Dividend Reinvestment has two actions combined into one:
1) Dividend Payout by the MF (Dividend Income)
2) The purchase of the same MF units on the same date with the dividend amount (Buy as per MProfit)
This means you are reinvesting your income in the same fund. In books of accounts, you will pass two entries, one is of dividend income and second is of the purchase of units. 'Buy' action is very important because when you sell your all units, the purchase dates of all units are taken into account (original units as well as units earned by way of dividend reinvestment).
So, in effect you will see higher investment than your original investment due to the dividend reinvestment.
The above explanation is very much to do with the purpose of accounting and filing of your tax returns.
Since, the dividend is declared from Mutual Fund corpus, you will see the fall in NAV and may see the loss in your investment if the NAV is down because markets are down. In order to judge your true return on any mutual fund scheme, you need to look at the annualised return (XIRR) report for mutual funds. This report shows Net Investment, Income (Dividend payout), total gain (amount) as well as annualised return (%). This report does not include dividend reinvestment to your total investment.