CHAPTER

15

INTERNAL RECONSTRUCTION
Internal Reconstruction
INTERNAL RECONSTRUCTIONCAPITAL REDUCTIONREORGANISATION
(Compromise/Arrangement with Shareholders, Creditors & Debenture
holders or with all)

16.1. What is Internal Reconstruction , explain its procedure

 It is an arrangement whereby a company makes changes in its Capital Structure and book value of
other Assets & Liabilities without closing (Liquidating) the company.
 The scheme is prepared with the approval of Shareholders, Debenture holders & other creditors
whose interest is affected and is sanctioned by the Court.
 It is normally adopted when company has accumulated losses, fictitious assets or its other assets
are having market values lower then the book values.
 As per the scheme the Equity Share Capital/ Pref. Share Capital/ Debentures and other liabilities
are reduced by agreed amount and this balance including reserves, profits or appreciation’s if any
is used to write off fictitious assets like P & L A/c (Dr. Balance), Discount/Commission on shares/
Debentures, Preliminary Expenses, Goodwill, Useless patents, trade marks etc. and to reduce
other assets to their proper values.
 Any balance left then is transferred to Capital Reserve A/c.
 Amount written off of fixed Assets should be shown in Balance Sheet for 5 years.
 The word ‘& Reduced’ should be added after the name of the Company only if so ordered by the
Court.
 Apart from above the scheme may contain raising of finance by calls on shares etc. and
repayment of certain liabilities for which necessary entries will come according to the exact nature
of transactions given in the question.

16.2. Draft the journal Entries for internal Reconstruction

Entries:
(1) Equity Share/Preference share/Debentures/other liabilities A/c Dr.
To Capital Red./Reconstruction/Reorganisation A/c
(with the amount of Reduction agreed)

(2) Capital Reduction/Reconstruction/Reorganisation A/c Dr.

To P & L A/c. (Debit Balance)
To Discount/Common Shares/Debentures A/c
To Preliminary Expenses A/c
To Goodwill A/c
To Stock, Plant and Machinery, Building etc. A/c.
(Amount of Capital reduction utilised to write-off various losses & Assets)
 Such items should be written-off even in absence of any direction in the question to write it off.

(iii) Capital Reduction/Reconstruction a/c balance left if any transferred to Capital Reserve
Reorganisation A/c Dr.
 Internal Reconstruction

To Capital Reserve A/c

Note 1: When the description of Capital A/c. (Like Pref. share/debenture) is changed altogether then
old capital A/c should be debited with full amount, amount of reduction should be credited to Capital
Reduction A/c and Balance should be credited to New Capital A/c.
Example. 6% Pref. Share of Rs.100/- each changed to 8% Pref. shares of Rs.75 each then Entry:
6% Pref. Share Capital A/c. Dr. 100
To Capital Reduction A/c. 25
To 8% Pref. Share Capital A/c. 75

Note 2: In addition to the above which are the usual items, entry for other items like part payment
to creditors, calls on partly paid shares, issue of further shares etc. will come according to information
as may be given in the question.

Illustration 1: (Adopted from Nov. 1987) : The Directors of Hardluck Ltd. decided to
recommend to the shareholders certain steps to put the affairs of the company back on the rails. On
30th June, 2011 the Balance Sheet of the Company was as under:
Liability Rs. Assets Rs.
Share Capital: Fixed Assets:
Authorised: Goodwill at Cost 22,600
1,00,000 Equity Share of Re.1 each 1,00,000 Freehold property at cost 50000
Less: Depreciation 8500 41,500
Issued and Paid: Plant and Machinery:
Issued and Paid 85,000 equity shares At Cost 119000
of Re.1 each fully paid 85,000 Less: Depreciation 59000 60,000
Reserve and Surplus: Investments:
Share Premium 15,000 Share at cost in associated 30,000
Current Liabilities: companies
Trade Creditors 64,500 Other quoted investments at cost 16,000
Bank Overdraft 56,500 Current Assets:
Loan from Bank 60,000 1,81,000 Stock 23,000
Debtors 19,900 42,900
Profit and Loss Account 68,000
2,81,000 2,81,000
The scheme of reconstruction as approved by the competent authorities, was as under:
1) The issued ordinary shares were reduced to 5 paise each paid up. The unpaid value of the
share was subsequently called by the company and paid by all the shareholders.
2) The balance of unissued capital was allotted to the Bank in part discharge of the loan. The
balance due was paid in cash.
3) The authorised capital of the company is to be increased by another 50,000 shares and these
are to be issued to the existing shareholder as right issue, the amount due from the
shareholders was realised.
4) Trade creditors to give up 20% of their claims and the balance due to them to be converted
into 12% secured Debentures of Rs.100 each.
5) Interest of Rs.6,500 on Overdraft to be waived by the Bank and the balance overdraft to be
paid off.
6) All amounts available, including share premium to be utilised to write off losses, goodwill and
the value of shares in associated companies.
Show the journal entries to record the above and also draw the Balance Sheet of the company after
the scheme is fully implemented. All workings should form part of your answer.
Solution:
Journal of Hardluck Ltd.
Particulars Debit Credit
1. Equity Capital a/c Dr. 80,750

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 Internal Reconstruction
Particulars Debit Credit
To Reconstruction A/c. 80,750
(85000 X 0.95) (Rs. 1 equity share written down to 0.05 per share)

Bank a/c Dr. 80,750

To Equity capital a/c (0.95 called and received on each share) 80,750

2. Bank loan a/c Dr. 60,000

To Equity share capital a/c 15,000
To Cash /bank a/c 45,000
(Banks loan settled)
3. Cash /bank a/c Dr. 50,000
To Equity Share capital a/c 50,000
(Rights shares allotted)

4. Creditors a/c Dr. 64,500

To Reconstruction a/c 12,900
To 12% Debenture a/c 51,600
(Creditors settled by allotting debentures for 80% value)

5. Bank O/D a/c Dr. 56,500

To Reconstruction a/c 6,500
To Cash /bank a/c 50,000
(Bank OD settled, Bank gave up claim for interest)

6. Reconstruction a/c Dr. 1,00,150

Share premium a/c Dr. 15,000
To P & L a/c 68,000
To Goodwill a/c 22,600
To Investment in associate Co. (Balancing Figure) 24,550
(Balance of reconstruction a/c. and share premium account utilised
to write off P&L account, goodwill and value in investment a/c.)

Reconstruction Account
Particulars Amount Particulars Amount
To P & L a/c 68,000 By Equity Share Capital 80,750
To Goodwill a/c 22,600 By Creditor 12,900
To Investment in associate a/c 24,550 By Bank Overdraft 6,500
(balance figure) By Share Premium 15,000
1,15,150 1,15,150

Balance Sheet of M/S Harkluck Ltd. (& Reduced)

As On 30.06.2011
Particulars Notes Rs.
1 3 4 5
I. EQUITY AND LIABILITIES
(1) Shareholders’ funds
Share capital 1,50,000

(2) Share application money pending allotment --

(3) Non-current liabilities
Long-term borrowings: Debenture 51,600

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(4) Current liabilities -

TOTAL 2,01,600
II. ASSETS
(1) Non-current assets
Fixed assets : Tangible
Freehold property 41,500
Plant & Machinery 60,000 1,01,500
Non-current investment (in Associate) 5,450 1,06,950

(2) Current assets

Current Investment 16,000
Stock in trade 23,000
Trade receivables 19,900
Cash and cash equivalents 35,750 94,650
TOTAL 2,01,600

Illustration 2: The Balance Sheet of BCR Ltd. as on 31st October, 2011 appears as below:
Balance Sheet as at October, 31, 2011
Liabilities Rs.
Share Capital:
1,50,000 equity shares of Rs.10 each fully paid 15,00,000
5,000 11% preference shares of Rs.100 each fully paid 5,00,000
Secured Loans:
11% Debentures 5,00,000
Interest accrued and due on debentures 1,10,000
Bank Overdrafts 6,30,000
Unsecured Loans 5,00,000
Interest accrued and due 1,50,000 6,50,000
Current Liabilities 5,00,000
43,90,000
Assets
Fixed Assets at cost 20,00,000
Less: Depreciation Reserve 15,00,000 5,00,000
Stock and Stores 6,00,000
Receivables 14,50,000
Other Current Assets 2,00,000
Miscellaneous Expenditure: Profit & Loss A/c. 16,40,000
43,90,000
A scheme of reconstruction has been agreed amongst the shareholders and the creditors, with the
following salient features:
a) Interest due on unsecured loans is waived.
b) 50% of the interest due on the debentures is waived.
c) The 11% preference shareholder’s right are to be reduced to 50% and converted into 15%
Debentures of Rs.100 each.
d) Current liabilities would be reduced by Rs. 50,000 on account of provisions no longer
required.
e) The bank agrees to the arrangement and to increase the cash credit/overdraft limits by
Rs.1,00,000 upon the shareholders agreeing to bring in a like amount by way of new equity.
f) Besides additional subscription as above, the equity shareholders agree to convert the
existing equity share into new 10 - rupee shares of total value Rs. 5,00,000.
g) The debit balance in the Profit and Loss Account is to be wiped out, Rs, 2,60,000 provided for
doubtful debts and the value of fixed assets increased by Rs. 4,00,000.
Redraft the Balance Sheet of the company based on the above scheme of reconstruction.
Solution:
Journal of BCR Ltd.
Particulars Debit Credit

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 Internal Reconstruction

Particulars Debit Credit

1. Interest accrued a/c Dr. 1,50,000
To Reconstruction a/c 1,50,000
(Interest payable on loan is waived)

2. Interest accrued on debenture a/c Dr. 55,000

To Reconstruction a/c 55,000
(Interest on debenture 50% waived)
3. Pref. share Capital a/c Dr. 5,00,000
To Reconstruction a/c 2,50,000
To Debenture a/c 2,50,000
(Preference share holders settled by giving debenture for 50% dues)

4. Current liability a/c Dr. 50,000

To Reconstruction a/c 50,000
(Provision not required written off)

5. Cash / bank a/c Dr. 1,00,000

To Equity share Capital a/c 1,00,000
(Share capital allotted as a condition by Bank to increase OD limit)

6. Equity share Capital a/c Dr. 15,00,000

To New Equity Share capital a/c 5,00,000
To Reconstruction a/c 10,00,000
(Rs.15 lac equity share, converted into new Rs.5 lac share capital)

7. Fixed Asset a/c Dr. 4,00,000

To Reconstruction a/c 4,00,000
(Fixed asset appreciated)

8. Reconstruction a/c Dr. 19,00,000

To P & L a/c 16,40,000
To Provision for Bad Debt a/c 2,60,000
(Losses written off against reconstructions account)

9. Reconstruction a/c Dr. 5,000

To Capital Reserve a/c 5,000
(Balance of reconstruction account transferred to capital reserve)

Note: Increasing the bank overdraft limit is not a transaction in it self and hence no entry. When this
limit will be used to make payments then balance will increase.
Reconstruction Account
Particulars Amount Particulars Amount
To P & L a/c 16,40,000 By Interest Accrued on loan a/c 1,50,000
To Provision for bad debt a/c 2,60,000 By Interest Accrued on debenture 55,000
To Capital Reserve a/c 5,000 By Preference Share Capital 2,50,000
(balance figure) By Current liability 50,000
By Equity Share Capital 10,00,000
By Fixed Asset 4,00,000
1,15,150 1,15,150

Balance Sheet of M/S BCR Ltd. (& Reduced)

As On 31.10.2011
Particulars Notes Rs.
1 3 4 5
I. EQUITY AND LIABILITIES

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 Internal Reconstruction

(1) Shareholders’ funds

Share capital 6,00,000
Reserves and surplus : Capital Reserve 5,000 6,05,000
(2) Share application money pending allotment --
(3) Non-current liabilities
Long-term borrowings
Secured : Debenture 7,50,000
Unsecured : Loan 5,00,000 12,50,000
(4) Current liabilities
Short term borrowings 6,30,000
Trade Payables 4,50,000
Other current liability : Interest accrued 55,000 11,35,000
TOTAL 29,90,000
II. ASSETS
(1) Non-current assets
Fixed assets 9,00,000
(2) Current assets
Stock in trade 6,00,000
Trade receivables 14,50,000
(-) R.D.D. 2,60,000 11,90,000
Cash and cash equivalents 1,00,000
Other Current Asset 2,00,000 20,90,000
TOTAL 29,90,000

Illustration 3: Fair-weather Limited ran into a patch of bad financial management and its affairs
were handed over to a Receiver appointed by the debenture-holders. Its statement of affairs was as
given below:
Assets Book Value Expected
to realise
Land and Building 8,00,000 10,00,000
Plant and Machinery 12,00,000 7,00,000
Stock-in-trade 8,00,000 5,50,000
Trade Debtors 9,50,000 4,75,000
Cash 1,50,000 1,50,000
39,00,000 28,75,000
Deduct : 7% First Mortgage Debentures 12,50,000
16,25,000
Deduct : 8% Second Mortgage Debentures 20,00,000
Deficiency regarding second debentures 3,75,000
Unsecured Creditor 4,50,000
Deficiency regarding unsecured creditor 8,25,000
Contributories:
40,000 Equity Shares of Rs.10 each fully paid-up 4,00,000
60,000 Equity Shares of Rs.10 each Rs.5 paid-up 3,00,000 7,00,000
Deficiency regarding contributories 15,25,000
All the mortgage debentures are held between two groups of individuals X and Y as indicated below:
X and his friends Y and his friends
Rs. Rs.
First Mortgage Debentures 7,50,000 5,00,000
Second Mortgage Debentures 12,50,000 7,50,000
In addition, X and Y rank as unsecured creditors to the extent of Rs.1,50,000 and Rs.1,00,000
respectively. Each of X and Y also hold 10,000 fully paid equity shares and 4,000 partly paid equity
shares in the Company.
The following scheme of re-construction was agreed upon:

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(i) The partly paid-up equity shares would be fully paid up by making a call, after the shares are
fully paid, all equity shares except to the extent indicated otherwise below, would be reduced
to shares of Rs.1 each fully paid-up.
(ii) X will give up all his claims regarding debentures and other credits, surrender all his equity
shares and would receive in return 10% mortgage debentures of Rs.18 lakhs and cash of Rs.
89,000.
(iii) Y will give up all his claims on debentures and credits. He will bring in cash of Rs. 75,000 and
in consideration would be issued with 10% mortgage debentures of Rs.10 lakhs.
(iv) The rest of the sundry creditors agree to give up 12 & ½ of their claims, get equity shares of
Rs.1 each fully paid up allotted to them for 30% of their claims and await discharge of the
balance in due course.
Pass journal entries (narration’s need not be given) to give effect to the above proposal and prepare
the Balance Sheet after re-construction. Workings should form part of your answer.
Solution:
BALANCE SHEET (Before Reconstruction)
Liabilities Amount Assets Amount
Equity Share Capital (Fully Paid) 4,00,000 Book value of Assets 39,00,000
Equity Share (Partly Paid) 3,00,000
7% Debentures 12,50,000 P & L Account (Bal. Fig.) 5,00,000
8% Debentures 20,00,000
Creditors 4,50,000
44,00,000 44,00,000

Journal of Fair-weather Limited

Particulars Debit Credit
1. Bank a/c Dr. 3,00,000
To Equity Share Capital a/c 3,00,000
(Final call of Rs. 5 on 60,000 shares made and received)

2. Equity Share Capital a/c Dr. 7,74,000

To Reconstruction a/c 7,74,000
(86,000 shares reduced by Rs. 9 each)

3. 7% Debentures a/c Dr. 7,50,000

8% Debentures a/c Dr. 12,50,000
Equity share Capital a/c Dr. 1,40,000
Creditors a/c Dr. 1,50,000
To 10% Debentures a/c 18,00,000
To Bank a/c 89,000
To Reconstruction a/c 4,01,000
(Arrangement with X & his friends)

4. 7% Debentures a/c Dr. 5,00,000

8% Debentures a/c Dr. 7,50,000
Creditors a/c Dr. 1,00,000
Bank a/c Dr. 75,000
To 10% Debentures a/c 10,00,000
To Reconstruction a/c 4,25,000
(Arrangement with Y & his friends)

5. Creditors a/c Dr. 85,000

To Reconstruction a/c 25,000
To Equity Share Capital a/c 60,000
(Balance creditors gave up 12.5% of their dues on receiving
equity shares for 30% of dues)

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 Internal Reconstruction

6. Land & Building a/c Dr. 2,00,000

To Reconstruction a/c 2,00,000
(Land and Building appreciated)

7. Reconstruction a/c Dr. 17,25,000

To Plant & Machinery a/c 5,00,000
To Stock a/c 2,50,000
To Debtors a/c 4,75,000
To P & L a/c 5,00,000
(Losses and over valuation of assets written off to
reconstruction a/c)

8. Reconstruction a/c Dr. 1,00,000

To Capital Reserve a/c 1,00,000
(Balance of reconstruction a/c transferred)

Balance Sheet of M/S Fair Weather Ltd. (After Reconstruction)

As On ……………….
Particulars Notes Rs.
1 3 4 5
I. EQUITY AND LIABILITIES
(1) Shareholders’ funds
Share capital : Equity 1,46,000
Reserves and surplus: : Capital Reserve 1,00,000 2,46,000

(2) Share application money pending allotment --

(3) Non-current liabilities
Long-term borrowings : 10% Debenture 28,00,000

(4) Current liabilities

Trade Payables 1,15,000
TOTAL 31,61,000
II. ASSETS
(1) Non-current assets
Fixed assets : Tangible
Land & Building 10,00,000
Plant & Machinery 7,00,000 17,00,000

(2) Current assets

Stock in trade 5,50,000
Trade receivables 4,75,000
Cash and cash equivalents 4,36,000 14,61,000
TOTAL 31,61,000

■ ■ ■

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