UNIT 10 DISSOLUTION OF A

PARTNERSHIP FIRM

10.0 Objectives
10.1 Introduction
10.2 Meaqjng of Dissolution
10.2.1 Dissolution of Partnership
10.2.2 Dissolution of a Firm
10.3 Modes of Dissolution '

10.4 Settlement of Accounts

.10.5 Accounting Treatment
10.5.1 Simple Dissolution
10.5 2 Dissolution on Account of insolvency of Partners
10.5.3 Dissolution on Sale to a Company
10.6 Let Us Sum Up
10.7 Key Words
10.8 Answers to Check Your Progress
10.9 Terminal Questions/Exercises

10.0 OBJECTIVES
After studying this unit you will be able to:
explain the meaning of dissolution
distinguish between dissolution of partnership and dissolution of a firm
enumerate the modes of dissolution
enlist the procedure for settlement of accounts
make necessary entries in the books on dissolution under various circumstances
and close them.

10.1 INTRODUCTION
In the previous two units you have studied that on the admission retirement or death
of a partner, the partnership comes to an end but the firm may continue, if the
partners so decide, with a new partnership coming into existence. But under certain
circumstances, the firm has to be discontinued and closed which is known as
dissolution of the firm. Hence, on dissolution of a firm the assets are to be disposed
off and the external liabilities are to be paid and the claims of the partners settled.
In this unit you will study the various modes and types of dissolution, the entries
required to be made on disposal of the assets of the firm and on payment of the
liabilities? the problems arising at the time of settlement of accounts of the partners
and their resolution as per the partnership deed and the Partnership Act.

10.2 MEANING OF DISSOLUTION

Dissolution means discontinuance. When it relates to the relationship between the
partners, it is called dissolution of partnership and when it relates to the business of
partnership, it is called dissolution of the firm. According to the Partnership Act,
1932 "The dissolution of partnership between all the partners of a firm is called the
dissolution of the firm. Therefore, the act distinguishes between the dissolution of
partnership and dissolution of the firm.
Dissolution of partnership means that the relationship between the partners changes
while the firm may continue its business under the same name, if the partners so
decide. On the other hand, dissolution of the firm means the complete closure of the
business of the firm. All the assets are disposed off and all the liabilities are
discharged. Therefore, under dissolution of the firm, the partrrership is autohatically
79
 dissolved. On the other hand, dissolution of partnership does .not
. necessarily result
in the dissolution of the firm.
10.2.1 Dissolution of Partnership
The partnership is deemed to have been dissolved in any of the following
circumstances:
i) expiry of the period of partnership
ii) completion of the venture for which it was formed
iii) admission of a partner
iv) retirement of a partner
v) death of a partner
vi) insolvency of a partner
In all the above-mentioned cases, the old partnership comes to an end but the
business may be carried on in the same name and style with a new partnership coming
into existence. Technically, even in the case of a change in the profit sharing ratio of
the existing partners, the old partnership is dissolved and a new one comes into
existence.
10.2.2 Dissolution of a Firm
In addition to the dissolution of the partnership. there is also the dissolution of the
firm under the following circumstances:
i) Where all the partners agree that the firm be dissolved.
ii) Where all the partners but one are insolvent.
iii) Where the business becomes unlawful.
iv) In the case of partnership at will when a partner @ves notice of dissolution.
v) When a competent court orders dissolution.
It must be clearly understood that dissolution of the partnership is only a legal
abstraction known to the insiders only, whereas dissolution of the firm is a real
physical break-up and discontinuance of the business leading to the ceasation of all
trading activities.

10.3 MODES OF DISSOLUTION

*

There are essentially two modes of dissolution of the firm and in the vrhole of this
unit the dissolution of the firm shall be discussed. The modes of disso'rution of the
firm are: (a) Dissolution without the order of the court, and (b) Dissolution by the
order of the court.
Mssolution without the order of the court
A firm is dissolved without the order of the court in any one of the following ways:
1) Dissolution by agreement (Sec. 40): A firm may be dissolved (i) with the consent
of all the partners or (ii) in accordance with a contract between the partners.
2) Compulsory dissolution (Sec. 41): A firm is compulsorily dissolved under the
following circumstances:
i) When all the partners or all the partners but one are adjudicated insolvent.
The reason is simple that an insolvent person ceases to be a partner and there
cannot be a partnership firm without at least two persons.
ii) When one of the partners is adjudicated insolvent unless there is a coptract
to the contrary.
iii) When the business becomes unlawful on the happening of some event.
3) Dissolution on the happening of certain contingencies; These are as follows:
i) the expiry of the term for which the firm was constituted
ii) the completion of the adventure
iii) the death of a partner
iv) the adjudication of a partner as an insolvent already discussed under (2) (ii)
above
4) Dissolution by Noticl: in case of partnership at wil!.
Dissolution by Court
Under Section 44, the court ian order dissolution of the firm on the following
80 grounds:
1) Where a partner becomes of an unsound mind
ii) Where a partner is permanently incapacitated to perform his duties
iii) Where a partner is guilty of misconduct
iv) Where a partner persistently commits breach of the partnership agreement
v) Where a partner has transferred the whole of his interest in the firm
vi) Where the business cannot be carried on except at a loss
vii) Where the court is satisfied that it is just and equitable that the firm should be

After dissolution, the rights and obligations of all the partners continue as before in
all the things necessary for the smooth winding up of the business of the firm.

10.4 SETTLEMENT OF ACCOUNTS

Normally partnership agreement goverrls the mode of settlement of accounts between
partners after the dissolution of a firm. But in the absence of any specific agreement
between the partners as to the mode of settlement of accounts between the partners
after the dissolution of the firm, the relevant provisions of the Partnership Act shall
apply, particularly Section 48 which stales:
In settling the accounts of a firm after dissolution the following rules, subject to
agreement by the partners, be observed:
a) Losses, ~ncludingdeficiencies of capital, shall be paid first out of profits, next out
of capital, and lastly, if necessary, by the partners individually in the proportions
in which they are entitled to share profits.
b) The assets of the firm, including any sums contributed by the partners to make
up deficiencies of capital, shall be applied in the following manner and order:
i) in paying the debts of the firm to third parties
ii) in paying to each partner rateably what is due to him from the firm for
advances as distinguished from capital
iii) in paying to each partner rateably what is due to him on account of capital and
iv) the residue, if any, shall be divided among the partners in the proportions in
which they are entitled to share profits.
The overall effect of the above provisions may be summarised in simple terms as

1) The assets of the firm must be first utilised in paying off the claims of third parties
against the firm.
2) ' The balance should be applied in repaying the advances (loans) made by the
partners to the firm as distinguished from the capital. If the amount is insufficient
to pay off the loans, they should be paid off rateably (proportionately).
3) The balance should be utilised in paying the claims of the partners in respect of
their capitals which should be after adjusting all accumulated profits or losses
and also drawings and realisations profit or loss.
Private Debts of Partners and Firms' Debts
The creditors of the firm (third party liabilities) shoula be paid out of the assets of
the firm. If there is any surplus, it will be divided among the partners as per their
claims which can be utilised for paying the private liabilities of the partners. Similarly,
the private creditors of partners should be first paid out of the private assets of
partners and if there is any surplus, it can be utilised for paying off the partnership

10.5 ACCOUNTING TREATMENT

As mentioned earlier, in case of dissolution of a firm, the trading activities of the
firm come to an end. The firm is to be wound up. Therefore, all the assets have to
be sold and the liabilities are to be paid off. For this purpose, a nominal account
named 'Realisation Account' is opened.
All the assets except cash in hand, bank balance, debit balance of P&L A/c and the
debit balances of partner's capital and current accounts are transferred to the debit
side of this account and are, thus, closed. Similarly, the accounts of all the outside
liabilities are closed by transferring them to the credit side of Realisation Account.
After closing these accounts, the assets aie sold off and the cash is realised which is
credited to the Realisation Account. With the cash so realised the liabilitbs are paid
off by debiting the Realisation Account and crediting the Cash Account. After this
the Realisation Account is balanced to work out the profit or loss on realisation.
The profit or loss is, then, divided amongst the partners in their profit sharing ratio.
Look at Figure 10.1 and see the proforma of Realisation Account.

Figure 10.1 Proforma of Realisation Account

Realisation Account

Dr.
Particulars ' Amount Particulars
Rs.
To Assets N c s By Liabilities N c s
(all the assets except (all the outside
Cash N c , Bank N c , debit Liabilities)
balances of P&L N c and
Partners' Capital N c ) By Bank N c
(cash realised on sale
To Bank N c of assets)
(cash paid to discharge
the liabilities) By Partners' Capital N c s
(Distribution of Loss,
To Partners' Capital Alcs if any)
(Distribution of profit,
if any)

There are three situations in case of dissolutiorr, viz.,

i) Simple dissolution
ii) Dissolution on account of insolvency of partners
iii) Dissolution on sale to a Company.
Under all the three categories of dissolution of firm the account books are to be
closed. Under the first two categories the assets of the firm are disposed off in the
market and the liabilities are paid off whereas in the case of sale to a company, most
assets and liabilities of the firm are transferred to the company and purchase
consideration realised. The assets not taken over by the company are disposed off in
the market and the liabilities not taken over by the company are paid off in cash and
the books are closed after paying the claims of the partners. Let us now discuss these
three situations one by one.

10.5.1 Simple Dissolution

By simple dissolution we mean that the partners have decided to dissolve the firm in
normal course and all the partners are solvent and the firm has not been sold to a
Joint Stock Company. Under simple dissolution the assets will be disposed off in the
market for cash although one or two items of assets may also be taken over by a
partner and the liabilities will be paid off and books closed. The journal entries
required to close the books under simple dissolution are as follows:
i) All the marketable assets (whether they realise anything or not) shall be
transferred to the Realisation Account at book values. Marketable assets shall
include all assets except cash in hand, bank balance, debit balance of profit and
loss account and debit balance of partners' capital or current accounts. Sundy
debtors should be transferred at gross value and any provision for doubtful
debts is to be regarded as liability. The entry will be as under:
Realisation A/c Dr. With the total amount
To Bills Receivable
To Debtors (Gross Figure) Individually, with their
To Stock respective book values.
To Preoaid Exvenses
 To Investments
To Furniture
To Plant & Machinery
To Land & Buildings
To Patents, Licences, Trade Marks, etc.
To Goodwill (it is a marketable asset and not fictitious)
ii) All the outside liabilities including the claims of relatives ef :ke partners and
the Provision for Doubtful Debts to be transferred to the credit side of
Realisation Account.
Creditors AJc Dr. Individually, with their
Provision for Doubtful Debts A/c Dr. respective book figures
Outstanding Expenses AJc Dr.
To Realisation A/c With the total amount
iii) For the disposal of theassets the entries may be made as follows depending on
the mode of disposal:
a) If the assets are sold for cash, the amount so realised should be debited to
Cash or Bank Account and Realisation Account should be credited.
CashiBank A/c Dr. With the total realised value
To Realisation A/c of all the assets
b) If any asset is taken over by a partner at an agreed value the partner should
be debited instead of cash and Realisation Account to be credited:
Partner' Capital AJc Dr. With the value of which
To Realisation A/c taken over
C) If there is an unrecorded asset (like furniture completely written off in
accounts but which is still in use and can be marketed), the entry for itssale
will be made and no entry is required for bringing it into account books.
The entry will be:
Cash AJc Dr. With the realised value
T o Realisation A/c
*
iv) For the discharge of outside liabilities Realisation Alc should be debited and
the re!want account to be credited depending upon the mode of discharge:
a) If cash is paid to discharge the claim, Realisation Account is debited and
Cash Account is credited:
Realisation AJc Dr. With the amount actually .
To Cash Alc
b) If a partner takes over the responsibility of discharging a liability, such
partner's capital account should be credited instead of cash
Realisation Alc Dr. With the amount at which
To Partner's Capital AJc taken one
c) If there is an unrecorded liability, it will also have to be paid off and the
entry will be:
Realisation AJc Dr. With the amount actually
To Cash AJc paid
(please note that there is no need of bringing the unrecorded liability into
books and the entry for payment of such liability will suffice)
v) The realisationlwinding up expenses, if any, incurred in the course of
dissolution should be debited to Realisation Account and the entry will be:
Realisation AJc Dr. With the amount of
To Cash Alc expenses
In case the realisation expenses are paid by the partner or the partners is
entrusted with the job of winding up, the entry will be
Realisation AJc Dr. With the amount of
To Partner's Capital AJc expenses
 loss which shculd be transferred to the capital accounts of the partners in their
profit sharing ratio.
The entry will be:
a) If there is realisation profit:
Realisation AJcs Dr. With the amount of
Profit
To Partners' Capital N c s Individually, in their
Profit sharing ratio
b) If there is realisation loss:
Partners' Capital AJcs Dr. Individually, in their
Profit sharing ratio
To Realisation A/c With the amount of Loss
vii) Loans advanced by partners as distinguished from their capital accounts should
be paid and the entry will be:
Parnter's Loan AJc Dr. With the amount of
To Cash A/c Loan
viii) All accumulated profits (standing in the name of Reserve Fund, General
Reserve, Profit and Loss Account credit balance etc.) and all accumulated losses
(standing in the name of profit and loss debit balance) should be transferred to
the partners' capital accounts in the profit sharing ratio as follows:
a) If there is accumulated Profit:
Reserve Fund Dr. As the case may be
General reserve Dr.
Profit and Loss A/c Dr.
To Partners' Capital AJcs Individually, in their profit
sharing ratio
b) If there is accumulated loss:
Partners' Capital AJcs Dr. Individually, in their profit
sharing ratio
T o Profit and Loss A/c With the amount of Loss
ix) In the end the claims of the partners in respect of their capitals will be settled.
If the capital account of a partner shows a debit balance, he will bring cash;
whereas if the capital account of a partner shows a credit balance, he will be
paid cash. Thus, all the accounts of the firm will be closed. The entries will be
as follows:
a) When the capital account shows a debit balance:
Cash A/c Dr. With the amount of
To Partners' Capital A/c deficiency
b) When the capital account shows a credit balance:
Partners' Capital AJc Dr. With the amount of
To Cash A/c final payment
Note: The amount finally payable to partner/partners must exactly be equal to the
amount of cash available.
Treatment of Goodwill: Goodwill is like any other saleable asset and it will be treated
on the same lines asany other saleable asset is treated. If it appears in the books, it
bill be transferred to Realisation Account and the sale proceeds shall be debited to
Cash Account and credited to Realisation Account. If it does not appear in books
but something is realised for it, it will be treated as unrecorded asset and its sale
proceeds shall be debited to Cash Account and credited to the Realisation Account,
like any other unrecorded asset. There is nothing special in the treatment of goodwill
on dissolution as such.
In case a partner agrees to buy the goodwill of the firm, his capital account shall bc
debited and Realisation Account shall be credited. But it should be remembered that
Goodwill is a saleable asset like any other asset though intangible but not fictitiou!
and it can be sold only at the time of dissolution and not otherwise. If the firm is
earning profits, the goodwill shall command some value but if the firm is not making
profits but is suffering losses, the goodwill may prove valueless but even then it woull
not be proper to treat it is fictitious asset. Look at Illustration 1 and see how the
books of the firm are closed in case of simple dissolution.
 Illustration 1 DiaealPtioada~m
The following is the Balance Sheet of A and B who shared profits in the ratio of 3:2
respectively:

Liabilities I Amount 1 Assets I Amount

Sundry Cred~tors 76,000 Cash at bank 23,000

I B~llspayable
Mrs. A's loan
Reserve Fund
30,oCO
20,000
10,000
Stock ~n trade
Debtors
Less Prov~s~on
40,OO
12.000

i
for Bad Debts 2.000 38.00
Capital Furn~ture 8,000
A 20.000 Mach~nerv 56,000

The firm wasdissolved on December 31, 1988. A took over investnre~~ts at an agreed
value of Rs. 16,000 and agreed to pay off the loan of Mrs. A. Stock realised
Rs. 10.000; Debtors Rs. 37,000; Furniture Rs. 9,000; and Machinery Rs. 50,000. The
creditors were paid off at a discount of 2112%. B agreed to realise the assets and pay

I
off the liabilities on a remuneration of Rs. 2,200. Actual expenses of realisation came
to be Ks. 2,000 which were paid by the firm. Give journal entries and prepare
Realisation Account, Partners' Capital Accounts and Bank Account to close the
books.
I Solution

1 I To Realisation N c ' I

i II To Realisation A/c
(total amount realised from sale of assets)

I iv) A's Capital M Dr. I

I v)
Realisation N c Dr.
1 1,04,10(!
I
' Dr.
 B's Capital Account

To Realisation .4/c
To Profit & Loss A/c

Bank Account

To Balance bid
To Realisation A/c

Check Your Progress A

1 State whether each of the following w o ~ M
result in dissolution of partnership or
dissolution of firm.
i) A, B and C are partners sharing profit & losses in the ratio 2:2:1. O n
December 21, 1989 C dies.
ii) X, Y and Z share profit & losses in the ratio of 1:2:1, Y is declared insolvent.
iii) P,Q and K are partners-sharing profits & losses in the ratio of 3:2:1. They agree
on dissolution.
iv) L, M and N share profits and losses equally. They decide to sell the firm and
d~videthe purchase consideration equally.

2 State whether following statements are True or False.

i) Diss~lutionof a firm automatically leads to the dissolution of partnership.
ii) The assets of the firm are first utilised in paying off the claim of the partners.
iii) All the assets and liabilities are closed by transferring them to a nominal
account called the Realisation Account.
iv) When an unrecorded liability is paid off Cash A/c is credited and Realisation
Alc is debited.
v) When realisation expznses are paid by the partner, the partner's capital A/c
is debited.

10.5.2 Dissolution os Account of Insolvency of Partners

The firm 1s normally dissolved when one or more partners become insolvent. The
procedure for closing the books under insolvency is almost the same as under simple
dissolution i.e. marketable assets and external liabilities are transferred t o a newly
opened Realisation Account and they are realised and paid off through the same
account and the loss or profit on realisation transferred to the capital accounts of the
partners. Thereafter if the capital account of a partner shows a debit balance, he
should pay the amount to the firm. But in case the partner is insolvent he will not be
able to pay at least the full amount. The sum not recoverable from the insolvent
partner is a loss to the firm. Now the question arises in which ratio thia loss should
be borne by the solvent partners? Pfior to the decision in Garner vs, Murray case
this was also treated as normal loss and borne by the solvent partners in their profit
sharing ratios. But in Garner vs. Murray case it was decided that such a loss was not
a trading loss but a capital loss which should be borne by the solvent partners in the
ratio of their capitals on the date of dissolution, for which the solvent partners should
bring the realisation loss in cash so that their capital accounts may show the balance
as on the date of dissolution. Although there has not been any court decision in India
in this respect, it is also followed in India. You know the capital account of partners 87
Partnership Accounts can be kept on fixed basis or on fluctuating basis. Let us nqw learn how to compute
the amount of deficiency of an insolvent partner to be borne by the solvent partners
in case uf fixed and fluctuating capitals.
Fixed and Fluctuating Capitals: If the capital accounts of the partners ark kept on
fixed basis, each partner w~llhave two accounts- one capital account and the other
a current account.'The capital account of each partner will show a fixed balance (the
same balance) year after year. All entries relating to drawings, profit or loss, interest
on capital or drawings etc. will be made in the current account of each partner. The
current account of a partner may show a debit balance or a credit balance but the
capital account of each partner will show the same fixed credit balance year after
year. Hence the deficiency of the insolvent partner will be borne by the solvent
partners in the ratio of their fixed capitals. Thus it is very easy to divide the deficiency
of the insolvent partner among the solvent partners if the capitals are kept on fixed
basis. But if the capital accounts of partners are kept on fluctuating basis, there will
be only one capital account and all entries relating to drawings, profit or loss. interest
on capital or drawings are made in the capital account. Thus, the balance in the
cap~talaccounts of each partner will fluctuate every year and every time an entry is
made. Under such situation, the deficiency of the insolvent partner will be borne by
the solvent partners in the ratio of their capitals as on the date of insolvency. This
means that all the accumulated profits or losses should first be divided among all the
partners (including the insolvent one) in their profit sharing ratios which will make
the capital accounts of the partners as on the date of insolvency. But no other entry
need be made. That is why when realisation loss is debited to the partners the Garner
vs. Murray decision requires the solvent partners to bring the realisation loss in cash

whether realisation loss is brought in cash or not. But if the question asks you to solve
it as per Garner vs. Murray rule, it would be advisable to show the realisation loss
as brought by the solvent partners in cash, which will make their capital account
balances as they were on the date of insolvency.
Dissolution on account of insolvency will be discussed under two sub-heads: (1) When
one of the partners is insolvent and (2) When all the partners are insolvent. The
accountini treatment in certain respects will be different under the two, Let us now
take them up one by one.
I

When One of the Partners is Insolvent

When a partner becomes insolvent and the books are to be closed, the entries upto
the preparation of Realisation Account and the transfer of realisation profit or loss
to the partners capital accounts will be the same as under simpke dissolution.
Thereafter the debit balande in the capital account of the insolvent partner after
adjusting any cash brought in by him (known as the deficiency of the insolvent
partner) shall be divided among the solvent partners in the capital ratio as explained
. above depending on whether the capital accounts are kept on fixed basis or
fluctuating basis.
Look at Illustration 2 and see how the books of account are closed when one partner
becomes insolvent.

Illustration 2
A , B and C are partners sharing profits in the ratio of 2:2:1 respectively. On
Dcccmher 31, 1988. theaate of dissolution of the firm, their Balance Sheet stood as
tollows:

Balance Sheet of A, B and C as on December 31, 1988

I

I.iahilities R9 Awtc
Creditors 30.lMH) Fixed Assets
Reserve Fund h.(lM) Barlk Balan~c
Capital Account9 Othcr Currcrit A99ct9
A 21,0(lo Current Account-C
B 9.tn)O
88 c -3.t~~) ~3.tnw)
 DLPsoluUan d a Partn~rrshipFirm

Rs. Rs.
To Realisation A/c 18,240 By Balance bld 3 .OOo
To C's Capital Alc 3,960 By Reserve Fund Alc 2.400
(share of deficiency) - By B's Capital A4 16.800
22,200
- 22.200
 C's Current 4ccuunt

Rs.
T o Balance bld 9,000 By Reserve Fund Alc
T o Real~sat~on
Alc -9,120 By C ' s Capital Alc
-
18,120

Bank Account

Rs.
T o Balance bld 1,500 By R e a l ~ s a t ~ oAlc
n
T o Realisat~onAlc 24.0M) By Realisation A/c
T o C's Cap~talAle 720 By A's Capital Alc
T o B's Capital Alc -7,800
-
34,020
-
Note: The reallsat~onloss of Rs. 45,600 and the Reserve Fund Rs. 6.000 have been dlvided V o n g the
partners lnclud~ngthe ~nsolventpartner in thelr proflt sharlng ratio of 2:2.1 respectivel$ But the
deficiency of the ~nsolventpartner C Rs. 13.20() after ddjustlng Rs. 720 brought by h ~ mIn cash 1s
dlvlded between the wlvent pdrt~er?.Aand B In t h c ~ rt~xedcapital ratlo wh~chis 21 .OM) 9.0Wor 7:3.

In lllustration 2 the capital accounts of the partners were kept on fixed basis and hence
the deficiency of the insolvent partner was divided between the solvent partners in
the ratio of their fixed capitals. But in case the capital accounts are kept on fluctuating
basis, the deficiency of the insolvent partner will be divided between the solvent
partners in the ratio of capitals as on the date of insolvency. lllustration 3 will help
you to clarify this point better.
Illustration 3
A , B, C and D are partners sharing profits in the ratio of 3:3:2:2 respectively. The
following is the Balance Sheet as on December 3 1 , 1988 when the firm was dissolved:

Balance Sheet as on December 31, 1988

L~abilities Assets
Rs. Rs.
Creditors lR.o()O Cashat Bank 3.MU3
General Reserve 201UIO Debtors 161UM)
Capital AecounJs Stock 22.000
A 21.000 Furniture 7.o(M)
B -
I2.oOU 33.olX) Capital Accounts
C I6 (MH)
- D - 7.000 23.0(H)
-
71 .OM)
- 7 1 ,Oo(I
-

Debtors realised Rs. 12,000; Stock Rs. 16,000 and Furniture Rs. 5,000. Creditors
were paid in full. Outstanding repairs bill for Rs. 3,500 was not recorded in the books.
Partners' joint life policy for Rs. 20,000 was surrendered for Rs. 3,500. The expenses
of realisation came to Rs. 500. C was insolvent but a sum of Rs. 4,200 was recovered
from hts estate. Write up accounts to close the books of the firm as per Garner vs.
Murray rule. You are also required to give proper working notes wherever necessary.

Solution
Realisation Account

Dr.

Rs.
To Debtors 16,000 By Creditors
To Stock A/c 22,000 By Bank A/c (assets real~sed)
To Furn~tureN c 7,000 By Bank.A/c
(Jolnt l ~ f epolicy)
90 To Bank Alc (crs. ant1 rep:rlrs) 2I 500 / I , V Capital A/cs (share of loss)
-
To Bank A/c (realisation exp.) 500 A 3,750 Dissolution of a Pa
B 3,750

A's Capital Account

Rs.
To Realisation (loss) 21,000
To C's Capital A/c 6,180 By General Reserve A/c 6,000
(share of deficiency)

B'4: Capital Account

Rs.
To Redlisation (loss) 3,750 By Balance bld 12,000
To C's Capital A/c 4,120 By General Reserve Alc 6,000
(share of deficiency)
To Bank A/c -
13,880 By Bank Alc
21,750
-- (payment of realisation loss) 21,750
-
-

C's Capital Account

Rs. Rs.
To Balance bld 16.000 By General ReserCe N c 4,000
To Realisation (loss) 2,500 By Rank Alc 4,200
By A's Capital Alc 6,180
By B's Capital Alc -
4,120
-
18,500

D's Capital Account

Rs.
To Balance bld 7,000 By General Reserve Alc 4,000
To Realisation (loss) 2,500 By Bank Alc
- 5,500
-
9,500 9,500

Bank Account

Rs.
To Balance 'old 21,500
To Realisation +/c 500
To Realisatit~nAlc 20.820
To A's Capital A/c 13.880
To B's Capital Alc
To C's Capital Alc
To D's Capital Alc

their respective shares in the accuniulated profits or losses which will be calculated

= 21,000 + 6,000 = 27,000. 91

 B = Capital + Share in General Reserve
= 12,000 + 6,000 = 18,000.
Hence Capital Ratio = 27,000:18,000
= 3:2.
Please note that although D is solvent but he will not share th,e deficiency of the
insolvent partner C because his capital account is showing a negative balance i.e.
debit balance. Thus, only A and B will share the deficiency and their ratio of
capital as on the date of insolvency is required.
2) In the question it is specifically mentioned that Garner vs. Murray rule should be
followed. Hence, the solvent partners should bring their share of realisation loss in
cash so as to know their capitals as on the date of insolvency.
When All the Partners are Insolvent
When all the partners become insol\.,ent, the unsecured creditors cannot be paid in
full as the amount available will not be svfficient to pay them in full. Hence, the
unsecured creditors should not be transferred to the Realisation Account but only
the marketable creditors which can be paid in full out of the sale proceeds of the asset
pledged against may be transferred tc; the Realisation Account. The assets shall be
realised and the secured creditors paid as above through the Realisation Account and
the realisation profit or loss transferred to the capital accounts of all the partners in
their profit sharing ratio as usual. If anything is recovered from fhe prikate estate of
any partner, it will be debited to Cash Account and credited to the partner's capital
account. Thereafter, the total amount of cash available will be paid to the unsecured
creditors. The unpaid balance in the unsecured creditors account shall then be
transferred to a newly opened Deficiency Account. Similarly, thc debit or credit
balance in the partners' capital accounts shall also be transferred to the Deficiency
Account. Thus all the accounts will be closed.
It may be noted here that when all the partners are insolvent, there is no solvent
partner to share the deficiency of the insolvent partners. Hence, the futile exercis,
of dividing the debit balance of some insolverlt partners among those insolvent
partners whose capital accounts show credit balance is totally uncalled for. It is
sufficient to open a Deficiency Account and to transfer the unpaid balance in
unsecured creditors account as well as the debit or credit balance in the partners
capital accounts to this account.
Illustrati~n4
The following is the Balance Sheet as on December 31, 1988 of A, B and C who
share profits equally.
Balance Sheet of A, B and C as on December 31, 1988
--
Idabilities Rs. Assets Rs.
Sundry Cred~tors 42.000 Cash ~nhand Z.(WW)
Bank Loan 0 , Stock 30,000
Cap~talAccounts A 8 . 0 Debtors 18,000
B 5.000 Furniture 5,000
C's Capital Account --
10.000
65,000 -
65.I)o

Due to pauci!y of funds the firm was dissolved on January 1, 1989. Bank b a n was
secured against stock which realised Rs. 22,000. The debtors realised Rs. 15,000 and
Furniture Rs. 2,000. The expenses on realisation were Rs. 1,MM. B and C could not
pay anything from their private estates.
However, a sum of Rs. 1,200 was received from the private estate of A.
Prepare accounts to close the books of the firm.
Solution
R m b a t b o Account

Dr.
Rs.
TOStyk NC 'Q,m Rv Rank I r a n 4/c
 18,OW By Cash Xic (assets realised) 39.000 Dissolution of 81 Partnership Firm

To Furniture A/c 5,000 By Partners Capital Ncs

(share of loss)
To Cash A/c (bank loan) 10,000 A 5,000
To Cash A/c (~xpenses)' r 1,000 B 5,000

Cash Account

To Balance bld
To Realisation A/c
To A's Capital Alc
---
Sundry Creditors Account

Rs. Rs .
To Cash N c 31,200 By Balance bld 42,000
To Deficiency A/c 10,800 -
42,000
-- 42,000
-

A's Capital Account

To Realisation A/c (loss)

Ti, Deficiency Alc
----

B's Capltal Account

T o Realisation A/c (loss)

C's Capital Account

To Realisation A/c (loss)

. -.---

Deficiency Accouat
--------
To C's Capital A/c
By A's Capital NC

Note: Bank loan is secured against stock and hence, i s fully secured as the sale proceeds of stock are
more than the amount of loan. Hence, it is transferred to Realisation A/c and paid oft there. As
all the partners are insolvent, the deficiency or surplus in their capital accounts have been
transferred to Deficiency Account. Similarly, the surplus in sundry creditors account is also
transferred.

account of the firm have to be closed. The procedure is more or less the same as
under simple dissolution. The assets taken over by the company (not all marketable
~~rtoclahlp
Accounts assets) are translerred to the Realisation Account which may also include cash if
taken over. Similarly, liabilities taken over by the company are also transferred to
Realisation Account. The purchase price commonly known as "Purchase'
Consideration" agreed between the parties is debited to the purchasing Company's
Account and credited to Realisation Account. The purchasing company settles the
purchase price by paying cash or issuing equity shares or both. Cash Account and
Equity Shares in Purchasing Company's Account will be debited and the account of
the purchasing company will be credited. Assets not taken over by the company are
disposed off and any profit or loss on such disposal is transferred to Realisation
Account. Or alternatively even those assets not taken over by the company be
transferred to the Realisation Account and realised through it, so that profit or loss
shall automatically get transferred to it. Similarly, liabilities not taken over by the
company will be paid off and any surplus or deficit shall be Gansferred to Realisation
Account. Alternatively, even those liabilities not taken over by the company may be
transferred to Realisation Account and paid off through it, so that the surplus or
deficit on this account automatically gets transferred to it. The expenses or
realisation, if any, shall be debited to Realisation Account. The balance in the
Realisation A/c will be either profit or loss whieh shall be transferred to the capital
accounts of the partners in their profit sharing ratios. The cash and shares received
. from the purchasing company will be divided among the partners as peg agreement
and books closed.
The purchase price may be glven in the question as a lump sum. But very often the
purchase price is not given but the student has to calculate it. There are two methods
of calculating purchase consideration. (1) Net Assets Method; and (2) Net Payments
Method. Under Net Assets Method, the agreed value of all the assets taken over by
the company including goodwill will be totalled from which the total of all the
liabilities taken over by the company shall be deducted and the resultant figure will
be the amount of net assets taken over and hence, the purchase consideration. Under
Net Payments Method, all the payments made by the purchasing company in the form
of cash, shares and debentures shall be totalled and this will be purchase
consideration. Sometimes, the purchasing company also pays the cost of winding up
of the firm which should be added to the purchase consideration. Another important
point to remember is the division of shares among the partners. The shares should
be divided among the partners as per agreement given in the question. But if nothing
is mentioned in the question in this respect, the shares may be divided in their profit
sharing ratios or alternatively in the ratio of their final claim. If the shares are divided
in profit sharing ratios, the balance claim will be paid in cash. But in case the shares
are divided in the ratio of their final claim, cash will also be divided in the same ratio.
Illustration 5
A , B and C were carrying on business in partnership sharing profits and losses in the
ratio of 5:3:2 respectively. On December 31, 1988 they agreed to sell their partnership
business to a limited company. The Balance Sheet of the firm as on the date of sale
was as follows:
Balance Sheet as on December 31, 1988

Liabilities Rs. Assets

Bank Loan 10,000 Buildings
Creditors 20,000 Machinery
Reserve Fund 10,000 Furniture
A's Capital 50,000 Book Debts
3&,000 Stock
C's Capital 32.000 Cash

The Company took the following assets at the valuations shown against each asset.
Buildings 80,080
Machinery 25,000
Furniture 5 ,OOo
Book Debts 38,000
Stock 30,000
94 Goodwill ??,000
Partnership Accounrs

i-
Rs.
T o A's CapitakNc 5,000 By Balance bld
T o B's Capital A/c 3 .rn
To C's Capital Alc -
2 ,000 -
10.000 10,000
-
Creditors taken over = Rs. 20,000.
Net Ahsets = Rs. 2,00,000 - Rs. 20,000 = Rs. 1,80,000.
The purchasing company has also agreed to pay the cost-sf
. winding up Rs. 4,000.
+
Hence, Purchase Consideration = Rs. 1,80,000 Rs. 4,000 = Rs. 1,84,000.
'2
Check Your Progress B
1 How do you settle the accounts of the partners in Garner vs Murray rule?
...............................................................................................................
...............................................................................................................
............................................................................................................... \

2 What are the different methods of calculating Purchase Consideration?

...............................................................................................................
...............................................................................................................
...............................................................................................................
3 Fill in the blanks.
i) ?he deficiency of insolvent partner is borne by the solve~itpartners in the
ratio of their .......................
ii) The share of loss on realisation is brought in .......................by the solvent
partners as per Gamer Vs. Murry rule.
iii) When all the partners are insolvent, the balance of Capital Accounts are
transferred to .......................Account.
iv) The purchase price at which the firm is sold is called .......................
v) The realisation profit is divided amongst the partners in .......................

10.6 LET US SUM UP

Dissolution means discontinuance. It can be dissolution of partnership or dissolution
of a firm. Dissolution of partnership means discontinuing the partnership relationship
whereas dissolution of a firm means discontinuing the trading activities of the firm.
A firm can be dissolved with or without the order of the court. On dissolution books
are to be closed and the accounts are to be settled.
All the assets are disposed off and the liabilities discharged. Liabilities are discharged
in the following order :
i) Third parties
ii) Loan and advances from partners
iii) Capital of partners
Accounting treatment of dissolution can be divided into three categories :
i) Simple Dissolution
ii) Dissolution on account of insolvency of partners
iii) Dissolution on sale to a company
Under simple dissolution, all the marketable assets are closed by transfer to the debit
side of an account called "Realisation Account". Similarly, all the outside liabilities
are closed by transfer to the credit side of Realisation Account. Then, all the assets
are disposed off and the liabilities are discharged. The balance of this account is profit
or loss which is divided amongst the partners in their profit sharing ratio. Ultimately,
the capital accounts of the partners are prepared and the balance is realised from or
paid to the partners.
Under dissolution on account of insolvency of one partner may be insolvent or all
partners may be insolvent. Realisation Account is prepared in the same manner as
in case of simple dissolution. In case one partner is declared insolveht, his deficiency
is borne by the remaining partners in their capital ratio keeping in view the nature
of capital accounts. When all the partners are declared insolvent, firstly the secured
creditors are-paid and then the payment is made to unsecured creditors. Any
 deficiency is transferred to Deficiency Account. Balances of Partner's Cdpital
Account is also transferred to Deficiency Account.
In case of dissolution on sale to a company the first step is the calculation of Purchase
Consideration. There are two methods for the calculation. i).Net Assets Method and
ii) Net Payments Method. The purchase consideration thus calculated is shown on
the credit side of Realisation Account. Purchase consideration may be received in
cash or the shares of the purchasing company which are divided amongst the pacners
in profit sharing ratio or ratio of final claim. All the assets and liabilities taken over
by the Purchasing Company are transferred to the Realisation Account. The assets
and liabilities not taken over are disposed off and discharged respectively. Any loss
or profit is transferred to the Realisation Account.

10.7 KEY WORDS

Deficiency of an Insolvent partner : Debit balance in the capital account of an
insolvent partner who is not in a position to pay to the firm from his private estate.
Dissolution : Discontinua~lceor break-up.
Dissolution of firm :'Break-up-of-%he firm and ceasation of business activities and,
consequefi'ly, closure of the books of accounts after settling all claims.
-
Dissolution of Partnership : Break-up of the partnership on admission, retirement,
death or insolvency of a partner but the business continues as usual.
Gamer vs. Murray Rule :The decision in Garner vs. Murray case according to which
the deficiency of an insolvent partner is to be divided among the solvent partners in
their capital ratio on the date of insolvency and the solvent partners are also required
to bring their share of realisation loss in cash.
Insolvent Partner : A partner who is not in a position to pay off his debts in full.
Realisation Loss :Loss incurredon realising the assets of the firm and paying off the
liabilities.
Winding-up Expenses : Expenses in connection with realisation of assets and paying
off liabilities.

10.8
- ANSWERS TO CHECK YOUR PROGRESS
A 1 i) Dissolution of partnership,
ii) Dissolution of partnership,
iii) Dissolution of firm,
iv) Dissolution of firm.
v) Dissolution of partnershiip.

B 3 i) Capitals as on the date of'dissolution

ii) Cash
iii) Deficiency
iv) Purchase consideration
v) Profit-sharing

10,9 TERMINAL QUESTIONSIEXERCISES

1) How would you distinguish between dissolution of partnership and dissolutioh of

Firm?
2) State legal provisions for adjusting losses and distributing assets on the dissolution
of partnership where.na agreement to the contrary exists.
98
 tnqolutkm of a Partmarship Flm
1) Atul, Bimal and Charu were partners sharing profits in the ratio of 2:2:1
respectively. Their Balance Sheet on December 31, 1988 is as follows :
Balance Sheet as on December 31, 1988

Rs. Assets C
Rs.
20,000 Cash 5 ,000
Reserve Fund 12,000 Debtors 22,000
Capital Accounts : Stock 15,000
Atul 40,000 Furniture 6,000
Bimal 20,000 Machinery 40,000
9,000
-
97,000
-

They decided to dissolve the firm. The assets realised as under :

Rs.
Debtors 16,000.
Stock 10,000
Furniture 2,000
Machinery 18,000
Goodwill nil
Creditors were paid off at a discount of 2%. Bimal was entrusted with the task of
realising assets and paying of liabilities for which he was to be credited with a sum
of Rs. 1,600. The actual winding up expenses were Rs. 1,200which were paid by
the firm. There was an unrecorded a3sets in the books which was taken over by
Bimal at an agreed price of Rs. 3,400. Repairs to mdchinery Rs. 800 were still
outstanding and were not recorded in books.
Draw up necessary account to close the books of the firm.
(Answer : Realisation Loss : Rs. 40,600, Atul receives Rs. 28,600. Bimal receives
Rs. 5,560, Charu brings Rs. 720)
2) A, B and C were partners in a firm. On December 31,1988 their capital accounts
were A --Rs. 40,000; B - Rs. 20,000 and C - Rs. 10,000. The Profit and Loss
Account on that date showed,a debit balance of Rs. 30,000. The firm was
dissolved on that date and the realisation loss came to be Rs. 36,000. C was
insolvent and was unable to bring anything from his private estate.
Calculate the amount of deficiency of the insolvent partner C to be borne by the
solvent partners A and B under the following situations :
a) If the capital accounts are kept on fixed basis
b) If the capital accounts are kept on fluctuating basis.
-
(Answer :Fixed basis : A Rs. 8,000 and B - Rs. 4,000;
Fluctuating basis : A - Rs. 9,000 and B - Rs. 3,000)
3) X, Y and Z were partners in a firm. On December 31,1987 their capital accounts

X (credit balance) Rs. 40,000

Y (credit balance)
Z (debit balance) Rs. 4,000 (Overdrawn) .
Creditors amounted to Rs. 28,900 were paid in full. There was no other liability.
There was no cash balance either. The assets realised Rs. 45,000 in all. Realisation
expenses amounted to Rs. 1,000. Z was insolverit.and only Rs. 2,000 could be
recovered from his private estate.
Prepare necessary accounts to close the books of the firm.
(Answer : Realisation loss : Rs. 30,000; Z's deficiency borne by X - Rs. 9,600
-
and by Y Rs. 2,400; X receives Rs. 20,400 while Y has to bring
Rs. 2,400) 99
4) A, B and C were partners in a firm sharing profits and losses in the ratio of 5:3:2
respectively. On December 31,1988 they decided to dissolve the firm when their
Balance Sheet was as under :

Balance Sheet as on December 31, 1988

Liabilities Rs. Assets Rs.

Creditors 24,000 Cash 2,000
B's Loan 10,000 Debtors 26,000
Capitals : A 24,000 Stock 22,000
B 16,000 Machinery 20,000
C 8,000 Investments 4,000
Current Accounts : A 10,000 Furniture 6,000
B 6,000 Current N c :C 6,000
Buildings 12;000
-
98,000 98,000
- -

A took over Buildings for Rs. 18,000 and B took overinvestments for Rs. 3,600.
Debtors, Stock and Machinery realised Rs. 22,000, Rs. 16,000 and Rs. 8,000
respectively. Furniture \;as sold for Rs. 4,000. The creditors were paid off at a
discount of ll/z%. There was a contingent liability for a bill receivable for
Rs. 2.400 discounted which was dishonoured by the drawee and it is estimated that
nothing will be recovered. Rs. 400 written off previously as bad debt were
recovered. Expenses of winding up were Rs. 800.
There was an unrecorded asset which ultimately realised Rs. 360 when sold in the
market.
A bill for repairs of machinery amounting to Rs. 520 was still not paid and was
also not recorded in books.
All the partners were declared insolvent.
Prepare necessary accounts to close the books of the firm.
(Answer : Realisation loss : Rs. 21,000; Insolvent Parnter C's deficiency borne
by A - Rs. 1,200 and by B - Rs. 800; A receives Rs. 4,300 and B
receives Rs. 11,300 excluding loan amount.)
5) A and B are partners in a firm sharing profits and losses in the ratio of 3:2
respectively. Their Balance Sheet as on December 31, 1988 was as follows.
- -
Balance Sheet as on December 31, 1988

Liabilities Rs. Assets

Creditors 18,000 Cash in hand

Reserve Fund 12,000 Debtors 24,000

Capital Alcs A 40,000 for Bad Debts 2,Oo'

B 30,000 Stock
Current N c s A 14,000 Furniture
B 12,000 Machinery
Buildings
Goodwill

1,26.000

The partners have decided to convert their business into a limited company as
from January 1,1989. For this purpose, a new company is formed which will take
over the business of the partnership firm. Current assets are taken over at book birdoilon d r PuWmhlp nnn
values and other assets at the values given below :
Name of the asset Agreed Value
Furniture 4,ooo
Machinery 20,000
Buildings 80,000
Goodwill ~,ooO

The company has agreed to issue equity shares of the face value of Rs. 10 each
as fully paid at par for the purchase consideration as agreed above.

Calculate purchase consideration and prepare necessary ledger accounts to close

9 I,
the books of the firm.
(Answer : Purcbase Consideration : Rs. 1,72,000; Profit on Realisation :
Rs. 64,000; A receives 9,960 shares and B receives 7,240 shares.

Note : These questions will help you to understand the unit better. Try to
write answers for them. But do not submit your answers to the
University for assessment. These are for your practice only.

- -

SOME USEFUL BOOKS

Maheshwari, S.N., 1998 : Introduction to Accounting Vikas Publishing House,
New Delhi. (Chapters 1, 2, 3 & 4 Section 111).
Gupta R.1,. and M. Radhaswamy, 1998. Advanced Accollnting Sultan Chand & Sons,
New Delhi. (Chapters 24).
Shukla, M.C., Grewal, T.S. & S.C. Gupta, 1998 : Advanced Accounts S. Chand & Co.
Ltd., New Delhi. (Chapter 9 & 10).
Monga J.R., Ahuja G.C. & Ashok Sehgal, 1998 : Advanced Accounting National
Publishing House, New Delhi.