Dissolution of Partnership Firm

2.1 Core concepts

Section 39 of the Partnership Act 1932 defines dissolution of the firm as the dissolution of partnership between all the partners of a firm — it breaks the relationship between all partners and ends the existence of the firm itself (NCERT §intro, p. 156). NCERT is explicit that this differs from the dissolution of partnership, which only changes the existing relationship between partners; the firm may continue business as before. Dissolution of partnership occurs on change in PSR, admission, retirement, death, insolvency of a partner, completion of the venture, or expiry of the partnership period (NCERT §4.1, p. 156-157).

Five modes of dissolution of a firm (§4.2, p. 157-158). (1) By agreement — with the consent of all partners or per contract; (2) Compulsory dissolution — when all or all-but-one partner become insolvent, or the business becomes illegal, or an event makes the business unlawful (e.g., a partner becomes an alien enemy); (3) On happening of certain contingencies — expiry of fixed term, completion of the venture, death of a partner, adjudication of a partner as insolvent; (4) By notice in a partnership at will — any partner may give notice in writing of his intention to dissolve; (5) By court at the suit of a partner on grounds of insanity, permanent incapacity, misconduct, breach of agreement, transfer of interest, business carried on at a loss, or any just-and-equitable ground.

Distinction between dissolution of partnership and dissolution of firm (NCERT §4.2 table, p. 158). Five bases — termination of business, settlement of assets/liabilities, court's intervention, economic relationship, and closure of books. Memorise the table — CUET asks for these bases as match-the-following.

Section 48 — Settlement of Accounts (§4.3, p. 159). Losses (including capital deficiencies) are met first out of profits, then out of capital, and lastly by partners individually in PSR. Assets (plus any partner contributions) are applied in this order: (i) third-party debts, (ii) partners' advances (loans, not capital), (iii) partners' capital, and (iv) residue distributed in PSR. Secured loans have precedence over unsecured loans while paying outside liabilities.

Section 49 — Firm Debts vs Private Debts (§4.3, p. 159). When firm debts and partners' private debts co-exist: firm property goes first to firm debts (any surplus then to partners' private use); private property goes first to private debts (any surplus may then go to firm debts if firm assets are inadequate). Private property excludes the personal properties of the partner's wife and children.

Garner vs Murray rule (NCERT §4.3 box, p. 160). Mentioned but excluded at this stage: if a partner is insolvent and cannot pay his capital deficiency, the irrecoverable sum is treated as a capital loss borne by the remaining solvent partners in the ratio of their capitals as on the date of dissolution.

Accounting treatment (§4.4, p. 160). On dissolution, all assets (except cash, bank and fictitious assets) and all external liabilities are transferred to a Realisation Account, which also records the sale of assets, payment of liabilities and realisation expenses. The balance of the Realisation A/c is the profit or loss on realisation, transferred to partners' capital accounts in PSR.

Format of Realisation Account (Fig. 4.1, NCERT p. 160). Debit side: intangible assets, land & buildings, plant & machinery, furniture, loans to other parties, bills receivable, sundry debtors (gross), cash for payment of liabilities (recorded and unrecorded), partner's capital for liability assumed. Credit side: bank loan/mortgage, sundry creditors, bills payable, bank overdraft, outstanding expenses, provision for doubtful debts, cash from sale of assets, partner's capital for assets taken over, investment fluctuation fund, and the balancing profit/loss.

Journal-entry list (§4.4.1, p. 164-166). Seventeen standard situations including: assets transferred at book value (debtors gross, provision separately to credit); liabilities transferred to credit; sale of assets via Bank; asset taken over by partner debits Partner's Capital; payment of liabilities credits Bank; partner discharging a liability credits Partner's Capital; no entry when creditor accepts asset in full settlement; entries for realisation expenses (firm/partner/agreed remuneration); unrecorded assets credited to Realisation when sold; unrecorded liabilities debited when paid; accumulated reserves transferred to partners in PSR (not to Realisation); fictitious assets debited to partners in PSR; partner's loan paid via Bank (not routed through Realisation).

Special situations. (i) When a partner is given an agreed remuneration for dissolution work and has also agreed to bear realisation expenses, no separate entry is recorded for actual expenses paid by the firm beyond the remuneration (NCERT Illustration 6 note, p. 176). (ii) When a creditor accepts an unrecorded asset (e.g., unrecorded investment) as part-payment of his dues, no journal entry is recorded for that part (NCERT Illustration 7 note, p. 178).

2.2 Definitions to memorise

2.3 Diagrams / processes to remember

Distinction Table — Dissolution of Partnership vs Dissolution of Firm (NCERT p. 158). Five bases — termination of business, settlement of assets and liabilities, court's intervention, economic relationship, closure of books. Memorise.

Fig. 4.1 — Realisation Account Format (NCERT p. 160). Standard T-format with all debit and credit items listed; the workhorse of every dissolution question.

Illustration 1 — Supriya & Monika 3:2 (NCERT p. 162-164). Minimal end-to-end Realisation A/c, Partners' Capital A/c, Bank A/c; profit on realisation ₹2,925.

Illustration 2 — Sita, Rita, Meeta 2:2:1 (NCERT p. 167-168). Treatment of unrecorded asset taken over by partner, realisation expenses where one partner agrees to bear them but the firm actually pays, discount on creditors.

Illustration 3 — Vibha, Shobha, Anubha (NCERT p. 168-169). Seven sub-cases of dissolution-expense and remuneration entries, including the "no entry" case when a partner takes over an asset towards remuneration.

Illustration 4 — Nayana & Arushi (NCERT p. 169-172). Full ledger set including Workmen Compensation Reserve, unrecorded investment realised, bad debts recovered, outstanding repair bill (unrecorded liability).

Process — Closing assets to Realisation A/c. (i) Transfer all assets (except cash, bank and fictitious) at book value to the Dr side of Realisation A/c (debtors gross, with provision credited separately). (ii) Transfer external liabilities to the Cr side of Realisation A/c. (iii) Record actual realisation of assets (Dr Bank, Cr Realisation). (iv) Record actual payment of liabilities (Dr Realisation, Cr Bank). (v) Record realisation expenses (Dr Realisation, Cr Bank). (vi) Compute the balance — profit or loss — and transfer to partners' capitals in PSR.

Process — Asset taken over / Liability assumed by partner. Asset taken over: Dr Partner's Capital, Cr Realisation. Liability assumed: Dr Realisation, Cr Partner's Capital.

Process — Creditor accepts an asset in full settlement. No journal entry. The asset (already on Dr side of Realisation) and the creditor (already on Cr side) cancel each other.

Process — Realisation expenses borne by partner. If a partner has agreed to bear realisation expenses and the firm pays — Dr Partner's Capital, Cr Bank (not Realisation). If the partner is given an agreed remuneration — Dr Realisation, Cr Partner's Capital for the remuneration; expenses are then his concern.

2.4 Common confusions / NTA trap points

1. Partner's loan is NOT routed through Realisation A/c. Paid via Bank directly. Likewise, loan to a partner (asset side) is settled through Bank, not Realisation (NCERT §4.4.1 entries 13 & 16, p. 166).
2. Bank overdraft IS an external liability and is transferred to Realisation A/c (NCERT Test-II Q1, p. 161).
3. Accumulated profits / reserves go to Partners' Capital in PSR, NOT to Realisation (NCERT §4.4.1 entry 14, p. 166).
4. Sundry debtors transferred at GROSS value. Provision for doubtful debts transferred separately to the credit (NCERT §4.4.1 entry 1, p. 164).
5. Creditor accepts asset in full settlement → NO entry. Partial settlements only record the cash portion (NCERT §4.4.1 entry 7, p. 165).
6. Realisation expenses borne by partner — Dr his Capital, not Realisation (NCERT §4.4.1 entry 8(c)(i), p. 165).
7. Dissolution of partnership vs Dissolution of firm. Partnership = relationship change, firm continues; Firm = business closes (NCERT §4.1-§4.2, p. 156-158).
8. Section 48 order. Outside debts → partners' loans → partners' capital → residue in PSR. Easy to invert (NCERT §4.3, p. 159).
9. Section 49 — private property first to private debts. Then surplus may help firm debts (NCERT §4.3, p. 159).
10. Garner vs Murray ratio. Capital ratio, not PSR — though this rule is outside CUET-level numerical (NCERT §4.3 box, p. 160).
11. Fictitious assets distributed in PSR. Preliminary expenses, deferred revenue expenditure, debit balance of P&L — debited to partners' capitals in PSR (NCERT §4.4.1 entry 15, p. 166).
12. Compulsory dissolution triggers. Insolvency of all/all-but-one partner, business becoming illegal/unlawful — not merely a change in PSR (NCERT §4.2, p. 157).

2.5 Journal entry templates

(a) Transfer of assets to Realisation A/c (NCERT §4.4.1 entry 1, p. 164)

(b) Transfer of liabilities to Realisation A/c (NCERT §4.4.1 entry 2)

(c) Sale of assets for cash (NCERT §4.4.1 entry 3)

(d) Asset taken over by a partner (NCERT §4.4.1 entry 4)

(e) Liability assumed by a partner (NCERT §4.4.1 entry 6)

(f) Realisation expenses — borne by partner; paid by firm (NCERT §4.4.1 entry 8(c)(i))

(g) Partner's loan paid off (NCERT §4.4.1 entry 16, p. 166)

(h) Distribution of profit on realisation (NCERT §4.4.1 entry 17)