dissolution of firm

dissolution of firm

best summary  notes

Dissolution  of firm


Dissolution of relationships between partners along with termination of business.

At the time of dissolution, all assets will be realized and liabilities should be repaid.

For dissolution following accounts will be prepared.

1 realization account

2 partners capital account

3 cash/bank account

1 realization account :

All assets and liabilities will be transferred at book value.

Provisions and reserves should be shown separately in realization account. Don’t net off.

Debtors will be debited and provision for debtors will be credited.

Firm’s debt vs. personal debt

Any partner becomes insolvent only after realizing all assets as well as firm’s share of asset.

From private property, partner first pay private debt, then only balance will bring in firm’s business as well as from firm’s assets first pay firm’s debt and then only from excess private debt can be paid.

If Any partner is unable to pay any debt, he will become insolvent.

All partners  become insolvent, firm will be insolvent.

Deficiency in case of insolvency:

When insolvent partner is unable to pay firm’s debt, outstanding balance of such partner is called deficiency which will be borne by solvent partner in agreed capital ratio.

Insolvency of firm


While making the payment pay in following sequence:

Outside secured debt

Outside unsecured debt

Partner’s loan

Partner’s capital

If any secured asset realized less than its liability, remaining portion of liability will be unsecured.

Q.7                 Realization account

Particulars Rs Particulars Rs
To stock    60,000 By bank
To other asset 1,09,000            stock 52,000
To goodwill    30,000  Other assets 90,000
To bank –exp.      3,000 By capital a/c
   A    24,000
   B    24,000
   C    12,000 60,000
2,02000 202000

Partner’s capital account

particulars A B C particulars A B C
To bal. 20000 By bal. 30000 20000
To realization loss 24000 24000 12000 By deficiency 4000 32000
24000 24000 32000 30000 24000 32000

Bank loan account

Particulars Rs Particulars Rs
TO Bank 50,000 By balance 50,000
50,000 50,000


Creditors’ account

Particulars Rs Particulars Rs
TO Bank 90,000 By balance 1,20,000
To deficiency 30,000
1,20,000 1,20,000

Deficiency account

Particulars Rs Particulars Rs
To B 4,000 By creditors 30,000
To C    32,000 By A 6,000
36,000 36,000


Piecemeal distribution:

In dissolution of firm, assets will be sold and liabilities will be paid off. But in practice, it happens gradually. After the sale of the assets liability will be paid off in the following sequence

Realization expenses

Secured creditors

unsecured creditors

partner’s loan ( not add in capital but pay proportionately )

contingent liability (amount set aside)

balance paid to partner’s capital

methods for distribution of cash among partners :

  • Maximum loss method

Under this method, at every stage it is assumed that no further realization of the assets.

Steps under maximum loss method

1 Calculate maximum loss at each stage

Maximum loss = total capital – asset realised

2 Deduct maximum loss from capital in profit and loss ratio

3 If any of the figures of step 2 is negative distribute it to other partners in the ratio of opening capital (after reserve and surplus)

This process will be continue until all figures becomes positive

4 Deduct positive value of step 3 from balance of capital

Above process will be carried at each stage.


It may arise in future as a liability like worker’s claim, bills discounted etc.

Provision should be raised before making payment to partner’s capital.

Although there is no column for contingent liability. It should be set aside and balance will be paid to partner’s capital.

Realization expenses:

It will be paid in priority so from first installment or available cash, first pay or set aside the realization expenses. But if actual expenses are less than provision, then excess will be added in last installment or installment in which it is finalized.

Any negative balance of partner distributed to other partners in capital ratio.

If fixed capital is given in balance sheet, balance will be distributed in fixed capital ratio

But if there is fluctuating capital opening capital + reserve –miscellaneous expenses.

Follow this ratio for distribution of loss.

Relative / proportionate capital method:

Under this method following steps will be followed.

A                B          C

A Balance of Capital

B Profit and loss ratio

C Base of capital= a/b

D bal of capital on the

Basis of minimum base

E = A – D

F repeat above steps for

Remaing two partners

Conversion of firm into company

There are certain similarities with amalgamation

Following accounts will be prepared

1 realization account

  • cash/bank account(if not taken by new company)
  • partner’s capital account
  • New company account

In amalgamation equity, preference and cash received as consideration can be directly distributed. But in sale of firm first PC will be brought in the firm and then it will be distributed to partners.

If base of distribution is not given distribute all consideration in the ratio of final claim of capital.


Purchase consideration

Equity shares, preference shares and cash given by new company to firm will be known as purchase consideration

Journal entry :


New company account Dr.

To realization account

Equity shares in new company DR.

Preference  shares in new co. DR.

Cash account Dr.

To new company account



Partner’s capital account Dr.

To Equity shares in new company .

To Preference  shares in new co.

To Cash account

(In final claim of capital ratio – i.e after current account and realization loss)

Amalgamation of firm:

Following accounts will be prepared

Revaluation account

Partner’s capital account

New firm’s account


In amalgamation of the company or conversion of firm in to company, we are preparing realization account, because all assets and liabilities account will be closed at book value as well as purchase consideration is given.

In amalgamation of firm asset and liabilities are revalued, hence revaluation account will be prepared.

Journal entries

Asset account dr.

To liabilities account

To revaluation account

(increase in assets and increase in liablilites)

Liabilities account dr.

To assets account

To revaluation account

(decrease in assets or liabilities)

Revaluation account transfer to capital:


Revaluation account dr.

To partner’s capital


Partner’s capital account dr.

To revaluation account

Transfer of asset and liabilities to new firm:

New firm account dr.

Liabilities account dr.

To assets account

Partner’s capital transfer to new firm account:

Partner’s capital account dr.

To new firm account

New firm account will be tallied