a) Capital Reconstruction
Dunstable Ltd has a statement of financial position with significant retained losses and
no cash (it holds a bank overdraft of £66,000). Its net assets stand at £84,000 and are
represented by the following capital and reserves:
£'000
Preference shares of £1 each fully paid
200
Ordinary shares of £1 each fully paid
100
Retained Earnings
(216)
Net assets
84
Dunstable has succeeded in creating a new product that its directors anticipate will
yield profits of £50,000 each year for at least the next five years, although this will
require additional funds. The following capital restructuring scheme has been
approved and authorised by its creditors:
1. 40% of the ordinary shares are to be surrendered.
2. The preference shares are to be surrendered and cancelled and the holder of every
50 preference shares will pay Dunstable £30 cash, and will be issued:
\textbullet One 7% loan note of £40 each, and
\textbullet 10 fully paid ordinary shares of £1 (redistributing the shares surrendered).
3. The freehold property is to be revalued upwards by £60,000.
4. The negative balance on retained earnings will be written off, and equipment will
be impaired by £4,000.
(i) Discuss the challenges that Dunstable would face in raising finance to fund its new
product given its current capital and reserves presentation. Explain how Dunstable
may be able to persuade both ordinary and preference shareholders - and its
creditors - to the restructuring scheme that is described above.
(12 marks)
(ii) Prepare the journals that would account for each of the adjustments (1) to (4)
outlined above and present a T-account of the Capital Reduction and
Reorganisation (CR&R) account that should clear to zero as a result of the
adjustments.
(12 marks)
