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Karnataka class 12 commerce Accountancy Settlement of accounts on dissolution of a firm

Karnataka class 12 commerce Accountancy Settlement of accounts on dissolution of a firm

Karnataka class 12 commerce Accountancy Settlement of accounts on dissolution of a firm

Settlement of Accounts – In case of dissolution of a firm, the firm ceases to conduct business and has to settle its accounts. For this purpose, it disposes off all its assets for satisfying all the claims against it. In this context it should be noted that, subject to agreement among the partners, the following rules as provided in Section 48 of the Partnership Act 1932 shall apply.

(a) Treatment of Losses Losses, including deficiencies of capital, shall be paid :

  • first out of profits,
  • next out of capital of partners, and
  • lastly, if necessary, by the partners individually in their profits sharing ratio.

(b) Application of Assets The assets of the firm, including any sum contributed by the partners to make up deficiencies of capital, shall be applied in the following manner and order:

  • In paying the debts of the firm to the third parties;
  • In paying each partner proportionately what is due to him/her from the firm for advances as distinguished from capital (i.e. partner’ loan);
  • In paying to each partner proportionately what is due to him on account of capital; and
  • the residue, if any, shall be divided among the partners in their profit sharing ratio.

Thus, the amount realised from assets along with contribution from partners, if required, shall be utilised first to pay off the outside liabilities of the firm such as creditors, loans, bank overdraft, bill payables, etc. (it may be noted that secured loans have precedence over the unsecured loans); the balance should be applied to repay loans and advances made by the partners to the firm. (in case the balance amount is not adequate enough to pay off such loans and advances, they are to be paid propartionately); and surplus, if any is to be utilised in settlement of the capital account balances, after adjusting all profits and losses.

Karnataka class 12 commerce Accountancy Settlement of accounts on dissolution of a firm

Private Debts and Firm’s Debts: Where both the debts of the firm and private debts of a partner co-exist, the following rules, as stated in Section 49 of the Act, shall apply.

(a) The property of the firm shall be applied first in the payment of debts of the firm and then the surplus, if any, shall be divided among the partners as per their claims, which can be utilised for payment of their private liabilities. (b) The private property of any partner shall be applied first in payment of his private debts and the surplus, if any, may be utilised for payment of the firm’s debts, in case the firm’s liabilities exceed the firm’s assets. \

It may be noted that the private property of the partner does not include the personal properties of his wife and children. Thus, if the assets of the firm are not adequate enough to pay off firm’s liabilities, the partners have to contribute out of their net private assets (private assets minus private liabilities).

Karnataka class 12 commerce Accountancy Settlement of accounts on dissolution of a firm

Karnataka class 12 commerce Accountancy Settlement of accounts on dissolution of a firm

Karnataka class 12 commerce Accountancy Settlement of accounts on dissolution of a firm

Karnataka class 12 commerce Accountancy Settlement of accounts on dissolution of a firm

Accounting Treatment When the firm is dissolved, its books of account are to be closed and the profit or loss arising on realisation of its assets and discharge of liabilities is to be computed. For this purpose, a Realisation Account is prepared to ascertain the net effect (profit or loss) of realisation of assets and payment of liabilities which may be is transferred to partner’s capital accounts in their profit sharing ratio. Hence, all assets (other than cash in hand bank balance and fictitious assets, if any), and all external liabilities are transferred to this account. It also records the sale of assets, and payment of liabilities and realisation expenses. The balance in this account is termed as profit or loss on realisation which is transferred to partners’ capital accounts in thier profit sharing ratio

Karnataka class 12 commerce Accountancy Settlement of accounts on dissolution of a firm

Settlement of Accounts on Dissolution

The first step in dissolution is the realisation of assets followed by the settlement of outside liabilities. All individual accounts for assets and liabilities, except cash, are closed by transferring their balances to a Realisation Account. Realisation account is the temporary account for accumulating all assets and liabilities for convenient accounting treatment. All ledger accounts except partner’s capital accounts and cash account are closed prior to realisation procedure. Accumulated profits or losses are directly transferred into the capital accounts in the profit sharing ratio. The following is the order of priority in settlement of liabilities and capital upon dissolution:

  • Expense incurred on realisation of assets such as commission, cartage, brokerage etc.
  • All outside creditors
  • Partner’s Loan accounts
  • Balances in Capital Accounts of partners

Karnataka class 12 commerce Accountancy Settlement of accounts on dissolution of a firm-Special Items in Accounting for Dissolution

Realisation Account: This is the most important account prepared to facilitate dissolution of firms. This is equal in importance to Revaluation Account in Reconstitution. There is no scope of revaluation of assets and liabilities of a firm under liquidation. Realisation account is used to accumulate all assets and liabilities in one place for convenient accounting steps for disposal and settlement of liabilities.

Treatment of Goodwill: Goodwill is the most prominent item in Reconstitution of partnership. But goodwill does not have any special treatment in dissolution. If it appears in the books it has to be transferred into Realisation Account. This will automatically gets transferred into the Capital Accounts of Partners, by way of realisation profit or loss. If goodwill does not appear in the books it is just ignored. There is no meaning in raising it or treating it in any way when the firm is being dissolved.

Realisation Expenses: Expenses of realisation such as commission paid to brokers for the disposal of assets, expenses on transportation of items, registration documentation charges for the assets sold etc. are debited to Realisation Account and credited to Cash Account. However if any partner agrees to bear the expense for a certain fees, the fees charged by the partner becomes the common expense which is debited in Realisation Account; whereas the actual realisation expense, if mentioned, should be treated as personal drawing of the partner concerned.

Wife’s Loan: Loans from a partners’ wife is to be treated as normal creditor. The basic aim of providing a loan in the name of partner’s wife is to by-pass the legal restrictions on the Loan from a Partner to the firm.

Provident Fund: Provident fund should be understood as a liability payable to the employees. It should be paid off even when the question is silent about its treatment. Same rule applies to all other outside liabilities, such as creditors, bills payable etc.

Specific Funds: Specific funds such as Investment Fluctuation Funds are preferably credited to Realisation account along with the transfer of related asset, which will get transferred to capital accounts by way of profit of loss on Realisation. Provision for doubtful debts, accumulated depreciation etc. must be credited to Realisation Account along with the transfer of assets.

Profits Kept Aside: General Reserve; credit balance in P& L Account etc should be directly transferred into the Capital Accounts of Partners, in the profit sharing ratio.

Unrecorded Assets: Unrecorded assets or assets which are completely written off may fetch some cash at the time of dissolution. There is no need of bringing them into books and selling them afterwards. It can be directly treated by crediting realisation account and debiting cash account.

Creditors Purchasing Some Assets in Part Settlement of Claim: When creditors purchase some of the assets in part settlement, this is not specifically recorded by way of a journal entry, since the asset and liability are appearing in the same Realisation Account. The balance amount due to the creditors is aid in full satisfaction of the claim. If the value of asset taken over is more than the amount due, the creditors will pay the excess amount to the firm.

Karnataka class 12 commerce Accountancy Settlement of accounts on dissolution of a firm

Karnataka class 12 commerce Accountancy Settlement of accounts on dissolution of a firm

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