Internal Reconstruction: Meaning, Purpose, Accounting Treatment and Capital Reduction (Overview) Questions

Question 1

State one objective of internal reconstruction.

Accepted Answer

One objective of internal reconstruction is to write off accumulated losses and present a stronger balance sheet while continuing the business.

Question 2

Define internal reconstruction.

Accepted Answer

Internal reconstruction is reorganisation of a company’s capital and liabilities within the same company to eliminate losses and improve financial position without forming a new company.

Question 3

What is capital reduction?

Accepted Answer

Capital reduction is a reorganisation in which the paid-up share capital is reduced or restructured to reflect losses or to adjust capital structure.

Question 4

What is Reconstruction (Capital Reduction) Account?

Accepted Answer

Reconstruction Account is the account used to record sacrifices made by shareholders/creditors and to apply that amount to write off losses and reduce overvalued assets.

Question 5

Give one example of a fictitious asset.

Accepted Answer

Preliminary expenses (or discount on issue of shares) is an example of a fictitious asset.

Question 6

Internal reconstruction forms a new company.

Accepted Answer

False. In internal reconstruction, the same company continues; no new company is formed.

Question 7

Explain any three objectives/benefits of internal reconstruction.

Accepted Answer

Internal reconstruction is done to (any three):

- eliminate **accumulated losses** (P&L debit balance).
- write down **overvalued assets** to realistic values.
- reduce over-capitalisation and improve **balance sheet** strength.
- avoid liquidation and continue business.

Thus, it improves creditworthiness and future fund-raising ability.

Question 8

Differentiate between internal reconstruction and external reconstruction.

Accepted Answer

Internal vs external reconstruction:

| Basis | **Internal** | **External** |
|---|---|---|
| Company | same company continues | new company formed |
| Method | scheme within existing entity | transfer business to new entity |
| Purpose | clean up balance sheet, continue | restart with new balance sheet |

Hence, internal reconstruction avoids forming a new company.

Question 9

Explain how Reconstruction A/c is used (any three items written off/adjusted).

Accepted Answer

Reconstruction A/c is used to write off/adjust (any three):

- **Debit balance of P&L A/c** (accumulated losses)
- **Fictitious assets** (preliminary expenses, discount on issue)
- write down **overvalued assets** (goodwill, fixed assets, inventory)
- create provision for doubtful debts, etc.

It “uses” the sacrifice amount to clean the balance sheet.

Question 10

Write the journal entry for reduction in share capital and transfer of sacrifice to Reconstruction A/c (format).

Accepted Answer

For reduction in equity share capital:

**Equity Share Capital A/c Dr** (old paid-up)  
  To **Equity Share Capital A/c** (new paid-up)  
  To **Reconstruction A/c** (sacrifice)

This credits Reconstruction A/c with the sacrifice amount.

Question 11

How is shareholders’ sacrifice calculated when face value is reduced? Illustrate with a small working.

Accepted Answer

Shareholders’ sacrifice = Old paid-up capital – New paid-up capital.

Illustration: 1,00,000 equity shares of ₹10 each fully paid reduced to ₹6 each fully paid.

Old paid-up = 1,00,000 × 10 = ₹10,00,000
New paid-up = 1,00,000 × 6 = ₹6,00,000
So **Sacrifice = ₹4,00,000**.

| Particulars | Amount (₹) |
|---|---:|
| Old paid-up capital | 10,00,000 |
| New paid-up capital | 6,00,000 |
| **Sacrifice** | **4,00,000** |

Question 12

Show the utilisation sequence of Reconstruction A/c for writing off losses and fictitious assets (any three items) using a flow/table.

Accepted Answer

After crediting Reconstruction A/c with total **sacrifice**, it is utilised (debited) to:

Flow: **Sacrifice** → Reconstruction A/c → **Write-offs** → Clean balance sheet

| Utilisation (Reconstruction A/c Dr) | Examples |
|---|---|
| Write off accumulated losses | **P&L (debit)** |
| Eliminate fictitious assets | **Preliminary expenses**, discount on issue |
| Reduce overvalued assets / create provisions | goodwill write-down, provision for bad debts |

This sequence ensures sacrifice is applied first to remove losses and non-real items.

Question 13

Explain Reconstruction (Capital Reduction) Account with format entries and its application (use a table).

Accepted Answer

### Meaning
Reconstruction (Capital Reduction) Account records the total **sacrifice** made by shareholders/creditors and then applies it to write off losses and reduce overvalued assets.

### How it is credited (sources)
- reduction in share capital (shareholders’ sacrifice)
- reduction in creditors/liabilities (creditors’ sacrifice)

### How it is debited (utilisation)
- write off **P&L debit balance**
- eliminate **fictitious assets**
- write down assets / create provisions

| Side | Typical items |
|---|---|
| **Credit** | sacrifices (capital, creditors) |
| **Debit** | write-offs (losses, fictitious assets) |

### Conclusion
It acts like a “clean-up fund”: sacrifice creates the fund and write-offs use the fund to rebuild a healthy balance sheet.

Question 14

Explain sacrifice by shareholders and creditors in internal reconstruction with a neat table and conclude.

Accepted Answer

**Sacrifice** means stakeholders agree to reduce their claims to help the company eliminate losses and continue.

### Shareholders’ sacrifice
- reduce paid-up value (₹10 → ₹5)
- accept reduction of arrears/unpaid amounts

### Creditors’ sacrifice
- accept part reduction of amount payable
- convert portion into debentures/equity

| Stakeholder | **Typical sacrifice** | Purpose |
|---|---|---|
| Shareholders | reduce capital | adjust capital to real value |
| Creditors | reduce/convert claim | reduce liability burden |

### Conclusion
Combined sacrifices create Reconstruction A/c credit, which is then used to write off losses and overvaluations, improving the balance sheet.

Question 15

Prepare an exam-style working format for internal reconstruction showing sacrifice and utilisation (flow/table).

Accepted Answer

A clean exam approach is to show **(1) sacrifice** and **(2) utilisation**.

### (1) Sacrifice working
| Particulars | Old claim | New claim | **Sacrifice** |
|---|---:|---:|---:|
| Equity share capital | xxx | xxx | xxx |
| Creditors | xxx | xxx | xxx |
| **Total** |  |  | xxx |

### (2) Utilisation of Reconstruction A/c
| Utilisation | Amount |
|---|---:|
| Write off P&L (debit) | xxx |
| Write off goodwill/fictitious assets | xxx |
| Reduce asset values / provisions | xxx |

Flow (write): Sacrifice → Reconstruction A/c credit → Write-offs → Rewritten Balance Sheet

### Conclusion
This format ensures marks for working even if small arithmetic mistakes occur.

Internal Reconstruction: Meaning, Purpose, Accounting Treatment and Capital Reduction (Overview)

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