Practice Questions: Internal Reconstruction
Chapter Seventeen
Syllabus topic 3, "Methods including alteration of share capital ... and accounting treatment for same"
Pages 43 to 45 of 85
How to use this chapter
Cover the answers. Work each question on paper, in the order [A Complete Worked Scheme: Old Balance Sheet to New] sets out: working notes, journal, Capital Reduction Account, Balance Sheet.
Then check. Check the Capital Reduction Account total before anything else: if it does not close, the error is upstream and the Balance Sheet cannot be right.
Question 1, short
Sona Ltd. has an issued capital of 20,000 equity shares of Rs 100 each, on which Rs 75 has been called and paid. The company resolves to sub-divide each share into shares of Rs 10 each.
State the number of shares after the sub-division and the amount paid on each, and pass the journal entry.
Question 2, medium
The Balance Sheet of Meera Ltd. stood as follows.
| Liabilities | Rs | Assets | Rs |
|---|---|---|---|
| 50,000 Equity shares of Rs 10 each, fully paid | 5,00,000 | Goodwill | 50,000 |
| 2,000 8% Preference shares of Rs 100 each, fully paid | 2,00,000 | Building | 3,00,000 |
| 10% Debentures | 2,00,000 | Plant | 2,50,000 |
| Sundry creditors | 1,00,000 | Stock | 1,00,000 |
| Sundry debtors | 80,000 | ||
| Cash at bank | 20,000 | ||
| Profit and Loss A/c | 2,00,000 | ||
| Total | 10,00,000 | Total | 10,00,000 |
A scheme of internal reconstruction was sanctioned. The equity shares are to be reduced to Rs 5 each fully paid. The preference shares are to be reduced to Rs 80 each fully paid. The creditors agreed to forgo 10 per cent of their claim. Goodwill and the debit balance of Profit and Loss are to be written off in full and plant is to be written down by Rs 30,000. Any balance is to be transferred to Capital Reserve.
Pass the journal entries, prepare the Capital Reduction Account and draw the Balance Sheet after the scheme.
Question 3, hard
The Balance Sheet of Tejas Ltd. stood as follows.
| Liabilities | Rs | Assets | Rs |
|---|---|---|---|
| 30,000 Equity shares of Rs 10 each, fully paid | 3,00,000 | Goodwill | 40,000 |
| 2,000 11% Cumulative Preference shares of Rs 100 each | 2,00,000 | Land | 2,00,000 |
| 11% Debentures | 1,50,000 | Machinery | 1,80,000 |
| Outstanding interest on debentures | 16,500 | Investments | 60,000 |
| Sundry creditors | 83,500 | Stock | 90,000 |
| Bank overdraft | 50,000 | Sundry debtors | 70,000 |
| Discount on Issue of Shares | 10,000 | ||
| Profit and Loss A/c | 1,50,000 | ||
| Total | 8,00,000 | Total | 8,00,000 |
The preference dividend is in arrears for two years. The following scheme was sanctioned. (1) The equity shares are to be reduced to Rs 3 each fully paid. (2) The preference shares are to be converted into an equal number of 9 per cent preference shares of Rs 75 each fully paid. (3) The investments are to be sold at a profit of 20 per cent. (4) The preference shareholders agreed to waive half the arrears of dividend, the balance being paid in cash. (5) The debenture-holders agreed to accept the machinery at Rs 1,30,000 and 200 new 13 per cent debentures of Rs 100 each in full settlement. (6) The debenture-holders agreed to forgo half the outstanding interest, the balance being paid in cash. (7) Goodwill, the Discount on Issue of Shares and the debit balance of Profit and Loss are to be written off in full. (8) Any balance is to go to Capital Reserve.
Practice Questions: Internal Reconstruction
Pass the journal entries, prepare the Capital Reduction Account and draw the Balance Sheet after the scheme.
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Answers
Question 1
2,00,000 shares of Rs 10 each, Rs 7.50 paid on each. The old share was 75 per cent paid, so each new share must be 75 per cent paid, which s.61(1)(d) requires.
| Particulars | Dr Rs | Cr Rs |
|---|---|---|
| Equity Share Capital (Rs 100 each) A/c ... Dr | 15,00,000 | |
| To Equity Share Capital (Rs 10 each) A/c | 15,00,000 | |
| (Being 20,000 equity shares of Rs 100 each, Rs 75 paid, sub-divided into 2,00,000 shares of Rs 10 each, Rs 7.50 paid, under s.61(1)(d)) | ||
| Total | 15,00,000 | 15,00,000 |
The entry is at the paid-up figure of Rs 15,00,000, not the nominal Rs 20,00,000. That is the mark most often lost here.
Question 2
| Working note | Computation | Rs |
|---|---|---|
| WN 1. Equity sacrifice | 50,000 at Rs (10 - 5) | 2,50,000 |
| WN 2. Preference sacrifice | 2,000 at Rs (100 - 80) | 40,000 |
| WN 3. Creditors' sacrifice | 10 per cent of Rs 1,00,000 | 10,000 |
| WN 4. Write-offs | Goodwill 50,000, Profit and Loss 2,00,000, Plant 30,000 | 2,80,000 |
Capital Reduction Account
| Dr. Particulars | Rs | Cr. Particulars | Rs |
|---|---|---|---|
| To Goodwill A/c | 50,000 | By Equity Share Capital A/c | 2,50,000 |
| To Profit and Loss A/c | 2,00,000 | By 8% Preference Share Capital A/c | 40,000 |
| To Plant A/c | 30,000 | By Sundry Creditors A/c | 10,000 |
| To Capital Reserve A/c | 20,000 | ||
| Total | 3,00,000 | Total | 3,00,000 |
Balance Sheet after the scheme
| Liabilities | Rs | Assets | Rs |
|---|---|---|---|
| 50,000 Equity shares of Rs 5 each, fully paid | 2,50,000 | Building | 3,00,000 |
| 2,000 8% Preference shares of Rs 80 each, fully paid | 1,60,000 | Plant | 2,20,000 |
| Capital Reserve | 20,000 | Stock | 1,00,000 |
| 10% Debentures | 2,00,000 | Sundry debtors | 80,000 |
| Sundry creditors | 90,000 | Cash at bank | 20,000 |
| Total | 7,20,000 | Total | 7,20,000 |
The check: the Balance Sheet fell from Rs 10,00,000 to Rs 7,20,000, a fall of Rs 2,80,000, which is exactly the total written off in WN 4.
Question 3
| Working note | Computation | Rs |
|---|---|---|
| WN 1. Equity sacrifice | 30,000 at Rs (10 - 3) | 2,10,000 |
| WN 2. Preference sacrifice | 2,000 at Rs (100 - 75) | 50,000 |
| WN 3. Profit on sale of investments | 20 per cent of Rs 60,000; proceeds Rs 72,000 | 12,000 |
| WN 4. Arrears of preference dividend | Rs 2,00,000 at 11 per cent for two years | 44,000 |
| WN 5. Arrears paid in cash | half of WN 4; the other half waived, and no entry for it | 22,000 |
| WN 6. Loss on machinery given to debenture-holders | book Rs 1,80,000 less Rs 1,30,000 agreed | 50,000 |
| WN 7. Debenture interest forgone | half of Rs 16,500; the balance paid | 8,250 |
| WN 8. Write-offs | Goodwill 40,000, Discount 10,000, Profit and Loss 1,50,000 | 2,00,000 |
Practice Questions: Internal Reconstruction
Capital Reduction Account
| Dr. Particulars | Rs | Cr. Particulars | Rs |
|---|---|---|---|
| To Bank, arrears of preference dividend paid | 22,000 | By Equity Share Capital A/c | 2,10,000 |
| To Machinery A/c, shortfall on transfer | 50,000 | By 11% Preference Share Capital A/c | 50,000 |
| To Goodwill A/c | 40,000 | By Investments A/c, profit on sale | 12,000 |
| To Discount on Issue of Shares A/c | 10,000 | By Outstanding Interest on Debentures A/c | 8,250 |
| To Profit and Loss A/c | 1,50,000 | ||
| To Capital Reserve A/c | 8,250 | ||
| Total | 2,80,250 | Total | 2,80,250 |
Balance Sheet after the scheme
| Liabilities | Rs | Assets | Rs |
|---|---|---|---|
| 30,000 Equity shares of Rs 3 each, fully paid | 90,000 | Land | 2,00,000 |
| 2,000 9% Preference shares of Rs 75 each, fully paid | 1,50,000 | Stock | 90,000 |
| Capital Reserve | 8,250 | Sundry debtors | 70,000 |
| 13% Debentures | 20,000 | ||
| Sundry creditors | 83,500 | ||
| Bank overdraft | 8,250 | ||
| Total | 3,60,000 | Total | 3,60,000 |
The bank overdraft. Rs 50,000 at the start, less the Rs 72,000 received for the investments, plus the Rs 22,000 of arrears and Rs 8,250 of interest paid, is Rs 8,250.
Three marks students lose on this question. Crediting the Capital Reduction Account with the waived arrears, which are not in the books and so cannot be forgiven in the ledger. Forgetting the Rs 50,000 shortfall on the machinery. And leaving the bank overdraft at Rs 50,000.
In short
- Work the question before reading the answer; a solution read is not a solution learnt.
- Check the Capital Reduction Account first. If it does not close, nothing after it can be right.
- The fall in the Balance Sheet total equals the total written off, less any gain credited.
- Arrears of preference dividend: waiving produces no entry, paying is a debit to Capital Reduction.
- Track every rupee of cash through the bank balance or overdraft.
The rest of this subject
These notes are cut from the University's printed syllabus. Open the syllabus itself, or the past papers, for the same subject.