This Section addresses the conditions under which a corporation may recognize a readjustment of its retained earnings or accumulated deficit balance.
The general requirement is that additional paid-in capital, however created, shall not be used to relieve the income account of the current or future years of charges that would otherwise be made to the income account. As an exception to this requirement, if a reorganized entity would be relieved of charges that would be required to be made against income if the existing corporation were continued, it may be permissible to accomplish the same result without reorganization provided the facts were as fully revealed to and the action as formally approved by the shareholders as in reorganization.
If a corporation elects to restate its assets, capital stock, additional paid-in capital, and retained earnings or accumulated deficit through a readjustment and therefore avail itself of permission to relieve its future income account or retained earnings account of charges that would otherwise be made against it, it shall make a clear report to its shareholders of the restatements proposed to be made, and obtain their formal consent. It shall present a fair balance sheet as at the date of the readjustment, in which the adjustment of carrying amounts is reasonably complete, in order that there may be no continuation of the circumstances that justify charges to additional paid-in capital.
When the amounts to be written off in a readjustment have been determined, they shall be charged first against retained earnings to the full extent of such retained earnings; any balance may then be charged against additional paid-in capital. An entity that has subsidiaries shall apply this rule in such a way that no consolidated retained earnings survive a readjustment in which any part of losses has been charged to additional paid-in capital. If the retained earnings of any subsidiaries cannot be applied against the losses before application against additional paid-in capital, the parent entity's interest in such retained earnings shall be regarded as capitalized by the readjustment just as retained earnings at the date of acquisition is capitalized, so far as the parent is concerned.
The effective date of the readjustment, from which the income of the entity is subsequently determined, shall be as near as practicable to the date on which formal consent of the stockholders is given, and shall ordinarily not be before the close of the last completed fiscal year. When the readjustment has been completed, the entity's accounting shall be substantially similar to that appropriate for a new entity.
Additional paid-in capital originating in such a readjustment is restricted in the same manner as that of a new corporation; charges against it shall be only those which may properly be made against the additional paid-in capital of a new corporation.
The accounting for tax benefits arising from deductible temporary differences and carryforwards related to a readjustment is addressed in Subtopic
852-740.