UNIT 4
INTERNAL RECONSTRUCTION
After studying the unit the students will be able to:
- Understand the types of reconstruction.
- Know the alternation of share capital.
- Explain the procedure of reconstruction.
- Understand the Accounting entries for reconstruction.
- Solve the practical problems on the unit.
The term reconstruction means reorganizing the capital structure of a company including the reduction of the claim of both the classes of shareholders & the creditors against the company. Sick companies (loss making companies) may be taken over by the profit making companies however in case of C/F of huge losses, assets are overvalued or undervalued, in such cases company may go for reconstruction. In other words, reconstruction is an exercise of restating assets & liabilities by the company whose balance sheet is not healthy but future is promising. It may be external or internal reconstruction.
The Company can be reconstructed internally or externally.
It means two types of reconstruction is possible:
External Reconstruction:
In case of external reconstruction a new company is formed to take over the business of an existing company which has suffered huge losses & which is in bad financial position. The vendor company goes into liquidation & its business is taken over by the new company.
Internal Reconstruction:
In case of internal reconstruction, the capital structure of the company is reorganized to infuse new life in the company. It includes alteration, reduction and reorganization of share capital of the company.
A limited company if authorized by its Articles of Association can alter (change) the capital clause of its Memorandum of Association. The alteration of share capital may be in following different ways: -
1. Increase in share capital by the issue of new shares
2. Consolidation of shares
Consolidation refers to conversion of shares of the smaller denomination into shares of larger denomination.
For example: 5000 equity shares of Rs. 10 each can be consolidated into 500 shares of Rs. 100 each.
3. Subdivision of shares
Sub division refers to conversion of shares of the larger denomination into shares of small denomination.
For example: 5000 equity shares of Rs. 100 each can be subdivided into 50000 shares of Rs. 10 each.
4. Conversion of shares into stock
A company may convert its shares into stock. Stocks may be in fractions which is not possible in case of shares. Conversion of shares into stock requires sanction of the Central Government.
5. Surrender of shares
In a reconstruction scheme the shareholders may be required to surrender a part of their shareholding. Such surrender may be either before immediate cancellation or for issue to some of the creditors of the company in satisfaction of their claim.
6. Cancellation of Unissued shares
In case a company cancels its unissued shares it does not require any accounting entry to be passed. The authorized shares capital of the company will stand reduced by the amount of unissued shares now cancelled.
Internal reconstruction scheme should be framed by careful study and proper valuation of assets and liabilities. It involves a compromise or arrangement between the company and its members or/and its creditors. However following aspects should be carefully taken care of while framing the scheme of internal reconstruction –
- For change in share capital in any form, it should be considered as per provisions of the M/A & A/A, and in case if required the company should alter the provisions in the M/A & A/A.
- Company is required to give a notice to the Register of Companies within 30 days of its passing resolution.
- Sanction of SEBI is necessary in certain cases.
- Board Resolution is necessary to effect the alteration.
Internal reconstruction means the reduction of capital to cancel any paid-up share capital which is lost during the course of business i.e. not represented by the real value of the assets.
A company can reduce its share capital in the followings ways:
a. Writing off lost capital
b. Refunding surplus paid-up capital.
c. Reducing the liability of the members for uncalled capital.
A company can reduce its share capital only when each of the following condition is satisfied
a. The A/A of the company must permit such reduction.
b. The company passes special resolution for reducing its share capital.
c. The company obtains the confirmation of the court.
Reduction of capital will be effective only when it is sanctioned by the court and registered with Registrar of Companies. Court may at its discretion order the words “And Reduced” to be added to the name of the company for the period prescribed.
Capital Reduction Account is opened in the ledger to give effect of sacrifice made by shareholders & others as well as to write off accumulated losses, fictitious assets, & change in values of assets/liabilities.
Sacrifice by Share holders:
- When the face value of share is changed
Share capital A/c (old) Dr.
(With paid up value of old shares)
To Share Capital A/c (new)
(With paid up value of new shares)
To Capital Reduction A/c (With difference)
2. When face value of share is not changed, only paid up value is changed
Share Capital A/c Dr.
To Capital Reduction A/c
(With the amount of reduction)
3. When shares are Consolidated
Share Capital A/c (say Rs. 10) Dr.
To Share Capital A/c (say Rs. 100)
4. When Shares are Subdivided
Share Capital A/c (say Rs. 100) Dr.
To Share Capital A/c (say Rs. 10)
5. When shares are converted into stock
Share Capital A/c Dr
To Share Stock A/c
Assets:
6. When the value of any asset is appreciated
Asset A/c (increase in value) Dr.
To Capital Reduction A/c
7. When the value of any asset is depreciated
Capital Reduction A/c Dr
To Asset A/c (decrease in value)
8. When recorded assets are disposed off/sold
Bank A/c Dr.
Capital Reduction A/c(if loss) Dr
To Assets A/c
To Capital Reduction A/c(if Profit)
(Note: Any profit or loss on sale should be transferred to Capital Reduction A/c)
9. When an unrecorded assets is sold off
Bank A/c Dr.
To Capital Reduction A/c
(Note: entire amount received on sale is profit as asset was unrecorded)
Liabilities:
10. When any sacrifice is made by the creditors
Creditors A/c (with sacrifice) Dr.
To Capital Reduction A/c
11. When any sacrifice is made by the Debenture Holders
Debentures A/c (decrease in value) Dr.
To Capital Reduction A/c
12. When new debentures are exchanged for old debentures
Old Debentures A/c Dr.
To New Debentures A/c
13. When recorded liability is paid for
Liability A/c Dr.
Capital Reduction A/c (if loss i.e. paid more) Dr
To Bank A/c
To Capital Reduction A/c (if profit i.e. paid less)
(Note: Any profit or loss should be transferred to Capital Reduction A/c)
14. When contingent liability/unrecorded liability/ Preference share dividend is paid
Capital Reduction A/c Dr.
To Bank A/c/ Eq sh cap/ Pref sh cap/ Debentures Etc.
(Note: No entry is required for amount foregone against such liability)
15. When provision for taxation, Capital Reserve, Securities Premium is utilised
Provision for Taxation A/c Dr.
Capital Reserve A/c Dr.
Securities Premium A/c Dr.
To Capital Reduction A/c
Writing off Losses:
16. When capital reduction is utilised for writing off fictitious assets, losses and excess value of other assets
Capital Reduction A/c Dr.
To P/L A/c
To Goodwill A/c
To Preliminary Expenses A/c
To Discount on Shares/Debentures A/c
To Other Assets A/c
To Capital Reserve A/c (if any balance is left)
17. Reconstruction Expenses
When Reconstruction expenses are paid
Capital Reduction A/c Dr.
To Bank A/c
18. Share Surrender:
When shares are surrendered
Share Capital A/c Dr
To Share Surrender A/c
19. When surrendered shares are converted into preference shares
Share Surrender A/c Dr.
To Preference Share Capital A/c
20. When surrendered shares are issued to creditors/payment of any liability
Share Surrender A/c Dr.
To Share Capital A/c
Creditors/Liability A/c Dr.
To Capital Reduction A/c
(Note: Profit or Loss on scheme to be transferred to capital Reduction A/c)
21. Cancellation of Shares not issued(balance in Share surrender A/c)
Share Surrender A/c Dr.
To Capital Reduction A/c
Issue of shares to public
22. When finance is raised by issue of shares
Bank A/c Dr.
To Share Capital A/c
Proforma:
Capital Reduction A/c
Particulars | Rs. | Particulars | Rs. |
To P & L A/c (Loss written off) To Goodwill A/c (Written off) To Preliminary expenses A/c (Written off) To Discount on Shares/Debentures (Written off) To Assets A/c (Decrease in value) To Bank A/c (payment of unrecorded liability) To Bank A/c (payment of Reconstruction Expenses) To Bank A/c (Refund of Directors Fees) To Capital Reserve (Balancing figure) | XX XX
XX
XX
XX
XX
XX
XX
XX | By Share Capital A/c (Amount of reduction) By Debentures A/c (Amount of Reduction) By Creditors A/c (Amount of Sacrifice) By Assets A/c (Increase in value) By Bank A/c (sate of unrecorded assets) |
XX
XX
XX
XX
XX |
| XXX |
| XXX |
