Chapter – 2Internal Reconstruction

Chapter outcomes:1.Meaning of internal reconstruction ; 2.Alternation of share capital;3.Scheme of compromise arrangement;4.Meaning of arrangement;5.Methods of arrangements;6.How to deal with preference dividends;7.Pro forma journal entries;8.Practical exercises;

Meaning of internal reconstruction

Internal reconstruction is the process in which the financial structure of a company is reorganized without dissolving the existing company and forming a new company. Internal reconstruction includes the following:1.Alternation of share capital;2.Reduction of share capital;3.Variation of shareholders rights;4.Scheme of compromise

Alteration of share capitalIn order to undertake internal reconstruction a company may attempt to alter the share capital in the following ways:1.Reduction in the number of shares: Under this method a company may pass a resolution in the annual general body meeting to reduce the number of shares. Example: 10,000 shares of RO 10, may be reduced to 5,000 shares of RO 10 each2.Reduction in the face value of the shares: Under this method, a company may reduce the face value of the shares. Example, shares of RO 10 each may be reduced to the shares of RO 5 each.

Scheme of compromise arrangement

Meaning of compromise:Compromise refers to an amicable settlement of differences by mutual concessions by parties to dispute. It may be noted that the compromise presupposes the existence of some dispute because there can be no compromise unless there is some dispute. The need for compromise arise for the settlement of some dispute between the company and its creditors/members.

Meaning of arrangement

The term ‘arrangement’ carries a wider sense than the term ‘compromise’. It implies re-arrangement of rights and the liabilities of a member or a class of members without the existence of any dispute. Arrangement includes re-organization of the share capital of a company by the consolidation of shares of different classes or by the division of the shares into shares of different classes or by both these methods.

An arrangement may involve any one or more of the following:

1. Debenture-holders foregoing their claims in whole or in part;

2. Debenture-holders exchanging their debentures for new debentures/shares;

3. Creditors foregoing their claims in whole or in part;4. Creditors agreeing to receive shares/debentures in

whole/in part payment of their claims;5. Preference shareholders foregoing their claims for

arrears of dividend;6. Preference shareholders agreeing to accept a reduced

rate of dividend in future;7. Fresh issue of shares to raise additional working capital;8. Writing off lost paid-up capital

How to deal with arrears of preference dividends:

1.If the claimants of preference dividends declared but not paid agree to sacrifice under a scheme of reconstruction, their sacrifice will be credited to the reconstruction account;

2.If the claimants of preference dividends agree to sacrifice under a scheme of reconstruction, no accounting entry is required to be passed since the company had not so far admitted any liability in respect of them

Pro forma Journal entries in the books of the company under reconstruction

The following journal entries are passed in the books of the company:1. When the number of shares is reduced:Share capital Account Dr. XXXXReconstruction Account Cr. XXXX(Being the reduction in the share capital)2. When the face value of shares is reduced :Share capital Account (RO 10 Dr. XXXXShare capital Account (RO 7) Cr. XXXXReconstruction Account Cr. XXXX(Being the face value of shares reduced)3.When the number of debentures is reduced:Debentures Account Dr. XXXXReconstruction Account Cr. XXXX(Being the reduction in debentures)

4. When the face value of debentures reduced:Debentures (RO10) A/C Dr. XXXXDebentures (RO 7) A/C Cr. XXXXReconstruction Account Cr. XXXX(Being the face value of debentures reduced)5. When the creditors forego their claims:Creditors account Dr. XXXXReconstruction A/C Cr. XXXX (Being the creditors reduced)6. When the accumulated losses are written off:Reconstruction account Dr. XXXXProfit and loss Account Cr. XXXXPreliminary expenses account Cr. XXXX Discount on issue of shares AC Cr. XXXXGoodwill account Cr. XXXXPatents account Cr. XXXXOther overvalued assets AC Cr. XXXX(Being the accumulated losses written off)7. For the expenses of reconstruction:Reconstruction Account Dr. XXXXBank Account Cr. XXXX