LIQUIDATION OF A CORPORATION

A corporation is considered insolvent when it is unable to pay its debts as they come due, or when its
total debts exceed the fair value of its assets. The inability to make payments in due course is referred to
as equity insolvency, whereas, having total debts that exceed the fair value of total assets is referred
to as bankruptcy insolvency. Debtor Corporation that are insolvent in the equity sense may be able to
avoid bankruptcy proceedings by negotiating an agreement directly with creditors which we call debt
restructuring, whereas, Debtor Corporation that are insolvent in the bankruptcy sense will ordinarily be
reorganized or liquidated under the supervision of a bankruptcy court.
What we will discuss only in this handout will be about liquidation of a corporation. The following
financial reports are prepared to aid the creditors and the court as to the progress of the liquidation.

STATEMENT OF AFFAIRS
An accounting statement that does provide relevant information for a liquidating company is
referred as the statement of affairs. This statement is a legal document prepared for the bankruptcy
court. The accountant’s statement of affairs is a financial statement that emphasizes liquidation values
and provides relevant information for the trustee in liquidating the debtor corporation. It also provides
information that may be useful to creditors and to the bankruptcy court. A statement of affairs is
prepared as of a specific date, and its shows balance sheet information with assets measured at expected
net realizable values and classified on the basis of availability for fully secured, partially secured, priority,
and unsecured creditors. Liabilities are classified in the statement of affairs as priority, fully secured,
partially secured, and unsecured. Historical cost valuations are also included in the statement for
reference purposes. An example is shown below. The following information was taken from the
Statement of Affairs filed by S Corporation to the bankruptcy court on August 1, 2018:

S Corporation
Statement of Affairs
August 1, 2019

Assets
Realizable Values - Realizable values
Liability Offsets for Available for
Book value Secured Creditors Unsecured Creditor
Pledged for Fully Secured Creditors
P 55,000 Land and building – net P60,000
Less: Mortgage payable P50,000
Interest payable 5,000 55,000 P 5,000

Pledged for Partially Secured Creditors

25,000 Accounts receivable P22,000
Less: Notes payable to bank P25,000
Interest payable 2,000 27,000 0

Available for Priority and Unsecured Creditors

3,000 Cash 3,000
7,000 Marketable securities 7,000
50,000 Inventories 55,000
4,000 Prepaid expenses 0
30,000 Equipment – net 12,000
6,000 Intangible assets 0
Total available for priority and unsecured creditors 82,000
Less: Priority liabilities 15,000
Total available for unsecured creditors 67,000
 Estimated deficiency 8,000
P180,000 P75,000
Liabilities and Stockholders’ Equity
Book Secured and Unsecure
Value Priority Claims Non-priority
Claims Priority Liabilities
P 13,000 Wages payable P 13,000
Property taxes payable 2,000
P 15,000
Fully Secured Creditors
50,000 Mortgage payable P 50,000
5,000 Interest payable 5,000
P55,000
Partially Secured Creditors
25,000 Notes payable - bank P25,000
5,000 Interest payable 2,000
P27,000
Less: Accounts receivable pledged 22,000 P 5,000
Unsecured Creditors
65,000 Accounts payable 65,000
5,000 Notes payable to suppliers 5,000
Stockholders’ Equity
200,000 Capital stock
( 187,000) Retained earnings .
P180,000 P75,000
Determine the estimated amount payable per peso of unsecured nonpriority liability.
Answer: P67,000/P75,000 = P0.8933 per peso

STATEMENT OF CASH RECEIPTS AND DISBURSEMENTS

This statement shows the beginning balance of cash, the various sources of cash, example, collection of
accounts, sales of assets and refund of prepaid items and also shows the various uses of cash, example
the payment of various expenses and liabilities. All disbursements require the approval of the court, so
the statement should be a useful financial summary. An example is shown below:

S Corporation in Trusteeship
Statement of Cash Receipts and Disbursements
From August 1 to August 31, 2019
Cash balance, August 1, 2019 P 3,000
Add: Cash receipts
Sale of inventory items P30,000
Sale of equipment 14,200
Sale of land and building 64,000
Refund from insurance policy 1,000
Collection of receivables 21,000
Total cash receipts 130,200
133,200
Deduct: Cash disbursements
Wages payable (priority claim) P13,000
Property taxes payable (priority claim) 2,000
Mortgage payable and interest (fully secured) 55,000
Bank note payable and interest (for secured portion) 21,000
Administrative expense (priority item) 3,000
 Total cash disbursements 94,000
Cash balance, August 31, 2019 P 39,200

STATEMENT OF CHANGES IN ESTATE EQUITY

This statement shows the losses and gains from sale of noncash assets, the losses from the write-offs of
intangible assets, accounts written off, discovered liabilities, expenses paid like trustees fees, etc.
Therefore, the statement explains the changes on the estate equity (owners’ equity), for a certain period
of time resulting from the liquidation of the corporation. An example is shown below:

S Corporation in Trusteeship
Statement of Changes in Estate Equity
From August 1 to August 31, 2019
Estate equity August 1, 2019 P 13,000
Less: Net loss on asset liquidation (see schedule below)P 18,800
Liability for utilities discovered 500
Administrative expenses 3,000
Trustee’s fee 2,000
Net decrease for the period ( 24,300)
Estate deficit August 31, 2019 P 11,300

Schedule of Net Losses on Asset Liquidation

Book value Proceeds on Gain or

August 1 Realization (loss)
Accounts receivable P25,000 P21,000 P( 4,000)
Inventories 50,000 48,000 ( 2,000)
Land and building 55,000 64,000 9,000
Equipment 30,000 14,200 (15,800)
Intangible assets 6,000 0 ( 6,000)
Net loss on liquidation of assets P (18,800)

STATEMENT OF REALIZATION AND LIQUIDATION

This statement is an activity statement that is intended to show progress toward the liquidation of a
debtor’s estate. Its original purpose is to inform the bankruptcy court and interest creditors of the
accomplishments of the trustee. An example is shown below:
Below is an illustrative statement of realization and liquidation of Apple Company which is under
receivership, for the month ended December 31, 2019.

Apple Company in Receivership

Star, Receiver
Statement of Realization and Liquidation
For the Month Ended December 31, 2019

Assets
Assets to be realized: Assets realized:
Marketable securities P 15,000 Marketable securities P 18,500
Accounts receivable 30,000 Accounts receivable 11,500
Merchandise 50,000 Assets not realized:
Assets acquired: Accounts receivable 22,000
Accounts receivable 5,000 Merchandise 20,000
Liabilities
Liabilities liquidated: Liabilities to be liquidated:
Accounts payable 35,000 Accounts payable 65,000
Liabilities not liquidated: Liabilities assumed:
Accounts payable 31,500 Accounts payable 1,500
Accrued expenses 350
Profit and Loss
Supplementary charges: Supplementary credits:
Purchases 1,500 Sales on account 5,000
Payment of expenses of Interest on marketable securities 150
receivership 7.500 Sales for cash 25,000

Determine the net income or loss for the period.

Answer: Assets:
Total assets to be realized P 95,000
Total assets acquired 5,000
P100,000
Total assets realized P 30,000
Total assets not realized 42,000
P 72,000 P28,000 net loss
Liabilities
Total liabilities to be liquidated P 65,000
Total liabilities assumed 1,500
P 66,500
Total liabilities liquidated P 35,000
Total liabilities not liquidated 31,850
66,850 P 350 net loss
Profit and Loss
Supplementary credits P 30,150
Supplementary debits 9,000 P21,150 net income
Net loss for the period P 7,200 net loss

DISCUSSION PROBLEMS

PROBLEM 1
The following information is available on June 1, 2017 to Samsung Company,
which is having difficulty in paying its liabilities as they become due:
Carrying
Amount
Cash P 8,960
Accounts receivable, net, fair value equal to carrying amount 103,040
Inventories, current fair value , P40,320 pledged on P47,040
of notes payable 87,360
Machinery and equipment, net, current fair value of P150,976
pledged on mortgage note payable 239,680
Office supplies, current fair value of P5,600 4,480
Wages payable 12,992
Taxes payable 2,688
Accounts payable 134,400
 Notes payable, P47,040 of which is secured by inventories 89,600
Mortgage note payable 112,896
Common stock, P5 par 224,000
Retained earnings, deficit 133,056

Additional information:
(1) Estimated liability to the trustee is P58,240.
(2) A delivery van previously given to the supervisor was returned to the
company, fair market value, P56,000.
REQUIRED:
a) Prepare a statement of affairs as of June 1, 2017.
b) Compute the estimated recoverable amounts to the different types of
creditors in the event of liquidation.
c) Prepare a statement of deficiency to unsecured creditors.

PROBLEM 2
SMDC Corp. a closely-held corporation was undergoing liquidation. The total
cash value of SMDC ’s bankruptcy estate after the sale of all assets and
payment of administrative expenses is P100,000.

SMDC has the following creditors:

• BDO Bank is owed P75,000 on a mortgage loan secured by SMDC ’s real

property. The property was valued at and sold, in bankruptcy, for
P70,000.
• The BIR has a P12,000 recorded judgment for unpaid corporate income
tax.
• National Office Supplies has an unsecured claim of P3,000 that was
timely filed.
• ACE Electric Company has an unsecured claim of P10,000 that was
timely filed.
• REH Publications has a claim of P16,000, which is secured by SMDC ’s
inventory that was valued and sold, in bankruptcy, for P2,000. The
claim was timely filed.

REQUIRED:
a) Calculate the total amount recoverable by partially-secured
creditors.
b) Calculate the total amount recoverable by unsecured creditors with
priority.
c) Calculate the total amount recoverable by fully secured creditors.
d) Calculate the total amount recoverable by unsecured creditors without
priority.

PROBLEM 3
The following data were taken from the statement of affairs of ROBINSONS
Corp.:
Assets pledged for fully secured liabilities (current fair
value, P75,000) P90,000
Assets pledged for partially secured liabilities (current
fair value P52,000) 74,000
Free assets (current fair value, P40,000) 70,000
Unsecured liabilities with priority 7,000
Fully secured liabilities 30,000
Partially secured liabilities 60,000
Unsecured liabilities without priority 112,000
1. The amount that will be paid to creditors with priority is:
a. P7,000 b. P6,000 c. P7,500 d. P6,200

2. The amount to be paid fully secured creditors is:

a. P30,000 b. P32,000 c. P20,000 d. P35,000

3. The amount to be paid to partially secured creditors is:

a. P52,700 b. P57,200 c. P56,200 d. P 57,000

4. The amount to be paid to unsecured creditors:

a. P78,200 b. P70,800 c. P72,000 d. P72,800

PROBLEM 4
A company that was to be liquidated had the following liabilities:
Income Taxes 10,000
Notes Payable secured by land 100,000
Accounts Payable 251,050
Salaries Payable 12,950
Administrative expenses for liquidation 20,000

The company had the following assets: Book Fair

Value Value
Current assets 100,000 95,000
Land 50,000 75,000
Building 150,000 200,000

Determine the following:

1. Total free assets:
A. 75,000 C. 275,000
B. 270,000 D. 295,000

2. Total liabilities with priority:

A. 19,000 C. 42,950
B. 37,950 D. 44,000

3. Net Free assets:

A. 226,000 C. 251,000
B. 247,050 D. 252,050

4. Total unsecured liabilities:

A. 244,000 C. 276,050
B. 251,050 D. 285,000

PROBLEM 5
The following information are related to STANK Corporation which is
undergoing liquidation:
a. A bank loan amounting to P455,000 is secured by inventories with
book value of P525,000 and net realizable value of P350,000.
b. Of the P1,120,000 accounts payable, P343,000 is secured by
accounts receivable amounting to P413,000 which is 10%
uncollectible.
c. Property and equipment costing P875,000 and which is depreciated
by 20% has a net realizable value of P588,000.
d. Other unrecorded liabilities are accrued interest payable on bank
loan, P45,500; salaries payable, P112,000; taxes payable, P63,000
and trustee’s fee, P52,500.
 e. Cash available before liquidation amounts to P87,500.

Compute for the estimated deficiency to unsecured creditors.

A. 450,800 C. 927,500
B. 882,000 D. 980,000

PROBLEM 6
The following data were taken from the statement of realization and
liquidation of CRASHED CO.
Assets to be realized 1,375,000 Assets acquired 750,000
Supplementary credits 2,800,000 Assets realized 1,200,000
Liabilities to be 2,250,000 Liabilities assumed 1,625,000
liquidated
Supplementary charges 3,125,000 Assets not realized 1,375,000
Liabilities liquidated 1,875,000 Liabilities not 1,700,000
liquidated
The ending balances of capital stock and retained earnings are P1,500,000 and
P238,000, respectively. A net loss of P738,000 was reported for the period.

What is the net gain/(loss) for the three-month period?

A. (325,000) C. 425,000
B. 250,000 D. 750,000

How much is the ending balance of cash?

A. 425,000 C. 1,325,000
B. 575,000 D. 1,375,000

PROBLEM 7
On December 31, 2019, the statement of affairs of BANKRUPT COMPANY, which is
in bankruptcy liquidation, included the following:
Assets pledged for fully secured liabilities 100,000
Assets pledged for partially secured liabilities 40,000
Free Assets 120,000
Fully secured liabilities 80,000
Partially secured liabilities 50,000
Unsecured liabilities with priority 60,000
Unsecured liabilities without priority 90,000

Compute the amount paid to:

Fully Secured Unsecured Partially Unsecured
Liabilities Liabilities w/ Secured Liabilities w/o
Priority Liabilities Priority
A. 80,000 60,000 50,000 70,000
B. 64,000 60,000 48,000 88,000
C. 80,000 48,000 60,000 72,000
D. 80,000 60,000 48,000 72,000
Problem 1
Jose enters into a 12-month telecom plan with the local mobile operator ABC on July 1, 20x9. The terms
of plan are as follows:
• Jose’s monthly fixed fee is P1,200.
• Jose receives a free handset at the inception of the plan.
ABC sells the same handsets for P14,000 and the same monthly prepayment plans without handset for
P500/month.
How should ABC recognize the revenues from this plan in line with PFRS 15 for 20x9?

Problem 2
PC HUB, a computer manufacturer, enters into a contract with AC University to deliver 30 computers for
total price of P600,000 (P20,000 per computer).
Due to necessary preparation works, PC HUB agrees to deliver the computers in 3 separate deliveries
during the forthcoming 3 months (10 computers in each delivery). AC University takes control over the
computers at delivery.
After the first delivery is made, AC University and PC HUB amend the contract. PC HUB will supply 20
additional computers (50 in total).
How should PC HUB account for the revenue from this contract for the year ended December 31 if:
• Scenario 1: The price for additional 20 computers was agreed at P388,000, being P19,400 per
computer. PC HUB provided a volume discount of 3% for the additional delivery, which reflects
the normal volume discounts provided in similar contracts with other customers.
• Scenario 2: The price for additional 20 computers was agreed at P280,000, being P14,000 per
computer. PC HUB provided a discount of 30% for the additional delivery because it hopes for
the future cooperation with AC University (nothing even discussed yet).
As of December 31, PC HUB delivered 40 computers (30 as agreed initially and 10 under the contract
amendment).

Problem 3
ManyBits is a software company who entered into contract with ABC Co on July 1, 20x9. Under the
contract, ManyBits is obliged to:
• Provide professional services consisting of customization and testing of a software product that
ABC has purchased from a third party.
• Provide post-implementation support for 1 year after the customized software is delivered.
The total contract price is P55,000.
ManyBits assessed its total cost for fulfilling the contract as follows:
• Cost of developers and consultants for customizing and testing the existing software: P43,000;
• Cost of consultants for post-delivery support: P2,000;
• Total estimated cost of fulfilling the contract: P45,000.
As of December 31, 20x9, ManyBits incurred the following costs of fulfilling the contract:
• Cost of developers and consultants for customizing and testing the software: P12,900.
How should ManyBits recognize revenue from this contract under PFRS 15 assuming that ManbyBits’
normally charges 10% for support services for the package price, no matter the package?

Problem 4
On January 1, 20x9, ABC Company enters into a contract to transfer Product One and Product Two to
XYZ Company for P200,000. The contract specifies that payment of Product One will not occur until
Product Two is also delivered. ABC Company determines that the stand alone prices are P60,000 for
product One and P140,000 for product Two. ABC Company delivers Product One to XYZ Company on
February 1, 20x9. Product Two is delivered on March 1, 20x9.

1. On January 1, 20x9, how much is the amount of accounts receivable to be recorded?

A. None C. P140,000
B. P60,000 D. P200,000

2. On February 1, 20x9, how much is the amount of accounts receivable to be recorded?

A. None C. P140,000
B. P60,000 D. P200,000

3. On February 1, 20x9, how much is the amount of revenue to be recorded?

A. None C. P140,000
B. P60,000 D. P200,000

4. On March 1, 20x9, how much is the amount of accounts receivable to be recorded?

A. None C. P140,000
B. P60,000 D. P200,000

5. On March 1, 20x9, how much is the amount of revenue to be recorded?

A. None C. P140,000
B. P60,000 D. P200,000

Problem 5
YSL sold 3,210 boxes of perfumes on January 20x8 at the price of P90 per box. The company offers a
full refund for any product returned within 30 days from the date of purchase. Based on historical
experience, YSL expects that 3% of sales will be returned.

1. How many performance obligations are there in each sale of a box of perfume?
A. None C. 2
B. 1 D. 3

2. How much revenue should YSL recognize in January?

A. Zero C. P280,233
B. P8,667 D. P288,900

Problem 6
On June 1, JOSEPH received a P5,000 deposit for 80 cases of wine. On June 10, the customer identified
specific wine bottles that are included in JOSEPH’s inventory, and asked JOSEPH not to ship the wine
until June 20 so the customer could ready space to store the wine. JOSEPH set aside the wine, boxed and
readied the wine for the customer. On June 20 the wine was shipped and delivered to the customer.
When will JOSEPH likely recognize the revenue?
A. June 20 C. June 1
B. June 10 D. Upon delivery

Problem 7
PINTOR Co sold for P300,000 construction materials to a local construction company for cash on June
25, 20x8. Because of flood in the area, the customer requested PINTOR to not ship the items from its
warehouse until July 3, 20x8, so PINTOR set aside the paint on June 26, packaged the items and were
made ready to ship on July 3. For the second quarter ending June 30, how much revenue should PINTOR
recognize for the sale to the local construction company?
A. No contract exists C. P150,000
B. Zero D. P300,000
Problem 8
DONG Services operates a website that links experienced consultants with businesses that need
consulting services. The consultants post their rates, qualifications, and references on the website, and
DONG receives 25% of the fee paid to the consultants in exchange for identifying potential customers.
ROCKSTAR Inc. contacts DONG and arranges to pay a consultation fee of P15,000 in exchange for a
business consulting services. DONG’s income statement would include the following with respect to this
transaction:
A. Revenue of P15,000 C. Revenue of P3,750
B. Revenue of P15,000 and cost of services of D. Revenue of P18,750 and cost of services of
P11, 250 P15,000

Problem 9
LAZADA sells Galaxy Phones, a cell phone band produced by SAMSUNG. LAZADA arranges its
operations such that customers receive the products directly from SAMSUNG. Customers purchase from
LAZADA using credit cards, and LAZADA forwards cash to SAMSUNG equal to the retail price less a
10% commission that LAZADA keeps. A customer placed an order for a Galaxy Phone selling at
P15,000. In this arrangement, how much revenue will LAZADA recognize for the sale of the phone?
A. No contract exists C. P 1,500
B. Zero D. P15,000

Problem 10
JOMARI Co sell television sets. Each TV has a one-year warranty (quality-assurance) that covers any
product defects. When customers purchase a TV, they also have the option to purchase an extended
three-year warranty that covers any defects or maintenance. The extended warranty sells for the same
amount regardless of whether it is purchased at the same time as the TV or at some other time.

1. How many performance obligations exists?

A. None C. 2
B. 1 D. 3

2. Assume a customer of JOMARI, SUGAR pays 20% less for the extended warranty if SUGAR
buys it at the same time they buy a TV. How many performance obligations exists?
A. None C. 2
B. 1 D. 3

Problem 11
Assume FTINESS Inc offers a deal whereby enrolling in a new membership for P7,000 provides a year of
unlimited access to facilities and also entitles the member to receive a voucher redeemable for 25% off
dance classes for one year. The dance classes are offered to gym members as well as to the general
public. A new membership normally sells for P7,200, and a one-year enrollment in dance classes sells for
an additional P5,000. FITNESS estimates that approximately 40% of the vouchers will be redeemed.
FITNESS offers a 10% discount on all one-year enrollments in classes as part of its normal promotion
strategy.

1. How many performance obligations are included in the new membership deal?
A. None C. 2
B. 1 D. 3

2. How much of the contract price would be allocated to each performance obligation (stand-alone
selling price of dance discount voucher and gym membership, respectively)?
A. P 0; P7,200 C. P7,500; P 0
B. P300; P7,200 D. P 280; P6,720

3. What is the journal entry to recognize the sale of a new membership. Clearly identify revenue or
deferred revenue associated with each performance obligation.
A. Cash 7,000
Deferred revenue-membership fees 6,720
Deferred revenue-dance option 280
B. Cash 7,000
Deferred revenue-membership fees 7,000
C. Cash 7,000
Deferred revenue-dance option 7,000
D. Cash 7,000
Revenue-membership fees 6,720
Revenue-dance option 2,180

Problem 12
On January 1, GEN enters into a contract with LORD for the sale of a high-end security scanner for
P630,000. The contract includes a put option the obliges GEN to repurchase the scanner machine from
LORD for P567,000 on or before December 31. The market value is expected to be P495,000 on
December 31. LORD pays GEN P630,000 on January 1. The transaction should be accounted for as a:
A. Sale C. No sale/lease
B. Lease D. Cannot be determined

Problem 13
NOREEN INC, a truck dealer, sells a truck on January 1, 2019, to MENDOZA INC for P3,000,000.
NOREEN agrees to repurchase the truck on December 31, 2020 for P3,630,000.

1. Assuming a 10% is imputed in the agreement, how much is the liability of NOREEN on January
1, 2019?
A. 1,500,000 C. 3,000,000
B. 1,815,000 D. 3,630,000

2. Using the information above, what is the interest expense for 2019?
A. None C. 330,000
B. 300,000 D. 630,000

3. How much should NOREEN INC record interest and retirement of its liability to MENDOZA
INC on December 31, 2020?
A. None C. 330,000; 3,630,000
B. 300,000; 3,600,000 D. 630,000; 3,630,000
 1

LONG-TERM CONSTRUCTION CONTRACTS

THE REVENUE RECOGNITION PRINCIPLE

The revenue recognition principle dictates that revenue be recognized when the earning process
is complete or virtually complete and an exchanged transaction has taken place. Revenue is therefore
typically recognized when the firm delivers goods, performs services, or as time passes (as in the case of
interest revenue or rent revenue). There are other points in the operating cycle where revenue could be
recognized. Revenue could be recognized as production takes place, when production is completed, or
as cash is collected from the customer. The following exhibit shows these possibilities. Although the
revenue recognition principle sets the general rule, there are circumstances where revenue is recognized
prior to or after delivery. These exceptional situations are depicted as follows:

EXHIBIT - REVENUE RECOGNITION TIME LINE

Production Production Sale Full Price
Begins Complete Delivery Collected
é PRODUCTION PERIOD é INVENTORY PERIOD é COLLECTION PERIOD é
Iè------------------------------------è-----------------------------è---------------------------I
ê ê ê ê ê
Percentage of Completed Accretion Revenue InstalmentSales
Completion Contract Basis Recognition Method and
Method Method Principle Cost Recovery
Revenue Recognition (General Rule) Method
for Special Products
with Immediate Marketability

REVENUE RECOGNITION PRIOR TO DELIVERY

Firms may justify recognizing revenue prior to delivery when the selling price of the product has
been reasonably assured, the firm has a reasonable basis for knowing or estimating the cost of the
product, and there is good reason to expect that the price will be collected. Revenue from long-term
construction products may be recognized as production takes place (percentage of completion method)
or when production is completed (completed-contract method). Revenue is often recognized upon
completion of production for special products with immediate marketability (gold, certain agricultural
crops). Some accountants argue that revenue should be recognized as products requiring long aging
period such as wine, increase in value while in the inventory (accretion basis).

Revenue earned on long-term construction projects may be recognized under the percentage of
completion or completed-contract methods.
Revenue is recognized prior to delivery for many long-term construction products. A signed
contract sets the price for the product, the construction company generally has good estimates of the
cost of construction, and there should normally be reasonable assurance that the contract price will
be collected. There are two methods in use for recognizing revenue from long-term construction
contracts - the percentage of completion method and the completed contract method. The general
use is the percentage of completion method.

1. Under the percentage of completion method, revenue is recognized as production takes place. At
the end of each accounting period, the construction company will determine the percentage of
completion of the product based upon costs to date and estimated total costs. An estimate of
final gross profit (contract price minus estimated total construction costs) is made. Gross profit
recognized for the period is the difference between total gross profit earned to date and gross
profit already recognized in previous periods. Construction costs to date plus the part of the total
gross profit earned to date are accumulated in the inventory account called Construction in
Process/Progress. The steps in using the percentage of completion method are described below.
 2

*Step One. Actual construction costs are accumulated in the inventory account, Construction in
Process/Progress.

*Step Two. Accounts Receivable is debited and Billings on Contracts is credited when the firm
bills the customer for progress payments. The billing account is a contra construction in process
account and is subtracted from that account when reporting construction in process in excess of
billings on the balance sheet.

*Step Three. Cash collected is credited to Accounts Receivable and debited to Cash.

*Step Four. At the end of each period the cumulative amount of gross profit earned to date on
the contract is estimated.

Costs incurred to Date

Percentage of Completion = --------------------------------
Estimated Total Costs
Gross profit Earned To Date = Percentage of completion X (Contract Price - Estimated Total Costs)

*Step Five. Gross profit to be recognized for the accounting period equals to gross profit earned
to date minus gross profit recognized in previous periods. The gross profit for the period is
debited to Construction in Process/Progress and credited to Contract Revenue. The balance in
Construction in Process/Progress equal to total construction costs to date plus recognized profit
earned to date. The current period construction costs are recognized as expenses. Contract
revenue equals current period construction costs plus gross profit recognized for the period.
*Step Six. When the contract is completed and fully billed, the debit balance in Construction in
Process/Progress will be identical to the credit balance in Billings on Contracts. The entry to close
out the project debits the billings account and credit the construction in process/progress
account.

The completed contract method recognizes all revenue when construction is completed. The
completed contract method is similar to recognizing revenue at the point of sale because when a
contract exists there should be a very limited holding period after construction is completed.
Under the completed contract method, no revenue is recognized until construction is completed.
The Construction in Process/Progress account will contain costs to date. It will not contain gross
profit earned to date. Gross profit earned over the life of the contract will be the same as under
the percentage of completion method.

The percentage of completion method is the preferable method for accounting for long term
contracts. The accounting profession considers the percentage of completion method to be
preferable when reasonable cost estimates are available. The completed contract method is used
when such estimates cannot be made. The percentage of completion method is considered at
present by the profession as GAAP.

Estimated losses on long-term contracts must always be recognized fully in the accounting period
when the loss estimate is made. This is true under both the percentage of completion and
completed contract methods. Any gross profit previously recognized under the percentage of
completion method must be removed from the Construction in Process/Progress account.
 3

DISCUSSION PROBLEMS

Problem 1
MARY COMPANY is in the construction business. In March 1, 2019, the company
entered into a three-year construction project with a contract price of
P5,000,000. The following were the transactions of the company for years
2019-2021.

2019 2020 2021

Construction costs per year P1,000,000 P1,400,000 P1,400,000
Estimated cost to complete 3,000,000 1,600,000 0
Billings per year 900,000 2,100,000 2,000,000
Collections per year 800,000 2,000,000 2,200,000

1. From the data given above, determine the gross profit on the
construction to be reported each year and the journal entries to be
prepared by the company for each year.

2. Assume that the total cost to complete project in 2020 amounts to

P4,800,000, determine the gross profit on the construction to be
reported each year.

3. Assume that the total cost to complete the project in 2020 amounts
to P5,200,000, determine the gross profit on the construction to be
reported each year.

Problem 2
CONSTRUCTION COMPANY is executing a construction project, which is expected
to take three years. The company has signed a fixed price contract for
P12,000,000. The details of the costs incurred to date 2020 are as follows:
Site labor costs 1,000,000
Costs of construction material 3,000,000
Depreciation of PPE used in construction 500,000
Marketing and selling costs 1,000,000
Total 5,000,000
Total contract costs estimated to complete 5,500,000

Determine the revenue, costs and profits to be recognized overtime in 2020.

GROSS
REVENUE COSTS PROFIT/(LOSS)
A. 5,400,000 4,500,000 900,000
B. 5,400,000 5,500,000 (100,000)
C. 6,000,000 4,500,000 1,500,000
D. 6,000,000 5,500,000 900,000

Problem 3
BUILDERS Construction is constructing an office building under contract. The
contract calls for progress billings and payments of P1,240,000 each quarter.
The total contract price is P14,880,000 and the company estimates total costs
of P14,200,000. The company estimates that the building will take three
years to complete and construction commences on 2022.

At December 31, 2023 BUILDERS Construction estimates that it is 75% complete

with their current construction project; however, the estimate of total costs
to be incurred has risen to P14,400,000 due to unanticipated price increases.
 4

How is the difference, debit/(credit) between the construction in progress

and the billings on construction in progress reported?
A. (3,380,000) C. 880,000
B. 1,240,000 D. (1,240,000)

If the building was 30% completed by the end of 2022, what is the total
amount of expenses to be reported for 2023?
A. 10,800,000 C. 6,390,000
B. 6,540,000 D. 6,300,000

Problem 4
On March 1, 2022, AGGREGATES Company enters a contract to build a hotel which
is estimated to cost P31,200,000. The company recognizes construction
revenue over time. Data on this project for 2022-2024 follow:
Contract Costs Est’d Costs
Billings incurred to Complete
2022 10,500,000 5,460,000 20,540,000
2023 12,500,000 9,984,000 13,156,000
2024 14,440,000 15,756,000 -
The contract contains a penalty clause that penalizes the company a reduction
of P70,000 from the contract price for every week of delay. In 2024, the
contract was delayed for 8 weeks

What is the gross profit for 2024?

A. 1,164,000 C. 1,724,000
B. 1,466,400 D. 1,824,000

Problem 5
MOC Construction Company started work on three job sites during the current
year. Any costs incurred are expected to be recoverable. Data relating to
the three jobs are given below:
Site Contract Cost Estimated Costs Billings on Collections
Price Incurred to Complete Contract on Billings
1 5,000,000 3,750,000 - 5,000,000 5,000,000
2 7,000,000 1,000,000 4,000,000 900,000 900,000
3 2,500,000 1,000,000 1,000,000 1,500,000 1,000,000

If the company records revenue over time, how much must be shown as current
asset in the balance sheet of MOC Construction Company as of December 31?
A. 5,500,000 C. 250,000
B. 500,000 D. 100,000

If the company records revenue at a point in time, how much must be shown as
current asset in the balance sheet of MOC Construction Company as of December
31?
A. 5,100,000 C. 250,000
B. 500,000 D. 100,000

Problem 6
LUGI Company is building two construction projects. The following
information relate to these projects during the year. Any costs incurred are
expected to be recoverable.
Project 1 Project 2
Contract Price 10,500,000 7,500,000
Costs incurred to date 6,000,000 7,000,000
Est’d costs to complete 3,000,000 1,000,000
Billings during the year 7,000,000 1,000,000
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Collections during the year 6,000,000 1,000,000

What amount of gross profit/(loss) should the company report in its income
statement for the year?
OVER TIME POINT IN TIME
A. 562,500 (500,000)
B. 500,000 (500,000)
C. 500,000 0
D. (500,000) 500,000

Problem 7
LAKE Corporation began construction work under a three-year contract. The
contract price is P4,800,000. The company uses the percentage-of-completion
method for financial accounting purposes. The income to be recognized each
year is based on the proportion of costs incurred to total estimated costs
for completing the contract. The financial statement presentations relating
to this contract at December 31 follow:
Statement of Financial Position
Accounts receivable-Construction contracts 200,00
Construction in progress 600,000
Contract Billings 480,000
Costs and recognized profit in excess of billings 120,000
Income statement
Income (before tax) on the contract recognized 120,000

How much cash was collected during the year?

A. 40,000 C. 280,000
B. 200,000 D. 480,000

What was the initial estimated income before tax on the contract?
A. 600,000 C. 800,000
B. 640,000 D. 960,000

Problem 8
UNSURE Company specializes in the construction of commercial and industrial
buildings. The contractor is experienced in bidding long-term construction
projects of this type, with the typical project lasting fifteen to twenty-
four months. The contractor uses the percentage of completion method of
revenue recognition since, given the characteristics of the contractor’s
business and contracts; it is the most appropriate method. Progress toward
completion is measured on a cost-to-cost basis. The company began work on a
lump-sum contract at the beginning of the year. As bid, the statistics were
as follows:
Lump-sum Price (contract price) 4,000,000
Estimated costs
Labor 850,000
Materials 1,750,000
Indirect cost 400,000 3,000,000
Estimated gross profit 1,000,000

At the end of the first year, the following was the status of the contract:
Billings to date 2,250,000
Cost incurred to date
Labor 464,000
Materials 648,000
Indirect cost 193,000 1,305,000
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Latest forecast of total cost 3,000,000

Included in the above costs incurred to date were standard electrical and
mechanical materials stored on the job site, but not yet installed, costing
P105,000. These costs should not be considered in the cost incurred to date.

Compute the percentage of completion on the contract at the end of the year.
A. 35% C. 43.50%
B. 40% D. 46.67%

Compute the amount of gross profit that would be reported on this contract at
the end of the year.
A. 200,000 C. 540,000
B. 400,000 D. 667,000

Problem 9
On January 1, 2017, Build Company entered into a construction contract with
an owner to build an oil refinery. The contract has the following
characteristics; the oil refinery is highly customized to the owner’s
specifications and changes to these specifications by the owner are expected
over the contract term. The oil refinery does not have an alternative use to
the contractor. Non-refundable, interim progress payments are required as a
mechanism to finance the contract. The owner can cancel the contract at any
time (with a termination penalty); any work in process is the property of the
owner. As a result, another entity would not need to re-perform the tasks
performed to date. Physical possession and title do not pass until
completion of the contract. The contractor determines that the contract has
a single performance obligation to build the refinery. The majority of
evidences suggests that the contractor’s performance creates an assets that
the customer controls and control is being transferred over time. Build
concludes that input method (cost to cost method) instead of output method is
a more reasonable method for measuring the progress toward satisfying its
performance obligation.

The contract duration is 3 years with total estimated contract revenue of

P300M. The total estimated contract cost as of December 31, 2017 is P200M.
The cost incurred during year 2017 as 120M including P20M related to
contractor-caused inefficiencies which do not represent/depict the transfer
of goods or services to the customer. As of December 31, 2018, the total
estimated contract cost becomes 250M due to increase in cost of raw
materials. The cost incurred during 2018 is P105M including P5M related to
contractor-caused inefficiencies which do not represent/depict the transfer
of goods or services to the customer.

Under IFRS 15, what is the net income/(loss) to be reported by the company
for the years ended December 31, 2017 and 2018?

Problem 10
Flordy Company entered into a long-term construction contract in January 1,
2017 to construct a building at a fixed price of P10M. Flordy determined
that the outcome of the construction cannot be estimated reliably. Flordy
normally bills its customers 50% at the middle of the first year, 20% at the
middle of the second year and the balance at the date of completion of
project. A mobilization fee of 10% of the contract price (deductible from
the final bill) is payable 30 days after the contract signing. The contract
provides that the customer shall pay 80% of the amount billed during the year
on or before December 31 subject to retention provision/withholding by
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customer of 5% of amount to be paid by the customer, which is intended to

protect the customer from the contractor failing to adequately complete its
obligation under the contract. The customer satisfactorily complied with the
contractual provision. Flordy’s accountant provide the following data for
the years ended December 31, 2017 and 2018:
2017 2018
Cost incurred to date P4,000,000 P7,000,000
Estimated cost to complete as of this date 9,000,000 4,000,000

What is the 12/31/2018 (1) Due from/(to) Customer, (2) excess of construction
in progress over progress billings and (3) realized gross profit/(loss),
respectively?
CMPC 131 Long Term Construction Contract
Prepared by: Joseph R. Mendoza CPA, MBA

CONSTRUCTION CONTRACT –an agreement negotiated for the construction of an asset or a combination of assets that are closely interrelated
or interdependent in terms of their design, technology and function or their ultimate purpose or use.
TYPES of Contracts Negotiating PRICE
1. SINGLE asset Contract 1. FIXED PRICE Contract – w/ cost escalation clause
2. GROUP asset contract 2. COST plus contract – GP based on cost incurred

TRANSACTIONS Accounted for:

1. Construction – COSTS incurred 3. COLLECTIONS of bill (A/R) 5. COMPLETION of Project
2. BILLINGS to customers 4. REVENUE and EXPENSE recognition

REVENUE and EXPENSE Recognition

A. % of completion method – used IF the outcome of the construction contract can be estimated reliably (reasonably measured).
 profit is recognized in accordance to the stage (%) of completion of the construction.
B. Zero profit (Cost Recovery) method – used if otherwise. Profit is recognized only upon completion of the construction.
 Before completion, revenue = costs (expenses) incurred.

% of COMPLETION Method
TRADITIONAL Method ALTERNATIVE Method
Contract Price (CP) (A) Pxx
Estimated Total Costs * (D) (xx)
Expected GP (E) Pxx Revenue to date (A x % of completion) Pxx
x % of Completion % Cost incurred to date (D x % of completion) (xx)
GP Realized to date (A - D) x %) Pxx GP Realized to date (E x % of completion) Pxx
GP realized – previous periods (xx) GP realized – previous periods (xx)
GP Realized this period Pxx GP Realized this period Pxx

Cost incurred to date (B) Pxx % of Completion = B/D

Estimated cost to complete (C) (xx)
Estimated Total costs * (D) Pxx

% of Completion
1. INPUT measure a. COST to COST method = cost incurred to date (B) / estimated total cost (D)
b. Efforts expended method = labor hours to date / estimated total labor hours
2. OUTPUT measures like estimates of engineers and architects
KEY Notes:
1. Profit = GP realized during the current period
2. In case of ANTICIPATED LOSS (Expected GP is negative), recognize the loss immediately, regardless of method used.
3. Cost incurred to date Pxx CIP = Revenue (Right to collect) Pxx
Realized Profit to date xx Progress Billings (to be collected) (xx)
Construction in Progress (CIP) to date Pxx Contract Asset (Contract Liability) Pxx CURRENT

ILLUSTRATIVE PROBLEM:
TAKDER Builders entered a contract to build the administrative building of a certain municipality. The construction began on January
1, 2019 and estimated time of completion is Oct. 1, 2022. The building cost is estimated to be P150 million and will be billed at P165
million. Data related to the construction is as follows:
2019 2020 2021 2022
Cost incurred to date P45,000,000 P75,000,000 P105,000,000 P150,000,000
Estimated cost to complete 105,000,000 75,000,000 45,000,000
Progress billings to date 21,000,000 60,000,000 105,000,000 165,000,000
Cash collected to date 21,000,000 54,000,000 90,000,000 165,000,000
REQUIREMENTS:
1. Estimated income for 2019, 2020, 2021 and 2022 under the % of completion method.
2. Journal entries for TAKDER Builders to record the transactions related to the construction.
3. Journal entry to record realization of gross profit (loss) on 2021, using % of Completion Method and Zero Profit Method,
assuming the estimated cost to complete on Dec. 31, 2021 is: Case 1 : P55 million Case 2 : P75 million
No great ideal is achieved without sacrificed! (Rene Almeras) A man of patience has great understanding (Proverbs 14:29)
CMPC 131 Long Term Construction Contract
Prepared by: Joseph R. Mendoza CPA, MBA

ILLUSTRATIVE Problem: FIXED PRICE CONTRACT

Requirement #1 2019 2020 2021 2022
Contract Price (A) 165,000,000 165,000,000 165,000,000 165,000,000
Estimated Total Costs (D) 150,000,000 150,000,000 150,000,000 150,000,000
Gross Profit to Date 15,000,000 15,000,000 15,000,000 15,000,000
% of Completion (B/D) 30% 50% 70% 100%
GP earned to date 4,500,000 7,500,000 10,500,000 15,000,000
GP earned Previous yrs (4,500,000) (7,500,000) (10,500,000)
GP earned this year 4,500,000 3,000,000 3,000,000 4,500,000

Cost incurred to date (B) 45,000,000 75,000,000 105,000,000 150,000,000

Estimated cost to complete (C) 105,000,000 75,000,000 45,000,000
Estimated Total Costs (D) 150,000,000 150,000,000 150,000,000 150,000,000

Requirement #2: Journal Entries

2019 2020 2021 2022
#1 Construction in Progress 45,000,000 30,000,000 30,000,000 45,000,000
Cash /Payable 45,000,000 30,000,000 30,000,000 45,000,000
#2 Accounts Receivable 21,000,000 39,000,000 45,000,000 60,000,000
Progress billings 21,000,000 39,000,000 45,000,000 60,000,000
#3 Cash 21,000,000 33,000,000 36,000,000 75,000,000
Accounts Receivable 21,000,000 33,000,000 36,000,000 75,000,000
#4 Construction in Progress 4,500,000 3,000,000 3,000,000 4,500,000
Cost of Construction 45,000,000 30,000,000 30,000,000 45,000,000
Construction revenue 49,500,000 33,000,000 33,000,000 49,500,000
#5 Progress Billings 165,000,000
Construction in Progress 165,000,000

Requirement #3: Installment Sales Method Cost Recovery Method

Case 1 Case 2 Case 1 Case 2
#4 Cost of Construction 30,000,000 30,000,000 30,000,000 30,000,000
Construction in Progress 4,218,750 22,500,000 15,000,000
Construction revenue 25,781,250 7,500,000 30,000,000 15,000,000

Case 1 Case 2
Contract Price (A) 165,000,000 165,000,000
Estimated Total Costs (D) 160,000,000 180,000,000
Gross Profit to Date 5,000,000 (15,000,000)
% of Completion (B/D) 65.63% 100%
GP earned to date 3,281,250 (15,000,000)
GP earned Previous yrs (7,500,000) (7,500,000)
GP earned this year (4,218,750) (22,500,000)

Cost incurred to date (B) 105,000,000 105,000,000

Est. cost to complete (C) 55,000,000 75,000,000
Estimated Total Costs (D) 160,000,000 180,000,000

% of Completion (B/D) 65.63% 58.33%

NOTES:
1. In case 2, since it resulted to negative GP to date, the entire loss is to be recognized. The % of completion will no longer be applied
during the year.
2. Final loss to be recognized must be after deducting the GP recognized during previous years, as shown by the CREDIT to CIP account.
3. Under Cost Recovery Method, no loss shall be recognized on Case 1 since the GP to date is positive and that there is no yet GP
recognized during 2019 and 2020. However, in Case 2, the entire loss of P15M will be fully recognized.
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FRANCHISE ACCOUNTING
FRANCHISING: ACCOUNTING BY FRANCHISOR
Franchise companies derive their revenue from one or both of two sources:
1. From sale of initial franchises and related assets or services, and
2. From continuing fees based on the operations of franchises.
Franchisor - the party who grants business rights under the franchise.
Franchisee - the party who operates the franchised business.
Normal services performed by franchisor:
1. Assistance in site selection.
a. Analyzing location.
b. Negotiating lease.
2. Evaluating potential income.
3. Supervision of construction activity.
a. Obtaining financing.
b. Designing building.
c. Supervising contractor while building.
4. Assistance in the acquisition of signs, fixtures, and equipment.
5. Bookkeeping and advisory services.
a. Setting up franchisee’s records.
b. Advising on income, real estate, and other taxes.
c. Advising on local regulations of the franchisee’s business.
6. Employee and management training.
7. Quality control.
8. Advertising and promotion.

INITIAL FRANCHISE FEES

The initial franchise fee is consideration for establishing the franchise relationship and providing some
initial services. Initial franchise fees are to be recorded as revenue only when and as the franchisor
makes “substantial performance” of the services it is obligated to perform and collection of the fee is
reasonably assured.

SUBSTANTIAL PERFORMANCE
Substantial performance occurs when the franchisor has no remaining obligation to refund any cash
received or excuse any nonpayment of a note and has performed all the initial services required under
the contract. Commencement of operations by the franchisee shall be presumed to be the earliest point
at which substantial performance has occurred, unless it can be demonstrated that

substantial performance of all obligations, including services rendered voluntarily, has occurred before
that time.

CONTINUING FRANCHISE FEES

Continuing franchise fees are received in return for the continuing rights granted by the franchise
agreement and for providing such services as management training, advertising and promotion, legal
assistance, and other support. Continuing fees should be reported as revenue when they are earned and
receivable from the franchisee, unless a portion of them has been designated for a particular purpose,
such as providing a specified amount for building maintenance or local advertising. In that case, the
portion deferred shall be an amount sufficient to cover the estimated cost in excess of continuing
franchise fees and provide a reasonable profit on the continuing services.

BARGAIN PURCHASES
In addition to paying continuing franchise fees, franchisees frequently purchase some or all of
their equipment and supplies from the franchisor. The franchisor would account for these sales as it
 7

would for any other product sales. Sometimes, however, the franchise agreements, grants the franchisee
the right to make bargain purchases of equipment or supplies after the initial franchise fee is paid. If the
bargain price is lower than the normal selling price of the same product, or if it does not provide the
franchisor a reasonable profit, then a portion of the initial franchise fee should be deferred. The deferred
portion would be accounted for as an adjustment of the selling price when the franchisee subsequently
purchases the equipment or supplies.
OPTIONS TO PURCHASE
A franchise agreement may give the franchisor an option to purchase the franchisee’s business.
As a matter of management policy, the franchisor may reserve the right to purchase a profitable
franchised outlet, or to purchase one that is in financial difficulty. If it is probable at the time the option is
given that the franchisor will ultimately purchase the outlet, then the initial franchisee fee should not be
recognized as revenue but should be recorded as a liability. When the option is exercised, the liability
would reduce the franchisor’s investment in the outlet.
FRANCHISOR’S COSTS
Franchise accounting also involved proper accounting for the franchisor’s costs. The objective is
to match related costs and revenues by reporting them as components of income in the same accounting
period. Franchisors should ordinarily
defer direct costs (usually incremental costs) relating to specific franchise sales for which revenue has not
yet been recognized. Costs should not be deferred, however, without reference to anticipated revenue
and its realizability. Indirect costs of a regular and recurring nature such as selling and administrative
expenses that are incurred irrespective of the level of franchise sales should be expensed as incurred.
DISCLOSURES OF FRANCHISORS
Disclosure of all significant commitments and obligations resulting from franchise agreements,
including a description of services that have not yet been substantially performed, is required. Any
resolution of uncertainties regarding the collectibility of franchise fees should be disclosed. Initial
franchise fees should be segregated from other franchise fee revenue if they are significant. Where
possible, revenues and costs related to franchisor-owned outlets should be distinguished from those
related to franchised outlets.
ILLUSTRATION OF ENTRIES FOR INITIAL FRANCHISE FEE
Assume that Jollibee Inc. charges an initial franchise fee of P5,000,000 for the right to operate a
franchisee of Jollibee. Of this amount, P1,000,000 is payable when the agreement is signed and the
balance is payable in five annual payments of P800,000 each. In return for the initial franchise fee, the
franchisor will help locate the site, negotiate the lease or purchase of the site supervise the construction
activity, and provide the bookkeeping services. The credit rating of the franchisee indicates that money
can be borrowed at 24%.

1. If there is reasonable expectation that the down payment may be refunded and if substantial future
services remain to be performed by Jollibee Inc., the entry should be:
Cash 1,000,000
Notes Receivable 4,000,000
Discount on Notes Receivable 1,803,680
Unearned Franchise Fee 3,196,320

2. If the probability of refunding the initial franchise fee is extremely low, the amount of future services
to be provided to the franchisee is minimal, collectibility of the note is reasonably assured, and
substantial performance has occurred, the entry should be:
Cash 1,000,000
Notes Receivable 5,000,000
Discount on Notes Receivable 1,803,680
Revenue from Franchise Fee 3,196,320
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3. If the initial down payment is not refundable, represents a fair m.easure of the services already
provided, with a significant amount of services still to be performed by the franchisor in future
periods, and collectibility of the note is reasonably assured, the entry should be:
Cash 1,000,000
Notes Receivable 4,000,000
Discount on Notes Receivable 1,803,680
Revenue from Franchise Fee 1,000,000
Unearned Franchise Fees 2,196,320

4. If the initial down payment is not refundable and no future services are required by the franchisor,
but collection of the note is so uncertain that recognition of the note as an asset is unwarranted, the
entry should be:
Cash 1,000,000
Revenue from Franchise Fees 1,000,000
5. Under the same conditions as those listed under 4 except that the down payment is refundable or
substantial services are yet to be performed, the entry should be:
Cash 1,000,000
Unearned Franchise Fees 1,000,000
In cases 4 and 5, where collection of the note is extremely uncertain, cash collections may be
recognized using the installment method or the cost recovery method.

DISCUSSION PROBLEMS

Problem 1
On December 31, 2021, RAP, Inc. authorized JIN to operate as a franchisee
for an initial franchise fee of P150,000. Of this amount, P60,000 was
received upon signing the agreement, and the balance, represented by a
note, is due in three annual payments of P30,000 each, beginning December
31, 2022. The present value on December 31, 2021 of the three annual
payments appropriately discounted is P72,000. According to the
agreement, the nonrefundable down payment represents a fair measure of
the services already performed by RAP, however, substantial future services
are required of RAP. Collectability of the note is reasonably certain.

On December 31, 2021, RAP should record unearned franchise fees in respect
of the JIN franchise of
A. 150,000 C. 72,000
B. 90,000 D. -0-

Problem 2
Hope Corp. sells a franchise for an initial fee of P1,400,000. A down
payment of P400,000 is required, with the balance covered by a P1,000,000,
10% note payable in five equal annual installments.

If all the material services have been performed and collectability of

the notes is reasonably assured, but the refund period has not yet
expired, what journal entry is needed to record the transaction?
A. Cash 400,000
Notes Receivable 1,000,000
Franchise Fees 1,400,000
B. Cash 400,000
Notes Receivable 1,000,000
Unearned Franchise Fees .. 1,400,000
 9

C. Cash 400,000
Notes Receivable 1,000,000
Franchise Fees 400,000
Unearned Franchise Fees .. 1,000,000
D. Cash 400,000
Notes Receivable 1,000,000
Franchise Fees 1,000,000
Unearned Franchise Fees .. 400,000

Problem 3
Kami, Inc. charges an initial franchise fee of P500,000 for the right to
operate to operate as a franchise of Kami. Of this amount, P100,000 is
payable when the agreement was signed and the balance is payable in a
noninterest bearing note in five annual payments of P80,000 each. In
return for the initial franchise fee, the franchisor will help locate the
site, negotiate the lease or purchase of the site, supervise the
construction activity, and provide the bookkeeping services. The credit
rating of the franchisee indicates that money can be borrowed at 8%.
The present value of an ordinary annuity of five annual receipts of P80,000
each discounted at 8% is P319,416.80. The discount represents the interest
revenue to be accrued by the franchisor over the payment period.

If the probability of refunding the initial franchise fee is extremely low,

the amount of future services to be provided to the franchisee is
minimal, collectability of the note is reasonably assured and substantial
performance has occurred:

The earned and unearned franchise fees would be as follows:

Earned Unearned
A. P -0- P500,000.00
B. -0- 419,416.80
C. 419,416.80 -0-
D. 319,416.80 100,000.00

Problem 4
SAPPHIRE CO. charges new franchisees an initial fee of P5,000,000. Of this
amount, P2,000,000 is payable in cash when the agreement is signed, and the
remainder is to be paid in three equal annual installments which are
evidenced by an interest-bearing promissory note. In consideration
therefore, SAPPHIRE CO. will assist in locating the business site,
conduct a market study to estimate earnings potential, supervise
construction of a building, and provide initial training to employees.

On December 3, 2021, Sapphire Co. entered into a franchising agreement

with EMERALD, INC. by the end of the year, SAPPHIRE CO. has completed
about 25% of the initial services at a cost of P300,000 and it has
ascertained that collection of the notes is reasonably assured.

For 2021, SAPPHIRE CO. should recognized franchise revenue of:

A. 5,000,000 C. 1,700,000
B. 2,000,000 D. -0-

Problem 5
SHAWARMA Inc. sells franchises to independent operators. The contract
 10

with the franchise includes the following provisions:

1. The franchise is charged an initial franchise fee of P120,000. Of
this amount, P20,000 is payable when the agreement is signed and
a P20,000, zero-interest bearing note, payable at the end of 5
subsequent years.
2. All of the initial franchise fee collected by the company is to
be refunded and the remaining obligation cancelled if, for any
reason, the franchise becomes unprofitable.
3. In return, for the initial franchise fee, the franchisor agrees
to (a) assist the franchisee in selecting the location for the
business, (b) negotiate the lease of the land, (c) obtain
financing and assist with building design, (d) supervise
construction, establish accounting and tax records, and (f)
provide expert advice over a 5-year period relating to such
matters as employee and management training, quality, control and
promotion. This continuing involvement by the franchisor helps
maintain the brand value for the franchise.
4. In addition to the initial franchise fee, the franchisee is
required to pay the franchisor a monthly fee of 2% of sales for
continuing services.
5. Management of the franchisor estimates that the value of the
services rendered to the franchisee at the time the contract is
signed amounts to at least P20,000. All franchisees to date have
opened their locations at the scheduled time, and none have
defaulted on any of the notes receivable. The credit ratings of
all franchisees would entitle them to borrow at the current
interest rate of 10%. The present value of an ordinary annuity
of five annual receipts of P20,000, each discounted at 10% is
P75,816.
What is the amount of franchise revenue assuming the franchise
agreement is signed at the beginning of the year?
A. Zero C. 100,000
B. 95,816 D. 120,000

If the franchisor completes the franchise startup tasks and the

franchise opens on July 1 of the current year, what is the current
year’s amount of franchise revenue?
A. Zero C. 95,816
B. 20,000 D. 100,000

Problem 6
At the beginning of the year, Drin got the franchise of Vin, a known
steak house of upscale patronage. The franchise agreement required a
P1,000,000 franchise fee payable P200,000 upon signing of the franchise and
the balance in four annual installments starting the end of the current
year. At present value using 12% as discount rate, the four installments
would approximate P399,300. The fees once paid are refundable. The
franchise may be cancelled subject to the provisions of the agreement.
Should there be unpaid franchise fee attributed to the balance of the main
fee (P1,000,000), same would become due and demandable upon
cancellation. Further, the franchisor is entitled to a 5% fee on gross
sales payable monthly within the first ten days of the following month.

The Credit Investigation Bureau rated Drin as AAA credit rating. The balance
of the franchise fee was guaranteed by a commercial bank.

The first year of operations yielded gross sales of P18,000,000, PIZZA's

 11

earned franchise fees for the first year is:

A. 900,000 C. 1,499,300
B. 1,100,000 D. 1,900,000

Problem 7
DJ Builders Enterprises, a franchisor, charges franchisees a "franchise fee"
of P1,000,000. Of this amount, a nonrefundable P400,000 is paid upon the
signing of the contract with the balance payable in three equal
installments after each year thereafter. DJ Builders will assist in locating
a suitable business site, conduct a market study, oversee the construction
of facilities, and provide initial training for employees.

On December 1, 2021, DJ Builders signed a franchising agreement for the U-

belt area. By the end of 2021, it was determined that the substantial
performance of the initial services had cost DJ Builders a total of
P300,000 and that collection of the balance of the franchise fee has been
reasonably assured. In its 2021 income statement, DJ Builders should report
franchise revenue and net income:
Franchise
Net Income
Revenue
A. P1,000,000 P700,000
B. 1,000,000 1,000,000
C. -0- -0-
D. 700,000 700,000

Problem 8
On September 1, 2021, ACE Company entered into franchise agreements with
two franchisees. The agreements required an initial fee payment of
P700,000 plus four P300,000 payments due every four (4) months, the first
payment due December 31, 2021. The market interest rate is 12%. The initial
deposit is refundable until substantial performance has been completed. The
following table describes each agreement:
Services
Performed Total Costs
Probability of by Franchisor Incurred to
Franchis Full Collection Dec. 31, 2021 Dec. 31, 2021
ee
A Likely Substantially P700,000
B Doubtful 25% N/A

The present and future value tables at 4% for four (4) periods were as
follows:
Present value of P 1 0.8548
Present value of an ordinary annuity of P1 3.6299
Future value of P 1 1.1699
Future value of an ordinary annuity of P1 4.2465

What amount of net income to be reported in 2021, assuming P1,000,000 was

received from each franchisee during the year:
Franchisee A Franchisee B
A. P1,088,970 P 0
B. 1,788,970 0
C. 1,132,529 0
 12

D. 1,132,529 43,559

Problem 9
On April 1, 2021, Motorola, Inc. entered into a franchise agreement with
a local businessman. The franchisee paid P90,000 and gave a P60,000, 8%, 3
year note payable with interest due annually on March 31. Motorola recorded
the P150,000 initial franchise fee as revenue on April 1, 2021. On December
30, 2021, the franchisee decided not to open the outlet under Motorola's
name. Motorola cancelled the franchisee's note and refunded P48,000 less
accrued interest on the note, of the P90,000 paid on April 1.
What entry should Motorola make on December 30, 2021?
A. Loss on Repossessed Franchise 48,000
Cash 48,000
B. Loss on Repossessed Franchise 44,400
Cash 44,400
C. Loss on Repossessed Franchise 104,400
Cash 44,400
Notes Receivable 60,000
D. Revenue from Franchise Fees 150,000
Interest Income 3,600
Cash 44,400
Notes Receivable 60,000
Revenue from Repossessed Franchise 42,000

Diamond’s Pizza Inc. enters into a franchise agreement on December 31, 2019, giving Domino Corp. the
right to operate as a franchisee of Diamond’s Pizza for 5 years. Diamond charges Domino an initial
franchisee fee of P475,000 for the right to operate as a franchisee. Of this amount, P190,000 is payable
when Domino Corp. signs the agreement, and the balance is payable in five annual payments of P57,000
each on December 31.

Consider the following for allocation of the transaction price at December 2019.
Rights to the trade name, market area, technical and propriety know-how P190,000.00
Services – training, etc 94,591.50
Machinery and equipment etc. (costing, P95, 000) 133,000.00
Total Transaction price P417,591.50

The credit rating of Domino indicates that money can be borrowed at 8%. The present value of an
ordinary annuity of five annual receipts of P57,000 each discounted at 8% is P227, 591.50. The discount
of P57,408.50 represents the interest revenue to be accrued by Diamond’s Pizza Inc. over the payment
period.
Training is completed in January 2020, the equipment is installed in January 2020 and Domino holds a
grand opening on February 4, 2020. On February 4, 2020 the franchise opens.
Domino also promises to pay on going royalty payments of 1% of its annual sales (payable every January
31 of the following year) and is obliged to purchase products from Diamond’s at its current stand alone
selling prices at the time of purchase.

1. How many performance obligations exist in this contract for franchise?

A. 2 C. 4
B. 3 D. 5

2. When should Diamond recognize revenue for the rights (combined) to the trade name, market
area and propriety know-how which give rise to a single performance obligation?
 13

A. No transaction C. Point in time

B. No revenue D. Over time

3. How much revenue (franchise revenue, service revenue and sales revenue – machinery and
equipment) would be recognized on December 31, 2019?
A. Zero C. P 133, 000.00
B. P 94, 591.50 D. P190, 000.00

4. How much revenue (franchise revenue, service revenue and sales revenue – machinery and
equipment) should be recognized on February 4, 2020?
A. P 94, 591.50 C. P 190, 000.00
B. P 133, 000.00 D. P417, 591.50

5. How much continuing franchise revenue be recognized on December 31, 2020 assuming the sales
of P 4,987,500 was generated for the first year of operations?
A. Zero C. P 190, 000.00
B. P 49, 875.00 D. P417, 591.50