Meaning of Dissolution of Firm
Dissolution of a Firm means the complete closure of the partnership business, ending the relationship among all the partners. After dissolution, the firm ceases to exist, all business activities stop and the accounts of the firm are settled through a proper accounting procedure. All assets are realised, liabilities are paid, partners’ loans are settled and the final balances are distributed among partners.
It differs from dissolution of partnership because dissolution of partnership only changes the relationship between partners, while dissolution of firm ends the entire business unit.
Accounting Treatment at the Time of Dissolution
At the time of dissolution, three major accounts are prepared to settle the books of the firm:
- 1. Realisation Account
- 2. Partners’ Capital Accounts
- 3. Cash/Bank Account
1. Realisation Account — Purpose & Treatment
The Realisation Account is prepared to determine profit or loss on the sale of assets and payment of liabilities.
Items Debited (Dr.)
- All assets transferred at book value (except Cash, Bank & fictitious assets).
- Realisation expenses.
- Liabilities paid in excess of book value.
- Cash/Bank paid for settlement of liabilities.
Items Credited (Cr.)
- All liabilities transferred at book value.
- Cash received from sale of assets.
- Assets taken over by partners.
- Liabilities settled at a discount.
Profit or Loss on Realisation
- If credit side > debit side → Profit transferred to Partners’ Capital A/c.
- If debit side > credit side → Loss transferred to Partners’ Capital A/c.
2. Partners’ Capital Accounts — Treatment
After transferring realisation profit/loss, the following adjustments are made:
- Transfer of reserves, undistributed profits to capital accounts.
- Transfer of drawings, interest on drawings, etc.
- Assets taken over by partners are reduced from their capital accounts.
- Liabilities taken over by partners are added to capital accounts.
- Final balances are settled through cash/bank account.
3. Cash/Bank Account — Treatment
The Cash or Bank Account is prepared to record all cash receipts and payments.
Receipts Include:
- Cash from sale of assets
- Cash collected from debtors
- Cash brought in by partners (if needed)
Payments Include:
- Payment of liabilities
- Payment of realisation expenses
- Payment of partner’s loan
- Settlement of partners’ final balances
Summary Table — Accounting Treatment at Dissolution
| Account | Purpose | Main Entries |
|---|---|---|
| Realisation Account | To find profit or loss on realisation of assets & liabilities | Transfer assets & liabilities; record sale proceeds; record expenses |
| Partners’ Capital Accounts | To determine the final amount due to/from each partner | Transfer realisation profit/loss; adjust reserves; assets/liabilities taken over |
| Cash/Bank Account | To settle all final payments | Record receipts from realisation; pay off liabilities; settle partners |
Conclusion
The dissolution of a firm requires a systematic procedure to settle all accounts. Realisation Account helps in determining profit or loss on realisation, Partners’ Capital Accounts assist in settling partner balances and Cash/Bank Account records all cash movements. Together, these ensure fair and accurate distribution at the time of dissolution.