UNIT 2
ACCOUNTING OF INTERNAL RECONSTRUCTION
The term reconstruction implies the process followed for reorganization of a company with respect to its capital structure including the reduction of claims of both the shareholders and the creditors of the company. Reconstruction of a company is required when it faces acute financial problems due to over capitalization or accumulation of operating losses.
There are two ways of effecting reconstruction of a company.
1. Internal reconstruction
2. External reconstruction
In the following the reconstruction of a company becomes desirable
- The capital structure of a company is complex and it is required to be made simple
- When accumulated losses of a company are large that they are required to be written off so that the company can depict a better position.
- When a part of the capital is not represented by available tangible assets.
- when change is required in the face value of shares of the company so that they can become attractive for future investors
MEANING OF INTERNAL RECONSTRUCTION AND EXTERNAL RECONSTRUCTION:
External reconstruction: The term external reconstruction as applied to a limited company means to ending up of an existing company and registering itself into a new one after a rearrangement of his financial position as approved by its shareholders and creditors and sanctioned by the NCLT. Such a step usually involve the writing off a Debit balance of statement of profit and loss, elimination of all fictitious assets if any from the balance sheet and consequent readjustment of share capital.
Internal reconstruction means a recourse undertaken to make necessary changes in the capital structure of a company without affecting the existence of the company. It is a plane in which a efforts are made to bring out the company from losses and put it in profitable position. In internal reconstruction of the existing company is liquidated Nor a new company is incorporated. Internal reconstruction of a company is done through the reorganization of is Share Capital in to Infuse new life into the company. It is a scheme of reorganization in which all interested parties volunteer to sacrifice in the form of reduction of paid up value of shares, amount of claim of the creditors, debenture holders and change in the rights attached to them.
DIFFERENCE BETWEEN INTERNAL RECONSTRUCTION AND EXTERNAL RECONSTRUCTION:
Points of difference | Internal reconstruction | External reconstruction |
| It is the scheme that would be carried out by means of capital reduction | It is the scheme will be carried out by liquidating the existing company and immediately incorporating another company to takeover the business of outgoing company. |
2. Continuation of parties | In Internal reconstruction, debentureholders, creditors and bank overdraft may continue. | Inexternal reconstruction, debenture holders, creditors and bank overdraft parties will have to be settled.
|
3. Reduction of tax liability | In internal reconstruction, the company will be able to set-off the past losses against future profits for income tax purposes, considerably reducing the tax liability. | Here, losses cannot be carried forward for income tax purposes since the business technically comes to an end with liquation. |
4. Time for processing | It is slow and tedious process | It is speedy process. |
FORMS OF INTERNAL RECONSTRUCTION:
- Alteration of share capital
- Reduction of share capital involving sacrifice of shareholders only
- Reduction of share capital involving sacrifice of shareholders and other stakeholders
These forms of internal reconstruction are explained as under:
- Alteration of share capital: A company limited by shares, can alter the capital clause of its memorandum of association under section 61(1) of the companies Act 2013, if
(I) The Articles of Association of the company permits.
(II) A resolution to this effect has been passed by the company in the general meeting.
Following are the different ways by which company can alter their share capital
a) Increase in share capital by issue of new shares: when a company is in need of additional capital, it can increase its paid up share capital by issuing shares if the company has not issued all the shares of its authorized. Accounting entries relating to the issue of shares will have to be passed for the fresh issue of shares. If the company has issued all of its authorized capital, then for the purpose of raising fund by the issue of fresh shares, it will have to increase its authorized capital first by altering the capital clause of Memorandum of Association of the company and permission of SEBI is also required to be obtained.
b) Consolidation of shares: Where the share capital of the company comprises shares of small denominations, the company may decide to change the smaller denomination into larger denomination. This is called Consolidation of shares. Following Journal entry for consolidation of shares is required to be passed:
Share capital A/c. Dr.(old denomination)
To share capital A/c (new denomination)
For example:
On 20-03-2020 X LTD passed a resolution to consolidate 100,000 fully paid equity shares of Rs. 10 each into 10,000 equity shares of Rs. 100 each. Show entry for consolidation of shares.
Solution.
In the books of X LTD
Journal Entries
Date | Particulars | LF | Debit(Rs.) | Credit (Rs.) |
20-03-2020 | Equity Share capital A/c. Dr.(Rs. 10) To Equity share capital A/c(Rs.100 each) (Being the consolidation of 100,000 equity shares of Rs 10 each fully paid into 10,000 equity shares of Rs. 100 each fully paid as per general meeting’s resolution No….dated 20-03-2020. |
| 10,00,000 |
10,00,000 |
c) Subdivision of shares: sub-division of shares is the reverse of consolidation in sub-division of shares, if value of a share is converted into smaller denomination from larger denomination. when the shares of a company are sub-divided in shares of small value it is known as sub-division of share.
Following journal entries is required to pass for sub-division of shares.
Share capital account Dr (old denomination)
To share capital account (new denomination)
For example, X Limited decides on 05.08. 2020 to sub-divide its 5000 equity shares of Rs. 100 each fully paid into equity shares of Rs.10 each fully paid.
Solution.
In the books of X ltd
Journal Entries
Date | Particulars | LF | Debit(Rs.) | Credit (Rs.) |
05-08-2020 | Equity Share capital A/c. Dr.(Rs. 100) To Equity share capital A/c(Rs.10 each) (Being the sub division of 5,000 equity shares of Rs.100 each fully paid into 50,000 equity shares of Rs. 10 each fully paid as per general meeting’s resolution No….dated 05-08-2020. |
| 500,000 |
5,00,000 |
d) Cancellation of capital cancellation: Cancellation of capital may take the following form
- Cancellation of unissued capital: cancellation of unissued capital means cancellation of unissued shares by company. It means that the part of the authorized capital which is the has not yet been issued to the public may be cancelled by the company
- Cancellation of uncalled capital: Cancellation of uncalled capital means cancellation of that part of the face value of the share which has not yet been called by the company.
e) Surrender of shares: sometimes reduction of share capital is effected through surrender of shares. For this purpose shares are subdivided into shares of smaller in nomination and the shareholders are made to surrender some of these subdivided shares. These shares so surrender facilitate reconstruction of company through reorganization. Debenture holders and the creditors' claim are settled through issue of surrendered shares. The amount foregone by these claimants is transferred to reconstruction account. Following are the journal Entries which are required to be passed under surrender of shares..
I) For surrender of shares by shareholders
Share capital A/c Dr. (Smaller denomination)
To share surrender A/c
II) For issue of surrendered shares to the creditors
Shares surrender A/c Dr.
To Equity share capital a/c
III) For cancellation of unissued surrendered shares
Unissued surrendered shares a/c Dr.
To Reconstruction a/c
Reduction of share capital:
A reduction of share capital is unlawful except when sanctioned by the National Company Law Tribunal (NCLT). “Conversion of share capital is one of the main principles of company law”. The share capital of a company is only security on which the creditors rely. Any reduction of share capital diminishes the fund out of which they are to be paid.
But sometimes there may be genuine necessity for the reduction of share capital. This power is, given by the section 66 ( 1) of the Companies Act 2013 subject to the compliance of conditions. According to this section a company may
(I) extinguish or reduce the liability on any of its shares in respect of share capital not paid up.
(II) cancel any paid up share capital which is lost or is unrepresented by any available assets
(III) pay of any paid up share capital which is in excess of what is required by the company.
Following are the conditions for affecting reduction of share capital. A company can reduce its share capital as per the provisions contained in the sections 64 to 66 the Companies Act 2013 which are as under
1) the articles of association of the company must permit it to reduce its capital;
2) The company in general meeting has passed a special resolution;
3) The National Company Law Tribunal has approved the scheme of reduction in share capital.
Procedure of Reducing of share capital
1)when a company is authorized by its articles of association to effect reduction of his share capital passes the special resolution to reduce its share capital then it is required to apply to the National Company Law Tribunal for its approval. If under the scheme of capital reduction the liability of shareholders does not decrease or they are not paid off excessively then the Tribunal without taking consent of the creditors may approve the scheme.
2)But if by the reduction, the liabilities of shareholders decrease or the capital is returned to them, then the Tribunal will give its creditors a chance to put their views. If any creditors disagrees with the scheme then a list of such creditors is prepared. The Tribunal after issuing a notice may also include other creditors within a specified time. The Tribunal may order the company either to take the consent of disagreed creditors for the scheme or to make the payment of whole amount due to them. If the Tribunal is satisfied that the consent of creditors for the scheme has been taken or their claims have been paid off or their rights are secured then it approves the scheme of reduction of share capital.
3)The Tribunal if it thinks fit may provide condition and may order the company to add 'And reduced' words with its name for a certain period. It may order the company to publish information regarding reduction in share capital or information in the interest of general public.
4)After receiving the approval of the NCLT the company will present a statement to the registrar showing amount of share capital , number of shares, face value of each share and paid up amount with the true copy of tribunal’s order.
5)The order of reduction in share capital will be effective from the date when the order of the Tribunal together with statement gets registered by the registrar.
ACCOUNTING ENTRIES FOR GIVING EFFECT TO THE CAPITAL REDUCTION SCHEME.
I)When the nomination of share is not reduced, only paid up value is reduced
Share capital account. Dr. (With amount of reduction)
To Capital reduction account
II) When denomination of shares is reduced
Share capital account Dr. (Old denomination)
To Share capital account (new denomination)
To Capital reduction account ( with amount of reduction)
III)If balance of any reserve transferred to capital reduction account
Reserve account Dr.(with name)
To capital reduction account
IV)For sacrifice made by debenture holders, if any
Debentures account Dr.
To Capital reduction account
V)For sacrifice made by Creditors, if any
Creditors account Dr.
To Capital reduction account
VI)For recording any increase in the value of assets on revaluation
Asset account Dr.
To capital reduction account
VII)For recording any decrease in the value of liability
Liability account Dr.
To Capital reduction account
VIII)For making any provision for contingent liability
Capital reduction account. Dr.
To provision for contingencies account.
IX)For writing off various accumulated losses, fictitious assets, loss on assets and liabilities
Capital reduction account. Dr.
To Statement of profit and loss
To preliminary expenses A/c
To Discount on issue of shares/Debentures A/c
To Goodwill/ patents/ trademark A/c
To Asset A/c
To provision for doubtful debts A/c
To Capital Reserve A/c (if any balance is left in capital reduction account after writing off)
ILLUSTRATION 1:
Following is the balance sheet of X LTD as at 31-03-2020:
Balance sheet as at 31-03-2020
Particulars | Amount (in Rs.) |
1.Shareholders' Fund: a) Share capital: 15000 Equity Shares of Rs.10 each 15,000, 5% Preference Shares of Rs.10 each b) Reserves and surplus: Surplus ( Debit balance of statement of profit and loss)
2.Current liabilities a)Trade payables: Creditors |
150,000 150,000
(60,000)
60,000 |
TOTAL | 300,000 |
II. ASSETS 1)Non current assets a) Tangible assets Machinery b) Intangible assets (Goodwill) 2) Current assets a) Stock b)Trade Receivables Debtors |
170000 25000
38000
67000 |
TOTAL | 300,000 |
In general meeting, it is decided that:
1) Equity shares of Rs.10 each be reduced to shares of Rs.6 each fully paid and 5% Preference Shares of Rs.10 each be reduced to 7% Preference Shares of Rs.7 each fully paid up. The number of shares in each case remains same.
2) The amounts so available be used for writing off:
I) Fictitious and intangible assets;
II) Machinery to the extent possible.
You are required to pass necessary journal entries and prepare balance sheet after implementation of reconstruction process.
Solution.
Statement of Sacrifice and Utilisation of funds.
SACRIFICE | RS. | UTILISATION | RS. |
Equity shares 15000× Rs. 4 (10-6) |
60,000 | Writing off: Statement of profit and loss Goodwill |
60000 25000 |
Preference Shares 15000 × Rs.3 (10-7) |
45,000 | Written down: Machinery |
20000 |
| 105,000 |
| 105000 |
IN THE BOOKS OF X LTD
JOURNAL ENTRIES
Date | Particularls | L.F | Dr.(Rs) | Cr.(Rs) |
2020 31st March | Equity shares capital A/c Dr. (Rs.10) To Equity shares capital A/c(Rs.6) To Capital reduction A/c (Being 15,000 Equity shares of Rs. 10 each fully paid reduced to Equity shares of Rs.6 each fully paid and balance transferred to Capital reduction account as per special resolution No......dated.....and confirmed by NCLT vide order dated.....) |
| 150,000 |
90,000 60,000 |
2020 31st March | 5% Preference shares capital A/c Dr. (Rs.10) To 7% Preference shares capital A/c(Rs.7) To Capital reduction A/c (Being 15,000 5% Preference shares of Rs. 10 each fully paid reduced to 7% Preference shares of Rs.7 each fully paid and balance transferred to Capital reduction account as per special resolution No......dated.....and confirmed by NCLT vide order dated.....) |
| 150,000 |
105,000
45,000 |
2020, 31st March | Capital reduction A/c. Dr To Statement of profit and loss To Goodwill A/c To Machinery A/c (Being the amount of capital reduction account used for writing off debit balance of profit and loss statement, Goodwill and machinery as per the scheme of reconstruction dated......) |
| 105,000 |
60,000 25,000 20,000 |
BALANCE SHEET OF X LTD (AND REDUCED)
As at 31st March, 2020
Particulars | Amount (in Rs.) |
1.Shareholders' Fund: a) Share capital: 15000 Equity Shares of Rs.6each 15,000, 7% Preference Shares of Rs.7 each b) Reserves and surplus: Surplus ( Debit balance of statement of profit and loss). (60000) Less. Written off as per reconstruction scheme 60,000
2.Current liabilities a)Trade payables: Creditors |
90,000 105,000
NIL
60,000 |
TOTAL | 255,000 |
II. ASSETS 1)Non current assets a) Tangible assets Machinery 170,000 Less. Written off as per reconstruction scheme 20,000 b) Intangible assets (Goodwill). 25,000 Less. Written off as per reconstruction scheme 25,000 2) Current assets a) Stock b)Trade Receivables Debtors |
150000
NIL
38000
67000 |
TOTAL | 255,000 |
ILLUSTRATION 2:
Following is the balance sheet of X LTD as at 31-03-2020:
Balance sheet as at 31-03-2020
Particulars | Amount (in Rs.) |
I. EQUITY AND LIABILITIES 1.Shareholders' Fund: a) Share capital: 50,000 Equity Shares of Rs.10 each 2,000, 5% Preference Shares of Rs.100 each b) Reserves and surplus: Surplus ( Debit balance of statement of profit and loss) Preliminary expenses General Reserve
2.Current liabilities a)Trade payables: Creditors Bills Payables |
500,000 200,000
(280,000) (5000) 230000
60,000 60,000 |
TOTAL | 765,000 |
II.ASSETS 1)Non current assets a) Tangible assets Machinery Land & Building b) Intangible assets (Goodwill) 2) Current assets a) Stock b)Trade Receivables Debtors Cash |
250,000 230,000 25,000
50,000
70,000 140,000 |
TOTAL | 765,000 |
In general meeting, it is decided that:
1) Equity shares of Rs.10 each be reduced to shares of Rs.6 each fully paid and 5% Preference Shares of Rs.10 each be reduced to 7% Preference Shares of Rs.7 each fully paid up. The number of shares in each case remains same.
2) The reduction of capital and Reserves are utilised to write off:
A)Fictitious and intangible assets;
B)Machinery 10%, and Land & Building to the extent possible.
You are required to pass necessary journal entries and prepare balance sheet after implementation of reconstruction process.
Solution.
Statement of Sacrifice and Utilization of funds.
SACRIFICE | RS. | UTILISATION | RS. |
Equity shares 50000× Rs. 4 (10-6) |
200,000 | Writing off: Statement of profit and loss Preliminary expenses Goodwill |
280000 5000 25000 |
Preference Shares 2000 × Rs.30 (100-70) |
60,000 | Written down: Machinery
|
25000 |
General Reserve | 230,000 | Land & Building | 155,000 |
| 490,000 |
| 490,000 |
IN THE BOOKS OF X LTD
JOURNAL ENTRIES
Date | Particulars | L.F | Dr.(Rs) | Cr.(Rs) |
2020 31st March | Equity shares capital A/c Dr. (Rs.10) To Equity shares capital A/c(Rs.6) To Capital reduction A/c (Being 50,000 Equity shares of Rs. 10 each fully paid reduced to Equity shares of Rs.6 each fully paid and balance transferred to Capital reduction account as per special resolution No......dated.....and confirmed by NCLT vide order dated.....) |
|
500,000 |
300,000
200,000 |
2020 31st March | 5% Preference shares capital A/c Dr. (Rs.100) To 7% Preference shares capital A/c(Rs.70) To Capital reduction A/c (Being 2,000 5% Preference shares of Rs. 10 each fully paid reduced to 7% Preference shares of Rs.7 each fully paid and balance transferred to Capital reduction account as per special resolution No......dated.....and confirmed by NCLT vide order dated.....) |
| 200,000 |
140,000 60,000 |
2020, 31st March | General Reserve A/c. Dr. To Capital reduction A/c (Being General Reserve eliminated from the books and transferred to Capital reduction account as per special resolution No...dated.... |
| 230,000 |
230,000 |
2020, 31st March | Capital reduction A/c. Dr To Statement of profit and loss To preliminary expenses A/c To Goodwill A/c To Machinery A/c (Being the amount of capital reduction account used for writing off debit balance of profit and loss statement, preliminary expenses, Goodwill and machinery as per the scheme of reconstruction dated......) |
| 335,000 |
280,000
5,000 25,000 25,000 |
BALANCE SHEET OF X LTD (AND REDUCED)
As at 31st March, 2020
Particulars | Amount (in Rs.) |
III. EQUITY AND LIABILITIES 1.Shareholders' Fund: a) Share capital: 50000 Equity Shares of Rs.6each 2,000, 7% Preference Shares of Rs.70 each
b) Reserves and surplus: Surplus (Debit balance of statement of profit and loss). (280000) Less. Written off as per reconstruction scheme 280,000 Preliminary expenses. (5000) Less. Written off as per reconstruction scheme 5000 General Reserve. 230,000 Less. Utilized for reconstruction scheme 230000 2.Current liabilities a)Trade payables: Creditors Bills Payables |
300,000 140,000
NIL
NIL
NIL
60,000 60,000 |
TOTAL | 560,000 |
IV. ASSETS 1)Non current assets a) Tangible assets Machinery 250,000 Less. Written off as per reconstruction scheme 25,000 Land & Building. 230,000 Less. Written off as per reconstruction scheme 155,000 b) Intangible assets (Goodwill). 25,000 Less. Written off as per reconstruction scheme 25,000 2) Current assets a) Stock b)Trade Receivables Debtors Cash |
225,000
75,000 NIL
50,000
70,000 140,000 |
TOTAL | 560,000 |
Reference:
- C.Mohan Juneja, Biplab Das, Atul Ch. Das Advanced Corporate Accounting, Kalyani Publishers
- S.P.Jain, K.L. Narang- Advanced Corporate Accounting, Kalyani Publishers
- B.B. Dam, H.C. Gautam- Advanced Corporate Accounting, Gayatri Publications, Guwahati
