Questions: QUESTION FOUR a. What is reconstruction and why would a firm want to reconstruct its capital structure? (4 Marks) b. Machambire-Kitundu Ltd (MKL) decided to reconstruct its financial structure. The following scheme of reconstruction was proposed. i. To reduce each share to TZS 6. ii. To write off debentures by 20% iii. To request the banker to write off interest on bank loan. iv. To reduce creditors by TZS 18,000 Information extracted from the statement of financial position of MKL included: a) 10,000 Equity shares of TZS 10 each fully paid. b) 20,000 equity shares of TZS 10 each TZS 8 paid. c) Debentures TZS 120,000, d) Bank loan TZS 90,000 (including interest of TZS 5,400); e) Creditors TZS 80,000. The retained earning account had a debit balance of TZS 110,400; preliminary expenses TZS 15,000; discount on shares debentures TZS 2,000. Required: Provide necessary entries and show the capital reduction account. (8.5 Marks)

QUESTION FOUR a. What is reconstruction and why would a firm want to reconstruct its capital structure? (4 Marks) b. Machambire-Kitundu Ltd (MKL) decided to reconstruct its financial structure. The following scheme of reconstruction was proposed. i. To reduce each share to TZS 6. ii. To write off debentures by 20% iii. To request the banker to write off interest on bank loan. iv. To reduce creditors by TZS 18,000 Information extracted from the statement of financial position of MKL included: a) 10,000 Equity shares of TZS 10 each fully paid. b) 20,000 equity shares of TZS 10 each TZS 8 paid. c) Debentures TZS 120,000, d) Bank loan TZS 90,000 (including interest of TZS 5,400); e) Creditors TZS 80,000. The retained earning account had a debit balance of TZS 110,400; preliminary expenses TZS 15,000; discount on shares debentures TZS 2,000. Required: Provide necessary entries and show the capital reduction account. (8.5 Marks)
Transcript text: QUESTION FOUR a. What is reconstruction and why would a firm want to reconstruct its capital structure? (4 Marks) b. Machambire-Kitundu Ltd (MKL) decided to reconstruct its financial structure. The following scheme of reconstruction was proposed. i. To reduce each share to TZS 6. ii. To write off debentures by $20 \%$ iii. To request the banker to write off interest on bank loan. iv. To reduce creditors by TZS 18,000 Information extracted from the statement of financial position of MKL included: a) 10,000 Equity shares of TZS 10 each fully paid. 3 Scanned with CamScanner b) 20,000 equity shares of TZS 10 each TZS 8 paid. c) Debentures TZS 120,000, d) Bank loan TZS 90,000 (including interest of TZS 5,400); e) Creditors TZS 80,000. The retained earning account had a debit balance of TZS 110,400; preliminary expenses TZS 15,000 ; discount on shares $\&$ debentures TZS 2,000. Required: Provide necessary entries and show the capital reduction account. (8.5 Marks)
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Solution

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a. What is reconstruction and why would a firm want to reconstruct its capital structure?

Reconstruction refers to the process of reorganizing a company's capital structure, which may involve altering the composition of its equity and debt. This can include actions such as reducing the nominal value of shares, converting debt into equity, or writing off certain liabilities. Firms may choose to reconstruct their capital structure for several reasons:

  1. Financial Stability: To improve financial stability by reducing debt levels and interest obligations, which can enhance liquidity and solvency.

  2. Operational Efficiency: To streamline operations and reduce costs associated with servicing high levels of debt or managing complex capital structures.

  3. Attract Investment: To make the company more attractive to investors by presenting a healthier balance sheet and potentially increasing the value of shares.

  4. Regulatory Compliance: To comply with regulatory requirements or to meet conditions set by creditors or investors.

b. Machambire-Kitundu Ltd (MKL) Reconstruction Scheme

To address the reconstruction scheme proposed by MKL, we need to make the necessary accounting entries and show the capital reduction account. Here is how the entries would be made based on the provided information:

  1. Reduction of Share Capital:

    • Reduce each fully paid share from TZS 10 to TZS 6.
    • Reduce each partly paid share from TZS 10 to TZS 6.

    Journal Entries:

    • Debit: Share Capital (10,000 shares x TZS 4) = TZS 40,000
    • Debit: Share Capital (20,000 shares x TZS 4) = TZS 80,000
    • Credit: Capital Reduction Account = TZS 120,000

  2. Write off Debentures by 20%:

    • Debentures are TZS 120,000, so 20% reduction is TZS 24,000.

    Journal Entry:

    • Debit: Debentures = TZS 24,000
    • Credit: Capital Reduction Account = TZS 24,000

  3. Write off Interest on Bank Loan:

    • Interest on the bank loan is TZS 5,400.

    Journal Entry:

    • Debit: Bank Loan = TZS 5,400
    • Credit: Capital Reduction Account = TZS 5,400

  4. Reduce Creditors by TZS 18,000:

    Journal Entry:

    • Debit: Creditors = TZS 18,000
    • Credit: Capital Reduction Account = TZS 18,000

Capital Reduction Account:

| Description | Amount (TZS) | |------------------------------|--------------| | Credit from Share Capital | 120,000 | | Credit from Debentures | 24,000 | | Credit from Bank Loan | 5,400 | | Credit from Creditors | 18,000 | | Total Credits | 167,400 |

The capital reduction account will be used to offset the debit balance in the retained earnings account and other preliminary expenses.

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