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Long Answer Questions · Q1

Q.Explain the process of dissolution of partnership firm?

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Dissolution of a partnership firm means the firm ceases to exist as a going concern. The process involves realising assets, paying off liabilities, settling partners' claims, and closing the books. The final step is distributing any surplus or deficit among the partners in their profit-sharing ratio.

Concept and Accounting Treatment

When a partnership firm dissolves, the legal entity ends. The accounting objective shifts from recording ongoing operations to winding up the business. The core principle is: all assets are sold, all external liabilities are paid, and the remaining cash (or deficit) is distributed among the partners according to their profit-sharing ratio.

The key account used is the Realisation Account. Think of it as a temporary account that summarises the entire dissolution process.

  • Debit side of Realisation Account: Records the book value of all assets (except cash/bank) transferred from the firm's books, plus any expenses paid for realisation (e.g., auctioneer's fees).
  • Credit side of Realisation Account: Records the sale proceeds of assets, the amount realised from debtors, and any liabilities taken over by a partner.

The balance of the Realisation Account is the profit or loss on realisation. This is transferred to the partners' capital accounts in their profit-sharing ratio.

Why this treatment? Because dissolution is a one-time event. We don't use the Profit and Loss Account for this. The Realisation Account captures the difference between the book value of assets and what they actually sold for, plus any unrecorded liabilities or expenses. This ensures partners share the final outcome of the business fairly.


Solution: Journal Entries and Ledger Accounts

Let's assume a simple case: A and B are partners sharing profits 3:2. Their firm is dissolved. The Balance Sheet on dissolution date shows:

LiabilitiesAmount (₹)AssetsAmount (₹)
Creditors20,000Cash5,000
A's Capital50,000Debtors30,000
B's Capital30,000Stock25,000
Furniture20,000
Plant20,000
Total1,00,000Total1,00,000

Additional Information:

  • Assets realised: Debtors ₹28,000; Stock ₹22,000; Furniture ₹18,000; Plant ₹22,000.
  • Creditors were paid ₹19,500 in full settlement.
  • Realisation expenses paid: ₹1,000.

Journal Entries

DateParticularsL.F.Debit (₹)Credit (₹)
1. Transfer of assets to Realisation Account
Realisation A/c Dr.95,000
To Debtors A/c30,000
To Stock A/c25,000
To Furniture A/c20,000
To Plant A/c20,000
(Being book value of assets transferred to Realisation Account)
2. Transfer of liabilities to Realisation Account
Creditors A/c Dr.20,000
To Realisation A/c20,000
(Being creditors transferred to Realisation Account)
3. Sale of assets
Bank A/c Dr.90,000
To Realisation A/c90,000
(Being assets realised: Debtors 28,000 + Stock 22,000 + Furniture 18,000 + Plant 22,000)
4. Payment of liabilities
Realisation A/c Dr.19,500
To Bank A/c19,500
(Being creditors paid in full settlement)
5. Realisation expenses paid
Realisation A/c Dr.1,000
To Bank A/c1,000
(Being realisation expenses paid)
6. Transfer of Realisation profit/loss
Realisation A/c Dr.5,500
To A's Capital A/c (3/5)3,300
To B's Capital A/c (2/5)2,200
(Being profit on realisation transferred to partners' capital accounts in 3:2 ratio)
7. Final payment to partners
A's Capital A/c Dr.53,300
B's Capital A/c Dr.32,200
To Bank A/c85,500
(Being final amount paid to partners on dissolution)

Realisation Account

ParticularsAmount (₹)ParticularsAmount (₹)
To Debtors A/c30,000By Creditors A/c20,000
To Stock A/c25,000By Bank A/c (assets sold)90,000
To Furniture A/c20,000
To Plant A/c20,000
To Bank A/c (creditors paid)19,500
To Bank A/c (expenses)1,000
To A's Capital A/c (profit)3,300
To B's Capital A/c (profit)2,200
Total1,10,000Total1,10,000

Partners' Capital Accounts

ParticularsA (₹)B (₹)ParticularsA (₹)B (₹)
To Bank A/c (final payment)53,30032,200By Balance b/d50,00030,000
By Realisation A/c (profit)3,3002,200
Total53,30032,200Total53,30032,200

Bank Account

ParticularsAmount (₹)ParticularsAmount (₹)
To Balance b/d5,000By Realisation A/c (creditors)19,500
To Realisation A/c (assets sold)90,000By Realisation A/c (expenses)1,000
By A's Capital A/c53,300
By B's Capital A/c32,200
Total95,000Total95,000

Working Notes

1. Calculation of Realisation Profit/Loss

ItemAmount (₹)
Total book value of assets transferred (Debtors 30,000 + Stock 25,000 + Furniture 20,000 + Plant 20,000)95,000
Add: Creditors paid (liability taken over)19,500
Add: Realisation expenses paid1,000
Total debit side1,15,500
Less: Creditors transferred (credit side)(20,000)
Less: Sale proceeds of assets (credit side)(90,000)
Net profit on realisation5,500

2. Distribution of Profit

  • A's share (3/5 of ₹5,500) = ₹3,300
  • B's share (2/5 of ₹5,500) = ₹2,200

3. Final Payment to Partners

  • A: Opening capital ₹50,000 + Profit ₹3,300 = ₹53,300
  • B: Opening capital ₹30,000 + Profit ₹2,200 = ₹32,200
Watch out

A common mistake is to transfer the cash/bank balance to the Realisation Account. Do not do this. Cash is not an asset to be realised; it remains in the Bank Account and is used to pay liabilities and partners. Also, remember that liabilities are transferred to the credit side of Realisation Account, not the debit side.

Tip

To quickly check if your Realisation Account is correct: The total of the debit side (assets book value + expenses + liabilities paid) should equal the total of the credit side (liabilities transferred + sale proceeds + profit). If they don't match, you've missed something.

✓Final answer

The dissolution process involves transferring assets and liabilities to a Realisation Account, selling assets, paying liabilities, and distributing the resulting profit or loss among partners in their profit-sharing ratio. In this example, the firm realised a profit of ₹5,500, which was shared between A (₹3,300) and B (₹2,200). A received ₹53,300 and B received ₹32,200 as final settlement.

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