Corporate Financial Reporting · Internal Reconstruction (Capital Reduction)

Capital Reduction Account and Journal Entries in Internal Reconstruction

Updated 11 October 2026 · Fact-checked

The Capital Reduction Account is a temporary account. You credit it with the amounts shareholders and others sacrifice under a reduction scheme, and debit it with losses, fictitious assets and asset write-downs. Pass the entries in order, check that the account balances to nil, and move any surplus to Capital Reserve.

Understand Capital Reduction Account and Journal Entries

In internal reconstruction, a company with accumulated losses and overvalued assets cleans up its balance sheet without closing down. It reduces its share capital and, sometimes, the claims of other parties. The loss is spread over those who agree to bear it.

Under section 66 of the Companies Act, 2013, a company limited by shares may reduce its share capital by a special resolution, subject to confirmation by the Tribunal. One permitted form is to cancel paid-up share capital that is lost or unrepresented by available assets. Another is to extinguish or reduce liability on shares not fully paid-up. A third is to pay off capital that is in excess of the company's wants. Reduction is not allowed if the company is in arrears in repaying deposits it accepted, or the interest on them.

The Capital Reduction Account (also called Reconstruction Account) is the bridge. Every sacrifice is credited to it: reduction in the value of shares, reduction in the amount of debentures or creditors' claims, and any other gain. Every item to be cleaned up is debited to it: debit balance of Profit and Loss, preliminary expenses, discount on issue, and write-downs of assets. Once all entries are passed, the account should close to nil. If credits exceed debits, the balance is a capital profit and goes to Capital Reserve.

Section 52 matters here. Under section 52(1), the Securities Premium Account is treated as if it were paid-up share capital for the provisions on reduction of share capital, except as the section provides. Notwithstanding sub-section (1), section 52(2) permits the account to be applied:

towards the issue of unissued shares to members as fully paid bonus shares;
in writing off preliminary expenses;
in writing off expenses of, or commission paid or discount allowed on, an issue of shares or debentures;
in providing for the premium payable on redemption of redeemable preference shares or debentures;
for the purchase of its own shares or other securities under section 68.

For any other use, section 52(1) applies the reduction provisions as if the account were paid-up share capital. So writing off general losses against it needs the section 66 reduction procedure. Section 52(3) allows a prescribed class of companies, whose financial statements comply with the prescribed accounting standards, to use it for paying up unissued equity shares as bonus shares, for writing off expenses, commission or discount on an issue of equity shares, and for purchase of its own shares or other securities under section 68. Follow the scheme given in the question.

The Tribunal can confirm the reduction only if creditors' claims are discharged, determined, secured or consented to. The accounting treatment must also conform to the accounting standards, with an auditor's certificate filed with the Tribunal. This is why exam questions state the scheme in full and expect you to follow it exactly.

Key rules to remember

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.

How to solve Capital Reduction Account and Journal Entries questions

Follow the same order for every scheme. It keeps your journal complete and the account balanced.

1Read the scheme and list every sacrifice: shares, preference shares, debentures, creditors, and any liability waived. Note new face values and share counts.
2Pass entries to convert old capital into new capital, crediting the sacrifice to Capital Reduction Account.
3Pass entries for other sacrifices, such as debenture holders accepting less or creditors waiving part of their claim. Credit each gain to Capital Reduction Account.
4Record any new cash, such as fresh shares issued or contributions, separately. Do not pass these through the Capital Reduction Account.
5List all items to be written off: debit balance of Profit and Loss, preliminary expenses, intangible assets, and each asset reduction. Debit total to Capital Reduction Account, with credit to each item.
6If the scheme requires a liability to be created, such as a contingent liability that becomes payable, debit it to Capital Reduction Account only if the scheme provides for it. Otherwise follow the treatment the scheme states.
7Post and close the Capital Reduction Account. If it balances to nil, stop. If credit exceeds debit, transfer the balance to Capital Reserve. Then prepare the revised balance sheet if asked.

Quickest way: Total-first method

When to use it: Use it when the scheme has many items and you must show the account quickly in a numerical question.

Total all sacrifices first. Write them on the credit side of a rough Capital Reduction Account.
Total all write-offs on the debit side.
Compare the two totals. If they differ, you will see the gap before passing journals.
Pass compact journal entries: one combined entry for capital reduction, one for write-offs.
Close the account to nil or to Capital Reserve and tick each scheme item.

Common mistakes in Capital Reduction Account and Journal Entries

Debiting an asset write-off to Profit and Loss instead of Capital Reduction Account.
Students treat write-downs as ordinary expenses.
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.
Students forget that the new capital continues in the books.
Fix: Credit the new share capital at its new paid-up amount. Credit only the difference to Capital Reduction Account.
Running the new issue of shares through the Capital Reduction Account.
All scheme items look alike.
Fix: Fresh issue of shares for cash goes to Bank and Share Capital. It is not a sacrifice and not a loss.
Leaving a surplus in the Capital Reduction Account.
Students stop once the entries are passed.
Fix: Always close the account. Credit surplus to Capital Reserve, because it is a capital profit.
Forgetting to write off the Profit and Loss debit balance and preliminary expenses.
These items are on the balance sheet, not in the scheme's numbered list.
Fix: Scan the balance sheet line by line. Every fictitious asset and accumulated loss normally goes to the Capital Reduction Account.
Miscounting shares after changing face value.
Students apply the new value to the old number of shares or the reverse.
Fix: Write the old shares, the new shares and their values in a small table before you start journalising.

Worked examples

Example 1

Mehta Textiles Ltd has 50,000 equity shares of ₹10 each fully paid. The Profit and Loss Account shows a debit balance of ₹1,50,000 and preliminary expenses are ₹20,000. Plant is shown at ₹4,00,000 and is to be written down by ₹80,000. Under the approved scheme, each share is reduced to ₹5 fully paid. Pass the journal entries and show the Capital Reduction Account.

Show the solution

Reduction per share = ₹10 − ₹5 = ₹5. Total sacrifice = 50,000 × ₹5 = ₹2,50,000.
Write-offs: Profit and Loss ₹1,50,000 + Preliminary expenses ₹20,000 + Plant ₹80,000 = ₹2,50,000.
Entry 1: Equity Share Capital (₹10) A/c Dr. ₹5,00,000 | To Equity Share Capital (₹5) A/c ₹2,50,000 | To Capital Reduction A/c ₹2,50,000.
Entry 2: Capital Reduction A/c Dr. ₹2,50,000 | To Profit and Loss A/c ₹1,50,000 | To Preliminary Expenses A/c ₹20,000 | To Plant A/c ₹80,000.
Capital Reduction Account: Credit side (By Equity Share Capital) ₹2,50,000. Debit side (To Profit and Loss ₹1,50,000, To Preliminary Expenses ₹20,000, To Plant ₹80,000) ₹2,50,000.
Credits equal debits, so the account closes to nil. No Capital Reserve arises.

Answer: Entries are passed as above. The sacrifice of ₹2,50,000 equals the write-offs of ₹2,50,000, so the Capital Reduction Account closes with nil balance.

Example 2

Kaveri Industries Ltd has 20,000 equity shares of ₹100 each fully paid and 10,000 8% debentures of ₹100 each. Under the scheme: (a) equity shares are reduced to ₹40 each fully paid; (b) debenture holders accept a ₹10 reduction per debenture; (c) the Profit and Loss debit balance of ₹6,00,000 and goodwill of ₹3,00,000 are written off; (d) land is revalued downward by ₹4,00,000. Pass the entries and close the Capital Reduction Account.

Show the solution

Share sacrifice = 20,000 × (₹100 − ₹40) = ₹12,00,000.
Debenture sacrifice = 10,000 × ₹10 = ₹1,00,000. Total credits = ₹13,00,000.
Write-offs = ₹6,00,000 + ₹3,00,000 + ₹4,00,000 = ₹13,00,000.
Entry 1: Equity Share Capital (₹100) A/c Dr. ₹20,00,000 | To Equity Share Capital (₹40) A/c ₹8,00,000 | To Capital Reduction A/c ₹12,00,000.
Entry 2: 8% Debentures A/c Dr. ₹1,00,000 | To Capital Reduction A/c ₹1,00,000.
Entry 3: Capital Reduction A/c Dr. ₹13,00,000 | To Profit and Loss A/c ₹6,00,000 | To Goodwill A/c ₹3,00,000 | To Land A/c ₹4,00,000.
Credits ₹13,00,000 equal debits ₹13,00,000, so the account closes to nil.

Answer: Total sacrifice is ₹13,00,000, equal to total write-offs. The Capital Reduction Account closes with nil balance and no Capital Reserve arises.

Exam tips

Show the Capital Reduction Account in T-form even if only journals are asked. It proves your work and earns method marks.
Read the scheme line by line and tick off each item as you journalise it. Missed items are the main source of lost marks.
When the account does not balance, recheck share counts and the asset list first. Do not force the balance with a plug figure.
In MCQs, look for the balance of the Capital Reduction Account. It is usually either nil or a Capital Reserve amount.
Mention that reduction needs a special resolution and Tribunal confirmation under section 66 when the question asks about the legal route.

Practice questions from Internal Reconstruction (Capital Reduction)

Capital Reduction Account and Journal Entries in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Capital Reduction Account and Journal Entries: frequently asked questions

What is a Capital Reduction Account?

It is a temporary account used in internal reconstruction. Sacrifices by shareholders and others are credited to it. Losses, fictitious assets and asset write-downs are debited to it.

What happens if the Capital Reduction Account has a credit balance?

A credit balance is a capital profit. It is transferred to Capital Reserve, unless the scheme directs otherwise.

Does a company need the Tribunal's approval to reduce its capital?

Yes. Under section 66 of the Companies Act, 2013, reduction needs a special resolution and confirmation by the Tribunal. The Tribunal also considers creditors' claims and the auditor's certificate on the accounting treatment.

Can securities premium be used to write off losses in a reconstruction?

Section 52(1) treats the Securities Premium Account as if it were paid-up share capital for the provisions on reduction. Notwithstanding that, section 52(2) permits its application for bonus shares, preliminary expenses, expenses, commission or discount on an issue of shares or debentures, premium on redemption of preference shares or debentures, and purchase of own securities under section 68. For any other use, such as writing off general losses, the reduction provisions of section 66 apply.