Dissolution of Partnership Firm (including Realisation Account)
Dissolution of Partnership Firm tests the closing entries, especially the Realisation Account, and the order in which cash is applied. The firm's assets are sold, liabilities are paid, and the remaining cash is distributed to partners.
Realisation Account
Transfer all assets except cash/bank and fictitious assets at book value to the debit of Realisation. Transfer all external liabilities except partner's loan and capital/reserves to the credit. Record sale of assets, payment of liabilities, realisation expenses and unrecorded items. The balance is realisation profit or loss, shared by partners in the profit-sharing ratio. Partner's loan is paid after external liabilities; it is not transferred to Realisation.
Order of payment
Cash is applied: realisation expenses, external liabilities, partner's loan, then partners' capitals. If a partner is insolvent and cannot make good the deficiency, the loss is borne by solvent partners in their capital ratio (Garner v Murray), unless the deed says otherwise.
Worked example
Assets (excluding cash) ₹5,00,000; external liabilities ₹2,00,000. Assets realise ₹4,40,000; expenses ₹10,000. Realisation loss = 5,00,000 - 4,40,000 + 10,000 = ₹70,000. The liabilities are paid at book value, so they create no gain or loss. The ₹70,000 is debited to partners' capital accounts in the profit-sharing ratio.
Traps
Do not transfer cash/bank to Realisation. Do not transfer partner's loan or capital to Realisation. A partner who takes over an asset at an agreed value is debited in the capital account, not cash. If a partner agrees to bear realisation expenses, do not debit Realisation. Write off fictitious assets through capital accounts. Check for unrecorded assets and liabilities.