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The syllabus for CAT Paper 6, Drafting Financial Statements requires candidates to be able to prepare partnership accounts in a number of circumstances. The purpose of this article is to outline what happens, in accounting terms, when a partnership is dissolved. DISSOLUTION OF A PARTNERSHIP When a partnership is dissolved all the accounts need to be balanced off and any cash surplus distributed to the partners. The following sequence may be followed: 1 The current account for each partner is cleared to their capital accounts, because it is no longer necessary to keep a distinction between the two types of accounts. 2 A realisation account is established and all assets (except cash) and liabilities are transferred to it at their net book value (NBV). 3 When the assets are sold and the liabilities settled, a double entry is made between the realisation account and the cash account. Any expenses incurred during realisation are debited to the realisation account. During some dissolutions, partners may decide to take some of the assets for themselves. In these circumstances it is recorded in their accounts. 4 Once all the assets are disposed of, and all the liabilities met, the balance on the realisation account is transferred to the partners account in their profit sharing ratio. A credit balance on the realisation account represents a profit on dissolution; a debit represents a loss. 5 The total amount due to the partners should equal the cash balance. The cash is distributed to the partners and the partnership is dissolved. EXAMPLE OF A PARTNERSHIP DISSOLUTION Harley and his son David have been in partnership for a number of years and share profits (and losses) in the ratio 2:1. However, on 1 June 2006 they decide to dissolve their partnership to pursue other interests. The balance sheet of the partnership at 31 May 2006 is given below: 48 student accountant March 2006

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dissolution of a partnership
relevant to CAT Scheme Paper 6

Harley and David Partnership Balance sheet as at 31 May 2006 $ Capital accounts $ Non-current (fixed) assets at net book value Equipment Motor vehicles 17,000 Current accounts Harley 4,000 David 2,500 6,500 Payables (creditors) Current assets Investments Receivables (debtors) Bank 10,000 14,000 500 24,500 11,000 34,500 34,500 $ $

Harley David

10,000 7,000

4,000 6,000 10,000

At dissolution, it was agreed by the partners that David could take some equipment, which had a net book value of $500, at a valuation of $750. Other equipment was sold for $3,300. All vehicles were sold for a total of $5,500. The receivables (debtors) only realised $11,300, and the payables (creditors) were settled for $10,000. The partners investments realised $13,400 and there were dissolution expenses of $800. You are required to show the relevant accounts and the final distribution between partners. APPROACH AND SOLUTION Students need to work methodically through a question like this. A good approach would be to follow the structure of events described above. The key steps are demonstrated below.

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Step 1 Combine the current and capital accounts: Partnership capital accounts Harley $ Capital accounts Balance b/f 10,000 Current accounts Balance b/f 4,000 David $ 7,000

d 2,500

In selling assets (for cash) Debit Cash and bank account Credit Realisation account Costs incurred during dissolution Debit Realisation account Credit Cash and bank account In paying payables (creditors) and redeeming loans (if taken) Debit Realisation account Credit Cash and bank account Assets taken out by partners Debit Partners account with agreed valuation of the asset Credit Realisation account with agreed valuation of the asset.

Step 2 Establish a realisation account and transfer the balances on all the assets (except the cash balance) and on liabilities at their book value. The assets will then be shown as debit entries and the liabilities as credit entries in the realisation account. In this example the realisation account will be as follows: Realisation account $ 4,000 6,000 10,000 14,000 $ 11,000

In this example the accounts will now appear as follows: Realisation account $ 4,000 6,000 10,000 14,000 $ 11,000 3,300 5,500 11,300 13,400 750

Equipment (NBV) Motor vehicles (NBV) Investments Receivables (debtors)

Payables (creditors)

Step 3 Now record what happens on the sale of the assets and the settlement of any debts. The key journals are:

Equipment (NBV) Motor vehicles (NBV) Investments Receivables (debtors) Cash and bank payments: Payables (creditors) settled Dissolution expenses Balance

Payables (creditors) Cash and bank proceeds: Equipment Motor vehicles Receivables (debtors) Investments Davids account (equipment)

10,000 800 450 45,250

45,250

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Realisation a/c (equip) Balance as at step 3

Balance b/f Equipment Motor vehicles Receivables (debtors) Investments

Step 4 It is helpful at this point to check that the accounts balance. In this example the balance on the accounts is as follows: $ 14,000 8,750 450 23,200 23,200 23,200 $

Credit Credit Debit

The balance on the realisation account is the profit (or loss) that has been achieved on realisation. In this example, a profit of $450 has been achieved. Step 5 The next step is to share the profit or loss between the partners in the profit sharing ratio. The partners are then paid and the partnership accounts closed by debiting the partners capital accounts and crediting the bank account. The final accounts for Harley and David on dissolution are as follows:

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Partnership capital accounts Harley $ David $ Harley $ David $ 7,000 Realisation account $ Equipment (NBV) 4,000 Motor vehicles (NBV) 6,000 Investments 10,000 Receivables (debtors) 14,000 Cash and bank payments: Payables (creditors) settled 10,000 Dissolution expenses 800 Profit on realisation: Harley: 2/3 300 David: 1/3 150 45,250 Payables (creditors) Cash and bank proceeds: Equipment Motor vehicles Receivables (debtors) Investments Davids account (equipment) $ 11,000 Capital accounts 750 Balance b/f 10,000 14,000 14,000 8,750 Current accounts Balance b/f 4,000 9,500 14,000 Cash and bank $ $ 500 Realisation account: 3,300 Payables (creditors) settled 10,000 5,500 Dissolution expenses 800 11,300 Balance as at step 3 23,200 13,400 34,000 34,000 2,500 9,500 3,300 5,500 11,300 13,400 750 45,250 Partnership capital accounts Harley $ Realisation a/c (equip) Cash (i) David $ 750 8,900 Capital accounts Balance b/f Current accounts Balance b/f Realisation account Harley $ 10,000 David $ 7,000 14,300 4,000 300 14,300 2,500 150 9,650 Partners accounts: Harley David Realisation account Cash and bank 14,300 9,650 (i) this is the amount due to each partner and is paid out from the partnership. Cash and bank $ 500 3,300 5,500 11,300 13,400 $ Realisation account: Payables (creditors) settled Dissolution expenses Partners accounts: Harley David Balance b/f Equipment Motor vehicles Receivables (debtors) Investments 10,000 800 14,300 8,900 34,000 34,000 Christopher Pyke is examiner for CAT Paper 6 March 2006