What is capital reduction account?

Introduction

A capital reduction account is an account used to pass entries related to the internal reconstruction of a company. During reconstruction, paid-up capital reduced is credited to this account; hence its name is capital reduction account. It is also known as the reconstruction account.

Type of account

A capital reduction account is a temporary account open just to carry out internal reconstruction. It represents the sacrifices made by the shareholders, debenture holders and creditors. Also, any appreciation in the value of assets is credited to this account. It is closed to capital reduction when internal reconstruction is completed.

Entries passed through capital reduction account

When paid-up capital is cancelled.

When paid-up capital is cancelled, the share capital account is debited and the capital reduction account is debited as share capital is getting reduced.

When assets and liabilities are revalued

At the time of internal reconstruction, the gain or loss on revaluation is transferred to the capital reduction account instead of the revaluation reserve.

Writing off of accumulated losses and intangible assets

The credit balance of the capital reduction account is used to write off the accumulated losses and intangible assets like goodwill, patents etc which are unrepresented by capital. The capital reduction account is debited and profit and loss account and intangible assets accounts are credited.

Treatment in books of account

The balance in the capital reduction account, whether debit or credit, it is transferred to the capital reduction account. Hence, it doesn’t appear on the balance sheet.