MCom I Semester Corporate Accounting Internal Reconstruction Reorganisation Study Material notes

MCom I Semester Corporate Accounting Internal Reconstruction Reorganisation Study Material notes: Journal Entries Balance Sheet Discussion Questions Long Answer Questions Short Answer Questions ( Most Important Topic Wise Notes for MCom Students )

BCom 3rd Year Auditing Practices India Study Material Notes In Hindi

Internal Reconstruction or Reorganization

In this neither any company is liquidated nor any new company is formed. In fact, under it company’s internal form is changed. This change may be of the following types: 1. Alteration of Share Capital: Section 94 of the Companies Act, 1956 empowers a limited company having a share capital to alter its share capital if it is so authorized by its Articles. This power is exercised in General Meeting and does not require confirmation by the Court. Alteration of capital may involve the following:

(a) Increase in share capital : A company can increase its share capital by issue of new shares by an ordinary resolution in the general meeting if the increase is within the authorised capital. But for increase beyond the authorised capital, the company is required to alter the capital clause of its Memorandum of Association by special resolution and to give its notice to the Registrar within 30 days of resolution.

No accounting entry is required to be passed in the books of the company for the increase in its authorized share capital. But when new shares are offered for subscription, accounting entries will be very much the same as has been explained in an earlier chapter.

(b) Decrease in share capital by cancelling the unissued shares : A company can cancel the shares which have not been subscribed or agreed to be subscribed by any person and this diminishes the amount of share capital. But no company can cancel the unpaid amount on shares already issued or agreed to be subscribed without the sanction of the Court as the same leads to reduction of capital. As the cancellation of unissued shares does not affect the issued share capital of a company, no accounting entry is required. Only the details of authorized share capital are to be changed in the Balance Sheet

(c) Consolidation of share capital : A company may consolidate any of its shares of smaller denomination (value) into shares of higher denomination. To make this change effective, share capital account with old denomination is closed and share capital account with new denomination is created. The accounting entry is :

Share Capital (Old denomination) Account                                Dr.

To Share Capital (New denomination) Account

(d) Sub-division of share capital : This implies converting shares of higher denomination into shares of smaller denomination. The entry is :

Share Capital (Old denomination) Account                                 Dr.

To Share Capital (New denomination) Account

(e) Conversion of shares into stock and reconversion of stock into shares : A company, if so authorised by its Articles, may convert any of its, fully paid shares into stock. The stock can be reconverted into fully paid up shares of any denomination. When shares are converted into stock, the share capital account will be closed by transfer to stock account by means of the following journal entry :

(Say) Equity Share Capital Account                                           Dr.

To Equity Stock Account

Conversely if stocks are reconverted into shares, stock account will be closed by transfer to share capital account.

(f) Reserve Capital : Section 99 of Companies Act provides that a company may by special resolution decide that any portion of uncalled amount on shares issued will be called up only on its liquidation. Such portion of share capital is known as reserve capital. No accounting entry is required to give effect to it.

(2) Reduction of Share Capital : Usually internal reconstruction involves reduction of share capital. Section 100 to 105 of Companies Act deal with it. Accordingly, it can be carried out by a company only It is authorised by its Articles and a special resolution is passed to that effect. It also requires confirmation of the Court.

Where the capital reduction involves variation of rights of different classes of shares, the consent of holders of atleast three-fourth of the shares of the class concerned must be obtained at a separate meeting of the affected class of shareholders by means of a resolution or in writing. Within 21 days after securing such consent holders of at least one-tenth of the issued shares of the affected class of shareholders may apply to the Court for the cancellation of such variation. In that case, variation will not have effect unless it is confirmed by the Court.

Interanl Reconstruction Reorganisation

Forms of Capital Reduction

Capital reduction can take any of the following three forms:

1Extinguishing or reducing the liability on shares held by shareholders in respect of uncalled or unpaid amount : This does not affect the paid-up value of shares; only partly paid shares become fully paid by reducing the face value of the shares to the level of their paid-up value. No journal entry is necessary to record this event. However, some accountants prefer to pass the following entry to record this fact :

Share Capital (partly paid-up) Account                      Dr

To Share Capital (fully paid-up) Account

2. Paying off the surplus paid-up capital : The share capital may be reduced by paying off the paid-up capital which is in excess of the needs of the company. This can be done with or without reducing the liability on the shares. Thus, surplus capital can be paid off in the following two ways: (a) Paying off surplus paid-up capital without reducing the face value of shares: In such a case, the following entries are passed :

(i) Share Capital Account                               Dr.                 with the amount to be paid off

To Sundry Shareholders Account

(ii) Sundry Shareholders Account                  Dr.                  with the amount paid off

To Bank Account In this case, the company shall have the right to call up in future the amount paid off on the shares.

(b) Paying off surplus paid-up capital by reducing the face value of shares : For example, for a fully paid share of Rs. 10, paying off Rs. 5 and reducing the face value of share from Rs. 10 to Rs. 5. The following entries are passed in such a case. () Share Capital (Old Face Value) Account Dr. (with total amount of old capital) To Share Capital (New Face Value) Account (with the amount to be kept as             new capital)

To Sundry Shareholders Account                   Dr             (with amount to be paid oft)

(ii) Sundry Shareholders Account                  Dr. with the amount paid off To Bank Account

In this case, the company shall not have any right to call up in future the amount paid off on these shares.

(c) Cancelling the paid-up capital : Where existing capital of the company is not represented by available assets, cancellation of paid-up capital to that extent is the most common method adopted by a company in such a case. The purpose is to improve the profitability of the existing company in tune with the real values of assets as against the given book values which do not represent the actual financial position of the enterprise. Under it, a meeting of different classes of shareholders is called-up and where borrowed capital is also lost, the debenture holders and creditors are also invited in the meeting and they are made to agree to sacrifice their claims to certain extent and their sacrifices are utilized to write off the accumulated losses and fictitious assets and to adjust the over-valuation of assets. For this purpose, a new according called Capital Reduction Account (or Reconstruction Account or Reorganisation Account) is opened to which sacrifices of different parties are credited and through which accumulated losses and fictitious assets are written off and over-valuations of assets adjusted. The preparation of Reconstruction Account is preferred when debenture holders and creditors too have to accept some reduction in their claims in addition to the shareholders and/or where there is appreciation in the value of any asset. The scheme of entries is as follows:

1 On reduction of paid-up capital :

Share Capital Account                                  Dr. with the amount of reduction

To Capital Reduction Account                      or To Reconstruction Account

If the denomination or description of capital is changed (e.g. the face value of shares is changed or rate of dividend is changed in case of preference shares), the old Capital Account is closed and new capital account is created with the new amount and the difference is transferred to Capital Reduction Account

Notes : (i)|  If any reserve appears in the books of the company, the same should be transferred to Capital Reduction Account so that no such reserve could be utilized for payment of dividend in future.

(ii) The Capital Redemption Reserve Account and Securities Premium Account can also be reduced in the same manner as the share capital account.

(iii) After granting the scheme of capital reduction, the Court may order the use of words “and reduced” after the name of the company for such period as it deems fit.

2. If debenture holders and creditors too make some sacrifice :

Debentures Account                  with the amount of sacrifice Sundry Creditors Account

To Capital Reduction Account

3. If there is appreciation in the value of an asset :

Respective Asset Account                                Dr. with the amount of appreciation

To Capital Reduction Account

4. On utilizing Capital Reduction Account for writing off accumulated losses, fictitious assets, and over-valuations of assets :

Capital Reduction Account                                  Dr

To Profit & Loss Account

To Goodwill Account

To Patent Account

To Trade Marks Account

To Preliminary Expenses Account

To Discount on Shares and Debentures Account

To Unrecorded Liability Account (if any) To Asset Account

To Capital Reserve Account (with the balance left, if any)

Illustration 1. Following is the Balance Sheet of Subhash Ltd. :

Internal Reconstruction Reorganisation

Note: Contingent Liabilities: (1) Suit pending in court claiming damages Rs. 50,000.

(2) Dividend on Preference Shares for four years Rs. 14,000. A scheme of reduction of capital was duly prepared and sanctioned whereby :

(a) The preference shares were to be reduced to an equal number of fully paid shares of Rs. 10 each and equity shares to an equal number of fully paid shares of Rs. 2.50 each. Authorized share capital to be re-organized into preference shares of Rs. 10 each and equity shares of Rs. 2.50 each.

(b) Stock were to be written off by Rs. 50,000 and bad debts and all intangible assets to be eliminated

(c) The preference shareholders agreed to waive half of the dividend arrears and receive equity shares in lieu of the balance.

(d) The debentureholders agreed to take over part of the Company’s property of the he 1 80.000 at an agreed price of Rs. 2,50,000 in satisfaction of part of their claim and to provide cash on a further floating charge of Rs. 1,50,000 after deducting arrears of inter

(e) The contingent liability in respect of damages materialized in the sum stated but the recovered Rs. 20,000 from a director responsible 20.000 from a director responsible for the same out of Rs. 40,000 standing to his credit moving off the balance in cash. The other directors agreed to take equity shares satisfaction of their loans.

Discussion Questions

Long Answer Questions

1 What is capital reduction scheme? What are its objects ? Discuss the legal formalities in this connection, if there are any.

2. What are the essential features of Internal Reconstruction ? Does it necessarily involve reduction of capital?

3. Under what conditions internal reconstruction becomes desirable ? Write essential features of internal reconstruction.

Short Answer Questions

(i) What is internal reconstruction ? What are the different forms of capital reduction ?

(ii) What is capital reduction scheme? What are its objects ?

Internal Reconstruction Reorganisation

Numerical

(i) On 31st March 2005, Sanjay Chemicals Ltd. had share capital of 40,000 Equity Shares of Rs. 10 each. Rs. 8 called up. In September 2005, the company decided to reduce Rs. 10 shares to Rs. 8 shares as fully paid by cancelling uncalled amount of Rs. 2 per share. Pass Journal entries.

Objective Type Questions

A State whether the following statements are ‘True’ or ‘False’:

(i) Internal reconstruction essentially involves capital reduction.

(ii) Creditors suffer most in any scheme of internal reconstruction.

(iii) A company is free to reduce or extinguish the uncalled liability of its members.

(iv) Cancellation of unissued capital is a case of capital reduction.

(v) Only unsuccessful companies undertake capital reduction.

Internal Reconstruction Reorganisation

(vi) After writing off lost capital, the balance of Capital Reduction Account is transferred to general reserve.

(vii) For a company to carry out capital reduction permission is required from SEBI

(viii) Internal reconstruction is generally attempted to get rid of dissenting shareholders.

(Answer: True i,v False ii, iii, iv, vi, vii, viii)

[B] Fill in the blanks :

(i) No journal entry is required for the cancellation of …………… share capital

(ii) After granting the scheme of capital reduction the Court may order the use of words ……… after the name of the company for a specified period.

(iii) Internal Reconstruction is generally resorted to writing off ………..

(iv) Reduction of capital is unlawful if it is not sanctioned by …………

Internal Reconstruction Reorganisation

Internal Reconstruction Reorganisation