CHAPTER 2 Internal Reconstruction odie ‘Meaning of Internal Reconstruction » Forms + Re-Organisation or Alteration of Share Capital ifferences Between Internal and External Reconstruction + Accounting Entries + Surrender of Shares + Illustration + Exercises Introduction ‘A.company might have suffered huge losses in the past or might have the problem of over-capitalisation or might have over valued its fixed assets because of inadequte provision for depreciation. Such a company faces the danger of going into liquidation either voluntarily or because of a petition by any of its Creditors \ces companies have three options, v or Debenture holders. In these circum: 1. To liquidate the company (Liquidation) 2. To reconstruct externally (External Reconstruction) 3. To feconstruct internally (Infernal Reconstruction) Meaning of Internal Reconstruction Internal Reconstruction is an arrangement made by companies whereby the claims of shareholders, creditors and other liabilities are altered/reduced, so that the accumulated losses are Debenture holders, .ce sheet shows the true and fair view of the financial written off, assets are valued at its fair value and the balan position, Forms of Internal Reconstruction Internal Reconstruction may take any of the following two forms: 1. Re-organisation or Alteration of Share Capital 2. Reduction of Share Capital and Other Liabilities. Re-organisation or Alteration of Share Capital Re-organisation or alteration of share capital refers to the rearrangement of the capital of the company and includes the following: (a) Increasing the share capital by making fresh issue of shares. (b) Decreasing: the share capital by cancelling the unissued shares.es Advanced Corporate Accounting (c) Conversion of shares into stock and vice versa. (d) Consolidation of shares of smaller amounts into shares of larger eee (e) Sub-division of shares of larger amounts into share of smaller amounts. ‘A company can alter its share capital if it is authorised by its [Articles of Association. Reduction of Share Capital and Other Liabilities cs i © Ke someti Reduction of share capital is an arrangement underwhich the capital of the snare a as mes even the claims of debentureholders and the creditors are reduced. The amount mac 7 i he rae reduction is uilised in writing off the accumulated losses, fictitious assets and the overvalued! portion o other assets. A company can reduce its paid-up capital if (a) it is passed and_/e}-a sanction of the court is obtained. Differences between Internal Reconstruction and External Reconstruction 1. No new company is formed in case of internal reconstruction. A ne\ ‘of external reconstruction. In case of internal reconstruction, no company is liquidated. In ease of external reconstruction, one company is liquidated 3. Internal reconstruction requires courts confirmation. But external reconstruction can be effected without court's confirmation. 4 Internal reconstruction is a slow and tedious process. But external reconstruction can be carried ‘out easily 5. In the case of internal reconstruction, the company is able to setoff its past losses against future profits, Whereas, in the case of external reconstruction, the past losses of the old company cannot be setoff against the future profits of the new company. i authorised by its articles, (b) a special resolution .w company is formed in case Accounting Entries 1. When reduction of Equity Share Capital; ~~ (Old) Equity Share Capital Account Dr. To (New) Equity Share Capital Account To Capital Reduction Account ole 2. When reduction of Preference Share Capital: cee) (Old) Pesfenence Share Capital Account eR To (New) Preference Share Capital To Capital Reduction Account When reduction of the amount due= mternal Reconstruct 73 5. When the appreciation in the value of assets: Assets. Account Dr. - To Capital Reduction Account 6 When the payment of reconstruction expenses: Reconstruction Expenses Account Dr. To Bank Account ulated losses and 7 When the utilisation of Capital reduction account balance in writing off various fictitious assets: Capital Reduction Account. > Dr ‘To Profitvand Loss Account (loss) ‘To Preliminary Expenses Account To Discount on issue of Shares or Debenture Account ‘To Underwriting Commission Account ‘To Advertising Suspenses Account To Reconstruction Expenses Account To Goodwill Acgount ‘To Patents or Trade Marks Account To Fixed Assets Account (Over valued assets) To Other Asseis.Account ” To Capital Reserves Account (if some balance is still left) Ilustration 1 (Problems on Journal Entries) (On the reconstruction of a company, the following term of their present holding ( were agreed upon: 50,000 shares of 210 cach) the following: ey The shareholders to receive in li (a) Fully paid Equity Shares equal to 34th oP their holdings. (b) 5% preference shares fully paid, 1o the extent of Y4th of the above new Equity Shares. p> (0), € 60.000. 6% Secoind Debentures. beam aupate of 50,000, 5% First Debestures was male and alloted payment forthe same having byen regeived The Goodwill, which stood at & 3,00,000 was written down to & 150,000 the Plant and machinery, which stood at € 1,00,000 were written down to % 75,000, The Frechold and Leasehold premises, which stood at & 1,50,000 were written down to % 1,25,000. Make the Journal Entries in the books of the company necessitated by the above reconstruction, (B.U,, B.Com., April, 1993) Solution: Journal Entries in the Books sigal SLNo. Particulars Dr. 4 i Q 1 (Old) Equity Share Capital Account TAaa Dr 2 To (ew) Equity Share Capital Account [AL 2/4) * sone. 40,000 To §% Preferenge Share Capit To £% Second jure Account Yo Capital Reduetion Account e {Heing the conversion of $0,000 Equity Share of £10 each to New Equity Shares, 6% Preference Shares and 5% Second Debentures} 0,000 bo,000