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NOTES

PARTNERSHIP DISSOLUTION
Dissolution of a Partnership
When a partnership ceases trading, its affairs are dissolved. This means that all of its
accounts have to be closed. The causes of dissolution might be:

the death, retirement or ill health of a partner;

an inadequate level of profits;
the business becoming a limited company;
a disagreement between partners about the future direction of the business.

When a partnership is dissolved, the assets of the business are sold and the proceeds
are distributed according to the Partnership Act (1890). This states that money should be
paid in the following order:

To business creditors (not including partners);

To partners that have lent money to the business;
To partners in respect of their current accounts;
To partners in respect of their capital accounts;

Any profit or loss on dissolution is divided according to the agreed profit sharing ratios. If
a loss is made, the money paid to partners in respect of their capital accounts will be
reduced. If the loss is so great that it is not covered by the Partners Capital, Current or
Loan accounts, then partners have to pay money into the businesss bank account. This
is because partners have unlimited liability for the businesss debts.
When disposing of a businesss assets, the partners might decide to take personal
ownership of some of those assets that formerly belonged to the business. For example,
they might keep the cars that they have used. If this happens, the values of any assets
taken are debited to the Partners Capital Account.
The dissolution of a partnership requires a realisation account to be opened. This
account records the book values of the assets to be disposed of on the debit side and
the proceeds from disposal on the credit side. The balance on the account represents
the profit or loss on disposal. If the value of debits is greater than the value of credits, a
loss is made. If credits exceed debits, a profit is made. Any profit or loss is transferred to
the Partners Capital Accounts.
To illustrate the bookkeeping entries involved when dissolving a partnership, consider
the example of Steve Price and Kumar Patel who ran an airport taxi service together in
Bristol. The partners agreed to dissolve the partnership because Steve decided to move
to Birmingham.
The balance sheet for Price and Patel as at 31 May 2009 is shown below:

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Price and Patel

Balance sheet as at 31.5.13
$
NON Current Assets:
Minibus
Motor car
Current assets
Debtors and prepayments
Bank
Cash
(-) Current liabilities
Trade creditors
Net current assets
Capital employed
(-) Long term liabilities
Bank loan
Net assets
Financed by:
Capital accounts:
Price
Patel
Current accounts:
Price
Patel

$
18,000
6,000
24,000

600
2,200
300
3,100
1,200
1,900
25,900
6,000
19,900
7,000
7,000
14,000
2,900
3,000

5,900
19,900

The realisation account, bank account sand partners capital accounts relating to the
dissolution of the partnership are shown in the example.

All asset accounts, except for the cash and bank accounts, are closed by
transferring the balances to the realisation account. The asset accounts are
credited and the realisation accounts are debited. In this case, for example, the
minibus account and the motorcar account are credited with $18,000 and $6,000
respectively. The realisation account is debited with $18,000 and $6,000.

Provisions accounts, such as depreciation and bad debts, are closed by

transferring the balances to the realisation accounts. The realisation account is
credited and the provisions accounts are debited with the value of the balances.

The proceeds from the disposal of assets are listed on the credit side of the
realisation account. In this case, the Minibus is sold for $21,000 and the amount
obtained from debtors is $500. The debit entries for these transactions are shown
in the bank account.

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Steve Price took ownership of the motorcar at an agreed value of $7,000.

Therefore his capital account is debited with $7,000 and the realisation account
credited with $7,000.

The creditors were paid off with money from the bank. In this case, trade
creditors were owed $1,200 so the bank account is credited with $1,200 and the
trade creditors account is debited. There was also a $6,000 bank loan that had
to be repaid. The loan account is debited with $6,000 and the bank account is
credited with $6,000. These transactions do not affect the realisation
account.

The dissolution of a partner often incurs some administration costs or

realisation expenses. For example, advertising costs might be incurred when
disposing of assets. In this case, realisation expenses for Steve Price and Kumar
Patel were $500. This payment is debited to the realisation account and is
credited to the bank account.

The balance on the realisation account is transferred to the partners capital

accounts once all disposals have been made. In this case, a profit of $3,400 was
made on the realisation account, which is divided equally between the two
partners. Therefore the partners capital accounts are credited with $1,700 each.

Any loans made by the partners to the business have to be repaid. The
bookkeeping entries required for this transaction are to be debiting the partners
loan accounts and credit the bank account. In this case, neither partner had lent
the business any money.

In order to close the partners current accounts, the balances are transferred to
their capital accounts. In this case the capital accounts of Steve Price and Kumar
Patel are credited with their current balances of $2,900 and $3,000 respectively.
If one or both the partners had a negative balance on his current account, the
amount would be debited to the capital account.

The remaining cash in hand or at the bank is used to repay the credit balances
on the partners capital accounts. Steve Price is paid $4,600 and Kumar Patel is
paid $11,700. Note that Kumar takes $11,400 from the bank and $300 in cash to
clear his capital account.

If either partner had a debit balances on his account, this would mean that
money is owed to the business. Therefore cash must be introduced by that
partner. The final balances on the partners capital accounts must be equal to the
combined balances on the cash and bank accounts. If they are not, an error has
been made in the bookkeeping when dissolving the business.

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NOTES

Realisation account, Bank account and Partners Capital accounts

Realisation Account
$
18,000 Bank - Minibus
6,000
Debtors
600 Motor car (taken by Price)
500

Minibus
Motor car
Debtors and prepayments
Bank realisation expenses
Profit on realisation:
Price Capital (1/2)
Patel Capital (1/2)

$
21,000
500
7,000

1,700
1,700
28,500

28,500

Bank Account
$
2,200 Trade creditors
Bank loan
21,000 Realisation expenses
500 Capital accounts:
Price
Patel
23,700

Balance b/d
Realisation: assets sold
Minibus
Debtors

$
1,200
6,000
500
4,600
11,400
23,700

Partners Capital Accounts

Realisation (motor car)
Bank
Cash

Price
$
7,000
4,600
11,600

Patel
$
Balances b/d
11,400 Profit on realisation
300 Current accounts
11,700

Price
$
7,000
1,700
2,900
11,600

Patel
$
7,000
1,700
3,000
11,700

The Garner v Murray (1904) rule

When a partnership is dissolved and a partner has a debit balance on his or her capital
account, the partner must pay money into the business bank account. If that partner
does not have sufficient financial resources to settle the account, the remaining partners
must bear the loss. However, the loss should not be shared according to the profit/ loss
sharing ratios, but according to the balances on their capital accounts. This ruling,
which relates to England, Wales and Northern Ireland, was established in 1904 in a court
case Garner v Murray. The court stated that, subject to any agreement to the contrary,
any deficiency on a partners capital account resulting from the dissolution of that
partnership, should be shared by the other partners not in their profit and loss sharing
ratio but in the ratio of last agreed capitals. This refers to the credit balances on their
capital accounts in the balance sheet at the end of the last trading year. It does not mean
the balances after assets have been realised.

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NOTES

To illustrate the Garner v Murray ruling, consider the example of Ann Gibbs, Trisha
Crawley and Ben Smith who agreed to dissolve their partnership at the end of 2009. The
credit balances on their capital accounts shown in the balance sheet as at 31 December
2009 were $20,000, $10,000 and $10,000 respectively. After the assets were realised,
the capital account balances were $5,000, $3,000 and negative $6000 respectively. Ben
Smith was unable to pay off his $6000 deficit. Consequently, according to the Garner v
Murray ruling, the deficit was paid by the remaining two partners according to the ratio of
the balance on their capital accounts at the end of the trading year. The amount paid by
each partner is calculated as follows.
Ann Gibbs

Trisha Crawley =

$20, 000
$6, 000 $4, 000
$20, 000 $10, 000
$10, 000
$6, 000 $2, 000
$20, 000 $10, 000

Since Ann Gibbs capital balance was bigger than Trisha Crawleys, Ann was obliged by
the ruling to pay off a greater proportion of Ben Smiths deficit. Note, however, that this
would not have been the case if the partners had made a different arrangement in their
original Deed of Partnership.

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PARTNERSHIP DISSOLUTION (LAYOUTS)

Realisation Account / Dissolution Account
$
xx

Fixed Assets (Balance sheet Values)

Stocks
Investments
Discount allowed
Bad Debts
Dissolution Costs / Liquidation Costs - Bank
Accrued Expenses (if given in additional notes)
* Realisation Gain Current Accounts - A
B
C

xx
xx
xx
xx
xx
xx
xx
xx
xx
xxx

$
Bank (Fixed Assets, Stocks,
Investments sold)
Drawings Current a/c (Assets taken over)
Discount Received
Decrease in Provision for Doubtful Debts
* Realisation Loss Current Accounts - A
B
C

xx
xx
xx
xx
xx
xx
xx

xxx

There would be either Realization Gain or Loss.

Current Accounts

Balance b/d
Drawings - Cash
- Stocks
- Investments
- Fixed Assets
* Realisation Loss
* Transfer to Capital a/c

A
$
xx
xx
xx
xx
xx
xx
xx
xxx

B
$
xx
xx
xx
xx
xx
xx
xx
xxx

C
$
xx
xx
xx
xx
xx
xx
xx
xxx

Balance b/d
* Realisation Gain
* Transfer to Capital a/c

A
$
xx
xx
xx

B
$
xx
xx
xx

C
$
xx
xx
xx

xxx

xxx

xxx

Note that there would never be a balance remaining in the Partners Current
Accounts.

Partners Current Account Balances would be transferred to their Capital

Accounts.

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NOTES

Capital Accounts

* Current Account balance

* Cash/ Bank

A
$
xx

B
$
xx

C
$
xx

xx
xxx

xx
xxx

xx
xxx

Balance b/d
* Current Account balance
* Cash/ Bank

A
$
xx
xx
xx
xxx

B
$
xx
xx
xx
xxx

Note that there would never be a balance remaining in the Partners Capital
Accounts.

Partners can either withdraw or invest cash into the firm.

If a partner is insolvent or bankrupt then the remaining existing partners would

compensate loss in accordance with Capital Ratio.

Lets suppose, C is insolvent then A and B compensate loss in accordance

with their Capital Ratio.

C
$
xx
xx
xx
xxx

Capital Accounts
* Current Account balance
* Capital C
* Cash/ Bank

A
$
xx
xx

B
$
xx
xx

C
$
xx
-

xx
xxx

xx
xxx

xxx

Balance b/d
* Current Account balance
* Capital A and B
* Cash/ Bank

A
$
xx
xx
xx
xxx

B
$
xx
xx
xx
xxx

C
$
xx
xx
xx
xxx

Bank Account
* Balance b/d
Receipts from Debtors
Realisation a/c (various assets sold)
* Capital Accounts - A
B
C

$
xx
xx
xx
xx
xx
xx

$
xx
xx
xx
xx
xx
xx
xx
xx
xx
xxx

* Balance b/d
Payment to Creditors
Dissolution Costs
Partner Loan repayment
Bank Loan repayment
Accrued Expenses
* Capital Accounts - A
B
C

xxx

Bank Opening balance would be either Debit or Credit.

Partners can either withdraw or invest cash into the firm.

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Note that there would never be a balance remaining in the Bank Account

PARTNERSHIP - DISSOLUTION

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