Notes On Dissolution of A Partnership Firm
Notes On Dissolution of A Partnership Firm
Notes On Dissolution of A Partnership Firm
Dissolution of a Firm
Dissolution of a firm takes place in the following cases:
Dissolution by agreement: A firm is dissolved in case where All the partners give
consent to it, or As per the terms of partnership agreement.
Compulsory dissolution : A firm is dissolved compulsorily
- Where all the partners or all except one partner, become insolvent or insane rendering them
incompetent to sign a contract;
- Where the business becomes illegal;
- Where all the partners except one decide to retire from the firm;
- Where all the partners or all except one partner dies;
- Where the partnership deed includes any provision regarding the happening of the Expiry
of the period for which the partnership was formed; Completion of the specific venture or
project for which the firm was formed.
Dissolution by notice: In case of partnership at will, the firm may be dissolved if any of
the partners gives a notice in writing to the other partners signifying his intention of
seeking dissolution of the firm.
Dissolution by court: A court, may order a partnership firm to be dissolved in case of a
suit by a partner in the following situations : A partner becomes insane; A partner
becomes permanently incapable of performing his duties as a partner; A partner
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deliberately and consistently commits breach of agreements relating to the management
of the firm; A partner‘s conduct is likely to adversely affect the business of the firm; The
partner transfers whole of his interest in the firm to a third party; The business of the
firm cannot be carried on, except at a loss; The court, on any ground, regards
dissolution to be just and equitable.
Settlement of Accounts
In case of dissolution of firm, the firm ceases to conduct business and has to settle its accounts.
For this purpose, it disposes off all its assets for making payment to all the claimants against it.
The Partnership Act provides the following rules for the settlement of accounts between the
partners:
- Loss to be paid first out of profits, next out of capital and lastly by the partners individually
in the proportion in which they were entitled to share the profits. In other words, losses are
to be shared by the partners in their profit sharing ratio;
- Assets of the firm are first to be applied in paying off the debts of the firm to the third
parties, next in paying off to each partner proportionately what is due to him from the firm
for advances as distinguished from capital; and the residue to be divided among the
partners in the proportion in which they were entitled to share profits.
In simple words, following is the order of payment from the proceeds of the sale of the firm:
- Expenses of realization;
- Payment to outside creditors. It is to be noted that secured creditors are to be paid off first
out of the proceeds of secured assets before anything is paid to unsecured creditors;
- Loans and advances made by partners‘ spouse;
- Loans and advances made by a partner apart from his capital; and - Final claims of the
partners on their capital account.
Debts of firm verses personal debts of partners If assets of the firm are not sufficient to pay off
the firm‘s creditors, the partners may be required to make contributions because of the unlimited
nature of the liability of the partner. In such a case, the partner will have the right to apply his
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personal assets in paying off his personal debts first. Thereafter, the remaining surplus of
personal assets will be used for making his contribution to satisfy the unsettled portion of outside
creditors.
Accordingly the following steps are taken:
- All assets would be disposed off and cash has to be realized;
- With the available funds, claims are satisfied in the following order—
1. Payment of expenses for realizing the assets and collection of debts;
2. Payment of outside liabilities of the firm, i.e. creditors, loans, bank overdrafts,
bills payable, advances from partners‘ relatives; 3. Loans and advances made
by a partner;
4. Repayment of advances extended by the partners;
5. Repayment of capital contribution to the partner;
6. Any surplus left, is distributed among all partners in their profit sharing ratio.
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Journal Entries
a. For transferring the assets:
- Transfer to the debit of realization account at their gross book values of all accounts of
assets excluding cash, bank and the fictitious assets. Dr. Realization a/c and Cr. Assets a/c
(individually)
- It is to be noted that debit balance such as accumulated losses deferred expenses are not
transferred to the realization account. These are transferred to the partners‘ capital
account in their profit sharing ratio by recording the following entry : Dr. Partners‘
capital a/c and Cr. Fictititous assets a/c
b. For transferring the liabilities
- All external liability accounts including provisions, if any, in respect of assets which have
been transferred to the realization account are closed by transferring them to the credit of
realization account at their book values. Dr. External liabilities a/c(Individually) and Cr.
Realization a/c
- Partners‘ capital account and loan account of the partner are prepared separately and are
not transferred to realization account.
c. For sale of assets Dr. Bank a/c(realized price) and Cr. Realization a/c
d. For an asset taken over by a partner Dr. Partner‘s capital a/c and Cr. Realization a/c
(Agreed price)
e. For payment to creditors: Any amount paid in cash to creditors, realisation account is
debited and cash/bank account is credited. Dr. Realization a/c and Cr. Bank a/c
f. Settlement with the creditors through transfer of asset: When a creditor accepts an asset
in part payment no entry is recorded. It is because the liability due to the creditors has
already been transferred to the credit of realization account and the asset taken over by
the creditor is appearing on the debit side of the realization account. Thus, the debit of
the asset cancels the credit of the corresponding liability in the realization account.
Sometimes, a creditor may accept part of his payment in cash and part of his payment by
taking over an asset. In this case, the entry will be recorded for cash payment only. For
example, a creditor to whom 10,000frs was due accepted office equipment worth
8,000frs. He will be paid 2,000 frs in cash by recording the following entry :
Dr. Realization a/c = 2,000
Cr. Bank a/c = 2,000
Whenever a creditor takes over an asset, there may be two situations:
a. When a creditor accepts an asset whose value is more than the amount due to him, he
will pay cash. It is recorded as: Dr. Bank a/c and Cr. Realization a/c
b. When a creditor accepts an asset as full and final settlement, no journal entry is
recorded.
Expenses of realization
a. When realization expenses are paid by the firm: Dr. Realization a/c and Cr. Bank a/c
b. When firm has agreed to pay partner a fixed amount towards realization expenses
irrespective of the actual realization expenses Dr. Realization a/c and Partners‘ capital
a/c
c. When the actual expenses are paid by the firm on behalf of a partner, the following entry
will be recorded: Dr. Partners‘ capital a/c and Cr. Bank a/c
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1. However, if a partner himself pays and agreed not to get them reimbursed, no journal
entry is recorded.
2. When the partner agrees to pay the expenses on behalf of the firm, the entry to be
recorded: Dr. Realization a/c and Cr. Partners‘ capital a/c
3. When liabilities are paid off Dr. Realization a/c and Cr. Bank a/c
4. When partner discharges a liability The liability account is transferred from realization
account to partner‘s capital account by recording the following entry : Dr. Realization
a/c and Cr. Partners‘ capital a/c
d. For realization of any unrecorded assets: Dr. Bank a/c and Cr. Realization a/c
e. Unrecorded asset taken over by a partner: Dr. Partners‘ capital a/c and Cr. Realization
a/c
f. For settlement of any unrecorded liability: Dr. Realization a/c and Cr. Bank a/c
g. Unrecorded liability taken over by a partner: Dr. Realization a/c and Cr. Partners‘
Capital a/c
h. When the profit (loss) on realization is transferred to partners’ capital account in their
respective profit sharing ratio: (a) In case of profit on realization Dr. Realization a/c
and Cr. Partners‘ Capitals a/c(individually) (b) In case of loss on realization Dr.
Partners‘ Capitals a/c (individually) and Cr. Realization a/c
For transferring accumulated profits and reserve: All accumulated profits and reserves are
transferred to the partners‘capital account in their respective profit sharing ratio: Dr.
Accumulated profit/reserves and Cr. Partners‘ capitals a/c (Individually)
i. Transfer of fictitious assets All accumulated losses and fictitious assets are debited to the
partners‘ capital accounts in their profit sharing ratio: Dr. Partners‘ capitals a/c
(Individually) and Cr. Accumulated losses/Fictitious Assets a/c
j. Payment of loans: Any loans due to partners are paid off: Dr. Partner‘s loan a/c and
Cr.
Bank a/c
k. Settlement of capital accounts:
If the partner‘s capital account shows debit balance, he is to bring in the necessary cash: Dr.
Bank a/c and Cr. Partners‘ capital a/c
In case of partners whose accounts show credit balance, the same is paid off: Dr. Partners‘
capitals a/c and Cr. Bank a/c
It may be noted that the aggregate amount finally payable to the partners must equal to the
amount available in the bank and cash accounts. Thus, all accounts of a firm are closed in case of
dissolution. At times, the Balance Sheet of the firm may not be available on dissolution of
partnership firm. In such a situation, first of all, all the relevant ledger balances are worked out
and then Balance Sheet of the firm on the date of its dissolution is prepared. Thereafter, the
process of dissolution is undertaken in the same manner as discussed above.
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account
2 Revaluation a/c is prepared at the time of It is prepared only at the time of dissolution
reconstitution of a firm of the firm
3 Revaluation account is prepared to find out Realization account is prepared to find out
the profit (loss) on the revaluation of the profit (loss) on the realization of assets
assets and liabilities and settlements of liabilities
4. It contains only those assets and liabilities It contains generally all assets and liabilities
which are revalued
5. The balance of this account is transferred to The balance of this account is transferred to
the old partners’ capital accounts the capital accounts of all partners
6. Accounting entries are made on the basis Accounting entries are made at the book
of the difference between book value and value of assets and liabilities
revalued figures
7. On revaluation, the accounts of assets and The accounts of assets and liabilities are
liabilities are not closed closed on preparation of realization account.
Exercise 1: Rean and Akama share the profits equally. They decided to dissolve their firm. Their
liabilities were: Rean‘s Capital 25,000frs; Akama‘s Capital 30,000frs; Creditors 12,500frs; Bills
payable 7,500frs; Assets of the firm realized 100,000frs by cheque. Prepare a Realization
Account.
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Exercise 2: (When balance sheet at the time of dissolution is not given)
Kumar, Tako and Nde commenced business on January 1, 2011 with capitals of 100,000frs,
80,000 frs and 60,000 frs respectively. Profits are shared in the ratio 4:3:3. Capitals carried
interest at 5% p.a. During 2011 and 2012 they made profits of 40,000frs and 50,000 frs (before
allowing interest on capitals). Drawings of each partner were 10,000frs per year. On December
31, 2012 the firm was dissolved. Creditors on that date were 24,000frs. The assets realized
260,000frs net. Prepare the necessary accounts to close the books of the firm.