Dissolution of a Partnership Firm notes: CBSE Class 12 Accountancy

1. Dissolution of partnership and dissolution of the firm

Dissolution of partnership: the existing agreement among the partners ends, for example on admission, retirement or death of a partner or a change in the profit-sharing ratio. The firm is reconstituted and its business and books carry on.

Dissolution of the firm: the business is closed and the relationship among all partners ends. Assets are realised, liabilities paid, partners settled and the books closed.

Dissolution of a firm always includes dissolution of the partnership; a dissolution of partnership need not end the firm.

Table comparing dissolution of partnership, where only the agreement ends and the business and books carry on, with dissolution of the firm, where the business is closed, assets are sold, liabilities paid and the books closed
Basis	Dissolution of partnership	Dissolution of the firm
What ends	The old agreement among the partners	The business and every partner’s relationship
Business	Carries on (reconstituted firm)	Is closed
Books	Continue; assets and liabilities revalued	Closed; assets sold, liabilities paid
Examples	Admission, retirement, death, change in ratio	Agreement to close, unlawful business, court order

Every dissolution of a firm is also a dissolution of partnership; not the other way round

Key terms

Dissolution of partnership: End of the existing agreement among partners while the firm continues in reconstituted form.
Dissolution of the firm: Closure of the business and end of the relationship among all the partners.
Reconstitution: Change in the partnership agreement with the business continuing.

2. Modes of dissolution of a firm

Mode	Section	Key point
By agreement	40	Consent of all the partners, or as their contract says
Compulsory	41	By law, whatever the partners wish; e.g. the business becomes unlawful
On contingencies	42	Unless agreed otherwise: fixed term expires, venture completed, a partner dies
By notice	43	Only a partnership at will; written notice to all other partners
By the court	44	Only on a partner’s suit, on a ground listed in the Act

Grounds for the court: unsound mind of a partner; permanent incapacity; misconduct harming the business; wilful or persistent breach of the agreement; transfer of a partner’s whole interest to a third party; business possible only at a loss; just and equitable grounds.

Indian Partnership Act 1932, Sections 40–44
Mode	Section	In short
By agreement	40	All partners consent, or as the contract provides
Compulsory	41	By law, e.g. the business becomes unlawful
On contingencies	42	Fixed term ends, venture completed, death of a partner (unless agreed otherwise)
By notice	43	Partnership at will: written notice by any partner
By the court	44	On a partner’s suit, on grounds the Act lists

Table: compulsory dissolution happens by law, for example when the firm’s trade is banned; dissolution on contingencies happens, unless agreed otherwise, when a fixed term ends, a venture is completed or a partner dies
Compulsory dissolution (Section 41)	On contingencies (Section 42)
Happens by law, even if the partners want to continue	Happens unless the partners have agreed otherwise
Example: a new law bans the firm’s trade	The fixed term of the firm ends
Example: the business can no longer be carried on lawfully	The venture the firm was formed for is completed
	A partner dies

Dissolution by notice (Section 43) needs a partnership at will and a written notice.
Ground for dissolution by the court (Section 44)	Imagined example
Unsound mind of a partner	A partner loses mental capacity; another partner sues
Permanent incapacity	A partner can never again do his share of the work
Misconduct or persistent breach	A partner keeps signing contracts the deed forbids
Transfer of whole interest	A partner sells his entire share to an outsider
Business only at a loss	Losses every year with no hope of recovery
Just and equitable ground	Deadlock: the partners cannot work together at all

Key terms

Partnership at will: A partnership with no fixed term and no particular venture; any partner may end it by written notice.
Compulsory dissolution: Dissolution that happens by operation of law, regardless of the partners’ wishes.

3. Settlement of accounts: Section 48

Unless the partners have agreed otherwise:

Losses (including a deficiency of capital) are borne in this order: from profits → from capital → by the partners personally in their profit-sharing ratio.

The firm’s assets (with any cash the partners bring in) are applied in this order:

Outside liabilities (debts to third parties).
Partners’ loans (advances), rateably.
Partners’ capitals, rateably.
Any residue, in the profit-sharing ratio.

Worked figure (imagined bakery): claims 2,20,000 − cash 2,10,000 = loss 10,000; capitals fall to 45,000 and 35,000.

Section 48, Indian Partnership Act 1932 (unless the partners agree otherwise)

Bar widths are computed from the amounts; the bank balance is used up exactly.

Loss = 2,20,000 − 2,10,000 = 10,000.
Order	Claim	Book (₹)	Paid (₹)
1	Creditors	90,000	90,000
2	Meena’s loan	40,000	40,000
3	Meena’s capital (less 1/2 of the loss)	50,000	45,000
3	Nitin’s capital (less 1/2 of the loss)	40,000	35,000
Total		2,20,000	2,10,000

Key terms

Outside liabilities: Amounts the firm owes to persons who are not partners: creditors, bills payable, loans from banks and others.
Rateably: In proportion to the amounts due to each partner.

4. The Realisation Account: transfers

Nominal account that records the sale of assets and the payment of liabilities and shows the profit or loss on realisation.

Transfer entries:

Realisation A/c Dr, To each asset A/c (book value; debtors gross; not cash, bank or fictitious assets).
Provisions A/c Dr, each outside liability A/c Dr, To Realisation A/c.

Not transferred: cash and bank; partners’ loans; capitals and current accounts; reserves and accumulated profits (credited to capitals); accumulated losses and deferred revenue expenditure (debited to capitals).

Format of the Realisation Account: on the debit side, assets at book value, cash paid for liabilities, realisation expenses, items paid or taken over by partners, and any profit; on the credit side, provisions, outside liabilities, cash from assets, assets taken over by partners, and any loss
Debit side (To)	Credit side (By)
All assets except cash, bank and fictitious assets, at book value (debtors gross)	Provisions against assets (doubtful debts, depreciation)
Cash paid to settle outside liabilities	All outside liabilities at book value
Realisation expenses borne by the firm	Cash received from assets, including unrecorded ones
Liabilities or expenses taken over or paid by a partner	Assets taken over by partners at agreed values
Balance: profit, to partners’ capitals	Balance: loss, to partners’ capitals

Table of items that do not pass through the Realisation Account: cash and bank, partners’ loans, capitals and current accounts, reserves and accumulated profits, and accumulated losses or deferred revenue expenditure
Item in the balance sheet	Where it goes on dissolution
Cash and bank balances	Stay in the Cash/Bank Account
Partner’s loan to the firm	Paid from the bank, after outside liabilities
Partners’ capitals and current accounts	Capital accounts, closed at the end
General Reserve; Profit and Loss credit balance	Credited to capitals, profit-sharing ratio
Profit and Loss debit balance; deferred revenue expenditure	Debited to capitals, profit-sharing ratio

Transfer entries for Narmada Textiles: assets to the debit of Realisation; provision and outside liabilities to its credit
Particulars	Dr (₹)	Cr (₹)
Realisation A/c Dr	3,50,000
To Building A/c		1,00,000
To Machinery A/c		1,00,000
To Furniture A/c		30,000
To Stock A/c		70,000
To Debtors A/c		50,000
(Being assets transferred to the Realisation Account)
Provision for Doubtful Debts A/c Dr	2,000
Creditors A/c Dr	60,000
Bills Payable A/c Dr	20,000
To Realisation A/c		82,000
(Being provision and outside liabilities transferred to the Realisation Account)

Key terms

Realisation Account: Nominal account prepared on dissolution to find the profit or loss on realising assets and settling liabilities.
Fictitious asset: A debit balance with no realisable value, such as a Profit and Loss debit balance or advertisement suspense.

5. Realising assets, paying liabilities, takeovers and unrecorded items

Event	Entry
Asset sold (recorded or unrecorded)	Bank A/c Dr, To Realisation A/c
Asset taken over by a partner	Partner’s Capital A/c Dr, To Realisation A/c
Liability paid (amount actually paid)	Realisation A/c Dr, To Bank A/c
Liability taken over by a partner	Realisation A/c Dr, To Partner’s Capital A/c
Unrecorded liability paid	Realisation A/c Dr, To Bank A/c
Creditor accepts an asset in full settlement	No entry
Creditor accepts an asset and some cash	Realisation A/c Dr, To Bank A/c (cash only)

The profit or loss on realisation = credit total − debit total, shared in the profit-sharing ratio.

Profit on realisation ₹18,000, shared 3:2:1.
Dr: Particulars	₹	Cr: Particulars	₹
To Building A/c	1,00,000	By Provision for Doubtful Debts A/c	2,000
To Machinery A/c	1,00,000	By Creditors A/c	60,000
To Furniture A/c	30,000	By Bills Payable A/c	20,000
To Stock A/c	70,000	By Bank A/c (Building realised)	1,34,000
To Debtors A/c	50,000	By Bank A/c (Machinery realised)	92,000
To Bank A/c (Creditors paid)	58,000	By Bank A/c (Debtors realised)	46,000
To Bank A/c (Bills Payable paid)	20,000	By Bank A/c (unrecorded computer sold)	5,000
To Bank A/c (realisation expenses paid)	4,000	By Asha's Capital A/c (Furniture taken over)	25,000
To Asha's Capital A/c (profit)	9,000	By Charu's Capital A/c (Stock taken over)	66,000
To Bhavesh's Capital A/c (profit)	6,000
To Charu's Capital A/c (profit)	3,000
Total	4,50,000	Total	4,50,000

Table of partner transactions: taking over an asset debits the partner’s capital and credits Realisation; taking over a liability or paying firm expenses debits Realisation and credits the partner’s capital
Transaction	Journal entry	Effect on the partner
Partner takes over an asset	Partner’s Capital A/c Dr, To Realisation A/c	Gets less cash at the end
Partner takes over (pays) a liability	Realisation A/c Dr, To Partner’s Capital A/c	Gets more cash at the end
Partner pays expenses for the firm	Realisation A/c Dr, To Partner’s Capital A/c	Gets more cash at the end

Table for unrecorded items: an unrecorded asset sold or taken over is credited to Realisation; an unrecorded liability paid by the firm or by a partner is debited to Realisation
Unrecorded item	What happens	Journal entry
Asset	Sold for cash	Bank A/c Dr, To Realisation A/c
Asset	Taken over by a partner	Partner’s Capital A/c Dr, To Realisation A/c
Liability	Paid by the firm	Realisation A/c Dr, To Bank A/c
Liability	Paid by a partner	Realisation A/c Dr, To Partner’s Capital A/c

Table of creditor settlements: accepting an asset in full settlement needs no entry; if cash is also paid, only the cash is recorded with Realisation debited; if the creditor pays the firm a difference, Bank is debited and Realisation credited
How the creditor is settled	Entry
Accepts an asset in full settlement	No entry
Accepts an asset plus some cash	Realisation A/c Dr, To Bank A/c (cash part only)
Accepts an asset worth more than the claim and pays the difference	Bank A/c Dr, To Realisation A/c (cash received)

Key terms

Unrecorded asset: An asset not shown in the books (for example, fully written off) that still has value on dissolution.
Profit on realisation: Excess of the credit side of the Realisation Account over its debit side.

6. Realisation expenses and remuneration to a partner

Two questions: who bears the expense, and who pays it?

Firm bears, firm pays → Realisation A/c Dr, To Bank A/c.
Firm bears, partner pays → Realisation A/c Dr, To Partner’s Capital A/c.
Partner bears, firm pays → Partner’s Capital A/c Dr, To Bank A/c.
Partner bears, partner pays → no entry.

Remuneration to a partner for winding up (with expenses to be borne by him): Realisation A/c Dr, To Partner’s Capital A/c with the remuneration only; the expenses follow the partner-bears rows above.

Table of five cases for realisation expenses: firm bears and pays, Realisation debit Bank credit; firm bears and partner pays, Realisation debit partner credit; partner bears and firm pays, partner debit Bank credit; partner bears and pays, no entry; remuneration is debited to Realisation and credited to the partner
Case	Entry
Firm bears and firm pays	Realisation A/c Dr, To Bank A/c
Firm bears, a partner pays	Realisation A/c Dr, To Partner’s Capital A/c
A partner bears, firm pays	Partner’s Capital A/c Dr, To Bank A/c
A partner bears and pays himself	No entry
Partner gets remuneration and bears expenses	Realisation A/c Dr, To Partner’s Capital A/c (remuneration); expenses as in rows 3 or 4

Journal entry for remuneration allowed to a partner for winding up the firm
Particulars	Dr (₹)	Cr (₹)
Realisation A/c Dr	5,000
To Gautam's Capital A/c		5,000
(Being remuneration allowed to Gautam for winding up the firm)

Key terms

Realisation expenses: Costs of winding up the firm, such as legal fees, advertising the sale and brokerage.
Remuneration for dissolution: A fixed sum allowed to a partner for carrying out the dissolution; a cost to the firm.

7. Partners’ capital and loan accounts, and the Bank Account

Capital accounts: opening balance (and current accounts) → reserves Cr / accumulated losses Dr → realisation profit Cr or loss Dr → assets taken over Dr → liabilities and expenses paid by the partner Cr → close.

Debit balance: Bank A/c Dr, To Partner’s Capital A/c (cash brought in).
Credit balance: Partner’s Capital A/c Dr, To Bank A/c (final payment).

Partner’s loan: Partner’s Loan A/c Dr, To Bank A/c, paid after outside liabilities and before capitals.

Bank Account: opening balance + cash from assets + cash brought in = liabilities and expenses paid + loans + capitals. It closes at nil.

General Reserve 24,000 shared 3:2:1: 12,000, 8,000, 4,000.
Dr: Particulars	Asha	Bhavesh	Charu	Cr: Particulars	Asha	Bhavesh	Charu
To Realisation A/c (assets taken over)	25,000	—	66,000	By Balance b/d	1,20,000	80,000	40,000
To Bank A/c	1,16,000	94,000	—	By General Reserve A/c	12,000	8,000	4,000
				By Realisation A/c (profit)	9,000	6,000	3,000
				By Bank A/c (cash brought in)	—	—	19,000
Total	1,41,000	94,000	66,000	Total	1,41,000	94,000	66,000

Partners’ loans are paid from the bank before any capital

The Bank Account closes at nil.
Dr: Particulars	₹	Cr: Particulars	₹
To Balance b/d	26,000	By Realisation A/c (liabilities paid)	78,000
To Realisation A/c (assets realised)	2,77,000	By Realisation A/c (realisation expenses)	4,000
To Charu's Capital A/c (cash brought in)	19,000	By Bhavesh's Loan A/c	30,000
		By Asha's Capital A/c	1,16,000
		By Bhavesh's Capital A/c	94,000
Total	3,22,000	Total	3,22,000

Key terms

Final payment: Cash paid to a partner to close his capital account after all adjustments.
Cash brought in: Cash a partner pays into the firm to make good a debit balance in his capital account.

Exam tips

Common mistakes

Transferring cash, bank, a partner’s loan or reserves to the Realisation Account.
Transferring debtors at the net figure and crediting the provision (counting it twice).
Recording an entry when a creditor accepts an asset in full settlement.
Debiting Realisation with expenses that a partner must bear.
Paying capitals before partners’ loans, or paying a partner before another partner’s debit balance is made good.
A Bank Account that does not close at nil: an item has been missed.

How marks are usually awarded

1 mark: correct option or entry.
3 marks: three journal entries, or a distinction on three bases.
4 marks: a Realisation Account, or a set of four entries with step marks.
6 marks: Realisation Account (about 2–3) + capital accounts (about 2) + Bank Account (about 1), or a full set of journal entries.

Not in the 2026–27 syllabus: piecemeal distribution of cash, sale of a firm to a company, and insolvency of partners (including its accounting treatment) are excluded from this chapter and are not examined.

Figures in SOYL practice are imagined; your board paper will give its own.

1. Dissolution of partnership and dissolution of the firm

Key terms

2. Modes of dissolution of a firm

Key terms

3. Settlement of accounts: Section 48

Key terms

4. The Realisation Account: transfers

Key terms

5. Realising assets, paying liabilities, takeovers and unrecorded items

Key terms

6. Realisation expenses and remuneration to a partner

Key terms

7. Partners’ capital and loan accounts, and the Bank Account

Key terms

Exam tips

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