Q.How is deficiency of creditors paid off at the time of dissolution of firm?

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. |

|---------|--------------------------|---------| …