Dissolution of Partnership Firms
What dissolution tests
Dissolution ends the economic relationship between partners: the firm's assets are realised, liabilities paid, and the balance distributed. The exam tests the Realisation Account, partner's loan accounts, capital deficiencies, and insolvency.
Core rules
- Open a Realisation Account: transfer all assets except cash and bank, and external liabilities. Provisions are transferred, not the corresponding asset's gross value twice.
- Cash and bank are not transferred; they are used to pay realisation expenses and liabilities.
- Realisation expenses: if borne by the firm, debit Realisation A/c and credit Cash/Bank; if borne by a partner, debit that partner's capital A/c.
- Sale of assets: debit Cash/Bank, credit Realisation. Realisation profit or loss is transferred to partners' capital accounts in the PSR.
- A partner's loan is paid before partner's capital. A secured loan is paid from the asset pledged; any shortfall is an unsecured liability.
- If a partner's capital account has a debit balance and the partner is insolvent, apply Garner v Murray: solvent partners bear the deficiency in their capital ratio, not the PSR, unless the deed says otherwise.
Worked example
Assets (book value) ₹90,000; liabilities ₹30,000; cash ₹5,000. Assets realise ₹70,000; realisation expenses ₹2,000 paid by the firm. Realisation A/c: debit assets ₹90,000 and cash expenses ₹2,000; credit cash ₹70,000. Loss = 90,000 + 2,000 − 70,000 = ₹22,000. Debit partners in PSR. Cash available = 5,000 + 70,000 − 2,000 − 30,000 = ₹43,000, which is distributed as capital. Reasoning: cash is never part of the Realisation Account; liabilities are paid before capital.
Traps
Transferring cash to Realisation; recording a provision and also deducting it from the asset; paying partner's loan after capital; ignoring a contingent liability that becomes payable; and sharing an insolvent partner's deficiency in the PSR instead of the capital ratio.