Reconstitution and Dissolution of Partnership Firms
Reconstitution covers internal rearrangement - a change in the profit-sharing ratio or amalgamation of firms - while dissolution brings the firm itself to an end.
Change in profit-sharing ratio
Treat it like a retirement without a new partner. Compute the sacrifice and gain, adjust goodwill through capital accounts, and revalue assets and liabilities if required. Reserves already in the books are distributed in the old ratio.
Dissolution
- Assets are transferred to the debit of the Realisation account and liabilities to its credit; cash is the medium and is not transferred.
- Cash received on sale of assets is credited to Realisation; payment of liabilities is debited to it.
- The resulting profit or loss is shared in the profit-sharing ratio.
- Order of application of cash under Section 48 of the Indian Partnership Act: outside debts, then partners' loans, then partners' capitals.
- A partner's private assets are applied first to private debts, then to firm debts. Where capitals are fixed and a partner is insolvent, the deficiency is borne by solvent partners in their capital ratio (Garner v. Murray).
Worked example
Assets of book value ₹3,60,000 realise ₹3,00,000; realisation expenses ₹10,000 are paid. Realisation loss = (3,60,000 − 3,00,000) + 10,000 = ₹70,000, divided between the partners in the profit-sharing ratio.
Traps
- Transferring cash and bank balances to the Realisation account.
- Forgetting the payment entry for creditors, which understates the loss.
- Not transferring the provision for doubtful debts along with debtors.
- Paying partners' loans before outside creditors.