Big picture
When a firm is dissolved, the business stops. Its assets are sold, its outside liabilities are paid, and whatever is left goes back to the partners. Three accounts tell the whole story:
Realisation Account: records the sale of assets and payment of liabilities, and shows the profit or loss on closing down.
Partners' Capital Accounts: collect each partner's capital, reserves, share of realisation profit or loss, and any asset or liability they personally took over.
Bank (or Cash) Account: shows every rupee received and paid. It must close at nil.
Learning goals
Distinguish dissolution of partnership from dissolution of the firm.
State the modes of dissolution of a firm.
Apply the order of settlement of accounts under Section 48.
Pass every Realisation Account entry, including assets taken over by partners and creditors, unrecorded items and expenses.
Prepare the Realisation Account, Partners' Capital Accounts and Bank Account to close the books.
Core ideas
1. Dissolution of partnership and dissolution of the firm
Point | Dissolution of partnership | Dissolution of firm |
|---|---|---|
Meaning | The existing agreement ends and a new one is made | The relationship among all partners ends |
Business | Continues | Stops |
Books of account | Continue; assets revalued | Closed; assets realised |
Examples | Admission, retirement, death, change in ratio | Insolvency of all but one partner, business becoming illegal |
Court's role | None | May be ordered by the court |
Every dissolution of the firm is also a dissolution of the partnership, but not the other way round.
2. Modes of dissolution of a firm
By agreement of all partners, or under a contract between them.
Compulsory dissolution: when all partners, or all but one, become insolvent; or when the business becomes illegal (say, the firm trades in a product the government bans).
On a contingency: when a firm formed for a fixed term ends, a firm formed for a single venture completes it, or a partner dies or becomes insolvent (unless the deed says the firm continues).
By notice: in a partnership at will, any partner can dissolve the firm by written notice to the others.
By the court, on a partner's petition, if a partner becomes of unsound mind or permanently incapable; is guilty of misconduct affecting the business; persistently breaches the agreement; transfers his whole interest to a third party; or if the business can only run at a loss, or for any other just and equitable reason.
3. Order of settlement (Section 48)
Losses, including any deficiency of capital, are paid first out of profits, then out of capital, and finally by partners individually in their profit-sharing ratio.
Assets, including sums contributed to make up deficiencies, are applied in this order:
paying outside creditors (third parties);
repaying partners' loans and advances (proportionately), as distinct from capital;
repaying each partner's capital;
any surplus is shared in the profit-sharing ratio.
Note. A partner's loan to the firm is not an outside liability. It is not transferred to the Realisation Account; it is paid directly after creditors. A loan from a partner's spouse or relative is an outside liability and goes to the Realisation Account like any creditor.
4. Realisation Account entries
Transfer of book balances
Transaction | Debit | Credit |
|---|---|---|
Assets transferred at book value (all except cash, bank, fictitious assets and partners' current accounts) | Realisation A/c | Sundry Assets A/cs |
Outside liabilities transferred at book value | Sundry Liabilities A/cs | Realisation A/c |
Provisions against assets (doubtful debts, depreciation) | Provision A/c | Realisation A/c |
Transfer assets at gross value and the provision separately; or transfer them net of the provision. Both give the same result.
Realising assets and paying liabilities
Transaction | Debit | Credit |
|---|---|---|
Asset sold for cash | Bank A/c | Realisation A/c |
Asset taken over by a partner | Partner's Capital A/c | Realisation A/c |
Unrecorded asset sold | Bank A/c | Realisation A/c |
Unrecorded asset taken over by a partner | Partner's Capital A/c | Realisation A/c |
Liability paid in cash | Realisation A/c | Bank A/c |
Liability taken over by a partner | Realisation A/c | Partner's Capital A/c |
Unrecorded liability paid | Realisation A/c | Bank A/c |
Partner's loan repaid | Partner's Loan A/c | Bank A/c |
Creditors accepting assets. No entry is passed when a creditor accepts an asset in full settlement, because the asset and the liability are both already in the Realisation Account. Only cash actually paid is recorded.
Example. Creditors of ₹50,000 accept machinery valued at ₹42,000 and the balance in cash. Only the cash is recorded: Realisation A/c Dr ₹8,000, To Bank A/c ₹8,000.
If creditors accept an asset worth more than their claim and pay the firm the difference, record the cash received: Bank A/c Dr, To Realisation A/c.
Realisation expenses
Situation | Entry |
|---|---|
Paid by the firm | Realisation A/c Dr, To Bank A/c |
Paid by a partner on behalf of the firm | Realisation A/c Dr, To Partner's Capital A/c |
A partner agrees to bear expenses for a fixed remuneration | Realisation A/c Dr, To Partner's Capital A/c (with the remuneration only; the actual expenses are his own) |
Expenses that a partner must bear are paid by the firm | Partner's Capital A/c Dr, To Bank A/c |
Closing the Realisation Account. Profit: Realisation A/c Dr, To Partners' Capital A/cs (profit-sharing ratio). Loss: Partners' Capital A/cs Dr, To Realisation A/c.
5. Partners' capital accounts on dissolution
Credit each partner with reserves and accumulated profits in the profit-sharing ratio; debit accumulated losses and fictitious assets (such as deferred advertisement expenditure) in the same ratio.
With fixed capitals, transfer current account balances to capital accounts first.
Debit any asset the partner took over; credit any liability they took over.
Credit realisation profit or debit realisation loss.
The final balance is settled in cash. A credit balance is paid to the partner: Partner's Capital A/c Dr, To Bank A/c. A debit balance means the partner brings cash in: Bank A/c Dr, To Partner's Capital A/c.
6. A complete dissolution problem
P and Q share profits 3:2. Their balance sheet on 31 March 2025, when they dissolved the firm:
Liabilities | ₹ | Assets | ₹ |
|---|---|---|---|
Creditors | 40,000 | Bank | 25,000 |
Bills payable | 10,000 | Debtors | 45,000 |
Q's Loan | 20,000 | Stock | 50,000 |
General Reserve | 15,000 | Investments | 20,000 |
P's Capital | 80,000 | Machinery | 70,000 |
Q's Capital | 60,000 | Deferred advertisement expenditure | 15,000 |
Total | 2,25,000 | Total | 2,25,000 |
Debtors realised ₹42,000. P took over the stock at ₹46,000 and Q took over the investments at ₹22,000. Machinery was sold for ₹60,000. Creditors were paid ₹38,000 in full settlement and bills payable were paid in full. An unrecorded computer was sold for ₹5,000. Realisation expenses of ₹3,000 were paid by the firm. Q's loan was repaid.
Realisation Account
Particulars | ₹ | Particulars | ₹ |
|---|---|---|---|
Debtors | 45,000 | Creditors | 40,000 |
Stock | 50,000 | Bills payable | 10,000 |
Investments | 20,000 | Bank: debtors | 42,000 |
Machinery | 70,000 | Bank: machinery | 60,000 |
Bank: creditors | 38,000 | Bank: unrecorded computer | 5,000 |
Bank: bills payable | 10,000 | P's Capital: stock | 46,000 |
Bank: expenses | 3,000 | Q's Capital: investments | 22,000 |
Loss: P (3/5) | 6,600 | ||
Loss: Q (2/5) | 4,400 | ||
Total | 2,36,000 | Total | 2,36,000 |
Partners' Capital Accounts
Dr Particulars | P | Q | Cr Particulars | P | Q |
|---|---|---|---|---|---|
Deferred advertisement | 9,000 | 6,000 | Balance b/d | 80,000 | 60,000 |
Realisation: asset taken | 46,000 | 22,000 | General Reserve | 9,000 | 6,000 |
Realisation loss | 6,600 | 4,400 | |||
Bank (final payment) | 27,400 | 33,600 | |||
Total | 89,000 | 66,000 | Total | 89,000 | 66,000 |
Bank Account
Receipts | ₹ | Payments | ₹ |
|---|---|---|---|
Balance b/d | 25,000 | Realisation: creditors and bills payable | 48,000 |
Realisation: debtors | 42,000 | Realisation: expenses | 3,000 |
Realisation: machinery | 60,000 | Q's Loan | 20,000 |
Realisation: computer | 5,000 | P's Capital | 27,400 |
Q's Capital | 33,600 | ||
Total | 1,32,000 | Total | 1,32,000 |
The bank account closes at nil, which confirms the working. Notice that Q's loan was paid straight from the bank, not through the Realisation Account, and that the deferred advertisement expenditure was written off to capitals, not to Realisation.
A reliable problem-solving routine
Transfer all assets (except cash, bank and fictitious assets) and all outside liabilities to the Realisation Account at book values.
Transfer reserves and accumulated profits to capitals; write off fictitious assets and accumulated losses to capitals. All in the profit-sharing ratio.
Record every realisation: assets sold, assets taken over by partners or creditors, unrecorded assets.
Record payments of liabilities, taking care with creditors who accept assets (record only cash).
Record realisation expenses according to who pays and who bears them.
Close the Realisation Account to capitals in the profit-sharing ratio.
Pay partners' loans, then settle capitals in cash. Check that the bank account closes at nil.
Connections that matter
Retirement and death settle with one partner while the firm continues; dissolution settles with all partners and the firm stops.
Partnership fundamentals supplies the profit-sharing ratio and fixed or fluctuating capital formats used in the final settlement.
Revaluation Account and Realisation Account look alike, but revaluation only restates values while the business continues; realisation records actual sales and payments.
Common mistakes
Transferring a partner's loan to the Realisation Account. It is paid directly, after outside creditors.
Transferring cash, bank or fictitious assets to the Realisation Account.
Recording the asset again when a creditor accepts it. Only the cash paid is entered.
Debiting actual expenses when a partner has agreed to bear them for a remuneration. Only the remuneration goes to Realisation.
Forgetting unrecorded assets and liabilities. They go to Realisation when realised or paid.
A bank account that does not close at nil. Recheck capitals and realisation entries.
Revision checklist
I can distinguish dissolution of partnership from dissolution of the firm.
I can list the modes of dissolution, including dissolution by the court.
I can state the Section 48 order of settlement.
I can pass every Realisation Account entry, including creditors accepting assets and expenses.
I can prepare Realisation, Capital and Bank Accounts that close correctly.