Fundamentals of Accounting · Partnership and LLP Accounts

Dissolution of a Partnership Firm: Accounting Entries

Updated 11 October 2026 · Fact-checked

Dissolution of a firm means the business closes and the partners' relationship ends. You open a Realisation Account, transfer assets and outside liabilities to it, record sales, payments and expenses, share the profit or loss among partners, then settle capital accounts. If a partner is insolvent, apply Garner v Murray.

Understand Dissolution of a Partnership Firm

A partnership can be dissolved in two ways. In dissolution of partnership, the relationship between the partners changes (a new partner joins, one retires, or the profit ratio changes) but the firm carries on. In dissolution of the firm, the business stops, assets are sold, liabilities are paid and the partners are paid off. Dissolution of the firm always ends the partnership. The reverse is not true.

When a firm is dissolved, you need one account to collect all the gains and losses from selling assets and paying liabilities. That is the Realisation Account. You move every real asset and every outside liability into it at book value. Cash and bank are not moved. Then you record what the assets actually fetched and what you actually paid. The balance is your profit or loss on realisation.

The law fixes the order of payment, unless the partners have agreed otherwise. Under Section 48 of the Indian Partnership Act, 1932, the firm's assets (including any money partners bring in to cover a capital deficiency) are applied first to debts owed to outsiders, then to each partner's advances (loans) as distinct from capital, then to each partner's capital. Any residue is shared in the profit-sharing ratio. Section 46 gives every partner the right to have the firm's property used to pay its debts and the surplus distributed.

Losses, including a deficiency of capital, are met first from profits, then from capital, and lastly, if needed, by the partners personally in their profit-sharing ratio (Section 48(a)). This is the default, subject to agreement.

If a partner is insolvent and cannot pay the deficiency in his capital account, the solvent partners bear it. Under the rule in Garner v Murray, which exam questions apply when told to or when the facts call for it, they share it in the ratio of their capitals (taken from the last balance sheet before dissolution), not in the profit-sharing ratio. Read the question: if it asks for the Section 48 default or gives an agreement, follow that.

Key rules to remember

Order of payment (Section 48(b)): Outside debts → partners' advances (loans) → partners' capital → residue in profit ratio; Each step is paid rateably. Cash must be enough for the earlier step before the next is paid. Applies subject to agreement.
Realisation Account balancing figure: Profit or loss = Credit side total − Debit side total; Credit side: liabilities transferred, cash from assets sold, assets taken by partners. Debit side: assets transferred, liabilities paid, expenses. Credit larger means profit.
Transfer of profit or loss: Profit: Realisation A/c Dr, to Partners' Capital A/cs. Loss: Partners' Capital A/cs Dr, to Realisation A/c; Share in the profit-sharing ratio.
Losses and deficiency (Section 48(a)): Profits → capital → partners individually in profit ratio; Default rule, subject to agreement.
Garner v Murray: Deficiency of insolvent partner is shared by solvent partners in the ratio of their capitals before dissolution; Use last balance sheet capitals, before adding reserves or sharing realisation loss. The insolvent partner's own share of loss stays in his account.
Final cash check: Opening cash and bank + realisation receipts − payments = total paid to partners; If the closing cash does not equal the closing capital total, there is an error.

How to solve Dissolution of a Partnership Firm questions

Use the same sequence for any dissolution question. Do the accounts in this order and the cash always balances.

1Read the balance sheet. Note which items are cash/bank, real assets, fictitious assets, outside liabilities, reserves, partners' loans and capitals.
2Open the Realisation Account. Debit it with all real assets (not cash, bank or fictitious assets) at book value. Credit it with all outside liabilities at book value.
3Record the realisation: credit the account with cash received from assets sold and with assets taken over by a partner. Debit it with liabilities paid, liabilities taken over by a partner and realisation expenses.
4Balance the Realisation Account. Transfer the profit or loss to partners' capital accounts in the profit-sharing ratio.
5Transfer reserves and accumulated profits to capital accounts (credit) and fictitious assets or accumulated losses (debit), in the profit ratio. Transfer partners' loans to a loan account or settle them before capital.
6Prepare the partners' capital accounts with all adjustments: opening capital, reserves, loss or profit, assets or liabilities taken over, expenses paid by a partner.
7If a partner has a debit balance and is insolvent, spread the deficiency over solvent partners (Garner v Murray if the question applies it). If solvent, he brings in cash.
8Prepare the Cash/Bank Account. Pay outsiders first, then partners' loans, then partners' capital. The closing balance must be nil.

Quickest way: Realisation shortcut: loss first, then the cash check

When to use it: Use when time is short and the question asks only for the final payments to partners or the Realisation Account result.

Find the book value of real assets, then subtract what they realised, and add liabilities paid minus liabilities transferred, plus expenses. This gives the loss or profit directly.
Share the loss or profit by the profit ratio and adjust each partner's capital.
Check: total cash available (opening cash plus realisation receipts, less payments to outsiders, loans and expenses) must equal the sum of final capital balances.
If a partner has a deficiency, adjust before the cash check. The total of capitals still equals cash left.

Common mistakes in Dissolution of a Partnership Firm

Transferring cash, bank balance or fictitious assets (such as Profit and Loss debit balance) to the Realisation Account.
Students move every asset because the instruction says to close all accounts.
Fix: Cash and bank are kept for the final settlement. Fictitious assets and accumulated losses go to the partners' capital accounts, not Realisation.
Showing reserves and accumulated profits in the Realisation Account.
They appear on the liabilities side, so they look like liabilities.
Fix: They belong to partners. Transfer them to capital accounts in the profit-sharing ratio.
Paying partners' capital before partners' loans.
Students treat loan and capital as the same kind of partner money.
Fix: Follow Section 48(b): outside debts, then partners' advances, then capital. Loans are paid before capital.
Sharing an insolvent partner's deficiency in the profit ratio when Garner v Murray applies.
Students are used to using the profit ratio for every loss.
Fix: Use the ratio of capitals standing before dissolution. Ignore adjustments for reserves, loss on realisation and drawings unless the question says otherwise.
Recording a partner's expenses or a liability taken over on the wrong side.
The entry touches both Realisation and the capital account, so students mix the sides.
Fix: An expense paid by a partner: Realisation Dr, Partner's Capital Cr. A liability taken over by a partner: Realisation Dr, Partner's Capital Cr. An asset taken over by a partner: Partner's Capital Dr, Realisation Cr.
Using the wrong ratio for Garner v Murray, such as the post-loss capital balances.
Students take capitals from the capital account after adjustments.
Fix: Take the capitals from the last balance sheet before dissolution. Note it down at the start.

Worked examples

Example 1

A and B share profits 3:2. Their balance sheet on dissolution shows: Capital A ₹60,000, B ₹40,000; Creditors ₹30,000. Assets: Cash ₹10,000, Debtors ₹40,000, Stock ₹50,000, Furniture ₹30,000. Debtors realised ₹36,000, stock ₹45,000 and furniture ₹24,000. Creditors were paid ₹28,000 in full settlement. Realisation expenses were ₹3,000, paid by the firm. Prepare the Realisation Account and show the final payment to partners.

Show the solution

Debit side of Realisation A/c: Debtors ₹40,000 + Stock ₹50,000 + Furniture ₹30,000 = ₹1,20,000. Add cash paid to creditors ₹28,000 and expenses ₹3,000. Total = ₹1,51,000.
Credit side: Creditors ₹30,000 + cash from assets (₹36,000 + ₹45,000 + ₹24,000 = ₹1,05,000). Total = ₹1,35,000.
Loss on realisation = ₹1,51,000 − ₹1,35,000 = ₹16,000.
A's share = ₹16,000 × 3/5 = ₹9,600. B's share = ₹16,000 × 2/5 = ₹6,400.
Capital: A = ₹60,000 − ₹9,600 = ₹50,400. B = ₹40,000 − ₹6,400 = ₹33,600. Total = ₹84,000.
Cash check: ₹10,000 + ₹1,05,000 − ₹28,000 − ₹3,000 = ₹84,000. This matches.

Answer: Loss on realisation is ₹16,000. Final payments: A ₹50,400 and B ₹33,600, which exhausts the cash of ₹84,000.

Example 2

A, B and C share profits equally. Their capitals on the last balance sheet were A ₹48,000, B ₹32,000 and C ₹10,000. Creditors were ₹30,000. Assets: Bank ₹10,000, Debtors ₹40,000, Stock ₹40,000, Machinery ₹30,000. The assets realised: Debtors ₹28,000, Stock ₹24,000 and Machinery ₹16,000. Creditors were paid in full. Realisation expenses of ₹3,000 were paid by the firm. C is insolvent and nothing can be recovered from him. Apply Garner v Murray and find the final payments to A and B.

Show the solution

Assets realised = ₹28,000 + ₹24,000 + ₹16,000 = ₹68,000.
Realisation debit side: real assets ₹1,10,000 (₹40,000 + ₹40,000 + ₹30,000) + creditors paid ₹30,000 + expenses ₹3,000 = ₹1,43,000.
Credit side: creditors ₹30,000 + cash from assets ₹68,000 = ₹98,000. Loss = ₹1,43,000 − ₹98,000 = ₹45,000.
Each partner's share of loss = ₹45,000 ÷ 3 = ₹15,000.
Capitals after loss: A = ₹48,000 − ₹15,000 = ₹33,000. B = ₹32,000 − ₹15,000 = ₹17,000. C = ₹10,000 − ₹15,000 = ₹(5,000), a deficiency.
Garner v Murray: A and B bear C's deficiency in their capital ratio of ₹48,000 : ₹32,000 = 3:2. A bears ₹5,000 × 3/5 = ₹3,000. B bears ₹2,000.
Final capitals: A = ₹33,000 − ₹3,000 = ₹30,000. B = ₹17,000 − ₹2,000 = ₹15,000.
Cash check: ₹10,000 + ₹68,000 − ₹30,000 − ₹3,000 = ₹45,000. A + B = ₹45,000. This matches.

Answer: Loss on realisation is ₹45,000. C's deficiency of ₹5,000 is borne by A ₹3,000 and B ₹2,000. Final payments: A ₹30,000 and B ₹15,000.

Exam tips

Draw the Realisation Account first, then capital accounts, then the Cash/Bank account. Examiners award marks for each account, so show all three.
In Paper 2, write short narrations for the entries and state the ratio you are using. If you use Garner v Murray, write one line stating why.
Note the capitals from the balance sheet at the start of the question. You need them later for Garner v Murray and they are easy to overwrite.
Do the cash check at the end. If cash does not equal total capital, look for a missing expense, reserve or partner's loan.
Read the verbs carefully: 'taken over', 'paid by the partner' and 'paid by the firm' change which account gets the entry.

Practice questions from Partnership and LLP Accounts

Dissolution of a Partnership Firm in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Dissolution of a Partnership Firm: frequently asked questions

What is the difference between dissolution of partnership and dissolution of a firm?

Dissolution of partnership means the relationship between the partners changes but the business continues, for example on admission or retirement of a partner. Dissolution of a firm means the business stops, assets are sold, liabilities are paid and the partners are settled. Dissolution of a firm always dissolves the partnership as well.

What is the Realisation Account?

It is a temporary account that collects the book value of the real assets and outside liabilities and the actual amounts realised or paid. Its balancing figure is the profit or loss on realisation. That figure is shared among partners in their profit ratio.

What is the Garner v Murray rule?

When a partner is insolvent and cannot make good a debit balance in his capital account, the solvent partners bear the loss in the ratio of their capitals before dissolution, not in their profit ratio. Use it when the question tells you to or when the facts require it. If there is an agreement or the question says otherwise, follow that.

In what order is cash paid on dissolution?

Under Section 48 of the Indian Partnership Act, 1932, subject to agreement: first debts to outsiders, then each partner's advances (loans) rateably, then each partner's capital rateably. Any remaining amount is shared in the profit-sharing ratio.

Where do reserves and fictitious assets go on dissolution?

Reserves and accumulated profits are credited to partners' capital accounts in the profit-sharing ratio. Fictitious assets and accumulated losses, such as a Profit and Loss debit balance, are debited to partners' capital accounts in the same ratio. They are not transferred to the Realisation Account.