Week 4

Dissolution of Partnership and Conversion of Partnership to Limited Liability Company

Learning Objectives
After delivering this lecture, students should be able to understand:
• The adjustments that are made to the partner’s accounts on dissolution of partnership;
• The Accounting entries necessary to close the existing partnerships and form a limited liability
company.

Dissolution of Partnership
Partners of a firm may decide to dissolve the firm for various reasons. The reasons may include the
following:
• The death of a partner
• Retirement of partner
• The bankruptcy of a partner
• The lunacy of a partner
• Amalgamation of partnership
• Conversion of partnership to Limited Liability Company

Whatever the cause of the dissolution, the following steps are necessary:
1. Transfer all non-cash assets to the Realization Account by
Dr. Realization Account with the book value of the assets
Cr. the Assets Accounts with the same.

2. Relevant expenses
Dr. Realization Account
Cr. Cash or Bank Account with all relevant expenses

3. Proceeds of assets
Dr. Bank or Cash
Cr. Realization Account with proceeds of assets

4. Assets taken over by any partners

Dr. Partners’ Capital Account
Cr. Realization Account with the agreed price.

5. Paying off liabilities:

Dr. Liability Account.
Cr. Bank or Cash with the value of the liabilities

6. Discount allowed by creditors:

Dr. Creditor’s Accounts
Cr. Realization Account with the discount allowed

7. Close the Realization Account to the Partner’s Capital Accounts.

8. Paying off the Partner’s current accounts to their capital accounts:

Dr. Current Accounts
Cr. Partner’s Capital Accounts.

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 9. Close off the Partner’s Capital Accounts by paying the amount due to them or by receiving the
amount due from them.

Treatment of deficiency due from a partner as a result of partnership’s dissolution (Rule in Garner
V Murray)
After dissolution, the capital account of a partner may have a debit balance. That is, the partner is
indebted to the partnership. If such partner is not binding by any agreement to pay the partnership for the
deficiency, the rule in Garner V Murray (1904) – a case in UK - applies. The rule or judgment is that the
deficiency (the balance that cannot be paid by the insolvent partner) should not be shared by the
remaining partners in the profit and loss sharing ratio but in the ratio or proportion of their last agreed
balances in their capital account. That is, the credit balances on their capital accounts in the normal
balance sheet drawn up at the end of their last accounting period. This implies that the remaining partners
will suffer the loss arising from the inability of the insolvent partner to fulfill his obligation to the
partnership.

Example 1
Samuel, David and Jonathan have been partners for some time, making up their account to 31st December
every year. The following was their balance sheet as at 31st December 2015.
N’000 N’000
Leasehold property 550,000
Motor vehicle 220,000
Furniture and fittings 150,000
920,000
Current assets:
Stock 420,000
Debtor 350,000
770,000
Less Current liability:
Creditors 390,000
Overdraft 91,000
481,000 289,000
1,209,000
Financed by
Capital account:
Samuel 255,000
David 200,000
Jonathan 275,000
Current account:
Samuel 75,000
David 50,000
Jonathan 49,000
Long-term loan 305,000
1,209,000

The partners share profits and losses in the ratio 2:2:1. On 31 st December, 2015 they agreed to dissolve
the partnership as a result of David becoming an invalid. Samuel took over one of the vehicles which had
a book value of N80m at a valuation of N150m. Jonathan took over half of stock for N250m. The

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leasehold properties, the remaining vehicle, fixtures and fittings realized N720m. Debtors realized
N320m. After paying the creditors in full, the partners received the monies due to them on capital
account.
Required:
1. The Realization Account
2. The Bank Account
3. The partner’s Capital Accounts

Conversion of a Partnership to a Limited Company Company

When a partnership is converted to a Company, the partnership is dissolved. The former partners may
become shareholders in the new company or not. The price put on the firm is known as the purchase
price or the purchase consideration.
The purchase consideration can be settled by:
-cash
- issue of shares to the partners
- issue of debentures
- partly by cash and by shares
- partly by shares and partly by debentures
- a combination of cash, shares and debentures
In order to retain their comparative positions in the shareholding of the new company, the shares could be
divided in the partners’ profit sharing ratio and the balances in their capital accounts are settled either by
cash being paid or received from the dissolution. Since the partnership would cease henceforth, the
accounting treatment of the sale of the partnership is similar to the entries passed when considering
the dissolution of partnership.

The settlement of the purchase consideration would necessitate the following entries:
1. Treat the purchaser (The limited liability company) as a debtor:
Dr. the Purchaser
Cr. the Realization Account with purchase consideration
2. Payment by cash:
Dr. Bank Account
Cr. the Purchaser
3. Payment by issue of shares
Dr. Ordinary Shares in Purchaser’s Name
Cr. Purchaser.
4. Payment by issue of debenture
Dr. Debenture in Purchaser’s Name
Cr. Purchaser
5. Closure of Partners Capital Account:
Dr. Partners’ Capital Accounts
Cr. Bank, Ordinary Shares, Debentures in Purchaser’s Account with appropriate amounts.
Example 2
Mazda, Nissan and Honda have been in partnership for several years sharing profits and losses in the ratio
5:3:2 respectively. On 1/1/2017 they decided to convert their business into a limited liability company
Toyota Ltd, on the same date. The statement of financial position at the close of business on 31/12/2016
was as shown below:
Statement of Financial Position as at 31st December, 2016
N’000 N’000 N’000 N’000
Freehold buildings 36,000
Vehicle (Cost less depreciation) 14,400

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Equipment (Cost less depreciation) 7,500
Stocks 18,375
Debtors (Less prov. For doubtful debt) 14,445
Bank 6,600
97,320
Less Creditors 9,000
88,320

Financed by:
Mazda Nissan Honda
Capital account 36,000 24,000 18,000 78,000
Current account 1,560 1,920 840 4,320
Loan account 2,000 2,000 2,000 6,000
39,560 27,920 20,840 88,320
Apart from the cash and one of the vehicles, all assets and liabilities were taken over by the company.
Honda took over one of the vehicles at a valuation of N6,000,000. The purchase consideration was
calculated as follows:
N’000
Freehold buildings 69,000
Vehicle (Cost less depreciation) 7,200
Equipment (Cost less depreciation) 4,800
Stocks 12,000
Debtors (Less prov. For doubtful debt) 13,800
Goodwill 24,000
130,800
Less Creditors 9,000
121,800
The company was to issue fully paid shares of N1,000 each to meet the purchase consideration.
Required:
Close the books of the partnership on the assumption that realization expenses was N5,000,000 and
prepare the balance sheet of Toyota Ltd. Immediately after the conversion.

Multiple Choice and short answer questions

Use the following information to answer questions 1 and 2.
Shola and Bada are in partnership and share profits in the ratio 2:3 on 1 September 2010, a new partner,
Carol joins the business introducing N24 million capital. The following also take place at this date:
• Goodwill is valued at N80 million
• The profit share ratio is to be 3:6:1
• Property is re-valued upwards by N70 million

Shola had a balance of N90m credit prior to adjusting the accounts. Goodwill is not retained in the
business.
1. Calculate the total amount of goodwill and revaluation surplus credit into Bada’s Capital Account.
A. N32m
B. N42m
C. N48m
D. N60m

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E. N90m
2. What is the balance in Shola’s Capital account after all adjustment?
A. N112m
B. N118m
C. N126m
D. N136m
E. N150m

Use the following information to answer questions 3 and 4

Joe, Okon and Koko were in partnership, sharing profits in the ratio 1: 1: 2 respectively. The capital
balance after the partnership was dissolved and all accounts closed were:
Joe N40 million Credit
Okon N60 million Credit
Koko N50 million Debit
3. State how Koko’s debit balance should be accounted for if he is not insolvent.
4. How much would Joe contribute to the deficiency of Koko, assuming that Koko is insolvent?
5. When a partnership is converted to a Company, the purchase consideration could be in form of (i)Cash
(ii)……………………and (iii)…………………….
6. What is the accounting entry for asset taken over by a partner, when a partnership is dissolved?
7. When a partner retires, the balance in his capital account after all adjustment has been completed is
transferred to………………account.

SOLUTION
1. B
2. C
3. Koko deficit would be settled from the surplus in his private estate
4. N20 million (40/100 x N50m). The rule in Garner V Murray applies.
5. Ordinary Share Capital account
6. Debit the partner’s Capital account
Credit the Realization account
7. 5 percent Loan Account