The document provides an overview of the dissolution of a firm, explaining the various reasons and modes of dissolution, how assets and liabilities are settled, and the accounting treatment involved when closing the books of the firm. Key points covered include defining dissolution of a firm, distinguishing it from dissolution of a partnership, the settlement of accounts according to section 48 of the Indian Partnership Act, and how insolvency of partners is handled, including the Garner vs Murray rule.

1. OVERVIEW OF
DISSOLUTION OF FIRM
Mrs. S. Subhashree,
Asst. Prof., Faculty of Commerce,
Parul Institute of Commerce – Parul University,
subhashree.sivaraman18051@paruluniversity.ac.in
24-02-2023
PSGR Krishnammal College for Women
Coimbatore.

2. Dissolution of a Firm
Introduction
• Dissolution means discontinuance or winding up or closure of a company.
• It may be either dissolution of a partnership or dissolution of firm.
• Dissolution of Firm refers to the situation wherein the partnership firm
ceases to exist.
• In simple word, partnership firm comes to an end, and relationship between
all the partners also comes to an end.

3. Reason for Dissolution of a Firm
Change in existing profit-sharing ratio among partners
Admission of a new partner
Retirement of a partner
Death of a partner
Insolvency of a partner
Completion of the venture, if partnership is formed
Expiry of period of partnership, if it is for a specific period of time.

4. Dissolution of a Partnership vs Firm
Basis Dissolution of Partnership Dissolution of Firm
Meaning Change in existing relations of
partner.
Discontinuance of partnership
among all the partners in the
firm
Termination of
business
The business is not
terminated.
The business of the firm is
closed.
Reason It take place at time of
admission, retirement or death
of partner.
It takes place mostly because of
insolvency of partners.

5. Continued …
Basis Dissolution of Partnership Dissolution of Firm
Settlement of
assets and
liabilities
Assets and liabilities are
revalued, and new balance
sheet is drawn.
Assets are sold and liabilities
are paid off.
Court’s
Intervention
Court does not intervene
because partnership is
dissolved by mutual
agreement
A firm can be dissolved by the
court order.
Closure of books Does not require to close
books of accounts.
The books of accounts are
closed.

6. Dissolution by
Agreement
Happening of
Certain
Contingency
Dissolution by
Court
Compulsory
Dissolution
Dissolution by
Notice
Modes of Dissolution of Firm

7. Settlement of Accounts in case of Dissolution of Firm
Settlement of Accounts in case of Dissolution of Firm (Section 48)
1. Treatment of Losses: [Section 48(a)]: Losses including deficiencies of
capital shall be paid in the following manner:
a. Out of Profit
b. Out of Capital
c. Lastly, if necessary, by the partners individually in their profit-sharing ratio

8. Continued…
2. Application of Assets: [Section 48(b)]: The assets of the firm, including
any sum contributed by the partners to make up the deficiencies, shall be
applied in the following manner:
a. To pay the firm’s debt (outside liabilities)
b. To pay the Partner’s Loan
c. To pay the capitals of the Partners
d. Finally, the surplus (if any) shall be distributed among the partners in their
profit sharing ratio.

9. Treatment of Firm’s Debt and Private Debts
Firm’s Debt: It is the amount which the Firm owes to its outsiders.
Private Debt: It is the amount which a partner owes in his personal capacity.
Where both the debts co-exist, the following rules, as per Section 49 of
the Indian Partnership Act, 1932, shall apply:
(i) Firm’s property is applied first in payment of firm’s debts and if there is
any surplus, then the share of each partner is applied in the payment of
his private debts or paid to him.
(ii) Partner’s private property is applied first in payment of his private
debts and the surplus (if any) in payment of firm’s debts (if the firm’s
liabilities exceed the firm’s assets)

10. Accounting Treatment
When a firm is dissolved, the accounting steps involved to close the books of the
firms are as follows:
1. Preparation of Realisation Account.
2. Treatment of unrecorded assets and liabilities.
3. Treatment of accumulated reserves, profits or losses
4. Treatment of Goodwill.
5. Closing the Capital Account of partners.
6. Preparation of Balance sheet as on the date of dissolution.

11. Insolvency of a Partner
Meaning
- If a partner having a debit balance in his capital account and he is unable to
bring in the necessary cash to make up the deficiency, he is said to be an
insolvent partner.
- The irrecovered debit balances is called as the loss due arising due to the
insolvency of a partner.
- If a partner become insolvent then the loss arising due to insolvency is not an
ordinary loss.

12. Insolvency of a Partner
Dissolution due to
insolvency
Insolvency of one
or more partner
Garner Vs.
Murray Rule
Insolvency of all
partner
Closure of
business

13. Garner vs Murray Rule
The Rule of Garner vs. Murray case is given below:
In case of insolvency of one or more partner, the solvent partners have
to
(1) Bring cash equal to their share of loss on realisation of assets and
liabilities.
(2) Bear the loss arising due to insolvency in the ratio of their Last Agreed
Capitals.

14. Last Agreed Capital
Case Meaning of Last Agreed Capital
In case of Fixed
Capitals
Last Agreed Capital means the Fixed Capital (given in the
Balance Sheet) without any adjustment.
In case of
Fluctuating
Capitals
Last Agreed Capital means the Capital after adjusting for
past accumulated reserves, profit or losses, drawings,
interest on capitals, interest on drawings, remuneration to
a partner etc. to the date of dissolution but before making
adjustment for profit or loss on realization.

15. Dissolution due to insolvency of all partner
- When all partners are insolvent and the firm’s assets fall short of its
liabilities, the creditors of the firm cannot be paid in full.
- The available cash with the firm (Cash in hand, bank balance, final amount
received from partner) is used first for paying realization expenses.
- The balance amount is paid to creditors proportionally.
- In order, to close books of the firm, Realisation account is prepared in the
usual manner without transferring the liabilities to realization account.
- all liabilities are discharged directly to the extent possible. Any balance left
unpaid is transferred to deficiency A/C.
- The partners capital account is also closed by transferring to deficiency A/C.

16. Piecemeal Distribution
- Generally, the assets sold upon dissolution of partnership are realized only in
small instalments, over a period of time.
- In such circumstance, the choice is either to distribute whatever is collected
or to wait till the whole amount realized is collected.
- In order to ensure that the distribution of cash among partners is in
proportionate to their interest in the partnership concern in which payment
should be made.

17. Maximum Loss Method
Steps-Maximum loss Method
1. First paid all out side liabilities
2. Then paid Partners loan if any
3. Pay to partners capital. Whenever cash is received, find out difference
between the available cash and balance in the Capital Accounts, the
difference is called as maximum loss.
4. The Maximum loss is distributed to capital accounts in profit sharing ratio
that is from the capital account, the shares of losses are deducted.

18. Continued…
5. Calculate the balance of Capital Accounts after distribution of the
maximum loss
6. If no capital account shows a negative balance distribute the available cash
among the partners exactly to their respective capital balances.
7. If any partners capital account shows a debit balance, write it off according
to Garner Vs Murray rule
8. As and when further realization are made and cash is to be distributed, the
above procedures is to be followed, in all subsequent payments among the
partners.