Dissolution of Partnership Firm – Class 12 Accountancy notes, important questions and MCQs

Chapter overview

Dissolution of partnership means a change in the relationship among partners, while the firm may continue; dissolution of the firm means the business is closed and the relationship among all partners ends. On dissolution of a firm, assets are sold, liabilities are paid and accounts of partners are settled through a realisation account, following the order laid down in Section 48 of the Indian Partnership Act, 1932.

Modes of dissolution

• Dissolution of partnership: admission, retirement, death or change in profit-sharing ratio, while the firm continues.
• Dissolution of the firm: by agreement, compulsory (insolvency of partners or business becoming illegal), on the happening of contingencies (expiry of term or completion of venture), by notice in a partnership at will, or by order of the court.

Settlement of accounts (Section 48)

• Losses, including deficiencies of capital, are paid first out of profits, then out of capital, and finally by partners individually in their profit-sharing ratio.
• Assets, including amounts contributed by partners to make up deficiencies, are applied in this order: first, debts of the firm to third parties; second, loans and advances by partners; third, partners' capital; and the remaining surplus is divided in the profit-sharing ratio.

Realisation account

• Assets (other than cash, bank and fictitious assets) are transferred to the debit side of the realisation account; outside liabilities are transferred to the credit side.
• Amounts realised from assets are credited and liabilities paid are debited; realisation expenses are debited.
• The profit or loss on realisation is transferred to partners' capital accounts in the profit-sharing ratio; accumulated profits and reserves are also distributed.
• Partners' loans are paid after outside liabilities, and finally partners' capital accounts are closed through cash or bank.

Key terms

Dissolution of firm

the closing of the business and ending of the relationship among all partners

Realisation account

an account prepared on dissolution to record sale of assets and payment of liabilities and find profit or loss

Partnership at will

a partnership with no fixed term, which can be dissolved by notice

Fictitious assets

items such as accumulated losses that have no realisable value, closed by transfer to partners' capital

Section 48

the provision of the Partnership Act laying down the order of settlement on dissolution

Important questions with answers

Quick revision

• Dissolution of partnership vs dissolution of firm.
• Modes: agreement, compulsory, contingency, notice, court.
• Section 48 order of settlement.
• Realisation profit or loss to partners in PSR.

Exam tips

• Learn the order of payment on dissolution: outside creditors → partners' loans → partners' capital → surplus.
• In realisation account questions, never transfer cash, bank or partners' loans to it.

Practice MCQs

1. Closing the business and ending the relationship among all partners is

   1. dissolution of partnership
   2. dissolution of firm
   3. admission
   4. retirement
   Show answer

   Answer: (b) dissolution of firm. The firm ceases to exist.

2. On dissolution, assets are sold and liabilities paid through the

   1. revaluation account
   2. realisation account
   3. capital account
   4. appropriation account
   Show answer

   Answer: (b) realisation account. It shows realisation profit or loss.

3. On dissolution, the first payment out of realised assets is made to

   1. outside creditors
   2. partners' capital
   3. partners' loans
   4. the government only
   Show answer

   Answer: (a) outside creditors. Third-party debts come first.

4. Partners' loans to the firm are paid

   1. after outside creditors but before capital
   2. before outside creditors
   3. after capital
   4. never
   Show answer

   Answer: (a) after outside creditors but before capital. This follows Section 48.

5. Which is NOT transferred to the realisation account

   1. machinery
   2. cash in hand
   3. stock
   4. outside creditors
   Show answer

   Answer: (b) cash in hand. Cash is used for payments.

6. Profit on realisation is shared by partners in the

   1. capital ratio
   2. profit-sharing ratio
   3. equal ratio always
   4. loan ratio
   Show answer

   Answer: (b) profit-sharing ratio. It is like any other profit.

7. A firm is dissolved if a partner becomes insolvent. This is dissolution

   1. compulsory
   2. by agreement
   3. by notice
   4. on contingency
   Show answer

   Answer: (a) compulsory. Insolvency forces dissolution.

8. A creditor of ₹20,000 accepts machinery worth ₹18,000 in full settlement. The realisation account effect is

   1. a profit of ₹2,000
   2. a loss of ₹2,000
   3. no entry
   4. a loss of ₹18,000
   Show answer

   Answer: (a) a profit of ₹2,000. The liability of ₹20,000 is settled with an asset worth ₹18,000.