Chapter – 2 Internal Reconstruction Chapter outcomes: Meaning of internal reconstruction ; Alternation of share capital; Scheme of compromise arrangement; Meaning of arrangement; Methods of arrangements; How to deal with preference dividends; Pro forma journal entries; Practical exercises; Dr. BALAMURUGAN MUTHURAMAN 2015-2016

Meaning of internal reconstruction Internal reconstruction is the process in which the financial structure of a company is reorganized without dissolving the existing company and forming a new company. Internal reconstruction includes the following: Alternation of share capital; Reduction of share capital; Variation of shareholders rights; Scheme of compromise 2015-2016

Alteration of share capital In order to undertake internal reconstruction a company may attempt to alter the share capital in the following ways: Reduction in the number of shares: Under this method a company may pass a resolution in the annual general body meeting to reduce the number of shares. Example: 10,000 shares of RO 10, may be reduced to 5,000 shares of RO 10 each Reduction in the face value of the shares: Under this method, a company may reduce the face value of the shares. Example, shares of RO 10 each may be reduced to the shares of RO 5 each. 2015-2016

Scheme of compromise arrangement Meaning of compromise: Compromise refers to an amicable settlement of differences by mutual concessions by parties to dispute. It may be noted that the compromise presupposes the existence of some dispute because there can be no compromise unless there is some dispute. The need for compromise arise for the settlement of some dispute between the company and its creditors/members. 2015-2016

Meaning of arrangement The term ‘arrangement’ carries a wider sense than the term ‘compromise’. It implies re-arrangement of rights and the liabilities of a member or a class of members without the existence of any dispute. Arrangement includes re-organization of the share capital of a company by the consolidation of shares of different classes or by the division of the shares into shares of different classes or by both these methods. 2015-2016

An arrangement may involve any one or more of the following: Debenture-holders foregoing their claims in whole or in part; Debenture-holders exchanging their debentures for new debentures/shares; Creditors foregoing their claims in whole or in part; Creditors agreeing to receive shares/debentures in whole/in part payment of their claims; Preference shareholders foregoing their claims for arrears of dividend; Preference shareholders agreeing to accept a reduced rate of dividend in future; Fresh issue of shares to raise additional working capital; Writing off lost paid-up capital 2015-2016

How to deal with arrears of preference dividends: If the claimants of preference dividends declared but not paid agree to sacrifice under a scheme of reconstruction, their sacrifice will be credited to the reconstruction account; If the claimants of preference dividends agree to sacrifice under a scheme of reconstruction, no accounting entry is required to be passed since the company had not so far admitted any liability in respect of them 2015-2016

Pro forma Journal entries in the books of the company under reconstruction The following journal entries are passed in the books of the company: 1. When the number of shares is reduced: Share capital Account Dr. XXXX Reconstruction Account Cr. XXXX (Being the reduction in the share capital) 2. When the face value of shares is reduced : Share capital Account (RO 10 Dr. XXXX Share capital Account (RO 7) Cr. XXXX Reconstruction Account Cr. XXXX (Being the face value of shares reduced) 3.When the number of debentures is reduced: Debentures Account Dr. XXXX Reconstruction Account Cr. XXXX (Being the reduction in debentures) 2015-2016

4. When the face value of debentures reduced: Debentures (RO10) A/C Dr 4. When the face value of debentures reduced: Debentures (RO10) A/C Dr. XXXX Debentures (RO 7) A/C Cr. XXXX Reconstruction Account Cr. XXXX (Being the face value of debentures reduced) 5. When the creditors forego their claims: Creditors account Dr. XXXX Reconstruction A/C Cr. XXXX (Being the creditors reduced) 6. When the accumulated losses are written off: Reconstruction account Dr. XXXX Profit and loss Account Cr. XXXX Preliminary expenses account Cr. XXXX Discount on issue of shares AC Cr. XXXX Goodwill account Cr. XXXX Patents account Cr. XXXX Other overvalued assets AC Cr. XXXX (Being the accumulated losses written off) 7. For the expenses of reconstruction: Reconstruction Account Dr. XXXX Bank Account Cr. XXXX 2015-2016