Question

explain reconstruction methods in business valuation?

Answer 1

Reconstruction is a process of the company' s reorganization concerning legal, operational ownership and other structures by revaluing.

It refers to the transfer of company or several companies business to a new company. Means old company will get put into liquidation and shareholders will agree to take shares of equivalent value in the new company.

Reconstruction is required when existing company is incurring loss for many years and statement of account doesn't show true and fair position of the business as a higher net worth is depicted than that of real one.

Objectives of Reconstruction

- To resolve the problem of overcapitalization/ huge accumulated losses / over valuation of assets.

-When the capital structure of a company is complex and is required to make it simple.

- When change is required in the face value of shares of the company.

- To raise the fresh capital by issuing new shares.

Types of Reconstruction

External Reconstruction- When a company is suffering losses for past several years and facing financial crisis the company can sell its business to another newly formed company.

Liquidation company is called " Vendor Company" and newly formed company is called" Purchased Company'.

Internal Reconstruction- It refers to internal re- organization of the financial structure of a company. It permits existing company to be continued.

In this, share capital is reduced to write off the past accumulated losses of the company.

Methods of Internal Reconstruction

1. Alteration of share capital- Under this method, the form of fresh issues of new shares can be taken, conversion of fully paid shares with stock, cancellation of unissued capital, consolidation of existing shares and sub- division of existing shares.

Journal entry:

For increase in share capital

Bank Account

To equity share capital Account

For Consolidation of Shares

Equity share capital A/c

To Equity share capital A/c

For sub- division

Equity share capital A/c

To Equity share capital A/ c

2. Variation of shareholders right- Under this method, share capital of the company is divided into two different classes of shares. The rights attached to the shares of any class may be varied with the consent in writing of the holders of not less than 3/4 th of the issued shares.

3.Reduction of share capital . A company is limited by shares or by guarantee and having a share capital may, by a special resolution, reduce the share capital in any manner.

Journal

Share Capital A/c

To Capital Reduction/ Reconstruction A/c

4. Compromise/ arrangements:An agreement between a company and its members and outside liabilities when the company faces financial problem.

Journal

When shareholders give up their claim to Reserves and accumulated profit

Reserve A/c

To Reconstruction A/c

When outsider liabilities is settled

Outside Liabilities A/c

To Reconstruction A/c

5. Surrender of shares : In this method shares are divided into shares of smaller denomination and then shareholders are made to surrender their shares to the company. These shares are then alloted to debenture holders and creditors so that liabilities are reduced. The unutilized shares are cancelled by transferred to Reconstruction A/c.