TOPIC 6 :

COMPANY RECONSTRUCTION

LEARNING OUTCOME
Student will be able to understand :
1.
2.

Internal reconstruction or capital reduction

External reconstruction

INTRODUCTION

A companys paid up has to be maintained except in circumstances

such as:
a) share buyback
b) capital reconstruction

There could be circumstances where company may reduce its capital

share:
a) Have more than its optimum level of capital.
b) Paid up capital was eroded by heavy losses.

Reconstruction takes place when a co. makes material and formal

changes on its capital structure.

2 types of reconstruction :
a) Internal
b) External

INTERNAL RECONSTRUCTION OR CAPITAL REDUCTION

Internal reconstruction may be undertaken by a

company that has surplus or whose capital was
eroded by trading losses.
Such a company may apply to the courts to reduce its
capital.
Section 64 of the CA 1965 permits a company to
reduce its capital provided the following conditions
are satisfied:
a) the scheme must be confirmed by the court.
b) the AOA of the company provides for a reduction
of capital.
c) special resolution was passed by the company.

Section 64 of the CA 1965 allows a company to reduce its

capital in any of the following 3 situations:

To reduce or
write off the
uncalled capital
on its shares.

Eg : Co. with 10 mil ordinary shares of

par value RM1 each, issued but paid to
80 sen each, decides to reduce the
ordinary shares to 80 sen each fully
paid.

To refund any
surplus capital

Eg : Co. with 10 mil issued and fully

paid ordinary share of RM1 each,
decides to reduce it shares to 70 sen
each fully paid; and to refund 30 sen
per share to the shareholders.

To cancel paidup capital not

represented by
assets

The paid up capital is reduced to reflect

the net assets of the co.

Section 64 of the CA 1965 allows a company to reduce its

capital in any of the following 3 situations:
a) To reduce or write off the uncalled capital on its
shares.
For e.g co. with 10 mil ordinary shares of par value RM1
each, issued but paid to 80 sen each, decides to reduce
the ordinary shares to 80 sen each
fully paid.
b) To refund any surplus capital (memulangkan lebihan
modal.
For e.g: a company with 10 mil issued and fully paid
ordinary share of RM1 each, decides to reduce it
shares to 70 sen each fully paid; and to refund 30 sen
per share to the shareholders.
c) To cancel paid-up capital not represented by assets.
The paid up share capital is reduced to reflect the net
assets of the co.

Reduce or Write Off the Uncalled

Capital on Its Share

A co. may have capital in excess of its need & at the

same time its shares may only be partly called up.
To reduce or write off uncalled capital, co. should has
sufficient capital and does not wish to make calls at all.
There must no accounting transactions no fund leave
or enter the company.
A memorandum entry is made to recognise the change
in the par value of the shares.
All legal and regulatory requirements have to be
complied with even though there is no change to the
present financial position of the co. by reducing or
writing off uncalled capital.

Refund Any Surplus Capital

When co. has excess financial resources and is not utilising

it.
Reasons to refund surplus capital :
a) Existence of excess of cash balances
b) Low return on capital.
c) Having excess capital may be detrimental (danger) to
the company as it may not be able to meet the shareholders
expectation of higher return, dividend or earning per
share.
One option is for the company to reduce the par value of the
shares and refund the surplus capital to the shareholders.
Accounting entries:
Dr. OSC
xx
Cr. Bank xx

Protection of Creditors

Section 64 of the CA 1965 protects the interest of

creditors where the proposed scheme of capital
reductions
(i) to reduce or write off the uncalled capital on its
shares.
(ii) to refund any surplus capital.
The creditors of the co. have the right to object to
the proposed capital reduction.
The court will confirm the capital reduction only
after the creditors claim are satisfied, settled or
secured and their consent obtained to the reduction
of capital.

Capital Reduction where Capital is Not

Represented by Available Assets
(Turnaround Situation)

One common reason why cos capital is eroded is when the

company has incurred heavy losses and unable to pay
dividends to its shareholders for a number of years.
The aim of reconstruction is to save the co. or normally
known as turn around.
Co. face heavy losses have 2 course of action.
a) wind up the company (tutup syarikat)
b) reconstruction

Liquidation of a co. involves:

a) the disposal of the assets
b) settlement of the liabilities
c) distributing the remaining assets to the
shareholders.
Reconstruction will be undertaken only when the co.
has evidence that it can make profits in the near
future and to be able to pay dividends to its
shareholders.
The accumulated trading losses will be written off
and carrying value of assets will be adjusted to
reflect the recoverable amount if the carrying
amounts are more than the recoverable amount.

ILLUSTRATION

The accumulated losses of RM 400,000 have eroded the paidup capital. The recoverable amount of the assets may be less
than carrying value.
There is also a cash flow problem as there is negative working
capital.
The net tangible asset cover per share is 30 sen. The value of
the shares has reduced (or depreciated) but in the books of
accounts no entries have been made to reflect the actual
situation.
In such a situation, the company can:
a) Continue to be in business and face further erosion of
capital;
b) Wind up its business; or
c) Reorganise

Internal reconstruction will involve taking

positive steps to earn profits with potential
dividend payments, adjusting the carrying
amounts of the assets, writing off the accumulated
losses and reducing the paid-up capital.
It may also involve the securing of additional
funds to trade and expand.
The company may issue additional shares to raise
funds.

Devising a Scheme of Capital

Reduction

The capital reduction scheme will be devised to

ensure that the capital that is lost is written-off
against claims of various parties affected by the
adverse financial situation faced by the co.
[capital against claims]
Normally ordinary shareholder will be the ones to
absorb the largest amount of losses.
Other such as preference shareholders, debenture
holder and even creditors may be willing to
absorb the losses by the co.

Factors to be Considered
The factors to be considered in determining the amount
of capital that is lost and how this loss should be
allocated:
Determine the total amount to be written-off
a) The accumulated losses have to be eliminated.
b) Assets have to be revalued and written down/up to fair
values.
The rights of the various creditors must be considered.
a) Sometimes, debenture holders and trade and other
creditors may accept a reduction on their claims or be
willing to convert their
claims into shares.
The ordinary shareholders should take the major loss as
they are the risk bearers.

Preference dividends arrears

a) Preference dividends may be arrears, and the
preference shareholders may be willing to waive
their
rights to the dividends in arrears.
Determine the amount of loss the preference share could
bear.
a) The preference shareholders may be willing to accept a
reduction in their paid-up capital especially if they do
not have any preferential rights to the prepayment of
capital over the ordinary shares.
b) The amount to be written-off the preference shares
must not be as large as for ordinary shares. By reducing
the nominal value of the preference shares, the preference
shareholders will be receiving reduced
amount of
dividends in the future.
The scheme devised should be equitable to all affected
parties.

EXAMPLE 1 (PG 263)

Below is the SOFP of Reduction Bhd as at 31 December x9

The following values are applicable to the assets of the co.

Take this value for the

computation of loss

Determine the loss.

As there is 1 class of shares, all losses may be borne

by the ordinary shareholders.
The OSC could be reduced by RM 210,000 (reduce
the OS to 30 sen each fully paid, 70 sen written-off)

ACCOUNTING ENTRIES

The accounting entries to:

a) record the assets at fair value
b) writing-off the accumulated losses
c) reduce the share capital with the lost capital
In order to record all entries, capital reduction account is
opened.
Normally, capital reduction a/c will be balance and NO carried
forward amount.
In practice, it is seldom possible to have no remaining balance
in the capital reduction a/c after implementing capital
reduction scheme.
If the balance were CREDIT, it is transferred to a CAPITAL
RESERVE ACCOUNT.
If DEBIT balance, it considered as a loss on reorganisation
which could be charge off as reorganisation expense in SOCI

Pro Forma Journal

EXAMPLE 2 (PG 266)

Facts are the same as in Example 1 above.
OS were reduced to 30 sen fully paid up and the existing
ordinary shareholders have agreed to take up 2 fully paid
OS for every 1 held.
Part of the cash raised by this issue is to be used to settle
the bank overdraft.
A special resolution was passed, and the approval of the
court was obtained for the scheme of capital reduction.
Required:
a) Journal entries
b) Capital reduction account
c) SOFP of the co. immediately after the capital reduction

Answer

EXAMPLE 3 (PG 268)

Notes:
a) Arrears on preference dividends were RM 20,000
b) There is contingent liability for damages of RM 30,000
which has not been provided.

A capital reduction scheme duly approved by the court was set

out as follows:
1. The preference shares to be reduced to 50 sen per share,
and
the ordinary shares reduced to 25 sen each.
2. The preference share holders to receive 1 ordinary share for
every RM 1 preference dividend in arrears.
3. Share premium account to be utilised for the scheme.
4. The accumulated losses and all intangible assets are to be
written off.
5. To write off RM 10,000 of inventories and RM 5,000 of
trade receivables as bad debts.
6. Assets were revalued as follows:
RM
Land and building
235,000
Fixtures and fittings
30,000
Investment
32,000

7. The directors agreed to accept ordinary shares in place of

their loans, and also agreed to subscribe for RM 40,000 in
ordinary shares of 25 sen per share.
8. Cost of reconstruction amounted to RM 2,000
9. Another special resolution was passed to restore authorised
capital.
Subsequently the following transactions took place:
i) The trade investments were sold for RM 32,000
ii) The contingent liability materialised to the amount
stated and the co. settled the full amount.
Required:
a) The journal entries
b) The necessary ledger accounts
c) The statement of financial position of co. after the capital
reduction had been completed.
Ignore taxation.

a) Journal entries

b) Ledger accounts

c) Statement of financial position

EXTERNAL RECONSTRUCTION

An alternative to internal reconstruction is to

undertake external reconstruction.
Common among smaller co (especially within
family control)
A new co. is formed by existing shareholders to
take over the assets and liabilities of the problem
co.
The consideration paid is usually in shares of new
co.

The old co. is wound up (close down).

The shareholder basically the same shareholder
from problem co.
To public, look like new establishment as name is
different, & different management.
Cost much expensive since need to form new
company.

Books of the Old Company

Closing entries in the old books same as co. being

liquidate under amalgamation & absorption
(chapter 7).
The realisation account is replaced with
realisation and reconstruction account.
The realisation and reconstruction account is
debited with all the assets disposed and
credited with the purchase consideration.

The balances in the various reverse accounts are

transferred to the realisation and reconstruction
account instead of to the sundry members
account.
This is to determine the full amount of loss
sustained by the co.
The loss determined is then borne by OS, PS and
other if any by crediting the realisation and
reconstruction account and debiting the sundry
members account.

EXAMPLE 4 (PG 273)

Given below is the statement of financial position of
Construction Bhd. As at 31 December x9.

The following scheme of reconstruction was agreed to by all

parties and the required approvals received:
A new co. named Reconstruction was to be formed with an
authorised capital of RM 700,000 made up of 200,000 8%
preference shares of RM 1 each and 500,000 ordinary
shares of RM 1 each.
Reconstruction was to acquire all the assets of Construction
for the following consideration:
1. RM 50,000 9% loan stock in Reconstruction will be
issued to satisfy the claims of the debenture holders of
Construction Bhd.
2. The trade payables will be paid RM 20,000 in cash and
the balance in 9% loan stock.

3. To issue 4 8% PS for every 5 PS in Construction.

4. The ordinary shareholders to receive 1 OS in
Reconstruction for every 3 OS in Construction.
5. The non-current assets were valued at RM 210,000 and
the current assets at RM 70,000.
Required :
Close the books of Construction Bhd.

Determine the purchase consideration.