Methods of Internal Reconstruction (Reduction of Share Capital, Compromise/Arrangements & Surrender of Shares)

Reduction of Share Capital

Section 100 of the Companies Act, 1956 lays down the procedure in respect of reduction of share capital. One way of doing this is reducing the paid-up capital. The share capital of a company which has been suffering losses continuously for a long time, is not truly represented by its assets. In such a case, any scheme for capital reduction should write-off that portion of capital which is already lost.

This reduction is a sacrifice by the shareholders and the amount of reduction or sacrifice is credited to a new account called Capital Reduction Account (or Reconstruction Account). The accounting treatment is as follows:

Reduction in paid up value only- Here the nominal value of the share remains the same and only the paid value is reduced. For example, the shareholders may agree to reduce the paid capital of ` 100 per share to paid value of ` 10 per share. The sacrifice is ` 90 and the entry will be

Share Capital Account    Dr. (` 90 X No. of Shares)

                     To Capital Reduction Account                (` 90 X No. of Shares)

Reduction in both nominal and paid up values- In this case, both the paid up capital and nominal value of the shares are reduced. Continuing the above example, the entry will be:

Share Capital Account (` 100 Share)          Dr. (` 100 X No. of Shares)

                      To Share Capital (` 10 Share)  (` 10 X No. of Shares)

                      To Capital Reduction Account               (` 90 X No. of Shares)

Thus in such treatment we debit the original Share Capital Account so as to close it, credit new Share Capital Account with the amount treated as paid up; and credit Capital Reduction Account with the difference. A certified copy of Court’s order and Minutes approved by the Court must be filed by the Registrar.

Compromise/Arrangements

A scheme of compromise and arrangement is an agreement between a company and its members and outside liabilities when the company faces financial problems. Such an arrangement therefore also involves sacrifices by shareholders, or creditors and debenture holders or by all.

Accounting treatment for some of the cases is as follows:

1. a) When equity shareholders give up there claim to reserves and accumulated profits:

Reserves Account            Dr

                           To Reconstruction Account              

.  (With the amount of reserves)

1. b) Settlement of outside liabilities at lesser amount: Liabilities such as sundry creditors may agree to accept less amount in lieu of final settlement. Treatment will be as follows:

Outside Liabilities Account           Dr

Provision Account, if any              Dr.

                                    To Reconstruction Account              

. (With the amount of sacrifice made by creditors, debenture holders etc.)

Surrender of Shares

The shareholders are made to surrender their shares. These shares are then allotted to debenture holders and creditors so that their liabilities are reduced. The un-utilised surrendered shares are then cancelled.