Dissolution of Partnership Firms
Two different events
Dissolution of partnership changes the relation between partners but the firm continues; dissolution of firm ends the business. Grounds: Section 40 by agreement; 41 compulsory when the business becomes unlawful; 42 on insolvency of all but one partner; 43 on notice by a partner at will; 44 by order of the court.
The Realisation Account
All assets except cash and bank, and all external liabilities, are transferred at book value to the Realisation Account. Sale proceeds of assets are credited; payments of liabilities and dissolution expenses are debited. The balance is profit or loss, shared in the profit-sharing ratio and transferred to the partners' capital accounts.
Order of settlement
Realisation → Bank → Partners' Capital → Partners' Loan. A partner's loan is repaid before capital, and a partner's debit balance is settled by bringing in cash, or by the rule in Garner v. Murray when he cannot pay.
Worked example
Book value of assets excluding cash ₹3,00,000; creditors ₹1,00,000. Assets realised ₹2,60,000; creditors paid ₹95,000 (a 5% discount); expenses ₹5,000. Debit side: 3,00,000 + 95,000 + 5,000 = ₹4,00,000. Credit side: 2,60,000 + 1,00,000 = ₹3,60,000. Loss on realisation ₹40,000, shared by the partners.
Traps
Passing cash entries through Realisation instead of the Bank Account; transferring cash and bank balances to Realisation; settling a partner's loan after capital; ignoring unrecorded assets taken over by a partner; and recording a contingent liability only once it becomes payable.