Chapter – 2
Internal Reconstruction
Chapter outcomes:
1. Meaning of internal reconstruction ;
2. Alternation of share capital;
3. Scheme of compromise arrangement;
4. Meaning of arrangement;
5. Methods of arrangements;
6. How to deal with preference dividends;
7. Pro forma journal entries;
8. Practical exercises;
Dr. BALAMURUGAN MUTHURAMAN
2015-2016
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Meaning of internal reconstruction
Internal reconstruction is the process in which
the financial structure of a company is
reorganized without dissolving the existing
company and forming a new company. Internal
reconstruction includes the following:
1.
2.
3.
4.
Alternation of share capital;
Reduction of share capital;
Variation of shareholders rights;
Scheme of compromise
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Alteration of share capital
In order to undertake internal reconstruction a company
may attempt to alter the share capital in the following
ways:
1. Reduction in the number of shares: Under this
method a company may pass a resolution in the
annual general body meeting to reduce the number
of shares. Example: 10,000 shares of RO 10, may be
reduced to 5,000 shares of RO 10 each
2. Reduction in the face value of the shares: Under this
method, a company may reduce the face value of the
shares. Example, shares of RO 10 each may be
reduced to the shares of RO 5 each.
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Scheme of compromise arrangement
Meaning of compromise:
Compromise refers to an amicable settlement of
differences by mutual concessions by parties to
dispute. It may be noted that the compromise
presupposes the existence of some dispute
because there can be no compromise unless
there is some dispute. The need for compromise
arise for the settlement of some dispute
between
the
company
and
its
creditors/members.
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Meaning of arrangement
The term ‘arrangement’ carries a wider sense than the
term ‘compromise’. It implies re-arrangement of rights
and the liabilities of a member or a class of members
without the existence of any dispute. Arrangement
includes re-organization of the share capital of a
company by the consolidation of shares of different
classes or by the division of the shares into shares of
different classes or by both these methods.
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An arrangement may involve any one or more of the
following:
1. Debenture-holders foregoing their claims in whole or in
part;
2. Debenture-holders exchanging their debentures for new
debentures/shares;
3. Creditors foregoing their claims in whole or in part;
4. Creditors agreeing to receive shares/debentures in
whole/in part payment of their claims;
5. Preference shareholders foregoing their claims for
arrears of dividend;
6. Preference shareholders agreeing to accept a reduced
rate of dividend in future;
7. Fresh issue of shares to raise additional working capital;
8. Writing off lost paid-up capital
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How to deal with arrears of preference dividends:
1. If the claimants of preference dividends declared but
not paid agree to sacrifice under a scheme of
reconstruction, their sacrifice will be credited to the
reconstruction account;
2. If the claimants of preference dividends agree to
sacrifice under a scheme of reconstruction, no
accounting entry is required to be passed since the
company had not so far admitted any liability in
respect of them
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Pro forma Journal entries in the books of the
company under reconstruction
The following journal entries are passed in the books of the company:
1. When the number of shares is reduced:
Share capital Account Dr. XXXX
Reconstruction Account Cr.
XXXX
(Being the reduction in the share capital)
2. When the face value of shares is reduced :
Share capital Account (RO 10 Dr. XXXX
Share capital Account (RO 7) Cr.
XXXX
Reconstruction Account
Cr.
XXXX
(Being the face value of shares reduced)
3.When the number of debentures is reduced:
Debentures Account Dr.
XXXX
Reconstruction Account Cr.
XXXX
(Being the reduction in debentures)
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4. When the face value of debentures reduced:
Debentures (RO10) A/C
Dr. XXXX
Debentures (RO 7) A/C
Cr.
XXXX
Reconstruction Account
Cr.
XXXX
(Being the face value of debentures reduced)
5. When the creditors forego their claims:
Creditors account
Dr. XXXX
Reconstruction A/C Cr.
XXXX
(Being the creditors reduced)
6. When the accumulated losses are written off:
Reconstruction account Dr. XXXX
Profit and loss Account
Cr.
XXXX
Preliminary expenses account Cr.
XXXX
Discount on issue of shares AC Cr.
XXXX
Goodwill account
Cr.
XXXX
Patents account
Cr.
XXXX
Other overvalued assets AC Cr.
XXXX
(Being the accumulated losses written off)
7. For the expenses of reconstruction:
Reconstruction Account
Dr. XXXX
Bank Account
Cr.
XXXX
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