ADVANCED FINANCIAL

REPORTING II
CAPITAL RECONSTRUCTION
AND
CAPITAL REDUCTION
 Lesson Objectives
By the end of the lesson, students should be able to:
• Explain circumstances that may lead a company to
go for capital reconstruction
• Discuss the nature and regulatory/legislative
framework that governs capital reduction/
reconstruction
• Design and implement a capital reduction scheme
• Explain when external reconstruction schemes are
necessary

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General Overview
• Companies operate and do business with the
assets they have.
• These assets are financed by ‘capital’ and this
capital can either be debt or equity.
• Sometimes, the amount or value of capital falls
below the value of the assets it finances.
• This is usually because the company is facing
difficulties and making persistent losses (income
deficits) amidst other business challenges

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 Indicators of Business
Difficulties
• Accumulated trading losses
• Arrears of unpaid loan interests
• No payment of dividends for several years
• Market value of equity shares falling below their
nominal value
• Lack of investor and market confidence in the entity
• Liquidity problems
• High labour turnover
• Key management personnel leaving
• Increasing cost of production but low revenues

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 Basis for
Capital Reconstruction
Two basis for CR
• There must be a real need for it to avoid
liquidation

• Where it would bring about a business

turnaround into profitability

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 For CR to be Successful
• For CR to be successful, all stakeholders must be
treated fairly, not equally.
• Stakeholders must be offered a better deal than
what they stand to get if the business goes into
liquidation.
• Stakeholders most affected here would primarily
be shareholders, creditors and debentureholders

Debentureholders must suffer less in a CR and

shareholders must suffer most (they are the owners
and stand to lose a lot upon liquidation)

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 A Reconstruction Scheme
• As said earlier, for CR to be successful, all
stakeholders must be treated fairly.
• A proposal is presented to all relevant
stakeholders outlining a scheme to turn
around into profitability.
• For the scheme to be accepted by all, it must
provide better benefits than liquidation and
the stakeholders involved treated fairly

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 Forms of CR
A reconstruction scheme can involve some or all
of the ff:
– Creation of new shares
– Cancellation of income surplus deficit against
shares or reserves
– Conversion of debt to equity
– Revaluation of assets
– Writing off intangibles
– Extending credit periods (moratorium), etc.

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 Some Definitions
• Capital reorganisation, capital reconstruction, capital
restructuring, and capital reduction all mean different
things.
• Capital reorganisation is a general term used to
describe a reconstruction, restructuring or a capital
reduction
• Capital reduction is the reduction of the capital (shares
plus reserves) of an entity as an alternative to
liquidation
• Capital reconstruction is also an alternative to
liquidation but this combines capital reduction with a
reduction in the amounts of creditors and
debentureholders

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 The Case of CPC

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 CPC – Cont’d
• In 2013 at the AGM, shareholders of CPC
asked its Board of Directors to consider capital
reconstruction to inject seed capital into the
company to solve its problems.
• The company had been unable to declare
dividends for close to 10 years.
• When it declared dividend for the Y/E
September 2008, it was GHC 0.0005 per share

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 CPC – Cont’d
• As at June 2016, number of workers declined
from 700 to 200
• Consistent losses (amounts in US$)
2016 (half year) 2014 2013 2012 2011

(5,307,007) (16,275,455) (11,772,004) (10,245,648) (6,818,757)

• As part of reconstruction, CPC converted an

outstanding debt of US $14,078,120.50 owed
to Ghana Cocoa Board into 937,247,936
ordinary shares
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 Capital Restructuring
• Altering the capital structure of a firm, in
reaction to the changed business conditions,
or as a means to fund the firm’s growth plans
• The process whereby a company’s financial,
ownership, legal or operational structures are
reconfigured to enhance efficiency
• Restructuring thus might not necessarily be
because the company is struggling

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 Union Savings and Loans restructured
in 2013 to raise GHC 149m to become
a bank

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Legal and Regulatory Framework
• Companies Act 2019 (Act 992)
• Corporate Insolvency and Restructuring 2020
(Act 1015)
The Process of Reconstruction:
– Call for EGM to propose a CR Scheme
– Decision made by special resolution (75% maj.)
– Must be approved by the High Court
– Registrar General (RG) must also approve
– The RG contacts debentureholders and creditors to
know if they are satisfied with the CR scheme
– Now the company can reconstruct

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 Designing and Implementing a CR
Scheme
In undergoing a reconstruction, 5 steps are essential
1. A share of proceeds from Liquidation
2. Calculation of amount needed for CR
3. Proposal of a CR Scheme
4. CR Account and other a/cs from the CR
Scheme
5. Statement of Fin Position right after CR

****Not all of these apply in all cases (esp. exams)

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 Proceeds from Liquidation
• As said earlier, stakeholders would only agree to CR if
they should benefit more from the business continuing
than on liquidation.
• This however needs to be proven or backed with
figures
• Thus, the company must show how the proceeds from
liquidation would be distributed to the stakeholders.
• And especially if some stakeholders would receive little
or nothing in the proceeds, they would welcome CR.
This step or computation is necessary only when
stakeholders have to be convinced that CR is the best
option

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 Proceeds from Liquidation
- Order of payment
The proceeds on liquidation from the sale of assets
would be distributed in the ff. order:
• Debt secured by a fixed charge
• Cost of liquidation
• Preferential payables (tax, SSNIT, PAYE, etc.)
• Payables secured by a floating charge
• Unsecured payables
• Preference shareholders
• Ordinary shareholders

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 Determining amount of
CR needed
• After stakeholders have agreed to CR, the
company needs to determine the amount of CR
needed.
• The amount of CR needed is the amount of
losses that have to be cleared to bring a
turnaround
• On computation of the amount needed, a CR
scheme is then drawn up or proposed to raise the
amount needed.
• Refer to the Forms of CR for examples of how the
amount can be raised

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Determining amount of CR needed
GHC
Intangible write-off XX
Intangible written up (rare) (XX)
Tangible assets write-off XX
Tangible assets written up(Reval) (XX)
Retained Earnings deficit write-off XX
Pref shares div in arrears (if payable) XX
Reconstruction costs XX
Amt of CR needed (losses to be cleared) XXX

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 Proposal of a CR Scheme
• Once we determine the amount of CR needed, then
this amount is raised from sacrifices of various
stakeholders.
• The scheme or proposal captures the sacrifices that
have to be made by each stakeholder (mostly
shareholders, DBs and creditors)
• The principle is that shareholders sacrifice most,
followed by creditors and DBs suffer least.
• Another important principle is drawing up the proposal
is that the stakeholders must be treated fairly.
In exam, the CR scheme or proposal is usually given

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Capital Reconstruction Account
• A CR a/c is drawn following proposals in the CR scheme
• Corresponding a/cs eg. Share capital, payables, cash
and other asset and liability a/cs that are affected by
the CR are also drawn up.
• The CR account is drawn up per the dictates of the CR
scheme.
• The Debit side of the CR a/c records all losses and
expenses under the CR scheme
• The Credit side of the CR a/c records all gains and
surpluses under the CR scheme
This is one of the most commonly tested areas in exams

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General Principles on CR A/C
• On Share transfer or share reduction
DR Stated Capital
CR Capital Reconstruction A/C

• On issue of new shares

DR Cash or Bank
CR Stated Capital

• On liability transfer or replacement or write down

DR Liability A/C
CR Capital Reconstruction A/C

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 General Principles on CR A/C
– Cont’d
• On Assets write down
DR Captial Reconstruction A/C
CR Asset A/C

• On Assets write up
DR Asset A/C
CR Capital Reconstruction A/C

• On Income Deficit write off

DR Capital Reconstruction A/C
CR Income Deficit A/C

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 General Principles on CR A/C
– Cont’d
• The DR and CR sides of the CR a/c must agree at
all times per the CR scheme
• However, this is not always the case.
• Sometimes, the amount raised from stakeholders
exceed the losses in CR.
• Thus the CR side of the CR a/c exceeds the DR
side.
• This balance is recorded as follows
DR Capital Reduction A/C
CR Capital Surplus A/C

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 General Principles on CR A/C
– Cont’d
• Rarely but however possible, the DR side of the
CR a/c can exceed the CR side.
• What this means is that the losses are more than
the gains from reconstruction.
• In order words, the amount raised from CR is not
enough to offset the losses.
• This usually happens if the CR scheme is not
drawn up properly.
• The implication here is that extra funds (or
sacrifices) have to be raised (or made) by the
stakeholders.

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 Statement of Fin. Pos.
after CR
• This is the last stage of the reconstruction process
• Here, a new SoFP is drawn up following the CR
scheme, the CR a/c and all other affected a/cs
• Other items on the old SoFP that have not been
affected by the CR exercise remain intact in the
new SoFP
• The new SoFP shows a better position (no income
deficit) of the firm than it was prior to CR.

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 External Reconstruction
• The CR that has just been discussed is an internal
reconstruction.
• Where an internal reconstruction cannot save the
company, an alternative is to undergo an external
reconstruction
• This involves forming a new company to take
over the business of the existing ailing company.
• In effect, the operations of the existing company
are wound up and net proceeds settled by cash
or shares or loan which are given to the existing
shareholders

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 Practice Questions

• Do not just read…practice questions involving

reconstruction!!!!

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