DISSOLUTION

OF

PARTNERSHIP

FIRM

INTRODUCTION
When the business of the firm is closed down and the relation of partners comes to an end, the firm is said to
have been dissolved. There is a distinction between the dissolution of partnership and dissolution of firm. When
one or more partners sever their connections with the firm but the remaining partners continue to carry on
business, it is the dissolution of partnership. But when there is a complete breakdown of relations among all the
partners and the business is closed down, it is termed as dissolution lf the firm, in this chapter; we shall deal
with accounts of the relationship when the firm is dissolved.

DISSOLUTION
OF
PARTNERSHIP
AND
FIRM:
At this stage, let us make clear the meaning of Dissolution of firm and Dissolution of Partnership.
According to Section 39 of the Indian partnership Act, The dissolution of Partnership between all the partners
of a firm is called the dissolution of firm. Thus dissolution of the firm means the complete and total cessation
of legal relations amongst all partners in dissolution of firms, the business of partnership is closed and after
payment of all liabilities, the capital is returned to partners.
But in case of retirement, death or insolvency of a partner, if the remaining partners continue the old
business of the firm, there is dissolution of partnership. In this case the firm is not dissolved but, only firm is reconstituted, In short, dissolution of partnership does not necessarily involve the dissolution of firm but
dissolution of firm is necessary involves dissolution of partnership.
CIRCUMSTANCES OF DISSOLUTION: The dissolution of partnership takes place under the following
circumstances.
a) When the firm was constituted for a fixed term, on the expiry of that term.
b) On the completion of particular venture, if constituted for a purpose.
c) On the death of a partner.
d) On the insolvency of a partner.
e) On the retirement of a partner.
A firm is dissolved under the following circumstances:
(1) When all the partners agree to dissolve the firm.
(2) When all the partners of all partners except one are declared insolvent.
(3) When all business of the firm becomes unlawful.
(4) When the partnership is at will, on any partner giving notice in writing to all the other partners of his intention
to dissolve the firm.
(5) When the court orders the dissolution of the firm.

(a)
(b)
(c)
(d)
(e)
(f)

Under the following circumstances, the court will order the dissolution of the firm.
When a partner becomes of unsound mind.
When a partner has become permanently incapable of performing duties
When a partner is guilty of misconduct which is likely to affect business.
When a partner persistently commits breach of partnership agreement
When a partner has transferred whole of his interest in the firm to a third party
When the business cannot be carried on except at a loss.
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(g) On any other ground which appears to the court just and equitable.
MODE OF SETTLEMENT OF ACCOUNTS:
When a firm is dissolved, the assets are sold off and out of the proceeds the liabilities of the firm are paid off,
then the surplus is applied in payment of partners loan, if any. Finally, the capital of the partners is returned.
When there is an agreement among the partners as to the way in which the accounts are to be settled, the
accounts should be settled accordingly. If there is not such agreement, the provision of sec. 48 of the Indian
Partnership Act, 1932 applies. The said provisions are as follows:
In settling the accounts of a firm after dissolution, the following rules shall be observed, subject to
agreement by the partners:
a) Losses including deficiencies of capital shall be paid first out off profits, next out of capital and lastly, if
necessary by the partners individually in the proportion in which they were entitled to share profits.
b) The assets of the firm, including any sums contributed by the partners to make up deficiencies of capital, shall
be applied in the following manner and order:
1) In the paying the debts of the firm to third parties.
2) In paying to each partner ratably what is due to him from the firm for advances as distinguished from capital.
3) In paying to each partner ratably what is due him on account of capital, and
4) The residue, if any, shall be divided among the partners in the proportion in which they were entitled to share
point.
STEPS TO BE TAKEN ON DISSOLUTION:
The above provisions of the partnership Act suggest the following steps to be taken on dissolutio n of the firm.
1) All the assets of the firm, including goodwill are sold or disposed off in any other way (E.g. a partner may take
over an asset)
2) The amount so realized is applied in paying off third party liabilities in the first balance.
3) If any one or more partners have advanced loan to the firm in addition to his capital, then these loan are repaid
next after repayment of third party liabilities.
4) Now, partners will ne paid what is due to them on capital accounts. If the surp lus is not enough to return the
full amount of capital, then the partner are paid ratably
5) Surplus, if any, left after returning capitals is paid to the partners in their profit sharing ratio.
Firm debts and private Debts: The liability of partners is unlimited, in the sense that the private property of
the partners can also be utilized for payment of rims debts. But, according to partnership Act, private property
of any partner must be utilized first in payment of partners private debts. Similarly, firms assets are first
applied in payment of firms debts and if there is any surplus, then the share of a partner in the said surplus can
be utilized in payment of the private debts.
ENTRIES ON DISSOLUTION RELIZATION ACCOINT:
On dissolution of a firm, books of account are closed. For this purpose all assets of the firm are disposed off and
liabilities paid off. For closing the account of assets and liabilities, the Realization Account is opened. All the
assets and liabilities are transferred to this account.
In case of admission or retirement of a partner, Profit and loss account is opened to record the increase
and decrease in the value of asset and liabilities. Realization account is not necessary in this case as the business
is to continue and assets are not to be disposed off. The book values of assets and liabilities are transferred to
realization account, as these accounts are to be closed. Assets have debit balances, hence they are credited in
order to close those account and are shown on debit side of realization account. Similarly, liabilities have credit
balances and they are debited to close them and are transferred to the credit of realization account.
ENTERIES ON DISSOLUTION
TRANSACTION
A/C TO BE DEBITED
A/C TO BE CREDITED
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1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

Closing account of assets

Closing account liabilities
On sale of assets
On payments of liabilities
On payment of dissolution exp.
Distributing realization profit
On payment of partners loan
Distributing General Reserve
Settling partners Cap.(Dr.)
Returning capitals to partners

1)
2)
3)
4)

Remember that while solving the example. All the balance given in the B/s must be transferred to following
four accounts.
Realization account
Partners capital account
Cash/Bank Account
Partners Loan A/c (if any)

REALIZATION ACCOUNT
PARTICULAR

Rs.

Realization A/c Dr
Liabilities A/c Dr
Cash/Bank A/c Dr
Realization A/c Dr
Realization A/c Dr

Assets A/c Cr.

Realization A/c Cr.
Realization A/c Cr.
Cash/Bank A/c Cr.
Cash/bank A/c Cr.

Realization A/c Dr
Partners loan A/c Dr
General reserve A/c Dr
Cash/Bank A/c Dr
Partners capital A/c Dr

Partners Capital A/c Cr.

Cash/Bank A/c Cr.
Partners capital A/c Cr.
Partners capital A/c Cr.
Cash/Bank A/c Cr.

PARTICULAR

Rs.

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To sundry assets (Entry

no.1).
Land and building
.
Plant and machinery
.
Stock
.
Debtors
To Cash/Bank
Payment of liabilities
.
(Entry no 4A)
.
Creditors
.
Bills payable
.
Contingent liabilities.
To partners Capital A/c
Liabilities taken over
(entry no. 4B)
To cash Account
Dissolution exps. ..
(entry no 5)
To balance being profit
transferred to partners capital
A/c
(Entry no. 6A)

..

1)

2)
3)

By sundry liabilities
(entry 2)
Creditors
.
Bills payable
.
Bank drafts
.
By Cash/Bank
Sales proceeds of
Assets
(Entry 4)
Land and building .
Plant and machinery .
By Partners Capital Account
Assets taken over .
(Entry No.3B)
By Balance being loss
transformed to partners capital
account
(entry no.6B)

.............
.
.

........................

Generally the expenses are paid by the firm. The same is debited to realization account and credited to Cash
Account
At times, one of the partners may agree to bear the expenses. In such case, if the firm pays the expenses, it
should be debited to capital account of the said partner and not to the realization account; the corresponding
credit being given to cash Account.
If the partner undertakes to bear the expenses. And when he pays the expenses, there should be no entry in the
firms books.
It may be agreed upon among the partners that one of them will be paid a fixed remuneration for attending to
the dissolution work, but he is required to bear the dissolution expenses. In such a circumstance, the fixed
remuneration is debited to Realization Account and credited to his Capital account. No entry is made in the
firms book when he (partner) pays the realization expenses.
GOOD
WILL
ON
DISSOLUTION:

Treatment of goodwill is similar to that of other assets on dissolution

1) When goodwill appears in the B/s on the date of dissolution, it should be transferred to the debit side of
realization account. Any Amount realized on sale of goodwill should then be credited of realization account like
any other asset. If nothing is realized, from goodwill; naturally no entry is made in the realization Account for
its realization.
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2) If goodwill does not appear in the books, the question of transferring to the debit side of realization account
does not arise. When some thing is realized on sale o f unrecorded goodwill, it should be credited to Realization
account which is ultimately transferred to the credit side of the partners Capital Accounts. Thus, partners get
the benefit of goodwill.

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