JIWAJI UNIVERSITY GWALIOR

Corporate accounting assignment

TOPIC – Internal reconstruction of a company

Submitted to Submitted by
Prof. Mehraj sir Sujata Dixit
M. Com 2 sem
MEANING
Internal Reconstruction is also known as Capital Reduction. Section 66 of the companies Act
governs the internal reconstruction. A company resorts to internal reconstruction or capital
reduction only in exceptional circumstances. Internal reconstruction result in the reduction of
the capital of the company.

Types Of Reconstruction

Reconstruction may be external or internal which are described below:

1. External reconstruction

When a company is suffering losses for the past several years and facing financial crisis, the
company can sell its business to another newly formed company. Actually, the new company is
formed to take over the assets and liabilities of the old company. This process is called external
reconstruction. In other words, external reconstruction refers to the sale of the business of
existing company to another company formed for the purposed. In external reconstruction, one
company is liquidated and another new company is formed. The liquidated company is called
"Vendor Company" and the new company is called "Purchasing Company". Shareholders of
Vendor Company become the shareholders of purchasing company.

2. Internal Reconstruction

Internal reconstruction refers to the internal re-organization of the financial structure of a

company. It is also termed as re-organization which permits the existing company to be
continued. Generally, share capital is reduced to write off the past accumulated losses of the
company. The accounting procedure of internal reconstruction is distinct from that of
amalgamation, absorption and external reconstruction.
CONDITIONS/ PROVISIONS REGARDING INTERNAL RECONSTRUCTION

AUTHORISATION BY ARTICLES OF ASSOCIATION

The company must be authorized by its articles of association to resort for capital reduction.
Articles of association contain all the details regarding the internal affairs of the company and
mention the clause containing manner of reduction of capital.

PASSING OF SPECIAL RESOLUTION

The company must pass the special resolution before resorting to capital reduction. The special
resolution can be passed only if the majority of the stakeholders are assenting to the internal
reconstruction. This special resolution must be get signed by the tribunal and deposited to the
registrar appointed under the Companies Act, 2013.

PERMISSION OF TRIBUNAL

The company must get the due permission of the court or tribunal before starting the process
of the capital reduction. The tribunal grants permission only it feels satisfied with the point that
the company is going fair and there is positive consent of every stakeholder.

PAYMENT OF BORROWINGS

As per Section 66 of the Companies Act, 2013, the company has to repay all the amounts it gets
deposited and also the interest due thereon before going for capital reduction.

CONSENT OF CREDITORS

The written consent of the creditors is required for the company which is going for capital
reduction. The court requires the company to secure the interest of the dissenting creditors.
The company gets the permission of the court after the court thinks fit that reduction of capital
will not harm the interest of the creditors.

PUBLIC NOTICE
The company has to make a public notice as per the directions of the tribunal stating that the
company is resorting to capital reduction. Also the company has to state the valid reasons for
the same.    

WAYS OF REDUCTION OF CAPITAL

The company limited by shares and limited by guarantee can go for internal reconstruction in
three ways:

By reducing or extinguishing the liability: the company can repay its liability on account of
uncalled amount on the shares issued. Under this method, the paid up shares capital of the
company would remain unchanged.  In this case, the uncalled liability is cancelled by passing
the following entry

Internal Reconstruction Vs External Reconstruction

BASIS FOR COMPARISON INTERNAL RECONSTRUCTION EXTERNAL RECONSTRUCTION

Meaning Internal reconstruction refers External reconstruction is one

to the method of corporate in which the company
restructuring wherein existing undergoing reconstruction is
company is not liquidated to liquidated to take over the
form a new one. business of existing company.

New company No new company is formed. New company is formed.

Use of specific terms in Balance Sheet of the company No specific terms are used in
Balance Sheet contains "And Reduced the Balance sheet.

Capital reduction Capital is reduced and the No reduction in the capital

external liability holders waive
their claims.

Approval of court Approval of court is must. No approval of court is

required.
 Transfer of Assets and No such transfer takes place. Assets and liabilities of
Liabilities existing company are
transferred to the new
company.

INTERNAL RECONSTRUCRION METHODS

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

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.
Reduction of share capital

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.

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.

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.

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.

In this process, the assets are restated, to represent fair values, and liabilities are restated to
show the settable amount, and thus the balance sheet shows a true picture. In this scheme,
trading losses and fictitious assets are written off, against the claim sacrificed by the debenture
holders, creditors, etc.

Definition of External Reconstruction

External Reconstruction is a process in which the company’s financial affairs are wound up, and
a new company is formed to take over the assets and liabilities of the existing company, after
the reorganization of the financial position. It requires the approval of shareholders, creditors
and National Company Law Tribunal (NCLT).

In external reconstruction, the undertaking is being continued by the company but is in

substance transferred to a company which is not an external one, but another entity that
comprises of almost same shareholders, to be carried on by the transferee company. The
accounting treatment of external reconstruction is same as the amalgamation in the nature of
the purchase.

Key Differences Between Internal and External Reconstruction

The following points are relevant on account of the differences between internal and external
reconstruction:

1. Internal reconstruction can be defined as the reorganization of the company,

without liquidating the existing company and forming a new one. On the other hand,
an external reconstruction is a form of corporate restructuring wherein the existing
company is liquidated to give birth to a new company, for continuing the business of
the existing one.
 2. No new company is formed in internal reconstruction. Conversely, the new company
is formed in the external reconstruction, to take over the business of the existing
company.

3. In internal reconstruction, the capital of the company is reduced, and external

liabilities such as debenture holders and creditors waive their claims by giving a
discount. On the other hand, in external reconstruction, there is no reduction in the
capital of the company.

4. In internal reconstruction, court’s approval is mandatory, because the reduction in

capital may affect the rights of the shareholders, which requires confirmation from
the court. As against, in external reconstruction, there is no such approval required.

5. When the company undergoes internal reconstruction process, the Balance sheet
prepared after the process contains the terms, “And Reduced.” On the contrary,
there are no specific terms used in the Balance Sheet in the case of external
reconstruction.

6. In internal reconstruction, since there is no new company is formed, there is no

transfer of assets and liabilities. Unlike, external reconstruction, assets, and liabilities
of the old company are transferred to the new company.

Forms of Internal Reconstruction of a Company (Scope of Internal Reconstruction)

Internal reconstruction of a company can be carried out in the following different ways. These
are as under:

1. Alteration of Share Capital; and

2. Reduction in Share Capital

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 its 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.

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.
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.

C) A company, in order to alter its share capital, may convert all or any of its fully paid up shares
into Stock or Stock into fully paid up shares. In case, shares are converted into Stock, the
members get a part of Stock Capital in place of shares. By converting Shares into Stock, any
amount of Stock Capital can be transferred to any other person.

D) When the shares of a company are sub-divided in shares of small value, it is known as sub-
division of shares. In sub-division of shares, the face value of a share is converted into smaller
denomination from larger denomination. The total capital of the company remains unaffected
by sub-division but the total number of shares increase.

E) Cancellation of capital may take the following form:

1. Cancellation of unissued capital; and

2. Cancellation of uncalled capital.

1. Cancellation of Unissued Capital:

Cancellation of unissued capital means cancellation of unissued shares by a company. It means

that the part of the authorised capital which has not yet been issued to the public may be
cancelled by the company.
(ii) Cancellation of uncalled capital: Cancellation of uncalled capital means cancellation of that
part of the face value of the share which has not yet been called by the company.

Reduction of 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.

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.