Reconstitution and Dissolution of Partnership Firms
Reconstitution here means a change in the profit sharing ratio without admission or retirement; dissolution means the firm is wound up. The exam tests goodwill adjustment, revaluation and the realisation account.
Change in profit sharing ratio
- Identify the sacrificing and gaining partners; goodwill is adjusted through capital accounts.
- Revalue assets and liabilities; the profit or loss goes to partners in the old ratio.
- Reserves and accumulated profits are distributed in the old ratio when the ratio changes.
Dissolution
- Governed by the Indian Partnership Act, 1932; the firm's assets are realised and liabilities paid.
- Open a realisation account: debit book value of assets (except cash and bank) and expenses; credit amounts realised and liabilities transferred.
- Pay outside liabilities first, then partners' loans, then partners' capitals.
- If a partner's capital is deficient and the partner is insolvent, apply Garner v Murray.
Worked example
Assets with a book value of ₹1,00,000 realise ₹80,000; liabilities of ₹30,000 are settled at ₹28,000; realisation expenses are ₹1,000. Loss on assets = ₹20,000; gain on liabilities = ₹2,000; expenses = ₹1,000. Net loss = 20,000 − 2,000 + 1,000 = ₹19,000, borne by partners in the profit sharing ratio.
Traps
- Transferring cash and bank balances to the realisation account.
- Ignoring fictitious assets, which must be written off.
- Paying partners' capitals before outside liabilities.
- Treating a secured loan as an ordinary liability without considering the asset charged.