Financial Reporting and Ethics - The Institute of Chartered ...

FINANCIAL REPORTING AND ETHICSfacing difficulties. The new company will absorb the ailingenterprise which appears to have been liquidated and taken over.Accounting entries passed in this case will be similar to thoseinvolved in `absorption’, under business combination.In this study pack, the term `Capital Reduction’ is used to includeCapital Reduction proper and Internal Capital Reconstruction.Generally, capital reduction may involve:(a) Implementing an already formulated scheme; and(b) Formulating a capital reduction scheme.3.9.4.3 Implementing An Already Formulated SchemeAn already formulated capital reduction scheme may beproposed by creditors or shareholders, agreed by all interestgroups and approved by the court. They are not required topropose a scheme that will be acceptable by all, in terms ofreducing the capital. What is required is simply to pass thenecessary accounting entries to give effect to the proposed schemewhich has already been agreed. Since the scheme has alreadybeen formulated, it is necessary to familiarize with the relevantterms.3.9.4.4 Principles of Implementing an already Formulated SchemeIn implementing an already formulated scheme, the followingprinciples should be borne in mind;(a) Any liability waived or cancelled constitutes a gain orprofit to capital reduction. The accounting entries are:DR - LiabilityCR - Capital reduction`Liability’ in this context is not limited to current and longterm liabilities, but is defined to include share capital(ordinary and preference shares).It should be noted that in capital reduction, the liabilityexpected to be waived or cancelled is restricted to ordinaryand preference shares, whereas in capital reconstruction,creditors would be involved.(b)Where a liability which is not represented in the balancesheet is waived or cancelled, it does not constitute a gainor capital reduction and should, therefore, be ignored. Inthat case, no accounting entry will be passed.You may be asked what is meant by “liability notrepresented in the balance sheet.” A typical example iscontingent liability. Most questions on capital reduction52