Lecture - 29-32 Dissolution of Partnership Firm

Dissolution of Partnership Firm
Lecture 29-32
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Outcomes of the lecture
To understand the meaning of

dissolution of partnership firm
Apprehend the accounting treatment in

case of dissolution of partnership firm

What is Partnership?
 A partnership is a kind of business
where a formal agreement between
two or more people is made who agree
to be the co-owners, distribute
responsibilities for running an
organization and share the income or
losses that the business generates.
 In India, all the aspects and functions
of the partnership are administered

under ‘The Indian Partnership Act
1932’.

Partnership Examples:
•Maruti Suzuki •Red Bull and GoPro

Dissolution of partnership Firm
The dissolution of partnership between all the
partners of a firm is called the dissolution of
the firm. In the case of dissolution of a firm, the
business of the firms is closed down and its
affairs are wound up. The assets are realized
and the liabilities are paid off.

Dissolution of Partnership Firm
The process of dissolution includes disposing of the assets
and the liabilities are paid off.
The firm discontinues all of its activities and no partner
has any relation with the other partners

Modes of dissolution of firm
 Dissolution without the intervention of the court
a) Dissolution by agreement
A firm may be dissolved:
(i) With the consent of all the partners.
(ii) In accordance with a contract between the partners.
b) Compulsory dissolution
 A firm is compulsorily dissolved:
 (i) By the adjudication as insolvent of all the partners or of all
partners except one.

 (ii) By the happening of any event which makes it unlawful
for the business of the firm to be carried on or for the

partners to carry it on in partnership.

CONTD….
c) Dissolution on the happening of certain contingencies.
 i) The death of a partner.
 (ii) The insolvency of a partner,
 (iii) The retirement of a partner,
d) Dissolution by notice at will

A Partnership at Will is a form of business partnership
where there is no fixed term agreed for the duration of the
partnership. In other words, it is completely open ended.
This differs from a usual business partnership by way of
agreement as this type comes to an end at any time when
a partner serves a notice to dissolve the partnership

Modes of dissolution of firm
 Dissolution by the court
a) Insanity (Where a partner of the firm has become of unsound mind.)
b) Permanent incapacity( means a disability of 50% and above suffered by partner)
c) Misconduct
d) Breach of agreement
e) Transfer of interest(A transfer of partnership interest takes place when
a partner in a business relinquishes their ownership rights and responsibilities to
another individual or company.)
f) Loss in business
g) Just and equitable

Steps in the dissolution process
 Step 1
 Prepare a balance sheet of the firm as on the
date of the dissolution of the firm

 Step 2
 Realize the non-cash assets which are not
acceptable for distribution in their present

form, pay the debts of the firm to third
parties. Realization account is prepared to
calculate the loss or profit on realization of
assets and settlement of liabilities. Loss or
profit on realization of assets and settlement
of liabilities is transferred to partners’ capital
accounts.

 Step 3
 Pay the amount due to each partner ratably
for advances (or Loan).

 Step 4
 Pay the available cash to the partners.

MCQ
 In which condition a partnership firm is deemed to be
dissolved?
(A) On a partner’s admission
(B) On retirement of a partner
(C) On expiry of the period of partnership
(D) On loss in partnership

MCQ
 In which condition a partnership firm is deemed to be
dissolved?
(A) On a partner’s admission
(B) On retirement of a partner
(C) On expiry of the period of partnership
(D) On loss in partnership

MCQ
Court can make an order to dissolve the firm when :
(A) Some partner has become fully mad
(B) Partnership deed is fully followed
(C) Continued future profits are expected
(D) Firm is running legal business

MCQ
Court can make an order to dissolve the firm when :
(A) Some partner has become fully mad
(B) Partnership deed is fully followed
(C) Continued future profits are expected
(D) Firm is running legal business

MCQ
On dissolution of a firm, out of the proceeds received
from the sale of assets will be paid first of all
(A) Partner’s Capital
(B) Partner’s Loan to Firm
(C) Partner’s additional capital
(D) Outside Creditors

MCQ
On dissolution of a firm, out of the proceeds received
from the sale of assets will be paid first of all
(A) Partner’s Capital
(B) Partner’s Loan to Firm
(C) Partner’s additional capital
(D) Outside Creditors

Accounting of Dissolution of Partnership
In case of dissolution of firm, the following
accounts are prepared to close the books of the
firm –
 1) Realization Account
 2) Partners’ loan account
 3) Partners’ capital account
 4) Cash or bank account

1) Realisation 2) Partners’
Account loan account
3) Partners’ 4) Cash or
capital account bank account

Realization account
 This is a special type of account. It is a
nominal account. The purpose of preparing
this account is to find out the result of
realization of assets and discharge of
liabilities.

Steps of making Realization A/C
Step 1. For Transfer of all accounts given in the
balance sheet
For transfer of assets – All the assets except cash in
hand, cash at bank, debit balance of current
accounts of partners and fictitious assets are
transferred to debit of this account at book values
as under –
Realization A/c----------------- Dr.

To Various assets (individually)
(For transfer of various assets to realization a/c)

Step 1. For Transfer of all accounts given in the
balance sheet
For transfer of outside liabilities – All the external
liabilities including partners loan are transferred to
the credit of realization account at book value as
under –
Various Liabilities A/c ---------Dr.

To Realization A/c
(For transfer of various liabilities to realization a/c)

Step 2. Disposal of assets
a. For sale of assets

Cash / Bank A/c -----------Dr.
To Realization A/c
(For assets realized in cash)

Step 2. Disposal of assets
b. Asset taken over by partner

Partner's Capital A/c-------- Dr.
To Realization A/c
(For assets taken over by a partner)

Step 3. Entry for payment of dissolution
expenses
a. For cash payment

Realization A/c ---------Dr.
To Cash / Bank A/c
(For payment of dissolution expenses)

expenses
b. For payment made by a partner

Realization A/c ---------Dr.
To Partner's Capital A/c
(For dissolution expenses paid by a partner)

expenses
c. if any partner is to bear all expenses of

realization
no journal entry is required in the books of the

firm

expenses
c. if the partner is paid the realization

expenses:
Partner's Capital A/c----------Dr.
To Cash / Bank A/c
(For dissolution expenses paid on behalf of a
partner.)

Step 4. Entry for payment of outside liabilities :
a. For cash payment

Realisation A/c ----------Dr.
To Cash / Bank A/c
(For payment to outside liabilities)

Step 4. Entry for payment of outside liabilities :
b. For liabilities taken over by a partner

Realisation A/c--------- Dr.
To Partner's Capital A/c
(For liabilities taken over by a partner)

Step 5. Entry for closing realisation account:
a. In case of profit
Realization A/c Dr.
To Partners' Capital A/c
(For profit on realization transferred to
partner's capital a/cs in their profit-sharing
ratio)

Step 5. Entry for closing realisation account:
b. In case of loss
Partners' capital A/cs --------Dr.
To Realization A/c
(For loss on realization transferred to partners'
capital a/cs in their profit-sharing ratio) )

Format of Realization Account


Partner’s loan Account
 This are transferred to the credit side of
realization account and the payments there of
are shown on debit side of realization
account. Alternatively, the payment can be
credited directly to cash account


Partner’s capital accounts
 All the reserved and undivided profit or loss,
realization profit or loss, balance of current
accounts. Now the difference is adjusted in
cash if there is credit balance it is surplus to
be withdrawn by the concerned partner from
their personal resources. Entry for surplus
withdrawn or deficiency brought in by the
concerned partner from their personal
resources.

Entry for surplus
a. Cash/Bank A/c-------- Dr.

To Partner’s capital A/c
(For deficit amount of capital brought in cash)

Entry for deficiency
b. Partner’s Capital A/c ----------Dr

To cash/Bank A/c
(For final payment made to a partners)

Format of Partner’s Capital Account


Cash account
 Cash/Bank Account is opened to record all cash
transactions. When the purpose is over the Cash Account
shows a balance, which is equal to the amounts due to
partners.
 At first opening balance is written. Then cash at bank is
also transferred to this account. Amount realized from
assets and deficiency brought in by partners is debited to
this account and payment of liabilities, realization
expenses and surplus withdrawn by partners are credited.
Now both side of cash account will be equal. The
agreement of both the sides of cash account is the cross
checks of accounting and arithmetical accuracy.

Format of Cash Account

MCQ
On dissolution of a firm, realisation account is debited
with
(A) All assets to be realised
(B) All outside liabilities of the firm
(C) Cash received on sale of assets
(D) Any asset taken over by one of the partners

MCQ
On dissolution of a firm, realisation account is debited
with
(A) All assets to be realised
(B) All outside liabilities of the firm
(C) Cash received on sale of assets
(D) Any asset taken over by one of the partners

MCQ
On firm’s dissolution, which one of the following account
should be prepared at the last?
(A) Realisation Account
(B) Partner’s Capital Accounts
(C) Cash Account
(D) Partner’s Loan Account

MCQ
On firm’s dissolution, which one of the following account
should be prepared at the last?
(A) Realisation Account
(B) Partner’s Capital Accounts
(C) Cash Account
(D) Partner’s Loan Account

MCQ
At the time of dissolution of firm, “Loan of partners”
(Loans given by partners to the firm) is paid out of the
amount realised on sale of assets :
(A) After making the payment of loans given by third
party
(B) After making the payment of balance of Capital
Accounts of partners
(C) After making the payment of above (A) and (B)
(D) Before the payment of loans given by third party

MCQ
At the time of dissolution of firm, “Loan of partners”
(Loans given by partners to the firm) is paid out of the
amount realised on sale of assets :
(A) After making the payment of loans given by third
party
(B) After making the payment of balance of Capital
Accounts of partners
(C) After making the payment of above (A) and (B)
(D) Before the payment of loans given by third party

Insolvency of Partners
 At the time of dissolution of a partnership firm,
the capital account of a partner may show a
debit balance after his share of realization loss
or profit and accumulated profits or losses etc.
have been transferred to his capital account.
 In such a case, the partner is a debtor of the
firm to the extent of debit balance in his
capital account and he has to bring in the
necessary cash to make up the deficiency in his
capital account.

Insolvency of Partners
 If the partner is unable to bring in the
necessary cash, e.g. when he cannot pay in
full the amount of debit balance in the capital
account, he is said to be insolvent.
 The solvent partners have to bear the capital
deficiency of the insolvent partner

Decision in Garner V/s Murray
 In this case Garner, Murray and Wilkins were
equal partners in England. Their capitals were
unequal. The Balance Sheet of the firm after
satisfying all the liabilities were as follows:

 Wilkins was insolvent and unable to pay
anything. Thus, the assets of the firm were
not sufficient to repay the capitals in full.
There was a dispute between the solvent
partners regarding the method of sharing of
loss due to insolvency of Wilkings.

 Justice Joyce held in 1904 as follows: "The
solvent partners are only liable to make good
their share of the deficiency, and that the
remaining assets should be divided among
them in proportion to their capitals,"

In other words, the learned judge held as
follows:
 1. The solvent partners should bring in cash
their share of the realization loss.

 2. The loss due to insolvency of a partner
should be borne by the solvent partners in

proportion to their last agreed capitals.
It should noted, that a partner having a debit
balance or nil balance, will not have to bear the
loss due to insolvency of a partner.

The loss arising out of partner’s insolvency shall
be borne by ____ as per Garner vs. Murray case
A. All the partners equally

B. Solvent partners in equal ratio
C. Solvent partners in capital ratio
D. All partners in profit sharing ratio

The loss arising out of partner’s insolvency shall
be borne by ____ as per Garner vs. Murray case
A. All the partners equally

B. Solvent partners in equal ratio
C. Solvent partners in capital ratio
D. All partners in profit sharing ratio

Meaning of last agreed capitals
 In case of fixed capital method, the
expression, "Last Agreed Capitals" means the
fixed capital. In case of fluctuating capital
method, it means the capitals after malting
adjustment for accumulated profits and
losses, drawings, interest on capital, salary to
a partner etc. to the date of dissolution but
before transferring realization loss or profit.

Example
 Suppose, A’s capital is Rs 1, 00,000 and B’s capital

is Rs 60,000, C’s capital shows a debit balance of
Rs 40,000. There is a reserve of Rs 60,000.
Dividing the reserve among A, B and C, each
partner will be credited with Rs 20,000. C is
insolvent.

Solution
 (a) If the capitals are fixed, the loss on C’s Capital
Account will be borne by A and B in the ratio of
10 : 6, i.e., capitals without adjustment for reserve;
and
 (b) If the capitals are fluctuating, the deficiency in
C’s Capital Account will be borne by A and B in the

ratio of 12 : 8 respectively, i.e., capitals after
adjustment for reserve.

Piecemeal distribution of cash
 Lets watch a video
 https://www.youtube.com/watch?
v=DLgVhCxXR0Y

 It has been presumed so far that all the
assets are realized on the date of dissolution
and all the liabilities are also simultaneously
discharged on the same day itself.
 But usually this is not true in practice.

 In actual practice, assets are realized
gradually, and liabilities are paid gradually
depending upon the amount realized from
the sale of assets.
 Therefore, the realization loss or profit can
be ascertained only after the realization of all

assets and payment of all liabilities.

Available cash is used in the
following order:
 1. Payment of realization expenses or a
provision is made for realization expenses

following order:
 2. Payment of outside liabilities i.e., bank loan,
sundry creditors, bills payable, outstanding
expenses etc.
 It must be noted here that a secured creditor has
priority whenever an asset provided by way of

security to the concerned creditor is realized.
 After satisfying the claim of the secured creditor the
surplus, if any, is paid to unsecured creditors.

 Amount realized from an asset which is not charged
or mortgaged is used to pay all the creditors,

whether secured or unsecured in the ratio of their
claims.

following order:
 3. Payment of partners' loan in the ratio of
their respective loans.

following order:
 4. Payment of partners capitals.

NOTE:
 If there is any contingent liability an account
of bills discounted, a provision should be
made in the beginning for the same and when
provision is no longer required, the amount
should be distributed.

Sale to a Limited Company
When a partnership converts itself into a joint stock
company or the business of the existing firm is acquired
by an existing company is called “sale to a limited
company”.
Realisation Account will be opened and assets transferred
to it, so also liabilities (but not if liabilities are not
assumed by the company).

Dissolution of firm can be made by
selling the business to a company
 True
 False

Dissolution of firm can be made by
selling the business to a company
 True
 False

Lets watch a video….
 https://www.youtube.com/watch?
v=wC5_BJkvYSc

Sale to a Limited Company
Some authorities recommend that shares in joint stock
companies should be divided among partners in the profit-
sharing ratio.
This will enable partners to enjoy any future profit or loss
on shares in the profit-sharing ratio.

When a partnership firm is sold to a Company,
it is nothing but dissolution of a firm resulting
on account of sale to a Company. Thus, the
same accounting procedure is followed for
closing the books of the firm as followed for
simple dissolution of a firm.
77
Accounting treatment
 Lets watch a video ……..
 https://www.youtube.com/watch?v=XQVkery-
b5k
78
WORTHNOTING POINTS IN CASE
OF SALE OF A FIRM TO A
COMPANY
79
1. All assets and outside liabilities (whether or not
taken over by the Purchasing Company) should be
transferred to the Realisation Account at their
respective book values.
However, ‘Cash and Bank Account’ should not be

transferred to the Realisation Account if it is given
that the purchasing Company is not taking over the
‘Cash and Bank Balances’.
80
Poll
 Following items is/are transerred to
realisation account at the time of converting
partnership business into company
 A. assets
 B. liabilities
 C. cash balance not taken over by company
 D. both a and b

Poll
 Following items is/are transerred to
realisation account at the time of converting
partnership business into company
 A. assets
 B. liabilities
 C. cash balance not taken over by company
 D. both a and b

2. On making due the purchase consideration, the
Purchasing Company’s Account should be debited and
Realisation Account should be credited.
83
84
Poll
 If company is paying total 50000 cash, equity
shares issued at 40000(4000 shares of 10
each), then purchase consideration will be-
 A. 50000
 B. 40000
 C. 90000
 D. 30000

Poll
 If company is paying total 50000 cash, equity
shares issued at 40000(4000 shares of 10
each), then purchase consideration will be-
 A. 50000
 B. 40000
 C. 90000
 D. 30000

3. On receipt of purchase consideration, Cash
Account/Equity Shares in Purchasing
Company/Preference Shares in Purchasing Company,
should be debited at their issue prices and the
Purchasing Company’s Account should be credited.
87
Poll
 On receipt of purchase consideration, Cash
Company/Preference Shares in Purchasing
Company, …………….Account should be
credited
 A. equity shares
 B. Preference shares
 C. purchasing company
 D. cash a/c

Poll
 On receipt of purchase consideration, Cash
Company/Preference Shares in Purchasing
Company, …………….Account should be
credited
 A. equity shares
 B. Preference shares
 C. purchasing company
 D. cash a/c

4. Where the issue price and the current market price of
the shares do not coincide, the difference should be
transferred to the partners’ capital accounts in their
profit shading ratio.
90
5. In the absence of an agreement as to the division of
shares (received from the Purchasing Company) among
the partners, such shares should be distributed among
the partners in the ratio of their final claims (i.e., in the
ratio of capitals standing after making all adjustments
like transfer of profit/loss on realisation, accumulated
profits /reserves /losses)
91
6. In case of conversion of a firm into a company if it is
specifically given that the partners agree to preserve
the same rights as regards the interest on capital and
the sharing of profits and losses as they had in the
partnership, the question of equity shares and the
preference shares to be issued to partners may be dealt
with in any one of the two ways.
92
93
94

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Dissolution of Partnership Firm

Made By: Chitsimran 2

To understand the meaning of

Apprehend the accounting treatment in

Made By: Chitsimran 3

of the partnership are administered

Made By: Chitsimran 4

•Maruti Suzuki •Red Bull and GoPro

Made By: Chitsimran 5

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partners except one.

for the business of the firm to be carried on or for the

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d) Dissolution by notice at will

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a) Insanity (Where a partner of the firm has become of unsound mind.)

b) Permanent incapacity( means a disability of 50% and above suffered by partner)

e) Transfer of interest(A transfer of partnership interest takes place when

a partner in a business relinquishes their ownership rights and responsibilities to

another individual or company.)

g) Just and equitable

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date of the dissolution of the firm

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acceptable for distribution in their present

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for advances (or Loan).

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Realization A/c----------------- Dr.

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Various Liabilities A/c ---------Dr.

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a. For sale of assets

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b. Asset taken over by partner

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a. For cash payment

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b. For payment made by a partner

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c. if any partner is to bear all expenses of

no journal entry is required in the books of the

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c. if the partner is paid the realization

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a. For cash payment

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b. For liabilities taken over by a partner

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