3. Settlement of Accounts

Settlement of Accounts

In a case where the partners do not have an agreement regarding the dissolution of the firm, the following provisions of the Indian Partnership Act 1932 will apply:

• The firm will pay the losses including the deficiency of capital firstly out of the profits, secondly out of the partner’s capital and lastly by the partners individually in their profit sharing ratio.
• The firm shall apply its assets including any contribution to make up the deficiency firstly, for paying the third party debts, secondly for paying any loan or advance by any partner and lastly for paying back their capitals. Any surplus left after all the above payments is shared by partners in profit sharing ratio.

Settlement of Accounts

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) Treatnent of Losses

Losses, including deficiencies of capital, shall be paid :

1. a. first out of profits,
2. b. next out of capital of partners, and
3. c. lastly, if necessary, by the partners individually in their profit 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:

1. a. In paying the debts of the firm to the third parties
   b. In paying each partner proportionately what is due to him/her from the firm for advances as distinguished from capital (i.e. partner' loan)
   c. In paying to each partner proportionately what is due to him on account of capital
   d. the residue, if any, shall be divided among the partners in their profit sharing ratio

Thus, the amount realised from assets along with contribution from partners, if required, shall be utilised first to pay off the outside liabilities of the firm such as creditors, loans, bank overdraft, bill payables, etc. (it may be noted that secured loans have precedence over the unsecured loans); the balance should be applied to repay loans made by the partners to the firm. (in case the balance amount is not adequate enough to pay off such loans and advances, they are to be paid propartionately). The amount left thereafter is utilised in settlement of capital account balances. Then the surplus if any is divided among partners in their profit sharing ratio.

Private Debts and Firn's Debts: 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.

1. a. 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.
   b. 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.

It may be noted that the private property of the partner does not include the personal properties of his wife and children. Thus, if the assets of the firm are not adequate enough to pay off firm's liabilities, the partners have to contribute out of their net private assets (private assets minus private liabilities).

Inability  of a Partner  to Contribute  Towards Deficiency

In the context of settlement of accounts among the partners there is still another important aspect to be noted, i.e., when a partner is unable to contribute towards the deficiency of his capital account (the account finally showing a debit balance), he/she is said to be insolvent, and the sum not recoverable is treated as capital loss for the firm. In the absence of any agreement, to the contrary, such a capital loss is to be borne by the remaining solvent partners in accordance with the principle laid down in Garner vs. Murray case, which states that the solvent partners have to bear such loss in the ratio of their capitals as on the date of dissolution. However, the accounting treatment relating to dissolution of partnership on account of insolvency of partners is not being taken up at this stage.