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Internal Reconstruction

1. Meaning of Reconstruction :
”Reconstruction of a company means re-organization of financial activities or
affairs of the company when its financial condition or position in not good or
satisfactory. This is accumulated loss and over valuation of assets etc.

Types of Reconstruction
1. External Re-construction
2. Internal Re-construction

1. Internal Re-construction :
It means re-arrangement or re-organization of the financial
activities or financial affairs of the company by re-valuation of its
assets, ascertaining the correct amount of liabilities or writing off the
accumulated losses by reducing the share capital of the company, with
or without changing the rights of share holders but without liquidation
of the company.

2. External Reconstruction:
It means winding up of existing company and transferring the
assets and liabilities at their natural value to new company.

Need of Internal Reconstruction :


1. True and Fair View of Financial Position: A company may
be incurring losses for several years. In cases the financial
position cannot reflect a true and fair view. Hence it
necessitates reorganization in order to disclose the actual
financial position of an enterprise
2. Value of Assets: On a careful analysis it may reveal that
such continues loss-making companies consist either
overvalued tangible assets or insignificant intangible assets.
To get rid of these unreal values of assets they should be
updated to their real values by way of reconstruction
3. External Liabilities : External liabilities include loan, payment
of preference dividends, debenture, etc These cannot be
reduced to a great extent to maximize profitability through
reorganization
4. Share capital : The capital figures (i.e the value of the net
assets) is not reliable as it tends to show a higher figure
than the real figure due to various factors such as
overvalued tangible assets, idle and valueless intangible
assets and fictitious assets and outstanding liabilities not
discharged on maturity date. Because of this the share
capital of such loss-incurring companies will not reflect the
real and fair value of the net assets of the company . To set
right this sort of over capitalization reconstruction is of
vital importance.
5. Remedial Measures: If proper reorganization does not take
place it will lead to total disaster. To escape from such a
scenario, reconstruction is necessary. To a certain extent.
Reconstruction is remedy to avoid unforeseen disaster to
companies. Proper diagnosis and reorganization may alleviate
such evils

Difference between Internal Reconstruction and External Reconstruction


Basis of Difference Internal Reconstruction External Reconstruction
1. Liquidation of It does not require liquidation of It involve liquidation of the
company the company company
2. Formation of It does not involve formation of It requires formation of a
company a new company new company which takes
over the business of
liquidating company.
3. Accounting It involves revaluation of assets It is recorded as per AS-14
Treatment and liquidation of an existing
company
4. Legal It requires fewer legal It requires more legal
Formalities formalities. There is no need to formalities
settle the claims of creditors
and debenture holders
5. Tax Benefit It ensure tax advantage to the A company is not allowed to
company carry forward its losses for
income tax purpose
6. Regulation It is done as per provisions of It is regulated by section 494
sections 100 of the companies of the companies act 1956
act
7. Reduction These is certain of capital and There is no reduction of
sometimes the outside liabilities capital in fact there is fresh
like debenture holders may share capital of the company
have to reduce their claim
Capital reduction (section 100 to 105)
Capital Reduction refers to the cancellation of that part of paid up capital which is lost
in operation which is not represented by existing assets. It is generally resorted to write
up the past accumulated loss of the company. It is unlawful except when sanctioned
by the court because conservation of capital is one of the main principles of the
company law. The issued share capital of a company represents the security on which
the creditors rely. Companies usually do not call the full value of shares at one time.
The uncalled capital act as a future security of creditor.

ACCORDING TO SECTION 100 OF THE Indian COMPANIES ACT 1956


If any company (limited by shares of limited by Guarantee) suffering from heavy
losses or having a debit balance of profit and loss account or the valuation of such
assets is doubtful or goodwill or assets have been overvalued or the capital is more
than its requirements than the company can reduce its share capital as per the
procedures laid down in the Indian Companies Act 1956.

Procedures of Reduction of Share Capital:


The procedures of reduction of share capital is done as per provision of the section 100
of the companies Act which are as follow
1. It is permitted by its articles of association
2. A special resolution is passed and this is done as per rule 46 of the Table A,
3. Permission of the court has been taken/obtained. The court permits only when it is
felt that the financial position of the company would improve in the future.
Otherwise, permission is not granted.
4. After receiving/ getting permission from the court the company is required to use
the term and reduced along with its name.

Calculation of Capital Reduction and its Utilization :


1. By reducing or extinguishing the liability of members for uncalled capital
2. By writing off any paid up capital which is lost or unrepresentative by
uncalled capital.
3. By paying off capital which is in excess of the wants of the company
4. Through any other method approved by the court,

Passing Journal entries


1. For reducing the Liability in Respect of Uncalled amount:

2. For Paying –Off the surplus Paid-Up Capital

Date Particular LF Debit Credit


Equity Share Capital a/c Dr xxx
To Equity share capital a/c xxx
To sundry Members a/c xxx

3. Writing-Off Lost Capital

Date Particular LF Debit Credit


Equity Share Capital a/c Dr xxx
Preference share capital a/c Dr xxx
To capital Reduction / Reconstruction a/c Xxx

4. Reduction in claim of creditors, Debenture Holders etc.,


- In case the debenture-holders or creditors also agree to forgo or reduce their
claims against the company

Date Particular LF Debit Credit


Debenture a/c Dr xxx
Creditors a/c Dr xxx
To Capital Reduction / Reconstruction Xxx
Date Particular LF Debit Credit
(Old) Debenture a/c xxx
To (New) Debenture a/c xxx
To capital Reduction / Reconstruction Xxx
ii) If the debentures-holders agree to accepts new debenture of lower amount:

5. Disposal of Reconstruction Account : When accumulated losses and fictitious


assets, intangible are written-off and over-valued assets and unrecorded liability are
adjusted.

Date Particular LF Debit Credit


Reconstruction a/c
To Profit and loss a/c
To preliminary Expenses a/c
To Discount on Issue of Share/Debenture a/c
To Goodwill
To Patent, Copyrights and Trademarks a/c
To Plant and Machinery a/c
To Furniture a/c
To other Fixed assets a/c
To Unrecorded Liability a/c

6. Expenses on Reconstruction : when expenses are incurred

Dat Particular LF Debit Credit


e
Reconstruction a/c Dr Xxx
To Bank a/c xxx

7. If shortfall in Reconstruction account : If there is a short fall i.e the amount required
to be adjusted against Reconstruction a/c is more than the amount standing to the
credit of Reconstruction account, accumulated profit in any form such as General
Reserve, Profit and Loss a/c (Cr) or profit and Loss Appropriation a/c or any unutilized
provision may be used

Dat Particular LF Debit Credit


e
General Reserve a/c Xxx
Profit and loss/Profit and Loss appropriation a/c Xxx
Provision a/c (Name) xxx
To Reconstruction a/c xxx

8. Balance Transfer to Capital Reserve :


Balance of Reconstruction a/c remaining after above adjustment is transferred to
capital Reserve:

Date Particular LF Debit Credit


Reconstruction a/c Xxx
To Capital Reserve a/c xxx
Particular Amount Particular Amount
Profit & Loss a/c (Loss Written off) Xxx Share capital Account (Reduction in Xxx
Paid-up value)
Intangible Assets Account (Useless XXX Debenture account (amount of Xxx
Intangible Assets Written off Reduction)
Individually)
Miscellaneous Expenditure (Written Xxx Creditors Account (amount of scarifies) Xxx
off- Each Expenses Individually)
Discount on Issue of share (written off) Xxx Fixed assets account (Increases in xxx
value)
Fixed asset a/c (Decrease in Value of Xxx Current assets account (Increases in xxx
Individually ) value )
Current Asset a/c (Decrease in value Xxxx Bank account (sale amount of xxx
Individually) Unrecorded assets)
Provision for Doubtful Debts Xxx Reserve account xxx
Bank account (Unrecorded liability Xxx Provision account ( to the Extent not xxx
paid) required )
Bank account (arrears of Preference Xxx
Dividend –paid)
New liability account Xxx
Bank account (Directors Fees Xxx
Refunded)
Capital Reserve a/c (If any Balance Xxx
Xxxx xxxx

Preparation of Balance sheet after Reconstruction :


The factors that should be taken into account while preparing the balance sheet after the
completion on internal reconstruction are as follows :

1.. The words “ And Reduced must be added to the name of the company . This should be continued
for certain accounting period as ordered by the court

2. i) the revised appreciated values of the assets on the date of internal reconstruction
must be shown in the balance sheet. The book values should be ignored.

ii. The amount of increases in the value of assets on account of revaluation should be shown in the
balance sheet.

iii) The revised lower figure i.e original cost-deprecation should be shown instead of book values.

3) i. For fixed assets, and investments, the amount written off should be shown separately for a
period of 5 years.

ii. For current assets and individual the amount written off need not be shown. They should be
shown only at their revised lower values.

iii) For provision such amount of provision should be shown as a deduction from the gross amount
in the inner column and only the net amount in the outer column.

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