Dissolution of a Partnership means ending the partnership relationship, while Dissolution of a Firm means closing down the entire business — selling off all assets, paying all liabilities, and settling accounts of all partners.
Distinction: Dissolution of Partnership vs. Dissolution of Firm
| Basis | Dissolution of Partnership | Dissolution of Firm |
|---|---|---|
| Meaning | Change in relations; firm may continue | Firm ceases to exist entirely |
| Business | Continues | Stops completely |
| When | Admission, retirement, death | Mutual agreement, court order, etc. |
Modes of Dissolution
1. Dissolution by Agreement (Voluntary): All partners mutually agree to dissolve. Most common.
2. Compulsory Dissolution: By operation of law — if all partners (or all but one) are declared insolvent, or if the business becomes illegal.
3. Dissolution on Happening of Certain Contingencies: On expiry of fixed term, completion of the venture, death of a partner (if deed so provides), insolvency of a partner.
4. Dissolution by Notice: In a partnership at will, any partner may dissolve by giving written notice.
5. Dissolution by Court (Judicial): Court can order dissolution on grounds such as: partner's misconduct, persistent breach of agreement, partner's permanent incapacity, the business cannot be carried on except at a loss, or on just and equitable grounds.
Realisation Account
When a firm dissolves, all assets are sold and liabilities paid. A Realisation Account is prepared to record this process (not to be confused with Revaluation Account).
- 1.Steps to prepare Realisation Account:
- 2.Transfer all assets (except cash/bank) to the Debit side of Realisation A/c
- 3.Transfer all external liabilities to the Credit side of Realisation A/c
- 4.Realisation of assets: Bank A/c Dr; To Realisation A/c Cr
- 5.Payment of liabilities: Realisation A/c Dr; To Bank A/c Cr
- 6.Dissolution expenses: Realisation A/c Dr; To Bank/Cash A/c Cr
- 7.If a partner takes over an asset: Partner's Capital A/c Dr; To Realisation A/c Cr
- 8.If a partner pays a liability: Realisation A/c Dr; To Partner's Capital A/c Cr
- 9.Balance of Realisation A/c = Profit or Loss on realisation, shared in P&L ratio
Payment of Liabilities (Garner vs. Murray Rule)
When a partner is insolvent (cannot pay their share of loss), the deficit is borne by solvent partners in the ratio of their last agreed capitals (not profit-sharing ratio) — this is the principle from the case Garner vs. Murray.
EXCEPTION: In India, the courts have modified the rule for Indian partnership firms — unless specifically agreed, the solvent partners bear the insolvent partner's deficit in their profit-sharing ratio (not capital ratio). NCERT/CBSE follows the Indian approach.
Settlement of Accounts on Dissolution
- 1.As per Section 48 of the Indian Partnership Act, 1932, the order of payment is:
- 2.External liabilities (creditors, loans from outsiders)
- 3.Partners' loans (amounts lent by partners other than capital)
- 4.Partners' capital accounts
- 5.Residual surplus — shared among partners in P&L ratio
Important Journal Entries on Dissolution
- Goodwill transferred: Realisation A/c Dr; To Goodwill A/c Cr
- Provision for bad debts transferred: Provision A/c Dr; To Realisation A/c Cr (reduces the debtor amount transferred)
- Investment in government securities realised: Bank A/c Dr; To Realisation A/c
- If a partner takes over a liability: Realisation A/c Dr; To Partner's Capital A/c
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A firm with partners A and B (ratio 3:2) is dissolved. Assets transferred to Realisation A/c: Sundry Assets Rs 2,00,000 (excluding cash Rs 5,000). Liabilities: Sundry Creditors Rs 40,000. Pass opening journal entry.
· Steps: · Realisation A/c Dr 2,00,000
To Sundry Assets A/c 2,00,000
Sundry Creditors A/c Dr 40,000
To Realisation A/c 40,000
Assets realised for Rs 1,50,000. Creditors paid Rs 38,000 (at a discount of Rs 2,000). Dissolution expenses Rs 3,000.
· Steps: · Bank A/c Dr 1,50,000; To Realisation A/c 1,50,000
Realisation A/c Dr 38,000; To Bank A/c 38,000
Realisation A/c Dr 3,000; To Bank A/c 3,000
Determine profit/loss on realisation (from Examples 1 and 2 combined).
· Steps: · Realisation A/c:
Debit: Assets 2,00,000 + Creditors paid 38,000 + Expenses 3,000 = 2,41,000
Credit: Creditors 40,000 + Cash realised 1,50,000 = 1,90,000
Loss on Realisation = 2,41,000 - 1,90,000 = Rs 51,000 shared 3:2 → A = Rs 30,600; B = Rs 20,400
Partner C takes over a machine worth Rs 25,000 at an agreed value of Rs 22,000. Pass entry.
· Steps: · C's Capital A/c Dr 22,000
To Realisation A/c 22,000
(The machine is already on the debit side of Realisation A/c from the first entry; agreed value credited shows it was taken at Rs 22,000)
On dissolution, there is a provision for doubtful debts of Rs 8,000 in the books. Debtors are Rs 60,000. Pass entry to transfer both to Realisation A/c.
· Steps: · Realisation A/c Dr 60,000
To Debtors A/c 60,000
Provision for Doubtful Debts A/c Dr 8,000
To Realisation A/c 8,000
(Net debit to Realisation = Rs 52,000 for debtors, net of provision)
Partner X agrees to pay his wife's loan of Rs 20,000 (which is a liability of the firm) personally. Pass entry.
· Steps: · Realisation A/c Dr 20,000
To X's Capital A/c 20,000
(X has personally discharged the firm's liability, so his capital is credited)
After settling all liabilities, the final cash balance is Rs 1,80,000. Partners P and Q have capitals of Rs 1,20,000 and Rs 60,000. Settle accounts.
· Steps: · P's Capital A/c Dr 1,20,000; To Bank A/c 1,20,000
Q's Capital A/c Dr 60,000; To Bank A/c 60,000
Total paid = Rs 1,80,000 = Cash available. Firm fully wound up.
Common mistakes
- Transferring Cash and Bank to Realisation Account — these are NEVER transferred to Realisation A/c.
- Confusing Realisation A/c (dissolution) with Revaluation A/c (reconstitution).
- Forgetting to transfer Provision for Bad Debts to the credit of Realisation A/c.
- Sharing insolvent partner's deficit in profit ratio instead of capital ratio (Garner vs. Murray) — remember CBSE follows the Indian approach (profit ratio).
Summary
Dissolution of a firm ends its existence. A Realisation Account collects all assets (not cash/bank) and all external liabilities, records their realisation/settlement, and yields a profit or loss. Dissolution expenses are debited to Realisation A/c. The order of payment follows Section 48: external liabilities first, then partners' loans, then capitals, then surplus. The Realisation Account is the centrepiece of all dissolution entries.