Chapter 16

Insolvency and liquidation

& Revision

Presenter

Associate Professor Parmod Chand

 Announcements

Final Exam - The FE format and instructions are available on

Moodle now. It will be held on Friday 11th February 2022 at 5pm.
Sitting arrangements will be published later.
Students will sit for the exam at their own registered campuses

Coursework marks - The marks will be up on Moodle by next week

Friday. Check that everything is correct.
 What is a winding-up?

• Process whereby a company is dissolved

• Company ceases to be a legal entity

• Also referred to as a liquidation

• Two modes:
– Winding-up in insolvency by the court
– Voluntary winding-up by members or creditors

• Accounting method the same in both cases

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 Winding-up by the court

• Where a company is insolvent, application may be made to the court

for winding-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

• Insolvency is the most common reason for liquidation – therefore

the major accounting problem is the apportionment of limited
assets between creditors and shareholders
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 Winding-up by the court

Corporations Act also contains general grounds for winding-

up. 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
• Directors have acted in self-interest or unfair or unjust
manner
• Directors actions have been oppressive, or unfairly prejudicial
or discriminatory
• ASIC issue a request for the company to be wound up

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 Winding-up by the court

Liquidator is appointed to oversee the liquidation. The task of

the liquidator is to:

• Take possession of the company’s assets

• Realise 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
• Bring about the dissolution of the company

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 Winding-up by the court

• The directors 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

• Within 2 months of receipt of the Statement of Affairs the

liquidator must lodge a report outlining:
– Estimated assets and liabilities of the company
– The causes of failure
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 Voluntary winding-up

A company may be wound-up voluntarily at the instance of

either the members or the creditors

Members voluntary winding-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

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 Voluntary winding-up

Creditor’s 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

• Creditors can nominate a liquidator. Where this is different

to the member appointed liquidator the creditors liquidator
will be appointed as a replacement

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 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

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 Powers of the liquidator

• In the case of a court ordered liquidation key powers under s

477(1) 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 parties claiming to be creditors
– Come to agreements regarding calls, liabilities and claims
existing

• Other powers are contained in s 477(2) and include everything that

is necessary to wind up the affairs of the company and distribute
the property
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 Priority of payment of debts

• The general principle under the Act is that all debts and claims
rank equally

• 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
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 Priority of creditors

1. Secured creditors
a) Secured by a specific charge
• Any excess is returned to the liquidator
• Any shortfall is classified as an unsecured creditor
b) Secured by a floating charge
• Where there are limited funds available, debts mentioned in
items 12, 14 and 15 receive priority

2. Expenses incurred by a liquidator or other relevant authority in

preserving, realising, to getting in property of the company, or in
carrying on the company’s business

3. Costs relating to court ordered applications

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 Priority of creditors

4. Debts relating to the indemnification of the administrator

5. Costs associated with the preparation of a report as to the affairs of
the company in the case of a court ordered liquidation
6. Costs of preparing a report by an administrator to be given to a
liquidator, if the company resolves to be wound up voluntarily
7. Costs of the audit of the liquidators accounts
8. Any other expenses properly incurred by a liquidator or other
relevant authority

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 Priority of creditors

9. Liquidator’s remuneration
10. Expenses incurred by members of a committee of inspection
11. Wages, super contributions and superannuation guarantee charge
payable to employees
– Limited to $2,000 for excluded employees
12. Workers compensation payable
13. Employees leave entitlements (e.g. annual leave, LSL, sick leave)
– Limited to $1,500 for excluded employees

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 Priority of creditors

14. Retrenchment payments to employees (except excluded

employees)
15. Ordinary unsecured creditors
– Includes shortfalls of secured debts and salary & wages, employee
entitlements and retrenchment payment to excluded employees
– Includes all debts payable to the government – e.g. PAYG tax, GST
– Although utility companies (electricity, telcos etc.) are unsecured
they commonly receive preferential treatment by threatening to
withdraw services

16. Deferred creditors

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 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

– Sufficient funds to pay creditors, but not to repay
share capital
– A surplus of funds

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 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, and deficiency is

borne by creditors

• Most common scenario in practice

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Sufficient funds to pay creditors, but not to
repay share capital
• Distributions made in accordance with the company’s
constitution
• For example, preference shareholders may received preferential
treatment over ordinary shareholders
• Distributions proposed by the liquidator are approved by a
special resolution of members
• It is common for company’s 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
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 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

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 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)
2. Realisation of assets
3. Possession of assets by secured creditors
4. Payment to the creditors in order of priority
5. Return of capital and surplus (if any) to shareholders

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 Accounting for liquidation

Realisation of assets
• Realisation of assets accounted for in the company’s records using
a “liquidation” account
• All assets (incl contra account but excl cash) are transferred to this
account
• On realisation 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
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 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

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 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

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 Question 1

QUESTION 16.2

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 Question 1 Solutions
       
Proceeds from sale of assets     $671 650
Less payment of debts (in order of priority)      

1. Liquidator's expenses $3 000  

2. Secured debts      
First mortgage $100 000    
Second mortgage 70 000 170 000  
3. Circulating security interest:      
Debentures   300 000  
4. Liquidator’s remuneration   8 000  
5. Wages:      
Employees 4 000    
Secretary 720    
Managing director 2 000    
Sales commission 500 7 220  
6. Employees' holiday pay   5 000 493 220
Amount available for unsecured creditors     178 430

7. Ordinary unsecured creditors      

  Owed Percent dividends Paid

Unsecured notes 100 000 90.04 90 040

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 Question 1 Solutions
Trade accounts payable 80 000 90.04 72 032

Fringe benefits tax 2 000 90.04 1 801

PAYG tax instalment 780 90.04 702

GST 1 989 90.04 1 790

Directors' fees 3 000 90.04 2 701

Managing director's salary 400 90.04 360

Second mortgage 10 000 90.04 9 004

  198 169   178 430

Percentage dividend to trade accounts payable = $178 430/198 169

= 90.04c in $

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 Tute Questions

No tutes will be held for this Topic and it will not be tested
in the final exam.

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 Topic 1

• Annual Reporting Requirements

• Materiality
• Events Occurring After Reporting Date

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 Topic 2

• Conceptual Framework
• Recognition and measurement criteria (A, L, R, E and
OE)
• Accounting Policies & changes
• Concepts of corporate governance

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 Topic 3

• Accounting for company income tax

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 Topic 4

• Revaluations and impairment of assets

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 Topic 5 & 6

• Presentation of financial statements

– Statement of Financial Position

– Statement of Profit or Loss and Other
Comprehensive Income
– Statement of Changes in Equity
– Statement of Cash flows

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 Topic 7

• Business Combinations

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 Topic 8, 9 & 10

• Consolidation: controlled entities

• Determination of control
• Worksheet entries at acquisition date
• Business combination valuation entries
• Pre-acquisition entry at acquisition date
• Intragroup transactions

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 Topic 11

• Accounting for investments in associates

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