Internal Reconstruction (Capital Reduction): formula sheet

Key formulas

Meaning in one line

Internal reconstruction = same company + reorganised capital and liabilities + losses written off

No new company is formed and the old company is not wound up.

Total amount to be written off

Debit balance of P&L + fictitious assets + overstated assets (reduction in value) + any new losses or liabilities

This total is normally met from the Capital Reduction Account created through the sacrifice.

Source of the write-off

Capital Reduction Account credit = sacrifice by shareholders + sacrifice by creditors/debenture holders + other gains in the scheme

Any balance left after writing off losses is transferred to Capital Reserve.

Entity test

Internal: one company continues. External and amalgamation: old company ends, new or transferee company takes over.

Use this to answer any 'differentiate' question.

Who may reduce

Company limited by shares, or limited by guarantee and having a share capital

Reduction needs a special resolution plus Tribunal confirmation (Section 66(1)).

Permitted forms (illustrative)

(a) reduce or extinguish liability on unpaid capital; (b)(i) cancel paid-up capital lost or unrepresented by assets; (b)(ii) pay off paid-up capital in excess of wants

The words 'in any manner and in particular' mean the list is not exhaustive.

Approval sequence

Special resolution → Tribunal application → notice to Central Govt, Registrar, SEBI (if listed), creditors → Tribunal order

Representations are to be made within three months of receipt of notice; silence means presumed no objection.

Creditor condition

Debt or claim of every creditor discharged, determined, secured, or consent obtained

This is the condition for the Tribunal to confirm under Section 66(3).

Accounting condition

Accounting treatment conforms to section 133 standards or other provision of the Act + auditor's certificate filed with Tribunal

Without this the Tribunal cannot sanction the application.

Post-order filing

Certified copy of order + approved minute to Registrar within 30 days of receipt of the copy

The minute shows share capital amount, number of shares, amount of each share and amount deemed paid up per share.

Prohibition

No reduction if company is in arrears in repaying deposits or interest on them

This covers deposits accepted before or after commencement of the Act.

Member liability after reduction

Liability on a share ≤ (amount of share as fixed by the order) − (amount paid or deemed paid)

Section 66(7): applies to past and present members.

Reduction in paid-up value per share

Sacrifice per share = old paid-up value per share − new paid-up value per share

Multiply by number of shares to get the credit to Capital Reduction Account. Example: ₹10 reduced to ₹6 gives ₹4 per share.

Total capital reduction credit

Capital Reduction Account (Cr.) = reduction in share capital + sacrifice by preference holders + sacrifice by debenture holders and creditors + other gains (e.g., liability waived)

Include only amounts actually given up under the scheme.

Use of Capital Reduction Account

Capital Reduction Account (Dr.) = accumulated losses + fictitious assets + asset write-downs + liability increases + expenses of the scheme

Any balance remaining after write-offs goes to Capital Reserve.

Conversion of share class

Entry: Old class A/c Dr. (old amount) To New class A/c (new amount) To Capital Reduction A/c (difference)

The difference between old and new amounts is the sacrifice.

Section 66 test for reduction

Special resolution + Tribunal confirmation + no arrears on deposits (or interest)

The proviso bars reduction if the company is in arrears in repaying deposits or interest. Auditor's certificate on accounting treatment must be filed with the Tribunal.

Section 61 alteration

Authority in articles + general meeting resolution

Covers increase, consolidation, conversion into stock, sub-division and cancellation of unissued shares. Not a reduction.

Sacrifice on shares

Sacrifice = Old amount per share − New amount per share, multiplied by number of shares

Credit this total to Capital Reduction Account. Check the number of shares after any consolidation or sub-division.

Entry for reducing share capital

Equity Share Capital (old) A/c Dr. | To Equity Share Capital (new) A/c | To Capital Reduction A/c

Debit the old paid-up amount, credit the new amount and the balancing sacrifice.

Entry for write-offs

Capital Reduction A/c Dr. | To Profit and Loss A/c / Preliminary Expenses / Assets (each at amount written off)

Debit the Capital Reduction Account with total losses and write-downs.

Closing test

Total credits to Capital Reduction A/c − Total debits = 0, or surplus to Capital Reserve

A surplus is a capital profit. A deficit means a scheme item is missing or wrongly computed.

Unpaid liability on shares

Reduction in uncalled amount per share × shares = reduction in liability

No entry is needed for uncalled capital if it is not shown in the books. If shown, adjust it and its credit.

Sacrifice by debenture holders or creditors

Sacrifice = Old claim − (face value of new securities + cash + any other consideration)

Credit the sacrifice to Capital Reduction Account. If the scheme gives them shares, use the face value of the shares issued, not the market value.

Arrears of cumulative preference dividend

Arrears = Rate % × Face value of preference shares × Number of years unpaid

Not a liability in the books. Pass an entry only when the scheme settles it, and then only for the amount settled. If waived, there is no entry.

Contingent liability crystallised under the scheme

Dr Capital Reduction A/c; Cr Liability or Provision for the claim

Do this only when the scheme says the claim is to be provided for or paid. Otherwise disclose it as a note.

Capital Reduction Account balance

Total credits (reduction of capital + sacrifices) − Total debits (losses, write-offs, settlements, provisions)

A credit balance goes to Capital Reserve. A debit balance means you missed a credit item. Check the scheme again.

Section 230 approval rule

Majority in number representing three-fourths in value of those voting + Tribunal sanction

The Tribunal may dispense with a creditors' meeting if creditors holding at least ninety per cent in value confirm the scheme by affidavit.

Balance sheet check

Total assets after scheme = Total capital and liabilities after scheme

A mismatch means a wrong entry or a missed item.

Sacrifice on a class of shares

Sacrifice = Number of shares × (Old paid-up value per share − New paid-up value per share)

Credit this to Capital Reduction Account. Do the same for preference shares if the scheme reduces them.

Sacrifice by creditors or debenture holders

Sacrifice = Old claim − Amount accepted (cash + shares + new debentures)

The accepted part is settled by cash or new securities. Only the waived part is credited to Capital Reduction Account.

Capital Reduction Account balance

Total credits (sacrifices) − Total debits (losses, write-downs, expenses) = Balance

Zero is the usual result. A credit balance goes to Capital Reserve as the scheme says.

Closing cash

Opening cash + Cash from new issues − Cash paid to creditors or others − Reconstruction expenses paid

Include only items settled in cash. Shares issued to creditors do not touch cash.

Balancing check

Total assets after scheme = Share capital + Reserves + Liabilities after scheme

Always test this before finalising the answer.

Quick revision

• Internal reconstruction keeps the same company alive; it reorganises capital and clears losses.
• Section 66 needs a special resolution and confirmation by the Tribunal on the company's application.
• A company in arrears on repaying deposits it accepted, or the interest on them, cannot reduce its capital.
• The Tribunal gives notice to the Central Government, Registrar, SEBI (listed companies) and creditors.
• The Tribunal can confirm the reduction if every creditor's debt is discharged, determined, secured or consented to.
• The auditor's certificate that the accounting treatment follows the accounting standards must be filed with the Tribunal.
• The company delivers the Tribunal order and minute to the Registrar within thirty days of receiving the order's copy.
• Section 66 does not apply to a buy-back of securities under Section 68.
• Capital Reduction Account: credit sacrifices, debit write-offs; its balance should be nil at the end.
• Fictitious assets and accumulated losses are written off first.
• Confirm that the revised balance sheet balances before you finish.

Common mistakes

• Treating internal reconstruction as the same as external reconstruction. Fix: Remember the entity test: internal keeps the same company; external winds up the old company and transfers the business to a new one.
• Saying a new company is formed in internal reconstruction. Fix: Write clearly that only capital and liabilities are reorganised; the legal entity is unchanged.
• Saying a special resolution alone is enough. Fix: Write 'special resolution and Tribunal confirmation' every time.
• Treating the three listed forms as the only forms allowed. Fix: Quote 'in any manner and in particular' to show the list is illustrative.
• Treating cancellation of unissued shares as capital reduction. Fix: Remember Section 61(1)(e) and 61(2): cancelling shares not taken or agreed to be taken is an alteration, not a reduction. It involves no Tribunal confirmation and no sacrifice by members.
• Crediting the whole new paid-up amount instead of only the difference to Capital Reduction Account. Fix: Always compute old value − new value per share, multiply by shares, and credit only that amount.
• Debiting an asset write-off to Profit and Loss instead of Capital Reduction Account. Fix: In a reconstruction scheme, losses and overvalued assets are absorbed by the Capital Reduction Account. Debit it, and credit the asset.
• Crediting the whole old capital instead of only the sacrifice. Fix: Credit the new share capital at its new paid-up amount. Credit only the difference to Capital Reduction Account.
• Passing an entry for arrears of preference dividend when the holders simply waive them. Fix: Arrears on cumulative preference shares are not booked until dividend is declared. If waived, pass no entry. Debit the Capital Reduction Account only for the part settled by shares, debentures or cash.
• Crediting the whole old debenture amount to Capital Reduction Account. Fix: Credit only the sacrifice: old debentures less the face value of new debentures, shares and cash given. Record the new securities in their own accounts.

Exam tips

• For 'meaning and objectives' questions, write a one-line definition first, then objectives as bullet points. Markers look for both.
• In a differentiate question, give at least four points and always include the entity test and the winding-up test.
• Link every objective to a balance sheet item, such as debit balance of P&L or goodwill. This shows application rather than recall.
• In MCQs, watch for options that describe liquidation or amalgamation. If the old company ends, it is not internal reconstruction.
• Do not quote a section number unless you are sure of it. Say that capital reduction needs member approval and Tribunal confirmation under the Companies Act, 2013.
• In MCQs, watch for the traps: ordinary resolution, board approval only, deposit arrears, and buy-back.
• In descriptive answers, list the steps in order and name the Tribunal, special resolution, auditor's certificate and thirty-day filing.
• Mention that members' liability after reduction is capped under section 66(7) when a question asks about members' position.