Partnership

Dissolution

1
Introduction
 A partnership may dissolve due to disagreement
among the partners, poor performance of the
firm or being taken over by another business.
 The assets of the partnership will be realized to
pay off the liabilities.
 The sales proceeds should be applied in the
following order,
 Pay off creditors first,
 then the partners’ advances, and
 Finally the partners’ capital

2
Realization Account
 In the partnership dissolution, an account
named as ‘Realization Account’ will be
opened to compute the profit or loss from
realization which should be shared among
the partners according to the profit or loss
sharing ratio

3
Nature of partnership dissolution

 Dissolution where the assets are sold

separately
 Dissolution where partnership is sold as a
whole

4
Dissolution where
Assets are sold
separately

5
Procedures of Dissolution
1. All assets will be sold to other persons or
taken over by partners
2. Settle the liabilities of the partnership to
outsiders or partners
3. Transfer any ‘profit or loss on realization’
to each partner’s capital accounts in
profit/loss sharing ratio
4. Merge the balances in the partners’
current accounts to their capital accounts
6
5. Any credit balance in each partner’s
capital account represents the amount
which can be withdrawn from the
partnership to each partner; any debit
balance in a partner’s capital account
represents additional cash to be injected
by that partners

7
Transactions Accounting entries
Close all asset accounts with Dr Realization
net book value to the Cr Assets
realization account (except
cash and bank because
these assets need not be
disposed of)
Cost of dissolution or any Dr Realization
losses or expenses incurred Cr Bank
on realization
Proceeds from the disposal Dr Bank
of assets Cr Realization

Assets taken over by a Dr Capital

partner without payment Cr Realization
8
Transactions Accounting entries
Asset taken over by partners No entries required
as a gift

Creditors taken over by a Dr Creditors

partner Cr Capital accounts

Payment to creditors with Dr Creditors

discounts received Cr Realization – discount
Cr Bank
Profit or loss on realization Dr Realization – profit
to be shared among the Cr Capital accounts
partners according to the or
profit-sharing ratio
Dr Capital
Cr Realization - loss 9
Transactions Accounting entries
Repayment of loan to a Dr Loan from partner
partner Cr Bank

Repayment of loan to an Dr Loan from outsider

outsider ( creditors) Cr Bank

Transfer any balances in Dr Current (for credit balance)

partners’ current accounts Cr Capitals
Or
Dr Capital
Cr Current (for debit balance)
Repayment of remaining Dr Capital
capital to partners Cr Bank
10
Example 1

11
John, Peter and Tom were partners sharing profits and losses in the
ratio 1:1:3.
The balance sheet as at 31 December 2006 was as follows:
Balance Sheet as at 31 December 2006
Fixed Assets Cost Dep NBV
Premises 180000 10000 170000
Motor Vehicles 27500 5500 22000
207500 15500 192000
Current assets
Stock 68250
Debtors 172500
Less: provision for bad debt 1265 171235
Bank 26065
265550
Less: Current Liabilities
Creditors 60000
Working Capital 205550
397550

12
Capital: John 100000
Peter 40000
Tom 160000 300000
Current: John 30000
Peter (10000)
Tom 70000 90000
Long – term liabilities
Loan from Tom 7550
397550

Assets and liabilities were disposed of as follows:

1. The premises were sold at $ 200000 and legal charges from the
sale amount to $10000
2. Tom took over the stock and motor vehicles at book value
3. Except for $2500, all debts were collected
4. The creditors were discharged for $56000
5. Realization expenses of $10000 were paid

Required:
Prepare the realization, Bank, Capital and Current account for the dissolution
of partnership 13
 Realization
Premises 170000

Premises
Bal b/f 180000 Prov. for depreciation 10000
Realization 170000
180000 180000
Provision for depreciation
Premises 10000 Bal b/f 10000

14
 Realization
Premises 170000
Motor Vehicles 22000

Motor Vehicles
Bal b/f 27500 Prov. for depreciation 5500
Realization 22000
27500 27500
Provision for depreciation
Motor Vehicles 5500 Bal b/f 5500

15
 Realization
Premises 170000
Motor Vehicles 22000
Debtors 171235

Debtors
Bal b/f 172500 Prov. for bad debts 1265
Realization 171235
172500 172500
Provision for Bad Debts
Motor Vehicles 1265 Bal b/f 1265

16
 Realization
Premises 170000
Motor Vehicles 22000
Debtors 171235
Stock 68250

Stock
Bal b/f 68250 Realization 68250

17
 Realization
Premises 170000 Bank – premises (200000-10000) 190000
Motor Vehicles 22000 - Debtors (172500-2500) 170000
Debtors 171235 Creditors – discount received 4000
Stock 68250
Bank- realization expenses 10000

Loan from Tom

Bank 7550 Bal b/f 7550

Bank
Bal b/f 26065 Realization - expenses 10000
Realization – premises 190000 Creditors 56000
- debtors 170000 Loan from Tom 7550

Creditors
Bank 56000 Bal b/f 60000
Realization – discount received 4000
60000 18
60000
 Realization
Premises 170000 Bank – premises (200000-10000) 190000
Motor Vehicles 22000 - Debtors (172500-2500) 170000
Debtors 171235 Creditors – discount received 4000
Stock 68250
Tom – stock 68250
Bank- realization expenses 10000
- MV 22000
Gain on realization:
John 1/5 2553
Peter 1/5 2553
Tom 3/5 7659 12765
454250 454250

Capital
John Peter Tom John Peter Tom
Realization: Bal b/f 100000 40000 160000
Stock 68250 Gain on realizaiton 2553 2553 7659
MV 22000

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 Capital
John Peter Tom John Peter Tom
Realization: Bal b/f 100000 40000 160000
Stock 68250 Gain on realizaiton 2553 2553 7659
MV 22000 Current 30000 70000
Current 10000
Bank 132553 32553 147409
132553 32553 147409 132553 32553 147409
Current
John Peter Tom John Peter Tom
Bal b/f 10000 Bal b/f 30000 - 70000
Capital 30000 70000 Capital 10000
30000 10000 70000 30000 10000 70000
Bank
Bal b/f 26065 Realization - expenses 10000
Realization – premises 190000 Creditors 56000
- debtors 170000 Loan from Tom 7550
Capital: John 132553
Peter 32553
Tom 147409
386065 20
386065
Dissolution where
partnership is sold
as a whole

21
Purchase consideration
 The purchase consideration is to be
discharged by the limited company (buyer)
to partners(seller) to take over the business
 Goodwill = Purchase consideration –
( assets at take-over value –
liabilities at take-over value)

22
As another way of dissolution, a partnership may be sold
as a going concern to either a new company or an
existing company. The amount paid for purchase of
partnership assets and liabilities is called the purchase
consideration or purchase price. The purchase
consideration may be in many forms such as share
capital, debentures, cash and bank, share premium or a
combination of the above. These are called discharging
items. On disposing of the partnership, the transaction
must be reflected in both the books of the partnership
(the vendor) and the company (the buyer).

23
Transactions Accounting entries
For dissolution of Old partnership (seller)
Close all asset accounts with Dr Realization
net book value to the Cr Assets
realization account (Bank
and cash may be taken over)
Cost of dissolution or any Dr Realization
losses or expenses incurred Cr Bank
on realization
Proceeds from sale of the Dr Vendee (buyer)
business (purchase Cr Realization
consideration)

24
Transactions Accounting entries
Liabilities taken over by the Dr Liabilities
buyer Cr Realization

The purchase consideration Dr Bank/ Shares/

settled by cheque, shares
and debentures
Repayment of remaining
capital to partners
debentures in purchaser’s
company
Cr buyer
Dr capital
Cr Bank/ shares/ debentures
in purchaser’s company

25
Transactions Accounting entries
For opening entries of New Company (buyer)
Assets taken over Dr Assets
Cr Business Purchase

Liabilities taken over Dr Business Purchase

Cr Liabilities

The purchase consideration Dr Business Purchase

offered Cr Vendor (seller)

The purchase consideration Dr Vendor (seller)

settled by cheques, shares Cr Bank/Shares/Debentures
and debentures
26
IN THE COMPANY’S BOOKS
After the acquisition of the partnership assets and
liabilities, the books of the company will change to reflect
the element of purchase consideration. In the books of the
company, the business purchase account is opened
Entries:
Asset acquired
Dr- Individual Assets A/c
Cr- Business Purchase A/.c

27
Liabilities acquired
Dr. Business Purchase A/c
Cr. Individual Liability A/cs for example accounts payable,
accruals

When the purchase consideration passes the business

purchase A/c is debited and the respective discharging
items are credited. That is;
Dr. Business Purchase A/c
Cr. Discharging item component for example share
capital, share premium

28
When the purchase consideration exceeds the Net book
value of Assets the excess is regarded as the good will.

Otherwise if the net book value of the asset exceeds the

purchase consideration. The excess is referred to as the
capital reserve

In case of Goodwill
Dr. Goodwill A/c
Cr. Business Purchase A/c

29
Example 2

30
On 31st 12 2009, the firm of Maggie, Tina and
Nancy decided to form a limited company, M,T &
N Ltd and to transfer business to the company.
The statement of financial position of the firm
was as below

31
ASSETS Shs. ‘000’ Shs. ‘000’
Fixed Assets
Freehold 30,000
Property
Plant 10,900
Fixtures and 1,500
fittings
42,400
Current Assets
Inventory 19,500
Receivables 68,830
Less Provision 2000 66,830
for bad debts
Cash at bank 4,500
Cash at hand 70
Total Assets 133,300
32
EQUITY AND
LIABILITIES
Equity
Partners’ Capital
Maggie 25,000
Tina 15,000
Nancy 10,000 50,000
Total Equity 50,000
Liabilities
Non-current
Liabilities
Long term bank loan 20,000
Current Liabilities
Accounts Payables 63,300
Total Equity and 133,300
Liabilities
33
The partners shared profits and losses in the ratio 2:1:1
for Maggie, Tina and Nancy respectively. The company
took over all the assets and liabilities except the long term
loan. The purchase consideration was shs 85,000,000 and
was payable as 25,000,000 cash, shs, 20,000,000 5%
debentures and shs 40,000,000 ordinary shares.
Expenses amounting to shs 600,000 were paid by the
firm. The debentures and shares were divided among
partners in the ratio 2:1:1 respectively.

Required
Show the relevant ledger accounts to close the
partnership
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Illustration 3

35
John, Peter and Tom were partners sharing profits and losses in the
ratio 1:1:3.
The balance sheet as at 31 December 1996 was as follows:
Balance Sheet as at 31 December 1996
Fixed Assets Cost Dep NBV
Premises 180000 10000 170000
Motor Vehicles 27500 5500 22000
207500 15500 192000
Current assets
Stock 68250
Debtors 172500
Less: provision for bad debt 1265 171235
Bank 26065
265550
Less: Current Liabilities
Creditors 60000
Working Capital 205550
397550

36
Capital: John 100000
Peter 40000
Tom 160000 300000
Current: John 30000
Peter (10000)
Tom 70000 90000
Long – term liabilities
Loan from Tom 7550
397550

On 31 December 1996, they incorporated a limited company, Fortune limited,

to take over the partnership business. Fortune Limited had an authorized
capital of $500000 ordinary shares of $1 each.

37
Assets and liabilities were disposed of as follows:
1. John took over the stock at book value. Tom collected all the debts except
$2500
2. The company took over the premises at a valuation of $200000, motor
vehicles at $25000, cash at bank and all the liabilities. Goodwill was
valued at $70000 for the purpose of the takeover
3. The purchase consideration was to be discharged by the issue to the
partners of 150000 ordinary shares at $1.2 each, according to the
profit-sharing ratio, and the balance was to be in cash
4. The company also issued 50000 ordinary shares at $1.2 for cash to
outsiders

Required:
Prepare the realization, Capital and the opening balance sheet for the new
company

38
 Realization Liabilities taken over by Ltd. Co.

Premises 170000 Creditors 60000

MV 22000 Loan from Tom 7550
Stock Bank be taken over 68250 Tom: debtors (172500-2500) 170000
Debtors 171235 John: stock 68250
Bank 26065 Fortune Ltd – purchase consideration
Capital: [(200000+25000+26065-7550-60000)
John 20353 +70000] 253515
Peter 20353
Tom 61059 101765
559315 559315

Purchase consideration=Asset-liabilities +goodwill

39
 Capital
John Peter Tom John Peter Tom
Current 10000 Bal b/f 100000 40000 160000
Realization Current 30000 70000
Stock 68250
Debtors 170000 Realization
Shares in -profit 20353 20353 61059
Fortune Ltd 36000 36000 108000
Bank 46103 14353 13059
(Bal. fig.)

150353 60353 291059 150353 60353 291059

Shares in Fortune Ltd.

150000*1.2 = 180000
John 1/5 36000
Peter 1/5 36000
Tom 3/5 108000 180000
40
 Fortune Limited
Balance sheet as at 1 Jan 1996
Fixed Assets
Goodwill 70000
Premises 200000
MV 25000
295000
Current Assets
Bank [26065 + (50000*1.2) –(46103+14353+13059)] 12550

Less: Current liabilities

Creditors 60000
Working Capital (47450)
247550

Share Capital
Ordinary Shares (150000*$1+50000*$1) 200000
Share Premium (150000*$0.2+150000*$0.2) 40000
240000
Long-term liabilities
Loan from Tom 7550
247550 41
Cash distribution
among partners

42
Cash Distribution Among Partners

 With the application of the Garner vs.

Murray rule
 When cash is to be distributed as soon as
possible ( Piecemeal realization)

43
With the application of
Garner vs. Murray
rule

44
With the application of Garner vs.
Murray rule
 Any CREDIT balance in each partner’s capital
account represents the amount which can be
withdrawn from the partnership to each partner
 Any DEBIT balance in a partner’s capital
account represents additional cash to be
injected by that partner. If he is insolvency to
repay the amount, the solvency partners will be
shared the amount in:
 Profit
& loss sharing ratio
 Any agreed ratio given in the examination question
 GARNER vs. MURRAY rule may be applied
45
What is Garner vs.
Murray rule?

46
Garner vs. Murray rule
 Under the rule, a partner is required to
contribute cash to eliminate the debit
balance in his capital account
 In the court case of Garner vs. Murray
(1904), it was held that subject to any
agreement to the contrary, such a debit
balance deficiency was to be shared by
the other partner not in their profit and loss
sharing ratio but “ the ratio of their last
agreed capitals”
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 If one partner is insolvent, his capital
deficiency will be shared by other partners
according to the ‘last agreed capital ratio’
(the ratio of the balances in the capital
accounts before the dissolution, in the
absence of any agreement to the contrary

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Piecemeal
Realization

49
Piecemeal realization
 Cash is distributed as it becomes available,
instead of waiting for all the assets to be realized
first
 Assets are sold piecemeal, and then outstanding
debts are paid and the remaining cash is finally
distributed to the partners as soon as possible
 This situation occurs because some assets can
be sold quickly, and some assets take longer
time to be sold (i.e. less liquid)
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Assumed Loss/Notional Loss
Method
 This is possible loss by assuming that the
remaining assets do not have any scrap
value
 Any unsold assets will be assumed loss in
each distribution

51
Steps on Piecemeal Dissolution
1. Find out the maximum possible loss
 Maximum possible loss
= NBV of assets to be realized - Total
proceeds form disposal
OR
 Maximum possible loss
= Total capital balances - Total cash to be
distributed to partners( i.e. cash available)

52
2. The maximum possible loss is shared by
the partners according to the profit-
sharing ratio
3. Apply the Garner vs. Murray rule if there
is any capital deficiency
4. Distribute any available cash to the
partners according to their remaining
capital balances
5. Repeat the process until all assets have
been realized
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Example 3

54
Au, Chow and Lee were partners sharing profits and losses in the ratio 2:2:1.
The balance sheet as at 31 December 1996 was as follows:
Balance Sheet as at 31 December 1996
Fixed Assets Cost Dep NBV
Goodwill 100000 100000
Land 150000 150000
Plant & Machinery 133000 55800 77200
Fixture & Fittings 30000 13000 17000
Motor Vehicles 32000 24000 8000
445000 92800 352200
Current assets
Stock 64000
Debtors 65000
Less: provision for bad debt 6000 59000
Cash 160
123160
Less: Current Liabilities
Creditors 57000
Bank Overdraft 128360
Working Capital 62200
290000
55
Capital: Au 120000
Chow 80000
Lee 30000 230000
Current: Au 20000
Chow 20000 40000
Long – term liabilities
Bank loan 20000
290000

On 31 December 1996 the partners agreed to dissolve the partnership

due to a disagreement between the partners. Assets were to be realized,
outstanding debts to be paid and the remainder to be shared by the
partners in an equitable manner.
Distributions of cash were to be made as soon as possible.

January
• Provision was made for dissolution expenses of $2400
• Land was sold for $200000
• The cash available was utilized to settle in full the bank overdraft, the
bank overdraft, the bank loan and all creditors after receiving discounts
56
March
• Stock which had originally costed $40000 was sold for $32000
• $15000 was received form debtors

April
• Plant & Machinery were sold for $51000 after paying carriage of $2000
• Fixtures and fittings were sold for $12000

May
• All the outstanding debtors, with the exception of a customer who owed
$4000 settled their accounts
• Motor vehicles were sold for $25000
• The remaining stock was sold for $22000
• Dissolution expenses amounted to $2100

Prepare distribution statement of cash at each stage

57
 Distribution Statement
Total Au Chow Lee
$ $ $ $
Capital accounts 230000 120000 80000 30000
Current accounts 40000 20000 20000
270000 140000 100000 30000
1st Distribution:
Cash available (w1) ( 47000)
Maximum possible loss (2:2:1) 223000 89200 89200 44600
50800 10800 (14600)
Lee’s capital deficiency shared by Au
And Chow in the last agreed capital ratio
(120000:80000) (8760) (5840) 14600
Cash distributed 42040 4960 0
2nd Distribution:
Capital balance 223000 97960 95040 30000
Cash available (51000+12000) (63000)
Maximum possible loss (2:2:1) 160000 64000 64000 32000
140000-42040 33960 31040 (2000)
Lee’s capital deficiency shared by Au
And Chow in the last agreed capital ratio
(120000:80000) (1200) (800) 2000
58
Cash distributed 32760 30240 0
3rd Distribution:
Capital balance 160000 65200 64800 30000
Cash available (W2) (93300)
Maximum possible loss (2:2:1) 66700 26680 26680 13340
Cash distributed 38520 38120 16660

97960-32760

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 W1 Cash available for 1st distribution:
January Opening balance 160
Receipt from land 200000
200160
Less: Payment
Assumed dissolution expenses 2400
‘Settle in full’ means (i.e. not actual expenses)
no more payment will be Bank overdraft 128360
paid. => the difference
Bank loan 20000
between 57000 and 49400
is discount received Creditors (Bal. Fig.) 49400 200160
0
=> no cash distribution to partners on January
March Receipts:
Stock 32000
Debtors 15000
First cash distributed to partners 47000

Back
60
Notes:
•Very often no cash is distributed to partners at first or second month
since outstanding debts must be repaid first and then the remaining
cash can then be distributed to partners.

•Even though the questions have not mentioned to repay outstanding

debts, you should make sure to keep some cash to prepare to repay debts
and could not be distributed it to partners

61
W3 Cash available for 3rd distribution:
May Receipts
Surplus in dissolution expenses(2400-2100) 300
Collection remaining debtors balance
(65000-15000-400) 46000
Receipts from MV 25000
Receipts from remaining stock 22000
93300

Back
62
 Realization

Goodwill 100000 Cash:

Land 150000 Land 200000
Plant & Machinery 77200 Stock (32000+22000) 54000
Fixtures & fittings 17000 Debtors (15000+46000) 61000
Motor Vehicles 8000 Plant & machinery 51000
Stock 64000 Fixture & fittings 12000
Debtors 59000 Motor vehicles 25000
Cash - dissolution expenses 2100 Creditors – discount rececived
(57000-49400) 7600
Capital:
Au (2/5) 26680
Chow (2/5) 26680
Lee (1/5) 13340 66700
477300 477300

63
 Capital
Au Chow Lee Au Chow Lee
Cash Bal b/f 120000 80000 30000
in March 40240 4960 Current 20000 20000
In April 32760 30240
in May 38520 38120 16660
Realization
-loss 26680 26680 26680

140000 100000 30000 140000 100000 30000

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