SCHOOL OF MANAGEMENT STUDIES

UNIT – V – Corporate Accounting-1 – SBAA1301

UNIT-5 INTERNAL RECONSTRUCTION

Alteration of Share Capital – Capital Reduction – Internal Reconstruction – Methods of

Internal Reconstruction.

Alteration of share capital and internal reconstruction

A change in the number of authorized shares a company may issue. Authorized shares are the
total shares a company is permitted by its charter to issue, as opposed to the number it
actually has issued. To alter share capital, a company must amend its charter and/or bylaws
and register the change with the appropriate regulatory authority

Definition
Increase or decrease in (or rearrangement of) the authorized share capital of a firm, as
permitted in its articles of association. Any such change requires (1) passing of a resolution to
the effect in the firm's general meeting, and (2) filing of the notice of alteration with the
appropriate governmental office
.When a company has been making losses for a number of years, the financial position
does not present a true and fair view of the state of the affairs of the company. In such a
company the assets are overvalued, the assets side of the balance sheet consists of fictitious
assets, useless intangible assets and debit balance in the profit and loss account. Such a
situation does not depict a true picture of financial statements and shows a higher net worth
than what the real net worth ought to be. In short the company is over capitalized. Such a
situation brings the need for reconstruction.
Reconstruction is a process by which affairs of a company are reorganized by revaluation of
assets, reassessment of liabilities and by writing off the losses already suffered by
reducing the paid up value of shares and/or varying the rights attached to different classes
of shares. The object of reconstruction is usually to reorganize capital or to compound with
creditors or to effect economies. Such a process is called internal reconstruction which is
carried out without liquidating the company and forming a new one.
However, there may be external reconstruction. Wherever an undertaking is being carried on
by a company and is in substance transferred, not to an outsider, but to another company
consisting substantially of the same shareholders with a view to its being continued by the
transferee company, there is external reconstruction. Such external reconstruction is essen-
tially covered under the category ‘amalgamation in the nature of merger’ in AS-14.
Accounting Entries on Internal Re-Construction
Entry for share capital reduced without changing the face value of the shares
Share Capital A/c
To Capital Reduction/Reconstruction A/c

Entry if face value of the shares is also changed on reduction of capital a new category
of share capital is created :
Share Capital A/c (Old)
To Share capital A/c (New) To
Capital reduction A/c

Entry where rate of dividend on preference shares is changed under the scheme of
reconstruction:
Preference Share Capital A/c (OLD)
To Preference Share Capital A/c (New)

Entry When debenture holder and creditors are also ready to reduce their claim against
company:
Debenture A/c Creditors A/c
To Capital reduction A/c

Entry in case of appreciation in the value of any asset:

Assets A/c
To Capital reduction A/c

Entry if any contingent liability matures and is to be paid immediately the following
entry is passed:
Capital reduction A/c To Liability payable A/c Liability Payable A/c
To Bank A/c
Entry for utilising the amount of capital reduction to w/o accumulated losses.
Capital Reduction A/c
To Profit & Loss A/c
To Preliminary Expenses A/c
To Discount on Shares /Debentures A/c
To Goodwill A/c
To Trade Assets A/c
To Patents/Copy rights
To Assets A/c
For transferring any balance left in the capital reduction account to capital reserve
account
Capital reduction a/c dr. (with the balance left)
To capital reserve a/c
External reconstruction is effected by liquidating the company. It is just like absorption. In it
a new company is formed to acquire the business of an existing company are transferred to
the newly formed company. But it is not done in the internal reconstruction.

Capital Reduction
Capital reduction refers to the cancellation of that part of paid up capital which is lost in
operations or which is not represented by existing assets. it is generally resorted to write off
the past accumulated losses of the company. It is unlawful except when sanctioned by the
court because conservation of capital is one of the main principles of the company law. The
issued share capital of a company represents the security on which the creditors rely.
Companies usually do not call the full value of shares at one time. The uncalled capital act as
a future security for the company’s creditors. Therefore, any reduction of capital reduces the
security of creditor.
A company is permitted to reduce its share capital by section 100 through following ways:
By reducing the uncalled liability of the members
By writing off the part of paid up capital which is lost in operations or which is not
represented by available assets.
By returning that part of paid up capital which is in the excess of the need of the company
Accounting procedure for Capital Reduction:
For extinguishing or reducing the uncalled liability of the member:
Equity Share Capital A/c
To Equity share Capital A/c

For writing off the part of paid up capital which is lost in operation or which is not
representing by available assets:
Equity Share Capital A/c
To Equity Share Capital A/c To Capital Reduction A/c

If the face value of shares remain unchanged

Equity Share Capital A/c
To Capital Reduction A/c

For reducing the capital by returning the excess capital:

Equity Share Capital A/c
To Equity Share Capital A/c To Equity Shareholders A/c

For payment to Shareholders

Equity Shareholders A/c
To Bank A/c

For uses of Capital reduction A/c

Capital Reduction A/c
To Accumulated Losses A/c To Goodwill A/c
To Fictitious Assets A/c To Other Assets A/c
To Capital Reserve A/c( Balancing Figure)

The company must apply to the court for an order confirming the capital reduction. The court
must look after the interests of creditors and shareholders before giving an order confirming
the capital reduction.
The court may make an order confirming the capital reduction. The court may make an order
confirming the capital reduction on such terms and conditions as it thinks proper, if it is
 satisfied that every creditor of the company entitled to object capital reduction has consented
to the reduction or that his debt has been discharged or secured by the company. The court
may also order the company to add the words “and reduced” to the name of the company for
such period as it deems fit. The court may also order the company to publish reasons for
reduction and all other information in regard there to for public information.
The order of the court confirming the reduction must be produced before the registrar and a
certified copy of the order and of the minutes of reduction should be filed with the registrar
for registration.
Note: in the following cases, procedure of reduction of capital is not called for:

Where redeemable preference shares are redeemed in accordance with the provisions of
section 80.
Where any shares are forfeited for non-payment of calls.
Where there is surrender of shares or a gift is made to a company of its own shares.
Where the nominal share capital of a company is reduced by cancelling any shares which
have not been taken or agreed to be taken by any person.

Alteration of share capital

(a) Increase in share capital by issue of new shares
(b) Consolidation of all as part of its existing shares
(c) Sub division of its existing shares
(d) Conversion of fully paid up into stock or vice-versa

In case of consolidation shares of smaller amount converted into shares of larger amount but
the value of share capital remain same.

In case of sub division shares of larger amounts converted into shares of smaller amounts but
the value of share capital remain same.;

In case of internal reconstruction a capital reduction account is to be opened, which is

credited with the amount sacrificed by the shareholders, debenture holders and creditors and
also due to increase in the value of any assets. Then the amount of capital reduction is utilised
for writing off fictitious assets, past losses and excess value of other assets. If there is any
balance of capital reduction account left after writing off the above losses, then it is to be
transferred to capital reserve account.The amount to be written off cannot exceed the amount
credited to the capital reduction amount. But if any reserve appears on the liabilities side of
the balance sheet, the same way be utilised in writing off the accumulated losses and assets.
If there is any contingent liability (like arrears of preference dividend etc.) and if the same is
forgone for the claimant, then no entry will be passed.
If any contingent liability or unrecorded liability (like reconstruction expenses) is to be paid,
then the following entry will be passed.

Capital reduction a/c Dr.

To cash /bank/share capital a/c

In case there is any profits or gain occur during the process of internal reconstruction then
such profits or gains must be credited to capital reduction account.The case of surrender of
shares, shareholders surrender part of their holdings to the company, which are utilised to
repay debenture holders, preference shareholders and other creditors of the company. Balance
of unused shares surrendered is to be cancelled by transferred to capital reduction account.

Concept of alteration of share capital: according to sec 94 of companies act, a ltd company, if
authorised by its articles can be made by passing an ordinary resolutions in general meeting
without the approval of court.
The company can increase its share capital by making fresh issue of shares. accounting
entries are the same as are made at the time of issue of shares. Consolidation of shares refers
to the conversion of existing shares of small amount into shares of large amount.
Consolidation does not bring any change in the amount of share capital. It only reduces the
no. of shares.

Sub-division of shares defines as the conversion of shares of larger denomination into shares
of smaller denomination is called sub-division of shares. sub division also does not bring any
change in the amount of share capital. It only increases the no. Of shares.
The company can convert its fully paid up shares into stock and vice versa. Partly paid up
shares can never be converted into stock.
The company can cancel only those shares which are not so far taken by public. Since
cancellation of unissued capital does not affect the paid up capital in any way, no entry is
required at the time of cancellation.
Alteration of share capital:- Problem no:-1
A company which has 2,000 equity shares of Rs.100 each decides to sub-divide them into
shares of Rs.10 each. The required journal entry is as follows.

Problem no:-2

A company decides to convert its Rs.10 equity share capital of Rs.8,00,000 into stock. The
following is the journal entry to be passed.

Problem no:-3

A company whose capital consists of 5,000 shares of Rs.100 each, Rs.75 called and paid,
decides to reduce the shares into 5,000 shares of Rs.75 each fully paid.

Problem no:-4

‘X’ Co. Ltd has the following shares as a part of its share capital 10,000 8% preference share
of Rs.100 each fully paid
50,000 equity shares of Rs.5 each fully paid.
20,000 equity share of Rs.10 each, Rs.8 called up and paid up. The company has decided to
alter the share capital as follows:-
To sub-divide the preference share into share of Rs.10 each
To consolidate the equity shares of Rs.5 each into shares of Rs.10 each
To convert the partly paid up equity shares into fully paid up shares of Rs.8 each, with
necessary legal sanctions
Journalize the alterations.
Capital reduction

Return of share capital Problem no:-5

Bee Ltd. has 60,000 equity shares of Rs.100 each, Rs.80 per share called up. Now the
company decides to pay off Rs.20 per share of the paid up capital and at the same time to
reduce the Rs.100 share to Rs.60 share fully paid up by cancelling the unpaid amount. Give
journal entries.
 Surplus in capital reduction account Problem no:-6
ABC company Ltd. passed resolution and got Court permission for the reduction of its share
capital by Rs.5,00,000 for the purposes mentioned as under:-

To write off the debit balances of P&L A/c Rs.2,10,000

To reduce the value of Plant & Machinery by Rs.90,000 and goodwill by Rs.40,000
To reduce the value of investments by Rs.80,000

The reduction was made by converting 50,000 preference share of Rs.20 each fully paid to
the same number of preference shares of Rs.15 each fully paid and by converting 50,000
equity shares of Rs.20 each on which Rs.15 is paid up into 50,000 equity shares of Rs.10
each fully paid up.

Pass journal entries to record the share capital reduction.

Problem no:-7

The following scheme of reconstruction has been approved for Divya Ltd.

1. The shareholders to receive in lieu of their present holding of 60,000 shares of Rs.10 each
fully paid the following:
Fully paid new equity shares equal to 1/3red of their holding
8% preference shares fully paid , to the extent of 1/5th of the above new equity shares
Rs.60,000 8% secured debentures
2. The debenture holders’ total claim of Rs.75,000 to be reduced to Rs.25,000. This will be
satisfied by the issue of 2,500 8% preference shares of Rs.10 each fully paid
3. An issue of Rs.50,000 6% first debentures was made and allotted, payment for the same
having been received in cash.
4. The goodwill which stood at Rs.3,00,000 was written down to Rs.50,000.Plant& Machinery
which stood at Rs.1,00,000 was written down to Rs.75,000
5. The freehold premises which stood at Rs.1,75,000 was written down by Rs.75,000.
Give journal entries in the books of Divya Ltd. for the above reconstruction scheme.
 Problem no:-8

The Balance sheet Kavitha Industries Ltd.as at 31.12.1994 was as follows.

Liabilities Rs Assets Rs
Share capital:- Goodwill 15,000
2,000 preference shares of Free hold properties 2,00,000
Rs.100 each 2,00,000 Plant & Machinery 3,00,000
4,000 Equity shares of Rs.100 each 5% 4,00,000 Stock 50,000
mortgage debentures 1,00,000 Debtors 40,000
Bank overdraft 50,000 P&LA/c 2,45,000
Creditors 1,00,000

8,50,000 8,50,000
The following reconstruction scheme was approved:

(a) Preference shares be reduced to 8% preference shares of Rs.60 each

(b) Equity shares to be reduced by Rs.80 each.
(c) The amount thus made available to be utilized to write off fictitious assets including goodwill
and Rs.50,000 from fixed assets
Give entries for the reconstruction and the final balance sheet.
Part-A

1. What is capital reduction?

2. What is Alteration of share capital?
3. What are surrendered shares?
4. Distinguish between internal and external reconstruction.
5. Write a note on capital reduction account.
6. X. Ltd. With a share capital of 10000 equity shares of Rs. 100 each fully paid carries out by,
proper resolution, a subdivision into shares of Rs. 10 each. Show the necessary journal entry
to give effect to the above resolution.
7. Y Ltd. has been suffering heavy losses in the past. So, it has decided to go for reconstruction
scheme by reducing 22000 Equity shares of Rs. 100 each into Rs. 50 each so as to write off
accumulated losses of Rs. 10,70,000. Give journal entries to record the above transaction.
8. In order to eliminate accumulated losses of Rs. 45000 from the balance sheet, a company has
decided to convert its 15000 7% preference shares of Rs. 10 each into 6% preference shares
of Rs. 10 each, Rs.6 per share paid. Show journal entries in the books of company
Part-B

1. What is the procedure to be followed for reducing share capital?

2. The following scheme of reconstruction was approved by ‘K’ Ltd.;
a. The shareholders to receive in lieu of their present holding of 50,000 shares of Rs.10,the
following:
Fully paid equity shares equal to 2/5th of their holdings.
5% preference shares to the extent of 1/5th of the above equity shares.
Rs. 60,000,6% debentures

b. The goodwill which stood at Rs.3,00,000 was written down to Rs.1,50,000.

c. Plant and Building were written down by Rs.20,000 and Rs.30,000 respectively . Draft
journal entries.
3. Balance Sheet of ‘S’ Ltd. Is given:
liabilities Rs. Assets Rs.
Authorised capital: Fixed Asset 1,00,000
30,000 Equity shares of Rs.10 3,00,000 Stock 60,000
each Debtors 90,000
Paid up Capital: Bank Balance 2,70,000
20,000 Equity shares of Rs.10 2,00,000
each
Profit & Loss A/c 6% 1,40,000
Debentures 1,20,000
Creditors 60,000

5,20,000 5,20,000

It was resolved in the Annual General Meeting:

(a) to pay a dividend of 10%
(b) to issue on bonus share for every four shares held on the date of Balance Sheet given above.
(c) To give existing shareholders the option to buy one Rs.10 share at Rs.14 each for every four
shares held prior to the issue of bonus shares.
(d) The debentures are to be redeemed at a premium of 4%
All the shareholders accepted the proposal (c) and exercised it. Pass journal entries and
prepare the Balance Sheet after giving effect to the above resolutions.