DR - Srinivas Madishetti Professor, School of Business Mzumbe University

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Business Reconstruction

Dr.Srinivas Madishetti
Professor,
School of Business
Mzumbe University
Reduction of Share Capital

 68. Disapplication re open-ended investment


companies.
 69. Special resolution for reduction of share

capital.
 70. Director's certificate of solvency.
 71. Application to court by creditors

objecting to the reduction.


 72. Liability of members and directors in

respect of reduced shares.


Relevant sections of companies act
2002
CHAPTER IX: ARRANGEMENTS AND RECONSTRUCTION
 229. Power to compromise with creditors and

membersTShs
 230. Information as to compromise to be circulated.
 231. Provisions for facilitating reconstruction and

amalgamation of companies.
 232. Power to acquire shares of shareholders

dissenting from scheme or contract approved by


majority.
CHAPTER IX OF COMPANIES ACT 2002:
ARRANGEMENTS AND RECONSTRUCTIONS
Power to compromise with creditors and members
 229.-(l) Where a compromise or arrangement is

proposed between a company and its creditors, or any


class of them, or between the company and its
members or any class of them, the court may, on the
application (in a summary way) of the company or of
any creditor or member of the company, or, in the
case of a company being wound up, of the liquidator,
order a meeting of the creditors or class of creditors,
or of the -members of the company or class of
members, as the case may be, to be summoned in
such manner as the court directs.
 (2) If a majority in number representing three-
fourths in value of the creditors or class of creditors
or members or class of members (as the case may
be), present and voting either in person or by proxy
at the meeting, agree to any compromise or
arrangement, the compromise or arrangement, if
sanctioned by the court is binding on all creditors or
the class of creditors or on the members or class of
members (as the case may be), and also on the
company or, in the case of a company in the course
of being wound up, on the liquidator and
contributories of the company.
 (3) The court's order under subsection (2) has no
effect until an office copy of it has been delivered to
the Registrar for registration; and a copy of every
such order shall be annexed to every copy of the
company's memorandum issued after the order has
been made or, in the case of a company not having a
memorandum, of every copy so issued of the
instrument constituting the company or defining its
constitution.
 (4) If a company makes default in complying with

subsection (3), the company and every officer of it


who is in default is liable to a fine.
 (5) In this section and the next -
 (a) ''company'' means any company that

maybe wound up under this Act, and


 (b) ''arrangement'' includes a reorganization

of the company's share capital by the


consolidation of shares of different classes or
by the division of shares into shares of
different classes, or by both of those
methods.
Information as to compromise to be circulated
230.-(I) The following applies where a meeting of
creditors or any class of creditors, or of members or
any class of members, is summoned under section
229.
 (2) With every notice summoning the meeting which

is sent to a creditor or member, there shall be sent


also a statement explaining the effect of the
compromise or arrangement and in particular stating
any material interests of the directors of the company
(whether as directors or as members or as creditors
of the company or otherwise) and the effect on those
interests of the compromise or arrangement, in so
far as it is different from the effect on the like
interests of other persons.
Business Reconstruction

 Capital Reduction and Reconstruction


 Accounting Entries
 Resulting Accounting statements
 External Reconstruction
Capital Reduction and Reconstruction

 A company, sometimes, may face the problems of


over-capitalization, accumulated loses etc.
thereby giving a sluggish picture of the financial
status.
 At this juncture there is a need for the

reorganization of the company.


 Reconstruction is a process of reorganization of

the over-capitalized company in order to run the


company efficiently and profitably in future.
 The process involves the writing of the

accumulated losses, fictitious assets so that the


balance sheet is made up with true values.
 There are two ways of reorganizing the company,

namely, external reconstruction and internal


reconstruction.
Types of Reconstruction-external
External Reconstruction :
 The company to be reconstructed may be

liquidated and a new company may take-over the


existing company which is specially incorporated
for that purpose.
 But this becomes often, difficult due to legal

formalities.
 Another problem is that the accumulated losses of

the liquidated company cannot be set off against


the profits of the newly formed company and
added to that it may not enjoy the tax advantage.
Therefore some companies prefer internal
reconstruction.
Types of Reconstruction-Internal
Internal Reconstruction :
 Internal reconstruction is a way of reorganization

of an over capitalized company without going for


liquidation.
 It is a process which requires alternation of share

capital in accordance with the provisions of the


sections 229 to 230 of the companies Act, 2002
and capital reduction under sections 68 to 72.
 In internal reconstruction the company enters into

an agreement with the creditors, debenture


holders, and shareholders for the alternation or
reduction of capital and liabilities. This process
does not involve either liquidation of the company
or formation of new company. This is purely an
internal arrangements.
Internal reconstruction - Alteration of Share capital :

Alteration of share capital may take the forms of:


 fresh issue of shares,
 subdivision and conversion of existing shares and
 cancellation of unissued share capital.
But alteration of capital does not give satisfactory
solution, hence, it is better that the reorganization
may be resorted to by passing an ordinary resolution
with the sanction of the articles of association for
that purpose.
Following are the forms of alteration of capital and
their accounting treatment.
i) Consolidation of shares : It is to consolidate the existing smaller
denomination shares into shares of larger amount. The entry to be passed is:
Share capital A/c 100
(10 shares of TShs 10 each)
To shares capital A/c 100
(one share of TShs 100 each)
ii) Subdivision of Shares : This is the subdivision of shares of larger amount
into shares of smaller denomination . This is the reverse case of the
consolidation of shares. The entry is:
Share capital A/c Dr 100
(one share of TShs 100 each)
To share capital A/c 100
(10 shares of TShs 10 each per share)
iii) Conversion : Conversion of shares into stock and reconversion of stock
into shares may be taken up as a process of alteration of share capital. Here
stock means a number of shares taken together. The entry required is
Share capital A/c.......... Dr
To Equity capital stock A/c.
Internal reconstruction - Alteration of Share capital contd:

Example : A company wishes to convert its 10,000


equity shares of TShs 100 each fully paid into stock
of TShs 1,100,000 on the basis of TShs 1100 of
stock of every 10 fully paid shares of TShs 100 each
Pass Journal entry.
Equity share capital A/c ........... Dr1,000,000
Discount on stock A/c ............ Dr 100,000
To equity capital stock A/c 1,100,000
(being the conversion of capital into capital stock)
iv) Cancellation : Decrease the unissued capital
without reducing the paid up capital. This does not
require any Journal entry.
Steps in capital reduction
Reductions of share Capital : Before going for capital
reduction the company should take into consideration
the following steps.
 According to the provision laid down in the
companies act of 2002 the reduction of share
capital is possible only when the articles permit to
do so by passing a special resolution to that effect.
 The company should, after applying to the court
seek confirmation order for the purpose of capital
reduction and such order should protect the
interests of the creditors and share holders. The
court having satisfied with the terms for reduction
of share capital would make an order for adding
the words ''and reduced'' to the name of the
company for such period as it thinks fit.
Steps in capital reduction contd:
 The reasons of capital reduction by court
order are to be published for public
information.
 The order of the court so obtained should
be produced before the registrar and a
certified copy of the order and of the
minutes of reduction of share capital should
be filed with the Registrar for registration.
Forms of Capital Reduction & Accounting procedure :

1. Reducing the uncalled capital :


 It is to write off the uncalled capital on those

shares which are partly paid up.


 But this affects the interest, of the creditors
because their security depends upon paid up
capital & uncalled capital.
 The writing off of the uncalled capital does not

affect the paid up capital, but it reduces the par


value of the shares.
Entry : Share capital A/c (old)........ Dr
To share capital A/c (New)
Example:
The paid up value of a company is TShs
9,00,000 of 10,000 shares of TShs 100 each,
TShs 90/- per share called-up. It is decided to
cancel the uncalled capital. Pass Journal entry.
Share capital A/c Dr. 9,00,000
To share capital A/c 9,00,000
(being the conversion of partly paid up share
TShs 100 each into fully paid-up share of
90
each by cancelling the uncalled capital)
Note : In both the cases the paid-up amount is
the same.
Forms of Capital Reduction & Accounting procedure :
2) Return of paid-up Capital : When the company
feels that it has excess of capital, it may return such
excess to its members. It involves reduction of
capital and reduces the face value of shares. The
entry required is.
1. Share capital A/c (old) Dr
To share capital (New)
To Share holder A/c
2. Share Holder A/c Dr
To Bank A/c
Example :
The paid up capital of a company is TShs 1,000,000
consisting of 10,000 shares of TShs 100 each fully
paid up. The company wants to return excess capital
of TShs 200,000 to its members. Pass Journal
entry.
1. Share capital A/c (TShs 100) Dr TShs1,000,000
To share capital A/c (TShs 80) 800,000
To share holders A/c (TShs 20) 200,000
(being the reduction of share capital to TShs 80
per share and surplus of TShs 20 per share
refunded to share holder)
2. Share holders A/c DrTShs 200,000
To Bank TShs 200,000
(being the amount refunded)
Forms of Capital Reduction & Accounting procedure :

3) The Reduction in paid-up capital :


 The amount of reduction in paid-up capital is not refunded
to the share holder but it is used for reorganization of its
financial position.
 This form of capital reduction is important from the view

point of internal reconstruction.


 Such portion of reduction of paid up capital is to be

transferred to an account called "capital reduction account" or


'reconstruction account".
 The entry required is

Share capital (old) A/c . Dr (paid up value of share)


To share capital (New) A/c (old capital converted into new
shares)
To capital Reduction A/c (Reduction of paid-up capital)
Note : The above entry will change the face value.
Contd:
The above entry with out change in face value
will be :
Share capital A/c Dr.
(with the amount of reduction in share capital)
To Reconstruction A/c
Note : Capital reduction and Reconstruction
account are inter changeably used. When there
is no appreciation of assets and / or reduction
of external liabilities, the word 'capital
reduction is used. Since, the scheme of
reorganization involves appreciation of assets,
adjustment of liabilities, it is better to use
'reconstruction' account, in place of capital
reduction account.
Forms of Capital Reduction & Accounting procedure :

In addition to the reduction of capital, internal reconstruction involves


other transactions like reduction of liabilities, appreciation or over
valuation of assets, writing off of accumulated losses. The entries
required are :
1) When creditors and Debenture holders forego the amount due to them.
Creditors A/c Dr
(with the amount foregone.)
Debenture holders A/c Dr
To capital reduction A/c
2. When any contingent liability is to be paid :
i) Capital reduction A/c Dr
To liability payable A/c
ii) Liability payable A/c Dr
To Bank
3) When any asset is appreciated :
Asset A/c ..... Dr (with the amount of appreciation).
To Capital reduction
Forms of Capital Reduction & Accounting procedure :

4. When the amount in capital reduction is used to


write off fictitious assets, past losses etc.
Capital Reduction A/cDr.
To profit & Loss A/c
To Goodwill
To Preliminary expenses
To Patents
To Plant & Machinery
To other assets
To unrecorded liability, if any,
To capital Reserve (Balancing figure)
Contd:
 The essence of the above entry is that the total amount
standing to the credit of capital reduction account
either will be equal to or more than the amounts to be
written off under consideration.
 If the account shows a credit balance, finally, the
difference shall be transferred to capital reserve
account. But the question of capital reduction account
falling short of the amounts to be written off does not
arise.
 In case, any deficit arises, that deficit may be made up
by utilizing general reserve or any other surpluses
provided the scheme approves.
 Finally the balance sheet of the reorganized company
will be prepared by taking all the changes in the assets
and liabilities as specified in the scheme of
reconstruction.
Capital Reduction & Accounting procedure

Ex: Covina Ltd. decided to reconstruct its financial structure.


The following scheme of reconstruction was proposed.
1. To reduce each share to TShs 6.
2. To write off debentures by 20%
3. To request the banker to write off interest on bank loan.
4. To reduce creditors by TShs 18,000
a) Share capital
(i) 10,000 Equity shares of TShs 10 each fully paid.
(ii) 20,000 equity shares of TShs 10 each TShs 8 paid.
b) Debentures TShs 1,20,000, bank loan TShs 90,000 (incl.
interest TShs 5,400); creditors TShs 80,000. P & L a/c (debit
balance) TShs 1,10,400 preliminary expenses TShs 15,000;
discount on shares & debentures TShs 2,000. Give necessary
entries and show the capital reduction account assuming that
the call money due was received on 20,000 equity shares.
Solution :

Journal of Covina
Particulars Dr. Cr.
(TShs) (TShs)
1. Equity shares capital A/c(10,000 x10) Dr 1,00,000
To Equity Share Capital A/c (10,000x6) 60,000
To Capital Reduction A/c (10,000 x4) 40,000
(Being the equity shares reduced to TShs 6 per share &
remaining amount transferred to capital reduction account)
2. Equity share capital A/c (20,000 x 8) Dr 1,60,000
To Equity share capital ((20,000 x 6) 1,20,000
To capital Reduction A/c ((20,000 x 2) 40,000
(Being the equity shares reduced to TShs 6 per share &
the remaining amount transferred to capital reduction)
3. Debentures A/c Dr 1,20,000
To Debentures A/c 96,000
To Capital Reduction A/c 24,000
(Being the debenture holders sacrificed 20% of their
claim transferred to capital reduction)
Solution contd:
4. Interest on Bank loan A/c Dr 5,400
To Capital Reduction A/c 5,400
(being the bank interest waived & transferred
to capital reduction)
5. Creditors A/c Dr 18,000
To Capital reduction A/c 18,000
(Being the creditors reduced)
6. Capital Reduction A/c Dr 1,27,400
To profit & Loss A/c 1,10,400
To Discount on shares & Debenture A/c 2,000
To preliminary expenses 15,000
(being the losses written off)
7. Bank A/c Dr 40,000
To share capital A/c 40,000
(being the uncalled shares on 20,000
equity share, called at TShs 2 each)
Solution contd:
Capital Reduction A/c
Dr. Cr.
TShs TShs
To profit & Loss A/c 1,10,400 By Equity capital A/c 40,000
To Discount on shares
& Debenture 2,000 By Equity capital A/c 40,000
To preliminary expenses 15,000 By Debentures A/c 24,000
By Interest as Bank loan 5,400
By creditors A/c 18,000
-----------------------------------------------------------------------
1,27,400 1,27,400

Illustration -2;
Balance Sheet of xLtd as on 31-3-2001
Liabilities TShs Assets TShs
Equity Capital Goodwill 2,00,000
50,000 shares of TShs 10each 5,00,000 Plant & Machinery 1,00,000
Sundry creditors 50,000 Premises 1,75,000
Bank overdraft 30,000 Debtors 25,000
Bills payable 20,000 P & L A/c 1,00,000
6,00,.000 6,00,000
Illustration contd;
Eg : To write off losses and goodwill the following
scheme of reconstruction was agreed upon.
1 The shareholders are to receive in lieu of their
present holding the following:
 Fully paid equity shares at 40% of their present

holding.
 5% preference shares fully paid to the extent of 20%

of the above new equity shares.


 TShs 60,000, 6% second debentures.
2. An issue of TShs 50,000, 5% first debentures were
allotted and payment was received in cash.
Goodwill was written down to TShs 1,50,000, Plant &
machinery was written down by TShs 25,000. The
premises were written down to TShs 1,50,000.
Give Journal entries and prepare Balance sheet.
Solution :

Journal Entries
Date Particulars LF Debit TShs Credit TShs
Equity share capital A/c Dr 5,00,000
(TShs 10)
To Equity share Capital (new) 2,00,000
(40% of capital)
To 5% preference capital a/c 40,000
(4000 x 10)
To 6% 2nd Debentures a/c 60,000
To Reconstruction a/c 2,00,000
(being the existing equity shares converted into new equity, preference
and debentures, the remaining transferred to reconstruction a/c)

Cash A/c Dr 50,000


To 5% 1st Debentures A/c 50,000
(being the debentures issued for cash)

Reconstruction A/c Dr 2,00,000


To goodwill A/c 50,000
To P & L 1,00,000
To Plant & Machinery A/c 25,000
To Premises A/c 25,000
(being the goodwill, losses and other assets written off as per the scheme)
Solution contd:

Balance Sheet of 'X' Ltd. (after reconstruction)


Liabilities TShs Assets TShs
Capital Goodwill 1,50,000
5% Preference shares Fixed Assets
4000 @ 10 each 40,000 Plant & Machinery 75,000
Equity shares
20,000 @ 10 each 2,00,000 Premises 1,50,000
Reserves & Surplus - Current Assets
Secured Loans - Debtors 25,000
* Unsecured loans Cash 50,000
5% 1st Debentures 50,000
6% 2nd Debentures 60,000
Current liabilities
Creditors 50,000
B/P 20,000
Overdraft 30,000

_______________________________________________________________
4,50,000 4,50,000
Illustration:
Eg: Balance sheet of Hope Ltd. as on 31-12-99
Liabilities TShs Assets Rs
Capital : Goodwill 55,000
5,000 6% Preference shares of
TShs 100 each fully paid 5,00,000Patents & trade makers 45,000
40,000 equity shares of
TShs 10 each fully paid 4,00,000 Buildings 2,15,000
Capital Reserve 25,000 Plant & Machinery 2,55,000
5% Debentures of
TShs 100 each 2,00,000 Furniture 60,000
Interest accrued on
debentures 30,000 Stock 90,000
Sundry creditors 1,55,000 Debtors 75,000
Bank 12,500
Cash 2,500
P & L A/c 4,80,000
Discount on Debentures20,000
13,10,000 13,10,000
Note : The preference dividend is in arrear for 3 years
Illustration contd:

It was decided to reconstruct the company. The following scheme was


prepared and duly approved by the court.
a) The preference shares shall be converted into 7% preference shares
of TShs 50 each.
b) The equity shares shall be reduced to TShs 3 each.
c) That the debentures shall be converted into 6% Debentures of TShs
75 each. The debenture holders also agreed to waive 50% of the
accrued interest.
d) Arrear preference dividend is to be cancelled.
e) Sundry creditors agreed to waive 50% of their claim and to accept
equity shares for TShs 30,000 of their renewed claim.
f)The assets are to be revalued as follows :
Buildings TShs 2,50,000; plant & Machinery TShs 2,25,000.
furniture TShs 55,000; stock in trade TShs 80,000; Sundry Debtors
TShs 70,000
g) Patents and trade marks and other fictitious assets are to be written
off as far as possible.
Give journal entries and prepare balance sheet after reconstruction.
Solution:
Solution : Journal Entries
Date Particulars LF Debit Credit
TShs TShs
31-12-99 6% preference share capital A/c Dr 5,00,000
To 7% preference share capital A/c 2,50,000
To Reconstruction A/c 2,50,000
(being the 6% preference shares converted into 7%preference shares of TShs 50
each)
Equity share capital A/c Dr 2,80,000
To Reconstruction A/c 2,80,000
(being the equity share value reduced to TShs 3 )
5% Debentures A/c Dr 2,00,000
To 6% Debentures A/c 1,50,000
To Reconstruction A/c 50,000
(being the 5% debentures (TShs100) converted into 6% debentures of TShs 75)
Accrued interest on debentures A/c Dr 15,000
To Reconstruction A/c 15,000
(Being the interest foregone by debenture holders)
Creditors A/c Dr 77,500
To Equity Share capital A/c 30,000
To Reconstruction A/c 47,500
(being 50% of the creditors reduced by the issue of equity shares)
Solution contd:
Buildings A/c Dr 35,000
To Reconstruction A/c 35,000
(Being the value of buildings increased)
Reconstruction A/c Dr 6,76,500
To Profit & Loss A/c 4,80,000
" Discount on shares A/c 20,000
" Patents & trademarks A/c 45,000
" Goodwill A/c 55,000
" Plant & Machinery A/c 30,000
" Furniture A/c 5,000
" Stock A/c 10,000
" Debtors A/c 5,000
" Capital Reserve A/c 26,500
(Being the losses, fictitious assets and other
assets written off as per the scheme of
reconstruction)
Solution contd:

Balance Sheet (and reduced) of Hope Ltd. as on 31-3-99


Liabilities TShs Assets TShs
Capital : Fixed Assets :
5000, 6% preference Buildings 2,50,000
shares of TShs 50 each 2,50,000 Plant & Machinery 2,25,000
50,000 Equity shares of 1,50,000 Furniture 55,000
TShs 3 each
(including share given Investments -
to creditors) Current Assets :
Reserves & Surplus Stock 80,000
Capital Reserve 52,500 Debtors 70,000
Secured loans Nil Cash at Bank 12,500
Unsecured loans
6% Debentures (TShs 75) 1,50,000 Cash 2,500
Current liabilities Misc. Expenditure -
Creditors 77,500
Accrued interest on
debentures 15,000
---------------
6,95,000 6,95,000
Surrender of Shares :

 Sometimes, reorganization of a company is done through surrender


of shares. In order to facilitate the company under this method,
shares are subdivided into shares of smaller value and the
shareholders are requested to surrender a part of them. The amount
so arranged by surrender of shares is used to reduce or wipe off the
trade liabilities and debentures.
 The amount of sacrifice made as above by the debenture holders
and creditors is transferred to capital reconstruction account for the
purpose of writing off losses.
 The entries required are :
1. When shares are surrendered :
Share capital A/c ............. Dr
To shares surrendered A/c.
2. When shares surrendered reissued :
Shares surrendered A/c .......... Dr
To Equity share capital.
3. When surrendered shares are cancelled :
Share surrendered A/c ......... Dr
To capital reduction A/c
Illustration:

Balance Sheet of Bombay Ltd. as on 31-3-99 was as follows


Liabilities TShs Assets TShs
Equity Capital Goodwill 50,000
Shares of TShs 10 each 3,00,000 Plant 3,00,000
8% preference shares of
TShs 10 each 2,00,000 Loose Tools 10,000
Share premium 90,000 Debtors 2,50,000
Loan from director 50,000 Stock 1,50,000
Creditors 3,00,000 Bank 45,000
O/S expenses 30,000 Profit and loss
account 1,75,000
O/S directors fee 20,000 Preliminary
-- expenses 10,000
9,90,000 9,90,000
Illustration contd:
The following scheme of reconstruction was approved by the court.
1. Existing equity shares to be converted into equity shares of TShs
2 each.
2.The preference shareholders agreed to forego their right to the arrears of
dividend for 3 years
3. Equity shareholders are to surrender 90% of their converted holdings.
4. Sundry creditors agreed to reduce their claim by 25%.
5. Out of the surrendered shares 17,500 shares are issued to creditors at
the rate of TShs 2 per share.
6. The directors agreed to sacrifice their loan and remuneration.
7. All the remaining surrendered shares are to be cancelled.
8. Write off the entire amount of goodwill, TShs 3,000 of loose tools, TShs
15,000 of stock and TShs 20,000 of Debtors.
9. Any amount available after writing off losses should be utilized in
writing down the value of plant.
10. Further 50,000 equity shares were issued to the existing holders to
raise the working capital.
 A holder of 100 equity shares opposed the scheme and his shares were

taken over by a director on a payment of TShs 1000.


Give Journal entries and prepare balance sheet after reconstruction.
Solution:
Solution :
Date Particulars LF Dr. (TShs) Cr.(TShs)
1. Equity share capital (old) A/c Dr 3,00,000
To Equity share capital A/c (new) 3,00,000
(Being the old shares converted into new shares of TShs 2 each)
2. Equity share capital A/c Dr 2,70,000
To Shares surrendered A/c 2,70,000
(Being 90% of the shares surrendered)
3. 8% pref. share capital A/c Dr 2,00,000
To 8% pref. Share capital A/c 2,00,000
(Being 8% pref. shares converted as 9% pref. Shares)
4. Creditors A/c Dr 75,000
To capital reduction A/c 75,000
(Being the creditors sacrificed 25% of their claim)
5. Shares surrendered A/c Dr 35,000
To Share Capital A/c (New) 35,000
(Being 17,500 shares issued)
6. Shares surrendered A/c Dr 2,35,000
To Capital reduction A/c 2,35,000
(Being the remaining surrendered shares transferred)
Solution contd:
7. Directors loan A/c Dr 50,000
Outstanding Directors fee A/c Dr 20,000
To Capital reduction A/c 70,000
(Being the above amounts transferred to capital reduction
A/c)
8. Capital reduction A/c Dr 3,80,000
To Goodwill 50,000
To P & L A/c 1,75,000
To Preliminary expenses a/c 10,000
To Loose tools A/c 3,000
To Stock A/c 15,000
To Provision for bad debts A/c 20,000
To Plant & Machinery A/c 1,07,000
(Bal. Fig)
(Being the goodwill, losses and
other assets, written off)
Solution contd:

9. Bank A/c Dr. 1,00,000


To Share capital A/c (New) 1,00,000
(Being shares issued at TShs 2 per share for working
capital)
10. Bank a/c Dr 1000
To Dissentient shareholder A/c 1,000
(Being cash received from Directors
for transfer of dissenting shares.)
11. Dissentient Shareholder a/c Dr 1,000
To Bank 1,000
(Being cash paid to dissentient shareholder)
Solution contd:
Bank A/c
Dr Cr.
To bal. b/d 45,000 By Dissenting share
holders A/c 1,000
To share capital 1,00,000 By balance c/d 1,45,000
To Dissentient share
holders 1,000 _______

1,46,000 1,46,000
Balance sheet of Bombay Ltd. as on 31-3----- (after reconstruction)
Liabilities TShs Assets TShs
Share capital Plant 1,93,000
Shares of TShs 2 each
(82500 shares) 1,65,000 Loose tools 7,000
Share premium 90,000 Stock 1,35,000
20,000 9% pref. shares2,00,000 Debtors 2,30,000
Creditors 2,25,000 Bank 1,45,000
Outstanding expenses 30,000 --
7,10,000 7,10,000
External Reconstruction

Meaning of external reconstruction


 External reconstruction refers to closing/liquidating the company and

starting again a new or a fresh. That is technically, a new company will be


floated or formed to take over the existing company. Internal
reconstruction refers to making internal arrangements for overcoming
financial difficulties.
Differences between amalgamation and external reconstruction
 1. Amalgamation of companies involves liquidation of two or more

companies, while external reconstruction involves liquidation of only one


company,
 2. Amalgamation of companies results in combination of companies, but

external reconstruction does not result in any such combination.


Differences between absorption and external reconstruction
 1. Absorption of companies does not involve formation of a new company,

however, external reconstruction involves formation of a new company,


 2. Absorption of companies results in liquidation of one or more

companies while external reconstruction results in liquidation of only one


company.
 3. Absorption of companies involves combination of companies, whereas

external reconstruction does not involve any combination.


Accounting for external reconstruction

 The accounting procedure in case of external


reconstruction is the same as in case of
amalgamation or absorption in the nature of
purchase. However, there are no different
kinds in this case, unlike in case of
amalgamation or absorption, which were of
two kinds viz, in nature of merger and in the
nature of purchase.
The steps in accounting for external reconstruction are outlined
below:

Calculation of purchase consideration:


 I. Ascertainment of discharge of purchase

consideration
 II. Closing the books of vendor company (Vendor

company is the company which is being liquidated


and taken over) or transferor company
 III. Passing opening entries in the books of

purchasing company ( i.e., transferee company or


the new company floated
Purchase Consideration

 Purchase Consideration refers to the consideration payable


by the purchasing company to the vendor company for
taking over the assets and liabilities of Vendor Company.
 Para 3(g) of Accounting Standard – 14 defines the term

purchase consideration as the “aggregate of the shares and


other securities issued and the payment made in the form
of cash or other assets by the transferee company to the
shareholders of the transferor company”. Although,
purchase consideration refers to total payment made by
purchasing company to the shareholders of Vendor
Company, its calculation could be in different methods, as
explained below:
 a. Lump sum method
 b. Net payments method
 c. Net Assets Method
 d. Other basis for purchase consideration
Methods:
 Lump sum Method: strictly speaking, this is not a method. Where the
purchase consideration amount is mentioned in the problem itself, it is
called Lump Sum consideration. This method, does not involve any
calculation regarding purchase consideration.
 Net Payments Method: under this method, the purchase consideration

will be the total of payments made (in any form)by purchasing


company to vendor company, on any basis. Generally, purchasing
company decides the payment to be made towards liabilities of Vendor
Company not taken over and towards expenses. The total of such
payment s will be the purchase consideration.
 Net Assets Method: under this method, purchase consideration will be

the excess of value of assets taken over by the purchasing company,


over the value of liabilities taken over. that is, under this method, the
purchase consideration will be
 Purchase Consideration = Assets taken over – Liabilities taken

(at ‘taken over ‘values) (at ‘taken over


‘value)
 Other basis of arriving at Purchasing Consideration

 1. Intrinsic value

 2. Exchange Ratio
How to identify the method of purchase consideration, applicable for the
given problem?
1. If the problem specifies the method to be adopted –
adopt the method specified
2. If the method is not specified in the problem, but
the amount of purchase consideration is given, it is
lump sum method and does not need any
calculation
3. When the payments made by purchasing company
to vendor company is given, with the statement
“Balance in……” then, “Net Asset Method” must be
adopted.
4. When the payment made by purchasing company
to Vendor Company is given liability wise or any
other item wise without the statement “Balance
in…..” then, “Net Payments Method” must be
adopted.
Discharge of purchase consideration

 Discharge of purchase consideration refers to the


form in which, the purchase consideration is
discharged by the purchasing company. Under
net payments method calculation and discharge
of purchase consideration would be one and the
same.
 Under net Assets Method and Lump Sum Method

based on the information in the problem the


mode of discharge must be ascertained.
 When the problem is silent about the mode of

discharge of purchase consideration, it must be


assumed that purchase consideration is
discharged by issue of equity shares of
purchasing company.
Closing of Books of Transferor Company -steps
Accounting Entries in the books of Transferor Company
1. For transfer of various assets including cash at their book value
Realization Account Dr.
To concerned Asset Account
 Note: cash and bank balance is transferred to realization account only when

it is taken over by the transferee company.


 Gross value of assets and provisions against that are separately transferred

to realization account. For example: Balance of debtors Rs 20,000 and


provision for doubtful debts Rs 10,000 are transferred separately because in
the ledger book, there are two separate accounts, namely, debtor account
showing a balance of Rs 20,000 (debit) and provision for doubtful debts
accounts showing a balance of RS 10,000 (credit) and both these accounts
are to be closed for final closure of books of the transferor company.
2. For transfer of various liabilities including debenture at their book value and
statutory reserve
Concerned Liability Account Dr.
To Realization Account
3. For purchase consideration due
Purchasing company account Dr.
To Realization Account
4. For the payment of realization 6. For payments of liabilities not
expenses taken over by the Transferee
a. If it is paid By Transferor company (including debenture if
company: not taken over)
Realization Account Dr. Realization Account Dr.
Cash/Bank Account To Cash/Bank Account
b. If it is paid by Purchasing 7. For preference share capital due:
Company: i. Payable at par
i. For making payment Prefe. Share Capital Account Dr.
Purchasing company account Dr. To Preference Share Holder’s
To cash/bank account Account
ii. For collecting the amount ii. Payable at a higher value
from purchasing company Prefe. Share Capital Account Dr.
Cash/ Bank Account Dr. (with face value)
To Purchasing Company Account Realization Account Dr.
5. For sale of assets not taken over (with premium on redemption)
iii. Payable at a lower value Equity Shareholder’s Account Dr.
Pref. Share Capital A/C Dr To Preliminary Expenses Account
To underwriting Commission
To Realization Account Account
To Preference Shareholders To discount on Issue of shares and
Account Debentures Account
8. For closing realization account To Profit and Loss Account
i. In case of profit Note: in case of amalgamation in the
Realization Account Dr. nature of merger, only share capital
To Equity Share Holders Account must be transferred to equity
ii. In case of loss shareholders account and all other
Equity Share Holders Account Dr. items belonging to shareholders must
To Realization Account be transferred to realization account.
9. For transfer of Share Capital, In case of amalgamation in the nature
reserves and profits : or purchase, all items relating to equity
Equity Share Capital Account Dr. shareholders must be transferred to
Reserve Account Dr. the equity shareholders account other
Note: When purchasing company issue
11. For the receipt of purchase debenture of discharge of vendor
consideration company debentures, in the books of
Equity Shares in Purchasing vendor company the debentures must
be shown as taken over, by purchasing
Company Account Dr.
company and credited to realization
Preference Shares in
account and later in the books of
purchasing of Transferee
purchasing company the discharge
Company account Dr. must be recorded by way of entry for
Cash/Bank Account Dr. exchange (as per requirements of AS
To Purchasing Company Account 14)
12. For the final payment made of
preference shareholders
Pref. Shareholder’s Account Dr.
To Cash/Bank Account
To shares or debentures in
Transferee company account
Opening Entries in the Books of Transferee Company or Purchasing Company

 The accounting treatment under External Reconstruction


in the books of transferee , only Business Purchase
Method (i.e., Amalgamation in the nature of purchase) is
applied because it involves substantial changes in values
of assets and liabilities. Moreover, there is only one
company and in fact, there is no merger.
 The following entries will be passed in the books of
purchasing company in the case of external
reconstruction.
A. Opening Entries in the case of Amalgamation in the nature of purchase
(Business Purchase Method)

1. For Purchase Consideration payable To Creditors


Business Purchase account Dr. To Bills Payable
To liquidators of Transferor company To Other liabilities
(With the amount of purchase To Business Purchase account
consideration ) To Capital Reserve account (bal. fig) (if
2. For incorporation of Assets and any)
Liabilities Note:
Plant and machinery account (revised 1. Revised value or fair value and not
value) Dr. book values of assets and liabilities
Land and building account (revised taken over are recorder.
value) Dr. 2. Reserves and surplus are not
Other fixed assets account (revised incorporated along with assets and
value) Dr. liabilities. But to carry forward
Debtors account (revised value) “Statutory Reserve” a separate entry is
Dr. passed through “amalgamation
Stock account (revised value) adjustment account”
3 For incorporation of Statutory
Reserves: 6. For making payment of debentures
Amalgamation Adjustment account Dr. and other liabilities of transferor
To Statutory Reserve account company:
(With the amount of statutory reserves Debenture/items of liability (i.e.
such as development rebate reserve, creditors) account Dr.
investment allowance reserve, export Discount on issue of debentures
profit reserve etc.) account Dr.
4. When there is no need for To debentures account
maintaining statutory reserves: To premium on issue of debentures
Statutory Reserve account Dr. account
To Amalgamation Adjustment account (With the issue of new debenture of
5. For discharge of Purchase transferee company to debenture
Consideration holders of transferor company)
Liquidator of Transferor Company 7. For incurring formation expenses:
account Dr.
Discount on issue of securities account Formation expenses/preliminary
Dr. expenses account Dr.
TREATMENT OF REALISATION EXPENSES

Various circumstances
1. Payment by transferor company and 3. Payments by Transferor company
also burden on transferor company: out of cash retained out of cash taken
Realization account Dr. over by the Transferee Company
To cash In this case, as cash has been retained
Note: no entry in the books of the out of the cash taken over by the
transferee company transferee company, the burden will be
2. Payment by transferee company and on the transferee company. As
also burden on transferee company: transferor company is not be bear
(payment in the form of these expenses, it transfers at the time
reimbursement) of transfer of assets, only that part of
A. In the books of Transferor Company cash to realization account which is
a. At the time of payment actually handed over to the transferee
Transferee Company account Dr. company. On payment of realization
To Cash account expenses the following entry is passes:
b. At the time of reimbursement Realization Account Dr.
Cash account Dr. To Cash Account
Illustration-2:
Following is the balance sheet of 'IT' Ltd. as on 31-3-2002

Liabilities TShs Assets TShs

Preference share cap. 10,00,000 Plant & Machinery 10,00,000

Equity share capital 20,00,000 Land and Buildings 20,00,000

Profit and loss A/c 4,00,000 Investments 4,00,000

General Reserve 6,00,000 Stock 6,00,000

Debentures 4,00,000 Debtors 8,00,000

Creditors 6,00,000 Cash 2,00,000

50,00,000 50,00,000

_____________________________________________________________________
Illustration contd:
'IT' Ltd. is absorbed by IT Refine Ltd. Which is newly formed in the
place of It ltd on the above date on the following terms.
1. Equity shares are to be repaid at 6% premium by issuing equity
shares in 'Q' Ltd.
2. Nine preference shares in 'Q' Ltd. are to be issued for five
preference shares held in 'IT' Ltd. face value of preference shares of
both the companies being same.
3. Stock is not taken over by 'Q' Ltd. and it realized TShs 2,00,000.
4. The fair value of assets taken over is as under.
Plants and Machinery TShs 8,00,000
Land and Buildings TShs 34,00,000
Investments TShs 2,00,000
Debtors TShsBook value less 10%.
Prepare Realization Account & Equity share holders Account in the
books of IT ltd. Write Journal entries in the books of Q Ltd.
Solution : Ledger Accounts in the 'Books of 'IT Ltd.‘
Dr Realization A/c Cr.

Particulars TShs Particulars

TShs
To Plant and Mach. A/c10,00,000 By DebentureA/c 4,00,000

To Land & Building A/c20,00,000 By Creditors A/c 6,00,000

To Investments A/c 4,00,000ByITrefineLtd(p.c) A/c 39,20,000

To Stock A/c 6,00,000 By Cash( Stock realized 2,00,000

To Debtors A/c 8,00,000 By Equity share

To Cash A/c 2,00,000 holders A/c (loss) 6,80,000

To preference share 8,00,000


Purchase consideration: TShs
Equity share in 'Q' (20,00,000 + 6% premium) 21,20,000
Add preference shares in ‘IT refine Ltd 18,00,000
39,20,000
Note : Since, the transferee company 'Q' Ltd. did not take the stock of 'IT' Ltd. it is a case of
purchase, so accounting treatment for purchase is given.

Dr Equity share holders A/c Cr

TShs

TShs

To Realization A/c (loss)6,80,000 By Equity share capital 20,00,000

To Equity share in By P and L A/c 4,00,000

IT refined Ltd. 21,20,000

To Cash A/c 2,00,000 By General Reserve A/c 6,00,000


Particulars LF Dr.(TShs) Cr. (TShs)

Business purchase A/c ............ Dr 3,920,000

To Liquidator of 'Z' Ltd. 3,920,000

(being the purchase consideration payable)

Plant and Machinery A/c Dr 800,000

Land and Buildings A/c Dr 3,400,000

Investment A/c Dr 200,000

Debtors A/c Dr 800,000

Cash A/c Dr 200,000

To Debentures 400,000

To creditors a/c 600,000


Liquidator of 'X' Ltd ..... Dr 39,20,000

To preference share capital A/c 18,00,000

To Equity share capital A/c 21,20,000


(being the purchase consideration discharged)
BALANCE SHEET OF IT REFINE LTD
LIABILITIES ASSETS

preference Plant and Machinery 800,000


share capital 1,800,000 Land and Buildings 3400,000
Equity share capital 2,120,000 Investment 200,000

Capital Reserve 400,000 Debtors 8,00,000

Creditors 600,000 Provision

Debentures on Debtors 80,000 720,000


400,000 Cash 200,000

_______________________________
_______________________________ 5,320.000

5,320,000

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