Q.Differentiate between redemption of debentures out of capital and out of profits.
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🔒 Start your 14-day free trial to unlock the full solution →Concept understanding — Capital Reserve Definition
Capital Reserve: The "Never-Say-Die" Profit
Think of a business like a person earning a salary. Most of that salary goes into daily expenses (rent, food, bills) — that's like Revenue Profit. But sometimes, you sell an old bike for ₹5,000 more than you expected. That's a one-time, unexpected gain. You wouldn't treat it as part of your regular monthly income, right? You'd probably put it aside for a rainy day.
That's the core idea of a Capital Reserve.
The Precise Meaning (NCERT Definition)
A Capital Reserve is a reserve that is created out of capital profits — profits that are not earned in the normal course of business. These are non-recurring gains.
Key sources of Capital Reserve (as per NCERT Class 12):
- Profit on sale of a fixed asset (e.g., selling an old machine for more than its book value)
- Profit on reissue of forfeited shares (the amount retained after reissuing shares that were earlier cancelled)
- Profit prior to incorporation (profit earned before the company was legally formed)
- Premium on issue of shares or debentures (the extra amount paid by investors above the face value — this is also a capital reserve, though sometimes shown separately as Securities Premium Reserve)
Capital Reserve is not available for distribution as dividends to shareholders. It is a "locked" reserve meant for specific purposes like writing off capital losses or issuing bonus shares.
Why It Matters
- Legal Requirement: The Companies Act restricts the use of capital profits. You cannot simply pay them out as dividends — that would be like selling your house and treating the money as your monthly salary. It's financially unsound.
- Financial Strength: A healthy capital reserve signals that the company has a cushion for unexpected capital losses or future expansion.
- Bonus Shares: Capital reserve is one of the sources from which a company can issue bonus shares (free shares to existing shareholders).
Accounting Treatment
When a capital profit arises, we credit the Capital Reserve account. The corresponding debit depends on the source.
Example 1: Profit on sale of a fixed asset
- Debit: Bank Account (with the sale proceeds)
- Credit: Asset Account (with the book value)
- Credit: Capital Reserve (with the profit)
Example 2: Profit on reissue of forfeited shares
- Debit: Share Forfeiture Account (with the amount transferred)
- Credit: Capital Reserve (with the profit)
Journal Entry (for profit on sale of asset):
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|---|
| Bank A/c Dr. | 1,00,000 | |||
| To Asset A/c | 70,000 | |||
| To Capital Reserve A/c | 30,000 | |||
| (Being profit on sale of asset transferred to capital reserve) |
Format in the Balance Sheet
In the Balance Sheet (under the head 'Shareholders' Funds'), Capital Reserve appears as a separate line item under Reserves and Surplus.
Format (as per NCERT Class 12): …
Redemption out of capital uses fresh funds without setting aside any profit, reducing working capital, whereas redemption out of profits sets aside an equal amount of distributable profit into a Debenture Redemption Reserve beforehand, keeping the company's capital intact. …
Redemption out of capital is funded without setting aside profits (and so reduces the company's working capital), while redemption out of profits sets aside an equal amount of distributable profit into a Debenture Redemption Reserve before redemption, so the company's capital base is preserved.
| Basis | Redemption Out of Capital | Redemption Out of Profits |
|---|---|---|
| Source of funds | Funded from capital resources — e.g. proceeds of a fresh issue of shares/debentures, or sale of assets — not out of accumulated profits | Funded out of the company's own accumulated distributable profits |
| Transfer to Debenture Redemption Reserve (DRR) | No amount (or a lesser amount, as permitted) is transferred out of profits to DRR before redemption | An amount equal to the nominal (face) value of debentures being redeemed is transferred from Surplus (Statement of P&L)/General Reserve to the Debenture Redemption Reserve before redemption |
| Effect on distributable profits | Profits remain untouched and fully available for dividend | A part of profits gets locked into DRR, reducing the amount available for dividend to shareholders in that year |
| Effect on working capital | Reduces the company's working capital/liquid resources, since fresh funds are used up in repaying debenture holders | Working capital is not directly reduced by the redemption itself, since profits already earned (not fresh funds) are used |
Showing the 12 most recent of 14 on this concept.
- CBSE 2026Set 67/4/11 markMCQQ.A portion of the uncalled capital reserved by a company to be called only in the event of winding up of the company is called : (A) Subscribed but not fully paid capital (B) Unissued capital (C) Subscribed capital (D) Reserve capital
›Reveal solutionSolution
The portion of uncalled capital that a company reserves to be called only upon its winding up is known as Reserve Capital.
In company accounting, understanding the different categories of share capital is fundamental. The question asks to identify a specific type of capital that has a unique restriction on when it can be called up. This restriction is crucial for the protection of creditors, ensuring there's a pool of funds available if the company faces liquidation.
Let's break down the concept:
Reserve Capital
Reserve Capital refers to a portion of a company's uncalled share capital that the company, by passing a special resolution, decides not to call up except in the event of its winding up. This means that this specific portion of capital cannot be demanded from shareholders during the normal course of business operations, even if the company faces financial difficulties. Its sole purpose is to provide a safety net for creditors during liquidation.
Why is it treated this way?
The creation of Reserve Capital is a strategic decision by the company to enhance the confidence of its creditors. By earmarking a portion of capital exclusively for winding-up scenarios, the company assures creditors that there will be additional funds available to settle their claims if the business ceases to operate. This capital cannot be mortgaged or charged, further safeguarding its availability for creditors. It is important to note that Reserve Capital is not disclosed in the company's Balance Sheet because it represents capital that has not yet been called up.
Distinguishing from other options:
- (A) Subscribed but not fully paid capital: This refers to the portion of capital that shareholders have agreed to buy (subscribed) but for which the company has not yet demanded the full payment (not fully paid). This uncalled portion can be called up by the company at any time during its normal operations, unlike Reserve Capital.
- (B) Unissued capital: This is the portion of the company's authorized capital that has not yet been offered to the public for subscription. It's capital that the company is permitted to issue but hasn't yet. Reserve Capital, on the other hand, is a part of the subscribed capital that remains uncalled. …
- CBSE 2026Set ANNUAL1 markQ.When the purchase price of a business is less than the net assets acquired, then which account is credited for the difference ?
›Reveal solutionSolution
If Purchase Consideration < Net Assets Acquired, the difference (a capital profit) is credited to Capital Reserve.
When a company takes over a running business (or purchases a bundle of assets and liabilities) and settles a Purchase Consideration, the accounting treatment of the difference between the Purchase Consideration and the Net Assets Acquired (Assets taken over − Liabilities taken over) depends on which is higher:
- If Purchase Consideration > Net Assets Acquired: the excess is Goodwill (a capital LOSS of sorts — paying more than the net worth of what was acquired), debited to Goodwill Account. …
- CBSE 2024Set 67/1/11 markMCQQ.Reserve capital is that part of _________ capital which cannot be called except at the time of winding up of the company. (A) Issued (B) Called up (C) Uncalled (D) Nominal
›Reveal solutionSolution
Reserve capital is a specific portion of a company's uncalled share capital that can only be called upon during the company's winding up.
Let's understand the different categories of share capital to correctly identify what reserve capital is. A company's capital structure is typically divided as follows:
- Authorised Capital (or Nominal Capital): This is the maximum amount of share capital that a company is legally permitted to issue to its shareholders, as stated in its Memorandum of Association.
- Issued Capital: This is the part of the authorised capital that the company has offered to the public for subscription.
- Subscribed Capital: This is the part of the issued capital that has actually been subscribed (applied for and allotted) by the public.
- Called-up Capital: This is the portion of the subscribed capital that the company has demanded from its shareholders.
- Uncalled Capital: This is the portion of the subscribed capital that the company has not yet demanded from its shareholders.
- Paid-up Capital: This is the portion of the called-up capital that shareholders have actually paid to the company.
Reserve Capital is a special concept related to the uncalled capital. According to Section 65 of the Companies Act, 2013, a company may, by special resolution, determine that any portion of its uncalled share capital shall not be capable of being called up except in the event and for the purpose of the company being wound up. This specific portion is known as Reserve Capital.
The primary purpose of creating Reserve Capital is to provide an additional layer of security to the company's creditors. In the event of liquidation, this capital can be called upon to settle the company's debts. It cannot be used for any other purpose, nor can it be charged as security for loans.
Watch outDo not confuse Reserve Capital with Capital Reserve. Capital Reserve is a part of a company's reserves and surplus, created out of capital profits (e.g., profit on sale of fixed assets, premium on issue of shares), and is shown on the liabilities side of the balance sheet. Reserve Capital, on the other hand, is a part of the uncalled share capital and does not appear in the balance sheet as a separate item, though its existence is disclosed in the notes to accounts. …
- CBSE 2024Set ANNUAL1 markQ.Answer in one word/sentence: Capital Reserve is created out of which type of profit?
›Reveal solutionSolution
Answer: Capital profit.
Capital Reserve is created out of capital profits - gains such as profit on sale of fixed assets, profit on re-issue of forfeited shares, or premium on issue of shares/debentures - and not from normal reve …
- CBSE 2023Set 67/3/11 markMCQQ.Which of the following statements is true for 'Reserve Capital' ? (A) It is a portion of the uncalled capital to be called only in the event of winding up of the company. (B) It is a part of the subscribed capital which has been called-up on the shares. (C) It is that portion of the called-up capital which has been actually received from the shareholders. (D) It is that part of the authorised capital that is actually issued to the public for subscription.
›Reveal solutionSolution
Reserve Capital is a portion of the uncalled capital that a company decides, by a special resolution, to call only in the event of winding up. Therefore, option (A) is correct.
This question tests your understanding of a specific term under the Companies Act. The key is to distinguish between called-up capital, paid-up capital, subscribed capital, and reserve capital. Reserve capital is not part of the called-up or paid-up amounts — it is deliberately kept as a safety net.
Concept and Treatment
Under the Companies Act, 2013, a company may, by a special resolution, decide that a portion of its uncalled capital shall not be called up except in the event of the company being wound up. This portion is called Reserve Capital. It is also known as Reserve Liability.
The purpose is to strengthen the company’s financial position and assure creditors that there is a reserve of uncalled capital available if the company is liquidated. Until winding up, the company cannot demand this amount from shareholders.
Now, let’s evaluate each option:
-
Option (A): "It is a portion of the uncalled capital to be called only in the event of winding up of the company."
This matches the definition exactly. Reserve capital is part of uncalled capital, and it can only be called when the company winds up.
-
Option (B): "It is a part of the subscribed capital which has been called-up on the shares."
This is incorrect. Called-up capital is the amount the company has already demanded from shareholders. Reserve capital is specifically not called up until winding up.
-
Option (C): "It is that portion of the called-up capital which has been actually received from the shareholders."
This describes paid-up capital, not reserve capital.
-
Option (D): "It is that part of the authorised capital that is actually issued to the public for subscription." …
-
- CBSE 2023Set ANNUAL1 markMCQQ.Profit on cancellation of own debenture is transferred to (A) Profit and Loss A/c (B) Capital Reserve A/c (C) Reserve A/c (D) Premium
›Reveal solutionSolution
Profit on cancellation (redemption by purchase in the open market) of own debentures is a capital profit, transferred to Capital Reserve A/c.
When a company purchases its own debentures from the market at a price lower than their nominal (face) value and cancels them, the difference is a gain. Because this gain arises from a capital transaction (dealing in the company's own securities) rather than from trading, it is not available for distribution as dividend and is tran …
- CBSE 2023Set ANNUAL1 markMCQQ.Capital reserve is created out of (A) Profit of revaluation (B) Profit on sale of assets (C) Profit on purchase of business (D) All of these
›Reveal solutionSolution
Capital reserve arises from capital profits — profit on revaluation, profit on sale of fixed assets and profit on purchase of a business — so 'All of these' is correct.
A capital reserve is created out of capital profits (profits not earned in the ordinary course of trading), which include:
- Profit on revaluation of assets and liabilities.
- Profit on sale of fixed assets.
- Profit on purchase of a business (capital reserve on acquisition). …
- CBSE 2023Set ANNUAL1 markQ.State whether True or False: Capital Reserves are created from Capital Profits.
›Reveal solutionSolution
The statement is True.
Capital Reserve is created out of capital profits - profits not earned in the normal course of business (e.g. profit on sale of fixed assets, profit on re-issue o …
- CBSE 2022Set ANNUAL1 markQ.What is capital reserve?
›Reveal solutionSolution
Capital Reserve is a reserve built from capital (non-trading) profits.
Capital Reserve is a reserve created out of capital profits — profits that do not arise from the normal trading/operating activities of the business, such as profit on reissue of forfeited shares, profit on sale of fixed assets, or premium received on redemption. Since these profits are not 'earned' through the regular business operations, they are not available for distribution to shareholders as dividend. Instead, they are kept aside as Capital Reserve and typically used for purpos …
- CBSE 2022Set ANNUAL1 markMCQQ.Capital reserve is formed if shares are ______.(a) issued(b) forfeited(c) forfeited and reissued(d) All of these
›Reveal solutionSolution
The profit earned on reissuing forfeited shares (after adjusting any loss on reissue) is transferred to Capital Reserve.
Merely issuing shares (at par or premium) does not by itself create a capital reserve — premium received goes to the Securities Premium Account, not Capital Reserve. Similarly, forfeiture alone (cancelling a defaulting shareholder's shares) only creates a balance in the Forfeited Shares Account; it becomes a capital reserve only after the shares are reissued. On reissue, any loss on reissue is first adjusted against the amount forfeited, and whatever surplus remains in the Forfeited Shares Account …
- CBSE 2022Set ANNUAL1 markMCQQ.Capital Reserve is utilised to meet ______.(a) capital losses(b) capital gain(c) unforseen events(d) short term purpose
›Reveal solutionSolution
Capital Reserve, being a capital-nature reserve, can only be used to meet capital losses, never to pay dividends or cover trading losses.
A Capital Reserve is created out of capital profits — profit on reissue of forfeited shares, profit on sale of fixed assets, premium on redemption received in certain cases, profit prior to incorporation, and the like. Because its source is capital (not trading) in nature, the law restricts how it may be used: it can be utilised to write off capital losses such as a loss on sale/discard of a fixed asset, to write off preliminary expenses or discount on the issue of shares/debentu …
- CBSE 2020Set 67/1/11 markMCQQ.Which of the following statements does not relate to 'Reserve Capital' : (A) It is part of uncalled capital of a company. (B) It cannot be used during the lifetime of a company. (C) It can be used for writing off capital losses. (D) It is part of subscribed capital.
›Reveal solutionSolution
Statement (C) does not relate to Reserve Capital — Reserve Capital can be called up only on winding-up, not during the company's lifetime to write off capital losses.
Concept: Reserve Capital
When a company issues shares, it may choose not to call the entire face value immediately. The portion not yet demanded is Uncalled Capital. Out of this uncalled capital, a company may, by passing a special resolution, earmark a portion that will not be called up except in the event of the company being wound up. This earmarked portion is Reserve Capital.
Reserve Capital is a statutory safeguard for creditors. Section 99 of the Companies Act, 2013 permits a limited company to determine by special resolution that any portion of its share capital which has not been already called up shall not be capable of being called up except in the event and for the purposes of the company being wound up. Once created, this reserve cannot be altered or cancelled except by an order of the Tribunal.
Key Characteristics of Reserve Capital
- Part of Uncalled Capital: Reserve Capital is carved out of the uncalled portion of subscribed capital. It remains uncalled during the normal life of the company.
- Cannot be used during the company's lifetime: By definition, Reserve Capital can be called up only when the company is being wound up. It is not available for any purpose — paying dividends, meeting losses, or writing off capital losses — while the company is a going concern.
- Part of Subscribed Capital: Since Reserve Capital is a portion of the share capital that shareholders have agreed to subscribe (but which has not been called), it forms part of the subscribed capital of the company.
- Available only on winding-up: The sole purpose is to provide an additional cushion to creditors at the time of liquidation.
Analysis of Each Statement
(A) It is part of uncalled capital of a company.
This is correct. Reserve Capital is a portion of the uncalled capital that the company has resolved not to call except on winding-up.
(B) It cannot be used during the lifetime of a company.
This is correct. Reserve Capital is ring-fenced and can be called up only when the company is being wound up, not during its normal operations.
(C) It can be used for writing off capital losses. …
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