Vikrant Parashar

“Success is directly proportional to the effort”

Internal Reconstruction
Meaning
The term reconstruction means reorganizing the
capital structure of a company including the
reduction of claims of both the shareholders and
the creditors against the company. Such
reconstruction generally becomes necessary on
account of bad financial position of the company.
It may be “External” or “Internal”.
In case of “External” reconstruction, a new
company is formed to take over the business of an
existing company which is in bad financial
position. The vendor company goes into
liquidation after selling its business to the new
company.
INTERNAL RECONSTRUCTION
In case of such reconstruction, the capital of the
company is reorganized to infuse new life in the
company. It includes both alteration and reduction
of share capital.

1 |Page
 Vikrant Parashar

1 Alteration of Share Capital

The Companies Act has used the word “Alteration

Proper” for alteration of share capital. Such
alteration can be done under the provisions of
Sections 94 – 97 of the Companies Act.
A company can make alterations by passing an
ordinary resolution, if it’s authorized by its
Articles of Association. Such alteration must be
notified and a copy of the resolution should be
filed with the Registrar within 30 days of the
passing of the resolution.
The term alteration proper includes the following:
1. INCREASE OF SHARE CAPITAL by issue
of new shares.
2. CONSOLIDATION OF THE EXISTING
SHARES into shares of larger denominations,
Shares of smaller denominations are converted into
shares of larger denominations. In such a case, the
paid up capital of the shares remains the same but
the number of shares is reduced.

2 |Page
 Vikrant Parashar

3. SUB-DIVISION OF SHARES into shares of

smaller divisions,
Shares of larger denominations are converted into
shares of smaller denominations. In such a case,
the paid up capital of the shares remains the same
but the number of shares gets increased.
4. CONVERSION OF FULLY-PAID UP
SHARES into STOCK and vice versa,
A company can convert its fully paid up shares into
stock or vice versa.
The accounting treatment will be as follows,
Share Capital A/c Dr.
To Capital Stock A/c
5. CANCELLATION OF UNISSUED SHARES,
In case a company cancels it unissued shares, it
does not require any accounting entry to be passed.
The authorized share capital will now stand
reduced by the amount of unissued shares now
cancelled.
--------------------------------------------------------------

3 |Page
 Vikrant Parashar

2 Reduction of Share Capital

A company can reduce its share capital as per the

provisions of Sections 100 – 105 of the Companies
Act.
A company can reduce its share capital only when
each of the following conditions are satisfied,
1. The Articles of Association of the company
permits such reduction.
2. The company passes a special resolution for
reducing its share capital.
3. The company obtains the confirmation of the
court in respect of such reduction.

ACCOUNTING ENTRIES

I. WRITING OFF LOST CAPITAL:

This means that writing off or canceling that part
of the paid-up capital which is not represented by
tangible assets.
4 |Page
 Vikrant Parashar

Example,
BALANCE SHEET
LIABILITIES ASSETS
Share Capital 100,000 Fixed Assets 50,000
Creditors 50,000 Current Assets 30,000
P&L A/c 50,000
Goodwill 20,000
150,000 150,000

The above B/S shows that the company has lost

Rs. 70,000 of its paid-up share capital. This may be
written of means of the following journal entry,
Share Capital A/c. Dr. 70,000
To Capital Reduction A/c. 70,000
Now we have to reduce both the nominal as well as
the paid-up value of share to Rs. 3 each. In such a
case, the following journal entry will be passed,
Share Capital A/c. (Rs. 10) Dr. 100,000
To Capital Reduction A/c. 70,000
To Share Capital (Rs. 3) A/c. 30,000

5 |Page
 Vikrant Parashar

II. REFUNDING SURPLUS PAID-UP

CAPITAL:
In case the company feels that it has more capital
than what it can profitably use, it may decide to
refund the surplus capital to its share-holders.

Example,
A company has a share capital of Rs. 100,000
divided into shares of Rs. 10 each. The company
decided to repay its members Rs. 2 per share and
make shares as of Rs. 8 fully paid-up.
The following journal entries will be passed in this
case,
Share Capital A/c. (Rs. 10) Dr. 100,000
To Share Capital (Rs. 8) A/c. 80,000
To Sundry Members A/c. 20,000
(For conversion of share capital & money due to
members)

6 |Page
 Vikrant Parashar

Sundry Members A/c. Dr. 20,000

To Bank A/c. 20,000
(For payment of money to members)

III. REDUCING LIABILITY OF MEMBERS

FOR UNCALLED CAPITAL:
In case the liability of the members in respect of
the uncalled share capital is reduced, the paid-up
value of the share capital will remain unchanged.
However, the members will be gained since they
will not have to pay money to the money to the
company to the extent of uncalled capital
cancelled.
Example,
A company has got a share capital of Rs. 100,000
divided into shares of Rs. 10 each, called and paid-
up Rs. 6 each. The company decided to cancel the
liability of the members to the extent of the Rs.2
per share, thus making the shares of Rs.8 each,
Rs.6 paid-up.

7 |Page
 Vikrant Parashar

The following journal entry will be passed in this

case,
Share Capital A/c. (Rs. 10) Dr. 100,000
To Share Capital (Rs. 8) A/c. 80,000
(Being conversion of shares of Rs.10 each into
shares of Rs.8 each)

IV. REDUCTION IN THE CLAIMS OF

CREDITORS, DEBENTURE HOLDERS
etc.:

Sometimes, the creditors and the debenture-holders

of the company are required to reduce their claims
against the company on account of heavy losses
suffered by the company which cannot be met in
full by the company’s shareholders.

8 |Page
 Vikrant Parashar

Example,
BALANCE SHEET (Liabilities Side)
LIABILITIES
13% Debentures of Rs.100 each 100,000
Creditors 50,000
150,000

Under the scheme of internal reconstruction, the

debenture holders accept to agree 15% Debentures
of Rs. 80000 in full satisfaction of the claims while
the creditors agree to reduce their claims by Rs.
10000.
The following journal entry will be passes for the
sacrifice made by the debenture holders and the
creditors,
13% Debentures A/c. Dr. 100,000
Unsecured Creditors A/c. Dr. 10,000
To 13% Debentures A/c. 80,000
To Capital Reduction A/c. 30,000

9 |Page
 Vikrant Parashar

V. DISPOSAL OF CAPITAL REDUCTION

ACCOUNT:
The Capital Reduction account represents the
sacrifice made by the various parties i.e.
shareholders, debenture holders, creditors etc. This
sacrifice is used for writing off accumulated losses,
intangible assets, overvaluation of assets etc.
Similarly any appreciation of assets, capital profits
etc. are also credited to this account. The balance
of this account is transferred to the capital reserve.
Capital Reduction A/c. Dr.
To Profit & Loss A/c. (debit balance)
To Goodwill A/c.
To Preliminary expenses A/c.
To Assets A/c.
To Capital Reserve (balance if any)

When there is an increase in the value of asset,

after revaluation,

10 | P a g e
 Vikrant Parashar

Particular Asset A/c. Dr.

To Capital Reduction A/c. (Amount of Increase)
VI. TREATMENT OF ARREARS OF
PREFERENCE DIVIDENDS:
The preference shareholders are entitled to get
dividend at a fixed rate in priority to other share-
holders. However the company, the company is not
bound to pay them dividends. Moreover, the
liability to pay dividends arises only when the
company has declared the dividends. Of course, no
dividend can be paid to the equity shareholders
unless all arrears of dividends in respect of
cumulative preference shares have been cleared.
Preference shares are always taken as cumulative
otherwise stated.
In case dividends in respect of the preference
shares have been declared but have not been paid
yet, the unpaid dividends will appear as a liability
in the company’s balance sheet. The claimants of
the unpaid dividends are just like any other
creditors of the company. In case they agree to
sacrifice under a reconstruction scheme, their
11 | P a g e
 Vikrant Parashar

sacrifice will be credited to the capital reduction

account.
In case the claimant of the preference dividend
agree under a reconstruction scheme, to sacrifice
either in whole or in part, their arrears of
dividends, no accounting entry is necessary since
the company has not so far admitted any liability in
respect of them.
However, if the company is required to pay in full
or in part the arrears of the preference dividend
under a reconstruction scheme, this will be an
additional loss to the company.
The following journal entries will be passed in
such case.
Capital Reduction A/c. Dr.
To Preference Dividends A/c.
(With the amount payable as dividends)
Preference Dividends A/c.
To Bank A/c.
(With the amount paid)

12 | P a g e