DISSOLUTION OF PARTNERSHIP FIRM - DIBRUGARH UNIVERSITY B.COM 1st Semester (CBCS) NOTES FINANCIAL ACCOUNTING UNIT -5




FINANCIAL ACCOUNTING
(CBCS)

UNIT -5

DISSOLUTION OF PARTNERSHIP FIRM



Q1. Define dissolution of a partnership firm?
Ans: Dissolution of partnership: Dissolution of partnership means a change in the existing relationship of partners through reconstitution of the firm without effecting the entity of the firm. The dissolution of partnership does not involve the complete breakdown of relationship among the partners but it merely means a change in the economic relationship.
Dissolution of a partnership firm:
According to Section 39 of the Indian Partnership Act, 1932, “The dissolution of partnership between all the partners of a firm is called the dissolution of the firm.”

Q2. Discuss the reasons that lead to dissolution of firm.
Ans: Following are reasons that lead to dissolution of firm:
1. When all the partners agree that the firm should be dissolved.
2. When all the partners, except one, have become insolvent.
3. When the business become illegal.
4. In case of partnership at will, where any partner gives notice of dissolution; and
5. When the court orders for dissolution.

Q3. What are the different modes of dissolution of partnership firm?
Ans: As per Section 40, 41, 42, 43, 44 of the Indian Partnership Act, 1932 which states that there are five modes of dissolution of partnership firm. They are as follows:
1. Dissolution by agreement (Section 40)
2. Compulsory dissolution (Section 41)
3. Dissolution on the happening of certain contingencies (Section 42)
4. Dissolution by notice of partnership at will (Section 43)
5. Dissolution by the court (Section 44)

Dissolution by Agreement: A firm may be dissolved with the consent of all the partners or in accordance with a contract between the partners.

Compulsory dissolution: A firm is compulsory dissolved in the following cases:
(i) When all the partners, except one become insolvent.
(ii) When all the partners become insolvent
(iii) When the business becomes illegal, and
(iv) When the number of partners exceed twenty in case of an ordinary business or ten in case of a banking business.

Dissolution on the happening of certain contingencies:  A firm may be dissolved on the happening of any one the following contingencies
(i) By the expiry of the term or duration of the firm.
(ii) By the completion of the venture for which firm was constituted.
(iii) By the death of a partner, and
(iv) By the adjudication of a partner as insolvent.

Dissolution by notice of partnership at will: When the partnership is at will, the firm may be dissolved by any partner giving notice in writing to all the other partners of his intention to dissolve the firm.

Dissolution by the court:
The court may dissolve a firm on any one of the following grounds:-
(i) When a partner become of unsound mind.
(ii) Where a partner becomes permanently incapable of performing his duties.
(iii) Where a partner is guilty of misconduct in carrying on the business.
(iv) Where a partner wilfully or persistently commits breach of agreement.
(v) Where a partner transferred whole of his interest in the firm to a third party.
(vi) Where the court finds that the business cannot be carried on except for a loss.

Q4. What are the differences between Dissolution of partnership and Dissolution of firm?
Ans: Following are the differences between Dissolution of partnership and Dissolution of firm:

Q5. State the procedure to be followed in settlement of accounts under section 48?
Ans: Section 48 of the Indian Partnership Act, 1932 governs settlement of accounts on dissolution of the firm. In setting the accounts of a firm after dissolution the following rules shall, subject to agreement by the partners, be observed:
a. Losses, including deficiencies of capital, shall be paid first out of profits, next out of capital, and lastly, if necessary, by the partners individually in the proportions in which they are entitled to share profits.
b. The assets of the firm, including any sums contributed by the partners to make up deficiencies of capital, shall be applied in the following manner and order:
i. In paying the debts of the firm to third parties;
ii. In paying to each partner rateably what is due to him from the firm for advances as distinguished from capital;
iii. In paying to each partner rateably what is due to him on account of capital; and
iv. The residue, if any, shall be divided among the partners in the proportions in which they are entitled to share profits.

Q6. What is Realisation Account?
Ans: Realisation account is a nominal account. It is prepared at the time of dissolution of partnership firm. It is prepared to find out profit or loss on realisation of assets and payment of liabilities when a firm is dissolved. The closing balance of this account transferred to partner’s capital account in their profit sharing ratio.

Q7. What are the objectives of preparing Realisation Account?
Ans: Following are the objectives of preparing Realisation Account:
a. It is prepared to close the books of account at the time of dissolution of firm.
b. It is prepared to record sale of assets and payment of liabilities and expenses.
c. It is prepared to find out profit or loss on realisation of assets and liabilities.

Q8. What are the differences between Revaluation A/c and Realisation A/c?
Ans: Following are the differences between Revaluation A/c and Realisation A/c:

Q9. Write a short note on Garner vs. Murray (Insolvency of a Partner)
Ans: At the time of dissolution, a partner owes a sum of money to the firm; he has to pay it to the firm. But if he is insolvent, he will not able to do so, at least not fully. The sum which is irrecoverable from an insolvent partner is, therefore, a loss. The question arises whether this loss is like the ordinary loss to be shared by the solvent partners in the profit sharing ratio or whether it is an extraordinary loss. Before the decision in Garner vs. Murray rule was made, such a loss was treated as ordinary loss. After the decision in Garner vs. Murray, the following rule is being followed for dividing loss among the partners:

a. First, the solvent partners should bring in cash equal to their share of the loss on realisation; and
b. Second, the loss due to the insolvency of a partner should be divided among other partners in following manner:
i. If the capitals are fixed, then that will be the ratio in which an insolvent partners’ loss will be borne; and
ii. If the capitals are fluctuating, all necessary adjustments in respect of reserves and surplus etc., should first be made. The ratio in which the insolvent partner’s loss will be divided will be the ratio of the resulting capitals.

Application of Garner vs. Murray rule in India

Some people believe that in India the decision in Garner vs. Murray does not apply. But there is nothing in the Indian Partnership Act which goes against the rule laid down in the case and it would be safe to follow it till an Indian court definitely rules against it.

Q10. Write a short note on Gradual Realisation of Assets and Piecemeal Distribution.
Ans: At the time of dissolution of partnership firm all the assets are realized on the date of dissolution, and that all the expenses and liabilities are paid off on that date. This assumption enables one to know immediately the profit or loss on realization which can then be transferred to the capital accounts; this determines the final amount due to partners. In actual practice, this assumption is far from valid. Assets are realized and cash collected gradually. Final results are not known till quite some time. In the meantime, the cash collected is distributed among the various parties. On a gradual realization of assets, the cash realized is distributed in the following order:

 i. First, expenses on realization are to be paid; then
ii. all the outside creditors have to be paid; then
iii. if surplus remains, any loans given by the partners over and above their capitals are paid; and
iv. last, all the partners’ capital will be paid off.

It is clear, therefore, that any cash in hand or cash collected should be distributed among creditors until all of them are paid off.

The main question is how to distribute cash among partners for return of capital. The available cash cannot be distributed according to the profit sharing ratio because that will leave the balances unpaid out of proportion. The cash available cannot also be distributed in the ratio of capitals because, than the partners will be forced to bear the final loss in the ratio of capitals which may be different from the profit sharing ratio.

Following are the two methods of cash distribution among partners as and when realized:
a. Proportionate capital method
b. Maximum loss method

a. Proportionate capital method: Under this method, the partners whose capital is more than proportionate to other partners’ capitals should first be refunded so much as to bring their capitals to proportionate levels. After this, the cash available should be distributed among the partners in the profit-sharing ratio.

b. Maximum loss method: The other method to deal with the problem is to calculate the maximum possible loss after outside creditors and partners loans have been paid off. This loss is transferred to the capitals and thus the amount payable to a partner would be known.

Q11. Write a short note on Conversion of partnership into company or acquisition of a firm by a company.
Ans: A partnership firm converts itself into a joint stock limited company or sells its business to an existing one. In either of the above case the existing partnership firm is dissolved and all the books of accounts are closed. The procedure of liquidation of the partnership business is same as in case of dissolution of firms but the assets of the firm are not disposed off and liabilities are not repaid instead they are transferred to the new company for a lump sum amount which is called purchase consideration.
Purchase consideration is the amount paid by the purchasing company to the vendor firm for taking over its assets and liabilities. The company may take over all assets or liabilities or any of them. The value of such assets taken over and liabilities assumed may be book value or current value but it depends upon agreement between them. The amount of purchase consideration may be paid in any forms as shares, debentures of the company and cash. Purchase consideration ascertainment is very important as it affect accounting entries in the books.

Methods of calculation of Purchase Consideration:
a. Lump sum method.
b. Net payment method.
c. Net assets method.  

*****