Dr.

Neyaz Ahmad
Assistant Professor
R.D.S., Col., Muz.

Chapter: 5
Dissolution of Partnership Firms

OBJECTIVES:

 After studying this Chapter, you will be able to:

 Explain the meaning of dissolution,
 Distinguish between dissolution of partnership and dissolution of a firm,
 Enumerate the modes of dissolution,
 Enlist the procedure for settlement of accounts,
 Make necessary Journal Entries in the books on dissolution under various
circumstances,
 And close them after learning numerical problems.

INTRODUCTION:

You have studied that on the admission, retirement or death of a partner, the
partnership comes to an end but the firm may continue, if the partners so decide,
with a new partnership coming into existence. But in some situation, the firm has
to be discontinued and closed down which is known as dissolution of the firm. So,
in dissolution of a firm, the assets are to be sold or disposed-off and the external
liabilities are to be paid. And the claims of the partners are settled. In this Chapter,
you will study the various modes and types of dissolution, the journal entries
required to be made on disposal of the assets and on payment of the liabilities. the
problems arising at the time of settlement of accounts of the partners and their
resolution as per the partnership deed and the Partnership Act 1932.

MEANING OF DISSOLUTION OF PARTNERSHIP:

Dissolution of partnership means that the relationship between the partners changes
while the firm may continue its business under the same name, if the partners so
decide.

MEANING OF DISSOLUTION OF FIRM:

Dissolution of the firm means completely closing the business of the firm. In such
situation, all the assets are disposed off and all the liabilities are paid. Therefore,
under dissolution of the firm, the partnership is automatically dissolved. On the
other hand, dissolution of partnership does not necessarily result in the dissolution
of the firm.
 Dr. Neyaz Ahmad
Assistant Professor
R.D.S., Col., Muz.

DISSOLUTION OF PARTNERSHIP:

The partnership is deemed to have been dissolved in all of the following situations:

i. On expiry of the period of partnership

ii. On completion of the business for which it was formed
iii. On admission of a partner
iv. On retirement of a partner
v. On death of a partner and
vi. On insolvency of a partner.

In all of the above situations, the old partnership (agreement) comes to an end but
the business may be carried on in the same name and style but with a new
partnership coming into existence. Also, in the case of a change in the profit-sharing
ratio of the existing partners, the old partnership (agreement) is dissolved and a new
agreement comes into existence.

DISSOLUTION OF PARTNERSHIP FIRM:

There is the dissolution of the firm under the following circumstances.

i. Where all the partners mutually agree to dissolve the firm

ii. Where all the partners become insolvent, except one partner
iii. Where the business of partnership becomes unlawful
iv. In the case of partnership at will, when a partner gives notice for dissolution.
v. When a court gives order for dissolution.

It must be clearly understood that dissolution of the partnership is only a legal sense
of direction known to the insiders only, whereas dissolution of the firm is a real
physical break-up and discontinuance of the business leading to the closure of all
trading activities.

MODES OF DISSOLUTION:

There are two modes of dissolution of the firm given as follows:

A. Dissolution without the order of the court, and

B. Dissolution by the order of the court.

(A) Dissolution without the order of the court:

A firm is dissolved without the order of the court in any one of the following ways:
 Dr. Neyaz Ahmad
Assistant Professor
R.D.S., Col., Muz.

1) Dissolution by Agreement (Sec. 40): According to section 40 of Partnership

Act,1932, a firm may be dissolved:

i. With the agreement of all the partners or dissolution at will

ii. In accordance with a contract between the partners.

2) Compulsory Dissolution (Sec.41): According to section 41 of Partnership Act

1932, a firm is compulsorily dissolved under the following cases.

i. When all the partners except one are declared insolvent.

The reason is simple that an insolvent person ceases to be a partner and there
cannot be a partnership firm without at least two persons.
ii. When one of the partners is declared insolvent unless there is an opposite
contract.
iii. When the business becomes unlawful on the happening of some event.

3) Dissolution on the happening of certain unforeseen events given as follows:

i. On the expiry of the term partnership business.

ii. On the completion of the adventure or the business.
iii. On the death of a partner
iv. On the adjudication of a partner as an insolvent already discussed under (2)
(ii) above and dissolution by notice in case of partnership at will 1(i).

4) Dissolution by giving Notice in case of partnership at will.

(B) Dissolution by and order of the Court (Sec.44):

As per section 44 of Indian Partnership Act 1932, the court can order dissolution of
the firm on the following grounds.

I. Where a partner becomes of an unsound mind,

II. Where a partner is permanently incapacitated to perform his duties,
III. Where a partner is guilty of misconduct,
IV. Where a partner persistently or regularly commits breach of the partnership
agreement,
V. Where a partner has transferred the whole of his interest in the firm,
VI. Where the business cannot be carried on except at a loss and,
VII. Where the court is satisfied that it is just and equitable that the firm should be
dissolved.

After dissolution, the rights and obligations of all the partners continue as before, in
all the things necessary for the smooth winding up of the business of the firm.
 Dr. Neyaz Ahmad
Assistant Professor
R.D.S., Col., Muz.

MODE OF SETTLEMENT OF ACCOUNTS:

Normally Partnership Agreement (Deed) governs the mode of settlement of accounts

between partners when the firm is dissolved. In the absence of any specific
agreement (deed) between the partners, the mode of settlement of accounts of the
partners on dissolution of the firm, the relevant provisions of Section 48 of the
Partnership Act, 1932 is applied.

Section 48 states that in settling the accounts of a firm after dissolution, the
following rules, subject to agreement by the partners, shall be observed:

a) Losses, including deficiencies of capital, shall be paid first out of profits, next out
of capital, and lastly, if necessary, by the partners individually in the proportions in
which they are entitled to share profits.

b) The assets of the firm, including any sums contributed by the partners to make
up deficiencies of capital, shall be applied in the following manner and order:

i. In paying the debts of the firm to third parties or creditors.

ii. In paying to each partner rateably what is due to him from the firm as a loan-
different from capital,
iii. In paying to each partner rateably what is due to him on account of capital
and,
iv. The remaining balance, if any, shall be divided among the partners in the
proportions in which they are entitled to share profits.

The overall effect of the above provisions may be summarised in simple terms as
follows:

1. The assets of the firm must be first utilised in paying off the claims of third
parties against the firm,
2. The balance should be applied in repaying the loans made by the partners to
the firm as distinguished from the capital. If the amount is insufficient to pay
off the loans, they should be paid off proportionately and,
3. The balance should be utilised in paying the claims of the partners in respect
of their capitals which should be after adjusting all accumulated profits or
losses and also drawings and realisations profit or loss.

Private Debts of Partners and Firms' Debts:

The creditors of the firm (third party liabilities) should be paid out of the assets of
the firm. If there is any surplus, it will be divided among the partners as per their
claims which can be utilised for paying the private liabilities of the partners.
 Dr. Neyaz Ahmad
Assistant Professor
R.D.S., Col., Muz.

Similarly, the private creditors of partners should be first paid out of the private
assets of partners and if there is any surplus, it can be utilised for paying off the
partnership debts.

Accounting Treatment:
In some situation, the firm has to be discontinued or closed down and this is known
as dissolution of the firm. On dissolution of a firm, the assets are sold or disposed-off
and the external liabilities are to be paid and the claims of the partners is settled.

In this chapter we will learn journal Entries required to be made on disposal of the
assets and on payment of the liabilities, problems arising at the time of settlement of
accounts of the partners and Resolution for settlement of partners account as per the
partnership deed and Act. 1932.

When a Partnership firm is dissolved due to any reason, the books of accounts of
partnership firm is to be closed. This means all the assets and the liabilities including
partners’ capital is closed by disposing the assets and paying of the liabilities. The
Balance Sheet Assets side items always shows Debit (Dr.) balance and The Liabilities
side items always shows Credit (Cr.) balance.

Journal Entry at the time of Dissolution

The following journal entry is recorded at the time of dissolution of Partnership Firm.

1) Transferring or closing tangible and intangible Assets A/c:

Realization A/c Dr.

To Assets. A/c

The assets both tangible and intangible are closed by Crediting concerned asset account and debating
realisation account. This is also called transferring assets to the Realisation Account in order to close such
account.

Note: Cash or bank balance are not transferred to realisation account. Fictitious Assets like Preliminary
Expense or debit balance of profit and loss are not transferred to realization a/c but partners’ capital account
and nothing is realized from these assets.

2) For transferring or closing Fictitious assets:

Partners' Cap. A/c Dr....
To Fictitious Asset A/c
 Dr. Neyaz Ahmad
Assistant Professor
R.D.S., Col., Muz.

Note: Fictitious assets includes past years’ preliminary expenses, Losses, advertisement expenses still
not written off etc.
3) When Liabilities and Provision are transferred to Realisation A/c:

Concerned Liabilities A/c Dr

Concerned Provisions A/c Dr

To Realization A/c

After transferring assets, liabilities and provision to realization account, the next step
is to collect money from sale of assets and to pay the external liabilities.

4) When cash is realized from sale of assets:

Cash/Bank A/c Dr.
To Realisation.......

Note: the cash is realised mostly from physical assets but not realised from fictitious
assets. If cash realized from any asset is not given, then it is assumed to be realised
at book value or fair market value.

5) When any asset is taken over by any partner:

Partner's Capital A/c Dr.
To Realisation A/c

6)When liabilities are paid off

Realization A/c Dr
To Cash/Bank

7) When any liability is taken over by any partner:

Realisation A/c Dr.
To Partner's Cap. A/c...

Note: Generally, Provision are not actually liabilities and thus these are not paid off.
But if there is a contingent or unrecorded liability that must be paid off by the firm
then

8) When contingent or unrecorded liabilities is paid-off.

Realization A/c Dr.
To Cash/Bank
 Dr. Neyaz Ahmad
Assistant Professor
R.D.S., Col., Muz.

9) When unrecorded liability is taken over by partner:

Realisation A/c Dr.
To Partner's Cap. A/c

10) When un-recoded assets is realised:

Cash/Bank A/c Dr.
To Realisation A/c
11) When unrecorded asset is taken over by partner:
Partner's Cap. A/c
To Realization A/c
12) When realisation Expense of selling assets is born and paid by partnership
firm:
Realization A/c Dr.
To Cash/Bank.
13) When realisation expense is paid by partner:

Realization A/c Dr.

To Partner's Cap. A/c

14. When Creditor takes over assets in settlement of their account:

No Entry is recorded

The Realization Account is Nominal Account. If the credit side balance is more than
the debit side of realisation account, it shows profit on realisation.

15) If there is Profit on Realisation:

Realisation A/c Dr.
To Partners' Capital A/c

(Being Realisation Profit is shared in profit sharing ratio)

16) If there is Loss on Realisation:

Partners' Capital A/c Dr.
To Realisation A/c
(Being Realisation loss shared in profit sharing ratio).
17) Accumulated Profit and Reserve accounts are closed:
General Reserve A/c Dr.
Profit & Loss A/c Dr.
To Partners Capital A/c
(Being accumulated profit shared in profit sharing ratio)
 Dr. Neyaz Ahmad
Assistant Professor
R.D.S., Col., Muz.

Format of Realization Account:

Realisation Account
Particulars Amount Particulars Amount
To Fixed Assets …..... By Liabilites …...
To Currrent Assets …...... By Provisions …...
By Partners' Capital …...
To Partners' Capital …....
By Cash/Bank:
To Cash/Bank: Fixed Asets:
Liabilities: Current Assets:
Unrecord. Liab: Unrecorded Asst: …...
Realisation Exp. ….....

To Partners' Capital: By Partners' Capital:

Profit on Rel. …........ Loss on Rel. ….....
…............ ….......

Illustration 1
The following is the balance sheet of a partnership firm of A, B and C who are
sharing Profit and losses in 3:2:1 as on March 31, 2020.

Balance Sheet as on March 31, 2020

Assets Amount Liabilities Amount
Cash ₹ 8,000 Creditors ₹ 5,000
Other Current Assets ₹ 22,000 Bank Loan ₹ 15,000
GoodWill ₹ 18,000 A's Capital ₹ 45,000
Other Fixed Assets ₹ 62,000 B's Capital ₹ 30,000
C's Cpaital ₹ 15,000
₹ 1,10,000 ₹ 1,10,000

On the above date partners have decided to dissolved the firm.

1) included in Current assets, stock of Rs 7,000 is taken by A.
2) Remaining current Assets is realised at 10% Discount.

3) Machinery of Rs. 28,000 is sold for Rs. 20,000 and Building with book value 40,000 is sold for Rs.
75,000.
4) There was an un-recoded typewriter which was sold for Rs. 7,000.
5) Bank loan is paid in full but creditors are paid only Rs. 4,000.
6. There is claim or liability for damage of a customer against the firm for Rs 3,000 in a lawsuit and it
is taken over by B to be paid by him.
7. The realisation expenses for selling assets amounts Rs. 1,200 and is paid by firm.
 Dr. Neyaz Ahmad
Assistant Professor
R.D.S., Col., Muz.

You are required

1) Pass Journal Entry and
2) Prepare Realization Account to determined realisation Profit or loss.
3) Prepare Cash Account before settlement of partners account.
4) Prepare Balance Sheet and show the realisation profit or loss in Balance sheet.
5) Pass Journal Entry for Distribution of Realisation Profit or Loss.
6) Prepare Partners' Capital Account or Close Realization Profit and Partners capital and Prepare
Cash account.

Solution.
1) Journal Entries in the books of Partnership Firm:
Date Particulars Debit Credit
Mar. 31 Realisation A/c ₹ 1,02,000
To Current Assets ₹ 22,000
To Goodwill 18,000
To Other Fixed Assets 62,000
(Being Assets transferred to Rel. Account)
Mar. 31 Creditors A/c 5,000
Bank Loan A/c 15,000
To Realisation A/c 20,000
(Being Liabilities trnasferred to Rel. A/c)
Mar. 31 Cash A/c 1,15,500
To Realisation A/c 1,15,500
(Being Cash collected from sale of assets)
(13,500 + 20,000 + 75,000 + 7,000 = 1,15,500)

Mar. 31 A's Capital Account 7,000

To Realisation A/c 7,000
(Being stock taken over by A)
Mar. 31 Realisation A/c 3,000
To B's Capital A/c 3,000

Mar. 31 Realisation A/c 20,200

To Cash 20,200
(Bieng Liabilities and Rel. expense paid off)
Mar. 31 Profit on Realisation 17,300
(142,500 - 125,200 = 17,300)

2) Realisation Account
 Dr. Neyaz Ahmad
Assistant Professor
R.D.S., Col., Muz.

Relization Account
Particular Amount Particular Amount
To Current Assets ₹ 22,000 By Creditors ₹ 5,000
To Goodwill ₹ 18,000 By Bank Loan ₹ 15,000
To Fixed Assets ₹ 62,000 By Cash ₹ 1,15,500
To B's Capital ₹ 3,000 By A's Capital ₹ 7,000
To Cash: ₹ 20,200
To Realisation Profit: ₹ 17,300
₹ 1,42,500 ₹ 1,42,500

3) Cash Account before settlement of partner account:

Cash Account
Particular Amount Particular Amunt
To Balance b/d ₹ 8,000 By Realisation A/c ₹ 20,200
To Realisation A/c 1,15,500 By Balance c/d 1,03,300
1,23,500 1,23,500

4) Balance Sheet After Disposal of assets and payment of Liabilities

Balance Sheet as on Mar. 31, 2020
Assets Liabilities
Cash ₹ 1,03,300 A's Capital (45,000 - 7,000) ₹ 38,000
B's Capital- (30,000 +3,000) ₹ 33,000
C's Capital ₹ 15,000
Realisation Profit ₹ 17,300
₹ 1,03,300 ₹ 1,03,300

5) Journal Entry for Distribution of Realisation Profit.

Date Particulars Debit Credit

Mar. 31 Realisation Profit ₹ 17,300
To A's Capital A/c ₹ 8,650
To B's Capita A/c ₹ 5,767
To C's Capital A/c ₹ 2,883
(Being Rel. Profit shared in 3:2:1 ratio)
 Dr. Neyaz Ahmad
Assistant Professor
R.D.S., Col., Muz.

6) Preparation of Partners’ Capital Account and Cash Account

Partners' Capital Account
Particulars A B C Particulars A B C
To Cash ₹ 46,650 ₹ 38,767 ₹ 17,883 By Balance c/d ₹ 38,000 ₹ 33,000 ₹ 15,000
By Rel. Profit ₹ 8,650 ₹ 5,767 ₹ 2,883
₹ 46,650 ₹ 38,767 ₹ 17,883 ₹ 46,650 ₹ 38,767 ₹ 17,883

Cash Account
To Balance b/d ₹ 1,03,300 By A's Capital A/c ₹ 46,650
By A's Capital A/c ₹ 38,767
By A's Capital A/c ₹ 17,883
₹ 1,03,300 ₹ 1,03,300