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ACCOUNTING GRADE 12
NOTES
$
50,000
36,000
(24000)
12000
62000
100,000
(38000)
62000
No provision has been made for Depreciation of the non current assets which at the date of the
balance sheet, were estimated to be worth $8000 and it has been discovered that a major
customer, owing $4,000 has become bankrupt. However, the directors are of the opinion that
the company will begin to make a profit of $5,000 per annum from now on.
Required:
(a) Journal entries to record the scheme of Capital reduction.
(b) A Balance Sheet as it will appear after the scheme put into effect.
Answer:
The shares are worth $0.62 ($62,000 / 100,000) on balance sheet values. After taking the
realisable values of the assets into account, the value of the shares is $(42,000 + 8,000) /
100,000 = $ 0.50. The accounting entries will require the use of a Capital Reduction Account:
Journal
Dr.
$
COMPANIES RECONSTRUCTION
Cr.
$
Page | 1
ACCOUNTING GRADE 12
NOTES
50,000
8,000
4,000
38,000
50,000
50,000
Cherry Ltd.
Balance Sheet as at 31 December 2011
$
Non current Assets
Current Assets
(-) Current Liabilities
$
42,000
32,000
(24,000)
8,000
50000
Net Assets
Share Capital and Reserves:
100,000 Ordinary shares of $0.50
50,000
Notes:
The share holders have not lost anything as a result of the reconstruction of the Capital of
the Company as their shares had already lost $0.50 of their value; the reconstruction merely
recognise this fact.
The debit balance has been eliminated from the retained earnings account. If the Profit of
$5,000 is achieved, it will be equivalent to a dividend of 10% payable to the shareholders
immediately; they will not have to wait 8 years ($38000/5000), for a dividend.
Sample answer 2:
Plant Ltds summarised Balance Sheet at 31 September 2011 is as follows:
Non Current Assets:
Goodwill
Properties
Plant and Equipment
Motor vehicles
Net Current assets
Equity:
1,600,000 ordinary shares of $1
COMPANIES RECONSTRUCTION
$000
100
600
250
50
350
1350
1600
Page | 2
ACCOUNTING GRADE 12
NOTES
(250)
1350
Further Information:
(i)
(ii)
The non current assets are considered to be overvalued and have been valued more
realistically as follows:
$000
420
150
30
Properties
Plant and equipment
Motor vehicles
(iii) Inventory has been over valued by $125,000. A major customer owing $25,000 has
become bankrupt.
The company has not paid any dividends for some years but the directors believe that the
company can become profitable again and start paying dividends once more. They purpose to
carry out a scheme of capital reduction with the agreement of the shareholders.
Required:
(a)
(b)
Redraft the Balance Sheet of Plant Ltd. as it will appear immediately after the completion
of the Capital Reduction.
Answer:
The Balance Sheet value of the shares in $0.84375 [$(1,600,000 250,000) 1,600,000]
After taking the overvaluation of the assets into account, the value of the shares is $0.50.
$000
1,600
(250)
(100)
(180)
(100)
(20)
(125)
(25)
800
Journal
$000
COMPANIES RECONSTRUCTION
$000
Page | 3
ACCOUNTING GRADE 12
NOTES
800
250
100
180
100
20
125
25
800
800
The balance on the Share Capital account has now been reduced from $1,600,000 to 800,000,
but the shareholders still hold share certificates for 1,600,000 share of $1. The directors may
correct this situation in various ways, but the two most likely are:
To give the shareholders certificates for One Ordinary share of $0.50 for every share of $1
they already hold.
To give the shareholders a certificate for One Ordinary share of $1 for every two shares they
already hold.
(b)
Plant Ltd
Balance Sheet immediately after the capital reduction
Non current assets:
$000
Properties
420
Plant and equipment
150
Motor vehicles
30
Net current assets
200
800
1,600,000 Ordinary shares of $0.50*
800
* Alternatively, 800,000 Ordinary shares of $1
COMPANIES RECONSTRUCTION
Page | 4
ACCOUNTING GRADE 12
NOTES
This figure tells the investors what their investment is worth. To find the value per share, simply
divide by the number of shares.
Net asset value per share =
Net Assets____________________________
Number of ordinary and preference shares
Sample answer 3:
Knotsogood Limited has been trading unprofitably for the past few years. The court has
recently approved a scheme of Capital reconstruction. A balance sheet at 31 August 2006
showed the following position:
Non Current Assets
Intangible: Goodwill
Tangible: Freehold land
Premises
Vehicles
Cost
$000
110
80
310
220
720
Investments
Current Assets:
Inventory
Trade receivables
Cash & cash equivalents (cash)
(-) Current Liabilities:
Trade payables
Cash & cash equivalents (Bank)
Depn.
$000
50
160
210
NBV
$000
110
80
260
60
510
210
40
56
4
100
80
100
(180)
(80)
640
(100)
540
500
200
250
Page | 5
ACCOUNTING GRADE 12
NOTES
(410)
540
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:
Two new Ordinary shares for every $1 of gross Preference dividend in arrears. The
share premium account was utilised for the issue.
Inventory costing $6000 had been included in the final accounts at its selling price of
$10000.
The Debenture holder took over the Freehold land at an agreed valuation of $125000. The
Balance was paid to the company.
Required:
(a)
(b)
(c)
The summarised balance sheet of Knotsogood Limited immediately after the completion of
the scheme of capital reconstruction.
(d)
Calculate the net asset value of each Ordinary share before and after the implementation
of the scheme.
(e)
Identify and explain one factor that the court would consider before agreeing to the
scheme of capital reconstruction.
[NOV 06 P4]
Answer:
(a)
(i)
(ii)
(iii)
Journal
Preference share Capital (200 x 0.50)
Capital Reconstruction account
Ordinary share Capital (500 x 0.75)
Capital Reconstruction account
Share premium
COMPANIES RECONSTRUCTION
Dr.
$000
100
Cr.
$000
100
375
375
24
Page | 6
(vii)
(viii)
ACCOUNTING GRADE 12
(b)
2006
31 Aug
Goodwill
Retained earnings
Inventory (10 6)
Trade receivables
(c)
NOTES
24
545
110
4
21
410
100
25
80
45
235
210
25
$000
100
375
45
25
545
Knotsogood Ltd.
Balance Sheet as at 31 August 2006
$000
$000
260
60
320
-
36
35
164
235
80
155
475
475
Page | 7
ACCOUNTING GRADE 12
NOTES
149
100
226
475
(d) (i) Net asset value of each Ordinary share before the scheme:
Net assets Preference shares
No. of Ordinary shares
340000* = $0.68 per share
500000
(ii) Net asset value of each Ordinary share after the scheme:
375000* = $0.63 per share
596000
* Note:
By issuing Preference shares Net Assets value increases. To calculate Net asset value of
each Ordinary share we need to deduct Preference shares value from net assets.
(e)
The share holders have not lost anything as a result of the reconstruction of the Capital of
the Company as their shares had already lost $0.75 of their value; the reconstruction
merely recognise this fact.
The debit balance has been eliminated from the retained earnings. If the business
achieves Profits in future years, profits would be payable to the shareholders immediately;
they will not have to wait for several years to get dividends.
COMPANIES RECONSTRUCTION
Page | 8