UNIT 5

Accounting for Dissolution and Conversion

5.1 Accounting for Dissolution of the Partnership firm including Insolvency of partners

Dissolution of partnership changes the existing relationship between partners but the firm may continue its business as before. The dissolution of partnership may take place in any of the following ways:

1. Change in existing profit sharing ratio among partners;
2. Admission of a new partner;
3. Retirement of a partner;
4. Death of a partner;
5. Insolvency of a partner;
6. Completion of the venture, if partnership is formed for that; and
7. Expiry of the period of partnership, if partnership is for a specific period of time;

Dissolution on Account of Insolvency of Partners

When one or more partner become insolvent the firm normally dissolves. Dissolution on account of insolvency will be discussed under two sub-heads: (1) When one of the partners is insolvent and (2) When all the partners are insolvent. The accounting treatment in certain respects will be different under the two

Before we understand the two aspects, lets discuss simple dissolution

Simple dissolution means that the partners have decided to dissolve the firm in normal course and all the partners are solvent and the firm has not been sold to a Joint Stock Company.

Under simple dissolution for cash the assets will be disposed off in the market although one or two items of assets may also be taken over by a partner and the liabilities will be paid off and books closed. The journal entries required to close the books under simple dissolution are as follows:

1. All the marketable assets except cash in hand, bank balance, debit balance of profit and loss account and debit balance of partners' capital or current accounts shall be transferred to the Realisation Account at book values.

Realisation A/c Dr. With the total amount

To Bills Receivable

To Debtors (Gross Figure)

To Stock

To Prepaid Expenses

To Investments

To Furniture

To Plant & Machinery

To Land & Buildings

To Patents, Licences, Trade Marks, etc.

To Goodwill (it is a marketable asset and not fictitious)

2.     All the outside liabilities including the claims of relatives of the partners and

 the Provision for Doubtful Debts to be transferred to the credit side of

 Realisation Account.

3.     For the disposal of the assets the entries may be made as follows depending on the mode of disposal:

If the assets are sold for cash, the amount so realised should be debited to Cash or Bank Account and Realisation Account should be credited.

If any asset is taken over by a partner at an agreed value the partner should be debited instead of cash and Realisation Account to be credited:

If there is an unrecorded asset (like furniture completely written off in accounts but which is still in use and can be marketed), the entry for its sale will be made and no entry is required for bringing it into account books. The entry will be:

Cash A/c Dr. With the realised value

To Realisation A/c

4.     For the discharge of outside liabilities Realisation A/c should be debited and the relevant account to be credited depending upon the mode of discharge:

If cash is paid to discharge the claim, Realisation Account is debited and Cash Account is credited:

Realisation A/c Dr. With the amount actually.

To Cash A/c

 If a partner takes over the responsibility of discharging a liability, such partner's capital account should be credited instead of cash

Realisation A/c Dr.

To Partner's Capital A/c

 If there is an unrecorded liability, it will also have to be paid off and the entry will be: Realisation A/c Dr. With the amount actually

To Cash A/c paid

5.     The realisation winding up expenses, if any, incurred in the course of dissolution should be debited to Realisation Account and the entry will be:

Realisation A/c Dr.

To Cash A/c

In case the realisation expenses are paid by the partner or the partners is entrusted with the job of winding up, the entry will be

Realisation A/c Dr.

To Partner's Capital AJc

6.     Loans advanced by partners as distinguished from their capital accounts should be paid and the entry will be:

Parnter's Loan A/c Dr.

To Cash A/c

7.     All accumulated profits (standing in the name of Reserve Fund, General Reserve, Profit and Loss Account credit balance etc.) and all accumulated losses (standing in the name of profit and loss debit balance) should be transferred to the partners' capital accounts in the profit sharing ratio as follows:

If there is accumulated Profit:

Reserve Fund Dr. As

General reserve Dr.

Profit and Loss A/c Dr.

To Partners' Capital A/cs

b) If there is accumulated loss:

Partners' Capital A/cs Dr. Individually

To Profit and Loss A/c

Dissolution of accounts of insolvency partner

The procedure for closing the books under insolvency is almost the same as under simple dissolution i.e. marketable assets and external liabilities are transferred to a newly opened Realisation Account and they are realised and paid off through the same account and the loss or profit on realisation transferred to the capital accounts of the partners. The capital account of the partners are kept on fixed basis or fluctuating basis.

Fixed and Fluctuating Capitals: each partner will have two accounts- one capital account and the other a current account, if the capital accounts of the partners are kept on fixed basis,.'Under capital account of each partner will show a fixed balance year after year. All entries relating to drawings, profit or loss, interest on capital or drawings etc. will be made in the current account of each partner. The current account of a partner may show a debit balance or a credit balance but the capital account of each partner will show the same fixed credit balance year after year. Hence the deficiency of the insolvent partner will be borne by the solvent partners in the ratio of their fixed capitals.

There will be only one capital account, If the capital accounts of partners are kept on fluctuating basis. Interest on capital or drawings are made in the capital account. Thus, the balance in the capital accounts of each partner will fluctuate every year and every time an entry is made. Under such situation, the deficiency of the insolvent partner will be borne by the solvent partners in the ratio of their capitals as on the date of insolvency. This means that all the accumulated profits or losses should first be divided among all the partners in their profit sharing ratios which will make the capital accounts of the partners as on the date of insolvency.

When one of the Partners is Insolvent

The entries in the preparation of Realisation Account and the transfer of realisation profit or loss to the partners capital accounts will be the same as under simple dissolution, When a partner becomes insolvent and the books are to be closed,. Then depending on whether the capital accounts are kept on fixed basis or fluctuating basis, the debit balance in the capital account of the insolvent partner after adjusting any cash brought in by him (known as the deficiency of the insolvent partner) shall be divided among the solvent partners in the capital ratio as explained above

When All the Partners are Insolvent

When all the partners become insolvent, the unsecured creditors cannot be paid in full as the amount available will not be sufficient to pay them in full. Hence, the unsecured creditors should not be transferred to the Realisation Account but only the marketable creditors which can be paid in full out of the sale proceeds of the asset pledged against may be transferred to; the Realisation Account. The assets shall be realised and the secured creditors paid through the Realisation Account and in their profit sharing ratio as usual the realisation profit or loss transferred to the capital accounts of all the partners. It will be debited to Cash Account and credited to the partner's capital account, if anything is recovered from the private estate of any partner. Thereafter, the total amount of cash available will be paid to the unsecured creditors. The unpaid balance in the unsecured creditors account shall then be transferred to a newly opened Deficiency Account. Similarly, the debit or credit balance in the partners' capital accounts shall also be transferred to the Deficiency Account. Thus all the accounts will be closed.

Key takeaways

1. The procedure for closing the books under insolvency is almost the same as under simple dissolution
2. Simple dissolution means that the partners have decided to dissolve the firm in normal course and all the partners are solvent and the firm has not been sold to a Joint Stock Company

5.2 Conversion of a partnership firm into joint stock company and piecemeal distribution.

Meaning:

To avail the facilities and advantages available to joint stock companies under Companies Act 1956, some partnership firms convert themselves into company. A company is formed to purchase the business of the firm. The purchase consideration is discharged by the company in the agreed mode. The shares and debentures received in the payment of purchase consideration are divided amongst partners. The partners become the shareholders of the company. Thus the firm is dissolved and a new company comes into being. The following are the two major advantages of conversion:

1. Number of members can exceed 20.

2. Member’s liabilities become limited.

Purchase Consideration

Meaning:

The value paid by the company to the firm for taking over the business of the firm is called purchase consideration which can be calculated by the following methods:

1. Lumpsum method – Here the purchase price is clearly given in the question
2. Net Payment method – Here the purchase price is the total of all the payments given by the company to the firm in discharge of purchase consideration.
3. Net Assets Method – In this method the purchase price is calculated by the following formula: Purchase consideration = Assets taken over at agreed values-Liabilities taken over at agreed values.

The following points should be considered while calculating purchase consideration:

1. Only those assets will be considered which are taken over by the company. The agreed values of such assets are added.

2. Only those liabilities are considered which are assumed by the company. The agreed values of such liabilities are deducted.

3. Normally cash and bank balance are included in purchase price but if they are not taken over, they will be ignored. Goodwill and prepaid expenses are also included in the assets taken over.

4. Fictitious assets and debit balance of P & L account are never included in the assets.

5. If it is given that business is taken over it means assets as well as liabilities both are taken over.

But if it is given that asset are taken over then only assets are considered and liabilities are ignored.

Distribution of purchase price amongst partners

The shares and debentures received from the company are divided amongst the partners in their final capital ratio. According to some author these are divided in the profit sharing ratio also. For this purpose if any ratio is given in the agreement of the partnership deed, it should be followed.

Accounting treatment

Entries in the books of vendor firm

The following entries are passed to close the books of vendor firm:

1. Transfer of assets to realisation account:

Realisation A/c Dr.

To Assets (individually) A/c

(Being assets transferred)

The following points must be remembered while passing this entry:

• All the assets whether or not taken over by the company are transferred to realisation account at book value.
• Cash and bank balance are transferred to realisation account only when they too are taken over by the company along with the other assets.
• Fictitious assets such as debit balance of P & L account and other unwritten off expenses are not transferred to realisation account. They are debited to partners’ capital account in their profit sharing ratio.
• Goodwill and other intangible assets such as prepaid expenses, trademarks, patent etc. are also debited to realisaion account.
• If any provision is made against any assets the gross value of the assets is debited to realisation account and the provisions are credited to realisation account:

2. Transfer of liabilities to realisation account:

Liabilities (individually) A/c Dr.

To Realisation A/c

(Being Liabilities transferred)

Note: All the liabilities whether or not taken over by the, company are transferred to realization account with the exception of reserves and surplus, Capital and current accounts of partners.

3. For purchase consideration

Purchasing Company Dr.

To Realisation A/c

(For purchase consideration due.)

4. On receipts of purchase price

Cash/Bank A/c Dr.

Shares in purchasing co. A/c Dr.

To Purchasing company

(For purchase consideration received)

5. Realisation of assets not taken by company :

Bank A/c Dr.

To Realisation A/c

(For cash recovered on sales of assets)

6. Payment of Liabilities not assumed by the company:

Realisation A/c Dr.

To Bank A/c

(Being payment made)

7. Realisation expenses (if borne by the firm)

Realisation A/c Dr.

To Bank A/c

(For payment of expenses of liquidation)

Note: If realisation expenses are borne by the company no entry is passed.

8. Payment of contingent liability:

Realisation A/c Dr.

To Bank A/c

(For the payment of contingent liabilities)

9. Profit on realization:

Realisation A/c Dr.

To Partner's Capital A/c

(For profit on realisation transferred to partner's capital a/c)

10. Loss on realisation :

Partners' Capital A/c Dr.

To Realisation A/c

(For loss on realisation transferred)

11. Payment to partners:

Partner's Capital A/c Dr.

To Bank A/c

To Shares in purchasing co.

(For cash and shares distributed amongst partners).

Entries in the books of purchasing company

1. For Purchase consideration:

Business Purchase A/c Dr.

To Vendor's firm A/c

(For purchase consideration becoming due.)

2. For assets and liabilities taken over:

3. For discharge of purchase price:

Vendor firm A/c Dr.

To Share Capital A/c

To Bank A/c

(Being payment made)

4. For bearing realisation expenses of Vendor:

Goodwill A/c or Capital Reserve A/c Dr.

To Bank

5. for formation expenses:

Preliminary Expenses A/c Dr.

To Bank A/C

Piecemeal distribution

It has been presumed so far that all the assets are realized on the date of dissolution and all the liabilities are also simultaneously discharged on the same day itself. But usually this is not true in practice. In actual practice, assets are realised gradually and liabilities are paid gradually depending upon the amount realised from the sale of assets. Therefore, the realization loss or profit can be ascertained only after the realization of all assets and payment of all liabilities. Available cash is used in the following order:

1. Payment of realisation expenses or a provision is made for realisation expenses.
2. Payment of outside liabilities i.e., bank loan, sundry creditors, bills payable, outstanding expenses etc. It must be noted here that a secured creditor has priority whenever an asset provided by way of security to the concerned creditor is realised. After satisfying the claim of the secured creditor the surplus, if any, is paid to unsecured creditors. Amount realised from an asset which is not charged or mortgaged is used to pay all the creditors, whether secured or unsecured in the ratio of their claims.
3. Payment of partners' loan in the ratio of their respective loans.
4. Payment of partners capitals.

If there is any contingent liability an account of bills discounted, a provision should be made in the beginning for the same and when provision is no longer required, the amount should be distributed.

Key takeaways

1. The shares and debentures received from the company are divided amongst the partners in their final capital ratio.
2. Payment of realisation expenses or a provision is made for realisation expenses.
3. Purchase consideration = Assets taken over at agreed values-Liabilities taken over at agreed values

References

1. Gupta R.L. and Radhaswamy. M, Sultan chand & Sons, New Delhi.
2. Shukla M. C. Grewal T. S and Gupta S.C., S. Chand & Sons. New Delhi.
3. Shukla S. M., Sahitya Bhawan Publication, Agra.
4. Murti Guru Prasad, Himalaya Publishing House, Mumbai.
5. Jain and Narang, Kalyani Publisher, New Delhi.
6. S. N. Maheswari, Vikas Publishing House, New Delhi.
7. Sharma and Gupta, RBD Publishing House, Jaipur.
8. Khatik S. K., Jitendra Saxena K, Extol Publication, Bhopal.
9. Gangwar Sharda, Himalaya Publishing House, Agra.