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Corporate Restructuring, Valuation and Insolvency · Accounting in Corporate Restructuring: Concept and Accounting Treatment

Accounting for Demerger and Internal Reconstruction

Updated 11 October 2026 · Fact-checked

In a demerger, the demerged company removes the transferred assets and liabilities at book value and adjusts the difference against reserves. The resulting company records them at the same book values and issues shares to shareholders. Internal reconstruction writes off losses and fictitious assets by reducing capital, using a Capital Reduction Account.

Understand Accounting for Demerger and Reconstruction

A demerger moves one or more undertakings out of an existing company (the demerged company) into another company (the resulting company). The resulting company issues its shares to the shareholders of the demerged company, in proportion to their holdings. The demerged company continues to exist. This is why a demerger is often called a spin-off.

Under Section 2(19AA) of the Income-tax Act, 1961 (the Income-tax Act, 2025 carries the same idea), tax neutrality needs the transfer to be of an undertaking, at book value, with proportionate share issue. Accounting follows the same logic. In the Ind AS framework, a demerger within a group is generally a common control transaction, covered in Ind AS 103 Appendix C, so book values are used and no fresh goodwill is created by fair valuing. Always follow the accounting treatment given in the scheme, as approved by the Tribunal, when it complies with the applicable accounting standards.

In the books of the demerged company: remove the assets and liabilities of the demerged undertaking at their book values. The excess of assets over liabilities is the net book value transferred. Adjust this against the share capital reduced (if the scheme cancels shares) and the balance against reserves, as the scheme says. If the scheme says the shares of the resulting company are issued directly to the demerged company's shareholders, the demerged company records no investment.

In the books of the resulting company: record the assets and liabilities at book values. Issue shares at the exchange ratio. The difference between the net assets taken over and the face value of shares issued goes to Capital Reserve (if net assets are higher) or is adjusted against reserves (if lower), as per the scheme.

Internal reconstruction is different. No new company is formed and no business is transferred. The same company reorganises its capital, often by reducing share capital under Section 66 of the Companies Act, 2013, to write off accumulated losses and fictitious assets, so that the balance sheet shows a true position. Entries pass through a Capital Reduction Account: credit it with the sacrifice made by shareholders and creditors, and debit it with the losses and assets written off. Any balance left in it is transferred to Capital Reserve.

Key rules to remember

Net book value transferred in demerger
Net book value = Book value of assets transferred − Book value of liabilities transferred
Use book values, not fair values, unless the scheme and applicable standard specify otherwise.
Resulting company: shares issued
Shares issued = Shares held in demerged company × Share entitlement ratio
The ratio is given in the scheme, based on a valuation report. Apply it to each shareholder's holding.
Capital reserve or adjustment in resulting company
Difference = Net assets taken over − Face value of shares issued (and any cash paid)
Positive difference: Capital Reserve. Negative difference: adjust against reserves as per the scheme.
Capital Reduction Account balance
Balance = Total sacrifice credited − Total losses and assets written off
A credit balance goes to Capital Reserve. A debit balance should normally be nil in a properly drawn scheme.
Demerger entry in demerged company (typical)
Dr Liabilities transferred; Dr Reserves / Share capital (balancing figure); Cr Assets transferred
The balancing debit is as per the scheme. Check it equals net book value transferred.
Resulting company entry (typical)
Dr Assets taken over; Cr Liabilities taken over; Cr Share capital (face value); Cr Capital reserve (balance)
If net assets are lower than the face value of shares issued, debit the shortfall to reserves instead.

How to solve Accounting for Demerger and Reconstruction questions

Use this order for any demerger or reconstruction question. Read the scheme terms first, because the scheme decides the adjustments.

  1. 1Identify the type: demerger (two companies) or internal reconstruction (one company). Note whose books are asked for.
  2. 2List the assets and liabilities of the undertaking transferred (demerger) or the items to be written off (reconstruction), with their book values.
  3. 3Work out net book value transferred, or the total of losses, fictitious assets and overvalued assets to be written off.
  4. 4Calculate shares issued using the given ratio, and the face value of those shares.
  5. 5Compute the difference and decide where it goes: Capital Reserve, reserves, or the Capital Reduction Account.
  6. 6Pass the journal entries in the correct books, with narrations. Check that debits equal credits.
  7. 7Prepare the Balance Sheet after the scheme if asked, and verify that total assets equal total equity and liabilities.

Quickest way: Net assets first, then plug

When to use it: When time is short and the question asks for entries or a post-scheme balance sheet.

  1. Write net assets of the undertaking in one line: assets minus liabilities.
  2. Compute shares issued at face value.
  3. The gap between the two is the only plug: Capital Reserve or a debit to reserves.
  4. For reconstruction, add up all write-offs first, then fix the sacrifice needed to cover them exactly.
  5. Pass entries and tick that each side totals the same.

Common mistakes in Accounting for Demerger and Reconstruction

  • Fair valuing assets in a demerger within a group

    Students mix up the acquisition method of Ind AS 103 with common control accounting.

    Fix: For common control transfers, use book values as per Appendix C and do not create goodwill from fair valuation.

  • Recording an investment in the resulting company's shares in the demerged company's books

    Students assume the demerged company receives the shares.

    Fix: Shares are normally issued directly to the shareholders of the demerged company, so no investment arises. Read the scheme.

  • Crediting the difference to Goodwill or profit in the resulting company

    Habit from purchase-method amalgamation.

    Fix: Excess of net assets over shares issued goes to Capital Reserve. A shortfall is adjusted against reserves as per the scheme.

  • Writing off assets in internal reconstruction without using the Capital Reduction Account

    Students shorten entries and lose the audit trail.

    Fix: Credit the sacrifice to Capital Reduction Account, then debit write-offs from it. Transfer any balance to Capital Reserve.

  • Forgetting the effect on both sides of the balance sheet when share capital is reduced

    Students change assets but not capital.

    Fix: Reduce share capital by the sacrifice and reduce assets or losses by the same total. Then re-check the balance sheet.

Worked examples

Example 1

Alpha Ltd demerges its Textile Division into Beta Ltd. Book values transferred: Fixed Assets ₹60,00,000; Inventory ₹20,00,000; Trade Payables ₹10,00,000; Loan ₹15,00,000. Beta Ltd issues 5,00,000 equity shares of ₹10 each fully paid to Alpha's shareholders. Alpha's scheme says the excess of net book value over share capital reduction is adjusted against General Reserve, and shares of Alpha are reduced by ₹30,00,000. Pass entries in both companies.

Show the solution
  1. Assets transferred = 60,00,000 + 20,00,000 = ₹80,00,000.
  2. Liabilities transferred = 10,00,000 + 15,00,000 = ₹25,00,000.
  3. Net book value = 80,00,000 − 25,00,000 = ₹55,00,000.
  4. Shares issued by Beta = 5,00,000 × ₹10 = ₹50,00,000.
  5. Beta's difference = 55,00,000 − 50,00,000 = ₹5,00,000, which goes to Capital Reserve.
  6. Alpha's balancing figure: net book value ₹55,00,000 less share capital reduced ₹30,00,000 = ₹25,00,000 debited to General Reserve.
  7. Alpha's entry: Dr Trade Payables 10,00,000; Dr Loan 15,00,000; Dr Share Capital 30,00,000; Dr General Reserve 25,00,000; Cr Fixed Assets 60,00,000; Cr Inventory 20,00,000. Debits total 80,00,000 and credits total 80,00,000.
  8. Beta's entry: Dr Fixed Assets 60,00,000; Dr Inventory 20,00,000; Cr Trade Payables 10,00,000; Cr Loan 15,00,000; Cr Equity Share Capital 50,00,000; Cr Capital Reserve 5,00,000. Both sides total 80,00,000.

Answer: Net book value ₹55,00,000. Alpha debits Share Capital ₹30,00,000 and General Reserve ₹25,00,000. Beta issues shares of ₹50,00,000 and credits Capital Reserve ₹5,00,000.

Example 2

Gamma Ltd has 1,00,000 equity shares of ₹10 each fully paid (₹10,00,000). It has Profit and Loss Account debit balance ₹3,00,000, Preliminary Expenses ₹50,000, and Machinery shown at ₹4,00,000 that is worth ₹3,50,000. The scheme reduces each share to ₹6 fully paid. Pass reconstruction entries and find the balance in the Capital Reduction Account.

Show the solution
  1. Reduction per share = ₹10 − ₹6 = ₹4. Total reduction = 1,00,000 × 4 = ₹4,00,000.
  2. Entry 1: Dr Equity Share Capital (₹10) 10,00,000; Cr Equity Share Capital (₹6) 6,00,000; Cr Capital Reduction Account 4,00,000.
  3. Write-offs: Profit and Loss debit 3,00,000; Preliminary Expenses 50,000; Machinery reduction 4,00,000 − 3,50,000 = 50,000. Total = ₹4,00,000.
  4. Entry 2: Dr Capital Reduction Account 4,00,000; Cr Profit and Loss Account 3,00,000; Cr Preliminary Expenses 50,000; Cr Machinery 50,000.
  5. Balance in Capital Reduction Account = 4,00,000 credited − 4,00,000 debited = Nil, so nothing moves to Capital Reserve.

Answer: Capital reduction is ₹4,00,000, exactly equal to total write-offs of ₹4,00,000. The Capital Reduction Account closes with a nil balance.

Exam tips

  • Begin by stating the basis: book values under Ind AS 103 Appendix C for common control, as per the Tribunal-approved scheme. This earns marks even if your arithmetic slips.
  • Show net assets, shares issued and the difference as three separate lines. Examiners award marks per step.
  • Use a proper narration with each entry and mention Section 66 when reducing share capital.
  • In theory-based answers, link the accounting to the tax conditions of a demerger and to the approved scheme.
  • Check the balance sheet balances at the end. A mismatch usually signals a missed write-off.

Practice questions from Accounting in Corporate Restructuring: Concept and Accounting Treatment

Accounting for Demerger and Reconstruction in other exams

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

Accounting for Demerger and Reconstruction: frequently asked questions

Which values are used in demerger accounting?

Book values are generally used, especially where the demerger is a common control transaction under Ind AS 103 Appendix C. The scheme approved by the Tribunal specifies the exact treatment, which must comply with applicable accounting standards.

Where does the balancing figure go in the resulting company?

If net assets taken over exceed the face value of shares issued, the excess is credited to Capital Reserve. If they are lower, the shortfall is adjusted against reserves as the scheme provides.

What is the Capital Reduction Account used for?

It collects the sacrifice by shareholders and creditors on credit side and the write-offs of losses and overvalued assets on debit side. Any credit balance left is transferred to Capital Reserve.

Does the demerged company get shares of the resulting company?

Usually no. In a typical demerger, the resulting company issues shares directly to the shareholders of the demerged company. Check the scheme wording in the question before deciding.