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Advanced Accounting · Internal Reconstruction

Accounting Entries for Internal Reconstruction

Updated 4 October 2026 · Fact-checked

Internal reconstruction entries move every sacrifice and gain through a Reconstruction (Capital Reduction) Account. Credit it with reductions in share capital and liabilities. Debit it with write-offs of losses and assets and with settlements the company pays. Any balance left over goes to capital reserve. Passing credit entries first is a convenient working order, not a rule.

Understand Accounting Entries for Internal Reconstruction

In internal reconstruction, a company reorganises its own capital and balance sheet without winding up. It does this because accumulated losses and overvalued assets make the balance sheet unreal. A reduction of share capital is done under Section 66 of the Companies Act, 2013. It needs authorisation by the company's articles, a special resolution and confirmation by the Tribunal. Creditors can object to the reduction, and the Tribunal considers their objections before it confirms. Once the Tribunal confirms, its order must be filed with the Registrar. Not every reconstruction reduces capital. Some schemes only alter or convert capital.

The key idea is sacrifice. Shareholders accept lower face values, creditors accept less than they are owed, and sometimes preference shareholders give up their arrears of dividend. All these sacrifices are gains for the company. They are credited to the Reconstruction Account.

The same account then absorbs the losses. You debit it with the debit balance of Profit and Loss, goodwill, preliminary expenses, and the write-down of assets such as plant, inventory and debtors. It also absorbs costs of the scheme and liabilities that were not in the books but must now be paid.

Arrears of preference dividend need care. Until the dividend is declared, it is not a liability in the books. It is only a contingent liability. So if holders waive the arrears, you pass no entry. If they get shares or cash in settlement, the amount given is a cost to the company, so you debit the Reconstruction Account.

At the end the Reconstruction Account should be nil. If it has a credit balance after all write-offs, transfer it to Capital Reserve. A debit balance means the scheme has not written off enough, so check your working.

Key rules to remember

Reduction of share capital
Old paid-up amount − New paid-up amount = Credit to Reconstruction A/c
Entry: Share capital (old) Dr; To Share capital (new); To Reconstruction A/c.
Liability settled for less
Liability due − Amount accepted = Credit to Reconstruction A/c
Entry: Creditors Dr; To Bank or Shares; To Reconstruction A/c.
Write-off of loss or asset
Reconstruction A/c Dr; To P&L debit balance / Goodwill / Preliminary expenses / Asset
Use the amount of reduction only, not the new value of the asset.
Increase in asset value
Asset A/c Dr; To Reconstruction A/c
Credit side gain. Pass only if the scheme revalues the asset upward.
Arrears of preference dividend
Waived: no entry. Settled by shares or cash: Reconstruction A/c Dr; To Share capital / Bank
Arrears are a contingent liability until declared, so they are not in the books.
Balance of Reconstruction A/c
Credit balance → Reconstruction A/c Dr; To Capital Reserve
Total credits − Total debits. Ideally the account closes at nil.

How to solve Accounting Entries for Internal Reconstruction questions

Use this working order for any question. It is a convenience, not a legal or ICAI requirement, but it keeps entries complete and makes the Reconstruction Account balance.

  1. 1Read the scheme and list every change: share capital, liabilities, assets, losses, arrears, expenses.
  2. 2Pass entries for conversion or reduction of share capital. Debit old capital, credit new capital, and credit the difference to Reconstruction A/c.
  3. 3Pass entries for liabilities. Debit the liability at book value, credit what is paid or issued, and credit the gain to Reconstruction A/c.
  4. 4Pass entries for new payments and unrecorded claims. Debit Reconstruction A/c and credit Bank or the liability. Do the same for arrears settled in shares.
  5. 5Pass entries for write-offs. Debit Reconstruction A/c and credit P&L debit balance, goodwill, preliminary expenses and assets written down. Debit the asset and credit Reconstruction A/c for any increase.
  6. 6Prepare the Reconstruction Account. Total the credits and debits and check they match.
  7. 7Transfer any credit balance to Capital Reserve. If there is a debit balance, recheck.
  8. 8Give narrations, then move on to the balance sheet if asked.

Quickest way: Credit side, debit side, tick-off

When to use it: Use this when a long scheme is given for 10-14 marks and time is short. It also helps with MCQs on the Reconstruction A/c balance.

  1. Draw a two-column Reconstruction A/c on your rough page.
  2. Add everything gained on the credit side: capital reductions, liabilities waived, asset increases.
  3. Add everything lost on the debit side: P&L balance, goodwill, asset write-offs, payments, shares issued for arrears.
  4. The difference is capital reserve if credit, or an error if debit. In an MCQ, this total alone often gives the answer.
  5. In the written answer, show each journal entry with its amount and a short narration. Examiners give separate step marks for each entry and for the account.

Common mistakes in Accounting Entries for Internal Reconstruction

  • Passing an entry for waived arrears of preference dividend.

    Students treat arrears as a recorded liability.

    Fix: Arrears not declared are only a contingent liability. If waived, pass no entry. Debit Reconstruction A/c only when shares or cash are given in settlement.

  • Crediting the new value of shares to Reconstruction A/c instead of the reduction.

    Students confuse the old amount, the new amount and the difference.

    Fix: Credit Reconstruction A/c only with the difference. The new amount stays in share capital.

  • Writing down an asset to its new value instead of writing off the reduction.

    The question gives the revised value, and the student uses it directly.

    Fix: Compute the reduction as book value minus revised value. Credit the asset with that amount only.

  • Forgetting to write off the P&L debit balance, goodwill or preliminary expenses.

    These are not mentioned in the scheme in clear words.

    Fix: Check the balance sheet for fictitious assets and losses. They are almost always written off in the scheme.

  • Leaving out unrecorded contingent claims that are now payable.

    Students look only at items in the balance sheet.

    Fix: Read the notes and the scheme. If a claim is settled, Reconstruction A/c Dr; To Bank or Liability.

  • Leaving a credit or debit balance in the Reconstruction A/c without comment.

    The students do not total the two sides.

    Fix: Always total the account. Move a credit balance to Capital Reserve. Recheck the working if there is a debit balance.

Worked examples

Example 1

A Ltd has 10,000 equity shares of ₹100 each fully paid and 2,000 8% preference shares of ₹100 each fully paid. The scheme: (i) equity shares are reduced to ₹40 each fully paid; (ii) preference shares are reduced to ₹80 each fully paid; (iii) the Profit and Loss debit balance of ₹3,00,000 and goodwill of ₹1,00,000 are written off; (iv) plant is reduced by ₹1,50,000; (v) inventory is reduced by ₹90,000. Pass the journal entries and prepare the Reconstruction Account.

Show the solution
  1. Equity reduction: 10,000 × (₹100 − ₹40) = ₹6,00,000.
  2. Preference reduction: 2,000 × (₹100 − ₹80) = ₹40,000.
  3. Total credit to Reconstruction A/c = ₹6,40,000.
  4. Write-offs: 3,00,000 + 1,00,000 + 1,50,000 + 90,000 = ₹6,40,000.
  5. Entry 1: Equity Share Capital (₹100) A/c Dr ₹10,00,000; To Equity Share Capital (₹40) A/c ₹4,00,000; To Reconstruction A/c ₹6,00,000.
  6. Entry 2: 8% Preference Share Capital (₹100) A/c Dr ₹2,00,000; To 8% Preference Share Capital (₹80) A/c ₹1,60,000; To Reconstruction A/c ₹40,000.
  7. Entry 3: Reconstruction A/c Dr ₹6,40,000; To Profit and Loss A/c ₹3,00,000; To Goodwill A/c ₹1,00,000; To Plant A/c ₹1,50,000; To Inventory A/c ₹90,000.
  8. Reconstruction A/c: credit side ₹6,00,000 + ₹40,000 = ₹6,40,000. Debit side ₹6,40,000. The account balances and no capital reserve arises.

Answer: Three entries are passed. The Reconstruction A/c shows credits of ₹6,40,000 and debits of ₹6,40,000, so it closes at nil.

Example 2

B Ltd has 5,000 equity shares of ₹100 each fully paid and 1,000 8% preference shares of ₹100 each fully paid, with preference dividend in arrears for 2 years. The scheme: (i) equity shares are reduced to ₹60 each fully paid; (ii) preference shares are reduced to ₹75 each fully paid; (iii) the arrears of preference dividend are settled by issuing 1,600 equity shares of ₹10 each, fully paid, at par; (iv) creditors of ₹2,00,000 accept ₹1,50,000 in full settlement, payable in cash; (v) a legal claim of ₹40,000 not recorded in the books is settled and paid in cash; (vi) the Profit and Loss debit balance of ₹1,50,000 and goodwill of ₹40,000 are written off and plant is reduced as needed to close the Reconstruction Account. Pass the journal entries and find the reduction in plant.

Show the solution
  1. Equity reduction: 5,000 × (100 − 60) = ₹2,00,000.
  2. Preference reduction: 1,000 × (100 − 75) = ₹25,000.
  3. Arrears: 1,00,000 × 8% × 2 = ₹16,000, settled by issuing 1,600 shares of ₹10 at par = ₹16,000. The arrears were not a liability in the books, so the shares issued are a cost to the company and the Reconstruction A/c is debited.
  4. Creditors: 2,00,000 − 1,50,000 = ₹50,000 gain, a credit.
  5. Total credits = 2,00,000 + 25,000 + 50,000 = ₹2,75,000.
  6. Debits before plant = 16,000 + 40,000 + 1,50,000 + 40,000 = ₹2,46,000.
  7. Plant write-down = 2,75,000 − 2,46,000 = ₹29,000.
  8. Entry 1: Equity Share Capital (₹100) A/c Dr ₹5,00,000; To Equity Share Capital (₹60) A/c ₹3,00,000; To Reconstruction A/c ₹2,00,000.
  9. Entry 2: 8% Preference Share Capital (₹100) A/c Dr ₹1,00,000; To 8% Preference Share Capital (₹75) A/c ₹75,000; To Reconstruction A/c ₹25,000.
  10. Entry 3: Reconstruction A/c Dr ₹16,000; To Equity Share Capital (₹10) A/c ₹16,000 (1,600 shares issued at par in settlement of arrears).
  11. Entry 4: Sundry Creditors A/c Dr ₹2,00,000; To Bank A/c ₹1,50,000; To Reconstruction A/c ₹50,000.
  12. Entry 5: Reconstruction A/c Dr ₹40,000; To Bank A/c ₹40,000.
  13. Entry 6: Reconstruction A/c Dr ₹2,19,000; To Profit and Loss A/c ₹1,50,000; To Goodwill A/c ₹40,000; To Plant A/c ₹29,000. Check: 1,50,000 + 40,000 + 29,000 = ₹2,19,000.
  14. Check: debits 16,000 + 40,000 + 2,19,000 = ₹2,75,000, equal to the credits.

Answer: Plant is reduced by ₹29,000. The Reconstruction A/c balances at ₹2,75,000 on each side, so there is no capital reserve.

Exam tips

  • Always show the Reconstruction Account after the journal entries. It earns marks and proves your entries tally.
  • Read the scheme line by line and tick each item as you pass its entry. Missed items cost the most marks.
  • For arrears of preference dividend, first check whether the dividend was declared. Undeclared arrears are a contingent liability, so waiver needs no entry.
  • In MCQs, compute the Reconstruction A/c credit and debit totals only. The balance usually gives the capital reserve or the plant write-off.
  • Write a short narration under each entry, such as 'Being equity shares reduced as per scheme'.

Practice questions from Internal Reconstruction

Accounting Entries for Internal 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 Entries for Internal Reconstruction: frequently asked questions

What is the Reconstruction Account in internal reconstruction?

It is a temporary account that collects sacrifices as credits and losses and write-offs as debits. It is also called the Capital Reduction Account. Its balance is usually nil, or a credit balance that goes to Capital Reserve.

How do you treat arrears of preference dividend in reconstruction?

Undeclared arrears are only a contingent liability, so they are not in the books. If holders waive them, pass no entry. If you issue shares or pay cash for them, debit Reconstruction A/c and credit share capital or bank.

Which entry comes first, credit side or debit side?

No law or ICAI rule fixes the order. Many students pass the entries that create credits first, such as capital reduction and waiver of liabilities, and then the write-offs. This is only a convenient working order, and it shows whether the gain is enough to cover the losses.

Where does a credit balance in the Reconstruction Account go?

After all write-offs, transfer a credit balance to Capital Reserve. It appears under Reserves and Surplus in the balance sheet.