CORPORATE

ACCOUNTING

Internal
Reconstruction

Submitted to:- Dr. Kajal

Submitted by:-

Bhanu Bains

307/19

BCom.LLb

Section-F
 1. INTRODUCTION

What is Reconstruction?

Re-construction is a process of re- organization of a

company. It takes place when the financial position of the company is not good
due to overvaluation of assets, accumulated losses etc. It is re-organization with
a view to run the company efficiently in the future. It involves writing off
accumulated losses, fictitious assets and overvaluation of assets out of the
sacrifice of the shareholders viz. shareholders, debenture holders and creditors
so as to give a realistic view of financial position of the company.

Need for Internal Reconstruction:

Internal Reconstruction is necessary due to the following reasons:

1. Final statements not True & Fair:

When the company is making heavy losses, the financial

statement do not show true and fair view of the state of affairs of the
company.

2. Assets:

The asset side of the balance sheet of a company may have intangible assets,
fictitious assets, accumulated losses, deferred revenue expenditure etc. The real
assets are shown at a high value. Due to losses adequate depreciation may not
be provided, stock may be valued at a higher rate. No provision may be made
for bad and doubtful debts.

3. Liabilities:

The Company may have secured and unsecured loans which

may be repaid. It may become overdue Interest on loan may be in arrears.

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 Creditors may be long overdue. Preference dividend on preference shares
may be in arrears over a long period.

4. Capital:

Capital of a company is lost due to drastic fall in the value

of assets. It is not represented by the by the real value of assets.

5. Reconstruction:

Due to continuous losses, basic structure of the company

gets damaged. The pillars on which the super structure is based become
weak and the company may collapse at any time. Hence the company has
to be placed on strong foundation in order to ensure stability in future.

2. TYPES OF RECONSTRUCTION

Company Reconstruction:

A term used to describe the drastic formal changes in a

company’s capital structure as a result of certain circumstances. There are two
types of reconstruction.

(1) External Reconstruction:

When a company has no power to operate his own business

due to heavy loss and it sells his all business to a new company. It will be
external reconstruction.

(2) Internal Reconstruction:

Internal Reconstruction means to do every action for

bringing the company out of losses. If a company is suffering heavy losses,
company can use the provision 94 of Indian Company law 1956 and reduce its
capital.
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 3. Provisions of company Law

(1) Alteration of share capital

o Increase of Authorized Capital-

 There should be a provision in the MOA and AOA for

increasing share capital. In case there is no provision in the
MOA and AOA, the company must change them.

 The company is required to give a notice to the Registrar as

regards this resolution within 30 days of its passing.

 Alteration of share capital beyond the authorized does not

require permission of the court.

 Sanction of the SEBI Is necessary if the shares to be offered are

more than the certain value.

 Board resolution is necessary to effect alteration.

o Consideration of shares-

 There must be a specific provisions for the consideration of the

A/A.

 Board resolution must be passed to convene a general

meeting of a share holder.

 An ordinary resolution passed by the general meeting is

necessary to undertake consolidation.

 Notice of consolidation of shares must be sent to the Registrar

of companies within one month.

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 o Subdivision of shares-

 AOA must make a provision for sub-division of shares.

 Resolution passed by general meeting is necessary.

 A notice is to be sent to the Registrar of company.

o Conversion of shares into stock-

o Only fully paid up shares can be converted into stocks.

o A/A must provide for conversion.

o Resolution at general meeting is necessary.

o Permission of stock exchange is necessary if the shares are

listed with a stock exchange.

o A notice to be sent to the Registrar of Companies.

Cancellation of shares

 A Company must be authorized by its A/A to effect the change.

 A resolution passed an extra ordinary general meeting must

sanction such a change.

(2) Capital Reduction

Legal Aspect

 A company is permitted to reduce its share capital under

Section 100 in any of the following ways:

 By reducing the liabilities on any of its shares in respect of

share capital not called.

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  By paying off any paid up capital which is in excess of the
requirements of a company.

 By cancellation of any paid up capital which is lost or which

is not represented by available assets.

 By any other method which may be approved by available

assets.

 A company cannot reduce its share capital unless it is

authorized by its AOA.

 A special resolution for reduction of capital must be passed by

the company.

 Capital Reduction must be approved by the court.

 The court may order confirmation of capital reduction on such

terms and conditions as it may think fit.

 The court may order the company to add the words “and
reduced” to the name of the company for such period as it may
deem fit.

 The order of the court must be produced before the Registrar of

the company and a certified copy of the same and of the
minutes should be filed with the Registrar of Companies for
registration.

 A company must publish reasons for reduction for public

information, if the court orders.

 A company must publish notice of registration in such a manner

as the court may direct.

 Every Balance Sheet subsequent to the reduction must show the

reduced figures with the date of reduction in place of the
original cost.

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 4. BASIC JOURNAL ENTRIES

Basic Journal Entries to be known before starting up with the problem are as
follows-

1) 20,000 Equity share of Rs. 100 each are reduced to share of Rs. 40
each fully paid up.

Equity share capital (of 100 each) A/c …Dr 2000000

To Equity share capital 800000
To Capital reduction A/c 1200000
(The face value has changed from Rs.100 to Rs.40.)

2) 20,000 Equity share of Rs. 100 each are reduced to share of Rs. 40
each Rs.20 paid up.

Equity share capital (of 100 each) A/c … Dr 2000000

To Equity share capital A/c 400000
To Capital reduction A/c 1600000

3) 20,000 Equity share of Rs. 100 each are reduced to share of Rs. 60
each fully paid up.

Equity share capital A/c …Dr 800000

To Capital reduction A/c 800000
(The face value has been retained at Rs.100. the paid up value is being
reduced.)

4) 20,000 Equity share of Rs. 100 each are reduced by Rs. 30 per share.

a) If it is assumed the face value has reduced then,

Equity share capital (Rs.100 each) A/c …Dr 2000000

To Equity share capital (of 70 each) 1400000

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 To Capital reduction A/c 600000

b) It is assumed that face value remains the same,

Equity share capital A/c …Dr 600000

To Capital reduction A/c 600000

5) Arrears of preference dividend.

a) If it is cancelled – No entry.

b) If it is settled (To the extent it is paid)

Capital reduction A/c …Dr

To Cash/Bank A/c
(Or)
To Equity share Capital A/c

6) Holders of 20000 11% Pref. share of Rs.100 each are allotted 20000
13% pref. share of Rs.20 each.

11% pref. share capital A/c …Dr 200000

To 13% Preference share capital A/c 400000

To Capital reduction A/c 1600000

7) Balance sheet.

7% Debenture 60000 Free hold land & 34000

Accrued interest 4200 building
64200

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 A piece of land valued in the books of Rs.6000 has been taken over by
debenture holders in part repayment of the principle at an agreed value of
Rs.14000. The debenture int. is settled in cash. The remaining freehold
land & building is revalued at Rs.40000.

a) Appreciation of land & building.

Free hold Land & Building A/c …Dr 8000

To Capital reduction A/c 8000

b) Takeover by 7% Debenture holder.

7% Debenture A/c …Dr 14000

To freehold Land & building A/c 14000

c) Payment of Accrued interest.

Accrued interest A/c …Dr 4200

To Cash/Bank A/c 4200

d) Appreciation of Bal. freehold land& building

Freehold land & building A/c Dr.12000

To Capital reduction A/c 12000

Total freehold land & building

34000

6000 28000

Takeover by Deb. Holders Appreciation to Rs.40000

for Rs.14000 (therefore appreciation Rs.12000)

8) If the outstanding Deb. Interest appearing in the Balance sheet is

canceled then it would result into a profit.

Accrued interest on 7% A/c …Dr

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 To Capital reduction A/c

9) Payment of unrecorded liability. In this case the treatment would be

similar to contingent liabilities for example - arrears of profit
dividend.

10) The creditors of Rs.50000 agreed for a remission of the

liability. On the condition that 25% of the net liability is paid
immediately. The balance is postponed and would be paid after four
years.

Creditors A/c …Dr 20000

(20% of 50000) To Capital reduction A/c 10000

(25% of 40000) To Cash/Bank A/c 10000

The liability of Rs.30000 is to be paid after 4 years. Current

liabilities should include amounts which is payable within a period of 12
months. Hence such balance of Rs.30000 should be reflected under the head
unsecured loans.

11) Sale of assets

Cash/Bank A/c …Dr

Capital reduction A/c (if loss) …Dr
To Assets A/c (Book value)
To Capital reduction A/c

12) Fresh issue of shares

Cash/Bank A/c …Dr

To Share capital A/c

13) Expenses of reconstruction

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 Capital reduction A/c …Dr
To Cash/Bank A/c

14) If there are any existing reserves i.e. reserves appearing on the
liabilities side of the balance sheet than it can be utilized for w/off the
losses. In this case transfer the reserve to the Capital reduction A/c.

Reserves A/c …Dr

To Capital reduction A/c
(The reserves should be utilized only if instructions are given.)

15) Write off the accumulated losses intangible assets, fictitious

assets and other assets (to the extent overvalued).

Capital reduction A/c …Dr

To Profit/Loss A/c
To Goodwill, Patents etc.
To Misc. expenditure A/c
To Other assets A/c
(To the extent over valued)

16) If there is any credit balance in the capital reduction A/c than
it should be transferred to capital reserve.

Capital reduction A/c …Dr

To Capital reserve A/c

17) Consolidation of shares

100000 equity shares of Rs.10 each are consolidated into 10000 equity
shares of Rs.100 each.

Equity share capital A/c (10 each) …Dr 1000000

To Equity share capital A/c (100 each) 1000000

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 18) Sub division of shares

10000 equity shares of Rs.100 each are being subdivided into 100000
equity share of Rs.10 each.

Equity share capital A/c (100 each) …Dr 1000000

To Equity share capital A/c (10 each) 1000000

(Neither consolidation nor sub division would affect the capital reduction
A/c)

5. ILLUSTRATIONS

(Q.1.) The following is the summarized balance sheet of X Ltd. As on 31 st

March, 1990:

Liabilities Amount Assets Amount

(Rs.) (Rs.)

Authorized and Issued Goodwill 1,20,000

Capital:
30,000 Preference Shares 3,00,000 Land and Building 2,67,000
of Rs. 10 each
6,00,000 Equity Shares 6,00,000 Plant 2,55,000
of
Rs. 1 each
6% Debentures Shares in Subsidiary Ltd. 75,000
(Secured on land and (at cost)
building) 1,20,000
Accrued Int. 6,000 1,26,000
Bank Overdraft 1,65,000 Stock 2,25,000
(Secured on stock)
Directors Loans 75,000 Debtors 2,70,000
Sundry Creditors 2,70,000 Profit and loss A/c 2,64,000

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 Deferred Expenditure:
Advertisement 60,000

15,36,000 15,36,000

NOTE:

 There is a contingent liability for damages of Rs. 30,000.

 Preference Shares are cumulative and dividends are in arrears for 3 years

A capital Reduction Scheme setting the following terms was duly approved:

1) The Preference Shares to be reduced to Rs. 8 per share and the Equity
Shares to 25 paisa each and to be consolidated as shares of Rs. 10 each
and Rs. 1 each fully paid respectively. The preference shareholders
waived 2/3rd of the dividend in arrears and received equity shares for the
balance. The Authorized capital to be restored to 30,000 preference
shares of Rs. 10 each and 6,00,000 equity shares of Rs. 1 each.
2) The shares in Subsidiary Ltd. Are sold to an outsider for Rs. 1,50,000.
3) All intangible assets are to be eliminated and bad-debts of Rs. 21,000 and
obsolete stock of Rs. 30,000 to be written off.
4) The debenture holders to take over the companies land and building
(book value-Rs. 54,000) at a price of Rs. 60,000 in part satisfaction of the
debentures and to provide further cash Rs. 45,000 on a floating charge.
The arrears of interest are paid.
5) Directors refund Rs. 10,000 of the fees previously received by them.
6) The contingent liability materialized in the sum stated but the company
recovered Rs. 15,000 of these damages in action against one of its
directors. This was debited to his loan account of Rs. 24,000. The balance
of which was paid in cash on his resignation.
7) The remaining directors agreed to take equity shares in satisfaction of
their loans.

You are required to:

A) Pass Journal Entries, including cash transactions,

B) Draft revised balance sheet.

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SOLUTION:

Journal Entries in the books of X Ltd

Date Particulars L Debit Credit

F (Rs.) (Rs.)

(1)
(i) Rs.10 Preference Shares A/c… Dr 3,00,000
To Rs.8 Preference Shares A/c 2,40,00
0
To Capital Reduction A/c 60,000
(Being preference shares of Rs. 10 each reduced
to Rs.8 per share.)

(ii) Rs.1 Equity Shares A/c … Dr 6,00,000

To Rs. 0.25 Equity Shares A/c 1,50,00
0
To Capital Reduction A/c 4,50,00
0
(Being equity shares of Rs. 1 each reduced to Rs.
0.25 per share.)

(iii) 30,000 Preference Shares A/c (Rs.8 )… 2,40,000

Dr
To 24,000 Preference Shares A/c (Rs.10) 2,40,00
0
(Being preference shares consolidated of Rs. 10
each as fully paid.)

(iv) 6,00,000 Equity Shares A/c (Rs. 0.25)… 1,50,000

Dr
To 1,50,000 Equity Shares A/c (Rs. 1) 1,50,00
0

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 (Being equity shares consolidated of Rs. 1 each as
fully paid.)

(v) Capital Reduction A/c… Dr 18,000

To Equity Share Capital A/c 18,000
rd
(Being 2/3 of dividend waived and received
equity shares for the balance.)

(2) Bank A/c… Dr 1,50,000

To Shares in Subsidiary Ltd. A/c 75,000
To Capital Reduction A/c 75,000
(Being shares in subsidiary ltd. are sold.)

(3) Capital Reduction A/c… 4,95,000

Dr
To Goodwill A/c 1,20,000
To Profit and Loss A/c 2,64,000
To Deferred Advertisement A/c 60,000
To Debtors A/c 21,000
To Obsolete Stock
(Being intangible assets, obsolete stock and
bad-debts written off.)

(4)
(i) Debentures A/c… Dr 60,000
To Land and Building A/c 54,000
To Capital Reduction A/c 6,000
(Being land & building taken over by debenture
holders for Rs. 60,000.)

(ii) Bank A/c… Dr 45,000

To Debentures A/c 45,000
(Being Rs. 45,000 cash provided on floating
charge.)

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 (iii) Interest A/c… Dr 6,000
To Bank A/c 6,000
(Being arrears of interest paid.)

(5) Bank A/c… Dr 10,000

To Capital Reduction A/c 10,000
(Being director’s fees refunded.)

(6)
(i) Director’s Loan A/c… 15,000
Dr
Capital Reduction A/c… 15,000
Dr
To Bank A/c 30,000
(Being contingent liability recovered to the
extent Rs. 15,000.)

(ii) Director’s Loan A/c… 9,000

Dr
To Bank A/c 9,000
(Being balance to the extent of Rs. 9,000 of
director’s loan was paid in cash.)

(7) Director’s Loan A/c… 51,000

Dr
To Equity Share Capital A/c 51,000
(Being directors were given equity shares in
satisfaction of their balance loan amount.)

(8) Bank Overdraft A/c… 1,60,000

Dr
To Bank A/c 1,60,000

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 (Being bank overdraft written off.)

Capital Reduction A/c

Dr. Cr.

Particulars Amount Particulars Amount

(Rs.) (Rs.)

To Equity Share Capital A/c 18,000 By Preference Share 60,000

capital A/c

To Goodwill A/c 1,20,000 By Equity Share 4,50,000

Capital A/c

To Profit and Loss A/c 2,64,000 By Bank A/c 75,000

To Deferred 60,000 By Debentures A/c 6,000

Advertisement A/c

To Debtors A/c 21,000 By Bank A/c 10,000

To Obsolete Stock A/c 30,000

To Bank A/c 15,000

To Capital Reserve A/c 73,000

(Balancing Figure)

6,01,000 6,01,000

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 Balance Sheet as on… (Revised)

Liabilities Amount Assets Amount

(Rs.) (Rs.)

Authorized Share Fixed Assets

Capital

30,000 Preference Shares 3,00,000 Land and Building 2,13,000

of Rs. 10 each
6,00,000 Equity Shares 6,00,000 Plant 2,55,000
of Rs. 1 each

Issued, Subscribed and Current Assets, Loans

Paid up Capital and Advances

2,19,000 Equity Shares 2,19,000 Stock 1,95,000

of Rs. 1 each fully paid

24000 6% Preference 2,40,000 Debtors 2,49,000

Shares of Rs. 10 each

Reserves and Surplus Bank -

Capital Reserve 73,000

6% Debentures 1,05,000

Bank Overdraft 5,000

Sundry Creditors 2,70,000

9,12,000 9,12,000

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(Q.2.) The following is the summarized balance sheet of Not so Well Ltd. as on
31st December, 1990:

Liabilities Amount Assets Amount

(Rs.) (Rs.)

Equity Shares Capital in 5,00,000 Land and Building 2,00,000

Rs. 100 shares

8% Preference Capital in 3,00,000 Plant and Machinery 2,00,000

Rs. 100 shares

18% Convertible 90,000 Invention and Promotion 1,00,000

Debenture Expenses
Loan from Bankers 1,10,000 Discount and Issue 30,000
(Secured) Expenses on shares and
debentures
Capital Reserve 40,000 Profit and Loss A/c 2,80,000

Forfeited Shares A/c 10,000 Stock in Hand 3,00,000

Sundry Creditors 1,60,000 Sundry Debtors 1,00,000

12,10,000 12,10,000

The dividend on preference shares were in arrears for last 3

years. The company had a very valuable property which stood highly
understated in the balance sheet and which is not afforded to sell. The said
being required for the business.

It was believed that worst was now over and companies new
invention was certain to bring sizeable profit in future. In view of these share
holders, debenture holders and the creditors agreed upon the following
scheme of reconstruction:

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 1) All fictitious assets including invention and promotion expenses were to
be written off.
2) Rs. 30,000 from debtors, Rs. 2,00,000 from stock and Rs. 1,50,000 from
plant and machinery were to be written off.
3) The convertible debentures were given the option of subscribing equity
shares of Rs. 30 each up to 50% of their face value, or subscribing
preference shares of Rs. 50 each up to 25% of their face value and the
remaining 25% was to be paid them in cash. All the debenture holders
exercised this option.
4) All capital reserves were to be utilized.
5) The creditors being unsecured agreed to reduce their claim by 25% on the
condition that they will be paid off before 31st December, 1995. They also
agreed not to charge any interest till the date of payment.
6) Preference shares were reduced to Rs. 50 per share and equity shares
were reduced to Rs. 30 per share.
7) Land and Buildings were revalued at such a figure so as to put through
the entire scheme.
8) Bankers were to be paid of fully. For this purpose, the company was to
issue 6,000 Equity shares of Rs. 30 each for cash.
9) The preference share holders agreed to waive the arrears of dividend.

Assuming that the scheme had been duly sanctioned by the

court, Pass Journal Entries; Prepare the Capital Reduction Account and
the new Balance Sheet.

SOLUTION:

Journal Entries in the books of not so well Ltd.

Date Particulars L Debit Credit

F (Rs.) (Rs.)

(1) Capital Reduction A/c…Dr 4,10,000

To Invention and promotion Expenses 1,00,000
A/c
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 To Discount and Issue Expenses A/c 30,000
To Profit and Loss A/c 2,80,000
(Being all fictitious assets written off.)

(2) Capital Reduction A/c…Dr 3,80,000

To Debtors A/c 30,000
To Stock A/c 2,00,000
To Plant and Machinery A/c 1,50,000
(Being debtors, stock and plant written off.)

(3) Debentures A/c…Dr 90,000

To Equity Shares A/c 45,000
To Preference Shares A/c 22,500
To Cash A/c 22,500
(Being debenture holders exercised their option.)

(4) Capital Reserve A/c…Dr 40,000

To Capital Reduction A/c 40,000
(Being capital reserve utilized.)

(5) Creditors A/c…Dr 40,000

To Capital Reduction A/c 40,000
(Being creditors agreed to be reduced by 25 %.)

(6)
(i) Equity Shares A/c…Dr 5,00,000
To Equity Shares A/c 1,50,000
To Capital Reduction A/c 3,50,000
(Being equity shares reduced to Rs. 30 per
share.)

(ii) Preference Shares A/c…Dr 3,00,000

To Preference Shares A/c 1,50,000
To Capital Reduction A/c 1,50,000
(Being preference shares reduced to Rs. 50 per
share.)

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(7)
(i) Loan from Bankers A/c…Dr 1,10,000
To Cash A/c 1,10,000
(Being bankers paid off fully.)

(ii) Cash A/c…Dr 1.80,000

To Equity Shares A/c 1,80,000
(Being 6000 equity shares of Rs. 30 each
issued for cash.)

(8) Land and Building A/c…Dr 2,10,000

To Capital Reduction A/c 2,10,000
(Being balance of capital reduction account.)

Capital Reduction A/c

Dr. Cr.

Particulars Amount Particulars Amount

(Rs.) (Rs.)

To Invention and 1,00,000 By Capital Reserve A/c 40,000

Promotion Expenses A/c

To Discount and Issue 30,000 By Creditors 40,000

Expenses A/c

To Profit and Loss A/c 2,80,000 By Equity Share 3,50,000

Capital A/c

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To Debtors A/c 30,000 By Preference Share 1,50,000
capital A/c

To Stock A/c 2,00,000 By Land and Building A/c 2,10,000

(Balancing Figure)

To Plant and Machinery A/c 1,50,000

7,90,000 7,90,000

Balance Sheet as on… (Revised)

Liabilities Amount Assets Amount

(Rs.) (Rs.)

Issued, Subscribed and Fixed Assets

Paid up Capital

12,500 Equity Shares 3,75,000 Land and Building 4,10,000

of Rs. 30 each fully paid

3,450 Preference Shares 1,72,500 Plant 50,000

of Rs. 50 each

Current Liabilities, Current Assets, Loans

Loans and Advances and Advances

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Sundry Creditors 1,20,000 Stock 1,00,000

Forfeited Shares 10,000 Debtors 70,000

Bank 47,500

6,77,500 6,77,500

6. CONCLUSION

With the completion of this project we had come to

know how internal reconstruction and why is it done.

If the balance sheet of the loss making company is

made, losses in the debit side will be seen. These shows zero assets, it is
clear indication to all creditors that company has no resources and all past
resources are utilized in bad project. So, to come out of this situation the
company has to generate profit. The profits can be generated when the
sacrifice would be made by the equity share holders, preference share
holders, debenture holders and creditors.

For the scheme of reconstruction the approval of all

the interested parties and the sanction of the court are necessary. So,
either shareholders or creditor can do above or take the action to liquidate
the company.

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 7. BIBLIOGRAPHY

We have complied the information of this project with

the help of the following sources-

o Books –

 TYBCOM Text Book

(Choudhary Chopde)

 TYBAF Text Book

(SHETH Publications)

o Internet Sites –

 www.flickr.com/photos/olive.../sets/72157619644288304/

 www.madisonscw.com/SubPage.aspx?page=2664

 powerelectronics.com/.../power_internal_construction_boosts/

 www.levelfive-audio.com/internal-construction.htm

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