Dissolution of partnership - Accounting Tuition

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:

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

Required:

Realisation Account
Capital account of Chan and Lee
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