What is dissolution?
Dissolution of a partnership is the process of ending the business: assets are sold, liabilities are settled, and the remaining balance is distributed to the partners. Dissolution may occur because a partner dies or retires, because of continuing losses, or by mutual agreement.
Dissolution is different from simply admitting or retiring a partner while the business carries on. In a full dissolution the firm stops trading altogether, so every asset must be turned into cash, every debt cleared, and the books finally closed. Careful, orderly accounting protects each partner's fair share of whatever remains.
The realisation account
The realisation account is the account that works out the profit or loss when assets are sold. Its rules:
- Assets (at book value) are debited to the realisation account.
- Proceeds from selling assets are credited to the realisation account.
- Dissolution expenses are debited.
- The realisation profit or loss is shared among partners in the profit-sharing ratio.
Key idea
If total debits (book value of assets + expenses) exceed credits (sale proceeds), there is a realisation loss. If the opposite, there is a realisation profit.
Worked example
Example
Assets with a book value of RM60,000 are sold for RM52,000. Dissolution expenses are RM2,000. Debits = 60,000 + 2,000 = RM62,000; credits = RM52,000. Realisation loss = RM10,000. Two partners share equally, so each bears RM5,000.
Order of settlement
On dissolution the cash is applied in a set order: first the outside creditors are paid, then any loans made by partners are repaid, and only the remaining cash is returned to the partners according to the final balances on their capital accounts. If a partner's account shows a debit balance, that partner must pay money into the business.
Remember
After the realisation loss is deducted from a capital account, the capital balance is the cash each partner receives. A partner with capital RM30,000 and a loss share RM5,000 receives RM25,000.