1

Internal
Reconstruction
IPCC Paper 1 : Accounting Chapter V
CA. S.S. Prathap, FCA

Learning Objectives
To understand the concept of Internal reconstruction
Learn to pass Reconstruction / Capital Reduction Journal

Entries.
Learn to do full fledged 16 marks exam sums .

Internal Reconstruction An Intro.

Internal Reconstruction - a kind of financial Re-engineering

When the company is having substantial accumulated losses it

becomes a sinking ship. Banks, Financial Institutions Sundry
Creditors will no more be willing to extend credit and there is
no way for the company to pull itself back to good health;
except through scarifies by the various stake holders
Preference and Equity Share Holders
Debenture Holders
Directors ......

Internal Reconstruction An Intro.

The sacrifices made by the stake holders are
Profits to the company and have to be credited to
a special a/c called
Reconstruction a/c ( old name is Capital Reduction a/c )

It is a nominal a/c and all gains of Internal

Reconstruction will be credited to it and all
expenses and losses will be debited to it .
If there is any credit balance in Reconstruction a/c
it has to be transferred to Capital Reserve a/c .

Steps
1
2
3

Carefully pass Journal Entries involving

reduction of capital , settlement of Liabilities and
revaluation of assets.

Note the changes in the Balance Sheet which

have to come in after reconstruction .

The Balance Sheet after reconstruction should

always have the heading (And Reduced) as per
Section 100 of Companies Act.

Methods of Internal Reconstruction

Alteration of Share Capital as per Section 94,95 and 97 of
the Companies Act.
Variation of Shareholders rights as per section 106 of the
Companies Act,1956.
Reduction of Share Capital as per Section 100 to 105 of
the Companies Act,1956
Surrender of Shares

Illustration 1
Vishnu Ltd has 20,000 Equity Shares of Rs.10/- each
=
Rs.2,00,000
The Equity Shares are to be reduced to Rs.4/- each
=
Rs.80,000
JOURNAL ENTRY :
Equity Share capital
Dr.
(Rs.10 Face Value)
To Equity share capital a/c
(Rs.4 each)
To Reconstruction a/c

2,00,000
80,000
1,20,000

Illustration 2
Adwait Ltd has 5000 Equity share of Rs.100/- each fully
paid up. They are to be divided into shares of Rs. 10/each.
JOURNAL ENTRY :
Equity Share capital a/c Dr.
(5,000 * 100)
To Equity Share capital a/c
(50,000 * 10)
(Being stock split)

5,00,000
5,00,000

Illustration 2 - Continued
50 % of new share were surrender .
JOURNAL ENTRY :
Share Capital a/c
Dr.
(25,000 * 10)
To Reconstruction a/c

2,50,000
2,50,000

10

Illustration No. 3
JSN Sum

11

JSN Ltd
The following is the Balance Sheet of JSN Ltd as on 31.03.2012.
12,000,10% Preference
share of Rs.100 each

12,00,000

Goodwill

90,000

24,000 , Equity shares of

Rs.100 each

24,00,000

Land and building

12,00,000

10% Debentures

6,00,000

Plant & Machinery

18,00,000

Bank Overdraft

6,00,000

Stock

2,60,000

Sundry Creditors

3,00,000

Debtors

2,80,000

Cash

30,000

Profit & Loss

14,00,000

Preliminary expenses

40,000

51,00,000

51,00,000

12

JSN Ltd (Contd...)

The equity Shares are to be reduced to shares of Rs.40

each fully paid and the preference shares to be reduced

to fully paid shares of Rs.75 each.
The debenture holders took over stock and debtors in full
satisfaction of their claims.
The land and Building to be appreciated by 30% and
Plant and Machinery to be depreciated by 30%.
The fictitious and intangible assets are to be eliminated.
Expenses of Reconstruction amounted to Rs.5,000
Give Journal Entries incorporating the above scheme of
Reconstruction and prepare the reconstruction Balance
Sheet .

13

JSN Ltd

Accounts to be opened :
1 . Reconstruction a/c
2 . Cash a/c

14

Steps

Record the sacrifice of Equity Share holders and

Preference Share holders . Credit Reconstruction a/c with
the gain.

Settlement of 10 % Debentures.

15

Step - 2
Revaluation of Land , Building , Plant and Machinery.
Debit Reconstruction a/c with accumulated losses (P & L
balance) , Goodwill a/c & Preliminary expenses .
Any remaining credit balance in Reconstruction a/c
transferred to Capital Reserve.

16

The Equity Shares are to be reduced

to shares of Rs.40 each fully paid
Equity share capital a/c(100)
To Equity Share capital a/c(75)
To Capital Reduction a/c

Dr. 24,00,000
9,60,000
14,40,000

(Being 24,000 equity shares of Rs.100 each reduced to Rs.40 each)

Reconstruction a/c
By Equity share holder

14,40,000

17

Preference shares to be reduced to

fully paid shares of Rs.75 each.
10% Pref. Share capital a/c(Rs.100)
Dr. 12,00,000
To 10% Pref.Share capital a/c(Rs.75)
9,00,000
To Capital Reduction a/c
3,00,000
(Being 12,000 Preference share of Rs.100 each reduced to Rs.75
each)

Reconstruction a/c
By Equity share holder

14,40,000

By 10% Pref.Share holders

3,00,000

18

The debenture holders took over stock and

debtors in full satisfaction of their claims.
10 % Debentures a/c
To Stock a/c
To Debtors a/c
To Capital Reduction a/c

Dr. 6,00,000
2,60,000
2,80,000
60,000

( Being debenture holders given stock and debtors in full settlement of

their claims )

Reconstruction a/c
By Equity share holder

14,40,000

By 10% Pref.Share holders

3,00,000

By 10% Debentures

60,000

19

Land and Building to be appreciated by 30%

Land and Building a/c
To Capital Reduction a/c

Dr. 3,60,000
3,60,000

( Being Land and Building appreciated by 30 % )

Reconstruction a/c
By Equity share holder

14,40,000

By 10% Pref.Share holders

3,00,000

By 10% Debentures

60,000

By Land & Buildings

3,60,000

20

Plant and Machinery to be

depreciated by 30%.
Capital Reduction A/c
Dr.
To Plant and Machinery A/c
(Being Plant and Machinery
depreciated by 30%)

5,40,000
5,40,000

Reconstruction A/c
To Plant and
Machinery

5,40,000

By Equity share holder

14,40,000

By 10% Pref.Share holders

3,00,000

By 10% Debentures

60,000

By Land & Buildings

3,60,000

21

Expenses of Reconstruction
amounted to Rs.5,000
Reconstruction a/c
To Cash a/c

Dr.

5,000
5,000

(Being expenses of reconstruction paid)

Cash A/c
To balance B/d

30,000

By Reconstruction

5,000

Reconstruction A/c
To Plant and
Machinery

5,40,000

By Equity share holder

14,40,000

To cash

5,000

By 10% Pref.Share holders

3,00,000

By 10% Debentures

60,000

By Land & Buildings

3,60,000

22

Cash a/c
To balance B/d 30,000 By Reconstruction
By c/s balance
30,000

5,000
25,000
30,000

23

The fictitious and intangible assets are

to be eliminated.
Capital Reduction a/c
Dr.
To Goodwill a/c
To Profit & Loss a/c
To Preliminary expenses a/c
To Capital Reserve a/c(bal. fig)

16,15,000
90,000
14,00,000
40,000
85,000

(Being various losses written off , assets written down and balances in
capital Reduction a/c transferred to Capital Reserve a/c)

24

Reconstruction a/c
To cash

5,000

By Equity share holder

14,40,000

To Plant & Mach

5,40,000

By 10% Pref.Share holders

3,00,000

To goodwill

90,000

By 10% Debentures

60,000

To Profit & Loss

14,00,000 By Land & Buildings

To Preliminary

40,000

To Capital Reserve

85,000
21,60,000

3,60,000

21,60,000

25

Reconstruction A/c
To cash

5,000

By Equity share holder

14,40,000

To Plant & Mach

5,40,000

By 10% Pref.Share holders

3,00,000

To Goodwill

90,000

By 10% Debentures

60,000

To Profit & Loss

14,00,000 By Land & Buildings

To Preliminary

40,000

To Capital Reserve

85,000
21,60,000

3,60,000

21,60,000

26

Notes to Accounts - 1
1.

Share Capital :
Equity share capital
24,000 equity shares of Rs.40
Preference share capital
12,000, 10% Preference
shares of Rs.75 each
TOTAL

9,60,000

9,00,000
18,60,000

27

Notes to Accounts - 2
2. Reserves and Surplus :
Capital Reserve

Rs.85,000

3. Tangible Assets :
Land and Building
Rs.15,60,000
Plant and Machinery Rs.12,60,000
TOTAL

Rs.28,20,000

28

Balance Sheet (And reduced)of JSN

Ltd as on 31.03.2012
I.

Note No.

Equity and Liabilities

(1) Shareholders Funds
(a) Share capital
(b) Reserves and Surplus

1
2

(2)Current Liabilities
Short term borrowings
Trade Payables

18,60,000
85,000

6,00,000
3,00,000
TOTAL

28,45,000

29

Balance Sheet (And reduced)of JSN

Ltd as on 31.03.2012
Note No.

II. Assets
(1) Non-Current assets
(a) Fixed Assets
Tangible Assets

(2) Current Assets

Cash and cash equivalents
(30,000 5,000)
TOTAL

28,20,000

25,000
28,45,000

30

Illustration No.4
Rocky Sum
May 2002 (20 marks)

31

Rocky Sum
The following is the Balance Sheet of Rocky Ltd. As at March
31,2002 :
Rs. In lacs
Liabilities :
Fully paid equity shares of Rs.10 each
500
Capital Reserve
6
12% Debentures
400
Debenture Interest Outstanding
48
Trade Creditors
165
Directors Remuneration Outstanding
10
Other Outstanding Expenses
11
Provisions
33
1,173

32

Rocky Sum (contd...)

Assets
Goodwill
Land and Building
Plant and Machinery
Furniture and Fixture
Stock
Debtors
Cash at bank
Discount on issue of Debentures
Profits and Loss Account

Rs. In lacs
15
184
286
41
142
80
27
8
390
1,173

33

Rocky Sum (Contd....)

The following scheme of Internal Reconstruction was
framed & approved by the Court & all the concerned
parties:
(i) All the equity shares be converted into the same
number of fully paid equity shares of Rs.2.50 each.
(ii) Directors agree to forego their outstanding
remuneration.
(iii) The debentureholders also agree to forego outstanding
interest in return of their 12% debentures being converted
into 13% debentures.
(iv) The existing shareholders agree to subscribe for cash,
fully paid equity shares of Rs.2.50 each for Rs.125 lacs.

34

Rocky Sum (Contd....)

(v) Trade creditors are given the option of either to accept fullypaid equity shares of Rs.2.50 each for the amount due to them
or to accept 80% of the amount due in cash. Creditors for
Rs.65 lacs accept equity shares whereas those for Rs.100 lacs
accept Rs.80 lacs in cash in full settlement.
(iv) The Assets are revalued as under:
Rs. in lacs
Land and building
230
Plant and Machinery
220
Stock
120
Debtors
76
Pass journal entries for all the above mentioned transactions
and draft the companys Balance Sheet immediately after the
reconstruction.

35

Rocky

Accounts to be opened :
1 . Reconstruction a/c
2 . Bank a/c

36

Steps
1
2
3

Open Reconstruction a/c and to its credit record the sacrifices of

Equity Share holders , Directors , 12 % Debenture holders and
trade creditors .

The Revaluation of assets should be passed through Reconstruction

a/c

The balance left in Reconstruction a/c should be used to write off

Goodwill
Discount on issue of Debentures and
Accumulated Losses (P&L a/c)

37

Journal Entries

38

All the equity shares be converted into the same

number of fully paid equity shares of Rs.2.50
each.
Rs. In lacs
Equity Share Capital
(Rs.10 each) a/c
Dr.
500
To Equity Share Capital
(Rs.2.50 each) a/c
125
To Reconstruction a/c
375
(Conversion of all the equity shares into the same number
of fully paid equity shares of Rs.2.50 each as per scheme
of reconstruction)
Reconstruction A/c
By Equity Share Capital A/c

375

39

Directors agree to forego their

outstanding remuneration. Rs. In lacs
Directors Remuneration
Out Standing a/c Dr.
10
To Reconstruction a/c
10
(Out Standing remuneration foregone by the directions as
per scheme of reconstruction)
Reconstruction A/c
By Equity Share Capital A/c

375

By Directors Remuneration O/s

10

40

The debentureholders also agree to forego outstanding

interest in return of their 12% debentures being converted
into 13% debentures.
Rs. In lacs
12% Debentures a/c
Dr.
400
Debenture Interest
Out Standing a/c
Dr.
48
To 13% Debentures a/c
400
To Reconstruction a/c
48
(Conversion of 12% debentures into 13% debentures ,
Debenture holders forgoing outstanding debenture
interest)
Reconstruction By
A/c
Equity Share Capital A/c
By Directors Remuneration O/s

375
10

By Debenture Interest Outstanding 48

41

The existing shareholders agree to subscribe for

cash, fully paid equity shares of Rs.2.50 each for
Rs. In lacs
Rs.125 lacs.
Bank
Dr.
125
To Equity Share
Application a/c
(Application money received for equity shares)

125

42

Trade creditors are given the option of either to

accept fully-paid equity shares of Rs.2.50 each
Rs. In lacs
Equity Share Application a/c Dr.
125
To Equity Share capital
(Rs.2.50 each) a/c
125
(Application money transferred to share capital)

43

Trade creditors are given the option of either to

accept fully-paid equity shares of Rs.2.50 each
Rs. In lacs

Trade Creditors
Dr.
165
To Equity Share Capital a/c
65
To Bank a/c
80
To Reconstruction a/c
20
(Trade creditors for Rs.65 lakhs accepting shares for full
amount and those for Rs.100 lakhs accepting cash equal
to 80% of claim in full settlement)
Reconstruction A/c
By Equity Share Capital A/c

375

By Directors Remuneration O/s

10

By Debenture Interest Outstanding 48

By Trade Creditors

20

44

Use of old Capital Reserve

Rs. In lacs
Capital Reserve
Dr.
6
To Reconstruction a/c
6
(Capital Reserve being used for purpose of reconstruction)
Reconstruction A/c
By Equity Share Capital A/c

375

By Directors Remuneration O/s

10

By Debenture Interest Outstanding 48

By Trade Creditors

20

By Capital Reserve

45

Revaluation of Land & Building

Rs. In lacs

Land and Building

Dr.
46
To Reconstruction a/c
46
(Appreciation made in the value of land and building as per
scheme of reconstruction)
Reconstruction A/c
By Equity Share Capital A/c

375

By Directors Remuneration O/s

10

By Debenture Interest Outstanding 48

By Trade Creditors

20

By Capital Reserve

By Land & Building

46

46

Writing off accumulated losses &

fictitious assets etc.
Rs. In lacs
Reconstruction a/c
Dr. 505
To Goodwill a/c
15
To Plant and Machinery a/c
66
To Stocks a/c
22
To Debtors a/c
4
To Discount on issue of
Debentures a/c
8
To Profit and Loss Account
390
(Writing off losses and reduction in the value of asset)

47

Reconstruction a/c
To Goodwill

15

By Equity Share Capital A/c

375

To Plant & Machinery

66

By Directors Remuneration O/s

10

To Stock

22

By Debenture Interest Outstanding 48

To Debtors

By Trade Creditors

20

To Discount on issue of debentures

By Capital Reserve

To Profit & Loss

390

By Land & Building

46

505

505

48

Note 1

Rs. In lacs

Equity Share capital as on 31.03.2002 (after

reconstruction)
Equity Share Capital(Rs.2.50 each)
(+) Fresh issue
(+) Equity shares issued to creditors

125
125
65
315

49

Note 2

Rs. In lacs

Cash at Bank as on 31.03.2002(after reconstruction)

Cash at Bank(before reconstruction)
27
(+)Proceeds from issue of equity shares
125
152
80

(-)Payment made to creditors

TOTAL

72

50

Balance Sheet (And reduced)of Rocky

Ltd as at 31.03.2012
Rs. Lakhs
I.

Equity and Liabilities

(1) Shareholders Funds
Share capital

Note No.
1

315

(2) Non - Current Liabilities

Long term borrowings

400

(3)Current Liabilities
Outstanding expenses
Provisions

11
33
TOTAL

759

51

Balance Sheet
II. Assets
(1) Non-Current assets
(a) Fixed Assets
Tangible Assets

Note No. Rs. In Lakhs

491

(2) Current Assets

Stock
Trade Receivables
Cash and cash equivalents
TOTAL

120
76
72
759

52

Ice sum
(16 Marks, Nov 2011)

53

Ice Sum
The Balance Sheet of M/s Ice Ltd as on 31-03-2011 is given below:
Liabilities
Amount
Assets
1,00,000 equity shares
Freehold Property
Rs 10 each fully paidup 10,00,000
4,000,8% Pref. shares
Rs 100 each fully paid
4,00,000
Plant and machinery
6% Debenture Secured
by freehold property
4,00,000
Trade Investments (atCost)
Arrear Interest
24,000 4,24,000
Sundry Debtors
Sundry Creditors
1,01,000
Stock-In-Trade
Directors Loan
3,00,000
Deferred Advertisement
Expenses
Profit & Loss Account
Total
22,25,000
Total

Amount
5,50,000

2,00,000

2,00,000
4,50,000
4,50,000
50,000
4,75,000
22,25,000

54

Ice Sum (Contd....)

The Board of Directors of the company decided upon the
following scheme of reconstruction with the consent of
respective stakeholders:
Preference shares are to be written down to Rs 80 each and
equity shares to Rs 2 each.
Preference dividend in arrear for 3 years to be waived by 2/3rd
and for balance 1/3rd, equity shares of Rs 2 each to be allotted.
Debenture holder agreed to take one freehold property at its
book value of Rs 3,00,000 in part payment of the holdings.
Balance debentures to remain as liability of the company.
Arrear debenture interest to be paid in cash.
Remaining free hold property to be valued Rs 4,00,000

55

Ice Sum(Contd....)
Investment sold out for Rs 2,50,000
75% of Directors loan to be waived and for the balance,

equity share of Rs 2 each to be allotted.

40% of sundry debtors, 80% of stock and 100% of
deferred advertisement expenses to be written off.
Companys contractual commitments amounting to Rs
6,00,000 have been settled by paying 5% penalty of
contract value.
Show the journal entries for giving effect to the internal
reconstruction and drawn the Balance Sheet of the
company after effecting the scheme.

56

Approach to the sum

The sacrifices of Preference
share holders , Directors have to be recorded and
credited to Reconstruction a/c .
For all other movements Journal
Entries to be passed .
The credit balance in
Reconstruction a/c to be used to write off Profit and loss
debit balance.

57

Journal Entries

58

Preference shares are to be written down to Rs 80

each and equity shares to Rs 2 each.
8% Preference share
capital a/c(Rs.100 each)
Dr.
To 8% Preference share
capital a/c (Rs.80 each)
To Capital Reduction a/c
(Being the preference shares of Rs.100
each reduced to Rs.80 each as per the
approved scheme)

Equity Share
capital a/c (Rs.10 each) Dr.
To Equity Share
capital a/c (Rs.2 each)
To Capital Reduction a/c
(Being the Equity shares of Rs.10 each
reduced to Rs.2 each)

4,00,000
3,20,000
80,000

10,00,000
2,00,000
8,00,000

59

Preference dividend in arrear for 3 years to be

waived by 2/3rd and for balance 1/3rd, equity
shares of Rs 2 each to be allotted.
Capital reduction a/c
Dr.
To Equity share capital a/c

32,000
32,000

(Being arrears of preference share

dividend of one year to be satisfied
by issue of 16,000equity shares of Rs.2 each)

60

Debenture holder agreed to take one freehold

property at its book value of Rs 3,00,000 in part
payment of the holdings.
6% Debentures a/c
Dr.
To Freehold property a/c
(Being claim settled in part by
transfer of freehold property)

3,00,000
3,00,000

61

Arrear debenture interest to be paid in

cash.

Accrued debenture interest a/c

To Bank a/c
(Being accrued debenture interest paid)

Dr.

24,000
24,000

62

Remaining free hold property to be valued

Rs 4,00,000.
The opening Freehold property was Rs.5,50,000 . Of this
3,00,000 was taken over by Debenture holders.
The balance remaining property of Rs.2,50,000 has been
valued upwards at Rs.4,00,000.
Freehold property a/c
Dr.
1,50,000
To Capital reduction a/c
1,50,000
(Being appreciation in the value of freehold property)

63

Investment sold out for Rs 2,50,000.

Bank a/c
Dr. 2,50,000
To Trade investment a/c
To Capital Reduction a/c
(Being trade investment sold on profit)

2,00,000
50,000

64

75% of Directors loan to be waived and for the

balance, equity share of Rs 2 each to be allotted.

Directors Loan a/c

Dr. 3,00,000
To Equity share capital a/c
To Capital Reduction a/c
(Being Directors loan waived by
75% and balance discharged by
issue of 37,500 equity shares of
Rs. 2 each)

75,000
2,25,000

65

40% of sundry debtors, 80% of stock and 100% of

deferred advertisement expenses to be written
off.
Reconstruction a/c
To Sundry Debtors a/c
To Stock in hand a/c
To Deferred
advertisement expenses a/c

Dr. 4,70,000
1,80,000
2,40,000
50,000

66

Companys contractual commitments amounting to Rs

6,00,000 have been settled by paying 5% penalty of
contract value.
Reconstruction a/c
To Bank a/c
(Being penalty paid)

Dr. 30,000
30,000

67

Write off of accumulated losses

Reconstruction a/c
Dr.
7,73,000
To P & L a/c
4,75,000
To Capital Reserve a/c
2,98,000
(Being Profit and loss account debit balance written off and
balance transferred to capital reserve account )

68

Notes to accounts
1 . Share Capital :
1,53,500 Equity shares of Rs.2 each
4,000 , 8% Preference shares of Rs.80

3,07,000
3,20,000

TOTAL

6,27,000

2 . Reserves and Surplus :

Capital Reserve

2,98,000

69

Notes to accounts
3 . Long Term Borrowings :
6% Debentures

1,00,000

4 . Tangible Assets :
Freehold Property
Plant & Machinery
TOTAL
5 . Cash and Cash Equivalents :
`
Cash at Bank
(2,50,000-24,000-30,000)

4,00,000
2,00,000
6,00,000

1,96,000

70

Balance Sheet (As reduced)of Ice Ltd

I.

Equity and Liabilities

Note No.
(1) Shareholders Funds
(a) Share capital
1
(b) Reserves and Surplus
2

6,27,000
2,98,000

(2)Non- Current Liabilities

Long term borrowings

1,00,000

(3)Current Liabilities
Trade Payables

1,01,000
TOTAL

Rs. Lacks

11,26,000

71

Balance Sheet (As reduced)of Ice Ltd

II. Assets
(1) Non-Current assets
(a) Fixed Assets
Tangible Assets

Note No.

(2) Current Assets

(a) Inventories
(b) Trade Receivables
(c)Cash and cash equivalents
TOTAL

Rs. In Lakhs

6,00,000

60,000
2,70,000
1,96,000
11,26,000

72

Lesson Summary
So we learnt how to handle an Internal Reconstruction

sum .
The first step is to pass Journal Entries , Credting
Reconstruction A/c with all gains and Debiting the various
stake holders who are sacrificing
The Assets and Liabilities should simultaneously be taken
at their revised valuation
The remaining credit balance in Reconstruction A/c
should be transferred to Capital Reserve A/c.

73

Thank You