INTERNAL RECONSTRUCTION OF COMPANIES

Table of Contents

Meaning:

Internal reconstruction is an internal re-arrangement of capital of a financially unsound company such that the company instead of going into liquidation, reconstructs itself internally by altering or by reducing capital of its shareholders, claims of debenture holders, creditors and other lenders with their consent. The essence of internal reconstruction is that there is neither liquidation of a company nor formation of a company but there is slight alteration in the claims of various parties.

Forms of internal reconstruction:

1. Reorganization or alteration of share capital: It refers to the re-arrangement of capital and

includes the following:

(a) Increase in the share capital by further issue of shares

(b) Decrease in the share capital by cancelling un-issued shares

(c) Conversion of fully paid shares into stock

d) Consolidation of shares of smaller amount into shares of larger amounts and vice- versa.

2. Reduction of share capital under the liabilities: It is an arrangement under which capital of shareholders and clients of outsiders are reduced and the amount so reduced is used for writing off of the accumulated losses, fictitious assets and overvalued portion of fixed assets.

 The reduction of capital includes the following:

(a) Reducing the liabilities of share capital to the extent of uncalled capital

(b) Reducing the share capital by returning that portion which is in excess of required amount.

Objectives of internal reconstruction:

The basic objective of internal reconstruction is to write off the accumulated losses, fictitious assets and overvalued assets of the company by reducing the capital or claims of third parties. For this purpose, an account namely “Capital Reduction A/c (or) Reconstruction A/c” is created in which all the amounts to the extent of which reduction is made in various accounts is credited to this a/c and the losses and overvalued assets are debited to this a/c. The surplus there on is retained by transferring to “Capital Reserve A/c”

Capital reduction

Capital reduction is the process of decreasing a company’s share capital (both equity and preference share capital) through share cancellations and share repurchases. The reduction of capital is done by the companies for various reasons, including increasing shareholder value and producing a more efficient capital structure.

Section 66 of the Companies Act, 2013 was enacted with the intention to allow companies to reduce their share capital in fair and equitable manner and in such a way that reduction does not impact the operations of the company and interest of the creditors remain protected.

Authorisation for Reduction of Share Capital:

A company limited by shares or limited by guarantee and having a share capital may, reduce the share capital by passing a special resolution, subject to the confirmation by the Tribunal (NCLT) and alter its memorandum by reducing the amount of its share capital and of its shares accordingly. The Tribunal has the absolute power to confirm or reject the scheme of reduction.

Modes of reduction of share capital:

Section 66(1) of the Companies Act, 2013 does not prescribe the manner in which the reduction of capital is to be affected nor is there any limitation on the power of the Tribunal to confirm the reduction, except that it must be satisfied that every creditor of the company has either consented to the said reduction or they have been paid off or their interest

has been secured

However, reduction of share capital may be affected in one of the following ways:

  1. Reduction of liability on unpaid amount: In respect of unpaid share capital, reducing the liability on any of its shares, (For example, if the shares are of face value of ₹100 each of which ₹ 75 has been paid, the company may reduce them to ₹ 75 fully paid-up shares and thus relieve the shareholders from liability on the uncalled capital of ₹25 per share); or
  2. Reduction in the paid-up value of the share: Cancelling or reducing the paid-up. This may be done either with or without extinguishing or reducing liability on any of its shares (For example, if the shares of face value of ₹100 each fully paid-up is represented by ₹75 worth of assets. In such a case, reduction of share capital may be affected by cancelling ₹25 per share and writing off similar amount of assets); or
  3. Re-payment of paid-up share capital: Re-payment of paid-up share capital, which is in excess of the needs of the company. This may be achieved either with or without extinguishing or reducing liability on any of its shares. (For example, shares of face value of ₹100 each fully paid-up can be reduced to face value of ₹75 each by paying back ₹25 per share.) Paid-up share capital for the purpose of capital reduction would include securities premium and capital redemption reserve also

Objectives of Capital Reduction:

Some of the objectives of capital reduction are mentioned below:

  1. Dividend payments: The most common objective is the payment of dividends. Capital reduction allows the elimination of accumulated losses, which would otherwise prevent the hen the accumulated losses are eliminated, the dividend payment of dividends. distributable reserves can be created.
  2. Returning surplus capital: A company may have capital which is surplus to its requirements for the foreseeable future and which it may therefore wish to return to its shareholders.
  3. Redeeming Shares: A company may wish to redeem its shares but it cannot do so if it has insufficient distributable reserves.
  4. Distributing non- cash assets: A company may also use a capital reduction to transfer non- cash assets that it owns to its shareholders, although this is relatively unusual.
  5. Structuring mergers and acquisitions a part of a scheme of arrangement: Capital reductions have become a popular method of structuring mergers and acquisitions or group restructurings
  6. Demergers: Capital reduction can be used to split one company’s activities into different companies, called a demerger. Demergers are often used with the help of a scheme of arrangement.

Provisions for Reduction of Share Capital under Companies Act, 2013

The provisions relating to capital reduction under the new companies act ,2013 are under:

  • A company constituted with limited liability by shares or guarantee and having share capital is alone entitled to reduce its liability of members.
  • It should have the power under its Articles of Association to do so. If the articles do not contain any provision for reduction of capital, the articles must first be altered so as to give such power
  • Reduction is regarded as internal restructuring of company, therefore decision of majority will prevail by way of special resolution
  • The reduction effected by such resolution must be confirmed by the National Company Law Tribunal (‘Tribunal’)
  • No capital reduction can be undertaken if the company is in arrears in the repayment of any deposits (including interest payable thereon) accepted by it.
  • Reduction takes effect on registration of the documents with the Registrar of Companies
  • Reduction is different from Diminution of shares which is regarded an cancellation of unsubscribed share capital.

Accounting Procedures: There are two main steps involved in the internal reconstruction namely.

1. Reduction of capital (both share capital and debt debt capital) and writing off of losses and passing journal entries accordingly.

2. Preparation of reconstructed balance sheet.

Capital reduction a/c: The capital reduction a/c can be taken as the base for passing journal entries. However, it is not compulsory in all the problems unless we are asked to Prepare it specifically. This a/c is prepared as under:

CAPITAL REDUCTION A/C

DR.CR.
ParticularsParticulars
To Goodwill written offXXXBy Equity Share capital a/cXXX
To P/L a/c written offXXX(With the amt foregone) 
To Other Misc. Exp Written offXXXBy Pref. Share Capital a/cXXX
To Dep. On fixed assetsXXX(With amount foregone) 
To Increase in any liabilityXXXBy Debentures a/cXXX
To Unrecorded liabilitiesXXX(With the amount foregone) 
To Reconstruction expensesXXXBy Creditors a/cXXX
(paid if any considering it as (With the amount foregone) 
additional liability) By Any Reserve a/cXXX
To O/s Preference Dividends a/cXXX(if given in the balance sheet) 
(Given outside B/S, if paid considering it By Any asset’s a/cXXX
as additional liability) (Appreciation in the value of assets if 
To capital reserve a/cXXXany) 
(Difference amt transferred)   
 XXX XXX

Journal Entries:

  1. For reducing the capital:

Share capital a/c (Old)                                      Dr.

To Share Capital a/c (New)

To Capital Reduction A/c (amt foregone)

(Being shares reduced to ….. and balance transferred to capital reduction a/c)

  • For reducing debentures or creditors if any:

Creditors a/c                                                     Dr.

(With foregone amount)

Debenture a/c                                                   Dr.

(With foregone amount)

To Capital Reduction a/c.

 (Being the above liabilities reduced and amount transferred to capital reduction a/c)

Note: In case the debenture holders accept for new debentures of different denomination, Or rate, then the following entry is passed:

Debentures A/c                                                 Dr. (Old)

To Debentures A/c (New)

To Capital Reduction A/c

(Being old debentures converted into new debentures)

  • For appreciation in the value of assets:

Concerned Asset a/c                                         Dr.

To Capital Reduction a/c

(Being appreciation in the value of assets transferred to capital reduction a/c)

  • For writing off of the losses and assets:

Capital reduction a/c                                         Dr.

To P&L a/c

To Goodwill a/c

To Preliminary Exp a/c

To Underwriting commission a/c

To Discount on issue of shares/debentures a/c

To Reconstruction Exp a/c

To Any other assets a/c (to the extent of reduction)

To Capital Reserve a/c (Balance amt)

(Being the above assets and liabilities written off and the balance transferred to capital a/c)

Other points to be noted:

  1. If any new shares are issued to the shareholders, the following entry is passed;

Bank a/c                                                           Dr.

To Eq. Share capital a/c or Pref. Share Capital a/c

(Being new shares offered to public and amount received)

  • For incurring reconstruction expenses following entry is passed:

Reconstruction Expenses a/c                 Dr.

To Cash/Bank A/c                                           

(Being Reconstruction Expenses incurred)

Note: The Reconstruction Exp a/c is closed by transferring it to Capital Reduction A/c by passing t

following entry.

Capital Reduction A/c                           Dr.

To Reconstruction expenses A/c

(Being expenses incurred)

  • If any reserves are given in the balance sheet then the same should be credited to capital reduction a/c. The entry for this is:

Reserves a/c                                         Dr.

To Capital Reduction A/c

(Being above reserves transferred to Capital Reduction A/c)

  • If there is any unrecorded liabilities (such as o/s debenture interest, o/s preference dividend etc), the same should be recorded as under:

 (i) Unrecorded Liabilities A/C              …Dr.

To Cash a/c

To Share capital A/c

(Being the unrecorded liabilities settled in the above form)

 (ii) Capital Reduction A/c                    …..Dr.

To Unrecorded Liabilities A/c

(Being unrecorded liabilities a/c closed by transferred to Capital Reduction a/c)

Note:

1. If such unrecorded liabilities are not paid/settled then the same is debited to capital reduction a,

and again, it is shown separately in the new balance sheet.

2. No entry should be passed for cancellation of any contingent liabilities such as arrears

preference dividends etc, given outside the balance sheet.

3. Always the fictitious assets such as P&L a/c (loss), underwriting commission, discount on issue

shares/debentures, preliminary expenses and goodwill should be written off compulsory whether

it is informed to write off or not.

PROBLEMS

Illustration 1. (Expected for 4 marks) A company after a series of heavy losses resolved reconstruct itself internally upon the following terms:

(a) The shareholders to forego 2/5 of their capital. As at present 50,000 shares of ₹10 each are allotted

(b) The goodwill of ₹1,50,000 need to be written off completely. The Plant and Machinery which stood at ₹1,00,000 were written down to ₹75,000. The free hold land needs to be written down by ₹25,000

Prepare the capital reduction a/c.

Illustration 2. (Expected for 4 marks) A public limited company passed necessary resolution and received the sanction of the court for reduction of capital by ₹5,00,000. They decided to:

(a) Write off losses of ₹2,10,000, P&M of ₹90,000, Goodwill of ₹40,000 and investments of ₹8,000

(b) The reduction was made by converting 50,000 pref. shares of ₹20 each fully paid, to the same number of shares of ₹15 each fully paid up and 50,000 shares of ₹20 each, ₹15 paid to the same number of ordinary shares of ₹10 each fully paid up. Prepare Capital Reduction a/c.

Illustration 3. (Expected for 4 marks) (May-2018/19 BNU) A Co. Ltd. made arrangements for its reconstruction. The shareholders had agreed to receive the following in exchange for 1,00,000 equity shares of ₹10 each held by them:

(a) Fully paid equity shares to the extent of 2/5th of their present holding.

(b) 5% preference shares to the extent of 1/5th of the above new equity shares as per condition (a), and

(c) 6% debentures of ₹1,20,000.

Further the company issued debentures of ₹1,00,000 to the public and the company received the amount in cash.

Goodwill of ₹4,00,000 was to be reduced to ₹2,00,000, Balance amount utilized completely to write off accumulated losses.

Give journal entries to the above scheme.

Illustration 4. (Expected for 4 marks) :The following agreement was made in the reconstruction of a Company.

1. The company had agreed to receive the following in exchange for 50,000 shares of ₹10 each held by them:

(a) Fully paid Equity shares up to the extent of 2/5th of the present holding.

(b) 5% Preference shares to the extent of 1/5th of the above new equity shares.

(c) 6% Debentures for ₹60,000

2. Goodwill of ₹3,00,000 was reduced to ₹1,50,000, Machinery was reduced from ₹1,00,000 to ₹80,000 & lease hold premises reduced from ₹1,50,000 to ₹1,30,000.

Give necessary journal entries.

Illustration 5. (Expected for 4 marks) A public limited company passed necessary resolution and received the sanction of the court for reduction of capital by ₹10,00,000. They decided to :

(a) Write off losses of ₹4,20,000, P&M of ₹1,80,000, Goodwill of ₹80,000 and investments of ₹16,000

(b) The reduction was made by converting 1,00,000 pref. shares of ₹20 each fully paid, to the same number of shares of ₹15 each fully paid up and 1,00,000 shares of ₹20 each, ₹15 paid to the same number of ordinary shares of ₹10 each fully paid up.

Pass journal entries.

Illustration 6. (Expected for 4 marks) (May-2017) Chandru Ltd. resorted to internal reconstruction.

The scheme was as under:

(a) 80,000 Equity shares of ₹10 each fully paid to be converted into 40,000 equity shares of ₹5 each fully paid

(b) ₹4,000, Pref. paid shares of ₹100 each 12% fully paid to be converted 1nto into 40,000 equity shares of ₹5 each fully paid.

(c) 600, 15% Debentures of ₹1,000 each to be discharged by the issue of 80,000 equity shares of ₹5 each fully paid.

(d) The amount so available be appropriated. to write to off the following:

P&L A/c (Dr.) -₹4,00,000 Goodwill-₹2,00,000 Machinery -₹1,50,000

Give journal entries to the above scheme

Illustration 7. (Expected for 4 marks) Prepare the capital reduction a/c from the following transactions in connection with internal reconstruction and pass journal entries

(a) 30,000 Equity shares of ₹10 each fully paid reduced to ₹5 each fully paid

(b) 300, 9% Debentures of ₹1,000 each converted into 1,500, 12% Debentures of ₹100 each

(c) The debit balance of P&L a/c is ₹1,50,000 and the preliminary expenses of ₹30,000 were written off.

(d) The value of P& M and Stocks were written down by ₹60,000 and ₹30,000 respectively.

Illustration 8. (Expected for 4 marks) X Ltd. passed a resolution for internal reconstruction due to heavy losses. The following scheme was adopted

(a) 10,000 Equity shares of ₹10 each fully paid be reduced to same number of equity shares of

₹6 each fully paid.

(b) 7%, 10,000 Preference shares of ₹10 each be reduced to 7 ½ % fully paid pref. shares of ₹7 each.

(c) The assets written off were: Loss of ₹45,000, Goodwill ₹10,000 and other fixed assets to the extent possible

(d) There were arrears of pref. dividends for last 3 years which was not shown in the balance sheet. The Pref. share holders agreed to forego this amount`

Pass necessary journal entries

Illustration 9. (Expected for 4 marks) (May-10) Given below is the balance sheet to Nayak Ltd. as on 31/03/21

LiabilitiesAssets
5,000, 8% Pref. Share capital (₹10 each)50,000Goodwill1,00,000
5,000 Equity Shares of ₹10 each50,000Buildings4,000
Sundry Creditors18,000Plant5,000
BOD20,000Debtors1,200
  Stock22,000
  Preliminary Exp3,000
  P&L A/c2,500
  Cash at Bank300
 1,38,000 1,38,000

The following scheme of reconstruction was adopted:

(a) ₹10 Preference Shares were to be reduced to an equal number of fully paid shares of ₹8 each.

(b) ₹10 equity shares were to be reduced to an equal number of fully paid shares of ₹5 each

(c) Creditors agreed to forego ₹8,000

(d) The amount available was to be utilized to the nominal assets and the balance if any to be written off goodwill.

Pass journal entries,

Illustration 10. (Expected for 4 marks) (Jun-09) Following is the Balance Sheet of Zenith Ltd. as on

31-3-21

LiabilitiesAssets
Share capital: Goodwill10,000
10,000 Shares of ₹10 each1,00,000Buildings20,500
BOD15,425Machinery50,850
Creditors15,000Stock10,275
  Debtors15,000
  Cash1,500
  P&L a/c20,800
  Preliminary expenses1,500
 1,30,425 1,30,425

The company adopted the following scheme of Internal Reconstruction:

(a) Reduce the present value of shares ₹5 each fully paid

(b) S. creditors agreed to forego 20% of their claims as the company decided to pay them Cash immediately.

(c) The company made a fresh issue of 6,000 Equity shares of ₹5 each fully paid

(d) The directors of the company found that the machinery is overvalued by ₹10,000. They also proposed to write off intangible assets and Profit and Loss A/c completely

Pass necessary Journal entries in the books of the company.

Illustration 11. (Expected for 10 marks) Following is the B/S of Bright Ltd. as on 31.03.21.

LiabilitiesAssets
Authorised Capital: Lease hold premises1,30,800
10,000 Pref. shares of ₹100 each10,00,000Plant & machinery42,200
10,000 Equity shares of ₹100 each Patents at cost8,50,000
Subscribed capital10,00,000Sundry Debtors76,500
7500 preference shares of ₹100 each fully Stock in trade55,000
paid7,50,000Cash in hand500
5000 Equity shares of ₹100 each fully Discount on issue of shares18,000
paid5,00,000Preliminary expenses12,000
Sundry creditors30,000P&L a/c1,15,000
Bank over draft20,000 
 13,00,000 13,00,000

The Co. suffered heavy losses & not getting on well. The following scheme of reconstruction was adopted.

(a) The preference shares reduced to an equal number of fully paid shares of ₹50 each.

(b) The equity shares be reduced to an equal number of shares of ₹25 each.

(c) The amount made so available be used to write off ₹30,800 of the lease hold premises ₹15000 of stock, 20% of plant & machinery & sundry debtors & balance available to write off patents

Pass journal entries & prepare the B/S after the reconstruction has been carried out.

Illustration 12. (Expected for 10 marks) (J-09(N/S)/Nov-2000): B/S of X,Y Ltd as at 31.03.21 was as

follows:

LiabilitiesAssets
2000 pref. shares of ₹100 each2,00,000Goodwill15,000
4000 shares of ₹100 each4,00,000freehold Premises2,00,000
5% mortgage debentures1,00,000Plant3,00,000
Bank over draft50,000Stock50,000
Creditors1,00,000P&L a/c2,45,000
  Sundry Debtors40,000
 8,50,000 8,50,000

The following schemes were approved by the court for the Co.

(1) The preference shares to be reduced to ₹75 per share & equity shares to ₹37.5 per share

(2) Debenture holders to take over the stock & debtors in full satisfaction of the amount due to them.

(3) Goodwill to be eliminated.

(4) Free hold premises to be depreciated by 50%.

(5) Plant to be appreciated by ₹150,000. Journalise & prepare the revised B/S.

Illustration 13. (Expected for 10 marks) (May-2013/June-10) The B/S of a P Co. stood as follows or

31.03.21.

LiabilitiesAssets
19,000 Equity shares of ₹ 100 each19,00,000Land & buildings1,00,000
Debentures1,00,000Machinery2,60,000
Creditors1,00,000Furniture20,000
  Stock3,70,000
  Sundry Debtors1,80,000
  Goodwill2,00,000
  P&L a/c9,70,000
 21,00,000 21,00,000

The Co. is to be reconstructed as follows:

(a) Shares of ₹100 are to be reduced to an equal number of fully paid shares of ₹40 each

(b) To issue 1000 new shares of ₹40 each as fully paid to debenture holders in full settlement

(c) The amount available is to be utilized in writing off the goodwill & P&L A/c & the balance sin writing down the value of machinery.

(d) Authorized capital of Co. is 20,000 shares of ₹100 each.

Give the necessary journal entries. Prepare capital reduction A/c & a reconstructed B/S.

Illustration 14. (Expected for 10 marks) (June-11) Balance  sheet of  Lakshmi Ltd. as on 31-3-21 was as

Follows:

LiabilitiesAssets
4,000 Pref. shares of ₹100 each4,00,000Goodwill30,000
8,000 Equity shares of ₹100 each8,00,000Buildings4,00,000
8% Mortgage Debentures2,00,000Machinery6,00,000
Bank loan1,00,000Stock1,00,000
Sundry creditors2,00,000Debtors80,000
  P & L account4,90,000
   
 17,00,000 17,00,000

The following scheme of internal reconstruction was approved by the court

(a) Preference shares are to be reduced to ₹50 each fully paid

(b) Equity shares are to be reduced to ₹ 25 each fully paid

(c) Debenture holders to take over stock and debtors in full settlement of their amount.

(d) Eliminate Good Will and P&L A/c completely.

(e) Plant value is reduced to 50% of its present value.

Journalize the entries of the above scheme of internal reconstruction and prepare the Revised Balance Sheet .

Illustration 15. (Expected for 10 marks) (April-2000/ Nov-93): Balance sheet of X Ltd., on 31.03,2

was as follows:

LiabilitiesAssets
Authorized capital: Goodwill70,000
6000 shares of ₹100 each6,00,000Land & buildings80,000
Issued capital: Plant1,50,000
2000 shares of ₹100 each fully paid2,00,000Stock50,000
200,5% debentures of ₹1000 each2,00,000Sundry Debtors43,000
Sundry creditors50,000Cash2,500
B/P5,000Preliminary expenses4,500
Bank over draft45,000P&L a/c1,00,000
   
 5,00,000 5,00,000

The following scheme of reconstruction was adopted.

(1) The paid-up value of each share to be reduced to ₹50 each.

(2) 5% debentures to be converted in to 100, 7/2% debentures of ₹1,000 each.

(3) Assets were revalued as under-

Buildings -72,000, Plant -1,40,000, stock – 45,000, Debtors subject to reserve for bad debts 2,500.

(4) Creditors agreed to fore go 1/4th the amount to them in return for shares for the balance.

Give the necessary journal entries & Prepare reconstructed B/S.

Illustration 16. (Expected for 10 marks) (M-16/03): The following is the B/S of XXX Ltd., as on 31.03.21.

LiabilitiesAssets
13% Cumulative preference shares ofFixed asset15,00,000
₹100each1,00,000Current assets35,00,000
Equity shares of ₹10 each7,00,000P&L a/c3,00,000
8% Debentures3,00,000  
Current liabilities39,00,000  
Provision for taxation3,00,000  
 53,00,000 53,00,000

The following scheme of reconstruction was adopted

(a) Fixed assets are to be written down by 33  %.

(b) Current assets are to be revalued at ₹27,00,000

(c) Preference shareholders decided to forego their arrears of dividend which are in arrears for 3 years

(d) The taxation liability is to be settled at ₹4,00,000.

(e) One of the Creditors of the Co. to whom the company owes ₹25,00,000 decides to forego 50% of his claim. He is allotted 1,00,000 equity shares of ₹5 each as part satisfaction of the balance of his claim

(f) The rate of Interest on Debentures is increased to 11%, the debentures holders surrender their existing Debentures of ₹100 each & exchange the same for debentures of ₹75 each.

(g) All existing equity shares are reduced to ₹5 each.

(h) All preference shares are reduced to ₹75 each.

Pass journal entries & show the B/S of the Co. after giving effect to the above.

Illustration 17. (Expected for 10 marks) (April-96): A state of affairs of empty Ltd., on 31.03.20 the

B/S was as follows

LiabilitiesAssets
20,000 Equity shares of ₹10each2,00,000Goodwill80,000
15,000,7% preference shares of ₹10 each,1,50,000Land & buildings1,75,000
13,000, 5% preference shares of ₹10 each65,000Machinery3,25,000
₹5 paid up Patents54,000
5% Debentures1,50,000Furniture15,000
8% Debentures3,00,000Investment75,000
Sundry creditors4,50,000Sundry Debtors4,15,000
Debentures interest due19,500Cash2,000
  Bank Balance18,000
  P&L a/c1,75,500
 13,34,500 13,34,500

The following capital reduction was approved by the court.

(a) 7% Preference shares of ₹10 each fully paid were to be reduced to 6% preference shares of ₹10 each, ₹6 share paid up.

(b) Equity shares of ₹10 each were to be reduced to shares of ₹5 each.

(c) 5% preference shares of ₹10 each were to be reduced to 4/2% preference shares of ₹10 each ₹3 per share paid up.

(d) The debenture holders agreed to forego the interest due to them.

(e) The Co. in the meantime recovered as damages a sum of ₹74,000 from a third party & it was decided to use this amount also to write off the capital losses. The reconstruction expenses came to ₹7,250.

Give journal entries to record the above & draw the reconstructed B/S.

Illustration 18. (Expected for 10 marks) (May-2018) Balance sheet of Farewell Ltd as on 31.3.2018

LiabilitiesAssets
2,000 Pref. Shares of ₹100 each2,00,000Goodwill15,000
4,000, Eq. shares of ₹100 each4,00,000Land & buildings2,00,000
8% Mortgage Debentures1,00,000Plant3,00,000
Bank Loan50,000Stock50,000
Sundry creditors1,00,000Sundry Debtors20,000
  Cash20,000
  P&L a/c2,45,000
 8,50,000 8,50,000

The following scheme is approved by the court:

(a)Preference shares are to be reduced to ₹50 per share fully paid.

(b) Equity shares to be reduced to ₹25 each fully paid.

(c) 8% Debenture holders to take over stock and debtors in full settlement of their amount.

(d) Cost of reconstruction was ₹15,000.

(e) Plant value is reduced to 50% of its present value.

Journalize & Prepare the Reconstructed B/s.

Illustration 19. (Expected for 10 marks) (May-2017) Balance sheet of Nischal Ltd as on 31.3.2021

LiabilitiesAssets
12% Pref. Shares of ₹100 each, fully paid12,00,000Goodwill2,00,000
Eq. shares of ₹10 each fully paid12,00,000Land & buildings12,00,000
10% Debenture8,00,00012,00,00 0 Plant & Machinery10,00,000
O/S Interest on Debentures80,000Furniture3,00,000
BOD60,000Patents1,50,000
Sundry creditors3,00,000Stock1,00,000
  Sundry Debtors1,30,000
  Bank60,000
  P&L a/c5,00,000
 36,40,000 36,40,000

The company passed a special resolution to reconstruct its affairs and got approval of the court.

The following scheme is approved by the court:

(a) 12% Preference shares are to be converted to same number of 15% preference shares of ₹75 per share fully paid.

(b) Equity shares to be reduced to ₹5 each fully paid.

(c) Debenture holders agreed to forego their outstanding interest in return for increase in the rate of interest to 15%.

(d) Creditors agreed to forego 25% of their claim

(e) Land and Buildings be valued at ₹15,00,000

(f) Bring down the value of Plant and machinery by 40%

(g) Write off all intangible and fictitious assets

Journalize & Prepare the Reconstructed B/s.

Illustration 20. (Expected for 10 marks) (April-95): The following is the balance sheet of Lakme Ltd., as on 31.03.21.

LiabilitiesAssets
Equity shares of ₹10 each10,00,000Goodwill2,00,000
10% Cumulative preference shares of Machinery10,00,000
₹100 each2,00,000Stock2,50,000
Sundry Creditors10,00,000Debtors2,00,000
  Bank50,000
  P&L A/C5,00,000
 22,00,000 22,00,000

Preference dividends were in arrears for the last 4 years. The following scheme is approved by the court:

(a) Equity shares to be reduced to ₹1 each.

(b) 50% of the Preference dividend in arrears to be paid in cash immediately & the balance of arrears to be forgone.

(c) Machinery to be depreciated by 5% &10% R.B.D on the debtors to be provided.

(d) All intangible assets to be written off

(e) Balance of Reconstruction A/c if any to be capitalized.

Journalize & Prepare the Reconstructed B/s.

Hint: Pass separate entry for payment of O/S preference dividends by debiting Pref. Dividends a/c and crediting Bank a/c. and again close O/s Pref. Dividends a/c by transferring it on debit side of Capital Reduction a/c.

Illustration 21. (Expected for 10 marks) (April-97): The following is the Balance Sheets of AB Ltd. As on 31-03-20

Liabilities Assets
Share Capital Goodwill10,000
Authorised: 20,000 shares of ₹10 each. Buildings20,500
Issued and paid up:2,00,000Machinery50,850
12,000 shares of ₹10 each1,20,000 Stock10,275
Less: Calls in arrears9,0001,11,000Debtors15,000
Sundry liabilities15,425Bank1,500
Provision for tax4,000P&L A/c20,800
  Preliminary Exp1,500
  1,30,425 1,30,425

The directors find that the machinery is overvalued by ₹10,000. Now it is proposed to write down

this asset to its true value and extinguishes good will and P & L A/c and preliminary expenses by adopting the following scheme .

1. Forfeit the shares on which the calls are outstanding to the extent of ₹3 per share

2. Reduce the paid up capital by ₹3 per share.

3. Re-issue the forfeited shares at ₹5 per share.

4. Utilize the provision for taxes if necessary

Draft journal entries and prepare the reconstructed B/S of the company.

Note: No. of shares forfeited = ₹9,000/₹3 = 3,000 shares

Illustration 22. (Expected for 10 marks) (Nov-92): The paid-up capital of the Bangalore Co. Ltd is ₹5,00,000 & it includes 2,000, 5% cumulative preference shares of ₹100 each & 30,000 ordinary shares of ₹10 each. Because of heavy losses, the company has decided to reduce the burden of its capital & has secured the required permission

1. Reduction in the value of patents by ₹70,000, Machinery by ₹17,000 & & equipment’s by ₹2,000.

2. Cancellation of the balance of loss of ₹1,98,000 as per P&L A/c.

3. Writing down the balance of research expenditure A/c by using the balance remaining in the capital reduction A/c.(The research expenditure shown in the B/S is at ₹79,000.)

The approved scheme of capital reduction is as follows:

(a) In exchange for every 5, 5% preference shares, issue of 3, 4% preference shares of ₹100 each & 20 ordinary shares of ₹2 each

(b) Issue of 1 ordinary shares of ₹2 in payment of arrears of preference shares dividend of ₹10.(The total arrears of Preference share dividend is ₹30,000. The dividend has not yet been declared)

(c) Issue of 1 new ordinary share of ₹2 in exchange for every 5 old ordinary shares

Draft suitable journal entries.

Illustration 23. (Expected for 10 marks) (Nov-96): The following scheme is approved by the court against Venus Ltd.:

(a) Loan creditors are to be paid off by selling investments which realized ₹35,000.

(b) Trade creditors agreed to accept preference shares of ₹5 each to the extent of 2/3rd of their dues in full satisfaction.

(c) The preference shares are to be reduced to shares of ₹3 each fully paid.

(d) The Ordinary shares are to be reduced to shares of ₹3 each & shareholders are to pay ₹2 per share making the shares again ₹5 fully paid

Following is the balance sheet of Venus Ltd., as on 31.03.20.

LiabilitiesAssets
Preference Share Capital75,000Building50,000
(15,000 shares of ₹5 each.) Stock1,00,000
Ordinary share capital1,50,000Debtors1,15,000
(30,000 shares of ₹5 each) Investments35,000
6% Debenture50,000Deficiency75,000
Loan creditors25,000  
Trade creditors75,000  
 3,75,000 3,75,000

Prepare Capital Reduction A/c & the reconstructed B/S of Venus Ltd. & pass journal entries.

QUESTIONS COVERING FOR SECTION-A

  • What is internal reconstruction

 It is an arrangement under which a company, instead of going into liquidation, reconstructs itself internally by merely altering or reducing the capital of its shareholders and the claims of its debenture holders and creditors with their consent.

  • When does the company resort to internal reconstruction?”

When there are huge accumulated losses and that the assets have very low realizable values further the company share holders are not willing to wind up the company, the company can resort _to internal reconstruction. The consent loan creditors and trade creditors is very important in internal reconstruction

  • What is the difference between External Reconstruction & Internal Reconstruction?

In the case of External Reconstruction, one company is liquidated and one new company is formed. Where as in the case Internal Reconstruction no company s liquidated and no new company is formed.

  • What do you mean by Capital Reduction?

Capital reduction is the process of decreasing a company’s share capital (both equity and preference share capital) through share cancellations and share repurchases. The reduction of capital is done by the companies for various reasons, including increasing shareholder value and producing a more efficient capital structure.

  • State any two objectives of Capital Reduction

Some of the objectives of capital reduction are mentioned below:

(b) Returning surplus capital

(a) Dividend payments

(d) Distributing non- cash assets

(c) Redeeming Share

  • What are the modes of capital reduction?

Reduction of share capital may be affected in one of the following ways:

(a) Reduction of liability on unpaid amount:

(b) Re-payment of paid-up share capital:

(c) Reduction in the paid-up value of the share:

  • What is Capital reduction account? What is its use?

Capital reduction account is an account in which, all the amounts to the extent of which reduction is made in various capitals and debts are credited to this account and all those asset and losses, which are to be written off, are debited to this account. It helps in writing off of losses, fictitious and overvalued assets

  • What entry is passed when there is any increase in the value of any asset in case of internal reconstruction?

The entry is: Concerned Asset A/c                                 ……..Dr

To Capital Reduction A/c

(With the amount of increase in asset)

  • State the basic objective of Internal Reconstruction/ State the main objective of capital reduction

The basic objective of Internal Reconstruction is to write off the accumulated losses of the company along with other worthless assets, by reducing the share capital or debt capital of the company and also to raise required working capital

  • Mention the two forms of Internal Reconstruction.

The two forms of Internal Reconstruction are:

(a) Re-organization or alteration of Share Capital

(b) Reduction of Share Capital and other liabilities

  • A company with a share capital of ₹1,00,000 equity shares of ₹10 each fully paid carries out by proper resolution sub-division of shares into ₹2 each fully paid. Show the journal entry effecting the above transaction.

Share Capital A/c (10 each)                               …..Dr              1,00,000

To Share Capital a/c (₹2each)                                                                1,00,000

(Being shares of ₹10 each sub divided into shares of ₹2 each)

  • What is Capital Reserve?

Generally, it is the reserve created out of the capital incomes. In case of Internal Reconstruction, it is created by transferring the surplus in the capital reduction a/c after writing off all the assets and losses.

  • What is meant by premium value of shares?

it refers to the additional amount collected over and above the face value of the share. It is regarded as the capital profits.

  • What is surrender of shares?

When a share holder is unable to pay the call money he can voluntarily return back the shares to the company and ask the company to cancel the shares in his name. Such an act is known as surrender of shares. It is benefitable to the share holder as he will be paid some portion of the paid up amount on the shares surrendered

  • State any two legal provisions relating to capital reduction under the Indian companies Act.

(a) The company can reduce the capital only if it is provided in the Articles of Association.

(b) A company must pass a special resolution for reducing the capital

(c) It must obtain the court’s permission before reducing the capital.

  • What is intangible asset? Give two examples

In tangible asset is fixed asset which can’t be seen or touched but has a realizable value.

Example: Good will Patents, Copyrights, Trademarks, Route permits, Tenancy rights etc.

QUESTIONS COVERING FOR SECTION-B

1. What are the objectives of Capital Reduction.

2. State the Provisions for Reduction of Share Capital under Companies Act, 2013

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