INTERNAL RECONSTR

UCTION
CHAPTER 3
Contents
01 THE CONCEPT OF CAPITAL REDUCTION @
INTERNAL RECONSTUCTION

02
FACTORS TO CONSIDER

03 ACCOUNTING TREATMENTS IN CAPITAL

REDUCTION & INTERNAL RECONSTRUCTION
THE CONCEPT OF CAPITAL REDUCTION @
INTERNAL RECONSTUCTION

Reconstruction takes place when a company makes material

and formal changes to its capital structure due to certain
circumstances.

A company may have to reduce its paid-up share capital such

as when its has more than its optimum level of capital or its
paid-up capital has been eroded by heavy losses.

A company may reduce its share capital in two ways:

a. By a special resolution and confirmation by the court or
b. By a special resolution supported by a solvency statement
 THE CONCEPT OF CAPITAL REDUCTION @
INTERNAL RECONSTUCTION
Reduction of share capital with court approval and special resolution

Section 116, Companies Act 2016 allows a company to reduce its capital in the following 3 situations:

Write off reduce or the Cancel any paid-up Return to the

01 liability on its unpaid 02 capital which is lost or
share capital. unrepresented by
assets. The paid-up
share capital is reduced
to reflect the net assets
of the company.
03 shareholders any paid-
up share capital which
is in excess of the
needs of the company

Section 116, Companies Act 2016 protect the interest of creditors.

The creditors have right to object the proposed capital reduction scheme.
The court will confirm the capital reduction only after the creditors are satisfied, settled or secured and their consent
to the reduction of capital obtained.
 THE CONCEPT OF CAPITAL REDUCTION @
INTERNAL RECONSTUCTION
Reduction of share capital by solvency statement
when a company is solvent, it may reduce its share capital by passing a special resolution.

a special resolution must be send to the Director of Inland Revenue and Registrar a notice stating that
a resolution was passed and including the text of the resolution and resolution date within 7 days of
the date the resolution was made.

All the directors of the company are to make solvency statement in relation to the reduction of share capital.
The statement has to be made within 14 days for a private company and 21 days for a public company of
the date of the resolution.
 FACTORS TO CONSIDER
When determining the amount of capital reduction, the following factors need to
be consider:

The total amount to be written off. The accumulated losses have

to be eliminated. Assets have to be revalued and written down/up
to fair value.

The rights of various creditors. Debenture holder accept a

reduction or willing to convert their claim into shares.

Apportionment of risk. Ordinary shareholders should take the

major loss.

Preference dividend in arrears. Preference shareholders may

be willing to waive their right to the dividends in arrears.
 FACTORS TO CONSIDER
When determining the amount of capital reduction, the following factors need to
be consider:

Amount of loss the preference shareholders could bear. The

preference shareholders may be willing to accept a reduction in
their paid-up capital. The preference shareholders will receive a smaller
amount of dividends in future.

The scheme devised should ensure that all affected parties

are treated equitably.
a) Amount written off share capital
e) Surplus on revaluation of assets Accounting entries for
Debit Relevant asset Capital Reduction Scheme
Debit Share capital accounts
Credit Capital reduction account To record the assets at fair
Credit Capital reduction account values, writing off the
accumulated losses and
f) Shares issued in settlement of liabilities reducing the share capital with
the lost capital.
b) Reserves utilized for the scheme Debit Relevant liability
Credit Share capital account Capital reduction account is
Debit Reserves accounts opened in order to entered the
Credit Capital reduction account amount written off the assets,
accumulated losses and share
g) Issue of new shares in lieu of preference capital.
dividends in arrears

c) To write off accumulated losses Debit Capital reduction account Capital reduction will be not to
Credit Share capital account have balances. If the credit
Debit Capital reduction account balance arises, the balance is
Credit Accumulated loss transferred as (i). If a debit
balance, it will considered as a
h) Expenses of capital reduction loss on reorganisation and will
Debit Capital reduction account be charged off as reorganisation
d) Amounts written off assets on revaluation expense in SOCI.
Credit Cash/Bank account
Debit Capital reduction account

Credit Relevant asset

i) Surplus on capital reduction account
Debit Capital reduction account
 Example 1
Given below is the statement of financial position of Reduction Bhd as at 31 December x9
RM
Land and building 100 000
Motor vehicles 50 000
Plant 50 000
Inventories 50 000
Trade receivables 40 000
290 000
300 000 ordinary shares 300 000
Accumulated losses (180 000)
120 000
Trade payables 80 000
Bank overdraft 90 000
290 000
 Example 1
Notes:
1. Ordinary shares were reduced to 30 sen each, fully paid. The existing ordinary
shareholders have agreed to take up 2 fully paid ordinary shares for every 1 held.

2. Part of the cash raised by this issue is to be used to settle the bank overdraft.

3. The fair values of these assets are as follows:

RM
Land and building 100 000
Motor vehicles 40 000
Plant 30 000
Inventories 50 000
Trade receivables 40 000

4. The accumulated losses and all intangible assets are to be written off.

5. A special resolution was passed and the approval of the court was obtained for the
scheme of capital reduction
 Example 1
Journal entries

Debit Credit
Ordinary shares 210 000
Capital reduction 210 000
(being ordinary shares written down to 30 sen per share)
(300 000 x RM0.70)

Bank 180 000

Ordinary shares 180 000
(being cash received for 600 000 (300 000 x 2) ordinary
shares of 30 sen each, fully paid)

Bank overdraft 90 000

Bank 90 000

(being settlement of overdraft

 Example 1
Journal entries

Debit Credit
Capital reduction 30 000
Motor vehicles 10 000
Plant 20 000

(being assets written down to current values)

Capital reduction 180 000

Accumulated losses 180 000

(being accumulated losses written off)

Capital reduction account

Capital Reduction Account

Motor vehicles 10 000 Ordinary shares 210 000

Plant 20 000
Accumulated losses 180 000
210 000 210 000
 Example 1
Statement of financial position immediately after the capital reduction
Reduction Bhd
Statement of financial position as at 31 December x9

RM
Land and building 100 000
Motor vehicles 40 000
Plant 30 000
Inventories 50 000
Trade receivables 40 000
Bank 90 000
350 000

900 000 ordinary shares, fully paid up 270 000

Trade payables 80 000

350 000
 Example 2
The summarised statement of financial position of Emergency Bhd as at 31 December x9 is
as follows:
RM RM
Issued and paid-up capital Non-current assets
500 000 ordinary shares 550 000 Research and development 105 000
100 000 5% cumulative preference shares 100 000 Land and building 200 000
Accumulated losses (350 000) Motor vehicles 50 000
Fixtures and fittings 35 000
Investments 30 000
8% debentures 100 000
Current liabilities
Trade payables 40 000 Current assets
Loan from directors 20 000 Inventories 40 000
Bank overdraft 32 000 Trade receivables 30 000
492 000 Cash in hand 2 000
492 000
 Example 2
Notes:
1. Arrears on preference dividends are RM20 000.
2. There is a contingent liability for damages of RM30 000 which has not been provided for.
3. A capital reduction scheme duly approved by the court was set out as follows:
i. The preference shares are to be reduced to 50 sen per share and the ordinary shares reduced to 25 sen each.
ii. The preference shareholders are to receive one ordinary share of 25 sen each for every RM1 preference dividend arrears.
iii. The accumulated losses and all intangible assets are to be written off.
iv. Inventories of RM10 000 and RM5 000 of bad debts are to be written off.
v. The fair values of the assets are as follows:

RM
Land and building 235 000
Fixtures and fittings 30 000

Investment 32 000

4. The directors agreed to accept ordinary shares in place of their loans and also agreed to subscribe for RM40 000 worth of
ordinary shares of 25 sen per share.
5. Cost of reconstruction amounted to RM2 000.
6. The following transaction took place:
i. The trade investments were sold for RM32 000.
ii. The contingent liability materialised to the amount stated and the company settled the full amount.

You are required to prepare:

i. The journal entries to record the capital reduction.
ii. The necessary ledger accounts
iii. The statement of financial position of Emergency Bhd immediately after the capital reduction.
 Example 2
Journal entries ( refer numbering in notes):
Debit Credit
3i Preference share capital (100 000 x 0.50) 50 000

Capital reduction 50 000

(being 5% cumulative preference shares reduced to 50 sen each, fully
paid)

Ordinary shares (500 000 x 0.85) 425 000

Capital reduction 425 000
(being ordinary shares written down to 25 sen per share, fully paid up)
3ii Capital reduction 5 000

Ordinary shares (20 000 x 0.25) 5 000

(being 20 000 ordinary shares issued in full satisfaction of preference
dividends in arrears of RM20 000)

3iii Capital reduction 455 000

Accumulated losses 350 000

Research and development 105 000
(being accumulated losses written off)
 Example 2
Journal entries ( refer numbering in notes):

Debit Credit
3 Capital reduction 20 000
iv Inventories 10 000
iv Trade receivables 5 000

v Fixtures and fittings 5 000

(being assets written down to fair value)

3. Land and building 35 000

v

Investment 2 000
Capital reduction 37 000
(being assets written up to fair value)

4 Directors’ loan 20 000

Ordinary share capital (80 000 x 0.25) 20 000
(being 80 000 ordinary shares issued in exchange for loans outstanding)
 Example 2
Journal entries ( refer numbering in notes):

Debit Credit
4 Bank 40 000
Ordinary shares (160 000 x 0.25) 40 000
(being 160 000 ordinary shares issued for cash to the directors of the company)

5 Capital reduction 2 000

Bank 2 000
(being expenses of reorganisation)

6.i Bank 32 000

Investments 32 000

(being trade investments sold)

6.ii Capital reduction 30 000

Contingent liability 30 000

(being liability recognised)

 Example 2
Journal entries ( refer numbering in notes):

Debit Credit
6.ii Contingent liability 32 000

Bank 32 000

(being settlement of contingent liability)

Capital reduction account

Capital Reduction Account

Ordinary share – 5 000 Preference shares capital 50 000

Preference share dividend

Accumulated losses 350 000 Ordinary shares capital 425 000

Research and development 105 000 Land and building 35 000

Fixtures and fittings 5 000 Investment 2 000

Inventories 10 000

Trade receivables 5 000

Contingent liability 30 000

Bank – Cost of reorganisation 2 000

512 000 512 000

 Example 2
Preference share capital account
Preference Share Capital Account

Capital reduction 50 000 Balance b/d 100 000

Balance c/d 50 000

100 000 100 000

Ordinary share account

Ordinary Share Capital Account

Capital reduction 425 000 Balance b/d 550 000

Balance c/d 190 000 Preference dividends 5 000

Directors’ loans 20 000

Bank 40 000

615 000 615 000

 Example 2
Statement of financial position immediately after the capital reduction
Emergency Bhd RM
Statement of financial position as at 31 December x9
Current assets
RM
Inventories 30 000
Issued and paid-up capital
Trade receivables 25 000
760 000 ordinary shares 190 000
Cash in hand 42 000 97 000
100 000 5% cumulative preference shares 50 000
412 000
240 000

Non-current liabilities

8% debentures 100 000

Current liabilities

Trade payables 40 000

Bank overdraft 32 000 72 000

412 000

Non-current assets

Land and building 235 000

Motor vehicles 50 000

Fixtures and fittings 30 000

315 000
Thank you