To investigate the mechanism of sludge reduction in activated sludge (AS) with an anaerobic side-stream reactor (ASSR), four AS systems with different digestion schemes were operated in the laboratory. The four systems are: a) AS+ASSR; b) AS+aerobic digester; c) AS+anaerobic digester; and d) AS with no solids wastage. The average sludge yield of AS+ASSR from two phases was 0.14 mgVSS/mgCOD, which is 22-54% less than that from the three other systems. The accounting of biomass in AS+ASSR system revealed that 50% of sludge is degraded in ASSR while the other half is degraded in the aeration basin. Furthermore, both whole sludge and centrate from ASSR led to a significant oxygen uptake in AS, indicating the importance of aerobic biodegradation in AS+ASSR system. The extracellular polymeric substances (EPS) data showed that base-extractable EPS was much smaller for AS with ASSR than with no wastage. In contrast, cation exchange resin-EPS was similar for both systems. These results indicate that degradation of base-extractable EPS accounts for the lower sludge yield in AS+ASSR, and based on the literature this organic pool is believed to be aluminium and/or iron-bound EPS. The microbial profile data suggests that recirculation in AS+ASSR selects some unique microorganisms. Further research is warranted to study their role in sludge reduction.