Accounting Treatment

When a partnership firm is dissolved, the business stops, and the books must be closed. The goal is to sell all assets, pay all liabilities, and return the remaining cash to the partners. To track whether the sale of assets and payment of debts results in a gain or a loss, we open a temporary account called the Realisation Account.

Purpose of the Realisation Account

The Realisation Account is the central tool for dissolution accounting. It is a nominal account that calculates the net profit or loss from the process of converting assets into cash and settling liabilities. This profit or loss is then transferred to the partners' capital accounts in their profit-sharing ratio.

What Goes into the Realisation Account?

The account is prepared by transferring all assets and all external liabilities from the balance sheet. Here is the rule:

• Debit side (Dr.): All assets (except cash, bank balance, and fictitious assets like preliminary expenses or deferred revenue expenditure) are transferred here. This is done by debiting the Realisation Account and crediting the respective asset accounts.
• Credit side (Cr.): All external liabilities (sundry creditors, bills payable, bank overdraft, outstanding expenses, provision for doubtful debts, etc.) are transferred here. This is done by crediting the Realisation Account and debiting the respective liability accounts.

Recording Actual Realisation and Payment

After the initial transfer, the Realisation Account records the actual cash transactions:

• Sale of assets: When an asset is sold, the cash received is debited to the Bank Account and credited to the Realisation Account.
• Payment of liabilities: When a liability is paid, the Realisation Account is debited and the Bank Account is credited.
• Realisation expenses: Any expenses incurred for the dissolution (e.g., legal fees, auctioneer's fees) are treated like a liability. The Realisation Account is debited, and the Bank Account is credited.
• Assets taken over by a partner: If a partner takes over an asset, the partner's capital account is debited, and the Realisation Account is credited (as if the partner paid the firm for it).
• Liability assumed by a partner: If a partner agrees to pay a liability, the Realisation Account is debited, and the partner's capital account is credited.

The Final Step: Profit or Loss on Realisation

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

• If the credit side is larger (Credit balance): This is a Profit on Realisation. It is transferred to the partners' capital accounts in their profit-sharing ratio.
  • Journal Entry: Realisation A/c Dr. → To Partner's Capital A/c (individually)
• If the debit side is larger (Debit balance): This is a Loss on Realisation. It is transferred to the partners' capital accounts in their profit-sharing ratio.
  • Journal Entry: Partner's Capital A/c (individually) Dr. → To Realisation A/c

Treatment of Reserves and Accumulated Profits/Losses

Reserves (like General Reserve) and accumulated profits (like a credit balance in the Profit & Loss Account) belong to the partners. They are not transferred to the Realisation Account. Instead, they are directly distributed to the partners in their profit-sharing ratio.

• Journal Entry for General Reserve: General Reserve A/c Dr. → To Partner's Capital A/c (individually)

Similarly, accumulated losses (a debit balance in the Profit & Loss Account) are written off by debiting the partners' capital accounts in their profit-sharing ratio.

Unrecorded Assets and Liabilities

Sometimes, an asset or liability exists but is not shown in the balance sheet.

• Unrecorded Asset: If it is sold, the cash received is credited to the Realisation Account. If a partner takes it over, the partner's capital account is debited, and the Realisation Account is credited.
• Unrecorded Liability: When paid, the Realisation Account is debited, and the Bank Account is credited.

Format of the Realisation Account

The textbook provides the following standard format. Note that the debit side shows assets transferred and expenses paid, while the credit side shows liabilities transferred and cash received.

Realisation Account