Q.Explain the process of settlement of accounts on dissolution of a partnership firm.
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Start your 14-day free trial to unlock the full solution →On dissolution, the firm settles accounts by first realising assets and paying off outside liabilities through a Realisation Account, then settling partners' loans, then capitals, in the order fixed by Section 48 of the Partnership Act.
When a partnership firm is dissolved, its affairs must be wound up — assets are sold/realised, outside liabilities are paid off, and the net surplus (or any deficiency) is finally settled among the partners. This process follows Section 48 of the Indian Partnership Act, 1932, and is carried out through the following steps:
Step 1 — Open a Realisation Account. All assets (other than cash/bank and any asset a partner has agreed to take over directly) are transferred to the debit of the Realisation Account at their book values; all outside liabilities (other than partners' loans/capitals) are transferred to its credit at their book values.
Step 2 — Realise the assets. Assets are sold/collected; the actual cash received is debited to Cash/Bank and credited to the Realisation Account. Any asset taken over by a partner is credited to the Realisation Account and debited to that partner's Capital Account (not to Cash).
Step 3 — Pay off outside liabilities. Liabilities are discharged in cash (debited to the Realisation Account, credited to Cash/Bank). If a partner undertakes to pay a liability personally, the Realisation Account is debited and that partner's Capital Account is credited.
Step 4 — Pay realisation expenses. Expenses of realisation (whether paid by the firm or by a partner on the firm's behalf, as agreed) are debited to the Realisation Account.
Step 5 — Close the Realisation Account, transferring the resulting profit or loss to all partners' Capital Accounts in their profit sharing ratio.
Step 6 — Settle accounts per Section 48's order of application of assets (including fresh cash brought in by partners, if capitals are in deficit):
- First, in paying the debts of the firm to third parties (outside liabilities, if not already settled through Realisation).
- Next, in paying each partner proportionately what is due for advances made to the firm (partners' loans), as distinguished from capital. …
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