Accounting for Capital Reconstruction

Rationale for Capital Reconstruction

To eliminate 3 issues that prevent a distressed company from recovering

  1. Negative retained earnings
    • Companies with accumulated losses are not allowed to pay dividends. One reason is that it prevents the shareholders from withdrawing money and leaving the debt holders high and dry.
    • This discourages potential investors from investing in the company.
    • The company will find it difficult to obtain debt financing as well.
  2. Overdue interest and debt
    • Distressed companies are cash strapped. Needing to pay interest puts burden on the company, and prevents it from committing necessary capital to turn around the business.
    • The debt and interest also results in high gearing and low interest coverage ratios, which again prevents the company from obtaining additional debt financing.
  3. Overdue dividends on cumulative preference shares
    • Same reasons as per debt, since preference shares are essentially debt.

Types of Entity Construction Schemes (accounting speak)

  1. Capital reduction
  2. Reconstruction
  3. Liquidation via a new company

Capital Reduction Scheme

This addresses the 1st point above. A capital reduction scheme essentially recognises the loss that the equity holders have incurred by adjusting equity reserve accounts. A company

  • Resets any negative retained earnings account by offsetting it with equity reserve accounts (e.g. share premium account first, followed by share capital account)
  • Writes off any unpaid share capital by reducing the value of its share capital and restating as fully paid shares.
  • Writes off share capital not backed by available assets (e.g. reducing intangibles and share capital)

Since this would allow equity holders to pay themselves dividends again, court approval is typically required so as to take into account the interests of other stakeholders (e.g. debt holders).

Reconstruction Schemes

This addresses the 2nd and 3rd points above. This involves the company

  • Writing off overdue debt interest and restructuring debt to have lower interest and extended maturity
  • Writing off cumulative preference shares dividend owed
  • Writing off amounts owed to suppliers
  • Issuing new shares (crediting equity reserves) to the previous debt holders, preference shares holders, suppliers for accepting to restructure the debts.

Essentially debt holders convert to being equity holders, possibly retaining a lower debt amount. This allows them to recover their funds through the company’s recovery, as opposed to not recovering their funds when the company collapses.

Liquidation via a New Company

This involves:

  • Selling assets to another company
  • Using the proceeds to pay down remaining debts, and liquidating the business.


  • Profit recognised is based on proceeds less carrying costs of remaining net assets.
  • The buyer of the assets will still recognise Goodwill based on the fair value of the assets bought.



9 thoughts on “Accounting for Capital Reconstruction


    Posted by BOGORO TAYLOR | April 7, 2012, 3:21 pm
    • Thanks for your comment Bogoro. My posts are not meant to be comprehensive teaching materials, they are merely a place to summarize what I’ve learnt so that I can refer to them in future if need be. If they happen to be useful to others, that’s good.

      Posted by whatheheckaboom | April 22, 2012, 8:10 am
  2. I like the explanation and understand that it is not intended to provide comprehensive teaching. Please, kindly tell me where i can get worked examples so i can adequately understand it

    Posted by pcctinfo | May 20, 2012, 5:10 am
  3. please what are the accounting arrangements for the capital reduction scheme

    Posted by Abofra Tetteh Reuben | June 16, 2012, 9:56 am
  4. What happpens if the company is sold at a price less than the total liability of the company?

    Posted by Agbeja Ayodeji | October 16, 2012, 6:00 am
  5. Thank you Whatheheckaboom ! Wondering how could you know and understand so many things. Is it many hours a day you spend to read books? I admire that.

    Thank you for all the useful posts.

    Posted by Inzaghi | January 27, 2014, 3:15 am
    • Hi Inzaghi, I do spend quite a bit of time reading various books and materials, but I have a pretty bad memory, so I use this blog as a means to summarize things that I have learnt, for future reference. Glad that you found the posts useful!

      Posted by whatheheckaboom | January 28, 2014, 1:55 pm

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Copyright © 2005-2014 All Rights Reserved.

Enter your email address to follow this blog and receive notifications of new posts by email.

Blog Stats

  • 400,094 hits
%d bloggers like this: