1. Dissolution of partnership and dissolution of the firm
Dissolution of partnership ends the existing agreement among the partners, but the firm continues: admission, retirement, death and a change in the profit-sharing ratio all reconstitute the firm, and its books are adjusted.
Dissolution of the firm ends the relation of partnership among all the partners. The business closes; the assets are realised, the liabilities paid and the partners settled, so every account in the books is closed.
A dissolution of the firm always dissolves the partnership; a dissolution of the partnership need not dissolve the firm.
Not in the ISC 2027 syllabus for this chapter: admission-cum-retirement, amalgamation of firms, conversion or sale to a company, piecemeal distribution and insolvency of partners.
| Basis | Dissolution of partnership | Dissolution of the firm |
|---|---|---|
| What ends | The old agreement among the partners | The relation among all partners and the business |
| Business | Continues (reconstitution) | Closed down |
| Books of account | Adjusted: revaluation, goodwill, capitals | Closed: Realisation, capital and Bank/Cash accounts |
| Examples | Admission, retirement, death, change in ratio | All partners agree to close; the court orders winding up |
| Link | May happen without dissolving the firm | Always dissolves the partnership too |
| Situation (imagined firms) | Partnership or firm? | Why |
|---|---|---|
| Sraboni retires from Bagdogra Tea Tasters; the other two carry on | Partnership only | Business continues under a new agreement |
| Nalbari Bell Metal admits a third partner | Partnership only | Reconstitution: books adjusted |
| All partners of Chumoukedima Bamboo Shoots agree to wind up and sell the assets | Firm | Business closed; every account settled |
| The partners of Naharlagun Cane Craft change their ratio from 1 : 1 to 3 : 2 | Partnership only | Same partners, new agreement |
Key terms
- Dissolution of partnership
End of the existing agreement among the partners while the firm and its business continue.
- Dissolution of the firm
End of the relation of partnership among all the partners, with the business closed and its books closed.
2. Settlement of accounts under Section 48
Section 48 of the Indian Partnership Act, 1932 governs the settlement of accounts between partners after dissolution, subject to any agreement among them.
(a) Losses, including deficiencies of capital: paid first out of profits, next out of capital, and lastly by the partners individually in their profit-sharing ratio.
(b) Application of assets (including sums partners contribute to make up deficiencies):
- debts of the firm to third parties;
- each partner rateably what is due for advances (loans), as distinct from capital;
- each partner rateably what is due on account of capital;
- the residue, if any, among the partners in their profit-sharing ratio.
Working: loss = total claims (outside debts + partners' loans + capitals) − cash available; capital paid = capital − share of loss.
| Ziro Kiwi Orchards (imagined) | Claim (₹) | Paid (₹) |
|---|---|---|
| Creditors (third parties) | 1,10,000 | 1,10,000 |
| Pratyush's loan | 30,000 | 30,000 |
| Oishee's capital less 3/5 of the loss | 70,000 | 58,000 |
| Pratyush's capital less 2/5 of the loss | 50,000 | 42,000 |
| Total | 2,60,000 | 2,40,000 |
Key terms
- Rateably
In proportion to the amounts due to each partner under that head.
- Deficiency of capital
The amount by which a partner's share of losses exceeds his capital.
3. The Memorandum Balance Sheet
A Memorandum Balance Sheet is the firm's balance sheet drawn up on the date of dissolution, in horizontal form, to set out the balances that must now be closed. It is a statement, not an account, and is not part of the double entry.
It is useful when the question gives ledger balances in a list, or when one figure (often cash/bank or a partner's capital) is missing: the missing figure is the balancing amount.
Check: total liabilities and capitals = total assets.
| Liabilities | ₹ | Assets | ₹ |
|---|---|---|---|
| Creditors | 38,000 | Umbrella-making Machines | 60,000 |
| Bills Payable | 6,000 | Stock | 34,000 |
| Ishfaq's Loan | 10,000 | Debtors | 22,000 |
| General Reserve | 8,000 | Cash in Hand (balancing figure) | 26,000 |
| Capital: Banalata | 50,000 | ||
| Capital: Ishfaq | 30,000 | ||
| Total | 1,42,000 | Total | 1,42,000 |
Key terms
- Memorandum Balance Sheet
A balance sheet prepared on the date of dissolution only to show the balances to be closed; not part of the double entry.
- Balancing figure
The amount that makes the two sides of a statement agree; used to find a missing balance.
4. The Realisation Account and the ISC rules for transfers
The Realisation Account is a nominal account opened on dissolution to find the profit or loss on realising the assets and settling the outside liabilities.
Transfer entries
- Realisation A/c Dr. To each asset A/c (gross book value; not cash, bank, a loan to a partner or fictitious assets).
- Related provision or fund A/c Dr., outside liability A/cs Dr. To Realisation A/c.
ISC 2027 rules
- A fund or reserve related to an asset or liability taken to Realisation is also transferred to Realisation, not to capitals (e.g. provision for doubtful debts, provision for depreciation, investment fluctuation fund).
- Bank overdraft is taken to the Bank/Cash A/c, not to Realisation; a bank loan is transferred to Realisation.
Silent items (ISC assumptions)
- Tangible assets and investments: realised at book value.
- Intangible assets, accrued income, prepaid expenses: realise nil.
- Liabilities: paid in full.
| Balance on the date of dissolution | Goes to (ISC 2027) |
|---|---|
| Assets (except cash/bank, loan to a partner, fictitious assets) | Realisation A/c, debit, at gross value |
| Provision or fund related to an asset or liability (doubtful debts, depreciation, investment fluctuation) | Realisation A/c, credit |
| Outside liabilities, bank loan | Realisation A/c, credit |
| Bank overdraft | Bank/Cash A/c (opening credit balance); not to Realisation |
| Partner's loan to the firm | Partner's Loan A/c; repaid through Bank/Cash |
| Loan given to a partner | Debited to that partner's Capital A/c |
| General reserve, credit balance of profit and loss | Partners' Capital A/cs, profit-sharing ratio |
| Debit balance of profit and loss, advertisement suspense | Partners' Capital A/cs (debit), profit-sharing ratio |
| Current accounts (fixed capitals) | Transferred to Capital A/cs |
| Debit side (To) | Credit side (By) |
|---|---|
| Assets other than cash/bank, at book (gross) value | Provisions and funds related to those assets |
| Cash paid for outside liabilities (incl. bank loan) | Outside liabilities at book value (incl. bank loan) |
| Realisation expenses borne by the firm | Cash from assets sold (recorded and unrecorded) |
| Liabilities or expenses paid by a partner (his capital) | Assets taken over by partners (their capitals) |
| Unrecorded liabilities paid | Loss (balancing figure) to capitals, profit-sharing ratio |
| Profit (balancing figure) to capitals, profit-sharing ratio |
| If the question is silent about… | Assume (ISC 2027) |
|---|---|
| A tangible asset or investments | Realised at book value |
| An intangible asset (goodwill, patents, trademarks) | Realises nothing |
| Accrued income or a prepaid expense | Realises nothing |
| The payment of a liability | Paid in full |
| Liabilities | ₹ | Assets | ₹ |
|---|---|---|---|
| Creditors | 48,000 | Goodwill | 12,000 |
| Bank Loan | 30,000 | Machinery | 1,30,000 |
| Bank Overdraft | 12,000 | Investments | 44,000 |
| Shehnaz's Loan | 20,000 | Stock | 52,000 |
| Investment Fluctuation Fund | 6,000 | Debtors 70,000 less Provision for Doubtful Debts 4,000 | 66,000 |
| General Reserve | 18,000 | Prepaid Insurance | 2,000 |
| Capital: Abhrajit | 90,000 | Loan to Dorjee | 8,000 |
| Capital: Shehnaz | 60,000 | ||
| Capital: Dorjee | 30,000 | ||
| Total | 3,14,000 | Total | 3,14,000 |
| Particulars | Dr (₹) | Cr (₹) |
|---|---|---|
| (i) Realisation A/c Dr. | 3,10,000 | |
| To Goodwill A/c | 12,000 | |
| To Machinery A/c | 1,30,000 | |
| To Investments A/c | 44,000 | |
| To Stock A/c | 52,000 | |
| To Debtors A/c | 70,000 | |
| To Prepaid Insurance A/c | 2,000 | |
| (Being assets transferred to the Realisation Account) | ||
| (ii) Provision for Doubtful Debts A/c Dr. | 4,000 | |
| Investment Fluctuation Fund A/c Dr. | 6,000 | |
| Creditors A/c Dr. | 48,000 | |
| Bank Loan A/c Dr. | 30,000 | |
| To Realisation A/c | 88,000 | |
| (Being related provisions and funds and outside liabilities transferred to the Realisation Account) |
| Kamalabari Mask Makers (imagined) | Rule | Amount (₹) |
|---|---|---|
| Stock: nothing said | Tangible: book value | 52,000 |
| Goodwill: nothing said | Intangible: nil | 0 |
| Prepaid insurance: nothing said | Prepaid expense: nil | 0 |
| Bank loan: nothing said | Liability: paid in full | 30,000 |
| Investment Fluctuation Fund | Related to investments: Realisation credit | 6,000 |
| Bank overdraft | Bank A/c, credit side | 12,000 |
| Loan to Dorjee | Dorjee's Capital A/c, debit | 8,000 |
Key terms
- Realisation Account
Nominal account recording the transfer, sale and settlement of assets and outside liabilities on dissolution; its balance is the profit or loss on realisation.
- Related fund or provision
A balance set aside against a particular asset or liability; it follows that item into the Realisation Account.
5. Realising assets, settling liabilities and unrecorded items
- Asset sold: Bank/Cash A/c Dr. To Realisation A/c.
- Asset taken over by a partner: Partner's Capital A/c Dr. To Realisation A/c (agreed value).
- Liability paid: Realisation A/c Dr. To Bank/Cash A/c (amount actually paid; a discount reduces it).
- Liability taken over by a partner: Realisation A/c Dr. To Partner's Capital A/c.
- Creditor accepts an asset in full settlement: no entry; if he also receives cash: Realisation A/c Dr. To Bank/Cash A/c (cash part only).
- Unrecorded asset sold or taken over: Bank/Cash or Partner's Capital A/c Dr. To Realisation A/c.
- Unrecorded liability paid: Realisation A/c Dr. To Bank/Cash A/c.
- Result: profit — Realisation A/c Dr. To Partners' Capital A/cs; loss — Partners' Capital A/cs Dr. To Realisation A/c (profit-sharing ratio).
| Event | Journal entry |
|---|---|
| Asset sold for cash | Bank/Cash A/c Dr. To Realisation A/c |
| Outside liability paid in cash | Realisation A/c Dr. To Bank/Cash A/c |
| Bank loan repaid | Realisation A/c Dr. To Bank/Cash A/c |
| Asset realises nothing | No entry (its book value stays on the debit side) |
| Liability settled at a discount | Realisation A/c Dr. To Bank/Cash A/c (amount actually paid) |
| Event | Journal entry |
|---|---|
| Partner takes over an asset | Partner's Capital A/c Dr. To Realisation A/c (agreed value) |
| Partner agrees to pay a liability | Realisation A/c Dr. To Partner's Capital A/c |
| Creditor accepts an asset in full settlement | No entry |
| Creditor accepts an asset and cash for the rest | Realisation A/c Dr. To Bank/Cash A/c (cash part only) |
| Unrecorded item | Journal entry |
|---|---|
| Asset sold | Bank/Cash A/c Dr. To Realisation A/c |
| Asset taken over by a partner | Partner's Capital A/c Dr. To Realisation A/c |
| Asset given to a creditor | No entry (the creditor's claim falls; only cash paid is entered) |
| Liability paid | Realisation A/c Dr. To Bank/Cash A/c |
| Liability paid by a partner | Realisation A/c Dr. To Partner's Capital A/c |
| Dr. Particulars | ₹ | Cr. Particulars | ₹ |
|---|---|---|---|
| To Goodwill A/c | 12,000 | By Provision for Doubtful Debts A/c | 4,000 |
| To Machinery A/c | 1,30,000 | By Investment Fluctuation Fund A/c | 6,000 |
| To Investments A/c | 44,000 | By Creditors A/c | 48,000 |
| To Stock A/c | 52,000 | By Bank Loan A/c | 30,000 |
| To Debtors A/c | 70,000 | By Bank A/c (Machinery realised) | 1,12,000 |
| To Prepaid Insurance A/c | 2,000 | By Bank A/c (Debtors realised) | 63,000 |
| To Bank A/c (Creditors paid) | 46,000 | By Bank A/c (Stock realised at book value) | 52,000 |
| To Bank A/c (realisation expenses paid) | 3,000 | By Abhrajit's Capital A/c (Investments taken over) | 38,000 |
| To Bank A/c (Bank Loan paid) | 30,000 | By Abhrajit's Capital A/c (loss) | 18,000 |
| By Shehnaz's Capital A/c (loss) | 12,000 | ||
| By Dorjee's Capital A/c (loss) | 6,000 | ||
| Total | 3,89,000 | Total | 3,89,000 |
Key terms
- Agreed value
The value at which a partner takes over an asset or a creditor accepts it, which may differ from book value.
- Unrecorded asset
An asset of the firm not shown in the books, such as one fully written off, that still fetches something on dissolution.
6. Realisation expenses
Test: whose cost is it, and whose money pays it?
| Case | Entry |
|---|---|
| Paid by the firm | Realisation A/c Dr. To Bank/Cash A/c |
| Paid by a partner on behalf of the firm | Realisation A/c Dr. To Partner's Capital A/c |
| Borne and paid by a partner | No entry (with a remuneration: Realisation A/c Dr. To Partner's Capital A/c, remuneration only) |
| To be borne by a partner, paid by the firm | Partner's Capital A/c Dr. To Bank/Cash A/c |
| Paid by a partner and reimbursed with a firm's asset | Realisation A/c Dr. To Partner's Capital A/c (expenses); Partner's Capital A/c Dr. To Realisation A/c (asset) |
| Realisation expenses | Entry |
|---|---|
| Paid by the firm | Realisation A/c Dr. To Bank/Cash A/c |
| Paid by a partner on behalf of the firm | Realisation A/c Dr. To Partner's Capital A/c |
| Borne and paid by a partner (no remuneration) | No entry |
| with a fixed remuneration to him | Realisation A/c Dr. To Partner's Capital A/c (remuneration only) |
| To be borne by a partner but paid by the firm | Partner's Capital A/c Dr. To Bank/Cash A/c |
| Paid by a partner, reimbursed with a firm's asset | Realisation A/c Dr. To Partner's Capital A/c; Partner's Capital A/c Dr. To Realisation A/c (asset) |
| Champaner Glass Beads (imagined): case | Dr. | Cr. | ₹ |
|---|---|---|---|
| Firm pays the expenses | Realisation A/c | Bank A/c | 4,500 |
| Hiral pays them for the firm | Realisation A/c | Hiral's Capital A/c | 4,500 |
| Hiral bears and pays them; no remuneration | — | — | No entry |
| Hiral gets ₹6,000, bears and pays them | Realisation A/c | Hiral's Capital A/c | 6,000 |
| Hiral bears them; firm pays | Hiral's Capital A/c | Bank A/c | 4,500 |
| Hiral pays; takes the bead-cutting table at an agreed value | Realisation A/c / Hiral's Capital A/c | Hiral's Capital A/c / Realisation A/c | 4,500 each |
Key terms
- Realisation expenses
Costs of winding up the firm, such as legal fees, advertisement of sale and brokerage.
- Remuneration for dissolution
A fixed amount allowed to a partner for carrying out the winding up, usually in return for bearing its expenses.
7. Loans, current accounts, capital accounts and the Bank/Cash Account
Order of closing: current accounts → reserves and accumulated losses → loan to a partner → realisation result → partners' loans repaid → cash brought in for debit balances → final payment.
- Current accounts (fixed capitals): balances transferred to the capital accounts; no adjustment passes through them.
- General reserve, credit balance of profit and loss: Reserve A/c Dr. To Partners' Capital A/cs.
- Debit balance of profit and loss, advertisement suspense: Partners' Capital A/cs Dr. To the account.
- Loan to a partner: Partner's Capital A/c Dr. To Loan to Partner A/c.
- Loan from a partner: Partner's Loan A/c Dr. To Bank/Cash A/c — even if his capital account has a debit balance (no set-off).
- Debit balance of capital: Bank/Cash A/c Dr. To Partner's Capital A/c (cash brought in).
- Final payment: Partners' Capital A/cs Dr. To Bank/Cash A/c.
- Bank overdraft: opening credit balance of the Bank A/c (By Balance b/d), cleared from the cash realised.
Check: every capital account and the Bank/Cash Account close at nil.
| Item | ISC treatment on dissolution |
|---|---|
| Bank overdraft | Opening credit balance of the Bank A/c (By Balance b/d); no transfer, no entry |
| Bank loan | Transferred to Realisation (Cr.); repayment debited to Realisation |
| Loan from a partner | Repaid through Bank/Cash, even if his capital is in debit (no set-off) |
| Loan to a partner | Partner's Capital A/c Dr. To Loan to Partner A/c |
| Current accounts | Balances transferred to the capital accounts; no adjustment through them |
| Dr. Particulars | Abhrajit (₹) | Shehnaz (₹) | Dorjee (₹) | Cr. Particulars | Abhrajit (₹) | Shehnaz (₹) | Dorjee (₹) |
|---|---|---|---|---|---|---|---|
| To Loan to Dorjee A/c | 8,000 | By Balance b/d | 90,000 | 60,000 | 30,000 | ||
| To Realisation A/c (assets taken over) | 38,000 | By General Reserve A/c | 9,000 | 6,000 | 3,000 | ||
| To Realisation A/c (loss) | 18,000 | 12,000 | 6,000 | ||||
| To Bank A/c | 43,000 | 54,000 | 19,000 | ||||
| Total | 99,000 | 66,000 | 33,000 | Total | 99,000 | 66,000 | 33,000 |
| Dr. Particulars | ₹ | Cr. Particulars | ₹ |
|---|---|---|---|
| To Realisation A/c (assets realised) | 2,27,000 | By Balance b/d (bank overdraft) | 12,000 |
| By Realisation A/c (liabilities paid) | 76,000 | ||
| By Realisation A/c (realisation expenses paid) | 3,000 | ||
| By Shehnaz's Loan A/c | 20,000 | ||
| By Abhrajit's Capital A/c | 43,000 | ||
| By Shehnaz's Capital A/c | 54,000 | ||
| By Dorjee's Capital A/c | 19,000 | ||
| Total | 2,27,000 | Total | 2,27,000 |
Key terms
- Final payment
Cash paid to each partner for the credit balance of his capital account, closing the books.
- Cash brought in
Cash contributed by a partner whose capital account shows a debit balance after all adjustments.
Exam tips
Common mistakes
- Transferring a related fund (investment fluctuation fund, provision) to the capitals instead of the Realisation Account, or a general reserve to Realisation.
- Sending the bank overdraft to Realisation; under ISC it opens the Bank/Cash Account. The bank loan does go to Realisation.
- Showing debtors net of the provision in the Realisation Account; transfer the gross figure and credit the provision.
- Making an entry when a creditor accepts an asset in full settlement.
- Debiting the Realisation Account with expenses that a partner must bear.
- Setting off a partner's loan against a debit balance in his capital account.
- Forgetting the ISC assumptions for silent items (tangible at book value; intangible, accrued and prepaid items nil; liabilities in full).
How marks are usually awarded (SOYL chapter tests on the ISC default pattern)
- 1 mark: objective items.
- 2 marks: two or three journal entries, a Memorandum Balance Sheet, or a distinction.
- 3 marks: a Realisation Account, a Section 48 payout, a Bank Account, or capital accounts.
- 5 marks in parts, e.g. (a) 2 + (b) 3: entries and a Realisation Account, or a Realisation Account with capital and Bank accounts.
- Full practical (practice, 8 marks): Realisation Account about 4, capital accounts about 3, Bank/Cash Account about 1–2; working notes for assumptions earn step marks. The ISC 2027 weightage for Dissolution in Paper I is 8 marks.
Figures in SOYL practice are imagined; your board paper will give its own.