Dissolution of a Partnership Firm

It is important to distinguish two terms. Dissolution of partnership is merely a change in the relationship among partners (on admission, retirement or death) — the firm continues. Dissolution of the firm means the business is closed down completely: assets are sold, liabilities paid, and the firm ceases to exist. This chapter deals with the latter.

A firm may be dissolved in several modes:

• By agreement — all partners agree to dissolve.
• Compulsory dissolution — when all but one partner become insolvent, or the business becomes unlawful.
• On the happening of certain events — expiry of the term, completion of the venture, or the death/insolvency of a partner (subject to agreement).
• By notice — in a partnership at will, any partner may dissolve by notice.
• By the court — e.g. a partner becomes of unsound mind, is guilty of misconduct, or the business runs only at a loss.

On dissolution of the firm, the central task is to realise (sell) the assets, pay off the liabilities, and distribute any surplus (or recover any deficiency) among the partners. This is done through a special account — the Realisation Account — studied next.

The Realisation Account is opened to record the sale of all assets and the payment of all liabilities, and to find the overall profit or loss on realisation. (Do not confuse it with the Revaluation Account used on admission/retirement — that only revalues; this one closes everything.)

The standard steps and entries:

• Transfer assets (at book value, except cash/bank) to the debit: Realisation A/c Dr / To Sundry Assets.
• Transfer outside liabilities to the credit: Sundry Liabilities A/c Dr / To Realisation A/c.
• Assets sold for cash: Cash/Bank A/c Dr / To Realisation A/c (the actual amount realised).
• Liabilities paid: Realisation A/c Dr / To Cash/Bank A/c.
• Realisation expenses paid: Realisation A/c Dr / To Cash.

The balancing figure is the profit or loss on realisation, transferred to all partners' capital accounts in their profit-sharing ratio. Key points: cash/bank is not transferred to Realisation (it is the medium of payment); accumulated reserves and the P&L balance are distributed directly to capitals (not through Realisation); and if a partner takes over an asset, his capital is debited and Realisation credited with the agreed value.

After realisation, the cash available is applied in a fixed order of payment laid down by Section 48 of the Partnership Act. The sequence matters because cash may be insufficient:

1. First, pay the firm's outside liabilities (creditors, bank loan, bills payable) and the expenses of realisation.
2. Next, repay any partner's loan to the firm (a partner who lent money, separate from capital).
3. Then, pay the partners' capital balances.
4. Finally, any surplus is divided among the partners in their profit-sharing ratio.

The treatment of losses follows the same logic in reverse: a loss on realisation is borne by partners in their PSR. If, after everything, a partner's capital account shows a debit balance, he must bring in cash to clear it. If he is insolvent and cannot pay, his deficiency is borne by the solvent partners (under the Garner v. Murray rule, in their capital ratio, though the basic syllabus often shares it in the PSR — follow the question).

Other accounts used: the Cash/Bank Account records all receipts and payments and must finally balance to nil; the Partners' Capital Accounts receive the realisation profit/loss, reserves and the loan/capital settlements. When all three — Realisation, Cash and Capital accounts — close to nil, the firm is fully wound up. For example, with cash of Rs 2,00,000 and creditors Rs 80,000, a partner's loan Rs 30,000 and capitals Rs 90,000, the order is: pay creditors 80,000, then the loan 30,000, then capitals 90,000 — leaving nil. Mastering this order is the final piece of partnership accounting.