Which of the following is a feature of dissolution of a firm, and not of dissolution of a partnership?

Answer: C. In dissolution of a firm the partnership between all partners ends, the assets are sold, the liabilities are paid and the books are closed. Options A, B and D describe dissolution of a partnership, where the firm keeps trading.

A firm is dissolved compulsorily when:

Answer: C. Compulsory dissolution happens when all partners or all but one become insolvent, or when the business becomes illegal. A retirement, a change in ratio and an admission only reconstitute the partnership.

According to the Partnership Act, 1932, after payment of third party debts the next claim to be paid is:

Answer: B. The order is outside liabilities, then each partner's loans and advances, then capital, and then any surplus in the profit sharing ratio. So the loan comes before capital.

Dissolution of Partnership Firm — CUET Accountancy Notes & MCQs

📌 Snapshot

How a partnership firm is closed: modes of dissolution, settlement of accounts and the Realisation Account.
The difference between dissolution of a partnership and dissolution of a firm, in five bases.
The order in which cash is paid out, and the entry for each situation: assets taken over, expenses, loans.
A complete dissolution worked from balance sheet to final bank payment, with the traps NTA sets.

📖 Detailed Notes

Written and reviewed by Devendra Dubey, Mathematics & Commerce faculty at UniDrill (M.Sc. Mathematics, Osmania University · 10 years teaching). Based on NCERT Accountancy Class XII (Accountancy Part I), Chapter 4.

When three friends decide to shut the shop

Sana, Tarun and Uma run a computer shop. The lease ends, sales have slowed and they decide to close. What happens now? The stock must be sold, customers must pay what they owe, suppliers must be paid, and Sana's father, who lent the firm ₹40,000, expects it back. After all that, whatever cash is left belongs to the partners, and if there is not enough, they must bear the shortfall.

The challenge for the accountant is that every asset and every outside liability is going to change hands at a different price from its book value. The tool for this is the Realisation Account, which collects all these changes in one place and shows whether the closure made a profit or a loss. This chapter is about when a firm can be dissolved, in what order it must be settled, and how that account is built.

Dissolution of the partnership versus dissolution of the firm

The two phrases sound the same but mean different things. In dissolution of a partnership, the relationship between partners changes (a partner is admitted, retires or dies, or the ratio changes), but the firm keeps trading. In dissolution of a firm, the partnership between all the partners ends and the business is wound up.

Basis	Dissolution of partnership	Dissolution of firm
Business	Continues as before	Stops, the business is closed
Assets and liabilities	Revalued and carried forward	Assets sold, liabilities paid
Court	No role	May order dissolution on the application of a partner
Relationship of partners	Changes, with a new agreement	Ends entirely
Books	Not closed, they continue	Closed after winding up

Dissolution of partnership happens on admission, retirement, death, insolvency of a partner, a change in the profit sharing ratio, completion of the venture, or the end of the period of the partnership. These are the reconstitution events of the earlier chapters.

The five modes of dissolving a firm

Mode	When it applies	Examples
By agreement	All partners consent, or the contract says so	Partners decide to wind up
Compulsory	Business becomes illegal, or all partners but one become insolvent	A licence is cancelled, or the business becomes unlawful
On contingencies	An event listed in the Act occurs, unless the deed says otherwise	Expiry of a fixed term, completion of the venture, death or insolvency of a partner
By notice	The partnership is at will, so no fixed term	Any partner gives written notice of his intention to dissolve
By the court	A partner applies on specified grounds	Insanity, permanent incapacity, misconduct, persistent breach of the agreement, transfer of interest, business running only at a loss, or any just and equitable ground

A partnership at will has no fixed period or purpose, which is why a single notice from any partner ends it.

Beyond the textbook. For the exam: once the firm is dissolved, the books are closed and the business is wound up. In reality: the firm does not vanish on the day of dissolution. Each partner keeps the authority to act for the firm to wind it up and complete unfinished business, and the partners stay liable to outsiders for dealings after dissolution until public notice of the dissolution is given. Why it matters: this is why a real closure comes with a notice in the newspaper, and why the Realisation Account is a process spread over weeks, not a single entry.

The order of settlement

The Partnership Act lays down who is paid first when the firm's assets are turned into cash. It is a ladder, and each rung is paid in full before the next one gets anything.

Rank	Paid to	Why this rank
1	Outsiders (third party debts and, among them, secured before unsecured)	They are creditors, not owners
2	Partners' loans and advances	A loan is a debt of the firm, not capital
3	Partners' capitals	These are the owners' funds
4	Any surplus, in the profit sharing ratio	It is profit, so it is shared like profit

Losses have an order of their own: first from profits, then from capital, and last, if needed, by the partners personally in the profit sharing ratio.

Worked example: why the ladder matters. The firm's assets realise ₹2,00,000. Outside liabilities are ₹1,20,000, Sana's loan is ₹40,000 and the partners' capital claims total ₹70,000.

Step	What we do	Cash left
1	Pay outsiders ₹1,20,000	₹80,000
2	Pay Sana's loan ₹40,000	₹40,000
3	Pay partners on account of capital. ₹40,000 is available against ₹70,000 due	Nil, with ₹30,000 unpaid

Sana is repaid in full before Tarun or Uma see any capital, because her loan ranks above capital. Common wrong step. Paying the loan out of the capital pool or treating it as capital. A loan is paid ahead of capital, which is why it is never routed through the Realisation Account.

Firm debts and private debts. When both exist, the Act says the firm's property goes first to the firm's creditors, and the partner's private property goes first to his private creditors. A surplus on either side may then be used for the other.

Property	Applied first to	Then
The firm's property	The firm's debts	Any surplus goes to the partners' private creditors
A partner's private property	His private debts	Any surplus may go to the firm's debts, if the firm falls short

Pause and predict: A partner is insolvent and the firm owes outsiders more than its assets can pay. Who is paid first from the partner's private property?

Check your answer: His own private creditors. Only the balance left after them can be used for the firm's debts.

The Realisation Account

When the firm is dissolved, every asset and every outside liability is moved into one nominal account, the Realisation Account. Assets are debited at their book value. Liabilities are credited at their book value. As each asset is sold the proceeds are credited, and as each liability is paid the payment is debited. The balancing figure is the profit or loss on realisation, shared by the partners in their profit sharing ratio.

Goes to the Realisation A/c	Stays out of it	Why
All assets except cash and bank (debtors at gross value)	Cash and Bank	They are used to settle the closure, not realised
Outside liabilities: creditors, bills payable, bank overdraft	Partners' Capital and Current A/cs	They are settled directly with the partners
Provision for doubtful debts, Investment Fluctuation Fund	Partners' loans (a liability) and loans to partners (an asset)	They are settled in cash outside the account
Unrecorded assets and liabilities, when realised or paid	General Reserve and accumulated profits	They belong to the partners
	Fictitious assets (preliminary expenses, debit balance of P&L)	They are losses, borne by the partners

Why debtors at gross? The provision for doubtful debts is itself transferred to the credit of the Realisation Account. So if debtors were moved at net value and the provision credited as well, the provision would be counted twice.

Entries for every situation

Situation	Debit	Credit
Assets transferred at book value	Realisation A/c	Each asset account
Liabilities and provisions transferred	Each liability or provision account	Realisation A/c
Assets sold	Bank A/c	Realisation A/c
Asset taken over by a partner	Partner's Capital A/c	Realisation A/c
Outside liability paid	Realisation A/c	Bank A/c
Liability taken over by a partner	Realisation A/c	Partner's Capital A/c
Creditor accepts an asset in full settlement	No entry	No entry
Unrecorded asset sold	Bank A/c	Realisation A/c
Unrecorded liability paid	Realisation A/c	Bank A/c
Reserves and accumulated profits	Reserve or P&L A/c	Partners' Capital A/cs, in profit sharing ratio
Accumulated loss or fictitious asset	Partners' Capital A/cs, in profit sharing ratio	The loss or asset account
Partner's loan repaid	Partner's Loan A/c	Bank A/c
Loss on realisation	Partners' Capital A/cs	Realisation A/c
Profit on realisation	Realisation A/c	Partners' Capital A/cs
Final payment to a partner	Partner's Capital A/c	Bank A/c

Why "no entry" for the creditor? When a creditor accepts an asset in full settlement, both the asset and the creditor are already in the Realisation Account, one on each side. They cancel each other and no cash moves. If the asset is worth less than his claim and he takes some cash for the rest, only the cash part is recorded, as Dr Realisation A/c, Cr Bank A/c.

Pause and predict: A creditor of ₹20,000 accepts machinery with a book value of ₹25,000 in full settlement. What entry is passed, and what does the Realisation Account show?

Check your answer: No entry. The machinery (₹25,000) is already debited and the creditor (₹20,000) already credited, so the account automatically shows the ₹5,000 difference as a loss.

Realisation expenses: who bears them?

Closing a firm costs money, and the partners often agree that one of them will look after it. The entry depends on who agreed to bear the cost and who actually paid it. Take expenses of ₹10,000 and a partner, Uma.

Case	Entry	Reason
Firm pays, and the firm bears them	Dr Realisation A/c ₹10,000, Cr Bank A/c ₹10,000	An ordinary expense of closing
Uma pays, and the firm bears them	Dr Realisation A/c ₹10,000, Cr Uma's Capital A/c ₹10,000	The firm owes her what she paid
Uma agrees to bear them, but the firm pays	Dr Uma's Capital A/c ₹10,000, Cr Bank A/c ₹10,000	It is her cost, so her capital absorbs it, not the Realisation A/c
Uma is given a fixed ₹8,000 for the work and bears all costs herself	Dr Realisation A/c ₹8,000, Cr Uma's Capital A/c ₹8,000	The fixed sum is the firm's expense. No entry for her actual costs

Common wrong entry. In the third case, debiting Realisation A/c. The firm would then bear a cost that Uma had agreed to carry.

A complete dissolution, step by step

Worked example: closing the shop. Sana, Tarun and Uma share profits 3:2:1. On 31 March the balance sheet is as follows, and they dissolve the firm.

Liabilities	₹	Assets	₹
Sana's Capital	1,50,000	Machinery	1,00,000
Tarun's Capital	1,00,000	Stock	90,000
Uma's Capital	50,000	Debtors	80,000
General Reserve	30,000	Bank	1,60,000
Sana's Loan	40,000	Profit and Loss A/c (Dr)	15,000
Creditors	70,000
Provision for Doubtful Debts	5,000
Total	4,45,000	Total	4,45,000

The following happens. Machinery is sold for ₹85,000. Tarun takes over stock with a book value of ₹30,000 at ₹27,000, and the rest is sold for ₹54,000. Debtors pay ₹70,000. An unrecorded investment is sold for ₹6,000. Creditors are paid ₹68,000 in full settlement. Realisation expenses of ₹5,000 are paid by the firm. An unrecorded repair bill of ₹4,000 is paid. Sana's loan is repaid.

The thinking: every asset and outside liability goes to Realisation (not cash, loan, capital or reserve), and each later line is either an asset leaving or a liability being paid.

Realisation Account.

Debit	₹	Credit	₹
Machinery	1,00,000	Creditors	70,000
Stock	90,000	Provision for Doubtful Debts	5,000
Debtors (gross)	80,000	Bank: machinery	85,000
Bank: creditors paid	68,000	Bank: stock sold	54,000
Bank: realisation expenses	5,000	Tarun's Capital: stock taken over	27,000
Bank: unrecorded repair bill	4,000	Bank: debtors	70,000
		Bank: unrecorded investment	6,000
		Loss on realisation, shared 3:2:1	30,000
Total	3,47,000	Total	3,47,000

Loss of ₹30,000 is borne as Sana ₹15,000, Tarun ₹10,000 and Uma ₹5,000. Next, the Capital Accounts, where credits are positive and debits negative.

Particulars	Sana (₹)	Tarun (₹)	Uma (₹)
Opening balance	1,50,000	1,00,000	50,000
General Reserve (3:2:1)	+15,000	+10,000	+5,000
Profit and Loss A/c, debit balance (3:2:1)	−7,500	−5,000	−2,500
Loss on realisation (3:2:1)	−15,000	−10,000	−5,000
Stock taken over	–	−27,000	–
Balance paid in cash	1,42,500	68,000	47,500

Finally, the Bank Account.

Receipts	₹	Payments	₹
Opening balance	1,60,000	Creditors	68,000
Machinery	85,000	Realisation expenses	5,000
Stock sold	54,000	Unrecorded repair bill	4,000
Debtors	70,000	Sana's Loan	40,000
Unrecorded investment	6,000	Sana's Capital	1,42,500
		Tarun's Capital	68,000
		Uma's Capital	47,500
Total	3,75,000	Total	3,75,000

The bank account closes to nil, which proves that every entry was right. The final balances of the three partners (1,42,500 + 68,000 + 47,500) total ₹2,58,000, the same as the cash left after outsiders and the loan have been paid.

Common wrong steps. First, moving Sana's loan through the Realisation Account. It is a debt to a partner, paid straight from the bank. Second, moving debtors at ₹75,000 (net) and also crediting the provision of ₹5,000, which counts it twice. Third, transferring the General Reserve to the Realisation Account, which would understate the loss by ₹30,000 and misstate every partner's capital. The reserve belongs to the partners.

Beyond the textbook. For the exam: every partner bears the loss on realisation in the profit sharing ratio, and each is paid what his capital account shows. In reality: a partner's capital account can end in a debit balance if his share of losses is more than his capital, and he must pay that deficiency into the firm. If he is insolvent and cannot, the English case of Garner v Murray, applied in India, holds that the solvent partners bear the shortfall in the ratio of their capitals, and not in the profit sharing ratio. Why it matters: a debit closing balance is a debt the partner owes the firm, so the final payments to the other partners depend on it being cleared.

Exam traps

Trap	Why it tempts	The truth
Partner's loan goes through the Realisation A/c	It is a liability	It is a debt to a partner, paid from Bank directly and ranks above capital
Debtors transferred net of provision	The balance sheet shows them net	Transfer at gross and credit the provision, so it is not counted twice
Bank overdraft is left out	It sounds like a bank item	It is an outside liability and is transferred to Realisation A/c
Reserves go to Realisation A/c	They are on the liabilities side	They belong to the partners and go to their capitals in the profit sharing ratio
Creditor takes an asset: journal entry passed	Something has changed hands	Both are already in the account. No entry
Expenses borne by the partner debited to Realisation A/c	The firm paid them	Dr that partner's Capital A/c, Cr Bank A/c
Fictitious assets are realised	They are assets	They have no value. They are debited to partners' capitals in the profit sharing ratio
Order of settlement: capital before loan	Capital sounds more important	Outsiders, then partners' loans, then capital, then surplus

Format and formula sheet

Item	Rule	When to use
Realisation A/c, debit side	Assets at book value (debtors gross), liabilities paid, expenses, loss	Every dissolution
Realisation A/c, credit side	Liabilities at book value, provisions, sale proceeds, assets taken over by partners, profit	Every dissolution
Result	$\text{Profit or loss} = \text{Credit side total} - \text{Debit side total}$ before the balancing figure	Find the profit or loss on realisation
Partner's share of loss	$\text{Loss} \times \text{Partner's profit share}$	Closing the Capital A/cs
Final cash to a partner	$\text{Capital} + \text{Reserve share} - \text{Loss shares} - \text{Assets taken over}$	Settling each partner (a partner's loan is repaid separately)
Check	Bank closes to nil	Proof that the entries tie

60-second revision

Topic	Remember
Firm versus partnership	Firm: all partners, business stops. Partnership: relationship changes, business goes on
Modes	Agreement, compulsory, contingencies, notice, court
Settlement order	Outsiders, partners' loans, partners' capital, surplus in profit sharing ratio
Firm and private debts	Firm property to firm debts first. Private property to private debts first
Realisation A/c	Assets at book value on debit, liabilities on credit, sale proceeds and payments, profit or loss to partners
Outside of Realisation	Cash, Bank, capitals, partners' loans, reserves, fictitious assets
Asset taken by partner	Dr his Capital A/c, Cr Realisation A/c
Liability taken by partner	Dr Realisation A/c, Cr his Capital A/c
Creditor takes asset	No entry
Expenses borne by partner, paid by firm	Dr his Capital A/c, Cr Bank A/c
Final check	Bank closes to nil after the partners are paid

Where this chapter connects

Dissolution is the end of the story begun in Accounting for Partnership: Basic Concepts, where the capital and current accounts you close here were opened. The Revaluation Account of Admission of a Partner and Retirement or Death of a Partner is the same idea as the Realisation Account, except that there the firm lives on and the assets are not sold. From here the course moves to company accounts, beginning with Accounting for Share Capital.

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