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Assignment No.

1
Topic

Reconstruction

Submitted By

Abdur Rub
SP07-BB-0005

Advance Accounting
Sir Manzoor Talat

Muhammad Ali Jinnah University


Basic Company Reconstruction
Thursday, October 11th, 2007

This article summarizes what is company reconstruction, its objectives and the different type of
company reconstruction.

Company Reconstruction is:

• A term used to describe the drastic formal changes in a company’s capital structure as a result of
certain circumstances.

Type of Reconstruction:-

• Divided into two(2) types namely


• Internal reconstruction
• External reconstruction

Internal Reconstruction:-

• Undertaken by companies that have surplus capital or companies whose capital has been eroded
by trading losses

• In this type of internal reconstruction, companies who wish to reduce their capital need to comply
with certain requirements of their local Companies Act. This normally involves the following:
• The capital reduction scheme must be confirmed by the court
• The articles of association of the company must provide for such reduction of capital and
• A special resolution must be passed by the company

Three(3) situations where the Companies Act ( in this case Malaysia) permits such capital reduction:-
1. To reduce or write off uncalled capital on any of its shares;
2. To cancel paid up capital not represented by assets; or
3. To refund any surplus capital i.e. Capital in excess of the needs of the company ( a company
which has par value of $1 applies to reduce to 50 cent per share so as to refund 50 cent per
share to the shareholders.

External Reconstruction:-

It is the process in which one existing company reconstructs itself with new name and identity.

Internal Company Reconstruction-Capital Reduction Where Capital Is Not Represented


By Available Assets
Monday, October 22nd, 2007
This article give readers the different situations where internal company reconstruction in term of
capital reduction where capital is not represented by available assets. A simple illustration is appended
below.

Besides, the factors to be considered in devising the capital reduction scheme are also narrated.

Situations In Capital Reduction Where Capital Is Not Represented by Available Assets:-

1. large amount of accumulated losses and or

1. some of the assets are overvalued/overstated

1. some of the assets are fictitious

Illustration:

Balance Sheet Of XYZ Ltd

Total Assets 500,000

Less: Current liabilities (450,000)


Net Assets 50,000

Ordinary Share of $1 each 600,000

Accumulated Losses (550,000)

Equity/Shareholder Funds 50,000

The above illustrates that XYZ Ltd has unwisely eroded its paid up share capital from $600,000 to $50,000.

So what next should XYZ Ltd do? XYZ Ltd can either:

• continue to be in business and face further erosion of capital vide it continuing trading losses
• wind up its business
• re-organize
By embarking on an internal reconstruction, XYZ Ltd should have the following intention:
• ability to start afresh to regain profitability
• adjust any unrepresented assets
• writing off the accumulated losses by reducing its paid up capital
• subsequently to issue additional shares to raise funds for its new plans.

The Need To Have A Properly Design Capital Reduction Scheme

In any Capital Reduction Scheme, it is imperative that the capital “lost” should be absorbed equitably by
the various parties hence the careful need to design the proper scheme. Needless to say, the ordinary
shareholders who are the risk taker need to bear the largest amount of reduction of capital. Next, it can be
the preference shareholder, debenture-holders and creditors to share in the absorption of the losses.

The following are some of the factors to consider when determining the amount of capital that is lost and
how this loss should be allocated:

1. Determine the total amount to be written off


1. the debit balance of the accumulated profit & loss needs to be eliminated
2. overvalued assets need to be written down
3. fictitious assets like preliminary expenses, recorded goodwill, patent, trademarks and other intangible
assets need to be written off
1. The rights of the various stakeholders need to be considered
• debenture holders, trade and other creditors-all the liabilities should be settled. The debenture
holders and creditors at times are willing to convert their claims into shares.
• preference shareholders -ensre that the reduction or written off vaue in preference shares must not
be higher than ordinary shares. Preference shareholders may be willing to convert their claims
( preference dividends in arreas) into shares or waive the rights to the arrears.
3. Ensure that the ordinary shareholder should bear the major brunt of the losses as they are risk takers in
the business
4. At the end, ensure that the scheme is equitable to all affected parties.

Understand the Difference between Internal Reconstruction And External


Reconstruction
Monday, October 22nd, 2007.

Internal Reconstruction:

1. No new company is formed. The existing company continues as a going


concern;
2. The ailing company will not gave into liquidation under the capital reduction
scheme and
3. Involves complying the requirements under the Companies Act.
External Reconstruction:-

1. A new company is formed by the existing shareholder of the old company to


take over the assets and liabilities;
2. The ailing company goes into liquidation and
3. There is no need to comply with particular clause in the Companies Act.