Internal Reconstruction Corporate accounting by bhumika Garg

CORPORATE ACCOUNTING
UNIT- IV
INTERNAL
RECONSTRUCTION
BY: BHOOMIKA GARG

INTRODUCTION
Internal Reconstruction is neither liquidation nor formation of a new
company to take over any new business. The existing company continues in
its legal entity form and is only reorganized internally. Thus, internal
reconstruction is concerned with the complete overhauling of the financial
position of the company. The purpose is to improve the profitability of the
existing company in relation to the true or real value of the assets as
compared to the existing book values which are either overvalued or
fictitious.

DIFFERENCE BETWEEN EXTERNAL RECONSTRUCTION
AND INTERNAL RECONSTRUCTION
Basis Internal Reconstruction External Reconstruction
Liquidation The existing company is not
liquidated.
The existing company is liquidated.
Formation No new company is formed but only
the rights of shareholders and
creditors are changed.
A new company is formed to take
over the liquidated company.
Reduction of capital There is certain reduction of capital
and sometimes the outside liabilities
like debenture holders may have to
reduce their claim.
There is no reduction of capital. In
fact there is a fresh share capital of
the company.
Take Over It does not involve takeover of the
business.
It involves takeover of the business.

METHODS OF INTERNAL RECONSTRUCTION
• The following methods are used to give proper shape to the scheme of Internal
reconstruction:
1. Alteration of Share Capital
2. Change in Shareholder’s rights
3. Reduction of Share Capital
4. Compromise and Arrangement
5. Surrender of Shares

ALTERATION OF SHARE CAPITAL
• Note: Alteration does not involve any reduction in share capital.
• If authorized by its Articles, a company may, in a general meeting by
passing an ordinary resolution, decide to sub-divide or consolidate the
shares into those of a smaller or higher denomination than that fixed by the
Memorandum of Association, so long as the proportion between the
paid up and unpaid amount, if any, on the shares continues to be the
same as it was in the case of the original shares.

ALTERATION OF SHARE CAPITAL
• Broadly alteration can be done in following ways:
1. Sub- division of shares
2. Consolidation of Shares
3. Conversion of fully paid shares into stock
4. Reconversion of stock into fully paid shares

SUB- DIVISION OF SHARES
Section 61 permits a company to sub- divide its shares of higher denominations (nominal value) into
shares of smaller denominations(nominal value). The consequences of sub- division of shares would be:
• In case of partly paid up shares, the proportion between the paid up and unpaid amount on the shares
continues to be the same after sub division as before.
• The effect of sub- division is that a shareholder becomes entitled to higher number of shares of smaller
nominal value in exchange for lesser number of shares of higher nominal value.
• The accounting entry to record sub- division of shares would be:
Equity Share Capital ( Rs. 10 share) Dr.
To Equity Share Capital ( Rs. 5 share) A/C

EXAMPLE
A company with a capital of Rs. 10,00,000 divided into 10,000 equity shares of Rs. 100 each on which
Rs. 75 is paid up decides to reorganize its capital by splitting one equity share of Rs. 100 each into 10
such shares of Rs. 10 each. Pass the journal entry.
Solution
• Equity Share Capital (Rs. 100) A/C Dr. 7,50,000
To Equity Share Capital (Rs. 10) A/C 7,50,000
(Being the sub-division of 10,000 shares of Rs. 100
each with Rs. 75 paid up thereon into 1,00,000 shares of
Rs. 10 each with Rs. 7.50 paid up thereon as per the resolution
of shareholders passed in the General Meeting held on...)

CONSOLIDATION OF SHARES
• In this case, the shares of, say Rs. 10 each may be converted into shares of Rs. 100 each.
The Accounting entry is:
Equity Share Capital (Rs. 10 share) Dr.
To Equity Share Capital (Rs. 100 share) A/C
Note: The proportion between the paid up and unpaid up amount must be same after
consolidation.

EXAMPLE
• A company with a subscribed equity share capital of Rs. 5,00,000 divided into 50,000 equity shares of Rs. 10 each on which Rs. 7 per share are paid up has
a total paid up equity capital of Rs. 3,50,000. The company decided to consolidate 10 equity shares of Rs. 10 each. Pass the necessary journal entry.
Solution
• Equity Share Capital (Rs. 10) A/C Dr. 3,50,000
To Equity Share Capital (Rs. 100) A/C 3,50,000
(Being the consolidation of 50,000 shares of Rs. 10
each with Rs. 7 paid up thereon into 5,000 shares of
Rs. 100 each with Rs. 70 paid up thereon as per the resolution
of shareholders passed in the General Meeting held on...)
Conclusion
The result is that there will be no change in the amount of total paid up capital of the company. Only the face value of the shares and the number of shares after
consolidation of shares get changed.

CONVERSION OF FULLY PAID SHARES INTO STOCK
• It means all or any of its fully paid shares may be converted into one unit of stock. For
example 5,000 equity shares of Rs. 10 each may be converted into Rs. 50,000 equity
stock. The accounting entry would be:
Equity share capital (Rs. 10 share) A/C Dr. 50,000
To Equity stock A/C 50,000

RECONVERSION OF STOCK INTO FULLY PAID SHARES
• It means Rs. 50,000 stock may be converted into 500 equity shares of Rs. 100 each. The
accounting entry would be:
Equity Stock A/C Dr. 50,000
To Equity share capital (Rs. 100) A/C 50,000

CHANGE IN SHAREHOLDER’S RIGHTS
• When a company has issued different classes of shares with different rights or privileges attached to such shares e.g.
rights as to dividend, voting rights etc. any of such right may be changed in any manner.
• For example, the company may change rate of (a) dividend on preference shares or (b) convert cumulative preference
shares into non-cumulative preference shares without changing the amount of share capital by passing the following
journal entries:
a) (Old)% Cum. Pref. Share Capital Account Dr.
(New)% Cum. Pref. Share Capital Account
b) % Cum. Pref. Share Capital Account Dr.
% Non-cum. Pref. Share Capital Account
Note: In both the above cases, only the specific rights of preference shareholders have been changed. There is no change in
the amount of share capital.

REDUCTION OF SHARE CAPITAL
• Section 66 of the Companies Act lays down the procedure in respect of reduction of share
capital. The capital reduction can take place in more than one way and, hence the
Accounting treatment is not same in each case. The different cases can be:
I. Case I: Reducing the Liability in respect of uncalled or unpaid amount.
II. Case II: Reducing by refunding the excess capital
III. Case III: Reducing the paid up capital. It can be further done in two ways:
a. Reduction in paid up value only
b. Reduction in both nominal and paid up values

CASE I: REDUCING THE LIABILITY IN RESPECT OF
UNCALLED OR UNPAID AMOUNT
• When the uncalled amount of the share capital is reduced or completely cancelled, the
shareholder’s are exempted from paying the amount to that extent in future. The journal
entry would be:
• Share Capital ( partly paid up) A/C Dr.
To share Capital ( fully paid up) A/C
Note: In such a case there is reduction in nominal value only and there is no reduction in the
paid up value.

CASE II: REDUCING BY REFUNDING THE EXCESS
CAPITAL
• It may not be possible for the company to utilize the whole of the capital possessed by it.
Thus, the company may refund the excess capital to its members. The accounting entry is:
a) Share Capital A/C Dr. ( with the amount to be refunded)
To Shareholder’s A/C
b) Shareholder’s A/C Dr. ( with the amount actually refunded)
To Bank A/C
Note: In such a case the share capital of the company would be reduced by the amount
refunded.

CASE III: REDUCING THE PAID UP CAPITAL
• This reduction is a sacrifice by the shareholders and the amount of reduction or sacrifice is
credited to a new account called Capital Reduction Account (or Reconstruction Account). It
is used for writing off the accumulated losses, useless intangible assets and over valued
amount of other assets. The accounting treatment is:
a) Reduction in paid up value only- Here the nominal value of the share remains the same and
only the paid value is reduced. For example, the shareholders may agree to reduce the paid
capital of Rs. 100 per share to paid value of Rs. 10 per share. The sacrifice is Rs. 90 and the
entry will be
Share Capital A/C Dr. (Rs. 90 X No. of Shares)
To Reconstruction A/C (Rs. 90 X No. of Shares)

CONTD.
b) Reduction in both nominal and paid up values- In this case, both the paid up capital and
nominal value of the shares are reduced. Continuing the above example, the entry will be:
Share Capital Account (Rs. 100 Share) Dr. (Rs. 100 X No. of Shares)
To Share Capital (Rs. 10 Share) (Rs. 10 X No. of Shares)
To Reconstruction A/C (Rs. 90 X No. of Shares)

COMPROMISE AND ARRANGEMENT
• A scheme of compromise and arrangement is an agreement between a company and its members and
outside liabilities when the company faces financial problems. Such an arrangement therefore also
involves sacrifices by shareholders, or creditors and debenture holders or by all. These sacrifices are
also credited to Reconstruction A/C. The accounting treatment is as follows:
a) When equity shareholders give up their claim to reserves and accumulated profits, if any
Reserves Account Dr. (With the amount of reserves)
To Reconstruction Account
b) Appreciation in the value of assets on revaluation
Fixed assets A/C Dr. ( with increase in value of fixed assets)
To Reconstruction A/C

CONTD.
c) Sale of Fixed assets at a profit
Bank A/C Dr. ( Sale Price)
To Fixed Assets A/C ( Book Value of the asset sold)
To Reconstruction A/C ( Profit on Sale)
d) Settlement of outside liabilities ( creditors, debenture holders etc.) at lesser amount
Outside liabilities A/C Dr. (With the amount of sacrifice)
Provisions A/C, if any Dr.

CONTD.
e) Payment of Outside Liabilities: The debenture holders or the creditors may have to be
paid in cash or they may accept some assets of the company or shares (or new debentures) in
settlement of their claims. The journal entry is:
Outside Liabilities A/C Dr. (Amount of liability)
To Bank A/C (Payment in cash)
To Share Capital A/C (Payment in shares)
To New Debentures A/C (Payment in new Debentures)
To Assets A/C (Payment in Assets)

CONTD.
f) Preference Dividend: There can be three situations:
i. Dividend declared and payable(i.e. given in the balance sheet) but sacrificed:
Preference dividend payable A/C Dr.
ii. Arrears of Dividend(i.e. does not given in the balance sheet) but paid now:
a) Reconstruction A/C Dr.
To Preference Shareholders A/C
b) Preference Shareholders A/C Dr.
To Bank A/C
iii. Dividend neither declared nor paid
No Entry, because there is no liability on the company and hence, there is no sacrifice.

SURRENDER OF SHARES
• It means handing over or giving up the possession of the shares to the company by the
shareholders. In Companies Act, surrender of shares amounts to reduction of share
capital. However, the surrender shares can be re- issued to:
To new shareholders
In reducing the trade Liabilities i.e. creditors
In reducing non- trading liabilities i.e. debenture holders
Note: When the surrendered shares are not re- issued, these are cancelled and the balance is
transferred to Reconstruction A/C

ACCOUNTING TREATMENT FOR SURRENDER OF
SHARES
a) On Surrender of Shares
Share Capital A/C Dr.
To Shares Surrendered A/C
b) On Re- issue of Surrendered Shares
Shares Surrendered A/C Dr.
To Share Capital A/C
• Note: Whether issued to new shareholders or to pay outside liabilities.
c) On Cancellation of Surrendered Shares
Shares Surrendered A/C Dr

EXAMPLE FOR SURRENDER OF SHARES
• The Equity shareholders of XYZ Ltd. agree to surrender their shares of Rs. 1,00,000.
Further, Rs. 80,000 debenture holders and Rs. 50,000 trade creditors agree to give up or
sacrifice or forego their claims by 50% each in exchange for equity shares to be issued
from the surrendered shares to settle their remaining claims. Journalize it.
a) On Surrender of Shares
Equity Share Capital A/C Dr. 1,00,000
To Shares Surrendered A/C 1,00,000
b) For issue of equity shares out of surrendered shares
Shares Surrendered A/C Dr. 65,000 ( 40,000 + 25,000)
To Equity Share Capital A/C 65,000

CONTD.
c) For Cancellation of claims by debenture holders and creditors
Debentures A/C Dr. 80,000
Trade Creditors A/C Dr. 50,000
To Reconstruction A/C 1,30,000
d) For Cancellation of the balance in shares surrendered A/C
Shares Surrendered A/C Dr. 35,000
To Reconstruction A/C 35,000
Note: Calculation of total sacrifice:
By shareholders 1,00,000
By Debenture holders 40,000
By Trade Creditors 25,000

UTILIZATION OF RECONSTRUCTION A/C
• At this stage the Reconstruction A/C will show some credit balance on account of sacrifice made by shareholders, outside
liabilities, profit on sale of fixed assets etc. Reconstruction A/C is utilized in following manner:
a) Writing Off fictitious and intangible Assets: The Accounting treatment is:
Reconstruction A/C Dr.
To Preliminary Expenses A/C
To Discount on issue of shares A/C
To Patents A/C
To Goodwill A/C
To Surplus A/C ( Negative Balance)
Note: These have to be written off whether given in the problem or not.

CONTD.
b) In writing down overvalued fixed and current assets: The accounting treatment is:
Reconstruction A/C Dr. ( With the Amount of Reduction)
To Fixed assets A/C ( Individual Fixed Assets
To Current Assets A/C ( Individual Current Assets)
c) Recording New Liability: The accounting treatment is:
To Particular Liability A/C
Note: If some unrecorded Liability is directly paid in cash, the journal entry would be:
To Bank A/C

CONTD.
d) Expenses of Reconstruction: The Accounting treatment is:
To Bank A/C
e) Credit Balance in Reconstruction: If there is some credit balance in Reconstruction A/c,
it is transferred to Capital Reserve A/C. The journal entry would be:
To Capital Reserve A/C

PROBLEM I: INTERNAL RECONSTRUCTION

SOLUTION
S. No Particulars Dr. Cr.
31.3.16 Equity Share Capital(Rs.100) A/C Dr.
To Equity Share Capital(Rs.5) A/C
20,00,000
1,00,000
19,00,000
31.3.16 Equity Share Capital(Rs.5) A/C Dr.
Equity Share Capital(Rs.10) A/C
1,00,000
1,00,000
31.3.16 O/S Deb. Interest A/C Dr.
1,20,000
1,20,000
31.3.16 12% Debentures A/C Dr.
To 14% Debentures A/C
5,00,000
5,00,000
31.3.16 Bank A /C Dr.
To Equity Share App. & All. A/C
5,00,000
5,00,000
31.3.16 Equity Share App. & All. A/C Dr.
To equity Share Capital A/C
5,00,000
5,00,000

SOLUTION
31.3.16 Trade Payables A/C Dr.
To Equity Share Capital (Rs.10) A/C
To Bank A/C
3,00,000
2,00,000
50,000
50,000
31.3.16 Land & building A/C Dr.
50,000
50,000
31.3.16 Reconstruction A/C Dr.
To Plant & Machinery A/C
To prov. For doubtful debts A/C
To Goodwill A/C
To Share Issue Expenses A/C
To Surplus A/C
To capital reserve (B.F)
21,20,000
90,000
5,000
25,000
20,000
19,80,000

BALANCE SHEET OF M/S DOWNHILL LTD. AS ON 31ST MARCH,
2016
Particulars Note No. Amt. Amt.
I. EQUITY AND LIABILITIES
Shareholder’s Fund
Share Capital
Non- Current Liabilities
Long Term Borrowings
Current liabilities
Short Term Provisions
TOTAL
II. ASSETS
Fixed Assets
Current Assets
Inventories
Trade Receivables
Cash & Bank Balances
Total
1
2
3
4
5
8,00,000
5,00,000
5,000
__________
13,05,000
__________
4,90,000
2,70,000
60,000
4,85,000
_________
13,05,000
_________

PROBLEM II: PREPARATION OF OPENING TRIAL
BALANCE

SOLUTION
• Note: As the Trial Balance or the Previous Balance Sheet is not given, there is some
missing information which is to be ascertained first and then only we may proceed further
with the solution. So, we will start with the preparation of trial balance:
Balance as at 31st March, 2017
Dr. Balance Amount Cr. Balance Amount
Goodwill
Freehold Property
Plant & Machinery
Stock
Debtors
Bank
Preliminary Expenses
Surplus(B.F)
( Negative)
50,000
1,60,000
4,90,000
1,30,000
80,000
20,000
30,000
1,77,000
________
11,37,000
Equity Sh. Cap.
8% Pref. Sh. Cap.
7% Deb.
O/S Deb. Interest
Creditors
Prov. For Dep.
4,00,000
2,50,000
2,00,000
7,000
1,60,000
1,20,000
___________
11,37,000

SOLUTION
31.3.17 Equity Share Capital A/C Dr.
2,00,000
2,00,000
To Equity Share Capital A/C
Arrears of Div.= (2,50,000*8%) * 4
= Rs. 80,000
No. of Equity Shares to be Issued
= 80,000/ 40
= 2,000 shares
Paid up Value of shares
= 2,000*5
= Rs. 10,000
10,000
10,000
31.3.17 8% Pref. Share Cap. A/C Dr.
To 10% Pref. Share Cap. A/C
2,50,000
2,00,000
50,000
O/S Deb. Int. A/C Dr.
To Debenture holders A/C
2,00,000
7,000
1,80,000
27,000

SOLUTION
31.3.17 Bank A/C Dr.
To Debenture holders A/C
20,000
20,000
31.3.17 Debenture holders A/C Dr.
To Freehold Property A/C
2,00,000
2,00,000
To Prov. For Dep. A/C
To Prov. For Doubtful Debts A/C
Note: Plant & Mach.= Rs. 4,90,000
Prov. For Dep. = Rs. 1,20,000
Revalued Amount = Rs. 3,50,000
Excess Prov . = Rs. 20,000
28,000
20,000
8,000
To Bank A/C
( On Account of Contingent Liability i.e. Payment
of Unrecorded Liability)
12,000
12,000
31.3.17 Creditors A/C Dr.
To Bank A/C
30,000
15,000
15,000

SOLUTION
To Surplus A/C ( Negative )
To Goodwill A/C
2,57,000
30,000
1,77,000
50,000
To Capital Reserve A/C
(2,00,000 - 10,000 + 50,000 + 27,000 + 40,000 –
28,000 – 12,000 + 15,000 – 2,57,000 )
25,000
25,000

PROBLEM III: INTERNAL RECONSTRUCTION

SOLUTION
31.3.10 Equity Share Capital (Rs.10) A/C Dr.
To Equity Share Capital (Rs. 5) A/C
7,50,000
7,50,000
31.3.10 Equity Share Capital (Rs. 5) A/C Dr.
To Shares Surrendered A/C
6,00,000
6,00,000
31.3.10 Preference Share Capital (Rs.100) A/C Dr.
To Preference Share Capital (Rs.80) A/C
5,00,000
4,00,000
1,00,000
31.3.10 Shares Surrendered A/C Dr.
90,000
90,000
31.3.10 Creditors A/C Dr.
3,00,000
3,00,000
To Equity Share Capital
75,000
75,000

SOLUTION
31.3.10 Unsecured Loan A/C Dr.
1,25,000
1,25,000
Balance in Shares Surrendered A/C
= (6,00,000 - 90,000 - 75,000)
4,35,000
4,35,000
To Bank A/C
25,000
25,000
To Goodwill A/C
To Plant A/C
To Equipment A/C
To Book Debts A/C
To Inventories A/C
To Surplus A/C
To Patents A/C
To P & M A/C (B.F.)
9,35,000
75,000
1,00,000
20,000
40,000
50,000
12,500
5,00,000
1,25,000
12,500

2016
Share Capital
Reserves & Surplus(SPR)
Non Current Liabilities
Long Term Provision
Current Liability
a) Trade Payables
b) Other
Total
II. Assets
Fixed Assets
Current Assets
Inventories
Trade Receivables
Cash and Cash Equivalents
Total
1
2
3
4
5
6
7
12,15,000
2,25,000
__________
4,50,000
62,500
__________
3,25,000
5,85,000
5,12,500
14,40,000
1,12,500
5,12,500
__________
20,65,000
__________
6,42,500
14,22,500
__________
20,65,000
__________

NOTES TO ACCOUNTS
Particulars Amount Amount
1. Share Capital
5,000, 10% Pref. Shares of Rs.80
each
1,63,000* Equity Shares of Rs. 5
Each
*(1,50,000 – 1,20,000 + 18,000 +
15,000 + 1,00,000)
2. Reserves & Surpluses
SPR
3. Long Term Provisions
Employees PF
4. Trade Payables
Creditors
5. Other Current Liabilities
O/S Expenses
6. Fixed Assets
P & M
Equipments
7. Cash and Cash Equivalents
4,00,000
8,15,000
__________
6,37,500
5,000
_________
37,500
(25,000)
5,00,000
12,15,000
2,25,000
1,12,500
4,50,000
62,500
6,42,500

PROBLEM IV: INTERNAL RECONSTRUCTION

SOLUTION
31.3.2017 8% Pref. Share Cap. A/C Dr.
3,00,000
2,10,000
90,000
31.3.2017 *Reconstruction A/C Dr.
Amt. of Dividend to be payable
= 70% of (3,00,000*8%)
*Treating it as an unrecorded Liability
16,800
16,800
O/S Deb. Int. A/C Dr.
To 10% Debentures A/C
3,00,000
54,000
3,00,000
54,000
31.3.2017 Sundry Creditors A/C Dr.
3,750
3,750
31.3.2017 Sundry Creditors A/C Dr.
Discount given by Creditors
1,725
1,725

SOLUTION
31.3.2017 Equity Share Capital A/c Dr.
1,50,000
1,50,000
To Surplus A/C
To Patents A/C
To Sundry Debtors A/C
To Fixed Assets A/C
To Investments A/C
To Bank A/C
Balance in Reconstruction A/C
= (90,000 – 16,800 + 54,000 + 3,750 + 1,725)
= 1,32,675
Deficit
= (2,82,675 – 1,32,675)
= 1,50,000
2,82,675
2,14,000
40,000
15,000
7,000
5,000
1,675
31.3.2017 Bank A/C Dr.
Cash brought by Equity Shareholders
4,50,000
4,50,000

SOLUTION
31.3.2017 Preference Shareholders A/C Dr.
Sundry Creditors A/C Dr.
Bank Overdraft A/C Dr.
To Bank A/C
2,26,800
36,526
75,000
3,38,325

2016
Share Capital
Non- Current Liabilities
Long Term Borrowings
TOTAL
II. ASSETS
Fixed Assets
Non Current Investments
Current Assets
Trade Receivables
Cash & Bank Balances
TOTAL
1
2
3
4
5
6
4,09,500
1,10,000
__________
8,00,000
3,00,000
___________
11,00,000
___________
5,53,000
27,500
5,19,500
___________
11,00,000
____________

NOTES TO ACCOUNTS
Particulars Amount Amount
1. Share Capital
50,000 Shares of Rs. 20 Each, Rs.
10 Paid Up
Less: Reduction In Share Capital
Add: Cash Brought
50,000 shares of Rs. 20 each, Rs. 16
Paid Up
2. Long Term Borrowings
10% Debentures
3. Fixed Assets
Book Value
Less: Depreciation
4. Non Current Investments
5. Trade Receivables
6. Cash & Cash Equivalents
5,00,000
(1,50,000)
4,50,000
___________
5,60,000
(7,000)
__________
8,00,000
3,00,000
5,53,000
27,500
4,09,500
1,10,000

Internal Reconstruction Corporate accounting by bhumika Garg

Internal Reconstruction Corporate accounting by bhumika Garg

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