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  1. 1. 1|Page DISSOLUTION OF PARTNERSHIP NIKET PATEL UNIT 3 DISSOLUTION OF PARTNERSHIP FIRM  INTRODUCTION When the business of the firm is closed down and the relation of partners comes to an end, the firm is said to have been dissolved. There is a distinction between the dissolution of partnership and dissolution of firm. When one or more partners sever their connections with the firm but the remaining partners continue to carry on business, it is the dissolution of partnership. But when there is a complete breakdown of relations among all the partners and the business is closed down, it is termed as dissolution lf the firm, in this chapter; we shall deal with accounts of the relationship when the firm is dissolved.  DISSOLUTION OF PARTNERSHIP AND FIRM: At this stage, let us make clear the meaning of “Dissolution of firm” and “Dissolution of Partnership”. According to Section 39 of the Indian partnership Act, “The dissolution of Partnership between all the partners of a firm is called the dissolution of firm.” Thus dissolution of the firm means the complete and total cessation of legal relations amongst all partners in dissolution of firms, the business of partnership is closed and after payment of all liabilities, the capital is returned to partners. But in case of retirement, death or insolvency of a partner, if the remaining partners continue the old business of the firm, there is dissolution of partnership. In this case the firm is not dissolved but, only firm is re-constituted, In short, dissolution of partnership does not necessarily involve the dissolution of firm but dissolution of firm is necessary involves dissolution of partnership.  CIRCUMSTANCES OF DISSOLUTION: The dissolution of partnership takes place under the following circumstances. a) When the firm was constituted for a fixed term, on the expiry of that term. b) On the completion of particular venture, if constituted for a purpose. c) On the death of a partner. d) On the insolvency of a partner. e) On the retirement of a partner. A firm is dissolved under the following circumstances: (1) When all the partners agree to dissolve the firm. (2) When all the partners of all partners except one are declared insolvent. (3) When all business of the firm becomes unlawful.
  2. 2. 2|Page DISSOLUTION OF PARTNERSHIP NIKET PATEL (4) When the partnership is at will, on any partner giving notice in writing to all the other partners of his intention to dissolve the firm. (5) When the court orders the dissolution of the firm. Under the following circumstances, the court will order the dissolution of the firm. (a) When a partner becomes of unsound mind. (b) When a partner has become permanently incapable of performing duties (c) When a partner is guilty of misconduct which is likely to affect business. (d) When a partner persistently commits breach of partnership agreement (e) When a partner has transferred whole of his interest in the firm to a third party (f) When the business cannot be carried on except at a loss. (g) On any other ground which appears to the court just and equitable.  MODE OF SETTLEMENT OF ACCOUNTS: When a firm is dissolved, the assets are sold off and out of the proceeds the liabilities of the firm are paid off, then the surplus is applied in payment of partner’s loan, if any. Finally, the capital of the partners is returned. When there is an agreement among the partners as to the way in which the accounts are to be settled, the accounts should be settled accordingly. If there is not such agreement, the provision of sec. 48 of the Indian Partnership Act, 1932 applies. The said provisions are as follows: In settling the accounts of a firm after dissolution, the following rules shall be observed, subject to agreement by the partners: a) Losses including deficiencies of capital shall be paid first out off profits, next out of capital and lastly, if necessary by the partners individually in the proportion in which they were 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: 1) In the paying the debts of the firm to third parties. 2) In paying to each partner ratably what is due to him from the firm for advances as distinguished from capital. 3) In paying to each partner ratably what is due him on account of capital, and
  3. 3. 3|Page DISSOLUTION OF PARTNERSHIP NIKET PATEL 4) The residue, if any, shall be divided among the partners in the proportion in which they were entitled to share point.  STEPS TO BE TAKEN ON DISSOLUTION: The above provisions of the partnership Act suggest the following steps to be taken on dissolution of the firm. 1) All the assets of the firm, including goodwill are sold or disposed off in any other way (E.g. a partner may take over an asset) 2) The amount so realized is applied in paying off third party liabilities in the first balance. 3) If any one or more partners have advanced loan to the firm in addition to his capital, then these loan are repaid next after repayment of third party liabilities. 4) Now, partners will ne paid what is due to them on capital accounts. If the surplus is not enough to return the full amount of capital, then the partner are paid ratably 5) Surplus, if any, left after returning capitals is paid to the partners in their profit sharing ratio. Firm debts and private Debts: The liability of partners is unlimited, in the sense that the private property of the partners can also be utilized for payment of rim’s debts. But, according to partnership Act, private property of any partner must be utilized first in payment of partner’s private debts. Similarly, firm’s assets are first applied in payment of firm’s debts and if there is any surplus, then the share of a partner in the said surplus can be utilized in payment of the private debts.  ENTRIES ON DISSOLUTION RELIZATION ACCOINT: On dissolution of a firm, books of account are closed. For this purpose all assets of the firm are disposed off and liabilities paid off. For closing the account of assets and liabilities, the ‘Realization Account’ is opened. All the assets and liabilities are transferred to this account. In case of admission or retirement of a partner, Profit and loss account is opened to record the increase and decrease in the value of asset and liabilities. Realization account is not necessary in this case as the business is to continue and assets are not to be disposed off. The book values of assets and liabilities are transferred to realization account, as these accounts are to be closed. Assets have debit balances, hence they are credited in order to close those account
  4. 4. 4|Page DISSOLUTION OF PARTNERSHIP NIKET PATEL and are shown on debit side of realization account. Similarly, liabilities have credit balances and they are debited to close them and are transferred to the credit of realization account. ENTERIES ON DISSOLUTION TRANSACTION A/C TO BE DEBITED A/C TO BE CREDITED 1. Closing account of assets Realization A/c Dr Assets A/c Cr. 2. Closing account liabilities Liabilities A/c Dr Realization A/c Cr. 3. On sale of assets Cash/Bank A/c Dr Realization A/c Cr. 4. On payments of liabilities Realization A/c Dr Cash/Bank A/c Cr. 5. On payment of dissolution Realization A/c Dr Cash/bank A/c Cr. exp. 6. Distributing realization profit Realization A/c Dr Partner’s Capital A/c Cr. 7. On payment of partner’s loan Partner’s loan A/c Dr Cash/Bank A/c Cr. 8. Distributing General Reserve General reserve A/c Dr Partner’s capital A/c Cr. 9. Settling partners Cap.(Dr.) Cash/Bank A/c Dr Partner’s capital A/c Cr. 10. Returning capitals to Partner’s capital A/c Dr Cash/Bank A/c Cr. partners Remember that while solving the example. All the balance given in the B/s must be transferred to following four accounts. 1) Realization account 2) Partner’s capital account 3) Cash/Bank Account 4) Partner’s Loan A/c (if any) REALIZATION ACCOUNT
  5. 5. 5|Page DISSOLUTION OF PARTNERSHIP NIKET PATEL PARTICULAR Rs. PARTICULAR Rs.To sundry assets (Entry no.1)…. By sundry liabilities Land and building …. (entry 2) Plant and machinery …. Creditors …. Stock …. Bills payable …. Debtors ………….. Bank drafts …. .............To Cash/Bank By Cash/Bank Payment of liabilities …. Sales proceeds of Assets (Entry no 4A) …. (Entry 4) Creditors …. Land and building …. Bills payable …. Plant and machinery …. ……………. Contingent liabilities. …………… By Partners Capital AccountTo partner’s Capital A/c Assets taken over …. Liabilities taken over ……. (Entry No.3B) ……………. (entry no. 4B) By Balance being lossTo cash Account transformed to partners capital Dissolution exps. ….. account …………… (entry no 5) (entry no.6B)To balance being profittransferred to partner’s capitalA/c (Entry no. 6A) …………… …………… ........................Generally the expenses are paid by the firm. The same is debited to realization account and credited toCash Account 1) At times, one of the partners may agree to bear the expenses. In such case, if the firm pays the expenses, it should be debited to capital account of the said partner and not to the realization account; the corresponding credit being given to cash Account. 2) If the partner undertakes to bear the expenses. And when he pays the expenses, there should be no entry in the firm’s books. 3) It may be agreed upon among the partners that one of them will be paid a fixed remuneration for attending to the dissolution work, but he is required to bear the dissolution expenses. In such a circumstance, the fixed remuneration is debited to Realization Account and credited to his Capital account. No entry is made in the firm’s book when he (partner) pays the realization expenses.
  6. 6. 6|Page DISSOLUTION OF PARTNERSHIP NIKET PATEL  GOOD WILL ON DISSOLUTION: Treatment of goodwill is similar to that of other assets on dissolution 1) When goodwill appears in the B/s on the date of dissolution, it should be transferred to the debit side of realization account. Any Amount realized on sale of goodwill should then be credited of realization account like any other asset. If nothing is realized, from goodwill; naturally no entry is made in the realization Account for its realization. 2) If goodwill does not appear in the books, the question of transferring to the debit side of realization account does not arise. When some thing is realized on sale of unrecorded goodwill, it should be credited to Realization account which is ultimately transferred to the credit side of the partner’s Capital Accounts. Thus, partners get the benefit of goodwill.