Accounting Treatment in Case of Dissolution : With the dissolution of firm normal business activity stops and process of realization of firm’s assets and payment of liabilities starts. 

To complete this process following accounts are prepared :

• Realization account
• Bank or cash account
• Partners’ capital account
• Other necessary accounts.

Realisation account is opened on the dissolution of a firm. The object of preparing this account is to determine gain (profit) or loss on the realisation of assets and payment of liabilities. 

Realisation account is prepared by:

• Transferring all assets except cash or bank account to the debit side of the account.
• Transferring all liabilities except partner’s loan account and partners’ capital account to the credit side of the account.
• Amount realised on sale of assets is credited to the account.
• Liabilities paid are debited to the account.
• Expenses incurred by the firm on dissolution are debited. Balance in the account is either profit or loss which is transferred to the capital account of the partners in their profit sharing ratio.

Account Entries Regarding Dissolution
(i) On Transfer of Assets (Except Bank or Cash Balance)
Realisation A/C
To Sundry Assets A/C
(Being balance of assets transferred)

(ii) On Transfer of Liabilities (Except Capital Account. Current Account, Reserve, P&L Account, Reserve Fund and Partners’ Loan Account) Sundry Liabilities A/c
To Realisation A/C
(Being balance of sundry liabilities transferred)

(iii) On Sale of Assets
Cash/Bank/A/C Dr.
To Realisation A/C
(Being cash realized from sale of assets)

(iv) On Taking Over Some Assets by a Partner
Partners Capital A/C Dr.
To Realisation A/C
(Being assets taken over by the partner)

(v) On Payment of Transferred Liabilities
Realisation A/c Dr.
To Cash/Bank A/C
(Being sundry liabilities paid off)

(vi) On Taking Responsibility of Payment of Any Liability by a Partner
Realisation A/C Dr.
To Partners’ Capital A/c
(Being liabilities taken over by the partners’)

(vii) On Payment of Unforeseen Liability or Dissolution Expenses
Realisation A/c Dr.
To Cash/Bank A/C
(Being expenses paid)

(viii) On Transfer of Credit Balance of (Profit) Realisation Account
Realisation A/C Dr.
To Partners’ Capital A/C
(Being profit transferred to capital Account)

(ix) Transfer of Debit Balance of (Loss) Realisation Account
Partners’ Capital A/C Dr.
To Realisation A/c
(Being loss transferred to capital Account)

(x) Expenses Paid by a Partner
Realisation A/C Dr.
To Partners’ Capital A/C
(Being expenses paid by partner)

(xi) On Bearing Any Realisation Expenses by a Partner as Realisation Agent.
Realisation A/c Dr.
To Partners’ Capital A/C
(Being commission allowed to partner)

[Note : Sometimes, liabilities are not transferred to realisation account. In such a case the liabilities are directly paid only profit loss if any arising out of it is transferred to realisation account. When such liabilities along with other liabilities which are not transferred to realisation account are paid and the following accounting entries are done in the following manner.]

(xii) On Payment of Liabilities over and Above the Book Value
Sundry Liabilities A/c Dr. (by book value)
Realisation A/C Dr. (by difference)
To Cash/Bank A/C (by amount paid)
(Being liabilities paid off and loss transferred)

(xiii) On Payment of Liabilities Below the Book Value Sundry
Liabilities A/c Dr. (by book value)
To Cash/Bank A/C (by amount paid)
To Realisation A/C (by difference amount)
(Being sundry liabilities paid off and profit transferred)

(xiv) On Payment of Partner’s Loan
Partner’s Loan A/c Dr. (by amount paid)
To Cash/Bank A/c
(Being loan paid off)

(xv) On Distribution of Old Undistributed Profit Dissolution is as follows
General Reserve A/C Dr.
Reserve Fund A/C Dr.
Profit and Loss A/C Dr.
To Partners’ Capital A/c
(Being undistributed profit transferred)

(xvi) On Distribution of Old Undistributed Loss
Partners’ Capital A/c Dr. (in profit sharing ratio)
To Profit and Loss A/C (by undistributed loss)
(Being undistributed loss transferred)

(xvii) On Bringing Cash by a Partner to Make up Deficiency of Capital
Cash/Bank A/C Dr. (by amount brought in)
To Partners’ Capital A/C
(Being cash brought by partners)

(xviii) On Payment of Capital Account Balance to Partners
Partners’ Capital A/C Dr. (by amount paid)
To Cash/Bank A/C
(Being balance of capital account paid)

[Note: Lastly, the balance in cash/bank is only as much as it is to be paid to the partners hence, with the last entry all accounts of the firm close automatically.]

Partners Capital Account: After the transfer of profit or loss on realisation, undistributed profit reserves etc. to the capital account of the partners, 

The balance of capital account are closed in the following manner :

1. When a partner is required to bring in cash to clear off his debit balance. The entry will be
Cash/Bank A/C Dr.
To Partners’ Capital A/C
(Being required cash brought in by the partner)

2. When a partner is paid the credit balance of his account
Partners’ Capital A/C Dr.
To Cash/Bank A/C
(Being excess cash paid to partner)

Cash or Bank Account:Opening balance of cash and bank and all the receipts are entered on the debit side of this account and all the payments are entered on the credit side of this account. This account must be prepared and closed last of all and the total of both the sides of this account must be equal. In this way this account also helps in the verification of the arithmetical accuracy of the account.

[Note: If cash balance and bank balance both are given in the balance sheet, only one account either a cash account or a bank account is prepared. If cash account is prepared an entry is passed for withdrawing the bank balance and if a bank account is prepared, the cash balance is deposited into the bank.]

Other Required Accounts : On the dissolution of firm, partner’s loan Account, partners current account, reserve and undistributed losses accounts are prepared and deficiency account in case of insolvency of all partners is also prepared.