COMPANY
RECONSTRUCTION
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OBJECTIVES
After you have studied this chapter, you will be able to:
1. Differentiate between internal and external
reconstruction.
2. Explain two way of capital reduction under internal
reconstruction.
3. Explain accounting treatment for internal and
external reconstruction.
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INTRODUCTION
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Reconstruction occurs when a company makes
material and formal changes to its capital structure.
A company may have to reduce its paid-up share
capital when:
a) it has more than its optimum level of capital or
b) its paid-up capital has been eroded by heavy
losses.
There are two types of reconstruction:
1) Internal reconstruction
2) External reconstruction
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INTERNAL RECONSTRUCTION OR CAPITAL
REDUCTION
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Internal reconstruction may be undertaken by a
company that has surplus capital or its capital has
been eroded by trading losses.
A company may reduce its share capital in one of
two ways:
1) By a special resolution and confirmation by the
court
2) By a special resolution supported by a solvency
statement
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Reduction of Share Capital with Court
Approval and Special Resolution
Section 116 of the Company Act 2016 allows a company
to reduce its capital in the following three situations:
a) Write off or reduce the liability on its unpaid share
capital. For example, a company with 50 million shares
with an issue of RM2.50 per share paid to RM1.80 each,
reduces the ordinary shares to RM1.80 each, fully paid.
b) Cancel any paid-up capital which is lost or
unrepresented by assets. The paid-up share capital is
reduced to reflect the net assets of the company.
c) Return to the shareholders any paid-up share capital
which in excess of the needs of the company.
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Reduction of Share Capital by Solvency
Statement
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All the directors of the company are to make a
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.
In the case of the reduction of capital, a company
satisfies the solvency test if:
1. Immediately after the reduction of capital there
is no ground on which the company could be
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found to be unable to pay its debts.
Reduction of Share Capital by Solvency
Statement
2. Either if it is intended to commence the winding up
of the company within 12 months after the
reduction of capital, the company will be able to
pay its debts within 12 months after the
commencement of the winding up; or in any other
case, the company will be able to pay its debts as
they become due during the period of 12 months
immediately following the date of the reduction of
capital.
3. The assets of the company exceed the liability of
the company at the end of the reduction of capital. 7
 Sections 64, Company Act 1965 allows company to
reduce its capital in 3 situations:
1. To reduce or write off the uncalled capital on its
shares.
2. To refund any surplus capital.
3. To cancel paid-up capital not represented by
assets.
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Reduce or Write Off the Uncalled Capital
On Company’s Shares
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A company may have capital in excess of its needs,
and at the same time its shares may only be partly
called up.
In this case, it may be in the interest of the company
to reduce or write off uncalled capital as the
company has more than sufficient capital and does
not wish to make the calls at all.
No accounting transaction.
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Refund of Surplus Capital
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It happens when the company has excess financial
resources and is not utilizing it.
Consequence ⇒ low return on capital.
Having excess capital may be detrimental to the
company as it may not be able to meet shareholders’
expectation of higher return, dividend or earnings
per share.
As a result, the company’s share price may fall.
One way to reduce its excess cash balances is for the
company to reduce the paid-up value of the shares
and refund the surplus capital to the shareholders.
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Refund of Surplus Capital
The accounting entries are:
Debit Ordinay share capital
Credit
Bank
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Capital Reduction Where Capital is Not
Represented by Available Assets (Lost
Capital)
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A company’s capital is eroded when the company has
incurred heavy losses and has unable to pay dividends to
its shareholders for number of years.
The company can either be wound up (liquidated) or
reconstructed.
Liquidation of a company involves the disposal of the
assets, settlement of the liabilities and distribution of the
remaining assets to the shareholders.
Known as “turnaround situation”.
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Capital Reduction Where Capital is Not
Represented by Available Assets (Lost Capital)

Given below is the statement of financial position of a
company whose capital is not represented by available assets.
ABC Sdn Bhd
Statement of Financial Position as at 31 December x4
Non-current tangible assets
Intangible assets
Current assets
600,000 ordinary shares
Accumulated losses
Current liabilities
RM
200,000
20,000
30,000
250,000
600,000
(400,000)
200,000
50,000
250,000
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Capital Reduction Where Capital is Not
Represented by Available Assets (Lost Capital)
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In this company, the accumulated losses of
RM400,000 have eroded the paid-up capital.
There is also a cash flow problem as there is negative
working capital (30,000-50,000 = -20,000).
In this situation the company can:
1) Continue to be in business and face further
erosion of capital.
2) Wind up its business
3) Reorganise
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Journal Entries To Record A Scheme Of
Capital Reduction
a)
b)
c)
d)
Amount written off share capital
Debit Share capital account
Credit
Capital reduction account
xxx
Reserves utilized for the scheme
Debit Reserve account
Credit
Capital reduction account
xxx
To write off accumulated losses
Debit Capital reduction account
Credit
Accumulated loss
xxx
Amount written off assets
Debit Capital reduction account
Credit
Relevant assets
xxx
xxx
xxx
xxx
xxx
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Journal Entries To Record A Scheme Of
Capital Reduction
e)
f)
g)
Surplus on revaluation of assets
Debit Relevant assets
Credit
Capital reduction account
xxx
Shares issued in settlement of liabilities
Debit Relevant liability
Credit
Share capital account
xxx
xxx
xxx
Issue of new shares in lieu of preference dividends in arrears
Debit Capital reduction account
xxx
Credit
Share capital account
xxx
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Journal Entries To Record A Scheme Of
Capital Reduction
h) Expenses of capital reduction
Debit Capital reduction account
Credit
Cash/bank account
i)
Surplus on capital reduction account
Debit Capital reduction account
Credit
Capital reserve account
xxx
xxx
xxx
xxx
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Example 1: Internal Reconstruction
(Refer to Attached file)
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EXTERNAL RECONSTRUCTION
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The existing company is wound up and the new
company is formed.
A new company is form by the existing shareholders
to take over the assets and liabilities of an ailing
company.
The consideration paid is usually in shares of the new
company.
The cost of undertaking an external reconstruction
will be higher as one company has to be wound up
and another formed.
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BOOKS OF THE OLD COMPANY
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The realization and reconstruction account (RR
account) is created.
The RR account is debited with all the assets
disposed of and credited with the purchase
consideration.
The balances in the various reserve accounts are
transferred to the RR account instead of to the
sundry members’ account. This is to determine the
full loss sustained by the company.
The loss borne by the shareholders is credited to the
RR account and debited to the sundry members’
account.
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EXAMPLE 2
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Given below is the statement of financial position of
Construction Bhd as at 31 December x9.
Non-current assets
Current assets
300,000 ordinary shares
100,000 6% preference shares
Accumulated losses
8% debentures
Trade payables
RM
200,000
100,000
300,000
300,000
100,000
400,000
(200,000)
200,000
50,000
50,000
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EXAMPLE 2
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A scheme of reconstruction was agreed to by all
parties and the required approvals received.
A new company named Reconstruction was formed
and its constitution states that the company’s capital
is made up of 8 percent preference shares and
ordinary shares.
Reconstruction acquired all the assets of
Construction for the following considerations:
a) A 9 % loan stock in Reconstruction worth
RM50,000 was issued to satisfy the claims of the
debenture holders of Construction Bhd.
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EXAMPLE 2
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The trade payables of RM20,000 were paid in cash
and the balance in 9% loan stock.
Four 8% preference shares were issued at RM1 each
for every five preference shares in Construction.
The ordinary shareholders received one ordinary
shares in Reconstruction for every three ordinary
shares in Construction. The ordinary shares have a
fair value of RM1 each.
The non-current assets were valued at RM210,000
and the current assets at RM70,000.
You are required to close the books of Construction
Bhd.
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EXAMPLE 2
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ANSWER
Determine the purchase consideration.
RM
To the ordinary shareholders
One ordinary shares for every three shares held (1/3 x
300,000 x RM1)
To the preference shareholders
Four preference shares for every five shares held (4/5 x
100,000 x RM1)
To the debenture holders
9% loan stock
To the trade payables
Cash
9% loan stock
100,000
80,000
50,000
20,000
30,000
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280,000
EXAMPLE 2
Realisation and Reconstruction Account
RM
Non-current assets
200,000 Reconstruction
Current assets
100,000 Loss on Realisation c/d
300,000
Balance b/d
Accumulated losses
20,000
300,000
20,000 Sundry member’s
account:
200,000
Preference
Ordinary
220,000
RM
280,000
20,000
200,000
220,000
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EXAMPLE 2
Realization and
reconstruction
Ordinary shares in
Reconstruction
Sundry Members-Ordinary
RM
200,000 Balance b/d
RM
300,000
100,000
300,000
300,000
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EXAMPLE 2
Realization and
reconstruction
Reconstruction Account
RM
280,000 Trade payable:
Cash
9% loan stock
Debenture holders:
9% loan stock
Sundry members
Preference
Ordinary
280,000
RM
20,000
30,000
50,000
80,000
100,000
280,000
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THE END
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