Dissolution of partnership


Dissolution is the end of the relationship between all the partners. This brings to an end the existence of the partnership firm and the books of accounts are closed down. In this case all assets are sold and liabilities repaid. A partnership may be dissolved because

  • the partners are constantly in disagreement and can no longer work together.
  • the partnership has a poor liquidity position and further trading would increase the debt.
  • the partnership is no longer profitable
  • a partner wishes to set up on his own, or a partner dies or retires.
  • of insolvency of one of the partners.
  • the partnership is converted into a company

A realisation account is used to record the transactions arising on dissolution. It is prepared to close all assets and liabilities which exist at the date of dissolution. The balance on Realisation account represents profit or loss on dissolution of business. This should be shared by all the partners in their agreed profit and loss sharing ratio.

When a partnership is dissolved, the assets of the business are disposed to external parties or taken over by partners at agreed values. Money is collected from credit customers and credit suppliers are paid. Partner’s loan and final balances in their capital accounts are repaid. A debit balance in a partner’s capital account represents amount owing by the partner to the firm. The partner will have to pay this owing amount from his personal resources to enable the partnership to settle the outstanding amount to the other partners.

Accounting entries for dissolution of a partnership business:

1. Transfer all assets

Dr Realisation account

Cr Assets

2. Sale of assets

Dr Bank account

Cr Realisation account

3. Assets taken by partner

Dr Capital account

Cr Realisation account

4. Receipts from customers

Dr Bank account

Cr Realisation account

5. Payment to trade payable

Dr Realisation account

Cr Bank account

6. Dissolution expenses and any other expense

Dr Realisation account

Cr Bank

7. Transfer of current account

If Debit balance

Dr Capital account

Cr Current account

If Credit balance

Dr Current account

Cr Capital Account    

8. Payment of Loan

Dr Loan account

Cr Bank account

After completing the above double entries, the Realisation account is close down. Profit or Loss arising from the realisation account is shared among partners in their profit sharing ratio.

9. Profit on realisation

Dr Realisation account

Cr Capital account

Loss on Realisation

Dr Capital account

Cr Realisation account

After closing down the realisation account, the capital account of partners must be paid through the bank account. Finally the total debit of the bank account must equal the total credit.


Worked Example

Chan and Lee were partners, sharing profits and losses in the ratio of 2 : 1. The following is the statement of financial position of the partnership as at 31 December 2010:


Statement of financial position as at 31 December 2010

$

$

$

Non Current assets

Cost

Accumulated depreciation

Net book value

Office equipment

75 000

35000

40 000

Motor vehicles

    54 000 

    29 000 

 25 000 


  129 000 

64 000

65 000

Current assets




Inventory


21 000


Trade receivable


22 400


Bank


    10 600 




54 000


Less Current Liabilities




Trade payables


 (23 000) 


Net Current assets



 31 000 




 96 000 

Financed by:




Capital : Chan


30 000


Capital : Lee


    20 000 

50 000

Current : Chan


26 000


Current :Lee


    20 000 

 46 000 




 96 000 


On 1 January 2011, Chan and Lee dissolved the partnership on the following terms:

  1. The office equipment and inventory were sold for $48 000 and $27 000, respectively.
  2. Receipts from credit customers amounted to $20 400.
  3. The motor vehicles were taken over by Lee at an agreed value of $22 000
  4. Discount received from credit suppliers amounted to $2 500.
  5. Dissolution costs amounted to $2 100


Required:

  1. Realisation Account
  2. Capital account of Chan and Lee
  3. Bank Account

Step 1 – Receipts from credit customers



$


Trade receivables

22 400


Less Bad debts

-


Less Discount allowed

(2 000)

Debit Realisation account

Receipts from customers

20 400

Debit Bank account


Step 2 – Payment to credit suppliers



$


Trade Payables

23 000


Less Discount received

(2 400)

Credit Realisation account

Payment to suppliers

20 600

Credit Bank account


Step 3


DR                                                                                   Realisation Account                                                                                  CR


$


$

Office equipment

40 000

Discount received

2 400

Motor vehicles

25 000

Bank – Office Equipment

48 000

Inventory

21 000

Bank – Inventory

27 000

Bad debts

-

Capital Lee – Motor Vehicles

22 000

Discount allowed

2 000



Bank – Dissolution Expenses

2 100



Profit on realisation




   Capital – Chan (2/3*9 300)

6 200



   Capital – Lee  (1/3* 9 300)

3 100




99 400


99 400


Step 4


DR                                                                                        Capital Account                                                                                        CR


Chan

Lee

 

Chan

Lee


$

$

 

$

$

Motor Vehicles


22 000

Balance b/f

30 000

20 000

Bank

62 200

21 100

Current account

26 000

20 000




Profit on realisation

6 200

3 100

 

62 200

43 100

 

62 200

43 100

 

Step 5

 

DR                                                                                        Bank Account                                                                                       CR


$

 

$

Balance b/f

10 600

Payment to suppliers

20 600

Receipts from credit customers

20 400

Dissolution expenses

2 100

Office equipment

48 000

Capital – Chan

62 200

Inventory

27 000

Capital – Lee

21 100


106 000

 

106 000