Key Points

Dissolution of a partnership is a change in the relationship between partners, but the firm may continue its business. Dissolution of a firm means the entire business is terminated and its existence comes to an end.

According to Section 39 of the Partnership Act 1932, the dissolution of a partnership between all the partners of a firm is called the 'dissolution of the firm'. This brings the business to a complete close.

A partnership firm can be dissolved either with the consent of all the partners or in accordance with a contract that already exists between the partners.

A firm is compulsorily dissolved when all partners (or all but one) become insolvent, or when the business of the firm becomes illegal.

Subject to contract, a firm is dissolved on the happening of certain events like the expiry of a fixed term, completion of a specific venture, death of a partner, or a partner being declared insolvent.

In the case of a 'partnership at will', the firm can be dissolved if any single partner gives a written notice to the other partners expressing their intention to dissolve the firm.

A court can order the dissolution of a firm on grounds such as a partner becoming insane, permanent incapacity of a partner, persistent breach of agreement, or if the business can only operate at a loss.

A Realisation Account is prepared at the time of dissolution to ascertain the net profit or loss from the sale of assets and settlement of liabilities. This profit or loss is then transferred to partners' capital accounts.

All assets (except cash, bank, and fictitious assets) are debited to the Realisation Account at book value. All external liabilities are credited to it. The account is then used to record the sale of assets and payment of liabilities.

The firm's assets are applied in a specific order: first to pay external debts, then to repay loans from partners, then to repay partners' capital, and any remaining surplus is distributed among partners as profit.

Losses, including deficiencies of capital, are first paid out of profits, then out of partners' capital, and lastly, if necessary, by the partners individually in their profit-sharing ratio.

The firm's property is used first to pay the firm's debts, while a partner's private property is used first to pay their private debts. Any surplus from one can be used to pay the other.

If an unrecorded asset is sold, the amount received is credited to the Realisation Account. If an unrecorded liability is paid, the amount paid is debited to the Realisation Account.

A loan from a partner to the firm is not transferred to the Realisation Account. It is paid off separately after all outside liabilities have been settled but before the repayment of capital.

Expenses incurred during the dissolution process are called realisation expenses. These are typically debited to the Realisation Account and credited to the Bank Account.

After transferring realisation profit or loss, reserves, and other adjustments, the final balances in the partners' capital accounts are settled. Credit balances are paid off, and partners must bring in cash for any debit balance.