Dissolution of Firm: Partner’s Capital Account

What is Dissolution of a Firm?

Dissolution of the firm is the discontinuation of the business and closure of all the books of accounts of the firm. Dissolution of the partnership means a change in the profit-sharing ratio of the existing partners in the firm and the business or the firm continues its operation. In case of dissolution of the partnership, a new partnership comes into existence with the change in the profit-sharing ratio.

“Dissolution of the firm means dissolution of partnership among all the partners in the firm.”

–Section 39 of the Indian Partnership Act,1932

Dissolution of the firm means dissolution of the partnership among the partners of the firm. The business is closed and an end comes to the business relationship among partners on the dissolution of the firm. The firm is dissolved either by a court order or without legal intervention. Firm is dissolved by court order when a partner becomes a person of unsound mind, permanently incapacitated, or found guilty of misconduct, on breach of partnership agreement purposely by any partner, the court then finds the dissolution of the firm justified. The firm is dissolved without court intervention when all the partners agree to do so, or when one or all partner becomes insolvent, the business becomes unlawful, completion of the venture, dissolution by notice; in case of partnership at will. On dissolution of the partnership, firm’s assets are realised and the liabilities are settled. All the reserves and accumulated profit and loss standing in the balance sheet on the date of dissolution are distributed among the partners in their profit-sharing ratio. The partner’s capital account is settled by making a payment to the credit balance in relation to the final settlement or the partner brings in the amount of deficiency(debit balance) to his/her capital account for the final settlement.

Accounting Treatment:

Step 1: The balances of the partner’s capital as appearing on the date of dissolution are recorded.

Step 2: The balance of the Current accounts of the partner is transferred to Capital accounts.

A. In case of debit balance in a Current Account of a partner:

B. In case of credit balance in a Current Account of a partner:

Step 3: Balances of reserves and accumulated profit and loss are transferred to the partner’s capital account in their profit-sharing ratio. 

A. For Distribution of Reserves and Accumulated Profits:

B. For writing off Accumulated Loss:

Step 4: On Realisation of assets and settlement of liabilities on the date of dissolution, the profit or loss arising upon the Realisation is transferred to the partner’s capital account in their profit sharing ratio.   

A. In case of realisation profit:

B. In case of realisation loss:

Step 5: In Realisation of any asset or settlement of any liability, if it is taken over by any partner, the concerned partner’s capital account is debited or credited respectively.

A. If Assets are taken over by the partner:

B. If Liability is taken over by any partner:

Step 6: If there is a partner’s loan in the Balance Sheet at the time of dissolution of the firm, the partner is repaid after the settlement of liabilities, i.e., making payment to outside parties.

A. When the business has taken a loan from the partner:

Note: In case the partner’s capital shows a debit balance, the amount of loan advanced is transferred to his capital on the credit side and the balance, if any of the partner’s loan amount is settled after the payment of the outside liability.

B. When a partner has taken a loan from the business:

Step 7: Partner’s Capital account is finally settled by balancing the capital account.

A. For closing partner’s capital account (credit balance) by making payment to partner:

B. For closing partner’s capital account (debit balance) by cash brought in by the concerned partner:

Format:

Illustration: 

Arya, Kali, and Rani were partners in the firm sharing profit and loss in the ratio 5:3:2. They decided to dissolve the business on 31st March 2022. The Balance Sheet on 31st March 2022 was:

a) Investments were taken over by Arya at ₹23,000.

b) Creditors of ₹31,000 were taken over by Rani at ₹29,500 and at ₹34,000 settled the remaining creditors.

c) All the Assets except Bank and Investment were sold to a company at ₹2,78,000 in cash. Goodwill could not realize any amount.

d) ₹2,900 was realised from a debtor which was written off as bad debts, which is not included above.

e) Insurance claim received ₹57,000 and an unrecorded asset of the firm was realised at ₹73,000.

f) Realisation Expenses were to be borne by Arya for which ₹13,500 was credited to her account. Actual Realisation expense paid out of firm’s Bank account amounted ₹15,000.

Solution: