receivable

Cash Outflows

 payment to acquire property and equipment

 payment to acquire debt or equity securities
 payment to make loans to others generally in the form of notes receivable

Cash Flows from Financing Activities

Financing activities include obtaining resources from owners and creditors.

Cash Inflows

 receipts from investment by owners

 receipts from issuance of notes payable

Cash Outflows

 payments to owners in the form of withdrawals

 payments to settle notes payable

54 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Eva Cammayo and Company
Statement of Cash Flows
For the Month Ended May 31, 2019

Cash Flows from Operating Activities:

Cash received from clients ₱ 604,000
Payments to suppliers (100,000)
Payments to employees (138,000)
Payments for office rent (80,000)
Payments for insurance (140,000)
Payments for utilities (30,000)
Net cash provided by (used in)operating activities ₱ 116,000

Cash Flows from Investing Activities:

Payments to acquire service vehicle -₱ 4,200,000
Payments to acquire office equipment (150,000)
Net cash provided by (used in) investing activities -₱ 4,350,000

Cash Flows from Financing Activities:

Cash received as investments by owners ₱ 2,500,000
Cash received from borrowings 2,100,000
Payments for withdrawals by owners (140,000)
Net cash provided by (used in) financing activities ₱ 4,460,000
Net Increase (Decrease) in Cash and Cash Equivalents ₱ 226,000
Cash and Cash Equivalents at the Beginning of the period 125,000
Cash and Cash Equivalents at the End of the period ₱ 351,000

Partner’s Equity

Capital Accounts

The capital accounts of each partner will be credited with the partner‟s original and additional
capital contributions, and debited with any permanent withdrawals. The balances of the partners‟
account will not change frequently. Capital accounts prepared in this manner are referred to as
fixed capital accounts.

55 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Current Accounts

The current account will be credited for salaries and interest on capital (in this case, with a debit
to profit and loss appropriation account). It will be debited for interest on drawings. At the end
of the year, it will be debited with the drawings account balance.

Partner's Current Account

Debit Credit
1. Interest on Drawings 1. Interest on Capital
2. Drawings 2. Partner's Salaries

3. Share in Residual Losses 3. Share in Residual Profits

The account shall also be credited with the share in the residual profits. Residual profits to be
divided using the profit or loss ratio is derived by adding interest on drawings and deducting
salaries and interest on capital to the accounting profit.

Current accounts can have either a debit or a credit balance, A credit balance will be undrawn
profits while a debit balance will be drawings in excess of the profits to which the partner is
entitled.

Drawing Accounts

A drawing account is maintained for each partner, This will be debited for any cash drawings
during the year. The balance of this account is transferred to the partner‟s current account at the
end of the year.

Interest on Drawings

Some partnership agreements will provide that partners will be charged interest on any drawings
made during the year. This is to deter partners from drawing cash from the business. The interest
on drawings is added to the profit for the year. It is debited to the individual partner‟s current
accounts and credited to the profit and loss appropriation account.

Illustration. Maribeth Buenviaje and Rey Fernan Refozar are partners sharing profits and losses
in the ratio 7:3 respectively. The following were taken from the partnership records for the fiscal
year ended May 31, 2019:

a. Partners‟ capital account balances: Buenviaje, P200,000 and Refozar, P140,000

56 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
b. Partners‟ Current accounts balances as at June 1, 2018: Buenviaje, P15,000 credit and
Refozar, P13,000 credit.

During the year, the partners made the following drawings from the partnership bank account:

Buenviaje: P10,000 on Aug. 31, 2018

P10,000 on Nov. 30, 2018

P10,000 on Feb. 28, 2019

P10,000 on May 31, 2019

Refozar: P7,000 on Aug. 31, 2018

P7,000 on Nov, 30, 2018

P7,000 on Feb, 28, 2019

P 7,000 on May 31, 2019

Interest is charged on drawings at 12% per annum. Interest is allowed on capital accounts and
credit balances on current accounts at 12% per annum. Refozar will receive a salary of P15,000
per annum. Profit for the year ended May 31, 2019 is P102,940.

a. Calculate the total interest chargeable on the partner‟s drawings.

Buenviaje:
8/31/2018 P 10,000 x 12% x 9/12 ₱ 900
11/30/2018 P 10,000 x 12% x 6/12 600
2/28/2019 P 10,000 x 12% x 3/12 300
₱ 1,800

Refozar:
8/31/2018 P7,000 x 12% x 9/12 ₱ 630
11/30/2018 P7,000 x 12% x 6/12 420
2/28/2019 P7,000 x 12% x 3/12 210
₱ 1,260
Total ₱ 3,060

57 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
b. Calculate the profit share of each partner

Profit for the year: P102,940 + P3,060 = P106,000

Buenviaje Refozar Total

Salaries ₱ 15,000 ₱ 15,000
12% Interest on Capital and
Current Accounts:
Buenviaje: 12% x P215,000 ₱ 25,800
Refozar: 12% x P153,000 ₱ 18,360 ₱ 44,160

Residual Profits to be Divided in a

Ratio of 70:30 [P106,000 -
P15,000 -P44,160 =P46,840]
Buenviaje: 70% x P46,840 ₱ 32,788
Refozar: 30% x P46,840 ₱ 14,052 ₱ 46,840
Share of Partners in Profits ₱ 58,588 ₱ 47,412 ₱ 106,000

c. Compute the balance of each partner‟s current account as at May 31, 2019.

Buenviaje Refozar Total

Beginning Balance ₱ 15,000 ₱ 13,000 ₱ 28,000
Share of Partners in Profits 58,588 47,412 106,000
Drawings (40,000) (28,000) (68,000)
Interest on Drawings (1,800) (1,260) (3,060)
Ending Balances ₱ 31,788 ₱ 31,152 ₱ 62,940

EXERCISES:

Direction: Journalize the entries and show the supporting computation for the problems.

Problem 1 Nikki Lim and Angel Go are partners. On March 1, 2020 Lim invested P400,000 while Go
invested P 500,000. Lim made additional investment of P 200,000 on August 31, 2020. Both partners
made permanent withdrawals of P60,000 each on October 31, 2020. The partnership generated an income
of P700,000 at year ended, December 31, 2020. It is the intention of the partnership that profit and losses
be credited or debited to drawing account.

58 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
1.a Assume that the partnership agreed to divide the profit in a ratio of 60:40 for Lim and Go
respectively, journalize the entry.

1.b Assume that the partnership agreement is based on the ratio of beginning capital of the year,
journalize the entry of the division of profit.

1.c Assume that the partnership agreement is based on the ratio of ending capital, journalize the division
of profit and losses

Problem 2 On January 1, 2020, Michael Cruz and Lourdes Santos formed a partnership. Cruz made an
initial investment of P600,000 while Santos invested P500,000. On June 30, 2020, Cruz made permanent
withdrawals of P75,000. Both partners made additional investment of P100,000 each on September 30,
2020. On December 31, 2020, the partnership obtained a profit of P800,000. It is the intention of the
partnership that profit and losses be credited or debited to drawing account.

2.a Assume that the partners agreed to divide profit based on the ratio of average capital balances,
journalize the entries.

2.b Assume that the partnership allowed 20% interest on average capital balances and the balance to be
divided in a ratio of 60:40 for Cruz and Santos respectively. Show the computation of partners share in
profit and journalize the division of profits.

2.c Assume that the partnership agreed to grant salaries to partners Cruz and Santos for P150,000 and
P100,000 respectively and the balance to be divided equally. Show the computation of partners share in
profit and journalize the division of profits.

2.d. Assume that Santos, the managing partner was given bonus of 25% of profit before bonus and the
balance to be divided equally. Show the computation of partners share in profit and journalize the
division of profits.

Problem 3 Joseph Dalangin and Marie Lopez are partners with average capital balances of P500,000 and
P600,000 respectively. As of December 31, 2020, the partnership generated a profit of P900,000. It is the
intention of the partnership that profit and losses be credited or debited to drawing account.

3.a Assume that the partnership agreement provided for a bonus of 30% of profit after bonus to
Dalangin, the managing partner and the balance to be divided equally. Show the computation of partners
share in profit and journalize the division of profits.

3.b Assume that the partnership agreed that bonus to managing partner, Dalangin is 30% of profit after
salaries and interest but before bonus and the balance to be divided in a ratio of 60:40 to Dalangin and
Lopez respectively. Salaries agreed were P75,000 and P50,000 to Dalangin and Lopez respectively and
interest of 20% on average capital balances. Show the computation of partners share in profit and
journalize the division of profits.

59 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
3.c Assume instead that the bonus to Dalangin is 30% of profit after salaries, interest of 20% on average
capital balances and after bonus and the balance to be divided equally. The salaries agreed were P75,000
and P50,000 to Dalangin and Lopez respectively. Show the computation of partners share in profit and
journalize the division of profits.

60 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Module 3: DISSOLUTION-Changes in Ownership

The dissolution of a partnership is the change in the relation of the partners caused by any
partner ceasing to be associated in the carrying on as distinguished from the winding up of the
business of the partnership (Civil Code of the Philippines, Article 1828).

On dissolution, the partnership is not terminated, but continues until the winding up of
partnership affairs is completed (Article 1829). Winding up is the process of settling the business
or partnership affairs after dissolution. Termination is that point in time when all partnership
affairs are wound up or completed, and is the end of the partnership life.

Limited life is one of the characteristics of a partnership. Any change in the membership of this
form of business organization will result to dissolution. Dissolution of the partnership does not
necessarily imply that business operations will come to an end. Most changes in the ownership of
a partnership are accomplished without interruption of its normal operations.

Dissolution should be distinguished from liquidation of a partnership. A partnership is said to be

liquidated when the business is terminated; a partnership may be dissolved without being
terminated but liquidation is always preceded by dissolution.

When partnership dissolution occurs, a new accounting entity is formed. The old partnership
should first adjust its books so that all accounts are properly stated at the date of dissolution.

Illustration. When the large international accounting firm, Sycip Gorres Velayo & Co., retires
and admits partners during the year, the former partnership is dissolved and a new partnership
begins with little outward evidence of any change. In fact, the new partnership may retain the
dissolved partnership‟s name. From the legal viewpoint, partnership is dissolved by admission or
by retirement of a partner. However, accountants are more concerned with the substance of an
event rather than with its legal form. Therefore, the accountants must evaluate all the
circumstances of the individual case to determine how a change in partners should be recorded.

CAUSES OF DISSOLUTION

Partnership dissolution due to changes in ownership occurs for varying reasons and the following
are more prevalent:

1. Admission of a partner

2. Withdrawal or retirement of a partner

3. Death of a partner

4. Incorporation of the partnership

61 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
ADMISSION OF A PARTNER

A new partner can only be admitted into a partnership with the consent of all the continuing
partners. This is based on the principle of delectus personae: No one becomes a member of the
partnership without the consent of all the members.

By admission of a new partner, the old partnership has been dissolved and it is important that a
new agreement be formulated to govern the continuing business operations. A person may
become a partner in an existing partnership by either of the following:

1. Purchase of an interest from one or more of the existing partners.

2. Investment of assets in the partnership by the new partner.

The foregoing situations are similar in the sense that the old partnership is legally dissolved; the
capital, and profit and loss ratio will be based on a new partnership agreement. But these are
dissimilar in the sense that the partnership receives no new resources when a third party
purchases an interest directly from existing partners, but it does receive new resources when a
third party becomes a partner by investing in the partnership.

Liability of Incoming Partner for Existing Obligations

A person admitted as a partner into an existing partnership is liable for all the obligations of the
partnership incurred before his admission as though he had been a partner when such obligations
were incurred. Such liability is limited to his capital contribution, unless otherwise agreed.

Illustration. Miravel Nazario, Martin Penaco and Ricardo Pangan formed NPP, a general
professional partnership, with a capital of P50,000 each on Feb. 14, 2019. On Apr. 8, the
partnership incurred an obligation of P200,000 to Teresita Buenaflor which will be payable on
Dec. 16. On June 13, Bienvenida Alvaro was admitted into the partnership; she contributed
P20,000.

Even if the obligation was incurred before Bienvenida Alvaro‟s admission into the partnership,
she is still liable to Teresita Buenaflor but only to the extent of her contribution. Total
partnership capital upon admission is P170,000 leaving a balance of P30,000 (deficit) which will
be shared by the old partners equally.

PURCHASE OF AN INTEREST FROM EXISTING PARTNERS

With the consent of all continuing partners, a person may be admitted into an existing
partnership by purchasing an interest directly from one or more of the existing partners. Payment

62 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
is made personally to the partner from whom the interest is obtained resulting to mere transfers
among capital accounts.

This type of admission will only result to a debit to the capital account of the selling partner for
the interest sold and credit to the capital account of the buying partner for the interest purchased.
The amount debited and credited is not affected by the actual price for the equity interest. In this
type of admission, the total assets, total liabilities and total partner‟s equity of the partnership are
not affected upon admission.

Illustration. Froilan Labausa and Reynaldo San Mateo are partners with capital balances of
P400,000 and P200,000 respectively. They share profits in the ratio of 3:1 respectively.

Case 1: Payment to old partners is equal to interest purchased. Partners Froilan Labausa and
Reynaldo San Mateo received an offer from Janet Matuguinas to purchase directly one-fourth of
each of their interest in the partnership for P150,000. The partners agreed to admit Janet
Matuguinas in the firm.

Froilan Labausa, Capital P100,000

Reynaldo San Mateo, Capital 50,000
Janet Matuguinas, Capital P150,000
To record admission of Matuguinas.

Computation:

Labausa: P400,000 x 1/4 = P100,000

San Mateo: P200,000 x 1/4 = P50,000
Interest transferred to Matuguinas = P150,000

One-fourth of each partner‟s capital was transferred to the new partner. The partnership did not
receive the cash paid because the transaction is between Matuguinas and partners Labausa and
San Mateo personally, not between Matuguinas and the partnership.

Case 2: Payment to old partners is less than the interest purchased. Assume that Janet
Matuguinas directly purchased one-third of each partner‟s interest in the business. Matuguinas
paid P160,000 for one-third of each partner‟s capital.

Froilan, Labausa, Capital P133,333

Reynaldo San Mateo, Capital 66,667
Janet Matuguinas, Capital P200,000
To record admission of Matuguinas.

Computation:
Labausa: P400,000 x 1/3 = P133,333
San Mateo: P200,000 x 1/3 = P66,667
63 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Interest transferred to Matuguinas = P200,000

The new partner was credited for P200,000 interest in the new partnership. The equity is
transferred to Matuguinas as its book value to the old partners of P200,000. The negotiated price
of P160,000 does not affect the entry because the exchange is between Matuguinas and the old
partners and does not involve partnership assets.

Case 3: Payment to old partners is more than the interest purchased. Partners Froilan
Labausa and Reynaldo San Mateo received an offer from Janet Matuguinas to purchase directly
30% of each of their interest in the partnership for P200,000. The partners agreed to admit Janet
Matuguinas as a member of the firm.

Froilan Labausa, Capital P120,000

Reynaldo San Mateo, Capital 60,000
Janet Matuguinas, Capital P180,000
To record admission of Matuguinas.

Computation:
Labausa: P400,000 x 30% = P120,000
San Mateo: P200,000 x 30% = P60,000
Interest transferred to Matuguinas = P180,000

Thirty percent of each partner‟s capital was transferred to the new partner. Just like in the other
preceding cases, the partnership did not receive the cash paid because the transaction is between
Matuguinas and partners Labausa and San Mateo personally, not between Matuguinas and
partnership.

INVESTMENT OF ASSETS IN A PARTNERSHIP

A person may be admitted into a partnership by investing cash or other assets in the business.
The assets are invested into the partnership and not given to the individual partners. The
investment will increase the total assets and the partners‟ equity.

Definition of Terms

Total Contributed Capital. It is the sum of the capital balances of the old partners and the
actual investment of the new partner.

Total Agreed Capital. It is the total capital of the partnership after considering the capital
credits given to each of the partners. Under the bonus method, total agreed capital is equal to the
total contributed capital though the capital credits to each partner may be equal to, greater than or
less than his capital contributions.

Bonus. It is the amount of capital or equity transferred by one partner to another partner.

64 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Capital Credit. It is the equity of a partner in the new partnership and is obtained by multiplying
the total agreed capital by the applicable percentage of interest of the partner.

Bonus to Old Partners

A partnership may be exceptionally attractive because of superior earnings record such that the
old partners may demand a premium from a new partner. This premium increases the old
partners‟ capital interest. This premium is effected either by allocating a portion of the
investment of the new partner to the old partner. The capital accounts of the old partners are
credited for the premium according to their profit and loss ratio.

Illustration. Rebecca Miranda and Kareen Leon are partners with capital balances of P400,000
and P200,000 respectively. They share profits in the ratio of 3:1. The partners agreed to admit
Gualberto Magdaraog Jr. as a member of the firm. The foregoing information will be the basis of
the following cases.

Case 1. Total agreed capital is stated. Assume that Gualberto Magdaraog Jr. invested
P250,000 for a one-fourth interest in the business. The partners decided not to revalue the assets
of the partnership and that the total agreed capital is P850,000.

Contributed Agreed
Capital Bonus Capital
Rebecca Miranda ₱ 400,000 ₱ 28,125 ₱ 428,125
Kareen Leon 200,000 9,375 ₱ 209,375
Total 600,000 37,500 637,500
Gualberto Magdaraog Jr. 250,000 (37,500) 212,500 *
Total ₱ 850,000 ₱ - ₱850,000

*P850,000 x 1/4 = P212,500

Distribution of Bonus:
Miranda: P37,500 x 3/4 = P28,125
Leon: P37,500 x 1/4 = P 9,375

The investment of Magdaraog resulted to a bonus because the total contributed capital of
P850,000 is equal to the agreed capital. The partnership net assets are increased only by the
amount of the new investment. The capital credit for Magdaraog of P212,500 is P37,500 less
than his actual investment. The difference represented the bonus allocated to the old partners in
their profit and loss ratio.
(1)
Cash P250,000
Gualberto Magdaraog, Capital P250,000
To record the investment of Magdaraog.
65 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
(2)
Gualberto Magdaraog Jr., Capital P37,500
Rebecca Miranda, Capital P28,125
Kareen Leon, Capital 9,375
To record bonus to old partners.
Case 2. Total agreed capital is not explicitly stated. Assume that Gualberto Magdaraog Jr.,
invested P400,000 in the business. Out of the total cash investment, P100,000 is considered as a
bonus to Partners Rebecca Miranda and Kareen Leon. The investment of Magdaraog resulted to
a bonus as stated. Under the bonus method, the total contributed capital is equal to the total
agreed capital. It is also clearly specified that the old partners will receive the bonus.

Contributed Agreed
Capital Bonus Capital
Rebecca Miranda ₱ 400,000 ₱ 75,000 ₱ 475,000
Kareen Leon 200,000 25,000 225,000
Total 600,000 100,000 700,000
Gualberto Magdaraog, Jr. 400,000 (100,000) 300,000
Total ₱ 1,000,000 ₱ - ₱ 1,000,000

Distribution of Bonus:
Miranda: P100,000 x 3/4 = P75,000
Leon: P100,000 x 1/4 = P25,000

(1)
Cash P400,000
Gualberto Magdaraog Jr., Capital P400,000
To record the investment of Magdaraog.

(2)
Gualberto Magdaraog Jr., Capital P100,000
Rebecca Miranda, Capital P75,000
Kareen Leon, Capital 25,000
To record bonus to old partners.

The capital credit for Magdaraog is P100,000 less than his actual investment. The difference
represented the bonus allocated to the old partners in their profit and loss ratio.

Bonus to New Partner

A new partner may be admitted into the partnership because of his vast financial resources,
extensive business network, distinctive reputation, unique management and/or technical skills.
The old partners may be willing to give a premium for all of these exceptional qualifications by
allowing a capital credit greater than the prospective partner‟s investment just to ensure his
66 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
association with the partnership. This premium will be treated as a bonus from the equities of the
old partners and credited to the new partner.

Case 1. Total agreed capital is stated. Assume that Gualberto Magdaraog Jr. invested P240,000
for a one-third interest in the business. The total agreed capital is P840,000. The investment of
Magdaraog resulted to a bonus as shown by the following table:

Contributed Agreed
Capital Bonus Capital
Rebecca Miranda ₱ 400,000 (30,000) ₱ 370,000
Kareen Leon 200,000 (10,000) 190,000
Total 600,000 (40,000) 560,000
Gualberto Magdaraog Jr. 240,000 40,000 280,000*
Total ₱ 840,000 - ₱ 840,000

*P840,000 x 1/3 = P280,000

Distribution of Bonus:
Miranda: P40,000 x 3/4 = P30,000
Leon: P40,000 x 1/4 = P10,000

(1)
Cash P240,000
Gualberto Magdaraog, Jr., Capital P240,000
To record the investment of Magdaraog.

(2)
Rebecca Miranda, Capital P30,000
Kareen Leon, Capital 10,000
Gualberto Magdaraog Jr., Capital P40,000
To record bonus to new partner.

The capital credit for Magdaraog of P280,000 is P40,000 more than his actual investment. This
difference represented a bonus to the new partner because the total contributed capital is equal to
the total agreed capital, and the capital credit to the new partner is more than his actual
investment. The equities of the old partners are decreased by P40,000 in their profit and loss
ratio.

Case 2. Total agreed capital is not explicitly stated. Assume that Gualberto Magdaraog Jr.,
invested P300,000 for a 50% interest in the business. Rebecca Miranda and Kareen Leon
transferred part of their capital balance to that of Gualberto Magdaraog Jr. as a bonus. The
investment of Magdaraog resulted to a bonus as stated. Under the bonus method, the total

67 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
contributed capital is equal to the agreed capital. It is also clearly specified that the new partner
will receive the bonus.

Contributed Agreed
Capital Bonus Capital
Rebecca Miranda ₱ 400,000 P (112,500) ₱ 287,500
Kareen Leon 200,000 (37,500) 162,500
Total ₱ 600,000 P(150,000) ₱ 450,000
Gualberto Magdaraog Jr. 300,000 150,000 450,000*
Total ₱ 900,000 - ₱ 900,000

*P900,000 x 50% = P450,000

Distribution of Bonus:
Miranda: P150,000 x 3/4 = P112,500
Leon: P150,000 x 1/4 = P37,500

(1)
Cash P300,000
Gualberto Magdaraog Jr., Capital P300,000
To record the investment of Magdaraog.

(2)
Rebecca Miranda, Capital P112,500
Kareen Leon, Capital 37,500
Gualberto Magdaraog Jr., Capital P150,000
To record bonus to new partner.

The capital credit for Magdaraog of P450,000 is P150,000 more than his actual investment. This
difference represented the bonus allocated to the new partner. The equities of the old partners are
decreased by P150,000 in their profit and loss ratio.

68 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
WITHDRAWAL OR RETIREMENT OF A PARTNER

A partner may withdraw or retire from a partnership for various reasons. Disputes with other partners, old
age, and pursuit for better opportunities are among the possible explanations. The withdrawal of a partner
dissolves the old partnership. This type of dissolution may be accomplished by either of the following
ways:

1. by selling his equity interest to one or more of the remaining partners

2. by selling his equity interest to an outsider

3. by selling his equity interest to the partnership

Sale of Interest to a Partner or an Outsider

When a partner‟s interest is sold to another partner or an outsider, the withdrawing partner is paid from
the personal assets of the buyer. Accounting for this sale is similar to admission by purchase of interest.
The total assets of the partnership are not affected by the consideration involved. The required entry will
only be a debit to the seller‟s capital account for his capital balance and a credit to the buyer‟s capital
account for the same amount.

There are times when a partner withdraws in the middle of the accounting period; in such a case, the
books of the partnership should be updated to determine the retiring partner‟s capital balance. Profits or
losses should be measured from the last closing of books to the date of withdrawal and distributed
according to their profit or loss sharing agreement.

Sale of Interest to the Partnership

When a withdrawing partner sells his interest to the partnership, the partner is paid from the assets of the
partnership. He may receive an amount equal to, greater than or less than the balance of his capital
account. The effect of withdrawal is to reduce the assets and the owners‟ equity of the partnership.

The accounting issues to be encountered here will be similar to admission by investment of assets but in a
reverse manner. Instead of a new partner joining the partnership by investing assets into the partnership,
an old partner is now leaving the partnership with the business distributing assets to the withdrawing

69 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
partner. Note that the withdrawing partner may receive his share of the business in partnership assets
other than cash.

Illustration. Suppose that Remedios Palaganas is retiring in midyear from the partnership Almazan,
Saclot, and Palaganas because of family relocation. Physical distance will prevent her from coping with
the daily rigors of their fashion and beauty consulting business. After the books have been adjusted for the
semi-annual profits but before revaluation, their capital balances are as follows:

Melinda Almazan, Capital P540,000

Greg Saclot, Capital 430,000
Remedios Palaganas, Capital 210,000

An independent appraiser revalued their cosmetics inventory to P380,000 ( a decrease of P60,000) and
their land to P1,010,000 (an increase of P460,000). The profit and loss ratio of the partners is 1:2:1.

The entries to record the revaluation of assets follow:

Melinda Almazan, Capital P15,000
Greg Saclot, Capital 30,000
Remedios Palaganas, Capital 15,000
Cosmetics Inventory P60,000
To revalue cosmetics inventory per appraisal.

Computation:
Almazan: P60,000 x 1/4 = P15,000
Saclot: P60,000 x 2/4 = P30,000
Palaganas: P60,000 x 1/4 = P15,000

Land P460,000
Melinda Almazan, Capital P115,000
Greg Saclot, Capital 230,000
Remedios Palaganas, Capital 115,000
To revalue land per appraisal.

Computation:
Almazan: P460,000 x 1/4 = P115,000
Saclot: P460,000 x 2/4 = P230,000
Palaganas: P460,000 x 1/4 = P115,000

After revaluation, the capital balances of the partners are shown below:
Melinda Almazan, Capital P640,000
Greg Saclot, Capital 630,000
Remedios Palaganas, Capital 310,000

Computation of Capital Balances:

Almazan: P540,000 – P15,000 + P115,000 = P640,000

Saclot: P430,000 – P30,000 + P230,000 = P630,000
Palaganas: P210,000 – P15,000 + P115,000 = P310,000

70 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Case 1. Withdrawal at book value. Assume that Remedios Palaganas agreed to accept payment equal to
her interest. The entry to record the payment of cash and the closing of capital will be:

Remedios Palaganas, Capital P310,000

Cash P310,000
To record retirement of Palaganas.

Case 2. Withdrawal at more than book value. Assume that Remedios Palaganas demanded a P400,000
settlement for her interest because she firmly believed that she contributed so much to the success of the
business. The remaining partners agreed for old time‟s sake. If the current fair value of the partnership‟s
net assets exceeded book value, the settlement price to the withdrawing partner will be greater than his
capital account balance. The excess payment is treated either as a bonus to the retiring partner from the
continuing partners.

Melinda Almazan, Capital P30,000

Greg Saclot, Capital 60,000
Remedios Palaganas, Capital 310,000
Cash P400,000
To record retirement of Palaganas with bonus from continuing partners.

Computation:

Almazan: P90,000 x 1/3 = P30,000

Saclot: P90,000 x 2/3 = P 60,000

The entry reflected the fact that Almazan and Saclot granted a P90,000 bonus to Palaganas that was
charged to their capital accounts in their profit and loss ratios.

Case 3. Withdrawal is less than book value. Assume that Remedios Palaganas is very eager to retire
and is willing to accept settlement at P280,000. When Palaganas, the retiring partner, received as
settlement an amount less than her capital balances, in effect, the partner is giving a part of her equity
interest to the continuing partners as bonus. The amount of the bonus is credited to the capital accounts of
the continuing partners in their profit and loss ratio.

Remedios Palaganas, Capital P310,000

Cash P280,000
Melinda Almazan, Capital 10,000
Greg Saclot, Capital 20,000
To record retirement of Palaganas with bonus to continuing partners.

Computation:

Almazan: P30,000 x 1/3 = P10,000

Saclot: P30,000 x 2/3 = P20,000

71 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Payment to a withdrawing partner at less than book value may also imply that the partnership assets are
overvalued. In this case, overvalued assets should be identified and reduced to their fair values.

DEATH OF A PARTNER

The death of a partner dissolves a partnership. When the death of a partner does not result to liquidation,
the accounting procedures to be followed are similar to those discussed in the withdrawal of a partner.
The deceased partner may be considered to have retired from the partnership and his heirs or estate can
expect to receive the amount of his interest from the business. If payment to the estate of the deceased
cannot be made immediately, the balance in the capital account of the deceased partner should be
transferred to a liability account payable to the estate.

INCORPORATION OF A PARTNERSHIP

A partnership may decide to incorporate after evaluating the various advantages of having a corporate
form of business organization. After the necessary adjusting and closing entries, the assets and liabilities
of the partnership are transferred to the corporation in exchange for shares of stocks. The shares received
by the partnership distributed to the partners based on their equity interests. In the books of the
corporation, the receipt of transferred assets and liabilities will be recorded along with the issuance of
share capital to the incorporators, the “former” partners.

Illustration: Madelyn Rialubin and Juanita Rabena, who share equally in profits and losses, have the
following items in their partnership‟s statement of financial position as at Dec. 31, 2019:

Cash ₱ 120,000 Accounts Payable ₱ 172,000

Accounts Receivable 100,000 Accum. Depreciation 8,000
Inventory 140,000 Madelyn Rialubin, Capital 140,000
Equipment 80,000 Juanita Rabena, Capital 120,000
Total ₱ 440,000 ₱ 440,000

They agreed to incorporate their partnership with the new corporation absorbing the net assets after the
following adjustments: providing for allowances for doubtful accounts of P10,000; restatement of the
inventory to its current fair value of P160,000; and additional recognition of depreciation on the
equipment of P3,000.

The corporation‟s share capital will have a par value of P100, and the partners will be issued the shares
equivalent to their adjusted capital balances. The journal entries to incorporate the partnership will be:

Cash P120,000
Accounts Receivable 100,000
Inventory 160,000
Equipment 69,000
Allowance for Doubtful Accounts P10,000
Accounts Payable 172,000
72 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Ordinary Share 267,000

EXERCISES:

Answer the following questions comprehensively:

1. Define dissolution. What are the causes of dissolution?
2. What is the principle of delectus personae? What is its relevance to the admission of a partner?
3. Differentiate total contributed capital from total agreed capital.
4. What is capital credit. How it is obtained?
5. Why is it stated that the accounting treatment of retirement by sale of interest to the partnership is the
exact reverse of admission by investment of assets?

Problem 1:
The capital accounts of Loida Cardenas and Cristina San Jose have balances of P150,000 and
P110,000, respectively. Daria Labalan and Helen Magada are to be admitted to the partnership. Labalan
buys one-fifth of Cardenas‟ interest for P35,000 and one-fourth of San Jose‟s interest for P25,000.
Magadia contributes P70,000 cash to the partnership, for which she is to receive an ownership equity of
P70,000.

Required:
a. Journalize the entries to record the admission of Labalan and Magada.
b. What are the capital balances of each partner after the admission of the new partners?

Problem 2:

After the tangible assets have been adjusted to fair values, the capital accounts of Rey Refozar and
Rogelio Ceradoy have balances of P75,000 and P125,000 respectively. Jiexel Manongsong is to be
admitted to the partnership, contributing P50,000 cash to the partnership for which he is to receive an
equity of P65,000. All partners share equally in profit.

Required:
a. Prepare the journal entry to record the admission of Manongsong who is to receive a bonus of P15,000.
b. Calculate the capital balances of each partner after the admission of the new partner.

Problem 3:

Castro and Falceso are partners who share profits and losses in a ratio of 2:3 respectively, and have the
following capital balances on Sept. 30, 2020: Castro, Capital, P100,000 Cr and Falceso, Capital,
P150,000 Cr. The partners agreed to admit Garachico to the partnership.

Required: Calculate the capital balances of each partner after the admission of Garachico, assuming that
bonuses are recorded when appropriate for each of the following assumptions:
1. Garachico paid Castro P50,000 for 40% of his interest.
2. Garachico invested P50,000 for a one –sixth interest in the partnership.
3. Garachico invested P50,000 for a 25% interest in the partnership.
4. Garachico invested P50,000 for a 15% interest in the partnership.

73 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
MODULE 4 –LIQUIDATION

The liquidation of a partnership is the winding up of its business activities characterized by sale of all
non-cash assets, settlement of all liabilities and distribution of the remaining cash to the partners. The
conversion of non-cash assets into cash is referred to as realization. This may either result to a gain or
loss on realization and shall be divided in the profit or loss ratio of the partners. In some cases, a
substantial loss on realization may yield for a partner a capital deficiency which is the excess of a
partner‟s share in losses over the partner‟s capital credit balance. This deficiency will certainly affect the
partnership interest – the sum of his capital and loan accounts – in the partnership.

RULES IN SETTLING ACCOUNTS AFTER DISSOLUTION

The following rules are subject to revisions by the agreement of the partners, either in their original
partnership agreement or in a dissolution agreement. (Civil Code of the Philippines, Article 1839).

Assets of the Partnership

The assets of the partnership consist of the following:

1. partnership property,

2. additional contributions of the partners needed for the payment of all liabilities

Order of Preference

The assets of a general partnership shall be applied in the following order:

1. First, those owing to outside creditors.

2. Second, those owing to inside creditors in the form of loans or advances for business expenses by the
partners.

3. Third, those owing to the partners with respect to their capital contributions,

4. Lastly, those owing to the partners with respect to their share of the profits.

The second preference above gives the partner with the loan account the option to exercise his right of
offset. This privilege is the legal right of a partner to apply part or all of his loan account balance against
his capital deficiency resulting from losses in the realization of the partnership assets.

Illustration. Winston Apalisoc, Beatriz Onate and Emerita Geron are partners in the prawn export
business. Initially, Winston Apalisoc contributed P300,000; Beatriz Onate, P200,000 and Emerita Geron,
P100,000. On the date of dissolution, the remaining assets of the partnership amounted to P1,000,000.
The partnership has outstanding obligations with Neo Aglugub, P140,000; Placido Tuddao, P100,000 and
loans payable to Winston Apalisoc, P40,000. The accounts of the Apalisoc, Onate and Geron partnership
shall be settled as follows:

74 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
1. First, Neo Aglugub and Placido Tuddao who are outside creditors shall be paid the total sum of
P240,000; thus, leaving a balance of P760,000 (P1,000,000 – P240,000) in partnership assets;

2. Second, Winston Apalisoc who is an inside creditor shall be paid his loan to the partnership of
P40,000; balance at P720,000 (P760,000-P40,000);

3. Third, the total contributions of Apalisoc, Onate and Geron to the initial partnership capital in the
amount of P600,000 will be paid; balance of assets at P120,000 (P720,000-P600,000);

4. Lastly, the balance of P120,000 shall be distributed to the partners in the ratio of their capital
contributions since there was no mention of an agreement entitled to 3/6 of P120,000 or P60,000; Beatriz
Onate, 2/6 or P40,000 and Emerita Geron, 1/6 or P20,000.

Insufficient Partnership Assets

In cases when the partnership assets are insufficient to settle all outside liabilities, the partners should
make additional contributions in the partnership. Any partner who contributed in excess of his share in
this liability has a right to collect the supposed additional contributions from the other partners.

Illustration. Assume in the illustration above that the outstanding obligations of the partnership, all
accruing to outside creditors, amounted to P1,120,000. The partnership assets of P1,000,000 will be
insufficient to fully settle these liabilities. The unpaid balance will be P120,000. Therefore, the partners
should contribute sufficient assets to cover the deficiency or loss. In the absence of an agreement, the
basis of the additional contributions shall be the ratio of their capital contributions.

As a result, Winston Apalisoc is still liable from his separate properties in the amount of P60,000; Beatriz
Onate, P40,000 and Emerita Geron, P20,000; these contributions will be used to settle the remaining
liabilities of P120,000. This sum of money is properly considered as partnership assets. In the event of
payment of Emerita Geron of the full amount of P120,000, she will have the right to recover the amount
that she has paid in excess of her share of the liability from Winston Apalisoc, P60,000 and from Beatriz
Onate, P40,000.

Preference of Partnership Creditors and Partners’ Separate Creditors

The creditors of the partnership shall have priority in payments over those of the partners‟ separate
creditors as regards the partnership properties. On the other hand, the creditors of the partners are
preferred with respect to the separate or personal properties of the partners.

Distribution of Separate Properties of an Insolvent Partner

If a partner is insolvent, his personal properties shall be distributed as follows:

1. First, those owing to separate creditors,

2. Second, those owing to partnership creditors,

75 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
3. Lastly, those owing to the partners by way of additional contributions when the assets of the
partnership were insufficient to settle all obligations.

Illustration. Assuming that because of the total partnership liabilities amounting to P1,120,000, Emerita
Geron is still personally liable to partnership creditors in the amount of P20,000. Her separate properties
in the amount of P90,000 shall first be applied to settle his personal obligations of P80,000 to Patrocinio
Abad and the balance of P10,000 to pay one-half of her liability of P20,000 to the creditors of the
partnership. This is in consonance with the rule that separate creditors are preferred over partnership
creditors as regards separate properties of a partner.

METHODS OF PARTNERSHIP LIQUIDATION

The following methods may be used when a partnership is liquidated:

1. Lump-sum method

Under this method, all non-cash assets are realized and the related gains or losses distributed and all
liabilities are paid before a single final cash distribution is made to the partners.

2. Installment method

Under this method, realization of non-cash assets is accomplished over an extended period of time. When
cash is available, creditors may partially or fully paid. Any excess may be distributed to the partners in
accordance with a program of safe payments or a cash priority program. This process persists until all the
non-cash assets are sold.

ENTRIES RELATED TO LIQUIDATION

The steps in the liquidation of a partnership will need the following pro-forma entries:

1. Sale of Non-Cash Assets

a. At Book Value

Cash xx
Non-Cash Assets xx

b. Above Book Value

Cash xx
Non-Cash Assets xx
Gain on Realization xx

c. Below Book Value

Cash xx
Loss on Realization xx
Non-Cash Assets x
76 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
2. Distribution of Gain or Loss on Realization based on P/L ratio

a. Distribution of Gain on Realization

Gain on Realization xx
Partner A, Capital xx
Partner B, Capital xx
Partner C, Capital xx

b. Distribution of Loss on Realization

Partner A, Capital xx
Partner B, Capital xx
Partner C, Capital xx
Loss on Realization xx

3. Payment of Liabilities

Liabilities xx
Cash xx

4. Exercise of Right of Offset

Partner A, Loan xx
Partner A, Capital xx

5. Additional Investment by Deficient Partner

Cash xx
Partner A, Capital xx

6. Deficiency Absorbed by Solvent Partner

Partner B, Capital xx
Partner A, Capital xx

7. Distribution of Cash to Partners

Partner A, Capital xx
Partner B, Capital xx
Partner C, Capital xx
Cash xx

LUMP-SUM LIQUIDATION
Under this method, all non-cash assets are realized and all liabilities are settled before a single final cash
distribution is made to the partners. The procedures below may be followed in lump-sum of liquidation:

1. Realization of non-cash assets and distribution of gain or loss on realization among the partners based
on profit and loss ratio.

2. Payment of liabilities.

77 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
3. Elimination of partners‟ 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 the order of priority:

a. If the deficient partner has a loan balance, then exercise the right to offset.
b. If the deficient partner is solvent, then he should invest cash to eliminate deficiency.
c. If the deficient partner is insolvent, then the other partners should absorb his deficiency.

4. Payments to partners, in the order of priority:

a. Loan accounts
b. Capital accounts

Illustration. Joel Feliciano, Evelyn Tria, and Nick Marasigan are partners in a public relations firm and
share profits and losses in the ratio of 2:2:1 respectively. They decided to liquidate their business on
December 31, 2019. The following is the condensed statement of financial position prepared prior to
liquidation:

Feliciano, Tria and Marasigan

Statement of Financial Position
December 31, 2019

Assets
Cash ₱ 200,000
Non-cash assets 3,400,000
Total Assets ₱ 3,600,000

Liabilities and Owner's Equity

Liabilities ₱ 1,120,000
Evelyn Tria, Loan 50,000
Nick Marasigan, Loan 80,000
Joel Feliciano, Capital 950,000
Evelyn Tria, Capital 600,000
Nick Marasigan, Capital 800,000
Total Liabilities and Capital ₱ 3,600,000

Case 1. Loss on Realization Fully Absorbed by Partners’ Capital Balances

Assume that the non-cash assets are sold at P2,500,000 with a resulting loss on realization of P900,000
which was distributed in the ratio of 4:4:2. The capital balance of each partner is sufficient to fully absorb
the share in the loss. The payment of cash to partnership creditors and the final distribution of the
remaining cash to the partners presented no problem.

78 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Feliciano, Tria and Marasigan
Statement of Liquidation
December 31, 2019

Non-Cash Marasigan Feliciano, Marasigan,

Cash Liabilities Tria, Loan Tria, Capital
Assets , Loan Capital Capital
P/L Percentages 40% 40% 20%
Balances before
Liquidation ₱ 200,000 ₱ 3,400,000 ₱ 1,120,000 ₱ 50,000 ₱ 80,000 ₱ 950,000 ₱ 600,000 ₱ 800,000
Sale of Non-Cash
Assets and Distribution
of Losses 2,500,000 (3,400,000) (360,000) (360,000) (180,000)
Balances 2,700,000 - 1,120,000 50,000 80,000 590,000 240,000 620,000
Payment of Liabilities to
Outsiders (1,120,000) (1,120,000)
Balances 1,580,000 - 50,000 80,000 590,000 240,000 620,000

Payments to Partners (1,580,000) (50,000) (80,000) (590,000) (240,000) (620,000)

1. Sale of Non-Cash Assets

Cash P2,500,000
Loss on Realization 900,000
Non-Cash Assets P3,400,000

Distribution of Loss on Realization based on P/L ratio

Joel Feliciano, Capital P360,000

Evelyn Tria, Capital 360,000
Nick Marasigan, Capital 180,000
Loss on Realization P900,000

2.Payment of Liabilities

Liabilities P1,120,000
Cash P1,120,000

3. Distribution of Cash to Partners

Evelyn Tria, Loan P50,000

Nick Marasigan, Loan 80,000
Joel Feliciano, Capital 590,000
Evelyn Tria, Capital 240,000
Nick Marasigan, Capital 620,000
Cash P1,580,000

79 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Case 2. Loss on Realization Resulting to a Capital Deficiency with Right of Offset

Assume that the non-cash assets are sold at P1,850,000 with a resulting loss on realization of P1,550,000,
which was distributed in the ratio 4:4:2. The capital balance of partner Evelyn Tria was insufficient to
fully absorb her share in the loss and thus, incurred a capital deficiency of P20,000. Instead of making an
additional investment, Tria opted to exercise her right to offset. A portion of her loan to the partnership
was applied to her deficient capital. Outside creditors were paid and a final distribution of the remaining
cash to the partners was made.

Feliciano, Tria and Marasigan

Statement of Liquidation
December 31, 2019

Non-Cash Marasigan Feliciano, Marasigan,

Cash Liabilities Tria, Loan Tria, Capital
Assets , Loan Capital Capital
P/L Percentages 40% 40% 20%
Balances before
Liquidation ₱ 200,000 ₱ 3,400,000 ₱ 1,120,000 ₱ 50,000 ₱ 80,000 ₱ 950,000 ₱ 600,000 ₱ 800,000
Sale of Non-Cash
Assets and Distribution
of Losses 1,850,000 (3,400,000) (620,000) (620,000) (310,000)
Balances 2,050,000 - 1,120,000 50,000 80,000 330,000 (20,000) 490,000
Payment of Liabilities to
Outsiders (1,120,000) (1,120,000)
Balances 930,000 - 50,000 80,000 330,000 (20,000) 490,000
Offset of Tria's Loan
against her Deficiency (20,000) 20,000
Balances 930,000 30,000 80,000 330,000 - 490,000

Payments to Partners (930,000) (30,000) (80,000) (330,000) - (490,000)

The entries are shown below:

1. Sale of Non-Cash Assets

Cash P1,850,000
Loss on Realization 1,550,000
Non-cash assets P3,400,000

Distribution of Loss on Realization based on Partners’ P/L ratio

Joel Feliciano, Capital P620,000

Evelyn Tria, Capital 620,000
Nick Marasigan, Capital 310,000
Loss on Realization P1,550,000

80 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
2. Payment of Liabilities
Liabilities P1,120,000
Cash P1,120,000

3. Exercise of Right of Offset

Evelyn Tria, Loan P20,000
Evelyn Tria, Capital P20,000

4. Distribution of Cash to Partners

Evelyn Tria, Loan P30,000
Nick Marasigan, Loan 80,000
Joel Feliciano, Capital 330,000
Nick Marasigan, Capital 490,000
Cash P930,000

Case 3. Loss on Realization Resulting to a Capital Deficiency to a Personally Solvent Partner

Assume that the non-cash assets are sold at P1,700,000 with a resulting loss on realization of P1,700,000
which was distributed in the ratio 4:4:2. The capital balance of partner Evelyn Tria was again insufficient
to fully absorb her share in the loss and thus, incurred a capital deficiency of P80,000. Tria exercised her
right of offset but it was not enough to cover her losses; she has no recourse but to invest additional cash
of P30,000 to fully eliminate her deficiency.

Feliciano, Tria and Marasigan

Statement of Liquidation
December 31, 2019

Non-Cash Marasigan Feliciano, Marasigan,

Cash Liabilities Tria, Loan Tria, Capital
Assets , Loan Capital Capital
P/L Percentages 40% 40% 20%
Balances before
Liquidation ₱ 200,000 ₱ 3,400,000 ₱ 1,120,000 ₱ 50,000 ₱ 80,000 ₱ 950,000 ₱ 600,000 ₱ 800,000
Sale of Non-Cash
Assets and Distribution
of Losses 1,700,000 (3,400,000) (680,000) (680,000) (340,000)
Balances 1,900,000 - 1,120,000 50,000 80,000 270,000 (80,000) 460,000
Payment of Liabilities to
Outsiders (1,120,000) (1,120,000)
Balances 780,000 - 50,000 80,000 270,000 (80,000) 460,000
Offset of Tria's Loan
against her Deficiency (50,000) 50,000
Balances 780,000 - 80,000 270,000 (30,000) 460,000
Additional Investments
by Tria 30,000 30,000
Balances 810,000 80,000 270,000 460,000

Payments to Partners (810,000) (80,000) (270,000) - (460,000)

81 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
The entries to illustrate the steps in liquidation are given below:
1. Sale of Non-Cash Assets
Cash P1,700,000
Loss on Realization 1,700,000
Non-Cash Assets P3,400,000

Distribution of Loss on Realization based on Partners’ P/L ratio

Joel Feliciano, Capital P680,000

Evelyn Tria, Capital 680,000
Nick Marasigan, Capital 340,000
Loss on Realization P1,700,000

2. Payment of Liabilities

Liabilities P 1,120,000
Cash P1,120,000

3. Exercise of Right of Offset

Evelyn Tria, Loan P50,000
Evelyn Tria, Capital P50,000

4. Additional Investment by Deficient Partner

Cash P30,000
Evelyn Tria, Capital P30,000

5. Distribution of Cash to Partners

Nick Marasigan, Loan P80,000

Joel Feliciano, Capital 270,000
Nick Marasigan, Capital 460,000
Cash P810,000

Case 4. Loss on Realization Resulting to a Capital Deficiency to a Personally Insolvent Partner

Assume the same facts as in Case 3 except that Evelyn Tria is personally insolvent and is unable to make
additional investments for her remaining deficiency of P30,000. In this case, Joel Feliciano and Nick
Marasigan have to absorb this deficiency as additional loss to them in the ratio of 4:2.

82 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Feliciano, Tria and Marasigan
Statement of Liquidation
December 31, 2019

Non-Cash Marasigan Feliciano, Marasigan,

Cash Liabilities Tria, Loan Tria, Capital
Assets , Loan Capital Capital
P/L Percentages 40% 40% 20%
Balances before
Liquidation ₱ 200,000 ₱ 3,400,000 ₱ 1,120,000 ₱ 50,000 ₱ 80,000 ₱ 950,000 ₱ 600,000 ₱ 800,000
Sale of Non-Cash
Assets and Distribution
of Losses 1,700,000 (3,400,000) (680,000) (680,000) (340,000)
Balances 1,900,000 - 1,120,000 50,000 80,000 270,000 (80,000) 460,000
Payment of Liabilities to
Outsiders (1,120,000) (1,120,000)
Balances 780,000 - 50,000 80,000 270,000 (80,000) 460,000
Offset of Tria's Loan
against her Deficiency (50,000) 50,000
Balances 780,000 - 80,000 270,000 (30,000) 460,000
Additional Losses to
Feliciano and
Marasigan (20,000) 30,000 (10,000)
Balances 780,000 80,000 250,000 450,000

Payments to Partners (780,000) (80,000) (250,000) - (450,000)

The entries to illustrate the steps in liquidation are given below:

1. Sale of Non-Cash Assets
Cash P1,700,000
Loss on Realization 1,700,000
Non-Cash Assets P3,400,000

Distribution of Loss on Realization based on Partners’ P/L ratio

Joel Feliciano, Capital P680,000

Evelyn Tria, Capital 680,000
Nick Marasigan, Capital 340,000
Loss on Realization P1,700,000

2. Payment of Liabilities

Liabilities P 1,120,000
Cash P1,120,000

3. Exercise of Right of Offset

Evelyn Tria, Loan P50,000
Evelyn Tria, Capital P50,00

83 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
4. Deficiency Absorbed by Solvent Partners
Joel Feliciano, Capital P20,000
Nick Marasigan, Capital 10,000
Evelyn Tria, Capital P30,000

5. Distribution of Cash to Partners

Nick Marasigan, Loan P80,000
Joel Feliciano, Capital 250,000
Nick Marasigan, Capital 450,000
Cash P780,000

Case 5. Partnership Insolvent but Partners Personally Solvent

Assume that the non-cash assets are sold at P900,000 with a resulting loss on realization of P2,500,000
distributed in the ratio 4:4:2. The cash balance after full realization of the non-cash assets in the amount
of P1,100,000 was not enough to settle all the liabilities to outsiders. Also, the capital balances of Joel
Feliciano and Evelyn Tria were insufficient to fully absorb their share in the loss and thus, incurred
capital deficiencies of P50,000 and P400,000, respectively.

Tria exercise her right to offset but it was not enough to cover her losses; she has no recourse but to invest
additional cash of P350,000 to fully eliminate her deficiency. Feliciano also invested P50,000. From these
investments, the partnership was able to pay in full the outside creditors. The balance of P380,000 is paid
to Marasigan for his loan and capital account balances of P80,000 and P300,000, respectively.

84 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Feliciano, Tria and Marasigan
Statement of Liquidation
December 31, 2019

Non-Cash Marasigan Feliciano, Marasigan,

Cash Liabilities Tria, Loan Tria, Capital
Assets , Loan Capital Capital
P/L Percentages 40% 40% 20%
Balances before
Liquidation ₱ 200,000 ₱ 3,400,000 ₱ 1,120,000 ₱ 50,000 ₱ 80,000 ₱ 950,000 ₱ 600,000 ₱ 800,000
Sale of Non-Cash
Assets and Distribution
of Losses 900,000 (3,400,000) (1,000,000) (1,000,000) (500,000)
Balances 1,100,000 - 1,120,000 50,000 80,000 (50,000) (400,000) 300,000
Payment of Liabilities to
Outsiders (1,100,000) (1,100,000)
Balances - 20,000 50,000 80,000 (50,000) (400,000) 300,000
Offset of Tria's Loan
against her Deficiency (50,000) 50,000
Balances - 20,000 - 80,000 (50,000) (350,000) 300,000
Additional Investment
of Feliciano and Tria 400,000 50,000 350,000
Balances 400,000 20,000 80,000 - 300,000
Payment of Liabilities (20,000) (20,000)
Balances 380,000 80,000 300,000
Payments to Partners (380,000) (80,000) - (300,000)

The pertinent entries for this case are shown below:

1. Sale of Non-cash Assets

Cash P900,000
Loss on Realization 2,500,000
Non-cash assets P3,400,000

Distribution of Loss on Realization based on Partners’ P/L Ratio

Joel Feliciano, Capital P1,000,000

Evelyn Tria, Capital 1,000,000
Nick Marasigan, Capital 500,000
Loss on Realization P2,500,000

2. Partial Payments of Liabilities

Liabilities P1,100,000
Cash P1,100,000

3. Exercise of Right of Offset

Evelyn Tria, Loan P50,000

Evelyn Tria, Capital P50,000
85 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
4. Additional Investment by Partners

Cash P400,000
Joel Feliciano, Capital P50,000
Evelyn Tria, Capital 350,000

5. Full payment of Liabilities

Liabilities P20,000
Cash P20,000

6. Distribution of Cash to Partners

Nick Marasigan, Loan P80,000

Nick Marasigan, Capital 300,000
Cash P380,000

Case 6. Partnership Insolvent and Partners Personally Insolvent

Loida Cardenas, Aristotle Go and Renante Balocating are partners who are sharing profits or losses in the
ratio of 4:3:2 respectively. They decided to liquidate their business on November 1, 2019 because of
constant credit problems. The partnership and partners Go and Balocating are currently unable to meet
their financial obligations. The partnership condensed balance sheet and the personal status of the partners
are as follows:

Cardenas, Go and Balocating

Statement of Financial Position
November 1, 2019

Assets

Cash ₱ 5,000
Non-cash Assets 605,000
Total Assets ₱ 610,000

Liabilities and Capital

Liabilities ₱ 370,000
Loida Cardenas, Capital 100,000
Aristotle Go, Capital 60,000
Renante Balocating, Capital 80,000
86 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Total Liabilities and Capital ₱ 610,000

Personal Status of Partners

(Excluding Interests in the Partnership)

Partner Personal assets Personal Liabilities

Loida Cardenas ₱ 310,000 ₱ 200,000

Aristotle Go 94,500 119,000
Renante Balocating 40,000 50,000

The non-cash assets are sold for P335,000, resulting to a loss on realization of P270,000. The cash
generated from the realization of all non-cash assets is inadequate for the full payment of the liabilities.
The partnership is insolvent and will depend for its solvent partners for relief.

After the distribution of loss on realization, Aristotle Go is deficient by P30,000. He can not make
additional investments since he is personally insolvent – his current personal deficit is P24,500 (P94,500
minus P119,000). The two other partners absorbed the deficiency, even if Cardenas has her own
deficiency. This is possible because Cardenas is personally solvent. In the case of Balocating, he is made
to share in the loss due to insolvency of Go though he is already personally insolvent because in the
partnership his capital balance is still a positive P20,000.

In the meantime, an additional investment of P40,000 is necessary from the solvent Cardenas to be used
to pay the remaining liabilities and the P10,000 balance in Balocating‟s capital account. The P10,000 that
Balocating received can now be used to pay off his personal creditors. Cardenas and Balocating can later
claim from Go his supposed additional investment due to capital deficiency after he has satisfied his
personal liabilities. This is if Go becomes insolvent in the future.

Cardenas, Go and Balocating

Statement of Liquidation
November 1, 2019

Non-Cash Cardenas, Go, Balocating,

Cash Assets Liabilities Capital Capital Capital
P/L ratio 4/9 3/9 2/9
₱ ₱
Balances before Liquidation 5,000 ₱ 605,000 370,000 ₱ 100,000 ₱ 60,000 ₱ 80,000
Sale of Non-Cash Assets and
Distribution of Losses 335,000 (605,000) (120,000) (90,000) (60,000)

Balances 340,000 - 370,000 (20,000) (30,000) 20,000

Payment of Liabilities
(partial) (340,000) (340,000)
Balances (20,000) (30,000) 20,000
87 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 - 30,000
Additional Losses to
Cardenas and Balocating (20,000) 30,000 (10,000)

Balances - 30,000 (40,000) - 10,000

Additional Investment by
Cardenas 40,000 40,000

Balances 40,000 30,000 - 10,000

Payment of Liabilities (full) (30,000) (30,000)

Balances 10,000 10,000

Payment to Balocating (10,000) (10,000)

Cardenas Go Balocating
Personal Assets ₱ 310,000 ₱ 94,500 ₱ 40,000
Less: Personal Liabilities 200,000 119,000 50,000
Excess (deficit) 110,000 (24,500) (10,000)
Amount recovered from
liquidation of the partnership 10,000
Loss to Personal Creditors None 24,500 None

The related entries below:

1. Sale of Non-Cash Assets

Cash P335,000
Loss on Realization 270,000
Non-cash assets P605,000

Distribution of Loss on Realization based on P/L ratio

Loida Cardenas, Capital P120,000
Aristotle Go, Capital 90,000
Renante Balocating, Capital 60,000
Loss on Realization P270,000

2. Partial payment of Liabilities

Liabilities P340,000
Cash P340,000
88 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
3. Additional losses to Partners with Positive Capital Balances

Loida Cardenas, Capital P20,000

Renante Balocating, Capital 10,000
Aristotle Go, Capital P30,000

4. Additional Investment by Partner

Cash P40,000
Loida Cardenas, Capital P40,000

5. Full payment of liabilities

Liabilities P30,000
Cash P30,000

6. Distribution of Cash to Partners

Renante Balocating, Capital P10,000

Cash P10,000

INSTALLMENT LIQUIDATION

Under this method, realization of non-cash assets is accomplished over an extended period of
time. It is a process of selling some assets, paying the creditors, paying the remaining cash to the partners,
realizing additional assets and making additional payments to the partners. The liquidation will continue
until all the non-cash assets have been realized and all available cash distributed to partnership creditors
and partners.

Installment payments to partners are appropriate if necessary safeguards are used to ensure that
all partnership creditors are paid in full and that no partner is paid more than the amount to which he
would be entitled after all losses on realization of assets are known. The procedures below may be
followed in installment liquidation:

1. Realization of non-cash assets and distribution of gain or loss on realization among partners
based on their profit and loss ratio.

2. Payment of liquidation expenses and adjustment for unrecorded liabilities; both of these items
will be distributed among the partners in their profit and loss ratio.

3. Payment of liabilities to outsiders.

4. Distribution of available cash based on a schedule of safe payments which assumes possible
losses due to inability of the partnership to dispose of a part of all the remaining non-cash
assets and failure of the partners with capital deficiencies to make additional contributions.
Payments to partners can also be made based on cash priority program.

89 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Illustration: The balance sheet of Christine Gamba, Nancy Mulles and Ma. Victoria Mones,
partners sharing profits in the ratio of 4:3:3 respectively, showed the following balances on
April 30, 2019, just before liquidation:

Gamba, Mulles and Mones

Statement of Financial Position
April 30, 2019

Assets Liabilities and Capital

Cash ₱ 315,000 Liabilities ₱ 435,000

Non-cash Assets 1,250,000 Ma. Victoria Mones, Loan 30,000
Christine Gamba, Capital 600,000
Nancy Mulles, Capital 350,000
Ma. Victoria Mones, Capital 150,000
Total Assets ₱ 1,565,000 Total Liabilities and Capital ₱ 1,565,000

In May, part of the assets are sold at book value, P300,000. In June, the remaining assets are sold for
P210,000. Assume that available cash is distributed to the proper parties at the end of May and at the end
of June. Assume further that partners are solvent and that ant partner who is deficient made appropriate
payment to the partnership on July 31.

Schedule A:

Gamba, Mulles and Mones

Schedule of Safe Payments
May 31, 2019

Gamba Mulles Mones

Cash balances before
Distribution of Cash ₱ 600,000 ₱ 350,000 ₱ 150,000
Loan Balance 30,000
Partners' Total Interest 600,000 350,000 180,000
Restricted Interest -possible
loss of P950,000 if nothing
is realized on remaining
non-cash assets; 4:3:3 ratio (380,000) (285,000) (285,000)
Balances 220,000 65,000
90 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 (105,000)
Restricted Interest -
additional possible loss of
P105,000* if Mones is
unable to satisfy her
possible deficiency, 4:3
ratio (60,000) (45,000) 105,000
Free Interest - amounts to be
paid to partners ₱ 160,000 ₱ 20,000 -

Schedule B

Gamba, Mulles and Mones

Schedule of Safe Payments
June 30, 2019

Gamba Mulles Mones

Cash balances before
Distribution of Cash ₱ 144,000 ₱ 108,000 -₱ 42,000
Restricted Interest-
Additional possible loss
of P42,000 if Mones is
unable to satisfy her
possible deficiency; 4:3
ratio (24,000) (18,000) 42,000
Free Interest - amounts
to be paid to partners ₱ 120,000 ₱ 90,000 -

It can be observed that the total partners‟ interest are continuously restricted for possible losses. A
partner‟s restricted interest represent the portion of a partner‟s interest which should remain available to
absorb possible future losses. Restricted interest are provided for assumed non-sale of remaining non-cash
assets and for assumed insolvency of deficient partners. When all of these restricted interests are satisfied,
the resulting balances will be referred to as free interests which are simply the amounts to be paid to the
partners. This payment should first be applied to loan then to capital in accordance with the rules on the
order of preference in liquidation.

91 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Gamba, Mulles, and Mones
Statement of Liquidation
May 1 to July 31, 2019

Non-Cash Gamba, Mulles, Mones,

Cash Assets Liabilities Mones, Loan Capital Capital Capital
Balances before Liquidation ₱ 315,000 ₱ 1,250,000 ₱ 435,000 ₱ 30,000 ₱ 600,000 ₱ 350,000 ₱ 150,000
May-Sale of Non-Cash Assets 300,000 (300,000)
Balances 615,000 950,000 435,000 30,000 600,000 350,000 150,000
May-Payment of Liabilities (435,000) (435,000)
Balances 180,000 950,000 - 30,000 600,000 350,000 150,000
May-Installment to Partners (Sch A) (180,000) (160,000) (20,000)
Balances - 950,000 30,000 440,000 330,000 150,000
June-Sale of Non-cash assets and
Distribution of Losses 210,000 (950,000) (296,000) (222,000) (222,000)
Balances 210,000 - 30,000 144,000 108,000 (72,000)
Right of Offset by Mones (30,000) 30,000
Balances 210,000 - 144,000 108,000 (42,000)
June-Installment to Partners (Sch B) (210,000) (120,000) (90,000)
Balances - 24,000 18,000 (42,000)
July-Investment 42,000 42,000
Balances 42,000 24,000 18,000 -
July-Final Installment (42,000) (24,000) (18,000)

1. Sale of Non-Cash Assets

Cash P300,000
Non-cash Assets P300,000

2. Payment of Liabilities

Liabilities P435,000
Cash P435,000

3. May Distribution of Cash to Partners

Christine Gamba, Capital P160,000

Nancy Mulles, Capital 20,000
Cash P180,000

4. Sale of Non-Cash Assets and Distribution of Loss on Realization

Cash P210,000
Christine Gamba, Capital 296,000
Nancy Mulles, Capital 222,000
Ma. Victoria Mones, Capital 222,000
Non-Cash Assets P950,000

5. Exercise of Right of Offset

Ma. Victoria Mones, Loan P30,000
Ma. Victoria Mones, Capital P30,000

92 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
6. June Distribution of Cash to Partners
Christine Gamba, Capital P120,000
Nancy Mulles. Capital 90,000
Cash P210,000

7. Additional Investment by Partner

Cash P42,000
Ma. Victoria Mones, Capital P42,000

8. July Distribution of Cash to Partner

Christine Gamba, Capital P24,000
Nancy Mulles, Capital 18,000
Cash P42,000

CASH PRIORITY PROGRAM

The use of safe payments schedules in support of the illustration in installment liquidation is a relative
method of computing the amount of safe payments to partners for it prevents excessive payments to any
partner. However, the approach is inefficient if numerous installment distributions are to be made to
partners. The repetitious procedures if schedule of safe payments can be avoided with the introduction of
an alternative device called cash priority program. This program which is prepared at the start of the
liquidation process will help the partners project when they can expect to be included in the cash
distribution. If the program is prepared, any amount of cash received from the realization of partnership
assets may be paid immediately to partnership creditors and later, the partners as specified in the program.

Illustration: Cecille Laguna, Ma. Concepcion Manalo, and Rosemarie Espanol divide profits, 60%, 25%
and 15% respectively. A balance sheet on June 30, 2019 just before partnership liquidation showed the
following balances.

Gamba, Mulles and Mones

Statement of Financial Position
June 30, 2019

Assets Liabilities and Capital

₱ ₱
Cash 50,000 Liabilities 350,000
Non-cash
Assets 925,000 Cecille Laguna, Capital 450,000

Ma. Concepcion Manalo, Capital 100,000

Rosemarie Espanol, Capital 75,000

₱ ₱
Total Assets 975,000 Total Liabilities and Capital 975,000
93 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Certain assets are sold in July at book value of P500,000 and available cash is distributed to appropriate
parties. Remaining assets are sold in August for August for P150,000 and cash is distributed in final
settlement.

Loss absorption balances represent the maximum loss that the partners can absorb without reducing their
equity below zero. The partner with the biggest capital exposure or loss absorption balance should be
prioritized in cash distribution. A partner with a relatively low loss absorption balance can be wiped out
by material realization loss.

In the figure of Cash Priority Program, Manalo has the lowest loss absorption balance and this means that
she is most vulnerable or susceptible to losses. Assume that a loss on realization amounted to P400,000,
Manalo‟s capital balance will become zero because her share in the loss will be P100,000 (P400,000 x
25%) which is equivalent to her capital interest. Laguna will be prioritized in her cash distribution
because of her higher loss absorption balance brought about by a larger capital interest and a higher profit
and loss sharing ratio. This is being done to be fair with her since she has the biggest capital exposure.

The next step is the preparation of the program would be to make the highest loss absorption
balance equal to the next highest. The difference will be the basis for the computation of the cash
priority payments to the partners. The cash priority payments can be obtained by multiplying the
excess or the difference in the loss absorption balances by the profit and loss ratio of the
respective partner. The procedure is continued until the loss absorption balances of all the
partners are equal. If the loss absorption balances are already equal, cash may be distributed to the
partners in their profit and loss ratio.

94 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Laguna, Manalo, and Espanol
Cash Priority Program
June 30, 2019

Cash Priority Payments to

Laguna Manalo Espanol Laguna Manalo Espanol
Capital Balances ₱ 450,000 ₱ 100,000 ₱ 75,000
Add: Loan Balances
Partners' Total Interest 450,000 100,000 75,000
Divide by: Profit and Loss Ratio 60% 25% 15%
Loss Absorption Balance 750,000 400,000 500,000
Priority I: To Laguna (250,000) P150,000*
500,000 400,000 500,000
Priority I: To Laguna and Espanol (100,000) (100,000) P60,000** P15,000**
₱ 400,000 ₱ 400,000 ₱ 400,000 ₱ 210,000 ₱ - ₱ 15,000

Priority III: Amounts in excess of

P225,000 *** based on P/L Ratio 60% 25% 15%

*P250,000 x 60% = P150,000

**P100,000 x 60% = P60,000;
P100,000 x 15% = P15,000
***P210,000 + P15,000 = P225,000

The entries related to this illustration are:

1. Sale of Non-Cash Assets

Cash P500,000
Non-Cash Assets P500,000

2. Payment of Liabilities
Liabilities P350,000
Cash P350,000

3. Distribution of Cash to Partners

Cecille Laguna, Capital P190,000
Rosemarie Espanol, Capital 10,000
Cash P200,000

95 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Computation
Laguna Espanol Total
Priority I: Laguna 150,000 150,000
Priority II: 60:15 ratio 50,000

Laguna: P50,000 x 60/75 40,000

Espanol: P50,000 x 15/75 10,000
190,000 10,000 200,000

The initial cash balance is P50,000 and this is increased by the P500,000 proceeds from the sale of non-
cash assets. The balance after settlement of liabilities of P350,000 is P200,000. This amount is now
available for distribution. Based on the cash priority program, Laguna should be given P150,000 being
the first priority. The total cash allocation for Priority II is P75,000. For this month, only P50,000 is
available after the P150,000 allocation to Laguna.

When cash is insufficient to fully satisfy the cash requirements in a particular priority, then the available
cash will be distributed in the ratio of the supposed allocation in that priority. In this instant case, the
P50,000 will be allocated in the ratio of the supposed allocation in priority II – P60,000 and P15,000 for a
total of P75,000. The ratio is 60/75 for Laguna and 15/75 for Espanol. The ratio only considered the two
partners since they are the only ones included in priority II. Meanwhile, the balance of P25,000 in priority
II will be allocated next month.

For the month of August, 2019

1. Sale of non-cash assets

Cash P150,000
Loss on Realization 275,000
Non-cash Assets P425,000

Distribution of Loss on Realization based on Partners’ P/L ratio

Cecille Laguna, Capital P165,000
Ma. Concepcion Manalo. Capital 68,750
Rosemare Espanol, Capital 41,250
Loss on Realization P275,000

2. Distribution of Cash to Partners

Cecille Laguna, Capital P95,000

Ma. Concepcion Manalo, Capital 31,250
Rosemarie Espanol, Capital 23,750
Cash P150,000

96 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Computation
Laguna Manalo Espanol Total
Priority II: balance of P25,000 ₱ 25,000
Laguna: P25,000 x 60/75 ₱ 20,000
Espanol: P25,000 x 15/75 ₱ 5,000
Priority III: To all partners in the ratio of
60:20:15 ₱ 125,000
Laguna: P125,000 x 60% ₱ 75,000
Manalo: P125,000 x 25% ₱ 31,250
Espanol: P125,000 x 15% ₱ 18,750
₱ 95,000 ₱ 31,250 ₱ 23,750 ₱ 150,000

Last month, the balance in priority II is P25,000. This will be satisfied since there is sufficient cash for
distribution this month. After satisfaction of the first two priorities, any excess cash will be distributed in
the profit and loss ratio of the partners since there is no more priority to satisfy other than the last priority.

Cash payments may be made in the profit and loss ratio only when installment payments have caused the
ratio of the partners‟ capital account balances to be the same as the profit and loss ratio.

First subtract the July payments to the partners, the distribution of loss on realization and the August
payments to the partners to fully satisfy priority II, from the capital balance before liquidation. The result
of these series of subtractions will be the capital balances after the satisfaction of the first two priorities in
the amounts of P75,000; P31,250 and P18, 750 for Laguna, Manalo and Espanol in that order. The total
of these balance is P125,000. The ratio of each capital balance to the total capital balances will then be
computed – Laguna, P75,000/P175,000 or 60%; Manalo, P31, 250/P125,000 or 25%, P18,750/P125,000
or 15%. Observe that the capital ratio yielded the same ratio as that in priority III of the cash priority
program.

97 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Laguna, Manalo, Espanol,
Capital Capital Capital Total
Balance before Liquidation 450,000 100,000 75,000 625,000
July-sale of Non-Cash Assets, No Gain or
Loss
Balances 450,000 100,000 75,000 625,000
July-Payments to Partners (190,000) (10,000) (200,000)
Balances 260,000 100,000 65,000 425,000
August-Sale of Non-Cash Assets (165,000) (68,750) (41,250) (275,000)
Balances 95,000 31,250 23,750 150,000
August-Payments to Partners, Balance of
Priority II (20,000) (5,000) (25,000)
Balances after 1st Two Priorities 75,000 31,250 18,750 125,000

Ratio of Capital Balances 60% 25% 15% 100%

EXERCISES:

Directions: Using Lump-sum Liquidation, show the statement of liquidation and make the
pertinent journal entries.

Problem 1 Presented below is the statement of financial position of the partnership. Assume that non-
cash assets were sold at P2,000,000 and losses are divided by the agreed ratio. Gutierez, Rodriguez and
Lopez are sharing profits and losses in 35:30:35 respectively.

Gutierez, Rodriguez, and Lopez

Statement of Financial Position
September 30, 2019

Assets

Cash 1,000,000
Non-Cash Assets 2,500,000
Total 3,500,000

Liabilities and Capital

Liabilities 950,000
Jose Gutierez, Loan 50,000
Rex Rodriguez, Loan 40,000
John Lopez, Loan 10,000
98 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Jose Gutierez, Capital 850,000
Rex Rodriguez, Capital 700,000
John Lopez, Capital 900,000
Total 3,500,000

Problem 2. Presented below is the statement of financial position of the partnership. Assume that non-
cash assets were sold at P 750,000.Luna exercised his right to offset. Luna, Rizal, and Mabini are sharing
profit and loss ratio in 40:40:20 respectively.

Luna, Rizal, and Mabini

Statement of Financial Position
June 30, 2019

Assets

Cash 450,000
Non-Cash Assets 3,000,000
Total 3,450,000

Liabilities and Capital

Liabilities 600,000
J. Luna, Loan 100,000
R. Rizal, Loan 40,000
J. Mabini , Loan 10,000
J. Luna, Capital 850,000
R. Rizal, Capital 950,000
J. Mabini ,Capital 900,000
Total 3,450,000

Problem 3. Based on Problem 2, assume that non-cash assets were sold at P 600,000. Luna and Rizal
exercised their right to offset. Luna was a solvent partner. Luna, Rizal, and Mabini are sharing profit and
loss ratio in 40:40:20 respectively.

Problem 4. Based on Problem no. 2, both Luna and Rizal exercised their right to offset. J. Luna is
insolvent and has no capacity to make additional investment. J. Mabini agreed to absorb Luna‟s
deficiency. Luna, Rizal, and Mabini are sharing profit and loss ratio in 40:40:20 respectively.

Problem 5. Presented below is a statement of financial position of the partners. Assume that non-cash
assets were sold at P500,000. Katigbak and Castro exercised their right of offset. Katigbak is a solvent
partner. Katigbak, Castro and Belen are sharing profits and losses in a ratio of 40:30:30 respectively.

99 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Katigbak, Castro, and Belen
Statement of Financial Position
March 31, 2019

Assets

Cash 500,000
Non-Cash Assets 2,700,000
Total 3,200,000

Liabilities and Capital

Liabilities 1,000,000
N. Katigbak, Loan 90,000
F. Castro, Loan 110,000
A. Belen, Loan 200,000
N. Katigbak, Capital 500,000
F. Castro, Capital 600,000
A. Belen, Capital 700,000
Total 3,200,000

Direction: Make a Cash Priority Program and journalize the pertinent entries
The balance sheet of partnership Evangelista, Bañez, and Luz showed the following balances as of
November 30, 2019. The partners share profit and loss in 50%, 20% and 30% respectively. Assume that
Part of the non-cash assets were sold at P 700,000 for the month of November and the remaining cash
were distributed to partners. The remaining non-cash assets were sold at P800,000 followed by
distribution of cash to partners.

Evangelista, Banez, Luz

Statement of Financial Position
November 30, 2019

Assets

Cash 90,000
Non-Cash Assets 2,160,000
Total 2,250,000

Liabilities and Capital

Liabilities 500,000
A. Evangelista, Capital 700,000
K. Banez, Capital 450,000
M. Luz, Capital 600,000
Total 2,250,000

100 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
MODULE 5: ACCOUNTING FOR CORPORATIONS

A Corporation is an artificial being created by operation of law, having the right of succession
and the powers, attributes and properties expressly authorized by law or incident to its existence (Revised
Corporation Code of the Philippines, Sec. 21).

Attributes of A Corporation

1. A corporation is an artificial being with a personality separate and apart from its individual
shareholders or members.

2. It is created by operation of law. It cannot come into existence by mere agreement of the parties as in
the case of business partnerships. Corporation require special authority or grant from the State, either by
special incorporation law that directly creates the corporation or by means of a general corporation law
(i.e., The Revised Corporation Code of the Philippines).

3. It enjoys the right of succession. A corporation shall have perpetual existence unless its articles of
incorporation provides otherwise. The death, withdrawal, insolvency or incapacity of the individual
shareholders or members will not dissolve the corporation. The transfer of ownership of shares of stock
does not dissolve the corporation.

4. It has the powers, attributes and properties expressly authorized by law or incident to its existence.

Advantages of a Corporation

1. The corporation has the legal capacity to act as a legal entity.

2. Shareholders have limited liability.

3. It has continuity of existence.

4. Shares of stock can be transferred without the consent of the other shareholders.

5. Its management is centralized in the board of directors.

6. Shareholders are not general agents of the business.

7. Greater ability to acquire funds.

Disadvantages of a Corporation

1. A corporation is relatively complicated in formation and management.

2. There is a greater degree of government control and supervision.

3. It acquires a relatively high cost of formation and operation.

4. It is subject to heavier taxation than other forms of business organizations.

101 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
5. Minority shareholders are subservient to the wishes of the majority.

6. In large corporations, management and control have been separated from ownership.

7. Transferability of shares permits the uniting of incompatible and conflicting elements in one venture.

CLASSES OF CORPORATION

Section 3 of the RCCP classified private corporations into:

1. Stock Corporation. Corporations which have share capital divided into shares are authorized to
distribute to the holders of such shares, dividends, or allotments of the surplus profits on the basis of the
shares held.

2. Non-stock Corporation. A non-stock corporation is one where no part of its income is distributable as
dividends to its members, trustees or officers. Any profit that a non-stock corporation may obtain as an
incident to its operation shall, whenever necessary or proper, be used for the furtherance of the purpose or
purposes to which the corporation was organized (Sec. 86).

Non-stock corporations may be formed or organized for charitable, religious, educational, professional,
cultural, recreational, fraternal, literary, scientific, social, civic service, or similar purposes like trade,
industry, agricultural, and like chambers or any combination.

OTHER CLASSIFICATIONS OF CORPORATIONS

1. According to Number of Persons:

A. Corporation Aggregate. A corporation consisting of more than one corporator.

B. Corporation Sole or a special form of corporation usually associated with the clergy. It is a corporation
which consists of only one member or corporator and his successor such as a bishop.

2. According to Nationality:

A. Domestic Corporation. A corporation organized under Philippine laws.

B. Foreign Corporation. A corporation formed, organized or existing laws other than the Philippines and
whole laws allow Filipino citizens and corporations to do business in its own country or State.

3. According to whether for Public and Private Purpose:

A. Public Corporation. A Corporation formed or organized for the government of a portion of the state
(e.g. province, cities, municipalities, and barangays)

B. Private Corporation. A corporation created for private aim, benefit or purpose.

4. According to whether for Charitable purpose or not:

A. Ecclesiastical Corporation. Those organized for religious purposes.

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B. Eleemosynary Corporation. Those established for public charity.

C. Civil Corporation. Those established for business or profit.

5. According to their legal right to corporate existence:

A. De jure Corporation. A corporation existing in fact and in law. It is organized in strict conformity with
the law.

B. De facto Corporation. A corporation existing in fact but not in law.

6. According to degree of public participation with regard to share ownership:

A. Close corporation. A corporation whose share ownership is limited to selected persons or members of
a family not exceeding 20 persons.

B. Open corporation. A corporation where the share is available for subscription or purchase by any
person.

C. Publicly-held corporation. A corporation with a class of equity securities listed on an exchange or

with assets in excess of P5,000,000 and having 200 or more holders, at least 200 of which are holding at
least 100 shares of a class of its equity securities(SRC Rule 3-1 M, Amended IRR of the Securities
Regulations Code (RA 8799).

7. According to their Relation to Another Corporation:

A. Parent or Holding Corporation. A corporation that is related to another corporation that it has the
power to either directly or indirectly elect the majority of the directors of a subsidiary corporation.

B. Subsidiary Corporation. A corporation controlled by another corporation known as a parent

corporatiom.

COMPONENTS of a CORPORATION

1. Corporators are those who compose a corporation, whether as stockholders or shareholders in a stock
corporation or as members in a nonstock corporation.

2. Incorporators are those stockholders or members mentioned in the Articles of Incorporation (AOI) as
originally forming and composing the corporation and who are signatories to said articles of
incorporation.

Section 10 of the RCCP provides that any person, partnership, association or corporation, singly or jointly
with others but more than fifteen (15) in number, may organize a corporation for any lawful purpose or
purposes.

Natural persons who are licensed to practice a profession, and partnerships or associations organized for
the purpose of practicing a profession, shall not be allowed to organize as a corporation unless otherwise
provided under special laws.
103 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Incorporators who are natural persons must be of legal age. Each incorporator of a stock corporation must
own or be a subscriber to at leasr one (1) share of the capital stock. A corporation with a single
stockholder is considered a one person corporation.

Incorporators are no longer confined to natural persons (i.e. human beings) . Artificial beings ( e.g.
partnership, association or corporation) can be incorporators.

Under the old Corporation Code, the minimum number of incorporators was five. Under the RCCP, one
person can form a corporation, the OPC. The requirement of not less than five (5) not more than fifteen
(15) trustees were retained in the case of educational corporations. (Sec. 106, and that “the number of
trustees shall be in multiples of five (5) and religious societies (Sec. 114).

Note: All incorporators (if they continue to be shareholders) are corporators of a corporation, but not all
corporators are incorporators. An incorporator will always retain his status as such though no longer
having an interest in the corporation.

3. Shareholders or stockholder are corporators in a stock corporation (Sec. 5). Shareholders may be
natural or juridical persons.

4. Members are corporators of a non-stock corporation (Sec. 5.)

5. Subscribers are persons who agreed to take and pay for original, unissued shares of a corporation
formed or to be formed. Note: All incorporators are subscribers but a subscriber need not be an
incorporator.

6. Promoter is a person who, acting alone or with others, takes initiative in founding and organizing the
corporation and receives consideration thereof.

f. Underwriters are usually investment bankers who have:

 agreed, alone or with others, to buy at stated terms an entire or a substantial part of an issue or
securities; or
 guaranteed the sale of an issue by agreement to buy from the issuing corporation any unsold
portion at a stated price
 agreed to use his best efforts to market all or part of an issue; or
 offered for sale shares he has purchased from a controlling stockholder

g. Independent director is a person who, apart from shareholdings and fees received from the
corporation, is independent of management and free from any business or other relationship which could,
or could reasonably be perceived to, materially interfere with the exercise of independent judgment in
carrying out the responsibilities as a director (Sec. 22).

The board of the following corporations vested with public interest shall have independent directors
constituting at least 20% of such board:

104 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
a. Corporations covered by Section 17.2 of Republic Act of 8799, “The Securities Regulation Code”,
namely those securities are registered with the SEC, corporations listed with an exchange or with assets of
at least P50M and having 200 or more holders of shares, with at least 100 shares of a class of its equity
shares;

b. Banks and quasi-banks, non-stock savings and loan associations (NSSLAs), pawnshops, corporations,
engaged in money service business, pre-need, trust and insurance companies, and other financial
intermediaries; and

c. Other corporations engaged in business vested with public interest similar to the above, as may be
determined by the Commission, after taking into account relevant factors which are germane to the
objective and purpose of requiring the election of an independent director, such as the extent of minority
ownership, type of financial products or securities issued or offered to investors, public interest involved
in the nature of business operations, and other analogous factors.

9. Additional General Power per RCCP. Every corporation incorporated under the RCCP is expressedly
given the power to enter into a partnership, joint venture, or any commercial agreement with natural or
juridical persons (Note: under BP68, only to enter into merger or consolidation with other corporations).
Also, domestic corporations are allowed to give donations in aid of any political party or candidate or for
purposes of partisan political activity (Sec. 35). These were not allowed in the Corporation Code.

CLASSES OF SHARES

1. Par value shares. One in which a specific amount is fixed in the articles of incorporation and appearing
on the certificate of stock. The par value is the minimum issue price of the shares.

Section 6 of the Code states that preference (or preferred) shares of stock may be issued only as par value
shares.

2. No-par value shares. One without any value appearing on the face of the certificate of stock. A no-par
value share may have a stated value which may be fixed in the articles of incorporation or by the board of
directors or the shareholders. Thus, the issue price may vary from time to time as it is usually fixed based
on the book value of the corporation‟s shares.

3. However, the minimum stated value of a no-par value share is five pesos (P5.00) per share. In
addition, shares issued without par value are deemed fully paid. Banks, trust, insurance and preneed
companies, public utilities, building and loan associations, and other corporations, authorized to obtain or
access funds from the publicly listed or not, shall not be permitted to issue no-par value shares of stock
(Sec. 6).

4. Voting shares. Those issued with the right to vote.

5. Non-voting shares. Those issued without the right to vote.

6. Ordinary shares. These shares entitle the holder to an equal pro-rata division of profits without any
preference.
105 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
7. Preference shares. These shares entitle the holder to certain advantages or benefits over the holders of
ordinary shares.

8. Founder shares may be given certain rights and privileges not enjoyed by the owners of other stocks.

9. Redeemable shares may be issued by the corporation when expressly provided in the articles of
incorporation. They are shares which may be purchased by the corporation from the holders of such
shares upon the expiration of a fixed period, regardless of the existence of unrestricted retained earnings
in the books of the corporation, and upon such other terms and conditions stated in the articles of the
incorporation and the certificate of stock representing the shares.

10. Treasury shares. A stock that has been issued by the corporation as fully paid and later reacquired but
not retired.

11. Promotion shares. Those issued to promoters as compensation in promoting the incorporation of a
corporation, or for services rendered in launching or promoting the welfare of the corporation.

12. Convertible shares. A stock when is convertible or changeable from one class to another class.

ARTICLES OF INCORPORATION (AOI)

Contents

Section 13 provides that all corporations organized under this Code shall file with the Securities and
Exchange Commission (SEC) articles of incorporation in any of the official languages duly signed and
acknowledged or authenticated, in such form and manner as may be allowed by the SEC, containing
substantially the following matters, except as otherwise prescribed by this Code or by special law:

1. The name of the Corporation;

2. The specific purpose or purposes for which the corporation is formed;

3. The principal place of business (specific address must be specified per SEC Memorandum Circular No.
3, Series of 2006) which must be within the Philippines;

4. The term of existence if the corporation has not elected perpetual existence;

5. The names, nationalities and residences of the incorporators;

6. The number of directors, which shall not be more than fifteen (15) or the number of trustees, which
may be more than fifteen(15);

7. The names, nationalities, and residences of the persons who shall act as directors or trustees until the
first regular directors or trustees are elected and qualified.

8. If it be a stock corporation:

a. Amount of authorized share capital in pesos,

106 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
b. Number of shares into which it is divided,

c. In case the shares are par value shares:

 the par value of each share,

 names, nationalities and residences of the original subscribers,
 the amount subscribed and paid by each subscriber on his subscription.

d. In case of no par value, the articles need only state such fact, and the number of shares into which said
share capital is divided.

9. If it be a non-stock corporation, the amount of its capital, the names, nationalities and residences of the
contributors and the amount contributed.

10. Such other matters consistent with law and which the incorporators may deem necessary and
convenient.

11. An arbitration agreement may be provided in the articles of incorporation pursuant to Section 181 of
the RCCP.

The articles of incorporation and applications for amendments thereto may be filed with the Commission
in the form of an electronic document, in accordance with the Commission‟s rules and regulations on
electronic filing.

No articles of incorporation or amendment to articles of incorporation of banks, banking and quasi-

banking institutions, preneed, insurance and trust companies, nonstick savings and loan associations
(NSSLAs), pawnshops, and other financial intermediaries shall be approved by the SEC unless
accompanied by a favorable recommendation of the appropriate government agency to the effect that such
articles or amendment in is accordance with the law.

REGISTRATION, INCORPORATION AND COMMENCEMENT OF CORPORATE

EXISTENCE

Under Section 18, a person or group of persons desiring to incorporate shall submit the intended corporate
name to the SEC for verification, If the Commission finds that the name is distinguishable from a name
already reserved or registered for the use of another corporation, not protected by law and not contrary to
law, rules and regulations, the name shall be reserved in favor of the incorporators. The incorporators
shall then submit their articles of incorporation and by-laws to the Commission.

If the Commission finds that the submitted documents and information are fully compliant with the RCCP
and other relevant laws, rules and regulations, SEC shall issue the certificate of incorporation. The
private corporation commences its corporate existence and juridical personality from the date the SEC
issues the certificate of incorporation under its official seal.

107 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
NON-USE OF CORPORATE CHARTER AND CONTINUOUS OPERATION

Section 21 states that if a corporation does not formally organize and commence its business within five
(5) years (Note: 2 years in the Corporation code) from the date of its incorporation, its certificate of
corporation shall be deemed revoked as of the day following the end of the five-year period.

However, if a corporation has commenced its business but subsequently becomes inoperative for a period
of at least five (5) consecutive years, the SEC may, after due notice and hearing, place the corporation
under delinquent status.

A delinquent corporation shall have a period of two (2) years to resume operations and comply with all
requirements that the SEC shall prescribe. Upon compliance by the corporation, the SEC shall issue an
order lifting the delinquent status. Failure to comply with the requirements and resume operations within
the period given by the SEC shall cause the revocation of the corporation‟s certificate of incorporation.

The SEC may also place the corporation under delinquent status in case of failure to submit the
reportorial requirements three (3) times, consecutively or intermittently within a period of five (5) years
(Sec. 177).

BY-LAWS

These are the rules of action adopted by the corporation for its internal government and for the
government of its officers, shareholders or members. Under Section 46, a private corporation may provide
in its by-laws for:

1. The time, place and manner of calling and conducting regular or special meetings of the directors or
trustees;

2. The time and manner of calling and conducting regular or special meeting and mode of modifying the
stockholders or members thereof.

3. The required quorum in meetings of stockholders or members and the manner of voting therein;

4. The modes* by which a stockholder, member, director or trustee may attend meetings and cast their
votes;

5. The form for proxies of stockholders and members and the manner of voting them;

6. The directors‟ or trustees‟ qualifications, duties, and responsibilities, the guidelines for setting the
compensation* of directors or trustees and officers, and the maximum number of other board
representations that an independent director* or trustee may have which shall, in no case , be more than
the number prescribed by the SEC;

7. The time for holding for the annual election of directors of trustees and the mode or manner of giving
notice thereof;

108 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
8. The manner of election or appointment and the term of office of all officers other than directors or
trustees.

9. The penalties for violation of the by-laws;

10. In the case of stock corporation, the manner of issuing stock certificates; and

11. Such other matters as may be necessary for the proper or convenient transaction of its corporate
affairs for the promotion of good governance and anti-graft and corruption measures.*

12. An arbitration agreement may be provided in the by-laws pursuant to Section 181.

*New provisions in the RCCP.

NO MINIMUM CAPITAL STOCK

Stock corporations shall not be required to have a minimum capital stock, except as otherwise specifically
provided by special law (Sec. 12). The minimum paid-in capital of at least P5,000 under Sec. 13 of the
Corporation Code of the Philippines was deleted.

There is also no minimum subscribed capital and no minimum paid-in capital requirement. The
requirement under Section 13 of the Corporation Code of the Philippines which states: “at the time of
incorporation, at least 25% of the authorized capital stock as stated in the articles of incorporation must be
subscribed and at least 25% of the total subscription must be paid upon subscription,” have been deleted
in the RCCP.

Note that the 25% subscribed and 25% paid-up rule is still applicable when the corporation increases its
capital stock (Sec. 37).

BASIC CORPORATE ORGANIZATIONAL STRUCTURE

The ultimate control of the corporation rests with the shareholders. They are the owners of the
corporation. The shareholders elect the top governing body of the corporation, the members of the board
of directors. The board of directors is responsible for the formulation of the overall policies for the
corporation and for the exercise of corporate powers. The board also elects a chairman of the board.

Directors shall be elected for a term of one (1) year from among the holder of stocks registered in the
corporation‟s books (Sec. 22). Independent directors ( as defined earlier) must be elected by the
shareholders present or entitled to vote in absentia during the election of directors (Sec. 22).

The election of the professional management team or the administrative officers us entrusted to the board.
This team may include the president; executive vice-president; vice-presidents in charge of sales,
manufacturing, accounting, finance, administration and other key areas; secretary; treasurer; and
controller. These officers implement the policies of the board of directors and actively manage the day-
to-day affairs of the corporation. Annually, a corporation holds the shareholders‟ meeting during which
the shareholders elect their directors and make other decisions.

109 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
The shareholders elect the Board of Directors. The Board of Directors elect the Officers. The offices hire
the employees.

Section 24 states that the president of a corporation must be a director of the corporation, but he cannot
act as president and secretary or as president and treasurer at the same time. The president is only officer
required by law to be a director.

The corporate secretary must be a resident and a citizen of the Philippines. He need not be a director
unless required by law to be a director.

The corporate secretary must be a resident and a citizen of the Philippines. He need not be a director
unless required by the corporate by-laws. It is generally the duty of the secretary to make and keep its
records and to make proper entries of the votes, resolutions and proceedings of the shareholders and
directors in the management of the corporation. The corporate treasurer is the proper officer entrusted
with the authority to receive and keep the money of the corporation and to disburse them as he may be
authorized. The treasurer may or may not be a director but is required per Sec. 24 of the RCCP to be a
resident of the Philippines.

If the corporation is vested with public, the board shall also elect a compliance officer (Sec 24).

There is no prohibition in the law against a shareholder being a director or officer of two or more
corporations. The Corporation Code does not prohibit a corporate officer from occupying the same
position in another Corporation organized for the same purpose. However, such situation may be
prohibited by special law, the articles of incorporation or the corporate by laws. There is a particular case
involving a business tycoon who wanted to become a San Miguel Corporation director although he was
already occupying the same post in two corporations directly competing with the food and beverage giant.
At that time, San Miguel amended its by-laws to provide for the disqualification of a shareholder from
being a director of the corporation if the former already occupies the same position in a competing firm.
The Supreme Court later upheld the decision of San Miguel. Thus, a corporation is authorized to prescribe
qualifications for its directors (Gokongwei vs. SEC, 89 SCRA 336).

RIGHTS OF A SHAREHOLDER

The following are some of the rights of a shareholder:

1. Right to be issued certificate of stock or other evidence of share ownership and to transfer such shares.

2. Right to vote via remote communication or in absentia (Note: under BP68, in person or by proxy only)
at shareholders meeting (Sec. 57).

3. Right to elect and remove directors.

4. Right to adopt, amend or repeal the by-laws.

110 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
5. Right to purchase a portion of any new shares issued to maintain the same percentage of stock
ownership. This right is known as the pre-emptive right. However, this right is not absolute and may be
denied.

6. Right to receive dividends when declared.

7. Right to inspect corporate books and records, and to receive financial reports of the corporation‟s
operation.

8. Right to participate in the distribution of corporate assets upon dissolution.

CORPORATE BOOKS AND RECORDS

Every private corporation, stock or non-stock, is required to keep books and records at its principal office
of the following:

1. Minutes book. It contains the minutes of the meetings of the directors and shareholders.

2. Stock and transfer book. It is a record of the names of shareholders, installments paid and unpaid by
shareholders and dates of payment, any transfer of stock and dates thereof, by whom and to whom made.

3. Books of accounts. These represent the record of all business transactions. The books of accounts
normally include the journal and the ledger.

4. Subscription book. It is a book of printed blank subscription.

5. Shareholders’ ledger. It is a ledger which details the number of shares issued to each shareholder.

6. Subscriber ledger. It is a subsidiary ledger for the subscription receivable account; it reports the
individual subscription of the subscribers.

7. Stock certificate book. It is a book of printed blank certificate of stock.

Section 73 provides that every corporation shall keep and carefully preserve as its principal office all
information relating to the corporation including but not limited to:

1. The articles of incorporation and by-laws of the corporation and all their amendments;

2. The current ownership structure and voting rights of the corporation, including lists of stockholders or
members, group structures, intra-group relations, ownership data, and beneficial ownership;

3. The names and addresses of all the members of the board of directors or trustees and the executive
officers;

4. A record of all business transactions;

5. A record of the resolutions of the board of directors or trustees and of the stockholders or members;

6. Copies of the latest reportorial requirements submitted to the Commissions; and

111 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
7. The minutes of all meetings of stockholders or members, and of the board of directors or trustees.

Section 74 states that a corporation shall furnish a stockholder or member, within ten (10) days from
receipt of their written request, its most recent financial statement, in the form and substance of the
financial reporting required by the SEC. At the regular meeting of stockholders or members, the board of
directors or trustees shall present to such stockholders or members a financial report of the operations of
the corporation for the preceding year, which shall include financial statements, duly signed and certified
in accordance with the RCCP, and the rules the SEC may prescribe. However, if the total assets or
liabilities of the corporation is less than P600,000, or such other amount as may be determined
appropriate by the Department of Finance, the financial statements may be certified under oath by the
treasurer and the president.

EXERCISES:

1. Define corporation. What are the essential attributes of a corporation?

2. Identify the advantages and disadvantages of a corporation.
3. Differentiate a stock from a non-stock corporation.
4. Identify the components of a corporation and briefly describe each.
5. Identify the kinds of corporation as to nationality and purpose.
6. Differentiate a public from a private corporations.
7. What is the purpose of having independent directors in the board?
8. What is an article of incorporation? State at least seven (7) important provisions included in
this instrument.
9. Distinguish par value stock from no-par value stock.
10. Explain the compositions and functions of the basic corporate organizational structure.
11. What are some rights of a shareholder?
12. Differentiate de jure corporation from a de facto corporation.
13. Who are the components of a corporation?
14. What are by-laws of a corporation?
15. What is the difference between ecclesiastical and eleemosynary corporation.

112 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
MODULE 6: SHARE CAPITAL

SHAREHOLDERS’ EQUITY & ITS COMPONENTS

Shareholders‟ equity is the equity section of a corporation‟s statement. Its two major components
are share capital and retained earnings. Share capital reflects the amount of resources received by a
corporation as a result of investment by shareholders, donations or other share capital transactions.
Retained earnings (or accumulated profits or losses) is the amount of capital accumulated and retained
through the profitable operations of the business.

SHARE CAPITAL

It is the shares to be subscribed and paid in or secured to be paid in by the shareholders, either in
money, property or services, at the time of organization of the corporation of afterwards, and upon which
it is to conduct its operations. The share, contributed or paid-in capital is further divided into the
following:

Legal Capital. It is the capital contributed by shareholder which comes from the sale of shares of stock.
The shares of stock issued are generally referred to as share capital. It is the portion of the contributed
capital or the minimum amount of the paid-in capital, which must remain in the corporation for the
protection of corporate creditors. The amount of legal capital is determined as follows:

 In case of par value shares, legal capital is the aggregate par value of all issued and subscribed
shares.
 In case of no-par value shares, legal capital is the total consideration received by the corporation
for the issuance of its shares to the shareholders including the excess of the issue price over the
stated value.

• Share Premium (or Additional Paid-in Capital). It is the portion of the paid-in capital
representing amounts paid by shareholders in excess of par. It may also result from transactions
involving treasury stocks, retirement of shares, donated capital, share dividends and any other
“gain” on the corporation‟s own stock transaction.

TWO BASIC TYPES OF SHARES

Share capital is divided into transferable shares of stock. A share of stock represents the interest or right
of a shareholder in a corporation and is evidenced by a certificate of stock. Share capital includes all
types of ownership shares in a corporation. Shareholders acquire either of the following basic types of
share capital:

• Ordinary Share. This share represents the basic ownership class of the corporation. When only
one class of share is issued, it must be ordinary share. Ordinary shares are the entity‟s residual
equity.

113 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 • Preference Share. This share gives its owners certain advantages over ordinary shareholders.
This special benefits relate either to the receipt of dividends when declared before the ordinary
shareholders or to priority claims on assets in the event of corporate liquidation.

TERMS RELATED TO SHARE CAPITAL

• Authorized Share Capital. The number of authorized shares indicates the maximum number of
shares the corporation can issue as specified in the article of incorporation. This maximum
number of shares when multiplied by the par value of the share will yield the authorized share
capital. Any increase or decrease in the authorized share capital requires prior approval of the
SEC and formal amendment to the articles of incorporation.

• Issued Share Capital. These are shares which have been sold and paid in full. Issued shares may
include treasury shares. Share capital, either ordinary shares account or preference shares
account, is credited for the total par value of fully collected subscriptions or in the case of no-par
value shares, for the total consideration received in relation to the issue. Share capital is debited
only when the issued shares are retired, redeemed or cancelled by the corporation.

• Subscribed Share Capital. It is the portion of the authorized share capital that has been
subscribed but not yet fully paid. This shareholder‟s equity account is credited for the total par
value of the shares subscribed and debited for the total par value of the fully collected
subscriptions.

• Outstanding Share Capital. These are issued shares, which are in the hands of the
shareholders. The number of outstanding shares will equal the difference between the issued
shares and the treasury shares.

• Treasury share. These are issued shares acquired by the corporation but not retired and are
therefore, awaiting to be reissued at a later date.

ACCOUNTING FOR ISSUANCE OF SHARE CAPITAL

The entry to record the issuance of share capital depends on whether the stock is with or without par
value.

 When shares with par value are sold, the proceeds should be credited to the shares capital
account to the extent of the par value of the shares, with any excess being reflected as share
premium.
 When shares without par value are sold, the proceeds should be credited to the share capital
account. If the no-par stock has a stated value, the excess proceeds over stated value may
alternatively be credited to share premium.

Section 64 of the RCCP prohibits the original issue of share capital (capital stock) for a consideration less
than the par or stated value (i.e. issued at a discount). Corporations set the par value of their ordinary
114 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
shares at nominal amounts such as P1 per share. The par value is no indication of its market value; it
merely indicates the amount per share to be entered in the share capital account.

CONSIDERATIONS FOR ISSUANCE OF SHARES

Share capital may be issued in exchange for any of the following considerations:

1. Actual cash paid to the corporation.

2. Tangible or intangible properties actually received by the corporation.

3. Labor already performed for or services actually rendered to the corporation.

4. Previously incurred indebtedness by the corporation.

5. Amounts transferred from unrestricted retained earnings to stated capital;

6. Outstanding shares exchanged for stocks in the event of reclassification or conversion;

7. Shares of stock in another corporation; and/or

8. Other generally accepted form of consideration (Sec. 61, RCCP).

In issuing its share capital, a corporation may avail of the services of the services of an investment banker
who is a specialist in marketing shares to investors. The investment banker may underwrite a share issue
which means that the banker agrees to buy the shares of the corporation and to sell them to investor. The
corporation considers the shares as sold because the underwriter will buy the shares that he is not able to
sell. The underwriter bears the risk in return for gains from selling the shares at a higher price higher than
that paid to the corporation. An investment banker who is not willing to underwrite may handle a share
issue on a best efforts basis. In this case, the banker undertakes to sell as may shares as possible at a set
price but the corporation bears the risk on unsold shares.

Share issue costs can be quite substantial given the work involved The costs include costs associated with
preparing, printing, and filing the relevant documentation and marketing the share issue. Various experts
are consulted to ensure a successful issue.

Per Philippine Interpretations Committee (PIC), the costs of listing shares in the stock market are not
considered as costs of an “equity transaction” since no equity instrument has been issued and hence, such
costs are recognized as an expense in profit or loss when incurred. They are as follows: road show
presentation, public relations consultant fees, and stock exchange listing fees.

Per IAS 32, paragraph 38, transaction costs that relate jointly to more than one transaction (for example,
costs of a concurrent offering of some shares and a stock listing of other shares) should be allocated on a
rational and consistent basis. Example of joint costs are as follows: Audit and other professional advice
relating to prospectus, opinion and counsel, tax opinion, fairness opinion and valuation report, and
prospectus design and printing.

115 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
SHARE ISSUANCES FOR CASH

Most share issues are for cash since the primary reason for issuing shares is to raise capital for a
corporation‟s operating activities. The entries to record the issuance of shares for cash will depend on
whether the share is with or without par value.

With Par Value

Issuing Share Capital at Par

Illustration. Narsan Holdings is authorized to issue P1,000,000 ordinary shares divided into 10,000
shares, with a par value of P100 per share. The diversified corporation issued on cash basis 2,000 shares
at par. The share issuance entry will be:

Cash P200,000
Ordinary shares P200,000

The amount of P200,000 invested in the corporation is called paid-in capital or contributed capital. The
credit to Ordinary Shares increases the share capital of the corporation.

Issuing Share Capital Above Par

Illustration. Suppose the 2,000 shares were sold at P150 per share, the entry follows:

Cash P300,000
Ordinary share P200,000
Share Premium 100,000

This sale of shares increases the corporation‟s contributed capital by P300,000. When the shares with par
value are sold, the proceeds should be credited to the Ordinary shares account to the extent of the par
value – in this case, P200,000; with any excess to be reflected in the Share Premium account. The excess
of P100,000 is not a “gain”. The corporation can neither earn a profit nor incur a loss when it issues
shares to or acquires shares from its shareholders.

Without Par Value

Issuing No-Par Share Capital

Illustration. Morning Star Travel is a domestic corporation engaged in the business of organizing tour
packages for Asian and European visitors to the Philippines. The entity which is located at J. Bacobo St.,
Manila, has two classes of shares – preference shares and no-par ordinary shares. 5,000 ordinary shares
were issued for P85,000. The entry to record the issue of these no-par shares will be:

Cash P85,000
Ordinary Shares P85,000

116 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
When shares without par value are sold, the proceeds should be credited to the Ordinary Shares account.
Accounting for issuance of preference shares is basically the same as that of ordinary shares. Note,
however, that Section 6 of the RCCP prohibits the issue of no-par value preference shares.

Issuing No-Par Share Capital with Stated Value

Illustration. Suppose that Morning Star Travel‟s no-par ordinary shares have a stated value of P20. The
entity issued 5,000 shares at P25 per share. The entry will be:

Cash P125,000
Ordinary shares P125,000

When shares without par value are sold, the proceeds should be credited to the Ordinary Shares account.
If no-par stock has a stated value, the excess proceeds overstated value – In this case, P5 per share, may
alternatively be credited to share premium.

Cash P125,000
Ordinary Shares P100,000
Share Premium 25,000

SUBSCRIPTION OF SHARES

There are times when a corporation sells its shares directly to investors on a subscription basis.
The subscription contract is a legally binding contract which provides for the number of shares
subscribed, the subscription price, , the terms of payment and other conditions of the transaction.

A subscriber becomes a shareholder upon subscription but the stock certificates evidencing
ownership over shares of stocks are not issued until the full collection of the subscription.

Illustration: Warranty Auto Shop, Inc. is a quality car care center located at St. Paul, San Antonio Village,
Makati City. Assume that 5,000 shares of P10 par value ordinary shares of the corporation were sold on
subscription at P12 per share on Sept 1, 2019 to Ashley Langga. Subscription instalments of P24,000 and
P36,000 will be due on Sept. 16 and 30, respectively.

The entries related are as follows:

Subscription Receivable P60,000

Subscribed Ordinary Share P50,000
Share Premium 10,000
To record subscription above par.

Cash P24,000
Subscription Receivable P24,000
To record initial instalment.

Cash P36,000
Subscription Receivable P36,000

117 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 To record final instalment

Subscribed Ordinary Shares P50,000

Ordinary Shares P50,000
To record issuance of stock certificates.

*The subscribed ordinary shares account represents the par value of the subscribed shares.
Subscription Receivable

It is a shareholder equity account. It is presented in the statement of financial position as a

deduction from the related subscribed ordinary shares. When subscription receivable is collectible within
one year, this may be shown as a current asset. It is debited for the total proceeds of the subscriptions to
the ordinary shares and credited for the collections on the subscriptions

There are instances when a subscriber fails to settle the subscriptions in full on the date specified
in the subscription contract or in the “call” made by the board of directors. In such case, the subscribed
shares are declared delinquent shares. The usual remedy is to dispose these shares in a public auction for
the account of the delinquent subscriber.

These shares will be sold to the person or the highest bidder who is willing to pay the “offer
price” which includes the full amount of the subscription balance plus accrued interest, cost of
advertisement and expenses of auction sale in exchange for the smallest number of shares. If there is no
bidder, the corporation may bid for the delinquent shares and the total amount due shall be credited as
paid in full in the books of the corporation. These shares shall be considered as treasury shares. A
shareholder may be sued directly by creditors to the extent of their unpaid subscriptions to the
corporation.

Illustration. Assuming the same facts as above except that the subscriber failed to settle part of his
subscriptions in the amount of P48,000. After complying with the legal procedures pertaining to
delinquency sale, a public auction was held. The offer price is P56,000 including P3,000 accrued interest
and P5,000 expenses of sale. Three bidders are willing to pay the offer price, namely:

Lenore Loqueloque 4,300 shares

Liz Un 4,500 shares
Winnie Villanueva 4,700 shares

Loqueloque is the highest bidder. The 5,000 shares are deemed fully paid. Ashley Langga, the original
subscriber, gets 700 shares and Loqueloque received 4,300 shares.

Subscriptions Receivable P60,000

Subscribed Ordinary Shares P50,000
Share Premium P10,000
To records subscription above par.

Cash P12,000

118 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Subscription Receivable P12,000
To record partial initial instalment.

Receivable from Highest Bidder P3,000

Interest Revenues P3,000
To record accrued interest on delinquent shares.

Receivable from Highest Bidder P5,000

Cash P5,000
To record auction expenses.

Cash P56,000
Receivable from Highest Bidder P8,000
Subscription Receivable 48,000
To record sale at public auction.

Subscribed Ordinary Shares P50,000

Ordinary Shares P50,000
To record issuance of stock certificate.

If there is no bidder, the corporation may bid for the delinquent shares and the total amount due
shall be credited as paid in full in the books of the corporation. These shares shall be considered as
treasury shares. All other entries will be the same except for the following:

Treasury Stock P 56,000

Receivable from Highest Bidder P8,000
Subscriptions Receivable 48,000
To record purchase of own shares.

EXERCISES:

Answer the following questions comprehensively.

1. What are the two components of shareholders‟ equity. Discuss briefly.

2. What is legal capital. How it is measured?
3. What is meant by share capital?
4. What are the two classes of share capital?
5. How do authorized, issued, subscribed, outstanding and treasury shares differ from one
another?
6. Distinguished share of stock and certificate of stock.
7. What are the accounting rules to be observed in recording share based payments to non-
employees and employees?
8. What are the two methods of accounting for share capital? Discuss each briefly.
9. What are treasury stocks?
10. What is the difference between callable preference shares, redeemable preference shares and
convertible preference shares
119 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Directions: Journalize the entries for the following transactions:

Case A.
On January 5, 2021, Magnificat Publishing House, Inc. was authorized to issue P2,500,000
ordinary shares divided into 100,000 shares with P25 par value. The corporation issued 20,000
shares at P30. The entry to record the issuance of share capital above par will be:

Case B.
Green Orchid Corporation is authorized to issue share capital amounting to P4,000,000 ordinary
shares with a par value of P50 divided into 80,000 shares. The corporation issued on cash basis
10,000 shares at par. The entry to record the issuance of share capital at par will be:

Case C.
Sunrise Corporation issued 15,000 ordinary shares for P150,000. The entry to record the issue of
no-par shares will be:

Case D.
Blue Horizon Corporation sold its 12,000 ordinary shares with par value of P25 at P40 to Nancy
Lina on January 7, 2020. Subscriptions receivable is divided in 4 equal installments due every
month starting February 7. Stock certificate was issued on the last date of installment. Journalize
the entries for the recording subscription above par, recording of initial installment up to the final
installment, and recording for the issuance of stock certificate:

Case E.
Continuing the problem, assume that Nancy Lina has only made two successful payments. In
order to dispose the delinquent shares, a public auction was held on June 30, 2020. Shares were
offered at P260,000 which includes P15,000 accrued interest and P5,000 auction expenses. Lyn
Sy was the highest bidder at her 10,000 shares offering. Journalize the entries for recording of
subscription above par, recording partial initial installment, recording accrued interest for
delinquent shares, recording auction expenses, recording sale at public auction and recording for
issuance of stock certificate.

MODULE 7: SHARE-BASED PAYMENTS

Classification of Share-Based Payments (SBP)

Per International Financial Reporting Standards (IFRS) No. 2, share-based payments can be classified
into three types:

Equity –Settled - entity receives goods or services as consideration for its own equity instruments
including shares and share including shares and share options.

Cash –settled – equity acquires goods or services by incurring liabilities amounts based on the value of its
own equities.

120 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Equity-Settled with Cash Alternative- entity receives or acquires goods or services and the entity or the
supplier, has the choice of whether the transaction is settled in cash or equity instruments.

Measurement

IFRS No. 2, Share-based payment, Equity Settled Share Based Payment, Transactions, paragraphs 10-13,
provides the following:

a. Share-based payments to non-employees are measured at fair value of the goods or services received. If
the fair value of the goods or services received cannot be reliably determined, then the fair value of the
equity instrument is used. The measurement date is the date the entity obtains the goods or the
counterparty renders services.

b. Share-based payments to employees including share options, the transactions should be measured at the
fair value of the equity instruments granted because the fair value of the service provided by the
employees generally is not reliably measurable. The fair value of the share options must be determined at
the date the option is granted.

The term “fair value” is the amount for which an asset can be exchanged, a liability settled, or an equity
instrument granted could be exchanged, between knowledgeable and willing parties in an arm‟s length
transaction. The fair value of the shares is determined using the following three-tier measurement
hierarchy: observable market prices if available, market data with reference to a recent transaction in the
entity‟s share, or a recent independent fair valuation of the entity or its principal assets.

Share-Based Payments to Non-Employees

Illustration – Shares for Assets. VYRR Construction and Development Corporation is a medium-sized,
closely-held entity based in Cagayan de Oro City. A group of Taiwanese investors would like to acquire
shares of the corporation because of its tremendous earnings potential. After much internal discussions,
initiated by its Chairman, Virginia Yacapin and its president, Ruth Russell, the investors were allowed to
make investments. One of the considerations given was a tract of land in Davao City with a fair value of
P10,000,000.

The entry to record the issue of 9,000 shares of P1,000 par ordinary shares in exchange for the land is as
follows:

Land P10,000,000
Ordinary shares P9,000,000
Share Premium 1,000,000
To record issuance of 9,000 shares in exchange for land.

Assuming that the shares of stock of the corporation illustrated is traded in the stock exchange and
therefore, with fair value, the basis to record the acquisition of the land will be the same as above. Note
that the first priority is fair value of the goods or consideration received. However, if only the fair value of
the ordinary shares issued its objectively determinable, then it will be the basis for recording the
acquisition of the land.

121 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Illustration – Shares for Services. A corporation may issue shares in exchange for legal accounting or
other services. These costs, which are incurred before the corporation begins operations, include
incorporation fees, legal fees for the preparation of the articles of incorporation and other expenditures
necessary for the formation of the corporation.

When shares are issued for services in connection with the incorporation, the account Organization
Expense may be debited at an amount equal to the fair value of such services (per IFRS 2, par. 10).
Shares shall not be issued for future services.

Per International Accounting Standards (IAS) No. 38, Intangible Assets, start –up costs which consists of
establishment costs such as legal and secretarial costs incurred in establishing a legal entity are
recognized as an expense when incurred. Organization cost should be expensed immediately. Before IAS
No. 38, costs of this nature are considered intangible assets.

Illustration: Dynasty BookSource Asia, Inc. engaged the services of a promoter during its formation and
organization. The corporation issued 800 shares of P100 par value ordinary shares for the services. The
fair market value of such services is P100,000. The entry will be:

Organization Expense P100,000

Ordinary Shares P80,000
Share Premium 20,000
To record issuance of 800 shares of stock in exchange for services.

If ordinary share is issued for an outstanding liability, the amount of the liability set off should be
measure for recording.

Share-Based Payments to Employees

Share plans and share options are increasingly common feature of remuneration for directors, senior
managers and other key personnel. It is a means of aligning employees‟ interest with those of the
shareholders and encouraging employee retention. A share option is a right, but not an obligation, to
subscribe to an entity shares at a specified price at a specified time in the future.

Definition of Terms

The grant date is the date at which the entity and another party (including an employee) agree to a share-
based payment arrangement. At grant date, the entity confers on the counterparty the right to cash or
equity instruments of the entity, provided the specified vesting conditions, if any are met.

To vest means to become an entitlement. Under a share-based payment arrangement, a counterparty‟s

right to receive cash or equity instruments of the entity vests when the counterparty‟s entitlement is no
longer conditional on the satisfaction of any vesting conditions. The vesting date is when the cash or
equity instruments granted vest.

The vesting period is the period during which all the specified vesting conditions of a share-based
payment arrangement are to be satisfied.

122 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Vesting conditions are the conditions that determine whether the entity receives the services that entitle
the counterparty to receive cash or equity instruments of the entity under a share-based payment
arrangement.

Illustration. On Jan. 1, 2018, Rey Rabago Freight Inc. granted 100 share options to each of its directors
on the condition that they remain with the entity for the next three years. Vesting period is 3 years (from
grant date to vesting date). Vesting condition is to remain with the entity for the next three years to Dec.
31, 2020.

Vesting conditions are either service conditions or performance conditions:

a. Service conditions require the counterparty to complete a specified period of service. For example, the
condition is a kind of service as it requires the directors to remain and provide a service to the entity for
the next three years to Dec. 31, 2020.

b. Performance conditions require the counterparty to complete a specified period of service and
specified performance targets to be met. For example, in addition to the service condition, the entity
could require a performance target. Performance conditions can be further categorized into:

 A market performance condition is a target that is based on the market price of the entity‟s equity
instruments, for example achieving a certain share price target.
 A non-,market performance condition is a target that is not based on the market price of the
entity‟s equity instruments, for example, profit targets and sales targets.

Recognition

Vesting Circumstances and Treatment

Equity instrument vests immediately – Recognize the services as employee benefits expense (in full) and
the increase in equity grant date (IFRS 2, par. 14).

Equity instrument does not vest until the counterparty completes a specified period of service – Recognize
the services and the increase in equity as they are received across the vesting period (IFRS 2, par. 15)

When an entity receives services from employees, they should recognize an expense in profit or loss
(Debit: Employee Benefits Expense). The corresponding credit entry will depend on the classification of
the share-based payments. For an equity –settled share-based payment, the entity should recognize the
corresponding increase in equity (Credit: Share Options Outstanding). For cash-settled share-based
payment, the entity should recognize the corresponding increase in liability (Credit: Liability).

Equity-Settled Share Based Payment Transactions

Where a grant of equity instruments is conditional upon satisfying specific vesting conditions, the total
expense (total employee benefits expense) should be measured using the grant date fair value of the share-
based payment and this total expense should be recognized over the vesting period.

Total Expense = No. of Equity Instruments Granted x % of Equity Instruments Expected to Vest x Grant Date Fair Value (of
Equity Instruments Granted)

Illustration: Imara Andam Farms, Inc. granted 100 share options to each of its 1,000 employees on Jan.
1, 2018, The grant is conditional upon the employee‟s remaining in the entity for the next three years. The

123 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
fair value of each share option at Jan. 1, 2018, the grant date, is P30. The 1,000 employees are expected to
remain with the entity for the next three years.

Total expense = 100 (1,000 x 100%) x P30 = P3,000,000

If the entity‟s expectation that the 1,000 employees will remain with the entity for the next three years
does not change for the whole period, the total expense will be recognized in profit or loss over the three
years‟ vesting period as follow:

Dec. 31, 2018:

Employee Benefit Expense P1,000,000
Share Options Outstanding P1,000,000

Dec. 31, 2019

Employee Benefits Expense P1,000,000
Share Options Outstanding P1,000,000

Dec. 31, 2020

Employee Benefits Expense P1,000,000
Share Options Outstanding P1,000,000

The share options can be exercised starting Jan. 1, 2021 and expire at the end of the year. The P100 par
value shares can acquired at P120. All options are exercised on Dec. 31, 2021.

Cash (100 x 1,000 x P120) 12,000,000

Share Options Outstanding 3,000,000
Ordinary Shares (100 x 1,000 x P100) 10,000,000
Share Premium 5,000,000

However, usually the percentage of equity instruments expected to vest changes over the vesting period.
In such a case, the entity will have to adjust the total expense to be recognized based on the changes in the
expected number of instruments that will vest.

Illustration. Assume that during 2018, 100 employees actually left the entity. At Dec. 31, 2018, the
entity estimates that another 90 of its employees will leave during the next two years to Dec. 31, 2020.
During 2019, 80 employees actually left the entity. At Dec. 31, 2019, the entity estimates that another 40
employees would leave during the year to Dec. 31, 2020. During 2020, 25 employees actually left the
entity.

The expense to be recognized in each year in relation to the share options over the three-year service
period is based on the estimated number of shares expected to vest. As options held by employees who
leave the entity will not vest, these are excluded from the amount recognized. The journal entries to
recognize the effect of equity-settled share options are as follows:

Dec. 31, 2018:

Employee Benefits Expense P810,000
Share Options Outstanding P810,000
[(100 options x (1,000 -100-90) employees x P30 x 1/3 years)]

124 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Dec. 31, 2019:
Employee Benefits Expense P750,000
Share Options Outstanding P750,000
[(100 options x (1,000 -100 = 900-80-40) employees x P30 x 2/3 yrs.)]-P810,000

Dec. 31, 2020:

Employee Benefits Expense P825,000
Share Options Outstanding P825,000
[(100 options x (1,000 -100-80 = 820-25)employees x P30 x 3/3 yrs.] – P750,000 – P810,000

At the end of each financial year over the vesting period, the amount expensed is adjusted to reflect the
best estimate of the number of share options that will vest. In this case, the total amount expensed over
the vesting period , P2,385,000 = total number of share options eventually vest [100 options x 795 ( that
is, 1,000-100-80-25)employees x fair value of share options at grant date (P30).

The impact of the employees‟ share options on the entity‟s financial statement for the year ended Dec. 31,
2018, 2019 and 2020 are shown below:

Imara Andam Farms, Inc.

Statement of Comprehensive Income (portion)
For the Year Ended Dec. 31

2018 2019 2020

Employee Benefits Expense P810,000 P750,000 P825,000

Imara Andam Farms, Inc.

Statement of Financial Position (portion) as at Dec. 31

2018 2019 2020

Equity
Share Capital xxx xxx xxx
Share Premium-Options Outstanding 810,000 1,560,000 2,385,000
Retained Earnings (810,000) (750,000) (825,000)

Cash-Settled Share-Based Payment Transactions

For cash-settled share based payment transactions, the entity should measure the goods or services
acquired and the liability incurred at the fair value of the liability. Until the liability is settled, the liability
is remeasured to fair value at the end of each reporting period and at the date of settlement. Any changes
in fair value are recognized in profit or loss for the period.

125 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
EXERCISES:

Make pertinent journal entries in the given problems:

BEST Mining and Development Corporation became popular due to its tremendous earning
potential. Matt Gokongwei, an investor was attracted to make investments. He was then allowed by the
corporation to do so because of his vast resources. The investor offered a land with a fair value of
P12,000,000. The corporation issued 10,000 ordinary shares with a par value of P1,000 in exchange of the
land.

a. What is the journal entry for the issuance of share capital?

If there was no equivalent cash price for the land and the land had no ready market but the shares
were actively traded at P1300 per share, the land would have been recorded at P13,000,000.

b. What is the pertinent journal entry?

Blue Horizon Architectural Designs, Inc. engaged the services of a promoter in its formation and
organization. The corporation issued 1,000 shares of P125 par value ordinary shares for the services. The
fair market value of such services is P150,000.

c. The entry will be:

Fresh Harvest, Inc. granted 200 shares options to each of each 500 employees on Jan 1, 2015. The
grant is conditional upon the employees‟ stay in the entity for the next 5 years. The fair value of each
share option on the date granted was P 50. The 500 employees are expected to remain with the entity for
the next 5 years.

1. What is the total expense?

2. What is the journal entry to record if the entity expects that 100% of the employees will stay for the
next five years?

Assuming that the share options can be exercised starting January 1, 2020 and expire at the end of
the year. The P70 par value shares can be acquired at P 85. All options are exercised on December 31,
2020.
3. What is the journal entry?

Assume that on 2015, 10 employees actually left the entity. On the 2016, 20 employees resigned.
Records showed that on the 2017, 15 employees left and 25 employees left on 2018. On 2019, 400
employees remained in the entity.
4. What is the journal entry to recognize the effects of equity-settled share options:

126 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
MODULE 8: TREASURY STOCKS

Treasury stocks are shares of stocks which have been issued and fully paid for, but subsequently
reacquired by the issuing corporation either by purchase, redemption, donation, or through other lawful
means. Such shares may again be disposed of for a reasonable price fixed by the board of directors.

Section 40 of the Revised Corporation Code provides that a stock corporation has the power to purchase
its own shares for a legitimate purpose provided it has unrestricted retained earnings. Some of the reasons
for the purchase of treasury stock are as follows: (1) to eliminate fractional shares arising out of share
dividends ; (2) to improve the stock market price by decreasing the supply of shares; (3) to pay dissenting
or withdrawing shareholders entitled to payment for their shares.

Paragraph 33 of International Accounting Standards (IAS) No. 32, Financial Instruments Presentation,
states that, if an entity reacquires its own equity instruments, these instruments (treasury shares) shall be
deducted from equity. No gain or loss shall be recognized in profit or loss on the purchase, sale, issue or
cancellation of an entity‟s own equity instruments. Such treasury shares may be acquired and held by the
entity or by other members of the consolidated group. Consideration paid or received shall be recognized
directly in equity.

Treasury stock is not an asset because the corporation may not own shares of itself. To reiterate, it is
reported as a deduction from the total shareholder‟s equity. There are two methods of accounting for
treasury stock (1) the par or stated value method and (2) cost method. In the first method, treasury stock is
debited for an amount equal to the par or stated value of the stock reacquired. The cost method is the
preferred method of accounting for treasury stocks by the Accounting Standards Council as stated in
SFAS No. 18, par.6. Only the cost method will be illustrated.

Purchase of Treasury Stock

When the cost method is used, treasury stock is recorded at cost regardless of whether the share is
acquired below or above par or stated value. If treasury stock is purchased for cash, the cost is equal to the
cash payment. If the treasury stock is acquired for non-cash consideration, the cost is usually measured by
the recorded amount of the non-cash assets surrendered or given in exchange.

The purchase of treasury shares does not decrease the number of shares issued; only the outstanding
shares decrease. The effect of the purchase is to decrease both total assets and total shareholders‟ equity.
Treasury stock transactions may affect cash flows but they have no effect on the profit of the corporation.

Illustration. Plantacion Ecoresort is a world class destination in Indang, Cavite. The operations have
been successful. To consolidate control over the enterprise and thus avoid a corporate takeover by
outsiders, the board of directors decided to minimize outstanding shares by purchasing 1,500 shares with
a par value of P1,000 for P2,000. The entry will be:

Treasury Stock P3,000,000

Cash P3,000,000
To record acquisition of treasury shares.

127 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Reissuance of Treasury Stock

At Cost. Assume that the treasury shares were subsequently reissued at cost.

Cash P3,000,000
Treasury stock P3,000,000
To record issue of treasury shares at cost.

Above Cost. Assume that all treasury shares were reissued at P2,500 per share.

Cash P3,750,000
Treasury stock P3,000,000
Share Premium-treasury 750,000
To record reissue of treasury shares above cost.

Treasury stock is always debited for the cost of the shares purchased or credited for the cost of shares
issued. There is no reference to par value, The excess over cost of P750,000 is not regarded as a “gain”
but as a component of share premium.

Below Cost. Assume that the 1,500 treasury shares were reissued at P1,500 per share.

Cash P2,250,000
Retained earnings 750,000
Treasury stock P3,000,000

The excess of the cost over reissue price of P750,000 should be debited to share premium-treasury to the
extent of its balance. In the absence of any balance, in this account, the “loss” is debited to retained
earnings. It is assumed in the above illustration that the share premium –treasury has a zero balance.

Retirement of Treasury Stock

The shares purchased may be subsequently retired. The ordinary shares account is reduced by its par
value. The number of shares issued is reduced by the stock retired. The treasury stock account is credited
at cost. Retirement may result in a “gain” or “loss”.

With Gain on Retirement

Assume that Plantacion Ecoresort purchased the treasury shares for P750 per share. Observe that there is
a “gain” on retirement if the cost of treasury shares is less than par value.

Ordinary Shares (1,500 shs. x P1,000 par) P1,500,000

Share Premium P375,000
Treasury Stock (1,500 shs. x P750 cost) 1,125,000

With Loss on Retirement

128 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Assume that a total of 10,000 shares have been issued at P1,500 per share prior to the purchase of treasury
shares. The entity purchased 1,500 treasury shares for P2,000/share, these were not reissued and were
ultimately retired.
Ordinary Shares (1,500 shs. x P1,000 par) P1,500,000
Share Premium 750,000
Retained Earnings 750,000
Treasury stock (1,500 shs. x P2,000 cost) P3,000,000
To record retirement of treasury shares.

*1,500 retired shares x (P1,500 issue – P1,000 par) = P750,000

The loss on retirement of P1,500,000 should be debited to the following accounts in the order given:

1) share premium to the extent of the credit when the share is issued
2) share premium from treasury stock transactions of the same class of share;
3) retained earnings

In relation to the illustration above, the credit to share premium applicable to the 1,500 shares when
originally issued was P750,000 [(P1,500 issue – P1,000 par) x 1,500 shares]. Hence, when the shares are
retired the debit to share premium is only to the extent of P750,000. The first priority was satisfied after
taking special notice of the limitation. There is no share premium-treasury so the balance of P750,000 was
debited to the retained earnings.

Illustration. The accounts below appeared in the trial balance of Jocelyn Cruz Events Management
Corporation as at Dec. 31, 2019:

Ordinary Shares, P150 par, 20,000 shares P2,700,000

Authorized, 18,000 shares issued
Subscriptions Receivable 170,000
Subscribed ordinary shares 270,000
Retained earnings 2,000,000
Share Premium 950,000
Treasury stock, 1,000 shares, at cost 250,000

1. Total authorized ordinary shares: 20,000 shs. x P150 = P3,000,000

2. Total unissued ordinary shares: 2,000 shs, x P150 = P300,000
3. Total issued ordinary shares: 18,000 shs. x P150 = P2,700,000
4. Ordinary shares subscribed: P270,000
5. Total Shareholders‟ Equity:

Ordinary Shares ₱ 2,700,000

Share Premium 950,000
Subscribed Ordinary Shares ₱ 270,000
Less: Subscriptions Receivable 170,000 100,000
Retained Earnings 2,000,000
Total 5,750,000
Less: Treasury Stock 250,000

129 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Total Shareholders' Equity ₱ 5,500,000

6. Number of shares issued: 18,000 shares

7. Number of shares subscribed: P270,000 /P150 = 18,000 shares
8. Number of treasury shares: 1,000 shares
9. Number of outstanding shares : 18,000 -1,000 = 17,000 shares

Summary of the Effects on Assets, Libilities and Equity

Shareholders'
Transaction Assets Liabilities Equity
Issuance of shares Increase No effect Increase
Purchase of Treasury shares Decrease No effect Decrease
Reissuance of Treasury stock Increase No effect Increase

DONATED CAPITAL
Contributions, including shares of the corporation, received from shareholders should be recorded at the
fair market value of the items received, with the credit going to share premium. If significant, such
contributions may be designated as donated capital. If the donation is in the form of shares of the
corporation, the account share premium or donated capital is credited at the time the shares are reissued.

Illustration:
Jocker‟s Food Industries Inc. received a new service van from its major shareholder as a gift. The donated
asset has a cash price of P350,000. The journal entry will be:

Service Vehicle P350,000

Donated Capital P350,000
To record receipt of the donated service van.

The donated asset increases the total assets and total shareholders equity by the fair market value of the
asset received. Donated capital is shown as part of share premium.

Illustration:
Assume instead that Jocker‟s Food Industries received 500 of P100 par value ordinary shares from its
major shareholder as a gift. The receipt of the donated share is recorded by means of a memorandum
entry as follows:

“Received 500 ordinary shares as donation”.

This transaction does not affect the assets, liabilities or shareholders‟ equity of the corporation. Note,
however, that the number of shares received as donation will reduce the outstanding shares,

These donated shares are essentially treasury stocks which may be reissued at any price. The sale of these
donated shares will increase assets and shareholders equity. Assume that 500 share were issued at P80 per
share. The entry will be:

Cash P40,000

130 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Donated Capital P40,000

CALLABLE PREFERENCE SHARES

Callable preference shares give the issuing corporation the right to purchase (retire) the shares from its
holders at a specified time. The amount paid to call and retire a preference share is its call price. It is
important to state that the redemption date is not definite for it is dependent on the corporation exercising
its “call”. To illustrate, a corporation issued 10,000 callable P50 par value preference shares for P60 per
share. The entries will be:

Cash (10,000 shs. x P60) P600,000

Preference shares (10,000 shs. x P50) P500,000
Share Premium-Preference 100,000

Later, the shares were called in at P75 per share. The entries will be:

Preference Shares P500,000

Share Premium – Preference 100,000
Retained Earnings 150,000
Cash (10,000 shs. x P75) P750,000

The retirement may result in a “gain” or “loss”. Gain is credited to share premium related to ordinary
shares. “Loss” is debited against share premium related to issuance of preference shares and then to
retained earnings.

REDEEMABLE PREFERENCE SHARES

Some financial instruments take the legal form of equity but are liabilities in substance and others may
combine features associated with equity instruments and features associated with financial liabilities.
International Accounting Standards (IAS No. 32), Financial Instruments, paragraph 17, states that:

a. A preference share that provides for mandatory redemption by the issuer for a fixed determinable
amount at a fixed or determinable future date, or gives the holder the right to require the issuer to redeem
the instrument at or after a particular date for a fixed or determinable amount is a financial liability.
b. A financial instrument that gives the holder the right to put it back to the issuer for cash or another
financial asset is a financial liability.

Illustration. On October 29, 2019, Viva Corporation issued P1,000,000 of 5% preference share at par
value. The preference shareholders have the right to force the entity to redeem the shares at par value if
the Federal Reserve Bank interest rate reached that level. Because the future event triggers redemption is
outside the control of both Viva and the shareholders, the preference shares must be classified a financial
liability. The entity to record issuance of the shares is as follows:

Cash P1,000,000
Redeemable Preference Shares Liability P1,000,000

Dividends paid to holders of redeemable preference shares shall be treated as interest expense.

CONVERTIBLE PREFERENCE SHARES

131 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Preference share is more attractive to investors if it carries right to exchange preference shares for a fixed
number of ordinary shares. When a corporation prospers, and its ordinary shares increases in value,
convertible preference shareholders can share in this success by converting into more valuable ordinary
shares, To illustrate:

Preference shares, P200 par value, 10,000 shares P2,000,000

Ordinary shares, P60 par value, 200,000 shares authorized,
100,000 shares outstanding 6,000,000
Share Premium-Preference 400,000
Share Premium – Ordinary 2,000,000
Retained Earnings 4,000,000

If the preference shares are all converted into ordinary shares in a 1:3 ratio, the entries:
Preference Shares P2,000,000
Share Premium – Preference 400,000
Ordinary shares (30,000 shs. x P60) P1,800,000
Share Premium-Ordinary 600,000

When convertibility is not provided in the articles of incorporation, the preference shares cannot be
converted into ordinary shares (SEC Opinion, Sec. 6. Par. 1m May 19, 1992).

Even if provided in the articles of incorporation, the conversion is not automatic as it would still require
an amendment to the articles of incorporation to avoid watering of stocks or issuance of shares in excess
of authorized share capital (SEC Opinion, Sept . 3, 1990).

EXERCISES:
On January 1, 2018, Coffee Growers Inc. minimized its outstanding shares by purchasing 2,750
shares with a par value of P 1,250 for P1,500.
1. What is the journal entry to record the acquisition of treasury shares?
Assume that the treasury shares were subsequently reissued at cost.
2. What is the journal entry to record the issuance of treasury shares at cost?
Assume that the treasury shares were subsequently reissued at P1,750.
3. What is the journal entry to record the issuance of treasury shares above cost?
Assume that the treasury shares were subsequently reissued at P1,000
4. What is the journal entry to record the issuance of treasury shares below cost?
Assume that Coffee Growers, Inc. purchased the treasury shares for P 900 per share.
5. What is the journal entry to record the retirement of treasury shares with gain on retirement?
Prior to the purchase of treasury shares, 7,000 shares have been issued at P1,000 per share. Coffee
Growers Inc. purchased 2,750 shares at P1,900. These shares were ultimately retired.
6. What is the journal entry to record the retirement of treasury shares with loss on retirement?

132 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
MODULE 9: TWO METHODS FOR ACCOUNTING FOR SHARE CAPITAL

The two methods of accounting for share capital authorization and issuance are as follows: the journal
entry method and the memorandum method. The difference between lies in the entries pertaining to
authorization and issuance of share capital.

Illustration: Lucky Draw Corporation was authorized to issue P400,000 ordinary shares divided into
4,000 shares with par value of P100 per share. On Aug 13, 2019, the corporation received subscriptions
for 1,000 shares at par from various individuals. As September 20, 2019, 600 of the subscribed shares
have been fully paid and the stock certificates issued correspondingly. Next day, the corporation issued
400 shares at par for cash. The entries are as follows:

Authorization

Journal Entry Method

Unissued Ordinary Shares 400,000
Authorized Ordinary Shares 400,000

Memorandum Method
Memo entry: The corporation was authorized to issue P400,000 ordinary shares, divided into 4,000 shares
with P100 par.

Shares Subscription at Par

Journal Entry Method

Subscription Receivable 100,000
Subscribed Ordinary share 100,000

Memorandum Method
Subscription Receivable 100,000
Subscribed Ordinary share 100,000

Subscriptions Fully Collected

Journal Entry Method
Cash 60,000
Subscription Receivable 60,000

Memorandum Method
Cash 60,000
Subscription Receivable 60,000

Issuance of Stock Certificates after Full Payment of Subscriptions:

Journal entry method

Subscribed ordinary shares 60,000

133 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Unissued ordinary shares 60,000

Memorandum Method
Subscribed Ordinary Shares 60,000
Ordinary shares 60,000

Cash Subscription at Par

Journal entry method
Cash 40,000
Unissued ordinary shares 40,000

Memorandum Method
Cash 40,000
Ordinary shares 40,000

Journal Entry Method

Shareholders' Equity:
Authorized Ordinary Shares, P100 par, 4,000 shares ₱ 400,000
Less: Unissued Ordinary shares, 3,000 shares 300,000
Issued Ordinary shares ₱ 100,000
Subscribed Ordinary shares ₱ 40,000
Less: Subscription Receivable 40,000 ₱ - ₱ 100,000

Memorandum Method
Shareholders' Equity:
Ordinary Shares, P100 parm 4,000 shares
authorized, 1,000 shares issued ₱ 100,000
Subscribed Ordinary shares ₱ 40,000
Less: Subscription Receivable 40,000 ₱ - ₱ 100,000

DONATED CAPITAL

Treasury shares are occasionally acquired by donation from shareholders. Shares may be
donated to enable the company to raise capital by reselling the shares. Contributions, including
shares of the corporation, received from shareholders should be recorded at the fair market value
of the items received, with the credit going to donated capital as portion of share premium. If
significant, such contributions may be designated as donated capital. If the donation is in the
form of shares of the corporation, the account share premium or donated capital is credited at the
time the shares are reissued. The donated asset increases the total assets and total shareholder‟s
equity by the fair market value of the asset received. Donated capital is shown as part of share
premium.

134 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Illustration A

Fortress Harvester, Inc. received a machinery from its major shareholder as a gift or donation.
The donated asset has a cash price of P500,000. The entry will be:

Machinery P500,000

Donated Capital P500,000

To record receipt of the donated machinery.

Illustration B

Assume that Fortress Harvester, Inc. received 1,000 shares with P100 par value ordinary shares
from a major stockholder as a gift.

The transaction does not affect the assets, liabilities or shareholders‟ equity of the corporation.
Note, however, that the number of shares received as donation will reduce the outstanding
shares.

The corporation will record the receipt as a memorandum entry if the fair value is not
known:

“ Received 1,000 shares of P100 par value ordinary shares as donation”.

These donated shares are essentially treasury stocks which may be reissued at any price.

The share of these donated shares will increase assets and shareholders‟ equity.

If the fair value of the donated share is known for P120:

The entry will be:

Treasury shares P 120,000

Donated Capital P120,000

To record the receipt of the donated capital.

Assume that 1,000 shares were issued at P150.

Cash P 150,000

135 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Treasury shares P120,000

Donated Capital 30,000

To record the sale of donated capital.

PREFERENCE SHARES

A special class of share capital that provides preferential rights, such as the right to receive
dividends and liquidation proceeds, before ordinary shareholders do. A preference share does not
have a voting right. It is formerly called as preferred stock.

Callable Preference Shares

These give the issuing corporation the right, but not the obligation, to purchase or reacquire
(retire) the shares from its holders at a specified, fixed or determinable call price. The amount
paid to call and retire a preference share is its call price. It is important to state that the
redemption date is not definite for its is dependent on the corporation exercising its “call”.

Illustrations:

A corporation issued 25,000 shares callable P40 par value ordinary shares for P50 per share. The
entries will be:

Cash (25,000 x P60) P 1,500,000

Preference Share (25,000 x 50) P 1,250,000

Share Premium-Preference 250,000

If the 25,000 shares were called at P70.

The entry will be:

Preference Share P 1,250,000

Share Premium- Preference 250,000

Retained Earnings 250,000

Cash (25,000 x P70) P 1,750,000

Loss is debited against share premium related to issuance of preference shares and to
retained earnings.

136 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Redeemable Preference Shares

It is a share that must be retired or reacquired by the issuing corporation, either at the option of
the shareholder, or in most cases, at a certain or determinable date. A preference share that must
be redeemed at a fixed or determinable date. A preference share that must be redeemed at a fixed
or determinable date is in substance a financial liability of the issuing corporation.

Some financial instruments take the legal form of equity but are liabilities in substance and
others may combine features associated with equity instruments and features associated with
financial liabilities.

International Accounting Standards (IAS No. 32), Financial Instruments, paragraph 17 states
that:

a. A preference share that provides for mandatory redemption by the issuer for a fixed or
determinable future date, or gives the holder the right to require the issuer to redeem the
instrument at or after a particular date for a fixed or determinable amount, is a financial liability.

b. A financial instrument that gives the holder the right to put it back to the issuer for cash or
another financial asset, is a financial liability.

Illustration:

On December 1, 2016, Enthusiastic Corporation P1,500,000 of 10% preference share at par

value. On October 7, 2018, the United Bank interest rate rises above 10%. In this event, the
preference shares must be classified as a financial liability. The entry to record issuance of the
shares is:

Cash P 1,500,000

Redeemable Preference Shares P1,500,000

Convertible Preference Shares

Preference share is more attractive to investors if it carries a right to exchange preference shares
for a fixed number of ordinary shares. When a corporation prospers its ordinary shares increased
its value, convertible preference shareholders can share in this success by converting into the
more valuable ordinary shares.

When convertible is not provided in the articles of incorporation, the preference shares cannot be
converted into ordinary shares. Even if provided in the articles of incorporation, the conversion is
not automatic as it would still require an amendment to the articles of incorporation to avoid
watering of stocks or issuance of shares in excess of authorized share capital.

137 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Illustration:

Preference Shares,

P200 par value, 10,000 shares P 2,000,000

Ordinary shares, P60 par value,

200,000 shares authorized,

100,000 shares outstanding 6,000,000

Share Premium –Preference 400,000

Share Premium – Ordinary 2,000,000

Retained Earnings 4,000,000

If the preference shares are all converted into ordinary shares in a 1:3 ratio, the entries:

Preference Shares P2,000,000

Share Premium-Preference 400,000

Ordinary Shares (30,000 x P60) P 1,800,000

Share Premium-Ordinary 600,000

RECAPITALIZATION

It is manifested when there is a change in the capital structure of the corporation.

The typical capitalization is as follows:

❑ Change from Par to No-Par

❑ Change from No-Par to Par

❑ Reduction of Par Value

❑ Reduction of Stated Value

Change from Par to No Par

Ordinary shares,

138 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 P 100 par value, 20,000 P 2,000,000

Share Premium 200,000

Retained Earnings 900,000

If all the par value shares are cancelled and replaced with the same number of P75
stated value shares, the entry will be:

Ordinary Shares P 2,000,000

Share Premium-Ordinary 200,000

Ordinary Shares (20,000 x 75) P1,500,000

Share Premium-Recapitalization 700,000

Change from No Par to Par

Ordinary Shares, no-par,

P65 stated value, 10,000 shares P650,000

Retained Earnings 150,000

If all the no-par value shares are cancelled and replaced with the same number of P80
par value shares, the recapitalization entries will be:

Ordinary share, no-par P 650,000

Retained Earnings 150,000

Ordinary shares P800,000

Reduction of Par Value

Ordinary shares,

P125 par value, 30,000 shares P 3,750,000

Share Premium 500,000

Retained Earnings 800,000

If the par value is reduced to P90, the recapitalization entries will be:

Ordinary Shares (30,000 x P35) P1,050,000

139 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Share Premium-Recapitalization P1,050,000

Reduction of Stated Value

Ordinary Shares,

P 85 stated value, 15,000 shares P 1,275,000

Retained Earnings 545,000

If the stated value is reduced to P50, the recapitalization will be:

Ordinary shares (15,000 x 35) P 525,000

Share Premium-Recapitalization P525,000

EXERCISES:

Natural Cosmetics, Inc. is authorized to issue P 1,000,000 ordinary shares divided into
20,000 shares with a par value of P50 per share. On February 7, 2019, the corporation received
subscriptions for 10,000 shares from various individuals. As of March 31, 2019, 7,000 shares
have been fully paid and stock certificate was issued. On April 1, 2019, the corporation issued
3,000 shares at par for cash.

1. Journalize entries for the following using the journal entry method and memorandum method:

a. Authorization

b. Subscription at par

c. Subscription fully collected

d. Issuance of stock certificate

e. Cash subscription at par

2. Make a statement of shareholder‟s equity section using the following:

a. Journal entry method

b. Memorandum method

140 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Module 10: RETAINED EARNINGS

Retained earnings represent the component of the shareholders‟ equity arising from the
retention of assets generated from the profit-directed activities of the corporation. At the end of
an accounting period, the Income Summary account of a corporation is closed to the Retained
Earnings. The retained earnings account is credited with the corporation‟s profit or debited with
the loss. The basic source of retained earnings is profit.

Distribution to shareholders of cash, property or stocks from unrestricted retained earnings

on the basis of all issued and fully paid shares, and all subscribed par value shares except
treasury shares are called dividends. Dividend declarations reduce retained earnings.

Effects of Prior Period Errors to Retained Earnings

• Credit entries increases retained earnings

• Debit entries decreases retained earnings

PRIOR PERIOD ERRORS- are errors discovered in the current period that are significant and
may affect the reliability of the financial statements at the date of their issue.

What is a DEFICIT?

A debit balance in the Retained Earnings account resulting from accumulated losses.

APPROPRIATED vs. UNAPPROPRIATED

Appropriated retained earnings are also termed as restricted retained earnings.

Unappropriated retained earnings are also termed as unrestricted retained earnings. These are
free and can be declared as dividends. Its restrictions may be legal, contractual or voluntary.

DIVIDENDS

It is a distribution of corporate income to its shareholders on a pro-rata basis. Potential

buyers and sellers of a corporation‟s shares are keenly interested in a company‟s dividend
policies and practices.Dividends are distributed out of accumulated earnings of the corporation,
except for a liquidating dividend that represents a return to the shareholders of their investment.

DIVIDENDS in general

 Retained earnings is not a cash fund waiting to be distributed as dividends. Instead, it is the
owner‟s equity account representing claim on all assets in general and not on any asset in
particular.
141 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 The corporation may have a sizeable balance in this account but may not have cash to pay a cash
dividend.

 Shareholders are not guaranteed dividends and dividends do not become a liability of the
corporation until the board of directors has formally declared a dividend distribution.

 Section 42 of the Revised Corporation Code states that dividends should only be declared out of
the unrestricted retained earnings.

 Dividends cannot be declared out of the legal capital of the corporation for the security of its
creditors.

 Dividends may take the form of cash, property or additional shares of stock of the corporation.

 Any form of dividend declaration should be based on the total subscription of a shareholder and
not merely on the shares already paid.

 Subscribers are considered shareholders from the time their subscriptions are accepted by the
corporation and not from the time they are issued stock certificates.

DIVIDENDS

• Dividends may take the form of cash, property or additional shares of stock of the corporation.

• Any form of dividend declaration should be based on the total subscription of shareholder and
not merely on the shares already paid.

• Dividends should only be declared out of the unrestricted retained earnings.

DATES INVOLVED IN DIVIDENDS

• Date of Declaration

• Date of Record

• Date of Payment

Date of Declaration

• On the date of declaration, the board of directors will adopt a resolution declaring that a
dividends shall be paid. The resolution will specify the amount, type and date of payment of this
dividend.

142 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
• It will also set a date of record. Cash dividends are declared solely by the board of directors
while share dividends will necessitate the concurrence of at least 2/3 of the outstanding
shareholders.

• The reduction of retained earnings is recognized in the accounts.

• Declared dividends are obligations of the firm. Dividends to be paid in cash or property become
a liability on this date. Shares distributable is also recognized. An entry is made by debiting
retained earnings and crediting a dividend liability or shares distributable account. Some
corporations debit a dividends declared account instead of the retained earnings account. This
account is nevertheless closed to the retained earnings account at the end of the year.

• Paragraph 10 of IFRIC provides that the liability to pay a dividend shall be recognised when the
dividend is appropriately authorized and is no longer at the discretion of the entity: (a) When
declaration of the dividend, e.g. by management or the board of directors, is approved by the
relevant authority, e.g. the shareholders, if the jurisdiction requires such approval, or (b) When
the dividend is declared, e.g. by management or the board of directors, if the jurisdiction does
not require further approval.

Date of Record

A list of shareholders entitled to the declared dividends is prepared at the date of record. If an
investor buys a share of stock after this date, he will not receive the dividend. The share is to be
traded ex-dividend. No entry is required on this date.

Date of Payment

The corporation settle its liability on this date. An entry is made debiting the dividend
liability or shares distributable account and crediting cash, property distributed or share capital.

Cash Dividends

Majority of dividends distributed by corporations is paid in cash. In declaring cash dividends,

a corporation must have both an appropriate amount of retained earnings and the necessary
amount of cash. Some investors view that a large retained earnings balance automatically
permits generous dividend distribution. A corporation however may successfully accumulate
earnings and at the same time not be sufficiently liquid to pay large dividends.

Many corporations, especially new firms in growth industries, finance their expansion from
assets generated through earnings and pay out small cash dividends or none at all. Dividends on
par value shares are stated as a certain percentage of the par value. As to no-par value shares, the
dividends are stated at a certain amount per share. When the board of directors declares a cash
dividend, an entry is made debiting Retained Earnings and crediting Cash Dividends Payable.
143 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 The account, cash dividends declared may be used in place of the debit to retained earnings.
At the end of the accounting period, this temporary shareholders account will be closed by
debiting retained earnings and crediting cash dividend declared. Cash dividend payable are
reported as current liabilities in the statement of financial position. Cash dividends decrease total
assets and total shareholders‟ equity.

It is worthwhile to reiterate that with the exception of treasury shares, all issued and fully
paid shares, and all subscribed par value shares are entitled to dividends when declared. The
subscribed shares must be par value shares. No-par value shares are considered as legally issued
only when fully paid. Unissued shares, subscribed no-par shares and treasury shares are not
entitled to dividends.

Illustration:

Assume that the Board of Directors of RED Corporation, at its meeting on December 1, 2017
declares a dividend of P2.00 per share payable on February 1, 2018, to shareholders of record
December 15, 2018. At the time of declaration, RED Corporation has 175,000 ordinary shares of
which 125,000 shares are held in treasury.

Journal Entries

2017

Dec. 1 Retained Earnings P100,000

Cash Dividends Payable P100,000

To record the declaration of dividends.

2018

Feb. 1 Cash Dividends Payable P100,000

Cash P100,000

To record the payment of dividends.

Property Dividends

A distribution to shareholders that is payable in non-cash assets is generally referred to as

property dividends or dividend in kind. Per IFRIC 17, paragraph 11, an entity shall measure a
liability to distribute non-cash assets as a dividend to its owners at the fair value of the assets to
be distributed.

144 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
Illustration – Property Dividends

3S Food Industries, Inc. based in Pulilan, Bulacan has 5,000 shares investment in another
entity accounted for as nonmarketable equity investment. The carrying amount of this investment
is P500,000. On Dec. 1, 2019, this growing food corporation declared as property dividends this
investment to all it outstanding par value shares to be distributed on Dec. 15, 2019. The fair
market value of the investment at the date of declaration was P950,000. There was no change in
fair value on settlement date.

 The entries to record the dividend declaration and distribution are as follows:

Retained earnings P950,000

Property dividends payable P950,000

To record declaration of dividend.

Property Dividends Payable P950,000

Investment in Equity Securities P500,000

Gain on Distribution of Property Dividends P450,000

To record distribution of dividend.

Because of the use of fair value, a problem will arise at settlement date if the fair value of
the assets to be distributed has changed.

Per IFRIC 17, paragraph 13 at the end of each reporting period and at the date of
settlement, the entity shall review and adjust the carrying amount of the dividend payable, with
any change in the carrying amount of the dividends payable recognized in equity as adjustments
to the amount of the distribution.

When an entity settles dividends payable, it shall recognize the difference, if any,
between the carrying amount of the assets distributed and the carrying amount of the dividend
payable in profit or loss.

Share Dividends

A corporation may distribute to shareholders additional shares of the entity‟s own share
as share dividends. This distribution does not transfer assets to the shareholders. This type of
dividend affects only the accounts within the shareholders‟ equity. Share dividends increase the

145 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
total share capital and decrease retained earnings account. Share dividend does not change their
percentage interests in the corporation although outstanding shares have increased.

Small Share Dividends

• These are dividends in which the additional shares issued are less than 20% of the
previously outstanding shares. These are share dividends recorded by transferring from
retained earnings to share capital the fair market value of the additional shares to be
issued. In cases when the fair market value is lower than the par or stated value, the par or
stated value will be the basis for recording.

• Siobe! Your Japanese Fastfood, Inc. chain is blessed with years of profitable operations
for its commitment to serve affordable and healthy Japanese food favorites. The
shareholders‟ equity before declaration of a 10% share dividend is as follows:

Ordinary shares, P50, 20,000

shares issued and outstanding ₱ 1,000,000
Share Premium 200,000
Total Share Capital ₱ 1,200,000
Retained earnings 650,000
Total Shareholders' Equity ₱ 1,850,000
 The declaration of a 10% share dividend will require the issuance of an additional 2,000
shares. Assume that the corporation‟s share is being traded at the stock exchange and that
the stock market price per share is P110. The fair market value of the shares to be
distributed is P220,000. The entries will be:

 Retained earnings P220,000

Shares Distributable P100,000

Share Premium 120,000

To record declaration of 10% share dividends.

 Shares Distributable P100,000

Ordinary shares P100,000

146 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 To record issuance of share dividends.

 Retained earnings is debited for the fair market value of the share dividends. Shares
distributable is credited for the par value of the shares to be distributed and share
premium for the balance. If a statement of financial position is prepared between the
declaration date and the distribution date of a share dividend, the shares distributable
account will be shown in the shareholders‟ equity immediately after the ordinary shares
account.

Increase
Before Dividends After Dividends
(Decrease)

Ordinary shares, P50, 20,000

shares issued and outstanding ₱ 1,000,000 ₱ 1,100,000 ₱ 100,000
Share Premium 200,000 320,000 120,000
Total Share Capital ₱ 1,200,000 ₱ 1,420,000 ₱ 220,000
Retained earnings 650,000 430,000 (220,000)
Total Shareholders' Equity ₱ 1,850,000 ₱ 1,850,000 ₱ -
Shares Issued and Outstanding 20,000 22,000 2,000

 When the share is distributed, only the components of the shareholders‟ equity changes;
retained earnings decreased by P220,000 and total share capital increased by 220,000.
The total shareholders‟ equity did not change. The receipt of a share dividend does not
alter the relative position of a shareholder. If 10% share dividend is distributed, all
shareholders increase their proportionate holdings by 10% and the total share outstanding
is increased by the same proportion. No profit is realized by the shareholders.

Large Share Dividends

If the share dividend is 20% or more of the previously outstanding shares such that the
effect is to reduce materially the market value per share, then only the par or stated value is
credited to ordinary shares with a corresponding debit to retained earnings.

 Assume instead that Siobe! Your Japanese Fastfood, Inc. chain declared a 20% share
dividend on its 20,000 issued and outstanding P50 par value shares. The corporation will
issue additional 4,000 shares due to the share dividend. The entries will be:

 Retained earnings P200,000

147 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
 Shares Distributable P200,000

To record declaration of 20% share dividends.

 Shares Distributable P200,000

Ordinary Shares P200,000

To record issuance of share dividends.

 The account titles used to record a large share dividend are the same as those for small
share dividends. Note though that the balance in the account-Share Premium remained
the same, this is because large share dividends are recorded at par value.

Increase
Before Dividends After Dividends
(Decrease)

Ordinary shares, P50, 20,000

shares issued and outstanding ₱ 1,000,000 ₱ 1,200,000 ₱ 200,000
Share Premium 200,000 200,000 -
Total Share Capital ₱ 1,200,000 ₱ 1,400,000 ₱ 200,000
Retained earnings 650,000 450,000 (200,000)
Total Shareholders' Equity ₱ 1,850,000 ₱ 1,850,000 ₱ -
Shares Issued and Outstanding 20,000 24,000 4,000

Liquidating Dividends

• Liquidating dividends are not distributions of earnings but rather returns of capital to the
investing shareholders.

• This type of dividend can be legally paid only under either of the following
circumstances:

(1) When the corporation is under dissolution and liquidation or (2) when the corporation is
engaged in the exploration of natural resources.

EXERCISES:

Directions: Answer the following questions comprehensively:

148 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.
1. What is retained earnings?

2. Discuss dividends in general?

3. What are the three important dates in the distribution of any dividends?

4. What shares are entitled to dividends?

5. What are property dividends? In case of dividend declaration, what amount is charged
against retained earnings?

6. What are the effects of cash and property dividends on total assets and total shareholder‟s
equity?

7. What are share dividends? Discuss the effects of these dividends on total assets and total
shareholder‟s equity?

8. When share dividends are declared, what amount is charged against retained earnings?

9. What are prior period errors? How are they presented in the statement of retained
earnings?

10. Differentiate small share dividends from large share dividends.

Problem 1:

The E. delos Santos, Inc. board of directors voted on June 1, 2018 to declare a 10% shares
distributable on July 1, to shareholders of record as of June 15. On June 1, E. delos Santos
has 500,000 shares of 10 par ordinary shares authorized, 55,000 shares are issued and 5,000
shares are held as treasury stock. E. delos Santos stock is selling for P45 per share on June 1.

Required: Prepare the entries needed on the declaration, record and payment date.

Problem 2:

The Pallorina Corporation board of directors voted on November 1 2018 to declare a 45%
share dividend, distributable on Dec. 31, to shareholders of record as Dec. 1. Pallorina‟s
articles authorize the issuance of 200,000 shares of P40 par ordinary shares. As of November
1, 2018, 50,000 ordinary shares are issued and outstanding. The market price of Pallorina
stock on Nov. 1 is P85 per share.

Required: Prepare the entries needed on the declaration, record and payment dates.

149 Reference: Ballada, W. & Ballada, S. (2020). Partnership and Corporation Accounting. 22th edition.