Month: May 2021

Management Notes

Legal Provisions relating to final Accounts

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As per section 5(b): ‘Banking’ means the accepting for the purpose of lending or investment of deposits of money from public, repayable on demand or otherwise and withdrawable by cheque, draft, order or there wise.

  • As per section 5(d): ‘Company’ means any company defined in section 3 of the company’s act, 1956 and includes a foreign company within meaning of section 591 of that Act.
  • As per section 5(c): Banking Company means any company which transacts the business of banking in India.

Section 210 of the Companies Act governs the preparation of final account of a Company. The Board of Directors of a Company must, within 18 month from the date of incorporation, and subsequently once a year, lay take the company in general meeting the Balance Sheet of the Com­pany and a Profit and Loss Account.

In case of non-profit Companies, an Income and expenditure Account should be submitted. The period to which the account relates is called a Financial Year of the Company. It may be less or more of a calendar year but must not exceed 15 months. It may also be extended to 18 months provided the Register has granted special permission.

The Profit and Loss Account or Income and Expenditure Account the relate, in the case of the first Annual General Meeting of the Company, in a period from the date of a incorporation to a day which shall not precede the day of the meeting by more than nine months.

And in case of any subsequent Annual General Meeting, the period runs from the date of the previous accounts to a date not more than six months prior to the date of meeting.

Section 211 prescribes the form of Balance Sheet and contents of Profit and Loss Account. Every Balance Sheet of Company shall give a true and fair view of the state of affairs of the Company as at the end of the financial year.

It shall also be in the form set out in part 1 of Schedule VI, or in such other form as may be approved by the Central Government [211 (1)].

Provided that nothing contained in this sub-section shall apply to any Insurance or Banking Company or any Company engaged in the generation of supply of electricity or to any other class of Company for which a form of Balance Sheet been specified in or under the Act governing such class of Company.

Every Profit and Loss Account of a Company shall give a true and, fair view of the profit and loss the Company for the financial year. It shall also comply with the requirements of part II of Schedule VI, so far as they are applicable thereto [Sec. 211 (2)].

This requirement does not apply to any Insurance or Banking Company or any Company engaged in the generation of supply of electric­ity, or any other class of company for which a form of Profit and Loss Account has been specified in or under the Act governing such class of Company.

Every Balance Sheet and every Profit and Loss Account of a Company shall be duly signed on behalf of the Board of Directors by the Manager or Secretary, if any, and by not less than two Direc­tors of the Company.

One of the Directors who sign shall be a Managing Director where there is one. The Balance Sheet and Profit and Loss Account must be approved by the Board before they are submitted to the auditors who must in turn attach their report thereto.

The Profit and Loss Account shall be annexed to the Balance Sheet and the auditor’s report shall be attached thereto. If there is any separate, special supplementary report by the auditor, it shall also be attached to the Balance Sheet.

If any person, being a Director of a Company, fails to take all reasonable step to company with the previsions, he shall, in respect of each offence, be punishable with imprisonment for a term which may extend to six months, or with imprisonment for a term which may extend to six months, or with fine which may extend to Rs. 1,000 or with both.

However, the punishment of imprisonment is given only when the offence is committed willfully.

Profit and Loss Account:

The Indian Companies Act is silent as to the form of Profit and Loss Account. But part II of Schedule VI contains a list of items of incomes and expenditure which should be included in the Profit and Loss Account.

The profit and Loss Account of a Company should give a true and fair view of the profit or loss of the Company for the financial year. The first account covers the period since the incorporation of the Company, and subsequent accounts cover the period since the date of the preceding account.

An Income and Expenditure Account takes the place of Profit and Loss Account in the case of a Company not trading for profit.

Statutory Requirements:

Profit and Loss Account shall be so made out as to clearly disclose the result of the working of the Company during the period covered by the account and shall disclose every material feature including credits or receipts and debits or expenses in respect of non-recurring expenditure or expenditure of an exceptional nature. It shall set out the various items relating to the income and expenditure of the Company under the most convenient heads and in particular shall disclose the following information in respect of the accounting period.

The Profit and Loss Account must be prepared with the directions given in part II Schedule VI of the Act. The important provisions are given below:

  1. (a) The turnover, that is, the aggregate amount for which sales are effected by the Company, giving the amount of sales in respect of each class of goods dealt with by the Company, and indicating the quantities of such sales for each class Separately.

(b) Commission paid to sole selling agent within the meaning of section 294 of the Act

(c) Commission paid to other selling agents.

(d) Brokerage and discount on sales other than sales trade discount.

  1. (a) In the case of manufacturing concerns, the purchase of raw material including consumption and the opening and closing stocks of the good produced indicating the quantity produced.

(b) In the case of trading concerns the purchases made and the opening and the Closing stocks.

(c) In the case of Companies rendering or supplying services, the gross income derived from service rendered or supplied.

(d) In the case of Company which falls under more than one of the categories mentioned in (a), (b) and (c) above, it shall be sufficient compliance with the requirements herein if the total amounts are shown in respect of the opening and closing stocks, purchases, sales up and the gross income from services rendered is shown.

(e) In the case of other Companies, the gross income derived under different heads.

  1. In the case of all concerns having work-in-progress, the amounts for which (such works have been completed) at the commencement and at the end of the accounting period.
  2. The amount provided for depreciation, renewals or diminution in value of fixed assets. If such provision is not made by means of a depreciation charge, the method adopted for making such provision.

If not provision is made for depreciation, the fact that no provision has been made shall be stated and the quantum of arrears of depreciation computed in accordance with Section 205 (2) of the Act shall be disclosed by way of a note.

The amount of interest on the Company’s debentures and other fixed loans, that is to say loans for fixed periods stating separately the amount of interest if any, paid or payable to the Managing Director, and the Manager, if any.

The amount of charge for Indian Income-tax and other Indian taxation on profit and distinguishing them.

The amount reserved for:

(a) Repayment of share capital and

(b) Repayment of loans.

(a) The aggregate, if material, of any amounts set aside or proposed to be set aside to reserves but not including provisions made to meet any specific liability, contingency or commitment known to exist at the date of the Balance Sheet.

(b) The aggregate, if material, of any amount withdraws from such reserves.

(a) The aggregate, if material of the amounts set aside to provisions made for meeting specific liabilities, contingencies or commitments.

(c) The aggregate, if material, of the amounts withdrawn from such provisions, as no longer required.

Expenditure incurred on each of the following items separately for each item:

(a) Consumption of stores and spare parts.

(b) Power and fuel.

(c) Rent.

(d) Repairs to Buildings.

(e) Repairs to Machinery.

(f) (i) Salaries, Wages and Bonus.

(ii) Contribution to provident and other funds.

(iii) Workmen and staff welfare expenses to the extent not adjusted from any previous provision or reserve.

(g) Insurance

(h) Rates and taxes including taxes on income.

(i) Miscellaneous expenses.

Provided that any item under which the expenses exceed 1% of the total revenue of the Com­pany or Rs. 5,000, whichever is higher, shall be shown as a separate and distinct item against an appropriate account head in the Profit and Loss Account and shall not be combined with any other items to be shown under Miscellaneous Expenses.

(a) The amount of income from investments, distinguishing between trade Investments.

(b) Other income by way of interest, specifying the nature of the income.

(c) The amount of income tax deducted if the gross income is stated under subparagraphs (a) and (b) above.

(a) Profit and losses on investments (showing distinctly the extent of the profits or losses earned or incurred on account of membership of a partnership firm) to the extent not adjusted from any previous provision or reserve.

(b) Profit and losses in respect of transactions of a kind not usually undertaken by the Company or undertaken in circumstances of an exceptional or non-recurring if material in amount.

(c) Miscellaneous income.

(a) Dividends from Subsidiary Companies.

(b) Provisions for losses of Subsidiary Companies.

The aggregate amount of dividends paid and proposed, and stating whether such amounts are subject to deduction of income tax or not.

Amount, if material, by which any items shown in the Profit and Loss Account is affected by any change in the basis of accounting. The Profit and Loss Account shall contain by way of a note detailed information showing separately the following payments provided or made during the financial year to the Directors (in­cluding Managing Directors) the Managing Agents, Secretaries and Treasurers or Manager, if any, by the Company.

The subsidiaries the Company, the subsidiaries of the Company of any other person:

Managerial remuneration under Section 198 of the Act paid or payable during the financial year.

Expenses reimbursed to the Managing Agent under Section 345.

Commission or other remuneration payable separately to a Managing Agent or his associate under Section 356,357 and 358.

Commission received or receivable under Section 356 by the Managing Agent or his associate as selling agent of other concerns in respect of contracts entered into by such concerns with the Company.

The money value of the contracts for the sale or purchase of goods and materials or supply of services, entered into by the Company with the Managing Agent or his associate under Section 360 during the financial year.

Other allowances and commission including guarantee commission. Any other perquisites or benefits in cash or in kind stating the money value where practicable.

Pensions, gratuities, payments from provident funds in excess of own subscription and interest thereon, compensation for loss of office, consideration in connection with retirement from office.

The Profit and Loss Account shall contain or give by way of a note a statement showing the computation of net profits in accordance with Section 340 of the Act with the relevant details of the calculation of the commission’s payable by way of percentage of such profits to the directors including Managing Directors or Managers, if any.

The Profit and Loss Account also contains by way of note detailed information in regard to amounts paid to the auditors whether as fees, expenses or otherwise for services rendered as auditor and in any other capacity.

(VIII) Special points to be remembered while preparing Balance Sheet:

  1. Calls-in-arrears:

It refers to the amount not paid by the shareholders on the calls made on them by the company. This item is usually given in the trial balance. It should be deducted from the called up the liabilities side of the Balance Sheet to find paid up capital.

If the Trial balance shows only the paid up capital and the call-in-arrears is given in the adjustment, the amount is first added to the paid up capital to show the called up capital and then deducted against so that the paid up capital can be shown in the outer column.

  1. Unclaimed dividend:

It refers to the amount of dividend not collected by the shareholders from the company. This item is always shown on the credit side of Trial Balance. It is shown on the liabilities side of the Balance Sheet under the heading “Current Liabilities”.

  1. Forfeited shares account:

This item appears as a credit item in the Trial Balance and is shown on the liabilities side of the Balance sheet by adding it to the paid up capital.

  1. Securities premium account:

This item is shown on the liabilities side of the Balance Sheet under the heading “Reserves and Surplus”.

Management Notes

Rebate on Bills Discounted

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Rebate on Bills Discounted is also known as Discount Received in Advance, or, Unexpired Discount or, Discount Received but not earned.

Its treatment is same as we do in the case of Interest Received in Advance.

Thus:

(i) If it is given only in the Trial Balance:

The same will be shown as a liability and will appear in the liability side of the Balance Sheet.

(ii) If it is given in adjustment:

In that case, the same is deducted from the Income from Interest and Discount in Profit and Loss Account and the same also will appear in the liability side of the Balance Sheet.

Method of Computation of Rebate on Bills Discounted:

For example, a customer discounts a bill of Rs. 60,000 for 3 months at 12% on 1st March 2000, it will be calculated as under:

Bank will earn discount @ 12% for 92 days i.e., = Rs. 60,000 x 12/100 x 92/365 = Rs. 1814.

But this amount of discount is meant for March, April and May. As accounts are prepared on 31st March each year, discount received for 61 days (30 + 31) for April and May is not actually earned. Thus, discount of 61 days i.e., Rs. 601 is called Rebate on Bill Discounted. So, actual income is Rs. 1213/- (i.e., 1814 – Rs. 601).

Treatment in Profit and Loss Account and Balance Sheet:

(i) Discount earned (up to 31.12.1992) will be credited to P & L A/c and unexpired discount will, however, be credited to Rebate on Bills Discounted A/c, and will appear in the liability side of the Balance Sheet.

(ii) Commissions earned will be credited to P & L A/c whereas customers’ liability for acceptance will appear on the asset side of the Balance Sheet and Acceptance on behalf of customer will appear in the liability side as contra items, and

(iii) Loans and advances will appear in the assets side of the Balance Sheet.

Management Notes

Slip system of Posting

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It is a method of rapid posting in books maintained under Double Entry principle. Under this system, posting is done from slips and not from journals or cash books.

Slips are loose leaves of journals and these are supplied either by the customers or by the bank staff.

Reasons for adoption of slip system

  • Slip System of accounting/ posting is adopted for the following reasons:
  • It ensures smooth flow of accounting.
  • It can distribute the work of posting among many persons.
  • It helps in keeping the accounts of customer upto date.
  • This system saves a lot of clerical labour as most of the slips are filled in by the customers and provide an objective evidence of the records.

Features of slip system of posting

  • Slip system of posting is based on the Double Entry System. Double Entry System is a system in which each entry affects the two accounts with same amount, i.e. debit is equals to the credit.
  • The transactions are entered into by providing the details on the slips.
  • It contains the different slips i.e. withdrawal slip, pay-in-slip and cheque for different types of transactions.
  • It records the transactions in ledger book of accounts.
  • Slips serves as the evidence for the transactions.

Advantages of Slip System:

(i) it reduces the possibility of errors and frauds;

(ii) it saves a lot of time since it is prepared by the customers themselves;

(iii) it provides a good system of internal check etc.

Disadvantages of Slip System:

Chances of Loss of Slips: Slips are just like the loose leaves of the paper. It may be lost, distorted or misappropriated very easily. Thus, it is unjustified to maintain the records in form of the slips.

No Verification: As the posting is done directly to the ledger accounts and no entry is made in the subsidiary books. So verification of accounts is not possible.

Types

Withdrawal Slip

Withdrawal Slip is the slip used for drawing the amount from the bank account. It is a document of bank on which a person writes the date, account number and amount of money to withdraw from the bank. These slips contain the following particulars to be filled:

  • Name of the Drawer having bank account
  • Account Number
  • Date
  • Branch of the Bank
  • Signature of the Drawer

PAY-IN-SLIP

This is also known as deposit Slip. It is a form supplied by a bank for a depositor to fill out and to deposit the money in the bank. Pay-in-slip is used to deposit the amount in the bank. These slips contains the following particulars to be filled:

  • Name of the Depositor having bank account
  • Contact Number
  • Account Number
  • PAN Number
  • Date
  • Branch of the Bank
  • Denominations of the money deposited
  • Signature of the Depositor

CHEQUES

Cheque is a negotiable instrument which can be transferred by mere hand delivery. It is a document issued by an individual to his or her bank, directing them to pay the person whose name is mentioned in the document the sum specified in it for such a document to be valid, it is important that the person issuing it has an account in the said bank. An issuer of the cheque is called Drawer, and the one to whom it is issued is the Drawee. Cheque is used to make safe and convenient payment. It is less risky and danger of loss is minimized.

Management Notes

Acquisition of business when new set of books are opened

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New set of books are opened

The following are the entries recorded by the purchasing company:

1. Purchasing consideration payable Business Purchase Account

  To Vendor Account

 Dr.
2. Acquiring various assets and liabilities at agreed value Various Assets Account

   To Various Liabilities Account

   To Business Purchase Account

 Dr.

Note: If the purchase price exceeds the net assets, the excess amount is debited to Goodwill Account; and if the net assets exceeds the purchase price, the excess amount is credited to Capital Reserve.

3. On payment of purchase price in kinds Vendor Account         Dr.
    To Share Capital Account
    To Debenture Account
    To Cash/Bank Account

Alternatively: The following entries can also Passed:
1. Acquiring various assets and liabilities at agreed value Various Assets Account Dr.
    To Various Liabilities Account  
    To Vendor Account  

 

Note: Any difference between the totals of debit and credit is debited to Goodwill Account or credited to Capital Reserve Account.

2. On payment of purchase price Vendor Account Dr.
    To Share Capital Account  
    To Debenture Account  
    To Cash/Bank Account  
Management Notes

Debtors and Creditors taken over on behalf of vendors

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Sometimes the purchasing company does not take over the debtors and creditors of the vendor company but it agrees to collect book debts and pays off the creditors out of the collections from debtors. For this purpose, the company charges a commission by way of certain percentage both on the amount collected from debtors as well as the amount paid to creditors. Any profit or loss (in the form of discount and bad debts) should be borne by the vendor since the purchasing company does this work on behalf of the vendors.

The following entries are to be passed:

  1. Entries in the Books of Vendors:
(a) For Closing Debtors Account  
  Purchasing Company Suspense, A/c Dr.
      To Debtors A/c  

Management Notes

Internal Reconstruction: Objectives, Types, Provisions, Accounting Treatment

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Internal Reconstruction refers to the process of reorganizing the financial structure of a financially troubled company without dissolving the existing entity or forming a new one. It involves restructuring the company’s capital, liabilities, and assets to improve its financial stability and operational efficiency. This may include reducing share capital, settling debts at a compromise, revaluing assets and liabilities, or altering shareholder rights. The objective is to revive the company by eliminating accumulated losses, reducing debt burden, and strengthening the balance sheet. Internal reconstruction requires approval from shareholders, creditors, and sometimes the National Company Law Tribunal (NCLT) under the Companies Act, 2013. Unlike amalgamation or external reconstruction, the company continues its operations under the same legal identity but with a restructured financial framework.

Objectives of Internal Reconstruction

  • To Wipe Out Accumulated Losses

One of the primary objectives of internal reconstruction is to eliminate accumulated losses from the company’s balance sheet. These losses often prevent a company from declaring dividends and reflect poor financial health. By reducing share capital or adjusting reserves, the losses are written off, making the balance sheet cleaner and more attractive to investors. This process gives the company a fresh start financially, improving its credibility in the eyes of stakeholders and potential financiers.

  • To Reorganize Share Capital

Over time, a company may have an overcapitalized or undercapitalized structure. Internal reconstruction helps reorganize this by reducing or consolidating shares, converting preference shares into equity, or altering share values. This adjustment aligns the capital structure with the company’s present financial position. It also ensures better utilization of funds, more realistic share values, and improved returns for shareholders. This ultimately enhances the company’s ability to raise capital and sustain operations more efficiently.

  • To Eliminate Fictitious or Overvalued Assets

Companies may carry fictitious or overvalued assets like preliminary expenses, goodwill, or inflated investments on their balance sheets. These non-productive assets distort the true financial position. Internal reconstruction aims to eliminate or adjust the values of such assets, ensuring the balance sheet reflects accurate values. This transparency is crucial for stakeholder trust, effective decision-making, and compliance with accounting standards. Correct asset valuation also improves ratios and financial health indicators used by investors and lenders.

  • To Reduce the Burden of Debt and Liabilities

Excessive or unmanageable liabilities can hinder a company’s ability to operate and grow. Internal reconstruction allows the company to renegotiate or restructure its obligations. It can include converting debt into equity, reducing interest rates, or seeking concessions from creditors. These measures help reduce the debt burden, lower interest outflows, and improve liquidity. A leaner liability structure strengthens the company’s long-term viability and provides better cash flow management for future development.

  • To Improve Financial Position and Creditworthiness

A company with a weak financial position may struggle to gain credit or attract investment. Internal reconstruction helps improve its balance sheet by eliminating losses, adjusting capital, and removing fictitious assets. This results in a more accurate representation of the company’s net worth. A stronger balance sheet enhances the company’s image in the financial market, increases investor confidence, and makes it easier to raise funds or get better credit terms from banks and institutions.

  • To Avoid Liquidation and Continue Business

When a company faces financial distress, liquidation may seem inevitable. However, internal reconstruction provides an alternative that allows the company to continue operating. Through reorganization and adjustments, the company can become viable again without being dissolved. This saves jobs, preserves business relationships, and retains the company’s market presence. It also gives the business a chance to revive, recover from losses, and potentially return to profitability, which benefits all stakeholders in the long run.

  • To Protect the Interests of Stakeholders

Internal reconstruction is designed to protect the interests of various stakeholders, including shareholders, creditors, employees, and customers. By restructuring debt and capital, the company becomes more stable and sustainable. Creditors may receive partial payments or equity in exchange for their claims, and shareholders may retain value in their investments. Employees benefit from continued employment, and customers from uninterrupted services. A successful internal reconstruction creates a win-win situation that balances losses while promoting long-term recovery.

Types of Internal Reconstruction

  • Reduction of Share Capital

This involves decreasing the paid-up value or number of shares issued by the company to write off accumulated losses or overvalued assets. It can take forms like reducing the face value of shares, cancelling unpaid share capital, or returning excess capital to shareholders. This process requires approval from shareholders, creditors, and the tribunal as per legal provisions. The goal is to align the capital with the company’s actual financial position and make the balance sheet healthier, paving the way for future profitability and investor confidence.

  • Reorganization of Share Capital

Reorganization refers to altering the structure of a company’s existing share capital without reducing its total value. It may involve converting one class of shares into another (e.g., preference to equity), subdividing shares into smaller units, or consolidating them into larger units. This type of reconstruction improves the flexibility and attractiveness of the company’s shareholding pattern. It helps cater to investor preferences, improve market perception, and better reflect the company’s operational scale and prospects.

  • Revaluation of Assets and Liabilities

In this type, the company reassesses the book value of its assets and liabilities to reflect their actual market values. Overvalued assets like goodwill or obsolete machinery are written down, while undervalued ones like land may be increased. Liabilities may also be restated, such as provisioning for doubtful debts. This brings transparency, accuracy, and credibility to the balance sheet, making financial statements more reliable for investors, auditors, and lenders. It supports better decision-making and financial planning.

  • Alteration of Rights of Stakeholders

Here, the company may alter the rights attached to different classes of shares or renegotiate terms with creditors. For example, preference shareholders may agree to a lower dividend or delayed payment. Creditors may agree to partial settlements or convert their dues into equity. These adjustments require consent and legal approval but help reduce financial stress on the company. It balances the expectations of stakeholders while improving the company’s survival chances and long-term sustainability.

Conditions/Provisions regarding Internal Reconstruction:

  • Approval by Shareholders and Creditors

Internal reconstruction requires the formal approval of shareholders through a special resolution passed in a general meeting. In addition, the consent of creditors, debenture holders, and other affected parties is essential, especially when their rights are altered or reduced. This ensures transparency and fairness in the reconstruction process. Without stakeholder consent, the plan cannot proceed legally, as it may negatively impact their financial interests. This step reflects democratic decision-making and protects the rights of those involved in the company’s capital structure.

  • Compliance with Section 66 of the Companies Act, 2013

Section 66 of the Companies Act, 2013 governs the reduction of share capital, a key element of internal reconstruction. It mandates that the company must apply to the National Company Law Tribunal (NCLT) for confirmation of the reduction. A detailed scheme, statement of assets and liabilities, and auditor’s certificate must accompany the application. The Tribunal will approve the plan only after ensuring that the interests of creditors and shareholders are safeguarded. Compliance ensures legal validity and protects against future legal disputes or financial misstatements.

  • Tribunal’s Sanction and Public Notice

Before implementing internal reconstruction, especially involving capital reduction, companies must obtain the sanction of the National Company Law Tribunal (NCLT). The Tribunal may direct the company to notify the public and creditors through advertisements in newspapers and seek objections. This transparency protects public interest and allows concerned parties to express their views. Only after hearing objections and verifying fairness does the Tribunal approve the scheme. This provision ensures accountability and protects the rights of both existing investors and the public.

  • Filing with Registrar of Companies (RoC)

After obtaining Tribunal approval, the company must file the sanctioned reconstruction scheme and any altered documents with the Registrar of Companies (RoC). This includes submitting revised copies of the Memorandum of Association and Articles of Association if they are modified. Filing ensures that the changes become part of the company’s legal records and are accessible to stakeholders and regulatory authorities. It completes the legal formalities and provides legitimacy and transparency to the restructuring process, keeping the company compliant with statutory requirements.

Steps in Internal Reconstruction

Internal reconstruction is a method used by companies to reorganize their financial structure and restore solvency without winding up the company. The process involves several steps, each aimed at strengthening the company’s capital base, eliminating losses, and improving financial stability. The key steps are explained below.

Step 1. Surrender of Shares by Shareholders

The first step in internal reconstruction often involves the voluntary surrender of shares by shareholders. Shareholders may agree to surrender a portion of their shares to reduce the company’s capital. This reduces the paid-up share capital and helps the company eliminate excess or overcapitalization. The surrendered shares are either cancelled or reduced in nominal value. This step is crucial to provide financial relief to the company and forms the foundation for the reconstruction process.

Step 2. Reduction of Share Capital

Once shares are surrendered, the company may proceed with a formal reduction of share capital. This requires approval from the court or shareholders as per the Companies Act, 2013. The nominal value of shares may be reduced to a more realistic level that aligns with the company’s actual assets. Capital reduction helps the company balance its capital with its true financial position, avoids excessive dividend obligations, and restores solvency.

Step 3. Writing Off Accumulated Losses

A major step in internal reconstruction is the writing off of accumulated losses. Losses, if carried forward, reduce the company’s net worth and affect its ability to attract investment. These losses can be written off against capital reduction account, share premium, or revaluation reserves. This step improves the financial position of the company, increases shareholder confidence, and ensures that the balance sheet reflects a true and fair view of assets and liabilities.

Step 4. Revaluation of Assets and Liabilities

Internal reconstruction often requires the revaluation of assets and liabilities. Fixed assets, investments, and other resources may be revalued to reflect their true market value. Similarly, liabilities may be reassessed to ensure proper provisions are made. Revaluation ensures that the company’s balance sheet presents a realistic picture of its financial health. It also helps in adjusting capital and reserves to cover losses and maintain solvency.

Step 5. Adjustment of Capital and Reserves

After revaluation, the company needs to adjust its capital and reserves to bring them in line with the revised financial structure. Capital reduction, reissue of shares, and utilization of reserves help eliminate discrepancies caused by losses or overvaluation. Reserves may be utilized to absorb losses or fund new capital requirements. This step ensures that the financial structure of the company is balanced and sustainable.

Step 6. Reissue of Shares

If required, the company may reissue shares at a revised value after surrender and reduction. This allows the company to raise new funds from shareholders and improve liquidity. Reissued shares help in strengthening capital base, attracting investors, and enhancing market confidence. The reissue may include shares at a discount, par value, or premium, depending on the financial requirement and investor willingness.

Step 7. Preparation of Revised Balance Sheet

The final step is the preparation of a revised balance sheet that reflects the effects of internal reconstruction. This includes adjusted share capital, revalued assets, written-off losses, and restructured reserves. The revised balance sheet shows the true financial position of the company after reconstruction. It provides a clear picture to shareholders, creditors, and investors regarding the solvency, stability, and operational efficiency of the company.

Accounting Treatment of Internal Reconstruction:

Sl. No.

 Transaction Journal Entry Explanation
1 Reduction of Share Capital (e.g., ₹10 shares reduced to ₹5) Share Capital A/c Dr.

To Capital Reduction A/c

 Reduced amount is transferred to Capital Reduction Account.
2 Writing off Accumulated Losses (e.g., P&L Debit Balance) Capital Reduction A/c Dr.

To Profit & Loss A/c

 Losses are adjusted against capital reduction amount.
3 Writing off Fictitious/Intangible Assets (e.g., Goodwill) Capital Reduction A/c Dr.

To Goodwill A/c (or other asset)

 Overvalued or non-existent assets are eliminated.
4 Revaluation of Assets (Increase in value) Asset A/c Dr.

To Revaluation Reserve A/c

 Assets appreciated in value are recorded.
5 Revaluation of Assets (Decrease in value) Revaluation Loss A/c Dr.

To Asset A/c

 Assets written down to reflect fair value.
6 Settlement with Creditors (e.g., ₹1,00,000 reduced to ₹80,000) Creditors A/c Dr. ₹1,00,000

To Bank/Cash A/c ₹80,000

To Capital Reduction A/c ₹20,000

 Partial liability settled; balance treated as capital gain.
7 Transfer of Capital Reduction balance to Capital Reserve Capital Reduction A/c Dr.

To Capital Reserve A/c

Remaining balance after adjustments is transferred to Capital Reserve.
Management Notes

Preparation of Final Statement after Reconstruction

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Preparing a Final statement after a Reconstruction Project involves consolidating all relevant financial information and presenting it in a clear, organized manner.

General Outline of the Steps involved:

  • Gather Financial Data:

Collect all financial records related to the reconstruction project. This includes invoices, receipts, contracts, and any other relevant documents.

  • Organize Expenses:

Categorize expenses into different cost categories such as labor, materials, equipment, permits, and subcontractor costs. Ensure all expenses are accurately recorded and accounted for.

  • Calculate Costs:

Summarize the total costs incurred during the reconstruction project. This includes both direct costs (e.g., materials, labor) and indirect costs (e.g., overhead expenses).

  • Review Budget vs. Actual:

Compare actual expenses to the initial budget for the project. Identify any discrepancies and analyze the reasons behind them. This will help in understanding where the project stayed on track and where it may have deviated.

  • Document Changes:

Note any changes or deviations from the original project scope, timeline, or budget. This includes change orders, delays, and any additional work performed.

  • Account for Contingencies:

If there were any unexpected costs or contingencies encountered during the project, make sure to document them and explain how they were addressed.

  • Prepare Income Statement:

Create an income statement that summarizes the revenue earned (if any) from the project and subtracts the total expenses incurred. This will provide a clear picture of the project’s financial performance.

  • Include Depreciation:

If applicable, include depreciation expenses for any assets used during the reconstruction project. This is important for accurately reflecting the true cost of the project over its useful life.

  • Finalize Statement:

Review the final statement for accuracy and completeness. Make any necessary adjustments or corrections.

  • Provide Explanations:

Include explanatory notes or comments where necessary to provide context for any significant variances or unusual items.

  • Distribution:

Once finalized, distribute the final statement to relevant stakeholders, such as project sponsors, investors, or regulatory authorities.

  • Archiving:

Keep a copy of the final statement for record-keeping purposes and future reference.

Specimen form of Liquidator final statement of account Liquidators final statement of Account:

Management Notes

When same set of books are continued

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But if the company desires to continue with the same set of books, the following accounting treatment should be suggested for the purpose:

(i) Open Revaluation Account:

A Revaluation Account should be opened where increased and decreased values of assets and liabilities are to be adjusted as we have seen in case of an admission of a partner. The profit or loss so made should be transferred to capital accounts.

(ii) Close Reserve:

Any balance of accumulated or undistributed profits or reserves should be transferred to capital accounts in profit-sharing ratio.

(iii) Close assets and liabilities not taken over:

Any asset or liability which is not taken over by the purchasing company should be transferred to capital accounts in profit- sharing ratio. But when an asset is worth its book value, the same can be transferred to capital accounts according to the ratio of final claim till the value of the asset is fluctuating.

(iv) Close Capital Accounts:

The Capital Accounts are then closed by transferring to Share Capital Amount, or Debentures Account or Cash Account.

Management Notes

Ledger accounts in the books of Transferor and Incorporation Entries in books of Transferee Company

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When a company is amalgamated (or absorbed), it must close its books, transfer all assets and liabilities to the transferee, and settle accounts with shareholders.

📘 1. Realisation Account

Entry No. Particulars Journal Entry
1 Transfer of assets Realisation A/c Dr.
    To Asset A/c (Individually)
2 Transfer of liabilities Liability A/c Dr.
    To Realisation A/c
3 Sale of business to transferee company Transferee Company A/c Dr.
    To Realisation A/c
4 Realisation expenses paid (if any) Realisation A/c Dr.
    To Bank A/c
5 Profit/Loss transferred to shareholders If profit: Realisation A/c Dr.
    To Equity SH A/c
If loss: Equity SH A/c Dr.
    To Realisation A/c
Entry No. Particulars Journal Entry
6 For receiving purchase consideration Shares A/c / Bank A/c Dr.
    To Transferee Company A/c
Entry No. Particulars Journal Entry
7 Transfer of share capital and reserves Share Capital A/c Dr.
General Reserve A/c Dr.
P&L A/c Dr.
    To Equity SH A/c
8 Settlement with shareholders (in shares/cash) Equity SH A/c Dr.
    To Shares A/c / Bank A/c

These are initial entries made in the books of the transferee to record the takeover of business from the transferor company.

📗 1. For taking over Assets and Liabilities

Entry No. Particulars Journal Entry
1 For assets taken over Asset A/c (Individually) Dr.
    To Business Purchase A/c
2 For liabilities taken over Business Purchase A/c Dr.
    To Liabilities A/c (Individually)
Entry No. Particulars Journal Entry
3 If consideration is discharged by issue of shares Business Purchase A/c Dr.
    To Equity Share Capital A/c
4 If any consideration paid in cash Business Purchase A/c Dr.
    To Bank A/c
5 If shares issued at premium Business Purchase A/c Dr.
    To Equity Share Capital A/c
    To Securities Premium A/c
Entry No. Particulars Journal Entry
6 For preliminary/incorporation expenses Preliminary Expenses A/c Dr.
    To Bank A/c

In transferor’s books:

  • Realisation A/c → Transfers & closes assets/liabilities

  • Transferee Company A/c → Receives consideration

  • Equity Shareholders A/c → Settles owners’ claims

In transferee’s books:

  • Business Purchase A/c → Records net value acquired

  • Assets and Liabilities → Debited/credited as per agreement

  • Share Capital / Bank A/c → Settles purchase consideration

Management Notes

Amalgamation in the Nature of Merger and Purchase

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Amalgamation is a strategic process in corporate restructuring where two or more companies combine to form a new entity or where one company is absorbed by another. The primary motive behind amalgamation is to achieve synergy, expand operations, eliminate competition, and enhance market reach. In accounting and legal terms, amalgamation is governed by the Companies Act, 2013, and is treated as per the accounting standard AS 14 – Accounting for Amalgamations.

AS 14 classifies amalgamation into two broad categories:

1. Amalgamation in the Nature of Merger

2. Amalgamation in the Nature of Purchase

Each type has distinct accounting treatments, legal conditions, and strategic implications, which are discussed in detail below.

Amalgamation in the Nature of Merger

Amalgamation in the nature of merger refers to a form of business combination in which two or more companies combine to form one single company and the business of the transferor company (selling company) is taken over by the transferee company (purchasing company). In this type of amalgamation, the companies are integrated in such a way that the identity of the transferor company is not treated as sold but as continued in the new or existing company. It is treated as a unification of business rather than a purchase.

Essential Conditions

For an amalgamation to be considered in the nature of merger, certain conditions must be satisfied:

  • All the assets and liabilities of the transferor company become the assets and liabilities of the transferee company.

  • Shareholders holding at least 90% of the equity shares of the transferor company become equity shareholders of the transferee company.

  • Consideration is discharged only by issue of equity shares (except for fractional cash adjustments).

  • The business of the transferor company is continued by the transferee company.

  • No adjustment is made to the book values of assets and liabilities except to bring uniformity in accounting policies.

Characteristics of Amalgamation in the Nature of Merger

  • Transfer of All Assets and Liabilities

In amalgamation in the nature of merger, the transferee company takes over all assets and all liabilities of the transferor company. Nothing is left behind in the old company. Fixed assets, current assets, investments, reserves, and obligations such as creditors and loans are completely transferred. This shows that the business is not purchased partially but combined fully. The transfer ensures continuity of operations and legal responsibilities. The transferee company becomes responsible for all contracts and commitments previously made by the transferor company.

  • Shareholders Become Shareholders of Transferee Company

At least 90% of the equity shareholders of the transferor company must become equity shareholders of the transferee company. This condition proves that ownership of business continues and is not sold to outsiders. Shareholders receive equity shares in exchange for their old shares and participate in future profits. Because the owners remain substantially the same, the transaction is considered a merger rather than a purchase. The continuity of ownership is the most important feature distinguishing merger from absorption.

  • Consideration Paid Only in Equity Shares

The purchase consideration is discharged mainly by issue of equity shares of the transferee company. Cash payment is not normally made except for fractional share adjustments. This ensures that shareholders of the transferor company continue to hold an ownership interest in the combined business. Payment in equity shares confirms that the business is unified and not acquired for money. It also helps the transferee company conserve cash and maintain liquidity after amalgamation.

  • Continuation of Business

After amalgamation, the business of the transferor company is continued by the transferee company. The same nature of operations, products, customers, and activities are maintained. There is no intention to liquidate or discontinue the business. Employees, contracts, and operations are usually retained. This continuity proves that the amalgamation is a merger of businesses rather than a closing down or selling of operations. The aim is long-term cooperation and growth of the combined enterprise.

  • No Revaluation of Assets and Liabilities

In a merger, assets and liabilities are recorded at their existing book values. No revaluation is made to increase or decrease their value. This is because the transaction is not considered a purchase but a continuation of business. Revaluation would create artificial profits or losses. Therefore, the balance sheet values remain unchanged, ensuring comparability of financial statements before and after amalgamation.

  • Use of Pooling of Interest Method

Accounting for amalgamation in the nature of merger is done by the Pooling of Interest Method. Under this method, financial statements of both companies are combined as if they were always a single entity. Assets, liabilities, and reserves are simply added together. The method avoids creation of goodwill and maintains historical accounting records. It reflects the true spirit of partnership between companies rather than acquisition.

  • Preservation of Reserves

All reserves of the transferor company, such as general reserve, capital reserve, and profit and loss balance, are carried forward in the books of the transferee company. These reserves are not written off. This preserves the financial history of the business and benefits shareholders because accumulated profits remain available for dividend or future use. The continuity of reserves is an important sign of a genuine merger.

  • No Recognition of Goodwill or Capital Profit

Normally no goodwill or capital profit arises because the purchase consideration equals the share capital taken over. Since the transaction is not treated as a purchase, the difference between net assets and consideration is not recognized as gain or loss. The accounting objective is continuity rather than valuation. Therefore, goodwill or capital reserve is generally avoided.

  • Unified Management and Control

After amalgamation, management and control of both companies are combined. Directors and key executives from both companies may participate in administration. The combined company functions as a single unit with one policy and decision-making authority. This unified management increases coordination, efficiency, and operational effectiveness, which is a major objective of merger.

  • Continuity of Business Identity

In amalgamation in the nature of merger, the business identity of the transferor company is not lost completely. Though legally dissolved, its operations, shareholders, and financial records continue in the transferee company. The combined enterprise is treated as a continuation of both companies. Because of this continuity, the transaction is regarded as a partnership or integration rather than an acquisition.

Accounting Treatment of Pooling of Interests Method

Amalgamation in the nature of merger is accounted for by the Pooling of Interest Method. Under this method, the assets, liabilities, and reserves of the transferor company are recorded by the transferee company at their existing book values. No revaluation of assets or liabilities is done because the business is treated as a continuation.

All reserves such as General Reserve, Profit and Loss Account, and other accumulated balances of the transferor company are carried forward and appear in the books of the transferee company. This preserves the financial position and past records of the business.

Under the Pooling of Interests Method, the books of the transferee company reflect:

  • Assets and liabilities of the transferor company at existing book values.

  • Reserves of the transferor company as they are, and not transferred to the Profit & Loss account.

  • No goodwill or capital reserve is recorded.

  • The difference in share capital is adjusted against reserves.

This method ensures continuity in financial reporting and is often preferred for strategic mergers between equals.

Example

Let’s consider two companies – A Ltd. and B Ltd.

  • A Ltd. and B Ltd. decide to merge and form a single company, A Ltd. (B Ltd. is absorbed).

  • All assets and liabilities of B Ltd. are taken over by A Ltd.

  • 95% of the shareholders of B Ltd. are issued equity shares in A Ltd.

  • No purchase consideration is paid in cash.

  • Business of B Ltd. is continued by A Ltd.

Since all five conditions are satisfied, this amalgamation is in the nature of merger.

Accounting Treatment of Goodwill or Capital Reserve

In this type of amalgamation, goodwill or capital reserve normally does not arise because the purchase consideration is equal to the share capital of the transferor company. If any difference occurs, it is adjusted in reserves rather than treated as goodwill. The objective is to maintain continuity of business and not to show acquisition profit or loss.

Journal Entries in the Books of Transferee Company

1. For recording assets and liabilities taken over

Business Purchase A/c Dr.
  To Liquidator of Transferor Company A/c

2. For incorporating assets and liabilities at book value

Assets A/c Dr.
  To Liabilities A/c

3. For payment of purchase consideration (issue of shares)

Liquidator of Transferor Company A/c Dr.
  To Equity Share Capital A/c

Features

  • It represents a genuine combination of companies.

  • Shareholders of transferor company become shareholders of transferee company.

  • Business operations continue without interruption.

  • Book values are maintained and reserves are preserved.

  • No gain or loss on acquisition is recognized.

Amalgamation in the Nature of Purchase

Amalgamation in the nature of purchase refers to a type of business combination in which one company acquires another company and takes over its business. In this case, the transferor company (selling company) is treated as being purchased by the transferee company (purchasing company). The transaction is similar to buying a business, and the shareholders of the transferor company generally do not continue as owners in the same proportion. Therefore, it is considered an acquisition and not a true merger.

Characteristics of Nature of Purchase

  • Acquisition of Business

In this type of amalgamation, the transferee company acquires the business of the transferor company just like a buyer purchases a running business. The relationship between the two companies is that of purchaser and vendor. The transferor company does not continue as a partner in the combined entity. The purpose is expansion, control, or gaining market advantage. Therefore, the transaction is treated as a purchase and not as a unification of equal companies.

  • Transfer of Selected Assets and Liabilities

The transferee company is not required to take over all assets and liabilities of the transferor company. It may choose only specific assets and certain liabilities according to the agreement. Unwanted or risky obligations can be left behind in the transferor company. This flexibility is an important feature because it allows the purchasing company to acquire only profitable parts of the business and avoid unnecessary risks or losses.

  • Shareholders Do Not Continue Ownership

Shareholders of the transferor company generally do not become equity shareholders of the transferee company in the same proportion. They are paid purchase consideration in cash, shares, debentures, or a combination of these. Because ownership is not continued, the transferor company loses its identity and is liquidated. This absence of continuity of ownership clearly distinguishes purchase from merger.

  • Consideration Paid in Various Forms

Purchase consideration may be paid in equity shares, preference shares, debentures, cash, or other securities. There is no restriction that payment must be only in equity shares. The purchasing company may even pay entirely in cash. This flexibility confirms that the transaction is an acquisition rather than a partnership arrangement and allows the transferee company to design payment according to its financial position.

  • Revaluation of Assets and Liabilities

In amalgamation in the nature of purchase, assets and liabilities of the transferor company are recorded at agreed or revised values. They are not necessarily recorded at book value. The transferee company may increase or decrease values to reflect fair market price. This revaluation ensures that the assets are recorded at realistic amounts in the new books of accounts.

  • Application of Purchase Method

Accounting treatment follows the Purchase Method. The transferee company records only the assets and liabilities taken over and ignores those not acquired. Financial statements are not combined as in merger. Instead, the acquisition is treated like buying a separate business. This method clearly recognizes the difference between old and new entity.

  • Reserves Not Carried Forward

Reserves such as general reserve, profit and loss balance, and other accumulated profits of the transferor company are not transferred to the books of the transferee company. Only statutory reserves may be recorded if required by law. Since the business is considered purchased, the past financial history of the transferor company is not continued.

  • Recognition of Goodwill or Capital Reserve

Difference between purchase consideration and net assets taken over results in goodwill or capital reserve. If consideration exceeds net assets, goodwill arises representing reputation and future earning capacity. If net assets exceed consideration, capital reserve arises showing a gain on purchase. This is a typical feature of acquisition accounting.

  • Discontinuance of Transferor Company

After completion of the transaction, the transferor company is liquidated and dissolved. Its legal existence comes to an end because its business has been sold. The transferee company becomes the sole owner of the acquired business and operates it under its own name and policies.

  • Independent Management Control

Management and control remain entirely with the transferee company. The purchasing company makes all decisions regarding operations, policies, and administration. Directors or managers of the transferor company may or may not be retained. The combined business operates under a single authority, showing clear acquisition rather than cooperation.

Accounting Treatment – Purchase Method

Under the Purchase Method, the transferee company:

  • Records assets and liabilities at fair market value (not book value).

  • Does not carry over reserves of the transferor company (except statutory reserves).

  • Recognizes the difference between the purchase consideration and net assets taken over as goodwill (if consideration > net assets) or capital reserve (if consideration < net assets).

This method reflects a new ownership and often results in changes in financial position due to revaluation.

Example:

Consider another case:

  • X Ltd. acquires Y Ltd. by paying ₹50 lakh in cash and taking over only selected assets.

  • Only 60% of Y Ltd.’s equity shareholders become shareholders of X Ltd.

  • Y Ltd.’s business is discontinued after acquisition.

  • Asset values are revalued at the time of acquisition.

This transaction fails to meet the conditions of merger and hence qualifies as an amalgamation in the nature of purchase.

Comparison Between Merger and Purchase

Basis Nature of Merger Nature of Purchase
Legal Form

Unification

Acquisition

Transfer of Assets/Liabilities

All assets and liabilities

Selected assets and liabilities

Shareholder Continuity

90% equity shareholders continue

Not necessary

Consideration Type

Only equity shares

Cash, shares, or other forms

Accounting Method

Pooling of Interests

Purchase Method

Reserves

Retained

Not carried forward

Goodwill/Capital Reserve

Not recorded

Arises due to difference in net assets

Business Continuity

Must continue

May or may not continue
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