Dissolution of Partnership - Partnership Accounts, Advanced Corporate Accounting B Com Notes | EduRev

Advanced Corporate Accounting

B Com : Dissolution of Partnership - Partnership Accounts, Advanced Corporate Accounting B Com Notes | EduRev

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Dissolution of a Partnership

When a partnership comes to an end, it is said to be dissolved according to the Indian Partnership Act, a firm may be dissolved in any of the following ways :

A. Dissolution by agreement

If all the partners give their consent for the dissolution of the firm or in accordance with the contract between them, the firm may be dissolved.

B. Compulsory Dissolution

The firm is dissolved compulsorily under the following conditions :—

1. Adjudication as insolvent of all the partners but one, or

2. By the happening of an event which makes it unlawful for the business of the firm to be carried on or for the partnership.

C. Contingent Dissolution :

A firm is dissolved on the happening of the following events subject to the agreement among the partners :—

1. If a firm is constituted for a fixed term it will be dissolved on the expiry of that term; or

2. If constituted for a particular venture, on the completion thereof; or

3. On the death of a partner; or

4. Of the adjudication of a partner as insolvent.

D. Dissolution by Notice

If the partnership business is carried on at will, the firm may be dissolved by ay partner giving notice in writing to all the partners of his intention to do so. The firm is dissolved as from the date mentioned in the notice as the date of dissolution. If no date is mentioned, the firm is dissolved as from the date of communication of the notice.

E. Dissolution by Court :

If any of the partners files a suit in the court, the court may order dissolution of the firm on the following ground

1. That a partner other than the partner suing has become of unsound mind, or has, become in any way permanently incapable of performing his duties as partner.

2. That a partner other than the partner suing is guilty of conduct which is likely to affect adversely the carrying on of the business.

3. That a partner other than the partner suing or wilfully or negligently and persistently commits breach of agreement relating to the management of the firm.

4. That a partner other than the partner suing has transferred the whole of his interest in the firm or a substantial part thereof to a third party or his share has been attached.

5. That the business of the firm cannot be carried on except at loss.

6. `Lastly, if the court think it ``just and equitable'' that the firm should be dissolved.

The partners are the right person to take charge of the assets and liabilities of the affairs of the partnership. In the process of winding up each partner has the power to bind the firm with his deeds. If, after dissolution by the court, the partners do not agree at the winding up, the court appoints a receiver, and if necessary, a manager for the purpose of dissolution. In case the partnership is dissolved due to the death or insolvency of one of the parters, the continuing or solvent partners are entitled to wind up the affairs of the firm.

In the settlement of accounts of the firm for dissolution, the Goodwill, subject to contract between the partners, is included in the assets. It may be sold either separately or along with the other assets of the firm. Similarly, subject to the agreement by the partners, all the accounts of the firm on dissolution must be settled according to following rules :—

1. Loss including deficiencies of capital shall be paid, first out of profit, next out of capital and lastly, if necessary by the partners individually in the proportion in which they were sharing profits and losses.

2. The assets of the firm including any amount or amounts contributed by the partner to make good deficiencies of capital shall be applied in the following order :—

(a) In paying debts and liabilities of the firm to persons who are not partners of the firm.

(b) In paying to the partner rateably, what is due to him as advances as distinguished from capital (that is to say, partners' loans have to be paid after paying off outsiders).

(c) In paying each partner rateably what is due from the firm to him in respect of capital.

(d) lately, if there is any surplus it shall be divided among the partners in proportions in which they were entitled to share profits.

On dissolution, the normal business of the firm comes to an end and the first thing the firm has to do is to settle the accounts with the third parties as well as among the partners themselves. For this purpose, the assets of the firm would be disposed off and cash realised. The cash so obtained will be first used for meeting all outside liabilities of the firm. If there is any left, it will be distributed among the partners. To sum up, the money available will be applied or used in the following manner.

(1) Payment of expenses on disposing of the assets and collecting the debts due to the firm.

(2) Payment of outside liabilities of the firm, e.g. creditors, borrowings, bank overdraft, bills payable, the loan from partners' wives etc.

(3) Repayment of the loans received from the partners.

(4) Repayment of the capital contribution of the partners.

(5) If there is still any surplus left after meeting the claims stated in 1 to 4 it will be shared by the partners in their Profit sharing Ratio.

All the above rules should be strictly followed in the solution of accounting problems on dissolution.

Dissolution Accounts

To find out the result of dissolution a special account is prepared which is termed as Realisation Account.
This account serves as a total of assets and liabilities account and all balance other than cash, capitals and profit and losses are transferred to this account. An up-to-date Balance Sheet showing the exact state of affairs of the firm is necessary. To close the books of a firm the following steps are taken :

1. All the assets except Cash and bank are transferred to the Realisation Account at their Book Values. For this purpose, Realisation Account is debited and individual assets accounts are credited. The effect of this entry is that all the accounts of different assets excluding Cash and Bank, are closed in the books of the firm.

Notes (I)

1. The following items on the asset side of the balance sheet are not transferred to the Realisation A/c—
(i) Cash in hand and cash at Bank
(ii) Debit balance of partner's current Accounts
(iii) Debit balance of profit and loss A/c.
(iv) Balance of deferred revenue expenditure such as prepaid expenses, advertisement, etc. which have no realisable value.
(v) Fictitious asses like value less patents, trademark etc.

These items (ii to v) will be transferred to capital/current accounts of the partners.

(II).1. Assets against which a provision or reserve exists, should be transferred to the realisation account at the gross figure and the provisions or reserve Accounts shall be transferred to the credit side of the realisation A/c.

2. Similarly, all the liabilities except partners' capitals, reserves and undistributed profits and their loans to the firm, are transferred to the credit side of the Realisation Account. This is done by means of a journal entry, debiting the individual liabilities accounts ad crediting Realisation Account.

3. When all the assets are sold for cash, the Cash Account or Bank Account is debited and the Realisation Account credited. If any assets is taken over by a partner, the capital account of the concerned partner is debited and Realisation Account is credited.

4. Expenses of realisation are paid out of the Cash or Bank; for this the Realisation Account is debited and Cash/Bank Account is credited. Sometimes, a partner may be paid commission at a certain rate calculated on the amount of assets realised and he is required to bear all expenses of realisation. In such a case the Journal entry will be—

Realisation A/c Dr.

To partner's current/capital Accounts

Generally of entry is made for the actual expenses paid by the partners. However, the actual expenses incurred by the partner may be treated as drawings by the partner in which case, the entry would be :—

Partner's current A/c/Capital Account Dr.

To Bank A/c.

Undisclosed or unrecorded assets and liabilities :

Some assets might have bee completely written off yet they are physically present in the business on dissolution these assets might be either sold or taken over by any partner or a creditor at agreed price.

Such asset would never be transferred to realization account, but the entries would be as under :—

(i) When sold for cash Bank A/c Dr.

To Realisation A/c

(ii) When taken over by a partner Partner's Capital A/c

To Realisation A/c

(iii) No entry if taken over by a creditor

Similary unrecorded liability will not be recorded in realisation A/c only the payment made will be shown as :

Realisation a/c Dr. when paid in cash

To Bank A/c

Realisation A/c Dr. When take over or paid by a partner

To Partner's capital A/c

5. The amount paid to settle liabilities already transferred to the Realisation Account is debited to the Realisation Account, crediting the Cash (or bank) Account.

6. The Realisation account is then balanced. The balance represents either loss or profit. Whatever the case may be, the balance is trasnsferred to the capital accounts of partners in their profit sharing ratio. The Realisation Account is thus closed.

7. If there is a loan by a partner, the same will be paid out of the cash. Partner's Loan Account will be debited and Cash Account credited.

8. If there is a General Reserve or an accumulated balance or profit in the books of partnership, it is transferred to the credit of partners' capital accounts in their profit sharing ratio.

9. If there is a deficiency in any partners' capital accounts he will be liable to make it up by bringing in cash.

10. When all the above steps are taken, the only accounts not closed as yet are the cash Account and Partner' Capital Accounts. The due balances of the partners are now paid in cash. The partner's capital accounts are debited and the Cash Account is credited with the actual amount of cash paid to them. In this way all the accounts are finally closed.

Payment of liabilities through surrender of assets — If any asset has been taken over or accepted by any creditor in full or part payment of the amount due to him, then the agreed value of the asset will be deducted from the amount due to the creditor and the payment will be nil, in case of full settlement or payment will be restricted to the balance amounts.

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