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1. Internal
Reconstruction
BY: BHOOMIKA GARG

2. 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.

3. 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.

4. Methods of Internal
Reconstruction
The following methods are used to give proper shape to the scheme of
Internal reconstruction:
Alteration of Share Capital
Change in Shareholder’s rights
Reduction of Share Capital
Compromise and Arrangement
Surrender of Shares

5. 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.

6. 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

7. Example
A company with a capital of Rs. 10,00,000 divided into 10,000 equity shares of `
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 10,000shares 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...)

8. 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.

9. 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.

10. Change in Shareholder’s Right
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.

11. 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:

12. 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.

13. 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.

14. 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)

15. 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)

16. 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 there 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
)

17. 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.
To Reconstruction A/C

18. 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)

19. 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.
To Reconstruction A/C
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.