Methods and Forms of Capital Reduction in Internal Reconstruction

Understand Methods and Forms of Capital Reduction

Key rules to remember

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.

How to solve Methods and Forms of Capital Reduction questions

1. 1Read the scheme line by line and list each change: share capital, preference shares, debentures, creditors, assets, liabilities.
2. 2Classify each change as a sacrifice (credit to Capital Reduction Account) or a write-off (debit to it). Sacrifices come from reduced claims. Write-offs come from losses and asset reductions.
3. 3Pass the entries for reducing or converting capital first. Show old balance, new balance and the difference.
4. 4Pass entries for sacrifices by creditors and debenture holders, crediting Capital Reduction Account for the amount given up.
5. 5Pass entries for fresh issues, cash received or paid, and expenses of reconstruction.
6. 6Pass the write-off entry: Capital Reduction A/c Dr. To Profit and Loss A/c, fictitious assets and asset reductions.
7. 7Check that the Capital Reduction Account balances. Transfer any credit balance to Capital Reserve.
8. 8If asked, prepare the revised balance sheet and confirm that assets equal capital plus liabilities.

Quickest way: Sacrifice-and-write-off tally

Common mistakes in Methods and Forms of Capital Reduction

• Treating cancellation of unissued shares as capital reduction.

  Both reduce authorised capital on paper, so they look alike.

  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.

  Students pass the entry using the new balance rather than the old minus new.

  Fix: Always compute old value − new value per share, multiply by shares, and credit only that amount.

• Forgetting that reducing paid-up value on partly paid shares must also treat uncalled amounts.

  Students focus on the face value and ignore calls in arrears or unpaid amounts.

  Fix: Check how much is paid and how much is unpaid. Section 66(1)(a) allows extinguishing or reducing liability on unpaid capital, so adjust the share capital and calls-in-arrears accounts together.

• Using Capital Reduction Account to write off only losses and ignoring asset write-downs and goodwill.

  Students stop at the Profit and Loss debit balance.

  Fix: List every item the scheme says to write off: goodwill, preliminary expenses, patents, and overvalued assets, plus increases in liabilities.

• Showing a creditor's sacrifice as income in the Profit and Loss Account.

  It looks like a gain, so students credit profit.

  Fix: Under a reconstruction scheme, the amount given up by creditors is credited to Capital Reduction Account, not to Profit and Loss, unless the question says otherwise.

• Stating that reduction needs only a board or general meeting resolution.

  Students mix up the procedure for alteration and reduction.

  Fix: Section 66 requires a special resolution and confirmation by the Tribunal. The proviso also bars reduction if the company is in arrears on deposits.

Worked examples