Topic 9 company_reconstruction_a141

COMPANY
RECONSTRUCTION
TOPIC 9
BKAF3063 FAR III A141 1

2
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
BKAF3063 FAR III A141

3
Reorganization & Reconstruction
 When company incurring heavy losses and has been unable to pay
dividends for few consecutive years. The company has two options:
- Winding up (liquidate)
- Reorganization (turn around)
 Reorganization - any alteration in the structure of the firm which
enables to adapt to changes in its environment.
 Reconstruction – reorganizing various aspects, from management,
finance, productions etc.
 Reorganization can only be undertaken if the company has evidence of
making profits in the near future and able to pay dividends to its
shareholders.

4
FINANCIAL DISTRESS COMPANY
RECONSTRUCTION LIQUIDATION
Either way:
COMPROMISE / ARRANGEMENT WITH:
- Debenture holders
- Creditors
- Shareholders
TAKEOVERS

5
Compromises and Arrangements
 S. 176 of CA – power to compromise with creditors and
members.
 “Arrangement” been defined in S. 176(11) to include a
reorganisation of the share capital of a company by the
consolidation of shares of different classes or by the division of
shares into shares of different classes or by both these methods.
 A company can enter into a compromise or arrangement with its
creditors or any class of them, or with its members or any class
of them without going into liquidation.

6
Debt Restructuring
 A debt restructuring scheme ensures that a business
survives if there is a reasonable prospect that it is viable
 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 & can’t pay co. B, B
then can’t pay C & so on).

7
Debt Restructuring…
Basic steps in debt restructuring :
a) assess process management.
b) financial stock take.
c) assess future cash flows.
d) 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.

8
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) reduce the current interest rate .
b) forgive some of the accrued interest or principal.
c) modify some other term of the debt agreement .
d) extend the maturity date of the original debt at a
lower rate of interest.
2. Creditor’s acceptance of assets or equity with a FV less
than the amount of the debt.

9
Two types of reorganization:
 Internal reorganization (S61,62,64 CA)
- redefinition of rights of shareholders:
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)
– changes in legal relationships with outsiders and accounting activity
beyond the company itself:
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

10
External Reorganization
 Involves with outsiders in few ways:
1. Disposal of all part of undertakings.
2. The rearrangement of the capital structure.
3. Expansion through business combination.
4. The devising of a scheme to avoid
liquidation

11
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 (MFRS 5)
 After the disposal, the remaining balance of
the sales proceeds might be distributed to
shareholders.

12
2. The rearrangement of the capital
structure
 May involve changes in debt capital
 Power to rearrange company’s debt capital by
redeeming debentures & unsecured notes
will depend on its articles & on the terms of
the contracts.

2. The rearrangement of the capital
structure… (cont)
☞ Example:
On 1 April 2008, PQR Berhad issued 7% unsecured notes worth RM1
million convertible into RM0.50 ordinary share at par on 1 May 2013.
On the maturity date, 80% by value of the note holders opted to
convert.
 Entries on 1 May 2013:
Dr. Unsecured notes 1,000,000
Cr. Sundry noteholders 1,000,000
Dr. Sundry noteholders 1,000,000
Cr. Ordinary share capital 800,000
Bank 200,000

14
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).
 MFRS 3 Business Combinations.

15
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.

16
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.
2. Reduction of paid up capital
1. Extinguish or reduce share capital not paid up
2. Cancellation of capital loss
3. Return of excess capital to shareholders
3. Issue of bonus shares
1. Recognition of the amount of capital required for operations.
2. Relieving shareholders’ of liability.
3. ‘tidying up’ the balance sheet.
4. Recognition of increases in the value of assets
4. Redemption of preference shares.

17
1. Alteration of Authorized Capital
 S62 CA – several ways:
1. increase or reduction in the amount of authorized
capital.
2. change in the par value of shares.
3. conversion of fully paid shares into unit of stock or vice
versa.
Difference between shares & stock: relate to divisibility & ease of
recording. It is not possible to sell part of a share while stock can be
sold in any amount.
No entry in the ledger or journal would be required as there
has been no change in paid up capital.

18
☞ Illustration 1:
Selamat Berhad had been incorporated on 1 January 1993 with
authorized capital of 10,000,000 ordinary shares of RM1.00 par, had an
issued and paid up capital of 1,000,000 ordinary shares of RM1.00 each
fully paid.
At the AGM held on 7 May 2013, the shareholders resolved:
1. To decrease authorized capital to RM7,000,000 by cancelling
3,000,000 unissued shares;
2. To alter the par value of the remaining unissued shares from RM1.00
to RM0.50; and
3. To convert the fully paid ordinary shares into stock units of RM20.00
each.
1. Alteration of Authorized Capital…

19
☞ Solution to Illustration 1
Stmt of capital presented at the meeting:
Authorized capital:
10,000,000 shares of RM1.00 each 10,000,000
Issued & paid up capital:
1,000,000 ordinary shares of RM1.00 each 1,000,000
Stmt of capital presented immediately after the meeting:
Authorized capital:
50,000 ordinary stock units of RM20.00 each 1,000,000
12,000,000 shares of RM0.50 each 6,000,000
50,000 ordinary stock units at RM20.00 each 1,000,000
RM
Authorized 10m
Issued 1m
Unissued 9m
Less 3m
Bal unissued 6m
RM6,000,000/0.50
1. Alteration of Authorized Capital…

20
2. Reduction of Paid Up Capital
 S64 CA - subject to confirmation by the Court & must be
authorised by its articles by special resolution to reduce its
share cap. 3 conditions:
1. Extinguish or reduce share capital not paid up
2. Cancel any paid up capital which is loss or is
unrepresented by available assets.
3. Return of excess capital to shareholders
• Pay off any paid up share capital which is an excess of the
needs of the company, and may, so far as is necessary,
alter its memorandum by reducing the amount of its
share capital and of its shares accordingly.

21
2. Reduction of Paid Up Capital…
1. Extinguish or reduce share capital not paid up:
 BOD to decide & propose whether to retain the right
to call up or to give up that right by canceling the
uncalled capital.
 If the uncalled capital is cancelled, the resources
available to discharge liabilities are reduced just as
effectively as when capital is returned to shareholders
by way of cash payment.
 The cancellation of uncalled capital reduces the par
value of the shares involved.

22
☞ Illustration 2:
Sejahtera Berhad has the following related to its capital as at 30 June 2013:
Authorized capital:
3,000,000 ordinary shares of RM1.00 each paid to RM0.90 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 company’s 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.

23
☞ Solution to Illustration 2
Journal entries:
Dr. Ord. Sh. Capital 1,200,000
Cr. Capital reduction 1,200,000
(reduction in paid up capital by RM0.40 per share on the
3,000,000 issued shares as per court order)
Ordinary Share Capital
Sh. Distr. 1,200,000 Bal b/f 2,700,000
Bal c/f 1,500,000
======== =======
Shareholders’ Distribution
Bank 1.200,000 OSC 1,200,000
======== =======
Dr. Capital reduction 1,200,000
Cr. Cash/Bank 1,200,000
(the return of part of paid up capital)

Stmt of capital after the distribution of surplus:
Authorized capital:
3,500,000
Par value RM1.00
Return in cash RM0.40
Cancel uncalled RM0.10
New par value RM0.50

25
2. Cancellation of capital loss:
 known as Turnaround Situation.
 Badly managed companies might suffer losses of some
of their paid-up cap due to a large scale embezzlement
or a series of operating losses or a fire in uninsured
building or by an economic, political or technological
changes.
 Hence, companies might have to write-off or writing
down the accounts which contain the loss including
adjusting their paid-up capital.

26
☺ Example of capital loss:
Issued & paid up capital 5,000,000
Less: Accumulated loss 3,000,000
2,000,000
☺ 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.

27
☞ Illustration 3:
The directors of Salam Akhir Berhad presented the following information to a
meeting of shareholders:
(a) Statement of Financial Position
30 June 2013
Property Plant & Equipment 5,000,000
Other Assets 4,000,000
9,000,000
Financed by:
Authorised, Issued & Paid up Capital:
10,000,000 ord. shares of RM1.00 each 10,000,000
Less: Retained Earnings (loss) (3,000,000)
Shareholders’ fund 7,000,000
Long Term Liabilities 2,000,000
9,000,000

28
(b) Market surveys indicate that trading conditions have improved so much
that future profits will be approximately RM1,000,000 per year.
(c) The market value of the PPE has recently fallen to RM2,500,000 and
the fall is expected to be permanent.
The directors proposed:
i) To reduce paid up capital by RM0.55 per share
ii) To write off the debit balance on Profit and Loss account; and
iii) To write the PPE account down to market value.
The proposals were approved.

29
 Solution to Illustration 3
Journal entries:
(reduction of paid up capital by RM0.55 per share on the
Dr. Capital reduction 5,500,000
Cr. Retained earnings (loss) 3,000,000
PPE 2,500,000
(Losses written as per court order)

‘000 ‘000
Cap. reduction 5,500 Bal b/f 10,000
Bal c/f 4,500
====== ======
Retained Earnings
‘000 ‘000
Bal b/f 3,000 Cap. Reduction 3,000
====== =====
PPE
‘000 ‘000
Bal b/f 5,000 Cap. Reduction 2,500
Bal c/f 2,500
===== =====
Capital Reduction
‘000 ‘000
Ret. earnings 3,000 OSC 5,500
PPE 2,500
===== =====

The balance sheet after the reduction:
Property Plant & Equipment 2,500,000
6,500,000
Financed by:
6,500,000

32
3. Return of excess capital to shareholders:
 Some financial statements show that company is having
more financial resources available than can be used
profitably (e.g. idle cash in the banks & ineffective
investment).
 The SURPLUS can be used to:
1. discharge liabilities
2. purchase income-producing assets such as shares &
debentures
3. enter into some additional business activity
4. pay large dividends to shareholders (by distributing retained
earnings)
5. return to present shareholders some of the capital which had
been contributed in the past

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 In choosing among the alternatives, the directors may
consider:
- the costs of the various types of finance available,
- the rates of return on other investments,
- the long-term effects (including the incidence of
taxation) on the co. & its shareholders,
- the requirements of the law relating to company [e.g.
For alternative (5), need to satisfy S. 64 of CA, need to
get approvals etc.].
 Could combine all the factors or combine several factors for an
arrangement scheme.

☞ Illustration 4:
Harapan Berhad
Statement of Financial Position
30 March 2013
Cash at bank 5,500,000
7,000,000
Financed by:
Retained Earnings 100,000
7,000,000

35
The company is operating in a declining industry and the directors have
considered how to use the surplus assets. They have discovered that no
profitable investment opportunity exists in the industry and that it would
be unprofitable to reduce liabilities by more than RM900,000. In addition,
they agreed that it would be unwise for the existing management to
attempt to move into other activities.
Therefore, after having obtained the appropriate approvals from creditors,
shareholders and the Court for reduction of capital, the directors put the
following reorganization into effect on 1 April 2013:
i) Pay off RM900,000 of the liabilities.
ii) Pay a dividend of RM0.02 per share; and
iii) Reduce the par value of all shares to RM0.45 and return RM0.55 per
share to shareholders.

Journal entries:
(reduction in paid up capital by RM0.55 per share on the
Dr. Dividends payable 100,000
Capital reduction 2,750,000
Cr. Bank 2,850,000
Dr. Liabilities 900,000
Cr. Bank 900,000
Dr. Retained Earnings 100,000
Cr. Dividend payable 100,000
(payment of dividend 5,000,000 x RM0.02)

37
Extract of Statement of Financial Position after the reduction of capital:
Harapan Berhad
Statement of Financial Position
30 March 2013
3,250,000
Cap. reduction 2,750,000 Bal b/f 5,000,000
Bal c/f 2,250,000
======= ========

38
 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.

☞ Illustration 5:
Harapan Tinggi Berhad
Statement of Capital
31 December 2013
Authorised Capital 7,000,000
Issued & Paid up Capital:
2,000,000 8% preference shares of RM1.00 each 2,000,000
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
RM0.40 per share.

40
Journal entries:
Dr. Ordinary Share Capital 2,000,000
Cr. Capital reduction – Ord. shares 2,000,000
(reduction of all ordinary shares to a par value of RM0.60 per
share by reducing paid up capital as per Court Order)
Dr. Preference Share Capital 400,000
Cr. Capital reduction - Pref. shares 400,000
(reduction of all preference shares to a par value 0f RM0.80 per
share by reducing paid up capital as per Court Order)

41
‘000 ‘000
Cap. reduction 2,000 Bal b/f 5,000
Bal c/f 3,000
====== ======
Capital Reduction - OS
‘000 ‘000
Bank 2,000 OSC 2,000
====== =====
Preference Share Capital
‘000 ‘000
Cap. reduction 400 Bal b/f 2,000
Bal c/f 1,600
===== =====
Capital Reduction - PS
‘000 ‘ 000
Bank 400 PSC 400
===== =====

Harapan Tinggi Berhad
31 December 2013
2,000,000 8% preference shares of RM0.80 each fully paid 1,600,000
5,000,000 ord. shares of RM0.60 each fully paid 3,000,000
4,600,000

43
3. Issue of Bonus Shares
 The issue of bonus shares does not add to the wealth of a
company, or vary the rights of the shareholders.
 It is merely a means of reclassifying the elements of
shareholders funds by capitalising some of them (by
converting some part of distributable profits into paid up
capital).
 The wealth of the shareholders may increase through
increase in the market value of shareholders’ investment,
even the share price may fall. It is assumed that the company
will maintain its traditional rate of cash dividends.

44
3. Issue of Bonus Shares…
 Bonus issue often used as a defence against take-over bid by
way of:
o persuade the shareholders to retain the shares for the
dividends.
o the increase in number of shares to be acquired by
bidders.
 Some internal reasons for the issue of bonus shares:
1. Recognition of the amount of capital required for
operations.
2. Relieving shareholders’ of liability.
3. ‘tidying up’ the balance sheet.
4. Recognition of increases in the value of assets.

45
(1) Recognition of the amount of capital required for
operations:
 Most companies “retain” some of each year’s profit in way of
retained earnings, unappropriated profits & profit and loss
appropriation (dividends paid not equal to reported profit).
 These are regarded as permanent capital.
 Argument: the balance sheet does not accurately describe the
situation and that all or most of the undistributed profit ought to
be converted into paid up capital through the issue of bonus
shares.

46
☞ Illustration 6:
SerbaTinggi Berhad
30 March 2013
Retained earnings 5,500,000
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.

 Solution to Illustration 6:
If articles permit the direct capitalization:
Journal entries:
If articles does not permit the direct capitalization:
Dr. Retained Earnings 5,000,000
Cr. Ordinary Share Capital 5,000,000
(bonus issue of five fully paid ordinary shares for every two
shares held out of retained earnings)
Dr. Retained Earnings 5,000,000
Cr. Dividend Payable 5,000,000
Dr. Dividend Payable 5,000,000
Cr. Ordinary Share Capital 5,000,000

48
The statement of capital after the bonus issue:
Retained earnings 500,000

49
(2) Relieving shareholders’ of liability:
 It happens when company decides to capitalise
undistributed profits by ‘paying up’ uncalled cap
rather than by making a bonus issue of fully paid
shares.
 This has the effect of relieving shareholders of the
liability to pay the uncalled capital.

50
☞ Illustration 7:
Sederhana Berhad
30 March 2013
Authorised Capital 20,000
10,000 ordinary shares of RM1.00 each paid to RM0.50 5,000
Shareholders’ fund 17,000
The directors resolve to ‘pay up’ the uncalled capital out of retained
earnings.

Journal entries:
Dr. Retained Earnings 5,000
Cr. Ordinary Share Capital 5,000
(capitalization of retained earnings by eliminating
uncalled capital)
The statement of capital after the bonus issue:
10,000 ordinary shares of RM1.00 each fully paid 10,000

52
(3) ‘tidying up’ the balance sheet :
 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 company’s Articles. BKAF3063 FAR III A141

53
 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.

54
(4) Recognition of increases in the value of assets :
 Revaluation of assets:
o Increase – upward revaluation (credit to revaluation
reserve)
o Decrease – downward revaluation (impairment, debit to
profit and loss)
 Revaluation gains (realised or unrealised) can be used to issue
bonus shares or to ‘pay up’ uncalled capital.

55
4. Redemption of Preference Shares
 Basically, a company is prohibited from returning back or
distributing capital to its shareholders, except under the
resolutions in S. 64 discussed earlier.
 However, company can create a class of share which carries:
o the right to a return of capital in future, or
o the right to redeem this class of shares at company’s
option.
 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.

56
4. Redemption of Preference Shares…
 WARNINGS in S. 61:
o The redemption shall not be taken as reducing the amount of
authorised share capital.
o The shares could only be redeemed:
- out of profits which would otherwise be available for
dividend; OR
- out of the proceeds of a fresh issue of shares made for the
purposes of the redemption; AND
- if they are fully paid-up.
 Even though paid-up cap is not reduced, the value of assets &
shareholders’ equity will decrease because the articles often require the
redemption at premium (to compensate shareholders for the loss of
income in the future). Thus, premium on redemption must be provided
for redemption out of profits or out of Share Premium Account.

57
4.Redemption of Preference Shares…
☞ Illustration 8:
Inferior Berhad
Extract from Statement of Financial Position as at 30 June 2013
Authorized Share Capital 10,000,000
2,000,000 8 % redeemable pref. shares of RM1.00 each fully paid* 2,000,000
6,000,000 ordinary shares of RM1.00 each fully paid 6,000,000
8,000,000
Share premium 500,000
Retained earnings 2,200,000
* 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 2015.
On 1 August 2013, the directors resolve to exercise the company’s option to redeem
all the preference shares.

I. Redeem out of retained earnings:
Journal entries:
Dr. Share premium 100,000
Cr. Red. pref shareholders distribution 100,000
Dr. Retained earnings 2,000,000
Cr. Capital redemption reserve 2,000,000
Dr. Redeemable preference share capital 2,000,000
Cr. Red. pref shareholders distribution 2,000,000
Dr. Red. pref shareholders distribution 2,100,000
Cr. Bank 2,100,000

Redeemable Preference Share Capital
‘000 ‘000
R.P.S.Distr. 2,000 Bal b/f 2,000
====== ======
Share Premium
‘000 ‘000
R.P.S.Distr. 100 Bal b/f 500
Bal c/f 400
====== =====
Retained Earnings
‘000 ‘000
C.Red. Res. 2,000 Bal b/f 2,200
Bal c/f 200
===== =====
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
==== ====

60
The statement of capital after the redemption:
RM‘000
6,000,000 ordinary shares of RM1.00 each fully paid 6,000
Capital redemption reserve 2,000
Share premium 400
Retained earnings 200

II. Redeem out of proceeds of a new share:
Journal entries:
Dr. Share premium 100,000
Cr. Red. pref shareholders distribution 100,000
Dr. Bank 2,000,000
Cr. Ordinary share capital 2,000,000
Dr. Redeemable preference share capital 2,000,000
Cr. Red. pref shareholders distribution 2,000,000
Dr. Red. pref shareholders distribution 2,100,000
Cr. Bank 2,100,000

Redeemable Preference Share Capital
‘000 ‘000
R.P.S.Distr. 2,000 Bal b/f 2,000
====== ======
Share Premium
‘000 ‘000
R.P.S.Distr. 100 Bal b/f 500
Bal c/f 400
====== =====
‘000 ‘000
Bal b/f 6,000
Bal c/f 8,000 Bank 2,000
===== =====
Red. Pref. Shareholders Distribution
‘000 ‘ 000
Bank 2,100 Share prem. 100
Red. PSC 2,000
===== =====

63
The statement of capital after the redemption:
RM‘000
8,000,000 ordinary shares of RM1.00 each fully paid 8,000
Share premium 400

Reference
 Jane Lazar & Tan Lay Leng (2003), Company
Account & Reporting, 5th Edition.

Topic 9 company_reconstruction_a141

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