Dissolution of Partnership Firm and Journal Entries


Partnership Accounts – Dissolution of Partnership Firms

Meaning of Dissolution

Dissolution 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 paid or settled. The partners can withdraw their capital investment. Further if there is any surplus or deficit comes the same will be shared by the partners in their profit sharing ratio.

Reasons of Dissolution of Partnership firm

Dissolution of a partnership firm can take place due to the following reasons:

a. Dissolution by Agreement: When the partners themselves reach an agreement to discontinue their business for any reason.

b. Compulsory Dissolution: Compulsory dissolution takes place because of business of the firm is declared illegal, or the partners become insolvent.

c. Dissolution by notice: A partner can demand dissolution of a partnership at will, by giving a notice to the firm.

d. Dissolution by Court: Court may initiate dissolution of a firm due to following circumstances:

i) When one of the partners has become of unsound mind
ii) When a partner is guilty of misconduct which may affect the business
iii) When a partner commits wilful breach of contract
iv) Any other reason which the court may find adequate

e. Dissolution by the expiry of a pre determined period or completion of event: Such partnerships will be dissolved due to completion of the specific period of or the project as the case may be.

Dissolution of Partnership and Dissolution of Partnership Firm

The 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 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:

Dissolution of Partnership

  • Only the agreement is dissolved, no physical disposal takes place.
  • The partners will continue to run the business with a new agreement.
  • Limited effect on employees or debtors and creditors of the business
  • Many dissolutions of agreement can take place during the life of a partnership business.
  • Admission, retirement and or death of a partner can result in compulsory dissolution of existing agreement. Dissolution of Partnership Firm
  • The Firm is dissolved, by selling off assets and settling liabilities.
  • The partners will discontinue the business
  • Since the business is closed down it affects the workers, debtors and creditors of the firm
  • Dissolution of firm can take place only once in the lifetime of a partnership business.
  • None of these events can lead to a compulsory dissolution of the firm.

Settlement of Accounts on Dissolution

The first step in dissolution is the realisation of assets and settlement of outside liabilities. All individual accounts for assets and liabilities, except cash, are closed by transferring their balances to a Realisation Account. Further Realisation account is the temporary account for accumulating all assets and liabilities. 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 dissolution:

i) Expense incurred on realisation of assets such as commission, cartage, brokerage etc.
ii) All outside creditors
iii) Partner’s Loan accounts
iv) Balances in Capital Accounts of partners

Special Items In Case of Dissolution

1. Treatment of Goodwill: Goodwill does not have any special treatment in dissolution. If it appears in the books it has to be transferred into Realisation Account. If goodwill does not appear in the books just ignored it.

2. Realisation Expenses: Expenses of realisation such as commission paid to brokers for the disposal of assets, 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 then treat as drawing of partner.

3. 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.

4. Provident Fund: Provident fund should be understood as a liability payable to the employees. It should be paid off.

5. Specific Funds: Specific funds like Investment Fluctuation Funds , Provision for doubtful debts and accumulated depreciation etc. must be credited to Realisation Account along with the transfer of assets.

6. 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.

7. Unrecorded Assets: Unrecorded assets are those 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. Thus realisation from thease assets can be directly credited to realisation account and by debiting cash account.

8. Transfer of Assets to Creditors : When creditors purchase some assets against amount due to them.  Debit the Creditors account by passing a journal entry and credit the assets account. If the value of asset taken over is more than the amount due, the creditors will pay the excess amount to the firm.

 

In the end Profit or loss on realization will be transferred to the Capital Accounts of partners in therir profit sharing ratio. Only Cash Account and Capital Accounts will be left. The final balances of each other will match exactly.  Cash will be paid off to capital accounts to close both the accounts.

This is the last transaction in the books of the firm.

The entire in realization can be summarized as follows:

Step 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. Therefore please reduce into just three account like;

i) Realisation Account
ii) Capital Accounts of Partners (considered one account)
iii) Cash Account

Step 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.

Step 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.

Journal Entries in Dissolution : 

Accounting for dissolution begins with the closing of assets and liabilities accounts by transferring them to Realisation Account.

i) For transfer of assets

Realisation Account Dr.

To Asset Account

ii) For Transfer of liabilities

Liability Account Dr.

To Realisation Account

Accumulated profits such as General Reserves, Profit and Loss Account Credit Balance etc. are transferred to capital Accounts in the profit sharing ratio.

iii) For transfer of accumulated profits

General Reserve; P&L etc. Dr.

To Realisation Account

Note: Provision for doubtful debts; Investment fluctuation fund etc. are credited to realization account. These are internal provisions may have no claim against the firm. Therefore,  finally ignore them.

iv) For assets realized

Cash/Bank account Dr

To Realisation Account

Note: 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.

v) For Liabilities paid off

Realisation Account Dr.

To Cash Account

vi) For asset taken over by a partner

Partner’s Capital Account Dr.

To Realisation Account

vii) For Liability taken up by the partner

Realisation Account Dr.

To Partner’s Capital Account

viii) For unrecorded asset taken over by a partner

Partner’s Capital Account Dr.

To Realisation Account

ix) Unrecorded Liability settled by the firm

Realisation Account Dr.

To Cash account

x) Realisation expense

Realisation Account Dr.

To Cash

xi) Asset taken over by creditors

Creditors A/c Dr

To Assets A/C

37 Comments

  • ajmal manihar (#)
    September 24th, 2015

    if cash in hand & cash at bank both appears in balance sheet then which account we have to open (dissolution chapter)

    • ca.aryendra (#)
      September 24th, 2015

      Use first cash account if balance is huge then deposit it to bank. Remaining balance of cash and bank account transfer in capital account.

    • avinash (#)
      November 26th, 2016

      I will be given in question

  • sunny (#)
    October 31st, 2015

    If capital reserves is shown in balance sheet then where we can show it at the time of dissolution of patnership.

    • ca.aryendra (#)
      November 1st, 2015

      Transfer it to partners capital in the profit share long ration if nothing mention in partnership ratio and if given in partnership deed then act accordingly.

    • Sachin (#)
      November 29th, 2015

      It is transfered directly to partners caiptal ac

      • ca.aryendra (#)
        December 7th, 2015

        if there is any reserve or fund againest assets or liability than it is better to transfer realisation account. However, if no payment of realization is required then you can transfer to partners capital account

  • Rishabh Gang (#)
    November 20th, 2015

    Why is goodwill not directly transferred in partners capital account in case of dissolution

    Even when tranferring in realisation account it will indirectly effect partners capital

    • ca.aryendra (#)
      December 18th, 2015

      each and every entry in realisation account would be effecting partners capital account, because good will is a intangible fixed assets and all assets should be routed through partners capital account.

    • sangram (#)
      April 14th, 2017

      Tu Hai

  • Yashansh Baranwal (#)
    December 5th, 2015

    What will be the journal entry?
    If A was entitled to receive ₹270 as remuneration for completing the dissolution work and was to bear the realisation expenses. The expenses of realisation ₹170 were paid out by A out of his profits.
    Ques from DISSOLUTION. I want my with explanation.

    • ca.aryendra (#)
      December 7th, 2015

      Remuneration dr 270
      To A 270
      A Dr 270
      To Cash 270
      Realisation A/c Dr 270
      To Remuneration Account 270

  • Venkateshwar reddy (#)
    January 2nd, 2016

    Why credit balance (liabilities) of realisation called as surplus ???

    • ca.aryendra (#)
      January 15th, 2016

      it means u got gain due to non payment of ur liability

  • Shweta (#)
    March 17th, 2016

    If creditors of rs.30000 accepted machinery of rs.28000 in full settlement then which entry is passed??

    • ca.aryendra (#)
      March 21st, 2016

      Creditors Debit Rs. 30,000/-
      To Machinery Rs. 28,000/-
      To Realization A/c Rs. 2,000/-

  • Balwant rana (#)
    April 11th, 2016

    if there in adjestment it is written thats the firm purchese some goods from creditors in previous year 2014 and received but omitted to be recored in books then what is the adjestment of this in the year 2015 ….

    DOUBT :.is that wheater it is first recored and then payment is made or directly paid without any proir recording….

    chapter name: dissoluation of partnership firm

    please reply immidatlly

    • ca.aryendra (#)
      April 20th, 2016

      Dear Balwant, it would be better, adjust it without taken on record or treat it as current year entry.

  • kushal atul negandhi (#)
    April 15th, 2016

    What is the entry for unrecorded liability of Rs3000

    • ca.aryendra (#)
      April 20th, 2016

      Realisatio account Dr
      To Cash account

      (Being 3,000/- paid to land lord against one month committed rent)
      Please note here unrecorded liability means contingent liability like one month salary to employee and two month future rent)

    • sabnam (#)
      May 27th, 2016

      a realisation account mai assets side mai to cash bol k entry hogi and cash account mai by realisation bol k entry hogi

      • ca.aryendra (#)
        June 12th, 2016

        It is unclear question I could not understand. What question u want to ask.
        Both is possible

  • Uttam Behera (#)
    May 23rd, 2016

    Sir (1)what do u mean by specific reserve and give the example of specific reserve and its treatment

    • ca.aryendra (#)
      May 26th, 2016

      Provision for Bed Debts and Depreciaiton Reserve. Then transfer it Realization account along with debtors and Assets.

  • Hayley (#)
    June 1st, 2016

    realisation account is open under balance sheet ?

    • ca.aryendra (#)
      June 12th, 2016

      No sub am it is your wrong question. Balance sheet is not a ledge is just a presentation of balances of various account.

  • Umang (#)
    September 11th, 2016

    Treatment of unrecorded liability and assets in case realized/ paid in cash or taken by partner in realisation a/c and partner’s capital a/c.

  • laxmi (#)
    September 13th, 2016

    sir, please explain unrecorded liability and asset treatment effect.
    is it wrong if we record the asset which was unrecorded and then write it off.

    what will be the treatment in the following case.

    creditors as on dec 2012 -25000

    goods amounting to 4000 have been purchased in nov 12 and had been received but their purchase was not recorded.

    in the book I refer, partners account have been debited with 4000 and realisation account has been credited.

    please reply soon.
    thank you.

    • gangwar (#)
      September 19th, 2016

      Purchase a/c Dr
      To Creditors
      (Being unrecorded purchase accounted for)
      Realisation A/c
      To Purchase
      (Purchase transfer to realisation account)
      Creditors A/c Dr
      To Cash
      (Being cash paid)

      Or you can directly treat as goods has been taken by partners then debit partners capital account and credit realisation account.

    • gangwar (#)
      September 30th, 2016

      Pp

  • gangwar (#)
    September 13th, 2016

    Hi I could not understand urgent query

  • avinash (#)
    November 26th, 2016

    Sir can you make a list of reserves ,,, funds ,goodwill, where to transfer

  • ankit dev (#)
    March 24th, 2017

    Sir I have a question…Suppose a is partner in firm and wile dissolution of firm…A,s loan(20,000) is pay off by unrecorded asset of 25,000 in full settlement …What,s it,s entry is to be passed…….

    • caaryendra (#)
      March 25th, 2017

      Partners Capital A/c Debit 20,000.00
      To Realisation A/s Credit 20,000.00

      (Being unrecorded assets taken by partner against loan of Rs. 20,000/-)

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