7 CAPITAL REDUCTION AND RECONSTRUCTION interests of the creditors are preserved. A Capital reduction scheme is adopted by companies having a high debit balance in the Profit and Loss Account and the losses appear to be permanent. Capital reduction means reducing the nominal value of share capital, for example a $1 share may be made into a $0.75 share, The capital reduction scheme must be accepted by all parties (shareholders, debenture holders and creditors) and should also be approved by the Court. tis important to open a Capital Reduction account Example 1 The summarised Statement of Financial Position of Levis Ltd at 31 December 2002 was as follows: $ Land and Buildings 15.000 Plant and Machinery 39.000 Inventory 12.800 Trade Receivables 14.000 Development Expenditure ~ 15.000 Cash at bank 1 200 Profit and Loss Account 17.000 114 000 Issued Capital 30 000 8% Preference shares of $1 30 000 60.000 ordinary share of $1 60 000 Trade Payables 24 000 114 000, . The following scheme of capital reduction was sanctioned by the court and agreed by the shareholders. (i) Preference Shares were to be reduced to $0.75 each, (ii) Ordinary shares were to be reduced to $0.10 each (iii) $2 500 was to be written off the inventory. (iv) Development expenditure and the debit balance on Profit and Loss Account were to be written off j () The balance remaining was uséd to reduce the book value of the plant. 166 ACCOUNTING for A Level12 Capital Reduction and Reconstruction REQUIRED ng Gummarised Statement of Financial Position as at 1 January 2003, assuming the implementation of the reconstruction scheme. Answer Capital Reduction Account $ s Inventory 2500 Preference Share Capital 7 500 Development Expenditure 15.000 Ordinary Share Capital 54.000 Profit and Loss Account Plant Statement of Financial Position at 1 January 2003 (Aster Capital Reduction) Non-Current Assets s s Land and Building. 15.000 Plant and Machinery 12.000 Current Assets Inventory 10 300 Trade Receivables 14.000 Cash and Bank _1.200 25 500 Less Current Liabilities Trade Payables _24 000 Capital and Reserves Ordinary shares of $0.1 8% Preference shares of $0.75 , ACCOUNTINGFinancial Accounting Example 2 Knotsogood lid has been trading unprofitably for the past few years. The court has recently approved a scheme of capital reconstruction A Statement of Financial Position at 31 August 2006 showed the following, Cost Accumulated NBV Depreciation $000 "$000 «$000 Non Current Assets Intangible Non Current Assets Goodwill 110.000 110 000 Tangible Non Current Assets Freehold land 80 000 80000 Premises 310000 50.000 260.000 Vehicles 220000 160.000 _ 60 000 720000 210000 510000, Investments at cost 210 000 Current assets Inventory 40 000 Trade Receivables 56 000 Cash 4.000 100 000, Current Liabilities Trade Payables 80 000 Bank overdraft 190.000 _180 000 Net Current Assets (80 000) 640 000, Less Non Current Liabilities 8% Debentures (2021) (secured on the freehold land) 100 000 ‘ 540 000 Capital and reserves Ordinary shares of $ 1 each fully paid 500 000 8% preference shares of § Teach fully paid 200 000 Share premium account 250 000 950 000 Less Profit and Loss account (410 000) 540.000 Authorised share capital 1.000 000 ordinary shares of $ 1 each 000 000, 500 000 8% preference shares of § 1 each 500.000 168 =~ ACCOUNTING for A Level12 Capital Reduction and Reconstruction Note: The preference shares are cumulative and the dividends on the shares are 3 years in arrears, The approved scheme for the reduction of capital was implemented as follows (i) ‘The preference shares were reduced to $0.50 per share. (ii) The ordinary shares were reduced to $0.25 per share. (iti) Two new ordinary shares issued for every $1 of gross preference dividend in arrears ‘The share premium account was utilised for the issue (iv) Goodwill was written off. In addition: (v) - Inventory costing $6 000 had been included in the final accounts at its selling price of $10 000. (vi) A debt of $21 000 was written off as bad. (vii) The debenture holder took over the freehold land at an agreed valuation of $125 000. The balance was paid to the company. (viii) The Investments were sold for $235 000. REQUIRED (a) Prepare a capital reconstruction account. (b) Prepare a Statement of Financial Position at 31 August 2006 immediately after the capital reconstruction had taken place. (c) Calculate the net asset value of each ordinary share (i) _ before the implementation of the scheme; (ii) after the implementation of the scheme. Identify and explain one factor that the court would consider before agreeing to the scheme of reconstruction. NoGP4Ql Answer @ Capital Reconstruction Account s s _, Goodwill 110.000 Preference Share Capital 100 000 Inventory 4.000 Ordinary Share Capital 375 000 Pro and Loss Account 410.000 _ Investment 25.000 Bad debt 21.000 Freehold Land 45 000 545.000 545.000 ACCOUNTING for A LevelFinancial Accounting Statement of Financial Position as at 31 August 2006 $ $ Non-Current Assets Premises 260 000 Vehicles 60.000, 320 000 Current Assets Inventory 40 000 4000 36 000 Trade Receivables (55000 - 21 000) 35 000 Bank (100 000 + 235 000 +25 000) 160 000 Cash 4000 ; 235 000, Less Current Liabilities Trade Payables 80.000 Less Non-Current Liabilities 8% Debentures Share Capital and Reserves Ordinary Shares of § 0.25 (s00 000-375 090 +24 000) 149 000, Preference Shares of § 0.5 100 000 Share Premium (250 00 ~ 24 0001 226 000 475.000 Freehold Land Account $ 5 Balance b/d 80.000 8% Debentures 100 000 Capital reduction 45.000 Bank 25 000 125.000 125.000 8% Debentures Account, 3 $ Freehold Land 100000 Balance 100 000 100.000 _100 000 __ Preference Dividend in arrears : (8/100 x 200 000 x 3) 5 48 000 Number of Shares issued = 48 000 x 2 96 000 Ordinary Share Capital 96 000 x 0.25 $ 24.000 Dr $ Share Premium Account 24 000 To Ordinary Share Capital ACCOUNTING for A Level12 Capital Reduction and Reconstruction Answer fo Net Asset Value of each ordinary share Ordinary share Capital Number of Ordinary Shares 500 000 + 250 000 - 410 000 500 000 = $0.68 149 000 + 226 000 eat $0.63 596 000 121 L Additional Exercises ‘The summarised Balance Sheet of A. Banana PLC at 31 August 1991 was as follows: $ s s s Fixed Assets Ordinary Shares of $1 Goodwill 1500 fully paid up 8.000 Patents 700 6% Cumulative Preference Shares Land & Buildings 3600 of $1 each fully paid up 2.000 Plant & Machinery 2.900 8 700 10 000 Current Assets Stock 1100 Less: Profit and Loss Balances 1 200 Debtors 1700 8 800 10% Debentures + 1.000 Current Liabilities Bank Creditors Director's Loan 1.700 11.500 Note: The dividends on preference shares are three years in arrears, Urgent consideration is being given to the following scheme of reconstruction. (i) Preference shares to be reduced to $0.75 each and ordinary shares to be reduced to $0.25 each. Such shares to be converted into ordinary stock (ii) Preference shareholders to waive two years dividend arrears and to receive fully paid ordinary stock valued at par in payment for the remaining year. (iii) The existing debentures to be cancelled and the debenture holders to be issued with $800 000 of 8% Debentures and §200 000 of fully paid up ordinary stock, (iv) All intangible assets to be written off. ACCOUNTING 7 for A LevelFinancial Accounting (1) The stock figure to be reduced by $50 000 and the debtor figure to be reduced by $100 000 to reflect more realistic values, (1) The directors to take up $250 000 ordinary stock at par, the existing loan accounts to be used in part payment. (vii) Costs of the reconstruction are estimated at $25 000. REQUIRED (4) Draft a capital reduction account showing the effects of the proposals listed above (©) Draft a revised balance sheet after the adjustments have been made NOIPIQ2 The following is the Balance Sheet of Joloss plc at 30 April 2002. : $000 $000 Intangible fixed asset ~ Goodwill 50 Tangible fixed assets 650 700 Current assets Stock Debtors Bank Creditors: amounts falling due within one year Share capital and reserves Ordinary shares of $1 1.000 Profit and Loss Account (224) 776 Gree the past years, Joloss plc has traded at a loss and no dividends have been paid to the shareholders during that time. the directors are of the opinion that Goodwill is now valueless. ‘The tangible fixed assets are cvervalued by $150 000... Some stock which cost $10 000 now has no value. Inclelel ne debtors istan amount of $16 000 from a customer who has now become insolvent the debit balance on the Profit and Loss Account to be eliminated and adjustments te be meas to the company’s assets to take account of the matters mentioned above, The directors’ policy in future will be to pay dividends which will be covered twice by earnings, The shareholders have agreed to the directors’ proposals and the capital reduction was effected on 1 May 2002 ACCOUNTING for A Levelthe are Lin sed one able ade 12 Capital Reduction and Reconstruction REQUIRED (i). Prepare the Balance Sheet as it will appear immediately ater the capital reduction {ii) Explain the reasons why the shareholders agreed to the reduction in the nominal value of their shares. J02P4Q2 The chairman of Kalamitty Ltd needs to obtain the consent of the sharcholders to a reduction of capital. The summarised Balance Sheet of Kalamitty Ltd at 30 September 2005 was as follows $000 Goodwill 50 Tangible fixed assets 1300 Net current assets 725 Ordinary shares of $1 Profit and Loss Account Further information: The company has not paid a dividend for the past few years The directors are aware of the following matters: 1 Goodwill is now valueless 2 The freehold premises have developed a structural fault and must now be written down by $225 000. Stock has been damaged by flooding and must be written down by $20 000. 4 Aimajor debtor owing $30 000 is in financial difficulties and is unlikely to pay. the company has secured a number of new, long-term profitable contracts and the directors are confident that in future the company will make annual profits of at least $70 000, The directo propose a scheme of capital reconstruction which will enable them to writ Gftthe debe balance on the Profit and Loss Account and adjust the accounts for items Sumbered 1 to 4 above. The scheme will not result in a change in the number of shares that hhave been issued. “the directors ate confident that the capital reconstruction will enable them to commence paying annual dividends of $50 000 in the year ending 30 September 2006, The current rate Dr interest on money invested outside the business is 2.89%. REQUIRED fa) Using the information given above, state the facts which the chairman should include ig i in hi letter to the shareholders to obtain their consent to the scheme of capital reduction. “The directors havé obtained the necessary consent and the scheme of capital reduction has been implemented. (b) Prepare the Balance Sheet as it appears after the scheme of capital reduction has been implemented. NosPaQ2 ACCOUNTING — 173 for A Level