Chapter 11. Internal Reconstruction – Corporate Accounting

11

Internal Reconstruction

LEARNING OBJECTIVES

After studying this chapter you should be able to understand:

  1. The nature of internal reconstruction.

  2. The need for internal reconstruction.

  3. Sections 94 to 97 of the Companies Act relating to alteration of share capital.

  4. Sections 100 to 105 of the Companies Act with respect to reduction of share capital.

  5. Section 106 relating to variation of shareholders’ rights.

  6. Section 391 to 393 and Section 394A of the Companies Act pertaining to compromise/ arrangement.

  7. Significance of surrender of shares.

  8. The accounting entries for the methods of reconstruction.

  9. The construction of balance sheet after internal reconstruction.

  10. The preparation of reconstruction account.

  11. The important key terms associated with “internal reconstruction”.

Nowadays, companies have been constantly engaged in restructuring their financial structure to effect economy and enhance profitability. Of the many devices adopted by them, reconstruction is one such device to achieve the desired goal. During such reorganization process, if the task is accomplished without liquidating the company, it is referred to as “internal reconstruction”. It is primarily concerned with creating a robust financial position of a company. It brings forth a true, fair and real value of assets through which the true financial position of a company can be projected. In this chapter, the need and various methods employed for internal reconstruction are discussed in detail.

11.1 NEED FOR INTERNAL RECONSTRUCTION
  1. True and fair view of financial position: A company may be incurring losses for several years. In such cases, the financial position cannot reflect a true and fair view. Hence, it necessitates reorganization in order to disclose the actual financial position of an enterprise.
  2. Value of assets: On a careful analysis, it may reveal that such continuous loss-making companies consist either overvalued tangible assets or insignificant intangible assets. To get rid of these unreal values of assets, they should be updated to their real values by way of reconstruction.
  3. External liabilities: External liabilities include loan, payment of preference dividends, debentures, etc. These cannot be discharged on stipulated and specified time. These have to be reduced to a great extent to maximize profitability through reorganization.
  4. Share capital: The capital figure (i.e., the value of net assets) is not reliable as it tends to show a higher figure than the real figure due to various factors such as overvalued tangible assets, idle and valueless intangible assets and fictitious assets, and outstanding liabilities not discharged on maturity date. Because of this, the share capital of such loss-incurring companies will not reflect the real and fair value of the net assets of the company. To set right this sort of over capitalization, reconstruction is of vital importance.
  5. Remedial measure: If proper reorganization does not take place, it will lead to total disaster. To escape from such a scenario, reconstruction is necessary. To a certain extent, reconstruction is remedy to avoid unforeseen disaster to companies. Proper diagnosis and reorganization may alleviate such evils.
11.2 METHODS OF INTERNAL RECONSTRUCTION

The following are the methods employed for internal reconstruction:

  1. Alteration of share capital
  2. Reduction of share capital
  3. Compromise/arrangement as per Sections 391 to 394(A)
  4. Variation of shareholder’s rights
  5. Surrender of shares
  6. Cancellation of unissued shares

11.2.1 Alteration of Share Capital

Under this method, alteration of share capital involving increase, consolidation or sub-division of share capital is done according to Section 94, 95 and 97 of the Companies Act.

Alteration will not involve reduction of share capital. Any public limited company can alter the capital clause of its Memorandum of Association (i) if it is authorized by its Articles of Association to carry out alteration and (ii) by an ordinary resolution passed in its general meeting. Alteration of share capital can be carried out in the following ways:

11.2.1.1 Increase of Share Capital

A company may increase its share capital by issuing new shares:

 

Accounting Entries:

(Full Amount Payable on Application)

(i) Bank A/c

Dr.   …

 

To Share Application & Allotment A/c

 

(ii) Share Application & Allotment A/c

Dr.   …

 

To Share Capital A/c

 

11.2.1.2 Consolidation of Shares

In this type, the existing shares of lower denomination are converted into shares of higher denomination.

 

Accounting Entry:

 

 

Share (Equity or.… % Preference) Capital A/c

Dr.   …

 

   To Share (Equity or … … % Preference) Capital A/c

 

Example: A company having 1,00,000 12% preference shares of 10 each decided to consolidate the shares into shares of 100 each. Pass the needed journal entry.

Journal Entry

One should note here that the paid up share capital remains the same, i.e. 10,00,000 only, but total number of shares is reduced to 10,000 from 1,00,000 shares. The face value of shares is increased from 10 to 100.

Care should be taken in case of partly paid shares to keep the proportion between the paid-up and unpaid amount at the same level after consolidation.

Example: A company with a subscribed capital of 1,00,000 divided into 10,000 equity shares of 10 each on which 6 per share are paid up. The company decides to consolidate equity shares of 10 each into 100 each. Pass the journal entry.

Accounting Entry:

Journal

Note: After consolidation, there is no change in the paid-up share capital i.e. 60,000. But the number of shares and its face value have changed. Paid-up value is also increased proportionately from 6 to 60.

11.2.1.3 Conversion of Fully Paid Shares into Stock

In this case, all or any of its fully paid shares may be converted into one unit of stock.

Example: A company decided to convert its 10,000 equity shares of 10 each into 1,00,000 equity stock.

Pass the entry.

Journal Entry

11.2.1.4 Reconversion of Stock into Shares (Fully Paid up)

Stock (of one unit) may be converted into shares.

Example: 1,00,000 equity stock is converted into 1,000 equity shares of 100 each fully paid. Pass the entry.

 

Journal

11.2.1.5 Sub-division of Shares

A company may sub-divide its shares of higher denomination into shares of smaller denomination.

Example: A company has 5,000 equity shares of 100 each. It decides to sub-divide these shares into 10 each. Pass the required journal entry:

 

Journal Entry

Paid-up capital remains unaffected whereas the face value of shares is reduced and the number of shares is increased.

11.2.1.6 Cancellation of Unissued Shares

Shares which have not been issued (till date) by the company are cancelled. These unissued shares are neither taken by any person nor agreed to be taken by any one.

On cancellation of unissued shares, the amount of share capital will be reduced to that extent that it only results in diminution of authorized share capital and it does not mean reduction share capital.

Example: A limited company has an authorized capital of 10,00,000 and issued capital of 7,50,000. It decides to alter its authorized capital (for unissued shares cancelled) to 7,50,000 and issued capital to 7,50,000.

There is no accounting entry for any cancellation of unissued shares. The reduced authorized capital is to be shown in the balance sheet of next accounting year only.

11.2.2 Capital Reduction

A Company can reduce its share capital as per the provisions of the Companies Act. Sections 100 to 105 of the Act laid down certain provisions with respect to reduction of capital. The following is the procedure to be followed for effecting reduction of share capital:

  1. There should be a specific clause relating to reduction of share capital in the Articles of Association.
  2. In case the articles of association are silent on this matter, a special resolution has to be passed to effect reduction of share capital in the general meeting.
  3. Court order has to be obtained for any reduction in share capital. (It should be observed here that for alteration of share capital, court permission is not necessary.)
  4. A copy of special resolution in reduction of share capital and the order of confirming such reduction must be filed with the Registrar of Companies.

11.2.2.1 Accounting Treatment for Capital Reduction

Reduction of share capital may take place in more than one form.

Form 1: Reducing the liability or extinguishing entirely the liability of the shareholders with respect to uncalled or unpaid amount.

When the uncalled amount of the share capital is reduced or entirely extinguished, the shareholders will be exempted from paying that amount to that extent in future. The shareholders are benefitted by such form of reduction of share capital.

Example: A company whose capital consists of 1,000 shares of 100 each, 75 called and paid, decides to reduce the shares into 1,000 shares of 75 each fully paid. Pass journal entry.

Net result: (i) Reduction in nominal value; (ii) No reduction in paid-up value.

Form 2—Refunding surplus capital: At times, some companies may be confronted with the problem of excess capital. Hence the company is forced to refund the excess capital to its members. The members will raise vehement objections because it will affect the security enjoyed by the creditors. Such a scheme of capital requiring the refund of surplus capital needs the approval of the Court.

 

(i) Share Capital A/c

Dr.   …

      (With the Amount to

To Sundry Shareholder’s A/c

 

…      Be Refunded)

(ii) Sundry Shareholders’ A/c

Dr.   …

      (With the Amount

To Bank A/c

 

…    Actually Refunded)

Example: A company whose paid-up capital includes 5,000 equity shares of 100 each fully paid decides to return 25 per share to the members, this reducing each share to 75 each, fully paid. Pass entries.

Net result: The share capital of the company will be reduced by the amount refunded. In this problem, the share capital is reduced from 5,00,000 to 3,75,000 because of the refund of 1,25,000 to the shareholders.

Form 3—Reducing the paid up capital (Writing off of lost capital not represented by assets): The share capital of the company which has been facing losses for a considerable period, usually continuously for a long period, may not be truly represented by the assets. The extent of loss will also get reflected in the form of goodwill, over-valuation of assets, etc. Hence, in the scheme of capital reduction, it is essential to write off or cancel that portion of capital which is already lost, not represented by assets accounting treatment.

A new account—reconstruction A/c or capital reduction A/c—has to be opened. The amount of reduction has to be credited to this account. This scheme of capital reduction may be carried out in the following two situations:

Situation 1—Reduction in the paid-up value and nominal value: In this case, the nominal value of the shares and the paid-up value is reduced.

Example: In a limited company, the shareholders agree to reduce the paid-up capital of 100 per share (10,000 shares) to fully paid shares of 60 per share. Pass entries.

 

Journal Entry

Situation 2—Reduction in the paid-up value only: In this case, the nominal value of the shares remains the same. But the paid-up value is reduced.

Example: A company decides to reduce 30 per share on its 50,000 equity shares of 100 each fully paid. Pass the required journal entry.

 

Journal Entry

11.2.3 Compromise and Arrangement

The scheme of compromise and arrangement is a kind of agreement between a company, its members and outside creditors. They agree to give up their claims. This scheme involves sacrifices by shareholders and creditors. This is dealt with in the Sections 390 to 396(A) of the Companies Act. There are many ways in such a scheme of compromise and arrangement as follows:

  1. When equity shareholders give up their claims to the reserves and accumulated profits (Sacrifice their amount due to company’s financial crisis):
  2. When there is appreciation in the value of assets on revaluation:

     

    Entry:

     

     

    Fixed Assets A/c

    Dr.   …

     

    To Reconstruction A/c

     

     

  3. When there is profit on sale of fixed assets:

    During internal reconstruction scheme, some fixed assets may be sold to meet the external liabilities. Profit arises on sale of fixed assets is to be credited to capital reduction A/c or reconstruction A/c.

     

    Entry:

     

     

    Fixed Assets A/c

    Dr.   …

     

    To Reconstruction A/c

     

     

  4. Outside liabilities settled at a lesser amount:

    Creditors, debenture holders and others (external liabilities) may accept less amount instead of their original claim (waiting for a long period for final settlement). This difference (sacrifice) between the original claim and agreed amount is to be credited to reconstruction A/c.

     

    Entry:

     

     

    Outside Liabilities A/c

    Dr.   …

     

    Provisions A/c

    Dr.   …

     

    To Reconstruction A/c

     

     

  5. Payment of outside liabilities:

    All the outside liabilities will have to be paid in any one of the following forms to settle their claims: cash, shares, new debentures, assets of the company.

     

    Entry:

     

     

    Outside Liabilities A/c

    Dr.   …

     

    To Bank A/c

     

    … (In Cash)

    To Share Capital A/c

     

    … (In Cash)

    To New Debenture A/c

     

    … (In Cash)

    To Assets A/c

     

    … (In Cash)

     

  6. Preference dividend:

    Case I: Dividend declared (Shown in b/s) but sacrificed:

     

    Entry:

     

     

    Proposed Preference Dividend A/c

    Dr.   …

     

    To Reconstruction A/c

     

     

    Case II: Arrears of dividend (not shown in b/s) but paid now:

     

    Entry:

     

     

    Reconstruction A/c

    Dr.   …

     

    To Bank A/c

     

     

    Case III: Dividend neither declared nor paid:

    No Entry

11.2.4 Variation of Shareholders’ Right

Limited companies issue various classes of shares with different rights. Some of such rights attached to the shares are voting rights, rights as to dividend, repayment of capital. The companies may change rate of dividend (on preference shares), cumulative preference shares into non-cumulative preference shares. These changes can be carried out without change in the amount of share capital.

Accounting Treatment:

  1. Entry for Reduction in the Rate of Dividend:

     

    10% Cumulative Preference Share Capital A/c

    Dr.   …

     

    To 9% Cumulative Preference Share Capital A/c

     

    (10% Cumulative Pref. Shares Are Changed into 9% Cumulative Preference Shares)

    Net result: Rate of dividend is changed from 10% to 9%. But there is no change in the amount of share capital.

  2. Entry for Change from Cumulative to Non-cumulative Preference Share:

     

    10% Cumulative Preference Share Capital A/c

    Dr.   …

     

    To 10% Non-cumulative Pref. Share Capital A/c

     

    (10% Cumulative Pref. Share Is Changed into 10% Non-cumulative Pref. Shares)

Net result: Only the right to dividend is changed from cumulative to Non-cumulative. But there is no change in the rate of dividend and the amount of share capital.

11.2.5 Surrender of Shares

During internal reconstruction, the shareholders may be asked to surrender their shares. In order to reduce the liabilities of the company, such surrendered shares are allotted to debenture holders and creditors. The balance, if any, i.e. the unutilized surrendered shares, is then cancelled.

11.3 HANDLING OF RECONSTRUCTION ACCOUNT

The primary aim of reconstruction is to show the true value of assets, liabilities and share capital of the company. The reconstruction A/c is to be utilized in the following ways one by one:

  1. Fictitious assets and intangible assets to be written off:

    The first task of internal reconstruction is to write off the fictitious assets and intangible assets from the books of accounts of the sick companies. Miscellaneous expenditures and P&L A/c debit balance are some fictitious assets. Invaluable patents, copyrights, trade marks, goodwill are some examples of intangible assets.

    Account Treatment:

     

    Entry:

     

     

    Reconstruction A/c

    Dr.   …

     

    To Fictitious Assets (Individually)

     

    To Intangible Assets (Individually)

     

     

  2. Overvalued fixed assets and current assets to be lowered down:

    The next step in the task of internal reconstruction is to bring down the particular assets to their correct values. This is done with the help of the following entry:

     

    Entry:

     

     

    Reconstruction A/c

    Dr.   …

     

    To Fixed Assets A/c (Individually)

     

    To Current Assets A/c (Individually)

     

     

    Note: Only the amount of reduction is to be entered here.

  3. New liability & new provisions to be brought into books of account:

    Some liabilities would not have been recorded. Some items may have to be treated as new liabilities. A new provision will have to be created during the course of internal reconstruction. Some unrecorded liability and provisions must be recorded now:

     

    Entry:

     

     

    Reconstruction A/c

    Dr.   …

     

    To Liability A/c (Individually)

     

    To Provision A/c (Individually)

     

     

    In case, if unrecorded liability is paid in cash, entry will be:

     

    Reconstruction A/c

    Dr.   …

     

    To Bank A/c

     

     

  4. Reconstructions expenses:

    All the expenses that are incurred in this process of internal reconstruction should be entered as:

     

    Reconstruction A/c

    Dr.   …

     

    To Bank A/c

     

     

  5. Transfer of credit balance to capital reserve A/c:

    Finally, the reconstruction account thus prepared has to be balanced like any other ledger accounts. In case, if there is credit balance (more sacrifice than write offs), it should be transferred to capital reserve A/c.

     

    Entry:

     

     

    Reconstruction A/c

    Dr.   …

     

    To Capital Reserve A/c

     

     

    With this entry, the scheme of internal reconstruction comes to an end, from the accounting point of view.

11.3.1 Specimen of Reconstruction Account

The next stage is the preparation of balance sheet.

11.4 BALANCE SHEET AFTER RECONSTRUCTION

The factors that should be taken into account while preparing the balance sheet after the completion of internal reconstruction are as follows:

  1. The words “And Reduced” must be added to the name of the company. This should be continued for certain accounting period as ordered by the court.
    1. The revised appreciated values of the assets on the date of internal reconstruction must be shown in the balance sheet. The book values should be ignored.
    2. The amount of increase in the value of assets on account of revaluation should be shown in the balance sheet.
    3. The revised lower figures, i.e., original cost-depreciation should be shown instead of book values.
    1. For fixed assets, the amount written off should be shown separately for a period of 5 years.
    2. For current assets, and investments, the amount written off need not be shown. They should be shown only at their revised lower values.
    3. For provisions, such amount of provision should be shown as a deduction from the gross amount in the inner column and only the net amount in the outer column.
GRADED ILLUSTRATIONS PART I—FOR UNDERGRADUATE COURSE

Illustration 11.1

Model: Alteration of share capital

Raj Co. Ltd. has the following shares as a part of its share capital:

  1. 20,000 10% Preference shares of 100 each fully paid
  2. 1,00,000 Equity shares of 5 each fully paid
  3. 40,000 Equity shares of 10 each, 7.50 called and paid up

The Company has decided to alter the share capital as follows:

  1. To sub-divide the preference shares into shares of 10 each.
  2. To consolidate the equity shares of 5 each into shares of 10 each.
  3. To convert the partly paid-up equity shares into fully paid-up shares of 7.50 each, with necessary legal sanctions.

    Journalize the alterations.

Solution

Books of Raj Co. Ltd.
Journal Entries

Illustration 11.2

Model: Surplus in capital reduction

XYZ Co. Ltd. passed resolution and got Court permission for the reduction of its share capital by 2,50,000 for the purposes mentioned in the following:

  1. To write off the debit balances of P&L A/c of 1,05,000
  2. To reduce the value of plant & machinery by 45,000 and goodwill by 20,000
  3. To reduce the value of investments by 40,000

The reduction was made by converting 25,000 preference shares of 20 each fully paid to the same number of preference shares of 15 each fully paid and by converting 25,000 equity shares of 20 each on which 15 is paid up into 25,000 equity shares of 10 each fully paid up.

Pass journal entries to record the share capital reduction.

 

[B.Com Madras University Modified]

Solution

Books of XYZ Co. Ltd.
Journal Entries

Illustration 11.3

Model: Capital reduction A/c (Reconstruction or reorganization A/c)—Issue of new debentures

The following scheme of reconstruction has been legally approved for Bhagya Ltd:

  1. In lieu of their present holding of 1,20,000 shares of 10 each fully paid, the shareholders are to receive the following:
    1. Fully paid new equity shares equal to one-third of their holding
    2. 10% Preference shares fully paid to the extent of one-fifth of the above new equity shares
    3. 1,20,000, 10% secured debentures
  2. The debenture holders’ total claim of 1,50,000 to be reduced to 50,000. This will be satisfied by issue of 5,000 10% preference shares of 10 each fully paid.
  3. An issue of 1,00,000 5% first debentures was made and allotted, payment for the same having been received in cash.
  4. The goodwill which stood at 6,00,000 was written down to 1,00,000. Plant & machinery which stood at 2,00,000 was written down to 1,50,000.
  5. The freehold premises which stood at 3,50,000 was written down by 1,50,000.

    Given the journal entries in the books of Bhagya Ltd. for the above reconstruction scheme.

Solution

Books of Bhagya Ltd.
Journal Entries

Illustration 11.4

Model: Preparation of reconstruction A/c and treatment of surplus in it

Veer Ltd. passed the necessary resolution and received sanction of the Court for the reduction of its share capital by 10,00,000 for the purposes numerated in the following:

  1. To write off the debit balance of P&L A/c 4,20,000
  2. To reduce the value of plant & machinery by 1,80,000 and of goodwill by 80,000
  3. To reduce the value of investments to market value by writing off 1,60,000

The reduction was made by converting 1,00,000 preference shares of 20 each fully paid to the same number of preferences shares of 15 each fully paid and by converting 1,00,00 ordinary shares of 20 each 15 paid up into 1,00,000 ordinary shares of 10 each fully paid.

Give journal entries necessary with respect to reduction of share capital and show how would you deal with the balance of the reduction of share capital account?

Solution

Important note: Reconstruction A/c, capital reduction A/c and capital reorganization A/c all denote one and the same.

 

In the Books of Veer Ltd.
Journal Entries
Reconstruction Account

Illustration 11.5

Preparation and utilization of capital reorganization account

The paid-up capital of Duari Ltd; amounted to 2,50,000 consisting of 25,000 equity shares of 10 each. Due to losses incurred by the company continuously, the directors of the company prepared a scheme of reconstruction which was duly approved by the Court as per following terms:

  1. In lieu of their present holdings, the shareholders are to receive:
    1. Fully paid equity shares equal to two-fifth of their holdings
    2. 12% Preference shares fully paid up to the extent of the above new equity shares
    3. 250 15% second debentures of 100 each
  2. An issue of 2,500 12% first debentures of 100 each was made and allotted; payment for the same being received in cash for forthwith
  3. The assets were reduced as follows:
    1. Goodwill from 1,50,000 to 75,000
    2. Machinery from 50,000 to 37,500
    3. Leasehold premises from 75,000 to 62,500

    Pass journal entries to give effect to the above-mentioned scheme of reconstruction and prepare capital reorganization account.

Solution

Note: Capital reduction A/c; capital reorganization A/c and reconstruction A/c all mean one and same.

 

Journal Entries
Capital Reorganization A/c

Illustration 11.6

Model: Preparation of balance sheet

Following a series of losses, ABC Co. Ltd. resolved to reduce its capital to 1,00,000 fully paid 5 shares and to eliminate share premium account. The company’s balance sheet prior to implementation of the reconstruction scheme was as follows:

It was resolved to apply the sum available under the scheme:

  1. To write off the goodwill account
  2. To write off the debit balance of P&L A/c
  3. To reduce the book values of the assets by the following amounts:

     

    Land & Building

    84,000

    Plant & Machinery

    1,34,000

    Stock

    67,200

     

  4. To provide a bad debts reserve of 10% of the book value of debtors

    Show the journal entries to give effect to the scheme and prepare the revised balance sheet after its implementation.

Books of ABC Ltd.
Journal Entries
Balance Sheet of ABC Co. Ltd. as on….. (And Reduced)

Illustration 11.7

Model: Issue of shares for arrears of preference dividend

The summarized balance sheet of Somnath Ltd. as at December 2010 was as follows:

 

Balance Sheet of ABC Co. Ltd. as on….. (And Reduced)

A scheme of capital reduction was approved on the following terms:

  1. The preference shareholders agree that their shares be reduced to fully paid shares of 50 each and to accept equity shares of 54 each fully paid in lieu of the dividend arrears
  2. The equity shareholders agree that their shares be reduced to a fully paid value of 5 each
  3. The authorized capital of the company is to remain at 15,00,000 divided into 2,00,000 equity shares of 5 each and 10,000 6% cumulative preference shares of 50 each
  4. All the intangible and fictitious assets are to be eliminated and bad debts of 25,000 and obsolete stocks of 40,000 are to be written off

Give the necessary journal entries to record the capital reduction and draw up the revised balance sheet.

 

[B.Com Calcutta University Modified]

Solution

Note: Preliminary expenses and P&L A/c are fictitious assets.

   Goodwill and patents & trademarks are intangible assets.

 

Books of Somnath Ltd.
Journal Entries

Fictitious assets and intangible assets will not be shown in the revised balance sheet, as they are to be eliminated off according to the direction given in the problem (As per terms of internal reconstruction).

 

Balance Sheet of Somnath Ltd. (And Reduced)
as on 31 December 2010

Illustration 11.8

Model: Assets written off in proportion of book values

The balance sheet of Parul Ltd. on 31 March 2011 was as follows:

The capital reduction scheme, approved by the Court is as follows:

  1. Holders of 8% debentures of 100 are to be given 10% debentures of 50 and preference shares of 10 each of equal amount for the remaining amount of 50
  2. The value of all preference shares including the preference shares given to debentures, as shown above, is to be reduced to 6 and dividend rate is to be increased up to 12%
  3. The value of equity shares is to be reduced to 2 each
  4. The existing equity shareholders are to purchase additional equity shares of 2,00,000 for cash to pay off the Bank overdraft
  5. All fictitious and intangible assets are to be written off and machinery and furniture are to be written off in proportion of book values, with the help of general reserve and capital reduction account.

    Pass necessary journal entries in the books of the company to record the above transactions. Prepare the company’s balance sheet after such changes.

Solution

Book of Parul Ltd.
Journal Entries
Balance Sheet of Parul Ltd.
(And Reduced) As on 31st March 2011.

Illustration 11.9

Model: Issue of shares for arrears of preference dividend—Assets written down in proportion to written down values

The following is the summarized balance sheet as on 31 March 2011:

The following schemes of capital reduction were duly sanctioned by Court:

  1. Equity shares to be reduced by 90 each
  2. Preference shares to be reduced to 90 each
  3. The debenture holders to waive their right over outstanding interest
  4. One new equity share paid up to the extent of 50% only to be issued for each 100 of gross preference dividend, which has not been declared since April 2009
  5. All credit balances not being the outside liabilities and all debt balances not being the amounts receivable as well as the intangible assets are to be written off
  6. Any balance available is to be utilized in writing down the fixed assets in proportion to their written down values.

You are required to give journal entries and balance sheet after the scheme of internal reconstruction is completed.

Solution

Journal Entries
Balance Sheet of … (And Reduced)
as on 31 March 2011

Illustration 11.10

Model: Sale of assets to settle debenture holders claim

The following is the balance sheet of Devi Ltd. As at 31 March 2011:

The following reconstruction scheme was duly sanctioned by Court:

  1. Equity shares were to be reduced to 1 each.
  2. Preference shares were to be reduced to 8 each.
  3. Debenture holders to forego their interest of 26,000, which is included among sundry creditors.
  4. Second debenture holders agreed to take over Chennai property at 2,50,000, accept an allotment of 15,000 Re 1 equity shares at par, and upon their forming a company called Roses Ltd.. to take over the Chennai property, they allotted Devi Ltd. 9,000 shares of 10 fully paid at par.
  5. The Chennai workmen’s compensation disclosed the fact that there were liabilities to the extent of 10,000. The investments pertaining to it were sold at a profit of 10% on book value and the liability was paid.
  6. Sundry assets were to be written down by 4,00,000.

Show the journal entries to give effect to the above and prepare the reconstructed balance sheet.

Solution

Books of Devi Ltd.
Journal Entries
Balance Sheet of Devi Ltd
(And Reduced) as on 31 March 2011

Illustration 11.11

Model: Surrender of shares

In order to reconstruct the balance sheet, Thomas Co. Ltd. passed the following resolutions:

  1. The share capital of the company consisting of 10,000 ordinary shares of 100 each to be converted into 1, 00,000 share of 10 each
  2. The shareholders to surrender 70% of their shares after such conversion
  3. The amount available should be utilized to write off machinery of 3, 00,000 stock 1, 50,000 and the balance available to write off the debit balance in P&L A/c

You are required to pass the necessary journal entries.

Solution

Books of Thomas Co. Ltd.
Journal Entries

Illustration 11.12

Model: Surrender of shares

A company’s position on 31 December 2010 was as follows:

 

     

60,000 Equity Shares of 100 Each

60,00,000

30,000 8% Debenture of 100 Each

30,00,000

Interest outstanding of Debentures

3,60,000

Creditors

15,00,000

Assets on that date were as follows:

 

Fixed Assets

60,00,000

Current Assets

19,50,000

 

Fixed assets were revalued at 28,80,000 and current assets at 14,40,000.

The reconstruction scheme approved by the Court was as follows:

  1. The shares were sub-divided into shares of 5 each and 90% of the shares were surrendered
  2. Claims of debenture holders were reduced to 14,70,000 for which 7,50,000 equity shares were allotted
  3. Creditors agreed to reduce their claims to 9,00,000, one-third of which was satisfied by issue of equity shares out of those surrendered

Draft journal entries.

Solution

Journal Entries
Balance Sheet of…
as on 31 December 2010
PART II—ADVANCED LEVEL
[B.Com (Hons); C.A.; I.C.W.A.; C.S. and M.Com)]

Illustration 11.13

Model: Dealing with taxes

The following is the balance sheet of Sick Ltd as on 31 March 2011:

The following scheme of reorganization is sanctioned:

  1. Fixed assets are to be written down by .
  2. Current assets are to be revalued at 13,50,000.
  3. Preference shareholders decide to forego their right to arrows of dividend which are in arrears for 3 years.
  4. The taxation liability of the company is settled at 2,00,000 and the same is paid immediately.
  5. One of the creditors of the company to whom it owes 12,50,000 decides to forego 50% of his claim. He is allotted 50,000 equity shares of 5 each in part satisfaction of the balance of his claim.
  6. The rate of interest on debentures is increased to 11%. The debenture holders surrender their debentures of 100 each and exchange the same for fresh debentures of 75 each.
  7. The existing equity and preference shares are reduced to 5 and 75 each, respectively.

[B.Com (Hons) Delhi Modified]

Solution

 

 

(a)

Equity Share Capital as Shown in Balance Sheet

3,50,000

Less:

Reduced from 10 to 5 per Share} i.e. 50%

1,75,000

 

 

1,75,000

Add:

Allotment to Creditors 50,000 × 5:

2,50,000

 

(i.e. (35,000 + 50,000 Shares) × 5

4,25,000

(b)

Preference Share Capital: as Shown in Balance Sheet

50,000

Less:

Reduced to 75 per Share

12,500

 

i.e. 500 × 25 (100 − 75)

37,500

 

(500 Pref. Shares × 75)

 

Sick Ltd.
Journal Entries
Balance Sheet of Sick Ltd. (And Reduced)*
as at 31 March 2011

*“And Reduced” has to be added only when directed by the Court.

Illustration 11.14

Model: Forfeiture of shares

The following is the balance sheet of Taurus Ltd. as on 31 March 2011:

The directors find that the machinery is overvalued by 50,000. It is now proposed to write down these assets to its true value and extinguish goodwill account, profit and loss and preliminary expenses accounts by adopting the following scheme:

  1. Forfeit the shares on which the calls are outstanding
  2. Reduce the paid-up capital by 3 per share
  3. Re-issue the forfeited shares as 5 per share
  4. Utilize the provision for taxes, if necessary

Draft the journal for taxes, if necessary for giving effect to the above scheme, and prepare the reconstructed balance sheet of the company.

 

[B.Com (Hons) Delhi Modified]

Solution

Taurus Ltd.
Journal Entries
Balance Sheet of Taurus Ltd. (And Reduced)
as on 1 April 2011

Illustration 11.15

Model: Arrears of dividend on pref. shares (Surrender of shares)

The balance sheet of Naina Lohia Ltd. as on 31 March 2011 was as follows:

Dividend on preference shares is in arrears for 5 years. The following scheme of reconstruction was approved by the Court:

  1. Equity shares are to be converted into 3,00,000 shares of 5 each.
  2. Equity shareholders agreed to surrender to the company 80% of their holdings.
  3. Preference shareholders agreed to forego their right to unpaid dividend. They also agreed to reduce each preference share from 100 to 80.
  4. Creditors agreed to reduce their claim by two-fifths in consideration of their getting shares of 1,80,000 out of surrendered equity shares.
  5. Unsecured loan is converted into 1,50,000 equity shares out of shares surrendered and remaining amount of loan is waived.
  6. Surrendered shares not utilized are to be cancelled.
  7. Assets are to be reduced as follows:

    Goodwill by 1,50,000; plant by 2,00,000; equipments by 40,000; book debts by 80,000; inventories by 1,00,000. All intangible and fictitious assets are to be written off.

  8. Any surplus left should be utilized in writing down the machinery plant further.
  9. Cost of reconstruction amounted to 50,000.
  10. Further 2,00,000 shares were issued to existing shareholders to increase working capital. The issue was fully subscribed and paid for.

Draft journal entries for the above arrangement. Also prepare reconstruction A/c.

 

[B.Com (Hons) Delhi 2010 Modified]

Solution

Books of Naina Lohia Ltd.
Journal Entries
Reconstruction Account

Illustration 11.16

The following is the Balance Sheet of X Ltd. as at 31 March 2011:

The following scheme of reconstruction is executed:

  1. Equity shares are reduced by 95 per share. They are then consolidated into 20,000 equity shares of 10 each.
  2. Debenture holders agree to forego outstanding debenture interest. As a compensation, 12% debentures are converted into 14% debentures, the amount remaining 10,00,000.
  3. Creditors are given the option to either accept 50% of their claim in cash in full settlement or to convert their claim into equity shares of 10 each. Creditors for 4,00,000 opt for shares in satisfaction of their claims and the rest accepted cash.
  4. To make payment to creditors and to augment working capital, the company issued 1,00,000 equity shares of 10 each at par, the entire amount being payable along with application. The issue was fully subscribed.
  5. Land and building are revalued at 4,00,000; plant and machinery at 4,20,000 and provision amounting to 10,000 is made for doubtful debts.

Pass journal entries to record the above.

 

[B.Com (Hons) Delhi 2007 Modified]

Solution

Journal Entries

Illustration 11.17

Model: Revaluation of assets—Surrender of shares.

The following information relates to Sick Ltd. as on 31 December 2010:

 

 

    

12,000 Equity Share of 100 Each

12,00,000

6,000 6% Debentures of 100 Each

6,00,000

Interest on Debentures Outstanding

72,000

Trade Creditors

3,00,000

Fixed Assets

12,00,000

Current Assets

3,90,000

 

The following scheme was duly agreed and approved by the Court:

  1. The shares were sub-divided into shares of 5 each and 90% of the shares were surrendered
  2. The total claims of debenture holders were reduced to 2,94,000 and in consideration of this, they were allotted shares (out of the surrendered shares) amounting to 1,50,000
  3. Creditors agreed to reduce their claims to 90,000, one-third of which was satisfied by issue of equity shares out of those surrendered
  4. Fixed assets were revalued at 5,76,000 and current assets were revalued at 2,88,000
  5. The shares surrendered but not re-issued were cancelled

You are required to draft the necessary journal entries and give the balance sheet of the company after reconstruction.

 

[B.Com (Hons) Delhi 2008 Modified]

Solution

Note: As P&L A/c is not given, it has to be ascertained by preparing the balance sheet as follows:

 

Balance Sheet (Before Reconstruction)
Books of Sick Ltd.
Journal Entries
Reconstruction Account
Balance Sheet of Sick Ltd. (And Reduced)
as on 18 January 2011

Illustration 11.18

Model: Maintenance of working capital

ABC Ltd., whose balance sheet as on 31 March 2011 given in the following, formulated a scheme of reconstruction details of which follow and secured approval of all concerned :

Preference dividend is in arrears for 1 year.

  1. Preference shareholders to give up their claims, inclusive of dividends, to the extent of 30% and desire to be paid off.
  2. Debenture holders agree to give up their claims to interest in consideration of their rate of interest being enhanced to 10%.
  3. Bank agrees to give up 50% of its interest outstanding in consideration of their claim being paid off at once.
  4. Sundry creditors would like to grant a discount of 5% if they were to be paid off immediately.
  5. Balances of P&L A/c, patents & copyrights and 25% of the sundry debtors of 2,40,000 to be written off. Fixed assets to be written down by 28,000. Investments to reflect their market value.
  6. To the extent not specifically stated, equity shareholders suffer no reduction of their rights.
  7. Cost of reconstruction is 6,700.

Pass journal entries in the books of the company assuming that the scheme has been put through fully with the equity shareholders bringing in necessary cash to pay off the parties and to leave a working capital of 4,40,000.

Draw the balance sheet after reconstruction.

 

[B.Com (Hons) Modified]

Solution

CALCULATIONS.

  1. Determination of Necessary Cash Brought in by Equity Shareholders:

     

     

     

        

    (i)

    Amount Paid to Pref. Shareholders

    :  9,07,200

     

    ( 8,40,000 + 67,200)

     

     

    70% of Face Value 70% of Interest

     

    (ii)

    Bank Overdraft

    :  3,00,000

    (iii)

    Sundry Creditors

    1,46,100

     

    ( 1,28,000 − 15,000 − 7,000)

     

    (iv)

    Reconstruction Costs

    :  6,700

     

     

    13,60,000

    (v)

    Working Capital to Be Maintained

    :  4,40,000

    (vi)

    Needed Cash Brought in by Shareholders

    :  18,00,000

  2. Calculation of Equity Share Capital A/c:

    Reduction of paid-up capital to make up the balance of reconstruction account is determined by preparing reconstruction account as follows:

Reconstruction A/c
Balance Sheet of ABC Ltd. (And Reduced)
as on 31 March 2011

Illustration 11.19

Model: Forfeiture of shares and utilizing the provision for taxes

The following is the balance sheet of Leo Ltd. as at 31 March 2011:

The directors have had a valuation made of the machinery and find it overvalued by 4,00,000. It is proposed to write down this asset to its true value and to extinguish the deficiency in the P&L A/c and to write off goodwill and preliminary expenses, by the adoption of the following course:

  1. Forfeit the shares on which the call is outstanding
  2. Reduce the paid-up capital by 3 per share
  3. Re-issue the forfeited share as fully paid shares of 7 each at 5 per share
  4. Utilize the provision for taxation, if necessary
    1. Draft the necessary journal entries
    2. Draw the company’s balance Sheet immediately after the implementation of the scheme of reconstruction

[B.Com (Hons) Delhi Modified]

Solution

Books of Leo Ltd.
Journal Entries
Reconstruction A/c
Balance Sheet of Leo Ltd.
as on 1 April 2011

Illustration 11.20

Model: Issue of shares—Redemption of debentures At premium bonus shares

The share capital of Gemini Ltd. consisted of 1,00,000 equity shares of 10 each fully paid. The company has accumulated out of profits a reserve fund of 10,00,000. It issued further 20,000 equity shares during 2010 at a premium of 30 per share and the entire amount had been realized.

An independent valuation of its assets increased the balance sheet values as thus:

Land and Buildings by

12,00,000

Plant and Machinery by

6,00,000

Stores and Spares by

5,00,000

 

The valuation reduced the amounts of the following:

Goodwill by

3,00,000

Patents by

2,00,000

At the end of 2010, it was decided to redeem 6,000 debentures of 100 each as 5% premium; to adopt the new valuation; and to allot two equity shares of 10 each as fully paid bonus shares for every equity share held.

It was also decided that the balance of reserve fund, after carrying out all the above arrangements, was to be capitalized. Pass journal entries to record these transactions in the books of Gemini Ltd.

 

[B.Com (Hons) Delhi Modified]

Solution

Books of Gemini Ltd.
Journal Entries

Illustration 11.21

Model: Interest of individuals in the company’s reconstruction scheme

Having accumulated huge losses, Aries Ltd. adopts a scheme of reconstruction on 31 March 2011, on which date its balance sheet is as follows:

 

Balance Sheet of Aries Ltd.
as on 31 March 2011

The following is the interest of Mr. X and Mr. Y in Aries Ltd.:

 

 

Mr.X ()

Mr. Y ()

11.5% First Debentures

1,50,000

1,00,000

12% Second Debentures

3,50,000

1,50,000

Sundry Creditors

1,00,000

50,000

 

6,00,000

3,00,000

Fully Paid up 50 Shares

1,50,000

1,00,000

Fully Paid up 40 Paid up

2,50,000

2,50,000

 

The following scheme of reconstruction is approved by all parties interested and also by the Court:

  1. Uncalled capital is to be called up in full and such shares and also fully paid-up shares pertaining to the earlier issue be converted into equal number of fully paid-up equity shares of 20 each
  2. Mr. X is to cancel 3,50,000 of his total debt (other than share amount), is to pay 1,00,000 to the company and to receive new 13% first debentures in full settlement
  3. Mr. Y is to cancel 1,50,000 of his total debt (excluding shares) and to accept new 13% first debentures for the balance
  4. The amount thus rendered available by the scheme be utilized in writing off goodwill, the debit balance of P&L A/c and in reducing the book value of computers by 7,50,000

You are required to pass the journal entries for all the above-mentioned transactions and prepare the initial balance sheet of the reconstructed company.

[C.A. (Inter). Modified]

Solution

Books of Aries Ltd.
Journal Entries
Balance Sheet Aries Ltd. (And Reduced)
as on 31 March 2011

Illustration 11.22

The following is the balance sheet of Singh Ltd. as at 31 March 2011:

The company decided on a scheme of reduction of capital which was duly authorized. The scheme provided as follows:

  1. The equity shares of 100 each, 50 paid up per share to be issued for each preference share
  2. Each existing equity share is to be reduced to 50 paid up, the face value remaining the same at 100
  3. 3,000 Equity shares were taken up by the directors and paid for by them to the extent of 50 each
  4. Arrears of preference dividend for the last four years is to be cancelled
  5. Debenture holders to receive 2,400 equity share of 100 each credited as fully paid up
  6. Unsecured creditors to be paid immediately to the extent of 10% of their claims and they accepting a remission of 20% of their claims
  7. The amount available as a result of the scheme to be used to write off the debit balance in the P&L A/c, to write down fixed assets by 30,000 and to adjust goodwill

You are required to give journal entries to record the above and give the balance sheet after the reconstruction is effected.

 

[I.C.W.A. (Final). Modified]

Solution

Singh Ltd.
Journal Entries
Singh Ltd.
Balance Sheet as on 31 March 2011

Illustration 11.23

Model: Typical

The balance sheet of A Ltd. as at 31 March 2011 was as follows:

Note: The arrears of preference dividends amounted to 1,02,400.

A Scheme of reconstruction was duly approved with effect from 1 April 2011 under the conditions stated in the following:

  1. The unpaid amount on equity shares would be called up.
  2. The preference shareholders would forego their arrears of dividends. In addition, they would accept a reduction of 2.50 per share. The dividend rate would be enhanced to 10%.
  3. The equity shareholders would accept a reduction of 7.50 per share.
  4. A Ltd. holds 43,200 shares in B. Ltd. This represents 15% of the share capital of that company. B Ltd. is not a quoted company. The average net profit (after tax) of the company is 5,00,000. The shares would be valued based on 12% capitalization rate.
  5. A bad debt provision @ 2% would be created.
  6. The other assets would be valued as follows:

     

    Intangibles

    96,000

    Plant

    2,80,000

    Freehold Premises

    7,60,000

    Stocks

    5,00,000

  7. The P&L A/c debit balance and the balance standing to the debt of deferred revenue expenditure A/c would be eliminated.
  8. The directors would have to take equity shares at the new face value of 2.50 per share in settlement of their loan.
  9. The equity shareholders, including the directors, who would receive equity shares in settlement of their loans, would take up two new equity shares for every one held.
  10. The preference shareholders would take up one new preference share for every four held.
  11. The authorized share capital would be restated to 28,00,000.
  12. The new face value of the shares—preference & equity—will be maintained at their reduced levels. You are required:
  1. To prepare the necessary ledger accounts to effect the above
  2. To prepare the balance sheet of the company after reconstruction

[I.C.W.A. (Final). Modified]

Solution

Investments in B Ltd. is calculated as:

Reconstruction A/c
Equity Share Capital A/c
Bank A/c
10% Cumulative Pref. Share Capital A/c
A Ltd. (And Reduced)
Balance Sheet as on 1 April 2011

Illustration 11.24

Model: Distribution of anticipated profits unrecorded liability

ABC Ltd. decided to recognize itself following a period of adverse trading conditions. The summarized balance sheet at 31 March 20… was as follows:

Preference dividend is in arrears for 3 years. The authorized share capital is 12 lakh 12% cumulative preference shares of 10 each and 24 lakh equity shares of 10 each. The following reconstruction scheme was formulated and duly approved:

  1. The existing equity shares were to be converted into fully paid up equity shares of 2 each. The equity shareholders were to accept a consequent reduction in their value of holdings. They further agree to subscribe to a new issue of equity shares on the basis of 2 for 3 at a price of 3.50 per share.
  2. The Preference Shareholders were to forego their right to arrear dividends. The existing 8,40,000 preference shares were to be exchanged for a new issue of 4,20,000 14% cumulative preference shares of 10 each and 42,00,000 in equity shares of 2 each.
  3. The debenture holders were to accept 5,00,000 equity shares of 2 each in settlement of their arrear interest and the interest rate on debentures was to be enhanced to 15%. The debenture holders were also to accept further 15% debentures of 16,00,000 at 90 per 100.
  4. Half of the directors’ loan was to be cancelled. The balance was to be settled by the issue of 96,000 equity shares of 2 each.
  5. Investments were to be sold at the current market value of 20,00,000.
  6. The bank overdraft was to be repaid in full.
  7. An amount of 20,00,000 was to be paid immediately to creditors. The balance amount would have to be paid in quarterly investments.
  8. All intangibles, deferred charges and the debit balance to P&L A/c were to be written off.
  9. Liability for damages unrecorded in books was to be settled for 17,60,000. A sum of 3,00,000 was to be recovered in this connection from the insurance company.
  10. The existing share premium account was to be utilized in full.
  11. Tangible fixed assets were to be revalued as:
    1. Land & Buildings            1,76,00,000
    2. Plant & Machinery            10,00,000
  12. Stocks were to be written down by 84,00,000.
  13. Debtors account was to be adjusted for an uncontrolled debt of 9,00,000.

It is expected that with the new arrangements, the company will be able to earn a return of 50,00,000 p.a. before interest and taxes. The company will not attract any tax liability for the next 5 years.

You are required to:

  1. Show the journal entries necessary to record the above scheme
  2. Prepare the summarized balance sheet of the company immediately after reconstruction
  3. Show how the anticipated profit will be distributed after the reconstruction

[I.C.W.A. (Final). Modified]

Solution

Books of ABC Ltd.
Journal Entries
ABC Ltd. (And Reduced)
Balance Sheet as at 1 April…
Distribution of Anticipated Profits:

 

 

   

Anticipated Profits (Before Interest & Taxes)

50,00,000

Less:

Debentures Interest 15% of 1,12,00,000

16,80,000

 

Profit Before Tax

33,20,000

Less:

Tax

Nil

 

Profit After Tax

33,20,000

Less:

Preference Dividend 14% on 42,00,000

5,88,000

 

Profit Available for Equity Shareholders

27,32,000

Less:

Equity Dividend (Taken to be @ 20%)

26,78,400

Retained Profit

53,600

Summary

Internal reconstruction is concerned with the assessment of the financial position of a company by revaluation of assets and liabilities to their true values.

Need for reconstruction: (i) To reflect a true and fair view of financial position (ii) To update the value of assets by eliminating fictitious and valueless intangible assets and bringing down the value of assets to their true value (iii) To correct override liabilities (iv) To ascertain real value of the net assets and (v) For a proper diagnostic and remedial measure.

Methods of internal reconstruction: (i) Alteration of share capital (ii) Reduction of share capital (iii) Variation of shareholders’ rights (iv) Compromise or arrangement and (v) Surrender of shares.

Accounting treatment for each method of internal reconstruction is explained in detail in the main part of the text. Reconstruction account— Preparation and utilization: For details refer text.

Preparation of balance sheet after reconstruction: Important factors to be taken into account: (i) Name of the company… (And reduced) (ii) To show revised appreciated figures in the valuation of assets and (iii) Strict compliance with the rules for amounts written off.

Various methods of internal reconstruction are explained in graded manner—Ref: Illustrations 11.1 to 11.24.

Key Terms

Internal Reconstruction: A scheme of re-organization of the company (Corrections on the value of assets and liabilities) without liquidation of the company.

Alternation of Share Capital: It involves increase, consolidation or sub-division of share capital. It does not involve reduction of share capital.

Reconstruction Account: The account to be prepared during the process of scheme of internal reconstruction.

QUESTION BANK

Objective Type Questions

 

I: State whether the following statements are true or false

  1. Only unsuccessful companies can undertake capital reduction.
  2. Internal reconstruction means reorganization of capital structure of a company by liquidating the company.
  3. Consolidation of shares will result in reduction in number of shares.
  4. Due to sub-division of shares, the paid-up capital will not be affected.
  5. A company can convert shares in to stock but cannot convert stock into shares.
  6. The authorized capital gets reduced, to the extent of unissued shares cancelled.
  7. Cancellation of unissued capital is not a case of capital reduction.
  8. Ordinary resolution will be sufficient for reduction of share capital.
  9. Consent of the creditors is required for return of capital.
  10. Amounts sacrificed by shareholders are credited to capital reserve A/c.
  11. In a scheme of reorganization, the amount of shares surrendered by shareholders is transferred to reconstruction.
  12. A company is free to reduce or extinguish the uncalled liability of its members.
  13. Any balance in securities premium A/c can be transferred to capital reorganization A/c.
  14. If the Articles of Association is silent on reduction of the share capital, the same cannot be carried out.
  15. If preference dividend is not declared, it is to be treated as contingent liability.

Answers:

  1. True
  2. False
  3. False
  4. True
  5. False
  6. True
  7. False
  8. False
  9. True
  10. False
  11. False
  12. False
  13. True
  14. False
  15. True

II: Fill in the blanks with apt word(s)

  1. Increasing the share capital by issue of new shares does not require______________ approval.
  2. The process of converting the existing shares of lower denomination into shares of higher denomination is known as_______________ .
  3. Consolidation of shares will not affect the amount of______________ .
  4. In sub-division of shares, _____________ capital does not change.
  5. A company can make alteration of share capital if it is authorized by _________________ of the company and by passing an ordinary resolution.
  6. A company can convert fully paid shares into ______________ and also reconvert_____________ back into shares.
  7. Cancellation of unissued share capital does not amount to ______________ of capital.
  8. In external reconstruction, the existing company will be _______________ .
  9. Confirmation of the ____________ is necessary for capital reduction.
  10. After granting the scheme of capital reduction, the court may order the use of words______________ after the name of the company for a specified period.
  11. No journal entry is required for the cancellation of ______________ share capital.
  12. Reconstruction A/c (Capital reduction A/c) is used in the scheme of ______________.
  13. Any surplus in capital reduction A/c is to be transferred to ______________.
  14. If preference dividend is declared, it appears under the head _________________ in the balance sheet.
  15. In a scheme of capital reduction, any new liability to be provided for such as arrears of preference dividend has to be met out of ______________.
  16. A ____________ balance in P&L A/c represents accumulated losses in the scheme of internal reconstruction.
  17. ____________ is not required if capital reduction involves the writing off of paid-up capital not represented by available assets.
  18. “____________ A/c” is an alternative term for “capital reorganization A/c”.
  19. Claim foregone by debenture holders should be transferred to ________________.
  20. Any gain on revolution of assets at the time of internal reconstruction will be _________________ to reconstruction A/c.

Answers:

  1. court
  2. consolidation
  3. share capital
  4. paid-up
  5. Articles of Association
  6. stock
  7. reduction
  8. liquidated
  9. Court
  10. “And Reduced”
  11. Unissued
  12. internal reconstruction
  13. capital reserve A/c
  14. current liabilities
  15. capital reduction
  16. debit
  17. Consent of Creditors
  18. Reconstruction A/c
  19. capital reduction
  20. credited

III: Multiple choice questions—Choose the correct answer

  1. The capital reduction scheme can be implemented after getting permission from
    1. Competent Court
    2. Central Government
    3. State Government
    4. SEBI
  2. ‘Reconstruction A/c’ is used in the case of
    1. external reconstruction
    2. internal reconstruction
    3. amalgamation
    4. absorption
  3. Which of the following is not “alteration of share capital”:
    1. consolidation of shares
    2. sub-division of shares
    3. cancelling or writing off lost capital, not represented by assets
    4. conversion of shares into stock and vice versa
  4. Any surplus in capital reduction account is transferred to
    1. general reserve A/c
    2. profit & loss A/c
    3. share capital A/c
    4. capital reserve A/c
  5. Preference shareholders’ sacrifice of undeclared preference dividend is to be credited to
    1. preference share capital A/c
    2. paid-up capital A/c.
    3. equity capital stock A/c
    4. none of these
  6. Any gain on revaluation of assets will be credited to
    1. capital reduction A/c
    2. general reserve A/c
    3. profit & loss A/c
    4. capital reserve A/c
  7. Any loss on revaluation of assets will be transferred to
    1. profit & loss A/c
    2. reconstruction A/c
    3. capital reserve A/c
    4. none of these
  8. Amounts sacrificed by shareholders are credited to
    1. capital reserve A/c
    2. profit & loss A/c
    3. reconstruction A/c
    4. balance sheet
  9. In consolidation of shares, total number of shares
    1. increases
    2. decreases
    3. does not change
    4. changes proportionately
  10. Effect of sub-division of shares:
    1. Paid-up capital and number of shares increase
    2. Paid-up capital increases but number of shares reduces
    3. Paid-up capital does not change but number of shares increases
    4. Paid-up capital does not change but number of shares reduces

Answers:

 

1 (a)

2 (b)

3 (c)

4 (d)

5 (d)

6 (a)

7 (b)

8 (c)

9 (b)

10(d)

 

 

Short Answer Questions

  1. Name the two types of alteration of the share capital of a company.
  2. What do you mean by “internal reconstruction”?
  3. What is meant by “external reconstruction”?
  4. What are the differences between “internal” and “external” reconstruction?
  5. Name the alternation of share capital, which does not require Court approval?
  6. What is the procedure laid down in Companies Act to alter the share capital?
  7. What is ‘consolidation” of shares? What is its net effect?
  8. What do you mean by “sub-division of shares”? Illustrate.
  9. What do you mean by “conversion of shares in the stock”? Give an example.
  10. Explain: cancellation of unissued shares.
  11. “Internal reconstruction” is preferred by companies—Why?
  12. Enlist the different forms of reduction of capital.
  13. How will you treat the following:
    1. Surplus/deficit in capital reduction account
    2. Arrears of preference dividend
    3. Surrender of shares
  14. What is the accounting treatment for “revaluation of assets” in the scheme of internal reconstruction?
  15. What are the statutory provisions for reducing share capital?
  16. Write short notes on reconstruction A/c.
  17. What are the important factors to be taken into consideration while drafting the restructured balance sheet after the scheme of reconstruction is completed?

Essay Type Questions

 

18. Explain the salient provisions of Sections 94 to 97 of the Companies Act.

19. Elucidate the different kinds of alterations of share capital with required accounting entries.

20. Explain the procedure to be adopted for reduction of share capital.

21. Write a note on the significance of reconstruction A/c. What special attention will you take to construct the balance sheet after the scheme of internal reconstruction is completed?

Exercises

 

Part A—For Undergraduate Level
  1. The share capital of VIR Ltd. consisted of the following:
    1. 30,000 6% Preference shares of 100 each and
    2. 1,50,000 Equity shares of 10 each
    3. The shares were fully paid

    The company had accumulated losses totaling 10,50,000 besides preliminary expenses of 60,000. It was also ascertained that fixed assets which stood in the books at

    42,00,000 were over valued to the extent of 12,00,000. The following scheme was adopted to write off the losses and reduce the assets:

    1. 6% Preference shares were to be converted into 7% pref. shares of 60 each
    2. Equity shares were to be reduced to 2 each Journalize.

    [Ans: Capital reduction (Total): 32,00,000; Transferred to capital reserve A/c: 1,20,000]

  2. The following scheme of reconstruction has been duly approved:
    1. The shareholders to receive the following in lieu of their present holding of 25,000 shares of 10 each:
      1. Fully paid equity shares equal to two- fifths of their holding
      2. 10% Preference shares, fully paid, to the extent of one-fifths the above new equity shares
      3. 30,000 14% second debentures
    2. An issue of 25,000 12% first debentures was made and allotted, payment for the same being received in cash forth with
    3. Goodwill which stood at 75,000 was completely written off
    4. Plant & machinery which stood at 50,000 was written down to 37,500
    5. Freehold & leasehold premises which stood at 87,500 were written down to 75,000

    Give journal entries in the books of the company necessitated by the above reconstruction.

    [Ans: Capital reduction (Total): 1,00,000]

  3. M/s Shiva Co. Ltd. was floated with a capital of 10,00,000 in 50,000 equity shares of 10 each and 50,000 preference shares of 10 each and the capital was fully subscribed and paid. The preference shares carried cumulative preference rights as to dividend but not as to capital repayment. The company was unsuccessful and sustained trading losses amounting to 1,50,000. In addition, the majority of the patents acquired by the company proved to be worthless.

    It was resolved to write off 5,00,000 of the subscribed capital by reducing each class of shares by 5 per share and to reduce the assets correspondingly by:

    1. Wiping out the debit balance of P&L A/c 1,50,000
    2. Writing down goodwill to the extent of 1,50,000
    3. Writing off patents by 1,50,000 and preliminary expenses of 50,000

    Pass the journal entries to give effect to the above transactions.

    [Ans: Capital reduction (Total): 5,00,000]

  4.  

    Balance Sheet of ABC Ltd.
    as on 31 March 20…

    It was resolved that equity share capital of 10 each be reduced to fully paid shares of 6 each and 7% preference shares of 10 each be reduced to 7½% fully paid preference shares of 7 each. Number of shares in each case remained the same. It was further resolved that amount so available be used for writing off the debit balance of P&L A/c and goodwill account and other fixed assets to the extent possible.

    There were arrears of preference dividend for the last 3 years and it was decided that they be cancelled.

    Draft the journal entries and prepare the revised balance sheet.

    [Ans: Capital reduction: 4,20,000; Fixed assets written off to the extent of 90,000; Balance sheet total: 7,80,000]

  5. Weak Ltd. had the following balance sheet as on 31 December 2010:

    The following reconstruction scheme was approved:

    1. Preference shares to be reduced to 8% pref. shares of 60 each
    2. Equity shares to be reduced by 80 each
    3. The amount thus made available to be utilized to write off fictitious assets including goodwill and 1,50,000 from fixed assets

    Give entries for the reconstruction and the final balance sheet.

    [Ans: Total capital reduction: 12,00,000; Balance transferred to capital reserve: 33,000; B/s total: 13,83,000]

  6. The Balance sheet of Swasthik Ltd. as at 31 December 2010 was as follows:

    The company got the following scheme of capital reduction approved by the Court:

    1. The preference shares to be reduced to 75 per share, fully paid up and the equity shares to 37.50
    2. The debenture holders took over the stock and book debts in full satisfaction of the amount due to them
    3. The goodwill A/c is to be eliminated
    4. The freehold properties to be depreciated by 50%
    5. The value of the plant & machinery to be increased by 2,00,000

    Give journal entries for the above and prepare the revised balance sheet.

    [Ans: Capital reduction A/c: 14,40,000; Balance sheet total: 18,00,000]

  7. Vee & Vee Ltd. was promoted to the year 2006. The working of the company was not successful. On 31 December 2010, the company’s balance sheet stood as follows:

    The company is to be reconstructed on the basis of the following scheme:

    1. 57,000 Shares of 100 each are to be reduced to an equal number of fully paid shares of 40 each
    2. The debt of 3,00,000 due to Stalin & Co. was also to be reduced the remaining 3,000 unissued shares being issued to them as fully paid up shares of 40 each in full settlement of the amount due to them
    3. The amount thus rendered available by the reduction of capital and by the above arrangement with Stalin & Co. is to be utilized in wiping off goodwill and P&L A/c and in writing down the value of machinery

    You are required to follow the scheme of reconstruction and prepare the new balance sheet of the company.

    [Ans: Hint: Machinery written off 90,000. Reconstruction A/c: 36,00,000; Balance sheet total: 27,00,000

  8. The following was the balance sheet of XYZ Ltd. as on 31 December 2010:

    Machinery value was 60,000 in excess. It is proposed to write down this asset and to extinguish P&L A/c debit balance and to write off goodwill and preliminary expenses by the adoption of the following scheme:

    1. Forfeit the shares on which the calls are outstanding
    2. Reduce the paid-up capital by 3 per share
    3. Re-issue the forfeited shares at 5 per share
    4. Utilize the provision for tax, if necessary

    You are required to draft the journal entries necessary and the balance sheet after carrying out the scheme.

    [Ans: Reconstruction A/c total: 2,53,800; B/s total: 6,18,750 provision for tax to be used 1,800]

  9. The following was the balance sheet of ABC Ltd. as on 31 March 20…. :

    The following scheme of reconstruction was duly approved:

    1. 7% Preference shares be converted into 9% preference shares, the amount being received by 30%.
    2. Equity shares be reduced to fully paid shares of 50 each.
    3. Land & buildings be appreciated by 20%.
    4. Debentures be reduced by 20%.
    5. All intangible assets, fictitious assets including patents and accumulated losses be written off. Utilize profit prior to incorporation, if necessary.
    6. Equity shareholders to subscribe equity shares of 4,00,000.

    The amount is to be utilized for acquiring new plant & machinery assuming the whole scheme to have been put through. Give journal entries and prepare the resultant balance sheet.

    [Ans: Reconstruction A/c total: 15,20,000; Utilization of profit prior to incorporation: 20,000; Balance sheet total: 38,20,000]

  10. On 31 December 20…., the balance sheet of sick company stood as follows:

    After carrying out the necessary formalities, the following scheme has been agreed upon the persons concerned:

    1. The 100 shares are to be reduced to 50 each
    2. The 10,000 shares which are unissued, are now to be issued as fully paid (i.e., at 50 each), to Strong Ltd. in full settlement of their loan
    3. The creditors accept 7,50,000 in fully paid debentures in full settlement of their debts
    4. The amount thus rendered available is to be utilized towards writing off goodwill, P&L A/c entirely and the balance to be used for writing down the machinery account

    Give journal entries to carry out the above scheme and prepare the balance sheet of the company after completion of the scheme.

    [Ans: Reconstruction A/c total: 27,50,000; Balance sheet total: 39,00,000; Machinery to be written off: 1,00,000]

  11. VRV Co. Ltd. resolved to write off one-half of its subscribed capital by reducing each 100 share, both preference & equity to 50 fully paid up and to reduce the book figures of its assets by an equivalent amount by wiping out the goodwill and the debit balance of P&L A/c and by writing down land and building by 75,000; plant & machinery by 50,000 and providing the balance for bad debts.

    The balance sheet of the company before the reduction of capital is as follows:

    Pass journal entries to give effect to the above resolution, showing the new balance sheet of the company.

    [Ans: Reconstruction A/c: 12,50,000; Balance sheet total: 17,50,000; Provision for bad debts: 25,000]

  12. The following is the balance sheet of RR Ltd. on 31 March 2011:

    Preference share dividends are in arrears for the last 4 years and the following scheme of reconstruction is passed by shareholders and approved by the Court:

    1. The 3,00,000 equity shares of 10 each are to be reduced to an equal number of equity shares of 1 each
    2. 50% of the preference dividend in arrears is to be paid in cash immediately and preference shareholders have agreed to forego the balance
    3. Plant & machinery are to be depreciated by 5% and a provision for doubtful debts is to be created @ 10% on debtors
    4. All intangible assets and fictitious assets are to be written off

    Pass journal entries to implement the above scheme and draft the reconstructed balance sheet.

    [B.Com Punjab University Modified]

    [Ans: Reconstruction A/c total: 27,00,000; Balance transferred to capital reserve A/c: 2,70,000; Total of balance sheet: 41,70,000]

  13. Below is given the balance sheet of Unlucky Ltd. as on 31 March 2011:

    Due to heavy losses, the company decided upon the following scheme of reconstruction:

    1. The preference shares were to be reduced to a value of 30 each. The equity shares were also to be reduced to the value of 30 each.
    2. The balance available was to be used to write off the debit balance of the P&L A/c 80,000 from stock and the full amount of preliminary expenses account. A provision of 1,20,000 was to be made against sundry debtors.

    The leasehold premises were to be reduced by 2,64,000 and the plant account to be reduced to 2,00,000.

    You are required to journalize the above transactions and prepare the reconstructed balance sheet.

     

    [B.Com (Pass). Calcutta University Modified]

    [Ans: Reconstruction A/c: 12,80,000; Total of balance sheet: 22,20,000]

  14. The balance sheet of Rita Ltd. as on 31 March 2011 was as follows:

    The preference share dividends are in arrears since 2007. The company passed a special resolution to reduce its capital and the following scheme was sanctioned by the Court.

    1. The preference shares to be reduced to 75 each fully paid and the arrears of dividend to be cancelled.
    2. The equity shares to be reduced to 25 each fully paid.
    3. The debit balance on P&L A/c and goodwill to be written off. Plant & machinery to be reduced by 20,000; of the book debts, 12,000 known to be bad to be written off, available balance to be used for writing down patents.

    The chairman of the company agreed to advance the sum of 50,000 to be secured by a mortgage at 5% p.a. on land & buildings. The cash is to be applied in paying off the bank loan and providing additional working capital.

    Pass journal entries giving effect to the above scheme and prepare the revised balance sheet of the company.

     

    [B.Com Kurukshetra Modified]

    [Ans: Reconstruction A/c: 3,12,500; Balance sheet total: 7,15,500; Patents to be written of: 10,500]

  15. The balance sheet of Disappointed Ltd. as at 31 March 2011 is as follows:

    The following reconstruction scheme is passed and duly sanctioned:

    1. Each share is to be sub-divided into ten fully paid equity shares of 1 each.
    2. After such sub-division, each shareholder shall surrender to the company 95% of his holding, for the purpose of re-issue to debenture holders and creditors as far as necessary and the balance cancelled.
    3. Of these surrendered, 69,000 shares of 1 each shall be converted into preference shares of 1 each fully paid.
    4. The claim of debenture holders shall be reduced by 5/6th and in consideration thereof, the debenture holders shall receive preference shares to the value of one-sixth of their claim as at 31 March 2011.
    5. The income tax liability is to be paid in full, and claims of other creditors to be reduced to one-fifth of their claims to be satisfied by the issue of equity shares of 1 each from the shares surrendered.
    6. The shares are surrendered and not re-issued to be cancelled.

      Set out journal entries and the resultant balance sheet assuming that the income tax liability is still outstanding and the amounts of the assets are unaltered.

    [B.Com Osmania University Modified]

    [Ans: Reconstruction A/c: 6,12,000; Balance transferred to capital reserve: A/c 2,91,000; Total of balance sheet: 4,71,000]

Exercises

 

Part B—For Advanced Level

 

16. The ledger balances of X Ltd. on 31 December 20… were as follows:

 

 

    

25,000 Equity Shares of 100 Each

25,00,000

12,500, 10% Preference Shares of 100 Each

12,50,000

Preference Dividend in Arrears

1,50,000

Creditors

6,25,000

Fixed Assets

25,00,000

Current Assets

8,12,000

 

The following scheme of reconstruction was adopted:

  1. The fixed assets were valued at 15,00,000 and current assets at 6,25,000
  2. The equity shares were sub-divided into shares of 5 each fully paid and 90% of these shares were surrendered
  3. The total claims of preference shareholders were reduced to 6,25,000 and in consideration of this, they were allotted equity shares, out of surrendered shares amounting to 3,12,500
  4. The creditors agreed to reduce their claims to 3,75,000, one-third of which was to be satisfied by the issue of equity shares out of those surrendered
  5. The remaining surrendered shares were cancelled

Pass journal entries and give the balance sheet after re-construction.

 

[B.Com (Hons) Delhi 2003 Modified)

[Ans: Reconstruction A/c: 28,12,500; Capital reserve A/c: 5,62,500; Balance sheet: 21,25,000]

17. The position of Eknath & Co. Ltd. as on 31 December 2010 stood as follows:

A revaluation of assets reveals the following:

Land and Building: 2,85,000; Plant & Machinery: 3,36,000;

Stock: 75,000; Debtors: 96,000; and Patents: 15,000.

The following scheme of reconstruction is framed and approved by the Court:

  1. The 6% preference shares be converted into 7.5% preference shares of 30 each fully paid.
  2. The equity shares be converted into shares of 5 each fully paid.
  3. The sundry creditors be given the option to either accept 50% of their claims in cash in fully satisfaction or to convert their claims into shares of 5 each.
  4. The revaluation of assets be adopted.

One third (in value) of the creditors accepted equity shares for their claims. The rest were paid cash which was raised by issuing 51,000 equity shares to the existing shareholders. All shares including preference shares were then consolidated (or sub-divided) into equity shares of 10. In view of the unsatisfactory state of affairs of the company, the debenture holders agreed to forego the interest due on debentures. Assuming that all necessary actions were taken, journalize the steps and also give the balance sheet after the scheme is put into effect.

 

[B.Com (Hons) Delhi 2006 Modified]

[Ans: Reconstruction A/c: 15,81,000; Balance sheet total: 9,30,000]

18. The following is the balance sheet of self-injured company as on 31 March 20…. :

The following scheme of reconstruction is sanctioned:

  1. Fixed assets are to be written down to 25,00,000.
  2. Current assets are to be revalued at 67,50,000.
  3. Preference shareholders agree to forego their right to arrears of dividend which are in arrears for 3 years.
  4. One of the creditors of the company, to whom the company owes 62,50,000 agree to forego one-half of this claims. He is allotted 10,000 equity shares of 25 each in part satisfaction of the balance of his claim.
  5. The taxation liability of the company is settled at 10,00,000.
  6. The rate of interest on debentures is raised to 12%. The debenture holders surrender their existing debentures of 5,000 each and exchange the same for fresh debentures of 3,750 each.
  7. All existing shares are reduced to 25 each.
  8. All preference shares are reduced to 375 each.

Make journal entries and thereafter prepare the balance sheet.

 

[B.Com (Hons). Delhi 2007 Modified]

[Ans: Reconstruction A/c: 49,50,000; Capital reserve: 7,00,000; Balance sheet total: 82,50,000]

19. The following information relates to Sick Ltd. as on 31 December 2010:

 

 

   

16,000 Equity Shares of 100
Each

16,00,000

 

8,000 6% Debentures of 100
Each

8,00,000

Interest on Debentures
Outstanding

96,000

Trade Creditors

4,00,000

Fixed Assets

16,00,000

Current Assets

5,20,000

 

The following scheme was duly agreed and approved by the Court:

  1. The shares were sub-divided into shares of 5 each and 90% of the shares were surrendered
  2. The total claims of debenture holders were reduced to 3,92,000, and in consideration of this, they were allotted shares (out of the surrendered shares) amounting to 2,00,000
  3. Creditors agreed to reduce their claims to 1,20,000, one-third of which was satisfied by issue of equity shares out of those surrendered
  4. Fixed assets were revalued at 7,68,000 and current assets were revalued at 3,84,000
  5. The shares surrendered but not re-issued were cancelled

    Make journal entries and give the balance sheet after reconstruction.

[B.Com (Hons) 2008 Modified]

[Ans: Reconstruction A/c: 20,24,000; Capital reserve: 2,80,000; B/s total: 11,52,000; P&L A/c: 7,76,000]

20. The following is the balance sheet of X Ltd. as at 31 March 20…:

The following scheme of reconstruction is executed:

  1. Equity shares are reduced by 95 per share. They are then consolidated into 50,000 equity shares of 10 each.
  2. Debenture holders agree to forego outstanding debentures interest. As a compensation 12% debentures are converted into 14% debentures, the amount remaining 25,00,000.
  3. Creditors are given the option either to accept 50% of their claim in cash in full settlement or to convert their claim into equity shares of 10 each. Creditors for 10,00,000 opt for shares in satisfaction of their claims and the rest accepted cash.
  4. To make payment to creditors and to augment working capital, the company issued 2,50,000 equity shares of 10 each at par. The entire amount being payable along with application. The issue was fully subscribed.
  5. Land and building are revalued at 10,00,000; plant & machinery at 10,50,000 and provision amounting to 25,000 is made for doubtful debts.

Pass journal entries to record the above.

 

[B.Com (Hons) Delhi 2009 Modified]

[Ans: Reconstruction A/c: 1,06,00,000]

21. The balance sheet of Naina Lohia Ltd. as at 31 March 20… was as follows:

Dividend on preference shares is in arrears for 5 years. The following scheme of reconstruction was approved by Court:

  1. Equity shares are to be converted into 30,000 shares of 5 each.
  2. Equity shareholders agreed to surrender to the company 80% of their holdings.
  3. Preference shareholders agreed to forego their right to unpaid dividend. They also agreed to reduce each preference share from 100 to 80.
  4. Creditors agreed to reduce their claim by two-fifth in consideration of their getting shares of 18,000 out of surrendered equity shares.
  5. Unsecured loan is converted into 15,000 equity shares out of shares surrendered and remaining amount of loan is waived.
  6. Surrendered shares not utilized are to be cancelled.
  7. Assets are to be reduced as follows:

    Goodwill by 15,000; plant by 20,000; equipment by 4,000; book debts by 8,000; inventories by 10,000. All intangible and fictitious assets are to be written off.

  8. Any surplus left should be utilized in writing down machinery and plant further.
  9. Cost of reconstruction amounted to 5,000.
  10. Further 20,000 shares were issued to existing shareholders’ increase working capital. The issue was fully subscribed and paid for.

Draft journal entries and prepare reconstruction A/c.

[B.Com (Hons) Delhi 2010 Modified]

[Ans: Reconstruction A/c: 1,92,000; Further amount utilized for plant A/c: 2,500]

22. The following information relates to Sick Ltd. as on 31 December 2010:

 

 

    

2,000 Equity Shares of 100 Each

20,00,000

10,000 6% Debentures of 100 Each

10,00,000

Interest on Debentures Outstanding

1,20,000

Trade Creditors

5,00,000

Fixed Assets

20,00,000

Current Assets

6,50,000

 

The following scheme was duly agreed and approved by the Court:

  1. The shares were subdivided into shares of 5 each and 90% of the shares were surrendered
  2. The total claims of debenture holders were reduced to 4,90,000 and in consideration of this, they were allotted shares (out of the surrendered shares) amounting to 2,50,000
  3. Creditors agreed to reduce their claims to 1,50,000, one-third of which was satisfied by issue of equity shares out of those surrendered
  4. Fixed assets were revalued at 9,60,000 and current assets were revalued 4,80,000
  5. The shares surrendered but not re-issued were cancelled

You are required to draft the necessary journal entries and give the balance sheet of the company after reconstruction.

[B.Com (Hons) Delhi 2008 Modified]

[Ans: Old balance sheet—P&L A/c: 9,70,000; Reconstruction A/c Capital reserve: 3,50,000; New balance sheet total: 14,40,000]

23. Following is the balance sheet of W Ltd. as on 31 March 20…:

 

Liabilities:

    

2,00,000 Equity Shares of 10 Each, Fully Paid up

20,00,000

6,000, 12% Preference Shares of 100 Each Paid up

6,00,000

11% Debentures

6,00,000

Interest Outstanding on Debentures

66,000

Loan from Bank (Including Interest Due)

1,72,800

Creditors

1,09,000

 

35,47,800

 

Assets:

   

Machinery

17,40,000

Furniture

2,00,000

Patents & Copyrights

80,000

Investments (Market Value 55,000)

65,000

Stock

6,00,000

Debtors

4,39,000

Cash at Bank

15,800

P&L A/c

4,08,000

 

35,47,800

 

Note: Preference dividend is in arrears for 2 years.

The following scheme of reconstruction has been agreed upon and duly approved by the Court:

  1. The existing equity shares are converted into equal number of fully paid equity shares of 7 each. The equity shareholders also agree to take up 1,00,000 new equity shares of 7 each, the total amount being paid by them immediately.
  2. The preference shareholders agree to forego arrears of dividend and accept 85% of their capital account by way of redemption of all the preference shares.
  3. The debenture holders agree to give up their claim to outstanding interest in consideration of the rare of interest on debentures being enhanced to 13.5%.
  4. Bank agrees to waive its claim to outstanding interest amounting to 12,800 provided the balance of loan 1,60,000 be paid off forth with.
  5. Investments are to appear at market value.
  6. Patents and copyrights are to be written off completely.
  7. Machinery is to be written down to the extent possible after writing off all other losses.

Pass journal entries necessary to implement the above-mentioned scheme and prepare the balance sheet of the company in the prescribed form immediately after the implementation of the scheme.

[C.S. (Inter). Modified]

[Ans: Balance sheet total: 33,19,000; Machinery to be reduced to the extent of 2,71,200]

24. The following is the balance sheet of Sick Co. Ltd. as on 31 March 20… :

The following scheme of reorganization is sanctioned:

  1. Fixed assets are to be written down by .
  2. Current assets are to be revalued at 13,50,000.
  3. Preference shareholders decide to forego their right to arrears of dividend which are in arrears for 3 years.
  4. The taxation liability of the company is settled at 2,00,000.
  5. One of the creditors of the company, to whom the company owes 12,50,000, decides to forego 50% of his claim. He is allotted 50,000 equity shares of 5 each in part satisfaction of the balance of his claim.
  6. The rate of interest on debentures is increased to 14%. The debenture holders surrender their existing debentures of 100 each and exchange the same for fresh debentures of 75 each.
  7. All existing equity shares are reduced to 5 each.
  8. All preference shares are reduced to 75 each.

Pass journal entries and the show the balance sheet of the company after giving effect to the above.

[C.S. (Inter). Modified]

[Ans: Reconstruction A/c: 8,50,000; Balance sheet total: 16,50,000]

25. Geetha and Shweta Ltd. had to pass to the hands of a receiver for debenture holders who held charge on all assets except uncalled capital. The following is the position as prepared by the receiver.

 

Share Capital:

    

40,000 Shares of 50 Each Fully Paid up

20,00,000

2,00,000 Shares of 50 Each, 25 per Share Paid up

50,00,000

First Debentures

50,00,000

Second Debentures

1,00,00,000

Unsecured Creditors

80,00,000

Bank Balance

60,00,000

Building, Plant & Machinery

80,00,000

(Estimated to Realize 30,00,000)

 

The following is the interest of Geetha and Shweta in the company:

 

Geetha

Shweta

 

   

   

First Debentures

40,00,000

10,00,000

Second Debentures

60,00,000

40,00,000

Unsecured Creditors

12,00,000

18,00,000

 

1,12,00,000

68,00,000

Share Capital:

 

 

Fully Paid Shares

10,00,000

10,00,000

Partly Paid Shares

20,00,000

20,00,000

The following scheme of reconstruction is proposed:

  1. Geeta is to cancel 62,00,000 of her total debt, pay cash 10,00,000 and she would be issued 60,00,000 first debentures in lieu of first and second debentures to be cancelled
    1. Shweta is to cancel her total debt by accepting 10,00,000 in cash and 10,00,000 in first debentures
    2. Shweta is to surrender for cancellation of 10,00,000 worth of fully paid-up shares
  2. Unsecured creditors, other than Geetha and Shweta, agree to reduce their debt by 20%, and accept in lieu there of 2,00,000 shares of 10 each fully paid up and the balance in cash payable in five equal annual instalments
  3. Uncalled capital is to be called up in full and 40 per share to be cancelled thus making shares of 10 each

Assuming the scheme is duly approved by all parties interested and by the Court, show the reconstructed balance sheet and the journal entries in the books of the company.

[C.A. (Final). Modified]

[Ans: Reconstruction A/c total: 2,10,00,000; Balance sheet total: 1,40,00,000]

26. The balance sheet of Y Ltd. as on 31 March 20… was as follows:

Note: Preference dividend is in arrears for last 3 years. Mr. A holds 10% first debentures for 2,00,000 and 10% second debentures for 3,00,000. He is also creditor for 50,000. Mr. B. holds 10% first debentures for 1,00,000 and 10% second debentures for 2,00,000 and is also creditor for 25,000.

The following scheme of reconstruction has been agreed upon and duly approved by the Court:

  1. All the equity shares be converted into fully paid equity shares of 5 each.
  2. The preference shares be reduced to 50 each and the pref. shareholders agree to forego their arrears of pref. dividends in consideration of which 9% preference shares are to be converted into 10% preference shares.
  3. Mr. A is to cancel 3,00,000 of his total debt including interest on debentures and to pay 50,000 to the company to receive new 12% debentures for the balance amount.
  4. Mr. B is to cancel 1,50,000 of his total debt including interest on debentures and to accept new 12% debentures for the balance amount.
  5. Trade creditors (other than A and B) agreed to forego 50% of their claim.
  6. Directors to accept settlement of their loans as to 60% thereof by allotment of equity shares and balance waived.
  7. There were capital commitments totalling 1,50,000. These contracts price as penalty.
  8. The directors refund 55,000 of the fees previously received by them.
  9. Reconstruction expenses paid 5,000.
  10. The taxation liability of the company is settled at 40,000 and the same is paid immediately.

The assets are revalued as follows:

Land & Building

14,00,000

Plant & Machinery

2,00,000

Stock

3,50,000

Debtors

1,50,000

Computers

90,000

Furniture & Fixtures

50,000

Trade Investment

2,00,000

Pass journal entries for all the above-mentioned transactions including amounts to be written off on goodwill, patents, loss in P&L A/c and discount on issue of debentures. Prepare bank A/c and working of allocation of interest on debentures between A and B.

[C.A. (Inter). Modified]

[Ans: Reconstruction A/c: 23,60,000; Interest on debentures: A— 50,000, B— 30,000; Bank A/c: 1,05,000],

27. The following is the balance sheet of ABC Ltd. as at 31 March 20…

The following scheme of internal reconstruction was framed, approved by the Court, all the concerned parties, and implemented:

  1. All the equity shares are converted into the same number of fully paid equity shares of 2.50 each.
  2. Directors agree to forego their outstanding remuneration.
  3. The debenture holders also agree to forego outstanding interest in return of their 12% debentures being converted into 13% debentures.
  4. The existing shareholders agree to subscribe for cash fully paid equity shares of 2.50 each for 625 lakh.
  5. Trade creditors are given the option of either to accept fully paid equity shares of 2.50 each for the amount due to them or to accept 80% of the amount due in cash. Creditors for 325 lakh accept equity shares whereas those for 500 lakh accept 400 lakh in cash in full settlement.

The assets are revalued as follows:

 

( in Lakhs)

Land & Building

1,150

Plant & Machinery

1,100

Stock

600

Debtors

380

Pass journal entries for all the above-mentioned transactions and draft the company’s balance sheet immediately after the reconstruction.

[Ans: Reconstruction A/c: 2,525 lakhs; Balance sheet total: 3,795 lakhs]

28. A Ltd. decided to reorganize its structure following a period of adverse trading conditions. The balance sheet of the company as on 31 March 20. showed the following:

Note: Preference dividends are in arrears for 4 years.

Subsequent to approval by the Court, a scheme for the reduction of capital, the following steps were taken:

  1. The preference Shares were reduced to 7.50 per share and the equity shares to 2.00 per share. After reduction, the shares were consolidated into 10 shares. The authorized capital was restored to 4,00,000 8% cumulative preference shares and 3,00,000 equity shares, both of 10 each.
  2. One new equity share of 10 was issued for every 40 of gross preference dividend in arrears.
  3. The balance on share premium A/c was utilized.
  4. The debenture holders took over the freehold property at an agreed figure of 1,50,000 and paid the balance to the company after deducting the amount due to them.
  5. Plant and machinery was written down to 2,80,000.
  6. Trade investment was sold for 64,000.
  7. Goodwill, preliminary expenses, debts of 17,200 and obsolete stock of 20,000 were written off.
  8. Contingent liability for which no provisions had been made was settled at 14,000 and of the amount, 12,600 was recovered from the insurers.
  9. Available cash is deposited in bank overdraft A/c

You are required:

  1. To show the journal entries necessary to record the above transactions in the company’s books
  2. To show capital reduction A/c & cash A/c
  3. To prepare the balance sheet after completion of the scheme.

[C.A. (Inter). Modified]

[Ans: Capital reduction A/c (Total): 3,80,000; Cash A/c: 1,01,200; B/s total: 6,66,800]

29. MD & Co. is in the hands of a receiver for debenture holders. The following statement of affairs is prepared:

Assets

Book

Realizable

 

Value

Value

 

Buildings

20,00,000

24,00,000

Machinery

40,00,000

16,00,000

Stock

32,00,000

8,00,000

Debtors

32,00,000

20,00,000

Cash

4,00,000

4,00,000

 

1,28,00,000

72,00,000

Less: 6% First Mortgage

= 40,00,000

   Debentures

                    

 

= 32,00,000

Less: 7% Second Mortgage

= 48,00,000

   Debentures

                    

   Deficiency Regarding

= 16,00,000

   Mortgage Debentures

 

Less: Unsecured Creditors

= 20,00,000

   Deficiency Regarding

= 36,00,000

   Unsecured Creditors

 

Less: Contributions aries:

   2,00,000 Fully Paid

 

   Shares of 10 Each

 

   20,00,000

 

   2,00,000 Shares of

 

    10 Each 4 Paid up

 

   8,00,000 _________

28,00,000

   Deficiency Regarding

64,00,000

   Contributories

 

All the debentures are held by A and B. First mortgage debentures are held as 24,00,000 and 16,00,000 respectively by A and B. Second mortgage debentures are held as 32,00,000 and 16,00,000 by A and B, respectively.

In addition, 8,00,000 of unsecured creditors are debts due to A and B for 4,00,000 each.

Further, fully paid 20,000 and 8,000 partly paid shares respectively under a scheme of reconstruction.

  1. Partly paid shares of 10 are to be fully called up and all shares, except as shown in (iii) below, are to be reduced shares of 1 fully paid up.
  2. A will cancel all his dues including debentures, pay 4,00,000 cash and will be issued new 8% first mortgage debentures of 44,00,000.
  3. B will cancel all his dues and surrender all his shares and will be paid 4,00,000 cash and new 8% first mortgage debentures of 24,00,000.
  4. Balance of unsecured creditors will sacrifice 20% and will be compensated to the extent of 10% of original amount by issue of equity shares of 1.

Pass the necessary journal entries and also draft the balance sheet after the scheme is put into operation.

[I.C.W.A. (Final). Modified]

[Ans: Hint: P&L A/c (prepared through B/L): 8,00,000. Reconstruction A/c (Total): 65,36,000; Balance sheet (Total): 84,000]

30. ABC Ltd. decided to reorganize itself following period of adverse trading conditions. The summarized balance sheet of the company at 31 March 2011 was as follows:

Preference divided is in arrears for 3 years. The authorized share capital is 30,00,000 12% cumulative preference shares of 10 each and 60,00,000 equity shares of 10 each.

The following reconstruction scheme was formulated and duly approved:

  1. The existing shares were to be converted into fully up equity shares of 2 each. The equity shares holders were to accept a consequent reduction in their value of holdings. They further agree to subscribe to a new issue of equity shares on the basis of 2 for 3 at price of 3.5 per share.
  2. The preference shareholders were to forego their right to arrear dividends. The existing 21,00,000 preference shares were to be exchanged for a new issue of 10,50,000 14% cumulative pref. shares of 10 each and 1,05,000 in equity shares of 2 each.
  3. The debenture holders were to accept 12,50,000 equity shares of 2 each in settlement of their arrear interest and the interest rate on debentures was to be enhanced to 15%. The debenture holders were also to accept further 15% debentures of 40,00,000 at 90 per 100.
  4. Half of the directors’ loan was to be cancelled. The balance was to be settled by the issue of 2,20,000 equity shares of 2 each.
  5. Investments were to be solid at the current market value of 50,00,000.
  6. The Bank overdraft was to be repaid in full.
  7. An amount of 50,00,000 was to be paid immediately to creditors. The balance amount would have to be paid in quarterly instalments.
  8. All intangibles, deferred charges and the debit balance to the P&L A/c were to be written off.
  9. Liability for damages unrecorded in books was to be settled for 4,00,000. A sum of 7,50,000 was to be recovered in this connection from the insurance company.
  10. The existing share premium A/c was to be utilized in full.
  11. Tangible fixed assets were to be revalued as:

     

    Land & Building

    4,40,00,000

    Plant & Machinery

    25,00,000

     

  12. Stock were to be written down to by 2,10,000.
  13. Debtors A/c was to be adjusted for an uncollectable debt of 22,50,000.

It is expected that under the new arrangements, the company will be able to earn a return of 1,25,00,000 p.a. before interest and taxes. The company will not attract any tax liability for the next 5 years.

You are required to:

  1. Show the journal entries necessary to record the above scheme.
  2. Prepare the summarized balance sheet of the company immediately after reconstruction
  3. Show how the anticipated profit will be distributed after the reconstruction

[I.C.W.A. (Final). Modified]

[Ans: Balance sheet total: 8,42,00,000; Capital reserve: 21,20,000; Distribution of anticipated profit: Profit after tax— 83,00,000; Profit available for equity— 68,30,000; Retained profit— 14,73,200]