CH 0 5 - INT ERNA L RECON STRUC TIO (CAPITA L R EDUC T ION)

Ch 05 - Internal Reconstruction (Capital Reduction)

Meaning
Capital Reduction is the repayment or writing down a company’s different classes of capital,
as a result of large accumulated losses or an excess of funds without profitable use.
Though Capital Reduction may be affected:
a) when a company accumulates huge surplus funds far in excess of its requirements;
b) when a company passes through a period of financial difficulties, accumulates losses or
has its assets over-valued.

Objective of Capital Reduction

When new capital has to be introduced by a company, the success of a new issue would
however, almost certainly be jeopardized by the existence of accumulated losses.
Therefore, it is prudent and usual to write-off these losses by putting a reconstruction
scheme into effect.
The objective of Capital Reduction is the resumption of the payment of normal dividends
out of the expected future profits without the necessity of using those to write-off the debit
balance of the Profit & Loss Account.

Procedure for Reduction of Capital

Note: Procedure for Reduction of Capital is discussed as per section 100 of the Companies
Act, 1956, which is replaced by the section 66 of the Companies Act, 2013. This section is
not yet notified.
1) The company must be authorized by its articles of association to reduce the share
capital. If there is no provision in the article in this respect, it must pass a Special
Resolution to alter its articles of association. It should be noted that an authority to do so
contained in the memorandum is of no avail.
2) The company must pass a Special Resolution to reduce the share capital.
3) The company must apply, be petitions, to the Court for an order confirming the
reduction. If the Court is satisfied that the creditor’s interests have been secured, it may
confirm the reduction. However, it may impose terms and conditions including a
direction that the word “and reduced” should be added after the name of the company
for a certain period of time, and that the company should publish the reasons for such
reduction. (For failure to add the words “and reduced” a penalty of Rs 500 is payable.)
4) The company has to deliver to the Registrar a certified copy of the Court’s order and a
minute approved by the Court showing the details of the shares for registration.
5) The Registrar will then register the order and the minute.
6) After registration of these, the Resolution to reduce the share capital shall take effect.
7) Notice of the registration shall be published in such a manner as the Court may direct.

When company has huge surplus funds far in excess of its requirements
Such reduction of capital may take any of the following forms:
1) The company may reduce the liability of the shareholders in respect of any unpaid
amount on the shares held by them.

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2) The company may pay-off any paid-up share capital which is in excess of its
requirements.

When the liability of the shareholders in respect of any Unpaid Amount on the Shares
held by them is Reduced
This form of capital reduction benefits the shareholders inasmuch as they will not be called
upon to pay the uncalled amount. In this case, the paid-up share capital of the company will
remain the same.

Journal Entry
Share Capital (Partly paid-up) Account Dr.
To Share Capital (Fully paid-up) Account

Illustration 1
ABC & Co. Ltd. had on 31st December, 2007, 80,000 Equity Shares of Rs 10 each, Rs 8 per
share called-up. In July, 2008, the company decided to reduce it to Rs 8 per share fully
paid-up by cancelling unpaid amount of Rs 2 per share.
You are required to pass necessary Journal Entries and show how the paid-up capital will
appear in the Balance Sheet as on 31st December, 2007 and 2008.

When the Excess Paid-up Capital is paid off

Sometimes, it may not be possible on the part of the company to employ profitably all the
capital received. In such a case, it may decide to return excess capital to the shareholders.
It should be noted that the paid-up capital of the company will be reduced by the amount
paid-off.

Journal Entries
1) If face value is NOT changed
a) Share Capital Account Dr. [Amount paid-off]
To Shareholders Account
b) Shareholders Account Dr.
To Bank Account

2) If face value is changed

a) Share Capital Account (Old) Dr. [Amount paid-off]
To Share Capital Account (New)
To Shareholders Account
b) Shareholders Account Dr.
To Bank Account

Illustration 2
ABC & Co. Ltd. had on 31st December, 2007, Rs 4,00,000 authorised capital divided into
40,000 Equity Shares of Rs 10 each. All these shares were issued and fully paid-up. In
June 2008, the company decided to paid-off Rs 2 per share to make the share of Rs 8 fully
paid-up.

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Pass necessary Journal Entries and show how the share capital will appear in the Balance
Sheet as on 31st December, 2007 and 2008.

Capital Reduction when Company passes through a period of financial difficulties

and has accumulates losses
(This is a situation where Paid-up Capital which is Lost or Not Represented by Available
Assets)
A life cycle exists for businesses as well as for individuals. When a business fail, large
amount of losses are incurred, the book values of the assets shown are much higher than
their fair market value. There are a variety of reasons for business failures, but it need
necessarily result in the collapse and dissolution of a company.
Some of the causes of business failures are as follows:
1) Management inefficiency, i.e., poor management.
2) State of trade and/or economy, which affects the concern as well as the industry.
3) Completion of the life cycle of the concern meaning thereby end of the expansion
phase.
4) Overexpansion or ramification.
5) Unforeseen internal or external disaster like certain demise of the business propeller
and struggle for power among his successors.
6) Invailability to innovate as per new invention like the computer.

Liquidation is the final step for financially destroyed businesses. Prior to that, however, the
management usually tries to work closely with the company’s creditors and lenders to
provide for their claims, while also attempting to ensure the continuation of the firm. In such
a case, capital is written down and the amount thus reduced is used to write-off the
fictitious assets and other over-valued assets. Sometimes, creditors, lenders and
debenture holders may be called upon to sacrifice a portion of their claims to make the
business stand on its own feet, which will be to the advantage of all.

Journal Entries
1) For replacement of share of one denomination by the share of another denomination.
Share Capital (Old denomination) Account Dr. [paid-up value of old shares]
To Share Capital (New denomination) Account [paid-up value of new shares]
To Capital Reduction/Reconstruction Account [Difference]

2) For reducing called-up Share Capital (without changing denomination)

Share Capital Account Dr. [Amount reduced]
To Capital Reduction/Reconstruction Account

3) For surplus on revaluation of fixed assets

Individual Fixed Asset Account Dr. [Amount of appreciation]
To Capital Reduction/ Reconstruction Account

4) For waiver of preference dividend completely

No Entry

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5) For waiver of preference dividend arrears by an issue of shares/debentures

Capital Reduction/ Reconstruction Account Dr.
To Share Capital Account
To Debentures Account

6) For issue of shares/debenture against accrued interest already provided in the Balance
Sheet
Accrued Interest Account Dr.
To Share Capital Account
To Debentures Account
To Capital Reduction/ Reconstruction Account

7) For expenses incurred on reconstruction

Capital Reduction/ Reconstruction Account Dr.
To Bank Account

8) For writing-off the fictitious assets and other assets

Capital Reduction/ Reconstruction Account Dr.
To Profit & Loss Account
To Goodwill Account
To Plant & Machinery Account
To Patent Account
To Stock account
Note: At the time of capital reduction, the fictitious assets and goodwill are to be
compulsorily written off, while other assets would be written off only if their value goes
down.
9) For capitalization of surplus on Capital Reduction Account
Capital Reduction/ Reconstruction Account Dr.
To Capital Reserve Account

Points to Remember
a) If the Court orders, the words “and reduced” should be added after the name of
the company for certain period.
b) In respect of fixed assets, the amount written-off under a scheme of
reconstruction must be shown for five years.

Illustration 3
The paid-up capital of S Ltd amounted to Rs 5,00,000, consisting of 50,000 equity shares of
Rs 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. The terms of
reconstruction were as under:

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a) In lieu of their present holding, the shareholders are to receive:

 Fully paid equity shares equal to 2/5ths of their present holding.
 12% preference shares fully paid-up, to the extent of 25% of the above new equity
shares.
 5,000, 11% second debentures of Rs 10 each.
b) An issue of 5,000, 10% first debentures of Rs 10 each was made and allotted; payment
for the same being received in cash forthwith.
c) The assets were reduced as follows: Goodwill from Rs 3,00,000 to Rs 1,50,000;
Machinery from Rs 1,00,000 to Rs 75,000; and Leasehold premises from Rs 1,50,000 to
Rs 1,25,000.

Pass journal entries to give effect to the abovementioned scheme of reconstruction and
show Capital Reorganisation Account.

Illustration 4
The following is the balance sheet of Weak Ltd as on 31.12.2006:
Liabilities Rs Assets Rs
Equity shares of Rs 100 each 1,00,00,000 Fixed Assets 1,25,00,000
12% Cumulative Preference 50,00,000 Investments (Market value Rs 10,00,000
shares of Rs 100 each 9,50,000)
10% Debentures of Rs 100 40,00,000 Current Assets 1,00,00,000
each
Sundry Creditors 50,00,000 Profit and Loss Account 4,00,000
Provision for Taxation 1,00,000 Preliminary Expenses 2,00,000
2,41,00,000 2,41,00,000

The following scheme of Reconstruction is sanctioned:

a) All the existing equity shares are reduced to Rs 40 each.
b) All preference shares are reduced to Rs 60 each.
c) The rate of interest on Debentures is increased to 12%. The debenture holders
surrender their existing debenture of Rs 100 each and exchange the same for fresh
debentures of Rs 70 each for every debenture held by them.
d) One of the creditors of the company to whom the company owes Rs 20,00,000 decides
to forego 40% of his claim. He is allotted 30,000 equity shares of Rs 40 each in full
satisfaction of his claim.
e) Fixed assets are to be written down by 30%
f) Current assets are to be revalued at Rs 45,00,000
g) The taxation liability of the company is settled at Rs 1,50,000
h) Investments to be brought to their market value.
i) It is decided to write off the fictitious assets.

Pass journal entries and show the Balance Sheet of the company after giving effect to the
above.

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Illustration 5
The following is the Balance Sheet of Weak Ltd. as on 31.3.2008:
Liabilities Rs. Assets Rs.
20,000 Equity Shares of Rs 10 2,00,000 Buildings 2,00,000
each
10% Non-cumulative Pref. Shares 50,000 Machinery 1,30,000
of Rs 100 each
8% Debentures 1,00,000 Patents 40,000
Trade Creditors 3,30,000 Inventories 80,000
Creditors for Expenses 20,000 Debtors 55,000
Preliminary Expenses 10,000
Profit & Loss A/c 1,85,000
7,00,000 7,00,000

With a view to reconstruct the company, it is proposed to:

a) Reduce –
 Equity shares by Rs 9 each;
 10% preference shares by Rs 40 each;
 8% debentures by 10%
 Trade creditors claim by one-third;
 Machinery to Rs 70,000;
 Inventories by Rs 10,000
b) Provide Rs 15,000 for doubtful debts.
c) Write off all the intangible assets.
d) Raise the rate of preference dividend to 13% and the rate of debenture interest to
13.5%.
Assuming that the aforesaid proposals are duly approved and sanctioned, pass the journal
entries to give effect to the above, and show the Company’s Post-construction Balance
Sheet.

Illustration 6
Green Limited had decided to reconstruct the Balance Sheet since it had accumulated huge
losses. The Balance Sheet of the company on 31.3.2000 before reconstruction is as below:
Liabilities Rs Assets Rs
Share Capital: Fixed Assets:
Authorised: Goodwill 20,00,000
1,50,000 Equity Shares of Rs 50 Building 10,00,000
each 75,00,000 Plant 10,00,000
Computers 25,00,000

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Subscribed & Paid-up Capital: Investments Nil

50,000 Equity Shares of Rs 50 25,00,000 Current Assets: Nil
each
1,00,000 Equity Shares of Rs 50 40,00,000 Profit & Loss A/c – Loss 20,00,000
each, Rs 40 per share paid up
Secured Loans:
12% First Debentures 5,00,000
12% Second Debentures 10,00,000
Current Liabilities:
Sundry Creditors 5,00,000
85,00,000 85,00,000

The following is in the interest of Mr. X and Mr. Y in Green Limited:

Particulars Mr. X (Rs) Mr. Y (Rs)
12% First Debentures 3,00,000 2,00,000
12% Second Debentures 7,00,000 3,00,000
Sundry Creditors 2,00,000 1,00,000
12,00,000 6,00,000
Fully Paid up Rs 50 Shares 3,00,000 2,00,000
Partly Paid up Shares (Rs 40 paid up) 5,00,000 5,00,000

The following scheme of reconstruction is approved by all parties interested and also by the
court:
a) Uncalled capital is to be called up in full and such shares and the other fully paid up
shares be converted into equity shares of Rs 20 each.
b) Mr. X is to cancel Rs 7,00,000 of his total debt (other than shares amount) and to pay
Rs 2 Lakhs to the company and to receive new 14% First Debentures for the balance
amount.
c) Mr. Y is to cancel Rs 3,00,000 of his total debt (other than equity shares) and to accept
new 14% First Debentures for the balance.
d) The amount thus surrendered available by the scheme shall be utilized in writing off
Goodwill, Profit & Loss Account (Loss) and the balance to write off the value of
computers.

You are required to draw the journal entries to record the same and also show the Balance
Sheet of the reconstructed company

Illustration 7
Following is the Balance Sheet of W Ltd as on 31st March, 2000:
Liabilities Rs Assets Rs

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1,00,000 Equity Shares of Rs 10 10,00,000 Machinery 8,70,000

each, fully paid-up
3,000 12% Pref Shares of Rs 100 3,00,000 Furniture 1,00,000
each, fully paid-up
11% Debentures 3,00,000 Patents and copyrights 40,000
Interest outstanding on debentures 33,000 Investments (market value 32,500
Rs 27,500)
Loan from bank (including interest 86,400 Stock 3,00,000
due)
Creditors 54,500 Debtors 2,19,500
Cash at Bank 7,900
Profit & Loss A/c 2,04,000
17,73,900 17,73,900
Note: Preference Dividend is in arrear for two years.

The following scheme of reconstruction has been agreed upon and duly approved:
a) The existing equity shares are converted into equal number of fully paid equity shares of
Rs 7 each. The equity shareholders also agree to take up 50,000 new equity shares of
Rs 7 each, the total amount being paid by them immediately.
b) The preference shareholders agree to forego arrears of dividend and accept 85% of
their capital amount by way of redemption of all the preference shares.
c) The debenture holders agree to give up their claim to outstanding interest in
consideration of the rate of interest on debentures being enhanced to 13.5%.
d) Bank agrees to waive its claim to outstanding interest amounting to Rs 6,400 provided
the balance of loan of Rs 80,000 to be paid off forthwith.
e) Investments are to appear at market value.
f) Patents and copyrights are to be written off completely.
g) 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.

Illustration 8
The following is the Balance Sheet of Downhill Ltd as on 31.12.2007:
Liabilities Rs Assets Rs
20,000 Equity Shares of Rs 100 each 20,00,000 Goodwill 25,000
12% Debentures 5,00,000 Land and Buildings 1,50,000
Outstanding Debenture Interest 1,20,000 Plant and Machinery 3,00,000
Creditors 3,00,000 Furniture 80,000
Stock 2,70,000

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Debtors 60,000
Cash at Bank 35,000
Preliminary Expenses 20,000
Profit & Loss A/c 19,80,000
29,20,000 29,20,000

The following scheme of reconstruction is executed:

a) Equity shares are reduced by Rs 95 per share. They are, then, consolidated into 10,000
equity shares of Rs 10 each.
b) Debenture holders agree to forego outstanding debenture interest. As compensation,
12% debentures are converted into 14% debentures, the amount remaining Rs
5,00,000.
c) 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 Rs 10 each. Creditors for Rs
2,00,000 opt for shares in satisfaction of their claims.
d) To make payment to creditors opting for cash payment and to augment working capital,
the company issues 50,000 equity shares of Rs 10 each at par, the entire amount being
payable along with applications. The issue was fully subscribed.
e) Land and buildings are revalued at Rs 2,00,000 whereas plant and machinery is to be
written down to Rs 2,10,000. A provision amounting to Rs 5,000 is to be made for
doubtful debts.

Pass journal entries and draft the company’s Balance Sheet immediately after the
reconstruction.

Illustration 9
X Ltd whose Balance Sheet as at 31st December, 2007 appears below formulated a
scheme of reconstruction, details of which follow and secured approval of all concerned.
Liabilities Rs Assets Rs
Equity share capital: Fixed Assets 5,60,000
50,000 Shares of Rs 20 each, Rs 10 paid 5,00,000
8% Preference share capital: Patents and copyrights 40,000
4,000 Shares of Rs 100 each, Rs 75 paid 3,00,000
up
Secured Loans: Investments at cost 32,500
9% Debentures 3,00,000 (M.V. Rs 27,500)
Interest accrued and due 54,000 3,54,000
Bank Overdraft 75,000 Current Assets 4,24,500
Sundry Creditors (including interest of Rs Profit & Loss A/c 2,14,000
7,500 due to Bank) 42,000
12,71,000 12,71,000
Preference dividend is in arrears for one year.

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a) Preference shareholders to give up their claims inclusive of dividends to the extent of

30% and desire to be paid-off.
b) Debenture holders agree to give up their claims to interest in consideration of their rate
of interest being enhanced to 10%.
c) Bank agrees to give up 50% of their interest outstanding in consideration of their being
paid off at once.
d) Sundry creditors would like to grant a discount of 5% if they were to be paid-off
immediately.
e) Balances on Profit & Loss A/c, Patents and Copyrights and 25% of the total Sundry
Debtors of Rs 60,000 to be written-off. Fixed assets to be written-down by Rs 7,000.
Investments to reflect their market value.
f) To the extent not specifically stated equity shareholders suffer no reduction of their
rights.
g) Cost of reconstruction Rs 1,675.

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 cash balance of Rs 10,000. Please draw the Balance Sheet after
reconstruction.

Illustration 10
The balance sheet of M/s Raman Ltd. as at 31st December,2007 is as follows:
Liabilities Rs. Assets Rs.
Paid up Capital Fixed Assets:
8000 Equity shares of Rs 100 8,00,000 Land, Building and Machinery 14,00,000
each fully paid
Secured Loan: Current assets:
8% Debenture 14,00,000 Stock 1,00,000
Accrued interest 70,000 Sundry debtors 40,000
Sundry creditors 4,50,000 Investments 15,000
Income tax liability 10,000 Cash at bank 1,03,000
Cash in hand 2,000
Profit and loss A/c 10,70,000
27,30,000 27,30,000

The fixed assets are heavily overvalued. A scheme of reconstruction was prepared and
passed. The salient points of the scheme are the following:
a) Each share shall be sub-divided into ten fully paid Equity shares of Rs. 10 Each
b) After such sub-division, each shareholder shall surrender to the company 90% of his
holding, for the purpose of re-issue to Debenture holders and Creditors so far as
required, and otherwise for cancellation.

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c) Of those surrendered 50000 Equity Shares of Rs. 10 each shall be converted into 8%
preference shares of Rs 10 each fully paid for Debenture holders.
d) The Debenture holders’ total claim shall be reduced to Rs 500000. This will be satisfied
by the issue of 50000 preference shares of Rs 10 each fully paid.
e) The claim of sundry creditors shall be reduced by 80% and the balance shall be
satisfied by allotting them Equity shares of Rs. 10 each, fully paid from the shares
surrendered.
f) Shares surrendered and not re-issued shall be cancelled.

A Member holding 100 Equity shares opposed the scheme and his shares were taken over
by a director on payment of Rs. 1000 as fixed by the court.

Illustration 11
The Balance Sheet as at 31st March, 2008 of Sickness Ltd. Was as under:
Liabilities Rs. Assets Rs. Rs.
Share capital Fixed assets:
8000 Equity share of Rs.100 each, 4,00,000 Goodwill at cost 40,000
Rs. 50 per share paid up
4000 11% Cumulative preference 4,00,000 Others 8,50,000
shares of Rs 100 Each, fully paid
up
8,90,000
Premium recd. On preference 40,000 Less: Depreciation 2,70,000 6,20,000
shares
General reserve 60,000 Investments 25,000
Current liabilities 3,10,000 Stock in trade 2,10,000
Contingent liabilities not provided: -- Sundry Debtors 2,55,000
(Preference Dividend is in arrears
for 3 yrs including the year ended
31st March, 2008.
Cash and bank 1,00,000
balance
12,10,000 12,10,000

The funds of the company are sufficient to discharge its liabilities including preference
Dividends in arrears. However, the company does not want to deplete its resources. It
would also like to reflect the value the some of its asset in a realistic manner. The Board of
directors of the company decided and proposed the following scheme of
rehabilitation/reconstruction to be effective from 1st April, 2008:
a) The cumulative preference shareholders are to be issued, in exchange of their holdings,
13% debentures of the face value of Rs. 100 each at a premium of 10%, fractional
holdings are to be paid off in cash.

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b) Arrears in preference dividends to be converted into equity shares of Rs 100, Rs. 50 per
share paid-up.
c) After the issue of the equity share mentioned in (2) above, the paid-up value of all the
equity shares is to be reduced to Rs 25 each.
d) The face value of all the equity shares is to be reduced to Rs 50 each and the balance
of the unpaid portion is to be called-up fully.
e) Goodwill has lost its value and has to be written-off. Market value of other fixed assets
is determined, as at 31st march, 2008 at Rs 500000.
f) Investments have no market value and have to be written-off.
g) Stock in trade is to be valued at 110% of its book value and sundry Debtors are to be
discounted by 5%

The scheme, as approved by the directors, is duly accepted by all authorities and put into
effect. During the working for the half year ended 30th Sep, 2008. It is noticed that the
trading for the period has resulted in an increase of bank balances by Rs. 55100 sundry
debtors by Rs. 40000, trade creditors by Rs. 26000. The increase in the bank balance was
prior to the company paying the half yearly interest on the debentures and redeeming one
half of the debentures on 30th Sep, 2008.
From the above information, you are required to prepare the balance sheet of sickness Ltd.
As at 30th Sep, 2008. All working notes, including journal entries, Ledger Accounts etc., are
to form part of your answer.

Illustration 12
The Balance Sheet of Y Ltd as on 31 March, 2003 was as follow:
Liabilities Rs. Assets Rs.
500000 Equity shares of Rs 10 50,00,000 Goodwill 10,00,000
each fully paid.
9%, 20000 preference sh. Of 20,00,000 Patent 5,00,000
Rs. 100 each fully paid
10% first debentures 6,00,000 Land and Building 30,00,000
10% Second debentures 10,00,000 Plant and Machinery 10,00,000
Debentures Interest outstanding 1,60,000 Furniture and Fixtures 2,00,000
Trade creditors 5,00,000 Computers 3,00,000
Directors loan 1,00,000 Trade investment 5,00,000
Bank O/D 1,00,000 Stock 10,00,000
Outstanding liabilities 40,000 Discount on issue of debentures 1,00,000
Provision for tax 1,00,000 Debtors 5,00,000
Profit and Loss A/c 15,00,000
96,00,000 96,00,000
Note: Preference dividend is in arrears for last three years.

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A hold 10% first debentures for Rs 400000 and 10% second debentures for Rs. 600000. He
is also creditors for Rs 100000.
B holds 10% first debentures for Rs 200000 and 10% second debentures for Rs. 400000
and is also creditors for Rs 50000
The following scheme of reconstruction has been agreed upon and duly approved by the
court:
a) All the equity shares be converted into fully paid equity shares of Rs. 5 each.
b) The preference shares be reduced to Rs 50 each and the preference shareholders
agree to forego their arrears of preference dividends in consideration of which 9%
preference shares are to be converted into 10% preference shares.
c) Mr. A is to cancel Rs 600000 of his total debt including interest on debentures and to
pay Rs 1 lakh to the company and to receive new 12% debentures for the balance
amount.
d) Mr. B is to cancel Rs 300000 of his total debt including interest on debentures and to
accept new 12% debentures for the balance amount.
e) Trade creditors (other A and B) agreed to forego 50% of their claim.
f) Directors to accept settlement of their loans as to 60% thereof by allotment of equity
shares and balance being waived.
g) There were capital commitments totaling Rs 300000. These contracts are to be
cancelled on payment of 5% of the contract price as a penalty.
h) The directors refund Rs 110000 of the fees previously received by them.
i) Reconstruction expenses paid Rs 10000.
j) The taxation liability of the company is settled at Rs 80000 and the same is paid
immediately.
k) The assets are revalued as under:
Land and Building 2800000
Plant and machinery 400000
Stock 700000
Debtors 300000
Computers 180000
Furniture and Fixtures 100000
Trade investment 400000
l) It is expected that due to changed condition and new management operating profit will
be earned at the rate of Rs 50,000 p.a after depreciation but before interest and tax.
Pass journal entries for all the above mentioned transactions including amounts to be
written off of goodwill, patents, loss in profit and loss account and discount on issue of
debenture.
Prepare bank account and working of allocation of interest on debentures between A and B.

Illustration 13
The Balance Sheet of A & Co. Ltd. as on 31-12-2011 is as follows:
Assets Rs. Rs.
Fixed Assets:
Freehold property 4,25,000

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Plant 50,000
Patent 37,500
Goodwill 1,30,000 6,42,500
Traded Investments (at cost) 55,000
Current Assets:
Trade receivables 4,85,000
Inventory 4,25,000 9,10,000
Profit and Loss Account 5,35,000
Total 21,42,500
Liabilities
Share Capital:
4,000 6% Cumulative Preference Shares of Rs.100 each 4,00,000
75,000 Equity Shares of Rs.10 each 7,50,000 11,50,000
6% Debentures (Secured on Freehold Property) 3,75,000
Accrued Interest 22,500 3,97,500
Current Liabilities:
Bank Overdraft 1,95,000
Trade payables 3,00,000
Directors’ Loans 1,00,000 5,95,000
Total 21,42,500
The Court approved a Scheme of re-organisation to take effect on 1-1-2012, whereby:
a) The Preference shares to be written down to Rs.75 each and Equity Shares to Rs.2
each.
b) Of the Preference Share dividends which are in arrears for four years, three fourths to
be waived and Equity Shares of Rs.2 each to be allotted for the remaining quarter.
c) Accrued interest on debentures to be paid in cash.
d) Debenture-holders agreed to take over freehold property, book value Rs.1,00,000 at a
valuation of Rs.1,20,000 in part repayment of their holdings and to provide additional
cash of Rs.1,30,000 secured by a floating charge on company’s assets at an interest
rate of 8% p.a.
e) Patents and Goodwill to be written off.
f) Inventory to be written off by Rs.65,000.
g) Amount of Rs.68,500 to be provided for bad debts.
h) Remaining freehold property to be re-valued at Rs.3,87,500.
i) Trade Investments be sold for Rs.1,40,000.
j) Directors to accept settlement of their loans as to 90% thereof by allotment of equity
shares of Rs.2 each and as to 5% in cash, and balance 5% being waived.
k) There were capital commitments totalling Rs.2,50,000. These contracts are to be
cancelled on payment of 5% of the contract price as a penalty.

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l) Ignore taxation and cost of the scheme.

You are requested to show Journal entries reflecting the above transactions (including cash
transactions) and prepare the Balance Sheet of the company after completion of the
Scheme.

Illustration 14
Faireweather Ltd Ran into a patch of bad financial management and its affairs were handed
over to a receiver appointed by the debenture holders. Its statement of affairs was as given
below:
Assets Book value Expected to realize
Rs. Rs.
Land and Building 8,00,000 10,00,000
Plant and Machinery 12,00,000 7,00,000
Stock in trade 8,00,000 5,50,000
Trade debtors 9,50,000 4,75,000
Cash 1,50,000 1,50,000
39,00,000 28,75,000
Deduct: 7% first mortgage debentures 12,50,000
16,25,000
Deduct: 8% second mortgage debenture 20,00,000
Deficiency regarding second Debenture 3,75,000
Unsecured creditors 4,50,000
Deficiency regarding unsecured creditors 8,25,000
Contributories:
40000 Equity shares of Rs10 each fully paid up 4,00,000
60000 equity shares of Rs 10 each, Rs 5 per share 3,00,000 7,00,000
paid up
Deficiency regarding contributories 15,25,000

All the mortgage debentures are held between two groups of individuals X and Y as
indicated below:
X and his friend Y and his friend
st
1 mortgage debentures Rs. 7,50,000 Rs. 5,00,000
2nd mortgage debentures Rs. 12,50,000 Rs. 7,50,000

In addition, X and Y rank as unsecured creditors to the extent of Rs 150000 and Rs.
100000 respectively. Each of X and Y also hold 10000 fully paid equity shares and 4000
partly paid equity shares in the company.
The following scheme of reconstruction was agreed upon:

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a) The partly paid up equity shares would be fully paid up by making a call; after the
shares are fully paid, all equity shares except to the extent indicated otherwise below,
would be reduced to shares of Rs 1 each fully paid up.
b) X will give up all his claims regarding debentures and other credits, surrender all his
equity shares and would receive in return 10% mortgage debentures of Rs 18 lakh and
cash of Rs 89000.
c) Y will give up all his claims on debentures and credits. He will bring in cash of Rs 75000
and in consideration would be issued with 10% mortgage debenture of Rs 10 lakhs.
d) The rest of the sundry creditors agree to give up 12.5% of their claims, get equity shares
of Re 1 each fully paid up allotted to them for 50% of their claims and await discharge of
the balance in due course.

Pass journal entries (narrations need not be given) to give effect to the above proposal and
prepare the balance sheet after re-construction

Home Assignment

Illustration 15
The summarised Balance Sheet of M/s. Ice Ltd. as on 31-03-2012 is given below:
Liabilities Rs Assets Rs
1,00,000 Equity shares of 10,00,000 Freehold property 5,50,000
Rs.10 each fully paid up
4,000, 8% Preference shares of 4,00,000 Plant and machinery 2,00,000
Rs.100 each fully paid
6% Debentures 4,00,000 Trade investment (at cost) 2,00,000
(secured by freehold property)
Arrear interest 24,000 Trade receivables 4,50,000
Trade payables 1,01,000 Inventories-in trade 3,00,000
Director’s loan 3,00,000 Profit and loss account 5,25,000
22,25,000 22,25,000

The Board of Directors of the company decided upon the following scheme of
reconstruction with the consent of respective stakeholders:
a) Preference shares are to be written down to Rs.80 each and equity shares to Rs.2 each.
b) Preference dividend in arrear for 3 years to be waived by 2/3rd and for balance 1/3rd,
equity shares of Rs.2 each to be allotted.
c) Debentureholders agreed to take one freehold property at its book value of Rs.3,00,000
in part payment of their holding. Balance debentures to remain as liability of the
company.
d) Arrear debenture interest to be paid in cash.
e) Remaining freehold property to be valued at Rs.4,00,000.
f) Investment sold out for Rs.2,50,000.

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g) 75% of Director’s loan to be waived and for the balance, equity shares of Rs.2 each to
be allotted.
h) 40% of Trade receivables, 80% of Inventories and 100% of debit balance of profit and
loss account to be written off.
i) Company’s contractual commitments amounting to Rs.6,00,000 have been settled by
paying 5% penalty of contract value.
Show the Journal Entries for giving effect to the internal re-construction and draw the
Balance Sheet of the company after effecting the scheme.
Answer: Refer ICAI Practice Manual July, 2015 Edition – Question 6, Pg 5.18.

Illustration 16
Given below is the summarized balance sheet of Rebuilt Ltd. as on 31.3.2012:
Liabilities Rs Assets Rs
Authorised and issued capital: Building at cost less 4,00,000
depreciation
12,000, 7% Preference shares 6,00,000 Plant at cost less depreciation 2,68,000
of Rs.50 each (Note: Preference
dividend is in arrear for five
years)
15,000 Equity shares of Rs.50 7,50,000 Trademarks and goodwill at 3,18,000
each cost
Loan 5,73,000 Inventory 4,00,000
Trade payables 2,07,000 Trade receivables 3,28,000
Other liabilities 35,000 Profit and loss A/c 4,51,000
21,65,000 21,65,000

The Company is now earning profits short of working capital and a scheme of
reconstruction has been approved by both the classes of shareholders. A summary of the
scheme is as follows:
a) The equity shareholders have agreed that their Rs.50 shares should be reduced to
Rs.2.50 by cancellation of Rs.47.50 per share. They have also agreed to subscribe for
three new equity shares of Rs.2.50 each for each equity share held.
b) The preference shareholders have agreed to cancel the arrears of dividends and to
accept for each Rs.50 share, 4 new 5% preference shares of Rs.10 each, plus 6 new
equity shares of Rs.2.50 each, all credited as fully paid.
c) Lenders to the company for Rs.1,50,000 have agreed to convert their loan into share
and for this purpose they will be allotted 12,000 new preference shares of Rs.10 each
and 12,000 new equity shares of Rs.2.50 each.
d) The directors have agreed to subscribe in cash for 40,000, new equity shares of Rs.2.50
each in addition to any shares to be subscribed by them under (a) above.
e) Of the cash received by the issue of new shares, Rs.2,00,000 is to be used to reduce
the loan due by the company.
f) The equity share capital cancelled is to be applied:
- to write off the debit balance in the profit and loss A/c; and

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- to write off Rs.35,000 from the value of plant.

g) Any balance remaining is to be used to write down the value of trademarks and
goodwill.
Show by journal entries how the financial books are affected by the scheme and prepare
the balance sheet of the company after reconstruction. The nominal capital as reduced is to
be increased to Rs.6,50,000 for preference share capital and Rs.7,50,000 for equity share
capital
Answer: Refer ICAI Study Material July, 2015 Edition – Question 5, Pg 5.15.
.

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