Chapter 5: Dissolution of Partnership Firm

Dissolution of Partnership & Dissolution of Firm are not the same thing. Whenever there is a change in constitution of the firm, the business of the firm continues. There is a change in constitution in case of admission, retirement & death of a partner. This change leads to dissolution of partnership & not dissolution firm. The relationship between the partners changes but the overall business of the firm continues as usual. However, in the case of dissolution of partnership firm, both the partnership & the business comes to an end. Dissolution of the firm is the end of partnership business. Dissolution of partnership occurs due to the following reasons;

1. Due to the admission of a new partner
2. Due to the retirement of a new partner
3. When a partner is declared insolvent
4. When the profit-sharing ratio is changed

DISSOLUTION OF FIRM

Dissolution of partnership firm occurs due to the following reasons;

1. Compulsory dissolution

• When all the partners or all partners except one become insolvent
• When the business becomes illegal
• When all the partners except one decide to retire
• When all the partners except one die
• When the partnership agreement comes to an end as per the provisions mentioned in the agreement.

2. Dissolution by Notice – In case of partnership at will, if any partner serves notice to other partners regarding his intention to dissolve the firm then it’ll amount to dissolution of partnership firm.
3. Dissolution by Agreement – When all the partners mutually agree to dissolve the firm, it is considered to be dissolution of firm.
4. Dissolution of the firm by Court – Under Section 44 of the Partnership Act, 1932, the court may order dissolution of the firm under following circumstances;

• A partner becomes insane
• Sheer impossibility of the business being carried on except at a loss
• Any other ground on which the court is satisfied that the business cannot be carried & it would be just & equitable that the business is wound up.

Section 39 of the Indian Partnership Act 1932 states that the dissolution of partnership firm among all the partners of the partnership firm is the Dissolution of the Partnership Firm. The dissolution of partnership firm ceases the existence of the organization.After this, the partnership firm cannot enter into any transaction with anybody. It can only sell the assets to realize the amount, pay the liabilities of the firm and discharge the claims of the partners.

However, the dissolution of a firm may be without or with the intervention of the court. It is noteworthy here that the dissolution of partnership may not necessarily result in the dissolution of the firm.But, dissolution of partnership firm always results in the dissolution of the partnership.

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.

ACCOUNTING TREATMENT -  JOURNAL ENTRIES

1. For transferring the assets

Transfer to the debit of realization account at their gross book values of all accounts of assets excluding cash, bank and fictitious assets.

Realization a/c Dr.
To Assets a/c(individually)

It is to be noted that debit balances such as accumulated losses and deferred expenses are not transferred to the realization account. These are transferred to the partners’ capital account in their profit sharing ratio by recording the following entry :

Partners’ capital a/c Dr.
To Fictitious assets a/c

2. For transferring the liabilities

All external liability accounts including provisions, if any, in respect of assets which have been transferred to the realization account are closed by transferring them to the credit of realization account at their book values.

External liabilities a/c(Individually) Dr.
To Realization a/c

Partners’ capital account and loan account of the partner are prepared separately and are not transferred to realization account.

3. For the sale of assets

Bank a/c(realized price) Dr.
To Realization a/c

4. For an asset taken over by a partner

Partner’s capital a/c Dr.
To Realization a/c(Agreed price)

5. For payment to creditors

Any amount paid in cash to creditors, realization account is debited and cash/bank account is credited.

Realization a/c Dr.
To Bank a/c

6. Settlement with the creditors through the transfer of asset 

When a creditor accepts an asset in part payment no entry is recorded. It is because the liability due to the creditors has already been transferred to the credit of realization account and the asset is taken over by the creditor is appearing on the debit side of the realization account. Thus, the debit of the asset cancels the credit of the corresponding liability in the realization account. Sometimes, a creditor may accept part of his payment in cash and part of his payment by taking over an asset. In this case, the entry will be recorded for cash payment only. 

For example, a creditor to whom Rs. 10,000 was due to accepted office equipment worth Rs. 8,000. He will be paid Rs. 2,000 in cash by recording the following entry :

Realization a/c Dr.Rs. 2,000
To Bank a/c Rs. 2,000

Whenever a creditor takes over an asset, there may be two situations :

(a) When a creditor accepts an asset whose value is more than the amount due to him, he will pay cash. It is recorded as :

Bank a/c Dr.
To Realization a/c

(b) When a creditor accepts an asset as a full and final settlement, no journal entry is recorded.
 

7. Expenses of realization

(a) When realization expenses are paid by the firm

Realization a/c Dr.
To Bank a/c

(b) When firm has agreed to pay partner a fixed amount towards realization expenses irrespective of the actual realization expenses

Realization a/c Dr.
To Partners’ capital a/c

(c) When the actual expenses are paid by the firm on behalf of a partner, the following entry will be recorded :

Partners’ capital a/c Dr.
To Bank a/c

(d) However, if a partner himself pays and agreed not to get them reimbursed, no journal entry is recorded.

(e) When the partner agrees to pay the expenses on behalf of the firm, the entry to be recorded :

Realization a/c Dr.
To Partners’ capital a/c

8. When liabilities are paid off

Realization a/c Dr.
To Bank a/c

9. When partner discharges a liability

The liability account is transferred from realization account to partner’s capital account by recording the following entry :

Realization a/c Dr.
Partners’ capital a/c

10. For realization of any unrecorded assets

Bank a/c Dr.
To Realization a/c

11. Unrecorded asset is taken over by a partner

Partners’ capital a/c Dr.

To Realization a/c

12. For settlement of any unrecorded liability

Realization a/c Dr.
To Bank a/c

13. Unrecorded liability is taken over by a partner

Realization a/c Dr.
To Partners’ Capital a/c

14. When the profit (loss) on realization is transferred to partners’ capital account in their respective profit sharing ratio :

(a) In case of profit on realization

Realization a/c Dr.
To Partners’ Capitals a/c(individually)

(b) In case of loss on realization

Partners’ Capitals a/c (individually) Dr.
To Realization a/c

15. For transferring accumulated profits and reserve

All accumulated profits and reserves are transferred to the partners’ capital account in their respective profit-sharing ratios:

Accumulated profit/reserves Dr.
To Partners’ capitals a/c (Individually)

16. Transfer of fictitious assets

All accumulated losses and fictitious assets are debited to the partners’ capital accounts in their profit sharing ratio :

Partners’ capitals a/c (Individually) Dr.
To Accumulated losses/Fictitious Assets a/c

17. Payment of loans

Any loans due to partners are paid off :

Partner’s loan a/c Dr.

To Bank a/c

18. Settlement of capital accounts

(a) If the partner’s capital account shows a debit balance, he is to bring in the necessary cash :

Bank a/c Dr.
To Partners’ capital a/c

(b) In the case of partners whose accounts show credit balance, the same is paid off :
Partners’ capitals a/c Dr.
To Bank a/c

It may be noted that the aggregate amount finally payable to the partners must equal to the amount available in the bank and cash accounts. Thus, all accounts of a firm are closed in case of dissolution. At times, the Balance Sheet of the firm may not be available on dissolution of partnership firm. In such a situation, first of all, all the relevant ledger balances are worked out and then the Balance Sheet of the firm on the date of its dissolution is prepared. Thereafter, the process of dissolution is undertaken in the same manner as discussed above.

What happens to goodwill on the dissolution of partnership?

We all know goodwill is an Intangible Asset. When the firm is shut down, It is common practice to sell all the assets. Thus goodwill that appeared in the Balance Sheet is transferred to the Debit side of the Realisation Account to be sold.

Journal Entry of Goodwill in Dissolution of the partnership Firm

Following are the accounting treatment with journal entries of goodwill at the time of dissolution of the partnership firm

When goodwill is transferred to Realisation Account.

Realization A/c Dr.
To Goodwill A/c
(Being goodwill transferred to realization a/c)

When goodwill is sold in cash

Bank (Cash) A/c Dr.
To Realisation A/c
(Being goodwill is sold)

When goodwill is taken over by Partner

Partner’s Capital A/c Dr
To Realisation A/c
(Being goodwill is taken over by partner)

Note:- If Nothing is mentioned about the realization amount of goodwill. It is assumed the market value of goodwill is nil and nothing is realized

(i) For Unrecorded Assets

An unrecorded asset is such an asset whose value is written off from books of accounts, but it is in usable form. It is shown as:
1. If sold in cash

Cash A/c Dr.

To Realisation A/c

(Unrecorded asset sold off for cash)
 

2. If taken over by any partner

Partner’s Capital A/c Dr.

To Realisation A/c

(Partner takes over unrecorded asset)

ii) For unrecorded liabilities

Liabilities that are not recorded in the books of a firm are called unrecorded liabilities. It can be shown in records as

1. When unrecorded liability is paid off

Realization A/c Dr.

To Cash A/c

(Paid in cash the price of unrecorded liability)

2. When undertaken by a partner

Realization A/c Dr.

To Partner’s Capital A/c

(Liability that is unrecorded is taken over by partner)

Difference Between Realisation and Revaluation Account