Dissolution of partnership vs dissolution of firm
Dissolution of partnership: the relationship among partners changes (admission, retirement, death, change in ratio) but the firm carries on. Books continue.
Dissolution of the firm: the relationship among all partners ends and the business closes. All books are closed.
Dissolution of the firm always means dissolution of the partnership, but not the other way round.
Modes of dissolution of a firm
- By agreement: all partners agree, or as per the deed.
- Compulsory: all or all but one partner become insolvent, or the business becomes illegal.
- On certain contingencies: end of fixed term, completion of the venture, death, insolvency of a partner (unless agreed otherwise).
- By notice: in a partnership at will, any partner gives written notice.
- By court: a partner becomes of unsound mind or permanently unable, misconduct, persistent breach of agreement, transfer of interest, continuous losses, or any just and equitable ground.
Settlement of accounts
Order of payment from the realised money (Section 48): first outside liabilities (creditors, bank loan), then partners' loans (advances) to the firm, then partners' capitals, and any surplus in profit ratio. Losses (including capital deficiencies) are met first from profits, then from capital, then by partners personally in the profit ratio.
Realisation Account
- Transfer assets (except cash/bank and fictitious assets) to the debit side at book value. Provisions against assets go to the credit side.
- Transfer outside liabilities to the credit side.
- Sale of assets: Bank Dr, To Realisation A/c.
- Payment of liabilities: Realisation A/c Dr, To Bank.
- Asset taken over by a partner: Partner's Capital Dr, To Realisation. Liability taken over by a partner: Realisation Dr, To Partner's Capital.
- Realisation expenses: Realisation Dr, To Bank (or To Partner's Capital if a partner pays; if the partner must bear them himself, no entry in the Realisation Account).
- Unrecorded assets sold: Bank Dr, To Realisation. Unrecorded liabilities paid: Realisation Dr, To Bank.
- Balance = profit or loss, shared in the profit ratio.
Partners' loans are not transferred to Realisation; they are paid directly: Partner's Loan A/c Dr, To Bank.
Partners' capital accounts and Cash/Bank Account
Partners' capital accounts receive: reserves and accumulated profits (credit), accumulated losses and fictitious assets (debit), realisation profit or loss, assets or liabilities they take over. The final balance is paid in cash (Capital Dr, To Bank) or brought in if negative (Bank Dr, To Capital).
The Bank Account starts with the opening balance, adds sale proceeds and cash brought in, deducts payments. It closes at zero. Piecemeal distribution, sale to a company and insolvency of partners are outside this syllabus.
Key formulas and definitions
- Realisation profit/loss = (Cash from assets + Liabilities transferred) − (Assets transferred + Liabilities paid + Expenses)
- Assets at book value → Dr side; Liabilities → Cr side
- Section 48 order: outsiders → partners' loans → capitals → surplus in profit ratio
- Final payment to partner = Capital + reserves ± realisation result ± takeovers
- Bank A/c must close at zero
Worked examples
1. Assets (other than cash) ₹3,00,000 sold for ₹2,80,000. Creditors ₹1,00,000 paid ₹95,000. Expenses ₹5,000. Find realisation result.
Dr: 3,00,000 + 95,000 + 5,000 = 4,00,000. Cr: 1,00,000 + 2,80,000 = 3,80,000. Loss ₹20,000.
2. A takes over stock of book value ₹20,000 at ₹18,000. Entry?
A's Capital A/c Dr ₹18,000, To Realisation A/c ₹18,000.
3. Creditors ₹50,000 accept furniture worth ₹30,000 and cash ₹18,000 in full settlement. Entry for cash?
Only cash is recorded: Realisation A/c Dr ₹18,000, To Bank ₹18,000 (furniture is already in Realisation).
4. An unrecorded computer is sold for ₹8,000 and an unrecorded bill of ₹3,000 is paid. Effect?
Realisation credited 8,000 and debited 3,000: net profit effect +₹5,000.
5. Realisation expenses ₹4,000 are to be borne by B, who is paid ₹5,000 remuneration for this and pays the expenses himself.
Realisation Dr ₹5,000, To B's Capital ₹5,000. Actual expenses paid by B: no entry in the firm's books.
6. After realisation, A's capital ₹90,000, B's ₹60,000, cash ₹1,50,000. Settle.
A's Capital Dr 90,000, B's Capital Dr 60,000, To Bank 1,50,000. Bank closes at zero.
Common mistakes
- Transferring cash or bank balance to the Realisation Account. They are not realised.
- Transferring a partner's loan to Realisation; it is paid separately after outsiders.
- Recording the asset given to a creditor as a separate entry when it is already in Realisation.
- Sharing realisation profit in the capital ratio instead of the profit ratio.