Questions
6 questions
Difficulty
Medium-Hard
Importance
Key for Class 12 boards
Overview
Dissolution of Partnership involves the closure of the firm's business and the termination of the existing relationship between partners. It is a critical topic in the Class 12 accounting syllabus, testing a student's ability to settle accounts, discharge liabilities, and distribute remaining assets. Mastering this ensures proficiency in the systematic liquidation process defined by the Indian Partnership Act, 1932.
Modes of Dissolution
Dissolution can occur either voluntarily by the partners or compulsorily by law. Understanding these modes is essential as it dictates the legal framework under which the firm must stop its operations.
- Dissolution by agreement (Section 40)
- Compulsory dissolution (Section 41)
- Dissolution on the happening of certain contingencies (Section 42)
- Dissolution by notice of partnership at will (Section 43)
- Dissolution by the court (Section 44)
Realisation Account
This is a nominal account prepared to determine the net profit or loss arising from the sale of assets and the payment of liabilities. All assets (excluding cash/bank) and all external liabilities are transferred to this account at their book values.
- Debit assets at book value; Credit liabilities at book value
- Sale of assets is credited to Realisation Account
- Payment of liabilities is debited to Realisation Account
- Unrecorded assets generate profit when sold
- Unrecorded liabilities generate loss when paid
Insolvency of Partners
When a partner cannot pay their share of a deficiency, the loss must be borne by the solvent partners. The accounting treatment for this is guided by the Garner v. Murray rule in the absence of a specific partnership agreement.
- Apply Garner v. Murray rule for deficiency
- Solvent partners bear loss in capital ratio
- Insolvent partner's capital account must be settled
- Cash brought by solvent partners is credited to their capital accounts
Piecemeal Distribution
This process involves distributing cash to partners as and when assets are realized rather than waiting for the entire liquidation process to finish. It requires strict adherence to the order of payment to external creditors and partners.
- Payment order: Realisation expenses, external creditors, partner loans, then capital
- Maximum Loss Method used to determine interim payments
- Highest Relative Capital Method (Surplus Capital Method)
- Proportionate distribution to partners based on capital ratio
Exam Tip
Always prepare the Realisation Account, Partner's Capital Accounts, and Bank/Cash Account in sequence, as the balance of one often dictates the entry for the next.
Common Mistakes
- Treating the transfer of Cash/Bank balances to the Realisation Account instead of using them for final payments.
- Ignoring the specific hierarchy of payment where external liabilities must be cleared before partner loans.
- Miscalculating the distribution of deficiency under the Garner v. Murray rule by using the Profit Sharing Ratio instead of the Capital Ratio.
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