ICAI Notes: Accounting for Reconstruction of Companies | Advanced Accounting for CA Intermediate PDF Download

 Page 1


 
 
 
 
LEARNING OUTCOMES 
a
    
 
CHAPTER 
14 
 
 
 
INTERNAL  
RECONSTRUCTION   
 
 
 
After studying this chapter, you will be able to: 
? Understand the meaning of term “reconstruction” and the types of 
reconstruction. 
? Understand the concept of Sub-division and consolidation of shares, 
conversion of shares into stock and vice versa 
? Understand the meaning of Capital reduction account and rules 
regarding the presentation of accounts post reconstruction in 
accordance with the provisions of the Companies Act 2013. 
  
© The Institute of Chartered Accountants of India
Page 2


 
 
 
 
LEARNING OUTCOMES 
a
    
 
CHAPTER 
14 
 
 
 
INTERNAL  
RECONSTRUCTION   
 
 
 
After studying this chapter, you will be able to: 
? Understand the meaning of term “reconstruction” and the types of 
reconstruction. 
? Understand the concept of Sub-division and consolidation of shares, 
conversion of shares into stock and vice versa 
? Understand the meaning of Capital reduction account and rules 
regarding the presentation of accounts post reconstruction in 
accordance with the provisions of the Companies Act 2013. 
  
© The Institute of Chartered Accountants of India
 
ADVANCED ACCOUNTING  
 14.2 
 
 
 
 
 1. MEANING OF RECONSTRUCTION 
When a company has been making losses for several 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 generally overvalued, as the balance sheet consists 
of fictitious assets, unrepresented intangible assets and debit balance in the profit 
and loss account (showing the carry forward of losses). Such a situation always 
leads the company to show a higher net worth and not depicting a true picture of 
financial statements. In short, the company is over capitalized. Such a situation 
brings the need for reconstruction/reorganization of the affairs. 
Types of Reconstruction
Internal Reconstruction
(Sections of the Companies 
Act 2013)
External reconstruction
(AS14 Accounting for 
Amalgamations)
Methods of Internal Reconstruction
Alteration 
of Share 
Capital
Sub-division and 
Consolidation of 
Shares
Conversion of share into 
stock or vice-versa
Variation of 
Shareholders’ 
rights
Reduction 
of Share 
Capital
Compromise/ 
Arrangement
Surrender 
of Shares
 CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
Page 3


 
 
 
 
LEARNING OUTCOMES 
a
    
 
CHAPTER 
14 
 
 
 
INTERNAL  
RECONSTRUCTION   
 
 
 
After studying this chapter, you will be able to: 
? Understand the meaning of term “reconstruction” and the types of 
reconstruction. 
? Understand the concept of Sub-division and consolidation of shares, 
conversion of shares into stock and vice versa 
? Understand the meaning of Capital reduction account and rules 
regarding the presentation of accounts post reconstruction in 
accordance with the provisions of the Companies Act 2013. 
  
© The Institute of Chartered Accountants of India
 
ADVANCED ACCOUNTING  
 14.2 
 
 
 
 
 1. MEANING OF RECONSTRUCTION 
When a company has been making losses for several 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 generally overvalued, as the balance sheet consists 
of fictitious assets, unrepresented intangible assets and debit balance in the profit 
and loss account (showing the carry forward of losses). Such a situation always 
leads the company to show a higher net worth and not depicting a true picture of 
financial statements. In short, the company is over capitalized. Such a situation 
brings the need for reconstruction/reorganization of the affairs. 
Types of Reconstruction
Internal Reconstruction
(Sections of the Companies 
Act 2013)
External reconstruction
(AS14 Accounting for 
Amalgamations)
Methods of Internal Reconstruction
Alteration 
of Share 
Capital
Sub-division and 
Consolidation of 
Shares
Conversion of share into 
stock or vice-versa
Variation of 
Shareholders’ 
rights
Reduction 
of Share 
Capital
Compromise/ 
Arrangement
Surrender 
of Shares
 CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
 
 
v
v 
v
v 
    
v 
 14.3 
 
INTERNAL 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 so that company can be bailed out from 
present situation without winding up the existing company.  
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 essentially covered under the category of 
‘amalgamation in the nature of merger’ in AS 14. 
Difference Between Internal and External Reconstruction 
Basis Internal Reconstruction External Reconstruction 
Liquidation and 
formation of 
new company 
The existing company is 
not liquidated rather the 
capital and debt structure 
is changed to bring the 
company back to normalcy 
The existing company is 
liquidated to form a new 
company in which the existing 
shareholders become 
shareholders of new company 
as well 
Reduction of 
capital and 
varying rights 
There is certain reduction 
of capital and sometimes 
the outside liabilities like 
debenture holders may 
have to reduce their claim 
in this scheme. 
There is no reduction of capital. 
In fact, there is a fresh share 
capital of the company. The 
shareholders need not vary 
their rights in company 
Legal position Internal reconstruction is 
done as per provisions of 
section 61 and 66 of the 
Companies Act, 2013. 
External reconstruction is 
regulated by section 232 of the 
Companies Act, 2013. 
Legal formalities  It requires court’s 
confirmation and other 
legal procedures before it 
can be implemented 
It can be affected without the 
court’s interference and less 
time-consuming process. 
© The Institute of Chartered Accountants of India
Page 4


 
 
 
 
LEARNING OUTCOMES 
a
    
 
CHAPTER 
14 
 
 
 
INTERNAL  
RECONSTRUCTION   
 
 
 
After studying this chapter, you will be able to: 
? Understand the meaning of term “reconstruction” and the types of 
reconstruction. 
? Understand the concept of Sub-division and consolidation of shares, 
conversion of shares into stock and vice versa 
? Understand the meaning of Capital reduction account and rules 
regarding the presentation of accounts post reconstruction in 
accordance with the provisions of the Companies Act 2013. 
  
© The Institute of Chartered Accountants of India
 
ADVANCED ACCOUNTING  
 14.2 
 
 
 
 
 1. MEANING OF RECONSTRUCTION 
When a company has been making losses for several 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 generally overvalued, as the balance sheet consists 
of fictitious assets, unrepresented intangible assets and debit balance in the profit 
and loss account (showing the carry forward of losses). Such a situation always 
leads the company to show a higher net worth and not depicting a true picture of 
financial statements. In short, the company is over capitalized. Such a situation 
brings the need for reconstruction/reorganization of the affairs. 
Types of Reconstruction
Internal Reconstruction
(Sections of the Companies 
Act 2013)
External reconstruction
(AS14 Accounting for 
Amalgamations)
Methods of Internal Reconstruction
Alteration 
of Share 
Capital
Sub-division and 
Consolidation of 
Shares
Conversion of share into 
stock or vice-versa
Variation of 
Shareholders’ 
rights
Reduction 
of Share 
Capital
Compromise/ 
Arrangement
Surrender 
of Shares
 CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
 
 
v
v 
v
v 
    
v 
 14.3 
 
INTERNAL 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 so that company can be bailed out from 
present situation without winding up the existing company.  
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 essentially covered under the category of 
‘amalgamation in the nature of merger’ in AS 14. 
Difference Between Internal and External Reconstruction 
Basis Internal Reconstruction External Reconstruction 
Liquidation and 
formation of 
new company 
The existing company is 
not liquidated rather the 
capital and debt structure 
is changed to bring the 
company back to normalcy 
The existing company is 
liquidated to form a new 
company in which the existing 
shareholders become 
shareholders of new company 
as well 
Reduction of 
capital and 
varying rights 
There is certain reduction 
of capital and sometimes 
the outside liabilities like 
debenture holders may 
have to reduce their claim 
in this scheme. 
There is no reduction of capital. 
In fact, there is a fresh share 
capital of the company. The 
shareholders need not vary 
their rights in company 
Legal position Internal reconstruction is 
done as per provisions of 
section 61 and 66 of the 
Companies Act, 2013. 
External reconstruction is 
regulated by section 232 of the 
Companies Act, 2013. 
Legal formalities  It requires court’s 
confirmation and other 
legal procedures before it 
can be implemented 
It can be affected without the 
court’s interference and less 
time-consuming process. 
© The Institute of Chartered Accountants of India
 
ADVANCED ACCOUNTING  
 14.4 
 2. METHODS OF INTERNAL RECONSTRUCTION 
For properly deploying the process of internal reconstruction following methods 
are generally employed or used simultaneously:  
2.1 Alteration of Share Capital 
According to Section 61 of the Companies Act 2013, a limited company can alter 
its share capital, if so authorized by its Articles, by passing an ordinary resolution 
in the general meeting. The provisions of the relevant sections of Companies Act 
will be applicable, but in this chapter, we are going to focus on the accounting 
treatment of the various conditions pertaining to internal reconstruction. 
The following types of Alteration can be done under Section 61- 
(a) Increase of authorized share capital; 
(b) Consolidation and sub-division into shares of larger or smaller denominations; 
(c) Conversion of all or any of the shares into stock or vice versa; 
(d) Cancellation of shares which have not been taken or agreed to be taken by any 
person. 
Sub-division and Consolidation of Shares 
The existing share capital can be sub-divided or consolidated into the shares into those 
of a smaller or higher denomination than that fixed by the Memorandum of 
Association, so long as the proportion between the paid up and unpaid amount, if any, 
on the shares continues to be the same as it was in the case of the original shares. 
For example, a company with a capital of ` 10,00,000 divided into 10,000 equity 
shares of ` 100 each on which ` 75 is paid up decides to reorganize its capital by 
splitting one equity share of ` 100 each into 10 such shares of ` 10 each. The 
consequential entry to be passed in such a case would be— 
  Dr. Cr. 
  ` ` 
Equity Share Capital ( ` 100) A/c Dr. 7,50,000  
 To Equity Share Capital ( ` 10) A/c   7,50,000 
© The Institute of Chartered Accountants of India
Page 5


 
 
 
 
LEARNING OUTCOMES 
a
    
 
CHAPTER 
14 
 
 
 
INTERNAL  
RECONSTRUCTION   
 
 
 
After studying this chapter, you will be able to: 
? Understand the meaning of term “reconstruction” and the types of 
reconstruction. 
? Understand the concept of Sub-division and consolidation of shares, 
conversion of shares into stock and vice versa 
? Understand the meaning of Capital reduction account and rules 
regarding the presentation of accounts post reconstruction in 
accordance with the provisions of the Companies Act 2013. 
  
© The Institute of Chartered Accountants of India
 
ADVANCED ACCOUNTING  
 14.2 
 
 
 
 
 1. MEANING OF RECONSTRUCTION 
When a company has been making losses for several 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 generally overvalued, as the balance sheet consists 
of fictitious assets, unrepresented intangible assets and debit balance in the profit 
and loss account (showing the carry forward of losses). Such a situation always 
leads the company to show a higher net worth and not depicting a true picture of 
financial statements. In short, the company is over capitalized. Such a situation 
brings the need for reconstruction/reorganization of the affairs. 
Types of Reconstruction
Internal Reconstruction
(Sections of the Companies 
Act 2013)
External reconstruction
(AS14 Accounting for 
Amalgamations)
Methods of Internal Reconstruction
Alteration 
of Share 
Capital
Sub-division and 
Consolidation of 
Shares
Conversion of share into 
stock or vice-versa
Variation of 
Shareholders’ 
rights
Reduction 
of Share 
Capital
Compromise/ 
Arrangement
Surrender 
of Shares
 CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
 
 
v
v 
v
v 
    
v 
 14.3 
 
INTERNAL 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 so that company can be bailed out from 
present situation without winding up the existing company.  
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 essentially covered under the category of 
‘amalgamation in the nature of merger’ in AS 14. 
Difference Between Internal and External Reconstruction 
Basis Internal Reconstruction External Reconstruction 
Liquidation and 
formation of 
new company 
The existing company is 
not liquidated rather the 
capital and debt structure 
is changed to bring the 
company back to normalcy 
The existing company is 
liquidated to form a new 
company in which the existing 
shareholders become 
shareholders of new company 
as well 
Reduction of 
capital and 
varying rights 
There is certain reduction 
of capital and sometimes 
the outside liabilities like 
debenture holders may 
have to reduce their claim 
in this scheme. 
There is no reduction of capital. 
In fact, there is a fresh share 
capital of the company. The 
shareholders need not vary 
their rights in company 
Legal position Internal reconstruction is 
done as per provisions of 
section 61 and 66 of the 
Companies Act, 2013. 
External reconstruction is 
regulated by section 232 of the 
Companies Act, 2013. 
Legal formalities  It requires court’s 
confirmation and other 
legal procedures before it 
can be implemented 
It can be affected without the 
court’s interference and less 
time-consuming process. 
© The Institute of Chartered Accountants of India
 
ADVANCED ACCOUNTING  
 14.4 
 2. METHODS OF INTERNAL RECONSTRUCTION 
For properly deploying the process of internal reconstruction following methods 
are generally employed or used simultaneously:  
2.1 Alteration of Share Capital 
According to Section 61 of the Companies Act 2013, a limited company can alter 
its share capital, if so authorized by its Articles, by passing an ordinary resolution 
in the general meeting. The provisions of the relevant sections of Companies Act 
will be applicable, but in this chapter, we are going to focus on the accounting 
treatment of the various conditions pertaining to internal reconstruction. 
The following types of Alteration can be done under Section 61- 
(a) Increase of authorized share capital; 
(b) Consolidation and sub-division into shares of larger or smaller denominations; 
(c) Conversion of all or any of the shares into stock or vice versa; 
(d) Cancellation of shares which have not been taken or agreed to be taken by any 
person. 
Sub-division and Consolidation of Shares 
The existing share capital can be sub-divided or consolidated into the shares into those 
of a smaller or higher denomination than that fixed by the Memorandum of 
Association, so long as the proportion between the paid up and unpaid amount, if any, 
on the shares continues to be the same as it was in the case of the original shares. 
For example, a company with a capital of ` 10,00,000 divided into 10,000 equity 
shares of ` 100 each on which ` 75 is paid up decides to reorganize its capital by 
splitting one equity share of ` 100 each into 10 such shares of ` 10 each. The 
consequential entry to be passed in such a case would be— 
  Dr. Cr. 
  ` ` 
Equity Share Capital ( ` 100) A/c Dr. 7,50,000  
 To Equity Share Capital ( ` 10) A/c   7,50,000 
© The Institute of Chartered Accountants of India
 
 
v
v 
v
v 
    
v 
 14.5 
 
INTERNAL RECONSTRUCTION 
(Being the sub-division of 10,000 shares of ` 100 each 
with ` 75 paid up thereon into 1,00,000 shares of ` 10 
each with ` 7.50 paid up thereon as per the resolution of 
shareholders passed in the General Meeting held on...) 
   
Similar entries will be passed on consolidation of shares of a smaller amount into 
those of a larger amount. 
Illustration 1 
On 31-12-20X1, B Ltd. had 20,000, ` 10 Equity Shares as authorized capital and the 
shares were all issued on which ` 8 was paid up. In June, 20X2 the company in 
general meeting decided to sub-divide each share into two shares of ` 5 with ` 4 
paid up. In June, 20X3 the company in general meeting resolved to consolidate 20 
shares of ` 5, ` 4 per share paid up into one share of ` 100 each, ` 80 paid up. 
Pass entries and show how share capital will appear in notes to Balance Sheet as on 
31-12-20X1, 31-12-20X2 and 31-12-20X3. 
Solution  
Journal Entries 
20X2   `  `  
June Equity Share Capital (` 10) A/c Dr. 1,60,000  
       To Equity Share Capital (` 5) A/c   1,60,000 
 (Being the sub-division of 20,000 shares 
of ` 10 each with ` 8 paid up into 40,000 
shares ` 5 each with ` 4 paid up by 
resolution in general meeting dated....)  
   
20X3 Equity Share Capital (` 5) A/c Dr. 1,60,000  
June        To Equity Share Capital (` 100) A/c   1,60,000 
 (Being consolidation of 40,000 shares of  
` 5 with ` 4 paid up into 2,000 ` 100 
shares with ` 80 paid up) 
   
© The Institute of Chartered Accountants of India