ACC703 FINANCIAL ACCOUNTING THEORY AND PRACTICE

LECTURE 8

Liquidation of Companies Textbook Reference: Leo et al. Company Accounting 8th Edition Chapter 20

What is a winding-up?
Process whereby a company is dissolved

At this point the company ceases to be a legal entity

Also referred to as a liquidation

Legal requirements contained in chapter 5 of Corporations Act

Two modes of winding up a company: Winding-up in insolvency and by the court Voluntary winding-up by members or creditors Accounting entries are the same in both cases

Winding-up in Insolvency and by the court

Where a company is insolvent, application may be made to the court for winding-up Application to the court may be made by the company itself, a creditor, a director and a contributory Once an application is made, the court may order the insolvent company to be wound up

Insolvency is presumed to exist under a number of circumstances set out in the Corporations Act. These include where:
A creditor serves a demand for unpaid debts over $2,000 and the debt remains unpaid after 3 months A receiver has been appointed under a floating charge on property A contributory refers to the holders or immediate past holders of shares in the company continued

Corporations Act also contains general grounds for windingup by the court. These include: The company has resolved by special resolution that it be wound-up The company does not commence business within a year of incorporation or suspends business for more than a year The company has no members Directors have acted in their own interests, or in a manner that is unfair or unjust to other members Affairs of the company are being conducted in a manner that is oppressive or unfairly prejudicial to, or unfairly discriminatory against a member or members, or in a manner that is contrary to the interests of the members as a whole
continued

 Insolvency is the most common reason for liquidation therefore the major accounting problem in liquidation is the apportionment of limited assets between creditors and shareholders A liquidator is appointed after the filing of the applications in order to see that the status quo of the company is maintained i.e. that the assets are not quickly drained from the company Liquidator is appointed to oversee the liquidation. The task of the liquidator is to: Take possession of the companys assets Realize the assets or carry on the business as necessary for the beneficial disposal of the assets Determine the creditors and order of priority of payment Pay the creditors Distribute the balance of funds (if any) to shareholders, or if necessary to make calls on shareholders for extra funds to meet creditors claims Bring about the dissolution of the company
continued

 The directors and secretary of the company must prepare and submit a Statement of Affairs to the liquidator within 14 days of the making of the order for winding-up The Statement of Affairs includes: Summary of assets and liabilities Details of charges over assets and secured liabilities Aim of the Statement of Affairs is to provide information concerning the companys estimated realizable values of assets and any expected surplus or deficiency of assets after deducting creditors claims After the liquidator has realized all the property, discharged the liability to creditors, and made a final return (if any) to contributories, he/she may apply to the court for the company to be deregistered. After deregistration, the company ceases to exist

Voluntary winding-up
A company may be wound-up voluntarily at the instance of either the members or the creditors Members voluntary winding-up The company is wound up by the members passing a special resolution to wind up Can only occur if the company is solvent Declaration of solvency must be made by the directors and attached to the statement of affairs
continued

Creditors voluntary winding-up

Occurs where there is no declaration of solvency. In such cases the winding-up is under the control of both members and creditors Company must provide creditors with a summary of affairs as well as a list of all creditors Creditors can nominate a liquidator, who will then proceed to wind up the company

Powers of the liquidator

Liquidator has wide ranging powers under the Corporations Act. Powers depend on whether the liquidation had been ordered by the court or is voluntary. In both cases liquidators must: Not make any concessions on any debts owing to the company of $20,000 or more Keep proper records in which entries and details of proceedings of meetings must be made Every 6 months during the liquidation appointment, the liquidator must prepare a statement of receipts and payments

continued

 In the case of a court ordered liquidation key powers of the liquidator include: Carry on the business of the company so far as is necessary for beneficial disposal or winding-up Pay any class of creditors in full Make arrangements with creditors or parties claiming to be creditors Come to agreements regarding calls, liabilities and claims existing, and take any security for the payment of such calls, liabilities and claims Other powers include everything that is necessary to wind up the affairs of the company and distribute the property Additional powers in relation to performing roles that are performed by the courts in court appointed liquidations (e.g. fixing a time when debts and claims must be proved)

Priority of payment of debts

The general principle under the Act is that all debts and claims rank equally and, if the property of the company is insufficient to meet them in full, they must be paid proportionately Many expectations to this rule. Four different categories of creditors Secured Preferential unsecured Ordinary unsecured Deferred A summary of priority of payment of creditors (assuming insolvency) is set out on the following slide

Priority of creditors
1. Secured creditors a) Secured by a specific charge Those claims against the company whereby the creditor has a charge against specific property, and holds a registered mortgage, bill of sale or lien over that property Any excess is returned to the liquidator Any shortfall is classified as an unsecured creditor b) Secured by a floating charge The security in this case does not relate to a specific item of property but relates to all assets of the company, i.e. It floats over whatever assets the company has at a particular time Where there are limited funds available, debts mentioned in items 12, 14 and 15 receive priority Expenses incurred by a liquidator or other relevant authority in preserving, realizing, to getting in property of the company, or in carrying on the companys business

2.

3.

Costs relating to court ordered applications

continued

4. 5.

Debts relating to the indemnification of the administrator Debts incurred by an official manager (where the management ceased < 2 months prior to the appointment of the liquidator) Costs associated with the preparation of a report as to the affairs of the company in the case of a court ordered liquidation Costs of the audit of the liquidators accounts Auditors fees related to the period of official management referred to in 5 above Any other expenses properly incurred by a liquidator or other relevant authority
continued

6.

7. 8. 9.

10. Liquidators remuneration 11. Expenses incurred by members of a committee of inspection

12. Wages and superannuation contributions payable to employees Limited to $2,000 for directors 13. Workers compensation payable
14. Employees leave entitlements Limited to $1,500 for directors 15. Retrenchment payments to employees (excluding directors)

continued

16. Unsecured creditors Includes shortfalls of secured debts and salary & wages, employee entitlements and retrenchment payment to directors Includes all debts payable to the government eg PAYE tax, VAT Although utility companies (electricity, etc) are unsecured they commonly receive preferential treatment by threatening to withdraw services 17. Deferred creditors

Rights of contributories
Contributories are defined as members or past members of a company In certain circumstance past shareholders may be required to contribute in the winding-up Three possible situations may arise Insufficient funds for creditors, requiring calls to be made on contributories Sufficient funds to pay creditors, but not to repay all share capital A surplus of funds over and above creditors claims and share capital

Insufficient funds for creditors

Where partly paid shares exist an order may be made to make calls on all or any of the contributories to the extent of their liability Once all shares have been paid in full, any deficiency is borne by creditors Most common scenario in practice

Sufficient funds to pay creditors, but not to repay share capital

Distributions made in accordance with the companys constitution For example, preference shareholders may receive preferential treatment over ordinary shareholders Distributions proposed by the liquidator are approved by a special resolution of members It is common for companys constitutions to specify that distributions are made on the basis of the number of shares held, regardless of the issue price of the shares Uncommon in practice

Surplus of funds
The rights of contributories to participate in a surplus should be specified in the constitution Note that a preference shareholders claim to preferential return of capital does not necessarily give them a right for preferential treatment with regard to a surplus Rare in practice

Accounting for liquidation

Five main tasks
1. Prepare relevant forms Statement of Affairs Summary of Affairs (creditors voluntary winding-up only) Declaration of solvency (members voluntary winding-up only) Realization of assets Possession of assets by secured creditors Payment to the creditors in order of priority Return of capital and surplus (if any) to shareholders

2. 3. 4. 5.

Accounting for liquidation

Realization of assets Realization of assets accounted for in the companys records using a liquidation account All assets (except cash) and all contra-asset accounts are transferred to this account On realization of the assets the cash account is debited and the liquidation account is credited Possession of assets by secured creditors

Assets over which a specific security is held are commonly taken into possessions by the secured creditor and sold Any net proceeds are handed to the liquidator, with any gain or loss credited to the liquidation account

Accounting for liquidation

Payment of creditors in order of priority

The remaining creditors are paid in order of priority Unrecorded liabilities (such as liquidation expenses) are accounted for by debiting the liquidation account and crediting the appropriate liability On settlement, the liability account is debited and cash credited Where creditors accept an amount lower than the carrying amount of the debt, this represents a discount given to the company and is accounted for by crediting the liquidation account

Accounting for liquidation

Return of capital to contributories Accounting procedures are: Calculate the distribution for each class of shareholder Make any necessary calls on unpaid capital Transfer share capital to a shareholders distribution account Transfer reserve accounts to the liquidation account Pay distributions by crediting the cash account and debiting the shareholders distribution account Transfer the balance of the liquidation account to the shareholders distribution account

 Basic format as follows: Liquidation

Carrying amts. of assets transferred (excluding cash) Unrecorded liabilities xx xx Contra-assets transferred xx Proceeds of sale xx Gain on disposal of secured asset after satisfaction of secured creditor xx Discounts from creditors xx Other reserves & retained earnings xx Balance (deficiency) transferred to Shareholders Distribution a/c xx xx

xx

Liquidators Cash
Balance Net amts. from secured creditors Proceeds on sale by liquidator Any calls on contributories xx xx xx xx xx Payment to creditors Distribution to contributories xx xx

xx

Shareholders Distribution
Distribution of cash to contributories xx Transfer of deficiency from Liquidation a/c xx xx Share capital xx

xx

Example: Bobby Ltd went into voluntary liquidation on 30 June 2011, its summarized statement of financial position then being:
Equity Share Capital: 80 000 shares issued at a price Of $1, called to 50c Less: Calls in arrears (20 000 at 25c) Current Assets Receivables Inventory Cash Non-current assets Land Plant Total assets Current Liabilities Payables Net Assets 5 000 6 000 4 000

40 000 (5 000)

15 000

20 000 9 000

29 000 44 000

Total Equity

35 000

9 000 35 000

All assets realized $30,000. Calls in arrears were fully collected. Payables allowed $500 discount. Costs of liquidation were $2,500. Record the above in the Liquidation a/c, the Liquidators Cash a/c and the Shareholders Distribution a/c

Liquidation
Carrying Amts: Land 20 000 Plant 9 000 Receivables 5 000 Inventory 6 000 Liquidation exp. Payable 2 500 42 500 Cash (from sale of assets) Discount from creditors Deficiency (to shareholders distribution a/c) 30 000 500 12 000 42 500

Liquidators Cash
Balance 4 000 Liquidation (sale of assets) 30 000 Calls in arrears 5 000 39 000 Liquidation exp payable 2 500 Payables 8 500 Shareholders distribution 28 000 39 000

Shareholders Distribution
Liquidation (deficiency) Cash 12 000 28 000 40 000 Share capital 40 000

40 000

End of Lecture 8

Tutorial Questions for Week 10

Leo et al. Company Accounting 8th Edition

Chapter 20

Review Questions: 2, 7, 11 Practice Questions: 20.3, 20.7, 20.9