Dissolution of Partnership Firm Class 12 Notes with Examples

Under Section 39 of the Indian Partnership Act, 1932, the dissolution of partnership between all the partners of a firm is called the dissolution of the firm. The firm stops transacting business altogether; only winding-up activities — selling assets, paying liabilities and settling the partners’ claims — continue after dissolution (NCERT, p. 156).

These notes follow the 2026-27 session and give you the whole chapter in revision-ready form: the meaning and modes of dissolution, the Section 48 order of settlement, Section 49 and the Garner vs Murray rule, the Realisation Account, the journal entries grouped into patterns, two worked examples with original figures, the mistakes students actually make, and a one-screen recap.

How This Chapter Builds: From Meaning to Final Settlement

The chapter follows one logical path: define what dissolution is, list the ways it can happen, and then apply the legal and accounting rules that close the books. The textbook’s own learning objectives map onto five steps (NCERT, p. 156).

1. Meaning of dissolution of the firm — Section 39, and the difference between dissolving a partnership and dissolving the firm (p. 156).
2. Modes of dissolution — the five ways a firm can end, and the seven ways a partnership alone can be dissolved (pp. 156–158).
3. Settlement rules — how losses are borne and how realised money is applied, under Sections 48 and 49, including the Garner vs Murray rule (pp. 159–160).
4. Realisation Account and journal entries — the account that measures the net gain or loss of winding up, and the seventeen entries that close the books (pp. 160–167).
5. Combined illustrations and questions — eleven full illustrations that mix the rules together, followed by the chapter’s question bank (pp. 162–192).

Step 4 is the mechanical core: prepare the Realisation Account, then the partners’ capital accounts, then the Bank Account — every dissolution solution in this chapter uses that sequence. The earlier reconstitution chapters are the background you need; from the Class 12 Accountancy notes hub you can revise this whole syllabus, including the retirement and death of a partner.

You can also browse the Class 12 notes and the general CBSE notes index. If you want to see any illustration solved in full, open the official NCERT Class 12 Accountancy I PDF — Chapter 4 (Dissolution of Partnership Firm) and read it alongside these notes.

What Does “Dissolution of Partnership Firm” Mean? Section 39 Explained

In earlier chapters, admission, retirement or death of a partner changed who the partners were, but the firm — the business — could continue under the same name. That is reconstitution, and it dissolves only the old partnership.

Section 39 of the Indian Partnership Act, 1932 defines the second, final event: dissolution of partnership between all the partners of a firm is called the dissolution of the firm (NCERT, p. 156). The legal relationship among every partner is broken, the firm’s existence ends, and no new business may be transacted.

From that point the firm only winds up: selling its assets, paying its liabilities and discharging the claims of the partners.

Original one-line example: if Radhika and Sumit run a bakery and agree to close the shop permanently, sell the ovens and stock, pay the flour supplier and settle each other’s claims, the firm — not just the partnership — is dissolved. No new bread is baked or sold after the closure decision.

Dissolution of Partnership vs Dissolution of Firm: The Comparison Table

First, the seven events that dissolve a partnership without ending the firm (NCERT, pp. 156–157):

• change in the existing profit sharing ratio among partners;
• admission of a new partner;
• retirement of a partner;
• death of a partner;
• insolvency of a partner;
• completion of the venture, if the partnership was formed for that venture;
• expiry of the period of partnership, if it was for a specific period.

The textbook contrasts the two events on five bases (p. 158):

The logical rule to remember: dissolution of the firm always dissolves the partnership, but dissolution of partnership need not dissolve the firm (p. 157).

The 5 Modes of Dissolution of a Firm

A firm may be dissolved with or without the intervention of the court, in five ways (NCERT, pp. 157–158):

1. By agreement — (a) with the consent of all the partners, or (b) in accordance with a contract between the partners.
2. Compulsory dissolution — forced by law when
   • all partners, or all but one, become insolvent, making them incompetent to sign a contract;
   • the business of the firm becomes illegal; or
   • a partner becomes an alien enemy — for example, through the declaration of war between his country and India.
3. On the happening of certain contingencies (subject to contract between the partners) — the fixed term expires; the venture is completed; a partner dies; or a partner is adjudicated insolvent.
4. By notice — only in a partnership at will (a partnership with no fixed term): any one partner gives the others written notice of intention to dissolve.
5. By court — at the suit of a partner, on any of these seven grounds:
   • a partner becomes insane;
   • a partner becomes permanently incapable of performing his duties as a partner;
   • a partner is guilty of misconduct likely to affect the business adversely;
   • a partner persistently commits breach of the partnership agreement;
   • a partner transfers the whole of his interest in the firm to a third party;
   • the business cannot be carried on except at a loss; or
   • on any ground the court regards dissolution as just and equitable.

One nuance: death or insolvency of a partner dissolves the partnership under the list in the previous section. For the firm, these same events operate as contingencies — the firm dissolves only if the contract does not provide otherwise (pp. 156–157).

Key Terms of Dissolution, Defined with Examples

These are the terms the textbook formally introduces in this chapter (NCERT, p. 184). Learn them once, and every later section shares the same vocabulary.

Settlement of Accounts: The Section 48 Rules in the Correct Order

When a firm dissolves, it must dispose of all its assets to satisfy all claims against it. Subject to agreement among the partners, Section 48 of the Indian Partnership Act, 1932 provides two ladders — one for the treatment of losses, one for the application of assets (NCERT, pp. 159–160).

In effect, the money realised from assets — plus any contribution from partners to make up capital deficiencies — goes first to outside liabilities (creditors, loans, bank overdraft, bills payable), then to the partners’ loans, then to their capitals, and any surplus is shared in the profit sharing ratio (p. 159).

Why this order exists: the law treats the firm as owing outsiders first; partners’ advances rank next because the partners lent money to their own firm; capital is repaid only after that; and the surplus is simply the reward of partnership, shared the way profits would be.

Micro example (proportionate payment): only Rs 5,000 is left after outside debts, while the partners’ loans are Rs 6,000 and Rs 4,000. The available money is applied in the ratio 6:4 = 3:2, so the first partner receives Rs 3,000 and the second receives Rs 2,000 — neither loan is fully paid, but both are paid proportionately.

Memory device: “Our Little Company Survives” — Outsiders, Loans, Capital, Surplus. The firm’s dues to outsiders come first; only after that can loans, capital and finally surplus be settled.

Firm’s Debts vs Partners’ Private Debts: Section 49 and the Garner vs Murray Rule

Where firm debts and a partner’s private debts exist together, Section 49 gives two estate rules (NCERT, p. 159):

• Firm property is applied first to payment of the firm’s debts; the surplus, if any, is divided among the partners by their claims and can then meet their private liabilities.
• A partner’s private property is applied first to payment of his private debts; the surplus may then be used for the firm’s debts, if the firm’s assets fall short of its liabilities.

Note the trap: the partner’s private property does not include the personal properties of his wife and children (p. 159).

Garner vs Murray (p. 160): when a partner’s capital account finally shows a debit balance — because he cannot contribute towards the deficiency — he is treated as insolvent. The sum not recoverable is a capital loss for the firm.

In the absence of an agreement to the contrary, this capital loss is borne by the remaining solvent partners in the ratio of their capitals as on the date of dissolution.

Be honest about scope: the textbook states this principle but does not teach the accounting treatment of dissolution on account of insolvency at this stage. For revision, remember the two differences — a realisation loss is shared in the profit sharing ratio, while an insolvent partner’s deficiency is shared in the capital ratio.

Realisation Account: Purpose, Format, and What Goes Where

Purpose: when the firm is dissolved, its books are to be closed, and the profit or loss from selling assets and paying liabilities must be computed.

The Realisation Account does exactly this — it records the realisation of assets, the payment of liabilities and the realisation expenses, and its balance (profit or loss on realisation) is transferred to the partners’ capital accounts in the profit sharing ratio (NCERT, p. 160).

What is transferred to it: all assets other than cash, bank balance and fictitious assets — sundry debtors at their gross value, with any provision for doubtful debts going to the credit side along with liabilities — and all external liabilities (pp. 160, 164).

This table reproduces the standard format the textbook gives as Fig. 4.1 (pp. 160–161). If a fixed asset has a provision for depreciation account, the same rule as for debtors applies — the asset is transferred at gross value and the provision goes to the credit side with liabilities (p. 164).

Fresh analogy — the closing down sale register.

Picture a shop holding a closing down sale: the entire stock is to be sold in one lot, every rupee of proceeds and every rupee of cost is recorded in a single register, and at the end the owners read off the net profit or loss of the whole clearance and split it between themselves.

The Realisation Account is exactly that register — it pulls together every asset sold and every liability paid during winding up, and the single net figure is shared by the partners in their profit sharing ratio. That is also why cash and bank never enter the account: they are the payment medium of the sale, not goods being sold.

And fictitious assets never enter because there is nothing to sell — writing them off is a capital matter between the partners, not a realisation.

The Journal Entries of Dissolution, Grouped for Revision

The textbook lists seventeen entries (NCERT, pp. 164–167). They are easier to recall as four clusters. In every entry below, the credit line is written after the debit line with “To”, as in the textbook.

Cluster A — Closing the balance sheet

Cluster B — The realisation transactions

Cluster C — Expenses and special items

Entries 12 and 17 are grouped with the final settlement in Cluster D below. Illustration 3 (pp. 168–169) is the model for every variation of expenses, remuneration and partner-bearer combinations in entries 8 and 9.

Cluster D — Final settlement

Two checkpoints for any solution: the aggregate amount finally payable to the partners must equal the amount available in the bank and cash accounts (p. 166), and the Bank Account must balance at the end.

Special Cases: Unrecorded Items, Partner’s Loan, Current Accounts and Reserves

These are the rules where one wrong direction loses the whole question. Each is stated as a rule with its textbook evidence.

• Partner’s loan on the liabilities side is paid directly after the outside debts — it never passes through the Realisation Account (entry 16, p. 166; the short answer on the partner’s loan, p. 184). Entry: Partner’s Loan A/c Dr — To Bank A/c.
• Loan to a partner on the assets side is recovered or repaid and never transferred to the Realisation Account (entry 13, p. 166; Illustration 8, pp. 178–179, shows it recovered through the Bank Account).
• Partner’s current accounts are closed by transfer to the respective capital accounts (Illustration 4, pp. 170–172).
• Accumulated profits, general reserve and workmen compensation reserve go to the partners in their profit sharing ratio, into their capital or current accounts — not to the Realisation Account (entry 14, p. 166; Illustration 4, p. 170).
• Fictitious assets and accumulated losses are written off against the partners in the profit sharing ratio (entry 15, p. 166).
• Unrecorded assets sold are credited to the Realisation Account; if a partner takes one over, his capital account is debited (pp. 165, 173).
• Unrecorded liabilities paid are debited to the Realisation Account (p. 166).
• Secured loans rank before unsecured loans inside the first application of assets (p. 159).

Worked Example 1: Simple Dissolution — Loss, Asset Taken Over, Partner Brings in Cash

Method: prepare the Realisation Account, then the partners’ capital accounts, then the Bank Account, and verify that every account balances.

Aarav and Bhavna share profits and losses in the ratio 3:2. Their balance sheet on March 31 was:

• Liabilities — Aarav’s capital Rs 60,000; Bhavna’s capital Rs 40,000; creditors Rs 30,000.
• Assets — bank Rs 10,000; debtors Rs 25,000; stock Rs 35,000; furniture Rs 20,000; machinery Rs 40,000.

The firm was dissolved. Debtors realised Rs 22,000; stock Rs 33,000; furniture Rs 18,000; Bhavna took over machinery at Rs 42,000; creditors were paid Rs 29,000; realisation expenses were Rs 1,500.

Method note: the profit or loss on realisation is always transferred in the profit sharing ratio, because it is the final trading result of the firm’s life (p. 160).

Worked Example 2: Partner’s Loan, Unrecorded Asset and Expenses Paid by a Partner

Method: the same three-account flow, with the special rules applied — the partner’s loan is paid directly, the unrecorded asset is credited to the Realisation Account, and the expenses paid by a partner are credited to her capital.

Karan and Leela share profits and losses in the ratio 3:2. Their balance sheet on March 31 was:

• Liabilities — Karan’s capital Rs 80,000; Leela’s capital Rs 40,000; Leela’s loan Rs 20,000; creditors Rs 50,000.
• Assets — bank Rs 15,000; debtors Rs 30,000; stock Rs 45,000; furniture Rs 25,000; machinery Rs 75,000.

On dissolution: machinery sold for Rs 72,000; debtors realised at 5 per cent discount (Rs 28,500); stock taken over by Karan at Rs 40,000; furniture sold for Rs 22,000; an unrecorded old computer sold for Rs 3,000; creditors settled at 2 per cent discount (Rs 49,000 paid); realisation expenses Rs 2,000 paid by Leela on the firm’s behalf; Leela’s loan repaid in full.

Note how the two discounts are captured inside the account: creditors were credited at Rs 50,000 but only Rs 49,000 left the bank, so the 2 per cent discount is automatically part of the balancing figure. The same logic hides the 5 per cent debtors discount — debtors were booked at Rs 30,000 but only Rs 28,500 came in.

Common Mistakes in Dissolution Questions, With Corrections

This misconception autopsy covers the wrong entries students actually write in dissolution questions, each paired with the correct treatment and the reason.

How to Write Complete Answers to This Chapter’s Questions

A checklist of what a complete answer to each type of question must contain. Six short answer questions, four long answer questions and a long numerical set close the chapter (NCERT, pp. 184–192).

• Difference questions (partnership vs firm; firm’s debts vs private debts; realisation vs revaluation) are best answered in table form — a point-wise comparison is complete only when every basis has an entry on both sides.
• Order of settlement (Section 48): give the complete ladder in sequence — losses first out of profits, then out of capital, then by the partners individually in the profit sharing ratio; assets applied to outsider debts (secured before unsecured), then partners’ loans proportionately, then capitals proportionately, then surplus in the profit sharing ratio. A complete answer includes both ladders.
• Partner’s loan question: answer both positions — (a) loan on the assets side (a loan by the firm to the partner) is recovered; (b) loan on the liabilities side (a loan from the partner to the firm) is paid directly after outside debts. State the entry for each.
• Unrecorded items: unrecorded assets are credited to the Realisation Account when sold, or the partner’s capital is debited when a partner takes them over; unrecorded liabilities, when paid, are debited to the Realisation Account.

For the realisation versus revaluation difference, the textbook raises the question but never tabulates the answer. This comparison gives a complete answer:

• Process of dissolution (long answer 1): structure the answer by stages — the decision to dissolve (any of the five modes), realisation of assets, payment of liabilities in the Section 48 order, settlement of the partners’ accounts, and closure of the books. Name the account or rule that handles each stage.
• Realisation Account (long answers 2 and 3): give the definition, the purpose, and the full two-sided format; define profit or loss on realisation and state its transfer in the profit sharing ratio (p. 160).
• Deficiency of creditors (long answer 4): answer with the treatment-of-losses ladder — losses, including deficiencies of capital, are paid first out of profits, next out of the capital of the partners, and lastly by the partners individually in the profit sharing ratio (p. 159).
• Numerical questions (pp. 185–192): follow one fixed structure — transfer entries for assets and liabilities, realisation transactions (sales, takeovers, payments, expenses), transfer of profit or loss to the capital accounts in the profit sharing ratio, then the capital accounts with final settlement, then the bank/cash account as the proof. If journal entries are asked, write narrations. Show working notes — for example, a discount on creditors must be computed and displayed. Validate by balancing the Bank Account: the aggregate payable to partners must equal the cash available (p. 166).

Revision Summary: The Chapter in One Look

1. Partnership vs firm — one-line contrast

Partnership dissolution changes the relationship; the business can continue. Firm dissolution ends the partnership between all partners and closes the business. Rule: dissolution of the firm always dissolves the partnership; dissolution of partnership need not dissolve the firm.

2. Section 48 — the two ladders (Our Little Company Survives)

Losses: profits → partners’ capital → partners individually in the profit sharing ratio. Assets: Outsiders (secured before unsecured) → Loans (proportionately) → Capital (proportionately) → Surplus in the profit sharing ratio.

3. Realisation Account — direction cheat sheet

• Debit side: assets transferred at book value; payment of liabilities; realisation expenses; unrecorded liabilities paid; liability taken over by a partner; profit transferred to partners (PSR).
• Credit side: external liabilities transferred; provision for doubtful debts; sale of assets (including unrecorded assets realised); assets taken over by partners; loss transferred to partners (PSR).

4. Partner-item quick reference

The NCERT closes the chapter with three summary points (p. 184): dissolution of a firm means the discontinuance of the partnership business and the end of economic relations between the partners — the firm realises all its assets, pays all its liabilities and closes its books; partnership dissolution on admission, retirement or death need not dissolve the firm; and the Realisation Account records the sale of assets and settlement of creditors, with the resulting profit or loss shared by the partners in their profit sharing ratio, after which the partners’ accounts are settled and the Cash or Bank Account is closed.

Frequently Asked Questions on Dissolution of Partnership Firm

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

Dissolution of partnership changes the relationship between partners — through admission, retirement, death, change in ratio, insolvency, completion of the venture or expiry of the period — while the firm may continue.

Dissolution of a firm, under Section 39 of the Indian Partnership Act 1932, is the dissolution of partnership between all the partners; the business closes, assets are sold, liabilities are paid and the books are closed (NCERT, p. 156).

Why is a partner’s loan not transferred to the Realisation Account?

Because a partner’s loan is an internal claim, not an outside liability. Under Section 48, the assets of the firm are applied first to third-party debts and then to partners’ loans proportionately, so the loan is paid directly — Partner’s Loan A/c Dr — To Bank A/c (entry 16, p. 166).

Transferring it to the Realisation Account would mix it with external liabilities and lose the priority the Act gives it.

What is the order of settlement of accounts when a firm is dissolved?

Section 48 lays down two orders. Losses — including deficiencies of capital — are met first out of profits, next out of partners’ capital, and lastly by the partners individually in the profit sharing ratio.

Assets are applied first to the firm’s debts to third parties (secured loans before unsecured), next to partners’ loans and advances proportionately, then to capitals proportionately, and any residue is divided in the profit sharing ratio (NCERT, p. 159).

On what grounds can a court order the dissolution of a firm?

At the suit of a partner, the court may dissolve a firm when a partner becomes insane; becomes permanently incapable of performing his duties; is guilty of misconduct likely to affect the business adversely; persistently commits breach of the partnership agreement; transfers the whole of his interest in the firm to a third party; when the business cannot be carried on except at a loss; or when the court regards dissolution as just and equitable (NCERT, p. 158).

Is a journal entry recorded when a creditor accepts an asset in full settlement of his dues?

No. When a creditor accepts an asset in full and final settlement of his account, no journal entry is recorded — the asset and the liability cancel each other out (entry 7, p. 165).

An entry is made only for the cash portion when the asset is accepted in part payment, or for the cash received from the creditor when the asset’s value exceeds the amount due.

What is the Garner vs Murray rule in the dissolution of a firm?

When a partner is unable to contribute towards the deficiency in his capital account (a final debit balance), he is treated as insolvent, and the sum not recoverable is a capital loss for the firm.

Under the Garner vs Murray principle, in the absence of an agreement to the contrary, the remaining solvent partners bear this loss in the ratio of their capitals as on the date of dissolution (NCERT, p. 160).

Reference: NCERT Class 12 Accountancy textbook, chapter Dissolution of Partnership Firm.