Key Notes: Dissolution of a Partnership Firm | Accountancy Class 12 - Commerce PDF Download

Dissolution of Partnership:

• Definition: Dissolution of partnership refers to the termination of an old partnership agreement (Partnership Deed) and the possible reconstitution of the firm.
• Causes: It can occur due to changes in profit-sharing ratios among existing partners, admission of a new partner, retirement, or death of a partner.
• Business Continuation: It may or may not result in the closure of the business as the remaining partners may choose to continue the business under a new agreement.

Types of Dissolution of Firms:

(A) Without the Intervention of the Court:

• Voluntary Dissolution: When all partners agree to dissolve the firm.
• Compulsory Dissolution: Occurs when all partners, except one, become insolvent or when the business becomes unlawful.
• Events-based Dissolution: Occurs on specific events like a partner's insolvency, fulfillment of the firm's objective, or the expiry of the firm's predetermined period.
• Dissolution by Notice: When the partnership has a fixed duration, any partner can dissolve it by giving notice.

(B) Dissolution by Order of the Court:

• Partner's Incapacity: When a partner becomes of unsound mind or permanently incapable of performing their duties.
• Misconduct: When a partner's misconduct harms the partnership.
• Breach of Partnership Agreement: If a partner consistently and deliberately breaches the partnership agreement.
• Transfer of Interest: When a partner transfers their entire interest to a third party without the consent of existing partners.
• Unavoidable Loss: When the court is satisfied that the partnership cannot continue without incurring losses.
• Equity and Justification: When the court deems dissolution equitable and justified.

Accounting Treatment of Dissolution:

• Realisation Account: To ascertain profit or loss on the realization of assets and payment of outsiders' liabilities.
• Partner’s Loan Account: If a partner has given a loan to the firm, it's settled after paying outside liabilities but before distributing capital.
• Partner’s Capital Accounts: Used to distribute profits, losses, and any remaining assets among the partners.
• Cash or Bank Account: Final account to ensure the books balance.

Preparation of Realisation Account:

• Entries for closing asset accounts and liability accounts are made.
• Provisions and reserves against assets are transferred to Realisation Account.
• Liabilities are transferred except for partner's loans and undistributed profits.
• Workmen’s Compensation Fund may be transferred partially if required.
• Realisation expenses are accounted for.
• The final balance indicates either profit or loss on realization.

Preparation of Partner’s Loan Account:

• If a partner has given a loan to the firm, the loan is repaid after outside liabilities are settled.

Preparation of Partner’s Capital Accounts:

• Undistributed profits and reserves are credited.
• Loss on realization and any assets taken over by partners are debited.
• Final payments to partners are made.

Preparation of Cash or Bank Account:

• Cash or bank balances are recorded.
• Any withdrawals or deposits are accounted for.

Preparation of Memorandum Balance Sheet:

• If not provided in the question, prepare a Memorandum Balance Sheet on the date of dissolution to determine the balancing figure.

Common Mistakes to Avoid:

• Ensure correct entries for assets and liabilities taken by partners.
• Account for dissolution expenses.
• Recognize the realization of unrecorded assets.
• Make provisions for payment of unrecorded liabilities.
• Treat fictitious assets correctly.

Key Points:

• Dissolution can occur voluntarily or involuntarily.
• Court intervention may be necessary in some cases.
• Proper accounting ensures a fair distribution of assets and liabilities among partners.
• A Memorandum Balance Sheet helps determine the final financial position of the firm.