Thursday, August 02, 2012

Dissolution of Partnership

Dissolution of Partnership and Firm:
Dissolution of a partnership means the termination of connections with the firm by some of the partners of the firm, and remaining partners of the firm continuing the business of the firm under the same firm’s name under an agreement. Hence, admission, retirement and a death of a partner are considered dissolution of partnership. The dissolution of partnership may take place in any of the following ways:
a)      Change in existing profit sharing ratio among partners;
b)      Admission of a new partner;
c)       Retirement of a partner;
d)      Death of a partner;
e)      Insolvency of a partner;
f)       Completion of the venture, if partnership is formed for that; and
g)      Expiry of the period of partnership, if partnership is for a specific period of time;
In case of dissolution of firm a new partnership agreement is formed, this is why the old partnership comes to an end and a new partnership begins.
Dissolution of a firm means discontinuation of the firm’s business and the relationship between the partners. According to Sec. 39 of Indian Partnership Act 1932, “Dissolution of firm means dissolution of partnership between all the partners in the firm."
Therefore when a firm is dissolved, assets of the firm are disposed off, liabilities are paid off and the accounts of all the partners are also settled.
Difference between dissolution of partnership and dissolution of firm.
Basis of distinction
Dissolution of partnership
Dissolution of firm
(a)          Relationship among all partners
Relation ship among all partners does not come to an end.
Relation ship among all partners does not come to an end.
(b)         Continuation of business
Business of the firm may continue.
Business of the firm does not continue.
(c)          Inter relationship
Dissolution of partnership may or may not result in dissolution of the firm.
Dissolution of the firm necessarily results in dissolution of partnership.

Modes of Dissolution of a Partnership Firm:
The dissolution of partnership between all the partners of a firm is called the "dissolution of the firm". A firm may be dissolved with the consent of all the partners or in accordance with a contract between the partners. The Indian Partnership Act, 1932 provides that a partnership firm may be dissolved in any of the following modes:
i.         Compulsory dissolution;
ii.       Dissolution on the happening of certain contingencies;
iii.      Dissolution by notice of partnership at will;
iv.     Dissolution by the court.

i) Compulsory Dissolution: A firm is dissolved by the adjudication of all the partners or of all the partners but one as insolvent, or by the happening of any event which makes it unlawful for the business of the firm to be carried on or for the partners to carry it on in partnership.
However, where more than one separate venture or business or undertaking is carried on by the firm, the illegality of one or more ventures or businesses or undertakings shall not by itself cause the dissolution of the firm in respect of its lawful ventures, businesses and undertakings.

ii) Dissolution on the Happening of Certain Contingencies: Subject to contract between the partners, a firm is dissolved:
i.         if constituted for a fixed term, by the expiry of that term;
ii.       if constituted to carry out one or more adventures or undertakings, by the completion thereof;
iii.      by the death of a partner; and
iv.     By the adjudication of a partner as an insolvent.

iii) Dissolution by Notice of Partnership at Will: Where the partnership is at will, the firm may be dissolved by any partner giving notice in writing to all the other partners of his intention to dissolve the firm.
The firm is dissolved as from the date mentioned in the notice as the date of dissolution or, if no date is so mentioned, as from the date of the communication of the notice.

iv) Dissolution by Court: A court may order a partnership firm to be dissolved in the following cases:
i.         When a partner becomes of unsound mind
ii.       When a partner becomes permanently incapable of performing his/her duties as a partner,
iii.      When partner deliberately and consistently commits breach of agreements relating to the management of the firm;
iv.     when a partner’s conduct is likely to adversely affect the business of the firm;
v.       when a partner transfers his/her interest in the firm to a third party;
vi.     When the court regards dissolution to be just and equitable.

Realisation Account:
Realisation Account is a nominal account. It is prepared to find out profit or loss on realisation of assets and payment of liabilities when a firm is dissolved. Any profit or loss on realisation is transferred to the capital accounts of all the partners in their profit sharing ratio.

Realisation Accounts is prepared in the following manner:
i.         All the realisable assets given in the books of the firm are entered at their book values on the debit side of the Realisation Account
ii.       All the external liabilities are entered at their book values on the credit side of the Realisation Account
iii.      On the realisation of assets, the actual amount of cash received is entered on the credit side of the account. - Cash/bank account is debited
iv.     On the payment of liabilities, the actual amount of cash paid is entered on the debit side of the account. Cash/bank account is credited
v.       Realisation expense if any, is also debited to the Realisation Account and bank account is credited
vi.     After making the above entries in the Realisation Account, the account is balanced. The profit or loss on realisation is transferred to the capital accounts of all the partners in their profit sharing ratio.

Revaluation Account
Realisation Account
(1) Revaluation account is prepared at the time of admission, retirement of death of a partner.
This account is prepared at the time of dissolution of a partnership firm.
(2) Revaluation account is prepared in order to work out the profit or loss on revaluation of assets and liabilities at the time of admission, retirement or death of a partner.
This account is prepared to work out the profit or loss on realisation of assets and payment to liabilities at the time of dissolution of the firm.
(3) Revaluation profit or loss is distributed only among the old partners of the firm in their profit sharing ratio.
Realisation profit or loss is distributed among all the partners in their profit sharing ratio.
(4) After preparing the revaluation account the firm’s business gets going with the same set of books.
After preparation of this account the firms business comes to an end.

Settlement of Accounts on Dissolution of Partnership:
                At the time of dissolution of the partnership the main question that arises is the settlement of accounts of the various parties like creditors, bank loans, partners' loans, partners' capital accounts. This issue has been dealt in detail by the section 48, 49 and 55 of the Partnership Act. The account of all these parties will be settled as under:
1)   If there is any Loss or Deficiency of capital it would be first paid out of the profits of the firm and then out of the Capital of the partners and if still any balance remains it would be realised from the Partners privately in their profit sharing ratio.
2)   The amount realised from the sale of the assets of the firm, debtors and the amount contributed by the partners if any would be applied in the following manner:
a)      Outside liabilities would be paid first which includes Creditors, Bills payables, Outstanding expenses, Bank Loans or outsiders' Loans (including the loans provided by the relatives of the partners), Employees Compensations or provident funds etc.
b)      Thereafter the Loans advanced by Partners to the firm will be paid off.
c)       Thirdly the Partners' Capital accounts will be settled.
d)      The balance left if any will be distributed among the partners in their profit sharing ratio. 

Accounting treatment when the firm is dissolved due to insolvency of partners:

When there are more than two partners and one becomes insolvent, the solvent partners are liable to bear the loss of insolvent partner. The loss is borne by the solvent partners in the following partners:
a)      When Garner Versus Murray rule is not applicable, the solvent partners are supposed to bear the loss according to the profit sharing ratio.
b)      When the Garner versus Murray rule is applicable, the solvent partners are liable to bear the loss of insolvent partners according to the current capital ratio.

Garner Vs. Murray, Lord Justice Joyce gave the following decision:
i.         Loss on realisation considered being ordinary loss and therefore to be shared by all the partners according to their profit sharing ratio.
ii.       Solvent partners to bring cash equal to their share of loss on realisation
iii.      Loss on account of deficiency of insolvent partner considered being capital loss; therefore   to be shared by solvent partners according to their last agreed capital.

Last Agreed Capital means
1.    In case of Fixed Capitals - Fixed Capital (as given in the Balance Sheet) without any adjustment
2.    In case of Fluctuating Capitals - Capital after making adjustments for past accumulated reserves, profits or  losses, drawings, Interest on capital, Interest on Drawing, remuneration to a partner etc. to the date of dissolution but before making adjustment for profit or loss on realisation.

In the case of dissolution of a firm where all the partners are insolvent, the following procedure should be followed:
a)   The Realisation Account is prepared without transferring external liabilities to it.
b)   Cash Account should be prepared after the Realisation Account.
c)    Cash in hand together with the amount realized on sale of asset and the amount received from the estate of insolvent partners shall be applied in the following order:
i)        For meeting the realization expenses
ii)       For meeting the external liabilities like bank loan, creditors, out standing expenses, etc.
iii)     For meeting partners loan account.
iv)     For paying partners’ capital account balances.
Note: In case of deficiency of cash, balances of above accounts shall be transferred to the Deficiency Account. (Deficiency Account: When all the partners become insolvent, external liabilities will not be met in full and balance due from partners also cannot be recovered from partners in full. Hence, the balance due to external creditors and balance due from partners are transferred to a separate account called Deficiency Account.)

Journal Entries in Dissolution
Accounting for dissolution begins with the closing of assets and liabilities accounts by transferring them to Realisation Account.
i) For transfer of assets
Realisation Account Dr.
To Asset Account

ii) For Transfer of liabilities
Liability Account Dr.
To Realisation Account
Accumulated profits such as General Reserves, Profit and Loss Account Credit Balance etc. are transferred to capital Accounts in the profit sharing ratio.

iii) For transfer of accumulated profits
Accumulated Profit Account (General Reserve; P&L etc.) Dr.
To Partner’s Capital Account
Note: Provision for doubtful debts; Investment fluctuation fund, Joint life Policy Fund etc. are credited to realization account and ignored thereafter. These are internal provisions having no claim against the firm and therefore these amounts will merge into realization profit or loss and finally get transferred to Capital Accounts of partners.

iv) For assets realized
Cash/Bank account Dr
To Realisation Account
Note: We do not have separate asset account anymore. Realisation account is the common account representing all assets and liabilities transferred into it. Please check the next entry also.

v) For Liabilities paid off
Realisation Account Dr.
To Cash/Bank Account

vi) For asset taken over by a partner
Partner’s Capital Account Dr.
To Realisation Account

vii) For Liability taken up by the partner
Realisation Account Dr.
To Partner’s Capital Account

viii) For unrecorded asset taken over by a partner
Partner’s Capital Account Dr.
To Realisation Account

ix) Unrecorded Liability settled by the firm
Realisation Account Dr.
To Cash/Bank account

x) Realisation expense
Realisation Account Dr.
To Cash/Bank account

xi) Asset taken over by creditors
No entry; Only settlement of balance amount is shown in the books.

xii) For distribution of Profit or Loss on Realisation
If Profit
Realisation Account Dr.
To Partner’s Capital Account
(Reverse entry is passed for loss on Realisation)

xiii) For final payment to partners:
Partner’s Capital Account Dr.
To Cash/Bank Account



I. Multiple Choice Questions: Choose the correct answer to the following:
1. Under Garner Vs Murray Rule, the insolvency loss should be borne by solvent partners according to
(a) Capital ratio (b) Profit sharing ratio (c) Final claims ratio (d) Maximum loss ratio.

2. A firm is unable to pay its debts when
(a) A partner is insolvent (b) A partner has debit balance (c) The firm is insolvent (d) None of the above.

3. Realisation A/c is a
(a) Nominal A/c (b) Real A/c (c) Personal A/c (d) None of the above.

4. When the realisation expenses are to be borne by a partner, it is credited to:
(a) Partner's capital A/c (b) Cash A/c (c) Realisation A/c (d) Profit & Loss A/c.

5. At the time of dissolution of a firm, assets taken over by a partner should be
(a) Credited to Realisation A/c (b) Debited to Realisation A/c (c) Realisation A/c should neither be debited nor credited (d) None of the above.

6. An unrecorded asset realised at the time of realisation is credited to:
(a) Realisation A/c (b) Revolution A/c (c) Capital Accounts.

7. Unrecorded liability when paid on dissolution of a firm is debited to
(a) Realisation A/c (b) Liability A/c (c) Partner's Capital A/c

8. Profit or loss on realisation should be divided among partners in the.
(a) Profit sharing ratio (b) Equally (c) Capital ratio

9. Provision for doubtful debts appearing at the time of dissolution of a firm transferred to:
(a) Debtors A/c (b) Realisation A/c (c) Cash A/c

10. General reserve appearing at the time of dissolution is transferred to
(a) Bank A/c (b) Realisation A/c (c) Capital A/c’s.

11. As per the dissolution of Garner Vs. Murray, the solvent partners are to bring cash equal to their share of loss:
(a) Personal debts (b) Bad debts (c) Realisation

12. Goodwill A/c is closed at the time of dissolution by transferring to:
(a) Realisation A/c (b) Liability A/c (c) Capital A/c

13. Proportionate Capital Method is otherwise called:
(a) Relative capital method (b) Maximum loss method (c) Balance method.

14. Joint life policy reserve appearing at the time of dissolution of a firm is transferred to
(a) Capital A/c’s (b) Realisation A/c (c) Neither two

15. Realisation made in parts is called
(a) Distribution of capital (b) Piece meal distribution (c) Equal share.

16. At the time of dissolution, all the assets of the firm are transferred to the realisation account at ________ values.
(a) Market (b) Book (c) Asset

17. On the insolvency of all the partners of a firm, the loss should be borne by
(a) All partners in their capital ratio (b) All partners in their profit sharing ratio (c) The creditors.

18. On the insolvency of a partner, the loss on account of the insolvent partner should be borne
(a) Equally (b) In profit sharing ratio (c) In the ratio of capitals after solvent partners bring cash equal to their share of loss on realisation.

19. The first step in the dissolution process is to:
(a) Prepare a balance sheet on the date of dissolution; (b) Distribute the available cash to the creditors;
(c) None of these.

20. A solvent partner will have to bear the deficiency of an insolvent partner when he has a
(a) Credit capital balance (b) Debit or nil capital balance (c) None of these

II. Fill in the blanks with the appropriate word/words:
1. A partnership firm comes to an end when the activities of the firm become Unlawful.
2. When a firm decides to close its business, it is said to be Dissolved.
3. Dissolution of a Firm is different from dissolution of Partnership.
4. The firm is compulsorily Dissolved when all the partners or all excepting one partner die.
5. The firm is dissolved by Court when a partner becomes of unsound mind.
6. The firm is dissolved by Agreement when all the partners give their consent.
7. If a partner takes over any liability, which is not recorded the amount is to be credited to Realisation A/C.
8. The expenses of realisation are debited to realisation A/c.

III. Given below are certain statements. Some of these statements are true and some of these are false. Write T’ against true statement and ‘F’ against false statements.
a)         At the time of dissolution an account including cash and bank are transferred to realisation account. F
b)         On dissolution of a firm, business operations of the firm are closed down. T
c)          After the preparation of realisation account, Gain or loss of realisation account transferred to Partners capital account. T
d)         Amount realised from the sale of an unrecorded asset is recorded in Realisation Account. T
e)         Balance of general reserve is transferred to partners’ capital account. T
f)          Realisation expenses paid by the partners on behalf of the firm are recorded in realisation account and partners capital account. T
g)         When partnership is dissolved, a liability taken by partner is debited to his capital A/c. F
h)         As per the decision in Garner Vs. Murray, a distinction should be made between trading losses and losses arising due to capital deficiency of insolvent partners. T
i)           If any partner has a debit balance in his capital A/c, then he is required to bring in Cash to clear it off. T
j)           Garner Vs. Murray does not apply when the firm is having only two partners. T
k)         A secured creditor always stands in a stronger position than an unsecured creditor. T
l)           The joint estate of the partners as a firm and their separate estates as individuals are administered separately. T
m)       Partner’s capitals are transferred to the Realisation Account with other liabilities of the firm. F
n)         Partner's loan is transferred to the Realisation Account. F
o)         Advance to a partner is transferred to Realisation Account. F
p)         Loan from the wife of a partner is not transferred to Realisation Account. F
q)         Employee’s provident fund is transferred to the Capital accounts of the partners in their profit sharing ratio. F
r)          Investment Fluctuation Reserve is transferred to the Realisation Account. T
s)          Realisation account is prepared to find out the net effect of realisation of various assets and payment of various liabilities. T
t)          All fictitious assets are transferred to the partners' capital accounts in the ratio of their respective capitals. F
u)         Partner's private assets are first used for payment of partner's private debts. T
v)         Firm's assets are first used for payment of firm's debts. T
w)       The liability of the partners is joint and several. T

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