Understanding the Liquidation Process in Financial Accounting: A Comprehensive Guide

Liquidation of a Company

The legal process of winding up a company is known as liquidation. Since a company is an artificial legal person created by law, it can be dissolved only through a formal legal procedure. The Companies Act specifies the detailed process through which companies may be wound up.

During liquidation, the assets of the company are realised (converted into cash), and the proceeds are used to settle the claims of creditors. If any surplus remains after paying all liabilities, it is distributed among the shareholders in accordance with the provisions of the company’s Articles of Association.

The liquidator is the person responsible for carrying out this process. Their duties include realising the company’s assets and settling its liabilities in an orderly and systematic manner.

Methods / Modes of Liquidation

1. Compulsory Winding Up - This occurs when the court orders the company to be wound up, usually on the petition of creditors, shareholders, or the government.
2. Voluntary Winding Up - This takes place when the members (shareholders) of the company decide to wind up the company on their own, without court intervention.
3. Voluntary Winding Up Under the Supervision of the Court - In this method, the winding-up process is initiated voluntarily by the members, but the court supervises the procedure to ensure proper conduct.

Compulsory winding up

A company may be wound up by the court under the following circumstances and this type of winding up is called compulsory winding up or winding up by the court

1. If the company is unable to pay its debt
2. If the default is made in filing the statutory report to the registrar or in holding the statutory meeting
3. If the company does not commence its business within a year from its incorporation or suspends it for a whole year.
4. If the number of members is reduced below 7 in case of a public company and below 2 in case of a private company
5. If the company has by special resolution resolved that the company may be wound up by the court.

Voluntary winding up

When members and creditors of a company decide to wind up the company without intervention of the court.

Two types 

1. Members voluntary winding up
2. Creditors voluntary winding up

Members voluntary winding up 

Directors of the company make a declaration of company’s solvency. In this declaration director have to give an assurance that the company will be able to pay its debts in full. This type of declaration by the directors of the company is called declaration of solvency. Appointment of liquidator and fixing has remuneration.

Creditors voluntary winding up 

If there is a voluntary winding up in which declaration of solvency has not been made by the directors, this winding up is called creditors voluntary winding up.

Voluntary winding up under supervision of court

At any time after a company has passed a resolution for voluntary winding up, the court make an order that the voluntary winding up shall continue but subject to such supervision of the court. Generally on terms and conditions of court. Fear of favourism, negligence or unnecessary delay.

Liquidator’s final statement of account

When the winding up is completed the liquidator has to prepare a final statement showing how much he realised and how the amount was distributed. This statement is just like final cash book.  It also called liquidator’s final statement of receipt & payment. It is statement not an account.

Receipts	Amount	Payments	Amount
To cash in hand or cash at bank		By legal expenses
To amount realised from sale of assets ·         Land & building ·         Plant & machinery ·         Furniture ·         Inventory (stock) ·         Trade receivable (debtor)		By liquidator’s remunerate ·         % on amount realised from assets. ·         % on amount paid to creditor ·         % on amount paid to shareholder
To surplus amount received from secured creditor		By liquidation expense or cost of winding up
To call from shareholder @Rs … on … shares		By debenture holder or offer creditor having floating charge on asset.
		By preferential creditor
		By offer unsecured creditors
		By preference shareholder
		By equity shareholder
	XXX		XXX

Illustration - (Liquidator’s Final Statement of Account)  X Ltd, with paid-up share capital of ₹1,00,000 divided into 10,000 equity shares of ₹10 each, went into voluntary liquidation on 31st March, 2013.

Liquidator realised the assets as follows:

• Land and Building – 50,000
• Plant and Machinery – 40,000
• Furniture – 10,000
• Stock – 15,000
• Debtors – 5,000

Its liabilities were as under:

• Secured Creditors – Secured on Land and Buildings – 20,000
• 8% Debentures – 25,000
• Preferential Creditors – 8,000
• Unsecured Creditors – 28,000

Liquidator’s remuneration was agreed at 3% on assets realised and 2% on the amount distributed among unsecured creditors. Expenses of liquidation amounted to ₹1,580 and the debentures were repaid on 30th September 2013. Prepare the Liquidator’s Final Statement of Account.

Solution

Receipts	Amount	Payments	Amount
To assets realised surplus from ·         land & building (50,000 – 20,000) = 30,000 ·         plant & machinery 40,000 ·         furniture = 10,000 ·         inventory (stock) = 15,000 ·         trade receivable (debtor) = 5,000	1,00,000	By liquidator’s remuneration ·         35 on 1,20,000 = 3,600 ·         2% on 8,000 = 160 ·         3% on 28,000 = 560	4,320
		By liquidation expense	1,580
		By 8% debenture holder – 25,000 ·         Add: interest – 1,000	26,000
		By preference creditor	8,000
		By unsecured creditor	28,000
		By equity shareholder (3.21 per share i.e. 32,100 – 10,000 share)	32,100
	1,00,000		1,00,000

Total Amt Available for Distribution – ₹1,20,000

Less: Liquidator’s Remuneration (3% on 1,20,000) – (3,600)

Balance – ₹96,400

Less: Liquidation Expenses – (1,580)

Balance – ₹94,820

Less: 8% Debenture – (25,000)

Balance – ₹69,820

Less: Interest Due on Debenture upto liquidation – —

Balance – ₹69,820

Less: Preferential Creditors – (8,000)

Balance – ₹61,820

Less: Liquidator’s Remuneration

2% on 8,000 – (160)

Balance – ₹61,660

Less: Unsecured Creditors – (28,000)

Balance – ₹33,660

Less: Liquidator’s Remuneration

2% on 28,000 – (560)

Balance – ₹33,100

Less: Interest due on Debentures after liquidation

(8% on ₹25,000 for 6 months) – (1,000)

Balance – ₹32,100

Payment to Equity Shareholders = ₹32,100

Statement of affairs

According to companies act, where the court has made a winding up order & appointed the official liquidator, the officers & directors of the company must make out and submit to the official liquidator within 21 days of the courts order a statement as to the affairs of the company. Such a statement is called statement of affairs.

It contains the following details:

1. The assets of the company, cash balance in hand, at the bank, negotiable securities etc.
2. Debts and liabilities of the company
3. The names, addresses and occupations of its creditors stating separately the amount of secured and unsecured debts and in the case of secured debts, particulars of the securities given their value and the dates on which they were given
4. The debts due to the company and names, addresses and occupation of the persons from whom they are due and the amount likely to be realized
5. Such further or other, information as may be prescribed by the central govt or as the official liquidator may require.

Deficiency or surplus account

Deficiency or surplus a/c is also annexed with the statement of affairs. It is prepared to prove the deficiency or surplus shown by the statement of affairs. In case of winding of a company, this account may show either surplus or deficiency. It is not necessary that only an insolvent company is wound up.

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