Tuesday, September 03, 2019

Dissolution of Partnership Firms


Dissolution of Partnership and Firm:
Dissolution of a partnership means the termination of connections with the firm by some of the partners of the firm, and remaining partners of the firm continuing the business of the firm under the same firm’s name under an agreement. Hence, admission, retirement and a death of a partner are considered dissolution of partnership. The dissolution of partnership may take place in any of the following ways:
a)      Change in existing profit sharing ratio among partners;
b)      Admission of a new partner;
c)       Retirement of a partner;
d)      Death of a partner;
e)      Expiry of the period of partnership, if partnership is for a specific period of time;
Dissolution of a firm means discontinuation of the firm’s business and termination of relationship between the partners. According to Sec. 39 of Indian Partnership Act 1932, “Dissolution of firm means dissolution of partnership between all the partners in the firm."
Therefore when a firm is dissolved, assets of the firm are disposed off, liabilities are paid off and the accounts of all the partners are also settled.

Difference between dissolution of partnership and dissolution of firm
Basis of distinction
Dissolution of partnership
Dissolution of firm
Relationship
Relationship amongst all the partners does not come to an end.
Relationship amongst all the partners comes to an end.
Continuation of business
Business of the firm may continue.
Business of the firm does not continue.
Inter relationship
Dissolution of partnership may or may not result in dissolution of the firm.
Dissolution of the firm necessarily results in dissolution of partnership.
Books of accounts
Books of accounts are not closed.
Books of accounts are closed.
Nature
Dissolution of partnership is voluntary.
Dissolution of partnership may sometimes compulsory or sometimes voluntary.
Account
Revaluation account is prepared.
Realisation account is prepared.
Modes of Dissolution of a Partnership Firm:
The dissolution of partnership between all the partners of a firm is called the "dissolution of the firm". A firm may be dissolved with the consent of all the partners or in accordance with a contract between the partners. The Indian Partnership Act, 1932 provides that a partnership firm may be dissolved in any of the following modes:
(i)     Dissolution by agreement
(ii)   Dissolution by notice of partnership at will;
(iii) Dissolution on the happening of certain contingencies;
(iv)  Compulsory dissolution;
(v)    Dissolution by the court.
(i) Dissolution by agreement: A firm may be dissolved with the consent of all the partners. A partnership is set up by an agreement; similarly, it can be dissolved by an agreement.
(ii) Dissolution by Notice of Partnership at Will: Where the partnership is at will, the firm may be dissolved by any partner giving notice in writing to all the other partners of his intention to dissolve the firm. The firm is dissolved as from the date mentioned in the notice as the date of dissolution or, if no date is so mentioned, as from the date of the communication of the notice.
(iii) Dissolution on the Happening of Certain Contingencies: Subject to contract between the partners, a firm is dissolved on the happening of certain contingencies:
a)      On expiry of the term for which the firm was constituted.
b)      If firm is constituted for a particular venture and that venture is completed.
c)       On the death of a partner; and
d)      By the adjudication of a partner as an insolvent.
(iv) Compulsory Dissolution: A firm is dissolved compulsorily:
(a) If all the partners or all the partners except one become insolvent.
(b) If the business of the firm is unlawful.
(v) Dissolution by Court: A court may order a partnership firm to be dissolved in the following cases:
a)      When a partner becomes of unsound mind.
b)      When a partner becomes permanently incapable of performing his/her duties as a partner.
c)       When partner deliberately and consistently commits breach of partnership agreement.
d)      When a partner’s conduct is likely to adversely affect the business of the firm.
e)      When a partner transfers his/her interest in the firm to a third party;
f)       When the court considers it just and equitable to dissolve the firm.
Realisation Account
Realisation account is prepared at the time of dissolution of firm. Realisation Account is a nominal account. It is prepared to find out profit or loss on realisation of assets and payment of liabilities when a firm is dissolved. Any profit or loss on realisation is transferred to the capital accounts of all the partners in their profit sharing ratio.
Realisation Accounts is prepared in the following manner:
i.        All the realisable assets given in the books of the firm are entered at their book values on the debit side of the Realisation Account
ii.      All the external liabilities are entered at their book values on the credit side of the Realisation Account
iii.    On the realisation of assets, the actual amount of cash received is entered on the credit side of the account. - Cash/bank account is debited
iv.     On the payment of liabilities, the actual amount of cash paid is entered on the debit side of the account. Cash/bank account is credited
v.       Realisation expense if any, is also debited to the Realisation Account and bank account is credited
vi.     After making the above entries in the Realisation Account, the account is balanced. The profit or loss on realisation is transferred to the capital accounts of all the partners in their profit sharing ratio.
The main objectives of preparing realisation account are:          
1) To close all the books of account at the times of dissolution of the firm.
2) To record all the transactions relating to the sale of assets and payment of liabilities.
3) To determine profit or loss due to the realisation of assets and liabilities.
Difference between Revaluation Account and Realisation Account:      
Basis
Revaluation Account
Realisation Account
Meaning
Revaluation account is prepared in order to work out the profit or loss on revaluation of assets and liabilities.
Realisation account is prepared to work out the profit or loss on realisation of assets and payment to liabilities.
Preparation
Revaluation account is prepared at the time of admission, retirement or death of a partner.
Realisation account is prepared at the time of dissolution of a partnership firm.
Closing of accounts
After preparing the revaluation account the firm’s business gets going with the same set of books.
After preparation of Realisation account, all the accounts of the firm are closed.
Remaining balance
Balance of this account is transferred to the capital account of old partners.
Balance of this account is transferred to the capital account of all partners.
Accounting entries
Entries are based on the difference between the book value and the revalued amount of assets and liabilities.
Entries are based on the book value of assets and liabilities.

Settlement of Accounts
As soon as a firm is dissolved, the normal business of the firm is discontinued and accounts of all the partners are settled. Usually the partnership deed contains the clause for settlement of partners account. But in the absence of any agreement between the partners, the provisions of Sec. 48 of the Indian Partnership Act are followed. The accounts of the partners are settled as follow:
1) When the firm has suffered huge losses, the undistributed profits, if any, are first of all to be applied to the payment of such losses. If the profits are insufficient, the capital must be applied for payment of the losses and lastly, if necessary, contributed by the partners individually in the proportion in which they share profits.
2) When a partnership firm is dissolved, its assets are disposed of and the proceeds there from including contribution by the partners are utilised in the following manner:
(a) First, in paying off the debts of the firm due to third parties;
(b) Then in paying to each partner ratably any advances or loans given by him in addition to or apart from his capital contribution;
(c) If any surplus is available after discharging the above liabilities, the capital con­tributed by the partners may be returned, if possible, in full or otherwise ratably;
(d) The surplus, if any, shall be divided among the partners in their profit-sharing ratios.
3) If the amount realised by sale of assets is not sufficient to discharge the claims of the creditors in full, the deficiency can be recovered proportion­ately from the personal properties of the partners. If any partner becomes insolvent, the remaining solvent partners will bear the loss in their capital ratio.
Insolvency of a Partner – (Rules of Garner vs. Murray)
If a partner’s capital account shows a debit balance on the dissolution of the firm, he is required to bring cash in the firm to settle his account. But if such partner is unable to satisfy his debt to the firm due to his insolvency, then his deficiency is to be borne by the solvent partners in accordance with the decision in Garner vs. Murray. According to the rules of Garner vs. Murray, in the absence of any agreement to the contrary, the deficiency of the insolvent partner’s capital account must be borne by other solvent partners in proportion to their capital which stood before the dissolution of the firm. The effect of this ruling is to make a distinction between an ordinary loss caused due to business operation and loss on account of insolvency of a partner.
Some important judgement in Garner vs. Murray case by Lord Justice Joyce was stated below:
a)      Loss on realisation considered being ordinary loss and therefore to be shared by all the partners according to their profit sharing ratio.
b)      Solvent partners to bring cash equal to their share of loss on realisation
c)       Loss on account of deficiency of insolvent partner considered being capital loss; therefore   to be shared by solvent partners according to their last agreed capital.
Accounting treatment when the firm is dissolved due to insolvency of partners:
1) When there are more than two partners and one becomes insolvent, the solvent partners are liable to bear the loss of insolvent partner. The loss is borne by the solvent partners in the following partners:
a)      When Garner Versus Murray rule is not applicable, the solvent partners are supposed to bear the loss according to the profit sharing ratio.
b)      When the Garner versus Murray rule is applicable, the solvent partners are liable to bear the loss of insolvent partners according to the ratio of last agreed capital.
Last Agreed Capital means
1.    In case of Fixed Capitals: Fixed Capital (as given in the Balance Sheet) without any adjustment
2.    In case of Fluctuating Capitals: Capital after making adjustments for past accumulated reserves, profits or  losses, drawings, Interest on capital, Interest on Drawing, remuneration to a partner etc. to the date of dissolution but before making adjustment for profit or loss on realisation.
2) In the case of dissolution of a firm where all the partners are insolvent, the following procedure should be followed:
a)   The Realisation Account is prepared without transferring external liabilities to it.
b)   Cash Account should be prepared after the Realisation Account.
c)    Cash in hand together with the amount realized on sale of asset and the amount received from the estate of insolvent partners shall be applied in the following order:
i)        For meeting the realization expenses
ii)      For meeting the external liabilities like bank loan, creditors, out standing expenses, etc.
iii)    For meeting partners loan account.
iv)    For paying partners’ capital account balances.
Note: In case of deficiency of cash, balances of above accounts shall be transferred to the Deficiency Account. (Deficiency Account: When all the partners become insolvent, external liabilities will not be met in full and balance due from partners also cannot be recovered from partners in full. Hence, the balance due to external creditors and balance due from partners are transferred to a separate account called Deficiency Account.)
Journal Entries in Dissolution
Accounting for dissolution begins with the closing of assets and liabilities accounts by transferring them to Realisation
Account.
i) For transfer of assets
Realisation Account Dr.
To Asset Account
ii) For Transfer of liabilities
Liability Account Dr.
To Realisation Account
Accumulated profits such as General Reserves, Profit and Loss Account Credit Balance etc. are transferred to capital Accounts in the profit sharing ratio.

iii) For transfer of accumulated profits
Accumulated Profit Account (General Reserve; P&L etc.) Dr.
To Partner’s Capital Account
Note: Provision for doubtful debts; Investment fluctuation fund, Joint life Policy Fund etc. are credited to realization account and ignored thereafter. These are internal provisions having no claim against the firm and therefore these amounts will merge into realization profit or loss and finally get transferred to Capital Accounts of partners.
iv) For assets realized
Cash/Bank account Dr
To Realisation Account
Note: We do not have separate asset account anymore. Realisation account is the common account representing all assets and liabilities transferred into it. Please check the next entry also.
v) For Liabilities paid off
Realisation Account Dr.
To Cash/Bank Account
vi) For asset taken over by a partner
Partner’s Capital Account Dr.
To Realisation Account
vii) For Liability taken up by the partner
Realisation Account Dr.
To Partner’s Capital Account
viii) For unrecorded asset taken over by a partner
Partner’s Capital Account Dr.
To Realisation Account
ix) Unrecorded Liability settled by the firm
Realisation Account Dr.
To Cash/Bank account
x) Realisation expense
Realisation Account Dr.
To Cash/Bank account
xi) Asset taken over by creditors
No entry; Only settlement of balance amount is shown in the books.
xii) For distribution of Profit or Loss on Realisation
If Profit
Realisation Account Dr.
To Partner’s Capital Account
(Reverse entry is passed for loss on Realisation)
xiii) For final payment to partners:
Partner’s Capital Account Dr.
To Cash/Bank Account

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