internal reconstruction
DESCRIPTION
Its a part of reconstruction sheme..TRANSCRIPT
1. INTRODUCTION
What is Reconstruction?Re-construction is a process of re-
organization of a company. It takes place when the financial position of the company is not good due to overvaluation of assets, accumulated losses etc. It is re-organization with a view to run the company efficiently in the future. It involves writing off accumulated losses, fictitious assets and overvaluation of assets out of the sacrifice of the shareholders viz. shareholders, debenture holders and creditors so as to give a realistic view of financial position of the company.
Need for Internal Reconstruction:
Internal Reconstruction is necessary due to the following reasons:
1. Final statements not True & Fair: When the company is making heavy losses,
the financial statement do not show true and fair view of the state of affairs of the company.
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2. Assets: The asset side of the balance sheet of a
company may have intangible assets, fictitious assets, accumulated losses, deferred revenue expenditure etc. The real assets are shown at a high value. Due to losses adequate depreciation may not be provided, stock may be valued at a higher rate. No provision may be made for bad and doubtful debts.
3. Liabilities: The Company may have secured and
unsecured loans which may be repaid. It may become overdue Interest on loan may be in arrears. Creditors may be long overdue. Preference dividend on preference shares may be in arrears over a long period.
4. Capital: Capital of a company is lost due to drastic
fall in the value of assets. It is not represented by the by the real value of assets.
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5. Reconstruction: Due to continuous losses, basic structure
of the company gets damaged. The pillars on which the super structure is based become weak and the company may collapse at any time. Hence the company has to be placed on strong foundation in order to ensure stability in future.
2. TYPES OF RECONSTRUCTION
Company Reconstruction:
A term used to describe the drastic formal changes in a company’s capital structure as a result of certain circumstances. There are two types of reconstruction.
(1) External Reconstruction:
When a company has no power to operate his own business due to heavy loss and it sells his all business to a new company. It will be external reconstruction.
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(2) Internal Reconstruction:
Internal Reconstruction means to do every action for bringing the company out of losses. If a company is suffering heavy losses, company can use the provision 94 of Indian Company law 1956 and reduce its capital.
3. Provisions of company Law
(1) Alteration of share capital
o Increase of Authorized Capital-
There should be a provision in the MOA and AOA for increasing share capital. In case there is no provision in the MOA and AOA, the company must change them.
The company is required to give a notice to the Registrar as regards this resolution within 30 days of its passing.
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Alteration of share capital beyond the authorized does not require permission of the court.
Sanction of the SEBI Is necessary if the shares to be offered are more than the certain value.
Board resolution is necessary to effect alteration.
o Consideration of shares-
There must be a specific provisions for the consideration of the A/A.
Board resolution must be passed to convene a general meeting of a share holder.
An ordinary resolution passed by the general meeting is necessary to undertake consolidation.
Notice of consolidation of shares must be sent to the Registrar of companies within one month.
o Subdivision of shares-
AOA must make a provision for sub-division of shares.
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Resolution passed by general meeting is necessary.
A notice is to be sent to the Registrar of company.
o Conversion of shares into stock-
o Only fully paid up shares can be converted into stocks.
o A/A must provide for conversion.
o Resolution at general meeting is necessary.
o Permission of stock exchange is necessary if the shares are listed with a stock exchange.
o A notice to be sent to the Registrar of Companies.
Cancellation of shares
A Company must be authorized by its A/A to effect the change.
A resolution passed an extra ordinary general meeting must sanction such a change.
(2) Capital Reduction6
Legal Aspect
A company is permitted to reduce its share capital under Section 100 in any of the following ways:
By reducing the liabilities on any of its shares in respect of share capital not called.
By paying off any paid up capital which is in excess of the requirements of a company.
By cancellation of any paid up capital which is lost or which is not represented by available assets.
By any other method which may be approved by available assets.
A company cannot reduce its share capital unless it is authorized by its AOA.
A special resolution for reduction of capital must be passed by the company.
Capital Reduction must be approved by the court.
The court may order confirmation of capital reduction on such terms and conditions as it may think fit.
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The court may order the company to add the words “and reduced” to the name of the company for such period as it may deem fit.
The order of the court must be produced before the Registrar of the company and a certified copy of the same and of the minutes should be filed with the Registrar of Companies for registration.
A company must publish reasons for reduction for public information, if the court orders.
A company must publish notice of registration in such a manner as the court may direct.
Every Balance Sheet subsequent to the reduction must show the reduced figures with the date of reduction in place of the original cost.
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4. BASIC JOURNAL ENTRIES
Basic Journal Entries to be known before starting up with the problem are as follows-
1) 20,000 Equity share of Rs. 100 each are reduced to share of Rs. 40 each fully paid up.
Equity share capital (of 100 each) A/c …Dr 2000000 To Equity share capital 800000 To Capital reduction A/c 1200000(The face value has changed from Rs.100 to Rs.40.)
2) 20,000 Equity share of Rs. 100 each are reduced to share of Rs. 40 each Rs.20 paid up.
Equity share capital (of 100 each) A/c … Dr 2000000 To Equity share capital A/c 400000
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To Capital reduction A/c 1600000
3) 20,000 Equity share of Rs. 100 each are reduced to share of Rs. 60 each fully paid up.
Equity share capital A/c …Dr 800000 To Capital reduction A/c 800000(The face value has been retained at Rs.100. the paid up value is being reduced.)
4) 20,000 Equity share of Rs. 100 each are reduced by Rs. 30 per share.
a)If it is assumed the face value has reduced then,
Equity share capital (Rs.100 each) A/c …Dr 2000000 To Equity share capital (of 70 each) 1400000 To Capital reduction A/c 600000
b) It is assumed that face value remains the same,
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Equity share capital A/c …Dr 600000 To Capital reduction A/c 600000
5) Arrears of preference dividend.
a) If it is cancelled – No entry.
b)If it is settled (To the extent it is paid)
Capital reduction A/c …Dr To Cash/Bank A/c (Or) To Equity share Capital A/c
6) Holders of 20000 11% Pref. share of Rs.100 each are allotted 20000 13% pref. share of Rs.20 each.
11% pref. share capital A/c …Dr 200000
To 13% Preference share capital A/c 400000
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To Capital reduction A/c 1600000
7) Balance sheet.
7% DebentureAccrued interest
600004200
Free hold land & building
34000
64200
A piece of land valued in the books of Rs.6000 has been taken over by debenture holders in part repayment of the principle at an agreed value of Rs.14000. The debenture int. is settled in cash. The remaining freehold land & building is revalued at Rs.40000.
a)Appreciation of land & building.
Free hold Land & Building A/c …Dr 8000
To Capital reduction A/c 8000
b)Takeover by 7% Debenture holder.
7% Debenture A/c …Dr 14000 To freehold Land & building A/c 14000
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c) Payment of Accrued interest.
Accrued interest A/c …Dr 4200 To Cash/Bank A/c 4200
d)Appreciation of Bal. freehold land& building
Freehold land & building A/c Dr.12000 To Capital reduction A/c 12000
Total freehold land & building 34000
6000 28000
Takeover by Deb. Holders Appreciation to Rs.40000
for Rs.14000 (therefore appreciation Rs.12000)
8) If the outstanding Deb. Interest appearing in the Balance sheet is canceled then it would result into a profit.
Accrued interest on 7% A/c …Dr
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To Capital reduction A/c
9) Payment of unrecorded liability. In this case the treatment would be similar to contingent liabilities for example - arrears of profit dividend.
10) The creditors of Rs.50000 agreed for a remission of the liability. On the condition that 25% of the net liability is paid immediately. The balance is postponed and would be paid after four years.Creditors A/c …Dr 20000
(20% of 50000) To Capital reduction A/c 10000
(25% of 40000) To Cash/Bank A/c 10000
The liability of Rs.30000 is to be paid after 4 years. Current liabilities should include amounts which is payable within a period of 12 months. Hence such balance of Rs.30000 should be reflected under the head unsecured loans.
11) Sale of assets
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Cash/Bank A/c …DrCapital reduction A/c (if loss) …Dr To Assets A/c (Book value) To Capital reduction A/c
12) Fresh issue of shares
Cash/Bank A/c …Dr To Share capital A/c
13) Expenses of reconstruction
Capital reduction A/c …Dr To Cash/Bank A/c
14) If there are any existing reserves i.e. reserves appearing on the liabilities side of the balance sheet than it can be utilized for w/off the losses. In this case transfer the reserve to the Capital reduction A/c.
Reserves A/c …Dr To Capital reduction A/c(The reserves should be utilized only if instructions are given.)
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15) Write off the accumulated losses intangible assets, fictitious assets and other assets (to the extent overvalued).
Capital reduction A/c …Dr To Profit/Loss A/c To Goodwill, Patents etc. To Misc. expenditure A/c To Other assets A/c (To the extent over valued)
16) If there is any credit balance in the capital reduction A/c than it should be transferred to capital reserve.
Capital reduction A/c …Dr To Capital reserve A/c
17) Consolidation of shares
100000 equity shares of Rs.10 each are consolidated into 10000 equity shares of Rs.100 each.
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Equity share capital A/c (10 each) …Dr 1000000 To Equity share capital A/c (100 each) 1000000
18) Sub division of shares
10000 equity shares of Rs.100 each are being subdivided into 100000 equity share of Rs.10 each.
Equity share capital A/c (100 each) …Dr 1000000 To Equity share capital A/c (10 each) 1000000
(Neither consolidation nor sub division would affect the capital reduction A/c)
5. ILLUSTRATIONS (Q.1.) The following is the summarized balance sheet of X Ltd. As on 31st March, 1990:
Liabilities Amount
Assets Amount
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(Rs.) (Rs.)
Authorized and Issued Capital:
Goodwill 1,20,000
30,000 Preference Shares of Rs. 10 each
3,00,000 Land and Building 2,67,000
6,00,000 Equity Shares ofRs. 1 each
6,00,000 Plant 2,55,000
6% Debentures(Secured on land and building) 1,20,000Accrued Int. 6,000
1,26,000
Shares in Subsidiary Ltd.(at cost)
75,000
Bank Overdraft(Secured on stock)
1,65,000 Stock 2,25,000
Directors Loans 75,000 Debtors 2,70,000Sundry Creditors 2,70,000 Profit and loss A/c 2,64,000
Deferred Expenditure:Advertisement
60,000
15,36,000
15,36,000
NOTE:
There is a contingent liability for damages of Rs. 30,000.
Preference Shares are cumulative and dividends are in arrears for 3 years
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A capital Reduction Scheme setting the following terms was duly approved:
1)The Preference Shares to be reduced to Rs. 8 per share and the Equity Shares to 25 paisa each and to be consolidated as shares of Rs. 10 each and Rs. 1 each fully paid respectively. The preference shareholders waived 2/3rd of the dividend in arrears and received equity shares for the balance. The Authorized capital to be restored to 30,000 preference shares of Rs. 10 each and 6,00,000 equity shares of Rs. 1 each.
2)The shares in Subsidiary Ltd. Are sold to an outsider for Rs. 1,50,000.
3)All intangible assets are to be eliminated and bad-debts of Rs. 21,000 and obsolete stock of Rs. 30,000 to be written off.
4)The debenture holders to take over the companies land and building (book value-Rs. 54,000) at a price of Rs. 60,000 in part satisfaction of the debentures and to provide further cash Rs. 45,000 on a floating charge. The arrears of interest are paid.
5)Directors refund Rs. 10,000 of the fees previously received by them.
6)The contingent liability materialized in the sum stated but the company recovered Rs. 15,000 of these damages in action against one of its directors. This was debited to his loan account of Rs. 24,000. The balance of which was paid in cash on his resignation.
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7)The remaining directors agreed to take equity shares in satisfaction of their loans.
You are required to:
A)Pass Journal Entries, including cash transactions,B) Draft revised balance sheet.
SOLUTION:
Journal Entries in the books of X Ltd
Date
Particulars LF
Debit(Rs.)
Credit
(Rs.)
(1)(i) Rs.10 Preference Shares A/c…
Dr3,00,00
0To Rs.8 Preference Shares A/c 2,40,0
00To Capital Reduction A/c 60,00
0(Being preference shares of Rs. 10 each reduced to Rs.8 per share.)
(ii) Rs.1 Equity Shares A/c … Dr
6,00,000
To Rs. 0.25 Equity Shares A/c 1,50,000
To Capital Reduction A/c 4,50,0
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00(Being equity shares of Rs. 1 each reduced to Rs. 0.25 per share.)
(iii) 30,000 Preference Shares A/c (Rs.8 )… Dr
2,40,000
To 24,000 Preference Shares A/c (Rs.10)
2,40,000
(Being preference shares consolidated of Rs. 10 each as fully paid.)
(iv) 6,00,000 Equity Shares A/c (Rs. 0.25)… Dr
1,50,000
To 1,50,000 Equity Shares A/c (Rs. 1)
1,50,000
(Being equity shares consolidated of Rs. 1 each as fully paid.)
(v) Capital Reduction A/c… Dr
18,000
To Equity Share Capital A/c 18,000
(Being 2/3rd of dividend waived and received equity shares for the balance.)
(2) Bank A/c… Dr
1,50,000
To Shares in Subsidiary Ltd. A/c 75,000
To Capital Reduction A/c 75,000
(Being shares in subsidiary ltd. are sold.)
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(3) Capital Reduction A/c… Dr
4,95,000
To Goodwill A/c 1,20,000
To Profit and Loss A/c 2,64,000
To Deferred Advertisement A/c 60,000
To Debtors A/c 21,000
To Obsolete Stock(Being intangible assets, obsolete stock and bad-debts written off.)
(4)(i) Debentures A/c…
Dr60,000
To Land and Building A/c 54,000
To Capital Reduction A/c 6,000(Being land & building taken over by debenture holders for Rs. 60,000.)
(ii) Bank A/c… Dr
45,000
To Debentures A/c 45,000
(Being Rs. 45,000 cash provided on floating charge.)
(iii) Interest A/c… Dr
6,000
To Bank A/c 6,000(Being arrears of interest paid.)
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(5) Bank A/c… Dr
10,000
To Capital Reduction A/c 10,000
(Being director’s fees refunded.)
(6)(i) Director’s Loan A/c…
Dr15,000
Capital Reduction A/c… Dr
15,000
To Bank A/c 30,000
(Being contingent liability recovered to the extent Rs. 15,000.)
(ii) Director’s Loan A/c… Dr
9,000
To Bank A/c 9,000(Being balance to the extent of Rs. 9,000 of director’s loan was paid in cash.)
(7) Director’s Loan A/c… Dr
51,000
To Equity Share Capital A/c 51,000
(Being directors were given equity shares in satisfaction of their balance loan amount.)
(8) Bank Overdraft A/c… Dr
1,60,000
To Bank A/c 1,60,0
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00(Being bank overdraft written off.)
Capital Reduction A/c
Dr. Cr.
Particulars Amount
(Rs.)
Particulars Amount
(Rs.)To Equity Share Capital A/c
18,000 By Preference Share capital A/c
60,000
To Goodwill A/c 1,20,000 By Equity Share Capital A/c
4,50,000
To Profit and Loss A/c 2,64,000 By Bank A/c 75,000
To Deferred Advertisement A/c
60,000 By Debentures A/c 6,000
To Debtors A/c 21,000 By Bank A/c 10,000
To Obsolete Stock A/c 30,000
To Bank A/c 15,000
To Capital Reserve A/c (Balancing Figure)
73,000
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6,01,000
6,01,000
Balance Sheet as on… (Revised)
Liabilities Amount
(Rs.)
Assets Amount
(Rs.)Authorized Share Capital
Fixed Assets
30,000 Preference Sharesof Rs. 10 each
3,00,000 Land and Building 2,13,000
6,00,000 Equity Shares of Rs. 1 each
6,00,000 Plant 2,55,000
Issued, Subscribed and Paid up Capital
Current Assets, Loans and Advances
2,19,000 Equity Shares of Rs. 1 each fully paid
2,19,000 Stock 1,95,000
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24000 6% Preference Shares of Rs. 10 each
2,40,000 Debtors 2,49,000
Reserves and Surplus
Bank -
Capital Reserve 73,000
6% Debentures 1,05,000
Bank Overdraft 5,000
Sundry Creditors 2,70,000
9,12,000
9,12,000
(Q.2.) The following is the summarized balance sheet of Not so Well Ltd. as on 31st December, 1990:
Liabilities Amount
(Rs.)
Assets Amount
(Rs.)
Equity Shares Capital in Rs. 100 shares
5,00,000 Land and Building 2,00,000
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8% Preference Capital in Rs. 100 shares
3,00,000 Plant and Machinery
2,00,000
18% Convertible Debenture
90,000 Invention and Promotion Expenses
1,00,000
Loan from Bankers(Secured)
1,10,000 Discount and Issue Expenses on shares and debentures
30,000
Capital Reserve 40,000 Profit and Loss A/c 2,80,000
Forfeited Shares A/c
10,000 Stock in Hand 3,00,000
Sundry Creditors 1,60,000 Sundry Debtors 1,00,000
12,10,000
12,10,000
The dividend on preference shares were in arrears for last 3 years. The company had a very valuable property which stood highly understated in the balance sheet and which is not afforded to sell. The said being required for the business.
It was believed that worst was now over and companies new invention was certain to bring sizeable profit in future. In view of these share holders, debenture holders and the creditors agreed upon the following scheme of reconstruction:
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1)All fictitious assets including invention and promotion expenses were to be written off.
2)Rs. 30,000 from debtors, Rs. 2,00,000 from stock and Rs. 1,50,000 from plant and machinery were to be written off.
3)The convertible debentures were given the option of subscribing equity shares of Rs. 30 each up to 50% of their face value, or subscribing preference shares of Rs. 50 each up to 25% of their face value and the remaining 25% was to be paid them in cash. All the debenture holders exercised this option.
4)All capital reserves were to be utilized.5)The creditors being unsecured agreed to reduce
their claim by 25% on the condition that they will be paid off before 31st December, 1995. They also agreed not to charge any interest till the date of payment.
6)Preference shares were reduced to Rs. 50 per share and equity shares were reduced to Rs. 30 per share.
7)Land and Buildings were revalued at such a figure so as to put through the entire scheme.
8)Bankers were to be paid of fully. For this purpose, the company was to issue 6,000 Equity shares of Rs. 30 each for cash.
9)The preference share holders agreed to waive the arrears of dividend.
Assuming that the scheme had been duly sanctioned by the court, Pass Journal Entries;
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Prepare the Capital Reduction Account and the new Balance Sheet.
SOLUTION:
Journal Entries in the books of not so well Ltd.
Date
Particulars LF
Debit(Rs.)
Credit(Rs.)
(1) Capital Reduction A/c…Dr 4,10,000
To Invention and promotion Expenses A/c
1,00,000
To Discount and Issue Expenses A/c
30,000
To Profit and Loss A/c 2,80,000
(Being all fictitious assets written off.)
(2) Capital Reduction A/c…Dr 3,80,000
To Debtors A/c 30,000To Stock A/c 2,00,00
0To Plant and Machinery A/c 1,50,00
0(Being debtors, stock and plant written off.)
(3) Debentures A/c…Dr 90,000To Equity Shares A/c 45,000To Preference Shares A/c 22,500
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To Cash A/c 22,500(Being debenture holders exercised their option.)
(4) Capital Reserve A/c…Dr 40,000To Capital Reduction A/c 40,000
(Being capital reserve utilized.)
(5) Creditors A/c…Dr 40,000To Capital Reduction A/c 40,000
(Being creditors agreed to be reduced by 25 %.)
(6)(i) Equity Shares A/c…Dr 5,00,00
0To Equity Shares A/c 1,50,000To Capital Reduction A/c 3,50,000
(Being equity shares reduced to Rs. 30 per share.)
(ii) Preference Shares A/c…Dr 3,00,000
To Preference Shares A/c 1,50,000To Capital Reduction A/c 1,50,000
(Being preference shares reduced to Rs. 50 per share.)
(7)(i) Loan from Bankers A/c…Dr 1,10,00
0To Cash A/c 1,10,000
(Being bankers paid off fully.)
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(ii) Cash A/c…Dr 1.80,000
To Equity Shares A/c 1,80,000(Being 6000 equity shares of Rs. 30 each issued for cash.)
(8) Land and Building A/c…Dr 2,10,000
To Capital Reduction A/c 2,10,000(Being balance of capital reduction account.)
Capital Reduction A/c
Dr. Cr.
Particulars Amount
(Rs.)
Particulars Amount
(Rs.)
To Invention and Promotion Expenses A/c
1,00,000 By Capital Reserve A/c
40,000
To Discount and Issue Expenses A/c
30,000 By Creditors 40,000
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To Profit and Loss A/c 2,80,000 By Equity Share Capital A/c
3,50,000
To Debtors A/c 30,000 By Preference Share capital A/c
1,50,000
To Stock A/c 2,00,000 By Land and Building A/c (Balancing Figure)
2,10,000
To Plant and Machinery A/c
1,50,000
7,90,000
7,90,000
Balance Sheet as on… (Revised)
Liabilities Amount
(Rs.)
Assets Amount
(Rs.)Issued, Subscribed and
Fixed Assets
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Paid up Capital
12,500 Equity Shares of Rs. 30 each fully paid
3,75,000 Land and Building 4,10,000
3,450 Preference Shares of Rs. 50 each
1,72,500 Plant 50,000
Current Liabilities, Loans and Advances
Current Assets, Loans and Advances
Sundry Creditors 1,20,000 Stock 1,00,000
Forfeited Shares 10,000 Debtors 70,000
Bank 47,500
6,77,500
6,77,500
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6. CONCLUSION
With the completion of this project we had come to know how internal reconstruction and why is it done.
If the balance sheet of the loss making company is made, losses in the debit side will be seen. These shows zero assets, it is clear indication to all creditors that company has no resources and all past resources are utilized in bad project. So, to come out of this situation the company has to generate profit. The profits can be generated when the sacrifice would be made by the equity share holders, preference share holders, debenture holders and creditors.
For the scheme of reconstruction the approval of all the
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interested parties and the sanction of the court are necessary. So, either shareholders or creditor can do above or take the action to liquidate the company.
7. BIBLIOGRAPHYWe have complied the
information of this project with the help of the following sources-
oBooks –
TYBCOM Text Book(Choudhary Chopde)
TYBAF Text Book (SHETH Publications)
o Internet Sites –
www.flickr.com/photos/olive.../sets/72157619644288304/
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www.madisonscw.com/SubPage.aspx?page=2664
powerelectronics.com/.../power_internal_construction_boosts/
www.levelfive-audio.com/internal-construction.htm
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