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CAPITAL RECONSTRUCTION
Chapter Outline
Compromises and arrangement, S176 Company Act 1965. Debt restructuring Internal reorganization (S61,62,64 CA) 1. alteration of authorized capital. 2. reduction of paid up capital. 3. issue of bonus shares. 4. redemption of preference shares. External reorganization (S176 178 CA) 1. sales of assets & liabilities to another company. 2. a scheme of arrangement with creditors. 3. business combination.
4. The devising of a scheme to avoid liquidation
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RECONSTRUCTION
Either way:
LIQUIDATION
TAKEOVERS
Debt Restructuring
A debt restructuring scheme ensures that a business survives if there is a reasonable prospect that it is viable. There are various benefits associated with the retention of viable businesses, as opposed to closure & liquidation
(quoted from Flynn, K. in Institute News, Akauntan Nasional, April 1999, p. 27).
Debt Restructuring
Among the advantages:
a) stakeholders like lenders, creditors & shareholders of companies in financial distress can benefit mutually from the programme. b) help save jobs. c) avert any possible contagion effects in the corporate
sector (i.e. co. A fails & cant pay co. B, B then cant pay C & so on).
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Debt Restructuring
Basic steps in debt restructuring :
a) b) c) d) assess process management. financial stock take. assess future cash flows. identify various alternatives available to increase its financial situation. e) negotiate with shareholders, creditors, employees, customers & suppliers. f) implement the plan which should lead to a win-win outcome for both creditors & debtors.
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Debt Restructuring
Most common form of debt restructuring:
1. Modification of the debt term to alleviate the short-term cash needs of the debtor. Example, creditors may: a) b) c) d) reduce the current interest rate . forgive some of the accrued interest or principal. modify some other term of the debt agreement . extend the maturity date of the original debt at a lower rate of interest.
2. Creditors acceptance of assets or equity with a FV less than the amount of the debt.
External Reorganization
Involves with outsiders in few ways: 1. Disposal of all part of undertakings.
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External Reorganization
1. Disposal of all part of undertakings :
. The sales of non current assets Need approval from the shareholders in the general meeting Includes the discontinuing operations (FRS 5) After the disposal, the remaining balance of the sales proceeds might be distributed to shareholders.
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External Reorganization
2. The rearrangement of the capital structure :
May involve changes in debt capital Power to rearrange companys debt capital by redeeming debentures & unsecured notes will depend on its articles & on the terms of the contracts.
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External Reorganization
Example: On 1 April 2000, PQR Berhad issued 7% unsecured notes worth RM1 million convertible into RM0.50 ordinary share at par on 1 May 2005. On the maturity date, 80% by value of the note holders opted to convert. Entries on 1 May 2005: Dr. Unsecured notes Cr. Sundry noteholders Dr. Sundry noteholders Cr. Ordinary share capital Bank
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External Reorganization
3. Expansion through business combination :
This type of reorganisation is motivated by a desire to expand within the industry or to diversify by acquiring businesses in other industries. The possibilities of the combination are limitless (the terms reorganisation, absorption,amalgamation, consolidation, acquisition, merger & takeover are used interchangeably or sometimes used in a very specific situation in the business world). FRS 3 Business Combinations.
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External Reorganization
4. The devising of a scheme to avoid liquidation :
The scheme is devised in conjunction with creditors & shareholders to avoid the last resort in financial difficulties i.e. liquidation.
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Internal Reorganization
1. Alteration of authorized capital
1. increase or reduce authorized capital. 2. change in the par value of shares. 3. conversion of shares into unit of stock or vice versa.
No entry in the ledger or journal would be required as there has been no change in paid up capital. KAF3063 FAR III A082 18
10,000,000
RM Authorized 10m Issued 1m Unissued 9m Less 3m Bal unissued 6m
1,000,000
1,000,000 6,000,000
RM6,000,000/0.50 20
1,000,000
5,000,000
2,700,000
As the company has more assets than can be used profitable at present, the directors proposed to reduce paid up capital and return the RM0.40 per share in cash to shareholders. Because they do not anticipate any growth in the companys activities, the directors also proposed to cancel the RM0.10 per share uncalled capital. In addition, they proposed that both of these changes ought to affect authorized capital. KAF3063 FAR III A082 23
1,200,000 1,200,000
Shareholders Distribution 1.200,000 OSC ======== 1,200,000 =======
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1,500,000
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The purpose of reduction for this type of loss is to generate a credit balance against which the debit balances representing the loss of capital can be written off.
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The directors of Salam Akhir Berhad presented the following information to a meeting of shareholders:
(a) Balance Sheet 30 June 2005 Property Plant & Equipment Other Assets Financed by: 5,000,000 4,000,000 9,000,000
Authorised, Issued & Paid up Capital: 10,000,000 ord. shares of RM1.00 each Less: Retained Earnings (loss) Shareholders fund
Long Term Liabilities
KAF3063 FAR III A082
(c)
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Ordinary Share Capital 000 000 Cap. reduction 5,500 Bal b/f 10,000 Bal c/f 4,500 ====== ======
Bal b/f
Retained Earnings 000 000 3,000 Cap. Reduction 3,000 ====== =====
PPE Bal b/f 000 000 5,000 Cap. Reduction 2,500 Bal c/f 2,500 ===== =====
Capital Reduction 000 Ret. earnings 3,000 OSC PPE 2,500 =====
000 5,500
=====
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Financed by: Authorised, Issued & Paid up Capital: 10,000,000 ord. shares of RM0.45 each Long Term Liabilities
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3. 4.
5.
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Dr. Retained Earnings 100,000 Cr. Dividend payable 100,000 (payment of dividend 5,000,000 x RM0.02) Dr. Ord. Sh. Capital 2,750,000 Cr. Capital reduction 2,750,000 (reduction in paid up capital by RM0.55 per share on the 5,000,000 issued shares as per court order)
Extract of balance sheet after the reduction of capital: Harapan Berhad Balance Sheet 30 March 2005 Authorised, Issued & Paid up Capital: 5,000,000 ord. shares of RM0.45 each Long Term Liabilities
In certain cases, reduction of capital may involve more than one class of shareholders.
As each class of capital issued by a company must be recorded in separate, appropriately described, accounts, a return of capital which affects more than one class of shares involves more accounting entries.
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Issued & Paid up Capital: 2,000,000 8% preference shares of RM1.00 each 5,000,000 ord. shares of RM1.00 each
2,000,000 5,000,000 7,000,000 The directors, having obtained all the approvals necessary, proceed to the following capital reduction: 1. reduce all preference shares to a par value of RM0.80 and return RM0.20 per share. 2. reduce all ordinary shares to a par value of RM0.60 and return KAF3063 FAR III A082 RM0.40 per share.
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Ordinary Share Capital 000 000 Cap. reduction 2,000 Bal b/f 5,000 Bal c/f 3,000 ====== ======
Bank
Preference Share Capital 000 000 Cap. reduction 400 Bal b/f 2,000 Bal c/f 1,600 ===== =====
Bank
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Issued & Paid up Capital: 2,000,000 8% preference shares of RM0.80 each fully paid 5,000,000 ord. shares of RM0.60 each fully paid
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Some internal reasons for the issue of bonus shares: 1. 2. 3. 4. Recognition of the amount of capital required for operations. Relieving shareholders of liability. tidying up the balance sheet. Recognition of increases in the value of assets.
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The directors estimated that to maintain its present level of operations, the company requires share capital and reserves of RM7 million. The directors recommend a bonus issue of five shares for every two held.
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Dr. Dividend Payable 5,000,000 Cr. Ordinary Share Capital KAF3063 FAR III A082
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Issued & Paid up Capital: 10,000 ordinary shares of RM1.00 each paid to RM0.50
Retained earnings Shareholders fund
The directors resolve to pay up the uncalled capital out of retained earnings.
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The statement of capital after the bonus issue: Authorised Capital Issued & Paid up Capital: 10,000 ordinary shares of RM1.00 each fully paid Retained earnings Shareholders fund
KAF3063 FAR III A082
20,000
10,000
7,000 17,000
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Bonus issue could tidy up a Balance Sheet by reducing the no. of accounts appear under the category of share capital & reserves.
4 types of the list of accounts:
1. Ac which relate to authorised, issued & paid-up cap 2. Ac which relate to undistributed profits 3. Ac which have been established under specific statutory provisions (Share Premium Ac - S. 60(2) (3); Cap Redemption Reserve - S. 61(5); Investment Fluctuation Reserve - S. 327). 4. Ac which have been established under specific provisions in the companys Articles.
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Hence the issuance of bonus shares will reduce those many accounts into less number of accounts. The presented statements will be easier to digest & will look simpler.
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S. 61 - if authorised by its articles, company can issue redeemable preference shares & the redemption shall be effected only by the manner provided by the articles.
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* These shares are redeemable at the option of the company, but a premium equal to 5% of the nominal value is payable if the shares are redeemed before 30 June 2007.
On 1 August 2005, the directors resolve to exercise the companys option to redeem all the preference shares. KAF3063 FAR III A082
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Journal entries: Dr. Share premium Cr. Red. pref shareholders distribution Dr. Retained earnings Cr. Capital redemption reserve Dr. Redeemable preference share capital Cr. Red. pref shareholders distribution Dr. Red. pref shareholders distribution Cr. Bank
KAF3063 FAR III A082
Redeemable Preference Share Capital 000 000 R.P.S.Distr. 2,000 Bal b/f 2,000 ====== ======
Share Premium 000 R.P.S.Distr. 100 Bal b/f Bal c/f 400 ======
Red. Pref. Shareholders Distribution 000 000 Bank 2,100 Share prem. 100 Red. PSC 2,000 ===== =====
Capital Redemption Reserve 000 000 Bal. c/f 2,000 R. Earnings 2,000 ==== ====
KAF3063 FAR III A082 60
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100,000 2,000,000
Redeemable Preference Share Capital 000 000 R.P.S.Distr. 2,000 Bal b/f 2,000 ====== ======
Share Premium 000 R.P.S.Distr. 100 Bal b/f Bal c/f 400 ======
Bal c/f
Ordinary Share Capital 000 000 Bal b/f 6,000 8,000 Bank 2,000 ===== =====
Red. Pref. Shareholders Distribution 000 000 Bank 2,100 Share prem. 100 Red. PSC 2,000 ===== =====
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Referrence
Jane Lazar & Tan Lay Leng (2003), Company Account & Reporting, 5 th Edition.
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