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Ch 7 · Partnership · T.S. Grewal — Double Entry Book Keeping

Dissolution of
Partnership Firm

75 MCQs 50 Flashcards T.S. Grewal Class 12 Updated May 2026
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Chapter Overview

Chapter 7 closes the Partnership unit. It explains what happens when a firm is wound up: the legal grounds on which dissolution may occur under the Indian Partnership Act, 1932 (Sections 39-44), and the accounting machinery used to bring the business to an orderly close. The chapter draws a sharp distinction between dissolution of partnership — a mere change in the relationship between partners, where the firm continues — and dissolution of the firm, where the business itself is wound up and the books are closed permanently.

The procedural heart of the chapter is the Realisation A/c. Every asset (except Cash, fictitious assets and P&L Dr balance) is transferred to it at book value, every outside liability is transferred at book value, sale proceeds are credited as cash receipts, payments to creditors are debited, realisation expenses are charged, and the resulting profit or loss is distributed to the partners in their OLD profit-sharing ratio. Special situations — unrecorded assets and liabilities, treatment of accumulated reserves and Workmen's Compensation Reserve, take-over of an asset or liability by a partner, creditor accepting an asset in settlement — all have their own distinctive entries that the chapter drills.

The chapter then sets out the order of payment under Section 48 — outside liabilities first, partners' loans next, capital balances third, surplus distributed in PSR — and the famous Garner v Murray (1904) rule for sharing an insolvent partner's capital deficiency among the solvent partners in their capital ratio (last agreed capitals), not the profit-sharing ratio. Cash/Bank A/c serves as the master clearing account through dissolution and must close at NIL.

What You'll Learn
Key Concepts
Distinction
Partnership vs Firm
Dissolution of partnership = relation among partners ends, firm continues. Dissolution of firm = business wound up, books closed permanently.
Modes
Modes of Dissolution
By agreement (Sec 40), compulsory (Sec 41), on contingencies (Sec 42), by notice in firm at will (Sec 43), by court (Sec 44).
Account
Realisation A/c
Opened only on dissolution. Records sale of all assets at agreed value, payment of all liabilities, realisation expenses; closing balance = profit/loss in OLD PSR.
Special
Unrecorded Assets / Liabilities
Asset realised in cash → Dr Cash / Cr Realisation. Liability paid in cash → Dr Realisation / Cr Cash. Take-overs route through partner's Capital A/c.
Priority
Section 48 Order of Payment
External liabilities first → partners' loans → capital balances → surplus in PSR. Partner's loan ranks BETWEEN creditors and capital.
Insolvency
Garner v Murray Rule
Insolvent partner's capital deficiency is borne by solvent partners in capital ratio (last agreed capitals before dissolution) — NOT in PSR.
Settlement
Capitals & Loan A/cs
Credit balance → firm pays cash. Debit balance → partner brings cash (else Garner v Murray). Loan-vs-deficit set-off if partner has both.
Master A/c
Cash / Bank A/c
Master clearing account during dissolution. Tracks every receipt and payment in priority order. Must close at NIL — non-zero indicates a missed entry.
Reserves
Treatment of Reserves
General Reserve, P&L Cr balance, etc. → Capitals in OLD PSR (NOT Realisation). Workmen's Comp Reserve: claim to Realisation, excess to Capitals.
Sample MCQs
Q1. The order of payment under Section 48 of the Indian Partnership Act, 1932 on dissolution of a firm is:
A. External liabilities → Partners' loan → Partners' capital → Surplus in PSR
B. Partners' capital → Partners' loan → External liabilities → Surplus in PSR
C. External liabilities → Partners' capital → Partners' loan → Surplus in PSR
D. Partners' loan → External liabilities → Partners' capital → Surplus in PSR
Section 48(b) prescribes a strict priority: (i) all outside liabilities first, (ii) partners' loans / advances next, (iii) partners' capital balances, (iv) any residual surplus distributed in the partners' PSR. A partner's loan is paid AFTER outside creditors but BEFORE capital — never lumped with capital.
Q2. On dissolution: Sundry Assets transferred Rs.10,00,000; Outside Liabilities transferred Rs.3,00,000. Assets realised Rs.8,50,000 and liabilities paid Rs.2,80,000. Realisation expenses Rs.20,000. The profit / loss on realisation is:
A. Profit Rs.50,000
B. Profit Rs.30,000
C. Loss Rs.1,90,000
D. Loss Rs.1,50,000
Realisation A/c — Debit: Assets 10,00,000 + Liabilities paid 2,80,000 + Expenses 20,000 = Rs.13,00,000. Credit: Liabilities transferred 3,00,000 + Sale proceeds 8,50,000 = Rs.11,50,000. Loss = 13,00,000 − 11,50,000 = Rs.1,50,000, shared in OLD PSR.
Q3. P, Q, R share profits 2:2:1. Last agreed capitals: P Rs.5,00,000, Q Rs.3,00,000, R Rs.2,00,000. Realisation loss Rs.10,00,000 shared in PSR makes R's capital Rs.2,00,000 Dr. R is insolvent. Per Garner v Murray, P bears how much of R's Rs.2,00,000 deficiency?
A. Rs.80,000
B. Rs.1,00,000
C. Rs.1,50,000
D. Rs.1,25,000
R's deficiency Rs.2,00,000 is borne by SOLVENT partners in the ratio of their LAST AGREED CAPITALS (not PSR). P : Q = 5,00,000 : 3,00,000 = 5 : 3. P's share = 2,00,000 × 5/8 = Rs.1,25,000. Q bears the remaining Rs.75,000.
Frequently Asked Questions
What is the difference between dissolution of partnership and dissolution of firm?
Dissolution of partnership merely changes the relationship among partners — admission, retirement, death or change in PSR — but the firm CONTINUES with the new constitution. Dissolution of the firm is the complete winding up of the business: every asset is realised, every liability is paid, and the firm ceases to exist. Section 39 of the IPA 1932 defines dissolution of firm as 'the dissolution of partnership between ALL the partners of a firm'.
What are the modes of dissolution under the Indian Partnership Act, 1932?
Five modes — Sections 40 to 44: (1) By agreement with consent of all partners (Sec 40); (2) Compulsory when business becomes unlawful or all but one partner are insolvent (Sec 41); (3) On contingencies — expiry of fixed term, completion of venture, death or insolvency of a partner (Sec 42); (4) By notice in a partnership at will (Sec 43); (5) By court order on grounds such as insanity, permanent incapacity, misconduct, persistent breach of the agreement, transfer of interest, or perpetual losses (Sec 44).
What is the Realisation A/c and what does it record?
Realisation A/c is opened only on dissolution of the firm. Debit side: all assets (except Cash, fictitious assets and P&L Dr balance) at book value, liabilities paid in cash, realisation expenses. Credit side: all outside liabilities at book value, provisions on assets (Provision for Doubtful Debts, IFR), sale proceeds of assets, and assets taken over by partners at agreed value. The balancing figure is the profit (or loss) on realisation, transferred to the partners' Capital A/cs in their OLD profit-sharing ratio.
What is the order of payment under Section 48 of the Indian Partnership Act, 1932?
Section 48(b) lays down a strict priority for applying the firm's assets on dissolution: (1) all outside liabilities (creditors, bills payable, bank loans, outstanding expenses) must be paid in full first; (2) then partners' loans and advances to the firm are repaid; (3) then partners' capital balances are settled; (4) any remaining surplus is distributed among the partners in their profit-sharing ratio. A partner's loan ranks BETWEEN outside creditors and capital balances — it is NEVER lumped with capital.
What is the Garner v Murray rule?
When a partner is insolvent and his Capital A/c shows a debit balance that he cannot bring in from his private estate, the deficiency is borne by the SOLVENT partners — but NOT in the profit-sharing ratio. The case Garner v Murray (1904) established that the deficiency is shared in the ratio of the solvent partners' LAST AGREED CAPITALS (capital balances standing just before dissolution, before recording realisation profit or loss). The realisation loss itself is shared by all partners (including the eventually insolvent one) in their OLD PSR; Garner v Murray applies only at the next step — to the resulting capital deficiency.
How are unrecorded assets and liabilities treated on dissolution?
An unrecorded asset exists physically but never appears in the books (e.g., a typewriter written off years ago, scrap, fully amortised patent earning royalty). When realised in cash: Cash/Bank A/c Dr / Realisation A/c Cr. If taken over by a partner: Partner's Capital A/c Dr / Realisation A/c Cr at the agreed value. An unrecorded liability paid in cash: Realisation A/c Dr / Cash/Bank A/c Cr. If taken over by a partner: Realisation A/c Dr / Partner's Capital A/c Cr. No reversal entry is needed because the item was never on the books.