CAPITAL RECONSTRUCTION

1.0 Explain:

a) Company reconstruction

- The reconstruction that takes place when a company makes material and

formal changes to its capital structure due to certain circumstances

- There are 2 types of reconstruction:

i. Internal reconstruction (capital reduction)

Is undertake by a company that has surplus capital or whose

capital was eroded by trading losses

Company may apply to the courts to reduce its share capital

ii. External reconstruction

A new company is formed by 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 old company is wound up

The s/holder of new company will mainly made up of the

s/holders of the old company

It’s like a new establishment as the name will be different and

there may be other changes, for example different in

management.

Cost the external reconstruction is higher

b) Rationale for restructuring a company

Internal reconstruction or capital reduction:

Company may undertake reconstruction in order to stay in business.

Sec 64 of the CA 1965 – protects the interest of creditors where the proposed

scheme of capital reduction involves situation such reduce @ write off the uncalled

capital on its share and refund any surplus capital.

To save the company or to turn around the company.

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c) Legal requirements on capital reduction

Internal reconstruction which is also known as capital reduction is a situation

whereby a company reconstructs its capital structure internally.

Internal reconstruction may be undertaken by a company that has surplus capital or

whose capital was eroded by trading losses.

It only involves all parties in the company like ordinary shareholders, preference

shareholders, creditors and debenture holders.

These parties will take part in absorbing part of company’s losses by sacrificing part

of their claims over the assets of the company.

Before a capital reduction scheme is implemented, the company must apply to courts

to get approval.

Section 64 of Malaysian Companies Act 1965 only allows a company to undertake

the scheme after the company fulfils the following conditions:

i. The scheme must be confirmed by the courts,

ii. Capital reduction scheme has been provided in the Articles of Association of the

company, and

iii. A special resolution must be passed at the general meeting.

d) Situations allowed by Companies to reduce its capital

i) To reduce or write off the uncalled capital on its shares.

For example, a company with 10,000,000 ordinary shares of par value RM1 each

issued but paid to 80 sen each fully paid.

ii) To refund any surplus capital, such as, capital in excess of the needs of the

company.

For example, a company with 10,000,000 issued and fully paid ordinary shares of

RM1 each, decides to reduce its shares to 70 sen each fully paid, and to refund

30 sen per share to the shareholders.

iii) To cancel paid-up capital not represented by assets.

The paid-up share capital is reduced to reflect the net assets of the company.

Reduce or Write Off the Uncalled Capital on Its Shares

A company may have a capital in excess of its need and at the same time its shares

may only be partly called up. To reduce or write off uncalled capital may be feasible in

situations where the company has more than sufficient capital and does not wish to make

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the calls at all. There is actually no accounting transaction in this case as no funds leave or

enter the company. However, the pool of potential funds available to the company, that is

uncalled capital, is now non-existent.

A memorandum entry is made to recognize the change in the par value of the shares.

All legal and regulatory requirements have to be complied with even though there is no

change to the present financial position of the company by reducing or writing off uncalled

capital.

Refund Any Surplus Capital

A similar situation to the above is where the company has excess financial resources

and is not utilizing it. One indicator of such a situation is the existence of excess of cash

balances and low return on capital. Having excess capital may be detrimental to the

company as it may not be able to meet the shareholder’s expectation of higher return,

dividend or earning per share. The company’s share price may fall.

One option is for the company to reduce the par value of the shares and refund the

surplus capital to the shareholders. When capital in excess of the company’s needs is

returned to the shareholders there is an outflow of funds.

Capital Reconstruction where Capital is Not Represented by Available Assets. (Popularly

Known as Turnaround Situation)

One common situation where a company’s capital is eroded is when the company

has incurred heavy losses and has been unable to pay dividends to its shareholders for a

number of years. In this case, the aim of reconstruction is to save the company or as

commonly known, to turn around the company.

Companies facing heavy financial losses have two courses of action. They can either

wind up the company or undergo reconstruction. Liquidation of a company involves the

disposal of the assets, settlement of the liabilities and disturbing the remaining assets to the

shareholders.

Reconstruction will be undertaken only when the company has evidence that it can

make profits in the near future and be able to pay dividends to its shareholders. The

accumulated trading losses will be written-off and the carrying value assets will be adjusted

to reflect the recoverable amount if the carrying amounts are more than the recoverable

amount.

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BUSINESS COMBINATION

1.0 INTRODUCTION

Definition of business combination:

Business combination is the businesses that merge between one another. The

combination can be occurred whether by acquiring the net asset of another entity or

by acquiring the issued voting share capital of that entity. The combination can be

horizontal (business in the same line) or vertical (business in different line but in the

same stream of activity.eg; company manufacture of car + company marketing car)

Reasons for business combination:

The main reason is to enjoy the economies of scale. For the same line combination,

the economies of scale could be derived from larger production units and cutting out

competition/become more competitive. While for different line combination, they can

enjoy economies of scale by share resources, cut down inefficient use of resources

and cost, and control/coordinate the different functions.

Form of business combination:

AMALGAMATION

-Two or more business combines together by selling the business to formed

new company

-new company formed to acquire asset and liabilities of old company

-eg; M Sdn. Bhd + L sdn. Bhd = LM Sdn. Bhd

ABSORPTION

-One dominant company acquire asset and liabilities of another company and

company being acquired is wound up

-eg; X Sdn. Bhd. + Z Sdn. Bhd = X Sdn. Bhd

TAKEOVERS

-acquire control in another company

-the acquiring company become holding/parent company and acquired

company become subsidiary

-takeover is the process of acquiring the majority of the issued share capital

of company.

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2.0 BASIC PRINCIPLES OF GROUP ACCOUNTS

Describe the concept of group and the objective of consolidated financial statements:

Group is when the holding company and its subsidiaries form a single commercial

entity. So, the holding company has to prepare a set of financial statements for the

group that called it as the consolidated financial statements. Not only prepare a set of

consolidated financial statement for the group, the holding company also has to

prepare the consolidated financial statement along with its own financial statements.

It means that the holding company has to prepare two sets of financial statements.

The objective of consolidate financial statements:

For the benefit of investors who are interested in appraising the performance of the

group

Efficiency of the directors and management in managing the resources under their

direct and indirect control.

Explain the relevance and importance of substance over form concept in relation to the

preparation of consolidated financial statements:

The parent company and the subsidiaries maintain separate accounting records and

prepare their own financial statements.

The commercial substances of relationship is that the holding company and its

subsidiaries form a single commercial entity (group). The holding Co. has to prepare

a set of FS to provide the commercial picture to the shareholder.

The financial statement for the group known as consolidated financial statements.

The holding company is to produce two sets of financial statements. The first step is

prepared on the basis a SLE, showing its acquisition of share in the subsidiary as a

non-current investment.

The second set, the CFS prepared on the basis that all items in the financial

statements are aggregated to form one set of financial statements. This second set

is a memorandum set of accounts.

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Definition of parent, subsidiary and NCI:

Parent - is as an entity that has one or more subsidiaries.

Subsidiary - is as an entity including an unincorporated entity that is controlled by another

entity. It is called subsidiary when the investor company control the composition of BOD,

control more than ½ voting power, hold more than ½ of issued share capital and when a

subsidiary of a subsidiary of the investor company.

Non-controlling interest (NCI) - is a group of shareholders who do not control an entity.

Define control and explain what constitutes control:

Control:

FRS 127 Consolidated and Separate Financial Statements – the power to govern financial

and operating policies of an entity to obtain benefits from its activities.

Explain what constitutes control:

Share Ownership and Potential Shares

Ownership of the majority of the voting power represent of control. FRS 127 states

control obtain when the investors owns directly or indirectly more than one-half of the voting

shares of the other entity.

An investor may have options or warrants that when exercised may give the investors an

increases in voting power and vice versa.

The existence and effect of potential voting share that are currently exercisable should be

consider when assessing whether potential voting right contribute to control except

management intention and financial ability.

Control Without Holding the Majority Voting Shares

Control is present even though the parent owns less than one-half of voting power of other

entity when the parents has:

a) Power over more than one – half of the voting rights by virtue of an agreement with

others investors

b) Power to govern financial and operating policies under statues or an agreement

c) Power to appoint or remove the majority of members of BOD or governing body

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d) Power to cast the majority of votes at meeting of BOD or equivalent governing body.

Explain when a parent is exempted from preparing consolidated financial statements:

The parents is wholly or partly owned subsidiary and the other owners were

informed and do not object when parent do not presenting CFS.

The debt or equity instruments are not traded in a public market {not listed co.}

The parents not in the process of issuing in a public market its debts or equity

instruments by filling its financial statements with the regulatory authorities

The ultimate or intermediate parent produces consolidated financial statements.

Explain circumstances when subsidiaries are not consolidated:

FRS 127 – when the parent losses control over a subsidiary. This loss control over the

investee may lost with @ without a change of ownership.

The Ninth Schedule of CA 1965 – allows parent Co. to exclude certain subsidiaries from

being consolidated.

The circumstances where the directors of the holding Co. to exclude subsidiaries from being

consolidated.

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Impracticable , the time/expenses involved outweigh the value of accounts to the members of the Co.

Controlling interest in the subsidiary is temporary

The subsidiary situated outside Malaysia and the control of the subsidiary is impaired

The accounts would be misleading to any member of group.

The nature of the business of the subsidiary is very different from the parent Co.

Explain the different group structure:

There are two types of group structure which are

o Vertical group

o Mixed group.

Vertical group/single group

The parent company may exercise control directly or indirectly over the subsidiaries. Direct

control exist when the parent company itself owns the controlling interest in the subsidiaries.

Mixed group

Mkxed group is when the company and subsidiaries are have controlling interest in each

other.

Method of Accounting for Business Combinations:

Acquisition method

The acquisition method (called the 'purchase method' in the 2004 version of IFRS 3) is used

for all business combinations.

Steps in applying the acquisition method are:

1. Identification of the 'acquirer' – the combining entity that obtains control of the

acquiree

2. Determination of the 'acquisition date' – the date on which the acquirer obtains

control of the acquiree [IFRS 3.8]

3. Recognition and measurement of the identifiable assets acquired, the liabilities

assumed and any non-controlling interest (NCI, formerly called minority interest) in

the acquiree

4. Recognition and measurement of goodwill or a gain from a bargain purchase

Measurement of acquired assets and liabilities

 Assets and liabilities are measured at their acquisition-date fair value (with a limited number

of specified exceptions).

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Measurement of NCI

IFRS 3 allows an accounting policy choice, available on a transaction by transaction basis,

to measure NCI either at:

fair value (sometimes called the full goodwill method), or

the NCI's proportionate share of net assets of the acquiree (option is available on a

transaction by transaction basis).

Acquired intangible assets

Must always be recognised and measured at fair value. There is no 'reliable measurement'

exception.

Goodwill

Goodwill is measured as the difference between:

the aggregate of (i) the acquisition-date fair value of the consideration transferred, (ii)

the amount of any NCI, and (iii) in a business combination achieved in stages, the

acquisition-date fair value of the acquirer's previously-held equity interest in the

acquiree; and

the net of the acquisition-date amounts of the identifiable assets acquired and the

liabilities assumed (measured in accordance with IFRS 3).

If the difference above is negative, the resulting gain is recognised as a bargain purchase in

profit or loss.

Business Combination Achieved in Stages (Step Acquisitions)

Prior to control being obtained, the investment is accounted for under IAS 28, IAS 31, or IAS

39, as appropriate. On the date that control is obtained, the fair values of the acquired

entity's assets and liabilities, including goodwill, are measured (with the option to measure

full goodwill or only the acquirer's percentage of goodwill). Any resulting adjustments to

previously recognised assets and liabilities are recognised in profit or loss. Thus, attaining

control triggers remeasurement. [IFRS 3.41-42]

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Provisional Accounting

If the initial accounting for a business combination can be determined only provisionally by

the end of the first reporting period, account for the combination using provisional values.

Adjustments to provisional values within one year relating to facts and circumstances that

existed at the acquisition date. [IFRS 3.45] No adjustments after one year except to correct

an error in accordance with IAS 8. [IFRS 3.50]

Cost of an Acquisition

Measurement: Consideration for the acquisition includes the acquisition-date fair value of

contingent consideration. Changes to contingent consideration resulting from events after

the acquisition date must be recognised in profit or loss. [IFRS 3.58]

Acquisition costs: Costs of issuing debt or equity instruments are accounted for under IAS

32 and IAS 39. All other costs associated with the acquisition must be expensed, including

reimbursements to the acquiree for bearing some of the acquisition costs. Examples of costs

to be expensed include finder's fees; advisory, legal, accounting, valuation and other

professional or consulting fees; and general administrative costs, including the costs of

maintaining an internal acquisitions department. [IFRS 3.53]

Contingent consideration: Contingent consideration must be measured at fair value at the

time of the business combination. If the amount of contingent consideration changes as a

result of a post-acquisition event (such as meeting an earnings target), accounting for the

change in consideration depends on whether the additional consideration is an equity

instrument or cash or other assets paid or owed. If it is equity, the original amount is not

remeasured. If the additional consideration is cash or other assets paid or owed, the

changed amount is recognised in profit or loss. If the amount of consideration changes

because of new information about the fair value of the amount of consideration at acquisition

date (rather than because of a post-acquisition event) then retrospective restatement is

required. [IFRS 3.58]

Explain related party relationship and its disclosure requirement.

Pre-existing Relationships and Reacquired Rights

If the acquirer and acquiree were parties to a pre-existing relationship (for instance, the

acquirer had granted the acquiree a right to use its intellectual property), this must must be

accounted for separately from the business combination. In most cases, this will lead to the

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recognition of a gain or loss for the amount of the consideration transferred to the vendor

which effectively represents a 'settlement' of the pre-existing relationship. The amount of the

gain or loss is measured as follows:

for pre-existing non-contractual relationships (for example, a lawsuit): by reference to fair

value

for pre-existing contractual relationships: at the lesser of (a) the favourable/unfavourable

contract position and (b) any stated settlement provisions in the contract available to the

counterparty to whom the contract is unfavourable.

However, where the transaction effectively represents a reacquired right, an intangible asset

is recognised and measured on the basis of the remaining contractual term of the related

contract excluding any renewals. The asset is then subsequently amortised over the

remaining contractual term, again excluding any renewals.

ACCOUNTING FOR ASSOCIATES

1.0 Associates:

According to FRS 128 defines an associates as an entity over which the investor has

a significant influence .

Associate company can be defined as a company where the holding company has a

long term interest, no control and holds a substantial interest and is able to influence

it.

Based on MASB 12, an associate company is an enterprise in which the investor has

a significant influence and which neither a subsidiary nor a joint venture of the

investor.

Based on MASB 12, a holding company has to account the associate under equity

method in the consolidated financial statement.

Significant Influence:

Significant influence is defined as the power to participate in the financial and

operating policy decisions of the investee but is not control over those policies.

If an investor holds, directly or indirectly, 20 per cent or more of the voting power of

the investee, it is presumed that the investor has significant influence, unless it can

be clearly demonstrated that this is not the case.

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Conversely, if the investor holds, directly or indirectly (eg through subsidiaries), less

than 20 per cent of the voting power of the investee, it is presumed that the investor

does not have significant influence, unless such influence can be clearly

demonstrated. A substantial or majority ownership by another investor does not

necessarily preclude an investor from having significant influence.

The existence of significant influence by an investor is usually evidenced in one or

more of the following ways:

a) representation on the board of directors or equivalent governing body of the

investee;

b) participation in policy-making processes, including participation in decisions

about dividends or other distributions;

c) material transactions between the investor and the investee;

d) interchange of managerial personnel; or

e) provision of essential technical information

Equity Method

The investment account, which is initially recorded at cost, is increased or deceased

by the investor’s share of the post-acquisition profits or losses of the investee company.

Adjustments to the investment account will also include other changes to the net assets of

the associate, such as those arising on revaluation of assets. Dividends and other

distributions from the investee reduce the investment account. The group’s statement of

comprehensive income will also reflect the investor’s share of the post-acquisition profit or

loss of the investee company.

Investment at cost XX

Add :

Post-acquisition reserves XX

Dividends XX

Impairment of goodwill XX

Carrying amount (XX)

XX_

1) Financial Year-End

The most recent financial statements of the associate will be used to account for the

results of operation and financial position of the associate with of the investor. Where the

financial year-end of the associate is not the same as that of the parent, the associate has to

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prepare for the investor, financial statements that will have the same year-end as that of the

investor.

Appropriate adjustments have to be made for transactions or events that occurred

between the ‘actual year-end’ and the adjusted year-end. In all cases the time difference

between the year-end of the investor and associate should not exceed three months.

2) Accounting Policies

If an associate uses accounting policies that are not the same as the investor, the

investor has to make the necessary adjustments to conform the associate’s accounting

policies to those of the investor.

3) Cumulative Preference Shares

The profit for the year of the associate has to be adjusted for dividends for the year due

to cumulative preference shares, regardless of whether the dividends are declared or not,

before the residual profit for the year is allocated to the investor.

4) Losses of Associates

If an associate earns losses and the investor’s share of the losses equals the investor’s

interest in the associate, the investor need not recognize further losses. The carrying amount

of the interest in the associate will be nil.

5) Other Long-term Interest in the Associate

Where the investor has lent funds to the associate, and there is no indication or

commitment for the associate to repay it, that lending is considered a net investment.

Therefore, the interest in the associate will comprise the carrying amount in the equity of the

associate plus the net investment.

ACCOUNTING FOR JOINT VENTURES

1.0 The definition of joint venture, venture, investor, and joint control are follows:

Joint Venture

An economic activity that involves two or more venturers bound by a contractual

arrangement that establishes joint control.

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Venture

An activity of a project which is new and it may possibly have a risk or dangerous. And also,

it cannot be sure that it will succeed.

Investor

A person, organization, or country that puts money into something in order to make a profit

or receive interest.

Joint control

The contractually agreed sharing of the control over an economic activity, and exists only

when the strategic, financial and operating decisions relating to the activity require the

unanimous consent of the parties sharing controls’.

2.0 Explain and differentiate the following types of joint venture:

a) Jointly Controlled Operations

b) Jointly Controlled Assets

c) Jointly Controlled Entities

Jointly Controlled Operations

In joint ventures of this nature, there is no establishment of a separate business

enterprise. Each venture uses its own assets and incurs its own expenses. However, there

will be an agreement as to how the profits or losses are to be shared.

For example, three friends decide to buy, recondition and sell secondhand cars. One

party may source for old cars, another repairs and reconditions, and the third undertakes the

selling process. At the end of the reporting period, a memorandum statement of

comprehensive income may be prepared to determine the share of profits of each venturer.

In the separate financial statements and in the consolidated financial statements, the

venturer will have to disclose the assets it controls and the liabilities it incurs together with its

share of revenue and expenses it incurs in relation to the joint venture.

Jointly Controlled Assets

This is a more complicated situation and again does not involve setting up a separate

entity. Here the venturers have joint control of one or more assets contributed for the joint

venture. Each venturer usually takes a share of the output and bears an agreed share of the

expenses.

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For example, three venturers may own a common holiday villa, each taking a share

in the rental and sharing in the expenses.

Another example of this type of joint venture is the use by the venturers of a common

asset such as a gas pipeline. A few companies may jointly operate an oil pipeline to

transport their own oil.

Jointly Controlled Entities

This form of joint venture involves the establishment of a separate entity which could

be a company, partnership or any other form of entity. The entity set up operates as a

separate business operation except that the venturers have joint control over the joint

venture. The joint venture will have its own set of accounts and prepare its own set of

financial statements. The venturers are entitled to a share of the results of the joint venture.

For the venturer, its contribution to the joint venture will be disclosed as an investment and

for the joint venture the contributions made by the venturers are capital contributions.

For example, if a company was established as a joint venture, the share capital will

be contributed by the venturers and the share capital in the joint venture will be held by the

individual venturer, which will be disclosed as investment in the separate financial

statements.

3.0 The Proportionate Consolidation Method Of Accounting For Jointly Controlled

Entities :

In proportionate consolidation, the investor’s share of the net assets will be

consolidated with that of the investor’s net assets. Each item of the assets and liabilities of

the assets and liabilities of the investor and the investor’s share of each item of asset and

liability of the joint venture will be aggregated. If the investor has a 25% interest in a joint

venture then only 25% of each asset and liability will be consolidated and not 100%, unlike

when consolidating a subsidiary and disclosing the non-controlling interest in the subsidiary.

There is no non-controlling interest in a joint venture from the perspective of the venturer.

In the statement of comprehensive income, the investor’s share of each line item of

revenue and expenses will be aggregated with that of the parent. For example, if the

venturer has 25% interest in a joint venture, then 25% of revenue and expenses of the joint

venture will be added to that of the investor.

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