Mehak and Ravish were partners in a firm. On dissolution of the firm, the loan given by Mehak to the firm was

Question

Q. Mehak and Ravish were partners in a firm. On dissolution of the firm, the loan given by Mehak to the firm was ₹ 30,000, by Ravish was ₹ 15,000, and by Mrs. Ravish was ₹ 10,000. The first payment will be made for : (A) Ravish's loan (B) Mehak's loan (C) Mrs. Ravish's loan (D) Mehak's loan and Ravish's loan in the ratio of their loan amount

(OR)

Surbhi and Leena were partners in a firm sharing profits and losses in the ratio of 5 : 3. Ashi was admitted as a new partner for 1/4 share in the profits of the firm. Ashi acquired 3/5 of her share from Surbhi. From the following, how much share did Ashi acquire from Leena : (A) 1/10 (B) 3/20 (C) 2/5 (D) 3/8

CBSECBSE Class XII Board 2023MCQ· 1mImportance★★★★★

✓ Free question

Concept understanding — Dissolution Accounting Treatment

Dissolution of a Partnership Firm – The Accounting Treatment

Let’s start with something you already know. Imagine you and a friend run a small tiffin service together. You both put in money, buy utensils, rent a space, and share the profits. One day, you decide to stop. You sell the utensils, pay the rent you owe, and split whatever cash is left. That’s dissolution — the end of the partnership.

Now, in Accountancy, dissolution means the firm ceases to exist. All assets are sold, all liabilities are paid off, and the remaining money (or loss) is divided among the partners. The accounting treatment is simply the set of rules we follow to record this winding-up process in the books.

Why does dissolution need a separate treatment?

During the life of a firm, we use a Profit and Loss Appropriation Account to share profits, and a Capital Account to track each partner’s stake. But when the firm dissolves, we stop using those accounts. Instead, we open a Realisation Account — the star of dissolution accounting.

The Realisation Account is like a temporary “sale and settlement” account. It collects:

All assets (except cash/bank) at their book value.
All liabilities (except partner’s loan or capital) at their book value.
The actual sale proceeds of assets.
The actual payment made to settle liabilities.
Any expenses of dissolution.

At the end, the balance of the Realisation Account — profit or loss on realisation — is transferred to the partners’ capital accounts in their profit-sharing ratio.

The accounting treatment step-by-step

Step 1: Transfer assets (except cash/bank) to the debit of Realisation Account

Journal entry:

Realisation A/c          Dr.   [Book value of all assets except cash/bank]
    To Sundry Assets A/c        [Individually or collectively]

Why? Because we are removing the assets from the books. The Realisation Account now “holds” them.

Step 2: Transfer liabilities (except partner’s loan or capital) to the credit of Realisation Account

Journal entry:

Sundry Liabilities A/c   Dr.   [Book value of all liabilities]
    To Realisation A/c          [Total liabilities]

Why? Liabilities are obligations. By transferring them to the credit side, we show that the Realisation Account will now handle their payment.

Step 3: Record sale of assets

When assets are sold:

Bank A/c                 Dr.   [Actual sale amount]
    To Realisation A/c          [Sale proceeds]

If an asset is taken over by a partner (instead of sold outside):

Partner’s Capital A/c    Dr.   [Agreed value]
    To Realisation A/c          [Agreed value]

Step 4: Record payment of liabilities

When liabilities are paid:

Realisation A/c          Dr.   [Amount paid]
    To Bank A/c                 [Amount paid]

If a liability is taken over by a partner:

Realisation A/c          Dr.   [Amount of liability]
    To Partner’s Capital A/c    [Amount of liability]

Step 5: Record dissolution expenses

If paid by the firm:

Realisation A/c          Dr.   [Expense amount]
    To Bank A/c                 [Expense amount]

If paid by a partner personally (and not reimbursed), no entry is needed — it’s treated as the partner’s contribution.

Step 6: Close the Realisation Account

After all assets are sold and liabilities paid, the Realisation Account will have a balance.

If the credit side is larger → Profit on Realisation → transfer to partners’ capital accounts in profit-sharing ratio.
If the debit side is larger → Loss on Realisation → transfer to partners’ capital accounts in profit-sharing ratio.

Journal entry for profit:

Realisation A/c          Dr.   [Profit amount]
    To Partner’s Capital A/c    [Each partner’s share]

For loss:

Partner’s Capital A/c    Dr.   [Each partner’s share]
    To Realisation A/c          [Loss amount]

Step 7: Close partners’ capital accounts

After all adjustments, the capital accounts show the final amount due to each partner. This is paid in cash:

Partner’s Capital A/c    Dr.   [Final balance]
    To Bank A/c                 [Amount paid]

If a partner’s capital account shows a debit balance (they owe the firm), they bring in cash:

Bank A/c                 Dr.   [Amount brought in]
    To Partner’s Capital A/c    [Amount brought in]

The format of the Realisation Account

Here’s how it looks in the NCERT textbook style:

Dr.	Realisation Account	Cr.
Particulars	Amount (₹)	Particulars
To Sundry Assets (all except cash/bank)	XXX	By Sundry Liabilities (all except partner’s loan/capital)
To Bank (liabilities paid)	XXX	By Bank (assets sold)
To Bank (dissolution expenses)	XXX	By Partner’s Capital (assets taken over)
To Partner’s Capital (liabilities taken over)	XXX	By Partner’s Capital (liabilities taken over)
To Partner’s Capital (profit transferred)	XXX	By Partner’s Capital (loss transferred)
Total	XXX	Total

Note

The Realisation Account is not a Profit and Loss Account. It does not show revenue or expenses of the business — only the gains or losses from converting assets to cash and settling liabilities.

A key distinction: Dissolution vs. Partnership Dissolution

In Class 12, you study dissolution of a partnership firm (the whole firm ends). This is different from dissolution of partnership (where the firm continues but partners change). In the latter, we use a Revaluation Account, not a Realisation Account. Don’t mix them up.

Common mistake to avoid

Students often forget to transfer all assets (except cash/bank) and all liabilities (except partner’s loan or capital) to the Realisation Account. Also, remember: cash and bank balances are not transferred — they remain in the Bank Account and are used to pay off dues.

Final takeaway

Dissolution accounting is about closing the books cleanly. The Realisation Account is the temporary workspace where we:

Remove assets and liabilities from the books.
Record actual sale and payment amounts.
Find the net gain or loss.
Distribute that gain/loss to partners.
Finally, settle each partner’s capital account in cash.

Once the Bank Account is empty and all partners’ capital accounts show zero, the books are closed. The firm is dissolved.

(a) First payment goes to Mrs. Ravish's loan — an external liability (C). (b) Ashi acquired 1/10 from Leena (A).

On dissolution the order is: outside/third-party liabilities first, then partners' loans, then capitals, then surplus. Mrs. Ravish is a third party (a partner's spouse), so her loan is an external liability paid before the partners' own loans (Mehak's and Ravish's).

✓Final answer

(C) Mrs. Ravish's loan.

Concept understanding — Sacrificing Ratio Definition

Let’s start with something you already know from everyday life.

Suppose you and your friend share a pizza equally — half each. One day, your friend says, “I’m not that hungry, you can have a bigger slice today.” So you take 60% and your friend takes 40%. Your friend has sacrificed 10% of the pizza in your favour. That 10% is the sacrificing ratio — the share your friend gave up so you could have more.

Now bring this into a partnership firm. Partners share profits in a fixed ratio (say 3:2). When a new partner is admitted, the old partners have to give up a part of their share to make room for the newcomer. The proportion in which they give up their shares is called the sacrificing ratio.

Precise meaning

Important

Sacrificing ratio = Old ratio – New ratio (for each old partner).

If the result is positive, that partner has sacrificed. If negative, that partner has gained (which is called the gaining ratio, used at retirement).

For example, if A and B share profits 3:2, and they admit C for a 1/5th share, the new ratio might become 2:2:1. Then:

A’s sacrifice = 3/5 – 2/5 = 1/5
B’s sacrifice = 2/5 – 2/5 = 0

So A alone sacrifices 1/5th of the total profit. That 1/5th is the sacrificing ratio between A and B — here it’s simply 1:0.

Why does it matter?

Because the new partner brings in goodwill (a premium) to compensate the old partners for the share they gave up. That goodwill is distributed among the sacrificing partners in their sacrificing ratio. If you don’t calculate the sacrificing ratio correctly, you’ll distribute the goodwill unfairly — and that’s a serious accounting error.

Accounting treatment

When the new partner brings in his share of goodwill in cash:

Journal entry:
- Debit: Cash/Bank A/c (with the amount brought in)
- Credit: Premium for Goodwill A/c (with the same amount)
Then the premium is distributed to the sacrificing partners:
- Debit: Premium for Goodwill A/c
- Credit: Old Partners’ Capital A/cs (individually, in sacrificing ratio)

If the new partner does not bring in cash, the adjustment is done through the capital accounts directly (the new partner’s capital is debited, and the old partners’ capitals are credited).

Format: Capital Accounts (showing goodwill adjustment)

Here’s how the old partners’ capital accounts look after the goodwill is credited (assuming A and B sacrifice in ratio 1:0, and C brings ₹50,000 as premium):

Particulars	A (₹)	B (₹)	C (₹)
To Balance b/d	—	—	—
By Premium for Goodwill A/c	50,000	—	—
By Balance c/d	…	…	…

(Only A gets the full ₹50,000 because he alone sacrificed.)

A quick check

Watch out

Never confuse sacrificing ratio with new ratio. The new ratio is what the partners will share in future. The sacrificing ratio is only about what the old partners gave up. They are not the same.

If you ever see a problem where the new partner’s share is given but the old ratio is unchanged, the sacrificing ratio equals the old ratio — because the new partner’s share is taken equally from the old partners. But that’s a special case, not the rule.

Final takeaway: Sacrificing ratio = Old ratio – New ratio. It determines who gets how much of the goodwill brought in by the new partner. Without it, the entire goodwill adjustment is meaningless.