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Unit 5: Internal Reconstruction of Companies

Reduction of capital is purely democratic and is decided by securing the consent of the holders notes
of at least three-fourth of the shares concerned in separate class meetings by means of special
resolution. If at least one-tenth of the issued shareholders are not satisfied with the resolution of
reduction of capital, they may apply to the court within 21 days after the resolution is passed. In
this case the decision of the court will be final.

Following are some exceptional cases in which reduction may take place without the sanction of
the court:

(a) When shares are forfeited by the company for non-payment of calls on instalments.
(b) When redeemable preference shares are redeemed in accordance with the provisions of
Section 80.
(c) When shares are surrendered to the company.

(d) When the company cancels any share of its nominal capital which has not been taken or
agreed to be taken by any person.
Accounting Treatment for Reduction of Capital: The accounting treatment of all the above cases
is mentioned below separately –
case i: reducing the liability of shareholders in respect of uncalled/unpaid amount
When unpaid amount of the share capital is reduced/extinguished by the company, shareholders
are benefited as they do not have to pay the amount to that extent in future. On the other side
the security of the creditors is reduced. As a result, the partly paid up shares become the fully
paid up shares and the face value of the shares reduced. The required journal entry to cancel the
uncalled amount will be as follows:
Share Capital (Partly paid up) Account Dr.
(with paid up amount of shares)
To Share Capital (fully paid up) Account
case ii: reduction in capital by refunding the excess capital
If the company is facing a problem of overcapitalization owing to more than one reason, such
as closure of a particular line of production, it may reduce the capital by refunding the excess
capital to its shareholders. As the reduction of paid up capital reduces the creditors’ security, the
creditors may object to such a scheme. Therefore, the scheme of reducing of capital by refunding
of excess capital should be sanctioned by the court after meeting out the creditors’ objections for
the purpose the following journal entries are recorded-
(a) When refunded amount of capital is due to shareholders–
Share Capital Account Dr.
(amount to be refunded)

To Shareholders’ Account.
(b) When excess amount of capital is to be refunded
Shareholders’ Account Dr.
(amount of refund)
To Bank Account
case iii: reduction in capital by reducing the paid up capital
If a limited company suffers losses continuously over a number of years, the assets side of its
balance sheet will show accumulated losses in the form of deferred expenses, intangible assets,
discount on issue of shares and debentures, underwriting commission, cost of issue of shares and

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