INTRODUCTION TO INTERNAL RECONSTRUCTION OF COMPANIES we have discussed ‘Amalgamation of Companies’ where two companies are merged together or one company is purchased by another to become a single company. In this unit we shall discuss another type of administrative and financial arrangement by which the capital structure of the company in question may be legally reconstructed. This is generally called ‘Internal Reconstruction’ of company. The term ‘Reconstruction’ implies the process followed for reorganisation of a company with respect to its capital structure including the reduction of claims of both the shareholders and the creditors of the company. Reconstruction of a company is required when it faces acute financial problems due to over capitalisation or accumulation of operating losses. In this unit we will discuss the meaning of internal reconstruction and external reconstruction of companies, the situation for internal reconstruction of companies, internal reconstruction by alteration of share capital and reduction of share capital and accounting treatment on internal reconstruction of companies. MEANING OF EXTERNAL RECONSTRUCTION AND INTERNAL RECONSTRUCTION A company can be reconstructed in any of the two ways. These are: (i) ‘External’ Reconstruction and (ii) ‘Internal’ Reconstruction. Reconstruction. Reconstruction : The T he term ‘External Reconstruction’ means the winding up of an (i) External Reconstruction existing company and registering itself into a new one after a rearrangement of its financial f inancial position. Thus, there are two aspects of ‘External Reconstruction’, Reconstruction’, one, winding winding up of an existing company and the other, rearrangement of the company’s financial position. Such arrangement shall be approved by its shareholders and creditors and shall be sanctioned by the National Company Law Tribunal (NCLT). Such a step usually involves the writting off of a debit balance on Profit and Loss Account, elimination elimination of all fictitious assets if any from f rom the Balance Sheet, and the consequent readjustment of share capital.
(ii) Internal Reconstruction: Internal reconstruction means a recourse undertaken to make necessary changes in the capital structure of a company without liquidating the existing company. In internal reconstruction neither the existing company is liquidated, nor is a new company incorporated. incorporated. It is a scheme in which efforts are made to bail out the company from losses and put it in profitable position. Internal reconstruction of a company is done through the reorganisation of its share capital. It is a scheme of reorganisation reorganisation in which all interested parties in the capital structure volunteer to sacrifice. They are the company’s shareholders, debenture holders, creditors etc. Under internal reconstruction, the accumulated trading losses and fictitious assets are written off against the sacrifice made by these interest holders in the form of reduction of paid up value of their interest.
SITUATIONS WHICH CALL FOR INTERNAL RECONSTRUCTION OF A COMPANY the situations which call for internal reconstruction reconstruction of a company. The following situations are generally responsible responsible for the internal reconstruction of a company :
(i) When the capital structure of a company is complex and it is required to make it simple. (ii) When there are huge accumulated losses and it is required to write off these losses to depict a better position of the company. (iii) When a part of the capital is not represented by available tangible assets. (iv) When change is required in the face value of shares of the company so that they can become attractive for future investors
FORMS OF INTERNAL RECONSTRUCTION Internal reconstruction of a company can be carried out in the following different ways. These are as under: (A) Alteration of Share Capital; and (B) Reduction in Share Capital Reduction in capital may be either involving sacrifice of shareholders only or involving sacrifice from Shareholders and other stakeholders, viz., debenture holders and creditors. Learners should note that the sacrifice is made either by the shareholders only or by the shareholders and other stakeholders jointly. It never happens that sacrifice is made by the creditors and debenture holders only.
Alteration of Share Capital Memorandum of Association contains capital clause of a company. Under Section 94 of the Companies Act 1956, a company, limited by shares, can alter this capital clause, if is permitted by (i) the Articles of Association of the company; and (ii) if a resolution to this effect is passed by the company in the general meeting. A company can alter share capital in any of the following ways: (a) The company may increase its capital by issuing new shares. (b) It may consolidate the whole or any part of its share capital into shares of larger amount. (c) It may convert shares into stock or vice versa. (d) It may sub-divide the whole or any part of it’s share capital into shares of smaller amount. (e) It may cancel those shares which have not been taken up and reduce its capital accordingly. To alter capital by any of the above modes require a resolution at a general meeting, but does not require confirmation by the National Company Law Tribunal. The company is required to give a notice to the Registrar within thirty days of alteration. The accounting treatment of the above five types of capital alteration is discussed below. Accounting Entries on Capital Alteration: (a) If the company has issued all of its authorised capital, then, for the purpose of raising fund by the issue of fresh shares, it will have to increase its authorised capital first. For increasing the authorised capital, the Capital clause of Memorandum of Association of the company is required to be altered and permission of S.E.B.I. is also required to be obtained. No accounting entry is necessary for increasing authorised share capital. The company will have to observe the formalities prescribed under the Companies Act, 1956. After the increase in authorised capital, if the company issues fresh shares to the public, necessary entries for the issue of shares shall have to be passed. The learners are advised to recall and refer Unit 1 for accounting entries on issue of shares.
(b) The company may decide to change the shares of smaller denomination into larger denomination. This process is called consolidation of shares. On account of consolidation, the total amount of capital of the company will not change but the number of shares will decrease. The following journal entry is required to be passed: Share Capital A/c (Old Denomination) Dr. To Share Capital A/c (New Denomination) (Being the consolidation of..... Shares of Rs...... each into .......... Shares of Rs......... each as per General Meeting Resolution No....... Dtd..........)
Reduction of Share Capital Sometimes there may be a genuine necessity for the reduction of capital. This power is, given by Section 100 of the Companies Act, subject to the compliance of conditions. According to this, a company may, (1) extinguish or reduce the liability on any of its shares in respect of share capital not paid up (2) cancel any paid-up share capital which is lost or is unrepresented by any available assets; (3) pay off any paid-up share capital which is in excess of what is required by the company. Conditions for effecting a reduction Following conditions are required to be fulfilled by a company to reduce its share capital – (a) The Articles of Association of the company must permit it to reduce its capital; (b) The company in general meeting shall pass a special resolution to reduce its capital; and (c) The approval of National Company Law Tribunal (previously Court) shall be obtained for the scheme of reduction in share capital. Methods of Reduction in Share Capital: There are three ways to give effect to the scheme of Reduction in Share Capital. These are as follows: (1) By extinguishing or reducing the liability on any of its shares. (2) By paying off any paid-up share capital which is in excess of what is required by the company. (3) By cancelling any paid- up capital which is lost or is unrepresented by any available assets. Accounting Entries on Reduction in Share Capital in the books of company Accounting of reduction in Share Capital by company in case of the above three methods is shown below: (1) Journal entry for reduction of liability in respect of the uncalled amount on Shares:
