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.

1
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. 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
 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.

3
 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.

4
  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.

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.

5
 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.
 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.

6
 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.

7
 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

8
 (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
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

9
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

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

10
 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

To Capital reduction A/c

11
 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

12
 Cash/Bank A/c …Dr
To Share capital A/c

13) Expenses of reconstruction

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)

13
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

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)

14
 5. ILLUSTRATIONS
(Q.1.) The following is the summarized balance sheet of X Ltd.
As on 31st 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

Deferred Expenditure:
Advertisement 60,000

15,36,00 15,36,00
0 0

15
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.

16
 You are required to:

A)Pass Journal Entries, including cash transactions,

B) Draft revised balance sheet.

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
17
 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
(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… Dr 4,95,000

To Goodwill A/c 1,20,00
0
To Profit and Loss A/c 2,64,00
0
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.)

18
 (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.)

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

(ii) Director’s Loan A/c… Dr 9,000

To Bank A/c 9,000

19
 (Being balance to the extent of Rs. 9,000 of
director’s loan was paid in cash.)

(7) Director’s Loan A/c… Dr 51,000

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… Dr 1,60,000

To Bank A/c 1,60,00
0
(Being bank overdraft written off.)

Capital Reduction A/c

Dr.
Cr.

Particulars Amoun Particulars Amoun

t t
(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

20
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)

6,01,00 6,01,00
0 0

Balance Sheet as on… (Revised)

Liabilities Amoun Assets Amoun

t t
(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

21
Issued, Subscribed Current Assets,
and Paid up Capital Loans 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

9,12,00 9,12,00
0 0

(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

22
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

12,10,00 12,10,00
0 0

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:
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.

23
 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

24
 F (Rs.) (Rs.)

(1) Capital Reduction A/c…Dr 4,10,000

To Invention and promotion Expenses 1,00,000
A/c
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.)

25
(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.)

(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 Amoun Particulars Amoun

26
 t t
(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

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

7,90,00 7,90,00
0 0

Balance Sheet as on… (Revised)

27
Liabilities Amoun Assets Amoun
t t
(Rs.) (Rs.)

28
Issued, Subscribed Fixed Assets
and 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 and Advances Loans and Advances

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

Forfeited Shares 10,000 Debtors 70,000

Bank 47,500

6,77,50 6,77,50
0 0

6. CONCLUSION
29
 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.

7. BIBLIOGRAPHY
30
 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/72157619644288
304/

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

 powerelectronics.com/.../power_internal_constructio
n_boosts/

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

31