Chapter dissolution-of-partnership-firm: Dissolution of Partnership Firm | Summary

A firm can be dissolved without court intervention or by court order. There are five modes: (1) Dissolution by Agreement — with consent of all partners or per contract; (2) Compulsory Dissolution — when all or all but one partners become insolvent, or the business becomes illegal; (3) On the happening of certain contingencies — expiry of fixed term, completion of venture, death or insolvency of a partner; (4) Dissolution by Notice — in a partnership at will, any partner can give written notice; (5) Dissolution by Court — on grounds such as insanity, permanent incapacity, misconduct, persistent breach, transfer of interest, continuous loss, or just and equitable grounds.

Dissolution of the firm necessarily brings dissolution of the partnership. The economic relationship between all partners comes to an end, the business is closed, assets are sold, liabilities are paid off, and the books of accounts are closed permanently.

The key differences between the two concepts lie across five dimensions. On the dimension of business continuity, dissolution of partnership does not terminate the business, while dissolution of the firm closes it completely. Regarding settlement of assets and liabilities, under partnership dissolution assets and liabilities are revalued and a new balance sheet is prepared; under firm dissolution assets are sold and liabilities paid off. Court intervention is absent in partnership dissolution but a court can order firm dissolution.

The economic relationship between partners continues in a changed form under partnership dissolution but completely ends under firm dissolution. Finally, under partnership dissolution the books are not closed since the business continues, whereas under firm dissolution all books of accounts are permanently closed.

On dissolution, Section 48 of the Partnership Act 1932 governs the treatment of losses and application of assets. Losses (including capital deficiencies) are met first from profits, then from partners' capital, and finally by partners individually in their profit-sharing ratio. Assets are applied in a strict order: first to pay third-party debts, then to repay partners' loans (advances distinguished from capital), then to repay partners' capital, and finally any surplus is distributed among partners in their profit-sharing ratio.

Where both firm debts and partners' private debts co-exist, Section 49 applies: firm property is first used for firm debts and any surplus goes to partners for their private liabilities; a partner's private property is first used for private debts and any surplus may be used for firm debts. The private property of a partner does not include the personal property of his wife and children.

When a partner is unable to contribute towards the deficiency in his capital account (a debit balance), he is treated as insolvent and the irrecoverable amount is treated as a capital loss for the firm. In the absence of any agreement to the contrary, such capital loss is borne by the remaining solvent partners in accordance with the Garner vs. Murray principle — that is, in the ratio of their capitals as on the date of dissolution.

The accounting treatment for dissolution due to insolvency of partners is not covered at the Class 12 level, but it is important to understand the principle: only solvent partners bear the loss, and they do so in the ratio of their last agreed capitals, not in the profit-sharing ratio.

When a firm is dissolved, a Realisation Account is prepared to close the books. All assets (except cash, bank balance, and fictitious assets) are transferred to the debit side of the Realisation Account at book value. All external liabilities (including provisions) are transferred to the credit side. Sale proceeds of assets are credited; payments for liabilities are debited. Realisation expenses are debited. If a partner takes over an asset, his capital account is debited; if a partner assumes a liability, his capital account is credited.

The balance of the Realisation Account represents profit or loss on realisation, which is transferred to partners' capital accounts in the profit-sharing ratio. Accumulated reserves and general reserve are transferred to capital accounts. Fictitious assets and accumulated losses are also transferred to capital accounts in the profit-sharing ratio. Partner's loans are repaid through the bank account, and finally capital accounts are settled through the bank account.

There are 17 sets of standard journal entries for dissolution. Assets are debited to Realisation Account and external liabilities are credited to it. Sale of assets: Bank A/c Dr. To Realisation A/c. Asset taken by partner: Partner's Capital A/c Dr. To Realisation A/c. Payment of liabilities: Realisation A/c Dr. To Bank A/c. Liability assumed by partner: Realisation A/c Dr. To Partner's Capital A/c. Realisation expenses paid by firm: Realisation A/c Dr. To Bank A/c. If paid by partner: Realisation A/c Dr. To Partner's Capital A/c. If partner agreed to bear but firm paid: Partner's Capital A/c Dr. To Bank A/c.

Unrecorded assets realised: Bank A/c Dr. To Realisation A/c. Unrecorded liabilities paid: Realisation A/c Dr. To Bank A/c. Profit on realisation: Realisation A/c Dr. To Partners' Capital A/cs. Loss on realisation: Partners' Capital A/cs Dr. To Realisation A/c. General reserve transferred: General Reserve A/c Dr. To Partners' Capital A/cs. Fictitious assets written off: Partners' Capital A/cs Dr. To Fictitious Asset A/c. Partner's loan repaid: Partner's Loan A/c Dr. To Bank A/c. Settlement of capital accounts: Partners' Capital A/cs Dr. To Bank A/c (or vice versa for debit balance partners).

Dissolution of a partnership firm is a significant legal and accounting event that ends the firm's existence permanently. The chapter establishes clear distinctions between dissolution of partnership and dissolution of the firm, describes five modes of firm dissolution, lays down the legal order for settling accounts under Sections 48 and 49 of the Partnership Act 1932, and explains the complete accounting procedure through the Realisation Account. Understanding these concepts is essential for correctly closing a firm's books and ensuring fair distribution of assets and losses among partners.

From an examination perspective, this chapter is consistently tested in CBSE Board exams through numerical questions on preparing the Realisation Account, Bank Account, and Partners' Capital Accounts, as well as theory questions on modes of dissolution, settlement of accounts, and journal entries for special transactions such as unrecorded assets, realisation expenses borne by a partner, remuneration to a partner, and asset or liability taken over by a partner. Students should master both the conceptual distinctions and the procedural journal entries to score well.