PARTNERSHIP FIRMS FOR DISSOLUTION (THEORY)
Q.1. Explain how accounts are settled when a partnership firm is dissolved?
Ans. When a firm is dissolved then immediately two consequences follow:
(i) Business of the firm is stopped and
(ii) A process is started whereby all assets of the firm will be realised or sold out or disposed off and all liabilities paid off or settled.
This entire process is done through or with the help of an account called "Realisation Account" which is in nature a Nominal Account and shows ultimately the profit or loss made by the firm in the entire process of realizations of the various assets and paying off of the various liabilities.
— Any secured debts of the firm if secured by way of mortgage or hypothecation against firm's assets.
— Any preferential debts of the firm, e.g., tax etc. payable to the Government.
— Other debts of the firm towards third or outside parties.
— Loans from partners.
— Balances on account of Capitals of the partners
At the end if the profit or loss on the Realisation Account has been transferred to the Capital Accounts of the partners, then the cash balance available should be just equal to the amount of balances in the Capital Accounts of the partners. After paying off the
capital balances, the balance in the firm's Cash or Bank A/c should also just be nil. All accounts of the firm should stand as 'Closed'.
Q.2. How is the insolvency of a partner treated in accounts? Explain.
Ans. Insolvency of a partner means that a partner is unable to pay his/her debts to the firm. At the end of the dissolution of the firm and settlement of accounts of all liabilities in order as required u/s 48 of the Partnership Act, 1932 if there remains a debit balance in the Capital Account of a partner, then it means that the firm has to receive money from that partner. This balance is to be checked after transferring the profit or loss to the firm on account of realisation amongst all the partners in their Profit Sharing Ratio. If a partner has a debit balance in his capital account, it means that the partner has to pay to the firm. Suppose, that a particular partner is unable to pay his debts to the firm, then he/she is assumed to be 'insolvent at least so from commercial point of view whether or not he/she has been adjudged 'insolvent' legally.
In such a case rule of the famous case "Garner vs. Murray" is applied. The loss arising to the firm because of non-payment of his/her dues or debts to the firm is to be transferred to the Capital Accounts of all the other partners in the ratio of the balances in their Capital Accounts which stood just before the dissolution process had started.
These balances in the Capital Accounts of the other partners are to be checked after transferring all the divisible balances appearing in the Balance Sheet, e.g.,
Profit and Loss Account, General Reserves, Capital Reserves, or accumulated past losses etc. but before adjusting the profit or loss on the Realisation Account.
If in the Capital Account of any partner there was a "Debit" Balance just before the dissolution process starts, then he/she need not share any loss arising to the firm because of insolvency of a partner.
This rule of Garner vs. Murray case (though an English case of old times) is applied in present times because the basis suggested is very just and equitable. So this loss should not be shared by other solvent partners in their Profit Sharing Ratio unless it is so laid
down in their Partnership Deed.
Some people are of the view that in India the decision in Garner vs. Murray does not apply. But there is nothing in the Indian Partnership Act, 1932 which goes against the rule laid down in Garner vs. Murray case. Therefore, it would be safe to follow it till an Indian court definitely gives a decision contrary to the decision given in Garner vs. Murray.
If an examination problem states that the rule in Garner vs. Murray is to be followed, the solvent partners should bring in cash in proportion of their respective shares of Loss on Realisation. If no mention is made of Garner vs. Murray decision in the problem to be solved, the solvent partners may not be required to do so. But the other ruling given in Garner vs. Murray must be followed, that is the solvent partners should bear the loss arising due to the insolvency of a partner in proportion to the balances in their Capital Accounts which stood before the dissolution of the firm or before adjusting profit or loss on Realisation Account in their Capital Accounts.