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Reconstruction

ACCOUNTANT (Student) (559 Points)

14 June 2020

After the process of Reconstruction, excess of Assets over liabilities would be shown as Goodwill on Reconstruction, whether it's same for the reverse, i.e., can capital reserve be shown on Reconstruction? Please explain

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2 Replies

yasaswi gomes (My grammar is 💯 good I) (7290 Points)
Replied 15 June 2020

Reconstruction is not an accounting term, but finance terminology used in capital restructuring which is used in investment appraisal to minimise WACC. Reconstruction is balancing debt and equity structures.

Next, due to new principle based accounting standards, it is prescribed that goodwill occurs due to acquisition only.

Then, using the balance sheet equation Equity=Assets-Liabilities. If the result is positive, then there is capital equal to excess assets already existing.

Also, there are two types of reserves, capital and revenue. These reserves are created out of profits for a specific purpose and to be used in the future. This has nothing to do with reconstruction.

yasaswi gomes (My grammar is 💯 good I) (7290 Points)
Replied 15 June 2020

If the mixture of debt and equity is 5000 and 5000.

The weights will be 0.5 and 0.5.

If Kd=10% and Ke= 15%, then WACC= 0.5*10%+(0.5*15%)= 12.5%

this 10000 raised capital is transferred to reserves to use it when the project starts.

If we restructure debt to 8000 and equity to 2000, the Wd=0.8 and We=0.2.

Then, WACC= 0.8*10%+(0.2*15%)= 11%

Irrespective of the restructuring, the company paid 10,000 to acquire a company and the NCI= 1000 and fair value of net identifiable assets= 6000₹, the Goodwill on acquisition is

10000

+1000

-6000

= 5000₹

This goodwill is not impacted by reserves but subsidiaries reserves are included in retained earnings. Next, when you reverse the acquisition, there is no guarantee that you will receive all the consideration back.