Capital Reconstruction Scheme

Introduction

If an entity is in financial difficulty it may have no

recourse but to accept liquidation as the final
outcome. However, it may be in a position to survive,
and indeed flourish, by taking up some future
contract or opportunities.
The only hindrance to this may be that any future
operations may need a prior cash injection. This
cannot be raised because the present structure and
status of the entity may not be attractive to current
and outside investors.
 A capital reconstruction scheme

A capital reconstruction scheme is a scheme whereby

a company re-organizes its capital structure after
persistent losses has resulted into income surplus
deficit and liquidity problems.
A reconstruction scheme might be agreed upon when
a company is in danger of being put into liquidation
but holds up good promise of profits in the future.
 Entity reconstruction profile

Accumulated trading losses.

Arrears of unpaid debenture and loan interest
No payment of equity dividends for several years
Market value of equity shares below their nominal
value.
Lack of investor and market confidence in the entity.
 Examples of Reconstruction scheme

(i) Creation of a new share capital of a different value from the existing
share capital or the cancellation of existing share capital.
(ii) The conversion of debt to equity and debt of one type to debt of
another.
(iii) Revaluation of assets to reflect their fair values.
(iv) Writing off intangible assets
(v) Writing off income surplus deficit
(vi) Calling on other stakeholders to make some sacrifices where
(necessary)
(vii) Additional capital injection to improve upon the liquidity situation
(usually by way of rights issues)
(viii) Closing down loss-making plant, delisting unprofitable product
line and/or introducing a potentially viable product line.
 For reconstruction scheme to be acceptable

(i) There must be a real need for it. i.e. it should be last scheme
to adopt without which the business would go into liquidation.
(ii) It should treat all stakeholders of the business fairly and
equitably .
(iii) It should offer stakeholders a better deal than if the
company went into liquidation. If it did not, the payables would
press for a winding up of the company.
 (iv)It should include an arrangement to pay off the company’s
existing debts or converting them into other forms of liability to
secure some financial relief to the reconstructed company.
(v) It should hold out a promise of profits in the future. i. e.
there should be turn around.
 Legal formalities

The following legal formalities must be followed in

adopting a reconstruction scheme.
- An extraordinary meeting of shareholders to
approve the scheme
- Approval by a High Court.
- Consent of other stakeholders.
The companies’ code provisions governing capital
reduction scheme are contained in section 75-79
 Capital reduction scheme

Under this scheme, an entity may;

1. Write off unpaid equity capital.
2. write off any equity capital which is lost or not
represented by available assets.
3. Write off any paid up equity capital which is in
excess of requirements
 Capital reduction scheme

1. Write off unpaid equity capital.

This situation may arise, for example, if there are
partly-paid shares in issue. The entity is effectively
reducing the nominal value of its equity share capital
by the amount not yet called up and paid by the equity
holders. For example, partly paid equity shares with a
nominal value of GH¢1 may be reduced to the amount
currently paid up, say GH¢0.75, in doing so, the equity
holders will no longer be required to pay the amount
still outstanding.
 Capital reduction scheme

2. Write off any equity capital which is lost or

not represented by available assets.
In this situation, the equity has a deficit on retained
earnings due to accumulated losses. This prevents
payment of an equity dividend and also depresses the
share price. In effect, the entity will write off this
deficit against any available components of equity to
clear all or part of the deficit on retained earnings.
 Capital reduction scheme

3. Write off any paid up equity capital which

is in excess of requirements.
In this situation, the entity uses surplus cash to
repay it equity holders.
 Reconstruction scheme

Reconstruction scheme extend the principle of the

capital reduction schemes by including the various
creditors within the scheme. In addition to reducing
equity share capital, reconstruction scheme may also
include:
 Writing off debenture loan interest arrears,
 Replacement of debenture loans with new loans having
different interest and capital repayment terms.
 Write off amounts owing to unsecured or trade payables
 Accounting entries for capital reconstruction scheme

Transaction Account to be debited Account to be credited

Amount written off share Share capital Capital reconstruction
capital
Asset write down Capital reconstruction Asset
Asset upward revaluation Asset Capital reconstruction
Income surplus deficit Capital reconstruction Income surplus
w/d
Waiver of pref div arrears Stated capital/ Loan capital
by an issue of shares/loan Capital reconstruction
capital
Cost of reconstruction Capital reconstruction Cash/Bank
Capitalization of surplus Capital reconstruction Capital surplus
on capital reduction acct
(if any)
 Example

DASA has the following statement of financial position at

20th june 2015.
 GH¢’000
Assets 500
 500
Equity and liabilities
Issued Equity shares at GH¢1 each 600
Share premium 100
Retained earnings (deficit) (300)
Liabilities 100
 500
 Example

DASA has the following problems:

 Accumulated losses which prevent payment of a dividend
should the entity become profitable at some future date.
 Issued equity share capital of GH¢600,000 which is only
backed by assets to the extent of GH¢500,000
 Difficulty in attracting new sources of equity and/or loan
finance
Required;
Apply a capital reduction scheme and restate the
statement of financial position at 30th June 2015
 Solution

Using the reduction of capital scheme, the deficit on

retained earnings could be cleared by reducing both
the share premium and issued equity capital
accounts. Any balance on share premium account
should be utilised first to minimise the reduction of
equity capital as follows;
 GH¢’000 GH¢’000
Dr Share premium 100
Dr Equity share capital 200
Cr Retained earnings 300
 Solution

Statement of Financial Position would be:

 GHC’000
Assets 500
 500
Equity and liabilities
Issued equity shares 400
Liabilities 100
 500
 Question 1

Kele Ltd is a private company. Three quarters of the

stated capital is held by the directors or members of
their families. The company’s draft Statement of
Financial Position as at the end of 2015 was as
follows:
 Statement of Financial Position at 31 December
2015
 Question 1

Non-Current assets GH¢ GH¢

Intangible assets: Development costs 85,000
Goodwill 60,000
Tangible assets: Land and buildings 270,000
Plant and machinery 326,000

Current Assets
Inventories 426,000
Receivables 531,000

Equity and liabilities

Stated capital (800,000 share of GH¢1 each) 800,000
Capital Surplus 50,000
Retained loss (232,000)
 Current liabilities
Payables 393,000
Bank loans and overdraft 687,000
1,698,000
 Question 1

i) Bank loans and overdrafts consist of a 10% loan of GH¢400,000

repayable in 2016 carrying a fixed charge on the company’s land
and buildings, and an unsecured overdraft of GH¢287,000.
 ii) The demand for the company’s products fell drastically in
recent years owing to the import of high quality and cheaper
products from Togo. The development costs appearing in the
Statement of financial Position above relate to a new product
which has been perfected to a marketable stage, and for which
there is believed to be a strong demand. The costs have been
properly capitalized in accordance with the provisions of relevant
accounting standards. The company is in urgent need of capital to
meet existing liabilities and the necessary new investment in plant
and working capital.
 Question 1

A scheme for financial reorganization has been drawn up for the consideration
of shareholders and payables.
 The terms are as follows:
i)The share of GH¢1.00 each are to be written down to GH¢0.20 per share and
subsequently (every five shares of GH¢0.20 each) are to be consolidated
into one fully paid share of GH¢1.00.
 ii) The existing shareholders are to subscribe for a rights issue of 2 new
ordinary shares, issued at GH¢1.00 per share, for every share held after the
proposed reduction and consolidation.
 iii) In full satisfaction of the GH¢687,000 owing, the bank agrees to accept an
immediate payment of GH¢87,000 and to consolidate the balance of GH
¢600,000 into a loan, carrying interest of 40% per annum, repayable in five
equal annual installments commencing 31 December 2016. The loan is to be
secured by a fixed charge on the land and buildings and a floating charge on the
company’s remaining assets.
 Question 1

iv) The credit balance on capital surplus account and debit balances
on the Retained loss account and goodwill, considered valueless,
are to be written off.
 
v) The assets listed below are to be restated at the following
amounts:
GH¢

Plant and Machinery 125,000

Inventory 210,000
Receivables 500,000
Land and Buildings 320,000
 Required:

Required:
Prepare the revised Statement of Financial Position
of Kele Ltd at 1 January 2016 giving effect to the
proposed scheme for reorganizing the company.