Dissolution of Partnership Firm and Settlement of Accounts

Dissolution of partnership firm is a process in which relationship between partners of firm is dissolved or terminated. If a relationship between all the partners of firm is dissolved then it is known as dissolution of firm. In case of dissolution of partnership of firm, the firm ceases to exist. This process includes the discarding and disposing of all the assets of firm or and settlements of accounts, assets, and liabilities. Learn more about Dissolution of partnership firm, legal provisions, and settlement of accounts.

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Dissolution of Partnership Firm

As we know that after the dissolution of partnership firm the existing relationship between the partner’s changes. But, the firm continues its activities. The dissolution of partnership takes place in any of the following ways:

1. Change in the existing profit sharing ratio.
2. Admission of a new partner
3. The retirement of an existing partner
4. Death of an existing partner
5. Insolvency of a partner as he becomes incompetent to contract. Thus, he can no longer be a partner in the firm.
6. On completion of a specific venture in case, the partnership was formed specifically for that particular venture.
7. On expiry of the period for which the partnership was formed.

 

Section 39 of the Indian Partnership Act 1932 states that the dissolution of partnership firm among all the partners of the partnership firm is the Dissolution of the Partnership Firm. The dissolution of partnership firm ceases the existence of the organization.

After this, the partnership firm cannot enter into any transaction with anybody. It can only sell the assets to realize the amount, pay the liabilities of the firm and discharge the claims of the partners.

However, the dissolution of a firm may be without or with the intervention of the court. It is noteworthy here that the dissolution of partnership may not necessarily result in the dissolution of the firm.

But, dissolution of partnership firm always results in the dissolution of the partnership.

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• Accounting Treatment of Dissolution

Learn about the Financial Statement of a Company here in detail.

Following are the ways in which dissolution of a partnership firm takes place:

1. Dissolution by Agreement

A firm may be dissolved if all the partners agree to the dissolution. Also, if there exists a contract between the partners regarding the dissolution, the dissolution may take place in accordance with it.

2. Compulsory Dissolution

In the following cases the dissolution of a firm takes place compulsorily:

• Insolvency of all the partners or all but one partner as this makes them incompetent to enter into a contract.
• When the business of the firm becomes illegal due to some reason.
• When due to some event it becomes unlawful for the partnership firm to carry its business. For example, a partnership firm has a partner who is of another country and India declares war against that country, then he becomes an enemy. Thus, the business becomes unlawful.

3. When certain contingencies happen

The dissolution of the firm takes place subject to a contract among the partners, if:

• The firm is formed for a fixed term, on the expiry of that term.
• The firm is formed to carry out specific venture, on the completion of that venture.
• A partner dies.
• A partner becomes insolvent.

4. Dissolution by Notice

When the partnership is at will, the dissolution of a firm may take place if any one of the partners gives a notice in writing to the other partners stating his intention to dissolve the firm.

5. Dissolution by Court

When a partner files a suit in the court, the court may order the dissolution of the firm on the basis of the following grounds:

• In the case where a partner becomes insane
• In the case where a partner becomes permanently incapable of performing his duties.
• When a partner becomes guilty of misconduct and it affects the firm’s business adversely.
• When a partner continuously commits a breach of the partnership agreement.
• In a case where a partner transfers the whole of his interest in the partnership firm to a third party.
• In a case where the business cannot be carried on except at a loss
• When the court regards the dissolution of the firm to be just and equitable on any ground.

Settlement of Accounts

In a case where the partners do not have an agreement regarding the dissolution of the firm, the following provisions of the Indian Partnership Act 1932 will apply:

• The firm will pay the losses including the deficiency of capital firstly out of the profits, secondly out of the partner’s capital and lastly by the partners individually in their profit sharing ratio.
• The firm shall apply its assets including any contribution to make up the deficiency firstly, for paying the third party debts, secondly for paying any loan or advance by any partner and lastly for paying back their capitals. Any surplus left after all the above payments is shared by partners in profit sharing ratio.

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Difference between the Dissolution of Partnership and Dissolution of Firm

Basis	Dissolution of Partnership	Dissolution of Firm
1. Closure of business	The business of the firm continues there is no closure.	The business of the firm gets discontinued.
2. Settling of assets and liabilities	There is a revaluation of assets and liabilities. Hence, they are shown at revalued figures in the Balance Sheet.	The liabilities are paid-off and assets are realized.
3. Intervention by court	In this case, there is no intervention by the court as the dissolution of partnership takes place by the mutual consent of all the partners.	The court may or may not intervene in this case.
4. Relationship	The relationship between the partners continues to exist though it may change its form.	The relationship between the partners ceases to exist.
5. The closing of Books of accounts	There is no closure of books as the business continues.	The books need closure as the business ceases to continue.