Class 12 Accountancy · Chapter 5 NotesDissolution of Partnership Firm
Learn about the dissolution of a partnership firm, including the meaning, modes, settlement of liabilities and assets, distribution of cash, and preparation of…
This chapter explains the process of dissolution of a partnership firm, which involves the termination of the partnership business and the settlement of all liabilities and assets. You will learn about the different modes of dissolution, the accounting treatment of goodwill and reserves, and the preparation of realization and partners' capital accounts. Understanding these concepts is crucial for managing the financial closure of a partnership firm and ensuring fair distribution of assets among partners.
What you'll learn
1Understand the meaning and modes of dissolution of a partnership firm
2Learn the process of settling liabilities and assets during dissolution
3Calculate and distribute cash to partners accurately
4Prepare a realization account to record the sale and settlement of assets and liabilities
5Prepare partners' capital accounts to reflect the final settlement of their capital balances
6Account for goodwill and reserves appropriately during the dissolution process
Chapter at a glance
01Meaning and Modes of Dissolution
02Settlement of Liabilities and Assets
03Preparation of Realization Account
04Preparation of Partners' Capital Accounts
05Accounting Treatment of Goodwill and Reserves
Detailed chapter notes
01
Meaning and Modes of Dissolution
Dissolution of a partnership firm refers to the process where the partnership business is terminated, and the firm ceases to exist. This involves the settlement of all liabilities and the distribution of assets among the partners. Dissolution can occur in several ways, including by agreement, compulsory dissolution, on the happening of certain contingencies, by notice, or by court order. It is important to distinguish between the dissolution of a partnership (which may not involve the firm) and the dissolution of a firm (which involves the complete closure of the business).
Dissolution of a firm involves the closure of the business and the settlement of all liabilities and assets.
Dissolution can be voluntary (by agreement or notice) or compulsory (by court order or specific events).
02
Settlement of Liabilities and Assets
During the dissolution of a partnership firm, all liabilities must be settled, and assets must be realized. Liabilities are paid off first from the assets realized, and if necessary, partners may need to contribute to cover any deficiencies. Assets are sold or distributed to settle the claims of the firm's creditors and partners. The process ensures that all financial obligations are met before the firm is closed.
Liabilities are settled first from the assets realized.
Partners may need to contribute to cover any deficiencies in settling liabilities.
03
Distribution of Cash to Partners
After settling all liabilities, the remaining cash is distributed to the partners. This distribution is done in a specific order: first to repay loans given by partners to the firm, then to settle their capital accounts, and finally, any surplus is divided among the partners in their profit-sharing ratio. Accurate calculation and distribution ensure fairness and compliance with legal requirements.
Cash is distributed first to repay loans given by partners to the firm.
Surplus cash is divided among partners in their profit-sharing ratio.
04
Preparation of Realization Account
The Realisation Account is prepared to record the transactions related to the sale of assets and settlement of liabilities. This account helps in ascertaining the profit or loss on the realization of assets and payment of liabilities. All assets (except cash and bank) and external liabilities are transferred to this account. The balance in this account, after all transactions, represents the profit or loss on realization, which is then transferred to the partners' capital accounts in their profit-sharing ratio.
Realisation Account records the sale of assets and settlement of liabilities.
Profit or loss on realization is transferred to partners' capital accounts.
05
Preparation of Partners' Capital Accounts
Partners' capital accounts are prepared to reflect the final settlement of their capital balances. These accounts include the transfer of any accumulated profits, reserves, and the settlement of loans and advances. The final balance in the partners' capital accounts indicates the amount due to each partner, which is then paid out from the available cash or bank balance. This ensures that each partner receives their rightful share of the firm's assets after all liabilities are settled.
Partners' capital accounts reflect the final settlement of their capital balances.
Accumulated profits and reserves are transferred to partners' capital accounts.
06
Accounting Treatment of Goodwill and Reserves
Goodwill and reserves are important components that need to be accounted for during the dissolution of a partnership firm. Goodwill, if any, is realized and distributed among the partners. Reserves, such as the general reserve, are also transferred to the partners' capital accounts in their profit-sharing ratio. Proper accounting treatment ensures that all financial aspects are correctly recorded and distributed, maintaining transparency and fairness in the dissolution process.
Goodwill is realized and distributed among the partners.
Reserves are transferred to partners' capital accounts in their profit-sharing ratio.
Want the complete chapter resources?Topic notes, quizzes and flashcards for Dissolution of Partnership Firm.
Dissolution of a partnership firm involves the termination of the business and settlement of all liabilities and assets.
Liabilities are settled first from the assets realized, and partners may need to contribute to cover any deficiencies.
Cash is distributed to partners in a specific order: first to repay loans, then to settle capital accounts, and finally, any surplus is divided in the profit-sharing ratio.
The Realisation Account records the sale of assets and settlement of liabilities, and the profit or loss on realization is transferred to partners' capital accounts.
Partners' capital accounts reflect the final settlement of their capital balances, including the transfer of accumulated profits and reserves.
Goodwill and reserves are accounted for during dissolution, with goodwill being realized and distributed, and reserves transferred to partners' capital accounts.
According to Section 39 of the Indian Partnership Act, 1932, dissolution of partnership between all the partners of a firm is called:
ADissolution of partnership
BDissolution of the firm
CReconstitution of the firm
DWinding up of the firm
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Answer: (B) Dissolution of the firm
Section 39 explicitly states that dissolution of partnership between all the partners of a firm is called dissolution of the firm.
Question 02
According to Section 48 of the Indian Partnership Act, 1932, what is the order of settlement of liabilities on dissolution of a firm?
AOutside liabilities, partner's loans, partner's capitals, surplus to partners in profit-sharing ratio
BPartner's loans, outside liabilities, partner's capitals, surplus to partners in profit-sharing ratio
COutside liabilities, partner's capitals, partner's loans, surplus to partners in profit-sharing ratio
DPartner's capitals, outside liabilities, partner's loans, surplus to partners in profit-sharing ratio
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Answer: (A) Outside liabilities, partner's loans, partner's capitals, surplus to partners in profit-sharing ratio
Section 48 prescribes that firm's debts (outside liabilities) are paid first, then partner's loans, then capitals, and any surplus is divided among partners in their profit-sharing ratio.
Question 03
According to Section 48 of the Partnership Act, 1932, what is the order of settlement of accounts on dissolution of a firm?
Section 48 prescribes that firm's debts to third parties are paid first, then partner's loans, then capitals, and any residue is divided in profit-sharing ratio.
Question 04
On dissolution of a firm, which of the following accounts is credited when an unrecorded asset is realised in cash?
ABank Account
BRealisation Account
CPartner's Capital Account
DRevaluation Account
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Answer: (B) Realisation Account
When an unrecorded asset is realised, it is a gain to the firm, so the Realisation Account is credited with the amount realised.
Question 05
On dissolution of a firm, the balance of a partner's loan account is transferred to:
ARealisation Account
BPartner's Capital Account
CBank Account
DPartner's Current Account
Show answer
Answer: (B) Partner's Capital Account
According to the chapter, partner's loan is not transferred to Realisation Account; it is paid off and the balance is transferred to the partner's capital account.
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Q1. Differentiate between dissolution of partnership and dissolution of a firm on the basis of termination of business and settlement of assets and liabilities.
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Model answer
Dissolution of partnership does not terminate the business; it continues, possibly with a changed relationship among partners. Assets and liabilities are revalued and a new balance sheet is drawn. In contrast, dissolution of a firm terminates the business completely. Assets are sold and liabilities are paid off, and the books of account are closed.
Sample question3 marks
Q2. State the order in which the assets of a firm are applied at the time of dissolution, as per Section 48 of the Indian Partnership Act, 1932.
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Model answer
As per Section 48, the assets of the firm, including any sum contributed by partners to make up deficiencies of capital, are applied in the following order: (i) first, in paying the debts of the firm to third parties; (ii) second, in paying each partner proportionately what is due to him/her from the firm for advances as distinguished from capital (i.e., partner's loan); (iii) third, in paying to each partner proportionately what is due on account of capital; and (iv) the residue, if any, is divided among the partners in their profit sharing ratio.
Sample question3 marks
Q3. State the order in which the firm's assets are applied in case of dissolution of a firm as per Section 48 of the Indian Partnership Act, 1932.
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Model answer
According to Section 48 of the Indian Partnership Act, 1932, the assets of the firm, including any sum contributed by partners to make up deficiencies of capital, shall be applied in the following order: first, in paying the debts of the firm to third parties; second, in paying each partner proportionately what is due to him/her from the firm for advances (i.e., partner's loan); third, in paying to each partner proportionately what is due on account of capital; and fourth, the residue, if any, shall be divided among the partners in their profit sharing ratio.
Sample question3 marks
Q4. State the journal entries to be passed for the transfer of assets and liabilities to the Realisation Account at the time of dissolution of a firm.
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Model answer
At the time of dissolution, all assets (except cash/bank and fictitious assets) are transferred to the debit side of the Realisation Account by passing the entry: Realisation A/c Dr. To Assets (Individually) A/c. All external liabilities and provisions are transferred to the credit side by passing the entry: Liabilities (Individually) A/c Dr. To Realisation A/c.
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Q5. On dissolution of a firm, how are accumulated profits and reserves, such as General Reserve, dealt with? Give the journal entry.
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Model answer
Accumulated profits and reserves, like General Reserve, are transferred to the partners' capital accounts in their profit-sharing ratio. The journal entry is: General Reserve A/c Dr. To Partners' Capital A/cs (individually). This is because these balances belong to the partners and are distributed among them at the time of dissolution.
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What is the difference between the dissolution of a partnership and the dissolution of a firm?
Dissolution of a partnership refers to the termination of the partnership relationship among partners, while dissolution of a firm involves the complete closure of the business and settlement of all liabilities and assets.
What is a Realisation Account?
A Realisation Account is prepared to record the transactions related to the sale of assets and settlement of liabilities during the dissolution of a partnership firm. It helps in ascertaining the profit or loss on realization.
How are liabilities settled during the dissolution of a firm?
Liabilities are settled first from the assets realized. If the assets are insufficient, partners may need to contribute to cover the deficiencies in their profit-sharing ratio.
In what order is cash distributed to partners during dissolution?
Cash is first used to repay loans given by partners to the firm, then to settle their capital accounts, and any surplus is divided among the partners in their profit-sharing ratio.
What is the accounting treatment of goodwill during dissolution?
Goodwill, if any, is realized and distributed among the partners. The amount realized from the sale of goodwill is recorded in the Realisation Account and then transferred to the partners' capital accounts.