Internal Reconstruction for CA Inter Advanced Accounting: A Worked Example With Journal Entries

Internal reconstruction is one of the most dependable questions in CA Inter Advanced Accounting. The format barely changes: a loss-making company, a scheme approved by shareholders and the Tribunal, journal entries, a Capital Reduction Account and a revised balance sheet. Get the structure right and the marks follow. This guide covers the legal basis briefly, then works a full example.

What Internal Reconstruction Is

ICAI's study material describes reconstruction as reorganising a company's affairs by revaluing assets, reassessing liabilities and writing off losses already suffered, by reducing the paid-up value of shares and/or varying the rights attached to shares. In internal reconstruction the company is not liquidated. In external reconstruction the business moves to a new company owned substantially by the same shareholders, which AS 14 treats as an amalgamation in the nature of merger.

The Legal Methods

Alteration of share capital (Section 61): if the articles allow it, an ordinary resolution in general meeting can sub-divide or consolidate shares, convert shares into stock or back, increase authorised capital or cancel unissued shares. No Capital Reduction Account is needed.
Variation of shareholders' rights (Section 48): for example, changing the dividend rate on preference shares. Close the old class and open the new one; again, no Capital Reduction Account.
Reduction of share capital (Section 66): by special resolution, subject to confirmation by the Tribunal (NCLT). Capital can be reduced by extinguishing liability on unpaid capital, paying off capital in excess of needs, or cancelling paid-up capital that is lost or unrepresented by available assets.
Compromise or arrangement with creditors and surrender of shares.

Under the proviso to Section 66(3), the Tribunal will not sanction a reduction unless the proposed accounting treatment conforms to the accounting standards under Section 133 and the company's auditor certifies this.

The Accounting Rules

Shareholders' sacrifice, creditors' sacrifice and any increase in asset values are credited to the Capital Reduction Account (also called the Reconstruction Account).
Accumulated losses (the debit balance of profit and loss), fictitious and intangible assets, and asset write-downs are debited to it.
Any credit balance left is transferred to Capital Reserve. If the account falls short, existing reserves are used.
"And Reduced" is added after the company's name only if the Tribunal so orders.

Worked Example

Phoenix Ltd. has the following summarised balance sheet as at 31 March 2026 (₹):

Equity share capital: 1,00,000 shares of ₹10 each, fully paid: 10,00,000
9% preference share capital: 3,000 shares of ₹100 each, fully paid: 3,00,000
Reserves and surplus: profit and loss (debit balance): (4,50,000)
10% debentures: 2,00,000
Trade payables: 2,50,000
Total equity and liabilities: 13,00,000
Goodwill: 1,00,000; land and building: 4,00,000; plant and machinery: 3,50,000; inventory: 2,50,000; trade receivables: 1,50,000; cash at bank: 50,000
Total assets: 13,00,000

The following scheme is approved by special resolution and confirmed by the Tribunal:

(a) Equity shares are reduced to ₹4 each, fully paid.
(b) Preference shares are reduced to ₹80 each, fully paid, and the dividend rate is raised to 10%.
(c) Debenture holders accept a 10% reduction in their claim.
(d) Trade payables give up 20% of their claim.
(e) Land and building is revalued at ₹4,60,000.
(f) Goodwill and the profit and loss debit balance are written off; plant is written down to ₹2,80,000; inventory is written down by ₹40,000; a provision for doubtful debts of ₹15,000 is created.
(g) Any balance in the Capital Reduction Account goes to Capital Reserve.

Journal Entries

1. Equity reduction
Equity Share Capital (₹10) A/c Dr. 10,00,000
To Equity Share Capital (₹4) A/c 4,00,000
To Capital Reduction A/c 6,00,000
(1,00,000 shares reduced from ₹10 to ₹4 under the scheme)

2. Preference reduction and variation of rights
9% Preference Share Capital (₹100) A/c Dr. 3,00,000
To 10% Preference Share Capital (₹80) A/c 2,40,000
To Capital Reduction A/c 60,000
(3,000 shares reduced to ₹80 and dividend rate changed to 10%)

3. Debenture holders' sacrifice
10% Debentures A/c Dr. 20,000
To Capital Reduction A/c 20,000

4. Creditors' sacrifice
Trade Payables A/c Dr. 50,000
To Capital Reduction A/c 50,000

5. Revaluation of land and building
Land and Building A/c Dr. 60,000
To Capital Reduction A/c 60,000

6. Write-offs
Capital Reduction A/c Dr. 6,75,000
  To Profit and Loss A/c 4,50,000
  To Goodwill A/c 1,00,000
  To Plant and Machinery A/c 70,000
  To Inventory A/c 40,000
  To Provision for Doubtful Debts A/c 15,000

7. Balance to capital reserve
Capital Reduction A/c Dr. 1,15,000
To Capital Reserve A/c 1,15,000

Capital Reduction Account

Credits: equity 6,00,000 + preference 60,000 + debentures 20,000 + trade payables 50,000 + land and building 60,000 = 7,90,000.
Debits: profit and loss 4,50,000 + goodwill 1,00,000 + plant 70,000 + inventory 40,000 + provision 15,000 = 6,75,000.
Balance to Capital Reserve: 7,90,000 - 6,75,000 = 1,15,000.

Balance Sheet After Reconstruction (₹)

Equity share capital: 1,00,000 shares of ₹4 each: 4,00,000
10% preference share capital: 3,000 shares of ₹80 each: 2,40,000
Reserves and surplus: capital reserve: 1,15,000
10% debentures: 1,80,000
Trade payables: 2,00,000
Total: 11,35,000
Land and building 4,60,000; plant and machinery 2,80,000; inventory 2,10,000; trade receivables 1,50,000 less provision 15,000 = 1,35,000; cash at bank 50,000
Total: 11,35,000

The balance sheet agrees. In the notes, show the reduction in share capital and the movement on capital reserve, and disclose the write-downs of fixed assets under the scheme.

Where Students Lose Marks

Crediting a sacrifice to profit and loss instead of the Capital Reduction Account.
Using the Capital Reduction Account for a sub-division or consolidation. Those are Section 61 alterations: just close the old class and open the new one at the same amount.
Forgetting the asset increase. An upward revaluation under the scheme is a credit to the Capital Reduction Account.
Leaving a balance in the account. It must close, to capital reserve or against reserves.
Writing off the debit balance of profit and loss twice, once in the reconstruction account and again in the balance sheet.

How It Appears in the MCQs

Expect 1- or 2-mark questions such as: the amount transferred to capital reserve; the paid-up value per share after a scheme; whether a given change needs Tribunal confirmation; or which account receives a creditor's sacrifice. Drill these in the internal reconstruction MCQs, then related chapters: buyback of securities and amalgamation. For the legal side, the share capital and debentures chapter of Corporate and Other Laws overlaps directly. For how the MCQ section works across all papers, see CA Inter MCQs in all six papers.

FAQs

Which section of the Companies Act 2013 governs reduction of share capital?
Section 66. It requires a special resolution and confirmation by the Tribunal.

Does sub-division of shares need a Capital Reduction Account?
No. Sub-division and consolidation are alterations under Section 61 and do not change the amount of paid-up capital.

Where does the balance of the Capital Reduction Account go?
A credit balance goes to Capital Reserve. If the account cannot absorb all the write-offs, existing reserves are used.

Is an upward revaluation credited to revaluation reserve?
Not when it is part of the reconstruction scheme. ICAI's study material credits it to the Capital Reduction Account.

Is internal reconstruction the same as amalgamation?
No. Internal reconstruction keeps the same company. External reconstruction transfers the business to a new company and falls under AS 14.

Sources

ICAI BoS, Intermediate Paper 1 Advanced Accounting, Chapter 14: Internal Reconstruction: methods, Sections 48, 61 and 66, accounting entries and presentation.
Companies Act, 2013, Section 66 (bare act text): special resolution, Tribunal confirmation and the proviso to Section 66(3). The authoritative text is on mca.gov.in.
ICAI BoS, study material applicable for January 2027. Chapter numbering differs between editions; use the edition listed for your attempt.