Liquidation Of a Company Defination with Example

LIQUIDATION

Definition and Necessity

"Liquidation" is the act of terminating or winding up the business by a company. In this case not only the business activities are closed, but steps are also taken to close the books of accounts.

When a company is in financial. difficulties, which cannot be overcome through internal reconstruction i.e. recapitalization measures described in the earlier section, the only way is the external reconstruction, which involves:

·         Winding up the old company

·         Formation of a new company to replace the liquidated company or its taking over by a new company.

Accounting Entries for Liquidation

The entries necessary to close the books of the company that goes into liquidation will be similar to those, which are required in the case of dissolution of the partnership, which have already been described. It is necessary to open a realization account in this case. The procedure for debit and credit is as under:

•          i.            Debit realization account and credit each asset account at book value. This will result in closing asset accounts in the ledger.
•        ii.            Debit each liability account by a credit to realization account if the liabilities are taken over by the purchasing company. This will close the liability accounts in the ledger.
•      iii.            Debit the purchaser's account and credit the realization account with the agreed purchase price.
•      iv.            If the expenses of liquidation are to be borne by the purchasing company, debit the purchasing company's account and credit bank.
•        v.            Debit realization account with other expenses not borne by the purchasing company and credit cash or bank. The realization account will now show profit or loss, which will be transferred to the shareholders' accounts.
•      vi.            Transfer the share capital account, reserve, funds, balance c profit and loss account to shareholders' accounts.
•    vii.             When purchasing a company or other purchasers make payment by cash or issue of shares, debit cash, and shares and credit the purchasing company.
•  viii.            Debit shareholders' account and credit cash and shares when the same are distributed to the shareholders.

This will close all the accounts of the liquidating company. The above procedure will be clear from the following example.

Detailed Example-

Given below is the balance sheet of M & N Company limited.

Capital & Liabilities             Amount             Assets                          Amount

20000 shares of Rs.IO each         200000         Land and Building                    100000

Debentures                                    100000         Plant & machinery                    25000

Reserve Fund                                 25000           Work in Progress                     30000

Dividend equalization Fund         20000           Stock                                           60000

Profit & Loss Appropriation        5100            Furniture & Fitting                     2500

Sundry Creditors                          30000           Sundry Debtors                         25000

                                                                              Cash at bank                              12500

                                                                              Cash in hand                              100 

A bargain is struck with A & B company limited according to which directors of M & N company agree to wind up their company by taking necessary steps and A & B is to take over the business of the liquidating company on the following terms and conditions:

        I.            The taking over the company to discharge all debentures at a premium of 5%.