Reconstruction is a process of the company’s reorganization, concerning legal, operational, ownership and other structures, by revaluing assets and reassessing the liabilities. There are two methods of reconstruction which are internal reconstruction and external reconstruction. The former is the method in which the reconstruction is undertaken without winding up the company and forming a new one, while the latter, is one whereby the existing company loses its existence, and a new company is set up to take over the business of the existing company.
Reconstruction is required when the company is incurring losses for many years, and the statement of account does not reflect the true and fair position of the business, as a higher net worth is depicted, than that of the real one. Here, in the given article, we are going to talk about all the important differences between internal and external reconstruction.
Definition of Internal Reconstruction
A recourse undertook by the enterprise, in which substantial changes are made in the company’s capital structure, without resorting to the liquidation of the existing company, is called internal reconstruction. In finer terms, it is the inner rearrangement of the company’s financial structure, in which the company undergoing reconstruction continues to exist.
Internal Reconstruction focuses on relieving the company from debts and losses by negotiating with the creditors and reducing the outstanding amount towards them, so as to reach a favorable position. The methods given below are generally employed to effect the internal reconstruction process:
In this process, the assets are restated, to represent fair values, and liabilities are restated to show the settable amount, and thus the balance sheet shows a true picture. In this scheme, trading losses and fictitious assets are written off, against the claim sacrificed by the debenture holders, creditors, etc.
Definition of External Reconstruction
External Reconstruction is a process in which the company’s financial affairs are wound up, and a new company is formed to take over the assets and liabilities of the existing company, after the reorganization of the financial position. It requires the approval of shareholders, creditors and National Company Law Tribunal (NCLT).
In external reconstruction, the undertaking is being continued by the company but is in substance transferred to a company which is not an external one, but another entity that comprises of almost same shareholders, to be carried on by the transferee company. The accounting treatment of external reconstruction is same as the amalgamation in the nature of the purchase.
Key Differences Between Internal and External Reconstruction
The following points are relevant on account of the differences between internal and external reconstruction:
The primary objective of reconstruction of an entity is the reorganization of its capital which can be done by canceling unrepresentative value of the assets of the business, settling creditors claim by taking the discount and achieving economies in operations.