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Corporate Financial Reporting · Absorptions, Amalgamations, External Reconstruction

External Reconstruction: Accounting Entries and Solved Problems

Updated 11 October 2026 · Fact-checked

External reconstruction is a scheme where an existing company transfers its business to a new company formed for it. The old company is dissolved without winding-up if the Tribunal's order so provides, or else wound up. To solve it, compute purchase consideration, close the old books through Realisation Account, then record the new company's assets at agreed values.

Understand External Reconstruction

In external reconstruction, the old company (the vendor or transferor) transfers its whole or part of its undertaking, property and liabilities to a new company (the purchaser or transferee). The new company is usually formed for this purpose and takes over the same business. The old company is then dissolved without winding-up where the Tribunal's order so provides. Otherwise it is wound up and its shareholders are paid through the liquidation.

Why do it? A company may have heavy accumulated losses, over-valued assets or a weak capital structure. Instead of reducing its own capital (internal reconstruction), it starts afresh in a new entity. Shareholders and creditors of the old company usually get shares or other securities in the new one, so the same people carry on the business.

Under the Companies Act, 2013, section 232 applies where a compromise or arrangement is proposed under section 230 for a scheme of reconstruction involving the merger or amalgamation of two or more companies. Under such a scheme, the whole or part of the undertaking, property or liabilities of the transferor company is transferred to a transferee company, or is divided among and transferred to two or more companies. An external reconstruction carried out in this way reaches the Tribunal through an application under section 230. The Tribunal may order meetings of creditors or members, and sub-sections (3) to (6) of section 230 apply to those meetings.

The merging companies must also circulate, for the meeting so ordered:

  • the draft scheme adopted by the directors;
  • confirmation that a copy of the draft scheme has been filed with the Registrar;
  • a directors' report explaining the effect of the scheme on each class of shareholders, key managerial personnel, promoters and non-promoter shareholders, including the share exchange ratio and any special valuation difficulties;
  • the expert's valuation report, if any;
  • a supplementary accounting statement, if the last annual accounts relate to a financial year ending more than six months before the first meeting.

The scheme must show an appointed date from which it is effective. After it is satisfied that the procedure has been followed, the Tribunal may sanction the scheme. It may then provide for transfer of property and liabilities, allotment of shares, continuation of legal proceedings, transfer of employees, dissolution of the transferor without winding-up, and provision for dissenting persons. The Tribunal will not sanction the scheme unless the company's auditor certifies that the accounting treatment proposed conforms to the accounting standards prescribed under section 133. A certified copy of the order must be filed with the Registrar within thirty days of receiving it.

Accounting has two sides. In the old company's books you open a Realisation Account, transfer the assets and liabilities taken over, record the purchase consideration, and settle shareholders through a Shareholders (or Equity Shareholders) Account. In the new company's books you record the business taken over at the agreed values, with the difference between purchase consideration and net assets taken over going to goodwill or capital reserve.

In exams, the scheme usually states which assets and liabilities are taken over, at what values, and how the consideration is paid. Your job is to follow those terms exactly. Where a question is set under Ind AS 103 and the parties are under common control, follow the common control rules instead of the purchase method; read the question for this.

Key rules to remember

Purchase consideration (net assets method)
PC = Agreed value of assets taken over − Liabilities taken over
Use only the assets and liabilities the new company actually takes over, at the values agreed in the scheme.
Purchase consideration (payment method)
PC = Shares at issue price + Debentures + Cash paid to the old company
Use the issue price of shares (including premium), not face value, unless the question says otherwise.
Realisation Account result
Profit or loss = PC received − (Book value of assets taken over − Liabilities taken over) − Realisation expenses borne by the old company
Net assets transferred means the book value of assets taken over less the liabilities taken over. Assets or liabilities not taken over are dealt with separately (realised or settled by the old company). Profit goes to shareholders' credit, loss to their debit, in the Shareholders Account.
Goodwill or capital reserve in new company
Goodwill = PC − Net assets taken over; Capital reserve = Net assets taken over − PC
Apply the sign carefully. PC above net assets gives goodwill; PC below gives capital reserve.
Settlement to shareholders of old company
Amount due = Share capital + Reserves + Realisation profit (or − loss) − Liabilities not taken over and paid by shareholders
Check that total shares and cash received from the new company equals the balance of the Shareholders Account.
Matters the Tribunal may provide for under section 232(3)
Transfer of property and liabilities; allotment of shares; continuation of legal proceedings; dissolution of the transferor without winding-up; provision for dissenters; transfer of employees
These are matters the Tribunal may provide for in its order. Section 232(3) does not prescribe a fixed sequence. Section 232(3)(d) covers dissolution without winding-up of the transferor company.

How to solve External Reconstruction questions

Follow the same order for every question. It keeps your entries clean and lets the examiner award method marks even if one value is wrong.

  1. 1Read the scheme and list which assets and liabilities the new company takes over, at what values, and which are left behind.
  2. 2Compute the purchase consideration. Use the net assets method if values are given for assets and liabilities, and cross-check with the payment method if the form of payment is given.
  3. 3In the old company's books, open the Realisation Account. Debit assets transferred at book value, credit liabilities transferred, credit purchase consideration due from the new company, and record realisation expenses and any assets or liabilities settled separately.
  4. 4Find the profit or loss on realisation and transfer it to the Shareholders Account. Close the Preference and Equity Shareholders accounts, and show receipt of shares and cash from the new company.
  5. 5Record the new company's journal entries: business purchase account, assets and liabilities at agreed values, and discharge of consideration through share capital, securities premium, debentures and cash.
  6. 6Work out goodwill or capital reserve in the new company and post it. Record preliminary expenses and share issue costs, if any, properly.
  7. 7Prepare the opening balance sheet of the new company and tally it. Check that assets equal equity and liabilities.

Quickest way: Net assets first, then payment check

When to use it: Use when the question gives agreed values of assets and liabilities and the way payment is made, and asks for journal entries or a balance sheet within limited time.

  1. Write a one-line list: assets taken over, liabilities taken over, and values given.
  2. Compute PC = assets − liabilities and then break PC into shares, debentures and cash. If the two do not match, recheck before moving on.
  3. Prepare the Realisation Account in T-form first. Its balancing figure gives profit or loss, which you need for the shareholders' settlement.
  4. Write the new company entries using one compound entry for taking over the business and one for discharging consideration.
  5. Compute goodwill or capital reserve as the balancing figure, and confirm the balance sheet totals tally.

Common mistakes in External Reconstruction

  • Including assets or liabilities that the new company has not taken over when computing purchase consideration.

    Students copy the full balance sheet without reading which items are excluded in the scheme.

    Fix: Tick each balance sheet item against the scheme before computing. Leave excluded items in the old company's books and settle them separately.

  • Using face value of shares instead of issue price when valuing consideration.

    The share premium detail is easy to miss in a long question.

    Fix: Underline the issue price. Consideration in shares = number of shares × issue price, with premium credited to Securities Premium in the new company.

  • Confusing external reconstruction with internal reconstruction and passing capital reduction entries.

    Both topics deal with losses and restructuring, so the entries look similar.

    Fix: Ask: is a new company taking over the business? If yes, use Realisation Account in the old books. If the same company continues, use Capital Reduction Account.

  • Treating the difference between PC and net assets as goodwill in every case.

    Students remember the goodwill rule but forget the opposite case.

    Fix: If PC is greater than net assets, it is goodwill. If PC is less, it is capital reserve. Verify the sign each time.

  • Forgetting realisation expenses or liabilities paid by the old company on behalf of the new company.

    These are small notes at the end of the question.

    Fix: Re-read the notes after finishing your account. Include every expense the old company bears in the Realisation Account, and record any amount the new company reimburses.

  • Treating external reconstruction and amalgamation as the same.

    Both transfer a business to another company for shares.

    Fix: In amalgamation, two or more going concerns combine and shareholders of the transferor generally continue in the combined entity. In external reconstruction, the new company is formed to take over one business to restructure it. The accounting mechanics of the transferor's books are similar, so identify the nature from the question.

Worked examples

Example 1

Alpha Ltd has the following balances: Fixed assets ₹6,00,000, Current assets ₹3,00,000, Equity share capital ₹5,00,000, Reserves ₹1,00,000, Current liabilities ₹3,00,000. Beta Ltd is formed to take over all assets and current liabilities, with fixed assets valued at ₹5,00,000 and current assets at book value. The purchase consideration is paid by Beta Ltd issuing 50,000 equity shares of ₹10 each at par to Alpha Ltd. Compute the purchase consideration, the realisation result and the new company's goodwill or capital reserve.

Show the solution
  1. Assets taken over at agreed values = ₹5,00,000 + ₹3,00,000 = ₹8,00,000.
  2. Liabilities taken over = ₹3,00,000.
  3. Net assets = ₹8,00,000 − ₹3,00,000 = ₹5,00,000.
  4. Check with payment method: 50,000 shares × ₹10 = ₹5,00,000. This matches, so PC = ₹5,00,000.
  5. Realisation Account in Alpha's books: debit assets at book value ₹6,00,000 + ₹3,00,000 = ₹9,00,000; credit liabilities ₹3,00,000 and PC ₹5,00,000. Net book assets = ₹6,00,000. PC ₹5,00,000 − ₹6,00,000 = loss of ₹1,00,000.
  6. Shareholders Account: capital ₹5,00,000 + reserves ₹1,00,000 − realisation loss ₹1,00,000 = ₹5,00,000, which equals the value of the 50,000 shares received. The account settles fully.
  7. In Beta's books, goodwill or capital reserve = PC − net assets = ₹5,00,000 − ₹5,00,000 = nil.

Answer: Purchase consideration is ₹5,00,000. Alpha Ltd makes a realisation loss of ₹1,00,000. Beta Ltd records no goodwill and no capital reserve.

Example 2

Gamma Ltd transfers its business to Delta Ltd. Assets taken over are valued at ₹12,00,000 and liabilities taken over at ₹2,00,000. Delta Ltd pays the purchase consideration by issuing 80,000 equity shares of ₹10 each at ₹11 per share and ₹1,20,000 in cash. Compute the purchase consideration, goodwill or capital reserve, and show the entries in Delta Ltd's books for discharge of consideration.

Show the solution
  1. Net assets taken over = ₹12,00,000 − ₹2,00,000 = ₹10,00,000.
  2. Purchase consideration by payment: shares 80,000 × ₹11 = ₹8,80,000, plus cash ₹1,20,000, total ₹10,00,000.
  3. PC equals net assets ₹10,00,000, so there is no goodwill and no capital reserve.
  4. Entry 1: Business Purchase A/c Dr ₹10,00,000 to Liquidator of Gamma Ltd ₹10,00,000.
  5. Entry 2: Assets Dr ₹12,00,000 to Liabilities ₹2,00,000 and to Business Purchase A/c ₹10,00,000.
  6. Entry 3: Liquidator of Gamma Ltd Dr ₹10,00,000 to Equity Share Capital ₹8,00,000 (80,000 × ₹10), to Securities Premium ₹80,000 (80,000 × ₹1) and to Bank ₹1,20,000.
  7. Check entry 3: ₹8,00,000 + ₹80,000 + ₹1,20,000 = ₹10,00,000.

Answer: Purchase consideration is ₹10,00,000. There is no goodwill or capital reserve. Delta Ltd issues equity share capital of ₹8,00,000, credits securities premium of ₹80,000 and pays ₹1,20,000 in cash.

Exam tips

  • In MCQs, the usual traps are purchase consideration on net assets and the sign of goodwill versus capital reserve. Compute both ways when time permits.
  • In descriptive answers, write the Realisation Account and the new company's journal entries separately and label them clearly. Each part earns its own marks.
  • For legal questions, state that the Tribunal sanctions the scheme, the scheme has an appointed date, the auditor certifies that the accounting treatment conforms to the accounting standards prescribed under section 133, and the order is filed with the Registrar within thirty days.
  • For comparison questions, use clear headings: purpose, entity continuing, accounts used, and treatment of shareholders. Do not write only definitions.
  • Always end with a balance sheet check. Equal totals show that your entries are consistent.

Practice questions from Absorptions, Amalgamations, External Reconstruction

External Reconstruction in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

External Reconstruction: frequently asked questions

What is the difference between internal and external reconstruction?

In internal reconstruction, the same company continues and restructures its capital, usually by reducing share capital and writing off losses. In external reconstruction, a new company takes over the business of the old company, which is then dissolved or wound up. The accounting uses a Capital Reduction Account for internal and a Realisation Account for external.

How is external reconstruction different from amalgamation?

Both involve transfer of a business to another company under a scheme. External reconstruction is mainly a restructuring of one business into a new company, often to deal with losses or capital structure. Amalgamation combines two or more companies. Read the facts in the question to decide which applies.

Is the old company wound up in external reconstruction?

Not necessarily. Under section 232(3)(d) of the Companies Act, 2013, the Tribunal may provide in its order for dissolution of the transferor company without winding-up. Where the order does not so provide, the old company is wound up in the usual way.

How do I treat the difference between purchase consideration and net assets?

If purchase consideration is higher than the net assets taken over, the excess is goodwill in the new company's books. If it is lower, the shortfall is capital reserve. Always use the agreed values from the scheme.