Journal Entries

Understanding the Journal Entries for Dissolution of a Partnership Firm

When a partnership firm is dissolved, the entire process of closing the books revolves around one central account: the Realisation Account. This account is opened to record the sale of assets, payment of liabilities, and the ultimate profit or loss on dissolution. Think of it as a temporary account that replaces all the asset and liability accounts of the firm.

The logic is straightforward: all assets (except cash, bank, and fictitious assets) are transferred to the debit side of the Realisation Account at their book values. All external liabilities are transferred to its credit side. Then, as assets are sold, the cash received is credited to the Realisation Account. When liabilities are paid, the amount paid is debited to the Realisation Account. The balance of this account — whether a profit or a loss — is finally transferred to the partners' capital accounts in their profit-sharing ratio.

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1. Transfer of Assets to Realisation Account

All assets except cash at bank, cash in hand, and fictitious assets (like preliminary expenses, discount on issue of shares, etc.) are closed by transferring them to the debit side of the Realisation Account at their book values.

Important points to note:

• Sundry debtors are transferred at their gross value (the full amount before deducting provision for doubtful debts).
• The provision for doubtful debts is transferred separately to the credit side of the Realisation Account along with liabilities.
• The same treatment applies to fixed assets where a provision for depreciation account is maintained — the asset is transferred at its original cost, and the provision is transferred to the credit side.

Journal Entry:

(Being assets transferred to Realisation Account at book value)

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2. Transfer of Liabilities to Realisation Account

All external liability accounts, including provisions (like provision for doubtful debts, provision for depreciation), are closed by transferring them to the credit of the Realisation Account.

Journal Entry:

(Being external liabilities transferred to Realisation Account)

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3. Sale of Assets

When assets are sold for cash, the amount realised is recorded.

Journal Entry:

(Being assets sold)

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4. Asset Taken Over by a Partner

When a partner takes over an asset (instead of it being sold to an outsider), the partner's capital account is debited and the Realisation Account is credited.

Journal Entry:

(Being asset taken over by partner)

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5. Payment of Liabilities

When liabilities are paid, the Realisation Account is debited and Bank is credited with the amount at which the liability is settled.

Journal Entry:

(Being liability paid)

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6. Liability Taken Over by a Partner

When a partner agrees to personally discharge a liability of the firm, the Realisation Account is debited and the partner's Capital Account is credited. This effectively means the firm is relieved of that liability, and the partner will pay it from their personal funds.

Journal Entry:

(Being liability taken over by partner)

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7. Settlement with Creditor Through Transfer of Assets

This situation has three possible scenarios:

Case A: Creditor accepts an asset in full and final settlement

No journal entry is recorded. The asset is simply given to the creditor, and the liability is considered settled. The Realisation Account already has the asset on its debit side and the liability on its credit side — the net effect is captured when the account is balanced.

Case B: Creditor accepts an asset as part payment

Only the cash payment is recorded. For example, if a creditor was owed ₹10,000, accepts office equipment worth ₹8,000, and is paid ₹2,000 in cash, the entry is made only for the cash payment of ₹2,000.

Journal Entry:

(Being balance amount paid to creditor)

Case C: Creditor accepts an asset whose value is more than the due amount

The creditor pays the excess amount in cash to the firm.

Journal Entry:

(Being excess amount received from creditor)

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8. Payment of Realisation Expenses

Realisation expenses are the costs incurred in the process of selling assets and paying liabilities. The treatment depends on who bears these expenses.

Case A: Expenses paid by the firm

(Being realisation expenses paid by the firm)

Case B: Expenses paid by a partner on behalf of the firm

(Being realisation expenses paid by partner on behalf of firm)

Case C: Partner has agreed to bear the realisation expenses

• If payment is made by the firm: The partner's Capital Account is debited (since the partner bears the cost) and Bank is credited.
• If the partner pays the expenses themselves: No entry is required.

Journal Entry (when firm pays but partner bears):

(Being realisation expenses borne by partner paid by firm)

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9. Remuneration to Partner for Dissolution Work

When a partner is given agreed remuneration for undertaking the dissolution work, the Realisation Account is debited and the partner's Capital Account is credited.

Journal Entry:

(Being remuneration allowed to partner for dissolution work)

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10. Realisation of Unrecorded Assets

Unrecorded assets (including goodwill not shown in the books) when realised are recorded as:

Journal Entry:

(Being unrecorded asset realised)

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11. Settlement of Unrecorded Liability

When an unrecorded liability is discovered and paid:

Journal Entry:

(Being unrecorded liability paid)

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12. Transfer of Profit or Loss on Realisation

After all assets have been sold and liabilities paid, the Realisation Account will show either a credit balance (profit) or a debit balance (loss).

Case A: Profit on Realisation (Credit Balance)

(Being profit on realisation transferred to partners' capital accounts in profit-sharing ratio)

Case B: Loss on Realisation (Debit Balance)

(Being loss on realisation transferred to partners' capital accounts in profit-sharing ratio)

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13. Settlement of Loan by Firm to a Partner

If the firm had given a loan to a partner, that loan is recovered during dissolution.

Journal Entry:

(Being loan from partner recovered)

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14. Transfer of Accumulated Profits/Reserves

Accumulated profits in the form of General Reserve, Workmen Compensation Reserve, etc., are transferred to partners' capital accounts in their profit-sharing ratio.

Journal Entry:

(Being general reserve transferred to partners' capital accounts)

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15. Transfer of Fictitious Assets

Fictitious assets (like preliminary expenses, discount on issue of shares, debit balance of Profit and Loss Account) are written off by transferring them to partners' capital accounts in their profit-sharing ratio.

Journal Entry:

(Being fictitious asset written off)

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16. Payment of Loans Due to Partners

Partner's loan (distinct from partner's capital) is an external liability of the firm and is paid off.

Journal Entry:

(Being partner's loan paid)

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17. Settlement of Partners' Capital Accounts

After all the above entries have been passed, each partner's capital account will show either a debit balance (the partner owes money to the firm) or a credit balance (the firm owes money to the partner).

If a partner's capital account shows a debit balance:

The partner brings in the necessary cash.

Journal Entry: …