What is the Reconstruction of a company?
It is the re-organization of company structure, be it legal, capital or organizational.
Reconstruction takes place through asset revaluation and reassessment of liabilities.
It takes place in two forms:
• Internal Reconstruction
• External Reconstruction Need
The need for alteration arises in the organization when:
• There is an over or undervaluation of assets and liabilities.
• The company has been facing a financial crisis for a while.
• Reduction in external liabilities to become profitable.
• To save organizations from unforeseen circumstances.
Accounting Treatment:
Let us see the accounting treatment during the internal rearrangement of capital.
Journal Entries
On the debit side, we record:-
1. The increase in the value of assets
2. Decrease in liabilities On the credit side, we record:-
1. Capital Reduction Account
2. Capital Reconstruction Account
We can avoid the debit balance of the Profit and Loss Account and the overvaluation of
assets. For this, we have to:
• Debit the Capital Reconstruction/Reduction Account.
• Credit the concerned account.
Note: We transfer the balance in the Capital Reduction A/c to the Capital Reserve A/c.
Balance Sheet
1. Companies must add the word “and Reduced" after their name on the Balance Sheet.
2. The Balance Sheet of the reconstructed company must show the written-off amount for
five years under respective assets.
Conditions or Provisions:
1. Article of Association: Companies can go for internal reconstruction post¬
authorization by the article of association. It specifies the course of action for all
crucial decisions of the company.
It must contain a clause clarifying the method and procedure of capital reduction.
2. Special Resolution: The Company must take consent from its stakeholder before
capital reduction. They pass a special resolution when most stakeholders agree to
alter the structure. In addition, the stakeholders must duly sign it.
3. Approval by Court: Approval of the court is necessary for internal restructuring.
Companies can start the procedure after getting permission for the same.
4. Repayment of Borrowings: Before reconstruction, the companies must clear all
borrowings and interest due.
5. Approval by Creditors: The court needs creditors’ approval in writing before giving
permission for capital reduction. The goal behind it is to protect the interest of the
creditors.
6. Notice to Public: The Company has to notify the public about capital alteration.
Therefore, the company issues a public notice mentioning valid reasons for
reconstruction.
METHODS OF INTERNAL RECONSTRUCTION
1. Alteration of Share Capital (Section 61 Company Act 2013)
In this, we alter the share capital to restructure the venture internally. Alteration can be in the
form of:
• Increment in Share Capital: The company issues new shares with a view to increasing
the share capital.
• Consolidation of Existing Shares: Here, we convert the existing shares or smaller
values into higher denominations.
• Conversion to stocks: In this alteration method, the shares are converted into stocks
and vice-versa. The fully paid shares are converted into one unit of stock.
• Subdivision: It includes converting shares with higher face values into smaller face
values.
• Cancellation of Unissued Shares: It involves cancelling the shares that the company
did not issue. Consequently, it results in a change in the structure of capital.
Journal entries for the above forms of alteration in share capital are as follows:
2. Reduction of Share Capital (Section 66, 67 Company Act 2013)
In this type of internal reconstruction, there is a reduction in the share capital. For capital
reduction, the company have to take confirmation from the tribunal.
The company must fulfil some conditions before capital reduction. These conditions are given
above under the head ' Conditions or Provisions' Extinguishment of Liability Here we write off the
uncalled amount, i.e. it is not asked from the shareholders. Consequently, the paid-up capital remains the same.
But there is a reduction in the shares' par value. Hence, it reduces the liability of the shareholders.
Payoff Surplus Paid-up Capital
The company may refund the amount that is in excess. This amount is in surplus with the
company and is returned to the shareholders. It can be done:-
• Without reducing the face value
• By reducing the face value
Writing off the paid-up capital
We use this method when the assets do not fairly depict the company’s capital loss. In this,
the capital reduction takes place by eliminating the lost capital and using it for:
• Writing-off fictitious and accumulated assets
• Reducing Losses
• Over-valued amount of assets
The face value of the shares may or may not change. Also, we open a reconstruction account
to transfer the reduced amount.
Journal Entries for reduction of the Capital structure are as follows:
Benefits of Internal Reconstruction
There are several advantages of restructuring companies’ capital structure. It helps in:-
1. Writing-off accumulated losses
2. Fair asset valuation in the balance sheet
3. Depicting the actual value in the financial statements
4. Taking the company back on track and making it profitable again
5. Availing tax advantage Features of Internal Restructuring
• New Company: There is no requirement to form a new venture.
• Liquidation: The process of liquidation of the company doesn’t take place.
• Reconstruction: In this, the current structure of the company’s capital is rebuilt.
• Overcapitalization: It helps optimize financial resources and adjust the excess capital.
FORMAT OF RECONSTRUCTION ACCOUNT
As mentioned above, we open a reconstruction account (nominal) while internal restructuring.
It depicts a reduction in the capital used for writing-off assets and losses.
The account is credited with the sacrifice by the shareholders & investors. Conversely, we
debit it with restructuring expenses and fictitious assets and losses. In the end, we transfer the
balancing figure to the Capital Reserve Account.
Format of Reconstruction Account
Particulars Amount Particulars Amount
To Statement of P & L (Written off) xxxxx By Share Capital A/c xxxxx
To Preliminary Expenses A/c (W/O) xxxxx (Amount of Reduction)
To Goodwill A/c (W/O) xxxxx By Debentures A/c xxxxx
To Discount on Shares/Debenture xxxxx (Amount of Reduction)
A/c (W/O) By Trade Payable A/c xxxxx
To Underwriting Commission (W/O) xxxxx (Amount of Sacrifice)
To Assets (Decrease in Value) xxxxx By Assets A/c xxxxx
To Bank A/c xxxxx (Increase in Value) xxxxx
(Payment of Unrecorded Liability) By Bank A/c
To Bank A/c xxxxx (Sale of Unrecorded Assets)
(Payment of Reconstruction Expenses)
To Capital Reserve A/c (Balancing xxxxx
Figure)
xxxxx xxxxx
Difference Between Internal and External Reconstruction
INTERNAL
BASIS EXTERNAL RECONSTRUCTION
RECONSTRUCTION
Meaning Liquidating the current capital to form
Altering the company’s existing
a new company is External
capital structure is Internal
Reconstruction
Reconstruction
Not required Liquidation is a must for the creation
Liquidation of a new company
It results in the construction of a new
company
New Company The process does not result in the
formation of a new company
Transfer of assets and liabilities takes
place
No transfer of assets and liabilities
Transfer of
Assets and
Liabilities
Accounting
We need to open a capital Here, we need to open a realization
restructuring account account
To write-off accumulated profits To gain a competitive advantage in the
Objective
market
In external reconstruction, approval by
Legal Approval There is a need for courts approval the court is not necessary
or restructuring
Example
The following is the Balance Sheet of Polar ltd. as of 31st March 2018.
Balance Sheet of Polar Ltd.
as of 31st March 2018
Liabilities Amount Assets Amount
10% Preference Share Capital 2,50,000 Goodwill 2,10,000
(2500 Shares of Rs. 100 each) Building 3,10,000
Equity Share Capital 4,50,000 Plant & Machinery 2,62,500
(45000 Shares of Rs. 10 each) Loose Tools 75,000
8% Debentures 1,80,000 Stock 60,000
Current Liabilities (Creditors) 3,00,000 Debtors 90,000
Cash & Bank 3,75,000
Profit & Loss 1,35,000
11,80,000 11,80,000
The reconstruction scheme of Polar Ltd. with due permission of the court and creditors is as
follows:-
1. Creditors are ready to accept 10% Debentures to settle half of their claims. The
remaining sum will be payable in cash.
2. Alteration in the face value of the preference shares, i.e. from 100 to 40 per share.
3. The reduction in the face value of the Equity share is Rs.2/- per share.
4. The amount of Goodwill is nil.
5. It has been identified that the following assets are overvalued:
Building Rs. 75000/-
Plant & Machinery Rs. 37500/-
Loose Tools Rs. 45000/-
Debtors Rs. 7500/-
Journalize the above transactions and prepare the reconstructed Balance Sheet.
Solution:-
Journal Entries of Polar Ltd.
S. No Particulars Dr. (*) Cr. {*)
1 10% Preference Share Capital A/c (Rs.100) Dr. 250000
To 10% Preference Share Capital A/c (Rs. 40) 100000
To Reconstruction A/c 150000
(Being preference shares reduced to Rs. 40 each)
2 Equity Share Capital A/c (Rs. 10) Dr. 450000
To Equity Share Capital A/c (Rs. 2) 90000
To Reconstruction A/c 360000
(Being equity shares reduced to Rs. 2 each)
3 Current Liabilities A/c Dr. 300000
To 8% Debentures A/c 150000
To Bank A/c 150000
(Being creditors settled)
4 Reconstruction A/c Dr. 345000
To P &L A/c 135000
To Goodwill A/c 210000
(Being fictitious and intangible written off)
5 Reconstruction A/c Dr. 165000
To Building A/c 75000
To Plant & Machinery A/c 37500
To Loose Tools A/c 45000
To Debtors A/c 7500
(Being assets written down)
The revised Balance Sheet of Polar Ltd. after reconstruction is as follows:
Balance Sheet of Polar Ltd. (and reduced)
as of 31st March 2018
Liabilities Amount Assets Amount
10% Preference Share 100000 Fixed Assets:
Capital Building 235000
Equity Share Capital 90000 Plant & Machinery 225000
(45000 Shares of Rs. 2 each) 330000 Loose Tools 30000
8% Debentures 112500 Current Assets:
Bank Overdraft Stock 60000
Debtors 82500
632500 632500
Final Words
Internal Reconstruction is the change in original capital allotment without liquidation.
Companies need to reconstruct their capital structure to remain profitable & set off losses.
It takes place by adjusting or reduction in the original structure. The company must fulfil the
criteria before restructuring its share capital structure.
