Class XII Accounts Fundamental Concepts
Accounts - Dissolution of Partnership Firms
of a partnership firm is the process by which the existence of a partnership
firm comes to an end. This involves the sale or disposal of assets, settlement
of liabilities and closing of books of accounts. Once the outside liabilities of
the firm are settled, the partners take away their capital investment. If there
is any surplus or deficit in this process it will be shared by the partners in
their profit sharing ratio.
of a partnership firm can take place on account of any of the following reasons:
Dissolution by Agreement: When the partners
themselves reach an agreement to discontinue their business for whatever reason,
it is known as dissolution by agreement.
Compulsory Dissolution: Compulsory dissolution
takes place when the business of the firm is declared illegal, or the partners
become insolvent or the citizen of an enemy country happens to be partner of the
Dissolution by notice: A partner can demand
dissolution of a partnership at will, by serving a notice to the firm.
Dissolution by Court: Court may initiate
dissolution of a firm under the following circumstances:
When one of the partners has become of unsound mind
When a partner is guilty of misconduct which may affect the business
When a partner commits wilful breach of contract
Any other reason which the court may find adequate
Dissolution by the expiry of a pre determined period or completion of event:
This dissolution takes place in case of particular partnerships which are formed
for a specific period or the completion of a specific project. Such partnerships
will be dissolved at the completion of the specific period of or the project as
the case may be.
of Partnership and Dissolution of Partnership Firm
term dissolution, referred in relation to a partnership business generally
denotes the winding up of the business. However, there is a difference between
‘dissolution of partnership’ and ‘dissolution of the partnership firm’.
The former indicates ending of agreement only to replace it with a new one, but
the latter indicates the ending of partnership business altogether. The
following points may be noted in comparison between the two:
the agreement is dissolved, no physical disposal takes place.
partners will continue to run the business with a new agreement.
effect on employees or debtors and creditors of the business
dissolutions of agreement can take place during the life of a
retirement and or death of a partner can result in compulsory
dissolution of existing agreement.
of Partnership Firm
Firm is dissolved, by selling off assets and settling liabilities.
partners will discontinue the business
the business is closed down it affects the workers, debtors and
creditors of the firm
of firm can take place only once in the lifetime of a partnership
of these events can lead to a compulsory dissolution of the firm.
of Accounts on Dissolution
first step in dissolution is the realisation of assets followed by the
settlement of outside liabilities. All individual accounts for assets and
liabilities, except cash, are closed by transferring their balances to a
Realisation Account. Realisation account is the temporary account for
accumulating all assets and liabilities for convenient accounting treatment. All
ledger accounts except partner’s capital accounts and cash account are closed
prior to realisation procedure. Accumulated profits or losses are directly
transferred into the capital accounts in the profit sharing ratio. The following
is the order of priority in settlement of liabilities and capital upon
Expense incurred on realisation of assets such as commission, cartage, brokerage
All outside creditors
Partner’s Loan accounts
Balances in Capital Accounts of partners
Items in Accounting for Dissolution
Realisation Account: This is the most important account prepared to
facilitate dissolution of firms. This is equal in importance to Revaluation
Account in Reconstitution. There is no scope of revaluation of assets and
liabilities of a firm under liquidation. Realisation account is used to
accumulate all assets and liabilities in one place for convenient accounting
steps for disposal and settlement of liabilities.
Treatment of Goodwill: Goodwill is the most prominent item in
Reconstitution of partnership. But goodwill does not have any special treatment
in dissolution. If it appears in the books it has to be transferred into
Realisation Account. This will automatically gets transferred into the Capital
Accounts of Partners, by way of realisation profit or loss. If goodwill does not
appear in the books it is just ignored. There is no meaning in raising it or
treating it in any way when the firm is being dissolved.
Realisation Expenses: Expenses of realisation such as commission paid to
brokers for the disposal of assets, expenses on transportation of items,
registration documentation charges for the assets sold etc. are debited to
Realisation Account and credited to Cash Account. However if any partner agrees
to bear the expense for a certain fees, the fees charged by the partner becomes
the common expense which is debited in Realisation Account; whereas the actual
realisation expense, if mentioned, should be treated as personal drawing of the
Wife’s Loan: Loans from a partners’ wife is to be treated as normal
creditor. The basic aim of providing a loan in the name of partner’s wife is
to by-pass the legal restrictions on the Loan from a Partner to the firm.
Provident Fund: Provident fund should be understood as a liability
payable to the employees. It should be paid off even when the question is silent
about its treatment. Same rule applies to all other outside liabilities, such as
creditors, bills payable etc.
Specific Funds: Specific funds such as Investment Fluctuation Funds are
preferably credited to Realisation account along with the transfer of related
asset, which will get transferred to capital accounts by way of profit of loss
on Realisation. Provision for doubtful debts, accumulated depreciation etc. must
be credited to Realisation Account along with the transfer of assets.
Profits Kept Aside: General Reserve; credit balance in P& L Account
etc should be directly transferred into the Capital Accounts of Partners, in the
profit sharing ratio.
Unrecorded Assets: Unrecorded assets or assets which are completely
written off may fetch some cash at the time of dissolution. There is no need of
bringing them into books and selling them afterwards. It can be directly treated
by crediting realisation account and debiting cash account.
Creditors Purchasing Some Assets in Part Settlement of Claim: When
creditors purchase some of the assets in part settlement, this is not
specifically recorded by way of a journal entry, since the asset and liability
are appearing in the same Realisation Account. The balance amount due to the
creditors is aid in full satisfaction of the claim. If the value of asset taken
over is more than the amount due, the creditors will pay the excess amount to
The treatment of creditors taking over part of the assets mentioned above is a
questionable accounting treatment. What I mentioned above is only on ‘examination
point of view’. The correct account treatment is to debit the Creditors
account in the Ledger by passing a journal entry and transferring the balance of
creditors into Realisation Account
or loss on realization will be transferred to the Capital Accounts of partners
in the profit sharing ratio. At the final stage of the realization process, only
Cash Account and Capital Accounts will be left. The final balances of each other
will match exactly, and the cash will be paid off to capital accounts to close
both the accounts. This is the last transaction in the books of the firm.
entire accounting steps in realization can be summarized as follows:
1: Reduce the Number of Accounts into THREE: As
you are aware each item in a detailed Balance Sheet represents an account in the
Ledger. You have to reduce them into just three accounts, namely
i) Realisation Account
ii) Capital Accounts of Partners (considered one account)
iii) Cash Account
2: Reduce the Number of Accounts into TWO: Major
activities of realisation process take place at this stage. Sell assets one by
one and add it to (debit) Cash and reduce it from (credit) Realisation Account.
Take out cash and pay to liabilities placed in the Realisation Account. Now the
Realisation Account is reduced to a residue, without any active accounts inside.
This balance is transferred into capital accounts as realisation profit or loss.
Now you have only two accounts, the Cash Account and the Capital Account.
3: Reduce the Number of Accounts to NIL: This
is the most interesting step. Here the cash balance has to be exactly equal to
the credit balance in capital account. Take out cash (cr); Pay off Capital
(Dr.), and there ends the Partnership Business.
Entries in Dissolution
for dissolution begins with the closing of assets and liabilities accounts by
transferring them to Realisation Account.
For transfer of assets
To Asset Account
For Transfer of liabilities
To Realisation Account
profits such as General Reserves, Profit and Loss Account Credit Balance etc.
are transferred to capital Accounts in the profit sharing ratio.
For transfer of accumulated profits
Profit Account (General Reserve; P&L etc.) Dr.
To Realisation Account
Provision for doubtful debts; Investment fluctuation 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.
For assets realized
To Realisation Account
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.
For Liabilities paid off
To Cash Account
For asset taken over by a partner
Capital Account Dr.
To Realisation Account
For Liability taken up by the partner
To Partner’s Capital Account
For unrecorded asset taken over by a partner
Capital Account Dr.
To Realisation Account
Unrecorded Liability settled by the firm
To Cash account
Asset taken over by creditors
entry; Only settlement of balance amount is shown in the books.
is the easiest chapter in Partnership accounts. You have 10 marks for this
chapter under revised syllabus. Here you need not remember different methods
of treatment of goodwill, no ratio calculations etc. Everything is plain and
simple. Pay serious attention to this chapter to secure full 10 marks. Look at
some of the important adjustments in the previous chapters becoming very
must have spent maximum time in understanding various ways of treatment of
goodwill in the earlier chapters. Here it is very simple; if there is goodwill
given in the Balance Sheet, just debit it in the realisation account and
forget it, yes, forget it. If it does not appear in the Balance Sheet, just
ignore it; who cares about the goodwill of a firm under liquidation anyway?
Simple, simple indeed!
Old Ratio, New Ratio, Sacrificing Ratio, Gaining Ratio, any other ratio? See
the long list of ratios you need NOT apply here. You have just one profit
sharing ratio, to transfer the profit or loss on realisation.
Revaluation: You need not struggle with the revaluation of assets and
liabilities. There are no provisions to be kept. Here you just have a
Realisation Account to move your ledger account items for the time being to
help you transfer them to cash as and when realised.
Balance Sheet In dissolution you have to prepare NO Balance Sheet at all.
Instead you have to destroy one Balance Sheet given in the question. Too good
to be true, but it is very true. What you have to do here is to break up old
Balance Sheet, extract cash out of it, pay to creditors and finally to owners.
Remember how funny it looked when you played video cassettes in reverse mode,
cars running backwards at full speed, food taken out of mouth and put back
into plate and all those funny stuff. Dissolution is the action replay of
partnership formation in the ‘reverse mode’. The process of forming cash
and other assets and liabilities in a business forming a Balance Sheet in the
beginning of a business is now reversed to show how a Balance Sheet melts into
cash, finally goes from the cash box to the owners’ pockets as return of
Steps, Easy Chapter, Study all the illustrations carefully and I need every
one of you get full marks in this chapter.
What is meant by dissolution of Partnership Firms?
What are the circumstances under which a Partnership firm is dissolved?
Distinguish between Dissolution of Partnership and Dissolution of Firm.
State order in which the claims against a firm under dissolution are settled.
State how the goodwill appearing in the books is treated at the time of
How is the general reserve treated on dissolution of a firm?
State accounting treatment of joint life policy of a firm not appearing in the
book surrendered for a certain amount.
How do you treat when an unrecorded asset is given to creditors in part
What is the accounting treatment for unrecorded liability is taken up by a
State how the entries would be made if a partner agrees to pay off his wife’s
loan? What if he does not agree to take up the loan?
A Partner and his wife gave loans to the firm. What difference is there between
these two loans on dissolution of the firm?