Module 1 (Partnership Formation)

Partnership
As defined in the New Civil Code in the Philippines (Art. 1767) “Is an organization where two or more
persons bind themselves to contribute money, property, or industry into a common fund with the
intention of dividing the profits among themselves”

- A partnership is a business with two or more owners that is not organized as a corporation

Elements of Partnership
Valid Contract
- Oral or written; investment in the form of immovable property requires public instrument

Legal Capacity
- Partners must have a legal capacity – of legal age, physically and mentally capable of entering
into contract

Contributions
- In the form of money, property or service

Purpose
- To share in the profits earned by the firm

1. There must be a valid contract whether oral or written

2. A partnership must be put up by person having legal capacity to contract

3. Their contribution must be in the form of money, property or service

4. The purpose of the business is to divide the profit among them

Article 1667 – With regards a written or oral contract, the law does not provide a mandatory
requirement for this, not unless the investment of the partner is in the form of immovable property in
which case a public instrument is necessary

Article 1772 – Every contract of partnership having capital of (P 3,000 or more), in money or property
shall appear in public instrument which must be recorded in the office of the Securities Exchange &
Commission. However, failure to do so does not negate the recognition of the partnership as a juridical
personality.

Distinct Features of Partnership

Voluntary Association
- Individuals, by their own free will, agree to join together and form a partnership.

Legal Entity
- Partnership has a juridical personality separate and distinct from the partners

- It can acquire, sell or dispose properties on its own

 - It can incur obligations and transact business in its name

- Article 1768 – It can acquire, sell or dispose properties, incur obligation and transact business in
its name

Written Agreement
- Is a contract between partners, also called the Articles of Partnership

- Is governed by contract law

- Outlines the rules of the partnership

Articles of Partnership
- Name, location, and nature of the business

- Name, capital contribution, and duties of each partner

- Procedures for admitting a new partner

- Method of sharing profits and losses among the partners

- Procedure for withdrawal of assets by the partners

- Procedures for withdrawal of a partner from the partnership

- Procedures for liquidating the partnership

Co – Ownership of Partnership
- Any asset contributed by a partner becomes property of the partnership

- The partner who contributed the property is no longer the sole owner of the property.

- Any new assets purchased by the partnership are owned by the partners

Co – Ownership of Profits
- Right to share in partnership profits

Mutual Agency
- Mutual agency means that every partner is a mutual agent of the firm

- Any partner can bind the business to a contract

- Partners cannot bind the business to contracts associated with personal matters

- Article 1818 – the partnership can be sued, together with the partners, by third parties when a
partner commits a wrongful act or a breach of trust

Limited Life
- A partnership has a limited life (Article 1830-1831)

- A dissolution is the ending of a partnership

- Voluntary Dissolution (withdrawal, retirement, bankruptcy, and admission of new partner)

 - Involuntary Dissolution (bankruptcy, death, and incapacity of a partner)

Examples of Dissolution include:

- Changes in the existing partners

- The withdrawal of a partner

- The death of a partner

- Adding a new partner (Note: This dissolves the old partnership but creates a new one)

Unlimited Liability
- Each partner has unlimited personal liability for the debts of the business

- Partners must pay the debts of the business with personal assets when the partnership cannot
pay its debts (This is known as unlimited liability)

- Article 1791 and 1853 – In the event cash flow problems occur and partnership assets are not
sufficient to liquidate partnership liabilities, the personal assets of the partners should be used
to help settle the company’s obligation

Taxable Entity
Partnership Income Tax (Ordinary Partnership)
- Taxable like a corporation

- Tax on income = 30% rate but was reduce to 20% effective 2021 for taxable income which is not
more than P 5,000

No Partnership Income Tax (General Professional Partnership)

- The partnership entity does not pay business income tax

- The net income (or net loss) flows through to the individual partners

- Partners pay personal income tax on their share of partnership income

- The professionals (accounting, tax, law, medicine and engineering) are taxed as individual
taxpayers (NIRC, Sec. 20 and 24)

Roles of Partnership
1. The partners are co-owners of the partnership property. It means that when a partner invests
his land or building, this ceases to be his personal property. Instead, this becomes joint property
of all the partners

2. The partners have unlimited liability. The partner become individually liable for all partnership
debts in the event that the partnership is not sufficient to cover up its liabilities. (Article 1791)
This means that in the event partnership assets are inadequate to settle the claims of the
partnership creditors, these creditors can seize the personal properties of anyone of the
partners

3. The partnership is bound by the acts of any partners since they are considered agents of the
partnership for the purpose of carrying its activities
Partner’s Capital Account
- Accounting for a partnership is much like accounting for a sole proprietorship

- Each partner needs a separate capital account

- Each partner has a withdrawal account

Difference Among the Form of Organization

Partnership Similarities Difference

vs Sole Proprietorship • Unlimited liability • Juridical or legal entity

• Can take an active role in • Taxable entity
managing the business
• Limited life
vs Corporation • Taxable entities (except for • Pp has limited life; corporation
GPP) has perpetual existence
• Juridical entities • Partners have unlimited
liability; shareholders’ liability is
limited to investment
• Partners can co-manage the
business; management in a
corporation is vested among few,
major shareholder’s

Partnership Advantages
Versus Sole Proprietorship
1. Partnership can raise more capital

2. Partnership brings together the abilities of more than one person

3. Partners working well together can add more value than by working alone

Versus Corporation
1. Partnership is less expensive to organize than a corporation, which requires a charter from the
state

2. There’s no double taxation. Partnership income is taxed only to the partners as individuals

Partnership Disadvantages
1. Partnership agreement may difficult to be formulate. Each time a new partner is admitted or a
partner withdraws, the business needs a new partnership agreement

2. Relations among partner may be fragile

3. Mutual agency and unlimited liability create personal obligations for each partner

4. Delectus Personae – difficulty in transferring ownership

Kinds of Partnership
As to Activity
- Trading or Non-Trading

As to Property
- Universal Partnership of all Present Property (Article 1778 of the New Civil Code) – is one where
all the partners contribute all their properties into a common fund

- Universal Partnership of Profits (Article 1780) - is one where the partner contributes all what
they will receive as a result of their work or service rendered during the lifetime of the
partnership. The partnership retain ownership over their present and future property.

- Particular Partnership (Article 1783)

As a Liability
General Partnership
- In a general partnership each partner is a co-owner of the business, with all the privileges and
risks of ownership

- The profits and losses of the partnership pass through to the partners, who then pay personal
income tax on their share of the income

Limited Partnership
- Has at least two classes of partners:

General Partner
- Takes primary responsibility and usually manages the business

- Has unlimited personal liability

- Is usually the last to receive a share of profits and losses

- Often gets all the excess profit after the limited partners get their share of the income

Limited Partner
- Do not participate in the day-to-day operations of the business

- Have no personal liability for the debts of the partnership beyond their contribution in the
business

- Usually have first claim to profits and losses but only up to a certain limit

- Have limited potential for profits

- Composed of at least one general partner with the other as limited partners who are liable to
partnership creditors only to the extent of their investment in the partnership.

- This type of partnership has two classes of partners: general and limited (Article 1816, 1843)
Kinds of Partner
General Partner Versus Limited Partner
General Partner

- One who manages the partnership

- Contributes property or service

- Has unlimited liability

- Assumes the risk of loss of personal property in the event partnership becomes insolvent

Limited Partner

- One who invests cash or property

- Liability to third party is limited only to his investment

- No active role in the management of the partnership

- Has no unlimited Liability

Capitalist Versus Industrial Partner

Capitalist Partner

- One who contributes money or property into the partnership fund

Industrialist Partner

- One who contributes industry or service only

- Usually designated as a managing partner

Real Versus Nominal Partner

- Real Partner is an actual partner

- Nominal Partner is a partner in name only

Ostensible Versus Secret Partner

- Ostensible Partner is known to the public that he is a partner

- Secret Partner is not known as such to the public

Universal Versus Particular Partner

- Universal Partner is one who’s participation extends to the entire business

- Particular Partner is one whose participation is limited to a unit or part of a business

Take note that an industrial partner is also a general partner, with unlimited liability and is not allowed
to engage in any other kind of business unless expressly authorized by the other partners (Article 1789)

How are Partnership Organized

- It is easy to form a partnership
 - No permissions are required from the government

- It is wise to enlist the assistance of an attorney

- The partners agree to contribute assets and abilities/skills to the partnership

Steps in Registering a Partnership

1. Register the Business Name at the Securities and Exchange Commission (SEC)

2. Obtain a Barangay Clearance

3. Register with the Social Security System (SSS)

4. Obtain Permit from the Mayor’s Office

5. Register the Business with the Bureau of Internal Revenue (BIR)

Documents Required to Set-up Partnership

1. Name Verification Slip

2. Article of Partnership (AP)

3. Joint Affidavit of two partners to change partnership name (not required if already stated in AP)

4. Registration of Data Sheet

5. Certificate of Bank Deposit

6. Name of the Partnership

7. Principal Office Address

Who can Form Partnership

- Two or more individuals with no existing businesses

- An individual with no existing business and another with an already existing business

- Two or more individuals with existing businesses

Partnership Contribution in Business

Cash
- To be recorded at its face value

Other Forms of Assets Properties

- To be recorded at its current fair market value or appraised value

Assets or Properties with Attached Liabilities Agreed to be Assumed by the Partnership

- Asset to be recorded at its current FMV; liability to be recorded at its face value; capital to be
recorded net of the liability

Service
- In which case, only a memorandum entry shall be recorded
An Already Existing Business
- Where assets to be transferred and liabilities to be assumed by the partnership shall be
recorded in its revalued or adjusted amounts

Transaction Affecting Partner Equity Accounts

- The accountant must have sufficient knowledge of the legal provisions regarding a partnership.

- In addition, the accountant uses the Articles of Co-Partnership as a guide in recording

transactions regarding the partners’ capital contributions, distribution of profit or loss,
dissolution and liquidation.

- Assets = Liabilities + Partners’ Equity

Partner’s Equity
- The rights of the partners over the net assets of the business are called Partners’ Equity.

- Each partner’s equity is represented by two accounts: Partner’s Capital and Partner’s Drawing

- In a partnership since there are two or more partners involved there is a plurality of capital and
drawing accounts

The capital accounts show permanent interest over the net assets of the partnership:

The drawing accounts show temporary interest over the net assets, the balances of which are closed to
the capital accounts at the end of the period:

Drawing Balance may be closed to capital account

Journal Entry:

Partner’s Drawing

- This is the temporary account used to reflect temporary interest of partner

Ordinarily there are two transactions affecting the account:

1. Share in the net profit (the agreement as to the manner of distribution is provided in the
Articles of Co-Partnership) is credited to the drawing account to increase the partner’s equity
and becomes a source of regular drawings by the partner; or share in net loss is debited to the
drawing account to decrease the partner’s equity as well as decrease the amount that a partner
can withdraw

2. Personal drawings may be formal as provided in the Articles of Co-Partnership either as salaries
or as irregular drawings debited to the drawing account and viewed as decreases in the overall
equity or interest of the partner.

- Balance of the drawing account is closed to the capital account

- If the share of the partner in the profit (credited to his drawing account) is greater than the
actual withdrawals made by him (debited to his drawing account), the credit balance of the
 drawing account called unwithdrawn profits is added to the capital account to arrive at the
total partner’s equity.

Illustrative Example
The partnership started operation on October 1. Apple, as managing partner, withdrew P10,000 cash as
monthly salary starting October 31 while Berry made a cash withdrawal only once for P10,000 at the end
of December. A net profit of P150,000 was reported at the end of the year which was divided equally
between them. Additional entries in the partnership books of Apple and Berry will appear thus:

Journal Entry

At the end of the year, the income and expense summary account and the drawing accounts of the
partners will appear as follows:

Updated T-Account (Drawings)

Updated Partner Equity

The balances in the drawing accounts represent unwithdrawn profits. These balances could be left open
and brought forward next accounting period especially if partners intend to withdraw them as per
agreement or closed to the capital accounts and made part of their permanent investments. The entry
to close the drawing balances to the capital accounts will appear thus:

Closing Drawing Account (Journal Entry)

Closing Drawing Account (T-Account)

The partners’ capital accounts, appearing in the Statement of Financial Position as Partners’ Equity, will
show a credit balance of P495,000 for Apple and a credit balance of P340,000 for Berry. Note that
whether or not the drawing balances are closed, the partners’ equity will remain the same.

Other Transaction Affecting Partner’s Capital

A variation in the partner’s investment may be made as described in the following transactions:

June 10 - A partnership note payable to the bank in the amount of P5,000 fell due and it was paid by
Apple out of her own personal cash.

July 5 - A personal receivable of Berry in the amount of P6,000 was collected and retained by the
partnership.

September 15 - A personal note of Berry payable to Filinvest in the amount of P3,500 was paid out of
the partnership cash.

November 10 - A partnership receivable of P2,000 was collected and retained by Apple

Loan Receivable Partner
- Assume that in the above June 10 transaction Apple paid for the note of the business for
P10,000 with the condition that it be paid back to him after three months. The entry in the
partnership books will be a credit to a Payable to Apple account rather than Apple, Capital.

- The partnership may loan cash to a partner which will give rise to a receivable account. For
instance, assume that on July 31 Berry received P20,000 cash to be repaid after sixty days.

Journal Entry

Loan Payable to a partner is a liability while Loan Receivable from a partner is an asset. (Both are not to
be considered in determining partner’s equity)

Opening the Books of Partnership

The first entries in the partnership book pertains to the contribution made by the partners. The
contributions may be in the form of cash, property, services or an already existing business.

Accounting Rules to be Followed

1. Contribution in the form of property should be recorded at current fair market value or
appraised value.

- Fair market value is the amount for which an asset could be exchanged between two
knowledgeable and willing parties in an arm’s length transaction

- This is in support of the Exchange Price or Cost Principle as stated in IAS 16

 - Fair treatment requires that the properties be valued at its current fair market value or
appraised value since these will become business properties; and the subsequently any gains or
loss from its sale will be shared by all partners according to their profit and loss agreement

2. Liabilities attached to the invested properties may be assumed by the partnership, in which case
the capital of the partner will be credited only for the net amount of the asset contribution.

3. Contribution in the form of service requires only a memorandum entry

Illustrative Examples
Case 1 (Contribution of Cash, Property, etc.,)
Santos, Ambros, and Carlos formed a partnership on August 1, 2019. Investments are as follows: Cash of
P50,000 from Santos, merchandise from Ambros which she bought last year for P50,000 but which has a
current fair value of 80% of its cost. Carlos is to be admitted as Sales Manager for a 10% share in the
profits.

Journal Entry

Case 2 (Contribution of Property w/Liability)

August 2 - Ambros decided to invest land costing P100,000 when she bought this in 2015 but its current
appraised value is P500,000. There is a mortgage balance of P50,000 on this property which is be
assumed by the partnership.

Journal Entry (w/Mortgage)

A liability called mortgage payable was set up decreasing the capital by P50,000.

Journal Entry (No Agreement of Mortgage)

If there was no agreement for the partnership to assume the mortgage balance
Investment of Already Existing Business
If investment is an already existing business, two accounting books will be affected:

- The sole proprietorship books

- The new books of the partnership

Accounting Procedures
1. On the Books of the Sole Proprietor, before getting admitted into the new Partnership

- Review the assets and liabilities for adjustment/ revaluation

- Update the assets and liabilities for any adjustment/revaluation agreed upon by the partners

 Adjustment will affect the capital account of sole proprietor

 No revenue or expense accounts should be used in making the adjustments

 The assets and liabilities of this business represent the partner’s capital contribution; thus, any
adjustment or revaluation passes through the capital account.

- Close the books at the adjusted amounts

2. On the Books of the newly formed Partnership

- Record each partners’ contribution, including the assets and liabilities of the former sole
proprietor, at the revalued or adjusted amounts.

Illustrative Example (Investment of Already Existing Business)

Peter has a bookstore called Peter Pan’s Bookstore which has been operating for five years. On March
1, 2019, Pilar Garces invites him to put up a partnership. Peter agrees to close his business and invests
his net assets in the partnership. Pilar agrees to put up cash equal to half of the contribution of Peter.
The following are the assets and liabilities of the bookstore on March 1, 2019:

The Articles of Co-partnership was drawn after considering the following

1. The allowance for bad debts should be adjusted to 15% of the accounts receivable

2. The furniture & fixtures should be 25% depreciated

3. Obsolete merchandise amounting to P3,000 be written off

4. Both partners will act as managing partners and share profits and losses according to their
capital contributors
Journal Entry

Note that Pan Capital was debited instead of Bad Debts, Depreciation Expense and Loss on Obsolete
Stock. Application of Accounting Rules (A2)

Closing the Adjusted Accounts

Peter Pan’s sole proprietorship business is now closed, and he would now transfer his assets and
liabilities (per partners’ agreement) into the newly formed partnership.
Bonus or Good Will Recognition
- Contributions of a partner may go beyond actual assets invested due to the following reasons: a
partner has special talents needed by the partnership or has a large base of clients/customers of
if a business is being transferred to the partnership promises exceptional by a partner.

Example:

Dr. Gil who recently passed the medical board examination wants to put up a medical clinic and invites
Dr. Casey, a known surgeon and medical practitioner, to join him. Dr. Gil agrees to contribute P 500, 000
while Dr. Casey agrees to contribute P 300, 000 only. They further agree on equal sharing ration on the
assets and profits.

Bonus Method
- Under this method, the skill and experience cannot be recognized as an asset specially since
there is no reliable measurement basis for this. Only the actual investment of P 500,000 and
P300, 000 can be recognized as assets.

Explanation in example: The partners may agree to adjust their capital amount to reflect an equal
sharing by transferring interest from Dr. Gil to Dr. Casey. Dr. Casey capital will be credited for P 400, 000
without making additional investment and Dr. Gil will also be credited for P 400, 000 although his actual
investment is P 500, 000. The transfer of capital of P 100,000 received by Dr. Casey from Dr. Gil is called
bonus capital. Total actual contributions stand at P 800,000.

Gil Casey Total

Agreed Capital P 400,000 P 400, 000 P 800, 000
Actual Contributions P 500, 000 P 300, 000 P 800, 000
Bonus (P 100, 000) P 100, 000 P0
Note: The total agreed capital is equal to total actual contributions. Using agreed capital, compute for a
50% interest for each partner

Journal Entry

Account Debit Credit

Cash 800, 000
Gil, Capital 400, 000
Casey, Capital 400, 000

Goodwill Method
- Under this method, two contributions are made by Dr. Casey: cash of P 300,000 and intangible
asset in the form of good will.

What is good will?

- Goodwill is an intangible asset representing ability to generate earning more than what is
normal or expected. Factors such as a good reputation (such as skillful surgeon) or a good
location
What are the effects on the accounting value if goodwill is recognized?

- Asset will increase (debit goodwill)

- Partner’s Equity will increase (credit partner capital)

Gil Casey Total

Agreed Capital P 500, 000 P 500, 000 P 1, 000, 000
Actual Contributions P 500, 000 P 300, 000 P 800, 000
Goodwill P0 P 200, 000 P 200, 000

Note:
- Under the bonus method, total agree capital = total actual contribution

Under the goodwill method, total agree capital > total actual contribution

Case 3 (Investment of an Already Existing Business with Recognition of Bonus and New Books are Set Up
for the Partnership) (See excel for Illustration)
Module 2 (Partnership Operation Distribution of Profit or Loss)
Factors to Consider in Dividing Profit or Loss
1. Capital contribution of each partner

2. Service to partnership

3. Expertise of partner/s

Rules for the Distribution of Profits

According to partner’s agreement

If no agreement:
Capitalist Partner
- Ratio of original capital investment or in its absence based on:

- Ratio of capital balances at the beginning of year

Industrialist Partner
- In the form of salary allowance that is just and equitable before the capitalist partner shall
divide the profits

Rules for the Distribution of Losses

According to partner’s agreement

If no agreement:
- If no agreement as to distribution of losses but there is an agreement for distribution of profits,
the losses shall be distributed based on profit sharing ratio

In the absence of agreement:

Capitalist Partner
- Ratio of original capital investment or in its absence based on

- Ratio of capital balances at the beginning of the year

Industrialist Partner
- Shall not be liable for any losses

Agreement in the Distribution of Profit

Equally agreed ratio or any agreed ratio
Based on partner’s capital
Original Capital Contribution
- May prove inequitable if there are material changes in the capital account during the year
Capital balances, beginning of the year
- When beginning capital balances are used in allocating profits, additional investments are
discouraged because additional investment will not be considered in the division of profits in the
year it was invested.

Capital balances, end of the year

- If ending capital balance are used, additional investments are encouraged only at the end of the
year

Average Capital Balances

- The use of average capital balances as a basis for distributing profits or loses is preferable
because it reflects the capital actually available for used by the partnership during the year

Providing interest on capital balances

- If the agreement provides interest on capital, it must be honored regardless the operation
yielded profit or loss

Providing Salary
- Partners devote their time and service in the partnership for profit, and not for salary. Hence,
salaries are not recorded as expenses but as Drawings

- Similarly with interest on capital, salaries to partners must be honored regardless the operation
yielded a profit or loss

Providing Bonus
- Normally given by the partnership to managing partners

Providing combination of interest, salary and bonus

- The partnership can provide distribution of profit on the combination of interest, salaries and
bonus, and the remainder based on the agreed distribution

The ratio can be expressed as

Proportion 1:1

Fraction ½ = 1/2

Percentage 50% / 50%

Illustration:

Partners, Richard, Piolo, Jericho agreed to distribute the profit 1:3:2

It can be shown as:

1:3:2/ 1/6 or 16.67%, 3/6 or 50%, 2/6 or 33.33%

Transaction on Partner Equity
Partners Drawing
Distribution of Loss is Debited on Partner Drawing

Possible choices after getting the total

Or
Partners’ Capital
Note: 100,000 is from additional investments

Illustration of Profit and Loss (see excel file for examples)

Module 3 (Partnership Dissolution)
DISSOLUTION defined as
Article 1828 of the New Civil Code defines dissolution as a change in relation of the partners ceasing to
be associated in carrying on the business. The legal provisions (Article 1830 and 1831) further give us
four causes of dissolutions:

1. By the act of the Partner, like when the partnership purpose or objective has already been
accomplished or by mutual agreement among the partners or a decision to withdraw from the
partnership

2. By operation of law, like when an event makes it illegal for the business to be carried on, or
when a partner becomes insolvent or dies, or by the civil interdiction of any one of the partners.

3. By judicial decree, like insanity of a partner, or commission of fraud by a partner, or by internal

dissension among partner

- Dissolution does not necessarily terminate the basic business operation of the partnership
except for the change in ownership

- In some instance, though it may lead to the termination or liquidation of the firm

- The accountant refers to the Articles of Co-Partnership for the agreement on how the
dissolution shall be implemented and may also advise the partners in the structuring of the
buy/sell agreement.

- The accountant records the dissolution according and revise the partner equity

Accounting Procedure Before Dissolution

With the change in ownership, it is as if a “new” partnership is created hence all adjustments and
revaluations of the existing partnership asset should be made before the new association of partners is
to take over:

1. Update the capital account of the existing partners as of dissolution date by revaluing the
partnership assets, determining the profit share of the partners from the last statement of
financial position to dissolute date, and closing their drawing accounts

2. If the dissolution contemplated upon was not provided for in the articles, the terms and
conditions for the dissolution should be ascertained from the partners

3. Record the dissolution or change in ownership and revise the partner equity

If the partner’s equity is given just before dissolution without mention of a need to revalue of assets or
record profit share, it is understood that the capital accounts have already been updated and therefore
ready for dissolution.
Articles of Co-Partnership Redrawn
It is important to redraw the Articles of Co-Partnership upon the dissolution since some provisions will
be affected such as: names of the partners and their contributions, manner of management, duties and
responsibilities of each other, their profit – sharing ratio, and manner of dissolving or liquidating the
partnership, to name a few

Updating Partner’s Equity Before Dissolution

(Illustrative Example) – see excel

Admission of New Partner

From the legal point of view, a new partner cannot be admitted without the unanimous consent of all
the partners. Admission of a new partner may take plays in one of two ways:

1. Purchasing an interest from one or more existing partners

2. Investing cash or other asset in the partnership

- A new partner may purchase a partnership interest from one or more existing partner

Asset Revaluation
- When the current values of the partnership asset are greater/lesser than the recorded value
(book values), the partners may agree to revalue the asset.

- Asset revaluation is a requirement to update capital accounts of partners before admitting a

new partner

- Upward or downward adjustment of partnership assets should affect only the existing partners

- If partnership assets are undervalued, an upward adjustment should be made to increase assets
and partner’s equity

- For asset impairment, if the current fair value (less cost to dispose) of the assets are lower than
their book values, a downward adjustment should be made to decrease the asset with a
corresponding decrease in the current partner, capital

Revaluation of assets cannot be implied in admission by purchase. This must be agreed upon by partners
and specifically mentioned in the problem

Revised Profit and Loss

- It is necessary that the articles of co-partnership be redrawn in consideration of the admission
of a new partner.

- New agreement as to managerial functions, division of profit and loss and the inclusion of new
partner are considered
 - In the event that a revised profit and loss was not considered by the partners, the current profit
and loss ratio should be revised accordingly based on the percent of interest the existing partner
is selling to the buying partner

If there is no profit or loss agreement from the start of partnership operation, distribution of
profit and loss after the dissolution shall be based on adjusted capital contributions
Interest Over Asset Against Interest Over Profit
- The equity or capital account represent interest of a partner over partnership assets

- Interest over profit may also be based on the capital account if that is the agreement, this was
provided by the law

- If there is no profit agreement, profit or loss share would be based on what partners contributed

- Interest over profit may not always be based on the capital contribution as there are other
factors which should be considered in determining fair and equitable distribution of profit

Investing in a Partnership
- A new partner may invest in existing partnership.

The following rules should be applied:

1. Since new partner is contributing to the partnership, the transaction is between the new partner
and the partnership

2. Contribution increases the partnership and partners equity

Bonus
- A bonus from the new partner may be required by the existing partners as a privilege of joining
the firm when current value of the partnership is more than the stated amounts of equity of the
existing partners

- The procedure is the same as in partnership formation where contribution of the new partner is
higher than the amount credit to his capital account

- The excess contribution called bonus capital will be credited to the existing partner capital’s
account

- A bonus from the exiting partner may be given to the new partner to entice the new partner
who has exceptional talents

- The capital credit of the new partner will be higher than the amount of contribution

- The excess capital is taken from the capital of the existing partners and given to the new partner
Asset Revaluation or Bonus may be Implied
What if problem does not specify that there should be asset revaluation or bonus ? If not given, it can
always be inferred there is none.

Bonus or asset revaluation may be implied based on the following rules:

1. There is no asset revaluation if total agreed equity is the same as total contribution capital, no
bonus if the new partner’s capital credit is the same as the actual contribution made

2. If total contributed capital is not equal to total agreed equity, there is asset revaluation

a. The asset is undervalued requiring an upward adjustment when total contributed capital is
lesser than total agreed equity

b. The assets are over valued and will require a downward adjustment when total contributed
capital is greater than total agreed equity. Remember that total contributed capital represents
asset contributions, so if it is higher than agreed equity it should be decreased

3. If total agreed equity is the same as total contributed capital but the new partner capital credit
is not the same as actual credit there is bonus

a. Bonus is for the new partner if the capital credit for the new partner is higher than the actual
contribution given

b. Bonus is for existing partner if the capital credit for the new partner is lesser than the actual
contributes given

Asset Impairment

- Is an adjustment for the existing partners only

Retirement of a Partner
From the legal point of view, a partner may leave the partnership as long as it is in accordance with the
partnership agreement with the partnership agreement and or with the consent of the other partner.
Otherwise, the retiring partner may be sued by the other partners for the damages resulting from such
action.

From the accounting point of view, the following rules must be observed:

1. Capital balance of the retiring partner must be updated as of retirement data to be used as a
basis for settlement. To take into consideration are the following: asset revaluation and profit
distribution (if retirement data is other than the end of the accounting period)

2. Revaluation will affect all the partners

3. For practicality, only capital of the retiring partners may be updated for profit or loss share
through estimation

4. The drawing account of the retiring partner must also be closed against the capital account
Death or Incapacity of a Partner
- Death or incapacity of a partner dissolves the original association but the business may still
continue operation with a substitute taking his place

- As provided with the articles of co-partnership, business may be continued by the remaining
partner with the interest of the deceased partner purchased by the remaining partners, in which
case the accounting procedures will be similar to the admission of a partner by purchase.

- The deceased partner share may be paid out of the partnership funds, in which case the
accounting procedures will be similar to retirement of a partner

If it takes time for the partnership to make cash settlement, the following procedures should be
observed:

1. Close the capital and drawing account to a liability account – Payable to Partner’s Estate

2. Compute for the partner’s share in the profit until date of death and credit to increase the
Payable to Partner’s Estate

3. From date of death to date of settlement, accrue interest on the total liability computed in
number 1 and 2

4. At the date of settlement, pay the liability which is now the sum of number 1 and 2

Incorporation of a Partnership
If a partnership needs more funds for growth and expansion of its business it may file for incorporation
by using the partnership assets as its starting capital. The books of the partnership will have to be
adjusted and closed and a statement of financial position prepared as a basis for the incorporation
Module 4 (Partnership Liquidation)
Although a partnership has an indefinite life it is not uncommon to hear that it was terminated for a
variety of reasons such as:

- retirement or death of a partner,

- disagreement among the partners,

- accomplishment of the purpose for which it was formed

- insolvency or bankruptcy

A business is insolvent when its assets are insufficient to pay existing claims of its creditors.

LIQUIDATION is defined as the process of winding up the affairs of the business towards its termination.

It will normally take three steps to accomplish this:

1. Converting or selling all remaining properties and non-cash assets into cash with gain or loss on
conversion allocated to all partners

2. Paying partnership liabilities and liquidation expenses

3. Distributing the remaining cash in payment of the partner’s interest (for loan and capital
balances including profit share)

- Care must be observed in selling the assets and disbursing the cash to partnership creditors and
to partners.

- The rights of all parties should be respected, all parties should be notified, and legal provisions
should be strictly followed.

- The services of the accountant will be needed in the preparation of the statement of financial
position which is the starting point of the liquidation process.

- The accountant also serves as counsel in the interpretation of the legal provisions and the
liquidation provisions in the Articles of Co-Partnership.

LEGAL PROVISIONS which should be considered based on the New Civil Code (ART 1839) are the
following:

1. Payment to creditors and partners should be made in the following order:

a. Those owing to outside creditor (other than partners)

b. Those owing to the partners other than their capital balance and share in the profit

c. Those owing to the partners for their capital, and

d. Those owing to partners for their share in the profits

 2. When partner becomes insolvent, the claim against his separate properties shall be ranked in
the following order:

a. Owing to personal creditors

b. Owing to partnership creditors

c. Owing to other partners for contribution made

3. Partnership creditors have priority over partnership properties; in the same manner that the
personal creditors have priority over partner’s personal properties

4. In case the partnership is insolvent, the general partner (including industrial partner) is liable to
pay the partnership creditors from his/her personal properties (Article 1797)

5. A deficient partner may apply the right offset to a loan balance owing him or her by the
partnership

6. A limited partnership is liable only to extent of his or her contribution in the partnership (Article
1856). A limited partner shall not receive any part of his contribution until all liabilities of the
firm have been paid, except to general partners and limited partners, and there remain property
of the partnership sufficient to pay them.

Type of Partnership Liquidation

1. Simple (Lump-sum) Liquidation – this is the process where all the non-cash assets are sold
before any cash is disbursed to the partnership creditors and partners

2. Installment Liquidation – this the process where the non-cash assets are sold in installments so
that the cash is disbursed to all equity interest as the cash become available

Terminologies Peculiar to Liquidation

1. Realization of Assets – process of selling or converting non-cash assets into cash

2. Gain on Realization of Assets – Cash Process from Sales of Assets > Book Value of Assets Sold

3. Loss on Realization of Assets – Cash Proceeds from Sales of Assets < Book Value of Assets Sold

4. Partnership is Solvent – Cash Balance after Realization of Assets > Liabilities payable to
Partnership Creditors

5. Partnership is Insolvent – Cash Balance after Realization of Assets < Liabilities payable to
Partnership Creditors

6. Capital Deficiency – Share of Partner in Losses (from operation & realization of assets) > Capital
Balance before Liquidation

Balance of Partner’s Capital is negative after Realization of Assets

= Debit Balance of Partner, Capital

= Negative Capital Balance

Capital Deficiency is Eliminated by:

 1. Apply the right offset

- If partnership has a lone from deficient partner

Account Debit Credit

Loan from Partner, B (Amount is Given)
Partner B, Capital (Amount is Given)

2. Deficient Partner make additional investment

- If deficient partner is solvent and general partner

Account Debit Credit

Cash (Amount is Given)
Partner B, Capital (Amount is Given)

3. Partner absorb the capital deficiency

- If deficient partner is insolvent

Account Debit Credit

Partner A, Capital (Amount is Given)
Partner B, Capital (Amount is Given)

7. Right of Offset – legal right to apply a portion or all of the amount owed to a partner against
his/her capital deficiency.

= Loan payable to a Partner Deducted from his/her Negative Capital Balance

8. Solvent Partner(s) – Partner’s Personal Asset > Partner’s Personal Liabilities, therefore the
partner is capable of making additional investment in case of Partnership Insolvency and/or
Partner Capital Deficiency

9. Insolvent Partner(s) - Partner’s Personal Asset < Partner’s Personal Liabilities, therefore the
partner is not capable of making additional investment, and his/her deficiency would be
absorbed by non-deficient or solvent partners.

10. Partner Interest – Loan Payable to Partner + his/her Capital Balance

Accounting Procedures in Lump-Sum Liquidation

1. Adjust the books and close remaining profits/losses to Capital Accounts. Statement of Financial
Position should be prepared.

2. Realization of assets, with resulting gain (loss) on realization added (deducted) to the partner's
capital accounts based on P/L ratio.

3. Payment of liabilities or claims owing to Partnership (Outside) Creditors

If Partnership is INSOLVENT: General - Solvent - with Capital Deficiency Partner(s) make additional
investment or makes full settlement to the Partnership creditors

4. Partners with Capital Deficiency - eliminate deficiency according to the following order

5. Payment of partners’ interest for:

a. Loan Balance

b. Capital Balance
Module 5 (Corporate Formation and Shareholder Equity)
Corporation
- A corporation is an artificial being created by operation of law having the right of succession and
the powers, attributes and properties expressly authorized by law or incident to its existence

Comparison of Equity Structure

Attributes of Corporation
1. Artificial Being – A corporation is a separate and distinct personality from the shareholders, and
such, it may acquire or dispose properties, incur and pay obligations, sue and be sued, in other
words, if the firm is viewed as separate and distinct personality from the people who own it.

2. Legal Personality – legally created by operation of law and as such is a juridical person with
rights, powers and duties pertaining thereto.

3. Perpetual Existence/ Right of succession – corporation used to have a mandatory 50-year life
span or “corporate term”. Now all corporation can legally live indefinite period of time

4. Corporate Ownership – the interest and right are divided into shares of stock. An investor buys
share of stocks to become a shareholder whose interest and rights in the firm is based on the
number of shares and kind of shares acquired.

5. Limited Liability – the shareholder is not liable for corporate acts nor are they liable for
corporate debts. Their personal properties cannot be confiscated and used to pay for the
corporate liabilities when corporation becomes insolvent.

6. Transfer of Interest – Shares can be transferred without the consent other shareholders.
Transfer of interest does not affect the business operations.
Advantages of Corporation
1. Capital – large amount of resources can be acquired by selling the shares through the
investment market.

2. Liability to corporate creditors – a shareholder is limited or liable only to extent of his or her
investment in the corporation. The personal assets of the shareholders are not available for the
satisfaction of the claim of the corporate creditors unlike a sole proprietor or partner.

3. Transferability of Interest – after shares are issued to a shareholder, these shares may be
transferred to others through the stock market (Philippine Stock Exchange) or through other
brokers or investment house.

4. Formation – it is easy to form a corporation especially by the small and medium enterprise with
the Revised Corporation Code enacted allowing a One Person Corporation.

5. Skilled Management – a corporation may be managed by a team of professionals hired to

oversee the daily operation of the firm. These managers are more likely to be specialized in the
area of marketing, finance, accounting and production.

Disadvantages of Corporation
1. Tax Liability – Before 2021, corporation were taxed based on 30% of net income earned. On
March 2021 the Corporate Recovery and Tax Incentives for Enterprise Act revised the rate to
20% based on the taxable net income which should not be more than P 5,000,000 and 25% for
those who are earning more.

2. Legal Requirement – Corporation are subject to government scrutiny more than the sole
proprietor and partnership because of the large numbers of investors and large amount of
capital involved. Corporation have to file for approval not only their Article of Incorporation but
also their Corporate By-Law to the Securities and Exchange Commission. They are also required
to file periodically their financial reports.

3. Control -not all of the shareholders have direct or active control over the affairs of the
corporation as they are not all directly involved in its daily operation. Only those who are
designated as board of directors or officers have direct influence over company policies or
operation.

Corporate Structures
Owners – Shareholders

Policy Makers – Board of Directors

Managers – President

- The corporators are the owners of the corporation

- They are also called shareholders in a stock corporation; they have ultimate control over the
corporation and have the right to elect the Board of Directors.

- The corporators are called members in non-stock corporation and have a right to elect the
Board of Trustees.
 - The founder of a corporation is called incorporators and these are the original shareholders
mentioned in the articles of incorporations

- The Board of Directors are responsible for the overall supervision of the firm. They have the
final authority on policy making and control of corporate activities. They evaluate management
performance and act on legal matters, as well.

- Expansion programs, dividend declaration, introduction of new products, entry in the new
market, ventures, mergers and consolidations are some of the problems tackled and decided
upon by the Board of Directors.

- The daily operation is delegated to the officers who are appointed by the Board of Directors.

- The President (Chief Executive Officer or CEO) and other officers are responsible for
implementing the policies set up and the plan drawn by the Board of Directors. Next to the
president are various officer called Vice Presidents who are given specific area of responsibility
as managers of the following departments: production, finance, marketing and human
resources.

Parties in the Formation of Corporation

1. Incorporators – originally forming and composing the corporation (shareholders or members
mentioned in the articles of incorporation)

2. Shareholders or stockholders – are corporators in a stock corporation

3. Members – are corporators in a non-stock corporation

4. Corporators – includes incorporators, shareholders or members

5. Subscriber – are person who have agreed to take and pay for the original, unissued shares of a
corporation formed or to be formed

6. Promoters – who bring about the formation of the corporation

7. Underwriters – usually investment bankers acting as middleman

Classification of Corporation
1. Private Corporation – owned or organized for a private purpose.

A. Stock Corporation

- Owned by individuals and/or by non-government units

- Ownership is sold in units called share of stocks, and owners are called shareholders or
stockholders

- It is organized for profit, and profit is to be distributed to shareholders

- Profit distributed to shareholders is called Dividends

B. Non-Stock Corporation
 - No shares of stocks = No dividends

- Non-Profit in nature (purpose is religious sect or religious schools, civic or social in nature)

- Owners are called members

2. Public Corporation – is a government corporation organized for the accomplishment of its public
function such as the national government, provincial city or municipal government

Classification of Private Corporation

According to Degree of Participation
1. Close corporation (privately – held) – limited to selected persons or family members not
exceeding 20 persons

2. Open corporation (publicly – held) – listed in the stock market for purchase by any one

According to Nationality
1. Domestic corporation – organized under Philippine laws

2. Foreign corporation – organized under foreign laws

Kinds of Stocks
As to right (basic type of share capital)
A. Common Stock/ Ordinary Share Stocks

- Represent basic ownership class

- This type of share when only one class is issued

- Owned by common shareholders of the company

- Entitled to voting rights

- Entitled to dividend and capital gains

- Incorporated with higher risk as will be settled after preference shares

B. Preferred Stock/ Preference Share (Preferred Stock)

- With preferential rights over the ordinary share. The common preferential right is over dividend
distribution and capital gain

- Usually issued at par and the dividend rate is expressed as a percentage of the par value

- Not entitled to voting rights

- Incorporated with lower risks as will be settled before the ordinary shares

Ex: 10% Preference Shares

As to value
A. Par Value Shares of Stock

- Fixed value is stated in the certificate of stock

 - The par value serves as the minimum basis for the amount of contribution

- Shares should be sold/issued at par and above par but not below par value

- Preference shares are always issued at par value

B. No Par Value of Stock

- No value is stated in the certificate of stock

- No par value but may have a stated value

- Stated value is fixed in the articles of incorporation or by the board

Legal Capital
- To protect creditors from liability, law requires a minimum permanent investment from the
shareholders.

- The minimum permanent investment called legal capital represents minimum assets of the
corporation

- Corporate creditors provide that contributed capital of a corporation constitute a “trust fund”
to which the corporate creditors have a right for satisfaction of their claims.

- This is called the Trust Fund Doctrine

Rights of Shareholders
An Investor, based on the number of shares purchased, enjoy the following rights:

1. Share in the corporate profit at the discretion of the Board of Directors. Exempted from this
right are treasury shares

2. Vote and attend annual stockholders meeting. Exempted from the right to vote are the
preferred shares, redeemable shares and treasury shares.

3. Share in the distribution of assets upon liquidation of the business

4. Sell or dispose of their share

5. Receive the same dividend given to all ordinary shareholder

6. Receive timely financial reports

7. Purchase additional shares of stock whenever there is an increase in the authorized capital stock
of corporation. This is called pre-emptive right.

Example: Santos is a shareholder with 500 shares with a par value of P100. Total share capital of the
corporation is 20,000 shares or P 2,000,000. His interest over the corporation is 2.5% =
(500/20,000).
 If corporation will increase its share capital to P 3,000,000 or 30,000 shares then Santo’s interest will
decrease to 1.67% = (500/30,000). To maintain his original interest, he must buy 250 shares more to
make it a total of 750 shares = (2.5%*30,000)

Incorporation Requirement
Forming of Private Corporation
1. Any person, partnership, association or corporation, singly or jointly with others but not more
than fifteen (15) in number, may organize a corporation for any lawful purpose or purposes.

2. Exempted from incorporating are the natural persons who are licensed to practice a profession,
and partnerships or associations organized for the purpose of practicing a profession unless
otherwise provided under special laws

Capitalization
3. Minimum Capital Stock is not required of Stock Corporation, except otherwise specifically
provided such as when capital stock is to be increased then the amount of capital stock number
or number of shares of no-par stock thereof actually subscribed should be 25% of the increase
in capital stock and 25% of the subscription has been paid in cash or property.

Corporate Records
1. Minutes of stockholder’s meeting

2. Minutes of directors meeting

3. Books of account where all business transaction are recorded

4. Stockholders’ ledger when shares issued for each stockholder are recorded

5. Subscribers’ ledger where subscription account for each subscriber is recorded

Authorized Share Capital

- This represent the maximum number of shares or amounts the corporation is allowed to issue

- A corporation therefore may not issue more than the total number of shares provided in the
articles

Stock Subscription
- Is an agreement to purchase shares of stock and states the number of shares being subscribed,
the subscription price, and terms of payments and call dates

- In the absence of fixed call dates, payment is made upon call by the Board of Directors

Share Capital
- This represent the amount paid by the shareholder whether in cash, property or service or
service and for which a certificate of stock is issued as evidence of stock ownership

Certificate of Stock
- This a written acknowledgement by the corporation of the shareholders interest in the
corporation and its net assets.
 - The practice is to issue a certificate for a block of shares subscribed and fully paid for.

- A subscriber is not entitled to a certificate unless the subscription made has been fully paid for.
However partial payments may be issued a certificate, at the option of the Board of Directors by
applying the payments based on the par value of a share of stock

To illustrate: assume that share holder A subscribed to 100 shares at the par value of P 100. Total
subscription is P 10,000. Assume he paid only P 5,000. The general rule is that since payment is not full,
no certificate may be issued to him. However, at the option of the Board, the payment may be applied
to 50 shares = (P 5,000/ divided by the par value of P 100). A certificate can then be issued for 50 shares.

Organization Expense
- In organizing a corporation, certain cost has to be incurred such as professional fees of lawyers,
accountants and promoters, licenses, printing costs, registration and the like.

- These are called organization cost or pre-incorporation costs that are to be recorded as an
organization expense

- There is stock issuance expense such as cost and printing of certificates, documentary stamps,
filing and registration fees and all other direct cost of selling stocks that may debited to the
additional paid in capital.

Selling or Issuing Share of Stocks

- Shares of stocks may be sold directly to the shareholder or indirectly through a brokerage firm
or stock broker.

- Sometimes investment house or the bank acts as underwriter and buy all the shares of stocks
offered by the corporation then offers these to the prospective investors at a higher price.

- Public offering (buying and selling of stocks) are most often done through Philippine Stock
Exchange where the brokers representatives converge daily

Shareholder Equity
- In a corporation it is called shareholders’ equity

- This represents the residual interest of the shareholders in the net assets of the corporation and
may therefore be expressed in an accounting equation as follows:

Asset = Liabilities + Shareholders Equity

The shareholder equity is divided into two parts

Contributed or Paid in Capital

- Contributed or paid in capital represent the total contribution made by the shareholder.

- Unlike sole proprietorship or partnership, the capital account titles for individual shareholders
are not maintained for two reasons – the number of shareholders involved and the constant
transfer of shares of stock form one investor to another

- The “capital” (needed investment) of corporation is divided into units called shares of stock
 - The investors buying shares of stock are called shareholders, and the equity over the
corporation is called Share Capital or Capital Stock

Retained Earnings or Accumulated Earnings

- In a partnership the drawing accounts are used to accumulate profit and against which
withdrawals are made while in corporation profits earned are accumulated in one account
called Retained Earning or Accumulated Earning against which dividends are drawn

- Distribution of profit (called dividends) to all shareholders can only be made upon declaration
by the Board of Directors

Accounting for Share of Stocks

1. Authorization – recording the maximum number of shares a corporation is authorized to issue.
This is called Authorized Share Capital or Authorized Capital Stock

2. Sale – when a shareholder buys and pay immediately in full, the shares are considered sold and
stock certificate is issued. The shares are called Share Capital

3. Subscription – a subscriber enters into a contract to buy a number of shares. A down payment is
usually required with the balance payable on fixed dates or upon call by the Board of Directors.
The shares called Subscribed Share Capital

4. Collection of Subscription – the subscription may be paid by the shareholders in cash, property,
or in form of service

5. Issuance of Certificate – once the subscription is collected in full, a certificate is issued

6. Reacquisition of Shares – the issuing corporation may reacquire (purchase or redeem) the
shares of stock which were originally issued with the intention of either reselling or retiring
these shares in the near future. These are called Treasury Shares.

Three movement of stocks transaction

Corporation Shareholders

1. Authorized Sold and Issued

2. Authorized Subscribed – Collected – Issued

3. Reacquired either to be resold or retired Issued

Terms Describe Stock regarding their movement

Authorized Shares
- maximum number allowed to be issued as authorized

- memorandum entry stating the authorized # of shares, and whether these shares are par value,
or no-par value shares
Issued Shares
- fully paid shares whether in cash wherein a stock certificate is issued to a shareholder

Subscribed Shares
- shares purchased by an investor subject to an installment payment contract. Once paid these
become issued shares also.

Treasury Shares
- from issued the shares are reacquired by the corporation, thus it is no longer outstanding.

- These are issued shares that were acquired by the corporation and awaiting to be reissued at a
later data

- Treasury Shares = Issued Shares – Outstanding Shares

Outstanding Shares
- These are stock still in the hands of shareholder therefore entitled to dividends

- Outstanding Shares = Issued Shares – Treasury Shares

Share Premium
- Excess proceeds over par value

- Share premium = (Issue Price – Par Value) * # of shares issued

Accounting Title for Stock Transaction

Share Capital
- For a par value stock, this account is credited at the par value when shares sold or subscribed
have been fully collected.

- For a nor par value stock, this account is credited for the total amount collected

Subscription Receivable
- This is an account debited at the subscription price based on the number of shares subscribed

- Credited to decrease when it is collected

- This is current asset if it is collectible within one year.

- If there is no call date, it is treated as a contra shareholder equity account and deducted from
Subscribed Share Capital to arrive at Paid in or Contributed Capital

Subscribed Share Capital

- This account is credited for the total par value of the shares subscribed

- Debited when subscription has been fully collected

- If stock is no par value, this account is credited for the total subscription price, similar to capital
share
Paid in Capital in Excess of Par
- This account is credited for contribution in excess of the par value or when shares are sold at a
premium

- Premium (substitute title is Share Premium)

Treasury Shares
- This account is debited for shares purchased by the corporation from the shares it has originally
issued out

Methods of Accounting for Stocks

1. There are two methods of accounting for stock transaction: memorandum entry method and
the journal entry method

2. Under the memorandum entry method, the authorized shares are recorded using a
memorandum entry only when shares are issued (Share Capital is increased by credit entry)

3. Under the journal entry method, the authorized capital is recorded by debiting Unissued Share
Capital. Every time shares are issued, the Unissued Share Capital is decreased by credit entry

Summary of Accounting for Stock at Par Value

1. Asset contribution may be in the form of cash, property or service

2. Following the Cost Principle, properties must be recorded at its fair market value or the fair
market value of the shares to be issued whichever is more clearly determinable

3. Services must be recorded at bill price

4. For par value stock, Share Capital and Subscribed Share Capital must be recorded at par value.
Share Capital is credited when stock certificate is issued only when the shares are fully paid

5. The Subscription Receivable is recognized at the subscription price, which may be at par or
above par

6. The excess contribution (the amount above the par value) is recorded as an Additional Paid in
Capital Account: Paid in Excess of Par or Share Premium

Statement of Financial Position

- Organization expenses being a nominal account is charged against accumulated profit or
retained earnings. IAS 8 (Financial Statement Presentation) still uses the title Retained Earnings
instead of Accumulated Profits

No Par Value Stocks Accounting

- The entries for no par value shares and for stated values are practically the same

- SFAS Bulletin No. 18 states that if the share is no par but with a stated value, the share capital
account and subscribed share capital account should be credited at whatever amount
contributed by the shareholders
 - Share capital is credited for the total consideration received, unlike in the par value shares
where the share capital is credited only at the par value with excess contribution credited to
Shae Premium

- No additional paid in account appears in a balance sheet for no value share

- An alternative method for no par with stated value is to use an additional paid in account for the
excess

Stock Transfer
- Recall that shares may be transferred (sold) by a shareholder to another person or entity
without the consent of the other shareholders.

- The seller – shareholder delivers the stock certificate to the buyer – shareholder, properly
endorsing the shares at the back of the certificate

- The stock certificate is surrendered to the corporate secretary who marks the stock certificate
“cancelled” on its face

- A new stock certificate is issued and transfer is recorded in the stock and transfer book: the
cancelled shares from the seller-shareholder and the issued shares to the new owner.

- Even if only a portion of shares held by a shareholder is sold, the stock certificate must still be
cancelled and two new certificates issued – for the portion retained by the seller-shareholder
and for the portion transferred to the buyer-shareholder.

- A stock transfer requires recording in the stock and transfer book only.

- No journal entry is made by the accountant in the accounting records since there is only a
change in the name shareholder.

Stock and Transfer Book

The corporation usually maintains special journals in recording business transactions. The stock
transaction is recorded in the following journal:

1. Authorization is recorded in the general journal

2. Stock subscription is recorded in the general journal

3. Collection of subscription is recorded in the cash receipt journal if shareholder pays in cash

- If shareholder pays in the form of non-cash such as land or merchandise or in the form of service
such as legal or consultancy service then it is recorded in the general journal

4. Issuance of shares of stock is also recorded in the general journal

Aside from the aforementioned accounting records, the stock transactions are also recorded in the stock
and transfer book. This is a book maintained by a corporation specifically to record movement of stocks
– sale, exchanges or transfer and cancellations. It consists primarily of three records: Shareholder’s
Journal, Shareholder’s Ledger and Subscription Ledger

Shareholder Journal
- Is a register where one notes down the number of shares issued and the number of shares
transferred

- No peso amount is recorded

- There are no debit and credits

- Issued shares are recorded on the right side of the register specifying to whom issued, certificate
number, number of shares issued and the signature of the shareholder

- Cancelled shared are recorded on the left side of the register specifying the name of the
shareholder who cancelled it, certificate number and number of shares cancelled

Shareholder Ledger
- Is a subsidiary ledger containing the accounts of each shareholder

- This is also kept in number of shares, not in peso amounts

- There are no debits and credits

- The posting will come from the shareholders’ journal

- It is also made up of two sections: the Certificate Cancelled section which is located on the left
side and the Certificate Issued section which is located on the right side

- The total number of shares in the shareholders’ ledger should tally with the total issued shares
found in the shareholders’ journal

Subscriber Ledger
- Is a subsidiary ledger containing the accounts of each subscriber

- The left side contains the stock subscribed or the value of subscription collectible (representing
the debit to the subscription receivable recorded by the accountant)

- The balance of each subscriber account when totaled should tally with the balance of
subscription receivable in the accountant general ledger

Updating the Stock and Transfer Book is very important as this will enable corporation to determine the
present shareholders who are entitled to vote and to receive dividends, this book is usually kept by the
corporate secretary who does the recording and updating. The responsibility of recording may also be
assigned to the accountant

Authorized Share Capital/ Amount of Authorized Capital (AC) = P 2,000,000

Number of Shares – 8,000

Par Value – 250

(Use the data to check the validity of the formula below)

Formula for Corporation Accounting
Outstanding Shares = Issued Shares – Treasury Shares

Treasury Shares = Issued Shares – Outstanding Shares

Issued Shares = Treasury Shares + Outstanding Shares

Share Premium = (Issue Price – Par Value) x # of shares issued

Par Value = Number/ Amount of Authorized Capital/ # of Shares

Authorized Amount = # Shares PV

# Shares = Amount of AC/ Par Value

Issue Price/ Share Price = Amount of Issued Shares/ # Shares Issued/Sold

Amount Issued = # Shares x Selling Price

# Shares = Amount Issued Shares/ Selling Price

Cost of Treasury Shares/Stocks = Amount of Treasury Shares/ # Shares TS

Amount of Treasury Shares = # Shares TS x Cost of Treasury Shares

# Shares of Treasury Stocks/Shares = Amount of Treasury Stocks/ Cost of Treasury Shares

Legal Capital = Share Capital (Issued & Outstanding) + Subscribed Capital + Share Premium

Unissued Shares = Authorized Shares – Issued Shares

Available for Subscription = Unissued Shares – Subscribed Shares

Module 6 (Additional Equity Transaction)

Ordinary Shares vs Preference Shares
- Investors believe that preference shares are less risky than the ordinary shares.

- Preference shares have a rate of return higher than ordinary shares.

 - Preference shares have a fixed rate of dividend amount and enjoy preferential rights over
dividend and over assets.

PREFERENTIAL RIGHTS
Preference over distribution of dividends
- Given priority claim in the distribution of dividends as against ordinary shares

- dividends carry privileges such as being cumulative or participating.

Preference over distribution of assets

- given priority claim in the distribution of corporate assets over the ordinary shares once the
corporation is liquidated.

Ordinary Shares Advantages

- Right to vote which preference shares do not usually have

- Right over residue dividends and assets after satisfying the preferential claims.

Extra Info:

Preference shares have a fixed dividend. When operation is profitable and a large dividend is
distributed, ordinary shares will likely to get a greater shar

Preference shares may be convertible to ordinary shares at the option of the shareholder or the
corporation. These shares may also be redeemable or repurchased by the corporation at a fixed
redemption price.

Legal Capital
- As discussed previously, one characteristic of a corporation which is disadvantageous from the
view of the corporate creditors, is the limited liability of the shareholder.

- What then will serve as protection for the creditor? To protect the creditors, the law prohibits
distribution of dividends or assets at an amount that will reduce the shareholder equity below
the legal capital

- What constitutes legal capital? Corporation Code states that legal capital is measured by 1) the
aggregate of the par value of all issued par values shares. 2) the cash and the value of any
contributions paid for all issued no par value shares.

- This amount represents the minimum assets which cannot be distributed to shareholders called
the Trust Fund Doctrine which serves as a cushion protection for corporate creditors

Delinquent Shares
- When stock subscription is not paid on call date or on date fixed by the board, and the stock is
said to be delinquent

- The law provided for a 30-day period from the subscription date or from call date within which
the subscriber should pay after which time the whole subscription is declared delinquent
 - The unpaid subscription may be sold in a public auction to the highest bidder

- The highest bidder is one who willing to pay for the least number of shares

- Payment includes the full amount of unpaid subscription plus accrued interest, advertising and
selling cost of the delinquent shares.

- Excess shares shall be issued to the defaulting subscriber

Treasury Share
- A company stock that it has previously issued and later reacquired, but subsequently reacquired
by the issuing corporation through purchase, redemption, donation, or some other lawful
means

- Such shares may again be disposed for a reasonable price as fixed by the Board

Features of the treasury shares

1. These are shares of stock of the corporation

2. Already been fully paid and issued to the shareholders

3. Reacquired by the corporation

Purchasing treasury shares reduces the assets and the shareholders equity of the corporation by the
same amount

How Shares are Reacquired?

- These shares may be reacquired by the corporation by right of redemption (Section 9 usually
applicable for preferred shares)

- Another method is purchasing the stock in the open (stock) market

- Lastly, through donation

As long as the shares remain in the treasury (corporation) they cease to have voting and dividend rights
like unissued shares. In fact, as property of the corporation these could be issued out as dividends

Why Corporation Reacquire Shares?

- To increase the net assets by buying low and selling high

- To improve the rate of return (dividend rate) to the shareholders since there are lesser
outstanding shares and lesser unproductive or idle assets

- To support the company stock price and avoid takeover

 - To reward valued employees with shares of stock

- When shares are retired, share capital will be permanently reduced, and in so doing, reduce
dividend distribution

- The corporation could resell this at a reasonable price as fixed by the Board of Directors. It could
be sold even at less than par, which is not a violation anymore of the par value rule, since it has
been originally issued out. Or it could be sold higher than the par value, the excess to be
recorded as additional paid in capital

- The corporation could use this as compensation to be paid to employees

- It sends a signal of the worth of the corporation stock and that the buy-back means that the
corporation has more than adequate resources to fund its own operations sans shareholders’
investment

Treasury Shares Basic

- The treasury share account has a normal debit balance. It is a contra equity account

- Treasury shares is recorded at cost, without reference to par value

- The Treasury Share account is reported beneath Retained Earning on the balance sheet as
reduction to equity

Accounting Method Treasury Shares

Cost Method
- Under the cost method, in purchasing treasury , regardless of whether the stock is a par value or
no-par shares and regardless of the original price, it should be recorded at the cost of amount
paid by the corporation

- If instead of a cash payment, the consideration is in the form of non-cash or property, the record
amount or book value of the non-cash property should be used as basis.

Par Value Method

- The par value method as the name implies recognize the treasury shares at par
 - The difference will be a debit to additional paid in capital, if there is any or if there is none debit
Accumulated or Retained Earnings

Presentation, Requirement and Restriction TS

- Presentation wise, since this is a negative account (debited), it should be deducted from total
shareholders’ equity

- This is a contra shareholders’ equity account and not an asset

- To protect corporate creditors and ensure that legal capital is not impaired, requires sufficient
unrestricted retained earnings to support the purchase of treasury shares

- For instance, if the corporation has unrestricted retain earnings amounting to P 100,000 then it
can reacquire treasury shares up to P 100,000 only

Restriction: after reacquiring the treasury shares, the corporation should see to it that an equal amount
of the accumulated earnings be restricted and not used for dividend distribution.

- This restriction or appropriation is reversed once treasury shares are sold.

- Only unappropriated or free Retained Earnings (Accumulated Earnings) is available for dividend
distribution to shareholders.