Unit 1 and 2

Nature and Formation of a Partnership

A partnership is a contract whereby two or more persons bind themselves to contribute

money, property or industry into a common fund with the intention of dividing the profit
among themselves (Article 1767 of the Civil Code of the Philippines). This joint effort
may be supported by a partnership agreement known as the Articles of Co-Partnership,
which is an agreement in writing among the partners governing the nature and terms of
the partnership contract. A written agreement is required when partnership capital is P
3,000 or more in money or in property. The Article of Co-partnership helps in avoid
misunderstanding among the partners. The written agreement among the partners
governs the formation, operation and dissolution of the partnership and is required to be
registered with SEC. The Article of Co-partnership contains the following information:

1. The name of the partnership;

2. The names, addresses of the partners, classes of partners stating whether the
partner is a general or a limited partner;
3. The effective date of the contract;
4. The purpose and principal place of business of the business;
5. The capital of the partnership stating the contributions of each of the partners;
6. The rights and duties of each of the partners;
7. The manner of dividing profit or loss among the partners;
8. The conditions under which the partners may withdraw money or other assets;
9. The manner of keeping the books of accounts;
10. The causes for dissolution and the provision for arbitration in settling disputes.

Characteristics of a Partnership
1. Based on contract – partnership is formed through the mutual agreement of all the
partners. The contract may be written or oral.
2. Voluntary association – no one should be forced or coerced in joining a
partnership.
3. Mutual agency – any partner may act as an agent of the partnership in conducting
its affairs.
4. Limited life – a partnership may be dissolved at any time by action of the partners
or by operation of law. The withdrawal, death, retirement, bankruptcy, incapacity
of a partner and the admission of a new partner dissolves the partnership.
5. Unlimited liability – the personal assets of a general partner may be used to
satisfy the claims of the creditors of the partnership if the partnership assets are
not enough to settle the liabilities to outsiders upon liquidation.
6. Co-ownership of property – properties contributed to the partnership are owned
by the partnership. Properties invested by a partner cease to be his own personal
property.

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 7. Co-ownership of profit – a partner has the right to share in partnership profits.
The partners are entitled to share in the firm’s profits as a return on their
investment.
8. Legal entity – a partnership has a legal personality separate and distinct from that
of each of the partners.
9. Income tax – partnerships are subject to income tax rate of 30% beginning the
fiscal year 2010 with the exception of general professional partnerships (i.e., those
partnerships organized for the exercise of professions, e.g., CPAs, doctors,
lawyers, etc.)

Advantages of a Partnership
1. It is easy and inexpensive to form and to dissolve. It may be created orally except
when partnership capital is P3,000 or more. A partnership is ended whenever
there are changes in the ownership structure such as withdrawal of a partner or
admission of a new partner.
2. Greater amount of capital may be raised compared to a sole proprietorship. The
combined capital of 2 or more partners offers a greater source of capital.
3. There is relative freedom and flexibility in decision-making compared to a
corporation. Decisions are effected simply by agreement among the partners
without the formalities necessary under a corporation.
4. It is better managed because more than one person supervises business affairs.
Better management results from the combined experience and ability of several
individuals.
5. The unlimited liability of general partners makes it reliable from the point of view
of creditors.

Disadvantages of a Partnership
1. There is lack of business continuity because it can be easily dissolved.
2. Limited amount of capital may be raised compared to a corporation.
3. The unlimited liability of a partnership deters many from joining in a partnership
form of business.
4. A general partner may be subjected to a personal liability for erroneous
management decisions made by his associates.
5. There is likelihood of dissension and disagreement when each of the partners has
the same authority in the management of the firm.
6. There is difficulty in transferring ownership interest because ownership interest in
the partnership cannot be transferred without the consent of all the partners.

Kinds of Partnerships
1. According to activities
a. Service – main activity is the rendering of services
b. Merchandising or Trading – main activity is the purchase or sale of goods
c. Manufacturing – main activity is the production of goods

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 2. According to liability
a. General – one wherein all the partners are general partners who are liable
for the partnership debts to the extent of their personal property after all
the partnership assets have been exhausted.
b. Limited – one consisting of one or more general partners and one or more
limited partners.

3. According to object
a. Universal partnership of all present property – one in which the partners
contribute all the property which actually belong to each of them, at the
time of the constitution of the partnership, to a common fund with the
intention of dividing the same among them as well as the profits which
they may acquire therewith. All assets contributed to the partnership and
subsequent acquisitions become common partnership assets.
b. Universal partnership of profits – one which comprises all that the partners
may acquire by their industry or work during the existence of the
partnership and the usufruct of movable or immovable property which
each of the partners may possess at the time of the institution of the
contract. The original movable or immovable property contributed do not
become common partnership assets.
c. Particular partnership – one which has for its object determinate things,
their use or fruits or a specific undertaking or the exercise of a profession
of vocation.

4. According to duration of partnership existence

a. Partnership at will – one for which no term is specified and is not formed
for a particular undertaking or venture and which may be terminated any
time by mutual agreement of the partners or the will of one alone.
b. Partnership with a Fixed Term – one in which the term or period for which
the partnership is to exist is agreed upon (Baysa and Lupisan, 2000).

Kinds of Partners
1. According to contribution
a. Capitalist – one who contributes capital in money or property.
b. Industrial – one who contributes industry, labor, skill or service
c. Capitalist-Industrial – one who contributes money, property and industry
2. According to Liability
a. General – one whose liability to third persons extends to his private
property
b. Limited – one whose liability to third persons is limited only to the extent
of his capital contribution to the partnership.
3. According to management
a. Managing Partner – one who manages actively the business of the
partnership
b. Silent – one who does not participate in the management of partnership
affairs.

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 4. Others
a. Nominal- a partner in name only.
b. Secret – one who takes active part in the business but whose connection
with the partnership is concealed on unknown to the public.
c. Dormant partner – one who does not take active part in the business and is
not known to the public as a partner.

Basic Features of Partnership Accounting

1. More than one capital and drawing accounts – there will be as many capital
accounts and as many drawing accounts as there are partners
2. Partner’s loans – partners may advance money to the partnership in the form of
loans when the business is in need of additional funds. The account title to be
credited is Loans Payable to Partner or Partner, Loan
3. Partner’s borrowings – the partnership may advance money to partners other than
withdrawals in the form of loans. The account title to be debited is Receivable
from Partner.
4. Partner’s salaries – partners are paid salaries for services rendered in the conduct
of partnership business.
5. Interest on investment – interest is allowed to earn on the asset investment of the
partners.
6. Division of profit and losses – net profit or net loss is to be divided among the
partners based on their agreement.

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 PARTNERSHIP FORMATION

Two Kinds of Partnership Formation

1. Two or more individuals form a business for the first time.

DATE PARTICULARS P/R D E B I T C R E D I T

Cash investment
July 1 Cash X X X X X
Rose, Capital X X X X X
To record initial investment.

Investment in the form of non-cash assets

July 1 Non-cah assets X X X X X
Rose, Capital X X X X X
To record initial investment.
Note: Fair market value of the non-cash asset
is used in recording the investment.

Investment in the form of non-cash assets with assumption of liability

July 1 Non-cah assets X X X X X
Liability X X X X X
Rose, Capital X X X X X
To record initial investment.
Note: Fair market value of the non-cash asset
is used in recording the investment;
credit the applicable liabilily account using
the loan balanceto be assumed by the
partnebrship; and credit the capital account
of the partner using the net amount
(I.e., non cash assets - liability).

Investment in the form of service or industry

Memorandum entry:
Guada is admitted as an industrial
partner with ____ share in profits.

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2. An individual forms a business with a sole proprietor or a sole proprietorship(s)
converted into a partnership

The following are the accounting procedures in converting a sole proprietorship form
of business into partnership.
a. Adjust the existing books of the sole proprietorship(s).
Date PARTICULARS P/R DEBIT CREDIT
Increase in the asset value with no contra-asset account
Asset X X X X
Rose, Capital X X X X

Decrease in the asset value with no contra-asset account

Rose, Capital X X X X
Asset X X X X

Increase in the asset value with contra-asset account

Contra-asset X X X X
Rose, Capital X X X X

Decrease in the asset value with contra-asset account

Rose, Capital X X X X
Contra-asset X X X X

Note: These adjusting entries are similar to year-end adjustments. The only difference is that the Capital account
replaces all the nominal accounts .

b. Close the existing books of the sole proprietorship(s).

Date PARTICULARS P/R DEBIT CREDIT
All contra asset accounts X X X X
All liability accounts X X X X
Rose, Capital X X X X
All asset accounts X X X X X

c. Record the investment of all the partners in the new set of partnership books.
Date PARTICULARS P/R DEBIT CREDIT
To record the investment of the sole proprietor
All assets from the original business X X X X X
Allowance for doubtful accounts X X X
All liabilty accounts X X X X
Rose, Capital X X X X X

Note 1: If the sole proprietor assets includes Accounts Receivable, the said account must be recorded at gros
amount and the allowance for doubtful accounts is carried over in the new set of partnership books.

Note 2: Depreciable assets are recorded in the new set of partnership books at their net cvarrying value, i.e.,
accumulated depreciation account is not recorded in the partnership books .

Note 3: Other partners' investment are recorded in the same way as in No. 1 (Formed by individulas)

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 Unit 3
Accounting for Division of Profits & Losses

Partnership Operations

Accounting for a partnership form of business is basically similar to that of a sole

proprietorship. For example, Purchase of supplies is debited either to Supplies or Supplies
Expense account and when merchandise are sold on account, the entry is to debit Accounts
receivable and credit the Sales account which is the same as that of a sole proprietorship In fact
the Accounting Cycle of a Partnership is similar to that of sole proprietorship:
1. Recording of the business transactions
2. Posting to ledgers
3. Preparing a trial balance
4. Preparing the worksheet
5. Recording adjusting entries
6. Prepare financial statements
7. Recording and posting closing entries
8. Preparing a post-closing trial balance
9. Recording and posting reversing entries

However, problems distinctive only to partnership operations are encountered in the

following:

1. Recording of partner’s loan account when a partner lends money to a partnership.

Date PARTICULARS P/R DEBIT CREDIT

July 1 Cash X X X X
Partner, loan or Loan Payable to Partner X X X X

2. Recording of loan extended by the partnership to the partner/s.

Date PARTICULARS P/R DEBIT CREDIT

July 1 Receivable from Partner X X X X
Cash X X X X

3. Recording of the closing entries of a partnership/Dividing partnership profits or

losses– individual drawing accounts of partners are not automatically closed to their
capital accounts in order to maintain the original capital balances of the partners as stated
in the Articles of Co-Partnership; drawing accounts are closed to the capital accounts
only if agreed upon in the articles of co-partnership.

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 a. Distributing net income
Date PARTICULARS P/R DEBIT CREDIT
Dec. 31 Income Summary X X X X
Rose, drawing X X X X
Guada, drawing X X X X

a. Distributing net loss

Date PARTICULARS P/R DEBIT CREDIT
Dec. 31 Rose, drawing X X X X
Guada, drawing X X X X
Income Summary X X X X

Partnership net income or net loss is shared according to the partners’ capital ratio unless the
partnership contract specifically indicates otherwise.
a. A partner's share of net income or net loss is recognized in the accounts through
closing entries.
b. Closing entries for a partnership are identical to the entries made for a proprietorship,
except for the use of multiple capital and drawing accounts.

The various income ratios that may be used include:

a. A fixed ratio, expressed as a proportion (6:4), a percentage (70% and 30%), or a
fraction (2/3 and 1/3).
b. A ratio based either on capital balances at the beginning of the year or on average
capital balances during the year.
c. Salaries to partners and the remainder on a fixed ratio.
d. Interest on partners' capitals and the remainder on a fixed ratio.
e. Salaries to partners, interest on partners' capitals, and the remainder on a fixed ratio.
The objective is to reach agreement on a basis that will equitably reflect the
differences among partners in terms of their capital investment and service to the partnership.

Provisions for salaries and interest must be applied before the remainder of net income
or net loss is allocated on the specified fixed ratio. Detailed information concerning the division
of net income or net loss should be shown at the bottom of the income statement.
4. Preparation of financial statements - the financial statements prepared for a partnership form of
business is basically the same as sole proprietorship except for the following:

a. Statement of Financial Position – the owner’s equity section is labeled Partners’ Equity

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 RGem Trading
Statement of Financial Position
December 31, 20X5

Assets
Note
Current assets
Cash P 78,000
Investment in Trading Securities 80,000
Trade and other receivables 3 154,000
Merchandise Inventory 120,000
Prepaid expenses 63,000 P 495,000

Property, Plant and Equipment 4 505,000

Total Assets P 1,000,000

Liabilites and Partners' Equity

Current liabilites
Trade and other payables 5 P 178,000

Long term liabilities

Mortgage Payable 314,000

Total liabilities P 492,000

Partners' Equity
Rose, Capital P 208,875
Guada, Capital 299,125 508,000
Total Labilities and Partners' Equity P 1,000,000

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b.Income Statement – an additional section called Distribution of Net Income or Net Loss is
included. This profit or loss distribution provides a full analysis of the distribution of earnings or
losses which is presented at the bottom part of the partnership income statement.

RGem Trading
Income Statement
For the year ended December 31, 20X5
Note
Net Sales Revenue 1 P 880,000
Cost of Sales 2 475,000
Gross profit P 405,000
Operating Expenses
General and administrative expense P 114,500
Distribution expense 102,500 217,000
Net income P 188,000

Distribution of Net Income

Rose Guada Total
Annual salary to managing partner P 60,000 P 60,000
10% interest on beginning capital 15,000 25,000 40,000
5% bonus based on net income 9,400 9,400
Balance: capital ratio (15/40; 25/40) 29,475 49,125 78,600
Net Income P 113,875 P 74,125 P 188,000

c. Statement of Partners’ Equity – a statement that reports the changes that have taken place in
the partners’ equity during the period. Each partner is provided a column heading which
explains details of the changes in his/her equity account.

RGem Trading
Statement of Changes in Partners' Equity
For the year ended December 31, 20X5

Rose Guada Total

Capital balances, January 1 P 150,000 P 250,000 P 400,000
Add: Net Income 113,875 74,125 188,000
Sub-total P 263,875 P 324,125 P 588,000
Less: Drawings 55,000 25,000 80,000
Capital balances P 208,875 P 299,125 P 508,000

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Capital Account of a Partner

Rose, Capital
Debit Credit
Permanent Initial and additional
withdrawals investments

Rules for Dividing Profit and Loss in a Partnership business

The computation of the result of business’ operation of a partnership is essentially the
same as that of the sole proprietorship. But the distribution to individual partners of this profit or
loss is the primary objective of the accounting process.

The income of the partnership is realized as the result of combining the contribution of
the partners in terms of capital investment, services rendered or time devoted in the management
of the business, and entrepreneurial ability or the partner’s personal business contacts and his
credit rating in the business community. And if profits or losses are to be divided fairly and
equitably these contributions by the partners must be properly considered. Therefore, the
following scheme may be adapted since the partnership’s net income may be viewed as a return
for:

1. services rendered – provide salaries to give recognition to the ability, experience or time
devoted by a partner to the business.
2. capital investment – provide interest to give recognition to differences in the capital
contribution given in proportion to the period such capital was actually used.
3. entrepreneurial ability or managerial skills - provide bonus which is an incentive or
special compensation which is usually based on net income.

The partnership may come up with their profit and loss ratio in the distribution of profits
and losses of the firm. This is the ratio in which partnership profits and losses are divided and
must be stated in the Articles of Co-Partnership. In the absence of any agreement as to the
division of profits or losses, the Philippine Partnership Law provides that the share of each
partner in the profit or loss shall be in proportion to what he has contributed, i.e., in accordance
with the partners’ contributed capital, but the industrial partner shall receive such shares as what
is just and equitable under the circumstances. The law also provides that if the sharing of profits
has been agreed upon by the partners, but no provision was made as to the distribution of losses,
the share of each partner in the losses shall be divided in the same manner that profits are
divided.

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Methods of Dividing Net Income
1. Equally
2. Arbitrary Ratio
a. Fractions
b. Percentages
c. Ratio and Proportion
3. Based on Capital Ratio
a. Original/Initial investment
b. Beginning capital balance
c. Ending capital balance
d. Average capital – most equitable method
4. Allowing Salaries, Interest and Bonus – considered as part of the distribution of net
income

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 Unit 4
PARTNERSHIP DISSOLUTION WITHOUT LIQUIDATION

A partnership depends upon the contractual agreement between or among partners;

therefore, the existence of the partnership business may be somewhat uncertain since it depends
on the personalities, moods, relationships of partners, etc. Any events or happenings that cause
the technical termination of a partnership may lead to a permanent dissolution or liquidation, if
the partners decide. Dissolution and liquidation in relation to partnerships are not synonymous.
A partnership is said to be dissolved when the original association for purposes of carrying on
activities has ended. A partnership is said to be liquidated when the business is terminated.

Dissolution
1. The change in the relation of the partners caused by any partner ceasing to be associated
in the carrying out of the business (Article 1825, Civil Code of the Philippines).
2. The termination of the life of an existing partnership.

Dissolution of an old partnership may be followed by:

1. the formation of a new partnership – new partnership continues the business activities of
the dissolved partnership without interruption.
2. liquidation – termination of business activities and winding up of partnership affairs
preparatory to going out of business.

Reasons why a partnership may be dissolved

1. Admission of a new partner
2. Retirement or withdrawal of a partner
3. Death, incapacity or insolvency of a partner
4. Incorporation of a partnership

Admission of a New Partner

1. The consent of all the partners is necessary.
2. There is a need to update the capital balances of the partners by
a. determining profit share of each partner from the last balance sheet date to
dissolution date.
b. revaluing/ adjusting partnership assets and liabilities using a temporary account
called the Capital Adjustment account.

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 a. Determine profit share of partners.

Date PA RTICULA RS P/R DEBIT CREDIT

Dec. 31 Income Summary X X X X
Rose, drawing X X X X
Guada, drawing X X X X

Rose, drawing X X X X
Guada, drawing X X X X
Rose, capital X X X X
Guada, capital X X X X

b. Revaluing/ adjusting partnership assets and liabilities

Increase in value of an asset without a contra-asset account

Date PA RTICULA RS P/R DEBIT CREDIT
July 1 Asset X X X X
Capital Adjustment X X X X

Decrease in value of an asset without a contra-asset account

Date PARTICULARS P/R DEBIT CREDIT
July 1 Capital Adjustment X X X X
Asset X X X X

Increase in value of an asset with a contra-asset account

Date PARTICULARS P/R DEBIT CREDIT
July 1 Contra-asset X X X X
Capital Adjustmnet X X X X

Decrease in value of an asset with a contra-asset account

Date PARTICULARS P/R DEBIT CREDIT
July 1 Capital Adjustment X X X X
Contra-asset X X X X

Increase in value of a liability account

Date PARTICULARS P/R DEBIT CREDIT
July 1 Capital Adjustment X X X X
Liability X X X X

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Decrease in the value of a liability account
Date PA RTICULA RS P/R DEBIT CREDIT
July 1 Liability X X X X
Capital Adjustment X X X X

Note: These adjusting entries are similar to the year-end adjustments that we studied in
partnership formation. The only difference is that, nominal accounts are being replaced
by the Capital Adjustment account.

Close the Capital Adjustment account

Date PARTICULARS P/R DEBIT CREDIT
July 1 Capital Adjustment X X X X
Rose, capital X X X X
Guada, capital X X X X
or
Rose, capital X X X X
Guada, capital X X X X
Capital Adjustment X X X X

Admission of a new partner

An existing partnership may admit a new partner with the consent of all the partners. When a
new partner is admitted, the partnership is dissolved and a new partnership is formed. Upon the
admission of a new partner, a new agreement covering partners’ interest, profits and loss sharing and
other consideration should be drawn because the dissolution of the original partnership cancels the old
agreement.

Types of Admission of a New Partner

1. By purchase of interest from one or more of the old partners
a. It is considered as a personal transaction between the selling partner and the buyer
who becomes a new partner.
b. It merely involves a transfer of capital of the selling partner to the capital of the
buying partner.
c. There is no increase in total assets and no increase in total partners’ equity.
Pro-forma entry
Date PARTICULARS P/R DEBIT CREDIT
July 1 Selling partner's name, capital X X X X
Buying partner, capital X X X X

Note: When a new partner is admitted by purchase of an interest,

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  The transaction is a personal one between one or more existing partners and the new
partner.
 Any money or other consideration exchanged is the property of the participants and not the
property of the partnership.
 Each partner's capital account is debited for the ownership claims that have been
relinquished, and the new partner's capital account is credited with the capital equity
purchased.
 Total assets, total liabilities, and total capital remain unchanged.

2. By investment or asset contributions to the partnership

A new partner may be admitted to the firm by investing directly to the partnership.
This method of admission of a new partner in the partnership implies the following:
a. It is a transaction between the partnership and the incoming partner.
b. It involves the investment of assets by new partner into the partnership.
c. Total assets and total partners’ equity will increase.
Pro-forma entry
Date PARTICULARS P/R DEBIT CREDIT
July 1 Cash X X X X
Non-cash asset X X X X
New partner, capital X X X X

Note:
When a new partner is admitted by the investment of assets, both the total net assets and
the total capital of the partnership increase. This is done by debiting Cash/Non Cash assets
and crediting the new partner's capital account. When the capital credit does not equal the
investment of assets in the partnership, the difference is considered either a bonus or
goodwill either to the existing partners or the new partner.

Framework in analyzing admission of a new partner by investment

Original New
Name of profit and Contributed Agreed profit and Analysis of
partners loss ratio Capital Capital loss ratio variance/difference
Old partner 1 % XX,XXX XX,XXX %
Old partner 2 % XX,XXX XX,XXX %
New partner XX,XXX XX,XXX %
TOTAL 100% XXX,XXX XXX,XXX 100%
Important terms used under admission by investment
1. Agreed capital (AC) – new capitalization of the new partnership which may be equal to,
more than the total contributed capital.
2. Contributed capital (CC) – the sum of the investments or contributions of the new and old
partners.
3. Fraction of interest – this is the interest or equity of a partner expressed in fraction
4. Percentage of interest – this is the interest or equity of a partner expressed in percentage.

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Bonus
1. It is an amount partners are willing to allow as additional credit to a partner’s capital in
excess of his actual capital contribution.
2. It is a transfer of capital from one partner to another

A bonus to old partners results when the new partner's capital credit on the date of admittance
is less than the new partner's investment in the firm. The procedure for determining the
new partner's capital credit and the bonus to the old partners is as follows:
a. Determine the total capital of the new partnership by adding the new partner's
investment to the total capital of the old partnership.
b. Determine the new partner's capital credit by multiplying the total capital of the new
partnership by the new partner's ownership interest.
c. Determine the amount of bonus by subtracting the new partner's capital credit from the
new partner's investment.
d. Allocate the bonus to the old partners on the basis of their income ratios.

A bonus to a new partner results when the new partner's capital credit is greater than the
partner's investment of assets in the firm. The bonus results in a decrease in the capital
balances of the old partners based on their income ratios before admission of the new partner.

Bonus to old partners

Date PARTICULARS P/R DEBIT CREDIT
July 1 New partner, capital X X X X
Old partner 1, Capital X X X X
Old partner 2, Capital X X X X

Bonus to new partner

Date PARTICULARS P/R DEBIT CREDIT
July 1 Old partner 1, capital X X X X
Old partner 2, capital X X X X
New partner, capital X X X X

Note: The amount of bonus is divided among the old partners using the original profit and loss
ratio.

Withdrawal of a Partner
As in the case of the admission of a partner, the withdrawal of a partner legally dissolves
the partnership. The withdrawal of a partner may be accomplished by (a) payment from partners'
personal assets or (b) payment from partnership assets. The former affects only the partners'
capital accounts, whereas the latter decreases total net assets and total capital of the partnership.

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 The withdrawal of a partner when payment is made from partners' personal assets is the
direct opposite of admitting a new partner who purchases a partner's interest.
a. Payment from partners' personal assets is a personal transaction between the partners.
b. Partnership assets are not involved and total capital does not change.
c. The effect on the partnership is limited to a realignment of the partners' capital balances.

Using partnership assets to pay for a withdrawing partner's interest is the reverse of
admitting a partner through the investment of assets in the partnership.
a. Payment from partnership assets is a transaction that involves the partnership.
b. Both partnership net assets and total capitals are decreased.
c. There are instances where asset revaluations may be recorded.

When the partnership assets paid are in excess of the withdrawing partner's capital interest,
a bonus to the retiring partner results. The bonus is deducted from the remaining partners'
capital balances on the basis of their income ratios at the time of the withdrawal.

When the partnership assets paid are less than the withdrawing partner's capital interest, a
bonus to the remaining partners results. The bonus is allocated to the capital accounts of the
remaining partners on the basis of their income ratios.

In a withdrawal of a partner
1. There is a need to update the capital balances of the partners by
a. determining profit share of each partner from the last balance sheet date to
dissolution date.
b. revaluing/ adjusting partnership assets and liabilities using a temporary account
called the Capital Adjustment account.

Types of Withdrawal of a Partner

1. Purchase of interest by another partner or an outsider
a. It is considered a personal transaction between the buying and selling partners.
b. It involves the transfer of the withdrawing partners’ capital to the capital account
of the buying partner.
2. Purchase of interest by the partnership
a. It is considered a transaction between the partnership and the outgoing partner.
b. It involves a decrease in capital with the corresponding decrease in partnership
assets or increase in partnership liabilities.

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By purchase of interest by another person or an outsider
Date PARTICULARS P/R DEBIT CREDIT
July 1 Withdrawing partner, capital X X X X
New partner, Capital X X X X

By purchase of interest by the partnership - Amount paid is equal to the withdrawing partner's capital

Date PARTICULARS P/R DEBIT CREDIT

July 1 Withdrawing partner, capital X X X X
Cash/Liability X X X X

By purchase of interest by the partnership - Amount paid is less than the withdrawing partner's capital
Bonus to the remaining partners
Date PARTICULARS P/R DEBIT CREDIT
July 1 Withdrawing partner, capital X X X X
Remaining partner 1, capital X X X X
Remaining partner 2, capital X X X X
Cash/Liability X X X X

By purchase of interest by the partnership - Amount paid is more than the withdrawing partner's capital
Bonus to the withdrawing partner
Date PARTICULARS P/R DEBIT CREDIT
July 1 Withdrawing partner, capital X X X X
Remaining partner 1, capital X X X X
Remaining partner 2, capital X X X X
Cash/Liability X X X X

Death of a Partner

The death of a partner dissolves the partnership, but provision generally is made for the
surviving partners to continue operations. When a partner dies it is necessary to determine the
partner's equity at the date of death.

Marivic Valenzuela-Manalo 7
 Unit 5
PARTNERSHIP DISSOLUTION WITH LIQUIDATION

Liquidation of a partnership means winding up the business usually by selling the

assets, paying the liabilities, and distributing the remaining cash to partners. A business
which is in the process of converting its assets into cash and making settlement with
creditors is said to be in liquidation.

In this unit, emphasis will be placed on the accounting problems and procedures
involved in the winding up (liquidation) of the partnership affairs. When the business is
to be liquidated, the account must be adjusted and closed, and the resulting income or
loss in the final period is transferred to the capital accounts of the partners.

The basic objectives of a partnership during liquidation process are to convert the
partnership assets to cash, to pay off partnership obligations and to distribute cash and
any unrealized assets to the individual partners.

Dissolution with Liquidation

1. A partnership is liquidated when its business operations are completely terminated
or ended.
2. It may be caused by any of the following factors:
a. The purpose for which the partnership was organized has been
accomplished.
b. The term/period covered by the partnership contract has terminated.
c. The firm became bankrupt.
d. The partners mutually agree to close the business.
3. Partnership assets are sold.
4. Partnership creditors are paid.
5. Remaining assets are distributed to the partners as a return of their investments.

Definition of Terms
1. Dissolution – the termination of the life of the partnership.
2. Liquidation – the process of winding up a business which normally consists of
conversion of assets into cash, payment of liabilities and distribution of remaining
among the partners.
3. Realization – the process of converting non-cash assets into cash.
 4. Gain on realization – the excess of the selling price over the carrying amount of
the non cash assets sold through realization.
5. Loss on realization – the excess of the carrying amount over the selling price of
the non cash assets sold through realization.
6. Capital deficiency – the excess of a partner’s share on losses over his capital
balance resulting to a debit balance in the capital account.
7. Deficient partner – a partner with a debit balance in his capital account.
8. Right of offset – the legal right to apply part or all of the amount owing to a
partner on a loan balance against a deficiency in his capital account resulting from
losses in the process of liquidation.
9. Partner’s interest – the sum of a partner’s capital, loan balance and advances to
the partnership.
10. Solvent partner – personal assets of the partner exceed his personal liabilities.
11. Insolvent partner – personal assets of the partner are less than his personal
liabilities.
12. Statement of Liquidation – an accounting statement summarizing the winding up
of the business affairs of the partnership.

Types of Liquidation
1. Lump-sum liquidation – a liquidation method whereby all assets are converted
into cash, all liabilities are paid, and all profits or losses are charged to the
partners followed by a single liquidating distribution to the partners.
2. Installment method – involves the selling of some assets, paying the liabilities of
the partnership, dividing the available cash to the partners, selling additional
assets and making further payments to partners. This process continues until all
the assets have been sold and all cash has been distributed to the creditors and to
the partners.

Procedures in Lump Sum Liquidation

1. Finish the accounting cycle.
a. Adjust the books.
b. Determine the net income/net loss and close the net income/net loss to
partners’ capital accounts.
c. Close all nominal accounts.
d. Close all drawing accounts to their respective capital accounts.

Marivic Valenzuela-Manalo 2
 2. Sell non-cash assets and distribute gain or loss on realization among partners
using profit and loss ratio.
a. Any difference between the selling price and carrying amount of the sold
assets shall be recorded in an account called Gain or Loss on Realization.
b. The Gain or Loss on Realization account shall be closed to the partners’
capital accounts using profit and loss ratio.
3. If partner’s capital balance results in a debit balance (deficient balance), the
following may happen:
a. If a partner has a loan balance – exercise the right of offset (apply the loan
balance against the debit balance).
b. If there is no loan or if capital balance still results in a debit balance:
b.1 If partner is solvent and a general partner – deficient partner makes
additional cash investment to remove his capital deficiency.
b.2 If partner is insolvent and general partner or if limited partner –
deficient partner is unable to pay; the remaining solvent partners will
absorb the deficiency.
4. Cash is to be distributed in the following order of priority:
a. First, to outside partnership creditors.
b. Second, to partners for loan accounts.
c. Third, to partners for capital accounts.
Note: The final distribution of cash to partners is made based on the partners’
capital balances and not based on the profit and loss ratio.

5. When cash is not sufficient to pay creditors, the solvent general partners shall
contribute the difference using their loss ratio.

Marivic Valenzuela-Manalo 3
 Pro-forma Statement of Liquidation (Lump-Sum Method)

Name of Partnership
Statement of Liquidation
Date Covered by the Liquidation
Non-
Cash cash Liabilities Rose, Rose, Guada,
assets Loan Capital Capital
Profit & loss ratio
Balances before realization
Realization and distribution of gain or
loss on realization
Balances
Payment of liabilities
Balances
Payment of partner’s loan
Balances
Distribution of cash to partners

Pro-forma Entries

DATE P A R T I C U L A R S P/R D E B I T C R E D I T
Selling/Realization of non-cash asset at a gain
July 1 Cash X X X X X
Allowance for doubtful accounts X X X X X
Accummulated depreciatiom X X X X X
Gain on realization X X X X X
Non-cash assets X X X X X

Selling/Realization of non-cash asset at a loss

July 1 Cash X X X X X
Allowance for doubtful accounts X X X X X
Accummulated depreciatiom X X X X X
Loss on realization X X X X X
Non-cash assets X X X X X

Important note: Gain or loss on realization account may not be used when liquidation statement
is prepared before actually recording the realization of assets in the general journal.
This means that gains are directly credited to the partner's individual capital accounts

Marivic Valenzuela-Manalo 4
DATE P AR T IC UL AR S P/R D E B I T C R E D I T

Closing the Gain or loss account when used

July 1 Gain on realization X X X X X
Rose, Capital X X X X X
Guada, Capital X X X X X
OR
July 1 Rose, Capital X X X X X
Guada, Capital X X X X X
Loss on realization X X X X X

Important note:
Gain or loss on realization account is closed to partners' capital accounts using profit & loss ratio.

Payment of partnership liabilities

Liabilities X X X X X
Cash X X X X X

Payment of loan to partner/s

Rose, Loan X X X X X
Cash X X X X X

Return of partners' capital

Rose, Capital X X X X X
Guada, Capital X X X X X
Cash X X X X X

Important note:
Return of partners' capital is based on their final capital balances and not based on P & L ratio.

Exercise right of off set

Guada, loan X X X X X
Guada, capital X X X X X

Exercise absorption of losses due to capital defiency of an insolvent and deficient partner/s
Guada, Capital X X X X X
Rose, capital X X X X X

Payment of deficient but solvent partner

Cash X X X X X
Guada, capital X X X X X

Marivic Valenzuela-Manalo 5
Special Notes
1. Make sure that the balances before liquidation show equality of debits and credits.
This will always be true after each liquidation transaction.
2. Maintain two columns for the debits – one for cash and one for non-cash assets.
3. Maintain separate columns for liabilities to outside creditors and liabilities to
partners.
4. Gain on realization increases capital while loss on realization decreases capital.
5. Figures in parentheses represent reduction in the account.
6. Double rule all columns when all columns are brought to zero balance.

Important notes to remember in lump sum partnership liquidation

1. The liquidation of a partnership terminates the business. In liquidation, it is necessary

to:
a. Sell non-cash assets for cash and recognize a gain or loss on realization.
b. Allocate gain/loss on realization to the partners based on their profit and loss
ratios.
c. Pay partnership liabilities in cash.
d. Distribute remaining cash to partners on the basis of their remaining capital
balances.

2. Each of the steps must be performed in sequence.

3. The liquidation of a partnership may result in no capital deficiency (all partners have
credit balances in their capital accounts) or in a capital deficiency (at least one
partner's capital account has a debit balance.)

4. When there is a capital deficiency, the partners with the deficiency may pay the
amount owed and the deficiency is eliminated.

5. If a partner with a capital deficiency is unable to pay the amount owed to the
partnership, the partners with credit balances must absorb the loss as follows:
a. The cash distributed to each partner is the difference between the partner's
present capital balance and the loss that the partner may have to absorb if the
capital deficiency is not paid.
b. The allocation of the deficiency is made on the profit and loss ratios that exist
between the partners with credit balances. The allocation is journalized and
posted.

Partnership Liquidation By Installment

Frequently partnership assets are not realized through an instantaneous sale but
may extend over several months. When this happens, the partners may prefer to receive

Marivic Valenzuela-Manalo 6
the amounts due to them in a series of installments rather than wait until all assets have
been converted to cash. Installment payments to partners are proper provided that
measures are taken to insure that all creditors are paid in full and that there is no over
distribution to one or more of the partners.

Nature of Installment Liquidation

1. Non-cash assets are sold on a piecemeal basis over an extended period of time.

2. Cash realized is immediately distributed to partners after fully satisfying

creditors’ claims or after setting aside sufficient cash for these liabilities.

3. Cash distribution to partners is considered as if it were the last because total gain
or loss on realization is not yet determined.

4. Remaining unsold assets must be treated as a complete loss.

5. Debit balances in capital and potential capital deficiencies are assumed

uncollectible.

6. Partners’ interests are reduced by cash distributions to a balance proportionate to

the partners’ profit and loss ratios.

7. Succeeding cash distributions are then based on the profit and loss ratio.

Procedures for Liquidation by Installment

The following are the accounting procedures that may be followed in

liquidating a partnership by installments:

1. Record the realization of assets and distribute the realized gains or losses among
the partners using profit and loss ratio.

2. Pay liquidation expenses and unrecorded liabilities, if there are any, and distribute
these among the partners using the profit and loss ratio.

3. Pay the liabilities to outsiders.

4. Distribute cash to partners after possible future losses have been apportioned to
partners or in accordance with an advance distribution plan.

 Restricted interest, in the accompanying schedule to determine amounts to

be paid to partners, shall consist of:
a. remaining unsold assets;

Marivic Valenzuela-Manalo 7
 b. cash withheld for possible expenses;
c. debit balances in capital.

Computation of Safe payments to Partners

In installment liquidation, cash distributions to partners are authorized even

before all the losses that may be incurred and charged against the partners are known.
Considerable care is therefore, required to insure an equitable distribution of cash to
partners.

The Statement of Partnership Liquidation is usually supported by a schedule of

safe installment payments to partners, simply called Schedule of Safe Payments,
prepared periodically. According to the schedule, each installment of cash is distributed
as if no more cash is forthcoming, either from sale of assets or from collection of
deficiencies from partners. Cash is, is therefore, distributed to a partner only if he has an
excess credit balances in his partnership interest (i.e., capital account or capital and loan
accounts combined)after absorption of his share of the maximum possible loss that may
occur. The possible loss consists of the following:

1. Total value of remaining non-cash assets. These assets are assumed unrealized,
i.e., they can not be sold, hence, they are considered loss chargeable to the
partners.

2. Cash withheld to pay for anticipated liquidation expenses and unrecorded

liabilities that may arise. The said expenses and liabilities represent possible loss
to the partners because upon payment, the amount paid is to be correspondingly
absorbed by the partners.

Additional loss may also accrue to the partners when a debit balance in any of the
capital account results from the foregoing allocation of possible loss. The
deficiency of any of the partners is absorbed by the other partners as additional
possible loss to them because he is presumed unable to pay anything to the firm.

Payment to partners based on periodic computation of safe payments bring, at

some point of the liquidation, the partners’ capital to the profit and loss ratio. The
absence of any partner’s deficiency after distribution of the possible loss signifies that the
ratio of the capital balances are in the profit and loss ratio. Preparation of schedules of
safe payments in subsequent periods are no longer necessary because all subsequent
payments can be made based solely on the profit and loss ratio. Each partners’ capital is
adequate to absorb his share of the maximum remaining possible loss.

Marivic Valenzuela-Manalo 8
 Introduction to Corporation Accounting

CORPORATION - an artificial being created by operation of law, having the right of

succession and the powers, attributes and properties expressly authorized by law or
incident to its existence (New Corporation Code of the Philippines). A corporation is an
entity created by law that is separate and distinct from its owners and its continued
existence is dependent upon the corporate statutes of the state in which it is incorporated.

Characteristics of a Corporation
The characteristics that distinguish a corporation from proprietorships and partnerships
are:
1. Separate legal entity – A corporation is an artificial being with a personality
separate from that of its individual owners (i.e., the corporation has separate legal
existence from its owners).
2. Created by operation of law – A corporation is generally created by operation of
law. The mere agreement of the parties cannot give rise to a corporation.
3. Right of succession – A corporation continues to exist notwithstanding the
withdrawal, death, insolvency or incapacity of the individual owners. Changes in
the ownership structure do not dissolve a corporation this means that the
corporation can have a continuous life.
4. Powers, attributes, properties expressly authorized by law – Being a creation of
law, a corporation can only exercise powers provided by law and powers which
are incidental to its existence.
5. Ownership divided into shares – Proprietorship in a corporation is divided into
units known as shares of stocks. Ownership is shown in shares of share capital,
which are transferable units.
6. Board of Directors (BOD) – Management of the business is vested in a board of
directors elected by the stockholders. The BOD is the governing body or decision-
making body of the corporation.
7. The stockholders have limited liability.
8. It is relatively easy for a corporation to obtain capital through the issuance of
stock.
9. The corporation is subject to numerous government regulations.
10. The corporation must pay an income tax on its earnings, and the stockholders are
required to pay taxes on the dividends they receive: the result is double taxation.

Marivic Valenzuela-Manalo 1
 Distinction between Partnerships and Corporations

Partnership Corporation
1. Formed by at least two persons. Initially formed by at least five persons.

2. Starts with agreement among partners; may Starts with the issuance of a certificate of
be formed orally. incorporation issued by SEC

3. Unlimited liability Limited liability

4. Limited life Unlimited life

5. Transfer of equity of a partner needs the Stocks can be transferred from one
consent of all the partners. stockholder to another without getting the
consent of the other stockholders.

6. Partner is an agent of the partnership. Stockholders do not act as agents of the

corporation.
Classes of Corporation
A. According to Purpose
1. Public – a corporation formed to render government service
2. Private – a corporation formed for a private purpose, aim or benefit.
3. Quasi-public – a private corporation which is given a franchise to perform
functions of a public character.
B. According to Law of Creation
1. Domestic – a corporation that is organized under Philippine laws.
2. Foreign -- a corporation that is organized under the laws of other countries.
C. According to Membership Holdings
1. Stock – a corporation in which the capital is divided into shares of stock and is
authorized to distribute dividends to the holders of such shares. A stock
certificate is a physical evidence of the shares of stock. Stock corporations are
generally profit-oriented.
2. Non-stock - a corporation in which capital comes from fees or contributions
given by individuals. No part of its income is distributed as dividends and any
profit shall be used to further the purpose(s) of the corporation. Non-stock
corporations are generally non-profit in nature.
D. According to the Extent of Membership
1. Open – a corporation whose ownership is widely held by many investors.
2. Closely held or family – a corporation in which 50% or more of its stock is
owned by five persons or less.

Marivic Valenzuela-Manalo 2
Components of a Corporation
1. Incorporators – persons who originally formed the corporation and whose names
appear in the Articles of Incorporation. They must be 5 but not more than 15
natural persons. They should not artificial persons.
2. Stockholders or shareholders – owners of a stock corporation.
3. Members – persons who gave fees or contributions to a non-stock corporation.
4. Corporators – persons who compose the corporation whether as stockholders or
members.
5. Promoters – persons who undertake the necessary steps and procedures to
organize the corporation.
6. Subscribers – persons who agreed to buy shares of stock but will pay at a later
date.
7. Underwriters – persons who undertake to sell the shares of stocks to the general
public.
Advantages of a Corporate Form of Business
1. Unlimited life. The corporation’s power of succession enables it to enjoy a
continuous existence.
2. The continuity of corporate existence enables it to obtain a strong credit line.
3. Bigger source of capital may be raised because many individuals invest funds in
the corporation.
4. Stockholders enjoy limited liability. Liability of stockholders is limited to the
extent of their investment in the corporation.
5. Ease of ownership transferability - shares of stocks may be transferred without the
consent of the other stockholders.
6. The corporation has the capacity to act as a legal entity.
7. Centralized management under the Board of Directors.

Disadvantages of a Corporate Form of Business

1. Difficulty in formation. It is not easy to form because of complicated legal
requirements and high costs in its organization.
2. The limited liability of the stockholders weakens or limits its credit capacity.
3. It is subject to more governmental control.
4. There is possibility of abuse of power by the Board of Directors because
centralized management restricts active participation by stockholders in the
conduct of corporate affairs.
5. Corporation’s activities are limited by the articles of incorporation.
6. It is subject to more taxes.

Marivic Valenzuela-Manalo 3
Legal Requirements in Organizing a Corporation
The process of organizing a corporation consists of three stages:
1. Promotion – makes preliminary arrangements and solicits subscription to raise
sufficient capital for the business. The following are the pre-incorporation
requirements:
a. At least 25% of the authorized share capital as stated in the articles of
incorporation must be subscribed.
b. At least 25% of total subscriptions must be paid upon subscription.
2. Incorporation – formalizes organization of the corporation by filing with SEC the
necessary documentary requirements such as articles of incorporation and
treasurer’s affidavit attesting compliance to the pre-incorporation requirements.
Upon approval, SEC issues a certificate of incorporation, the date of which is
considered as the date of registration or incorporation.
3. Commencement of the business – the business should start its business within two
years from the date of incorporation.
Costs incurred in connection with the formation of the corporation are recorded as
an expense. Examples of organization costs are filing fees, cost of printing stock
certificates, promoters’ commission and legal fees. Any one of the following account
titles may be used in recording organization costs:
1. Pre-operating Costs
2. Organization Expense
3. Organization Costs
Articles of Incorporation
The Articles of Incorporation enumerates the powers and limitations conferred upon the
corporation by the government. It includes the following information:
1. The name of the corporation;
2. The purpose or purposes for which the corporation is formed;
3. The place of the principal office of the corporation;
4. The term of existence of the corporation, not exceeding 50 years;
5. The names, nationalities and addresses of the incorporators;
6. The names of the directors who will serve until their successors are duly elected
and qualified in accordance with the by-laws;
7. The authorized share capital, the classes of stocks to be issued and the number of
each class of stock indicating the par value if there is any;
8. The amount of subscription to the share capital, the names of the subscribers and
the number of shares subscribed by each;
9. The total amount paid on the subscriptions and the amount paid by each
subscriber on his subscription.

Marivic Valenzuela-Manalo 4
By-Laws
The by-laws of a corporation contain provisions for the internal administration of the
corporation. The by-laws should be filed within one month from the date of issuance of
the certificate of incorporation. The by-laws normally include the following:
1. The date, place and manner of calling the annual stockholders’ meeting;
2. The manner of conducting meetings;
3. The circumstances which may permit the calling of special meetings of the
stockholders;
4. The manner of voting and the use of proxies;
5. The manner of electing the directors;
6. The term of office of the directors;
7. The authority and duties of the directors;
8. The manner of selecting the corporate officers;
9. The procedures for amending the articles of incorporation and by-laws.

Corporate Books and Records

The corporation generally maintains the following books of accounts and records:
1. Journals and Ledgers;
2. Minute books for meetings of stockholders;
3. Minute books for meetings of Board of Directors;
4. Stock and Transfer book - contains record of all stock, the names of stockholders
or members alphabetically arranged; the installment paid and unpaid on all stocks,
for which subscription has been made, any sale or transfer of stock.

Classes of Stock
1. Par value –a share of stock that is given a definite or fixed value in the articles of
incorporation.
2. No par value – a share of stock that has no fixed value; it may not be issued for
less than P5.00.
3. Ordinary share –the basic issue or ordinary/common type of shares. The ordinary
share entitles the holder to the following basic rights:
a. Right to vote in stockholders’ meeting;
b. Right to share in corporate profits (dividends);
c. Right to share in corporate profits upon liquidation;
d. Right to purchase additional shares of stocks in the event that the
corporation increases its share capital (pre-emptive right).

Marivic Valenzuela-Manalo 5
 4. Preference share - entitles the holder to some specific preferences over the
ordinary share such as
a. Preference as to payment of dividends;
b. Preference as to distribution of assets upon liquidation.

Terms Commonly Used in Corporation Accounting

1. Authorized shares – - refer to the maximum number of shares which may be

issued by a corporation as set forth in the articles of incorporation.

2. Issued shares – represent shares which were issued to stockholders in the past
which at present may or may not be in the hands of stockholders.

3. Unissued shares – shares which have never been issued and are available for
issuance in the future.

4. Outstanding shares – the total shares of stocks issued to subscribers or

stockholders, whether or not fully or partially paid (as long as there is a binding
subscription agreement) except treasury shares.

5. Treasury shares - shares which have been issued and fully paid for but
subsequently reacquired by the issuing corporation by purchase or by donation..

6. Subscribed shares – shares which investors have contracted to acquire.

7. Subscription -is a contract between a subscriber (buyer of stock) and a corporation

( issuer of stock) whereby the former purchases shares of stocks of the latter with
the payment to be made at the later date.

8. Certificate of stock - a written acknowledgment by the corporation of the

stockholder’s interest in the corporation and its net assets.

9. Share Premium/Paid in capital in excess of par value/stated value - this account is

credited for contribution in excess of par or stated value.

10. Pre-emptive right - the right of a stockholder to maintain his ownership interest in
the corporation trough purchase of additional shares when new capital is issued.

Marivic Valenzuela-Manalo 6
 Unit 7
ACCOUNTING FOR CORPORATION FORMATION
Accounting for Share Capital/Transactions

Forming a Corporation
The formation of a corporation involves (a) filing an application with the
Securities and Exchange Commission (SEC), (b) paying an incorporation fee, (c)
receiving a charter (articles of incorporation), and (d) developing by-laws.
a. Costs incurred in forming a corporation are called organization costs.
b. These costs include fees to underwriters, legal fees, state incorporation fees,
and promotional expenditures.
c. Organization costs are expensed as incurred.

Ownership Rights of Stockholders

When chartered, the corporation may begin selling ownership rights in the form
of shares of stock. Each share of ordinary share gives the stockholder the following
ownership rights:
a. To vote for the board of directors and in corporate actions that require
stockholder approval.
b. To share in corporate earnings through the receipt of dividends.
c. To maintain the same percentage ownership when additional shares of ordinary
share are issued (preemptive right).
d. To share in assets upon liquidation (residual claim).

Stock Issue Considerations

Authorized stock/share is the amount of stock/share a corporation is allowed to sell as
indicated by its charter.
a. The authorization of share capital does not result in a formal accounting entry.
b. The difference between the shares of stock authorized and the shares issued is
the number of unissued shares that can be issued without amending the charter.

A corporation has the choice of issuing ordinary share directly to investors or

indirectly through an investment-banking firm (brokerage house). Direct issue is typical
in closely held companies, whereas indirect issue is customary for a publicly held
corporation.

Par value share/stock is share capital that has been assigned a value per share in
the corporate charter. It represents the legal capital per share that must be retained in the
business for the protection of corporate creditors.

No-par share/stock is share capital that has not been assigned a value in the
corporate charter. In many states the board of directors can assign a stated value to the
shares, which becomes the legal capital per share. When there is no assigned stated
value, the entire proceeds are considered to be legal capital.

Marivic Valenzuela-Manalo 7
 The primary objectives in accounting for the issuance of ordinary share are to (a)
identify the specific sources of paid-in capital and (b) maintain the distinction between
paid-in capital and retained earnings.

When par value ordinary share is issued for cash, the par value of the shares is
credited to Ordinary share and the portion of the proceeds that is above or below par
value is recorded in a separate paid-in capital account.

When no-par ordinary share has a stated value, the stated value is credited to
Ordinary share. When the selling price exceeds the stated value, the excess is credited to
Paid-in Capital in Excess of Stated Value. When no-par stock does not have a stated
value, the entire proceeds are credited to Ordinary share.

Basic Share capital Transactions

There are 5 basic share capital transactions:
1. Authorization –records the maximum number of shares a corporation is
authorized to issue.
2. Sale of stocks – a stockholder buys stocks and pays immediately in full. Stock
certificate is issued to the stockholder.
3. Subscription –a subscriber enters into a contract to buy shares of stock.
4. Collection – a subscriber pays his subscription either partially or in full.
5. Issuance of certificate – if a subscription is fully paid; a stock certificate is issued
to the subscriber.

Share capital
Share capital may be paid by the stockholder or subscriber in the form of
1. money/cash
2. property – record the value of the property using the following amounts:
a. fair value of the property received
b. fair value of the shares of stock, whichever is clearly determinable;
c. par value of the shares of stock
3. labor or services – record the cost of the labor or services using the fair value of
the services rendered.
Important:
When shares of stock are issued for services or non-cash assets, cost
is either the fair market value of the consideration given up or the
consideration received, whichever is more clearly determinable (Weygant, et
al, 2006).

Share capital may be issued

1. at par
2. at a premium – at an amount more than the par value. The amount in excess of
par value is treated as share premium.

Marivic Valenzuela-Manalo 8
Share capital cannot be issued at a discount or an amount less than par under the
Philippine setting.
When the value assigned to the asset received is greater than the par value times the
number of shares issued, such issuance is called watered stock. The overstatement is
done to comply with the requirement of the law that the stock should not be issued at less
than its par value. When the value of the asset received is understated, the stock is said to
contain secret reserves.

Accounting Methods to Record Share capital Transactions

1. Memo entry method
2. Journal entry method

Pro-forma Entries – Par Value Stock Subscribed or Sold at Par

Transaction Memo Entry Method Journal Entry Method
Authorization Authorized to issue _____ shares with a Unissued share capital xxx
par value of P___. Authorized share capital xxx

Sale Cash xxx Cash xxx

Share capital xxx Unissued share capital xxx
Subscription Subscriptions receivable xxx Subscriptions receivable xxx
Subscribed share capital xxx Subscribed share capital xxx
Collection Cash xxx Cash xxx
Subscriptions receivable xxx Subscriptions receivable xxx
Issuance of Subscribed share capital xxx Subscribed share capital xxx
certificate Share capital xxx Unissued share capital xxx

Pro-forma Entries – Par Value Stock Subscribed or Sold at a Premium

Transaction Memo Entry Method Journal Entry Method
Authorization Authorized to issue _____ shares with Unissued share capital xxx
a par value of P___. Authorized share capital xxx

Sale Cash xxx Cash xxx

Share capital xxx Unissued share capital xxx
Share premium xxx Share premium xxx
Subscription Subscriptions receivable xxx Subscriptions receivable xxx
Subscribed share capital xxx Subscribed share capital xxx
Share premium xxx Share premium xxx

Collection Cash xxx Cash xxx

Subscriptions receivable xxx Subscriptions receivable xxx
Issuance of Subscribed share capital xxx Subscribed share capital xxx
certificate Share capital xxx Unissued share capital xxx

Marivic Valenzuela-Manalo 9
 Special Notes:

1. The Subscription Receivable account title is always recorded at subscription prices

computed as follows:
Subscriptions receivable = subscribed shares x subscription price
2. Subscribed Share capital and Share capital accounts are always recorded/credited
at par value.
3. Share Premium/Paid in Capital in Excess of Par is recorded/credited at amount in
excess of par computed as follows:
Paid in capital in excess of par = (Subscription price – par value) (subscribed shares)

Accounting for Two Classes of Stock

The two classes of stock are ordinary share and preference share. Ordinary share entitles
the holder to the four basic rights of a stockholder. Preference share is generally issued
with par value and with a dividend rate. Voting right is frequently given exclusively to
ordinary shareholders. The pro-form entries to record share capital transactions for two
classes of stock are the same. However, the account titles must be labeled as to whether
it is common or preferred. The following account titles may be used.

Ordinary Preference

Subscriptions receivable – ordinary Subscriptions receivable – preference

Subscribed ordinary share Subscribed preference share
Share premium- ordinary Share premium-preference
Ordinary share Preference share

Accounting for No Par Shares

No par shares do not have a definite or fixed value.
1. No par shares are recorded using the memo entry method only.
2. The entire consideration received by the corporation for its no par value shares
shall be treated as capital and shall not be liable for distribution as dividends.
3. Preferred shares which are preferred as to assets can be issued only with par
value.
4. Banks, trust companies, public utilities, buildings and loan associations, insurance
companies cannot issue no-par stocks.
5. No par value shares may not be issued at an amount less than P5 per share.
6. While no par value shares do not carry a nominal value in the certificate, a selling
price may be assigned. This value is called stated value. Stated value should not
be less than P5 per share.

Marivic Valenzuela-Manalo 10
Pro-forma Entries: No Par Value Stock (Memo Entry Method)

Transaction No Stated Value With Stated Value

Authorization Authorized to issue _____ shares, no Authorized to issue _____ shares, no
par. par with a stated value of P___.
Sale Cash xxx Cash xxx
Share capital , no par xxx Share capital, no par xxx
Share premium stated value xxx

Subscription Subscriptions receivable xxx Subscriptions receivable xxx

Subscribed share capital xxx Subscribed share capital xxx
Share premium-
Pxx stated value xxx

Collection Cash xxx Cash xxx

Subscriptions receivable xxx Subscriptions receivable xxx
Issuance of Subscribed share capital xxx Subscribed share capital xxx
certificate Share capital , no par xxx Share capital, no par xxx

Incorporating a Partnership
A partnership may incorporate after considering the many advantages of a corporate form of
business. It is advisable that new set of books is used by the newly formed corporation.

Steps or procedures in converting a partnership into corporate form of business

Books of the Partnership Books of the Corporation
1. Finish the accounting cycle. 1. Record authorized capital sock.
2. Revalue the assets and liabilities using 2. Record the subscription of incorporators.
the Capital Adjustment account.
3. Close the balance of the Capital 3. Record the transfer of the assets and
Adjustment account to the partners’ liabilities of the partnership to the
capital accounts in accordance with corporation. This serves as the payment
their profit and loss ratio. of the subscription of the partners who
became incorporators.
 Accounts receivable is transferred
at gross amount together with the
allowance for bad debts.
 Depreciable assets are transferred at
net carrying amount.
4. Close the accounts of the partnership 4. Record the issuance of stocks to
except the capital accounts. incorporators.
5. Record the receipt of stocks.
6. Record the distribution of stocks.

Marivic Valenzuela-Manalo 11
Pro-forma Entries: Books of the Partnership
a. Adjust the existing partnership books
Date PARTICULARS P/R DEBIT CREDIT
Increase in the asset value with no contra-asset account
Asset X X X X
Capital adjustment X X X X

Decrease in the asset value with no contra-asset account

Capital Adjustment X X X X
Asset X X X X

Increase in the asset value with contra-asset account

Contra-asset X X X X
Capital adjustment X X X X

Decrease in the asset value with contra-asset account

Capital adustment X X X X
Contra-asset X X X X

Close Capital adjustment account withdedit balance

Rose, Cpital X X X X
Guada, Capital X X X X
Cpital adjustment
X X X X
Close Capital adjustment account with credit balance
Capital adustment X X X X
Rose, Capital X X X X
Guada, Capital X X X X
Note: These adjusting entries are similar to year-end adjustments. The only difference is that the
Capital Adjustment account replaces all the nominal accounts which is eventually
closed to the individual capital accounts of the partners.

Marivic Valenzuela-Manalo 12
 b. Close all the ledger accounts with balances except the partners'
capital account and debit "Receivable from Name of Corporation
Date PARTICULARS P/R DEBIT CREDIT

Receivable fron Name of Corporation X X X X

Liabilities X X X X
Allowance for bad debts X X X X
Accumulated depreciation - PPE X X X X
Assets X X X X
To record the trasnfer of assets and liabilities
to the newly formed corporation.

c. Record the recipt of stocks from the newly formed corporation

Date PARTICULARS P/R DEBIT CREDIT
Stocks of Name of Corporation X X X X
Receivable from Name of Corporation X X X X
To record receipt of stock certificates

d. Record the distribution of stocks to the partners.

Date PARTICULARS P/R DEBIT CREDIT
Rose, Capital X X X
Guada, Capital X X X X
Stocks of Name of Corporation X X X X
To record receipt of stock certificates

Note: The debits to the partners’ capital accounts represent their final capital balances

Pro-forma Entries: Books of the New Corporation

Authorization Authorized to issue _____ shares

with a par value of P ___.

Subscription Subscriptions receivable xxx

Subscribed share capital xxx

Collection/Transfer of Assets xxx

partnership assets and liabilities
Liabilities xxx
Allowance for bad debts xxx
Subscriptions receivable xxx

Issuance of stock Subscribed share capital xxx

certificates Share capital xxx

Marivic Valenzuela-Manalo 13
 Accounting for Delinquent Subscription

There are instances when a subscriber cannot pay in full the amount he subscribed
to. Payment of the balance on subscription may either be specified in the contract of
subscription or in lieu thereof may be subject to call by the Board of Directors.

According to the Corporation Code of the Philippines, if

within thirty (30) days from the said date, no payment is
made; all stocks covered by said subscription shall thereupon
become delinquent and shall be subject to sale.

When a subscriber fails to pay his subscription on the call date, the corporation sends
several notices to remind him of his obligation. If no payment was made by the
subscriber, his subscription is declared as delinquent subscriptions and the subscriber is
called a defaulting subscriber. And these delinquent stocks are offered for sale in a
public auction.

1. The sale of the delinquent stocks is advertised to have possible buyers/bidders.

All expenses incurred relating to the sale of the delinquent shares will be charged
or debited to Receivable from Highest Bidder account since this amount will
eventually be collected to the highest bidder together with the unpaid balance of
the subscription.
2. An auction sale is conducted where a highest bidder is chosen.
3. The sale of the delinquent subscription is issued to the highest bidder.
4. The highest bidder is the one who is willing to pay the unpaid balance of the
subscription plus accrued interest plus all expenses related to the sale and who is
willing to receive the least/smallest number of shares.
5. Once the subscription is fully paid, all subscribed shares are issued. Shares are
first given to the highest bidder. The excess shares are given to the defaulting
subscriber.
6. If there is no bidder, all of the delinquent shares will be issued in the name of the
corporation. Such shares are considered treasury shares. The defaulting
subscriber does not get any share of stock.

Marivic Valenzuela-Manalo 14
Pro-forma Entries using the Short Method of accounting for delinquent stocks

a. Record the subscription

Date PARTICULARS P/R DEBIT CREDIT

Subscription receivable X X X X
Suscribed share capital X X X X

b. Record partial collection

Cash X X X X
Subscription receivable X X X X

c. Corporation sends several notices but no payment was made by the subscriber
No entry

d. The corporation incurred costs related to the selling of the delinquent shares
Receivable from highest bidder X X X X
Cash X X X X

e. The highest bidder pays and corresponding stock certificates are issued
Cash X X X X
Subscribed share capital X X X X
Receivable fro highest bidder X X X X
Subscriptions receivable X X X X
Share capital X X X X

OR
f. If there is no bidder at all
Treasury stock X X X X
Subscribed share capital X X X X
Receivable fro highest bidder X X X X
Subscriptions receivable X X X X
Share capital X X X X

Illustrative problem:

Assume that Joseph subscribed 250 shares of Ordinary share at P25.00 (P20.00 is
the par value). After paying 50% on his subscriptions, he defaulted. Due process was
taken and the shares were declared delinquent. Advertising and other cost including
those advances made by the corporation amounted to P500.00

At the public auction, bids from Mary, Clare and Luisa were received. Mary bid
230 shares; Clare for 240; and Luisa for 245 shares. The highest bidder paid the
amount due and stock certificate was issued by the corporation.

REQUIRED: Record the above transactions.

Marivic Valenzuela-Manalo 15
 Unit 8
Accounting for Changes in Shareholders’ Equity

Corporate Capital
Owner's equity in a corporation is identified as stockholders' equity, shareholders'
equity, or corporate capital. The stockholders' equity section of a corporation's balance
sheet consists of: (a) paid-in (contributed) capital, and (b) retained earnings (earned capital).

Paid-in or contributed capital is the investment of cash and other assets in the
corporation by stockholders in exchange for capital stock.

Retained earnings account is net income retained in a corporation and is part of the
stockholders’ claim on the total assets of the corporation. The entire amount of retained
earnings may be presumed to be unrestricted as to dividend declaration unless restrictions are
indicated in the financial statements.

a. Net income is recorded in Retained Earnings by a closing entry with a debit to

Income Summary and a credit to Retained Earnings.
Pro-forma entry:
Income Summary xxx
Retained Earnings xxx
To close net income for the period.

b. A net loss is debited to Retained Earnings in a closing entry.

Pro-forma entry:
Retained Earnings xxx
Income Summary xxx
To close net loss for the period.

c. The retained earnings (earned capital) account is part of the stockholders' equity
section of a corporation.
d. A debit balance in Retained Earnings is identified as a deficit and is reported as a
deduction in the stockholders’ equity section.

Retained Earnings Restrictions

1. Retained earnings restrictions make a portion of the retained earnings balance
currently unavailable for dividends.
2. Restrictions result from one or more of the following causes:
a. Legal restrictions. Many states require a corporation to restrict retained
earnings for the cost of treasury stock purchased.
Pro-forma entry:
Retained Earnings xxx
Retained earnings appropriated for cost of treasury stocks xxx
To record appropriation for cost of treasury shares.

b. Contractual restrictions or any future contingencies. Long-term debt

contracts may restrict retained earnings as a condition for a loan.
Pro-forma entry:
Retained Earnings xxx
Retained earnings appropriated for contingencies xxx
To record appropriation for future contingencies.

c. Voluntary restrictions. The board of directors may voluntarily create

retained earnings restrictions for specific purposes (for example, future
plant expansion).
Pro-forma entry:
Retained Earnings xxx
Retained earnings appropriated for plant expansion xxx
To record appropriation for future plant expansion.

3. Retained earnings restrictions are generally disclosed in the notes to the financial
statements.

The retained earnings account has a normal credit balance. A debit balance in
the retained earnings account is called a deficit.

4. When the cause for restriction no longer exists, the appropriation is not necessary
anymore. A reversing entry is prepared restoring the amount of appropriation back
to the unrestricted balance.

Pro-forma entry:
Retained earnings appropriated for plant expansion xxx
Retained Earnings xxx
To record reversal of the appropriation for future plant expansion.
In Summary:

Retained Earnings
Debit Credit

Net loss Net income

Appropriations for treasury Reversal of appropriations

shares, contingencies, plant
expansion, etc.

Losses from sale of treasury

stock

Declaration of dividends
 ACCOUNTING FOR TREASURY SHARES

Treasury stock/shares is an entity’s own stock that has been issued and then reacquired but
not canceled. The corporation may reissue these treasury shares at some future date.

From this definition, three requisites must be present in order that a stock should
qualify as treasury stock.
1. The stock must be the entity’s own stock.
2. The stock must have been issued originally.
3. The stock is reacquired but not canceled.
(Valix and Peralta, 2006)

Reasons for Acquiring Treasury Stock

1. To obtain stock to be used in the acquisition of plant assets.
2. To improve earnings per share by reducing the number of shares outstanding.
3. To invest excess cash temporarily.
4. To support the market price of the stock.
5. To increase the ratio of liabilities to stockholders’ equity.
6. To obtain shares for conversion of other securities such as preferred stock.
(Baysa and Lupisan, 2007)

Two Accounting Methods to Record Treasury Stock

1. Cost method – This is the method to be used under local accounting standards
2. Par value method

Two Kinds of Treasury Stock

1. Reacquisition by purchase – under the cost method
a. Treasury stocks are recorded at cost.
Pro-forma entry:
Treasury Stock xxx
Cash xxx
Re-acquired own stocks at P__ per share.

b. When treasury stocks are reissued or sold at more than cost, the indicated gain
is credited to an account called “Share premium - treasury shares”.
Pro-forma entry:
Cash xxx
Treasury Stock xxx
Share premium - treasury shares xxx
Re-issued treasury stocks at above cost.
 c. When treasury stocks are reissued or sold below cost, the indicated loss is
debited to 1) Share premium - treasury shares if there is an existing balance
for this account until all the amount has been exhausted and
2) Retained Earnings if the entire amount in the Share premium - treasury
shares account has been fully exhausted.
Pro-forma entry:
Cash xxx
Share premium - treasury shares xxx
Treasury Stock xxx
Re-issued treasury stocks below cost.

Or

Pro-forma entry:
Cash xxx
Share premium - treasury shares xxx
Retained Earnings xxx
Treasury Stock xxx
Re-issued treasury stocks below cost.

Or

Pro-forma entry:
Cash xxx
Retained Earnings xxx
Treasury Stock xxx
Re-issued treasury stocks below cost.

2. Reacquisition by donation – Donated stock refers to shares of stock received by the

entity from its stockholders by way of donation. These stocks are actually treasury
stock and may therefore be reissued at any price without any discount liability.

Donated stock is secured without cost and consequently, it does not affect the
entity’s assets, liabilities and stockholders’ equity, although it reduces outstanding
shares. However, the reissue or resale of donated stock increases assets and
additional paid in capital. Contributions, including stock of the corporation, received
from shareholders shall be recorded at the fair value of the items received with the
credit going to “Additional Paid in Capital – Donated Stocks” account.
(Valix and Peralta, 2006)

Pro-forma entry for the receipt of own shares of stocks as donation

Memorandum entry: Received ___ shares from RGM as donation.

 Pro-forma entry for the sale of donated shares

Cash xxx
Share premium - donated stocks xxx
Re-issuance of stocks received as donation.

Important Notes
1. Treasury shares do not have the status of outstanding shares, therefore, these shares
are not entitled for dividends.
2. Treasury shares do not entitle the holder to the rights of a stockholder.
3. Treasury stock is not viewed as an asset (i.e., Investments in Trading Securities) but
as a reduction to total stockholders’ equity.
4. To protect creditors, a portion of retained earnings shall be restricted equal to the cost
of the treasury stock.
 Unit 9
Accounting for Accumulated Profits/Losses

Dividends
A dividend is a distribution by a corporation to its stockholders on a pro rata
(proportional) basis. Dividends may be in the form of cash, property, scrip, or stock.
The power to declare dividends is vested upon the board of directors. Dividends shall
be paid out of unrestricted or free retained earnings.
The following shares are entitled to receive dividends:
a. all issued and outstanding shares
b. all subscribed par value shares

The following shares are not entitles to receive dividends:

a. unissued shares
b. subscribed no par shares
c. treasury stock

Two Kinds of Dividends

1. Dividends out of earnings – distribution to stockholders of corporate earnings in
proportion to the number of shares held by them; also known as return on investment.
2. Dividends out of capital (liquidating dividends) – a return of stockholders’ invested
capital; also known as return of investment.

Forms of dividends
A cash dividend is a pro rata distribution of cash to stockholders. For a
corporation to pay a cash dividend, it must have (a) retained earnings, (b) adequate
cash, and (c) declared dividends.
A scrip dividend is a deferred cash dividend. This is consisting of a written
promise to pay certain amounts at some future date. A scrip dividend is declared when
the corporation has sufficient retained earnings balance but not sufficient funds at the
time for a cash dividend. The payment normally includes the principal amount and an
interest at a specified rate.
A property dividend is a dividend distributable in the form of non cash assets.
This type of dividend reduces retained earnings by the cost or carrying value of the
property on the date of declaration. Property distributed normally takes the form of
assets that can be easily divided or allocated among stockholders, for example, the
stocks of other corporation owned by the company (Lupisan and Baysa, 2007).
A stock dividend is a distribution of dividends in the form of corporation’s own
stock.
Three dates are important in connection with dividends:
a. Declaration datethe date on which the board of directors formally
declares a cash dividend and the liability is recorded.
b. Record datethe date that marks the time when ownership of outstanding
shares is determined from the stockholders' records maintained by the
corporation.
c. Payment datethe date dividend checks are mailed to the stockholders and
the payment of the dividend is recorded.

Preference stockholders must be paid dividends before common stockholders

receive dividends.
a. When preferred stock is cumulative, any dividends in arrears must be paid
to preferred stockholders before allocating any dividends to common
stockholders.
b. When preferred stock is not cumulative, only the current year's dividend
must be paid to preferred stockholders before paying any dividends to
common stockholders.

Stock Dividend
1. A stock dividend is a pro rata distribution to stockholders of the
corporation’s own stock. The corporation declares stock dividends when it
wishes to declare dividends but at the same time retain the net assets of the
business.
2. For a corporation to declare stock dividends there should be unrestricted
retained earnings and available original and unissued shares which may be
issued as stock dividends
3. A stock dividend results in a decrease in retained earnings and an increase in paid-
in capital. Unlike a cash dividend, a stock dividend does not decrease total
stockholders’ equity or total assets. It only involves transfer of amount from
retained earnings to contributed capital.
4. For small stock dividends (less than 20%) the accounting profession recommends
that the board of directors assign the fair market value per share. Par or stated
value per share is normally assigned for large stock dividends (greater than 20%).
5. Stock dividends have no effect on the par or stated value per share, but the
number of shares outstanding increases, and the book value per share
decreases.
Two Kinds of Stock Dividends
1. Small stock dividends – a stock dividend representing less than 20% of the outstanding
shares. The account Retained earnings is debited for the fair market value of the stock
on the date of declaration. When the fair market value of the stock is used, the following
entry is made at the declaration date:

Date of Declaration: Pro-forma Entry

Retained Earnings ........................................................................ xxx
Stock Dividends Distributable .................................................. xxx
Share premium – Stock dividend ............................................ xxx

Stock Dividends Distributable is reported in paid-in capital as an addition to

either common or preferred stock issued. This account is credited for the par or stated
value of the shares to be distributed regardless of whether the stock dividend is small or
large. This account is not a current liability because it will not be settled through the
use of current assets and is shown as an addition to capital stock outstanding.
Share premium-Stock dividend account is credited for the excess of the fair
market value over its par or stated value.

Date of Distribution: Pro-forma entry

Stock Dividends Distributable ………….……………...… xxx
Ordinary or Preference share ………………………………….. xxx

2. Large stock dividends – a stock dividend representing 20% or more of the outstanding
shares. The account Retained earnings is debited for the par or stated value of the stock.

Date of Declaration: Pro-forma Entry

Retained Earnings ........................................................................ xxx
Stock Dividends Distributable .................................................. xxx

Date of Distribution: Pro-forma entry

Stock Dividends Distributable …………………………….… xxx
Ordinary or Preference share …… …………………………….. xxx

Stock dividends change the composition of stockholders' equity because a

portion of retained earnings is transferred to paid-in capital. However, total
stockholders' equity and the par or stated value per share remains the same.
Cash Dividends
1. A cash dividend is a pro rata distribution of cash to stockholders.
2. For a corporation to pay a cash dividend, it must have:
a. Retained earnings.
b. Adequate cash.
c. A declaration of dividends.
3. Three dates are important in connection with dividends:
a. The declaration date: the date the board of directors formally declares
(authorizes) the cash dividend and announces it to stockholders. An entry is
required to recognize the decrease in retained earnings, and the increase in
the liability dividends payable.
Date of Declaration: Pro-forma Entry
Retained Earnings ..................................................... xxx
Dividends Payable…............................................... xxx

b. The record date: the date when ownership of the outstanding shares is
determined for dividend purposes. The records maintained by the
corporation supply this information.
Date of Record: No Entry

c. The payment date: the date the dividend checks are mailed to the
stockholders and the payment of the dividend is recorded.
Date of Payment: Pro-forma entry
Dividends Payable…................................................ xxx
Cash……………………………………………….………..xxx

4. Preferred stock has priority over common stock in regard to dividends. Preferred
stockholders must be paid any unpaid prior-year dividends before common
stockholders receive dividends if the preferred stock is cumulative.

Shareholders' Equity Statement

Instead of presenting a detailed stockholders' equity section in the balance sheet
and a retained earnings statement, many companies prepare a shareholders' equity
statement.
Corporation Income Statement
1. Income statements for corporations are the same as the statements for
proprietorships or partnerships except for the reporting of income taxes. Income
tax expense is reported in a separate section of the corporation income statement
before net income.
2. A corporation is considered a separate legal entity for income tax purposes.
Income tax expense and the related liability for income taxes payable are recorded
as part of the adjusting process.
 Unit 9 - Special Topics

Book Value per Share

(Reference: Financial Accounting by Peralta and Valix)

BOOK VALUE PER SHARE (BVPS)

It is the amount that would be paid on each share assuming the company
is liquidated and the amount available to shareholders is exactly the amount
reported as shareholders’ equity.

FORMULAS IN COMPUTING BVPS

1. One class of stock

BVPS = Total Shareholders’ Equity

Number of shares outstanding

2. Two classes of stock

BVPS = Preference Shareholders’ Equity

(Preference Share Number of preference shares
outstanding

BVPS = Ordinary Shareholders’ Equity

(Ordinary Share) Number of ordinary shares outstanding

Book value per share represents the equity an ordinary stockholder has in the
net assets of the corporation from owning one share of stock. Book value per
share is not synonymous with the value of the stock in liquidation and does not
generally equal market value per share.
 Apportionment of Total Shareholders’ Equity into Its
Preference and Ordinary Components

1. An amount equal to the par or stated value is allocated to the preference

share and ordinary share

2. Any balance of the shareholders’ equity in excess of par is apportioned

taking into account the liquidation value and dividend rights of the preference
shareholders.

3. For book value purposes, following are assumed to be available for

dividends:
 Accumulated Profit
 Share Premium
 Revaluation Reserve
4. Where there are treasury share and subscribed share capital, the share
capital outstanding is computed as follows:

Shares Amount
Share capital issued xx P xx
Add: Share capital subscribed xx xx
Sub-total xx P xx
Less: Treasury share at par xx xx
Amount and shares outstanding xx P xx

5. Treasury share shall be treated as a retired share. Any gain on retirement is

added to Share Premium, and loss on retirement is charged first to Share
Premium and then to Accumulated Profit.

Important things to Remember about BVPS

1. Liquidation value – amount to be received upon the liquidation of the

corporation. It can be more than the par value.

2. In the absence of liquidation values, the preference shareholders shall

receive and amount equal to the par or stated value.

3. If there is a deficit, the preference shareholders would share on a pro-rata

basis with ordinary shareholders.

4. The preference share call price or redemption price is ignored for book
value computation.
 5. Preference to assets – preference shareholders are entitled to payment not
only for the liquidation value but also for dividends in arrears.

6. Preference as to dividends
 Non-cumulative
 Cumulative
 Non-participating
 Participating
7. In the absence of any statement to the contrary, the preference share is
preference as to dividends.

8. In the absence of specific designation, preference share is assumed to be

non-cumulative and non-participating.

9. Dividends in arrears include current dividends.

10. If there are two classes of preference share with different dividend rates -
a. if both are participating, the lower rate is the basis for ordinary share
allocation
b. if only one is participating, the basis for ordinary share allocation is the
rate of the participating preference share.

11. In computing for share outstanding, the Subscriptions Receivable balance

is NOT deducted from Subscribed Share Capital.
 Earnings per Share
Reference: Philippine Accounting Standards (PAS 33)

The earnings per share figure is the amount attributable to every share of
ordinary share outstanding during the period.

The objective of the basic earning earnings per share information is to provide a
measure of the interest of each ordinary share of a parent entity in the
performance of the entity over the reporting period.

It is not necessary to compute EPS for preference shares because there is a

definite rate of return for such share.

Earnings per share (EPS) indicates the net income earned by each share of
outstanding ordinary stock.
a. The formula for computing earnings per share is:

Weighted
Average Earnings
Net income  =
Ordinary Shares per Share
Outstanding

b. Most companies are required to report earnings per share on the

income statement.
c. When the income statement contains any of the sections for material non-
typical items, earnings per share should be disclosed for each
component.
d. When there has been a change in the number of shares outstanding
during the year, the denominator in the formula becomes the weighted
average shares outstanding.

When a corporation has both preference and ordinary stocks outstanding,

dividends declared on preference stock are subtracted from net income in
determining earnings per share. If the preference stock is cumulative, the
dividend for the current year is deducted whether or not it is declared.
Two presentations of earnings per share:

1. Basic earnings per share

2. Diluted earnings per share

Enterprises required disclosing earnings per share:

1. The presentation of earnings per share is required for enterprises whose

ordinary shares or potential ordinary shares are publicly traded and
2. By enterprises that are in the process of issuing ordinary shares or
potential ordinary shares in the public securities market.

Note: Nonpublic enterprises are not required to present earnings per

share but are encouraged to do so in their financial statements.

Uses of earning per share:

a. It is a determinant of the market price of ordinary share.

b. It is a “measure of performance”.
c. It is the basis of dividend policies of the company.

Simple Capital Structure VS. Complex Capital Structure

1. Simple Capital Structure – means that the corporation has only ordinary and
nonconvertible preference share.

2. Complex Capital Structure – means that the corporation has one or more
instruments outstanding that could result in issuance of additional ordinary
shares.
 BASIC EARNINGS PER SHARE

1. Basic EPS – considers only ordinary shares issued and outstanding.

2. The Basic Equation:

Net Income

Ordinary Shares Outstanding

or

Net Income – Dividend on Preference Share

Weighted Average Ordinary Shares Outstanding

Notes:

 The net income is equal to the amount after deducting dividends on

preference stock.

 If the preference share is cumulative, the preference dividend for the

current year only is deducted from the net income, whether such dividend
is declared or not.

 If the preference share is non-cumulative, the preference dividend for the

current year is deducted from the net income only if there is a declaration.

 Stock dividend is recognized retroactively, meaning, it is treated as a

change from the date, the original shares are issued.

Pro forma computations of Weighted Average Shares:

1.)
Date Shares Months Month-
outstanding shares
Total - month shares
Weighted average =
12
2.)
Date Shares Stock Months Month-shares
Dividend outstanding