Dissolution of Partnership Firm
1. Introduction
Dissolution of a partnership firm signifies the end of the partnership agreement, resulting in the closure of the firm. It involves settling the firm’s debts, distributing the remaining assets among the partners, and terminating the firm’s existence as a legal entity.
2. Modes of Dissolution
Dissolution of a partnership firm can occur in various ways:
- Dissolution by Agreement: The partners may mutually agree to dissolve the firm.
- Compulsory Dissolution: Occurs when all partners, except one, are declared insolvent or if the business becomes illegal.
- Dissolution by Notice: In a partnership at will, any partner can dissolve the firm by giving notice to the other partners.
- Dissolution by Court: The court can order dissolution on grounds such as insanity, misconduct, or breach of agreement by a partner.
3. Settlement of Accounts on Dissolution
The settlement of accounts during dissolution involves several steps:
- Realization of Assets: All the assets of the firm are sold, and the proceeds are used to settle the firm’s obligations.
- Payment of Liabilities: The firm’s liabilities are settled in a specific order:
- External liabilities (creditors).
- Loans and advances from partners.
- Partner’s capital accounts.
- Distribution of Remaining Assets: Any remaining assets are distributed among the partners according to their capital balances and profit-sharing ratios.
4. Preparation of Realization Account
The realization account is prepared to record the sale of assets, payment of liabilities, and distribution of the remaining balance to partners. The format of the realization account is:
Realization Account
Particulars Amount Particulars Amount
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Assets Transferred:
Sundry Assets XXX Sundry Liabilities XXX
Debtors XXX Creditors XXX
Stock XXX Bank (Assets Realized) XXX
Fixed Assets XXX Bank (Liabilities Paid) XXX
Furniture XXX Bank (Expenses) XXX
Outstanding Expenses XXX
Bank (Dissolution Expenses) XXX
Capital Accounts (Deficit) XXX
Loss (Transferred to Partners' Capital Accounts) XXX
Profit (Transferred to Partners' Capital Accounts) XXX5. Settlement of Partner’s Capital Accounts
The balance in each partner’s capital account is settled by paying out any amounts due. This includes the partner’s share of profit or loss on realization.
5.1. Example of Partner’s Capital Account Format
Partner's Capital Account
Particulars Partner A Partner B Partner C Total
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Balance b/d XXX XXX XXX XXX
Realization Profit/Loss XXX XXX XXX XXX
Loan Settled XXX XXX XXX XXX
Bank XXX XXX XXX XXX
Cash/Bank XXX XXX XXX XXX6. Dissolution by Insolvency of a Partner
If a partner is insolvent, their capital account will show a debit balance. This loss is borne by the solvent partners according to the principles laid down in Garner vs. Murray:
- The loss is borne by the solvent partners in their profit-sharing ratio.
7. Accounting Treatment in Dissolution
The dissolution involves several key accounting treatments:
- Closing the Books: All books of accounts are closed by transferring the balances to the realization account.
- Disposal of Assets and Liabilities: Assets are realized (sold), and liabilities are paid off.
- Settlement of Partner’s Accounts: Partners’ capital accounts are settled, and the remaining cash is distributed.
8. Dissolution Expenses
Dissolution expenses, including legal and administrative costs, are paid out of the firm’s assets before distributing any remaining balance to the partners.
9. Illustration
Example:
M/s XYZ & Co. decides to dissolve their firm on 31st March 20XX. The following balances are available:
- Cash: ₹10,000
- Debtors: ₹50,000
- Stock: ₹30,000
- Furniture: ₹20,000
- Creditors: ₹40,000
- Partners’ Capital: X: ₹40,000, Y: ₹20,000, Z: ₹10,000
- The assets are realized as follows: Debtors: ₹45,000, Stock: ₹25,000, Furniture: ₹15,000
Solution:
- Realization Account:
Realization Account
Particulars Amount Particulars Amount
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Debtors 50,000 Creditors 40,000
Stock 30,000 Bank (Debtors Realized) 45,000
Furniture 20,000 Bank (Stock Realized) 25,000
Bank (Furniture Realized) 15,000
Bank (Expenses) 5,000
Partners' Capital A/c (Loss) 10,000- Partners’ Capital Account:
Partner's Capital Account
Particulars X Y Z Total
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Balance b/d 40,000 20,000 10,000 70,000
Realization Loss 4,000 4,000 2,000 10,000
Bank 36,000 16,000 8,000 60,00010. Conclusion
The dissolution of a partnership firm requires systematic steps to settle accounts, including realization of assets, payment of liabilities, and distribution of remaining balances to partners. Understanding these procedures ensures a fair and transparent closure of the firm’s operations.
