Internal Reconstruction of a Company: Meaning, Methods & Impact

The concept of internal reconstruction of a company is crucial for businesses facing financial imbalances without dissolving their corporate identity. Internal restructure is a financial restructuring of a company where such a company reorganized its financial structure to rectify imbalance created due to accumulated losses or overvaluation of assets but not to cease its legal existence. It was restructuring of its share capital, revaluation of its assets, and possibly its re-negotiation with its creditors, thereby improving the financial health and future prospects of the company. Internal reconstruction is a financial and operational strategy used by a company to reorganize its internal arrangement. When a corporation encounters financial struggles, it may undergo internal restructuring. Internal reconstruction of a company is when a company changes how it's owned and run. It doesn't become a new company or shut down completely. The company might want to change how much ownership each shareholder has or reduce the amount of money they owe to others. To do this, the company might lower the amount of money it's worth and ask people for a break on what they owe.

Internal reconstruction of a company is a vital topic to be studied for the commerce related exams such as the UGC NET Commerce Examination.

In this article, the readers will be able to know about the following:

• Internal Reconstruction of a Company
• Internal Reconstruction Accounting Treatment
• Key Reasons for Internal Reconstruction of Company
• Top Methods of Internal Reconstruction of a Company
• Journal Entries for Internal Reconstruction with Examples
• Features of Internal Restructuring
• Difference Between Internal and External Reconstruction of a Company

Click Here to Download UGC NET Paper 1 Important Questions PDF

Internal Reconstruction of a Company

Internal reconstruction of a company is a way to reorganize its finances. Without shutting it down completely. It's also called reorganization, and it helps the company keep running.

Usually, the company reduces the share capital to cover previous losses. The accounting process for internal reconstruction differs from amalgamation, absorption, and external reconstruction. Companies may need to restructure for different reasons. Like facing financial difficulties, low sales, and high competition. Or because of too much debt or loss of competitiveness.

These actions can improve the company's financial position. Decreasing the amount of debt it owes compared to the company's ownership. This will also help the company to raise money more easily.

Fig: internal reconstruction of company

Accounting treatment is an important aspect of internal reconstruction. It depicts the systematic reflection of changes in capital, assets, liabilities, and reserves on the records of a company. The main aim of this treatment is to reflect a clearer and truer view of the financial position-a view that has its limitations in affecting the legal persona of the company.

For this reason, this part holds a great significance for the UGC NET, CA Foundation/Inter, B.Com, and MBA finance students, as well as for various practical accounting applications.

What is a Reconstruction Account?

The Reconstruction Account (also called Capital Reduction Account) is a temporary nominal account created to record the effects of all internal reconstruction transactions.

• It is used to accumulate gains from various sources like:
• Reduction in share capital
• Forgiveness of liabilities by creditors
• Revaluation of liabilities/assets
• It is debited with losses such as:
• Writing off fictitious assets (like goodwill, accumulated losses, preliminary expenses)
• Revaluation losses or asset write-downs
• Final Transfer: Any remaining balance in the Reconstruction Account is transferred to Capital Reserve (if credit balance) or debited from General Reserve (if debit balance). 

Accounting Rules (Debit/Credit Logic)

Here's how to understand debits and credits in the context of internal reconstruction:

Key Reasons for Internal Reconstruction of Company

Understanding the reasons behind internal reconstruction of a company can help stakeholders assess when such restructuring is necessary. Internal reconstruction aids a firm in getting better financially and making better choices. Firms do this in order to solve issues such as excessive debt, poor performance, or becoming better organized to ensure future success.

Debt Reduction

A major reason for internal reconstruction is the reduction of how much money the firm owes. When a business is over-indebted, it may not be able to pay bills, which can damage its business. By lowering debt, the business can save and invest in expansion. This also reduces the stress of paying bills and makes the business stronger. Lowering debt gives the business more room to invest in new ventures and opportunities.

Enhancing Financial Health

Internal reconstruction helps to improve the overall financial health of the company. If a company is losing money or not making enough, it may be forced to restructure how it saves and spends money. This might mean cutting costs or developing new ways of increasing income. A company with better financial health can grow at a quicker pace and become more profitable. Making these changes also helps the company avoid getting into future financial trouble.

Structuring the Business Organization

Occasionally, businesses must rearrange the way they are structured to make it all work more efficiently. This might mean merging departments or rearranging jobs in the company to be more productive. When a business has a good and organized structure, employees can more easily do their jobs well. An organized business is able to get things done more quickly, conserve time, and make fewer errors. Organizing the business organization is necessary to keep the firm on track and prepared for growth.

Attracting New Investors

Reconstruction within can make a company more appealing to new investors. When a firm addresses its financial issues and streamlines, it demonstrates to investors that it is a good investment opportunity. Investors will be more willing to fund a company that is on the rise and aims for long-term success. Having new investors can provide the company with additional funds to grow and expand. This makes the company stronger and provides it with better chances of success in the future. 

Improving Business Performance

Performance enhancement is another reason for internal reform. A company may be struggling with the way it operates, e.g., having poor sales or poor production. The internal reforms may correct such problems and have the company operate effectively. For example, the company can seek means of enhancing sales or improving customer services. If the company operates to the best of its capacity, it can grow, generate more revenues, and become a healthier company.

Top Methods of Internal Reconstruction of a Company

The various methods of internal reconstruction aim to restore financial health without altering the company’s legal existence. There are various means through which a company can reconstruct itself internally. These means make the company more organized, pay off debts, and become financially stable.

Reducing Share Capital

One form of internal reconstruction is to decrease the company's share capital. This is where the company decreases the overall value of its shares, which are similar to fragments of ownership in the company. This will make the company's accounts easier and enable it to lower its debts. Decreasing share capital can also assist the company in concentrating on increasing and getting bigger. In this way, the company will be able to utilize its resources more effectively and acquire new investors.

Revaluing Assets

Another form of internal reconstruction is revaluing assets, which are the properties of a company, such as buildings, equipment, or machinery. At times, the company must verify if the value of its assets has changed over time. If they have decreased in value, the company can update their value to provide an actual representation of its finances. This assists the business in making improved decisions regarding what to retain or sell. Asset revaluing also assists the business in saving on taxes and gaining a clear idea of its actual value.

Writing Off Bad Debts

The tactic of writing off bad debts is accomplished when an organization decides to take debts off the books that will never be paid. Some customers or businesses owe money but simply cannot pay it back to the business. Once the business writes off such debts, it can now turn its attention to the collection of money that will actually come in. The effect of writing off bad debt presents a realistic image of the business, less encumbered from stressing about debts that would never be collected. By writing off bad debt, the business can then focus on preferred activities.

Consolidation of Business Arms

Another internal reconstruction technique can be through consolidation of business arms. This rationalizes the way different departments or segments cooperate with one another to become more efficient. For instance, where a firm has two departments carrying out similar functions, it can merge them into one. This brings about cost savings, possible eradications of waste and enhances overall effectiveness for the organization. The consolidation of business arms enables the organization to sharpen its focus on the areas where it is most competent, and boost greater effectiveness.

Staff Reduction or Alterations

Sometimes, internal restructuring entails reducing or changing a number of employees. It may not always involve firing personnel but could include the reassignment of duties to improve the efficiency of the company. The company can promote individuals into senior positions or hire new people with special, rare skill sets. Cutting or altering staff might allow the company to save costs and better focus on priority jobs. This makes the company well organized and ready for further growth in the future.

Journal Entries for Internal Reconstruction with Examples

Internal reconstruction is a procedure adopted by companies to transform their financial structure without calling for liquidation of the company. It comprises a whole range of accounting and financial changes such as writing off of assets, amendment of liabilities, revaluation of assets, etc. For internal reconstruction, here are a few journal entries that are common:

Reduce the Share Capital

To reduce the face value of shares, the entry can be:

Equity Share Capital A/C Dr. 

Reconstruction A/C Cr. 

Forfeiture of Shares

When shares are forfeited, the entry is:

Equity Share Capital A/C (Forfeited share value) Dr. 

Shares Forfeited A/C (Amount received on forfeited shares) Cr. 

Reconstruction A/C (Unpaid amount)

Methods of Internal Reconstruction 

Internal reconstruction helps a company change its changes to improve its finances and organization. There are several ways in which a company can correct or change its business operations to be healthier and stronger.

Minimizing the Company's Debt

One way of internal reconstruction is minimizing the company's debt. This may involve working out with the individuals or firms the company has debts to pay, requesting a reduction in amount to be returned. At other times, the company can receive some of the debt to be waived. The company is saving money and prevents itself from becoming bogged down by bills as it reduces debts. This is enabling the company to concentrate on expanding and making its business rather than fret about paying too much.

Altering the Company's Share Capital

The other is altering the company's share capital, which is the funds put in by individuals who have ownership in the company through shares. The company can opt to lower the worth of its shares or merge shares into a fewer number of more valuable ones. This makes the company appear stronger and stable to investors. By altering share capital, the business can also get more investors or retain existing ones. It's similar to getting a bunch of people who are interested in investing in the business and ensuring they all remain engaged in the best manner possible.

Revaluing Assets

Revaluing assets is when the business considers what it possesses and updates their value on paper. For instance, if a business has outdated machinery or structures, they may determine that these items are worth less or more than previously. This allows the business to understand the actual value of what it owns and make better choices about what to do with or sell those items. It can also enable the business to pay less in taxes if they demonstrate that their assets are less valuable. Revaluing assets provides the company with a better idea of its true value.

Dividing or Merging Sections of the Company

Firms also divide or merge sections of the business to become better. A firm may divide off a section of the business that is not earning sufficient profits or does not match the rest of the business. Alternatively, they might merge sections of the business to make it more efficient and robust. This enables the company to do what it is best suited for and enhance overall performance. Merging or splitting enables the company to become more structured and prepared for future success.

Reducing or Changing the Number of Employees

From time to time, a business will decide, as a cost piece, to downsize or change the composition of its workforce. Downsizing may refer to hiring fewer workers, promoting employees to a higher rank, or asking some employees to resign if the company no longer requires them. This will help the business reduce expenditure and use its funds more efficiently. However, fairness and kindness to the employees during all these changes is essential. Reducing or changing employees will help the company remain strong and have the right people in the right jobs.

Characteristics of Internal Restructuring

A company that is doing poorly may require some changes to improve its chances for success. One way that it could make this happen is through internal restructuring. Internal restructuring simply means making changes within the company, such as hiring fewer employees and becoming more efficient with work processes. In this section of the article, we will examine some of the most important features of internal restructuring.

Identifying the Need for Restructuring

Before restructuring a company, one must decide if there is a necessity for change. That can be for several reasons. Such as changes in the market, new competitors, or decreasing profits. After the problem has been established, a plan can be formed to address the root of the problem. That plan needs to be directed at fixing the root problems in order to succeed with change.

Reorganizing Departments

One major feature of internal reconstruction of a company is that it avoids legal complexities while internally realigning financial operations. Internal restructuring is a way for businesses to improve how they work. This can involve changing how departments are organized. One way is to combine similar departments. While another is to break large departments into smaller, more specialized units. The goal is to create a structure that fits better with the company's goals. Making it easier to adjust to changes in the marketplace.

Reducing Staff

When a company is reorganizing, it might have to cut its employees to cut costs. This is referred to as downsizing. It can be done by firing people or giving them the choice to leave on their own. However, this must be done with care and compassion towards employees. The company must assist them in getting new jobs. 

Streamlining Processes

They are doing the restructuring within the organization by changing things in the way that they operate. It may bean effort to simplify business processes. By eliminating tasks, steps are removed altogether, and some jobs may be taken over by machines. This saves the company money, and results in an operation that is more efficient. 

Changing Reporting Lines

The internal restructuring may need to change how people report to each other. This means redefining roles and responsibilities. Or creating new positions to support company goals. Having a clear reporting hierarchy helps everyone understand their responsibilities.

When a company is not doing well, it may need to make changes to improve its success. One way to do this is through internal restructuring. This means making changes within the company. Such as reducing the number of employees and making work processes more efficient. In this part of the article, we will explore some of the key features of internal restructuring.

Identifying the Need for Restructuring

Before restructuring a company, one must decide if there is a necessity for change. That can be for several reasons. Such as changes in the market, new competitors, or decreasing profits. After the problem has been established, a plan can be formed to address the root of the problem. That plan needs to be directed at fixing the root problems in order to succeed with change.

Reorganizing Departments

Internal restructuring is a way for businesses to improve how they work. This can involve changing how departments are organized. One way is to combine similar departments. While another is to break large departments into smaller, more specialized units. The goal is to create a structure that fits better with the company's goals. Making it easier to adjust to changes in the marketplace.

Reducing Staff

When a company is reorganizing, it might have to cut its employees to cut costs. This is referred to as downsizing. It can be done by firing people or giving them the choice to leave on their own. However, this must be done with care and compassion towards employees. The company must assist them in getting new jobs. 

Streamlining Processes

They are doing the restructuring within the organization by changing things in the way that they operate. It may bean effort to simplify business processes. By eliminating tasks, steps are removed altogether, and some jobs may be taken over by machines. This saves the company money, and results in an operation that is more efficient. 

Changing Reporting Lines

The internal restructuring may need to change how people report to each other. This means redefining roles and responsibilities. Or creating new positions to support company goals. Having a clear reporting hierarchy helps everyone understand their responsibilities.

Difference Between Internal and External Reconstruction of a Company

Internal and external reconstruction are two methods by which a company can become healthier financially, but they differ in their methods. Internal reconstruction entails changing things from within the company, whereas external reconstruction entails calling in outside assistance or merging with other companies.

Conclusion

Internal reconstruction is a process of systematic changes like curtailing share capital, writing off losses, revaluing assets, and modifying liabilities.Internal reconstruction of a company is an effective strategy for reviving a business without forming a new legal entity. Its purpose is to bring back financial health, increase sustainability, and strengthen the position of the firm in the market. Looking to enhance your grades in government exams and excel in your career? Look no further than Testbook. Testbook is India's leading online exam preparation site. Sign up today to gain access to expert-led courses.