The document discusses internal and external reconstruction of companies. Internal reconstruction refers to reorganizing a company's financial structure without liquidating it, such as reducing share capital to write off losses. External reconstruction involves liquidating an existing company and transferring its assets/liabilities to a new company formed to take over the business. The objectives, types, differences, and accounting treatments of internal and external reconstruction are explained through examples and journal entries.

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EXTERNAL RECONSTRUCTION AND INTERNAL RECONSTRUCTION
What is Reconstruction?
Reconstruction is a process of the company’s reorganization, concerning legal, operational,
ownership and other structures, by revaluing assets and reassessing the liabilities. I refers to
the transfer of company or several companies’ business to a new company. This, therefore,
means that the old company will get put into liquidation, and shareholders will therefore agree
to take shares of equivalent value in the new company. Reconstruction is required when the
company is incurring losses for many years, and the statement of account does not reflect the
true and fair position of the business, as a higher net worth is depicted, than that of the real one.
In other words, “Reconstruction” involves the winding up of an existing company and the
transfer of its assets and liabilities to a new company formed for the purpose of taking over the
business and undertaking of the existing company. Shareholders in the existing company
become shareholders in the new company. The business undertaking and shareholders of the
new company are substantially the same as those of the old company.
Objectives of Reconstruction
1. To resolve the problem of over-capitalization/huge accumulated losses/over valuation of
assets.
2. When the capital structure of a company is complex and is required to make it simple
3. When change is required in the face value of shares of the company
4. To generate surplus for writing off accumulated losses & writing down overstated assets.
5. Raising the fresh capital by issuing new shares.
6. Changing altogether the memorandum of association of the company.
7. To generate cash for working capital needs, replacement of assets, to add balancing
equipment’s, modernise plant & machinery etc.
Types of Reconstruction
A company can be reconstructed in any of the two ways. These are:
1. External Reconstruction and
2. Internal Reconstruction.
External Reconstruction: When a company is suffering losses for the past several years and
facing financial crisis, the company can sell its business to another newly formed company.
Actually, the new company is formed to take over the assets and liabilities of the old company.
This process is called external reconstruction. In other words, external reconstruction refers to
the sale of the business of existing company to another company formed for the purposed. In
external reconstruction, one company is liquidated and another new company is formed. The
liquidated company is called "Vendor Company" and the new company is called "Purchasing
Company". Shareholders of Vendor Company become the shareholders of purchasing
company.
Internal Reconstruction: Internal reconstruction refers to the internal re-organization of the
financial structure of a company. It is also termed as re-organization which permits the existing
company to be continued. Generally, share capital is reduced to write off the past accumulated
losses of the company.

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Difference between amalgamation and external reconstruction
 Amalgamation of companies involves liquidation of two or more companies, while
external reconstruction involves liquidation of only one company.
 Amalgamation of companies results in combination of companies, but external
reconstruction does not result in any such combination.
Accounting procedure for external reconstruction: The Accounting procedure in case of
external reconstruction is the same as in case of amalgamation in the nature of purchase.
[SAME JOURNAL ENTRIES]
Methods, Calculation and discharge of purchase consideration: is the same as in case of
amalgamation.
Differentiate between Internal and External reconstruction
Basis of Distinction Internal Reconstruction External Reconstruction
Meaning Internal reconstruction refers
to the method of corporate
restructuring wherein
existing company is not
liquidated to form a new one.
External reconstruction is
one in which the company
undergoing reconstruction is
liquidated to take over the
business of existing
company.
New company No new company is formed. New company is formed.
Capital reduction Capital is reduced and the
External liability holders
waive their claims.
No reduction in the capital
Transfer of Assets and
Liabilities
No such transfer takes place. Assets and liabilities of
existing company are
transferred to the new
company.
Application It is done to ensure an inner
rearrangement
Of financial structure.
It is done to form a new
Company.
Approval of Tribunal Required. Not required.
Liquidation Liquidation of company is
not done.
Liquidation of company is
must
losses against
profits
It can set off past losses
against future profits.
Since a new company is
Established, losses of the old
company can’t be set off
against the profits of the new
company.
ACCOUNTING ENTRIES FOR INTERNAL RECONSTRUCTION
SL NO PARTICULARS DR CR
1 For Reduction of Equity Share capital:
(old) Equity Share capital A/c Dr
To (New) Equity Share Capital A/c
To Capital Reduction A/c

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2 For Reduction of Preference Share capital:
(old) Preference Share Capital A/c Dr
To (new) Preference Share capital
To Capital Reduction A/c
3 For Reduction of the amount due to debenture holders:
(old) Debenture A/c Dr
To (New) Debenture A/c
To Capital Reduction A/c
4 For reduction of the amount due to creditors:
Creditors A/c Dr
To Capital Reduction A/c
5 For Appreciation in the value of assets:
Assets A/c Dr
To Capital Reduction A/c
6 For the payment of reconstruction expenses:
Reconstruction Expenses A/c Dr
To Bank A/c
7 For Utilization of capital reduction account in writing off
accumulated losses and various fictitious assets:
Capital Reduction A/c Dr
To profit and loss A/c (Loss)
To Preliminary Expenses A/c
To Discount on issue of shares or debenture A/c
To Underwriting Commission A/c
To Advertising Suspense A/c
To Reconstruction Expenses A/c
To Goodwill A/c
To patent or trade mark A/c
To Capital Reserve A/c (if some balance is still left)

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ILLUSTRATIONS ON EXTERNAL RECONSTRUCTION
Illustration 1 - External Reconstruction
P Co after a series of heavy loss resolve to go into voluntary liquidation and to reconstruct by
means of a new company under the name NP Co. on the date of reconstruction
The balance sheet of P Co as follows:
Liabilities Amt Assets Amt
Capital : 200000
shares of Rs 5 Each
1000000Building 392500
Sundry creditors 30000Machinery 239000
Bills payable 10000Motor lorry 19400
Bank loan 15000Stock 91410
Sundry Debtors 109100
Bank 3590
P&L 200000
1055000 1055000
The following is the scheme of Reconstruction:
a) The new company is to take over the assets of the old company and not the liabilities.
b) Capital of the new company is to consist of 500000 shares of Rs 5 each.
c) The new company is to issue 280000 shares of Rs 5 each credited with Rs 2.50 per share
as paid up to the old company and to pay to it Rs 100000 in cash by way of purchase
consideration.
d) The balance of Rs 2.50 per share payable by the members of the new company is duly
received.
Record the journal entries in the books of both the companies and prepare balance sheet of the
new company.
Illustration 2
The balance sheet of B Ltd as on 31/03/2020
Liabilities Amt Assets Amt
40000 shares of Rs 10
each fully paid
400000Land and Building 320000
Creditors 300000Plant and machinery 130000
Stock 70000
Debtors 120000
Cash 500
Preliminary expenses 5000
P&L 54500
700000 700000
The following scheme of reconstruction was approved by the court:
a) The company is to go into liquidation and a new company S Ltd with an authorized capital
of Rs 800000 is to be formed to take over the assets and liabilities.
b) Preferential creditors of Rs 10000 included in the above balance sheet are to be paid in
full.
c) Unsecured creditors to receive either i) 50% of their claim in cash or ii) 6% Debentures
in the new company equivalent to their claim at par.
d) Shareholders of B Ltd to be allotted one share of Rs 10 each in the new company , Rs 5
per share paid up for every existing share held by them.

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e) Reconstruction cost amounting to Rs 6000 to be paid by B Ltd from cash made available
by the new company, in addition to other purchase consideration mentioned above.
Half of the unsecured creditors in value opted out for immediate cash payment for which
purpose necessary cash was made available by the new company, which made a call of Rs5
each on the partly paid share, allotted as aforesaid. The new company valued all the assets
(except L&B) taken over from B Ltd at book value.
Prepare balance sheet of S Ltd giving effect to the above transaction.
Illustration 3 - External Reconstruction
The following is the balance sheet of India traders Ltd as on 31/03/2019
Liabilities Amt Assets Amt
500, 6% Cumulative Preference
shares of Rs 100 each fully paid
up
50000Goodwill 55000
15000 equity shares of R 10 each
fully paid up
150000Sundry assets 164500
7% Debentures 20000Cash 500
Sundry creditors 50000P&L a/c 30000
250000 250000
Note: Preference dividends are in arrears for 4 years.
The company being unable to raise further capital, a scheme of reconstruction as detailed
below was agreed upon:
a) New India trader’s Ltd company was formed with an authorized capital of Rs 325000
all in Equity shares of Rs 10 each.
b) One equity share in the new company Rs 5 paid up issued for every equity share in the
old company.
c) Twenty equity shares in the new company of Rs 5 paid up to be issued for each
preference shares in the old company.
d) Arrears of Preference dividend be cleared by issuing one equity shares in the new
company for due of dividend on every 5 cumulative preference shares in the old company a
fully paid up.
e) Debenture holders agree to receive 2000 equity share in the new company as fully paid
up.
f) The remaining unissued equity share are to be taken over and paid for in full by the
directors of the new company.
g) The assets and liabilities of the old company are taken over by New India Ltd, subject
to writing down of Sundry assets by Rs 40000 and adjusting the goodwill as required.
You are required to prepare opening entry and balance sheet.

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ILLUSTRATIONS ON INTERNAL RECONSTRUCTION
Illustration - 1
The Balance Sheet of ABC Ltd 0n 31-3-2020 was as follows
Liabilities Amount Asset Amount
2000 shares of Rs. 100 each
Fully Paid-up 200000 Goodwill 70000
200, 5% Debentures of Rs.
1000 each 200000 Building 80000
Creditors 50000 Plant 150000
Bills Payables 5000 Stock 50000
Bank OD 45000 Debtor 43000
Cash 2500
Preliminary Expenses 4500
P/L Account 100000
500000 500000
The following scheme of Reconstruction was adopted
1. The paid up value of each share to be reduced to Rs. 50 each
2. 5% Debentures to be converted into 100, 7.5% Debentures of Rs. 1000 each
3. The asset was revalued as under Building Rs. 72000, Plant Rs. 140000, and Stock Rs.
45000, Debtors subject to Reserve for bad debts Rs. 2500
4. Creditors agreed to forgo 1/4th
of the amount due to them in return for shares for the
balance.
5. Goodwill and fictitious assets to be written off entirely.
Give the necessary journal entries.
Illustration - 2
Balance Sheet of XY Ltd as on 31-3-2020 was as follows
Liabilities Amount Asset Amount
2000 Preference shares of Rs.
100 each
200000 Goodwill 15000
4000 Equity shares of Rs. 100
each
400000 Freehold Property 200000
5% Mortgage Debentures 100000 Plant 300000
Creditors 100000 Stock 50000
Bank OD 50000 Debtor 40000
P/L Account 245000
850000 850000
The following scheme was approved by the court of the company.
1. Preference shares to be reduced to Rs. 75 per share and Equity shares to Rs. 37.50 per
share.
2. Debenture holders to take overstock and book debt in full satisfaction of the amount due
to them
3. Goodwill to be eliminated
4. Freehold premises to be depreciated by 50%.
5. Plant to be appreciated by Rs. 50000

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Journalese and prepare the revised balance sheet
Illustration - 3
Balance Sheet of a private company stood as follows on 31-03-2019.
Liabilities Amount Asset Amount
19000 shares of Rs. 100 each 1900000 L&B 100000
Creditors 100000 Machinery 260000
Debentures 100000 Furniture 20000
Stock 370000
Debtors 180000
Goodwill 200000
P&L 970000
2100000 2100000
The company is to be reconstructed as follows:
a. Shares of Rs.100 are to be reduced to an equal number of fully paid shares of Rs. 40
each
b. To issue 1000 new shares of Rs. 40 each as fully paid up to debentures holders in full
settlement
c. The amount available is to be utilized in writing off the goodwill and P&L and the
balance in writing down the value of the machinery.
d. The authorized capital of the company is 20000 shares of Rs. 1000 each
Give the necessary journal entries. Prepare the capital reduction account and balance sheet
Illustration - 4
The following is the balance sheet of MS Ltd as of 31-03-2019.
Liabilities Amount Asset Amount
13% Preference shares of Rs. 100 each 100000 Fixed Asset 1500000
Equity shares of Rs. 10 each 700000 Current Asset 3500000
8% Debentures 300000 P&L 300000
Current Liabilities 3900000
Provision for Taxation 300000
5300000 5300000
The following scheme of reconstruction was adopted
a. Fixed assets are to be written down by 33.33%.
b. Current assets are to be revalued at Rs. 2700000
c. Preference shareholders decided to forgo their right to arrears of dividend which are in
arrear for the last three years.
d. The taxation liability is settled Rs. 400000
e. One of the creditors of the company to whom the company owes Rs. 2500000 decided
to forgo 50% of his claim. He is allotted 100000 equity shares of Rs. 5 each in part
satisfaction of the balance of his claim.
f. The rate of interest on debentures is increased to 11%. The debenture holders surrender
their existing debentures of Rs 100 each and exchange the same for fresh debentures of Rs.
75 each.
g. All existing equity shares are reduced to Rs. 5 each.

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h. All preference shares are reduced to Rs. 75 each.
Pass the journal entries and show the balance sheet of the company after giving effect to the
above.
Illustration - 5
The following is the balance sheet of A Ltd as on 31/03/2019
Liabilities Amt Assets Amt
Share capital :
Shares of Rs 10 each
1000000 Goodwill 200000
10% Cumulative preference shares of
Rs 100 each
200000 Machinery 1000000
Sundry liabilities 1000000 Stock 250000
Debtors 200000
Bank 50000
P&L A/c 500000
2200000 2200000
Preference dividends are in arrears for the last 4 years. The following scheme is approved by
the court.
a) Equity shares to be reduced to Rs 1 each.
b) 50% of preference dividend in arrears to be paid in cash immediately and the balance of
arrears is agreed to be foregone.
c) Machinery to be depreciated by 5% and 10% RBD on the debtors to be provided.
d) All intangible assets to be written off.
e) Balance of reconstruction account of any to be capitalized.
Journalize and prepare a reconstructed balance sheet.
Illustration - 6
Balance sheet if Indian construction Ltd as on 31-03-2020
Liabilities Amt Assets Amt
Authorized capital:
20000 equity shares of Rs 10 each 200000
Goodwill 10000
Paid up capital:
12000 equity shares of Rs 10
each 120000
Less : calls in
arrears (9000)
(Rs 3 per share on 3000 shares)
1,11,000
Land and building 20500
Sundry creditors 15425Machinery 50850
Provision for taxes 4000Preliminary expense 1500
Stock 10275
Book debts 15000
Cash at bank 1500
P&L A/c:

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Balance as per last
B/S 22000
(-) Profit of this year (1200) 20800
130425 130425
A valuation of machinery reveals that it is overvalued by Rs 10000. It is proposed to write
down this asset to it true value, to eliminate the deficiency in the P&L A/c and to write off
goodwill and preliminary expenses by adopting the following course:
1. Forfeit the shares on which call is outstanding.
2. Reduce the paid-up capital by Rs 3 per share; face value remaining the same
3. Reissue the forfeited shares at Rs 5 per share.
4. Utilize the provision for taxes if necessary.
All the above was duly put into action. Pass necessary journal entries and draw up the balance
sheet of the company after carrying out the terms of the scheme.
Illustration - 7
On the reconstruction of a company the following terms were agreed upon:
The shareholders to receive in lieu of their present holding (50000 shares of Rs 10 each) the
following:
a) Fully paid equity shares equal to 2/5th
of their holdings.
b) 5% preference shares fully paid to the extent of 1/5th
of the above new equity shares.
c) Rs 60000, 6% second debentures.
An issue of Rs 50000, 5% first debentures were made and allotted payment for the same having
been received in cash.
The goodwill which stood at Rs 300000 was written down to Rs 150000.
The P&M which stood at Rs 100000 was written down to Rs 75000.
Freehold and leasehold premises which stood at Rs 150000 were written down to Rs 125000.
Pass journal entries in the books of the company for the above transaction.