The Hindu Business Line : To get a sick company going, everybody chips in

A holds 10 per cent first debentures for Rs 4,00,000 and 10 per cent second debentures for Rs 6,00,000. He is also creditors for Rs 1,00,000. B holds 10 per cent first debentures for Rs 2,00,000 and 10 per cent second debentures for Rs 4,00,000 and is also creditors for Rs 50,000.

The following scheme of reconstruction has been agreed upon and duly approved by the court.

i) All the equity shares be converted into fully paid equity shares of Rs 5 each.

ii) The preference shares be reduced to Rs 50 each and the preference shareholders agree to forego their arrears of preference dividends in consideration of which 9 per cent preference shares are to be converted into 10 per cent preference shares.

iii) Mr A is to cancel Rs 6,00,000 of his total debt, including interest on debentures, and to pay Rs 1 lakh to the company and receive new 12 per cent debentures for the balance amount.

iv) Mr B is to cancel Rs 3,00,000 of his total debt, including interest on debentures, and to accept new 12 per cent debentures for the balance amount.

v) Trade creditors (other than A and B) agreed to forego 50 per cent of their claim.

vi) Directors to accept settlement of their loans as to 60 per cent thereof by allotment of equity shares and balance being waived.

vii) There were capital commitments totalling Rs 3,00,000. These contracts are to be cancelled on payment of 5 per cent of the contract price as a penalty.

viii) The directors refund Rs 1,10,000 of the fees previously received by them.

ix) Reconstruction expenses paid Rs 10,000.

x) The taxation liability of the company is settled at Rs 80,000 and the same is paid immediately.

xi) The assets are revalued as shown in Table 21.

Pass journal entries for all these transactions, including amounts to be written off of as goodwill, patents, loss in profit and loss account and discount on issue of debentures.

Prepare bank account and working of allocation of interest on debentures between A and B.

This is a fairly simple question. Entries required for reconstruction of Y Ltd on March 31, 2003, are as follows (narrations provided):

1) Equity share capital (Rs 10 each fully paid) account Dr. — Rs 50,00,000

To equity share capital (Rs 5 each fully paid) account — Rs 25,00,000

To Reconstruction account — Rs 25,00,000

(Being the conversion of equity of Rs 10 each to fully paid shares

of Rs 5 each — amount foregone by equity shareholders cr. to

reconstruction account)

2) Nine per cent preference share capital account Dr. (Rs 100 each) — Rs 20,00,000

To 10 per cent preference share capital account (Rs 50 each) — Rs 10,00,000

To Reconstruction account — Rs 10,00,000

(Being reduction of preference share capital to shares of Rs 50 each, amount foregone by preference shareholders credited to reconstruction account - arrears dividend cancelled.)

3) 10 per cent first debentures account Dr — Rs 4,00,000

10 per cent second debentures account Dr — Rs 6,00,000

Debenture interest outstanding account Dr — Rs 1,00,000

Sundry creditors account Dr. — Rs 1,00,000

Cash account Dr. — Rs 1,00,000

To Reconstruction account — Rs 6,00,000

To 12 per cent debentures account — Rs 7,00,000

(Being monies due to Mr A cancelled to the extent of Rs 3 lakh and credit to reconstruction account. Balance due, including cash received, further satisfied by allotment of 12 per cent debentures.)

4) 10 per cent first debentures account Dr. — Rs 2,00,000

10 per cent second debentures account Dr. — Rs 4,00,000

Debenture interest outstanding account Dr. — Rs 60,000

Sundry creditors account Dr. — Rs 50,000

To Reconstruction account — Rs 3,00,000

To 12 per cent debentures account — Rs 4,10,000

(Being monies due to Mr B cancelled to the extent of Rs 3 lakh and credit to reconstruction account. Balance due, further satisfied by allotment of 12 per cent debentures.)

5) Sundry creditors account Dr. — Rs 1,75,000

To Reconstruction account — Rs 1,75,000

(50 per cent of balance of creditors, no more payable, on waiver as per scheme transferred to reconstruction account: Total crs — Rs 5,00,000;

Less: A and B — Rs 1,50,000; balance — Rs 3,50,000)

6) Directors' loan account Dr. — Rs 1,00,000

To Reconstruction account — Rs 40,000

To Equity share capital account — Rs 60,000

(Being equity share capital allotted to directors as settlement of loan

40 per cent waiver transferred to reconstruction account as profit.)

7) Reconstruction account Dr. — Rs 15,000

To cash account — Rs 15,000

(Amount paid as penalty for cancellation of a capital commitment)

8) Cash account Dr. — Rs 1,10,000

To reconstruction account — Rs 1,10,000

(Refund from directors of earlier fees received by them transferred to reconstruction account)

9) Reconstruction expenses account Dr. — Rs 10,000

To cash account — Rs 10,000

(Being reconstruction expenses incurred.)

10) Provision for tax account Dr. — Rs 1,00,000

To Cash account — Rs 80,000

To Reconstruction account — Rs 20,000

(Being the tax provision settled at Rs 80,000. Balance tax provision of Rs 20000 transferred to reconstruction on settlement.)

11) Reconstruction account Dr. — Rs 47,45,000;

To Goodwill account — Rs 10,00,000

To Patent account — Rs 5,00,000

To Land and building account — Rs 2,00,000

To Plant and machinery account — Rs 6,00,000

To Furniture and fixtures account — Rs 1,00,000

To Computers account — Rs 1,20,000

To Trade Investment account — Rs 1,00,000

To Stock account — Rs 3,00,000

To Discount on issue of debenture account — Rs 1,00,000

To P&L account — Rs 15,00,000

(Amounts available on reconstruction on scheme cr. to reconstruction

used to write off balances in goodwill, patent, P&L account and discount on issue of debentures in full and other assets to the extent required.)

The bank account is shown in Table 22.

Allocation of debenture interest written off: A — Rs 1,00,000; B — Rs 60,000.

Allocation of new 12 per cent debentures: A — Rs 7,00,000; and B — Rs 7,10,000

A reconstruction account and balance-sheet after reconstruction is also prepared for better understanding (see Tables 23 and 24)

Software accounting

HOW is software acquired for internal use accounted under AS 26?

Software acquired for internal use could be an expenditure or an intangible asset.

The appendix to AS 26 states that the cost of a software acquired for internal use should be recognised as an asset if it meets the criteria of para 20 and 21 of the standard.

Paras 20 and 21 dictate that an intangible asset can be recognised if (if and only if) it is probable that future economic benefits attributable to asset will flow to the enterprise and the cost of the intangible can be measured reliably.

Para 21 supplements to say that proper judgment is to be used to assess the economic benefits and their certainty.

According to para 23 the asset is to be initially measured at cost.

Deferred taxes

WHAT are the principles for recognition of deferred taxes under AS 22?

The underlying principle to recognise deferred taxes is explained in AS 22 itself.

The objective of AS 22 is to prescribe accounting treatment for taxes on income.

Taxes on income are accrued in the same period as the revenue and expenses to which they relate.

Since tax income and accounting income may be different (due to depreciation, disallowances, carry forward of losses for set off, and so on), the taxes saved in one year, say, on account of accelerated rate of depreciation under the I-T Act is nullified in the later years due to a reduced depreciation in I-T in later years for the same asset.

Simply put, reduced taxes in a year is not really a saving but a deferment.

The standard mandates to provide for such deferment as deferred tax apart from the taxes that has to be paid normally, namely the current tax.

The Standard requires recognition of timing differences (such as depreciation explained).

Timing difference leads to a deferred tax asset (DTA) or a liability (DTL). All DTL are to be recognised in P&L whereas to recognise DTA the following points are to be noted:

a) DTA relating to carry forward of losses are to be recognised only if there is a virtual certainty that there will be enough future profits to set off those losses.

b) Other timing differences leading to DTA (like disallowance under Section 43B) can be recognised if there is a reasonable certainty of making deductibility in the subsequent years.

(To be concluded)

(Suggested answers to the November 2003 CA (PE II) paper on accountancy.)

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