Dissolution of Partnership Firm Lms

Partnership - Dissolution of a Partnership Firm

Topic - 1 | Dissolution of Partnership –Basic Concepts:

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Study Material & Notes

Study Material & Notes for the Chapter 7

Partnership – Dissolution of Partnership

I. DISSOLUTION OF PARTNERSHIP –BASIC CONCEPTS

A. Meaning of Dissolution of Firm

According to Section 39 of the Partnership Act 1932, the dissolution of partnership between all the partners of a firm is called the dissolution of the firm.
It is the breaking or discontinuance of relationship between all the partners which is termed as the dissolution of partnership firm.
This brings an end to the existence of firm, and no business is transacted after dissolution except the activities related to closing of the firm. As the affairs of the firm are to be wound up by selling firm’s assets and paying its liabilities and discharging the claims of the partners.

B. Meaning of Dissolution of Partnership

Dissolution of a partnership means termination of old partnership agreement and a reconstitution of firm due to admission, retirement and death of a partner. In dissolution of a partnership the remaining partners may agree to carry on the business under a new agreement.

C. Distinction between Dissolution of Partnership and Dissolution of Firm:

Basis	Dissolution (Reconstitution) of Partnership	Dissolution of Partnership Firm
Meaning	Dissolution of partnership means change in existing relations of the partners. The firm continues its business.	Dissolution of a firm means the dissolution of partnership among all the partners of the firm and the firm’s business is closed
Closure of books	It does not require closure of books of account because business is not closed.	Books of Account are closed as the business is closed
Court’s Intervention	Court does not intervene because partnership is dissolved by mutual agreement	A firm may be dissolved by court order
Settlement of assets and liabilities	Assets are revalued and liabilities are reassessed	All the Assets other than cash are realized and liabilities are paid
Economic Relationship	Economic relationship between the partners changes	Economic relations between the partners comes to an end
Continuity of business	Business of the firm continues	Business of the firm comes to an end
Effect	Dissolution of partnership may or may not involve dissolution of firm	Dissolution of firm also means dissolution of partnership

D. MODES OF DISSOLUTION OF PARTNERSHIP

1) MODES OF DISSOLUTION OF PARTNERSHIP

all the partners give consent
as per the terms of the partnership agreement

2) Compulsory Dissolution

When all the partners or all excepting one partner becomes insolvent or of unsound mind.
When business of the firm becomes illegal

3) On Happening of an Event or Contingent Dissolution–

On expiry of the term for which the firm was constituted
On completion of the venture
On the death of a partner
On adjudication of a partner as insolvent

4) By Notice

In case of a partnership at will, the firm may be dissolved if any one of the partner gives a notice in writing to the other partners.

5) Dissolution By Court – Court may pass Order for the dissolution when

A Partner becomes a person of unsound mind
A partners becomes permanently incapable of performing his/her duties as a Partner
A partner is guilty of misconduct which is likely to adversely affect the business of the firm;
A partner persistently commits breach of partnership agreement;
A partner transfers his/her interest in the firm to a third party;
The business of the firm cannot be carried on except at a loss
The court regards dissolution to be just and equitable.

E. Settlement of Accounts on Dissolution of a Partnership Firm (Sec 48)

In case of dissolution of a firm, the firm ceases to conduct business and has to settle its accounts. For this purpose, it disposes off all its assets for satisfying all the claims against it.
In this context it should be noted that, subject to agreement among the partners, the following rules as provided in Section 48 of the Partnership Act 1932 shall apply.

(a) Treatment of Losses:-

Losses, including deficiencies of capital, shall be paid :

(i) first out of profits,

(ii) next out of capital of partners, and

(iii) lastly, if necessary, by the partners individually in their profits sharing ratio.

(b) Application of Assets

The assets of the firm, including any sum 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 the third parties;

(ii) In paying each partner proportionately what is due to him/her from the firm for advances as distinguished from capital (i.e. partner’ loan);

(iii) In paying to each partner proportionately what is due to him on account of capital; and

iv) the residue, if any, shall be divided among the partners in their profit sharing ratio.

F. Firm Debt and Private Debts (Sec 49)

Where both the debts of the firm and private debts of a partner co-exist, the following rules, as stated in Section 49 of the Act, shall apply.

The property of the firm shall be applied first in the payment of debts of the firm and then the surplus, if any, shall be divided among the partners as per their claims, which can be utilised for payment of their private liabilities.
The private property of any partner shall be applied first in payment of his private debts and the surplus, if any, may be utilised for payment of the firm’s debts, in case the firm’s liabilities exceed the firm’s assets.

Firm’s Debts	Private Debts
Debts owned by the firm to the outsiders	Debts owned by a partner in his/her personal capacity e.g. Home Loan fm Bank
Utilization of Firm’s Property	Utilization of Partner’s Property
(a) Firm’s Debts	(a) Private Debts
(b) Private Debts	(b) Firm’s Debts

Topic - 2 | Accounting Treatment on Dissolution -Realisation A/c:

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Study Material & Notes

Study Material & Notes for the Chapter 7

Partnership – Dissolution of Partnership

II. ACCOUNTING TREATMENT ON DISSOLUTION OF PARTNERSHIP

Accounts to be prepared

Realisation Account
Partner’s Loan Account
Partner’s Capital Accounts
Cash or Bank Account

A. Realisation Account

When the firm is dissolved it becomes necessary to settle its liabilities and dispose off its assets. The residual, if any, is taken by the partners to their home.
For this purpose, a separate account called ‘Realisation Account’ is opened. All the Asset accounts (excluding Cash in hand/at bank and Fictitious assets) are closed and transferred at their book value debiting Realisation Account.
Similarly, all the external Liabilities accounts are closed and transferred at their book value crediting Realisation Account.
Amount realised from the sale of assets is credited and amount paid towards discharge of liabilities is debited to the Realisation account
Expenses on Realisation/dissolution are debited to this account
Realisation is a nominal Account. Excess of Credit over Debit is the profit on Realisation and is credited to Partners Capital Accounts in their profit-sharing ratio and vice versa.

Important to Note:

If realized value of any asset is not given it means its Realisation value is zero
If settlement value of any liability is not provided it means it is paid at book value

Treatment of Balance Sheet Items

Balance Sheet

Liabilities

Treatment

Assets

Treatment

Partners’ Capital/Current Account

Partners’ Capital

Goodwill

Realisation

General Reserve/Profit & Loss A/c

Partners’ Capital

Land & Buildings

Realisation

Workmen Compensation Reserve

Various scenarios

Plant & Machinery

Realisation

Investment Fluctuation Reserve

Realisation

Cash & Bank

Separate A/c

Creditors/Bills Payable

Realisation

Stock, Prepaid Exp

Realisation

Partners’ Loan Accounts

Separate A/c

Debtors

Realisation

Partners’ Relative Loan Accounts

Realisation

Provision for doubtful debts

Realisation

Bank Loan/Bank Overdraft

Realisation

Investments

Realisation

Provident Fund/Pension Payable

Realisation

Fictitious Assets

Partners’ Capital

Income Received in Advance

Realisation

Profit & Loss (Dr. Balance)

Partners’ Capital

Journal Entries

Transaction

Entry

Amount

For Transfer of Realizable Asset to Realisation A/c

Realisation A/c……….Dr.

To Respective Assets A/c

(Assets transferred to Realisation A/c)

Debit

Credit

For Transfer of Outside liabilities to Realisation A/c

Respective Liabilities A/c……….Dr.

To Realisation A/c

(Liabilities transferred to Realisation A/c)

Debit

Credit

For Sale of assets (recorded/unrecorded) on cash

Cash A/c……….Dr.

To Realisation A/c

(Amount realised on sale of assets)

Debit

Credit

For assets (recorded/ unrecorded) taken over by a Partner

Respective Partner’s Capital A/c……….Dr.

To Realisation A/c

(Asset taken over by Partner)

Debit

Credit

For Settlement of liabilities (recorded /unrecorded) in cash

Realisation A/c……….Dr.

To Cash/Bank A/c

(Settlement of liabilities in cash)

Debit

Credit

For liabilities (recorded/unrecorded) taken over by a Partner

Realisation A/c……….Dr.

To Respective Partner’s Capital A/c

(Liability taken over by Partner)

Debit

Credit

Settlement of Liability in exchange of assets of equivalent amount

No Entry

For settlement of Liability in exchange of asset (Liability > Asset). Balance settled in cash

Realisation A/c……….Dr.

To Cash/Bank A/c

(Settlement of liabilities in cash)

Debit

Credit

For settlement of Liability in exchange of asset (Asset > Liability). Balance received in cash

Cash/Bank A/c……….Dr.

To Realisation A/c

(Amount realised on sale of assets)

Debit

Credit

Closure of Realisation A/c and Credit > Debit (means profit)

Realisation A/c……….Dr.

To Partners’ Capital A/c

(Profit on Realisation transferred to Partners Capital A/c)

Debit

Credit

Closure of Realisation A/c and Debit > Credit (means loss)

Partners’ Capital A/c……….Dr.

To Realisation A/c

(Loss on Realisation transferred to Partners Capital A/c)

Debit

Credit

Important to Note:

If Realisation of any tangible/intangible is not mentioned in the question, its realizable value is deemed as nil
If settlement value of any liability is not mentioned in the question, it is deemed to be settled at book value
Any Provision/Fund against the asset is also transferred to Realisation A/c e.g. Provision for Depreciation, Bad debts, Discount on Debtors or Investments Fluctuation Fund

Balance Sheet

Dr. Cr.

Particulars

Amount

Particulars

Amount

To All Asset A/c

(Except Cash/Bank)

To Cash/Bank A/c

(Payment of external liabilities)

To Partners’ Capital A/cs

(Liability paid by partners)

To Cash/Bank A/c

(Expenses on Realisation)

To Partners’ Capital A/cs

(Realisation exp paid by Partner)

To Partners’ Capital A/cs

(Transferring profit on Realisation)

Book Value

By All Outside Liabilities A/c

By Cash/Bank A/c

(Amount realized on sale of assets)

By Partners’ Capital A/cs

(Assets taken over by partners)

By Partners’ Capital A/cs

(Transferring loss on Realisation)

Book Value

Topic - 3 | Accounting Treatment on Dissolution –Capital, Loan & Cash:

Video Lectures [3]

Study Material & Notes

Study Material & Notes for the Chapter 7

Partnership – Dissolution of Partnership

III. ACCOUNTING TREATMENT ON DISSOLUTION OF PARTNERSHIP

2(A) Loan Given by Firm to Partner

A firm may have given to Loan to a partner
Loan Given to a Partner is an Asset
On Dissolution Loan given to a Partner is closed and transferred to respective Partner’s capital A/c

Journal Entries

Transaction

Entry

Amount

When Partner has either credit or debt Balance in his/her Capital A/c

Partner’s Capital A/c……….Dr.

To Loan To Partner A/c

(Partner Loan A/c is transferred to Partner’s Capital A/c)

Debit

Credit

Loan to Partner Account

Dr. Cr.

Particulars	Amount	Particulars	Amount
To Balance b/d		By Partner’s Capital A/c
Total		Total

2 (B) Loan Given by Partner to Firm

A firm may have received Loan from a partner
Loan from a Partner is not an Outside Liability hence it is not transferred to the Realisation A/c
Accounting treatment for Loan received from Partner’s is to first close the Partner Capital A/c making all adjustments related to transfer of Free reserves, Fictitious assets, Assets/liabilities taken over, Profit/Loss on realisation etc.
Treatment of Loan given by a partner depends on the balance in partner’s capital account at this stage:

- If Partner has Credit balance in his/her Capital A/c, balance in his/her Loan A/c is repaid in cash
- If Partner has Debit balance in his/her Capital A/c, balance in his/her Loan A/c is transferred to his/her Capital A/c

Journal Entries

Transaction

Entry

Amount

(i) When Partner has credit Balance in his/her Capital A/c

Partner’s Loan A/c……….Dr.

To Cash/Bank A/c

(Repayment of Partner’s Loan A/c by cash)

Debit

Credit

(ii) When Partner has debit balance in his/her Capital A/c

Partners’ Loan A/c……….Dr.

To Partner’s Capital A/c

(Partner’s Loan transferred to Partner’s Capital A/c)

Debit

Credit

Loan to Partner Account

Dr. Cr.

Particulars	Amount	Particulars	Amount
To Bank or Partner’s Capital A/c		By Balance b/d
Total		Total

3 Partner’s Capital Accounts

After all the adjustments related to partners’ capital accounts and transfer of profit or loss on realisation to the partners’ capital accounts, the capital accounts are closed in the following manner:

Partner’s Capital Account

Dr. Cr.

Particulars

Amount

Particulars

Amount

To Fictitious Assets/Undistributed Losses A/c

To Realisation A/c (Assets taken over)

To Partner’s Loan A/c

To Partner’s Current A/c (Debit balance)

To Realisation A/c (Loss)

To Cash/Bank A/c (Surplus in Capital A/c)

By Balance b/d

By Reserves/Accumulated Profits

By Realisation A/c (Liabilities taken over)

By Partner’s Current A/c (Credit balance)

By Partner’s Loan A/c

By Realisation A/c (Expenses)

By Realisation A/c (Gain)

By Cash/Bank A/c (Deficit in Capital A/c)

Total

Journal Entries

Transaction

Entry

Amount

(i) In case of Surplus i.e. Credit balance, the partner needs to be paid off balance in his/her account in cash

Partner’s Capital A/c……….Dr.

To Cash/Bank A/c

(Cash paid to Partner)

Debit

Credit

(ii) In case of Deficit i.e. Debit balance e partner, the partner needs to be bring in balance in his/her account in cash

Cash/Bank A/c……….Dr.

To Partner’s Capital A/c

(Cash brought-in by the Partner)

Debit

Credit

4 Cash Account

Cash Account

Dr. Cr.

Particulars

Amount

Particulars

Amount

To Balance b/d

To Realisation A/c (sale of assets)

To Cash A/c (if both Cash & Bank A/cs)

To Partner Capital A/c (settlement)

By Realisation A/c (payment of liabilities)

By Realisation A/c (expenses)

By Partner Loan A/c (repayment)

By Realisation A/c (Bank overdraft)

By Partner Capital A/c (settlement)

Total

Journal Entries

Transaction

Entry

Amount

(i) For Cash deposited into Bank

Bank A/c……….Dr.

To Cash A/c

(Cash deposited into Bank)

Debit

Credit

((ii) For Cash withdrawn from Bank

Bank A/c……….Dr.

To Cash A/c

(Cash withdrawn from Bank)

Debit

Credit

Journal Entries

Transaction

Entry

Amount

(i) In case of Surplus i.e. Credit balance, the partner needs to be paid off balance in his/her account in cash

Partner’s Capital A/c……….Dr.

To Cash/Bank A/c

(Cash paid to Partner)

Debit

Credit

(ii) In case of Deficit i.e. Debit balance e partner, the partner needs to be bring in balance in his/her account in cash

Cash/Bank A/c……….Dr.

To Partner’s Capital A/c

(Cash brought-in by the Partner)

Debit

Credit

Important to Note:

If both Cash A/c as well Bank A/c are given in the question, assume Cash is deposited into Bank. Pass the journal entry & do Ledger posting accordingly.

Treatment of Workmen Compensation Reserve and Claim

Payment of Workmen Claim in all the cases is routed through Realisation A/c
Workmen Compensation Reserve to the extent of Workmen Claim is transferred to Realisation A/c
Workmen Compensation Reserve in excess of Workmen Claim is distributed to Partner’s Capital A/c

Reserve	Claim	Journal Entry	Amount
Yes	No	Workmen Compensation Reserve A/c………Dr To All Partners Capital A/c (in their PSR)	Reserve Amount Reserve Amount
No	Yes	Realisation A/c………………………………………….Dr. To Cash/Bank A/c	Claim Amount Claim Amount
Yes	Yes	Realisation A/c………………………………………… Dr.	Claim Amount
Claim>WCR		To Cash/Bank A/c	Claim Amount
		Workmen Compensation Reserve A/c………Dr. To Realisation A/c	Reserve Amount Reserve Amount
Yes	Yes	Realisation A/c………………………………………… Dr.	Claim Amount
Claim<WCR		To Cash/Bank A/c	Claim Amount
		Workmen Compensation Reserve A/c………Dr To Realisation A/c To All Partners Capital A/c (in their PSR)	Reserve Amount Claim Amount Reserve – Claim

WCR in excess of Workmen Claim is distributed to Partner’s Capital A/c

Treatment of Workmen Compensation Reserve and Claim

Situation	Type	Born by	Paid by	Journal Entry
Dissolution expenses borne and paid by the Firm	Expenses	Firm	Firm	Realisation A/c…………………Dr. To Cash/Bank A/c
Expenses borne by firm and paid by Partner	Expenses	Firm	Partner	Realisation A/c…………………Dr. To Partner’s Capital A/c
Firm gives contract to Partner (including expenses)	Remuneration	Firm	Due to Partner	Realisation A/c…………………Dr. To Partner’s Capital A/c
	Expenses	Partner	Partner	No Entry
	Expenses	Partner	Firm	Partner’s Capital A/c……………Dr. To Cash/Bank A/c
Firm gives contract to Partner (excluding expenses or question is silent on who paid)	Remuneration	Firm	Due to Partner	Realisation A/c…………………Dr. To Partner’s Capital A/c
	Expenses	Firm	Partner	Realisation A/c…………………Dr. To Cash/Bank A/c
	Expenses	Firm	Partner	Realisation A/c……………Dr. To Partner’s Capital A/c
Expenses borne by firm and paid by Partner	Expenses	One Partner	Another Partner	Partner’s Capital A/c…………Dr. (Bearing expenses) To Partner’s Capital A/c (Paying expenses)

Topic - 4 | Memorandum Balance Sheet:

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Study Material & Notes

Study Material & Notes for the Chapter 7

Partnership – Dissolution of Partnership

IV. Memorandum Balance Sheet

If Balance Sheet is not provided in the question a Memorandum Balance Sheet needs to be prepared.
Whatever items of Assets, Liabilities, Reserves & Partner’s Capital with their respective amounts is provided in the question is put up in the Memorandum Balance Sheet.
In the Memorandum Balance Sheet so prepared, the total of Liabilities side may not match with total of Assets side.
The balancing figure represents the amount of any missing asset/liability/reserve
If Liabilities > Assets the missing item is assumed to be Sundry Assets and
if Assets > Liabilities the missing item is assumed to be Profit & Loss account
Once Memorandum Balance Sheet is ready, Realisation A/c is prepared and the remaining steps for closure of various accounts are same.

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Partnership - Dissolution of a Partnership Firm

Topic - 1 | Dissolution of Partnership –Basic Concepts:

Topic - 2 | Accounting Treatment on Dissolution -Realisation A/c:

Topic - 3 | Accounting Treatment on Dissolution –Capital, Loan & Cash:

Topic - 4 | Memorandum Balance Sheet:

Multiple Choice Questions (MCQs)

Past Year Question Papers with solutions

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