Dissolution of Partnership Firms
Dissolution closes the firm: assets are sold, outside liabilities are paid, and whatever remains is distributed to partners.
The Realisation Account
Transfer every asset except cash and bank balances, and except fictitious balances such as the debit balance of Profit and Loss, to the debit of Realisation at book value. Transfer all external liabilities to the credit at book value. Do not transfer the partner's loan, capital accounts, reserves or the credit balance of Profit and Loss - these are settled through the capital accounts. On sale of an asset, credit Realisation with the proceeds; realisation expenses are debited; liabilities paid are debited. The balancing figure is profit or loss on realisation, shared in the profit-sharing ratio through the capital accounts. Cash is then applied: outside liabilities first, then the partner's loan, then partners' capitals.
Insolvency of a partner
A partner's capital deficiency is borne by the solvent partners in the ratio of their capitals as at dissolution (the Garner v. Murray rule), not in the profit-sharing ratio. If a solvent partner's capital is itself insufficient, that further deficiency is shared by the remaining solvent partners in the profit-sharing ratio (maximum loss method).
Worked example
Assets of book value ₹2,00,000 realise ₹1,80,000; outside liabilities of ₹60,000 are paid in full; realisation expenses are ₹5,000. Loss on realisation = ₹2,00,000 + ₹5,000 − ₹1,80,000 = ₹25,000, shared 3:2 as ₹15,000 and ₹10,000 through the capital accounts.
Traps
Transferring cash and bank to Realisation; transferring the partner's loan or capital to Realisation; distributing an insolvent partner's deficiency in the profit-sharing ratio; ignoring an unrecorded asset taken over by a partner or expenses paid privately by a partner.