College of Accountancy

CORPORATE LIQUIDATION
Contents:
1.1. Corporate Liquidation
1.2. Other Parties Involve in a Corporate Liquidation
1.3. Financial Reports
1.3.1. Statement of Affairs
1.3.1.1. Format of the Statement of Affairs
1.4. Accounting and Reporting for Trustee/Receiver

Lesson 1.1 Corporate Liquidation

A corporation may experience financial difficulty which leads to insolvency. A business
enterprise is insolvent when the sum of all its debts is greater than all of its assets at fair
valuation.
An insolvent corporation may opt to liquidate in order to be discharge from its
obligations. If the corporation will liquidate, it will sell its assets and the proceeds will be
distributed to the creditors.
Lesson 1.2 Other Parties Involve in a Corporate Liquidation
a. Securities and Exchange Commission (SEC)
A company may voluntarily file a petition with the Securities and Exchange Commission
(SEC) for its liquidation. The corporation is given three years from the date of approval
within which to wind up its affairs.
b. Receiver or Trustee
Appointed by the SEC following the filing of a petition for liquidation or bankruptcy. The
duties of the receiver in a liquidation focuses on the realization of assets and the payment of
liabilities rather than on the preservation and continuation of the business. In the course of
liquidation, the receiver may continue activity if that is in the interest of an orderly
liquidation.
Usually prepares a statement of cash receipt and cash disbursement, and a statement of
realization and liquidation.
Lesson 1.3 Financial Reports
Corporation in liquidation usually prepares two classes of financial reports. First, which
is the initial report shows the available assets values and debts of the debtor corporation. This
report is known as the Statement of Affairs. The second, is the periodic report of the receiver
known as the Statement of Realization and Liquidation, this shows how the receiver managed
the assets of the debtor corporation on behalf of the creditors.
Lesson 1.3.1 Statement of Affairs
Normally, the start of liquidation, a statement of affairs is prepared for the
corporation to provide information about the current financial position of the company.
The statement of affairs is not a going-concern report; it is an important report for
the anticipated liquidation of a company. Thus, historical cost figures are not relevant.
The various parties concerned desire information that reflects (1) the net realizable value
of the debtor’s assets and (2) the ultimate application of these proceeds to specific
liabilities. The assets and liabilities are reported according to the classification relevant to
liquidation.
Consequently, assets are classified into three categories as follows:
1. Assets pledged to fully secured creditors. Certain assets may be pledged as
security for a particular liability, and the estimated realizable value of the assets
equals or exceeds the amount of the liability. Such assets may also yield resources
to cover unsecured liabilities. The building with an estimated realizable of

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P3,000,000, which secures a P2,000,000 mortgage liability, is an example of an

assets pledged to a fully secured creditor. After the mortgage is paid, P1,000,000
remains for unsecured creditors.
2. Assets pledged to partially secured creditors. Other assets that are pledged as
security for a particular liability and the realizable value of the assets is less the
amount of the liability. Partial payment of the liability will utilize the entire asset
value, nothing will be left for the unsecured liabilities. The equipment with an
estimated realizable value of P30,000, which secures a P50,000 note payable, is
an example, of an asset pledged ti a partially secured creditor.
3. Free assets. Assets that is not pledged as security for any particular liability, and
thus available to meet the claims of priority liabilities and unsecured creditors.
Free assets also include the value of assets pledged to fully secured creditors in
excess of the related liabilities. In example no. 1, P1,000,000 if the value of the
building is included as free assets.
The liabilities of the company are classified into four categories and listed in parallel
fashion on the next page.
1. Unsecured liabilities with priority. When creditor has no lien on any specific
assets of the debtor corporation, but its claims rank ahead of other unsecured
liabilities in the order of payment, the claims are considered unsecured liabilities
with priority. These liabilities, in order to priority are:
a. Administrative expenses of the receiver.
b. Unpaid employee’s salaries and wages, and benefits plans.
c. Taxes
2. Fully secured creditors. For these liabilities, the creditors have lien on specific
assets, whose estimated realizable value equals or exceeds the amount of the
liability. For example, a bank holds a P2,000,000 mortgage on a building of a
debtor corporation, and the building has an estimated realizable value of
P3,000,000. The mortgages, therefore, is fully secured, and the bank is referred to
as a fully secured creditor.
3. Partially secured creditors. In some cases, the creditors have a lien on specific
assets but the estimated realizable value of those assets is less than the amount of
the liability. For example, a finance company holds a P50,000 note secured by
equipment of debtor corporation, but the equipment has an estimated realizable
value of only P30,000. This note is partially secured, and the finance company is
referred to as a partially secured creditor.
4. Unsecured creditors. All other liabilities for which the creditor has no lien on any
specific assets of the debtor corporation are unsecured. This includes the
unsecured portion of the liability to partially secured creditors. In the example
above, there is note payable to finance company for P50,000 secured by the
equipment worth P30,000; the difference of P20,000 is added to the unsecured
liabilities.

Lesson 1.3.1.1 Format of the Statement of Affairs

The format of the state of affairs centers on the important aspects of liquidation
reporting. Other formats may be used. For example, book values are generally
presented on the statement of affairs along with the estimated realizable values. As
previously discussed, estimated realizable values are important because the company
is no longer going concern and information relating to the status of the various classes
of creditors is to be presented. However, book values are also useful because when
compared to estimated realizable values, expected gains or losses upon liquidation are
determined. Thus, the statement of affairs usually appears in the format.

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ABC Corporation
State of affairs
Date
Book Assets Estimated Available for
Values Realizable Unsecured
Values Creditors
Pledged to fully secured creditors:
Pxx (list) Pxx
Less: Liabilities to fully secured creditors xx Pxx
Pledged to partially secured creditors:
xx (list) Pxx -
Free assets:
xx (list) xx xx

Total free assets xx

Less: Creditors with priority xx

Net free assets xx

Estimated deficiency (to balance) xx
Pxx Pxx

Book Liabilities and Stockholders’ Equity Secured Unsecured

Values and Nonpriority
Priority Liabilities
Claims
Liabilities with priority:
Pxx (list) Pxx -
Fully secured creditors: xx -
Partially secured creditors:
xx (list) xx
Less: Value of pledged assets xx Pxx
Unsecured creditors:
x (list) xx
xx Stockholders’ equity -
Pxx Pxx

Illustration:
To illustrate the preparation of this statement, assume that the XYZ Company has
experienced severe financial difficulties in recent times and is currently insolvent. The
company officials are trying to decide whether to see liquidation, reorganization or debt
restructuring. Consequently, they have asked their accountant to produce statement of
affairs to assist them in formulating an appropriating strategy. Statement of financial
position for XYZ, prepared as if the company were going concern, is presented below.

XYZ Company
Statement of Financial Position
June 30, 20x1

ASSETS
Current assets
Cash P 2,000
Marketable securities 15,000
Accounts receivable 23,000
Inventory 41,000
Prepaid expenses 3,000 P 84,000

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Property and equipment (net):

Land 100,000
Building 110,000
Equipment 80,000 290,000
Intangible assets 15,000
Total assets P 389,000

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Notes payable (secured by inventory) P 75,000
Accounts payable 60,000
Accrued expenses 18,000 P 153,000

Long-term liabilities:
Notes payable (secured by lien on land and building) 200,000

Stockholder’ equity
Capital stock 100,000
Retained earnings (deficit) (64,000) 36,000

Total liabilities and stockholders’ equity P 389,000

Before the preparation of a statement of affairs, additional data must be

ascertained concerning the insolvent company and its assets and liabilities. Hence, the
following information has been accumulated about the XYZ Company:
1. The marketable securities reported on the balance sheet has appreciated in value
since being acquired and is now worth P20,000. Dividends of P500 are currently
due from this investment.
2. P12,000 of the company’s accounts receivable can still be collected.
3. The inventory held by the company can be sold for P43,000.
4. A refund of P1,000 will be received from the various prepaid expenses but the
company’s intangible assets have no resale value.
5. The land and building can still be sold for P231,000. While the equipment can
only be sold for P32,000.
6. Administrative expenses of P21,500 are estimated if liquidation of the company
does occur.
7. Accrued expenses include salaries of P12,000 and payroll taxes from wages but
not yet paid to the government total P3,000.
8. Interest of P5,000 on the company’s long-term liabilities has not been accrued for
first six month of 20x1.

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From the above data, the statement of affairs for XYZ Company would be:
XYZ Company
State of Affairs
June 30, 20x1

Book Assets Estimated Available for

Values Realizable Unsecured
Values Creditors
Pledged with fully secured creditors:
P210,000 Land and building P231,000
Less: Notes payable (long term) (200,000)
Interest payable (5,000) P26,000

Pledged with partially secured creditors:

41,000 Inventory P43,000 -0-

Free assets:
2,000 Cash P 2,000
15,000 Marketable securities 20,000
-0- Dividend receivable 500
23,000 Accounts receivable 12,000
3,000 Prepaid expenses 1,000
80,000 Equipment 32,000
15,000 Intangible assets -0- 67,500

Total free assets 93,500

Less: Liabilities with priority (sec a) (36,500)b

Net free assets 57,000c

Estimated deficiency (squeeze Figure) 38,000d
P389,000 P95,000

Book Liabilities and Stockholders’ Equity Secured and Unsecured

values Priority claims Nonpriority
Liabilities
Liabilities with priority:
P-0- Administrative expenses P 21,500
12,000 Salaries payable 12,000
3,000 Payroll taxes payable 3,000
Total 36,500a

Fully secured creditors:

200,000 Notes payable (Long Term) 200,000
-0- Interest payable 5,000
Total 205,000

Partially secured creditors:

75,000 Notes payable 75,000
Less: Inventory (43,000) P32,000

Unsecured creditors:
60,000 Accounts payable 60,000
3,000 Accrued expenses 3,000 63,000
36,000 Stockholders’ equity -
P389,000 P95,000

The following should be specifically noted in the statement of affairs:

a. The current and non-current classification usually applied to assets and liabilities
are omitted. Since the company is on the verge of going out of business. Such

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classification is meaningless. Instead, the statement is designed to separate the

secured and unsecured balances.
b. Book values are presented on the left side of the schedule but only for
informational purposes. These figures are not relevant. All assets are reported at
net realizable value, whereas liabilities are shown at the amount required for
statement.
c. The dividends receivable and the interest payable are both included in the
statement, although neither has been recorded on the balance sheet. Currently
updated figures must be disclosed within the statement of affairs.
d. Liabilities having priority are individually identified with the liabilities section
(a). Because these claims will be paid before other unsecured creditors, the
P35,500 total also is deducted directly from the free assets (b). Although not yet
incurred, estimated administrative expenses are included in this category since
such expenses will be necessary for liquidation.
e. According to this statement, if liquidation occurs, XYZ Company expects to have
only P57,000 in free assets remaining after settling all liabilities with priority (c).
Unfortunately, the liabilities section shows unsecured claims with a total of
P95,000. These creditors, therefore, face a P38,000 loss (P95,000 – P57,000) if
the company is liquidated (d). This final distribution is often converted in an
expected recovery percentage computed as follows.
𝑁𝑒𝑡 𝐹𝑟𝑒𝑒 𝐴𝑠𝑠𝑒𝑡𝑠
𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑅𝑒𝑐𝑜𝑣𝑒𝑟𝑦 𝑅𝑎𝑡𝑒 = = 60%
𝑈𝑛𝑠𝑒𝑐𝑢𝑟𝑒𝑑 𝐶𝑙𝑎𝑖𝑚𝑠
Thus, unsecured creditors can anticipate receiving only 60 percent of their
claims. Unsecured creditor, for example, who is owed P1,000 by this company
should anticipate collecting only P600 (P1,000 x 60%) following liquidation.
Fully secured creditors, of course, receive the full amount owed them, as well as
those creditors with priority claims.
Estimated Amount to Be Recovered by Each Class of Creditors
The accountant for the XYZ Company may prepare the summary of estimate amounts to
be recovered by each class of their creditors as shown below:
XYZ Company
Estimated amounts to Be Recovered by Creditors
June 30, 20x1

Class of creditors Total Claims Computation Estimated

Recovery
Unsecured with priority P 36,500 100% P 36,500
Fully secured 205,000 100% 205,000
Partially secured 75,000 P43,000 + (32,000 x 60%) 62,200
Unsecured without priority 63,000 60% 37,800
Total P379,500 P 341,500

Lesson 1.4 Accounting and Reporting for Trustee/Receiver

Normally, the trustee opens a new set of accounting records. The assets and liabilities of
the debtor corporation are recorded in the trustee’s book at book values, rather than at their net
realizable values. Contra assets accounts are omitted because they are not necessary in
liquidation. These accounting procedures are used to keep the trustee’s accounting records as
simple as possible.

The reports usually prepared by the trustee are a statement of cash receipt and cash
disbursement, and a statement of realization and liquidation.

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Illustration of the Accountability Technique

In the liquidation of XYZ Company on June 30, 20x1. The following entry should be prepared to
open the trustee’s books”

Cash 2,000
Marketable 15,000
Accounts receivable 23,000
Inventory 41,000
Prepaid expenses 3,000
Land 100,000
Building 110,000
Equipment 80,000
Intangible assets 15,000
Notes payable 75,000
Accounts payable 60,000
Accrued expenses 18,000
Long term notes payable 200,000
Estate equity 36,000
The record of assets and liabilities of XYZ Company at book values.

After the assumption of the estate, the trustee records gains, losses, and liquidation
expenses directly to the estate equity account. Any unrecorded assets or liabilities the trustee
discovers are likewise recorded in the estate equity account. All assets acquired and liabilities
incurred after the trustee takes charge of the estate are identified as “new”.

The transactions and events during the first month of XYZ Company’s trusteeship and the
related journal entries to record them in the trustee’s books are illustrated on the next page.

1. The accounting shown in illustration above are adjusted to correct balances as June 30.
Hence, the dividends receivable and interest payable are recognized.

Estate equity 4,500

Dividends receivable – new 500
Interest payable – new 5,000

2. The trustee expends P7,000 to sell the inventory at a price of P51,000. The net cash is
applied to the notes payable for which the inventory had served as partial security.

Cash 44,000
Inventory 41,000
Estate equity 3,000

Note payable 44,000

Cash 44,000

3. Collection is made of the P500 cash dividend accrued as of June 30. The related
investments reported at P15,000 are then sold for P19,600.

Cash 20,100
Marketable securities 15,000
Dividend receivable 500
Estate equity 4,600

4. Accounts receivable of P16,000 are collected. The remaining balance is written off as bad
debts.
Cash 16,000
Estate equity 7,000
Accounts receivable 23,000

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5. The trustee determines that no refund is available from any of the company’s prepaid
expenses. The intangible assets also are removed from the accounting records because
they have no cash value.

Estate equity 18,000

Prepaid expenses 3,000
Intangible assets 15,000

6. The land and building are sold for P208,000 with P205,000 of this money was used to
pay off the secured creditors.

Cash 208,000
Estate equity 2,000
Land 100,000
Building 110,000

Notes payable (L/T) 200,000

Interest payable 5,000
Cash 205,000

7. The equipment is sold for P42,000 cash.

Cash 42,000
Estate equity 38,000
Equipment 80,000

8. Various administrative expenses of P24,900 are paid.

Estate equity 24,900

Cash 24,900

After the above entries are entered on the trustee’s books, financial statements are prepared to
show the progress of liquidation and company’s financial position.

Statement of Cash Receipts and Disbursements. The statement of cash receipts and
disbursements is prepared from the entries in the cash account as summarized below:

Cash
Balance, July 1, 20x1 P 2,000 Notes payable P 44,000
Inventory sold 44,000 Notes payable and interest 205,000
Dividends receivable 500 Administrative expenses 24,900
Marketable securities sold 19,600
Accounts receivable 16,000
Land and building sold 208,000
Equipment sold 42,000
P 332,100 P 273,900
Balance, July 31, 20x1 P 58,200

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The trustee’s statement of cash receipts and disbursement for the period July 1, to July 31, 20x1.

Illustration 4

XYZ Company
Statement of Cash Receipts and Disbursements in Trusteeship
From July 1 to July 31, 20x1

Cash balance, July 1, 20x1 P 2,000

Add: Cash receipts
Sale of inventory P 44,000
Collection of dividend receivable 500
Sale of marketable securities 19,000
Collection of accounts receivable 16,000
Sale land and building 208,000
Sale equipment 42,000 330,100
Total 332,100
Less: Cash disbursements
Notes payable (partially secured) P 44,000
L/T notes payable and interest (fully secured) 205,000
Administrative expenses (priority claim) 24,900 273,900

Cash balance, July 31, 20x1 P 58,200

Statement of Estate Deficit. The data presented in this statement were taken from the entries
made to the estate equity accounts as shown below:

Estate equity (deficit)

Adjustments for dividends and interest P 4,500 July 1, 20x1, balance P36,000
Accounts receivable written off 7,000 Inventory gain 3,000
Prepaid expenses and intangible assets 18,000 Marketable securities gain 4,600
Land and building loss 2,000
Equipment loss 38,000
Administrative expenses 24,900
P 94,400 P43,600
July 31, 20x1, balance P 50,800

The statement of estate deficit for XYZ Company is presented below:

XYZ Company in Trusteeship

Statement of Estate Deficit
From July 1 to July 31, 20x1

Estate equity, July 1, 20x1 P 36,000

Adjusted for dividends and interest (4,500)
Adjusted balance 31,500
Net gain (loss) on realization:
Accounts receivable written off P( 7,000)
Prepaid expenses and intangible assets written off (18,000)
Land and building ( 2,000)
Equipment (38,000)
Inventory 3,000
Marketable securities 4,600
Total (57, 400)
Administrative expenses paid (24,900) (82, 300)
Estate deficit, July 31, 20x1 P(50,800)

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Statement of Financial Position. A statement of financial position is prepared from the account
balances taken from the general ledger of the company and is presented below:

XYZ Company in Trusteeship

Statement of financial Position
July 31, 20x1

Assets
Cash P 58,200
Total P 58,200

Liabilities and estate deficit

Notes payable P 31,000
Accounts payable 60,000
Accrued expenses 18,000

Total liabilities 109,000

Less: Estate deficit 50,800

Total P 58,200

Statement of realization and liquidation. This statement shows a complete record of the
transactions of the receiver for a period of time. Its structure is similar to a T account, and it is
composed of three elements: asset transaction, and income/loss transactions. The structure of T
accounts for assets and liabilities with hypothetical figures appear as follows:

Assets Account
Ending balance 100 70 Decrease
Increase 50 80 Ending balance
150 150

Liability Account
Decrease 60 40 Beginning balance
Ending balance 30 50 Increase
90 90

The above structure is to be applied to the activities of the trustee or the receiver. The
first duty of the receiver is to realize the assets, that is, to convert the non-cash assets into cash so
that creditors may be paid. The process of realization may be done in several ways. Some assets
may be realized by normal operation, such as the continuing collection of receivables from
customers. Other assets may be realized by sale. During realization, gains and losses on asset
sales may occur, expenses may be incurred, and revenues may be earned. The realization
activities may be presented in T account format as follows:

Assets (Except Cash)

Assets to be realized Assets realized-Decreases
Assets acquired-Increases Assets not realized

Income effect of Realization

Expenses and losses Revenues and gains

The second task of the receiver is to liquidate the liabilities, that is, to make full or partial
settlement with the creditors. Again, gains or losses may occur in the process if liquidation, as
may expenses or revenues. The liquidation activities may also be presented in T account form as
follows:

Liabilities
Liabilities Liquidated Liabilities to be liquidated
Liabilities not liquidated Liabilities incurred

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Income of Liquidation
Expenses and loses Revenues and gains

Illustration

XYZ Company in Trusteeship

Statement of Realization and Liquidation
July 1, 20x1 to July 31, 20x1

ASSETS
Assets to Be Realized Assets Realization
Marketable securities P 15,000 Marketable securities P 19,600
Account receivable 23,000 Account receivable 16,000
Inventory 41,000 Inventory 44,000
Prepaid expenses 3,000 Prepaid expenses -0-
Land 100,000 Land and Building 208,000
Building 110,000 Equipment 42,000
Equipment 80,000 Intangible assets -0-
Intangible assets 15,000 Dividends receivable 500
Total P 387,000 Total P 330,100

Assets Acquired (new) Assets Not Realized:

Dividends receivable P 500 None

LIABILITIES
Liabilities liquidated: Liabilities to Be Liquidated:
Notes payable P 44,000 Notes payable P 75,000
Long term notes payable 200,000 Accounts payable 60,000
Interest payable 5,000 Accrued expenses 18,000
Long term notes payable 200,000
Total P 249,000 Total P 353,000

Liabilities Not Liquidated: Liabilities Incurred (new)

Notes payable P 31,000 Interest payable P 5,000
Accounts payable 60,000
Accrued expenses 18,000
Total P 109,000

INCOME OR LOSS AND SUPPLEMENTARY ITEMS

Supplementary Expenses Supplementary revenues
Administrative expenses 24,900 Net Loss 82,300
P 770,400 P 770,400

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Alternative Formation of Statement of Realization and Liquidation

The traditional statement of realization and liquidation presented in above was a complex and not
too understandable accounting presentation. A form that should be more useful to the parties
concerned than the traditional statement is presented below:

XYZ Company in Trusteeship

Statement or Realization and Liquidation
For the Month Ended July 31, 20x1

Estate Equity, June 30, 20x1 P 36,000

Adjustment:
Dividend receivable P 500
Interest payable ( 5,000) ( 4,500)
Adjusted balance: 31,500

Assets Realized:
Book values Realization Gain
June 30 Proceeds (loss)
Accounts receivable P 23,000 P 16,000 P (7,000)
Inventory 41,000 44,000 3,000
Marketable securities 15,000 19,600 4,600
Land and building 210,000 208,000 (2,000)
Equipment 80,000 42,000 (38,000)
Prepaid expenses 3,000 -0- (3,000)
Intangible assets 15,000 -0- (15,000) (57,400)

Liabilities Liquidated:
Notes payable P 44,000
Long term notes payable 200,000
Interest payable 5,000
Total P249,000

Administrative expenses paid (24,900)

Estate deficit, July 31, 20x1 P(50,800)

Closing the Books of the Trustee.

The total remaining liabilities of P109,000 (all unsecured creditors) receive P.5340 on the peso
(P58,200 / P109,000) in final settlement of their claims. Entries to record the cash distribution
are as follows:

Notes payable (P31,000 x .5340) 16,550

Accounts payable (P60,000 x .5340) 32,040
Accrued expenses (P18,000 x .5340) 9,610
Cash 58,200
To record of the unsecured creditors.

The estimate is now fully administered by the trustee. The trustee makes the following entry to
close the books of the XYZ Company.

Notes payable 14,450

Accounts payable 27,960
Accrued expenses 8,390
Estate deficit 50,800
To close the trustee’s books

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